American Addiction Centers AAC S
February 24, 2016 - 5:10pm EST by
bm25
2016 2017
Price: 23.06 EPS -$.08 n/m
Shares Out. (in M): 22 P/E n/m n/m
Market Cap (in $M): 508 P/FCF n/m n/m
Net Debt (in $M): 126 EBIT 19 23
TEV ($): 635 TEV/EBIT 35x 33x
Borrow Cost: Available 0-15% cost

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  • Bankruptcy
  • Fraud
 

Description

Thesis

AAC will file for Chapter 11 bankruptcy this year, wiping out shareholders.  With over 100% of its profits coming from over-billing insurers on drug tests and massive reimbursements cuts happening now, we see AAC’s EBITDA declining by 60%+ in FY16 and EPS turning negative.  We see AAC defaulting on its debt in the middle of this year, leaving the equity worthless.

 

While there has been a Seeking Alpha article written on this premise that AAC does excessive drug testing, the write-up was sloppy.  More importantly, it doesn’t take into account the recent updates to insurers’ reimbursement guidelines, nor did the author conduct the confirmatory channel checks with payors that we’ve done.  AAC’s top three customers, which account for 41% of its revenue, have each significantly changed their reimbursement guidelines in the last three months, with the impact to be felt starting in 1Q16.  Additionally, just last month, substance abuse providers in California (AAC’s second largest state) have begun to receive clawback notices from insurers for previously paid claims.

                                                                                                                                                               

Background

AAC is the country’s second-largest chain of substance centers (think of a bunch of Betty Ford clinics but less posh).  A JOBS Act IPO, AAC came public in October 2014 at $15.00/share, quickly zooming up to $45 as sell-side analysts touted it as “the best growth story in small-cap healthcare,” as the company aggressively expanding its bed count through acquisitions and de novo openings.  The stock plummeted last summer on news that its President, co-founder and second largest shareholder (22% stake currently) was indicted by a California Grand Jury on 2nd degree murder charges and elder abuse (in an unprecedented move, two of AAC’s subsidiaries were also indicted, as well as several lower level employees).  While obviously tragic and significant in other ways, the murder charges are ancillary to the short thesis.

 

The Bull thesis is predicated on several alleged secular trends, against which AAC is intending to execute an aggressive roll-up strategy.  One, the Affordable Care Act expanded insurance coverage for mental health treatment, of which substance abuse is one such area.  Two, culturally, there is less of a stigma for people to “admit they have a problem” and seek help in the form of going to a rehab center. Three, from the provider standpoint, the substance industry is highly fragmented, with many operators being not-for-profits; AAC is the second largest provider behind Acadia Healthcare (ACHC), due to its acquisition CRC Health Group in 1Q15.

 

Our thesis is that AAC is over-earning because over 100% of its profitability comes from excessively charging payors for unnecessary drug testing performed on its patients.  Ostensibly a chain of rehab facilities, in reality, AAC is an out-of-network lab in disguise, using the façade of a rapidly growing substance abuse provider as a loss leader to drive drug testing business to its lab. 

 

The insurance community has been talking about excessive drug testing claims over a year now, and began taking small steps to address the issue in late 2014, with AAC beginning to feel the impact in 3Q15.  Its 4Q15 pre-announcement last month shows the impact is continuing.  But a step-function change is now taking place, based on public updates from insurers, coupled with our channel checks, indicating that reimbursement changes are dramatically accelerating beginning in early 2016.

 

Business Economics

Using 2015 numbers (AAC pre-announced on Jan 26; I’m using the high-end of their range), AAC generated $212mm of revenue, $43mm of EBITDA and 91C of EPS.  Revenue is broken out accordingly:

 

     

 

FY15

Total Revenue

   

212

Of which:

     

Client-related rev - Per Diem

   

144

Client-related rev - Drug Testing

 

60

Other

   

7

       

% mix

     

Client-related rev - Per diem

   

68%

Client-related rev - Drug testing

   

28%

Other

   

3%

 

Client-related revenue is revenue AAC receives for its core business of treating patients for substance abuse.  Other revenue is from an acquisition AAC did last year of behavioral health lead gen company.  Client-related revenue is bifurcated between Drug Testing and other ancillary services revenue, which are one-off services that AAC gets reimbursed/paid for on an a la carte basis, and the “Per Diem” revenue, which is the daily fee that AAC receives for patient staying in its rehab facilities (the Per Diem can be broken down further into different levels of treatment intensity, but for simplicity I list it as one item).

 

What does this $60mm of Drug Testing revenue equate to in terms of unit economics?  Last year, AAC treated 563 patients per day on average (this is disclosed).  Based on 365 days, this equates to $294/patient/day of Drug Testing revenue.  For a typical 30-day stay at a rehab facility, that equals $8,800 of revenue over that stay solely for Drug Testing.  Think about that for a second.  This company is generating $8,800 in revenue for having drug addicts pee in a cup during their month-long stay at an AAC facility.  Based on our conversations with current and former management, we estimate this breaks down to, on average, 2-3 drug tests per week at an average revenue per specimen tested of $700-1,000.

 

We believe this $60mm of revenue from Drug Testing earns 90%+ margins.  (Shockingly, management won’t quantify what the margin is, only to acknowledge that it’s high.)  This is because the incremental cost of running a drug test on a urine specimen is small, in the tens of dollars (patients literally pee into a cup and have it checked for cocaine, barbiturates, etc.), while AAC receives $700-1,000 in reimbursements per specimen.  For conservatism, we estimate the incremental cost to test a specimen is $50-75/test.  At ~92% margin on its drug tests, this $60mm of revenue translates into $56mm of EBITDA.  Accordingly, based on AAC’s FY15 EBITDA of $43mm, we can see that the rest of AAC’s revenue generates negative EBITDA.

 

     

FY15

EBITDA

   

43

Of which:

     

Per diem

   

(16)

Drug testing

   

56

Other [1]

   

3

       

% margin

     

Total

   

20%

Of which:

     

Per diem

   

(11%)

Drug testing

   

92%

Other

   

45%

       

% mix

     

Per diem

   

(38%)

Drug testing

   

131%

Other

   

8%

       
       

[1] Other Revenue had a 40% EBITDA margin when acquired, according to AAC's press release

on 07/02/15, which we estimate is ~45% now given some synergies

 

 

For comparison, we’ve spoken with former executives at CRC Health – the largest player in the substance abuse space, which was bought by ACHC last year – who told us their revenue from drug testing is < 5% of total; the simple reason is twofold:

a)       AAC’s 2-3 tests per week compares to a standard testing frequency of 2-3 tests per 30-day stay,

b)       At $700-1,000 of reimbursement per specimen, AAC is massively over-billing, as most Drug Testing claims aren’t reimbursed on an a la carte basis like AAC’s (who is almost entirely out-of-network), but rather are simply considered a cost of doing business which is implicitly reimbursed for in the Per Diem revenue

 

Moreover, besides speaking with CRC Health, other checks with smaller providers and industry consultants corroborate that AAC is an egregious abuser of drug testing claims.


So what…AAC is over-earning / over-charging today, what’s going to change that?  What’s changing is that the largest insurers are all making significant changes to their reimbursement guidelines, which will lead to massive declines in the amount payors reimburse substance abuse providers for drug testing:

 

·         Anthem (Blue Cross California and Blue Cross Colorado are 11% and 16% of revenue):

o    https://www.anthem.com/medicalpolicies/guidelines/gl_pw_c166612.htm (guideline number: CG-LAB-09)

·         Blue Cross Blue Shield Texas (13% of revenue): 

o    http://www.medicalpolicy.hcsc.net/medicalpolicy/activePolicyPage?lid=ifojvj2i&corpEntCd=TX1 (guideline number: MED207.154)

·         UnitedHealth (likely high-single digit % of revenue):

o    https://www.unitedhealthcareonline.com/ccmcontent/ProviderII/UHC/en-US/Main%20Menu/Tools%20&%20Resources/Policies%20and%20Protocols/Medicare%20Advantage%20Reimbursement%20Policies/Q/QualitativeDrugTesting.pdf (guideline number: QDT12182013RP)

 

Blue Cross California and BCBS Colorado (subsidiaries of Anthem) and BCBS Texas are named customers accounting for 41% of all AAC’s reimbursements, (we estimate UnitedHealth is in the HSD %).  We’ve spoken with multiple payors who say that such changes will reduce drug testing reimbursements to substance abuse providers by 90%.  While our checks varied on the timing of these changes – with one suggesting this 90% drop is happening now and another expecting 30-40% annual declines in reimbursements over the next several years – the impact to AAC is catastrophic.

 

We conservatively assume that these reimbursement cuts play out over several years.  Our estimate is that the $294/patient/day of Drug Testing revenue that AAC received in FY15 will decline ~50% to $148 in FY16.  Note that this still means that in FY16, 18% of AAC’s total revenue will come from Drug Testing (vs < 5% for CRC Health), equating to over $4,440 of Drug Testing revenue per 30-day stay.  See below for how FY15 results would look, adjusted for the change in Drug Testing reimbursements:


 

 

       

FY15A

Adjs

PF FY15

Total Revenue

   

212

 

182

Of which:

           

Client-related rev - Per diem

 

144

 

144

Client-related rev - Drug testing

 

60

(30)

30

Other

     

7

 

7

             

% mix

           

Client-related rev - Per diem

 

68%

 

79%

Client-related rev - Drug testing

 

28%

 

17%

Other

     

3%

 

4%

             

Avg patient stays per day

 

563

 

563

Drug Testing rev per patient per day

 

$294

($146)

$148

             

EBITDA

 

 

 

43

 

13

Of which:

           

Per diem

     

(16)

 

(16)

Drug testing

   

56

(29)

26

Other [1]

     

3

 

3

             

% margin

           

Total

     

20%

 

7%

Of which:

     

0%

   

Per diem

     

(11%)

 

(11%)

Drug testing

   

92%

 

87%

Other

     

45%

 

45%

             

% mix

           

Per diem

     

(38%)

 

(122%)

Drug testing

   

131%

 

198%

Other

     

8%

 

25%

 

 

Our actual FY16 results call for $19mm of total EBITDA on $286mm of total revenue, given growth in bed count (both de novo and acquisition), but the punchline is the same.

 

Importantly: these changes to reimbursements haven’t hit reported results yet.  The above policy updates have effective dates ranging from 11/01/15 to 01/01/16, meaning that they are not yet in the FY15 results pre-announced last month.  (Even the November updates didn’t impact 4Q15 reported results as there is a lag between when a provider submits a claim and when it eventually gets denied by the payor.)   So this will be all incremental to FY16 results.  While there has been some initial pressure on Drug Testing reimbursements beginning in 3Q15 that impact is actually based on older, less stringent medical guideline updates that pre-date the ones linked to above. 

 

Finally, last month, Health Net, a large-California based insurer started sending notices to multiple substance abuse providers in the state seeking to clawback previously paid claims that it now believes were fraudulent (see here for background: http://www.behavioral.net/article/health-net-looking-fraud-among-treatment-centers).  California is AAC’s second largest state, with 19% of its beds.  While we don’t know whether or not AAC is being targeted by Health Net, it wouldn’t shock us if at some point the company was a target.  This is, after all, the state where AAC and its former President are on trial for murder.  AAC is also cited multiple times in a scathing study by the CA state legislature (see http://sooo.senate.ca.gov/sites/sooo.senate.ca.gov/files/Rogue%20Rehab%209_4_12.pdf for mentions of AAC subsidiary “A Better Tomorrow”)

 

Valuation and Leverage

On FY15 EBITDA, AAC trades at 13x (which compares to the 10x that ACHC paid to acquire CRC Health last year).  However, on our FY16E EBITDA of $19mm, it trades at 32x (we have negative EPS given the high interest expense).

 

AAC ended FY15 with 3.4x of leverage relative to its max allowable leverage of 4.5x (on gross debt of $145mm).  Given the steep drop off in EBITDA, we have leverage going 9x by the end of FY16 (their leverage covenant also steps down to 4.25x in 2Q16). 

 

Accordingly, we expect AAC to default on its debt this year.  With the decline in EBITDA being structural (and drug testing reimbursements getting worse in subsequent years), we see no residual value to the equity in a bankruptcy. 

 

 

Note that last October, AAC got $50mm in commitments from its sponsor, Deerfield Management, with $25mm coming in the form of a 2.5% note convertible at $30/share and another $25mm from a 12.0% subordinate note – hardly a vote of confidence in AAC’s prospects.  

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Catalysts

·         FY16 guidance (expected on 4Q15 call on Feb 23)

·         Default on its bank debt (expected middle of 2016)

 

·         Chapter 11 bankruptcy

    sort by   Expand   New

    Description

    Thesis

    AAC will file for Chapter 11 bankruptcy this year, wiping out shareholders.  With over 100% of its profits coming from over-billing insurers on drug tests and massive reimbursements cuts happening now, we see AAC’s EBITDA declining by 60%+ in FY16 and EPS turning negative.  We see AAC defaulting on its debt in the middle of this year, leaving the equity worthless.

     

    While there has been a Seeking Alpha article written on this premise that AAC does excessive drug testing, the write-up was sloppy.  More importantly, it doesn’t take into account the recent updates to insurers’ reimbursement guidelines, nor did the author conduct the confirmatory channel checks with payors that we’ve done.  AAC’s top three customers, which account for 41% of its revenue, have each significantly changed their reimbursement guidelines in the last three months, with the impact to be felt starting in 1Q16.  Additionally, just last month, substance abuse providers in California (AAC’s second largest state) have begun to receive clawback notices from insurers for previously paid claims.

                                                                                                                                                                   

    Background

    AAC is the country’s second-largest chain of substance centers (think of a bunch of Betty Ford clinics but less posh).  A JOBS Act IPO, AAC came public in October 2014 at $15.00/share, quickly zooming up to $45 as sell-side analysts touted it as “the best growth story in small-cap healthcare,” as the company aggressively expanding its bed count through acquisitions and de novo openings.  The stock plummeted last summer on news that its President, co-founder and second largest shareholder (22% stake currently) was indicted by a California Grand Jury on 2nd degree murder charges and elder abuse (in an unprecedented move, two of AAC’s subsidiaries were also indicted, as well as several lower level employees).  While obviously tragic and significant in other ways, the murder charges are ancillary to the short thesis.

     

    The Bull thesis is predicated on several alleged secular trends, against which AAC is intending to execute an aggressive roll-up strategy.  One, the Affordable Care Act expanded insurance coverage for mental health treatment, of which substance abuse is one such area.  Two, culturally, there is less of a stigma for people to “admit they have a problem” and seek help in the form of going to a rehab center. Three, from the provider standpoint, the substance industry is highly fragmented, with many operators being not-for-profits; AAC is the second largest provider behind Acadia Healthcare (ACHC), due to its acquisition CRC Health Group in 1Q15.

     

    Our thesis is that AAC is over-earning because over 100% of its profitability comes from excessively charging payors for unnecessary drug testing performed on its patients.  Ostensibly a chain of rehab facilities, in reality, AAC is an out-of-network lab in disguise, using the façade of a rapidly growing substance abuse provider as a loss leader to drive drug testing business to its lab. 

     

    The insurance community has been talking about excessive drug testing claims over a year now, and began taking small steps to address the issue in late 2014, with AAC beginning to feel the impact in 3Q15.  Its 4Q15 pre-announcement last month shows the impact is continuing.  But a step-function change is now taking place, based on public updates from insurers, coupled with our channel checks, indicating that reimbursement changes are dramatically accelerating beginning in early 2016.

     

    Business Economics

    Using 2015 numbers (AAC pre-announced on Jan 26; I’m using the high-end of their range), AAC generated $212mm of revenue, $43mm of EBITDA and 91C of EPS.  Revenue is broken out accordingly:

     

         

     

    FY15

    Total Revenue

       

    212

    Of which:

         

    Client-related rev - Per Diem

       

    144

    Client-related rev - Drug Testing

     

    60

    Other

       

    7

           

    % mix

         

    Client-related rev - Per diem

       

    68%

    Client-related rev - Drug testing

       

    28%

    Other

       

    3%

     

    Client-related revenue is revenue AAC receives for its core business of treating patients for substance abuse.  Other revenue is from an acquisition AAC did last year of behavioral health lead gen company.  Client-related revenue is bifurcated between Drug Testing and other ancillary services revenue, which are one-off services that AAC gets reimbursed/paid for on an a la carte basis, and the “Per Diem” revenue, which is the daily fee that AAC receives for patient staying in its rehab facilities (the Per Diem can be broken down further into different levels of treatment intensity, but for simplicity I list it as one item).

     

    What does this $60mm of Drug Testing revenue equate to in terms of unit economics?  Last year, AAC treated 563 patients per day on average (this is disclosed).  Based on 365 days, this equates to $294/patient/day of Drug Testing revenue.  For a typical 30-day stay at a rehab facility, that equals $8,800 of revenue over that stay solely for Drug Testing.  Think about that for a second.  This company is generating $8,800 in revenue for having drug addicts pee in a cup during their month-long stay at an AAC facility.  Based on our conversations with current and former management, we estimate this breaks down to, on average, 2-3 drug tests per week at an average revenue per specimen tested of $700-1,000.

     

    We believe this $60mm of revenue from Drug Testing earns 90%+ margins.  (Shockingly, management won’t quantify what the margin is, only to acknowledge that it’s high.)  This is because the incremental cost of running a drug test on a urine specimen is small, in the tens of dollars (patients literally pee into a cup and have it checked for cocaine, barbiturates, etc.), while AAC receives $700-1,000 in reimbursements per specimen.  For conservatism, we estimate the incremental cost to test a specimen is $50-75/test.  At ~92% margin on its drug tests, this $60mm of revenue translates into $56mm of EBITDA.  Accordingly, based on AAC’s FY15 EBITDA of $43mm, we can see that the rest of AAC’s revenue generates negative EBITDA.

     

         

    FY15

    EBITDA

       

    43

    Of which:

         

    Per diem

       

    (16)

    Drug testing

       

    56

    Other [1]

       

    3

           

    % margin

         

    Total

       

    20%

    Of which:

         

    Per diem

       

    (11%)

    Drug testing

       

    92%

    Other

       

    45%

           

    % mix

         

    Per diem

       

    (38%)

    Drug testing

       

    131%

    Other

       

    8%

           
           

    [1] Other Revenue had a 40% EBITDA margin when acquired, according to AAC's press release

    on 07/02/15, which we estimate is ~45% now given some synergies

     

     

    For comparison, we’ve spoken with former executives at CRC Health – the largest player in the substance abuse space, which was bought by ACHC last year – who told us their revenue from drug testing is < 5% of total; the simple reason is twofold:

    a)       AAC’s 2-3 tests per week compares to a standard testing frequency of 2-3 tests per 30-day stay,

    b)       At $700-1,000 of reimbursement per specimen, AAC is massively over-billing, as most Drug Testing claims aren’t reimbursed on an a la carte basis like AAC’s (who is almost entirely out-of-network), but rather are simply considered a cost of doing business which is implicitly reimbursed for in the Per Diem revenue

     

    Moreover, besides speaking with CRC Health, other checks with smaller providers and industry consultants corroborate that AAC is an egregious abuser of drug testing claims.


    So what…AAC is over-earning / over-charging today, what’s going to change that?  What’s changing is that the largest insurers are all making significant changes to their reimbursement guidelines, which will lead to massive declines in the amount payors reimburse substance abuse providers for drug testing:

     

    ·         Anthem (Blue Cross California and Blue Cross Colorado are 11% and 16% of revenue):

    o    https://www.anthem.com/medicalpolicies/guidelines/gl_pw_c166612.htm (guideline number: CG-LAB-09)

    ·         Blue Cross Blue Shield Texas (13% of revenue): 

    o    http://www.medicalpolicy.hcsc.net/medicalpolicy/activePolicyPage?lid=ifojvj2i&corpEntCd=TX1 (guideline number: MED207.154)

    ·         UnitedHealth (likely high-single digit % of revenue):

    o    https://www.unitedhealthcareonline.com/ccmcontent/ProviderII/UHC/en-US/Main%20Menu/Tools%20&%20Resources/Policies%20and%20Protocols/Medicare%20Advantage%20Reimbursement%20Policies/Q/QualitativeDrugTesting.pdf (guideline number: QDT12182013RP)

     

    Blue Cross California and BCBS Colorado (subsidiaries of Anthem) and BCBS Texas are named customers accounting for 41% of all AAC’s reimbursements, (we estimate UnitedHealth is in the HSD %).  We’ve spoken with multiple payors who say that such changes will reduce drug testing reimbursements to substance abuse providers by 90%.  While our checks varied on the timing of these changes – with one suggesting this 90% drop is happening now and another expecting 30-40% annual declines in reimbursements over the next several years – the impact to AAC is catastrophic.

     

    We conservatively assume that these reimbursement cuts play out over several years.  Our estimate is that the $294/patient/day of Drug Testing revenue that AAC received in FY15 will decline ~50% to $148 in FY16.  Note that this still means that in FY16, 18% of AAC’s total revenue will come from Drug Testing (vs < 5% for CRC Health), equating to over $4,440 of Drug Testing revenue per 30-day stay.  See below for how FY15 results would look, adjusted for the change in Drug Testing reimbursements:


     

     

           

    FY15A

    Adjs

    PF FY15

    Total Revenue

       

    212

     

    182

    Of which:

               

    Client-related rev - Per diem

     

    144

     

    144

    Client-related rev - Drug testing

     

    60

    (30)

    30

    Other

         

    7

     

    7

                 

    % mix

               

    Client-related rev - Per diem

     

    68%

     

    79%

    Client-related rev - Drug testing

     

    28%

     

    17%

    Other

         

    3%

     

    4%

                 

    Avg patient stays per day

     

    563

     

    563

    Drug Testing rev per patient per day

     

    $294

    ($146)

    $148

                 

    EBITDA

     

     

     

    43

     

    13

    Of which:

               

    Per diem

         

    (16)

     

    (16)

    Drug testing

       

    56

    (29)

    26

    Other [1]

         

    3

     

    3

                 

    % margin

               

    Total

         

    20%

     

    7%

    Of which:

         

    0%

       

    Per diem

         

    (11%)

     

    (11%)

    Drug testing

       

    92%

     

    87%

    Other

         

    45%

     

    45%

                 

    % mix

               

    Per diem

         

    (38%)

     

    (122%)

    Drug testing

       

    131%

     

    198%

    Other

         

    8%

     

    25%

     

     

    Our actual FY16 results call for $19mm of total EBITDA on $286mm of total revenue, given growth in bed count (both de novo and acquisition), but the punchline is the same.

     

    Importantly: these changes to reimbursements haven’t hit reported results yet.  The above policy updates have effective dates ranging from 11/01/15 to 01/01/16, meaning that they are not yet in the FY15 results pre-announced last month.  (Even the November updates didn’t impact 4Q15 reported results as there is a lag between when a provider submits a claim and when it eventually gets denied by the payor.)   So this will be all incremental to FY16 results.  While there has been some initial pressure on Drug Testing reimbursements beginning in 3Q15 that impact is actually based on older, less stringent medical guideline updates that pre-date the ones linked to above. 

     

    Finally, last month, Health Net, a large-California based insurer started sending notices to multiple substance abuse providers in the state seeking to clawback previously paid claims that it now believes were fraudulent (see here for background: http://www.behavioral.net/article/health-net-looking-fraud-among-treatment-centers).  California is AAC’s second largest state, with 19% of its beds.  While we don’t know whether or not AAC is being targeted by Health Net, it wouldn’t shock us if at some point the company was a target.  This is, after all, the state where AAC and its former President are on trial for murder.  AAC is also cited multiple times in a scathing study by the CA state legislature (see http://sooo.senate.ca.gov/sites/sooo.senate.ca.gov/files/Rogue%20Rehab%209_4_12.pdf for mentions of AAC subsidiary “A Better Tomorrow”)

     

    Valuation and Leverage

    On FY15 EBITDA, AAC trades at 13x (which compares to the 10x that ACHC paid to acquire CRC Health last year).  However, on our FY16E EBITDA of $19mm, it trades at 32x (we have negative EPS given the high interest expense).

     

    AAC ended FY15 with 3.4x of leverage relative to its max allowable leverage of 4.5x (on gross debt of $145mm).  Given the steep drop off in EBITDA, we have leverage going 9x by the end of FY16 (their leverage covenant also steps down to 4.25x in 2Q16). 

     

    Accordingly, we expect AAC to default on its debt this year.  With the decline in EBITDA being structural (and drug testing reimbursements getting worse in subsequent years), we see no residual value to the equity in a bankruptcy. 

     

     

    Note that last October, AAC got $50mm in commitments from its sponsor, Deerfield Management, with $25mm coming in the form of a 2.5% note convertible at $30/share and another $25mm from a 12.0% subordinate note – hardly a vote of confidence in AAC’s prospects.  

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    Catalysts

    ·         FY16 guidance (expected on 4Q15 call on Feb 23)

    ·         Default on its bank debt (expected middle of 2016)

     

    ·         Chapter 11 bankruptcy

    Messages


    SubjectEarnings Quality, Leverage Covenant
    Entry02/24/2016 06:27 PM
    Memberbm25

    This was my application posting so it was written before AAC's 4Q15 results were reported yesterday.  I have three main takeaways: 

    1. Earnings quality is abysmal: GAAP EPS was 2C vs "Adjusted" EPS of 17C.  All add-backs were cash.  "Adjusted" EBITDA of $9.4mm compares to EBITDA of $4.8mm.  
    2. FY16 guidance makes no sense: while management doesn't disclose how many add-backs go into their "Adjusted" EBITDA and EPS guidance, but it's presumably a lot per the 4Q15/FY15 figures.  4Q15 "Adjusted" EBITDA margin was 16%, down from 20% in 3Q15 and 27% in 2Q15 (en route to 6% on our FY16 numbers).  That aside, Per Bed costs implied in the "Adjusted" EBITDA are guided to be down 18% y/y after having grown 15% for FY15 and 15% in 4Q15 specifically.
    3. Leverage much higher than it appears: on $145mm of gross debt and management's reported FY15 Adjusted EBITDA of $44mm implies 3.3x leverage as of 4Q15.  However, EBITDA, as calculated under the Credit Agreement is only $34mm, 24% less than what management reports as the Credit Agreement (BofA is the lender) limits the flurry of add-backs that managements reports to the street.  On this basis, leverage is 4.32x vs the current leverage covenant of 4.50x (which steps down to 4.25x next quarter).  AAC has an additional $34mm of operating leases (not in the $145mm above) that the SEC called the company out on for not including in their 10Q (it's unclear based on my current read of the Credit Agreement whether this is counted in the leverage ratio or not).

      Here's the Credit Agreement: 
      https://www.sec.gov/Archives/edgar/data/1606180/000156459015001496/aac-ex1027_20141231460.htm
      Here's the operating lease disclosure:
      https://www.sec.gov/Archives/edgar/data/1606180/000119312515417388/filename1.htm
      Also on the issue of leverage/liquidity, AAC disclosed that they didn't / couldn't repay a $1mm note due last quarter:
      https://www.sec.gov/Archives/edgar/data/1606180/000156459015010373/aac-ex108_166.htm

     


    SubjectChp. 11
    Entry02/24/2016 10:25 PM
    Memberthecafe

    Interesting idea. Not sure about the bankruptcy so soon though; I imagine revolver lenders would prefer an amendment to leverage covenant over a filing, which buys the equity some time.


    SubjectRe: Chp. 11
    Entry02/25/2016 09:46 AM
    Memberbm25

    While I would agree with you if there was a minor and temporary violation of a covenant, we estimate leverage will be nearly 10x by 4Q16 given the 50%+ decline in EBITDA this year (plus management said on the earnings call that they intend to draw their $25mm sub debt facility (12% interest rate) in Q1).


    Here's another, maybe more intuitive way, to think about what this business is worth.  AAC's tangible common equity is $23mm (and debt is $145mm).  With a structural impairment to the earnings power of this business, AAC's lenders will have no option but to restructure the business.

    As an aside, with a market cap of a little over $500mm, AAC is trading at 22x tangible book (for a facility-based business).  This management team are either the greatest value creators ever, or this stock is woefully overvalued even absent a BK.


    SubjectRe: fundamental earnings power?
    Entry02/25/2016 10:02 AM
    Memberbm25

    ndn - great questions.  Let me address them each:

     

    1. CRC's pre-deal EBITDA margins were indeed 25.6%.  We've spoken with former CRC execs and the reason is fourfold:
      a) a large portion of CRC's earnings come from running methadone clinics, which are highly profitable; we estimate the part of CRC's business that is a true comp to AAC had a mid-teens EBITDA margin pre-deal
      b) CRC's sponsor cut G&A to the bone ahead of the sale (which is not unusual when you're shopping a company) 
      c) CRC had much more scale (ie, 2.5x more beds at acquisition than AAC has)
      d) CRC's cost structure is inherently leaner than AAC's as most of its reimbursements are either govt or in-network private payors; AAC business model was predicated on entirely out-of-network private payor reimbursements and $1000 ASPs on drug tests.  Said differently, AAC's bloated cost structure was not built to handle the large cuts to reimbursements the industry is now facing.
    2. This is partially answered by 1(c) and 1(d) above.  Additionally, AAC has large corporate overhead (eg, they lease a $25mm jet from the CEO).  They're also seeing large deleveraging from the loss of this drug testing revenue - there are lots of fixed costs they incur to run their lab which will largely still be there even as reimbursement rates are cut.
    3. Correct.  I'd also add that we do suspect to see much more creative accounting throughout this year.  If you look back at the 3Q15 and 4Q15 earnings release, each quarter there was a new type of add-back in Adjusted EBITDA/EPS will optically helped soften the blow of declining drug test earnings.  We'll likely see some new add-backs starting in 1Q16.

    SubjectQuestion
    Entry02/25/2016 12:02 PM
    MemberHTC2012

    Great post - seems very interesting. A couple quick questions.

    1. 2Q seemed to be the high mark for lab and it has decelerated significantly from 38% of revenue in 2Q to 22% of revenue in 4Q. If you are right on the margin, shouldn't EBITDA in 4Q have completely collapsed? It doesn't seem to have done that....did other rates increase to offset this decline?

    2. I think you said that EBITDA margins in the lab busines is 90%+. Could it actually be lower because you need to allocatem fixed cost to this business....RJ analyst says 80m of fixed costs? I guess incremental margins are still v. high but I think the starting point of lab being ~100% of EBITDA might be high....thoughts?

    3. What are your thoughts on the opportunity to do testing for 3rd parties as they have hyped? 

     


    SubjectRe: Question
    Entry02/25/2016 12:26 PM
    Memberthecafe

    Just to add to HTC2012 question about margins...it looks like CRC Health has ~20% EBITDA margins and as you mentioned >95% of this is per diem. So then why would you expect AAC's per diem segment to have such materially worse margins? I assume CRC is a better operator and benefits from some operating leverage, but seems like a very large discrepancy.


    SubjectRe: Re: Question
    Entry02/25/2016 12:32 PM
    Memberthecafe

    Apologies - just seeing ndn already covered this.


    SubjectCredit where credit is due
    Entry02/25/2016 04:52 PM
    MemberElmSt14

    Welcome to the site BM.  We agree with your thesis that AAC has enormous red-flags.  We were short last year before the indictment because of many of the factors you mention.

    That being said, I think you need to give credit to the Seeking Alpha report that really put this short on the map last year.  You say that the report was "sloppy" but we thought it was extremely meticulous, original and well researched and it sent a $1 billion market cap company down 50%.  So, let's give credit where credit is due.  


    SubjectRe: Question
    Entry02/25/2016 08:03 PM
    Memberbm25

    HTC, to take your questions in reverse order, I think the 3rd party testing is overhyped.  Why use AAC when LabCorp and Quest have been doing this for years.  And aren't on trial for murder...nobody got fired for buying IBM, especially when IBM's competitor is on trial for murder.  Suffice it to say, our industry checks have found this claim by management laughable.

    As for the fixed costs of the lab, I have no idea where the RJ anlayst got 80m from...all lab revenue was only 60m last year.  There are clearly fixed costs in this business, but that goes to a prior response I posted as a partial explanation for why AAC's overhead is so high.   

     

    For your first question, see the table below.  Using a simple model assuming lab revenue is 90% margin, we can see that most of the margin changes we've seen since 2Q15 are from lab revenue declines and increasingly creative use of add-backs:

     

    Simple Model

            2Q15 3Q15 4Q15
    Lab, % of sales         38% 26% 22%
    bps chg qoq           (1,200) (400)
    Implied chg in ttl EBITDA margin w/ lab at 90% margin (a)   (1,080) (360)
                   
    Reported         2Q15 3Q15 4Q15
    Revenue         53.8 57.4 58.3
    Adjusted EBITDA       14.4 11.7 9.4
    % of sales         26.8% 20.3% 16.1%
    bps chg qoq (b)         (650) (423)
                   
    Unexplained chg in margin vs Simple Model, bps     430 (63)
    (b) - (a)              
                   
    Add-backs, ex stock comp       2.9 4.9 6.3
    % of sales         5.4% 8.5% 10.9%
    bps chg qoq  (c)         311 234
                   
    New unexp'd chg in margin vs Simple Model, bps     119 (297)
    (b) - (a) - (c)              

     

    So what's this mean?  In 3Q15, all but ~100bps of the margin change was explained by lab revenue decline/add-backs.  Why then were AAC's reported margins better than the simple model would imply?  There are a few potential explanations, but curiously, AAC's "Billed Days" (the number of days they bill insurers per avg patient stay) spiked from ~32 in Q2 to ~52 in Q3 (and vs 23 in FY14)...now did their patients suddenly need another 20-30 days of treatment to get better or was AAC trying to plug the hole in their earnings from lost lab revenue.... (search "billed days" in the Q to see: https://www.sec.gov/Archives/edgar/data/1606180/000156459015010373/aac-10q_20150930.htm)

    Now in 4Q15, AAC's reported margins were ~300bps worse than the simple model and add-backs would explain, why?  This was probably due to the incremental drag from having two new facilities that were operating well below capacity (River Oaks in FL and Sunrise in NJ).


    SubjectRe: Credit where credit is due
    Entry02/25/2016 08:08 PM
    Memberbm25

    Elm, that's fair.  In an attempt to engage readers of the SA piece who thought they may have come across something repetitive here, I made a poor choice of words.  


    SubjectRe: 1st qtr 2016
    Entry02/26/2016 04:43 PM
    Memberbm25

    lpartners, I just about spit my coffee out when the company said that on the call.  So, no, I don't think it is possible.  

     

    I would refer you to the three links in the write-up that show the latest medical policy updates from BCBS TX, Anthem (BC CA and BCBS CO) and United, all recently coming into effect.  The impact of these will be hitting AAC in Q1.  Of course, look out for new-fangled add-backs.  Per my reply in #10 below, add-backs to EBITDA (in both $ and % of sales) have increased every quarter since the company went public.


    SubjectRe: A few questions
    Entry02/28/2016 06:43 PM
    Membertml2106

     

     

     


    SubjectRe: Re: Earnings Quality, Leverage Covenant
    Entry02/28/2016 06:45 PM
    Membertml2106

    Cries, I'm new to lab space but saw that article on Millennium last year.  Do you know how levered they were when they filed?


    SubjectInsider Selling
    Entry03/08/2016 09:17 AM
    Memberbm25

    Total coincidence, undoubtedly:

     

    http://ir.americanaddictioncenters.org/file.aspx?IID=4544120&FID=33277557

     

    AAC Holdings, Inc. Executives Enter into Prearranged Stock Trading Plans
    Company Release - 03/08/2016 06:30

    BRENTWOOD, Tenn.--(BUSINESS WIRE)-- AAC Holdings, Inc. (NYSE: AAC) announced that pursuant to guidelines specified by Rule 10b5-1 under the Securities Exchange Act of 1934 and AAC’s policies with respect to insider sales, Michael Cartwright, the Company’s Chairman and Chief Executive Officer, Kirk Manz, the Company’s Chief Financial Officer, and Jerrod Menz, the Company’s former President, have adopted prearranged stock trading plans as part of their individual long-term strategies for asset diversification and tax planning.

    Rule 10b5-1 permits corporate officers, directors and other insiders of public companies to adopt written, prearranged stock trading plans for selling specified amounts of stock. The plans may be adopted only when the individual is not in possession of material, non-public information and may be used to gradually diversify investment portfolios and to minimize the market effect of stock sales by spreading them out over an extended period of time.

    Under the 10b5-1 plans, Mr. Cartwright may sell up to 550,000 shares, Mr. Manz may sell up to 54,250 shares, and Mr. Menz may sell up to 470,000 shares, all of which are subject to certain predetermined minimum price conditions, over a period of one year. The total shares to be sold represent less than 10% of the outstanding holdings for each of the respective sellers. The transactions under these plans will commence no earlier than March 14, 2016 and will be disclosed publicly through required Form 144 and Form 4 filings with the Securities and Exchange Commission.

    Prior to any stock sales under the plan, Mr. Cartwright and related family trusts collectively own 5,726,666 shares of AAC’s stock, Mr. Manz and related family trusts own 563,638 shares, and Mr. Menz and related family trusts collectively own 4,922,821 shares. Assuming the complete sale of stock under these plans, Mr. Cartwright, Mr. Manz and Mr. Menz will collectively own approximately 44% of AAC Holdings’ outstanding stock, as compared with 49% currently.


    SubjectRe: A few questions
    Entry03/09/2016 01:00 PM
    Memberbm25

    Handley, apologies on the slow response.  The 10K came out today so I can give you the most recent answers here.

     

    1. Their revenue is almost entirely out of network; they have zero Medicare/Medicaid exposure; 10% of their revenue is self-pay/out-of-pocket and the other 90% is commercial pay (again, which is almost all out of network)
    2. Here's there revenue recognition language:
      We recognize revenues from commercial payors at the time services are provided based on our estimate of the amount that payors will pay us for the services performed. We estimate the net realizable value of revenues by adjusting gross client charges using our expected realization and applying this discount to gross client charges. Our expected realization is determined by management after taking into account the type of services provided and the historical collections received from the commercial payors, on a per facility basis, compared to the gross client charges billed.    

      Basically what this means is AAC books revenue based on a) whatever it decides to bill the client (which it has wide discretion over since they're mostly out of network) less b) whatever discount it decides it needs to apply to (a).

      This is important b/c AAC disclsoed that 31% of its Accounts Receivable are greater than 180 days delinquent  (up from 24% y/y).  On an A/R balance of $61mm at 4Q15, that's $18mm of revenue booked but will almost certainly not be collected.  Given the lattitude mgt has in booking revenues, that's arguably $18mm of inflated revenue booked...and that's also $18mm of earnings booked (said differently, if/when AAC has to write-off that $18mm, Shareholder Equity will go down $18mm to make both sides of the Balance Sheet balance).  

      Furthermore, note what AAC says about its A/R:
      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.

      Now, color me cynical, but if an insurance company sends a check to a drug/alcohol addict (recovering, hopefully), how likely do you think it is that said addict will give send that money to AAC (particularly if he hasn't done so after 180 days).

    SubjectRe: Few Questions
    Entry04/20/2016 09:58 PM
    Memberbm25

    Humkae, sorry for the delayed response here.  To answer your questions:

     1.     As mentioned, we've heard varying views from payors as to the timing, with one suggesting as much as a 90% cut this year alone.  Our estimate is for a 50% cut this year, but view the ultimate decline as probably being close to that 90% figure.  Keep in mind, last year's $295/day of Drug Testing Revenue equates $8,900 of reimbursements for drug tests over a typical 30 day stay...could this be cut by 90% to $900?  We think so.  Especially given that these tests cost < $25 to administer, and are not even separately reimbursed for in-network providers (ie, maybe we get to a point where drug test reimbursements for out-of-network providers are cut by 100%).

    a.     We're confident that the cuts will be worse than the 20-45% you cite...just doing math, if one holds constant the 4Q15 ADR from Drug tests, you'd have a ~35% decline for FY16.  However, as cited in the write-up, changes to reimbursement guidelines for three of AAC's biggest payors weren't effective until 11/1/15 and beyond, meaning AAC's Q4 reported results wouldn't have had any impact from this (given the lag between payor changes and when a provider like AAC would change its revenue booking).  Additionally, the thesis on AAC is predicated on drug testing reimbursement cuts, but w/o this dynamic, leverage is a problem for them.  Beginning this quarter, 2Q16, their leverage ratio convenant stepped down to 4.25x.  They ended 4Q15 at 3.28x leverage (not counting the $31mm of operating leases they have).  Since 4Q15, they've (likely) continued to burn cash (FCF was negative $45mm last year or ~$11mm/qtr); they spent $13.5mm in cash on an EBITDA b/e business last week (which they had to use 12% sub debt to fund); they announced yday they spent another $5mm buying an Econo Lodge motel to turn into a "sober living facility";  and they have another $7mm of cash to be spent on acquisition closing this quarter.  So just taking that $11m x 2 qtrs + $13mm + $5mm + $7mm of cash spent on acquisitions, would put leverage at 4.34x based on FY15 "Adjusted" EBITDA, per management.  For all of the reasons discussed - not only the reimbursement thesis but also how management's "Adjusted" EBITDA massivley overstates EBITDA per AAC's credit agreement - EBITDA this year should be down meaningfully vs FY15's "Adjusted" EBITDA.

    2.     It’s hard to talk specifically to your numbers without seeing them, but I will tell you we're above street on revenues for this year (at nearly $290mm; sell-side consistently under-models revenue) and given margin compression we have EBITDA of $19mm.  We're not modeling DSO's to blow out, but it certainly wouldn't surprise me in the least, particularly with the latest updates to the payor medical reimbursement guidelines.  The key point on the BK is that the combination of:

    a.     the cut in EBITDA,

    b.     the massive disparity between management’s “Adjusted EBITDA” and our calculation of EBITDA under the credit agreement (see my first message below), and

    c.     the increasing drains on cash (per above)

    Should result in a huge spike in leverage later this year, leading to a default.  And with < $20mm of tangible equity, I don’t see anything left for shareholders in a bankruptcy.

     

    Finally, in the interest of consolidating messages, I came across this Glassdoor review...obviously these sorts of datapoints need to be taken with a grain of salt, but the point about relations with insurers fits with what we've heard throughout our diligence: 

    https://www.glassdoor.com/Reviews/Employee-Review-American-Addiction-Centers-RVW10039094.htm

     

     

     


    SubjectQ1 initial thoughts
    Entry05/05/2016 07:19 PM
    Memberbm25

    I'm surprised, even in a heavily shorted name like this, how much the market seemed to misread today's results.  While headline EPS of 20C seemed to beat consensus of 17C (and revenue, as always, beat the chronically under-modeled sell-side estimate), this 20C is not a real number. 

     

    The 20C that management reports as its "Adjusted" EPS, was a) once again full of add-backs and b) not adjusted for a one-off tax benefit.  Adjusting the Adjusted EPS, I arrive at a "real" adjusted EPS of 8C:

     

        Management     Add-backs Real  
        "Adjusted" Tax [1]   Above Adjusted  
        Earnings Adj Pro Forma RayJay [2] Earnings GAAP
    EBT   3,758   3,758 (2,205) 1,553 (289)
    Income tax   (260) (1,168) (1,428) 838 (590) 20
    % IT rate   7%   38% 38% 38% 7%
    Net income   3,498   2,330 (1,367) 963 (269)
    Non-controlling interest 855   855 -- 855 855
    Net income to common 4,353   3,185 (1,367) 1,818 586
                   
    EPS   $0.20   $0.14 ($0.06) $0.08 $0.03

     

    [1] Using normalized 38% tax rate    
    [2] Add-Backs      
        RayJay Reported Delta
    Stock-based comp 1,980 2,638 658
    Restructuring -- -- --
    Litigation   1,500 2,325 825
    Acq & Startup Exps  1,000 1,722 722
    Total   4,480 6,685 2,205

     (I'm using Raymond James numbers here because their 16C estimate for Q1 was the closest to consensus of 17C.)

     


    SubjectRe: Q1 initial thoughts
    Entry05/05/2016 07:57 PM
    Memberthrive25

    Are you sticking with the thesis, intact? 


    SubjectRe: Q1 initial thoughts
    Entry05/18/2016 05:34 PM
    Memberahnuld

    thoughts on decline in urine revs being 27%, you think still more downside? They discuss adding extra services to their labs but I doubt 3rd party is as profitable as in house driven volume.

     

    Their AR is wild. about 1/3rd is over 180 days due. Overall AR up more than revs y-o-y. also surprised stock hasnt dropped


    Subjectterrible Q3
    Entry11/03/2016 09:47 AM
    Memberahnuld

    mazel tov, great short. Curious how they explain away the massive decline in revs per day/bed on the call. I always assumed the debt would at least be good, now it looks tight on that. ANy idea when they start tripping up covenants?

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