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 March 31, 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)

 

8750 N. CENTRAL EXPRESSWAY, SUITE 1800

DALLAS, TEXAS 75231

(Address of principal executive offices)

(214) 526-6740

(Registrant’s telephone number, including area code)

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 April 25, 2006 was 21,637,020.

REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
QUARTERLY REPORT ON FORM 10-Q
FOR THE PERIOD ENDED MARCH 31, 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)
(in thousands)

																						Accumulated
		Common Stock								Additional												Other
		Number				Par				Paid-In				Unearned				Accumulated				Comprehensive
		of Shares				Value				Capital				Compensation				Deficit				Income				Total
Balance at January 1, 2006			21,690				$ 217				$ 213,096				$ (52	)			$ (32,065	)			$ 1,987			$ 183,183
Reclassification of unearned compensation upon adoption of SFAS No. 123(R)			—				—				(52	)			52				—				—			—
Compensation expense related to stock-based awards			—				—				1,245				—				—				—			1,245
Cash dividends declared			—				—				—				—				(8,276	)			—			(8,276	)
Repurchase and retirement of common stock			(53	)			(1	)			(1,034	)			—				—				—			(1,035	)
Comprehensive loss:
Net loss			—				—				—				—				(8,239	)			—			(8,239	)
Change in fair value of derivative asset			—				—				—				—				—				2,196			2,196
Total comprehensive loss			—				—				—				—				—				—			(6,043	)
Balance at March 31, 2006			21,637				$ 216				$ 213,255				$ —				$ (48,580	)			$ 4,183			$ 169,074

 

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.

5

REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 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 months ended March 31, 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, including reclassifying an amount equal to the increase in par value from additional paid-in capital to common stock.

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (Continued)

2.   Acquisitions

During the three months ended March 31, 2006, the Company purchased two ice companies. Including direct acquisition costs, the total acquisition consideration was $1.4 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 $0.7 million was allocated to goodwill ($0.3 million) and other intangible assets ($0.4 million). Other intangible assets are comprised of customer lists, which are being amortized on a straight line basis over useful lives of 15 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 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.

The following unaudited pro forma information presents the Company’s consolidated results of operations (i) for the three months ended March 31, 2006 as if the 2006 acquisitions had all occurred on January 1, 2006 and (ii) for the three months ended March 31, 2005 as if the 2006 and 2005 acquisitions had all occurred on January 1, 2005:

 

3.   Inventories

Inventories consists 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.

 

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (Continued)

In November 2004, the Financial Accounting Standards Board (“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. This statement is effective for fiscal years beginning after July 15, 2005. 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. The Discount Notes were sold at 66.333% of the stated principal amount, which resulted in gross proceeds of $100.2 million. The net proceeds of the offering, together with a dividend of approximately $28.4 million from Reddy Group, were used to redeem all of Reddy Holdings’ existing series A preferred stock for approximately $99.2 million, to pay accumulated dividends on such stock as of the date of redemption in the amount of approximately $15.0 million and to pay a dividend of approximately $10.4 million to Reddy Holdings’ common stockholders. In connection with these transactions, Reddy Group made a special transaction payment of approximately $1.2 million in the aggregate to certain members of management and certain directors.

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 10½% 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 10½% per annum.

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

·        not guaranteed by any of Reddy Holdings’ subsidiaries;

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

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (Continued)

·        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 principal amount 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 of the offering. The net proceeds were used to consummate Reddy Holding’s acquisition of Packaged Ice,

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (Continued)

which included the repayment of  the Packaged Ice’s $255 million aggregate principal amount of 9¾% Senior Subordinated Notes due February 1, 2005 and the outstanding balance of $61.7 million under its bank credit facility. Interest was payable semiannually on February 1 and August 1, commencing on February 1, 2004. In conjunction with issuance of the Subordinated Notes, $7.0 million of debt issuance costs were incurred. 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, including Credit Suisse First Boston as Administrative Agent, Canadian Imperial Bank of Commerce and Bear Stearns Corporate Lending, Inc. (the “Old Credit Facility”). The Old Credit Facility provided for a six-year term loan in the amount of $135 million (the “Original Term Loan”) and a five-year revolving credit facility (the “Old Revolving Credit Facility”) in the amount of $35 million. Proceeds of the Original Term Loan were used to consummate the merger as discussed in Note 1. On November 6, 2003, the Old Credit Facility was amended to provide a Supplemental Term Loan (together with the Original Term Loan, referred to as the “Old Term Loans”) in the amount of $45 million, the proceeds of which were used to fund a portion of the cost of an acquisition. The Supplemental Term Loan had substantially the same terms as the Original Term Loan.

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 March 31, 2006, the Company had $54.2 million of availability under the Revolving Credit Facility, which was net of outstanding standby letters of credit of $5.8 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 March 31, 2006, the weighted average interest rate of borrowings outstanding under the Credit Facility was 6.3%. 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

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (Continued)

the term of the LIBOR loan exceeds 90 days. Reddy Group pays a quarterly fee on the average availability under the Revolving Credit Facility based on 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 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 March 31, 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 next 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 March 31, 2006, it would have received $4.2 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 March 31, 2006 and December 31, 2005, long-term obligations consisted of the following:

 

11

REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (Continued)

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.

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 at a public offering price of $18.50 per share. A portion of the shares were sold by Reddy Holdings and a portion were sold by certain of Reddy Holdings’ stockholders. The number of shares offered by Reddy Holdings and the selling stockholders was 6,911,765 and 3,288,235, respectively. The selling stockholders also granted the underwriters a 30-day option to purchase up to 1,530,000 additional shares to cover any over-allotments. The underwriters’ over-allotment option was exercised on August 11, 2005. Reddy Holdings received proceeds from the offering, net of issuance costs, of $116.2 million on August 12, 2005.

