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

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

Overview

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

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

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

During the remainder of fiscal year 2009, we intend to continue to focus our sales and marketing efforts on our market leading CareFRESH®, CareFRESH® Colors and CareFRESH® Ultra brands of small animal bedding products. CareFRESH® Colors is our colored bedding offering and CareFRESH® Ultra is our white small animal bedding. Both are premium line extensions to our core product, CareFRESH®.
Over the next two to three fiscal quarters we also expect to fully evaluate our Healthy Pet ™ cat litter line. Our Healthy Pet™ brand consists of a range of "natural" cat litters made from cellulose fiber, wood, grain and plant-based materials. These products are aimed at the "holistic" market and are designed to be healthier for pets and people than traditional clay litter because of potential health problems associated with crystalline silica in clay products.

In the remainder of fiscal year 2009 and fiscal year 2010, we intend to continue to make significant investments in the review of ancillary product lines and in the exploration of new synergistic business opportunities. We believe that this investment in new product lines and business opportunities will continue to move us toward developing more diversified sources of income, which we anticipate will help reduce the risks associated with a substantial reliance on sales from a single product line.

Results of Operations

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


                          Three months                        Three months
                             ended                               ended
                           October 31,         Percent         October 31,         Percent        Percentage
                              2008            of Sales            2007            of Sales          Change
Sales, net               $         9,603             100 %   $         9,028             100 %              6 %
Cost of goods sold                 6,352              66 %             6,287              70 %              1 %
Gross Profit                       3,251              34 %             2,741              30 %             19 %

Selling, general and
administrative
expenses                           1,990              21 %             1,487              16 %             34 %

Income from operations             1,261              13 %             1,254              14 %              1 %

Interest income                       24               0 %                18               0 %             33 %
Interest expense                     (88 )            -1 %              (103 )            -1 %            -15 %

Income before taxes                1,197              12 %             1,169              13 %              2 %

Income taxes                        (361 )            -4 %              (425 )            -5 %            (15 )%

Net income               $           836               9 %   $           744               8 %             12 %

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

                            Nine months                            Nine months
                               ended              Percent             ended              Percent        Percentage
                          October 31, 2008       of Sales        October 31, 2007       of Sales          Change
Sales, net               $           27,362             100 %   $           24,794             100 %             10 %
Cost of goods sold                   18,799              69 %               17,250              70 %              9 %
Gross Profit                          8,563              31 %                7,544              30 %             14 %

Selling, general and
administrative
expenses                              5,615              21 %                4,878              20 %             15 %

Income from operations                2,948              11 %                2,666              11 %             11 %

Interest income                          52               0 %                   65               0 %            -20 %
Interest expense                       (249 )            -1 %                 (291 )            -1 %            -14 %

Income before taxes                   2,751              10 %                2,440              10 %             13 %

Income taxes                         (1,010 )            -4 %                 (947 )            -4 %              7 %

Net income               $            1,741               6 %   $            1,493               6 %             17 %

During the third quarter of fiscal year 2009, our net sales increased by 6% as compared to the same quarter in fiscal year 2008. This growth in net sales was mainly the result of continued growth in sales of our animal care products. For the first nine months of fiscal year 2009, our net sales increased by 10% as compared to the same period in fiscal year 2008. This increase in net sales was a result of increases in the sales of our core animal care products with significant customers and a sales program focused on filling in national distribution gaps. During the third quarter of fiscal year 2009, net sales for animal care products grew from $8,834,000 to $9,327,000 as compared to the same period of fiscal year 2008. In the first nine months of fiscal year 2009, net sales for animal care products grew from $24,187,000 to $26,673,000 as compared to the same period of fiscal year 2008. We had strong sales levels with all of our bedding products, including our CareFRESH®, CareFRESH® Ultra™, and CareFRESH® Colors products, particularly when the general economy is taken into consideration. Net sales of our industrial products increased from $194,000 to $276,000 from the third quarter of fiscal years 2008 compared to the same period in 2009 and increased from $607,000 to $689,000 for the first nine months of fiscal year 2009 compared to the same period in 2008. Our strategy in regard to our industrial line of products has remained the same, which is to effectively service existing customers while focusing growth on animal care products.

We currently believe that our fiscal year 2009 overall annual net sales will grow approximately 8% to 12% over our fiscal year 2008 net sales levels.
Specifically, during fiscal year 2009, we expect sales of natural, non-colored CareFRESH® in pet specialty channels to grow slightly over sales levels from fiscal year 2008 as we fill in distribution holes throughout the United States.
In recent years, we have also introduced line extensions such as CareFRESH Ultra™ and CareFRESH® Colors. Also, during the second quarter of fiscal year 2009, we rolled out our first private label product with Petco, which will solidify our relationship with a key customer and expand our product offerings in their pet bedding category. Although we anticipate that natural CareFRESH® will continue to represent the majority of our sales through fiscal year 2009, we also see growth opportunities for our full line of bedding products as they continue to gain market share and growing customer acceptance, subject to the following challenges. First, as we add new items to our line of products, they will need to compete for limited shelf space at the pet specialty stores with our other existing products and those of our competitors, which could limit the number of products we are able to sell at a particular store. Second, although we believe that the high quality of our CareFRESH® line of products gives us a significant competitive advantage, many of our competitors have a larger breadth of products and more established relationships with the mass merchandiser and grocery stores, which makes competition in these channels more challenging for us. Finally, the economic downturn in the United States could result in lower than expected sales growth of our products, as a result of reduced customer traffic at our major customers' stores. With respect to our lines of cat litter products, subject to the caveats described above, we are entering an evaluation phase to determine the future potential of this product line. During the remainder of fiscal year 2009, we will continue our existing product line maintenance strategy with our industrial/commercial line of products.

Gross Profit

Both of our production facilities are now operating at efficiency levels that are at or near the pre-construction expectations of management. Nonetheless, during the first nine months of fiscal year 2009, our production facilities continued to face challenges that directly affected their production costs.
These challenges included the additional burden of increases in utility rates, increased depreciation, increased costs of materials, and increased fuel surcharges on freight. Mostly as a result of these production costs our gross margin (gross profit divided by sales) remained at 31% in the first nine months of fiscal year 2009 as compared to 30% for the first nine months of fiscal year 2008. For the third quarter of fiscal year 2009 our gross margin rose to 34% as compared to 30% for the third quarter of fiscal year 2008. This increase was due to significant improvements made to our production efficiencies. We believe this improvement in gross margin is indicative of future margin level potential but, as already described, may not be consistently reachable if external costs such as materials, transportation, and utilities increase.

As discussed in Note 3 ("Segmented Information") to the consolidated financial statements included elsewhere in this Quarterly Report on Form 10-Q, operating income, including selling, general and administrative expenses but before depreciation for our animal care product segment, decreased by 2% in the third quarter of fiscal year 2009 as compared to the same period in fiscal year 2008, and for the first nine months of fiscal year 2009 increased by 9% as compared to the same period in fiscal year 2008. We also generated an operating profit before depreciation for our industrial product segment for the first nine months of fiscal year 2008 as compared to an operating loss for the first nine months of fiscal year 2009.

For fiscal year 2009 we expect that our gross margin will be in the range of 30% to 33%. The following cost factors have provided a challenge to improving gross margins. Though they have improved in recent months, we still see significant uncertainty in this trend due to existing erratic economic conditions. First, due to high fuel costs, transportation of our product to our customers is expected to put downward pressure on our gross margin. Second, we are not achieving the overall reduced costs of raw materials that we had initially expected due to slow reactions from raw material suppliers in response to our request for additional supplies, increases in the prices of petroleum-based product prices, such as the cost of plastic bags, and the shortage of key low-cost raw material sources for certain of our facilities and product lines.

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

Selling, General and Administrative Expenses

During the third quarter of fiscal year 2009, our selling, general and administrative expenses increased by 34% as compared to the same quarter in fiscal year 2008. For the first nine months of fiscal year 2009 our selling, general, and administrative expenses increased by 15% as compared to the same period in the prior year.

