UNITED STATES
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, 2004.
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 1-4422
ROLLINS, INC.
(Exact name of registrant as specified in its charter)
Delaware 51-0068479
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2170 Piedmont Road, N.E., Atlanta, Georgia
(Address of principal executive offices)
30324
(Zip Code)
(404) 888-2000
(Registrant's telephone number, including area code)
________________________________
Indicate by check mark 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 [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in rule 12b-2 of the Exchange Act).
Yes [ X ] No [ ]
Rollins, Inc. had 45,670,081 shares of its $1 Par Value Common Stock outstanding
as of October 15, 2004.
ROLLINS, INC. AND SUBSIDIARIES
INDEX
PART I FINANCIAL INFORMATION Page No.
--------------
Item 1. Financial Statements.
Consolidated Statements of Financial Position as of September 30,
2004 and December 31, 2003 2
Consolidated Statements of Income for the Three and Nine Months
Ended September 30, 2004 and 2003 3
Consolidated Statements of Cash Flows for the Nine Months Ended
September 30, 2004 and 2003 4
Notes to Consolidated Financial Statements 5
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations. 11
Item 3. Quantitative and Qualitative Disclosures About Market Risk. 18
Item 4. Controls and Procedures. 18
PART II OTHER INFORMATION
Item 1. Legal Proceedings. 19
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 19
Item 4. Submission of Matters to a Vote of Security Holders. 19
Item 6. Exhibits. 19
SIGNATURES 20
PART I FINANCIAL INFORMATION
Item 1. Financial Statements.
ROLLINS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
(In thousands except share and per share data)
September 30, December 31,
2004 2003
-------------------- ------------------
(Unaudited)
ASSETS
Cash and Cash Equivalents $ 40,894 $ 59,540
Marketable Securities 0 21,866
Trade Receivables, Net of Allowance for
Doubtful Accounts of $5,762 and $4,616,
respectively 63,358 48,471
Materials and Supplies 11,002 9,837
Deferred Income Taxes 21,838 23,243
Other Current Assets 11,283 7,414
-------------------- ------------------
Current Assets 148,375 170,371
Equipment and Property, Net 45,186 35,836
Goodwill 114,333 72,498
Customer Contracts and Other Intangible Assets 79,448 30,333
Deferred Income Taxes 9,701 15,902
Other Assets 30,804 24,964
-------------------- ------------------
Total Assets $ 427,847 $ 349,904
==================== ==================
LIABILITIES
Accounts Payable $ 14,378 $ 12,290
Accrued Insurance 13,049 13,050
Accrued Payroll 38,684 31,019
Unearned Revenue 66,566 46,007
Accrual for Termite Contracts 21,700 21,500
Other Current Liabilities 28,110 21,156
-------------------- ------------------
Current Liabilities 182,487 145,022
Accrued Insurance, Less Current Portion 25,181 26,024
Accrual for Termite Contracts, Less Current Portion 21,684 22,373
Long-Term Accrued Liabilities 19,252 17,711
-------------------- ------------------
Total Liabilities 248,604 211,130
-------------------- ------------------
Contingencies
STOCKHOLDERS' EQUITY
Common Stock, par value $1 per share; 99,500,000
shares authorized; 45,668,269 and 45,156,674
shares issued and outstanding, respectively 45,668 45,157
Additional Paid-In Capital 7,767 4,408
Accumulated Other Comprehensive Loss (313) (314)
Unearned Compensation (3,595) (239)
Retained Earnings 129,716 89,762
-------------------- ------------------
Total Stockholders' Equity 179,243 138,774
-------------------- ------------------
Total Liabilities and Stockholders' Equity $ 427,847 $ 349,904
==================== ==================
The accompanying notes are an integral part of these consolidated financial statements.
2
ROLLINS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(In thousands except per share data)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------- ------------------------------------
2004 2003 2004 2003
---------------- ---------------- ---------------- -----------------
REVENUES
Customer Services $ 202,257 $ 178,262 $ 568,647 $ 518,489
---------------- ---------------- ---------------- -----------------
COSTS AND EXPENSES
Cost of Services Provided 106,748 96,065 297,547 275,549
Depreciation and Amortization 6,249 5,065 16,670 15,258
Sales, General & Administrative 70,080 61,413 193,410 178,101
Gain on Sale of Assets (315) 33 (14,457) (36)
Interest Income (68) (120) (265) (280)
---------------- ---------------- ---------------- -----------------
182,694 162,456 492,905 468,592
---------------- ---------------- ---------------- -----------------
INCOME BEFORE INCOME TAXES 19,563 15,806 75,742 49,897
---------------- ---------------- ---------------- -----------------
PROVISION FOR INCOME TAXES
Current 9,502 4,728 24,413 15,481
Deferred (1,577) 1,278 7,163 3,480
---------------- ---------------- ---------------- -----------------
7,925 6,006 31,576 18,961
---------------- ---------------- ---------------- -----------------
NET INCOME $ 11,638 $ 9,800 $ 44,166 $ 30,936
================ ================ ================ =================
EARNINGS PER SHARE - BASIC $ 0.25 $ 0.22 $ 0.97 $ 0.69
================ ================ ================ =================
EARNINGS PER SHARE - DILUTED $ 0.25 $ 0.21 $ 0.95 $ 0.67
================ ================ ================ =================
Average Shares Outstanding---Basic 45,660 45,115 45,504 45,049
Average Shares Outstanding---Diluted 46,797 45,994 46,731 46,170
DIVIDENDS PER SHARE $ 0.06 $ 0.05 $ 0.18 $ 0.15
================ ================ ================ =================
The accompanying notes are an integral part of these consolidated financial statements.
3
ROLLINS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
(Unaudited)
Nine Months Ended
September 30,
----------------------------------------
2004 2003
------------------ -----------------
OPERATING ACTIVITIES
Net Income $ 44,166 $ 30,936
Adjustments to Reconcile Net Income to Net
Cash Provided by Operating Activities:
Depreciation and Amortization 16,670 15,258
Deferred Income Taxes 7,606 7,748
Other, Net 335 314
Gain on Sale of Assets (14,457) (36)
(Increase) Decrease in Assets, Net of Businesses Acquired:
Trade Receivables (7,980) (4,810)
Materials and Supplies 500 69
Other Current Assets (3,420) (3,565)
Other Non-Current Assets (1,787) (60)
Increase (Decrease) in Liabilities, Net of Businesses
Acquired:
Accounts Payable and Accrued Expenses 12,891 11,727
Unearned Revenue 12,960 6,484
Accrued Insurance (3,103) (1,275)
Accrual for Termite Contracts (865) 668
Long-Term Accrued Liabilities (3,536) (4,724)
------------------ -----------------
Net Cash Provided by Operating Activities 59,980 58,734
------------------ -----------------
INVESTING ACTIVITIES
Sale of Marketable Securities, Net 21,866 (27,000)
Purchases of Equipment and Property (6,707) (8,744)
Acquisitions (103,415) (1,543)
Proceeds From Sale of Assets, Net of Deferred Gain 15,473 0
------------------ -----------------
Net Cash Used in Investing Activities (72,783) (37,287)
------------------ -----------------
FINANCING ACTIVITIES
Dividends Paid (8,187) (6,754)
Other 2,344 2,058
------------------ -----------------
Net Cash Used in Financing Activities (5,843) (4,696)
------------------ -----------------
Net (Decrease) Increase in Cash and Cash Equivalents (18,646) 16,751
Cash and Cash Equivalents At Beginning of Period 59,540 38,315
------------------ -----------------
Cash and Cash Equivalents At End of Period $ 40,894 $ 55,066
================== =================
The accompanying notes are an integral part of these consolidated financial statements.
