Reddy Ice Holdings 10-K 2007
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2006
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)
(Registrants telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None.
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes o No x
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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.
Indicate by check mark if 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 Act. (Check one):
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 aggregate market value of common stock held by non-affiliates as of June 30, 2006 was approximately $282.3 million, using the closing price per share of $20.35, as reported on the New York Stock Exchange as of such date.
The number of shares of registrants common stock outstanding as of March 9, 2007 was 21,809,395.
Part III incorporates certain information by reference to the Proxy Statement for the 2007 Annual Meeting of Stockholders
REDDY ICE HOLDINGS, INC.
ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
Other than statements of historical facts, statements made in this Form 10-K, 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 subsidiary to make distributions to us in amounts sufficient to make dividend payments to our stockholders in accordance with our dividend policy;
· our substantial leverage and ability to service our debt and pay dividends;
· the restrictive covenants under our indebtedness;
· the availability of capital sources;
· fluctuations in our operating costs, including in the prices of electricity, fuel, polyethylene and other required expenses;
· competitive practices in the industry in which we compete;
· changes in labor conditions;
· our capital expenditure requirements;
· the risks associated with acquisitions and the failure to integrate acquired businesses;
· technological changes and innovations;
· legislative or regulatory requirements; and
· all the other factors described herein under Item 1A.
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.
Our Internet website address is www.reddyice.com. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through our website as soon as reasonably practicable after they are electronically filed with, or furnished to, the Securities and Exchange Commission. Our Corporate Governance Guidelines, Board of Directors committee charters (including the charters of the Audit Committee, Compensation Committee, and Corporate Governance and Nominating Committee), Insider Trading Policy and Code of Business Conduct and Ethics are also available on our website.
We are the largest manufacturer and distributor of packaged ice in the United States, serving approximately 82,000 customer locations in 31 states and the District of Columbia under the Reddy Ice® brand name. Our principal product is ice packaged in seven to fifty pound bags, which we sell to a highly diversified customer base, including supermarkets, mass merchants and convenience stores. For the year ended December 31, 2006, we sold approximately 1.9 million tons of ice. Our products are primarily sold throughout the southern United States (the Sun Belt), one of the most attractive regions in the country for packaged ice sales due to warm weather, extended peak selling seasons and favorable population growth patterns. Population growth is one of the primary drivers for growth in demand for packaged ice, and we operate in many of the fastest growing metropolitan areas in the United States. In addition, our broad geographic reach helps insulate us from the impact of cool or rainy weather in any particular region. No other manufacturer and distributor of packaged ice in the United States has the geographic presence, infrastructure or capacity necessary to meet the multi-state demands of customers in our markets.
Our business is characterized by consistent annual customer demand, attractive margins and modest annual capital requirements. Based on past experience, retail consumer demand for packaged ice is relatively unaffected by adverse economic conditions due to its low cost and the lack of readily available substitutes. For the year ended December 31, 2006, we had revenues and net income of $346.0 million and $14.7 million, respectively.
We operate in two business segments: ice products and non-ice products and operations. Ice products accounted for approximately 96% of our total revenues in 2006. This segment consists of the traditional manufacture and delivery of ice from a central point of production to the point of sale as well as sales from The Ice Factory® machines, our proprietary equipment located in our customers high volume locations that produce, package and store ice through an automated, self-contained process. In 2006, traditional ice manufacturing and Ice Factory sales accounted for approximately 90% and 10% of our ice product revenues, respectively. Non-ice products and operations consist of refrigerated warehousing and the manufacture and sale of bottled water.
We market our ice products to satisfy a broad range of customers, primarily under the Reddy Ice brand name. We produce ice in cube, half-moon, cylindrical and crushed forms (collectively referred to as cubed ice) as well as block forms. Our primary ice product is cubed ice packaged in small bags (typically seven and ten pounds), which we sell principally to convenience stores and supermarkets. We also sell significant amounts of medium bags of cubed ice (16 to 20 pounds) and ten-pound block bags to the same convenience stores and supermarkets. We sell cubed ice in assorted bag sizes ranging from 16 to 50 pounds to restaurants, bars, stadiums, vendors and caterers and block ice in 10-, 25- and 300- pound sizes to our commercial, agricultural and industrial customers. The majority of our sales are direct to supermarket chains, convenience stores, mass merchants and other commercial customers. In addition, a portion of our products is sold through distributors who deliver ice to our customers on our behalf and who resell ice to their own customers.
We have built a strong and loyal customer base by providing a high level of service and quality at competitive prices utilizing our extensive network of ice manufacturing plants and distribution centers. We have a diverse customer base and long-standing relationships with our customers across all major retail channels as evidenced by our high retention rates with prominent supermarkets, mass merchants and convenience stores such as Albertsons, Circle-K, ExxonMobil, Food Lion, Kroger, 7-Eleven and Wal-Mart. Our largest customer, Wal-Mart and Sams Club on a combined basis, accounted for approximately 11% of our revenue in 2006 and 2005. Most of our major customers, including nineteen of our top twenty
retail ice customers in terms of revenues, have purchased ice from us and our predecessor companies for over a decade. Within our markets, we are generally the sole supplier of packaged ice to the majority of our top twenty retail ice customers. The percentage of our total revenues derived from and volume sold to national and regional convenience and grocery store chains has grown over the last several years as each of these retail channels has consolidated. We have benefited from supplying these national and regional retailers as many of these customers have grown at rates in excess of industry averages.
At March 9, 2007, we owned or operated 63 ice manufacturing facilities, 59 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.
We estimate that the annual wholesale market for packaged ice is approximately $1.8 billion, which includes manufacturers such as ourselves and in-house production, primarily by small retail operations and, to a lesser extent, by large retailers. The packaged ice industry is highly fragmented and is led by us and two multi-state operators. The industry includes numerous local and regional companies of varying size and resources, with most ice manufacturers having annual revenues of less than $1 million.
Traditional ice manufacturers produce and distribute packaged ice from a centrally located facility and, as a result of high transportation costs, are typically limited to servicing customers within approximately 100 miles from the point of production. Packaged ice suppliers compete based primarily on service, quality and price, with success dependent upon prompt and reliable delivery during peak seasonal months, an efficient manufacturing and distribution system, high-density customer distribution routes within a region and high customer concentration in a market area. Each customer location typically carries one brand of ice provided by a single supplier.
The packaged ice industry 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. We believe volume growth in the packaged ice industry generally tracks population growth, thus favoring geographic markets with faster population growth. Demand within specific geographic markets can also be affected by weather conditions, with cool or rainy weather negatively impacting ice purchases.
Our business strategy is to strengthen our competitive position, increase revenues and drive profitability by:
Enhancing Revenue Growth. We believe there are several opportunities to maintain and grow our revenues through:
Growth from Our Existing Customers. We intend to capitalize on our long-standing customer relationships by growing with our large national and regional customers as they seek to increase their market penetration and consolidate the retail segments in which they operate. As the sole supplier in our regions to the majority of these customers, we are well positioned to share in our customers growth. In addition, for certain customers for whom we are not the sole supplier, there is a likely opportunity to capture incremental volume as these customers continue to reduce their supplier base in order to achieve efficiencies across the supply chain.
New Product Introductions. We continue to broaden our product offerings through the introduction of new sizes of bagged ice. We believe that introducing new bag sizes at various price points offers an opportunity to enhance our product mix and increase our sales and operating margins.
