AAC Ares Acquisition Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1.    Description of Business

AAC Holdings, Inc. (collectively with its subsidiaries, the “Company” or “AAC Holdings”) was incorporated on February 12, 2014. The Company is headquartered in Brentwood, Tennessee, and provides substance abuse treatment services for individuals with drug addiction, alcohol addiction and co-occurring mental/behavioral health issues. In addition to the Company’s substance abuse treatment services, the Company performs clinical diagnostic laboratory services, provides physician services to clients and operates a broad portfolio of internet assets that service millions of website visits each month serving families and individuals struggling with addiction and seeking treatment options. As of September 30, 2017, the Company, through its subsidiaries, operated 10 residential substance abuse treatment facilities, 18 standalone outpatient centers, and 4 sober living facilities.

2. Basis of Presentation and Recently Issued Accounting Pronouncements

Principles of Consolidation

The Company conducts its business through limited liability companies and C-corporations, each of which is a direct or indirect wholly owned subsidiary of the Company. The accompanying condensed consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries, and the accounts of variable interest entities (“VIEs”) in which the Company is the primary beneficiary. All intercompany transactions and balances have been eliminated in consolidation.

The Company consolidated seven professional groups (“Professional Groups”) that constituted VIEs as of September 30, 2017 and 2016. The Professional Groups are responsible for the supervision and delivery of medical services to the Company’s clients. The Company provides management services to the Professional Groups. Based on the Company’s ability to direct the activities that most significantly impact the economic performance of the Professional Groups, provide necessary funding and the obligation and likelihood of absorbing all expected gains and losses, the Company has determined that it is the primary beneficiary of these Professional Groups.

The accompanying condensed consolidated balance sheets as of September 30, 2017 and December 31, 2016 include assets of $2.3 million and $1.4 million and liabilities of $0.4 million and $0.7 million related to the VIEs, respectively. The accompanying condensed consolidated statements of operations include net loss attributable to noncontrolling interest of $1.1 million and $1.5 million related to the VIEs for the three months ended September 30, 2017 and 2016, respectively, and net loss attributable to noncontrolling interest of $3.1 million and $3.4 million for the nine months ended September 30, 2017 and 2016, respectively.

The accompanying condensed consolidated financial statements are unaudited, with the exception of the December 31, 2016 balance sheet, which is consistent with the audited financial statements at that date but does not include all of the information and footnotes required by U.S. generally accepted accounting principles (“GAAP”) for a complete set of financial statements. The information contained in these condensed consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto for the fiscal year ended December 31, 2016 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on March 7, 2017. Management believes that all adjustments of a normal, recurring nature considered necessary for a fair presentation have been included. In addition, the interim financial information does not necessarily represent or indicate what the operating results will be for the year ending December 31, 2017 for many reasons including, but not limited to, acquisitions, dispositions, capital financing transactions, changes in interest rates and the effects of other trends, risks and uncertainties. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Actual results could differ from those estimates.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation.

Recently Issued Accounting Standards Updates

In January 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) 2017-04, “Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”). The new guidance eliminates the requirement to calculate the implied fair value of goodwill (i.e., Step 2 of the current goodwill impairment test) to measure a goodwill impairment charge. Instead, entities will record an impairment charge based on the excess of a reporting unit’s carrying amount over its fair value (i.e., measure the charge based on the current Step 1). ASU 2017-04 is effective for annual and interim impairment tests for periods beginning after December 15, 2019. The Company does not believe that the provisions of ASU 2017-04 will have a material impact on the Company’s financial statements upon adoption.

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In August 2016, the FASB issued ASU 2016-15, “Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments” (“ASU 2016-15”). Among other clarifications, ASU 2016-15 clarifies certain items, including the classification of payments for debt prepaymen t or debt extinguishment costs, including third-party costs, premiums paid, and other fees paid to lenders that are directly related to the debt prepayment or debt extinguishment, excluding accrued interest, which will now be included in the Financing Acti vities section in the Statements of Cash Flows. The new standard is effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company chose to early adopt the provisions of ASU 2016-15 during the nine months ended September 30, 2017, which impacted the condensed consolidated statement of cash flows by allowing debt extinguishment costs incurred during the nine months ended September 30, 2017 to be classified as a financing activity rather than an operating activity.

