4. Summary of Significant Accounting Policies

Use of Estimates

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

General and Administrative Costs

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

Client Related Revenues

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

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

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

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

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

Other Revenue

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

Allowance for Contractual and Other Discounts

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

Accounts Receivable and Allowance for Doubtful Accounts

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

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

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

Balance at December 31, 2012	$	4,278
Additions charged to provision for doubtful accounts		10,950
Accounts written off, net of recoveries		(1,908	)
Balance at December 31, 2013	$	13,320
Additions charged to provision for doubtful accounts		11,391
Accounts written off, net of recoveries		(16,243	)
Balance at December 31, 2014	$	8,468
Additions charged to provision for doubtful accounts		18,113
Accounts written off, net of recoveries		(9,704	)
Balance at December 31, 2015	$	16,877

Cash and Cash Equivalents

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

Property and Equipment

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

		Range of Lives
Computer software and equipment		3 years
Buildings		36 years
Furniture, fixtures and equipment		5 years
Vehicles		5 years
Equipment under capital lease		3-5 years
Leasehold improvements		Life of the asset or lease,
		whichever is less

Goodwill and Intangible Assets

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

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

Long-Lived Asset Impairment

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

Accrued Liabilities

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

	Year Ended December 31,
	2014		2015
Accrued payroll liabilities	$	6,536	$	10,090
Accrued litigation settlement		158		800
Accrued legal fees		317		479
Income taxes payable		—		2,527
Accrued property, plant, and equipment		—		1,487
Other		3,400		6,270
Total accrued liabilities	$	10,411	$	21,653

Segments

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

Advertising Expenses

Advertising costs are expensed as the related activity occurs.

Stock-Based Compensation

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

Earnings Per Share

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

Income Taxes

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

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

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

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

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

Fair Value Measurements

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

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

Comprehensive Income

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

Recent Pronouncements

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

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

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

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

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