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.

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (Continued)

Since August 1, 2005, the board of directors of Reddy Holdings have 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.

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 and 9,625 RSUs on February 22, 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

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (Continued)

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.

Compensation expense associated with the 2005 Equity Incentive Plan was $0.9 million during the three months ended March 31, 2006. 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 period ending August 12 in 2006 to 2009. Performance-vested RSUs are being expensed on the same basis as it is management’s belief that the performance condition for each period will be met. As of March 31, 2006, 697,625 shares were reserved for issuance and 43,075 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 March 31, 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 the three months ended March 31, 2006 and 2005. 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.   Net Loss Per Share

The computation of net loss per share is based on net loss divided by the weighted average number of shares outstanding. For the three months March 31, 2006, there were 399,000 shares of restricted stock and 691,000 RSUs which are not included in the computation of diluted net loss per share as their effect would

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (Continued)

be anti-dilutive. For the three months March 31, 2005, there were 1,536,000 stock options which are not included in the computation of diluted net loss per share as their effect would be anti-dilutive.

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.

In connection with the vesting of restricted stock on February 28, 2006 (see Note 6), the Company realized an excess tax benefit of $1.3 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).

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 warehouses and the manufacturing and distribution 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 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 months ended March 31, 2006 and 2005.

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REDDY ICE HOLDINGS, INC. AND SUBSIDIARY
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
FOR THE THREE MONTHS ENDED MARCH 31, 2006 AND 2005 (Continued)

Segment information for the three months ended March 31, 2006 and 2005 was as follows:

 

The reconciliation of Segment EBITDA to net loss for the three months ended March 31, 2006 and 2005 was as follows:

 

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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;

·       availability of capital sources;

·       fluctuations in operating costs, including 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;

·       legislative or regulatory requirements; and

·       all the other factors described herein under Item 1A of Part II.

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 93% of our revenues in the three months ended March 31, 2006 and 92% of revenues in the three months ended March 31, 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 sales in 2005 was primarily due to the effects of the hurricane season, which caused a significant increase in sales during the third quarter of 2005. The lower level 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 sales 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 and Amortization.   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 12% of revenues in the three months ended March 31, 2006 and 2005.

Facilities.   At March 31, 2006, we owned or operated 58 ice manufacturing facilities, 54 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 March 31, 2006 Compared to Three Months Ended March 31, 2005

 

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Revenues:   Revenues increased $5.6 million from the three months ended March 31, 2005 to the three months ended March 31, 2006. This increase is primarily due to the effects of the higher average pricing, increases in ice volume sales due to warmer and drier average weather conditions in our markets and the continuing positive effects of package sizing initiatives, which consists primarily of converting a portion of our ice sales from seven to ten pound bags.

Cost of Sales (Excluding Depreciation):   Cost of sales (excluding depreciation) increased $2.7 million from the three months ended March 31, 2005 to the three months ended March 31, 2006. This increase in cost of sales is primarily due to increased costs of plastic bags, electricity, fuel and third party distribution expense related to sales volume increases. Bag costs and fuel costs also increased due to higher market prices of energy related items. Partially offsetting these increases was a $0.6 million decrease in insurance costs, primarily health insurance, and a $0.4 million decrease in other employee benefit costs.

Labor costs, including associated payroll taxes and benefit costs (including health insurance), accounted for approximately 32% and 36% of revenues in the three months ended March 31, 2006 and 2005, respectively. Cost of plastic bags represented approximately 7% of revenues in the three months ended March 31, 2006 and 6% of revenues in the three months ended March 31, 2005. Fuel expenses represented approximately 4% and 3% of revenues in the three months ended March 31, 2006 and 2005, respectively. Expenses for independent third party distribution services represented approximately 6% of revenues in the three months ended March 31, 2006 and 2005. Electricity expense represented approximately 7% of revenues in the three months ended March 31, 2006 and 2005.

Depreciation Expense Related to Cost of Sales:   Depreciation expense related to cost of sales decreased $0.03 million due to the effect of asset dispositions and assets becoming fully depreciated, partially offset by additional depreciation expense of approximately $0.5 million associated with production and distribution equipment placed in service during 2005 and early 2006.

Operating Expenses:   Operating expenses increased $2.3 million from the three months ended March 31, 2005 to the three months ended March 31, 2006. This increase is primarily due to an increase of $1.0 million in non-cash stock-based compensation expense, an increase of $0.7 million in accrued incentive compensation and $0.5 million of professional services and other costs incurred during the three months ended March 31, 2006 in connection with a potential acquisition that we are no longer pursuing, partially offset by reduced bad debt expense of $0.4 million.

Depreciation and Amortization:   Depreciation and amortization increased $0.01 million from the three months ended March 31, 2005 to the three months ended March 31, 2006. This increase is primarily due to additional amortization expense associated with the intangible assets recorded in connection with the acquisitions completed in 2005 and the three months ended March 31, 2006.

Interest Expense:   Interest expense decreased $2.4 million from the three months ended March 31, 2005 to the three months ended March 31, 2006, primarily due to the repurchase of substantially all of our 87¤8% senior subordinated notes on August 15, 2005, partially offset by a $1.5 million increase in term loan interest.

Liquidity and Capital Resources

We generate cash from the sale of packaged ice through traditional delivery methods, by which we manufacture, package and store ice at a central facility and transport it to our customers’ retail locations when needed, and through Ice Factories, which manufacture, package and store ice in our customers’ retail locations. Our primary uses of cash are (a) cost of sales, (b) operating expenses, (c) debt service, (d) dividends on our common stock, (e) capital expenditures related to replacing and modernizing the capital equipment in our traditional ice plants and acquiring and installing additional Ice Factories and (f) acquisitions. Historically, we have financed our capital and working capital requirements, including our

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acquisitions, through a combination of cash flows from operations, borrowings under our revolving credit facilities and operating leases.

