10-Q 1 d00861e10vq.txt FORM 10-Q ================================================================================ SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark one) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2002 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______ to _______ Commission file number 333-29357 PACKAGED ICE, INC. (Exact Name of Registrant as Specified in Its Charter) TEXAS 76-0316492 (State or other jurisdiction of (I.R.S. Employer Identification No.) incorporation or organization) 3535 TRAVIS STREET, SUITE 170 DALLAS, TEXAS 75204 (Address of principal executive offices) (214) 526-6740 (Registrant's telephone number, including area code) Indicate by check whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] The total number of shares of common stock, par value $0.01 per share, outstanding as of November 5, 2002 was 20,357,304. ================================================================================ PACKAGED ICE, INC. AND SUBSIDIARIES QUARTERLY REPORT ON FORM 10-Q FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 TABLE OF CONTENTS

2 PART I - FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS PACKAGED ICE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED BALANCE SHEETS

See notes to condensed consolidated financial statements. 3 PACKAGED ICE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

See notes to condensed consolidated financial statements. 4 PACKAGED ICE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (DEFICIT) (UNAUDITED)

See notes to condensed consolidated financial statements. 5 PACKAGED ICE, INC. AND SUBSIDIARIES CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

See notes to condensed consolidated financial statements. 6 PACKAGED ICE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 1. GENERAL The condensed consolidated financial statements of Packaged Ice, Inc. and its wholly owned subsidiaries (the "Company") included herein are unaudited, except for the balance sheet as of December 31, 2001 that has been prepared from the audited financial statements for that date. These financial statements have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission ("SEC"). As applicable under the SEC's regulations, certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been condensed or omitted. All significant intercompany balances and transactions have been eliminated upon consolidation, and all adjustments which, in the opinion of management, are necessary for a fair presentation of the financial position, results of operations and cash flows for the periods covered have been made and are of a normal and recurring nature. Accounting measurements at interim dates inherently involve greater reliance on estimates than at year end and are not necessarily indicative of results for the full year. The financial statements included herein should be read in conjunction with the consolidated financial statements and the related notes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 2001. 2. NEW ACCOUNTING PRONOUNCEMENTS On January 1, 2002, the Company adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 changed the accounting for goodwill from an amortization method to an impairment-only approach. Amortization of goodwill, including goodwill recorded in past business combinations, ceased upon adoption of this statement. Adoption of this statement resulted in a charge to net income of $73.2 million (net of $0 tax). Prospectively, the Company will annually evaluate the carrying amount of goodwill associated with its operating segments using a market valuation approach to identify any potential impairment of goodwill. On January 1, 2002, the Company adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial accounting and reporting requirements for the impairment and disposal of long-lived assets. Adoption of this statement did not have a significant effect on the Company's consolidated financial position or results of operations. In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145, among other things, amends SFAS No. 4 and SFAS No. 64 to require that gains and losses from the extinguishment of debt generally be classified within continuing operations. The provisions of SFAS No. 145 are effective for fiscal years beginning after May 15, 2002 and early application is encouraged. The Company adopted SFAS No. 145 on April 1, 2002. As a result of the adoption of this statement, the extraordinary gain on extinguishment of debt reported in the consolidated statement of operations for the quarter ended March 31, 2002 was reclassified to continuing operations in the quarter ended June 30, 2002. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 replaces Emerging Issues Task Force (EITF) Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." This standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. This statement is effective for exit or disposal activities that are initiated after December 31, 2002. The Company does not believe that the adoption of SFAS 146 will have a significant impact on its financial statements. 7 PACKAGED ICE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 (CONTINUED) 3. ACQUISITIONS During the three and nine months ended September 30, 2002, the Company did not acquire any additional businesses. The Company has accounted for all of its prior acquisitions using the purchase method of accounting and, accordingly, the purchase price has been allocated to the assets and liabilities acquired based on fair value at the date of the acquisitions. The excess of the aggregate purchase price over the fair market value of the net assets acquired was recorded as goodwill and other intangibles and was amortized over 40 years through December 31, 2001. As discussed in Note 2, amortization of goodwill ceased upon adoption of SFAS 142 on January 1, 2002. Goodwill amortization expense was $1.4 million and $4.0 million in the three and nine months ended September 30, 2001, respectively. Amortization expense of other intangible assets resulting from the Company's acquisitions was $0.3 million for the three months ended September 30, 2002 and 2001 and $1.0 million and $1.2 million for the nine months ended September 30, 2002 and 2001, respectively. 4. INVENTORIES Inventories contain raw materials, supplies and finished goods. Raw materials and supplies consist of ice packaging materials, spare parts, bottled water supplies and merchandiser parts. Finished goods consist of packaged ice and bottled water. Inventories are valued at the lower of cost or market. Cost is determined using the first-in, first-out and average cost methods.

5. EARNINGS (LOSS) PER SHARE The computation of earnings (loss) per share is based on net income (loss), after deducting the dividend requirement of preferred stock, divided by the weighted average number of shares outstanding. Options and warrants to purchase 5,039,393 and 4,895,824 shares of common stock that are outstanding but exercisable at prices above the Company's average common stock price for the three and nine months ended September 30, 2002 and 2001, respectively, have not been included in the computation of diluted net earnings (loss) per share and weighted average common shares outstanding. For the nine months ended September 30, 2002 and 2001, there are 563,405 and 492,821 shares, respectively, of anti-dilutive securities which are not included in the diluted net loss per share calculation. 8 PACKAGED ICE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 (CONTINUED)

6. LONG-TERM OBLIGATIONS The Company had $270 million in aggregate principal amount of 9 3/4% Senior Notes outstanding as of December 31, 2001. On each of January 30, 2002 and June 24, 2002, the Company purchased and retired 9 3/4% Senior Notes with a par value of $2.5 million. On July 30, 2002, the Company purchased and retired 9 3/4% Senior Notes with a par value of $5.0 million, for a total of $10 million through September 30, 2002. These purchases resulted in a total gain on extinguishment of debt of $1.5 million. The 9 3/4% Senior Notes were issued pursuant to the indenture dated January 28, 1998, as amended (the "Indenture"). The 9 3/4% Senior Notes are general unsecured obligations of the Company and are senior in right of payment to all existing and future subordinated indebtedness of the Company and pari passu to all senior indebtedness of the Company. The 9 3/4% Senior Notes are effectively subordinated to the Company's bank credit facility. The 9 3/4% Senior Notes contain certain covenants that, among other things, limit the ability of the Company and its restricted subsidiaries to pay any cash dividends or make distributions with respect to the Company's capital stock, to incur indebtedness or to create liens. The Company's 9 3/4% Senior Notes are guaranteed, fully, jointly and severally, and unconditionally, on a senior unsecured basis by each of the Company's current and future wholly owned subsidiaries. The Company has an $88 million credit facility (the "Credit Facility"), consisting of a $38 million revolving loan (the "Line of Credit") and a $50 million term loan (the "Term Loan"). At September 30, 2002, the Company had approximately $26.3 million of availability under the Line of Credit. Principal balances outstanding under the Line of Credit bear interest per annum, at the Company's option, at the London Inter-Bank Offered Rate ("LIBOR") plus 3.5% or the prime rate (as announced from time to time by JPMorgan Chase Bank) plus 1.5%. No principal payments are required until the final 9 PACKAGED ICE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 (CONTINUED) maturity date of October 31, 2004. Principal balances outstanding under the Term Loan bear interest per annum, at the Company's option, at LIBOR plus 4% or the prime rate plus 2%, with a minimum of 9.5%. At September 30, 2002, the weighted average interest rate of borrowings outstanding under the Credit Facility was 9.19%. Interest is payable monthly. For fiscal years beginning on or after January 1, 2002, there is a mandatory principal payment on the Term Loan equal to 65% of the Company's Excess Cash Flow (as defined in the Credit Facility). This principal payment is due within 10 days of delivery to the lenders of the annual audited financial statements, which may occur no later than 90 days after a fiscal year end. In accordance with the Credit Facility, the principal payment can be waived if certain conditions are met and the Company pays the Amortization Waiver Fee (as defined in the Credit Facility). Any balance outstanding under the Term Loan is due upon the final maturity date of October 31, 2004. On November 28, 2000, the Company entered into an interest rate collar agreement (the "Collar Agreement"). If the Index Rate (30-day LIBOR, as defined in the Collar Agreement) exceeds 7.75%, the Company will receive the difference between the Index Rate and 7.75%. If the Index Rate falls below 5.75%, the Company will pay the difference plus 1%. Any amounts payable or receivable are settled monthly. The Collar Agreement has a notional amount of $50 million and a term of 4 years. If the Company had been required to settle the Collar Agreement as of September 30, 2002, the Company would have had to pay $5.2 million. The Company is exposed to credit risk in the event of nonperformance by the counterparty to the Collar Agreement, however the Company anticipates that the counterparty will fully perform its obligations under the Collar Agreement. As of September 30, 2002, the Company had $7.1 million of standby letters of credit outstanding, primarily to secure certain insurance obligations. The Credit Facility contains financial covenants which include limitations on capital expenditures and the maintenance of certain financial ratios, as defined in the Credit Facility, and is collateralized by substantially all of the Company's assets and the capital stock of all of the Company's significant subsidiaries. At September 30, 2002, the Company was in compliance with these covenants. At September 30, 2002 and December 31, 2001, long-term obligations consisted of the following:

10 PACKAGED ICE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 (CONTINUED) 7. CAPITAL STOCK The Company currently is authorized to issue up to 50,000,000 shares of common stock, par value $0.01 per share, of which 20,357,304 shares were outstanding at September 30, 2002 and up to 5,000,000 shares of preferred stock, par value $0.01 per share. As of September 30, 2002, the Company had authorized 500,000 shares of 10% exchangeable preferred stock, of which 383,832 shares were issued and outstanding. As of September 30, 2002, the Company had reserved shares of common stock for the exercise of stock options under its various stock option plans as follows: o 393,700 shares reserved under the 1994 Stock Option Plan; 229,450 outstanding o 1,000,000 shares reserved under the 1998 Stock Option Plan; 896,890 outstanding o 900,000 shares reserved under the 2001 Stock Option Plan; 860,500 outstanding. As of September 30, 2002, 3,542,284 shares were reserved for issuance upon the exercise of outstanding warrants. Additionally, 500,000 shares were reserved for issuance under the 2000 Employee Stock Purchase Plan (the "ESPP"). Through September 30, 2002, 499,809 shares had been issued under the ESPP. Contributions to the ESPP have been suspended until such time that additional shares are approved by the Company's shareholders. On May 16, 2002, the Company adopted the 2002 Senior Executive Restricted Stock Plan (the "Restricted Stock Plan"). Upon adoption of the Restricted Stock Plan, certain executives were granted a total of 200,000 shares of the Company's common stock. Such restricted shares are not transferable by the executive and have no voting rights. The market value of the Company's common stock at the date of issuance was $1.22 per share. The removal of the restrictions is contingent upon the Company achieving certain performance goals for the fiscal year ending December 31, 2002. As of September 30, 2002, management does not believe that the performance goals included in the Restricted Stock Plan will be met. Accordingly, no expense related the Restricted Stock Plan was recognized in the three months ended September 30, 2002 and the expense recognized in the three months ended June 30, 2002 was reversed. 8. COMMITMENTS AND CONTINGENCIES The Company is involved in various claims, lawsuits and proceedings arising in the ordinary course of business. While there are uncertainties inherent in the ultimate outcome of such matters and it is impossible to presently determine the ultimate costs that may be incurred, management believes the resolution of such uncertainties and the incurrence of such costs will not have a material adverse effect on the Company's consolidated financial position, results of operations or cash flows. 9. SEGMENT INFORMATION The Company has two reportable segments: (1) ice products and (2) non-ice products and services. Ice products include the manufacture and distribution of packaged ice products through traditional ice manufacturing and delivery and the Ice Factory, which is a proprietary machine that produces, packages, stores and merchandises ice at the point of sale through an automated, self-contained system. Non-ice products and services include refrigerated warehouses, manufacturing and distribution of bottled water and the sale and leasing of ice production equipment. During 2001, the Company sold the majority of its ice production equipment leasing business and two small cold storage operations. 11 PACKAGED ICE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 (CONTINUED) The Company evaluates performance of each segment based on earnings before interest, taxes, depreciation, amortization, the gain or loss on disposition of assets, the gain or loss on the extinguishment of debt and the cumulative effect of changes in accounting principles ("EBITDA") and does not allocate assets by segment. Segment information for the three months ended September 30, 2002 and 2001 is as follows:

Segment information for the nine months ended September 30, 2002 and 2001 is as follows:

Reconciliation of EBITDA to net income (loss) before preferred dividends for the three and nine month periods ended September 30, 2002 and 2001 is as follows:

12 PACKAGED ICE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 (CONTINUED) 10. SUBSIDIARY GUARANTORS The Company's 9 3/4% Senior Notes are guaranteed, fully, jointly and severally, and unconditionally, on a senior subordinated basis by all of the Company's current and future, direct and indirect subsidiaries (the "Subsidiary Guarantors"). The following tables set forth the condensed consolidating financial statements for Packaged Ice, Inc. (the "Parent") and its subsidiaries, all of which are wholly owned. There are currently no restrictions on the ability of the Subsidiary Guarantors to transfer funds to the Parent in the form of cash dividends, loans or advances. The following is the condensed consolidating balance sheet as of September 30, 2002:

13 PACKAGED ICE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 (CONTINUED) The following is the condensed consolidating balance sheet as of December 31, 2001:

14 PACKAGED ICE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 (CONTINUED) The following is the condensed consolidating statement of operations for the three months ended September 30, 2002:

The following is the condensed consolidating statement of operations for the three months ended September 30, 2001:

15 PACKAGED ICE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 (CONTINUED) The following is the condensed consolidating statement of operations for the nine months ended September 30, 2002:

The following is the condensed consolidating statement of operations for the nine months ended September 30, 2001:

16 PACKAGED ICE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 (CONTINUED) The following is the condensed consolidating statement of cash flows for the nine months ended September 30, 2002:

17 PACKAGED ICE, INC. AND SUBSIDIARIES NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2002 (CONTINUED) The following is the condensed consolidating statement of cash flows for the nine months ended September 30, 2001:

18 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and the related notes and other information included elsewhere in this Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2001, previously filed with the SEC. UNCERTAINTY OF FORWARD LOOKING STATEMENTS AND INFORMATION Other than statements of historical facts, statements made in this report on Form 10 constitute "forward-looking statements" that represent our expectations or beliefs concerning future events. We believe the expectations reflected in such forward-looking statements are accurate. However, we cannot assure you that such expectations will occur. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our company's actual results, performance or achievements to be materially different from future results expressed or implied by the forward-looking statements. Factors you should consider that could cause these differences are: o general economic trends and seasonality; o substantial leverage and ability to service debt; o availability of credit facilities and restrictive covenants under the credit facilities; o competitive practices in our industry; o availability of capital sources; and o risks associated with acquisitions. You should not unduly rely on these forward-looking statements as they speak only as of the date of this report. Except as required by law, we are not obligated to publicly release any revisions to these forward looking statements to reflect events or circumstances occurring after the date of this report or to reflect the occurrence of unanticipated events. Important factors that could cause our actual results to differ materially from our expectations are discussed elsewhere in this report. GENERAL Packaged Ice, Inc. is the largest manufacturer and distributor of packaged ice in the United States and currently serves over 73,000 customer locations in 31 states and the District of Columbia. We have grown significantly since our incorporation in 1990, primarily through the implementation of a consolidation strategy within the highly fragmented packaged ice industry. Since April 1997, we have completed 84 acquisitions of traditional ice companies, principally in the southern half of the United States. These acquisitions have enabled us to enter new geographic regions, increase our presence in established markets, gain additional production capacity, realize cost savings from economies of scale and leverage the acquired companies' relationships with grocery and convenience store customers. Our acquisition pace significantly slowed starting in late 1999, and has subsequently stopped with the exception of a few small tuck-in acquisitions, which are acquisitions intended to add incremental production and/or distribution capabilities in an established market. We generally do not anticipate any significant acquisition activity in the near future, but may continue to evaluate such opportunities as they become available. We currently are focused on increasing profitability and strengthening our balance sheet through debt reduction. We operate in two business segments - ice products and non-ice products and operations. Ice products accounted for approximately 91% of revenues in 2001 and 92% of revenues for the nine months ended September 30, 2002. Ice products consist of the following two activities: o the manufacture and delivery of traditional ice from a central point of production to the point of sale; and o the installation of Ice Factories, our proprietary machines that produce, package, store and merchandise ice at the point of sale through an automated, self-contained system. 19 Our other business segment, non-ice products and operations, consists of refrigerated warehousing and the manufacturing and sale of bottled water. Our cost of sales includes costs associated with plant occupancy, raw materials, delivery, labor and utility-related expenses. With the Ice Factory, plant occupancy, delivery and utility costs are eliminated, but costs associated with customer service representatives and machine technicians are added to the cost of sales. Our operating expenses are costs associated with selling, general and administrative functions. These costs include executive officers' compensation, office and administrative salaries and costs associated with leasing office space. At September 30, 2002, we owned or operated 50 ice manufacturing plants, 49 distribution centers, seven refrigerated warehouses, one bottled-water manufacturing facility and had an installed base of 2,964 Ice Factories. THREE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO THREE MONTHS ENDED SEPTEMBER 30, 2001 Revenues: Revenues decreased $1.8 million, from $88.3 million for the three months ended September 30, 2001 to $86.5 million for the three months ended September 30, 2002. Revenues decreased $1.4 million in our ice segment as a result of the sale of our traditional ice business in California in December 2001, offset by increased volume sales and higher average sales prices in our remaining markets. Volume increases were primarily due to two factors: 1) more favorable weather in the three months ended September 30, 2002 as compared to the same period last year, especially in our Mid-Atlantic markets, and 2) the effects of the terrorist attacks in New York City and Washington, D.C. on September 11, 2001, which were not present in the current year. The attacks of September 2001 caused the cancellation of many special events and a reduction in recreational activity across the country, which had a negative impact on volume sales. Non-ice revenues decreased $0.4 million, due to reduced activity in our bottled water business, the sale of our ice production equipment sales and leasing business and two cold storage facilities in 2001, offset by increased activity in our remaining cold storage operations. Cost of Sales: Cost of sales decreased $2.2 million, from $50.6 million for the three months ended September 30, 2001 to $48.4 million for the three months ended September 30, 2002. This decrease primarily resulted from the sale of our traditional ice business in California in December 2001, offset by increases related to higher sales in our remaining markets and increased electricity costs. As a percentage of revenues, cost of sales was 57.3% for the three months ended September 30, 2001 and 56.0% for the three months ended September 30, 2002. Gross Profit: Gross profit increased $0.3 million, from $37.7 million for the three months ended September 30, 2001 to $38.0 million for the three months ended September 30, 2002. Gross profit in our ice operations increased $1.0 million, due to increased sales in our non-California markets and more efficient operations in our traditional ice plants, offset by increased electricity costs. Gross profit in our non-ice operations decreased $0.7 million due to increased labor costs in our cold storage operations. As a percentage of revenues, gross profit was 42.7% for the three months ended September 30, 2001 and 44.0% for the three months ended September 30, 2002. Operating Expenses: Operating expenses decreased $0.5 million, from $8.6 million for the three months ended September 30, 2001 to $8.1 million for the three months ended September 30, 2002. This decrease resulted from a decrease in labor and benefits due to consolidation of administrative functions and headcount reductions during the first nine months of 2001 and the sale of our traditional ice business in California in December 2001. There were no similar costs in the current year. As a percentage of revenues, operating expenses decreased from 9.8% for the three months ended September 30, 2001 to 9.3% for the three months ended September 30, 2002 20 Depreciation and Amortization: Depreciation and amortization decreased $1.7 million, from $7.7 million for the three months ended September 30, 2001 to $6.0 million for the three months ended September 30, 2002. This decrease was due to (1) dispositions of fixed assets over the last twelve months and (2) the adoption of Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets" on January 1, 2002. SFAS No. 142 changed the accounting for goodwill from an amortization method to an impairment-only approach. Amortization of goodwill, including goodwill recorded in past business combinations, ceased upon adoption of this statement. Offsetting this decrease in expense is additional depreciation expense related to property additions since September 30, 2001. As a percentage of revenues, depreciation and amortization decreased from 8.7% for the three months ended September 30, 2001 to 6.9% for the three months ended September 30, 2002. Gain (Loss) on Disposition of Assets: During the three months ended September 30, 2002, we sold certain non-core assets, including several pieces of real estate for a net loss of $1.6 million. During the three months ended September 30, 2001, we sold certain non-core assets, including several pieces of real estate and one cold storage facility for a net loss of $0.2 million. Gain on Extinguishment of Debt: During the three months ended September 30, 2002, we purchased and retired 9 3/4% Senior Notes with a total par value of $5.0 million, which resulted in a gain on extinguishment of debt of $0.7 million. Interest Expense: Interest expense increased $0.4 million, from $8.4 million for the three months ended September 30, 2001 to $8.8 million for the three months ended September 30, 2002. As a percentage of revenues, interest expense increased from 9.5% for the three months ended September 30, 2001 to 10.2% for the three months ended September 30, 2002. The dollar increase in interest expense was due to higher payments under our interest rate swap agreement and a higher average interest rate on the term loan included in our amended Credit Facility, offset by lower average borrowings and lower interest rates on the revolving loan under our Credit Facility and lower outstanding balances of our 9 3/4% Senior Notes. NINE MONTHS ENDED SEPTEMBER 30, 2002 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30, 2001 Revenues: Revenues decreased $5.6 million, from $198.3 million for the nine months ended September 30, 2001 to $192.7 million for the nine months ended September 30, 2002. Revenues decreased $4.0 million in our ice segment as a result of the sale of our traditional ice business in California in December 2001, offset by increased volume sales and higher average sales prices in our remaining markets. Increased volumes are due to better weather conditions around the country and the recovery from the effects of the terrorist attacks in New York City and Washington, D.C. on September 11, 2001. Revenues in our non-ice operations decreased $1.6 million for the nine months ended September 30, 2002 compared with the same period in 2001, primarily due to an increase in business at our Virginia cold storage plants, offset by the sale of several non-core operations (including our ice production equipment sales and leasing business and two small cold storage operations) during 2001. Cost of Sales: Cost of sales decreased $7.4 million, from $123.1 million for the nine months ended September 30, 2001 to $115.7 million for the nine months ended September 30, 2002. As a percentage of revenues, cost of sales decreased from 62.1% for the nine months ended September 30, 2001 to 60.0% for the nine months ended September 30, 2002. This decrease primarily resulted from the sale of our traditional ice operations in California, offset by increases in electricity and insurance costs. Gross Profit: Gross profit increased $1.8 million, from $75.2 million for the nine months ended September 30, 2001 to $77.0 million for the nine months ended September 30, 2002. As a percentage of revenues, gross profit increased from 37.9% for the nine months ended September 30, 2001 to 40.0% for the nine months ended September 30, 2002. These increases were the result increased operating efficiencies in our plants, higher average sales prices and the sale of our traditional ice business in California, which generated lower gross profit margins than our other markets. 21 Operating Expenses: Operating expenses decreased $3.0 million, from $27.3 million for the nine months ended September 30, 2001 to $24.3 million for the nine months ended September 30, 2002. This decrease resulted from a decrease in labor and benefits due to consolidation of administrative functions and headcount reductions during the first nine months of 2001 and the sale of our traditional ice business in California in December 2001. As a percentage of revenues, operating expenses decreased from 13.7% for the nine months ended September 30, 2001 to 12.6% for the nine months ended September 30, 2002. This decrease was due to greater efficiencies as our current period general and administrative expenses were reduced at a greater rate than sales decreased from the nine months ended September 30, 2001. Depreciation and Amortization: Depreciation and amortization decreased $4.3 million, from $23.2 million for the nine months ended September 30, 2001 to $18.9 million for the nine months ended September 30, 2002. As a percentage of revenues, depreciation and amortization decreased from 11.7% for the nine months ended September 30, 2001 to 9.8% for the nine months ended September 30, 2002. This decrease was primarily due to (1) dispositions of fixed assets over the last twelve months and (2) the adoption of SFAS No. 142, "Goodwill and Other Intangible Assets" on January 1, 2002. SFAS No. 142 changed the accounting for goodwill from an amortization method to an impairment-only approach. Amortization of goodwill, including goodwill recorded in past business combinations, ceased upon adoption of this statement. Offsetting this decrease in expense is additional depreciation expense related to property additions since September 30, 2001. Gain (Loss) on Disposition of Assets: During the nine months ended September 30, 2002, we sold certain non-core assets, including several pieces of real estate, for a net loss of $1.9 million. During the nine months ended September 30, 2001, we sold certain non-core assets, including several pieces of real estate, substantially all of our ice production equipment sales and leasing business and one cold storage facility for a net gain of $0.1 million. Gain on Extinguishment of Debt: During the nine months ended September 30, 2002, we purchased and retired 9 3/4% Senior Notes with a total par value of $10.0 million, which resulted in a gain on extinguishment of debt of $1.5 million. Interest Expense: Interest expense increased $1.4 million, from $24.9 million for the nine months ended September 30, 2001 to $26.3 million for the nine months ended September 30, 2002. As a percentage of revenues, interest expense increased from 12.5% for the nine month periods ending September 30, 2001 to 13.7% for the nine months ended September 30, 2002. The dollar increase in interest expense was due to higher payments under our interest rate swap agreement and a higher average interest rate on the term loan included in our amended Credit Facility, offset by lower average borrowings and lower interest rates on the revolving loan under our Credit Facility and lower outstanding balances of our 9 3/4% Senior Notes. Cumulative Effect of Change in Accounting Principle: On January 1, 2002, we adopted SFAS No. 142, "Goodwill and Other Intangible Assets." Adoption of this statement resulted in a charge to net income of $73.2 million (net of $0 tax). LIQUIDITY AND CAPITAL RESOURCES We generate cash from the sale of packaged ice through traditional delivery methods, by which we manufacture, package, and store ice at a central facility and transport it to our customers' retail locations when needed, and through Ice Factories, which manufacture, package and store ice in our customers' retail locations. Our primary uses of cash are (a) cost of sales, (b) operating expenses, (c) debt service, (d) capital expenditures related to acquiring and installing additional Ice Factories and replacing and modernizing our other capital equipment and (e) acquisitions. During May 2002, we resolved all outstanding issues relating to the energy alliance agreement we had with a third party that had filed for bankruptcy in December 2001. In connection with this settlement, we purchased certain fixed assets from the third party. As a result of this settlement, we estimate that our capital 22 expenditures for 2002 will total approximately $14.0 to $14.5 million, which will primarily be used to maintain and expand our traditional ice operations. Through September 30, 2002, we had spent $13.1 million or over 90% of our estimated annual total. There can be no assurance that capital expenditures will not exceed this estimate. We initiated a leasing program for some of our Ice Factory installations in late 1999 and continued to utilize that strategy during 2000 and early 2001. Beginning in the second quarter of 2001, we stopped using operating leases for our Ice Factory installations. Our current annual obligation under these operating leases is approximately $4 million. During 2001, we began a program to redeploy certain machines from locations that generate relatively low profit margins to locations that we anticipate will generate higher margins. We anticipate the continuation of that program throughout 2002. During 2001, we placed 235 new machines, net of removals, and do not expect substantial machine additions, net of removals, in 2002. Any capital expenditures associated with the redeployment program or the placement of new machines are contained within our 2002 capital expenditure plan of $14.0 million to $14.5 million. As we have consolidated acquisitions into the existing company infrastructure, we have identified non-core and excess assets. In 2001, we realized proceeds of approximately $11.0 million as a result of dispositions of non-core assets, excess assets and our traditional ice business in California. We are continuing to market certain excess and non-core assets that we have determined to be disposable and anticipate proceeds of at least $3 million in 2002. In the first nine months of 2002, we experienced a loss and generated positive cash flows from operations in the amount of $21.6 million. At September 30, 2002, we had net working capital of approximately $1.6 million (surplus of $6.2 million exclusive of the line of credit) and had approximately $26.3 million available under our revolving credit facility. Our business is highly seasonal. Although we have experienced a significant increase in positive cash flow from operations, we have reported, and may in the future, report negative cash flows during the first and fourth quarters when the weather is generally cooler. We believe, however, that our overall treasury management of cash on hand and available borrowings under our credit facility will be adequate to meet debt service requirements, fund ongoing capital requirements, and satisfy working capital and general corporate needs. At September 30, 2002, we had approximately $314.8 million of total debt outstanding as follows: o $260.0 million of 9 3/4% senior notes due 2005; o $54.6 million outstanding under our credit facility; and o $0.2 million of other debt, net of debt discount. We have an $88 million senior credit facility (the "Credit Facility"), consisting of a $38 million line of credit (the "Line of Credit") and a $50 million term loan (the "Term Loan"). Principal balances outstanding under the Line of Credit bear interest per annum, at our option, at the London Inter-Bank Offered Rate ("LIBOR") plus 3.5% or the prime rate (as announced from time to time by JPMorgan Chase Bank) plus 1.5%. The outstanding balance of the Line of Credit was $4.6 million at September 30, 2002 and was classified as a current liability because of our intention to use the Line of Credit to fund our working capital. No principal payments are required until the final maturity date of October 31, 2004. Principal balances outstanding under the Term Loan bear interest per annum, at our option, at LIBOR plus 4% or the prime rate plus 2%, with a minimum of 9.5%. At September 30, 2002, the weighted average interest rate of borrowings outstanding under the Credit Facility was 9.19%. Interest is payable monthly. For fiscal years beginning on or after January 1, 2002, there is a mandatory principal payment on the Term Loan equal to 65% of our Excess Cash Flow (as defined in the Credit Facility). This principal payment is due within 10 days of delivery to the lenders of the annual audited financial statements, which may occur no later than 90 days after a fiscal year end. In accordance with the Credit Facility, we have the option of not making the principal payment otherwise required if certain conditions are met and we pay the lenders a fee, the calculation of which is defined in the Credit Facility. Any balances outstanding under the Term Loan are due October 31, 2004. 23 At this time, we anticipate exercising our option to not make the principal payment for 2002. We estimate that the related fee will be approximately $0.3 to $0.4 million, and will be paid in March or April of 2003. The fee will be reflected in our 2002 results of operations. Covenants contained in the Credit Facility and the indenture governing the 9 3/4% senior notes require us to meet certain financial tests, and other restrictions limit our ability to pay dividends, borrow additional funds or to acquire or dispose of assets. All of our assets and the capital stock of all of our significant subsidiaries collateralize the Credit Facility. The 9 3/4% senior notes are generally unsecured obligations, and are senior in right of payment to all existing and future subordinated debt (as defined in the indenture) and pari passu to all of our senior indebtedness. The 9 3/4% senior notes are effectively subordinated to the Credit Facility. The borrowing base under the Line of Credit is comprised of eligible accounts receivable and eligible equipment and in addition, from January 28 to July 31 of each calendar year, a $10 million seasonal overadvance. As of November 4, 2002, our availability under the Line of Credit was approximately $27 million. We anticipate that our availability plus available cash balances will continue to grow throughout the fourth quarter of 2002. We expect this increased availability plus cash balances as the result of higher cash flows from operations associated with the seasonality of our business and lower capital expenditures. On each of January 30, 2002 and June 24, 2002, we purchased and retired 9 3/4% Senior Notes with a par value of $2.5 million. On July 30, 2002, we purchased and retired 9 3/4% Senior Notes with a par value of $5.0 million, for a total of $10 million through September 30, 2002. These purchases resulted in a total gain on extinguishment of debt of $1.5 million. As we generate cash over the remainder of 2002, we will continue to evaluate our options regarding the deployment of any cash flow in excess of the amount we feel will be needed to operate our business through the spring of 2003. Options for deploying excess cash flow include additional purchases of our 9 3/4% senior notes on the open market, additional capital expenditures and acquisitions. At September 30, 2002, we had $7.1 million of standby letters of credit outstanding, primarily to secure certain insurance obligations. In the future, we may be required to increase our letters of credit due to new insurance policies and electricity supply contracts. During 1999 and continuing into 2000, the pace of our acquisition activities slowed significantly and has subsequently ceased with the exception of one small tuck-in acquisition completed in 2001. The decreased acquisition activity is generally due to the decline in the price of our common stock from the time of our initial public offering in January 1999. In 1999, in connection with possible future acquisitions, we filed an "acquisition shelf" registration statement to register the sale of up to five million shares of common stock of which 3,953,780 remain unissued as of September 30, 2002. Although we do not expect to continue to acquire traditional ice companies during 2002 and 2003, we may continue to look at acquisition opportunities as they become available in certain circumstances. We may need to raise additional funds through public or private debt or equity financing to take advantage of opportunities that may become available to us, including acquisitions and more rapid expansion. The availability of such capital will depend upon prevailing market conditions and other factors over which we have no control, as well as our financial condition and results of operations. There can be no assurance that sufficient funds will be available to finance intended acquisitions or capital expenditures to sustain our recent rate of growth. NEW ACCOUNTING PRONOUNCEMENTS On January 1, 2002, we adopted Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and Other Intangible Assets." SFAS No. 142 changed the accounting for goodwill from an amortization method to an impairment-only approach. Amortization of goodwill, including goodwill recorded in past business combinations, ceased upon adoption of this statement. Adoption of this statement resulted in a charge to net income of $73.2 million (net of $0 tax). Prospectively, we will annually evaluate the carrying amount of goodwill associated with our operating segments using a market valuation approach to identify any potential impairment of goodwill. 24 On January 1, 2002, we adopted SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." SFAS No. 144 addresses financial accounting and reporting requirements for the impairment and disposal of long-lived assets. Adoption of this statement did not have a significant effect on our consolidated financial position or results of operations. In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No. 145, "Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections." SFAS No. 145, among other things, amends SFAS No. 4 and SFAS No. 64 to require that gains and losses from the extinguishment of debt generally be classified within continuing operations. The provisions of SFAS No. 145 are effective for fiscal years beginning after May 15, 2002 and early application is encouraged. We adopted SFAS No. 145 on April 1, 2002. As a result of the adoption of this statement, the extraordinary gain on extinguishment of debt reported in the consolidated statement of operations for the quarter ended March 31, 2002 was reclassified to continuing operations in the quarter ended June 30, 2002. In June 2002, the FASB issued SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities." SFAS No. 146 replaces Emerging Issues Task Force (EITF) Issue 94-3, "Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity." This standard requires companies to recognize costs associated with exit or disposal activities when they are incurred rather than at the date of a commitment to an exit or disposal plan. This statement is effective for exit or disposal activities that are initiated after December 31, 2002. We do not believe that the adoption of SFAS 146 will have a significant impact on our consolidated financial position or results of operations. GENERAL ECONOMIC TRENDS AND SEASONALITY Our results of operations are generally affected by economic trends in our market area, but results to date have not been impacted by general inflation or recession trends. If we encounter an extended period of high inflation, we believe we will be able to pass on the higher costs to our customers. However, we cannot be assured that economic trends will not negatively impact our operations in the future. The ice business is highly seasonal. We experience seasonal fluctuations in our net sales and profitability with a disproportionate amount of our net sales and a majority of our net income typically realized in the second and third calendar quarters. We believe that over 60% of our revenues will occur during the second and third calendar quarters when the weather conditions are generally warmer and demand is greater, while less than 40% of our revenues will occur during the first and fourth calendar quarters when the weather is generally cooler. As a result of seasonal revenue declines and the lack of proportional corresponding expense decreases, we will experience lower profit margins and possibly experience losses during the first and fourth calendar quarters. In addition, because our operating results depend significantly on sales during our peak season, our quarterly results of operations may fluctuate significantly if the weather is unusually cool or rainy. RISK FACTORS OUR SUBSTANTIAL DEBT OBLIGATIONS MAY PREVENT US FROM FUNDING PLANNED ACTIVITIES, MAY REQUIRE US TO SEEK ADDITIONAL DEBT OR EQUITY FINANCING, SELL SELECTED ASSETS OR DIMINISH OUR ABILITY TO REACT TO CHANGES IN OUR INDUSTRY. We have financed many of our acquisitions through the issuance of debt, and consequently, we have substantial debt service requirements. At September 30, 2002, our total indebtedness was $314.8 million. Our high level of debt could have important consequences to us, including the following: o A substantial portion of our cash flow must be dedicated to paying interest on our debt. This reduces the level of cash flow available to fund working capital, capital expenditures and acquisitions. 25 o The indenture that governs the 9 3/4% senior notes and the credit agreement for our Credit Facility require us to meet certain financial tests. Additionally, there are other restrictions that limit our ability to pay dividends, borrow additional funds or to dispose of assets. These covenants and restrictions may affect our flexibility in planning for and reacting to changes in our business. o Our high level of debt diminishes our ability to react to changes in general economic, industry and competitive conditions. If we are unable to generate enough cash flow to make debt service payments, we may be required to: o seek additional debt or equity financing, or renegotiate our existing debt arrangements on terms which may be less favorable than our current arrangements; o sell selected assets; or o reduce or delay planned capital expenditures. There can be no assurance that we could accomplish any of these measures. In addition, we will be required to repay or refinance our Credit Facility, 9 3/4% senior notes and potentially our mandatorily redeemable preferred stock between October 31, 2004 and April 15, 2005. No assurances can be given that we will be able to accomplish these repayments or refinancings on acceptable terms and conditions. OUR FAILURE TO SUCCESSFULLY COMPETE COULD ADVERSELY AFFECT OUR PROSPECTS AND FINANCIAL RESULTS. Our businesses are highly competitive. We have many competitors in each of our product, service and geographic markets. Competition in our businesses is based primarily on price and service. If we fail to successfully compete against our competitors, our business will be adversely affected. Winning new customers is important to our future growth, as the overall demand for ice tends to be relatively flat. There are low barriers to entry in the ice industry and we could be adversely affected by any expansion of capacity by our existing competitors or by new entrants in our markets. We could also be adversely affected if our larger grocery or convenience store customers decide to manufacture their own ice. THE SEASONAL NATURE OF THE ICE BUSINESS RESULTS IN LOWER PROFITS, AND EVEN LOSSES, IN THE FIRST AND FOURTH CALENDAR QUARTERS OF THE YEAR. We experience seasonal fluctuations in our sales and profitability with a disproportionate amount of our sales and a majority of our net income typically realized in the second and third calendar quarters when the weather is generally warmer. As a result of these seasonal revenue declines and the lack of a corresponding decrease in expenses during the first and fourth calendar quarters, we will likely experience lower profit margins and possibly even losses during these periods. In addition, because our operating results depend significantly on sales during the second and third calendar quarters, our results of operations during these periods may fluctuate significantly if the weather is unusually cool or rainy. THE RESULTS OF OUR OPERATIONS MAY BE ADVERSELY AFFECTED BY WEATHER. Cold or rainy weather can decrease sales, while extremely hot weather may increase our expenses, each resulting in a negative impact on our operating results and cash flow. Ice consumers, the ultimate users of our products, demand ice for a variety of reasons, but many of them buy ice in connection with outdoor-related activities, both commercial and recreational. As a result, demand for ice increases in hotter, sunnier weather, and conversely, demand decreases in colder, wetter weather. During extended periods of extremely cold and rainy weather on a national basis, our revenues and resulting profits may substantially decline. In addition, extremely hot weather does not necessarily result in greater profits. During extended periods of extremely hot weather, our profits and cash flow may decline because of an increase in expenses in response to excess demand. We may have to transport ice from one plant to another, and in some cases, purchase ice from third party sources and transport it to a specific market to meet this excess demand. 