| INTERNATIONAL ABSORBENTS INC ITEM 1A RISK FACTORS RISK FACTORS The following risk factors and other information included in this Annual Report should be carefully considered |
| The risks and uncertainties described below are not the only ones we face |
| Additional risks and uncertainties not presently known to us or that we currently deem immaterial also may impair our business operations |
| If any of the following risks occur, our business, financial condition, operating results and cash flows could be materially adversely affected |
| We are still building 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 are still attempting 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 |
| We may be adversely affected by trends in the retail industry |
| With the growing trend towards retail trade consolidation, we are increasingly dependent upon key retailers whose bargaining strength is growing |
| Our business may be negatively affected by changes in the policies of our retailer customers, such as inventory delisting, limitations on access to shelf space, price demands and other conditions |
| In addition, as a result of the desire of retailers to more closely manage inventory levels, there is a growing trend among retailers to make purchases on a “just-in-time” basis |
| This requires us to shorten our lead time for production in certain cases and more closely anticipate demand, which could in the future require the carrying of additional inventories and increase our working capital and related financing requirement |
| A significant deterioration in the financial condition of one of our major customers could have a material adverse effect on our sales, profitability and cash flow |
| We continually monitor and evaluate the credit status of our customers and attempt to adjust sales terms as appropriate |
| Despite these efforts, a bankruptcy filing by a key customer could have a material adverse effect on our business, results of operations and financial condition |
| We depend on a few customers for a significant portion of our business |
| Our two largest customers accounted for approximately 23prca (Petco) and 22prca (Petsmart) of our net sales in fiscal year 2006, while the same customers accounted for approximately 22prca and 21prca, respectively, of our net sales in fiscal year 2005 |
| The loss of, or significant adverse change in, our relationship with any of these key retailers could cause our net sales, income from operations and cash flow to decrease substantially |
| 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 |
| Our future growth may depend on our ability to penetrate new domestic and international markets, which could reduce our profitability |
| Our current sales projections indicate that growth in sales will 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 |
| 10 _________________________________________________________________ Other significant challenges to conducting business in foreign countries include, among other factors, local acceptance of our products, political instability, currency controls, changes in import and export regulations, changes in tariff and freight rates, and fluctuations in foreign exchange rates |
| We might not be able to penetrate these markets and any market penetration that occurs might not be timely or profitable |
| If we do not penetrate these markets within a reasonable time, we will be unable to recoup part or all of the significant investments we may have made in attempting to do so |
| We cannot be certain that our product innovations and marketing successes will continue |
| As noted above, 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 |
| We compete against numerous other companies, some of which are more established in their industries and have substantially greater revenue or resources than we do |
| Our products compete against national and regional products and private label products produced by various suppliers |
| To compete effectively, among other things, we must: • maintain our relationships with key retailers; • 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 |
| Our inability to compete effectively could have a material adverse effect on our business, results of operations and financial condition |
| Additional increases in our costs of goods sold, including the costs of raw materials, transportation costs or labor expenses, could have an adverse effect on our financial condition |
| Our business places heavy reliance on raw materials being readily available |
| Although we believe that there are a number of pulp and paper mills in British Columbia, Canada, the State of Washington, the State of Georgia, and the State of Florida that can provide us with the raw materials necessary to conduct our business, any significant decreases in supplies, or any increase in costs or a greater increase in delivery costs for these materials, could result in a decrease in our margins, which would harm our financial condition |
| For example, in the second quarter of fiscal year 2005, we experienced a decreased availability of our main raw material, waste wood fiber, which resulted in downward pressure on our gross profits for the period |
| We currently do not have ideal raw material sources for our needed primary raw material, waste wood pulp, to be supplied to our Georgia facility |
| Although we believe we will be able to obtain the required material in the region, any significant shortfall of material would result in a significant increase in the cost of producing our primary products |
| In addition, we have recently experienced exceedingly high energy and transportation expenses |
| Any further increases in these costs will continue to 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 |
| 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, 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 |
| 11 _________________________________________________________________ If we do not obtain all material licenses and permits required by government, we may be subject to regulatory action by government authorities |
| Moreover, if our policies and procedures do not comply in all respects with existing laws and regulations, our activities may violate such laws and regulations |
| Even if our policies and procedures do comply, but our employees fail or neglect to follow them in all respects, we might incur similar liability |
| For example, if a regulatory authority finds that a current or future product or production run is not in compliance with any of these regulations, we may be fined, production may be stopped or a product may be pulled from the shelves, any of which could adversely affect our financial conditions and operations |
| In addition, any adverse publicity associated with any noncompliance may damage our reputation and our ability to successfully market our products |
| Furthermore, the rules and regulations are subject to change from time to time and while we closely monitor developments in this area, we have no way of anticipating whether changes in these rules and regulations will be made that would impact our business adversely |
| Additional or revised regulatory requirements, whether labeling, environmental, health and safety, tax or otherwise, could have a material adverse effect on our financial condition and results of operations |
| We have significant indebtedness, the nonpayment of which could harm our business |
| As of January 31, 2006, we had total long-term and current indebtedness under our bonds of dlra7cmam263cmam000 |
| We make interest payments (and principal payments on the taxable bond) on the indebtedness under our bonds, which are due in 2007 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 the event of an economic downturn |
| There is no guarantee 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 are in 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 |
| 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 (“PCAOB”) that require 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 |
| Additionally, it is possible that as we continue our ongoing review and analysis of internal control over financial reporting for compliance with the Sarbanes-Oxley Act of 2002, additional weaknesses in internal controls may be discovered |
| 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 |
| 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 affecting the US economy, 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 |
| We may also choose to raise additional capital due to market conditions or strategic considerations even if we believe that we have sufficient funds for our current or future operating plans |
| 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 includes 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 |
| 12 _________________________________________________________________ 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 currently are 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 |
| 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 |
| The inability to successfully obtain or protect our patents could harm our competitive advantage |
| Our success will depend, in part, on our ability to maintain protection for our products under US patent laws, to preserve our trade secrets and to operate without infringing the proprietary rights of third parties |
| We have been issued two US patents |
| Patent applications may not successfully result in an issued patent |
| Issued patents may be subject to challenges and infringements |
| Furthermore, others may independently develop similar products or otherwise circumvent our patent protection |
| Should we fail to obtain and protect our patents, our competitive advantage will be harmed |
| The products that we manufacture could expose us to product liability claims, and our manufacturing process may pose additional risks |
| Our business exposes us to potential product liability risks that are inherent in the manufacture and distribution of certain of our products |
| Although we generally seek to insure against such risks, there can be no assurance that such coverage is adequate or that we will be able to maintain such insurance on acceptable terms |
| A successful product liability claim in excess of our insurance coverage could have a material adverse effect on us and any successful material product liability claim could prevent us from obtaining adequate product liability insurance in the future on commercially reasonable terms |
| Moreover, as part of our manufacturing process, we use complex and heavy machinery and equipment that can pose severe safety hazards, especially if not properly and carefully used |
| Natural disasters could decrease our manufacturing capacity |
| Most of our current and planned manufacturing facilities are located in geographic regions that have experienced major natural disasters, such as earthquakes, floods, and hurricanes |
| Our disaster recovery plan may not be adequate or effective |
| We do not carry earthquake or flood insurance |
| Other insurance that we carry is limited in the risks covered and the amount of coverage |
| Our insurance would not be adequate to cover all of our resulting costs, business interruption and lost profits when a major natural disaster occurs |
| A natural disaster rendering one or more of our manufacturing facilities totally or partially unusable, whether or not covered by insurance, would materially and adversely affect our business and financial condition |
| The price for our common shares may continue to be volatile |
| The market price of our common shares, like that of many other emerging 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 |
| The liquidity of our stock depends in part on our continued listing with the American Stock Exchange |
| In March 2003, we received official notice from the American Stock Exchange (“AMEX”) 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 AMEX listing standards, including standards related to stock price, market capitalization and corporate governance |
| If we are unable to do so, AMEX could de-list our stock, in which event the liquidity and the value of our shares could be adversely impacted |
| 13 _________________________________________________________________ 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 US 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-US courts predicated solely upon the US federal securities laws; or enforce against us or our directors or officers in non-US courts judgments of courts in the United States predicated upon the civil liability provisions of the US federal securities laws |
| 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 above 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 Forward-looking statements include, but are not limited to, statements referring to our future growth strategies, prospects for the future, potential financial results, market and product line growth, abilities to enter new markets, ability to introduce new products, benefits from infrastructure improvements and our competitiveness and profitability as a result of new sales and marketing programs |