Our ability to generate cash from our operations is subject to weather, general economic, financial, competitive, legislative, regulatory and other factors that are beyond our control. As a result, we cannot assure you that our business will generate sufficient cash flow from operations in amounts sufficient to enable us to service our debt and to fund our other liquidity needs. If we do not have sufficient liquidity, we will have to take actions such as reducing or delaying the payment of dividends to our common stockholders, strategic acquisitions, investments and joint ventures, selling assets, restructuring or refinancing our debt or seeking additional equity capital. We cannot assure you that any of these remedies could, if necessary, be effected on commercially reasonable terms, or at all. In addition, the terms of our debt instruments may restrict us from adopting some of these alternatives.

During the three months ended March 31, 2006, capital expenditures totaled $4.0 million. As we have consolidated acquisitions into the existing company infrastructure, we have identified non-core and excess assets which can be disposed of. From time to time, we also dispose of other assets which are no longer useful in our operations. As a result of dispositions of these non-core and excess assets, we realized proceeds of approximately $0.4 million in the three months ended March 31, 2006. Our net capital expenditures in the three months ended March 31, 2006 were $3.6 million.

In the three months ended March 31, 2006, we completed the acquisition of two small ice companies for a total cash purchase price of approximately $1.4 million, including direct acquisition costs of $0.03 million. We will continue to evaluate acquisition opportunities as they become available. In conjunction with these evaluations, we will consider our liquidity, availability under Reddy Group’s senior credit facility, mandatory principal repayments under our debt agreements and availability of other capital resources.

Cash Flows for the Three Months Ended March 31, 2006 and 2005

Net cash used in operating activities was $9.4 million and $14.7 million in the three months ended March 31, 2006 and 2005, respectively. The decrease in cash used in operating activities was primarily the result of a $1.8 million reduction in our net loss, which was primarily driven by a $2.4 million reduction in interest expense as a result of the debt refinancing and principal reductions completed in connection with the initial public offering of our common stock on August 12, 2005. In addition, $1.5 million less cash was used in operating activities by changes in working capital in the three months ended March 31, 2006 as compared to changes in working capital in the three months ended March 31, 2005, principally as a result of changes in the timing of our interest payments following the initial public offering of our common stock, partially offset by increases in accounts receivable due to increased revenues in the three months ended March 31, 2006.

Net cash used in investing activities was $5.0 million and $5.3 million in the three months ended March 31, 2006 and 2005, respectively. The decrease in cash used in investing activities is primarily due to a $1.8 million decrease in property and equipment additions, primarily related to the timing of our capital expenditure budget in 2006 versus 2005, partially offset by a $1.4 million increase in the cost of acquisitions. During the three months ended March 31, 2006, we completed two acquisitions for $1.4 million. We did not complete any acquisitions in the three months ended March 31, 2005.

Financing activities used net cash of $9.3 million in the three months ended March 31, 2006, compared to providing net cash of $18.3 million in the three months ended March 31, 2005. During the three months ended March 31, 2005, the exercise of employee stock options and net borrowings under our revolving credit facility provided cash of $19.0 million, only $0.7 million of which was used to repay debt. In the three months ended March 31, 2006, there were no cash inflows from financing activities while $8.3 million was used to pay cash dividends to our common stockholders and $1.0 million was used to repurchase common stock.

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Long-term Debt and Other Obligations

Overview.   At March 31, 2006, we had approximately $355.8 million of total debt outstanding as follows:

·       $115.6 million of Reddy Holdings’ 101¤2% senior discount notes due 2012 (net of unamortized discount of $34.9 million);

·       $240.0 million of outstanding term loans under Reddy Group’s senior credit facility which matures on August 12, 2012; and

·       $0.2 million of other debt.

Senior Discount Notes.   On October 27, 2004, Reddy Holdings issued $151.0 million in aggregate principal amount at maturity of 101¤2% senior discount notes due 2012 in a private placement offering. The senior discount notes were sold at 66.333% of the stated principal amount, which resulted in gross proceeds of $100.2 million. We used the net proceeds of the offering, together with a dividend of approximately $28.4 million from Reddy Group to redeem all of Reddy Holdings’ existing series A preferred stock for approximately $99.2 million, to pay accumulated dividends on such stock as of the date of redemption in the amount of approximately $15.0 million and to pay a dividend of approximately $10.4 million to our common stockholders. In connection with these transactions, Reddy Group made a special transaction payment of approximately $1.2 million in the aggregate to certain members of management and certain directors.

Each senior discount note had an initial accreted value of $663.33 per $1,000 principal amount at maturity. The accreted value of each senior discount note increases 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 senior discount notes are unsecured obligations of Reddy Holdings and are:

·       not guaranteed by any of Reddy Holdings’ subsidiaries;

·       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 senior discount notes include customary covenants that restrict, among other things, the ability to incur additional debt or issue certain preferred stock, pay dividends or redeem, repurchase or retire our capital stock or subordinated indebtedness, make certain investments, incur liens, enter into arrangements that restrict dividends from our subsidiaries, merge or sell all or substantially all of the assets or enter into various transactions with affiliates. Prior to November 1, 2007, we may redeem up to 35% of the principal amount of the senior discount notes at a redemption price of 110.5% of the principal amount 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 senior discount notes. From and after November 1, 2008, we may redeem any or all of the senior discount notes by paying a redemption premium which is initially 5.25% of the principal amount at maturity of the notes, and will decline annually to zero commencing on November 1, 2010. If a change of control occurs on or prior to November 1, 2007, we may, at our option, redeem all, but not less than all, of the senior discount notes at a redemption price equal to the sum of

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(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 we experience a change of control and do not elect to make the optional redemption described in the previous sentence, we will be required to make an offer to repurchase the senior discount notes at a price equal to 101% of their accreted value, plus accrued and unpaid interest, if any, to the date of purchase. We may also be required to make an offer to purchase the senior discount notes with proceeds of asset sales that are not reinvested in our business or used to repay other indebtedness. We registered the senior discount notes with the SEC pursuant to a registration statement that was declared effective on August 26, 2005.

The indenture governing our senior discount notes restricts the amount of dividends, distributions and other restricted payments we may pay. Under the indenture, we are restricted from paying dividends on our common stock unless, at the time of such payment:

·       no default or event of default has occurred and is continuing or would occur as a consequence thereof;

·       the consolidated coverage ratio set forth in the indenture governing our senior discount notes exceeds 2.0 to 1.0; and

·       there is sufficient capacity under the buildup amount under the indenture governing our senior discount notes.

In addition, regardless of whether we could make any restricted payments under the buildup amount provision referred to above, we may (1) make dividend payments at any time in an aggregate amount of up to $15.0 million if no default has occurred and is continuing under the indenture and (2) following our initial public offering, pay dividends on our capital stock of up to 6.0% per year of the cash proceeds (net of underwriters’ fees, discounts, commissions or other expenses paid by us) received by us from all such public equity offerings subject to specified conditions. Accordingly, we are able to pay approximately $7.0 million annually in dividends under this 6.0% provision. However, the amount of dividend payments permitted under this 6.0% provision will correspondingly reduce the amount we would otherwise have available to us under the buildup amount for restricted payments, including dividends. At March 31, 2006, Reddy Holdings had $8.4 million of cash on hand that was not subject to any restrictions under Reddy Group’s senior credit facility.

The consolidated coverage ratio under the indenture governing our senior discount notes means the ratio of our EBITDA for the most recent four fiscal quarters to our consolidated interest expense for such four quarter period. “EBITDA” under the indenture governing our senior discount notes is defined as the sum of our consolidated net income plus our income tax expense, our interest expense, our depreciation and amortization expense, unrealized non-cash gains or losses or non-cash charges in respect of hedging obligations required to be taken under generally accepted accounting principles, unrealized foreign currency translation gains or losses and all other non-cash charges, except to the extent representing an accrual or reserve for a future cash expenditure). “Consolidated net income” under the indenture governing our senior discount notes is defined as net income of Reddy Holdings and its restricted subsidiaries: plus or minus cash dividends received on investments or equity in net losses of persons other than restricted subsidiaries, respectively; provided that the following are not included in consolidated net income: (i) net income or loss of subsidiaries acquired in pooling of interests transactions for any period prior to the date of their acquisition, (ii) any net income of a subsidiary restricted in the payment of a dividend (other than certain permitted restrictions, including those under our existing credit facilities and our new credit facilities), (iii) gains or losses from non-ordinary course asset sales, (iv) extraordinary gains or losses, (v) the cumulative effect of changes in accounting principles, (vi) non-recurring fees and expenses and write offs of deferred financing costs related to the financing transactions in connection with the 2003 merger with Packaged Ice and, (vii) any fees, charges, costs or expenses relating to our initial public offering and the related transactions and paid in cash, to the extent deducted in the determination

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of consolidated net income. “Consolidated interest expense” under the indenture governing our senior discount notes is defined as total interest expense plus, to the extent not included in total interest expense, (i) interest expense attributable to capital leases, (ii) amortization of debt discount and issuance costs, (iii) capitalized interest, (iv) non-cash interest expense, (v) fees on letters of credit, (vi) net payments pursuant to hedging obligations, (vii) dividends accrued on certain disqualified stock (viii) interest incurred in connection with investments in discontinued operations, (ix) interest on guaranteed indebtedness and (x) cash contributions to employee stock ownership plans to the extent they are used to pay interest or fees on indebtedness incurred by such plans. We are generally required to calculate our consolidated coverage ratio on a pro forma basis to give effect to incurrences and repayments of indebtedness as well as acquisitions and dispositions.

The buildup amount equals 50% of our consolidated net income accrued during the period (treated as one accounting period) from July 1, 2003 to the end of the most recent fiscal quarter for which internal financial statements are available (or, if such consolidated net income is a deficit, minus 100% of such deficit), plus, the net cash proceeds of the issuance of capital stock, subject to certain exceptions, and any cash capital contribution received by us from our stockholders in each case after August 15, 2003 plus the amount by which our indebtedness is reduced on our balance sheet as a result of the conversion or exchange of such indebtedness for our capital stock, plus the net reduction in certain restricted investments made by us, less the amount of certain restricted payments we make from time to time, including, among other things, the payment of cash dividends.

Senior Credit Facility.   On August 12, 2005, Reddy Group entered into a senior credit facility in an aggregate amount of $300.0 million, with the lenders being a syndicate of banks, financial institutions and other entities, including Credit Suisse First Boston, as Administrative Agent, Canadian Imperial Bank of Commerce and Bear Stearns Corporate Lending, Inc. and Lehman Brothers Inc. The senior credit facility provided for a seven-year term loan in the amount of $240.0 million and a five-year revolving credit facility in the amount of $60.0 million. Proceeds of the term loan were used to repay Reddy Group’s prior senior credit facility.

At March 31, 2006, we had $54.2 million of availability under the revolving credit facility, net of outstanding standby letters of credit of $5.8 million. The standby letters of credit are used primarily to secure certain insurance obligations. At this time, we do not anticipate any significant changes in our standby letters of credit until late in the second quarter of 2006, at which time collateral will be required for our 2006 policy renewals. However, later in 2006, this additional new collateral will be offset by reductions in collateral related to earlier policy years. Principal balances outstanding under the revolving credit facility bear interest per annum, at our 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 March 31, 2006, the weighted average interest rate of borrowings outstanding under the senior credit facility was 6.3%. 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 LIBOR loan exceeds 90 days. Reddy Group pays a quarterly fee on the average availability under our existing revolving credit facility based on an annual rate of 0.5%. Except as described below, the terms of the senior credit facility prohibit Reddy Group from paying dividends and otherwise transferring assets to Reddy Holdings, except for certain limited dividends, the proceeds of which must be used to maintain Reddy Holdings’ corporate existence.

The senior credit facility does not require any scheduled principal payments prior to the 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 senior credit facility, an event of default will occur under

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the senior credit facility. Under the senior credit facility, Reddy Group may only pay dividends to Reddy Holdings if Reddy Group’s total leverage ratio for the most recently ended fiscal quarter is less than or equal to 3.75 to 1.0. In addition, the senior credit facility precludes Reddy Group from declaring any dividends if an event of default under the senior 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 senior credit facility contains financial covenants, which include the maintenance of certain financial ratios, as defined in the senior 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 Reddy Group’s senior credit facility and such guarantee is secured by the capital stock of Reddy Group. At March 31, 2006, Reddy Group was in compliance with these covenants.

Under the restricted payments covenant in Reddy Group’s senior credit facility, we generally are restricted from paying dividends. However, the covenant includes an exception for paying dividends in an amount not greater than our Cumulative Distributable Cash for the period (taken as one accounting period) from July 1, 2005 to the end of our most recently-ended fiscal quarter for which a covenant compliance certificate under Reddy Group’s senior credit facility has been delivered to the lenders.

“Cumulative Distributable Cash” is defined under Reddy Group’s senior credit facility as:

(a)         $10,000,000, plus

(b)         “Available Cash” for the period (taken as one accounting period) from July 1, 2005 to the end of our most recently-ended fiscal quarter for which a covenant compliance certificate under Reddy Group’s senior credit facility has been delivered to the lenders, plus

(c)         the amount of any net cash proceeds received by Reddy Holdings from issuances of shares of Reddy Holdings capital stock after the closing of our initial public offering to the extent we have contributed such proceeds to Reddy Group, less

(d)         (i) the amount of payments made by Reddy Group to Reddy Holdings to fund dividend payments on, or repurchases of, Reddy Holdings capital stock or to pay cash interest expense on, or redeem or repurchase, Reddy Holdings notes, (ii) amounts used to make restricted investments, less

(e)         to the extent occurring after the end of the most recently ended reference period and until taken into account in determining Available Cash for the fiscal quarter in which such event has occurred, (i) cash payments for acquisitions (except to the extent funded with indebtedness or proceeds of asset sales or casualty events) and (ii) mandatory repayment of loans under our new credit facilities (other than under the revolving credit facility) during a dividend suspension period.

“Available Cash” for any fiscal quarter is defined under Reddy Group’s senior credit facility as:

(a)         Adjusted EBITDA for such fiscal quarter, plus,

(b)         to the extent not included in net income used to calculate for any fiscal quarter such Adjusted EBITDA, the cash amount realized in respect of extraordinary, non-recurring or unusual gains, and less

(c)         (i) to the extent included in net income used to calculate for any fiscal quarter such Adjusted EBITDA, the amount of Reddy Group’s cash interest expense, Reddy Group’s cash tax expense, the cash cost of any extraordinary, nonrecurring or unusual losses, cash payments on account of non-cash losses or non-cash charges, (ii) capital expenditures (except to the extent funded with indebtedness (other than the revolving credit facility) or proceeds of asset sales or casualty events), (iii) cash payments for acquisitions (except to the extent funded with indebtedness or proceeds of asset sales or casualty events) and (iv) payments and prepayments of the principal amount of

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indebtedness (other than payments and prepayments of the revolving credit facility) other than to the extent funded with indebtedness (other than indebtedness under our revolving credit facility).

“Adjusted EBITDA” is defined under Reddy Group’s senior credit facility to be the sum of:

(a)         net income, plus

(b)         to the extent deducted in determining net income, the sum of (i) amounts attributable to depreciation and amortization, (ii) income tax expense, (iii) interest expense, (iv) any other non-cash charges (less non-cash income) for which no cash reserves (or receivables) have been or will be set aside (or created) including non-cash compensation expenses, (v) any loss from the extinguishment of indebtedness, (vi) any fees paid prior to the closing date of our initial public offering in respect of the monitoring agreement, (vii) transaction adjustments (as defined in Reddy Group’s senior credit facility and including the fees and expenses incurred in connection with our initial public offering and the related transactions), (viii) all fees and expenses incurred in connection with permitted acquisitions to the extent accounted for as expenses, (ix) for the four fiscal quarters ending after September 30, 2004, an amount equal to the sum of (x) the special transaction payments paid to certain members of management and certain directors in connection with the issuance of the senior discount notes not to exceed $1.3 million plus (y) an amount not to exceed $4.0 million for other expenses incurred in connection with the issuance of the senior discount notes and the related amendment to Reddy Group’s senior credit facility which was in effect at the time of the senior discount notes offering.

Under Reddy Group’s senior credit facility, Reddy Group may only pay dividends to us to make dividend payments on our common stock if Reddy Group’s total leverage ratio for the most recently ended fiscal quarter for which a covenant compliance certificate has been delivered is less than or equal to 3.75 to 1.0. If at the end of any fiscal quarter, Reddy Group’s leverage ratio is greater than 3.75 to 1.0, and therefore Reddy Group is not permitted to pay dividends, Reddy Group will be required by Reddy Group’s senior credit facility to apply 50% of Reddy Group’s Available Cash generated during each such quarter to make a mandatory prepayment of the loans under Reddy Group’s senior credit facility.

In addition, we and Reddy Group will be precluded from paying any dividends if an event of default under Reddy Group’s senior credit facility has occurred and is continuing. In particular, it will be an event of default if Reddy Group’s total leverage ratio exceeds 4.0 to 1.0 or Reddy Group’s interest coverage ratio is less than 3.25 to 1.0.

The following table presents Adjusted EBITDA on a pro forma basis after giving effect to the adjustments permitted under the description of the definition of Adjusted EBITDA set forth above. Adjusted EBITDA is different from EBITDA that is derived solely from GAAP components. Adjusted EBITDA should not be construed as an alternative to net loss, cash flows from operations or net cash from operating or investing activities as defined by GAAP, and it is not necessarily indicative of cash available to fund our cash needs as determined in accordance with GAAP. In addition, not all companies use identical calculations, and this presentation may not be comparable to similarly titled measures of other companies. A reconciliation of net loss to EBITDA and Adjusted EBITDA follows the table.

 

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The following table sets forth a reconciliation of net loss to EBITDA and Adjusted EBITDA:

(a)           Represents the elimination of monitoring fees paid to affiliates of our Sponsors prior to the closing of our initial public offering on August 12, 2005.

(b)          Represents costs incurred in connection with our initial public offering and related transactions and includes $0.5 million of non-cash stock-based compensation expense related to a grant of common stock to certain employees.

(c)           Represents the incremental Adjusted EBITDA of acquired businesses as if each acquisition had been consummated on the first day of the period presented. All acquisitions included herein were consummated on or before March 31, 2006.

(d)          Represents the elimination of historical lease expense resulting from the purchase of certain leased real estate in the third quarter of 2005.

Liquidity Outlook.   Due to the seasonal nature of our business, we record the majority of our sales and profits during the months of May through September. The majority of the cash generated from those operations is received between July and November. We have used the excess cash generated from our 2005 selling season to fund our operations during the winter months, as well as capital expenditures, acquisitions and dividends to our common stockholders.

We estimate that our capital expenditures for 2006 will be approximately $16 million to $18 million, which will primarily be used to maintain and expand our traditional ice operations. There can be no assurance that our capital expenditures will not exceed this estimate. In the normal course of our business, we dispose of obsolete, worn-out and unneeded assets. As a result of dispositions of excess assets, we estimate that we will generate proceeds of approximately $2 million to $3 million in 2006 for net capital expenditures of approximately $13 million to $16 million.

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Based on our expected level of operations, we believe that cash flows from operations, together with available borrowings under our revolving credit facility, will be adequate to meet our future liquidity needs for at least the next twelve months. As of April 26, 2006, we had approximately $54.2 million of availability under our revolving credit facility, which reflected a $13.5 million outstanding balance under our revolving credit facility and standby letters of credit of $5.8 million. During the next two months, we expect availability under our revolving credit facility will range between approximately $52 million to $56 million due to borrowings on our revolving credit facility to fund operations, capital expenditures and debt service. Such borrowing under our revolving credit facility are expected on a seasonal basis as our cash flows from operations decline to their lowest point during March and April due to reduced sales in January and February and the need to finance seasonal increases in accounts receivable and inventories as temperatures and sales volumes begin to increase in April and May. As part of our ongoing acquisition program, we are currently pursuing several small acquisition opportunities which are in various stages of negotiations. If we are successful in completing any of these transactions during the next two months, additional borrowings under our revolving credit facility may be required.

During the latter part of the second quarter of 2006 and into the third quarter of 2006, we expect availability under our revolving credit facility will increase to approximately $50 million to $55 million. As noted previously, we record the majority of our sales and profits during the months of May through September and the majority of the cash generated from those operations is received in August through November. During those months in 2006, we expect to repay all amounts borrowed under our revolving credit facility in the spring, fund dividends on our common stock, fund current capital expenditures and debt service and build up cash balances.

Off-Balance Sheet Arrangements

We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

General Economic Trends and Seasonality

Our results of operations are generally affected by the economic trends in our market area, but results to date have not been significantly impacted by inflation. If we experience an extended period of high inflation, which affects multiple expense items, we believe that we will be able to pass on these higher costs to our customers.

The ice business is highly seasonal, with the bulk of demand coming in the warmer spring and summer months. We experience seasonal fluctuations in our net sales and profitability. We make a disproportionate amount of our sales in the second and third calendar quarters. We also typically have net income in these same periods, whereas we typically experience net loss in the first and fourth quarters. We believe that over two-thirds of our revenues will occur during the second and third calendar quarters when the weather conditions are generally warmer and demand is greater, while less than one-third of our revenues will occur during the first and fourth calendar quarters when the weather is generally cooler. This belief is consistent with historical trends. As a result of seasonal revenue declines and the lack of proportional corresponding expense decreases, we will most likely experience lower margins and even losses during the first and fourth calendar quarters. In addition, because our operating results depend significantly on sales 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 more national or regional basis.

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Item 3.        Quantitative and Qualitative Disclosures About Market Risks

Market risk generally represents the risk that losses may occur in the value of financial instruments as a result of movements in interest rates, foreign currency exchange rates and commodity prices. Our main market risk category is interest rate risk.

We are exposed to some market risk due to the floating interest rates under Reddy Group’s senior credit facility. Principal balances outstanding under the term loan and the revolving credit facility bear interest, at our option, at the London Inter-Bank Offered Rate (“LIBOR”) plus 1.75% or the prime rate (as announced from time to time by the administrative agent) plus 0.75%.