26 THE MARKET VALUE OF OUR COMMON STOCK COULD BE FURTHER ADVERSELY AFFECTED IF WE CONTINUE TO REPORT OPERATING LOSSES. Since our Company was formed in 1990, we have reported substantial net losses. This has been primarily due to the following: o interest expenses primarily associated with our 9 3/4% senior notes and debt under our Credit Facility o substantial depreciation of property, plant and equipment o substantial amortization of goodwill and other intangible assets primarily associated with our acquisitions and market expansion and an impairment charge of $73.2 million that was recognized in connection with the adoption of SFAS 142 on January 1, 2002. As of September 30, 2002, we had an accumulated deficit of $131.0 million and total shareholders' deficit of $17.7 million. We cannot guarantee that we will be profitable in the future. INCREASES IN THE PRICES OF ELECTRICITY, CERTAIN RAW MATERIALS AND OTHER REQUIRED EXPENSES COULD HAVE AN ADVERSE EFFECT ON OUR RESULTS OF OPERATIONS. We use substantial amounts of electricity in connection with our manufacturing process. Over the last three years, we had fixed this cost at rates that were generally lower than market rates by entering into a supply and management agreement with a third party. On December 2, 2001, that third party filed for bankruptcy under Chapter 11 of the United States Bankruptcy Code, thereby breaching its agreement with us. Since that time, we have been paying market rates for electricity that are higher than those under the supply agreement. Through the first nine months of 2002, our electricity costs were $1.9 million higher than the same period in 2001. We anticipate that the annual impact of these higher rates will approximate $2 million. Further increases in market rates could potentially have an adverse impact on our operations. Our business is sensitive to increases in the cost of fuel to operate the refrigerated trucks we use to deliver ice and to increases in the cost of polyethylene, which in turn increases the cost of our bags. We have already experienced increases in fuel costs and health benefits and if the prices for these resources and other required expenses should increase, we will experience increased costs that we may not be able to pass along to our customers. There can be no assurance that significant changes in the prices of plastic bags, water, fuel, insurance or other commodities would not have a material adverse effect on our business, results of operations and cash flow. OUR DEPENDENCE ON A SINGLE MANUFACTURER FOR THE PROPRIETARY BAGGING DEVICE USED IN THE ICE FACTORY EXPOSES US TO A RISK OF NOT MEETING INSTALLATION COMMITMENTS TO CUSTOMERS. A Texas company manufactures our proprietary-bagging device used in the Ice Factory under an exclusive original equipment manufacturing agreement. This device is highly technical in nature, and there can be no assurance that we could quickly locate, or ever locate, alternative sources of supply for the bagging device if this company was unable to meet our requirements. A shortage of the bagging device could restrict our ability to grow by entering new markets through the installation of the Ice Factory. WE MAY BE EXPOSED TO SIGNIFICANT ENVIRONMENTAL LIABILITIES. Our ice manufacturing and storage operations could create conditions that might result in environmental accidents, and cause us to be named as defendants in lawsuits. We currently carry liability insurance that we believe is adequate to cover our losses in these situations. However, this insurance may be insufficient to pay for all or a large part of these losses. If our insurance failed to cover these losses, our profits and our cash flow would decrease. 27 WE MAY NOT HAVE THE ABILITY TO PURCHASE THE 9 3/4% SENIOR NOTES IN THE EVENT OF A CHANGE OF CONTROL. As of September 30, 2002, the majority of our debt consisted of $260.0 million of 9 3/4% senior notes. If there is a change of control of Packaged Ice, such as a merger or sale by us of all or substantially all of our assets, the holders of the 9 3/4% senior notes have the right to require us to purchase the outstanding 9 3/4% senior notes at 101% of the principal amount of the notes plus any accrued and unpaid interest. We may not have the ability to raise the funds necessary to finance the purchase of the 9 3/4% senior notes if the holders require such a purchase. This could result in a default under other debt agreements, including our Credit Facility. CHANGES IN GOVERNMENT LAWS AND REGULATIONS AND COULD HAVE AN ADVERSE EFFECT ON OUR RESULTS OF OPERATIONS. Like any food company, we are subject to various local, state and federal laws relating to many aspects of our business, including labeling, sanitation, health and safety, and manufacturing processes. We cannot predict the types of government regulations that may be enacted in the future by the various levels of government or how existing or future laws or regulations will be interpreted or enforced. The enactment of more stringent laws or regulations or a stricter interpretation of existing laws and regulations may require additional expenditures by us, some of which could be material. ACCIDENTS INVOLVING OUR PRODUCTS AND EQUIPMENT COULD EXPOSE US TO CLAIMS FOR DAMAGES. We are subject to a risk of product liability claims and adverse publicity if a consumer is allegedly harmed while using our products or equipment. Any such claim may result in negative publicity, loss of revenues, or higher costs associated with litigation against Packaged Ice or being named as a defendant in lawsuits asserting large claims. We currently carry product liability insurance that we believe is adequate to cover our losses in these situations. However, this insurance may be insufficient to pay for all or a large part of these losses. If our insurance does not pay for these losses, our results of operations and cash flow would decrease. OUR LIMITED PATENT PROTECTION MAY NOT PREVENT COMPETITORS FROM USING OUR PROPRIETARY BAGGING DEVICE OR DEVELOPING A SIMILAR MACHINE, WHICH COULD REDUCE OUR COMPETITIVE ADVANTAGE. Other than patents that we own or licenses we have on the bagging device in the Ice Factory, we currently do not have patents on any of our products. We believe the patents on the bagging device are important to the Ice Factory as a whole, but there can be no assurance that any issued patent will provide us with a meaningful competitive advantage. It is also our practice to protect certain of our proprietary materials and processes by relying on trade secrets laws and non-disclosure and confidentiality agreements. There can be no assurance that confidentiality or trade secrets will be maintained or that others will not independently develop or obtain access to such materials or processes. WE NOW HAVE A COMPETITOR IN THE ICE FACTORY MARKET, WHICH COULD TAKE SOME OF OUR CUSTOMERS' BUSINESS. As the sole major company using an on-site ice production and delivery system, we had a distinct competitive advantage because the Ice Factory is preferred to traditional ice delivery by many of our high volume customers and the Ice Factory sector of our business gives us more flexibility during peak seasons than our competitors. In 2001, a competitor began testing a similar machine in certain of its markets. If our competitor is successful with the rollout of this system, it is possible that we may lose business we have gained and business we would gain as a result of the Ice Factory, which will result in decreased cash flows and results of operations. 28 ACQUISITIONS MAY RESULT IN THE RECORDING OF GOODWILL AND OTHER INTANGIBLES ASSETS, AND MAY HAVE A NEGATIVE IMPACT ON OUR RESULTS OF OPERATIONS. Although we currently have no plans to do so, if we begin acquiring other businesses again as part of our strategy, such acquisitions could result in the recording of goodwill and other intangibles assets. Goodwill and other intangible assets represented 41.7% of our total assets and exceeded shareholders' deficit by $172.9 million as of September 30, 2002. Accounting principles generally accepted in the United States of America require that acquisitions initiated after June 30, 2001 be accounted for under the purchase method of accounting. Any resulting goodwill will remain on the balance sheet and not be amortized. Furthermore, the amortization of goodwill created by acquisitions prior to June 30, 2001 ceased on December 31, 2001. We will be required to test these assets on an annual basis or whenever there is reason to suspect that their values have been diminished or impaired and write-downs may be necessary, which would increase our losses. The adoption of this accounting principle on January 1, 2002 resulted in an initial impairment charge of $73.2 million. ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK Market risk generally represents the risk that losses may occur in the value of financial instruments as a result of movements in interest rates, foreign currency exchange rates and commodity prices. On November 28, 2000, we entered into an interest rate collar agreement (the "Collar Agreement"). The Collar Agreement has a notional amount of $50 million and a term of 4 years. If the Index Rate (30-day LIBOR, as defined in the Collar Agreement) exceeds 7.75%, we will receive the difference between the Index Rate and 7.75%. If the Index Rate falls below 5.75%, we will pay the difference plus 1%. If we had been required to settle the Collar Agreement as of September 30, 2002, we would have had to pay $5.2 million. We are exposed to some market risk due to the floating interest rates under our Credit Facility. Principal balances outstanding under the Line of Credit bear interest, at our option, at the London Inter-Bank Offered Rate ("LIBOR") plus 3.5% or the prime rate (as announced from time to time by JP Morgan Chase Bank) plus 1.5%. The Term Loan bears interest, at our option, at LIBOR plus 4% or the prime rate plus 2%, with a minimum of 9.5%. As of September 30, 2002, the Credit Facility had an outstanding principal balance of $54.6 million at a weighted average interest rate of 9.19% per annum. Due to our interest rate collar agreement and the fact that the Term Loan has a minimum interest rate of 9.5%, the effect of a change in interest rates on our interest expense depends on the level of LIBOR rates. At September 30, 2002, the 30-day LIBOR rate was 1.82%. The following table shows the approximate annual increase (decrease) in interest expense given the current principal balances of all our debt if LIBOR were to increase by 1% from the levels indicated below:

29 ITEM 4. CONTROLS AND PROCEDURES Within the 90 days prior to the date of filing this Quarterly Report on Form 10-Q, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Exchange Act Rule 15d-14. The evaluation was carried out under the supervision of our Chief Executive Officer and Chief Financial Officer and with the participation of our management group. Based upon that evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that our disclosure controls and procedures are effective in alerting them on a timely basis to material information that is required to be included in our periodic SEC filings. Subsequent to the date of that evaluation, there have been no significant changes in our internal controls or in other factors that could significantly affect internal controls, nor were any corrective actions required with regard to significant deficiencies and material weaknesses. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS We are from time to time party to legal proceedings that arise in the ordinary course of business. We do not believe that the resolution of any threatened or pending legal proceedings will have a material adverse affect on our financial position, results of operations or liquidity. ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS On November 1, 2002, we elected to pay in kind dividends on our 10% exchangeable preferred stock, which totaled 19,349 shares of 10% exchangeable preferred stock and warrants to purchase 148,841 shares of common stock at $13.00 per share. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS None. ITEM 5. OTHER INFORMATION None. 30 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS: The following is a list of exhibits filed as part of this Form 10-Q. Where so indicated by footnote, exhibits, which were previously filed, are incorporated by reference. EXHIBIT NO. DESCRIPTION 99.1+ William P. Brick Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 99.2+ Steven J. Janusek Certification Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. ---------- + Filed herewith. (b) REPORTS ON FORM 8-K: Packaged Ice, Inc. filed a report on Form 8-K with the Securities & Exchange Commission on September 5, 2002, which reported the resignation of one of the Company's directors and the appointment of a new director. 31 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. PACKAGED ICE, INC. Date: November 5, 2002 By: /s/ WILLIAM P. BRICK ------------------------------------ William P. Brick Chief Executive Officer Date: November 5, 2002 By: /s/ STEVEN J. JANUSEK ------------------------------------ Steven J. Janusek Chief Financial and Accounting Officer 32 CERTIFICATION UNDER THE EXCHANGE ACT RULES I , William P. Brick, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Packaged Ice, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 5, 2002 /s/ WILLIAM P. BRICK ----------------------------------------- William P. Brick, Chief Executive Officer 33 CERTIFICATION UNDER THE EXCHANGE ACT RULES I , Steven J. Janusek, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Packaged Ice, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 5, 2002 /s/ STEVEN J. JANUSEK ------------------------------------------ Steven J. Janusek, Chief Financial Officer 34 INDEX TO EXHIBITS

---------- + Filed herewith.

PACKAGED ICE INC 10-Q