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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

For the fiscal year ended December 31, 2015

or

For the transition period from                      to                     

Commission File Number: 001-36643

 

AAC HOLDINGS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

200 Powell Place

Brentwood, Tennessee 37027

(Address, including zip code, of registrant’s principal executive offices)

(615) 732-1231

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Securities registered pursuant to Section 12(g) of the Act: None

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No   x

As of June 30, 2015, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the registrant’s common stock held by non-affiliates of the registrant (based on the closing price of $43.56 on that date), was approximately $235,100,000.  Common stock held by each officer and director and by each person known to the registrant who owned 5% or more of the outstanding common stock has been excluded in that such persons may be deemed affiliates.   This determination of affiliate status is not necessarily a conclusive determination for other purposes.

As of March 1, 2016, there were 22,985,364 shares of the registrant’s common stock outstanding.   

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive proxy materials for its 2016 Annual Meeting of Stockholders are incorporated by reference into Part III hereof.  

 

 

 

 

 

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AAC HOLDINGS, INC.

ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

 

 

 

 

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PART I

Unless we indicate otherwise or the context requires, “we,” “our,” “us” and the “company” refer, prior to the Reorganization Transactions discussed below, to American Addiction Centers, Inc. and, after the Reorganization Transactions, to AAC Holdings, Inc., in each case together with their consolidated subsidiaries, respectively. The term “Holdings” refers to AAC Holdings, Inc. and the term “AAC” refers to American Addiction Centers, Inc.

 

 

Item 1. Business.

 

Company Overview

We believe we are a leading provider of inpatient substance abuse treatment services for individuals with drug and alcohol addiction. As of December 31, 2015, we operated nine residential substance abuse treatment facilities located throughout the United States, focused on delivering effective clinical care and treatment solutions across 897 beds, which included 482 licensed detoxification beds. We also operate nine standalone outpatient centers. As of December 31, 2015, we had under development a 93-bed chemical dependency recovery hospital (“CDRH”) near Aliso Viejo, California. In addition, we are in the process of expanding our Recovery First facility in the Fort Lauderdale, Florida area to accommodate 22 additional detoxification beds and are also expanding the Oxford Centre facility to accommodate 44 additional residential beds and 48 sober living beds. In addition to our inpatient and outpatient treatment services, we perform drug testing and diagnostic laboratory services and provide physician services to our clients.

 

The majority of our approximately 1,600 employees are highly trained clinical staff who deploy research-based treatment programs with structured curricula for detoxification, residential treatment, partial hospitalization and intensive outpatient care. By applying a tailored treatment program based on the individual needs of each client, many of whom require treatment for a co-occurring mental health disorder, such as depression, bipolar disorder and schizophrenia, we believe we offer the level of quality care and service necessary for our clients to achieve and maintain sobriety.

 

We believe we are also one of the largest internet marketers in the addiction treatment industry with respect to website visits and leads generated. Following our acquisition of Referral Solutions Group, LLC (“RSG”) on July 2, 2015, combined with our existing internet assets, we now operate a broad portfolio of internet assets that services millions of website visits each month. RSG, through its wholly owned subsidiary Recovery Brands, a leading publisher of “authority” websites such as Rehabs.com and Recovery.org, serves families and individuals struggling with addiction and seeking treatment options through comprehensive online directories, treatment provider reviews, forums and professional communities.  Recovery Brands also provides online marketing solutions to other treatment providers such as enhanced facility profiles, audience targeting, lead generation and tools for digital reputation management.

 

We have made substantial investments in our treatment facilities with a specific focus on providing aesthetically pleasing properties and grounds, numerous amenities, healthy food and a courteous and attentive staff to distinguish us from our competitors. Our commitment to clinical excellence, premium facilities and customer service has allowed us to form relationships across a broad set of key referral sources, including hospitals, other treatment facilities, employers, alumni and employee assistance programs. Our platform is supported by a centralized infrastructure that includes a multi-faceted sales and marketing program, call center operations, a laboratory facility, billing and collection services and other support functions. This infrastructure, in conjunction with our premium service offerings, has enabled us to develop a strong national brand. The substantial investments we have made at a corporate level contribute to our operational efficiencies and provide us flexibility to place clients at a variety of our facilities in order to optimize care that best fits both the clients’ clinical needs and their insurance benefits.

 

We have demonstrated the ability to grow our business organically and generate attractive returns on investments with our de novo developments and acquisitions. Our three completed de novo developments, Greenhouse, Desert Hope and River Oaks, added 440 total beds on a combined basis.   Greenhouse and Desert Hope each achieved profitability within the first year of its respective opening and it is currently expected that River Oaks will achieve profitability within the first year of its October 2015 opening. During 2015, we completed four acquisitions which added a total of 249 residential beds and seven standalone outpatient centers.

 

Our net revenues have increased to $212.3 million in 2015 from $133.0 million in 2014, representing a growth rate of 60%. In addition, for the years ended December 31, 2015 and 2014, we had $44.3 million and $21.1 million in Adjusted EBITDA, respectively, representing a growth rate of 110%.  For the years ended December 31, 2015 and 2014, net income attributable to AAC Holdings, Inc. stockholders was $11.2 million and $7.6 million, respectively, representing a 47% growth rate. For the years ended December 31, 2015 and 2014, approximately 90% of our revenues were reimbursable by commercial payors, including amounts paid by such payors to clients, and the remaining portion was payable directly by our clients. We currently do not receive any revenues from Medicare and Medicaid programs. See “Selected Financial Data” for a discussion of Adjusted EBITDA and a reconciliation of Adjusted EBITDA to net income, the most directly comparable GAAP measure.

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Our History

Holdings was incorporated in the first quarter of 2014 and completed the following transactions in the second quarter of 2014, which are collectively referred to as the “Reorganization Transactions”:

 

After the Reorganization Transactions, Holdings owned (i) 93.6% of the then outstanding common stock of AAC, (ii) 100% of the outstanding common membership interests in BHR, which represented 100% of the voting rights in BHR, and (iii) 100% of the outstanding membership interests in CRMS.  

 

In October 2014, we completed the initial public offering (“IPO”) of 5,750,000 shares of our common stock, which included the exercise in full of the underwriters’ option to purchase an additional 250,000 shares from us and 500,000 shares from certain selling stockholders.  Our net proceeds from the IPO were approximately $68.8 million, after deducting underwriting discounts and commissions and other offering costs.  

 

Following our IPO, in November 2014, Holdings completed a subsidiary short-form merger with AAC and a wholly-owned merger subsidiary whereby the legacy holders of AAC common stock who did not participate in the Private Share Exchange received 1.571119 shares of Holdings common stock for each share of AAC common stock owned at the effective time of the merger (for an aggregate of approximately 293,040 shares of Holdings common stock).  As a result of the short-form merger, AAC is a wholly-owned subsidiary of Holdings.

 

Business Strategy

We have developed our company and the American Addiction Centers national brand through substantial investment in our facilities, our clinical expertise, our professional staff and our national sales and marketing program. We anticipate a number of factors will continue to accelerate demand for our services, including increased awareness and de-stigmatization of substance abuse treatment and recent healthcare reform improving access to care, particularly for young adults now able to access their parents’ insurance. We seek to extend our position as a leading provider of treatment for drug and alcohol addiction by executing the following growth strategies:

 

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On February 24, 2015, we completed the acquisition of the Ringwood property. We expect to develop the Ringwood property into an inpatient facility with approximately 150 beds.  

We also completed the acquisition of a memory care hospital in Aliso Viejo, California in April 2015. We began renovation and rehabilitation of the 93 bed facility in the second quarter of 2015 and expect to apply for a license to operate the facility as a CDRH. We anticipate that we will invest approximately $5.0 million for renovations and construction and have a targeted completion date of the second quarter of 2016.

 

We received licensure for our Las Vegas, Nevada outpatient facility in January 2015 and immediately began seeing clients, and we received licensure for our Arlington, Texas outpatient facility in February 2015 and began seeing clients in April 2015. We developed these outpatient centers to provide additional programming space for our nearby residential facilities. In addition, on April 17, 2015, we acquired the assets of Clinical Services of Rhode Island (“CSRI”), which added three in-network outpatient centers in Rhode Island, on August 10, 2015, we acquired the assets of The Oxford Centre, which added three outpatient centers in Mississippi, and on October 1, 2015, we acquired Sunrise House which added one additional in-network outpatient center in New Jersey. In addition, on December 10, 2015, we entered into a definitive agreement to acquire Wetsman Forensic, L.L.C. and certain of its affiliates, which collectively operate seven in-network outpatient centers, and on the same date entered into a definitive agreement to acquire Solutions Recovery, Inc. and certain of its affiliates, which collectively operate three in-network outpatient centers.  We are also in the process of expanding Oxford Centre to accommodate 48 sober living beds.  

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Our Services and Solutions

We provide quality, comprehensive and compassionate care to adults struggling with alcohol and/or drug abuse and dependence as well as co-occurring mental health issues. We maintain a research-based, disciplined treatment plan for all clients with schedules designed to engage the client in an enriched recovery experience. Our purpose and passion is to empower the individual, their families and the broader community through the promotion of optimal wellness of the mind, body and spirit.

Our curriculum, which is peer reviewed and research-based, has been recognized as one of our program strengths by the Commission on Accreditation of Rehabilitation Facilities, or CARF, a leader in the promotion and accreditation of quality, value and optimal outcomes of service. In particular, research studies show that certain aspects of our treatment programs, such as offering longer treatment stays, are effective for producing long-term recovery. In addition, we offer a variety of forms of therapy types and settings and related services that the National Institute on Drug Abuse has recognized as effective. We offer the following types of therapy: motivational interviewing, cognitive behavioral therapy, rational emotive behavior therapy, dialectical behavioral therapy, solution-focused therapy, eye movement desensitization and reprocessing, and systematic family intervention. Our variety of therapy settings includes individual, group, family, recovery-oriented challenge, expressive (with a focus on music and art) and equine and trauma therapies.

We offer a full spectrum of treatment services to clients, based upon individual needs as assessed through comprehensive evaluations at admission and throughout participation in the program. The assignment to, and frequency of, services corresponds to individualized treatment plans within the context of the level of care and treatment intensity level.

Detoxification: Detoxification is usually conducted at an inpatient facility for clients with physical or psychological dependence. Detoxification services are designed to clear toxins out of the body so that the body can safely adjust and heal itself after being dependent upon a substance. Clients are medically monitored 24 hours per day, seven days per week by experienced medical professionals who work to alleviate withdrawal symptoms through medication, as appropriate. We provide detoxification services for several substances including alcohol, sedatives and opiates.

Residential Treatment: Residential care is a structured treatment approach designed to prepare clients to return to the general community with a sober lifestyle, increased functionality and improved overall wellness. Treatment is provided on a 24 hours per day, seven days per week basis, and services generally include a minimum of two individual therapy sessions per week, regular group therapy, family therapy, didactic and psycho-educational groups, exercise (if cleared by medical staff), case management and recreational activities. Medical and psychiatric care is available to all clients, as needed, through our contracted professional physician groups.

Partial Hospitalization: Partial hospitalization is a structured program providing care at least five days a week for no fewer than six hours a day. This program is designed for clients who are stable enough physically and psychologically to participate in everyday activities, but who still require a degree of medical monitoring. Services include a minimum of weekly individual therapy, regular group therapy, family education and therapy, didactic and psycho-educational groups, exercise (if cleared by medical staff), case management and off-site recovery meetings and activities. Medical and psychiatric care is available to all clients, as needed, through our contracted professional physician groups.

Intensive Outpatient Services: Less intensive than the aforementioned levels of care, intensive outpatient services is a structured program providing care three days a week for three hours per day at a minimum. Designed as a “step down” from partial hospitalization, this program reinforces progress and assists in the attainment of sobriety, reduction of detrimental behaviors and improved overall wellness of clients while they integrate and interact in the community. Services include weekly individual therapy, group therapy, family education and therapy, didactic and psycho-educational groups, case management, off-site recovery meetings and activities, and intensive transitional and aftercare planning.

Ancillary Services: In addition to our inpatient and outpatient treatment services, we perform drug testing and diagnostic laboratory services.  We also provide physician services to our clients through the Professional Groups.  We believe drug testing of clients is an important component of substance abuse treatment. Clients are tested for illicit substances upon admission and thereafter on a random basis and as otherwise determined to be medically necessary.  We process drug testing for all of our facilities at our laboratory using time of flight mass spectrometry technology located in Brentwood, Tennessee.  

Sober Living Facilities: To facilitate our growing outpatient business, we provide sober living arrangements that serve as an interim environment for clients transitioning from residential treatment centers to lower levels of care and eventually back to their former living arrangements. Sober living facilities enable us to utilize existing beds for clients requiring higher levels of care, while

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still providing housing for clients completing outpatient treatment programs. We have contracted with providers of sober living accommodations and, in situations where third party sober living arrangements are not available, we have leased housing to provide such accommodations to our clients. We typically provide transportation between sober living housing and our outpatient centers.  We expect that we will continue to rely on sober living facilities as a complement to the expansion of our outpatient services.  

Depending on the specific needs of our client census at any given time, we are able to repurpose certain beds within a treatment facility to provide varying levels of care, subject to licensure requirements. As a result, rather than tracking the number of beds within a given level of care at any one time, management records and evaluates the number of billed days for each level of care over a given period of time. For instance, detoxification and residential treatment levels of care feature higher per day gross client charges than partial hospitalization and intensive outpatient levels of care but also require greater levels of more highly trained medical staff. For the year ended December 31, 2015, detoxification and residential treatment services accounted for 38% of total billed days, and partial hospitalization and intensive outpatient services accounted for the remaining 62% of total billed days. For the year ended December 31, 2014, detoxification and residential treatment services accounted for 27% of total billed days, and partial hospitalization and intensive outpatient services accounted for the remaining 73% of total billed days.

 

Considering the high level of co-occurring substance abuse, mental health and medical conditions, we offer clients a spectrum of psychiatric, medical and wellness-focused services based upon his or her individual needs as assessed through comprehensive evaluations at admission and throughout his or her participation in the program. To maximize the likelihood of long-term recovery, all program levels provide clients access to the following services: assessment of individual substance abuse, mental health and medical history and physical within 24 to 72 hours of admission; psychiatric evaluations; psychological evaluations and services based on client needs; follow-up appointments with physicians and psychiatrists; medication monitoring; educational classes regarding health risks, nutrition, smoking cessation, HIV awareness, life skills, healthy nutritional programs and dietary plans; access to fitness facilities; interactive wellness activities such as swimming, basketball and yoga; and structured daily schedules designed for restorative sleep patterns.

 

In addition, we believe drug testing of clients is an important component of substance abuse treatment. Clients are tested for substances at our facilities upon admission, on a random basis, and as otherwise determined to be medically necessary. Drug test samples are obtained at our facilities and sent to an off-site laboratory for analysis.  Currently, we process drug testing for all of our facilities at our laboratory using time of flight mass spectrometry technology located in Brentwood, Tennessee. We believe we utilize industry standard practices for drug testing and laboratory services.

 

We emphasize clinical treatment, as well as the therapeutic value of overall physical and nutritional wellness. We are committed to providing fresh and nutritious meals throughout a client’s stay in order to promote healthy routines beginning with diet and exercise. Some of our facilities offer comprehensive work-out facilities, and many locations offer various exercise classes and other amenities. We support long-term recovery for clients through research-based methodologies and individualized treatment planning while utilizing 12 step programs, which are a set of guiding principles outlining a course of action for recovery.

 

We believe we have a differentiated ability to manage dual diagnosis cases and coordinate treatment of individuals suffering from the common combination of mental illness and substance abuse simultaneously. These clients participate in education and discussion-oriented groups designed to provide information regarding the psychiatric disorders that co-occur with chemical dependency.

 

We place a strong emphasis on tracking client satisfaction scores in order to measure our client and staff interaction and overall outcome and reputation. In addition to client satisfaction surveys that we receive after a client’s discharge, we also solicit feedback during a client’s stay at our residential facilities. This allows us to further tailor an individual’s treatment plan to emphasize the programs that have been more impactful and helpful to a particular client.

 

We believe in tracking clinical outcomes.  We have entered into a partnership with Centerstone Research Institute to conduct independent three-year longitudinal outcome studies on the effectiveness of our clinical approach. We are currently in the early stages of data gathering, and we anticipate reviewing our initial findings in 2016.

 

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Facilities

As of December 31, 2015, we operated nine residential substance abuse treatment facilities and nine standalone outpatient substance abuse treatment facilities located throughout the United States. The following table presents information, as of December 31, 2015, about our network of substance abuse treatment facilities, including current facilities, facilities under development, and properties under contract:

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In addition, we lease approximately 102,000 square feet of office space located in Brentwood, Tennessee for our new corporate headquarters and call center. The initial term of the lease is for ten years, with one option to extend the lease for five years. We also lease approximately 11,000 square feet of laboratory space in Brentwood, Tennessee to perform quantitative drug testing and other laboratory services that support our treatment facilities. The lease for our laboratory space expires in May 2018.

 

New Property Developments and Acquisitions

 

For a discussion of our facilities under development and recent acquisitions, see the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations – New Property Developments and Acquisitions”.

 

Sales and Marketing

Sales and marketing supports the development of our brand and advances our comprehensive lead-generation platform.  The primary sources of our new clients include:

 

 

 

 

Call Center Operations

We maintain a 24 hours per day, seven days per week call center currently staffed by over 100 employees. Our centralized call center is situated at our corporate headquarters in Brentwood, Tennessee, and focuses on enrolling clients identified by our sales and marketing activities into new client admissions.  As part of its role, the call center team conducts benefits verification and handles all communication with insurance companies, completes client assessments, begins the pre-certification process for treatment

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authorization, chooses the proper treatment facility for the client’s clinical and financial needs and assists clients with arrangements and logistics.  

 

Professional Groups

We are affiliated with a professional group (the “Professional Groups”) in six of the states in which we currently operate.  These Professional Groups engage physicians and mid-level service providers and provide professional services to our clients through professional services agreements with each treatment facility.  Under the professional services agreements, the Professional Groups also provide a physician to serve as medical director for the applicable facility.  The Professional Groups either bill the payor for their services directly or are compensated by the treatment facility based on fair market value hourly rates.  Each of the professional services agreements has a term of five years and will automatically renew for additional one year periods.  For additional information related to the Professional Groups, see Note 2 to our audited financial statements included elsewhere in this report.

 

Competition

We believe we are one of the largest for-profit companies focused on substance abuse treatment in the United States.  According to IBISWorld, approximately 77% of all substance abuse treatment clinics in the United States have a single location, and approximately 57% of all substance abuse treatment clinics have fewer than 20 employees.  Many of the largest for-profit addiction treatment providers operate in the broader behavioral healthcare sector without focusing primarily on substance abuse.  We believe our size and core focus on substance abuse treatment provide us with an advantage over competitors in terms of building our brand and marketing our platform to potential clients.

 

The market for mental health and substance abuse treatment facilities is highly fragmented with approximately 15,000 different facilities providing services to the adult and adolescent population, of which only 35% are operated by for-profit organizations.  Our residential treatment facilities compete with several national competitors and many regional and local competitors.  Some of our competitors are government entities and supported by tax revenues, and others are non-profit entities that are primarily supported by endowments and charitable contributions.  We do not receive financial support from these sources.  Some larger companies in our industry, including Acadia Healthcare Company, Inc. and its subsidiary CRC Health Corp., compete with us on a national scale and offer substance abuse treatment services among other behavioral healthcare services.  To a lesser extent, we also compete with other providers of substance abuse treatment services, including other inpatient behavioral healthcare facilities and general acute care hospitals.

 

We believe the primary competitive factors affecting our business include:

 

 

 

 

 

 

 

 

 

 

 

Regulatory Matters

Overview

Substance abuse treatment providers are regulated extensively at the federal, state and local levels. In order to operate our business and obtain reimbursement from third-party payors, we must obtain and maintain a variety of licenses, permits, certifications and accreditations. We must also comply with numerous other laws and regulations applicable to the conduct of business by substance

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abuse treatment providers. Our facilities are also subject to periodic on-site inspections by the agencies that regulate and accredit them in order to determine our compliance with applicable requirements.

 

The laws and regulations that affect substance abuse treatment providers are complex, and change frequently.  We must regularly review our organization and operations and make changes as necessary to comply with changes in the law or new interpretations of laws or regulations. Significant public attention has focused on the healthcare industry, including attention to the conduct of industry participants and the cost of healthcare services. In recent years, there have been heightened coordinated civil and criminal enforcement efforts relating to the healthcare industry by both federal and state government agencies. The ongoing investigations relate to, among other things, various referral practices, cost reporting, billing practices, credit balances, physician ownership and joint ventures involving hospitals and other healthcare providers. We expect that healthcare costs and other factors will continue to encourage both the development of new laws and regulations and increased enforcement activity.

 

We believe we are in substantial compliance with all applicable laws and regulations and, except for the ongoing California matter, are not aware of any material pending or threatened investigations involving allegations of wrongdoing. Compliance with such laws and regulations may be subject to future government review and interpretation, as well as significant regulatory action including fines, penalties and exclusion from government health programs.

 

Licensure, Accreditation and Certification

All of our substance abuse treatment facilities are licensed under applicable state laws where licensure is required. Licensing requirements typically vary significantly depending upon the state in which a facility is located and the types of services provided.  The types of licensed services that our facilities provide include medical detox, residential, partial hospitalization, intensive outpatient, outpatient treatment, ambulatory detox, and community housing.  In addition, our employed case managers, therapists, nurses, and medical providers and technicians may be subject to individual state license requirements.

 

Our Desert Hope, Recovery First, and River Oaks facilities are, and any future facilities that store and dispense controlled substances will be, required to register with the U.S. Drug Enforcement Administration, or DEA, and abide by DEA regulations regarding controlled substances.  Each of our treatment facilities has a certificate under the Clinical Laboratory Improvement Amendments of 1988, or CLIA, to conduct urinalysis screening for its clients. In addition, our time of flight mass spectrometry laboratory is licensed under CLIA for high complexity drug testing and is also licensed under applicable state laws in states where such licensure is required to provide diagnostic testing services in 44 states.

 

Each of our substance abuse treatment facilities has obtained or are in the process of obtaining accreditation from CARF and/or The Joint Commission, which are the primary accreditation bodies in the substance abuse treatment industry.  CARF and The Joint Commission accredit behavioral health organizations providing mental health and alcohol and drug use and addiction treatment services, as well as opiate treatment programs, and many other types of programs. This type of accreditation program is intended to improve the quality, safety, outcomes and value of healthcare services provided by accredited facilities.  CARF and The Joint Commission require an initial application and completion of on-site surveys demonstrating compliance with accreditation requirements. Accreditation is granted for a specified period, typically ranging from one to three years, and renewals of accreditation require completion of a renewal application and an on-site renewal survey. 

 

We believe that all of our facilities and programs are in substantial compliance with current applicable state and local licensure, certification and accreditation requirements. In addition, we believe all of our facilities are in substantial compliance with the standards of the accrediting body, CARF or The Joint Commission. Periodically, state and local regulatory agencies as well as accreditation entities conduct surveys of our facilities and may find from time to time that a facility is not in full compliance with all of the accreditation standards. Upon receipt of any such finding, the facility timely submits a plan of correction and corrects any cited deficiencies.

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FDA Laws and Regulations

The FDA has regulatory responsibility over, among other areas, instruments, test kits, reagents and other devices used by clinical laboratories to perform diagnostic testing. A number of esoteric tests we develop internally are offered as laboratory developed tests (“LDTs”). The FDA has claimed regulatory authority over all LDTs, but has stated that it exercises enforcement discretion for most LDTs performed by high complexity CLIA-certified laboratories. The FDA has announced guidance initiatives that may significantly impact the clinical laboratory testing business, including by increasing regulation of LDTs.

Fraud, Abuse and Self-Referral Laws

We do not currently bill or accept payments from Medicare or Medicaid. Therefore, our operations are generally not impacted by the anti-kickback provisions of the Social Security Act, commonly known as the Anti-kickback Statute, or the federal prohibition on physician self-referrals, commonly referred to as the Stark Law. The Anti-kickback Statute prohibits the payment, receipt, offer, or solicitation of remuneration of any kind in exchange for items or services that are reimbursed under federal healthcare programs. The Stark Law prohibits physicians from referring Medicare and Medicaid patients to healthcare providers that furnish certain designated health services, including laboratory services and inpatient and outpatient hospital services, if the physicians or their immediate family members have ownership interests in, or other financial arrangements with, the healthcare providers, unless an exception applies. Many states have anti-kickback and physician self-referral prohibitions similar to the federal statutes and regulations. These state laws are often drafted broadly to cover all payors (i.e., not restricted to Medicare and other federal healthcare programs) and often lack interpretative guidance.  A violation of these laws could result in a prohibition on billing payors for such services or an obligation to refund amounts received, result in civil or criminal penalties and adversely affect the state license of any program or facility found to be in violation.

 

Federal prosecutors have broad authority to prosecute healthcare fraud. For example, federal law criminalizes the knowing and willful execution or attempted execution of a scheme or artifice to defraud any healthcare benefit program as well as obtaining by false pretenses any money or property owned by any healthcare benefit program. Federal law also prohibits embezzlement of healthcare funds, false statements relating to healthcare and obstruction of the investigation of criminal offenses.  These federal criminal offenses are enforceable regardless of whether an entity or individual participates in the Medicare program or any other federal healthcare program.

 

False Claims

We are subject to state and federal laws that govern the submission of claims for reimbursement. These laws generally prohibit an individual or entity from knowingly and willfully presenting a claim (or causing a claim to be presented) for payment from Medicare, Medicaid or other third-party payors that is false or fraudulent. The standard for “knowing and willful” often includes conduct that amounts to a reckless disregard for whether accurate information is presented by claims processors. Penalties under these statutes include substantial civil and criminal fines, exclusion from the Medicare program and imprisonment.

 

One of the most prominent of these laws is the federal False Claims Act, or FCA, which may be enforced by the federal government directly or by a qui tam plaintiff (or whistleblower) on the government’s behalf. When a private plaintiff brings a qui tam action under the FCA, the defendant often will not be made aware of the lawsuit until the government commences its own investigation or determines whether it will intervene.  When a defendant is determined by a court of law to be liable under the FCA, the defendant may be required to pay three times the amount of the alleged false claim, plus mandatory civil penalties of between $5,500 and $11,000 for each separate false claim. The Bipartisan Budget Act of 2015 requires these and certain other civil monetary penalties to increase by up to 150% by August 1, 2016, and to increase annually thereafter based on updates to the consumer price index.

 

Many states have passed false claims acts similar to the FCA.  Under these laws, the government may impose a penalty and recover damages, often treble damages, for knowingly submitting or participating in the submission of claims for payment that are false or fraudulent or which contain false or misleading information.  These laws may be limited to specific programs (such as state workers’ compensation programs) or may apply to all payors.  In many cases, alleged violations of these laws may be brought by a whistleblower who may be an employee, a referring physician, a competitor, a client or other individual or entity, and who may be eligible for a portion of any recovery.  Further, like the federal law, state false claims act laws generally protect employed whistleblowers from retribution by their employers.

 

Although we believe that we have procedures in place to ensure the accurate completion of claims forms and requests for payment, the laws, regulations and standards defining proper billing, coding and claim submission are complex and have not been subjected to extensive judicial or agency interpretation.  Billing errors can occur despite our best efforts to prevent or correct them,

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and we cannot assure you that the government or a payor will regard such errors as inadvertent and not in violation of the applicable false claims act laws or related statutes.

 

Privacy and Security Requirements

There are numerous federal and state regulations that address the privacy and security of client health information. In particular, federal regulations issued under the Drug Abuse Prevention, Treatment and Rehabilitation Act of 1979 strictly restrict the disclosure of client identifiable information related to substance abuse and apply to any of our facilities that receive any federal assistance, which is interpreted broadly to include facilities licensed, certified or registered by a federal agency. Further, the Health Insurance Portability and Accountability Act of 1996, or HIPAA privacy and security regulations extensively regulate the use and disclosure of individually identifiable health information (known as “protected health information”) and require covered entities, which include most health providers, to implement and maintain administrative, physical and technical safeguards to protect the security of such information. Additional security requirements apply to electronic protected health information. These regulations also provide clients with substantive rights with respect to their health information.

 

The HIPAA privacy and security regulations also require our substance abuse treatment programs and facilities to impose compliance obligations by written agreement on certain contractors to whom our programs disclose client information known as “business associates.” Covered entities may be subject to penalties as a result of a business associate violating HIPAA if the business associate is found to be an agent of the covered entity. Business associates are also directly subject to liability under the HIPAA privacy and security regulations.  In instances where our programs act as a business associate to a covered entity, there is the potential for additional liability beyond the program’s covered entity status.

 

Covered entities must report breaches of unsecured protected health information to affected individuals without unreasonable delay but not to exceed 60 days of discovery of the breach by a covered entity or its agents. Notification must also be made to the U.S. Department of Health and Human Services, or HHS, and, in certain situations involving large breaches, to the media. HHS is required to publish on its website a list of all covered entities that report a breach involving more than 500 individuals. All non-permitted uses or disclosures of unsecured protected health information are presumed to be breaches unless the covered entity or business associate establishes that there is a low probability the information has been compromised. Various state laws and regulations may also require us to notify affected individuals in the event of a data breach involving individually identifiable information without regard to whether there is a low probability of the information being compromised.

 

Violations of the HIPAA privacy and security regulations may result in civil penalties of up to $50,000 per violation for a maximum civil penalty of $1,500,000 in a calendar year for violations of the same requirement. HIPAA also provides for criminal penalties of up to $250,000 and ten years in prison, with the severest penalties for obtaining or disclosing protected health information with the intent to sell, transfer or use such information for commercial advantage, personal gain or malicious harm. In addition, state attorneys general may bring civil actions seeking either injunction or damages in response to violations of the HIPAA privacy and security regulations that threaten the privacy of state residents.  HHS is required to impose penalties for violations resulting from willful neglect, is required to perform compliance audits and has announced its intent to perform audits in 2016.

 

Our programs remain subject to any privacy-related federal or state laws that are more restrictive than the HIPAA privacy and security regulations. These laws vary by state and could impose additional requirements and penalties. For example, some states impose strict restrictions on the use and disclosure of health information pertaining to mental health or substance abuse treatment. The Federal Trade Commission also uses its consumer protection authority to initiate enforcement actions in response to data breaches or other privacy or security lapses.

 

We enforce a health information privacy and security compliance plan, which we believe complies with the HIPAA privacy and security regulations and other applicable requirements. Compliance with federal and state privacy and security requirements has required and will continue to require us to expend significant resources.

 

Mental Health Parity Legislation and the Affordable Care Act

The regulatory framework in which we operate is constantly changing. Both the Mental Health Parity and Addiction Equity Act of 2008, or MHPAEA, and the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010, collectively known as the Affordable Care Act, may require that we make operational changes to comply with such laws and regulations. The MHPAEA is a federal parity law that requires large group health insurance plans that offer mental health and addiction coverage to provide that coverage on par with financial requirements and treatment limitations of coverage offered for other illnesses. The scope of coverage offered by health plans must comply with federal and state laws and must be consistent with generally recognized independent standards of current medical practice. The MHPAEA also contains a cost exemption that operates to temporarily exempt a group health plan from the MHPAEA’s requirements if compliance with the MHPAEA becomes too costly.