Growth from Outsourcing Trends of Large Retailers. Several large retailers continue to produce packaged ice in-house. Consistent with general outsourcing trends among retailers, we have assumed certain ice supply requirements in the past for a number of large retail chains that previously operated captive ice manufacturing facilities, including Albertsons, HEB and Safeway. We should be able to capture additional volume from new and existing customers if retailers continue to choose to outsource and focus on their core competencies.
Selectively Pursuing Acquisitions. The packaged ice industry continues to be highly fragmented. We will continue to pursue strategic acquisitions in existing or adjacent geographic markets that enhance the density of our distribution routes, provide capacity rationalization opportunities, increase our market penetration in existing markets or expand our presence in contiguous markets. Through March 9, 2007, we have completed five acquisitions with an aggregate acquisition cost of approximately $11.3 million. In 2006, we acquired ten businesses for purchase prices aggregating approximately $12.9 million, including direct acquisition costs of $0.3 million. In 2005, we acquired two businesses for total acquisition costs of approximately $0.9 million and purchased certain leased real estate assets for a purchase price of $2.5 million. In addition, we made 11 acquisitions in 2004, for purchase prices aggregating $16.9 million. We completed the integration of these acquisitions with our operations, financial and management systems and customer service departments during the year in which these acquisitions were consummated.
Continuing Efficiency Improvements. In the last six years, we have consolidated our ice manufacturing and distribution facilities, reducing the total number of facilities (including all acquired facilities) from 148 to 122 at March 9, 2007. As we have reduced the number of facilities, we have increased our overall capacity by relocating equipment and investing in new equipment. We have identified several opportunities for continued facility consolidations that we expect can be implemented without a significant increase in capital expenditures. In addition, we believe there are opportunities for continued efficiency improvements through distribution route optimization, the introduction of new technologies and processes in our plants and consolidation of administrative functions.
We market our ice products to satisfy a broad range of customers, primarily under the Reddy Ice brand name. We produce our ice in cube, half-moon, cylindrical and crushed forms and also produce ice in block forms. Our primary ice product is cubed ice packaged in small bags (primarily seven and ten pounds), which we sell principally to convenience stores and supermarkets. We also sell significant amounts of medium bags of cubed ice (16 to 20 pounds) and ten-pound block bags to the same convenience stores and supermarkets. We sell cubed ice in assorted bag sizes ranging from 16 to 50 pounds to restaurants, bars, stadiums, vendors and caterers. In addition, we sell block ice in 10-, 25- and 300-pound sizes to commercial, agricultural and industrial customers.
We continue to broaden our product offerings through the introduction of new sizes of bagged cubed ice as well as new ice products. New bag sizes such as ten-pound bags of cubed ice may offer an opportunity to enhance revenue and income from operations. In 2006, sales of ten-pound bags of cubed ice accounted for approximately 42% of ice product revenues, an increase from approximately 24%, 5% and 0.1% of ice product revenues in 2005, 2004 and 2003, respectively. We expect sales of ten-pound bags as a percentage of ice product revenues to continue to increase in 2007. In addition, we continue to develop and test new products, packaging and service options.
To ensure that the water supplied by each municipality meets our quality standards, the water is often filtered for use in the ice making process. We use low micron filtration, carbon filtration, water softeners, ozone generators and reverse osmosis as needed to achieve the proper water quality needed to produce a clear product. All of our ice manufacturing facilities are certified by the International Packaged Ice
Association. This certification requires the inspection of more than 50 areas of operations, ensuring high water quality, a sanitary operating environment and safe working conditions.
We manufacture ice in two ways: the vertical plate method and the vertical tube method. In both methods, water is circulated over cold vertical surfaces where the flowing water freezes into ice. The process of freezing the water while in motion acts as a final purification process by extracting minerals and other dissolved solids still present in the water following the filtration process. When the ice builds to the proper thickness it is detached from the plates or tubes by heating the freezing surfaces. In the vertical plate method, the sheet of ice falls onto a motor driven cutter, which chops the ice into smaller sizes and empties into a collection bin. In the vertical tube method, as the tube of ice falls into the collection bin, it is cut into small cubes by a rotating cutter. From the collection bin, the ice is transferred to a central refrigerated holding bin where the ice is mechanically raked and dried before it is packaged.
From the central refrigerated holding bin, the ice is then mechanically screened to remove any small pieces and to separate the ice according to size. The ice is then transferred to packaging machines, where the ice is measured and packaged into a variety of bag sizes. After bagging the ice, the product is palletized and stored in our cold storage vaults before being delivered to customer locations.
For the majority of our manufacturing facilities, we use ammonia as the refrigerant in the ice makers and storage vaults. Ammonia is a common refrigerant used for most industrial refrigeration systems.
Due to high product transportation and shipping costs, the ice business has historically been a regional service business in which manufacturers produce and package ice at centrally located facilities and distribute to a limited market radius of approximately 100 miles. Due to these geographic constraints and the limited amount of product differentiation in the packaged ice industry, we focus on maintaining an efficient service, distribution and pricing system in each of our markets. We deliver ice through both traditional distribution methods and the on-site Ice Factory system. We believe that this unique combination of distribution service offerings enables us to better serve our customers.
Traditional Distribution. We produce and bag ice at centrally located manufacturing facilities and subsequently sell the product with several delivery alternatives. These delivery alternatives include (1) delivering packaged ice directly to the customers retail locations and stocking our merchandisers, (2) delivering pallet quantities to retail locations where our customers employees stock our merchandisers and (3) warehouse shipments of ice from our facilities to the facilities of our customers who choose to deliver ice to their retail locations through their own distribution network. Our products are delivered through our own distribution operation as well as by third-party distributors who transport and deliver the product to our customers. These distributors also purchase ice from us for resale to their own customers. To store ice inventory, we own or rent appropriate freezer space. We own or lease approximately 1,200 trucks for distribution in non-peak periods. During the peak summer months, we estimate that we may rent up to approximately 200 additional trucks.
We currently serve approximately 79,000 customer locations through traditional distribution methods, principally through the use of our company owned ice merchandisers that are installed at most of our customers locations. Our size and scale provide us with an efficient production and distribution network by providing us with customer density, additional production capacity and dedicated distribution centers. The increased customer density has improved routing efficiencies and reduced our transportation costs, which represent our largest cost component. In addition, our production capacity in adjacent geographic markets has allowed us to avoid out of ice situations and related lost sales during peak periods.
In 2006, traditional ice manufacturing and distribution accounted for approximately 90% of our ice segment revenues.
Ice Factory. The Ice Factory is our proprietary self-contained automated system placed at the customers location that manufactures, bags and stores packaged ice. Each unit is built to our specifications and includes an ice maker, merchandiser and bagging machine. The unit is capable of producing and packaging approximately one ton of ice per day. The Ice Factory is most frequently used in high volume supermarkets and other commercial locations. The Ice Factory, when combined with traditional delivery methods, provides our customers with the flexibility to meet their specific supply requirements in a cost-efficient manner. Transportation costs, the most significant costs of traditional ice delivery, are eliminated by on-site production. As a result of these cost savings, we believe that The Ice Factory provides us with operating efficiencies in high volume locations compared to traditional ice delivery.
Ice Factory locations are selected only after a thorough review and analysis of historical ice sales and the local competitive environment. Approximately 800 of our installed base of approximately 3,000 Ice Factories are operated and maintained by other ice suppliers under management agreements with us. In 2006, Ice Factories accounted for approximately 10% of ice product revenues.
We believe that providing frequent, regular and reliable service and support to our customers is one of the most important elements in operating our Ice Factory network. We have a routine route servicing system, which utilizes trained service representatives to perform the regularly scheduled service procedures, and we maintain toll-free telephone support for responding to customer calls regarding repairs and maintenance.
We market our ice products to a broad range of customers, including supermarket chains, mass merchants, convenience stores, wholesale ice and food distributors, commercial users, resorts and restaurants, agricultural buyers and competitive producers and self-suppliers who experience supply shortages. The primary purchasers of our traditional ice products and users of our Ice Factory are retailers with no internal ice production capacity. We believe that our high level of service and quality products at competitive prices results in customer loyalty.
We have a diversified customer base. Our largest customer, Wal-Mart and Sams Club on a combined basis, accounted for approximately 11% of our revenues in 2006 and 2005 and 10% of our revenues in 2004. Our other largest national accounts include the supermarket chains Albertsons, Kroger and Safeway; and the convenience and petroleum store chains Circle K, 7-Eleven and ExxonMobil. Major regional customers include the supermarket chains Publix, Winn-Dixie, Food Lion and HEB and the convenience and petroleum store chains Valero, The Pantry and RaceTrac. In 2006, our sales, measured in terms of tons, were allocated to our retail channels as follows: 45% to supermarket and mass merchant chains, 28% to convenience and petroleum store chains, 13% to distributors and 14% to other channels. The percentage of our total volume, measured in terms of tons, sold to national and regional supermarket, mass merchant and convenience and petroleum store chains has grown from approximately 54% in 2002 to approximately 58% in 2006, due to consolidation within those retail channels.
Our sales and marketing personnel communicate regularly with our existing customers and initiate discussions with potential new customers. Sales and marketing personnel at our corporate headquarters, along with certain members of our senior management, communicate with our larger national and regional chain customers while our field personnel handle smaller local customers and local representatives of our larger national and regional chain customers.
Typically, our customer relationships are long term and turnover of major customers is infrequent. As a result, a significant portion of our corporate sales and marketing efforts are focused on maintaining and expanding these existing relationships. We also regularly explore and develop new customer relationships.
The traditional packaged ice industry is highly competitive and highly fragmented. In the United States, the traditional packaged ice industry is led by us and two smaller, multi-state, multi-facility suppliers. Although these multi-state suppliers generally do not serve customers in our primary markets, we do compete with numerous smaller local and regional companies of varying sizes and competitive resources. Most ice manufacturers have annual revenues of less than $1 million. In addition to our direct competition, numerous convenience and grocery retailers operate commercial ice plants for internal use or manufacture and bag ice at their store locations. However, our ice products generally do not face competition within a particular store as almost all of our customers rely on a single supplier of packaged ice at each point of sale. From time to time, new competitors emerge to compete with us in various areas, including the technology and distribution methods included in The Ice Factory. Historically, such competitors have not had a significant impact on our business.
Competition in the packaged ice industry is based primarily on service, quality and price. To compete successfully, an ice manufacturer must be able to offer significant supply and distribution capacity on a seasonal basis while maintaining cost efficiency. We are the largest company in the packaged ice industry, serving customers in 31 states and the District of Columbia. Our large geographic footprint, manufacturing capacity and distribution infrastructure, including traditional ice delivery, warehouse delivery and The Ice Factory, gives us the ability to service large retailers across multiple states and regions in a variety of ways. Because of these attributes, we are positioned to benefit from continued consolidation within our customer base and from increased reliance by national and regional customers on suppliers that serve multiple markets.
We have been providing ice products and delivery services to many of our large customers for more than a decade. Our customers depend on our consistent ability to ensure prompt and reliable delivery, particularly during peak seasonal months. The strength of our customer relationships is further reinforced by the fact that almost all of our customers rely on a single supplier of packaged ice at each point of sale. We believe that the strength of our customer relationships provides us with a significant competitive advantage over other suppliers in our markets.
From 1997 through 1999, we pursued a consolidation strategy within the highly fragmented packaged ice industry. During that period, we completed approximately 80 acquisitions. Significant acquisitions included the purchase of Reddy Ice Corporation from Suiza Foods Corporation in April 1998 and the purchase of Cassco Ice & Cold Storage, Inc., which we refer to as Cassco, in July 1998. Reddy Ice Corporation, prior to our acquisition of it, had been active in the consolidation of the packaged ice industry, having made 28 acquisitions from January 1997 to April 1998. Cassco was a leading regional producer and distributor of packaged ice products and was an owner/operator of refrigerated warehouses in the mid-Atlantic region. We did not complete any significant acquisitions from 2000 through the third quarter of 2003.
In the fourth quarter of 2003, we acquired two ice companies for purchase prices aggregating $67.4 million, the more significant of which was Triangle Ice Co., Inc. (Triangle), the purchase price for which was approximately $64.3 million. With revenues of approximately $30.0 million for the fiscal year ended April 30, 2003, Triangle owned or operated eight ice manufacturing facilities and one distribution center and had an aggregate daily ice manufacturing capacity of approximately 2,085 tons.
In 2004, we completed eleven acquisitions for a total purchase price of approximately $16.9 million, including direct acquisition costs of $0.5 million. In 2005, we completed two acquisitions for a total purchase price of approximately $0.9 million, including direct acquisition costs of $0.02 million, and purchased certain leased real estate assets for a purchase price of $2.5 million. The purchase price for each of these acquisitions in 2004 and 2005 was paid from our available working capital. Annual revenue associated with each of the acquisitions in 2004 and 2005 ranged from $0.1 million to $3.2 million and aggregated approximately $14 million.
In 2006, we completed ten acquisitions for a total purchase price of $12.9 million, including direct acquisition costs of $0.3 million. The purchase price for these acquisitions in 2006 was paid from our available working capital. Annual revenue associated with each of the acquisitions ranged from $0.1 million to $3.0 million and aggregated approximately $8.3 million. The 2006 acquisitions added four ice manufacturing facilities and three distribution centers to the facilities we own or operate. Through March 9, 2007, we have completed five acquisitions with an aggregate cost of approximately $11.3 million.
We will continue to consider strategic acquisitions in existing or adjacent geographic markets that enhance the density of our distribution routes, provide capacity rationalization opportunities, increase our market penetration in existing markets or expand our presence in contiguous markets.
In recent years, as part of our strategy to reduce our debt and make better use of our assets, we began a program to evaluate and dispose of excess and non-core assets, including real estate and equipment. In 2006, 2005 and 2004, we realized $2.0 million, $2.1 million and $2.7 million, respectively, in proceeds from non-core assets disposed of, primarily through the sale of real estate. In 2006, 2005 and 2004, we recorded losses on the dispositions of assets in the amount of $1.1 million, $1.8 million and $0.4 million, respectively. In 2006, an impairment of $0.4 million was recorded on two pieces of real estate. There were no impairments or writedowns of real estate in 2005 or 2004.
We also derive revenues from other goods and services, which consist of refrigerated warehousing and the manufacture and sale of bottled water. Revenues from these non-ice products and operations have accounted for approximately 4%, 5% and 6% of our total revenues during the years ended December 31, 2006, 2005 and 2004, respectively.
At March 9, 2007, we directly employed approximately 1,600 company employees and retained approximately 600 additional employees through temporary employment agencies. Each year, during the second and third calendar quarters, our labor force increases to approximately 3,000 total employees due to seasonal increases in ice demand and during the first and fourth calendar quarters, our labor force decreases to approximately 2,100 total employees due to seasonal decreases in ice demand. We direct and control the hiring process for substantially all of these seasonal employees, while using temporary employment agencies for payroll administration and risk management of workers compensation insurance. We generally have not experienced any difficulty in meeting these seasonal employment needs. Labor, including the associated payroll taxes and benefit expenses, is our most significant expense item and was approximately 32% of our revenues for the year ended December 31, 2006. As of March 9, 2007, no employees were represented by a union or subject to a collective bargaining agreement. We have never experienced a work stoppage due to labor difficulties and we believe our relationship with our employees is good.
We have not experienced any material supply problems in the past with respect to our business segments.
We use large quantities of plastic bags. The cost of bags was approximately 7% of our revenues in 2006. There are numerous plastic bag manufacturers throughout the United States with the capability of providing for our plastic bag needs. Although one company dominates the industry, we currently purchase bags from several companies to ensure price competition. Historically, market prices for plastic bags have fluctuated in response to a number of factors, including changes in polyethylene prices. During 2006, increases in the price of plastic bags resulted in approximately $3.0 million of additional costs. Significant increases in the cost of plastic bags could have a material adverse effect on our business as we may not be able to pass this expense through to our customers. We continue to evaluate means to control these costs in the future.
Electricity is a significant component of our manufacturing costs. The cost of electricity was approximately 6% of our revenues in 2006. Since 2002, our plants have been operating in both regulated and deregulated electricity markets. A significant number of our manufacturing facilities operate in regulated electricity markets and pay rates based on standard schedules for similar industrial facilities. With the assistance of an outside consultant and our own internal resources, we regularly monitor and review rate schedules, usage and other statistical data to ensure proper billing and identify additional cost control opportunities that may be available in these regulated markets. In deregulated electricity markets, we regularly evaluate market conditions and competing suppliers to obtain the best pricing available. Significant increases in electricity rates in both the regulated and deregulated markets in which we operate could have a material adverse effect on our results of operations as we may not be able to pass this expense through to our customers. The effect of electric rate increases in 2006 was approximately $1.5 million. We expect rate increases in 2007 to have a reduced impact as market prices for oil and gas appear to have moderated recently and a fixed rate electric supply contract in Texas has been renewed at lower prices for a one-year term beginning in June 2007.
We also use large quantities of fuel in our distribution process. Numerous vendors throughout the United States provide the fuel for our vehicles. Fuel expenses in 2006 were approximately 4% of revenues. Market prices for fuel have fluctuated widely in the past. Significant increases in fuel prices could have a material adverse effect on our business as we may not be able to pass this expense through to our customers. During 2006, increases in the price of fuel resulted in approximately $1.4 million of additional costs.
We have relationships with approximately 175 third party ice distributors and co-packers throughout our market area who deliver a portion of our products to our customers and sell ice to their own customers. We have contractual relationships with approximately 115 of these distributors and co-packers. Our contracts contain standard terms governing their relationship with us, including exclusivity and price. Distributors handled approximately 31% of our ice sales, measured in terms of tons, in 2006, either delivering the product to our customers for a delivery fee or reselling the ice to their own customers. We generally do business with distributors under one of two arrangements. Beginning in the first half of 2004, we began shifting the majority of our distributors to an arrangement that results in reporting sales and cost of sales (excluding depreciation) at their gross, rather than net, amounts. Total costs related to these distribution services were approximately 6% of our revenues in 2006.
Internal information systems are critical to our ability to operate efficiently. We are able to monitor individual manufacturing plants and Ice Factory performance on a daily basis through automated and manual reporting systems. This information enables us to track detailed cost and profitability information,
identify opportunities to redistribute traditional manufacturing capacity among markets, assess the cost-effectiveness of an Ice Factory at a particular location and analyze market sales trends. In addition, all of our accounting and financial reporting functions are integrated into a single accounting platform that is installed in all reporting locations and connected to our central facility in Dallas, Texas. This system facilitates centralized cash management, timely financial reporting, consistent reporting formats and inventory tracking. In 2005, we began implementing mobile technology with our delivery personnel to create and record sales transactions. As of December 31, 2006, we have completed implementation of the handheld technology at all of our locations and are now in the process of extending this mobile technology to our distributors. As of March 9, 2007, we have completed approximately 45% of targeted distributor routes. We are also continuing to evaluate new programs to improve and enhance certain administrative functions
We regard The Ice Factory® as proprietary and rely primarily on a combination of patents, nondisclosure and confidentiality agreements and other protection methods to secure and protect our intellectual property rights. We hold or have exclusive rights to several patents relating to The Ice Factory, including the bagging device and the overall assembly of the unit. The patents filed in North America relating to The Ice Factory expire at various dates from 2010 through 2014. In addition, we have developed or acquired a number of trademarks (both registered and common law) and trade names for use in our ice business, and we hold licenses for the use of additional trademarks from third parties. We believe the use of our trademarks creates goodwill and results in product differentiation. However, we do not believe that the loss of any of our trademarks would have a material adverse effect on our business or results of operations.
The packaged ice industry is subject to various federal, state and local laws and regulations. These require us to, among other things, obtain licenses for our plants and machines, pay annual license and inspection fees, comply with certain detailed design and quality standards regarding our plants and Ice Factories and continuously control the quality and quantity of our ice.
Our packaged ice products are subject to federal and state regulation as a food pursuant to the Federal Food, Drug and Cosmetic Act, regulations promulgated thereunder by the Food and Drug Administration and analogous state statutes. These statutes and regulations impose comprehensive food manufacturing practices governing the sanitary conditions of the facilities where ice is manufactured, the design and maintenance of the equipment used to manufacture the ice, the quality of source water and the sanitary practices of employees during ice production. We cannot predict the types of government regulations that may be enacted in the future by federal, state or local governments or how existing or future laws or regulations will be interpreted or enforced. The enactment of more stringent laws or regulations or a stricter interpretation of existing laws and regulations may require additional expenditures by us, some of which could be material. Various states have imposed additional requirements including (1) quarterly testing of ice for the presence of microbes and certain substances regulated under the federal Safe Drinking Water Act, (2) specific requirements for keeping ice packaging operations separate from other activities and (3) labeling requirements for the bags used, including the name of the ice manufacturer, the manufacturing location and the net weight. Certain of our Ice Factories and ice manufacturing facilities are subject to routine and random safety, health and quality inspections. We believe that our facilities, manufacturing practices and Ice Factories are in substantial compliance with all applicable federal, state and local laws and regulations and that we will be able to maintain such substantial compliance in the future.
We are subject to certain health and safety regulations, including Occupational Safety and Health Act regulations. These regulations require us to comply with certain manufacturing, health and safety standards to protect our employees from accidents. From time to time, our employees experience accidents on the job, which on occasion will result in a review or an investigation by the Occupational Safety and Health Administration. Such reviews may result in penalties or the requirement that we make modifications to our procedures or facilities, all of which may result in increased costs.
Our ice manufacturing, bottled water and cold storage operations are subject to a wide range of environmental laws and regulations governing, among other things, air emissions, wastewater discharges, the use, management and disposal of hazardous and non-hazardous materials and wastes, and the cleanup of contamination. These requirements are complex, changing and tend to become more stringent over time. Noncompliance with such laws and regulations, or incidents resulting in environmental releases, could cause us to incur substantial costs, including cleanup costs, fines and penalties, third party claims for personal injury, investments to retrofit or upgrade our facilities and programs, or curtailment of our operations.
Our facilities use refrigerants such as ammonia and Freon in manufacturing and cold storage operations. We have implemented risk and safety management plans at our facilities, as required under applicable laws and regulations, based on the quantity of ammonia stored and/or used at these locations. We will continue to review our facilities on an ongoing basis, including recently acquired facilities, to evaluate the feasibility of reducing on-site ammonia storage through engineering controls or, where required, to implement or update such programs. Some of our facilities that use various Freon compounds may not be in compliance with applicable Freon refrigerant requirements, including leak detection and repair, recordkeeping or reporting. We will continue to identify subject facilities and to implement procedural or mechanical changes as necessary to comply with applicable laws and regulations. To date, maintaining compliance with and addressing violations under these and other environmental laws and regulations has not had a significant effect on our business, financial condition or results of operations. However, significant operating costs and capital expenditures could be incurred if additional or more stringent requirements are imposed in the future.
From time to time, our use of ammonia has resulted in incidents that have temporarily disrupted our manufacturing operations and resulted in liability for administrative penalties and claims for personal injury. To date our costs to resolve these liabilities have not been material. Although we carry liability insurance against such losses, we could incur significant costs if our coverage is not sufficient to pay for all or a large part of any judgments against us, or if our carrier refuses coverage for these losses.
In addition, some Freon refrigerants are subject to phase-outs and, as a result, are very costly to obtain. We will continue to reduce our dependence on such Freon compounds by upgrading or modifying our operations and by identifying approved substitutes. Based on current information, we believe that the Freon phase-outs will not impede our ability to produce ice and provide cold storage or result in material cost increases for Freon substitutes.
Certain of our current and former facilities have a history of industrial or commercial operations. Because some environmental laws can impose liability for the entire cost of cleanup upon any of the current or former owners or operators, regardless of fault, it is possible that we could become liable for investigating or remediating contamination at these properties if any investigation or remediation is required in the future. Such costs have not historically had, and are not expected to have in the future, a material adverse effect on our business, financial condition or results of operations.
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%, 69% and 68% of our annual revenues occurred during the second and third calendar quarters in each of 2006, 2005 and 2004. Approximately 66% of our annual revenues also occurred during the second and third calendar quarters of 2003 and 68% occurred during the second and third calendar quarters of 2002, 2001 and 2000. For information on our revenues per quarter for each of 2006, 2005 and 2004, see Note 15 to our audited financial statements included under Item 8. 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.
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, incremental 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.
Our actual cash available to pay dividends may not 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.
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 are permitted to do so under the agreements governing our debt), which would increase our leverage and limit our funding alternatives for other uses;
· amend the terms of our credit facilities 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, which could limit our ability to grow.
Our ability to pay dividends will be restricted by agreements governing our debt, including our credit facilities and the indenture governing our senior discount notes and by Delaware law.
Our credit facilities and the indenture governing our senior discount notes restrict our ability to pay dividends. We refer you to Liquidity and Capital ResourcesLong-term Debt and Other Obligations under Item 7, 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.
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 December 31, 2006, we had outstanding indebtedness of approximately $364.9 million, which represented approximately 69% of our total consolidated capitalization on a book basis. As of December 31, 2006, we also had availability of $53.6 million (net of standby letters of credit of approximately $6.4 million) under our revolving credit facility.
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 our credit facilities permit us, under certain circumstances, to incur a significant amount of additional indebtedness. For example, our credit facilities allow 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 our 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 our credit facilities 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.
Our credit facilities 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 7.
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 credit facilities could result in a default under such facilities. If any such default occurs, the lenders may elect to declare all obligations under our credit facilities 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 our credit facilities 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 profit 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 resulting net income 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.
Increases in the prices of electricity, certain raw materials, fuel, insurance and other required expenses could, if we cannot pass those price increases along to our customers, have an adverse effect on our results of operations.
We use substantial amounts of polyethylene, which is the primary raw material used to manufacture the bags we use to package our ice, electricity in connection with our manufacturing process and fuel to operate the refrigerated trucks for ice delivery. We also carry general liability, workers compensation, health and vehicle insurance. We have already experienced increases in bag costs, fuel costs, electricity costs and insurance costs and may experience further increases in such costs in the future. If the prices for these items or other expenses increase beyond the amounts that we are able to pass along to our customers, our margins and our operating cash flow would decrease.
Our acquisitions may not be successfully integrated and could cause unexpected financial or operational difficulties.
In 2005 and 2006, we completed a total of 12 acquisitions. We anticipate that we may, from time to time, selectively acquire additional businesses, assets or securities of companies that we believe would provide a strategic fit with our business. Acquisitions are also accompanied by risks, such as potential exposure to unknown liabilities of acquired companies and the possible loss of key employees and customers of the acquired business. Further, acquisitions are subject to risks associated with the difficulty and expense of integrating the operations and personnel of the acquired companies, the potential disruption to our business and the diversion of management time and attention, any of which could increase the costs of operating our business, negate the expected benefits of the acquisitions or result in the loss of customers.
We could incur substantial costs as a result of violations of or liabilities under environmental laws.
Our operations are subject to a wide range of environmental laws and regulations governing, among other things, air emissions, wastewater discharges, the use, management and disposal of hazardous and non-hazardous materials and wastes and the cleanup of contamination. Noncompliance with such laws and regulations, or incidents resulting in environmental releases, could cause us to incur substantial costs, including cleanup costs, fines and penalties, third party claims for personal injury, investments to retrofit or upgrade our facilities and programs, or curtailment of our operations. For example, our ice manufacturing and cold storage operations use refrigerants such as ammonia and Freon. Some of our facilities may not be in compliance with certain Freon refrigerant requirements, such as leak detection and repair, recordkeeping or reporting. In addition, the market price of Freon is rising as a result of phase-outs under federal laws, which could significantly increase our operating costs in the future if we are not able to obtain approved substitutes. From time to time, our use of ammonia has resulted in releases that have temporarily disrupted our manufacturing operations and resulted in lawsuits or administrative penalties.
Material violations of, or liabilities under, environmental laws may require us to incur substantial costs which could reduce our margins, or to divert resources from ongoing environmental programs and improvements, which could delay our efforts to integrate acquisitions and upgrade our operations, or expose us to risk of further environmental liability.
Our business could be disrupted or we could incur substantial costs because of government laws and regulations.
We are subject to various federal, state and local laws relating to many aspects of our business, including labeling, sanitation, health and safety and manufacturing processes. We cannot predict the types of government regulations that may be enacted in the future by the various levels of government or how existing or future laws or regulations will be interpreted or enforced. The enactment of more stringent laws or regulations or a stricter interpretation of existing laws and regulations may cause a disruption in our operations or require additional expenditures by us, some of which could be material. We may incur material costs and liabilities in order to comply with any such laws and regulations and such costs and liabilities may result in substantial expenses to us and could divert managements time and attention.
If we are unable to retain senior executives and attract and retain other qualified employees, our business might be adversely affected.
