UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark one)

x                               QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2006

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 001-32596

REDDY ICE HOLDINGS, INC.

(Exact name of registrant as specified in its charter)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one): Large accelerated filer   o   Accelerated filer   o   Non-accelerated filer   x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes  o No  x

The number of shares of registrant’s common stock outstanding as of November 1, 2006 was 21,809,395.

REDDY ICE HOLDINGS, INC. AND SUBSIDIARY

QUARTERLY REPORT ON FORM 10-Q

FOR THE PERIOD ENDED SEPTEMBER 30, 2006

TABLE OF CONTENTS

 

1

PART I—FINANCIAL INFORMATION

Item 1.                        Financial Statements

REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)

 

See notes to condensed consolidated financial statements.

2

REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

 

See notes to condensed consolidated financial statements.

3

REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
(Unaudited)

 

See notes to condensed consolidated financial statements.

4

REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

 

See notes to condensed consolidated financial statements.

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 and 2005

1.                 General

The condensed consolidated financial statements of Reddy Ice Holdings, Inc. and its wholly owned subsidiary (together, the “Company”) included herein are unaudited; however, the balance sheet as of December 31, 2005 has been derived from the audited financial statements for that date. These financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). As applicable under the SEC’s regulations, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. All significant intercompany balances and transactions have been eliminated upon consolidation, and all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position, results of operations and cash flows for the periods covered have been made and are of a normal and recurring nature. The financial statements included herein should be read in conjunction with the consolidated financial statements and the related notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2005. Operating results for the three and nine months ended September 30, 2006 are not necessarily indicative of the results to be achieved for the full year.

Reddy Ice Holdings, Inc., a Delaware corporation (“Reddy Holdings”), and its wholly owned subsidiary, Cube Acquisition Corp. (“Cube”), a Texas corporation, were formed on behalf of Trimaran Fund Management LLC (“Trimaran”) and Bear Stearns Merchant Banking (“Bear Stearns”) on May 8, 2003 for the purpose of acquiring Packaged Ice, Inc. (“Packaged Ice”) and effecting certain capital transactions in connection with such acquisition. On August 15, 2003, Cube merged with and into Packaged Ice, with Packaged Ice being the surviving corporation. As a result of the merger, Packaged Ice was delisted from the American Stock Exchange. Reddy Holdings and Cube conducted no operations during the period from May 8, 2003 through August 14, 2003. In connection with the merger, Packaged Ice was renamed Reddy Ice Group, Inc. (“Reddy Group”). Reddy Holdings and its wholly owned subsidiary, Reddy Group, are referred to collectively herein as the “Company”.

On August 12, 2005, Reddy Holdings completed an initial public offering of its common stock (see Note 6). As a result of the offering, Reddy Holdings’ common shares are publicly traded on the New York Stock Exchange under the ticker symbol “FRZ”.

The Company manufactures and distributes packaged ice products and bottled water and owns and operates refrigerated warehouses. The Company is the largest manufacturer of packaged ice products in the United States. The Company serves approximately 82,000 customer locations in 31 states and the District of Columbia.

On August 2, 2005, the Company effected a 138 for 1 stock split and, in conjunction therewith, amended and restated the Company’s certificate of incorporation to increase the number of authorized shares of the Company’s common stock and preferred stock. All common share and per common share amounts in these condensed consolidated financial statements prior to August 2, 2005 have been retroactively adjusted for all periods presented to give effect to the stock split.

In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements”. SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value estimates. This standard is effective for fiscal years beginning after

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 and 2005

November 15, 2007. The Company is currently evaluating the impact that this standard may have on its results of operations and financial position.

In September 2005, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108. SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements. SAB 108 is effective for fiscal years beginning after November 15, 2006. The Company is currently evaluating the impact that this standard may have on its results of operations and financial position.

2.                 Acquisitions

During the nine months ended September 30, 2006, the Company purchased nine ice companies, with two of these purchases occurring during the three months ended September 30, 2006. Including direct acquisition costs, the total acquisition consideration was $12.8 million. The total purchase price was allocated to the acquired assets and assumed liabilities based upon estimates of their respective fair values as of the respective closing dates using valuations and other studies. The following table summarizes the estimated fair values of the assets acquired and the liabilities assumed at the date of acquisition (dollars in millions):

 

The excess of the aggregate purchase price over the net assets acquired of $8.1 million was allocated to goodwill ($4.6 million) and other intangible assets ($3.5 million). Other intangible assets are comprised of customer lists, which are being amortized on a straight line basis over useful lives of 8 to 30 years.

