**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

**FORM 10-Q**

**(Mark one)**

**x***                              *QUARTERLYREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**Forthe quarterly period ended September 30, 2006**

**OR**

**o**                                 TRANSITIONREPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF1934

**Forthe transition period from                 to                **

**Commissionfile number 001-32596**

**REDDY ICE HOLDINGS, INC.**

(Exact name of registrantas specified in its charter)

| **DELAWARE**                                                     | ** ** | **56-2381368**                        |
|------------------------------------------------------------------|------------|---------------------------------------|
| (State or other  jurisdiction of  incorporation or organization) |       | (I.R.S. Employer  Identification No.) |
| **8750 N. CENTRAL EXPRESSWAY,  SUITE 1800  DALLAS, TEXAS 75231** |
| (Address of principal executive offices)                         |
| **(214) 526-6740**                                               |
| (Registrant’s telephone number, including area code)        |

 

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

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

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

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

 

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**REDDYICE HOLDINGS, INC. AND SUBSIDIARY**

**QUARTERLYREPORT ON FORM 10-Q**

**FOR THE PERIODENDED SEPTEMBER 30, 2006**

**TABLEOF CONTENTS**

|                   | ** **                                                                                                                         |   | **Pag**e |
|-------------------|------------------------------------------------------------------------------------------------------------------------------------|--------|----------|
| ** **        | **PART I—FINANCIAL  INFORMATION**                                                                                        |   |     |   |
| Item 1.           | Condensed Consolidated Financial  Statements                                                                                       |   |     |   |
|              | Condensed  Consolidated Balance Sheets as of September 30, 2006 and December 31,  2005 (unaudited)                       |   | 2        |   |
|              | Condensed  Consolidated Statements of Operations for the three and nine months ended  September 30, 2006 and 2005 (unaudited) |   | 3        |   |
|              | Condensed  Consolidated Statement of Stockholders’ Equity for the nine months ended  September 30, 2006 (unaudited)      |   | 4        |   |
|              | Condensed  Consolidated Statements of Cash Flows for the nine months ended September 30,  2006 and 2005 (unaudited)           |   | 5        |   |
|              | Notes  to the Condensed Consolidated Financial Statements                                                                          |   | 6        |   |
| Item 2.           | Management’s Discussion and  Analysis of Financial Condition and Results of Operations                                        |   | 18       |   |
| Item 3.           | Quantitative and Qualitative  Disclosures about Market Risk                                                                        |   | 32       |   |
| Item 4.           | Controls and Procedures                                                                                                            |   | 32       |   |
| ** **        | **PART II—OTHER INFORMATION**                                                                                            |   |     |   |
| Item 1.           | Legal Proceedings                                                                                                                  |   | 33       |   |
| Item 1A.          | Risk Factors                                                                                                                       |   | 33       |   |
| Item 2.           | Unregistered Sales of Equity  Securities and Use of Proceeds                                                                       |   | 33       |   |
| Item 3.           | Defaults Upon Senior  Securities                                                                                                   |   | 33       |   |
| Item 4.           | Submission of Matters to a  Vote of Security Holders                                                                               |   | 33       |   |
| Item 5.           | Other Information                                                                                                                  |   | 33       |   |
| Item 6.           | Exhibits                                                                                                                           |   | 33       |   |
| SIGNATURES        |                                                                                                                               | 34     |     |
| INDEX TO EXHIBITS |                                                                                                                               | 35     |     |

 

1

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**PART I—FINANCIALINFORMATION**

**Item 1.**                        *Financial Statements*

**REDDY ICE HOLDINGS, INC. AND SUBSIDIARYCONDENSED CONSOLIDATED BALANCE SHEETS(Unaudited)**

| ** **                                                                                                                                                                                      | ** ** | **September 30,**              | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                      | ** ** | **2006**                            | ** ** | **2005**              | ** ** |
| ** **                                                                                                                                                                                      | ** ** | **(in thousands,**             | ** ** |
| ** **                                                                                                                                                                                      | ** ** | **except share amounts)** | ** ** |
| ***ASSETS***                                                                                                                                                                                    |       |                                |       |                  |       |   |   |   |   |
| CURRENT ASSETS:                                                                                                                                                                                 |       |                                |       |                  |       |   |   |   |   |
| Cash and cash equivalents                                                                                                                                                                       |       |                                | $          | 34,345                |       |   |   | $ | 33,997 |   |   |
| Accounts receivable, net                                                                                                                                                                        |       |                                | 39,689     |                  |       |   | 23,376 |   |   |
| Inventories                                                                                                                                                                                     |       |                                | 11,766     |                  |       |   | 10,087 |   |   |
| Prepaid expenses and other current assets                                                                                                                                                       |       |                                | 3,202      |                  |       |   | 2,356 |   |   |
| Deferred tax assets                                                                                                                                                                             |       |                                | 2,091      |                  |       |   | 2,740 |   |   |
| Total current assets                                                                                                                                                                            |       |                                | 91,093     |                  |       |   | 72,556 |   |   |
| PROPERTY AND  EQUIPMENT, net                                                                                                                                                                    |       |                                | 234,466    |                  |       |   | 231,816 |   |   |
| GOODWILL                                                                                                                                                                                        |       |                                | 216,202    |                  |       |   | 214,968 |   |   |
| OTHER  INTANGIBLES, net                                                                                                                                                                         |       |                                | 81,439     |                  |       |   | 82,345 |   |   |
| OTHER ASSETS                                                                                                                                                                                    |       |                                | 2,762      |                  |       |   | 2,079 |   |   |
| TOTAL                                                                                                                                                                                           |       |                                | $          | 625,962               |       |   |   | $ | 603,764 |   |   |
| ***LIABILITIES  AND STOCKHOLDERS’ EQUITY***                                                                                                                                                |       |                                |       |                  |       |   |   |   |   |
| CURRENT LIABILITIES:                                                                                                                                                                            |       |                                |       |                  |       |   |   |   |   |
| Current portion of long-term obligations                                                                                                                                                        |       |                                | $          | 55                    |       |   |   | $ | 65 |   |   |
| Revolving credit facility                                                                                                                                                                       |       |                                | —     |                  |       |   | — |   |   |
| Accounts payable                                                                                                                                                                                |       |                                | 15,271     |                  |       |   | 12,962 |   |   |
| Accrued expenses                                                                                                                                                                                |       |                                | 20,828     |                  |       |   | 18,150 |   |   |
| Dividends payable                                                                                                                                                                               |       |                                | 8,828      |                  |       |   | 8,296 |   |   |
| Total current liabilities                                                                                                                                                                       |       |                                | 44,982     |                  |       |   | 39,473 |   |   |
| LONG-TERM  OBLIGATIONS                                                                                                                                                                          |       |                                | 361,687    |                  |       |   | 352,895 |   |   |
| DEFERRED TAX  LIABILITIES, net                                                                                                                                                                  |       |                                | 39,010     |                  |       |   | 28,213 |   |   |
| COMMITMENTS AND  CONTINGENCIES (Note 10)                                                                                                                                                        |       |                                | —     |                  |       |   | — |   |   |
| STOCKHOLDERS’  EQUITY:                                                                                                                                                                     |       |                                |       |                  |       |   |   |   |   |
| Common stock: $0.01 par value; 75,000,000 shares  authorized; 21,809,395 and 21,690,042 shares issued and outstanding at  September 30, 2006 and December 31, 2005, respectively |       |                                | 218        |                  |       |   | 217 |   |   |
| Additional paid-in capital                                                                                                                                                                      |       |                                | 215,734    |                  |       |   | 213,096 |   |   |
| Unearned compensation                                                                                                                                                                           |       |                                | —     |                  |       |   | (52 | ) |   |
| Accumulated deficit                                                                                                                                                                             |       |                                | (38,278    | )                     |       |   | (32,065 | ) |   |
| Accumulated other comprehensive income                                                                                                                                                          |       |                                | 2,609      |                  |       |   | 1,987 |   |   |
| Total stockholders’ equity                                                                                                                                                                 |       |                                | 180,283    |                  |       |   | 183,183 |   |   |
| TOTAL                                                                                                                                                                                           |       |                                | $          | 625,962               |       |   |   | $ | 603,764 |   |   |

 

See notes to condensed consolidated financial statements.

2

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**REDDY ICE HOLDINGS, INC. AND SUBSIDIARYCONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS(Unaudited)**

| ** **                                                                       | ** ** | **Three Months Ended  September 30,**                  | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                       | ** ** | **2006**                                                              | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                       | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Revenues                                                                         |       | $                                                                     | 126,063    |                                                | $          | 126,562 |   | $ | 284,447 |   | $ | 258,929 |   |
| Cost of sales  (excluding depreciation)                                          |       | 72,414                                                                |       | 69,073                                              |       | 170,971 |   | 153,851 |   |
| Depreciation  expense related to cost of sales                                   |       | 4,818                                                                 |       | 4,716                                               |       | 14,479 |   | 14,191 |   |
| Gross profit                                                                     |       | 48,831                                                                |       | 52,773                                              |       | 98,997 |   | 90,887 |   |
| Operating expenses                                                               |       | 12,346                                                                |       | 13,111                                              |       | 37,533 |   | 31,245 |   |
| Depreciation and  amortization expense                                           |       | 1,504                                                                 |       | 1,413                                               |       | 4,403 |   | 4,280 |   |
| Loss on  dispositions of assets                                                  |       | 16                                                                    |       | 804                                                 |       | 131 |   | 991 |   |
| Impairment of  assets                                                            |       | 3,348                                                                 |       | —                                              |       | 3,718 |   | 5,725 |   |
| Management  agreement termination fees and transaction bonuses and expenses |       | —                                                                |       | 6,171                                               |       | — |   | 6,171 |   |
| Income from  operations                                                          |       | 31,617                                                                |       | 31,274                                              |       | 53,212 |   | 42,475 |   |
| Loss on  extinguishment of debt                                                  |       | —                                                                |       | 28,189                                              |       | — |   | 28,189 |   |
| Interest expense                                                                 |       | 7,304                                                                 |       | 8,389                                               |       | 21,636 |   | 27,526 |   |
| Income (loss)  before income taxes                                               |       | 24,313                                                                |       | (5,304                                              | )          | 31,576 |   | (13,240 | ) |
| Income tax  benefit (expense)                                                    |       | (9,241                                                                | )          | 2,211                                               |       | (12,030 | ) | 5,362 |   |
| Net income (loss)                                                                |       | $                                                                     | 15,072     |                                                | $          | (3,093 | ) | $ | 19,546 |   | $ | (7,878 | ) |
| Basic net income  (loss) per share:                                              |       |                                                                  |       |                                                |       |   |   |   |   |
| Net income (loss)                                                                |       | $                                                                     | 0.70       |                                                | $          | (0.17 | ) | $ | 0.92 |   | $ | (0.52 | ) |
| Weighted average common shares outstanding                                       |       | 21,454                                                                |       | 18,054                                              |       | 21,331 |   | 15,254 |   |
| Diluted net  income (loss) per share:                                            |       |                                                                  |       |                                                |       |   |   |   |   |
| Net income (loss)                                                                |       | $                                                                     | 0.69       |                                                | $          | (0.17 | ) | $ | 0.90 |   | $ | (0.52 | ) |
| Weighted average common shares outstanding                                       |       | 21,774                                                                |       | 18,054                                              |       | 21,684 |   | 15,254 |   |
| Cash dividends  declared per share                                               |       | $                                                                     | 0.40000    |                                                | $          | 0.20788 |   | $ | 1.18250 |   | $ | 0.20788 |   |

 

See notes to condensed consolidated financial statements.

3

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

| ** **                                                                            | ** ** | **Common Stock**   | ** ** | ** **     | ** ** | ** **                       | ** ** | ** **                 | ** ** | **Accumulated**          | ** ** | ** **                       | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------------|------------|----------------|------------|----------------------------------|------------|----------------------------|------------|--------------------------|------------|----------------------------------|------------|
| ** **                                                                            | ** ** | **Number  of  Shares**  | ** ** | **Par  Value** | ** ** | **Additional  Paid-In  Capital** | ** ** | **Unearned  Compensation** | ** ** | **Accumulated  Deficit** | ** ** | **Other  Comprehensive  Income** | ** ** | **Total** | ** ** |
| ** **                                                                            | ** ** | **(in thousands)** | ** ** |
| Balance at January 1, 2006                                                       |       |                    | 21,690     |           |       | $                                | 217        |                       |       | $                        | 213,096    |                             |       |   | $ | (52 | ) |   |   | $ | (32,065 | ) |   |   | $ | 1,987 |   |   | $ | 183,183 |   |
| Reclassification of unearned compensation upon  adoption of SFAS No. 123(R) |       |                    | —     |           |       | —                           |       |                       | (52        | )                        |       |                             | 52         |   |   |   | — |   |   |   | — |   |   | — |   |
| Compensation expense related to stock-based awards                                    |       |                    | —     |           |       | —                           |       |                       | 3,726      |                     |       |                             | —     |   |   |   | — |   |   |   | — |   |   | 3,726 |   |
| Cash dividends declared                                                               |       |                    | —     |           |       | —                           |       |                       | —     |                     |       |                             | —     |   |   |   | (25,759 | ) |   |   | — |   |   | (25,759 | ) |
| Repurchase and retirement of common stock                                             |       |                    | (53        | )              |       | (1                               | )          |                       | (1,034     | )                        |       |                             | —     |   |   |   | — |   |   |   | — |   |   | (1,035 | ) |
| Vesting of restricted stock units                                                     |       |                    | 172        |           |       | 2                                |       |                       | (2         | )                        |       |                             | —     |   |   |   | — |   |   |   | — |   |   | — |   |
| Comprehensive income:                                                                 |       |                    |       |           |       |                             |       |                       |       |                     |       |                             |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income                                                                            |       |                    | —     |           |       | —                           |       |                       | —     |                     |       |                             | —     |   |   |   | 19,546 |   |   |   | — |   |   | 19,546 |   |
| Change in fair  value of derivative                                                   |       |                    | —     |           |       | —                           |       |                       | —     |                     |       |                             | —     |   |   |   | — |   |   |   | 622 |   |   | 622 |   |
| Total  comprehensive income                                                           |       |                    |       |           |       |                             |       |                       |       |                     |       |                             |       |   |   |   |   |   |   |   |   |   |   | 20,168 |   |
| Balance at  September 30, 2006                                                   |       |                    | 21,809     |           |       | $                                | 218        |                       |       | $                        | 215,734    |                             |       |   | $ | — |   |   |   | $ | (38,278 | ) |   |   | $ | 2,609 |   |   | $ | 180,283 |   |

 

See notes to condensed consolidated financial statements.

4

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**REDDY ICE HOLDINGS, INC. AND SUBSIDIARYCONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)**

| ** **                                                                                | ** ** | **Nine Months Ended** | ** ** |
|-------------------------------------------------------------------------------------------|------------|---------------------------------|------------|
| ** **                                                                                | ** ** | **September 30,**          | ** ** |
| ** **                                                                                | ** ** | **2006**                        | ** ** | **2005** | ** ** |
| ** **                                                                                | ** ** | **(in thousands)**         | ** ** |
| CASH FLOWS FROM OPERATING ACTIVITIES:                                                     |       |                            |       |   |   |
| Net income (loss)                                                                         |       | $                               | 19,546     |   | $ | (7,878 | ) |
| Adjustments to reconcile net income (loss) to net  cash provided by operating activities: |       |                            |       |   |   |
| Depreciation and  amortization                                                            |       | 18,882                          |       | 18,471 |   |
| Amortization of debt  issue costs and debt discounts                                      |       | 10,066                          |       | 10,141 |   |
| Loss on dispositions of  assets                                                           |       | 131                             |       | 991 |   |
| Impairment of assets                                                                      |       | 3,718                           |       | 5,725 |   |
| Stock-based compensation  expense                                                         |       | 3,726                           |       | 1,822 |   |
| Deferred taxes                                                                            |       | 11,264                          |       | (5,362 | ) |
| Loss on extinguishment of  debt                                                           |       | —                          |       | 28,189 |   |
| Change in assets and liabilities, net of the effects  of acquisitions:                    |       |                            |       |   |   |
| Accounts receivable,  inventory and prepaid expenses                                      |       | (18,650                         | )          | (24,685 | ) |
| Accounts payable, accrued  expenses and other                                             |       | 5,465                           |       | 4,933 |   |
| Net cash provided by  operating activities                                                |       | 54,148                          |       | 32,347 |   |
| CASH FLOWS FROM INVESTING ACTIVITIES:                                                     |       |                            |       |   |   |
| Property and equipment  additions                                                         |       | (15,262                         | )          | (15,749 | ) |
| Proceeds from  dispositions of property and equipment                                     |       | 703                             |       | 1,936 |   |
| Cost of acquisitions                                                                      |       | (12,788                         | )          | (929 | ) |
| Cost of purchases of  leased assets                                                       |       | —                          |       | (2,473 | ) |
| Net cash used in  investing activities                                                    |       | (27,347                         | )          | (17,215 | ) |
| CASH FLOWS FROM FINANCING ACTIVITIES:                                                     |       |                            |       |   |   |
| Proceeds from the  exercise of employee stock options                                     |       | —                          |       | 1,799 |   |
| Proceeds from the  issuance of common stock, net of issuance costs                        |       | —                          |       | 116,196 |   |
| Proceeds from the  issuance of debt                                                       |       | —                          |       | 240,000 |   |
| Deferred debt costs                                                                       |       | —                          |       | (5,264 | ) |
| Repurchase and retirement  of common stock                                                |       | (1,035                          | )          | — |   |
| Cash dividends paid                                                                       |       | (25,227                         | )          | — |   |
| Repayments under the  credit facility, net                                                |       | —                          |       | (5,450 | ) |
| Repayment of long-term  obligations                                                       |       | (191                            | )          | (348,124 | ) |
| Net cash used in  financing activities                                                    |       | (26,453                         | )          | (843 | ) |
| NET INCREASE IN CASH AND  CASH EQUIVALENTS                                                |       | 348                             |       | 14,289 |   |
| CASH AND CASH  EQUIVALENTS, BEGINNING OF PERIOD                                           |       | 33,997                          |       | 4,478 |   |
| CASH AND CASH  EQUIVALENTS, END OF PERIOD                                                 |       | $                               | 34,345     |   | $ | 18,767 |   |
| SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:                                         |       |                            |       |   |   |
| Cash payments for  interest                                                               |       | $                               | 11,510     |   | $ | 22,053 |   |
| Borrowings under the  credit facility                                                     |       | $                               | 45,905     |   | $ | 75,900 |   |
| Repayments on the credit  facility                                                        |       | $                               | (45,905    | ) | $ | (81,350 | ) |
| Cash dividends declared,  not paid                                                        |       | $                               | 8,828      |   | $ | 4,507 |   |
| Increase in fair value of  derivative                                                     |       | $                               | 622        |   | $ | 629 |   |
| Additions to property and  equipment included in accounts payable                         |       | $                               | 282        |   | $ | — |   |
| Conversion of accounts  receivable to notes payable                                       |       | $                               | 120        |   | $ | — |   |
| Issuances of notes payable                                                                |       | $                               | —     |   | $ | 88 |   |

 

See notes to condensed consolidated financial statements.

5

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

**1.**                 General

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

Reddy Ice Holdings, Inc., a Delaware corporation(“Reddy Holdings”), and its wholly owned subsidiary, Cube Acquisition Corp. (“Cube”),a Texas corporation, were formed on behalf of Trimaran Fund Management LLC (“Trimaran”)and Bear Stearns Merchant Banking (“Bear Stearns”) on May 8, 2003 forthe purpose of acquiring Packaged Ice, Inc. (“Packaged Ice”) and effectingcertain capital transactions in connection with such acquisition. On August 15,2003, Cube merged with and into Packaged Ice, with Packaged Ice being thesurviving corporation. As a result of the merger, Packaged Ice was delistedfrom the American Stock Exchange. Reddy Holdings and Cube conducted nooperations during the period from May 8, 2003 through August 14,2003. In connection with the merger, Packaged Ice was renamed Reddy Ice Group, Inc.(“Reddy Group”). Reddy Holdings and its wholly owned subsidiary, Reddy Group,are referred to collectively herein as the “Company”.

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

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

On August 2, 2005, the Company effected a 138 for1 stock split and, in conjunction therewith, amended and restated the Company’scertificate of incorporation to increase the number of authorized shares of theCompany’s common stock and preferred stock. All common share and per commonshare amounts in these condensed consolidated financial statements prior to August 2,2005 have been retroactively adjusted for all periods presented to give effectto the stock split.

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

6

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

November 15, 2007. TheCompany is currently evaluating the impact that this standard may have on itsresults of operations and financial position.

In September 2005,the SEC issued Staff Accounting Bulletin (“SAB”) No. 108. SAB 108 providesguidance on the consideration of the effects of prior year misstatements inquantifying current year misstatements. SAB 108 is effective for fiscal yearsbeginning after November 15, 2006. The Company is currentlyevaluating the impact that this standard may have on its results of operationsand financial position.

**2.**                 Acquisitions

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

| Total assets  acquired     |   | $   | 5.0    |   |
|----------------------------|--------|-----|--------|--------|
| Total liabilities  assumed |   | 0.3 |   |
| Net assets acquired        |   | $   | 4.7    |   |

 

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

During 2005, the Company purchased two ice companiesfor total acquisition consideration of $0.9 million. The results ofoperations of the 2005 and 2006 acquisitions are included in the Company’sconsolidated results of operations from the date of each acquisition, whichoccurred on August 1, 2005 and September 30, 2005 and on variousdates throughout 2006.

Thefollowing unaudited pro forma information presents the Company’s consolidatedresults of operations (i) for the three months and nine months ended September 30,2006 as if the 2006 acquisitions had all occurred on January 1, 2006 and (ii) forthe three months and nine months ended September 30, 2005 as if the2006 and 2005 acquisitions had all occurred on January 1, 2005:

| ** **                   | ** ** | **Three Months Ended** | ** ** | **Nine Months Ended** | ** ** |
|------------------------------|------------|----------------------------------|------------|---------------------------------|------------|
| ** **                   | ** ** | **September 30,**           | ** ** | **September 30,**          | ** ** |
| ** **                   | ** ** | **2006**                         | ** ** | **2005**                        | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                   | ** ** | **(in thousands)**          | ** ** |
| Pro forma  revenues          |       | $                                | 126,261    |                            | $          | 129,789 |   | $ | 287,142 |   | $ | 265,708 |   |
| Pro forma net income  (loss) |       | 15,081                           |       | (2,667                          | )          | 19,690 |   | (6,895 | ) |
|                              |            |                                  |            |                                 |            |  |  |  |  |  |  |  |  |

 

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

7

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

**3.**                 Inventories

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

| ** **                  | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
|-----------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                  | ** ** | **2006**                | ** ** | **2005**              | ** ** |
| ** **                  | ** ** | **(in thousands)** | ** ** |
| Raw materials and  supplies |       |                    | $          | 9,536                 |       |   |   | $ | 7,801 |   |   |
| Finished goods              |       |                    | 2,230      |                  |       |   | 2,286 |   |   |
| Total                       |       |                    | $          | 11,766                |       |   |   | $ | 10,087 |   |   |

 

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

**4.**                 Accrued Expenses

| ** **                                                                                                     | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                                                                                     | ** ** | **2006**                | ** ** | **2005**              | ** ** |
| ** **                                                                                                     | ** ** | **(in thousands)** | ** ** |
| Accrued compensation and  employee benefits, including payroll taxes and workers’ compensation  insurance |       |                    | $          | 8,901                 |       |   |   | $ | 9,758 |   |   |
| Accrued interest                                                                                               |       |                    | 3,918      |                  |       |   | 3,329 |   |   |
| Accrued property, sales  and other taxes                                                                       |       |                    | 2,856      |                  |       |   | 539 |   |   |
| Accrued utilities                                                                                              |       |                    | 2,328      |                  |       |   | 1,425 |   |   |
| Other accrued insurance                                                                                        |       |                    | 1,654      |                  |       |   | 1,940 |   |   |
| Other                                                                                                          |       |                    | 1,171      |                  |       |   | 1,159 |   |   |
| Total                                                                                                          |       |                    | $          | 20,828                |       |   |   | $ | 18,150 |   |   |

 

**5.**                 Revolving CreditFacility and Long-Term Obligations

*10**1**¤**2% SeniorDiscount Notes.**  *OnOctober 27, 2004, Reddy Holdings issued $151 million at maturity of 10*1**¤**2**%*Senior Discount Notes due 2012 (the “Discount Notes”) in a private placementoffering. Each Discount Note had an initial accreted value of $663.33 per$1,000 principal amount at maturity. The accreted value of each Discount Notewill increase from the date of issuance until November 1, 2008 at a rateof 101¤2%per annum such that the accreted value will equal the stated principal amountat maturity on November 1, 2008. Thereafter, cash interest will accrue andbe payable semi-annually at a rate of 101¤2% per annum.

The Discount Notesare unsecured obligations of Reddy Holdings and are:

·       not guaranteed by any ofReddy Holdings’ subsidiaries;

8

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

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

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

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

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

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

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

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

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

*8**7**¤**8% SeniorSubordinated Notes.**  *OnJuly 17, 2003, Cube completed the sale of $152 million of 8*7**¤**8**%* Senior Subordinated Notes due August 1,2011 (the “Subordinated Notes”) in connection with a private placementoffering. The Subordinated Notes were priced at 99.297%, which resulted in grossproceeds of $150.9 million. At the closing of the merger on August 15,2003 (see Note 1), Reddy Group assumed Cube’s obligations under theSubordinated Notes and the related indenture and received the net proceeds 

9

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

of the offering. Inconnection with the closing of Reddy Holdings’ initial public offering of itscommon stock, substantially all the outstanding Subordinated Notes wereredeemed (see discussion below in “Senior Credit Facility” for furtherinformation).

*SeniorCredit Facility.**  *OnAugust 15, 2003, Reddy Group entered into a $170 million senior securedcredit facility with the lenders being a syndicate of banks, financialinstitutions and other entities (the “Old Credit Facility”). The Old CreditFacility provided for a six-year term loan in the amount of $135 millionand a five-year revolving credit in the amount of $35 million. On November 6,2003, the Old Credit Facility was amended to increase the size of the term loanby $45 million.

On August 12, 2005, Reddy Group amended andrestated its credit facility with a syndicate of banks, financial institutionsand other entities as lenders, including Credit Suisse First Boston, asAdministrative Agent, Canadian Imperial Bank of Commerce, Bear StearnsCorporate Lending, Inc. and Lehman Brothers, Inc. (the “CreditFacility”), to increase the maximum amount of the revolving credit facility to$60 million (the “Revolving Credit Facility”), provide for a $240 million termloan (the “Term Loan”), reduce the applicable margins on both the RevolvingCredit Facility and Term Loan and extend the maturity of the Revolving CreditFacility to August 12, 2010 and the Term Loan to August 12, 2012.Borrowings under the Revolving Credit Facility and the Term Loan, along withproceeds from the Company’s initial public offering (see Note 6), were used torepay the Old Credit Facility, repurchase substantially all of the Company’sexisting Subordinated Notes and fund other related transactions. A loss onextinguishment of debt of $28.1 million was incurred in connection with thesetransactions. The loss was due to the payment of tender premiums and consentfees to the holders of the Subordinated Notes ($17.3 million), thewrite-off of deferred debt costs and original issue discount related to theSubordinated Notes and the Old Credit Facility ($10.6 million) and other feesand expenses ($0.2 million).

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

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

The Revolving Credit Facility and Term Loan do notrequire any scheduled principal payments prior to their stated maturity dates.Subject to certain conditions, mandatory repayments of the Revolving CreditFacility and Term Loan (and if the Term Loan is no longer outstanding,mandatory commitment reductions of the Revolving Credit Facility) are requiredto be made with portions of the proceeds from (1) asset sales, (2) theissuance of debt securities and (3) insurance and condemnation awards,subject to various exceptions. In the event of a change in control, as definedin the Credit Facility, an event of default will occur under the CreditFacility. Under the Credit Facility, Reddy Group may only pay dividends toReddy Holdings if Reddy Group’s leverage ratio for the most recently endedfiscal quarter is less than or equal to 3.75 to 1.0. In addition, the CreditFacility precludes Reddy Group from declaring any dividends if 

10

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

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

The Credit Facility contains financial covenants,which include the maintenance of certain financial ratios, as defined in theCredit Facility, and is collateralized by substantially all of Reddy Group’sassets and the capital stock of all of its subsidiaries. Reddy Holdingsguarantees the Credit Facility and such guarantee is secured by the capitalstock of Reddy Group. At September 30, 2006, Reddy Group was in compliancewith these covenants.

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

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

| ** **                                                             | ** ** | **September 30,**  | ** ** | **December 31,** | ** ** |
|------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------|------------|
| ** **                                                             | ** ** | **2006**                | ** ** | **2005**              | ** ** |
| ** **                                                             | ** ** | **(in thousands)** | ** ** |
| Credit facility—Term  Loan                                        |       |                    | $          | 240,000               |       |   |   | $ | 240,000 |   |   |
| 101¤2%  Senior Discount Notes                                     |       |                    | 150,500    |                  |       |   | 150,500 |   |   |
| Less: Unamortized debt  discount on 101¤2%  Senior Discount Notes |       |                    | (28,873    | )                     |       |   | (37,846 | ) |   |
| Other                                                                  |       |                    | 115        |                  |       |   | 306 |   |   |
| Total long-term  obligations                                           |       |                    | 361,742    |                  |       |   | 352,960 |   |   |
| Less: Current maturities                                               |       |                    | 55         |                  |       |   | 65 |   |   |
| Long-term obligations, net                                             |       |                    | $          | 361,687               |       |   |   | $ | 352,895 |   |   |

 

**6.      Capital Stock**

*CommonStock.**  *ReddyHoldings is authorized to issue up to 75,000,000 shares of common stock, parvalue $0.01 per share. Holders of Reddy Holdings’ common stock are entitled toone vote per share on all matters to be voted on by stockholders and areentitled to receive dividends, if any, as may be declared from time to time bythe Board of Directors of Reddy Holdings. Upon any liquidation or dissolutionof Reddy Holdings, the holders of common stock are entitled, subject to anypreferential rights of the holders of preferred stock, to receive a pro ratashare of all of the assets remaining available for distribution to stockholdersafter payment of all liabilities.

11

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

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

On March 17, 2005,certain employees exercised stock options granted under the 2003 Stock OptionPlan to purchase 248,198 shares of Reddy Holdings’ common stock for anaggregate purchase price of approximately $1.8 million. On August 8,2005, Reddy Holdings amended the 2003 Stock Option Plan to accelerate theschedule for vesting of time-based options, immediately vest all outstandingperformance-based options, allow unvested options to be exercised forrestricted stock with identical vesting schedules and provide for acceleratedvesting of options upon the termination of an option holder’s employment undercertain circumstances. During the three months ended September 30, 2005, acharge of $0.5 million was recorded in “Operating Expenses” in the consolidatedstatements of operations in connection with the acceleration of vestingschedules.

On August 12, 2005,certain employees and directors performed a cashless exercise of stock optionsgranted under the 2003 Stock Option Plan, which resulted in the issuance of808,818 shares of common stock, 465,651 of which were restricted shares. Inaccordance with the 2003 Stock Option Plan, as amended, restricted shares veston the following schedule: 40% on February 28, 2006, 40% on January 16,2007 and 20% on July 1, 2007. In connection with the scheduledvesting on February 28, 2006, the Company purchased and retired 51,256shares of common stock from employees for $1.0 million to provide the employeeswith funds to satisfy their minimum statutory federal and state tax withholdingobligations related to the vesting of their restricted stock on that date. Thepurchase price was $20.20 per share, the closing market price on February 28,2006.

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

| ** **                | ** ** | ** **              | ** ** | **Dividend**          | ** ** | **Dividend**          | ** ** | **Total**          | ** ** |
|---------------------------|------------|-------------------------|------------|-----------------------|------------|-----------------------|------------|--------------------|------------|
| **Declaration Date** | ** ** | ** **              | ** ** | **Record Date**  | ** ** | **Payable Date** | ** ** | **Per share** | ** ** | **Dividend** | ** ** |
| August 11, 2005      |       | September 30, 2005 |       | October 17, 2005 |       | $                     | 0.20788    |               | $          | 4.5 million |   |
| December 15, 2005    |       | December 30, 2005  |       | January 17, 2006 |       | $                     | 0.3825     |               | $          | 8.3 million |   |
| March 15, 2006       |       | March 31, 2006     |       | April 17, 2006   |       | $                     | 0.3825     |               | $          | 8.3 million |   |
| June 15, 2006        |       | June 30, 2006      |       | July 17, 2006    |       | $                     | 0.4000     |               | $          | 8.7 million |   |
| September 15, 2006   |       | September 29, 2006 |       | October 16, 2006 |       | $                     | 0.4000     |               | $          | 8.8 million |   |
|                           |            |                         |            |                       |            |                       |            |                    |            |  |  |  |  |

* *

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

**7.**                 Employee BenefitPlans

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

12

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

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

Generally, fifty percent of each award of RSUs (the “Time-vestedRSUs”) will vest in four equal annual installments beginning on August 12,2006 and continuing on August 12 of each of the following three years,provided the recipient remains employed with the Company through such vestingdates. The remaining fifty percent of each award of RSUs (the “Performance-vestedRSUs”) will vest in four equal annual installments beginning on August 12,2006 and continuing on August 12 of each of the following three years,provided the recipient remains employed with the Company through such vestingdates and the applicable performance condition for the applicable vestingperiod is met. The performance condition for each vesting period will be basedon the Company’s earned distributable cash per share (as defined in the relatedrestricted share unit agreement) for such vesting period. Each vesting periodwill begin on July 1 and end on June 30 of the subsequent year. AllRSUs will immediately vest in full, and shares will be distributed, at the timeof a Change in Control (as defined in the 2005 Equity Incentive Plan). If inany performance period the performance condition for a subsequent performanceperiod is achieved, Performance-vested RSUs will be entitled to dividendequivalent rights in the subsequent performance period equal to the dividendswhich would be payable on the shares of common stock represented by the RSUssubject to vesting in that period. Payments of such dividend equivalents willbe made in cash to the holders of RSUs at the time of actual dividend paymentsand will not be subject to vesting. Time-vested RSUs will not be entitled todividend equivalent rights. Based on the Company’s financial results for thevesting period ended June 30, 2006, the performance condition for thePerformance-vested RSUs eligible for vesting on August 12, 2006 was met. Atotal of 172,375 Time-vested RSUs and Performance-vested RSUs vested on August 12,2006. Furthermore, the performance targets for the remaining three vestingperiods were met as of June 30, 2006. Therefore, the holders of unvestedPerformance-based RSUs will be entitled to dividend equivalent payments for theperiod from July 1, 2006 to June 30, 2007.

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

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

13

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

the three monthsended September 30, 2006 and 2005 and $0.8 million during the nine monthsended September 30, 2006 and 2005, excluding the effect of theacceleration of vesting schedules discussed in Note 6. Such compensationexpense was recorded in “Operating Expenses” in the consolidated statements ofoperations.

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

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

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

**8.**                 EarningsPer Share

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

| ** **                                                                                   | ** ** | **Three Months Ended  September 30,**                  | ** ** | **Nine Months Ended  September 30,** | ** ** |
|----------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                                   | ** ** | **2006**                                                              | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                                   | ** ** | **(in thousands, except per share amounts)** | ** ** |
| Earnings (loss) for basic and diluted computation:                                           |       |                                                                  |       |                                                |       |   |   |   |   |
| Net income (loss)                                                                            |       | $                                                                     | 15,072     |                                                | $          | (3,093 | ) | $ | 19,546 |   | $ | (7,878 | ) |
| Basic earnings (loss) per share:                                                             |       |                                                                  |       |                                                |       |   |   |   |   |
| Weighted average common shares outstanding                                                   |       | 21,454                                                                |       | 18,054                                              |       | 21,331 |   | 15,254 |   |
| Net income (loss)                                                                            |       | $                                                                     | 0.70       |                                                | $          | (0.17 | ) | $ | 0.92 |   | $ | (0.52 | ) |
| Diluted earnings (loss) per share:                                                           |       |                                                                  |       |                                                |       |   |   |   |   |
| Weighted average common shares outstanding                                                   |       | 21,454                                                                |       | 18,054                                              |       | 21,331 |   | 15,254 |   |
| Shares issuable from assumed conversion of  restricted stock and restricted stock units |       | 320                                                                   |       | —                                              |       | 353 |   | — |   |
| Weighted average common shares outstanding, as  adjusted                                     |       | 21,774                                                                |       | 18,054                                              |       | 21,684 |   | 15,254 |   |
| Net income (loss)                                                                            |       | $                                                                     | 0.69       |                                                | $          | (0.17 | ) | $ | 0.90 |   | $ | (0.52 | ) |

 

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

**9.**                 Income Taxes

The Company’s effective tax rate differs from thefederal statutory income tax rate of 35% due to state income taxes and theeffect of permanent differences, primarily the non-deductible portion of theinterest expense recognized on the 101⁄2% Senior Discount Notes. The effectiverate for the three and nine months ended September 30, 2006 includes theeffect of the recent Texas corporatetax legislation, enacted on May 18, 2006, which changes the existing Texasfranchise tax from a tax based on net income or taxable capital to an incometax based on a defined calculation of gross margin (the “Margin Tax”). Theeffective date of the new legislation is January 1, 2008, which means thatthe Company will file its first Margin Tax return on May 15, 2008 based onits 2007 results.

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

In June 2006, theFASB issued FASB Interpretation (“FIN”) No. 48, “Accounting forUncertainty in Income Taxes”. FIN 48 clarifies the accounting for uncertaintyin income taxes recognized in an entity’s financial statements in accordancewith SFAS No. 109, “Accounting for Income Taxes”. FIN 48 prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina return and also provides guidance on derecognition, classification, interestand penalties, accounting in interim periods, disclosure and transition. Thisinterpretation is effective for fiscal years beginning after December 15,2006. The Company is currently evaluating the impact that this standard mayhave on its results of operations and financial position.

**10.**          Commitmentsand Contingencies

The Company is involved invarious claims, lawsuits and proceedings arising in the ordinary course ofbusiness. There are uncertainties inherent in the ultimate outcome of suchmatters and it is impossible to presently determine the ultimate costs that maybe incurred. Management believes the resolution of such uncertainties and theincurrence of such costs will not have a material adverse effect on the Company’sconsolidated financial position, results of operations or cash flows.

**11.**          SegmentInformation

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

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

15

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

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

Segmentinformation for the three months ended September 30, 2006 and 2005 was asfollows:

| ** **                               | ** ** | **Three Months Ended  September 30, 2006** | ** ** | **Three Months Ended  September 30, 2005** | ** ** |
|------------------------------------------|------------|----------------------------------------------------------------|------------|----------------------------------------------------------------|------------|
| ** **                               | ** ** | **Ice**                                                        | ** ** | **Non-Ice**                                                    | ** ** | **Total** | ** ** | **Ice** | ** ** | **Non-Ice** | ** ** | **Total** | ** ** |
| ** **                               | ** ** | **(in thousands)**                                        | ** ** |
| Revenues                                 |       |                                                           | $          | 122,923                                                        |       |   | $ | 3,140 |   | $ | 126,063 |   | $ | 122,314 |   | $ | 4,248 |   | $ | 126,562 |   |
| Cost of sales  (excluding  depreciation) |       |                                                           | 70,196     |                                                           |       | 2,218 |   | 72,414 |   | 66,303 |   | 2,770 |   | 69,073 |   |
| Operating  expenses                      |       |                                                           | 11,933     |                                                           |       | 413 |   | 12,346 |   | 12,581 |   | 530 |   | 13,111 |   |
| Segment EBITDA                           |       |                                                           | $          | 40,794                                                         |       |   | $ | 509 |   | $ | 41,303 |   | $ | 43,430 |   | $ | 948 |   | $ | 44,378 |   |
| Total assets                             |       |                                                           | $          | 605,187                                                        |       |   | $ | 20,775 |   | $ | 625,962 |   | $ | 588,355 |   | $ | 25,390 |   | $ | 613,745 |   |

 

Segmentinformation for the nine months ended September 30, 2006 and 2005 was asfollows:

| ** **                              | ** ** | **Nine Months Ended  September 30, 2006** | ** ** | **Nine Months Ended  September 30, 2005** | ** ** |
|-----------------------------------------|------------|---------------------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                              | ** ** | **Ice**                                                       | ** ** | **Non-Ice**                                                   | ** ** | **Total** | ** ** | **Ice** | ** ** | **Non-Ice** | ** ** | **Total** | ** ** |
| ** **                              | ** ** | **(in thousands)**                                       | ** ** |
| Revenues                                |       | $                                                             | 274,509    |                                                          | $          | 9,938 |   | $ | 284,447 |   | $ | 247,890 |   | $ | 11,039 |   | $ | 258,929 |   |
| Cost of sales  (excluding depreciation) |       | 164,465                                                       |       | 6,506                                                         |       | 170,971 |   | 146,675 |   | 7,176 |   | 153,851 |   |
| Operating  expenses                     |       | 36,213                                                        |       | 1,320                                                         |       | 37,533 |   | 29,745 |   | 1,500 |   | 31,245 |   |
| Segment EBITDA                          |       | $                                                             | 73,831     |                                                          | $          | 2,112 |   | $ | 75,943 |   | $ | 71,470 |   | $ | 2,363 |   | $ | 73,833 |   |
| Total assets                            |       | $                                                             | 605,187    |                                                          | $          | 20,775 |   | $ | 625,962 |   | $ | 588,355 |   | $ | 25,390 |   | $ | 613,745 |   |

 

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

| ** **                                                                  | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|-----------------------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                                                  | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                                                  | ** ** | **(in thousands)**                              | ** ** |
| Total Segment EBITDA                                                        |       | $                                                    | 41,303     |                                                | $          | 44,378 |   | $ | 75,943 |   | $ | 73,833 |   |
| Depreciation expense related to cost of sales                               |       | (4,818                                               | )          | (4,716                                              | )          | (14,479 | ) | (14,191 | ) |
| Depreciation and amortization expense                                       |       | (1,504                                               | )          | (1,413                                              | )          | (4,403 | ) | (4,280 | ) |
| Loss on dispositions of assets                                              |       | (16                                                  | )          | (804                                                | )          | (131 | ) | (991 | ) |
| Impairment of assets                                                        |       | (3,348                                               | )          | —                                              |       | (3,718 | ) | (5,725 | ) |
| Management agreement termination fees and  transaction bonuses and expenses |       | —                                               |       | (6,171                                              | )          | — |   | (6,171 | ) |
| Loss on extinguishment of debt                                              |       | —                                               |       | (28,189                                             | )          | — |   | (28,189 | ) |
| Interest expense                                                            |       | (7,304                                               | )          | (8,389                                              | )          | (21,636 | ) | (27,526 | ) |
| Income tax benefit (expense)                                                |       | (9,241                                               | )          | 2,211                                               |       | (12,030 | ) | 5,362 |   |
| Net income (loss)                                                           |       | $                                                    | 15,072     |                                                | $          | (3,093 | ) | $ | 19,546 |   | $ | (7,878 | ) |

 

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

**12.**          Impairmentof Assets

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

 

17

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

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

**Uncertainty ofForward Looking Statements and Information**

Otherthan statements of historical facts, statements made in this Form 10-Q,statements made by us in periodic press releases, oral statements made by ourmanagement to analysts and stockholders and statements made in the course ofpresentations about our company constitute “forward-looking statements”intended to qualify for the safe harbor from liability established by thePrivate Securities Litigation Reform Act of 1995. We believe the expectationsreflected in such forward-looking statements are accurate. However, we cannotassure you that such expectations will occur. These forward-looking statementsinvolve known and unknown risks, uncertainties and other factors that may causeour actual results, performance or achievements to be materially different fromfuture results expressed or implied by the forward-looking statements. Factorsyou should consider that could cause these differences are:

·       generaleconomic trends and seasonality;

·       weatherconditions;

·       theability of our subsidiaries to make distributions to us in amounts sufficient tomake dividend payments to our stockholders in accordance with our dividendpolicy;

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

·       therestrictive covenants under our indebtedness;

·       theavailability of capital sources;

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

·       competitivepractices in the industry in which we compete;

·       changesin labor conditions;

·       ourcapital expenditure requirements;

·       therisks associated with acquisitions and the failure to integrate acquiredbusinesses;

·       technologicalchanges and innovations;

·       costsassociated with potential product liability claims or liabilities underenvironmental laws;

·       legislativeor regulatory requirements; and

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

You should not unduly relyon 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 anyrevisions to these forward-looking statements to reflect events orcircumstances occurring after the date of this report or to reflect theoccurrence of unanticipated events. Important factors that could cause ouractual results to differ materially from our expectations are discussedelsewhere in this report.

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**General**

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

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

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

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

***Seasonality.******  ***The packagedice business is highly seasonal, characterized by peak demand during the warmermonths of May through September, with an extended peak selling season inthe southern United States. Approximately 69%, 68% and 66% of our annualrevenues occurred during the second and third calendar quarters in each of2005, 2004 and 2003. Approximately 68% of our annual revenues also occurredduring the second and third calendar quarters of 2002, 2001 and 2000. Thehigher level of revenues in 2005 was primarily due to the effects of thehurricane season, which caused a significant increase in revenues during thethird quarter of 2005. The decrease in 2003 was primarily due to the timing ofour acquisitions, which occurred in the fourth quarter of that year. As aresult of seasonal revenue declines and a less than proportional decline inexpenses during the first and fourth quarters, we typically experience lowermargins resulting in losses during these periods. In addition, because ouroperating results depend significantly on revenues during our peak season, ourquarterly results of operations may fluctuate significantly as a result ofadverse weather during this peak selling period if the weather is unusuallycool or rainy on a national or regional basis.

***Revenues.******  ***Our revenuesprimarily represent sales of packaged ice, packaged ice bags for use in our IceFactory equipment, bottled water and cold storage services. There is no rightof return with respect to these products or services. A portion of our revenuesalso represents fees earned under management agreements for Ice Factorieslocated outside our primary territories that are recognized as earned undercontract terms.

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

·       manufacturing anddistribution labor costs;

·       raw materials (primarily ofpolyethylene-based plastic bags);

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

·       utility expenses (primarilyelectricity used in connection with the manufacturing, storage and distributionprocesses); and

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

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***DepreciationExpense Related to Cost of Sales and Depreciation and Amortization Expense.******  ***Depreciationand amortization are divided into two line items—depreciation expense relatedto cost of sales and depreciation and amortization expense. Depreciationexpense related to cost of sales consists of depreciation expense for ourproduction and distribution equipment. Depreciation and amortization expenseconsists of depreciation and amortization expense for our selling, general andadministrative functions.

***Operating Expenses.******  ***Our operatingexpenses are costs associated with selling, general and administrativefunctions. These costs include executive officers’ compensation, office andadministrative salaries, insurance, legal and other professional services andcosts associated with leasing office space. Labor costs, including associatedpayroll taxes and benefit costs but excluding non-cash stock-based compensationexpense, included in operating expenses represented approximately 7% ofrevenues in the nine months ended September 30, 2006 and 2005.

***Facilities.******  ***At September 30,2006, we owned or operated 60 ice manufacturing facilities, 57 distributioncenters, approximately 79,000 merchandisers (cold storage units installed atcustomer locations), approximately 3,000 Ice Factories, five refrigeratedwarehouses and one bottled water plant. As of the same date, we had anaggregate daily ice manufacturing capacity of approximately 17,000 tons.

**Three Months Ended September 30, 2006 Compared toThree Months Ended September 30, 2005**

| ** **                                                                  | ** ** | **Three Months Ended** | ** ** | ** **                               | ** ** | ** **  | ** ** |
|-----------------------------------------------------------------------------|------------|----------------------------------|------------|------------------------------------------|------------|-------------|------------|
| ** **                                                                  | ** ** | **September 30,**           | ** ** | **Change from Last Year** | ** ** |
| ** **                                                                  | ** ** | **2006**                         | ** ** | **2005**                                 | ** ** | **Dollars** | ** ** | **%** | ** ** |
| ** **                                                                  | ** ** | **(in thousands)**          | ** ** |
| ***Consolidated  Results***                                                 | ** ** | ** **                       | ** ** | ** **                               | ** ** | ** **  | ** ** | ** ** | ** ** |
| Revenues                                                                    |       | $                                | 126,063    |                                     | $          | 126,562     |       | $ | (499 | ) | (0.4 | ) |
| Cost of sales (excluding depreciation)                                      |       | 72,414                           |       | 69,073                                   |       | 3,341       |       | 4.8 |   |
| Depreciation expense related to cost of sales                               |       | 4,818                            |       | 4,716                                    |       | 102         |       | 2.2 |   |
| Gross profit                                                                |       | 48,831                           |       | 52,773                                   |       | (3,942      | )          | (7.5 | ) |
| Operating expenses                                                          |       | 12,346                           |       | 13,111                                   |       | (765        | )          | (5.8 | ) |
| Depreciation and amortization expense                                       |       | 1,504                            |       | 1,413                                    |       | 91          |       | 6.4 |   |
| Loss on dispositions of assets                                              |       | 16                               |       | 804                                      |       | (788        | )          | (98.0 | ) |
| Impairment of assets                                                        |       | 3,348                            |       | —                                   |       | 3,348       |       | — |   |
| Management agreement termination fees and  transaction bonuses and expenses |       | —                           |       | 6,171                                    |       | (6,171      | )          | (100.0 | ) |
| Income from operations                                                      |       | 31,617                           |       | 31,274                                   |       | 343         |       | 1.1 |   |
| Loss on extinguishment of debt                                              |       | —                           |       | 28,189                                   |       | (28,189     | )          | (100.0 | ) |
| Interest expense                                                            |       | 7,304                            |       | 8,389                                    |       | (1,085      | )          | (12.9 | ) |
| Income (loss) before income taxes                                           |       | 24,313                           |       | (5,304                                   | )          | 29,617      |       | 558.4 |   |
| Income tax benefit (expense)                                                |       | (9,241                           | )          | 2,211                                    |       | (11,452     | )          | (518.0 | ) |
| Net income (loss)                                                           |       | $                                | 15,072     |                                     | $          | (3,093      | )          | $ | 18,165 |   | 587.3 |   |
| ***Ice Operations:***                                                       |       |                             |       |                                     |       |        |       |   |   |
| Revenues                                                                    |       | $                                | 122,923    |                                     | $          | 122,314     |       | $ | 609 |   | 0.5 |   |
| Cost of sales (excluding depreciation)                                      |       | 70,196                           |       | 66,303                                   |       | 3,893       |       | 5.9 |   |
| Depreciation expense related to cost of sales                               |       | 4,569                            |       | 4,445                                    |       | 124         |       | 2.8 |   |
| Gross profit                                                                |       | 48,158                           |       | 51,566                                   |       | (3,408      | )          | (6.6 | ) |
| Operating expenses                                                          |       | 11,933                           |       | 12,581                                   |       | (648        | )          | (5.2 | ) |
| ***Non-Ice Operations:***                                                   |       |                             |       |                                     |       |        |       |   |   |
| Revenues                                                                    |       | $                                | 3,140      |                                     | $          | 4,248       |       | $ | (1,108 | ) | (26.1 | ) |
| Cost of sales (excluding depreciation)                                      |       | 2,218                            |       | 2,770                                    |       | (552        | )          | (19.9 | ) |
| Depreciation expense related to cost of sales                               |       | 249                              |       | 271                                      |       | (22         | )          | (8.1 | ) |
| Gross profit                                                                |       | 673                              |       | 1,207                                    |       | (534        | )          | (44.2 | ) |
| Operating expenses                                                          |       | 413                              |       | 530                                      |       | (117        | )          | (22.1 | ) |

* *

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*Revenues:**  *Revenues decreased $0.5 millionfrom the three months ended September 30, 2005 to the three months ended September 30,2006. This decrease is due to a $1.1 million reduction in the revenues of ournon-ice operations, driven primarily by the loss of the bottled water operation’slargest customer, partially offset by a $0.6 million increase in revenues inour ice operations. The increase in ice operations revenues is related tohigher average pricing and the effects of acquisitions completed during thelast half of 2005 and 2006 (approximately $2.0 million), offset by volumereductions related to significantly less favorable weather patterns in most ourmarkets in the month of September.

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

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

*DepreciationExpense Related to Cost of Sales:**  *Depreciation expense related tocost of sales increased  $0.1 million dueto additional depreciation expense associated with production and distributionequipment placed in service during 2005 and the first nine months of 2006,partially offset by the effect of asset dispositions and assets becoming fullydepreciated.

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

*Depreciationand Amortization:**  *Depreciationand amortization increased $0.1 million from the three months ended September 30,2005 to the three months ended September 30, 2006. This increase isprimarily due to additional amortization expense associated with the intangibleassets recorded in connection with the acquisitions completed during 2005 andthe nine months ended September 30, 2006.

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

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

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**Nine Months Ended September 30, 2006 Compared toNine Months Ended September 30, 2005**

| ** **                                                        | ** ** | **Nine Months Ended** | ** ** | ** **                               | ** ** |
|-------------------------------------------------------------------|------------|---------------------------------|------------|------------------------------------------|------------|
| ** **                                                        | ** ** | **September 30,**          | ** ** | **Change from Last Year** | ** ** |
| ** **                                                        | ** ** | **2006**                        | ** ** | **2005**                                 | ** ** | **   Dollars   ** | ** ** | **   %   ** | ** ** |
| ** **                                                        | ** ** | **(in thousands)**         | ** ** |
| ***Consolidated  Results***                                       | ** ** | ** **                      | ** ** | ** **                               | ** ** |   | ** ** | ** ** |   | ** ** | ** ** |
| Revenues                                                          |       | $                               | 284,447    |                                     | $          | 258,929 |   |   | $ | 25,518 |   |   | 9.9 |   |
| Cost of sales  (excluding depreciation)                           |       | 170,971                         |       | 153,851                                  |       |   | 17,120 |   |   | 11.1 |   |
| Depreciation  expense related to cost of sales                    |       | 14,479                          |       | 14,191                                   |       |   | 288 |   |   | 2.0 |   |
| Gross profit                                                      |       | 98,997                          |       | 90,887                                   |       |   | 8,110 |   |   | 8.9 |   |
| Operating  expenses                                               |       | 37,533                          |       | 31,245                                   |       |   | 6,288 |   |   | 20.1 |   |
| Depreciation and  amortization expense                            |       | 4,403                           |       | 4,280                                    |       |   | 123 |   |   | 2.9 |   |
| Loss on  dispositions of assets                                   |       | 131                             |       | 991                                      |       |   | (860 | ) |   | (86.8 | ) |
| Impairment of  assets                                             |       | 3,718                           |       | 5,725                                    |       |   | (2,007 | ) |   | (35.1 | ) |
| Management  termination fees and transaction bonuses and expenses |       | —                          |       | 6,171                                    |       |   | (6,171 | ) |   | (100.0 | ) |
| Income from  operations                                           |       | 53,212                          |       | 42,475                                   |       |   | 10,737 |   |   | 25.3 |   |
| Loss on  extinguishment of debt                                   |       | —                          |       | 28,189                                   |       |   | (28,189 | ) |   | (100.0 | ) |
| Interest expense                                                  |       | 21,636                          |       | 27,526                                   |       |   | (5,890 | ) |   | (21.4 | ) |
| Income (loss) before  income taxes                                |       | 31,576                          |       | (13,240                                  | )          |   | 44,816 |   |   | 338.5 |   |
| Income tax  benefit (expense)                                     |       | (12,030                         | )          | 5,362                                    |       |   | (17,392 | ) |   | (324.4 | ) |
| Net income (loss)                                                 |       | $                               | 19,546     |                                     | $          | (7,878 | ) |   | $ | 27,424 |   |   | 348.1 |   |
| ***Ice  Operations:***                                            |       |                            |       |                                     |       |   |   |   |   |   |   |
| Revenues                                                          |       | $                               | 274,509    |                                     | $          | 247,890 |   |   | $ | 26,619 |   |   | 10.7 |   |
| Cost of sales  (excluding depreciation)                           |       | 164,465                         |       | 146,675                                  |       |   | 17,790 |   |   | 12.1 |   |
| Depreciation  expense related to cost of sales                    |       | 13,742                          |       | 13,373                                   |       |   | 369 |   |   | 2.8 |   |
| Gross profit                                                      |       | 96,302                          |       | 87,842                                   |       |   | 8,460 |   |   | 9.6 |   |
| Operating  expenses                                               |       | 36,213                          |       | 29,745                                   |       |   | 6,468 |   |   | 21.7 |   |
| ***Non-Ice  Operations:***                                        |       |                            |       |                                     |       |   |   |   |   |   |   |
| Revenues                                                          |       | $                               | 9,938      |                                     | $          | 11,039 |   |   | $ | (1,101 | ) |   | (10.0 | ) |
| Cost of sales  (excluding depreciation)                           |       | 6,506                           |       | 7,176                                    |       |   | (670 | ) |   | (9.3 | ) |
| Depreciation  expense related to cost of sales                    |       | 737                             |       | 818                                      |       |   | (81 | ) |   | (9.9 | ) |
| Gross profit                                                      |       | 2,695                           |       | 3,045                                    |       |   | (350 | ) |   | (11.5 | ) |
| Operating expenses                                                |       | 1,320                           |       | 1,500                                    |       |   | (180 | ) |   | (12.0 | ) |

* *

*Revenues:*   Revenues increased $25.5 million fromthe nine months ended September 30, 2005 to the nine months ended September 30,2006. This increase is primarily due to increases in ice volume salesdue to significantly warmer and drier average weather conditions in our markets(especially during the months of April and May 2006), the continuingpositive effects of package sizing initiatives, which consists primarily ofconverting a portion of our ice sales from seven pound to ten pound bags, theeffects of the higher average pricing, and the effects of acquisitionscompleted during the nine months ended September 30, 2006. Approximately$3.2 million of the increase was due to acquisitions. Within our non-icesegment, revenues decreased $1.1 million, primarily in our bottled wateroperation as a result of the loss of that operation’s largest customer duringthe three months ended September 30, 2006.

*Costof Sales (Excluding Depreciation):*   Cost of sales(excluding depreciation) increased $17.1 million from the nine months ended September 30,2005 to the nine months ended September 30, 2006. This increase in cost ofsales is primarily due to increased costs of plastic bags, electricity, fuel,ice transport and third party distribution expense related to sales volumeincreases. The unit costs of plastic bags, fuel, 

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electricity and third partdistribution costs also increased, primarily due to higher market prices ofenergy related items. Acquired ice operations represented approximately $2.0million of the increase.

Labor costs, including associated payroll taxes andbenefit costs (including health insurance), accounted for approximately 22% and23% of revenues in the nine months ended September 30, 2006 and 2005,respectively. Cost of plastic bags represented approximately 7% of revenues inthe nine months ended September 30, 2006 and 2005. Fuel expensesrepresented approximately 4% and 3% of revenues in the nine months ended September 30,2006 and 2005, respectively. Expenses for independent third party distributionservices represented approximately 6% of revenues in the nine months ended September 30,2006 and 2005. Electricity expense represented approximately 5% of revenues inthe nine months ended September 30, 2006 and 2005.

*DepreciationExpense Related to Cost of Sales:**  *Depreciation expense related tocost of sales increased $0.3 million due to additional depreciation expenseassociated with production and distribution equipment placed in service during2005 and 2006, partially offset by the effect of asset dispositions and assetsbecoming fully depreciated.

*OperatingExpenses:*   Operating expenses increased$6.3 million from the nine months ended September 30, 2005 to thenine months ended September 30, 2006. This increase is primarily due to anincrease of $2.4 million in non-cash stock-based compensation expense, anincrease of $1.8 million in accrued incentive compensation, an additional $0.6million in labor costs and an increase of $2.0 million in professional servicesand insurance, which was partially offset by reductions in bad debt and otherexpenses of $0.5 million. Included in professional services is $1.2 million ofcosts incurred during the three months ended June 30, 2006 related to thesecondary stock offering and to a potential acquisition which was not completed.

*Depreciationand Amortization:*   Depreciation and amortizationincreased $0.1 million from the nine months ended September 30, 2005to the nine months ended September 30, 2006. This increase was primarilydue to additional amortization expense associated with the intangibleassets recorded in connection with the acquisitions completed in 2005 and thefirst nine months of 2006.

*Impairmentof Assets:*   During the nine months ended September 30,2006, we recorded a non-cash goodwill impairment charge of $3.3 million in thebottled water portion of our non-ice business segment in accordance with SFAS No. 142,“Goodwill and Other Intangibles” as a result of a significant reduction insales volumes related to the loss of that operation’s most significant customer.We also reviewed two pieces of real estate during the nine months ended September 30,2006 in our ice business segment in accordance with SFAS No. 144, “Accounting for the Impairment or Disposal ofLong-Lived Assets” as a resultof a pending sale of one property and physical damage to another. As a resultof this review, we recorded an impairment charge of $0.4 million.

During the nine monthsended September 30, 2005, we also recorded a non-cash goodwillimpairment charge of $5.7 million in the cold storage portion of our non-icebusiness segment in accordance with SFAS No. 142 as a result of theloss of one of that business’ significant customers.

*Interest expense:**  *Interest expense decreased $5.9 million from the ninemonths ended September 30, 2005 to the nine months ended September 30,2006, primarily due to the repurchase of substantially all of our 87¤8%senior subordinated notes on August 15, 2005, partially offset by a $4.6million increase in term loan interest related to increased principle balancessubsequent to the refinancing of the credit facility in August 2005 andthe effect of higher interest rates on the unhedged portion of our variablerate debt.

**Liquidity andCapital Resources**

We generate cash from the sale of packaged ice throughtraditional delivery methods, by which we manufacture, package and store ice ata central facility and transport it to our customers’ retail locations 

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when needed, and throughIce Factories, which manufacture, package and store ice in our customers’retail locations. Our primary uses of cash are (a) cost of sales, (b) operatingexpenses, (c) debt service, (d) dividends on our common stock, (e) capitalexpenditures related to replacing and modernizing the capital equipment in ourtraditional ice plants and acquiring and installing additional Ice Factoriesand (f) acquisitions. Historically, we have financed our capital andworking capital requirements, including our acquisitions, through a combinationof cash flows from operations, borrowings under our revolving credit facilityand operating leases.

Our ability to generate cash from our operations issubject to weather, general economic, financial, competitive, legislative, regulatoryand other factors that are beyond our control. As a result, we cannot assureyou that our business will generate sufficient cash flow from operations inamounts sufficient to enable us to service our debt and to fund our otherliquidity needs. If we do not have sufficient liquidity, we will have to takeactions such as reducing or delaying the payment of dividends to our commonstockholders, strategic acquisitions, investments and joint ventures, sellingassets, restructuring or refinancing our debt or seeking additional equitycapital. We cannot assure you that any of these remedies could, if necessary,be effected on commercially reasonable terms, or at all. In addition, the termsof existing and future debt instruments may restrict us from adopting some ofthese alternatives.

During the nine months ended September 30, 2006,capital expenditures totaled $15.3 million. As we have consolidatedacquisitions into the existing company infrastructure, we have identifiednon-core and excess assets which can be disposed of. From time to time, we alsodispose of other assets which are no longer useful in our operations. As aresult of dispositions of these non-core and excess assets, we realizedproceeds of approximately $0.7 million in the nine months ended September 30,2006. As a result, our net capital expenditures in the nine months ended September 30,2006 were $14.6 million.

In the nine months ended September 30,2006, we completed the acquisitions of nine ice companies for a total cashpurchase price of approximately $12.8 million, including direct acquisitioncosts of $0.3 million. We will continue to evaluate acquisitionopportunities as they become available. In conjunction with these evaluations,we will consider our liquidity, availability under Reddy Group’s senior creditfacility, mandatory principal repayments under our debt agreements and theavailability of other capital resources.

**Cash Flows for theNine Months Ended September 30, 2006 and 2005**

Net cash provided by operating activities was $54.1 millionand $32.3 million in the nine months ended September 30, 2006 and2005, respectively. The increase was primarily due to an increase in net incomeof $27.4 million, from a loss of $7.9 million in the nine months ended September 30,2005 to net income of $19.5 million in the nine months ended September 30,2006, related to the loss on extinguishment of debt of $28.2 million in 2005that did not repeat in 2006. In addition to this increase in income, there wasa $6.6 million decrease in cash used by changes in working capital.

Net cash used in investing activities was$27.3 million and $17.2 million in the nine months ended September 30,2006 and 2005, respectively. The increase in net cash used in investingactivities was primarily due to an increase in acquisitions. During the ninemonths ended September 30, 2006, we completed nine acquisitions for atotal cost of $12.8 million. During the same period in 2005, we completed twoacquisitions and the purchase of leased assets for a total cost of $3.4million.

Net cash used in financingactivities was $26.5 million and $0.8 million in the nine months ended September 30,2006 and 2005, respectively. The increase in cash used in financing activitiesis primarily due to the payment of $25.2 million of dividends to our commonstockholders and the repurchase of common stock for $1.0 million in nine monthsended September 30, 2006, while the combination of Reddy Holding’s initialpublic offering of its common stock, employee stock option exercises and debtrefinancing resulted in a net use of cash of only $0.8 million in the ninemonths ended September 30, 2006.

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**Long-term Debt andOther Obligations**

***Overview.***   At September 30,2006, we had approximately $361.7 million of total debt outstanding asfollows (in thousands):

| Credit  Facility—Term Loans due 2012                                         |   | $       | 240,000 |   |
|-----------------------------------------------------------------------------------|--------|---------|---------|--------|
| Revolving Line of  Credit due 2010                                                |   | —  |    |
| 101⁄2% Senior  Discount Notes due 2012, net of unamortized discount of $28,873 |   | 121,627 |    |
| Other                                                                             |   | 115     |    |
| Total debt                                                                        |   | $       | 361,742 |   |

*** ***

***Senior Discount Notes.******  ***On October 27,2004, Reddy Holdings issued $151.0 million in aggregate principal amountat maturity of 101⁄2% senior discount notes due 2012 in a private placementoffering. Each senior discount note had an initial accreted value of $663.33per $1,000 principal amount at maturity. The accreted value of each seniordiscount note increases from the date of issuance until November 1, 2008at a rate of 101⁄2% per annum such that the accreted value will equal the statedprincipal amount at maturity on November 1, 2008. Thereafter, cashinterest will accrue and be payable semi-annually at a rate of 101⁄2% per annum.The senior discount notes are unsecured obligations of Reddy Holdings and are:

·       not guaranteed by any ofReddy Holdings’ subsidiaries;

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

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

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

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

The senior discount notes include customary covenantsthat restrict, among other things, the ability to incur additional debt orissue certain preferred stock, pay dividends or redeem, repurchase or retireour capital stock or subordinated indebtedness, make certain investments, incurliens, enter into arrangements that restrict dividends from our subsidiaries,merge or sell all or substantially all of the assets or enter into varioustransactions with affiliates. Prior to November 1, 2007, we may redeem upto 35% of the principal amount of the senior discount notes at a redemptionprice of 110.5% of the accreted value amount thereof, plus accrued and unpaidinterest to the date of redemption, with funds raised in equity offerings thatare specified in the indenture governing the senior discount notes. From andafter November 1, 2008, we may redeem any or all of the senior discountnotes by paying a redemption premium which is initially 5.25% of the principalamount at maturity of the notes, and will decline annually to zero commencingon November 1, 2010. If a change of control occurs on or prior to November 1,2007, we may, at our option, redeem all, but not less than all, of the seniordiscount notes at a redemption price equal to the sum of (i) the accretedvalue of the notes as of the redemption date, (ii) a premium equal to 125%of one year’s coupon payment and (iii) any accrued and unpaid interest tothe date of redemption. If we experience a change of control and do not electto make the optional redemption described in the previous sentence, we will berequired to make an offer to repurchase the senior discount notes at a priceequal to 101% of their accreted value, plus accrued and unpaid interest, ifany, to the date of purchase. We may also be required to make an offer topurchase the senior discount notes with proceeds of asset sales that are notreinvested in our business or used to repay other indebtedness.

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

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

·       the consolidated coverageratio set forth in the indenture governing our senior discount notes exceeds2.0 to 1.0; and

·       there is sufficientcapacity under the buildup amount under the indenture governing our seniordiscount notes.

In addition, regardless of whether we could make anyrestricted payments under the buildup amount provision referred to above, wemay (1) make dividend payments at any time in an aggregate amount of up to$15.0 million if no default has occurred and is continuing under theindenture and (2) following our initial public offering, pay dividends onour capital stock of up to 6.0% per year of the cash proceeds (net ofunderwriters’ fees, discounts, commissions or other expenses paid by us)received by us from all such public equity offerings subject to specifiedconditions. Accordingly, we are able to pay approximately $7.0 millionannually in dividends under this 6.0% provision. However, the amount ofdividend payments permitted under this 6.0% provision will correspondinglyreduce the amount we would otherwise have available to us under the buildupamount for restricted payments, including dividends. At September 30,2006, Reddy Holdings had $8.0 million of cash on hand that was not subjectto any restrictions under Reddy Group’s senior credit facility.

The consolidated coverage ratio under the indenturegoverning our senior discount notes means the ratio of our EBITDA for the mostrecent four fiscal quarters to our consolidated interest expense for such fourquarter period. “EBITDA” under the indenture governing our senior discountnotes is defined as the sum of our consolidated net income plus our income taxexpense, our interest expense, our depreciation and amortization expense,unrealized non-cash gains or losses or non-cash charges in respect of hedgingobligations required to be taken under generally accepted accountingprinciples, unrealized foreign currency translation gains or losses and allother non-cash charges, except to the extent representing an accrual or reservefor a future cash expenditure). “Consolidated net income” under the indenturegoverning our senior discount notes is defined as net income of Reddy Holdingsand its restricted subsidiaries: plus or minus cash dividends received oninvestments or equity in net losses of persons other than restrictedsubsidiaries, respectively; provided that the following are not included inconsolidated net income: (i) net income or loss of subsidiaries acquiredin pooling of interests transactions for any period prior to the date of theiracquisition, (ii) any net income of a subsidiary restricted in the paymentof a dividend (other than certain permitted restrictions, including those underour existing credit facilities and our new credit facilities), (iii) gainsor losses from non-ordinary course asset sales, (iv) extraordinary gainsor losses, (v) the cumulative effect of changes in accounting principles, (vi) non-recurringfees and expenses and write offs of deferred financing costs related to thefinancing transactions in connection with the 2003 merger with Packaged Iceand, (vii) any fees, charges, costs or expenses relating to our initialpublic offering and the related transactions and paid in cash, to the extentdeducted in the determination of consolidated net income. “Consolidatedinterest expense” under the indenture governing our senior discount notes isdefined as total interest expense plus, to the extent not included in totalinterest expense, (i) interest expense attributable to capital leases, (ii) amortizationof debt discount and issuance costs, (iii) capitalized interest, (iv) non-cashinterest expense, (v) fees on letters of credit, (vi) net paymentspursuant to hedging obligations, (vii) dividends accrued on certaindisqualified stock (viii) interest incurred in connection with investmentsin discontinued operations, (ix) interest on guaranteed indebtedness and (x) cashcontributions to employee stock ownership plans to the extent they are used topay interest or fees on indebtedness incurred by such plans. We are generallyrequired to calculate our consolidated coverage 

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ratio on a pro forma basisto give effect to incurrences and repayments of indebtedness as well asacquisitions and dispositions.

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

***Senior CreditFacility.******  ***On August 12, 2005, Reddy Groupentered into an amended and restated senior credit facility in an aggregateamount of $300.0 million, with the lenders being a syndicate of banks,financial institutions and other entities, which currently includes Credit Suisse,Cayman Islands Branch, as Administrative Agent, Bear Stearns Corporate Lending, Inc.,Canadian Imperial Bank of Commerce, Lehman Brothers Inc. and Wachovia Bank,N.A. The senior credit facility provides for a seven-year term loan in theamount of $240.0 million and a five-year revolving credit facility in theamount of $60.0 million.

At September 30, 2006, we had $53.2 million ofavailability under the revolving credit facility, which was net of outstandingstandby letters of credit of $6.8 million. The standby letters of creditare used primarily to secure certain insurance obligations. In connection withthe renewal of certain insurance policies in the second and third quarters of2006, our outstanding standby letters of credit will increase through the firstquarter of 2007. However, later in 2006, this additional new collateral will bepartially offset by reductions in collateral related to earlier policy years.We currently expect outstanding standby letters of credit to reach a maximum ofapproximately $7.7 million during the fourth quarter of 2006.

Principal balances outstanding under the revolvingcredit facility bear interest per annum, at our option, at the sum of the baserate plus 0.75% or LIBOR plus 1.75%. The base rate is defined as the greater ofthe prime rate (as announced from time to time by the Administrative Agent) orthe federal funds rate plus 0.5%. At September 30, 2006, the weightedaverage interest rate of borrowings outstanding under the senior creditfacility was 7.25%. Interest on base rate loans is payable on the last day ofeach quarter. Interest on LIBOR loans is payable upon maturity of the LIBORloan or on the last day of the quarter if the LIBOR loan exceeds 90 days.Reddy Group pays a quarterly fee on the average availability under our existingrevolving credit facility based on an annual rate of 0.5%. Except as describedbelow, the terms of the senior credit facility prohibit Reddy Group from payingdividends and otherwise transferring assets to Reddy Holdings, except forcertain limited dividends, the proceeds of which must be used to maintain ReddyHoldings’ corporate existence.

The senior credit facility does not require anyscheduled principal payments prior to the stated maturity dates. Subject tocertain conditions, mandatory repayments of the revolving credit facility andterm loan (and if the term loan is no longer outstanding, mandatory commitmentreductions of the revolving credit facility) are required to be made withportions of the proceeds from (1) asset sales, (2) the issuance ofdebt securities and (3) insurance and condemnation awards, subject tovarious exceptions. In the event of a change in control, as defined in thesenior credit facility, an event of default will occur under the senior creditfacility. Under the senior credit facility, Reddy Group may only pay dividendsto Reddy Holdings if Reddy Group’s total leverage ratio for the most recentlyended fiscal quarter is less than or equal to 3.75 to 1.0. In addition, thesenior credit facility precludes Reddy Group from declaring any dividends if anevent of default under the senior credit facility has occurred and iscontinuing. In particular, it will be an event of default if Reddy Group’sleverage ratio exceeds 4.0 to 1.0 or Reddy Group’s interest coverage ratio isless than 3.25 to 1.0.

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The senior credit facility contains financialcovenants, which include the maintenance of certain financial ratios, asdefined in the senior credit facility, and is collateralized by substantiallyall of Reddy Group’s assets and the capital stock of all of its subsidiaries.Reddy Holdings guarantees Reddy Group’s senior credit facility and suchguarantee is secured by the capital stock of Reddy Group. At September 30,2006, Reddy Group was in compliance with these covenants.

Under the restricted payments covenant in Reddy Group’ssenior credit facility, we generally are restricted from paying dividends.However, the covenant includes an exception for paying dividends in an amountnot greater than our Cumulative Distributable Cash for the period (taken as oneaccounting period) from July 1, 2005 to the end of our most recently-endedfiscal quarter for which a covenant compliance certificate under Reddy Group’ssenior credit facility has been delivered to the lenders.

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

(a)    $10,000,000,plus

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

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

(d)   (i) theamount of payments made by Reddy Group to Reddy Holdings to fund dividendpayments on, or repurchases of, Reddy Holdings capital stock or to pay cashinterest expense on, or redeem or repurchase, Reddy Holdings notes, (ii) amountsused to make restricted investments, less

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

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

(a)    AdjustedEBITDA for such fiscal quarter, plus,

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

(c)    (i) tothe extent included in net income used to calculate for any fiscal quarter suchAdjusted EBITDA, the amount of Reddy Group’s cash interest expense, Reddy Group’scash tax expense, the cash cost of any extraordinary, nonrecurring or unusuallosses, cash payments on account of non-cash losses or non-cash charges, (ii) capitalexpenditures (except to the extent funded with indebtedness (other than therevolving credit facility) or proceeds of asset sales or casualty events), (iii) cashpayments for acquisitions (except to the extent funded with indebtedness orproceeds of asset sales or casualty events) and (iv) payments andprepayments of the principal amount of indebtedness (other than payments andprepayments of the revolving credit facility) other than to the extent fundedwith indebtedness (other than indebtedness under our revolving creditfacility).

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

(a)    netincome, plus

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(b)   to theextent deducted in determining net income, the sum of (i) amountsattributable to depreciation and amortization, (ii) income tax expense, (iii) interestexpense, (iv) any other non-cash charges (less non-cash income) for whichno cash reserves (or receivables) have been or will be set aside (or created)including non-cash compensation expenses, (v) any loss from theextinguishment of indebtedness, (vi) any fees paid prior to the closingdate of our initial public offering in respect of the monitoring agreement, (vii) transactionadjustments (as defined in Reddy Group’s senior credit facility and includingthe fees and expenses incurred in connection with our initial public offeringand the related transactions), (viii) all fees and expenses incurred inconnection with permitted acquisitions to the extent accounted for as expenses,(ix) for the four fiscal quarters ending after September 30, 2004, anamount equal to the sum of (x) the special transaction payments paid tocertain members of management and certain directors in connection with theissuance of the senior discount notes not to exceed $1.3 million plus (y) anamount not to exceed $4.0 million for other expenses incurred in connectionwith the issuance of the senior discount notes and the related amendment toReddy Group’s senior credit facility which was in effect at the time of thesenior discount notes offering.

Under Reddy Group’s senior credit facility, ReddyGroup may only pay dividends to us to make dividend payments on our commonstock if Reddy Group’s total leverage ratio for the most recently ended fiscalquarter for which a covenant compliance certificate has been delivered is lessthan or equal to 3.75 to 1.0. If at the end of any fiscal quarter, Reddy Group’sleverage ratio is greater than 3.75 to 1.0, and therefore Reddy Group is notpermitted to pay dividends, Reddy Group will be required by Reddy Group’ssenior credit facility to apply 50% of Reddy Group’s Available Cash generatedduring each such quarter to make a mandatory prepayment of the loans underReddy Group’s senior credit facility.

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

Thefollowing table presents Adjusted EBITDA on a pro forma basis after givingeffect to the adjustments permitted under the description of the definition ofAdjusted EBITDA set forth above. Adjusted EBITDA is different from EBITDA thatis derived solely from GAAP components. Adjusted EBITDA should not be construedas an alternative to net loss, cash flows from operations or net cash fromoperating or investing activities as defined by GAAP, and it is not necessarilyindicative of cash available to fund our cash needs as determined in accordancewith GAAP. In addition, not all companies use identical calculations, and thispresentation may not be comparable to similarly titled measures of othercompanies. A reconciliation of net income to EBITDA and Adjusted EBITDA followsthe table.

| ** **                 | ** ** | **Twelve Months**            | ** ** |
|----------------------------|------------|-----------------------------------|------------|
| ** **                 | ** ** | **Ended September 30,** | ** ** |
| ** **                 | ** ** | **2006**                          | ** ** |
| ** **                 | ** ** | **(in thousands)**           | ** ** |
| Pro forma  adjusted EBITDA |       |                              | $          | 89,945 |   |   |
| Total leverage  ratio      |       |                              | 2.7:1.0    |   |   |
| Interest coverage ratio    |       |                              | 5.7:1.0    |   |   |

 

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Thefollowing table sets forth a reconciliation of net income to EBITDA andAdjusted EBITDA:

| ** **                                     | ** ** | **Twelve Months**            | ** ** |
|------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                     | ** ** | **Ended September 30,** | ** ** |
| ** **                                     | ** ** | **2006**                          | ** ** |
| ** **                                     | ** ** | **(in thousands)**           | ** ** |
| Net income                                     |       |                              | $          | 15,307 |   |   |
| Depreciation expense  related to cost of sales |       |                              | 19,126     |   |   |
| Depreciation and  amortization expense         |       |                              | 5,814      |   |   |
| Interest expense                               |       |                              | 28,531     |   |   |
| Income tax benefit                             |       |                              | 10,144     |   |   |
| EBITDA                                         |       |                              | 78,922     |   |   |
| Other non-cash charges:                        |       |                              |       |   |   |
| Stock-based compensation  expense              |       |                              | 4,851      |   |   |
| Loss on dispositions of  assets                |       |                              | 988        |   |   |
| Loss on extinguishment  of debt                |       |                              | —     |   |   |
| Impairment of assets                           |       |                              | 3,718      |   |   |
| Transaction expenses(a)                        |       |                              | 649        |   |   |
| Adjusted EBITDA                                |       |                              | $          | 89,128 |   |   |
| Acquisition  adjustments(b)                    |       |                              | 817        |   |   |
| Pro forma adjusted EBITDA                      |       |                              | $          | 89,945 |   |   |

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(a)           Represents costsrelated to the secondary stock offering which closed on May 30, 2006. Thesecondary offering costs were paid by Reddy Holdings from the excess cashremaining from the proceeds of the initial public offering of its common stockin August 2005.

(b)          Representsthe incremental Adjusted EBITDA of acquired businesses as if each acquisitionhad been consummated on the first day of the period presented. All acquisitionsincluded herein were consummated on or before September 30, 2006.

***Interest Rate Hedging Agreement***

Effective September 12,2005, Reddy Group entered into an interest rate hedging agreement (the “Hedge”)to fix the interest rate on a portion of our term loan facility. The Hedge hasa term of three years and ten months and an initial notional balance of$220 million. The notional balance decreases by $20 million on October 12of each of the next three years, beginning on October 12, 2006. ReddyGroup pays a fixed rate of 4.431% on the notional balance outstanding andreceives an amount equal to 3-month LIBOR. Any net payable or receivableamount is settled quarterly. If Reddy Group had been required to settle theHedge as of September 30, 2006, it would have received $2.6 million.The fair value of the Hedge is included in the caption “Other Assets” in theconsolidated balance sheet. Changes in the fair value of the Hedge are recordedas “Other Comprehensive Income” in the consolidated statement of stockholders’equity. Reddy Group is exposed to risk of loss in the event of non-performanceby the counterparty to the Hedge; however, we do not anticipate non-performanceby the counterparty.

***Liquidity Outlook***

Due to the seasonal nature of our business, we recordthe majority of our revenues and profits during the months of May throughSeptember. The majority of the cash generated from those operations is receivedbetween July and November.

We estimate that our capital expenditures for 2006will be approximately $16 million to $18 million, which willprimarily be used to maintain and expand our traditional ice operations. Therecan be no assurance that our capital expenditures will not exceed thisestimate. In the normal course of our business, we dispose of obsolete,worn-out and unneeded assets. As a result of dispositions of excess assets, we 

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estimate that we willgenerate proceeds of approximately $2 million to $3 million in 2006 fornet capital expenditures of approximately $13 million to $16 million.

Based on our expectedlevel of operations, we believe that cash flows from operations, together withavailable borrowings under our revolving credit facility, will be adequate tomeet our future liquidity needs for at least the next twelve months. As of November 1,2006, we had approximately $31 million of cash on hand and $52.8 millionof availability under our revolving credit facility, which reflectedoutstanding standby letters of credit of $7.2 million. As part of ourongoing acquisition program, we are currently pursuing several smallacquisition opportunities which are in various stages of negotiations. If we aresuccessful in completing any of these transactions or a series of transactions,borrowings under our revolving credit facility may be required.

**Recent AccountingPronouncements**

In June 2006, the Financial Accounting StandardsBoard (“FASB”) issued FASB Interpretation (“FIN”) No. 48, “Accounting forUncertainty in Income Taxes”. FIN 48 clarifies the accounting for uncertaintyin income taxes recognized in an entity’s financial statements in accordancewith SFAS No. 109, “Accounting for Income Taxes”. FIN 48 prescribes arecognition threshold and measurement attribute for the financial statementrecognition and measurement of a tax position taken or expected to be taken ina return and also provides guidance on derecognition, classification, interestand penalties, accounting in interim periods, disclosure and transition. Thisinterpretation is effective for fiscal years beginning after December 15,2006. We are currently evaluating the impact that this standard may have on ourresults of operations and financial position.

In September 2006, the Financial AccountingStandards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”)No. 157, “Fair Value Measurements”. SFAS No. 157 defines fair value,establishes a framework and for measuring fair value in generally acceptedaccounting principles and expands disclosures about fair value estimates. Thisstandard is effective for fiscal years beginning after November 15, 2007. Weare currently evaluating the impact that this standard may have on our resultsof operations and financial position.

In September 2005,the SEC issued Staff Accounting Bulletin (“SAB”) No. 108. SAB 108 providesguidance on the consideration of the effects of prior year misstatements inquantifying current year misstatements. SAB 108 is  effective for fiscal years beginning after November 15,2006. We are currently evaluating the impact that this standard may have on ourresults of operations and financial position.

**Off-Balance SheetArrangements**

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

**General EconomicTrends and Seasonality**

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

The ice business is highlyseasonal, with the bulk of demand coming in the warmer spring and summermonths. Accordingly, we experience seasonal fluctuations in our net sales andprofitability. We make a disproportionate amount of our sales in the second andthird calendar quarters. We also typically have net income in these sameperiods, whereas we typically experience net loss in the first and fourthcalendar quarters. We believe that over two-thirds of our revenues will occurduring the second and third calendar 

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quarterswhen the weather conditions are generally warmer and demand is greater, whileless than one-third of our revenues will occur during the first and fourthcalendar quarters when the weather is generally cooler. This belief isconsistent with historical trends. As a result of seasonal revenue declines andthe lack of proportional corresponding expense decreases, we will most likelyexperience lower profit margins and even losses during the first and fourthcalendar quarters. In addition, because our operating results dependsignificantly on sales during our peak season, our quarterly results ofoperations may fluctuate significantly as a result of adverse weather duringthis peak selling period if the weather is unusually cool or rainy on a morenational or regional basis.

**Item3.**                        *Quantitative and Qualitative Disclosures About Market Risks*

Market risk generallyrepresents the risk that losses may occur in the value of financial instrumentsas a result of movements in interest rates, foreign currency exchange rates andcommodity prices. Our main market risk category is interest rate risk.

We are exposed to somemarket risk due to the floating interest rates under Reddy Group’s seniorcredit facility. Principal balances outstanding under the term loan and therevolving credit facility bear interest, at our option, at the LondonInter-Bank Offered Rate (“LIBOR”) plus 1.75% or the prime rate (as announcedfrom time to time by the administrative agent) plus 0.75%.

Effective September 12,2005, we entered into an interest rate hedging agreement (the “Hedge”) to fixthe interest rate on a portion of the term loan outstanding under the seniorcredit facility. The Hedge has a term of three years, ten months and an initialnotional balance of $220 million. The notional balance decreases by $20 millionon each October 12 during 2006-2008. We pay a fixed rate of 4.431%on the notional amount and receive an amount equal to 3-month LIBOR. Anynet payable or receivable amount is settled quarterly. If we had been requiredto settle the Hedge as of September 30, 2006, we would have received $2.6million. Reddy Group is exposed to risk of loss in the event of non-performanceby the counterparty to the Hedge. However, we do not anticipate non-performanceby the counterparty.

As of September 30,2006, the senior credit facility had an outstanding principal balance of$240.0 million at a weighted average interest rate of 7.25% per annum. At September 30,2006, the 30-day LIBOR rate was 5.32%. If LIBOR were to increase by 1%from that level, the annual increase in interest expense, given our principalbalances at September 30, 2006 and the effect of the Hedge, would beapproximately $0.2 million.

**Item4.**                        *Controls and Procedures*

The Company, under thesupervision and with the participation of its management, including the ChiefExecutive Officer and Chief Financial Officer, evaluated the effectiveness ofthe design and operation of our “disclosure controls and procedures” (asdefined in Rules 13a-15(e) and 15d-15(e) under theSecurities Exchange Act of 1934 (the “Exchange Act”)) as of the end of theperiod covered by this report. Based on that evaluation, the Chief ExecutiveOfficer and the Chief Financial Officer concluded that our disclosure controlsand procedures were effective as of September 30, 2006 to ensure thatinformation relating to us and our consolidated subsidiaries required to bedisclosed in our reports filed or submitted under the Exchange Act is recorded,processed, summarized and reported within the time periods specified in the SEC’srules and forms, and that such information is accumulated and communicatedto our management, including our Chief Executive Officer and Chief FinancialOfficer, as appropriate to allow timely discussions regarding requireddisclosure. It should be noted, however, that the design of any system ofcontrols is limited in its ability to detect errors, and there can be noassurance that any design will succeed in achieving its stated goals under allpotential future conditions, regardless of how remote. There has been no changein our internal control over financial reporting during the quarter ended September 30,2006 that has materially affected, or is reasonably likely to materiallyaffect, our internal control over financial reporting.

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**PART II—OTHERINFORMATION**

**Item1.**                        *Legal Proceedings*

We are from time to timeparty to legal proceedings that arise in the ordinary course of business. We donot believe that the resolution of any such threatened or pending legalproceedings will have a material adverse affect on our financial position,results of operations or liquidity.

**Item1A.**                *Risk Factors*

In addition to the riskfactors previously disclosed in Part I, Item 1A of the Company’s AnnualReport on Form 10-K for the fiscal year ended December 31,2005, the Company has identified the following new and updated risk factors:

***Future sales of our shares could depress the marketprice of our common stock.***

Sales of a substantialnumber of shares of common stock in the public market by our current stockholders,or the threat that substantial sales may occur, could cause the market price ofour common stock to decrease significantly or make it difficult for us to raiseadditional capital by selling stock. In connection with the secondary stockoffering completed in May 2006, our directors and executive officers, aswell as the selling stockholders in the offering, entered into 90-daylock-up agreements at the request of the underwriters. As of August 21,2006, those parties became eligible to sell in the public market an aggregateof 5,004,251 shares of our common stock that they held after the offering,subject to the applicable volume, manner of sale, holding period and otherlimitations of Rule 144 under the Securities Act of 1933.

We cannot predict the sizeof future issuances of our common stock or the effect, if any, that futureissuances and sales of shares of our common stock will have on the market priceof our common stock. Sales of substantial amounts of our common stock(including shares issued in connection with an acquisition), or the perceptionthat such sales could occur, may adversely affect prevailing market prices forour common stock.

***Limited trading volume of our common stock maycontribute to its price volatility.***

For the first nine monthsof 2006, the average daily trading volume for our common stock as reported bythe New York Stock Exchange was approximately 114,000 shares. As a result,relatively small trades may have a significant impact on the price of ourcommon stock.

**Item 2.****                       ***Unregistered****Sales**of Equity Securities and Use of Proceeds***

None.

**Item3.**                        *Defaults Upon Senior Securities*

None.

**Item4.**                        *Submission of Matters to a Vote of Security Holders*

None.

**Item5.**                        *Other Information*

None.

**Item 6.**                        *Exhibits*

See Index to Exhibits which follows the signature page hereto.

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**SIGNATURES**

Pursuantto the requirements of the Securities Exchange Act of 1934, the registrant hasduly caused this report to be signed on its behalf by the undersigned thereuntoduly authorized.
|                              |   | **REDDY  ICE HOLDINGS, INC.**            |
|------------------------------|--------|------------------------------------------|
| Date:  November 2, 2006 | By:    | /s/ WILLIAM P. BRICK                     |   |
|                         |   | William P. Brick                         |
|                         |   | *Chief Executive Officer*                |
| Date:  November 2, 2006 | By:    | /s/ STEVEN J. JANUSEK                    |   |
|                         |   | Steven J. Janusek                        |
|                         |   | *Chief Financial and Accounting Officer* |

 

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**INDEXTO EXHIBITS**

| Exhibit No. | ** ** | **Description**                                                     |
|------------------|------------|---------------------------------------------------------------------|
| 31.1†       |       | Rule 15d-14(a) Certification  of Chief Executive Officer. |
| 31.2†       |       | Rule 15d-14(a) Certification  of Chief Financial Officer. |
| 32.1†       |       | Rule 1350  Certification of Chief Executive Officer.           |
| 32.2†       |       | Rule 1350  Certification of Chief Financial Officer.           |

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†                    Filedherewith.

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