During the three and sixnine months ended JuneSeptember 30, 2006 and 2005, we granted options for 24,000, 620,000, 595,000604,000, 1,224,000, 397,000 and 920,0001,317,000 shares, respectively, to employees and directors at the weighted average per share exercise price of $8.56, $6.52, $7.34$4.86, $5.70, $6.41 and $6.77,$6.49, respectively,

     In June 2006, board certified psychiatristThe City Court of Gary, Indiana, and addiction expert Harold C. Urschel, III, M.D., M.M.A., lead investigator on the first clinical study of the PROMETA treatment protocol for stimulant dependence, reported that more than 80% of study participants experienced a significant clinical benefit after treatment with no adverse events. Clinical benefit during the 12-week study was measured through decrease in cravings, reduction of methamphetamine use, and treatment retention. According to Dr. Urschel, the 50-subject study, which contained no active drug abuse counseling support, concluded that PROMETA demonstrated clinical utility with chronic, relapsing methamphetamine-dependent patients who also reported decreased cravings.

     We view the PCA and Gary Court adoptions as important milestones and as references for our efforts in the criminal justice system.

     In July 2006, our Swiss foreign subsidiary signed PROMETA license and services agreements with three sites in Switzerland to serve the international market. Our international operations to date have not yet been significant, consisting primarily of legal and other consulting services, development and start-up activities.

     Our net revenues for the three months ended JuneSeptember 30, 2006 increased by $942,000,$710,000, or 410%197%, to $1.2$1.1 million from $230,000$361,000 for the three months ended JuneSeptember 30, 2005, and increased by 79% over the first quarter of 2006. These increases were2005. The increase was primarily due to an increase inrevenue contributions from new licensees, including the number of patients treated and the expansion of the number of revenue-contributing licensees.PROMETA Center. In the secondthird quarter of 2006, 175156 patients were treated by 2029 licensee sites, compared to 4072 patients treated by six11 sites in the comparable periodthird quarter of last year. Our average revenue per patient treated by our commercial licensees increased by 14%35% to $6,700$6,764 in the current quarter compared to $5,750$5,014 for the same period last year. This increase was primarily attributable to patients treated by the newly-opened PROMETA Center, which generates higher average revenues per patient than our other licensed sites due to consolidation of its gross revenues in our financial statements, and lower average discounts granted by our licensees in the current quarter than in the same period last year.

     For the sixnine months ended JuneSeptember 30, 2006, our net revenues increased by $1.4$2.1 million, or 321%265%, to $1.8$2.9 million from $433,000$794,000 in the same period last year, due to revenue generated by the PROMETA Center and other new licensees, as well as an increase in revenue generated by the number of patients treated and expansion oflicensees in existence during the number of contributing licensees. Duringsame period last year. For the first half ofnine months ended September 30, 2006, 271427 patients were treated by 2434 licensee sites, compared to 80152 patients treated by six11 sites in the same period last year. Our average revenue per patient treated during the first half of the yearnine months ended September 30, 2006 increased by 25%29% to $6,736$6,747 compared to $5,413$5,224 for the comparable period last year.nine months ended September 30, 2005. As within the current

     We expect to continue to incur negative cash flows and net losses for at least the next twelve months. Based upon our current plans, including anticipated growth in our revenues and the expansionincreased expenses of expanding our business into managed care and government sponsored programs, we believe that our existing cash reserves willmay not be sufficient to meet our operating expenses and capital requirements for approximately twelve months. However, changes in our business strategy, technology developmentbefore we begin to generate positive cash flows. Accordingly, we most likely will seek additional funds through the sale of shares of preferred or marketing planscommon stock or other events affecting our operating plans and expenses may result in the expenditure of existing cash reserves before that time. If this occurs, ourthrough public or private financing. Our ability to meet our cash obligations as they become due and payable will depend on our ability to generate increased revenues over current levels, reduce operating costs, sell securities, borrow funds, or some combination thereof. We may seek additional funding through public or private financing or through collaborative arrangements with strategic partners. We may not be successful in raising necessary funds on acceptable terms, or at all.

     From time to time, we may be involved in litigation relating to claims arising out of our operations in the normal course of business. As of the date of this filing, we are not currently involved in any legal proceeding that we believe would have a material adverse effect on our business, financial condition or operating results.

     The following table sets forth a summary of our material minimum contractual obligations and commercial commitments as of JuneSeptember 30, 2006 (in thousands):

     As of JuneSeptember 30, 2006, we had no off-balance sheet arrangements.

     The discussion and analysis of our financial condition and results of operations is based upon our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. Generally accepted accounting principles require management to make estimates, judgments and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. We base our estimates on experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that may not be readily apparent from other sources. Our actual future results may differ from those estimates.

     We consider our critical accounting estimates to be those that (1) involve significant judgments and uncertainties, (2) require estimates that are more difficult for management to determine, and (3) may produce materially different results when using different assumptions. Management has discussed these critical accounting estimates, the basis for their underlying assumptions and estimates and the nature of our related disclosures herein with the Audit Committee of the Board of Directors. Our critical accounting estimates cover the following areas:

     The amounts recorded in the financial statements for share-based expense could vary significantly if we were to use different assumptions. For example, the assumptions we have made for the expected volatility of our stock price have been made using volatility averages of other public healthcare companies, since we have a limited history as a public company and our actual stock price volatility would not be meaningful. If we were to use the actual volatility of our stock price, there may be a significant variance in the amounts of share-based expense from the amounts reported. For example, based on the 2005 assumptions used for the Black-Scholes pricing model, a 50% increase in stock price volatility would have increased the fair values of options by approximately 25%.

     We have capitalized significant costs, and plan to capitalize additional costs, for acquiring patents and other intellectual property directly related to our products and services. We will continue to evaluate our intangible assets for impairment on an ongoing basis by assessing the future recoverability of such capitalized costs based on estimates of our future revenues less estimated costs. Since we have not recognized significant revenues to date, our estimates of future revenues may not be realized and the net realizable value of our capitalized costs of intellectual property may become impaired.

     In May 2005, the FASB issued SFAS 154, “Accounting Changes and Error Corrections.” SFAS 154 replaces APB 20, “Accounting Changes” and SFAS 3, “Reporting Accounting Changes in Interim Financial Statements” and establishes retrospective application as the required method for reporting a change in accounting principle. SFAS 154 provides guidance for determining whether retrospective application of a change in accounting principle is impracticable and for reporting a change when retrospective application is impracticable. The reporting of a correction of an error by restating previously issued financial statements is also addressed. SFAS 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. We do not expect the adoption of this statement to have a material impact on our financial statements.

     We invest our cash in short term commercial paper, certificates of deposit, money market accounts and marketable securities. We consider any liquid investment with an original maturity of three months or less when purchased to be cash equivalents. We classify investments with maturity dates greater than three months when purchased as marketable securities, which have readily determined fair values as available-for-sale securities. Our investment policy requires that all investments be investment grade quality and no more than ten percent of our portfolio

     We have evaluated, with the participation of our Chief Executive Officerchief executive officer and our Chief Financial Officer,chief financial officer, the effectiveness of our system of disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation our Chief Executive Officerchief executive officer and our Chief Financial Officerchief financial officer have determined that they are effective in connection with the preparation of this report. There were no changes in the internal controls over financial reporting that occurred during the quarter ended JuneSeptember 30, 2006 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

     This report contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to the financial condition, results of operations, business strategies, operating efficiencies or synergies, competitive positions, growth opportunities for existing products, plans and objectives of management, markets for stock of Hythiam and other matters. Statements in this report that are not historical facts are hereby identified as “forward-looking statements” for the purpose of the safe harbor provided by Section 21E of the Exchange Act and Section 27A of the Securities Act. Such forward-looking statements, including, without limitation, those relating to the future business prospects, revenues and income of Hythiam, wherever they occur, are necessarily estimates reflecting the best judgment of the senior management of Hythiam on the date on which they were made, or if no date is stated, as of the date of this report. These forward-looking statements are subject to risks, uncertainties and assumptions, including those described in the “Risk Factors” in Item 1 of Part I of our most recent Annual Report on Form 10-K, filed with the SEC, that may affect the operations, performance, development and results of our business. Because the factors discussed in this report could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any such forward-looking statements. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

     You should understand that the following important factors, in addition to those discussed above and in the “Risk Factors” could affect our future results and could cause those results to differ materially from those expressed in such forward-looking statements: