Attached files

file filename
EX-23.1 - CONSENT OF MOSS ADAMS LLP - INTERNATIONAL ABSORBENTS INCiax_ex231.htm
EX-32.1 - CERTIFICATION - INTERNATIONAL ABSORBENTS INCiax_ex321.htm
EX-31.1 - CERTIFICATION - INTERNATIONAL ABSORBENTS INCiax_ex311.htm
EX-32.2 - CERTIFICATION - INTERNATIONAL ABSORBENTS INCiax_ex322.htm
EX-31.2 - CERTIFICATION - INTERNATIONAL ABSORBENTS INCiax_ex312.htm
EX-21.1 - SUBSIDIARIES OF THE REGISTRANT - INTERNATIONAL ABSORBENTS INCiax_ex211.htm
EX-10.5.5 - WRITTEN SUMMARY OF VERBAL AMENDMENT - INTERNATIONAL ABSORBENTS INCiax_ex1055.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-K

(Mark One)
 
þ
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
   
For the fiscal year ended January 31, 2010
   
OR
   
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 
For the transition period from ____________ to ____________              
 
Commission file number:  1-31642
 
 
 INTERNATIONAL ABSORBENTS INC.
(Exact name of registrant as specified in its charter)
 
British Columbia, Canada
 
98-0487410
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
 
1569 Dempsey Road
North Vancouver, British Columbia Canada
 
V7K 1S8
(Address of principal executive offices)
 
(Zip Code)

(604) 681-6181
(Registrant’s telephone number, including area code)
 
Securities registered pursuant to Section 12(b) of the Act:
 
Title of each class
 
Name of each exchange on which registered
Common Shares, no par value per share
 
NYSE Amex LLC
 
Securities registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes o No  þ
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes o No  þ
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.   Yes þ No  o
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  þ
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
Large accelerated filer  o Accelerated filer   o
Non-accelerated filer
(Do not check if a smaller reporting company)
 o Smaller reporting company   þ
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes o No  þ
 
Aggregate market value of the voting and non-voting common equity held by non-affiliates of the registrant as of July 31, 2009, based upon the closing price of the common stock as reported by NYSE Amex on such date, was approximately $17,579,037.

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

Class
 
Outstanding at April 18, 2010
Common Shares, no par value per share
 
6,410,282 shares

DOCUMENTS INCORPORATED BY REFERENCE

None
 
 


 
 

 

INTERNATIONAL ABSORBENTS INC.
Annual Report on Form 10-K
For the Fiscal Year Ended January 31, 2010
 
TABLE OF CONTENTS
 
 
Item Number       Page Number  
    PART I      
           
1.   Business      1  
1A.   Risk Factors      8  
1B.   Unresolved Staff Comments      15  
2.   Properties      15  
3.   Legal Proceedings      15  
4.  
(Removed and Reserved) 
    15  
             
    PART II        
             
5.  
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
    16  
6.  
Selected Financial Data 
    17  
7.  
Management's Discussion and Analysis of Financial Condition and Results of Operations 
    18  
7A.  
Quantitative and Qualitative Disclosures About Market Risk 
    26  
8.  
Financial Statements and Supplementary Data 
    27  
9.  
Changes in and Disagreements With Accountants on Accounting and Financial Disclosure 
    49  
9A(T).  
Controls and Procedures
    49  
9B  
Other Information 
    49  
             
   
PART III
       
             
10.  
Directors, Executive Officers and Corporate Governance 
    50  
11.  
Executive Compensation 
    55  
12.  
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
    67  
13.  
Certain Relationships and Related Transactions, and Director Independence 
    69  
14.  
Principal Accounting Fees and Services 
    71  
             
    PART IV        
             
15.  
Exhibits, Financial Statement Schedules 
    75  
SIGNATURES     74  
EXHIBIT INDEX     76  
 
 Unless otherwise indicated, all dollar amounts in this report are U.S. dollars.
 
 
 

 

PART I

ITEM 1.  BUSINESS

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

As more fully described in our definitive proxy statement filed with the Securities and Exchange Commission (the “SEC”) on April 16, 2010 (the “Proxy Statement”), on December 14, 2009, International Absorbents entered into an Arrangement Agreement (the “Arrangement Agreement”) with IAX Acquisition Corporation, a Delaware corporation (“Parent”), and IAX Canada Acquisition Company Inc., a corporation incorporated under the laws of the Province of British Columbia (“Canada Sub”) and a wholly-owned subsidiary of Parent. The Arrangement Agreement provides that, upon the terms and subject to the conditions set forth in the Arrangement Agreement, Parent, through its wholly-owned subsidiary, will acquire all of the outstanding common shares of International Absorbents for $4.75 per common share in cash, with International Absorbents continuing as the surviving corporation (the “Arrangement”). As a result of the Arrangement, International Absorbents will become a wholly-owned subsidiary of Parent. The consummation of the Arrangement is subject to various closing conditions, including obtaining the approval of the Arrangement by our shareholders and the Supreme Court of British Columbia.  The Arrangement Agreement contains certain termination rights for International Absorbents, Parent and Canada Sub and further provides that, upon termination of the Arrangement Agreement under specified circumstances, International Absorbents may be required to pay Parent a termination fee of 4% of the aggregate purchase price.  Our board of directors and the board of directors of Parent have approved the Arrangement Agreement.  In addition, concurrently with the execution of the Arrangement Agreement, certain of our executive officers, who together hold approximately 11.2% of our issued and outstanding common shares, have entered into a support agreement whereby they agreed, among other things, to vote all common shares held by them in favor of the approval of the Arrangement. 

This Annual Report on Form 10-K may be deemed to be solicitation material in respect of the proposed Arrangement.  The Proxy Statement contains important information about the Arrangement and related matters.  INVESTORS AND SHAREHOLDERS ARE URGED TO READ THE PROXY STATEMENT CAREFULLY.  Investors and shareholders are able to obtain free copies of the Proxy Statement and other documents filed with the SEC by us through the web site maintained by the SEC at www.sec.gov.  In addition, investors and shareholders may obtain free copies of the Proxy Statement and other documents filed with the SEC from us by contacting David Thompson, Corporate Secretary, by telephone at (604)681-6181, or by mail at International Absorbents Inc., Investor Relations, 1569 Dempsey Road, North Vancouver, British Columbia V7K 1S8 Canada.

We and our directors and executive officers may be deemed to be participants in the solicitation of proxies from our shareholders in connection with the Arrangement.  Information regarding the interests of these directors and executive officers in the Arrangement is included in the Proxy Statement.  Additional information regarding these directors and executive officers is also included in this Annual Report in Part III.
 
FORWARD-LOOKING STATEMENTS

This Annual Report and the documents incorporated herein by reference contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”) based on current expectations, estimates and projections about our industry and our management’s beliefs and assumptions.  They can be identified by the use of forward-looking words such as “believes,” “expects,” “plans,” “may,” “will,” “would,” “could,” “should” or “anticipates” or other comparable words, or by discussions of strategy, plans or goals that involve risks and uncertainties that could cause actual results to differ materially from those currently anticipated. You are cautioned that any forward-looking statements are not guarantees of future performance and involve risks and uncertainties, including those set forth below under “Item 1A-Risk Factors” and as described from time to time in our reports filed with the SEC, including this Annual Report on Form 10-K and our Quarterly Reports on Form 10-Q.  Such forward-looking statements include, but are not limited to, statements with respect to the following:
 
 
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    ·      
our future growth strategies and prospects for the future;
    ·      
the proposed Arrangement between International Absorbents, Parent and Canada Sub;
    ·      
potential financial results, including anticipated revenue and gross profits;
    ·      
projected benefits from our ongoing efforts to improve our infrastructure and production facilities;
    ·      
the impact of economic conditions on our financial condition, consumer preferences and ability to remain competitive;
    ·      
our ability to control expenses and improve operating efficiencies;
    ·      
our market and product line growth and ability to enter new markets;
    ·      
our ability to introduce new products and remain competitive; and
    ·      
our competitiveness and profitability as a result of consumer preferences and sales and marketing programs.

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

General

International Absorbents is the parent company of its wholly owned U.S. subsidiary, Absorption.  Absorption accounts for almost all of the consolidated entity’s assets and annual sales revenue.  As such, International Absorbents is the holding company and Absorption is its operating entity.  There are no other subsidiaries of International Absorbents.
 
Absorption is engaged in developing, manufacturing and marketing a wide range of animal care and industrial cleanup absorbent products made from off-specification and reclaimed cellulose fibers.  International Absorbents was incorporated on May 13, 1983 under the laws of British Columbia, Canada under the name West-Norse Resources Ltd, and changed its name to Absorptive Technologies Inc. in 1986 and to International Absorbents Inc. in 1999.  Absorption was incorporated on July 25, 1985 in the State of Nevada.
 
Absorption is a leading manufacturer and seller of premium small animal bedding in North America. The primary product that we sell in this market is small animal bedding sold under the brand name CareFRESH®.  We consider the activities that surround the manufacture and distribution of CareFRESH® to be our core business.  We have also expanded the animal care segment of our business by the addition of new sales channels and the introduction of animal food.

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

Business Strategy

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

Our business strategy is to promote and grow our core business and to create diversification in our market channels, our production methods, and our product lines in an effort to add strength and breadth to our business structure.  As a result, we continue to dedicate resources to improving our infrastructure for the support of our core business and creating more product and customer diversification.  We believe that this strategy continues to provide results.  Specifically, we continue to grow sales in our core business and improve the production process of our core CareFRESH® product while expanding sales of new products and existing products in new market channels.

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

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

Our leading product is small animal bedding made from cellulose fiber. It is used as a substrate for rodents, rabbits, reptiles and hand-fed exotic birds instead of wood shavings, hardwood chips or corn cobs. We believe that our product is superior to traditional bedding materials because it is better able to control and contain animal waste odors.  We are a significant bedding supplier to major pet store chains and to independent pet stores through the use of a wide North American network of wholesale distributors.  The bedding is also widely used by universities and research facilities.  We market our animal bedding under the CareFRESH®, CareFRESH® Colors™ and CareFRESH® Ultra™ brands of small animal bedding in the pet specialty channel.  CareFRESH® Colors is our colored bedding offering and CareFRESH® Ultra is our white small animal bedding.  Both are premium line extensions to our core product, CareFRESH®.  We also distribute our small animal pet bedding under the brands Healthy Pet™ and Critter Care™ in the grocery and/or mass merchandiser distribution channels.

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

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

Through our joint marketing alliance with Supreme Petfoods Ltd, a privately held British firm, we distribute a premium line of small animal food products to pet stores across North America under such brand names as Russel Rabbit™, Gerty Guinea Pig™ and Reggie Rat™ brand premium diets.  In addition, during fiscal year 2010, we introduced a proprietary line of small animal foods branded CareFRESH® Complete™.

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

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

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

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

Markets

A majority of our animal care products are sold in the pet specialty channel, through wholesale distributors throughout North America, and to two major pet supply retailers and one major general merchandise retailer, which are our three largest customers as described below under “Risk Factors.”  Competition for the small animal bedding business comes primarily from regional suppliers of wood shavings and major small animal food/bird seed manufacturers who sell wood shavings and corncob bedding as product line extensions.  These food manufacturers offer distributors and retailers the advantage of a single source supply, cross marketing opportunities between food and bedding and, in some cases, strong brand recognition within the pet specialty channel.  While we believe no other company currently has a product that performs as well as our proprietary flagship product, the success of our product has led to the entry of additional competitors in the cellulose bedding category.
 
 
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The consolidation of the pet retail business that began over 10 years ago has expanded in recent years to the distributor level. This means that there are fewer, but larger, customers for our products.  We believe that the logistical requirements of serving these larger customers are a barrier to entry into the market for many smaller companies.  However, the larger customers frequently seek supply partners with more than one product line in order to reduce supply chain costs and to be able to deal with fewer suppliers. Manufacturers are being consolidated as well, primarily by private equity firms and two public companies.  We will continue to expand our product offerings in order to take advantage of our existing relationships with major customers and the wholesale distributor network we have established.  We estimate that we have product in 80% of the pet specialty stores in North America and enjoy a market share of approximately 30% in the pet specialty channel for our flagship CareFRESH® brand.

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

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

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

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

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

Industry, Market Trends, and Competition

Based on information in trade publications, feedback received during our participation in trade and professional associations and communications with our customers and suppliers, we believe that over the past several years trends have resulted in changes in the markets that we serve.  As discussed below, our products and distribution methods are designed to respond to changes in demand resulting from these trends. We do not yet have enough information to determine how the ongoing economic downturn will impact trends discussed below or how it may affect demand for our products or our ability to maintain our current pricing strategy.
 
 
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Our primary small animal care product, CareFRESH®, which is made from cellulose fibers, has become a product leader in its market segment.  We believe that, until recently, our product’s success in the market segment caused a change in consumer buying habits away from the traditional wood shavings products and into cellulose fiber products.  However, the current economic uncertainties have at least temporarily reversed this trend.  As a result, we believe that some price-sensitive consumers have made the financial decision to purchase competing products that do not perform as well as CareFRESH® but are less expensive than our products.  We anticipate that as the economy improves this recent trend will once again reverse.  However, we are currently in the process of developing new products to address the price-sensitive consumer.

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

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

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

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

Raw Materials

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

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

Other raw materials used in the production of our products include chemical binders which are readily available from several suppliers.  We believe that the loss of one or two of our suppliers would not have a significant effect on our operations.  The loss of any supplier may cause an increase in freight costs, the amount of which would depend on the distance to the alternative source.  Our operations could be adversely affected if a general shortage of raw material were to occur and persist.  To date, we have not experienced any serious production delays because raw materials were unavailable.
 
 
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Marketing and Distribution
 
Manufacturing, marketing and distribution activities are carried out by Absorption and its wholesale distributors. During fiscal year 2010 we increased our investment in sales and marketing in an effort to increase distribution efficiencies, increase market share and launch new products.
 
Our products are sold through multiple wholesale distributions and direct buying retailers throughout North America. In addition our products are sold in markets in Canada, Great Britain, Belgium, Australia, Singapore, Japan, Taiwan, South Korea, Greece, France, Denmark, Israel and China.
 
Research and Development

Current research and development activities include refining existing products, as well as developing new pet products and related manufacturing processes for both the animal care industry and industrial cleanup markets.  Our research and development department also analyzes and tests the competitive products to determine new applications for our existing products.  Research and development expenses were $5,000 during both fiscal years 2010 and 2009.

Intellectual Property

In general, we attempt to protect our intellectual property rights through patent, copyright, trademark and trade secret laws and contractual arrangements.  Absorption has been issued three U.S. patents, of which one remains current and two have expired, and has one pending patent relating to various degradable particulate absorbent materials and our manufacturing process.  However, there can be no assurance that our efforts will be effective to prevent misappropriation of our technology, or to prevent the development and design by others of products or technologies similar to or competitive with those developed by us.  Moreover, upon expiration of our issued patent, our competitors will have the ability to develop products that are currently protected by this patent.

Number of Employees

As of March 31, 2010, we had 117 employees, of which 112 were full-time employees and none of which were represented by labor unions.  In addition, we employ a small number of temporary employees and contractors to provide management, administration, manufacturing, and marketing services.
 
 
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Product Liability

We design and manufacture most of our standard products and expect that we will continue to do so in the foreseeable future. As a result, we believe that we are able to manage the design process and help minimize product liability risks. In addition we employ engineers and designers to design and test our products under development and maintain a quality control system in an ongoing effort to decrease defects in our products.

Environmental and Other Governmental Regulations

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

All our filings with the SEC, including our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on form 8-K and amendments to those reports, filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, are available free of charge on our internet website, www.internationalabsorbents.com.  Reports are posted as soon as reasonably practicable after such material is filed with, or furnished to, the SEC. They can be found through the investor relations section under the “SEC Filings” tab on our website.
 
 
7

 
 
ITEM 1A.  RISK FACTORS

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

The announcement and pendency of our proposed Arrangement and intensifying competition from our competitors have had, and could continue to have, an adverse effect on our business.

On December 14, 2009, we entered into the Arrangement Agreement which provides that, upon the terms and subject to the conditions set forth in the Arrangement Agreement, Parent, through its wholly-owned subsidiary, will acquire all of the outstanding common shares of International Absorbents for $4.75 per common share in cash, with International Absorbents continuing as the surviving corporation (the “Arrangement”). As a result of the Arrangement, International Absorbents will become a wholly-owned subsidiary of Parent. The consummation of the Arrangement is subject to various closing conditions, including obtaining the approval of the Arrangement by our shareholders and the Supreme Court of British Columbia.

The announcement and pendency of the Arrangement may be having an adverse effect our business. Revenues and profitability may be adversely affected by customers’ and employee uncertainty and other disruptions as well as intensified competition from our competitors as they attempt to take advantage of the uncertainties. In addition, we have incurred legal and other expenses in connection with the pending Arrangement which has adversely affected profitability. All of these factors are likely to continue to adversely affect our business and have an adverse effect on our financial condition or results of operations.

Under the terms of the Arrangement Agreement, we have agreed to operate our business in the ordinary course consistent with past practice, as well as to refrain from taking certain actions in the conduct of our business without Parent’s prior written consent until the consummation of the Arrangement.  Actions that may require Parent’s consent include, but are not limited to, new indebtedness, capital expenditures, loans and investments, manufacturing and customer agreements, acquisitions, issuance of securities, and the repurchase of shares of the Company’s common stock. These restrictions could adversely affect our business and have an adverse affect on our financial condition or results of operations.

The failure to complete the proposed Arrangement could adversely affect our business.

There is no assurance that the proposed Arrangement or any other transaction will occur. If the proposed Arrangement or a similar transaction is not completed, the share price of our common shares may drop to the extent that the current market price of our common shares reflects an assumption that a transaction will be completed. In addition, upon termination of the Arrangement Agreement under specified circumstances, we may be required to pay Parent a termination fee of 4% of the aggregate purchase price.  Further, a failed transaction may result in negative publicity and a negative impression of us in the investment community. Finally, any disruptions to our business resulting from the announcement and pendency of the Arrangement and from intensifying competition from our competitors, including any adverse changes in our relationships with our customers, vendors and employees, could continue or accelerate in the event of a failed transaction.  There can be no assurance that our business, these relationships or our financial condition will not be adversely affected, as compared to the condition prior to the announcement of the Arrangement, if the Arrangement is not consummated.

We continue to work to build our market presence and are subject to substantial competition that could inhibit our ability to succeed as planned.

We are one of many companies that compete in the animal care market.  We continue to build and maintain our market presence as we compete with both domestic and foreign companies.  Any reputation that we may successfully gain with retailers for quality product does not necessarily translate into name recognition or increased market share with the end consumer.  Our products may not be well received by pet owners, or other companies may surpass us in product innovations. Any failure to continue to gain consumer awareness and market share could decrease our revenues and have an adverse effect on our financial results.
 
 
8

 

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

Any material decline in the amount of consumer spending could reduce our sales.  In addition, our premium products are generally priced higher than our competitors’ products, and in an economic downturn, consumers may elect to purchase lower-priced products.  In fact, we believe that as a result of current economic uncertainties, some price-sensitive consumers have made the financial decision to purchase competing products that do not perform as well as CareFRESH® but are less expensive than our products.  We believe this trend has resulted in decreased sales and to the extent such trend continues, it could further reduce our sales and/or force us to lower our prices, which could reduce profitability, and, in each case, harm our business. The success of our business depends in part on our ability to identify and respond to evolving trends in demographics and consumer preferences. Failure to timely identify or effectively respond to changing consumer tastes, preferences, spending patterns and animal care needs could adversely affect our relationship with our customers, the demand for our products and services, our market share and our profitability.
 
We depend on a few customers for a significant portion of our business.

Our three largest customers accounted for approximately 26%, 20% and 12% of our net sales in fiscal year 2010, while the same customers accounted for approximately 26%, 23% and 10%, respectively, of our net sales in fiscal year 2009.  We are dependent on these customers to maintain our financial condition and to generate forecasted operating results.

Any material deterioration in the financial condition of one of our major customers could have a material adverse effect on our sales, profitability and cash flow.  The loss of, or reduction in, orders from any significant customer, losses arising from customer disputes regarding shipments, fees, merchandise condition or related matters, or our inability to collect accounts receivable from any major customer could reduce our income from operations and cash flow.  These risks are heightened as a result of the ongoing global economic uncertainties.

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

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

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

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

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

We operate in highly competitive industries, which have experienced increased consolidation in recent years.  We compete against numerous other companies, some of which are more established in their industries and have substantially greater revenue or resources than we do.  Our products compete against national and regional products and private label products produced by various suppliers.  To compete effectively, among other things, we must:
 
 
9

 

    ·      
maintain our relationships with key retailers and distributors;
    ·      
develop and grow brands that are attractive to consumers and gain market share;
    ·      
continually develop innovative new products that appeal to consumers;
    ·      
maintain strict quality standards; and
    ·      
deliver products on a reliable basis at competitive prices.

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

Increases in our costs of goods sold, including the costs of raw materials, transportation costs or labor expenses, or inefficiencies at our production facilities could have an adverse effect on our financial condition.

Our business places heavy reliance on raw materials being readily available.  Although we believe that there are a number of pulp and paper mills in British Columbia, Canada, the State of Washington, the State of Georgia, and the State of Florida that can provide us with the raw materials necessary to conduct our business, any significant decreases in supplies, or any increase in costs or a greater increase in delivery costs for these materials, could result in a decrease in our margins, which would harm our financial condition. Although we believe we will be able to obtain the required material in the region, any significant shortfall of material would result in a significant increase in the cost of producing our primary products.

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

In addition, during fiscal year 2010, our production facility in Jesup, Georgia continued to experience operational inconsistencies, and both of our production facilities faced challenges that directly affected their production costs.  These challenges included increased energy costs, materials cost, ongoing maintenance costs associated with achieving a high rate of product quality and production efficiencies, and high freight cost during the last half of the year.  To the extent that these inconsistencies and/or challenges continue, our business, results of operations and financial condition could be adversely impacted.
 
Rising energy prices could adversely affect our operating results.
 
In the last few years, energy prices have periodically risen dramatically, including the cost of natural gas, which has resulted in increased fuel costs for our businesses and raw materials costs for our branded products.  Moreover, while we have installed new burners at our facilities to heat our dryers, due to the prevalence of high energy costs throughout the county, there is now a higher demand and a resulting shortage of the materials necessary to fuel these burners.  Rising energy prices could adversely affect consumer spending and demand for our products and increase our operating costs, both of which would reduce our sales and operating income.

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

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

If we do not obtain all material licenses and permits required by government, we may be subject to regulatory action by government authorities.  Moreover, if our policies and procedures do not comply in all respects with existing laws and regulations, our activities may violate such laws and regulations.  Even if our policies and procedures do comply, but our employees fail or neglect to follow them in all respects, we might incur similar liability.  For example, if a regulatory authority finds that a current or future product or production run is not in compliance with any of these regulations, we may be fined, production may be stopped or a product may be pulled from the shelves, any of which could adversely affect our financial conditions and operations.
 
 
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In addition, any adverse publicity associated with any noncompliance may damage our reputation and our ability to successfully market our products.  Furthermore, the rules and regulations are subject to change from time to time and while we closely monitor developments in this area, we have no way of anticipating whether changes in these rules and regulations will be made that would impact our business adversely.  Additional or revised regulatory requirements, whether labeling, environmental, health and safety, tax or otherwise, could have a material adverse effect on our financial condition and results of operations.

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

As of January 31, 2010, we had total long-term and current indebtedness under three different bonds of $5,787,000.  We make interest payments (and principal payments on the taxable bond) on the indebtedness under these bonds, which are due in 2014, 2019, and 2019.  We may incur substantial additional debt in the future.  Our indebtedness could limit our ability to obtain necessary additional financing for working capital, capital expenditures, debt service requirements or other purposes in the future; to plan for, or react to, changes in technology and in our business and competition; and to react in a timely manner to the ongoing global economic downturn.  In addition, our indebtedness makes us vulnerable to interest rate fluctuations because our bonds due 2019 bear interest at variable rates.  Any significant interest rate increase could have an adverse effect on our financial condition.

Moreover, there can be no assurance that we will be able to meet our debt service obligations.  If we are unable to generate sufficient cash flow or obtain funds for required payments, or if we fail to comply with covenants in our indebtedness, we will be in default.  The indebtedness underlying our bonds is secured by a mortgage on our real property and a security interest in our assets.  If we default under the agreements governing our indebtedness, the creditors may be able to foreclose on our property and assets, which would substantially harm our business and financial condition.  Additionally our letter of credit on our Georgia bond financing expires in September 2011 and there can be no assurance we will be able to renew it.  If the letter of credit is not renewed we will be required to pay off the bonds in full.

To the extent that the proposed Arrangement is not consummated, we will continue to incur substantial costs in connection with the requirements of the Sarbanes-Oxley Act of 2002.
 
The Sarbanes-Oxley Act of 2002 (the “Act”) introduced new requirements regarding corporate governance and financial reporting. Among the many requirements is the requirement under Section 404 of the Act for management to annually assess and report on the effectiveness of our internal control over financial reporting and for our registered public accountant to attest to this report. Based on the requirements in effect as of the date of this Annual Report, to the extent that the Arrangement is not consummated prior to that time, at the end of fiscal year 2011 our auditors will be required to issue a report on our internal control over financial reporting for inclusion in our Annual Report on Form 10-K for the fiscal year ending January 31, 2011. We expect that the costs to comply with these requirements would be significant and would adversely affect our operating results.

If we fail to maintain an effective system of internal and disclosure controls, we may not be able to accurately report our financial results or prevent fraud.
 
Effective internal and disclosure controls help us to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company.  If we cannot provide reliable financial reports or prevent fraud, our reputation and operating results would be harmed.  As a result, current and potential shareholders could lose confidence in our financial reporting, which would harm our business and the trading price of our securities.  We have in the past discovered deficiencies in our internal controls as defined under interim standards adopted by the Public Company Accounting Oversight Board that required remediation. Furthermore, our independent auditor has, in the past, advised us that it had noted certain reportable conditions in our internal financial reporting and accounting controls. As we continue our ongoing review and analysis of internal control over financial reporting for compliance with the Act, we may encounter problems or delays in completing the review and evaluation and implementing improvements. Additionally, we may identify deficiencies that need to be addressed in our internal control over financial reporting or other matters that may raise concerns for investors. Should we, or our independent registered public accounting firm, determine in future periods that we have significant deficiencies or material weaknesses in our internal control over financial reporting, or if we are unable to receive a positive attestation from our independent auditors, our results of operations or financial condition may be adversely affected, investors may lose confidence in the reliability of our financial statements and the price of our common stock may decline.
 
 
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If we need to raise additional capital for our operating plan, our business would be harmed if we were unable to do so on acceptable terms, and current volatility and uncertainties in the global capital and credit markets may adversely affect our ability to access credit.

We currently anticipate that our existing capital resources and cash flows from operations will enable us to maintain our currently planned operations for the foreseeable future.  However, our current operating plan may change as a result of many factors, including general economic conditions, which are beyond our control.  If we are unable to generate and maintain positive operating cash flows and operating income in the future, we may need additional funding.

Financial turmoil affecting the banking system and financial markets and the risk that additional financial institutions may consolidate or become insolvent has resulted in a tightening in the credit markets, a low level of liquidity in many financial markets, and volatility in credit, currency and equity markets. In such an environment, there is a risk that lenders, even those with strong balance sheets and sound lending practices, could fail or refuse to honor their legal commitments and obligations under existing credit commitments, including but not limited to: extending credit up to the maximum permitted by credit facility, renewing existing credit facilities and/or honoring loan commitments.  If our lender fails to honor its legal commitments under our line of credit, or if we are unable to renew our credit facility on favorable terms or at all, it could be difficult in this environment to replace our credit facility on similar terms. If additional capital were needed, our inability to raise capital on favorable terms would harm our business and financial condition.  To the extent that we raise additional capital through the sale of equity or debt securities convertible into equity, the issuance of these securities could result in dilution to our shareholders.

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

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

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

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

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

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

Other significant challenges to conducting business in foreign countries include, among other factors, local acceptance of our products, political factors, currency controls, changes in import and export regulations, changes in tariff and freight rates, and fluctuations in foreign exchange rates.  We might not be able to penetrate these markets and any market penetration that occurs might not be timely or profitable.  If we do not penetrate these markets within a reasonable time, we will be unable to recoup part or all of the significant investments we may have made in attempting to do so.
 
 
12

 

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

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

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

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

Natural disasters could decrease our manufacturing capacity.

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

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

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

It might be difficult for a third-party to acquire us even if doing so would be beneficial to our shareholders.
 
In fiscal year 2007, we adopted a shareholder rights plan, and in fiscal year 2010, the shareholders ratified the continued existence of the shareholder rights plan.  The shareholder rights plan is designed to protect shareholders from unfair, abusive or coercive take-over strategies, including the acquisition of control of our company by a bidder in a transaction or series of transactions that does not treat all shareholders equally or fairly or provide all shareholders an equal opportunity to share in the premium paid on an acquisition of control.  Although the proposed Arrangement is not subject to the terms of the shareholders rights plan, the shareholder rights plan could discourage certain types of take-over bids that might be made for us and may render more difficult a merger, tender offer, assumption of control by the holders of a large block of our securities or the removal of incumbent management, even though certain of such transactions or effects might be beneficial in the judgment of certain shareholders or shareholders generally.  For example, the shareholder rights plan could have the effect of preventing a particular take-over bid from being made or being successful, even though a majority of our shareholders might wish to participate in that take-over bid.  The shareholder rights plan will cause substantial dilution to a person or group that attempts to acquire us other than through a “permitted bid” (as defined in the plan) or on terms approved by the Board.  If triggered, the shareholder rights plan will also likely cause substantial dilution to any shareholder who fails to or elects not to exercise its rights.  The existence of these anti-takeover provisions could limit the price that investors might be willing to pay in the future for our common shares.
 
 
13

 

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

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

The liquidity of our stock depends in part on our continued listing with the NYSE Amex LLC.

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

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

Our principal executive offices, a majority of our directors and certain of our officers are located in and/or residents of Canada, and all or a substantial portion of such persons’ assets are located outside the United States. As a result, it may be difficult for investors to obtain jurisdiction over us or our directors or officers in courts in the United States in actions predicated on the civil liability provisions of the U.S. federal securities laws; enforce against us or our directors or officers judgments obtained in such actions; obtain judgments against us or our directors or officers in actions in non-U.S. courts predicated solely upon the U.S. federal securities laws; or enforce against us or our directors or officers in non-U.S. courts judgments of courts in the United States predicated upon the civil liability provisions of the U.S. federal securities laws.
 
 
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ITEM 1B.  UNRESOLVED STAFF COMMENTS

Not Applicable

ITEM 2.  PROPERTIES

Ferndale, Washington

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

During fiscal year 2004, we completed the construction of a 122,000 square foot production, warehousing, and office space facility on this property.  The construction of this facility was financed through the issuance of industrial revenue bonds in the amount of $2,910,000 and from cash on hand.  Manufacturing of our animal care products and some ancillary products along with the majority of our warehousing takes place at this facility.

During fiscal year 2008 we completed the closure and move of our Bellingham, Washington manufacturing facility to our Ferndale, Washington location.  The cost of the move and additional facility related construction was approximately $4,900,000, of which $3,300,000 was financed through cash on hand and $1,600,000 was financed through bond financing with GE Capital Public Finance, Inc., as described below in Note 8(“Long-term debt”) to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

Jesup, Georgia

On August 20, 2003, we purchased 14 acres of land zoned light industrial in Jesup, Georgia for $140,000, which included a 41,000 square foot steel warehouse building.  During fiscal year 2005, we constructed approximately 45,000 square feet of additional warehousing and manufacturing space on the property at a cost of $6,650,000 (including equipment we installed).  The construction was financed with cash on hand and a debt facility from Branch Banking &Trust Co. (“BB&T”). Pursuant to our letter of credit with BB&T and in connection with the issuance of certain tax exempt bonds by Wayne County Industrial Development Authority (“Wayne County IDA”), we sold our real property in Jesup, Georgia to Wayne County IDA and are currently leasing the real property back from Wayne County IDA.  Upon repayment of the bonds in full, Wayne County IDA will transfer all right, title and interest in the real property and related production facility to Absorption for no additional consideration.  While the bonds remain outstanding, as security for the indebtedness underlying the letter of credit, BB&T will hold a mortgage on the real property and a security interest in the equipment assets located on that property.  Please see Note 8 (“Long-term debt”) to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information regarding this financing transaction.   We manufacture and warehouse multiple product lines in both segments at this facility.

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

Vancouver, British Columbia, Canada

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

Our owned properties are subject to mortgages to secure the indebtedness under our bonds and long-term debt, which together amounted to $5,787,000 as of January 31, 2010.

ITEM 3.  LEGAL PROCEEDINGS
 
Except for ordinary routine litigation incidental to our business, there are no material legal proceedings pending to which we are a party, or of which any of our properties is the subject.
 
ITEM 4.  (REMOVED AND RESERVED)
 
 
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PART II

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

Market information

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

   
FISCAL YEAR
2010
   
FISCAL YEAR
2009
 
   
HIGH
   
LOW
   
HIGH
   
LOW
 
                         
First quarter
    3.00       2.11       4.99       3.62  
Second quarter
    3.19       2.62       4.98       2.75  
Third quarter
    3.87       3.05       3.65       2.09  
Fourth quarter
    4.62       3.71       4.80       1.66  

Holders

We had 427 holders of record of our Common Shares as of March 19, 2010.

Dividends

We have not paid dividends to the holders of our common shares.  The decision whether to pay dividends and the amount thereof is at the discretion of our board of directors, and will be governed by such factors as earnings, capital requirements and our operating and financial condition. In addition, our credit facility prohibits us from paying dividends without our lender’s consent. Furthermore, the indentures pursuant to which our bonds were issued each prohibit us from declaring a cash dividend unless, after giving effect to such dividend, we would not be in default under such indentures, we remain in compliance with certain financial ratios and the amount of the dividend did not exceed the limits set forth in the indentures.  We intend to retain our earnings primarily to finance the continuing growth of our business and do not intend to pay any dividends for the foreseeable future.

Exchange controls and other limitations affecting security holders

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

Subject to the exceptions noted below for World Trade Organization (“WTO”) investors, investments which require prior notification under the Investment Act are all direct acquisitions of Canadian businesses with assets of (Cdn) $5,000,000 or more and all indirect acquisitions of Canadian businesses with assets of more than (Cdn) $50,000,000 or with assets between (Cdn) $5,000,000 and (Cdn) $50,000,000 which represent more than 50% of the value of the total international operations.  In addition, specific acquisitions or businesses in designated types of activities related to Canada’s cultural heritage or national identity could be reviewed if the government considers it to be in the public interest to do so.
 
 
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The WTO investor exception to the Investment Act provides special review thresholds in the case of acquisitions by such investors.  WTO investors include individuals who are a national of a WTO member or who has the right of permanent residence in relation to a WTO member, governments of WTO members and entities that are not Canadian controlled but which are WTO investor controlled.  The United States is a member of the WTO.  The WTO review thresholds are calculated using a formula and for 1996 and 1997 are (Cdn) $168,000,000 and (Cdn) $172,000,000.

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

ITEM 6.  SELECTED FINANCIAL DATA

Not Applicable
 
 
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ITEM 7.   MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
This discussion is intended to further the reader’s understanding of the consolidated financial statements, financial condition, and results of operations of International Absorbents and Absorption. It should be read in conjunction with the consolidated financial statements, notes and tables which are included elsewhere in this Annual Report on Form 10-K.

Some statements and information contained in this “Management's Discussion and Analysis of Financial Condition and Results of Operations” are not historical facts but are forward-looking statements. For a discussion of these forward-looking statements and important factors that could cause results to differ materially from the forward-looking statements, see Item 1 of Part I, “Business — Forward-Looking Statements” and Item 1A of Part I, “Risk Factors.”

Overview

International Absorbents is the parent company of its wholly owned U.S. subsidiary, Absorption.  International Absorbents is a holding company and Absorption is its operating entity.

As more fully described in our definitive proxy statement filed with the Securities and Exchange Commission (the “SEC”) on April 16, 2010 (the “Proxy Statement”), on December 14, 2009, International Absorbents entered into an Arrangement Agreement (the “Arrangement Agreement”) with IAX Acquisition Corporation, a Delaware corporation (“Parent”), and IAX Canada Acquisition Company Inc., a corporation incorporated under the laws of the Province of British Columbia (“Canada Sub”) and a wholly-owned subsidiary of Parent. The Arrangement Agreement provides that, upon the terms and subject to the conditions set forth in the Arrangement Agreement, Parent, through its wholly-owned subsidiary, will acquire all of the outstanding common shares of International Absorbents for $4.75 per common share in cash, with International Absorbents continuing as the surviving corporation (the “Arrangement”). As a result of the Arrangement, International Absorbents will become a wholly-owned subsidiary of Parent. The consummation of the Arrangement is subject to various closing conditions, including obtaining the approval of the Arrangement by our shareholders and the Supreme Court of British Columbia.

Management divides the activities of the operating company into two segments: the animal care industry and the industrial cleanup industry.  We manufacture, distribute and sell products for these segments to both distributors and direct buying retailers.

Absorption is a leading manufacturer and seller of premium small animal bedding in North America. The primary product that we sell in this market is small animal bedding sold under the brand name CareFRESH®.  We consider the activities that surround the manufacture and distribution of CareFRESH® to be our core business.  Our business strategy is to promote and grow our core business and to create diversification in our market channels, our production methods, and our product lines in an effort to add strength and breadth to our business structure.  As a result, we continue to dedicate resources to improving our infrastructure for the support of our core business, and creating more product and customer diversification.

The financial results from fiscal year 2010 were below the expectations of management both in terms of top line sales (see “Net Sales” below) and bottom line profits (see “Net Income” below).  As described in the “Gross Profits” discussion below, during the fiscal year ended January 31, 2010 we met our expectations for improvements in gross profits, which we believe improved as a result of our ongoing plan to maximize the efficiencies of the manufacturing capital investments we have made during the past several years as well as from the reduction in the cost of some of the raw materials we use in our manufacturing process.  Selling, general and administrative expenses grew as expected from an operational perspective, as investments were made in the development of new product lines and market channels.  These expenses also grew due to costs incurred in connection with the proposed Arrangement.
 
 
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During fiscal year 2010, we continued to focus our sales and marketing efforts on our market leading CareFRESH®, CareFRESH® Colors and CareFRESH® Ultra brands of small animal bedding products.  CareFRESH® Colors is our colored bedding offering and CareFRESH® Ultra is our white small animal bedding.  Both are premium line extensions to our core product, CareFRESH®.  In addition, during the year we introduced a proprietary line of small animal foods branded CareFRESH® Complete™.  We also continue to sell our Healthy Pet™ cat litter line.  Our Healthy Pet™ brand consists of a range of “natural” cat litters made from cellulose fiber, wood, grain and plant-based materials.  Through our joint marketing alliance with Supreme Petfoods Ltd, a privately held British firm, we distribute a premium line of small animal food products to pet stores across North America under such brand names as Russel Rabbit™, Gerty Guinea Pig™ and Reggie Rat™ brand premium diets.  To date our sales growth has come from our small animal bedding and food products and not from our cat litter products.

Results of Operations

The following table illustrates our financial results for fiscal year 2010 as compared to the prior fiscal year.  (U.S. dollars, in thousands):

   
January 31,
2010
   
Percent of
Sales
   
January 31,
2009
   
Percent of
Sales
   
Percentage
Change
 
Sales
    34,575       100 %     35,752       100 %     -3 %
Cost of Goods Sold
    22,555       65 %     24,270       68 %     -7 %
Gross Profit
    12,020       35 %     11,482       32 %     5 %
                                         
Selling, General and Administrative
    8,956       26 %     7,575       21 %     18 %
                                         
Income from Operations
    3,064       9 %     3,907       11 %     -22 %
                                         
Interest Income
    11       0 %     62       0 %     -82 %
Interest Expense
    (226 )     -1 %     (315 )     -1 %     -28 %
                                         
Profit before Taxes
    2,849       8 %     3,654       10 %     -22 %
                                         
Income Taxes
    (1,399 )     -4 %     (1,415 )     -4 %     -1.1 %
                                         
Net Income
    1,450       4 %     2,239       6 %     -35 %

Net Sales

In fiscal year 2010, our net sales decreased by 3% as compared to fiscal year 2009.  We believe that the decrease was the result of our retail customers reducing their inventory levels and, to a lesser extent, from a shift in consumer spending preferences to lower-priced products.  During fiscal year 2010, net sales for animal care products decreased from $34,934,000 to $33,884,000, as compared to fiscal year 2009.  Net sales of our industrial cleanup products decreased from $818,000 in fiscal year 2009 to $691,000 in fiscal year 2010.  We experienced reductions in domestic sales for all of our key bedding products, including CareFRESH®, CareFRESH® Ultra™, and CareFRESH® Colors products, partially offset by an increase in international sales, as well as in sales of our Healthy Pet™ bedding line.  Our strategy with regard to our industrial cleanup products has remained the same, which is to effectively service existing customers while focusing growth on animal care products.

We are uncertain how current economic uncertainties will affect our sales during fiscal year 2011.  At the end of the fiscal year some retailer customers were starting to show slight improvements in out-the-door sales and, as a result, were increasing inventory levels.  Based on these trends, we believe that our overall annual net sales will improve during fiscal year 2011.  Specifically, during fiscal year 2011, we expect sales of natural, non-colored CareFRESH® in pet specialty channels to improve slightly over sales levels from fiscal year 2010.  We believe this will be mostly driven by increased sales of our brand extension products, rather than from a growth in the sales of our core product.  We will continue to invest in promotional activity on the retail level.  We anticipate that natural CareFRESH® will continue to represent the majority of our sales through the 2011 fiscal year.  We also see growth opportunities for our full line of bedding products and believe they will continue to gain market share and growing customer acceptance. However, as we add new items to our line of products, they will need to compete for limited shelf space at the pet specialty stores with our other existing products and those of our competitors, which could limit the number of products we are able to sell at a particular store. Also, although we believe that the high quality of our CareFRESH® line of products gives us a significant competitive advantage, many of our competitors have a larger breadth of products and more established relationships with the mass merchandiser and grocery stores, which makes competition in these channels more challenging for us.  Further, the ongoing global economic uncertainties have resulted in lower than expected sales growth of our products, as a result of decreased consumer spending and reduced customer traffic at our major customers’ stores. With respect to our lines of cat litter products, subject to the considerations described above, we expect revenue growth to be flat to down during the coming fiscal year.
 
 
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Gross Profit

As fiscal year 2010 came to an end, our production facility in Ferndale, Washington was operating beyond management’s expectations, while our facility in Jesup, Georgia continued to experience operational inconsistencies, and both of our production facilities faced challenges that directly affected their production costs.  These challenges included increased input costs, materials cost, ongoing maintenance costs associated with achieving a high rate of product quality and production efficiencies, and high freight cost during the last half of the year.  However, even in light of these additional costs, we were able to improve our gross margin (gross profit divided by sales) from 32% in fiscal year 2009 to 35% in fiscal year 2010.
.

For fiscal year 2011 we expect that our gross margin will decrease.  The reasons for this expectation are as follows.  First, economic conditions will continue to make it challenging to raise prices.  Second, we are not achieving the overall reduced costs of raw materials that we had initially expected due to:  our product mix (with increased sales of our higher-cost products); slow and uncertain  reactions from raw material suppliers in response to our request for additional supplies; and the shortage of key low-cost raw material sources for certain of our facilities.  Third, depreciation charges resulting from our new production facilities will also have a negative effect on our gross margin.  Fourth, any slowdown in sales could result in increased production costs on a per unit basis due to a loss of efficiencies gained from higher production rates.

We plan to continue to make capital investments in infrastructure and technology at all of our facilities to help decrease the costs of production, though at a lower rate than in recent years.

Selling, General and Administrative Expenses

During fiscal year 2010, our selling, general and administrative expenses increased by 18% as compared to fiscal year 2009. This increase was primarily the result of costs related to the proposed Arrangement, which as of January 31, 2010 totaled $903,000.  Net of these one-time expenses, sales, general, and administrative expenses increased by 6% in fiscal year 2010 as compared to fiscal year 2009.  This increase was primarily the result of investments made in sales and marketing and new product development.

We anticipate that investments in sales and marketing programs and new product development costs, along with our stock-based compensation expenses and growing public company reporting expenses, will continue to increase selling, general and administrative expenses during fiscal year 2011, though not at the rate at which they increased during the current fiscal year.  During fiscal year 2011, we intend to continue our marketing and new product development initiatives.  Our seasoned sales staff is respected in the animal care industry and has proven to be efficient and effective in selling to the wholesale distribution segment of the pet specialty channel.  We feel that the fiscal year 2011 sales plan should enable us to achieve our strategic objectives without significantly increasing our selling expenses, provided that this projection may change depending on the reaction of our competitors.  On the administrative side, costs resulting from compliance with SEC and NYSE Amex requirements are projected to continue to grow and we may also need to hire additional administrative personnel growth as sales levels increase.

As discussed in Note 14 (“Segmented Information”) to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K, operating income including selling, general and administrative expenses, but before depreciation for our animal care product segment, decreased by 16% in fiscal year 2010 as compared to fiscal year 2009

Interest Expense

Interest expense in fiscal year 2010 totaled $226,000 as compared to $315,000 during fiscal year 2009.  This decrease was due to a reduction in the variable interest rate we pay on the bonds that were used to finance the Jesup, Georgia facility and the reduction in principal amounts as we pay off our bonds according to their terms.  We currently have no plans to enter into additional debt financing, which means that we are projecting a decrease in interest expenses in fiscal year 2011 as the principal portion of our existing debt is paid down.  This projection assumes that variable interest rates will remain low during fiscal year 2011.
 
 
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Income Tax
 
Absorption incurred federal income taxes during fiscal year 2010 at an effective rate of 49%.  The effective rate is higher than the rate incurred during fiscal year 2009 (of 38%).  This increased rate was the result of the costs incurred in connection with the proposed Arrangement, resulting in a net operating loss in Canada, which is fully reserved for through a valuation allowance.  A valuation allowance has been reserved for all Canadian deferred income tax assets as these assets are not expected to be utilized in future periods.

Net Income

Our net income for the year ended January 31, 2010 decreased by 35% as compared to the same period in the prior fiscal year. This decrease in net income as compared to the prior period was the result of a slight decrease in sales and an increase in our selling, general, and administrative costs, primarily caused by expenses related to the proposed Arrangement.  We believe that our ability to remain profitable in fiscal year 2010 despite a decrease in sales and an increase in selling, general and administrative costs was the result of a continued concentration on the implementation of the key components of our business plan that focus on increasing production efficiencies and controlling indirect costs.

Our focus during fiscal year 2011 will be to improve current sales levels as the global economy begins to improve, and minimize the growth of our selling general and administrative costs while attempting to maintain gross profit margins.  Our biggest challenges for the coming fiscal year will be maintaining existing sales levels as the buying habits of retail customers continue to change, continuing the improvement of our gross margin, and maintaining selling, general and administrative expenses at levels that create opportunities for future growth.  We will continue to invest in future marketing programs to offset competitive pressures as necessary.  In addition, we anticipate that existing levels of depreciation resulting from our prior investment in plant and equipment will negatively affect our fiscal year 2011 net income.

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 decreased by 14% during fiscal year 2010 as compared to fiscal year 2009.  The decrease for fiscal year 2010 was substantially the result of a reduction in sales and higher selling, general, and administrative costs.

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

 
     For the year ended        
(U.S. dollars in thousands)
 
January 31,
2010
   
January 31,
2009
   
Percentage
Change
 
                   
Net Income (as reported on Condensed Consolidated Statement of Operations)
  $ 1,450     $ 2,239          
Interest expense
    226       315          
Interest income
    (11 )     (62 )        
Income tax provision
    1,399       1,415          
Depreciation & amortization
    1,757       1,830          
EBITDA
  $ 4,821     $ 5,737       -16 %
 
During fiscal year 2011, management will continue to focus on EBITDA as a key performance indicator.
 
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Liquidity and Capital Resources

During fiscal year 2010 we focused on improving the production efficiencies at both of our plants.  Our improved gross margin in the last half of fiscal year 2010 was the result of both the success we had in improving production efficiencies and the reduction in energy and transportation costs.  We believe that the improvement in our production facilities will help provide a solid return on the investments we have made in capital expansion over the past several years.

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

   
As of January 31,
2010
   
As of January 31,
2009
 
Financial Condition
           
Total Assets
  $ 32,610     $ 31,281  
Total Liabilities
    10,356       10,895  
Total Equity
  $ 22,254     $ 20,386  
                 
Debt/equity ratio
    0.47       0.53  
Assets/debt ratio
    3.15       2.87  
                 
Working Capital
               
Current assets
  $ 13,277     $ 11,465  
Current liabilities
  $ 3,716     $ 3,595  
                 
Current ratio
    3.57       3.19  
                 
Cash Position
               
Cash, restricted cash & short term investments
  $ 7,140     $ 4,146  
Cash generated from operations
  $ 5,593     $ 3,644  
 
Financial Condition

During fiscal year 2010, the value of our total assets increased.  This was primarily the result of an increase in cash and cash equivalents generated from operating activities.  Accounts receivable remained flat during the fiscal year and our inventory levels decreased as a result of tight management controls.  In addition, current liabilities increased only slightly.  These changes in current accounts were offset by limited capital investments, which resulted in our significant increase in cash balances.  We also had a decrease in total liabilities resulting from the payment made on the principal portion of our long term debt.

As discussed under Note 8 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, we currently have three long-term debt facilities, including our September 2006 bond financing arrangement with GE Capital Public Finance, Inc (“GECPF”), our March 2003 bond financing with GECPF and our September 2004 tax-exempt bond financing with BB&T.

We believe that our main credit risk exposure in fiscal year 2011 will come from meeting the covenants included in our debt facilities and the marketability of tax exempt industrial revenue bonds.  As of the end of fiscal year 2010 we were over minimum financial requirements and under maximum requirements included in these covenants.  The covenant-related ratios that we believe pose the most significant risk in the future are those based on cash flow.  Any significant decrease in our cash flow could result in the breach of one or more of these loan covenants. If we fail to satisfy the financial covenants or other requirements contained in our debt facilities, our debts could become immediately payable at a time when we are unable to pay them, which would adversely affect our liquidity and financial condition.  In addition, if we are to make cash flow decisions to remain within our loan covenants, these decisions could affect our ability to effectively execute on our long term business strategy.
 
 
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The marketability of tax exempt industrial revenue bonds is a potential industry-wide issue, and is not related to our liquidity or results from operations.  The industrial revenue bonds for our Jesup, Georgia facility are remarketed and the industrial revenue bonds for our Ferndale, Washington facility are held by GE Capital Public Finance, Inc.  If the industrial revenue bonds that are remarketed were not able to be sold, due to a market failure, according to the terms of the bond agreement, we would likely have to pay off the outstanding balance, which is currently $2,800,000.

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

Working Capital

During fiscal year 2010, our working capital position continued to improve as current assets increased and current liabilities increased only slightly.  The majority of the increase in current assets was the result of increased cash generated from operating activities.  Current liabilities increased primarily due to increases in taxes payable and amounts due to a related party in connection with the proposed Arrangement.  These changes resulted in our current ratio (current assets divided by current liabilities) increasing from 3.19 at the end of fiscal year 2009 to 3.57 at the end of fiscal year 2010.

In fiscal year 2011 we expect that if sales levels grow, our current assets will continue to increase as a result of positive cash flow and an increase in accounts receivable and inventories.  We also expect that current liabilities will increase as a result of growing accounts payable related to the general growth of the company.  Even though we expect both current assets and current liabilities to grow, we believe that our net working capital position will improve over the coming fiscal year.

Cash Position

We believe that our existing cash on hand and our long-term debt currently provide us with enough cash to meet our existing needs for the foreseeable future.  Cash and investments increased during fiscal year 2010, primarily as a result of cash generated from operations. We expect cash on hand to increase during fiscal year 2011, mostly as a result of cash generated from operations which will not be significantly off-set by cash used for investing activities.  We will continue to closely monitor both current liabilities and current assets as they relate to the generation of cash, with an emphasis on maximizing potential sources of cash.

Cash Generated from Operations

During fiscal year 2010 we generated $5,593,000 in cash from operating activities.  The cash generated during fiscal year 2010 was a 53% increase over the $3,644,000 in cash generated during fiscal year 2009.  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 2011, although it cannot be assured that this will be the case.

Financing and Investing Activities

Cash used for financing activities during fiscal year 2010 was $877,000.  This was the result of principal payments made on our long-term debt.  Cash used in investing activities during fiscal year 2010 was approximately $1,722,000.   This cash was used for the acquisition of fixed assets.  A portion of these assets were production-related items that were replaced as part of our ongoing maintenance program.  We also made several investments during fiscal year 2010 to reduce costs and improve efficiencies in the areas of fiber recovery, energy use, and product handling.

We believe that for the near future we will not need to use cash to invest in significant capital improvements.  We will continue to use cash to fully maintain our existing facilities and to make improvements which we expect will increase production efficiencies and reduce manufacturing costs.
 
 
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Related Party Transaction
 
In connection with the Arrangement, in response to an unsolicited offer to purchase International Absorbents, we engaged in an auction process to solicit potential bids related to the sale of International Absorbents and incurred significant costs in connection therewith.  Included in these expenses is $326,000 owed to Arctic Acquisitions, Inc. (“Arctic”), an entity partially owned by certain of our executive officers and one of our directors, as reimbursement of certain fees and expenses incurred by Arctic during our auction process.  The independent members of our board of directors as well as our audit committee determined that the activities engaged in by Arctic during the auction process helped to increase the value of our common shares and thus generate additional value for our shareholders.  Specifically, among other things, Artic made the initial viable bid which commenced the auction process. Therefore, the independent members of our board of directors determined that incurrence and reimbursement of these expenses was in the best interest of the company and its shareholders.  
 
Off-Balance Sheet Arrangements

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

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

Critical Accounting Policies

Introduction

In preparing our consolidated financial statements in conformity with accounting principles generally accepted in the United States, management makes judgments, assumptions and estimates that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.  We believe that the material estimates that are particularly susceptible to significant change relate to the determination of the allowance for doubtful accounts, income taxes, including deferred income taxes and the related valuation allowance, accrual for self-insured medical insurance plans, sales incentives and stock based compensation.   As part of the financial reporting process, our management collaborates to determine the necessary information on which to base judgments and develop estimates used to prepare the consolidated financial statements.  Historical experience and available information is used to make these judgments and estimates.  However, different amounts could be reported using different assumptions and in light of different facts and circumstances.  Therefore, actual amounts could differ from the estimates reflected in the consolidated financial statements.
 
In addition to the significant accounting policies described in Note 2 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, we believe that the following discussion addresses our critical accounting policies.

Inventory

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

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

Revenue Recognition

If the actual costs of sales returns and incentives were to significantly exceed the recorded estimated allowance, our sales would be adversely affected in that we would record additional reserves which would reduce our net sales revenue.  Revenues from the sale of products are recognized at the time title passes to the purchaser, which is generally when the goods are conveyed to a carrier. When we sell F.O. B. destination point, title is transferred and we recognize revenue on delivery or customer acceptance, depending on terms of the sales of the agreement.  All revenue is recognized net of any discounts, returns, allowances and sales incentives.  The Company participates in trade-promotions programs such as shelf price reductions and consumer coupon programs that require the Company to estimate and accrue the expected costs of such programs. Historically we have not had sales returns or incentive requests applied to a fiscal year in greater amounts than what was reserved for.  By following our revenue recognition policies we have been able to accurately assess the value of both sales returns and sales incentives.  We have annually updated the sales incentive amounts that are annually accrued to match the sales incentive agreements that we have with our customers.  By doing so, we have maintained a consistent methodology while adjusting our estimates to more closely reflect our activities within the market place.  We believe that it is unlikely that our assumptions or methodology for accounting for revenue recognition, sales returns, and sales incentives will change in the future.  However, we do believe that it is likely that the actual estimates that we use for our sales incentive programs and sales returns may change in the future from time to time as a result of a dynamic marketplace.

Income Tax

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

Effective February 1, 2007, the Company adopted Accounting Standards Codification (“ASC”) Topic 740, Income Taxes, which prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. Though the validity of any tax position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. Because of this, whether a tax position will ultimately be sustained may be uncertain. Under FIN 48, the impact of an uncertain tax position that is more likely than not of being sustained upon audit by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained.
 
 
25

 
 
Stock-Based Compensation

Effective February 1, 2006, we adopted the fair value recognition provisions of ASC 718, Stock Compensation, using the modified prospective transition method. Under that transition method, compensation cost recognized in fiscal year ended January 31, 2007 and all subsequent fiscal years thereafter includes: (a) compensation cost for all stock-based payments granted prior to, but not yet vested, as of January 31, 2006, based on the grant date fair value estimated in accordance with the original provisions of ASC 718, and (b) compensation cost for all stock-based payments granted subsequent to February 1, 2006, based on the grant date fair value estimated in accordance with the current provisions of ASC 718. Results for prior periods have not been restated, as provided for under the modified-prospective method.  For details regarding the effect on our financial statements of using this methodology, please see Note 2 of our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.

In our calculation of stock-based compensation we use the Black-Scholes model.  This model is an estimate of potential actual results.  As such, actual results may vary significantly from our estimated stock-based compensation expense.  Specifically, in the event that options were to expire at an exercise price which is below the option’s strike price and the options are not exercised, then we would have taken stock-based compensation expense for options which did not ultimately have a dilutive effect on the outstanding common shares.  We do not expect to change our methodology for calculating stock-based compensation in the future.
 
ITEM 7A.   QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not Applicable
 
 
26

 
 
ITEM 8.FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

INDEX

Report of Independent Registered Public Accounting Firm
Page 28
   
Consolidated Balance Sheets at January 31, 2010 and 2009
Page 29
   
Consolidated Statements of Income for the Fiscal Years ended January 31, 2010 and 2009
Page 30
   
Consolidated Statements of Changes In Stockholders’ Equity for the Fiscal Years ended January 31, 2010 and 2009
Page 31
   
Consolidated Statements of Cash Flows for the Fiscal Years ending January 31, 2010 and 2009
Page 32
   
Notes to Consolidated Financial Statements, January 31, 2010 and 2009
Page 33

 
27

 


Report of Independent Registered Public Accounting Firm
 
 
 
To the Board of Directors and Stockholders
International Absorbents Inc. and Subsidiary
 
 
We have audited the accompanying consolidated balance sheets of International Absorbents Inc. and Subsidiary (the “Company”) as of January 31, 2010 and 2009, and the related consolidated statements of income, stockholders’ equity and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
 
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
 
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of International Absorbents Inc. and Subsidiary as of January 31, 2010 and 2009, and the consolidated results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
 

 
/s/ Moss Adams LLP
 

Seattle, Washington
April 29, 2010

 
28

 
 
International Absorbents Inc. and Subsidiary
Consolidated Balance Sheets
As at January 31, 2010 and 2009
(in thousands of U.S. dollars)
 
   
2010
   
2009
 
             
Assets
           
Current assets:
           
Cash and cash equivalents
  $ 7,140     $ 4,146  
Accounts receivable, net
    2,637       2,699  
Inventories, net
    3,157       4,286  
Prepaid expenses
    172       162  
Deferred income tax asset
    171       172  
Total current assets
    13,277       11,465  
                 
Property, plant and equipment, net
    19,155       19,610  
Other assets, net
    178       206  
Total assets
  $ 32,610     $ 31,281  
                 
Liabilities and Stockholders' Equity
               
                 
Current liabilities:
               
Accounts payable and accrued liabilities
  $ 2,197     $ 2,686  
Related party payables
    332       5  
Current portion of long-term debt
    899       877  
Income taxes payable
    288       27  
Total current liabilities
    3,716       3,595  
                 
Deferred income tax liability
    1,603       1,364  
Long-term debt
    4,888       5,787  
Other long term liabilities
    149       149  
Total liabilities
    10,356       10,895  
                 
                 
                 
Stockholders' equity:
               
                 
Common stock, no par value -
               
Unlimited shares authorized,
               
6,410,282 issued and outstanding at
               
January 31, 2010 and 2009
    8,487       8,487  
Additional paid in capital
    2,241       1,823  
Retained earnings
    11,526       10,076  
Total stockholders' equity
    22,254       20,386  
Total liabilities and stockholders' equity
  $ 32,610     $ 31,281  
                 
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
29

 

International Absorbents, Inc. and Subsidiary
Consolidated Statements of Income
For the years ended January 31, 2010 and 2009
(in thousands of U.S. dollars, except earnings per share amounts)

   
2010
   
2009
 
             
Sales, net
  $ 34,575     $ 35,752  
Cost of goods sold
    22,555       24,270  
Gross Profit
    12,020       11,482  
                 
Selling, general and administrative expenses
    8,956       7,575  
                 
Income from operations
    3,064       3,907  
Interest expense
    (226 )     (315 )
Interest income
    11       62  
Income before provision for income taxes
    2,849       3,654  
                 
Income tax provision
    (1,399 )     (1,415 )
Net income
  $ 1,450     $ 2,239  
                 
Basic earnings per share
  $ .23     $ .35  
Fully diluted earnings per share
  $ .22     $ .35  
                 
Weighted average number of shares outstanding
               
(in thousands)
               
 Basic
    6,410       6,410  
Diluted
    6,457       6,446  
 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
30

 
 
International Absorbents Inc. and Subsidiary
Consolidated Statement of Changes in Stockholders’ Equity
For the years ended January 31, 2010 and 2009
(in thousands of U.S. dollars)
 
   
Common
Shares
(in 1,000's)
   
 
   
Additional
Paid in
Capital
   
 
   
Total
 
                 
 
   
Stock-
 
                 
Retained
   
Holders'
 
       
Amount
        Earnings    
Equity
 
                               
Balance as of January 31, 2008
    6,410       8,487       1,365       7,837       17,689  
Stock based compensation
    -       -       458       -       458  
Net income
    -       -       -       2,239       2,239  
                                         
Balance as of January 31, 2009
    6,410     $ 8,487     $ 1,823     $ 10,076     $ 20,386  
Stock based compensation
    -       -       418       -       418  
Net income
    -       -       -       1,450       1,450  
                                         
Balance as of January 31, 2010
    6,410     $ 8,487     $ 2,241     $ 11,526     $ 22,254  

 
The accompanying notes are an integral part of these consolidated financial statements.
 
 
31

 
 
International Absorbents Inc. and Subsidiary
Consolidated Statement of Cash Flows
For the years ended January 31, 2010 and 2009
(in thousands of U.S. dollars)
 
   
2010
   
2009
 
             
Cash flows from operating activities
           
             
Net income
  $ 1,450     $ 2,239  
Adjustments to reconcile net income to net cash
               
used for operating activities
               
Depreciation and amortization
    1,757       1,830  
Loss on disposal of equipment
    1       1  
Stock-based compensation
    418       458  
Deferred taxes
    240       240  
Changes in operating assets and liabilities
               
Accounts receivable
    62       (340 )
Inventories
    1,129       (1,120 )
Prepaid expenses
    (10 )     (7 )
Accounts payable and accrued liabilities
    (42 )     268  
Income taxes receivable/payable
    261       (27 )
Due to related party
    327       (1 )
Other long term liabilities
    -       103  
Net cash flows from operating activities
    5,593       3,644  
                 
Cash flows from investing activities
               
Purchase of property, plant and equipment
    (1,722 )     (1,450 )
Net cash flows from investing activities
    (1,722 )     (1,450 )
                 
Cash flows from financing activities
               
Repayment of long-term debt
    (877 )     (857 )
Net cash flows from financing activities
    (877 )     (857 )
                 
                 
Net change in cash
    2,994       1,337  
                 
Cash and cash equivalents, beginning of period
    4,146       2,809  
                 
Cash and cash equivalents, end of period
  $ 7,140     $ 4,146  
                 
Cash paid for interest (net of amounts capitalized)
  $ 224     $ 321  
                 
Cash paid for income taxes
  $ 893     $ 1,099  
                 
Non-cash investing activities
               
Increase (decrease) in property, plant and equipment and
               
accounts payable for purchase of plant and equipment
  $ (447 )   $ 454  
                 

The accompanying notes are an integral part of these consolidated financial statements.
 
 
32

 
 
Notes to Consolidated Financial Statements
International Absorbents Inc. and Subsidiary


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

As more fully described in our definitive proxy statement filed with the Securities and Exchange Commission (the “SEC”) on April 16, 2010 (the “Proxy Statement”), on December 14, 2009, IAX entered into an Arrangement Agreement (the “Arrangement Agreement”) with IAX Acquisition Corporation, a Delaware corporation (“Parent”), and IAX Canada Acquisition Company Inc., a corporation incorporated under the laws of the Province of British Columbia (“Canada Sub”) and a wholly-owned subsidiary of Parent. The Arrangement Agreement provides that, upon the terms and subject to the conditions set forth in the Arrangement Agreement, Parent, through its wholly-owned subsidiary, will acquire all of the outstanding common shares of IAX for $4.75 per common share in cash, with IAX continuing as the surviving corporation (the “Arrangement”). As a result of the Arrangement, IAX will become a wholly-owned subsidiary of Parent. The consummation of the Arrangement is subject to various closing conditions, including obtaining the approval of the Arrangement by our shareholders and the Supreme Court of British Columbia.  The Arrangement Agreement contains certain termination rights for IAX, Parent and Canada Sub and further provides that, upon termination of the Arrangement Agreement under specified circumstances, IAX may be required to pay Parent a termination fee of 4% of the aggregate purchase price.  The IAX board of directors and the board of directors of Parent have approved the Arrangement Agreement.  In addition, concurrently with the execution of the Arrangement Agreement, certain of IAX’s executive officers, who together hold approximately 11.2% of IAX’s issued and outstanding common shares, have entered into a support agreement whereby they agreed, among other things, to vote all common shares held by them in favor of the approval of the Arrangement. 

The Company operates in two segments and is engaged in the development and sale of value added products made from waste short fiber pulp (“SFP”) utilizing proprietary technology. The Company predominately markets and sells animal and pet bedding products that are sold in consumer retail and commercial bedding markets.  In addition, the Company markets and sells SFP-based products used for general industrial spill cleanup, marine oil-cleanup, and oil/water filtration, and hydro mulch products. The Company has established distribution primarily in North America.

2.         Significant accounting policies
 
Generally accepted accounting principles

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

Accounting Standards Codification

On September 15, 2009, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Codification (“ASC”), which became the single source of authoritative generally accepted accounting principles in the United States of America (“GAAP”). The ASC changed the referencing of financial standards but did not change or alter existing U.S. GAAP. The ASC became effective for the Company in the third quarter of fiscal year 2010.

Basis of presentation

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

Cash and cash equivalents

Cash and cash equivalents includes cash and highly liquid investments with original maturities of 90 days or less.
 
 
33

 

Accounts receivable and allowance for doubtful accounts

The Company typically offers credit terms to its customers without collateral.  The Company records accounts receivable at the face amount less an allowance for doubtful accounts.  On a regular basis, the Company evaluates its accounts receivable and establishes these allowances based on a combination of specific customer circumstances, as well as credit conditions and the history of write-offs and collections.  Where appropriate, the Company obtains credit rating reports and financial statements of the customer to initiate and modify their credit limits.   The Company obtains credit insurance for certain accounts that qualify for coverage in order to minimize credit risk exposure.  If circumstances related to specific customers change, our estimates of the recoverability of receivables could materially change.  At January 31, 2010 and 2009, management considered all accounts receivable in excess of the allowances for doubtful accounts to be fully collectible.

Inventories

Finished good inventories are valued at the lower of cost (determined on the first-in, first-out basis) or net realizable value. Cost includes direct materials, labor and overhead allocation.  Raw materials and supplies are valued at the lower of cost (determined on the first-in, first-out basis) or net realizable value. The Company records inventory reserves for obsolete and slow-moving items. Inventory reserves are based on inventory turnover trends and historical experience. As of January 31, 2010 and 2009, inventory reserves were $90,000 and $41,000, respectively.

Property, plant and equipment

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

Impairment of long lived assets

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

Other assets

Other assets include deferred financing fees, which represent costs incurred in connection with long-term debt (see Note 8).  As of January 31, 2010 and 2009, the deferred financing fees were $178,000 and $206,000, respectively, which are net of accumulated amortization of $166,000 and $138,000, respectively. Amortization expense was $28,000 and $30,000 for the years ended January 31, 2010 and 2009, respectively.  The Company is amortizing into interest expense the deferred financing fees on a straight line basis which approximates the interest method over the term of the related debt.

Revenue recognition

Revenues from the sale of products are recognized at the time title passes to the purchaser, which is generally when the goods are conveyed to a carrier. When the Company sells F.O.B. destination point, title is transferred and the Company recognizes revenue on delivery or customer acceptance, depending on terms of the sales agreement.
 
 
34

 

All revenue is recognized net of any discounts, returns, allowances and sales incentives, including coupon redemptions and rebates. The Company participates in trade-promotion programs such as shelf price reductions and consumer coupon programs that require the Company to estimate and accrue the expected costs of such programs. Store coupons creating an obligation to the third party are recognized as a liability when distributed based upon expected consumer redemptions. The Company maintains liabilities based on historical experience and management’s judgment at the end of each period for the estimated expenses incurred, but unpaid for these programs.  Net revenue is presented net of any taxes collected from customers and remitted to government entities.

Shipping and handling costs

Revenues generated from shipping and handling costs charged to customers are included in sales and were $349,000 and $433,000 in fiscal years 2010 and 2009, respectively.  Shipping and handling costs for outbound and inbound shipping charges are included in cost of goods sold and were $3,230,000 and $4,645,000 in fiscal years 2010 and 2009, respectively.
 
 
Foreign exchange

The Company’s reporting currency is the U.S. dollar.  The Company considers the U.S. dollar to be the functional currency in foreign jurisdictions.  Accordingly, amounts denominated in foreign currencies are re-measured to U.S. dollars at historical and current exchange rates.  Gains and losses resulting from foreign currency transactions are included in the consolidated statement of earnings.

Advertising

Advertising costs are expensed when incurred and were $478,000 and $211,000 during fiscal years 2010 and 2009, respectively.

Net earnings per share

Basic net earnings per share is computed using the weighted average number of common shares outstanding for the period.  Diluted net earnings per share is computed using the weighted average number of common shares and potentially dilutive common share equivalents outstanding.  Stock options that are anti-dilutive are not included in diluted net earnings per share.

Income taxes
 
The Company accounts for income taxes using the asset and liability method. The liability method recognizes the amount of tax payable at the date of the financial statements as a result of all events that have been recognized in the financial statements, as measured by the provisions of currently enacted tax laws and rates. The accumulated tax effect of all temporary differences is presented as deferred federal income tax assets and liabilities within the balance sheet. A valuation allowance is established when necessary to reduce deferred tax assets to the amounts expected to be realized.
 
Effective February 1, 2007, the Company adopted ASC 740, “Unrecognized Tax Benefits,” which prescribes a comprehensive model for how a company should recognize, measure, present and disclose in its financial statements uncertain tax positions that the company has taken or expects to take on a tax return. Though the validity of any tax position is a matter of tax law, the body of statutory, regulatory and interpretive guidance on the application of the law is complex and often ambiguous. Because of this, whether a tax position will ultimately be sustained may be uncertain. The impact of an uncertain tax position that is more likely than not of being sustained upon audit by the relevant taxing authority must be recognized at the largest amount that is more likely than not to be sustained. No portion of an uncertain tax position will be recognized if the position has less than a 50% likelihood of being sustained
 
Stock-based employee compensation

Effective February 1, 2006, the Company adopted the fair value recognition provisions of ASC 718, “Compensation-Stock Compensation” using the modified prospective transition method. Under this transition method, compensation cost recognized in fiscal year ended January 31, 2007 and all subsequent fiscal years thereafter includes: (a) compensation cost for all stock-based payments granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value calculated in accordance with the original provisions of ASC 718, and (b) compensation cost for all stock-based payments granted subsequent to January 1, 2006, based on the grant date fair value calculated in accordance with the current provisions of ASC 718.
 
 
35

 

Total stock-based compensation expense recognized in the income statement for the years ended January 31, 2010 and 2009 was $412,000 and $454,000, respectively, of which $15,000 and $18,000, respectively, was recognized in cost of goods sold and $397,000 and $436,000, respectively, was recognized in selling, general and administrative expenses. All of the stock-base compensation was related to incentive stock options held by employees and non-employee directors for which no tax benefit is recognized.

ASC 718 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 option valuation model, which incorporates various assumptions including volatility, expected life forfeiture rate and risk-free interest rates. The assumptions used for the years ended January 31, 2010 and 2009 and the resulting estimates of weighted-average fair value per share of options granted during those periods are as follows:


         
Jan. 31, 2010
   
Jan. 31, 2009
 
 
                   
a )
risk free interest rate
    0.00 %     1.96 %
                       
b )
expected volatility
    24.10 %     110.41 %
                       
c )
expected dividend yield
    0.00 %     0.00 %
                       
d )
estimated average life (in years)
    0.50       4.47  

The expected life of the options represents the estimated period of time until exercise and is based on historical experience of similar awards, giving consideration to the contractual terms, vesting schedules and expectations of future employee behavior. Expected stock price volatility is based on historical volatility of the Company’s stock. The risk-free interest rate is based on the implied yield available on U.S. Treasury zero-coupon issues with an equivalent remaining term. The Company has not paid dividends in the past and does not plan to pay any dividends in the near future. As stock-based compensation expense recognized is based on awards ultimately expected to vest, it should be reduced for estimated forfeitures. ASC 718 requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. The Company’s forfeiture rate is calculated based on the Company’s historical experience of awards which ultimately vested.

The remaining unvested compensation for the fair value of stock options to be recognized was $347,000 and $760,000 at January 31, 2010 and 2009, respectively.

Other stock-based compensation

The Company accounts for equity instruments issued in exchange for the receipt of goods or services from other than employees and non-employee directors in accordance with ASC 505, Equity Based Payments to Non-Employees. 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. Stock-based compensation recognized under was $6,000 and $4,000 during 2010 and 2009, respectively.

Comprehensive income

The Company has adopted ASC 220, which establishes standards for reporting and presentation of comprehensive income and its components in consolidated financial statements. Comprehensive income includes all changes in equity during the period, except those resulting from transactions with shareholders of the Company. It has two components: net income and other comprehensive income.  The Company has no material components of other comprehensive income or accumulated other comprehensive income.
 
 
36

 

Use of estimates

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

New accounting pronouncements
 
In September 2006, the FASB issued accounting guidance which defines fair value, establishes a framework for measuring fair value and enhances disclosures about fair value measures required under other accounting pronouncements, but did not change existing guidance as to whether or not an instrument is carried at fair value. This guidance was initially effective for fiscal years beginning after November 15, 2007.  However, in February 2008, the FASB delayed the effective date of this guidance with respect to all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008.  The Company adopted this guidance as it applies to financial assets and liabilities as of February 1, 2008 and as it applies to nonfinancial assets and nonfinancial liabilities as of February 1, 2009. The adoption of this guidance did not have a material impact on the Company’s results of operations or financial condition.

In February 2007, the FASB issued accounting guidance which permits entities to choose to measure many financial instruments and certain other items at fair value. This guidance was effective for fiscal years beginning after November 15, 2007, and the Company adopted this guidance effective as of February 1, 2008. The adoption of this guidance did not have a material impact on the Company’s results of operations or financial condition.
 
In December 2007, the FASB issued accounting guidance which 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. This guidance also establishes disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. This guidance was effective for fiscal years beginning after December 15, 2008.  The Company adopted this guidance effective as of February 1, 2009, and will apply the provisions of this guidance for any acquisition after the adoption date.  The adoption of this guidance did not have a material impact on the Company’s results of operations or financial condition.
 
In March 2008, the FASB issued accounting guidance that significantly increases the disclosure requirements for derivative instruments.  The new requirements include the location and fair value amounts of all derivatives by category reported in the consolidated balance sheet; the location and amount of gains or losses of all derivatives and designated hedged items by category reported in the consolidated income statement or in other comprehensive income in the consolidated balance sheet; and measures of volume such as notional amounts.  For derivatives designated as hedges, the gains or losses must be divided into the effective portions and the ineffective portions.  This guidance 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.  This guidance was effective for financial statements issued for fiscal years beginning after November 15, 2008 and interim periods within those fiscal years. The Company adopted this guidance effective as of February 1, 2009.  As this guidance relates specifically to disclosures, the adoption of this guidance had no impact on the Company’s results of operations or financial condition.
 
In April 2009, the FASB issued accounting guidance which changes the method for determining whether an other-than-temporary impairment exists for debt securities and the amount of the impairment to be recorded in earnings. This guidance was effective for interim and annual periods ending after June 15, 2009, and the Company adopted this guidance effective as of May 1, 2009.  The adoption of this guidance did not have a material impact on the Company’s results of operations or financial condition.
 
In April 2009, the FASB issued accounting guidance which requires fair value disclosures in both interim as well as annual financial statements in order to provide more timely information about the effects of current market conditions on financial instruments.  This guidance was effective for interim and annual periods ending after June 15, 2009, and the Company adopted this statement effective as of May 1, 2009.  As this guidance relates specifically to disclosures, the adoption of this guidance did not have an impact on the Company’s results of operations or financial condition.
 
 
37

 

In May 2009, the FASB issued accounting guidance which establishes general standards of accounting for, and disclosure of, events that occur after the balance sheet date but before the financial statements are issued or are available to be issued. The Company adopted this guidance during the second quarter of fiscal year 2010. The Company performed an evaluation of events through April 21, 2010, the date which the financial statements for the fiscal year 2010 were issued, for the purpose of identifying events which required adjustment to, or disclosure in, the Company’s financial statements as of and for the year ended January 31, 2010.
 
3.         Fair Value Measurements

ASC 820 (formerly Statement of Financial Accounting Standards (SFAS) No. 157, “Fair Value Measurements”) provides a single definition of fair value, together with a framework for measuring it, and requires additional disclosure about the use of fair value to measure assets and liabilities.
 
ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.  ASC 820 establishes a three-level hierarchy, which encourages an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.  The three levels of the hierarchy are defined as follows:

Level 1 – inputs to the valuation techniques that are quoted prices in active markets for identical assets or liabilities

Level 2 – inputs to the valuation techniques that are other than quoted prices but are observable for the assets or liabilities, either directly or indirectly

Level 3 – inputs to the valuation techniques that are unobservable for the assets or liabilities

Effective February 2, 2008, the Company adopted ASC 820 for financial assets and liabilities measured at fair value and other non-financial assets and liabilities measured at fair value on a recurring basis.
 
The Company had no financial instruments measured at fair value on a recurring basis for the fiscal year ended January 31, 2010 or the fiscal year ended January 31, 2009.
 
Effective July 31, 2009, the Company adopted ASC Topic 825 (ASC 825-10-65) (formerly FASB Staff Position (FSP) FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments”).  ASC 825 requires that the fair value of all financial assets and liabilities for which it is practicable to estimate fair value and are within the scope of SFAS 107, “Disclosures about Fair Value of Financial Instruments,” be disclosed for interim and annual periods.
 
The Company’s financial instruments not measured at fair value on a recurring basis include cash and certain cash equivalents, accounts receivable, short-term borrowings, accounts payable, accrued liabilities and long-term debt and are reflected in the financial statements at cost.  With the exception of the long-term debt, cost approximates fair value for these items due to their short-term nature.  The fair value of our variable rate bond financing approximates the carry value.  The fair value of our fixed rate bond financing was not practicable for the Company to estimate. The Company currently has not developed a valuation model necessary to make the estimate and the cost of obtaining an independent valuation appears excessive considering the materiality of the instruments to the entity.
 
 
38

 

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

   
2010
   
2009
 
             
Accounts receivable
           
    Trade
  $ 2,697     $ 2,744  
 Allowance for doubtful accounts
    (60 )     (45 )
    $ 2,637     $ 2,699  
                 
Inventories
               
 Raw materials
  $ 1,436     $ 2,006  
 Finished goods
    1,721       2,280  
    $ 3,157     $ 4,286  
                 
Accounts Payable and accrued liabilities
               
Accounts payable
               
   Trade
  $ 720     $ 1,031  
  Equipment and other
    6       453  
Accrued Liabilities
               
Payroll
    759       746  
 Other
    712       456  
    $ 2,197     $ 2,686  
                 

5.        Property, Plant and Equipment

   
2010
   
2009
 
Property, plant and equipment
           
Land
  $ 1,547     $ 1,547  
 Buildings
    10,237       8,950  
 Equipment
    16,939       15,961  
 Construction in progress
    186       1,189  
                 
    $ 28,909     $ 27,647  
Less:  Accumulated depreciation
    (9,754 )     (8,037 )
    $ 19,155     $ 19,610  

Depreciation expense from property, plant and equipment for the fiscal years ended January 31, 2010 and 2009 was $1,729,000 and $1,800,000, respectively.

6.        Concentration of credit risk
 
Financial instruments that potentially subject the Company to significant concentrations of credit risk consist principally of cash and cash equivalents, restricted cash, short-term investments and trade accounts receivable. Receivables arising from sales to customers are generally not significant individually and are not collateralized; as a result, management continually monitors the financial condition of its customers to reduce the risk of loss. The Company had three customers who individually exceeded 10% of sales, who collectively accounted for 69% and 44% of total trade accounts receivable at January 31, 2010 and 2009, respectively, and who collectively accounted for 58% and 59% of total sales during the fiscal year ending January 31, 2010 and 2009, respectively.

The Company invests its cash and cash equivalents in high quality issuers. These cash balances may be insured by the Federal Deposit Insurance Corporation, the Canada Deposit Insurance Corporation, the Securities Investor Protection Corporation or through other private insurance purchased by the issuer. The Company maintains its cash in demand deposits and money market accounts held primarily by four banks and in the normal course of business, maintains cash balances in excess of these insurance limits.
 
 
39

 

7.        Operating line of credit
 
As of May, 2009 the company has chosen to not carry an operating line of credit.

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

   
2010
   
2009
 
Tax-exempt bonds
  $ 5,787     $ 6,664  
Total debt
    5,787       6,664  
Less: current portion
    (899 )     (877 )
Long-term debt
  $ 4,888     $ 5,787  

On September 14, 2006, the Company entered into a bond financing agreement in the amount of $1,600,000 with GE Capital Public Finance, Inc. (“GECPF”) to fund the purchase and installation of manufacturing equipment to be used in connection with the closure and relocation of the Bellingham, Washington production facility to the new Ferndale, Washington manufacturing and warehouse facility.  GECPF agreed to fund and guarantee the Economic Development Revenue Bond issued by the Washington State Economic Finance Authority at a fixed interest rate of 5.70%, amortized over 90 months with interest-only payments during the six months of construction.  If Absorption defaults under the terms of the loan agreement, including failure to pay any amount when due or violating any of the financial and other covenants, GECPF may accelerate all amounts then-owing under the bond.  Costs incurred in issuing the bond were $32,000.  The bond is secured by the equipment financed. At January 31, 2010 and 2009 the balance outstanding was $1,028,000 and $1,240,000, 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 ( 0.36 % as of  March 25, 2010) plus a  letter of credit fee of 0.95%, a remarketing fee of 0.125% and a $2,000 annual trustee fee.  The term of these bonds is seven years for the equipment portion and 15 years for the real estate portion.  The bond is secured by the property, building, and equipment financed.  At January 31, 2010 and 2009, the balance outstanding was $2,800,000 and $3,300,000, respectively.  The letter of credit expires September 2, 2011, at which time it will need to be renewed.

In March 2003, the Company completed a $2,910,000 bond financing, comprised of $2,355,000 as tax exempt and $555,000 as taxable.  The bonds were issued through the Washington Economic Development Finance Authority in Washington State.  The purchaser and holder of the bonds is GECPF.  The tax exempt bonds have a fixed rate of 5.38% with a term of 190 months, maturing February 2019, and with interest-only payments for the first 52 months.  The taxable bonds had a fixed rate of 5.53% a term of 52 months, and matured in August 2007. The indebtedness underlying the bonds is secured by a mortgage on the real property, and a security interest in the equipment assets, located in Whatcom County, Washington. At January 31, 2010 and 2009, the balance outstanding was $1,959,000 and $2,124,000 on the tax-exempt bonds, respectively.
 
 
40

 

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

   
Long-term
 
   
Debt
 
Fiscal Year ending January 31,:
     
2011
  $ 899  
2012
    922  
2013
    646  
2014
    671  
2015
    462  
Thereafter
    2,187  
         
    $ 5,787  

9.        Capital stock
 
Common shares

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

During both fiscal years 2010 and 2009, no common stock options were exercised.

Stock options

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

The exercise price of stock options under the 2003 Omnibus Plan will be at least equal to the fair market value of the Common Shares on the date of grant for each incentive stock option or an amount equal to no less than 85% of fair market value for each non-qualified stock option, or the acceptable discount amount allowed under applicable securities laws. The exercise price of options granted under the 2003 Omnibus Plan must be paid in cash, property, qualifying services or under a qualifying deferred payment arrangement. In addition, subject to applicable law, the Company may make loans to individual grantees on such terms as may be approved by the Board of Directors for the purpose of financing the exercise of options granted under the 2003 Omnibus Plan and the payment of any taxes that may be due in respect of such exercise. The Compensation Committee will fix the term of each option, but no option under the 2003 Omnibus Plan will be exercisable more than ten years after the option is granted. Each option will be exercisable at such time or times as determined by the Compensation Committee, provided, however, that no stock option granted under the 2003 Omnibus Plan, or any portion thereof, to any grantee who is subject to Section 16 of the Exchange Act shall be exercisable prior to seven (7) months after the grant date of the option; and stock options, or any portion thereof, granted to grantees who are not subject to Section 16 of the Exchange Act shall not be exercisable prior to ninety (90) days after the grant date of the option. Upon a grantee’s termination of employment with the Company or its subsidiary (other than as a result of death), the 2003 Omnibus Plan provides for an expiration of any outstanding options expire immediately or within a period of 12 months or less, depending upon the cause of termination. No option shall be transferable by the option holder otherwise than by will or the laws of descent.
 
 
41

 

The following table summarizes the Company’s stock option activity for the years ended January 31, 2010 and 2009:
         
Weighted
       
   
 
   
Average
   
Intrinsic
 
   
Shares
   
Price
   
Value
 
Outstanding at January 31, 2008
    563,517     $ 3.95     $ 196,800  
Granted
    174,680       3.55          
Exercised
    -       -          
Repurchased, surrendered or expired
    (42,517 )     (3.24 )        
                         
Outstanding at January 31, 2009
    695,680     $ 3.89     $ -  
Granted
    -       -          
Exercised
    -       -          
Repurchased, surrendered or expired
    (8,566 )     (3.78 )        
                         
Outstanding at January 31, 2010
    687,114     $ 3.90     $ 472,014  
Vested
    312,303     $ 4.08     $ 165,203  
 
The following table summarizes information about options outstanding at January 31, 2010:
 
 
   
 
   
Weighted
   
 
         
 
 
 
   
Number outstanding at
   
average
   
Outstanding
   
Number
   
Exercisable
 
Range of
   
outstanding at
   
remaining
   
weighted average
   
exercisable at
   
weighted average
 
exercise
   
January 31,
   
contractual life
   
average
   
January 31,
   
average
 
prices
    2010      (months)     exercise price     2010     exercise price  
$ 3.20       100,000       39     $ 3.20       25,000     $ 3.20  
  3.25       40,000       4       3.25       40,000       3.25  
  3.55       168,014       59       3.55       43,203       3.55  
  3.60       100,000       50       3.60       15,000       3.60  
  4.00       40,000       11       4.00       40,000       4.00  
  4.60       139,100       20       4.60       49,100       4.60  
  4.70       100,000       14       4.70       100,000       4.70  
                                             
$ 3.20 – 4.70       687,114       34     $ 3.90       312,303     $ 4.08  
 
At January 31, 2010, the Company had 365,326 remaining Common Shares available to be granted under the 2003 Omnibus Plan.

There were outstanding options to purchase 7,000 Common Shares issued to individuals who are not employees or directors of the Company as of January 31, 2010.

During December 2009, the board of directors approved an extension of the term to May 31, 2010 for 40,000 outstanding stock options.

Restricted stock units

The Company granted -0- and 75,120 restricted stock units (“RSUs”) to employees during the years ended January 31, 2010 and 2009, respectively. The RSUs have both a service and a performance condition that must be satisfied before vesting will occur.  The fair value of these RSUs is based on the fair value of the Companies common stock on the award date and the probability of achieving the performance condition. The weighted average grant date fair value of the RSUs was -0- and -0- during the years ended January 31, 2010 and 2009, respectively.

During fiscal year 2010, 37,560 RSUs expired. The outstanding RSUs at January 31, 2010 and 2009 were 37,560 and 75,120, respectively.  The intrinsic value of the outstanding RSUs was $170,898 and $197,566 as of January 31, 2010 and 2009, respectively.
 
 
42

 

All stock options granted by the Company that have not been exercised into common shares prior to the effective time of the Arrangement will be cancelled for cash consideration equivalent to the positive difference, if any, between $4.75 and the exercise price thereof, all in accordance with the terms of the Arrangement Agreement and all of the Company’s outstanding restricted stock units ("RSUs") that have not been converted into common shares of the Company prior to the effective time of the Arrangement will be cancelled for $4.75 per RSU.

10.     Employee benefit plan
 
The Company initiated a 401(k) savings plan for employees during fiscal year 2006. Employees with at least 12 months of service are eligible to participate. Under the terms of the retirement savings plan, the Company provides matching contributions equal to 100% of each participant’s contribution up to 3% of a participant’s eligible compensation and 50% of each participant’s contribution over 3% up to a maximum of 5%. The Company’s contributions to the plan totalled $103,000 and $107,000 for the years ended January 31, 2010 and 2009, respectively.
 
11.      Related party transactions
 
General and administrative expenses for fiscal year 2010 and 2009 included $76,000 and $81,000, respectively, each year for office rent and related services which were incurred on a cost reimbursement basis from a corporation owned and controlled by an officer and director of the Company. At January 31, 2010 and 2009, $6,000 and $5,000, respectively, were owing to this related party.
 
In connection with the Arrangement, in response to an unsolicited offer to purchase the Company, the Company engaged in an auction process to solicit potential bids related to the sale of the Company and incurred significant costs in connection therewith.  Specifically, included in the Company’s related party payables for the third quarter of fiscal year 2010 is $326,000 owed to Arctic Acquisitions, Inc. (“Arctic”), an entity partially owned by certain of the Company’s executive officers and one of its directors, as reimbursement of certain fees and expenses incurred by Arctic during the Company’s auction process. The independent members of the Company’s board of directors and the Company’s audit committee approved the reimbursement of these expenses.

12.     Income taxes
 
The components of income before income taxes are as follows (in thousands of U.S. dollars):
 
   
2010
   
2009
 
             
U.S.
  $ 4,019     $ 3,784  
Canada
    (1,170 )     (130 )
    $ 2,849     $ 3,654  

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

   
2010
   
2009
 
             
U.S.
  $ 1,133     $ 1,103  
State
    15       52  
Canada
    10       20  
    $ 1,158     $ 1,175  
 
 
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The components of the provision for deferred income taxes consist of the following (in thousands of U.S. dollars):

   
2010
   
2009
 
             
U.S.
  $ 231     $ 339  
State
    10       (99 )
Canada
    -       -  
    $ 241     $ 240  
 
The provision for income taxes differs from the amount computed by applying the statutory income tax rate to net income before taxes as follows (in thousands of U.S. dollars):

   
2010
   
2009
 
             
Income tax at statutory rate (Canada)
  $ 851     $ 1,128  
Difference in foreign tax rate
    153       118  
Permanent differences
    16       10  
Stock option expense
    138       151  
Domestic production deduction
    (74 )     (64 )
Unrealized foreign exchange loss
    91       -  
Change in valuation allowance
    382       (333 )
Change in tax rate
    69       32  
Effect from remeasurement from
               
Canadian currency
    (187 )     300  
State and local , net
    20       (18 )
Other differences
    (60 )     91  
    $ 1,399     $ 1,415  
 
Deferred income taxes are provided for temporary differences. Deferred income tax assets and liabilities are comprised of the following (in thousands of U.S. dollars):

   
2010
   
2009
 
Deferred income tax assets
           
      Net operating loss carryforward
  $ 297     $ -  
      Intangibles     16       16  
      Non-deductible liabilities and other
    172       172  
      State tax credits
    172       168  
      Unrealized loss
    119       35  
      Valuation allowance
    (433 )     (51 )
    $ 343     $ 340  
Deferred income tax liabilities
               
      Property, plant and equipment
    (1,775 )     (1,532 )
    $ (1,775 )   $ (1,532 )
 
The deferred state tax credits referenced above are job tax credits from the state of Georgia which are available to offset Georgia taxable income in future years. These credits can be carried forward 10 years and begin expiring January 31, 2018.

The Company has recorded a valuation allowance against deferred tax assets which relates to uncertainties related to utilization of Canadian deferred tax assets.  The valuation allowance increased by $382,000 during the year ended January 31, 2010 and decreased by $333,000 during the year ended January 31, 2009.
 
The Company has not provided for Canadian deferred income taxes on undistributed earnings of International Absorbent’s U.S. subsidiary because of its intention to indefinitely reinvest these earnings in the U.S. The determination of the amount of the unrecognized deferred U.S. income tax liability related to the undistributed earnings is not practicable.
 
 
44

 

A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (in thousands):

   
2010
   
2009
 
Balance at beginning of year
  $ 149     $ 45  
Settlements
    -       -  
Additions for tax positions of current period
    -       70  
Additions for tax positions of prior periods
    -       34  
    $ 149     $ 149  
 
The Company is subject to taxation in the United States, Canada and various state jurisdictions. The material jurisdictions that are subject to examination by tax authorities are for tax years after fiscal year 2005. The Company classifies interest and penalties on tax uncertainties as components of the provision for income taxes.

13.    Commitments and contingencies
 
Operating leases

The Company has entered into various operating lease agreements for equipment that expire in 2010 to 2013. Rental expenses for the year ended January 31, 2010 and 2009 were $134,000 and $251,000, respectively. Minimum annual rental payments under non-cancellable operating leases are approximately $61,000, $48,000, and $1,000 for the years ending January 31, 2011, 2012 and 2013, respectively.

Legal matters

The Company is subject to ordinary routine litigation incidental to the Company’s business.  Currently, there are no material legal proceedings pending to which the Company is a party, or of which any of the Company’s properties is the subject.

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

The Company defines its business segments primarily based upon the market in which its customers sell products, as well as how the Company internally manages its various business activities.  The Company operates principally in two business segments: the animal care industry and the industrial cleanup industry.  Management decisions on resource allocation and performance assessment are made currently based on these two identifiable segments.

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.
 
 
45

 

Business segment data (in thousands of U.S. dollars)
 
   
2010
 
   
Animal
         
 
 
   
Care
    Industrial    
Consolidated
 
                   
Sales, net
  $ 33,884     $ 691     $ 34,575  
Operating cost and expenses
    29,099       655       29,754  
Operating income (loss) before depreciation
    4,785       36       4,821  
and amortization
                       
Depreciation and amortization
                    (1,757 )
Interest expense
                    (226 )
Interest Income
                    11  
                         
Net income before taxes
                  $ 2,849  
 
   
2009
 
   
Animal
   
 
   
 
 
   
Care
   
Industrial
   
Consolidated
 
                   
Sales, net
  $ 34,934     $ 818     $ 35,752  
Operating cost and expenses
    29,246       769       30,015  
Operating income (loss) before depreciation
    5,688       49       5,737  
and amortization
                       
Depreciation and amortization
                    (1,830 )
Interest expense
                    (315 )
Interest Income
                    62  
                         
Net income before taxes
                  $ 3,654  
 
Sales revenues by geographic areas are as follows:

   
2010
   
2009
 
             
United States
  $ 32,358     $ 33,512  
Canada
    961       1,093  
Other countries
    1,256       1,147  
    $ 34,575     $ 35,752  
                 
           Three customers from the Animal Care segment represent 10% or more of the Company’s sales.
               
                 
      2010       2009  
                 
Customer A
  $ 6,986     $ 8,084  
Customer B
    8,962       9,329  
Customer C
    4,048       3,631  
    $ 19,996     $ 21,044  

 
46

 
 
15.     Earnings per share
 
   
2010
 
   
Net Income
   
Shares
   
Per share
 
   
(numerator)
   
(denominator)
   
amount
 
                   
Basic earnings per share
                 
Net income available to stockholders
  $ 1,450,000       6,410,000     $ 0.23  
Effect of dilutive securities
                       
Stock options to purchase common stock
    -       47,000          
Diluted earnings per shares
                       
Net income available to stockholders
  $ 1,450,000       6,457,000     $ 0.22  
                         
                         
                         
 
   
2009
 
   
Net Income
   
Shares
   
Per share
 
   
(numerator)
   
(denominator)
   
amount
 
                   
Basic earnings per share
                 
Net income available to stockholders
  $ 2,239,000       6,410,000     $ 0.35  
Effect of dilutive securities
                       
Stock options to purchase common stock
    -       36,000          
Diluted earnings per shares
                       
Net income available to stockholders
  $ 2,239,000       6,446,000     $ 0.35  
 
The Company excludes all potentially dilutive securities from its diluted net income per share computation when their effect would be anti-dilutive (strike price less than market value). The following common stock equivalents were excluded from the earnings per share computation because the exercise prices of the stock options and rights were greater than or equal to the average price of the common shares, and therefore their inclusion would have been anti-dilutive:

   
2010
   
2009
 
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
    587,114       555,680  
 
 
47

 
 
16.     Selected Quarterly Financial Data (in thousands of U.S. dollars, except per share amounts)
 
The following table sets forth selected quarterly financial data for each of the quarters in fiscal years 2010 and 2009:

   
2010
 
   
Fourth
   
Third
   
Second
   
First
 
   
Quarter
   
Quarter
   
Quarter
   
Quarter
 
                         
Sales, net
  $ 8,481     $ 8,358     $ 9,256     $ 8,480  
Cost of goods sold
    5,741       5,574       5,876       5,364  
Gross Profit
    2,740       2,784       3,380       3,116  
                                 
Selling, general and administrative expenses
    2,335       2,368       2,040       2,213  
                                 
Income from operations
    405       416       1,340       903  
Interest expense
    (53 )     (55 )     (57 )     (61 )
Interest income
    1       2       3       5  
Income before provision for income taxes
    353       363       1,286       847  
                                 
Income tax provision
    (272 )     (327 )     (469 )     (331 )
Net income
  $ 81     $ 36     $ 817     $ 516  
                                 
Basic earnings per share
  $ .01     $ .01     $ .13     $ .08  
Fully diluted earnings per share
  $ .00     $ .01     $ .13     $ .08  
                                 
Weighted average number of shares outstanding
                               
(in thousands)
                               
 Basic
    6,410       6,410       6,410       6,410  
    Diluted
    6,529       6,454       6,448       6,484  
                                 
 
   
2009
 
   
Fourth
   
Third
   
Second
   
First
 
   
Quarter
   
Quarter
   
Quarter
   
Quarter
 
                         
Sales, net
  $ 8,390     $ 9,603     $ 9,298     $ 8,461  
Cost of goods sold
    5,471       6,352       6,496       5,951  
Gross Profit
    2,919       3,251       2,802       2,510  
                                 
Selling, general and administrative expenses
    1,960       1,990       1,820       1,805  
                                 
Income from operations
    959       1,261       982       705  
Interest expense
    (66 )     (88 )     (79 )     (82 )
Interest income
    10       24       14       14  
Income before provision for income taxes
    903       1,197       917       637  
                                 
Income tax provision
    (405 )     (361 )     (355 )     (294 )
Net income
  $ 498     $ 836     $ 562     $ 343  
                                 
Basic earnings per share
  $ .08     $ .13     $ .09     $ .05  
Fully diluted earnings per share
  $ .08     $ .13     $ .09     $ .05  
                                 
Weighted average number of shares outstanding
                               
(in thousands)
                               
Basic
    6,410       6,410       6,410       6,410  
Diluted
    6,485       6,446       6,440       6,467  

 
48

 
 
ITEM 9.  CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None

ITEM 9A(T).  CONTROLS AND PROCEDURES

Disclosure Controls and Procedures

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

Management’s Report on Internal Control Over Financial Reporting

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

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

Management conducted an evaluation of the effectiveness of our internal control over financial reporting as of January 31, 2010, based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this evaluation, management concluded that the Company’s internal control over financial reporting was effective as of January 31, 2010.

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

Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting that occurred during our fourth quarter ended January 31, 2010, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

ITEM 9B.  OTHER INFORMATION

Effective as of April 27, 2010, our board of directors, with Gordon Ellis declaring his interest as a holder of outstanding restricted stock unit performance awards and abstaining from voting, based on the recommendation of our compensation committee and in light of the pending Arrangement, approved an amendment to each Performance Award Agreement for Restricted Stock Units held by our executive officers, each of which was granted on September 17, 2008, to extend the determination date (as defined in each agreement) from April 30, 2010 to May 31, 2010 for purposes of calculating whether the performance targets had been achieved for fiscal year 2010 and determining the vesting percentage for the first 50% of the restricted stock units thereunder.
 
 
49

 
 
PART III

General

As more fully described in our definitive proxy statement filed with the Securities and Exchange Commission (the “SEC”) on April 16, 2010 (the “Proxy Statement”), on December 14, 2009, International Absorbents entered into an Arrangement Agreement (the “Arrangement Agreement”) with IAX Acquisition Corporation, a Delaware corporation (“Parent”), and IAX Canada Acquisition Company Inc., a corporation incorporated under the laws of the Province of British Columbia (“Canada Sub”) and a wholly-owned subsidiary of Parent. The Arrangement Agreement provides that, upon the terms and subject to the conditions set forth in the Arrangement Agreement, Parent, through its wholly-owned subsidiary, will acquire all of the outstanding common shares of International Absorbents for $4.75 per common share in cash, with International Absorbents continuing as the surviving corporation (the “Arrangement”). As a result of the Arrangement, International Absorbents will become a wholly-owned subsidiary of Parent. The consummation of the Arrangement is subject to various closing conditions, including obtaining the approval of the Arrangement by our shareholders and the Supreme Court of British Columbia.  The Arrangement Agreement contains certain termination rights for International Absorbents, Parent and Canada Sub and further provides that, upon termination of the Arrangement Agreement under specified circumstances, International Absorbents may be required to pay Parent a termination fee of 4% of the aggregate purchase price.  Our board of directors and the board of directors of Parent have approved the Arrangement Agreement.  In addition, concurrently with the execution of the Arrangement Agreement, certain of our executive officers, who together hold approximately 11.2% of our issued and outstanding (on a fully diluted basis) common shares, have entered into a support agreement whereby they agreed, among other things, to vote all common shares held by them in favor of the approval of the Arrangement. 

ITEM 10.  DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

Directors and Executive Officers of the Company

The Articles of the Company provide that the number of directors on our board of directors may be determined by a majority of the shareholders, but shall be the greater of three directors, the number of directors most recently set by ordinary resolution and the number of directors who were most recently elected or continuing in office following the retirement of any directors. In addition, the Articles of the Company provide for the division of the board of directors into two classes, whereby the term of office for each class of directors alternately expires upon the second succeeding general meeting. Currently, Class I has two directors with terms expiring in 2010, and Class II has three directors with terms expiring in 2011.

There is no arrangement or understanding between any director or executive officer and any other person pursuant to which the director or executive officer was selected as a director or executive officer.
 
 
50

 

The following table sets forth certain information about our current directors and executive officers as of April 29, 2010.

Name
 
Age
 
Position
Year First Elected or Appointed
Term to Expire
 
Gordon L. Ellis
  63  
Director, Chairman, President, Chief Executive Officer
  1985   2010  
                   
Michael P. Bentley
  47  
Director
  2003   2010  
                   
John J. Sutherland
  60  
Director
  1988   2011  
                   
Lionel G. Dodd
  70  
Director
  2002   2011  
                   
Daniel J. Whittle
  55  
Director
  2003   2011  
                   
David H. Thompson
  49  
Chief Financial Officer, Secretary
  1998   2010  
                   
Douglas E. Ellis
  58  
President of Absorption Corp.
  1998   2010  
                   
Shawn M. Dooley
  50  
Vice President of Absorption Corp.
  1991   2010  

The following is a brief summary of the business experience of each director and executive officer.
 
Gordon L. Ellis became a Class I director of our predecessor West-Norse Resources Ltd in July 1985, which changed its name to Absorptive Technologies Inc. (“Absorptive”) in 1986 and to International Absorbents Inc. in 1999. In July 1988 Mr. G. Ellis was elected executive chairman of the board. Appointed as our president and chief executive officer in November 1996, Mr. G. Ellis has been responsible for managing our business affairs, overall growth and expansion since that time. For the past 14 years, Mr. G. Ellis has devoted half his time to our company and the other half in unrelated venture capital and investment business enterprises. Mr. G. Ellis is also a director of Absorption Corp., our wholly-owned subsidiary (“Absorption”). In 1972, Mr. G. Ellis received a Bachelor of Science degree in geophysics and in 1974 a Masters degree in Business Administration in International Finance, both from the University of British Columbia. Mr. G. Ellis is a registered professional engineer, a chartered director, a member of both the Canadian Institute of Mining Metallurgy and the Society of Exploration Geophysicists. Since September 2005, Mr. G. Ellis has been a director of United States Commodity Funds, LLC, which is the sole general partner of United States Oil Fund, LP, United States Natural Gas Fund, LP, United States 12 Month Oil Fund, LP, United States Gasoline Fund, LP and United States Heating Oil Fund, LP, each a commodity pool listed on the NYSE Arca, which invests primarily in futures contracts. Between June and August 2006, Mr. G. Ellis was a director of El Capitan Precious Metals Inc. Mr. G. Ellis is a director/trustee of Polymer Solutions, Inc., a public company that liquidated in 2004 (“PSI”). Mr. G. Ellis is the brother of Douglas Ellis, the president of Absorption.

Mr. G. Ellis possesses valuable corporate leadership expertise and exceptional business acumen. As the longest standing board member, Mr. G. Ellis provides the board with useful insights into management, as well as knowledge of all aspects of our business and its history.
 
 
51

 

John J. Sutherland became a Class II director of our predecessor Absorptive in August 1988 and has served as a director since that time. He is chair of the audit committee and serves on the corporate governance committee and the strategic alternatives special committee. Mr. Sutherland graduated from the BC Institute of Technology in 1970, and in 1976 received his certified general accountant designation. Since February 2007, Mr. Sutherland has been vice president and chief financial officer of Goldgroup Resources Inc., a private company involved in the exploration and development of mining properties focused in Mexico. In May 2007, Mr. Sutherland joined Uracan Resources, a uranium exploration company listed on the TSX Venture Exchange (“TSX-V”), as its chief financial officer and corporate secretary, and he became a director of Uracan Resources in April 2009. He joined Arco Resource Group (Formerly Atomic Minerals Ltd.) in December 2007 as a director and serves on the compensation and audit committees. Arco Resource Group engages in mining exploration and development and is listed on the TSX-V. In October 2007, Mr. Sutherland joined Silex Ventures Ltd., a capital pool company listed on the TSX-V, as a director and serves on the company’s audit committee. From June 2002 to January 2010, Mr. Sutherland was a director of Aquiline Resources Inc., a publicly held company listed on the Toronto Stock Exchange (“TSX”), engaged in gold and silver exploration projects in Argentina. He served on the compensation and audit committees of Aquiline Resources and was also a member of its special committee in connection with a take-over offer valued at $626 million, which was completed in January 2010. From June 2007 to November 2009, Mr. Sutherland was a director of Polo Biology Global Group Corporation (formerly Amicus Capital Corp, a capital pool company), a manufacturer specializing in probiotic and enzyme-based health and beauty products and listed on the TSX-V. From January 2007 to September 2008, Mr. Sutherland served as a director and the president of Cyprium Resources Inc., a company engaged in mining and exploration listed on the OTC Bulletin Board. From March 2003 to September 2006, Mr. Sutherland was vice president and director of Tekion, Inc., a private company developing and marketing fuel cells and a director/trustee of PSI.  From March 1997 until his resignation on January 15, 2001, Mr. Sutherland was president and chief executive officer of ASC Avcan Systems Corporation (“ASC”), a public company listed on the TSX-V and primarily engaged in providing technology services to utility companies. On January 31, 2001, the controlling shareholder placed ASC in bankruptcy protection and KPMG Inc. was appointed as trustee in bankruptcy. On April 26, 2001, the assignment in bankruptcy was annulled by the Supreme Court of British Columbia and a proposal to all creditors with claims totalling approximately $1.3 million was approved by the court. KPMG Inc. as trustee in bankruptcy subsequently released ASC’s assets to ASC and operations resumed. In December 2002 ASC changed its name to Optimal Geomatics Inc.

Mr. Sutherland brings significant financial expertise and extensive public-company experience to our board of directors, as well as over 22 years of service to and knowledge of our company. He has extensive knowledge in financial management and corporate matters gained through his international business experience as an executive officer and director in a variety of industries. Mr Sutherland has a solid understanding of business opportunities as he has completed a number of mergers, acquisitions, strategic alliances, venture capital and private equity transactions, and reorganizations and restructurings with both public and private companies. He is a philanthropist and generously served on a number of boards of non-profit charitable organizations. Mr. Sutherland provides our board with accounting and finance expertise, valuable management experience and a solid understanding of company business opportunities.

Lionel G. Dodd has been a Class II director since October 2002. He is chair of the corporate governance committee and a member of the compensation committee and the strategic alternatives special committee. Mr. Dodd received an MBA from the University California at Berkeley in 1963 and a Bachelor of Commerce Degree from the University of Saskatchewan in 1962. From November 1999 to May 2008, Mr. Dodd was a director and served on the corporate governance and audit committees of Pope & Talbot, Inc., a publicly-held pulp and wood products company, which filed for protection under the Companies Creditors Arrangement Act of Canada and for relief under the United States Bankruptcy Code, and is currently within the jurisdiction of these two acts. Between January 2007 and January 2008, Mr. Dodd was a director of Infowave Software Inc., a publicly-held company listed on the TSX providing advanced power electronic products and systems, where he also served on the corporate governance, audit and special committees. Between November 2004 and May 2007, Mr. Dodd was a director and served as a member of the audit committee of Xantrex Technology Inc., a publicly-held company listed on the TSX which provides advanced power electronics products. Between 2002 and 2005, Mr. Dodd was a director of Braintech, Inc., a publicly-traded company on the OTC Bulletin Board, which gives vision to industrial robots that handle and assemble parts. He served on the corporate governance, audit and compensation committees of Braintech. In addition, between 2001 and 2005, Mr. Dodd was a director and served on the corporate governance & compensation committees of Napier Environmental Technologies Inc., a company listed on the TSX which manufactures environmental paint removal and wood restoration products. In November 2004 Napier filed a Notice of Intention to make a proposal under Canada’s Bankruptcy and Insolvency Act and emerged from protection of that Act in July 2005 with the same name and listing. Mr. Dodd has served as an executive officer or director for a number of publicly traded and private companies in Canada and the United States prior to the periods described above.
 
Mr. Dodd brings to the board extensive knowledge of cross-border manufacturing and marketing operations, has valuable experience in governance and regulatory environments, and possesses excellent judgment in risk management. Mr. Dodd’s expertise in developing business and financial plans, succession planning and recruiting also make him a valuable member of our board. Further, he has valuable experience with raising capital, joint ventures, acquisitions, post-acquisition integration, divestments, strategic alliances, expansion, downsizing and restructuring.
 
 
52

 
 
Daniel J. Whittle has been a Class II director since June 2003. Mr. Whittle is chair of the compensation committee, a member of the audit committee and a member of the strategic alternatives special committee. Mr. Whittle received a Bachelor of Science degree in physics from Lebanon Valley College in 1976, and a Ph.D in physics from the University of Pennsylvania in 1982. Mr. Whittle is currently the president of Patent Leverage LLC, which was formed in June 2003 after Mr. Whittle became registered as a U.S. patent agent. From April 2000 to June 2003, Mr. Whittle served as the senior vice president at Gretag Professional Imaging, and subsequently Oce Display Graphics Systems following an acquisition. Prior to that, from July 1999 to February 2000, Mr. Whittle was a director of H.K. Productions in London, England, a subsidiary of Gretag Imaging. His executive management experience also includes positions as director of engineering at Firetrol, and vice president of R&D and manufacturing and later president and chief executive officer of Cymbolic Sciences. Mr. Whittle held various technical and management positions in engineering and manufacturing for 12 years at IBM. During 1994, he was also a course instructor and director of Management Development, Inc. a non-profit organization affiliated with the Kenan-Flagler Business School at the University of North Carolina. Since March 2008, Mr. Whittle has served on the Seattle Chapter Board of the Licensing Executives Society, a professional organization.
 
Mr. Whittle brings to the board valuable expertise in financial management, marketing and manufacturing from his background in senior management and directorships with global businesses. His contributions on the board include areas such as intellectual property planning, compensation, executive and employee management, and knowledge of the economy of the Pacific Northwest of the US, where our main facility is located.
 
Michael P. Bentley has been a Class I director since June 2003. Mr. Bentley is chair of the strategic alternatives special committee and a member of the corporate governance, audit and compensation committees. He has a Bachelor of Arts degree from the University of British Columbia and a Master of Science in management from Stanford University. Since February 1999, Mr. Bentley has been president of M64 Management, which provides governance, strategy and marketing consulting services. Since December 2003, Mr. Bentley has been a director, and since November 2008 president, of Sierra Mountain Minerals, Inc. (doing business as SierraSil Health Inc.), a company that produces and markets a mineral health supplement. Prior to that, he served in a variety of management positions at Canfor Corporation from 1985 to 1999. Since November 2009 Mr. Bentley has served on the Canadian Forces Liaison Council (BC Region). Past board positions include Wittke Inc., which traded on the TSX-V until it was acquired in 2002, and a number of private companies and charitable organizations including the Business Family Centre at the UBC Sauder School of Business.
 
Mr. Bentley brings valuable knowledge of production, marketing, and sales to his role as a director, acquired through various executive management and board positions. Mr. Bentley also possess an excellent understanding of the pulp and fiber industry, an industry that provides most of our raw goods.
 
David H. Thompson has been an employee of Absorption since April 1993, and has been our chief financial officer since March 1998, and secretary since March 2003. Mr. Thompson holds a Bachelor’s degree in Finance and International Business from the University of Washington.
 
Douglas E. Ellis served as a director of our company from July 1998 until June 2004. Mr. D. Ellis became our chief operating officer in August 2004. He became an employee of Absorption in February 2003 and had been providing management services to our company through Current Systems, a proprietorship owned by Mr. D. Ellis, since April 1986. He has served as president of Absorption since March 1999. Prior to joining Absorption, Mr. D. Ellis spent many years in the heavy construction industry as a project engineer for pulp and paper mills and related projects. Mr. D. Ellis is the brother of Gordon L. Ellis, who is a director of our company and of Absorption, as well our chairman, president and chief executive officer. Mr. D. Ellis holds a diploma in Structural Engineering.

Shawn M. Dooley served as a director of our company from July 1998 until June 2003. Mr. Dooley has been associated with Absorption since 1991 and has been vice president of Absorption since June 1998. Prior to joining Absorption, Mr. Dooley spent nine years at Purina Mills, Inc. Mr. Dooley holds Bachelor of Science degrees in Agricultural Education and Agricultural Resource Economics from Oregon State University.
 
Except as described above, there are no family relationships among our directors and officers.
 
 
53

 
 
Section 16(a) Beneficial Ownership Reporting Compliance
 
Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our officers, directors and persons who beneficially own more than 10% of a registered class of our equity securities to file reports of securities ownership and changes in such ownership with the SEC. Officers, directors and greater than 10% beneficial owners also are required by the rules promulgated by the SEC to furnish to us copies of all Section 16(a) forms they file.
 
Based solely on our review of the copies of such forms received by us, we believe that, during the fiscal year ended January 31, 2010, such officers, directors and greater than 10% beneficial owners filed all reports required of them on a timely basis.
 
Code of Business Conduct and Ethics
 
We adopted a code of business conduct and ethics applicable all employees, including our executive officers, and to our directors, which is a “code of ethics” as defined by applicable SEC rules. The code of business conduct and ethics in its current version is publicly available on our website at www.internationalabsorbents.com, under the main menu item titled “Governance.” If we make any amendments to the code of business conduct and ethics other than technical, administrative, or other non-substantive amendments, or grant any waivers, including implicit waivers, from a provision of the code of business conduct and ethics to our principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, we will disclose the nature of the amendment or waiver, its effective date, and to whom it applies, on our website or in a current report on Form 8-K filed with the SEC.
 
Audit Committee
 
The audit committee is composed of John J. Sutherland, chair, Michael P. Bentley and Daniel J. Whittle. The board of directors has determined that, after consideration of all relevant factors, Messrs. Sutherland, Bentley and Whittle qualify as “independent” directors under applicable rules of NYSE Amex and the SEC. Each member of the audit committee is able to read and understand fundamental financial statements and footnotes, including our consolidated balance sheets, consolidated statements of earnings, consolidated statements of changes in stockholders’ equity and consolidated statements of cash flows. The board of directors has designated Mr. Sutherland as the “audit committee financial expert” as defined under applicable SEC rules, and also determined that he possesses the requisite “financial sophistication” under applicable NYSE Amex Standards. The current version of the audit committee charter is posted on our internet site, www.internationalabsorbents.com, under the main menu item titled “Governance.”
 
The audit committee has been appointed by the board to oversee our accounting and financial reporting and the audits of our financial statements. The audit committee is directly responsible for the appointment, compensation, retention and oversight of the work of our independent auditors. Among other responsibilities, the audit committee pre-approves all auditing and permissible non-auditing services of the independent auditors (subject to de minimus exceptions); reviews the audited financial statements with management; obtains, reviews and discusses reports from the independent auditors; reviews major proposed changes to our accounting and auditing policies suggested by the independent auditors; reviews with management correspondence from regulators that raise material accounting policy issues; assesses the independence of the independent auditors; reviews and discusses with management and the independent auditors the adequacy of our internal controls, internal audit procedures and disclosure controls and procedures; and reviews and approves all related-party transactions. The audit committee held four meetings during fiscal year 2010.
 
 
54

 
 
ITEM 11. EXECUTIVE COMPENSATION

COMPENSATION OF NAMED EXECUTIVE OFFICERS AND DIRECTORS
 
Summary Compensation Table
 
The following table sets forth the compensation paid for services rendered to our company and our subsidiary during the past two fiscal years to (i) our chief executive officer and (ii) the two most highly compensated executive officers other than the chief executive officer who were serving as executive officers at the end of fiscal 2010 and whose total compensation for fiscal 2010 exceeded $100,000 in the aggregate (collectively, the “named executive officers”).
 
Name and
Principal Position
 
Fiscal Year
 
Salary
($)
   
Bonus
($)(2)
   
Stock Awards
($)(3)
   
Option Awards
($)(3)
   
Nonequity Incentive Plan Compensation ($)(4)
   
All Other Compensation
($)
   
Total
($)
 
 Gordon L. Ellis Chairman,   2010   $ 106,080 (1)   $ 25,174     $ 0     $ 0     $ 16,069     $ 0     $ 147,323  
President and Chief Executive Officer
 
2009
  $ 102,590 (1)   $ 0     $ 0     $ 81,153     $ 49,654     $ 0     $ 233,397  
David H. Thompson   2010   $ 164,800     $ 38,563     $ 0     $ 0     $ 17,304     $ 9,283 (5)   $ 229,950  
Chief Financial Officer and Secretary
 
2009
  $ 160,000     $ 0     $ 0     $ 81,153     $ 54,240     $ 8,416 (5)   $ 303,809  
Douglas E. Ellis
 
2010
  $ 164,800     $ 27,027     $ 0     $ 0     $ 28,840     $ 19,307 (6)   $ 239,974  
Chief Operating Officer and President of Absorption
 
2009
  $ 160,000     $ 0     $ 0     $ 81,153     $ 54,240     $ 18,161 (6)   $ 313,554  
 
(1)  
The compensation earned by Mr. G. Ellis in his role as chief executive officer is paid to Gordann, an entity owned and controlled by Mr. G. Ellis.
 
(2)  
Represents discretionary cash bonuses awarded to the executive officers for fiscal year 2010 outside of the cash incentive plan, as described below in the section titled “Short-Term Incentives – Cash Bonuses for Executive Officers.”
(3)  
The amounts in these columns reflect the aggregate grant-date fair value of equity awards granted during the indicated fiscal year in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification Topic 718 for stock-based compensation (formerly FAS 123R) pursuant to the 2003 Omnibus Incentive Plan. Assumptions used in the calculation of these amounts are included in Note 2 (Significant Accounting Policies) to our audited financial statements for the fiscal year ended January 31, 2010, under the heading “Stock-Based Employee Compensation,” which financial statements are included in this Annual Report. In light of the proposed Arrangement, no stock-based awards were granted to the named executive officers during fiscal year 2010, as noted below under the heading “Long-Term Incentives – Equity Compensation.”
(4)  
Consists of cash incentive plan compensation earned upon the achievement of certain performance objectives, as described below in the section titled “Short-Term Incentives – Cash Bonuses for Executive Officers.”
(5)  
Payments made or accrued on Mr. Thompson’s behalf include benefits under our 401(k) plan in the amount of $8,762 and 7,895 for fiscal years 2010 and 2009, respectively, and life insurance premiums of $521 for each of fiscal years 2010 and 2009.
(6)  
Mr. D. Ellis is not eligible to participate in our benefit plans and receives cash in lieu of certain benefits paid to U.S. resident employees and Mr. Thompson. Payments made or accrued include cash in lieu of comprehensive benefits of $5,000 for each of fiscal years 2010 and 2009; cash in lieu of matching benefits under our 401(k) plan in the amount of $8,962 and $8,218 for fiscal years 2010 and 2009, respectively; Medicare-equivalency payments of $3,249 and $2,979 for fiscal years 2010 and 2009, respectively; and reimbursement of Health Insurance BC of $1368 and $1,236 for fiscal years 2010 and 2009, respectively. Also included are life insurance premiums of $728 for each of fiscal years 2010 and 2009, paid for the benefit of Mr. D. Ellis.
 
 
55

 
 
Description of Employment Agreements With our Named Executive Officers
 
Below is a description of each named executive officer’s existing employment agreement with us.  In the event that the Arrangement is completed, each of Shawn Dooley, Douglas Ellis and David Thompson has agreed to amend his existing employment agreement effective as of the completion of the Arrangement, to, among other things, amend the term of the employment agreement and the definitions of “cause” and “good reason,” and provide for customary non-competition, non-solicitation and cooperation provisions. In the event that the Arrangement is consummated, effective as of the completion of the Arrangement, Gordon Ellis has agreed to terminate his employment agreement and accept a consulting services agreement with us for a term of three years.  Pursuant to the consulting services agreement, Gordon Ellis would receive a consulting fee of $100,000 per year and will be subject to non-competition, non-solicitation and cooperation provisions.  The consulting services agreement will also provide Gordon Ellis with severance payments for termination of the consulting agreement without cause.  The terms of these proposed arrangements with our executive officers are further described in the Proxy Statement.
 
Gordon L. Ellis entered into an employment agreement with us on October 1, 1998. The initial term of the agreement was five years, and thereafter it automatically renews for additional two-year terms, with the current term expiring September 30, 2011, unless either party gives notice of termination within 90 days prior to the expiration of the then-current term. The agreement is also subject to earlier termination. Pursuant to the agreement, effective June 1, 2000, we pay 65% of the average base salary of our two highest paid executives to Gordann, a company controlled by Mr. G. Ellis. In addition, the agreement provides that the board shall determine on an annual basis an appropriate incentive bonus for Mr. G. Ellis based on how much time and effort he has contributed to the company to its success over the past year, as discussed below under “Short-Term Incentives – Cash Bonuses for Executive Officers.” Moreover, under the employment agreement, Mr. G. Ellis is entitled to participate in our benefit plans and the 2003 Omnibus Incentive Plan (the “2003 Omnibus Plan”). The agreement further states that in any one year, Mr. G. Ellis will be able to exercise his vested options at which time he will be eligible for immediate reissue of an equal number of new options; however, such reissue options have not been granted to Mr. G. Ellis under the 2003 Omnibus Plan, and grants are instead made as described below.
 
David H. Thompson entered into an amended and restated employment agreement with us on December 30, 2008, primarily to clarify and modify certain types of payments in order to address the requirements of Section 409A of the Code (“Section 409A”). The agreement provides that once Mr. Thompson reaches the age of 60, the term of the agreement will be renewable each year automatically unless either party gives notice of termination within 90 days prior to the expiration of the then-current term. Under this agreement, Mr. Thompson’s annual base salary was set at $160,000. This base salary is reviewed annually based on the criteria discussed below under “Determination of Base Salaries for Executive Officers.” The agreement also provides that the board shall set and determine each year how bonuses will be awarded to Mr. Thompson based on target criteria to be agreed to by Mr. Thompson and our compensation committee at the beginning of each fiscal year in accordance with our compensation policies as described below under “Short-Term Incentives – Cash Bonuses for Executive Officers,” and that these bonuses, if earned, are paid on a predetermined date the following year. In addition, under the employment agreement, Mr. Thompson is entitled to participate in our benefit plans and the 2003 Omnibus Plan.
 
Douglas E. Ellis entered into an amended and restated employment agreement with Absorption on December 30, 2008 primarily to clarify and modify certain types of payments in order to address the requirements of Section 409A. The term of the new agreement expires on October 6, 2010; which is the current expiration date of Mr. D. Ellis’s work visa (Mr. D. Ellis is a resident of Canada). In addition, the agreement provides that once Mr. D. Ellis reaches the age of 60, the term of the agreement will be reduced to a term of one year, with automatic renewals thereafter on an annual basis for additional one-year terms unless either party gives notice of termination within 90 days prior to the expiration of the then-current term. Under this agreement, Mr. D. Ellis’s annual base salary was set at $160,000. This base salary is reviewed annually based on the criteria discussed below under “Determination of Base Salaries for Executive Officers.” The agreement also provides that the board shall set and determine each year how bonuses will be awarded to Mr. D. Ellis based on target criteria to be agreed to by Mr. D. Ellis and our compensation committee at the beginning of each fiscal year in accordance with our compensation policies as described below under “Short-Term Incentives – Cash Bonuses for Executive Officers,” and that these bonuses, if earned, are paid on a predetermined date the following year. In addition, under the employment agreement, Mr. D. Ellis is entitled to participate in our benefit plans (on a cash equivalent basis given his status as a Canadian resident) and the 2003Omnibus Plan.
 
See the section below titled “Potential Payments Upon Termination or Change in Control” for additional information concerning the employment agreements with our named executive officers.
 
 
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Determination of Base Salaries for Executive Officers
 
In general, our policy with respect to base salaries is to compensate executive officers for services rendered during the fiscal year. Unlike our cash bonuses and equity compensation programs described below, which are designed to reward executive officers for their individual and group performance along with our results and are tied to various short-term and long-term goals and milestones, the purpose of base salary is to provide executive officers with a baseline level of earnings that is competitive for similarly situated employees. Our policy is to pay a competitive base salary at the 50th percentile of the market for such positions. The compensation committee also gives additional consideration to experience, performance and knowledge.
 
In accordance with this policy, base salaries for three of our executive officers – namely, the chief financial officer, the vice president of Absorption and the chief operating officer – are determined by the compensation committee by reviewing comparable positions with similar companies in the same job markets and surveys that are publicly available, as well as consulting contracts that have been commissioned. Those sources included Milliman, Inc. (“Milliman”), Washington Employers, Inc. (“WE”), and United States and Washington State government labor statistics. The market data reviewed suggested that proposed increases would align the executive officers’ salaries with the average median salary for officers at similarly situated companies based on revenue and industry in North America. Based on this information, for fiscal year 2010, the compensation committee approved a 3%, or $4,800, increase in the annual base salary for each of the chief financial officer, vice president of Absorption and the chief operating officer. For our chief operating officer, the compensation committee also approved a $5,000 increase to his annual compensation that was effective as of fiscal year 2009, in addition to cash in lieu of certain other benefits, based upon the fact that he is ineligible to participate in most of our company-sponsored employee benefits.
 
Pursuant to the terms of his employment agreement, our chief executive officer, who works half-time for our company, receives a salary equal to 65% of the average of the base salaries of our two highest paid executives as measured each May, with the base salary adjustment for the chief executive officer, if any, made each June. The rationale for this formula is that doubling 65% on a part-time position yields a 30% premium for a full-time position, which the compensation committee believes is an appropriate premium for the position of chief executive officer. For fiscal year 2010, the two highest paid executives were Douglas Ellis and David Thompson. As a result of the increase in the base salaries of Douglas Ellis and David Thompson, the chief executive officer received a 3%, or $3,120, increase in annual base salary for fiscal year 2010 as compared to the prior year.
 
Short-Term Incentives – Cash Bonuses for Executive Officers
 
Pursuant to our cash incentive compensation plan, each executive officer may earn two different types of cash bonuses, the shared performance bonus (“shared bonus”) and the individual performance bonus (“individual bonus”) which together determine the aggregate annual cash bonus (“annual bonus”). The shared bonus consists of two elements: (1) the achievement of certain shared financial objectives (which constitute 50% of the annual bonus target); and (2) the achievement of certain shared corporate strategic objectives (which constitute 30% of the annual bonus target). The individual bonus may be earned based on the achievement of certain individual bonus objectives (which constitute 20% of the annual bonus target). The target amount annual bonus is set at an amount equal to a percentage of the executive officer’s base salary. The following table sets forth the target bonus percentages for each named executive officer for fiscal year 2010:
 
   
Annual Bonus Target
(Percentage of Base Salary)
   
Shared Bonus Target
(Percentage of Annual
Bonus Target)
   
Individual Bonus Target
(Percentage of Annual
Bonus Target)
 
       
Shared Financial Objectives (ROIC)
   
Corporate Strategy Objectives
   
Individual Performance Objectives
 
Chief Executive Officer
    50 %     50 %     30 %     20 %
Chief Financial Officer
    35 %     50 %     30 %     20 %
Chief Operating Officer
    35 %     50 %     30 %     20 %
 
In general, the target annual bonus is set at an amount such that if all objectives are achieved and the target annual bonus is awarded, then each executive officer will receive aggregate cash compensation that falls in the median of industry standards for peer executives at similarly situated companies. The sum of the three elements of the annual bonus may be greater than 100% of the annual bonus target (and up to 200%) if an executive officer exceeds his target objectives.
 
 
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The compensation committee typically allocates a greater portion of the potential annual bonus to the shared bonus component. Because the shared bonus objectives are most often tied to overall company performance, these objectives are weighed more heavily by the compensation committee in determining cash bonuses for the executive officers. This practice reflects our policy of tying executive compensation to our performance and aligning it with the interests of our shareholders. With respect to all of the compensation objectives, the compensation committee strives to align such goals to our business strategy, and to ensure that such goals are specific, measurable, attainable, realistic and timely (“SMART”).
 
The financial shared bonus objectives are tied to the achievement of a financial metric known as return on invested capital (“ROIC”). ROIC is a calculation used to assess a company’s efficiency at allocating the capital under its control to profitable investments. The ROIC measure gives a sense of how well a company is using its capital to generate returns. The general equation for ROIC is the quotient achieved by dividing net income less dividends by total capital.
 
During the first quarter of each fiscal year, the chief executive officer and the compensation committee set a target range for the ROIC. In setting this range, the compensation committee includes a minimum ROIC which needs to be achieved before any financial shared bonus may be achieved, as well as a maximum ROIC beyond which no additional financial shared bonus will be awarded. The maximum threshold is intended to ensure that windfall results are rewarded back to the shareholders and not only to the executive officers.
 
The corporate strategy shared bonus objectives are based on three or four corporate strategy objectives applicable to the executive officers as a whole, developed in advance by the chief executive officer and agreed to by the compensation committee. Corporate strategy objectives may include, for example, the protection and expansion of core products, new product or market initiatives, and efficiencies in operational capabilities. At the end of each fiscal year, the chief executive officer will provide data to the compensation committee which is used to assess the level of achievement of the corporate strategy objectives by the executive officers as a group. This achievement is expressed as a percentage, and in any year when the overall achievement of the corporate strategy objectives is less than 50%, the payout under this metric will be zero. The compensation committee, in consultation with the board of directors, will determine the level of achievement of these objectives.
 
Each executive officer suggests two or three individual performance objectives based on the executive officer’s role in our business plan for a particular year and how the executive officer can contribute specifically to our overall business plan. The objectives must be agreed upon by the compensation committee and the chief executive officer (other than with respect to the chief executive officer’s own individual performance objectives, which are approved by the board of directors or the compensation committee without the chief executive officer’s involvement). At the end of each fiscal year, the compensation committee assesses the level of achievement of the individual performance objectives, which are expressed as a percentage. In any year when the overall achievement of the individual performance objectives is less than 50%, the payout under this metric will be zero.
 
In April 2010, based on the results for fiscal year 2010, the chief executive officer presented his assessment of the achievement of ROIC, the corporate strategy objectives and the individual performance objectives by each executive officer (other than the chief executive officer’s own performance, which was reviewed by the board of directors without his involvement) to the compensation committee. The compensation committee determined that the company achieved actual ROIC of 7.7% for fiscal year 2010; however, excluding the transaction costs incurred by the company in connection with the pending Arrangement, the compensation committee determined that the Company would have achieved an “as-adjusted” ROIC of 10.4%.  This was below the target set of 11% (but above the minimum threshold of 5.3%).  In addition, in reviewing the performance of each executive officer, the compensation committee also considered how each officer’s performance was impacted as a result of time and resources spent by such officer in connection with the pending Arrangement.
 
Based on these factors, the compensation committee determined that the named executive officers attained 86.5% of the corporate strategy objectives (without making any adjustment for the impact of the Arrangement); and further that the chief executive officer achieved 68% of his individual performance objectives, the chief financial officer achieved 97.5% of his individual performance objectives, and the chief operating officer achieved 91% of his individual performance objectives, in each case, on an as-adjusted basis.  Pursuant to the terms of the cash incentive plan (based on actual ROIC and otherwise without adjusting for the impact of the Arrangement), the compensation committee awarded the chief executive officer $16,069, the chief financial officer $17,304 and the chief operating officer $28,840.  In addition, in light of the impact of the pending Arrangement on the company’s ROIC and each executive officer’s performance as described above, the compensation committee also awarded each executive officer a discretionary cash bonus outside of the cash incentive plan as follows:  $25,174 for the chief executive officer, $38,563 for the chief financial officer and $27,027 for the chief operating officer.
 
To comply with Section 409A, it is our policy to pay bonuses in the first payroll period that ends on or after the last day of the first quarter of the fiscal year following the year as to which the bonus was earned.
 
 
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Long-Term Incentives – Equity Compensation
 
We currently maintain the 2003 Omnibus Incentive Plan as our equity plan. The purpose of the 2003 Omnibus Plan is to promote our long-term growth and profitability by giving eligible participants, including the executive officers, an opportunity to receive our capital stock, thereby (i) providing key people with incentives to improve shareholder value and to contribute to our growth and financial success, and (ii) enabling us to attract, retain and reward the best available persons for positions of substantial responsibility. These awards are generally subject to vesting.
 
In the past, the chief executive officer presented the compensation committee with a recommendation for each other executive officer regarding the type of equity grant under the 2003 Omnibus Plan and the suggested number of shares. In determining the number of stock options to award to each other executive officer, the chief executive officer evaluated market data regarding stock ownership by executives at similar companies and prior equity grants to each executive officer. The compensation committee then considered the recommendation presented by the chief executive officer and thereafter made a determination for all of the executive officers, including the chief executive officer, of the type of grant and number of underlying shares of stock, and vesting and other terms.
 
On September 10, 2008, the board, upon recommendation of the compensation committee, adopted a new long-term incentive policy proposed by Caliber Leadership Systems Inc., a third party consulting firm. Under this policy, the compensation committee typically issues a combination of stock options and performance awards for restricted stock units, as opposed to only stock options, to ensure a competitive plan that rewards for longer term performance while providing significant upside potential in the event of a new product or new market that results in substantial growth in stock value. The restricted stock units are subject to performance-based vesting milestones. In general, our policy has been to make two restricted stock unit grants, each at an amount that would be generally equal to one-third of a comparable stock option grant in terms of the number of underlying common shares, which helps reduce potential dilution to shareholders. One of the two restricted stock unit grants has vesting criteria based on our performance in the second and third fiscal years following the year of grant; the other restricted stock unit grant has vesting criteria based on our performance in the year of grant, and generally requires a superior or “stretch” level of achievement.
 
Under the long-term incentive policy, when making annual equity awards to the executive officers, the base salary applicable to each of the named executive officers (other than the chief executive officer), which base salary is identical as to these officers with respect to fiscal year 2010, and has been expected to remain so going forward, is first multiplied by 1.25, then divided by the per-share value of the common shares on the date of grant. The resulting amount is then divided in half, with that quotient being the number of stock options granted. That number is then divided by three to determine the number of restricted stock units included in each of two grants. The resulting numbers of options and restricted stock units are granted to each executive officer, with each receiving grants for the same number of underlying common shares. With respect to fiscal year 2009, in accordance with this policy, the number of options granted to each executive officer on September 17, 2008 (which is also the vesting commencement date), was $160,000 x 1.25 / $3.55 / 2 = 28,170 shares, with an exercise price of $3.55 per share; and the number of restricted stock units included in each of the two restricted stock unit grants to each executive officer made on that date was 28,170 / 3 = 9,390. Under the vesting terms, first applied to these fiscal year 2009 grants, options vest at 20% per year over five years, measured from the vesting commencement date, with a seven year term (no longer subject to performance vesting), and restricted stock units vest over three years based upon the achievement of certain ROIC targets. If the ROIC targets are not achieved, the restricted stock units are forfeited; options (which are not otherwise exercised) will expire at the end of their term.
 
For fiscal year 2009, the first grant of 9,390 restricted stock units to each named executive officer vests according to the criteria set forth below in the footnotes to the “Outstanding Equity Awards at Fiscal Year-End” table, and the second grant of 9,390 restricted stock units to each named executive officer was subject to the achievement of certain ROIC targets, including the achievement of ROIC of at least 11.5% for fiscal year 2009. However, in April 2009 the board determined that this ROIC threshold had not been met, and accordingly the restricted stock units subject to the second grant were forfeited by each named executive officer at that time.
 
On September 9, 2009, the compensation committee elected to suspend any issuance of stock-based performance awards for fiscal year 2010 due to then-ongoing discussions regarding a potential acquisition of our company, including an outstanding acquisition proposal submitted by Arctic Acquisitions Inc., an entity affiliated with certain members of our management, as described below. As a result, no stock options or restricted stock unit performance awards were issued during fiscal year 2010.
 
 
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Outstanding Equity Awards at Fiscal Year-End
 
The following table provides information with respect to outstanding equity awards held by the named executive officers as of the end of fiscal year 2010. The equity awards were granted under the 2003 Omnibus Plan and are subject to the terms and conditions set forth below.
 
U.S. Dollars
   
Option Awards
 
Stock Awards
 
Name
 
Number of Securities Underlying Unexercised Options
(#) Exercisable
 
Number of Securities Underlying Unexercised Options
(#) Unexercisable(1)
   
Option Exercise Price
($)
 
Option Expiration Date
 
Equity Incentive Plan
Awards: Number of Unearned Shares, Units or Other Rights
That Have Not Vested
(#)(2)
   
Equity Incentive Plan
Awards: Market or
Payout Value of
 Unearned Shares, Units
or Other Rights That
Have Not Vested
($)
 
Gordon L. Ellis
    5,634     22,536 (3)   $ 3.55  
September 17, 2015
  9,390 (4)   $ 42,725 (5)
      7,500     17,500 (6)   $ 3.60  
March 30, 2014
             
      10,000     15,000 (7)   $ 3.20  
April 3, 2013
             
      25,000 (6)   -     $ 4.60  
March 30, 2012
             
      25,000 (7)   -     $ 4.70  
March 30, 2011
             
Dave H. Thompson
    5,634     22,536 (3)   $ 3.55  
September 17, 2015
  9,390 (4)   $ 42,725 (5)
      7,500     17,500 (6)   $ 3.60  
March 30, 2014
             
      10,000     15,000 (7)   $ 3.20  
April 3, 2013
             
      25,000 (6)   -     $ 4.60  
March 30, 2012
             
      25,000 (7)   -     $ 4.70  
March 30, 2011
             
Douglas E. Ellis
    5,634     22,536 (3)   $ 3.55  
September 17, 2015
  9,390 (4)   $ 42,725 (5)
      7,500     17,500 (6)   $ 3.60  
March 30, 2014
             
      10,000     15,000 (7)   $ 3.20  
April 3, 2013
             
      25,000 (6)   -     $ 4.60  
March 30, 2012
             
      25,000 (7)   -     $ 4.70  
March 30, 2011
             
 
 
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(1)  
Under the terms of the Arrangement Agreement, in the event that the Arrangement is consummated, each stock option to purchase our common shares outstanding immediately prior to the effective time of the Arrangement, to the extent not exercised before such time, will be automatically cancelled and the holder thereof shall receive the positive difference, if any, between $4.75 per common share and the applicable exercise price of such cancelled stock option (without interest and less applicable withholding taxes).  The disclosure in this table does not reflect any potential accelerated vesting arising as a result of the proposed Arrangement.
 
(2)  
Under the terms of the Arrangement Agreement, in the event that the Arrangement is consummated the restricted stock units set forth in this column will become fully vested in accordance with our compensation committee’s decision to treat the restricted stock units consistently with the treatment of the stock options in respect of accelerated vesting upon a change of control, as permitted under the 2003 Omnibus Plan.  In the event that the Arrangement is consummated, each restricted stock unit outstanding immediately prior to the effective time of the Arrangement, to the extent not converted into common shares before such time, will be automatically cancelled and the holder thereof shall receive $4.75 per restricted stock unit (without interest and less applicable withholding taxes).  The disclosure in this table does not reflect any potential accelerated vesting arising as a result of the proposed Arrangement.
 
(3)  
These stock options were granted on September 17, 2008 and vest at the rate of 20% per year over five years, subject to continued employment with us.
 
(4)  
These restricted stock unit performance awards were granted on September 17, 2008. The vesting schedule is set forth in the following table:
 
Total Restricted Stock
Units Subject to
Performance Vesting
(#)
 
Performance
Year
 
Incremental Percentage of
Grant that May Vest During Period
(Annual Vesting)
 
ROIC Target Met
in Performance Year
(%)
 
Total Percentage of Units
 that May Have Vested if All Targets Are Met
(Cumulative Vesting)
9,390  
Fiscal year ending January 31, 2010
 
50% (or 4,695 units)
 
Greater Than 12.6%
 
50% (or 4,695 units)
   
Fiscal year ending January 31, 2011
 
50% (or 4,659 units)
 
Greater than 14.6%
 
100% (or 9,390 units)
 
These restricted stock unit performance awards are subject to, among other things, a continuous service requirement in addition to meeting the minimum performance requirement or such award is forfeited in whole, as described in the agreement governing such restricted stock units.  Effective as of April 27, 2010, our board of directors, with Gordon Ellis declaring his interest as a holder of outstanding restricted stock unit performance awards and abstaining from voting, based on the recommendation of our compensation committee and in light of the pending Arrangement, approved an amendment to the outstanding restricted stock unit performance awards held by our executive officers to extend the determination date from April 30, 2010 to May 31, 2010 for purposes of calculating whether the performance targets had been achieved for fiscal year 2010 and determining the vesting percentage for the first 50% of the restricted stock unit performance awards.
 
(5)  
The amounts in this column reflect the market value of the restricted stock unit performance awards, and were calculated by multiplying the closing market price of our common shares at the end of the last completed fiscal year, which was $4.55 as of January 29, 2010, the last trading day of fiscal year 2010, by the number of restricted stock units.
 
(6)  
These stock options were granted on April 13, 2007 and each option to purchase 25,000 shares vests over five years according to the vesting schedule in the following table:
 
 
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Date
 
Incremental Percentage of Option
that May Vest
During Period
(Annual Vesting)
   
Total Percentage of Option that May
 Have Vested if All Targets Are Met
(Cumulative Vesting)
 
March 30, 2008
    0 %     0 %
March 30, 2009
    10-35 %     35 %
March 30, 2010
    10-35 %     70 %
March 30, 2011
    10-35 %     100 %
March 30, 2012
   
Difference between 100% and
percentage vested to date (such that
option is vested in full after five years)
      100 %
 
The percentage that may vest in the second, third and fourth years is determined by a formula that is based on our weighted average ROIC since the beginning of fiscal year 2008. Specifically, for the options granted in fiscal year 2008, if our weighted average ROIC is 7.5% or less, then 10% of the options will vest, and if the weighted average ROIC performance is 20% or better, then 35% of the options will vest. For each 2.5% increase in weighted average ROIC beyond 7.5%, an additional 5% of the options vest up to the maximum of 35% as noted above. Any portion of the options that is unvested as of end of the fifth year will then vest in full regardless of our performance. During the cumulative period between the beginning of fiscal year 2008 and the end of fiscal year 2010, our weighted average ROIC measured 7.8%. Therefore, in accordance with the above vesting schedule, an additional 15% of the options granted on April 13, 2007 (or 3,750 per named executive officer) were vested as of April 19, 2010, for an aggregate of 7,500 vested since the date of grant.
 
(7)  
These stock options were granted on April 12, 2006 and vest according to the vesting schedule in the following table:
 
Date
 
Incremental Percentage of Option
that May Vest
During Period
(Annual Vesting)
   
Total Percentage of Option that May
Have Vested if All Targets Are Met
(Cumulative Vesting)
 
March 30, 2007
    0 %     0 %
March 30, 2008
    10-35 %     35 %
March 30, 2009
    10-35 %     70 %
March 30, 2010
    10-35 %     100 %
March 30, 2011
   
Difference between 100% and
percentage vested to date (such that
option is vested in full after five years)
      100 %
 
The percentage that may vest in the second, third and fourth years is determined by a formula that is based on our weighted average ROIC since the beginning of fiscal year 2007. Specifically, for the options granted in fiscal year 2007 (on April 12, 2006), if our weighted average ROIC is 7.5% or less, then 10% of the options will vest, and if the weighted average ROIC performance is 20% or better, then 35% of the options will vest. For each 2.5% increase in weighted average ROIC beyond 7.5%, an additional 5% of the options vest up to the maximum of 35% as noted above. Any portion of the options that is unvested as of end of the fifth year will then vest in full regardless of our performance. Our weighted average ROIC must exceed 7.5% for the measurement period in order for options to vest on their anniversary date. During the cumulative period between the beginning of fiscal year 2007 and the end of fiscal year 2010, our weighted average ROIC was 9%. Therefore, in accordance with the above vesting schedule, an additional 15% of the options granted on April 12, 2006 (or 3,750 per named executive officer) were vested as of April 19, 2010, for an aggregate of 10,000 vested since the date of grant.
 
(8)  
These stock options were granted on April 27, 2005 and were fully vested as of March 30, 2010.
 
(9)  
These stock options were granted on April 7, 2004 and were fully vested as of March 30, 2009.
 
 
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Retirement Savings and 401(k) Plan
 
We currently have no pension or retirement plans in place except the Absorption Corp 401(k) Plan, which was implemented as of April 1, 2006 and which is available to all eligible employees. We make a matching contribution on behalf of each eligible participant, including all executive officers and non-executive employees who are U.S. residents. Mr. G. Ellis and Mr. D. Ellis are not U.S. residents are thus ineligible to participate. The matching contribution is equal to 100% of what an employee contributes up to 3% of the employee’s salary, plus 50% of what the employee contributes up to the next 2% of the employee’s salary. All contributions are 100% vested when made.
 
Stock Plans and Outstanding Grants
 
The 2003 Omnibus Plan is administered by the compensation committee. The compensation committee has the authority to determine eligible persons, the time and type of grant and the number of shares to be used for each award, impose such terms, limitations, restrictions and conditions upon each award and in addition modify, extend or renew an outstanding award. The maximum awards available for grant under the 2003 Omnibus Plan shall not exceed an aggregate of 1,100,000 Shares. Participation in the 2003 Omnibus Plan is open to all our employees, officers, directors and consultants or of any parent or subsidiary company, as well as employees of certain persons that provide management services and independent consultants and advisers. Types of available awards include stock options, stock appreciation rights, restricted or unrestricted share awards, phantom stock, performance awards, or any combination of the foregoing. In the event of a merger, reorganization, consolidation, recapitalization, stock dividend, stock split, reverse stock split, spin-off or similar transaction or other change in corporate structure affecting the common shares adjustments or other substitutions will be made to the awards granted under the 2003 Omnibus Plan.
 
For fiscal year 2010, on September 9, 2009, the compensation committee elected to suspend any issuance of stock-based performance awards to the executive officers for fiscal year 2010 due to then-ongoing discussions regarding a potential acquisition of our company, including an outstanding acquisition proposal submitted by Arctic Acquisitions Inc., an entity affiliated with certain members of our management, as described below.. As a result, no stock options or restricted stock unit performance awards were issued during fiscal year 2010.
 
Effective December 11, 2009, in light of the proposed Arrangement, the board approved an extension to the expiration date for certain outstanding stock options held by our independent directors, namely Michael Bentley, Lionel Dodd, John Sutherland and Daniel Whittle. The total number of common shares subject to these options is 40,000 and the expiration date was extended from December 13, 2009 to May 31, 2010.
 
In addition, effective as of April 27, 2010, our board of directors, with Gordon Ellis declaring his interest as a holder of outstanding restricted stock unit performance awards and abstaining from voting, based on the recommendation of our compensation committee and in light of the pending Arrangement, approved an amendment to the outstanding restricted stock unit performance awards held by our executive officers to extend the determination date from April 30, 2010 to May 31, 2010 for purposes of calculating whether the performance targets had been achieved for fiscal year 2010 and determining the vesting percentage for the first 50% of the restricted stock unit performance awards.
 
Under the 2003 Omnibus Plan, stock options to purchase a total of 687,114 common shares at exercise prices ranging from (U.S.) $3.20 to (U.S.) $4.70, with expiry dates beginning May 31, 2010, were outstanding at January 31, 2010. Pursuant to the vesting terms of the stock option agreements, stock options to purchase 312,303 common shares were eligible for exercise at January 31, 2010. In addition, as of January 31, 2010, 37,560 restricted stock units were outstanding under performance awards.
 
Potential Payments upon Termination or Change in Control
 
We consider the maintenance of a sound management team to be essential to protecting and enhancing the best interests of the company and its shareholders. To that end, we recognize that the possibility of a change in control may exist from time to time, and that this possibility, and the uncertainty and questions it may raise among management, may result in the departure or distraction of management personnel to the detriment of the company and its shareholders. We determined that appropriate steps should be taken to encourage the continued attention and dedication of members of our management to their duties without the distraction that may arise from the possibility of a change in control.  In addition, it is standard in our industry for employers to offer their executives severance arrangements upon termination without cause.
 
Accordingly, our executive officers have entered into employment agreements with us that provide for the payment of specified compensation and other benefits in connection with a termination for disability or death, termination for cause, termination without cause, resignation or a change in control, including consummation of the Arrangement.  In the event that the Arrangement is consummated, each of these officers has agreed to enter into new arrangements with Parent as described above and in the Proxy Statement.  Therefore, it is expected that the existing separation payment rights would not be triggered in the event the Arrangement is completed.
 
 
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The following is a description of the rights which the four executive officers have under their existing arrangements.
 
Gordon L. Ellis – CEO, President and Chairman.  Under the terms of his employment agreement, in the event that Mr. G. Ellis’s employment is terminated as a result of his disability (as defined in the employment agreement), Mr. G. Ellis shall be entitled to receive his current base salary for a period of three months after he is terminated or a total of nine months from the start of the disability, whichever is longer, as well as a payment of his annual cash incentive compensation prorated as of the date of termination. In the event that Mr. G. Ellis’s employment is terminated as a result of his death, his estate shall be entitled to receive an amount equal to Mr. G. Ellis’s base salary through the end of the month in which his death occurs as well as a payment of his annual cash incentive compensation prorated as of the date of termination. Upon Mr. G. Ellis’s voluntary resignation he is entitled to receive his current base salary for a period of up to three months or for such length of time as approved by the board. If Mr. G. Ellis is terminated without cause (as defined in the employment agreement) he shall be entitled to his then current base salary which has accrued through the date of termination, payment of his annual cash incentive compensation prorated up to the date of termination and shall continue to receive his monthly base salary for the remainder of the employment agreement. If Mr. G. Ellis is terminated for cause (as defined in the employment agreement) he shall not be entitled to any compensation other than his current base salary which has accrued through the date of termination. In the event of a change in control, Mr. G. Ellis is entitled to receive all options, whether vested or unvested and any additional incentive packages, other than restricted stock units, previously granted to him which have not vested immediately upon the change in control being completed. Restricted stock units will terminate unless Mr. Ellis provides continuous services to us or our successor (if that successor is approved by the compensation committee) as an employee or independent contractor until the applicable determination date (as that date is defined in the restricted stock unit agreement). If Mr. Ellis provides services to a permitted successor on a part-time basis up to the determination date, then such part-time service shall be deemed to meet the continuous service requirement if it amounts to at least fifty percent of the time spent in a full-time equivalent position. All such compensation shall be treated in the same manner for all our executive officers, unless a particular executive officer’s employment agreement specifies different treatment.
 
Mr. G. Ellis has agreed not to directly or indirectly engage in competition with us in any phase of our business for two years following the date of his termination except in connection with a termination without cause.
 
David H. Thompson – Chief Financial Officer.  Under the terms of his employment agreement with Absorption, in the event that Mr. Thompson’s employment is terminated as a result of his disability (as defined in the agreement), Mr. Thompson shall be entitled to receive severance compensation. The total severance amount is equal to his monthly base salary for the most recent month, multiplied by 24, plus the aggregate bonus received for the prior two fiscal years. However, if Mr. Thompson is also entitled to receive salary replacement benefits from a company-sponsored disability plan, then our total severance obligation is reduced by the amount of the salary replacement benefits. The severance amounts shall be paid in equal monthly instalments over 24 months. In addition, we shall continue Mr. Thompson’s other benefits, including medical and dental, for the 24-month period, and all of Mr. Thompson’s options will continue until they expire or such shorter period of time required by applicable state and federal securities laws. Notwithstanding the foregoing, Mr. Thompson shall not be entitled to any severance or benefits that extend beyond the age of 65. In the event that Mr. Thompson’s employment is terminated as a result of his death, his estate shall be entitled to receive the payments owing under any life insurance policy which is part of our benefits. In the absence of such life insurance policy, then Mr. Thompson’s estate shall be entitled to receive payments equal to his prior monthly base salary multiplied by 24 plus the aggregate bonus received for the prior two fiscal years, along with benefits that went along with his salary and that may be payable to his estate. These payments shall be paid in equal monthly installments over 24 months. Following termination for death, all of Mr. Thompson’s options will continue until they expire or such shorter period of time required by applicable state and federal securities laws.
 
 
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If Mr. Thompson is terminated for cause (as defined in the employment agreement) or upon his voluntary resignation, he shall not be entitled to any compensation other than his then-current base salary and benefits which have accrued through the date of termination; provided, however that upon his voluntary resignation he shall also be entitled to payment of his annual bonus prorated as of the date of termination. In the event that Mr. Thompson is terminated without cause (as defined in the employment agreement), then he shall be entitled to payment of his current base salary plus all benefits for a period of 24 months following such termination, plus the aggregate bonus received for the prior two fiscal years. These severance amounts are payable in equal monthly instalments over 24 months. In the event of a change in control (as defined in the employment agreement), Mr. Thompson is entitled to receive all options and stock grants previously made to him, and their treatment is governed by the applicable plans. On a change of control Mr. Thompson is entitled to receive any additional incentive packages previously granted to him that have not vested. In addition, any performance award granted under the 2003 Omnibus Plan is handled in accordance with the change of control provisions of such plan. Moreover, for a 12-month period following a change in control, if Mr. Thompson’s duties or compensation are materially reduced such that Mr. Thompson could claim constructive dismissal (as defined in his employment agreement), then upon actual termination within the 12-month period Mr. Thompson shall have the right to claim severance as if he had been terminated without cause.  Notwithstanding the foregoing, Mr. Thompson shall not be entitled to any severance payments or benefits that extend beyond the age of 65. Mr. Thompson has agreed to not directly or indirectly assist or encourage any person to be involved in any manner to invest or promote any business or activity of a similar nature, if Mr. Thompson has terminated the employment agreement due to disability (as defined in the employment agreement), resignation, or in connection with a change in control (as defined in the employment agreement), during any time in which Mr. Thompson is receiving severance payments or for a period of one year, whichever is longer.
 
To the extent that Section 409A applies, certain severance payments may be subject to a six-month delay. If the delay rule applies, any accrued severance shall be paid in the seventh month following termination.
 
Doug E. Ellis – Chief Operating Officer.  Under the terms of his employment agreement with Absorption, in the event that Mr. D. Ellis’s employment is terminated as a result of his disability (as defined in the agreement), Mr. D. Ellis shall be entitled to receive severance compensation. The total severance amount is equal to his monthly base salary for the most recent month, multiplied by 24, plus the aggregate bonus received for the prior two fiscal years. However, if Mr. D. Ellis is also entitled to receive salary replacement benefits from a company-sponsored disability plan, then our total severance obligation is reduced by the amount of the salary replacement benefits. The severance amounts shall be paid in equal monthly instalments over 24 months. In addition, we shall continue Mr. D. Ellis’s other benefits, including medical and dental, for the 24-month period, and all of Mr. D. Ellis’s options will continue until they expire or such shorter period of time required by applicable state and federal securities laws. Notwithstanding the foregoing, Mr. D. Ellis shall not be entitled to any severance or benefits that extend beyond the age of 65. In the event that Mr. D. Ellis’s employment is terminated as a result of his death, his estate shall be entitled to receive the payments owing under any life insurance policy which is part of our benefits. In the absence of such life insurance policy, then Mr. D. Ellis’s estate shall be entitled to receive payments equal to his prior monthly base salary multiplied by 24 plus the aggregate bonus received for the prior two fiscal years, along with benefits that went along with his salary and that may be payable to his estate. These payments shall be paid in equal monthly instalments over 24 months. Following termination for death, all of D. Ellis’s options will continue until they expire or such shorter period of time required by applicable state and federal securities laws.
 
If Mr. D. Ellis is terminated for cause (as defined in the employment agreement) or upon his voluntary resignation, he shall not be entitled to any compensation other than his then-current base salary and benefits which have accrued through the date of termination; provided, however that upon his voluntary resignation he shall also be entitled to payment of his annual bonus prorated as of the date of termination. In the event that Mr. D. Ellis is terminated without cause (as defined in the employment agreement), then he shall be entitled to payment of his current base salary plus all benefits for a period of 24 months following such termination, plus the aggregate bonus received for the prior two fiscal years. These severance amounts are payable in equal monthly instalments over 24 months. In the event of a change in control (as defined in the employment agreement), Mr. D. Ellis is entitled to receive all options and stock grants previously made to him, and their treatment is governed by the applicable plans. On a change of control Mr. D. Ellis is entitled to receive any additional incentive packages previously granted to him that have not vested. In addition, any performance award granted under the 2003 Omnibus Plan is handled in accordance with the change of control provision of such plan. Moreover, for a 12-month period following a change in control, if Mr. D. Ellis’s duties or compensation are materially reduced such that Mr. D. Ellis could claim constructive dismissal (as defined in his employment agreement), then upon actual termination within the 12-month period Mr. D. Ellis shall have the right to claim severance as if he had been terminated without cause.  Notwithstanding the foregoing, Mr. D. Ellis shall not be entitled to any severance payments or benefits that extend beyond the age of 65 years. Mr. D. Ellis has agreed to not directly or indirectly assist or encourage any person to be involved in any manner to invest or promote any business or activity of a similar nature, if Mr. D. Ellis has terminated the employment agreement due to disability (as defined in the employment agreement), resignation, or in connection with a change in control (as defined in the employment agreement), during any time in which Mr. D. Ellis is receiving severance payments or for a period of one year, whichever is longer.
 
 
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To the extent that Section 409A applies, certain severance payments may be subject to a six-month delay. If the delay rule applies, any accrued severance shall be paid in the seventh month following termination.
 
DIRECTOR COMPENSATION
 
Directors who are employees receive no additional compensation for serving on the board or its committees.
 
In fiscal year 2010, we provided the following annual compensation to directors who are not employees:
 
U.S. Dollars
Name
 
Fees Earned or
Paid in Cash
($)
   
Stock Option Awards
($)(1)(2)
   
All Other
Compensation
($)(3)
   
Total
($)
 
Michael P. Bentley
  $ 57,750     $ 8,257     $ 14,281     $ 80,288  
Lionel G. Dodd
  $ 38,250     $ 8,257     $ 14,281     $ 60,788  
John J. Sutherland
  $ 40,750     $ 8,257     $ 14,281     $ 63,288  
Daniel J. Whittle
  $ 39,250     $ 8,257     $ 14,281     $ 61,788  
 
(1)  
The amounts in this column reflect the aggregate grant-date fair value of stock option awards granted during the fiscal year in accordance with FASB Accounting Standards Codification Topic 718 for stock-based compensation (formerly FAS 123R) under the 2003 Omnibus Plan. Assumptions used in the calculation of these amounts are included in Note 2 (Significant Accounting Policies) to our audited financial statements for the fiscal year ended January 31, 2010, under the heading “Stock-Based Employee Compensation,” which financial statements are included in this Annual Report.
 
(2)  
The aggregate number of stock options outstanding, of which all are vested, for each director under the 2003 Omnibus Plan as of January 31, 2010 was as follows: Mr. Bentley held 20,000 stock options; Mr. Dodd held 20,000 stock options; Mr. Sutherland held 20,000 stock options; and Mr. Whittle held 20,000 stock options.
 
(3)  
The amounts in this column reflect cash amounts paid to independent directors in June 2009 in lieu of stock options for fiscal year 2009, which options had been due to be granted in December 2008 but were delayed as a result of a change in our long-term incentive policies.  The board approved the cash payments in lieu of stock options on June 10, 2009 as a result of then-ongoing discussions related to a potential acquisition of our company..
 
We paid our non-employee directors a retainer of $3,000 per quarter during fiscal year 2010. In addition, we paid non-employee directors $1,250 for each board meeting attended (whether in person or via teleconference); $1,000 for each committee meeting attended at which the director served as chair; and $500 for each committee meeting attended at which the director did not serve as chair.
 
The compensation philosophy for the non-employee director annual retainer and meetings fees is to pay a competitive compensation for these elements at the midpoint of the market, measured against the practices of comparable companies. This same philosophy also extends to the long-term director incentive compensation in the form of equity awards. The compensation committee has historically relied upon specific surveys such as Milliman, the Watson Wyatt General Independent Board Study and the Tower Perrin Pacific Northwest Boards Survey for comparative purposes. Since fiscal year 2004, each independent director has received an annual stock option grant of 10,000 shares in the fourth quarter, with an exercise price equal to the fair market value on the date of grant. Following the adoption of new executive compensation practices in September 2009, the compensation committee began considering changes to its current practices regarding director stock-based compensation.
 
For fiscal year 2010, on September 9, 2009, the compensation committee elected to suspend any issuance of stock-based performance awards to the executive officers for fiscal year 2010 due to then-ongoing discussions regarding a potential acquisition of our company, including an outstanding acquisition proposal submitted by Arctic Acquisitions Inc., an entity affiliated with certain members of our management, as described below. As a result, no stock options or restricted stock unit performance awards were issued during fiscal year 2010.
 
Effective December 11, 2009, in light of the proposed Arrangement, the board approved an extension to the expiration date for certain outstanding stock options held by our independent directors, namely Michael Bentley, Lionel Dodd, John Sutherland and Daniel Whittle. The total number of common shares subject to these options is 40,000 and the expiration date was extended from December 13, 2009 to May 31, 2010.
 
 
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ITEM 12.  SECURITY OWERNSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGMENT AND RELATED STOCKHOLDER MATTERS.

The following table provides information as of April 27, 2010, with respect to common share ownership by:
 
    ·      
the persons known to us to beneficially own more than 5% of our common shares;
 
    ·      
each director;
 
    ·      
each named executive officer (as defined above under the title “Compensation of Named Executive Officers”); and
 
    ·      
all directors and executive officers as a group.
 
Beneficial ownership is determined in accordance with the rules of the SEC. In computing the number of our common shares beneficially owned by a person and the percentage ownership of that person, common shares subject to options, warrants and securities convertible into common shares held by that person that are vested and/or exercisable as of April 27, 2010 or within 60 days thereof are deemed outstanding (but such options, warrants and securities convertible into common shares are not deemed outstanding for the purpose of computing the beneficial ownership of any other person). As of April 27, 2010, there were 6,410,282 common shares outstanding. Except as otherwise indicated in the footnotes below, all of the common shares listed for a person named in the table are directly held by such person with sole voting and dispositive power.
 
On December 14, 2009, we entered into an Arrangement Agreement with Parent and Canada Sub. The Arrangement Agreement provides that, upon the terms and subject to the conditions set forth in the Arrangement Agreement, Parent, through its wholly-owned subsidiary, will acquire all of our outstanding common shares for $4.75 per common share in cash, with International Absorbents continuing as the surviving corporation. As a result of the Arrangement, we will become a wholly-owned subsidiary of Parent. The consummation of the Arrangement is subject to various closing conditions, including obtaining the approval of the Arrangement by our shareholders and the Supreme Court of British Columbia.  As described below in Item 13 of this Annual Report, in the event the Arrangement is consummated, the vesting of the outstanding options and restricted stock units would be accelerated; however, for purposes of this table, these calculations do not reflect any potential accelerated vesting arising as a result of the proposed Arrangement.
 
Unless otherwise noted, the address for each shareholder below is: c/o International Absorbents Inc., 1569 Dempsey Road, North Vancouver, British Columbia, Canada V7K 1S8.
 
    
Name and Address of Beneficial Owner
 
Amount and Nature of Beneficial Ownership
   
Percent of Class
 
                 
Gordon L. Ellis
    469,985 (1)     7.2 %
                 
Douglas E. Ellis
    241,523 (2)     3.7 %
                 
David H. Thompson
6960 Salashan Parkway,
Ferndale, Washington, United States 98248
    111,885 (3)     1.7 %
                 
John J. Sutherland
    32,500 (4)     *  
                 
Lionel G. Dodd
    25,000 (5)     *  
                 
Michael P. Bentley
    24,000 (6)     *  
                 
Daniel J. Whittle
6960 Salashan Parkway,
Ferndale, Washington, United States 98248
    20,800 (7)     *  
                 
First Wilshire Securities Management, Inc.
1224 East Green Street, Suite 200,
Pasadena, CA 91106
    942,329 (8)     14.9 %
                 
IAX Acquisition Corporation and IAX Canada Acquisition Company Inc.,
c/o Kinderhook Industries, LLC
888 Seventh Avenue, 16th Floor
New York, New York, United States
    717,325 (9)     11.2 %
                 
Arctic Acquisitions Inc.
    716,491 (10)     11.2 %
Directors and Executive Officer as a Group (8 Persons)
    1,112,161 (11)     16.4 %

* Indicates that beneficial ownership is less than 1% of the class.
 
 
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(1)  
Includes 100,576 common shares held by Gordann Consultants Ltd., an entity in which Mr. G. Ellis owns a 51% interest and Mr. G. Ellis’s spouse owns a 49% interest, or Gordann, over which Mr. G. Ellis has shared voting and dispositive power; 10,000 common shares held by Shelan Development Corp., an entity owned by Gordann, over which Mr. G. Ellis has shared voting and dispositive power; 15,000 common shares held by Stelyconi Enterprises Ltd., an entity owned by Gordann, over which Mr. G. Ellis has shared voting and dispositive power; and 122,300 common shares held by ABE Industries (1980) Inc., an entity owned by Gordann, over which Mr. G Ellis has shared voting and dispositive power. Also includes 73,134 common shares issuable pursuant to fully vested stock options held by Mr. G. Ellis.
 
(2)  
Includes 25,000 common shares held by Mr. D. Ellis’s children, over which Mr. D. Ellis has voting and dispositive power. Also includes 73,134 common shares issuable pursuant to fully vested stock options held by Mr. D. Ellis.
 
(3)  
Includes 73,134 common shares issuable pursuant to fully vested stock options held by Mr. Thompson.
 
(4)  
Includes 20,000 common shares issuable pursuant to fully vested stock options held by Mr. Sutherland.
 
(5)  
Includes 20,000 common shares issuable pursuant to fully vested stock options held by Mr. Dodd.
 
(6)  
Includes 20,000 common shares issuable pursuant to fully vested stock options held by Mr. Bentley.
 
(7)  
Includes 20,000 common shares issuable pursuant to fully vested stock options held by Mr. Whittle.
 
(8)  
Based on information provided by First Wilshire Securities Management, Inc. (“First Wilshire”), a broker-dealer and investment adviser, in an amended Schedule 13G filed on February 17, 2010. According to the Schedule 13G, First Wilshire has sole dispositive power over all 942,329 common shares, with sole voting power over 54,283 of such shares.
 
(9)  
IAX Canada Acquisition Company Inc., IAX Acquisition Corporation, International Absorbents Holdings, LLC, Kinderhook Capital Fund III, L.P., Kinderhook Capital Fund III GP, LLC, Thomas L. Tuttle, Robert E. Michalik and Christian P. Michalik (collectively "Kinderhook") reported their beneficial ownership on a Schedule 13D/A filed with the SEC on December 24, 2009. The filing indicated that as of December 14, 2009, Kinderhook had shared voting power for 717,325 common shares, which represents 11.2% of the total common shares outstanding as of that date.
 
(10)  
Based on information provided in Amendment No. 2 to Schedule 13D filed on July 17, 2009, the Reporting Persons, namely, Gordon L Ellis, Douglas E. Ellis, David H. Thompson, Terry Holland, Paul Clinton and Wayne Henderson, entered into a joint filing agreement for the purposes of Arctic Acquisitions Inc. proposing a written offer to acquire all our outstanding shares. According to the Schedule 13D, Gordon L. Ellis has sole voting and dispositive power over 186,475 common shares and shared voting and dispositive power over 247,876 common shares for an aggregate of 434,351 commons shares; Douglas E. Ellis has voting and dispositive powers over 205,889 common shares; David H. Thompson has sole voting and dispositive powers over 75,585 common shares and 666 shared voting and dispositive power for an aggregate of 76,251 common shares; and no shares are beneficially owned by Terry Holland, Paul Clinton and Wayne Henderson
 
(11)  
See footnotes (1) through (7) above. Includes Gordon L. Ellis, Douglas E. Ellis, Shawn M. Dooley, David H. Thompson, John J. Sutherland, Lionel G. Dodd, Michael P. Bentley and Daniel J. Whittle. With respect to Mr. Dooley, vice president of Absorption, the amount consists of 113,334 common shares held by Mr. Dooley and 73,134 common shares issuable pursuant to fully vested stock options held by Mr. Dooley.

 
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Equity Compensation Plan Information

The following table provides information about equity awards under the 2003 Omnibus Plan as of January 31, 2010:

U.S. Dollars
   
(a)
   
(b)
   
(c)
 
Plan category
 
Number of securities to be
issued upon exercise
of outstanding options,
warrants and rights
   
Weighted-average
exercise price
of outstanding options,
warrants and rights
   
Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
 securities reflected
in column (a))
 
Equity compensation plans approved by security holders
    724,674 (1)   $ 3.70       365,326  
Equity compensation plans not approved by security holders
    -0-       -0-       -0-  
Total
    724,674     $ 3.70       365,326  
 
(1)           Amount includes 37,560 outstanding restricted stock units unvested as of January 31, 2010.
 
ITEM 13.  CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

Transactions with Related Persons
 
Arrangement Agreement.  On December 14, 2009, we entered into the Arrangement Agreement with Parent and Canada Sub. As described above in Item 12 of this Annual Report on Form 10-K, Parent and Canada Sub may be deemed to beneficially own approximately 11.2% of our outstanding common shares. The Arrangement Agreement provides that, upon the terms and subject to the conditions set forth in the Arrangement Agreement, Parent, through its wholly-owned subsidiary, will acquire all of our outstanding common shares for $4.75 per common share in cash, with International Absorbents continuing as the surviving corporation. As a result of the Arrangement, we will become a wholly-owned subsidiary of Parent. The consummation of the Arrangement is subject to various closing conditions, including obtaining the approval of the Arrangement by our shareholders and the Supreme Court of British Columbia.  The Arrangement Agreement contains certain termination rights for us, Parent and Canada Sub and further provides that, upon termination of the Arrangement Agreement under specified circumstances, we may be required to pay Parent a termination fee of 4% of the aggregate purchase price.
 
Support Agreement.  In connection with the transactions contemplated by the Arrangement Agreement, our executive officers, who collectively beneficially own approximately 11.2% of our total outstanding common shares, contemporaneously entered into a support agreement with Parent and Canada Sub to, among other things, vote the respective common shares owned by them, or over which they exercise voting power, in favor of the Arrangement and against any proposal for a competing arrangement or acquisition proposal, except as specifically provided therein.  The shareholders who entered into the support agreement did not receive any consideration for doing so (other than any consideration they are otherwise entitled to receive under the Arrangement in respect of their common shares, stock options and restricted stock units).
 
Stock Options.  In the event that the Arrangement is consummated, each stock option to purchase our common shares outstanding immediately prior to the effective time of the Arrangement, to the extent not exercised before such time, will be automatically cancelled and the holder thereof shall receive the positive difference, if any, between $4.75 per common share and the applicable exercise price of such cancelled stock option (without interest and less applicable withholding taxes).  
 
In addition, effective December 11, 2009, in light of the proposed Arrangement, our board of directors approved an extension to the expiration date for certain outstanding stock options held by our independent directors, namely Michael Bentley, Lionel Dodd, John Sutherland and Daniel Whittle. The total number of common shares subject to these options is 40,000 and the expiration date was extended from December 13, 2009 to May 31, 2010 in light of the proposed Arrangement.
 
 
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Restricted Stock Unit Performance Awards. In the event that the Arrangement is consummated, the outstanding restricted stock units, all of which are held by our executive officers, will become fully vested upon completion of the Arrangement in accordance with our compensation committee’s decision to treat the restricted stock units consistently with the treatment of the stock options in respect of accelerated vesting upon a change of control, as permitted under the 2003 Omnibus Plan.  In the event that the Arrangement is consummated, each restricted stock unit outstanding immediately prior to the effective time of the Arrangement, to the extent not converted into common shares before such time, will be automatically cancelled and the holder thereof shall receive $4.75 per restricted stock unit (without interest and less applicable withholding taxes).  
 
In addition, effective as of April 27, 2010, our board of directors, with Gordon Ellis declaring his interest as a holder of outstanding restricted stock unit performance awards and abstaining from voting, based on the recommendation of our compensation committee and in light of the pending Arrangement, approved an amendment to the outstanding restricted stock unit performance awards held by our executive officers to extend the determination date from April 30, 2010 to May 31, 2010 for purposes of calculating whether the performance targets had been achieved for fiscal year 2010 and determining the vesting percentage for the first 50% of the restricted stock unit performance awards.
 
New Employment Arrangements and Grant of Incentive Equity.  In the event that the Arrangement is consummated, each of Shawn Dooley, Douglas Ellis and David Thompson has agreed to amend his existing employment agreement effective as of the completion of the Arrangement, to, among other things, amend the term of the employment agreement and the definitions of “cause” and “good reason,” and provide for customary non-competition, non-solicitation and cooperation provisions.  In the event that the Arrangement is consummated, effective as of the completion of the Arrangement, Gordon Ellis has agreed to terminate his employment agreement and accept a consulting services agreement for a term of three years.  Pursuant to the consulting services agreement, Gordon Ellis shall receive a consulting fee of $100,000 per year and will be subject to non-competition, non-solicitation and cooperation provisions.  The consulting services agreement will also provide Gordon Ellis with severance payments for termination of the consulting agreement without cause.
 
Pursuant to the Arrangement Agreement, in the event that the Arrangement is consummated, each of the four executive officers named above shall be required to enter into a non-competition agreement with Parent, as a result of which they will be subject to non-solicitation and non-competition covenants for a period of five years after the date of the Arrangement.
 
In addition, in the event that the Arrangement is consummated, each of the four executive officers named above will receive non-voting incentive equity interests in an affiliate of Parent and may be provided with an opportunity to invest in such affiliate after the completion of the Arrangement.
 
Expense Reimbursement for Arctic Acquisitions Inc.  Arctic Acquisitions Inc. was a potential acquirer of the company and is affiliated with certain members of our management, including Gordon L. Ellis, our CEO, President and Chairman, Douglas Ellis, our Chief Operating Officer and the President of Absorption Corp., and David Thompson, our Chief Financial Officer and Corporate Secretary.  We have agreed to reimburse Arctic’s costs in making its bid, up to CAN $350,000, upon the closing of a transaction or upon written notice that the current sales transaction with Parent has been terminated or suspended, conditioned upon management’s continuing cooperation with the sale process.
 
Management Services Agreement.  During each of fiscal year 2010 and fiscal year 2009, we were party to a management services agreement with Gordann, of which our chief executive officer, Mr. G. Ellis, owns a 51% interest. Please see “Compensation of Directors and Named Executive Officers” for description of the compensation paid or payable under this agreement. The compensation committee approved and continues to monitor this arrangement consistent with the policy described below.

Review and Approval of Transactions with Related Persons
 
The board of directors has adopted a written policy and procedures for review, approval and monitoring of transactions involving us and related persons as defined under applicable SEC rules. The policy covers any related-person transaction that meets the minimum threshold for disclosure under the relevant SEC rules (generally, transactions involving amounts exceeding the lesser of $120,000 or one percent of the average of our total assets at year end for the last two completed fiscal years, and in which a related person has or will have a direct or indirect material interest).
 
 
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Policy
 
·  
Related-person transactions must be approved by the audit committee (or, with respect to compensation decisions, the compensation committee), who will approve the transaction only if they determine that it is in our best interests. In considering the transaction, the appropriate committee will consider all relevant factors, including as applicable (i) our business rationale for entering into the transaction; (ii) the alternatives to entering into a related person transaction; (iii) whether the transaction is on terms comparable to those available to third parties, or in the case of employment relationships, to employees generally; (iv) the potential for the transaction to lead to an actual or apparent conflict of interest and any safeguards imposed to prevent such actual or apparent conflicts; and (v) the overall fairness of the transaction to us.
 
·  
The relevant committee will periodically monitor the transaction to ensure that there are no changed circumstances that would render it advisable for us to amend or terminate the transaction.
 
Procedures
 
·  
Management or the affected director or executive officer will bring the matter to the attention of the chief executive officer, the chair of the audit committee, and the secretary.
 
·  
The chief executive officer will determine (or if he is involved in the transaction, the chair of the audit committee) whether the matter should be considered by the audit committee or compensation committee, each of which consists only of independent directors.
 
·  
If a director is involved in the transaction, he or she will be recused from all discussions and decisions about the transaction.
 
·  
The transaction must be approved in advance whenever practicable, and if not practicable, must be ratified as promptly as practicable if it otherwise meets the requirement of the related-person policy.
 
·  
The relevant committee will review the transactions annually to determine whether it continues to be in our best interests.
 
Board Independence
 
Consistent with NYSE Amex listing standards, the board has adopted corporate governance guidelines. The corporate governance guidelines address matters relating to the board, its committees and its members’ qualifications, including the requirement that the board have a majority of independent directors. Pursuant to the corporate governance guidelines, after consideration of all relevant factors, the board has affirmatively determined that each of the following directors is independent within the meaning of the NYSE Amex Standards and does not have a material relationship with our company that would interfere with the exercise of independent judgment: Michael P. Bentley, Lionel G. Dodd, John J. Sutherland and Daniel J. Whittle.
 
ITEM 14.  PRINCIPAL ACCOUNTING FEES AND SERVICES
 
Audit Fees
 
The aggregate fees billed by our independent registered public accounting firm, Moss Adams LLP, for professional services rendered for the audit of our annual financial statements for fiscal years 2010 and 2009 and quarterly reviews of the financial statements included in our Forms 10-Q for fiscal years 2010 and 2009 were approximately (U.S.) $184,878 and (U.S.) $165,500, respectively.
 
Audit-Related Fees
 
There were no fees billed by Moss Adams LLP for assurance and related services that were reasonably related to the performance of its audit of our financial statements for fiscal years 2010 and 2009 and not reported under the caption “Audit Fees.”
 
Tax Fees
 
There were no fees billed by Moss Adams LLP for tax compliance, tax advice or tax planning services rendered to us for fiscal years 2010 and 2009.
 
 
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All Other Fees
 
Fees billed by Moss Adams for fiscal years 2010 and 2009 were $2,600 and $0, respectively, for other services rendered to us by Moss Adams LLP.  The fees for fiscal year 2010 were billed for services related to due diligence conducted in connection with the proposed Arrangement.
 
The audit committee pre-approves all audit and non-audit services performed by our independent auditors and the fees to be paid in connection with such services in order to ensure that the provision of such services does not impair the auditors’ independence. Unless the audit committee provides general pre-approval of a service to be provided by the independent auditors and the related fees, the service and fees must receive specific pre-approval from the audit committee. All general pre-approvals of services and fees are pursuant to the terms of a written audit committee pre-approval policy, which describes the services subject to general pre-approval. The term of any general pre-approval is twelve (12) months unless otherwise specified by the audit committee. The audit committee annually reviews and generally pre-approves the services that may be provided by, and the fees that may be paid to, the independent auditors without obtaining specific pre-approval. The audit committee most recently made such review and general pre-approvals of the auditors’ engagement letter in December 2009. The audit committee will review and revise the list of general pre-approved services from time to time as necessary.

 
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PART IV


ITEM 15.  EXHIBITS, FINANCIAL STATEMENT SCHEDULES

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

1. Financial Statements.

The following Financial Statements are included in Part II, Item 8:
 
Report of Independent Registered Public Accounting Firm  Page 28
   
Consolidated Balance Sheets at January 31, 2010 and 2009  Page 29
   
Consolidated Statements of Income for the Fiscal Years ended January 31, 2010 and 2009  Page 30
   
Consolidated Statements of Stockholders’ Equity for the Fiscal Years ended January 31, 2010 and 2009  Page 31
   
Consolidated Statements of Cash Flows for the Fiscal Years ending January 31, 2010 and 2009  Page 32
   
Notes to Consolidated Financial Statements, January 31, 2010 and 2009  Page 33
 
2. Financial Statement Schedules.

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

3. Exhibits.

The exhibits listed in the accompanying Index to Exhibits on page 76 are filed or incorporated by reference as part of this Annual Report on Form 10-K.

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

INTERNATIONAL ABSORBENTS INC., a
British Columbia, Canada corporation
 
 Signature     Title     Date 
/s/Gordon L. Ellis
 
Chairman of the Board of Directors,
 
April 29, 2010
Gordon L. Ellis
 
President and Chief Executive Officer
(Principal Executive Officer)
   
         
/s/David H. Thompson    Chief Financial Officer      April 29, 2010
 David H. Thompson    Secretary    
    (Principal Financial and Accounting Officer)    
 
 
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POWER OF ATTORNEY
 
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Gordon L. Ellis his attorney-in-fact, with the power of substitution, for him in any and all capacities, to sign any amendments to this Report on Form 10-K, and to file same, with exhibits thereto and other documents in connection therewith, with the U.S. Securities and Exchange Commission, hereby ratifying and confirming all that said attorney-in-fact, or his substitutes, may do or cause to be done by virtue hereof.

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.
 
 
 Signature     Title     Date 
/s/Gordon L. Ellis
 
Chairman of the Board of Directors,
 
April 29, 2010
Gordon L. Ellis
 
President and Chief Executive Officer
(Principal Executive Officer)
   
         
/s/John J. Sutherland
  Director   April 29, 2010
John J. Sutherland
       
         
/s/Daniel J. Whittle
  Director    April 29, 2010
Daniel J.  Whittle
       
         
/s/Lionel G. Dodd   Director   April 29, 2010
Lionel G. Dodd
       
         
/s/Michael P. Bentley   Director   April 29, 2010
 Michael P. Bentley        
         
/s/David H. Thompson   Chief Financial Officer                                              April 29, 2010
David H. Thompson    Secretary    
    (Principal Financial and Accounting Officer)    

 
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EXHIBIT INDEX

3.1
Notice of Articles of the Company (incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended July 31, 2006)
 
3.2
Articles of the Company (incorporated by reference to Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the quarter ended July 31, 2006)
 
4.1+
Shareholder Rights Plan dated June 11, 2009 (incorporated by reference to Exhibit 4.1 to the Company’s Quarterly Report on Form 10-Q filed September 11, 2009)
 
10.1*
Employment Agreement dated as of October 1, 1998 between the Company and Gordon L. Ellis (incorporated by reference to Exhibit 10.3 to the Company’s Annual Report on form 10-KSB for the fiscal year ended January 31, 2003)
 
10.2*
Amended and Restated Employment Agreement dated as of December 30, 2008 between Absorption Corp. and David H. Thompson (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on January 2, 2009)
 
10.3*
Amended and Restated Employment Agreement dated as of December 30, 2008 between Absorption Corp. and Douglas Ellis (incorporated by reference to Exhibit 10.2 to Current Report on Form 8-K filed on January 2, 2009)
 
10.4*
Amended and Restated Employment Agreement dated as of December 30, 2008 between Absorption Corp. and Shawn Dooley (incorporated by reference to Exhibit 10.3 to Current Report on Form 8-K filed on January 2, 2009)
 
10.5.1*
2003 Omnibus Incentive Plan (incorporated by reference to Exhibit 99.1 to Amendment No. 1 to Company’s Registration Statement on Form S-8 filed on September 21, 2004)
 
10.5.2*
Form of Stock Option Agreement under the 2003 Omnibus Incentive Plan (incorporated by reference to Exhibit 10.9(a) to the Company’s Annual Report on Form 10-K/A for the fiscal year ended January 31, 2007)
 
10.5.3*
Form of Performance Award Agreement for Restricted Stock Units (Performance-based award for fiscal year ending January 31, _____) under the 2003 Omnibus Incentive Plan (incorporated by reference to Exhibit 10.4 to the Company’s Current Report on Form 8-K filed on January 2, 2009)
 
10.5.4*
Form of Performance Award Agreement for Restricted Stock Units (Annual award for fiscal year(s) ending January 31, ____) under the 2003 Omnibus Incentive Plan (incorporated by reference to Exhibit 10.5 to the Company’s Current Report on Form 8-K filed on January 2, 2009)
 
Written Summary of Verbal Amendment, effective as of April 27, 2010, to Performance Award Agreements for Restricted Stock Units for each of Gordon L. Ellis, David H. Thompson, Douglas Ellis and Shawn Dooley
 
10.6*
Form of Indemnification Agreement for Directors and Executive Officers of the Company (incorporated by reference to Exhibit 99.1 to the Company’s Current Report on Form 8-K filed on April 30, 2008)
 
10.7
Tax Exempt Loan Agreement Among GE Capital Public Finance, Inc., as Lender, and Washington Economic Development Finance Authority, as Issuer, and Absorption Corp., as Borrower, dated as of March 1, 2003 (incorporated by reference to Exhibit 10.7 to the Company’s Annual Report on Form 10-KSB for the fiscal year ended January 31, 2003)
 
10.8
Taxable Rate Loan Agreement Between GE Capital Public Finance, Inc., as Lender, and Absorption Corp, as Borrower, dated as of March 1, 2003 (incorporated by reference to Exhibit 10.8 to the Company’s Annual Report on Form 10-KSB for the fiscal year ended January 31, 2003)
 
10.9
Wayne County Industrial Development Authority Tax-Exempt Industrial Development Revenue Bonds (Absorption Corp. Project), Series 2004 dated September 2, 2004 (incorporated by reference to Exhibit 10.14 to the Company’s Quarterly Report on Form 10-QSB for the quarter ended July 31, 2004)
 
10.10
Letter of Credit and Reimbursement Agreement between Absorption Corp. and Branch Banking and Trust Company dated September 1, 2004 (incorporated by reference to Exhibit 10.15 to the Company’s Quarterly Report on Form 10-QSB for the quarter ended July 31, 2004)
 
 
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10.11
BB&T Security Agreement dated September 1, 2004 between Absorption Corp. and Branch Banking and Trust Company (incorporated by reference to Exhibit 10.16 to the Company’s Quarterly Report on Form 10-QSB for the quarter ended July 31, 2004)
 
10.12
BB&T Guaranty Agreement between Branch Banking and Trust Company and International Absorbents Inc. dated September 1, 2004 (incorporated by reference to Exhibit 10.17 to the Company’s Quarterly Report on Form 10-QSB for the quarter ended July 31, 2004)
 
10.13
Lease Agreement dated as September 1, 2004 by and between Wayne County Industrial Development Authority and Absorption Corp. (incorporated by reference to Exhibit 10.18 to the Company’s Quarterly Report on Form 10-QSB for the quarter ended July 31, 2004)
 
10.14
Washington Economic Development Finance Authority Economic Development Revenue Bond dated September 14, 2006 (incorporated by reference to Exhibit 10.19 to the Company’s Quarterly Report on Form 10-Q for the quarter ended October 31, 2006)
 
10.15
Loan Agreement among GE Capital Public Finance, Inc., as lender, Washington Economic Development Finance Authority, as issuer, and Absorption Corp., as borrower, dated as of September 1, 2006 (incorporated by reference to Exhibit 10.20 to the Company’s Quarterly Report on Form 10-Q for the quarter ended October 31, 2006)
 
10.16
Corporate Guaranty and Negative Pledge Agreement given by International Absorbents Inc. dated as of September 1, 2006 (incorporated by reference to Exhibit 10.21 to the Company’s Quarterly Report on Form 10-Q for the quarter ended October 31, 2006)
 
10.17
Rental contracts between the Company and ABE Industries (1980) Inc. dated March 15, 2003 (incorporated by reference to Exhibit 10.18 to the Company’s Annual Report on Form 10-K for the fiscal year ended January 31, 2007)
 
10.18
Arrangement Agreement dated December 14, 2009 by and among IAX Acquisition Corporation, IAX Canada Acquisition Company Inc. and the Company (incorporated by reference to Exhibit 2.1 to the Company’s Current Report on Form 8-K filed on December 15, 2009)
 
Subsidiaries of the Registrant
 
Consent of Moss Adams LLP
 
Certification of Chief Executive Officer pursuant to Exchange Act Rule 13a-14
 
Certification of Chief Financial Officer pursuant to Exchange Act Rule 13a-14
 
Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350
 
Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350
_____________________
* Indicates a management contract or compensatory plan or arrangement.
+ Replaces previously filed exhibit.

 
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