Reddy Ice Holdings (FRZ)

Headquartered in Dallas, Reddy Ice Holdings is the largest manufacturer and distributor of packaged ice in the United States. The company sells its products primarily under the Reddy Ice brand to approximately 82,000 consumer locations in 31 states and the District of Columbia. Reddy Ice manufactures and distributes packaged ice in cube, half-moon, cylindrical, crushed, and blocked forms, primarily under Reddy Ice brand name. The company sells directly to supermarket chains, mass merchants, and convenience stores, such as Albertson's, Circle-K, Exxon Mobil, Food Lion, Kroger, 7-Eleven, and Wal-Mart. The company also sells to wholesale ice and food distributors, bars, stadiums, airlines, government agencies, construction companies, resorts, restaurants, agricultural buyers, and other commercial customers. As of March 10, 2008, the company owned or operated 67 ice manufacturing facilities, 60 distribution centers and approximately 3,000 ice factories. The company has an aggregate daily ice manufacturing capacity of about 18,000 tons.

The majority of sales are directed to supermarket chains, mass merchants, and convenience stores. In 2007, 45% of sales (in tons) were derived from supermarket and mass merchant chains, 29% from convenience and petroleum chain stores, 13% from distributors, and 13% from other channels. The percentage of total volume (in tons) sold to national and regional supermarket, mass merchant and convenience & petroleum store chains has increased from 54% in 2002 to 59% in 2007. The company's primary ice product is cubed ice, packaged in small bags (typically seven and ten pounds), which are sold principally to convenience stores and supermarkets. Significant amounts of medium bags of cubed ice (16 to 20 pounds) and ten-pound block bags are sold to the same convenience stores and supermarkets.

On August 15, 2003, Packaged Ice, Inc. merged with Cube Acquisition Corp., a wholly-owned subsidiary of Reddy Ice Holdings, Inc. Packaged Ice was renamed Reddy Ice Group, Inc., and is a wholly-owned subsidiary of Reddy Ice Holdings, which was established in May 2003. In August 2005, Reddy Ice Holdings completed its initial public offering of 11,730,000 shares at a price of $18.50 per share. Bear, Stearns, Lehman Brothers, Credit Suisse First Boston, Goldman Sachs, and CIBC were the lead underwriters of the offering. In the third quarter of 2007, the company sold the bottled water business and substantially all of the company's cold storage business for total gross cash proceeds of approximately $20.3 million.

Reddy Ice Holdings has become the largest supplier of packaged ice in the United States, primarily through acquisitions. Between 1997 and 1999, the company completed approximately 80 acquisitions, including the purchase of Reddy Ice Corporation from Suiza Foods in April 1998 and the purchase of Cassco Ice & Cold Storage in July 1998. Prior to its acquisition, Reddy Ice Corporation, itself, had made 28 acquisitions between January 1997 and April 1998. Cassco was a leading regional producer with refrigerated warehouses in the mid-Atlantic region. The company did not complete any significant acquisitions from 1999 until the fourth quarter of 2003, when Triangle Ice Company was acquired for $64.3 million. Triangle operated primarily in North and South Carolina with eight ice manufacturing facilities having an aggregate daily ice manufacturing capacity of 2,085 tons. In 2004 and 2005, Reddy Ice Holdings completed thirteen acquisitions for $17.8 million, adding three ice manufacturing facilities and five distribution centers to the company. In 2006, the company completed 10 acquisitions for $12.9 million, adding four ice-manufacturing facilities and three distribution centers. In 2007, the company completed 20 acquisitions and one facility for $27.2 million. Management continues to pursue strategic acquisitions to improve distribution routes, rationalize capacity, and expand both in existing and into contiguous markets.

Rising commodity costs (primarily polyethylene, electricity, and fuel) are negatively affecting the company's profitability. The company uses a large quantity of plastic bags, whose costs accounted for approximately 7% of revenues in 2007. Historically, market prices for plastic bags have fluctuated with changes in polyethylene prices. A significant increase in the cost of plastic bags can negatively affect the level of profitability, if the company cannot pass the additional cost to its customers. In addition, in 2007 the increase in energy (electricity and fuel) prices resulted in incremental costs of approximately $2 million. Electricity is also a significant component of manufacturing costs, which accounted for approximately 6% of revenues in 2007. The company's plants have operated in both regulated and deregulated electricity markets, both of which can incur increases in electricity rates. The effect of electric rate increases in 2006 was $1.5 million. However, the increase in 2007 had a reduced impact on operations ($1.1 million) since a fixed rate electric supply contract in Texas was renewed at lower price with a one-year term beginning in June 2007. Management expects continued rate increases in 2008 as utilities continue to pass through the effects of rising oil and gas prices.

The packaged ice business is highly seasonal and results in the company reporting losses in the first and fourth quarters of the year. Peak demand for ice occurs during the warmer months of May through September, though the peak selling season is extended in the southern United States. Approximately 69% of the company's annual revenues are generated during the second and third calendar quarters therefore, there are seasonal fluctuations in net sales and profitability. During the first and fourth quarters, when seasonal revenue declines, expenses do not decline proportionally and Reddy Ice experiences significantly lower margins, resulting in net losses during those periods. In addition, peak sales can be affected by cool or rainy weather and peak expenses can be negatively affected by extremely hot weather as the company incurs additional costs as it responds to excess demand by transporting ice from one plant to another and, in some cases, purchasing ice from third party sources. Seasonal variations could have a material adverse effect on the timing of the company's cash flows and, therefore, could affect the ability to service debt obligations and to pay dividends.

Management lowered guidance twice in 2007 due to poor weather and earnings were ultimately reported $0.08 below the lowered expected range of $0.51 to $0.70 per diluted share. Also, 2007 net revenues were $339 million, well below from initial expectations of $360 million to $370 million. Based on the financial results of the first quarter 2008 and escalating energy and commodity prices, management began lowering guidance for 2008. Earnings in 2008 are now expected to be in the range of $0.95 to $1.14 per diluted share compared to prior guidance of $1.16 to $1.35 per diluted share.

Acquisitions are a strategic priority for management and a significant number have been closed in the last four years. Acquisitions are accompanied by financial, operational, and integration risks. Acquisition targets may have potential unknown liabilities and, upon closing, key employees and customers could be lost. An acquisition not only diverts management's time away from normal operations, but also could cause unexpected financial or operational difficulties. The expense of integrating personnel and the acquired operations also can negate the expected benefits of the acquisition. Lastly, the integration process can result in the loss of customers and/or potentially disrupt the company's operations.

Though Reddy Ice Holdings received a merger offer from GSO Capital Partners LP in 2007, the deal was terminated upon subsequent due diligence. Therefore, investors should not expect a private transaction valuation from investing in shares of Reddy Ice Holdings. On July 2, 2007, a merger agreement was announced with GSO Capital Partners for $1.1 billion or $31.25 per share in cash. Though the transaction was expected to close by the fourth quarter of 2007 and shareholders approved the transaction in October 2007, GSO Capital Partners first extended the pre-closing marketing period and later terminated the planned merger, opting to pay $21 million in cash to Reddy Ice Holdings in order to terminate the merger agreement.

The loss of one or more of the company's larger customers could adversely affect the cash flow and profits of Reddy Ice. The company's largest customer, Wal-Mart and Sam's Club on a combined basis, accounted for approximately 12% of revenues in both 2006 and 2007.

Reddy Ice Holdings is highly leveraged with a debt-to-capitalization ratio of 71%. The company's balance sheet is leveraged with $344 million in long term debt as of December 31, 2007. In addition, goodwill and other intangible assets account for 49% of total assets, largely due to acquisitions. Interest expenses increased by 5.7% in 2007, primarily due to the increase associated with the 10 % senior discount notes and higher average balances on the revolving credit facility.

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