As filed with the Securities and Exchange Commission on June 9 , 2004
Registration No. 333-112353333 -______

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________
AMENDMENT NO. 3
TO
FORM S-1
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
CATASYS, INC.
____________________
HYTHIAM, INC.
(Exact name of registrant as specified in its charter)

____________________
Delaware
8090
88-0464853
Delaware809088-0464853
(State or other jurisdiction of
incorporation or organization)
(Primary Standard Industrial
Classification Code Number)
(I.R.S. Employer
Identification Number)
____________________
Hythiam, Inc.
11150 Santa Monica Boulevard, Suite 1500
Los Angeles, California 90025
(310) 444-4300

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
____________________
Terren S. Peizer
John C. Kirkland, Esq.Chief Executive Officer
Greenberg Traurig, LLPc/o Catasys, Inc.
2450 Colorado Avenue, Suite 400E
11150 Santa Monica Boulevard, Suite 1500
Los Angeles, California 9040490025
(310) 586-7700444-4300

(Address,Name, address, including zip code, and telephone number, including area code, of agent for service)
Copies to:

Kenneth R. Koch, Esq.
Mintz, Levin, Cohn, Ferris,
Glovsky, and Popeo, P.C.
The Chrysler Center
666 Third Avenue
New York, NY 10017
____________________(212) 935-3000 (telephone number)
(212) 983-3115 (facsimile number)
Approximate date of commencement of proposed sale to the public: As soon as practicable promptly after the effective date of this registration statement.
 
If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933 as amended, other than securities offered only in connection with dividend or interest reinvestment plans, check the following box.box:    Sþ
 
If this Form is filed to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, please check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.£o
 
If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.£o
 
If this formForm is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.£o
 
If deliveryIndicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer  o
Accelerated filer  o
Non-accelerated filer  o
Smaller reporting company  þ
(Do not check if a smaller reporting company)
CALCULATION OF REGISTRATION FEE
Title of Each Class of Securities to be Registered
Proposed Maximum
 Aggregate Offering
 Price (1)
Amount of
 Registration Fee (3)
[___] shares of common stock, $0.0001 par value$5,000,000$
Warrants to purchase [___] shares of common stock (2)$5,000,000$
[___]  shares of common stock issuable upon exercise of the warrants  
Total$10,000,000$1,161.00

(1)This Registration Statement shall also cover any additional shares of common stock which become issuable by reason of any stock dividend, stock split or other similar transaction effected without the receipt of consideration that results in an increase in the number of the outstanding shares of common stock of the registrant.
(2)The securities registered also include such indeterminate number of shares of common stock as may be issued upon exercise of warrants pursuant to the antidilution provisions of the warrants.
(3)Calculated pursuant to Rule 457(o) of the rules and regulations under the Securities Act of 1933.
The registrant hereby amends this prospectus is expectedregistration statement on such date or dates as may be necessary to be madedelay its effective date until the registrant shall file a further amendment that specifically states that this registration statement shall thereafter become effective in accordance with Section 8(a) of the Securities Act of 1933, as amended, or until the registration statement shall become effective on such date as the Commission, acting pursuant to Rule 434, please check the following box.£said Section 8(a), may determine.
____________________
Subject to Completion, Dated ,_____ 2011
 
The information in this preliminary prospectus is not complete and may be changed without notice. The Selling Shareholderschanged. We may not sell these securities until the registration statement filed with the Securities and Exchange Commission is effective. This preliminary prospectus is not an offer to sell these securities and the Selling Shareholders areis not soliciting offersan offer to buy these securities in any jurisdictionstate where the offer or sale of these securities is not permitted.

PROSPECTUS
[___] Shares of Common Stock
and
Warrants to Purchase up to [___] Shares of Common Stock
We are offering [___] shares of our common stock and warrants.  Each investor investing $[___] or more will receive five-year warrants to purchase an aggregate of up to [___] shares of common stock at a price of $[___] per share.  We are not required to sell any specific dollar amount or number of shares of common stock or warrants, but will use our best efforts to sell all of the shares of common stock and warrants being offered.  The offering expires on the earlier of (i) the date upon which all of the shares of common stock and warrants being offered have been sold, or (ii) ___________, 2011.

Our common stock is traded on the OTC Bulletin Board under the symbol “CATS”.  On April 20, 2011 the last reported sales price for our common stock was $0.07 per share.
Investing in our common stock involves a high degree of risk. You should review carefully the risks and uncertainties described under the heading “Risk Factors” beginning on page 4 of this prospectus, and under similar headings in any amendments or supplements to this prospectus.
Per ShareTotal 
Public Offering Price$$  
Underwriting Discounts and Commissions		$$
Offering Proceeds before expenses$$ 

SUBJECT TO COMPLETION, DATED ____________, 2004

PROSPECTUS
10,967,528 Shares
Common Stock
____________________
This prospectus relatesWe estimate the total expenses of this offering will be approximately $400,000. Because there is no minimum offering amount required as a condition to the resale of up to 10,967,528 shares of common stock of Hythiam, Inc., a Delaware corporation, that the shareholders whom we refer toclosing in this document asoffering, the “Selling Shareholders”actual public offering amount and proceeds to us, if any, are not presently determinable and may offer from time to time. As used in this prospectus, “Selling Shareholders” includesbe substantially less than the Selling Shareholders named intotal maximum offering set forth above. Some of the table undersecurities may be sold by the section titled “Selling Shareholders” beginning on page 14 of this prospectus. The sharesofficers and directors of our common stock being offered by this prospectus were previously issued to the Selling ShareholdersCompany. None of these officers or are issuable on the exercise of warrants for such shares.
As described in this prospectus under the section titled “Use of Proceeds,” except for the exercise price upon the exercise of warrants, weemployees will not receive any of the proceeds fromcommission or compensation for the sale of the sharessecurities.  We have no current arrangements nor have we entered into any agreements with any underwriters, broker-dealers or selling agents for the sale of our common stock by the Selling Shareholders.
Subject tosecurities, but we plan on entering into such arrangements and agreements.  If we can engage one or more underwriters, broker-dealers or selling agents and enter into any such arrangement(s), the restrictions described in this prospectus, the Selling Shareholders (directly, or through agents or dealers designated from time to time) may sell the shares of our common stock being offered by this prospectus from time to time until March 1, 2005, on terms to be determined at the time of sale. If this prospectus is not amended prior to that date, unsold shares subject to this prospectussecurities will be deregistered. The Selling Shareholders may at that time be able to sell their shares in accordance with the provisions of Rule 144(d) of the Securities Act of 1933. The prices at which these shareholders may sell the shares will be determined by the prevailing market price for the shares sold through such licensed underwriter(s), broker-dealer(s) and/or in negotiated transactions. To the extent required, the number of shares of our common stock to be sold, the purchase price, the public offering price, the names of any such agent or dealer and any applicable commission or discount with respect to a particular offering will be set forth in an accompanying prospectus supplement.selling agent(s). See “Plan of Distribution” beginning on page 26.15 of this prospectus for more information on this offering.

Our common stockThis offering will terminate on ___________, 2011, unless the offering is quoted onfully subscribed before that date or we decide to terminate the American Stock Exchange underoffering prior to that date. In either event, the symbol “HTM.” On June 4, 2004,offering may be closed without further notice to you. All costs associated with the last reported sale priceregistration will be borne by us.  As there is no minimum purchase requirement, no funds are required to be escrowed and all net proceeds will be available to us at closing for use as set forth in “Use of our common stock as reported on the Amex was $4.00 per share.
Investing in our common stock involves risks. See “Risk Factors”Proceeds” beginning on page 3 to read about factors you should consider before buying shares of our common stock.15.

Neither the Securities and Exchange Commission nor any state securities commission has approved or disapproved of these securities or passed upon the accuracyadequacy or adequacyaccuracy of this prospectus.  Any representation to the contrary is a criminal offense.
____________________

The shares of Common Stock may be sold directly by us to investors or through our underwriters.  See "Plan of Distribution".  

The date of this prospectus is June 8, 2004_______________, 2011.
 
TABLE OF CONTENTS
Page
PROSPECTUS SUMMARY1
RISK FACTORS4
DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS14
USE OF PROCEEDS15
DILUTION15
PLAN OF DISTRIBUTION15
DESCRIPTION OF SECURITIES16
OUR BUSINESS17
PROPERTIES26
LEGAL PROCEEDINGS26
MARKET FOR OUR COMMON EQUITY27
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
28
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE40
MANAGEMENT41
EXECUTIVE COMPENSATION45
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT50
RELATED PARTY TRANSACTIONS51
LEGAL MATTERS52
EXPERTS52
INDEMNIFICATION UNDER OUR CERTIFICATE OF INCORPORATION AND BYLAWS52
WHERE YOU CAN FIND MORE INFORMATION53
ABOUT THIS PROSPECTUS

You should rely only on the information contained in or incorporated by reference in this prospectus and any applicable prospectus supplement. We have not authorized anyone to provide you with different or additional information. If anyone provides you with different or inconsistent information, you should not rely on it. The information contained in this preliminary prospectus is not complete and may be changed without notice. The Selling Shareholders may not sell theseaccurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or any sale of securities until the registration statement filed with the Securities and Exchange Commission is effective.described in this prospectus. This preliminary prospectus is not an offer to sell these securities and the Selling Shareholders areit is not soliciting offersan offer to buy these securities in any jurisdiction where the offer or sale of these securities is not permitted. You should assume that the information appearing in this prospectus or any prospectus supplement, as well as information we have previously filed with the SEC and incorporated by reference, is accurate as of the date on the front of those documents only. Our business, financial condition, results of operations and prospects may have changed since those dates.
 

Page
Prospectus Summary

1

Risk Factors3
   Risks Related to Our Business3
      Risks Related to Our Intellectual Property6
   Risks Related to Our Industry 8
   Risks Related to Our Common Stock11
Cautionary Statement Concerning Forward-Looking Information13
Use of Proceeds13
Dividend Policy13
Selling Shareholders 14
Plan of Distribution26
Description of Capital Stock27
Legal Matters 28
Business                                                                             28
Property39
Legal Proceedings39
Market for Our Securities39
Selected Financial Data41
Management’s Discussion and Analysis of Financial Condition and Results of Operations42
Quantitative and Qualitative Disclosures About Market Risk 47
Management 47
Executive Compensation50
Security Ownership of Certain Beneficial Owners and Management 53
Certain Relationships and Related Transactions54
Indemnification Under Our Certificate of Incorporation and Bylaws 54
Where You Can Find Additional Information54
Index to Financial StatementsF-1


PROSPECTUS SUMMARY

This summary highlights information contained elsewhere in this prospectus. This summary doesmay not contain all of the information that you should consider before investing in our common stock.may be important to you. You should read thisthe entire prospectus, carefully, especially “Risk Factors” and ourincluding the financial statementsdata and related notes.notes, and risk factors.

Our BusinessCompany

Hythiam™ isAs used herein, “we,” “us,” “our” or the “Company” refers to Catasys, Inc.

We are a development-stage healthcare services management company. We have been unprofitable since our inceptioncompany, providing specialized behavioral health management services for substance abuse to health plans, employers and we expectunions through a network of licensed healthcare providers and its employees.  The Catasys substance dependence program (Ontrak) was designed to incur substantial additional operating losses for at least the foreseeable future as we increase 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 profitablyaddress substance dependence as a commercial enterprise.
We were formedchronic disease. The program seeks to lower costs and improve member health through the delivery of integrated medical and psychosocial interventions combining elements of traditional disease management and on-going “care coaching”, including our proprietary PROMETA® Treatment Program for the purpose of researching, developing, licensing and commercializing innovative technology to improve the treatment of alcoholism and drug addiction. Our technologystimulant dependence.  The PROMETA Treatment Program, which integrates behavioral, nutritional and medical components, is focusedalso available on treating addiction ata private-pay basis through licensed treatment providers and a company managed treatment center that offers the source—the brain. Our proprietary, patented and patent-pending treatment protocols are designed to treat addiction by stabilizing neurological function.
We license our HANDSPROMETA Treatment Protocol™ to healthcare providers to treat addictions to alcohol, cocaine and other addictive stimulants—Program, as well as combinations of these drugs. HANDS™ is a medically supervised treatment process in which designated prescription medications are administered in specific sequences, amounts and rates under the supervision of a licensed physician. The treatment is designedother treatments for detoxification, or the medically managed withdrawal from the psychoactive substance. HANDS also seeks neurostabilization, or stabilizing the patient’s brain chemistry, in order to eliminate cravings, enhance cognitive function and facilitate a pain-free withdrawal, thereby resulting in accelerated recovery.substance dependencies.
 
ForSubstance Dependence

Scientific research indicates that not only can drugs interfere with normal brain functioning, but they can also have long-lasting effects that persist even after the treatment of alcoholism, cocaine and other addictive stimulants,drug is no longer being used. Data indicates that at some point changes may occur in the HANDS Treatment Protocol consists of two to three consecutive days of treatment in a hospital or licensed healthcare facility, thereby reducing inpatient treatment time. Our protocols do not use sedating medications such aslong-acting benzodiazepines, and therefore do not require either gradually tapering off such medications or a washout period to allow the patient to fully recover from the sedative effects of such medications.
Limited initial results indicate that our protocols may significantly reduce or eliminate withdrawal symptoms, have significantly higher initial completion rates than conventional treatments, and reduce or eliminate the physical cravingsbrain 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 a major factor in relapse. Such results were not obtained by formal research studies,unable to stop drug use or remain drug abstinent without effective treatment. Professional medical treatment may not be statistically significant, have not been subjectednecessary to detailed scientific scrutiny, and may not be indicative of the long-term future performance of our protocols. We intend to sponsor formal scientific studies for the protocols to further substantiate and confirm their clinical efficacy.
We generate revenues by charging fees to licensed healthcare providers for access to our proprietary protocols and the right to use them in treating their patients, and for providing administrative management services in connection with the HANDS treatments. HANDS is currently used only for private pay patients, and no reimbursement is sought from Medicare, health insurers or other third-party payors. The administrative services we offer to health care providers include providing on-site liaisons, client and hospital education, continuing care information, marketing and sales support, data collection and aggregation, patient registration and patient follow-up data collection.
We also provide hospitals and attending physicians with information and administrative services to facilitate continuing care services, that help patients rebuild their lives after recovering from the physical effects of addiction and learn new life skills to maintain sobriety.
end this physiologically-based compulsive behavior. We believe that addressing the structurephysiological basis of our businesssubstance dependence as part of an integrated treatment program will improve clinical outcomes and operations as outlined above will be in substantial compliancereduce the cost of treating dependence.

Substance dependence is a worldwide problem with applicable lawsprevalence rates continuing to rise despite the efforts by national and regulations. However, the healthcare industry is highly regulated,local health authorities to curtail its growth. Substance dependence disorders affect many people and the criteria are often vaguehave wide-ranging social consequences. In 2008, an estimated 22.2 million Americans aged 12 and subject to change and interpretation by various federal and state legislatures, courts, enforcement and regulatory authorities. Our commercial viability is therefore subjectolder were classified with substance dependence or abuse, of which only 2.3 million received treatment at a specialty substance abuse facility, according to the legalNational Survey on Drug Use and regulatory risks outlinedHealth published by the Substance Abuse and Mental Health Services Administration (SAMHSA), an agency of the U.S. Department of Health and Human Services.

Pharmacological options for alcohol dependence exist and a number of pharmaceutical companies have introduced or announced drugs to treat alcohol dependence. These drugs may require chronic or long-term administration. In addition, several of these drugs are generally not used until the patient has already achieved abstinence, are generally administered on a chronic or long-term continuing basis, and do not represent an integrated treatment approach to addiction. We believe the PROMETA Treatment Program can be used at various stages of recovery, including initiation of abstinence and during early recovery, and can also complement other existing treatments. As such, our treatment programs offer a potentially valuable alternative or addition to traditional treatment methods. We also believe the best results can be achieved in the “Risk Factors” section beginning on page 3programs such as our Catasys offering that integrates psychosocial and medical treatment modalities and provide longer term support.

Our Market

The true impact of this prospectus.substance dependence is often under-identified by organizations that provide healthcare benefits. The reality is that substance dependent individuals:

 ●Are prevalent in any organization;
 1●
Cost health plans and employers a disproportionate amount of money;
●Have higher rates of absenteeism and lower rates of productivity; and
Our Offices
●Have co-morbid medical conditions incur increased costs for the treatment of these conditions compared to a non-substance dependent population.

When considering substance dependence-related costs, many organizations only look at direct treatment costs–usually behavioral claims.  The reality is that substance dependent individuals generally have overall poorer health and lower compliance, which leads to more expensive treatment for related, and even seemingly unrelated, co-occurring medical conditions. In fact, of total healthcare claims costs associated with substance dependence populations, the vast majority are medical claims and not behavioral treatment costs.
 
1

As December 31, 2008 there were over 191 million lives in the United States covered by various managed care programs including Preferred Provider Organizations (PPOs), Health Maintenance Organizations (HMOs), self-insured employers and managed Medicare/Medicaid programs.   Each year, based on our analysis, approximately 1.9% of commercial plan members will have a substance dependence diagnosis, and that figure may be lesser or greater for specific payors depending on the health plan demographics and location.  A smaller, high-cost subset of this population drives the majority of the claims costs for the overall substance dependent population.  For commercial members with substance dependence and a total annual claims cost of at least $7,500, the average annual per member claims cost is $25,500, compared to an average of $3,250 for a commercial non-substance dependent member, according to our research.

Our Solution: OnTrak and the PROMETA Treatment Program

Under our OnTrak solution for managed care, we work with health plans and employers to customize our program to meet a plan’s structural needs and pricing—either a case rate per patient or a per-enrolled member, per-month fee.  Our substance dependence program is designed for increased enrollment, longer retention and better health outcomes so we can help payors improve member care and achieve lower costs, and in addition help employers and organized labor reduce medical costs, absenteeism and job-related injuries in the workplace, thereby improving productivity.

OnTrak®

Our OnTrak integrated substance dependence solution combines innovative medical and psychosocial treatments with elements of population health management and ongoing member support to help organizations treat and manage substance dependent populations, and is designed to lower the overall costs of members diagnosed with substance dependence. We believe the benefits of Catasys include improved clinical outcomes and decreased costs for the payor, and improved quality of life and productivity for the member.

We believe OnTrak is the only program of its kind dedicated exclusively to substance dependence. The OnTrak substance dependence program was developed by addiction experts with years of clinical experience in the substance dependence field. This experience has helped to form key areas of expertise that sets Catasys apart from other solutions, including member engagement, working directly with the member treatment team and a more fully integrated treatment offering.

Our OnTrak integrated substance dependence program includes the following components:  Member identification, enrollment/referral, provider network, outpatient medical treatment, outpatient psychosocial treatment, care coaching, monitoring and reporting, and our proprietary web based clinical information platform (eOnTrak).

PROMETA® Treatment Program

Our PROMETA Treatment Program is an integrated, physician-based outpatient addiction treatment program that combines three components–medical treatment, nutritional support and psychosocial therapy–all critical in helping people address addiction to alcohol and stimulants (e.g. cocaine and methamphetamine). The program is designed to help relieve cravings, restore nutritional balance and initiate counseling.

Historically, the disease of addiction has been treated primarily through behavioral intervention, with fairly high relapse rates. We believe the PROMETA Treatment Program offers an advantage to traditional alternatives because it provides a treatment methodology that is discreet and only mildly sedating, and can be initiated in only three days, with a two-day follow-up treatment three weeks later. The initiation of treatment under PROMETA involves the oral and intravenous administration of pharmaceuticals in a medically directed and supervised setting. The medications used in the PROMETA Treatment Program have been approved by the Food and Drug Administration (FDA) for uses other than treatment of substance dependence. Treatment generally takes place on an outpatient basis at a properly equipped outpatient setting or clinic, or at a hospital or other in-patient facility, by physicians and healthcare providers who have licensed the rights to use our PROMETA Treatment Program. Following the initial treatment, our treatment program provides that patients receive one month of prescription medication, nutritional supplements, nutritional guidelines designed to assist in recovery, and individualized psychosocial or other recovery-oriented therapy chosen by the patient in conjunction with their treatment provider. The PROMETA Treatment Program provides for a second, two-day administration at the facility, which takes place about three weeks after initiation of treatment. The medical treatment is followed by continuing care, such as individual or group counseling, as a key part of recovery.

Our Strategy

Our business strategy is to provide a quality integrated medical and behavioral program to help organizations treat and manage substance dependent populations to impact total healthcare costs associated with members with a substance dependence diagnosis. We intend to grow our business through increased adoption of our OnTrak integrated substance dependence solutions by managed care health plans, employers, unions and other third-party payors.

Key elements of our business strategy include:

●Demonstrating the potential for improved clinical outcomes and reduced cost associated with using our Catasys programs with key managed care and other third-party payors;
●Educating third-party payors on the disproportionately high cost of their substance dependent population;
●Providing our Catasys integrated substance dependence solutions to third-party payors for reimbursement on a case rate or monthly fee; and
●Generating outcomes data from our OnTrak program to demonstrate cost reductions and utilization of this outcomes data to facilitate broader adoption.
2
As an early entrant into offering integrated medical and behavioral programs for substance dependence, Catasys will be well positioned to address increasing market demand.  Our Catasys program will help fill the gap that exists today: a lack of programs that focus on smaller populations with disproportionately higher costs and that improve patient care while controlling overall treatment costs.

Corporate Information

We are incorporated under the laws of the State of Delaware.  Our principal executive offices are located at 11150 Santa Monica Boulevard, Suite 1500, Los Angeles, California 90025, and our telephone number is (310) 444-4300. OurWe maintain an Internet website is located at www.hythiam.com. Information contained on our website is not incorporated by reference into this prospectus and you should not consider information on our website a part of this prospectus.http://www.catasyshealth.com.

THE OFFERING
 
The Offering
HythiamSecurities Offered[_______]  shares of Common Stock
Warrants to purchase up to [_______]  shares of common stock
[______]  shares of common stock offered by Selling Shareholders
10,967,528 shares(1)issuable upon exercise of the warrants
Hythiam common
Common stock authorized and outstanding as of June 8, 2004April 21, 2011
834,419,950 shares
 
24,975,207
Common stock to be outstanding after the offering assuming the sale of all shares covered hereby and assuming no exercise of the warrants for the shares covered by this prospectus
[___________] shares
Common stock to be outstanding after the offering assuming the sale of all shares covered hereby and assuming the exercise of all warrants for the shares covered by this prospectus
[___________] shares
Use of proceeds
We estimate that we will not receive anyup to $9.6 million in net proceeds from the sale of the sharessecurities in this offering, based on a price of common stock covered[$____] per unit and after deducting underwriting discounts and commissions and estimated offering expenses payable by this prospectus
Transfer AgentAmerican Stock Transfer & Trust Company
Amex SymbolHTMus.  We will use the proceeds from the sale of the securities for working capital needs, capital expenditures and other general corporate purposes. See “Use of Proceeds” for more information.
  
(1)Based on the estimated maximum number of shares of our common stock that may be sold by the Selling Shareholders named in this prospectus.
The Selling Shareholders may sell the shares of our common stock subject to this prospectus from time to time and may also decide not to sell all the shares they are allowed to sell under this prospectus. The Selling Shareholders will act independently of Hythiam in making decisions with respect to the timing, manner and size of each sale. Furthermore, the Selling Shareholders may enter into hedging transactions with broker-dealers in connection with distributions of shares or otherwise.
About this Prospectus
This prospectus is part of a registration statement that we are filing with the Securities and Exchange Commission, or the “SEC,” on behalf of the Selling Shareholders, who are named in the table under the section titled “Selling Shareholders” beginning on page 14 of this prospectus, utilizing a “shelf” registration process. Under this shelf registration process, the Selling Shareholders may, from time to time until this registration statement is withdrawn from registration by Hythiam, sell the shares of our common stock being offered under this prospectus in one or more offerings.
This prospectus provides you with a general description of the securities that the Selling Shareholders may offer. To the extent required, the number of shares of our common stock to be sold, the purchase price, the public offering price, the names of any agent or dealer and any applicable commission or discount with respect to a particular offering by any Selling Shareholder may be set forth in an accompanying prospectus supplement. You should read both this prospectus and any prospectus supplement together with the additional information described in the section titled “Where You Can Find Additional Information,” beginning on page 54.
You should rely only on the information contained in this prospectus or any related prospectus supplement. We have not, and the Selling Shareholders may not, authorized anyone to provide you with different information. We are not, and the Selling Shareholders are not, making an offer of the shares of our Common Stock to be sold under this prospectus in any jurisdiction where the offer or sale is not permitted. You should not assume that the information contained in this prospectus or any related prospectus supplement is accurate as of any date other than the date on the front cover of this prospectus or the related prospectus supplement, or that the information contained in any document incorporated by reference is accurate as of any date other than the date of the document incorporated by reference. We undertake no obligation to publicly update or revise such information, whether as a result of new information, future events or any other reason.
Prior to making a decision about investing in our common stock, you should carefully consider the specific risks contained in the section titled “Risk Factors” below, and any applicable prospectus supplement, together with all of the other information contained in this prospectus and any prospectus supplement or appearing in the registration statement of which this prospectus is a part.
HANDS™, HANDS Treatment Protocol™, Hythiam™ and the Hythiam logo are trademarks of Hythiam. All other trademarks and trade names referred to in this prospectus are the property of their respective owners.
Risk factorsThe shares of common stock offered hereby involve a high degree of risk. See “Risk Factors” beginning on page 4.
 2  
Dividend policy		We currently intend to retain any future earnings to fund the development and growth of our business. Therefore, we do not currently anticipate paying cash dividends on our common stock.
 
Trading SymbolOur common stock currently trades on the OTC Bulletin Board under the symbol “CATS.OB.”

 

RISK FACTORS

An investment in our common stock involves a high degree of risk. Before investing in our common stock, youYou should carefully consider the specific risks detailed in this “Risk Factors” section and any applicable prospectus supplement, together withevaluate all of the other information contained in this prospectus, including the risk factors listed below. Risks and any prospectus supplement.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 you may lose all or part of your investment.future events and circumstances could differ significantly from those anticipated in the forward-looking statements contained in this report.

Risks Relatedrelated to Our Businessour business

We are a development stage company withhave 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, commenced operations in June 2003, and began generating limited revenues in the third quarter of 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 substantial operating losses and if we are not ablemay be unable to raise necessaryobtain additional funds we may havefinancing, causing our independent auditors to reduce or stop operationsexpress substantial doubt about our ability to continue as a going concern.

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 $75,000been unprofitable since our inception in 2003 and $67,000 in the first quarter of 2004, all generatedexpect to incur substantial additional operating losses and negative cash flow from a single hospital. Our accumulated deficit through March 31, 2004 was $6.6 million. We anticipate that operating deficits will continue to arise duringoperations for at least the next 12 to 18 monthstwelve months.  As of our operations. Because many of our costs generally will not decrease with decreases in revenues, 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 reserves were $16.6 million and $13.9 million at December 31, 20032010, these conditions raised substantial doubt as to our ability to continue as a going concern. At December 31, 2010, cash and Marchcash equivalents amounted to $4.6 million. During the year ended December 31, 2004, respectively. Our current cash burn rate is approximately $1 million per month. If our revenues do not increase above current levels and our expenses continue at the current rate,2010, our cash reserves willand cash equivalents used in operating activities amounted to $8.4 million. Although we have recently taken actions to decrease expenses, increase revenues and obtain additional financing, there can be exhausted by May 2005, andno assurance that 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 tosuccessful in 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 fundingefforts. We may not be available to ussuccessful in raising necessary funds on acceptable terms or at all.all, and we may not be able to offset this by sufficient reductions in expenses and increases in revenue. If this occurs, we aremay be unable to obtain adequate financing on a timely basis,meet our cash obligations as they become due and we may be required to further delay or reduce or stopoperating expenses and curtail our operations, any of which would have a material adverse effect on our business.us.

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 effected
The need to conduct the HANDS Protocol under the guidance of a physician requires us to enter into licenses with hospitals 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 and other healthcare facilities to utilize our protocols in treating their patients. To date, all of our revenues have been derived from licensing fees from only one hospital, and only two hospitals have entered into agreements with us. Rollout is anticipated to be dependent on our ability to negotiate and conclude licensing agreements with hospitals within major metropolitan areas across the country. 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 do not generate 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 addiction 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 collaborations, we may not reach definitive agreements with any of them. Even if we enter into these arrangements, we may not be able to maintain these relationships or establish new ones in the future on acceptable terms. Furthermore, these arrangements may require us to grant rights to third parties or may have other terms that are burdensome to us, and may involve the acquisition of our securities. Our partners may decide to develop alternative technologies either on their own or in collaboration with others. If any of our partners terminate their relationship with us or fail to perform their obligations in a timely manner, the development or commercialization of our potential technology and protocols may be substantially delayed.
We may fail to successfully manage and maintain the growth ofgrow our business, which could adversely effectaffect our results of operations, financial condition and business.

As we implement commercial operations and continue expanding our sales and marketing activities, thisContinued expansion could put significant strain on our management, operational and financial resources. To manage future growth, we will need to continue to hire, train and manage additional employees, particularly a specially-trained sales force to market our protocols. Concurrent with expanding our operational and marketing activities, we will also be increasing our research and development activities, most significantly the development of protocols for other types of addictions, with the expectation of ultimately commercializing those products. We have maintained a small financial and accounting staff, and our reporting obligations as a public company, as well as ourThe need to comply with the requirements of the Sarbanes-Oxley Act of 2002, the rules and regulations of the Securities and Exchange Commission and the American Stock Exchange,SEC will continue to place significant demands on our financial and accounting staff, on our financial, accounting and information systems, and on our internal controls. As we grow, we will need to add additional accounting staffcontrols and continue to improve our financial, accounting and information systems and internal controls in order to fulfill our reporting responsibilities and to support growth in our business. We cannot assure you that our current and planned personnel, systems, procedures, and controls willany of which may not be adequate to support our anticipated growth or management willgrowth. We may not be able to effectively hire, train, retain, motivate and manage required personnel. Our failure to manage growth effectively could limit our ability to satisfy our reporting obligations, or achieve our marketing, commercialization and commercialization goalsfinancial goals.  Recent actions to reduce costs and streamline our operations could place further demands on our personnel, which could hinder our ability to effectively execute on our business strategies.

We will need additional funding, and we cannot guarantee that we will find adequate sources of capital in the future.

We have incurred negative cash flows from operations since inception and have expended, and expect to continue to expend, substantial funds to grow our business. We currently estimate that our existing cash, cash equivalents and marketable securities will only be sufficient to fund our operating expenses and capital requirements into the second half of 2011.  We could require additional funds before we achieve positive cash flows and we may never become cash flow positive.

If we raise additional funds by issuing equity securities, such financing will result in further dilution to our stockholders. Any equity securities issued also may provide for rights, preferences or privileges senior to those of holders of our common stock. If we raise additional funds by issuing additional debt securities, these debt securities would have rights, preferences and privileges senior to those of holders of our common stock, and the terms of the debt securities issued could impose significant restrictions on our operations. If we raise additional funds through collaborations and licensing arrangements, we might be required to relinquish significant rights to our technology or products, or to satisfygrant licenses on terms that are not favorable to us.

We do not know whether additional financing will be available on commercially acceptable terms, or at all. If adequate funds are not available or are not available on commercially acceptable terms, we may need to continue to downsize, curtail program development efforts or halt our reporting and other obligations as a public company.operations altogether.

Our treatment protocolsprograms may not be as effective as we believe them to be, which could limit or prevent us from establishing and maintaining product revenuesour revenue growth.

Our belief in the efficacy of our treatment protocolsOnTrak solution and PROMETA Treatment Program is based on a limited number of unpublished studies primarily in Spain,and commercial pilots that have been conducted to date and our very limited initial experience with a relatively small number of patients in the United States.patients. Such results may not be statistically significant, have not been subjected to detailedclose scientific scrutiny, and may not be indicative of the long-term future performance and safety of treatment with our protocols. While we haveprograms.  Future controlled scientific studies, may yield results that are unfavorable or demonstrate that treatment with our programs is not experienced such problems, if our treatment protocols cannot be effectively implemented on a large scale basisclinically effective or safe. If the initially indicated results cannot be successfully replicated or maintained over time, utilization of our programs could decline substantially. Our success is dependent on our ability to enroll third-party payor members in our OnTrak programs. Large scale outreach and enrollment efforts have not been conducted and we may not be unableable to implement our business model.achieve the anticipated enrollment rates.
 
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Our marketing effortsOnTrak Program or PROMETA Treatment Program may not result inbecome widely accepted, which could limit our growth.

Further marketplace acceptance of our protocols in the marketplace, which could adversely effect our revenues and earnings
While we have been able to generate initial interest in our protocols among a limited number of healthcare providers, there can be no assurance that our efforts or the efforts of others will be successful in fostering acceptance of our protocols in the target markets. Of the approximately 30 healthcare providers who have entered into the confidentiality agreement we require in order to disclose information about our treatment protocols,we entered into active discussions or negotiations with approximately a dozen. As of the date of this prospectus, two have licensed our protocols, one has declined primarily because it did not have the required bed license for a chemical dependency unit, and we remain in various levels of discussions with the others. If our marketing and promotional efforts are not as successful as we expect them to be, the likelihood of expending all of our funds prior to reaching a level of profitability will be increased.
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Marketplace acceptance of our protocolsprograms may largely depend upon healthcare providers’ and third-party payors’ interpretation of our limited data, the results of studies, pilots and programs, including financial and clinical outcome data from our OnTrak Programs, or upon reviews and reports that may be given by independent researchers. We intend to sponsor formal scientific studies by third party payors to further substantiate and confirm the clinical effectiveness of our protocols.researchers or other clinicians. In the event the testing by such groupsresearch does not giveestablish our treatment technology high approval ratings,programs to be safe and effective, it is unlikely we will be able to achieve significantwidespread market acceptance.

