For Your Consideration: The following report will be issued on a quarterly basis and seeks to provide a comprehensive breakdown and assessment of publicly traded corporations with exposure to the behavioral health industry. Moreover, expect the insights provided herein to evolve on a quarterly basis as more data is available both intra-corporation and across the industry and future reports should address additional macro-industry insights and benchmarks amalgamated from other corporation’s reports.
Few corporations in the behavioral health industry have garnered the attention that American Addiction Center has. Featured in the New York Times ‘The Daily’ podcast and having recently settled a high-profile lawsuit levied against the corporation by shareholders, American Addiction Center is in the unenviable position of being one of the only publicly traded behavioral health providers– exposing it to levels of disclosures of information otherwise privately held. Moreover, as facility operators such as AAC scale, effective management becomes increasingly difficult. Inasmuch as these disclosures might present managerial challenges to AAC’s executives, it provides prescient data that reflect the health of its business and, in a market dominated by privately held corporations, useful information for insights into the behavioral health space at large.
As a blog dedicated to the economics and investment opportunities present in the behavioral health industry, MyMedinomics will regularly feature American Addiction Center as both an investment opportunity and a tool to extrapolate critical data for other similar but privately held providers. This post, at its core, will assess AAC’s third quarter (Q3) 2017 earnings results, provide a cursory review of the self-reported metrics AAC has provided, offer more in-depth assessments tools, and catalogue points of concern, optimism or unaddressed lingering questions. Moreover, as the blog proceeds it will begin to create industry-specific benchmarks and indices by which AAC’s future quarterly reports can be measured.
American Addiction Center Holdings Company profile:
The American Addiction Center Holdings Inc. (NYSE: AAC) provides services specific to the addiction treatment segment of the healthcare industry. Their services range from detoxification, to residential and outpatient care for substance abuse recovery, in addition to diagnostic laboratory services and non-client related marketing offerings for third party facilities.
With 1,139 residential beds, 636 detoxification beds spread across 12 facilities, American Addiction Center derives a majority of its revenues from short-term residential treatment. Moreover, with 18 outpatient facilities, AAC also drives secondary revenues from downstream programs aimed at supplementing their clients’ care following discharge from their residential facilities. Moreover, tertiary revenues are derived from diagnostic-laboratory services and marketing fees from outside providers; however, these revenues are subject to substantial fluctuations from quarter to quarter and do not represent a core source of AAC’s operations.
American Addiction Center is currently planning several expansion projects, which it hopes will better equip it to compete in new markets such as New England and Rhode Island, with the recent acquisition of AdCare for $85 million.
As of market close on the final day of Q3 2017, AAC was trading at $9.95 per share with roughly 24 million shares outstanding– giving it a market capitalization of roughly $222.4 million dollars. 2017 third quarter earnings posted by AAC, reflect earnings of $0.03 per diluted share fueled by a growth in revenues, despite lower client volume. In an effort to increase operating efficiencies and maximize profits, AAC was able to yield greater daily reimbursement rates for its residential and outpatient services. Ultimately, the longevity and continued growth of AAC will be derived primarily from a growth in client volume. By definition in the behavioral health industry, business success stems from delivering quality care efficiently and the capacity to scale client volume without reducing operational efficiencies and quality standards. In reality, it is highly unlikely that AAC will be able to replicate its growth in average daily reimburse-ables and, more likely, will continue seeing considerable volatility as it works with insurance providers desperate to reduce costs. With their pending projects and underlying plans to expand services, AAC is well-positioned to grow its market– adding new residential beds and outpatient programs– in markets largely underserved and in need of additional chemical dependency resources.
The Provided Metrics:
- Total revenue increased 14% to $80.4 million
- Average daily residential revenue (ADR) increased 48% to $925 and average revenue per outpatient visit (ARV) increased 33% to $437
- Total average daily census increased to 974 compared with 967
- Outpatient visits increased 21% to 18,491
- Net income available to AAC Holdings, Inc. common stockholders was $0.8 million, or $0.03 per diluted common share, compared with a net loss available to AAC Holdings, Inc. common stockholders of $2.5
- Adjusted EBITDA increased 24% to $14.9 million (see non-GAAP reconciliation herein)
The initial metrics presented in AACs’ earnings (presented above) reflect positive trendlines in their ability to maximize revenues and efforts to unlock efficiencies in their billing department. Moreover, for an industry in which the level of client acuity is vertically-oriented– with an emphasis by insurance providers of stepping clients down to a lower level of care– the underlying growth in outpatient programming with a stabilized residential census reflects an increased effort to find synergies between their programs. These metrics, on the surface, bode well for a corporation well-positioned to reap the rewards of positive secular trends amidst a well-chronicled national prescription drug and opioid epidemic.
Assessing Performance Metrics:
AAC reports 17 Key Performance Metrics (KPIs) by which to monitor the health of its facilities and programs across the nation. These metrics point to two critical measures of success: client volume and the average revenues derived from each of their services. On the whole, the most positive of these metrics point entirely to increased rates of reimbursements. Residential and outpatient revenue rates are up substantially relative to 3rd quarter of 2016. Worth further consideration and not mentioned in the earning report are the factors responsible for driving this uptick. As a provider that derives its revenue from private insurance, the increased rates may be explained as the product of cost sharing split between two payors: insurance providers and clients (i.e. deductibles, co-insurance, co-payments and cash-pay). Without this data, it is difficult to formulate an explanation. Perhaps AAC has cleaned-up its collections to the point at which clients responsibility per their insurance plan are being better enforced or AAC has increased its bargaining power with insurers that is better reflected in their rates for services. Other positive factors include a slight uptick in average length of episode for clients (an imperfect proxy for clinical outcomes) and a substantial increase in outpatient visits from 15,299 to 18,491 (20.8%).
Outside of the revenues, several of the operating metrics provided by AAC leave considerable room for improvement. Year over year admissions are down by 6%, while residential bed count is down by nearly 15%. With a decline in overall bed availability, one would rightfully expect a consistent, if not improved, rate in bed utilization. However, bed utilization is down from 82% to 75% year over year. Moreover, this decline is not accounted for or explained in the quarterly statement and could be indicative a series of causal factors such as decline in resources dedicated to marketing, increased competition in certain regional markets, and/or recent issues related to public relations and negative media attention.
To best assess the health of AAC as a business and potential investment, a more comprehensive set of data and standards by which to measure AAC need to be delineated. Provided below are 30 data points created from the initial information available in AAC’s Q3 report. Over time, this data set will reflect quarterly changes in AAC’s reporting; they will also be applied to other industry providers to create a performance benchmark, which will create an industry standard by which operators can be measured against. In some instances, information may be lacking– corresponding data points will be left blank. A cursory explanation of each data point will be addressed below, as will the methodology of each, where necessary.
A: Market Cap (Diluted Shares): Market capitalization reflects the market value of a company and is calculated by multiplying the share price by the amount of outstanding shares. As of the end of Q3 2017, AAC’s market capitalization was an approximate $233.5 million– or $9.95 per share. This number reflects a particularly rough year for AAC shares, with its market capitalization shrinking year over year from nearly $400 million– shares trading at 17.39– at the close of Q3 2016.
B: Total Approximated Bed Count: The total approximated bed count is an estimation of the combined beds or daily treatment units for both residential and outpatient (sober living inclusive). It is calculated by adding the ‘Effective Residential Bed Count’ with the ‘daily outpatient units’ (Total outpatient units divided by days in the quarter) provided at facilities across AAC’s treatment platform. This metric serves as a proxy for capacity and– in conjunction with industry wide reimbursement rates– will help determine if AAC is sufficiently unlocking the value of its treatment platforms. Reflected above is a year over year growth in bed count, despite the fact that residential beds shrunk in Q3 17’ relative to Q3 16’. Importantly, AAC has substantially grown its outpatient capabilities.
C: Value Per Residential Bed: If one was to think of AAC’s treatment as a range of services provided on a basis of acuity, residential beds would serve as the ultimate source of income and future outpatient revenues when a client graduates from residential programming. As such, the value on a per bed basis creates a useful tool for assessing the performance of competitors and application of valuation for privately held companies. As of market close September 30, 2017, a residential bed at one of AAC’s facilities had an average market valuation of $196,000– down substantially year over year. This metric is calculated by finding the ratio of residential revenue to total revenue multiplied by the market capitalization and further divided by the number of outstanding residential beds. This metric, while useful, is short-sighted on several basis: it does not account for nuances in residential versus detoxification bed and it only reflects the share of residential revenue to revenue on a quarterly basis. Perhaps, in future reports, this blog can feature a weighted value per bed– less tied to fluctuation in share price.
D: Provisions for Bad Debt: Revenue: Bad Debts are over 12% of the size of revenues for Q3 17’.
The last non-self-explanatory metric provided above is the last of the row and warrants some additional explanation. Direct healthcare providers have a distinct disadvantage in their mechanisms and procedures by which they receive payment for services. As providers, their source of revenue is often bifurcated between insurance companies and directly from clients. However, each source presents unique challenges. First and foremost, insurance companies often have substantial leverage in negotiating with providers and can erect substantial barriers for providers. Requirements to obtain authorizations before services, requests for additional documentation and medical records once claims are submitted and a cumbersome appeals process are some of the many mechanisms that insurance providers use to exert influence and leverage over medical providers. Moreover, clients often share some semblance of financial responsibility per their insurance plan (co-insurance, deductibles and such) but determining these costs prior to treatment are cumbersome– especially for out-of-network providers. As such, medical facilities often operate with the expectation that clients will fulfill their financial responsibility once services have been rendered, which shifts financial risks significantly onto the providers abilities to recoup payments, often to their own detriment. In assessing the share of quarterly bad debt to revenue, a few important financial calculations can be accounted for: the true value of revenue after discounting the ratio of bad debt provisions, the true value of accounts receivable given discounting in the assets provisions, and the efficacy of the collection and billing department of AAC as a whole.
E: Accounts Receivable: Total Asset Ratio: As of Q3 2017, Accounts Receivable accounted for 22% of assets held by AAC.
Generally speaking, Accounts Receivable is especially pertinent to the healthcare industry. The expectations of payment for services provided or goods rendered is far less precarious in other industries than healthcare, where consumers are individual patients or insurance companies– who either possess insufficient resources to cover services or, in the case of insurance companies, possess substantial barriers and specialized requirements before payment can be rendered with post-facto clauses and reasons for denial. All in all, a dollar of accounts receivable for a healthcare provider is often worth less in the behavioral health industry than generally accepted in most other businesses. That being said, a watchful eye towards accounts receivable as a share of assets is vital in gauging the fiscal health of a company and potential pitfalls in its books.
F: Accounts Receivable: Quarterly Revenue: As of market close in Q3 17’, accumulated accounts receivable constitute 115% of revenue for the quarter. Again, as explained above, accounts receivable, especially for healthcare, can present challenges. Moreover, without transparency in AR recording– bad debts can be hidden in AR and/or AR accounts aging can be skewed towards monies more likely to not be collected in full. Ultimately, a growth in this ratio is indicative of a growing inability to monetize services and can warp the impression of available assets.
G: Standard Deviation of Average Length of Stay: There is insufficient data to record this measure.
While lengthening the average length of stay (ALOS) may represent efforts to best meet clients needs and maximize value in the process of delivering quality care, the core ability to meet clients needs and account for their experiences escapes the crude ALOS measure. Instead, providing a standard deviation among all clients average length of stay better indicates how universally and, ultimately, serves as a better proxy for quality of care and measure of client experience.
H: Diversity of Revenue Stream: Q3 2017, AAC has a 10.7 measure of revenue diversity (the lower the better). This measure is determined by averaging the top 3 sources of AAC’s revenue sources– i.e. insurance companies. This metric helps in determining the level of exposure AAC carries to certain insurance providers (or in the case of other providers: government programs etc.). Not all revenue is created equal. Over-reliance on particular insurance companies can pose risks to AAC, as bargaining power is shifting away from AAC to their payors.
I: Marketing to Revenue: In Q3 2017, revenue constituted 3.8% of revenue; in Q3 of 2017, this measure was 6.6%. With a national presence and the need to differentiate itself in the industry, marketing and advertising represents a key sunk cost through which AAC can capture market share and ensure that it generates sufficient client volume. In a highly fractured market place, with no particular provider with more than 5 percent of the market share, effective marketing is paramount to AAC’s success. Per industry standards, a corporation expecting growth should allocate between 7-12% of revenue towards marketing and advertising– of which AAC is falling short. Ultimately, the share of marketing and advertising as a cost relative to revenue is an early indicator of client volume and can reflect potential troubles in competing in the market.
J: Book Value/Shareholders Equity: As of Q3 17’, AAC’s book value is $156,359,000. Book value is an accounting measure of a company’s value through the calculation of assets less liabilities– an overly simplified explanation.
K: Book Value per Adjusted AR: With a more realistic, albeit imperfect, calculation of accounts receivable value, book value is subject to change as well. Due to the fact that ‘accounts receivable’ is one of the leading factors in calculating AAC’s assets, book value decreases by 11,141,000 when a more realistic approach to AR is determined.
L: Market Value to Book Value: As of Q3 17’, AAC had a market to book value ratio of 1.49.
One of central metrics that investors seek when determining if an equity is undervalued is the ratio of market value to book value. This ratio represents the multiple by which investors and fair market prices the equity relative to the strict book value. Firms with lower Market to Book ratios often reflect greater value to investors.
M: Price to Earnings Ratio: Due to the fact that AAC has yielded negative earnings in the previous 12 months, a PE ratio can not be determined.
On its surface, American Addiction Center is a business well-positioned to reap the benefits of a booming nation-wide demand for quality substance abuse treatment. It’s recent settlement of a lawsuit levied against it by shareholders and transition to new, key executive staff, suggest that AAC is committed to addressing its core weaknesses. Its current acquisition and expansion plans, although costly, will help AAC build a national brand and reach local markets badly in need of substance abuse treatment facilities.
Moreover, by conventional standards, AAC trades cheaply. With a current share price of $9.07 (1/22/18), AAC trades just above its book value; it also trades substantially off of its 52-week trading high of $13.06. Prospective value investors should consider AAC, provided it can address several concerns listed below.
- In a highly competitive space, AAC needs to better differentiate itself as a leader in quality care and clinically sound outcomes. Something that requires an intensive marketing campaign and strong regional outreach, which AAC has seemingly cut back on; Not to mention the unsavory publicity AAC has received as of late in the press. Moving forward, AAC needs to allay investors concerns by emphasizing new campaigns to improve community relations and sufficiently market their programs to compete in a wide-open marketplace.
- Accounts Receivables: The prospect of investing in a highly undervalued company in a growing space is certainly appealing. Nevertheless, without greater financial reporting on accounts receivable including Aging Reports, the distribution of payors and an accurate valuation of per fair market value of accounts receivable too much of AAC’s conditions remain uncertain.
- Ultimately, the success of any facility– especially those utilizing private insurance– rests on its ability to deliver quality outcomes and, in the case of AAC, an above-average rate of recovery. AAC needs to prioritize metrics that suggest a quality experience in its programs, which will ultimately serve as the engine of long-term and sustainable growth.
- What to look for in the near future from AAC: a) higher occupancy rates across its residential facilities, b) consistency in ‘Average Daily Revenue’ at both Residential and Outpatient levels of care c) marketing investment rate above 6% of revenues, d) a shrinking ratio of bad debt provisions to Revenue e) stabilization of revenues from diagnostic services and/or an average diagnostic revenue on a per client basis.
- Although AAC has experienced growing revenues, it also saw its expenditures related to services increase– albeit at a lesser rate. Nonetheless, AAC needs to propose a measure to ensure that growing costs are addressed and adequately accounted for. After all, year over year, AAC operated fewer residential beds– the most costly of its services– and still saw its expenditures rise.