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The Affordable Care Act poses both opportunities and risks for us. The Affordable Care Act represents significant change to the healthcare industry, including reforming the health insurance market, adopting a number of payment reform measures, attempting to reduce the overall growth rate of healthcare spending, strengthening fraud and abuse enforcement as well as adopting numerous specific provisions applicable to individual segments of the healthcare industry. The impact of the Affordable Care Act on each of our programs may vary. Further, its overall impact is difficult to determine because of uncertainty around a number of factors, including issues around the timing and manner of implementation of certain provisions not yet in effect, the possibility of amendment, repeal or judicial modification, and our inability to predict how individuals, employers, health plans and providers will react to the requirements of the Affordable Care Act.

 

We believe that one enduring effect of the Affordable Care Act has been an increase in payment reform efforts by federal and state government payors and commercial payors. These efforts take many forms including the growth of accountable care organizations, or ACOs, pay-for-performance bonus arrangements, partial capitation arrangements and the bundling of services into a single payment. The result of these efforts is that more risk of the overall cost of care is being transferred to providers. As institutional providers and their affiliated physicians assume more risk for the cost of care, we expect more services to be furnished within provider networks formed to accept these types of payment reforms. Our ability to compete and retain our traditional sources of clients may be adversely affected by our exclusion from such networks or our inability to be included in such networks.

 

Overall, the expansion of health insurance coverage under the Affordable Care Act is expected to be beneficial to the substance abuse treatment industry. Health insurers are prohibited from denying coverage to individuals because of preexisting conditions. Further, all new small group and individual market health plans must cover ten essential health benefit categories, which include mental health and substance abuse disorder services. Likewise, the Affordable Care Act requires small group and individual market plans to comply with the requirements of MHPAEA. According to 2013 HHS estimates, these changes will ensure coverage for mental health and substance abuse disorders for 62.5 million Americans.

 

The expansion of commercial insurance for substance abuse treatment services may result in a higher demand for services from all providers. It is also likely to bring new competitors to the market, some of which may be better capitalized and have greater market penetration than we do. Further, we expect increased demand for substance abuse treatment services to also increase the demand for case managers, therapists, medical technicians and others with clinical expertise in substance abuse treatment that may make it both more difficult to adequately staff our substance abuse treatment facilities and could significantly increase our costs in delivering treatment, which may adversely affect both our operations and profitability. This increased demand may be tempered somewhat by the $35 million received in both 2014 and 2015 by the Substance Abuse and Mental Health Services Administration to expand the mental and behavioral health workforce through a partnership with the Health Resources and Services Administration.

 

CLIA, Accreditation and Licensure of Our Laboratory

Our Brentwood clinical laboratory facility and treatment facilities are licensed as required by the appropriate federal and state agencies.  CLIA regulates virtually all clinical laboratories by requiring that they be certified by the federal government and comply with various technical, operational, personnel and quality requirements intended to ensure that laboratory testing services are accurate, reliable and timely.

Pursuant to CLIA, a review is required to renew the certificates every two years.  Additionally, we are regularly subject to survey and inspection to assess compliance with program standards and may be subject to additional random inspections. Standards for testing under CLIA are based on the level of complexity of the tests performed by the laboratory. Laboratories performing high complexity testing are required to meet more stringent requirements than laboratories performing less complex tests. Our clinical laboratory facility performs high complexity testing and holds a CLIA certificate of accreditation. Our treatment facilities currently are certified for waiver testing because they only furnish urinalysis, a low complexity test.  Our laboratory facility currently is certified for complex testing.

CLIA does not preempt state laws that are more stringent than federal law. State laws may require additional personnel qualifications, quality control, record maintenance and/or proficiency testing. A number of states in which we operate have implemented their own regulatory and licensure requirements. In addition, some states require laboratories that solicit or test samples collected from individuals within that state to hold a laboratory license even though the laboratory does not have physical operations within the state. Our laboratory facility is located in Brentwood, Tennessee, and is licensed as a clinical laboratory in Tennessee. Our laboratory facility is also licensed in other states as required to process test samples originating from individuals within such states. Our laboratory facility is accredited by COLA and participates in the College of American Pathologists (“CAP”) proficiency program.

Health Planning and Certificates of Need

The construction of new healthcare facilities, the expansion, transfer or change of ownership of existing facilities and the addition of new beds, services or equipment may be subject to state laws that require prior approval by state regulatory agencies under

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certificate of need (“CON”) laws. These laws generally require that a state agency determine the public need for construction or acquisition of facilities or the addition of new services. Review of CON applications and other healthcare planning initiatives may be lengthy and may require public hearings. Violations of these state laws may result in the imposition of civil sanctions or revocation of a facility’s license. Currently, no states in which we operate have CON requirements for substance abuse treatment centers applicable to our facilities.

 

Other State Healthcare Laws

Most states have a variety of laws that may potentially impact our operations and business practices.  For instance, many states in which our programs operate prohibit corporations (and other legal entities) from practicing medicine by employing physicians and certain non-physician practitioners.  These prohibitions on the corporate practice of medicine impact how our programs structure their relationships with physicians and other affected non-physician practitioners. These arrangements, however, have typically not been vetted by either a court or the affected regulatory body.

 

Similarly, many states prohibit physicians from sharing a portion of their professional fees with any other person or entity.  These so-called fee-splitting prohibitions range from prohibiting arrangements resembling a kickback to broadly prohibiting percentage-based compensation and other variable compensation arrangements with physicians.

 

If our arrangements with physicians were found to violate a corporate practice of medicine prohibition or a state fee-splitting prohibition, our contractual arrangements with physicians in such states could be adversely affected, which, in turn, may adversely affect both our operations and profitability. Further, we could face sanctions for aiding and abetting the violation of the state’s medical practice act.

 

Local Land Use and Zoning

Municipal and other local governments also may regulate our treatment programs. Many of our facilities must comply with zoning and land use requirements in order to operate and many of our de novo acquisition targets will be contingent upon zoning and land use approvals.  For example, local zoning authorities regulate not only the physical properties of a healthcare facility, such as its height and size, but also the location and activities of the facility. In addition, community or political objections to the placement of treatment facilities can result in delays in the land use permit process and may prevent the operation of facilities in certain areas.

 

Risk Management and Insurance

The healthcare industry in general continues to experience an increase in the frequency and severity of litigation and claims. As is typical in the healthcare industry, we could be subject to claims that our services have resulted in injury to our clients or had other adverse effects. In addition, resident, visitor and employee injuries could also subject us to the risk of litigation. While we believe that quality care is provided to our clients and that we substantially comply with all applicable regulatory requirements, an adverse determination in a legal proceeding or government investigation could have a material adverse effect on our financial condition.

 

We maintain commercial insurance coverage on an occurrence basis for general and professional liability claims with no deductible, a primary $1.0 million per claim limit and an annual aggregate primary limit of $3.0 million with umbrella coverage for an additional $20.0 million limit.

 

Compliance Programs

Compliance with government rules and regulations is a significant concern throughout our industry, in part due to evolving interpretations of these rules and regulations.  We seek to conduct our business in compliance with all statutes and regulations applicable to our operations.  To this end, we have established an informal compliance program that reviews for regulatory compliance procedures, policies and facilities throughout our business.  Our executive management team is responsible for the oversight and operation of our compliance program.  We provide periodic and comprehensive training programs to our personnel, which are intended to promote the strict observance of our policies designed to ensure compliance with the statutes and regulations applicable to us.  

 

Environmental, Health and Safety Matters

 

We are subject to various federal, state and local environmental laws that: (i) regulate certain activities and operations that may have environmental or health and safety effects, such as the handling, storage, transportation, treatment and disposal of medical and pharmaceutical waste products generated at our facilities, the presence of other hazardous substances in the indoor environment and protection of the environment and natural resources in connection with the development or construction of our facilities; (ii)

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impose liability for costs of cleaning up, and damages to natural resources from, past spills, waste disposals on and off-site or other releases of hazardous materials or regulated substances; and (iii) regulate workplace safety, including the safety of workers who may be exposed to blood-borne pathogens such as HIV, the hepatitis B virus and the hepatitis C virus. Our laboratory and some of our treatment facilities generate infectious or other hazardous medical waste due to the illness or physical condition of our clients and in connection with performing laboratory tests. The management of infectious medical waste is subject to regulation under various federal, state and local environmental laws, which establish management requirements for such waste. These requirements include record-keeping, notice and reporting obligations. Management believes that our operations are generally in compliance with environmental and health and safety regulatory requirements or that any non-compliance will not result in a material liability or cost to achieve compliance. Historically, the costs of achieving and maintaining compliance with environmental laws and regulations at our facilities, including our laboratory, have not been material. However, we cannot assure you that future costs and expenses required for us to comply with any new, or changes in existing, environmental and health and safety laws and regulations or new or discovered environmental conditions will not have a material adverse effect on our business, financial condition or results of operations.

 

Employees

As of December 31, 2015, we employed approximately 1,600 people, consisting of approximately 1,400 full-time employees and approximately 200 part-time employees.  None of our employees is represented by a labor union or covered by a collective bargaining agreement. We believe that our employee relations are good.

Available Information

We file certain reports with the Securities and Exchange Commission (the “SEC”), including annual reports on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K. The public may read and copy any materials we file with the SEC at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, DC 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. We are an electronic filer, and the SEC maintains an Internet site at http://www.sec.gov that contains the reports, proxy and information statements and other information we file electronically. Our website address is www.americanaddictioncenters.org. We make available free of charge, through our website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and all amendments to those reports filed or furnished pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, or the Exchange Act, as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. Our website and the information contained therein or linked thereto are not intended to be incorporated into this Annual Report on Form 10-K.

 

 

Item 1A. Risk Factors

Our actual operating results may differ materially from those described in forward-looking statements as a result of various factors, including but not limited to, those described below. You should carefully consider the following risk factors in addition to the other information included in this Annual Report on Form 10-K.

 

Risks Related to Our Business

Our revenues, profitability and cash flows could be materially adversely affected if we are unable to operate certain key treatment facilities, our corporate office or our laboratory facility.

We derive a significant portion of our revenues from three treatment facilities located in California, Nevada and Texas. These treatment facilities accounted for 65.1% of our total revenues in 2015 and 79.4% in 2014. It is likely that a small number of facilities will continue to contribute a significant portion of our total revenues in any given year for the foreseeable future. Additionally, we have a centralized corporate office that houses our accounting, billing and collections, information technology, marketing and call center departments and a high complexity laboratory facility that conducts quantitative drug testing and other laboratory services. If any event occurs that would result in a complete or partial shutdown of any of these facilities or our centralized corporate office or laboratory, including, without limitation, any material changes in legislative, regulatory, economic, environmental or competitive conditions in these states or natural disasters such as hurricanes, earthquakes, tornadoes or floods or prolonged airline disruptions due to a natural disaster or for any reason, such event could lead to decreased revenues and/or higher operating costs, which could have a material adverse effect on our revenues, profitability and cash flows.  

 

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An increase in uninsured and underinsured clients or the deterioration in the collectability of the accounts of such clients could have a material adverse effect on our business, financial condition and results of operations.

Collection of receivables from third-party payors and clients is critical to our operating performance. Our primary collection risks are (i) the risk of overestimating our net revenues at the time of billing, which may result in us receiving less than the recorded receivable, (ii) the risk of non-payment as a result of commercial insurance companies denying claims, (iii) the risk that clients will fail to remit insurance payments to us when the commercial insurance company pays out-of-network claims directly to the client, (iv) resource and capacity constraints that may prevent us from handling the volume of billing and collection issues in a timely manner and (v) the risk of non-payment from uninsured clients. Additionally, our ability to hire and retain experienced personnel also affects our ability to bill and collect accounts in a timely manner. We establish our provision for doubtful accounts based on the aging of the receivables and taking into consideration historical collection experience by facility, services provided, payor source and historical reimbursement rate, current economic trends and percentages applied to the accounts receivable aging categories. At December 31, 2015, our allowance for doubtful accounts represented approximately 21.7% of our accounts receivable balance as of such date, with three commercial payors each representing in excess of 10% of the accounts receivable balance as of December 31, 2015. We routinely review accounts receivable balances in conjunction with these factors and other economic conditions that might ultimately affect the collectability of the client accounts and make adjustments to our allowances as warranted. Significant changes in business operations, payor mix or economic conditions, including changes resulting from implementation of the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (the “Affordable Care Act”), could affect our collection of accounts receivable, cash flows and results of operations. In addition, increased client concentration in states that permit commercial insurance companies to pay out-of-network claims directly to the client instead of us, such as California and Nevada, could adversely affect our collection of receivables. Increases in the growth of uninsured and underinsured clients or in our provision for doubtful accounts or unexpected changes in reimbursement rates by third-party payors could have a material adverse effect on our business, financial condition and results of operations.

 

We rely on our multi-faceted sales and marketing program to continuously attract and enroll clients in our network of facilities.  Any disruption in our national sales and marketing program would have a material adverse effect on our business, financial condition and results of operations.

We believe our national sales and marketing program, including the July 2015 acquisition of RSG, provides us with a competitive advantage compared to treatment facilities that primarily target local geographic areas and use fewer marketing channels to attract clients. If any disruption occurs in our national sales and marketing program for any reason or if we are unable to effectively attract and enroll new clients to our network of facilities, our ability to maintain census could be adversely affected, which would have a material adverse effect on our business, financial condition and results of operations.

 

In addition, our ability to grow or even to maintain our existing level of business depends significantly on our ability to establish and maintain close working and referral relationships with hospitals, other treatment facilities, employers, alumni, employee assistance programs and other referral sources. We have no binding commitments with any of these referral sources. We may not be able to maintain our existing referral relationships or develop and maintain new relationships in existing or new markets. If we lose existing relationships with our referral sources, the number of people to whom we provide services may decline, which may adversely affect our revenues. Also, if we fail to develop new referral relationships, our growth may be restrained.

 

We derive a significant portion of our revenues from providing services to clients covered by third-party payors who could reduce their reimbursement rates or otherwise restrain our ability to obtain, or provide services to, clients. This risk is heightened because we are generally an “out-of-network” provider.

Managed care organizations and other third-party payors pay for the services that we provide to many of our clients.  For 2015, approximately 90% of our revenues were reimbursable by third-party payors, including amounts paid by such payors to clients, with the remaining portion payable directly by our clients. If any of these third-party payors reduce their reimbursement rates or elect not to cover some or all of our services, our business, financial condition and results of operations may be materially adversely affected.  

 

In addition to limits on the amounts payors will pay for the services we provide to their members, controls imposed by third-party payors designed to reduce admissions and the length of stay for clients, including post-admission authorizations and utilization review, have affected and are expected to continue to affect our facilities. Utilization review entails the review of the admission and course of treatment of a client by third-party payors. Inpatient utilization, average lengths of stay and occupancy rates continue to be negatively affected by payor-required preadmission authorization and utilization review and by payor pressure to maximize outpatient and alternative healthcare delivery services for less acutely ill clients. Efforts to impose more stringent cost controls are expected to continue. Although we are unable to predict the effect these controls and changes will have on our operations, significant limits on the scope of services reimbursed and on reimbursement rates and fees could have a material adverse effect on our business, financial condition and results of operations. If the rates paid or the scope of laboratory or other substance abuse treatment services covered by

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third-party commercial payors are reduced, our business, financial condition and results of operations could be materially adversely affected.

 

For certain facilities, we are considered an “out-of-network” provider by the majority of third-party payors, and, therefore, we bill our full charges for services covered by such third-party payors.  Third-party payors generally attempt to limit use of out-of-network providers by requiring clients to pay higher copayment and/or deductible amounts for out-of-network care. Additionally, third-party payors have become increasingly aggressive in attempting to minimize the use of out-of-network providers by disregarding the assignment of payment from clients to out-of-network providers (i.e., sending payments to clients instead of out-of-network providers), capping out-of-network benefits payable to clients, waiving out-of-pocket payment amounts and initiating litigation against out-of-network providers for interference with contractual relationships, insurance fraud and violation of state licensing and consumer protection laws.  If third-party payors impose further restrictions on out-of-network providers, our revenues could be threatened, forcing our facilities to participate with third-party payors and accept lower reimbursement rates compared to our historic reimbursement rates.

 

Third-party payors also are entering into sole source contracts with some healthcare providers, which could effectively limit our pool of potential clients. Moreover, third-party payors are beginning to carve out specific services, including substance abuse treatment and behavioral health services, and establish small, specialized networks of providers for such services at fixed reimbursement rates. Continued growth in the use of carve-out arrangements could materially adversely affect our business to the extent we are not selected to participate in such smaller specialized networks or if the reimbursement rate is not adequate to cover the cost of providing the service.

 

If we overestimate the reimbursement amounts that payors will pay us for services performed, it would increase our revenue adjustments, which could have a material adverse effect on our revenues, profitability and cash flows and lead to significant shifts in our results of operations from quarter to quarter that may make it difficult to project long-term performance.  

 

We recognize revenues from commercial payors at the time services are provided based on our estimate of the amount that payors will pay us for the services performed. We estimate the net realizable value of revenues by adjusting gross client charges using our expected realization and applying this discount to gross client charges. Through December 31, 2013, our expected realization was determined by management after taking into account historical collections received from the commercial payors since our inception compared to the gross client charges billed. Beginning in January 2014, we enhanced the methodology related to our net realizable value to more quickly react to potential changes in reimbursements by facility, by type of service and by payor. As a result, management adjusted the expected realization discount, on a per facility basis, to reflect a twelve-month historical analysis of reimbursement data by facility in addition to considering the type of services provided, the payors and the gross client charge rates by facility. This adjustment resulted in a decrease in our expected realization for the first half of 2014.   A significant or sustained decrease in our collection rates could have a material adverse effect on our operating results. There is no assurance that we will be able to maintain or improve historical collection rates in future reporting periods.

 

Estimates of net realizable value are subject to significant judgment and approximation by management.  It is possible that actual results could differ from the historical estimates management has used to help determine the net realizable value of revenues.  If our actual collections either exceed or are less than the net realizable value estimates, we will record a revenue adjustment, either positive or negative, for the difference between our estimate of the receivable and the amount actually collected in the reporting period in which the collection occurred.   A significant negative revenue adjustment could have a material adverse effect on our revenues, profitability and cash flows in the reporting period in which such adjustment is recorded. In addition, if we record a significant revenue adjustment, either positive or negative, in any given reporting period, it may lead to significant shifts in our results from operations from quarter to quarter, which may limit our ability to make accurate long-term predictions about our future performance.

 

Certain third-party payors account for a significant portion of our revenues, and the reduction of reimbursement rates or coverage of services by any such payor could have a material adverse effect on our revenues, profitability and cash flows.  

For the year ended December 31, 2015, approximately 15.1% of our revenue reimbursements came from Anthem Blue Cross Blue Shield of Colorado, 12.5% came from Blue Cross Blue Shield of Texas, 11.5% came from Aetna, and 11.1% came from Blue Cross Blue Shield of California. No other payor accounted for more than 10% of our revenue reimbursements for the year ended December 31, 2015. For the year ended December 31, 2014, approximately 18.1% of our revenue reimbursements came from Anthem Blue Cross Blue Shield of Colorado, 13.3% came from Blue Cross Blue Shield of Texas, 12.9% came from Aetna, 10.5% came from Blue Cross Blue Shield of California, and 10.5% came from United Behavioral Health. No other payor accounted for more than 10% of our revenue reimbursements for the year ended December 31, 2014. If any of these or other third-party payors reduce their reimbursement rates for the services we provide or otherwise implement measures, such as specialized networks, that reduce the payments we receive, our revenues, profitability and cash flows could be materially adversely affected.

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Our acquisition strategy exposes us to a variety of operational, integration and financial risks, which may have a material adverse effect on our business, financial condition and results of operations.

A principal element of our business strategy is to grow by acquiring other companies and assets in the mental health and substance abuse treatment industry. We evaluate potential acquisition opportunities consistent with the normal course of our business. Our ability to complete acquisitions is subject to a number of risks and variables, including our ability to negotiate mutually agreeable terms with the counterparties, our ability to finance the purchase price and our ability to obtain any licenses or other approvals required to operate the assets to be acquired. We may not be successful in identifying and consummating suitable acquisitions, which may impede our growth and negatively affect our results of operations and may also require a significant amount of management resources. In addition, growth, especially rapid growth, through acquisitions exposes us to a variety of operational and financial risks. We summarize the most significant of these risks below.

 

Integration risks.  We must integrate our acquisitions with our existing operations. This process involves various components of our business and the businesses we have acquired, including the following:

 

The integration of acquisitions with our operations could be expensive, require significant attention from management, may impose substantial demands on our operations or other projects and may impose challenges on the combined business including, without limitation, consistencies in business standards, procedures, policies, business cultures and internal controls and compliance. In addition, certain acquisitions require a capital outlay, and the return we achieve on such invested capital may be less than the return that we could achieve on other projects or investments.

 

Benefits may not materialize. When evaluating potential acquisition targets, we identify potential synergies and cost savings that we expect to realize upon the successful completion of the acquisition and the integration of the related operations. We may, however, be unable to achieve or may otherwise never realize the expected benefits. Our ability to realize the expected benefits from potential cost savings and revenue improvement opportunities is subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond our control, such as changes to government regulation governing or otherwise impacting the substance abuse treatment and behavioral healthcare industries, reductions in reimbursement rates from third-party payors, operating difficulties, difficulties obtaining required licenses and permits, client preferences, changes in competition and general economic or industry conditions. If we do not achieve our expected results, it may adversely impact our results of operations.

 

Assumptions of unknown liabilities.  Businesses that we acquire may have unknown or contingent liabilities, including, without limitation, liabilities for failure to comply with healthcare laws and regulations. Although we typically attempt to exclude significant liabilities from our acquisition transactions and seek indemnification from the sellers of such facilities for at least a portion of these matters, we may experience difficulty enforcing those indemnification obligations, or we may incur material liabilities for the past activities of acquired facilities. Such liabilities and related legal or other costs and/or resulting damage to a facility’s reputation could negatively impact our business.

 

Completing Acquisitions.  Suitable acquisitions may not be accomplished due to unfavorable terms. Further, the cost of an acquisition could result in a dilutive effect on our results of operations, depending on various factors, including the amount paid for an acquired facility, the acquired facility’s results of operations, the fair value of assets acquired and liabilities assumed, effects of subsequent legislation and limits on reimbursement rate increases. In addition, we may have to pay cash, incur additional debt or issue equity securities to pay for any such acquisition, which could adversely affect our financial results, result in dilution to our existing stockholders, result in increased fixed obligations or impede our ability to manage our operations.

 

Managing growth.  Some of the facilities we have acquired or may acquire in the future may have had significantly lower operating margins than the facilities we operated prior to the time of our acquisition thereof or had operating losses prior to such acquisition. If we fail to improve the operating margins of the facilities we acquire, operate such facilities profitably or effectively integrate the operations of acquired facilities, our results of operations could be negatively impacted.

 

 

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Our level of indebtedness could adversely affect our ability to meet our obligations under our indebtedness, react to changes in the economy or our industry and to raise additional capital to fund our operations.

 

As of December 31, 2015, we had total debt of $145.1 million outstanding.  We have historically relied on debt financing to fund our real estate development and our operating cash flow requirements, and we expect such debt financing needs to continue.  A summary of the material terms of our indebtedness can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources.” Our level of indebtedness could have important consequences to our stockholders. For example, it could:

 

Our operating flexibility is limited in significant respects by the restrictive covenants in our credit facility and subordinated convertible notes, and we may be unable to comply with all covenants in the future.

Our 2015 Credit Facility and subordinated convertible notes impose restrictions that could impede our ability to enter into certain corporate transactions, as well as increases our vulnerability to adverse economic and industry conditions, by limiting our flexibility in planning for, and reacting to, changes in our business and industry. These restrictions limit our and our subsidiaries’ ability to, among other things:

 

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In addition, our 2015 Credit Facility requires us to meet certain financial covenants. The restrictions may prevent us from taking actions that we believe would be in the best interests of our business and may make it difficult for us to successfully execute our business strategy or effectively compete with companies that are not similarly restricted. Our 2015 Credit Facility and subordinated convertible notes also contain cross-default and cross-acceleration provisions, respectively, that would apply to each other and to any other material indebtedness we may have. We may also incur future debt obligations that might subject us to additional restrictive covenants that could affect our financial and operational flexibility. Our ability to comply with these restrictive covenants in future periods will largely depend on our ability to successfully implement our overall business strategy. We cannot assure you that we will be granted any waivers or amendments to the 2015 Credit Facility or under the subordinated convertible notes if for any reason we are unable to comply with the terms of the 2015 Credit Facility and subordinated convertible notes in the future. The breach of any of these covenants or restrictions could result in a default under the 2015 Credit Facility and/or subordinated convertible notes, which could result in the acceleration of our debt. In the event of an acceleration of our debt, we could be forced to apply all available cash flows to repay such debt and could be forced into bankruptcy or liquidation. 

 

We will need additional financing to execute our business plan and fund operations, which additional financing may not be available on reasonable terms or at all.

As of December 31, 2015, we had $52.2 million of working capital. Our acquisition and de novo development strategies will require substantial capital. During 2015, we announced and/or completed eight acquisitions with an aggregate cash purchase price of approximately $151 million. During the same period, we purchased two properties with an aggregate cash purchase price of approximately $20.0 million.

 

To fund our acquisition and development strategies, we may consider raising additional funds through various financing sources, including the sale of our equity securities and the procurement of commercial debt financing. However, there can be no assurance that such funds will be available on commercially reasonable terms, if at all. If such financing is not available on satisfactory terms, we may be unable to expand or continue our business as desired and operating results may be adversely affected. Any debt financing will increase expenses and must be repaid regardless of operating results and may involve restrictions limiting our operating flexibility. If we issue equity securities to raise additional funds, the percentage ownership of our existing stockholders will be reduced, and our stockholders may experience additional dilution in net book value per share.

 

Our ability to obtain needed financing may be impaired by such factors as the capital markets, both generally and specifically in our industry, which could impact the availability or cost of future financings. If the amount of capital we are able to raise from financing activities, together with our revenues from operations, is not sufficient to satisfy our capital needs, we may be required to decrease the pace of, or eliminate, our acquisition strategy and potentially reduce or even cease operations.

 

Our business may face significant risks with respect to future de novo expansion, including the time and costs of identifying new geographic markets, the ability to obtain necessary licensure and other zoning or regulatory approvals and significant start-up costs including advertising, marketing and the costs of providing equipment, furnishings, supplies and other capital resources.

As part of our growth strategy, we intend to develop new substance abuse treatment facilities in existing and new markets, either by building a new facility or by acquiring an existing facility with an alternative use and repurposing it as a substance abuse treatment facility.  Such de novo expansion involves significant risks, including, but not limited to, the following:

 

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As a result of these and other risks, there can be no assurance that a de novo treatment facility will become profitable.

 

Our ability to maintain census and the average length of stay of our clients is dependent on a number of factors outside of our control, and if we are unable to maintain census, or if we experience a significant decrease in average length of stay, our business, results of operations and cash flows could be materially adversely affected.

Our revenues are directly impacted by our ability to maintain census and, to a lesser extent, the average length of stay of our clients.  These metrics are dependent on a variety of factors, many of which are outside of our control, including the effectiveness of our sales and marketing efforts, our referral relationships, our staffing levels and facility capacity, the extent to which third-party payors require preadmission authorization or utilization review controls, competition in the industry and the decisions of our clients to seek and commit to treatment.  A significant decrease in census or, to a lesser extent, average length of stay could materially adversely affect our revenues, profitability and cash flows due to lower reimbursements received and the additional resources required to collect accounts receivable and to maintain our existing level of business. 

Given the client-driven nature of the substance abuse treatment sector, our business is dependent on clients seeking and committing to treatment. Although increased awareness and de-stigmatization of substance abuse treatment in recent years has resulted in more people seeking treatment, the decision of each client to seek treatment is ultimately discretionary.  In addition, even after the initial decision to seek treatment, our adult clients may decide at any time to discontinue treatment and leave our facilities against the advice of our physicians and other treatment professionals.  For this reason, among others, average length of stay can vary among periods without correlating to the overall operating performance of our business. Management does not view average length of stay as a key metric with respect to our operating performance; however, if clients or potential clients decide not to seek treatment or discontinue treatment early, census and average length of stay could decrease and, as a result, our business, financial condition and results of operations could be adversely affected.

 

As a provider of treatment services, we are subject to governmental investigations and potential claims and legal actions by clients, employees and others, which may increase our costs and have a material adverse effect on our business, financial condition and results of operations.

Given the addiction and mental health issues of clients and the nature of the services provided, the substance abuse treatment industry is heavily regulated by governmental agencies and involves significant risk of liability.  We and others in our industry are exposed to the risk of governmental investigations and lawsuits or other claims against us and our physicians and professionals arising out of our day to day business operations, including, without limitation, client treatment at our facilities and relationships with healthcare providers that may refer clients to us.  Addressing any investigations, lawsuits or other claims may distract management and divert resources, even if we ultimately prevail.  Regardless of the outcome of any such investigation, lawsuit or claim, the publicity and potential risks associated with the investigation, lawsuit or claim could negatively impact the perception of the Company by clients, investors or others.  Fines, restrictions, penalties and damages imposed as a result of an investigation or a successful lawsuit or claim that is not covered by, or is in excess of, our insurance coverage may increase our costs and reduce our profitability.  Our insurance premiums have increased year over year, and insurance coverage may not be available at a reasonable cost in the future, especially given the significant increase in insurance premiums generally experienced in the healthcare industry.

 

We are also subject to potential medical malpractice lawsuits and other legal actions in the ordinary course of business. Some of these actions may involve large claims as well as significant defense costs. We cannot predict the outcome of these lawsuits or the effect that findings in such lawsuits may have on us. All professional and general liability insurance we purchase is subject to policy limitations. We believe that, based on our past experience, our insurance coverage is adequate considering the claims arising from the operation of our facilities. While we continuously monitor our coverage, our ultimate liability for professional and general liability claims could change materially from our current estimates. If such policy limitations should be partially or fully exhausted in the future or if payments of claims exceed our estimates or are not covered by our insurance, it could have a material adverse effect on our financial condition and results of operations.

 

Certain of our current and former employees and certain of our subsidiaries are defendants in a criminal proceeding that could result in a substantial disruption to our business.

 

On July 29, 2015, a California court unsealed a criminal indictment returned by a grand jury against certain of our subsidiaries, our former President and former member of our Board of Directors, a current facility-level employee and three former

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employees.  The indictment was returned in connection with a criminal investigation by the California Department of Justice and charged the defendants with second-degree murder and dependent adult abuse in connection with the death of a client in 2010 at one of our former locations. We believe the allegations are legally and factually unfounded and intend to contest them vigorously. We have always strived to deliver and will continue to seek to provide, quality, comprehensive, compassionate care to individuals and families struggling with alcohol and drug addictions and mental and behavioral health issues. Defending ourselves against the indictment could potentially entail costs that are material and could require significant attention from our management. If the defendants were to be convicted of the crimes alleged in the indictment, potential penalties could include fines, restitution, conditions of probation and other remedies. Given the relatively early stage of this proceeding, we cannot estimate the amount or range of loss if the defendants were to be convicted; however, such loss could be material. Regardless of the outcome of the indictment, the publicity and potential risks associated with the indictment could negatively impact the perception of our Company by clients, investors and others. The consequences of the current criminal proceeding, as well as consequences of any future governmental investigation or lawsuit of any related or unrelated matter, could have a material adverse effect on our business and results of operations.

 

We operate in a highly competitive industry, and competition may lead to declines in client volumes and an increase in labor costs, which could have a material adverse effect on our business, financial condition and results of operations.

