UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark one)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2003
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 No. 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 Identification No.)
incorporation or organization)
2170 Piedmont Road, N.E., Atlanta, Georgia 30324
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (404) 888-2000
Securities registered pursuant to Section 12(b) of the Act:
Name of each
Title of each class Exchange on which registered
------------------------------ ------------------------------
Common Stock, $1 Par Value The New York Stock Exchange
The Pacific Stock Exchange
Securities registered pursuant to section 12(g) of the Act: None.
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes X No
The aggregate market value of Rollins, Inc. Common Stock held by non-affiliates
on June 30, 2003 was $362,429,930 based on the reported last sale price of
common stock on June 30, 2003, which is the last business day of the
registrant's most recently completed second fiscal quarter.
Rollins, Inc. had 45,351,754 shares of Common Stock outstanding as of February
27, 2004.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2004 Annual Meeting of Stockholders of
Rollins, Inc. are incorporated by reference into Part III, Items 10-14.
Rollins, Inc.
Form 10-K
For the Year Ended December 31, 2003
Table of Contents
Page
Part I
Item 1. Business. 7
Item 2. Properties. 12
Item 3. Legal Proceedings. 12
Item 4. Submission of Matters to a Vote of Security Holders. 13
Item 4.A. Executive Officers of the Registrant. 13
Part II
Item 5. Market for Registrant's Common Equity, Related Stockolder Matters and Issuer
Purchases of Equity Securities. 14
Item 6. Selected Financial Data. 15
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. 15
Item 7.A. Quantitative and Qualitative Disclosures about Market Risk. 23
Item 8. Financial Statements and Supplementary Data. 24
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures. 41
Item 9.A. Controls and Procedures. 41
Part III
Item 10. Directors and Executive Officers of Registrant. 43
Item 11. Executive Compensation. 43
Item 12. Security Ownership of Certain Beneficial Owners and Management. 43
Item 13. Certain Relationships and Related Transactions. 43
Item 14. Principal Auditor Fees and Services. 43
Part IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. 44
Signatures. 47
Schedule II. 49
Exhibit Index. 50
PART I
Item 1. Business.
General
Rollins, Inc. (the "Company") was originally incorporated in 1948 under the
laws of the state of Delaware as Rollins Broadcasting, Inc.
The Company is a national service company with headquarters located in
Atlanta, Georgia, providing pest and termite control services to both
residential and commercial customers in North America. Services are performed
through a contract that specifies the pricing arrangement with the customer.
Orkin, Inc. ("Orkin"), a wholly owned subsidiary of the Company founded in
1901, is one of the world's largest pest and termite control companies. It
provides customized services from over 400 locations to approximately 1.6
million customers. Orkin serves customers in the United States, Canada and
Mexico, providing essential pest control services and protection against termite
damage, rodents and insects to homes and businesses, including hotels, food
service establishments, food manufacturers, retailers and transportation
companies. Orkin operates under the Orkin(R) and PCO Services, Inc.(R)
trademarks and the AcuridSM service mark. The Orkin(R) brand name makes Orkin
the most recognized pest and termite company in the country. The PCO Services
brand name provides similar brand recognition in Canada. The Company is the
largest pest control provider in Canada.
The Company has only one reportable segment, its pest and termite control
business. Revenue, operating profit and identifiable assets for this segment,
which includes the United States, Canada and Mexico, are included in Item 8 of
this document under financial statements and supplementary data on pages 24 and
25. 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.
A bimonthly pest control service initiative was offered in limited markets
beginning in 1999 and was implemented as a primary service offering in 2000 to
better service our residential customers, and has grown to represent 55% of the
residential customer base at the end of 2003. This program provides greater
convenience to our customers and enables the Company to achieve technician
productivity improvements and other service efficiencies, including lower fleet
costs.
In order to better understand its customers and prospects, in 2003 the
Company initiated market research efforts to help identify specific residential
pest control market segments. Three segments were determined to be the ideal new
customer groups for Orkin. These are sectors that the Company believes offer the
best opportunity to create long and prosperous relationships. Management
believes that all of these groups are willing to pay a higher price for a pest
control service that meets their needs. They indicated a desire for a company
with a strong positive reputation, and one with the most professional and
knowledgeable technicians. They also want to do business with a company whose
service will be safe for their children and pets, and a firm that is responsive
to their requests. These are attributes that Orkin delivers every day; however,
this validation will enable the Company to do a better job communicating these
strengths.
To effectively and efficiently achieve sales goals in today's highly
competitive environment, representatives have a greater need for new technology
to help them improve their productivity. Orkin began testing automated sales
management software in 2003. This software is currently being used to track the
sales process, allowing the pipelines to be easily reviewed to capitalize on
opportunities that are readily identified. Account information, statistics,
contact information, future tasks and events are tracked by location with upward
flow to the sales management organization. The reporting and forecasting
features also enable management to have a better overview and expectation of the
entire network.
The Company has also reorganized its marketing department to include
Business Development Managers (BDM). Each BDM is responsible for creating a
market development plan for future customer growth and retention for his or her
division. They provide advocacy by working with local, regional and divisional
management to ensure the success of their division as it relates to sales
training, new customer marketing and sales plan achievement.
In 2003, Orkin developed a corporate partnership with the National Science
Teachers Association (NSTA) that is designed to assist teachers in educating the
country's youth about the importance of insects in the environment. As a
partner, we are providing teaching and instructional materials directly to
teachers and through the
7
NSTA's website. All this behind-the-scenes support is further reinforced by
offering a "real live" Orkin Man to provide in-school presentations.
Orkin's commercial pest control programs enable us to deliver customized
service to industries such as food processing and distribution, discount and
grocery retailers, fast food, healthcare and restaurants. As the nation's
largest commercial pest control provider, the Company services national chains
(primarily sold through the Orkin National Accounts division) as well as
locally-owned businesses. A primary goal of the Company is to grow national
account revenue at a pace that will enable us to further expand our market
share.
Orkin introduced the Gold Medal Protection program in the United States in
2003. This custom-designed pest control service is targeted to specific high-end
customers primarily in the food manufacturing and processing industry. The
program provides a comprehensive reporting system that meets federal and state
regulatory requirements. It also guarantees free retreatment if the customer is
not satisfied and Orkin commits to paying any regulatory penalties as a result
of a shortfall in our service. This is the first pest control program of its
kind in North America to receive ISO 9002 certification.
Also in 2003, the Company also introduced a Commercial Pest Control Quality
Assurance Program. This program helps ensure consistent service, improves our
personnel and builds stronger customer relations. The program utilizes
floor-level inspections by Orkin Q.A. inspectors while accompanied by branch,
region, and on occasion division management staff. A new Commercial Pest Control
Expectation Manual was developed for our branches to clearly communicate the
Company's service expectations, and our locations and people are audited against
this manual.
Research has shown that termites cause more damage to American structures
than fires and storms combined. Orkin offers a treatment customized to a home's
needs including inside, outside and within the foundation. Our directed liquid
and directed liquid plus bait programs have been developed in conjunction with
the entomology departments at leading universities. As a result, our approach to
treating for subterranean termites has become the standard adopted by most pest
control operators today.
Orkin is leveraging recent investments in technology and process
improvement to advance business practices in the commercial business line.
Re-engineering efforts are targeted at enhancing integration between sales,
customer management, service delivery and billing processes to provide a higher
level of service to these customers.
In 2003, the Company successfully launched its new Intranet, which provides
quick and efficient communications between the field and home office. Through
the efforts of our Company Webmaster and the Web Advisory Committee, there were
several key milestones achieved this year. The Intranet provided significant
cost savings by providing Material Safety Data Sheets and Product Labels through
MyOrkin Intranet. This is a very important requirement that enables
instantaneous compliance with state and federal product use regulations. The
Orkin Training Department now has a state-of-the-art means to better
communicate the availability of an elaborate array of training tools and
reference materials through the MyOrkin/Training site. The MyOrkin/Marketplace,
another company Intranet address, was created for branches to more efficiently
order promotional products and company forms.
In 2003, Orkin began outsourcing some of its chemical distribution
utilizing new Internet branch systems to ease ordering of product. Test branch
locations are now receiving shipments in two to four days while reducing the
carrying cost of excess inventory and shipping costs.
The Global Positioning System (GPS) technology, introduced three years ago,
has resulted in improved driver safety and service production. Now, newer
generation GPS units are being installed that allow 24 / 7 monitoring and
reporting of speed, location, and seatbelt usage as well as allowing remote
updating of mapping software. This technology also details the route a service
technician takes rather than just noting stops. These units create reports that
are easier to read and allow data to be sent directly to a server with no
removable chip to be taken out at the end of the day. Although this equipment is
only being utilized in some of our locations, we are optimistic that it will be
a building block to creating a comprehensive "routing and scheduling" system in
the future.
As part of our continuous home office process improvement mandate, a Human
Resources Service Center was established from three autonomous departments:
Payroll, Benefits and Human Resources. Everything from new-hire paperwork to
retirement forms is now available through this new center. We are pleased that
this consolidation has improved our service to the field while reducing costs.
8
The dollar amount of service contracts and backlog orders as of the end of
the Company's 2003 and 2002 calendar years was approximately $31.3 million and
$28.4 million, respectively. Backlog services and orders are usually provided
within the month following the month of receipt, except in the area of prepaid
pest control and bait monitoring services, which are usually provided within
twelve months of receipt. The Company does not have a material portion of its
business that may be subject to renegotiation of profits or termination of
contracts at the election of a governmental entity.
In spring 2003, Orkin was recognized by Training magazine as one of the Top
100 companies to excel in training and employee development. In addition, Orkin
was one of only five companies selected for the magazine's Editor's Choice list.
The award is given to select companies that have created positive learning
environments for their workforce.
Orkin attained further recognition this year for its training program by
achieving first place honors for the BEST Award given by the American Society
for Training and Development. The Rollins Training Center, located in Atlanta,
was specifically referenced as evidence of the Company's dedication to employee
performance improvement. The Rollins Training Center has a full-size house and
several other real examples of building structures where technicians can see the
relationship between pests and home construction. They can also practice
performing pest treatments under the supervision of qualified instructors. In
the classrooms, technicians acquire guidance in customer relations, pest problem
solving and advanced technical skills through highly interactive instructor-led
training.
In 2004, the Company plans to expand the Training Center to include
hands-on instructional areas for commercial pest control services with
additional classroom space and a media production facility.
The Rollins Customer Care Center achieved its ISO 9002 quality
certification in 2001. It is joined by forty-seven dedicated commercial branches
that have also completed the ISO 9002 quality certification process.
The Company continues to expand its growth through the Orkin franchise
program. This program is primarily used in smaller markets where it is currently
not economically feasible to locate a conventional Orkin branch. There is a
contractual buyback provision at the Company's option with a pre-determined
purchase price using a formula applied to revenues of the franchise. There were
44 Company franchises at the end of 2003 compared to 36 at the end of 2002.
Seasonality
The business of the Company is affected by the seasonal nature of the
Company's pest and termite control services. The increase in pest pressure and
activity, as well as the metamorphosis of termites in the spring and summer (the
occurrence of which is determined by the timing of the change in seasons), has
historically resulted in an increase in the revenue of the Company's pest and
termite control operations during such periods as evidenced by the following
chart.
Total Net Revenues
- ------------------------------------------------------------------------------
2003 2002 2001
- ------------------------------------------------------------------------------
First Quarter $155,122 $153,302 $150,280
Second Quarter 185,105 184,189 180,731
Third Quarter 178,262 174,063 169,223
Fourth Quarter 158,524 153,871 149,691
- ------------------------------------------------------------------------------
Inventories
The Company has relationships with multiple vendors for pest and termite
control treatment products and maintains a sufficient level of chemicals,
materials and other supplies to fulfill its immediate servicing needs and to
alleviate any potential short-term shortage in availability from its national
network of suppliers.
Competition
The Company believes that Orkin competes favorably with competitors as one
of the world's largest pest and termite control companies. The Company competes
with a number of pest and termite control companies, including Terminix and
Ecolab.
9
The principal methods of competition in the Company's pest and termite
control business are quality of service and guarantees, including the money-back
guarantee on pest and termite control, and the termite retreatment and damage
repair guarantee to qualified homeowners.
Research and Development
Expenditures by the Company on research activities relating to the
development of new products or services are not significant. Some of the new and
improved service methods and products are researched, developed and produced by
unaffiliated universities and companies. Also, a portion of these methods and
products are produced to the specifications provided by the Company. Some of the
more recent studies that have been conducted on behalf of the Company include
studies on fly pathogens, ant pathogens, and other pests found in the food
processing environment by the University of Florida. Additionally, an integrated
pest management study completed in 2003, was performed by the Virginia
Polytechnic Institute. Additional research at the University of Florida involves
the impact of soil type and soil compaction on termites' tunneling behavior.
Also, Texas A&M has continued studies on both termites and fire ants, using
biological control agents for population reduction and predicting the time
termites swarm each year. The Company also conducts tests of new products with
the specific manufacturers of such products. In the summer of 2003, Orkin began
test marketing a mosquito control program in the United States and Canadian
provinces. While working to address the threat of mosquito-borne diseases in the
U.S., a highly successful West Nile Virus program was implemented in Ontario,
Canada. It provided thousands of larvicide treatments on breeding grounds while
reducing the population of adult, biting mosquitoes. The Company intends to
expand the mosquito control program in Canada and other U.S. markets in the
spring of 2004.
Environmental and Regulatory Considerations
The Company's Pest Control business is subject to various legislative and
regulatory enactments that are designed to protect the environment, public
health and consumer protection. Compliance with these requirements has not had a
material negative effect on the Company's financial position, results of
operations or liquidity.
Federal Insecticide Fungicide and Rodentcide Act ("FIFRA")
This federal law (as amended) grants the responsibility of the states to be
the primary agent in enforcement and conditions under which pest control
companies operate. Each state must meet certain guidelines of the Environmental
Protection Agency in regulating the following: licensing, record keeping,
contracts, standards of application, training and registration of products. This
allows each state to institute certain features that set their regulatory
programs in keeping with special interests of the citizens' wishes in each
state. The pest control industry is impacted by these federal and state
regulations.
Food Quality Protection Act of 1996 ("FQPA")
The FQPA governs the manufacture, labeling, handling and use of pesticides
and does not have a direct impact on how we conduct our business.
Environmental Remediation
The Comprehensive Environmental Response, Compensation and Liability Act
("CERCLA"), also known as Superfund, is the primary Federal statute regulating
the cleanup of inactive hazardous substance sites and imposing liability for
cleanup on the responsible parties. Responsibilities governed by this statute
include the management of hazardous substances, reporting releases of hazardous
substances, and establishing the necessary contracts and agreements to conduct
cleanup. Customarily, the parties involved will work with the EPA and under the
direction of the responsible state agency to agree and implement a plan for site
remediation.
Employees
The number of persons employed by the Company as of February 27, 2004 was
approximately 7,300 compared to 7,600 at December 31, 2002. This decrease in the
number of employees is due to the continued transition to every-other-month pest
control service, which has resulted in the need for fewer technicians.
10
Recent Developments
The Board of Directors, at its quarterly meeting on January 27, 2004,
approved a 20% increase in the Company's quarterly dividend. The increased
regular quarterly dividend of $0.06 per share will be payable March 10, 2004 to
stockholders of record at the close of business February 10, 2004. The Company's
new annual dividend rate is $0.24 per share.
On March 8, 2004, the Company entered into a definitive agreement to
acquire, through a purchase of assets, the pest control business and certain
ancillary operations of Western Industries, Inc. and its affiliates. The
aggregate consideration will be paid in a combination of cash and marketable
securities, on hand as well as borrowings from an outside party to be arranged
in connection with the purchase, and is expected to range from approximately
$105.0 to $110.0 million. The amount to be financed has not been determined at
this time. The Company is anticipating closing on the purchase in the second
quarter of 2004.
Available Information
Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current
Reports on Form 8-K and amendments to these reports, are available free of
charge on our web site at www.rollins.com as soon as reasonably practicable
after those reports are electronically filed with or furnished to the Securities
and Exchange Commission.
Risk Factors
We may not be able to compete in the competitive and technical pest control
industry in the future.
We operate in a highly competitive industry. Our revenues and earnings may
be affected by the following factors: changes in competitive prices, weather
related issues, general economic issues and governmental regulation. We compete
with other large pest control companies, as well as numerous small pest control
companies for a finite number of customers. We believe that the principal
competitive factors in the market areas that we serve are product and service
quality and availability, reputation for safety, technical proficiency and
price. Although we believe that our experience and reputation for safety and
quality service is excellent, we cannot assure that we will be able to maintain
our competitive position.
We may not be able to identify, complete or successfully consolidate
acquisitions.
Acquisitions have been and will continue to be an important element of our
business strategy. We cannot assure that we will be able to identify and acquire
acceptable acquisition candidates on terms favorable to us in the future. We
cannot assure that we will be able to consolidate successfully the operations
and assets of any acquired business with our own business. Any inability on our
part to consolidate and manage the growth from acquired businesses could have a
material adverse effect on our results of operations and financial condition.
Our operations are affected by adverse weather conditions.
Our operations are directly affected by the weather conditions across the
United States and Canada. The business of the Company is affected by the
seasonal nature of the Company's pest and termite control services. The increase
in pest pressure and activity, as well as the metamorphosis of termites in the
spring and summer (the occurrence of which is determined by the timing of the
change in seasons), has historically resulted in an increase in the revenue and
income of the Company's pest and termite control operations during such periods.
Our inability to attract and retain skilled workers may impair growth potential
and profitability.
Our ability to remain productive and profitable will depend substantially
on our ability to attract and retain skilled workers. Our ability to expand our
operations is in part impacted by our ability to increase our labor force. The
demand for skilled employees is high, and the supply is very limited. A
significant increase in the wages paid by competing employers could result in a
reduction in our skilled labor force, increases in the wage rates paid by us, or
both. If either of these events occurred, our capacity and profitability could
be diminished, and our growth potential could be impaired.
Our operations could be affected by pending and ongoing litigation.
In the normal course of business, Orkin is a defendant in a number of
lawsuits, including Helen Cutler and Mary Lewin v. Orkin Exterminating Company,
Inc. et al. pending in the District Court of Houston County, Alabama
11
and Butland et al. v. Orkin Exterminating Company, Inc. et al. pending in the
Circuit Court of Hillsborough County, Tampa, Florida 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. Some
lawsuits have been filed (Ernest W. Warren and Dolores G. Warren et al. v. Orkin
Exterminating Company, Inc., et al.; Elizabeth Allen and William Allen et al. v.
Rollins, Inc. and Orkin Exterminating Company, Inc.; Francis D. Petsch, et al.
v. Orkin Exterminating Company, Inc. et al.; and 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. The Company believes them 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.
Our operations may be adversely affected if we are unable to comply with
regulatory and environmental laws.
Our business is significantly affected by environmental laws and other
regulations relating to the pest control industry and by changes in such laws
and the level of enforcement of such laws. We are unable to predict the level of
enforcement of existing laws and regulations, how such laws and regulations may
be interpreted by enforcement agencies or court rulings, or whether additional
laws and regulations will be adopted. We believe our present operations
substantially comply with applicable federal and state environmental laws and
regulations. We also believe that compliance with such laws has had no material
adverse effect on our operations to date. However, such environmental laws are
changed frequently. We are unable to predict whether environmental laws will, in
the future, materially affect our operations and financial condition. Penalties
for noncompliance with these laws may include cancellation of licenses, fines,
and other corrective actions, which would negatively affect our future financial
results.
Item 2. Properties.
The Company's administrative headquarters and central warehouse, both of
which are owned by the Company, are located at 2170 Piedmont Road, N.E.,
Atlanta, Georgia 30324. The Company owns or leases several hundred branch
offices and operating facilities used in its business as well as the Rollins
Training Center located in Atlanta, Georgia. None of the branch offices,
individually considered, represents a materially important physical property of
the Company. The facilities are suitable and adequate to meet the current and
reasonably anticipated future needs of the Company.
Item 3. Legal Proceedings.
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 and are seeking monetary damages and injunctive
relief for alleged breach of contract arising out of alleged missed or
inadequate reinspections. The attorneys for the plaintiffs contend that the case
is suitable for a class action and the court has ruled that the plaintiffs would
be permitted to pursue a class action lawsuit against Orkin. Orkin believes this
case to be without merit and intends to defend itself vigorously at trial. The
trial is currently set for early June 2004. 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 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.
12
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. Some lawsuits have been filed (Ernest W. Warren and
Dolores G. Warren et al. v. Orkin Exterminating Company, Inc., et al.; Elizabeth
Allen and William Allen et al. v. Rollins, Inc. and Orkin Exterminating Company,
Inc.; Francis D. Petsch, et al. v. Orkin Exterminating Company, Inc. et al.; and
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. The Company believes them 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.
Item 4. Submission of Matters to a Vote of Security Holders.
There were no matters submitted to a vote of security holders, through the
solicitation of proxies or otherwise, during the fourth quarter of 2003.
Item 4.A. Executive Officers of the Registrant.
Each of the executive officers of the Company was elected by the Board of
Directors to serve until the Board of Directors' meeting immediately following
the next Annual Meeting of Stockholders or until his earlier removal by the
Board of Directors or his resignation. The following table lists the executive
officers of the Company and their ages, offices with the Company, and the dates
from which they have continually served in their present offices with the
Company.
Date First Elected
Name Age Office with Registrant to Present Office
- --------------------------------------------------------------------------------
R. Randall Rollins(1) 72 Chairman of the Board 10/22/91
Gary W. Rollins(2) 59 Chief Executive Officer,
President and Chief
Operating Officer 7/24/01
Michael W. Knottek(3) 59 Senior Vice President
and Secretary 4/23/02
Harry J. Cynkus(4) 54 Chief Financial Officer
and Treasurer 5/28/98
Glen W. Rollins(5) 37 Vice President 4/23/02
(1) R. Randall Rollins and Gary W. Rollins are brothers.
(2) Gary W. Rollins was elected to the office of President and Chief Operating
Officer in January 1984. He was elected to the additional office of Chief
Executive Officer in July 2001. In February 2004, he was named Chairman of
Orkin, Inc.
(3) Michael W. Knottek joined the Company in June 1997 as Vice President and,
in addition, was elected Secretary in May 1998. He became Senior Vice
President in April of 2002. From 1992 to 1997, Mr. Knottek held a variety
of executive management positions with National Linen Service, including
Senior Vice President of Finance and Administration and Chief Financial
Officer. Prior to 1992, he held a variety of senior positions with Initial
USA, finally serving as President from 1991 to 1992.
(4) Harry J. Cynkus joined the Company in April 1998 and, in May 1998, was
elected Chief Financial Officer and Treasurer. From 1996 to 1998, Mr.
Cynkus served as Chief Financial Officer of Mayer Electric Company, a
wholesaler of electrical supplies. From 1994 to 1996, he served as Vice
President - Information Systems for Brach & Brock Confections, the acquirer
of Brock Candy Company, where Mr. Cynkus served as Vice President - Finance
and Chief Financial Officer from 1992 to 1994. From 1989 to 1992, he served
as Vice President - Finance of Initial USA, a division of an international
support services company. Mr. Cynkus is a Certified Public Accountant.
(5) Glen W. Rollins is the son of Gary W. Rollins. He joined the Company in
1989 and has held a variety of positions within the organization including
Executive Vice President of Orkin, Inc., to which he was elected in June
2001. In April 2002, he was named Vice President of Rollins, Inc. In
February 2004, he was named President and Chief Operating Officer of Orkin,
Inc.
13
PART II
Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities.
The Common Stock of the Company is listed on the New York and Pacific Stock
Exchanges and is traded on the Philadelphia, Chicago and Boston Exchanges under
the symbol ROL. The high and low prices of the Company's common stock and
dividends paid for each quarter in the years ended December 31, 2003 and 2002
(2002 and first quarter 2003 prices were adjusted for the stock split effective
March 10, 2003) were as follows:
STOCK PRICES AND DIVIDENDS
Rounded to the nearest $.01
Stock Price Dividends Stock Price Dividends
------------------------ Paid ------------------------- Paid
2003 High Low Per Share 2002 High Low Per Share
- ----------------------------------------------------------------------------------------------------------------------------
First Quarter $23.90 $17.07 $.05 First Quarter $14.50 $12.53 $.033
Second Quarter 24.90 18.21 .05 Second Quarter 14.47 12.13 .033
Third Quarter 19.73 16.37 .05 Third Quarter 14.32 12.20 .033
Fourth Quarter 23.48 17.80 .05 Fourth Quarter 19.00 12.41 .033
- ----------------------------------------------------------------------------------------------------------------------------
The number of stockholders of record as of February 27, 2004 was 1,515.
14
Item 6. Selected Financial Data.
The following summary financial data of Rollins highlights selected
financial data and should be read in conjunction with the financial statements
included elsewhere in this document. FIVE-YEAR FINANCIAL SUMMARY
Rollins, Inc. and Subsidiaries
All earnings per share and dividends per share have been restated for 2002,
2001, 2000 and 1999 for the three-for-two stock split effective March 10, 2003
for all shares held on February 10, 2003.
Years Ended December 31,
------------------------------------------------------------------------------
(in thousands except per share data) 2003 2002 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------
OPERATIONS SUMMARY
Revenues $677,013 $665,425 $649,925 $646,878 $584,098
Income Before Income Taxes 60,030 43,726 27,326 15,403 11,532
Net Income $ 35,761 $ 27,110 $ 16,942 $ 9,550 $ 7,150
Earnings Per Share - Basic:
Net Income 0.79 0.60 0.37 0.21 0.16
Earnings Per Share - Diluted:
Net Income 0.77 0.60 0.37 0.21 0.16
Dividends per Share 0.20 0.13 0.13 0.13 0.13
----------------------------------------------------------------------------------------------------------------------
FINANCIAL POSITION
Years Ended December 31,
------------------------------------------------------------------------------
2003 2002 2001 2000 1999
- ----------------------------------------------------------------------------------------------------------------------
Total Assets $349,904 $318,338 $296,559 $298,819 $309,948
Noncurrent Capital Lease
Obligations - - - 256 2,450
Long-Term Debt 1,734 2,913 4,895 4,656 5,328
Stockholders' Equity 138,774 90,690 85,498 78,599 71,790
Shares Outstanding at Year-End 45,157 44,799 45,105 45,054 44,822
----------------------------------------------------------------------------------------------------------------------
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
RESULTS OF OPERATIONS
% Better/Worse as
Year Ended December 31, Compared to Prior Year
------------------------------------------------------------------------------
(in thousands 2003 2002 2001 2003 2002
- ----------------------------------------------------------------------------------------------------------------------
Revenues $677,013 $665,425 $649,925 1.7% 2.4%
Cost of Services Provided 362,422 361,318 361,921 (0.3) 0.2
Depreciation and Amortization 20,179 21,635 20,292 6.7 (6.6)
Sales, General and Administrative 236,514 238,180 240,628 0.7 1.0
(Gain)/Loss on Sale of Assets (1,700) 762 (44) N/M N/M
Interest Income (432) (196) (198) 120.4 (1.0)
------------------------------------------------------------------------------
Income Before Income Taxes 60,030 43,726 27,326 37.3 60.0
Provision for Income Taxes 24,269 16,616 10,384 (36.1) (60.0)
------------------------------------------------------------------------------
Net Income $ 35,761 $ 27,110 $ 16,942 31.9% 60.0%
- ----------------------------------------------------------------------------------------------------------------------
15
General Operating Comments
The Company's continued emphasis on customer retention, along with building
recurring revenues, was the primary driver of revenue growth of 3.0% in the
fourth quarter and 1.7% for the year ended December 31, 2003 as compared to the
prior year periods, despite a sluggish economy and unseasonably wet and cold
weather conditions in parts of the U.S. in the first half of 2003. Revenues were
up 1.2% in the first quarter, 0.5% in the second quarter and 2.4% in the third
quarter as compared to the prior year periods.
The financial results for the fourth quarter and the twelve months ended
December 31, 2003 were positively impacted by the continued benefit of our
recent service initiatives, which included every-other-month residential pest
control service, Gold Medal premium commercial pest control services, and
termite directed liquid and baiting treatment.
For the fourth quarter of 2003, the Company had net income of $4.8 million
compared to net income of $3.7 million in the fourth quarter of 2002, which
represents a 29.5% increase. In addition to the revenue increase of 3.0%, the
Company achieved margin improvement in Cost of Services Provided of 1.3
percentage points, expressed as a percentage of revenues, offset by an increase
in Sales, General and Administrative expenses of 0.4 margin points or $2.2
million due to higher marketing expenses. In addition, the Company recorded an
increase in its tax provision of approximately $1.1 million as describes further
below.
For the year ended December 31, 2003, the Company had net income of $35.8
million compared to net income of $27.1 million in 2002, which represents a
31.9% increase. In addition to the revenue increase of 1.7%, the Company
achieved margin improvements, expressed as a percentage of revenues, in Cost of
Services Provided of 0.8 percentage points and in Sales, General and
Administrative of 0.9 percentage points.
For the year ended December 31, 2003, the Company generated additional cash
of $21.2 million compared to $29.7 million for 2002. The Company had total Cash
and Short-Term Investments of $59.5 million as of December 31, 2003 a 55.4%
increase from December 31, 2002.
The Company began its Orkin franchise program in the U.S. in 1994, and
established its first international franchise in Mexico in 2000. On October 10,
2003, the Company announced the establishment of a second international Orkin
franchise in Panama. At December 31, 2003, Orkin had 44 franchises in total.
Results of Operations - 2003 Versus 2002
Revenues for the year ended December 31, 2003 were $677.0 million, an increase
of $11.6 million or 1.7% from last year's revenues of $665.4 million. The
Company's revenue growth was very similar across its primary services, which are
residential pest control, commercial pest control, and termite service. The
growth in pest control revenues for the year reflects growth in the customer
base, better average selling prices, continued improvements in customer
retention, and successful price increase campaigns. Every-other-month service,
our primary residential pest control service offering, continues to grow in
importance, comprising 55% of our residential pest control customer base at
December 31, 2003. In commercial pest control, the Company continued to receive
favorable reaction to the rollout of its premium Gold Medal service, which
specifically targets food processing and manufacturing companies, and also
achieved improvements in average prices on new sales and successful price
increases from existing customers. This past summer, Orkin began test marketing
a mosquito control program in the northern United States and Canada. While
working to address the threat of mosquito-borne diseases in the U.S., a highly
successful West Nile virus preventative program was also implemented in Ontario,
Canada. Two provinces were provided thousands of larvicide treatments to
mosquito breeding grounds reducing the population of adult mosquitoes and their
eggs. The Company intends to expand the mosquito control program in Canada and
other U.S. markets in the spring of 2004. As another sign of strengthening in
the commercial market, the Company achieved a monthly record high of sales to
national accounts in September 2003.
Termite revenues increased in the fourth quarter as a result of higher new job
completions and continued growth in recurring revenues from bait monitoring and
renewal revenues, although termite revenues for the twelve months ended December
31, 2003 decreased slightly, mainly as a result of the unusually wet and cold
weather in parts of the U.S. in the first half of 2003. Per the National
Climatic Data Center's 109 years of tracking weather data, temperatures in the
Northeast Region of the country were the 10th coldest on record, and the
Southeast experienced the second wettest six month period on record. The
Company's foreign operations accounted for approximately 6% of total revenues
for the year ended December 31, 2003.
16
The business of the Company is affected by the seasonal nature of the Company's
pest and termite control services as evidenced by the following chart.
Total Net Revenues
- ------------------------------------------------------------------------------
2003 2002 2001
- ------------------------------------------------------------------------------
First Quarter $155,122 $153,302 $150,280
Second Quarter 185,105 184,189 180,731
Third Quarter 178,262 174,063 169,223
Fourth Quarter 158,524 153,871 149,691
- ------------------------------------------------------------------------------
Cost of Services Provided for the year ended December 31, 2003 increased $1.1
million or 0.3%, although the expense margin expressed as a percentage of
revenues improved by 0.8 percentage points, representing 53.5% of revenues for
the year ended December 31, 2003 compared to 54.3% of revenues in the prior
year. The dollar increase was mainly due to an increase in fleet expenses, as a
result of higher fuel costs and a temporary spike in vehicle counts in the first
quarter as the Company transitioned to a new fleet agreement, and an increase in
fringe benefit costs due to higher pension and group medical costs, partially
offset by improvements in service salaries, administrative salaries, and
materials and supplies. Service technician productivity and average pay
continued to improve, which leads to better employee retention and, in
Management's opinion, improved customer retention.
Sales, General and Administrative for the year ended December 31, 2003 decreased
$1.7 million or 0.7% and, as a percentage of revenues, improved by 0.9
percentage points or 2.5%, averaging 34.9% of total revenues compared to 35.8%
for the prior year. The improvement for the year was a result of the home office
process improvement initiative started in 2002, lower field administrative costs
as a result of technology and organizational investments, lower sales payroll
due to lower staffing and partly from the formation of in-bound call centers,
and lower bad debt expenses due to better collections and improvement in the
receivables aging statistics. These were partially offset by higher fringe
benefit costs, advertising, and an increase in the summer sales program costs.
Depreciation and Amortization expenses for the year ended December 31, 2003 were
$1.5 million or 6.7% lower than the prior year. The decrease was due to certain
technology assets becoming fully depreciated in the last twelve months. The
Company had approximately $10.6 million in capital expenditures during the year
ended December 31, 2003 compared to $10.4 million in 2002.
In addition, the Company realized a net gain of $1.7 million from the sale or
disposal of assets in the fourth quarter of 2003.
The Company's effective tax rate was 38.0% for the periods prior to the fourth
quarter of 2003. The effective tax rate was increased to 40.4% in 2003 to
reflect an increase in the effective state income tax rate for the year, as well
as "true up" adjustments in the fourth quarter of approximately $1.1 million. As
a result, the effective tax rate for the fourth quarter increased to 52.4%.
Results of Operations - 2002 Versus 2001
Revenues for the year ended December 31, 2002 increased to $665.4 million, an
increase of $15.5 million or 2.4% from 2001 revenues of $649.9 million. The
Company's foreign operations made up less than 6.0% of the Company's total
revenues in 2002 and 2001. The revenue increase was mainly attributable to a
modest increase in revenues from pest control services, as termite revenues were
flat with the prior year. The growth in pest control revenues reflects the
beneficial impact of better customer retention and a successful residential
summer sales program, factors that combined to produce a net gain in the
customer base as well as higher average selling prices. Within the U.S., the
Company had an improvement in customer retention, a modest increase in new sales
units and an overall improvement in average selling prices, resulting in a
higher ending customer base at the end of the year. Every-other-month service,
our primary residential pest control service offering, continued to grow in
importance, comprising almost 50% of our residential pest control customer base
at the end of 2002. Our commercial revenues grew, mainly as a result of better
pricing on new sales, a successful price increase campaign for existing
customers in 2002, and the introduction of new products and services during the
year. Although termite revenues were flat in 2002 as a result of a decrease in
sales to new customers, the Company experienced an improvement in recurring
17
revenues mainly from enhanced renewal retention and higher bait monitoring
services. Despite the decrease in termite sales dollars, the Company managed to
achieve a slight improvement in average selling prices.
Cost of Services Provided for the year ended December 31, 2002 decreased
$603,000 or 0.2% and margins improved by 1.4 percentage points, representing
54.3% of revenues in 2002 compared to 55.7% of revenues in the prior year.
Improvement for the year ended December 31, 2002 can be mainly attributed to the
Company's recent service initiatives that have increased productivity, reduced
headcount, and created other efficiencies and better asset utilization. The
Company achieved reductions in service salaries, personnel related expenses,
materials and supplies, travel and fleet expense, which were partially offset by
slightly higher insurance and claims charges. Pest control and termite
technician productivity improved, as did employee retention. The Company
believes that better employee retention has a direct impact on customer
retention. Better fleet management led to a decrease in the average number of
vehicles and an improvement in revenues per vehicle.
Sales, General and Administrative for the year ended December 31, 2002 decreased
$2.4 million or 1.0%, and improved by 1.2 percentage points in 2002, averaging
35.8% of total revenues compared to 37.0% for the prior year. Improvement for
the year was mainly attributed to reduced personnel related expenses, fleet
expense, telephone expense, travel expense, bad debt expense and sales
promotions, partially offset by higher summer selling program expense and
advertising expense.
Depreciation and Amortization expenses for the year ended December 31, 2002 were
approximately $1.3 million or 6.6% higher than the prior year. The increase was
primarily due to the depreciation associated with FOCUS, the Company's new
proprietary branch computer system. The rollout of FOCUS to the branches was
completed in the fourth quarter of 2001. As a result of the adoption of SFAS No.
142, the amortization of goodwill has been discontinued as of January 1, 2002,
causing a decrease in goodwill amortization expense of approximately $2.2
million partially offset by an increase in amortization expense of $2.0 million
due to a change in the expected life of customer contracts.
The Loss on Sale of Assets for the year ended December 31, 2002 of $762,000 was
mainly due to the write-off of obsolete field IT equipment.
Net income for the year ended December 31, 2002 includes the effects of adopting
SFAS No. 142, which did not have a material impact on the Company's overall
results of operations. In addition, if SFAS No. 142 had been adopted in the year
ended December 31, 2001, it would not have had a material impact on net income
previously reported for the year ended December 31, 2001.
The Company's tax provision of $16.6 million for the year ended December 31,
2002 reflects increased taxable income over the prior year. The effective tax
rate of 38% was consistent between periods presented.
Related Party Transactions
At the Company's October 22, 2002 Board of Directors' meeting, the
independent directors of the Board of Directors and the Audit Committee approved
three related party transactions. The Audit Committee and the independent
directors were furnished with full disclosure of the transactions, including
independent appraisals, and determined that the terms of each transaction were
reasonable and fair to the Company. The first approval was the purchase of the
Rollins Training Center on October 31, 2002 for $3.1 million from RTC, LLC, a
company controlled by R. Randall Rollins, Chairman of the Board of Rollins, Inc.
The second approval was the purchase of hand-held computer software development
known as PowerTrak Version 1.0 from RRR Associates, a company controlled by R.
Randall Rollins. The purchase was made during the fourth quarter of 2002 at an
approved purchase price of $250,000. The third approval was a lease agreement
effective July 1, 2002 that expires June 30, 2007 for company real estate in
Okeechobee County, Florida to be leased to Rollins Ranch, a division of LOR,
Inc., a company controlled by R. Randall Rollins and Gary W. Rollins, Chief
Executive Officer, President and Chief Operating Officer of Rollins, Inc. The
annual lease rate on this real estate is $131,939. In the opinion of Management,
these related party transactions were reasonable and fair to the Company and
will not have a material effect on the Company's financial position, results of
operations or liquidity.
At the Company's January 28, 2003 Board of Directors' meeting, the
independent directors of the Board of Directors and the Audit Committee approved
four related party transactions. The Audit Committee and the independent
directors were furnished with full disclosure of the transactions, including
independent appraisals, and determined that the terms of each transaction were
reasonable and fair to the Company and will not have a material
18
effect on the Company's financial position, results of operations or liquidity.
The first approval was the ratification of the current arrangement between
Rollins, Inc. and LOR, Inc., a company controlled by R. Randall Rollins and Gary
W. Rollins, related to sharing the aviation hangar located at the
Dekalb-Peachtree Airport as well as the usage of a JetStar II, owned by Rollins,
Inc., and the Gulfstream III N30WR, owned by LOR, Inc. The Jetstar II was sold
by Rollins, Inc. in October 2003 and Rollins, Inc. purchased a Gulstream III
N330WR to replace it in October 2003 (see discussion below). LOR, Inc. leases
half of the hangar from Rollins, Inc. for a total annual lease amount of
$14,873. This lease expires on January 24, 2008. The hangar currently houses
three airplanes, two of which are not owned by Rollins, Inc. and reside on the
portion of the hangar leased by LOR, Inc. All other expenses related to the
hangar are also shared equally by Rollins, Inc. and LOR, Inc. Total expenses for
2003 were approximately $116,000, which includes rental, utilities, maintenance
and repairs, depreciation, property tax and miscellaneous expense. Pursuant to
this arrangement the usage is billed on a monthly basis. The Jetstar II was
charged at a rate of $5,250 before it was sold and the Gulstream III's are
charged at a rate of $12,745 each, per month. All expenses related to each
respective aircraft are paid for by the owner of each aircraft, except for fuel.
Fuel is paid for by Rollins, Inc. and billed monthly to the company using the
aircraft. Additionally, when Mr. R. Randall Rollins and Mr. Gary W. Rollins used
the JetStar II, prior to its sale, or use the Gulfstream III N330WR for personal
use they are billed for such use at the rate of $1,000 per hour, which
approximates the fuel cost. The total hourly usage for 2003 was approximately
5.4 hours or $5,400. The Company on occasion uses the Gulfstream III N30WR and
is also billed for its use at a rate of $1,000 per hour, which approximates the
fuel cost. The second approval was the ratification of the arrangement
concerning the rental of office space to LOR, Inc. located at 2170 Piedmont Road
N.E., Atlanta, Georgia 30324. The property located at 2170 Piedmont Road is
owned by Rollins Continental, Inc. a wholly owned subsidiary of Rollins, Inc.
Currently LOR, Inc. occupies approximately 360 square feet of office space in
the building located at 2170 Piedmont Road. The annual rental rate is $3,924.
The third approval was the ratification of the arrangement concerning the rental
of office space to LOR, Inc. located at 710 Lakeshore Circle, Atlanta, Georgia
30324. The property located at 710 Lakeshore Circle is also owned by Rollins
Continental, Inc. Currently LOR, Inc. occupies approximately 3,344 square feet
of office space in the building located at 710 Lakeshore Circle. The annual
rental rate is $40,800. The fourth approval was the ratification of the current
arrangement related to the payment of fees for the services of a
programmer/analyst that was employed by LOR, Inc. but has become employed by
Rollins, Inc. in the first quarter of 2003. The programmer/analyst is being used
to further develop the PowerTrak Version 1.0 hand-held computer software
purchased in the fourth quarter of 2002 (as discussed in the above paragraph).
The hourly wage paid to LOR, Inc. was $32 per hour, which equated to $66,560 per
year, including overhead. In the opinion of Management, these related party
transactions were reasonable and fair to the Company and will not have a
material effect on the Company's financial position, results of operations or
liquidity.
At the Company's October 28, 2003 Board of Directors' meeting, the
independent directors of the Board of Directors and the Audit Committee approved
an amendment to the arrangements with LOR, Inc. regarding the usage of the
aircrafts, as discussed above, to provide that they would substitute the
Gulfstream III N330WR for the Jetstar II, that was sold, with all other
provisions remaining the same except that the Gulfstream III N330WR is charged
at a rate of $12,745 per month. The decision was based on full disclosure
including independent appraisals. In the opinion of Management, this related
party transaction was reasonable and fair to the Company and will not have a
material effect on the Company's financial position, results of operations or
liquidity.
Employees of Rollins, Inc. confer with employees of LOR, Inc. and RRR
Associates and vice versa. No fees are charged for these services because, in
the opinion of Management, the activity is mutually beneficial and offsetting.
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
19
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.
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. However, it is not possible to accurately predict future
significant claims. 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
20
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 is 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
Years ended December 31
------------------------------------------
(in thousands) 2003 2002 2001
----------------------------------------------------------------------------------------------------
Net Cash Provided by Operating Activities $62,019 $53,694 $29,558
Net Cash Used in Investing Activities (34,006) (12,155) (9,178)
Net Cash Used in Financing Activities (6,788) (11,874) (12,129)
Net Increase in Cash and Short-Term Investments 21,225 29,665 8,251
----------------------------------------------------------------------------------------------------
The Company believes its current cash balances, future cash flows from
operating activities and available borrowings under its $55.0 million line of
credit will be sufficient to finance its current operations and obligations, and
fund expansion of the business for the foreseeable future. The Company's
operations generated cash of $62.0 million for the year ended December 31, 2003,
compared with cash provided by operating activities of $53.7 million in 2002 and
$29.6 million in 2001. The 2003 results were achieved primarily from higher Net
Income and strong advance payments received from customers. The decrease in
Long-Term Accrued Liabilities in 2003 was due to a $5.0 million and a $9.8
million contribution to the defined benefit retirement plan made in April and
December of 2003, respectively.
The Company invested approximately $10.6 million in capital expenditures
during the year ended December 31, 2003. Capital expenditures for the year
consisted primarily of equipment replacements and upgrades and improvements to
the Company's management information systems. The Company expects to invest
between $10.0 million and $12.0 million in 2004 in capital expenditures. During
the year, the Company made several acquisitions totaling $1.5 million compared
to $1.8 million during 2002. The Company continues to seek new acquisitions and
will give consideration to any unusually attractive acquisition opportunities
presented. A total of $9.0 million was paid in cash dividends ($0.05 per share a
quarter) during the year, compared to $6.0 million or $0.033 per share a quarter
during 2002. The Company did not repurchase any shares of Common Stock in 2003
and there remain 649,684 shares authorized to be repurchased. At the January 27,
2004 Board of Directors' Meeting the Board approved a 20% increase in the
quarterly dividend, from $0.05 to $0.06 per share to holders of record on
February 10, 2004 payable March 10, 2004. The Company has increased the dividend
for the second consecutive year. The capital expenditures, acquisitions, stock
repurchases and cash dividends were funded entirely through existing cash
balances and operating activities. The Company maintains a $55.0 million credit
facility with a commercial bank, of which $32.0 million in Letters of Credit
were outstanding as of December 31, 2003 and February 27, 2004.
On March 8, 2004, the Company entered into a definitive agreement to
acquire, through a purchase of assets, the pest control business and certain
ancillary operations of Western Industries, Inc. and its affiliates. The
aggregate consideration will be paid in a combination of cash and marketable
securities, on hand as well as borrowings from an outside party to be arranged
in connection with the purchase, and is expected to range from approximately
$105.0 to
21
$110.0 million. The amount to be financed has not been determined at this time.
The Company is anticipating closing on the purchase in the second quarter of
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
defendant in Helen Cutler and Mary Lewin v. Orkin Exterminating Company, Inc. et
al pending in the District Court of Houston County, Alabama. Other lawsuits
against Orkin, and in some instances the Company, are also being vigorously
defended, including the Warren, Allen, Petsch, and Stevens cases. For further
discussion, see Note 7 to the accompanying financial statements.
The Company made a required contribution of $5.0 million and a voluntary
contribution of $9.8 million to its defined benefit retirement plan (the "Plan")
during 2003 as a result of the Plan's funding status. Upon evaluation of the
plan as of December 31, 2003, it was determined that the plan's accumulated
benefit obligation was funded and therefore the previously recorded minimum
pension liabilities were reversed. The Company believes that it will make
contributions in the amount of approximately $3.0 to $6.0 million 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.
The decline in the Accrual for Termite Contracts of $2.6 million or 5.5%
reflects improvement in the experience rate. The number of new termite claims
declined for the fifth year in a row and was 10.9% lower than 2002, which is a
result of improved treatment techniques, more effective termiticides, shorter
term guarantees and quality assurance initiatives. Accrued Insurance decreased
$2.9 million or 6.9% during the year as a result of improved experience rate,
attributable to the Company's proactive management of issues associated with
self-insured risks.
Contractual Obligations
The impact that the Company's contractual obligations as of December 31,
2003 are expected to have on our liquidity and cash flow in future periods is as
follows:
Payments due by period
---------------------------------------------------------------------------------
Less than 1 More than 5
Contractual Obligations(in thousands) Total year 1-3 years 3-5 years years
- -----------------------------------------------------------------------------------------------------------------------
Long-Term Debt $ 713 $ 378 $ 294 $ 41 $ ---
Non-cancelable operating leases 71,327 19,144 25,873 10,470 15,840
Acquisition notes payable 3,747 1,162 1,915 502 168
-------------- ---------------- ---------------- --------------- ----------------
Total (1) $75,787 $20,684 $28,082 $11,013 $16,008
- -----------------------------------------------------------------------------------------------------------------------
(1) Minimum pension funding requirements are not included as such amounts have
not been determined. The Company estimates that it will contribute
approximately $3.0 to $6.0 million to the plan in fiscal 2004.
Impact of Recent Accounting Pronouncements
In November 2002, the Emerging Issues Task Force issued EITF 00-21, Revenue
Arrangements with Multiple Deliverables, which is effective for revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The
Company adopted EITF 00-21 in the third quarter of 2003. This EITF addresses how
to account for arrangements that involve the delivery or performance of multiple
products, services, and/or rights to use assets. The Company's termite baiting
service involves multiple deliverables, consisting of an initial directed liquid
termiticide treatment, installation of termite monitoring stations, and
subsequent periodic monitoring inspections. The portion of the termite baiting
service sales price applicable to subsequent periodic monitoring inspections,
which is determined based on fair value, is deferred and recognized over the
first year of each contract. The portion of the sales price applicable to the
termiticide treatment and installation of the monitoring services is determined
under the residual method (the total sales price less the fair value of the
monitoring inspections). Revenues from the termiticide treatment and
installation of the termite monitoring stations are recognized upon performance
of the service and installation. The adoption of this EITF did not have a
significant effect on the Company's financial position, results of operations or
liquidity.
22
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 are effective for all variable interest
entities created or acquired after January 31, 2003. In December 2003, the
Financial Accounting Standards Boards issued a revision to FIN 46 referred to as
Interpretation No. 46 (R). Among other provisions, the revision extends the
adoption date of FIN 46 (R) to the first quarter of 2004 for variable interest
entities created prior to February 1, 2003. The Company believes the adoption of
the Interpretation, with respect to variable interest entities created prior to
February 1, 2003 will not have a material impact on the financial position,
results of operations or liquidity of the Company. During 2003, the Company
adopted FIN 46 with respect to franchise entities created after January 31,
2003. The adoption did not have a significant effect on the Company's financial
position or results of operations (see Note 1 to the accompanying financial
statements).
Forward-Looking Statements
This Annual Report contains forward-looking statements within the meaning
of the Private Securities Litigation Reform Act of 1995. Such forward-looking
statements include statements regarding the expected impact of potential future
pension plan contributions, related party transactions, the outcome of
litigation arising in the ordinary course of business and the outcome of the
Helen Cutler and Mary Lewin v. Orkin Exterminating Company, Inc. et al.
("Cutler") and the Butland et al. v. Orkin Exterminating Company, Inc. et al.
("Butland") litigation on the Company's financial position, results of
operations and liquidity; the adequacy of the Company's resources to fund
operations and obligations; the Company's projected 2004 capital expenditures;
the impact of recent accounting pronouncements; the expected outcome of the
growth of national account revenue; and the impact of expected pension plan
contributions in the near future. The actual results of the Company could differ
materially from those indicated by the forward-looking statements because of
various risks, timing and uncertainties including, without limitation, the
possibility of an adverse ruling against the Company in the Cutler, Butland or
other litigation; general economic conditions; market risk; changes in industry
practices or technologies; the degree of success of the Company's 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; potential increases in labor costs;
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.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
Market Risk
As of December 31, 2003, 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 $55.0 million credit facility. Due to the absence of such
borrowings as of December 31, 2003, this risk was not significant in 2003 and is
not expected to have a material effect upon the Company's results of operations
or financial position going forward. However, the Company does maintain
approximately $32.0 million in Letters of Credit. 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.
23
Item 8. Financial Statements and Supplementary Data.
CONSOLIDATED STATEMENTS OF FINANCIAL POSITION
Rollins, Inc. and Subsidiaries
- -----------------------------------------------------------------------------------------------------------------------
At December 31, (in thousands except share and per share data) 2003 2002
-----------------------------------------
ASSETS
Cash and Short-Term Investments $ 59,540 $ 38,315
Marketable Securities 21,866 ---
Trade Receivables, Net of Allowance for Doubtful Accounts of
$4,616 and $5,441, respectively 48,471 48,671
Materials and Supplies 9,837 10,662
Deferred Income Taxes 23,243 20,035
Other Current Assets 7,414 9,470
--------------------------------------------
Current Assets 170,371 127,153
Equipment and Property, Net 35,836 38,880
Goodwill 72,498 72,392
Customer Contracts and Other Intangible Assets 30,333 35,507
Deferred Income Taxes 15,902 44,406
Other Assets 24,964 ---
--------------------------------------------
Total Assets $349,904 $318,338
--------------------------------------------
LIABILITIES
Accounts Payable $ 12,290 $ 12,138
Accrued Insurance 13,050 11,740
Accrued Compensation and Related Liabilities 31,019 29,554
Unearned Revenue 46,007 43,049
Accrual for Termite Contracts 21,500 19,000
Other Current Liabilities 21,156 15,312
-------------------- -----------------------
Current Liabilities 145,022 130,793
Accrued Insurance, Less Current Portion 26,024 30,222
Accrual for Termite Contracts, Less Current Portion 22,373 27,446
Accrued Pension --- 10,769
Long-Term Accrued Liabilities 17,711 28,418
--------------------------------------------
Total Liabilities 211,130 227,648
--------------------------------------------
Commitments and Contingencies
STOCKHOLDERS' EQUITY
Common Stock, par value $1 per share; 99,500,000
shares authorized; 45,156,674 and 44,799,368
shares issued and outstanding, respectively 45,157 44,799
Additional Paid-In Capital 4,408 299
Accumulated Other Comprehensive Loss (314) (16,947)
Retained Earnings 89,523 62,539
--------------------------------------------
Total Stockholders' Equity 138,774 90,690
--------------------------------------------
Total Liabilities and Stockholders' Equity $349,904 $318,338
--------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
24
CONSOLIDATED STATEMENTS OF INCOME
Rollins, Inc. and Subsidiaries
- -------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31, (in thousands except per share data) 2003 2002 2001
- -------------------------------------------------------------------------------------------------------------------------------
REVENUES
Customer Services $677,013 $665,425 $649,925
----------------------------------------------------
COSTS AND EXPENSES
Cost of Services Provided 362,422 361,318 361,921
Depreciation and Amortization 20,179 21,635 20,292
Sales, General and Administrative 236,514 238,180 240,628
(Gain)/Loss on Sale of Assets (1,700) 762 (44)
Interest Income (432) (196) (198)
----------------------------------------------------
616,983 621,699 622,599
INCOME BEFORE INCOME TAXES 60,030 43,726 27,326
----------------------------------------------------
PROVISION FOR INCOME TAXES
Current 13,864 13,680 6,771
Deferred 10,405 2,936 3,613
----------------------------------------------------
24,269 16,616 10,384
----------------------------------------------------
NET INCOME $ 35,761 $ 27,110 $ 16,942
----------------------------------------------------
EARNINGS PER SHARE - BASIC
Net Income $ 0.79 $ 0.60 $ 0.37
----------------------------------------------------
EARNINGS PER SHARE - DILUTED
Net Income $ 0.77 $ 0.60 $ 0.37
----------------------------------------------------
Average Shares Outstanding - Basic 45,069 45,021 45,200
Average Shares Outstanding - Diluted 46,206 45,409 45,398
DIVIDENDS PAID PER SHARE $ 0.20 $ 0.13 $ 0.13
The accompanying notes are an integral part of these consolidated financial
statements.
25
CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY
Rollins, Inc. and Subsidiaries
- -----------------------------------------------------------------------------------------------------------------------------------
(in thousands) Accumulated
Other
Common Stock Retained Paid- Comprehensive Comprehensive Treasury
Shares Amount Earnings In-Capital Income (Loss) Income (Loss) Stock Total
------------------------------------------------------------------------------------------------------
Balance at January 1, 2001 45,054 $45,054 $33,545 $ --- $ --- $ --- $ --- $ 78,599
--------
Net Income 16,942 16,942 16,942
Other Comprehensive Income,
Net of Tax
Minimum Pension Liability
Adjustment (4,047) (4,047)
Foreign Currency
Translation Adjustments (775) (775)
-------- --------
Other Comprehensive Loss (4,822) (4,822)
--------
Comprehensive Income $ 12,120
--------
Cash Dividends (6,028) (6,028)
Common Stock Purchased (1,503) (107) (1,610)
Common Stock Issued for
Acquisitions of Companies 31 31 469 --- 500
Issuance of 401(k) Company
Match 108 108 1,712 --- 1,820
Three-for-Two Stock Split 71 71 (17) (54) ---
Other 2 2 95 --- 97
------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 45,266 $45,266 $44,537 $ 678 $ --- $ (4,822) $ (161) $ 85,498
--------
Net Income 27,110 27,110 27,110
Other Comprehensive Income,
Net of Tax
Minimum Pension Liability
Adjustment (12,135) (12,135)
Foreign Currency
Translation Adjustments 10 10
--------
Other Comprehensive Loss (12,125) (12,125)
--------
Comprehensive Income $ 14,985
--------
Cash Dividends (6,004) (6,004)
Common Stock Purchased (90) (90) (3,316) (2,519) (241) (6,166)
Issuance of 401(k) Company
Match --- --- 1,634 90 1,724
Three-for-Two Stock Split (27) (27) 102 (75) ---
Other 37 37 110 506 --- 653
------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 45,186 $45,186 $62,539 $ 299 $ --- $ (16,947) $ (387) $ 90,690
--------
Net Income 35,761 35,761 35,761
Other Comprehensive Income,
Net of Tax
Minimum Pension Liability
Adjustment 16,182 16,182
Foreign Currency
Translation Adjustments 518 518
Unrealized Loss on
Investments (67) (67)
--------
Other Comprehensive Income 16,633 16,633
--------
Comprehensive Income $ 52,394
--------
Cash Dividends (9,010) (9,010)
Issuance of 401(k) Company
Match --- --- 2,087 72 2,159
Three-for-Two Stock Split 24 24 75 (99) ---
Other 361 361 158 2,022 2,541
------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 45,571 $45,571 $89,523 $ 4,408 $ --- $ (314) $ (414) $138,774
------------------------------------------------------------------------------------------------------
The accompanying notes are an integral part of these consolidated financial
statements.
26
CONSOLIDATED STATEMENTS OF CASH FLOWS
Rollins, Inc. and Subsidiaries
- -------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31, (in thousands except per share data) 2003 2002 2001
- -------------------------------------------------------------------------------------------------------------------------------
OPERATING ACTIVITIES
Net Income $ 35,761 $ 27,110 $ 16,942
Adjustments to Reconcile Net Income to Net Cash
Provided by Operating Activities:
Depreciation and Amortization 20,179 21,635 20,292
Provision for Deferred Income Taxes 10,405 3,643 3,360
Other, Net 654 955 250
(Increase) Decrease in Assets:
Trade Receivables 339 (115) 1,620
Materials and Supplies 878 1,244 1,085
Other Current Assets 2,056 945 (3,396)
Other Non-Current Assets (199) (44) (2,476)
Increase (Decrease) in Liabilities:
Accounts Payable and Accrued Expenses 9,776 (6,645) 5,413
Unearned Revenue 2,959 15,579 1,088
Accrued Insurance (2,889) (663) (6,322)
Accrual for Termite Contracts (2,573) (4,429) (6,776)
Long-Term Accrued Liabilities (15,327) (5,521) (1,522)
----------------------------------------------------
Net Cash Provided by Operating Activities 62,019 53,694 29,558
----------------------------------------------------
INVESTING ACTIVITIES
Purchases of Equipment and Property (10,597) (10,367) (8,474)
Acquisitions of Companies (1,543) (1,788) (704)
Purchase of Marketable Securities, Net (21,866) --- ---
----------------------------------------------------
Net Cash Used in Investing Activities (34,006) (12,155) (9,178)
----------------------------------------------------
FINANCING ACTIVITIES
Dividends Paid (9,010) (6,004) (6,028)
Common Stock Purchased --- (6,166) (1,610)
Payments on Capital Leases --- (256) (1,829)
Payments under the Credit Facility --- --- (1,400)
Other 2,222 552 (1,262)
----------------------------------------------------
Net Cash Used in Financing Activities (6,788) (11,874) (12,129)
----------------------------------------------------
Net Increase in Cash and Short-Term Investments 21,225 29,665 8,251
Cash and Short-Term Investments at Beginning of Year 38,315 8,650 399
----------------------------------------------------
Cash and Short-Term Investments at End of Year $ 59,540 $ 38,315 $ 8,650
----------------------------------------------------
Supplemental Disclosure of Cash Flow Information
Cash Paid for Interest $ 349 $ 436 $ 581
Cash Paid for Income Taxes $ 20,213 $ 10,893 $ 5,954
The accompanying notes are an integral part of these consolidated financial
statements.
27
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2003, 2002, and 2001, Rollins, Inc. and Subsidiaries
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Business Description - Rollins, Inc. (the "Company") is a national service
company with headquarters located in Atlanta, Georgia, providing pest and
termite control services to both residential and commercial customers.
Orkin, Inc. ("Orkin"), a wholly owned subsidiary of the Company founded in
1901, is one of the world's largest pest and termite control companies. It
provides customized services from over 400 locations to approximately 1.6
million customers. Orkin serves customers in the United States, Canada, and
Mexico, providing essential pest control services and protection against termite
damage, rodents and insects to homes and businesses, including hotels, food
service establishments, food manufacturers, retailers and transportation
companies. Orkin operates under the Orkin(R) and PCO Services, Inc.(R)
trademarks and the AcuridSM service mark.
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.
Principles of Consolidation - 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 entities that require consolidation.
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.
Revenues - 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 is
reasonably assured.
Advertising - Advertising expenses are charged to income during the year in
which they are incurred. The total advertising costs were approximately $31.9
million, $30.0 million and $30.2 million in 2003, 2002 and 2001, respectively.
Cash and Short-Term Investments - The Company considers all investments with a
maturity of three months or less to be cash equivalents. Short-term investments
are stated at cost, which approximates fair market value.
28
Marketable Securities - The Company maintains investments held with 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.
Realized losses on sales of marketable securities totaled $24,900 for the year
ended December 31, 2003. 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. As of December 31, 2003, the
fair value of marketable securities approximates $22.0 million and includes an
unrealized loss of $108,787. The Company's marketable securities generally
consist of United States government, corporate and municipal debt securities.
All of the Company's marketable securities at December 31, 2003 mature in less
than twelve months.
Materials and Supplies - Materials and supplies are recorded at the lower of
cost (first-in, first-out basis) or market.
Income Taxes - The Company provides for income taxes based on Statement of
Financial Accounting Standards (SFAS) No. 109, Accounting for Income Taxes,
which requires recognition of deferred tax liabilities and assets for the
expected future tax consequences of events that have been included in the
consolidated financial statements or tax returns.
Equipment and Property - Depreciation and amortization, which includes the
amortization of assets recorded under capital leases, are provided principally
on a straight-line basis over the estimated useful lives of the related assets.
Annual provisions for depreciation of $13.6 million in 2003, $15.0 million in
2002 and $13.6 million in 2001, have been reflected in the Consolidated
Statements of Income in the line item entitled Depreciation and Amortization.
These annual provisions for depreciation are computed using the following asset
lives: buildings, ten to forty years; and furniture, fixtures, and operating
equipment, three to ten years. Expenditures for additions, major renewals and
betterments are capitalized and expenditures for maintenance and repairs are
expensed as incurred. The cost of assets retired or otherwise disposed of and
the related accumulated depreciation and amortization are eliminated from the
accounts in the year of disposal with the resulting gain or loss credited or
charged to income.
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 practice 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.
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
29
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.
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.
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. Basic and diluted EPS in 2002 and 2001 have been restated for the
three-for-two stock split in March of 2003. A reconciliation of the number of
weighted-average shares used in computing basic and diluted EPS is as follows:
(in thousands except per share data and per share amounts) 2003 2002 2001
- ------------------------------------------------------------------------------------------------------------
Basic and diluted earnings available to stockholders (numerator): $ 35,761 $ 27,110 $ 16,942
Shares (denominator):
Weighted-average shares outstanding 45,069 45,021 45,200
Effect of Dilutive securities:
Employee Stock Options 1,137 388 198
---------------------------------
Adjusted Weighted-Average Shares 46,206 45,409 45,398
Per share amounts:
Basic earnings per common share $ 0.79 $ 0.60 $ 0.37
Diluted earnings per common share $ 0.77 $ 0.60 $ 0.37
- ------------------------------------------------------------------------------------------------------------
Stock-Based Compensation - 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
under those plans 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.
30
Years Ended December 31,
----------------------------------------------
(in thousands, except per share data) 2003 2002 2001
---------------------------------------------------------------------------------------------------
Net income, as reported $ 35,761 $ 27,110 $ 16,942
Deduct: Total stock-based employee compensation
expense determined under fair value based method
for all awards, net of related tax effects
(1,240) (1,853) (1,508)
----------------------------------------------
Pro forma net income $ 34,521 $ 25,257 $ 15,434
----------------------------------------------
Earnings per share:
Basic-as reported $ 0.79 $ 0.60 $ 0.37
Basic-pro forma $ 0.77 $ 0.56 $ 0.34
Diluted-as reported $ 0.77 $ 0.60 $ 0.37
Diluted-pro forma $ 0.75 $ 0.56 $ 0.34
---------------------------------------------------------------------------------------------------
The per share weighted-average fair value of stock options granted during
2003, 2002, and 2001 was $4.05, $2.53, and $3.57, respectively, on the date of
grant, using the Black-Scholes option-pricing model with the following
weighted-average assumptions:
2003 2002 2001
- --------------------------------------------------------------------------------
Risk-Free Interest Rate 3.96% 3.98% 5.10%
Expected Life, in Years Range from 4 to 8 Range from 4 to 8 8
Expected Volatility 10.70% 12.50% 15.76%
Expected Dividend Yield 1.07% 1.04% 1.10%
- --------------------------------------------------------------------------------
Comprehensive Income (Loss) - Other Comprehensive Income (Loss) results from
foreign currency translations, minimum pension liability adjustments and
unrealized loss on marketable securities.
New Accounting Standards - In November 2002, the Emerging Issues Task Force
issued EITF 00-21, Revenue Arrangements with Multiple Deliverables, which is
effective for revenue arrangements entered into in fiscal periods beginning
after June 15, 2003. The Company adopted EITF 00-21 in the third quarter of
2003. This EITF addresses how to account for arrangements that involve the
delivery or performance of multiple products, services, and/or rights to use
assets. The Company's termite baiting service involves multiple deliverables,
consisting of an initial directed liquid termiticide treatment, installation of
termite monitoring stations, and subsequent periodic monitoring inspections. The
portion of the termite baiting service sales price applicable to subsequent
periodic monitoring inspections, which is determined based on fair value, is
deferred and recognized over the first year of each contract. The portion of the
sales price applicable to the termiticide treatment and installation of the
monitoring services is determined under the residual method (the total sales
price less the fair value of the monitoring inspections). Revenues from the
termiticide treatment and installation of the termite monitoring stations are
recognized upon performance of the service and installation. The adoption of
this EITF did not have a significant effect on the Company's financial position,
results of operations or liquidity.
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 are effective for all variable interest
entities created or acquired after January 31, 2003. In December 2003, the
Financial Accounting Standards Boards issued a revision to FIN 46 referred to as
Interpretation No. 46 (R). Among other provisions, the revision extends the
adoption date of FIN 46 (R) to the first quarter of 2004 for variable interest
entities created prior to February 1, 2003. The Company believes the adoption of
the Interpretation, with respect to variable interest entities created prior to
February 1, 2003, will not have a material impact on the financial position,
results of operations or liquidity of the
31
Company. During 2003, the Company adopted FIN 46 with respect to franchise
entities created after January 31, 2003. The adoption did not have a significant
effect on the Company's financial position or results of operations.
Franchising Program - Orkin has 44 franchises as of December 31, 2003, 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 December 31, 2003
and 2002, notes receivable from franchises aggregated $3.9 million and $2.6
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
reasonable assured, which amounted to approximately $2.2 million in 2003, $1.1
million in 2002, and $0.3 million in 2001, and are included as revenues in the
accompanying Consolidated Statements of Income. 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 $1.4 million and $1.1 million at December 31, 2003
and 2002, respectively. Royalties from franchises are accrued and recognized as
revenues as earned on a monthly basis. Revenues from royalties were $1.4 million
in 2003, $1.2 million in 2002, and $0.9 million in 2001. The Company's maximum
exposure to loss relating to the franchises aggregate $2.5 million and $1.5
million in December 31, 2003 and 2002, 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.
Reclassifications - Certain amounts for previous years have been reclassified to
conform with the 2003 consolidated financial statement presentation.
Three-for-Two Stock Split - The Board of Directors, at its quarterly meeting on
January 28, 2003, authorized a three-for-two stock split by the issuance on
March 10, 2003 of one additional common share for each two common shares held of
record at February 10, 2003. All share and per share data for 2002 and 2001
appearing in the consolidated financial statements and related notes have been
retroactively adjusted for this stock split.
2. TRADE RECEIVABLES
Trade receivables, net, at December 31, 2003, totaling $48.5 million and at
December 31, 2002, totaling $48.7 million, are net of allowances for doubtful
accounts of $4.6 million and $5.4 million, respectively. Trade receivables
include installment receivable amounts, which are due subsequent to one year
from the balance sheet dates. These amounts were approximately $6.2 million and
$6.4 million at the end of 2003 and 2002, respectively. Trade receivables also
include notes receivable due from franchises which amount to $3.9 million and
$2.6 million as of December 31, 2003 and 2002, respectively. The carrying amount
of notes receivable approximates fair value as the interest rates approximate
market rates. The Allowance For Doubtful Accounts is principally calculated
based on the application of estimated loss percentages to delinquency aging
totals, based on contractual terms, for the various categories of receivables.
Bad debt write-offs occur according to company policies that are specific to
pest control, commercial and termite accounts. At any given time, the Company
may have immaterial amounts due from related parties, which are invoiced and
settled on a regular basis. Receivables due from related parties were $55,000 as
of December 31, 2003, as compared to $64,000 as of December 31, 2002.
3. EQUIPMENT AND PROPERTY
Equipment and property are presented at cost less accumulated depreciation
and are detailed as follows:
(in thousands) 2003 2002
- --------------------------------------------------------------------------------
Buildings $ 13,194 $ 13,118
Operating Equipment 39,273 34,522
Furniture and Fixtures 5,845 6,601
Computer Equipment and Systems 30,417 32,544
-------------------------
88,729 86,785
Less - Accumulated Depreciation 57,747 52,381
-------------------------
30,982 34,404
Land 4,854 4,476
-------------------------
$ 35,836 $ 38,880
- --------------------------------------------------------------------------------
32
4. GOODWILL AND OTHER INTANGIBLE ASSETS
Intangibles consist primarily of goodwill and customer contracts and also
includes trademarks and non-compete agreements, all related to businesses
acquired. Goodwill represents the excess of the purchase price over the fair
value of net assets of businesses acquired. The carrying amount of goodwill was
$72.5 million as of December 31, 2003 and $72.4 million as of December 31, 2002.
Goodwill arising from acquisitions prior to November 1970 has never been
amortized for financial statement purposes, since, in the opinion of Management,
there has been no decrease in the value of the acquired businesses. Prior to
2002, the values assigned to all intangible assets, including goodwill for
acquisitions completed subsequent to November 1970 and prior to June 30, 2001,
were amortized on a straight-line basis over the estimated useful lives of the
assets, not exceeding 40 years.
On January 1, 2002, the Company adopted FASB Statement No. 142, Goodwill
and Other Intangible Assets. As of January 1, 2002, amortization of goodwill and
trademarks was terminated, and instead the assets are subject to periodic
testing for impairment. The Company completed its annual impairment analyses as
of September 30, 2003. Based upon the results of these analyses, the Company has
concluded that no impairment of its goodwill or trademarks has occurred.
Customer contracts and non-compete agreements are amortized on a
straight-line basis over the period of the agreements, as straight-line best
approximates the ratio that current revenues bear to the total of current and
anticipated revenues, based on the estimated lives of the assets. In accordance
with Statement 142, the expected lives of customer contracts and non-compete
agreements were reviewed, and it was determined that customer contracts should
be amortized over a life of 8 to 12 1/2 years dependent upon customer type. The
impact of this review in 2002 was an increase in amortization expense on
customer contracts of $2.0 million. The carrying amount and accumulated
amortization for customer contracts are as follows:
December 31,
-------------------------
(in thousands) 2003 2002
- --------------------------------------------------------------------------------
Customer contracts $ 46,563 $ 44,963
Less: accumulated amortization (18,474) (13,036)
-------------------------
$ 28,089 $ 31,927
- --------------------------------------------------------------------------------
Had the Company adopted the provisions of Statement 142 as of January 1, 2001,
the effects on net income would have been as follows:
Years ended December 31,
-------------------------------------------------
(in thousands) 2003 2002 2001
- ------------------------------------------------------------------------------------------------------
Net income (as reported) $ 35,761 $ 27,110 $ 16,942
Effect of ceasing goodwill amortization --- --- 2,219
Effect of change in customer contract lives --- --- (2,005)
-------------------------------------------------
Pro forma net income $ 35,761 $ 27,110 $ 17,156
Pro forma basic net income per share $ 0.79 $ 0.60 $ 0.38
Pro forma diluted net income per share $ 0.77 $ 0.60 $ 0.38
- ------------------------------------------------------------------------------------------------------
Total intangible amortization expense was approximately $6.9 million in 2003,
$6.7 million in 2002 and $6.6 million in 2001. Amortization of customer
contracts and non-competes was approximately $6.9 million in 2003, $6.7 million
in 2002 and $4.4 million in 2001 and goodwill amortization was $2.2 million in
2001. Estimated amortization expense for each of the five succeeding fiscal
years is as follows:
December 31,
-------------------------------------------------
2004 $6,617
2005 6,143
2006 5,981
2007 5,542
2008 5,101
33
5. INCOME TAXES
The Company's income tax provision consisted of the following:
(in thousands) 2003 2002 2001
- ------------------------------------------------------------------------------------------------------
Current:
Federal $ 10,238 $ 9,969 $ 4,405
State 2,188 2,644 1,095
Foreign 1,438 1,067 1,271
Deferred:
Federal 9,955 2,707 3,254
State 607 232 359
Foreign (157) (3) ---
-------------------------------------------------
Total income tax provision $ 24,269 $ 16,616 $ 10,384
- ------------------------------------------------------------------------------------------------------
The primary factors causing income tax expense to be different than the
federal statutory rate for 2003, 2002 and 2001 are as follows:
(in thousands) 2003 2002 2001
- ------------------------------------------------------------------------------------------------------
Income taxes at statutory rate $ 21,010 $ 15,304 $ 9,564
State income tax expense (net of Federal benefit) 1,817 1,719 712
Foreign tax expense 1,200 874 360
Other 242 (1,281) (252)
-------------------------------------------------
$ 24,269 $ 16,616 $ 10,384
- ------------------------------------------------------------------------------------------------------
The Provision for Income Taxes resulted in an effective tax rate of 40.4%
on Income Before Income Taxes for the year ended December 31, 2003. For 2002 and
2001, the effective tax rate was 38.0%. The effective income tax rate differs
from the annual federal statutory tax rate primarily because of state and
foreign income taxes. During 2003, 2002 and 2001, the Company paid income taxes
of $20.2 million, $10.9 million and $5.9 million, respectively, net of refunds.
Deferred income taxes reflect the net tax effects of the temporary
differences between the carrying amounts of assets and liabilities for financial
reporting purposes and income tax purposes. Significant components of the
Company's deferred tax assets and liabilities at December 31, 2003 and 2002 are
as follows:
December 31,
-------------------------
(in thousands) 2003 2002
- --------------------------------------------------------------------------------
Deferred tax assets:
Termite Accrual $ 15,977 $ 16,747
Insurance and Contingencies 20,471 26,596
Compensation and Benefits 2,772 2,211
Net Pension Liability --- 2,193
State Operating Loss Carryforwards 7,784 7,784
Other 3,958 11,383
-------------------------
50,962 66,914
Deferred tax liabilities:
Prepaid Pension (9,611) ---
Depreciation and Amortization (2,206) (2,473)
-------------------------
(11,817) (2,473)
-------------------------
Net deferred tax asset $ 39,145 $ 64,441
- --------------------------------------------------------------------------------
34
6. ACCRUAL FOR TERMITE CONTRACTS
A reconciliation of changes in the accrual for termite contracts for the
years ended December 31, 2003, 2002 and 2001 is as follows:
(in thousands) 2003 2002 2001
- ------------------------------------------------------------------------------------------------------
Beginning Balance $ 46,446 $ 50,875 $ 57,651
Current Year Provision 21,600 21,050 17,800
Settlements, Claims and Expenditures (24,173) (25,479) (24,576)
-------------------------------------------------
Ending Balance $ 43,873 $ 46,446 $ 50,875
- ------------------------------------------------------------------------------------------------------
7. COMMITMENTS AND CONTINGENCIES
The Company has several operating leases expiring at various dates through
2017. The minimum lease payments under non-cancelable operating leases with
terms in excess of one year, in effect at December 31, 2003, are summarized as
follows:
(In thousands)
- -----------------------------------------------------------------
2004 $ 19,144
2005 16,212
2006 9,661
2007 5,918
2008 4,552
Thereafter 15,840
------------
$ 71,327
- -----------------------------------------------------------------
Total rental expense under operating leases charged to operations was $28.0
million, $27.4 million and $28.7 million for the years ended December 31, 2003,
2002 and 2001, respectively.
The Company maintains a credit facility with a bank that allows it to
borrow up to $55.0 million on an unsecured basis at the bank's prime rate of
interest or the indexed London Interbank Offered Rate (LIBOR) under which $32.0
million in Letters of Credit were outstanding at December 31, 2003. No
borrowings were outstanding under this credit facility as of December 31, 2003,
2002 or 2001.
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 and are seeking monetary damages and injunctive
relief for alleged breach of contract arising out of alleged missed or
inadequate reinspections. The attorneys for the plaintiffs contend that the case
is suitable for a class action and the court has ruled that the plaintiffs would
be permitted to pursue a class action lawsuit against Orkin. Orkin believes this
case to be without merit and intends to defend itself vigorously at trial. The
trial is currently set for early June 2004. 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 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.
35
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.
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. Some lawsuits have been filed (Ernest W. Warren and
Dolores G. Warren et al. v. Orkin Exterminating Company, Inc., et al.; Elizabeth
Allen and William Allen et al. v. Rollins, Inc. and Orkin Exterminating Company,
Inc.; Francis D. Petsch, et al. v. Orkin Exterminating Company, Inc. et al.; and
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. The Company believes them 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.
8. EMPLOYEE BENEFIT AND STOCK COMPENSATION PLANS
The Company maintains a noncontributory tax-qualified defined benefit
retirement plan (the "Plan") covering employees meeting certain age and service
requirements. The Plan provides benefits based on the average compensation for
the highest five years during the last ten years of credited service (as
defined) in which compensation was received, and the average anticipated Social
Security covered earnings. The Company funds the Plan with at least the minimum
amount required by ERISA. The Company made contributions of $14.8 million to the
Plan in 2003. Effective January 1, 2002, the Company adopted amendments to the
Plan including a change to the benefit calculation and limiting plan
participation to current participants. These amendments are reflected in benefit
obligations below.
The funded status of the Plan and the net amount recognized in the
statement of financial position are summarized as follows as of December 31:
(in thousands) 2003 2002
- --------------------------------------------------------------------------------
CHANGE IN BENEFIT OBLIGATION
Obligation at Beginning of Year $109,294 $ 94,006
Service Cost 4,682 3,825
Interest Cost 7,800 7,246
Actuarial Loss 10,205 8,081
Benefits Paid (4,149) (3,864)
-------------------------
Obligation at End of Year 127,832 109,294
CHANGE IN PLAN ASSETS
Fair Value of Plan Assets at Beginning of Year 88,713 76,942
Actual Return on Plan Assets 16,398 (4,365)
Employer Contribution 14,800 20,000
Benefits Paid (4,149) (3,864)
-------------------------
Fair Value of Plan Assets at End of Year 115,762 88,713
-------------------------
Funded Status (12,070) (20,581)
Unrecognized Net Actuarial Loss 42,511 42,236
Unrecognized Prior Service Benefit (5,477) (6,345)
Adjustment Required to Recognize Minimum Liability --- (26,079)
- --------------------------------------------------------------------------------
Net Amount Recognized $ 24,964 $(10,769)
- --------------------------------------------------------------------------------
Amounts Recognized in the Statements of Financial Condition Consist of:
- --------------------------------------------------------------------------------
(in thousands) 2003 2002
- --------------------------------------------------------------------------------
Prepaid cost $ 24,964 $ 15,310
Minimum pension liability --- (26,079)
-------------------------
Net Amount Recognized $ 24,964 $(10,769)
- --------------------------------------------------------------------------------
The accumulated benefit obligation for the defined benefit pension plan was
$115,653 and $99,483 at December 31, 2003 and 2002, respectively. Rollins, Inc.
uses a December 31 measurement date for its Qualified Plan.
36
Increases (decreases) in the minimum pension liability which were charged
(credited) to other comprehensive income (loss) were $26.1 million, ($19.9)
million and ($6.2) million in 2003, 2002 and 2001, respectively.
The weighted-average assumptions as of December 31 were used to determine
the projected benefit obligation and net benefit cost:
2003 2002
- --------------------------------------------------------------------------------
Projected Benefit Obligation
Discount Rate 6.250% 6.875%
Rate of Compensation Increase 3.500% 3.875%
Net Benefit Cost
Discount Rate 6.875% 7.375%
Expected Return on Plan Assets 8.000% 8.000%
Rate of Compensation Increase 3.875% 4.375%
- --------------------------------------------------------------------------------
The return on plan assets reflects the weighted-average of the expected
long-term rates of return for the broad categories of investments held in the
plan. The expected long-term rate of return is adjusted when there are
fundamental changes in the expected returns on the plan investments.
The components of net periodic benefit cost for the past three years are
summarized as follows:
(in thousands) 2003 2002 2001
- ------------------------------------------------------------------------------------------------------
Service Cost $ 4,682 $ 3,825 $ 4,794
Interest Cost 7,800 7,246 7,207
Expected Return on Plan Assets (8,492) (7,553) (7,458)
Net Amortizations:
Amortization of Net Loss 2,023 838 62
Amortization of Net Prior Service Benefit (868) (868) (75)
-------------------------------------------------
Net Periodic Benefit Cost $ 5,145 $ 3,488 $ 4,530
- ------------------------------------------------------------------------------------------------------
At December 31, 2003 and 2002, the Plan's assets were comprised of listed
common stocks and U.S. government and corporate securities. Included in the
assets of the Plan were shares of Rollins, Inc. Common Stock with a market value
of $10.2 million and $7.7 million at December 31, 2003 and 2002, respectively.
The Plan's weighted average asset allocation at December 31, 2003 and 2002
by asset category, along with the target allocation for 2004, are as follows:
Target Percentage of Percentage of
Allocations Plan Assets as of Plan Assets as of
Asset Category for 2004 December 31, 2003 December 31, 2002
- --------------------------------------------------------------------------------------------------------
Equity Securities - Rollins stock 10.0% 8.8% 8.7%
Equity Securities - all other 46.5% 48.5% 46.6%
Debt Securities - core fixed income 37.0% 37.8% 39.0%
Debt Securities - high yield 0% 0% 0%
Real Estate 0% 0% 0%
Other 6.5% 4.9% 5.7%
---------------------------------------------------
Total 100.0% 100.0% 100.0%
- --------------------------------------------------------------------------------------------------------
Our investment strategy for our pension plan is to maximize the long-term
rate of return on plan assets within an acceptable level of risk in order to
minimize the cost of providing pension benefits. The investment policy
establishes a target allocation for each asset class, which is rebalanced as
required. The plan utilizes a number of investment approaches, including
individual market securities, equity and fixed income funds in which the
37
underlying securities are marketable, and debt funds to achieve this target
allocation. The Company expects to contribute $3.0 to $6.0 million to the
pension plan in 2004.
The Company sponsors a deferred compensation 401(k) plan that is available
to substantially all employees with six months of service. The plan provides for
a matching contribution (made in the form of Common Stock of the Company) of
thirty cents ($.30) for each one dollar ($1.00) of a participant's contributions
to the plan that do not exceed 6 percent of his or her annual compensation
(which includes commissions, overtime and bonuses). The Company match percentage
remained the same in 2003. The charges to expense for the Company match were
approximately $2.3 million in 2003, $2.3 million in 2002 and $2.0 million in
2001. At December 31, 2003, 2002 and 2001 approximately, 26.6%, 22.9% and 17%,
respectively of the plan assets consisted of Rollins, Inc. Common Stock. Total
administrative fees for the plan were approximately $265,000 in 2003, $278,500
in 2002 and $308,000 in 2001.
The Company has one Employee Stock Incentive Plan, adopted in April 1998
(the "1998 Plan") as a supplement to the 1994 Plan. An aggregate of 2.25 million
shares of Common Stock may be granted under various stock incentive programs
pursuant to this plan, at a price not less than the market value of the
underlying stock on the date of grant. Options may be issued under the 1998 Plan
through April 2008. The majority of options expire ten years from the date of
grant, if not exercised, and vest 20% each year over 5 years.
Options are also outstanding under prior Employee Stock Incentive Plans
(the "1984 Plan" and the "1994 Plan"). Under these plans, 4.05 million shares of
Common Stock were subject to options granted during the ten-year periods ended
October 1994 and January 2004, respectively. The options were granted at the
fair market value of the shares on the date of grant and expire ten years from
the date of grant, if not exercised. No additional options will be granted under
the 1984 Plan and 1994 Plan.
Option transactions during the last three years for the 1984, 1994 and 1998
plans are summarized as follows:
2003 2002 2001
- ------------------------------------------------------------------------------------------------------
Number of Shares Under Stock Options:
Outstanding at Beginning of Year 3,327,883 2,465,250 2,753,160
Granted 450,000 1,168,500 258,750
Exercised (320,472) (67,667) (6,075)
Cancelled (286,738) (238,200) (540,585)
-------------------------------------------------
Outstanding at End of Year 3,170,673 3,327,883 2,465,250
Exercisable at End of Year 1,594,622 1,388,252 1,082,070
Weighted-Average Exercise Price:
Granted $ 18.64 $ 12.85 $ 12.17
Exercised 11.41 10.45 8.83
Cancelled 13.06 12.15 13.05
Outstanding at End of Year 13.31 12.43 12.16
Exercisable at End of Year 12.54 12.44 12.60
- ------------------------------------------------------------------------------------------------------
38
Information with respect to options outstanding and options exercisable at
December 31, 2003 is as follows:
Average Remaining
Contractual Life Number
Exercise Price Number Outstanding (In Years) Exercisable
- --------------------------------------------------------------------------------
$ 18.92 70,500 0.08 52,200
16.17 4,500 1.08 2,700
13.92 16,500 2.08 9,900
12.83 94,923 3.08 74,673
13.13 633,014 4.33 633,014
10.88 547,440 5.08 402,389
9.83 134,407 6.08 60,907
12.17 180,637 7.08 65,887
12.77 975,752 8.08 261,752
14.04 78,000 8.08 31,200
18.64 435,000 9.08 ---
- --------------------------------------------------------------------------------
3,170,673 1,594,622
- --------------------------------------------------------------------------------
9. ACCUMULATED OTHER COMPREHENSIVE INCOME/(LOSS)
Accumulated other comprehensive income/(loss) consists of the following (in
thousands):
Unrealized
Minimum Foreign Loss
Pension Currency on Marketable
Liability Translation Securities Total
- ---------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 $ --- $ --- $ --- $ ---
Change during 2001:
Before-tax amount (6,212) (1,192) --- (7,404)
Tax benefit 2,165 417 --- 2,582
------------------------------------------------------------------------
(4,047) (775) --- (4,822)
------------------------------------------------------------------------
Balance at December 31, 2001 $ (4,047) $ (775) $ --- $ (4,822)
Change during 2002:
Before-tax amount (19,867) 14 --- (19,853)
Tax benefit (expense) 7,732 (4) --- 7,728
------------------------------------------------------------------------
(12,135) 10 --- (12,125)
------------------------------------------------------------------------
Balance at December 31, 2002 $ (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)
- ---------------------------------------------------------------------------------------------------------------
10. RELATED PARTY TRANSACTIONS At the Company's October 22, 2002 Board of
Directors' meeting, the independent directors of the Board of Directors and the
Audit Committee approved three related party transactions. The Audit Committee
and the independent directors were furnished with full disclosure of the
transactions, including independent appraisals, and determined that the terms of
each transaction were reasonable and fair to the Company. The first approval was
the purchase of the Rollins Training Center on October 31, 2002 for $3.1 million
from RTC, LLC, a company controlled by R. Randall Rollins, Chairman of the Board
of Rollins, Inc. The second approval was the purchase of hand-held computer
software development known as PowerTrak Version 1.0 from RRR Associates, a
company
39
controlled by R. Randall Rollins. The purchase was made during the fourth
quarter of 2002 at an approved purchase price of $250,000. The third approval
was a lease agreement effective July 1, 2002 that expires June 30, 2007 for
company real estate in Okeechobee County, Florida to be leased to Rollins Ranch,
a division of LOR, Inc., a company controlled by R. Randall Rollins and Gary W.
Rollins, Chief Executive Officer, President and Chief Operating Officer of
Rollins, Inc. The annual lease rate on this real estate is $131,939. In the
opinion of Management, these related party transactions were reasonable and fair
to the Company and will not have a material effect on the Company's financial
position, results of operations or liquidity.
At the Company's January 28, 2003 Board of Directors' meeting, the
independent directors of the Board of Directors and the Audit Committee approved
four related party transactions. The Audit Committee and the independent
directors were furnished with full disclosure of the transactions, including
independent appraisals, and determined that the terms of each transaction were
reasonable and fair to the Company and will not have a material effect on the
Company's financial position, results of operations or liquidity. The first
approval was the ratification of the current arrangement between Rollins, Inc.
and LOR, Inc., a company controlled by R. Randall Rollins and Gary W. Rollins,
related to sharing the aviation hangar located at the Dekalb-Peachtree Airport
as well as the usage of a JetStar II, owned by Rollins, Inc., and the Gulfstream
III N30WR, owned by LOR, Inc. The Jetstar II was sold by Rollins, Inc. in
October 2003 and Rollins, Inc. purchased a Gulfstream III N330WR to replace it
in October 2003 (see discussion below). LOR, Inc. leases half of the hangar from
Rollins, Inc. for a total annual lease amount of $14,873. This lease expires on
January 24, 2008. The hangar currently houses three airplanes, two of which are
not owned by Rollins, Inc. and reside on the portion of the hangar leased by
LOR, Inc. All other expenses related to the hangar are also shared equally by
Rollins, Inc. and LOR, Inc. Total expenses for 2003 were approximately $116,000,
which includes rental, utilities, maintenance and repairs, depreciation,
property tax and miscellaneous expense. Pursuant to this arrangement the usage
is billed on a monthly basis. The Jetstar II was charged at a rate of $5,250
before it was sold and the Gulfstream III's are charged at a rate of $12,745
each, per month. All expenses related to each respective aircraft are paid for
by the owner of each aircraft, except for fuel. Fuel is paid for by Rollins,
Inc. and billed monthly to the company using the aircraft. Additionally, when
Mr. R. Randall Rollins and Mr. Gary W. Rollins used the JetStar II, prior to its
sale, or use the Gulfstream III N330WR for personal use they are billed for such
use at the rate of $1,000 per hour, which approximates the fuel cost. The total
hourly usage for 2003 was approximately 5.4 hours or $5,400. The Company on
occasion uses the Gulfstream III N30WR and is also billed for its use at a rate
of $1,000 per hour, which approximates the fuel cost. The second approval was
the ratification of the arrangement concerning the rental of office space to
LOR, Inc. located at 2170 Piedmont Road N.E., Atlanta, Georgia 30324. The
property located at 2170 Piedmont Road is owned by Rollins Continental, Inc. a
wholly owned subsidiary of Rollins, Inc. Currently LOR, Inc. occupies
approximately 360 square feet of office space in the building located at 2170
Piedmont Road. The annual rental rate is $3,924. The third approval was the
ratification of the arrangement concerning the rental of office space to LOR,
Inc. located at 710 Lakeshore Circle, Atlanta, Georgia 30324. The property
located at 710 Lakeshore Circle is also owned by Rollins Continental, Inc.
Currently LOR, Inc. occupies approximately 3,344 square feet of office space in
the building located at 710 Lakeshore Circle. The annual rental rate is $40,800.
The fourth approval was the ratification of the current arrangement related to
the payment of fees for the services of a programmer/analyst that was employed
by LOR, Inc. but has become employed by Rollins, Inc. in the first quarter of
2003. The programmer/analyst is being used to further develop the PowerTrak
Version 1.0 hand-held computer software purchased in the fourth quarter of 2002
(as discussed in the above paragraph). The hourly wage paid to LOR, Inc. was $32
per hour, which equated to $66,560 per year, including overhead. In the opinion
of Management, these related party transactions were reasonable and fair to the
Company and will not have a material effect on the Company's financial position,
results of operations or liquidity.
At the Company's October 28, 2003 Board of Directors' meeting, the
independent directors of the Board of Directors and the Audit Committee approved
an amendment to the arrangements with LOR, Inc. regarding the usage of the
aircrafts, as discussed above, to provide that they would substitute the
Gulfstream III N330WR for the Jetstar II, that was sold, with all other
provisions remaining the same except that the Gulfstream III N330WR is charged
at a rate of $12,745 per month. The decision was based on full disclosure
including independent appraisals. In the opinion of Management, this related
party transaction was reasonable and fair to the Company and will not have a
material effect on the Company's financial position, results of operations or
liquidity.
Employees of Rollins, Inc. confer with employees of LOR, Inc. and RRR
Associates and vice versa. No fees are charged for these services because, in
the opinion of Management, the activity is mutually beneficial and offsetting.
40
11. UNAUDITED QUARTERLY DATA
All earnings per share data for the quarters prior to the second quarter of
2003 have been restated for the three-for-two stock split on March 10, 2003.
(In thousands except per share data) First Second Third Fourth
- ------------------------------------------------------------------------------------------------------------------------
2003
Revenues $155,122 $185,105 $178,262 $158,524
Gross Profit (Revenues - Cost of Services Provided) 71,043 89,515 82,196 71,837
Net Income 7,274 13,862 9,800 4,825(a)
Earnings per Share - Basic 0.16 0.31 0.22 0.11
Earnings per Share - Diluted 0.16 0.30 0.21 0.10
- ------------------------------------------------------------------------------------------------------------------------
(a) During the fourth quarter of 2003, the Company recorded year-end
adjustments to certain accrued liabilities, prepaid expenses, accrued
receivables and income tax accounts resulting in a net after tax charge of
$2.4 million ($0.05 per diluted share).
- ------------------------------------------------------------------------------------------------------------------------
2002
Revenues $153,302 $184,189 $174,063 $153,871
Gross Profit (Revenues - Cost of Services Provided) 69,317 87,003 80,007 67,780
Net Income 4,940 11,691 6,754 3,725
Earnings per Share - Basic and Diluted 0.11 0.26 0.15 0.08
- ------------------------------------------------------------------------------------------------------------------------
2001
Revenues $150,280 $180,731 $169,223 $149,691
Gross Profit (Revenues - Cost of Services Provided) 64,689 82,621 74,742 65,952
Net Income 2,021 9,038 4,268 1,615
Earnings per Share - Basic and Diluted 0.04 0.20 0.09 0.04
- -----------------------------------------------------------------------------------------------------------------------
12. SUBSEQUENT EVENTS (unaudited)
On March 8, 2004, the Company entered into a definitive agreement to
acquire, through a purchase of assets, the pest control business and certain
ancillary operations of Western Industries, Inc. and its affiliates. The
aggregate consideration will be paid in a combination of cash and marketable
securities, on hand as well as borrowings from an outside party to be arranged
in connection with the purchase, and is expected to range from approximately
$105.0 to $110.0 million. The amount to be financed has not been determined at
this time. The Company is anticipating closing on the purchase in the second
quarter of 2004.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures.
None.
Item 9A. 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 December 31, 2003. Based on
this evaluation, our principal executive officer and principal financial officer
concluded that, except as set forth in the paragraph below, our disclosure
controls and procedures were effective 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.
We have identified the following significant deficiency in our internal
control framework: There was a deficiency with respect to the accounting for
deferred income tax assets and liabilities, federal and state income tax payable
accounts and the provision for income taxes.
41
The Company has evaluated the deficiencies and established additional
reconciliation and review policies and procedures to ensure proper accounting
for all income tax activity. The Company has revised its reconciliation policies
and procedures to reconcile activity and prove cumulative temporary differences
balances. Furthermore, the Company has established additional accounts to better
track income tax activity.
The deficiency resulted in "true up" adjustments recorded in the fourth
quarter of 2003 of approximately $1.1 million, as discussed in "Management's
Discussion and Analysis of Financial Condition and Results of Operations". The
adjustments did not have a material impact on previously reported periods.
In addition, there were no significant changes in our internal control over
financial reporting during the quarter ended December 31, 2003 that could
significantly affect these controls.
42
PART III
Item 10. Directors and Executive Officers of the Registrant.
Information concerning directors and executive officers is included in the
Company's Proxy Statement for its 2004 Annual Meeting of Stockholders, in the
section titled "Election of Directors". This information is incorporated herein
by reference. Information about executive officers is contained on page 13 of
this document.
Audit Committee and Audit Committee Financial Expert
Information concerning the Audit Committee of the Company and the Audit
Committee Financial Expert(s) is included in the Company's Proxy Statement for
its 2004 Annual Meeting of Stockholders, in the section titled "Corporate
Governance and Board of Directors Compensation, Committees and Meetings." This
information is incorporated herein by reference.
Code of Ethics
The Company has adopted a code of Business Conduct that applies to all
employees. In addition, the Company has adopted a Supplemental Code of Business
Conduct and Ethics for directors, the Principal Executive Officer and Principal
Financial and Accounting Officer. Both of these documents are available on the
Company's website at www.rollins.com.
Section 16(a) Beneficial Ownership Reporting Compliance
Information regarding compliance with Section 16(a) of the Exchange Act is
included under "Section 16(a) Beneficial Ownership Reporting Compliance" in the
Company's Proxy Statement for its 2004 Annual Meeting of Stockholders, which is
incorporated herein by reference.
Item 11. Executive Compensation.
The information under the caption "Executive Compensation" included in the
Proxy Statement for the Annual Meeting of Stockholders to be held April 27, 2004
is incorporated herein by reference.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information under the captions "Capital Stock", "Election of Directors"
and "Equity Compensation Plan Information" included in the Proxy Statement for
the Annual Meeting of Stockholders to be held April 27, 2004 is incorporated
herein by reference.
Item 13. Certain Relationships and Related Transactions.
The information under the caption "Certain Relationships and Related Party
Transactions" included in the Proxy Statement for the Annual Meeting of
Stockholders to be held April 27, 2004 is incorporated herein by reference.
Item 14. Principal Auditor Fees and Services.
Information regarding principal auditor fees and services is set forth
under "Principal Auditor Fees and Services" in the Company's Proxy Statement for
its 2004 Annual Meeting of Stockholders, which information is incorporated
herein by reference.
43
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
(a) Consolidated Financial Statements, Financial Statement Schedule and
Exhibits.
1. Consolidated financial statements listed in the accompanying
Index to Consolidated Financial Statements and Schedule are filed
as part of this report.
2. The financial statement schedule listed in the accompanying Index
to Consolidated Financial Statements and Schedule is filed as
part of this report.
3. Exhibits listed in the accompanying Index to Exhibits are filed
as part of this report. The following such exhibits are
management contracts or compensatory plans or arrangements:
(10) (a) Rollins, Inc. 1984 Employee Incentive Stock Option Plan
is incorporated herein by reference to Exhibit 10 as filed
with its Form 10-K for the year ended December 31, 1996.
(10) (b) Rollins, Inc. 1994 Employee Stock Incentive Plan is
incorporated herein by reference to Exhibit (10)(b) as filed
with its Form 10-K for the year ended December 31, 1999.
(10) (c) Rollins, Inc. 1998 Employee Stock Incentive Plan is
incorporated herein by reference to Exhibit A of the March
24, 1998 Proxy Statement for the Annual Meeting of
Stockholders held on April 28, 1998.
(10) (d) Lease Agreement dated July 1, 2002 between Rollins
Continental, Inc. and Rollins Ranch, a division of LOR, Inc.
incorporated herein by reference as filed with its Form 10-Q
for the quarter ended September 30, 2002 filed on November
14, 2002.
(10) (e) Stock Option Agreement dated January 22, 2002 for Gary
W. Rollins, Chief Executive Officer, President and Chief
Operating Officer is incorporated herein by reference as
filed with its Form 10-K for the year ended December 31,
2002 filed on March 17, 2003.
(b) Reports on Form 8-K.
On October 29, 2003, the Company furnished a report on Form
8-K, which reported under Item 9 that on October 29, 2003,
the Company reported earnings for the third quarter ended
September 30, 2003.
On October 29, 2003, the Company furnished a report on Form
8-K, which reported under Item 9 that on October 29, 2003,
the Board of Directors has declared a regular quarterly
dividend of $0.05 per share.
44
(c) Exhibits (inclusive of item 3 above):
(2) (a) Asset Purchase Agreement by and between Orkin
Exterminating Company, Inc. and PRISM Integrated Sanitation
Management, Inc. is incorporated herein by reference to
Exhibit (2) as filed with its Form 10-Q filed on August 16,
1999.
(b) Stock Purchase Agreement as of September 30, 1999, by and
among Orkin Canada, Inc., Orkin Expansion, Inc., S.C.
Johnson Commercial Markets, Inc., and S.C. Johnson
Professional, Inc. is incorporated herein by reference to
Exhibit (2)(b) as filed with its Form 10-K for the year
ended December 31, 1999.
(c) Asset Purchase Agreement as of October 19, 1999 by and
between Orkin Exterminating Company, Inc., Redd Pest Control
Company, Inc., and Richard L. Redd is incorporated herein by
reference to Exhibit (2)(c) as filed with its Form 10-K for
the year ended December 31, 1999.
(d) First Amendment to Asset Purchase Agreement dated as of
December 1, 1999, by and among Orkin Exterminating Company,
Inc., Redd Pest Control Company, Inc. and Richard L. Redd is
incorporated herein by reference to Exhibit (2)(d) as filed
with its Form 10-K for the year ended December 31, 1999.
(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 by reference to Exhibit (3) (ii) as filed with
its Form 10-Q for the quarterly period ended June 30, 2003.
(iii)Amendment to the By-laws of Rollins, Inc. is incorporated
herein by reference to Exhibit (3) (iii) as filed with its
Form 10-Q for the quarterly period ended March 31, 2001.
(iv) Amendment to the By-laws of Rollins, Inc. is incorporated
herein by reference to Exhibit (3) (iv) as filed with its
Form 10-K for the year ended December 31, 2002 filed March
17, 2002.
(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.
(10) (a) Rollins, Inc. 1984 Employee Incentive Stock Option Plan
is incorporated herein by reference to Exhibit (10) as filed
with its Form 10-K for the year ended December 31, 1996.
(10) (b) Rollins, Inc. 1994 Employee Stock Incentive Plan is
incorporated herein by reference to Exhibit (10)(b) as filed
with its Form 10-K for the year ended December 31, 1999.
(10) (c) Rollins, Inc. 1998 Employee Stock Incentive Plan is
incorporated herein by reference to Exhibit A of the March
24, 1998 Proxy Statement for the Annual Meeting of
Stockholders held on April 28, 1998.
(10) (d) Lease Agreement dated July 1, 2002 between Rollins
Continental, Inc. and Rollins Ranch, a division of LOR, Inc.
incorporated herein by reference as filed with its Form 10-Q
for the quarter ended September 30, 2002 filed on November
14, 2002.
45
(10) (e) Stock Option Agreement dated January 22, 2002 for Gary
W. Rollins, Chief Executive Officer, President and Chief
Operating Officer is incorporated herein by reference as
filed with its Form 10-K for the year ended December 31,
2002 filed on March 17, 2003.
(10) (f) Closing Statement dated October 31, 2002 between Rollins
Continental, Inc. and RTC, LLC, a company controlled by R.
Randall Rollins, Chairman of the Board of Rollins, Inc is
incorporated herein by reference as filed with its Form 10-K
for the year ended December 31, 2002 filed on March 17,
2003.
(21) Subsidiaries of Registrant.
(23) Consent of Ernst & Young LLP, Independent Auditors.
(24) Powers of Attorney for Directors.
(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.
46
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
By: /s/ GARY W. ROLLINS
----------------------
Gary W. Rollins
Chief Executive Officer, President and Chief
Operating Officer
(Principal Executive Officer)
Date: March 15, 2004
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
/s/ GARY W. ROLLINS By: /s/ HARRY J. CYNKUS
--------------------- ---------------------
By: Gary W. Rollins Harry J. Cynkus
Chief Executive Officer, President Chief Financial Officer
and Chief Operating Officer and Treasurer
(Principal Executive Officer) (Principal Financial and
Date: March 15, 2004 Accounting Officer)
Date: March 15, 2004
The Directors of Rollins, Inc. (listed below) executed a power of attorney
appointing Gary W. Rollins their attorney-in-fact, empowering him to sign this
report on their behalf.
R. Randall Rollins, Director
Wilton Looney, Director
Henry B. Tippie, Director
James B. Williams, Director
Bill J. Dismuke, Director
- --------------------------------------------------------------------------------
/s/ GARY W. ROLLINS
- -----------------------
Gary W. Rollins
As Attorney-in-Fact & Director
March 15, 2004
47
ROLLINS, INC. AND SUBSIDIARIES
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND SCHEDULE
(Item 15)
Page Number From
This Form 10-K
----------------
(1) Consolidated Financial Statements
Consolidated Statements of Financial Position as of December 31, 2003 and 2002 24
Consolidated Statements of Income for each of the three years in the period ended
December 31, 2003 25
Consolidated Statements of Stockholders' Equity for each of the three years in the period
ended December 31, 2003 26
Consolidated Statements of Cash Flows for each of the three years in the period ended
December 31, 2003 27
Notes to Consolidated Financial Statements 28-41
Report of Ernst & Young LLP, Independent Auditors 52
(2) Financial Statement Schedules
Schedule II - Valuation and Qualifying Accounts 49
Schedules not listed above have been omitted as either not applicable,
immaterial or disclosed in the Consolidated Financial Statements or notes
thereto.
48
ROLLINS, INC. AND SUBSIDIARIES
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2003, 2002, AND 2001
(in thousands of dollars)
Additions
----------------------------------
Balance at Charged to Charged to Balance at
Beginning Costs and Other End of
Description of Period Expenses Accounts Deductions (1) Period
- -----------------------------------------------------------------------------------------------------------------------------------
Year ended December 31, 2003
Allowance for doubtful accounts $ 5,441 $ 4,822 $ --- $ 5,647 $ 4,616
----------------------------------------------------------------------------------
Year ended December 31, 2002
Allowance for doubtful accounts $ 6,973 $ 5,705 $ --- $ 7,237 $ 5,441
----------------------------------------------------------------------------------
Year ended December 31, 2001
Allowance for doubtful accounts $ 8,729 $5,950 $ --- $ 7,706 $ 6,973
----------------------------------------------------------------------------------
NOTE: (1) Deductions represent the write-off of uncollectible receivables,
net of recoveries.
49
ROLLINS, INC. AND SUBSIDIARIES
INDEX TO EXHIBITS
Exhibit Number
(2) (a) Asset Purchase Agreement by and between Orkin
Exterminating Company, Inc. and PRISM Integrated Sanitation
Management, Inc. is incorporated herein by reference to
Exhibit (2) as filed with its Form 10-Q filed on August 16,
1999.
(b) Stock Purchase Agreement as of September 30, 1999, by and
among Orkin Canada, Inc., Orkin Expansion, Inc., S.C.
Johnson Commercial Markets, Inc., and S.C. Johnson
Professional, Inc. is incorporated herein by reference to
Exhibit (2)(b) as filed with its Form 10-K for the year
ended December 31, 1999.
(c) Asset Purchase Agreement as of October 19, 1999 by and
between Orkin Exterminating Company, Inc., Redd Pest Control
Company, Inc., and Richard L. Redd is incorporated herein by
reference to Exhibit (2)(c) as filed with its Form 10-K for
the year ended December 31, 1999.
(d) First Amendment to Asset Purchase Agreement dated as of
December 1, 1999, by and among Orkin Exterminating Company,
Inc., Redd Pest Control Company, Inc. and Richard L. Redd is
incorporated herein by reference to Exhibit (2)(d) as filed
with its Form 10-K for the year ended December 31, 1999.
(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 by reference to Exhibit (3) (ii) as filed with
its Form 10-Q for the quarterly period ended June 30, 2003.
(iii)Amendment to the By-laws of Rollins, Inc. is incorporated
herein by reference to Exhibit (3) (iii) as filed with its
Form 10-Q for the quarterly period ended March 31, 2001.
(iv) Amendment to the By-laws of Rollins, Inc. is incorporated
herein by reference to Exhibit (3) (iv) as filed with its
Form 10-K for the year ended December 31, 2002 filed March
17, 2002.
(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.
(10) (a) Rollins, Inc. 1984 Employee Incentive Stock Option Plan
is incorporated herein by reference to Exhibit (10) as filed
with its Form 10-K for the year ended December 31, 1996.
(10) (b) Rollins, Inc. 1994 Employee Stock Incentive Plan is
incorporated herein by reference to Exhibit (10)(b) as filed
with its Form 10-K for the year ended December 31, 1999.
(10) (c) Rollins, Inc. 1998 Employee Stock Incentive Plan is
incorporated herein by reference to Exhibit A of the March
24, 1998 Proxy Statement for the Annual Meeting of
Stockholders held on April 28, 1998.
(10) (d) Lease Agreement dated July 1, 2002 between Rollins
Continental, Inc. and Rollins Ranch, a division of LOR, Inc.
incorporated herein by reference as filed with its Form 10-Q
for the quarter ended September 30, 2002 filed on November
14, 2002.
(10) (e) Stock Option Agreement dated January 22, 2002 for Gary
W. Rollins, Chief Executive Officer, President and Chief
Operating Officer is incorporated herein by reference as
filed with its Form 10-K for the year ended December 31,
2002 filed on March 17, 2003.
(10) (f) Closing Statement dated October 31, 2002 between Rollins
Continental, Inc. and RTC, LLC, a company controlled by R.
Randall Rollins, Chairman of the Board of Rollins, Inc is
incorporated herein by reference as filed with its Form 10-K
for the year ended December 31, 2002 filed on March 17,
2003.
(21) Subsidiaries of Registrant.
(23) Consent of Ernst & Young LLP, Independent Auditors.
(24) Powers of Attorney for Directors.
(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.
50
MANAGEMENT'S RESPONSIBILITY FOR FINANCIAL REPORTING
To the Stockholders of Rollins, Inc.:
The management of Rollins, Inc. is responsible for the integrity and
objectivity of the consolidated financial statements and other financial
information presented in this report. These statements have been prepared in
conformity with accounting principles generally accepted in the United States
consistently applied and include amounts based on the best estimates and
judgments of management.
Rollins maintains a system of internal accounting controls designed to
provide reasonable assurance, at a reasonable cost, that assets are safeguarded
against loss or unauthorized use and that the financial records are adequate and
can be relied upon to produce financial statements in accordance with accounting
principles generally accepted in the United States. The internal control system
is augmented by written policies and procedures, an internal audit program and
the selection and training of qualified personnel. This system includes policies
that require adherence to ethical business standards and compliance with all
applicable laws and regulations.
The consolidated financial statements for the year ended December 31, 2003
and 2002, have been audited by Ernst & Young LLP, independent auditors, and the
financial statements for the year ended December 31, 2001 have been audited by
other auditors. In connection with its audit, Ernst & Young develops and
maintains an understanding of Rollins' accounting and financial controls and
conducts tests of Rollin's accounting systems and other related procedures as it
considers necessary to render an opinion on the financial statements.
The Audit Committee of the Board of Directors, composed solely of outside
directors, meets periodically with Rollins' management, internal auditors and
independent auditors to review matters relating to the quality of financial
reporting and internal accounting controls, and the independent nature, extent
and results of the audit effort. The Committee recommends to the Board
appointment of the independent auditors. Both the internal auditors and the
independent auditors have access to the Audit Committee, with or without the
presence of management.
/s/ GARY W. ROLLINS /s/ HARRY J. CYNKUS
- ------------------- -------------------
Gary W. Rollins Harry J. Cynkus
Chief Executive Officer, President and Chief Financial Officer
Chief Operating Officer and Treasurer
Atlanta, Georgia
March 15, 2004
51
REPORT OF INDEPENDENT AUDITORS
The Board of Directors and Stockholders
Rollins, Inc.
We have audited the accompanying consolidated statements of financial
position of Rollins, Inc. and Subsidiaries as of December 31, 2003 and 2002, and
the related consolidated statements of income, stockholders' equity and cash
flows for the years then ended. Our audits also included the financial statement
schedule for the years ended December 31, 2003 and 2002, listed in the Index at
Item 15(a). These financial statements and schedule are the responsibility of
the Company's management. Our responsibility is to express an opinion on these
financial statements and schedule based on our audits. The consolidated
financial statements and schedule of Rollins, Inc. and Subsidiaries for the year
ended December 31, 2001 were audited by other auditors who have ceased
operations and whose report dated February 15, 2002 expressed an unqualified
opinion on those statements and schedule before the restatement adjustments
described in Notes 1, 4, 5 and 6.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.
In our opinion, the 2003 and 2002 financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Rollins, Inc. and Subsidiaries at December 31, 2003 and 2002, and the
consolidated results of their operations and their cash flows for the years then
ended in conformity with accounting principles generally accepted in the United
States. Also, in our opinion, the related financial statement schedule for the
years ended December 31, 2003 and 2002, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
As discussed above, the consolidated financial statements and schedule of
Rollins, Inc. and Subsidiaries for the year ended December 31, 2001 were audited
by other auditors who have ceased operations. As described in Note 1, on January
28, 2003, the Company's board of directors approved a 3-for-2 stock split, and
all references to number of shares and per share information in the consolidated
financial statements have been adjusted to reflect the stock split on a
retroactive basis. We audited the adjustments that were applied to restate the
number of shares and per share information reflected in the 2001 consolidated
financial statements. Our procedures included (a) agreeing the authorization for
the 3-for-2 stock split to the Company's underlying records obtained from
management, and (b) testing the mathematical accuracy of the restated number of
shares, earnings per share, common stock stated at par value and other
applicable disclosures such as stock options. Also as discussed in Note 4, the
consolidated financial statements of Rollins, Inc. and Subsidiaries for the year
ended December 31, 2001 have been revised to include the transitional
disclosures required by Statement of Financial Accounting Standards No. 142,
Goodwill and Other Intangibles, which was adopted by the Company as of January
1, 2002. Our audit procedures with respect to the disclosures in Note 4 with
respect to 2001 included (a) agreeing the previously reported net income to the
previously issued financial statements, (b) agreeing the adjustments to reported
net income representing amortization expense (including any related tax effects)
recognized in those periods related to goodwill that is no longer being
amortized as a result of initially applying Statement No. 142 (including any
related tax effects) to the Company's underlying records obtained from
management, (c) agreeing all 2001 separate asset and accumulated amortization
balances as disclosed for individual intangibles to the Company's underlying
accounting records obtained from management, (d) agreeing all 2001 amortization
expense disclosures to the Company's underlying accounting records obtained from
management and (e) testing the mathematical accuracy of the reconciliation of
pro forma net income to reported net income. Also as discussed in Note 6, the
consolidated financial statements of Rollins, Inc. and Subsidiaries for the year
ended December 31, 2001 have been revised to include the transitional
disclosures required by FASB Interpretation No. 45, Guarantor's Accounting and
Disclosure Requirements for Guarantees, Including Direct Guarantees of
Indebtedness of Others, which were adopted by the Company as of December 31,
2002. Our audit procedures with respect to the disclosures in Note 6 with
respect to 2001 included (a) agreeing the previously reported beginning and
ending balances of the accrual for termite contracts to the previously issued
financial statements and (b) agreeing the provisions and settlements, claims and
expenditures made during the year to the Company's underlying records obtained
from management. The disclosures in Note 5 of the consolidated financial
statements of Rollins, Inc. and Subsidiaries for the year ended December 31,
2001 have been revised to disclose
52
additional detail with respect to the components of the provision for income
taxes and certain components of deferred income tax amounts. Our audit
procedures with respect to the disclosures in Note 5 with respect to 2001
included agreeing the components of the provision for income taxes and deferred
tax amounts to the Company's underlying records obtained from management. In our
opinion, such adjustments and disclosures are appropriate and have been properly
applied. However, we were not engaged to audit, review, or apply any procedures
to the 2001 consolidated financial statements of the Company other than with
respect to such adjustments and, accordingly, we do not express an opinion or
any other form of assurance on the 2001 consolidated financial statements taken
as a whole.
/s/ Ernst & Young LLP
- -----------------------
Ernst & Young
Atlanta, Georgia
March 15, 2004
53