Our success depends in part on our ability to attract, hire, train and retain qualified managerial, sales and marketing personnel. Competition for these types of personnel is high. We may be unsuccessful in attracting and retaining the personnel we require to conduct our operations successfully. Our success also depends to a significant extent on the continued service and performance of our senior management team and in particular on the continued service of Messrs. William P. Brick and Jimmy C. Weaver. Mr. Brick currently serves as our Chairman and Chief Executive Officer. Mr. Weaver currently serves as our President and Chief Operating Officer. In addition, we do not carry key man life insurance. Our inability to successfully attract and retain personnel or the loss of any member of our senior management team could impair our ability to execute our business plan.
Accidents involving our products and equipment could expose us to increased costs as a result of product liability claims.
We are subject to a risk of product liability claims and adverse publicity if a consumer is or claims to be harmed while using our products or equipment. Any such claim may result in negative publicity, loss of revenues or higher costs associated with litigation.
We currently carry product liability insurance. However, this insurance may be insufficient to pay for all or a large part of these losses. If our insurance does not adequately cover these losses, our results of operations and cash flow would decrease and such a decrease could be material.
We may lose customers business to competitors as a result of our limited intellectual property protection, including on The Ice Factory®.
As the sole major ice supplier using an on-site production and delivery system at our customers retail locations, we have enjoyed a competitive advantage over our competitors. Our proprietary Ice Factory system is preferred by certain of our high volume customers to traditional ice delivery and gives us more flexibility during peak seasons. Competitors sometimes test machines similar to The Ice Factory. If any of our competitors are successful with the rollout of a competing system, we could lose business to these companies, which would result in decreased cash flows and results of operations.
It is also our practice to protect certain of our proprietary materials and processes by relying on trade secrets laws and non-disclosure and confidentiality agreements. Confidentiality or trade secrets may not be maintained and others may independently develop or obtain access to such materials or processes, which could adversely affect our competitive position and ability to differentiate our products and services from our competitors offerings.
Limitations on our ability to utilize our tax assets before they expire may negatively affect financial results and the ability to pay dividends.
As of December 31, 2006, we had net operating loss carryforwards for U.S. federal income tax purposes of approximately $105 million, of which approximately $64 million were generated prior to August 15, 2003. There are annual limitations on the utilization of the $64 million portion of the net operating loss carryforwards due to changes in ownership on and prior to August 15, 2003. Further, since at the closing of our initial public offering on August 12, 2005 our prior equity investors ceased to own a majority of our common stock, new limitations apply to the approximately $41 million of net operating loss carryforwards that were generated from August 15, 2003 to August 12, 2005 and additional limitations apply to the net operating loss carryforwards generated prior to August 15, 2003.
If we are not able to utilize our tax assets in the manner or in the timeframe we anticipate, our future after-tax cash flow available for payment of dividends on our common stock will be reduced.
Any significant reduction in goodwill and other intangible assets would have an adverse effect on the value of our business.
Our acquisitions have resulted in significant amounts of goodwill and other intangible assets. Goodwill, which relates to the excess of cost over the fair value of the net assets of the businesses acquired, and intangible assets totaled approximately $296.3 million at December 31, 2006, representing approximately 49% of our total assets. In the future, goodwill and intangible assets may increase as a result of future acquisitions. Goodwill and intangible assets are reviewed at least annually for impairment. Impairment may result from, among other things, deterioration in the performance of acquired businesses, adverse market conditions, adverse changes in applicable laws or regulations, including changes that restrict the activities of the acquired business, and a variety of other circumstances. During 2006, we recorded a non-cash impairment charge of $3.3 million to goodwill in the bottled water portion of our non-ice products and operations business segment as a result of a significant reduction in bottled water sales volumes related to a particular customer. During 2005, we recorded a non-cash impairment charge of $5.7 million to goodwill in the cold storage portion of our non-ice products and operations business segment as a result of a significant reduction in cold storage sales volumes related to a particular customer. The amount of these and any future impairments must be charged to earnings. Any future determination requiring the write-off of a significant portion of the goodwill and intangible assets recorded on our balance sheet would have an adverse effect on the value of our business.
The market for our common stock may be volatile, which could cause the value of your investment to decrease.
Volatility in the market price of our common stock may prevent you from being able to sell our common stock held by you at or above the price you paid for it. The market price of our common stock may fluctuate widely as a result of various factors, such as period-to-period fluctuations in our actual or anticipated operating results, sales of our common stock by our existing equity investors, failure to pay dividends at anticipated levels, developments in our industry, the failure of securities analysts to cover our common stock or changes in financial estimates by analysts, failure to meet financial estimates by analysts, competitive factors, general economic and securities market conditions and other external factors. Also, securities markets worldwide experience significant price and volume fluctuations. This market volatility, as well as general economic or market conditions, and market conditions affecting the stock of companies in our industry in particular, could reduce the market price of our common stock in spite of our operating performance.
Limited trading volume of our common stock may contribute to its price volatility.
For the year ended 2006, the average daily trading volume for our common stock as reported by the New York Stock Exchange was approximately 118,000 shares. As a result, relatively small trades may have a significant impact on the price of our common stock.
If our share price is volatile, we may be the target of securities litigation, which is costly and time-consuming to defend.
In the past, following periods of market volatility in the price of a companys securities, security holders have often instituted class action litigation. If the market value of our common stock experiences adverse fluctuations and we become involved in this type of litigation, regardless of the outcome, we could incur substantial legal costs and our managements attention could be diverted from the operation of our business, causing our business to suffer.
We are a holding company with no operations, and unless we receive dividends, distributions, advances, transfers of funds or other payments from our subsidiary, we will be unable to pay dividends on our common stock and meet our debt service and other obligations.
We are a holding company and conduct all of our operations through our subsidiary. We do not have, apart from our ownership of our subsidiary, any independent operations. As a result, we will rely on dividends and other payments or distributions from our subsidiary to pay dividends on our common stock and meet our debt service and other obligations. The ability of our subsidiary to pay dividends or make other payments or distributions to us will depend on our operating results and may be restricted by, among other things, the covenants that are contained in our credit facilities and the covenants of any future outstanding indebtedness we or our subsidiary may incur.
In addition, because we are a holding company, claims by our stockholders will be structurally subordinated to all existing and future liabilities and obligations (whether or not for borrowed money) of our subsidiary, including obligations under our new credit facilities. Therefore, in the event of our bankruptcy, liquidation or reorganization, our assets and those of our subsidiary will be able to satisfy the claims of our stockholders only after all of our and our subsidiarys liabilities and obligations have been paid in full.
Provisions of our charter documents and the DGCL may inhibit a takeover, which could negatively affect our stock price.
Provisions of our charter documents and the DGCL, the state in which we are incorporated, could discourage potential acquisition proposals or make it more difficult for a third party to acquire control of our company, even if doing so might be beneficial to our stockholders. Our amended and restated certificate of incorporation and by-laws provide for various procedural and other requirements that could make it more difficult for stockholders to effect certain corporate actions. For example, our amended and restated certificate of incorporation authorizes our board of directors to determine the rights, preferences, privileges and restrictions of unissued series of preferred stock without any vote or action by our stockholders. Our board of directors could therefore authorize and issue shares of preferred stock with voting or conversion rights that could dilute the voting power or diminish other rights of holders of our common stock. Additional provisions are included in our amended and restated certificate of incorporation and by-laws which could make it more difficult for stockholders to effect certain corporate actions, including:
· the sole power of a majority of the board of directors to fix the number of directors and to fill any vacancy on the board of directors;
· requirements for advance notification of stockholder nominations and proposals; and
· the inability of stockholders to act by written consent and restrictions on the ability of stockholders to call special meetings.
These provisions may discourage acquisition proposals and may make it more difficult or expensive for a third party to acquire a majority of our outstanding voting stock or may delay, prevent or deter a merger, acquisition, tender offer or proxy contest, which may negatively affect our stock price.
We maintain our principal executive offices in Dallas, Texas, where we lease approximately 20,129 square feet of space. The lease in Dallas expires in 2015. At March 9, 2007, we owned or leased 63 ice manufacturing plants, 59 distribution centers, five refrigerated warehouses and one bottled water plant. As of March 9, 2007, we leased 14 of our ice manufacturing plants and 18 of our distribution centers. The
leases are scheduled to expire at various dates from 2007 to 2016. Including an installed base of approximately 3,000 Ice Factories, we had a combined, rated ice manufacturing capacity of approximately 17,000 tons per day. We believe that our current physical properties, along with our planned capital expenditures, are adequate for us to execute our current business strategy.
Certain manufacturing and distribution facilities may be permanently closed in conjunction with our continuing consolidation plans, while others may be closed on a seasonal basis depending upon production requirements. As of March 9, 2007, we have two properties that are being marketed for disposition. These properties are excluded from the table below.
The following is a list of our active facilities and total rated traditional ice manufacturing capacity as of March 9, 2007:
(1) Does not include the rated ice manufacturing capacity of our installed Ice Factories, which was approximately 3,000 tons per day in the aggregate as of March 9, 2007.
We are 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 difficult to determine the ultimate costs that we may incur. We believe the resolution of such uncertainties and the incurrence of such costs will not have a material adverse effect on our consolidated financial position, results of operations or cash flows.
During the quarter ended December 31, 2006, no matters were submitted to a vote of security holders.
Our common stock was listed on the New York Stock Exchange under the symbol FRZ on August 10, 2005. Prior to that time, there was no public market for our common stock. The following table presents the high and low sales prices for the common stock on the New York Stock Exchange during the periods indicated and the dividends declared during such periods:
(1) See Dividend Policy below for additional information regarding dividends.
As of March 9, 2007 there were approximately 110 registered holders of record of our common stock and 21,809,395 shares of our common stock outstanding. Because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these record holders.
Since the completion of our IPO, our board of directors has declared dividends on our common stock as follows:
As previously announced, we intend to continue paying quarterly dividends at an annual rate of $1.60 per share on our common stock outstanding, subject to the Boards decision to declare these dividends and various restrictions on our ability to do so. The Board will evaluate whether to pay a dividend on a quarterly basis and will base its decisions on, among other things, our results of operations, cash requirements, financial condition, contractual restrictions and other factors the Board may deem relevant.
The amounts available to us to pay further cash dividends are restricted by our credit facilities and the indenture governing our outstanding senior discount notes. For additional information about the
restrictions on our ability to pay future dividends, see Item 7. Managements Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital ResourcesLong-term Debt and Other Obligations.
Information concerning securities authorized for issuance under equity compensation plans is set forth in Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
The following information relates to the sales and other issuances of our securities within the past three fiscal years, none of which were registered pursuant to the Securities Act of 1933 as amended (the Securities Act).
On August 16, 2004, we sold 17,250 shares of common stock and 125 shares of our Series A preferred stock to one of our independent directors. The shares were sold for cash proceeds equal to $7.25 per common share and $1,000 per preferred share or an aggregate of $250,000. These shares were issued without registration under the Securities Act by reason of the exemption from registration afforded by the provisions of Section 4(2) thereof, as a transaction by an issuer not involving any public offering.
On October 27, 2004, we sold $151,000,000 aggregate principal amount at maturity of our 101¤2% Senior Discount Notes due 2012 (the senior discount notes). We received gross proceeds of approximately $100.2 million upon the issuance of the senior discount notes.
The initial purchasers of the senior discount notes and the principal amount purchased by each such purchaser are listed in the table below:
The issuance of the senior discount notes to the initial purchasers was made in reliance on Section 4(2) under the Securities Act and the senior discount notes were subsequently resold by the initial purchasers pursuant to Rule 144A and Regulation S thereunder. The sale of the senior discount notes was made without general solicitation or advertising.
On August 9, 2005, we registered 11,730,000 shares of our common stock for an aggregate offering price of $217,005,000 in our initial public offering. On August 12, 2005 we closed the sale by us and the selling stockholders of a total of 11,730,000 shares of our common stock in our initial common stock offering at a price of $18.50 per share in a firm commitment underwritten initial public offering. Of the shares sold in the offering, 6,911,765 shares were sold by us and the remaining 4,818,235 shares were sold by the selling stockholders. This offering was effected pursuant to a Registration Statement on Form S-1 (File No. 333-122751), which the SEC declared effective on August 9, 2005. Bear, Stearns & Co. Inc., Lehman Brothers Inc., Credit Suisse First Boston LLC, Goldman, Sachs & Co. and CIBC World Markets Corp. served as lead underwriters in the offering. The gross proceeds of the offering were allocated as follows:
· approximately $89.1 million was received by the selling stockholders; and
· we received the remaining $127.9 million.
The proceeds of the offering received by us, together with $256.0 million in borrowings under our credit facilities, were used as follows:
· approximately $9.0 million was paid to the underwriters in connection with the underwriting discount;
· approximately $11.0 million was used in connection with offering expenses, printing fees, listing fees, filing fees, accounting fees and legal fees in connection with the offering and with the related transactions;
· approximately $184.5 million was used in connection with the repayment of our previous credit facilities;
· approximately $169.8 million was used to repurchase the our senior subordinated notes; and
· approximately $9.6 million was retained by Reddy Holdings as additional cash in hand.
On August 26, 2005, we paid $0.4 million to purchase and retire senior discount notes with an aggregate principal amount at maturity of $0.5 million. On February 28, 2006, 186,261 shares of previously issued restricted stock issued to certain members of management and independent directors vested according to their terms. We withheld 51,256 of such shares on that date in satisfaction of statutory federal and state tax withholding obligations on behalf of employees whose restricted stock vested on that date and used $1.0 million of the retained proceeds of our initial public offering to fund these withholding obligations. The withheld shares were assigned a value equal to the closing price on February 28, 2006. The members of management received no cash proceeds from the repurchases.
The following table sets forth, for the periods and dates indicated, selected consolidated data derived from our consolidated financial statements. The following information should be read in conjunction with our consolidated financial statements, including the notes thereto, and Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations appearing elsewhere in this report.
On August 15, 2003, Packaged Ice, Inc. merged with Cube Acquisition Corp., a wholly-owned subsidiary of Reddy Ice Holdings, Inc. Packaged Ice, which was renamed Reddy Ice Group, Inc. (Reddy Group), was the surviving corporation and became a wholly-owned subsidiary of Reddy Holdings, which was established on May 8, 2003. Reddy Holdings and Cube Acquisition conducted no operations from May 8, 2003 to August 14, 2003. Reddy Holdings and Reddy Group are collectively referred to as the Successor. Packaged Ice prior to the merger is referred to as the Predecessor. Because of purchase accounting, certain amounts may not be comparable between the Predecessor and Successor. On January 1, 2007, Reddy Group merged with its wholly-owned subsidiary, Reddy Ice Corporation (Reddy Corp.), with Reddy Corp. being the surviving entity.
(1) Represents the sum of the Successors results for the period from May 8, 2003 (Date of Inception) to December 31, 2003 and the Predecessors results from January 1, 2003 to August 14, 2003. The Successor conducted no operations from May 8, 2003 to August 14, 2003.
