AAC Holdings' (AAC) CEO Michael Cartwright on Q4 2015 Results - Earnings Call Transcript

| About: AAC Holdings, (AAC)

AAC Holdings, Inc. (NASDAQ:AAC)

Q4 2015 Earnings Conference Call

February 23, 2016 11:00 AM ET

Executives

Andrew McWilliams - Chief Accounting Officer

Michael Cartwright - Chairman and Chief Executive Officer

Kirk Manz - Chief Financial Officer

Analysts

Ryan Daniels - William Blair

John Ransom - Raymond James

Ann Hynes - Mizuho Securities

Paula Torch - Avondale Partners

Toby Wann - Obsidian Research Group

Operator

Good day and welcome to the AAC Holdings’ Fourth Quarter Earnings Call and Webcast. All participants will be in listen-only mode. [Operator Instructions]. After today’s presentation, there will be an opportunity to ask questions. [Operator Instructions]. Please note this event is being recorded.

I would now like to turn the conference over to Mr. Andrew McWilliams, the Chief Accounting Officer. Please go ahead.

Andrew McWilliams

Good morning. I’m Andrew McWilliams, Chief Accounting Officer of AAC Holdings and I’d like to welcome you to our fourth quarter 2015 conference call.

To the extent any non-GAAP financial measure is discussed in today’s call, you will find a reconciliation of that measure to the most directly comparable financial measure calculated according to GAAP on our website by following the Investor Relations link to Press Releases in viewing this mornings’ news release.

This conference call may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995, including statements, among others, regarding AAC’s expected quarterly and annual financial performance. For this purpose, any statements made during this call that are not statements of historical facts may be deemed to be forward-looking statements. Without limiting the foregoing, the words believes, anticipates, plans, expects and similar expressions are intended to identify forward-looking statements.

You are hereby cautioned that these statements may be affected by the important factors, among others set forth in AAC’s filings with the Securities and Exchange Commission and in the company’s fourth quarter earnings release. And consequently, actual operations and results may differ materially from the results discussed in the forward-looking statements. The company undertakes no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

At this time for opening remarks, I will now turn the conference over to our Chairman and Chief Executive Officer, Michael Cartwright.

Michael Cartwright

Good morning. In addition to Andrew, I’m here today with our Chief Financial Officer, Kirk Manz and other members of our executive management team. Kirk and I each have some remarks about the fourth quarter and our 2016 outlook. After that, we will open the line for your questions.

I’d like to begin with a quick update on our longitudinal outcome study. All legacy treatment centers, which are, those operating before the IPO, are now participating in the outcome study. We are now tracking approximately 800 participants and we expect to track over 4,000 participants by the end of 2016.

Some demographic data to report: two thirds of the respondents are male, 36% list heroin or opioid as their primary substance compared to 40% for alcohol and the average age is 35. We evaluate clients at intake, discharge, two-months, six-months and 12-months following discharge.

In respect to the outcomes, we’re seeing promising data from the two-months, post discharge data that demonstrate improvement across all seven dimensions measured, which include positive changes related to medical and psychiatric problems, alcohol and drug use, legal concerns, family functioning and employment.

Now to Q4 performance. Operating metrics continued the accelerated pace we set early in the second half of the year. Our business development team and call center had another record-breaking quarter. Residential client admissions totaled 2,462 in the fourth quarter, a 93% increase from a year ago and up 24% compared with the third quarter. Average daily residential census was 670 in the fourth quarter, up 60% from a year ago and up 20% from the third quarter.

Total residential bed capacity at the end of the fourth quarter was 897, up 82% from the prior year and up 35% from the third quarter. The sequential increase in capacity was related to the acquisition of 110 beds at Sunrise and the opening of 162 beds at River Oaks, offset by the closing of FitRx and The Academy on December 31.

Effective bed capacity based on our planned staffing levels was 785 at the end of the fourth quarter. Effective bed utilization which is our census divided by our effective beds was 84% for the fourth quarter down from 85% in the prior year period and down from 89% in the third quarter, mainly due to the additions of Sunrise and River Oaks. Effective utilization at our legacy treatment centers was 89%. As a reminder, we’ve historically said that we consider 85% to be fully utilized.

Average daily residential revenue was $840 for the fourth quarter, down from $966 a year ago and down from $973 in the third quarter. 51% of the year-over-year decrease in average daily residential revenue was driven by lower revenue for drug testing that we had been anticipating. And 49% of the decrease was the result of lower ADR from acquired facilities primarily Sunrise and Oxford.

