Overview

Ingles, a leading supermarket chain in the Southeast, operates 201 supermarkets in Georgia (74), North Carolina (68), South Carolina (36), Tennessee (20), Virginia (2) and Alabama (1). The Company locates its supermarkets primarily in suburban areas, small towns and rural communities. Ingles supermarkets offer customers a wide variety of nationally advertised food products, including grocery, meat and dairy products, produce, frozen foods and other perishables and non-food products, including health and beauty care products and general merchandise, as well as quality private label items. In addition, the Company focuses on selling high-growth, high-margin products to its customers through the development of book sections, media centers, floral departments, premium coffee kiosks, certified organic products, bakery departments and prepared foods including delicatessen sections. During fiscal 2000, the Company began adding fuel centers and pharmacies at select store locations. As of June 27, 2009, the Company operated 69 in-store pharmacies and 65 fuel centers.

Ingles also operates two other lines of business, fluid dairy processing and shopping center rentals. The fluid dairy processing segment sells approximately 34% of its products to the retail grocery segment and approximately 66% of its products to third parties. Real estate ownership (including the shopping center rental segment) is an important component of the Company's operations, providing both operational and economic benefit.

Critical Accounting Policies

Critical accounting policies are those accounting policies that management believes are important to the portrayal of Ingles' financial condition and results of operations, and require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We base our estimates on historical experience and other factors we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the

carrying values of assets and liabilities that are not readily apparent from other sources. As management estimates, by their nature, involve judgment regarding future uncertainties, actual results may differ materially from these estimates.

Self-Insurance

The Company is self-insured for workers' compensation and group medical and dental benefits. Risks and uncertainties are associated with self-insurance; however, the Company has limited its exposure by maintaining excess liability coverage. Self-insurance liabilities are established based on claims filed and estimates of claims incurred but not reported. The estimates are based on data provided by the respective claims administrators. These estimates can fluctuate if historical trends are not predictive of the future. The majority of the Company's properties are self-insured for casualty losses and business interruption; however, liability coverage is maintained.

Asset Impairments

The Company accounts for the impairment of long-lived assets in accordance with Statement of Financial Accounting Standards (SFAS) No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets." For assets to be held and used, the Company tests for impairment using undiscounted cash flows and calculates the amount of impairment using discounted cash flows. For assets held for sale, impairment is recognized based on the excess of remaining book value over expected recovery value. The recovery value is the fair value as determined by independent quotes or expected sales prices developed by internal associates. Estimates of future cash flows and expected sales prices are judgments based upon the Company's experience and knowledge of local operations and cash flows that are projected for several years into the future. These estimates can fluctuate significantly due to changes in real estate market conditions, the economic environment, capital spending decisions and inflation. The Company monitors the carrying value of long-lived assets for potential impairment each quarter based on whether any indicators of impairment have occurred.

Closed Store Accrual

For properties closed prior to December 31, 2002 that were under long-term lease agreements, the present value of any remaining liability under the lease, discounted using risk-free rates and net of expected sublease recovery, is recognized as a liability and expensed. For all store closures subsequent to the adoption of SFAS No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," effective December 31, 2002, the liability is recognized and expensed based on the difference between the present value of any remaining liability under the lease and the present value of the estimated market rate at which the Company expects to be able to sublease the properties. The Company's estimates of market rates are based on its experience, knowledge and typical third-party advice or market data. If the real estate and leasing markets change, sublease recovery could vary significantly from the recoveries originally assumed, resulting in a material change in the Company's recorded liability. The closed store accrual is included in the line item "Accrued expenses and current portion of other long-term liabilities" on the Condensed Consolidated Balance Sheet.