In addition, our ability to achieve further marketplace acceptance for our Catasys Program may be dependent on our ability to contract with a sufficient number of third party payors to and demonstrate financial and clinical outcomes from those agreements. If we are unable to secure sufficient contracts to achieve recognition of acceptance of our OnTrak program or if our program does not demonstrate the expected level of clinical improvement and cost savings it is unlikely we will be able to achieve widespread market acceptance.

Disappointing results for our PROMETA Treatment Program or Catasys Program, or failure to attain our publicly disclosed milestones, could adversely affect market acceptance and have a material adverse effect on our stock price.

There are several studies, evaluations and pilot programs that have been completed or are currently in progress that are evaluating our PROMETA Treatment Program and the OnTrak Program. Some results have been published and we expect results to become available and/or published over time.  Disappointing results, later-than-expected press release announcements or termination of evaluations, pilot programs or commercial programs could have a material adverse effect on the commercial acceptance of the PROMETA Treatment Program, our stock price and on our results of operations.  In addition, announcements regarding results, or anticipation of results, may increase volatility in our stock price.  In addition to numerous upcoming milestones, from time to time we provide financial guidance and other forecasts to the market.  While we believe that the assumptions underlying projections and forecasts we make publicly available are reasonable, projections and forecasts are inherently subject to numerous risks and uncertainties.  Any failure to achieve milestones, or to do so in a timely manner, or to achieve publicly announced guidance and forecasts, could have a material adverse effect on our results of operations and the price of our common stock.

Our industry is highly competitive, and we may not be able to compete successfullysuccessfully.

The healthcare business, in general, and the addictionsubstance dependence treatment business in particular, are highly competitive. Hospitals and healthcare providers that treat addiction are highly competitive and we must convince them that they will benefit by use of our protocols. We will compete with many types of addictionsubstance dependence treatment methods, treatment facilities and other service providers, many of whom are more established and better funded than we are. Many of these other productstreatment methods and servicesfacilities are well established in the same markets we will target, have substantial sales volume, and are provided and marketed by companies with much greater financial resources, facilities, organization, reputation and experience than we have. The historical focus on the use of psychological or behavioral therapies, as opposed to medical or physiological treatments for substance dependence, may create further resistance to penetrating the substance dependence treatment market.

The addiction medication naltrexone is marketed by a number of generic pharmaceutical companies as well as under the trade name ReVia® by Bristol Myers Squibb. Although naltrexone must be administered on a chronic or continuing basis and is associated with relatively high rates of side effects, including nausea, it has been shown to reduce cravings in the treatment of alcoholism. U.S. sales are estimated to be just under $25 million per year for this treatment. There are also a number of companies reported to be developing or marketing medications for reducing craving in the treatment of alcoholism. These include:alcoholism, including:

 

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●     		Alkermesthe addiction medication naltrexone, an opiate receptor antagonist, is developing a depot form of naltrexone. This product is a long-acting injectable form of naltrexone intended to be administeredmarketed by a physician via monthly injections. A recent press release reportsnumber of generic pharmaceutical companies as well as under the product was found to reduce the ratetrade names ReVia ®  and Depade ® , for treatment of heavy drinking in males by 25% to 48% relative to placebo, depending on dosage, but to have no statistically significant impact on drinking in women. Alkermes reports that it intends to submit an NDA to the FDA by the end of 2004.alcohol dependence;
   
           

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●		Merck AG is developing acamprosate,VIVITROL®, an extended release formulation of naltrexone manufactured by Alkermes, administered via monthly injections for the treatment of alcohol dependence in patients who are able to abstain from drinking in an outpatient setting, and are not actively drinking prior to treatment initiation. Alkermes reported that in clinical trials, when used in combination with psychosocial support, VIVITROL was shown to reduce the number of drinking days and heavy drinking days and to prolong abstinence in patients who abstained from alcohol the week prior to starting treatment;
●Campral® Delayed-Release Tablets (acamprosate calcium), an NMDA antagonist. The product must bereceptor antagonist taken two to three times per day on a chronic or long-term basis.basis and marketed by Forest Laboratories.  Clinical studies supported the effectiveness in the maintenance of abstinence for alcohol-dependent patients who had undergone inpatient detoxification and were already abstinent from alcohol; and
●Tropiramate (Topamax®), a drug manufactured by Ortho-McNeill Jannssen, which is approved for the treatment of seizures. A multi-site clinical trial reported in October 2007 found that tropiramate significantly reduced heavy drinking days in alcohol-dependent individuals.

We see these products as being potentially useful during the continuing care phase of treatment following treatment by the HANDS Protocols, but not being directly competitive. To the best of our knowledge, there are no treatments or medications approved, marketed or in development within the U.S. that reduce the cravings for cocaine, methamphetamine or other additive prescription psychostimulants. However, ourOur competitors may develop and introduce new processes and products that are equal or superior to our protocolsprograms in treating addictions.alcohol and substance dependencies. Accordingly, we may be adversely affected by any new processes and technology developed by our competitors.
 
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There are approximately 2,50013,500 facilities reporting to the Substance Abuse and Mental Health Services Administration tothat provide detoxification servicessubstance abuse treatment on an inpatient or outpatient basis. Well known examples of residential treatment programs include The Meadows,the Betty Ford CenterCenter®, Caron Foundation®, Hazelden® and Sierra Tucson.Tucson®. In addition, individual physicians may provide detoxificationsubstance dependence treatment in the course of their practices.  While we believe our products and services are unique, we operate in highly competitive markets. We compete with other healthcare management service organizations and disease management companies, including MBHOs, HMOs, PPOs, third-party administrators and other specialty healthcare and managed care companies. Most of our competitors are significantly larger and have greater financial, marketing and other resources than us.  We believe that our ability to offer customers a comprehensive and integrated substance dependence solution, including
the Hands Treatment Protocol offers an advantageutilization of innovative medical and psychosocial treatments, and our unique technology platform will enable us to traditional alternatives because it provides a detoxification methodology that is non-sedating, can be completed in only two to three days, offers an immediate improvement in cognitive function, and reduces craving, a primary cause of relapse.
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compete effectively.  However, we anticipate several potential points of resistance to penetrating the addiction treatment market. First, there is the historical focus on the use of psychological or behavioral therapies as opposed to medical or physiological treatments for addiction. Healthcare providers and potential patients may be resistant to the transition of treating addiction as a disease rather than as a behavioral aberration. Second, healthcare providers may be reluctant to use the HANDS Protocols due to the absence of published clinical studies supporting their efficacy. While we have embarked upon an active clinical program which is intended to lead to publications in medical journals, there can be no assurance that we will not encounter more effective competition in the clinical program will leadfuture, which would limit our ability to acceptable resultsmaintain or that the results will be published. If we are unable to penetrate these substantial barriers to entry we may not be able to successfully implementincrease our business plan.business.

We depend on key personnel, the loss of which could impact the ability to manage our businessbusiness.

Our future success depends on the performance of our senior management and key professionaloperating personnel. It therefore depends to a significant extent on retaining the services of our key executive officers, in particular our chairman and chief executive officer, Terren S. Peizer, our director and chief operating officer, Anthony M. LaMacchia, our chief financial officer, Chuck Timpe, our senior vice president of sales, James W. Elder, and our senior vice president of medical affairs, David E. Smith, M.D. Each of these key executives is party to an employment agreement which, subject to termination for cause or good reason, has a term of four or five years. While we believe our relationships with our executives are good and do not anticipate any of them leaving in the near future, the

The loss of the services of Mr. Peizer or any other key member of management and operating personnel could have a material adverse effect on our ability to manage our business.

We and our Chief Executive Officer are a party to litigation, which, if determined adversely to us, could adversely affect our cash flow and financial results.

We and our Chief Executive Officer are party to a litigation in which the plaintiffs assert causes of action for conversion, a request for an order to set aside fraudulent conveyance and breach of contract. While we have not experiencedbelieve the plaintiffs’ claims are without merit and we intend to vigorously defend the case, there can be no assurance that the litigation will be resolved in our favor. If this case is decided against us or our Chief Executive Officer, it may cause us to pay substantial damages, and other related fees. Regardless of whether this litigation is resolved in our favor, any problems in attractinglawsuit to which we are a party will likely be expensive and retaining desirable employees,time consuming to defend or resolve. This could also divert management’s time and attention away from business operations, which could harm our success is dependent uponbusiness. Costs of defense and any damages resulting from litigation, a ruling against us or a settlement of the litigation could adversely affect our ability to continue to attractcash flows and retain qualified management, professional, administrative and sales personnel to support our future growth.financial results. Please see “Item 3 Legal Proceedings” for more information.

We aremay be subject to personal injury claims,future litigation, which could result in substantial liabilities that may exceed our insurance coveragecoverage.

All significant medical treatments and procedures, including treatment utilizing our treatment protocols,programs, involve the risk of serious injury or death. Even under proper medical supervision, withdrawal from alcohol may cause severe physical reactions. While we have not been the subject of any personal injurysuch claims, our business entails an inherent risk of claims for personal injuries which are subject to the attendant risk ofand substantial damage awards. A significant sourceWe cannot control whether individual physicians will apply the appropriate standard of potential liability iscare, or conform to our treatment programs in determining how to treat their patients. While our agreements typically require physicians to indemnify us for their negligence, or alleged negligence by physicians treating patients using our protocols.there can be no assurance they will be willing and financially able to do so if claims are made. In addition, our contracts maylicense agreements require us to indemnify physicians, hospitals or their affiliates for losses resulting from claims ofour negligence. There can be no assurance that a future claim or claims will not be successful or, including the cost of legal defense, will not exceed the limits of available insurance coverage.

We currently have insurance coverage for up to $5 million per year for personal injury claims.claims, directors’ and officers’ liability insurance coverage, and errors and omissions insurance. We may not be able to maintain adequate liability insurance in accordance with standard industry practice, with appropriate coverage based on the nature and risks of our business, at acceptable costs andor on favorable terms. Insurance carriers are often reluctant to provide liability insurance for new healthcare services companies and products due to the limited claims history for such companies and products. In addition, based on current insurance markets, weWe expect that liability insurance will be more difficult to obtain and that premiums will increase over time.time and as the volume of patients treated with our programs increases. In the event of litigation, regardless of its merit or eventual outcome, or an award against us during a time when we have no available insurance or insufficient insurance, we may sustain significant lossesdamages or settlement expense (regardless of a claim's merit), litigation expense and significant harm to our reputation.

If third-party payors fail to provide coverage and adequate payment rates for our programs, our revenue and prospects for profitability will be harmed.

Our future revenue growth will depend in part upon our ability to contract with third-party payors, such as self-insured employers, insurance plans and unions for our OnTrak program. To date, we have not received significant amount of revenue from our OnTrak substance dependence programs from managed care organizations and other third-party payors, and acceptance of our OnTrak substance dependence programs is critical to the future prospects of our business. In addition, third-party payors are increasingly attempting to contain healthcare costs, and may not cover or provide adequate payment for treatment using our programs. Adequate third-party reimbursement might not be available to enable us to realize an appropriate return on investment in research and product development, and the lack of such reimbursement could have a material adverse effect on our operations and could adversely affect our revenues and earnings.
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We may not be able to achieve promised savings for our OnTrak contracts, which could result in pricing levels insufficient to cover our costs or ensure profitability.

We anticipate that many or all of our OnTrak contracts will be based upon anticipated or guaranteed levels of savings for our customers and achieving other operational metrics resulting in incentive fees based on savings.  If we are unable to meet or exceed promised savings or achieve agreed upon operational metrics, or favorably resolve contract billing and interpretation issues with our customers, we may be required to refund from the amount of fees paid to us any difference between savings that were guaranteed and the savings, if any, which were actually achieved; or we may fail to earn incentive fees based on savings. Accordingly, during or at the end of the contract terms, we may be required to refund some or all of the fees paid for our services.  This exposes us to significant risk that contracts negotiated and entered into may ultimately be unprofitable. In addition, managed care operations are at risk for costs incurred to provide agreed upon services under our program. Therefore, failure to anticipate or control costs could have materially adverse effects on our business.

Our prior international operations may be subject to foreign regulation.

The criteria of foreign laws, regulations and requirements are often vague and subject to change and interpretation. Our prior international operations may become the subject of foreign regulatory, civil, criminal or other investigations or proceedings, and our interpretations of applicable laws and regulations may be challenged. The defense of any such challenge could result in substantial cost and a diversion of management’s time and attention, regardless of whether it ultimately is successful. If we fail to comply with any applicable international laws, or a determination is made that we have failed to comply with these laws, our financial condition and results of operations could be adversely affected.

Our ability to utilize net operating capitalloss carryforwards may be limited.

As of December 31, 2010, we had net operating loss carryforwards (NOLs) of approximately $151.3 million for federal income tax purposes that will begin to expire in 2023. These NOLs may be used to offset future taxable income, to the extent we generate any taxable income, and thereby reduce or eliminate our future federal income taxes otherwise payable. Section 382 of the Internal Revenue Code imposes limitations on a corporation's ability to utilize NOLs if it experiences an ownership change as defined in Section 382.  In general terms, an ownership change may result from transactions increasing the ownership of certain stockholders in the stock of a corporation by more than 50 percent over a three-year period. In the event that an ownership change has occurred, or were to occur, utilization of our NOLs would be subject to an annual limitation under Section 382 determined by multiplying the value of our stock at the time of the ownership change by the applicable long-term tax-exempt rate as defined in the Internal Revenue Code. Any unused annual limitation may be carried over to later years.  We may be found to have experienced an ownership change under Section 382 as a result of events in the past or the issuance of shares of common stock upon a conversion of notes, or a combination thereof.  If so, the use of our NOLs, or a portion thereof, against our future taxable income may be subject to an annual limitation under Section 382, which may substantially impair or destroy the investmentsresult in expiration of stockholders.a portion of our NOLs before utilization.

Risks Related To Our Intellectual Propertyrelated to our intellectual property

We may not be able to adequately protect the proprietary treatment protocolsPROMETA Treatment Program which are the core ofis important to our businessbusiness.

We consider the protection of our proprietary treatment protocolsPROMETA Treatment Program to be criticalimportant to our business prospects. We obtained the rights to some of our most significant patent-pendingPROMETA technologies through a licensean agreement whichthat is subject to a number of conditions and restrictions, and a breach or termination of that agreement or the bankruptcy of any party to that agreement could significantly impact our ability to use and develop our technologies.
In addition,  We have three issued U.S. patents, one relating to the pendingtreatment of cocaine dependency with our PROMETA Treatment Program, one relating to our PROMETA Treatment Program for the treatment of certain symptoms associated with alcohol dependency, and one related to the treatment of methamphetamine dependency with our PROMETA Treatment Program. The patent applications filed andwe have licensed by usor filed may not issue as patents, and any issued patents may notbe too narrow in scope to provide us with significanta competitive advantages. Anyadvantage. Our patent position is uncertain and includes complex factual and legal issues, including the existence of prior art that may preclude or limit the scope of patent protection. Issued patents that have been or may be issued to us will generally expire twenty years after they are filed. Other inventorstheir priority date.  Two of our three issued U.S. patents will expire in 2021 and the third in 2028. Further, our patents and pending applications for patents and other intellectual property have been pledged as collateral to secure our obligations to pay certain debts, and our default with respect to those obligations could result in the transfer of our patents to our creditor.  In the event of such a transfer, we may have filed earlier patent applications which we are unaware of, thatbe unable to continue to operate our business.

Patent examiners may preventreject our patent applications and thereby prevent us from being granted.receiving more patents.  Competitors, orlicensees and others may at any time institute challenges against the validity or enforceability of any patent owned by us,challenge our patents and, if successful, our patents may be denied, subjected to reexamination, rendered unenforceable, or invalidated. In addition, theThe cost of litigation to uphold the validity of patents, and to protect and prevent infringement of patents can be substantial. Maintaining and prosecuting a patent portfolio might require funds that may not be available.
We may not be able to adequately protect the aspects of our treatment protocolsprograms that are not subject to patent protection,patented or are subject tohave only limited patent protection. Furthermore, competitors and others may independently develop similar or more advanced treatment protocolsprograms and technologies, may design around aspects of our technology, or may discover or duplicate our trade secrets and proprietary methods.
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To the extent we utilize processes and technology that constitute trade secrets under stateapplicable laws, we must implement appropriate levels of security for those trade secrets to secure theensure protection of such laws, which we may not do effectively. For some of our proprietary rights, we may need to secure assignments of rights from independent contractors and third parties to perfect our rights, and if we fail to do so they may retain ownership rights in the intellectual property upon which our business is based. Policing compliance with our confidentiality agreements and unauthorized use of our technology is difficult, and we may be unable to determine whether piracy of our technology has occurred.difficult. In addition, the laws of many foreign countries do not protect proprietary rights as fully as the laws of the United States.
While we have not had any such problems to date, the The loss of any of theour trade secrets or proprietary rights which we believe aremay be protected under the foregoing intellectual property safeguards may result in the loss of our competitive advantage over present and potential competitors. Our intellectual property may not prove to be an effective barrier to competition, in which case our business could be materially adversely affected.
 
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Our pending patent applications disclose and claim various approaches to the use of the PROMETA Treatment Program.  There is no assurance that we will receive one or more patents from these pending applications, or that, even if we receive one or more patents, the patent claims will be sufficiently broad to create patent infringement liability for competitors using treatment programs similar to the PROMETA Treatment Program.

Confidentiality agreements with employees, licensees and others may not adequately prevent disclosure of trade secrets and other proprietary informationinformation.

In order to protect our proprietary technology and processes, we rely in part on confidentiality provisions in our agreements with employees, licensees, treating physicians and others. These agreements may not effectively prevent disclosure of confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information. In addition, others may independently discover trade secrets and proprietary information. To date we have had one instance, in February 2004, in which it was necessary to send a formal demand to cease and desist using our protocols to treat patients to a consultant who had signed a confidentiality agreement. He subsequently complied with the demand and signed an employee innovation, proprietary information and confidentiality agreement, and an intellectual property assignment agreement. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position.
We may not be able to adequately protect our other intellectual property rights, which could limit our ability to compete
While we believe we have proprietary ownership, assigned or licensed rights in intellectual property which is capable of protection under federal copyright and patent laws, and under state laws regarding trade secrets, we may not have taken appropriate legal measures, and may not be able to adequately secure the necessary protections for our intellectual property. We have not patented allhad several instances in which it was necessary to send a formal demand to cease and desist using our programs to treat patients due to breach of confidentiality provisions in our technologies, or registered all of our trademarks or copyrightsagreements, and until we do so, we must rely on various state and common law rights for enforcement of the rightsin one instance have had to exclusive use our trade secrets, trademark and copyrights.file suit to enforce these provisions.

Our trademark applications for our trademarks HANDS™, The HANDS Patient Protocol™, HANDS Treatment Protocol™, Hythiam™ and the Hythiam logo are pending before the U.S. Patent and Trademark Office, and we have not yet been granted registration for these marks. If our trademark registrations are objected to or denied that may impact our ability to use and protect our brand names and company and product identity.
Although we have applied for trademarks for some of our brand names, and patents on some of our products, in the future we may decide not to secure federal registration of certain copyrights, trademarks or patents to which we may be entitled. Failure to do so, in the case of copyrights and trademarks, may reduce our access to the courts, and to certain remedies of statutory damages and attorneys’ fees, to which we may be entitled in the event of a violation of our proprietary and intellectual rights by third parties. Similarly, the failure to seek registration of any patents to which we may be entitled may result in loss of patent protection should a third party copy the patentable equipment, technology or process. The loss of any proprietary rights which are protectable under any of the foregoing intellectual property safeguards may result in the loss of a competitive advantage over present or potential competitors, with a resulting decrease in the profitability for us. There is no guarantee that such a loss of competitive advantage could be remedied or overcome by us at a price which we would be willing or able to pay.
We may be subject to claims that we infringe the intellectual property rights of others, and unfavorable outcomes could harm our businessbusiness.

Our future operations may be subject to claims, and potential litigation, arising from our alleged infringement of patents, trade secrets or copyrights owned by other third parties. We intend to fully comply with the law in avoiding such alleged infringements. However, withinWithin the healthcare, drug and bio-technology industry, establishedmany companies have actively pursued such infringements, and have initiated suchpursue infringement claims and litigation, which has mademakes the entry of competitive products more difficult. There can be no guarantee that we will notWe may experience such claims or litigation initiated by existing, better-funded competitors.competitors and by other third parties. Court-ordered injunctions may prevent us from continuing to market existing products or from bringing new products to market and the outcome of litigation and any resulting loss of revenues and expenses of litigation may substantially affect our ability to meet our expenses and continue operations.
 
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Risks related to our industry

The recently enacted healthcare reforms pose risks and uncertainties that may have a material adverse affect on our business.
Risks Related
There may be risks and uncertainties arising from the recently enacted healthcare reform and the implementing regulations that will be issued in the future. If we fail to comply with these laws or are unable to deal with these risks and uncertainties in an effective manner, our financial condition and results of operations could be adversely affected.

Our Industry
The healthcare industry in which we operate is subject to substantialpolicies and procedures may not fully comply with complex and increasing regulation by state and federal authorities, which could hinder, delaynegatively impact our business operations.

Our PROMETA Treatment Program has not been approved by the Food and Drug Administration (FDA), and while the drugs incorporated in the PROMETA Treatment Program have been approved for other indications, they are not FDA approved for the treatment of alcohol or preventsubstance dependency. We have not sought, and do not currently intend to seek, FDA approval for the PROMETA Treatment Program.  It is possible that in the future the FDA could require us from commercializing our protocolsto seek FDA approval for the PROMETA Treatment Program.

We generate revenues by charging fees directly to the healthcare providers who license our technology and contract for our sevices. The healthcare industry is highly regulated and continues to undergo significant changes as third-party payors, such as Medicare and Medicaid, traditional indemnity insurers, managed care organizations and other private payors increase efforts to control cost, utilization and delivery of healthcare services. Although we and our licensees do not currently bill or seek reimbursement from Medicare, Medicaid or other governmental organizations for the treatment of patients using the HANDS Treatment Protocol, we are nevertheless subject to the overall effect of the changes created by increased cost control and financial pressures on the industry. We believe that this industry will continue to be subject to increasing regulation, political and legal action, thescope and effect of which we cannot predict. Legislation is continuously being proposed, enacted and interpreted at the federal, state and local levels to regulate healthcare delivery and relationships between and among participants in the healthcare industry. Many healthcare laws are complex, applied broadly and subject to interpretation by courts and government agencies. Many existing healthcare laws and regulations were enacted without anticipation of our business structure or our products and services, yet these laws and regulations may be applied to us and our products and services. Our failure, or the failure of our customers and business partners, accurately to anticipate the application of these healthcare laws and regulations could create liability for us and negatively impact our business.
Healthcare companies are subject to extensive and complex federal, state and local laws, regulations and judicial decisions governing various matters such as the licensing and certification of facilities and personnel, the conduct of operations, billing policies and practices, policies and practices with regard to patient privacy and confidentiality, and prohibitions on payments for the referral of business and self-referrals. There are federaldecisions. The U.S. Congress and state lawslegislatures are considering legislation that govern patient referrals, physician financial relationships, submission of healthcare claims and inducementcould limit funding to beneficiaries of federal healthcare programs. Many states prohibit business corporations from practicing medicine, employing or maintaining control over physicians who practice medicine, or engaging in certain business practices, such as splitting fees with healthcare providers. Some or all of these state and federal regulations may apply to us or the services we intend to provide or may provide in the future.
our licensees.  In addition, the Food and Drug Administration, or FDA regulates development, testing, labeling, manufacturing, marketing, promotion, distribution, record-keeping and reporting requirements for prescription drugs, medical devices and biologics. Other regulatory requirements apply to dietary supplements, including vitamins. Compliance with laws and regulations enforced by theseregulatory agencies that have broad discretion in applying them may be required relative to anyfor our programs or other medical productsprograms or services developed or used by us. Failure to comply with applicableMany healthcare laws and regulations may require modification and redesign of our products, or elimination of the product. We may not have the financial resources to modify our products or implement new designs. Accordingly, our ability to market our protocols in compliance with applicable laws and regulations may be a threshold test for our survival.
There can be no assurance that government regulations applicable to our proposed productsbusiness are complex, applied broadly and services or thesubject to interpretation thereof will not changeby courts and therebygovernment agencies. Regulatory, political and legal action and pricing pressures could prevent us from marketing some or all of our products and services for a period of time or permanently. We are unableOur failure, or the failure of our licensees, to predictcomply with applicable regulations may result in the extentimposition of adverse governmental regulation which might arisecivil or criminal sanctions that we cannot afford, or require redesign or withdrawal of our programs from future federal, state or foreign legislative, judicial or administrative action. The federal government from time to time has made proposals to change aspects of the delivery and financing of healthcare services. We cannot predict what form any such legislation may take, how the courts would interpret it, or what effect such legislation would have on our business. It is possible that any such legislation ultimately enacted will contain provisions which may adversely affect our business.market.
 
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We may be subject to regulatory, enforcement and investigative proceedings, which may find thatcould adversely affect our policies and procedures do not fully comply withcomplex and changing healthcare regulationsfinancial condition or operations.

We have established policies and procedures that we believe will be sufficient to ensure that we operate in substantial compliance with applicable laws, regulations and requirements. Patients treated using the HANDS Treatment Protocol receive medical care in accordance with orders from their attending physicians. Each licensed physician is responsible for exercising their own independent medical judgment in determining the specific application of our treatment protocols, and the appropriate course of care for each patient. No employment relationship is expected to exist between us and the attending physicians who treat patients using our protocol. In the course of performing our administrative duties, we may bill and collect funds from patients on behalf of the healthcare provider, and disburse a portion of that money to the facility and/or the attending physician for professional services rendered. We do not currently operate our own healthcare facilities, employ our own treating physicians or provide medical advice or treatment to patients. The hospitals and licensed healthcare facilities that contract for the use of our technology own their facility license, and control and are responsible for the clinical activities provided on their premises. After the treatment procedure, local clinics and healthcare providers specializing in drug abuse treatment administer and provide follow up care. While we believe that our business practices are consistent with applicable law, the criteria are often vague and subject to change and interpretation.
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We maycould become the subject of regulatory, enforcement, or other investigations or proceedings, and our relationships, business structure, and interpretations of applicable laws and regulations may be challenged. The defense of any such challenge could result in substantial cost and a diversion of management’s time and attention. Thus,In addition, any such challenges could require significant changes to how we conduct our business. Any such challenge could have a material adverse effect on our business, regardless of whether it ultimately is successful. If we fail to comply with any applicable laws, or a determination is made that we have failed to comply with theseany applicable laws, our business, financial condition and results of operations could be adversely affected. In addition, changes in health care laws or regulations may restrict our operations, limit the expansion of our business or impose additional compliance requirements.

The promotion of our products and servicestreatment programs may be found to violate federal law concerning “off-label”off-label uses of prescription drugs, which could prevent us from marketing our protocolsprograms.

TheGenerally, the Food, Drug, &and Cosmetic Act, or FDC(FDC) Act, requires that a prescription drugsdrug be approved by the FDA for a specific medical indication bybefore the FDA prior to their marketingproduct can be distributed in interstate commerce.  Although the FDC Act does not prohibit a doctor’s use of a drug for another indication (this is referred to as off-label use), it does prohibit the promotion of a drug product for an unapproved use. The FDA also permits the non-promotional discussion of information related to off-label use in the context of scientific or medical communications. Our procedural medical protocols call fortreatment programs include the use of prescription drugs that have been approved by the FDA, but not for the treatment of chemical dependencydependence and drug addiction, conditions not namedwhich is how the drugs are used in our programs. Although we carefully structure our communications in a way that is intended to comply with the drugs’ official labeling. While theFDC Act and FDA allows for pre-approval exchange of scientific information, providedregulations, it is nonpromotional in nature and does not draw conclusions about the ultimate safety or effectiveness of the unapproved drug, and generally does not regulate licensed physicians who prescribe approved drugs for non-approved or “off-label” uses in the independent practice of medicine,possible that our promotion of our products and services mayactions could be found to violate FDA regulations orthe prohibition on off-label promotion of drugs. In addition, the FDC Act. The FDA has broad discretion in interpreting those regulations. IfAct imposes limits on the FDA determinestypes of claims that our promotion of our medical treatment protocols constitutes labeling ormay be made for a dietary supplement, and the promotion of prescription drugsa dietary supplement beyond such claims may also be seen as the unlawful promotion of a drug product for an unapproved uses, or brings anuse. Because our treatment programs also include the use of nutritional supplements, it is possible that claims made for those products could also put us at risk of FDA enforcement action against us for violatingmaking unlawful claims.

Violations of the FDC Act or FDA regulations can result in a range of sanctions, including administrative actions by the FDA (such as issuance of a Warning Letter), seizure of product, issuance of an injunction prohibiting future violations, and imposition of criminal or civil penalties. A successful enforcement action could prevent promotion of our treatment programs and we may be unable to continue operating under our current business model. Even if we defeat any FDA challenge,an enforcement action, the expenses and publicity associated with defendingdoing so, as well as the claimnegative publicity concerning the “off-label” use of drugs in our treatment programs, could adversely affect our business and results of operation.

The FDA has recently increased enforcement efforts in the area of promotion of “off-label” use of drugs, and we cannot assure you that our business practices or third party clinical trials will not come under scrutiny.

Treatment using our protocolprograms may be found to be investigational,require FDA or other review or approval, which could delay or prevent commercializationthe study or use of our protocolstreatment programs.

Under authority of the FDC Act, the FDA asserts jurisdiction over allextensively regulates entities and individuals engaged in the conduct of clinical trials, orwhich broadly includes experiments in which a drug is administered to human subjects. Hospitalshumans.  FDA regulations require, among other things, submission of a clinical trial treatment program for FDA review, obtaining from the agency an investigational new drug (IND) exemption before initiating a clinical trial, obtaining appropriate informed consent from study subjects, having the study approved and clinics have establishedsubject to continuing review by an Institutional Review Boards, or IRBs, to reviewBoard (IRB), and approve clinical trials using investigational treatments in their facilities. Certain investigations involving new drugs or off-label uses for approved drugs are subjectreporting to FDA approvals. Hospitals and clinics also generally mustsafety information regarding the conduct of the trial.  Certain third parties have permission from the FDA before charging patients for an investigational drug administered in a clinical trial. While the decision about seeking IRB review isengaged or are engaging in the discretion of, and is the responsibility of, each hospital or physician, use of our treatment protocolprogram and the collection of outcomes data in ways that may be considered to constitute a clinical trial, and that may be subject to FDA regulations and require IRB approval and oversight.  In addition, it is possible that use of our treatment program by individual physicians in treating their patients may be found to constitute a clinical trial or investigation that requires IRB review or FDA approval.submission of an IND or is otherwise subject to regulation by FDA.  The FDA has broad authority in interpreting and applying its regulations, so there can be no assurance that FDA will not find that use of our protocols by our licensees or collection of outcomes data on that use constitutes ato inspect clinical investigation subjectsites and IRBs, and to IRBtake action with regard to any violations.  Violations of FDA regulations regarding clinical trials can result in a range of actions, including suspension of the trial, prohibiting the clinical investigator from ever participating in clinical trials, and FDA jurisdiction.criminal prosecution.  Individual hospitals and physicians may also submit their use of our protocols in treatment programs to their IRBs, and there is no assurance individual IRBs will not find that use to be a clinical trial that requires FDA approval or that they will notwhich may prohibit or place restrictions on that use. Either of these results mayit.  FDA enforcement actions or IRB restrictions could adversely affect our business and the ability of our customers to charge for certain componentsuse our treatment programs.

The FDA has recently increased enforcement efforts regarding clinical trials, and we cannot assure you that the activities of treatmentour customers or others using our protocols.treatment programs will not come under scrutiny.

Failure to comply with FTC or similar state laws could result in sanctions or limit the claims we can make.

Our promotional activities and materials, including advertising to consumers and professionals, and materials provided to licensees for their use in promoting our treatment programs, are regulated by the Federal Trade Commission (FTC) under the FTC Act, which prohibits unfair and deceptive acts and practices, including claims which are false, misleading or inadequately substantiated. The FTC typically requires competent and reliable scientific tests or studies to substantiate express or implied claims that a product or service is safe or effective. If the FTC were to interpret our promotional materials as making express or implied claims that our treatment programs are safe or effective for the treatment of alcohol, cocaine or methamphetamine addiction, or any other claims, it may find that we do not have adequate substantiation for such claims. Allegations of a failure to comply with the FTC Act or similar laws enforced by state attorneys general and other state and local officials could result in administrative or judicial orders limiting or eliminating the claims we can make about our treatment programs, and other sanctions including substantial financial penalties.
 
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Our business practices may be found to constitute illegal fee-splitting or corporate practice of medicine, which may lead to penalties and adversely effectaffect our businessbusiness.

Many states, including California in which our principal executive offices areand our managed treatment center is located, have laws that prohibit business corporations, such as Hythiam,us, from practicing medicine, exercising control over medical judgments or decisions of physicians, or engaging in certain arrangements with physicians such as employment, payment for referrals or fee-splitting, with physicians.fee-splitting. Courts, regulatory authorities or other parties, including physicians, may assert that we are engaged in the unlawful corporate practice of medicine by providing administrative and ancillaryother services in connection with our protocols,treatment programs or by consolidating the revenues of the physician practices we manage, or that our contractual arrangements to licenselicensing our technology for a license fee that could be characterized as a portion of the patient fees, or subleasing space and providing turn-key business management to affiliated medical groups in exchange for management and licensing fees, constitute improper fee-splitting or payment for referrals, in which case we could be subject to civil and criminal penalties, our contracts could be found legally invalid and unenforceable, in whole or in part, or we could be required to restructure our contractual arrangements. There canIf so, we may be no assurance that this will not occur or, if it does, that we would be ableunable to restructure our contractual arrangements on favorable terms.terms, which would adversely affect our business and operations.

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Our business practices may be found to violate anti-kickback, physician self-referral or false claims laws, which may lead to penalties and adversely effectaffect our business
business.

The healthcare industry is subject to extensive federal and state regulation with respect to financial relationships and “kickbacks”kickbacks involving health carehealthcare providers, physician self-referral arrangements, filing of false claims and other fraud and abuse issues. Federal anti-kickback laws and regulations prohibit certain offers, payments, solicitations, or receipts of remuneration in return for (i) referring patients for items or services covered by Medicare, Medicaid or other federal health care program,healthcare programs, or (ii) purchasing, leasing, ordering or arranging for or recommending any service, good, item or facility for which payment may be made by a federal health care program. In addition, subject to numerous exceptions, federal physician self-referral legislation, commonly known as the Stark law, generally prohibits a physician from orderingreferring patients for  certain designated health services reimbursable by Medicare Medicaid or other federal healthcare programMedicaid  from any entity with which the physician has a financial relationship. While we do not currently seek such third party reimbursement, we intend to do so in the future. In addition,relationship, and many states have similar laws, some of which are not limited to services reimbursed by federal healthcare programs.analogous laws. Other federal and state laws govern the submission of claims for reimbursement, or false claims laws. One of the most prominent of these laws is the federal Civil False Claims Act. In recent cases, the government has taken the position thatAct, and violations of other laws, such as the federal anti-kickback lawslaw or the FDA prohibitions against promotion of off-label uses of drugs, shouldmay also be prosecuted as violations of the Civil False Claims Act.
While we believe we have structured our relationships to comply with all applicable requirements, federal Federal or state authorities may claim that our fee arrangements, agreements and relationships with contractors, hospitals and physicians violate these anti-kickback, self-referral or false claims laws and regulations. These laws are broadly worded and have been broadly interpreted by courts. It is often difficult to predict how these laws will be applied, and they potentially subject many typical business arrangements to government investigation and prosecution, which can be costly and time consuming. Violations of these laws aremay be punishable by monetary fines, civil and criminal penalties, exclusion from participation in government-sponsored health carehealthcare programs and forfeiture of amounts collected in violation of such laws. Some states also have similar anti-kickback and self-referral laws, imposing substantial penalties for violations. If our business practices are found to violate any of these provisions, we may be unable to continue with our relationships or implement our business plans, which would have an adverse effect on our business and results of operations.

We may be subject to healthcare anti-fraud initiatives, which may lead to penalties and adversely effectaffect our businessbusiness.

State and federal governments are devoting increased attention and resources to anti-fraud initiatives against healthcare providers, takingand may take an expansive definition of fraud that includes receiving fees in connection with a healthcare business that is found to violate any of the complex regulations described above. Recent legislation expanded the penalties for heath care fraud, including broader provisions for the exclusion of providers from the Medicare, Medicaid and other healthcare programs. While to our knowledge we have not been the subject of any anti-fraud investigations, if such a claim were made defending our business practices could be time consuming and expensive, and an adverse finding could result in substantial penalties or require us to restructure our operations, which we may not be able to do successfully.

Our use and disclosure of patient information is subject to privacy and security regulations, which may result in increased costscosts.

In conducting research or providing administrative services to healthcare providers in connection with the use of our protocols,treatment programs, we may collect, use, disclose, maintain and transmit patient information in ways that will be subject to many of the numerous state, federal and international laws and regulations governgoverning the collection, dissemination, use, anddisclosure, storage, transmission and/or confidentiality of patient-identifiable health information, including the federaladministrative simplification requirements of the Health Insurance Portability and Accountability Act of 1996 and related rules, or HIPAA. The three rules that were promulgated pursuant to HIPAA that could most significantly affect our business are the Standards for Electronic Transactions, or Transactions Rule; the Standards for Privacy of Individually Identifiable Health Information, or Privacy Rule;its implementing regulations (HIPAA) and the Health Insurance Reform:Information Technology for Economic and Clinical Health Act of 2009 (HITECH). The HIPAA Privacy Rule restricts the use and disclosure of patient information, and requires safeguarding that information. The HIPAA Security Standards,Rule and HITECH establish elaborate requirements for safeguarding patient information transmitted or Security Rule. The respective compliance dates for these rules for most entities were and are October 16, 2003, April 16, 2003 and April 21, 2005.stored electronically. HIPAA applies to covered entities, which may include most healthcare facilities and does include health plans that will contract for the use of our protocolsprograms and our services. The HIPAA and HITECH rules require covered entities to bind contractors like Hythiamus to compliance with certain burdensome HIPAA rule requirements known as business associate requirements and data security provision and reporting requirements. If we are providing management services that include electronic billing on behalf of a physician practice or facility that is a covered entity, we may be required to conduct those electronic transactions in accordance with the HIPAA and HITECH regulations governing the form and format of those transactions. Services provided under our Catasys program also require us to comply with HIPAA, HITECH, Title 42 of the Code of Federal Regulations, which governs the confidentiality of certain patient identified drug and alcohol information, and other privacy and security regulations. Other federal and state laws restricting the use and protecting the privacy and security of patient information also apply to our customerslicensees directly and in some cases to us, either directly or indirectly.
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The HIPAA Transactions Rule establishes format and data content standards for eight of the most common healthcare transactions. When we perform billing and collection services on behalf of our customers we may be engaging in one of more of these standard transactions and will be required to conduct those transactions in compliance with the required standards. The HIPAA Privacy Rule restricts the use and disclosure of patient information, requires entities to safeguard that information and to provide certain rights to individuals with respect to that information. The HIPAA Security Rule establishes elaborate requirements for safeguarding patient information transmitted or stored electronically. We may be required to make costly system purchases and modifications to comply with the HIPAA and HITECH rule requirements that will beare imposed on us and our failure to comply may result in liability and adversely affect our business. Our failure to comply with the applicable regulations may result in imposition of civil or criminal sanctions that we cannot afford, or require redesign or withdrawal of our programs from the market.
 
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Federal and state consumer protection laws are being applied increasingly by the Federal Trade Commission, or FTC and state attorneys general to regulate the collection, use, storage, and disclosure of personal or patient information, through web sites or otherwise, and to regulate the presentation of web site content. Courts may also adopt the standards for fair information practices promulgated by the FTC, which concern consumer notice, choice, security and access.
Numerous other federal and state laws protect the confidentiality and security of personal and patient information. These laws in many cases are not preempted by the HIPAA rules and may be subject to varying interpretations by courts and government agencies, creating complex compliance issues for us and our customers and potentially exposing us to additional expense, adverse publicity and liability. Other countries also have, or are developing laws governing the collection, use, disclosure and transmission of personal or patient information and these laws could create liability for us or increase our cost of doing business.

NewOur business arrangements with health information standards, whether implemented pursuantcare providers may be deemed to HIPAA, congressional action or otherwise,be franchises, which could have a significant effect onnegatively impact our business operations.

Franchise arrangements in the mannerUnited States are subject to rules and regulations of the FTC and various state laws relating to the offer and sale of franchises.  A number of the states in which we must handle health care related data,operate regulate the sale of franchises and require registration of the franchise offering circular with state authorities and the costdelivery of complying with these standards could be significant. If we do not properly comply with existinga franchise offering circular to prospective franchisees.  State franchise laws often limit, among other things, the duration and scope of non-competitive provisions, the ability of a franchisor to terminate or newrefuse to renew a franchise and the ability of a franchisor to designate sources of supply.  Franchise laws and regulations relatedare complex, apply broadly and are subject to patient health informationinterpretation by courts and government agencies.  Federal or state authorities or healthcare providers with whom we contract may claim that the agreements under which we license rights to our technology and trademarks and provide services violate these laws and regulations. Violations of these laws are punishable by monetary fines, civil and criminal penalties, and forfeiture of amounts collected in conducting research or providing servicesviolation of such laws. If our business practices are found to constitute franchises, we could be subject to civil and criminal penalties, our contracts could be found invalid and unenforceable, in whole or civil sanctions.in part, or we could be required to restructure our contractual arrangements.  We may be unable to continue with our relationships or restructure them on favorable terms, which would have an adverse effect on our business and results of operations.  We may also be required to furnish prospective franchisees with a franchise offering circular containing prescribed information, and restrict how we market to or deal with healthcare providers, potentially limiting and substantially increasing our cost of doing business.

Certain of our professional healthcare employees, such as nurses, must comply with individual licensing requirements.

All of our healthcare professionals who are subject to licensing requirements, such as our care coaches, are licensed in the state in which they are physically present.  Multiple state licensing requirements for healthcare professionals who provide services telephonically over state lines may require us to license some of our healthcare professionals in more than one state.  New and evolving agency interpretations, federal or state legislation or regulations, or judicial decisions could increase the requirement for multi-state licensing of all call center health professionals, which would increase our costs of services.
 
Risks related to our common stock

Our common stock is thinly traded, and it is therefore susceptible to wide price swings.

Our common stock is traded on the OTC Bulletin Board under the symbol “CATS.OB.” Thinly traded stocks are more susceptible to significant and sudden price changes than stocks that are widely followed by the investment community and actively traded on an exchange or NASDAQ. The liquidity of our common stock depends upon the presence in the marketplace of willing buyers and sellers. We maycannot assure you that you will be able to find a buyer for your shares. In the future, if we successfully list the common stock on a securities exchange or obtain NASDAQ, or other national securities exchange, trading authorization, we will not be able to profitably adaptassure you that an organized public market for our securities will develop or that there will be any private demand for the common stock. We could also subsequently fail to satisfy the changing healthcare and addiction treatment industry, which may reducestandards for continued exchange listing or eliminate our commercial opportunity
Healthcare organizations, public and private, continue to change the manner in which they operate and pay for services. In recent years, the healthcare industry has been subject to increasing levels of government regulation of reimbursement rates and capital expenditures, among other things. For example, while we do not believe it will impact our operations because we do not currently seek Medicare reimbursement, the recently enacted Medicare Prescription Drug, Improvement and Modernization Act of 2003 changes substantially the way Medicare will pay for prescription drugs and also creates or reforms other healthcare reimbursement. Proposals to reform the healthcare system have been considered by Congress and state legislatures. Any new legislative initiatives, if enacted, may further increase government regulation ofNASDAQ or other involvement in healthcare, lower reimbursement rates and otherwise changenational securities exchange trading, such as standards having to do with a minimum share price, the operating environment for healthcare companies. We cannot predict the likelihoodminimum number of all future changes in the healthcare industry in general,public shareholders or the addiction treatment industry in particular, or what impact they may have on our earnings, financial condition or business.
Risks Related to Our Common Stock
The saleaggregate market value of shares by the Selling Shareholders may significantly impact the market pricepublicly held shares. Any holder of our common stocksecurities should regard them as a long-term investment and should be prepared to bear the economic risk of an investment in our securities for an indefinite period.

TheFailure to maintain effective registration and sale of shares by the Selling Shareholders may significantly effect the market price of our stock. Most of the Selling Shareholders acquired their shares at $2.50 in connection with the September 29, 2003 merger between the registrant and Hythiam, Inc., or were granted shares or options in exchange for providing us with technology or services. We currently have 1,119,969 registered shares trading on Amex. The 10,967,528 shares provided for in this registration statement represent approximately 44% of our 24,975,207 currently outstanding shares of common stock. Because the shares are being registered on behalf of the Selling Shareholders, we have no control over which of the Selling Shareholders will actually sell all or any portion of their shares, or at what price. Unless an amendment to this prospectus is filed before that date, sales must occur by March 1, 2005 to be subject to this prospectus. However, the Selling Shareholders may thereafter be able to sell their shares in accordance with the provisions of Rule 144(d) promulgated under the Securities Act of 1933, as amended.
In addition, future sales of substantial amounts of our common stock, including shares that we may issue upon exercise of outstanding options and warrants,internal controls could adversely affect our operating results and the market price offor our common stock. Further, if

Section 404 of the Sarbanes-Oxley Act of 2002 requires that we maintain internal control over financial reporting that meets applicable standards. As with many smaller companies with small staff, material weaknesses in our financial controls and procedures may be discovered. If we are unable, or are perceived as unable, to produce reliable financial reports due to internal control deficiencies, investors could lose confidence in our reported financial information and operating results, which could result in a negative market reaction and adversely affect our ability to raise additional funds through the issuance of common stock or securities convertible into or exercisable for common stock, the percentage ownership of our stockholders will be reduced and the price of our common stock may fall.capital.
 
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Approximately 33% of our stock is controlled by our chairman and chief executive officer, who has the ability to substantially influence the election of directors and other matters submitted to stockholders.

13,600,000, 207,045,924 and 22,216,628 shares are held of record by Reserva Capital, LLC, Socius LLC and Bonmore, LLC, respectively , whose sole managing member is our chairman and chief executive officer. The actual shares owned represent 29% of our 834,419,950 shares outstanding as of March 28, 2011. As a result, he has and is expected to continue to have the ability to significantly influence the election of our Board of Directors and the outcome of all other issues submitted to our stockholders. The interests of these principal stockholders may not always coincide with our interests or the interests of other stockholders, and they may act in a manner that advances his best interests and not necessarily those of other stockholders. One consequence to this substantial influence or control is that it may be difficult for investors to remove management of our Company. It could also deter unsolicited takeovers, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices.

Our stock price may be subject to substantial volatility, and you may lose all or a substantial partthe value of your investment may decline.

Our common stock is traded on the American Stock Exchange. There is a limited public float, and trading volume historically has been limited and sporadic. Prior to the registrant’s September 29, 2003 merger with Hythiam, Inc.,The market price of our common stock traded between $.50 and $.54 per share (when adjusted for a subsequent split) on very limited volume of less than 20,000 shares per quarter with no trades in some quarters, and since the merger has traded between $4.13 and $8.40 per share on volume ranging from zero to 280,000 shares per day. As a result, the current price for our common stock on the Amex is not necessarily a reliable indicator of our fair market value.experienced downward substantial volatility. The price at which our common stock will trade may be highly volatile and may fluctuate as a result of a number of factors, including without limitation, the number of shares available for sale in the market, quarterly variations in our operating results and actual or anticipated announcements of pilots and scientific studies of the effectiveness of our PROMETA Treatment Program, our OnTrak Program, announcements regarding new or discontinued OnTrak Program contracts, new products or services by us or competitors, regulatory investigations or determinations, acquisitions or strategic alliances by us or our competitors, recruitment or departures of key personnel, the gain or loss of significant customers, changes in the estimates of our operating performance, actual or threatened litigation, market conditions in our industry and the economy as a whole.

Numerous factors, including many over which we have no control, may have a significant impact on the market price of our common stock, including:

●announcements of new products or services by us or our competitors; current events affecting the political, economic and social situation in the United States and other countries where we operate;
●trends in our industry and the markets in which we operate;
●changes in financial estimates and recommendations by securities analysts;
●acquisitions and financings by us or our competitors;
●the gain or loss of a significant customer;
●quarterly variations in operating results;
●volatility in rates of exchanges between the US dollar and the currencies of the foreign countries in which we operate;
●the operating and stock price performance of other companies that investors may consider to be comparable;
●purchases or sales of blocks of our securities; and
●issuances of stock.

Furthermore, stockholders may initiate securities class action lawsuits if the market price of our stock drops significantly, which may cause us to incur substantial costs and could divert the time and attention of our management.

Future sales of common stock by existing stockholders, or the perception that such sales may occur, could depress our stock price.

The company is controlledmarket price of our common stock could decline as a result of sales by, or the perceived possibility of sales by, our existing stockholders.  We have completed a single principal stockholder who hasnumber of private placements of our common stock and other securities over the abilitylast several years, and we have effective resale registration statements pursuant to determinewhich the election of directors andpurchasers can freely resell their shares into the outcome of matters submitted to stockholders
As of May 17, 2004, Reserva, LLC, a limited liability company whose sole managing member is Terren S. Peizer, our chairman and chief executive officer, beneficially owned approximately 55%market.  In addition, most of our outstanding shares are eligible for public resale pursuant to Rule 144 under the Securities Act of 1933, as amended.  Approximately 293 million shares of our common stock. As a result, he presentlystock are currently held by our affiliates and may continuebe sold pursuant to havean effective registration statement or in accordance with the abilityvolume and other limitations of Rule 144 or pursuant to determineother exempt transactions.  Future sales of common stock by significant stockholders, including those who acquired their shares in private placements or who are affiliates, or the electionperception that such sales may occur, could depress the price of our boardcommon stock.

Future issuances of directorscommon stock and hedging activities may depress the outcometrading price of all other issues submitted to our stockholders. The interestscommon stock.

Any future issuance of this stockholder may not always coincide withequity securities, including the issuance of shares upon direct registration, upon satisfaction of our interestsobligations, compensation of vendors, exercise of outstanding warrants, or effectuation of a reverse stock split, of which we have already received approval from our stockholders, could dilute the interests of otherour existing stockholders, and itcould substantially decrease the trading price of our common stock.  We currently have outstanding approximately 208 million options and 94 million warrants to acquire our common stock at prices between $0.01 and $8.56 per share. We may actissue equity securities in the future for a manner that advances its best interestsnumber of reasons, including to finance our operations and not necessarily thosebusiness strategy, in connection with acquisitions, to adjust our ratio of debt to equity, to satisfy our obligations upon the exercise of outstanding warrants or options or for other stockholders. One consequence to this substantial stockholder’s control is that itreasons.
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There may be difficultfuture sales or other dilution of our equity, which may adversely affect the market price of our common stock.

In the future, we may need to raise additional funds through public or private financing, which might include sales of equity securities. The issuance of any additional shares of common stock or securities convertible into, exchangeable for investorsor that represent the right to remove managementreceive common stock or the exercise of such securities could be substantially dilutive to holders of our common stock. Holders of shares of our common stock have no preemptive rights that entitle holders to purchase their pro rata share of any offering of shares of any class or series. The market price of our common stock could decline as a result of sales of shares of our common stock made after this offering or the perception that such sales could occur. Because our decision to issue securities in any future offering will depend on market conditions and other factors beyond our control, we cannot predict or estimate the amount, timing or nature of our future offerings. Thus, our stockholders bear the risk of our future offerings reducing the market price of our common stock and diluting their interests in us.

A large number of shares may be sold in the market following this offering, which may depress the market price of our common stock.

A large number of shares may be sold in the market following this offering, which may depress the market price of our common stock.  Sales of a substantial number of shares of our common stock in the public market following this offering could cause the market price of our common stock to decline.  If there are more shares of common stock offered for sale than buyers are willing to purchase, then the market price of our common stock may decline to a market price at which buyers are willing to purchase the offered shares of common stock and sellers remain willing to sell the shares. All of the company. It could also deter unsolicited takeovers, including transactionssecurities sold in which stockholders might otherwise receive a premium for their shares over then current market prices.the offering will be freely tradable without restriction or further registration under the Securities Act.

Provisions in our certificate of incorporation, bylaws, charter documents and Delaware law could discourage a change in control, or an acquisition of us by a third party, even if the acquisition would be favorable to you, thereby and adversely effectaffect existing stockholdersstockholders.

Our certificate of incorporation and the Delaware General Corporation Law contain provisions that may have the effect of making more difficult or delaying attempts by others to obtain control of our company,Company, even when these attempts may be in the best interests of stockholders. OurFor example, our certificate of incorporation also authorizes our boardBoard of directors,Directors, without stockholder approval, to issue one or more series of preferred stock, which could have voting and conversion rights that adversely affect or dilute the voting power of the holders of common stock. Delaware law also imposes conditions on certain business combination transactions with “interested stockholders.”
These provisions and others that could be adopted in the future could deter unsolicited takeovers or delay or prevent changes in our control or management, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices. These provisions may also limit the ability of stockholders to approve transactions that they may deem to be in their best interests.

We may incur increased costs asdo not expect to pay dividends in the foreseeable future, and accordingly you must rely on stock appreciation for any return on your investment.

We have paid no cash dividends on our common stock to date, and we currently intend to retain our future earnings, if any, to fund the continued development and growth of our business. As a result, of recently enacted and proposed changes in laws and regulations relatingwe do not expect to corporate governance matters.
Recently enacted and proposed changespay any cash dividends in the laws and regulations affecting public companies, including the provisionsforeseeable future.  Further, any payment of the Sarbanes-Oxley Act of 2002 and rules adopted or proposed by the Securities and Exchange Commission and by the American Stock Exchange,cash dividends will result in increased costs to us as we evaluate the implications of any new rules and respond to their requirements. New rules could make it more difficult or more costly for us to obtain certain types of insurance, including director and officer liability insurance, and we may be forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The impact of these events could also make it more difficult for us to attract and retain qualified persons to servedepend on our board of directors, our board committees or as executive officers. We cannot predict or estimate the amount of the additional costs we may incur or the timing of such costs to comply with any new rules and regulations.
12 
CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION
This prospectus 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 Hythiamcapital requirements and other matters. Statementsfactors, including contractual restrictions to which we may be subject, and will be at the discretion of our Board of Directors.

We may use these proceeds in this prospectus that areways with which you may not historical facts are hereby identified as “forward-looking statements” foragree.

We have considerable discretion in the purposeapplication of the safe harbor provided by Section 21Eproceeds of this offering. You will not have the opportunity, as part of your investment decision, to assess whether the proceeds are being used in a manner agreeable to you. You must rely on our judgment regarding the application 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 datenet proceeds of this prospectus. These forward-looking statements are subject to risks, uncertainties and assumptions, including those described inoffering. The net proceeds may be used for corporate purposes that do not improve our profitability or increase the section entitled “Risk Factors,” beginning on page 3 that may affect the operations, performance, development and resultsprice of our business. Because the factors discussedshares. The net proceeds may also be placed in this prospectus could cause actual resultsinvestments that do not produce income 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.that lose value.

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

 l

general economic conditions,

 l

●      		the effectivenessanticipated results of clinical studies on our treatment programs, and the publication of those results in medical journals;

●      plans to have our treatment programs approved for reimbursement by third-party payers;

●      plans to license our treatment programs to more healthcare providers;
13
●      marketing plans to raise awareness of our planned advertising, marketingPROMETA Treatment Program and promotional campaigns,Catasys treatment programs; and

 l

physician and patient acceptance of our products and services, including newly introduced products,

 l

competition among addiction treatment centers,

 l

●      		anticipated trends and conditions in the industry in which we operate, including regulatory changes,

 l

development of new treatment modalities,

 l

our future operating results, capital needs, and our ability to obtain financing, and

 l

other risks and uncertainties as may be detailed from time to time in our public announcements and filings with the SECfinancing.

We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or any other reason. All subsequent forward-looking statements attributable to Hythiamour Company or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to herein. In light of these risks, uncertainties and assumptions, the forward-looking events discussed in this prospectusreport may not occur.

USE OF PROCEEDSDISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS

All of our common stock being offered under thisThis prospectus is being sold bycontains or for the account of the Selling Shareholders. We will not receive any proceeds from the sale of our common stock by or for the account of the selling stockholders. We may receive a maximum of approximately $2,849,125 from the exercise of warrants by the selling stockholders, assuming all warrants were exercised for cash in full. Any proceeds received by us in connection with the exercise of warrants will be used for working capital and general corporate purposes.
DIVIDEND POLICY
We have never declared or paid cash dividends on our common stock. We currently plan to retain any earnings to finance the growth of our business rather than to pay cash dividends. Payments of any cash dividends in the future will depend on our financial condition, results of operations and capital requirements, as well as other factors deemed relevant by our board of directors.
13 
SELLING SHAREHOLDERS
Background on the Merger
The registrant, which was formerly known as Alaska Freightways, Inc., was incorporated in the state of Nevada on June 1, 2000, and previously provided transportation and freight brokerage services in the state of Alaska. Immediately prior to the merger described below, the company sold all of its assets and liabilities to certain of its stockholders in exchange for cancellation of 3,010,000 of its 3,568,033 then outstanding shares, and the remaining outstanding 558,033 shares were forward split 2.007-to-one into 1,119,969 shares.  As a result, at the time of the merger, the registrant had substantially no operating assets, liabilities or operations.
On September 29, 2003, Hythiam, Inc., a development stage company incorporated in the state of New York on February 13, 2003, merged with and into Hythiam Acquisition Corp., a newly-formed, wholly-owned subsidiary of the registrant, then known as Alaska Freightways, Inc. Also on September 29, 2003, the registrant reincorporated in Delaware by merging with and into Hythiam, Inc., a Delaware corporation. On October 14, 2003, Hythiam Acquisition Corp. changed its name to Hythiam, Inc., and on October 16, 2003 merged with and into the registrant. Following the merger, reincorporation and consolidation transactions described above, the registrant, Hythiam, Inc., a Delaware corporation, is now the sole surviving entity.
In exchange for all of their shares of common stock of Hythiam, Inc., a New York corporation, which were purchased for $2.50 per share, and their options to purchase such common stock, such stockholders were issued an aggregate of 23,486,916 shares of our common stock on September 29, 2003. In addition, certain stockholders and consultants have been issued 148,322 shares and warrants to purchase an additional 852,290 shares of our common stock in exchange for services.
On May 17, 2004 we issued 360,000 shares in the name of Xino Corporation in connection with the acquisition of certain intellectual property as described under the section titled “Certain Relationships and Related Transactions” on page 54. Such shares have been pledged and are being held to secure Xino’s remaining obligations to us and may not be released or sold until such obligations are satisfied.
We have agreed to register for resale by the persons listed below (the “Selling Shareholders”) all of the shares of our common stock issued to them, as well as all shares issuable upon the exercise of warrants granted to them. The number of shares being registered pursuant to this registration statement may be adjusted to prevent dilution resulting from stock splits, stock dividends or similar transactions.
Table of Selling Shareholders
The table below presents information regarding the Selling Shareholders and the shares of our common stock that they may offer and sell from time to time under this prospectus.
   Percentage of shares
Hythiam common stock
beneficially owned
   