Our River Oaks facility in Tampa, opened on October 16, 2015, and we’ve increased staffing levels a couple of times since then to accommodate up to 110 beds. Today River Oaks is serving over 100 clients in just four months after opening. We currently anticipate River Oaks to achieve positive cash flow by Q2 which would be ahead of schedule.

Our chemical dependency rehabilitation hospital near Laguna Beach, California is nearing completion. We currently anticipate opening this facility in the second quarter of 2016. We are anticipating 93 beds at this stage pending final licensure which is a pick-up of non-additional beds from what we were originally planning.

Turning to the rest of our de novo and organic growth pipeline, let me update you on our other projects. We currently anticipate the 22 detox beds at our Recovery First location to come online in the fourth quarter of 2016. The 44 additional residential beds and 48 sober living beds at the Oxford Center are going to take a little longer than previously thought due to the necessity of upgrading the general infrastructure at the Main Oxford campus. We now anticipate these beds coming online in the first half of 2017.

As we discussed last quarter, Ringwood remains on hold for the time being as we allocate available capital to other projects.

Our expansion into the outpatient business has been a resounding success. In 2014, we did not have a material outpatient presence. In 2015, we had 12,879 outpatient visits and generated over $12.5 million in facility and lab related revenue from these visits.

In 2016, we expect to grow our outpatient business even more through enhanced sober living arrangements in Las Vegas, provided by the Solutions Recovery Acquisition, the additional outpatient centers from the Sunrise, Oxford Solutions and Townsend Acquisitions and through additional housing in Arlington that we hope to have finalized in the next few months.

We believe 2016 will be a transitional year for our lab business as we expect to address the lower toxicology reimbursements we have been projecting for some time, with generated from new services and providing lab services to third parties.

For instance, we currently anticipate offering hematology and pharmacogenetics in Q2 of this year. In addition, we are currently providing services to third party providers, though we did not expect the third party lab revenue would be significant until late in the year.

We have also initiated development of a 10,000-square foot In-Network laboratory outside of New Orleans that should be completed in the third quarter of this year. This laboratory is significantly larger than Townsend’s existing lab and will mirror our Brentwood lab in terms of state-of-the-art equipment and diagnostic capabilities.

We continue to execute on our M&A strategy to finish out 2015. In Q4, we announced agreements to acquire Solutions Recovery and In-Network provider in Las Vegas, with 70 residential beds and over 100 sober living beds as well as Townsend and In-Network provider in Louisiana with seven outpatient centers, 32 residential beds and an In-Network laboratory. Both of these are currently expected to close in the second quarter of this year.

Before I hand the call over to Kirk, I’d like to recap what we were able to accomplish in 2015. Our first full year as a public company, considering what we’ve been dealing with in the State of California, we’ve increased bed capacity by 82% from 2014. We increased admissions by 64% from 2014. We improved average daily residential census by 43%. We diversified our payer mix, In-Network beds as of 12/31/15 and now 19% of our capacity up from zero percent.

We diversified geographically by adding operations in Rhode Island, Mississippi, in New Jersey, and soon Louisiana. We divested unprofitable units and closed FitRx and The Academy. We added outpatient capabilities to the opening of Las Vegas and Arlington outpatient centers in the acquisition of seven additional outpatient centers.

We completed four provider acquisitions including Recovery First, CSRI, Oxford Center and Sunrise House, and announced the acquisitions of Solutions Recovery and Townsend. We completed the Acquisition of Recovery Brands which has reduced our customer acquisition cost and helped establish us as a leading internet marker in the addiction space.

We significantly expanded our lab capabilities. We completed the relocation of our corporate offices, which enables us to significantly expand our call center and billing capabilities in 2016. And did I say we doubled our adjusted EBITDA. We did all the above in our first full year as a public company, in spite of the overhang from the California matter. 2015 was a year of exceptional growth for our company. And we are just as excited about 2016.

With that said, let me turn the call over to Kirk Manz to talk more about our financial highlights.

Kirk Manz

Thanks Michael. Our revenue for the fourth quarter of 2015 was $58.3 million, a 57% increase from the fourth quarter of 2014 and up 2% from the third quarter of 2015. The increase in revenue was primarily the result of increased census and greater outpatient visits as well as contributions from recovery brands. Total revenue for 2015 was $212 million, a 60% increase from 2014.

Adjusted EBITDA for the fourth quarter was $9.4 million or 16% of revenue compared to $6.6 million or 18% of revenue in the prior year and $11.7 million or 20% of revenue for the third quarter of 2015. The sequential quarter decrease in our adjusted EBITDA margin, which was anticipated in our full-year 2015 guidance, was primarily due to lower revenue from drug testing.

Ancillary client related revenue, which includes drug testing, lab revenue and professional services, was 22% of total client related revenue for the fourth quarter compared with 26% in the third quarter of 2015. We reiterate our expectation of lower testing and lab reimbursements and expect that ancillary services will decrease to the mid-to-high teens as a percentage of our client related revenue by year-end. Adjusted EBITDA for 2015 was $44.3 million, 110% increase from 2014.

We achieved adjusted EPS of $0.17 in the fourth quarter compared with $0.20 in the prior year and $0.27 in the third quarter of 2015. On a per diluted share basis, net income available to common stockholders was $0.02 for the fourth quarter of 2015 compared with $0.15 in the prior year period and $0.11 in the third quarter. The current period adjustments were primarily related to acquisition related costs, de novo startup costs, litigation settlements and legal fees as well as facility losses and closing expenses related to FitRx and The Academy.

Litigation in California legal expenses had a negative impact of $0.08 on our EPS. Adjusted EPS for the fiscal year of 2015 was $0.97, an 87% increase from fiscal 2014. AAC’s tax rate for 2015 was 36% compared to our annual tax rate of 29% for 2014. Cash provided by operating activities was $0.4 million for the fourth quarter of 2015 compared with cash flows provided by operating activities of $2.2 million a year ago and cash flows used by operating activities of $0.8 million in the third quarter of 2015.

Our cash flows from operating activities were negatively impacted by $1.8 million of increased outflows related to the California Legal Defense, of which, $1.7 million was expensed in the quarter. Total cash provided by operating activities for the fiscal year 2015, was $6.2 million, a 23% decrease from fiscal 2014.

Days, sales outstanding were 96 days for the fourth quarter compared with 71 days a year ago and 93 days in the third quarter. As disclosed in our pre-announcement last month, we experienced a drag in the fourth quarter due to the ICD-10 implementation, new facility startup, acquired AR and delays resulting from the conversion to a new billing platform for our laboratory.

That being said, December and January were the two best collection months we’ve experienced to date. DSOs were 89 and 85 days respectively in those two months. Our ratio of cash deposits to net revenue was 100% for 2015 compared to 100% in 2014 and has remained in the range of 99.3% to 101.8% for the last eight quarters, which gives us confidence that we are adequately reserved.

We had $18.8 million of cash at quarter-end with outstanding debt inclusive of our senior credit facility in Deerfield convertible notes of $145.1 million. Our leverage at quarter-end was 3.3 times trailing 12 months adjusted EBITDA. We have yet to draw on the Deerfield subordinated debt that we anticipate doing so in the first quarter to fund the announced acquisitions of Townsend and Solutions Recovery.

Turning to our expectations for 2016, we anticipate revenue of $265 million to $275 million, which assumes an average daily residential census for the year of 800 inclusive of Laguna Treatment Hospital and the additional beds at Recovery First, average daily residential revenue of $800 to $825 and approximately $32 million to $34 million of additional revenue contribution from standalone outpatient centers and related lab services from those visits as well as from Recovery Brands, Townsend and Solution Recovery acquisitions.

We anticipate $52 million to $55 million in adjusted EBITDA and adjusted earnings per diluted share in the range of $0.95 to $1.03. These expectations assume an annual effective tax rate of 37% to 39% and approximately 23 million diluted weighted average shares outstanding for the year. Our guidance excludes the impact from future acquisitions, transaction related expenses, de novo startup expenses and expenses related to legal defenses.

This concludes our prepared remarks. I will now ask the operator to open the line for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. And our first question will come from Ryan Daniels of William Blair. Please go ahead.

Ryan Daniels

Yes, gentlemen, thanks for the color thus far. Kirk let me start with one for you, just in regards to the EBITDA outlook for 2016. I wonder if you can provide a little more color on the potential cadence through the year. I guess, more specific, I’m curious if we might see a dip down sequentially in Q1 with the lab pressure continuing and before the deals and some of the new bed development and that rise through the back half of the year or do you anticipate a pretty gradual up-tick on a more consistent basis through the year?

Kirk Manz

I anticipate probably little bit of a dip on the front-end until we get the Laguna Treatment Center opened, and get the full benefit of the River Oaks fully staffed in the second half of the year.

Ryan Daniels

Okay. And then, the Laguna Hospital clearly, a pretty important part of the bed additions for the year. Can you give us a little bit more color on the remaining hurdles there, I know the construction is in your control but maybe a little bit on the licensure and some of the startup for hiring and how that’s going there to staff the facility?

Kirk Manz

For the, I’m sorry Ryan, can you repeat that?

Ryan Daniels

Yes, just for the Laguna Hospital, kind of the key next steps to staff that, to ensure the licensure to complete construction as that is a big piece of the bed additions for the year?

Michael Cartwright

For Laguna, yes, sorry. First, I want to clarify on going into 2016. I don’t think you’ll see a dip from fourth quarter. I want to clarify what Kirk said. We do think that the first half will be lower than the second half. And that would be when we bring on solutions, Laguna, the hospital, as well as Townsend and Louisiana. So, you’ll definitely see a pick-up in the second half, but I just want to be clear that we don’t see a dip from fourth quarter going into first quarter.

Ryan Daniels

Okay, that’s helpful.

Michael Cartwright

In terms of the staffing plan for Laguna, we’ve already begun staffing up the Laguna operations. As of now, the renovations are complete. We actually got, I don’t know if you noticed on our presentation, but we got 93 beds, we just actually got that submitted through the city last month that increased the bed count I think by about 9, so that we are really excited about that. And we’ll be submitting for the CDHR [ph] licensure and anticipate we’ll have that in the first half of this year.

Ryan Daniels

Okay. That’s helpful. And then, thinking about the lab business as you look to offer the novel test and then launch the third party sales. Are you going to be developing a separate sales force for that or would that be more telesales at HQ or maybe leveraging Recovery Brands or refer Solutions Group to sell that?

Michael Cartwright

I think it’s a combination but we definitely are starting on a team that dedicates themselves just to the lab. Townsend has a lab that they’ve had an operation for quite some time. It’s an In-Network lab in Louisiana. And the gentleman that ran that actually ran a large region for Lab Corp. And he’ll be heading up the sales team for the outside team related to the laboratory.

So, I see this as a separate unit but I do see leverage across all of our platforms with our outside sales team as well as all the relationships that we built in the industry that I think once we start rolling this out as a product line, we’ll definitely take advantage of relationships we’ve already built.

Ryan Daniels

Okay, perfect. And then, just one last one I guess for Kirk again on the two transactions that have been announced but not yet closed yet. I know you’ve talked about those being breakeven EBITDA, the way they’re currently operated. But you’ll operate them under profitability. Should we be thinking of those adding $1 million or $2 million to the EBITDA outlook for the year? Is that a pretty safe assumption?

Kirk Manz

I would probably say $1 million to $2 million, we would expect since - we would expect these to come online in Q2 of this year. It’s going to take us a little bit of terms and turnaround to get those ramped up. But $1 million to $2 million for EBITDA for 2016 I think is a good place.

Ryan Daniels

Okay, perfect. Thanks guys. Appreciate it.

Operator

Our next question will come from John Ransom of Raymond James. Please go ahead.

John Ransom

Hi, good morning. You guys have been busy. Just to talk about outpatient for a minute. Can you give us some visit data that supports that 33 million and the kind of rate per day including lab to go with that?

Kirk Manz

On, the outpatient side for 2016 in terms of the guidance?

John Ransom

Yes, the guidance, the 30 - it’s quite a bit higher than where you were running in 4Q. And could, I just want to talk about visits rate per day and how it kind of ramps during the year?

Kirk Manz

Yes, actually we would expect the outpatient as a portion of that 32 million to 34 million to be in $13 million to $15 million range. So, it’s not the $32 million to $34 million, you’re also getting a pick-up from RSG and also Townsend Solution as part of that $32 million to $34 million. So, outpatient is little less than half of that.

John Ransom

I see, okay, that wasn’t clear, okay. And then the second point, when you talk about revenue going to mid-to-high teens, how much more In-Network revenue would you have this year as a percent of your total residential revenue versus last year, so how much of it is coming down or is it just a function of more In-Network revenue versus having rate pressure into your test?

Kirk Manz

Well, we’ve got right now about 19% of our beds at our In-Network with the addition of Townsend and solutions that will add some more In-Network. We hadn’t been fully staffed at the Sunrise House - or excuse me, the beds are not fully utilized at the Sunrise House so that’s going to bring on some additional In-Network revenue for 2016.

So, the ADR for the In-Network is kind of coming in what we thought it would be in the sense of being roughly half of the added network. And so, I would kind of build you a model on that.

John Ransom

But I’m saying, the lab revenue coming down to the mid-to-high teens, how much of that is actual reimbursement pressure versus just more In-Network revenue?

Kirk Manz

The bulk of that is going to be reimbursement pressure. There will be some dilution in the general ADR that’s coming from the lower ADRs from the other facilities.

John Ransom

Okay.

Kirk Manz

The drop this past year was roughly half lab pressure and half lower dilution from lower ADR from the In-Network facility. So, we would expect maybe a little bit more coming from the lab coming in 2016.

John Ransom

So, if we look sequentially, your lab went from 26 to 22, but your rate per day went down more than that, I mean, rate per day sequentially was 1.30, roughly versus just you think 4% of lab would be much less than that. So, was the rest of that just acquisition mix Oxford in there and Tampa having lower revenues from third quarter to fourth quarter?

Kirk Manz

It’s predominantly Oxford and Sunrise House.

John Ransom

Okay, got you. And just a couple of other things, as we think about DSOs this year, where do you think they stepped down to and save a lot, and I know it’s a process but what do you think they’d be running - what are you thinking about back of the year?

Michael Cartwright

It’s been, we’ve consistently seen in the past where we would think it to be kind of in that 80 to 90 day range. Obviously we had some good gains in December and January. So, our goal is to try to get that closer to 80 by the end of the year.

John Ransom

Okay, 80 by the end of the year, okay. Well, that’s all. And the capital you draw down from Deerfield is that going to be on the convert side or on the sub-debt side?

Kirk Manz

Sub-debt.

John Ransom

So, the 12% not the 2.5%?

Kirk Manz

Correct.

John Ransom

Okay, got you. All right. Thank you.

Michael Cartwright

Thanks John.

Kirk Manz

Thanks John.

Operator

Our next question will come from Ann Hynes from Mizuho Securities. Please go ahead.

Ann Hynes

Hi. Could you tell us from a cash perspective what you expect your de novo startup cost to be for 2016? And I think you mentioned on the call that you did delay a de novo and in New Jersey, could we just have a couple of more details on why? And then I think lastly, strategically going forward, would you prefer de novo activity over acquisitions or how do you balance that for deployment of cash?

Michael Cartwright

Let me answer the first part and then I’ll let Kirk jump into the cash flow. Ringwood was postponed basically it’s a $20 million all-in proposition. We own the property, we already have the clients. We definitely will continue to do that project. But cost of capital went up for us in 2015. We anticipate that’s going to change in 2016 and I think that you may see us put that back on the game plan later in the year.

But until we have access to capital with a little lower cost, it made sense for us to reallocate those dollars to Mississippi. We could build similar amount of beds in Mississippi for a much lower cost at our Oxford Center. So, you’ve noticed we’ve added another 48 sober living and 48 inpatient beds to the campus there. So, that’s really, we just reallocated our dollars more than anything else.

And look, we like de novo projects they just take a longer period of time and a lot of upfront capital. So, I think you’ll see us do a combination of de novo and acquisitions as we’ve done in the past. I don’t think you’ll see our playbook changing.

Ann Hynes

Okay.

Kirk Manz

In terms of dollars amounts Ann, we’re looking at roughly $30 million to $32 million of capital outlays that we would project that kind of encompass the beds at Oxford, getting Laguna online, expanding Recovery First, we’ve got some sober living projects. We’ve got the lab project down in Townsend. So that’s kind of what we’re targeting as CapEx expenditure related to bringing new beds online and expanding some of our existing facilities.

Ann Hynes

Okay. And just from a competitive landscape, UHS and ACHC obviously expanded in the substance abuse market over the past year with significant acquisitions. Do you think that changes the competitive landscape for you at all as it’s more difficult to get that patient referral because they more active in it?

Michael Cartwright

I actually look forward to them getting in this industry. Look, UHS has been a dominant player in the psychiatric hospital place for years. And I have very much respect Acadia and what they’ve been able to do both at site solutions that team. And now at Acadia, I hope that they put as much emphasis on the addiction field as they do on the psychiatric hospital field.

The National Association of Psychiatric Hospital Health Systems is the board that I just joined that UHS and Acadia has gone. And there is a sub-committee of that that focuses on addiction. So I’m hoping with bigger players in this field, we can do some legislation and lobbying and really put some emphasis on this field which it really deserves.

You realize there are 15,000 different small providers throughout the United States that many times don’t have a voice, it’s nice to see some multi-billion dollar companies come into this space and can provide voice. And I know they have great programs and their systems are in place. So I think they’ll be great competitors. I don’t really look at it as a downside I look to it as an upside.

And believe me, there is enough for all of us in terms of acquisition opportunities. Like I said there are 15,000 different standalone providers out there that all of us could spend the next three to five years aggregating this space. And I think we’ll have plenty to do.

Ann Hynes

Okay, great. And just lastly on I guess the California lawsuit you’ve been updating your website. But is there anything else you want to add or any update you want to give us?

Michael Cartwright

I wish I could, I mean, the State of California does not move at the pace that I would like to see it move at. Maybe they have a lot on their docket. There is an update there. We put in our 995 motion. We hope to hear back on that motion at some point. I feel extremely strong about that motion, I don’t know if you’ve had a chance to look at the website and take a look at the fact that the corner came out and did another declaration that basically said again as we’ve been saying from the very beginning, the gentleman died of a heart-attack.

So, I think it will just have to work its way through the California system. But at the end of the day, I think everyone knows the outcome is going to be that we’ve not done anything wrong and none of the employees did anything wrong.

Ann Hynes

All right. So, I guess from a timing perspective, we hope to get a judgment on the dismissal before March 18, is that - if I’m reading that right?

Michael Cartwright

I have no idea. Again, the California system moves at its own pace, I don’t want to predict timing. I have to leave that to other people.

Ann Hynes

Thanks.

Operator

Our next question will come from Paula Torch of Avondale Partners. Please go ahead.

Paula Torch

Hi everybody, good morning. Kirk, I just wanted to quickly drill down on the revenue guidance for a second and just understand how Townsend and Solutions Recovery are being baked into this. So, is it not going to be baked into the average daily census in terms of the beds since it’s not being driven? And I guess by the core revenue since it’s going to be in the separate line item. I’m just, I’m not sure as to why it’s not part of the beds and then the average daily revenue and so on and so forth? And maybe it is, and I’m just not getting it?

Kirk Manz

We’ve got kind of the core based on the average daily census of that 800, we kind of breakout the kind of the additional revenue that’s coming from the outpatient and what we would consider from RSG from Townsend. So the revenue that we’re getting contributed from Townsend Solutions, are not impacting the ADC or the ADR at this stage.

Paula Torch

Okay. And in terms of longer term, Townsend and Solutions, that’s certainly going to have a little bit of an impact on the ADR I would imagine once that does come in 2017, is that the right way to think about it?

Kirk Manz

Yes, it has less ADR at both of those acquisitions in we do currently. So it would have some dilutive effect certainly.

Michael Cartwright

But it will also have some effect in the fact that they have an In-Network lab that we’re doing third party business on. So, we also see revenue there that’s margin rich business as well. So, I don’t, I’m trying to follow the question Paula.

Paula Torch

Well, I’m just trying to think about how to bake it all in, in terms of thinking out to 2017 given that you’ve got a little bit of a higher mix from In-Network beds and then you’ve got the In-Network lab that’s going to come in which could potentially offset some of the pressures on the pricing reimbursement if I understand that correctly or maybe I’m just reading too much into it?

Michael Cartwright

No, I mean, certainly we’re adding more capacity on the In-Network side, that’s going to have a lower ADR in terms of the blended rate. So, going into 2017, we would expect more In-Network beds that we have in our system that’s going to pull on the ADR a little bit.

Paula Torch

Okay. And then on the lab, the additional service lines that you’re adding. What type of pricing and volume assumptions does that come with if you care to share? And are those test seeing similar rate pressure as the tests that are coming in now?

Kirk Manz

I think it’s, I think we need to spend a little bit more time to kind of give a better guidance in terms of what that’s going to be.

Paula Torch

Okay. And then in your prior presentation, you discussed I think it was or presentation you put out in the beginning of February. Some savings of about $10 million in advertising costs. And so how should we think about flowing that through the model, is this going to happen ratably or what should we expect advertising cost to be as a percent of revenue in 2016?

Kirk Manz

We think it’s going to come down. We’re going to pick-up some margin improvement on the customer acquisition and advertising costs in 2016. So, we’re hoping to pick up, it could be 100 to 200 basis points there by the end of the year.

Paula Torch

Okay. And then just a quick question on outpatient, I noticed that the visits remain flat on a sequential basis, is that just due to seasonality or just capacity issues and maybe how should we expect that to pick-up as you bring on the acquisitions especially in the Las Vegas market with the addition of the sober living beds?

Michael Cartwright

Yes, no, I just think that you started to see it stabilize out at the two locations. And now we’re looking at how do, we develop different markets. I think with the solutions acquisition, it gives us access to additional sober living which folks can stay longer in that Las Vegas market. Same thing in Dallas, I think that you’ll see us be able to expand our Dallas market as well over 2016. But from Q3 to Q4, you just saw a stabilizing effect that I think that you’ll see it continue to ramp up in 2016, especially towards the second half of the year.

Paula Torch

Okay, great. And then, maybe one last one from me just on the margin guidance, I know we’re sort of sitting around the low-end of the 20% to 25% margin goal that you put forth on a long-term basis. So, I’m just wondering do you still expect that to be a good goal and what really needs to happen I guess to get us towards the mid-point to the high-end of the range longer term?

Michael Cartwright

I think it’s still the goal and I think it’s very achievable. We did have headwinds which we told everybody we would related to the laboratory, we’ve been very clear with that when we went on our IPO road show. We’ve been very clear on just about every phone call we’ve had in 2015 that we would see rate pressure in there. And we certainly saw it. And during that time you saw that our margins kind of ended up where we predicted they would end up for 2015.

Look, we grew from $21 million in EBITDA to $44 million in EBITDA exactly like we said we would do. Our margins ended up pretty much what we said they would be for the year. So, I think that we’re very, very pleased with what we did with 2015 with the headwinds that we predicted. And we managed our way through it.

I think in 2016, there are some things that we found that we can do to increase that margin a little bit more with our outpatient services as well as our marketing as well as third party lab that we’ve already started to go down those paths. So, the path that we’ve laid out for 2016, we feel very confident about. And we look forward to 2016.

Paula Torch

Okay, great. Thank you.

Operator

[Operator Instructions]. Our next question will come from Toby Wann of Obsidian Research Group. Please go ahead.

Toby Wann

Hi guys thanks for taking the questions. Quickly on the other revenue category that you guys disclosed. You kind of dropped, on a percentage basis, it was a big number but on an absolute dollar basis, it wasn’t that big on a sequential drop. Just kind of get some color around that if you could?

Kirk Manz

Yes, that’s coming from Recovery Brands and as we kind of indicated when we acquired them that over time we would be taking more of their calls that historically they’ve sold to other providers out there. We would be bringing that in-house. So that’s kind what you’re seeing in Q4.

Toby Wann

Okay. And then, on salaries, wages and benefits, it’s kind of as a percentage of revenue come up around 57% or 50.7% sorry. Is that kind of sort of decent increase relative to where we were kind of looking for it to come out? And is that more a function of inefficiency due to the ramp of River Oaks where you have the expenses but you don’t have necessarily the associated revenue to kind of balance that out or kind of how should we think about the underlying reasoning behind that?

Kirk Manz

Yes, the bulk of the increase of the salaries and wages came from Sunrise House, Recovery Oaks and then having a full quarter of Oxford. There are some other components to it in terms of workers comp and stock comp and things like that. But the bulk of it had to do with the new facilities that came online. And so, you’ll see that is kind of more along the lines of the startup and acquisition costs and as a percentage of the total revenue we would hope that that would come more in line with prior levels as we get into 2016.

Toby Wann

Okay. And then just one last from me, in terms of kind of per patient acquisition costs, kind of how that shake out during the quarter versus the trends historically kind of where you foresee that going over time?

Michael Cartwright

We’ve seen some strong improvements as results of the Recovery Brand’s transaction. It has significantly lowered our customer acquisition cost. We feel we’re kind of a good kind of zone with them at this particular stage. We expect in 2016 to take more of their calls as well. So, as we talked in the earlier question, we expect to get some margin improvement in terms of reduction of our advertising and marketing cost throughout the course of this year. So, we are optimistic that we’ll continue to improve on our customer acquisition cost.

Toby Wann

Okay, thanks so much.

Michael Cartwright

Yes.

Operator

Our next question is a follow-up we have John Ransom from Raymond James. Please go ahead.

John Ransom

You guys are looking forward to a second opportunity to speak to me, I know, so here it is. Just kind of following up on a couple of things, so, looking at the two acquisitions you did in December, you expect them to close when exactly, sometime in the second quarter?

Michael Cartwright

Yes, they’ll close in the second quarter.

John Ransom

Okay. Now, just for kind of picking and modeling purposes, Kirk, are they going to stay in that outpatient and other segments, I know there are some in-patient stuff, are they going to migrate into the in-patient line and pulled out of that segment for 2017? I think that’s what Paula was getting at.

Kirk Manz

Yes, you’re going to have a combination of both because Solutions has 70 beds, so that’s going to kind of come into your average daily census. Townsend has got little over 30 beds there as well. So, really those two acquisitions are going to startle both the residential and the outpatient side.

John Ransom

All right. So, how much of that $16 million is residential revenue then roughly between the two entities?

Kirk Manz

Between the two entities, it’s a higher percentage, I should say the larger percentage absolutions and a much lower percentage of Townsend really as a function of the total debt that they have and Townsend has a much stronger outpatient presence throughout Louisiana. So, they’re weighted a little differently depending on the two acquisitions.

John Ransom

But just to be clear, is that going to stay in that outpatient line and then flip in ‘17 or is it going to immediately go in the split between the residential and outpatient?

Kirk Manz

It will split.

John Ransom

In other words, that $33 million doesn’t include the full $16 million that you’re buying of outpatient revenue?

Kirk Manz

Correct. Are you talking about the $32 million to $34 million of this other?

John Ransom

Yes, yes, so you gave guidance and I think initially I thought you said well, that’s our existing outpatient then we bought $16 million of revenue but now you’re telling me the $16 million revenue, some of that’s going to be residential and some of that. So, where does the rest of the outpatient revenue come from just new beds and expansions that you mentioned?

Kirk Manz

If we took that $32 million to $34 million and broke it down, our existing outpatient is kind of being little less than half of that, all right. And then you’re going to have Recovery Brands kind of trailing down in terms of their normal contribution. So we’re going to take more calls, we’re going to expect to generate less from that.

And that kind of leaves you with balance of $10 million to $15 million-ish coming from combination of Townsend and Solutions. So, that is and kind of the guidance separate in part from our outpatient, kind of our legacy outpatient part of our business. So, out of that Townsend Solution, you’re going to have part of that’s going to be outpatient business and part of that’s going to be increased residential centers.

John Ransom

And when you bring on lab, are you bearing that in that segment as well or is that going to be a separate one when you start doing lab for other third parties?

Michael Cartwright

Once it becomes material I mean, right now we’re doing a little bit but it’s not significant. We would expect it to start to get significant towards the end of the year. But third party labs, we would expect to be in the bucket of the other revenues. So it would be along with that line item of RSG.

John Ransom

But that’s part of your guidance the $32 million to $34 million include some third party lab?

Michael Cartwright

That’s correct.

John Ransom

Grow I mean, it will grow, okay. And then finally, Tampa, that’s a big one obviously, when do you expect to step-up the capacity of Tampa, how long are you going to stick with the 110 other than 162 that you have available?

Michael Cartwright

I’d say the first half of the year we’ll stabilize where we are right now. And then towards the second half of the year you’ll see that grow. I think right now look, we did a great job opening that place up and now having over 100 patients in there. That’s a pretty big patient population to manage. So I think we feel very comfortable managing that program the way it is. And then again, in the second half of the year you’ll see it step-up in terms of the census.

John Ransom

Okay, so second half. And then my last question is if you had all the bed capacity you wanted Michael, how many more beds could you fill just based on your existing call volume and what you’re already sending out through recovery brands?

Michael Cartwright

It’s a good question.

John Ransom

Thank you.

Michael Cartwright

I don’t know the exact number. It is. I don’t know the exact number. But look, you followed our company for years now and you’ve seen that our issue is not necessarily being filling the beds our issue has been bringing on additional product lines. And so, that’s going to continue to be our challenge through 2016 is opening more beds, Laguna, we’re going to get it opened up, Oxford, get that construction finalized and underway.

So, we definitely feel like that we can fill more beds. We’ve built a great team. We’ve got a great outside sales team that represents our company extremely well around the country. And then we have a really good multimedia team as well as a marketing strategy on the internet. So we definitely feel like that our marketing is solid. I just can’t give you an exact number of how many de novo beds we can open tomorrow.

But we certainly are pacing and I think at the right pace. We want to open more In-Network beds as well. I think you’ll see expand some of the locations that we have throughout 2016 and ‘17, where we have In-Network beds, because we get a lot of those phone calls today throughout the United States where we’d love to be able to help that patient.

The other thing I’m really excited about John is in 2016 we’ll finally start getting some of that research data like I was talking about earlier in my comments, we’re just now starting to get the throughput in our studies. And so, I’m really excited to be able to report on that as we go forward into 2016.

John Ransom

And so, when we think about let’s say just make up a number 125 ADC at Tampa and we can make up at revenue per day. What is the contribution margin at a facility level, I know you got a big corporate cost with marketing and lab and what not. But as you bring these beds on, how do we think about the contribution margin for a big de novo at a network project like Tampa?

Kirk Manz

Contribution margins, again, keep in mind that we do all the sales and marketing costs, all the back-office, everything from a corporate standpoint. So we would normally expect to have somewhere in the neighborhood of about 40% to 50% contribution margins from the facility that then flows up to the corporation which then pays for the corporate overhead and all the sales and marketing.

Michael Cartwright

And the exciting think John, is, as we continue to add beds, as we continue to grow, your operating cost from the corporate infrastructure and sales and marketing infrastructure, are pretty fixed. And so, when we talk about getting the margin increase, I think you’ll see that naturally happen as we continue to add beds across the United States in 2016 with these additional acquisitions.

John Ransom

Yes. And how does that compare on the In-Network, is that margin the same or is it a little bit low, I imagine it’s a little lower on the In-Network contribution?

Kirk Manz

It’s a little lower.

John Ransom

Okay, yes. All right. Thank you.

Michael Cartwright

Thanks John.

Kirk Manz

Thanks.

Operator

Having no further questions, this will conclude our question-and-answer session.

Operator

Ladies and gentlemen, the conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.

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