United States
SECURITIES AND EXCHANGE COMMISSION

For The Fiscal Year Ended December 31, 2004

Commission File Number 333-58246

HYTHIAM, INC.

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act: Common Stock, $0.0001 par value

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES þ NO o

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     As of June 30, 2004, the aggregate market value of the common stock held by non-affiliates of the registrant was approximately $32,625,621 based on the $3.00 closing bid price on Amex on that date. This amount excludes the value of 13,740,000 shares of common stock directly or indirectly held by the registrant’s affiliates.

     As of March 28, 2005 there were 30,115,179 shares of the registrant’s common stock outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

     Portions of the registrant’s proxy statement for its 2005 annual meeting of stockholders to be held on June 17, 2005, are incorporated by reference into Part III of this report.

HYTHIAM, INC.
Form 10-K Annual Report
For The Fiscal Year Ended December 31, 2004

TABLE OF CONTENTS

Forward-Looking Statements

     This report contains forward-looking statements that involve risks and uncertainties. Our actual results may differ materially from those discussed due to factors such as, among others, limited operating history, difficulty in developing, exploiting and protecting proprietary technologies, intense competition and substantial regulation in the healthcare industry. Additional information concerning factors that could cause or contribute to such differences can be found in the following discussion, including the “Risks Factors” section below, as well as in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

ITEM 1. BUSINESS

Overview

     Hythiam, Inc. is a development stage healthcare services management company, focused on delivering solutions for those suffering from alcoholism and other substance dependencies. We research, develop, license and commercialize innovative physiological treatment protocols for substance dependence. Our HANDS Protocols™ are designed for use by healthcare providers to treat those diagnosed with dependence to alcohol, cocaine, methamphetamine, as well as combinations of these drugs. Specifically, there are two HANDS Protocols: the HANDS Protocol™ for Alcohol Dependence and the HANDS Protocol™ for Stimulant Dependence (or combined dependence to alcohol and stimulants). Changes in the neurochemistry of the brain underlie the hallmarks of substance dependence, including craving, tolerance, withdrawal symptoms and relapse. The HANDS Protocols include medically supervised procedures designed to target receptor sites in the brain that regulate neurotransmitters implicated in brain processes of substance dependence. The HANDS Protocols also provide for a maintenance program that includes medications and incentives for patients to continue with their recovery process through individualized continuing care programs. As a result, our HANDS Protocols represent a comprehensive approach to managing substance dependence that is designed to address both the physiological and psychological aspects of the disease, thereby offering patients an opportunity to transition into a healthier lifestyle.

     We generate revenues by charging fees to licensed healthcare providers for access to our proprietary protocols for use in treating their patients. We also provide proprietary administrative services to assist physicians and facilities with staff education, marketing and sales support, and outcomes tracking for data analysis. We intend to provide leased space and management services to a physician practice in 2005 under a management services contract with an affiliated physician group.

     We have been unprofitable since our inception and may incur substantial additional operating losses for at least the next twelve months as we incur expenditures on research and development, implement commercial operations and allocate significant and increasing resources to sales, marketing and other start-up activities. Accordingly, our activities to date are not as broad in depth or scope as the activities we may undertake in the future, and our historical operations and financial information are not necessarily indicative of the future operating results or financial condition or ability to operate profitably as a commercial enterprise.

     We do not currently operate our own healthcare facilities, employ our own treating physicians or provide medical advice or treatment to patients. The hospitals, licensed healthcare facilities, and physicians that contract for the use of our technology own their facility or professional license and control and are responsible for the clinical activities provided on their premises. Following the treatment procedure, local clinics and healthcare providers specializing in drug abuse treatment administer and provide aftercare treatment.

     Patients receive medical care in accordance with orders from their attending physicians. Each physician with license rights to use the HANDS Protocols is responsible for exercising their own independent medical judgment in determining the specific application of our protocols, and the appropriate course of care for each patient.

     No employment relationship currently exists between us and the attending physicians who treat patients using our protocols. In the course of performing our administrative duties, we may bill and collect funds from patients on behalf of the healthcare provider, and, in accordance with directions from the providers, disburse a portion of that money to the facility and/or to the attending physician for professional services rendered.

     We believe that the structure of our business and operations as outlined above will be in substantial compliance with applicable laws and regulations. However, the healthcare industry is highly regulated, and the criteria are often vague and subject to change and interpretation by various federal and state legislatures, courts, and enforcement and regulatory authorities. Our commercial viability is therefore subject to the legal and regulatory risks outlined in the “Risk Factors” section of this Report.

Background on Substance Dependence

     Substance dependence disorders comprise a worldwide public health problem that affects many people and has wide-ranging social consequences. In 2002, an estimated 22 million Americans suffered from substance dependence or abuse due to drugs, alcohol or both, according to the National Survey on Drug Use and Health published by the Substance Abuse and Mental Health Services Administration (SAMHSA) in the U.S. Department of Health and Human Services. Summarizing data from the Office of National Drug Control Policy (ONDCP) and the National Institute on Alcohol Abuse and Alcoholism (NIAAA), the economic cost of alcohol and drug abuse exceeds $345 billion annually in the U.S., of which the health care component is over $41 billion and productivity losses account for approximately $245 billion. In comparison, the National Cancer Institute estimates that 9.6 million Americans suffer from cancer, and the Centers for Disease Control report on the Health Burden of Chronic diseases projects the economic cost of cancer in 2002 to total more than $170 billion, consisting of over $60 billion in direct medical costs, and over $110 billion for indirect costs such as lost productivity.

     Historically, the disease of substance dependence has been treated primarily through behavioral intervention, with fairly high relapse rates. SAMHSA reports that only 54% of those treated for alcoholism and 51% of those treated for cocaine and other stimulants complete the detoxification procedure. SAMHSA’s Drug and Alcohol Services Information System states that treatment completion rates in 2000 for outpatient treatment were only 41% for alcohol and 20% for cocaine. For patients who do complete treatment, the NIAAA reports relapse rates three months following treatment for alcohol dependence to be 50%. For the treatment of cocaine dependence, the Drug Abuse Treatment Outcome Survey (DATOS) reports a relapse rate of 69% one year following 90 days or less of outpatient treatment and 80% one year following 90 days or less of long-term residential treatment.

     Those suffering from alcohol and/or drug dependence have often been characterized as having social disorders or a lack of self-discipline and, as noted above, there are relatively high relapse rates utilizing conventional treatment methodologies. While we believe the psychological approach to substance dependence treatment is important, we recognize that physiological factors should be addressed first to provide the patient the best chance for recovery. We believe our physiological approach, focused on addressing the neurochemical imbalances in the brain caused or worsened by substance dependence, provides a substantial commercial opportunity.

Substance Dependence as a Disease

     Recent scientific research provides evidence that not only can drugs interfere with normal brain functioning but can also have long-lasting effects that persist even after the drug is no longer being used. At some point, changes may occur in the brain that can turn drug and alcohol abuse into substance dependence, a chronic, relapsing and sometimes fatal disease. Those dependent on drugs may suffer from compulsive drug craving and usage and be unable to quit by themselves. Professional medical treatment is often necessary to end this physiologically based compulsive behavior.

     We believe that the ability to successfully treat the physiological basis of substance dependence can improve treatment outcome, reduce the cost of treating dependence, and reduce cost to society of managing adverse consequences of alcohol and drug abuse, decreasing related criminality and violence, and reducing the costs associated with high risk behavior. According to NIAAA, 44% of all deaths due to liver cirrhosis are alcohol related, with most of these deaths occurring in people 40 to 65 years old. One study found that 20 to 37% of all emergency room trauma cases involve alcohol use (Roizen, J., Alcohol and Trauma, 1988). Another study evaluated the incidence of cardiomyopathy in asymptomatic alcoholic men, finding that 46% exhibited evidence of cardiomyopathy (Rubin, E., The Effects of Alcoholism on Skeletal and Cardiac Muscle, 1989).

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     The consequences of alcoholism and alcohol abuse affect most American families. One study estimated that 20-25% of all injury-related hospital admissions are the result of alcoholism or alcohol problems (Waller J., Diagnosis of Alcoholism in the Injured Patient, 1988). According to the National Commission Against Drunk Driving, nearly 600,000 Americans are injured in alcohol-related traffic crashes each year, resulting in 17,000 fatalities.

     Cocaine and crack use place a heavy load upon our criminal justice system. According to a Bureau of Justice Statistics Bulletin, “Prisoners in 2001,” published in August 2002, approximately 20% of the 1.2 million state and 55% of the 143,000 federal prisoners were convicted of drug offenses. The ONDCP reports that over 30% of all arrestees test positive for cocaine or crack. In 2001, over 17% of all Federal defendants were charged with cocaine/crack drug offenses.

     The consequences of cocaine and crack use extend beyond the criminal justice system. The National Institute on Drug Abuse (NIDA) reports the medical complications of cocaine use to include heart arrhythmias and heart attacks, chest pain and respiratory failure, strokes, seizures, and headaches, as well as abdominal pain and nausea. NIDA also notes that there have been no medications available to treat cocaine dependence.

     Methamphetamine abuse is now recognized as a major problem in the U.S. The 2003 National Survey on Drug Use and Health reports that approximately 12.3 million Americans ages 12 and older reported trying methamphetamine at least once during their lifetimes, representing 5.2% of the population ages 12 and older, an increase from just under 2% of the adult population in 1994. According to the ONDCP December 2001, publication, “What America’s Users Spend on Illegal Drugs,” there was a significant increase in methamphetamine users during the last decade. In 2000 the number of chronic users was reported to be 595,000, more than double the 259,000 users reported in 1990. Findings from The Drug and Alcohol Services Information System (DASIS) Report published by the Office of Applied Studies, SAMHSA, in September 2004, show that methamphetamine hospital admissions have increased from 1% in 1992 to 7% in 2002.

     According to a NIDA Research Report “Methamphetamine: Abuse and Addiction” (January 2002), the effects of methamphetamine use can include addiction, psychotic behavior, and brain damage. Methamphetamine is highly addictive and users trying to abstain from use may suffer withdrawal symptoms that include depression, anxiety, fatigue, paranoia, aggression, and intense cravings for the drug. Chronic methamphetamine use can cause violent behavior, anxiety, confusion, and insomnia. Users can also exhibit psychotic behavior including auditory hallucinations, mood disturbances, delusions, and paranoia, possibly resulting in homicidal or suicidal thoughts. According to NIDA’s report “Methamphetamine Linked to Long-Term Damage to Brain Cells” (March 2000), use of methamphetamine can cause damage to the brain that is detectable months after the use of the drug. The damage to the brain caused by methamphetamine use is similar to damage caused by Alzheimer’s disease, stroke, and epilepsy.

Development of the Company

     We have acquired, licensed and developed proprietary, patented and patent-pending treatment protocols designed to treat the physiological component of the disease of substance dependence. Our first such proprietary technology, the HANDS Protocols, are designed for those diagnosed with dependencies to alcohol, cocaine, methamphetamine, or a combination of these drugs. Specifically, there are two HANDS Protocols: the HANDS Protocol for Alcohol Dependence and the HANDS Protocol for Stimulant Dependence (or combined dependence to alcohol and stimulants). The HANDS Protocols are medically supervised procedures designed to correct the neurochemical imbalances and alteration in brain neuroreceptors induced or made worse by chronic heavy use of alcohol or stimulant drugs. The protocols provide for nutritional supplementation, one-month of pharmacotherapy, and incentives for patients to participate in psychosocial or other recovery-oriented therapy of their choice. The HANDS Protocols are designed to minimize withdrawal symptoms, reduce cravings, and provide patients with aftercare support as they progress through the recovery process. Initiation of the HANDS Protocols offers the convenience of a 2 to 3 day treatment. In summary, the HANDS Protocols represent a medically supervised approach to treatment rooted in the belief that by addressing the underlying physiologic aspects of substance dependence, dependent persons may be afforded an opportunity to better address the behavioral and environmental components of their disease.

     Retrospective data collected from patients treated with the HANDS Protocols at our first U.S. licensee treatment center suggest promising results in terms of treatment completion rates, abstinence rates and reduction of cravings based on patient follow-up ranging from three to twelve months post treatment. These limited initial results were not obtained by formal research studies, may not be statistically significant, have not been subjected to detailed scientific scrutiny, and may not be indicative of the long-term future performance of our protocols. We are currently in the process of awarding unrestricted grants for research studies of our protocols to generate data on the efficacy of the protocols.

Plan of Operation

     During our initial development stage we have focused on raising capital to fund our development activities, complete the hiring of our senior management team and supporting staff, and the build-out, furnishing and equipping of our corporate offices. We plan to continue to invest in the needed infrastructure, both in management as well as systems and equipment, to develop, market and implement our business plan. Throughout the remainder of the year we will increase our staff, purchase equipment and develop information systems to support new treatment sites which license our HANDS Protocols.

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     Over the coming year, we will continue to implement commercial operations, commence substantial marketing activities, and allocate significant and increasing resources to sales and marketing. We have entered into agreements with fourteen hospitals and licensed healthcare providers to date, of which twelve were signed in the last six months and are in various stages of training and start-up. Our licensees treated 37 patients in 2004, including 14 in the fourth quarter. Little Company of Mary — San Pedro Hospital in Southern California treated 34 of these patients, 11 in the fourth quarter. We intend to enter into agreements with additional hospitals and other healthcare providers to increase both geographic penetration and the number of patients treated. As revenues are generally related to the number of patients treated, key indicators of our financial performance will be the number of facilities and healthcare providers that license our technology, and the number of patients that are treated by those providers using our HANDS Protocols.

     Our protocols are not currently approved for payment by any health insurance company or third-party payor. To date, patients treated with the HANDS Protocol have been substantially private-pay patients.

     Our plan is to apply our technology to an existing industry we view as fragmented with participants that include healthcare providers such as physicians, psychologists, nurses, therapists, interventionists, counselors, hospitals, residential treatment centers, outpatient treatment facilities, and self-help groups. Over time, we expect patients to be referred for treatment by physicians and treatment centers using our technology and through self-referrals, patients’ family members, friends, employers and associated unions, as well as employee assistance programs, criminal justice systems, healthcare providers, third party payors, and government agencies. We believe that the HANDS Protocols can provide a significant improvement to current treatment methodologies by addressing a spectrum of patient needs, including both physiological and psychological elements of substance dependence.

U.S. Market Opportunity

     The U.S. market consists of a broad spectrum of people who are addicted to or have cravings for alcohol, psychostimulants (e.g., cocaine, crack, methamphetamine, crystal meth, speed), tranquilizers and opiates (e.g., heroin, morphine, codeine, methadone, Vicodin®, OxyContin®, Darvon®, Dilaudid®, Demerol®). In 2002, an estimated 22 million Americans suffered from substance dependence or abuse due to drugs, alcohol or both, according to SAMHSA. According to the report, only 3.5 million individuals aged twelve or over received some kind of treatment. Further, according to NIAAA, approximately 50% of people treated for alcohol dependence relapse within three months.

     Relapse rates are higher for those suffering from cocaine dependence as opposed to alcohol. The DATOS reports cocaine relapse rates of 69% after one year for those undergoing 90 days or less of outpatient drug free treatment. For those undergoing 90 days or less of long-term residential treatment, relapse rates were 80% at one year post-treatment.

     There are currently no effective pharmacotherapies for methamphetamine or cocaine dependence.

Development and Acquisition of Our Technology

     Much of our proprietary, patented and patent pending substance dependence technology, currently known as the HANDS Protocols, was developed by Dr. Juan José Legarda, a European scientist educated at the University of London who has spent most of his professional career conducting research related to substance abuse. Through his studies and research, Dr. Legarda discovered the adverse physical effects of substance abuse on the brain and began to develop technologies that specifically focused on the neurochemistry of the brain as a core part of addictive behavior modification.

     In 2002, Dr. Legarda filed Patent Cooperation Treaty (PCT) applications in Spain for treatment protocols that he developed for dependencies to alcohol and cocaine, which remain pending. We acquired the rights to these patent filings in March 2003 through a technology purchase and license agreement with Dr. Legarda’s company, Tratamientos Avanzados de la Adiccion S.L. Subsequent to acquiring these rights, we filed U.S. patent applications based on the prior PCT filings, as well as provisional U.S. patent applications for additional treatment protocols for alcohol, cocaine and other addictive stimulants. If these patents are issued, they will expire 20 years from the dates of original filing. These issued and pending patents and ongoing improvements we continue to research and develop comprise our technology known as the HANDS Protocols.

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Our Innovative Medically Supervised Treatment Options

     Studies published by the National Institute on Drug Abuse (NIDA) and National Institute on Alcoholism and Alcohol Abuse (NIAAA) illustrate the neurochemical and physical changes to the brain wrought by chronic alcohol and drug abuse and dependence.

     While treating the psychological component of the disease is important, we recognize that physiological factors of substance dependence should be addressed first to provide patients with an improved chance for recovery. The HANDS Protocols are innovative medically supervised treatment programs for the treatment of alcohol and/or stimulant dependencies. Specifically, there are two HANDS Protocols: the HANDS Protocol for Alcohol Dependence and the HANDS Protocol for Stimulant Dependence (or combined dependence to alcohol and stimulants). The protocols are designed for use by healthcare providers to treat those diagnosed with dependence to alcohol, cocaine, and methamphetamine, as well as combinations of these drugs, by targeting neurochemical imbalances in the brain that have been caused or worsened by chronic exposure to alcohol and/or stimulants.

     The HANDS Protocols involve administration of pharmaceuticals and nutritional supplementation in a medically supervised setting which is initiated over a period of 2 to 3 consecutive days. The HANDS Protocol for Stimulant Dependence (or combination stimulant and alcohol dependence) also provides for a second medically supervised procedure of 2 consecutive days about 3 weeks after the initial treatment. An initial assessment is done prior to beginning the HANDS Protocol. The HANDS Protocol includes a comprehensive medical exam along with orally and intravenously administered medications and nutritional supplements. The intravenous treatment sessions typically last about 4 hours. While there may be mild discomfort from preparing and removing the I.V. (for intravenous administration of medications), the HANDS Protocols are designed to ensure that the patient is as comfortable as possible throughout the medically supervised procedures. The HANDS Protocols are designed to minimize patient sedation. Some of the medications in the treatment regimen may cause temporary drowsiness.

     For those patients who receive their treatment in a hospital, or “inpatient” setting, the balance of time spent at the treatment facility is intended to ensure that the patient is well rested and comfortable between the relatively short treatment periods. Many patients take meals and choose to sleep much of the time between treatments. For those patients receiving care in an “outpatient” facility, the HANDS™ treating physician monitors them after the treatment session, after which time the patient is released to an accompanying person and returns the following day(s) for completion of their treatment. Following the medically supervised treatments, patients receive one month of oral pharmacotherapy and incentives to participate in psychosocial or other recovery-oriented therapy of their choice.

     Based on our limited initial experience with a small number of patients in the U.S., patients who have been through prior treatment programs report that cravings for alcohol or stimulants are significantly reduced or eliminated with the HANDS Protocols, and that they emerge from treatment with greater mental clarity.

     Initiation of the HANDS Protocols offers the convenience of a 2 to 3 day treatment. The short period of inpatient or outpatient stay during treatments provides patients convenience and the ability to manage their time away from work and family. We believe the short treatment period is a major advantage over traditional treatments which typically consist of 5 to 14 days of combined inpatient treatment and washout period, plus up to 28 days in a rehabilitation or residential treatment center. The traditional treatment requires extended time off work and away from family and friends. This is particularly relevant since approximately 73% of all current adult illicit drug users are employed, and loss of time from work can be a major deterrent for seeking treatment.

     We believe that the HANDS Protocols can be used at any stage of recovery, and can complement existing treatments. The protocols may be appropriate for alcohol- or stimulant-dependent patients if they are:

	•	Seeking a targeted, medical approach for combating their disease;
	•	Disappointed with or have failed other treatment options;
	•	Are unable to commit to lengthy traditional rehabilitation programs.

     Additionally, we provide proprietary administrative services to assist physicians and facilities with staff education, marketing and sales support, and outcomes tracking for data analysis.

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Competition

     Conventional forms of treatment for alcohol or stimulant dependence are divided into phases: detoxification or withdrawal, which is typically conducted in medically supervised environments; and relapse prevention, which is often conducted through short- or long-term therapeutic facilities or programs, most of which do not offer medical management options. Typically such medically managed programs require long-term usage of pharmaceuticals, resulting in low patient compliance. Regardless of the approach, there is great variability in the durations of the treatment procedures, the levels of medical supervision, the costs to the patients and the relapse rates.

     Currently accepted practice for withdrawing patients from a dependence on alcohol consists of heavily sedating the patient at an inpatient hospital facility for a period of 3 to 5 days. Due to the heavy sedation, the patient typically is stabilized for an additional 5 to 7 days. This procedure, while medically necessary due to the dangers of convulsions when withdrawing alcoholics from alcohol, does not relieve the patient’s cravings or desire to drink. Further, the drugs typically used during this procedure (the most commonly utilized medications are Valium® (diazepam), Ativan® (lorazepam), and Xanax® (alprazolam)) can be addictive, require a time-intensive dose tapering and washout period and may cause side effects.

Treatment Programs

     There are approximately 2,500 facilities reporting to the Substance Abuse and Mental Health Services Administration (SAMSHA) that provide substance dependence medical treatment services on an inpatient or outpatient basis. Well-known examples of residential treatment programs include the Betty Ford Center, Caron Foundation, Hazelden and Sierra Tucson. In addition, individual physicians may provide substance dependence treatment in the course of their practices.

     There appears to be no reliable information about the success rates of these programs, nor agreed upon standards of how outcomes should be measured (e.g., self-reported abstinence or reduction in days of heavy drinking). SAMHSA reports that only 54% of those treated for alcoholism and 50% of those treated for cocaine and other stimulants complete the detoxification procedure. SAMHSA reports in its Drug and Alcohol Services Information System that treatment completion rates in 2000 for outpatient treatment were only 41% for alcohol and 20% for cocaine. These low treatment completion rates are highly associated with relapse rates.

     Many of these traditional treatment programs have established name recognition and their treatments may be covered in large part by insurance or other third party payors. Our protocols are not currently covered by insurance. To date, patients treated with the HANDS Protocols have been substantially private-pay patients, currently our primary market for the HANDS Protocol.

Treatment Medications

     The addiction medication naltrexone, an opiate receptor antagonist, is marketed by a number of generic pharmaceutical companies as well as under the trade name ReVia® by Bristol Myers Squib, for treatment of alcohol dependence. However, naltrexone must be administered on a chronic or continuing basis and is associated with relatively high rates of side effects, including nausea. U.S. sales are estimated to be just under $25 million per year for this treatment.

     The French pharmaceutical firm Sanofi Aventis SA has announced plans to seek FDA approval for the experimental drug rimonabant, trade name Acomplia, next year. It claims the drug may be used to treat addiction, including fighting relapse in alcohol and cocaine abuse. No human test results for rimonabant in alcohol abuse have yet been published.

     There are also a number of companies reported to be developing medications for reducing craving in the treatment of alcoholism. These include:

•

Alkermes is developing a long-acting injectable form of naltrexone, Vivitrex®, intended to be administered by a physician via monthly injections. The company reports results from a phase III clinical study indicated that in the overall study population, patients treated with Vivitrex 380 mg experienced approximately a 25% reduction in the rate of heavy drinking relative to placebo. Alkermes reports it intends to submit a new drug application (NDA) to the FDA in the first half of 2005.

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•

Merck AG has received FDA approval to market Campral® Delayed-Release Tablets (acamprosate calcium). Acamprosate is an NMDA receptor antagonist. The product must be taken two to three times per day on a chronic or long-term basis. Forest Pharmaceuticals is marketing this product within the U.S.

     While withdrawal from cocaine dependence is not considered to involve a significant risk of death, withdrawal symptoms from current detoxification procedures are unpleasant. Following an extended period of dependence, cocaine addicts generally are unable to experience the feeling of pleasure during and following detoxification as a result of the effects of cocaine on the brain. Detoxification procedures typically involve the use of sedatives to assist patients through this difficult period. Following treatment, cue induced cravings, however, are especially pronounced and may re-occur for months to years. Several classes of pharmaceutical agents have been investigated as potential maintenance agents (e.g.,anti-depressants and dopamine agonists); however, none are FDA approved for treatment of cocaine dependence or generally accepted in medical practice. Their effects are variable in terms of providing symptomatic relief, and many of the agents may cause side effects or may not be well tolerated by patients.

     There are currently no accepted medical treatments for methamphetamine dependence. Anti-depressants and dopamine agonists have been investigated as possible maintenance therapies, but none have been FDA approved or are generally accepted for medical practice. In October 2004 Yaupon Therapeutics announced it has initiated human clinical testing of its plant-derived experimental treatment for methamphetamine addiction, Lobeline, in a phase-I safety trial.

     As noted above, we believe the HANDS Protocols can be used at any stage of recovery, and can complement existing treatments. As such, our protocols offer a potentially valuable alternative to traditional medical treatment. Moreover, because treatment with the HANDS Protocols is designed to target neurochemical imbalances in the brain over a short course of treatment, we do not view the current medical therapies as directly competitive.

Our Competitive Advantage

     We believe the HANDS Protocols can offer an advantage to traditional alternatives for several reasons. First, treatment provided under the HANDS Protocols is designed to addresses a spectrum of patient needs, including physiological, nutritional and psychological elements. Second, the HANDS Protocols are targeted, medically supervised procedures designed to address the neurochemical imbalances in the brain caused or worsened by substance dependence. The rationale for the approach is that by addressing the underlying physiologic aspects of substance dependence, dependent persons may be afforded an opportunity to better address the behavioral and environmental components of their disease. Third, initiation of the HANDS Protocols offers the convenience of a 2 to 3 day treatment. Fourth, the HANDS Protocols are designed to minimize withdrawal symptoms, reduce cravings, and provide patients with support as they progress through the recovery process. Fifth, the protocols are designed for use at any stage of recovery, and can complement existing treatments.

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Alcohol

Stimulants (Cocaine and Methamphetamine)

     Following treatment patient self-reports include elimination of cravings and increased mental clarity and focus (cognitive function). Further, patients were asked to rate their quality of life before and after treatment, most of whom reported both immediate and sustained post-treatment improvement in sleep, appetite, mood, concentration, memory, work, relationships and stress.

     The outcomes shown above are for patients treated with the current HANDS Protocols in one treatment center. Outcome information was obtained by follow-up phone interview by the clinical site manager. The limited initial results of the retrospective evaluation were not obtained in a formal research study, may not provide a sufficient sample size to draw any conclusions regarding efficacy, and may not be indicative of the long-term future performance of our protocols. In addition, patients’ statuses may change after longer periods of post-treatment follow-up, negatively affecting the overall results of the treatment outcomes collected to date. We are currently in the process of awarding unrestricted grants for research studies in special populations and controlled studies to test the efficacy of the HANDS Protocols. Formal research, further studies, independent research reports or reviews may qualify or contradict the limited results that we have observed.

     We believe that the total cost of providing treatment using the HANDS Protocols falls within the typical range of prices for conventional treatment programs. We also believe, based on the limited initial results discussed above, that treatment using our protocols may have higher completion rates, greater compliance, reduction or elimination of withdrawal symptoms, reduction or elimination of cravings, improved cognitive functioning and potentially lower relapse rates.

Our Strategy

     We intend to continue our efforts to: (1) exploit our current proprietary, patent-pending treatment technology by expanding the number of treatment sites that license our protocols; (2) increase awareness about the HANDS approach among consumers and, ultimately, professional audiences, through both local and national marketing initiatives designed to increase patient throughput to sites with license rights to the protocols; and (3) acquire, license, develop and bring to market new substance dependence treatment protocols via our own internal research and development as well as strategic alliances with major research institutions worldwide.

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1. Expand the Number of Inpatient Treatment Sites

We currently have multi-year contracts with fourteen hospitals and healthcare providers to license and utilize the HANDS Protocols, of which twelve were signed in the last six months and are in various stages of training and start-up. For the year ended December 31, 2004, HANDS licensing fees from one hospital in Los Angeles accounted for 86% of our revenues. We intend to continue to develop a system of licensees within the U.S. authorized to use the HANDS Protocols for those diagnosed with dependence to alcohol, cocaine or methamphetamine, as well as combinations of these drugs.

We are actively engaged in seeking to expand our base of treatment sites, focusing on large metropolitan areas within the U.S. We will focus our expansion plans on densely populated cities, particularly in states where patients are migrating to other states for treatment at residential facilities. We believe our treatment protocols will provide hospitals and physicians access to an affordable and convenient treatment alternative for their substance dependent patients.

2. Local and National Marketing Initiatives to Consumers and Professionals

The HANDS Protocols represent a medically supervised approach to treatment rooted in the belief that by addressing the underlying physiologic aspects of substance dependence, dependent persons may be afforded an opportunity to better address the behavioral and environmental components of their disease. We intend to utilize both local and national marketing initiatives to raise awareness of the HANDS approach in order to increase patient awareness of the HANDS Protocols. The marketing strategy will initially focus on consumers, by providing education and information that emphasizes substance dependence as a disease, highlights the potential benefits of HANDS as an innovative and convenient medically supervised treatment approach, and encourages consumers to consult treatment for more information.

As data from our research studies become available, we will expand our marketing initiatives to more aggressively target the professional community (e.g., physicians, counselors, therapists, payors and other allied professionals). This staged strategic approach to our marketing efforts takes into account: (i) the need to increase patient awareness of licensee sites; and (ii) that a more robust data dossier will be required by the professional community.

3. Develop New Substance Dependence Treatment Protocols

Our goal is to bring new treatment protocols to market on an ongoing basis. We will seek to acquire or license new substance dependence treatment protocols that may be developed in the future. Further, we intend our internal research programs will utilize an array of alliances and partnerships with other organizations specializing in the research and development of new substance dependence treatment technologies. We believe that this research alliance strategy will seek to create, maintain and strengthen our position as a leader in dependence treatment technology.

Our Technology, Products and Services

     Our treatment technology is based on studies and research that have established that substance dependence is associated with altered cortical activity and changes in neurotransmitter function, which are critical to brain function. Moreover, the changes in the neurochemistry of the brain underlie the hallmarks of substance dependence, including craving, tolerance, withdrawal symptoms and relapse. Our protocols are designed to address the neurochemical imbalances in the brain induced or exacerbated by substance dependence, as well as provide nutritional supplementation and incentives for individualized continuing care. We have labeled this proprietary approach the HANDS Protocols. There are two products available for licensing by hospitals and other healthcare providers: the HANDS Protocol for Alcohol Dependence and the HANDS Protocol for Stimulant Dependence (or combined dependence to alcohol and stimulants). Additionally, we provide proprietary administrative services to assist physicians and facilities with staff education, marketing and sales support, and outcomes tracking for data analysis.

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     The HANDS Protocols consist of:

	•	A comprehensive physical exam, including specific laboratory tests, prior to initiation of treatment
	•	Medical supervised administration of prescription medications and nutritional supplements
	•	Discharge prescription medications and nutritional supplements
	•	Information about and incentives for individualized continuing care options

     The HANDS Protocols involve the off-label administration of both oral and intravenously administered medications that have been FDA approved for indications other than substance dependence. While the risks and benefits of the combinations of the medications used in the HANDS Protocols have not been established, physicians are permitted to prescribe prescription drugs for off-label uses in the independent practice of medicine. The HANDS Protocols are not appropriate for all patients. It is up to the HANDS treating physician to decide whether treatment with the HANDS Protocols is appropriate for any given patient. The HANDS treating physician must make the treatment decision regarding appropriateness of using the HANDS Protocol during the detoxification, or any other stage, of substance dependence recovery. Some of the medical tests may be performed by the potential patient’s primary care physician and be reviewed in collaboration with the HANDS treating physician. It is up to the HANDS treating physician to decide where and by whom any required medical tests will be performed. We do not endorse or recommend any particular physicians and identify for information purposes only those physicians who have obtained license rights to use the HANDS Protocols. We make no representations about the quality of care rendered by these or any other physicians. We do not provide medical advice or medical treatment and make no claims about the effectiveness and suitability of the HANDS Protocols for any individual patient.

Sales and Marketing

     Substance dependence is a worldwide problem with prevalence rates continuing to rise despite the efforts by national and local health authorities to curtail its growth. We will focus on expanding our presence in the U.S. market by targeting geographic areas with high numbers of substance dependent individuals, and licensing our protocols and providing our services to healthcare providers in those areas. We will focus our direct sales efforts on recruiting new healthcare providers in identified target markets to expand our number of treatment site customers.

     Our marketing strategy is based upon developing and promoting a comprehensive treatment approach integrating proprietary state-of-the-art treatment protocols, assessment tools, education, and information about aftercare programs. We will co-promote programs with our licensees through community outreach initiatives, local sponsorship of professional education programs, public relations, targeted advertising and direct mail. On a national level, we will promote our proprietary brands through Internet marketing, advocacy development, targeted advertising, and sponsorship of educational programs.

     Our marketing of the HANDS Protocols will be done in two ways:

	•	Promoting broad awareness
	•	Focused target market initiatives

     Broad awareness will be done via our consumer website, press releases, endorsements, printed media advertising, Internet promotions and local radio, television and print media coverage. We will support local targeted marketing efforts of the hospitals, healthcare facilities and other healthcare providers that license our HANDS Protocols. Additional target market campaigns may be accomplished via local publications, direct mail, seminars, forums, tradeshows, community outreach and email to generate referral sources and referrals.

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Community Outreach

     As noted above, a cornerstone to our marketing strategy will be to increase awareness among consumer audiences by providing education and information about substance dependence as a disease, and the HANDS Protocols as an innovative, convenient medically supervised treatment approach. Working in concert with our licensees, we intend to create or leverage community forums (e.g., community presentations, health fairs, etc.) that will provide opportunities to engage our target segments, most notably consumers (i.e., potential patients, their families and friends), leaders from the local business communities and, to a lesser extent (until data is available from the HANDS™ research studies), referral sources within the healthcare community. We also intend to utilize direct mail or other outreach vehicles to offer branded educational and informational materials to promote a direct and iterative “dialogue” with consumers (and, pending data availability, professional constituents).

     Our community outreach activities may also involve partnering with third-party organizations – on either a local or national level – to further increase the penetration of these initiatives within targeted market segments, as well as provide a potential public relations platform to enhance the reach of the initiatives.

Public Relations

     The goal of our public relations program will be primarily to promote awareness and generate leads from consumers (i.e., potential patients, their families and friends), with a secondary emphasis on referral sources, healthcare professionals and third-party organizations. This may be done via press releases, endorsements, and media placement campaigns. The forms of media that will be targeted for placement will be print media, local radio segments and stories, Internet postings, local, regional, and national television segments and stories. We believe this form of awareness/lead generation to be superior to advertising both in terms of quality of awareness and number of leads generated.

Advertising

     We anticipate that advertising will be limited to local publications in regional treatment center areas, specific trade publications for occupations with high substance dependence rates, healthcare professional publications with subscribers who would be good referral sources and top Internet search engines.

     In addition to our goal of the HANDS Protocols becoming a preferred treatment method for individuals seeking to pay for treatment privately, we believe that third party payors, including entities from both the government and private sectors, will be important to our long-term growth. We will conduct business development initiatives to secure the acceptance and endorsement of treatment using our Protocols as appropriate for reimbursement by third party payors, nationally recognized substance dependence treatment organizations and governmental organizations.

Target Payor Groups

     In developing our marketing plan, we have taken into consideration the following market dynamics for our efforts:

Traditional Payors

Private Pay

To date, patients treated with the HANDS Protocol have been substantially private-pay patients. Our protocols are not currently approved for payment by any health insurance companies or other third-party payors. According to reports by SAMHSA, of persons aged twelve or older who received any alcohol or illicit drug treatment, more paid for all or part of their most recent treatment with their own savings or earnings (or those of family or friends) than any other source (47.4%). We will continue to focus our efforts on targeted communication to private pay patients (and their families) emphasizing the convenience and potential benefits of treatment using the HANDS Protocols. Moreover, as we are aware of no generally accepted medical treatments for methamphetamine dependence, we will have the opportunity to communicate the potential benefits of the HANDS Protocol for Stimulant Dependence to persons affected by methamphetamine dependence.

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Managed Care, Insurance and other Third-Party Reimbursement

In order to compete effectively for managed care agreements and receive adequate reimbursement from payors for treatment using our protocols, clinical evidence must demonstrate that use of the HANDS Protocols is a beneficial and cost effective treatment approach. We will, through our clinical and market research activities, gather and disseminate appropriate data to the payor community that should validate the benefits and cost effectiveness of treatment using the HANDS Protocols. We believe that studies involving the HANDS Protocols have the potential to demonstrate cost effectiveness across patient populations. We plan to include or contract directly with disease state management providers in the design and conduct of our outcome studies.

Other Payor Groups

Drug Courts and Prison Systems

According to a Bureau of Justice Statistics Bulletin, “Prisoners in 2001,” published in August 2002, approximately 20% of the 1.2 million state and 55% of the 143,000 federal prisoners were convicted of drug offenses. A significant number of state and federal prisoners receive alcohol treatment after admission into prison. We believe that state and federal prison systems are in need of a more beneficial and convenient treatment alternative and we intend to solicit major prison systems to utilize our protocols. More importantly, we will seek to work with state and federal justice systems to intervene prior to incarceration with a goal of reducing the number of drug offenders admitted into prison.

Drug courts first came to prominence in 1989 as a means to deal with the growing number of alleged offenders involved with substance abuse. According to the “Drug Court Activity Fact Sheet, May 9, 2003,” the number of drug courts grew to 475 in 1999 and as of May 1, 2003, there are 1,042 drug courts located in all 50 states, with over 400,000 participants to date. Drug courts generally encourage the user to seek treatment in lieu of incarceration. We will seek to engage and educate all parties (judges, attorneys, physicians, counselors) that influence the selection of the drug treatment facility.

Employee Assistance Programs

Approximately 15% of the American workforce is unionized. Many of these unions and large employers support employee assistance programs (EAPs) that are well positioned to assist employees with a variety of social, legal, financial, and medical issues including substance dependence. For many blue-collar workers with addictive disabilities, EAPs are the first line of defense and support. For us, these EAPs may provide a potential referral source for centers that license our technology for qualified clients with third-party financial support. According to InfoUSA, there are approximately 1,100 EAPs in the United States. We plan to begin addressing this market by targeting discussions with large benefit companies that administer EAPs.

Research and Development

     We have contracted with a Contract Research Organization (CRO) to establish a clinical outcomes registry for the monitoring and evaluation of up to 750 patients undergoing the HANDS Protocols at our commercial licensee sites. We are also in the process of awarding unrestricted grants for a number of research studies commencing in 2005 to generate clinical data on the HANDS Protocols. The research studies will include open label studies for alcohol and methamphetamine dependence as well as controlled, double-blind studies conducted by preeminent researchers in the field of substance dependence. The combined cost of these studies and patient outcomes registry is estimated at approximately $8 million over the next two years. We expect the outcomes data from these studies may serve as validation for third-party payors.

     We intend to continually enhance our substance dependence treatment technology and products as well as research and develop new products to maintain technological competitiveness and deliver increasing value to new and existing customers. We are in the process of seeking to establish research collaborations with researchers specializing in the science of substance dependence.

     We will continue to expand our target markets by acquiring or licensing treatment methods for other substance dependencies as new technology is developed and becomes available.

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Proprietary Rights and Licensing

     Our success depends upon a number of factors, including our ability to protect our proprietary technology and operate without infringing on the proprietary rights of others. We rely on a combination of patent, trademark, trade secret and copyright laws and contractual restrictions to protect the proprietary aspects of our technology. To help ensure compliance with our license/joint venture agreements, we intend to deploy onsite business area managers. In March 2003 we acquired the patent-pending treatment protocols for alcohol and stimulants, which we have branded the HANDS Protocols. We have the following branded trade names:

	•	Hythiam™
	•	HANDS™
	•	HANDS Protocols™
	•	HANDS Protocol™
	•	The HANDS Patient Protocol™
	•	HANDS Treatment Protocol™

     We impose restrictions in our protocol license agreements on our customers’ rights to utilize and disclose our technology. We also seek to protect our intellectual property by generally requiring employees and consultants with access to our proprietary information to execute confidentiality agreements and by restricting access to our proprietary information. We require that, as a condition of their employment, employees assign to us their interests in inventions, original works of authorship, copyrights and similar intellectual property rights conceived or developed by them during their employment with us.

Financial Information about Segments

     We currently have only one business segment, domestic licensing of the HANDS Protocols, which generated 100% of our revenues for the year ended December 31, 2004.

Employees

     As of December 31, 2004, we employed 37 persons. We anticipate hiring additional employees over the next year to meet our growth expectations.

Executive Officers and Directors

     The following table sets forth certain information regarding our directors and executive officers.

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     Terren S. Peizer served until October 2003 as Chief Executive Officer of Clearant, Inc., which he founded in April 1999 to develop and commercialize a universal pathogen inactivation technology. He served as Chairman of its board of directors from April 1999 to October 2004 and a Director until February 2005. From February 1997 to February 1999, Mr. Peizer served as President and Vice Chairman of Hollis-Eden Pharmaceuticals, Inc., a NasdaqNM listed company. In addition, from June 1999 through May 2003 he was a Director, and from June 1999 through December 2000 he was Chairman of the Board, of supercomputer designer and builder Cray Inc., a NasdaqNM company, and remains its largest beneficial stockholder. Mr. Peizer has been the largest beneficial stockholder and held various senior executive positions with several technology and biotech companies. In these capacities he has assisted the companies with assembling management teams, boards of directors and scientific advisory boards, formulating business and financial strategies, investor and public relations, and capital formation. Mr. Peizer has a background in venture capital, investing, mergers and acquisitions, corporate finance, and previously held senior executive positions with the investment banking firms Goldman Sachs, First Boston and Drexel Burnham Lambert. He received his B.S.E. in Finance from The Wharton School of Finance and Commerce.

     Anthony M. LaMacchia is a senior healthcare executive who, prior to joining the company in July 2003, was the Business Development Principal of GME Solutions, a healthcare financial consulting company providing Medicare graduate medical education and kidney acquisition cost recovery services, since October 2002. From November 1999 to April 2002, he was President & Chief Executive Officer of Response Oncology, Inc., a diversified physician practice management company. He was recruited to this financially distressed company to direct a high-risk turnaround, and when continued market declines and debt covenant breaches compelled a bankruptcy filing, directed the company through all phases of the chapter 11 process, the sale of all assets and the closure of its facilities. In June 1999, Mr. LaMacchia left Salick Health Care, Inc., which developed and operated outpatient cancer and kidney treatment centers and a clinical research organization engaging in pharmaceutical and clinical treatment trials, as Executive Vice President & Chief Operating Officer, having started with the company as Director of Strategic Planning & Reimbursement in 1984. Previously, Mr. LaMacchia held positions of increasing responsibility with Blue Cross of California, Ernst & Young and Cedars-Sinai Medical Center. He is a Certified Public Accountant who received his B.S. in Business Administration, Accounting from California State University, Northridge.

     Chuck Timpe is a senior financial executive with over 30 years experience in the healthcare industry. Since March 1998 he has served as a Director and since June 2002 as Chairman of the Audit Committee for IPC-The Hospitalist Company, a $90 million physician specialty practice business. Prior to joining the company in June 2003, Mr. Timpe was Chief Financial Officer from its inception in February 1998 of Protocare, Inc., a clinical research and pharmaceutical outsourcing company which merged with Radiant Research, Inc. in March 2003, creating one of the country’s largest clinical research site management organizations. Previously, he was a principal in private healthcare management consulting firms he co-founded, Chief Financial Officer of National Pain Institute, Treasurer and Corporate Controller for American Medical International (now Tenet Healthcare Corp., an NYSE company), and a member of Arthur Andersen LLP’s healthcare practice, specializing in public company and hospital system audits. Mr. Timpe received his B.S. from University of Missouri, School of Business and Public Administration, and is a Certified Public Accountant.

     Monica Alfaro Welling has over 15 years of experience in all areas of U.S. and global marketing, sales and new product planning within endocrinology, nephrology, osteoporosis, CNS, gastroenterology, and genitourology. Prior to joining the company in March 2004, she was Senior Director Global Strategic Marketing for BOTOX™ for Allergan, Inc., where she directed market development, product development, and strategic planning for a brand with annual sales exceeding $360 million. Prior to joining Allergan, from August 1989 to February 2000, Ms. Welling held various positions at Novo Nordisk A/S in Denmark, most recently as Head of International hGH Strategic Marketing. As the head of marketing, new business development and new product marketing for all growth hormone related products/devices and therapeutic areas, she was responsible for brands with annual global sales of $260 million. She received a B.S. in Biology from the University of California, Irvine and an M.B.A. in International Marketing from South Danish University in Denmark.

     James W. Elder has more than 25 years of experience in the healthcare industry, and in business development, marketing and sales of pharmaceuticals for the treatment of pain and substance abuse. From June 1978 to January 2000 and from June 2003 until joining Hythiam in September 2003, Mr. Elder held various positions at Mallinckrodt, Inc. related to marketing, business development and sales of pain management and addiction treatment products. As Business Director of Mallinckrodt’s Addiction Treatment business unit, he launched a series of methadone and naltrexone products, creating a business with over 60% share of the opioid addiction treatment market. At Mallinckrodt, he led ATForum.com, the premier healthcare professional education website for addictionologists concerned with treating addictions to opioids. From March 2002 to June 2003 Mr. Elder operated a consulting firm, assisting pharmaceutical companies with developing marketing and business plans. From January 2000 to March 2002 he was Senior Vice President of Marketing and Sales for DrugAbuse Sciences, Inc., a private specialty pharmaceutical company developing medications for the treatment of alcohol and drug abuse. While there, he launched AlcoholMD.com, a premier medical education website serving addiction-related healthcare professionals. Mr. Elder received a B.A. in Chemistry from University of Missouri-Columbia and an M.B.A. from Southern Illinois University.

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     David E. Smith, M.D. has more than thirty-five years of experience in the treatment of addictive disease, the psychopharmacology of drugs, and research strategies in the management of drug abuse problems. Dr. Smith is President and Medical Director of Haight Ashbury Free Clinics, Inc. which he founded in 1967, and has been Medical Consultant, Professional Recovery Program at The Betty Ford Center since 1994, and Medical Director of the California State Alcohol and Drug Programs and of the California Collaborative Center for Substance Abuse Policy Research since 1998. He has held consultancies and other positions at numerous professional organizations, including Doping Control Officer for the Winter Olympics in February 2002. Dr. Smith has authored over 300 scientific articles and has been named to a number of honors, including a Drug Abuse Treatment Award, National Association, State Alcohol and Drug Abuse Coordinators in 1984, Career Achievement Award, National Association of State Alcohol and Drug Abuse Directors in 1994, and Best Doctors in America, Pacific Region in 1996-97. He is a member of the Editorial Boards of numerous professional publications, has been Editor-in-Chief of AlcoholMD.com, a medical education and information website focusing on alcohol problems and alcoholism, since January 2000, and is Executive Editor of the Journal of Psychoactive Drugs which he founded in 1967. He was granted Fellow status by the American Society of Addiction Medicine (A.S.A.M.) in 1996, is past President of A.S.A.M. and the California Society of Addiction Medicine, and was named to the Council of Fellows of the California Association of Alcoholism and Drug Abuse Counselors in 1998. Dr. Smith received a B.S. in Zoology from University of California, Berkley and an M.S. in Pharmacology and his M.D. from University of California, San Francisco, where he has been an Associate Clinical Professor of Clinical Toxicology since 1967.

  Leslie F. Bell has more than 35 years of experience in business and the practice of corporate and healthcare law. He is a director and senior executive of Salick Cardiovascular Centers LLC. From late 1997 until 2004 he was a Director and Senior Executive of Bentley Health Care, Inc. and certain of its subsidiaries, each of which was a developer and provider of disease-state outpatient, health care facilities and services. Mr. Bell was Co-Chairman and Co-Chief Executive Officer of Tractus Medical, Inc., a provider of patented relocatable ambulatory surgical center/operating rooms, which he co-founded in January 2002 until its sale in October 2004. From its inception in 1983 through several public offerings and until its sale completed in 1997 for a total of approximately $480 million, he served as a Director, Executive Vice President and Chief Financial Officer and from 1996 to 1997 was President of Salick Health Care, Inc. Mr. Bell has also served as a Director of YES Clothing Co. from 1990 to 1995. He was previously a Deputy Attorney General of the State of California, and managing partner of the law firm Katz, Hoyt & Bell. Mr. Bell attended the University of Illinois, received a J.D. (with honors) from University of Arizona College of Law, and is a member of the University of Arizona College of Law Board of Visitors and Dean’s Economic Council. Mr. Bell is licensed to practice law and is the sole director and President of Leslie F. Bell, Inc., a professional law corporation. He is also a director of various tax-exempt organizations principally formed to support research and education for specified health problems.

     Hervé de Kergrohen, M.D. since August 2002 has been a Partner with CDC Enterprises Innovation in Paris, a European venture capital firm, and since January 2001 has been Chairman of BioData, an international healthcare conference in Geneva. He sits on several boards with U.S. and European private health care companies, including Kuros BioSurgery and Bioring SA in Switzerland since January 2003, Praxim SA and Exonhit in France since September 2002, and Clearant, Inc. since December 2001. From February 1999 to December 2001 he was Head Analyst for Darier Hentsch & Co., then the third largest Geneva private bank and manager of its CHF 700 million health care fund. From February 1997 to February 1998 he was the Head Strategist for the international health care sector with UBS AGin Zurich. Dr. de Kergrohen started his involvement with financial institutions in 1995 with Bellevue Asset Management in Zug, Switzerland, the fund manager of BB Biotech and BB Medtech, where he covered the healthcare services sector. He was previously Marketing Director with large U.S. pharmaceutical companies such as Sandoz USA and G.D. Searle, specialized in managed care. Dr. de Kergrohen received his M.D. from Université Louis Pasteur, Strasbourg, and holds an M.B.A. from Insead, Fontainebleau.

     Richard A. Anderson has more than a decade of experience in business development, strategic planning and financial management. He was the Chief Financial Officer of Clearant, Inc. from November 1999 to March 2005 and has been a Director since November 1999. He served as Chief Financial Officer of Intellect Capital Group from October 1999 through December 2001. From February through September 1999, he was an independent financial consultant. From August 1991 to January 1999, Mr. Anderson was with PriceWaterhouseCoopers, LLP, most recently a Director and founding member of PriceWaterhouseCoopers Los Angeles Office Transaction Support Group, where he was involved in operational and financial due diligence, valuations and structuring for high technology companies. He received a B.A. in Business Economics from University of California, Santa Barbara.

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     Ivan M. Lieberburg, Ph.D., M.D. is currently Executive Vice President, Chief Medical Officer at Elan Company, plc, a worldwide biopharmaceutical company listed on the NYSE, where he has held a number of positions over the last seventeen years, most recently Senior Vice President of Research. Dr. Lieberburg sits on the scientific advisory boards of Health Care Ventures, Flagship Ventures, NewcoGen, and the Keystone Symposium. Prior to joining Elan in 1987, he performed his postdoctoral research at The Rockefeller University and his medical residency and postdoctoral fellowship at University of California, San Francisco, where he is presently a Clinical Professor of Medicine. He previously held faculty positions at Albert Einstein School of Medicine and Mt. Sinai School of Medicine. Dr. Lieberburg has authored over 100 scientific publications, and has been named to a number of honors including Rockefeller University Fellow, Public Health Corps Scholar, National Research Service Award, Hartford Foundation Scholar and McKnight Foundation Fellow in Neuroscience. He is board certified in internal medicine and endocrinology/metabolism. Dr. Lieberburg received an A.B. in biology from Cornell University, a Ph.D. in Neurobiology from The Rockefeller University and an M.D. from University of Miami School of Medicine.

     Marc G. Cummins is a Managing Partner of Catterton Partners, a private equity investor in consumer products and service companies with over $1 billion of assets under management. Prior to joining Catterton in 1998, Mr. Cummins spent fourteen years at Donaldson, Lufkin & Jenrette Securities Corporation where he was Managing Director of the Consumer Products and Specialty Distribution Group, and was also involved in leveraged buyouts, private equity and high yield financings. He currently serves on the boards of several private companies including Case Logic Inc., Floorgraphics Inc., Titan Outdoor, LLC and DoveBid, Inc. Mr. Cummins received a B.A. in Economics, magna cum laude, from Middlebury College, where he was honored as a Middlebury College Scholar and is a member of Phi Beta Kappa. He also received an M.B.A. in Finance with honors from The Wharton School at the University of Pennsylvania.

Organization of Company

     Hythiam, Inc., a development stage company, was formed and incorporated in New York on February 13, 2003, by Reserva, LLC, a non operating company wholly owned by the company’s chief executive officer. The registrant, which was formerly known as Alaska Freightways, Inc. (“Alaska”), was incorporated in the state of Nevada on June 1, 2000, and previously provided transportation and freight brokerage services in the state of Alaska. In September and October 2003, Alaska sold substantially all of its operating assets and liabilities, merged with the Company, changed its name to Hythiam, Inc. and reincorporated in Delaware on September 29, 2003. Following merger, reincorporation and consolidation transactions, the registrant is now the sole surviving entity. Because the Company was the sole operating company at the time of the merger with Alaska, the merger was accounted for as a reverse acquisition, with the Company deemed the acquirer for accounting purposes.

Executive Officers

     There are no family relationships among any of our directors, executive officers or key employees. We consider Terren S. Peizer, Anthony M. LaMacchia, Chuck Timpe, Monica Alfaro Welling, James W. Elder and David E. Smith, M.D. to be our executive officers.

Codes of Ethics

     We have adopted a Code of Conduct and Ethics that applies to all company directors, officers and employees. We have also adopted a Code of Ethics for CEO and Senior Financial Officers that applies to our chief executive officer and senior financial officers, including our principal financial officer and principal accounting officer.

Risk Factors

     You should carefully consider and evaluate all of the information in this report, including the risk factors listed below. Risks and uncertainties in addition to those we describe below, that may not be presently known to us, or that we currently believe are immaterial, may also harm our business and operations. If any of these risks occur, our business, results of operations and financial condition could be harmed, the price of our common stock could decline, and future events and circumstances could differ significantly from those anticipated in the forward-looking statements contained in this report.

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Risks Related to Our Business

We are a development stage company with a limited operating history, making it difficult to evaluate our future performance

     We are a development stage company with a very limited history of operations. We were formed in February 2003 and commenced operations in June 2003. Investors have no substantive financial information on prior operations to evaluate the company as an investment. Our potential future success must be viewed in light of the problems, expenses, difficulties, delays and complications often encountered in the formation of a new business. We will be subject to the risks inherent in the ownership and operation of a startup development stage company such as regulatory setbacks and delays, fluctuations in expenses, competition, the general strength of regional and national economies, and governmental regulation. Any failure to successfully address these risks and uncertainties would seriously harm our business and prospects.

We expect to continue to incur operating losses, and if we are not able to raise necessary additional funds we may have to reduce or stop operations

     We have not generated significant revenues or become profitable, may never do so, and may not generate sufficient working capital to cover the cost of operations. We had revenues of $192,000 in 2004 and $75,000 in 2003, primarily generated from a single hospital. Our accumulated deficit through December 31, 2004 was $15.4 million. We anticipate that operating deficits will continue to arise during the next 12 months of our operations. Because many of our costs generally will not decrease, the cost of operating the company will exceed the income therefrom during this period. No party has guaranteed to advance additional funds to us to provide for any such operating deficits. Our cash and marketable securities reserves were approximately $27 million as of December 31, 2004. Our current cash burn rate is approximately $1.0 million per month. We expect to increase our monthly expenditures over the next twelve months as we increase staff, commence marketing activities, expand the number of licensees and initiate research studies. If our revenues do not meet expectations and our expenses continue to increase, our cash reserves will be exhausted in approximately fifteen months, and we will be required to seek additional funds.

     We may seek additional funding through public or private financings or collaborative arrangements. If we obtain additional capital through collaborative arrangements, these arrangements may require us to relinquish greater rights to our technologies and protocols than we might otherwise have done. If we raise additional capital through the sale of equity, or securities convertible into equity, further dilution to our then existing stockholders will result. If we raise additional capital through the incurrence of debt, our business may be affected by the amount of leverage we incur, and our borrowings may subject us to restrictive covenants. Additional funding may not be available to us on acceptable terms, or at all. If we are unable to obtain adequate financing on a timely basis, we may be required to delay, reduce or stop operations, any of which would have a material adverse effect on our business.

We are dependent on third party healthcare providers licensing and using our products and services, and if they delay or fail to do so our revenues and earnings could be adversely affected

      Only a physician may treat patients using the HANDS Protocols, which requires us to enter into licenses with hospitals, properly equipped outpatient settings or other treatment facilities in order to provide convenient treatment access points for patients. Our sales are therefore dependent to a significant degree upon the relationships we can establish with hospitals, physicians and other healthcare facilities to license our protocols for treating their patients. Through December 31, 2004, substantially all of our revenues have been derived from licensing fees from only one hospital. As of March 28, 2005, fourteen hospitals and healthcare providers have entered into agreements with us, twelve of whom have signed contracts with us since September 30, 2004. The number of patients treated in 2004 by our licensees was 37, including 14 in the fourth quarter. Rollout is anticipated to be dependent on our ability to negotiate and conclude licensing agreements within major metropolitan areas across the country and their ability to generate patients. If we are unable to enter into similar arrangements with additional healthcare providers for any reason, that would significantly limit our growth potential and negatively impact our business prospects. In addition, if hospitals and healthcare providers do not attract sufficient patient volume and revenue they may not be willing to carry or continue to offer our products and services.

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     The success of our protocols is ultimately dependent upon referrals of patients to facilities that license our technology and upon the use of our protocols by physicians in treating their patients. There is no requirement for physicians to refer their patients to facilities that license our protocols, or to use our protocols in treating their patients. They are free to refer patients to any other substance dependence treatment service, program or facility, and to treat their patients using whatever method they determine to be in the patients’ best interests. The failure of our products and services to generate physician referrals to facilities that use our products and services, or the loss of key referring physicians or physicians that use our protocols could have a material adverse effect on operations and could adversely affect our revenues and earnings.

We may be dependent on third party collaborations to develop our products and services and, if they fail or refuse to perform, commercialization of our protocols may be delayed

     Our future success will depend in part on establishing and maintaining effective strategic partnerships and collaborations to gain access to treatment modalities, expand and complement our research, development and commercialization capabilities, and reduce the cost of developing and commercializing protocols on our own. While we are in discussions with a number of companies and institutions to establish relationships and collaborati