During 2005, the Company purchased two ice companies for total acquisition consideration of $0.9 million. The results of operations of the 2005 and 2006 acquisitions are included in the Company’s consolidated results of operations from the date of each acquisition, which occurred on August 1, 2005 and September 30, 2005 and on various dates throughout 2006.

The following unaudited pro forma information presents the Company’s consolidated results of operations (i) for the three months and nine months ended September 30, 2006 as if the 2006 acquisitions had all occurred on January 1, 2006 and (ii) for the three months and nine months ended September 30, 2005 as if the 2006 and 2005 acquisitions had all occurred on January 1, 2005:

 

Additionally, unaudited pro forma revenues for the full year 2005, assuming the 2006 and 2005 acquisitions had all occurred on January 1, 2005, was $328,199,000.

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 and 2005

3.                 Inventories

Inventories consist of raw materials, supplies and finished goods. Raw materials and supplies consist of ice packaging materials, spare parts, bottled water supplies and merchandiser parts. Finished goods consist of packaged ice and bottled water. Inventories are valued at the lower of cost or market and include overhead allocations. Cost is determined using the first-in, first-out and average cost methods.

 

In November 2004, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 151, “Inventory Costs—an amendment of ARB No. 43, chapter 4”. SFAS No. 151 seeks to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs and wasted material (spoilage) in the determination of inventory carrying costs. The statement requires such costs to be treated as a current period expense. The Company adopted SFAS No. 151 on January 1, 2006. The adoption of SFAS No. 151 did not have a material effect on the Company’s results of operations and financial position.

4.                 Accrued Expenses

 

5.                 Revolving Credit Facility and Long-Term Obligations

101¤2% Senior Discount Notes.   On October 27, 2004, Reddy Holdings issued $151 million at maturity of 101¤2% Senior Discount Notes due 2012 (the “Discount Notes”) in a private placement offering. Each Discount Note had an initial accreted value of $663.33 per $1,000 principal amount at maturity. The accreted value of each Discount Note will increase from the date of issuance until November 1, 2008 at a rate of 101¤2% per annum such that the accreted value will equal the stated principal amount at maturity on November 1, 2008. Thereafter, cash interest will accrue and be payable semi-annually at a rate of 101¤2% per annum.

The Discount Notes are unsecured obligations of Reddy Holdings and are:

·       not guaranteed by any of Reddy Holdings’ subsidiaries;

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 and 2005

·       senior in right of payment to all of Reddy Holdings’ future subordinated indebtedness;

·       equal in right of payment with any of Reddy Holdings’ existing and future unsecured senior indebtedness;

·       effectively subordinated to Reddy Holdings’ existing and future secured debt, including Reddy Holdings’ guarantee of Reddy Group’s senior credit facility; and

·       structurally subordinated to all obligations and preferred equity of Reddy Holdings’ subsidiaries.

The Discount Notes include customary covenants that restrict, among other things, Reddy Holdings’ ability to incur additional debt or issue certain preferred stock, pay dividends or redeem, repurchase or retire its capital stock or subordinated indebtedness, make certain investments, create liens, enter into arrangements that restrict dividends from its subsidiaries, merge or sell all or substantially all of its assets or enter into various transactions with affiliates. Prior to November 1, 2007, Reddy Holdings may redeem up to 35% of the principal amount of the Discount Notes at a redemption price of 110.5% of the accreted value thereof, plus accrued and unpaid interest to the date of redemption, with funds raised in equity offerings that are specified in the indenture governing the Discount Notes. From and after November 1, 2008, Reddy Holdings may redeem any or all of the Discount Notes by paying a redemption premium, which is initially 5.25% of the principal amount at maturity of the notes and declines annually to 0% for the period commencing on November 1, 2010 and thereafter. If a change of control occurs prior to November 1, 2007, Reddy Holdings may, at its option, redeem all, but not less than all, of the Discount Notes at a redemption price equal to the sum of (i) the accreted value of the notes as of the redemption date, (ii) a premium equal to 125% of one year’s coupon payment and (iii) any accrued and unpaid interest to the date of redemption. If Reddy Holdings experiences a change of control and does not elect to make the optional redemption described in the previous sentence, Reddy Holdings will be required to make an offer to repurchase the Discount Notes at a price equal to 101% of their accreted value, plus accrued and unpaid interest, if any, to the date of purchase. Reddy Holdings may also be required to make an offer to purchase the senior discount notes with proceeds of asset sales that are not reinvested in the Company’s business or used to repay other indebtedness.

The Discount Notes were registered with the SEC effective August 26, 2005, pursuant to the Registration Rights Agreement (the “Rights Agreement”) entered into at the time of issuance.