4
ROLLINS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
NOTE 1. BASIS OF PREPARATION AND OTHER
Basis of Preparation - The consolidated financial statements included
herein have been prepared by Rollins, Inc. (the "Company"), without
audit, pursuant to the rules and regulations of the Securities and
Exchange Commission applicable to quarterly reporting on Form 10-Q.
These consolidated financial statements have been prepared in
accordance with Statement of Financial Accounting Standard No. 94,
Consolidation of All Majority-Owned Subsidiaries ("SFAS 94") and Rule
3A-02(a) of Regulation S-X. In accordance with SFAS 94 and with Rule
3A-02(a) of Regulation S-X, the Company's policy is to consolidate all
subsidiaries and investees where it has voting control. The Company
does not have any subsidiaries or investees where it has less than a
100% equity interest or less than 100% voting control, nor does it
have any interest in other investees, joint ventures, or other
variable interest entities that require consolidation under FASB
interpretation No. 46, Consolidation of Variable Interest Entities
(FIN 46).
Footnote disclosures normally included in financial statements
prepared in accordance with accounting principles generally accepted
in the United States have been condensed or omitted as permitted by
such rules and regulations. These consolidated financial statements
should be read in conjunction with the financial statements and
related notes contained in the Company's annual report on Form 10-K
for the year ended December 31, 2003.
In the opinion of management, the consolidated financial statements
included herein contain all adjustments, consisting of a normal
recurring nature, necessary to present fairly the financial position
of the Company as of September 30, 2004 and December 31, 2003, the
results of its operations for the three and nine months ended
September 30, 2004 and 2003 and cash flows for the nine months ended
September 30, 2004 and 2003. Operating results for the three and nine
months ended September 30, 2004 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2004.
The Company has only one reportable segment, its pest and termite
control business. The Company's results of operations and its
financial condition are not reliant upon any single customer or a few
customers or the Company's foreign operations.
Estimates Used in the Preparation of Consolidated Financial
Statements--The preparation of the consolidated financial statements
in conformity with accounting principles generally accepted in the
United States requires Management to make estimates and assumptions
that affect the amounts reported in the accompanying notes and
financial statements. Actual results could differ from those
estimates.
Cash and Cash Equivalents--The Company considers all investments with
a maturity of three months or less to be cash equivalents. Short-term
investments, all of which are cash equivalents, are stated at cost,
which approximates fair market value.
Marketable Securities--From time to time, the Company maintains
investments held by several large, well-capitalized financial
institutions. The Company's investment policy does not allow
investment in any securities rated less than "investment grade" by
national rating services.
Management determines the appropriate classification of debt
securities at the time of purchase and re-evaluates such designations
as of each balance sheet date. Debt securities are classified as
available-for-sale because the Company does not have the intent to
hold the securities to maturity. Available-for-sale securities are
stated at their fair values, with the unrealized gains and losses, net
of tax, reported as a separate component of stockholders' equity.
Realized gains and losses and declines in value judged to be other
than temporary on available-for-sale securities are included in
interest income. In the first quarter of 2004, the Company sold the
balance of its marketable securities, the proceeds of which were used
to pay the primary portion of the Western Industries, Inc. acquisition
completed in the second quarter of 2004. The cost of securities sold
is based on the specific identification method. Interest and dividends
on securities classified as available-for-sale are included in
interest income. The Company's marketable securities generally consist
of United States government, corporate and municipal debt securities.
Comprehensive Income (Loss)--Other Comprehensive Income (Loss) results
from foreign currency translations and unrealized gain/losses on
marketable securities.
5
New Accounting Standards--In December 2002, the FASB issued
Interpretation No. 46, Consolidation of Variable Interest Entities
("FIN 46"). The Interpretation requires that a variable interest
entity be consolidated by a company if that company is subject to a
majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual
returns or both. The consolidation requirements of FIN 46, as revised,
were effective in 2003 for all variable interest entities created or
acquired after January 31, 2003 and extended the adoption date of FIN
46 (R) to the first quarter of 2004 for variable interest entities
created prior to February 1, 2003. The adoption of FIN 46 did not have
an effect on the Company's financial position or results of
operations.
Franchising Program - Orkin had 49 franchises as of September 30,
2004, including international franchises in Mexico, established in
2000, and Panama, established in 2003. Transactions with franchises
involve sales of customer contracts to establish new franchises,
initial franchise fees and royalties. The customer contracts and
initial franchise fees are typically sold for a combination of cash
and notes due over periods ranging up to 5 years. As of September 30,
2004 and December 31, 2003, notes receivable from franchises
aggregated $5.5 million and $3.9 million, respectively. The Company
recognizes gains from the sale of customer contracts at the time they
are sold to franchises and collection on the notes is reasonably
assured. The gain amounted to approximately $906,000 in the third
quarter of 2004 compared to $131,000 in third quarter of 2003, and is
included as revenues in the accompanying Consolidated Statements of
Income. The Company has recognized gains from the sale of customer
contracts of approximately $1.8 million for the nine months ended
September 30, 2004, as compared to approximately $2.3 million for the
nine months ended September 30, 2003. Initial franchise fees are
deferred for the duration of the initial contract period and are
included as unearned revenue in the Consolidated Statements of
Financial Position. Deferred franchise fees amounted to $1.6 million
and $1.4 million at September 30, 2004 and December 31, 2003,
respectively. Royalties from franchises are accrued and recognized as
revenues as earned on a monthly basis. Revenues from royalties were
$467,000 in the third quarter of 2004 compared to $395,000 in the
third quarter of 2003 and were $1.3 million and $1.1 million for the
nine months ended September 30, 2004 and 2003, respectively. The
Company's maximum exposure to loss relating to the franchises
aggregated $3.9 million and $2.5 million at September 30, 2004 and
December 31, 2003, respectively.
Fair Value of Financial Instruments--The Company's financial
instruments consist of cash, short-term investments, marketable
securities, trade and notes receivables, accounts payable and other
short-term liabilities. The carrying amounts of these financial
instruments approximate their fair values.
Seasonality--The revenues of the Company are affected by the seasonal
nature of the Company's pest and termite control services as evidenced
by the following chart.
Total Net Revenues
------------------------------------------
2004 2003 2002
- --------------------------------------------------------------------------------
First Quarter $158,692 $155,122 $153,302
Second Quarter 207,698 185,105 184,189
Third Quarter 202,257 178,262 174,063
Fourth Quarter N/A 158,524 153,871
- --------------------------------------------------------------------------------
6
NOTE 2. EARNINGS PER SHARE
In accordance with SFAS No. 128, Earnings Per Share ("EPS"), the
Company presents basic EPS and diluted EPS. Basic EPS is computed on
the basis of weighted-average shares outstanding. Diluted EPS is
computed on the basis of weighted-average shares outstanding plus
common stock options outstanding during the year which, if exercised,
would have a dilutive effect on EPS. A reconciliation of the number of
weighted-average shares used in computing basic and diluted EPS is as
follows:
Three Months Ended Nine Months Ended
--------------------------- --------------------------
September 30, September 30,
--------------------------- --------------------------
(In thousands except per share data amounts) 2004 2003 2004 2003
- ----------------------------------------------------------------------------------------------- --------------------------
Basic and diluted earnings available to stockholders
(numerator): $11,638 $ 9,800 $44,166 $30,936
=========================== ==========================
Shares (denominator):
Weighted-average shares outstanding 45,660 45,115 45,504 45,049
Effect of Dilutive securities:
Employee Stock Options 1,137 879 1,227 1,121
--------------------------- --------------------------
Adjusted Weighted-Average Shares and Assumed
Exercises 46,797 45,994 46,731 46,170
Per share amounts:
Basic earnings per common share $0.25 $0.22 $0.97 $0.69
Diluted earnings per common share $0.25 $0.21 $0.95 $0.67
- ----------------------------------------------------------------------------------------------- --------------------------
NOTE 3. CONTINGENCIES
Orkin, one of the Company's subsidiaries, is a named defendant in
Helen Cutler and Mary Lewin v. Orkin Exterminating Company, Inc. et
al. pending in the District Court of Houston County, Alabama. The
plaintiffs in the above mentioned case filed suit in March of 1996
seeking monetary damages and injunctive relief for alleged breach of
contract arising out of alleged missed or inadequate reinspections.