Vendor Allowances

The Company receives funds for a variety of merchandising activities from the many vendors whose products the Company buys for resale in its stores. These incentives and allowances are primarily comprised of volume or purchase based incentives, advertising allowances, slotting fees, and promotional discounts. The purpose of these incentives and allowances is generally to help defray the costs incurred by the Company for stocking, advertising, promoting and selling the vendor's products. These allowances generally relate to short term arrangements with vendors, often relating to a period of a month or less, and are negotiated on a purchase-by-purchase or transaction-by-transaction basis. Whenever possible, vendor discounts and allowances that relate to buying and merchandising activities are recorded as a component of item cost in inventory and recognized in merchandise costs when the item is sold. Due to system constraints and the nature of certain allowances, it is sometimes not practicable to apply allowances to the item cost of inventory. In those instances, the allowances are applied as a reduction of merchandise costs using a rational and systematic methodology, which results in the recognition of these incentives when the inventory related to the vendor consideration received is sold. Vendor allowances applied as a reduction of merchandise costs totaled $26.0 million and $24.1 million for the fiscal quarters ended June 27, 2009 and June 28, 2008, respectively. For the nine-month periods ended June 27, 2009 and June 28, 2008, vendor allowances applied as a reduction of merchandise costs totaled $75.1 million and $74.6 million, respectively. Vendor advertising allowances that represent a reimbursement of specific identifiable incremental costs of advertising the vendor's specific products are recorded as a reduction to the related expense in the period that the related expense is incurred. Vendor advertising allowances recorded as a reduction of advertising expense totaled $3.7 million and $3.4 million for the fiscal quarters ended June 27, 2009 and June 28, 2008, respectively. For the nine-month periods ended June 27, 2009 and June 28, 2008, vendor advertising allowances recorded as a reduction of advertising expense totaled $10.2 million and $10.1 million, respectively.

If vendor advertising allowances were substantially reduced or eliminated, the Company would likely consider other methods of advertising as well as the volume and frequency of its product advertising, which could increase or decrease its expenditures.

Similarly, the Company is not able to assess the impact of vendor advertising allowances on the creation of additional revenues, as it has no way to measure whether such allowances directly generate revenue for its stores.

Uncertain Tax Positions

Despite the Company's belief that its tax positions are consistent with applicable tax laws, the Company believes that certain positions are likely to be challenged by taxing authorities. Settlement of any challenge can result in no change, a complete disallowance, or some partial adjustment reached through negotiations or litigation. Significant judgment is required in evaluating the Company's tax positions. The Company's positions are evaluated in light of changing facts and circumstances, such as the progress of its tax audits as well as evolving case law. Income tax expense includes the impact of position provisions for and changes to uncertain tax positions as the Company considers appropriate. Unfavorable settlement of any particular position would require use of cash. Favorable resolution would be recognized as a reduction to income tax expense at the time of resolution.

Results of Operations

Ingles operates on a 52 or 53-week fiscal year ending on the last Saturday in September. There are 13 and 39 weeks of operations included in the unaudited condensed consolidated statements of income for the three and nine-month periods ended June 27, 2009 and June 28, 2008. Comparable store sales are defined as sales by grocery stores in operation for the entire duration of the previous and current fiscal periods. Sales from replacement stores, major remodels, minor remodels and the addition of fuel stations to existing stores are included in the comparable store sales calculation from the date thereof. A replacement store is a new store that is opened to replace an existing nearby store that is closed. A major remodel entails substantial remodeling of an existing store and may include additional retail square footage. A minor remodel includes repainting, remodeling and updating the lighting and equipment throughout an existing store. For the three and nine-month periods ended June 27, 2009 and June 28, 2008, comparable store sales include 195 and 194 stores, respectively.

The following table sets forth, for the periods indicated, selected financial information as a percentage of net sales. For information regarding the various segments of the business, see Note I "Lines of Business" to the Unaudited Condensed Consolidated Financial Statements.

                                       Three Months Ended                            Nine Months Ended
                              June 27, 2009          June 28, 2008          June 27, 2009          June 28, 2008
Net sales                             100.0 %                100.0 %                100.0 %                100.0 %
Gross profit                           24.6 %                 22.9 %                 24.5 %                 23.2 %
Operating and
administrative expenses                20.5 %                 18.9 %                 20.9 %                 19.3 %
Rental income, net                       -  %                  0.1 %                  0.1 %                  0.1 %
Income from operations                  4.1 %                  4.1 %                  3.7 %                  4.1 %
Other income, net                        -  %                  0.1 %                  0.1 %                  0.1 %
Interest expense                        2.0 %                  1.4 %                  1.8 %                  1.5 %
Loss on early
extinguishment of debt                  1.2 %                   -  %                  0.4 %                   -  %
Income taxes                            0.3 %                  0.8 %                  0.6 %                  1.0 %
Net income                              0.6 %                  1.9 %                  1.0 %                  1.7 %

Three Months Ended June 27, 2009 Compared to the Three Months Ended June 28, 2008

Net income for the third quarter of fiscal 2009 totaled $4.7 million, compared with net income of $16.0 million earned for the third quarter of fiscal 2008. During the third quarter of fiscal 2009, the Company issued $575 million aggregate principal amount of senior notes in a private placement and used a portion of the proceeds to repay existing debt that carried call premiums or prepayment penalties. As a result, the Company incurred debt extinguishment expenses totaling $10.2 million during the third quarter of 2009. Excluding this amount and higher interest expense from increased total debt, income from operations as a percentage of sales was 4.1% and 4.0% for the third quarters of fiscal year 2009 and 2008, respectively.

Net Sales. Net sales decreased 1.0% to $826.8 million for the three months ended June 27, 2009 from $835.3 million for the three months ended June 28, 2008. Excluding gasoline, net sales increased 5.1%. The average retail price of gasoline was approximately $1.50 per gallon lower comparing the third quarter of fiscal 2009 with the previous year. Ingles operated 201 stores at June 27, 2009, compared to 197 stores at June 28, 2008. Retail square footage was approximately 10.7 million at June 27, 2009 and approximately 10.1 million at June 28, 2008.

Sales comparisons are also affected by the timing of the Easter holiday. In fiscal 2008, Easter fell in the Company's second fiscal quarter, but occurred in the Company's third quarter of fiscal year 2009. Excluding gasoline sales and the effect of Easter sales, grocery segment comparable store sales increased 1.9% for the three months ended June 27, 2009 compared with the three months ended June 28, 2008.

Comparable store sales growth excluding gasoline is slightly lower than the Company's recent experience, reflecting the current economic recession and its effect on consumer spending. The number of customer transactions (excluding gasoline) increased 7.8%, while the average transaction size (excluding gasoline) decreased by approximately 1.3%.

Sales by product category (amounts in thousands) are as follows:

                                  Three Months Ended     Three Months Ended
                                    June 27, 2009          June 28, 2008
         Grocery                 $            336,332   $            319,488
         Non-foods                            171,952                158,326
         Perishables                          197,215                185,508
         Gasoline                              95,873                139,759

         Total grocery segment   $            801,372   $            803,081

The grocery category includes grocery, dairy, and frozen foods.

The non-foods include alcoholic beverages, tobacco, pharmacy, health and video.

The perishable category includes meat, produce, deli and bakery.

Changes in grocery segment sales for the quarter ended June 27, 2009 are summarized as follows (dollars in thousands):

  Total grocery sales for the three months ended June 28, 2008       $ 803,081
  Comparable store sales decrease (including gasoline)                 (30,860 )
  Additional Easter sales for the three months ended June 27, 2009       7,546
  Impact of stores opened in fiscal 2008 and 2009                       23,042
  Impact of stores closed in fiscal 2008 and 2009                       (1,424 )
  Other                                                                    (13 )

  Total grocery sales for the three months ended June 27, 2009       $ 801,372

Net sales to outside parties for the Company's milk processing subsidiary decreased $6.9 million or 21.3% in the June 2009 quarter compared to the June 2008 quarter. The sales decrease is attributable to a 33.5% decrease in raw milk costs, which are generally passed on to customers in the pricing of milk products, offset by an increase in the volume of gallons sold.

Gross Profit. Gross profit for the three-month period ended June 27, 2009 increased $12.3 million or 6.4% to $203.4 million, or 24.6% of sales, compared to $191.1 million, or 22.9% of sales, for the three-month period ended June 28, 2008.

The increase in grocery segment gross profit dollars was primarily due to the higher sales volume. Grocery segment gross profit as a percentage of total sales was affected by the influence of gasoline prices and margins. Gasoline prices were significantly lower during the June 2009 quarter compared with the June 2008 quarter. Excluding gasoline sales, grocery segment gross profit as a percentage of sales was 27.6% for the three months ended June 27, 2009 compared to 27.7% for the same quarter of last fiscal year. The Company has responded to the current competitive environment by keeping prices as low as possible in order to grow sales and market share.

