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Announcement:

MOODY'S AFFIRMS RATINGS OF INGLES MARKETS, INCORPORATED (CORPORATE FAMILY RATING AT B1); OUTLOOK REMAINS STABLE

16 Feb 2006
MOODY'S AFFIRMS RATINGS OF INGLES MARKETS, INCORPORATED (CORPORATE FAMILY RATING AT B1); OUTLOOK REMAINS STABLE

Approximately $350 Million of Debt Securities Affected

New York, February 16, 2006 -- Moody's Investors Service affirmed the ratings of Ingles Markets, Incorporated ("Ingles"), including the corporate family rating of B1, following the company's receipt of a Wells Notice from the Securities and Exchange Commission and following Ingles' disclosure of multiple material weaknesses in its system of controls in its fiscal 2005 Form 10-K. The rating outlook remains stable. The ratings affirmation reflects Moody's belief that Ingles can absorb a moderate civil penalty, if one is incurred as a result of the investigation by the SEC, at its current rating level, which already incorporates Moody's concerns about less than optimum controls and procedures as well as ownership and management concentration in the founding family.

Ratings affirmed:

Corporate family rating at B1

$350 million 8.875% senior subordinated notes due in 2011 at B3

Moody's does not rate any of the company's secured or unsecured bank debt.

In January 2006, the SEC issued a "Wells Notice", indicating that the staff of the SEC intends to recommend that the Commission bring a civil enforcement action against Ingles. The civil enforcement action, which may include a civil penalty, relates to certain vendor contracts entered in 2002 and 2003 and internal control accounting issues that have been the subject of the previously disclosed formal SEC investigation and which resulted in the restatement of the company's financial statements for fiscal years 2002 and 2003 and the first three quarters of fiscal 2004.

In addition, Ingles initial report on the effectiveness of its internal controls over financial reporting, as required under Section 404 of the Sarbanes-Oxley Act of 2002, disclosed multiple "material weaknesses" in the company's system of controls. This report, included in Ingles' fiscal 2005 Form 10-K, discussed material weaknesses in the company's internal controls related to the accounting for vendor income, as well as material control deficiencies related to the basic segregation of duties across accounting functions and information technology general controls. In light of Ingles' recent history of financial statement restatements, the ongoing SEC investigation and turnover in the company's key finance and accounting staff, these material weakness call into question not only management's ability to prepare accurate financial reports but also its ability to control the business. These concerns, which are factored into our current rating, are somewhat mitigated by the company's ongoing remediation efforts which to date have included the creation of an internal audit department and increased training of key accounting personnel.

The Category B material weaknesses, as discussed above, also indicate weaknesses in the quality of corporate governance at Ingles. The nine member Ingles' board has very little independence, in Moody's view; the board includes three family members (two as top executives, the father as CEO and his son as Chairman/Vice President of Operations, and a daughter, a former executive), three senior managers (including the CFO) and three outside directors, only one of whom Moody's considers as independent. CEO Robert Ingle maintains substantial ownership and voting control (50.6 percent of Class A common stock and 95 percent of Class B common stock). The financial restatements, subsequent identification of materials weak nesses and the receipt of a Wells Notice point, in our opinion, to a lack of director oversight on key accounting and financial processes. The loss through resignation of the CFO, the controller and an accounting manager in mid-year 2005 severely hampered remediation efforts.

The ratings of Ingles are based on the company's solid regional franchise, robust comparable store sales growth, modern store base and the application of excess cash flow to debt reduction over the past two fiscal years, as well as the intense competition facing grocery retailers, Ingles' ongoing reliance on bilateral lines of credit, and the previously mentioned corporate governance and control issues.

Ingles' solid market positions in the economically vibrant regions of Georgia, the Carolinas and Tennessee have produced comparable store sales increases that are high for a supermarket chain -- 6.7% for the fiscal year ended in September 2004, 6.1% for fiscal 2005 and 9.8% in the recent first fiscal quarter. Organic sales growth and the quality of its stores have resulted in stable operating margins, before rental income, and cash flow generation sufficient to reduce debt by approximately $76.6 million since the end of fiscal 2003. Ingles' capital expenditures are significant given the company's desire to maintain a modern store base. The negative impact of Ingles' aggressive dividend policy has been somewhat softened by the proceeds from the exercise of stock options recently. Moody's expects that shareholder enhancement will remain a major use of free cash flow. Ingles' reliance on bilateral bank lines of credit of $135 million expiring in October and November 2006, instead of a larger long-term syndicated credit agreement, is also a credit negative for a company of this size. However, the unencumbered book value of the company's large real estate portfolio provides an alternative source of long-term liquidity.

The stable rating outlook reflects Moody's expectation that operating profitability and market share can be maintained and that shareholder enhancement will not increase leverage.

A rating upgrade would require positive free cash flow generation and its application at least partially to debt reduction; maintenance of debt to EBITDA (based on Moody's standard analytical adjustments) below 5 times; the strengthening of the company's liquidity profile by a committed syndicated bank loan facility; remediation of weaknesses in controls; and improvement in corporate governance in terms of a higher proportion of independent directors on Ingles' board.

Conversely, ratings could be lowered if Ingles were to incur a material fine that challenged its financial flexibility; or if a significant deterioration in its franchise or an increase in returns to shareholders caused its credit metrics to weaken such that debt to EBITDA rose above 6 times.

The B3 rating on the senior subordinated notes considers that this debt is contractually subordinated to significant amounts of more senior obligations. The more senior claims are principally comprised of $220 million of mortgages and other secured debt and $135 million of bilateral unsecured credit lines, currently used only for $16.1 million of letters of credit. Given unencumbered real property and equipment value of about $407.6 million at September 24, 2005, Moody's expects that this subordinated debt class has a good level of protection in a distressed scenario.

Ingles Markets, Incorporated, headquartered in Asheville, North Carolina, operates 197 supermarkets principally in Georgia, North Carolina, South Carolina, and Tennessee. Revenue for the fiscal year ended September 24, 2005 exceeded $2.27 billion.

New York
Angela Jameson
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Elaine E. Francolino
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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