AAC Ares Acquisition Corporation

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Unaudited

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 inpatient and outpatient substance use treatment services for individuals with drug addiction, alcohol addiction and co-occurring mental/behavioral health issues. In connection with the Company’s substance use treatment services, the Company performs drug testing, diagnostic laboratory services and provides physician services to clients. T he Company operates numerous facilities located throughout the United States, including inpatient substance abuse treatment facilities, standalone outpatient centers and sober living facilities that focus on delivering effective clinical care and treatment solutions.

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 June 30, 2018 and 2017. The Professional Groups are responsible for the supervision and delivery of medical services to the Company’s clients, and 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 June 30, 2018 and December 31, 2017 include assets of $1.0 million and $2.1 million, respectively, and liabilities of $0.7 million and $0.4 million, respectively related to the VIEs. The accompanying condensed consolidated statements of operations include net loss attributable to noncontrolling interest of $2.0 million and $1.0 million for the three months ended June 30, 2018 and 2017, respectively, and net loss of $3.9 and $2.0 million for the six months ended June 30, 2018 and 2017, respectively.

The accompanying condensed consolidated financial statements are unaudited, with the exception of the December 31, 2017 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, 2017 included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission (the “SEC”) on February 23, 2018. 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, 2018 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 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 an 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 statements of operations. 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.

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AAC Holdings, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In May 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers” (“Topic 606”), which outlines a five-step model for recognizing revenue and supersedes most existing revenue recognition guidance, including guidance specific to the healthcare industry. The core principle of the new standard is that a company should recog nize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. The two permitted transition methods under the new standard are the full retrospective method and the modified retrospective approach. The guidance was effective January 1, 2018, and was applied to all contracts on a modified retrospective basis.

The Company has analyzed the impact of the standard based on a review of its accounting policies and practices in relation to the five-step model to ensure proper assessment of operating results under Topic 606.

The analysis of the Company’s processes under the new revenue standard is complete and supports the recognition of revenue over time as clients simultaneously receive and consume the benefits of the services provided. However, the adoption of the standard has an impact on the presentation of revenue recognized and the provision for doubtful accounts due to additional requirements within Topic 606. As a result of these new requirements, substantially all of the Company’s adjustments related to bad debt will now be recorded as a direct reduction to revenue as opposed to the provision for doubtful accounts included within operating expenses.

The only activity that will be recorded in operating expenses from 2018 onward will be bad debt related to specific customers that experience significant adverse changes in creditworthiness, such as bankruptcies. The Company recorded $0.4 million of expense related to one of our digital outreach platform customers during the quarter ended June 30, 2018.

The initial application of Topic 606 had no impact to the beginning balances of the Company's consolidated financial statements as of January 1, 2018. In adopting Topic 606, the Company elected the practical expedients related to immaterial contract acquisition costs and insignificant financing components of the transaction price.

For the three and six months ended June 30, 2018, t he impact on the Company's Condensed Consolidated Statements of Operations was as follows (in thousands):

3 .   Client Related Revenue and Non-Client Related Revenue

Client Related Revenue

Client related revenue primarily consists of service charges related to providing addiction treatment and related services, including diagnostic laboratory services. As it relates to recognizing revenue, the Company’s contracts are with the individuals for whom the Company provides care. The majority of the Company’s contracts with clients have a single performance obligation because the promise to deliver services is not separately identifiable from other promises in the contracts. The Company’s performance obligations are satisfied over time as clients simultaneously receive and consume the benefits provided. Therefore, the Company recognizes revenue in the same period the services are performed, and there are no remaining performance obligations at period-end.

Due to the nature of the industry, there are often more than two parties to the service transactions (including customers, providers and payors), and the estimation of revenue is complex and requires significant judgment. Management estimates variable consideration using the expected value method. The expected value method is used when an entity has a large number of contracts with similar characteristics, as is the case with the Company’s contracts. The transaction price is recorded based on the estimated ultimate value remaining after all uncertainty is resolved. The estimates of variable consideration are based largely on an assessment of the Company’s anticipated performance as well as historical, current, and forecasted information. The Company updates its estimate of the transaction price at the end of each reporting period, and any amounts allocated to a satisfied performance obligation are recognized as revenue or a reduction of revenue in the period in which the transaction price changes.

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AAC Holdings, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The follow ing tables summarize the composition of our client related revenue for inpatient treatment facility services, outpatient facility and sober living services, and client related diagnostic services. Inpatient treatment facility services include revenues from related professional services, and client related diagnostic services includes revenues from point of care services as well as laboratory services.

For the three months ended June 30, 2018 and 2017, on an as reported basis (in thousands):

For the three months ended June 30, 2018 and 2017, on a comparable accounting basis as if the Company had not adopted Topic 606 (in thousands):

For the six months ended June 30, 2018 and 2017, on an as reported basis (in thousands):

For the six months ended June 30, 2018 and 2017, on a comparable accounting basis as if the Company had not adopted Topic 606 (in thousands):

Non-Client Related Revenue

Non-client related revenue consists of diagnostic laboratory services provided to clients of third-party addiction treatment providers, addiction care treatment services for individuals in the criminal justice system and services provided to third-party behavioral health providers who use our digital outreach platforms.

Revenue from diagnostic laboratory services provided to clients of third-party addiction treatment providers is recognized at the point in time when the order is completed. These contracts have a single performance obligation, and the transaction price is agreed upon between the Company and the third-party lab provider to services being rendered.

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AAC Holdings, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Revenue for addiction care treatment services for individuals in the criminal justice system is recognized as services are provided in accordance with contracts with certain Massachusetts state agencies.

Revenue from third-party behavioral health providers who use our digital outreach platforms is recognized over time as these customers simultaneously receive and consume the benefits of the services provided. The Company’s marketing contracts typically have one performance obligation. There are no significant judgments in determining the transaction price as the price is listed in the contract and not subject to change.

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 $21.3 million and $17.6 million for the three months ended June 30, 2018 and 2017, respectively, and $43.3 and $36.7 million for the six months ended June 30, 2018 and 2017, respectively.

5.   Earnings (Loss) Per Share

Basic earnings (loss) 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, and outstanding convertible debt securities. Diluted EPS attributable to common stockholders is computed by dividing net income attributable to common stockholders by the weighted average number of diluted common shares outstanding during the period.

The following table presents the components of the numerator and denominator used in the calculation of basic and diluted EPS for the three and six months ended June 30, 2018 and 2017 (in thousands, except share data):

For the three months ended June 30, 2018 and 2017, t he Company had 156,779 and 11,985 potentially dilutive shares, respectively. For the six months ended June 30, 2018 and 2017, the Company had 90,288 and 23,970 potentially dilutive shares, respectively. These dilutive shares are not included in the diluted EPS calculation above because to do so would be anti-dilutive for the periods presented.

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AAC Holdings, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

6.   Acquisition

On March 1, 2018, the Company acquired all of the outstanding shares of AdCare, Inc., a Massachusetts corporation (“AdCare”), and wholly owned subsidiary of AdCare Holding Trust, a Massachusetts business trust (the “Seller”), which we refer to as the “AdCare Acquisition.” AdCare and its subsidiaries offer treatment of drug and alcohol addiction and own, among other things, a 114-bed hospital, five outpatient centers in Massachusetts, a 59-bed residential inpatient treatment center and two outpatient centers in Rhode Island. AdCare was purchased for total consideration of $83.9 million, subject to adjustments as set forth in the Securities Purchase Agreement (the “Purchase Agreement”), by and among AAC Healthcare Network, Inc., AAC Holdings, AdCare, and the Seller. The consideration was comprised of (i) approximately $65.2 million in cash, excluding expenses and other adjustments, (ii) approximately $5.4 million in shares of AAC Holdings’ common stock (or 562,051 shares at $9.68 per share), (iii) a promissory note in the aggregate principal amount of approxima tely $9.6 million (the “AdCare Note”), and (iv)  contingent consideration valued at $0.9 million recorded in accrued and other current liabilities. The Company acquired $2.7 million of cash on hand at AdCare, which was returned to the Seller within 60 days of the acquisition as required by the Purchase Agreement. The contingent consideration that can be earned by the seller ranges from zero to $3.1 million, subject to achievement of a certain adjusted EBITDA target over the 12 months following the transactio n date.

FASB ASC 805 requires that the fair value of a contingent consideration liability be updated at each reporting period until the contingency is resolved. The Company remeasured the fair value of the contingent consideration related to the AdCare Acquisition as of June 30, 2018 and determined that the fair value as of this date was $0.7 million. The decrease in the fair value of $0.2 million was included as an acquisition related expense for the three months ended June 30, 2018.

The AdCare Acquisition was accounted for as a business combination in accordance with FASB ASC 805,  Business Combinations . For U.S. federal income tax purposes, the Purchase Agreement contemplates that the AdCare Acquisition shall be treated as an “applicable asset acquisition” as defined in Section 1060 of the Code. The Company recorded the transaction based upon the fair value of the consideration paid. This consideration was preliminarily allocated to the fair value of the assets acquired and liabilities assumed on the acquisition date. The Company is further assessing the valuation of receivables, assumed liabilities, real property, intangible assets, and contingent consideration, some of which are dependent on the completion of the valuation assessment being performed by independent specialists.

The preliminary allocation of assets acquired and liabilities assumed on the acquisition date, based on the fair value of AdCare, is as follows (in thousands):

Acquisition-related costs for the transaction were recorded as acquisition-related expenses in the consolidated statements of operations.

Total AdCare revenue and income before income tax expense from the date of acquisition through June 30, 2018 was approximately $17.2 million and $ 2.3 million, respectively. The following pro forma results of operations of the Company for the three and six months ended June 30, 2018 and June 30, 2017, are presented as if the AdCare Acquisition had occurred on January 1, 2017.

The pro forma loss before income tax benefit for six months ended June 30, 2018 was adjusted to exclude approximately $0.4 million of nonrecurring acquisition costs and to include additional interest expense of $0.4 million and depreciation and amortization expense of $0.2 million.

The pro forma loss before income tax benefit for the three months ended June 30, 2017 was adjusted to include additional interest expense of $1.5 million and depreciation and amortization expense of $0.2 million. The pro forma loss before income tax benefit for the six months ended June 30, 2017 was adjusted to include additional interest expense of $3.0 million and depreciation and amortization expense of $0.5 million.

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7.   Accounts Receivable

For the six months ended June 30, 2018, approximately 12.4% of the Company’s revenues were reimbursed by Anthem Blue-Cross Blue-Shield of Texas and 10.3% were reimbursed by Blue-Cross Blue-Shield of Florida. No other payor accounted for more than 10.0% of revenue reimbursements for the six months ended June 30, 2018.

For the six months ended June 30, 2017, approximately 11.1% of the Company’s revenues were reimbursed by Anthem Blue-Cross Blue-Shield of Nevada, 10.2% were reimbursed by Blue-Cross Blue-Shield of Florida and 10.0% were reimbursed by Blue-Cross Blue-Shield of Texas. No other payor accounted for more than 10.0% of revenue reimbursements for the six months ended June 30, 2017.

As of June 30, 2018, substantially all accounts receivable aged greater than 360 days were fully reserved in our condensed consolidated financial statements.

The following table presents a summary of our aging of accounts receivable, net of the allowance for doubtful accounts as of June 30, 2018 and 2017:

Approximately $12.3 million and $14.6 million of accounts receivable, net of the allowance for doubtful accounts, at June 30, 2018 and December 31, 2017, 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 remaining balance. An account is written off only after the Company has pursued collection efforts or otherwise determines an account to be uncollectible.

8.   Property and Equipment, Net

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

For the three months ended June 30, 2018 and 2017, depreciation expense was $5.4 million and $4.7 million, respectively.

For the six months ended June 30, 2018 and 2017, depreciation expense was $10.5 million and $9.7 million, respectively.

9.   Goodwill and Intangible Assets

The Company has only one operating segment, substance use and behavioral healthcare treatment services, for segment reporting purposes. The substance abuse and 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 has no intangible assets with indefinite useful lives other than goodwill. The Company performed its most recent goodwill impairment testing as of December 31, 2017 and did not incur an impairment charge.

12

AAC Holdings, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

The Company’s goodwill balance as of June 30, 2018 and December 31, 2017 was $197.2 and $ 134.4 million, respectively. The increase in goodwill is due to the AdCare Acquisition as shown below and discussed in Note 6 (Acquisition) (in thousands):

Other identifiable intangible assets and related accumulated amortization consisted of the following as of June 30, 2018 and December 31, 2017 (in thousands):

Amortization expense for the three months ended June 30, 2018 and 2017 was $0.5 million and $0.4 million, respectively.

Amortization expense for the six months ended June 30, 2018 and 2017 was $0.9 million and $0.8 million, respectively.

A ll intangible assets are amortized using the straight-line method. The following table presents amortization expense expected to be recognized during fiscal years subsequent to June 30, 2018 (in thousands):

10.   Debt

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

13

AAC Holdings, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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 matures on June 30, 2023 and requires quarterly principal repayments in an amount equal to $ 1.7 million for September 30, 2017 through June 30, 2019, $3.4 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 matures on June 30, 2022. A s of June 30, 2018, there was an outstanding balance of $32.0 million under the 2017 Revolver .

The 2017 Credit Facility also includes an incremental facility allowing 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 effect 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 (as defined in the 2017 Credit Facility) 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 o r additional lenders.

On September 25, 2017, the Company obtained the 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.

On March 1, 2018, in conjunction with the AdCare Acquisition, the Company borrowed $65.0 million of Incremental Term Loans under the 2017 Credit Facility. The Company incurred approximately $2.6 million in deferred financing costs related to underwriting and other professional fees as a result of the $65.0 million Incremental Term Loan borrowing.

Borrowings under the 2017 Credit Facility bear intere st at a rate tied to the Alternative Base Rate (as defined in the 2017 Credit Facility) or the Adjusted London Interbank Offered Rate (“LIBOR”) (at the Company’s option). ABR Loans (as defined in the 2017 Credit Facility) made under the 2017 Revolver bear interest at a rate per annum equal to the Alternative Base Rate plus 5.0% per annum. ABR Loans made under the 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.

The Company is permitted to voluntarily reduce the unutilized portion of the commitment amount and repay outstanding loans under the 2017 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% premium if paid after the second anniversary of the closing but before the third anniversary of the closing.

14

AAC Holdings, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

In addition, the 2017 C redit 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 deferred financing costs related to the initial 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 June 30, 2018, $300.9 million was outstanding under the 2017 Credit Facility, including $32.0 million related to the 2017 Revolver and $268.9 million related to the 2017 Term Loan. The Company’s availability under the 2017 Revolver was $23.0 million, less $5.0 million of outstanding letters of credit.

As of June 30, 2018, the Company was in compliance with all applicable covenants under the 2017 Credit Facility.

Subordinated Note

On March 1, 2018, in conjunction with the AdCare Acquisition, in consideration for covenants and agreements set forth in the Purchase Agreement, the Company issued the AdCare Note to the Seller, in the original principal amount of $9.6 million, which matures on September 29, 2023 and accrues interest at a fixed rate per annum equal to 5.0%, compounded annually. Payments of principal and interest pursuant to the AdCare Note commenced on April 30, 2018 and will continue until the maturity date.

2015 Credit Facilities

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. The 2015 Credit Facility initially consisted of a $50.0 million revolving credit facility and a $75.0 million term loan. In connection with entering into the 2017 Credit Facility on June 30, 2017, all amounts outstanding under the 2015 Credit Facility were fully repaid.

15

AAC Holdings, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

On October 2, 2015, the Company entered into two financing facilities with affiliates of Deerfie ld 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 Cre dit Facility on June 30, 2017, all amounts outstanding under the Deerfield Facility were fully repaid.

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 financing costs.

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. As of December 31, 2017, there was no remaining liability related to the interest rate swap agreements. Refer to Note 14 (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.

11.   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 1.5% from 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 increase will always be between 1.5% and 3.0%.

Due to the nature of the agreement between MedEquities and the Company, the transaction did not qualify for sale-leaseback accounting under GAAP. Therefore, the Sale-Leaseback Facilities remain on the Company’s balance sheets and continue to be depreciated over their remaining useful lives. The Company accounted for the $25.0 million of proceeds, less $0.4 million of transaction costs, as a financing obligation, of which $0.1 million was classified as a short-term liability. On a monthly basis, a portion of the payment is allocated to principal, which reduces the obligation balance, and interest, computed based on the Company’s incremental borrowing rate at the time of the transaction.

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

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AAC Holdings, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

12.   Stockholders’ Equity and Stock Based Compensation

Stock Based Compensation Plans

The Company granted 150,000 and 408,000 shares of restricted common stock to certain of its employees as part of the 2014 Equity Incentive Plan, as amended from time to time (the “Plan”), during the six months ended June 30, 2018 and 2017, respectively. These restricted common shares vest annually over a period of three years beginning on December 31 of the year the restricted common stock was granted. Additionally, the Company granted 36,000 and 38,000 shares of fully vested common stock during the six months ended June 30, 2018 and 2017, respectively, to its non-employee directors pursuant to the Plan. The Company recognized $0.4 million and $0.3 million of compensation expense for the six months ended June 30, 2018 and 2017, respectively, as a result of the non-employee director grants.

The Company recognized $1.4 million and $2.1 million in equity-based compensation expense for the three months ended June 30, 2018 and 2017, respectively. The Company recognized $2.2 million and $4.2 million in equity-based compensation expense for the six months ended June 30, 2018 and 2017, respectively. As of June 30, 2018, there was $3.8 million of unrecognized compensation expense related to unvested restricted stock, which is expected to be recognized over the remaining weighted average vesting period of 1.7 years.  

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

Employee Stock Purchase Plan

For the six months ended June 30, 2018 and 2017, the Company issued 27,900 and 50,362 shares, respectively, of the Company’s common stock under its Employee Stock Purchase Plan, as amended from time to time (“ESPP”).

For both the six months ended June 30, 2018 and 2017, the Company recognized $0.1 million of compensation expense related to the ESPP.

Registration Statement

On June 8, 2018, the Company filed a shelf registration statement on Form S-3 (File No. 333-225536) with the SEC (the “Registration Statement”). The Registration Statement, which was declared effective by the SEC on June 22, 2018, permits us to offer to the public from time to time in one or more offerings issue up to an aggregate of $150.0 million in securities, consisting of common stock, preferred stock, warrants and units, at prices and on terms that the Company will decide at the time of any offering. To date, no securities have been issued pursuant to the Registration Statement.

13.   Income Taxes

The provision for income taxes for the three and six months ended June 30, 2018 reflects an income tax benefit of $ 0.1 million and $1.6 million, respectively, at an effective tax rate of 1.7 % and 18.2%, respectively.

The provision for income taxes for the three and six months ended June 30, 2017 reflects an income tax expense of $0.6 million and an income tax benefit of $3,000, respectively, at an effective tax rate of 24.1% and 0.1%, respectively.

The increase in income tax benefit from the comparable periods in 2017 and the change in the effective tax rate is primarily related to  the tax treatment of stock compensation, litigation settlement expense and the effect of the Tax Cuts and Jobs Act.

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14.   Fair Value of Financial Instruments

The carrying amounts reported at June 30, 2018 and December 31, 2017 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 June 30, 2018 and December 31, 2017.

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 the Company’s nonperformance risk and the respective counterparty’s nonperformance risk. The fair value measurement of interest rate swaps utilized Level 2 inputs. Refer to Note 10 (Debt) for further discussion of the interest rate swap agreements.

15.   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 alleged 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. On December 28, 2017, the parties entered into a settlement term sheet with the plaintiffs’ representatives to memorialize an agreement in principle to settle the litigation. On February 15, 2018, the parties entered into a Stipulation of Settlement, consistent with the December 28, 2017 agreement in principle, that provided for defendants’ payment of an aggregate settlement amount of $25,000,000 (which includes attorneys’ fees to be approved by the court) to establish a settlement fund (the “Settlement Fund”). The Stipulation of Settlement provides that the Settlement Fund was to be funded as follows: (a) defendant Jerrod N. Menz will sell 300,000 shares and contribute the cash derived from such sale(s) to the Settlement Fund; and (b) the Company and individual defendants will pay in cash the difference, if any, between the Settlement Fund and the stock component addressed in (a). The Stipulation of Settlement includes the dismissal of all claims against the Company and the individual defendants, a denial by defendants of any wrongdoing and no admission of liability. On March 7, 2018, the court entered an order preliminarily approving the settlement. On March 23, 2018, the Company paid the full amount of the Settlement Fund and is preserving its claim to recover the 300,000 shares that Jerrod N. Menz was supposed to contribute. On June 11, 2018, the court entered an order and final judgment consistent with the terms of the parties’ Stipulation of Settlement.

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AAC Holdings, Inc.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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. On February 14, 2018, the parties agreed on a Stipulation of Settlement that provided for (a) implementation of certain corporate governance enhancements; (b) a mutual exchange of releases and dismissal of the litigation with prejudice; (c) denial by defendants of any wrongdoing and no admission of liability; and (d) payment by the Company of $1,000,000 in attorneys’ fees and costs for the benefit brought to the Company as a result of the litigation. On March 15, 2018, the court entered an order preliminarily approving the settlement. On May 7, 2018, the court entered an order and final judg ment consistent with the terms of the parties’ Stipulation of Settlement.

The claims presented for the actions pending in Tennessee and Nevada have been presented to the Company’s insurance carriers, which have denied coverage. However, the Company and insurers have continued to discuss the Company’s demand for coverage. The Company, at this time, is unable to predict what, if any, settlement amount will be contributed by its insurance carriers.

As of December 31, 2017, the Company had accrued $23.3 million in litigation costs related to the Tennessee and Nevada claims ($22.3 million related the Tennessee claim and $1.0 million related to the Nevada claim). The Company paid $25.0 million related to the Tennessee claim and recognized $2.7 million of additional litigation settlement expense in the first quarter of 2018. In the second quarter of 2018, the Company paid the remaining $1.0 million of accrued litigation related to the Nevada claim.

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. On May 10, 2018, defendants filed an amended cross-complaint alleging claims for fraud and reformation of the Securities Purchase Agreement against the plaintiffs. 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.

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. 

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