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Section 1: 10-K (10-K)

aac-10k_20171231.htm

 

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

(Mark One)

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2017

or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission File Number: 001-36643

 

AAC HOLDINGS, INC.

(Exact Name of Registrant as Specified in Its Charter)

 

 

Nevada

 

35-2496142

(State or other jurisdiction of
incorporation or organization)

 

(I.R.S. Employer
Identification No.)

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:

 

Title of each Class

 

Name of exchange on which registered

Common Stock, $0.001 par value

 

New York Stock Exchange

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  

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  

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      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      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, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer

 

  

Accelerated filer

 

Non-accelerated filer

 

  (Do not check if a smaller reporting company)

  

Smaller reporting company

 

 

 

 

 

Emerging growth company

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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  

As of June 30, 2017, 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 $6.93 on that date), was approximately $100,400,000. 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 February 16, 2018, there were 23,897,669 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive proxy materials for its 2018 Annual Meeting of Stockholders are incorporated by reference into Part III hereof.

 

 

 


 

AAC HOLDINGS, INC.

ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

 

PART I

 

 

Item 1.    Business

  

3

Item 1A. Risk Factors

  

14

Item 1B. Unresolved Staff Comments

  

27

Item 2.    Properties

  

27

Item 3.    Legal Proceedings

  

28

Item 4.    Mine Safety Disclosures

  

29

PART II

  

 

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

  

30

Item 6.    Selected Financial Data

  

32

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

  

34

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

  

52

Item 8.    Financial Statements and Supplementary Data

  

52

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

  

52

Item 9A. Controls and Procedures

  

52

Item 9B. Other Information

  

53

PART III

  

 

Item 10.  Directors, Executive Officers and Corporate Governance

  

54

Item 11.  Executive Compensation

  

54

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

  

54

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

  

54

Item 14.  Principal Accounting Fees and Services

  

54

PART IV

  

 

Item 15.  Exhibits and Financial Statement Schedules

  

55

Item 16.  Form 10-K Summary

  

57

SIGNATURES

  

 

 

 

 

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PART I

Unless we indicate otherwise or the context requires, “we,” “our,” “us” and the “Company” refer to AAC Holdings, Inc., together with our subsidiaries. The term “AAC” refers to our wholly owned subsidiary, American Addiction Centers, Inc.

 

Item 1. Business

Company Overview

We are a provider of inpatient and outpatient substance use treatment services for individuals with drug addiction, alcohol addiction and co-occurring mental/behavioral health issues. In connection with our treatment services, we perform clinical diagnostic laboratory services and provide physician services to our clients. As of December 31, 2017, we operated 9 residential substance abuse treatment facilities located throughout the United States, focused on delivering effective clinical care and treatment solutions across 939 residential beds, including 630 licensed detoxification beds, 19 standalone outpatient centers and 5 sober living facilities across 409 beds for a total of 1,348 combined residential and sober living beds.

We are also an internet marketer in the addiction treatment industry operating a broad portfolio of internet assets that service millions of website visits each month. Through our portfolio of websites, such as Rehabs.com and Recovery.org, we serve families and individuals struggling with addiction and seeking treatment options through comprehensive online directories of treatment providers, treatment provider reviews, forums and professional communities. We also provide online marketing solutions to other treatment providers such as enhanced facility profiles, audience targeting, lead generation and tools for digital reputation management.

Our highly trained clinical staff 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 or schizophrenia, we believe we offer the level of quality care and service necessary for our clients to achieve and maintain sobriety.

The Company was incorporated as a Nevada corporation on February 12, 2014 for the purpose of acquiring the common stock of AAC and to engage in certain reorganization transactions in connection with the initial public offering of our common stock, which was completed in October 2014 (the “IPO”). AAC was incorporated as a Nevada corporation on February 27, 2007.

Business Strategy

We have developed our company and the American Addictions Centers national brand through substantial investment in our clinical expertise, our facilities, our professional staff and our national sales and marketing program. We seek to extend our position as a leading provider of treatment for drug and alcohol addiction by executing the following growth strategies:

 

 

Clinical excellence and outcomes-driven treatment. We seek to set the national standard for quality and outcomes in addiction treatment. AAC is committed to ongoing measurement and transparency regarding patient outcomes, as evidenced by the recent publication of a three-year outcomes study, which is available on our website. Information from this study or our website is not incorporated by reference into this report. In addition to measurement of patient outcomes and satisfaction with treatment, we are continually working to advance utilization of modern, evidence-based interventions that address addiction as a chronic brain disease, as supported by the science. We believe AAC is now well-positioned to be a national quality leader in addiction treatment.

 

Improve census at existing facilities. We seek to improve census and client demand by increasing our client leads through our multi-faceted sales and marketing program, consisting of our national sales team, recommendations from alumni and healthcare professionals, internet, television and print advertising and potential client inquiries. By utilizing multiple sales and marketing channels, we generate significant inbound call volume from potential clients and the people close to them, and our consultative call center approach enables us to effectively identify and enroll qualified clients.

 

Expand outpatient operations. We actively pursue opportunities to add outpatient centers to complement our broader network of residential treatment facilities. We believe expanding our reach by developing or acquiring premium outpatient facilities of a quality consistent with our inpatient services will further enhance our brand and our ability to provide a more comprehensive suite of services across the spectrum of care. Outpatient centers are expected to be an increasingly important source of leads for our residential programs as we believe a portion of clients receiving outpatient treatment will ultimately need a higher level of care. Moreover, we believe this will position us to better serve those clients whose payors require outpatient treatment as a prerequisite to any inpatient treatment. We also make available sober living accommodations to clients completing treatment at lower levels of care. These sober living arrangements enable us to utilize existing beds for clients requiring higher levels of care while still providing an interim environment for clients transitioning from residential treatment centers to lower levels of care and eventually back to their former living arrangements. We anticipate that we will continue to expand our sober living accommodations to complement our expanding outpatient services.


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Expand capacity at existing residential and standalone outpatient facilities. When market conditions indicate, we anticipate selectively increasing our number of residential beds, expanding our clinical facility space, expanding our sober living bed capacity and hiring additional clinical staff to enable us to provide services to additional clients.

 

Pursue de novo development of facilities. De novo development plays an important role in the growth of our facility base. Our de novo facility development consists of either building a new facility from the ground up or acquiring an existing facility with an alternative use and repurposing it as a substance abuse treatment facility. We have developed multiple full-service residential treatment facilities: Greenhouse, a former luxury spa in Dallas, Texas; Desert Hope, a former assisted living facility in Las Vegas, Nevada; River Oaks, a former adolescent behavioral facility in Riverview (Tampa area), Florida; and Laguna Treatment Hospital, a chemical dependency recovery hospital in Aliso Viejo, California, which is the first such hospital designation for one of our treatment facilities. We believe the success of these facilities provides us with the experience to develop additional premium facilities across the United States with comparable scale, capabilities and quality.

 

Opportunistically pursue acquisitions of individual treatment facilities and multi-facility operations. We selectively seek opportunities to expand and diversify our geographic presence, service offerings and the portion of the population that can access our services based on their individual healthcare coverage through acquisitions. All six acquisitions of treatment providers we have completed since the completion of our IPO have involved the acquisition of in-network providers. As we continue to expand, we plan to establish greater payor mix diversification between out-of-network, in-network, government (e.g., Medicare and Medicaid) and private pay clients. IBISWorld, an industry research organization, estimates that there were approximately 10,000 mental health and substance abuse treatment companies in operation in 2017, most of which are small, regional operations. We believe this high level of fragmentation presents us with the opportunity to acquire facilities or small providers and upgrade their treatment programs and facilities to improve client care and as a result improve our operating metrics. We believe that our brand recognition, marketing platform and referral network will enable us to improve census at acquired facilities.

 

Target complementary growth opportunities. There are additional growth opportunities that we are selectively pursuing that are complementary to our current business. These include, without limitation, providing laboratory services to other substance abuse treatment providers and expanding other ancillary services. For example, our high complexity, mass spectrometry laboratories are capable of providing full service clinical diagnostic testing (including toxicology, hematology, chemistry, infectious disease, hormones and genetics) in 44 states, including California, Florida, Louisiana, Mississippi, Nevada, New Jersey, Rhode Island and Texas, where we currently operate facilities.

 

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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 (“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, 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 and family therapies, recovery-oriented challenge therapies, expressive therapies (with a focus on music and art), equine and trauma therapies. We also provide Medicated-Assisted Treatment (“MAT”), which is the use of FDA-approved medications, in combination with counseling and behavioral therapies, to provide a “whole-patient” approach to the treatment of substance use disorders. We believe that it is particularly effective for treating certain conditions such as opioid use disorder, alcohol use disorder and tobacco use disorder. The use of MAT has been shown to significantly reduce overdoses from opioids and to improve long-term abstinence. MAT is an important and integral treatment modality at all AAC facilities.

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 individual needs as assessed through comprehensive evaluations at admission and throughout 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, medical history and physical condition within 48 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.

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 to a particular client.

We believe in tracking clinical outcomes. In 2014, we entered into a partnership with Centerstone Research Institute to conduct independent three-year longitudinal outcome studies on the effectiveness of our clinical approach. This study is now complete, and the findings are available on our website. We will continue to measure outcomes going forward in order to drive continual improvement in our programs.

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

Detoxification (“detox”). 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.

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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 a minimum of 20 hours per week. 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 are comprised of a structured program providing care three days per 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.