(2) All dividends declared in the year ended December 31, 2005 were paid after August 12, 2005, the closing date of the initial public offering of our common stock.
(3) Working capital is defined as current assets less current liabilities.
(4) Excludes the costs of acquisitions and purchases of leased assets.
The following discussion should be read in conjunction with the Item 6. Selected Financial Data, and our consolidated financial statements, including the notes thereto beginning on page F-1, and the other information appearing elsewhere in this report.
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 segmentsice products and non-ice products and operations. Ice products accounted for approximately 96%, 95% and 94% of revenues in 2006, 2005 and 2004, respectively. Our ice products business segment 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. Our results of operations are 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. As a result of this seasonality and the fixed costs in our business, the proportion of revenues earned in our ice and non-ice business segments and the ratio of costs to revenues in any given quarter are not necessarily indicative of the ratios for a full year. Revenues within specific markets can also be affected by weather conditions, with cool or rainy weather negatively impacting demand and extremely hot weather increasing our costs as we respond to excess customer demand for our products. Approximately 69%, 69%
and 68% of our revenues occurred during the second and third calendar quarters in 2006, 2005 and 2004, respectively. As a result of seasonal revenue declines and a less than proportional decline in certain expenses during the first and fourth calendar quarters, we typically experience lower profit margins resulting in losses during these periods. In addition, because a significant portion of our annual sales are generated during the second and third calendar quarters, our annual results of operations may fluctuate significantly if the weather during these periods is cool or rainy. Cool and rainy weather has a negative impact on operations, while warm and dry weather generally has a positive impact. For additional information concerning the impact of seasonality on our results of operations, see General Economic Trends and Seasonality.
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 earnings 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).
Depreciation Expense Related to Cost of Sales and Depreciation and Amortization. Depreciation and amortization are divided into two line itemsdepreciation 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 8% and 7% of sales in 2006 and 2005, respectively.
Facilities. At March 9, 2007, we owned or operated 63 ice manufacturing facilities, 59 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.
Revenues: Revenues increased $26.3 million from 2005 to 2006. This increase was primarily due to an increase in volume sales, primarily in the second quarter of 2006 as a result of favorable weather conditions in most of our markets, and the effects of package sizing initiatives, which consisted primarily of converting a portion of our ice sales from seven to ten pound bags. Also contributing to the increase was higher average pricing and the effects of the acquisitions of ice companies (approximately $4.4 million). Partially offsetting these increases in revenues was a $2.4 million decrease in non-ice revenue, primarily due to volume decreases in our bottled water business related to the loss of its largest customer.
Cost of Sales (Excluding Depreciation): Cost of sales (excluding depreciation) increased $16.6 million from 2005 to 2006. This increase in cost of sales (excluding depreciation) was primarily due to the increased volume sales referred to above, approximately $2.9 million of additional costs associated with acquired ice operations, a $6.0 million increase in fuel, plastic bags and electricity costs due to market increases in energy prices and a $3.0 million increase in third party distribution costs related to increased volume sales and rate increases. Partially offsetting these increases was a $1.3 million reduction of costs in
our non-ice operations, primarily labor costs in our bottled water operation related to decreased sales volumes.
Labor costs, including associated payroll taxes and benefit costs (including health insurance), accounted for approximately 23% and 24% of revenues in 2006 and 2005, respectively. Cost of plastic bags represented approximately 7% of revenues in 2006 and 2005. Fuel expenses represented approximately 4% and 3% of revenues in 2006 and 2005. Expenses for independent third party distribution services represented approximately 6% of revenues in 2006 and 2005, respectively. Electricity expense represented approximately 6% and 5% of revenues in 2006 and 2005, respectively.
Depreciation Expense Related to Cost of Sales: Depreciation expense related to cost of sales increased $0.7 million from 2005 to 2006 as a result of additional depreciation expense associated with new production and distribution equipment placed in service during 2006 and assets acquired through the acquisition of ice companies throughout 2006, partially offset by the effect of asset dispositions.
Operating Expenses: Operating expenses increased $7.9 million from 2005 to 2006. The increase is primarily due to $2.3 million of increased incentive compensation, increased non-cash stock-based compensation of $2.3 million, additional labor costs related to wage increases and acquisitions of $0.8 million and a $1.8 million increase in professional services. Professional services include $1.2 million of costs related to the secondary stock offering completed in May 2006 and a potential acquisition that was not completed in the first quarter of 2006, as well as approximately $0.5 million of costs related to the implementation of the Sarbanes-Oxley Act requirements related to internal controls.
Depreciation and Amortization: Depreciation and amortization increased $0.2 million from 2005 to 2006. This increase was primarily due to additional amortization expense associated with the intangible assets recorded in connection with the acquisitions completed in 2006.
Impairment of Assets: Due to the significant reduction in bottled water sales volumes related to the loss of a particular customer, we evaluated the goodwill recorded in the bottled water portion of our non-ice business segment in accordance with Statement of Financial Accounting Standards (SFAS) No. 142, Goodwill and Other Intangibles as of September 30, 2006. As a result of such evaluation, we recorded a non-cash impairment charge of $3.3 million during the three months ended September 30, 2006, which resulted in the full write-off of the goodwill associated with our bottled water operation.
We also reviewed two pieces of real estate in our ice business in accordance with SFAS No. 144, Accounting for the Impairment of Disposal of Long-Lived Assets, as a result of a pending sale of one property and physical damage to another. As a result of this review, we recorded an impairment charge of $0.4 million in the three months ended June 30, 2006.
Due to a significant reduction in cold storage sales volumes related to a particular customer, we evaluated the goodwill recorded in the cold storage portion of its non-ice business segment in accordance with SFAS No. 142 as of June 30, 2005. As a result of such evaluation, we recorded a non-cash impairment charge of $5.7 million during the three months ended June 30, 2005, which resulted in the full write-off of goodwill in our cold storage operations.
Management Agreement Termination Fees and Transaction Bonuses and Expenses: In connection with our initial public offering and the related transactions in August 2005, we recorded expenses of $6.2 million. These charges were related to payments to our majority owners to terminate the management services agreement (approximately $4.0 million), transaction bonuses to certain employees (approximately $1.8 million) and other fees and expenses (approximately $0.4 million).
Loss on Extinguishment of Debt: In connection with our initial public offering and the related transactions in August 2005, we redeemed substantially all of our 87¤8% senior subordinated notes pursuant to a tender offer and consent solicitation and repaid all balances outstanding under our credit facility. We incurred a loss of $28.1 million in connection with these repayments consisting of the tender premiums and
consent fees paid to the holders of the 87¤8% senior subordinated notes (approximately $17.3 million), the write-off of deferred debt costs and original issue discount related to the 87¤8% senior subordinated notes and the credit facility (approximately $10.6 million) and other fees and expenses (approximately $0.2 million). Additionally, during the three months ended September 30, 2005, we paid $0.4 million to purchase and retire senior 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.
Interest Expense, net: Interest expense, net decreased $5.7 million from 2005 to 2006. This decrease was primarily due to a $9.0 million reduction in interest expense associated with the 87¤8% senior subordinated notes that were repurchased in August 2005 and a $0.9 million increase in interest income earned on cash and cash equivalent balances, partially offset by a $3.7 million increase in term loan interest related to increased principal balances subsequent to the refinancing of our bank credit facility in August 2005.