Gross profit for the Company's milk processing subsidiary for the June 2009 quarter increased $0.5 million or 10.3% to $5.6 million, or 14.8% of sales, compared to $5.1 million, or 10.9% of sales for the June 2008 quarter. Raw milk prices were significantly lower during the June 2009 quarter, which increased gross profit as a percentage of sales, as relatively stable per-gallon milk profit margins were applied to the lower sales price. Case volume sales increased, providing additional gross profit dollars.

In addition to the direct product cost, the cost of goods sold line item for the grocery segment includes inbound freight charges. The milk processing segment is a manufacturing process; therefore, the costs mentioned above as well as purchasing and receiving costs, production costs, inspection costs, warehousing costs, internal transfer costs, and other costs of distribution incurred by the milk processing segment are included in the cost of sales line item, while these items are included in operating and administrative expenses for the grocery segment.

The Company's gross margins may not be comparable to those of other retailers, since some retailers include all of the costs related to their distribution network in cost of goods sold and others, like the Company, exclude a portion of the costs from gross profit, including the costs instead in a line item such as operating and administrative expenses.

Operating and Administrative Expenses. Operating and administrative expenses increased $11.6 million or 7.4% to $169.7 million for the three months ended June 27, 2009, from $158.1 million for the three months ended June 28, 2008. As a percentage of sales, operating and administrative expenses were 20.5% for the three months ended June 27, 2009 compared to 18.9% for the three months ended June 28, 2008. Excluding gasoline sales and associated gasoline operating expenses (primarily payroll), operating expenses

were 23.1% of sales for the third fiscal 2009 quarter compared to 22.6% for the third fiscal quarter of 2008. In general, the Company's increased store development activities have resulted in higher personnel, depreciation and occupancy costs. Current unfavorable economic conditions have extended the time needed for new and redeveloped stores to reach targeted levels of sales and profitability.

A breakdown of the major increases in operating and administrative expenses is as follows:

                                                             Increase
                                               Increase       as a %
                                              in millions    of sales
             Salaries and wages              $         5.6       0.67 %
             Depreciation and amortization   $         2.8       0.34 %
             Utilities and fuel              $         1.3       0.16 %
             Taxes and licenses              $         1.2       0.14 %
             Warehouse expense               $         1.1       0.13 %

Salaries and wages increased in dollars due to additional labor hours required for the increased sales volume and the accelerated number of new and remodeled stores.

Depreciation and amortization increased as a result of the Company's higher level of capital expenditures.

Utilities and fuel expense increased due to increases in retail square footage.

Taxes and licenses increased due to increased property taxes in many of the Company's markets and the development of new and remodeled stores.

Warehouse expenses increased due to increased deliveries from the Company's warehouse to its stores and from additional labor costs needed to process increased volume of both incoming and outgoing product shipments.

Rental Income, Net. Rental income, net totaled $0.3 million for the June 2009 compared with $0.7 million for the June 2008 quarter. The Company's expansion and relocation activities have resulted in less tenant space available for lease. In addition, current economic conditions have reduced occupancy rates and rent collections.

Other Income, Net. Other income, net totaled $0.4 million and $0.8 million for the three-month periods ended June 27, 2009 and June 28, 2008, respectively. The decrease consists primarily of lower unit sales prices for waste paper and packaging.

Interest Expense. Interest expense increased $4.8 million for the three-month period ended June 27, 2009 to $16.4 million from $11.6 million for the three-month period ended June 28, 2008. Total debt at June 2009 was $855.7 million compared to $666.6 million at June 2008. In May 2009, the Company issued $575.0 million aggregate principal amount of senior notes due in 2017 (the "Notes"). Note proceeds were used to pay off $349.8 million aggregate principal amount of senior subordinated debt maturing in 2011, pay off $45.3 million of indebtedness outstanding under the Company's committed lines of credit, and pay off $77.7 million of secured indebtedness.

Loss on early extinguishment of debt. In conjunction with the payoff of the Company's $349.8 million of senior subordinated debt and $77.7 million of secured indebtedness, the Company incurred call premiums and prepayment penalties totaling $6.8 million and wrote off $3.4 million of unamortized capitalized loan issuance costs associated with the paid off debt.

