UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q (Mark One) [ X ] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2004. OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ Commission file number 1-4422 ROLLINS, INC. (Exact name of registrant as specified in its charter) Delaware 51-0068479 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 2170 Piedmont Road, N.E., Atlanta, Georgia (Address of principal executive offices) 30324 (Zip Code) (404) 888-2000 (Registrant's telephone number, including area code) ________________________________ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Indicate by check mark whether the registrant is an accelerated filer (as defined in rule 12b-2 of the Exchange Act). Yes [ X ] No [ ] Rollins, Inc. had 45,670,081 shares of its $1 Par Value Common Stock outstanding as of October 15, 2004.
ROLLINS, INC. AND SUBSIDIARIES INDEX PART I FINANCIAL INFORMATION Page No. -------------- Item 1. Financial Statements. Consolidated Statements of Financial Position as of September 30, 2004 and December 31, 2003 2 Consolidated Statements of Income for the Three and Nine Months Ended September 30, 2004 and 2003 3 Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2004 and 2003 4 Notes to Consolidated Financial Statements 5 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. 11 Item 3. Quantitative and Qualitative Disclosures About Market Risk. 18 Item 4. Controls and Procedures. 18 PART II OTHER INFORMATION Item 1. Legal Proceedings. 19 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 19 Item 4. Submission of Matters to a Vote of Security Holders. 19 Item 6. Exhibits. 19 SIGNATURES 20
PART I FINANCIAL INFORMATION Item 1. Financial Statements.
ROLLINS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF FINANCIAL POSITION (In thousands except share and per share data) September 30, December 31, 2004 2003 -------------------- ------------------ (Unaudited) ASSETS Cash and Cash Equivalents $ 40,894 $ 59,540 Marketable Securities 0 21,866 Trade Receivables, Net of Allowance for Doubtful Accounts of $5,762 and $4,616, respectively 63,358 48,471 Materials and Supplies 11,002 9,837 Deferred Income Taxes 21,838 23,243 Other Current Assets 11,283 7,414 -------------------- ------------------ Current Assets 148,375 170,371 Equipment and Property, Net 45,186 35,836 Goodwill 114,333 72,498 Customer Contracts and Other Intangible Assets 79,448 30,333 Deferred Income Taxes 9,701 15,902 Other Assets 30,804 24,964 -------------------- ------------------ Total Assets $ 427,847 $ 349,904 ==================== ================== LIABILITIES Accounts Payable $ 14,378 $ 12,290 Accrued Insurance 13,049 13,050 Accrued Payroll 38,684 31,019 Unearned Revenue 66,566 46,007 Accrual for Termite Contracts 21,700 21,500 Other Current Liabilities 28,110 21,156 -------------------- ------------------ Current Liabilities 182,487 145,022 Accrued Insurance, Less Current Portion 25,181 26,024 Accrual for Termite Contracts, Less Current Portion 21,684 22,373 Long-Term Accrued Liabilities 19,252 17,711 -------------------- ------------------ Total Liabilities 248,604 211,130 -------------------- ------------------ Contingencies STOCKHOLDERS' EQUITY Common Stock, par value $1 per share; 99,500,000 shares authorized; 45,668,269 and 45,156,674 shares issued and outstanding, respectively 45,668 45,157 Additional Paid-In Capital 7,767 4,408 Accumulated Other Comprehensive Loss (313) (314) Unearned Compensation (3,595) (239) Retained Earnings 129,716 89,762 -------------------- ------------------ Total Stockholders' Equity 179,243 138,774 -------------------- ------------------ Total Liabilities and Stockholders' Equity $ 427,847 $ 349,904 ==================== ================== The accompanying notes are an integral part of these consolidated financial statements.
2 ROLLINS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (In thousands except per share data) (Unaudited)
Three Months Ended Nine Months Ended September 30, September 30, ---------------------------------- ------------------------------------ 2004 2003 2004 2003 ---------------- ---------------- ---------------- ----------------- REVENUES Customer Services $ 202,257 $ 178,262 $ 568,647 $ 518,489 ---------------- ---------------- ---------------- ----------------- COSTS AND EXPENSES Cost of Services Provided 106,748 96,065 297,547 275,549 Depreciation and Amortization 6,249 5,065 16,670 15,258 Sales, General & Administrative 70,080 61,413 193,410 178,101 Gain on Sale of Assets (315) 33 (14,457) (36) Interest Income (68) (120) (265) (280) ---------------- ---------------- ---------------- ----------------- 182,694 162,456 492,905 468,592 ---------------- ---------------- ---------------- ----------------- INCOME BEFORE INCOME TAXES 19,563 15,806 75,742 49,897 ---------------- ---------------- ---------------- ----------------- PROVISION FOR INCOME TAXES Current 9,502 4,728 24,413 15,481 Deferred (1,577) 1,278 7,163 3,480 ---------------- ---------------- ---------------- ----------------- 7,925 6,006 31,576 18,961 ---------------- ---------------- ---------------- ----------------- NET INCOME $ 11,638 $ 9,800 $ 44,166 $ 30,936 ================ ================ ================ ================= EARNINGS PER SHARE - BASIC $ 0.25 $ 0.22 $ 0.97 $ 0.69 ================ ================ ================ ================= EARNINGS PER SHARE - DILUTED $ 0.25 $ 0.21 $ 0.95 $ 0.67 ================ ================ ================ ================= Average Shares Outstanding---Basic 45,660 45,115 45,504 45,049 Average Shares Outstanding---Diluted 46,797 45,994 46,731 46,170 DIVIDENDS PER SHARE $ 0.06 $ 0.05 $ 0.18 $ 0.15 ================ ================ ================ ================= The accompanying notes are an integral part of these consolidated financial statements.
3 ROLLINS, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) (Unaudited)
Nine Months Ended September 30, ---------------------------------------- 2004 2003 ------------------ ----------------- OPERATING ACTIVITIES Net Income $ 44,166 $ 30,936 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Depreciation and Amortization 16,670 15,258 Deferred Income Taxes 7,606 7,748 Other, Net 335 314 Gain on Sale of Assets (14,457) (36) (Increase) Decrease in Assets, Net of Businesses Acquired: Trade Receivables (7,980) (4,810) Materials and Supplies 500 69 Other Current Assets (3,420) (3,565) Other Non-Current Assets (1,787) (60) Increase (Decrease) in Liabilities, Net of Businesses Acquired: Accounts Payable and Accrued Expenses 12,891 11,727 Unearned Revenue 12,960 6,484 Accrued Insurance (3,103) (1,275) Accrual for Termite Contracts (865) 668 Long-Term Accrued Liabilities (3,536) (4,724) ------------------ ----------------- Net Cash Provided by Operating Activities 59,980 58,734 ------------------ ----------------- INVESTING ACTIVITIES Sale of Marketable Securities, Net 21,866 (27,000) Purchases of Equipment and Property (6,707) (8,744) Acquisitions (103,415) (1,543) Proceeds From Sale of Assets, Net of Deferred Gain 15,473 0 ------------------ ----------------- Net Cash Used in Investing Activities (72,783) (37,287) ------------------ ----------------- FINANCING ACTIVITIES Dividends Paid (8,187) (6,754) Other 2,344 2,058 ------------------ ----------------- Net Cash Used in Financing Activities (5,843) (4,696) ------------------ ----------------- Net (Decrease) Increase in Cash and Cash Equivalents (18,646) 16,751 Cash and Cash Equivalents At Beginning of Period 59,540 38,315 ------------------ ----------------- Cash and Cash Equivalents At End of Period $ 40,894 $ 55,066 ================== ================= The accompanying notes are an integral part of these consolidated financial statements.
4 ROLLINS, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) NOTE 1. BASIS OF PREPARATION AND OTHER Basis of Preparation - The consolidated financial statements included herein have been prepared by Rollins, Inc. (the "Company"), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission applicable to quarterly reporting on Form 10-Q. These consolidated financial statements have been prepared in accordance with Statement of Financial Accounting Standard No. 94, Consolidation of All Majority-Owned Subsidiaries ("SFAS 94") and Rule 3A-02(a) of Regulation S-X. In accordance with SFAS 94 and with Rule 3A-02(a) of Regulation S-X, the Company's policy is to consolidate all subsidiaries and investees where it has voting control. The Company does not have any subsidiaries or investees where it has less than a 100% equity interest or less than 100% voting control, nor does it have any interest in other investees, joint ventures, or other variable interest entities that require consolidation under FASB interpretation No. 46, Consolidation of Variable Interest Entities (FIN 46). Footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted as permitted by such rules and regulations. These consolidated financial statements should be read in conjunction with the financial statements and related notes contained in the Company's annual report on Form 10-K for the year ended December 31, 2003. In the opinion of management, the consolidated financial statements included herein contain all adjustments, consisting of a normal recurring nature, necessary to present fairly the financial position of the Company as of September 30, 2004 and December 31, 2003, the results of its operations for the three and nine months ended September 30, 2004 and 2003 and cash flows for the nine months ended September 30, 2004 and 2003. Operating results for the three and nine months ended September 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. The Company has only one reportable segment, its pest and termite control business. The Company's results of operations and its financial condition are not reliant upon any single customer or a few customers or the Company's foreign operations. Estimates Used in the Preparation of Consolidated Financial Statements--The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States requires Management to make estimates and assumptions that affect the amounts reported in the accompanying notes and financial statements. Actual results could differ from those estimates. Cash and Cash Equivalents--The Company considers all investments with a maturity of three months or less to be cash equivalents. Short-term investments, all of which are cash equivalents, are stated at cost, which approximates fair market value. Marketable Securities--From time to time, the Company maintains investments held by several large, well-capitalized financial institutions. The Company's investment policy does not allow investment in any securities rated less than "investment grade" by national rating services. Management determines the appropriate classification of debt securities at the time of purchase and re-evaluates such designations as of each balance sheet date. Debt securities are classified as available-for-sale because the Company does not have the intent to hold the securities to maturity. Available-for-sale securities are stated at their fair values, with the unrealized gains and losses, net of tax, reported as a separate component of stockholders' equity. Realized gains and losses and declines in value judged to be other than temporary on available-for-sale securities are included in interest income. In the first quarter of 2004, the Company sold the balance of its marketable securities, the proceeds of which were used to pay the primary portion of the Western Industries, Inc. acquisition completed in the second quarter of 2004. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in interest income. The Company's marketable securities generally consist of United States government, corporate and municipal debt securities. Comprehensive Income (Loss)--Other Comprehensive Income (Loss) results from foreign currency translations and unrealized gain/losses on marketable securities. 5 New Accounting Standards--In December 2002, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN 46"). The Interpretation requires that a variable interest entity be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. The consolidation requirements of FIN 46, as revised, were effective in 2003 for all variable interest entities created or acquired after January 31, 2003 and extended the adoption date of FIN 46 (R) to the first quarter of 2004 for variable interest entities created prior to February 1, 2003. The adoption of FIN 46 did not have an effect on the Company's financial position or results of operations. Franchising Program - Orkin had 49 franchises as of September 30, 2004, including international franchises in Mexico, established in 2000, and Panama, established in 2003. Transactions with franchises involve sales of customer contracts to establish new franchises, initial franchise fees and royalties. The customer contracts and initial franchise fees are typically sold for a combination of cash and notes due over periods ranging up to 5 years. As of September 30, 2004 and December 31, 2003, notes receivable from franchises aggregated $5.5 million and $3.9 million, respectively. The Company recognizes gains from the sale of customer contracts at the time they are sold to franchises and collection on the notes is reasonably assured. The gain amounted to approximately $906,000 in the third quarter of 2004 compared to $131,000 in third quarter of 2003, and is included as revenues in the accompanying Consolidated Statements of Income. The Company has recognized gains from the sale of customer contracts of approximately $1.8 million for the nine months ended September 30, 2004, as compared to approximately $2.3 million for the nine months ended September 30, 2003. Initial franchise fees are deferred for the duration of the initial contract period and are included as unearned revenue in the Consolidated Statements of Financial Position. Deferred franchise fees amounted to $1.6 million and $1.4 million at September 30, 2004 and December 31, 2003, respectively. Royalties from franchises are accrued and recognized as revenues as earned on a monthly basis. Revenues from royalties were $467,000 in the third quarter of 2004 compared to $395,000 in the third quarter of 2003 and were $1.3 million and $1.1 million for the nine months ended September 30, 2004 and 2003, respectively. The Company's maximum exposure to loss relating to the franchises aggregated $3.9 million and $2.5 million at September 30, 2004 and December 31, 2003, respectively. Fair Value of Financial Instruments--The Company's financial instruments consist of cash, short-term investments, marketable securities, trade and notes receivables, accounts payable and other short-term liabilities. The carrying amounts of these financial instruments approximate their fair values. Seasonality--The revenues of the Company are affected by the seasonal nature of the Company's pest and termite control services as evidenced by the following chart. Total Net Revenues ------------------------------------------ 2004 2003 2002 - -------------------------------------------------------------------------------- First Quarter $158,692 $155,122 $153,302 Second Quarter 207,698 185,105 184,189 Third Quarter 202,257 178,262 174,063 Fourth Quarter N/A 158,524 153,871 - -------------------------------------------------------------------------------- 6 NOTE 2. EARNINGS PER SHARE In accordance with SFAS No. 128, Earnings Per Share ("EPS"), the Company presents basic EPS and diluted EPS. Basic EPS is computed on the basis of weighted-average shares outstanding. Diluted EPS is computed on the basis of weighted-average shares outstanding plus common stock options outstanding during the year which, if exercised, would have a dilutive effect on EPS. A reconciliation of the number of weighted-average shares used in computing basic and diluted EPS is as follows:
Three Months Ended Nine Months Ended --------------------------- -------------------------- September 30, September 30, --------------------------- -------------------------- (In thousands except per share data amounts) 2004 2003 2004 2003 - ----------------------------------------------------------------------------------------------- -------------------------- Basic and diluted earnings available to stockholders (numerator): $11,638 $ 9,800 $44,166 $30,936 =========================== ========================== Shares (denominator): Weighted-average shares outstanding 45,660 45,115 45,504 45,049 Effect of Dilutive securities: Employee Stock Options 1,137 879 1,227 1,121 --------------------------- -------------------------- Adjusted Weighted-Average Shares and Assumed Exercises 46,797 45,994 46,731 46,170 Per share amounts: Basic earnings per common share $0.25 $0.22 $0.97 $0.69 Diluted earnings per common share $0.25 $0.21 $0.95 $0.67 - ----------------------------------------------------------------------------------------------- --------------------------
NOTE 3. CONTINGENCIES Orkin, one of the Company's subsidiaries, is a named defendant in Helen Cutler and Mary Lewin v. Orkin Exterminating Company, Inc. et al. pending in the District Court of Houston County, Alabama. The plaintiffs in the above mentioned case filed suit in March of 1996 seeking monetary damages and injunctive relief for alleged breach of contract arising out of alleged missed or inadequate reinspections. The attorneys for the plaintiff contend that the case is suitable for a class action and the court ruled that the plaintiffs would be permitted to pursue a class action lawsuit. The parties have now agreed to settle this matter and the court has approved an order of settlement. The Company agreed to pay certain attorney fees, $5,000 each to the two named plaintiffs, and agreed to perform additional termite reinspections, if requested by individual members of the class. The Company anticipates that this matter will be concluded in the near future. In the opinion of Management, the resolution of this action will not have a material adverse effect on the Company's financial position, results of operations or liquidity. Orkin is also a named defendant in Butland et al. v. Orkin Exterminating Company, Inc. et al. pending in the Circuit Court of Hillsborough County, Tampa, Florida. The plaintiffs filed suit in March of 1999 and are seeking monetary damages and injunctive relief. The Court ruled in early April 2002, certifying the class action lawsuit against Orkin. Orkin appealed this ruling to the Florida Second District Court of Appeals which remanded the case back to the trial court for further findings. Orkin believes this case to be without merit and intends to defend itself vigorously through trial, if necessary. At this time, the final outcome of the litigation cannot be determined. However, in the opinion of Management, the ultimate resolution of this action will not have a material adverse effect on the Company's financial position, results of operations or liquidity. Orkin is involved in certain environmental matters primarily arising in the normal course of business. In the opinion of Management, the Company's liability under any of these matters would not materially affect its financial condition or results of operations. Orkin has received from the Office of the Florida Attorney General a subpoena for documents relating to the company's termite work in the state of Florida. Orkin is cooperating fully with the Office of the Attorney General. Additionally, in the normal course of business, Orkin is a defendant in a number of lawsuits, which allege that plaintiffs have been damaged as a result of the rendering of services by Orkin personnel and equipment. Orkin is actively contesting these actions. Certain of these lawsuits have been filed (Ernest W. Warren and Dolores 7 G. Warren et al. v. Orkin Exterminating Company, Inc., et al.; Francis D. Petsch, et al. v. Orkin Exterminating Company, Inc. et al.; Bob J. Stevens v. Orkin Exterminating Company, Inc. and Rollins, Inc.) in which the Plaintiffs are seeking certification of a class. The cases originate in Georgia, Florida, and Texas. In the matter of Larry Hanna, et. al. v. Rollins, Inc. dba Rollins Service Bureau formerly pending in the District Court for the Northern District of Indiana (Hammond Division) in which the Plaintiffs were seeking certification of a class, the plaintiffs have voluntarily dismissed the suit. The action alleged violations of the Fair Debt Collection Practices Act. Additionally, an arbitration has been filed in Jacksonville, Florida, by Cynthia Garrett against Orkin (Cynthia Garrett v. Orkin, Inc.) in which the plaintiff is seeking certification of a class. The Company believes all of these cases to be without merit and intends to vigorously contest certification and defend itself through trial, if necessary. In the opinion of Management, the outcome of these actions will not have a material adverse effect on the Company's financial position, results of operations or liquidity. NOTE 4. STOCKHOLDERS' EQUITY During the third quarter and nine months ended September 30, 2004, approximately 40,000 and 415,000 shares of common stock, respectively, were issued upon exercise of stock options by employees. As permitted by SFAS No. 123, Accounting for Stock-Based Compensation, the Company accounts for employee stock compensation plans using the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to Employees. No stock-based employee compensation cost is reflected in net income, as all options granted had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.
Three Months Ended Nine Months Ended September 30 September 30, -------------------------- ------------------------ (In thousands, except per share data) 2004 2003 2004 2003 ------------- ------------ ------------ ----------- Net income, as reported $11,638 $9,800 $44,166 $30,936 Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects (202) (483) (606) (1,449) ------------- ------------ ------------ ----------- Pro forma net income $11,436 $9,317 $43,560 $29,487 ------------- ------------ ------------ ----------- Earnings per share: Basic-as reported $0.25 $0.22 $0.97 $0.69 Basic-pro forma $0.25 $0.21 $0.95 $0.65 Diluted-as reported $0.25 $0.21 $0.95 $0.67 Diluted-pro forma $0.24 $0.20 $0.93 $0.64
8 NOTE 5. ACCUMULATED OTHER COMPREHENSIVE LOSS
Accumulated other comprehensive loss consists of the following (in thousands): Unrealized Minimum Foreign Loss on Pension Currency Marketable Liability Translation Securities Total - ---------------------------------------------------------------------------------------------------------------- Balance at January 1, 2003 $ (16,182) $ (765) $ -- $ (16,947) Change during 2003: Before-tax amount.. 26,079 842 (108) 26,813 Tax benefit (expense) (9,897) (324) 41 (10,180) --------------------------------------------------------------- 16,182 518 (67) 16,633 Balance at December 31, 2003 $ -- $ (247) $ (67) $ (314) Change during first nine months of 2004: Before-tax amount.. -- (113) 108 (5) Tax benefit (expense) -- 47 (41) 6 --------------------------------------------------------------- -- (66) 67 1 --------------------------------------------------------------- Balance at September 30, 2004 $ -- $ (313) $ -- $ (313) - ----------------------------------------------------------------------------------------------------------------
NOTE 6. ACCRUAL FOR TERMITE CONTRACTS The Company maintains an accrual for termite contracts representing the estimated costs of reapplications, repair claims and associated labor, chemicals, and other costs relative to termite control services performed prior to the balance sheet date. A reconciliation of the beginning and ending balances of the accrual for termite contracts is as follows: Nine Months Ended September 30, ----------------------------- (In thousands) 2004 2003 ----------------------------------------------------------------------------- Beginning Balance $43,873 $46,446 Current Period Provision 11,682 17,596 Settlements, Claims and Expenditures Made During the Period (12,544) (16,928) Western 373 0 ---------------------------- Ending Balance $43,384 $47,114 ----------------------------------------------------------------------------- NOTE 7. PENSION AND POST-RETIREMENT BENEFIT PLANS The following represents the net periodic pension benefit costs and related components in accordance with SFAS 132 ( R ): Components of Net Pension Benefit Cost
Three Months Ended Nine Months Ended September 30, September 30, ---------------------------- ------------------------------ (in thousands) 2004 2003 2004 2003 -------------------------------------------------------------------------------------------------------- Service Cost $ 1,297 $ 1,171 $ 3,891 $ 3,513 Interest Cost 2,074 1,950 6,222 5,850 Expected Return on Plan Assets (2,394) (2,123) (7,182) (6,369) Amortization of: Prior Service Benefit (217) (217) (651) (651) Unrecognized Net Loss 845 506 2,535 1,518 ----------------------------------------------------------- Net Periodic Benefit Cost $ 1,605 $ 1,287 $ 4,815 $ 3,861 --------------------------------------------------------------------------------------------------------
9 A contribution of $3.0 million was made to the pension plan in April 2004. The Company may contribute an additional amount up to $5.0 million to the pension plan in 2004. NOTE 8. RELATED PARTY TRANSACTIONS On April 28, 2004, the Company sold real estate in Okeechobee County, Florida to LOR, Inc., a company controlled by R. Randall Rollins, Chairman of the Board of Rollins, Inc. and Gary W. Rollins, Chief Executive Officer, President and Chief Operating Officer of Rollins, Inc. for $16.6 million in cash. The sale resulted in a net gain after tax of $8.1 million or $0.17 per share since the real estate had appreciated over approximately 30 years it had been owned by the Company. The Company deferred a portion of the gain pending the completion of a survey that may result in the return of a portion of the proceeds. The real estate was under a lease agreement with annual rentals of $131,939 that would have expired June 30, 2007. On May 28, 2004, the Company sold real estate in Sussex County, Delaware to LOR, Inc. for $111,000 in cash. The sale resulted in an immaterial net gain after tax. The Board of Directors, at its quarterly meeting on January 27, 2004, approved the formation of a committee (the "Committee") made up of Messrs. Bill J. Dismuke and James B. Williams, who are independent directors, to evaluate the transactions. In addition, the Company on October 22, 2004 purchased real estate located at 2158 Piedmont Road, N.E., Atlanta, Georgia 30324, adjacent to the Company's headquarters, from LOR, Inc. for $4.6 million. The Committee was furnished with full disclosure of the transactions, including independent appraisals, and determined that the terms of the transactions were reasonable and fair to the Company. The Company has reached an agreement on the sale of an additional piece of real estate in Sussex County, Delaware to LOR, Inc. or an entity wholly owned by LOR, Inc. The transaction will take place prior to December 31, 2004 and will result in a gain after taxes. The Company expects a gain of approximately $10.3 million, net of costs, on the sale of the property or $.12 to $.13 per share after taxes. NOTE 9. ACQUISITIONS On April 30, 2004, the Company acquired substantially all of the assets and assumed certain liabilities of Western Pest Services ("Western"), and the Company's consolidated financial statements include the operating results of Western from the date of the acquisition. Neither Western nor its principals had any prior relationship with the Company or its affiliates. Western was engaged in the business of providing pest control services and the Company intends to continue this business. The acquisition was made pursuant to an Asset Purchase Agreement (the "Western Agreement") dated March 8, 2004, between Rollins, Inc. and Western Industries, Inc. and affiliates. The consideration for the assets and certain noncompetition agreements (the "Purchase Price") was approximately $106.6 million, including approximately $7.0 million of assumed liabilities. The Purchase Price was funded with cash on hand, the sale of property located in Okeechobee County, Florida and a $15.0 million senior unsecured revolving credit facility. Pursuant to the Western Agreement, the Company acquired substantially all of Western's property and assets, including accounts receivable, real property leases, seller contracts, governmental authorizations, data and records, intangible rights and property and insurance benefits. As described in the Western Agreement, the Company assumed only specified liabilities of Western and obligations under disclosed assigned contracts. The Company engaged an independent valuation firm to determine the allocation of the purchase price to Goodwill and identifiable Intangible assets. Such valuation resulted in the allocation of $41.3 million to Goodwill and $55.2 million to other intangible assets, principally customer contracts. The finite-lived intangible assets, principally customer contracts, are being amortized over periods principally ranging from 8 to 12.5 years on a straight-lined basis. On April 30, 2004, in a transaction ancillary to the Western acquisition, the Company acquired Residex Corporation ("Residex"), a company that distributes chemicals and other products to pest management professionals, pursuant to an Asset Purchase Agreement (the "Residex Agreement") dated March 8, 2004, between Rollins, Inc. and Western Industries, Inc., JBD Incorporated and Residex Corporation. Subsequently on April 30, 2004, the Company sold Residex to an industry distribution group. The amounts involved were not material and no gain or loss was recognized on the transaction. Prior to the acquisition, Western Pest Services was recognized as a premier pest control business and ranked as the 8th largest company in the industry. Based in Parsippany, NJ, the Company provides pest elimination and prevention to homes and businesses to over 130,000 customers from New York to Virginia with additional operations in Georgia and Florida. Western is primarily a commercial pest control service company and its 10 existing businesses complement most of the services that Orkin offers, in an area of the country in which Orkin has not been particularly strong, the Northeast. The Company's consolidated statements of income include the results of operations of Western for the period beginning May 1, 2004 through September 30, 2004. NOTE 10. PRO FORMA FINANCIAL INFORMATION The pro forma financial information presented below gives effect to the Western acquisition as if it had occurred as of the beginning of our fiscal year 2004 and 2003, respectively. The information presented below is for illustrative purposes only and is not necessarily indicative of results that would have been achieved if the acquisition actually had occurred as of the beginning of such years or results which may be achieved in the future.
Three Months Ended Nine Months Ended September 30, September 30, ---------------------------------- ------------------------------------ 2004 2003 2004 2003 ---------------- ---------------- ---------------- ----------------- REVENUES Customer Services $ 202,257 $ 196,515 $ 595,325 $ 574,332 ================ ================ ================ ================= INCOME BEFORE INCOME TAXES 19,563 14,510 75,700 46,614 ================ ================ ================ ================= NET INCOME $ 11,638 $ 8,996 $ 44,151 $ 28,900 ================ ================ ================ ================= EARNINGS PER SHARE - BASIC $ 0.25 $ 0.20 $ 0.97 $ 0.64 ================ ================ ================ ================= EARNINGS PER SHARE - DILUTED $ 0.25 $ 0.20 $ 0.94 $ 0.63 ================ ================ ================ ================= Average Shares Outstanding---Basic 45,660 45,115 45,504 45,049 Average Shares Outstanding---Diluted 46,797 45,994 46,731 46,170
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations. Overview The Company's investment in its new marketing and sales initiatives and continued emphasis on customer retention as well as the acquisition of Western, resulted in revenue growth of 13.5% in the third quarter of 2004 compared to the third quarter of 2003. For the third quarter of 2004, the Company had net income of $11.6 million, or $0.25 per diluted share, an 18.8% increase over the prior year's third quarter, when we reported net income of $9.8 million, or $0.21 per diluted share. With the large concentration of commercial business acquired as part of the Western acquisition, the Company's revenue saw a 21.6% increase in Commercial Pest Control, a 12.6% increase in Residential Pest Control and a 3.6% increase in Termite. The historical business prior to the Western acquisition increased, Residential continued its strong showing from last quarter with growth increasing 7.0%, Commercial increasing 4.6% with a decrease in Termite of 2.8%. Termite was the service line most impacted by the multiple hurricanes that hit the southeast, which probably accounted for half of this decline. In total, the Company estimates that the hurricanes probably cost a minimum of $0.5 million in lost revenue. The Company's focus for 2004 has been to increase revenue at a faster rate and remains on target to achieve this goal. Sales performance continues to improve, as do customer and employee retention and profitability. The Company continues to take positive steps to elevate to the next level in providing world-class service to both residential and commercial customers while growing revenues and profitability. This is evident through customer retention and employee productivity improvement. In early August, the Company signed an agreement with Univar USA whereby Univar will provide warehouse, logistical and delivery services for Orkin's branches throughout the United States. Univar had been successfully supplying Orkin's Pacific Division and the Western Commercial Region for the past year. We expect the rollout will be completed by year-end. 11 This decision will enable the Company to concentrate even more on its core pest and termite control business. It will speed up the delivery of products to all branches, which will result in an improved service support while lowering branch inventories. As part of the agreement with Univar, Univar also acquired certain assets of Dettelbach Pesticide Corp, a wholly owned subsidiary of Orkin. Dettelbach, a pest control distributor, offered insecticides, termiticides, and equipment to pest control professionals and previously contributed approximately $3.5 million in annual revenue to the Company. The Company believes that the commercial area offers good growth potential and feels it is uniquely positioned to gain market share of this business segment. To that end, the Company has initiated an internal "commercial project" that consists of five action teams working to identify areas in which we might take commercial pest control capabilities, specifically sales, service and administration, to an even higher level. The Company is pleased with the early findings of these teams and we expect the teams to report back by year-end with their comprehensive recommendations. We expect to begin implementing the reengineering of our commercial business in 2005, and that this will be a multi-year undertaking. This quarter the Company engaged a new public accounting firm, Grant Thornton. Grant Thornton is a leading global firm dedicated to serving the needs of middle-market companies, and enjoys an excellent reputation. The Company has been named among the 200 Best Small Companies in America by Forbes Magazine in its November 1, 2004 issue. In order to qualify for this list, companies had to show a consistent pattern of positive growth for the past five years, have sales between $5 million and $750 million, net profit margins of greater than 5% and share prices above $5 as of October 1, 2004. In the Company's residential business area, the focus on market segmentation continues to provide growth in lead generation, which is driving the residential growth. This quarter Orkin enjoyed a 7% increase in residential pest control revenue compared to the third quarter of 2003. The Company continues to see lead increases in general through its interactive website. The Company was negatively impacted with respect to sales and leads in some of its Southeast markets due to the multiple hurricanes. The Company's regional call centers are also continuing to have a positive impact on processing phone leads with an improving closure rate. We continued to roll more regions into the centers, and we estimate that 75% of all leads will be handled through a network of regional call centers next year. The Company's Gold Medal program, Orkin's pest control offering to food processors and manufacturers, is continuing to add prestigious accounts. The Company continues to improve its handheld computer capabilities, which is critical to these customers. The Company is in the early stages of the educational projects that it is co-developing with the Centers for Disease Control and Prevention (CDC) and look forward to reporting on the work being done with them over the next 12 months. The Company's mosquito offering provided modest progress this past summer. The Company continues to learn from their experiences in their sales and marketing approach in this area. One key learning experience is that without the accompanying imminent threat of potential disease, (West Nile Virus), as opposed to prevention, sales become a challenge. The 2004 season was unusual in that the West Nile incidents were in areas of the country that were not typical and were not covered in the Company's tests. It also becomes important to make better use of technicians to inform our customers about add-on offerings to build value and revenue. The Company's people remain its most important asset and the Company continues to invest in providing them with superior training to provide the highest quality service to customers. The Company recently expanded its award winning training facility, adding a designated commercial service area that replicates some of the typical customer facilities including a commercial kitchen, bakery, hospital room, supermarket, motel room and warehouse space. The Company's total training space is now 27,000 square feet. The Company has also begun construction of a media and video studio facility. The financial results for the third quarter of 2004 were positively impacted by the continued benefit of recent service and sales and marketing initiatives, which included every-other-month residential pest control service, Gold Medal premium commercial pest control services, the investment in Business Development Managers for every Orkin division, the Commercial Pest Control Quality Assurance Program, termite directed liquid and baiting treatment, and the creation of or enhancement of regional call centers, which have enabled better accountability over leads and better coordination of scheduling starts for new customers. 12 Gross margin for the quarter improved to 47.2%, compared to 46.1% for the third quarter of 2003. While the Company enjoys continued productivity improvements at Orkin, the driver in margin improvement was a significant reduction in insurance, litigation and claims expense. The Company has stressed for the last several years the various improvements made with regard to termite work and the Company is continuing to see the cumulative impact of the numerous initiatives taken. Year-to-date actual claim payments have decreased approximately 28% or almost $4.8 million from last year. The number of both new and open claims continues to decline significantly. This reduction was partially offset by property damage incurred during the various hurricanes this year. The uninsured portion is currently estimated and recorded at $0.8 million. Fleet costs increased $0.7 million due to recent increases in oil prices. The Company experienced a 16.7% increase in the average gas price per gallon over last year. The Company was able to temper some of the increase by reducing the average number of miles driven per vehicle per month by over 7%. Lastly, the Company recorded approximately $1.0 million in additional benefit costs related to the vacation accrual. The Company just completed programming and testing this past quarter of a project to centralize and standardize record keeping of vacation and the resulting liability was greater than previously estimated. Results of Operations
% Better/ % Better/ Three Months Ended (Worse) as Nine Months Ended (Worse) as September 30, Compared to September 30, Compared to Prior Year Prior Year ------------------------ --------------- --------------------------- --------------- (in thousands) 2004 2003 2004 2004 2003 2004 ------------ ----------- --------------- --------------- ----------- --------------- Revenues $202,257 $178,262 13.5% $568,647 $518,489 9.7% Cost of Services Provided 106,748 96,065 (11.1) 297,547 275,549 (8.0) Depreciation and Amortization 6,249 5,065 (23.4) 16,670 15,258 (9.3) Sales, General and Administrative 70,080 61,413 (14.1) 193,410 178,101 (8.6) Gain on Sale of Assets (315) 33 N/M (14,457) (36) N/M Interest Income (68) (120) (43.3) (265) (280) (5.4) ------------ ----------- --------------- --------------- ----------- --------------- Income Before Income Taxes 19,563 15,806 23.8 75,742 49,897 51.8 Provision for Income Taxes 7,925 6,006 (32.0) 31,576 18,961 (66.5) ------------ ----------- --------------- --------------- ----------- --------------- Net Income $ 11,638 $ 9,800 18.8% $ 44,166 $ 30,936 42.8% ============ =========== =============== ===========
Revenues for the quarter ended September 30, 2004 increased to $202.3 million, an increase of $24.0 million or 13.5%, inclusive of the Western acquisition completed on April 30, 2004, from last year's third quarter revenues of $178.3 million. For the third quarter of 2004 the primary revenue driver was the acquisition of Western, which contributed $17.6 million during the quarter as well as the residential pest control business, which grew at 7.0%. The Company's movement over the last year to regional incoming call centers has led to greater efficiency in the handling and capturing of calls and with the improved closure, greater sales and revenue. Every-other-month service, our primary residential pest control service offering, continues to grow in importance, comprising 57.9% of our residential pest control customer base at September 30, 2004. Revenues for the nine month period ended September 30, 2004 increased to $568.6 million, an increase of $50.2 million or 9.7% from last year's first nine month period revenues of $518.5 million. The Company's foreign operations accounted for approximately 7% of total third quarter revenues in both 2004 and 2003. The revenues of the Company are affected by the seasonal nature of the Company's pest and termite control services as evidenced by the following chart. Total Net Revenues --------------------------------------- 2004 2003 2002 - -------------------------------------------------------------------------------- First Quarter $158,692 $155,122 $153,302 Second Quarter 207,698 185,105 184,189 Third Quarter 202,257 178,262 174,063 Fourth Quarter N/A 158,524 153,871 - -------------------------------------------------------------------------------- 13 Cost of Services Provided for the third quarter ended September 30, 2004 increased $10.7 million or 11.1%, although the expense expressed as a percentage of revenues decreased by 1.1 percentage points, representing 52.8% of revenues for the third quarter 2004 compared to 53.9% of revenues in the prior year third quarter. For the first nine months of 2004, Cost of Services Provided increased $22.0 million or 8.0%, and, as a percentage of revenues, improved by 0.8 percentage points, representing 52.3% of revenues for the first nine months of 2004 compared to 53.1% of revenues in the prior year. Cost of Services Provided as a percentage of revenues decreased primarily due to continuing improvements in insurance and claims, as well as continued employee productivity improvements at Orkin. These were partially offset by Western's higher Cost of Services Provided as a percentage of revenues. One area in which the Company experienced some minor expense increases was fleet, which was the result of higher lease, fuel and the cost of the Western fleet. Sales, General and Administrative for the third quarter ended September 30, 2004 increased $8.7 million or 14.1% and, as a percentage of revenues, had a slight increase of 0.1 percentage points or 0.3%, representing 34.6% of total revenues compared to 34.5% for the prior year quarter. For the first nine months of 2004, Sales, General and Administrative increased $15.3 million or 8.6%, while margins improved by 0.4 percentage points, representing 34.0% of revenues for the first nine months of 2004 compared to 34.4% of revenues in the prior year. The decrease in Sales, General and Administrative as a percentage of revenue was mainly attributable to the discontinuation of an ineffective advertising campaign that was conducted in Canada in 2003. The savings were partially offset by the higher Sales, General and Administrative costs of Western. Depreciation and Amortization expenses for the third quarter ended September 30, 2004 were $1.2 million or 23.4% higher than the prior year quarter. For the first nine months of 2004, Depreciation and Amortization expenses were approximately $1.4 million or 9.3% higher than the prior year. The increase was due to the addition of depreciation and amortization from the acquisition of Western partially offset by lower capital spending and certain technology assets becoming fully depreciated in the last twelve months. As part of the Western acquisition, $55.2 million of finite-lived intangible assets, principally customer contracts, were acquired. They will be amortized over periods principally ranging from 8 to 12.5 years. This represents a non-cash charge and will increase our amortization by approximately $6.0 million to approximately $12.8 million per year. For the third quarter ended September 30, 2004 amortization of $3.2 million was 80.8% higher that the prior period quarter. For the first nine months of 2004, amortization of $7.6 million was 61.8% higher that the prior year. Income Taxes. The Company's tax provision of $7.9 million for the third quarter ended September 30, 2004 reflects increased pre-tax income over the prior year period and an increase in the effective tax rate. The effective tax rate was 40.5% for the third quarter ended September 30, 2004, up from 38.0% for the third quarter ended September 30, 2003. The increase reflects increases in the Company's effective state income tax rate, as well as the impact of permanent differences associated with the Company's Canadian operations. Critical Accounting Policies We view critical accounting policies to be those policies that are very important to the portrayal of our financial condition and results of operations, and that require Management's most difficult, complex or subjective judgments. The circumstances that make these judgments difficult or complex relate to the need for Management to make estimates about the effect of matters that are inherently uncertain. We believe our critical accounting policies to be as follows: Accrual for Termite Contracts--The Company maintains an accrual for termite contracts representing the estimated costs of reapplications, repair claims, associated labor and chemicals, settlements, awards and other costs relative to termite control services performed prior to the balance sheet date. The Company contracts an independent third party actuary on an annual basis to provide the Company an estimate of the liability based upon historical claims information for the largest portion of the accrual. In addition, Management estimates and accrues for costs outside the scope of the actuarial study including the estimated costs of retreatments, representing costs to be incurred that are estimatable at the balance sheet date, as well as liability and costs associated with claims in litigation. The actuarial study and historical experience are major considerations in determining the accrual balance, along with Management's knowledge of changes in business practices, contract changes, ongoing claims, and termite remediation trends. The accrual is established based on all these factors. Management makes judgments utilizing these operational and other factors but recognizes that they are inherently subjective due to the difficulty in predicting settlements and awards. Other factors that may impact future cost include chemical life expectancy and government regulation. It is significant that the actual number of claims has decreased in recent years due to changes in the Company's business practices. However, it is not possible to accurately predict future significant claims. Positive changes to our business practices include revisions made to our contracts, more effective treatment methods that include a directed-liquid baiting program, more effective termiticides, and expanded training methods and techniques. 14 Accrued Insurance--The Company self-insures, up to specified limits, certain risks related to general liability, workers' compensation and vehicle liability. The estimated costs of existing and future claims under the self-insurance program are accrued based upon historical trends as incidents occur, whether reported or unreported (although actual settlement of the claims may not be made until future periods) and may be subsequently revised based on developments relating to such claims. The Company contracts an independent third party actuary on an annual basis to provide the Company an estimated liability based upon historical claims information. The actuarial study is a major consideration, along with Management's knowledge of changes in business practices and existing claims compared to current balances. The reserve is established based on all these factors. Management's judgment is inherently subjective and a number of factors are outside Management's knowledge and control. Additionally, historical information is not always an accurate indication of future events. It should be noted that the number of claims has been decreasing due to the Company's proactive risk management to develop and maintain ongoing programs. Initiatives that have been implemented include pre-employment screening and an annual motor vehicle report required on all its drivers, utilization of a Global Positioning System that has been fully deployed to our Company vehicles, post-offer physicals for new employees, and pre-hire, random and post-accident drug testing. The Company has improved the time required to report a claim by utilizing a "Red Alert" program that provides serious accident assessment twenty four hours a day and seven days a week and has instituted a modified duty program that enables employees to go back to work on a limited-duty basis. Revenue Recognition--The Company's revenue recognition policies are designed to recognize revenues at the time services are performed. For certain revenue types, because of the timing of billing and the receipt of cash versus the timing of performing services, certain accounting estimates are utilized. Residential and commercial pest control services are primarily recurring in nature on a monthly or bi-monthly basis, while certain types of commercial customers may receive multiple treatments within a given month. In general, pest control customers sign an initial one-year contract, and revenues are recognized at the time services are performed. For pest control customers, the Company offers a discount for those customers who prepay for a full year of services. The Company defers recognition of these advance payments and recognizes the revenue as the services are rendered. The Company classifies the discounts related to the advance payments as a reduction in revenues. Termite baiting revenues are recognized based on the delivery of the individual units of accounting. At the inception of a new baiting services contract upon quality control review of the installation, the Company recognizes revenue for the delivery of the monitoring stations, initial directed liquid termiticide treatment and installation of the monitoring services. The amount deferred is the fair value of monitoring services to be rendered after the initial service. The amount deferred for the undelivered monitoring element is then recognized as income on a straight-line basis over the remaining contract term, which results in recognition of revenue in a pattern that approximates the timing of performing monitoring visits. Baiting renewal revenue is deferred and recognized over the annual contract period on a straight-line basis that approximates the timing of performing the required monitoring visits. Traditional termite treatments are recognized as revenue at the time services are performed. Traditional termite contract renewals are recognized as revenues at the renewal date in order to match the revenue with the approximate timing of the corresponding service provided. Interest income on installment receivables is accrued monthly based on actual loan balances and stated interest rates. Franchise fees are treated as unearned revenue in the Statement of Financial Position for the duration of the initial contract period. Royalties from Orkin franchises are accrued and recognized as revenues as earned on a monthly basis. Gains on sales of pest control customer accounts to franchises are recognized at the time of sale and when collection of the proceeds under notes are reasonably assured. Contingency Accruals--The Company is a party to legal proceedings with respect to matters in the ordinary course of business. In accordance with Statement of Financial Accounting Standards No. 5, Accounting for Contingencies, the Company estimates and accrues for its liability and costs associated with the litigation. Estimates and accruals are determined in consultation with outside counsel. It is not possible to accurately predict the ultimate result of the litigation. However, in the opinion of Management, the outcome of the litigation will not have a material adverse impact on the Company's financial condition or results of operations. Liquidity and Capital Resources Cash and Cash Flow Nine Months Ended September 30, --------------------------------------- (in thousands) 2004 2003 - -------------------------------------------------------------------------------- Net Cash Provided by Operating Activities $ 59,980 $ 58,734 Net Cash Used in Investing Activities (72,783) (37,287) Net Cash Used in Financing Activities (5,843) (4,696) ---------- ---------- Net Increase/(Decrease) in Cash and Cash Equivalents $ (18,646) $ 16,751 - -------------------------------------------------------------------------------- 15 The Company believes its current cash and cash equivalents balances, future cash flows from operating activities and available borrowings under its $70.0 million credit facilities will be sufficient to finance its current operations and obligations, and fund expansion of the business for the foreseeable future and the acquisition of other select pest control businesses. The Company's operating activities generated cash of $60.0 million for the first nine months ended September 30, 2004, compared with cash provided by operating activities of $58.7 million for the same period in 2003. Cash flows from operating activities in 2004 were relatively consistent with 2003. The Company invested approximately $6.7 million in capital expenditures during the first nine months ended September 30, 2004, compared to $8.7 million during the same period in 2003, and expects to invest between $2.0 million and $3.0 million for the remainder of 2004. Capital expenditures for the first nine months consisted primarily of the purchase of equipment replacements and upgrades and improvements to the Company's management information systems. During the first nine months, the Company made acquisitions totaling $103.4 million, compared to $1.5 million during the same period in 2003. Acquisitions were primarily funded by cash on hand, sales of marketable securities of approximately $21.9 million, proceeds from sale of assets and borrowings under a senior unsecured revolving credit facility (See below for further discussion). A total of $8.2 million was paid in cash dividends ($0.18 per share) during the first nine months of 2004, compared to $6.8 million or $0.15 per share during the same period in 2003. The Company did not repurchase any shares of Common Stock in the first nine months of 2004 and there remain 649,684 shares authorized to be repurchased. The capital expenditures and cash dividends were funded entirely through existing cash balances and operating activities. The Company maintains $70.0 million of credit facilities with commercial banks, of which no borrowings were outstanding as of September 30, 2004 or October 15, 2004. The Company maintains approximately $33.5 million in Letters of Credit which reduced its borrowing capacity under the credit facilities. These Letters of Credit are required by the Company's fronting insurance companies and/or certain states, due to the Company's self-funded status, to secure various workers' compensation and casualty insurance contracts. These letters of credit are established by the bank for the Company's fronting insurance companies as collateral, although the Company believes that it has adequate liquid assets, funding sources and insurance accruals to accommodate such claims. On April 28, 2004, the Company entered into a $15.0 million senior unsecured revolving credit facility. The entire amount of the credit facility was used to fund a portion of the Western Industries, Inc. acquisition that the Company closed on April 30, 2004. The Company repaid the full amount of the credit facility in May 2004. On April 28, 2004, the Company sold real estate in Okeechobee County, Florida to LOR, Inc., a company controlled by R. Randall Rollins, Chairman of the Board of Rollins, Inc. and Gary W. Rollins, Chief Executive Officer, President and Chief Operating Officer of Rollins, Inc. for $16.6 million in cash. The sale resulted in a net gain after tax of $8.1 million or $0.17 per share since the real estate had appreciated over approximately 30 years it had been owned by the Company. The Company deferred an immaterial portion of the gain pending the completion of a survey that may result in the return of a portion of the proceeds. The real estate was under a lease agreement with annual rentals of $131,939 that would have expired June 30, 2007. On May 28, 2004, the Company sold real estate in Sussex County, Delaware to LOR, Inc. for $111,000 in cash. The sale resulted in an immaterial net gain after tax. The Board of Directors, at its quarterly meeting on January 27, 2004, approved the formation of a committee (the "Committee") made up of Messrs. Bill J. Dismuke and James B. Williams, who are independent directors, to evaluate the transactions. In addition, the Company on October 22, 2004 purchased real estate located at 2158 Piedmont Road, N.E., Atlanta, Georgia 30324, adjacent to the Company's headquarters, from LOR, Inc. for $4.6 million. During a Board of Directors meeting on October 20, 2004, the Committee was furnished with full disclosure of the transactions, including independent appraisals, and determined that the terms of the transactions were reasonable and fair to the Company. The Committee was furnished with full disclosure of the transactions, including independent appraisals, and determined that the terms of the transactions were reasonable and fair to the Company. The Company has reached an agreement on the sale of an additional piece of real estate in Sussex County, Delaware to LOR, Inc. or an entity wholly owned by LOR, Inc. The transaction will take place prior to December 31, 2004 and will result in a substantial gain of approximately $10.3 million, net of costs, on the sale of the property or $.12 to $.13 per share after taxes. On April 30, 2004, the Company acquired substantially all of the assets and assumed certain liabilities of Western Pest Services ("Western"), and the Company's consolidated financial statements include the operating results of Western from the date of the acquisition. Neither Western nor its principals had any prior relationship with the Company or its affiliates. Western was engaged in the business of providing pest control services and the Company intends to continue this business. The acquisition was made pursuant to an Asset Purchase Agreement (the "Western Agreement") dated March 8, 2004, between Rollins, Inc. and Western Industries, Inc. and affiliates. The consideration for the assets and certain noncompetition agreements (the "Purchase Price") was for approximately $106.6 million, including approximately $7.0 million of assumed liabilities. The Purchase Price was funded with cash on hand, the sale of property located in Okeechobee County, Florida and a $15.0 million senior unsecured revolving credit facility. 16 Pursuant to the Western Agreement, the Company acquired substantially all of Western's property and assets, including accounts receivable, real property leases, seller contracts, governmental authorizations, data and records, intangible rights and property and insurance benefits. As described in the Western Agreement, the Company assumed only specified liabilities of Western and obligations under disclosed assigned contracts. The Company engaged an independent valuation firm to determine the allocation of the purchase price to Goodwill and identifiable Intangible assets. Such valuation resulted in the allocation of $41.3 million to Goodwill and $55.2 million to other intangible assets, principally customer contracts. The finite-lived intangible assets, principally customer contracts, are being amortized over periods principally ranging from 8 to 12.5 years on a straight-lined basis. On April 30, 2004, in a transaction ancillary to the Western acquisition, the Company acquired Residex Corporation ("Residex"), a company that distributes chemicals and other products to pest management professionals, pursuant to an Asset Purchase Agreement (the "Residex Agreement") dated March 8, 2004, between Rollins, Inc. and Western Industries, Inc., JBD Incorporated and Residex Corporation. Subsequently on April 30, 2004, the Company sold Residex to an industry distribution group. The amounts involved were not material and no gain or loss was recognized on the transaction. Prior to the acquisition, Western Pest Services was recognized as a premier pest control business and ranked as the 8th largest company in the industry. Based in Parsippany, NJ, the Company provides pest elimination and prevention to homes and businesses to over 130,000 customers from New York to Virginia with additional operations in Georgia and Florida. Western is primarily a commercial pest control service company and its existing businesses complement most of the services that Orkin offers, in an area of the country in which Orkin has not been particularly strong, the Northeast. The Company's consolidated statements of income include the results of operations of Western for the period beginning May 1, 2004 through September 30, 2004. Orkin, one of the Company's subsidiaries, is aggressively defending a class action lawsuit filed in Hillsborough County, Tampa, Florida. In early April 2002, the Circuit Court of Hillsborough County certified the class action status of Butland et al. v. Orkin Exterminating Company, Inc. et al. Orkin is also a named defendant in Helen Cutler and Mary Lewin v. Orkin Exterminating Company, Inc. et al. pending in the District Court of Houston County, Alabama. The plaintiffs in the above mentioned case filed suit in March of 1996 seeking monetary damages and injunctive relief for alleged breach of contract arising out of alleged missed or inadequate reinspections. The attorneys for the plaintiff contend that the case is suitable for a class action and the court ruled that the plaintiffs would be permitted to pursue a class action lawsuit. The parties have now agreed to settle this matter and the court has approved an order of settlement. The Company agreed to pay certain attorney fees, $5,000 each to the two named plaintiffs, and agreed to perform additional termite reinspections, if requested by individual members of the class. The Company anticipates that this matter will be concluded in the near future. In the opinion of Management, the resolution of this action will not have a material adverse effect on the Company's financial position, results of operations or liquidity. Other lawsuits or arbitrations against Orkin, and in some instances the Company, are also being vigorously defended, including the Warren, Petsch, and Stevens cases and the Garrett arbitration. The matter of Larry Hanna, et. al. v. Rollins, Inc. dba Rollins Service Bureau formerly pending in the District Court for the Northern District of Indiana (Hammond Division) has been dismissed. For further discussion, see Note 3 to the accompanying financial statements. A contribution of $3.0 million was made to the pension plan in April 2004. The Company may contribute an additional amount up to $5.0 million to the pension plan in 2004. In the opinion of Management, additional Plan contributions will not have a material effect on the Company's financial position, results of operations or liquidity. Impact of Recent Accounting Pronouncements In December 2002, the FASB issued Interpretation No. 46, Consolidation of Variable Interest Entities ("FIN 46"). The Interpretation requires that a variable interest entity be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity's activities or entitled to receive a majority of the entity's residual returns or both. The consolidation requirements of FIN 46, as revised, were effective in 2003 for all variable interest entities created or acquired after January 31, 2003 and extended the adoption date of FIN 46 (R) to the first quarter of 2004 for variable interest entities created prior to February 1, 2003. The adoption of FIN 46 did not have an effect on the Company's financial position or results of operations (see Note 1 to the accompanying financial statements). 17 Forward-Looking Statements This Quarterly Report contains statements that constitute "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The actual results of the Company could differ materially from those indicated by the forward-looking statements because of various risks and uncertainties, including without limitation, general economic conditions; market risk; changes in industry practices or technologies; the degree of success of the Company's pest and termite process reforms and pest control selling and treatment methods; the Company's ability to identify potential acquisitions; climate and weather trends; competitive factors and pricing practices; the cost reduction benefits of the corporate restructuring may not be as great as expected or eliminated positions may have to be reinstated in the future; expected benefits of the commercial division re-eingeering may not be realized, potential increases in labor costs; uncertainties of litigation; and changes in various government laws and regulations, including environmental regulations. All of the foregoing risks and uncertainties are beyond the ability of the Company to control, and in many cases the Company cannot predict the risks and uncertainties that could cause its actual results to differ materially from those indicated by the forward-looking statements. A more detailed discussion of potential risks facing the Company can be found in the Company's Report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2003. Item 3. Quantitative and Qualitative Disclosures About Market Risk. As of September 30, 2004, the Company maintained an investment portfolio subject to short-term interest rate risk exposure. The Company has been affected by the impact of lower interest rates on interest income from its short-term investments. The Company is also subject to interest rate risk exposure through borrowings on its $70.0 million credit facilities. Due to the absence of such borrowings as of September 30, 2004, this risk was not significant in the first nine months of 2004 and is not expected to have a material effect upon the Company's results of operations or financial position going forward. The Company is also exposed to market risks arising from changes in foreign exchange rates. The Company believes that this foreign exchange rate risk will not have a material effect upon the Company's results of operations or financial position going forward. Item 4. Controls and Procedures. Under the supervision and with the participation of our Management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of the design and operations of our disclosure controls and procedures, as defined in rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as of September 30, 2004. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level such that the material information required to be included in our Securities and Exchange Commission ("SEC") reports is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms relating to Rollins, Inc., including our consolidated subsidiaries, and was made known to them by others within those entities, particularly during the period when this report was being prepared. In addition, there were no significant changes in our internal control over financial reporting during the quarter that could significantly affect these controls. As of September 30, 2004, we did not identify any significant deficiency or material weaknesses in our internal controls, and therefore no corrective actions were taken. 18 PART II OTHER INFORMATION Item 1. Legal Proceedings. See Note 3 to Part I, Item 1 for discussion of certain litigation. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
Issuer Purchases Of Equity Securities Total Number of Shares Purchased as Maximum Number of Total Number Part of Publicly Shares that May Yet of Shares Average Price Announced Be Purchased Under Month Purchased (1) Paid per Share Repurchase Plan the Repurchase Plan ------------------ --------------- ---------------- --------------------- ---------------------- July 2004 3,008 $23.37 0 649,684 August 2004 3,314 $23.25 0 649,684 September 2004 2,365 $24.35 0 649,684 =============== ================ ===================== ====================== Total 8,687 $23.59 0 649,684 (1) All repurchases shown are repurchases in connection with exercise of employee stock options.
Item 4. Submission of Matters to a Vote of Security Holders. Item 6. Exhibits. (a) Exhibits (3)(i) Restated Certificate of Incorporation of Rollins, Inc. is incorporated herein by reference to Exhibit (3) (i) as filed with its Form 10-K for the year ended December 31, 1997. (ii) Amended and Restated By-laws of Rollins, Inc. is incorporated herein by reference to Exhibit (3) (ii) as filed with its Form 10-Q for the quarterly period ended March 31, 2004. (4) Form of Common Stock Certificate of Rollins, Inc. is incorporated herein by reference to Exhibit (4) as filed with its Form 10-K for the year ended December 31, 1998. (31.1) Certification of Chief Executive Officer Pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (31.2) Certification of Chief Financial Officer Pursuant to Item 601(b)(31) of Regulation S-K, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. (32.1) Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 19 SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ROLLINS, INC. (Registrant) Date: October 28, 2004 By: /s/ Gary W. Rollins -------------------------------------------- Gary W. Rollins Chief Executive Officer, President and Chief Operating Officer (Member of the Board of Directors) Date: October 28, 2004 By: /s/ Harry J. Cynkus --------------------------------------------- Harry J. Cynkus Chief Financial Officer and Treasurer (Principal Financial and Accounting Officer) 20