The substance abuse treatment industry is highly competitive, and competition among substance abuse treatment providers (including behavioral healthcare facilities) for clients has intensified in recent years. There are behavioral healthcare facilities that provide substance abuse and other mental health treatment services comparable to at least some of the services offered by our facilities in each of the geographical areas in which we operate. Some of our competitors are owned by tax-supported governmental agencies or by nonprofit corporations and may have certain financial advantages not available to us, including endowments, charitable contributions, tax-exempt financing and exemptions from sales, property and income taxes.  If our competitors are better able to attract clients, expand services or obtain favorable participation agreements at their facilities, we may experience a decline in client volume, which could have a material adverse effect on our business, financial condition and results of operations.

 

Our operations depend on the efforts, abilities and experience of our management team, physicians and medical support personnel, including our nurses, mental health technicians, therapists and counselors.  We compete with other healthcare providers in recruiting and retaining qualified management, physicians, nurses and other support personnel responsible for the daily operations of our facilities.

 

The nationwide shortage of nurses and other medical support personnel is a significant operating issue facing us and other healthcare providers. This shortage may require us to enhance wages and benefits to recruit and retain nurses and other medical support personnel or require us to hire more expensive temporary or contract personnel. In addition, certain of our facilities are required to maintain specified nurse-staffing levels. To the extent we cannot meet those levels, we may be required to limit the services provided by these facilities, which could have a corresponding adverse effect on our net operating revenues.

 

Increased labor union activity is another factor that could adversely affect our labor costs. Although we are not aware of any union organizing activity at any of our facilities, we are unable to predict whether any such activity will take place in the future. To the extent that a portion of our employee base unionizes, it is possible that our labor costs could increase materially.

 

We cannot predict the degree to which we will be affected by the future availability or cost of attracting and retaining talented medical support staff. If our general labor and related expenses increase, we may not be able to raise our rates correspondingly. Our failure to either recruit and retain qualified management, physicians, nurses and other medical support personnel or control our labor costs could have a material adverse effect on our business, financial condition and results of operations.

 

We depend heavily on key management personnel, and the departure of one or more of our key executives or a significant portion of our local facility management personnel or sales force could have a material adverse effect on our business, financial condition and results of operations.

The expertise and efforts of our key executives, including our chief executive officer, chief operating officer, chief financial officer and general counsel, and other key members of our facility management personnel and sales staff are critical to the success of our business. We do not currently have employment agreements or non-competition covenants with any of our key executives. The loss of the services of one or more of our key executives or of a significant portion of our facility management personnel or sales staff could significantly undermine our management expertise and our ability to provide efficient, quality healthcare services at our facilities.  Furthermore, if one or more of our key executives were to terminate employment with us and engage in a competing business, we would be subject to increased competition, which could have a material adverse effect on our business, financial condition and results of operations.

Our business depends on our information systems and our inability to effectively integrate, manage and keep secure our information systems could disrupt our operations and have a material adverse effect on our business.

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Our business depends on effective and secure information systems that assist us in, among other things, admitting clients to our facilities, monitoring census and utilization, processing and collecting claims, reporting financial results, measuring outcomes and quality of care, managing regulatory compliance controls, and maintaining operational efficiencies.  These systems include software developed in-house and systems provided by external contractors and other service providers.  To the extent that these external contractors or other service providers become insolvent or fail to support the software or systems, our operations could be negatively affected.  Our facilities also depend upon our information systems for electronic medical records, accounting, billing, collections, risk management, payroll and other information.  If we experience a reduction in the performance, reliability, or availability of our information systems, our operations and ability to process transactions and produce timely and accurate reports could be adversely affected.

 

Our information systems and applications require continual maintenance, upgrading, and enhancement to meet our operational needs.  Our acquisitions require transitions and integration of various information systems. We regularly upgrade and expand our information systems’ capabilities. If we experience difficulties with the transition and integration of information systems or are unable to implement, maintain, or expand our systems properly, we could suffer from, among other things, operational disruptions, regulatory problems, working capital disruptions and increases in administrative expenses.

 

In addition, we could be subject to a cyber-attack that bypasses our information technology security systems and other security incidents that result in security breaches, including the theft, loss or misappropriation of individually identifiable health information subject to HIPAA and other privacy and security laws, proprietary business information, or other confidential or personal data. Such an incident could also disrupt our information technology business systems, cause us to incur significant investigation and remediation expenses, and subject us to litigation, government inquiries, penalties and reputational damages. Information security and the continued development, maintenance and enhancement of our safeguards to protect our systems, data, software and networks is a priority for us. As security threats continue to evolve, we may be required to expend significant additional resources to modify and enhance our safeguards and investigate and remediate any information security vulnerabilities. If we are subject to cyber-attacks or security breaches, our business, financial condition and results of operations could be adversely impacted.

 

Further, our information systems are vulnerable to damage or interruption from fire, flood, natural disaster, power loss, telecommunications failure, break-ins and similar events.  A failure to implement our disaster recovery plans or ultimately restore our information systems after the occurrence of any of these events could have a material adverse effect on our business, financial condition and results of operations.  Because of the confidential health information we store and transmit, loss of electronically-stored information for any reason could expose us to a risk of regulatory action, litigation, possible liability and loss.

 

Failure to adequately protect our trademarks and any other proprietary rights could have a material adverse effect on our business, financial condition and results of operations.

 

We maintain a trademark portfolio that we consider to be of significant importance to our business, and we may acquire additional trademarks or other proprietary rights in acquisitions that we pursue as part of our growth strategy. If the actions we take to establish and protect our trademarks and other proprietary rights are not adequate to prevent imitation of our services by others or to prevent others from seeking to block sales of our services as an alleged violation of their trademarks and proprietary rights, it may be necessary for us to initiate or enter into litigation in the future to enforce our trademark rights or to defend ourselves against claimed infringement of the rights of others. Any legal proceedings could result in an adverse determination that could have a material adverse effect on our business, financial condition and results of operations.

 

Failure to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act could have a material adverse effect on our business.

We are required to maintain effective internal control over financial reporting in accordance with Section 404 of the Sarbanes-Oxley Act in the course of preparing our consolidated financial statements. If we are unable to maintain effective internal control over financial reporting, we may be unable to report our financial information on a timely basis, may suffer adverse regulatory consequences or violations of NYSE listing rules. There could also be a negative reaction in the financial markets due to a loss of investor confidence in us and the reliability of our financial statements. Confidence in our financial statements is also likely to suffer if we report a material weakness in our internal control over financial reporting. In addition, we have incurred and will continue to incur incremental costs in order to improve our internal control over financial reporting and comply with Section 404 of the Sarbanes-Oxley Act, including increased auditing and legal fees.

Risks Related to Regulatory Matters

If we fail to comply with the extensive laws and government regulations impacting our industry, we could suffer penalties, be the subject of federal and state investigations or be required to make significant changes to our operations, which may reduce

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our revenues, increase our costs and have a material adverse effect on our business, financial condition and results of operations.

Healthcare service providers are required to comply with extensive and complex laws and regulations at the federal, state and local government levels relating to, among other things:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Failure to comply with these laws and regulations could result in the imposition of significant civil or criminal penalties, loss of license or certification or require us to change our operations, which may have a material adverse effect on our business, financial condition and results of operations. Both federal and state government agencies as well as commercial payors have heightened and coordinated civil and criminal enforcement efforts as part of numerous ongoing investigations of healthcare organizations.

 

We endeavor to comply with all applicable legal and regulatory requirements, however, there is no guarantee that we will be able to adhere to all of the complex government regulations that apply to our business. We seek to structure all of our relationships with physicians to comply with applicable anti-kickback laws, physician self-referral laws, fee-splitting laws and state corporate practice of medicine prohibitions.  We monitor these laws and their implementing regulations and implement changes as necessary. However, the laws and regulations in these areas are complex and often subject to varying interpretations.  For example, if an enforcement agency were to challenge the compensation paid under our contracts with professional physician groups, we could be required to change our practices, face criminal or civil penalties, pay substantial fines or otherwise experience a material adverse effect as a result.

 

We may be required to spend substantial amounts to comply with legislative and regulatory initiatives relating to privacy and security of client health information.

There are currently numerous legislative and regulatory initiatives at the federal and state levels addressing client privacy and security concerns. In particular, federal regulations issued under the Drug Abuse Prevention, Treatment and Rehabilitation Act of

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1979 strictly restrict the disclosure of client identifiable information related to substance abuse. These requirements apply to any of our facilities that receive any federal assistance, which is interpreted broadly to include facilities licensed, certified or registered by a federal agency. In addition, the federal privacy and security regulations issued under HIPAA require our facilities to comply with extensive administrative requirements on the use and disclosure of individually identifiable health information (known as “protected health information”) and require covered entities, which include most healthcare providers, to implement and maintain administrative, physical and technical safeguards to protect the security of such information. Additional security requirements apply to electronic protected health information. These regulations also provide clients with substantive rights with respect to their health information and impose substantial administrative obligations on our facilities, including the requirement to enter into written agreements with contractors, known as business associates, to whom our programs disclose protected health information. We may be subject to penalties as a result of a business associate violating HIPAA, if the business associate is found to be our agent.  Covered entities must notify individuals, the U.S. Department of Health and Human Services, or HHS, and, in some cases, the media of breaches involving unsecured protected health information. HHS and state attorneys general are authorized to enforce these regulations. Violations of the HIPAA privacy and security regulations may result in significant civil and criminal penalties, and data breaches and other HIPAA violations may give rise to class action lawsuits by affected clients under state law.

 

Our programs remain subject to any privacy-related federal or state laws that are more restrictive than the HIPAA privacy and security regulations. These laws vary by state and could impose additional requirements and penalties. For example, some states impose strict restrictions on the use and disclosure of health information pertaining to mental health or substance abuse. Further, most states have enacted laws and regulations that require us to notify affected individuals in the event of a data breach involving individually identifiable information. In addition, the Federal Trade Commission may use its consumer protection authority to initiate enforcement actions in response to data breaches or other privacy or security lapses.

 

As public attention is drawn to issues related to the privacy and security of medical and other personal information, federal and state authorities may increase enforcement efforts, seek to impose harsher penalties as well as revise and expand laws or enact new laws concerning these topics. Compliance with current as well as any newly established provisions or interpretations of existing requirements will require us to expend significant resources. Increased focus on privacy and security issues by enforcement authorities may increase the overall risk that our substance abuse treatment facilities may be found lacking under federal and state privacy and security laws and regulations.

 

Our treatment facilities operate in an environment of increasing state and federal enforcement activity and private litigation targeted at healthcare providers.

Both federal and state government agencies have heightened and coordinated their civil and criminal enforcement efforts as part of numerous ongoing investigations of healthcare companies and various segments of the healthcare industry. These investigations relate to a wide variety of topics, including relationships with physicians, billing practices and use of controlled substances. The Affordable Care Act included an additional $350 million of federal funding over ten years to fight healthcare fraud, waste and abuse, including $30 million for federal fiscal year 2016. From time to time, the HHS Office of Inspector General and the Department of Justice have established national enforcement initiatives that focus on specific billing practices or other suspected areas of abuse. Although we do not currently bill Medicare or Medicaid for substance abuse treatment services, there is a risk that specific investigation initiatives could be expanded to include our treatment facilities. In addition, increased government enforcement activities, even if not directed towards our treatment facilities, also increase the risk that our facilities, physicians and other clinicians furnishing services in our facilities, or our executives and directors, could be named as defendants in private litigation such as state or federal false claims act cases or consumer protection cases, or could become the subject of complaints at the various state and federal agencies that have jurisdiction over our operations. Any governmental investigations, private litigation or other legal proceedings involving any of our facilities, our executives or our directors, even if we ultimately prevail, could result in significant expense and could adversely affect our reputation or profitability. In addition, we may be required to make changes in our laboratory or other substance abuse treatment services as a result of an adverse determination in any governmental enforcement action, private litigation or other legal proceeding, which could materially adversely affect our business and results of operations.

 

Changes to federal, state and local regulations, as well as different or new interpretations of existing regulations, could adversely affect our operations and profitability.

Because our treatment programs and operations are regulated at federal, state and local levels, we could be affected by different regulatory changes in different regional markets. Increases in the costs of regulatory compliance and the risks of noncompliance may increase our operating costs, and we may not be able to recover these increased costs, which may adversely affect our results of operations and profitability.

 

Many of the current laws and regulations are relatively new. Thus, we do not always have the benefit of significant regulatory or judicial interpretation of these laws and regulations. In the future, evolving interpretations or enforcement of these laws and regulations could subject our current or past practices to allegations of impropriety or illegality or could require us to make changes in our treatment facilities, equipment, personnel, services or capital expenditure programs. A determination that we have violated these

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laws, or a public announcement that we are being investigated for possible violations of these laws, could adversely affect our business, operating results and overall reputation in the marketplace.

 

In addition, federal, state and local regulations may be enacted that impose additional requirements on our facilities.  Adoption of legislation or the creation of new regulations affecting our facilities could increase our operating costs, restrain our growth, limit us from taking advantage of opportunities presented and could have a material adverse effect on our business, financial condition and results of operations.  Adverse changes in existing comprehensive zoning plans or zoning regulations that impose additional restrictions on the use of, or requirements applicable to, our facilities may affect our ability to operate our existing facilities or acquire new facilities, which may adversely affect our results of operations and profitability.

 

We are subject to uncertainties regarding the impact of the Affordable Care Act and related payment reform efforts, which represent a significant change to the healthcare industry.

The Affordable Care Act provides for increased access to coverage for healthcare and seeks to reduce healthcare-related expenses. Overall, the expansion of health insurance coverage under the Affordable Care Act is expected to be beneficial to the substance abuse treatment industry. Health insurers are prohibited from denying coverage to individuals because of preexisting conditions. Further, all new small group and individual market health plans must cover ten essential health benefit categories, which include substance abuse addiction and mental health disorder services. The Affordable Care Act also requires small group and individual market plans to comply with the requirements of the Mental Health Parity and Addiction Equity Act of 2008, which was previously limited to group health plans and group insurers. According to 2013 HHS estimates, these changes will ensure coverage for substance abuse addiction treatment and mental health disorders treatment for 62.5 million Americans.

The expansion of commercial insurance for substance abuse treatment services under the Affordable Care Act may result in a higher demand for services from all providers. This may bring new competitors to the market, some of which may be better capitalized and have greater market penetration than we do. Further, we expect increased demand for substance abuse treatment services to also increase the demand for case managers, therapists, medical technicians and others with clinical expertise in substance abuse treatment, which may make it more difficult to adequately staff our substance abuse treatment facilities and could significantly increase our costs in delivering treatment, which may adversely affect both our operations and profitability.

One of the many impacts of the Affordable Care Act has been a dramatic increase in payment reform efforts by federal and state government payors as well as commercial payors. These efforts take many forms, including the growth of ACOs, pay-for-performance bonus arrangements, partial capitation arrangements and the bundling of services into a single payment. One result of these efforts is that more risk of the overall cost of care is being transferred to providers. As institutional providers and their affiliated physicians assume more risk for the cost of care, we expect more services to be furnished within provider networks formed to accept these types of payment reform. Our ability to compete and to retain our traditional sources of clients may be adversely affected by our exclusion from such networks or our inability to be included in such networks.

The Affordable Care Act remains subject to court challenges, legislative efforts to repeal or amend the law and regulatory interpretation. We cannot predict the impact that the Affordable Care Act and related rulemaking and regulations may have on our business, results of operations, cash flow, capital resources and liquidity or whether we will be able to adapt successfully to the changes required by the Affordable Care Act.

Change of ownership or change of control requirements imposed by state and federal licensure and certification agencies as well as third-party payors may limit our ability to timely realize opportunities, adversely affect our licenses and certifications, interrupt our cash flows and adversely affect our profitability.

State licensure laws and many federal healthcare programs (where applicable) impose a number of obligations on healthcare providers undergoing a change of ownership or change of control transaction.  These requirements may require new license applications as well as notices given a fixed number of days prior to the closing of affected transactions.  These provisions require us to be proactive when considering both internal restructuring and acquisitions of third-party targets.  Failure to provide such notices or to submit required paperwork can adversely affect licensure on a going forward basis, can subject the parties to penalties and can adversely affect our ability to operate our facilities.

 

Many third-party payor agreements, including government payor programs, also have change of ownership or change of control provisions.  Such provisions generally include a prior notice provision as well as require the consent of the payor in order to continue the terms of the payor agreement.  Abiding by the terms of such provisions may reopen pricing negotiations with third-party payors where the provider currently has favorable reimbursement terms as compared to the market. Failure to comply with the terms of such provisions can result in a breach of the underlying third-party payor agreement. Currently, we have few third-party payor agreements; however, as substance abuse treatment coverage and payment reform initiatives continue to expand, these types of provisions could have a significant impact on our ability to realize opportunities and could adversely affect our cash flows and profitability.

 

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We could face risks associated with, or arising out of, environmental, health and safety laws and regulations.

We are subject to various federal, state and local laws and regulations that:

 

 

 

 

Compliance with these laws and regulations could increase our costs of operation. Violation of these laws may subject us to significant fines, penalties or disposal costs, which could negatively impact our results of operations, financial position or cash flows. We could be responsible for the investigation and remediation of environmental conditions at currently or formerly operated or leased sites, as well as for associated liabilities, including liabilities for natural resource damages, third-party property damage or personal injury resulting from lawsuits that could be brought by the government or private litigants relating to our operations, the operations of our facilities or the land on which our facilities are located. We may be subject to these liabilities regardless of whether we lease or own the facility, and regardless of whether such environmental conditions were created by us or by a prior owner or tenant, or by a third-party or a neighboring facility whose operations may have affected such facility or land, because liability for contamination under certain environmental laws can be imposed on current or past owners or operators of a site without regard to fault. We cannot assure you that environmental conditions relating to our prior, existing or future sites or those of predecessor companies whose liabilities we may have assumed or acquired will not have a material adverse effect on our business.

 

State efforts to regulate the construction or expansion of healthcare facilities could impair our ability to operate and expand our facilities.

The construction of new healthcare facilities, the expansion, transfer or change of ownership of existing facilities and the addition of new beds, services or equipment may be subject to state laws that require prior approval by state regulatory agencies under certificate of need (“CON”) laws. These laws generally require that a state agency determine the public need for construction or acquisition of facilities or the addition of new services. Review of CONs and other healthcare planning initiatives may be lengthy and may require public hearings. We currently do not operate facilities in any states where a CON is required to be obtained for capital expenditures exceeding a prescribed amount, changes in capacity or services offered. However, states in which we now or may in the future operate may require CONs under certain circumstances not currently applicable to us or may impose standards and other health planning requirements upon us. Violation of these state laws and our failure to obtain any necessary state approval could:

 

 

 

If we are unable to obtain required regulatory, zoning or other required approvals for renovations and expansions, our growth may be restrained and our operating results may be adversely affected.  In the past, we have not experienced any material adverse effects from such requirements, but we cannot predict their future impact on our operations.

Risks Related to Our Organization and Structure

We are a holding company with nominal net worth and will depend on dividends and distributions from our subsidiaries to pay dividends, if any.

AAC Holdings, Inc. is a holding company with nominal net worth. We do not conduct any business operations other than our investments in our subsidiaries. Our business operations are conducted primarily out of our direct operating subsidiary, AAC. As a result, our ability to pay dividends, if any, will be dependent upon cash dividends and distributions or other transfers to us from our subsidiaries, including AAC. Payments to us by our subsidiaries will be contingent upon their respective earnings and subject to any limitations on the ability of such entities to make payments or other distributions to us. In addition, our subsidiaries, including our direct operating subsidiary, AAC, are separate and distinct legal entities and have no obligation to make any funds available to us.

 

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Our directors, executive officers and principal stockholders and their respective affiliates have substantial control over the company and could delay or prevent a change in corporate control.

Our directors, executive officers and holders of more than 5% of our common stock, together with their affiliates, owned, in the aggregate, approximately 69.7% of our outstanding common stock as of December 31, 2015.  Michael T. Cartwright, our Chairman and Chief Executive Officer, and his affiliates owned approximately 25.1% of our common stock, and Jerrod N. Menz, our former President, a former member of our Board of Directors and an employee of the Company, and his affiliates owned approximately 21.6% of our common stock, in each case as of December 31, 2015.  As a result, these stockholders, acting together, have substantial control over the outcome of matters submitted to our stockholders for approval, including the election of directors and any merger, consolidation or sale of all or substantially all of our assets. In addition, these stockholders, acting together, will continue to have significant influence over the management and affairs of our company. Accordingly, this concentration of ownership may have the effect of:

 

 

 

 

Anti-takeover provisions in our articles of incorporation, bylaws and Nevada law could prevent or delay a change in control of our company.

Provisions in our articles of incorporation and amended and restated bylaws, which we refer to as our bylaws, may discourage, delay or prevent a merger, acquisition or change of control. These provisions could also discourage proxy contests and make it more difficult for stockholders to elect directors and take other corporate actions. These provisions:

 

 

 

 

 

 

 

 

The lack of public company experience of our management team could adversely impact our ability to comply with the reporting requirements of U.S. securities laws.

 

Our management team’s public company experience is limited to the operation of the Company since its IPO in October 2014, and their limited experience could impair our ability to comply with legal and regulatory requirements such as those imposed by the SEC, the New York Stock Exchange, or NYSE, or the Sarbanes-Oxley Act. In addition, we have limited accounting personnel and other related resources with SEC reporting experience. Despite recent reforms made possible by the JOBS Act, compliance with the securities laws and regulations, as well as the requirements of the NYSE, occupies a significant amount of time of our management and significantly increases our legal, accounting and other expenses, and will continue to do so in the future, particularly after we no longer qualify as an “emerging growth company.” Our senior management may not be able to implement programs and policies in an effective and timely manner that adequately respond to such increased legal, regulatory compliance and reporting requirements, including maintaining internal controls over financial reporting. Any such deficiencies, weaknesses or lack of compliance could have

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a material adverse effect on our ability to comply with the reporting requirements of the Exchange Act, which is necessary to maintain our public company status. If we fail to fulfill any of these public company reporting obligations, our ability to continue as a U.S. public company will be in jeopardy.

 

We are an emerging growth company, and we cannot be certain if the reduced reporting requirements applicable to emerging growth companies will make our common stock less attractive to investors.

 

We are an “emerging growth company” as defined under the JOBS Act. For as long as we continue to be an emerging growth company, we may take advantage of exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies, including not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements and exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We could be an emerging growth company for up to five years following the completion of our IPO in October 2014, although we could lose that status sooner if our revenues exceed $1 billion, if we issue more than $1 billion in non-convertible debt in a three year period or if the market value of our common stock held by non-affiliates meets or exceeds $700 million as of any June 30th before that time, in which case we would no longer be an emerging growth company as of the following December 31st. If some investors find our common stock less attractive because we may rely on these exemptions, there may be a less active trading market for our common stock, and our stock price may be more volatile.

 

Under the JOBS Act, emerging growth companies can also delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have irrevocably elected not to avail ourselves of this extended transition period for implementing new or revised accounting standards and, therefore, will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies that are not emerging growth companies.

 

 

Item 1B. Unresolved Staff Comments.

None.

 

 

Item 2. Properties.

A listing of our owned and leased facilities is included in Item 1 of this report under the heading “Facilities.” Additionally, we lease approximately 102,000 square feet of office space located at 200 Powell Place, Brentwood, Tennessee. We also lease approximately 11,000 square feet of laboratory space in Brentwood, Tennessee to perform quantitative drug testing and other laboratory services that support our treatment facilities.  We believe that these facilities are in good condition and suitable for our present requirements.

 

 

Item 3. Legal Proceedings.

From time to time, we may be engaged in various lawsuits and legal proceedings in the ordinary course of our business. Except as described below, we are currently not aware of any legal proceedings the ultimate outcome of which, in our judgment based on information currently available, would have a material adverse effect on our business, financial condition or results of operations.

 

State of California

 

On July 29, 2015, the Superior Court of the State of California court unsealed a criminal indictment returned by a grand jury against our subsidiaries ABTTC, Inc. dba A Better Tomorrow Treatment Centers, Forterus, Inc. and Forterus Health Care Services, Inc., Jerrod N. Menz, our former President and former member of our Board of Directors, as well as a current facility-level employee and three former employees.  Mr. Menz remains an employee of the Company. The indictment was returned in connection with a criminal investigation by the California Department of Justice and charged the defendants with second-degree murder and dependent adult abuse in connection with the death of a client in 2010 at one of our former locations. We believe the allegations are legally and factually unfounded and intend to contest them vigorously. Pending before the court are motions to dismiss the indictment on various legal and factual grounds.  Trial has been set for May 6, 2016.  Given the early stage of this proceeding, we cannot estimate the amount or range of loss if the defendants were to be convicted; however, such loss could be material.

 

Kasper v. AAC Holdings, Inc. et al. and Tenzyk c. AAC Holdings, Inc. et al.

 

On August 24, 2015, a shareholder filed a purported class action in the United States District Court for the Middle District of Tennessee against the Company and certain of its current and former officers.  The plaintiff generally alleges that the Company and certain of its current and former officers violated Sections 10(b) and/or 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by making allegedly false and/or misleading statements and failing to disclose certain information.  On

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September 14, 2015, a second class action against the same defendants asserting essentially the same allegations was filed in the same court.  On October 26, 2015, the court entered an order consolidating these two described actions into one action.  On February 29, 2016, the plaintiff filed a consolidated amended complaint.  The Company intends to defend this action vigorously.  At this time the Company cannot predict the results of this litigation with certainty, and cannot estimate the amount or range of loss, if any.  The Company believes the disposition of this action will not have a material adverse effect on its consolidated results of operations or consolidated financial position.

 

Other

The Company is aware of various other legal matters arising in the ordinary course of business. To cover these types of claims, the Company maintains insurance it believes to be sufficient for its operations, although some claims may potentially exceed the scope of coverage in effect. Plaintiffs in these matters may request punitive or other damages that may not be covered by insurance.

 

Item 4. Mine Safety Disclosures

Not applicable.

 

 

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PART II

 

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.

 

Market Information and Price Range of Common Stock

Our common stock began trading on October 2, 2014 and is listed for trading on the NYSE under the symbol “AAC.” Prior to that date, there was no public market for our common stock. The following table sets forth the high and low sales prices per share of our common stock as reported on the NYSE for the period in which our stock has been listed:

 

 

Stock Performance Graph

 

The following graph compares the cumulative total return on our common stock during the period from October 2, 2014 (the day our common stock began trading on the NYSE) through December 31, 2015, with the cumulative total return of the S&P 500 Index and the S&P Health Care Index.   The S&P 500 Index includes 500 companies representing all major industries.   The S&P Health Care Index is a group of 56 companies involved in a variety of healthcare related businesses.   The graph assumes $100 invested on October 2, 2014 in our common stock and in each index and assumes reinvestment of dividends, if any.  Stock price performance shown in the graph is not necessarily indicative of future stock performance.

 

 

 

 

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Holders of Record

 

On March 1, 2016, the closing price of our common stock on the NYSE was $20.34 per share.  As of March 1, 2016, there were approximately 189 holders of record of our common stock.  This does not include the number of persons whose stock is in nominee or “street” name accounts through brokers.

 

Dividend Policy

 

Holdings has never declared or paid cash dividends on our common stock. We currently intend to retain all available funds and any future earnings to support our operations and finance the growth and development of our business, and therefore, we do not anticipate paying cash dividends in the foreseeable future. Any future determination related to the payment of dividends will be made at the discretion of our Board of Directors and will depend on, among other factors, our results of operations, financial condition, capital requirements, contractual restrictions, business prospects and other factors our Board of Directors may deem relevant.

 

Equity Compensation Plan Information

 

See Part III, “Item 12—Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” for information regarding securities authorized for issuance under our equity compensation plans.

 

Unregistered Sale of Equity Securities and Issuer Purchases of Company Stock

 

As partial consideration for our acquisition of certain intellectual property assets of GigaVoice, LLC, a Florida limited liability company (“GigaVoice”), which closed on April 17, 2015, we issued 17,110 shares of our common stock to the owner of GigaVoice on January 1, 2016.

 

The transaction set forth in this subsection of Item 5 did not involve any underwriters, underwriting discounts or commissions or any public offering.  This transaction was made in reliance upon Section 4(a)(2) of the Securities Act (or Rule 506 of Regulation D promulgated thereunder) as a transaction by an issuer not involving a public offering.  The recipient of the securities in this transaction represented his intentions to acquire the securities for investment only and not with a view to or for sale in connection with any distribution thereof, and appropriate legends were placed upon the stock certificates or book-entry positions representing the shares issued in the transaction.  The recipient had adequate access, through his relationship with the Company, to information about the Company.

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Item 6. Selected Financial Data.

The following table presents our selected historical consolidated financial data as of the dates and for the periods indicated. Holdings was formed as a Nevada corporation on February 12, 2014, and acquired 93.6% of the outstanding shares of common stock of AAC on April 15, 2014 in connection with the Reorganization Transactions related to our IPO. As a result of the short-form merger completed in November 2014, AAC is a wholly-owned subsidiary of Holdings. Prior to the completion of the Reorganization Transactions, Holdings had not engaged in any business or other activities except in connection with its formation. Accordingly, all financial data herein relating to periods prior to the completion of the Reorganization Transactions is that of AAC and its consolidated subsidiaries.

The selected consolidated financial data below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and with our consolidated financial statements and notes thereto included elsewhere in this Annual Report on Form 10-K. The selected financial data in this section is not intended to replace our consolidated financial statements and the related notes.  Our historical results are not necessarily indicative of results that may be expected in the future.

 

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Adjusted EBITDA, adjusted net income available to AAC Holdings, Inc. common stockholders, and adjusted diluted earnings per share (herein collectively referred to as "Non-GAAP Disclosures") are “non-GAAP financial measures” as defined under the rules and regulations promulgated by the U.S. Securities and Exchange Commission.

Management defines Adjusted EBITDA as net income adjusted for interest expense, depreciation and amortization expense, income tax expense, stock-based compensation and related tax reimbursements, litigation settlement and California matter related expense, reorganization expense (which includes the Reorganization Transactions and expenses associated with the amendment and restatement of our then-existing credit facility), acquisition-related expense and certain other non-capitalized costs associated with our 2015 Credit Facility, de novo start-up expense and certain other non-recurring charges.  Where applicable, these include professional services for accounting, legal, valuation services and licensing expenses.

Management defines Adjusted Net Income Available to AAC Holdings, Inc. common stockholders as net income available to AAC Holdings, Inc. common stockholders adjusted for the redemption of BHR Series A Preferred Units in February 2015, litigation settlement and California matter related expense, reorganization expense (which includes the Reorganization Transactions and expenses associated with the amendment and restatement of our then-existing credit facility), acquisition-related expense and certain other non-capitalized costs associated with our 2015 Credit Facility, de novo start-up expense and certain other non-recurring charges and the income tax effect of the non-GAAP adjustments at the then applicable effective tax rate.  

The Non-GAAP Disclosures are considered supplemental measures of the Company’s performance and are not required by, or presented in accordance with, generally accepted accounting principles, or GAAP. The Non-GAAP Disclosures are not measures of the Company’s financial performance under GAAP and should not be considered as an alternative to net income or any other performance measures derived in accordance with GAAP. Management has included information concerning Non-GAAP Disclosures because they believe that such information is used by certain investors as a measure of a company’s historical performance. Management believes these measures are frequently used by securities analysts, investors and other interested parties in the evaluation of issuers of equity securities, many of which present EBITDA and Adjusted EBITDA when reporting their results. Because Non-GAAP Disclosures are not determined in accordance with GAAP, they are subject to varying calculations and may not be comparable to similarly titled measures of other companies. Management’s presentation of Non-GAAP Disclosures should not be construed as an inference that our future results will be unaffected by unusual or non-recurring items.

Reconciliation of Adjusted EBITDA to Net Income

 

 

Reconciliation of Adjusted Net Income Available to AAC Holdings, Inc. Common Stockholders to Net Income Available to AAC Holdings, Inc. Common Stockholders

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

This Annual Report on Form 10-K, the documents that it incorporates by reference and the documents into which it may be incorporated by reference, may contain, and from time to time the Company and its managements may make certain statements that constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995.  These forward-looking statements are made only as of the date of this annual report.  In some cases, you can identify forward-looking statements by terms such as “anticipates,” “believes,” “continues,” “could,” “estimates,” “expects,” “intend,” “may,” “might,” “potential,” “predicts,” “projects,” “plan,” “should,” “will,” “would,” and similar expressions intended to identify forward-looking statements, although not all forward-looking statements contain these words.  Forward-looking statements may include information concerning Holdings’ possible or assumed future results of operations, including descriptions of Holdings’ revenues, profitability, outlook and overall business strategy.  These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results and performance to be materially different from the information contained in the forward-looking statements.  These risks, uncertainties and other factors include, without limitation: (i) our inability to operate our facilities; (ii) our reliance on our sales and marketing program to continuously attract and enroll clients; (iii) a reduction in reimbursement rates by certain third-party payors for inpatient and outpatient services and point of care and diagnostic lab testing; (iv) our failure to successfully achieve growth through acquisitions and de novo expansions; (v) uncertainties regarding the timing of the closing of pending acquisitions; (vi) our failure to achieve anticipated financial results from prior or pending acquisitions; (vii) the possibility that a governmental entity may prohibit, delay or refuse to grant approval for the consummation of the acquisitions; (viii) a disruption in our ability to perform diagnostic drug testing services; (ix) maintaining compliance with applicable regulatory authorities, licensure and permits to operate our facilities and lab; (x) a disruption in our business related to the recent indictment of certain of our subsidiaries and current and former employees, including a former senior executive; (xi) our inability to agree on conversion and other terms for the balance of convertible debt; (xii) our inability to meet our covenants in our loan documents; (xiii) our inability to obtain senior lender consent to exceed the current $50 million limit in unsecured subordinated debt; (xiv) our inability to integrate newly acquired facilities; (xv) a disruption to our business and reputational and potential economic risks associated with the civil securities claims brought by shareholders; and (xvi) general economic conditions, as well as other risks discussed in the “Risk Factors” section of this Annual Report on Form 10-K, and other filings with the Securities and Exchange Commission.  As a result of these factors, we cannot assure you that the forward-looking statements in this annual report will prove to be accurate.  Investors should not place undue reliance upon forward-looking statements.

Overview

We are a provider of inpatient and outpatient substance abuse treatment services for individuals with drug and alcohol addiction.  In addition to our inpatient and outpatient treatment services, we perform drug testing and diagnostic laboratory services and provide physician services to our clients.  As of December 31, 2015, we operated nine residential substance abuse treatment facilities located throughout the United States, focused on delivering effective clinical care and treatment solutions across 897 beds, which includes 482 licensed detoxification beds, and nine standalone outpatient centers.  As of December 31, 2015, we also had a 93-bed facility near Aliso Viejo, California under development that we expect to open as a chemical dependency recovery hospital (“CDRH”) in the second quarter of 2016.  In addition, we are in the process of expanding our Recovery First facility in the Fort Lauderdale, Florida area to accommodate 22 additional detoxification beds, and are also expanding The Oxford Centre facility to accommodate 44 additional residential beds and 48 sober living beds.  

The majority of our approximately 1,600 employees, as of December 31, 2015 are highly trained clinical staff who deploy research-based treatment programs with structured curricula for detoxification, residential treatment, partial hospitalization and intensive outpatient care.  By applying a tailored treatment program based on the individual needs of each client, many of whom require treatment for a co-occurring mental health disorder, such as depression, bipolar disorder and schizophrenia, we believe we offer the level of quality care and service necessary for our clients to achieve and maintain sobriety.

We are also an internet marketer in the addiction treatment industry with respect to website visits and leads generated. Following our acquisition of RSG in July 2015, combined with our previously existing internet assets, we now operate a broad portfolio of internet assets that services millions of website visits each month. RSG, through its wholly owned subsidiary Recovery Brands, LLC (“Recovery Brands”), a leading publisher of “authority” websites such as Rehabs.com and Recovery.org, serves families and individuals struggling with addiction and seeking treatment options through comprehensive online directories, treatment provider reviews, forums and professional communities.  Recovery Brands also provides online marketing solutions to other treatment providers such as enhanced facility profiles, audience targeting, lead generation and tools for digital reputation management.

 

 

 

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2015 Developments

Existing Facilities and Ancillary Services

On January 1, 2015, we increased capacity at our Forterus facility in Temecula, California with the addition of 31 beds, including 24 detoxification beds.

On January 6, 2015, we entered into an office space lease for our new corporate headquarters and call center pursuant to which AAC agreed to lease approximately 102,000 square feet of office space located in Brentwood, Tennessee. We relocated to the new headquarters in the fourth quarter of 2015.

On January 8, 2015, our 20,000 square foot substance abuse outpatient center in Las Vegas, Nevada, received licensure for intensive outpatient treatment services and immediately began treating patients at the facility.

On February 18, 2015, our 20,000 square foot substance abuse outpatient center in Arlington, Texas, received licensure for intensive outpatient treatment services and began treating patients at the facility in April 2015.

In April 2015, we began performing definitive and confirmatory lab testing for AAC facilities in Rhode Island and California.

In August 2015, we completed an 8,000-square-foot expansion of our lab in Brentwood, Tennessee.

On December 31, 2015, we ceased operations at The Academy and FitRx due to their continued unprofitability and our realignment to focus solely on adult addiction treatment.  FitRx had 20 beds and was focused on binge eating and similar disorders. The Academy was a residential treatment facility with 18 beds that was focused on providing substance abuse treatment services to adolescent clients.

New Property Developments and Acquisitions

On February 20, 2015, we acquired the assets of Recovery First, a Florida-based provider of substance abuse treatment and rehabilitation services, including a 63-bed inpatient substance abuse treatment facility in the greater Fort Lauderdale, Florida area, for cash consideration of $13.0 million (the “Recovery First Acquisition”).  

On February 24, 2015, we acquired a property in Ringwood, New Jersey for aggregate cash consideration of $6.4 million, which we expect to develop into an inpatient facility with approximately 150 beds (the “Ringwood Property Acquisition”).  

On April 1, 2015, we acquired a memory care hospital in Aliso Viejo, California for an aggregate purchase price of $13.5 million in cash (the “Aliso Viejo Acquisition”). We began renovation and rehabilitation of the 93-bed facility in the second quarter of 2015 and expect to apply for a license to operate it as a CDRH. We expect to invest approximately $5.0 million for renovations and construction and have targeted a completion date in the second quarter of 2016.

On April 17, 2015, we completed the acquisition of the assets of CSRI, a provider of intensive outpatient substance abuse treatment services in Greenville, Portsmouth and South Kingstown, Rhode Island, for an aggregate of $665,000 in cash and approximately 42,460 shares of our common stock (the “CSRI Acquisition”).

On April 17, 2015, we acquired certain marketing assets with a value of $1.1 million for an aggregate of cash consideration of $0.5 million and 17,110 shares of the Company’s common stock.

On July 2, 2015, we acquired RSG, a leading publisher in the substance abuse treatment industry with a comprehensive portfolio of websites and marketing assets, for aggregate consideration of approximately $32.5 million in cash and 540,193 shares of our common stock (the “RSG Acquisition”).

On July 2, 2015, we also acquired Taj Media, a premier digital marketing agency with significant experience in the substance abuse treatment industry, for aggregate consideration of approximately $2.2 million in cash and 37,253 shares of our common stock (the “Taj Media Acquisition”).

On August 10, 2015, we completed the acquisition of the assets of The Oxford Centre, a Mississippi-based provider of substance abuse treatment and rehabilitation services, including a 76-bed inpatient substance abuse treatment facility in Etta,

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Mississippi and three outpatient facilities in Oxford, Tupelo and Olive Branch, Mississippi, for an aggregate of $35.0 million in cash and the assumption of certain liabilities (the “Oxford Centre Acquisition”).

On October 1, 2015, we completed the acquisition of the assets of Sunrise House, a New Jersey-based provider of substance abuse treatment and rehabilitation services, including a 110-bed inpatient substance abuse treatment facility in Lafayette, New Jersey, for cash consideration of $6.6 million and the assumption of certain liabilities (the “Sunrise House Acquisition”).

On October 16, 2015, we began treating clients at our River Oaks facility, a 162-bed residential treatment center located near Tampa, Florida after completing construction and receiving licensure.  The total construction cost of the River Oaks facility was $18.8 million.

On December 11, 2015, we signed a definitive agreement to acquire the assets of Wetsman Forensic Medicine, LLC (d/b/a Townsend) and its affiliates for an aggregate of $12.75 million in cash and $8.5 million in restricted shares of Holdings’ common stock.  Townsend is a leading substance abuse treatment provider in Louisiana and operates seven in-network outpatient centers in Louisiana that deliver intensive outpatient treatment as well as a 32-bed in-network facility located in Scott, Louisiana that offers detoxification and inpatient treatment. Townsend also operates an in-network lab that services these facilities.  The acquisition is subject to certain closing conditions such as the assignment of certain contracts and the receipt of certain licenses necessary to operate the business, and is expected to close in the second quarter of 2016. In addition, on February 1, 2016 we initiated development of a 10,000-square foot in-network laboratory outside of New Orleans that we expect to be completed in the third quarter of this year.   We currently anticipate that this lab expansion will increase the operational capacity of Townsend’s existing in-network lab.

On December 11, 2015, we signed a definitive agreement to acquire assets of Solutions Recovery, Inc. and its affiliates and associated real estate assets for an aggregate of $6.75 million in cash and $6.25 million in restricted shares of Holdings’ common stock.  The acquisition will provide 124 sober living beds; 70 licensed in-network detox, residential, and halfway house beds; and three in-network outpatient centers.  The acquisition is subject to certain closing conditions such as the assignment of certain contracts and the receipt of certain licenses necessary to operate the business, and is expected to close in the second quarter of 2016.

Financing

On March 9, 2015, we entered into a five-year, $125.0 million senior secured credit facility with Bank of America, N.A., as administrative agent for the lenders party thereto (the “2015 Credit Facility”), which consists of a $50.0 million revolver and a $75.0 million term loan.  We used a portion of the proceeds from the $75.0 million term loan to repay $24.9 million of prior indebtedness.   On July 1, 2015, we borrowed $15.0 million under the revolver, and on August 7, 2015, we borrowed an additional $32.0 million under the revolver.  Proceeds were used to fund de novo development projects and acquisitions. For additional discussion related to the 2015 Credit Facility, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financing Relationships.”

On October 2, 2015, we entered into two financing facilities with affiliates of Deerfield Management Company, L.P (“Deerfield”). The capital commitment consists of $25.0 million of subordinated convertible debt and up to $25.0 million of unsecured subordinated debt, together with an incremental facility of up to an additional $50.0 million of subordinated convertible debt (subject to certain conditions). We issued $25.0 million of subordinated convertible debt at closing.   A portion of the proceeds to date have been primarily used for de novo development activities and the remaining proceeds will be used to fund our active acquisition strategy, de novo pipeline and for other corporate purposes.  For additional discussion, see “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financing Relationships.”

Components of Results of Operations

Client Related Revenue.  Our client related revenue primarily consists of service charges related to providing addiction treatment and related services, including the collection and laboratory testing of urine for controlled substances. We recognize revenues at the estimated net realizable value in the period in which services are provided. For the years ended December 31, 2014 and 2015, approximately 90% of our client related revenues were reimbursable by commercial payors, including amounts paid by such payors to clients, with the remaining revenues payable directly by our clients. Given the scale and nationwide reach of our network of substance abuse treatment facilities, we generally have the ability to serve clients located across the country from any of our facilities, which allows us to operate our business and analyze revenue on a system-wide basis rather than focusing on any individual facility.

 

For the year ended December 31, 2015, approximately 15.1% of our client related revenue reimbursements came from Anthem Blue Cross Blue Shield of Colorado, 12.5% came from Blue Cross Blue Shield of Texas, 11.5% came from Aetna, and 11.1% came from Blue Cross Blue Shield of California.  No other payor accounted for more than 10% of our client related revenue reimbursements for the year ended December 31, 2015.  For the year ended December 31, 2014, approximately 18.1% of our client related revenue reimbursements came from Anthem Blue Cross Blue Shield of Colorado, 13.3% came from Blue Cross Blue Shield of

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Texas, 12.9% came from Aetna, 10.5% came from Blue Cross Blue Shield of California, and 10.5% came from United Behavioral Health.  No other payor accounted for more than 10% of our client related revenue reimbursements for the year ended December 31, 2014.  

The following table summarizes the composition of our client related revenues for detoxification and residential treatment services, partial hospitalization and intensive outpatient treatment services, and point-of-care drug testing, diagnostic laboratory services, professional groups and other ancillary services for the years ended December 31, 2014 and 2015:

 

¹ Professional groups and other ancillary services represent less than 10% of the total percentage of commercial payor revenues for point-of-care drug testing, diagnostic laboratory services, professional groups and other ancillary services.

The increase in detoxification and residential treatment services as a percentage of client related revenues and the decrease in partial hospitalization and intensive outpatient treatment services as a percentage of client related revenues was primarily related to the 28% increase in licensed detoxification beds during 2015 as a result of acquisitions and the opening of River Oaks in October 2015. As of December 31, 2015, we had 482 licensed detoxification beds compared to 378 licensed detoxification beds as of December 31, 2014.

The increase in point-of-care drug testing, diagnostic laboratory services, professional groups and other ancillary services as a percentage of client related revenues in fiscal 2015 compared to fiscal 2014 was primarily related to the addition of high complexity lab testing revenues from our facilities in Florida and California as a result of beginning to provide such services in December 2014 and April 2015, respectively.  This increase was partially offset by a decline in the number of tests performed on a per client basis and a decline in reimbursement rates for point-of-care testing and diagnostic laboratory services during the second half of 2015.  We experienced a decline of 12% in point-of-care drug testing, diagnostic laboratory services, professional groups and other ancillary services as a percentage of client related revenues for the six months ended December 31, 2015 compared to the six months ended June 30, 2015.  Point-of-care drug testing, diagnostic laboratory services, professional groups and other ancillary services as a percentage of client related revenues for the six months ended December 31, 2015 was 24% compared to 36% for the six months ended June 30, 2015.  

We recognize revenues from commercial payors at the time services are provided based on our estimate of the amount that payors will pay us for the services performed. We estimate the net realizable value of revenues by adjusting gross client charges using our expected realization and applying this discount to gross client charges. Our expected realization is determined by management after taking into account the type of services provided and the historical collections received from the commercial payors, on a per facility basis, compared to the gross client charges billed.

Our accounts receivable primarily consists of amounts due from commercial payors. The client self-pay portion is usually collected upon admission and in limited circumstances the client will make a deposit and negotiate the remaining payments as part of the services. We do not recognize revenue for any amounts not collected from the client in either of these situations. From time to time, we may provide free care to a limited number of clients, which we refer to as scholarships. We do not recognize revenues for scholarships provided. Included in the aging of accounts receivable are amounts for which the commercial insurance company paid out-of-network claims directly to the client and for which the client has yet to remit the insurance payment to us (which we refer to as “paid to client”). Such amounts paid to clients continue to be reflected in our accounts receivable aging as amounts due from commercial payors. Accordingly, our accounts receivable aging does not provide for the distinct identification of paid to client receivables.

Other Revenue.  Our other revenue consists of service charges from the delivery of quality targeted leads to behavioral and mental health service businesses through our operating subsidiary RSG, which was acquired on July 2, 2015.  Revenue is recognized when persuasive evidence of an arrangement exists, services have been rendered, the fee for services is fixed or determinable, and collectability of the fee is reasonably assured. 

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Operating Expenses. Our operating expenses are primarily impacted by nine categories of expenses: salaries, wages and benefits; advertising and marketing; professional fees; client related services; other operating expenses; rentals and leases; provision for doubtful accounts; depreciation and amortization; and acquisition-related expenses.

Key Drivers of Our Results of Operations. Our results of operations and financial condition are affected by numerous factors, including those described under “Risk Factors” and those described below:

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The following table presents, for the years ended December 31, 2014 and 2015, the average length of stay and average billed days with respect to detoxification and residential treatment services and partial hospitalization and intensive outpatient services of our commercial payor clients:

The average length of stay and average billed days with respect to our private pay clients, which is not separately allocated to any category of service is approximately 35 days for the year ended December 31, 2014 and 31 days for the year ended December 31, 2015, respectively.

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Results of Operations

The following table presents our consolidated income statements for the periods indicated (dollars in thousands):

 

 

Comparison of Year ended December 31, 2015 to Year ended December 31, 2014

Client Related Revenue

Client related revenues increased $72.8 million, or 54.7%, to $205.8 million for the year ended December 31, 2015 from $133.0 million for the year ended December 31, 2014. Revenues were positively impacted by an increase in average daily residential census, outpatient visits at our nine standalone outpatient centers, and an increase in high complexity lab testing.    

Our average daily residential census increased by 42.6% to 562 clients for the year ended December 31, 2015 from 396 clients for the year ended December 31, 2014.  The increase in average daily residential census was driven by the 60 bed expansion of Greenhouse in July 2014, the 31 bed expansion at Forterus in January 2015, the Recovery First Acquisition, which added 56 beds, in February 2015, the Oxford Centre Acquisition, which added 76 beds, in August 2015, the Sunrise House Acquisition, which added 110 beds in October 2015, and the opening of River Oaks, which added 162 beds, in October 2015.

With the opening of the Desert Hope Outpatient Center in January 2015, the opening of the Greenhouse Outpatient Center in April 2015, the CSRI Acquisition in April 2015 (which added three standalone outpatient centers), the Oxford Centre Acquisition in

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August (which added three standalone outpatient centers), and the Sunrise House Acquisition in October 2015 (which added one standalone outpatient center), we now operate nine standalone outpatient centers.  We had 12,879 outpatient visits at our nine standalone outpatient centers for the year ended December 31, 2015.      

As a percentage of client related revenues, point-of-care drug testing, diagnostic laboratory services, professional groups and other ancillary services were 30% and 26% for the years ended December 31, 2015 and 2014, respectively.  We experienced a decline of 14% in point-of-care drug testing, diagnostic laboratory services, professional groups and other ancillary services as a percentage of client related revenues for the six months ended December 31, 2015 compared to the six months ended June 30, 2015.    Point-of-care drug testing, diagnostic laboratory services, professional groups and other ancillary services as a percentage of client related revenues for the six months ended December 31, 2015 was 24% compared to 38% for the six months ended June 30, 2015.  The decline as a percentage of client related revenues was related to a combination of a decrease in the number of tests performed on a per patient basis and a decline in reimbursement rates for point-of-care testing and diagnostic laboratory services during the second half of 2015. We currently anticipate continued reimbursement pressure on point-of care testing and diagnostic laboratory services and as a result expect a marginal decline in point-of-care drug testing, diagnostic laboratory services, professional groups and other ancillary services as a percentage of client related revenues in subsequent quarters. However, we currently anticipate that the declines in reimbursement rates for point-of-care testing and diagnostic laboratory services will be partially offset by an expansion of our laboratory services to include hematology and pharmacogenetics currently anticipated in the second quarter of 2016 and by providing laboratory services to third party providers beginning during 2016.  However, we do not currently anticipate revenues from third party providers to be meaningful until late in 2016.  

Other Revenue

Other revenue increased $6.5 million for the year ended December 31, 2015 compared to zero for the year ended December 31, 2014.  Other revenue consists of service charges from the delivery of quality targeted leads to behavioral and mental health service businesses obtained through phone calls from online inquiries and click-throughs from our suite of websites and network ad campaigns through RSG, which we acquired in July 2015.

Salaries, Wages and Benefits

Salaries, wages and benefits increased $36.7 million, or 67.1%, to $91.4 million for the year ended December 31, 2015 from $54.7 million for the year ended December 31, 2014.  The increase in salaries and wages was primarily impacted by growth in our residential facilities and our standalone outpatient centers.  Our number of employees increased by approximately 720 employees, or 93%, to approximately 1,600 employees at December 31, 2015, from approximately 880 employees at December 31, 2014. Also contributing to the increase was an increase in stock based compensation of $2.7 million to $5.8 million for the year ended December 31, 2015 from $3.1 million for the year ended December 31, 2014.  As a percentage of revenues, salaries, wages and benefits were 43.1% of total revenues for the year ended December 31, 2015 compared to 41.1% of total revenues for the year ended December 31, 2014. 

Advertising and Marketing

Advertising and marketing expenses increased $5.1 million, or 32.5%, to $20.8 million for the year ended December 31, 2015 from $15.7 million for the year ended December 31, 2014.  The increase in advertising and marketing expense was primarily driven by the continued expansion of our national advertising and marketing programs, including the acquisitions of RSG and Taj Media in July 2015. As a percentage of revenues, advertising and marketing expenses were 9.8% of total revenues for the year ended December 31, 2015 compared to 11.8% of total revenues for the year ended December 31, 2014.  The decrease in advertising and marketing expenses as a percentage of revenue is partially attributable to efficiencies gained through the RSG Acquisition and the Taj Media Acquisition.

Professional Fees

Professional fees were $10.3 million for the year ended December 31, 2015 compared to $8.1 million for the year ended December 31, 2014. The increase in professional fees was primarily related to approximately $3.1 million of professional fees incurred during the second half of 2015 associated with certain litigation in California as partially offset by a decrease in professional fees related to the elimination of customer and billing collection fees as a result of the CRMS Acquisition in April 2014.

Client Related Services

Client related services expenses increased $5.0 million, or 46.3%, to $15.8 million for the year ended December 31, 2015 from $10.8 million for the year ended December 31, 2014. The increase in expense was primarily related to increases in clinician fees paid as a result of the increase in average daily residential census to 562 for the year ended December 31, 2015 from 396 for the year

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ended December 31, 2014.   As a percentage of revenues, client related services expenses were 7.4% of total revenues for the year ended December 31, 2015 compared to 8.1% of total revenues for the year ended December 31, 2014.  The decline in client related services expenses as a percentage of revenues was primarily related to increased revenues for high complexity lab testing for our facilities in Florida and California and increased other revenues which do not require client related services.

Other Operating Expenses

Other operating expenses increased $9.2 million, or 68.1%, to $22.7 million for the year ended December 31, 2015 from $13.5 million for the year ended December 31, 2014.  The increase was primarily the result of additional operating expenses associated with the expansions and acquisitions that occurred in fiscal 2015.  As a percentage of revenues, other operating expenses were 10.7% of total revenues for the year ended December 31, 2015 compared to 10.2% of total revenues for the year ended December 31, 2014.

Rentals and Leases

Rentals and leases increased $3.2 million, or 152.4%, to $5.3 million for the year ended December 31, 2015 from $2.1 million for the year ended December 31, 2014.  As a percentage of revenues, rentals and leases were 2.5% of total revenues for the year ended December 31, 2015 compared to 1.6% of total revenues for the year ended December 31, 2014. The increase was primarily the result of increased rent as a result of the bed expansion at Forterus in January 2015, the Recovery First Acquisition in February 2015, the lease associated with our new corporate headquarters and call center beginning in June 2015, and the acquisitions of RSG and Taj Media in July 2015. 

Provision for Doubtful Accounts

The provision for doubtful accounts increased $6.7 million, or 58.8%, to $18.1 million for the year ended December 31, 2015 from $11.4 million for the year ended December 31, 2014. The increase in the provision for doubtful accounts was primarily related to the 54.7% increase in client related revenues during 2015. Also contributing to the increase was an increase in the aging of our accounts receivable as of December 31, 2015 primarily due to acquisitions, a conversion to new lab billing software in the third and fourth quarters and ICD-10 conversion. As a percentage of revenues, the provision for doubtful accounts was 8.5% of total revenues for the year ended December 31, 2015 compared to 8.6% of total revenues for the year ended December 31, 2014.  

We establish our provision for doubtful accounts based on the aging of the receivables and taking into consideration historical collection experience by facility, services provided, payor source and historical reimbursement rate, current economic trends and percentages applied to the accounts receivable aging categories. As of December 31, 2015, all accounts receivable aged greater than 360 days were fully reserved in our consolidated financial statements. In assessing the adequacy of the allowance for doubtful accounts, we rely on the results of detailed reviews of historical write-offs and recoveries (the hindsight analysis) as a primary source of information to utilize in estimating the collectability of our accounts receivable. We perform the hindsight analysis utilizing rolling twelve-month accounts receivable collection, write-off and recovery data. We supplement this hindsight analysis with other analytical tools, including, but not limited to, historical trends in cash collections compared to net revenues less bad debt and days sales outstanding.

The following table presents a summary of our aging of accounts receivable as of December 31, 2015 and 2014:

 

During the second quarter of 2014, management analyzed the past two years of accounts receivable collection and write-off history and the current projected bad debt write-offs for all client accounts covered by insurance. Based on the results of this analysis, including improvements noted in the credit quality of receivables aged 120-180 days, management concluded that the current methodology for establishing the allowance for doubtful accounts resulted in, and would continue to result in, an overstatement of the reserve requirement. As a result, management revised the estimates used to establish the provision for doubtful accounts, effective as of the second quarter of 2014. This change in estimate reduced the reserve percentages applied to various aging classes of accounts receivable aged less than 360 days to more closely reflect actual collection and write-off history that we have experienced and expect to experience in the future. These adjustments resulted in a reserve release of approximately $1.5 million during the second quarter of 2014.

 

 

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Litigation Settlement

Litigation settlement expense increased $1.9 million to $2.4 million for the year ended December 31, 2015 from $0.5 million for the year ended December 31, 2014. During 2015, we recognized $2.2 million in litigation expense related to reserves established for the Horizon matter, which was settled in October 2015.  For further discussion of significant legal matters, see Note 16 to the Company’s Consolidated Financial Statements included in this annual report.

Depreciation and Amortization

Depreciation and amortization expense increased $3.1 million, or 66.0%, to $7.8 million for the year ended December 31, 2015 from $4.7 million for the year ended December 31, 2014.  As a percentage of revenues, depreciation and amortization expense was 3.7% of total revenues for the year ended December 31, 2015, compared to 3.5% of total revenues for the year ended December 31, 2014.  The increase in depreciation and amortization expense was primarily attributable to additions of property and equipment and intangible assets as a result of recent acquisitions and facility expansions.

Acquisition-related Expense

Acquisition-related expense increased $2.6 million, or 302.5%, to $3.4 million for the year ended December 31, 2015 from $0.8 million for the year ended December 31, 2014.  The acquisition-related expense for the year ended December 31, 2015 was primarily related to professional fees and travel costs associated with our acquisition activity in fiscal 2015, during which we completed or announced eight acquisitions.  As a percentage of revenues, acquisition-related expense was 1.6% of total revenues for the year ended December 31, 2015, compared to 0.6% of total revenues for the year ended December 31, 2014. 

Interest Expense

Interest expense was $3.6 million for the year ended December 31, 2015 compared to $1.9 million for the year ended December 31, 2014.  The increase in interest expense was primarily the result of an increase in outstanding debt as partially offset by a reduction in interest rates.  Outstanding debt at December 31, 2015 was approximately $145.1 million compared to $28.6 million at December 31, 2014.  The interest rate on the $118.9 million outstanding under the 2015 Credit Facility was 3.33% at December 31, 2015 and the interest rate outstanding on the $25.0 million of 2015 Subordinated Convertible Debt was 2.5% at December 31, 2015. 

As a percentage of revenues, interest expense was 1.7% of total revenues for the year ended December 31, 2015 compared to 1.4% of total revenues for the year ended December 31, 2014.

Bargain Purchase Gain

Bargain purchase gain was $1.8 million for the year ended December 31, 2015 compared to zero for the year ended December 31, 2014.   The bargain purchase gain is directly attributable to our acquisition of the Sunrise House in October 2015.   As the fair value of the net acquired assets exceeded the consideration paid for the Sunrise House, a bargain purchase gain was recognized in the fourth quarter of 2015.  

Income Tax Expense

For the year ended December 31, 2015, income tax expense was $4.8 million, reflecting an effective tax rate of 36.4%, compared to $2.6 million, reflecting an effective tax rate of 28.6%, for the year ended December 31, 2014.   The prior year effective tax rate included a 4.2% benefit related to the release of a valuation allowance and a 3.2% benefit related to income taxed directly to flow-through owners of BHR prior to the acquisition of BHR on April 15, 2014.  

Net Loss Attributable to Noncontrolling Interest

For the year ended December 31, 2015, net loss attributable to noncontrolling interest was $2.8 million compared to net loss attributable to noncontrolling interest of $1.2 million for the year ended December 31, 2014, representing a $1.6 million change.  The net loss attributable to noncontrolling interest is directly related to our consolidated variable interest entity (“VIE”).   During the year ended December 31, 2014, we consolidated one real estate VIE, BHR, through April 15, 2014 at which point it became a wholly owned subsidiary; and five professional group VIEs.   During the year ended December 31, 2015, noncontrolling interest was comprised of six professional group VIEs.  

 

 

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Comparison of Year ended December 31, 2014 to Year ended December 31, 2013

 

Client Related Revenues

Client related revenues increased $17.3 million, or 15.0%, to $133.0 million for the year ended December 31, 2014 from $115.7 million for the year ended December 31, 2013. Client related revenues were positively impacted by a 16.8% increase in average daily residential census to 396 for the year ended December 31, 2014 from 339 for the year ended December 31, 2013. The increase in average daily residential census was driven by the 60 bed expansion of the Greenhouse facility in July 2014 and the continued expansion of both our outside sales force and our national advertising program. While client related revenues were positively impacted by the increase in average daily residential census, this increase was partially offset by a 1.6% decrease in average daily residential revenue to $920 for the year ended December 31, 2014 from $935 for the year ended December 31, 2013. As previously disclosed, through December 31, 2013, our expected realization was determined by management after taking into account historical collections received from the commercial payors since our inception compared to the gross client charges billed. Beginning in January 2014, we enhanced our methodology related to our net realizable value to more quickly react to potential changes in reimbursements by facility, by type of service and by payor. As a result, management adjusted the expected realization to reflect a historical analysis of reimbursement data by facility in addition to considering the type of services provided, the payors and the gross client charge rates. This adjustment resulted in a decrease in our expected realization in 2014.  For the years ended December 31, 2014 and 2013, we did not recognize any other revenue.

 

Salaries, Wages and Benefits

Salaries, wages and benefits increased $7.8 million, or 16.6%, to $54.7 million for the year ended December 31, 2014 from $46.9 million for the year ended December 31, 2013. As a percentage of revenues, salaries, wages and benefits were 41.1% of revenues for the year ended December 31, 2014 compared to 40.5% of revenues for the year ended December 31, 2013. The increase was primarily related to the impact of stock compensation expense for the year ended December 31, 2014 compared to the year ended December 31, 2013 relating to the vesting of equity award grants under our 2007 Stock Incentive Plan. Also, our Chief Operating Officer commenced employment in February 2013 and our General Counsel and Secretary commenced employment in December 2013. Accordingly, our salaries, wages and benefits for the year ended December 31, 2014 included their salaries for the entire period of 2014. The increase was also impacted by the addition of staff in connection with the CRMS Acquisition in April 2014.

 

Advertising and Marketing

Advertising and marketing expenses increased $2.2 million, or 16.3%, to $15.7 million for the year ended December 31, 2014 from $13.5 million for the year ended December 31, 2013. As a percentage of revenues, advertising and marketing expenses were 11.8% of revenues for the year ended December 31, 2014 compared to 11.7% of revenues for the year ended December 31, 2013. The increase was primarily driven by the expansion of our national advertising program, an increased emphasis on internet advertising campaigns and marketing efforts targeted at increasing census for the Greenhouse facility expansion, which was completed in July 2014.

 

Professional Fees

Professional fees decreased $2.2 million, or 21.4%, to $8.1 million for the year ended December 31, 2014 from $10.3 million for the year ended December 31, 2013. As a percentage of revenues, professional fees were 6.1% of revenues for the year ended December 31, 2014 compared to 8.9% of revenues for the year ended December 31, 2013. The decrease in professional fees is primarily related to the elimination of customer and billing collection fees as a result of the CRMS Acquisition in April 2014.

 

Client Related Services

Client related services expenses increased $2.8 million, or 35.0%, to $10.8 million for the year ended December 31, 2014 from $8.0 million for the year ended December 31, 2013. As a percentage of revenues, client related services expenses were 8.1% of revenues for the year ended December 31, 2014 compared to 6.9% of revenues for the year ended December 31, 2013. The increase was primarily related to increases in clinician fees paid due to greater census in detoxification and residential beds which require greater numbers of more highly qualified medical staff. Detoxification and residential treatment services accounted for 27% of total billed days for the year ended December 31, 2014 compared to 23% of total billed days for the year ended December 31, 2013. Also contributing to the increase in client related services expenses were increases in clinician fees as a result of the consolidation of the Professional Groups effective October 1, 2013.

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Other Operating Expenses

Other operating expenses increased $1.9 million, or 16.4%, to $13.5 million for the year ended December 31, 2014 from $11.6 million for the year ended December 31, 2013. As a percentage of revenues, other operating expenses were 10.2% of revenues for the year ended December 31, 2014 compared to 10.0% of revenues for the year ended December 31, 2013.

 

Rentals and Leases

Rentals and leases decreased $2.5 million, or 54.3%, to $2.1 million for the year ended December 31, 2014 from $4.6 million for the year ended December 31, 2013. As a percentage of revenues, rentals and leases were 1.6% of revenues for the year ended December 31, 2014 compared to 4.0% of revenues for the year ended December 31, 2013. The decrease was primarily related to a reduction in rent expense resulting from the consolidation of Greenhouse Real Estate, LLC effective October 8, 2013 and the BHR Acquisition in April 2014.

Provision for Doubtful Accounts

The provision for doubtful accounts increased $0.4 million, or 3.6%, to $11.4 million for the year ended December 31, 2014 from $11.0 million for the year ended December 31, 2013. As a percentage of revenues, the provision for doubtful accounts was 8.6% of revenues for the year ended December 31, 2014 compared to 9.5% of revenues for the year ended December 31, 2013.

We establish our provision for doubtful accounts based on the aging of the receivables and taking into consideration historical collection experience by facility, services provided, payor source and historical reimbursement rate, current economic trends and percentages applied to the accounts receivable aging categories. As of December 31, 2014, all accounts receivable aged greater than 360 days were fully reserved in our consolidated financial statements. In assessing the adequacy of the allowance for doubtful accounts, we rely on the results of detailed reviews of historical write-offs and recoveries (the hindsight analysis) as a primary source of information to utilize in estimating the collectability of our accounts receivable. We perform the hindsight analysis on a quarterly basis, utilizing rolling twelve-month accounts receivable collection, write-off and recovery data. We supplement this hindsight analysis with other analytical tools, including, but not limited to, historical trends in cash collections compared to net revenues less bad debt and days sales outstanding.

During the second quarter of 2014, management analyzed the past two years of accounts receivable collection and write-off history and the current projected bad debt write-offs for all client accounts covered by insurance. Based on the results of this analysis, including improvements noted in the credit quality of receivables aged 120-180 days, management concluded that the current methodology for establishing the allowance for doubtful accounts resulted in, and would continue to result in, an overstatement of the reserve requirement. As a result, management revised the estimates used to establish the provision for doubtful accounts, effective as of the second quarter of 2014. This change in estimate reduced the reserve percentages applied to various aging classes of accounts receivable aged less than 360 days to more closely reflect actual collection and write-off history that we have experienced and expect to experience in the future. These adjustments resulted in a reserve release of approximately $1.5 million during the second quarter of 2014.

During the third and fourth quarters of 2014, we continued to experience favorable collections of accounts receivable as noted by a decrease in accounts receivable aged greater than 180 days as a percentage of total accounts receivable to 24.1% at December 31, 2014 from 36.3% at December 31, 2013.

The following table presents a summary of our aging of accounts receivable as of December 31, 2013 and 2014:

 

 

Litigation Settlement

Litigation settlement expense decreased $2.1 million, or 80.8%, to $0.5 million for the year ended December 31, 2014 from $2.6 million for the year ended December 31, 2013. As a percentage of revenues, litigation settlement expense was 0.4% of revenues for the year ended December 31, 2014 compared to 2.2% of revenues for the year ended December 31, 2013. The year ended December 31, 2013 reflects $2.5 million of litigation settlement expense related to a State of California wage and hour class action claim.

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Restructuring

Restructuring expenses for the year ended December 31, 2013 were $0.8 million. Two call centers were closed in the third quarter of 2013 and were consolidated with the existing call center at our headquarters in Brentwood, Tennessee to create a centralized call center. The call center operations were centralized in order to manage costs more effectively and optimize the call center’s view of client services, thus streamlining the placement of clients to treatment facilities. In addition, the Leading Edge facility, which was acquired in the 2012, was closed in June 2013. Management elected to close the facility because the amenities and the service offerings at the facility were inconsistent with our long-term strategy. During the transition period leading up to closing, clients that would have been candidates for the Leading Edge facility were referred to other treatment facilities, primarily Desert Hope. As a result of the facility closure, we recorded restructuring and exit charges of $0.5 million in the year ended December 31, 2013. These charges consisted of $0.2 million of payroll, severance and employee related costs and facility exit costs related to ongoing lease obligations of approximately $0.3 million. Restructuring expenses related to centralizing the call centers totaled $0.3 million in the year ended December 31, 2013 related to severance and relocation costs.

Depreciation and Amortization

Depreciation and amortization expense increased $1.7 million, or 56.7%, to $4.7 million for the year ended December 31, 2014 from $3.0 million for the year ended December 31, 2013. As a percentage of revenues, depreciation and amortization expense was 3.5% of revenues for the year ended December 31, 2014 compared to 2.6% of revenues for the year ended December 31, 2013. The increase was primarily the result of the consolidation of Greenhouse Real Estate, LLC in October 2013 and the acquisition of BHR in April 2014. The increase in depreciation and amortization expense was also attributable to additions of property and equipment.

Acquisition-related Expense

Acquisition-related expense was $0.8 million for the year ended December 31, 2014.   As a percentage of revenues, acquisition-related expense was 0.6% of revenues for the year ended December 31, 2014.  The acquisition-related expense for the year ended December 31, 2014 was primarily related to professional fees associated with our acquisition activity in the fourth quarter of 2014.   For the year ended December 31, 2013, we did not recognize any acquisition-related expense.

Interest Expense

Interest expense was $1.9 million for the year ended December 31, 2014 and $1.4 million for the year ended December 31, 2013. As a percentage of revenues, interest expense was 1.4% of revenues for the year ended December 31, 2014 compared to 1.2% of revenues for the year ended December 31, 2013. The increase in interest expense is related to the consolidation of Greenhouse Real Estate, LLC in October 2013, and the additional interest expense related to increased outstanding debt obligations associated with the Greenhouse expansion, which was completed in July 2014. In July 2014, the Company also entered into two interest rate swap agreements to mitigate its exposure to interest rate risks. The interest rate swap agreements have a combined initial notional amount of $21.6 million which fixes the interest rates over the life of the interest rate swap agreements. The Company has not designated the interest rate swaps as hedges and, therefore, changes in the fair value of the interest rate swaps are included in interest expense in the audited consolidated income statements. The change in fair value during the year ended December 31, 2014 was approximately $431,000.

Income Tax Expense

For the year ended December 31, 2014, income tax expense was $2.6 million, reflecting an effective tax rate of 28.6%, compared to $0.6 million, reflecting an effective tax rate of 29.2%, for the year ended December 31, 2013.

Net Loss (Income) Attributable to Noncontrolling Interest

For the year ended December 31, 2014, net loss attributable to noncontrolling interest was $1.2 million compared to net income attributable to noncontrolling interest of $0.7 million for the year ended December 31, 2013, representing a $1.9 million change. This change was primarily the result of the consolidation of the Professional Groups effective October 1, 2013.

 

Liquidity and Capital Resources

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General

Our primary sources of liquidity are net cash generated from operations, borrowings under our 2015 Credit Facility, proceeds from the issuance of subordinated convertible debt, and proceeds from issuances of our common stock. We also have utilized operating lease transactions with respect to commercial properties primarily to perform client services and provide space for administrative facilities.  We expect that our future funding for working capital needs, capital expenditures, long-term debt repayments and other financing activities will continue to be provided from some or all of these sources.  Our future liquidity could be impacted by our ability to access capital markets, which may be restricted due to our credit ratings, general market conditions, leverage capacity, the outcome of pending litigation and by existing or future debt agreements.

We anticipate that our current level of cash on hand and internally generated cash flows will be sufficient to fund our anticipated working capital needs, debt service and repayment obligations and interest and maintenance capital expenditures for at least the next twelve months. However, to the extent we pursue acquisitions or facility expansions in the future, we may need to access additional capital resources to fund such activities.

Cash Flow Analysis

Our cash flows are summarized as follows (in thousands):

 

 

Net Cash Provided by Operating Activities

Cash provided by operating activities was $6.2 million for the year ended December 31, 2015, compared to $8.0 million for the year ended December 31, 2014.  Cash flows for operations for the year ended December 31, 2015 were positively impacted by net income, adjusted for non-cash expenses, as well as the timing of accounts payable and accrued liabilities for the year ended December 31, 2015 as compared to 2014.  These increases were more than offset by an increase in accounts receivable of $30.9 million for the year ended December 31, 2015 as compared to the year ended December 31, 2014, and by approximately $6.6 million of increased cash outflows related to certain litigation in California, of which $3.1 million was expensed during 2015.  The increase in accounts receivable was primarily related to an increase in revenues in 2015 as compared to 2014.   Also contributing to the increase in accounts receivable were increases related to billing and collection delays associated with our acquisitions and conversion to new lab billing software in the second half of 2016.  Working capital totaled $52.2 million at December 31, 2015 and $63.2 million at December 31, 2014.  The decrease of $9.7 million was primarily attributable to funding of acquisitions and de novo development projects.

Cash provided by operating activities was $8.0 million for the year ended December 31, 2014, an increase of $4.6 million compared to cash provided by operating activities of $3.4 million for the year ended December 31, 2013. The $4.6 million increase in cash provided by operating activities in the year ended December 31, 2014 as compared to the year ended December 31, 2013 primarily related to the benefit from the increase in accrued liabilities and depreciation and amortization expense as partially offset by an increase in prepaid expenses and other assets. Working capital totaled $63.2 million at December 31, 2014 and $1.2 million at December 31, 2013. We used a portion of the net proceeds from the IPO to repay the $13.1 million balance, in full, of our prior revolving line of credit, the BHR term loan of $1.6 million and the final $7.3 million payment related to the settlement of certain litigation.

 

Net Cash Used in Investing Activities

Cash used in investing activities was $143.4 million for the year ended December 31, 2015, an increase of $123.9 million compared to cash used in investing activities of $19.5 million for the year ended December 31, 2014.  The increase was primarily related to the business acquisitions, net of cash acquired, and de novo development activity during 2015, including $35.0 million for The Oxford Centre, $32.2 million for RSG, $13.5 million for the purchase of a property in Aliso Viejo, California, $13.0 million for Recovery First, $10.2 million for the development of River Oaks, $6.6 million for Sunrise House, $6.4 million for the purchase of a property in Ringwood, New Jersey, $2.2 million for Taj Media, and $0.6 million for CSRI, with the remaining amount primarily related to continuing costs associated with our de novo projects and completion of our new corporate headquarters.

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Cash used in investing activities was $19.5 million for the year ended December 31, 2014, an increase of $6.4 million compared to cash used in investing activities of $13.1 million for the year ended December 31, 2013. The increase was primarily related to $3.5 million paid in connection with the BHR Acquisition and the CRMS Acquisition, an increase in capital expenditures of $2.6 million, and $0.5 million placed in escrow related to the acquisition of Recovery First.  These increases in cash used in investing activities were partially offset by the net receipt of notes and other receivables from related parties of $0.2 million.

 

Net Cash Provided by Financing Activities

Cash provided by financing activities was $107.4 million for the year ended December 31, 2015, an increase of $49.4 million compared to cash provided by financing activities of $58.0 million for the year ended December 31, 2014.  The increase was primarily related to net proceeds from the 2015 Credit Facility of $120.8 million and $24.2 million from the financing transaction with Deerfield, and partially offset by the redemption of the BHR Series A Preferred Units of $8.5 million, repayments of long-term debt and capital leases of $27.6 million and repayments of subordinated notes payable of $1.0 million.

Cash provided by financing activities was $58.0 million for the year ended December 31, 2014, an increase of $47.0 million compared to cash provided by financing activities of $11.0 million for the year ended December 31, 2013. The increase was primarily related to proceeds of $69.5 million from the sale of the common stock in connection with our IPO and proceeds of $8.2 million from the sale of BHR Series A Preferred Units, as partially offset by an increase in payments on long-term debt and capital leases of $4.4 million and a decrease in proceeds from the revolving line of credit and long-term debt of $23.5 million.

Financing Relationships

2015 Credit Facility

On March 9, 2015, we entered into a five year $125.0 million senior secured credit facility (the “2015 Credit Facility”) with Bank of America, N.A., as administrative agent for the lenders party thereto.   The 2015 Credit Facility consists of a $50.0 million revolver and a $75.0 million term loan.  For additional discussion of our 2015 Credit Facility and a summary of its terms of, see Note 9 to the accompanying consolidated financial statements.    

We used approximately $24.9 million of the proceeds from the $75.0 million term loan to repay in full our then outstanding real estate debt, certain equipment loans and certain capital leases. We did not incur any significant early termination fees.  Remaining borrowings were primarily used to fund acquisitions and de novo development projects.

On July 1, 2015 and August 7, 2015, we borrowed $15.0 million and $32.0 million, respectively, under the $50.0 million revolver portion of the 2015 Credit Facility.  Proceeds from these borrowings were primarily used to fund acquisitions and de novo development projects.

As of December 31, 2015, we had $47.0 million outstanding under our revolver and $73.1 million outstanding on our term loan.  As of December 31, 2015, our availability under the revolver portion of the 2015 Credit Facility was $0.7 million, net of $2.3 million in standby letters of credit issued for various corporate purposes that are secured by the Company’s revolver. The 2015 Credit Facility also has an accordion feature that allows the total borrowing capacity to be increased to $200.0 million, subject to certain conditions, including obtaining additional commitments from lenders. At December 31, 2015, the Company was in compliance with all applicable covenants.

Deerfield Financing

On October 2, 2015, we completed the closing of two financing facilities with affiliates of Deerfield.  The capital commitment consists of $25.0 million of subordinated convertible debt and up to $25.0 million of unsecured subordinated debt, together with an incremental facility of up to an additional $50.0 million of subordinated convertible debt (subject to certain conditions).  We issued $25.0 million of subordinated convertible debt at closing and currently anticipate we will use the proceeds to fund acquisition opportunities, our de novo pipeline and for other corporate purposes.

The $25.0 million of subordinated convertible debt bears interest at an annual rate of 2.50% and matures on September 30, 2021. The $25.0 million of subordinated convertible debt is convertible into shares of our common stock at $30.00 per share. In addition, we may borrow up to $25.0 million of unsecured subordinated debt that will bear interest at an annual rate of 12.0% and mature on September 30, 2020. The $25.0 million of unsecured subordinated debt may be drawn for acquisition financing through September 30, 2016 and can be repaid under certain conditions without penalty prior to October 2, 2017. We currently anticipate borrowing the remaining $25.0 million of unsecured subordinated debt in the first half of 2016 to fund announced acquisitions.

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BHR Preferred Equity

For a summary of the terms of the BHR Series A Preferred Units, see Note 3 to the accompanying consolidated financial statements.  

On February 25, 2015, we exercised our call provision and redeemed 100% of the outstanding Series A Preferred Units for a total redemption price of approximately $8.5 million, which included $0.2 million for the 3.0% call premium and $0.3 million for unpaid preferred returns.

Related Party Notes Payable  

During 2015, we had outstanding notes payables resulting from seller financing from a 2012 acquisition.  On August 31, 2015, one of the notes payable was paid in full.  The remaining note payable which constitutes a balloon payment was amended, which required a principal payment of $0.3 million upon execution of the amendment, extended the maturity date to February 29, 2016, and increased the interest rate to 6.25%.  The amount outstanding on this note at December 31, 2015 was $1.2 million.  On February 29, 2016, we paid in full the outstanding balance, including principal payments of $1.2 million and accrued interest of $0.2 million.  

Subordinated Promissory Notes (Related Party and Non-related Party)

In March 2012 through April 2012, we issued $1.0 million of subordinated promissory notes to certain accredited investors, of which $0.2 million was issued to one of our directors. The notes bore interest at 12% per annum. Interest was payable monthly and the principal amount was due, in full, on the applicable maturity date of the note. Notes in the principal amount of $0.2 million matured on March 31, 2015 and the remaining notes, in the principal amount of $0.8 million, matured on March 31, 2017. In connection with the issuance of these notes, we issued detachable warrants to the lenders to purchase 112,658 shares of AAC common stock at $0.64 per share. The warrants were exercisable at any time up to their expiration on March 31, 2022. We recorded a debt discount of $0.1 million related to the warrants which reduced the carrying value of the subordinated notes. As of December 31, 2014, the outstanding balance, net of the unamortized debt discount of $71,000, was $0.9 million, of which $0.2 million was due to one of our directors. In connection with the Reorganization Transactions, warrants representing 106,728 shares of AAC common stock were exercised in March 2014 and the remaining warrants representing 5,930 shares of AAC common stock were exercised in April 2014.   On February 27, 2015, we repaid in full the $1.0 million of the outstanding subordinated promissory notes.

Capital Lease Obligations  

We have capital leases with third party leasing companies for equipment and office furniture. The capital leases bear interest at rates ranging from 3.9% to 5.3% and have maturity dates from March 2017 through March 2019. Total obligations under capital leases at December 31, 2015 were $0.8 million, of which $0.3 million was included in the current portion of long-term debt.

 

Contractual Obligations

The following table sets forth information regarding our contractual obligations as of December 31, 2015:

 

 

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Consolidation of VIEs

The Professional Groups engage physicians and mid-level service providers and provide professional services to our clients through professional services agreements with each treatment facility. Under the professional services agreements, the Professional Groups also provide a physician to serve as medical director for the applicable facility. The Professional Groups either bill the payor for their services directly or are compensated by the treatment facility based on fair market value hourly rates. Each of the professional services agreements has a term of five years and will automatically renew for additional one-year periods.

We provided the initial working capital funding in connection with the formation of the Professional Groups and recorded a receivable. We make additional advances to the Professional Groups during periods in which there is a shortfall between revenues collected by the Professional Groups from the treatment facilities and payors, on the one hand, and the Professional Group’s contracting expenses and payroll requirements, on the other hand, thereby increasing the balance of the receivable. Excess cash flow of the Professional Groups is repaid to us, resulting in a decrease in the receivable. The Professional Groups are obligated to repay these funds and are charged commercially reasonable interest. We had receivables from the Professional Groups at December 31, 2015. The receivables due to us from the Professional Groups are eliminated in consolidation as the Professional Groups are VIEs of which we are the primary beneficiary.

AAC has entered into written management services agreements with each of the Professional Groups under which AAC provides management and other administrative services to the Professional Groups. These services include billing, collection of accounts receivable, accounting, management and human resource functions and setting policies and procedures. Pursuant to the management services agreements, the Professional Groups’ monthly revenues will first be applied to the payment of operating expenses consisting of refunds or rebates owed to clients or payors, compensation expenses of the physicians and other service providers, lease payments, professional and liability insurance premiums and any other costs or expenses incurred by AAC for the benefit of the Professional Groups and, thereafter, to the payment to AAC of a management fee equal to 20% of the Professional Groups’ gross collected monthly revenues. As described above, AAC will also provide financial support to each Professional Group on an as-needed basis to cover any shortfall between revenues collected by such Professional Groups from the treatment facilities and payors and the Professional Group’s contracting expenses and payroll requirements. Through these arrangements, we are directing the activities that most significantly impact the financial results of the respective Professional Groups; however, treatment decisions are made solely by licensed healthcare professionals employed or engaged by the Professional Groups as required by various state laws. Based on our ability to direct the activities that most significantly impact the financial results of the Professional Groups, provide necessary funding and the obligation and likelihood of absorbing all expected gains and losses, we have determined that we are the primary beneficiary, and, therefore, consolidate the six Professional Groups as VIEs.

Off Balance Sheet Arrangements

We have entered into various non-cancelable operating leases expiring through June 2025. Commercial properties under operating leases primarily include space required to perform client services, sober living accommodations for our clients, and space for administrative facilities. Rent expense was $5.3 million and $2.1 million for the years ended December 31, 2015 and 2014, respectively.

 

Critical Accounting Policies

Our consolidated financial statements have been prepared in accordance with GAAP. In preparing our consolidated financial statements, we are required to make certain estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses included in the financial statements. Estimates are based on historical experience and other available information, the results of which form the basis of such estimates. While we believe our estimation processes are reasonable, actual results could differ from our estimates. The following accounting policies are considered critical to our operating performance and involve subjective and complex assumptions and assessments.

Revenue Recognition

We provide services to our clients in both inpatient and outpatient treatment settings. Revenues are recognized when services are performed at the estimated net realizable value amount from clients, third-party payors and others for services provided. We receive the majority of payments from commercial payors at out-of-network rates. Client service revenues are recorded at established billing rates less adjustments to estimate net realizable value. Adjustments are recorded to state client service revenues at the amount

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expected to be collected for the service provided based on historic adjustments for out-of-network services not under contract. Provisions for estimated third party payor reimbursements are provided in the period related services are rendered and adjusted in future periods when actual reimbursements are received.

Prior to admission, insurance coverage, as applicable, is verified and the client self-pay amount is determined. The client self-pay portion is generally collected upon admission. In some instances, clients will pay out-of-pocket as services are provided or will make a deposit and negotiate the remaining payments as part of the services. These out-of-pocket payments are included in accrued liabilities in the accompanying consolidated balance sheets and revenues related to these payments are deferred and recognized over the period services are provided. We do not recognize revenue for any amounts not collected from the client. From time to time, we may provide scholarships to a limited number of clients. We do not recognize revenues for scholarships provided.

We recognize revenues from commercial payors at the time services are provided based on our estimate of the amount that payors will pay us for the services performed. We estimate the net realizable value of revenues by adjusting gross client charges using our expected realization and applying this discount to gross client charges. Through December 31, 2013, our expected realization was determined by management after taking into account historical collections received from the commercial payors since our inception compared to the gross client charges billed. Beginning in January 2014, we enhanced the methodology related to our net realizable value to more quickly react to potential changes in reimbursements by facility, by type of service and by payor. As a result, management adjusted the expected realization discount, on a per facility basis, to reflect a historical analysis of reimbursement data by facility in addition to considering the type of services provided, the payors and the gross client charge rates by facility. This change resulted in a decrease in our expected realization in the first six months of 2014.

Estimates of net realizable value are subject to significant judgment and approximation by management. It is possible that actual results could differ from the historical estimates management has used to help determine the net realizable value of revenues. If our actual collections either exceed or are less than the net realizable value estimates, we will record a revenue adjustment, either positive or negative, for the difference between our estimate of the receivable and the amount actually collected in the reporting period in which the collection occurred.

In cases where the demand for our services exceeded our capacity, we historically entered into contractual arrangements with other parties to provide corporate support services. Based on criteria outlined in ASC 605, Revenue Recognition, management determined that we were the principal party to the corporate support services provided. As a result, revenues generated through our contractual arrangements were included in revenues at their expected realizable amount while the subcontracted service payments made to the subcontracted parties were included in client expenses. The need for these contractual arrangements decreased as we increased bed capacity in the second half of 2012 and in the first half of 2013 as a result of the opening of the Desert Hope facility. During 2014 and 2015, we did not utilize these types of contractual arrangements.

Our other revenue consists of service charges from the delivery of quality targeted leads to behavioral and mental health service businesses through our operating subsidiary RSG, which was acquired on July 2, 2015.  Revenue is recognized when persuasive evidence of an arrangement exists, services have been rendered, the fee for services is fixed or determinable, and collectability of the fee is reasonably assured. 

Allowance for Contractual and Other Discounts

We derive the majority of our revenue reimbursements from commercial payors at out-of-network rates. Management estimates the allowance for contractual and other discounts based on its historical collections experience. The services authorized and provided and related reimbursement are often subject to interpretation and negotiation that could result in payments that differ from our estimates.

Allowance for Doubtful Accounts

Accounts receivable primarily consist of amounts due from third-party commercial payors and clients and we record accounts receivable net of contractual discounts. Our ability to collect outstanding receivables is critical to our results of operations and cash flows. Accounts receivable are reported net of an allowance for doubtful accounts, which is management’s best estimate of accounts receivable that could become uncollectible in the future. Accordingly, the accounts receivable reported in our consolidated financial statements are recorded at the net amount expected to be received. Our primary collection risks are (i) the risk of overestimating our net revenues at the time of billing that may result in us receiving less than the recorded receivable, (ii) the risk of non-payment as a result of commercial insurance companies denying claims, (iii) the risk that clients will fail to remit insurance payments to us when the commercial insurance company pays out-of-network claims directly to the client, (iv) resource and capacity constraints that may prevent us from handling the volume of billing and collection issues in a timely manner and (v) the risk of non-payment from uninsured clients. In evaluating the collectability of accounts receivable and evaluating the adequacy of our allowance for doubtful accounts, management considers a number of factors, including historical experience, the age of the accounts and current economic

54

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trends. We continually monitor our accounts receivable balances and utilize retrospective reviews and cash collection data to support our estimates of the allowance for doubtful accounts. In the second quarter of 2014, we analyzed our recent collection experience and made adjustments to the calculation of the net realizable value of our accounts receivable to take into account our collections experience over the past two years and improvements in the credit quality of our aged receivables. Estimates of our allowance for doubtful accounts are determined on a quarterly basis and adjusted monthly thereafter based on actual collections. If actual future collections are less favorable than those projected by management, additional allowances for uncollectible accounts may be required. There can be no guarantee that we will continue to experience the same collection rates that we have experienced in the past. We do not believe that there are any significant concentrations of revenues from any particular payor that would subject us to significant credit risks in the event a payor becomes unwilling or unable to pay claims.

Goodwill and Intangible Assets

Goodwill represents the excess of the purchase price over the fair value of the identifiable net assets acquired. Goodwill and intangible assets with indefinite lives are not amortized, but instead tested for impairment at least annually or whenever events or changes in circumstances indicate the carrying value may not be recoverable. We have no intangible assets with indefinite useful lives other than goodwill. We consider the following to be important factors that could trigger an impairment review: significant underperformance relative to historical or projected future operating results; identification of other impaired assets within a reporting unit; significant adverse changes in business climate or regulations; significant changes in senior management; significant changes in the manner of use of the acquired assets or the strategy for our overall business; and significant negative industry or economic trends.

Goodwill is assessed for impairment using a fair value approach at the reporting unit level. The goodwill impairment test is a two-step process, if necessary. The provisions for the accounting standard of goodwill provide an entity with the option to assess qualitative factors to determine whether the existence of events or circumstances leads to the determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. This qualitative assessment is referred to as a “step zero” approach. If, based on the qualitative factors, an entity determines it is not more likely than not that the fair value of a reporting unit is less than its carrying value, the entity may skip the two-step impairment test required by accounting guidance. If an entity determines otherwise or, at the option of the entity, if a step zero is not performed, step one of the two-step impairment test is required. Under step one, the fair value of the reporting unit is compared with its carrying value (including goodwill). If the fair value of the reporting unit is less than its carrying value, an indication of goodwill impairment exists for the reporting unit and the entity must perform step two of the impairment test (measurement). Under step two, an impairment loss is recognized for any excess of the carrying amount of the reporting unit’s goodwill over the implied fair value of that goodwill. The implied fair value of goodwill is determined by allocating the fair value of the reporting unit in a manner similar to a purchase price allocation and the residual fair value after this allocation is the implied fair value of the reporting unit goodwill. Fair value of the reporting unit is determined using a discounted cash flow analysis. If the fair value of the reporting unit exceeds its carrying value, step two does not need to be performed. Impairment shall be recognized to the extent that the carrying amount of goodwill exceeds its implied fair value. In performing step one of the goodwill impairment test, we compare the carrying amount of the reporting unit to the estimated fair value.

In assessing the recoverability of goodwill, we consider historical results, current operating trends and results, and make estimates and assumptions about revenues, margins and discount rates based on our budgets, business plans, economic projections and anticipated future cash flows. Each of these factors contains inherent uncertainties, and management exercises substantial judgment and discretion in evaluating and applying these factors.

The annual goodwill impairment test is performed as of December 31 of each year, utilizing the two-step test. We concluded that the carrying value of the reporting unit as of December 31, 2015 did not exceed its fair value, and thus no indication of impairment was present.

Long-Lived Assets and Intangible Assets Subject to Amortization

Long-lived and intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. Impairment is measured by the amount by which the carrying value of the assets exceeds the fair value of the assets.

Accounting for Income Taxes

We account for income taxes in accordance with ASC 740, Income Taxes. Under the asset and liability method of ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

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Under ASC 740, the effect on the deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided for significant deferred tax assets when it is more likely than not that such assets will not be recovered.

Our practice is to recognize interest and/or penalties related to uncertain income tax positions in income tax expense.

Stock-Based Compensation Expense

We measure compensation expense for all stock-based awards at fair value on the date of grant and recognize compensation expense over the service period for the awards expected to vest.

 

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Our interest expense is sensitive to changes in market interest rates. With respect to our interest-bearing liabilities, our long-term debt outstanding at December 31, 2015 consisted of $120.1 million of variable rate debt with interest based on LIBOR plus an applicable margin. In July 2014, we entered into two interest rate swap agreements to mitigate our exposure to interest rate risks. The interest rate swap agreements have initial notional amounts of $13.2 million and $8.9 million which fix the interest rates over the life of the interest rate swap agreements at 4.73% and 4.21%, respectively.  A hypothetical 1% increase in interest rates would decrease our pre-tax income and cash flows by approximately $1.0 million on an annual basis based upon our borrowing level at December 31, 2015.

 

Item 8. Financial Statements and Supplementary Data.

Information with respect to this Item is contained in our consolidated financial statements beginning on Page F-1 of this Annual Report on Form 10-K.

 

 

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

Not applicable.

 

 

Item 9A. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, our management conducted an evaluation, with the participation of our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and that such information is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Report of Management on Internal Control Over Financial Reporting for the Fiscal Year Ended December 31, 2015

Our management is responsible for establishing and maintaining effective internal control over financial reporting, as such term is defined in Rule 13a-15(f) under the Exchange Act. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

 Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an assessment of the effectiveness of our internal control over financial reporting based on the framework in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework). Based on our assessment under the framework in Internal Control — Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2015.

 This annual report does not include an attestation report from our registered public accounting firm regarding internal control over financial reporting. Management's report was not subject to attestation by our registered public accounting firm pursuant to rules of the SEC that permit emerging growth companies, which we are, to provide only management's report in this annual report.

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Changes in Internal Control Over Financial Reporting

There have been no changes in our internal control over financial reporting during the fourth quarter ended December 31, 2015, that have materially affected, or are reasonably likely to materially affect our internal control over financial reporting.

 

 

Item 9B. Other Information.

Not applicable.

PART III

 

 

Item 10. Directors, Executive Officers and Corporate Governance.

 

The information required by this Item is incorporated by reference to information set forth under the captions “Corporate Governance,” “Management” and “Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive proxy statement for our 2016 Annual Meeting of Stockholders scheduled to be held on or about May 17, 2016, which we intend to file within 120 days after our fiscal year end.

 

We have adopted a Code of Business Conduct and Ethics that applies to all of our directors, officers and employees and a Code of Ethics for Senior Financial Officers. These documents, as well as the charters of the Nominating and Corporate Governance Committee, Audit Committee and the Compensation Committee, are available on the Investor Relations section of our website at www.americanaddictioncenters.com under the captions “About Us,” “Investor Relations,” “Corporate Profile” and “Governance Documents.” Upon the written request of any person, we will furnish, without charge, a copy of any of these documents. Requests should be directed to AAC Holdings, Inc., 200 Powell Place, Brentwood, Tennessee 37027, Attention: Kathryn Sevier Phillips, General Counsel and Secretary. We intend to disclose any amendments to our Code of Ethics and any waiver from a provision of our code, as required by the SEC, on our website.

 

 

Item 11. Executive Compensation

The information required by this Item is incorporated by reference to information set forth under the captions “Executive Compensation” and “Corporate Governance – Director Compensation” in our definitive proxy statement for our 2016 Annual Meeting of Stockholders scheduled to be held on or about May 17, 2016, which we intend to file within 120 days after our fiscal year end.

 

 

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by this Item is incorporated by reference to information set forth under the captions “Security Ownership of Certain Beneficial Owners and Management” and “Equity Compensation Plan Information” in our definitive proxy statement for our 2016 Annual Meeting of Stockholders scheduled to be held on or about May 17, 2016, which we intend to file within 120 days after our fiscal year end.

 

Item 13. Certain Relationships and Related Transactions, and Director Independence

The information required by this Item is incorporated by reference to information set forth under the captions “Certain Relationships and Related Person Transactions” and “Corporate Governance” in our definitive proxy statement for our 2016 Annual Meeting of Stockholders scheduled to be held on or about May 17, 2016, which we intend to file within 120 days after our fiscal year end.

 

 

Item 14. Principal Accounting Fees and Services

The information required by this Item is incorporated by reference to information set forth under the proposal “Ratification of Appointment of Independent Registered Public Accounting Firm” in our definitive proxy statement for our 2016 Annual Meeting of Stockholders scheduled to be held on or about May 17, 2016, which we intend to file within 120 days after our fiscal year end.

 

 

 

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PART IV

 

 

Item 15. Exhibits and Financial Statement Schedules.

(a) The following documents are filed as part of this Annual Report on Form 10-K:

The consolidated financial statements required to be included in Part II, Item 8, Financial Statements and Supplementary Data, begin on Page F-1 and are submitted as a separate section of this report.

All schedules are omitted because they are not applicable or are not required, or because the required information is included in the consolidated financial statements or notes in this report.

The exhibits required by Item 601 of Regulation S-K are listed in the Exhibit Index and incorporated by reference herein.

 

 

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INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

 

 

F-1

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

Board of Directors and Stockholders

AAC Holdings, Inc.

Brentwood, Tennessee

We have audited the accompanying consolidated balance sheets of AAC Holdings, Inc. as of December 31, 2015 and 2014 and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2015.  These financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States).  Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of AAC Holdings, Inc. at December 31, 2015 and 2014, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2015, in conformity with accounting principles generally accepted in the United States of America.

/s/ BDO USA, LLP

Nashville, Tennessee

March 8, 2016

 

 

 

F-2

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AAC HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands)

 

See accompanying notes to consolidated financial statements.

 

 

 

F-3

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AAC HOLDINGS, Inc. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share amounts)

 

 

See accompanying notes to consolidated financial statements

 

 

 

F-4

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AAC HOLDINGS, Inc. AND SUBSIDIARIES

Consolidated Statements of Stockholders’ Equity

(In thousands, except share amounts)

 

F-5

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See accompanying notes to consolidated financial statements.

 

 

 

F-6

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AAC HOLDINGS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

 

 

 

 

See accompanying notes to audited consolidated financial statements.

 

 

F-7

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AAC HOLDINGS, Inc. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Dollars in thousands)

 

 

 

See accompanying notes to audited consolidated financial statements.

 

 

 

F-8

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AAC Holdings, Inc.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

 

 

1. Description of Business

AAC Holdings, Inc. (collectively with its subsidiaries, the “Company” or “Holdings”), was incorporated on February 12, 2014 for the purpose of acquiring all the common stock of American Addiction Centers, Inc. (“AAC”) and to engage in certain reorganization transactions as more fully described in Note 3.  The Company is headquartered in Brentwood, Tennessee and provides substance abuse treatment services for individuals with drug and alcohol addiction.  In addition to the Company’s substance abuse treatment services, the Company performs drug testing and diagnostic laboratory services and provides physician services to clients.  At December 31, 2015, the Company, through its subsidiaries, operated nine residential substance abuse treatment facilities, and nine standalone outpatient centers.

Following the Company’s acquisition of Referral Solutions Group, LLC (“RSG”) on July 2, 2015, combined with its previously existing internet assets, the Company operates a broad portfolio of internet assets that service millions of website visits each month. RSG, through its wholly owned subsidiary Recovery Brands, LLC (“Recovery Brands”), a leading publisher of “authority” websites such as Rehabs.com and Recovery.org, serves families and individuals struggling with addiction and seeking treatment options through comprehensive online directories, treatment provider reviews, forums and professional communities. Recovery Brands also provides online marketing solutions to other treatment providers such as enhanced facility profiles, audience targeting, lead generation and tools for digital reputation management.   

 

 

2. Basis of Presentation

Principles of Consolidation

The Company conducts its business through limited liability companies and C-corporations, each of which is a direct or indirect wholly owned subsidiary of the Company.  The accompanying consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries, the accounts of variable interest entities (“VIEs”) in which the Company is the primary beneficiary, and certain professional groups through rights granted to the Company by contract to manage and control the business of such professional groups.  All intercompany transactions and balances have been eliminated in consolidation.

The Private Share Exchange (defined below) between the Company and AAC’s stockholders (as discussed in Note 3) was accounted for similar to a common control transaction resulting in the assets, liabilities, and equity of AAC being carried over at their historical bases.  At the time of the Private Share Exchange, Holdings was a shell company that had not conducted any business and had no material assets or liabilities.  As such, the historical financial statements presented for periods prior to the Private Share Exchange represent the historical results of operations of AAC.

During the year ended December 31, 2014, the Company consolidated one real estate VIE, Behavioral Healthcare Realty, LLC (“BHR”) through April 15, 2014, at which point BHR was acquired by the Company and became a wholly owned subsidiary of the Company (see Note 3 for further discussion).  At the time of the BHR Acquisition, BHR leased two treatment facilities to the Company under long-term triple net leases and was renovating and constructing additional treatment facilities that it planned to lease to the Company. The Company was the primary beneficiary as a result of its guarantee of BHR’s debt prior to the BHR Acquisition.  The Company also consolidated five professional groups (“Professional Groups”) that constituted VIEs as of December 31, 2014 and six Professional Groups that constituted VIEs as of December 31, 2015.  The Professional Groups are responsible for the supervision and delivery of medical services to the Company’s clients.  The Company provides management services to the Professional Groups.  Based on the Company’s ability to direct the activities that most significantly impact the economic performance of the Professional Groups, provide necessary funding to the Professional Groups and the obligation and likelihood of absorbing all expected gains and losses of the Professional Groups, the Company has determined that it is the primary beneficiary of these Professional Groups.  

The accompanying consolidated balance sheets as of December 31, 2014 and 2015 include assets of $0.5 million and $1.4 million, respectively, and liabilities of $3.3 million and $0.6 million, respectively, related to the VIEs.  The accompanying consolidated income statements include net (income) loss attributable to noncontrolling interest of $(0.7) million, $1.2 million and $2.8 million related to the VIEs for the years ended December 31, 2013, 2014 and 2015, respectively.

The accompanying consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”).  The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

 

 

F-9

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3. Reorganization Transactions

On April 15, 2014, the Company completed the following transactions which were all completed substantially concurrently (collectively, the “Reorganization Transactions”):

As a result of the foregoing transactions, the Company owned (i) over 93.6% of the outstanding common stock of AAC, (ii) 100% of the outstanding common membership interests in BHR, and (iii) 100% of the outstanding membership interests in CRMS. To help fund or facilitate these transactions, the following additional financing transactions were undertaken in 2014 prior to or in connection with the aforementioned transactions: (i) AAC sold 741,322 shares of its common stock in a private placement to certain accredited investors from February 2014 through April 2014, with net proceeds of $6.0 million, (ii) BHR sold 8.5 Series A Preferred Units in a private placement to certain accredited investors in January and February 2014 with net proceeds of $0.4 million (See Note 10), (iii) BHR redeemed 36.5 Series A Preferred Units from certain accredited investors in April 2014 (See Note 10) and (iv) BHR sold 160 new Series A Preferred Units in a private placement to an accredited investor in April 2014 with net proceeds of $7.8 million (see Note 10).

Private Share Exchange

Certain common shares of AAC issued in 2008 under the previous Board of Directors exceeded the number of shares duly authorized by AAC’s Articles of Incorporation. These common shares were previously classified as mezzanine equity in the consolidated balance sheets because they did not meet the definition of permanent equity as a result of these legal imperfections. To cure these legal imperfections and in preparation for an initial public offering, in the first quarter of 2014, the Company initiated a voluntary private share exchange with certain of AAC’s stockholders whereby the Company offered to certain of AAC’s stockholders the opportunity to receive one share of the Company’s common stock for (i) each share of AAC’s common stock held by such stockholders and (ii) a release from claims arising from or related to the share imperfections (collectively, the “Private Share Exchange”). The Private Share Exchange was conditioned upon, among other things, holders of AAC’s common stock who participated in the Private Share Exchange validly assigning and transferring to the Company at least 90% of the outstanding shares of AAC prior to the expiration of the Private Share Exchange. The Private Share Exchange expired in April 2014, and at the expiration of the Private Share Exchange, holders representing 93.6% of AAC’s common stock had exchanged their shares for shares of common stock of the Company, and AAC became a majority-owned subsidiary of the Company. The Private Share Exchange was accounted for similar to a common control transaction resulting in the assets, liabilities and equity of AAC being carried over at their historical bases. Prior to the completion of the Reorganization Transactions, Holdings had not engaged in any business or other activities except in connection with its formation. Shares of AAC common stock that were not exchanged remained in mezzanine equity or stockholders’ equity until the completion of the short-form merger in November 2014.

Behavioral Healthcare Realty, LLC Acquisition

On April 15, 2014, BHR redeemed 36.5 of its noncontrolling Series A Preferred Units for $1.8 million. These former holders of Series A Preferred Units used the proceeds from the redemption to purchase 224,697 shares of AAC’s common stock at $8.12 per share as part of an exempt common stock offering. Included in the aforementioned transaction, nine of the Series A Preferred Units were redeemed from directors and relatives of directors who purchased 55,406 shares of AAC’s common stock valued at approximately $450,000.

Simultaneously, BHR amended and restated its Limited Liability Company Agreement which among other things changed the rights and privileges of the Series A Preferred Units. On April 15, 2014, BHR received $7.8 million in net proceeds from the sale of 160 units ($50,000 per unit) of its noncontrolling Series A Preferred Units to BNY Alcentra Group Holdings, Inc. (“Alcentra”). Alcentra received a 1% fee at closing and was entitled to receive a 12% per annum preferred return on its initial investment, payable quarterly in arrears. In the event of a non-payment, the preferred return compounded on a quarterly basis computed on an actual/360 day basis. In the event of non-payment for three months, the preferred return increased to 15.0%, and further increased to 18.0% if not paid beginning in the fourth month, with each increase compounding on a quarterly basis computed on an actual/360 day basis. The Series A Preferred Units contained certain embedded issuer call and holder put provisions. BHR had the option to redeem a minimum

F-10

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of 40 Series A Preferred Units and up to 100% of the outstanding Series A Preferred Units for $50,000 per unit, plus (i) any accrued and unpaid preferred return and (ii) a call premium of (a) 3.0% through April 15, 2015, (b) 2.0% from April 16, 2015 through April 15, 2017 and (c) no premium any time after April 15, 2017. Alcentra had a put right that, if exercised, required BHR to redeem all of the issued and outstanding Series A Preferred Units by making a payment equal to $50,000 per unit plus the accrued but unpaid preferred return. Alcentra was able to exercise its put right for a period of 30 days following the 36th month or 48th month after the date of issuance and at any time following the 60th month after the date of issuance. In the event of a sale of a property owned by BHR, Alcentra was entitled to the repayment of its initial capital contribution plus (i) any accrued and unpaid preferred return and (ii) any applicable call premium. As long as any of the Series A Preferred Units were outstanding, distributions to affiliates of BHR were limited to $3.0 million annually.

The Series A Preferred Units generally had no voting or approval rights regarding the management of BHR. However, the holders of Series A Preferred Units were entitled to vote with respect to (i) any action that would change the rights or restrictions of the Series A Preferred Units in a way that would adversely affect such holders and (ii) the creation or issuance of any other security convertible into or exercisable for any equity security of BHR having rights, preferences or privileges senior to the common units of BHR. In addition, unanimous approval of all BHR members, including the holders of Series A Preferred Units, is required to approve the sale by BHR of more than 50% of its real property, more than 50% of the voting or economic rights of any BHR subsidiary or the merger, consolidation, sale of all or substantially all of the assets of BHR or sale of a majority of the common units of BHR.

In addition, so long as Alcentra owned at least 60 Series A Preferred Units, subject to adjustment for certain BHR redemptions, the manager of BHR could not engage in certain transactions without the approval of a majority of the Series A Preferred Unit holders, including, without limitation, the following: (i) liquidate, dissolve or wind up the business of BHR; (ii) authorize the issuance of additional Series A Preferred Units or any class or series of equity securities with rights, preferences or parity with or senior to that of the Series A Preferred Units; (iii) declare or pay any cash distribution or make any other distribution not permitted under the limited liability company agreement; (iv) pay any management or similar fees; (v) pay rebates or reduce payments payable by any primary tenants or (vi) make payments to affiliates of BHR in excess of $3.0 million per year in the aggregate.

Substantially concurrent with the Private Share Exchange, the Company acquired all of the outstanding common membership interests of BHR by issuing 820,124 shares of Company common stock (at a fair value of $8.54 per share as determined by the Company), paying $3.0 million in cash and assuming of a $1.7 million term loan from a financial institution to the Company’s CEO, former President and CFO. The original proceeds from this loan were used to repay a loan related to Greenhouse Real Estate, LLC and was accounted for as an additional capital contribution in BHR. The Company refinanced the assumed term loan and was required to make monthly principal payments of $35,855 to a financial institution, plus 5.0% interest and a balloon payment of $1.4 million in April 2015. In the event of an initial public offering prior to April 2015, the Credit Facility required that the Company immediately repay the $1.7 million assumed and refinanced term loan with proceeds from the IPO. Prior to the BHR Acquisition, BHR was controlled by the CEO, former President and CFO of the Company. BHR owned the real property associated with treatment facilities, which were leased to the Company, as well as other properties that were currently in development or were being held for future development. The BHR Acquisition was accounted for as a common control transaction as BHR was already being consolidated as a VIE in accordance with FASB ASC 810, Consolidations, and, accordingly, the Company recognized $4.9 million of the $11.8 million in fair value of consideration transferred (consisting of $3.0 million cash consideration, the $1.7 million loan assumed and the net deferred tax liabilities of $0.2 million). The Company eliminated the noncontrolling interest attributable to BHR of $3.7 million with the excess of fair value over the carrying value of noncontrolling interest recorded as a reduction to additional paid-in capital of $1.2 million.

Clinical Revenue Management Services, LLC Acquisition

On April 15, 2014, the Company acquired all the outstanding membership interests of CRMS in exchange for $0.5 million in cash and 234,324 common shares of the Company’s common stock (at a fair value of $8.54 per common share as determined by the Company) for total consideration paid of $2.5 million (collectively, the “CRMS Acquisition”). The purchase price was based upon a third party valuation report of CRMS obtained by the Company. CRMS provides billing and collections services to the Company and has no customers other than the Company. After this acquisition, all billing and collection services for the Company are performed by a wholly owned subsidiary. Prior to its acquisition by the Company, CRMS was owned by the spouses of the Company’s CEO and former President. The purchase price resulted in a premium to the fair value of the net assets acquired and, correspondingly, the recognition of goodwill. The amount recorded for goodwill is consistent with the Company’s intentions for the acquisition.

The acquisition was accounted for as a business combination. The Company recorded the transaction based upon the fair value of the consideration paid. This consideration was allocated to the assets acquired and liabilities assumed at the acquisition date based on their fair values as follows (in thousands):

 

 

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Qualitative factors that contributed to the recognition of goodwill include certain intangible assets that are not recognized as a separate identifiable intangible asset apart from goodwill. Intangible assets not recognized apart from goodwill consist primarily of the assembled workforce. The goodwill recognized is not deductible for income tax purposes. Acquisition related costs totaled $0.1 million and were expensed in other operating expenses in the audited consolidated statement of income for the year ended December 31, 2014.

The results of operations for CRMS from the acquisition date of April 15, 2014 are included in the consolidated income statements for the year ended December 31, 2014 and include revenue of $4.0 million and income before income taxes of $1.8 million. The following presents the unaudited pro forma revenues and income before income taxes of the combined entity had the CRMS Acquisition occurred on the first day of the period presented (in thousands):  

 

Fair Value of Shares Issued

The Company determined the fair value of shares of restricted common stock of the Company issued in connection with the BHR Acquisition and the CRMS Acquisition to be $8.54 per share. Management analyzed a valuation report prepared by an independent third party with respect to the valuation of the Company taking into account the Private Share Exchange, the BHR Acquisition and the CRMS Acquisition. In particular, the valuation report analyzed the potential impact of the then-proposed Reorganization Transactions on the valuation of the Company, such as the increase in 2013 pro forma net income as a result of BHR results of operations being included for all of 2013. The valuation report also noted that the impact of the BHR Acquisition on the enterprise value would be mixed, as the additional EBITDA generated at the Company level due to recapture rents and cash and non-cash expenses was not sufficient to overcome the negative impact on enterprise value of BHR’s debt outstanding for the entire year. With respect to CRMS, the analysis determined that it would allow the recapture of additional EBITDA (on a pro forma basis for 2013) due to a combination of recapture revenues (commissions no longer paid) and the expected cost savings. In determining the fair value of the Company’s common stock, management also considered investor demand in the private placement of AAC common stock from February 2014 through April 2014 at $8.12 per share, the improved projected results of operations of the remainder of 2014 and the probability of an initial public offering in 2014. Based on the foregoing analysis, the Company determined the fair value of the Company’s common stock as of April 15, 2014 to be $8.54 per share.

Initial Public Offering and Short-Form Merger

On October 7, 2014, the Company completed an initial public offering (“IPO”) of 5,750,000 shares of its common stock at a public offering price of $15.00 per share, which included the exercise in full of the underwriters’ option to purchase an additional 250,000 shares from the Company and 500,000 shares from certain stockholders.  Net proceeds to the Company from the IPO were approximately $68.8 million, after deducting underwriting discounts and offering costs.

On November 10, 2014, the Company completed a subsidiary short-form merger with AAC and a wholly-owned merger subsidiary whereby the legacy holders of AAC common stock who did not participate in the Private Share Exchange received 1.571119 shares of Holdings common stock for each share of AAC common stock owned at the effective time of the merger (for an aggregate of approximately 293,040 shares of Holdings common stock).  Upon completion of the short-form merger, Holdings owned 100% of the outstanding shares AAC.  The Private Share Exchange was accounted for similar to a common control transaction resulting in the assets, liabilities and equity of AAC being carried over at their historical bases. Shares of AAC common stock that were not exchanged remained in mezzanine equity or stockholders’ equity until the completion of the short-form merger in November 2014.   The short-form merger was accounted for as an equity transaction in accordance with ASC 810, Consolidation.

 

 

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4. Summary of Significant Accounting Policies

Use of Estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses at the date and for the periods that the consolidated financial statements are prepared. On an ongoing basis, the Company evaluates its estimates, including those related to insurance adjustments, provisions for doubtful accounts, goodwill and intangible assets, long-lived assets, deferred revenues and income taxes. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results could materially differ from those estimates.

 

General and Administrative Costs

The majority of the Company’s expenses are “cost of revenue” items. Costs that could be classified as general and administrative expenses include the Company’s corporate overhead costs, which were $28.1 million, $25.3 million, and $48.2 million for the years ended December 31, 2013, 2014, and 2015, respectively.

 

Client Related Revenues

The Company provides services to its clients in both inpatient and outpatient treatment settings. Client related revenues are recognized when services are performed at estimated net realizable value from clients, third-party payors and others for services provided. The Company receives the majority of payments from commercial payors at out-of-network rates. Client related revenues are recorded at established billing rates less adjustments to estimate net realizable value. Adjustments are recorded to state client service revenues at the amount expected to be collected for the service provided based on historic adjustments for out-of-network services not under contract. Prior to admission, each client’s insurance is verified and the client self-pay amount is determined. The client self-pay portion is generally collected upon admission. In some instances, clients will pay out-of-pocket as services are provided or will make a deposit and negotiate the remaining payments as part of the services. These out-of-pocket payments are included in accrued liabilities in the accompanying consolidated balance sheets and revenues related to these payments are deferred and recognized over the period services are provided. From time to time, scholarships may be provided to a limited number of clients. The Company does not recognize revenues for care provided via scholarships.

For the year ended December 31, 2013, approximately 12.3% of the Company’s revenue reimbursements came from Blue Cross Blue Shield of California, 12.1% came from Aetna, and 10.3% came from United Behavioral Health. No other payor accounted for more than 10% of the Company’s revenue reimbursements for the year ended December 31, 2013.

For the year ended December 31, 2014, approximately 18.1% of the Company’s revenue reimbursements came from Anthem Blue Cross Blue Shield of Colorado,  13.3% came from Blue Cross Blue Shield of Texas, 12.9% came from Aetna, 10.5% came from Blue Cross Blue Shield of California, and 10.5% came from United Behavioral Health. No other payor accounted for more than 10% of the Company’s revenue reimbursements for the year ended December 31, 2014.

For the year ended December 31, 2015, approximately 15.1% of the Company’s revenues were reimbursed by Anthem Blue Cross Blue Shield of Colorado; 12.5% by Blue Cross Blue Shield of Texas; 11.5% by Aetna, and 11.1% were reimbursed by Blue Cross Blue Shield of California. No other payor accounted for more than 10% of revenue reimbursements for the year ended December 31, 2015.

In prior years in cases where the demand for services exceeded capacity, the Company entered into contractual arrangements with other parties to provide services. Management evaluated and determined the Company was the principal party to the services provided. Revenues generated through the Company’s contractual arrangements are included in revenues at their expected realizable amount while the subcontracted service payments made are included in client related services. The need for these contractual arrangements decreased as the Company increased its bed capacity in the second half of 2012 and further decreased with the increased bed capacity in the first quarter of 2013 as a result of the opening of Desert Hope. None of the contractual arrangements were utilized during 2014 or 2015.

Other Revenue

The Company’s other revenue consists of service charges from the delivery of quality targeted leads to behavioral and mental health service businesses through the Company’s operating subsidiary Referral Solutions Group, LLC, which was acquired on July 2, 2015.  Revenue is recognized when persuasive evidence of an arrangement exists, services have been rendered, the fee for services is fixed or determinable, and collectability of the fee is reasonably assured.

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Allowance for Contractual and Other Discounts

The Company derives the majority of its revenues from commercial payors at out-of-network rates. Management estimates the allowance for contractual and other discounts based on its historical collection experience. The services authorized and provided and related reimbursement are often subject to interpretation and negotiation that could result in payments that differ from the Company’s estimates.

Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable primarily consists of amounts due from third-party payors (non-governmental) and private pay clients and is recorded net of contractual discounts. The Company’s ability to collect outstanding receivables is critical to its results of operations and cash flows. Accounts receivable is reported net of an allowance for doubtful accounts, which is management’s best estimate of accounts receivable that could become uncollectible in the future. Accordingly, accounts receivable reported in the Company’s consolidated financial statements is recorded at the net amount expected to be received. The Company’s primary collection risks are (i) the risk of overestimating net revenues at the time of billing that may result in the Company receiving less than the recorded receivable, (ii) the risk of non-payment as a result of commercial insurance companies denying claims, (iii) the risk that clients will fail to remit insurance payments to the Company when the commercial insurance company pays out-of-network claims directly to the client, (iv) resource and capacity constraints that may prevent the Company from handling the volume of billing and collection issues in a timely manner, (v) the risk that clients do not pay the Company for their self-pay balance (including co-pays, deductibles and any portion of the claim not covered by insurance) and (vi) the risk of non-payment from uninsured clients. The Company’s allowance for doubtful accounts is based on historical experience, but management also takes into consideration the age of accounts, creditworthiness and current economic trends when evaluating the adequacy of the allowance for doubtful accounts. An account is written off only after the Company has pursued collection efforts or otherwise determines an account to be uncollectible.

At December 31, 2014, 20.7% of accounts receivable was from Anthem Blue Cross Blue Shield of Colorado, 13.0% was from Blue Cross Blue Shield of California, and 10.6% was from Blue Cross Blue Shield of Texas.  At December 31, 2015, 22.4% of accounts receivable was from Anthem Blue Cross Blue Shield of Colorado and 15.0% was from Blue Cross Blue Shield of California. No other payor accounted for more than 10% of accounts receivable at December 31, 2014 or 2015.

A summary of activity in the Company’s allowance for doubtful accounts is as follows (in thousands):

 

 

 

Cash and Cash Equivalents

The Company considers all highly liquid investments with maturities of three months or less when purchased to be cash equivalents.

 

Property and Equipment

Property and equipment are stated at cost or at acquisition date fair value for assets obtained in business combinations, net of accumulated depreciation and amortization. Expenditures for maintenance and repairs are charged to expense as incurred. The Company capitalizes interest on construction projects and such interest is included in the cost of the related asset. Assets held for development are classified as construction in progress and the Company does not depreciate these assets until they are placed in service. Leasehold improvements are amortized over their estimated useful lives or the remaining lease period, whichever is less. Assets under capital leases are amortized over the lease term or in the event of transfer of ownership at the end of the lease over the economic life of the leased asset. Amortization expense related to assets under capital lease is included with depreciation and amortization expense in the consolidated statements of income. Depreciation is calculated using the straight-line method over the estimated economic useful lives of the assets, as follows:

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Goodwill and Intangible Assets

The Company has only one operating segment, substance abuse/behavioral healthcare treatment services, for segment reporting purposes. The substance abuse/behavioral healthcare treatment services operating segment represents one reporting unit for purposes of the Company’s goodwill impairment test. Goodwill represents the excess of the purchase price over the fair value of the identifiable net assets acquired. Goodwill and intangible assets with indefinite lives are not amortized, but instead are tested for impairment at least annually or whenever events or changes in circumstances indicate the carrying value may not be recoverable.  If the carrying value of goodwill exceeds its implied fair value, an impairment loss is recorded. The Company’s annual impairment tests of goodwill and other indefinite-lived intangibles in 2014 and 2015 resulted in no impairment charges. The Company has no intangible assets with indefinite useful lives other than goodwill.

The Company’s other intangible assets principally relate to trademarks, marketing intangibles, non-compete agreements, and leasehold interests acquired during business combinations. Trademarks and marketing intangibles are amortized over a period of ten years, non-compete agreements are amortized over the five-year term of the agreements, and leasehold interests are amortized over the remaining life of the leases.

Long-Lived Asset Impairment

Long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to future net undiscounted cash flows expected to be generated by the asset. Impairment is measured by the amount by which the carrying value of the assets exceeds the fair value of the assets. The Company did not identify any indicators of impairment during the years ended December 31, 2014 and 2015.

Accrued Liabilities

The Company’s accrued liabilities, reflected as a current liability in the accompanying consolidated balance sheets, consist of the following (in thousands):

 

 

Segments

The focus of all Company operations is centered on a single service, substance abuse/behavioral healthcare treatment. As such, the Company has one operating segment. The Company is organized and operates as one reportable segment, consisting of various treatment facilities located in the United States. The treatment facilities operate in the same industry and have similar economic characteristics, services and clients. Management has the ability to direct and serve clients in any of these facilities, which allows management to operate the Company’s business and analyze its revenues on a system-wide basis rather than focusing on any individual facility. The Company’s chief operating decision maker evaluates performance and manages resources based on the results of the consolidated operations as a whole.

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Advertising Expenses

Advertising costs are expensed as the related activity occurs.

Stock-Based Compensation

The Company accounts for stock-based compensation to employees using a fair-value based method for costs related to all share-based payments. Prior to the Company’s stock being traded in an active market, the Company estimated the fair value of employee restricted stock awards on the date of grant based on the appraised fair value.  The fair value of the portion of the award that is ultimately expected to vest is recognized as expense on a straight-line basis over the requisite service periods in the Company’s consolidated statements of income.

Earnings Per Share

Basic and diluted earnings per common share are calculated based on the weighted-average number of shares outstanding in each period and dilutive stock options, non-vested shares, convertible debt securities, and warrants, to the extent such securities have a dilutive effect on earnings per share using the treasury stock method. The two-class method determines earnings per share for each class of common stock and participating preferred stock and their respective participation rights in undistributed earnings. Effective with the elimination of the Series B Preferred Stock in the first quarter of 2013, the Company no longer has two classes of stock.

Income Taxes

The Company accounts for income taxes using the asset and liability method. Under the asset and liability method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.

The effect on the deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided for significant deferred tax assets when it is more likely than not that such assets will not be recovered.

The Company’s practice is to recognize interest and/or penalties related to uncertain income tax positions in income tax expense.

For the years ended December 31, 2013, 2014 and 2015, the Company had no accrued interest or penalties related to income tax matters in income tax expense.

VIEs included in the accompanying consolidated financial statements consist of various corporations and a partnership.  As discussed in Note 3, the Company acquired BHR on April 15, 2014, prior to that date, BHR was a partnership for income tax purposes.  Partnerships are characterized as flow through entities for federal and certain state income tax purposes, taxes for the VIEs that are considered partnerships are not recorded in the accompanying consolidated financial statements, except for certain state taxes imposed at the entity level. Taxes that are imposed on the owners of these partnerships are not included in the accompanying consolidated financial statements.  Taxes attributable to BHR after the acquisition date are included in these consolidated financial statements.

Fair Value Measurements

Fair value, for financial reporting purposes, is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.

Disclosure is required about how fair value was determined for assets and liabilities and following a hierarchy for which these assets and liabilities must be grouped, based on significant levels of inputs as follows: Level 1—quoted prices in active markets for identical assets or liabilities; Level 2—quoted prices in active markets for similar assets and liabilities and inputs that are observable for the asset or liability; or Level 3—unobservable inputs for the asset or liability, such as discounted cash flow models or valuations. The determination of where assets and liabilities fall within this hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

 

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Comprehensive Income

As of December 31, 2013, 2014, and 2015, the Company did not have any components of other comprehensive income. As such, comprehensive income equaled net income for each of the periods presented in the accompanying consolidated statements of income.

Recent Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers”, which outlines a single comprehensive model for recognizing revenue and supersedes most existing revenue recognition guidance, including guidance specific to the healthcare industry. Companies across all industries will use a new five-step model to recognize revenue from customer contracts. The new standard, which replaces nearly all existing GAAP and International Financial Reporting Standards revenue recognition guidance, will require significant management judgment in addition to changing the way many companies recognize revenue in their financial statements. The standard is effective for public entities for annual and interim periods beginning after December 15, 2017, with early adoption permitted for annual periods beginning after December 15, 2016.  The Company is currently evaluating the impact that the adoption of this standard will have on its revenue recognition policies and procedures, financial position, result of operations, cash flows, financial disclosures and control framework.

In March 2015, the FASB issued ASU No. 2015-03, “Simplifying the Presentation of Debt Issuance Costs”.  The update is effective for financial statements issued for fiscal years beginning after December 15, 2015, and those interim periods within those fiscal years, with early adoption permitted.  The update requires debt issuance costs related to a note to be reported in the balance sheet as a direct deduction from the face amount of that note on a retrospective basis upon adoption.  The Company determined to early adopt the revised guidance and presented $1.9 million of deferred debt issuance costs associated with the Company’s 2015 Credit Facility (as later defined) net of the debt balance at December 31, 2015 (see Note 9).  The impact on prior periods was not material.

In September 2015, the FASB issued ASU 2015-16, “Business Combinations:  Simplifying the Accounting for Measurement-Period Adjustments” (“ASU 2015-16”).  ASU 2015-16 eliminates the requirement for an acquirer to retrospectively adjust its financial statements for changes to provisional amounts that are identified during the measurement-period following the consummation of a business combination.  Instead, ASU 2015-16 requires these types of adjustments to be made during the reporting period in which they are identified and would require additional disclosure or separate presentation of the portion of the adjustment that would have been recorded in the previously reported periods as if the adjustment to the provisional amounts had been recognized as of the acquisition date.  ASU 2015-16 is effective prospectively for fiscal years beginning after December 15, 2015, including interim periods within those years, with earlier application permitted for financial statements that have not been issued.  The adoption of ASU 2015-16 is not expected to have a material impact on the Company’s results of operations. 

 

In November 2015, the FASB issued ASU 2015-17, “Income Taxes: Balance Sheet Classification of Deferred Taxes” (“ASU 2015-17”).  ASU 2015-17 requires deferred tax assets and liabilities to be netted and presented as a single non-current amount in the balance sheet, rather than separating them into current and non-current amounts. The Company prospectively adopted the provisions of ASU 2015-17 during the fourth quarter of 2015. Prior periods were not retrospectively adjusted.  The adoption of ASU 2015-17 had no impact on the Company’s results of operations or cash flows.

 

In February 2016, the FASB issued ASU No. 2016-02, “Leases”. The new standard establishes a right-of-use (ROU) model that requires a lessee to record a ROU asset and a lease liability on the balance sheet for all leases with terms longer than 12 months. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition in the income statement.  The new standard is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. A modified retrospective transition approach is required for lessees for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements, with certain practical expedients available.  The Company is currently evaluating the impact that adoption of this new standard will have on its consolidated financial statements.

 

 

5. Earnings Per Share

Earnings per share (“EPS”) was calculated using the two-class method required for participating securities up until 2013. Series B Preferred Stock was entitled to dividends at the rate equal to that of common stock.  Undistributed earnings allocated to these participating securities were subtracted from net income in determining net income attributable to common stockholders. Net losses, if any, were not allocated to these participating securities. Effective with the elimination of the Series B Preferred Stock in the first quarter of 2013, the Company no longer has two classes of stock.

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Basic EPS is computed by dividing net income attributable to common stockholders by the weighted-average number of shares of common stock outstanding for the period. Common shares outstanding include both the common shares classified as mezzanine equity and those classified as equity.

For the calculation of diluted EPS, net income attributable to common stockholders for basic EPS is adjusted by the effect of dilutive securities, including awards under stock-based payment arrangements, and outstanding convertible debt securities. Diluted EPS attributable to common stockholders is computed by dividing net income attributable to common stockholders by the weighted-average number of fully diluted common shares outstanding during the period.

The following tables reconcile the numerator and denominator used in the calculation of basic and diluted EPS for years ended December 31, 2013, 2014 and 2015 (in thousands except share and per share amounts):

 

 

The Company has included common stock that is classified as mezzanine equity in the denominator for basic and diluted EPS calculations for 2013 and 2014.

 

 

6.  Acquisitions

On February 20, 2015, the Company acquired certain assets of Recovery First, Inc. (“Recovery First”), a Florida-based provider of substance abuse treatment and rehabilitation services, for $13.0 million in cash and the assumption of certain liabilities.  The purchase price was based upon arms-length negotiations between the Company and Recovery First, an unrelated third party, that resulted in a premium to the fair value of the net assets acquired (including identifiable intangible assets) and, correspondingly, the recognition of goodwill. The amount recorded for goodwill is consistent with the Company’s intentions for the acquisition and is deductible for income tax purposes.

On April 17, 2015, the Company acquired certain assets of Clinical Services of Rhode Island, Inc. (“CSRI”), a provider of intensive outpatient substance abuse treatment services, for $0.7 million in cash and 42,460 in shares of Holdings’ common stock.  The purchase price was based upon arms-length negotiations between the Company and CSRI, an unrelated third party, that resulted in a premium to the fair value of the net assets acquired and, correspondingly, the recognition of goodwill.  The amount recorded for goodwill is consistent with the Company’s intentions for the acquisition and is deductible for income tax purposes.

On July 2, 2015, the Company acquired RSG, an online publisher in the substance abuse treatment industry with a portfolio of websites and marketing assets, for $32.5 million in cash and 540,193 in shares of Holdings’ common stock.  The purchase price was based upon arms-length negotiations between the Company and RSG, an unrelated third party, that resulted in a premium to the fair value of the net assets acquired and, correspondingly, the recognition of goodwill.  The amount recorded for goodwill is consistent with the Company’s intentions for the acquisition and is deductible for income tax purposes.

On July 2, 2015, the Company acquired Taj Media, LLC (“Taj Media”), a digital marketing agency with addiction treatment industry expertise, for $2.2 million in cash and 37,253 in shares of Holdings’ common stock.  The purchase price was based upon arms-length negotiations between the Company and Taj Media, an unrelated third party, that resulted in a premium to the fair value of the net assets acquired and, correspondingly, the recognition of goodwill.  The amount recorded for goodwill is consistent with the Company’s intentions for the acquisition and is deductible for income tax purposes.

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On August 10, 2015, the Company acquired certain assets of The Oxford Centre, Inc. and its affiliates (“Oxford”), which operates a 76-bed residential facility located on a 110-acre campus in Etta, Mississippi, which is 65 miles southwest of Memphis, Tennessee, and three outpatient treatment locations in Oxford, Tupelo and Olive Branch, Mississippi, for $35.0 million in cash.  The purchase price was based upon arms-length negotiations between the Company and Oxford, an unrelated third party, that resulted in a premium to the fair value of the net assets acquired and, correspondingly, the recognition of goodwill.  The amount recorded for goodwill is consistent with the Company’s intentions for the acquisition and is deductible for income tax purposes.

On October 1, 2015, the Company acquired certain assets of Sunrise House Foundation, Inc. (“Sunrise House”), a non-profit corporation operating a 110-bed substance abuse treatment center, 30 halfway house beds and two outpatient programs in Western New Jersey, for $6.6 million in cash.  The purchase price was based upon arms-length negotiations between the Company and Sunrise House, an unrelated third party, that resulted in a fair value assessment of the net assets acquired of $8.4 million.  The $1.8 million of assets in excess of the purchase price was recorded as a bargain purchase gain and is included in “Bargain purchase gain” in the consolidated statements of income.  Prior to recording this gain, the Company reassessed its identification of assets acquired and liabilities assumed, including the use of independent valuation experts to assist the Company in appraising the personal property, real property and intangible assets acquired. The Company believes there were several factors that contributed to this transaction resulting in a bargain purchase gain, including historical losses incurred by the business.

Each of these acquisitions was accounted for as a business combination in accordance with FASB ASC 805, Business Combinations. The Company recorded each transaction based upon the fair value of the consideration paid. This consideration was allocated to the assets acquired and liabilities assumed at the corresponding acquisition dates, based on their fair values.  The fair values of assets acquired and liabilities assumed, at the corresponding acquisition dates, were as follows (in thousands):

 

 

Acquisition-related costs for the acquisitions were expensed in acquisition-related expenses in the consolidated statements of income.

 

 The results of operations for the acquired entities from the respective acquisition dates are included in the consolidated statements of income for the year ended December 31, 2015, and include revenues of $23.0 million and income before income taxes of $6.9 million.  The following presents the unaudited pro forma revenues and income before taxes of the combined entity had the acquisitions occurred on January 1, 2014 (in thousands):

 

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7. Property and Equipment, net

Property and equipment consisted of the following (in thousands):

 

 

Acquired Property

On February 24, 2015, the Company purchased a piece of property including buildings, structures, and 96 acres of land in Ringwood, New Jersey for $6.4 million in cash and recorded the balance as construction in progress. The Company funded the purchase price from cash on hand with the intention of converting the property into a treatment center.

On April 1, 2015, the Company acquired a 93-bed hospital in southern California for cash consideration of $13.5 million and recorded the balance as construction in progress and land.  The Company funded the purchase price from cash on hand with the intention of converting the property into a chemical dependency recovery hospital.

 

 

8. Goodwill and Intangible Assets

The Company’s goodwill balance was $12.7 million and $108.7 million as of December 31, 2014 and 2015, respectively. The increase in goodwill relates to the acquisitions noted below and as discussed in Note 6.

 

 

Other identifiable intangible assets and related accumulated amortization consisted of the following as of December 31, 2014 and 2015 (in thousands):  

 

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Changes to the carrying value of identifiable intangible assets during the year ended December 31, 2015 were as follows (in thousands):  

 

 

On April 17, 2015, the Company acquired certain marketing assets with a value of $1.1 million for cash consideration of $0.5 million and 17,110 shares of the Company’s common stock issued on January 1, 2016, with an estimated fair value of $0.5 million at the date of acquisition.

 

The weighted-average amortization periods of the acquired intangible assets are as follows:

 

 

At December 31, 2015, all intangible assets are amortized using a straight-line method.  The following table presents amortization expense expected to be recognized during fiscal years subsequent to December 31, 2015 (in thousands):

 

 

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9. Notes Payable and Revolving Line of Credit

A summary of the Company’s debt obligations, net of unamortized discounts, is as follows (in thousands):

 

 

Credit Facility

The Company’s prior credit facility borrowing base provided for borrowings up to the lesser of (i) $20 million or (ii) 80% of the Company’s eligible accounts receivable at any time prior to February 1, 2014, and 70% of the Company’s eligible accounts receivable at any time on or after February 1, 2014, subject to adjustment if the aggregate of all returns, rebates, discounts, credits and allowances for the immediately preceding three months is less than 8% of the Company’s gross revenues for such period. The prior credit facility was secured by the Company’s accounts receivable, deposit accounts and other rights to payment, inventory, and equipment, and was guaranteed jointly and severally by all of the Company’s subsidiaries that have significant operations and/or assets and the Company’s CEO and former President. The prior credit facility, as amended, required the Company to maintain a tangible net worth ratio not greater than 2.50 to 1.00, a fixed charge coverage ratio not less than 1.25 to 1.00, and net income of at least $1.00, all determined as of each quarter end. The prior credit facility limited capital expenditures to $0.1 million in each fiscal year unless approved by the financial institution, limited additional borrowing to $50,000 during the term of the agreement unless approved by the financial institution, limited operating lease expense to $0.1 million in each fiscal year and prohibited the payment of dividends in cash or stock. The prior credit facility also contained a cross-default clause linking a default under the prior credit facility to the occurrence of a default by the Company under any other debt agreement, material lease commitment, contract, instrument or obligation.

The Company was not in compliance with certain financial covenants contained in the prior credit facility as of March 31, 2014. These covenant violations created a cross-default under the debt agreements between the same lender and each of Greenhouse Real Estate, LLC (“Greenhouse Real Estate”), Concorde Real Estate, LLC (“Concorde Real Estate”), and The Academy Real Estate, LLC (“Academy Real Estate”), but for which the Company obtained waivers.

On April 15, 2014, the Company’s prior credit facility was amended and restated and included a waiver for the noncompliance with the financial covenants and negative covenants described in the preceding paragraphs.

On April 15, 2014, the Company entered into a Second Amended and Restated Credit Facility (the “2014 Credit Facility”) with Wells Fargo Bank, National Association. The 2014 Credit Facility made available to the Company a $15.0 million revolving line of credit, subject to borrowing base limitations (the “Amended Revolving Line”), and amended and restated two existing term loans in the outstanding principal amounts of $0.6 million (“Term Loan A”) and $1.5 million (“Term Loan B”). In June 2014, the Company repaid in full the $1.5 million outstanding balance of Term Loan B.

The Amended Revolving Line bore interest at one-month LIBOR, plus an applicable margin that was determined by the Company’s leverage ratio, as defined by the agreement, at the end of each quarter. A quarter-end leverage ratio of 4.75 to 1.00 or above resulted in an applicable margin of 3.00%, a ratio below 4.75 to 1.00 and equal to or above 4.00 to 1.00 results in an applicable margin of 2.75%, and a ratio below 4.00 to 1.00 results in an applicable margin of 2.50%. Term Loan A bore interest at LIBOR plus 3.15%. The borrowing base for the Amended Revolving Line was 70% of the Company’s eligible accounts receivable and was

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established with the understanding that the aggregate of all returns, rebates, discounts, credits and allowances, exclusive of the initial adjustment to record net revenues at the time of billing, for the immediately preceding three months would be less than 20% of gross revenues for such period (up from the previous restriction of 8%).

On December 18, 2014, the Company terminated the 2014 Credit Facility, after having repaid the then outstanding principal balance of $487,500 plus accrued interest.   The 2014 Credit Facility also included one outstanding term loan in the outstanding principal amount of $0.5 million. The Company did not incur any early termination penalties as a result of the early termination of the 2014 Credit Facility.

On March 9, 2015, the Company entered into a five year $125.0 million senior secured credit facility (the “2015 Credit Facility”) with Bank of America, N.A., as administrative agent for the lenders party thereto.   The 2015 Credit Facility consists of a $50.0 million revolving credit facility and a $75.0 million term loan.  The Company used the proceeds to re-pay certain existing indebtedness, fund acquisitions and de novo treatment facilities and for general corporate purposes.  The 2015 Credit Facility also has an accordion feature that allows the total borrowing capacity to be increased up to $200.0 million, subject to certain conditions, including obtaining additional commitments from lenders.  On June 16, 2015, the Company amended the 2015 Credit Facility to remove from the definition of “change of control” what is often referred to as a “dead hand proxy put” provision.

The 2015 Credit Facility requires quarterly term loan principal repayments for the outstanding term loan of $0.9 million from September 30, 2015 to December 31, 2016, $1.4 million from March 31, 2017 to December 31, 2017, $2.3 million from March 31, 2018 to December 31, 2018, and $2.8 million from March 31, 2019 to December 31, 2019, with the remaining principal balance of the term loan due on the maturity date of March 9, 2020.  Repayment of the revolving loan is due on the maturity date of March 9, 2020.    The 2015 Credit Facility generally requires quarterly interest payments.

Borrowings under the 2015 Credit Facility are guaranteed by the Company and each of its subsidiaries and are secured by a lien on substantially all of the Company’s and its subsidiaries’ assets. Borrowings under the 2015 Credit Facility bear interest at a rate tied to the Company’s Consolidated Total Leverage Ratio (defined as Consolidated Funded Indebtedness to Consolidated EBITDA, in each case as defined in the 2015 Credit Facility).   Eurodollar Rate Loans with respect to the 2015 Credit Facility bear interest at the Applicable Rate plus the Eurodollar Rate (each as defined in the 2015 Credit Facility) (based upon the LIBOR Rate (as defined in the 2015 Credit Facility) prior to commencement of the interest rate period). Base Rate Loans with respect to the 2015 Credit Facility bear interest at the Applicable Rate plus the highest of (i) the federal funds rate plus 0.50%, (ii) the prime rate and (iii) the Eurodollar Rate plus 1.0% (the interest rate at December 31, 2015 was 3.33%).  In addition, the Company is required to pay a commitment fee on undrawn amounts under the revolving credit facility of 0.35% to 0.50% depending on the Company’s Consolidated Total Leverage Ratio (the commitment fee rate at December 31, 2015 was 0.45%).   The Applicable Rates and the unused commitment fees of the 2015 Credit Facility are based upon the following tiers:   

The 2015 Credit Facility requires the Company to comply with customary affirmative, negative and financial covenants, including a Consolidated Fixed Charge Coverage Ratio, Consolidated Total Leverage Ratio and a Consolidated Senior Secured Leverage Ratio (each as defined in the 2015 Credit Facility). The Company may be required to pay all of its indebtedness immediately if the Company defaults on any of the financial or other restrictive covenants contained in the 2015 Credit Facility.  The financial covenants include maintenance of the following:

 

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At December 31, 2015, the Company was in compliance with all applicable covenants under the 2015 Credit Facility.

The Company incurred approximately $1.4 million in debt issuance costs related to underwriting and other professional fees, and deferred these costs over the term of the 2015 Credit Facility.  Additionally, the Company used approximately $24.9 million of the proceeds from the $75.0 million term loan to repay in full the outstanding real estate debt, certain equipment notes and certain capital leases. The Company did not incur any significant early termination fees.    

On July 1, 2015, the Company borrowed $15.0 million under the $50.0 million revolver of the 2015 Credit Facility.  The Company used the proceeds to fund de novo development projects, acquisitions, and general corporate purposes.

On August 7, 2015, the Company borrowed $32.0 million under the $50.0 million revolver of the 2015 Credit Facility.  The Company used the proceeds to fund de novo development projects, acquisitions, and general corporate purposes.

As of December 31, 2015, the Company’s availability under the $50.0 million revolving credit facility of the 2015 Credit Facility was $0.7 million, net of $47.0 million in borrowings as noted above, and $2.3 million in standby letters of credit issued for various corporate purposes.  

Interest Rate Swap Agreements

In July 2014, the Company entered into two interest rate swap agreements to mitigate its exposure to fluctuations in interest rates. The interest rate swap agreements had initial notional amounts of $8.9 million and $13.2 million which fix interest rates over the life of the respective interest rate swap agreement at 4.21% and 4.73%, respectively.  The notional amounts of the swap agreements represent amounts used to calculate the exchange of cash flows and are not the Company’s assets or liabilities.  The interest payments under these agreements are settled on a net basis.  The Company has not designated the interest rate swaps as cash flow hedges and therefore the changes in the fair value of the interest rate swaps are included within interest expense in the consolidated statements of income.

The fair value of the interest rate swaps at December 31, 2014 and 2015 represented a liability of $431,000 and $464,000, respectively, and is reflected in other long-term liabilities on the consolidated balance sheets.  Refer to Note 15 for further discussion of fair value of the interest rate swap agreements.  The Company’s credit risk related to these agreements is considered low because the swap agreements are with a creditworthy financial institution.

The following table sets forth the Company’s interest rate swap agreements at December 31, 2015 (dollars in thousands):

 

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Real Estate Debt

As discussed in Note 3, on April 15, 2014, the Company acquired BHR and assumed a $1.8 million term loan, which was subsequently paid off in 2014 with proceeds from the Company’s IPO.  The Company’s total real estate debt totaled $24.6 million at December 31, 2014. The terms of the debt are discussed below. On March 9, 2015, the Company repaid in full all outstanding real estate debt as discussed further below.  The Company did not incur any early termination penalties in the repayment of the debt.

 

Concorde Real Estate

In conjunction with the consolidation of Concorde Real Estate on June 27, 2012, the Company assumed a $3.5 million promissory note which was refinanced in July 2012 and replaced with loans totaling $7.4 million in two tranches to fund the renovation of the Desert Hope facility. The first tranche totaled $4.4 million and bore interest at 3.0% plus one-month LIBOR, with interest payable monthly, and required a lump sum principal payment in July 2013. The second tranche totaled $3.0 million, bore interest at 2.0% plus the lender’s prime rate (3.25% at December 31, 2012), with interest payable monthly, and required a lump sum principal payment in July 2013.

 

In May 2013, Concorde Real Estate refinanced these two outstanding loans with a $9.6 million note payable with a maturity of May 15, 2018. The additional debt in 2013 was used to redeem the preferred membership interests in Concorde Real Estate. The note required monthly principal payments of $53,228 plus interest and a balloon payment of $6.6 million due at maturity. Interest was calculated based on a 360 day year and accrued at the Company’s option of either (i) one-month LIBOR (as defined in the agreement) plus 2.5%, with such rate fixed until the next monthly reset date, or (ii) floating at one-month LIBOR (as defined in the agreement) plus 2.5%. In the event that the Company elected the floating option for either two consecutive periods or a total of three periods, the floating rate increased by 0.25%. The interest rate at December 31, 2014 was 2.67% and the amount outstanding at December 31, 2014 was $8.6 million.  The Company repaid this note in full on March 9, 2015 for its stated outstanding principal balance and did not incur any early termination fees.

The note was guaranteed by the Company and its CEO and former President and was secured by a deed of trust and the assignment of certain leases and rents. The note contained financial covenants that required the Company to maintain a fixed charge coverage ratio of not less than 1.25 to 1.00. The note also contained a cross-default clause linking a default under the note to the occurrence of a default by any guarantor or an affiliate of a guarantor with respect to any other indebtedness.

Greenhouse Real Estate

Greenhouse Real Estate entered into a $13.2 million construction loan facility (the “Construction Facility”) with a financial institution on October 8, 2013 to refinance existing debt related to a 70-bed facility and to fund the construction of an additional 60 beds at this facility located in Grand Prairie, Texas. Monthly draws could be made against the Construction Facility based on actual construction costs incurred.

Interest, which was payable monthly, was calculated based on a 360 day year and accrued at the Company’s option of either (i) one-month LIBOR (as defined in the agreement) plus 3.0%, with such rate fixed until the next monthly reset date, or (ii) floating at one-month LIBOR (as defined in the agreement) plus 3.0%. In the event that the Company elected the floating option for either two consecutive periods or a total of three periods, the floating rate increased by 0.25%.

At Greenhouse Real Estate’s option, the Construction Facility was convertible to a permanent term loan with an extended maturity of October 31, 2019 provided (i) there was no default, (ii) the construction was 100% complete, (iii) there was no material adverse change, as determined by the financial institution in its sole discretion, in the financial condition of Greenhouse Real Estate and (iv) other terms and conditions were satisfied. The maximum amount that could be converted was 65% of the appraised value at the time of the conversion. If at the time of the conversion the loan value exceeded the 65% loan-to-value ratio, Greenhouse Real Estate was permitted to make principal payments to reduce the loan-to-value to the 65% threshold. In the event Greenhouse Real Estate did not elect to or was unable to convert the Construction Facility to a permanent term loan, Greenhouse Real Estate was required to pay an exit fee equal to 3.0% of the then outstanding balance.  Principal payments at the time of the conversion were to be calculated based on a 15-year amortization schedule, and monthly principal and interest payments were required with a balloon payment at maturity.

The Construction Facility was secured by a deed of trust and the assignment of certain leases and rents and was guaranteed by the Company and the CEO and former President of the Company. Greenhouse Real Estate was required to maintain a minimum debt service coverage ratio of 1.25 to 1.00. The note also contained a cross-default clause linking a default under the Greenhouse Real Estate loan to the occurrence of a default by any guarantor or an affiliate of a guarantor with respect to any other indebtedness.

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In August 2014, the outstanding balance of the construction loan was converted to a $12.7 million permanent loan that matured in August 2019 and had an annual interest rate equal to the one-month LIBOR plus 2.5%. The permanent loan required monthly principal payments of $70,778 plus interest and a balloon payment of $8.5 million at maturity.  The outstanding balance at December 31, 2014 was $12.5 million and the interest rate was 2.67%.  The Company repaid this note in full on March 9, 2015 for its stated outstanding principal balance and did not incur any early termination fees.

Academy Real Estate

In May 2013, the Company, through Academy Real Estate, obtained a $3.6 million note payable (the “Academy Loan”) from a financial institution to fund a portion of the acquisition of the property located in Riverview, Florida (just outside of Tampa, Florida). The note payable matured on November 10, 2013 and was renewed under identical terms.  In connection with the Company’s sale to BHR of its membership interests of Academy Real Estate on December 10, 2013, BHR assumed the $3.6 million note payable. Interest, which was payable monthly, was calculated based on a 360 day year and accrued at the Company’s option of either (i) one-month LIBOR (as defined in the agreement) plus 3.0%, with such rate fixed until the next monthly reset date or (ii) floating at one-month LIBOR (as defined in the agreement) plus 3.0%.  In the event that the Company elected the floating option for either two consecutive periods or a total of three periods, the floating rate increased by 0.25%. In April 2014, the Company effected an amendment to the Academy Loan to extend the maturity date to July 14, 2019. Under the amended Academy Loan, the Company made monthly principal payments of $30,000 plus interest commencing in October 2014 and a balloon payment of remaining unpaid principal of $1.9 million at the maturity date.  The agreement required the Company to maintain a minimum fixed charge coverage ratio of 1.25 to 1.00 and contained other restrictive financial covenants. The agreement also contained a cross-default clause linking a default under the Academy Loan note to the occurrence of a default by any guarantor or an affiliate of a guarantor with respect to any other indebtedness. The outstanding balance at December 31, 2014 was $3.5 million and the interest rate was 3.17%.  The Company repaid this note in full on March 9, 2015 for its stated outstanding principal balance and did not incur any early termination fees.

At December 31, 2013 and 2014, the Company was in compliance with the financial covenants of the BHR debt. The instances of noncompliance under its prior credit facility created a cross-default with the Construction Facility, the Concorde Real Estate note payable and the Academy Loan.  The Company obtained a waiver for the covenant defaults under its prior credit facility for 2012, and the amendment and restatement of its prior credit facility in April 2014 included a waiver for the noncompliance of the financial covenants and negative covenants that occurred under the prior credit facility in 2013 and the quarter ended March 31, 2014.  The Company also obtained waivers for the cross-defaults under the Construction Facility, the Concorde Real Estate note payable and the Academy Loan.

Behavioral Healthcare Realty, LLC

As discussed in Note 3, the Company assumed a $1.7 million term loan in conjunction with the acquisition of BHR. The Company refinanced this loan with a financial institution and the new loan required monthly principal payments of $35,855 plus interest at 5.0% with a balloon payment of $1.4 million due at maturity in April 2015. The Company used a portion of the net proceeds from the IPO received in October 2014 to repay in full the outstanding balance of the term loan of $1.6 million on October 7, 2014.

Acquisition Related Debt

On August 31, 2012, the Company acquired certain assets of AJG Solutions, Inc. and its subsidiaries and the equity of B&B Holdings INTL LLC (collectively, the “TSN Acquisition”) from the two individual owners of such entities (the “TSN Sellers”). The Company financed a portion of the TSN Acquisition with the following sources of debt. The Company entered into a $6.2 million subordinated note payable with the TSN Sellers. Under the terms of the agreement, the note was separated into the following tranches: (i) $2.2 million paid in equal monthly principal installments over 36 months, bearing interest at 5% per annum, (ii) $2.5 million due on August 31, 2015 (the “Balloon Payment”), bearing interest at 3.125% per annum and (iii) a contingent balloon payment of up to $1.5 million due on August 31, 2015 (the “Contingent Payment”), bearing interest at 3.125% per annum. The Contingent Payment was contingent on the achievement of certain performance metrics over the term of the note. Due to the contingent nature of the Contingent Payment, a discount of approximately 13% was applied to the Contingent Payment to reflect the weighted-average probability the Contingent Payment would not be made. In April 2013, $0.5 million outstanding under the Balloon Payment was converted into 95,451 shares of the Company’s common stock at a conversion price of $5.24 per share. The Company estimated the fair value of the Contingent Payment each reporting period through an analysis of the TSN Sellers’ estimated achievement of the performance metrics specified in the agreement. Based upon this analysis, the Company determined a claw back of $0.5 million of the Contingent Payment existed at December 31, 2013 and, accordingly, adjusted the outstanding balance of the Balloon Payment to $3.0 million at that date. In addition to the claw back on the Contingent Payment, the Company included a reduction of 118,576 shares of common stock in the computation of its earnings per share for the year ended December 31, 2013 to reflect the claw back of those

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shares based upon this analysis.  On August 15, 2014, the Company entered into two settlement agreements with one of the TSN Sellers.  Pursuant to the terms of the settlement agreements, the Company agreed to pay $7.6 million in exchange for full and final satisfaction of all obligations to the party.  As a result, the Company repaid $0.2 million of the note payable and $1.5 million of Balloon Payment.   

On August 31, 2015, the Company paid in full the remaining note payable balance and entered into an amendment on the Balloon Payment with the remaining party of the TSN Sellers.  Under the modified note, the Company made a principal payment of $0.3 million at the date of execution, extended the maturity date to February 29, 2016, and increased the interest rate to 6.25% per annum. On February 29, 2016, the Company paid in full the outstanding balance of the acquisition debt, including principal payments of $1.2 million and accrued interest of $0.2 million.

At December 31, 2014 and 2015, the outstanding balance remaining under the seller subordinated notes payable was $1.8 million and $1.2 million, respectively.  

Subordinated Debt Issued with Detachable Warrants (Related Party and Non-related Party)

In March and April 2012, the Company issued $1.0 million of subordinated promissory notes, of which $0.2 million was issued to a director of the Company. The notes bore interest at 12% per annum. The notes were scheduled to mature at various dates throughout 2015 and 2017. Interest was payable monthly and the principal amount was due, in full, on the applicable maturity date of the note. In connection with the issuance of these notes, the Company issued detachable warrants to the lenders to purchase a total of 112,658 shares of common stock of AAC at $0.64 per share. The warrants were exercisable at any time up to their expiration on March 31, 2022. The Company recorded a debt discount of $0.1 million related to the warrants which reduced the carrying value of the subordinated notes.  As of December 31, 2014, the outstanding balance of the notes, net of the unamortized debt discount of $55,000, was $0.9 million, of which $0.2 million was owed to a director of the Company. On February 27, 2015, the Company repaid in full the $1.0 million of the outstanding subordinated promissory notes.  The Company did not incur any early termination fees.

The Company calculated the fair value of warrants issued with the subordinated notes using the Black-Scholes valuation method. The following assumptions were used to value the warrants at the issuance date: a stock price of $1.36, an exercise price of $0.64, expected life of 10 years, expected volatility of 20%, risk free interest rates ranging from 2.1% to 4.0% and no expected dividend yield. In March 2014, warrants representing the right to purchase 106,728 shares of common stock of AAC were exercised and a total of 106,728 shares of common stock of AAC were issued to the exercising warrant holders, including 23,717 shares to a director of the Company.

 

2015 Subordinated Debt Issuance

On October 2, 2015, the Company entered into two financing facilities with affiliates of Deerfield Management Company, L.P. The financing facilities consist of $25.0 million of subordinated convertible debt and up to $25.0 million of unsecured subordinated debt, together with an incremental facility of up to an additional $50.0 million of subordinated convertible debt (subject to certain conditions). The Company issued $25.0 million of subordinated convertible debt at closing and currently intends to use the proceeds to fund pending acquisitions, its de novo pipeline and for other corporate purposes.  The $25.0 million of subordinated convertible debt bears interest at an annual rate of 2.50% and matures on September 30, 2021. The $25.0 million of subordinated convertible debt funded at closing is convertible into shares of the Company’s common stock at $30.00 per share.

The Company may borrow up to $25.0 million of unsecured subordinated debt that will bear interest at an annual rate of 12.0% and mature on September 30, 2020. The $25.0 million of unsecured subordinated debt may be drawn for acquisition financing through September 30, 2016 and can be repaid under certain conditions without penalty prior to October 2, 2017.

The Company incurred approximately $0.8 million in debt issuance costs related to underwriting and other professional fees, and deferred these costs over the term of the debt. At December 31, 2015, $25.0 million remained outstanding, with an interest rate of 2.50%.

 

 

 

 

 

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A summary of future maturities of long-term debt, as of December 31, 2015, is as follows (in thousands):

 

 

 

10. Mezzanine Equity

Share Imperfections

In 2008, preferred shares were issued by the previous board of directors of AAC prior to the timely filing of a Certificate of Designation with the Secretary of State of Nevada. Additionally in 2008, certain common shares were issued by the previous board of directors of AAC that were in excess of the number of shares duly authorized by AAC’s Articles of Incorporation. AAC has classified these preferred and common shares as mezzanine equity at the original purchase price in the audited consolidated balance sheets because they do not meet the definition of permanent equity as a result of these legal imperfections.

To address these issues, in April 2014, the Company conducted the Private Share Exchange with certain stockholders of AAC, whereby holders representing 93.6% of the outstanding shares of common stock of AAC, which were classified in both Mezzanine Equity and Stockholders’ Equity, exchanged their shares on a one-for-one basis for shares of the Company’s common stock. The Private Share Exchange was conditioned upon, among other things, a release by each exchanging stockholder of any and all potential claims arising from corporate actions that were not conducted in compliance with Nevada law.

Statement of Mezzanine Equity

Changes to mezzanine amounts were as follows (dollars in thousands).  

 

BHR Series A Preferred

In October 2013, BHR amended its limited liability company agreement to permit the issuance of Series A Preferred Units. In the fourth quarter of 2013, BHR received proceeds of $1.4 million from the sale of 28 Series A Preferred Units valued at $50,000 per unit. An entity controlled by the spouse of one of the Company’s directors purchased $200,000 of the Series A Preferred Units. The unit holders were entitled to receive a 12% per annum preferred return on their initial investment, payable quarterly in arrears, had no equity appreciation ability and limited voting rights that were conditioned upon BHR’s default on the distribution of the 12% preferred return. The Series A Preferred Units contained certain embedded issuer call and holder put provisions. BHR had the option to call and redeem all or any portion of the Series A Preferred Units for $50,000 per unit plus any accrued and unpaid preferred return at any time after the twelfth month of issuance. The holders of the Series A Preferred Units had a put right during three periods

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discussed below, that, if exercised, required BHR to redeem 100% of the issued and outstanding Series A Preferred Units by making a payment equal to $50,000 per unit plus the accrued but unpaid preferred return. The holder was able to exercise the put right on the 36th month, 48th month and 60th month following the date of issuance for a 30-day period. In the event of a sale of a property owned by BHR, the holders of the Series A Preferred Units were entitled to the repayment of their initial capital contribution plus any accrued and unpaid preferred return. The Company classified the Series A Preferred Units as noncontrolling interest as a part of mezzanine equity because the potential redemption was not within the complete control of BHR until the last put option period had expired.

 

In January and February of 2014, BHR sold 8.5 units of Series A Preferred Units, valued at $50,000 per unit, with proceeds to BHR of $0.4 million, net of issuance costs of $11,300. A director of the Company purchased five Series A Preferred Units for $0.3 million at $50,000 per unit. After the sale, 36.5 Series A Preferred Units were outstanding totaling approximately $1.8 million. On April 15, 2014, BHR redeemed all 36.5 outstanding Series A Preferred Units for $1.8 million. These former holders of Series A Preferred Units used the proceeds to purchase 224,697 shares of AAC common stock at $8.12 per share as part of an exempt common stock offering. A director and relative of a director of the Company received approximately $450,000 and purchased 55,406 shares of AAC common stock in connection with the redemption of nine Series A Preferred Units.

On April 15, 2014, BHR sold 160 units of Series A Preferred Units, valued at $50,000 per unit, with proceeds to BHR of $7.8 million, net of issuance costs of $0.2 million. The issuance costs were being amortized over a 36 month period, the first date the holder could put the shares back to the Company. See Note 3 for a complete disclosure of the major components of this transaction and the related Series A Preferred Units.  On February 25, 2015, the Company exercised its call provision and redeemed 100% of the outstanding Series A Preferred units for a total redemption price of approximately $8.6 million which included $0.2 million for the 3.0% call premium and $0.4 million for unpaid preferred returns.

 

 

11. Stockholders’ Equity

Common Stock

During 2013, the Company sold 1,424,124 shares of its common stock in an exempt offering at $5.24 per share, which the Company’s management estimated to be fair value. Included in the total shares issued were 715,883 shares sold to directors of the Company and 4,774 shares sold to each of the CFO, Chief Operating Officer (“COO”) and the Vice President of Marketing. The Company issued 1,338,809 of these shares in March 2013 and 85,315 in April 2013. Additionally, 286,353 shares were issued to the Company’s CEO upon conversion of $1.5 million in subordinated debt and 95,451 shares were issued to a Vice President of the Company upon conversion of $0.5 million under the balloon payment issued by the Company.

In connection with the exempt offering described above, a Company employee subscribed for 19,090 shares of common stock at $5.24 per share, which the Company’s management estimated to be fair value. As consideration for the shares, the employee issued to the Company a subscription note receivable in the amount of $0.1 million. The Company forgave this subscription note receivable over a 12-month period ending on July 1, 2014. During 2013, the Company recorded $42,000 in compensation expense and additional paid-in capital related to this forgiveness.

In April 2013, the Company redeemed 698,259 shares of common stock from one of the TSN Sellers at $5.24 per share, which the Company’s management estimated to be fair value, for an aggregate purchase price of $3.7 million.

In February and March 2014, AAC received proceeds of $4.2 million, net of $12,500 in issuance costs, from the sale of 516,625 shares of its common stock at $8.12 per share, which the Company’s management determined to be fair value, in an exempt common stock offering. Included within the total shares sold in the Company’s 2014 private placement were 61,563 shares sold to directors of the Company, 12,313 shares sold to the Company’s General Counsel and Secretary, 6,156 shares sold the Company’s COO and 3,078 shares sold to one of the Company’s Vice Presidents. The share price was based, in part, on an independent valuation analysis obtained in December 2013.

On April 11, 2014, AAC granted 77,765 shares of restricted common stock to its General Counsel and Secretary under the Company’s 2007 Stock Incentive Plan (the “Incentive Plan”), of which 38,883 shares vested immediately with the remaining 38,882 shares vesting on April 10, 2015. The fair value on the award date was $8.12 per share, as determined by the Company’s management. As a result of the award, AAC recorded $0.3 million of compensation expense, $0.2 million of additional compensation expense to satisfy the employee’s personal tax obligation related to the vesting of the grant during the second quarter of 2014, and $0.3 million ratably over the one-year vesting period. Additionally, on April 11, 2014, AAC granted 4,744 shares of its common stock to a non-executive employee. AAC recorded $39,000 of compensation expense and $30,000 of additional compensation expense to satisfy the employee’s personal tax obligation related to the stock grant during the second quarter of 2014.

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On April 17, 2014, AAC redeemed a total of 14,318 shares of its common stock at $8.12 per share, which the Company’s management estimates to be fair value, for an aggregate redemption price of $0.1 million.

In connection with the issuance of subordinated notes in 2012, AAC issued detachable warrants to the lenders to purchase a total of 112,658 shares of common stock at $0.64 per share. The warrants were exercisable at any time up to their expiration on March 31, 2022. In March 2014, 106,728 of the outstanding warrants were exercised and a total of 106,728 shares of AAC common stock were issued to the exercising warrant holders, including 23,717 shares to a Company director. In April 2014, the remaining outstanding warrants for the purchase of 5,930 shares of AAC common stock were exercised.

In connection with the 2013 exempt offering of AAC common stock, a Company employee subscribed for 19,090 shares of common stock at $5.24 per share, which the Company’s management estimated to be fair value. As consideration for the shares, the employee issued to the Company a subscription note receivable in the amount of $0.1 million. The Company forgave this subscription note receivable over a 12-month period ending on July 1, 2014.  During the year ended December 31, 2014, the Company recorded $58,000, respectively, in compensation expense related to this forgiveness.

Stock Split

On September 18, 2014, a 1.571119-for-1 stock split in the form of a stock dividend was effected. The common share and per share amounts included in the consolidated financial statements have been adjusted to reflect the stock split for all periods presented.

Initial Public Offering and Short-Form Merger

On October 7, 2014, the Company completed an IPO of 5,750,000 shares of its common stock at a public offering price of $15.00 per share, which included the exercise in full of the underwriters’ option to purchase an additional 250,000 shares from the Company and 500,000 shares from certain stockholders.  Net proceeds to the Company from the IPO were approximately $68.8 million, after deducting underwriting discounts and offering costs.

 

On November 10, 2014, the Company completed a subsidiary short-form merger with AAC and a wholly-owned merger subsidiary whereby the legacy holders of AAC common stock who did not participate in the Private Share Exchange received 1.571119 shares of Holdings common stock for each share of AAC common stock owned at the effective time of the merger (for an aggregate of approximately 293,040 shares of Holdings common stock).  Upon completion of the short-form merger, Holdings owned 100% of the outstanding shares of AAC.  The short-form merger was accounted for as an equity transaction in accordance with ASC 810, Consolidation.

 

 

12. Stock Based Compensation Plans

2007 Stock Incentive Plan

The Company adopted the Incentive Plan in 2007. An aggregate of 3,927,798 shares of common stock were reserved for issuance pursuant to the Incentive Plan. Upon adoption of the 2014 Equity Incentive Plan (defined below), the Incentive Plan is no longer active, and as a result, the Company does not anticipate any further issuances under the plan.  As of December 31, 2014 and 2015, no stock options had been granted and no options were outstanding.    

In November 2013, the Company issued a total of 145,824 shares of restricted common stock to its COO, Vice President of Business Development and Vice President of Marketing under the Incentive Plan, of which 36,455 shares vested on December 31, 2014, and the remaining 109,369 shares vested ratably at the end of each of the first three quarters in 2014. The fair value on the award date was $6.49 per share, which the Company’s management estimated to be fair value. As a result of the award, the Company recorded $0.2 million and $0.7 million of compensation expense, and $0.1 million and $0.8 million of additional compensation expense to satisfy the employees’ minimum personal tax obligations related to the vesting of the grant during 2013 and 2014, respectively. Such expenses are included on the Company’s consolidated statements of income under the caption “salaries, wages and benefits.”

The valuation of the Company’s common stock for the November 2013 stock awards was determined in accordance with the guidelines outlined in the American Institute of Certified Public Accounts Practice Aid, Calculation of Privately-Held Company Equity Securities Issues as Compensation. The Company engaged a third party valuation firm to construct a probability-weighted expected return model (“PWERM”) and to assist and advise management in determining the appropriate inputs and metrics to the model. Because there was no public market for the Company’s common stock, the board of directors, with input from management, exercised significant judgment and considered numerous objective and subjective factors to determine the fair value of the Company’s common stock as of the November 14, 2013, including the following factors:

 

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The Company used PWERM in determining the Company’s equity value for the November 2013 grant. PWERM is an analysis of future values of a company for several likely liquidity scenarios that may include a strategic sale or merger, an initial public offering or the dissolution of a company, as well as a company’s enterprise value assuming the absence of a liquidity event. For each possible future event, the future values of the company are estimated at certain points in time. This future value is then discounted to a present value using an appropriate risk-adjusted discount rate. Then, a probability is estimated for each possible event based on the facts and circumstances as of the valuation date. Using PWERM, the Company estimated the value of the Company’s common stock based upon an analysis of varying values for the Company’s common stock assuming (i) the completion of an initial public offering, (ii) a merger or acquisition and (iii) the continuation as a private company. The Company applied a percentage probability weighting to each of these scenarios based on the Company’s expectations of the likelihood of each event. Based on the foregoing PWERM analysis, the fair value of November 19, 2013 grants of 145,824 shares of restricted common stock was determined to be $6.49 per share, as estimated by the Company’s management.

In March 2014, AAC granted 5,834 shares of fully vested common stock to each of its five non-employee directors. The Company recognized $0.2 million of compensation expense in the first quarter of 2014 as a result of these grants. The fair value on the award date was $8.12 per share, as estimated by the Company’s management.  

2014 Equity Incentive Plan

The Company adopted the 2014 Equity Incentive Plan (“2014 Incentive Plan”) in 2014. An aggregate of 1,571,120 shares of common stock are reserved for issuance pursuant to the 2014 Incentive Plan. The Incentive Plan is administered by the Board of Directors, which determines, subject to the provisions of the 2014 Incentive Plan, the employees, directors or consultants to whom incentives are awarded.

On October 7, 2014, the Company granted a total of 158,000 shares of restricted common stock under the 2014 Incentive Plan.  The shares vest annually over a period of four years from issuance.

On January 7, 2015, the Company granted a total of 400,000 shares of restricted common stock under the 2014 Incentive Plan.  The shares vest quarterly over a period of three years.

On January 8, 2015, the Company granted 2,544 shares of fully vested common stock to each of its five non-employee directors. The Company recognized $0.4 million of compensation expense for the year ended December 31, 2015, as a result of these grants. The fair value on the award date was $29.37 per share based on the closing market value of the Company’s common stock on the NYSE.

On July 9, 2015, the Company granted 3,174 shares of restricted common stock under the 2014 Incentive Plan.  Of these shares, 75% vested immediately, with the remaining amount vesting quarterly over a one year period.

On November 23, 2015, the Company granted 405,000 shares of restricted common stock under the 2014 Incentive Plan.  

On January 13, 2016, the Company granted 140,000 shares of restricted common stock under the 2014 Incentive Plan.  The shares vest quarterly over a period of three years.

The Company recognized $1.2 million, $3.1 million, and $5.6 million in stock based compensation expense for the years ended December 31, 2013, 2014 and 2015, respectively.  As of December 31, 2015, there was $19.0 million of unrecognized compensation expense related to unvested restricted stock grants, which is expected to be recognized over the remaining weighted average vesting period of 2.6 years.

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A summary of share activity under the Incentive Plan is set forth below:

 

On January 13, 2016, the Company issued 30,000 shares of fully vested common stock to each of its five non-employee directors.  Additionally, on January 13, 2016, the Company issued 110,000 shares of restricted stock under the plan, which vest quarterly over a three year period.

 

Employee Stock Purchase Plan

On May 19, 2015, the Company’s shareholders approved the Company’s Employee Stock Purchase Plan (“ESPP”), which was adopted by the Board of Directors in the fourth quarter of 2014.  The ESPP enables eligible employees to purchase shares of the Company’s common stock through a payroll deduction during certain option periods, generally commencing on January 1 and July 1 of each year and ending on June 30 and December 31 of each year.  On the exercise date (the last trading day of each option period), the cumulative amount deducted from each participant’s salary during that option period will be used to purchase the maximum number of shares of the Company’s common stock at a purchase price equal to the lesser of (i) 85% of the closing market price of the Company’s common stock as quoted on the New York Stock Exchange on the exercise date or (ii) 85% of the closing market price of the Company’s common stock as quoted on the New York Stock Exchange on the grant date, subject to certain limitations and restrictions.  In July 2015, the Company issued 12,637 shares of the Company’s common stock at a stock price of $25.68 in connection with employee deductions of $0.3 million contributed in the January 1, 2015 through June 30, 2015 ESPP option period.   At December 31, 2015, the Company recorded a liability of $0.2 million related to employee deductions contributed during the July 1, 2015 through December 31, 2015 period.  

For the year ended December 31, 2015, the Company recognized $222,000 of compensation expense related to the ESPP. The company did not recognize any expense related to the ESPP in 2013 or 2014.

 

 

 

13. Restructuring Expenses

During the first half of 2013, the Company implemented restructuring plans to centralize its call centers and to close Leading Edge, a facility acquired in 2012 as the amenities and the service offerings at the Leading Edge facility were inconsistent with the Company’s long-term strategy. Restructuring and exit charges of $0.8 million were expensed in 2013 related to these restructuring activities.

As a result of the facility closure, the Company recorded restructuring charges of $0.5 million, including payroll, severance and other employee related costs of $0.2 million and facility exit charges of $0.3 million during the year ended December 31, 2013.  The remaining restructuring liability at December 31, 2014 was classified in the consolidated balance sheet as accrued liabilities of $13,000 related to remaining facility costs.  These costs were paid in full during the first quarter of 2015.  As a result there is no remaining liability at December 31, 2015.

 

 

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14. Income Taxes

Income tax expense consisted of the following for the years ended December 31, 2013, 2014 and 2015:

  

 

 The company’s effective income tax rate for the years ended December 31, 2013, 2014 and 2015 reconciles with the federal statutory rate as follows:

 

Deferred income tax assets (liabilities) are comprised of the following at December 31, 2014 and 2015:

 

 

The Company’s valuation allowance of $0.6 million is related to state NOLs, which are limited due to apportionable income to certain jurisdictions.

 

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The Company had $0.1 million of uncertain tax positions as of December 31, 2014 and 2015.  The Company's uncertain tax positions are related to tax years that remain subject to examination by the relevant taxing authorities.  The Company may be subject to examination by the Internal Revenue Service ("IRS") for calendar years 2012 through 2015. Additionally, any net operating losses that were generated in prior years and utilized in these years may also be subject to examination by the IRS.  Generally, for state purposes, the Company's 2012 through 2015 tax years remain open for examination by tax authorities.  The Company has not been notified of any federal or state income tax examinations.

At December 31, 2015, the Company had approximately $0.7 million in federal net operating losses attributable to the VIEs which will expire between 2032 and 2034.  In addition, the Company had $1.2 million in state net operating losses which expire between 2027 and 2034 and $0.5 million in state tax credits, which expire in 2029.  

 

 

15. Fair Value of Financial Instruments

The carrying amounts reported at December 31, 2014 and 2015 for cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable and accrued liabilities approximate fair value because of the short-term maturity of these instruments and are categorized as Level 1 within the GAAP fair value hierarchy. The fair value of the Company’s revolving line of credit is categorized as Level 2. The carrying amount of the Company’s debt approximates fair value because interest rates approximate the current rates available to the Company.

The Company has debt with variable and fixed interest rates. The fair value of debt with fixed interest rates was determined using the quoted market prices of debt instruments with similar terms and maturities, which are considered Level 2 inputs. The fair value of debt with variable interest rates was also measured using Level 2 inputs, including good faith estimates of the market value for the particular debt instrument, which represent the amount an independent market participant would provide, based upon market observations and other factors relevant under the circumstances. The carrying value of such debt approximated its estimated fair value at December 31, 2014 and 2015.

The Company has entered into interest rate swap agreements to manage exposure to fluctuations in interest rates. Fair value of the interest rate swaps is determined using a pricing model based on published interest rates and other observable market data. The fair value was determined after considering the potential impact of collateralization, adjusted to reflect both the Company’s own nonperformance risk and the respective counterparty’s nonperformance risk. The fair value measurement of interest rate swaps utilizes Level 2 inputs. At each of December 31, 2014 and 2015, the fair value of the interest rate swaps represented a liability of $0.5 million. Refer to Note 9 for further discussion of the interest rate swap agreements.

Intangible assets are measured at fair value on a non-recurring basis. These assets are classified in Level 3 of the fair value hierarchy. Goodwill and other indefinite-lived intangibles are tested for impairment at least annually, or more frequently if circumstances indicate that the carrying amount exceeds fair value.

The Company estimates the fair values of goodwill and other indefinite-lived intangibles utilizing multiple measurement techniques. The estimation is primarily determined based on an estimate of future cash flows (income approach) discounted at a market derived weighted-average cost of capital. The income approach has been determined to be the most representative of fair value because the Company’s equity does not have an active trading market. Other unobservable inputs used in these valuations include management’s cash flow projections and estimated terminal growth rates. The valuation of indefinite-lived intangible assets also includes an unobservable input for royalty rate, which is based on rates used by comparable industries.

The useful lives of definite-lived intangible assets (customer relationships) are evaluated whenever events or circumstances warrant a revision to the remaining amortization period. The fair value of definite-lived intangible assets is based on estimated cash flows from the future use of the asset, discounted at a market derived weighted-average cost of capital.

No impairment charges were recorded related to goodwill or other intangible assets for the years ended December 31, 2013, 2014, and 2015.

Long-lived assets are measured at fair value on a non-recurring basis and are classified in Level 3 of the fair value hierarchy. The fair value is estimated utilizing unobservable inputs, including appraisals on real estate as well as evaluations of the marketability and potential relocation of other assets in similar condition and similar market areas. The Company analyzes long-lived assets on an annual basis for any triggering events that would necessitate an impairment test. No impairment charges were recorded for the years ended December 31, 2013, 2014, and 2015.

 

 

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16. Commitments and Contingencies

Operating Leases

The Company has entered into various operating leases expiring through October 2018. Commercial properties under operating leases primarily include space required to perform client services and space for administrative facilities.  Rent expense was $4.6 million, $2.1 million and $5.3 million for the years ended December 31, 2013, 2014 and 2015, respectively. Included in such amounts were related party rent expenses totaling $1.3 million for the year ended December 31, 2013. With the consolidation of Greenhouse Real Estate, LLC as a variable interest entity in October 2013 (refer to Note 3), there was no longer any lease expense with related parties.

The future minimum lease payments under non-cancelable operating leases with remaining terms of one or more years as of December 31, 2015 consisted of the following (in thousands):

 

The Company recognizes rent expense on a straight line basis with the difference between rent expense and rent paid recorded as deferred rent. Such amount is included in accrued liabilities in the consolidated balance sheets.

 

Litigation

In April 2013, two wage and hour claims were filed against the Company in the State of California and were subsequently consolidated into a class action. In June 2013, the parties agreed to settle the substantive claims for $2.5 million during mediation. Once the settlement became probable, the Company established a $2.5 million reserve during the second quarter of 2013 for this matter. Subsequently, on April 9, 2014 and following court approval, the Company settled this matter with payment of $2.6 million.  

Bevell Settlement

On February 3, 2014, AAC filed an action against James D. Bevell in the U.S. District Court in the Middle District of Tennessee, alleging breach of contract and tortious interference with business practices arising out of Mr. Bevell’s breach of his non-compete agreements. Mr. Bevell is the former Chief Innovation Officer of AAC.  On July 16, 2014, Mr. Bevell filed an action, for which an amended complaint was filed on August 15, 2014, in the Chancery Court for the State of Tennessee in Williamson County which alleged the defendants breached fiduciary duties owed to Mr. Bevell and breached the Agreement Among Stockholders entered into in connection with the TSN Acquisition.   On August 15, 2014, AAC, entered into settlement agreements to resolve all outstanding disputes among the parties (the “Bevell Settlement”).  Pursuant to the terms of the Bevell Settlement, the Company agreed to pay Mr. Bevell the sum of approximately $7.6 million.   In addition, pursuant to the terms of the Bevell Settlement, the Company eliminated the debt payable to Mr. Bevell of $1.9 million and Mr. Bevell surrendered 698,259 shares ($5.7 million) of AAC common stock that were subsequently cancelled.   There was no impact to the Company’s consolidated statement of operations as a result of the Bevell Settlement.       

Horizon Blue Cross Blue Shield of New Jersey v. Avee Laboratories et al.

On September 4, 2013, Horizon Blue Cross Blue Shield of New Jersey (“Horizon”) filed an amended complaint in the Superior Court of New Jersey against several defendants, including Leading Edge Recovery Center, LLC, one of the Company’s subsidiaries. Leading Edge Recovery Center, LLC formerly operated a drug and alcohol treatment facility in New Jersey. Horizon alleges the defendants submitted and caused others to submit unnecessary drug tests in violation of New Jersey law and is seeking recovery for monetary and treble damages. The parties have reached a confidential settlement in this matter and consider it closed. The Company recognized $1.5 million in reserves related to this matter in the second quarter of 2015, and increased the reserve amount by $0.7 million to $2.2 million in reserves related to this matter during 2015.  Upon execution of the settlement, the Company made a payment of $1.2 million and agreed to pay $0.1 million per month until the full settlement amount has been paid in full.  As of December 31, 2015, the Company had paid a total of $1.4 million with a balance remaining of $0.8 million.   

 

 

 

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State of California

 

On July 29, 2015, the Superior Court of the State of California court unsealed a criminal indictment returned by a grand jury against the Company’s subsidiaries ABTTC, Inc. dba A Better Tomorrow Treatment Centers, Forterus, Inc. and Forterus Health Care Services, Inc., Jerrod N. Menz, the Company’s former President and former member of the Company’s Board of Directors, as well as a current facility-level employee and three former employees.  Mr. Menz remains an employee of the Company. The indictment was returned in connection with a criminal investigation by the California Department of Justice and charged the defendants with second-degree murder and dependent adult abuse in connection with the death of a client in 2010 at one of the Company’s former locations. We believe the allegations are legally and factually unfounded and intend to contest them vigorously. Pending before the court are motions to dismiss the indictment on various legal and factual grounds.  Trial has been set for May 6, 2016.  Given the early stage of this proceeding, the Company cannot estimate the amount or range of loss if the defendants were to be convicted; however, such loss could be material.

 

Kasper v. AAC Holdings, Inc. et al. and Tenzyk c. AAC Holdings, Inc. et al.

 

On August 24, 2015, a shareholder filed a purported class action in the United States District Court for the Middle District of Tennessee against the Company and certain of its current and former officers.  The plaintiff generally alleges that the Company and certain of its current and former officers violated Sections 10(b) and/or 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by making allegedly false and/or misleading statements and failing to disclose certain information.  On September 14, 2015, a second class action against the same defendants asserting essentially the same allegations was filed in the same court.  On October 26, 2015, the court entered an order consolidating these two described actions into one action.  On February 29, 2016, the plaintiff filed a consolidated amended complaint.  The Company intends to defend this action vigorously.  At this time the Company cannot predict the results of litigation with certainty, and cannot estimate the amount or range of loss, if any.  The Company believes the disposition of this action will not have a material adverse effect on its consolidated results of operations or consolidated financial position.

Other

The Company is aware of various other legal matters arising in the ordinary course of business. To cover these types of claims, the Company maintains insurance it believes to be sufficient for its operations, although some claims may potentially exceed the scope of coverage in effect. Plaintiffs in these matters may request punitive or other damages that may not be covered by insurance. After taking into consideration the evaluation of such matters by the Company’s legal counsel, the Company’s management believes the outcome of these matters will not have a material impact on the Company’s consolidated financial position, results of operations and cash flows.

401(k) Plan

The Company has a qualified 401(k) savings plan (the “Plan”) which provides for eligible employees (as defined) to make voluntary contributions to the Plan. The Company makes contributions to the Plan based upon the participants’ level of participation, which is fully vested at the time of contribution. For each of the years ended December 31, 2014 and 2015, the Company contributions under this Plan were $0.5 million.

 

17. Related Parties

In addition to the related party transactions discussed elsewhere in the notes to the consolidated financial statements, the consolidated financial statements include the following related party transactions. Prior to the Company’s IPO, it had at times received advances from or made advances to current significant stockholders. These amounts have been included in the consolidated balance sheets and notated as “related party accounts” (see Notes 3, 9, and 16).

During 2013, the Company outsourced its medical billing and collection process to CRMS. The two owners and officers of CRMS at that time were the spouses of the CEO and former President of the Company. Pursuant to a written service agreement, CRMS was paid (i) the greater of $0.1 million per month or 5.0% of the monthly collected revenues and (ii) 7.0% of the Professional Groups collected revenues. The service agreement included a one year term with automatic renewals unless one party terminates the agreement with 90 days’ notice. Total amounts paid to CRMS under the service agreement during the years ended December 31, 2012 and 2013 were $0.6 million and $2.8 million, respectively. The Company recognized expense of $0.6 million in 2012 and $3.4 million in 2013 associated with this service agreement. The Company leased office space and furniture to CRMS under a month to month arrangement in 2013, and total rental income recognized in 2013 was $0.1 million. During 2013, CRMS occupied space in the Company’s building but no rents were charged by the Company. The Company classifies these sublease proceeds as an offset to rentals and leases in the consolidated statements of income.  As discussed in Note 3, the Company acquired CRMS on April 15, 2014.  Total amounts paid to CRMS from January 1, 2014 to the date of acquisition under the service agreement were $0.1 million.  During

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this period, the Company recognized expense of $0.1 million.  The results of operations for CRMS from the acquisition date are included in the consolidated income statements for the year ended December 31, 2015.

The Company is a party to certain placement agreements with Vaco, LLC (“Vaco”). One of the Company’s directors, who is also a stockholder, is an executive officer and an equity owner of Vaco. Vaco provides the Company with accounting professionals and other staff, either on a temporary or permanent basis. Vaco is typically paid 25% of each employee’s first year salary as a placement fee or paid an hourly rate for temporary professional services. Total payments and expense recognized related to this agreement were $0.1 million for each of the years ended December 31, 2013, 2014, and 2015.

From March 2013 through April 2013, the Company issued 1,423,574 shares of common stock, at a price of $5.24 per share, which the Company’s management estimated to be fair value, to certain accredited investors, for an aggregate offering price of $7.5 million. In addition, as part of the 2013 offerings, an employee of the Company subscribed for 19,090 shares of common stock at $5.24 per share. As consideration for the shares, the employee issued the Company a subscription note receivable in the amount of $0.1 million. The Company forgave this subscription note receivable over a 12-month period.

 

An entity beneficially owned by Mr. Cartwright, the Company’s Chief Executive Officer, owns an airplane that the Company uses for business purposes in the course of its operations pursuant to a written lease agreement. The Company pays an hourly rate for use of the airplane as well as fuel and certain maintenance costs.  For the years ended December 31, 2014 and 2015, the Company made aggregate payments to the related entity for use of the airplane of approximately $0.3 million and $1.0 million, respectively.

The Company utilized a construction company owned by its Vice President of Development as a general contractor for various 2015 construction projects.  The Company reimbursed the construction company at cost for any expenses it incurred in serving as its general contractor during 2015 which totaled approximately $7.7 million.

 

 

18. Quarterly Information (Unaudited)

The tables below present summarized unaudited quarterly results of operations for the years ended December 31, 2014 and 2015. Management believes that all necessary adjustments have been included in the amounts stated below for a fair presentation of the results of operations for the periods presented when read in conjunction with the Company’s consolidated financial statements for the years ended December 31, 2014 and 2015. Results of operations for a particular quarter are not necessarily indicative of results of operations for an annual period and are not predictive of future periods.

 

 

       

 

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

Dated: March 8, 2016

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

 

 

 

 

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EXHIBIT INDEX

 

 

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