Income Taxes. Income tax expense as a percentage of pre-tax income increased to 37.5% in the June 2009 quarter compared to 29.9% in the June 2008 quarter. The filing of the Company's fiscal year 2008 income tax return resulted in adjustments to provisions for state taxes and for deferred income taxes that were recorded in the current fiscal quarter.

Net Income. Net income totaled $4.7 million, 0.6% of sales, for the three-month period ended June 27, 2009. Basic and diluted earnings per share for Class A Common Stock were $0.20 and $0.19, respectively, for the June 2009 quarter. Basic and diluted earnings per share for Class B Common Stock were each $0.18 for the June 2009 quarter. Net income totaled $16.0 million, 1.9% of sales, for the three-month period ended June 28, 2008. Basic and diluted earnings per share for Class A Common Stock were $0.68 and $0.65, respectively, for the June 2008 quarter. Basic and diluted earnings per share for Class B Common Stock were each $0.62 for the June 2008 quarter.

Nine Months Ended June 27, 2009 Compared to the Nine Months Ended June 28, 2008

Net income for the first nine months of fiscal 2009 totaled $23.6 million, compared with net income of $41.7 million earned for the first nine months of fiscal 2008. During the third quarter of fiscal 2009, the Company issued $575 million principal amount of senior notes and used a portion of the proceeds to repay existing debt that carried call premiums or prepayment penalties. As a result, the

Company incurred debt extinguishment expenses totaling $10.2 million during the third quarter of 2009. Higher income taxes as a percentage of pre-tax income and higher expenses resulting from the Company's recent higher level of store development activities also contributed to decreased net income during the first nine months of fiscal year 2009.

Net Sales. Net sales for the nine months ended June 27, 2009 increased 1.1% to $2.42 billion, compared to $2.40 billion for the nine months ended June 28, 2008. Excluding gasoline, net sales increased 5.3%. The average retail price of gasoline was approximately $1.18 per gallon lower comparing the nine months of fiscal 2009 with the previous year. Excluding gasoline, sales improved in each product category. The Company believes current economic conditions sales result in a greater amount of in-home dining by customers, including substitution of the Company's ready to eat products instead of restaurant dining.

Grocery segment comparable store sales excluding gasoline for the nine-month period grew $76.9 million, or 3.9%. The number of customer transactions (excluding gasoline) increased 7.2%, while the average transaction size (excluding gasoline) decreased by approximately 18 cents. The Company believes this transaction data may reflect cost-conscious customers dining out less and changing purchasing habits towards lower priced items.

Sales by product category (amounts in thousands) are as follows:

                                   Nine Months Ended     Nine Months Ended
                                     June 27, 2009         June 28, 2008
          Grocery                 $         1,021,869   $           964,513
          Non-foods                           493,407               463,085
          Perishables                         574,371               537,427
          Gasoline                            249,286               333,052

          Total grocery segment   $         2,338,933   $         2,298,077

The grocery category includes grocery, dairy, and frozen foods.

The non-foods include alcoholic beverages, tobacco, pharmacy, health and video.

The perishable category includes meat, produce, deli and bakery.

Changes in grocery segment sales for the nine months ended June 27, 2009 can be summarized as follows (dollars in thousands):

    Total grocery sales for the nine months ended June 28, 2008   $ 2,298,077
    Comparable store sales decrease (including gasoline)               (7,482 )
    Impact of stores opened in fiscal 2008 and 2009                    55,037
    Impact of stores closed in fiscal 2008 and 2009                    (6,695 )
    Other                                                                  (4 )

    Total grocery sales for the nine months ended June 27, 2009   $ 2,338,933

Net sales to outside parties for the Company's milk processing subsidiary decreased $20.5 million or 14.2% in the June 2009 nine-month period compared to the June 2008 nine-month period. The sales decrease is primarily attributable to decreased raw milk costs in the nine-month period ended June 27, 2009 compared to the nine-month period ended June 28, 2008. Raw milk cost decreases are typically passed on to customers in the pricing of milk products. The volume of gallons sold increased over the comparable nine-month periods.

The Company expects sales growth for the remainder of fiscal 2009 to approximate the rate of growth experienced in the first nine months of this fiscal year. Sales growth for the remainder of fiscal year 2009 will be influenced to some extent by market fluctuations in the per gallon price of gasoline and milk, . . .