The attorneys for the plaintiff contend that the case is suitable for
a class action and the court ruled that the plaintiffs would be
permitted to pursue a class action lawsuit. The parties have now
agreed to settle this matter and the court has approved an order of
settlement. The Company agreed to pay certain attorney fees, $5,000
each to the two named plaintiffs, and agreed to perform additional
termite reinspections, if requested by individual members of the
class. The Company anticipates that this matter will be concluded in
the near future. In the opinion of Management, the resolution of this
action will not have a material adverse effect on the Company's
financial position, results of operations or liquidity.
Orkin is also a named defendant in Butland et al. v. Orkin
Exterminating Company, Inc. et al. pending in the Circuit Court of
Hillsborough County, Tampa, Florida. The plaintiffs filed suit in
March of 1999 and are seeking monetary damages and injunctive relief.
The Court ruled in early April 2002, certifying the class action
lawsuit against Orkin. Orkin appealed this ruling to the Florida
Second District Court of Appeals which remanded the case back to the
trial court for further findings. Orkin believes this case to be
without merit and intends to defend itself vigorously through trial,
if necessary. At this time, the final outcome of the litigation cannot
be determined. However, in the opinion of Management, the ultimate
resolution of this action will not have a material adverse effect on
the Company's financial position, results of operations or liquidity.
Orkin is involved in certain environmental matters primarily arising
in the normal course of business. In the opinion of Management, the
Company's liability under any of these matters would not materially
affect its financial condition or results of operations.
Orkin has received from the Office of the Florida Attorney General a
subpoena for documents relating to the company's termite work in the
state of Florida. Orkin is cooperating fully with the Office of the
Attorney General.
Additionally, in the normal course of business, Orkin is a defendant
in a number of lawsuits, which allege that plaintiffs have been
damaged as a result of the rendering of services by Orkin personnel
and equipment. Orkin is actively contesting these actions. Certain of
these lawsuits have been filed (Ernest W. Warren and Dolores
7
G. Warren et al. v. Orkin Exterminating Company, Inc., et al.; Francis
D. Petsch, et al. v. Orkin Exterminating Company, Inc. et al.; Bob J.
Stevens v. Orkin Exterminating Company, Inc. and Rollins, Inc.) in
which the Plaintiffs are seeking certification of a class. The cases
originate in Georgia, Florida, and Texas. In the matter of Larry
Hanna, et. al. v. Rollins, Inc. dba Rollins Service Bureau formerly
pending in the District Court for the Northern District of Indiana
(Hammond Division) in which the Plaintiffs were seeking certification
of a class, the plaintiffs have voluntarily dismissed the suit. The
action alleged violations of the Fair Debt Collection Practices Act.
Additionally, an arbitration has been filed in Jacksonville, Florida,
by Cynthia Garrett against Orkin (Cynthia Garrett v. Orkin, Inc.) in
which the plaintiff is seeking certification of a class. The Company
believes all of these cases to be without merit and intends to
vigorously contest certification and defend itself through trial, if
necessary. In the opinion of Management, the outcome of these actions
will not have a material adverse effect on the Company's financial
position, results of operations or liquidity.
NOTE 4. STOCKHOLDERS' EQUITY
During the third quarter and nine months ended September 30, 2004,
approximately 40,000 and 415,000 shares of common stock, respectively,
were issued upon exercise of stock options by employees. As permitted
by SFAS No. 123, Accounting for Stock-Based Compensation, the Company
accounts for employee stock compensation plans using the intrinsic
value method prescribed by Accounting Principles Board Opinion No. 25,
Accounting for Stock Issued to Employees. No stock-based employee
compensation cost is reflected in net income, as all options granted
had an exercise price equal to the market value of the underlying
common stock on the date of grant. The following table illustrates the
effect on net income and earnings per share if the Company had applied
the fair value recognition provisions of FASB Statement No. 123,
Accounting for Stock-Based Compensation, to stock-based employee
compensation.
Three Months Ended Nine Months Ended
September 30 September 30,
-------------------------- ------------------------
(In thousands, except per share data) 2004 2003 2004 2003
------------- ------------ ------------ -----------
Net income, as reported $11,638 $9,800 $44,166 $30,936
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects (202) (483) (606) (1,449)
------------- ------------ ------------ -----------
Pro forma net income $11,436 $9,317 $43,560 $29,487
------------- ------------ ------------ -----------
Earnings per share:
Basic-as reported $0.25 $0.22 $0.97 $0.69
Basic-pro forma $0.25 $0.21 $0.95 $0.65
Diluted-as reported $0.25 $0.21 $0.95 $0.67
Diluted-pro forma $0.24 $0.20 $0.93 $0.64
8
NOTE 5. ACCUMULATED OTHER COMPREHENSIVE LOSS
Accumulated other comprehensive loss consists of the following (in thousands):
Unrealized
Minimum Foreign Loss on
Pension Currency Marketable
Liability Translation Securities Total
- ----------------------------------------------------------------------------------------------------------------
Balance at January 1, 2003 $ (16,182) $ (765) $ -- $ (16,947)
Change during 2003:
Before-tax amount.. 26,079 842 (108) 26,813
Tax benefit (expense) (9,897) (324) 41 (10,180)
---------------------------------------------------------------
16,182 518 (67) 16,633
Balance at December 31, 2003 $ -- $ (247) $ (67) $ (314)
Change during first nine months of 2004:
Before-tax amount.. -- (113) 108 (5)
Tax benefit (expense) -- 47 (41) 6
---------------------------------------------------------------
-- (66) 67 1
---------------------------------------------------------------
Balance at September 30, 2004 $ -- $ (313) $ -- $ (313)
- ----------------------------------------------------------------------------------------------------------------
NOTE 6. ACCRUAL FOR TERMITE CONTRACTS
The Company maintains an accrual for termite contracts representing
the estimated costs of reapplications, repair claims and associated
labor, chemicals, and other costs relative to termite control services
performed prior to the balance sheet date. A reconciliation of the
beginning and ending balances of the accrual for termite contracts is
as follows:
Nine Months Ended
September 30,
-----------------------------
(In thousands) 2004 2003
-----------------------------------------------------------------------------
Beginning Balance $43,873 $46,446
Current Period Provision 11,682 17,596
Settlements, Claims and Expenditures Made
During the Period (12,544) (16,928)
Western 373 0
----------------------------
Ending Balance $43,384 $47,114
-----------------------------------------------------------------------------
NOTE 7. PENSION AND POST-RETIREMENT BENEFIT PLANS
The following represents the net periodic pension benefit costs and
related components in accordance with SFAS 132 ( R ):
Components of Net Pension Benefit Cost
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ------------------------------
(in thousands) 2004 2003 2004 2003
--------------------------------------------------------------------------------------------------------
Service Cost $ 1,297 $ 1,171 $ 3,891 $ 3,513
Interest Cost 2,074 1,950 6,222 5,850
Expected Return on Plan Assets (2,394) (2,123) (7,182) (6,369)
Amortization of:
Prior Service Benefit (217) (217) (651) (651)
Unrecognized Net Loss 845 506 2,535 1,518
-----------------------------------------------------------
Net Periodic Benefit Cost $ 1,605 $ 1,287 $ 4,815 $ 3,861
--------------------------------------------------------------------------------------------------------
9
A contribution of $3.0 million was made to the pension plan in April
2004. The Company may contribute an additional amount up to $5.0
million to the pension plan in 2004.
NOTE 8. RELATED PARTY TRANSACTIONS
On April 28, 2004, the Company sold real estate in Okeechobee County,
Florida to LOR, Inc., a company controlled by R. Randall Rollins,
Chairman of the Board of Rollins, Inc. and Gary W. Rollins, Chief
Executive Officer, President and Chief Operating Officer of Rollins,
Inc. for $16.6 million in cash. The sale resulted in a net gain after
tax of $8.1 million or $0.17 per share since the real estate had
appreciated over approximately 30 years it had been owned by the
Company. The Company deferred a portion of the gain pending the
completion of a survey that may result in the return of a portion of
the proceeds. The real estate was under a lease agreement with annual
rentals of $131,939 that would have expired June 30, 2007. On May 28,
2004, the Company sold real estate in Sussex County, Delaware to LOR,
Inc. for $111,000 in cash. The sale resulted in an immaterial net gain
after tax. The Board of Directors, at its quarterly meeting on January
27, 2004, approved the formation of a committee (the "Committee") made
up of Messrs. Bill J. Dismuke and James B. Williams, who are
independent directors, to evaluate the transactions. In addition, the
Company on October 22, 2004 purchased real estate located at 2158
Piedmont Road, N.E., Atlanta, Georgia 30324, adjacent to the Company's
headquarters, from LOR, Inc. for $4.6 million. The Committee was
furnished with full disclosure of the transactions, including
independent appraisals, and determined that the terms of the
transactions were reasonable and fair to the Company. The Company has
reached an agreement on the sale of an additional piece of real estate
in Sussex County, Delaware to LOR, Inc. or an entity wholly owned by
LOR, Inc. The transaction will take place prior to December 31, 2004
and will result in a gain after taxes. The Company expects a gain of
approximately $10.3 million, net of costs, on the sale of the property
or $.12 to $.13 per share after taxes.
NOTE 9. ACQUISITIONS
On April 30, 2004, the Company acquired substantially all of the
assets and assumed certain liabilities of Western Pest Services
("Western"), and the Company's consolidated financial statements
include the operating results of Western from the date of the
acquisition. Neither Western nor its principals had any prior
relationship with the Company or its affiliates. Western was engaged
in the business of providing pest control services and the Company
intends to continue this business. The acquisition was made pursuant
to an Asset Purchase Agreement (the "Western Agreement") dated March
8, 2004, between Rollins, Inc. and Western Industries, Inc. and
affiliates. The consideration for the assets and certain
noncompetition agreements (the "Purchase Price") was approximately
$106.6 million, including approximately $7.0 million of assumed
liabilities. The Purchase Price was funded with cash on hand, the sale
of property located in Okeechobee County, Florida and a $15.0 million
senior unsecured revolving credit facility.
Pursuant to the Western Agreement, the Company acquired substantially
all of Western's property and assets, including accounts receivable,
real property leases, seller contracts, governmental authorizations,
data and records, intangible rights and property and insurance
benefits. As described in the Western Agreement, the Company assumed
only specified liabilities of Western and obligations under disclosed
assigned contracts.
The Company engaged an independent valuation firm to determine the
allocation of the purchase price to Goodwill and identifiable
Intangible assets. Such valuation resulted in the allocation of $41.3
million to Goodwill and $55.2 million to other intangible assets,
principally customer contracts. The finite-lived intangible assets,
principally customer contracts, are being amortized over periods
principally ranging from 8 to 12.5 years on a straight-lined basis.
On April 30, 2004, in a transaction ancillary to the Western
acquisition, the Company acquired Residex Corporation ("Residex"), a
company that distributes chemicals and other products to pest
management professionals, pursuant to an Asset Purchase Agreement (the
"Residex Agreement") dated March 8, 2004, between Rollins, Inc. and
Western Industries, Inc., JBD Incorporated and Residex Corporation.
Subsequently on April 30, 2004, the Company sold Residex to an
industry distribution group. The amounts involved were not material
and no gain or loss was recognized on the transaction.
Prior to the acquisition, Western Pest Services was recognized as a
premier pest control business and ranked as the 8th largest company in
the industry. Based in Parsippany, NJ, the Company provides pest
elimination and prevention to homes and businesses to over 130,000
customers from New York to Virginia with additional operations in
Georgia and Florida. Western is primarily a commercial pest control
service company and its
10
existing businesses complement most of the services that Orkin offers,
in an area of the country in which Orkin has not been particularly
strong, the Northeast. The Company's consolidated statements of income
include the results of operations of Western for the period beginning
May 1, 2004 through September 30, 2004.
NOTE 10. PRO FORMA FINANCIAL INFORMATION
The pro forma financial information presented below gives effect to
the Western acquisition as if it had occurred as of the beginning of
our fiscal year 2004 and 2003, respectively. The information presented
below is for illustrative purposes only and is not necessarily
indicative of results that would have been achieved if the acquisition
actually had occurred as of the beginning of such years or results
which may be achieved in the future.
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------------- ------------------------------------
2004 2003 2004 2003
---------------- ---------------- ---------------- -----------------
REVENUES
Customer Services $ 202,257 $ 196,515 $ 595,325 $ 574,332
================ ================ ================ =================
INCOME BEFORE INCOME TAXES 19,563 14,510 75,700 46,614
================ ================ ================ =================
NET INCOME $ 11,638 $ 8,996 $ 44,151 $ 28,900
================ ================ ================ =================
EARNINGS PER SHARE - BASIC $ 0.25 $ 0.20 $ 0.97 $ 0.64
================ ================ ================ =================
EARNINGS PER SHARE - DILUTED $ 0.25 $ 0.20 $ 0.94 $ 0.63
================ ================ ================ =================
Average Shares Outstanding---Basic 45,660 45,115 45,504 45,049
Average Shares Outstanding---Diluted 46,797 45,994 46,731 46,170
Item 2. Management's Discussion and Analysis of Financial Condition and
Results of Operations.
Overview
The Company's investment in its new marketing and sales initiatives and
continued emphasis on customer retention as well as the acquisition of Western,
resulted in revenue growth of 13.5% in the third quarter of 2004 compared to the
third quarter of 2003.
For the third quarter of 2004, the Company had net income of $11.6 million, or
$0.25 per diluted share, an 18.8% increase over the prior year's third quarter,
when we reported net income of $9.8 million, or $0.21 per diluted share.
With the large concentration of commercial business acquired as part of the
Western acquisition, the Company's revenue saw a 21.6% increase in Commercial
Pest Control, a 12.6% increase in Residential Pest Control and a 3.6% increase
in Termite. The historical business prior to the Western acquisition increased,
Residential continued its strong showing from last quarter with growth
increasing 7.0%, Commercial increasing 4.6% with a decrease in Termite of 2.8%.
Termite was the service line most impacted by the multiple hurricanes that hit
the southeast, which probably accounted for half of this decline. In total, the
Company estimates that the hurricanes probably cost a minimum of $0.5 million in
lost revenue.
The Company's focus for 2004 has been to increase revenue at a faster rate and
remains on target to achieve this goal. Sales performance continues to improve,
as do customer and employee retention and profitability.
The Company continues to take positive steps to elevate to the next level in
providing world-class service to both residential and commercial customers while
growing revenues and profitability. This is evident through customer retention
and employee productivity improvement.
In early August, the Company signed an agreement with Univar USA whereby Univar
will provide warehouse, logistical and delivery services for Orkin's branches
throughout the United States. Univar had been successfully supplying Orkin's
Pacific Division and the Western Commercial Region for the past year. We expect
the rollout will be completed by year-end.
11
This decision will enable the Company to concentrate even more on its core pest
and termite control business. It will speed up the delivery of products to all
branches, which will result in an improved service support while lowering branch
inventories.
As part of the agreement with Univar, Univar also acquired certain assets of
Dettelbach Pesticide Corp, a wholly owned subsidiary of Orkin. Dettelbach, a
pest control distributor, offered insecticides, termiticides, and equipment to
pest control professionals and previously contributed approximately $3.5 million
in annual revenue to the Company.
The Company believes that the commercial area offers good growth potential and
feels it is uniquely positioned to gain market share of this business segment.
To that end, the Company has initiated an internal "commercial project" that
consists of five action teams working to identify areas in which we might take
commercial pest control capabilities, specifically sales, service and
administration, to an even higher level. The Company is pleased with the early
findings of these teams and we expect the teams to report back by year-end with
their comprehensive recommendations. We expect to begin implementing the
reengineering of our commercial business in 2005, and that this will be a
multi-year undertaking.
This quarter the Company engaged a new public accounting firm, Grant Thornton.
Grant Thornton is a leading global firm dedicated to serving the needs of
middle-market companies, and enjoys an excellent reputation.
The Company has been named among the 200 Best Small Companies in America by
Forbes Magazine in its November 1, 2004 issue. In order to qualify for this
list, companies had to show a consistent pattern of positive growth for the past
five years, have sales between $5 million and $750 million, net profit margins
of greater than 5% and share prices above $5 as of October 1, 2004.
In the Company's residential business area, the focus on market segmentation
continues to provide growth in lead generation, which is driving the residential
growth. This quarter Orkin enjoyed a 7% increase in residential pest control
revenue compared to the third quarter of 2003.
The Company continues to see lead increases in general through its interactive
website. The Company was negatively impacted with respect to sales and leads in
some of its Southeast markets due to the multiple hurricanes.
The Company's regional call centers are also continuing to have a positive
impact on processing phone leads with an improving closure rate. We continued to
roll more regions into the centers, and we estimate that 75% of all leads will
be handled through a network of regional call centers next year.
The Company's Gold Medal program, Orkin's pest control offering to food
processors and manufacturers, is continuing to add prestigious accounts. The
Company continues to improve its handheld computer capabilities, which is
critical to these customers.
The Company is in the early stages of the educational projects that it is
co-developing with the Centers for Disease Control and Prevention (CDC) and look
forward to reporting on the work being done with them over the next 12 months.
The Company's mosquito offering provided modest progress this past summer. The
Company continues to learn from their experiences in their sales and marketing
approach in this area. One key learning experience is that without the
accompanying imminent threat of potential disease, (West Nile Virus), as opposed
to prevention, sales become a challenge. The 2004 season was unusual in that the
West Nile incidents were in areas of the country that were not typical and were
not covered in the Company's tests. It also becomes important to make better use
of technicians to inform our customers about add-on offerings to build value and
revenue.
The Company's people remain its most important asset and the Company continues
to invest in providing them with superior training to provide the highest
quality service to customers. The Company recently expanded its award winning
training facility, adding a designated commercial service area that replicates
some of the typical customer facilities including a commercial kitchen, bakery,
hospital room, supermarket, motel room and warehouse space. The Company's total
training space is now 27,000 square feet. The Company has also begun
construction of a media and video studio facility.
The financial results for the third quarter of 2004 were positively impacted by
the continued benefit of recent service and sales and marketing initiatives,
which included every-other-month residential pest control service, Gold Medal
premium commercial pest control services, the investment in Business Development
Managers for every Orkin division, the Commercial Pest Control Quality Assurance
Program, termite directed liquid and baiting treatment, and the creation of or
enhancement of regional call centers, which have enabled better accountability
over leads and better coordination of scheduling starts for new customers.
12
Gross margin for the quarter improved to 47.2%, compared to 46.1% for the third
quarter of 2003. While the Company enjoys continued productivity improvements at
Orkin, the driver in margin improvement was a significant reduction in
insurance, litigation and claims expense. The Company has stressed for the last
several years the various improvements made with regard to termite work and the
Company is continuing to see the cumulative impact of the numerous initiatives
taken. Year-to-date actual claim payments have decreased approximately 28% or
almost $4.8 million from last year. The number of both new and open claims
continues to decline significantly. This reduction was partially offset by
property damage incurred during the various hurricanes this year. The uninsured
portion is currently estimated and recorded at $0.8 million.
Fleet costs increased $0.7 million due to recent increases in oil prices. The
Company experienced a 16.7% increase in the average gas price per gallon over
last year. The Company was able to temper some of the increase by reducing the
average number of miles driven per vehicle per month by over 7%.
Lastly, the Company recorded approximately $1.0 million in additional benefit
costs related to the vacation accrual. The Company just completed programming
and testing this past quarter of a project to centralize and standardize record
keeping of vacation and the resulting liability was greater than previously
estimated.
Results of Operations
% Better/ % Better/
Three Months Ended (Worse) as Nine Months Ended (Worse) as
September 30, Compared to September 30, Compared to
Prior Year Prior Year
------------------------ --------------- --------------------------- ---------------
(in thousands) 2004 2003 2004 2004 2003 2004
------------ ----------- --------------- --------------- ----------- ---------------
Revenues $202,257 $178,262 13.5% $568,647 $518,489 9.7%
Cost of Services Provided 106,748 96,065 (11.1) 297,547 275,549 (8.0)
Depreciation and Amortization 6,249 5,065 (23.4) 16,670 15,258 (9.3)
Sales, General and Administrative 70,080 61,413 (14.1) 193,410 178,101 (8.6)
Gain on Sale of Assets (315) 33 N/M (14,457) (36) N/M
Interest Income (68) (120) (43.3) (265) (280) (5.4)
------------ ----------- --------------- --------------- ----------- ---------------
Income Before Income Taxes 19,563 15,806 23.8 75,742 49,897 51.8
Provision for Income Taxes 7,925 6,006 (32.0) 31,576 18,961 (66.5)
------------ ----------- --------------- --------------- ----------- ---------------
Net Income $ 11,638 $ 9,800 18.8% $ 44,166 $ 30,936 42.8%
============ =========== =============== ===========
Revenues for the quarter ended September 30, 2004 increased to $202.3 million,
an increase of $24.0 million or 13.5%, inclusive of the Western acquisition
completed on April 30, 2004, from last year's third quarter revenues of $178.3
million. For the third quarter of 2004 the primary revenue driver was the
acquisition of Western, which contributed $17.6 million during the quarter as
well as the residential pest control business, which grew at 7.0%. The Company's
movement over the last year to regional incoming call centers has led to greater
efficiency in the handling and capturing of calls and with the improved closure,
greater sales and revenue. Every-other-month service, our primary residential
pest control service offering, continues to grow in importance, comprising 57.9%
of our residential pest control customer base at September 30, 2004. Revenues
for the nine month period ended September 30, 2004 increased to $568.6 million,
an increase of $50.2 million or 9.7% from last year's first nine month period
revenues of $518.5 million. The Company's foreign operations accounted for
approximately 7% of total third quarter revenues in both 2004 and 2003.
The revenues of the Company are affected by the seasonal nature of the Company's
pest and termite control services as evidenced by the following chart.
Total Net Revenues
---------------------------------------
2004 2003 2002
- --------------------------------------------------------------------------------
First Quarter $158,692 $155,122 $153,302
Second Quarter 207,698 185,105 184,189
Third Quarter 202,257 178,262 174,063
Fourth Quarter N/A 158,524 153,871
- --------------------------------------------------------------------------------
13
Cost of Services Provided for the third quarter ended September 30, 2004
increased $10.7 million or 11.1%, although the expense expressed as a percentage
of revenues decreased by 1.1 percentage points, representing 52.8% of revenues
for the third quarter 2004 compared to 53.9% of revenues in the prior year third
quarter. For the first nine months of 2004, Cost of Services Provided increased
$22.0 million or 8.0%, and, as a percentage of revenues, improved by 0.8
percentage points, representing 52.3% of revenues for the first nine months of
2004 compared to 53.1% of revenues in the prior year. Cost of Services Provided
as a percentage of revenues decreased primarily due to continuing improvements
in insurance and claims, as well as continued employee productivity improvements
at Orkin. These were partially offset by Western's higher Cost of Services
Provided as a percentage of revenues. One area in which the Company experienced
some minor expense increases was fleet, which was the result of higher lease,
fuel and the cost of the Western fleet.
Sales, General and Administrative for the third quarter ended September 30, 2004
increased $8.7 million or 14.1% and, as a percentage of revenues, had a slight
increase of 0.1 percentage points or 0.3%, representing 34.6% of total revenues
compared to 34.5% for the prior year quarter. For the first nine months of 2004,
Sales, General and Administrative increased $15.3 million or 8.6%, while margins
improved by 0.4 percentage points, representing 34.0% of revenues for the first
nine months of 2004 compared to 34.4% of revenues in the prior year. The
decrease in Sales, General and Administrative as a percentage of revenue was
mainly attributable to the discontinuation of an ineffective advertising
campaign that was conducted in Canada in 2003. The savings were partially offset
by the higher Sales, General and Administrative costs of Western.
Depreciation and Amortization expenses for the third quarter ended September 30,
2004 were $1.2 million or 23.4% higher than the prior year quarter. For the
first nine months of 2004, Depreciation and Amortization expenses were
approximately $1.4 million or 9.3% higher than the prior year. The increase was
due to the addition of depreciation and amortization from the acquisition of
Western partially offset by lower capital spending and certain technology assets
becoming fully depreciated in the last twelve months. As part of the Western
acquisition, $55.2 million of finite-lived intangible assets, principally
customer contracts, were acquired. They will be amortized over periods
principally ranging from 8 to 12.5 years. This represents a non-cash charge and
will increase our amortization by approximately $6.0 million to approximately
$12.8 million per year. For the third quarter ended September 30, 2004
amortization of $3.2 million was 80.8% higher that the prior period quarter. For
the first nine months of 2004, amortization of $7.6 million was 61.8% higher
that the prior year.
Income Taxes. The Company's tax provision of $7.9 million for the third quarter
ended September 30, 2004 reflects increased pre-tax income over the prior year
period and an increase in the effective tax rate. The effective tax rate was
40.5% for the third quarter ended September 30, 2004, up from 38.0% for the
third quarter ended September 30, 2003. The increase reflects increases in the
Company's effective state income tax rate, as well as the impact of permanent
differences associated with the Company's Canadian operations.
Critical Accounting Policies
We view critical accounting policies to be those policies that are very
important to the portrayal of our financial condition and results of operations,
and that require Management's most difficult, complex or subjective judgments.
The circumstances that make these judgments difficult or complex relate to the
need for Management to make estimates about the effect of matters that are
inherently uncertain. We believe our critical accounting policies to be as
follows:
Accrual for Termite Contracts--The Company maintains an accrual for termite
contracts representing the estimated costs of reapplications, repair claims,
associated labor and chemicals, settlements, awards and other costs relative to
termite control services performed prior to the balance sheet date. The Company
contracts an independent third party actuary on an annual basis to provide the
Company an estimate of the liability based upon historical claims information
for the largest portion of the accrual. In addition, Management estimates and
accrues for costs outside the scope of the actuarial study including the
estimated costs of retreatments, representing costs to be incurred that are
estimatable at the balance sheet date, as well as liability and costs associated
with claims in litigation. The actuarial study and historical experience are
major considerations in determining the accrual balance, along with Management's
knowledge of changes in business practices, contract changes, ongoing claims,
and termite remediation trends. The accrual is established based on all these
factors. Management makes judgments utilizing these operational and other
factors but recognizes that they are inherently subjective due to the difficulty
in predicting settlements and awards. Other factors that may impact future cost
include chemical life expectancy and government regulation. It is significant
that the actual number of claims has decreased in recent years due to changes in
the Company's business practices. However, it is not possible to accurately
predict future significant claims. Positive changes to our business practices
include revisions made to our contracts, more effective treatment methods that
include a directed-liquid baiting program, more effective termiticides, and
expanded training methods and techniques.
14
Accrued Insurance--The Company self-insures, up to specified limits, certain
risks related to general liability, workers' compensation and vehicle liability.
The estimated costs of existing and future claims under the self-insurance
program are accrued based upon historical trends as incidents occur, whether
reported or unreported (although actual settlement of the claims may not be made
until future periods) and may be subsequently revised based on developments
relating to such claims. The Company contracts an independent third party
actuary on an annual basis to provide the Company an estimated liability based
upon historical claims information. The actuarial study is a major
consideration, along with Management's knowledge of changes in business
practices and existing claims compared to current balances. The reserve is
established based on all these factors. Management's judgment is inherently
subjective and a number of factors are outside Management's knowledge and
control. Additionally, historical information is not always an accurate
indication of future events. It should be noted that the number of claims has
been decreasing due to the Company's proactive risk management to develop and
maintain ongoing programs. Initiatives that have been implemented include
pre-employment screening and an annual motor vehicle report required on all its
drivers, utilization of a Global Positioning System that has been fully deployed
to our Company vehicles, post-offer physicals for new employees, and pre-hire,
random and post-accident drug testing. The Company has improved the time
required to report a claim by utilizing a "Red Alert" program that provides
serious accident assessment twenty four hours a day and seven days a week and
has instituted a modified duty program that enables employees to go back to work
on a limited-duty basis.
Revenue Recognition--The Company's revenue recognition policies are designed to
recognize revenues at the time services are performed. For certain revenue
types, because of the timing of billing and the receipt of cash versus the
timing of performing services, certain accounting estimates are utilized.
Residential and commercial pest control services are primarily recurring in
nature on a monthly or bi-monthly basis, while certain types of commercial
customers may receive multiple treatments within a given month. In general, pest
control customers sign an initial one-year contract, and revenues are recognized
at the time services are performed. For pest control customers, the Company
offers a discount for those customers who prepay for a full year of services.
The Company defers recognition of these advance payments and recognizes the
revenue as the services are rendered. The Company classifies the discounts
related to the advance payments as a reduction in revenues. Termite baiting
revenues are recognized based on the delivery of the individual units of
accounting. At the inception of a new baiting services contract upon quality
control review of the installation, the Company recognizes revenue for the
delivery of the monitoring stations, initial directed liquid termiticide
treatment and installation of the monitoring services. The amount deferred is
the fair value of monitoring services to be rendered after the initial service.
The amount deferred for the undelivered monitoring element is then recognized as
income on a straight-line basis over the remaining contract term, which results
in recognition of revenue in a pattern that approximates the timing of
performing monitoring visits. Baiting renewal revenue is deferred and recognized
over the annual contract period on a straight-line basis that approximates the
timing of performing the required monitoring visits. Traditional termite
treatments are recognized as revenue at the time services are performed.
Traditional termite contract renewals are recognized as revenues at the renewal
date in order to match the revenue with the approximate timing of the
corresponding service provided. Interest income on installment receivables is
accrued monthly based on actual loan balances and stated interest rates.
Franchise fees are treated as unearned revenue in the Statement of Financial
Position for the duration of the initial contract period. Royalties from Orkin
franchises are accrued and recognized as revenues as earned on a monthly basis.
Gains on sales of pest control customer accounts to franchises are recognized at
the time of sale and when collection of the proceeds under notes are reasonably
assured.
Contingency Accruals--The Company is a party to legal proceedings with respect
to matters in the ordinary course of business. In accordance with Statement of
Financial Accounting Standards No. 5, Accounting for Contingencies, the Company
estimates and accrues for its liability and costs associated with the
litigation. Estimates and accruals are determined in consultation with outside
counsel. It is not possible to accurately predict the ultimate result of the
litigation. However, in the opinion of Management, the outcome of the litigation
will not have a material adverse impact on the Company's financial condition or
results of operations.
Liquidity and Capital Resources
Cash and Cash Flow
Nine Months Ended September 30,
---------------------------------------
(in thousands) 2004 2003
- --------------------------------------------------------------------------------
Net Cash Provided by Operating Activities $ 59,980 $ 58,734
Net Cash Used in Investing Activities (72,783) (37,287)
Net Cash Used in Financing Activities (5,843) (4,696)
---------- ----------
Net Increase/(Decrease) in Cash and Cash
Equivalents $ (18,646) $ 16,751
- --------------------------------------------------------------------------------
15
The Company believes its current cash and cash equivalents balances, future cash
flows from operating activities and available borrowings under its $70.0 million
credit facilities will be sufficient to finance its current operations and
obligations, and fund expansion of the business for the foreseeable future and
the acquisition of other select pest control businesses. The Company's operating
activities generated cash of $60.0 million for the first nine months ended
September 30, 2004, compared with cash provided by operating activities of $58.7
million for the same period in 2003. Cash flows from operating activities in
2004 were relatively consistent with 2003.
The Company invested approximately $6.7 million in capital expenditures during
the first nine months ended September 30, 2004, compared to $8.7 million during
the same period in 2003, and expects to invest between $2.0 million and $3.0
million for the remainder of 2004. Capital expenditures for the first nine
months consisted primarily of the purchase of equipment replacements and
upgrades and improvements to the Company's management information systems.
During the first nine months, the Company made acquisitions totaling $103.4
million, compared to $1.5 million during the same period in 2003. Acquisitions
were primarily funded by cash on hand, sales of marketable securities of
approximately $21.9 million, proceeds from sale of assets and borrowings under a
senior unsecured revolving credit facility (See below for further discussion). A
total of $8.2 million was paid in cash dividends ($0.18 per share) during the
first nine months of 2004, compared to $6.8 million or $0.15 per share during
the same period in 2003. The Company did not repurchase any shares of Common
Stock in the first nine months of 2004 and there remain 649,684 shares
authorized to be repurchased. The capital expenditures and cash dividends were
funded entirely through existing cash balances and operating activities. The
Company maintains $70.0 million of credit facilities with commercial banks, of
which no borrowings were outstanding as of September 30, 2004 or October 15,
2004. The Company maintains approximately $33.5 million in Letters of Credit
which reduced its borrowing capacity under the credit facilities. These Letters
of Credit are required by the Company's fronting insurance companies and/or
certain states, due to the Company's self-funded status, to secure various
workers' compensation and casualty insurance contracts. These letters of credit
are established by the bank for the Company's fronting insurance companies as
collateral, although the Company believes that it has adequate liquid assets,
funding sources and insurance accruals to accommodate such claims.
On April 28, 2004, the Company entered into a $15.0 million senior unsecured
revolving credit facility. The entire amount of the credit facility was used to
fund a portion of the Western Industries, Inc. acquisition that the Company
closed on April 30, 2004. The Company repaid the full amount of the credit
facility in May 2004.
On April 28, 2004, the Company sold real estate in Okeechobee County, Florida to
LOR, Inc., a company controlled by R. Randall Rollins, Chairman of the Board of
Rollins, Inc. and Gary W. Rollins, Chief Executive Officer, President and Chief
Operating Officer of Rollins, Inc. for $16.6 million in cash. The sale resulted
in a net gain after tax of $8.1 million or $0.17 per share since the real estate
had appreciated over approximately 30 years it had been owned by the Company.
The Company deferred an immaterial portion of the gain pending the completion of
a survey that may result in the return of a portion of the proceeds. The real
estate was under a lease agreement with annual rentals of $131,939 that would
have expired June 30, 2007. On May 28, 2004, the Company sold real estate in
Sussex County, Delaware to LOR, Inc. for $111,000 in cash. The sale resulted in
an immaterial net gain after tax. The Board of Directors, at its quarterly
meeting on January 27, 2004, approved the formation of a committee (the
"Committee") made up of Messrs. Bill J. Dismuke and James B. Williams, who are
independent directors, to evaluate the transactions. In addition, the Company on
October 22, 2004 purchased real estate located at 2158 Piedmont Road, N.E.,
Atlanta, Georgia 30324, adjacent to the Company's headquarters, from LOR, Inc.
for $4.6 million. During a Board of Directors meeting on October 20, 2004, the
Committee was furnished with full disclosure of the transactions, including
independent appraisals, and determined that the terms of the transactions were
reasonable and fair to the Company. The Committee was furnished with full
disclosure of the transactions, including independent appraisals, and determined
that the terms of the transactions were reasonable and fair to the Company. The
Company has reached an agreement on the sale of an additional piece of real
estate in Sussex County, Delaware to LOR, Inc. or an entity wholly owned by LOR,
Inc. The transaction will take place prior to December 31, 2004 and will result
in a substantial gain of approximately $10.3 million, net of costs, on the sale
of the property or $.12 to $.13 per share after taxes.
On April 30, 2004, the Company acquired substantially all of the assets and
assumed certain liabilities of Western Pest Services ("Western"), and the
Company's consolidated financial statements include the operating results of
Western from the date of the acquisition. Neither Western nor its principals had
any prior relationship with the Company or its affiliates. Western was engaged
in the business of providing pest control services and the Company intends to
continue this business. The acquisition was made pursuant to an Asset Purchase
Agreement (the "Western Agreement") dated March 8, 2004, between Rollins, Inc.
and Western Industries, Inc. and affiliates. The consideration for the assets
and certain noncompetition agreements (the "Purchase Price") was for
approximately $106.6 million, including approximately $7.0 million of assumed
liabilities. The Purchase Price was funded with cash on hand, the sale of
property located in Okeechobee County, Florida and a $15.0 million senior
unsecured revolving credit facility.
16
Pursuant to the Western Agreement, the Company acquired substantially all of
Western's property and assets, including accounts receivable, real property
leases, seller contracts, governmental authorizations, data and records,
intangible rights and property and insurance benefits. As described in the
Western Agreement, the Company assumed only specified liabilities of Western and
obligations under disclosed assigned contracts.
The Company engaged an independent valuation firm to determine the allocation of
the purchase price to Goodwill and identifiable Intangible assets. Such
valuation resulted in the allocation of $41.3 million to Goodwill and $55.2
million to other intangible assets, principally customer contracts. The
finite-lived intangible assets, principally customer contracts, are being
amortized over periods principally ranging from 8 to 12.5 years on a
straight-lined basis.
On April 30, 2004, in a transaction ancillary to the Western acquisition, the
Company acquired Residex Corporation ("Residex"), a company that distributes
chemicals and other products to pest management professionals, pursuant to an
Asset Purchase Agreement (the "Residex Agreement") dated March 8, 2004, between
Rollins, Inc. and Western Industries, Inc., JBD Incorporated and Residex
Corporation. Subsequently on April 30, 2004, the Company sold Residex to an
industry distribution group. The amounts involved were not material and no gain
or loss was recognized on the transaction.
Prior to the acquisition, Western Pest Services was recognized as a premier pest
control business and ranked as the 8th largest company in the industry. Based in
Parsippany, NJ, the Company provides pest elimination and prevention to homes
and businesses to over 130,000 customers from New York to Virginia with
additional operations in Georgia and Florida. Western is primarily a commercial
pest control service company and its existing businesses complement most of the
services that Orkin offers, in an area of the country in which Orkin has not
been particularly strong, the Northeast. The Company's consolidated statements
of income include the results of operations of Western for the period beginning
May 1, 2004 through September 30, 2004.
Orkin, one of the Company's subsidiaries, is aggressively defending a class
action lawsuit filed in Hillsborough County, Tampa, Florida. In early April
2002, the Circuit Court of Hillsborough County certified the class action status
of Butland et al. v. Orkin Exterminating Company, Inc. et al. Orkin is also a
named defendant in Helen Cutler and Mary Lewin v. Orkin Exterminating Company,
Inc. et al. pending in the District Court of Houston County, Alabama. The
plaintiffs in the above mentioned case filed suit in March of 1996 seeking
monetary damages and injunctive relief for alleged breach of contract arising
out of alleged missed or inadequate reinspections. The attorneys for the
plaintiff contend that the case is suitable for a class action and the court
ruled that the plaintiffs would be permitted to pursue a class action lawsuit.
The parties have now agreed to settle this matter and the court has approved an
order of settlement. The Company agreed to pay certain attorney fees, $5,000
each to the two named plaintiffs, and agreed to perform additional termite
reinspections, if requested by individual members of the class. The Company
anticipates that this matter will be concluded in the near future. In the
opinion of Management, the resolution of this action will not have a material
adverse effect on the Company's financial position, results of operations or
liquidity. Other lawsuits or arbitrations against Orkin, and in some instances
the Company, are also being vigorously defended, including the Warren, Petsch,
and Stevens cases and the Garrett arbitration. The matter of Larry Hanna, et.
al. v. Rollins, Inc. dba Rollins Service Bureau formerly pending in the District
Court for the Northern District of Indiana (Hammond Division) has been
dismissed. For further discussion, see Note 3 to the accompanying financial
statements.
A contribution of $3.0 million was made to the pension plan in April 2004. The
Company may contribute an additional amount up to $5.0 million to the pension
plan in 2004. In the opinion of Management, additional Plan contributions will
not have a material effect on the Company's financial position, results of
operations or liquidity.
Impact of Recent Accounting Pronouncements
In December 2002, the FASB issued Interpretation No. 46, Consolidation of
Variable Interest Entities ("FIN 46"). The Interpretation requires that a
variable interest entity be consolidated by a company if that company is subject
to a majority of the risk of loss from the variable interest entity's activities
or entitled to receive a majority of the entity's residual returns or both. The
consolidation requirements of FIN 46, as revised, were effective in 2003 for all
variable interest entities created or acquired after January 31, 2003 and
extended the adoption date of FIN 46 (R) to the first quarter of 2004 for
variable interest entities created prior to February 1, 2003. The adoption of
FIN 46 did not have an effect on the Company's financial position or results of
operations (see Note 1 to the accompanying financial statements).
17
Forward-Looking Statements
This Quarterly Report contains statements that constitute "forward-looking
statements" within the meaning of the Private Securities Litigation Reform Act
of 1995. The actual results of the Company could differ materially from those
indicated by the forward-looking statements because of various risks and
uncertainties, including without limitation, general economic conditions; market
risk; changes in industry practices or technologies; the degree of success of
the Company's pest and termite process reforms and pest control selling and
treatment methods; the Company's ability to identify potential acquisitions;
climate and weather trends; competitive factors and pricing practices; the cost
reduction benefits of the corporate restructuring may not be as great as
expected or eliminated positions may have to be reinstated in the future;
expected benefits of the commercial division re-eingeering may not be realized,
potential increases in labor costs; uncertainties of litigation; and changes in
various government laws and regulations, including environmental regulations.
All of the foregoing risks and uncertainties are beyond the ability of the
Company to control, and in many cases the Company cannot predict the risks and
uncertainties that could cause its actual results to differ materially from
those indicated by the forward-looking statements. A more detailed discussion of
potential risks facing the Company can be found in the Company's Report on Form
10-K filed with the Securities and Exchange Commission for the year ended
December 31, 2003.
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
As of September 30, 2004, the Company maintained an investment portfolio subject
to short-term interest rate risk exposure. The Company has been affected by the
impact of lower interest rates on interest income from its short-term
investments. The Company is also subject to interest rate risk exposure through
borrowings on its $70.0 million credit facilities. Due to the absence of such
borrowings as of September 30, 2004, this risk was not significant in the first
nine months of 2004 and is not expected to have a material effect upon the
Company's results of operations or financial position going forward. The Company
is also exposed to market risks arising from changes in foreign exchange rates.
The Company believes that this foreign exchange rate risk will not have a
material effect upon the Company's results of operations or financial position
going forward.
Item 4. Controls and Procedures.
Under the supervision and with the participation of our Management, including
our principal executive officer and principal financial officer, we conducted an
evaluation of the effectiveness of the design and operations of our disclosure
controls and procedures, as defined in rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as of September 30, 2004. Based on this
evaluation, our principal executive officer and principal financial officer
concluded that our disclosure controls and procedures were effective at the
reasonable assurance level such that the material information required to be
included in our Securities and Exchange Commission ("SEC") reports is recorded,
processed, summarized and reported within the time periods specified in SEC
rules and forms relating to Rollins, Inc., including our consolidated
subsidiaries, and was made known to them by others within those entities,
particularly during the period when this report was being prepared.
In addition, there were no significant changes in our internal control over
financial reporting during the quarter that could significantly affect these
controls. As of September 30, 2004, we did not identify any significant
deficiency or material weaknesses in our internal controls, and therefore no
corrective actions were taken.
18
PART II OTHER INFORMATION
Item 1. Legal Proceedings.
See Note 3 to Part I, Item 1 for discussion of certain litigation.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Issuer Purchases Of Equity Securities
Total Number of
Shares Purchased as Maximum Number of
Total Number Part of Publicly Shares that May Yet
of Shares Average Price Announced Be Purchased Under
Month Purchased (1) Paid per Share Repurchase Plan the Repurchase Plan
------------------ --------------- ---------------- --------------------- ----------------------
July 2004 3,008 $23.37 0 649,684
August 2004 3,314 $23.25 0 649,684
September 2004 2,365 $24.35 0 649,684
=============== ================ ===================== ======================
Total 8,687 $23.59 0 649,684
(1) All repurchases shown are repurchases in connection with exercise of employee stock options.
Item 4. Submission of Matters to a Vote of Security Holders.
Item 6. Exhibits.
(a) Exhibits
(3)(i) Restated Certificate of Incorporation of Rollins, Inc. is
incorporated herein by reference to Exhibit (3) (i) as filed
with its Form 10-K for the year ended December 31, 1997.
(ii) Amended and Restated By-laws of Rollins, Inc. is
incorporated herein by reference to Exhibit (3) (ii) as
filed with its Form 10-Q for the quarterly period ended
March 31, 2004.
(4) Form of Common Stock Certificate of Rollins, Inc. is
incorporated herein by reference to Exhibit (4) as filed
with its Form 10-K for the year ended December 31, 1998.
(31.1) Certification of Chief Executive Officer Pursuant to Item
601(b)(31) of Regulation S-K, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
(31.2) Certification of Chief Financial Officer Pursuant to Item
601(b)(31) of Regulation S-K, as adopted pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
(32.1) Certification of Chief Executive Officer and Chief Financial
Officer Pursuant to 18 U.S.C. Section 1350, As Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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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.
ROLLINS, INC.
(Registrant)
Date: October 28, 2004 By: /s/ Gary W. Rollins
--------------------------------------------
Gary W. Rollins
Chief Executive Officer, President
and Chief Operating Officer
(Member of the Board of Directors)
Date: October 28, 2004 By: /s/ Harry J. Cynkus
---------------------------------------------
Harry J. Cynkus
Chief Financial Officer and Treasurer
(Principal Financial and Accounting Officer)
20