Annual report pursuant to Section 13 and 15(d)

EMPLOYEE BENEFIT AND STOCK COMPENSATION PLANS

v2.4.0.6
EMPLOYEE BENEFIT AND STOCK COMPENSATION PLANS
12 Months Ended
Dec. 31, 2011
EMPLOYEE BENEFIT AND STOCK COMPENSATION PLANS  
EMPLOYEE BENEFIT AND STOCK COMPENSATION PLANS

13.   EMPLOYEE BENEFIT AND STOCK COMPENSATION PLANS

Employee Benefit Plans

Defined Benefit Pension Plans

Rollins, Inc. Retirement Income Plan

The Company maintains several noncontributory tax-qualified defined benefit pension plans (the "Plans") covering employees meeting certain age and service requirements. The Plans 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 Plans with at least the minimum amount required by ERISA. The Company made contributions of $4.9 million to the Plans during the year ended December 31, 2011 with $5.2 million in contributions made for 2010 and $5.0 million for 2009.

In June 2005, the Company froze the Rollins, Inc. defined benefit pension plan. The Company currently uses December 31 as the measurement date for its defined benefit post-retirement plans. The funded status of the Plans and the net amount recognized in the statement of financial position are summarized as follows as of:

 
  December 31,  
(in thousands)
  2011
  2010
 
   

CHANGE IN ACCUMULATED BENEFIT OBLIGATION

             

Accumulated Benefit obligation at beginning of year

  $ 183,972   $ 159,539  

Pension plans acquired upon acquisitions of companies

        5,317  

Service cost

    158     86  

Interest cost

    9,879     9,514  

Actuarial (gain) loss

    12,205     16,651  

Benefits paid

    (8,793 )   (7,135 )

Liability gain due to curtailment

    (510 )    
       

Accumulated Benefit obligation at end of year

    196,911     183,972  

CHANGE IN PLAN ASSETS

             

Market value of plan assets at beginning of year

    171,457     144,644  

Pension plans acquired upon acquisitions of companies

        3,733  

Actual return on plan assets

    (2,520 )   25,039  

Employer contribution

    4,900     5,176  

Benefits paid

    (8,793 )   (7,135 )
       

Fair value of plan assets at end of year

    165,044     171,457  
       

Funded status

  $ (31,867 ) $ (12,515 )
   

Amounts Recognized in the Statement of Financial Position consist of:

 
  December 31,  
(in thousands)
  2011
  2010
 
   

Noncurrent liabilities

  $ (31,867 ) $ (12,515 )
   

Amounts Recognized in Accumulated Other Comprehensive Income consists of:

 
  December 31,  
(in thousands)
  2011
  2010
 
   

Net loss

  $ 87,035   $ 62,538  
   

Included in the Plans are newly acquired pension plans from acquisitions of companies during the year ended December 31, 2010. The accumulated benefit obligation for the defined benefit pension plans were $196.9 million and $184.0 million at December 31, 2011 and 2010, respectively. Accumulated benefit obligation and projected benefit obligation are materially the same for the Plans. Pre-tax increases in the pension liability which were (charged, net of tax) credited to other comprehensive income/(loss) were $(24.5) million, $(1.9) million and $(23) thousand in 2011, 2010 and 2009, respectively.

The following weighted-average assumptions as of December 31 were used to determine the accumulated benefit obligation and net benefit cost:

 
  December 31,  
 
  2011
  2010
  2009
 
   

ACCUMULATED BENEFIT OBLIGATION

                   

Discount rate

    5.01 %   5.51 %   6.01 %

Rate of compensation increase

    N/A     N/A     N/A  

NET BENEFIT COST

                   

Discount rate

    5.51 %   6.01 %   6.81 %

Expected return on plan assets

    7.00 %   7.00 %   7.00 %

Rate of compensation increase

    N/A     N/A     N/A  
   

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 discount rate reflects the current rate at which the pension liabilities could be effectively settled at the end of the year. In estimating this rate, for fiscal year's 2011, 2010 and 2009 the Company utilized a yield curve analysis.

Components of Net Periodic Benefit Cost and Other
Amounts Recognized in Other Comprehensive Income

 
  Pension Benefits  
(in thousands)
  2011
  2010
  2009
 
   

Net Periodic Benefit Cost

                   

Service cost

  $ 158   $ 86   $  

Interest cost

    9,879     9,514     9,530  

Expected return on plan assets

    (12,080 )   (11,437 )   (10,974 )

Amortization of net loss

    1,800     1,115     963  
       

Net periodic benefit

  $ (243 ) $ (722 ) $ (481 )
       

Other Changes in Plan Assets and Benefit Obligations
Recognized in Other Comprehensive Income

                   

Net (gain)/loss

  $ 26,297   $ 3,048   $ 986  

Amortization of net loss

    (1,800 )   (1,115 )   (963 )
       

Total recognized in other comprehensive income

    24,497     1,933     23  
       

Total recognized in net periodic benefit cost and other comprehensive income

  $ 24,254   $ 1,211   $ (458 )
   

The Company does not expect to amortize a net gain or loss in 2012. At December 31, 2011 and 2010, the Plan's assets were comprised of listed common stocks and U.S. government and corporate securities, real estate and other. Included in the assets of the Plan were shares of Rollins, Inc. Common Stock with a market value of $34.1 million and $30.3 million at December 31, 2011 and 2010, respectively.

The Plans' weighted average asset allocation at December 31, 2011 and 2010 by asset category, along with the target allocation for 2012, are as follows:

Asset category
  2012
  2011
  2010
 

Cash

  0% – 5%   0.6%   1.1%

Equity Securities – Rollins stock

  10% – 20%   20.6%   18.1%

Domestic Equity – all other

  20% – 30%   12.7%   21.7%

Global Equity

  10% – 20%   11.4%   3.6%

International Equity

  10% – 20%   11.6%   11.3%

Debt Securities – core fixed income

  15% – 50%   18.9%   21.4%

Tactical Composite

  10% – 20%   12.5%   8.3%

Real Estate

  0% – 10%   4.3%   3.7%

Real Return

  0% – 10%   7.4%   4.6%

Other

  0% – 5%   0.0%   6.2%
     

Total

  100.0%   100.0%   100.0%
 

For each of the asset categories in the pension plan, the investment strategy is identical—maximize the long-term rate of return on plan assets with 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 plans utilize a number of investment approaches, including individual market securities, equity and fixed income funds in which the underlying securities are marketable, and debt funds to achieve this target allocation. The Company and management are considering making contributions to the pension plans of approximately $5.0 million during fiscal 2012.

Included among the asset categories for the Plans' investments are real estate and other comprised of real estate and hedge funds. These investments are categorized as level 3 investments and are valued using significant non-observable inputs which do not have a readily determinable fair value. In accordance with ASU No. 2009-12 "Investments In Certain Entities That Calculate Net Asset Value per Share (Or Its Equivalent)," these investments are valued based on the net asset value per share calculated by the funds in which the plan has invested. These valuations are subject to judgments and assumptions of the funds which may prove to be incorrect, resulting in risks of incorrect valuation of these investments. The Company seeks to mitigate against these risks by evaluating the appropriateness of the funds' judgments and assumptions by reviewing the financial data included in the funds' financial statements for reasonableness.

Fair Value Measurements

The Company's overall investment strategy is to achieve a mix of approximately 70 percent of investments for long-term growth and 30 percent for near-term benefit payments, with a wide diversification of asset types, fund strategies and fund managers. Equity securities primarily include investments in large-cap and mid-cap companies. Fixed-income securities include corporate bonds of companies in diversified securities, mortgage-backed securities, and U.S. Treasuries. Other types of investments include hedge funds and private equity funds that follow several different investment strategies.

Some of our assets, primarily our private equity, real estate and hedge funds, do not have readily determinable market values given the specific investment structures involved and the nature of the underlying investments. For the December 31, 2011 plan asset reporting, publicly traded asset pricing was used where possible. For assets without readily determinable values, estimates were derived from investment manager discussions focusing on underlying fundamentals and significant events.

The following table presents our plan assets using the fair value hierarchy as of December 31, 2011. The fair value hierarchy has three levels based on the reliability of the inputs used to determine fair value. See note 7 for a brief description of the three levels under the fair value hierarchy.

 
   
  Total
  Level 1
  Level 2
  Level 3
 
   

(1)

 

Cash and Cash Equivalents

  $ 918   $ 918   $   $  

(2)

 

Fixed Income Securities

    31,167         31,167      

 

 

Domestic Equity Securities

                   

 

 

    Rollins, Inc. Stock

    34,050     34,050          

 

 

    Other Securities

    21,032     21,032          

 

 

Global Equity Securities

    18,751     18,751          

(3)

 

International Equity Securities

    19,120     9,316     9,804      

(4)

 

Tactical Composite

    20,680         20,680      

(5)

 

Real Estate

    7,092             7,092  

(6)

 

Real Return

    12,234         12,234      

(7)

 

Alternative Investments

                 
   

 

 

Total

  $ 165,044   $ 84,067   $ 73,885   $ 7,092  
   

The following table presents our plan assets using the fair value hierarchy as of December 31, 2010. The fair value hierarchy has three levels based on the reliability of the inputs used to determine fair value.

 
   
  Total
  Level 1
  Level 2
  Level 3
 
   

(1)

 

Cash and Cash Equivalents

  $ 10,747   $ 10,747   $   $  

(2)

 

Fixed Income Securities

    37,464         37,464      

 

 

Domestic Equity Securities

                   

 

 

    Rollins, Inc. Stock

    30,265     30,265          

 

 

    Other Securities

    37,989     37,989          

 

 

Global Equity Securities

    5,953         5,953      

(3)

 

International Equity Securities

    19,789     9,272     10,517      

(4)

 

Tactical Composite

    13,875         13,875      

(5)

 

Real Estate

    6,248             6,248  

(6)

 

Real Return

    7,704         7,704      

(7)

 

Alternative Investments

    1,423             1,423  
   

 

 

Total

  $ 171,457   $ 88,273   $ 75,513   $ 7,671  
   
(1)
Cash and cash equivalents, which are used to pay benefits and plan administrative expenses, are held in Rule 2a-7 money market funds.

(2)
Fixed income securities are primarily valued using a market approach with inputs that include broker quotes, benchmark yields, base spreads and reported trades.

(3)
Some International equity securities are valued using a market approach based on the quoted market prices of identical instruments in their respective markets.

(4)
Tactical Composite funds invest in stocks, bonds and cash, both domestic and international. These assets are valued primarily using a market approach based on the quoted market prices of identical instruments in their respective markets.

(5)
Real estate fund values are primarily reported by the fund manager and are based on valuation of the underlying investments, which include inputs such as cost, discounted future cash flows, independent appraisals and market based comparable data.
(6)
Real Return funds invest in global equities, commodities and inflation protected core bonds that are valued primarily using a market approach based on the quoted market prices of identical instruments in their respective markets.

(7)
Alternative Investments are Hedge Funds consisting of fund-of-fund LLC or commingled fund structures. The LLCs are primarily valued based on Net Asset Values [NAVs] calculated by the fund and are not publicly available. The commingled fund NAV is calculated by the manager on a daily basis and has monthly liquidity. The Company is in the process of liquidating the Plans' alternative investments.

The following table presents a reconciliation of Level 3 assets held during the year ended December 31, 2011.

 
  Balance at
December 31,
2010

  Net Realized
and Unrealized
Gains/(Losses)

  Net
Purchases,
Issuances and
Settlements

  Net
Transfers
In to/
(Out of)
Level 3

  Balance at
December 31,
2011

 
   

Real Estate

  $ 6,248   $ 844   $   $   $ 7,092  

Alternative Investments

    1,423     (11 )   (1,412 )        
   

Total

  $ 7,671   $ 833   $ (1,412 ) $   $ 7,092  
   

The following table presents a reconciliation of Level 3 assets held during the year ended December 31, 2010.

 
  Balance at
December 31,
2009

  Net Realized
and Unrealized
Gains/(Losses)

  Net
Purchases,
Issuances and
Settlements

  Net
Transfers
In to/
(Out of)
Level 3

  Balance at
December 31,
2010

 
   

Real Estate

  $ 5,209   $ 1,039   $   $   $ 6,248  

Alternative Investments

    21,832     1,269     (12,799 )   (8,879 )   1,423  
   

Total

  $ 27,041   $ 2,308   $ (12,799 ) $ (8,879 ) $ 7,671  
   

The estimated future benefit payments over the next ten years are as follows:

(in thousands)
   
 
   
2012     9,088  
2013     9,637  
2014     10,218  
2015     10,819  
2016     11,375  
Thereafter     62,715  
   
Total   $ 113,852  
   

Defined Contribution 401(k) Plan

The Company sponsors a defined contribution 401(k) Plan that is available to a majority of the Company's full-time employees the first of the calendar quarter following completion of three months of service. The Plan is available to non full-time employees the first day of the calendar quarter following one year of service upon completion of 1,000 hours in that year. The Plan provides for a matching contribution of fifty cents ($.50) for each one dollar ($1.00) of a participant's contributions to the Plan that do not exceed 6 percent of his or her eligible compensation (which includes commissions, overtime and bonuses). The charge to expense for the Company match was approximately $7.0 million for the years ended December 31, 2011 and 2010 and $6.6 million for the year ended December 31, 2009. At December 31, 2011, 2010 and 2009 approximately, 35.5%, 35.1% and 29.3%, respectively of the plan assets consisted of Rollins, Inc. Common Stock. Total administrative fees paid by the Company for the Plan were approximately $42 thousand in 2011, $52 thousand in 2010 and $91 thousand in 2009.

Nonqualified Deferred Compensation Plan

The Deferred Compensation Plan provides that participants may defer up to 50% of their base salary and up to 85% of their annual bonus with respect to any given plan year, subject to a $2,000 per plan year minimum. The Company may make discretionary contributions to participant accounts. The Company currently plans to credit accounts of participants of long service to the Company with certain discretionary amounts ("Pension Plan Benefit Restoration Contributions") in lieu of benefits that previously accrued under the Company's Retirement Income Plan up to a maximum of $245,000. The Company intends to make Pension Plan Benefit Restoration Contributions under the Deferred Compensation Plan for five years. The first contribution was made in January 2007 for those participants who were employed for all of the 2006 plan year. Only employees with five full years of vested service on June 30, 2005 qualify for Pension Plan Benefit Restoration Contributions. Under the Deferred Compensation Plan, salary and bonus deferrals and Pension Plan Benefit Restoration Contributions are fully vested. Any discretionary contributions are subject to vesting in accordance with the matching contribution vesting schedule set forth in the Rollins 401(k) Plan in which a participant participates. The Company made its last contributions associated with this plan during the first quarter of 2011.

Accounts will be credited with hypothetical earnings, and/or debited with hypothetical losses, based on the performance of certain "Measurement Funds." Account values are calculated as if the funds from deferrals and Company credits had been converted into shares or other ownership units of selected Measurement Funds by purchasing (or selling, where relevant) such shares or units at the current purchase price of the relevant Measurement Fund at the time of the participant's selection. Deferred Compensation Plan benefits are unsecured general obligations of the Company to the participants, and these obligations rank in parity with the Company's other unsecured and unsubordinated indebtedness. The Company has established a "rabbi trust," which it uses to voluntarily set aside amounts to indirectly fund any obligations under the Deferred Compensation Plan. To the extent that the Company's obligations under the Deferred Compensation Plan exceed assets available under the trust, the Company would be required to seek additional funding sources to fund its liability under the Deferred Compensation Plan.

Generally, the Deferred Compensation Plan provides for distributions of any deferred amounts upon the earliest to occur of a participant's death, disability, retirement or other termination of employment (a "Termination Event"). However, for any deferrals of salary and bonus (but not Company contributions), participants would be entitled to designate a distribution date which is prior to a Termination Event. Generally, the Deferred Compensation Plan allows a participant to elect to receive distributions under the Deferred Compensation Plan in installments or lump-sum payments.

At December 31, 2011 the Deferred Compensation Plan had 41 life insurance policies with a net face value of $38.5 million. The cash surrender value of these life insurance policies were worth $9.8 million and $9.4 million at December 31, 2011 and 2010, respectively.

The estimated life insurance premium payments over the next five years are as follows:

(in thousands)
   
 
   
2012   $ 1,631  
2013     1,698  
2014     1,801  
2015     1,810  
2016     1,690  
   
Total   $ 8,630  
   

Total expense/(income) related to deferred compensation was $218 thousand, $130 thousand and $22 thousand in 2011, 2010, and 2009, respectively. The Company had $10.1 million in deferred compensation assets as of December 31, 2011 and 2010, respectively, located within other assets on the Company's consolidated statements of financial position and $9.8 million and $9.9 million in deferred compensation liability as of December 31, 2011 and 2010, respectively, located within long-term accrued liabilities on the Company's consolidated statements of financial position. The amounts of assets were marked to fair value.

Stock Compensation Plans

All share and per share data has been adjusted for the three-for-two stock split effective December 10, 2010.

Stock options and time lapse restricted shares (TLRSs) have been issued to officers and other management employees under the Company's Employee Stock Incentive Plan. The Company's stock options generally vest over a five-year period and expire ten years from the issuance date.

TLRSs provide for the issuance of a share of the Company's Common Stock at no cost to the holder and generally vest after a certain stipulated number of years from the grant date, depending on the terms of the issue. The Company issued TLRSs that vest over ten years prior to 2004. TLRSs issued 2004 and later vest in 20 percent increments starting with the second anniversary of the grant, over six years from the date of grant. During these years, grantees receive all dividends declared and retain voting rights for the granted shares. The agreements under which the restricted stock is issued provide that shares awarded may not be sold or otherwise transferred until restrictions established under the plans have lapsed.

For the year ended December 31, 2011, the Company issued approximately 0.1 million shares of common stock upon exercise of stock options by employees and issued 0.5 million shares in 2010. In addition, the Company issued time lapse restricted shares of 0.7 million, 0.9 million and 0.7 million for the years ended December 31, 2011, 2010 and 2009, respectively.

The Company issues new shares from its authorized but unissued share pool. At December 31, 2011, approximately 5.2 million shares of the Company's common stock were reserved for issuance. In accordance with FASB ASC Topic 718, "Compensation—Stock Compensation." The Company uses the modified prospective application method of adoption, which requires the Company to record compensation cost, related to unvested stock awards as of December 31, 2005 by recognizing the unamortized grant date fair value of these awards over the remaining service periods of those awards with no change in historical reported earnings. Awards granted after December 31, 2005 are valued at fair value and recognized on a straight line basis over the service periods of each award. The Company estimates restricted share forfeiture rates based on its historical experience.

In order to estimate the fair value of stock options, the Company used the Black-Scholes option valuation model, which was developed for use in estimating the fair value of publicly traded options, which have no vesting restrictions and are fully transferable. Option valuation models require the input of highly subjective assumptions and these assumptions can vary over time.

The following table summarizes the components of the Company's stock-based compensation programs recorded as expense ($ in thousands):

 
  Twelve months ended December 31,  
 
  2011
  2010
  2009
 
   

Time Lapse Restricted Stock:

                   

Pre-tax compensation expense

  $ 7,555   $ 7,538   $ 5,800  

Tax benefit

    (2,909 )   (2,902 )   (2,233 )
       

Restricted stock expense, net of tax

  $ 4,646   $ 4,636   $ 3,567  
   

As of December 31, 2011, $24.4 million of total unrecognized compensation cost related to time-lapse restricted shares is expected to be recognized over a weighted average period of approximately 4.1 years.

Option activity under the Company's stock option plan as of December 31, 2011, 2010 and 2009 and changes during the year ended December 31, 2011 were as follows:

 
  Shares
  Weighted
Average
Exercise
Price

  Weighted
Average
Remaining
Contractual
Term
(in years)

  Aggregate
Intrinsic
Value

 
   

Outstanding at December 31, 2008

    986     4.71     3.39     7,236  

Exercised

    (328 )   4.84              

Forfeited

    (5 )   3.22              
       

Outstanding at December 31, 2009

    653     4.67     2.44     5,348  

Exercised

    (517 )   4.67              
       

Outstanding at December 31, 2010

    136     4.66     1.59     2,056  

Exercised

    (103 )   4.48              
       

Outstanding at December 31, 2011

    33   $ 5.26     0.93   $ 553  
       

Exercisable at December 31, 2011

    33   $ 5.26     0.93   $ 553  
   

The aggregate intrinsic value in the table above represents the total pre-tax intrinsic value (the difference between the Company's closing stock price on the last trading day of the year and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on that day. The amount of aggregate intrinsic value will change based on the fair market value of the Company's stock.

The aggregate intrinsic value of options exercised during the years ended December 31, 2011, 2010 and 2009 was $1.7 million, $5.2 million and $2.4 million, respectively. Exercise of options during the years ended December 31, 2011, 2010 and 2009 resulted in cash receipts of $0.1 million, $0.3 million and $0.5, respectively.

The following table summarizes information on unvested restricted stock units outstanding as of December 31, 2011, 2010 and 2009:

 
  Number of
Shares
(in thousands)

  Weighted-Average
Grant-Date
Fair Value

 
   

Unvested Restricted Stock Grants

             

Unvested as of December 31, 2008

    2,453   $ 9.80  

Forfeited

    (26 )   9.48  

Vested

    (412 )   8.51  

Granted

    721     10.99  
       

Unvested as of December 31, 2009

    2,737     10.31  

Forfeited

    (277 )   10.99  

Vested

    (666 )   9.51  

Granted

    871     12.32  
       

Unvested as of December 31, 2010

    2,664     11.09  

Forfeited

    (74 )   12.90  

Vested

    (574 )   10.08  

Granted

    670     19.30  
       

Unvested as of December 31, 2011

    2,686   $ 13.31