In June 2016, the FASB issued ASU 2016-13, “Financial Instruments-Credit Losses: Measurement of Credit Losses   on Financial Instruments,” (“ASU 2016-13”) which updates the impairment model for most financial assets and certain other instruments. For trade receivables and other instruments, entities will be required to use an updated forward-looking expected loss model that generally will result in the earlier recognition of allowances for losses. The new standard is effective for annual reporting periods beginning after December 15, 2019, including interim periods within those years, with early adoption permitted only as of annual reporting periods beginning after December 15, 2018. The Company continues to evaluate the provisions of ASU 2016-13 to determine the impact on the Company’s financial statements.

In March 2016, the FASB issued ASU 2016-09, “Compensation-Stock Compensation: Improvements to Employee Share-Based Payment Accounting” (“ASU 2016-09”). ASU 2016-09 requires that all excess tax benefits and tax deficiencies resulting from share-based payments be recognized as income tax expense or benefit in the income statement, which eliminates the accounting for additional paid-in capital pools. ASU 2016-09 also allows companies to make an entity-wide policy election to either estimate the number of stock-based awards that are expected to vest or account for forfeitures as they occur. With regards to the Statement of Cash Flows, both inflows and outflows of cash related to excess tax benefits will be classified as operating activities, whereas prior to this update, excess tax benefits as cash inflows were to be classified as financing activities. Also, cash paid by an employer when directly withholding shares for tax-withholding purposes (“net share settlement”) will now be classified as a financing activity. The new standard is effective for fiscal years beginning after December 15, 2016, including interim periods within those fiscal years. The Company adopted ASU 2016-09 on a prospective basis, effective January 1, 2017. Prior periods have not been adjusted. The adoption of the ASU impacted the classification of tax payments made by the Company on behalf of its employees for net share settlement amounts within the condensed consolidated statement of cash flows , resulting in $1.0 million of tax payments being classified as a financing activity during the nine months ended September 30, 2017.

In February 2016, the FASB issued ASU 2016-02, “Leases” (“ASU 2016-02”). 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 financing 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 anticipates that the adoption of ASU 2016-02 will result in an increase in both total assets and total liabilities. The Company is continuing to evaluate the impact that adoption of this standard will have on its consolidated financial statements.

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers” (“Topic 606”), which outlines a single comprehensive model for recognizing revenue and supersedes most existing revenue recognition guidance, including guidance specific to the healthcare industry. Updates to this standard have been issued subsequent to the initial standard. Companies across all industries will use a new five-step model to recognize revenue from customer contracts. The new standard, will require significant management judgment in addition to changing the way many companies recognize revenue in their financial statements. The new guidance will also require enhanced disclosures about the nature, amount, timing, and uncertainty of revenue and cash flows arising from customer contracts, including revenue recognition policies to identify performance obligations, assets recognized from costs incurred to obtain and fulfill a contract, and significant judgments in measurement and recognition. 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 will adopt the standard on January 1, 2018. As the Company progresses with its implementation efforts to adopt Topic 606, management continues to evaluate and refine its estimates of the anticipated impact the new standard will have on its revenue recognition policies, procedures, financial position, results of operations, cash flows and financial disclosures. The Company continues to evaluate and currently expects that it may adopt the modified retrospective method of adoption. Additionally, the Company currently anticipates that as a result of changes required by Topic 606, a significant majority of the provision for doubtful accounts will be presented as a direct reduction to revenue as opposed to being presented as a separate line item. To date, the Company is in the early stages of its implementation process.

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3 .   Non-Client Related Revenue

Our non-client related revenue consists of service charges from the delivery of  quality targeted leads to behavioral and mental health service businesses through our operating subsidiary Referral Solutions Group, LLC and its wholly owned subsidiary, Recovery Brands, LLC, which was acquired on July 2, 2015, and diagnostic laboratory services provided to clients of third-party addiction treatment providers. 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.

4.    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 $17.5 million and $20.7 million for the three months ended September 30, 2017 and 2016, respectively, and $54.2 million and $55.8 million for the nine months ended September 30, 2017 and 2016, respectively.

5.   Earnings Per Share

Basic earnings per share (“EPS”) is computed by dividing net income attributable to common stockholders by the weighted-average number of shares of common stock outstanding for the period.

For the calculation of diluted EPS, net income attributable to common stockholders for basic EPS is adjusted by the effect of dilutive securities, including awards under stock-based payment arrangements. Diluted EPS attributable to common stockholders is computed by dividing net income attributable to common stockholders by the weighted-average number of fully diluted common shares outstanding during the period.

The following tables reconcile the numerator and denominator used in the calculation of basic and diluted EPS for the three and nine months ended September 30, 2017 and 2016 (in thousands except share and per share amounts):

For the three months ended September 30, 2017 and 2016, t he Company had 138,571 and 4,879 potentially dilutive shares, respectively. For the nine months ended September 30, 2017 and 2016, the Company had 902,293 and 9,759 potentially dilutive shares, respectively. These shares are not included in the EPS calculation above for the three months ended September 30, 2016, and the nine months ended September 30, 2017 and 2016, because to do so would be anti-dilutive for the periods presented.

6.    Accounts Receivable and Allowance for Doubtful Accounts

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

For the nine months ended September 30, 2017, approximately 11.3% of the Company’s revenues were reimbursed by Anthem Blue Cross Blue Shield of Nevada; 10.8% by Blue Cross Blue Shield of Texas; and 10.0% by Blue Cross Blue Shield of Florida. No other payor accounted for more than 10.0% of revenue reimbursements for the nine months ended September 30, 2017.

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For the nine months ended September 30, 2016, approximately 11.0 % of the Company’s revenues were reimbursed by Anthem Blue Cross Blue Shield of Colorado; 10.7% by Blue Cross Blue Shield of Texas; 10.3% by Aetna; and 10.3% by Blue Cross Blue Shield of Florida. No o ther payor accounted for more than 10.0% of revenue reimbursements for the nine months ended September 30, 2016.

Approximately $12.1 million and $10.4 million of the accounts receivable, net of the allowance for doubtful accounts, at September 30, 2017 and December 31, 2016, respectively, includes accounts where the Company has received a partial payment from a commercial insurance company and the Company is continuing to pursue additional collections for the balance that the Company estimates remains outstanding. An account is written off only after the Company has pursued collection efforts or otherwise determines an account to be uncollectible.

7.  Property and Equipment, net

Property and equipment consisted of the following (in thousands):

8.  Goodwill and Intangible Assets

The Company’s business comprises a single reporting segment for impairment test purposes. 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 has no intangible assets with indefinite useful lives other than goodwill. The Company performed its most recent goodwill impairment testing as of December 31, 2016 and did not incur an impairment charge.

The Company’s goodwill balance as of both September 30, 2017 and December 31, 2016 was $134.4 million.  

Other identifiable intangible assets and related accumulated amortization consisted of the following as of September 30, 2017 and December 31, 2016 (in thousands):

Amortization expense for both the three months ended September 30, 2017 and 2016 was $0.4 million. Amortization expense for the nine months ended September 30, 2017 and 2016 was $1.2 million and $1.1 million, respectively.

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9 .  Debt

A summary of the Company’s debt obligations, net of debt issuance costs, is as follows (in thousands):

2017 Credit Facility

On June 30, 2017, the Company entered into a senior secured credit agreement with Credit Suisse AG, as administrative agent and collateral agent and the lenders party thereto (the “2017 Credit Facility”). The 2017 Credit Facility initially made available to the Company a $40.0 million revolving line of credit (the “2017 Revolver”) and a term loan in an aggregate original principal amount of $210.0 million (the “2017 Term Loan”). As discussed further below, on September 25, 2017 the 2017 Revolver was increased to $55.0 million. The 2017 Credit Facility also provides for standby letters of credit in an aggregate undrawn amount not to exceed $7.0 million.

The 2017 Term Loan will mature on June 30, 2023 and requires scheduled quarterly principal repayments in an amount equal to $ 1.3 million for September 30, 2017 through June 30, 2019, $2.6 million for September 30, 2019 through March 31, 2023, with the remaining principal balance of the term loan due on the maturity date of June 30, 2023. The 2017 Term Loan was fully drawn on June 30, 2017.

The 2017 Revolver will mature on June 30, 2022 and $14.5 million was drawn on the 2017 Revolver on June 30, 2017. The Company paid down the outstanding loans under the 2017 Revolver during the three months ended September 30, 2017 and as of September 30, 2017, there were no outstanding loans related to the 2017 Revolver .

The 2017 Credit Facility also includes an incremental facility providing for the Company to incur Additional Term Loans in an aggregate principal amount of up to $25.0 million (plus such additional amounts, so long as, after giving pro forma ef fect to the incurrence of such additional borrowings, the Company’s Senior Secured Leverage Ratio (as defined in the 2017 Credit Facility) would be less than 3.90:1.00) (each, an “Incremental Term Loan”) and/or Additional Revolving Commitments in an aggregate principal amount of up to $15.0 million (the “Incremental Revolver”) , each subject to the satisfaction of certain conditions contained in the 2017 Credit Facility, including obtaining additional commitments from existing or additional lenders. On September 25, 2017, the Company obtained its Incremental Revolver from certain incremental revolving credit lenders thereby increasing the 2017 Revolver pursuant to the 2017 Credit Facility from $40.0 million to $55.0 million. The lenders under the 2017 Credit Facility are not under any obligation to provide any Incremental Term Loans.

Borrowings under the 2017 Credit Facility bear interest at a rate tied to the Alternative Base Rate or the Adjusted London Interbank Offered Rate (“LIBOR”) (at the Company’s option, and both as defined in the 2017 Credit Facility). ABR Loans (as defined in the 2017 Credit Facility) made as a 2017 Revolver bear interest at a rate per annum equal to the Alternative Base Rate plus 5.0% per annum. ABR Loans made as a 2017 Term Loan bear interest at a rate per annum equal to the Alternate Base Rate plus 5.75% per annum. Eurodollar Loans (as defined in the 2017 Credit Facility) made under the 2017 Revolver bear interest at the applicable Adjusted LIBOR plus 6.0%. Eurodollar Loans made under the 2017 Term Loan bear interest at the applicable Adjusted LIBOR plus 6.75% (with a 1.0% floor). In addition, under the 2017 Credit Facility, the Company will pay a commitment fee for the undrawn portion of the 2017 Revolver of 0.5% per annum, payable on a quarterly basis.

Borrowings under the 2017 Credit Facility are guaranteed by the Company’s wholly owned subsidiary, American Addiction Centers, Inc., and certain of its other subsidiaries pursuant to that certain Guarantee and Collateral Agreement, dated as of June 30, 2017, by and among the Company, each of the subsidiary guarantors party thereto and Credit Suisse AG, as collateral agent (the “Guarantee and Collateral Agreement”). The obligations under the 2017 Credit Facility and the Guarantee and Collateral Agreement are secured by a lien on substantially all of the Company’s and each subsidiary guarantor’s assets.

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The Company is permitted to voluntarily reduce the unutilized portion of the commitment amount and repay outstanding loans under the 201 7 Credit Facility at any time without premium or penalty, other than customary “breakage” costs with respect to Eurodollar Loans and, with respect to the 2017 Term Loan, if certain repricing transactions are consummated or certain mandatory repayments are made, (i) a yield maintenance premium within one year after the closing as set forth in the 2017 Credit Facility, (ii) a 2.0% premium if paid after the first anniversary of the closing but before the second anniversary of the closing and (iii) a 1.0% premi um if paid after the second anniversary of the closing but before the third anniversary of the closing.

In addition, the 2017 Credit Facility requires the Company to prepay the outstanding 2017 Term Loan, subject to certain exceptions, with:

The 2017 Credit Facility requires the Company to not permit its Senior Secured Leverage Ratio (as defined in the 2017 Credit Agreement) to exceed the following ratios on or after each quarter end:

In addition, the 2017 Credit Facility places certain restrictions on the ability of the Company and its subsidiaries to, among other things, incur debt and liens; merge, consolidate or liquidate; dispose of assets; enter into hedging arrangements; pay dividends and make other restricted payments; undertake transactions with affiliates; enter into restrictive agreements on dividends and other distributions; make negative pledges; enter into certain sale-leaseback transactions; make certain investments; prepay or modify the terms of certain indebtedness; and modify the terms of certain organizational agreements.

The 2017 Credit Facility contains customary events of default, including payment defaults, breaches of representations and warranties, covenant defaults, cross-defaults to other material indebtedness, certain events of bankruptcy and insolvency, material judgments, certain ERISA events, invalidity of loan documents and certain changes in control.

The Company incurred approximately $12.9 million in debt issuance costs related to underwriting and other professional fees, of which $7.6 million related to the 2017 Term Loan and $5.3 million related to the 2017 Revolver.

As of September 30, 2017, the Company’s availability under the 2017 Revolver was $55.0 million, less any outstanding letters of credit.

In addition, subsequent to September 30, 2017, the Company also secured a $65.0 million acquisition financing commitment related to the pending acquisition of AdCare, Inc. (“AdCare”). See Note 15 (Subsequent Events) for further discussion.

As of September 30, 2017, the Company was in compliance with all applicable covenants under the 2017 Credit Facility.

2015 Credit Facility

On March 9, 2015, the Company entered into a five-year senior secured credit facility (the “2015 Credit Facility”) with Bank of America, N.A., as administrative agent for the lenders party thereto. In connection with entering into the 2017 Credit Facility on June 30, 2017, all amounts outstanding under the 2015 Credit Facility were fully repaid. The 2015 Credit Facility initially consisted of a $50.0 million revolving credit facility and a $75.0 million term loan. On July 13, 2016, the Company increased its 2015 Credit Facility to $171.3 million, consisting of a $50.0 million revolving credit facility and a $121.3 million term loan. The facility was scheduled to mature in March 2020 and bore interest at LIBOR plus a margin between 2.25% to 3.75% or a base rate plus a margin between 1.25% and 2.75%, in each case depending on the Company’s Total Consolidated Leverage Ratio (defined as Consolidated

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Funded Indebtedness to Consolidated EBITDA, in each case as defined in the 2015 Credit Facility, as amended) . In addition, the Company was required to pay a commitment f ee on undrawn amounts under the revolving loan of the 2015 Credit Facility of 0.35% to 0.60% depending on the Company’s Consolidated Total Leverage Ratio.

During the quarter ended June 30, 2017, the Company incurred approximately $5.4 million in debt extinguishment costs related to the repayment of the 2015 Credit Facility and the Deerfield Facility, which consisted of a $3.0 million consent fee related to calling the Deerfield Facility (the “Deerfield Facility Consent Fee”), as well as a write-off of $2.3 million of previously deferred debt issuance costs.

2015 Subordinated Debt

On October 2, 2015, the Company entered into two financing facilities with affiliates of Deerfield Management Company, L.P. (“Deerfield”). The financing facilities consisted of $25.0 million of subordinated convertible debt and up to $25.0 million of unsecured subordinated debt (the “Deerfield Facility”). In connection with entering into the 2017 Credit Facility on June 30, 2017, all amounts outstanding under the Deerfield Facility were fully repaid. The Company issued $25.0 million of subordinated convertible debt at closing of the Deerfield Facility. The $25.0 million of subordinated convertible debt bore interest at an annual rate of 2.50% and would have matured on September 30, 2021. The $25.0 million of subordinated convertible debt funded at closing of the Deerfield Facility was convertible into shares of the Company’s common stock at $30.00 per share. In the second quarter of 2016, the Company issued $25.0 million of unsecured subordinated debt under the Deerfield Facility and used the proceeds to fund the acquisitions of Wetsman Forensic Medicine, LLC (d/b/a Townsend) and its affiliates, a hotel in Arlington, Texas and Solutions Recovery, Inc., its affiliates and unsecured real estate assets. The unsecured subordinated debt bore interest at an annual rate of 12.0% and would have matured on October 2, 2020.

Interest Rate Swap Agreements

In July 2014, the Company entered into two interest rate swap agreements to mitigate its exposure to fluctuations in interest rates. On June 29, 2017, the Company terminated the interest rate swap agreements. The fair value of the interest rate swap agreements as of December 31, 2016 represented a liability of $0.3 million . Refer to Note 13 (Fair Value of Financial Instruments) for further discussion of fair value of the interest rate swap agreements.

Prior to terminating the interest rate swap agreements on June 29, 2017, the interest rate swap agreements had notional amounts of $7.2 million and $10.5 million which fixed the interest rates over the life of the respective swap agreement at 4.21% and 4.73%, and were set to mature in May 2018 and August 2019, respectively. The notional amounts of the swap agreements represented amounts used to calculate the exchange of cash flows and were not the Company’s assets or liabilities. The interest payments under these agreements were to be settled on a net basis. The Company did not designate the interest rate swaps as cash flow hedges, and therefore, the changes in the fair value of the interest rate swaps are included within interest expense in the condensed consolidated statements of operations.

10.  Financing Lease Obligation

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

Simultaneously with the sale of the Sale-Leaseback Facilities, the Company, through its subsidiaries and MedEquities entered into an operating lease, dated August 9, 2017, in which the Company will continue to operate the Sale-Leaseback Facilities. The operating lease provides for a 15-year term for each facility with two separate renewal terms of five years each if the Company chooses to exercise its right to extend the lease term.

The initial annual minimum rent payable from the Company to MedEquities is $2.2 million due in equal monthly installments of $0.2 million. On the first, second and third anniversary of the lease date, the annual rent will increase to an amount equal to 101.5% of the annual rent in effect for the immediately preceding year. On the fourth anniversary of the lease date and thereafter during the lease term, the annual rent will increase to the amount equal to the CPI Factor (as defined in the Lease) multiplied by the annual rent in effect for the immediately preceding year; provided, however, that the adjusted annual rent will never be less than an amount equal to 101.5% or greater than an amount equal to 103.0% of the annual rent in effect for the immediately preceding year.

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Due to the nature of the agreement between MedEquities and the Company, the transaction does not qualify for sale-leaseback accounting under GAAP. Therefore, the Sale-Leaseback Facilities will remain on the Company’s balance sheet and will continue to be depreciated over the remaining life of the asset. The Company accounted for the $25.0 million of proceeds, less $0.4 million of transaction costs, as a financing obligation, of which $ 0.2 million was classified as a short-term liability. On a monthly basis, a portion of the payment is alloca ted to principal, which reduces the obligation balance, and interest, computed based on the Company’s incremental borrowing rate. The lease with MedEquities is accounted for as an operating lease under GAAP.

A summary of the Company’s financing lease obligation is as follows (in thousands):

11.  Stockholders’ Equity and Stock Based Compensation

Stock Based Compensation Plans

The Company granted 408,000 and 110,000 shares of restricted common stock as part of the 2014 Equity Incentive Plan as amended from time to time (the “Plan”) during the nine months ended September 30, 2017 and 2016, respectively. The restricted common stock granted during the nine months ended September 30, 2017 vest annually over a period of three years beginning on December 31, 2017. The restricted common stock granted during the nine months ended September 30, 2016 vest quarterly over a period of three years beginning on March 31, 2016. Additionally, the Company granted 38,000 and 30,000 shares of fully vested common stock during the nine months ended September 30, 2017 and 2016, respectively, to its five non-employee directors pursuant to the Plan. The Company recognized $0.3 million and $0.5 million of compensation expense for the nine months ended September 30, 2017 and 2016, respectively, as a result of the non-employee director grants.

  The Company recognized $1.9 million and $2.1 million in equity-based compensation expense for the three months ended September 30, 2017 and 2016, respectively. The Company recognized $6.0 million and $6.8 million in equity-based compensation expense for the nine months ended September 30, 2017 and 2016, respectively. As of September 30, 2017, there was $6.8 million of unrecognized compensation expense related to unvested restricted stock, which is expected to be recognized over the remaining weighted average vesting period of 1.9 years.  

A summary of share activity under the Plan is set forth below:

Employee Stock Purchase Plan

For the nine months ended September 30, 2017 and 2016, the Company issued 97,589 and 44,174 shares of the Company’s common stock under its Employee Stock Purchase Plan, as amended from time to time (“ESPP”), respectively, for an aggregate purchase price of $7.09 and $18.71, respectively.

For both the three months ended September 30, 2017 and 2016, the Company recognized $0.1 million of compensation expense related to the ESPP. For the nine months ended September 30, 2017 and 2016, the Company recognized $0.2 million and $0.3 million of compensation expense related to the ESPP, respectively.

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12. Income Taxes

The provision for income taxes for the three and nine months ended September 30, 2017, both reflect an income tax benefit of $0.5 million, at an effective tax rate of 55.6% and 8.6%, respectively. The provision for income taxes for the three and nine months ended September 30, 2016 reflects an income tax benefit of $0.8 million and $0.9 million, respectively, at an effective rate of 15.9% and 16.6%, respectively. The change in effective tax rate is primarily due to the effect of permanent tax differences when compared to pre-tax book loss as well as discrete items pertaining to stock compensation.

The Internal Revenue Service is currently conducting a routine examination of the Company’s 2013 and 2014 tax returns. The results of such examination and impact on the Company’s results of operation are not known at this time.

13.  Fair Value of Financial Instruments

The carrying amounts reported at September 30, 2017 and December 31, 2016 for cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable and accrued liabilities approximate fair value because of the short-term maturity of these instruments.

The Company has debt with variable interest rates. The fair value of this debt was measured using Level 2 inputs, including good faith estimates of the market value for the particular debt instrument, which represent the amount an independent market participant would provide based upon market observations and other factors relevant under the circumstances. The carrying value of such debt approximated its estimated fair value at September 30, 2017 and December 31, 2016.

Prior to terminating the interest rate swap agreements on June 29, 2017, the Company had entered into the agreements to manage exposure to fluctuations in interest rates. Fair value of the interest rate swaps was determined using a pricing model based on published interest rates and other observable market data. The fair value was determined after considering the potential impact of collateralization, adjusted to reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk. The fair value measurement of interest rate swaps utilized Level 2 inputs. Refer to Note 9 (Debt) for further discussion of the interest rate swap agreements.

14.  Commitments and Contingencies

Litigation

Shareholder Litigation

On August 24, 2015, a shareholder filed a purported class action in the United States District Court for the Middle District of Tennessee against the Company and certain of its current and former officers ( Kasper v. AAC Holdings, Inc. et al.) . The plaintiff generally alleges that the Company and certain of its current and former officers violated Sections 10(b) and/or 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder by making allegedly false and/or misleading statements and failing to disclose certain information. On September 14, 2015, a second class action against the same defendants asserting essentially the same allegations was filed in the same court ( Tenzyk v. AAC Holdings, Inc. et al.) . On October 26, 2015, the court entered an order consolidating these two described actions into one action. On April 14, 2016, the Company and the individual defendants filed a motion to dismiss the complaint for failure to state a claim. On July 1, 2016, the court denied the motion to dismiss. On July 14, 2017, the court granted the plaintiffs’ motion for class certification. In a related matter, on November 28, 2015, a shareholder filed a derivative action on behalf of AAC Holdings, Inc. in the Eighth Judicial District Court for Clark County, Nevada ( Bushansky v. Jerrod N. Menz et al.)  against AAC Holding’s board of directors and certain of its officers alleging that these directors and officers breached their fiduciary duties and engaged in mismanagement and illegal conduct. On January 19, 2016, the Court entered an Order staying this litigation pending the earlier of the close of discovery in the related securities class action pending in Tennessee or the deadline for appealing any dismissal of the securities class action. The Company is vigorously defending these actions and is also engaged in informal settlement discussions to resolve these actions. It is reasonably possible that the Company may incur a loss in connection with these matters. The Company is unable to reasonably estimate the amount or range of any such loss given that the matter is still in discovery. Any loss incurred in connection with adverse outcomes in these matters could be material. 

RSG Litigation

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

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Other

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

15.  Subsequent Events

On October 6, 2017, in conjunction with the Company’s pending acquisition of AdCare, the Company secured a $65.0 million incremental term loan commitment in conjunction with the 2017 Credit Facility, subject to customary closing conditions and regulatory provisions. In connection with the financing, the Company committed to a ticking fee that commenced on October 17, 2017, at a rate of LIBOR plus 3.375%, and will increase to LIBOR plus 6.75% for November 2017 through the closing date of the acquisition.

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