Outpatient Services. Traditional outpatient services are delivered in regularly scheduled sessions, usually less the nine hours per week. Outpatient services include professionally directed screening, assessment, therapy, and other services designed to support successful transition to the community and long-term recovery. These services are tailored to a person’s specific needs and stage of recovery and may involve many modalities, including motivational enhancement, family therapy, educational groups, occupational and recreational therapy, psychotherapy and pharmacotherapy.

Ancillary Services. In addition to our inpatient and outpatient treatment services, we provide medical monitoring for adherence to addiction treatment as well as clinical diagnostic laboratory services. We also provide physician services to our clients through our contracted professional physician groups. We believe toxicological monitoring of clients is an important component of substance abuse treatment. Clients are evaluated for illicit substances upon admission and thereafter on a random basis and as otherwise determined to be medically necessary by the treating physician. We conduct laboratory testing for our facilities using quantitative liquid chromatography time-of-flight mass spectrometry technology located in Brentwood, Tennessee, as well as our laboratory in Slidell, Louisiana.

Sober Living Facilities. 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 still providing housing for clients completing outpatient treatment programs. We provide sober living arrangements to clients through our owned and leased properties in Arlington, Texas; Las Vegas, Nevada; Oxford, Mississippi; Fort Lauderdale, Florida; San Diego, California; Aliso Viejo, California, and through third party providers with whom we contract to provide sober living arrangements near our existing outpatient centers. We typically provide transportation between sober living housing and our outpatient centers. We plan to continue using sober living facilities as a complement to our outpatient services.


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Facilities

The following table presents information about our network of substance abuse treatment facilities, including current facilities and facilities under development as of December 31, 2017:

 

 

 

 

 

 

Facility Name

State

Beds(1)

IN/OON(2)

Property

Residential(3)

 

 

 

 

 

Laguna Treatment Hospital

CA

93

OON

Owned

 

River Oaks

FL

162

OON

Owned

 

Recovery First

FL

56

IN

Owned/Leased

 

Townsend New Orleans

LA

36

IN

Leased

 

Oxford Treatment Center

MS

124

OON

Owned

 

Sunrise House

NJ

110

IN

Owned

 

Desert Hope

NV

148

OON

Owned

 

Solutions Treatment Center

NV

80

IN

Leased

 

Greenhouse

TX

130

OON

Owned

 

Total Residential Beds

 

939

 

 

 

 

 

 

 

 

Sober Living

 

 

 

 

 

San Diego Sober Living

CA

36(4)

n/a

Leased

 

Recovery First - Ft. Lauderdale East

FL

83

n/a

Leased

 

Resolutions Oxford

MS

72

n/a

Owned/Leased

 

Resolutions Las Vegas

NV

138

n/a

Leased

 

Resolutions Arlington

TX

80

n/a

Leased

 

Total Sober Living Beds

 

409

 

 

Total Beds

 

1,348

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

State

Locations

IN/OON(2)

Property

Outpatient

 

 

 

 

 

San Diego Outpatient

CA

1

OON

Leased

 

Recovery First Outpatient

FL

1

IN

Leased

 

Oxford Outpatient Center

MS

3

OON

Owned/Leased

 

Townsend Outpatient Centers

LA

7

IN

Leased

 

Sunrise House Outpatient

NJ

1

IN

Owned

 

Desert Hope Outpatient Center

NV

1

OON

Leased

 

Solutions Outpatient

NV

1

IN

Leased

 

Clinical Services of Rhode Island Outpatient

RI

3

IN

Leased

 

Greenhouse Outpatient

TX

1

OON

Leased

Total Outpatient Facilities

 

19

 

 

 

 

 

 

 

 

 

(1)

Bed capacity reflected in the table represents total available beds. Actual capacity utilized depends on current staffing levels at each facility and may not equal total bed capacity at any given time.

 

(2)

Facility type reflects the primary payor type of the clients served at the facility: in-network (IN) or out-of-network (OON).

 

(3)

Residential facilities generally have the ability to provide detox, residential, partial hospitalization and intensive outpatient services.

 

(4)

In December 2017, we transitioned the 36 residential beds located at our San Diego Addiction Treatment Center into sober living beds in conjunction with the consolidation of our southern California operations.

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:

 

National Sales Force. We deploy and manage a sales force of approximately 70 representatives nationwide that focuses primarily on marketing to hospitals, other treatment facilities, employers, unions, alumni and employee assistance programs. In addition, our varied facilities located across the United States allow us to reach a broad audience of potential clients and their families and build a nationally recognized brand. This nationally branded, multi-channel approach has helped increase our number of admitted residential clients from 11,849 in 2016 to 12,299 in 2017, an increase of 3.8%.


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Internet, Television and Print Advertising. Advertising through various media represents another important opportunity to obtain new clients as well as to develop our national brand. We operate a broad portfolio of internet assets that service millions of website visits each month. Through comprehensive online directories of treatment providers, treatment provider reviews, forums and professional communities, our addiction-related websites such as Rehabs.com and Recovery.org serve families and individuals who are struggling with addiction and seeking treatment options. Additionally, we continue to pursue advertising opportunities in television commercials, radio spots, newspaper articles, medical journals and other print media that promote our facilities and have the intent to build our integrated, national brand.

 

Recommendations by Alumni. We often receive new clients who were directly referred to our facilities by our alumni, as well as their friends and families. As our national brand continues to grow and our business continues to increase, we believe our alumni will become an increasingly important source of business for us.

Call Center Operations

We maintain a 24 hours per day, seven days per week call center. 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. As part of its role, the call center team conducts benefits verification, handles initial communication with insurance companies, completes client assessments, begins the pre-certification process for treatment 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 groups of physicians and mid-level service providers that provide certain professional services to our clients through professional services agreements with certain of our treatment facilities (the “Professional Groups”). 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 consolidated financial statements included elsewhere in this report.

Competition

We believe we are one of the leading 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 10,000 different companies 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 that are supported by tax revenue, 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 compete with us on a national scale and offer substance use treatment services among other behavioral healthcare services. To a lesser extent, we also compete with other providers of substance use treatment services, including other inpatient behavioral healthcare facilities and general acute care hospitals.

We believe the primary competitive factors affecting our business include:

 

quality of clinical programs and services;

 

reputation and brand recognition;

 

overall aesthetics of the facilities;

 

amenities offered to clients;

 

relationships with payors and referral sources;

 

sales and marketing capabilities;

 

information systems and proprietary data analytics;

 

senior management experience; and

 

national scope of operations.


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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 provision of substance abuse disorder services. Our facilities are also subject to periodic on-site inspections by the regulatory and accreditation agencies 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. In recent years, significant public attention has focused on the healthcare industry, including attention to the conduct of industry participants and the cost of healthcare services. Federal and state government agencies have heightened and coordinated civil and criminal enforcement efforts relating to the healthcare industry. The ongoing investigations relate to, among other things, 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.

While we believe we are in substantial compliance with all applicable laws and regulations, and we are not aware of any material pending or threatened investigations involving allegations of wrongdoing, there can be no assurances of compliance. 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 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, medical providers and technicians may be subject to individual state license requirements.

Our facilities that store and dispense controlled substances are required to register with the U.S. Drug Enforcement Administration (“DEA”) and abide by DEA regulations regarding controlled substances. Each of our substance abuse treatment facilities has obtained or is 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. 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. 

The Clinical Laboratory Improvement Amendments of 1988 (“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. Standards for testing under CLIA are based on the level of complexity of the tests performed by the laboratory. A CLIA certificate of waiver is maintained by each of our treatment facilities that only perform the types of tests waived under CLIA, such as point-of-care drug analysis, glucose monitoring and pregnancy testing.

Our Brentwood, Tennessee, clinical laboratory facility and our Slidell, Louisiana laboratory facility both perform high complexity testing. Both laboratories hold a CLIA certificate of accreditation, certifying them for complex testing, and are therefore required to meet more stringent requirements than laboratories performing less complex testing. We are regularly subject to survey and inspection to assess compliance with program standards. Both labs that perform high complexity testing are also accredited by the Commission on Office Laboratory Accreditation (“COLA”) and participate in the College of American Pathologists (“CAP”) proficiency program.

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 Brentwood laboratory facility is licensed as a medical reference laboratory by the state of Tennessee. It is also licensed in other states as required to process test samples originating from individuals within such states.


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We believe that all of our facilities and programs are in substantial compliance with current applicable state and local licensure, certification and accreditation requirements. 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 will submit a plan of correction and remedy any cited deficiencies.

FDA Laws and Regulations

The Food and Drug Administration (“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 exercises enforcement discretion in not mandating FDA approval for most LDTs performed by high complexity CLIA certified laboratories. The FDA released draft guidance in 2014 that would increase regulation of LDTs but has indefinitely delayed finalizing the guidance.

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. However, we are in the process of enrolling our laboratories in Medicare and Medicaid, and we intend to acquire other providers, including those that participate in Medicare or Medicaid. For example, upon the closing of our pending acquisition of AdCare, we will provide services to patients under Medicare and Medicaid. As a result, we anticipate these restrictions will affect our operations in the future.

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. Many states have anti-kickback and physician self-referral prohibitions similar to the federal statutes and regulations. Some of these state laws are drafted broadly to cover all payors (i.e., not restricted to Medicare and other federal healthcare programs), and they often lack interpretative guidance. A violation of these laws could result in a prohibition on billing payors for such services, an obligation to refund amounts received, or civil or criminal penalties and could 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 (“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 $10,957 and $21,916 for each separate false claim, after considering 2018 updates to such penalties. These and certain other civil monetary penalties will increase annually 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.

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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, and we cannot assure 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 (known as the “Part 2 Regulations”) restrict the disclosure of, and regulate the security of, client identifiable information related to substance abuse and apply to any of our facilities that receive 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 (“HIPAA”), extensively regulates the use and disclosure of individually identifiable health information (known as “protected health information”) and requires 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 and the Part 2 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 privacy and security regulations 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 (“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.

After considering 2018 updates to penalty amounts, violations of the HIPAA privacy and security regulations may result in civil penalties of up to $55,910 per violation for a maximum civil penalty of $1,677,299 in a calendar year for violations of the same requirement. These penalties will increase annually based on updates to the consumer price index. 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 and to perform compliance audits.

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 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. We may be required to make operational changes to comply with revisions made to the Part 2 Regulations that generally became effective on February 2, 2018.

Mental Health Legislation and Reform Efforts

The regulatory framework in which we operate is constantly changing. For example, the Mental Health Parity and Addiction Equity Act of 2008 (“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 21st Century Cures Act (“Cures Act”), enacted in 2016, requires development of an action plan for enhanced enforcement of mental health parity requirements and additional compliance guidance for health plans regarding coverage under parity laws. Among other initiatives aimed at improving care for people with mental health and substance use disorders, the Cures Act includes provisions intended to increase the healthcare workforce dedicated to such treatment and expand programs that divert people with mental health and substance use disorders toward alternatives to incarceration. However, the impact of the Cures Act largely depends on its implementation by agencies such as HHS and on future appropriations by Congress.

Over the last decade, the U.S. Congress and certain state legislatures have passed a large number of laws intended to result in extensive change to the healthcare industry. 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, is the most prominent of these legislative reform efforts. It resulted in reforms to the health insurance market and expansion of public program coverage, among other changes. As currently structured, the law requires all non-grandfathered small group and individual market health plans to cover ten essential health benefit categories, which currently include substance abuse addiction and mental health disorder services.

The Affordable Care Act poses both opportunities and risks for us but, overall, the expansion of health insurance coverage under the law has been beneficial for the substance abuse treatment industry. However, the overall and continued impact of the Affordable Care Act is difficult to determine, as the presidential administration and certain members of Congress have stated their intent to repeal or make significant changes to the Affordable Care Act, its implementation and its interpretation. For example, in October 2017, the president signed an executive order directing agencies to relax limits on certain health plans, potentially allowing for fewer plans that adhere to specific Affordable Care Act coverage mandates. Further, effective January 1, 2019, Congress eliminated the financial penalty associated with the individual mandate that was established by the Affordable Care Act.

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 certificate of need (“CON”) or determination of need (“DON”) 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 or DON 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.

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 applicable 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 are 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 may also regulate our treatment programs. Many of our facilities must comply with zoning and land use requirements in order to operate. 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. Like other providers of healthcare-related services, 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. See Item IA, Risk Factors — “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 results of operations and reputation.”

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We maintain commercial insurance coverage for general liability claims with a $50,000 deductible and professional liability claims with a $150,000 deductible, a primary $1.0 million per claim limit and an annual aggregate primary limit of $3.0 million with umbrella coverage for an aggregate $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 a compliance program that monitors our regulatory compliance procedures and policies at our facilities and 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.

On October 21, 2016, certain of our subsidiaries, AAC (formerly known as Forterus, Inc.), Forterus Health Care Services, Inc., and ABTTC, Inc. (the “Defendants”), agreed to the entry of a Permanent Injunction and Final Judgment (the “PIFJ”) with the Bureau of Medi-Cal Fraud and Elder Abuse of the Office of the Attorney General of the State of California (“BMFEA”). Pursuant to the terms of the PIFJ, we were required to, among other things, (i) institute a three-year compliance program (the “California Compliance Program”) with respect to our California facilities that includes maintaining or developing and implementing certain policies and procedures to promote each covered facility’s compliance with applicable statutes, regulations and the PIFJ, under the responsibility of our Chief Compliance Officer; (ii) establish a Compliance Committee composed of the Compliance Officer and senior personnel responsible for overseeing clinical operations to address issues raised by the Compliance Officer in connection with the Compliance Program and (iii) establish an oversight committee of the Board of Directors, or a committee of the Board of Directors, to review the adequacy and responsiveness of the California Compliance Program. In addition, for a period of 30 months following the effective date of the PIFJ, the Defendants are required to retain a qualified independent monitor, appointed by BMFEA after consultation with the Defendants, to assess the effectiveness of the Defendants’ quality control systems and patient care.

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) 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 that 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. See Item 1A, Risk Factors — “We could face risks associated with, or arising out of, environmental, health and safety laws and regulations.”

Employees

As of December 31, 2017, we employed approximately 2,100 people. Employees at the Sunrise House facility in New Jersey are part of the Health Professionals and Allied Employees (“HPAE”) labor union. From May 23, 2017 to July 5, 2017, the Sunrise House facility was temporarily not serving clients as a result of an employee strike at that location. On June 14, 2017, a settlement was reached with HPAE, and Sunrise House began readmitting clients on July 5, 2017. As a result of our Sunrise House facility entering into a three-year collective bargaining agreement with the HPAE on June 14, 2017, a majority of our employees at Sunrise House are now represented by a collective bargaining agreement. None of our other employees are represented by a labor union or covered by a collective bargaining agreement. We believe that our employee relations are good.

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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 revenue, 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 facilities.

We derive a significant portion of our revenue from four treatment facilities located in California, Florida, Nevada and Texas. These treatment facilities accounted for 51% of our total revenue in 2017. It is likely that a small number of facilities will continue to contribute a significant portion of our total revenue in any given year for the foreseeable future. Additionally, we have a centralized corporate office that houses our accounting, billing and collections, information technology, and call center departments, centralized marketing offices and two high complexity laboratory facilities that conduct quantitative drug testing and other laboratory services. If any event occurs that results in a complete or partial shutdown of any of these facilities, our centralized corporate office, our centralized marketing offices or two laboratory facilities, 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 revenue and/or higher operating costs, which could have a material adverse effect on our revenue, profitability and cash flows.

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

We believe our national sales and marketing program 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. Negative changes to our existing referral relationships may cause the number of people to whom we provide services to decline, which may adversely affect our revenue. Also, if we fail to develop new referral relationships, our growth may be restrained.

Third-party payors could reduce their reimbursement rates or otherwise restrain our ability to obtain or provide services to clients, which could adversely impact our business, financial condition and results of operation. 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 2017, approximately 92.3% of our revenue was 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.

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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 preadmission 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 could 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 substance use treatment services covered by third-party commercial payors are reduced, our business, financial condition and results of operations could be materially adversely affected.

Third-party payors often use plan structures, such as narrow networks or tiered networks, to encourage or require clients to use in-network providers. In-network providers typically provide services through third-party payors for a negotiated lower rate or other less favorable terms. 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 directly to clients instead of to 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. The majority of third-party payors consider certain of our facilities to be “out-of-network” providers. If third-party payors impose further restrictions on out-of-network providers, our revenue 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 out-of-network services performed, it would increase our revenue adjustments, which could have a material adverse effect on our revenue, 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.

For out-of-network services, we recognize revenue 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 revenue by adjusting gross client charges using our expected realization and applying this discount to gross client charges. 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 revenue. 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 revenue, 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 changes 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 revenue, and the reduction of reimbursement rates or coverage of services by any such payor could have a material adverse effect on our revenue, profitability and cash flows.

For the year ended December 31, 2017, approximately 11% of our revenue came from Anthem Blue-Cross Blue-Shield of Nevada, 11% came from Blue-Cross Blue-Shield of Texas and 10% came from Blue-Cross Blue-Shield of Florida. No other payor accounted for more than 10% of our revenue for the year ended December 31, 2017. For the year ended December 31, 2016, approximately 11% of our revenue came from Anthem Blue-Cross Blue-Shield of Florida, 10% came from Blue-Cross Blue-Shield of Texas and 10% came from Aetna. No other payor accounted for more than 10% of our revenue for the year ended December 31, 2016. As reflected for the periods above, these more significant payors can also change from year to year. 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 revenue, profitability and cash flows could be materially adversely affected.


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A deterioration in the collectability of the accounts receivables 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 revenue 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) in certain states, 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 and (iv) resource and capacity constraints that may prevent us from handling the volume of billing and collection issues in a timely manner. Additionally, our ability to hire and retain experienced personnel 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, 2017, our allowance for doubtful accounts increased to approximately 38% of our accounts receivable balance as of such date from 24% as of December 31, 2016, with two commercial payors each representing in excess of 10% of the accounts receivable balance as of December 31, 2017. 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 adjust our allowances as warranted. Significant changes in business operations, payor mix or economic conditions, including changes resulting from legislation or other health reform efforts, including efforts, (including to repeal or significantly change 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 the provider, such as California and Nevada, could adversely affect our collection of receivables. Increases 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.

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

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. 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 cybersecurity risks such as 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 disrupt our information technology business systems, impede clinical operations, 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 are 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. Cyber-attacks may also impede our ability to exercise sufficient disclosure controls. 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 that 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.

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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.

An 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, 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:

 

physicians and employees who are not familiar with our operations;

 

clients who may elect to switch to another substance abuse treatment provider;

 

assignment or termination of material contracts, including commercial payor agreements;

 

regulatory compliance programs and state and federal licensing requirements; and

 

disparate operating, information and record keeping systems and technology platforms.