Costs resulting from our compliance with requirements of the Securities and Exchange Commission continue to have an impact on our general and administrative expenses. We are investing in infrastructure, mainly in the form of additional personnel, to review our ancillary product lines and explore new synergistic business opportunities. We believe that this investment in new product lines and business opportunities will continue to move us toward developing more diversified sources of income, which we anticipate will help reduce the risks associated with a substantial reliance on sales from a single product.

During the remainder of fiscal year 2009, we intend to fund marketing initiatives at rates greater than in fiscal year 2008. Our seasoned sales staff is respected in the animal care industry and has proven to be efficient and effective in selling to the wholesale distribution segment of the pet specialty channel. We expect to enhance our sales staff to include expertise in specific markets where we see growth opportunities. We feel that this plan should enable us to achieve our strategic objectives without significantly increasing our selling expenses. On the administrative side, costs resulting from compliance with SEC requirements are projected to continue to grow and we may also need to hire additional administrative personnel as sales levels increase.

Interest Expense

Interest expense decreased in the third quarter of fiscal year 2009 by 15% as compared to the same quarter of fiscal year 2008. Interest expense in the first nine months of fiscal year 2009 decreased by 14% as compared to the same period in fiscal year 2008. These decreases were due to payment during fiscal year 2008 of principal amounts on the bonds used to finance the construction of both of our manufacturing facilities and to lower average interest rates during the current periods. We currently have no plans to enter into additional debt financing, which means that we are projecting a decrease in interest expense in fiscal year 2009 as the principal portion of our existing debt continues to be paid down.

Income Tax

We incurred federal income taxes during the first nine months of fiscal year 2009 at an effective rate of 37%. The effective rate is lower than the rate incurred during fiscal year 2008 of 39% due to the proportion of stock-based compensation expense from stock options that are not deductible for federal income taxes as compared to net income before taxes. We anticipate that the effective rate going forward will fluctuate depending on the ratio of net income before taxes to stock-based compensation recognized in a particular period. Losses incurred in Canada by International Absorbents have been fully reserved through the recording of a valuation allowance as Canadian net operating losses and deferred tax assets are not expected to be utilized in future periods.

Net Income

Our net income for the quarter ended October 31, 2008 increased by 12% as compared to the same period in the prior fiscal year. For the nine months ended October 31, 2008, net income increased by 17% as compared to the same period in fiscal year 2008. These increases in net income from the same periods in the prior fiscal year were primarily caused by an increase in net sales revenues off set by an increase in our selling, general and administrative expenses.

We expect that in the remainder of fiscal year 2009 we will be able to continue to increase sales as compared to the prior year and manage our selling, general and administrative costs. We believe that our biggest challenges for the remainder of fiscal year 2009 will be to continue to improve our gross margin and maintain projected net sales growth rates as the economy goes into a recession. We will continue to invest in future marketing programs to offset competitive pressures as necessary and anticipate additional administrative costs resulting from regulatory requirements. In addition, we anticipate

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

We believe that one of our key financial and operating performance metrics is earnings before interest, taxes, depreciation, and amortization (EBITDA). Our EBITDA increased by 1% during the third quarter of fiscal year 2009 as compared to the third quarter of fiscal year 2008. For the first nine months of fiscal year 2009 our EBITDA increased by 11% as compared to the same period in the prior fiscal year. The increases were primarily the result of increased sales while maintaining our gross margin which was off set by increases in our selling, administrative, and general expenses.

EBITDA is not a measure of financial performance under generally accepted accounting principles (GAAP) in the United States. Accordingly, it should not be considered a substitute for net income, cash flow provided by operating activities, or other income or cash flow data prepared in accordance with GAAP.
However, we believe that EBITDA may provide additional information with respect to our financial performance and our ability to meet our future debt service, capital expenditures and working capital requirements. This measure is widely used by investors and rating agencies in the valuation, comparison, rating, and investment recommendations of companies. In addition, we use EBITDA as one of several factors when measuring performance that can effect 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: