Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

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Presentation

This discussion should be read in conjunction with our audited financial statements and related notes included elsewhere in this document. The following discussion (as well as other discussions in this document) contains forward-looking statements. Please see “Cautionary Statement Regarding Forward-Looking Statements” for a discussion of uncertainties, risks and assumptions associated with these statements.

The Company

Rollins, Inc. (the “Company”) was originally incorporated in 1948 under the laws of the state of Delaware as Rollins Broadcasting, Inc. The Company is an international service company with headquarters located in Atlanta, Georgia, providing pest and termite control services through its wholly-owned subsidiaries to both residential and commercial customers in North America, Australia, and Europe with international franchises in Central America, South America, the Caribbean, the Middle East, Asia, the Mediterranean, Europe, Africa, and Mexico. Services are performed through a contract that specifies the treatment specifics and the pricing arrangement with the customer.

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.

Overview

RESULTS OF OPERATIONS

														% better/(worse) as
		(in thousands)												compared to prior year
Years ended December 31,		2016				2015				2014				2016				2015
Revenues		$	1,573,477			$	1,485,305			$	1,411,566				5.9	%			5.2	%
Cost of services provided			772,348				735,976				707,739				(4.9	)			(4.0	)
Depreciation and amortization			50,902				44,522				43,509				(14.3	)			(2.3	)
Sales, general and administrative			490,528				463,742				441,706				(5.8	)			(5.0	)
Gain on sales of assets, net			(777	)			(1,953	)			(618	)			(60.2	)			216.0
Interest income			(160	)			(160	)			(254	)			—				37.0
Income before income taxes			260,636				243,178				219,484				7.2				10.8
Provision for income taxes			93,267				91,029				81,820				(2.5	)			(11.3	)
Net income		$	167,369			$	152,149			$	137,664				10.0	%			10.5	%

General Operating Comments

2016 marked the Company’s 19th consecutive year of improved revenues and profits. Revenues for the year rose 5.9 percent to $1.573 billion compared to $1.485 billion for the prior year. Income before income taxes increased 7.2% to $260.6 million compared to $243.2 million the prior year. Net income increased 10.0% to $167.4 million, with earnings per diluted share of $0.77 compared to $152.1 million, or $0.70 per diluted share for the prior year.

All of our business lines experienced growth for the year, with residential pest control revenues up 7.3%, commercial pest control revenues up 4.4% and termite revenues up 6.3%.

The Company experienced growth in our Specialty Brands, Emerging Opportunity and Wildlife Brands all of which reported impressive growth numbers for the year. These results underscore the value that the Company is experiencing in selectively acquiring, market-leading specialty pest control, and wildlife companies.

Rollins continued to make inroads in expanding brand recognition through growing the Company’s international presence in 2016 both through expansion in Australia and entry into the United Kingdom. The Company also announced it established 23 new Orkin international franchises during the year. Twelve of these franchises are located in China, while the others are located in Brazil, Mongolia, Pakistan, Kazakhstan, Mexico, Ecuador, Bolivia, Malaysia and the Kingdom of Cambodia. All of these franchises will offer commercial and residential pest control as well as termite services where applicable. With the addition of these new franchises we have now established Orkin’s presence in 45 countries through 70 international franchises.

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The Company is pleased with the successful Orkin rollout of the customer relationship management (CRM) system (BOSS), and is benefiting from the investments made updating this system to improve the customer experience.

Strategic acquisitions remain a priority for Rollins, and as in the past, we will continue to seek out companies that are a “fit” for us in both, the pest control and wildlife areas of our business.

Results of Operations—2016 Versus 2015

Overview

The Company’s revenues increased to $1.573 billion in 2016, a 5.9% increase compared to 2015. Gross margin increased to 50.9% for 2016 from 50.4% in 2015. Sales, general and administrative expense remained flat at 31.2% of revenues in 2016 compared to 2015. The Company’s depreciation and amortization margin increased 0.2 percentage points to 3.2% in 2016 compared to 3.0% in 2015. Rollins’ net income of $167.4 million in 2016 was an increase of $15.2 million or 10.0% over $152.1 million in 2015. Net profit margin improved to 10.6% in 2016 from 10.2% in 2015. Rollins continued to expand our global brand recognition with acquisitions in the United States, Australia, and the United Kingdom as well as expanding our Orkin international franchise program in numerous countries around the globe. The Company is now in 47 countries and continues to seek new opportunities.

Revenues

Revenues for the year ended December 31, 2016 were $1.573 billion, an increase of $88.2 million or 5.9% from 2015 revenues of $1.485 billion. Growth occurred across all service lines and brands with our Canadian and Australian companies being hindered by unfavorable foreign currency exchange rates. Organic growth and pricing accounted for approximately 5.2% of our increase and our acquisitions contributed the remaining revenue growth. Commercial pest control represented approximately 40% of the Company’s revenue in 2016 and grew 4.4% due to increases in sales, increased bed bug revenue, an increase in commercial fumigations, and acquisitions. Commercial pest control was negatively impacted by foreign currency exchange as Orkin Canada and Rollins Australia are heavily commercial. Residential pest control which represented approximately 42% of the Company’s revenue, increased 7.3% driven by increased leads, the improved closure and pricing as well as increased TAEXX® homebuilder installations, bed bug revenues and acquisitions. The Company’s termite business, which represented approximately 17% of the Company’s revenue, grew 6.3% in 2016 due to acquisitions, increases in drywood fumigations and ancillary service sales, (such as moisture control and insulation).

The Company implemented its traditional price increase program in June 2016. Less than 2% of the Company’s revenue increase came from pricing actions. Approximately 80% of the Company’s pest control revenue was recurring in 2016 as well as 2015.

The Company’s foreign operations accounted for approximately 7% of total revenues for each of the years ended December 31, 2016 and 2015, respectively. Foreign currency exchange translation and increased domestic revenues have reduced the percentage in both years. The Company established new franchises in several international countries around the globe in 2016 for a total of 70 Orkin international franchises, two Canadian Critter Control franchises, and four Australian franchises operated by Murray Pest Control at December 31, 2016, compared to 48 Orkin international franchises and two Canadian Critter Control franchises at December 31, 2015.

International and domestic franchising revenue was less than 1% of the Company’s revenues for 2016. Orkin had 120 and 99 franchises (domestic and international) at December 31, 2016 and 2015, respectively. The Company had 94 Critter Control franchises and 4 Murray Pest Control franchises at December 31, 2016, down 14 from 2015. Critter Control Operations, Inc., a wholly-owned subsidiary of the Company, has begun the process of purchasing Critter Control franchises. Revenue from franchises was up 8.4% in 2016 compared to 2015.

Cost of Services Provided

For the twelve months ended December 31, 2016 cost of services provided increased $36.4 million or 4.9%, compared to the twelve months ended December 31, 2015. Gross margin for the year increased to 50.9% for 2016 compared to 50.4% for 2015 due to favorable service salary cost as we finalized the roll-out of BOSS, our CRM and operating system, improving our routing and scheduling to maximize efficiencies, lower personnel related expenses as healthcare claims were lower than expected, and insurance and claims were lower as a percentage of revenues as we continue to focus on efficiency and safety. The favorable margins were partially offset by professional fees as we used outside sources to roll-out BOSS. We experienced good cost controls across most spending categories during 2016 compared to 2015.

Depreciation and Amortization

For the twelve months ended December 31, 2016, depreciation and amortization increased $6.4 million, or 14.3% compared to the twelve months ended December 31, 2015. The dollar increase was due primarily to depreciation increasing $5.4 million as we began to depreciate our CRM software BOSS, while amortization of intangible assets increased as we acquired 34 companies in 2016.

Sales, General and Administrative

For the twelve months ended December 31, 2016, sales, general and administrative (SG&A) expenses increased $26.8 million, or 5.8% compared to the twelve months ended December 31, 2015. SG&A remained flat at 31.2% of revenues for each of the years 2016 and 2015. The Company had a one-time tax event to dissolve its subsidiary, Kinro Investment Inc. This increased SG&A expense $9.1 million or 0.6 percentage points due to the one-time tax event that was offset as a credit in income tax expense. Sales salaries increased due to the increase in sales commissions and service contracts increased as a result of maintaining the BOSS system. The increases were offset by decreases as a percentage of revenue by administrative salaries as we continue to grow revenue with a static headcount, personnel related expense margin decreased due to lower than expected healthcare claims, and decreases in insurance claims as we continue to focus on efficiency and safety, and telephone costs we negotiate contracts for Internet service.

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Gain on Sales of assets, Net

Gain on sales of assets, net decreased to $0.8 million for the year ended December 31, 2016 compared to $2.0 million gain in 2015. The Company recognized gains from the sale of owned vehicles and owned property in 2016 and 2015. The decrease was due to the Company selling two buildings in 2015.

Interest (Income)/Expense, Net

Interest income, net for each of the years ended December 31, 2016 and 2015 was $0.2 million. Interest income for each year is due to interest received on cash balances in the Company’s various cash accounts.

Taxes

The Company’s effective tax rate decreased to 35.8% in 2016 compared to 37.4% in 2015, due primarily to a one-time tax event in 2016 and differences in state and foreign income taxes.

Results of Operations—2015 Versus 2014

Overview

The Company’s gross margin increased to 50.4% for 2015 from 49.9% in 2014. Sales, general and administrative expense decreased in 2015 to 31.2% of revenue versus 31.3% in 2014. The Company’s depreciation and amortization margin decreased 0.1 point to 3.0 % in 2015 compared to 3.1% in 2014. Rollins’ net income of $152.1 million in 2015 was an increase of $14.5 million or 10.5% over $137.7 million in 2014. Net profit margin improved to 10.2% in 2015 from 9.8% in 2014.

Revenues

Revenues for the year ended December 31, 2015 were $1.485 billion, an increase of $73.7 million or 5.2% from 2014 revenues of $1.412 billion. Growth occurred across all service lines and brands with our foreign companies being hurt by unfavorable exchange rates. Organic growth and pricing accounted for approximately 4.2% of our increase and our acquisitions contributed the remaining revenue growth. Commercial pest control represented approximately 41% of the Company’s revenue in 2015 and grew 3.3% in 2015 due to increases in sales, improvements in cancellations, increased bed bug revenue, an increase in commercial fumigations, and acquisitions. Residential pest control which also represented approximately 41% of the Company’s revenue, increased 6.6% driven by increased leads, closures and pricing as well as increased TAEXX® homebuilder installations, bed bug revenues and acquisitions. The Company’s termite business, which represented approximately 17% of the Company’s revenue, grew 4.6% in 2015 due to increases in drywood fumigations and ancillary service sales, and acquisitions.

The Company implemented its traditional price increase program in June 2015. Less than 2% of the Company’s revenue increase came from pricing actions. Nearly 80% of the Company’s pest control revenue was recurring in 2015 and 2014.

The Company’s foreign operations accounted for approximately 7% and 8% of total revenues for the years ended December 31, 2015 and 2014, respectively. Currency exchange translation is the cause of the decreased percentage. The Company established new franchises in China, El Salvador, Mexico, Colombia, the Republic of Georgia, Bahrain, Qatar, Hong Kong, Macau, and South Korea in 2015 for a total of 48 international franchises at December 31, 2015 with 37 at December 31, 2014. Orkin had 99 and 92 franchises (domestic and international) at December 31, 2015 and 2014, respectively.

Cost of Services Provided

For the twelve months ended December 31, 2015 cost of services provided increased $28.2 million or 4.0%, compared to the twelve months ended December 31, 2014. Gross margin for the year increased to 50.4% for 2015 compared to 49.9% for 2014 due to reduced fleet costs due to the drop in gasoline prices, favorable service salaries as we continue to improve our routing and scheduling to maximize efficiencies and favorable administrative salary margins as we continue to focus on efficiency. The favorable margins were partially offset by our casualty claim development, increases in supplies as a result of increased sales and increases in personnel related costs as group premiums continue to increase. We experienced good cost controls across most spending categories.

Depreciation and Amortization

For the twelve months ended December 31, 2015, depreciation and amortization increased $1.0 million, or 2.3% compared to the twelve months ended December 31, 2014. The dollar increase was due primarily to depreciation increasing $2.7 million as we depreciate our customer relationship management software “BOSS”, while amortization of intangible assets decreased as we fully amortized several intangible assets during the 12 month period.

Sales, General and Administrative

For the twelve months ended December 31, 2015, sales, general and administrative (SG&A) expenses increased $22.0 million, or 5.0% compared to the twelve months ended December 31, 2014. SG&A decreased to 31.2% of revenues compared to 31.3% of revenues in the prior year. As a percentage of revenues, SG&A decreased due to the Company’s leveraging our SG&A expenses against higher revenues, reducing our bad debt expense with our collections efforts and experiencing lower gasoline costs, partially offset by higher sales salaries.

Gain on Sales of assets, Net

Gain on sales of assets, net increased to $2.0 million for the year ended December 31, 2015 compared to $0.6 million gain in 2014. The Company recognized gains from the sale of owned vehicles and property in 2015 and 2014. The increase was due to the Company selling two buildings in 2015.

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Interest (Income)/Expense, Net

Interest income, net for the year ended December 31, 2015 was $0.2 million, a decrease of $0.1 million compared to $0.3 million in 2014. Interest income for the year is due to interest received on cash balances in the Company’s various cash accounts.

Taxes

The Company’s effective tax rate increased to 37.4% in 2015 compared to 37.3% in 2014, due primarily to differences in state and foreign income taxes.

Liquidity and Capital Resources

Cash and Cash Flow

Cash from operating activities is the principal source of cash generation for our businesses.

The most significant source of cash in Rollins’ cash flow from operations is customer-related activities, the largest of which is collecting cash resulting from services sales. The most significant operating use of cash is to pay our suppliers, employees, tax authorities and others for a wide range of material and services.

The Company’s cash and cash equivalents at December 31, 2016, 2015, and 2014 were $142.8 million, $134.6 million, and $108.4 million, respectively.

		2016				2015				2014
Net cash provided by operating activities		$	226,525			$	196,356			$	194,146
Net cash used in investing activities			(76,842	)			(69,942	)			(89,471	)
Net cash used in financing activities			(136,371	)			(97,216	)			(106,519	)
Effect of exchange rate changes on cash			(5,101	)			(2,996	)			(8,000	)
Net increase (decrease) in cash and cash equivalents		$	8,211			$	26,202			$	(9,844	)

Cash Provided by Operating Activities

The Company’s operations generated cash of $226.5 million for the year ended December 31, 2016 primarily from net income of $167.4 million, compared with cash provided by operating activities of $196.4 million in 2015 and $194.1 million in 2014. The Company believes its current cash and cash equivalents balances, future cash flows expected to be generated from operating activities and available borrowings under its $175.0 million credit facility will be sufficient to finance its current operations and obligations, and fund expansion of the business for the foreseeable future.

The Company made contributions totaling $3.3 million to the Rollins, Inc. and its wholly-owned subsidiaries’ defined benefit retirement plans (the “Plans”) during the year ended December 31, 2016 and $5.0 million and $5.3 million during the years ended December 31, 2015 and 2014, respectively, as a result of the Plans’ funding status. The Company is considering making contributions to its Plans of approximately $5.5 million during fiscal year 2017. 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.

Cash Used in Investing Activities

The Company used $76.8 million on investing activities for the year ended December 31, 2016 compared to $69.9 million and $89.5 million during 2015 and 2014, respectively, and of that, invested approximately $33.1 million in capital expenditures during 2016 compared to $39.5 million and $28.7 million during 2015 and 2014, respectively. Capital expenditures for the year consisted primarily of property purchases, equipment replacements and technology related projects. The Company expects to invest between $25.0 million and $28.0 million in 2017 in capital expenditures. During 2016, the Company’s subsidiaries acquired several small companies totaling $46.3 million compared to $33.5 million in acquisitions during 2015 and $63.3 million in 2014. The expenditures for the Company’s acquisitions were funded with cash on hand. The Company continues to seek new acquisitions.

Cash Used in Financing Activities

The Company used cash of $136.4 million on financing activities for the year ended December 31, 2016, compared to $97.2 million and $106.5 million during 2015 and 2014, respectively. A total of $109.0 million was paid in cash dividends ($0.50 per share) during the year ended December 31, 2016 including a special dividend paid in December 2016 of $0.10 per share, compared to $91.8 million paid in cash dividends ($0.42 per share) during the year ended December 31, 2015, including a special dividend paid in December 2015 of $0.10 per share and $75.8 million ($0.35 per share) during the year ended December 31, 2014, including a special dividend paid in December 2014 of $0.07 per share.

The Company used $22.7 million to repurchase on the open market 0.8 million shares of its common stock at a weighted average price of $27.19 per share during 2016 compared to $0.4 million to purchase 19 thousand shares at an weighted average price of $22.42 in 2015 and $29.3 million to purchase 1.5 million shares at a weighted average price of $19.46 in 2014. There remain 5.1 million shares authorized to be repurchased under prior Board approval. In addition to the shares purchased on the open market, the Company repurchased $8.4 million, $7.0 million and $6.2 million of common stock for the years ended December 31, 2016, 2015 and 2014, respectively, from employees for the payment of taxes on vesting restricted shares.

The Company’s $142.8 million of total cash at December 31, 2016, is primarily cash held at various banking institutions. Approximately $54.4 million is held in cash accounts at international bank institutions and the remaining $88.4 million is primarily held in Federal Deposit Insurance Corporation (“FDIC”) insured non-interest-bearing accounts at various domestic banks which at times may exceed federally insured amounts.

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The Company’s international business is expanding and we intend to continue to grow the business in foreign markets in the future through reinvestment of foreign deposits and future earnings as well as acquisitions of unrelated companies. Repatriation of cash from the Company’s foreign subsidiaries is not a part of the Company’s current business plan.

The Company maintains a large cash position in the United States while having no third-party debt to service. Rollins maintains adequate liquidity and capital resources, without regard to its foreign deposits, that are directed to finance domestic operations and obligations and to fund expansion of its domestic business.

On October 31, 2012, the Company entered into a Revolving Credit Agreement with SunTrust Bank and Bank of America, N.A. for an unsecured line of credit of up to $175.0 million, which includes a $75.0 million letter of credit subfacility, and a $25.0 million swingline subfacility. The Credit Agreement was amended on October 30, 2014 to extend the maturity date to October 31, 2018 and add three optional one year extensions. On October 27, 2015 the Company exercised a one year extension option to extend the maturity date to October 31, 2019. As of December 31, 2016, no borrowings were outstanding under the line of credit or under the swingline subfacility. The Company maintains approximately $35.0 million in letters of credit. These letters of credit are required by the Company’s fronting insurance companies and/or certain states, due to the Company’s self-insured status, to secure various workers’ compensation and casualty insurance contracts coverage. The Company believes that it has adequate liquid assets, funding sources and insurance accruals to accommodate such claims.

The Revolving Credit Agreement is guaranteed by certain of Rollins’ domestic-subsidiaries. The maturity date of the Credit Agreement is October 31, 2019, subject to up to two optional extensions of the Credit Agreement for one year each. Revolving loans under the Revolving Credit Agreement bear interest at one of the following two rates, at the Company’s election:

	·	the Base Rate, which shall mean the highest of (i) the per annum rate which the Administrative Agent publicly announces from time to time as its prime lending rate, (ii) the Federal Funds rate, plus 0.50% per annum, and (iii) the Adjusted LIBOR Rate (which equals LIBOR as increased to account for the maximum reserve percentages established by the U.S. Federal Reserve) determined on a daily basis for an interest period of one (1) month, plus 1.0% per annum.

	·	with respect to any Eurodollar borrowings, the Adjusted LIBOR Rate plus an additional amount, which varies between .75% and 1.00%, based upon Rollins’ then-current debt-to-EBITDA ratio. As of December 31, 2015, the additional rate allocated was .75%.

The Revolving Credit Agreement contains customary terms and conditions, including, without limitation, certain financial covenants including covenants restricting the Company’s ability to incur certain indebtedness or liens, or to merge or consolidate with or sell substantially all of its assets to another entity. Further, the Revolving Credit Agreement contains financial covenants restricting the Company’s ability to permit the ratio of the Company’s consolidated debt to EBITDA to exceed certain limits.

The Company remained in compliance with applicable debt covenants at December 31, 2016 and expects to maintain compliance throughout 2017.

Litigation

For discussion on the Company’s legal contingencies, see note 13 to the accompanying financial statements.

Off Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments

Other than the operating leases disclosed in the table that follows, the Company has no material off balance sheet arrangements.

The impact that the Company’s contractual obligations as of December 31, 2016 are expected to have on our liquidity and cash flow in future periods is as follows:

		Payments due by period
Contractual obligations (in thousands)		Total				Less than 1 year				1 - 3 years				4 - 5 years				More than 5 years
Business combination related liabilities		$	10,484			$	8,520			$	1,959			$	5			$	—
Non-cancelable operating leases			124,076				31,595				39,148				26,182				27,151
Unrecognized Tax Positions (1)			3,095				3,095				—				—				—
Total (2)		$	137,655			$	43,210			$	41,107			$	26,187			$	27,151

	(1)	These amounts represent expected payments with interest for unrecognized tax benefits as of December 31, 2016.

	(2)	Minimum pension funding requirements are not included as funding will not be required. The company is considering making contributions to its pension plans of approximately $5.5 million during 2017.

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Critical Accounting Policies

The Company views 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 claims representing the estimated costs of reapplications, repairs and associated labor and chemicals, settlements, awards and other costs relative to termite control services. Factors that may impact future cost include termiticide 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 precisely predict future significant claims. Accruals for termite contracts are included in other current liabilities and long-term accrued liabilities on the Company’s consolidated statements of financial position.

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 a semi-annual basis to provide the Company an estimated liability based upon historical claims information. The actuarial study is a major consideration in establishing the reserve, along with management’s knowledge of changes in business practice and existing claims compared to current balances. 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. The Company continues to be proactive in risk management to develop and maintain ongoing programs to reduce claims. Initiatives that have been implemented include pre-employment screening and an annual motor vehicle report required on all its drivers, post-offer physicals for new employees, pre-hire, random and post-accident drug testing, increased driver training and a post-injury nurse triage program for employees.

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, bi-monthly or quarterly 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 installation of the monitoring stations, initial directed liquid termiticide treatment and servicing of the monitoring stations. A portion of the contract amount is deferred for the undelivered monitoring element. This portion is 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. The allocation of the purchase price to the two deliverables is based on the relative selling price. There are no contingencies related to the delivery of additional items or meeting other specified performance conditions. 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.

Revenue received for conventional termite renewals is deferred and recognized on a straight-line basis over the remaining contract term; and, the cost of reinspections, reapplications and repairs and associated labor and chemicals are expensed as incurred. For outstanding claims, an estimate is made of the costs to be incurred (including legal costs) based upon current factors and historical information. The performance of reinspections tends to be close to the contract renewal date and while reapplications and repairs involve an insubstantial number of the contracts, these costs are incurred over the contract term. As the revenue is being deferred, the future cost of reinspections, reapplications and repairs and associated labor and chemicals applicable to the deferred revenue are expensed as incurred. The Company accrues for noticed claims. The costs of providing termite services upon renewal are compared to the expected revenue to be received and a provision is made for any expected losses.

All revenues are reported net of sales taxes.

Contingency Accruals—The Company is a party to legal proceedings with respect to matters in the ordinary course of business. In accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 450 “Contingencies,” Management estimates and accrues for its liability and costs associated with the litigation. Estimates and accruals are determined in consultation with outside counsel. Because it is not possible to accurately predict the ultimate result of the litigation, judgments concerning accruals for liabilities and costs associated with litigation are inherently uncertain and actual liabilities may vary from amounts estimated or accrued. 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. Contingency accruals are included in other current liabilities and long-term accrued liabilities on the Company’s consolidated statements of financial position.

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Defined benefit pension plans — In 2005, the Company ceased all future benefit accruals under the Rollins, Inc. defined benefit plan, although the Company remains obligated to provide employees benefits earned through June 2005. The Company also includes the Waltham Services, LLC Hourly Employee Pension Plan to the Company’s financial statements. The Company accounts for these defined benefit plans in accordance with the FASB ASC Topic 715 “Compensation- Retirement Benefits”, and engages an outside actuary to calculate its obligations and costs. With the assistance of the actuary, the Company evaluates the significant assumptions used on a periodic basis including the estimated future return on plan assets, the discount rate, and other factors, and makes adjustments to these liabilities as necessary.

The Company chooses an expected rate of return on plan assets based on historical results for similar allocations among asset classes, the investments strategy, and the views of our investment adviser. Differences between the expected long-term return on plan assets and the actual return are amortized over future years. Therefore, the net deferral of past asset gains or losses ultimately affects future pension expense. The Company’s assumption for the expected return on plan assets is 7.0% which is unchanged from the prior year.

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, the Company utilizes a yield curve approach. The approach utilizes an economic model whereby the Company’s expected benefit payments over the life of the plans is forecast and then compared to a portfolio of corporate bonds that will mature at the same time that the benefit payments are due in any given year. The economic model then calculates the one discount rate to apply to all benefit payments over the life of the plan which will result in the same total lump sum as the payments from the corporate bonds. The discount rate was 4.45% as of December 31, 2016 compared to 4.7% in 2015 and 4.15% in 2014. A lower discount rate increases the present value of benefit obligation.

As set forth in note 14 to the Company’s financial statements, included among the asset categories for the Plan’s investments are real estate, tactical composite and alternative investments comprised of investments in 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 Accounting Standards Update (“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_._

As of December 31, 2016, the defined benefit plans were under-funded and the recorded change within accumulated other comprehensive income increased stockholders’ equity by $3.0 million before tax and $1.7 million after tax.

New Accounting Standards

Recently adopted accounting standards

In May 2015, the FASB issued Accounting Standards Update (“ASU”) 2015-07, Fair Value Measurement (Topic 820): Disclosures for Investments in Certain Entities That Calculate Net Asset Value per Share (or Its Equivalent) (“ASU 2015-07”). Under the guidance, investments measured at NAV, as a practical expedient for fair value, are excluded from the fair value hierarchy. Removing investments measured using the practical expedient from the fair value hierarchy is intended to eliminate the diversity in practice that currently exists with respect to the categorization of these investments. The new guidance is effective in 2017, however early adoption is permitted. We have elected to early adopt ASU 2015-07 retrospectively for the investments eligible for the NAV practical expedient.

In November 2015, the FASB issued ASU No. (ASU) 2015-17, Balance Sheet Classification of Deferred Taxes, which requires that deferred tax liabilities and assets be classified as noncurrent in a classified statement of financial position. The amendments in this update apply to all entities that present a classified statement of financial position. The current requirement that deferred tax liabilities and assets of a tax-paying component of an entity be offset and presented as a single amount is not affected by the amendments in this update. The amendments in this update are effective for the Company’s financial statements issued for annual periods beginning after December 15, 2017, and interim periods within annual periods beginning after December 15, 2018. Earlier application is permitted for all entities as of the beginning of an interim or annual reporting period. The amendments in this update may be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. We have elected to early adopt ASU 2015-17 retrospectively in the first quarter of 2016. As a result, we have presented all deferred tax assets and liabilities as noncurrent on our consolidated balance sheets, and have reclassified current deferred tax assets and liabilities on our consolidated balance sheet as of December 31, 2015. There was no net impact on our results of operations as a result of the adoption of ASU 2015-17.

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Recently issued accounting standards to be adopted in 2017 or later

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which requires an entity to recognize the amount of revenue to which it expects to be entitled for the transfer of promised goods or services to customers. The ASU will replace most existing revenue recognition guidance in GAAP when it becomes effective. In July 2015, the FASB approved a one-year deferral of this standard, with a revised effective date for fiscal years beginning after December 15, 2017. Early adoption is permitted, although not prior to fiscal years beginning after December 15, 2016. The standard permits either of the following transition methods: (i) a full retrospective approach reflecting the application of the standard in each prior reporting period with the option to elect certain practical expedients, or (ii) a retrospective approach with the cumulative effect of initially adopting ASU 2014 – 09 recognized at the date of adoption (which includes additional footnote disclosures). The new standard is effective for the Company in its fiscal year 2018 and permits the use of either the retrospective or a cumulative effect transition method. The Company is evaluating the new standard on its consolidated financial statements and related disclosures. The Company anticipates using the modified retrospective approach and intends to engage a consultant to assist the Company with implementation of this standard.

In August 2015, the FASB issued ASU No. 2015-14 (Topic 606): Revenue from Contracts with Customers. ASU 2015-14 defers the effective date of Update 2014-09 for all entities by one year. Public business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in Update 2014-09 to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Earlier application is permitted only as of annual reporting periods beginning after December 15, 2016, including interim reporting periods within that reporting period. All other entities should apply the guidance in Update 2014-09 to annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019. All other entities may apply the guidance in Update 2014-09 earlier as of an annual reporting period beginning after December 15, 2016, including interim reporting periods within that reporting period. All other entities also may apply the guidance in Update 2014-09 earlier as of an annual reporting period beginning after December 15, 2016, and 2 interim reporting periods within annual reporting periods beginning one year after the annual reporting period in which the entity first applies the guidance in Update 2014-09. The new standard is effective for the Company in its fiscal year 2018 and permits the use of either the retrospective or a cumulative effect transition method. The Company is evaluating the new standard on its consolidated financial statements and related disclosures. The Company anticipates using the modified retrospective approach and intends to engage a consultant to assist the Company with implementation of this standard.

In February 2016, the FASB issued ASU No. 2016-02, Leases, which require lessees to recognize assets and liabilities on the balance sheet for the rights and obligations created by all leases with terms of more than 12 months. The ASU also will require disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. These disclosures include qualitative and quantitative information. The amendments in this update are effective for the Company’s financial statements issued for annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after December 15, 2018. Earlier application is permitted as of the beginning of an interim or annual reporting period. The Company is currently evaluating the impact of this standard on its consolidated financial statements.

In March 2016, the FASB issued ASU No. 2016-09, Improvements to Employee Share-Based Payment Accounting, which involve several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, and classification on the statement of cash flows. Some of the areas for simplification apply only to nonpublic entities. The amendments in this update are effective for the Company’s financial statements issued for annual periods beginning after December 15, 2016, and interim periods within annual periods. Earlier adoption is permitted for any entity in any interim or annual reporting period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. An entity that elects early adoption must adopt all of the amendments in the same period. The Company is currently evaluating the impact of this standard on its consolidated financial statements.

In August 2016, the FASB issued ASU No. 2016-15, Statement of Cash Flow Classification of Certain Cash Receipts and Cash Payments, which addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The amendments in this update are effective for the Company’s financial statements issued for annual periods beginning after December 15, 2017, and interim periods within annual periods. Earlier adoption is permitted for any entity in any interim or annual reporting period. The Company is currently evaluating the impact of this standard on its consolidated financial statements.

In January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which requires an entity to evaluate if substantially all of the fair value of the gross assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets; if so, the set of transferred assets and activities is not a business. The guidance also requires a business to include at least one substantive process and narrows the definition of outputs by more closely aligning it with how outputs are described in ASC 606. The amendments in the update are effective for the Company’s financial statements issued for fiscal years beginning after December 15, 2017, and interim periods within those years. Early adoption is permitted. We do not expect this standard to have a material impact on the Company’s reported results of operations or financial position.

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In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which eliminates the requirement to calculate the implied fair value of goodwill (i.e., Step 2 of today’s goodwill impairment test) to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value (i.e., measure the charge based on today’s Step 1). The standard in this update is effective for the Company’s financial statements issued for fiscal years beginning in 2020. Early adoption is permitted for annual and interim goodwill impairment testing dates after January 1, 2017. We do not expect this standard to have a material impact on the Company’s reported results of operations or financial position.

Forward-Looking Statements

This Annual Report contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements include statements regarding management’s belief that the Company maintains sufficient supplies to fulfill its immediate needs and to alleviate potential short-term shortages in such supplies; environmental remediation costs estimated to be incurred are not material to the Company’s financial condition or operating results; management’s belief in the adequacy of the Company’s facilities to meet its future needs; the outcome of litigation, as discussed in the Legal Proceedings section and elsewhere, and the Company’s belief that such litigation will not have a material adverse effect on the Company’s financial condition, results of operations or liquidity; the Company’s expectation to continue its payment of cash dividends; plans regarding acquisitions; the adequacy of the Company’s resources and borrowings to fund operations, obligations, and expansions; management’s belief that any additional pension plan contributions will not have a material effect on the Company’s financial position, results of operation or liquidity; the Company’s projected 2017 capital expenditures; the plans to grow the business in foreign markets through reinvestment of foreign deposits and future earnings and through acquisitions of unrelated companies; the Company’s expectation to maintain compliance with the covenants contained in its Revolving Credit Agreement throughout 2017; the impact and amount of the Company’s contractual obligations; management’s expectations regarding termite claims and factors that impact future costs from those claims; the expected cost of termite renewals; the expected collectability of accounts receivable; expected tax consequences; expectations and plans regarding any losses from franchisees; the impact of recent accounting pronouncements; and interest rate risks and foreign exchange currency risk on the Company’s financial position, results of operations and liquidity. The actual results of the Company could differ materially from those indicated by the forward-looking statements because of various risks, timing and uncertainties including, without limitation, the possibility of an adverse ruling against the Company in pending litigation; general economic conditions; market risk; changes in industry practices or technologies; the degree of success of the Company’s termite process reforms and pest control selling and treatment methods; the Company’s ability to identify potential acquisitions; climate and weather trends; competitive factors and pricing practices; potential increases in labor costs; and changes in various government laws and regulations, including environmental regulations. All of the foregoing risks and uncertainties are beyond the ability of the Company to control, and in many cases the Company cannot predict the risks and uncertainties that could cause its actual results to differ materially from those indicated by the forward-looking statements.