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, 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 uncertainties may include changes to regulations 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 in excess of any indemnification 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 had or may have significantly lower operating margins than the facilities we operated prior to the time of our acquisition thereof or had or may have 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.


17


 

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

As of December 31, 2017, we had total debt of $207.4 million outstanding. We have historically relied on debt financing to partially fund our acquisitions, de novo projects and facility expansions, 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:

 

make it more difficult for us to satisfy our obligations with respect to our indebtedness, resulting in possible defaults on, and acceleration of, such indebtedness;

 

increase our vulnerability to general adverse economic and industry conditions;

 

require us to dedicate a substantial portion of our cash flows from operations to payments on indebtedness, thereby reducing the availability of such cash flows to fund working capital, capital expenditures and other general corporate requirements or to carry out other aspects of our business;

 

limit our ability to obtain additional financing to fund future working capital, capital expenditures and other general corporate requirements or to carry out other aspects of our business;

 

limit our ability to make material acquisitions or take advantage of business opportunities that may arise; and

 

place us at a potential competitive disadvantage compared to our competitors that have less debt.

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

On June 30, 2017, the Company entered into a senior secured credit agreement with Credit Suisse AG, as administrative agent and collateral agent and the lenders party thereto (the “2017 Credit Facility”). Our 2017 Credit Facility imposes restrictions that could impede our ability and our subsidiaries’ 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 ability to, among other things:

 

incur or guarantee additional debt;

 

pay dividends on our capital stock;

 

redeem, repurchase, retire or otherwise acquire any of our capital stock;

 

enter into leases, including those in connection with sale-leaseback transactions;

 

make certain payments or investments;

 

create liens on our assets;

 

make any substantial change in the nature of our business as it is currently conducted; and

 

merge or consolidate with other companies or transfer all or substantially all of our assets.

In addition, our 2017 Credit Facility requires us to meet a senior leverage ratio financial covenant and may preclude additional borrowings. This restriction 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 2017 Credit Facility also contains cross-default and cross-acceleration provisions that would apply to 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 2017 Credit Facility if for any reason we are unable to comply with the terms of the 2017 Credit Facility in the future. The breach of any of these covenants or restrictions could result in a default under the 2017 Credit Facility, 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.

18


 

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

To fund our acquisition and development strategies, we may consider raising additional funds through various financing sources, including the sale of our common or preferred stock 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 revenue 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:

 

 

the time and costs associated with identifying locations in suitable geographic markets, which may divert management attention from existing operations;

 

the possibility of changes to comprehensive zoning plans or zoning regulations that imposes additional restrictions on use or requirements, which could impact our expansion into otherwise suitable geographic markets;

 

the need for significant advertising and marketing expenditures to attract clients;

 

our ability to provide each de novo facility with the appropriate equipment, furnishings, materials, supplies and other capital resources;

 

our ability to obtain licensure and accreditation, establish relationships with healthcare providers in the community and delays or difficulty in installing our operating and information systems;

 

the costs of evaluating new markets, hiring experienced local physicians, management and staff and opening new facilities, and the time lags between these activities and the generation of sufficient revenue to support the costs of the expansion; and

 

our ability to finance de novo expansion and possible dilution to our existing stockholders if our common stock is used as consideration.

As a result of these and other risks, there can be no assurance that we will be able to develop de novo treatment facilities or that a de novo treatment facility will become profitable and such expansion could expose us to liabilities or loss.

Our ability to maintain census is dependent on a number of factors outside of our control, and if we are unable to maintain census, our business, results of operations and cash flows could be materially adversely affected.

Our revenue is directly impacted by our ability to maintain census. These metrics are dependent on a variety of factors, many of which are outside of our control, including our referral relationships, average length of stay of our clients, 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 could materially adversely affect our revenue, profitability and cash flows due to fewer or 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 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. If clients or potential clients decide not to seek treatment or discontinue treatment early, census could decrease and, as a result, our business, financial condition and results of operations could be adversely affected.

19


 

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 results of operations and reputation.

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 other 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 investigation, lawsuit or other claim 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 harm our reputation or the reputation of our management and negatively impact the perception of the Company by clients, investors or others and could have a materially adverse impact on our financial condition and results of operations. 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, they could have a material adverse effect on our financial condition and results of operations.

We operate in a highly competitive industry where 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 with third-party payors, 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.

Increased labor union activity is another factor that could adversely affect our labor costs. A labor union, HPAE, represents our employees at Sunrise House. As a result, with respect to our Sunrise House facilities, we are subject to the risk of labor disputes, strikes, work stoppages and other labor-relations matters. Although we are not aware of any union organizing activity at any of our other facilities, we are unable to predict whether any such activity will take place in the future.

We depend heavily on key executives and other key management personnel, and the departure of one or more of our key executives or other key management personnel 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, and other management personnel are critical to the success of our business. We do not currently have employment agreements or non-compete covenants with any of our key executives. The loss of the services of one or more of our key executives 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.

20


 

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, or may suffer adverse regulatory consequences or violations of New York Stock Exchange 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 our revenue, 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:

 

licensure, certification and accreditation of substance use treatment services;

 

licensure, CLIA certification and accreditation of laboratory services;

 

handling, administration and distribution of controlled substances;

 

necessity and adequacy of care and quality of services;

 

licensure, certification and qualifications of professional and support personnel;

 

referrals of clients and permissible relationships with physicians and other referral sources;

 

claim submission and collections, including penalties for the submission of, or causing the submission of, false, fraudulent or misleading claims and the failure to repay overpayments in a timely manner;

 

consumer protection issues and billing and collection of client-owed accounts issues;

 

communications with clients and consumers;

 

privacy and security of health-related information, client personal information and medical records;

 

physical plant planning, construction of new facilities and expansion of existing facilities;

 

activities regarding competitors;

 

FDA laws and regulations related to drugs and medical devices;

 

operational, personnel and quality requirements intended to ensure that clinical testing services are accurate, reliable and timely;

 

health and safety of employees;

 

handling, transportation and disposal of medical specimens and infectious and hazardous waste; and

 

corporate practice of medicine, fee-splitting, self-referral and kickback prohibitions.

21


 

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, any of 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, the Part 2 Regulations restrict the disclosure, and regulate the security, of client identifiable information related to substance abuse. These requirements apply to any of our facilities that receive 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 requirements on the use and disclosure of protected health information and 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, 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 may 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.

22


 

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 $10 million for each of federal fiscal years 2018 through 2020. 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 use treatment services, there is a risk that specific investigation initiatives could be expanded to include our treatment facilities or laboratory services. In addition, increased government enforcement activities, even if not directed towards our treatment facilities or laboratories, 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 or laboratories, our executives or our directors, even if we ultimately prevail, could result in significant expense, adversely affect our reputation or profitability and materially adversely affect our financial condition and results of operation. In addition, we may be required to make changes in our laboratory or other substance use 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 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. 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 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 or 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 direction and impact of healthcare reform efforts, particularly efforts to repeal or significantly modify the Affordable Care Act.

The healthcare industry is subject to changing political, regulatory, scientific and technological changes, which have resulted and may continue to result in initiatives intended to reform the industry. The most prominent of recent efforts, the Affordable Care Act, as currently structured, provides for increased access to coverage for healthcare and seeks to reduce healthcare-related expenses. Among other mandates, it requires all new small group and individual market health plans to cover ten essential health benefit categories, which currently include substance abuse addiction and mental health disorder services. However, efforts by the presidential administration and certain members of Congress to repeal or make fundamental changes to the Affordable Care Act, its implementation and/or its interpretation have cast significant uncertainty on the future of the law. For example, in 2017, Congress eliminated the penalties associated with the individual mandate, effective January 2019, which may affect rates of insurance coverage. We are unable to predict the full impact of the Affordable Care Act and related regulations or the impact of its repeal or modification on our operations in light of the uncertainty regarding whether or how the law will be changed, what alternative reforms, if any, may be enacted or what other actions may be taken. Any government efforts related to health reform may have an adverse effect on our business, results of operations, cash flow, capital resources and liquidity. Moreover, the general uncertainty of health reform efforts, particularly if Congress elects to repeal provisions of the Affordable Care Act but delays the implementation of repeal or fails to enact replacement provisions at the time of repeal, may negatively impact our payment sources or demand for our services.

23


 

The expansion of health insurance coverage under the Affordable Care Act has been beneficial to the substance abuse treatment industry. This is due, in part, to higher demand for treatment services, which resulted from the requirement that small group and individual market plans comply with the requirements of the Mental Health Parity and Addiction Equity Act of 2008, which previously applied only to group health plans and group insurers. The 21st Century Cures Act requires development of an action plan for enhanced enforcement of mental health parity requirements and additional guidance for health plans regarding compliance with parity laws. Increased demand for treatment services may bring new competitors to the market, some of which may be better capitalized and have greater market penetration than we do. In addition, we expect increased demand for substance use treatment services to 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 and subsequent legislation 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 accountable care organizations, 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 that are formed for these types of payment arrangements. 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.

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.

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:

 

regulate certain activities and operations that may have environmental or health and safety effects, such as the generation, handling and disposal of medical and pharmaceutical wastes;

 

 

impose liability for costs of cleaning up, and damages to natural resources from, past spills, waste disposals on and off-site and other releases of hazardous materials or regulated substances; and

 

regulate workplace safety.

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.

24


 

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 a determination of public need and prior approval by state regulatory agencies under CON laws or other healthcare planning initiatives. Review of CONs and similar proposals may be lengthy and may require public hearings. 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:

 

result in our inability to acquire a targeted facility, complete a desired expansion or make a desired replacement; or

 

result in the revocation of a facility’s license or imposition of civil or criminal penalties on us, any of which could have a material adverse effect on our business, financial condition and results of operations.

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.

We may be unable to successfully implement the Compliance Program or timely implement recommendations made by the Compliance Officer in connection with the Compliance Program or otherwise comply with the Permanent Injunction and Final Judgment.

On October 21, 2016, the Defendants, agreed to the entry of the PIFJ with BMFEA relating to the criminal charges filed against the Defendants in connection with the death of a client in 2010 at one of our former locations. Pursuant to the terms of the PIFJ, we were required to, among other things, (i) institute the California Compliance Program with respect to our California facilities that includes maintaining or developing and implementing certain policies and procedures to promote each covered facility’s compliance with applicable statutes, regulations and the PIFJ, under the responsibility of our Chief Compliance Officer; (ii) establish a Compliance Committee composed of the Compliance Officer and senior personnel responsible for overseeing clinical operations to address issues raised by the Compliance Officer in connection with the Compliance Program and (iii) establish an oversight committee of the Board of Directors, or a committee of the Board of Directors, to review the adequacy and responsiveness of the California Compliance Program. In addition, for a period of 30 months following the effective date of the PIFJ, which was October 21, 2016, the Defendants shall retain a qualified independent monitor, appointed by BMFEA after consultation with the Defendants, to assess the effectiveness of the Defendants’ quality control systems and patient care.

Since 2016, we have incurred costs in connection with the implementation of and compliance under the California Compliance Program and PIFJ, and expect to continue to incur, costs in connection with the California Compliance Program and with the PIFJ. The Company has been subject to the California Compliance Program for 16 months and continues to comply with its obligations and interactions with the Compliance Officer. Such efforts will be ongoing during the full term of the California Compliance Program. If we are not able to successfully fulfill our obligations under the California Compliance Program or timely implement recommendations made by the Compliance Officer in connection with the California Compliance Program, the BMFEA may pursue remedies under the PIFJ, including assessment of fines and civil and criminal actions. Should the BMFEA pursue remedies under the PIFJ, we could face significant fines and actions, which could have a material adverse effect on our business, financial condition, results of operations and cash flows.

Changes in tax laws or their interpretations, or becoming subject to additional U.S., state or local taxes, could negatively affect our business, financial condition and results of operations.

We are subject to tax liabilities, including federal and state taxes such as excise, sales/use, payroll, franchise, withholding, and ad valorem taxes. Changes in tax laws or their interpretations could decrease the amount of revenues we receive, the value of any tax loss carryforwards and tax credits recorded on our balance sheet and the amount of our cash flow, and have a material adverse impact on our business, financial condition and results of operations. Some of our tax liabilities are subject to periodic audits by the respective taxing authority which could increase our tax liabilities. If we are required to pay additional taxes, our costs would increase and our net income would be reduced, which could have a material adverse effect on our business, financial condition and results of operations.

On December 22, 2017, President Trump signed into law the “Tax Cuts and Jobs Act,” which includes significant changes to the taxation of business entities. These changes include, among others, a reduction in the corporate income tax rate. We continue to examine the impact this tax reform legislation may have on our business. Notwithstanding the reduction in the corporate income tax rate, the overall impact of this tax reform is uncertain, and our business and financial condition could be adversely affected.


25


 

Risks Related to the Acquisition of AdCare

Our pending acquisition of AdCare, Inc. (“AdCare”) is subject to customary closing conditions and regulatory provisions and may not be consummated, and if not consummated under certain circumstances, we may be subject to termination fees under the Purchase Agreement (as defined below).

On September 13, 2017, we announced that we had entered into a Securities Purchase Agreement (the “Purchase Agreement”) with AdCare, AdCare Holding Trust, a Massachusetts business trust (“AdCare Trust”) and AAC Healthcare Network, Inc., one of our wholly owned subsidiaries, to acquire AdCare. Our obligation to complete the acquisition is subject to certain additional customary closing conditions and regulatory provisions. The Purchase Agreement contains certain termination rights, including the possible payment of a Termination Fee (as defined in the Purchase Agreement) to AdCare Trust, if, among other things, we breach any covenant, representation or warranty which prevents the satisfaction of any condition to the obligations of AdCare or AdCare Trust at closing and which has not been waived by AdCare Trust; if AdCare Trust has satisfied all closing conditions and we fail to close the transaction; or if we fail to satisfy certain conditions precedent to obtain any financing to fund the purchase price of the transaction. The acquisition is currently anticipated to close in the next 30 to 60 days, subject to the receipt of certain governmental approvals, financing and customary closing conditions. We cannot assure that the acquisition will be consummated on this timeline or at all.

If we are unable to complete our contemplated acquisition of AdCare, our expected financial results and the market value of our common stock could be adversely affected.

If the contemplated acquisition of AdCare is not completed for any reason, we would have devoted substantial resources and management attention to the transaction without realizing the accompanying benefits expected by our management, and our financial condition and results of operations and the market value of our common stock may be adversely affected. Additional risks and uncertainties associated with an inability to complete the transaction include the diversion of the attention of our employees and management due to activities related to the acquisition, which may harm our relationships with our employees, patients, suppliers and other business partners, and may negatively impact our financial condition and results of operations; or may result in negative publicity and a negative impression of us in the investment community.

The failure to successfully integrate AdCare’s business and operations may adversely affect our future results.

We believe that the acquisition of AdCare will result in certain benefits to us, including our ability to provide services to patients under the Medicare and Medicaid programs. However, to realize these anticipated benefits, the business and operations of AdCare must be successfully integrated into our existing business. The success of the acquisition will depend on our ability to realize these anticipated benefits. Other potential difficulties we may encounter as part of the integration process include (i) the challenge of integrating complex systems, operating procedures, regulatory compliance programs, technology, networks and other assets of AdCare in a seamless manner that minimizes any adverse impact on our employees, patients, suppliers and other business partners; and (ii) potential unknown liabilities, liabilities that are significantly larger than we currently anticipate and unforeseen increased expenses or delays associated with the acquisition, including costs to integrate AdCare’s business that may exceed the costs that we currently anticipate. Accordingly, the contemplated benefits of the pending AdCare acquisition may not be realized fully, or at all, or may take longer to realize than expected.

Risks Related to Our Organization and Structure

Our directors, executive officers and certain employees 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 certain employees owned, in the aggregate, approximately 33% of our outstanding common stock as of December 31, 2017. Michael T. Cartwright, our Chairman and Chief Executive Officer, and his affiliates owned approximately 21% of our common stock as of December 31, 2017. 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:

 

delaying, deferring or preventing a change in corporate control;

 

impeding a merger, consolidation, takeover or other business combination involving us; or

 

discouraging a potential acquirer from making a tender offer or otherwise attempting to obtain control of us.

26


 

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:

 

permit our Board of Directors to issue up to 5,000,000 shares of preferred stock, with any rights, preferences and privileges as they may designate, including the right to approve an acquisition or other change in our control;

 

provide that the authorized number of directors may be changed only by resolution of the Board of Directors;

 

provide that all vacancies, including newly created directorships, may, except as otherwise required by law, be filled by the affirmative vote of a majority of directors then in office, even if less than a quorum;

 

provide that stockholders seeking to present proposals before a meeting of stockholders or to nominate candidates for election as directors at a meeting of stockholders must provide notice in writing in a timely manner and also specify requirements as to the form and content of a stockholder’s notice;

 

provide that our stockholders may not take action by written consent, but may only take action at annual or special meetings of our stockholders;

 

do not provide for cumulative voting rights (therefore allowing the holders of a majority of the shares of common stock entitled to vote in any election of directors to elect all of the directors standing for election, if they should so choose); and

 

provide that special meetings of our stockholders may be called only by the Chairman of the Board of Directors, our Chief Executive Officer and the Board of Directors pursuant to a resolution adopted by a majority of the total number of authorized directors or the holders of a majority of the outstanding shares of voting stock.

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 Jumpstart Our Business Startups Act (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 revenue exceeds $1.07 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 in Brentwood, Tennessee for our 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 laboratory space in Brentwood, Tennessee to perform quantitative drug testing and other laboratory services that support our treatment facilities. Additionally, we lease laboratory space in Slidell, Louisiana that operates as the Townsend in-network laboratory. We believe that these facilities are in good condition and suitable for our present requirements.

27


 

Item 3. Legal Proceedings

Litigation

Shareholder Litigation

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 (Kasper v. AAC Holdings, Inc. et al.). 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 (Tenzyk v. AAC Holdings, Inc. et al.). On October 26, 2015, the court entered an order consolidating these two described actions into one action. On April 14, 2016, the Company and the individual defendants filed a motion to dismiss the complaint for failure to state a claim. On July 1, 2016, the court denied the motion to dismiss. On July 14, 2017, the court granted the plaintiffs’ motion for class certification. On December 28, 2017, the parties entered into a settlement term sheet with the plaintiffs’ representatives to memorialize an agreement in principle to settle the litigation. On February 15, 2018, the parties entered into a Stipulation of Settlement, consistent with the December 28, 2017 agreement in principle, that provides for defendants’ payment of an aggregate settlement amount of $25,000,000 (which includes attorneys’ fees to be approved by the court) to establish a settlement fund (the “Settlement Fund”). The Settlement Fund will be funded as follows: (a) defendant Jerrod N. Menz will sell 300,000 shares and contribute the cash derived from such sale(s) to the Settlement Fund; and (b) the Company and individual defendants will pay in cash the difference between the Settlement Fund and the stock component addressed in (a). The Stipulation of Settlement includes the dismissal of all claims against the Company and the individual defendants, a denial by defendants of any wrongdoing and no admission of liability. The settlement is subject to preliminary and final court approval, which cannot be assured. On February 16, 2018, plaintiffs filed a motion for preliminary approval of the settlement and attached the Stipulation of Settlement. That motion is currently pending before the court.

In a related matter, on November 28, 2015, a shareholder filed a derivative action on behalf of AAC Holdings, Inc. in the Eighth Judicial District Court for Clark County, Nevada (Bushansky v. Jerrod N. Menz et al.) against AAC Holding’s board of directors and certain of its officers alleging that these directors and officers breached their fiduciary duties and engaged in mismanagement and illegal conduct. On January 19, 2016, the Court entered an Order staying this litigation pending the earlier of the close of discovery in the related securities class action pending in Tennessee or the deadline for appealing any dismissal of the securities class action. On February 14, 2018, the parties agreed on a Stipulation of Settlement that provides for (a) implementation of certain corporate governance enhancements; (b) a mutual exchange of releases and dismissal of the litigation with prejudice; (c) denial by defendants of any wrongdoing and no admission of liability; and (d) payment by the Company of $1,000,000 in attorneys’ fees and costs for the benefit brought to the Company as a result of the litigation. The settlement is subject to preliminary and final court approval, which cannot be assured. On February 15, 2018, plaintiff filed a motion for preliminary approval of the settlement and attached the Stipulation of Settlement. That motion is currently pending before the court. 

 The claims presented for the actions pending in Tennessee and Nevada have been presented to the Company’s insurance carriers, which have denied coverage. However, the Company and insurers have continued to discuss the Company’s demand for coverage. The Company, at this time, is unable to predict what, if any, settlement amount will be contributed by its insurance carriers. A discussion of the Company’s litigation settlement expense related to the Tennessee and Nevada actions can be found in “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Results of Operations.”

RSG Litigation

On June 30, 2017, Jeffrey Smith, Abhilash Patel and certain of their affiliates filed a lawsuit in the Superior Court of the State of California in Los Angeles County against the Company, AAC, Sober Media Group, LLC, and certain of the Company’s current and former officers (Jeffrey Smith, Abhilash Patel v. American Addiction Centers, Inc. et al.). Messrs. Smith and Patel are former owners of Referral Solutions Group, LLC (RSG) and Taj Media, LLC, which were acquired by the Company in July 2015. The plaintiffs generally allege that, in connection with the Company’s acquisition, the defendants violated California securities laws and further allege intentional misrepresentation, common law fraud, equitable fraud, promissory estoppel, civil conspiracy to conceal an investigation and civil conspiracy to conceal profitability. The Company intends to vigorously defend this action. Given the early stage of this matter, there are not sufficient facts available to reasonably assess the potential outcome of this matter or reasonably assess any estimate of the amount or range of any potential outcome.

28


 

Other

The Company is also aware of various other legal matters arising in the ordinary course of business. To cover these other types of claims as well as the legal matters referenced above, the Company maintains insurance it believes to be sufficient for its operations, although some claims may potentially exceed the scope of coverage in effect and the insurer may argue that some claims, including, without limitation, the claims described above, are excluded from coverage. Plaintiffs in these matters may also request punitive or other damages that may not be covered by insurance. Except as described above, after taking into consideration the evaluation of such matters by the Company’s legal counsel, the Company’s management believes at this time that the anticipated outcome of these matters will not have a material impact on the Company’s consolidated financial position, results of operations or cash flows.

Item 4. Mine Safety Disclosures

Not applicable.

 

29


 

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 is listed for trading on the NYSE under the symbol “AAC.” The following table sets forth the high and low sale prices of our common stock as reported by the NYSE during the indicated quarters:

 

 

High

 

 

Low

 

2017

 

 

 

 

 

 

 

First Quarter

$

9.68

 

 

$

7.05

 

Second Quarter

$

8.99

 

 

$

5.99

 

Third Quarter

$

13.06

 

 

$

5.99

 

Fourth Quarter

$

11.94

 

 

$

7.41

 

 

 

 

 

 

 

 

 

2016

 

 

 

 

 

 

 

First Quarter

$

24.11

 

 

$

14.36

 

Second Quarter

$

22.91

 

 

$

17.70

 

Third Quarter

$

24.38

 

 

$

16.51

 

Fourth Quarter

$

19.98

 

 

$

6.01

 

 

 On February 16, 2018, the closing price of our common stock on the NYSE was $8.32 per share. As of February 16, 2018, there were 451 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.

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, 2017, 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 58 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.

 

 

 

10/2/2014

 

12/31/2014

 

12/31/2015

 

12/31/2016

 

12/31/2017

 

AAC Holdings, Inc.

$

100.00

 

 

167.14

 

 

103.03

 

 

39.14

 

 

48.65

 

S&P 500

$

100.00

 

 

105.79

 

 

105.02

 

 

115.04

 

 

137.38

 

S&P 500 Health Care Index

$

100.00

 

 

108.38

 

 

114.03

 

 

109.06

 

 

130.88

 

30


 

Dividend Policy

The Company 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. The Company is also restricted under the terms of its 2017 Credit Facility from declaring or making, or agreeing to declare or make, any dividend on our common stock.

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

None.

Issuer Purchases of Equity Securities by the Issuer and Affiliated Purchasers

During the three months ended December 31, 2017, the Company had no publicly announced plans or programs to repurchase shares. However, the Company withheld shares of Company common stock to satisfy employee minimum statutory tax withholding obligations payable upon the vesting of restricted stock, as follows:

 

Total number of shares purchased

 

 

Aggregate price paid per share

 

 

Total number of shares purchased as part of publicly announced plans or programs

 

 

Maximum number of shares that may yet to be purchased under the plans or programs

 

October 1, 2017 through October 31, 2017

 

5,285

 

 

$9.17

 

 

 

 

 

 

 

November 1, 2017 through November 30, 2017

 

 

 

 

 

 

 

 

 

 

 

December 1, 2017 through December 31, 2017

 

33,512

 

 

$9.00

 

 

 

 

 

 

 

 


31


 

Item 6. Selected Financial Data

The following table presents our selected historical consolidated financial data as of the dates and for the periods indicated. AAC Holdings, Inc. 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 certain 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 such 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 such 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.

 

 

Year Ended December 31,

 

 

 

2017

 

 

2016

 

 

2015

 

 

2014

 

 

2013

 

 

 

(Dollars in thousands, except share data)

 

Income Statement Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Client related revenue

 

$

308,538

 

 

$

270,569

 

 

$

205,752

 

 

$

132,968

 

 

$

115,741

 

Non-client related revenue

 

 

9,103

 

 

 

9,201

 

 

 

6,509

 

 

 

 

 

 

 

Total revenue

 

$

317,641

 

 

$

279,770

 

 

$

212,261

 

 

$

132,968

 

 

$

115,741

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Salaries, wages and benefits

 

 

146,390

 

 

 

141,073

 

 

 

91,406

 

 

 

54,707

 

 

 

46,856

 

Client related services

 

 

27,031

 

 

 

24,446

 

 

 

15,754

 

 

 

10,794

 

 

 

7,986

 

Provision for doubtful accounts

 

 

36,914

 

 

 

21,485

 

 

 

18,113

 

 

 

11,391

 

 

 

10,950

 

Advertising and marketing

 

 

12,315

 

 

 

18,275

 

 

 

20,821

 

 

 

15,683

 

 

 

13,493

 

Professional fees

 

 

12,638

 

 

 

16,468

 

 

 

10,316

 

 

 

8,075

 

 

 

10,277

 

Other operating expenses

 

 

36,309

 

 

 

29,627

 

 

 

22,708

 

 

 

13,518

 

 

 

11,615

 

Rentals and leases

 

 

7,514

 

 

 

7,363

 

 

 

5,298

 

 

 

2,106

 

 

 

4,634

 

Litigation settlement

 

 

23,607

 

 

 

1,292

 

 

 

2,379

 

 

 

487

 

 

 

2,588

 

Restructuring

 

 

 

 

 

 

 

 

 

 

 

 

 

 

806

 

Depreciation and amortization

 

 

21,504

 

 

 

17,686

 

 

 

7,837

 

 

 

4,662

 

 

 

3,003

 

Acquisition-related expenses

 

 

1,162

 

 

 

2,691

 

 

 

3,401

 

 

 

845

 

 

 

 

Total operating expenses

 

 

325,384

 

 

 

280,406

 

 

 

198,033

 

 

 

122,268

 

 

 

112,208

 

(Loss) income from operations

 

 

(7,743

)

 

 

(636

)

 

 

14,228

 

 

 

10,700

 

 

 

3,533

 

Interest expense, net

 

 

16,811

 

 

 

8,175

 

 

 

3,607

 

 

 

1,872

 

 

 

1,390

 

Loss on extinguishment of debt

 

 

5,435

 

 

 

 

 

 

 

 

 

 

 

 

 

Gain on contingent consideration

 

 

 

 

 

(1,350

)

 

 

 

 

 

 

 

 

 

Bargain purchase gain

 

 

 

 

 

 

 

 

(1,775

)

 

 

 

 

 

 

Other expense (income), net

 

 

116

 

 

 

(500

)

 

 

(725

)

 

 

(93

)

 

 

36

 

(Loss) income before income tax expense

 

 

(30,105

)

 

 

(6,961

)

 

 

13,121

 

 

 

8,921

 

 

 

2,107

 

Income tax (benefit) expense

 

 

(5,018

)

 

 

(1,220

)

 

 

4,780

 

 

 

2,555

 

 

 

615

 

Net (loss) income

 

 

(25,087

)

 

 

(5,741

)

 

 

8,341

 

 

 

6,366

 

 

 

1,492

 

Less: net loss (income) attributable to noncontrolling interest

 

 

4,508

 

 

 

5,152

 

 

 

2,833

 

 

 

1182

 

 

 

(706

)

Net (loss) income attributable to AAC Holdings, Inc. stockholders

 

 

(20,579

)

 

 

(589

)

 

 

11,174

 

 

 

7,548

 

 

 

786

 

Deemed contribution-redemption of Series B Preferred Stock

 

 

 

 

 

 

 

 

 

 

 

 

 

 

1,000

 

BHR Series A Preferred Unit dividend

 

 

 

 

 

 

 

 

(147

)

 

 

(693

)

 

 

 

Redemption of BHR Series A preferred Units

 

 

 

 

 

 

 

 

(534

)

 

 

 

 

 

 

Net (loss) income available to AAC Holdings, Inc.

common stockholders

 

$

(20,579

)

 

$

(589

)

 

$

10,493

 

 

$

6,855

 

 

$

1,786

 

Earnings per share attributable to common stockholders:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic (loss) earnings per common share

 

$

(0.88

)

 

$

(0.03

)

 

$

0.49

 

 

$

0.41

 

 

$

0.13

 

Diluted (loss) earnings per common share

 

$

(0.88

)

 

$

(0.03

)

 

$

0.48

 

 

$

0.41

 

 

$

0.12

 

32


 

Weighted-average common shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

23,277,444

 

 

 

22,718,117

 

 

 

21,605,037

 

 

 

16,557,655

 

 

 

13,855,797

 

Diluted

 

 

23,277,444

 

 

 

22,718,117

 

 

 

21,661,259

 

 

 

16,619,180

 

 

 

14,291,937

 

Balance Sheet Data (as of the end of the period):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

13,818

 

 

$

3,964

 

 

$

18,750

 

 

$

48,540

 

 

$

2,012

 

Working capital

 

$

51,367

 

 

$

51,137

 

 

$

52,187

 

 

$

63,153

 

 

$

1,220

 

Total assets

 

$

428,275

 

 

$

383,884

 

 

$

316,049

 

 

$

145,952

 

 

$

81,638

 

Total debt, including current portion

 

$

201,173

 

 

$

189,106

 

 

$

145,141

 

 

$

28,641

 

 

$

43,075

 

Total stockholders' equity, including noncontrolling interests

 

$

136,168

 

 

$

154,788

 

 

$

136,488

 

 

$

95,141

 

 

$

11,883

 


33


 

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

This Annual Report on Form 10-K contains forward-looking statements within the meaning of the federal securities laws. 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,” “could,” “estimates,” “expects,” “may,” “potential,” “predicts,” “projects,” “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 the Company’s possible or assumed future results of operations, including descriptions of the Company’s revenue, 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 effectively 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 definitive lab testing; (iv) an increase in our provision for doubtful accounts based on the aging of receivables; (v) our failure to successfully achieve growth through acquisitions and de novo projects; (vi) uncertainties regarding the timing of the closing of acquisitions, including the pending acquisition of AdCare; (vii) the possibility that a governmental entity may prohibit, delay or refuse to grant approval for the consummation of an acquisition; (viii) our failure to achieve anticipated financial results from contemplated and prior acquisitions, including the pending AdCare acquisition; (ix) a disruption in our ability to perform diagnostic laboratory services; (x) maintaining compliance with applicable regulatory authorities, licensure and permits to operate our facilities and laboratories; (xi) a disruption in our business and reputational and economic risks associated with the civil securities claims brought by shareholders or claims by various parties; (xii) inability to meet the covenants in our loan documents; (xiii) our inability to effectively integrate acquired facilities; and (xiv) 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 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 use treatment services for individuals with drug addiction, alcohol addiction and co-occurring mental/behavioral health issues. In connection with our treatment services, we perform clinical diagnostic laboratory services and provide physician services to our clients. As of December 31, 2017, we operated nine residential substance abuse treatment facilities located throughout the United States, focused on delivering effective clinical care and treatment solutions across 939 residential beds, including 630 licensed detoxification beds, 19 standalone outpatient centers, and 5 sober living facilities across 409 beds for a total of 1,348 combined residential and sober living beds.

We are also an internet marketer in the addiction treatment industry operating a broad portfolio of internet assets that service millions of website visits each month. Through our Recovery Brands’ portfolio of websites, such as Rehabs.com and Recovery.org, we serve families and individuals struggling with addiction and seeking treatment options through comprehensive online directories of treatment providers, 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.

Our highly trained clinical staff 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 or schizophrenia, we believe we offer the level of quality care and service necessary for our clients to achieve and maintain sobriety.

2017 Developments

Pending Acquisition

On September 13, 2017, we, together with our subsidiary, entered into the Purchase Agreement with AdCare, and AdCare Trust. AdCare and its subsidiaries offer treatment of drug and alcohol addiction and own, among other things, a 114-bed hospital, five outpatient centers in Massachusetts, a 52-bed (46 currently licensed) residential treatment center and two outpatient centers in Rhode Island.

We have agreed to acquire from AdCare Trust all of the issued and outstanding shares of common stock of AdCare in exchange for the following: (i) the payment by us of $70.0 million in cash, (ii) the delivery by us of such number of unregistered shares of our common stock (“Common Shares”), equal to $5.0 million divided by the average closing price per Common Share on the NYSE during the ten trading day period ending three business days prior to the closing date (the “Closing Stock Consideration”); and (iii) the delivery of a promissory note issued by us to AdCare Trust in the principal amount of $10.0 million (the “Promissory Note”), for aggregate consideration of $85.0 million, subject to adjustments as set forth in the Purchase Agreement.

34


 

The cash portion of the acquisition is anticipated to be financed through a combination of proceeds from the issuance of an incremental term loan under the 2017 Credit Facility, capacity under the 2017 Revolver and cash on hand. The Promissory Note will mature no more than 91 days after the latest maturity date of the term loans under the 2017 Credit Facility, which are currently scheduled to mature on June 30, 2023, and will bear interest on its unpaid principal amount at a fixed rate of 5.0%, compounded annually. At closing, the Closing Stock Consideration will be deposited in escrow as security for potential post-closing indemnity claims (the “Escrow Fund”) and $0.5 million in cash will be deposited in escrow for shortfalls in AdCare’s net working capital. In addition, post-closing indemnity claims for certain matters will be affected first by a set off against the Promissory Note and, to the extent such claim for indemnification exceeds the then outstanding principal and interest due under the Promissory Note, any remaining claims will be paid from the Escrow Fund.

The Purchase Agreement contains customary representations and warranties by the parties, as well as customary indemnification provisions and termination rights for the parties. Further, pursuant to the Purchase Agreement, the parties have also agreed to customary covenants, including, among others, covenants relating to (i) the conduct of AdCare’s business during the interim period between the execution of the Purchase Agreement and the completion of the acquisition; and (ii) obligations to obtain any consents, approvals, permits, or authorizations which are required to be obtained in order to complete the acquisition under any applicable federal or state laws or regulations. The acquisition is currently anticipated to close in the next 30 to 60 days, subject to the receipt of certain governmental approvals, financing and customary closing conditions. We cannot assure that the acquisition will be consummated on this timeline or at all.

Facility Updates

In December 2017, we converted the 36 residential beds located at our San Diego Addiction Treatment Center into sober living beds in conjunction with the consolidation of our southern California operations.

In October 2017, we opened Townsend Recovery Center New Orleans where we have leased one floor from New Orleans East Hospital in New Orleans, Louisiana and operate 36 beds to provide detoxification and residential treatment services.

In August 2017, we relocated our Recovery First West Palm facility from West Palm Beach, Florida to Fort Lauderdale, Florida. By relocating Recovery First West Palm closer to our Fort Lauderdale facility, we expect to gain additional operational efficiencies.

In July 2017, we voluntarily closed our remaining beds at our Forterus facility in order to consolidate our southern California operations closer to Laguna Treatment Hospital. By consolidating our operations closer to Laguna Treatment Hospital, we gained additional operational efficiencies. As a result of closing the beds at Forterus, we had a net reduction in bed count of 37. As our residential daily census at Laguna Treatment Hospital grows, we expect to add additional sober living beds and outpatient services near our Laguna Treatment Hospital.

From May 23, 2017 to July 5, 2017, our Sunrise House facility was temporarily not serving clients due to an employee strike at that location. On June 14, 2017, a settlement was reached with the union, and Sunrise House began readmitting clients on July 5, 2017. As a result of our Sunrise House facility entering into a three-year collective bargaining agreement with the HPAE on June 14, 2017, a majority of our employees at Sunrise House are now represented by a collective bargaining agreement.

Bed Count Summary

The following table shows the break out of our total bed count between residential beds and sober living beds as of December 31, 2017 and 2016, respectively:

 

 

 

 

 

 

 

 

 

 

 

 

 

As of December 31, 2017

 

 

As of December 31, 2016

 

 

Increase / (Decrease)

 

Residential Beds

 

939

 

 

 

1,140

 

 

 

(201

)

Sober Living Beds

 

409

 

 

 

202

 

 

 

207

 

Total Beds

 

1,348

 

 

 

1,342

 

 

 

6

 

Financing

On June 30, 2017, we entered into the 2017 Credit Facility. The 2017 Credit Facility initially made available a term loan in the aggregate principal amount of $210.0 million (the “2017 Term Loan”) and a $40.0 million revolving line of credit (the “2017 Revolver”). The 2017 Credit Facility also provides for standby letters of credit in an aggregate undrawn amount not to exceed $7.0 million. We used the proceeds to repay $205.4 million of certain existing indebtedness under the 2015 Credit Facility and the Deerfield Facility (as defined below). For discussion of our 2017 Credit Facility, and a summary of its terms, see “Financing Relationships” below and Note 7 (Long-Term Debt) to the accompanying consolidated financial statements. As of December 31, 2017, under our 2017 Credit Facility, we had $207.4 million outstanding on our 2017 Term Loan.

35


 

In addition, on September 25, 2017, we entered into an Incremental Loan Assumption Agreement (“the Incremental Agreement”), with the Incremental Revolving Credit Lenders (as defined in the Incremental Agreement), Credit Suisse AG, Cayman Islands Branch, as administrative agent (“Credit Suisse”), and the other Loan Parties (as defined in the Incremental Agreement) party thereto, relating to the 2017 Credit Facility. The Incremental Agreement provided for an increase in our existing revolving line of credit from $40.0 million to $55.0 million.

On October 6, 2017, in conjunction with our pending acquisition of AdCare, we also secured a $65.0 million incremental term loan commitment in conjunction with our 2017 Credit Facility, subject to customary closing conditions and regulatory provisions. In connection with the financing, we committed to a ticking fee that commenced on October 17, 2017, at a rate of LIBOR plus 3.375%, and which increased to LIBOR plus 6.75% from November 2017 until the closing date of the acquisition.

In connection with the effectiveness of the 2017 Credit Facility, on June 30, 2017, we terminated our then outstanding financing facilities with affiliates of Deerfield Management Company, L.P. (“Deerfield”), which consisted of $25.0 million of subordinated convertible debt and up to $25.0 million of unsecured subordinated debt (the “Deerfield Facility”).

On August 9, 2017, we closed a sale-leaseback transaction with MedEquities Realty Operating Partnership, LP, a subsidiary of MedEquities Realty Trust, Inc. (“MedEquities”), for $25.0 million (“2017 Sale-Leaseback”), in which MedEquities purchased from our subsidiaries two drug and alcohol rehabilitation outpatient facilities and two sober living facilities: the Desert Hope Facility and Resolutions Las Vegas, each located in Las Vegas, Nevada, and the Greenhouse Facility and Resolutions Arlington, each located in Arlington, Texas (collectively, the “Sale-Leaseback Facilities”).

Simultaneously with the sale of the Sale-Leaseback Facilities, we, through our subsidiaries, and affiliates of MedEquities entered into an operating lease, dated August 9, 2017 (the “Lease”), in which we will continue to operate the Sale-Leaseback Facilities. The Lease provides for a 15-year term for each facility with two separate renewal terms of five years each if we choose to exercise our right to extend the lease term. The initial annual minimum rent payable to MedEquities pursuant to the Lease is $2.2 million due in equal monthly installments of $0.2 million.

Due to the nature of the agreement between MedEquities and us, the transaction does not qualify for sale-leaseback accounting under accounting principles generally accepted in the United States of America (“GAAP”). Therefore, the Sale-Leaseback Facilities will remain on our balance sheet and will continue to be depreciated over the life of the asset. We accounted for the $25.0 million of proceeds, less $0.4 million of transaction costs, as a financing obligation, of which $0.1 million was classified as a short-term liability. On a monthly basis, a portion of the payment is allocated to principal, which reduces the obligation balance, and interest, computed based on our incremental borrowing rate.

Key Personnel Update

Candance Henderson-Grice

On February 3, 2017, Candance Henderson-Grice resigned as Chief Operating Officer of the Company. In connection with her resignation, she entered into a separation agreement and release, which provided for, among other things, aggregate payments of $0.6 million to be paid over the course of 2017.

Jerrod Menz

On September 8, 2017, Jerrod Menz resigned from the board of directors and as an employee of the Company for personal reasons. In connection with his resignation, he forfeited 50,000 shares of restricted stock and entered into a 24-month separation and release agreement with the Company in exchange for an aggregate payment of $0.7 million.

Kirk Manz

Effective December 31, 2017, Kirk Manz resigned as Chief Financial Officer of the Company. In connection with his resignation, on November 9, 2017, he entered into a separation agreement and release with the Company, which provided for, among other things, the payment of $0.5 million.

Andrew McWilliams

Effective January 1, 2018, Andrew McWilliams transitioned into the role of Chief Financial Officer of the Company, immediately following Mr. Manz’s departure. Mr. McWilliams also retains his title as Chief Accounting Officer of the Company.

Michael Nanko

Effective January 15, 2018, Michael Nanko started in his role as President and Chief Operating Officer of the Company.

36


 

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 clinical diagnostic laboratory services. We recognize revenue at the estimated net realizable value in the period in which services are provided. For the years ended December 31, 2017 and 2016, approximately 92.3% and 90.0%, respectively, of our client related revenue was reimbursable by commercial payors, including amounts paid by such payors to clients, with the remaining revenue 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. Revenue concentration by payor remains modest. For the year ended December 31, 2017, no single payor accounted for more than 11.4% of our revenue, with the top three payors accounting for 32.6% of our revenue. For the year ended December 31, 2016, no single payor accounted for more than 10.5% of our revenue with the top three accounting for approximately 31.3% of our revenue.

The following table summarizes the composition of our client related revenue for residential treatment facility services, outpatient facility and sober living services and client related diagnostic services for the years ended December 31, 2017 and 2016:

 

 

December 31, 2017

 

 

December 31, 2016

 

 

Increase (Decrease)

 

 

 

Amount

 

 

%

 

 

Amount

 

 

%

 

 

Amount

 

 

%

 

Residential treatment facility services1

 

$

246,976

 

 

 

80.0

%

 

$

189,502

 

 

 

70.0

%

 

$

57,474

 

 

 

30.3

%

Outpatient facility and sober living services2

 

 

29,080

 

 

 

9.4

%

 

 

16,676

 

 

 

6.2

%

 

 

12,404

 

 

 

74.4

%

Client related diagnostic services3

 

 

32,482

 

 

 

10.5

%

 

 

64,391

 

 

 

23.8

%

 

 

(31,909

)

 

 

(49.6

%)

Total client related revenue

 

$

308,538

 

 

 

100.0

%

 

$

270,569

 

 

 

100.0

%

 

$

37,969

 

 

 

14.0

%

 

 

(1)

Residential treatment facility services and related professional services.

 

(2)

Outpatient facility services, related professional services and sober living services.

 

(3)

Client related diagnostic services, which includes point of care drug testing and client related diagnostic laboratory services.

Client related diagnostic services revenue for the year ended December 31, 2017, decreased 49.6% to $32.5 million compared with $64.4 million for the year ended December 31, 2016. Client related diagnostic services revenue as a percentage of total client related revenue was 10.5% for the year ended December 31, 2017 compared to 23.8% for the year ended December 31, 2016. The decrease in client related diagnostic services is a result of previously anticipated lower reimbursements combined with a shift in the mix of client related diagnostic services from higher reimbursed tests to lower reimbursed tests.

We recognize client related revenue 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. For in-network contracts, client related revenue is based on previously set contracted rates. We receive the majority of payments from commercial payors at out-of-network rates. We estimate the net realizable value of revenue 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 considering the type of services provided and the historical collections received from commercial payors, on a per facility basis, compared to gross client charges billed.

Our accounts receivable primarily consists of amounts due from commercial payors. We do not recognize revenue for any amounts not collected from the client. From time to time, we may provide free care to clients, which we refer to as scholarships. We do not recognize revenue for any scholarships that we provide. 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. Also included in the aging of accounts receivable are amounts where we have received a partial payment from the commercial insurance company and are continuing to pursue additional collections for the estimated remaining balance outstanding.

Non-Client Related Revenue. Our non-client related revenue consists of service charges from the delivery of quality targeted leads to behavioral and mental health service businesses and diagnostic laboratory services provided to clients of third-party addiction treatment providers. Non-client related 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.

Operating Expenses. Our operating expenses are primarily impacted by the following categories of expenses:

 

Salaries, wages and benefits. We employ a variety of staff related to providing client care, including case managers, therapists, medical technicians, housekeepers, cooks and drivers, among others. Our clinical salaries, wages and benefits expense is largely driven by the total number of beds in our facilities, our average daily census (“ADC”) and the number of outpatient visits. We also employ a professional sales force and staff a centralized call center. Our corporate staff includes accounting, billing and finance professionals, marketing and human resource personnel, IT staff and senior management.

37


 

 

Client related services. Client related services consist of physician and medical services as well as client meals, pharmacy, travel and various other expenses associated with client treatment. Client related services are significantly influenced by our ADC and the number of outpatient visits.