On July 28, 2005, Reddy Holdings obtained the requisite consents from the holders of the Discount Notes to amend the definition of “Consolidated Net Income” in the indenture governing the Discount Notes in order to exclude certain one-time costs and expenses associated with Reddy Holdings’ initial public offering of its common stock (see Note 6).

On August 26, 2005, Reddy Holdings paid $0.4 million to purchase and retire Discount Notes with an aggregate principal amount at maturity of $0.5 million. A loss of $0.046 million was recognized in connection with this transaction.

87¤8% Senior Subordinated Notes.   On July 17, 2003, Cube completed the sale of $152 million of 87¤8% Senior Subordinated Notes due August 1, 2011 (the “Subordinated Notes”) in connection with a private placement offering. The Subordinated Notes were priced at 99.297%, which resulted in gross proceeds of $150.9 million. At the closing of the merger on August 15, 2003 (see Note 1), Reddy Group assumed Cube’s obligations under the Subordinated Notes and the related indenture and received the net proceeds

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 and 2005

of the offering. In connection with the closing of Reddy Holdings’ initial public offering of its common stock, substantially all the outstanding Subordinated Notes were redeemed (see discussion below in “Senior Credit Facility” for further information).

Senior Credit Facility.   On August 15, 2003, Reddy Group entered into a $170 million senior secured credit facility with the lenders being a syndicate of banks, financial institutions and other entities (the “Old Credit Facility”). The Old Credit Facility provided for a six-year term loan in the amount of $135 million and a five-year revolving credit in the amount of $35 million. On November 6, 2003, the Old Credit Facility was amended to increase the size of the term loan by $45 million.

On August 12, 2005, Reddy Group amended and restated its credit facility with a syndicate of banks, financial institutions and other entities as lenders, including Credit Suisse First Boston, as Administrative Agent, Canadian Imperial Bank of Commerce, Bear Stearns Corporate Lending, Inc. and Lehman Brothers, Inc. (the “Credit Facility”), to increase the maximum amount of the revolving credit facility to $60 million (the “Revolving Credit Facility”), provide for a $240 million term loan (the “Term Loan”), reduce the applicable margins on both the Revolving Credit Facility and Term Loan and extend the maturity of the Revolving Credit Facility to August 12, 2010 and the Term Loan to August 12, 2012. Borrowings under the Revolving Credit Facility and the Term Loan, along with proceeds from the Company’s initial public offering (see Note 6), were used to repay the Old Credit Facility, repurchase substantially all of the Company’s existing Subordinated Notes and fund other related transactions. A loss on extinguishment of debt of $28.1 million was incurred in connection with these transactions. The loss was due to the payment of tender premiums and consent fees to the holders of the Subordinated Notes ($17.3 million), the write-off of deferred debt costs and original issue discount related to the Subordinated Notes and the Old Credit Facility ($10.6 million) and other fees and expenses ($0.2 million).

At September 30, 2006, the Company had $53.2 million of availability under the Revolving Credit Facility, which was net of outstanding standby letters of credit of $6.8 million. The standby letters of credit are used primarily to secure certain insurance obligations.

Principal balances outstanding under the Credit Facility bear interest per annum, at Reddy Group’s option, at the sum of the base rate plus 0.75% or LIBOR plus 1.75%. The base rate is defined as the greater of the prime rate (as announced from time to time by the Administrative Agent) or the federal funds rate plus 0.5%. At September 30, 2006, the weighted average interest rate of borrowings outstanding under the Credit Facility was 7.25%. Interest on base rate loans is payable on the last day of each quarter. Interest on LIBOR loans is payable upon maturity of the LIBOR loan or on the last day of the quarter if the term of the LIBOR loan exceeds 90 days. Reddy Group pays a quarterly fee on the average availability under the Revolving Credit Facility at an annual rate of 0.5%.

The Revolving Credit Facility and Term Loan do not require any scheduled principal payments prior to their stated maturity dates. Subject to certain conditions, mandatory repayments of the Revolving Credit Facility and Term Loan (and if the Term Loan is no longer outstanding, mandatory commitment reductions of the Revolving Credit Facility) are required to be made with portions of the proceeds from (1) asset sales, (2) the issuance of debt securities and (3) insurance and condemnation awards, subject to various exceptions. In the event of a change in control, as defined in the Credit Facility, an event of default will occur under the Credit Facility. Under the Credit Facility, Reddy Group may only pay dividends to Reddy Holdings if Reddy Group’s leverage ratio for the most recently ended fiscal quarter is less than or equal to 3.75 to 1.0. In addition, the Credit Facility precludes Reddy Group from declaring any dividends if

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 and 2005

an event of default under the Credit Facility has occurred and is continuing. In particular, it will be an event of default if Reddy Group’s leverage ratio exceeds 4.0 to 1.0 or Reddy Group’s interest coverage ratio is less than 3.25 to 1.0.