Effective September 12, 2005, we entered into an interest rate hedging agreement (the “Hedge”) to fix the interest rate on a portion of the term loan outstanding under the senior credit facility. The Hedge has a term of three years, ten months and an initial notional balance of $220 million. The notional balance decreases by $20 million on each October 12 during 2006-2008. We pay a fixed rate of 4.431% on the notional amount and receive an amount equal to 3-month LIBOR. Any net payable or receivable amount is settled quarterly. If we had been required to settle the Hedge as of December 31, 2005, we would have received $4.2 million. Reddy Group is exposed to risk of loss in the event of non-performance by the counterparty to the Hedge. However, we do not anticipate non-performance by the counterparty.

As of March 31, 2006, the senior credit facility had an outstanding principal balance of $240.0 million at a weighted average interest rate of 6.3% per annum. At March 31, 2006, the 30-day LIBOR rate was 4.8%. If LIBOR were to increase by 1% from that level, the annual increase in interest expense, given our principal balances at March 31, 2006 and the effect of the Hedge, would be approximately $0.2 million.

Item 4.                        Controls and Procedures

The Company, under the supervision and with the participation of its management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures were effective as of March 31, 2006 to ensure that information relating to us and our consolidated subsidiaries required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely discussions regarding required disclosure. It should be noted, however, that the design of any system of controls is limited in its ability to detect errors, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions, regardless of how remote. There has been no change in our internal control over financial reporting during the quarter ended March 31, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II—OTHER INFORMATION

Item 1.                        Legal Proceedings

We are from time to time party to legal proceedings that arise in the ordinary course of business. We do not believe that the resolution of any such threatened or pending legal proceedings will have a material adverse affect on our financial position, results of operations or liquidity.

Item 1A.                Risk Factors

Risks Relating to Our Dividend Policy

The payment of dividends is at the sole discretion of our board of directors and the reduction or elimination of dividends would negatively affect the market price of our common stock.

We are not obligated to pay dividends on our common stock. The payment of dividends is at the sole discretion of our board of directors and our board of directors may decide to eliminate or reduce any dividends paid on our common stock. Any reduction or elimination of dividends could cause the market price of our common stock to decline and could further cause your shares of common stock to become less liquid, which may result in losses by you.

Even if our board of directors desires to declare and pay dividends, we might not have cash in the future to pay dividends in the intended amounts or at all.

Our ability to pay dividends, and our board of directors’ determination to keep our dividend policy, will depend on numerous factors, including the following:

·       the state of our business, competition and changes in our industry;

·       changes in the factors, assumptions and other considerations made by our board of directors in reviewing and revising our dividend policy;

·       our future results of operations, financial condition, liquidity needs and capital resources;

·       our various expected cash needs, including cash interest and principal payments on our indebtedness, capital expenditures, the purchase price of acquisitions, costs associated with being a public company and taxes; and

·       potential sources of liquidity, including borrowing under our revolving credit facility or possible asset sales.

We cannot assure you that our actual cash available to pay dividends will in fact equal or exceed the amount necessary to pay dividends at any time. Over time, our capital and other cash needs will invariably be subject to uncertainties, which could affect whether we pay dividends and the level of any dividends we may pay in the future. In addition, to the extent that we would seek to raise additional cash from additional debt incurrence or equity security issuances, we cannot assure you that such financing will be available on reasonable terms or at all. Each of the factors listed above could negatively affect our ability to pay dividends in accordance with our dividend policy or at all.

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If our estimates relating to dividends payable in the future change, you may not receive the amount of dividends you expected.

If our estimates of cash available to pay dividends in the future were to fall below our expectations, our assumptions as to estimated cash needs were to be too low or if other applicable assumptions were to prove incorrect, we may need to:

·       either reduce or eliminate dividends, which may result in a decline in the market price or liquidity, or both, of our common stock;

·       fund dividends by incurring additional debt (to the extent we were permitted to do so under the agreements governing our then existing debt), which would increase our leverage and limit our funding alternatives for other uses;

·       amend the terms of Reddy Group’s senior credit facility or the indenture governing our senior discount notes to permit us to pay dividends or make other payments if we are otherwise not permitted to do so, which is likely to require us to incur significant costs;

·       fund dividends from future issuances of equity securities, which could be dilutive to our stockholders and negatively affect the market price of our common stock;

·       fund dividends from other sources, such as by asset sales or by working capital, which would leave us with less cash available for other purposes; and

·       reduce other expected uses of cash, such as capital expenditures and acquisitions, which could limit our ability to grow.

Our ability to pay dividends will be restricted by agreements governing our debt, including Reddy Group’s senior credit facility and the indenture governing our senior discount notes and by Delaware law.

Reddy Group’s senior credit facility and the indenture governing our senior discount notes restrict our ability to pay dividends. We refer you to “Liquidity and Capital Resources” under Item 2 of Part I, where we describe the terms of our indebtedness, including provisions limiting our ability to declare and pay dividends.

Additionally, under the Delaware General Corporation Law, or DGCL, our board of directors may not authorize payment of a dividend unless it is either paid out of our surplus, as calculated in accordance with the DGCL, or if we do not have a surplus, it is paid out of our net profits for the fiscal year in which the dividend is declared and/or the preceding fiscal year.

If, as a result of these restrictions, we are required to reduce or eliminate the payment of dividends, a decline in the market price or liquidity, or both, of our common stock could result. This may in turn result in losses by you.

Our dividend policy may limit our ability to pursue growth opportunities, which may harm our competitive position and cause the market price of our common stock to decline.

If we continue paying dividends at the level currently anticipated under our dividend policy, we may not retain a sufficient amount of cash to consummate acquisitions, and may need to seek financing to fund a material expansion of our business, including any significant acquisitions or to pursue growth opportunities requiring capital expenditures significantly beyond our current expectations. The risks relating to funding any dividends, or other cash needs as a result of paying dividends, are summarized in the preceding risk factors. If we are unable to take timely advantage of growth opportunities, our future financial condition and competitive position may be harmed, which in turn may adversely affect the market price of our common stock.

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Risks Relating to Our Business

We have a substantial amount of indebtedness, which may reduce our cash flow and impede our ability to pay dividends on our common stock, remain in compliance with debt covenants, make payments on our indebtedness and operate our business.

As of March 31, 2006, we had outstanding indebtedness of approximately $355.8 million, which represented approximately 68% of our total consolidated capitalization on a book basis. As of March 31, 2006, we also had availability of $54.2 million under Reddy Group’s revolving credit facility (net of standby letters of credit of approximately $5.8 million).

Our substantial indebtedness could have important consequences. For example, it could:

·       make it more difficult for us to comply with the terms of our outstanding debt;

·       require us to dedicate a substantial portion of our cash flow to pay principal and interest on our debt, thus making it more difficult for us to pay dividends on our common stock;

·       make us more vulnerable to, and reduce our flexibility in planning for, changes in general economic, industry and competitive conditions;

·       limit our ability to borrow additional amounts for working capital, capital expenditures, acquisitions, debt service requirements, execution of our strategy, or other purposes; and

·       place us at a disadvantage compared to our competitors with less debt.

Any of the above listed factors could make us more vulnerable to defaults and place us at a competitive disadvantage, therefore making an investment in our common stock less attractive when compared to other investments. Further, if we do not have sufficient earnings to service our debt, we would need to refinance all or part of our existing debt, sell assets, borrow more money or sell securities, none of which we can guarantee we will be able to do on commercially reasonable terms or at all.

We could incur more indebtedness, which may increase the risks associated with our substantial leverage, including our ability to service our indebtedness and pay dividends on our common stock.

The indenture governing our senior discount notes and Reddy Group’s senior credit facility permit us, under certain circumstances, to incur a significant amount of additional indebtedness. For example, Reddy Group’s senior credit facility allows us to incur up to an additional $80.0 million of incremental term loans under the credit facility, subject to certain conditions. In addition, we may incur additional indebtedness through Reddy Group’s revolving credit facility. If we incur additional debt, the risks associated with our substantial leverage, including our ability to service our debt and pay dividends on our common stock, would increase. This, in turn, could negatively affect the market price of our common stock.

The terms of Reddy Group’s senior credit facility and the indenture governing our senior discount notes may restrict our current and future operations, particularly our ability to respond to changes in our business or to take certain actions.

Reddy Group’s senior credit facility and the indenture governing our senior discount notes contain, and any future indebtedness of ours would likely contain, a number of financial and other restrictive covenants that impose significant operating and financial restrictions on us, including restrictions that may limit our ability to engage in acts that may be in our best long-term interests. For a more complete description of these covenants and restrictions, see “Liquidity and Capital Resources” under Item 2 of Part I.

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The operating and financial restrictions and covenants in our existing and future debt agreements may adversely affect our ability to finance future operations or capital needs or to engage in other business activities. A breach of any of the restrictive covenants in our new credit facilities could result in a default under such facilities. If any such default occurs, the lenders may elect to declare all obligations under Reddy Group’s senior credit facility to be immediately due and payable, enforce their security interest or require us to apply all of our available cash to repay these borrowings, any of which would result in an event of default under our senior discount notes. If the debt under Reddy Group’s senior credit facility or our senior discount notes were to be accelerated, our business operations would be interrupted, which would adversely affect the market price of our common stock.

The seasonal nature of the ice business results in losses and lower margins in the first and fourth quarters of the year.

We experience significant seasonal fluctuations in our net sales and profitability. We make a disproportionate amount of our sales in the second and third calendar quarters when the weather is generally warmer, which results in an increased demand for ice. We also earn our net income during these same periods. As a result of seasonal revenue declines and the lack of a corresponding decrease in certain expenses, we experience net losses and materially lower margins during the first and fourth calendar quarters. Variations in demand could have a material adverse effect on the timing of our cash flows and therefore limit our ability to timely service our obligations with respect to our indebtedness and to pay dividends. In addition, because our operating results depend significantly on sales during the second and third calendar quarters, our results of operations may fluctuate significantly if the weather during these periods is cool or rainy.

Weather conditions and weather events can decrease our sales or increase our expenses.

Cool or rainy weather can decrease sales, while extremely hot weather may increase our expenses, each resulting in a negative impact on our operating results and cash flow. Ice consumers demand ice for a variety of reasons, but many of them buy ice in connection with outdoor related activities, both commercial and recreational. As a result, demand for ice increases during periods of warm, sunny weather, and conversely, demand decreases during periods of cool, rainy weather. During extended periods of cool or rainy weather on a national basis, our revenues and results of operations may substantially decline. Also, hot weather does not necessarily result in greater net income. During extended periods of hot weather, our profits and cash flow may decline because of an increase in expenses in response to excess demand. We may have to transport ice from one plant to another and, in some cases, purchase ice from third party sources and transport it to a specific market to meet this excess demand, resulting in higher expenses and inconsistent service and product quality. Finally, although extreme weather events such as hurricanes can cause an increase in volume sales, those sales are not necessarily profitable due to added costs and disruptions to our normal service and distribution routes.

Our failure to successfully compete in our markets, retain existing customers and obtain new customers could limit our prospects and cause us to lose market share.

Our businesses are highly competitive. We have many competitors in each of our geographic markets offering similar products and services. Competition in our businesses is based primarily on service, quality and price. We could lose market share if we fail to successfully compete against our competitors in any of these areas, if our existing competitors expand their capacity, if new entrants successfully penetrate our markets, if we fail to adequately serve our existing base of customers, or if our larger grocery or convenience store customers decide to manufacture their own ice rather than purchase our products.

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