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

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 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 compared to prior year
	(in thousands)
Years ended December 31,	2017				2016				2015				2017			2016
Revenues	$	1,673,957			$	1,573,477			$	1,485,305			6.4	%		5.9	%
Cost of services provided	819,943				772,348				735,976				(6.2	)		(4.9	)
Depreciation and amortization	56,580				50,902				44,522				(11.2	)		(14.3	)
Sales, general and administrative	503,433				490,528				463,742				(2.6	)		(5.8	)
Gain on sales of assets, net	(242		)		(777		)		(1,953		)		(68.9	)		(60.2	)
Interest income	(259		)		(160		)		(160		)		61.9			—
Income before income taxes	294,502				260,636				243,178				13.0			7.2
Provision for income taxes	115,378				93,267				91,029				(23.7	)		(2.5	)
Net income	$	179,124			$	167,369			$	152,149			7.0	%		10.0	%

General Operating Comments

2017 marked the Company’s 20th consecutive year of improved revenues and profits. Revenues for the year rose 6.4 percent to $1.674 billion compared to $1.573 billion for the prior year. Income before income taxes increased 13.0% to $294.5 million compared to $260.6 million the prior year. Net income increased 7.0% to $179.1 million, with earnings per diluted share of $0.82 compared to $167.4 million, or $0.77 per diluted share for the prior year.

The Company’s 2017 net income was negatively affected by the 2017 Tax Cuts and Jobs Act (“TCJA”) which was signed in to law on December 22, 2017. The estimated negative impact of the enactment of the TCJA was an $11.6 million increase to tax expense, which was a direct decrease to net income. The $11.6 million increase in tax was as follows: $8.0 million from transition tax on foreign earnings, $2.9 million from the revaluation of deferred tax assets, and $0.7 million from reductions in tax benefits on stock compensation. This resulted in a $0.05 per diluted share decrease in net income for the year.

Net income excluding the effect of the TCJA increased 13.9% to $190.7 million or $0.87 per share. Net income and diluted earnings per share excluding the effect of the TCJA are non-GAAP financial measures. Management believes these measures help investors understand the effect of these on reported results.

All of the Company’s business lines experienced growth for the year, with residential pest control revenues up 6.4%, commercial pest control revenues up 5.1% and termite and ancillary services revenues up 9.7%.

During the year, the Company increased its presence around the world with the addition of 11 new Orkin international franchises. HomeTeam Pest Defense announced that they had reached one million TAEXX® installations. We acquired Northwest Exterminating based in Marietta, GA which contributed in the growth of the Company's revenues the last five months. Strategic acquisitions remain a priority for Rollins. The Company also continued to improve our routing and scheduling capabilities as we utilize our Customer Service Manager (“CSM”) BOSS and its Virtual Route Management feature. BOSS has been fully implemented in the Orkin’s U.S. operations.

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—2017 Versus 2016

Overview

The Company’s revenues increased to $1.674 billion in 2017, a 6.4% increase compared to 2016. Gross margin increased to 51.0% for 2017 from 50.9% in 2016. Sales, general and administrative expense were 30.1% of revenues in 2017 compared to 31.2% in 2016. The Company’s depreciation and amortization margin increased 0.2 percentage points to 3.4% in 2017 compared to 3.2% in 2016. Rollins’ net income of $179.1 million in 2017 was an increase of $11.7 million or 7.0% over $167.4 million in 2016. Net profit margin improved to 10.7% in 2017 from 10.6% in 2016. Rollins continued to expand our global brand recognition with acquisitions in the United States and Canada as well as expanding our Orkin international franchise program in numerous countries around the globe. The Company is now in 53 countries and continues to seek new international opportunities.

Revenues

Revenues for the year ended December 31, 2017 were $1.674 billion, an increase of $100.5 million or 6.4% from 2016 revenues of $1.573 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 4.5% of our increase and our acquisitions contributed the remaining revenue growth. Commercial pest control represented approximately 40% of the Company’s revenue in 2017 and grew 5.1% due to increases in sales, an emphasis on closing leads, increased bed bug revenue, 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 6.4% driven by an increase in lead closure, pricing, as well as increased TAEXX® homebuilder installations, and acquisitions. The Company’s termite business, which represented approximately 18% of the Company’s revenue, grew 9.7% in 2017 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 2017. Less than 2% of the Company’s revenue increase is attributable to pricing actions. Approximately 80% of the Company’s pest control revenue was recurring in 2017 as well as 2016.

The Company’s foreign operations accounted for approximately 8% and 7% of total revenues for the years ended December 31, 2017 and 2016, respectively. The Company established new franchises in several international countries around the globe in 2017 for a total of 81 Orkin international franchises, two Canadian Critter Control franchises, and eleven Australian franchises operated by Murray Pest Control and Scientific Pest Management at December 31, 2017, compared to 70 Orkin international franchises, two Canadian Critter Control franchises and seven Australian Franchises at December 31, 2016.

International and domestic franchising revenue was less than 1% of the Company’s revenues for 2017. Orkin had 128 and 120 franchises (domestic and international) at December 31, 2017 and 2016, respectively. The Company had 89 Critter Control franchises at December 31, 2017, down 5 from 2016. Critter Control Operations, Inc., a wholly-owned subsidiary of the Company, has begun the process of purchasing Critter Control franchises. Revenue from franchises was down 2.9% in 2017 compared to 2016 as we acquire franchises from Critter Control.

Cost of Services Provided

For the twelve months ended December 31, 2017 cost of services provided increased $47.6 million or 6.2%, compared to the twelve months ended December 31, 2016. Gross margin for the year increased to 51.0% for 2017 compared to 50.9% for 2016 due to favorable service salary cost as we utilize BOSS, our CRM and operating system and VRM to improve our customer routing and scheduling to maximize efficiencies. We had lower administrative salaries as we maximize our efficiencies and lower insurance and claims as we saw reductions in our actuarial calculations on future losses and lower vehicle loss expenses. The favorable margins were partially offset by higher fleet costs as gasoline prices rose and leased vehicle costs as we replace our fleet and materials and supplies as we increase termite treatments. We experienced good cost controls across most spending categories during 2017 compared to 2016.

Depreciation and Amortization

For the twelve months ended December 31, 2017, depreciation and amortization increased $5.7 million, or 11.2% compared to the twelve months ended December 31, 2016. The dollar increase was primarily due to depreciation increasing $2.7 million or 10.7% as we continue to depreciate our CRM software BOSS, while amortization of intangible assets increased $3.0 million or 11.5% for 2017 due to the additional amortization of customer contracts of Northwest Exterminating, as well as several other acquisitions over the last year.

Sales, General and Administrative

For the twelve months ended December 31, 2017, sales, general and administrative (SG&A) expenses increased $12.9 million, or 2.6% compared to the twelve months ended December 31, 2016. SG&A decreased to 30.1% of revenues for the year ended December 31, 2017 compared to 31.2% in 2016. The Company had a one-time tax event to dissolve its subsidiary, Kinro Investment Inc. in 2016. 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. Administrative salaries were relatively flat to prior year as we reduced the number of temporary personnel working on the BOSS system. Personnel related costs were marginally lower as we experienced leveling of our premiums. Gains in these areas were partially offset by higher sales salaries, fleet expense, and contractor expenses for various projects as well as the aforementioned 2016 foreign tax withholding expense.

Gain on Sales of assets, Net

Gain on sales of assets, net decreased to $0.2 million for the year ended December 31, 2017 compared to $0.8 million in 2016. The Company recognized gains from the sale of owned vehicles and owned property in 2017 and 2016.

Interest Income, Net

Interest income, net for each of the years ended December 31, 2017 and 2016 was $0.3 million and $0.2 million, respectively. 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 increased to 39.2% in 2017 compared to 35.8% in 2016, due primarily to the effects of the TCJA in 2017, a one-time tax event in 2016 and differences in state and foreign income taxes. The estimated impact of the enactment of the TCJA was an $11.6 million increase to tax expense, which was a direct decrease to net income. The $11.6 million increase in tax was as follows: ($8.0 million from transition tax on foreign earnings, $2.9 million from the revaluation of deferred tax assets, and $0.7 million from reductions in tax benefits on stock compensation). The increase due to the TCJA was partially offset by a reduction related to the implementation of ASU 2016-09 that was a $4.0 million benefit. Management believes that the Corporate tax rate in 2018 will be in the mid 20% range with a lower rate in the first quarter 2018 adjusted throughout the year to the mid 20% range for the year.

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 countries around the globe in 2016 for a total of 70 Orkin international franchises, two Canadian Critter Control franchises, and seven Australian franchises operated by Murray Pest Control and Scientific Pest Management 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 as we negotiate contracts for Internet service.

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.

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, 2017, 2016, and 2015 were $107.1 million, $142.8 million, and $134.6 million, respectively.

	2017				2016				2015
Net cash provided by operating activities	$	235,370			$	226,525			$	196,356
Net cash used in investing activities	(154,175		)		(76,842		)		(69,942		)
Net cash used in financing activities	(130,263		)		(136,371		)		(97,216		)
Effect of exchange rate changes on cash	13,333				(5,101		)		(2,996		)
Net increase (decrease) in cash and cash equivalents	$	(35,735	)		$	8,211			$	26,202

Cash Provided by Operating Activities

The Company’s operations generated cash of $235.4 million for the year ended December 31, 2017 primarily from net income of $179.1 million, compared with cash provided by operating activities of $226.5 million in 2016 and $196.4 million in 2015. 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’s made no contributions to the Rollins, Inc. and its wholly-owned subsidiaries’ defined benefit retirement plans (the “Plans”) during the year ended December 31, 2017. The Plans were fully-funded with a prepaid balance. We contributed $3.3 million and $5.0 million during the years ended December 31, 2016 and 2015, respectively, as a result of the Plans’ funding status. The Company’s management is not expecting to make a contribution during fiscal year 2018. In the opinion of management, additional Plan contributions, if any, 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 $154.2 million on investing activities for the year ended December 31, 2017 compared to $76.8 million and $69.9 million during 2016 and 2015, respectively, and of that, invested approximately $24.7 million in capital expenditures during 2017 compared to $33.1 million and $39.5 million during 2016 and 2015, 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 2018 in capital expenditures. During 2017, the Company’s and its subsidiaries acquired Northwest Exterminating as well as several small companies for a total of $130.2 million compared to $46.3 million and $33.5 million in acquisitions during 2016 and 2015, respectively. 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 $130.3 million on financing activities for the year ended December 31, 2017, compared to $136.4 million and $97.2 million during 2016 and 2015, respectively. A total of $122.0 million was paid in cash dividends ($0.56 per share) during the year ended December 31, 2017 including a special dividend paid in December 2017 of $0.10 per share, compared to $109.0 million in cash dividends paid ($0.50 per share) during the year ended December 31, 2016, including a special dividend paid in December 2016 of $0.10 per share and $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.

The Company did not purchase shares on the open market during the year ended December 31, 2017 while using $8.2 million to repurchase 0.8 million shares of its common stock at a weighted average price of $27.19 per share during 2016 and $0.4 million to purchase 19 thousand shares at an weighted average price of $22.42 in 2015. There remain 5.1 million shares authorized to be repurchased under prior Board approval. The Company repurchased $8.2 million, $8.4 million, and $7.0 million of common stock for the years ended December 31, 2017, 2016 and 2015, respectively, from employees for the payment of taxes on vesting restricted shares.

The Company’s $107.1 million of total cash at December 31, 2017, is primarily cash held at various banking institutions. Approximately $57.8 million is held in cash accounts at international bank institutions and the remaining $49.3 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.

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.

For Information regarding our Revolving Credit Agreement see Note 3 - Debt of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K).

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, 2017 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	$	29,389			$	18,661			$	10,728			$	—			$	—
Non-cancelable operating leases	143,539				34,112				24,890				38,713				45,824
Unrecognized Tax Positions (1)	4,084				4,084				—				—				—
Total (2)	$	177,012			$	56,857			$	35,618			$	38,713			$	45,824

(1)	These amounts represent expected payments with interest for unrecognized tax benefits as of December 31, 2017.

(2)	Minimum pension funding requirements are not included as funding will not be required.

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 retains, 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 retained loss 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 with 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.

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 4.0% as of December 31, 2017 compared to 4.45% in 2016 and 4.7% in 2015. 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, 2017, the defined benefit plans were fully-funded and the recorded change within accumulated other comprehensive income increased stockholders’ equity by $19.0 million before tax and $14.2 million after tax.

Recent Accounting Guidance

See Note 1 - Summary of Significant Accounting policies of the Notes to Financial Statements (Part II, Item 8 of this Form 10-K) for further discussion.

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 (i) management's belief that the Company competes favorably with competitors, (ii) the expectation for the Company's corporate tax rate for 2018; (iii) the Company's maintenance of sufficient supplies to fulfill its immediate needs and to alleviate potential short-term shortages in such supplies, (iv) any environmental remediation costs estimated to be incurred are not material to the Company's financial condition or operating results, (v) the adequacy of the Company's facilities to meet its future needs; (vi) 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; (vii) the belief that the Company has adequate liquid assets, funding sources and accruals to satisfy any claims; (viii) the Company's expectation to continue its payment of cash dividends; (ix) plans regarding acquisitions and franchise expansion; (x) the adequacy of the Company's resources and borrowings to fund operations, obligations, and expansions; (xi) management's belief that the Company is not expected to make a contribution to the Plans in 2018; (xii) the Company's projected 2018 capital expenditures; (xiii) the plans to grow the business in foreign markets through reinvestment of foreign deposits and future earnings and through acquisitions of unrelated companies; (xiv) the Company's expectation to maintain compliance with the covenants contained in its Revolving Credit Agreement throughout 2018; (xv) the impact and amount of the Company's contractual obligations; (xvi) management's expectations regarding termite claims and factors that impact future costs from those claims; (xvii) the expected cost of termite renewals; (xviii) the expected collectability of accounts receivable; (xix) the expected tax consequences and the impact of the TCJA; (xx) expectations and plans regarding any losses from franchisees; (xxi) the impact of recent accounting pronouncements; (xxii) and interest rate risks and foreign exchange currency risk on the Company's financial position, results of operations and liquidity and (xxiii) the ability of the Company to utilize all of its foreign net operating losses and the possibility that the Company's unrecognized tax benefits will increase in the next 12 months. 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.