The Credit Facility contains financial covenants, which include the maintenance of certain financial ratios, as defined in the Credit Facility, and is collateralized by substantially all of Reddy Group’s assets and the capital stock of all of its subsidiaries. Reddy Holdings guarantees the Credit Facility and such guarantee is secured by the capital stock of Reddy Group. At September 30, 2006, Reddy Group was in compliance with these covenants.

Interest Rate Hedging Agreement.   Effective September 12, 2005, Reddy Group entered into an interest rate hedging agreement (the “Hedge”) to fix the interest rate on a portion of its Term Loan. The Hedge has a term of three years and ten months and an initial notional balance of $220 million. The notional balance decreases by $20 million on October 12 of each of the following three years, beginning on October 12, 2006. Reddy Group pays a fixed rate of 4.431% on the notional balance outstanding and receives an amount equal to 3-month LIBOR. Any net payable or receivable amount is settled quarterly. If Reddy Group had been required to settle the Hedge as of September 30, 2006, it would have received $2.6 million. The fair value of the Hedge is included in the caption “Other Assets” in the consolidated balance sheet. Changes in the fair value of the Hedge are recorded as “Other Comprehensive Income” in the consolidated statement of stockholders’ equity. Reddy Group is exposed to risk of loss in the event of non-performance by the counterparty to the Hedge; however, it does not anticipate non-performance by the counterparty.

At September 30, 2006 and December 31, 2005, long-term obligations consisted of the following:

 

6.      Capital Stock

Common Stock.   Reddy Holdings is authorized to issue up to 75,000,000 shares of common stock, par value $0.01 per share. Holders of Reddy Holdings’ common stock are entitled to one vote per share on all matters to be voted on by stockholders and are entitled to receive dividends, if any, as may be declared from time to time by the Board of Directors of Reddy Holdings. Upon any liquidation or dissolution of Reddy Holdings, the holders of common stock are entitled, subject to any preferential rights of the holders of preferred stock, to receive a pro rata share of all of the assets remaining available for distribution to stockholders after payment of all liabilities.

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 and 2005

On February 11, 2005, Reddy Holdings filed a registration statement on Form S-1 with the SEC for a proposed initial public offering of its common stock. The registration statement was declared effective by the SEC on August 10, 2005. Reddy Holdings sold 6,911,765 shares and received proceeds from the offering, net of issuance costs, of $116.2 million on August 12, 2005. An additional 3,288,235 shares were sold by certain of Reddy Holdings’ stockholders.

On March 17, 2005, certain employees exercised stock options granted under the 2003 Stock Option Plan to purchase 248,198 shares of Reddy Holdings’ common stock for an aggregate purchase price of approximately $1.8 million. On August 8, 2005, Reddy Holdings amended the 2003 Stock Option Plan to accelerate the schedule for vesting of time-based options, immediately vest all outstanding performance-based options, allow unvested options to be exercised for restricted stock with identical vesting schedules and provide for accelerated vesting of options upon the termination of an option holder’s employment under certain circumstances. During the three months ended September 30, 2005, a charge of $0.5 million was recorded in “Operating Expenses” in the consolidated statements of operations in connection with the acceleration of vesting schedules.

On August 12, 2005, certain employees and directors performed a cashless exercise of stock options granted under the 2003 Stock Option Plan, which resulted in the issuance of 808,818 shares of common stock, 465,651 of which were restricted shares. In accordance with the 2003 Stock Option Plan, as amended, restricted shares vest on the following schedule: 40% on February 28, 2006, 40% on January 16, 2007 and 20% on July 1, 2007. In connection with the scheduled vesting on February 28, 2006, the Company purchased and retired 51,256 shares of common stock from employees for $1.0 million to provide the employees with funds to satisfy their minimum statutory federal and state tax withholding obligations related to the vesting of their restricted stock on that date. The purchase price was $20.20 per share, the closing market price on February 28, 2006.

Since August 1, 2005, the board of directors of Reddy Holdings has declared the following dividends on the Company’s common stock:

 

Preferred Stock.   Reddy Holdings is authorized to issue up to 25,000,000 shares of $0.01 par value preferred stock, all of which is currently undesignated and unissued.

7.                 Employee Benefit Plans

2005 Equity Incentive Plan.   On August 8, 2005, the board of directors and stockholders of Reddy Holdings approved the 2005 Equity Incentive Plan. Under the 2005 Equity Incentive Plan, up to 750,000 shares of common stock may be issued to employees, directors and certain third parties in connection with various incentive awards, including stock options, restricted shares and restricted share units. On October 18, 2005, Reddy Holdings filed a Registration Statement on Form S-8 with the SEC to cover the reoffer and resale of up to 750,000 shares of Reddy Holdings’ common stock that Reddy Holdings may issue in the future to participants in the 2005 Equity Incentive Plan.

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 and 2005

On November 3, 2005, 9,300 unrestricted common shares were granted to certain employees under the 2005 Equity Incentive Plan. Restricted share units (“RSUs”) have been granted to certain employees and the independent directors of Reddy Holdings in the following amounts: 682,000 RSUs on November 3, 2005, 10,000 RSUs on November 15, 2005, 9,625 RSUs on February 22, 2006, 13,650 RSUs on August 12, 2006, 4,500 RSUs on September 1, 2006 and 2,250 RSUs on September 29, 2006. Each RSU provides for the grant of one share of unrestricted common stock on the date that the vesting terms of each RSU is satisfied.

Generally, fifty percent of each award of RSUs (the “Time-vested RSUs”) will vest in four equal annual installments beginning on August 12, 2006 and continuing on August 12 of each of the following three years, provided the recipient remains employed with the Company through such vesting dates. The remaining fifty percent of each award of RSUs (the “Performance-vested RSUs”) will vest in four equal annual installments beginning on August 12, 2006 and continuing on August 12 of each of the following three years, provided the recipient remains employed with the Company through such vesting dates and the applicable performance condition for the applicable vesting period is met. The performance condition for each vesting period will be based on the Company’s earned distributable cash per share (as defined in the related restricted share unit agreement) for such vesting period. Each vesting period will begin on July 1 and end on June 30 of the subsequent year. All RSUs will immediately vest in full, and shares will be distributed, at the time of a Change in Control (as defined in the 2005 Equity Incentive Plan). If in any performance period the performance condition for a subsequent performance period is achieved, Performance-vested RSUs will be entitled to dividend equivalent rights in the subsequent performance period equal to the dividends which would be payable on the shares of common stock represented by the RSUs subject to vesting in that period. Payments of such dividend equivalents will be made in cash to the holders of RSUs at the time of actual dividend payments and will not be subject to vesting. Time-vested RSUs will not be entitled to dividend equivalent rights. Based on the Company’s financial results for the vesting period ended June 30, 2006, the performance condition for the Performance-vested RSUs eligible for vesting on August 12, 2006 was met. A total of 172,375 Time-vested RSUs and Performance-vested RSUs vested on August 12, 2006. Furthermore, the performance targets for the remaining three vesting periods were met as of June 30, 2006. Therefore, the holders of unvested Performance-based RSUs will be entitled to dividend equivalent payments for the period from July 1, 2006 to June 30, 2007.

Compensation expense associated with the 2005 Equity Incentive Plan was $0.9 million and $2.9 million during the three and nine months ended September 30, 2006, respectively. Such compensation expense was recorded in “Operating Expenses” in the consolidated statements of operations. Approximately twenty-five percent of the Time-vested RSUs are being expensed during each twelve-month period ending August 12 in 2006 to 2009. Performance-vested RSUs are being expensed on the same basis as the first annual installment met the performance condition as of June 30, 2006 and it is management’s belief that the performance condition for each subsequent period will also be met. As of September 30, 2006, 538,950 shares were reserved for issuance and 29,375 shares were available for grant under the 2005 Equity Incentive Plan.

2003 Stock Option Plan.   The 2003 Stock Option Plan was amended on August 8, 2005 (see Note 6). On August 12, 2005, all outstanding options under the 2003 Stock Option Plan were exercised in exchange for restricted shares (see Note 6). At September 30, 2006, 57,883 shares of common stock were available for grant under the 2003 Stock Option Plan. The Company does not intend to make any additional grants under this plan. Compensation expense associated with the 2003 Stock Option Plan was $0.3 million during

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 and 2005

the three months ended September 30, 2006 and 2005 and $0.8 million during the nine months ended September 30, 2006 and 2005, excluding the effect of the acceleration of vesting schedules discussed in Note 6. Such compensation expense was recorded in “Operating Expenses” in the consolidated statements of operations.

Effective January 1, 2005, the Company adopted the fair value recognition provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, as amended by SFAS No. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”. Under the provisions of SFAS No. 148, the Company selected the modified prospective method of adoption and therefore began recognizing stock-based employee compensation cost related to all employee equity grants outstanding at the date of adoption, as well as grants made or modified thereafter.

In December 2004, the FASB issued SFAS No. 123(R), “Share-Based Payment”, which established accounting standards for all transactions in which an entity exchanges its equity instruments for goods and services. SFAS No. 123(R) generally requires companies to measure the cost of employee services received in exchange for an award of equity instruments based on the fair value of the award on the date of the grant. The standard requires grant date fair value to be estimated using either an option-pricing model which is consistent with the terms of the award or a market observed price, if such a price exists. Such cost must be recognized over the period during which an employee is required to provide service in exchange for the award, which is usually the vesting period. The standard also requires the Company to estimate the number of instruments that will ultimately be issued, rather than accounting for forfeitures as they occur.

The Company adopted SFAS No. 123(R) on January 1, 2006 using the modified prospective method and straight line amortization of compensation cost. The adoption of this standard did not have a material effect on the Company’s results of operations and financial position.

8.                 Earnings Per Share

The computation of net income (loss) per share is based on net income (loss) divided by the weighted average number of shares outstanding. For the three and nine months ended September 30, 2005, there were 0.3 million and 1.4 million shares, respectively, of dilutive securities which are not included in the computation of diluted net loss per share as their effect would be anti-dilutive.

 

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 and 2005

9.                 Income Taxes

The Company’s effective tax rate differs from the federal statutory income tax rate of 35% due to state income taxes and the effect of permanent differences, primarily the non-deductible portion of the interest expense recognized on the 10½% Senior Discount Notes. The effective rate for the three and nine months ended September 30, 2006 includes the effect of the recent Texas corporate tax legislation, enacted on May 18, 2006, which changes the existing Texas franchise tax from a tax based on net income or taxable capital to an income tax based on a defined calculation of gross margin (the “Margin Tax”). The effective date of the new legislation is January 1, 2008, which means that the Company will file its first Margin Tax return on May 15, 2008 based on its 2007 results.

In connection with the vesting of restricted stock on February 28, 2006 (see Note 6) and August 12, 2006 (see Note 7), the Company realized an excess tax benefit of $4.2 million. Because the Company is not currently making cash payments for income taxes due to its net operating loss (“NOL”) carryforwards, such excess benefit has not been recognized in the Company’s financial statements and is being reported as a “suspended NOL carryforward” in the footnotes to the consolidated financial statements in accordance with SFAS No. 123(R).

In June 2006, the FASB issued FASB Interpretation (“FIN”) No. 48, “Accounting for Uncertainty in Income Taxes”. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes”. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a return and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. This interpretation is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact that this standard may have on its results of operations and financial position.

10.          Commitments and Contingencies

The Company is involved in various claims, lawsuits and proceedings arising in the ordinary course of business. There are uncertainties inherent in the ultimate outcome of such matters and it is impossible to presently determine the ultimate costs that may be incurred. Management believes the resolution of such uncertainties and the incurrence of such costs will not have a material adverse effect on the Company’s consolidated financial position, results of operations or cash flows.

11.          Segment Information

The Company has two reportable segments: (1) ice products and (2) non-ice products and services. Ice products include the manufacture and distribution of packaged ice products through traditional ice manufacturing and delivery and The Ice Factory®, which is a proprietary machine that produces, packages, stores and merchandises ice at the point of sale through an automated, self-contained system. Non-ice products and services include refrigerated warehousing for third parties and the manufacturing and sale of bottled water.

The Company evaluates the performance of each segment based on earnings before interest, taxes, depreciation, amortization, gain or loss on disposition of assets, impairment of assets, loss on

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 and 2005

extinguishment of debt and management agreement termination fees and transaction bonuses and expenses (“Segment EBITDA”). Segment assets are not a factor in the evaluation of performance. There were no intersegment sales during the three and nine months ended September 30, 2006 and 2005.

Segment information for the three months ended September 30, 2006 and 2005 was as follows:

 

Segment information for the nine months ended September 30, 2006 and 2005 was as follows:

 

The reconciliation of Total Segment EBITDA to net income (loss) for the three and nine month periods ended September 30, 2006 and 2005 was as follows:

 

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) (Continued)
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2006 and 2005

12.          Impairment of Assets

Due to a significant reduction in bottled water sales volumes related to the loss of that operation’s largest customer, the Company evaluated the goodwill recorded in the bottled water portion of its non-ice business segment in accordance with SFAS No. 142, “Goodwill and Other Intangibles” as of September 30, 2006. The goodwill was valued using a market valuation approach based on valuations of comparable businesses, multiples of earnings of comparable businesses and discounted cash flows. As a result of such evaluation, the Company recorded a non-cash impairment charge of $3.3 million during the three months ended September 30, 2006.

 

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Item 2.                        Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and the related notes and other information included elsewhere in this Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2005, previously filed with the SEC. As used in this section, “Reddy Group” refers to Reddy Ice Group, Inc., formerly known as Packaged Ice, Inc., and not its subsidiaries, and “Reddy Holdings” refers to Reddy Ice Holdings, Inc. and not its subsidiaries.

Uncertainty of Forward Looking Statements and Information

Other than statements of historical facts, statements made in this Form 10-Q, statements made by us in periodic press releases, oral statements made by our management to analysts and stockholders and statements made in the course of presentations about our company constitute “forward-looking statements” intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. We believe the expectations reflected in such forward-looking statements are accurate. However, we cannot assure you that such expectations will occur. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from future results expressed or implied by the forward-looking statements. Factors you should consider that could cause these differences are:

·       general economic trends and seasonality;

·       weather conditions;

·       the ability of our subsidiaries to make distributions to us in amounts sufficient to make dividend payments to our stockholders in accordance with our dividend policy;

·       our substantial leverage and ability to service our debt and pay dividends;

·       the restrictive covenants under our indebtedness;

·       the availability of capital sources;

·       fluctuations in our operating costs, including in the prices of electricity, fuel, polyethylene and other required expenses;

·       competitive practices in the industry in which we compete;

·       changes in labor conditions;

·       our capital expenditure requirements;

·       the risks associated with acquisitions and the failure to integrate acquired businesses;

·       technological changes and innovations;

·       costs associated with potential product liability claims or liabilities under environmental laws;

·       legislative or regulatory requirements; and

·       all the other factors described herein under Item 1A of Part II and in Item 1A of Part I of our
Annual Report on Form 10-K.

You should not unduly rely on these forward-looking statements, as they speak only as of the date of this report. Except as required by law, we are not obligated to publicly release any revisions to these forward-looking statements to reflect events or circumstances occurring after the date of this report or to reflect the occurrence of unanticipated events. Important factors that could cause our actual results to differ materially from our expectations are discussed elsewhere in this report.

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General

Overview.   We are the largest manufacturer and distributor of packaged ice in the United States and currently serve approximately 82,000 customer locations in 31 states and the District of Columbia. We operate in two business segments—ice products and non-ice products and operations. Ice products accounted for approximately 97% of our revenues in the nine months ended September 30, 2006 and 96% of revenues in the nine months ended September 30, 2005. Our ice products business consists of:

·       the traditional manufacture and delivery of ice from a central point of production to the point of sale; and

·       the installation and operation of The Ice Factory®, our proprietary equipment located in our customers’ high volume locations that produces, packages and stores ice through an automated, self-contained system.

Our other business segment, non-ice products and operations, consists of refrigerated warehousing for third parties and the manufacture and sale of bottled water.

Seasonality.   The packaged ice business is highly seasonal, characterized by peak demand during the warmer months of May through September, with an extended peak selling season in the southern United States. Approximately 69%, 68% and 66% of our annual revenues occurred during the second and third calendar quarters in each of 2005, 2004 and 2003. Approximately 68% of our annual revenues also occurred during the second and third calendar quarters of 2002, 2001 and 2000. The higher level of revenues in 2005 was primarily due to the effects of the hurricane season, which caused a significant increase in revenues during the third quarter of 2005. The decrease in 2003 was primarily due to the timing of our acquisitions, which occurred in the fourth quarter of that year. As a result of seasonal revenue declines and a less than proportional decline in expenses during the first and fourth quarters, we typically experience lower margins resulting in losses during these periods. In addition, because our operating results depend significantly on revenues during our peak season, our quarterly results of operations may fluctuate significantly as a result of adverse weather during this peak selling period if the weather is unusually cool or rainy on a national or regional basis.

Revenues.   Our revenues primarily represent sales of packaged ice, packaged ice bags for use in our Ice Factory equipment, bottled water and cold storage services. There is no right of return with respect to these products or services. A portion of our revenues also represents fees earned under management agreements for Ice Factories located outside our primary territories that are recognized as earned under contract terms.

Cost of Sales (Excluding Depreciation).   Our cost of sales (excluding depreciation) consists of costs related to the manufacture and distribution of our products, including, in particular:

·       manufacturing and distribution labor costs;

·       raw materials (primarily of polyethylene-based plastic bags);

·       product delivery expenses, including fuel and vehicle rental expense related to products delivered by our own distribution network, as well as fees paid to distributors who deliver ice to our customers on our behalf;

·       utility expenses (primarily electricity used in connection with the manufacturing, storage and distribution processes); and

·       Ice Factory-related costs associated with customer service representatives and machine technicians (note, however, that Ice Factories generally do not increase our plant occupancy, delivery or utility costs).

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Depreciation Expense Related to Cost of Sales and Depreciation and Amortization Expense.   Depreciation and amortization are divided into two line items—depreciation expense related to cost of sales and depreciation and amortization expense. Depreciation expense related to cost of sales consists of depreciation expense for our production and distribution equipment. Depreciation and amortization expense consists of depreciation and amortization expense for our selling, general and administrative functions.

Operating Expenses.   Our operating expenses are costs associated with selling, general and administrative functions. These costs include executive officers’ compensation, office and administrative salaries, insurance, legal and other professional services and costs associated with leasing office space. Labor costs, including associated payroll taxes and benefit costs but excluding non-cash stock-based compensation expense, included in operating expenses represented approximately 7% of revenues in the nine months ended September 30, 2006 and 2005.

Facilities.   At September 30, 2006, we owned or operated 60 ice manufacturing facilities, 57 distribution centers, approximately 79,000 merchandisers (cold storage units installed at customer locations), approximately 3,000 Ice Factories, five refrigerated warehouses and one bottled water plant. As of the same date, we had an aggregate daily ice manufacturing capacity of approximately 17,000 tons.

Three Months Ended September 30, 2006 Compared to Three Months Ended September 30, 2005

 

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Revenues:   Revenues decreased $0.5 million from the three months ended September 30, 2005 to the three months ended September 30, 2006. This decrease is due to a $1.1 million reduction in the revenues of our non-ice operations, driven primarily by the loss of the bottled water operation’s largest customer, partially offset by a $0.6 million increase in revenues in our ice operations. The increase in ice operations revenues is related to higher average pricing and the effects of acquisitions completed during the last half of 2005 and 2006 (approximately $2.0 million), offset by volume reductions related to significantly less favorable weather patterns in most our markets in the month of September.

Cost of Sales (Excluding Depreciation):   Cost of sales (excluding depreciation) increased $3.3 million from the three months ended September 30, 2005 to the three months ended September 30, 2006. This increase in cost of sales is primarily due to increased unit costs of plastic bags, electricity, fuel, and third party distribution expenses in our ice business. Acquired ice operations represented approximately $1.2 million of the increase. Offsetting these increases was a $0.6 million reduction of costs in our non-ice businesses, primarily in our bottled water operation in connection with the loss that operation’s largest customer.

Labor costs, including associated payroll taxes and benefit costs (including health insurance), accounted for approximately 20% of revenues in the three months ended September 30, 2006 and 2005. Cost of plastic bags represented 7% of revenues in the three months ended September 30, 2006 and 2005. Fuel expenses represented approximately 4% and 3% of revenues in the three months ended September 30, 2006 and 2005, respectively. Expenses for independent third party distribution services represented approximately 6% and 5% of revenues in the three months ended September 30, 2006 and 2005, respectively. Electricity expense represented approximately 6% and 5% of revenues in the three months ended September 30, 2006 and 2005, respectively.

Depreciation Expense Related to Cost of Sales:   Depreciation expense related to cost of sales increased  $0.1 million due to additional depreciation expense associated with production and distribution equipment placed in service during 2005 and the first nine months of 2006, partially offset by the effect of asset dispositions and assets becoming fully depreciated.

Operating Expenses:   Operating expenses decreased $0.8 million from the three months ended September 30, 2005 to the three months ended September 30, 2006. This decrease is primarily due to a decrease of $1.2 million in accrued incentive compensation and a $0.3 million decrease in bad debt expense, offset by an increase of $0.4 million in non-cash stock-based compensation expense and an additional $0.3 million in labor and other costs.

Depreciation and Amortization:   Depreciation and amortization increased $0.1 million from the three months ended September 30, 2005 to the three months ended September 30, 2006. This increase is primarily due to additional amortization expense associated with the intangible assets recorded in connection with the acquisitions completed during 2005 and the nine months ended September 30, 2006.

Impairment of Assets:   During the three months ended September 30, 2006, we recorded a non-cash goodwill impairment charge of $3.3 million in the bottled water portion of our non-ice business segment in accordance with SFAS No. 142, “Goodwill and Other Intangibles” as a result of the loss of a significant customer.

Interest Expense:   Interest expense decreased $1.1 million from the three months ended September 30, 2005 to the three months ended September 30, 2006, primarily due to the repurchase of substantially all of our 87¤3% senior subordinated notes on August 15, 2005, partially offset by a $1.5 million increase in term loan interest related to increased principle balances subsequent to the refinancing of the credit facility in August 2005 and the effect of higher interest rates on the unhedged portion of our variable rate debt.

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