 
Selling Shareholders(1)
Shares of Hythiam common stock to be resold in the offering(2)
Number of shares of Hythiam common stock owned
Before offering of
the resale shares
After offering of the resale shares(2)
O. Lee Tawes III
388 Bedford Center Road
Bedford Hills, NY 10507
40,00040,000*0
Richard Jordon TTEE
1502 Bullion Cir.
San Jose, CA 95120
20,00020,000*0
14 
Bruce Jackson
132 Rowayton Woods Drive
Norwalk, CT 06854
20,00020,000*0
E. Keene Wolcott
4545 North Lane
Del Mar, CA 92004
20,00020,000*0
Barry Nussbaum
2775 Via De La Valle, Suite 205
Del Mar, CA 92014
40,00040,000*0
Jason Barry
6009 Paseo Delicias, Suite A, PO Box 2813
Rancho Santa Fe, CA 92067
40,00040,000*0
Mary L. Cruse & CM Cruse III
P.O. Box 9298
Rancho Santa Fe, CA 92067
20,00020,000*0
Barry Moores
P.O. Box 491
5041 El Secreto
Rancho Santa Fe, CA 92067
140,000140,000*0
Michael L. Baller
3926 S. Magnolia Way
Denver, CO 80237
20,00020,000*0
Bruce M. Wermuth
2190 Cowper St
Palo Alto, CA 94301
20,00020,000*0
Gary E. Roebuck, DDS
43 Halley Drive
Pomona, NY 10970
10,00010,000*0
Jay Gottlieb
27 Misty Brook Lane
New Fairfield, CT 06812
20,00020,000*0
Zeke LP
1235 Westlakes Drive, Suite 400
Berwyn, PA 19312
1,200,0001,200,0004.8%0
J.J. Pierce
5125 W. Lake Avenue
Littleton, CO 80123
10,00010,000*0
Delaware Charter Guarantee FBO Joseph J. Pierce
IRA
5125 W. Lake Avenue
Littleton, CO 80123
10,00010,000*0
Excell Alliance Overseas, Inc. LTD
CC Cristamar Local 43-B Avda Delas Nacines
Unidas 29660
Perto Banus Mabella Malaga, Spain 00002 00001
12,00012,000*0
Heather Marie Evans
12906 N. 4th Street
Parker, CO 80123
4,0004,000*0
Michael Kirby
6765 E. Dorado Avenue
Greenwood Village, CO 80111
10,000(5)10,000(5)*0
Mark Massa
7435 E. Parkview Avenue
Englewood, CO 80111
3,0003,000*0
15 
Dawn SR. Cangilla
720 Stonemont Ct.
Castlerock, CO 80108
10,00010,000*0
ECAP Ventures, LLC
2560 W. Main St., #200
Littleton, CO 80120
10,00010,000*0
Bleu Ridge Consultants, Inc. Profit Sharing
Plan & Trusts
5770 S. Beech Ct.
Greenwood Village, CO 80121
17,00017,000*0
Charitable Remainder Trust of Mary Jane Brasel,
Timothy J. Brasel TTEE
5770 S. Beech Ct.
Greenwood Village, CO 80121
5,0005,000*0
Charitable Remainder Trust of Susan A. Brasel,
Timothy J Brasel TTEE
5770 S. Beech Ct.
Greenwood Village, CO 80121
5,0005,000*0
John Glotfelty
14003 Rosehill Lane
Overland, KS 66221
4,0004,000*0
Charitable Remainder Trust of Timothy J. Brasel
5770 S. Beech Ct.
Greenwood Village, CO 80121
6,0006,000*0
Paul Dragul
950 E. Harvard Avenue, Suite 500
Denver, CO 80210
20,00020,000*0
Earnco MPPP
2560 W. Main St., #200
Littleton, CO 80120
20,00020,000*0
The Laurick Trust (Stanley Gottlieb Trustee)
575 Cranbury Road
East Brunswick, NJ 08816
20,00020,000*0
MF LLC
14 Red Tail Drive
Highland Ranch, CO 80126
30,00030,000*0
GVI PS LLC
14 Red Tail Drive
Highland Ranch, CO 80126
40,00040,000*0
GVI PI LLC
14 Red Tail Drive
Highland Ranch, CO 80126
40,00040,000*0
CAM LLC
14 Red Tail Drive
Highland Ranch, CO 80126
30,00030,000*0
Jeff P. Ploen
6590 E. Lake Pl.
Englewood, CO 80111-4411
20,00020,000*0
Underwood Family Partners
2921 Cliffside Ct.
Castle Pines, CO 80104
100,000100,000*0
Stephen A. Garnock
30 Southgate Circle
Massapequa Park, NY 11762
5,0005,000*0
16 
Conrad Riggs
16577 Via Floresta
Pacific Palisades, CA 90272
20,00020,000*0
James Scoropuski
1 Acclaim Plaza
Glen Cove, NY 11542
100,000100,000*0
Woodland Partners
68 Wheatley Road
Brookville, NY 11545
50,00050,000*0
Baracuda Motors, Inc.
2936 Bay Drive
Merrick, NY 11566
10,00010,000*0
Robert Holmes
205 Asharokem Avenue
Northpoint, NY 11768
20,00020,000*0
Terry Phillips
2711 Royenwood Drive
Midlothiam, VA 23113
40,00040,000*0
Dianne Borden
19 Canterbury Place
Cranford, NJ 07016
20,00020,000*0
Thomas Allen Forti
7270 S. Logan St.
Centennial, CO 80122
10,00010,000*0
William C. Bossang A/C/F Rhett Bossang
11 Scotia Sea
Newport Coast, CA 92657
8,0008,000*0
Fiserv FBO William Bossang Sep IRA
Spencer Edwards, Inc.
6041 S. Syracuse Way, #305
Englewood, CO 80111
10,00010,000*0
The Cutler-Roth Family Trust(Dated Aug. 6, 2003)
1370 Skeel Drive
Camarillo, CA 93010
10,00010,000*0
Blackwoods Management Group LTD
55 Frederick Street
Nassau, Bahamas
40,00040,000*0
Ina Kagel
605 Walden Drive
Beverly Hills, CA 90210
20,00020,000*0
Performance Capital Group, LLC
14 Wall Street, 27th Fl.
New York, NY 10005
20,000(5)20,000(5)*0
The Riverview Group, LLC
c/o Millenium Partners
666 Fifth Avenue, 8th Fl.
New York, NY 10103
800,000800,0003.2%0
London Family Trust
212 Aurora Drive
Montecito, CA 93108
200,000200,000*0
MacDonald J. Bowyer
15257 De Pauw Street
Pacific Palisades, CA 90272
30,00030,000*0
17 
Russel Dixon
P.O. Box 675683
Rancho Santa Fe, CA 92067
40,00040,000*0
Adrian Hernandez
435 Orange Street
Hanford, CA 93230
8,0008,000*0
John A. Moore
101 Brookmeadow Road
Wilmington, DE 19807
40,00040,000*0
Scott A. Kunkel
7801 Mid Cities Blvd., #400
Forth Worth, TX 76180
5,0005,000*0
Fowler Family Trust
210 Yerba Buena Avenue
Los Altos, CA 94022
10,00010,000*0
Lawrence J. Rubinstein & Camille S. Rubenstein
20 Oakwood Way
West Windsor, NJ 08550
20,00020,000*0
R.E. & M. Petersen Living Trust
6420 Wilshire Blvd., 20th Fl.
Los Angeles, CA 90048
400,000400,0001.6%0
Edwin Bertolas Revocable Living Trust
855 Cofair Court
Solana Beach, CA 92075
12,00012,000*0
Russell Candela
3 Bluebell Road
Colts Neck, NJ 07722
20,00020,000*0
Orlin M. Sorensen
22529 39th Avenue SE
Bothell, WA 98021
24,00024,000*0
Jeffrey Chandler
P.O. Box 1192-6122 Paseo Delicias
Rancho Santa Fe, CA 92067
60,00060,000*0
Fenway Advisory Group Pension & Profit Sharing Group
1364 Stropella Road
Los Angeles, CA 90077
50,00050,000*0
John Nordstrom
9320 Orangewood Tr.
Denton, TX 76207
5,0005,000*0
Darcel A. Murphy
12913 Polvera Ct.
San Diego, CA 92128
10,00010,000*0
Geraldine Young
1840 Calistoga Dr.
San Jose, CA 95124
20,00020,000*0
William J. McCluskey
340 E. 63rd St., #6-A
New York, NY 10021
20,000(5)20,000(5)*0
Joseph P. Sullivan
184 S. Carmelina Avenue
Los Angeles, CA 90049
30,00030,000*0
Michael Neider
12095 N.W. 39th Street
Coral Springs, FL 33065
24,00024,000*0
18 
HCFP Brenner Securities, LLC
888 Seventh Avenue, 17th Fl.
New York, NY 10106
16,00016,000*0
Chris Lowe
4400 N. Scottsdale
Scottsdale, AZ 85251
20,00020,000*0
Roger S. Haber
C/o Kraditor & Harbor, P.C.
1212 Avenue of the Americas, 3rd Fl.
New York, NY 10036
10,00010,000*0
James Gandolfini
c/o AFM
1212 Avenue of the Americas, 3rd Fl.
New York, NY 10036
80,00080,000*0
Steven Schirripa
c/o AFM
1212 Avenue of the Americas, 3rd Fl.
New York, NY 10036
10,00010,000*0
Rosalind Wyman
10430 Bellagio Drive
Los Angeles, CA 90077
8,0008,000*0
Dawn M. Begam
30 North Strawberry Lane
Morelau Hills, OH 44022
4,0004,000*0
John E. Deeb
807 Linda Flora Drive
Los Angeles, CA 90049
20,00020,000*0
Paul Alberti
8172 Woodview Court
Williamsville, NY 14221
10,00010,000*0
Robert Chernow
4 Fox Run Lane
Westport, CT 06880
40,00040,000*0
Leonard Cohen
250 Broad Street
Shrewbury, NJ 07702
10,00010,000*0
Michael Cohen
15 Town Gate Lane
Syosset, NY 11791
10,00010,000*0
David M. Drury
1047 Center Oak Drive
Pittsburgh, PA 15237
20,00020,000*0
Jonathan Ellman
11 Western Road
Wayland, MA 01778
10,00010,000*0
Richard A. Falk
31 Kinross Drive
San Rafael, CA 94901-2419
10,00010,000*0
Anthony Kirincic
23 Villanova Laane
Dix Hills, NY 11746
40,00040,000*0
Ned Laybourne & Lynn Laybourne JTWROS
208 Knollcrest Court
Martinez, CA 94553
20,00020,000*0
19 
Paul LeFevre
32 Moulton Road
Duxbury, MA 02332
20,00020,000*0
David & Patricia Lindner
3390 Jason Court
Bellmore, NY 11710
40,000(5)40,000(5)*0
Robert Melnick
1074 Bonnie Brae Boulevard
Denver, CO 80209
20,00020,000*0
Kevin O’Connell
3831 North Freeway Boulevard
Sacramento, CA 95834
20,00020,000*0
Marrion W. Peebles III
420 West 4th Street, Suite 202E
Winston, NC 29101
10,00010,000*0
Walter and Barbara Pollack JTWROS
5 Cross Timber
Barrington Hills, IL 60010
10,00010,000*0
Jed Raynor
140 South Ocean Avenue
Freeport, NY 11520
10,00010,000*0
Alan Schriber
2413 60th Avenue, S.E
Mercer Island, WA 98040
20,00020,000*0
Kevin Smith
1121 Chestnut Avenue
Wilmette, IL 60091
20,00020,000*0
Eric Tanner
3 Falconridge
Coto De Caza, CA 92679
10,00010,000*0
Rick Wilcoxen
456 Heights Road
Ridgewood, NJ 07450
10,00010,000*0
Orion Biomedical Offshore Fund, LP
787 7th Avenue, 48th Fl.
New York, NY 10019
71,40071,400*0
Orion Biomedical Fund, LP
787 7th Avenue, 48th Fl.
New York, NY 10019
328,600328,6001.3%0
Steve Zimmerman
212 Candi Lane
Columbia, SC 29210
10,00010,000*0
Russell J. Hampshire
19689 Horace Street
Chatsworth, CA 91331
20,00020,000*0
Kirlin Holding Corporation
6901 Jericho Turnpike
Syosset, NY 11791
40,000(5)40,000(5)*0
Ralph Karubian
5321 Franklin Avenue
Los Angeles, CA 90027
40,00040,000*0
Crotalus, Inc.
718 Lincoln Boulevard, Suite 2
Santa Monica, CA 90402
40,00040,000*0
20 
Karen Jennings
154 South Layton Drive
Los Angeles, CA 90049
8,0008,000*0
Smithfield Fiduciary LLC c/o Highbridge Capital
Management, LLC
9 West 57th Street, 7th Floor
New York, NY 10019
400,000400,0001.6%0
Eckhard J. Schulz and Nancy A. Schulz, Trustees
of the Schulz Family Trust U/D/T dated January 5,
1990, as amended
891 Campbell Avenue
Los Altos, CA 94024
30,00030,000*0
Matt Mogol
2037 Whitley Avenue
Los Angeles, CA 90068
8,0008,000*0
ISS Management LLC
4600 Campus, Suite 110
Newport Beach, CA 92660
20,00020,000*0
Donehew Fund Limited Partnership
111 Village Parkway, Bldg. 2
Marietta, GA 30067
100,000100,000*0
Costa Azul Alliance, SA
C/o Rowland Day
18881 Von Karman, Suite 1500
Irvine, CA 92312
400,000400,0001.6%0
Derinton Financial Limited
C/o Rowland Day
18881 Von Karman, Suite 1500
Irvine, CA 92312
400,000400,0001.6%0
Rowland W. Day II
18881 Von Karman, Suite 1500
Irvine, CA 92312
100,000100,000*0
Robert H. Donehew
4405 Paper Mill Road
Marietta, GA 30067
60,00060,000*0
Aaron Shrira
614 Camden Drive
Beverly Hills, CA 90210-3239
24,00024,000*0
Medical Systems Development Corp Profit
Sharing Trust
620 Village Trace
Marietta, GA 30067
20,00020,000*0
Gary Meyerson, MD
235 Trimble Chase Court
Atlanta, GA 30342
20,00020,000*0
Clarion Capital Corporation
1801 East 9th Street, Suite 1120
Cleveland, OH 44114
80,00080,000*0
Clarion Partners, LP
1801 East 9th Street, Suite 1120
Cleveland, OH 44114
80,00080,000*0
21 
Morton A. Cohen TTEE FBO The Morton A.
Cohen Revocable Living Trust
1801 East 9th Street, Suite 1120
Cleveland, OH 44114
40,00040,000*0
Rossmor Limited Partnership
1801 East 9th Street, Suite 1120
Cleveland, OH 44114
80,00080,000*0
Clarion Offshore Fund, LTD.
Cayman Islands
80,00080,000*0
Dynamic Equity Hedge Fund
Ontario, Canada
20,00020,000*0
Lendi LTD
1801 East 9th Street, Suite 1120
Cleveland, OH 44114
20,00020,000*0
Richard Beleson
849 Union Street
San Francisco, CA 94133
80,00080,000*0
LIB Holdings
259 W. 10th St., #2H
New York, NY 10014
40,00040,000*0
PCG Tagi (Series J) LLC
360 North Crescent Drive, North Building
Beverly Hills, CA 90210
600,000600,0001.6%0
RG Securities
165 EAB Plaza, West Tower 6th Floor
Uniondale, NY 11556
100,000(6)100,000(6)*0
Jack Silver
920 5th Avenue
New York, NY 10021
200,000200,000*0
Gary Bryant
16 Carmel Woods
Laguna Niguel, CA 92677
20,00020,000*0
Al Kau
33671 Chula Vista
Monarch Beach, CA 92629
20,00020,000*0
David Duff
2845 Salado Trail
Fort Worth, TX 76118
8,0008,000*0
Robert W. Gile
7825 Hightower Dr
Fort Worth, TX 76180
4,0004,000*0
Stan Caplan
10180 Telesis Ct
Suite 395
San Diego, CA 92121
20,00020,000*0
Omicron Master Trust
c/o Omicron Capital LLP
810 7th Avenue, 39th Floor
New York, NY 10022
400,000400,0001.6%0
Richard Lee
21151 Maria Lane
Saratoga, CA 95070
40,00040,000*0
22 
Lori Pineda
16696 Magneson Loop
Los Gatos, CA 95032
24,00024,000*0
PMC Holdings, LLC
8436 W. 3rd St. #2H
Los Angeles, CA 90048
40,00040,000*0
CEOcast, Inc.
55 John Street—11th Floor
New York, NY 10038
8,3228,322*0
Tratamientos Avanzados de la Adicción S.L.
Avda. Fuentalarreina 8
Madrid Spain 28007
835,916835,9163.4%0
Scott Olson
C/o J. P. Turner & Co.
3340 Peachtree Road, Suite 2300
Atlanta, Georgia 30326
1,575(3)1,575(3)*0
JP Turner Partners
C/o J. P. Turner & Co.
3340 Peachtree Road, Suite 2300
Atlanta, Georgia 30326
263(3)263(3)*0
Patrick Power
C/o J. P. Turner & Co.
3340 Peachtree Road, Suite 2300
Atlanta, Georgia 30326
262(3)262(3)*0
Anthony Kirincic
C/o Kirlin Securities, Inc.
6901 Jericho Turnpike
Syosset, New York 11791
11,550(3)11,550(3)*0
David Lindner
C/o Kirlin Securities, Inc.
6901 Jericho Turnpike
Syosset, New York 11791
11,550(3)11,550(3)*0
Aeryn Seto
C/o Kirlin Securities, Inc.
6901 Jericho Turnpike
Syosset, New York 11791
1,200(3)1,200(3)*0
Willliam Silva
C/o Kirlin Securities, Inc.
6901 Jericho Turnpike
Syosset, New York 11791
1,050(3)1,050(3)*0
Kirlin Securities, Inc.
6901 Jericho Turnpike
Syosset, New York 11791
14,650(3)14,650(3)*0
RG Capital Fund, LLC
C/o RG Securities, LLC
165 EAB Plaza, West Tower, 6th Floor
Uniondale, New York 11556-0165
25,000(3)25,000(3)*0
James Scibelli
C/o RG Securities, LLC
165 EAB Plaza, West Tower, 6th Floor
Uniondale, New York 11556-0165
25,000(3)25,000(3)*0
Roth Capital Partners, LLC
24 Corporate Plaza
Newport Beach, CA 92660
86,800(3)86,800(3)*0
23 
Michael Kirby
C/o Spencer Edwards, Inc.
6041 South Syracuse Way, Suite 305
Englewood, Colorado 80111
20,055(3)20,055(3)*0
Gordon Dihle
C/o Spencer Edwards, Inc.
6041 South Syracuse Way, Suite 305
Englewood, Colorado 80111
3,677(3)3,677(3)*0
Edward Price
C/o Spencer Edwards, Inc.
6041 South Syracuse Way, Suite 305
Englewood, Colorado 80111
3,008(3)3,008(3)*0
Len Rothstein
C/o Western International Securities, Inc.
70 South Lake Avenue, Suite 700
Pasadena, California 91101
3,250(3)3,250(3)*0
Richard Beleson
849 Union Street
San Francisco, California 94133
16,000(4)16,000(4)*0
Costa Azul Alliance, SA
C/o Day & Campbell, LLP
2030 Main Street, Suite 1600
Irvine, California 92614
80,000(4)80,000(4)*0
Rowland W. Day II, AS Trustee of the Day
Family Trust Established April 30, 1990
C/o Day & Campbell, LLP
2030 Main Street, Suite 1600
Irvine, California 92614
20,000(4)20,000(4)*0
Derington Financial Limited
C/o Day & Campbell, LLP
2030 Main Street, Suite 1600
Irvine, California 92614
80,000(4)80,000(4)*0
Donehew Fund Limited Partnership
C/o Robert Donehew
4405 Paper Mill Road
Marietta, Georgia 30067
20,000(4)20,000(4)*0
Medical Systems Development Corp Profit
Sharing Trust
C/o Robert Donehew
4405 Paper Mill Road
Marietta, Georgia 30067
4,000(4)4,000(4)*0
Gary Meyerson, M.D.
C/o Robert Donehew
4405 Paper Mill Road
Marietta, Georgia 30067
4,000(4)4,000(4)*0
Robert Donehew
4405 Paper Mill Road
Marietta, Georgia 30067
12,000(4)12,000(4)*0
Aaron Shrira
614 North Camden Drive
Beverly Hills, California 90210-3239
19,200(4)19,200(4)*0
Jack Silver
920 5th Avenue
New York, New York 10021
50,000(4)50,000(4)*0
24 
Clarion Capital Corporation
1801 East 9th Street, Suite 1120
Cleveland, Ohio, 44114
16,000(4)16,000(4)*0
Clarion Partners , L.P.
1801 East 9th Street, Suite 1120
Cleveland, Ohio, 44114
16,000(4)16,000(4)*0
Clarion Offshore Fund, LTD.
1801 East 9th Street, Suite 1120
Cleveland, Ohio, 44114
16,000(4)16,000(4)*0
Dynamic Equity Hedge Fund
1801 East 9th Street, Suite 1120
Cleveland, Ohio, 44114
4,000(4)4,000(4)*0
Lendi LTD
1801 East 9th Street, Suite 1120
Cleveland, Ohio, 44114
4,000(4)4,000(4)*0
Morton A. Cohen TTEE FBO The Morton A.
Cohen Revocable Living Trust
1801 East 9th Street, Suite 1120
Cleveland, Ohio, 44114
8,000(4)8,000(4)*0
Rosmor Limited Partnership
1801 East 9th Street, Suite 1120
Cleveland, Ohio, 44114
16,000(4)16,000(4)*0
Westhaven Properties, Inc.
C/o Day & Campbell, LLP
2030 Main Street, Suite 1600
Irvine, California 92614
80,000(4)80,000(4)*0
Stephen Shapiro
62 Orchard Road
Demarest, New Jersey 07627
12,500(4)12,500(4)*0
Roy Lessard
7453 Fairway Road
La Jolla, California 92037
3,200(4)3,200(4)*0
Bob Miller
The Trippoak Group, Inc.
499 Park Avenue, 20th Floor
New York, NY 10022
12,500(4)12,500(4)*0
Alan Budd Zuckerman
Genesis Select Corporation
2033 11th Street
Boulder, CO 80302
150,000(4)150,000(4)*0
Xino Corporation
9025 Wilshire Blvd., Suite 301
Beverly Hills, CA 90211
360,000360,0001.4%0
___________

 *

Less than 1%.

(1)

This table is based upon information supplied to us by the Selling Shareholders.

 (2)

Assumes that the Selling Shareholders sell all of the shares available for resale

 (3)

Represents shares underlying warrants issued as compensation for acting as our placement agents in connection with the September 29, 2003 private placement to registered broker dealers or their affiliates who, with respect to the shares of our common stock they may sell pursuant to this prospectus, may be deemed to be “underwriters” within the meaning of the Securities Act of 1933, as amended.
25 

 (4)

Represents shares underlying warrants.

 (5)

Represents shares issued at $2.50 per share to affiliates of registered broker dealers who, with respect to the shares of our common stock they may sell pursuant to this prospectus, may be deemed to be “underwriters” within the meaning of the Securities Act of 1933, as amended. The affiliates purchased the shares in the ordinary course of business, and at the time of the purchase had no agreements or understandings to distribute the securities.

 (6) 

Represents shares issued as compensation for acting as our placement agent in connection with the September 29, 2003 private placement to a registered broker dealer who, with respect to the shares of our common stock it may sell pursuant to this prospectus, may be deemed to be an “underwriter” within the meaning of the Securities Act of 1933, as amended.
Relationship of Selling Shareholders to the Company
Tratamientos Avanzados de la Adicción S.L. is owned and controlled by Dr. Juan José Legarda, a member of our board of directors. The registered broker dealers noted in footnotes (3), (5) and (6) above acted as our placement agents in connection with the September 29, 2003 private placement. None of the other Selling Shareholders listed above has held any position or office, or has had any material relationship, with Hythiam or any of our affiliates within the past three years.
PLAN OF DISTRIBUTION
We do not know of any plan of distribution for the resale of our common stock by the Selling Shareholders. Hythiam will not receive any of the proceeds from the sale by the Selling Shareholders of any of the resale shares.
We expect that the Selling Shareholders or transferees may sell the resale shares from time to time in transactions on the Amex or any exchange upon which the company may become listed, in privately negotiated transactions or a combination of such methods of sale, at fixed prices which may be changed, at market prices prevailing at the time of sale, at prices related to such prevailing market prices or at negotiated prices. The Selling Shareholders may sell the resale shares to or through broker-dealers, and such broker-dealers may receive compensation from the Selling Shareholders or the purchasers of the resale shares, or both.
At any time a particular offer of resale shares is made, to the extent required, a supplemental prospectus will be distributed which will set forth the number of resale shares offered and the terms of the offering including the name or names of any underwriters, dealers or agents, the purchase price paid by any underwriter for the resale shares purchased from the Selling Shareholders, any discounts, commission and other items constituting compensation from the Selling Shareholders and any discounts, concessions or commissions allowed or paid to dealers. We do not presently intend to use any forms of prospectus other than print
As noted in the table of Selling Shareholders, some of the Selling Shareholders are registered broker dealers or their affiliates who, with respect to the shares of our common stock they may sell pursuant to this prospectus, may be deemed to be “underwriters”incorporates forward-looking statements within the meaning of the Securities Actsection 27A of 1933, as amended. The Selling Shareholders and any broker-dealers who act in connection with the sale of resale shares hereunder may be deemed to be “underwriters” as that term is defined in the Securities Act and any commissions received by them and profit on any resale of shares might be deemed to be underwriting discounts and commissions under the Securities Act.
Any or allsection 21E of the salesExchange Act. These forward-looking statements are management’s beliefs and assumptions. In addition, other written or other transactions involvingoral statements that constitute forward-looking statements are based on current expectations, estimates and projections about the resale shares described above, whether by the Selling Shareholders, any broker-dealer or others,industry and markets in which we operate and statements may be made pursuantby or on our behalf. Words such as “should,” “could,” “may,” “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate,” variations of such words and similar expressions are intended to this prospectus. In addition,identify such forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict. There are a number of important factors that could cause our actual results to differ materially from those indicated by such forward-looking statements.

We describe material risks, uncertainties and assumptions that could affect our business, including our financial condition and results of operations, under “Risk Factors” and may update our descriptions of such risks, uncertainties and assumptions in any resale sharesprospectus supplement. We base our forward-looking statements on our management’s beliefs and assumptions based on information available to our management at the time the statements are made. We caution you that qualify for sale under Rule 145actual outcomes and results may differ materially from what is expressed, implied or forecast by our forward-looking statements. Accordingly, you should be careful about relying on any forward-looking statements. Reference is made in particular to forward-looking statements regarding growth strategies, financial results, product development, competitive strengths, intellectual property rights, litigation, mergers and acquisitions, market acceptance or continued acceptance of the Securities Act may be sold under Rule 145 rather than under this prospectus.
In order to comply with the securities laws of certain states, if applicable, the resale shares may be sold in such jurisdictions only through registered or licensed brokers or dealers.
The Selling Shareholdersour products, accounting estimates, financing activities, ongoing contractual obligations and any other persons participating in the sale or distribution of the resale shares will be subject to liabilitysales efforts. Except as required under the federal securities laws and must comply with the requirements of the Securities Act and the Exchange Act, including Rule 10b-5 and Regulation M under the Exchange Act. These rules and regulations may limitof the timingSEC, we do not have any intention or obligation to update publicly any forward-looking statements after the distribution of purchases and salesthis prospectus, whether as a result of shares of our common stock by the Selling Shareholdersnew information, future events, changes in assumptions, or other persons. Under these rules and regulations, the Selling Shareholders and other persons participating in the sale or distribution:otherwise.
 
26 
14

USE OF PROCEEDS

We estimate that we will receive up to $9.6 million in net proceeds from the sale of the securities in this offering, based on a price of $[____] per unit and after deducting underwriting discounts and commissions and estimated offering expenses payable by us.  We will use the proceeds from the sale of the securities for working capital needs, capital expenditures and other general corporate purposes.

Pending any ultimate use of any portion of the proceeds from this offering, we intend to invest the proceeds in a variety of capital preservation investments, including short-term, interest-bearing instruments such as United States government securities and municipal bonds.

If a warrant holder elects to pay the exercise price, rather than exercising the warrants on a “cashless” basis, we may also receive proceeds from the exercise of warrants.  We cannot predict when, or if, the warrants will be exercised.  It is possible that the warrants may expire and may never be exercised.

DILUTION
 
Dilution represents the difference between the offering price and the net tangible book value per share immediately after completion of this offering. Net tangible book value is the amount that results from subtracting total liabilities and intangible assets from total assets.  Dilution of the value of the shares you purchase is a result of the lower book value of the shares held by our existing stockholders.  The following tables compare the differences of your investment in our shares with the investment of our existing stockholders.

 l

may not engage in any stabilization activity in connection with our common stock,

  l

must furnish each broker which offers resale shares covered by this prospectus with the number of copies of this prospectus and any supplement which are required by the broker, and

  l

may not bid for or purchase any of our common stock or attempt to induce any person to purchase any of our common stock other than as permitted under the Exchange Act.

At __________, 2011, the net tangible book value of our shares of common stock was $[_________] or approximately $[_____] per share based upon 834,419,950 shares outstanding.  After giving effect to our sale of [______] shares of common stock at a public offering price of $[____] per share, and after deducting underwriting discounts and commissions and estimated offering expenses, our pro forma net tangible book value as of _________, 2011  would have been $[______], or $[______] per share.  This represents an immediate increase in net tangible book value of $[______] per share to existing stockholders and an immediate dilution in net tangible book value of $[_____] per share to purchasers of securities in this offering.
These restrictions may affect
The above discussion does not include the marketabilityfollowing:

23,198,177 shares of any resalecommon stock reserved for future issuance under our equity incentive plans.  As of April 15, 2011, there were 207,801,823 options outstanding under such plans with a weighted average exercise price of $0.09 per share;

94,364,030 shares offered byof common stock issuable upon exercise of outstanding warrants as of April 15, 2011, with exercise prices ranging from $0.01 per share to $5.23 per share;

[_____] shares of common stock issuable upon exercise of warrants at an exercise price of $[_____] per share sold as part of  this offering.

PLAN OF DISTRIBUTION

As of the Selling Shareholders.
We will make copiesdate of this prospectus, available towe have not entered into any arrangements with any underwriter, broker-dealer or selling agent for the Selling Shareholders and have informed the Selling Shareholders of the need for delivery of a copy of this prospectus to each purchaser of the resale shares prior to or at the time of any sale of the resale shares offered hereby.
securities.  We intend to engage one or more underwriters, broker-dealers or selling agents to sell the securities.  We intend to compensate underwriters, broker-dealers or selling agents that sell securities in this offering with a cash commission of no more than [___] % of the gross proceeds from the securities sold by them. Some of the securities may suspend the effectivenessbe sold by certain officers and directors of our Company, none of whom will receive any commission or use of, or trading under, the registration statement if we shall determine thatcompensation for the sale of any securities pursuant to the registration statement would:securities. The offering will be presented by us primarily through mail, telephone, electronic transmission and direct meetings in those states in which it has registered the securities.
 

 l

materially impede, delay or interfere with any material pending or proposed financing, acquisition, corporate reorganization or other similar transaction involving the company for which we have authorized negotiations; materially adversely impair the consummation of any pending or proposed material offering or sale of any class of securities by the company, or

 l

require disclosure of material nonpublic information that, if disclosed at such time, would be materially harmful to the interests of the company and our stockholders.
15
 
All costs and expenses associated with registering the resale shares being offered hereunder with the SEC will be paid by the company.

DESCRIPTION OF SECURITIES

The Selling Shareholders may agree to indemnify certain persons including broker-dealers or others, against certain liabilities in connection with any offeringdescriptions of the resale shares including liabilities undersecurities contained in this prospectus summarizes all the Securities Act. We have not agreed to indemnify any Selling Shareholders, their broker-dealers or others against any liabilities in connection with any offeringmaterial terms and provisions of the resale shares including liabilities under the Securities Act. Wevarious types of securities that we may enter into agreements with the Selling Shareholders regarding, among other things, the ability of the Selling Shareholders to sell shares registered for resale under the registration statement and compliance by the selling stockholder with the Securities Act and the Exchange Act.offer.

DESCRIPTION OF CAPITAL STOCKCommon stock

Common stock

We are authorized to issue 200,000,0002,000,000,000 shares of common stock, $0.0001 par value, and 50,000,000 shares of preferred stock, $0.0001 par value. The following description of our capital stock is intended to be a summary and does not describe all provisions of our certificate of incorporation or bylaws or Delaware law applicable to us. For a more thorough understanding of the terms of our capital stock, you should refer to our certificate of incorporation and bylaws, which are included as exhibits to the registration statement of which this prospectus is a part.
Common Stock

As of June 8, 2004,April 15, 2011, there were 24,975,207834,419,950 shares of our common stock issued and outstanding, held by approximately 200101 record holders and approximately 8005,846 beneficial owners. In addition, as of June 8, 2004,April 15, 2011, there were warrants and options outstanding to purchase approximately 5,816,808302,165,853 shares of our common stock.

27 


The holders of common stock are entitled to one vote per share on all matters to be voted upon by stockholders. Subject to preferences that may be applicable to any outstanding preferred stock, holders of common stock are entitled to receive ratably dividends as may be declared by the board of directors out of funds legally available for that purpose.  In the event of ourliquidation, dissolution, or winding up, the holders of common stock are entitled to share ratably in all assets remaining after payment of liabilities and the liquidation preferences of any outstanding preferred stock. The common stock has no preemptive or conversion rights, other subscription rights, or redemption or sinking fund provisions. All issued and outstanding shares of common stock are fully paid and non-assessable.

Preferred Stock

     There


Anti-Takeover Provisions of Delaware Law and Charter Provisions

We are nosubject to Section 203 of the Delaware General Corporation Law, which prohibits a publicly-held Delaware corporation from engaging in a “business combination,” except under certain circumstances, with an “interested stockholder” for a period of three years following the date such person became an “interested stockholder” unless:

●before such person became an interested stockholder, the board of directors of the corporation approved either the business combination or the transaction that resulted in the interested stockholder becoming an interested stockholder;

●upon the consummation of the transaction that resulted in the interested stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding shares held by directors who also are officers of the corporation and shares held by employee stock plans; or

●at or following the time such person became an interested stockholder, the business combination is approved by the board of directors of the corporation and authorized at a meeting of stockholders by the affirmative vote of the holders of 66 2/3% of the outstanding voting stock of the corporation which is not owned by the interested stockholder.

The term “interested stockholder” generally is defined as a person who, together with affiliates and associates, owns, or, within the three years prior to the determination of interested stockholder status, owned, 15% or more of a corporation’s outstanding voting stock. The term “business combination” includes mergers, asset or stock sales and other similar transactions resulting in a financial benefit to an interested stockholder. Section 203 makes it more difficult for an “interested stockholder” to effect various business combinations with a corporation for a three-year period. The existence of this provision would be expected to have an anti-takeover effect with respect to transactions not approved in advance by our board of directors, including discouraging attempts that might result in a premium over the market price for the shares of common stock held by stockholders.

The ability of the board of directors to issue shares of preferred stock designated or outstanding. Theand to set the voting rights, preferences and other terms thereof, without further stockholder action, may be deemed to have an anti-takeover effect and may discourage takeover attempts not first approved by the board of directors, hasincluding takeovers which stockholders may deem to be in their best interests. If takeover attempts are discouraged, temporary fluctuations in the authority, without further action by the stockholders, to issue up to 50,000,000 shares of preferred stock in one or more series and to designate the rights, preferences, privileges and restrictions of each series. The issuance of preferred stock could have the effect of restricting dividends on the common stock, diluting the voting power of the common stock, impairing the liquidation rights of the common stock, or delaying or preventing a change in control without further action by the stockholders. No shares of preferred stock are outstanding and we have no present plans to issue any shares of preferred stock.

LEGAL MATTERS

     Certain legal matters in connection with this prospectus will be passed upon for us by Greenberg Traurig, LLP, Santa Monica, California. Greenberg Traurig, LLP and its attorneys hold no shares of our common stock, but have been issued non-qualified stock options to purchase up to 50,000 sharesmarket price of our common stock, which vest one-thirdmay result from actual or rumored takeover attempts, may be inhibited. These provisions, together with the ability of our board of directors to issue preferred stock without further stockholder action could also delay or frustrate the removal of incumbent directors or the assumption of control by stockholders, even if the removal or assumption would be beneficial to our stockholders. These provisions could also discourage or inhibit a merger, tender offer or proxy contests, even if favorable to the interests of stockholders, and could depress the market price of our common stock. In addition, our bylaws may be amended by action of the board of directors.


Warrants

In connection with this offering, we will issue one warrant for each share of common stock purchased or issued..  Each warrant entitles the holder to purchase one share of common stock at an exercise price of $[_____] per year over three years.

share.  After the expiration of the five-year exercise period, warrant holders will have no further rights to exercise such warrants.

16

The warrants may be exercised only for full shares of common stock, and may be exercised on a “cashless” basis.  If the registration statement covering the shares issuable upon exercise of the warrants is no longer effective, the warrants may only be exercised on a “cashless” basis and will be issued with restrictive legends unless such shares are eligible for sale under Rule 144.  We will not issue fractional shares of common stock or cash in lieu of fractional shares of common stock.  Warrant holders do not have any voting or other rights as a stockholder of our Company.  The exercise price and the number of shares of common stock purchasable upon the exercise of each warrant are subject to adjustment upon the happening of certain events, such as stock dividends, distributions, and splits.

OTC Bulletin Board Listing

Our common stock is listed on the OTC Bulletin Board under the trading symbol “CATS”.
OUR BUSINESS

Overview

     Alcohol

Our Company

We are a healthcare services company, providing specialized behavioral health services for substance abuse to health plans, employers and unions through a network of licensed healthcare providers and its employees.  The Catasys substance dependence program was designed to address substance dependence as a chronic disease. The program seeks to lower costs and improve member health through the delivery of integrated medical and psychosocial interventions combining long term “care coaching”, including our proprietary PROMETA® Treatment Program for alcoholism and stimulant dependence.  The PROMETA Treatment Program, which integrates behavioral, nutritional and medical components, is also available on a private-pay basis through licensed treatment providers and a company managed treatment center that offers the PROMETA Treatment Program, as well as other treatments for substance dependencies.
Our unique PROMETA Treatment Program is designed for use by health care providers seeking to treat individuals diagnosed with dependencies to alcohol, cocaine or methamphetamine, as well as combinations of these drugs.  The PROMETA Treatment Program includes nutritional supplements, FDA-approved oral and IV medications used off-label and separately administered in a unique dosing algorithm, as well as psychosocial or other recovery-oriented therapy chosen by the patient and his or her treatment provider.  As a result, our PROMETA Treatment Program represents an innovative approach to managing substance dependence designed to address physiological, nutritional and psychosocial aspects of the disease, and are thereby intended to offer patients an opportunity to achieve sustained recovery.

We have been unprofitable since our inception in 2003 and may continue to incur operating losses for at least the next twelve months.

Substance Dependence

Scientific research indicates that not only can drugs interfere with normal brain functioning, but they can also have long-lasting effects that persist even after the drug is no longer being used. Data indicates that at some point changes may occur in the brain that can turn drug and alcohol abuse into substance dependence—a chronic, relapsing and addiction comprisesometimes fatal disease. Those dependent on drugs may suffer from compulsive drug craving and usage and be unable to stop drug use or remain drug abstinent without effective treatment. Professional medical treatment may be necessary to end this physiologically-based compulsive behavior. We believe that addressing the physiological basis of substance dependence as part of an integrated treatment program will improve clinical outcomes and reduce the cost of treating dependence.

Substance dependence is a worldwide publicproblem with prevalence rates continuing to rise despite the efforts by national and local health problem that affectsauthorities to curtail its growth. Substance dependence disorders affect many people and hashave wide-ranging social consequences. In 2002,2008, an estimated 2222.2 million Americans suffered fromaged 12 and older were classified with substance dependence or abuse, due to drugs, alcohol or both,of which only 2.3 million received treatment at a specialty substance abuse facility, according to the National Survey on Drug Use and Health published by the Substance Abuse and Mental Health Services Administration (SAMHSA) in, an agency of the U.S. Department of Health and Human Services.
17

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$365 billion annually in the U.S., including $42 billion in healthcare costs and approximately $262 billion in productivity losses. Despite these staggering figures, it is a testament to the unmet need in the market that only a small percentage of those who need treatment actually receive help. Traditional treatment methods are often not particularly effective.

There are over 13,500 facilities reporting to SAMHSA that provide substance dependence treatment. Historically, the disease of substance dependence has been treated primarily through behavioral intervention, with fairly high relapse rates. SAMHSA’s TEDS 2005 report states that in 2005 only 71% of those treated for alcoholism and 57% of those treated for cocaine completed detoxification, and that alcohol and cocaine outpatient treatment completion rates were only 47% and 24%, respectively.

Conventional forms of treatment for substance dependence generally focus on the psychosocial aspect of the disease, conducted through residential or outpatient treatment centers, individual counseling and self-help programs like Alcoholics Anonymous and Narcotics Anonymous. Such services are paid for by government funds as covered health insurance benefits or out-of-pocket on private pay basis.

Pharmacological options for alcohol dependence exist and a number of pharmaceutical companies have introduced or announced drugs to treat alcohol dependence. These drugs may require chronic or long-term administration. In addition, several of these drugs are generally not used until the patient has already achieved abstinence, are generally administered on a chronic or long-term continuing basis, and do not represent an integrated treatment approach to addiction. We believe the PROMETA Treatment Program can be used at various stages of recovery, including initiation of abstinence and during early recovery, and can also complement other existing treatments. As such, our treatment programs offer a potentially valuable alternative or addition to traditional treatment methods. We also believe the best results can be achieved in programs such as our Catasys offering that integrates psychosocial and medical treatment modalities and provide longer term support.

Our Market

The true impact of substance dependence is often under-identified by organizations that provide healthcare benefits. The reality is that substance dependent individuals:

●Are prevalent in any organization;

●Cost health plans and employers a disproportionate amount of money;

●Have higher rates of absenteeism and lower rates of productivity; and

●Have co-morbid medical conditions incur increased costs for the treatment of these conditions compared to a non-substance dependent population.

When considering substance dependence-related costs, many organizations only look at direct treatment costs–usually behavioral claims.  The reality is that substance dependent individuals generally have overall poorer health and lower compliance, which leads to more expensive treatment for related, and even seemingly unrelated, co-occurring medical conditions. In fact, of total healthcare claims costs associated with substance dependence populations, the vast majority are medical claims and not behavioral treatment costs.

As December 31, 2008 there were over 191 million lives in the United States covered by various managed care programs including Preferred Provider Organizations (PPOs), Health Maintenance Organizations (HMOs), self-insured employers and managed Medicare/Medicaid programs.   Each year, based on our analysis, approximately 1.9% of commercial plan members will have a substance dependence diagnosis, and that figure may be lesser or greater for specific payors depending on the health plan demographics and location.  A smaller, high-cost subset of this population drives the majority of the claims costs for the overall substance dependent population.  For commercial members with substance dependence and a total annual claims cost of at least $7,500, the average annual per member claims cost is $25,500, compared to an average of $3,250 for a commercial non-substance dependent member, according to our research.
18
In October 2008, the Wellstone and Domenici Mental Health Parity and Addiction Equity Act was passed as part of the nation’s Troubled Assets Relief Program (TARP) financial bail-out package.  The bill requires that behavioral coverage be no less favorable than medical coverage, which is expected to increase utilization of mental health services, causing health plans’ costs to rise.   The increased costs will be most acute for members who recur frequently throughout the behavioral health plan system. We expect that this parity bill, the continuing difficult economic environment and increasing focus on containing healthcare costs will heighten commercial plans’ interest in programs that can lower their cost and increase their interest in seeking solutions.

Our Solution: OnTrak and the PROMETA Treatment Program

Under our OnTrak solution, we work with health plans and employers to customize our program to meet a plan’s structural needs and pricing—either a case rate per patient or a per-enrolled member, per-month fee.  Our Catasys substance dependence program is designed for increased enrollment, longer retention and better health outcomes so we can help payors improve member care componentand achieve lower costs, and in addition help employers and organized labor reduce medical costs, absenteeism and job-related injuries in the workplace, thereby improving productivity.

We are in a position to respond to a largely unmet need in the healthcare industry by offering an innovative and integrated substance dependence treatment solution in an effort to reduce overall medical costs, improve clinical outcomes and improve quality of care for patients.  People suffering from alcohol and drug dependence have a clinical disease, but are often characterized as having a social disorder or a lack of self-discipline.  In this context, with few pharmaceutical options for substance dependence available, traditional treatment approaches have generally focused on the psychosocial aspect of the disease.  While we recognize the psychosocial approach to substance dependence treatment is over $41 billionimportant, we believe that a more comprehensive approach to this multi-factorial disease should be addressed as part of an integrated treatment approach intended to provide patients with an improved chance for recovery.  We believe our integrated approach offers patients a better opportunity to achieve their individual recovery goals.

OnTrak®

Our OnTrak integrated substance dependence solution combines innovative medical and psychosocial treatments with elements of population health management and ongoing member support to help organizations treat and manage substance dependent populations, and is designed to lower the overall costs of members diagnosed with substance dependence. We believe the benefits of Catasys include improved clinical outcomes and decreased costs for the payor, and improved quality of life and productivity losses account for approximately $245 billion. In comparison, the National Cancer Institute estimatesmember.

We believe OnTrak is the only program of its kind dedicated exclusively to substance dependence. The OnTrak substance dependence program was developed by addiction experts with years of clinical experience in the substance dependence field. This experience has helped to form key areas of expertise that 9.6 million Americans suffersets Catasys apart from cancer,other solutions, including member engagement, working directly with the member treatment team and a more fully integrated treatment offering.

Our OnTrak integrated substance dependence program includes 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 directfollowing components:  Member identification, enrollment/referral, provider network development and training, outpatient medical treatment, outpatient psychosocial treatment, care coaching, monitoring and reporting, and our proprietary web based clinical information platform (eOnTrak).

We identify those who have been diagnosed as substance dependent and who incur significant costs and over $110 billionmay be appropriate for indirect costs such as lost productivity.

enrollment into OnTrak.  We then enroll targeted members into the Catasys program through direct mailings, email and telephonic outreach, and through referral through health plan sources.  After enrollment/referral, we optimize patient outcomes through a specially trained sub-network of providers, utilizing integrated treatment modalities.  Outpatient medical treatment follows, where we utilize the most advanced pharmacologic treatments (including PROMETA Treatment Program for alcohol and stimulant dependence and SUBOXONE ®  for opioid dependence) in order to provide more immediate and sustained results.  This is paired with outpatient psychosocial treatment where we utilize our proprietary psychosocial model and Relapse Prevention Program in order to enhance the neurophysiologic effect gained from the medical treatment by helping members develop improved coping skills and a recovery support network.  Throughout the treatment process, our care coaches work directly with members to keep them engaged in treatment by proactively supporting members to enhance motivation, minimize lapses and enable lifestyle modifications consistent with the recovery goals.  We also link providers and care coaches to member information through our web based clinical information platform, enabling each provider to be better informed with a member’s treatment in order to assist in providing the best possible care. Periodically we will provide outcomes reporting on clinical and financial metrics to our customers to demonstrate the extent of the program’s value.


PROMETA® Treatment Program

Our PROMETA Treatment Program is an integrated, physician-based outpatient addiction treatment program that combines three components–medical treatment, nutritional support and psychosocial therapy–all critical in helping people address addiction to alcohol and stimulants (e.g. cocaine and methamphetamine). The program is designed to help relieve cravings, restore nutritional balance and initiate counseling.
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Historically, the disease of addiction has been treated primarily through behavioral intervention, with fairly high relapse rates. 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’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 after 90 days or less of long-term residential treatment.

     Those suffering from alcohol and drug addictions have often been characterized as having social disorders or a lack of self-discipline, and there are relatively high relapse rates utilizing conventional treatment methodologies. We believe the medical communityPROMETA Treatment Program offers an advantage to traditional alternatives because it provides a treatment methodology that is readydiscreet and only mildly sedating, and can be initiated in only three-days, with a two-day follow-up treatment three weeks later. The initiation of treatment under PROMETA involves the oral and intravenous administration of pharmaceuticals in a medically directed and supervised setting. The medications used in the PROMETA Treatment Program have been approved by the Food and Drug Administration (FDA) for uses other than treatment of substance dependence. Treatment generally takes place on an outpatient basis at a properly equipped outpatient setting or clinic, or at a hospital or other in-patient facility, by physicians and healthcare providers who have licensed the rights to use our PROMETA Treatment Program. Following the initial treatment, our treatment program provides that patients receive one month of prescription medication, nutritional supplements, nutritional guidelines designed to assist in recovery, and individualized psychosocial or other recovery-oriented therapy chosen by the patient in conjunction with their treatment provider. The PROMETA Treatment Program provides for a newsecond, two-day administration at the facility, which takes place about three weeks after initiation of treatment. The medical treatment approach. While weis followed by continuing care, such as individual or group counseling, as a key part of recovery.


We believe the psychological approachshort initial treatment period when using our PROMETA Treatment Program is a major advantage over traditional inpatient and residential treatment programs, which typically consist of up to addiction28 days of combined inpatient detoxification and recovery in a rehabilitation or residential treatment is important, we recognize that physiological factors shouldcenter. Treatment with PROMETA does not require an extensive stay at an inpatient facility. Rather, the PROMETA Treatment Program offers the convenience of a three-day treatment, followed by a two-day follow-up treatment three weeks later, which can be addressed first to provide the patient the best chance for recovery. We believe our physiological approach, focusedadministered on stabilizing neurological function, provides a substantial commercial opportunity.

     We have acquired, licensed and developed proprietary, patented and patent-pending treatment protocols designed to combat alcohol and drug addiction by treating the physiological componentan outpatient basis. The outpatient nature of the disease. Our first such proprietary technology,treatment provides the HANDSopportunity for the care to be provided in a discreet manner and without long periods away from home or work. This is particularly relevant since results from the National Survey on Drug Use and Health – 2007 reported that approximately 75% of adults using illicit drugs in 2007 were employed, and loss of time from work can be a significant deterrent to seeking treatment.


The PROMETA Treatment Protocol™, is designed to treat addictions to alcohol, cocaine and other addictive stimulants—as well as combinations of these drugs. HANDS™ is a medically supervised treatment protocol for neurostabilization and detoxification from alcohol and/or addictive psychostimulants designed to simultaneously facilitate pain-free withdrawal, eliminate cravings and enhance cognitive function, resulting in accelerated recovery. Unlike many current practices for withdrawing addicted patients from alcohol, cocaine or other addictive stimulants, our HANDS Treatment Protocol eliminates the use of sedating medications, reduces inpatient treatment time, and requires no tapering or washout period.

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     Our limitedProgram provides for:


●A comprehensive physical examination, including specific laboratory tests, prior to initiation of treatment by the treating physician, to determine if the patient is appropriate for PROMETA;

●Prescription medications delivered in a unique dosing algorithm administered in a physician-supervised setting. The initial treatment occurs during three consecutive daily visits of about two hours each, followed by a two-day follow-up treatment three weeks later;

●A nutritional plan and recommendations, designed to help facilitate and maintain the other aspects of recovery; and

●One month of prescription at-home medications and nutritional supplements and education following the initial treatment.

Initial results indicate that the protocolPROMETA Treatment Program may significantly reduce or eliminate withdrawal symptoms, have substantiallybe associated with higher initial completion rates than conventional treatments, improved cognitive function and most importantly, eliminate thereduced physical cravings thatwhich can be a major factor in relapse. By providing what we believerelapse, thus allowing patients to be a more beneficial method formeaningfully engage in counseling or other forms of psychosocial therapy. These initial conclusions have been reported in the treatment of the physiological component of the disease, the HANDS Treatment Protocol can offer moreover 3,500 patients an improved chance for recovery. Our initial results are based on a limited number of unpublished reports, primarilyat licensed sites, commercial pilots and in Spain, andresearch studies conducted to study our very limited initial experience with a small number of patients in the United States. Such results were not obtained by formal research studies,treatment programs. They may not be statistically significant, have not been subjected to detailed scientific scrutiny,confirmed by additional double-blind, placebo-controlled research studies, and may not be indicative of the long-term future performance of our protocols.treatment programs.

Current research indicates that substance dependence is associated with altered cortical activity and changes in neurotransmitter function in the specific areas of the brain which are critical to normal brain function. Moreover, changes in the neurochemistry of the brain may underlie the hallmarks of substance dependence, including tolerance, withdrawal symptoms, craving, decrease in cognitive function and propensity for relapse. We believe the PROMETA Treatment Program may offer an advantage to traditional alternatives for several reasons:

●The PROMETA Treatment Program includes medically directed and supervised procedures designed to address neurochemical imbalances in the brain that may be caused or worsened by substance dependence. The rationale for this approach is that by addressing the underlying physiological balance thought to be disrupted by substance dependence, dependent persons may be better able to address the behavioral/psychological and environmental components of their disease;

●By first addressing the physiologic components of the disease, substance dependent patients may have a better opportunity to address the behavioral and environmental components, enabling them to progress through the various stages of recovery;

●The PROMETA Treatment Program is designed to address a spectrum of patient needs, including physiological, nutritional and psychological elements in an integrated way;

●Treatment using the PROMETA Treatment Program generally can be performed on an outpatient basis and does not require long periods away from home or work; and

●The PROMETA Treatment Program may be initiated at various stages of recovery, including initiation of abstinence and during early recovery, and can complement other treatment modalities.

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Additionally, we provide training, education and other administrative services to assist physicians, healthcare providers and treatment centers with staff education, marketing and administrative support.

Treatment with PROMETA is not appropriate for everyone. PROMETA is not designed for use with those diagnosed with dependence to opiates, benzodiazepines, or addictive substances other than alcohol or stimulants. The PROMETA-treating physician must make the treatment decision for each individual patient regarding the appropriateness of using the PROMETA Treatment Program during the various stages of recovery.

Our Strategy

Our business strategy is to provide a quality integrated medical and behavioral program to help organizations treat and manage substance dependent populations to impact both the medical and behavioral health costs associated with members with a substance dependence diagnosis. We intend to sponsor formal scientific studiesgrow our business through increased adoption of our Catasys integrated substance dependence solutions by managed care health plans, employers, unions and other third-party payors.

Key elements of our business strategy include:

●Providing our Catasys integrated substance dependence solutions to third-payors for reimbursement on a case rate or monthly fee;

●Educating third-party payors on the disproportionately high cost of their substance dependent population; and

●Demonstrating the potential for improved clinical outcomes and reduced cost associated with using our Catasys programs with key managed care and other third-party payors.

As an early entrant into offering integrated medical and behavioral programs for substance dependence, Catasys will be well positioned to address increasing market demand.  Our Catasys program will help fill the gap that exists today: a lack of programs that focus on smaller populations with disproportionately higher costs and that improve patient care while controlling overall treatment costs.

OnTraks – Integrated Substance Dependence Solutions

There are currently over 191 million lives in the United States covered by various managed care programs, including PPOs, HMOs, self-insured employers and managed Medicare/Medicaid programs. We believe our greatest opportunities for growth are in this market segment.

Our proprietary OnTrak integrated substance dependence solutions are designed to improve treatment outcomes and lower the utilization of medical and behavioral health plan services by high utilizers and high risk enrollees.  Our OnTrak substance dependence programs include medical and psychosocial interventions and the use of our PROMETA Treatment Program, a proprietary web based clinical information platform and database, clinical algorithms, psychosocial programs and integrated care coaching services.

Another important aspect of the Catasys program is that the program is flexible and can be altered in a modular way to enable us to partner with payors to meet their needs.  As a service delivery model, the OnTrak program can be modified to cover particular populations and provide for varying levels of service. In this way OnTrak can work with payors to identify, engage and treat medically and behaviorally a broader spectrum of patients struggling with substance dependence in a way that is consistent with payors’ business needs.

Our value proposition to our customers includes that the OnTrak program is designed for the protocolsfollowing benefits:

●A specific program aimed at addressing high-cost conditions by improving patient care and reducing overall healthcare costs can benefit health plans that do not have or do not wish to dedicate the capacity, ability or focus to develop these programs internally;

●Increased worker productivity by reducing workplace absenteeism, compensation claims and job related injuries;

●Decreased emergency room and inpatient utilization;

●Decreased readmission rates; and

●Healthcare cost savings (including medical, behavioral and pharmaceutical).
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Managed Treatment Center

We currently manage one treatment center located in Santa Monica, California (dba the Center To Overcome Addiction.). We manage the business components of the treatment center and license the PROMETA Treatment Program and use of the name and trademark in exchange for management and licensing fees under the terms of full business service management agreements. The treatment center operates in a state-of-the-art outpatient facility and offers the PROMETA Treatment Program for dependencies on alcohol, cocaine and methamphetamines, as well as a full range of other behavioral health services on a private pay and insurance reimbursed basis. Under generally accepted accounting principles (GAAP), the revenues and expenses of the managed treatment center is included in our consolidated financial statements.

Self-pay Patients – Licensees

Another source of our revenues to date has been from license fees derived from the licensing of our PROMETA Treatment Program to physicians and other licensed treatment providers.  Although we plan to continue to provide licenses to our existing licensees for the treatment of substance dependencies using our PROMETA Treatment Program, we do not expect to significantly invest in or expand this line of business at this time. Accordingly, in 2009 and 2010 we significantly reduced our resources in each market area to more closely match our resources and expenditures with revenues from our licensees in each market.

International Operations

In 2009 we ceased all of our international operations to reduce costs and focus on our domestic OnTrak program, and have no plans to expand internationally in the near future.

Clinical Data from Research Studies

There have been several research studies evaluating treatment with the PROMETA Treatment Program, conducted by leading research institutions and preeminent researchers in the field of alcohol and substance abuse. In 2006 and 2007 Dr. Harold C. Urschel III conducted an open-label methamphetamine study followed by a randomized, double-blind, placebo-controlled methamphetamine study, the results of which were peer-reviewed and published in July 2007 and November 2009, respectively.  Dr. Urschel’s double-blind placebo-controlled study showed that the pharmacological component of the PROMETA Treatment Program versus placebo had a statistically significant reduction of cravings for methamphetamine.  This data further validates our PROMETA Treatment Program with respect to reducing cravings. Moreover, no patients reported any major adverse events or had to discontinue the treatment due to side effects.

In August 2009, Dr. Raymond Anton’s study on alcohol dependent subjects was published in the August issue of the Journal of Clinical Psychopharmacology. The study was conducted at the Medical University of South Carolina, and among the researchers’ findings were that key results demonstrated a statistically significant difference in use for subjects who exhibited pre-treatment withdrawal symptoms. The results are the first to be published in a peer-reviewed scientific journal from a double-blind, placebo-controlled study conducted to assess the impact of the PROMETA Treatment Program on alcohol dependence.

In January 2009, the Institute of Additive Medicine completed a 120-subject randomized, double-blind, placebo-controlled study of the PROMETA Treatment Program’s acute and immediate effects on cravings and cognition in alcohol dependent subjects was completed in January 2009.  The study was designed and supervised by alcoholism researcher, Joseph R. Volpicelli, M.D., Ph.D., at the Institute of Addiction Medicine in Philadelphia. This study demonstrated that for patients with lower symptoms of withdrawal and a clinical history of alcohol withdrawal symptoms, when treated with PROMETA experienced a statistically significant decrease in alcohol craving and alcohol consumption during the active treatment phase, as compared to placebo. This study is in the publication process.

Many drug treatment experts agree that minimizing cravings is critical to supporting recovery, and that cravings are an important indicator of relapse. Published clinical research has shown that cravings are a key cause of continued drug use and relapse for those patients trying to end drug use. In a study titled “Craving predicts use during treatment for methamphetamine dependence: a prospective, repeated-measures, within-subject analysis,” published in Drug and Alcohol Dependence in 2001, it was shown that among the test population, craving scores that preceded use were 2.7 times higher than craving scores that preceded abstinence. This confirms the long-held conviction among clinicians that cravings drive substance dependent individuals to continue to use, even when they truly desire to stop.

We believe such results from published studies will enhance acceptance of the PROMETA Treatment Program and assist in our efforts to increase third-party payor support for our OnTrak substance dependence program.

In a step to further substantiateensure the integrity of the clinical data, the independent physicians who are conducting clinical trials of the PROMETA Treatment Program own their study data and confirmhave complete control over the resulting data.
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Our Operations

Healthcare Services

The OnTrak integrated substance dependence solution combines innovative medical and psychosocial treatments with elements of population health management and ongoing member support to help organizations treat and manage substance dependent populations to impact both the medical and behavioral health costs associated with substance dependence and the related co-morbidities.

Through March 2011, we have entered into agreements for our OnTrak program with one employer and three health plans. The employer program commenced operations in 2010 and three health plan programs are anticipated to commence operations during 2011.

We are currently marketing our OnTrak integrated substance dependence solutions to managed care health plans, employers and unions for reimbursement on a case rate or monthly fee basis, which involves educating third party payors on the disproportionately high cost of their substance dependent population and demonstrating the potential for improved clinical efficacy.

     Our plan isoutcomes and reduced cost associated with using our Catasys programs.


License and Management  Services

To date, a substantial portion of our healthcare services revenues has been derived from license fees for the use of the PROMETA Treatment Program in treating self-pay patients, and consolidation of self-pay patient revenues from our managed treatment centers. We commenced operations in July 2003 and signed our first licensing and administrative services agreement in November 2003. Under our licensing agreements, we provide physicians and other licensed treatment providers access to applyour PROMETA Treatment Program, education and training in the implementation and use of the licensed technology and marketing support. We receive a fee for the licensed technology and related services, generally on a per patient basis. As of December 31, 2010, we had active licensing agreements with physicians, hospitals and treatment providers for 14 sites throughout the United States.  However, we streamlined our operations during 2008 and 2009 our field and regional sales personnel cover only one of these markets as of April 15, 2011. We may enter into agreements on a selective basis with additional healthcare providers to increase the availability of the PROMETA Treatment Program, but generally in markets where we are presently operating or where such sites will provide support for our Catasys products.  Since July 2003, over 3,500 patients have completed treatment using our PROMETA Treatment Program at our licensed sites, and in commercial pilots and research studies conducted to study our treatment programs.

We currently manage one treatment center under a licensing agreement, located in Santa Monica, California (dba The Center to Overcome Addiction), whose revenues and expenses are included in our consolidated financial statements.

We do not operate our own healthcare facilities, employ our own treating physicians or provide medical advice or treatment to patients. We provide services, which assist health plans to manage their substance dependence populations, and access to tools that physicians may use to treat their patients as they determine appropriate. The hospitals, licensed healthcare facilities and physicians that contract for the use of our technology own their facilities or professional licenses, and control and are responsible for the clinical activities provided on their premises. Patients receive medical care in accordance with orders from their attending physicians.  Licensed physicians with rights to use the PROMETA Treatment Program exercise their independent medical judgment in determining the use and specific application of our treatment programs, and the appropriate course of care for each patient.

Competition

Healthcare Services

Our OnTrak product offering focuses primarily focus on substance dependence and is marketed to health plans, employers and unions. While we believe our products and services are unique, we operate in highly competitive markets. We compete with other healthcare management service organizations, including managed behavioral health organizations (MBHOs) that manage behavioral health benefits, perform utilization reviews, provide case management and pay their network of providers for behavioral health services delivered. Most of our competitors are significantly larger and have greater financial, marketing and other resources than us. In addition, customers that are managed care companies may seek to provide similar specialty healthcare services directly to their members, rather than by contracting with us for such services.  Behavioral health conditions, including substance dependence, are typically managed for insurance companies by internal divisions or third-parties (MBHOs) frequently under capitated arrangements.  Under such arrangements, MBHOs are paid a fixed monthly fee and must pay providers for provided services, which gives such entities an existing industryincentive to decrease cost and utilization of services by members.  We compete to differentiate our integrated program for high utilizing substance dependence members from the population of utilization management programs that MBHOs offer.

We believe that our ability to offer customers a comprehensive and integrated substance dependence solution, including the utilization of innovative medical and psychosocial treatments, and our unique technology platform will enable us to compete effectively.  However, there can be no assurance that we view as fragmented with participantswill not encounter more effective competition in the future, which would limit our ability to maintain or increase our business.
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License and Management  Services

PROMETA Treatment Program

Our PROMETA Treatment Program focuses on providing licensing, administrative and management services to licensees that administer PROMETA and other treatment programs, including health care providers such as physicians, psychologists, nurses, therapists, interventionists, counselors, hospitals, residentialmedical practices and treatment centers outpatientthat are licensed and managed by us. We compete with many types of substance dependence treatment methods, treatment facilities and self-help groups. We expectother service providers. Conventional forms of treatment for alcohol dependence are usually divided into the following phases:

●Detoxification, which is typically conducted in medically directed and supervised environments;

●Rehabilitation, which is often conducted through short- or long-term therapeutic facilities or programs, most of which do not offer medical management options; and

●Psychosocial care that is provided via structured outpatient treatment programs.

Conventional forms of treatment for stimulant dependence generally consist only of relapse prevention (psychosocial and recovery oriented therapy), conducted through therapeutic programs.  Regardless of the approach, there is great variability in the duration of treatment procedures, level of medical supervision, price to the patients, and success rates.

Treatment Programs

There are over 13,500 facilities reporting to the SAMHSA that provide substance dependence treatment. 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. Many of these traditional treatment programs have established name recognition, and their treatments may be referred for treatmentcovered in large part by physicians and treatment centersinsurance or other third party payors. To date, treatments using our technology through self-referrals, patients’ family members, friends, employersPROMETA Treatment Program has generally not been covered by insurance, and associated unions, as well as employee assistance programs, criminal justice systems, health care providers, third party payors,patients treated with the PROMETA Treatment Program have been substantially self-pay patients.

Traditional treatment approaches for substance dependence focus mainly on group therapy, abstinence and government agencies.behavioral modification, while the disease’s underlying physiology and pathology is rarely addressed, resulting in fairly high relapse rates. We believe that the HANDSour PROMETA Treatment Protocol can provide a significantProgram offers an improvement to current treatment methodologiestraditional treatments because the integrated PROMETA Treatment Program is designed to target the pathophysiology induced by reducingchronic use of alcohol or eliminating the patient’s craving while increasing their cognitive function, resultingother drugs in reduced relapse ratesaddition to nutritional and improved patient outcomes.

Addiction as a Disease

     Recent scientific research provides evidence that not only can drugs interfere with normal brain functioning but can also have long-term effects on brain metabolism and activity. At some point, changes may occur in the brain that can turn drug and alcohol abuse into addiction, a chronic, relapsing illness. Those addicted to drugs may suffer from compulsive drug craving and usage and be unable to quit by themselves, and professional medical treatment is often necessary to end this physiologically based compulsive behavior.

psychosocial aspects of substance dependence.  We believe the PROMETA Treatment Program offers an advantage to traditional alternatives because it provides an integrated treatment methodology that is discreet, mildly sedating and can be initiated in only three-days, with a second two-day treatment three weeks later. Our PROMETA Treatment Program also provides for one month of prescription medication and nutritional supplements, integrated with psychosocial or other recovery-oriented therapy.


We further believe the abilityshort initial outpatient treatment period when using our PROMETA Treatment Program is a major advantage over traditional inpatient treatments and residential treatment programs, which typically consist of approximately 15 to successfully treat addictions28 days of combined inpatient detoxification and recovery in a rehabilitation or residential treatment center. The PROMETA Treatment Program does not require an extensive stay at an inpatient facility. Rather, the treatment program can havegenerally be administered on an effect not only on drug abusers, but on society as a whole by reducing the costoutpatient basis. This is particularly relevant since approximately 75% of treating the addiction as well as the cost of treating conditions attributable to substance abuse, decreasing related criminality and violence, and reducing the costs associatedadults classified 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 studied 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.)

     The consequences of alcoholism and alcohol abuse effect most American families. One study estimates 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 addiction.

U.S. Market Opportunity

     The U.S. market consists of a broad spectrum of people who are addicted to or have cravings for alcohol, psycho-stimulants (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 12 or over received some kindare employed, and loss of treatment, with 2 million treated at self-help groups offering psychological therapy. Further, according to NIAAA, approximately 50% of people treatedtime from work can be a major deterrent for alcohol dependence relapse within three months, and 90% are likely to experience at least one relapse within 4 years.

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     Relapse rates are higher for those suffering from cocaine addiction 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 freeseeking treatment.  For those undergoing 90 days or less of long-term residential treatment, relapse rates were 80% at one year post-treatment.

Due to the above factors,Moreover, we believe there is a substantial market potential forthe PROMETA Treatment Program can be used at various stages of recovery, including initiation of abstinence and during early recovery, and can complement other forms of alcohol and drug abuse treatments. As such, our treatment protocols.

Developmentprogram offers a potentially valuable alternative or addition to traditional behavioral or pharmacotherapy treatments.


Treatment Medications

There are currently no generally accepted medical treatments for methamphetamine dependence. Anti-depressants and Acquisitiondopamine agonists have been investigated as possible maintenance therapies, but none have been FDA approved or are generally accepted for medical practice.

Several classes of pharmaceutical agents have been investigated as potential maintenance agents (e.g., anti-depressants and dopamine agonists) for cocaine dependence; however, none are FDA approved for treatment of cocaine dependence or generally accepted widely 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 a number of companies developing or marketing medications for reducing craving in the treatment of alcoholism. Currently available medications include:

●The addiction medication naltrexone, an opiate receptor antagonist, is marketed by a number of generic pharmaceutical companies as well as under the trade names ReVia ®  and Depade ®  for treatment of alcohol dependence;
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●VIVITROL®, an extended release formulation of naltrexone manufactured by Alkermes, is administered via monthly injections for the treatment of alcohol dependence in patients who are able to abstain from drinking in an outpatient setting, and are not actively drinking prior to treatment initiation. Alkermes reported that in clinical trials, when used in combination with psychosocial support, VIVITROL was shown to reduce the number of drinking days and heavy drinking days and to prolong abstinence in patients who abstained from alcohol the week prior to starting treatment;

●Campral® Delayed-Release Tablets (acamprosate calcium), an NMDA receptor antagonist taken two to three times per day on a chronic or long-term basis and marketed by Forest Laboratories.  Clinical studies supported the effectiveness in the maintenance of abstinence for alcohol-dependent patients who had undergone inpatient detoxification and were already abstinent from alcohol; and

●Tropiramate (Topamax®), a drug manufactured by Ortho-McNeill Jannssen, which is approved for the treatment of seizures. A multi-site clinical trial reported in October 2007 found that tropiramate significantly reduced heavy drinking days in alcohol-dependent individuals.

Development of Our Technology

     Our


Much of our proprietary, patented and patent patent–pending, addiction treatmentsubstance dependence technology known as the PROMETA Treatment Program, was developed by Dr. Juan José Legarda, a member of our board and a European scientist educated at the University of London who has spent most of his professional career studying the science of addiction. Through his studies andconducting research Dr. Legarda discovered the adverse physical effects of addictions on the brain and beganrelated to develop treatment technologies that specifically focused on brain detoxification and recovery as a core part of addictive behavior modification.

     On August 15, 2000, Dr. Legarda was issued U.S. Patent No. 6,103,734 for the treatment of opiate addiction. This patent, which will expire on August 27, 2016, was acquired by a medical technology company now known as Xino Corporation, and we acquired the patent in August 2003 at a foreclosure sale of Xino’s assets by Reserva, LLC in satisfaction of debt owed to Reserva by Xino. Reserva is owned and controlled by Terren S. Peizer, our chairman and chief executive officer and majority shareholder.

substance abuse. In 2002, Dr. Legarda filed Patent Cooperation Treaty (PCT) applications in Spain forto protect treatment protocolsprograms that he developed for treating addictionsdependencies to alcohol and cocaine, which remain pending.cocaine. 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 which we pay a royalty of three percent of the amount the patient pays for treatment using our treatment programs. After acquiring these rights, we filed U.S. patent applications and other national phase patent applications based on the prior PCT filings, as well as provisional U.S. patent applications forto protect aspects of additional treatment protocolsprograms for alcohol, cocaine and other addictive stimulants. If these


We have three issued U.S. patents for our Prometa Treatment Program for the treatment of cocaine dependency, methamphetamine dependency and for the treatment of certain symptoms associated with alcohol dependence. We have also received allowances, issuances or notices that patent grants are intended for our core intellectual property for the treatment of alcohol and/or stimulant dependence in Austria, Belgium, Denmark, Finland, France, Germany, Ireland, Italy, the Netherlands, Portugal, South Africa, Spain, Sweden, Switzerland, Turkey, and the United Kingdom.

Once patents are issued, they generally 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 Treatment Protocol™.

Our Solution

     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. These studies involve the use of objective analytical tools including Positron Emission Tomography (PET) as well as other diagnostic tools. In drug abuse research, PET scans are being used to identify the brain sites where drugs and naturally occurring neurotransmitters act, to show how quickly drugs reach and activate a neural receptor, and to determine how long drugs occupy these receptors and how long they take to leave the brain. PET is also being used to show brain changes following chronic drug abuse, during withdrawal from drugs, and while the research volunteer is experiencing drug craving. In addition, PET can be used to assess the brain effects of pharmacological and behavioral therapies for drug abuse (The Basics of Brain Imaging, NIDA).

     While treating the psychological component of the disease is important, Hythiam recognizes that physiological factors of addiction should be addressed first to provide patients with an improved chance for recovery. The HANDS Treatment Protocol™ is designed to treat alcohol, cocaine and other addictive stimulants, as well as combinations of these drugs, by targeting specific neurological transmitters and receptors which have been damaged as a result of chemical addiction and dependence.

     We license our HANDS Treatment Protocol to healthcare providers to treat addictions to alcohol, cocaine and other addictive stimulants—as well as combinations of these drugs. HANDS™ is a medically supervised treatment process in which designated prescription medications are administered in specific sequences, amounts and rates under the supervision of a licensed physician. The treatment is designed for detoxification, or the medically managed withdrawal from the psychoactive substance. HANDS also seeks neurostabilization, or stabilizing the patient’s brain chemistry, in order to eliminate cravings, enhance cognitive function and facilitate a pain-free withdrawal, thereby resulting in accelerated recovery. Limited initial results indicate that our protocols may significantly reduce or eliminate withdrawal symptoms, have significantly higher completion rates than conventional treatments, and reduce or eliminate the physical cravings that can be a major factor in relapse. Such 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 intend to sponsor formal scientific studies for the protocols to further substantiate and confirm their clinical efficacy.

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     For the treatment of alcoholism, cocaine and other addictive stimulants, the HANDS Treatment Protocol consists of two to three consecutive days of detoxification treatment in a hospital or at a licensed healthcare facility, thereby reducing inpatient treatment time. For cocaine and other addictive stimulants there is a two day follow-up treatment three weeks later. Unlike traditional detoxification therapy, use of the HANDS Treatment Protocol is non-sedating and patients remain awake throughout their treatment. Our protocols do not use sedating medications such as long-acting benzodiazepines, and therefore do not require either gradually tapering off such medications or a washout period to allow the patient to fully recover from the sedative effects of such medications. The short period of inpatient stay during treatments provides patients convenience and the ability to manage their time away from work and family. We believe the short treatment period when using the HANDS Treatment Protocol is a major advantage over traditional treatments which typically consist of 5 to 14 days of combined inpatient detoxification 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. 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 also provide hospitals and attending physicians with information and administrative services to facilitate continuing care services that help patients rebuild their lives after recovering from the physical effects of addiction, and learn new life skills to maintain sobriety.

Competition

     Conventional forms of addiction detoxification are typically conducted in medically supervised environments. Regardless of the approach, there is great variability in the durations of the detoxification procedure, the levels of medical supervision, the costs to the patients and the recidivism rates.

     Currently accepted practice for withdrawing patients from an addiction to 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 as a “washout.” 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 can be addictive and may cause side effects.

     While withdrawal from cocaine addiction is not considered to involve a significant risk of death, 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 effect of cocaine on the brain. Detoxification procedures typically involve the use of sedatives to assist patients through this difficult period. Cravings, however, are especially pronounced and may re-occur for months to years, and the medications most commonly used can be addictive and cause side effects.

     The addiction medication naltrexone is marketed by a number of generic pharmaceutical companies as well as under the trade name ReVia® by Bristol Myers Squib, and has been shown to reduce cravings in the treatment of alcoholism. 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. There are also a number of companies reported to be developing medications for reducing craving in the treatment of alcoholism. These include:

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     We see these products as being potentially useful during the continuing care phase of treatment following treatment by the HANDS Protocols, but not being directly competitive. To the best of our knowledge, there are no treatments or medications available within the U.S. that reduce the cravings for cocaine, methamphetamine or other additive prescription psychostimulants.

     These detoxification procedures are conducted at public and private hospitals, and public and private addiction treatment facilities throughout the country. SAMHSA lists approximately 2,500 facilities that report conducting detoxification procedures.

     There are approximately 2,500 facilities reporting to the Substance Abuse and Mental Health Services Administration (SAMSHA) to provide detoxification services on an inpatient or outpatient basis. Well known examples of month-long residential treatment programs include The Meadows, Betty Ford Center, Hazeldon Institute and Sierra Tucson. In addition, individual physicians may provide detoxification treatment in the course of their practices. There appears to be no standard protocol or reliable reporting mechanism for measuring outcomes. 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 directly related to relapse rates.

Our Competitive Advantage

     We believe the Hands Treatment Protocol offers an advantage to traditional alternatives because it provides a detoxification methodology that is non-sedating, can be completed in only two to three days, offers an immediate improvement in cognitive function, and reduces craving, a primary cause of relapse.

     Current treatments for detoxification from alcohol and addictive psychostimulants generally consist of administration of high doses of long-acting benzodiazepines over several days which results in sedation. In addition, these benzodiazepines are themselves potentially addictive. The dose of the benzodiazepines must be gradually reduced or tapered over time rather than abruptly halted, which could result in adverse reactions. Since these medications are long-acting, it takes a wash-out period of several days following the last dose before the patient fully recovers from the sedative effects.

     The HANDS Treatment Protocol™ for alcoholism consists of two consecutive days of detoxification treatment in a hospital or at a licensed healthcare facility. For cocaine and other addictive stimulants, the HANDS™ protocol consists of three consecutive days of detoxification treatment, with two consecutive days of follow-up treatment three weeks later. Patients are not sedated during the procedure, and most patients remain awake and comfortable throughout the procedure. To date, substantially all patients have completed the initial detoxification treatment procedure. We attribute the high completion rate to the fact that the voluntary procedure is designed to be comfortable and nonsedating, detoxification is completed within only two to three days (as compared to a week or more for many traditional treatment programs), and patients report experiencing increased mental clarity and focus (enhanced cognitive function), and significantly reduced or eliminated craving.

     A report of data collected retrospectively by the Spanish government on 221 patients treated by Dr. Legarda in Madrid, Spain as of March 2003 with the original protocol acquired by Hythiam showed the following results:

     100% of the 221 patients completed the treatment procedure. 21 of these patients did not enroll in an aftercare program, and their post-treatment outcomes were not included in the report. As of the date that the data was collected, the 200 patients were in various stages of aftercare, ranging from 3 months to over 23 months. Results for the patients who had completed or were scheduled to have completed 6 months and 23 months of aftercare are summarized below:

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*“unknown status” indicates patients who were no longer in an aftercare program, and whose outcome results were unknown. There is no available information to suggest either success or failure of the treatment program for these patients.

     At Little Company of Mary–San Pedro Hospital, 30 patients were treated from November 2002 through March 2004 with the HANDS Treatment Protocol, of whom over 60% had unsuccessfully undergone prior treatment. For 22 patients undergoing our HANDS for Alcohol protocol, 100% completed treatment and 77% are currently in remission, with one patient's current status unknown (5%).

     For eight patients undergoing our HANDS for Stimulants protocol at Little Company of Mary Hospital, 100% completed the initial treatment, and six completed the full treatment. Two patients completed the primary treatments but did not return for the follow-up treatments, against medical advice, and have relapsed. Two of the patients who completed the full treatment have relapsed. The other four patients report remainingissued U.S. patents will expire in remission. We believe that the completion and success rates for the stimulants treatment may not be as high as the alcohol treatment, in substantial part because stimulants require a follow-up treatment three weeks after the initial detoxification treatment. Stimulants may also be more difficult addictions to treat, since the industry success rates for stimulants treatments are lower than for alcohol treatments generally.

     The most significant outcomes following treatment have included patient self-reports of increased mental clarity and focus (cognitive function) and loss of interest in and cravings for using the substance of addiction. Further, patients report the HANDS Treatment Protocol reduces or eliminates other common symptoms of Post Acute Withdrawal Syndrome (PAWS), including memory problems, emotional overreactions, sleep disorders, physical coordination problems and stress sensitivity.

     The results of these unpublished reports and very limited initial experiences were not obtained in formal research studies, 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 intend to sponsor formal scientific studies for the protocols to further substantiate and confirm their clinical effectiveness. 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 Treatment Protocol falls within the typical range of prices for conventional treatment programs. We also believe that treatment using our protocols can have higher completion rates, greater compliance, elimination of withdrawal symptoms, reduction or elimination of cravings, improved cognitive functioning and potentially lower relapse rates. The following is a list of advantages we believe our treatment technologies may demonstrate over traditional treatment methodologies:

1.
The HANDS Treatment Protocol™ requires substantially less treatment time than do current treatment regimens. Current practice for detoxification from alcohol, cocaine and other addictive stimulants can require from 5 to as many as 14 days of combined inpatient treatment and washout period. The HANDS Treatment Protocol for alcohol, cocaine and other addictive stimulants takes less than one hour per day for two to three consecutive days of treatment. Since treatment using the HANDS Treatment Protocol can be completed in 2 to 3 days at a time, individuals can return to work and their families with minimal time off or time away from normal activities. According to the New York State Office of Alcoholism and Substance Abuse Services, 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.
2.
The HANDS Treatment Protocol eliminates the need for sedating medications traditionally utilized for detoxification from alcohol, cocaine and other addictive stimulants. In addition to the problems associated with sedation, the most commonly utilized medications such as Valium® (diazepam), Ativan® (lorazepam), and Xanax® (alprazolam) can themselves pose a significant risk of addiction and require a time-intensive dose tapering and washout period.
3.
The completion rate for treatment for alcohol addiction using the HANDS Treatment Protocol has been 100% for all patients treated to date, compared to current detoxification procedures for alcohol that have a completion rate of 54%, according to SAMHSA.
4.
Treatment using the HANDS Treatment Protocol usually results in elimination of cravings and an improvement in cognition. Improved cognitive abilities, coupled with reduced or eliminated craving, can result in improved judgment and may be a factor in the reduced incidence of relapse compared to traditional therapies. Immediately following completion of treatment using the HANDS Treatment Protocol, most patients have reported no interest in drinking or using cocaine or other addictive stimulants.

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Our Strategy

     We generate revenues by charging fees to licensed healthcare providers for access to our proprietary protocols2021 and the right to use themthird in treating their patients, and for providing administrative management services in connection with the HANDS treatments. The administrative services we offer include providing on-site liaisons, client and hospital education, continuing care information, marketing and sales support, data collection and aggregation, patient registration and patient follow-up data collection.

     We intend to: (1) exploit our current proprietary, patented and patent-pending treatment technology by expanding the number of treatment sites that license our technology; (2) on behalf of healthcare providers licensing our technology, identify, market to and facilitate access to aftercare treatment centers; and (3) acquire, license, develop and bring to market new addiction treatment protocols via our own internal research and development as well as strategic alliances with major research institutes worldwide.

1.Expand the Number of Inpatient Treatment Sites

We currently have a multi-year contract with a hospital and drug addiction treatment facility in the greater Los Angeles area which is licensing and utilizing the HANDS Treatment Protocol™. For the year ended December 31, 2003, HANDS™ licensing fees from this hospital accounted for 100% of our revenues. Building upon our initial site in California, we intend to develop a system of licensees within the U.S. authorized to use the HANDS Treatment Protocol in treating addictions to alcohol, cocaine, and other addictive stimulants, 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 abuse patients.

2.Market to Aftercare Treatment Centers

The HANDS Treatment Protocol is designed not only to provide a rapid means for completing detoxification, but also to reduce or eliminate the patient’s cravings for alcohol or addictive stimulants. We believe this to be a critical first step which can accelerate the recovery process. We intend to identify treatment centers that focus on providing recovery-related aftercare, and to facilitate access to this care.

3.Develop New Addiction Treatment Protocols

Our goal is to bring new treatment protocols to market on an ongoing basis. We will seek to acquire or license new addiction 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 addiction treatment technologies. We believe that this research alliance strategy will seek to create, maintain and strengthen our position as a leader in addiction treatment technology.

Our Technology, Products and Services

     Our addiction treatment technology is based on studies and research on the adverse physical effects of addictions on the brain and the development of treatment technologies that specifically focus on detoxification and restoration of damaged neurons as a core part of addictive behavior modification, to minimize cravings for drugs and alcohol and improve the cognitive function of the patient. Our treatment protocols seek to restore damage to the brain caused by addiction. We have labeled this proprietary treatment protocol the HANDS Treatment Protocol™. Our products and services include the different treatment protocols for alcohol, cocaine and other addictive stimulants we license to hospitals and other healthcare providers. We also offer administrative services that we plan to make available to our clients, including provision of an on-site liaison, marketing and sales support, data collection and aggregation, patient registration and patient follow-up data collection.

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     The HANDS for Alcohol Protocol consists of:


  • administration of prescription medications during two days of treatment
  • amino acids
  • nutrients and vitamins
  • discharge medication prescription

    •      The HANDS for Stimulants Protocol consists of:

         Detoxification is completed following the first day of treatment. Cognitive enhancement and craving reduction and elimination are completed following the second and third day of treatment. The cognitive enhancement and craving reduction and elimination are surrogate markers for the physiological change and neurostabilization of the brain.

         The prescription medications used in the HANDS Protocols are FDA approved and readily available from a hospital or outside pharmacy. While our protocols call for the use of these prescription drugs for the treatment of chemical dependency and drug addiction, conditions not named in the drugs’ official labeling, licensed physicians are permitted to prescribe prescription drugs for off-label uses in the independent practice of medicine, and we therefore do not believe our protocols require FDA approval.

    Research and Development

         We intend to continually enhance our addiction 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 addiction.

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

    Sales and Marketing

         Substance dependency is a worldwide problem with dependency rates continuing to rise despite the efforts by national and local health authorities to curtail its growth. We will initially 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 hospital sites 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 Internet marketing, direct mail, and local sponsorship of professional education programs. On a national level, we will promote our proprietary brands through professional journal advertising, direct mail, Internet marketing, and sponsorship of educational programs. In addition to our goal of the HANDS Treatment Protocol™ becoming the 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 addiction treatment organizations and governmental organizations.

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         HANDS is currently used only for private pay patients, and no reimbursement is sought from Medicaid, insurance or other third-party reimbursement. In developing our marketing plan, we have taken into consideration the following market dynamics for our efforts:

    Traditional Payors

    1.Private Pay

    According to reports by SAMHSA, of persons aged 12 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 initially focus our efforts on targeted communication emphasizing that the cost effectiveness of treatment using the HANDS Treatment Protocol™ will provide private pay patients with a preferred alternate choice for treatment. We will communicate the benefits of the HANDS Treatment Protocol, which include a short-term inpatient treatment time of two or three consecutive days for alcohol, cocaine and other stimulant dependence. Compared to the typical 7 to 14 days of combined inpatient and washout period for sedative-based detoxification, use of the HANDS Treatment Protocol can significantly reduce the disruption to patients’ lives caused by treatment. Detoxification using the HANDS Treatment Protocol can easily be fit into a weekend or short absence from work. Further, the HANDS Treatment Protocol is designed to significantly improve aftercare compliance and success by reducing relapse rates.

    2.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, healthcare providers must demonstrate that use of the HANDS Treatment Protocol is a beneficial and cost effective treatment. We will, through our clinical and market research activities, gather and disseminate appropriate data to the payors that should validate the benefits and cost effectiveness of treatment using the HANDS Treatment Protocol. We believe the economic benefits provided by the HANDS Treatment Protocol include reduction in healthcare costs and improved membership retention, while providing positive medical outcomes. We plan to include or contract directly with disease state management providers in the design and conduct of our outcome studies.

    3.Medicaid

    We intend to solicit Medicaid endorsements of treatment using our protocols on a state-by-state basis utilizing outcomes data developed by our licensees. Based upon initial results, our HANDS Treatment Protocol can offer better outcomes than traditional approaches. To date, 100% of the patients treated by physicians using the HANDS Treatment Protocol for alcohol have completed treatment, compared to the national average of 54% for alcoholism.

    Other Payor Groups

    1.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 drug addiction. 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.

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

    3.Employers

    Many large employers are self-insured and use an insurance company as a third-party administrator to benefit claims. As such, these employers have a direct vested interest in reducing healthcare costs. According to most recent reports by ONDCP and NIAAA, productivity losses resulting from drug abuse in 2000 amounted to approximately $110 billion and productivity losses resulting from alcoholism was $134 billion 1998. We plan to educate and directly solicit large employers and employer coalitions. By communicating both employer coalitions and trade unions, we believe that treatment provided using the HANDS™ protocols can become the treatment of choice for substance abuse.

    4.Federal and State Governments

    We believe the U.S. Government will be a significant third-party payor as well as a potential referral source our customers. It finances TRICARE, CHAMPUS, the Veterans Administration hospital system, and drug abuse education and prevention programs. California’s Proposition 36 and Arizona’s Proposition 200 redirect the states’ priorities back towards rehabilitation as opposed to punishment, and may provide us an opportunity to work with both states’ criminal justice systems.

    Product Marketing

    We anticipate that our product marketing will be done in two ways:

         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™ treatment technologies. Additional target market campaigns may be accomplished via local publications, direct mail, seminars, forums, tradeshows, and email to generate referral sources and referrals.

    Public Relations

         The goal of our public relations program will be to promote awareness and generate leads from referral sources, healthcare professionals and organizations, government agencies, and end users. This may be done via press releases, endorsements, and media placement campaigns. The forms of media that will be targeted for placement will be local radio segments, print articles, internet postings, local, regional, and national television/radio 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.

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    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.

    Strategic Alliances

         The organizations listed below are indicative of the types of entities with whom we will seek to develop alliances. Developing such alliances will be an important component of our success when entering new markets, developing referral sources for our customers and growing market share.

    1.Residential Treatment Centers

    Most residential treatment centers rely on local hospitals to provide detoxification treatment for patients prior to admission to the residential program. We will seek to identify and provide information to these treatment facilities on behalf of our hospital affiliates and licensees to facilitate their ability to provide patients with the combined benefits of treatment using the HANDS Treatment Protocol™ and the residential aftercare program.

    2.Community-Based Clinics

    Community-based clinics, whose patients include families of abuse, drunk drivers, drug abusers, etc., are a regular source of referrals for hospitals. We will seek to educate these clinics on the value and benefits of our treatment methods. We believe that the relatively low treatment dropout rate and recidivism rate and greater compliance for our treatment protocols may offer a competitive advantage for the clinics that can offer their patients access to treatment using our protocol.

    3.Proprietary for Profit, Government, and Private Not-for-Profit Treatment Programs

    These types of organizations provide a variety of recovery treatment services. We will seek to enter into agreements with these organizations, pursuant to which we will license the HANDS Treatment Protocol and provide our services, including the facilitation of continuing care.

    Proprietary Rights and Licensing


    Our success depends upon a number of factors, includingin large part on 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 directors. In March 2003, we acquired the patent-pending treatment protocols for alcohol and cocaine, which we have branded the HANDS Treatment Protocol™. We have the followingOur branded trade names:


    ●OnTrak®;

  • HANDS™
    • ●eOnTrak®;

    ●PROMETA®.

  • The HANDS Patient Protocol™

  • HANDS Treatment Protocol™

    • We impose restrictions in our protocol license agreements on our customers’licensees’ 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 aconditiona 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.

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    Financial Information about Segments

    We manage and report our operations through two business segments: Healthcare and License and Management. The Healthcare segment includes the OnTrak integrated substance dependence solutions marketed to health plans, employers and unions. The License and Management services segment provides licensing, administrative and management services to licensees that administer PROMETA and other treatment programs, including a managed treatment center that is licensed and managed by us.

    Employees


    As of June 4, 2004,December 31, 2010, we employed a total of approximately 3233 persons. We anticipate hiring additional employees over the next yearare not a party to meet our growth expectations. With the exception of our executive officers, allany labor agreements and none of our employees are represented by a labor union.
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    PROPERTIES

    Information concerning our principal facilities, all of which were leased at will. Our chairman and chief executive officer, Terren S. Peizer, director and chief operating officer, Anthony M. LaMacchia, chief financial officer, Chuck Timpe, senior vice president of sales, James W. Elder, and senior vice president of medical affairs, David E. Smith, M.D. are each party to an employment agreement which, subject to termination for cause or good reason, has a term of four or five years. We have not experienced any problems in attracting and retaining desirable employees, and we believe our relationships with our employees are good.

    PROPERTY

    December 31, 2010, is set forth below:

    Location 
    		Use
    Approximate
    Area in
    Square Feet
    11150 Santa Monica Blvd.
    Los Angeles, California
    		Principal executive and administrative offices10,700
    1315 Lincoln Blvd.
    Santa Monica, California
    Medical office space for The Center to
    Overcome Addiction
    		2,700
    Surrendered Office Space
    1700 Montgomery St.
    San Francisco, California
    		Medical office space4,000
    Our principal executive offices, including all of our sales, marketing and administrative functions,offices are located in Los Angeles, California and consist of leased office space totaling approximately 10,700 square feet. The initial term of approximately 10,688 square feetthe lease expired in Los Angeles, California. TheDecember 2010. In December 2010, we amended and extended the lease commenced on December 15, 2003, and has an initialfor three years. Our base rent ofis currently approximately $33,000 per month, subject to annual adjustment over its seven-year term. adjustments, with aggregate minimum lease commitments at December 31, 2010, totaling approximately $1.2 million. Concurrent with the three year extension, the Board of Directors approved a sublease of approximately one-third of the office space to Reserva, LLC an affiliate of our Chairman and CEO. Reserva, LLC will pay our Company pro-rata rent during the three-year lease period.
    In April 2005 we entered into a five-year lease for approximately 5,400 square feet of medical office space in Santa Monica, California, which is occupied by The Center to Overcome Addiction, which operates under a full service management agreement with us. Our base rent was approximately $19,000 per month. In May 2009, we entered into an amendment to our lease for this facility calling for the deferral of a portion of the rent for a period of seven months. As a result of the amendment our rent was reduced by approximately $8,000 per month beginning June 1, 2009 and ending December 31, 2009. According to the terms of the agreement beginning January 1, 2010, the base rent and the deferred rent were due in installments with all rents to be paid prior to the termination of the lease in August 2010. In August 2010, with all base and deferred rents paid in full, we entered into another amendment to our lease for a six-month extension after which it converts to a month-to-month lease. At December 31, 2010, the minimum base rent for the medical office in Santa Monica including aggregate minimum lease commitments was approximately $10,700, subject to annual adjustment.

               In August 2006, our Company entered into a five-year lease agreement for approximately 4,000 square feet of medical office space for a company managed treatment center in San Francisco, CA.  Our Company ceased operations at the center in January 2008.  In the first quarter of 2009, our Company ceased making rent payments under the lease.  In March, 2010 our Company settled the outstanding lease commitment for $200,000 to be paid in monthly installments from March 2010 through February 2011. All payments under this settlement agreement have subsequently been paid in full.
    We believe this facility will bethat the current office space is adequate to meet our needs for the foreseeable future. As we expand, we may lease additional regional office facilities, as necessary, to service our customer base.

    needs.


    LEGAL PROCEEDINGS


    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 prospectus,report, 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.

    We are however involved in litigation (“Isaka Matter”) as described below.


    On or about August 18, 2006, plaintiffs Isaka Investments, Ltd., Sand Hill Capital International Inc. and Richbourg Financial Ltd. (the “Plaintiffs”) filed a complaint in the Los Angeles Superior Court, entitled Isaka Investments, Ltd., Sand Hill Capital International, Inc. and Richbourg Financial, Ltd. vs. Xino Corporation, an entity from which our Company had acquired certain assets, and a number of other additional individuals and entities, including our Company, our Company’s Chairman and Chief Executive Officer, Terren S. Peizer, and other members of the Company’s Board of Directors. The Board of Directors and other parties were dismissed by way of demurrer. In July 2007, Plaintiffs filed their second amended complaint, asserting causes of action for conversion, a request for an order to set aside an alleged fraudulent conveyance and breach of contract against our Company, Mr. Peizer, and others.   In August 2007, our Company and Mr. Peizer, among others, filed an answer to the second amended complaint denying liability and asserting numerous affirmative defenses.  In June 2008, our Company, Mr. Peizer, and others, filed a motion for summary judgment, or alternatively, summary adjudication, and in April 2009, the Court granted summary adjudication as to each cause of action and consequently summary judgment in favor of our Company and Mr. Peizer, among others.  The Plaintiffs appealed the summary judgment and in October 2010, the Court of Appeal reversed the trial court’s ruling.  The Court of Appeal’s decision was not on the merits, but rather provides that there are sufficient material issues of fact for the case to be tried.  The Court of Appeal issued a remittitur in December 2010, and Plaintiffs have filed a motion for leave to amend the second amended complaint, which motion our Company opposed.  We have had very limited discussion of settlement and our Company believes Plaintiffs’ claims are without merit and intends to continuously, and vigorously defend the case.
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    MARKET FOR OUR SECURITIES

    COMMON EQUITY


    Market Information

    and Dividend Policy


    Our common stock is listed for trading on the American Stock Exchange under the symbol “HTM.” Prior to December 15, 2003, the stock was quotedtraded on the OTC Bulletin Board. Following is a list by fiscal quarters ofBoard under the symbol “CATS.”  The following table summarizes, for the periods indicated, the high and low sales prices offor the stock:

      Sales Prices
    2004 High Low
    		 
    		 
    1st Quarter         $8.40         $4.13
           
    2003 High Low
    		 
    		 
    4th Quarter $7.50 $6.70
    3rd Quarter(2)(4) $7.10 $7.10
    2nd Quarter(2) $0.54 $0.52
    1st Quarter(3)  —  —
           
    2002  High  Low
    		 
    		 
    4th Quarter(2) $0.54 $0.50
    3rd Quarter(1)(2) $0.54 $0.54
    2nd Quarter(1)  —  —
    1st Quarter(1)  —  —

    39

    Notes to Stock Price Table:

    (1)
    		There were no trades reported on the OTCBB prior to September 27, 2002.
    (2)
    		Adjusted to reflect a 2.007 for one forward stock split on September 30, 2003, and rounded down to the next whole cent.

    Over-the-counter market quotations may reflect inter-dealer prices, without retail mark-up, mark-down or commissions and may not necessarily represent actual transactions.

    (3)
    		There were no trades reported on the OTCBB during this quarter.
    (4)
    		Hythiam, Inc. merged with the registrant on September 29, 2003. See “Background on the Merger” under “Selling Shareholders” on page 14. There were no trades reported on the OTCBB during this quarter prior to that date.

    On June 4, 2004, the last reported sale price of our common stock on the Amex was $4.00 per share.

    Holders and Dividends

         As of June 8, 2004, there were approximately 200 record holders and approximately 800 beneficial owners of our common stock.

    as reported to OTC:


      Closing Sales Prices 
    2011 High Low 
    1st Quarter $0.11 $0.04 
            
    2010 High Low 
    4th Quarter $0.11 $0.03 
    3rd Quarter  0.16  0.05 
    2nd Quarter  0.30  0.16 
    1st Quarter  0.58  0.22 
            
    2009 High Low 
    4th Quarter $0.77 $0.27 
    3rd Quarter  0.44  0.24 
    2nd Quarter  0.36  0.23 
    1st Quarter  0.68  0.18 

    We have never declared or paid any dividends. We may, as our boardBoard of directorsDirectors deems appropriate, continue to retain all earnings for use in our business or may consider paying dividends in the future.

    40

    SELECTED FINANCIAL DATA

         The following selected financial data is qualified by reference to, and should be read in conjunction with, the Financial Statements of the Company and related Notes thereto included in this prospectus and “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

    (In thousands, except per share amounts)   
         Period from 
         February 13, 
         2003 
         (Inception) 
      Three Months  through 
      ended March 31,  December 31, 
      2004  2003 
      
    		  
    		 
    STATEMENT OF OPERATIONS DATA      
    Revenues$67         $75 
    Operating expenses      
       General and Administrative      
          Salaries and benefits 1,288  1,617 
          Other expenses, including $568 and $337 related to stock-based payments 1,686  1,928 
       Depreciation and amortization 143  75 
      
    		  
    		 
          Total operating expenses 3,117  3,620 
      
    		  
    		 
    Loss from operations (3,050) (3,545)
    Interest income 40  41 
      
    		  
    		 
    Loss before provision for income taxes (3,010) (3,504)
      
    		  
    		 
    Provision for income taxes 2  — 
      
    		  
    		 
    Net loss$(3,012)$(3,504)
      
    		  
    		 
    Basic and diluted loss per share$(0.12)$(0.21)
      
    		  
    		 
    Weighted average shares outstanding 24,613  16,888 
      
    		  
    		 
    CASH FLOW STATEMENT DATA      
    Net cash used in operating activities$(2,408)$(1,675)
    Net cash provided by (used in) investing activities 634  (16,226)
    Net cash provided by financing activities —  21,345 
           
           
    BALANCE SHEET DATA (as of March, 31, 2004 and December 31, 2003)      
    Cash and cash equivalents$1,670 $3,444 
    Total current assets 14,711  17,344 
    Total assets 20,135  22,580 
    Total liabilities 2,065  2,092 
    Stockholders’ equity 18,070  20,488 

    Note:Corresponding comparative information


    Securities Authorized for the period ended March 31, 2003 is not included because it was immaterial for the prior period and would provide no useful information to the investor since business activity had not yet commenced.

    41

    Issuance Under Equity Compensation Plans
       
    Number of
    securities to be
    issued upon
    exercise of
    outstanding
    options, warrants
    and rights (a)
    		   
    Weighted-average
    exercise price of
    outstanding
    options, warrants
    and rights (b)
    		  Number of
    securities
    remaining
    available for
    future issuance
    under equity
    compensation
    plans [excluding
    securities
    reflected
    in column (a)]
    		 
    Equity Compensation plans approved by         
    security holders  207,914,510  $0.07   22,190,886 
    Equity Compensation plans not approved            
    by security holders  -   -   - 
    Total  207,914,510  $0.07   22,190,886 
    27

    MANAGEMENT’S DISCUSSION AND ANALYSIS OF
    FINANCIAL
    CONDITION AND RESULTS OF OPERATIONS

    General

    We are a healthcare services company, providing through our Catasys Health subsidiary specialized behavioral health management services for substance abuse to health plans, employers and unions through a network of licensed and company managed health care providers.  The following discussionOnTrak substance dependence program was designed to address substance dependence as a chronic disease. The program seeks to lower costs and improve member health through the delivery of integrated medical and psychosocial interventions in combination with long term “care coaching,” including our proprietary PROMETA® Treatment Program. The PROMETA Treatment Program, which integrates behavioral, nutritional, and medical components, is also available on a private-pay basis through licensed treatment providers and company managed treatment centers that offer the PROMETA Treatment Program, as well as other treatments for substance dependencies.

    Our Strategy

    Our business strategy is to provide a quality, integrated medical and behavioral program to help organizations treat and manage substance dependent populations to impact total healthcare costs associated with members with a substance dependence diagnosis. We intend to grow our business through increased adoption of our financial conditionOnTrak integrated substance dependence solutions by managed care health plans, employers, unions and other third-party payors.

    Key elements of our business strategy include:

    ●
    		Demonstrating the potential for improved clinical outcomes and reduced cost associated with using our OnTrak programs with key managed care and other third-party payors;

    ●
    		Educating third-party payors on the disproportionately high cost of their substance dependent population;

    ●
    		Providing our Catasys integrated substance dependence solutions to third-payors for reimbursement on a case rate, monthly fee, savings generated or a combination thereof; and

    ●
    		Generate outcomes data from our OnTrak program to demonstrate cost reductions and utilization of this outcomes data to facilitate broader adoption.

    Reporting

    In 2010 we changed the names of our reporting segments. We manage and report our operations through two business segments: healthcare services and license and management services. The healthcare services (previously behavioral services) segment includes OnTrak and its integrated substance dependence solutions marketed to health plans, employers and unions through a network of licensed and company managed healthcare providers. The license and management (previously healthcare services) segment provides licensing, administrative and management services to licensees that administer the PROMETA Treatment Program and other treatment programs, including a managed treatment center that is licensed and managed by us. In 2009, we revised our segments to reflect the disposal of our interest in Comprehensive Care Corporation (CompCare). Our behavioral health managed care services segment, which previously had been comprised entirely of the operations of CompCare, is now presented in discontinued operations and is not a reportable segment (see Note 12— Discontinued Operations). Catasys operations were previously reported as part of behavioral health, but is now segregated and reported separately in healthcare services. Prior years have been restated to reflect this revised presentation. Most of our consolidated revenues and assets are earned or located within the United States

    Discontinued Operations

    In January, 2009 we sold our interest in our controlled subsidiary CompCare, a behavioral health managed care company in which we had acquired a majority controlling interest in January 2007, for aggregate gross proceeds of $1.5 million. We recognized a gain of approximately $11.2 million from the sale of our CompCare interest, which is included in discontinued operations in our consolidated statement of operations for the year ended December 31, 2009.
    28
    Results of Operations

    Table of Summary Financial Information

    The table below and the discussion that follows summarize our results of operations should be read in conjunction with our financial statements and the related notes, and the other financial information included in this prospectus.

    Forward-Looking Statements

    The forward-looking comments contained in the following discussion involve risks and uncertainties. Our actual results may differ materially from those discussed here due to factors such as, among others, limitedcertain selected operating history, difficulty in developing, exploiting and protecting proprietary technologies, intense competition and substantial regulation in the healthcare industry. Additional factors that could cause or contribute to such differences can be found in the following discussion, as well as under the “Risks Factors” heading beginning on page 3.

    Overview

    Hythiam Inc. is a healthcare services management company formedstatistics for the purpose of researching, developing, licensing and commercializing technologies designedlast two fiscal years (amounts in thousands):


    CATASYS, INC. AND SUBSIDIARIES
    CONSOLIDATED STATEMENTS OF OPERATIONS
      Twelve Months Ended 
    (In thousands, except per share amounts) December 31, 
      2010  2009 
    Revenues      
    Healthcare services revenues $28  $- 
    License & Management revenues  420   1,530 
    Total revenues $448  $1,530 
             
    Operating expenses        
    Cost of healthcare services  255   509 
    General and administrative  12,784   18,034 
    Impairment losses  -   1,113 
    Depreciation and amortization  882   1,248 
    Total operating expenses  13,921   20,904 
             
    Loss from operations  (13,473)  (19,374)
             
    Interest and other income  131   941 
    Interest expense  (1,025)  (1,142)
    Loss on extinguishment of debt  -   (330)
    Gain on the sale of marketable securities  696   160 
    Other than temporary impairment of marketable securities  -   (185)
    Change in fair value of warrant liability  (6,303)  341 
    Loss from continuing operations before provision for income taxes  (19,974)  (19,589)
    Provision for income taxes  22   18 
    Loss from continuing operations $(19,996) $(19,607)
             
    Discontinued Operations:        
    Results of discontinued operations, net of tax  -   10,449 
             
    Net income (loss) $(19,996) $(9,158)
             
    Basic and diluted net income (loss) per share:        
    Continuing operations $(0.23) $(0.34)
    Discontinued operations  -   0.18 
    Net income (loss) per share $(0.23) $(0.16)
             
    Weighted number of shares outstanding  86,862   57,947 
    The accompanying Notes to improve the treatment of alcoholism and drug addiction. Our HANDS Treatment ProtocolTM is designed for use by healthcare providers to treat addictions to alcohol, cocaine and other addictive stimulants, as well as combinationsConsolidated Financial Statements are an integral part of these drugs. HANDSTM is a medically supervised treatment protocol for neurostabilization and detoxification from alcohol and/or addictive psychostimulants designedstatements.

    Summary of Consolidated Operating Results

    As we continue to simultaneously eliminate cravings, enhance cognitive function and facilitate a pain-free withdrawal, resulting in accelerated recovery.

         We are a development-stage company, have been unprofitable sincestreamline our inception and expect to incur substantial additional operating losses for at least the foreseeable future 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.

         From inception through March 31, 2004, we have recognized license fee revenues for a limited number of patients who have been treated at Little Company of Mary–San Pedro Hospital using the HANDS Treatment Protocol. In November 2003 we signed a three-year contract with that hospital, and in May 2004 signed a contract with Lake Chelan Community Hospital of Washington. We intend to enter into similar agreements with additional hospitals and licensed healthcare providers and increase the number of patients treated.

    Wefocus on managed care opportunities for our Catasys product offerings, actions we have devoted substantially alltaken to reduce expenses have led to continued declines in loss from operations in our continuing operations, compared to prior years. Our decision to exit markets that were not profitable and make significant reductions in field and regional sales personnel in our licensing operations, the curtailment of our cash resources to datemanaged treatment center operations (including terminating the management services agreements associated with our managed treatment center in Dallas, Texas) and the shut-down of our international operations have resulted in lower revenues compared to the paymentprior years.

    29

     Loss from continuing operations before provision for taxes for the twelve months ended December 31, 2010 amounted to $20.0 million compared to $19.6 million for the twelve months ended December 31, 2009. Overall the loss from continuing operations increased by $385,000, however there were improvements in cost primarily due to the following:

    ·Decrease in general and administrative expenses by $5.2 million due to the streamlining of operations during 2009 and 2010.
    ·There were no impairment losses in 2010 compared to $1.1 million in 2009. The 2009 amount was due to $758K in fixed assets impairments and $356K in intangible assets impairments, there were no such impairments in 2010.
    ·There were no other than temporary impairment of marketable securities for the year-ended December 31, 2010 compared to $185,000 for the year-ended December 31, 2009, due to the redemption of all Auction Rate Securities during 2010.
    ·Interest expense decreased by $117,000 and cost of healthcare services also decreased by $254,000.
    These improvements were offset by a $1.1 million decline in revenue due to streamlining of salariesour license and benefits, legalmanagement services operations as we continue to increase our focus on managed care opportunities and professionalreposition ourselves in the marketplace. Additionally, these improvements were offset by a loss due to change in warrant liabilities of $6.3 million compared to a gain of $341,000 in 2009.The decline in total revenues resulted mainly from the impact of streamlining of our healthcare services operations during 2009 and other general2010 to increase our focus on managed care opportunities, including the elimination of field andadministrative expenses. During 2003 regional sales personnel and through Marchtermination of our management services agreement associated with our managed treatment center in Dallas, Texas.

    Included in the loss from continuing operations before provision for taxes for the year ended December 31, 2004, we used approximately $42010 and December 31, 2009 were consolidated non-cash charges for depreciation and amortization expense of $882,000 and $1.3 million, there was no loss on extinguishment of debt for the year-ended December 31, 2010 compared to $330,000 in operations2009 and approximately $3share-based compensation expense of $5.0 million in capital expenditures and acquisition$4.6 million, for 2010 and 2009 respectively.

    In 2010, our loss before provision for income taxes also included a $696,000 gain on sale of intellectual property, leaving a balance of approximately $14 million in cash and marketable securities at March 31, 2004. As we implement commercial operations and allocate significant and increasing resourcescompared to sales, marketing and other start-up activities, we expect our monthly cash operating expenditures to increase to an average$160,000 in 2009.  In addition, the 2009 loss after provision for income taxes included a $10.4 million gain on sale of approximately $1.1 million per month for the remainderCompcare.

    Reconciliation of 2004, excluding operating costs related to planned treatment sites.

         We may seek to raise additional funding through public or private financing or through collaborative arrangements with strategic partners. We may also seek to raise additional capital through public or private placement of shares of preferred or common stock, in order to increase the amount of our cash reserves on hand.

    Our Offices

    We are incorporated under the laws of the State of Delaware. Our principal executive offices are located at 11150 Santa Monica Boulevard, Suite 1500, Los Angeles, California 90025, and our telephone number is (310) 444-4300. Our website is located at www.hythiam.com. Information contained on our website is not incorporated by reference into this report and you should not consider information on our website a part of this report.

    42

    Segment Results of Operations

         During the period from February 13, 2003 (Inception) to March 31, 2003, we had not commenced any business activities.


    The following table presentssummarizes and reconciles the loss from operations of our reportable segments to the loss before provision for income taxes from our consolidated statements of operations data for each of the quarters from inception through 2003 year end, and unaudited information for the quarteryears ended MarchDecember 31, 2004. We believe that all necessary adjustments have been included to present fairly2010 and 2009:
    (In thousands)For the year ended December 31, 
     2010  2009 
           
    License and management services$(17,116) $(15,642)
    Healthcare services (2,272)  (3,947)
    Loss from continuing operations before       
    provision for income taxes$(19,388) $(19,589)
    30
    License and Management Services

    The following table summarizes the quarterly information when read in conjunction with our annual financial statements and related notes. The operating results for any quarter are not necessarily indicative ofhealthcare services for the results for any subsequent quarter.

       Quarter Ended   
             
     June 30, September 30, December 31, March 31, 
     2003 2003 2003 2004 
     
    		 
    		 
    		 
    		 
     (in thousands, except per share amounts) 
    Revenues$—     $44     $31     $67 
    Operating expenses            
       General and administrative            
          Salaries and benefits 63  364  1,190  1,288 
          Other expenses 138  515  1,275  1,686 
    Depreciation and amortization —  9  66  143 
     
    		 
    		 
    		 
    		 
    Loss from operations (201) (844) (2,500) (3,050)
    Interest income —  3  38  40 
    Loss before provision for            
       income taxes (201) (841) (2,462) (3,010)
    Provision for income taxes —  —  —  2 
     
    		 
    		 
    		 
    		 
    Net loss$(201)$(841)$(2,462)$(3,012)
     
    		 
    		 
    		 
    		 
    Basic and diluted loss per share$(0.02)$(0.06)$(0.13)$(0.12)
     
    		 
    		 
    		 
    		 

    years ended December 31, 2010 and 2009:

    (In thousands, except patient treatment data)For the year ended December 31, 
     2010  2009 
    Revenues     
    U.S. licensees$150  $559 
    Managed treatment centers 270   837 
    Other revenues -   134 
    Total healthcare services revenues$420  $1,530 
            
    Operating expenses       
    Cost of healthcare services$255  $509 
    General and administrative expenses       
    Salaries and benefits 8,029   5,443 
    Other expenses 1,869   9,485 
    Research and development -   - 
    Impairment losses -   355 
    Depreciation and amortization 882   1,165 
    Total operating expenses$11,035  $16,957 
            
    Loss from operations$(10,615) $(15,427)
    Interest and other income 131   941 
    Interest expense (1,025)  (1,142)
    Loss on extinguishment of debt -)  (330 
    Gain on the sale of marketable securities 696   160 
    Other than temporary impairment on marketable securities -   (185)
    Change in fair value of warrant liabilities (6,303)   341 
    Loss before provision for income taxes$(17,116) $(15,642)
            
    PROMETA patients treated       
    U.S. licensees 35   117 
    Managed treatment centers 24   85 
    Other -   11 
      59   213 
            
    Average revenue per patient treated (a)
    		       
    U.S. licensees$4,281  $4,386 
    Managed treatment centers 6,592   6,196 
    Other -   - 
    Overall average 5,221   5,511 
            
    (a)  The average revenue per patient treated excludes administrative fees and other non-PROMETA patient revenues.
    31
    Year Ended December 31, 2010 Compared to Year Ended December 31, 2009

    Revenues

    Revenues

    Revenue decreased by $1.1 million in the year ended December 31, 2010 compared to the same period in 2009,  primarily due to our decision to streamline our operations and focus on managed care opportunities in our healthcare segment. We have a limited history of operations, have not yet commenced substantial marketing activities,exited unprofitable territories and have not generatedmade significant revenues from operations. From inception through March 31, 2004, we have recognized license fee revenues for a limited number of patients who have been treated at Little Company of Mary–San Pedro Hospital using the HANDS Patient Protocol. In November 2003 we signed a three-year contract with that hospital formalizing the previous arrangementsreductions in field and setting forth the terms ofregional sales personnel in our licensing agreement,operations, decreased advertising curtailed our managed treatment center operations (including terminating the management services agreements associated with our managed treatment center in Dallas, Texas). These actions resulted in a decline in licensed sites contributing to revenue and in May 2004 signed a five-year contract with Lake Chelan Community Hospital of Washington. These contracts provide for the licensing of our proprietary treatment protocols and the provision of additional services, including data collection and reporting and marketing services. Our combined fees for the licensed technology and services are set on a per patient basis. As we implement commercial operations and allocate significant and increasing resources to sales and marketing, we intend to enter into similar agreements with additional hospitals and licensed healthcare providers and increase the number of patients treated.

    We generate revenues from fees that we charge to hospitals, healthcare facilities and other healthcare providers that license our HANDSTM protocols. Revenues are generally related to the number of patients treated. Key indicators of our financial performance in the future will be theThe number of facilities and healthcare providerslicensed sites that will contract with uscontributed to license our technologyrevenues in 2010 decreased from 29 to 14 and the number of patients that are treated decreased by those providers using72% in 2010 compared to 2009. The change in average revenue per patient treated at U.S. licensed sites and managed treatment centers was insignificant between 2010 and 2009.


    Cost of Healthcare Services

    Cost of healthcare services consists of royalties we pay for the HANDS protocols. Asuse of the date ofPROMETA Treatment Program, and costs incurred by our consolidated managed treatment center for direct labor costs for physicians and nursing staff, continuing care expense, medical supplies and treatment program medicine costs. The decrease in these costs reflects the decrease in revenues from this prospectus we had two hospitals under contract with a limited number of patients treated usingtreatment center.

    General and Administrative Expenses

    General and administrative expense amounted to $9.9 million for the HANDS protocols.

    Expenses

    We have devoted substantiallyyear ended December, 31, 2010, includes share-based compensation expense, compared to $14.9 million for the same period in 2009. Excluding such costs, total general and administrative expense decreased by $5.0 million in 2010 when compared to 2009. The decrease was due to reductions in all of our resourcesexpense categories, but primarily due to the payment of salaries and benefits legal and professionaloutside services, resulting from the continued streamlining of operations to focus on managed care opportunities in our healthcare services, formerly behavioral health segment.


    Research and Development and Pilot Programs

    No research and development expense was recognized during 2009 and 2010.

    Impairment Losses

    There were no impairment charges recorded for the year ended December 31, 2010, compared to $355,000 for the year ended December 31, 2009. The impairment was due to impairment testing performed on intellectual property related to additional indications for the use of the PROMETA Treatment Program that was non-revenue generating.

    Interest and Other Income

    Interest and other income for the year ended December 31, 2010 decreased by $810,000 compared to the same period in 2009 due to decreases in the invested balance of marketable securities and settlement of the Put Option associated with the redemption of Auction Rate Securities (ARS).

    Interest Expense

    Interest expense for the year ended December 31, 2010 decreased by $117,000 compared to the same period in 2009 due lower average debt balances following the UBS line and Highbridge debt payoff in June and July 2010, respectively.

    Losses from Extinguishment of Debt

    We recognized no losses on extinguishment of debt during the year ended December 31, 2010 compared to $330,000 in 2009 resulting from pay-downs of $1.4 million and $318,000 on our senior secured note in February and September 2009, respectively. Such losses included accelerated amortization of debt discount totaling $208,000 for the year ended December 31, 2009.

    Gain on the Sale of Marketable Securities

    As of December 31, 2010 all our ARS was redeemed at par by the issuer, resulting in proceeds of approximately $10.2 million and a gain of approximately $696,000 compared to a gain of $160,000 in 2009.
    32
    Change in Fair Value of Warrant Liabilities

    We issued warrants of our common stock in November 2007, September 2009, July 2010, October 2010, November 2010 and the amended and restated senior secured note in July 2008. The warrants are being accounted for as liabilities in accordance with Financial Accounting Standards Board (FASB) accounting rules, due to provisions in some warrants that protect the holders from declines in our stock price and a requirement to deliver registered shares upon exercise of the warrants, which is considered outside our control.  The warrants are marked-to-market each reporting period, using the Black-Scholes pricing model, until they are completely settled or expire.

    The change in fair value of the warrants amounted to a net loss of $6.3 million for the year ended December 31, 2010, compared to a net gain of $341,000 for the same period in 2009.

    Healthcare Services

    The following table summarizes the operating results for behavioral health for the years ended December 31, 2010 and 2009:

      For the year ended 
    (in thousands) December 31, 
      2010  2009 
           
    Revenues $28  $- 
            
    Operating Expenses     
    General and administrative expenses       
    Salaries and benefits $2,145  $2,651 
    Other expenses  155   455 
    Impairment charges  -   758 
    Depreciation and amortization  -   83 
    Total operating expenses $2,300  $3,947 
             
    Loss before provision for income taxes $(2,272) $(3,947)
    Year Ended December 31, 2010 Compared to Year Ended December 31, 2009

    Revenues

    There were no revenues in 2009, as the first OnTrak contract was not launched until 2010. 2010 revenue reflects only one program with an employer. As of December 2010, two health plan contracts were signed covering significantly bigger populations than in 2009 and we expect to start producing revenue by the second half of 2011.  In addition, a Massachusetts based Plan was signed in April 2011.
    General and Administrative Expenses

    Total general and administrative expenses duringdecreased by $806,000 in 2010 when compared to 2009, due mainly to a $506,000 decrease in salaries, a $175,000 decline in other general expenses, and a $125,000 reduction in consulting and outside services expense.

    Impairment Losses

    There were no impairment losses recorded in 2010, compared to $758,000 in 2009. The 2009 impairment was due to an impairment analysis performed on the carrying values of software related to our start-up period. Indisease management program, which were deemed irrecoverable and were fully impaired. 
    33
    Depreciation and Amortization

    Depreciation and amortization for the quarteryear ended MarchDecember 31, 2004, our total operating expenses were approximately $3.1 million,2009 consisted of which $1.3 million was attributable to salaries and benefits. We expect salaries and benefit costs to continue to increase by 10 to 15% per quarter as we add staff to support our anticipated growth. Rent expense increased by $53,000 over the prior quarter as a resultdepreciation of the commencement of our new office lease atcapitalized software prior to the beginning of the quarter. Accounting, auditing and legal fees increased by $128,000 from the prior quarter primarily due to costs related to completing our annual audit and filing our annual report on Form 10-K and this registration statementimpairment discussed above. There was no depreciation during the quarter ended March 31, 2004.

    43

         We have also expended approximately $2.4 millionsame periods in lease build-out costs, computer hardware and software costs, telephone and communication systems, office furniture and other office equipment in connection with the opening of our corporate offices in new lease space. We have invested in the infrastructure we believe we will need, both in management as well as systems and equipment, to develop, market and implement our business plan.

    2010.


    LIQUIDITY AND CAPITAL RESOURCES

    Liquidity and Capital Resources

         We have financed our operations since inception primarily through the saleGoing Concern


    As of shares of our stock. Last yearApril 8, 2011 we received net proceeds of approximately $21 million from the private placement of equity securities. During 2003 and through March 31, 2004, we used approximately $4 million in operations and approximately $3 million in capital expenditures and acquisition of intellectual property, leavinghad a balance of approximately $14$2.3 million cash on hand. We had a working capital of approximately $1.5 million at December 31, 2010. We have incurred significant net losses and negative operating cash flows since our inception. We could continue to incur negative cash flows and net losses for the next twelve months. Our current cash burn rate is approximately $450,000 per month, excluding non-current accrued liability payments. We expect our current cash resources to cover expenses into September, 2011.

    In July 2010 we closed on $2 million of a registered direct financing with certain institutional investors which represented $1.7 million in cash, cash equivalentsnet proceeds to our Company.
    In October 2010, we entered into Securities Purchase Agreements with accredited investors, for $500,000 of 12% senior secured convertible notes (the “Bridge Notes”) and marketable security investments at March 31, 2004.

         Since we are a developing business, our prior operating costs are not representativewarrants to purchase shares of our expected on-going costs. common stock.


    In November 2010, our Company completed a private placement with certain accredited investors for gross proceeds of $6.9 million (the “Offering”). Of the gross proceeds, $503,000 represented the exchange of the Bridge Notes and accrued interest and $215,000 represented the cancellation of an accrued compensation liability to our Chairman and CEO. Our Company incurred approximately $364,000 in financial advisory, legal and other fees in relation to the offering. In addition, our Company issued warrants to purchase 5,670,000 shares of common stock at an exercise price $.01 per share to the financial advisors. Our Company issued 100,000,000 shares of common stock at a price of $0.01 per share and sold $5.9 million in aggregate principal of 12% senior secured convertible notes (the “Notes”) to the investors on a pro rata basis. The Notes were to mature on the second anniversary of the closing.  The Notes were secured by a first priority security interest in all of our Company’s assets. The Notes and any accrued interest convert automatically into common stock either (a) if and when sufficient shares become authorized or (ii) upon a reverse stock split at a conversion price of $0.01 per share, subject to certain adjustments, including certain share issuances below $0.01 per share. Our Company agreed to use its best efforts to file a proxy statement seeking shareholder approval to increase the number of authorized shares or effect a reverse stock split within 30 days of closing. Our Company filed a proxy statement in January 2011 and the stockholders approved both proposals listed above and the Board of Directors decided to implement the increase in authorized shares of common stock. Our Company filed an amendment to its Certificate of Incorporation, effective March 17, 2011, which increased the authorized shares of common stock and the Notes with accrued interest automatically converted to common stock. In addition, each non-affiliated investor in the Offering investing $2,000,000 or more also received five-year warrants to purchase an aggregate of 21,960,000 shares of our Company common stock at an exercise price of $0.01 per share. One investor received such warrants. The net cash proceeds to our Company from the Offering were estimated to be $6.4 million inclusive of the October transaction and after offering expenses.

    Our ability to fund our ongoing operations and continue as a going concern is dependent on signing and generating revenue from new contracts for our Catasys managed care programs and the success of management’s plans to increase revenue and continue to control expenses. We are currently in the process of implementing our recent Catasys contracts in Nevada, Kansas, and Massachusetts, and we expect these contracts to become operational in the second quarter of 2011. Over the last two years, management took actions that have resulted in reduced annual operating expenses.  We have renegotiated certain leasing and vendor agreements to obtain more favorable pricing and to restructure payment terms with vendors, and have paid some expenses through the issuance of common stock. In the fourth quarter of 2010 and the first quarter of 20042011, management has reduced cost through new lease arrangements on its corporate headquarters and streamlining personnel and other operating costs. These reductions have been somewhat offset by increased expenditures related to contract implementations. We anticipate increasing the number of personnel and incurring additional operating costs during 2011 to service our contracts as they become operational. During the year ended December 31, 2010, we settled, through the issuance of common stock, approximately $1.2 million of liabilities. In previous periods, we have focused on completing the hiring ofexited markets for our senior management team and supporting staff, andlicensee operations that we have begun to devote resources to marketing and business development. As we implement commercialdetermined would not provide short-term profitability. We may exit additional markets for our licensee operations and allocate significantfurther curtail or restructure our managed treatment center to reduce costs.
    34
    In addition, we and increasing resourcesour Chief Executive Officer are party to sales, marketinga litigation in which the plaintiffs assert causes of action for conversion, a request for an order to set aside fraudulent conveyance and breach of contract. While we believe the plaintiffs’ claims are without merit and we intend to continue to vigorously defend the case, there can be no assurance that the litigation will be resolved in our favor. If this case is decided against us or our Chief Executive Officer, it may cause us to pay substantial damages, and other start-uprelated fees. Regardless of whether this litigation is resolved in our favor, any lawsuit to which we are a party will likely be expensive and time consuming to defend or resolve. Costs of defense and any damages resulting from litigation, a ruling against us or a settlement of the litigation could have a significant negative impact our liquidity, including our cash flows. Please see “Item 3 Legal Proceedings” for more information.

    Cash Flows

    We used $8.4 million of cash for continuing operating activities we expect our monthlyduring the year ended December 31, 2010 compared to $13.4 million of cash for continuing operating expendituresactivities during the same period last year. Use of funds in 2004 to increase to an averageoperating activities include general and administrative expense (excluding share-based compensation expense), and the cost of healthcare services revenue, which totaled approximately $1.1$5.3 million per month for the remainder ofyear ended 2010, compared to $6.4 million for the same period in 2009. This decrease in net cash used reflects the decline in such expenses from our efforts to streamline operations.
    Capital expenditures for the year excluding operating costs related to planned treatment sites.

         In the first quarter we expended approximately $300,000 to complete the build-out, furnishing and equipping of our new corporate offices. We plan to spend approximately $800,000 in additional capital expenditures in 2004 as we increase our staff, purchase equipment and develop information systems for new treatment sites opened by licensees. We continue to invest in the infrastructure we believe we will need, both in management as well as systems and equipment, to develop, market and implement our business plan.

    ended 2010 were not material. Our future capital expenditure requirements will depend upon many factors, including progress with our marketing our technologies,efforts, the time and costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims and other proprietary rights, the necessity of, and time and costs involved in obtaining, regulatory approvals, competing technological and market developments, and our ability to establish collaborative arrangements, effective commercialization, marketing activities and other arrangements. We expect to continue to incur negative cash flows and net losses for at least the next twelve months. Based upon


    As discussed above, our current plans we believe that our existing capital resources will be sufficientcall for expending cash at a rate of approximately $450,000 per month, excluding non-current accrued liability payments. We also anticipate cash inflow to meet our operating expenses and capital requirements until we achieve profitability. However, changes in our business strategy, technology development or marketing plans or other events affecting our operating plans and expenses may resultincrease in the expendituresecond half of existing2011 as we implement our recently executed contracts. However, there can be no assurance that these contracts will produce cash beforeand we expect our current cash resources to cover expenses through September 2011. We will need to seek additional sources of capital at such time and there is no assurance that time. If this occurs, our ability to meet our cash obligations as they become due and payable will depend on our ability to sell securities, borrow funds or some combination thereof. We may not be successful in raising necessary funds on acceptable terms, or at all.

         We may seek to raise additional funding through public or private financing or through collaborative arrangements with strategic partners. We may also seek to raise additional capital through publiccan be raised in an amount which is sufficient for us or private placementon terms favorable to our stockholders.

    Senior Secured Note
    In January 2007, we entered into a securities purchase agreement pursuant to which we sold to Highbridge International LLC (Highbridge) (a) $10 million original principal amount of a senior secured note and (b) warrants to purchase up to approximately 250,000 shares of preferred orour common stock in order(adjusted to increase the amount of our cash reserves on hand.

    44

    Contractual Obligations and Commercial Commitments

         The following table sets forth a summary of our material contractual obligations and commercial commitments285,185 shares as of December 31, 2003:

         Less than        More than 
    Contractual Obligations Total  1 year  1 - 3 years  3 - 5 years  5 years 
    		 
    		  
    		  
    		  
    		  
    		 
    Operating lease obligations (1)    $2,992,000      $392,000      $822,000      $874,000      $904,000 
    Lease build-out/furniture and equipment                
       commitments (2)  333,000  333,000  —  —  — 
      
    		 
    		 
    		 
    		 
    		 
      $3,325,000 $725,000 $822,000 $874,000 $904,000 
      
    		 
    		 
    		 
    		 
    		 
    (1)
    		Operating lease commitment for our corporate office lease, including deferred rent liability, as more fully described in Note 9 to the financial statements included in this prospectus.
    (2)
    		Commitments of approximately $333,000 in the first quarter 2004 for completion of lease build-out costs, computer hardware and software costs, telephone and communication systems, office furniture and other office equipment in connection with the relocation of our corporate offices to new lease space.

    Off-Balance Sheet Arrangements

    2007). The note bore interest at a rate of prime plus 2.5%, interest payable quarterly commencing in April, 2007, and originally matured in January, 2010, The note was redeemable at our option anytime prior to maturity at a redemption price ranging from 103% to 110% of the principal amount during the first 18 months and was originally redeemable at the option of Highbridge beginning in July, 2008. We paid $5 million in principal under this note through the issuance of common stock in conjunction with a financing in 2007.


    In August, 2009, we amended and restated the senior secured note with Highbridge to extend the maturity date from January 15, 2010 to July 15, 2010, and Highbridge agreed to give up its optional redemption rights. We also committed to exercising our right to sell our ARS in accordance with the terms of the rights offering by UBS, who sold them to us, and use the proceeds from the sale to redeem the note and to provisions that we would use a portion of any capital raised to redeem the note. We also amended all 1.8 million warrants that had been previously issued to Highbridge to purchase shares of our common stock, to change the exercise price to $0.28 per share, and extend the expiration date to five years from the amendment date. In July 2010, we paid off the outstanding balance of the note from the net proceeds of the ARS redemptions (see below).
    35
    During the year ended December 31, 2010, we issued common stock which triggered an anti-dilution adjustment to the 1.3 million warrants associated with the 2008 amended and restated senior and secured note held by Highbridge LLC. The adjustment resulted in an increase to the number of warrants outstanding in the amount of  1,960,000 and a decrease in the exercise price from $0.28 to $0.11 per share. We paid this note in full upon maturity in July 2010.

    UBS Line of Credit

    In May 2008, our investment portfolio manager, UBS, provided us with a demand margin loan facility collateralized by our ARS, which allowed us to borrow up to 50% of the UBS-determined market value of our ARS.

    In October 2008, UBS made a “Rights” offering to its clients pursuant to which we were entitled to sell to UBS all ARS held in our UBS account, which we accepted. As part of the offering, UBS provided us a line of credit (replacing the demand margin loan), subject to certain restrictions as described in the prospectus, equal to 75% of the market value of the ARS, until they are purchased by UBS.. Loans under the line of credit were subject to a rate of interest based upon the current 90-day U.S Treasury bill rate plus 120 basis points, payable monthly and were carried in short-term liabilities on our  Consolidated Balance at December 31, 2009. As of MarchJune 30, 2010 all ARS were redeemed at par and the line of credit was paid in full.

    OFF BALANCE SHEET ARRANGEMENTS

    As of December 31, 20042010, we had no off-balance sheet arrangements.


    CRITICAL ACCOUNTING ESTIMATES

    Critical Accounting Estimates

    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 (GAAP). GAAP 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. On an on-going basis, we evaluate the appropriateness of our estimates and we maintain a thorough process to review the application of our accounting policies. Our actual results may differ from these 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. We have 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 our Board of Directors. We believe our accounting policies related to share-based compensation expense, the impairment assessments for intangible assets, valuation of marketable securities and estimation of the fair value of warrant liabilities involve our most significant judgments and estimates that are material to our consolidated financial statements. They are discussed further below.

    Share-based compensation expense

    We account for the issuance of stock, stock options and warrants for services from non-employees based on an estimate of the fair value of options and warrants issued using the Black-Scholes pricing model. This model’s calculations include the exercise price, the market price of shares on grant date, weighted average assumptions for risk-free interest rates, expected life of the option or warrant, expected volatility of our stock and expected dividend yield.
    36

    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 based on the historical volatility of our stock, measured over a period generally commensurate with the expected term. If we were to use a different volatility than the actual volatility of our stock price, there may be a significant variance in the amounts of share-based expense from the amounts reported. Based on the 2010 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%. The weighted average expected option term for 2010 and 2009 reflects the application of the simplified method set out in SEC Staff Accounting Bulletin No. 107, which defines the life as the average of the contractual term of the options and the weighted average vesting period for all option tranches.

    From time to time, we have retained terminated employees as part-time consultants upon their resignation from our Company. Because the employees continued to provide services to us, their options continued to vest in accordance with the original terms. Due to the change in classification of the option awards, the options were considered modified at the date of termination. The modifications were treated as exchanges of the original awards in return for the issuance of new awards. At the date of termination, the unvested options were no longer accounted for as employee awards and were accounted for as new non-employee awards. The accounting for the portion of the total grants that have already vested and have been previously expensed as equity awards is not changed. There were no employees moved to consulting status in 2010.

    Impairment of Intangible Assets

    We have capitalized significant costs for acquiring patents and other intellectual property directly related to our products and services. We review our intangible assets for impairment whenever events or circumstances indicate that the carrying amount of these assets may not be recoverable. In reviewing for impairment, we compare the carrying value of such assets to the estimated undiscounted future cash flows expected from the use of the assets and/or their eventual disposition. If the estimated undiscounted future cash flows are less than their carrying amount, we record an impairment loss to recognize a loss for the difference between the assets’ fair value and their carrying value. Since we have not recognized significant revenue to date, our estimates of future revenue may not be realized and the net realizable value of our capitalized costs of intellectual property or other intangible assets may become impaired.

    At December 31, 2009, we had an independent third-party perform a valuation of our intellectual property. They relied on the “relief from royalty” method, as this method was deemed to be most relevant to the intellectual property assets of our Company.  We determined that the estimated useful lives of the remaining intellectual property properly reflected the current remaining economic useful lives of the assets.

    Using the external 2009 valuation as a basis, we performed an impairment test on intellectual property as of December 31, 2010 and after considering numerous factors we determined that the carrying value of certain intangible assets was recoverable and did not exceeded the fair value. As such there were no impairment charges recorded for the year ended 2010.

    Valuation of Marketable Securities

    Investments include ARS, U.S. Treasury bills, commercial paper and certificates of deposit with maturity dates greater than three months when purchased, which are classified as available-for-sale investments and reflected in current or long-term assets, as appropriate, as marketable securities at fair market value. Unrealized gains and losses are reported in our consolidated balance sheet within accumulated other comprehensive loss and within other comprehensive loss. Realized gains and losses and declines in value judged to be “other-than-temporary” are recognized as a non-reversible impairment charge in the Statement of Operations on the specific identification method in the period in which they occur.

    We regularly review the fair value of our investments. If the fair value of any of our investments falls below our cost basis in the investment, we analyze the decrease to determine whether it represents an other-than-temporary decline in value. In making our determination for each investment, we consider the following factors:

    ·How long and by how much the fair value of the investments have been below cost;
    ·The financial condition of the issuers;
    ·Any downgrades of the investment by rating agencies;
    ·Default on interest or other terms; and
    ·Our intent and ability to hold the investments long enough for them to recover their value.

    37
    There had been continued auction failures with our ARS portfolio, quoted prices for our ARS did not exist though the year ended December 31, 2009 thus un-observable inputs were used. In June 2010, we redeemed all our ARS portfolio at par.

    Warrant Liabilities

    We issued warrants of our common stock in November 2007, September 2009, July 2010, October, 2010, November 2010 and the amended and restated Highbridge senior secured note in July 2008. The warrant agreements include provisions that require us to record them as a liability, at fair value, pursuant to FASB accounting rules, including provisions in some warrants that protect the holders from declines in our stock price and a requirement to deliver registered shares upon exercise, which is considered outside of our control. The warrant liabilities are marked-to-market each reporting period and changes in fair value are recorded as a non-operating gain or loss in our statement of operations, until they are completely settled or expire. The fair value of the warrants is determined each reporting period using the Black-Scholes option pricing model, and is affected by changes in inputs to that model including our stock price, expected stock price volatility, interest rates and expected term.

    The change in fair value of the warrant liabilities amounted to a net loss of $6.3 million in 2010 compared to net gain of $341,000 in 2009.

    RECENT ACCOUNTING PRONOUNCEMENTS

    Recently Adopted

    In February 2010, the FASB issued ASU 2010-09, “Subsequent Events, Amendments to Certain Recognition and Disclosure Requirements” which made a number of changes to the existing requirements to the FASB Accounting Standards Codification 855 Subsequent Events. The amended guidance was effective upon issuance and as a result of the amendments, SEC filers that file financial statements after February 24, 2010 are not required to disclose the date through which subsequent events have been evaluated. This ASU was adopted as of  December 31, 2010 and did not have a material impact on our consolidated financial statements.

    In January 2010, the FASB issued ASU 2010-06, “Fair Value Measurements and Disclosures: Improving Disclosures about Fair Value Measurements” which is intended to enhance the usefulness of fair value measurements by requiring both the disaggregation of the information in certain existing disclosures, as well as the inclusion of more robust disclosures about valuation techniques and inputs to recurring and non-recurring fair value measurements. The amended guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disaggregation requirement for the reconciliation disclosure of Level 3 measurements, which is effective for fiscal years beginning after December 31, 2010 and for interim periods within those years. This ASU was adopted as of December 31, 2010 and did not have a material impact on our consolidated financial statements.

    In January 2010, the FASB issued ASU 2010-02, “Accounting and Reporting for Decreases in Ownership of a Subsidiary – Scope Clarification” which is intended to clarify which transactions require a decrease in ownership provisions particularly for non-controlling interests in consolidated financial statements. In addition, it requires increased disclosures about deconsolidation of a subsidiary. It requires retrospective application and is effective for the first interim or annual periods ending on or after December 15, 2009. Adoption of this ASU did not have a material impact on our consolidated financial statements.

    In January 2010, the FASB issued ASU 2020-01 “Accounting for Distributions to Shareholders with Components of Stock and Cash” which is intended to clarify the accounting treatment for a stock portion of a shareholder distribution that (1) contains both cash and stock components, (2) allows shareholders to select their preferred form of distribution, and (3) limits the total amount of cash to be distributed. It defines a stock dividend as a dividend that takes nothing from the property of an entity and adds nothing to the interests of an entity’s shareholders because the proportional interest of each shareholder remains the same. The stock portion of the distribution must be treated as a stock issuance and be reflected in the EPS calculation prospectively. It requires retrospective application and is effective for annual periods ending on or after December 15, 2009. Adoption of this ASU did not have a material impact on our consolidated financial statements.
    38

    In August 2009, the FASB issued ASU 2009-15, which changes the fair value accounting for liabilities. These changes clarify existing guidance that in circumstances in which a quoted price in an active market for the identical liability is not available, an entity is required to measure fair value using either a valuation technique that uses a quoted price of either a similar liability or a quoted price of an identical or similar liability when traded as an asset, or another valuation technique that is consistent with the principles of fair value measurements, such as an income approach (e.g., present value technique). This guidance also states that both a quoted price in an active market for the identical liability and a quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair value measurements. This ASU was adopted effective on January 1, 2010 and did not have a material impact on our consolidated financial statements.

    In June 2009, the FASB issued ASU 2009-17, “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities,” the FASB issued changes to the accounting for variable interest entities. These changes require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity; to require ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity; to eliminate the quantitative approach previously required for determining the primary beneficiary of a variable interest entity; to add an additional reconsideration event for determining whether an entity is a variable interest entity when any changes in facts and circumstances occur such that holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance; and to require enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity. These changes became effective for us beginning on January 1, 2010. The adoption of this change did not have a material impact on our consolidated financial statements.

    In June 2009, the FASB issued ASU 2009-16, “Accounting for Transfers of Financial Assets,” which changes the accounting for transfers of financial assets. These changes remove the concept of a qualifying special-purpose entity and remove the exception from the application of variable interest accounting to variable interest entities that are qualifying special-purpose entities; limits the circumstances in which a transferor derecognizes a portion or component of a financial asset; defines a participating interest; requires a transferor to recognize and initially measure at fair value all assets obtained and liabilities incurred as a result of a transfer accounted for as a sale; and requires enhanced disclosure; among others. These changes became effective January 1, 2010 and did not have a material impact on our financial statements.

    Recently Issued

    The following Accounting Standards Updates were issued between December 31, 2009 and December 31, 2010 and contain amendments and technical corrections to certain SEC references in FASB's codification:

    In April 2010, the FASB issued ASU 2010-13, “Share-based payment awards denominated in certain currencies” provides clarification on an employee share-based payment award that has an exercise price denominated in the currency of the market in which a substantial portion of the entity’s equity shares trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity should not classify such an award as a liability if it otherwise qualifies as equity. The amended guidance is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. Our Company expects to adopt the amended guidance on January 1, 2011. Our Company does not believe that the adoption of the amended guidance will have a significant effect on its consolidated financial statements.
    39

    In April 2010, the FASB issued ASU 2010-17, “Milestone Method of Revenue Recognition” guidance to address accounting for research or development arrangements in which a vendor satisfies its performance obligations over time, with all or a portion of the consideration contingent on future events, referred to as milestones. The new guidance allows a vendor to adopt an accounting policy to recognize all of the arrangement consideration that is contingent on the achievement of a milestone in the period the milestone is achieved, if the milestone meets the criteria to be considered a substantive milestone. The milestone method described in the new guidance is not the only acceptable revenue attribution model for milestone consideration. However, other methods that result in the recognition of all of the milestone consideration in the period the milestone is achieved are precluded. A vendor is not precluded from electing to apply a policy that results in the deferral of some portion of the milestone consideration. The new guidance is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those fiscal years, beginning on or after June 15, 2010, with early adoption permitted. If an entity early adopts in a period that is not the beginning of its fiscal year, it must apply the guidance retrospectively from the beginning of the year of adoption. A vendor may elect to adopt the new guidance retrospectively for all prior periods, but is not required to do so. Our Company is still evaluating the effect, if any; the amended guidance may have on its consolidated financial statements.

    Effects of Inflation


    Our most liquid assets are cash and cash equivalents and marketable securities.equivalents. Because of their liquidity, these assets are not directly affected by inflation. Because we intend to retain and continue to use our equipment, furniture and fixtures and leasehold improvements, we believe that the incremental inflation related to replacement costs of such items will not materially affect our operations. However, the rate of inflation affects our expenses, such as those for employee compensation and contract services, which could increase our level of expenses and the rate at which we use our resources.

    Critical Accounting Policies


    Quantitative and Estimates

         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 results may differ from those estimates.

         We consider our critical accounting policies to be those that involve significant uncertainties, require judgments or estimates that are more difficult for management to determine or that may produce materially different results when using different assumptions. We consider the following accounting policies to be critical:


    We are a development stage companynot required to provide quantitative and have not recognized any significant revenues to date. Revenues in the future will be recognized based on contracts with our customers that will provide for payments of fees to us for licensing our technology and providing administrative services. We will need to determine revenues earned based on the terms of these contracts, which may require the use of estimates, including collectibility of accounts receivable. We recognize revenues based on fees that are fixed or determinable, and only upon delivery or completion of services rendered.

    45


    CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIALDISCLOSURE

    We have not recognized significant revenues to date,had any changes in or disagreements with accountants on accounting and financial disclosure.
    40
    MANAGEMENT

    Executive Officers and Directors

    The following table lists our estimates of future revenues may not be realizedexecutive officers and the net realizable value of our capitalized costs of intellectual property may become impaired.

         Our critical accounting policies are more fully described in Note 2 to our audited financial statements for the year ended December 31, 2003 included in this prospectus.

    Recent Accounting Pronouncements

         In November 2002, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No. (“FIN”) 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires a guarantor to recognize a liability, at the inception of the guarantee, for the fair value of obligations it has undertaken in issuing the guarantee and also to include more detailed disclosures with respect to guarantees. FIN 45 is effective for guarantees issued or modified after December 31, 2002 and requires the additional disclosures for interim or annual periods ended after December 15, 2002. The initial recognition and measurement provisions of FIN 45 did not have an effect on our financial position or results of operations.

         In December 2002, the FASB issued Statement of Financial Accounting Standards (“SFAS”) 148, “Accounting for Stock-Based Compensation—Transition and Disclosure.” SFAS 148 amends SFAS 123, “Accounting for Stock-Based Compensation” to provide alternative methods of transition to SFAS 123’s fair value method of accounting for stock-based employee compensation. It also amends and expands the disclosure provisions of APB 28, “Interim Financial Reporting,” to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements. While SFAS 148 does not require companies to account for employee stock options using the fair-value method, the disclosure provisions apply to all companies for fiscal years ending after December 15, 2002 regardless of whether they account for stock options in accordance with the intrinsic value method of APB 25. We have elected to use the intrinsic value method under APB 25 to account for stock options issued to employees and have incorporated the expanded disclosures under SFAS 148 into our Notes to Financial Statements.

         In January 2003, the FASB issued FIN 46, “Consolidation of Variable Interest Entities.” The primary objectives of FIN 46 are to provide guidance on the identification and consolidation of variable interest entities. Variable interest entities are entities that are controlled by means other than voting rights. The guidance applies to variable interest entities created after January 31, 2003. In December 2003, the FASB revised FIN46, delaying the effective dates for certain entities and making other amendments to clarify application of the guidance. We have reviewed the provisions of FIN 46 and 46R and have determined that we have no variable interest entities; consequently, there was no impact on our financial statements.

         In June 2003, the FASB issued, SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 requires certain instruments, including mandatorily redeemable shares, to be classified as liabilities, not as part of stockholders’ equity or redeemable equity. For instruments that are entered into or modified after May 31, 2003, SFAS 150 is effective immediately upon entering the transaction or modifying terms. For other instruments covered by SFAS 150 that were entered into before June 1, 2003, Statement 150 is effective for the first interim period beginning after June 15, 2003. The implementation of SFAS 150 had no impact on our financial position or results of operations.

    46

    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

         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. We adhere to an investment policy which requires that all investments be investment grade quality and no more than ten percent of our portfolio may be invested in any one security or with one institution. At December 31, 2003, our investment portfolio consisted of investments in highly liquid, high grade commercial paper, short-term variable rate securities and certificates of deposit. The weighted average interest rate of cash equivalents and marketable securities helddirectors serving at December 31, 2003 was 1.2%.

         Investments in both fixed rate2010.  Our executive officers are elected annually by our Board of Directors and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair market value adversely impacted due to a rise in interest rates, while floating rate securities with shorter maturities may produce less income if interest rates fall. The market risk associated with our investments in debt securities is substantially mitigated byserve at the frequent turnoverdiscretion of the portfolio.

    MANAGEMENT

    Directors and Executive Officers

         The following table sets forth certain information regardingBoard of Directors.  Each current director is serving a term that will expire at our Company's next annual meeting.  There are no family relationships among any of our directors andor executive officers.

         Director
    Name Age PositionSince
    		 
    		 
    Terren S. Peizer          44     Director, Chairman of the Board of Directors and CEO2003
    Anthony M. LaMacchia 50 Director, Chief Operating Officer2003
    Chuck Timpe 57 Chief Financial Officer 
    James W. Elder 52 Senior Vice President - Marketing and Business Development 
    David E. Smith, M.D. 64 Senior Vice President - Medical Affairs, Chair of Clinical Advisory 
        Board 
    Leslie F. Bell, Esq. 64 Director, Chair of Audit Committee, Member of Compensation2003
        Committee 
    Hervé de Kergrohen, M.D. 46 Director, Chair of Nominations and Governance Committee, Member2003
        of Audit Committee 
    Richard A. Anderson 34 Director, Member of Audit Committee2003
    Ivan M. Lieberburg, Ph.D., M.D. 54 Director, Chair of Compensation Committee, Chair of Scientific2003
        Advisory Board, Member of Clinical Advisory Board 
    Juan José Legarda, Ph.D. 48 Director, Member of Nominations and Governance Committee,2003
        Member of Scientific Advisory Board, Member of Clinical Advisory 


    NameAgePosition
    Officer or Director Since
    Terren S. Peizer51Director, Chairman of the Board and Chief Executive Officer2003
        
    Richard A. Anderson41Director, President and Chief Operating Officer2003
        
    Peter Donato41Chief Financial Officer2010
        
    Andrea Grubb Barthwell, M.D.56Director, Chair of Compensation Committee, Member of the Audit and Nominations and Governance Committees2005
        
    Kelly McCrann55Director, Chair of Nominations and Governance Committee, Member of the Audit Committee, Member of the Compensation Committee2010
        
    Jay A. Wolf37Lead Director, Chair of Audit Committee, Member of Nominations and Governance Committee, Member of Compensation Committee2008

    Terren S. Peizer is the founder of our Company and has served as our chief executive officer and chairman of our Board of Directors since our inception in February 2003.  He has served as Managing Director of Socius Capital Partners, LLC, since September 2009. Mr. Peizer has served on the board of Xcorporeal, Inc. since August 2007 and was executive chairman until October 20032008. Mr. Peizer also served as Chief Executive Officerchief executive officer of Clearant, Inc., a company which he founded in April 1999 to develop and commercialize a universal pathogen inactivation technology, and remains Executive Chairmanuntil October 2003. He served as chairman of its board of directors. Fromdirectors from April 1999 to October 2004 and as a director until February 1997 to February 1999, Mr. Peizer served as President and Vice Chairman of Hollis-Eden Pharmaceuticals, Inc., a NasdaqNM listed company.2005. In addition, from June 1999 through May 2003 he was a Director,director, and from June 1999 through December 2000 he was Chairmanchairman of the Board,board, of supercomputer designer and builder Cray Inc., a NasdaqNM company, and remains its largest beneficial stockholder.NASDAQ Global Market company. Mr. Peizer has been the largest beneficial stockholder and has held various senior executive positions with several technology and biotech companies. In these capacities heHe has assisted the companies withby assembling management teams, boards of directors and scientific advisory boards, formulating business and financial strategies, and investor and public relations, and capital formation. From June 2000 to October 1, 2002, he was non-executive chairman of the board of Internet start-up company Brightcube, Inc., which filed chapter 7 bankruptcy on September 30, 2002.relations. 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.

    47


    Anthony M. LaMacchiaRichard A. Anderson 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, has served as Executive Vice President &our 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 anddirector since June 2002 as Chairman of the Audit Committee for IPC-The Hospitalist Company, a $75 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. He was on the board of the not-for-profit Granada Hills Community Hospital from 1996 to October 2002, which filed chapter 11 bankruptcy on November 26, 2002, after Provident Healthcare West, LLC, a wholly-owned subsidiary of Provident Foundation, Inc., assumed control. Mr. Timpe received his B.S. from University of Missouri, School of Business and Public Administration, and is a Certified Public Accountant.

    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.

    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.July 2003. He has held consultancies and other positions at numerous professional organizations, including Doping Control Officer for the Winter Olympics in Februrary 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.

    48

    Leslie F. Bell, Esq. has more than 35almost twenty years of experience in business and the practice of corporate and healthcare law. He has served as a Director and Senior Executive of Bentley Health Care, Inc., a developer and provider of outpatient, health care facilities and services since November 1997. Mr. Bell also serves as 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. From its inception in 1983 through several public offerings and until its sale in 1997 for approximately $480 million, he served as a Director, Executive Vice President and Chief Financial Officer and from 1996 to 1997 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 Deputy Attorney General of the State of California, and managing partner of the law firm Katz, Hoyt & Bell. Mr. Bell attended 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.

    Hervé de Kergrohen, M.D. since August 2002 has been a Partner with CDC Ixis Innovation in Paris, a European venture capital firm and advisor to several financial institutions including Lombard Odier Darier Hentsch & Cie, Geneva and Global Biomedical Partners, Zurich, 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, Exonhit and Entomed in France since September 2002, and Clearant, Inc. since December 2001. From February 1999 to December 2001 he was Head Analyst for Darier Hentsch, Geneva 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 Brinson of Chicago, a Manager of CHF 700 billion for UBS AG, 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, operating and financial management. He has been a Director andwas the Chief Financial Officerchief financial officer of Clearant, Inc. sincefrom November 1999 until March 2005, and served as Chief Financial Officer of Intellect Capital Groupa director from OctoberNovember 1999 through December 2001. From October 2000 to October 2002, he served as a Director of Brightcube, Inc. From February through September 1999, he was an independent financial consultant. From August 1991 to January 1999,March 2006.  Mr. Anderson was with PriceWaterhouseCoopers, LLP, most recentlypreviously a Directordirector and founding member of PriceWaterhouseCoopers LLP’s, Los Angeles Office Transaction Support Group,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.

    41

    Ivan M. Lieberburg, Ph.D.Peter Donato has served as our Chief Financial Officer since August 2010.  Mr. Donato has nearly 20 years of progressive financial management experience in large, publicly traded companies as well as small, entrepreneurial companies. He began his career in public accounting with Ernst & Young, and most recently served as CFO of Iris International, a NASDAQ traded medical diagnostics equipment manufacturer, from 2007 to 2010 and from  2006 to 2007, he was CFO of Gamma Medica-Ideas, an early stage medical imaging company.  He is credited for establishing a strong and timely reporting structure, improved control environment, recruiting and retaining strong accounting, finance and IT teams, as well as developing and maintaining strong relationships with external stakeholders including: investors, coverage analysts, bankers, insurance brokers and auditors.  He has held positions with increasing responsibilities at General Motors, Honda, Scotts-Miracle Gro, and Accellent.  Mr. Donato graduated from The Ohio State University (Fisher College) with a BS in Business Administration and earned an MBA from the University of Akron. He is also a Certified Public Accountant.

    Andrea Grubb Barthwell, M.D., M.D.F.A.S.A.M., has served as a director since 2005. Dr. Barthwell is currentlythe founder and Chief Executive ViceOfficer of the global health care and policy-consulting firm EMGlobal LLC and Director at Two Dreams Outer Banks Treatment Center.  President Chief Scientific and Medical OfficerGeorge W. Bush nominated Dr. Barthwell in December 2001 to serve as Deputy Director for Demand Reduction in the Office of National Drug Control Policy (ONDCP).  The United States Senate confirmed her nomination on January 28, 2002.  As a member of the President's sub-cabinet, Dr. Barthwell was a principal advisor in the Executive Office of the President (EOP) on policies aimed at Elan Company, plc,reducing the demand for illicit drugs. Dr. Barthwell received a worldwide biopharmaceutical company listedBachelor of Arts degree in Psychology from Wesleyan University, where she serves on the NYSE, whereBoard of Trustees, and a Doctor of Medicine from the University of Michigan Medical School.  Following post-graduate training at the University of Chicago and Northwestern University Medical Center, she began her practice in the Chicago area.  Dr. Barthwell served as President of the Encounter Medical Group (EMG, an affiliate of EMGlobal), was a founding member of the Chicago Area AIDS Task Force, hosted a weekly local cable show on AIDS, and is a past president of the American Society of Addiction Medicine.  Dr. Barthwell received the Betty Ford Award, given by the Association for Medical Education and Research in Substance Abuse and has been named by her peers as one of the "Best Doctors in America" in addiction medicine.

    Kelly J. McCrann has served as a director of our Company since December 9, 2010. Mr. McCrann has over 30 years of experience managing and operating healthcare companies. Most recently, he has heldserved as Chairman and Chief Executive Officer of Xcorporeal, Inc., a numbermedical device company from 2008 to 2010. Mr. McCrann was responsible for product development, strategic partnerships and facilitating the sale of positions over the last fifteen years, most recentlycompany. Previously, he served as Senior Vice President of Research. Dr. LieberburgDaVita Inc., from 2006 to 2007, where he was responsible for all home based renal replacement therapies for the United States' second largest kidney dialysis provider. Prior to that, Mr. McCrann was the Chief Executive Officer and President of PacifiCare Dental and Vision, Inc and has held executive positions at Professional Dental Associates, Inc., Coram Healthcare Corporation, HMSS, Inc. and American Medical International and began his career as a consultant with McKinsey & Company. He is a graduate of University of California, Los Angeles and the Harvard Business School. Mr. McCrann currently sits on the scientificBoards of Loma Linda University Medical Center and Sound Surgical Technologies, Inc. He is a former director of Dental One, Inc., InPatient Consultants, Inc., OrthoSynetics, Inc. and Xcorporeal, Inc. Mr. McCrann is currently serving as an independent consultant.

    Jay A. Wolf, Mr. Wolf is currently a Managing Member of Juniper Capital Partners, LLC a Merchant Bank focused  on investing in distressed assets. From October 2009 until December of 2010, Mr. Wolf served as the principal of Wolf Capital LP an investment advisory boardsfirm focused on small cap public companies. From November 2003 until September 2009, Mr. Wolf was a partner at Trinad Capital LLC, an activist hedge fund focused on micro-cap public companies. During his work at Trinad, Mr. Wolf assisted distressed and early stage public companies through active board participation, the assembly of Health Care Ventures, Flagship Ventures, NewcoGen,management teams and the Keystone Symposium.business and financial strategies. Prior to joining Elanhis work at Trinad, Mr. Wolf served as executive vice president of Corporate Development for Wolf Group Integrated Communications Ltd. Prior to that, Mr. Wolf worked at Canadian Corporate Funding, Ltd., a Toronto-based merchant bank as an analyst in 1987, he performedthe firms senior debt department and subsequently for Trillium Growth Capital, the firms venture capital fund. Mr. Wolf is our lead independent director and also serves as the Chairman of our Audit Committee. Mr. Wolf is the Executive Chairman of Zoo Entertainment Inc. (ZOOG). He is a former director of Asianada, Inc., ProLink Holdings Corp., Mandalay Media, Inc., Atrinsic, Inc., Shells Seafood Restaurants, Inc., Optio Software, Inc., Xcorporeal Operations, Inc., Zane Acquisition I, Inc., Zane Acquisition II, Inc., Starvox Communications, Inc. and Noble Medical Technologies, Inc.  Mr. Wolf is also a member of the board of governors of Cedars-Sinai Hospital. Mr. Wolf received his postdoctoral research at The Rockefeller UniversityB.A from Dalhousie University.  Mr. Wolf was Chief Operating Officer and his medical residency and postdoctoral fellowship at UniversityChief Financial Officer of Starvox Communications, Inc. from March 2005 to March 2007.On March 26, 2008, StarVox Communications, Inc. filed a voluntary petition for liquidation under Chapter 7 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Northern District of California, San Francisco, whereJose.Shells Seafood Restaurants, Inc., a company for which Mr. Wolf formerly served as a director, filed a voluntary petition for reorganization under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court for the Middle District of Florida, Tampa Division, on September 2, 2008.  Mr. Wolf’s broad range of investment and operations experience, which includes senior and subordinated debt lending, private equity and venture capital investments, mergers and acquisitions advisory work and public equity investments, equip him with the qualifications and skills to serve on our board of directors.
    42

    Involvement in certain legal proceedings
    None of our directors or executive officers has, except as set forth in “Legal Proceedings”, during the past five years:

    ●been convicted in a criminal proceeding or been subject to a pending criminal proceeding (excluding traffic violations and other minor offences);

    ●had any bankruptcy petition filed by or against the business or property of the person, or of any partnership, corporation or business association of which he was a general partner or executive officer, either at the time of the bankruptcy filing or within two years prior to that time;

    ●been subject to any order, judgment, or decree, not subsequently reversed, suspended or vacated, of any court of competent jurisdiction or federal or state authority, permanently or temporarily enjoining, barring, suspending or otherwise limiting, his involvement in any type of business, securities, futures, commodities, investment, banking, savings and loan, or insurance activities, or to be associated with persons engaged in any such activity;

    ●been found by a court of competent jurisdiction in a civil action or by the Securities and Exchange Commission or the Commodity Futures Trading Commission to have violated a federal or state securities or commodities law, and the judgment has not been reversed, suspended, or vacated;

    ●been the subject of, or a party to, any federal or state judicial or administrative order, judgment, decree, or finding, not subsequently reversed, suspended or vacated (not including any settlement of a civil proceeding among private litigants), relating to an alleged violation of any federal or state securities or commodities law or regulation, any law or regulation respecting financial institutions or insurance companies including, but not limited to, a temporary or permanent injunction, order of disgorgement or restitution, civil money penalty or temporary or permanent cease-and-desist order, or removal or prohibition order, or any law or regulation prohibiting mail or wire fraud or fraud in connection with any business entity; or

    ●been the subject of, or a party to, any sanction or order, not subsequently reversed, suspended or vacated, of any self-regulatory organization (as defined in Section 3(a)(26) of the Exchange Act (15 U.S.C. 78c(a)(26))), any registered entity (as defined in Section 1(a)(29) of the Commodity Exchange Act (7 U.S.C. 1(a)(29))), or any equivalent exchange, association, entity or organization that has disciplinary authority over its members or persons associated with a member.

    Code of Ethics

    Our Board of Directors has adopted a code of ethics applicable to our chief executive officer, chief financial officer and persons performing similar functions.  Our code of ethics is presently a Clinical Professorfiled as Exhibit 14.1 to our annual report on Form 10-K for the fiscal year ended December 31, 2010 and can be found on our website at http://www.catasyshealth.com.

    Committees of Medicine,the Board of Directors

    Audit committee

    The audit committee consists of three directors, Mr. Wolf, Dr. Barthwell and held faculty positions at Albert Einstein SchoolMr. McCrann. The Board of MedicineDirectors has determined that each of the members of the audit committee are independent as defined by the Nasdaq rules, meet the applicable requirements for audit committee members, including Rule 10A-3(b) under the Exchange Act, and Mt. Sinai SchoolMr. Wolf qualifies as audit committee financial experts as defined by Item 401(h)(2) of Medicine. Dr. Lieberburg has authored over 100 scientific publications,Regulation S-K. The duties and has been named to a numberresponsibilities of honors including Rockefeller University Fellow, Public Health Corps Scholar, National Research Service Award, Hartford Foundation Scholarthe audit committee include (i) selecting, evaluating and, McKnight Fellow. He is board certifiedif appropriate, replacing our independent registered accounting firm, (ii) reviewing the plan and scope of audits, (iii) reviewing our significant accounting policies, any significant deficiencies in the design or operation of internal controls or material weakness therein and any significant changes in internal medicinecontrols or in other factors that could significantly affect internal controls subsequent to the date of their evaluation and endocrinology/metabolism.(iv) overseeing related auditing matters.
    43
    Nominations and governance committee

    The nominations and governance committee consists of up to three directors who are independent as defined by the Nasdaq rules. The committee consists of Mr. Wolf, Mr. McCrann, and Dr. Lieberburg received an A.B. in biology from Cornell University, a Ph.D. in Neurobiology fromBarthwell. The Rockefeller Universitycommittee nominates new directors and an M.D. from University of Miami School of Medicine.

    periodically oversees corporate governance matters.


    Juan José Legarda, Ph.D. has extensive experience in the biotechnology and pharmaceutical industries, and is the principal inventorThe charter of the company’s HANDS Treatment Protocols™. Since 1988, Dr. Legarda has been Foundernominations and Presidentgovernance committee provides that the committee will consider board candidates recommended for consideration by our stockholders, provided the stockholders provide information regarding candidates as required by the charter or reasonably requested by us within the timeframe proscribed in Rule 14a-8 of a healthcare company specializing inRegulation 14A under the treatment of addictions, which is now known as Tratamientos Avanzados de la Adicción S.L. There, he developed new treatments for opiate addiction, alcohol dependenceExchange Act, and cocaine addictions, filing patent applications which he has licensedother applicable rules and regulations. Recommendation materials are required to be sent to the company. Dr. Legarda previously developed special projects for the Universal Exhibition of 1992 in Seville, was a lecturer in psychopathology at University of Seville,nominations and worked as a clinical psychologist in private and public institutions such as the university hospitals of Barcelona and Bilbao. He has published papers in numerous scientific journals and has organized and participated in national and international congresses. Dr. Legarda obtained a M.Sc. in psychology from Universidad Pontificia of Salamanca, and a Ph.D. from University of London for research on psychophysical and cognitive aspects of craving at its Institute of Psychiatry.

    49

    Executive Officers

    governance committee c/o Catasys, Inc., 11150 Santa Monica Blvd., Suite 1500, Los Angeles, California 90025. There are no family relationships amongspecific minimum qualifications required to be met by a director nominee recommended for a position on the board of directors, nor are there any specific qualities or skills that are necessary for one or more of our board of directors to possess, other than as are necessary to meet any requirements under the rules and regulations applicable to us. The nominations and governancecommittee considers a potential candidate's experience, areas of expertise, and other factors relative to the overall composition of the board of directors.


    The nominations and governance committee considers director candidates that are suggested by members of the board of directors, as well as management and stockholders. Although it has not previously done so, the committee may also retain a third-party executive search firm to identify candidates. The process for identifying and evaluating nominees for director, including nominees recommended by stockholders, involves reviewing potentially eligible candidates, conducting background and reference checks, interviews with the candidate and others (as schedules permit), meeting to consider and approve the candidate and, as appropriate, preparing and presenting to the full board of directors an analysis with respect to particular recommended candidates. The nominations and governance committee endeavors to identify director nominees who have the highest personal and professional integrity, have demonstrated exceptional ability and judgment, and, together with other director nominees and members, are expected to serve the long term interest of our stockholders and contribute to our overall corporate goals.

    Compensation committee

    The compensation committee consists of three directors who are independent as defined by the Nasdaq rules. The committee consists of Dr. Andrea Grubb Barthwell (chairman) and Mr. Jay Wolf. The compensation committee reviews and recommends to the board of directors for approval the compensation of our executive officers.
    44
    EXECUTIVE COMPENSATION

    Summary Compensation Table

    The following table sets forth the cash and non-cash compensation for our named executive officers or key employees. during the 2010 and 2009 fiscal years.

                  Non-    
                Non- Qualified All  
                Equity Deferred Other  
              Option Incentive Compen Compen-  
    Name and     Stock Awards Compen sation sation  
    Principal Position Year Salary Bonus Awards (1) sation Earnings (2) Total
                       
    Terren S. Peizer, 2010   450,000               -               -    2,011,605                 -                      - - 2,461,605
    Chairman & Chief 2009   450,000                -                - 468,450                 -                      -         11,969(3)    930,419
    Executive Officer                                                                                                     
                               
    Richard A. Anderson, 2010   350,000               -               - 1,666,033                 -                      - 21,495 2,037,528
    President and 2009   350,000 -               -    522,064                 -                   - 20,489 892,553
    Chief Operating Officer                                                                        
                               
    Christopher S. Hassan, 2010 100,792               -               -       71,323                 -                   -         - 172,115
    Chief Strategy Officer 2009 302,377               -               -    408,960                 -                   - 17,754      729,091
                       
    Maurice S. Hebert 2010 41,956 - - 3,343 - - - 45,299
    Senior Vice President - 2009 240,000 -  - 141,857 - - 14,491 396,348
    Scientific Affairs                  
                       
    Peter Donato 2010   69,000               -               - 9,881                 -                   - - 78,881
    Chief Financial Officer 2009    -               -               - -                 -                   - -     -

     (1)      Amounts reflect the compensation expense recognized in our Company's financial statements in 2010 and 2009 for stock option awards granted to the executive officers in accordance with FASB accounting rules. The grant-date fair values of stock options are calculated using the Black-Scholes option pricing model, which incorporates various assumptions including expected volatility, expected dividend yield, expected life and applicable interest rates. See notes to the consolidated financial statements in this report for further information on the assumptions used to value stock options granted to executive officers. The option award amounts include incremental compensation expense of $1,714,721 for Mr. Peizer and $1,478,897 for Mr. Anderson related to the December 9, 2010 Grants that vested immediately.
    (2)Includes group life insurance premiums and medical benefits for each officer.
    (3)Includes $11,969 in 2009 for automobile allowance, including tax gross-ups.
    (4)Amounts for Mr. Hebert and Mr. Donato represent pro-rata salary earned on annual salaries of $240,000 and $220,000, respectively.

    Executive employment agreements

    Chief executive officer

    We considerentered into a five-year employment agreement with our chairman and chief executive officer, Terren S. Peizer, Anthony M. LaMacchia, Chuck Timpe, James Eldereffective as of September 29, 2003, which automatically renewed for an additional five years upon completion of the initial term. Mr. Peizer currently receives an annual base salary of $450,000, with annual bonuses targeted at 100% of his base salary based on goals and David E. Smith, M.D. to be our executive officers.

    Board of Directors

         Directors are elected by the stockholdersmilestones established and reevaluated on an annual basis by mutual agreement between Mr. Peizer and serve until their successors have been electedthe Board. His base salary and qualified. All non-employee directors are eligiblebonus target will be adjusted each year to receive grantsnot be less than the median compensation of stock options under our 2003 Stock Option Plan. On September 29, 2003, wesimilarly positioned CEO’s of similarly situated companies. Mr. Peizer receives executive benefits including group medical and dental insurance, term life insurance equal to 150% of his salary, accidental death and long-term disability insurance, and a car allowance of $2,500 per month, grossed up for taxes.  In 2009, Mr. Peizer was granted each non-employee directoradditional stock options to purchase the following number of959,000 shares of our Common Stock at ten percent above the fair market value on the grant date vesting over three years.  On December 9, 2010, 59,400,000 additional options were granted to purchase shares of our common stock at 10% above fair market value, or $0.044 per share with vesting periods matching previous vesting terms.  As a result, 46,332,000 of the 59,400,000 stock options vested immediately with 13,068,000 vesting matching vesting terms of the previous stock options. All unvested options vest immediately in the event of a change in control, termination without good cause or resignation with good reason. In the event that Mr. Peizer is terminated without good cause or resigns with good reason prior to the end of the term, he will receive a lump sum equal to the remainder of his base salary and targeted bonus for the year of termination, plus three years of additional salary, bonuses and benefits. If any of the provisions above result in an excise tax, we will make an additional “gross up” payment to eliminate the impact of the tax on Mr. Peizer.

    45

    President and chief operating officer, chief strategy officer

    We entered into four-year employment agreements with our president and chief operating officer, Richard A. Anderson and our chief strategy officer Christopher S. Hassan effective April 19, 2005 and July 27, 2006, respectively.  Mr. Anderson’s agreement renewed for an additional four year term in 2009. Mr. Hassan resigned on April 16, 2010.  Mr. Anderson currently receives an annual base salary of $350,000, and Mr. Hassan, while employed, received an annual base salary of $302,377, each with annual bonuses targeted at 50% of his base salary based on achieving certain milestones. Mr. Anderson’s compensation will be adjusted each year by an amount not less than the Consumer Price Index. They each receive, or received when employed, executive benefits including group medical and dental insurance, term life insurance, accidental death and long-term disability insurance. Upon employment, Mr. Anderson was granted options to purchase 280,000 shares of our Common Stock, in addition to the 120,000 options previously granted to him as a non-employee member of our Board of Directors, and Mr. Hassan was granted options to purchase 400,000 shares of our Common Stock. Each of the options was granted at the fair market value on the date of grant, vesting 20% each year over five years. Mr. Anderson and Mr. Hassan were granted additional options to purchase shares of our Common Stock in 2009, as set forth in the table below, at the fair market value on the date of grant, vesting over three years.  In addition on December 9, 2010, Mr. Anderson was granted options to purchase 59,400,000 shares of our common stock at $0.04 per share, the fair market value at the date of the grant.  The options are subject to previous vesting schedules, and as a result, 43,956,000 of the 59,400,000 stock options vested immediately. Mr. Hassan’s options were cancelled 90 days after his employment ended.  The options will vest immediately in the event of a change in control, termination without cause or resignation with good reason. In the event of termination without good cause or resignation with good reason prior to the end of the term, upon execution of a mutual general release, Mr. Anderson will receive a lump sum equal to one year of salary and bonus, and will receive continued medical benefits for one year unless he becomes eligible for coverage under another employer's plan. If he is terminated without cause or resigns with good reason within twelve months following a change in control, upon execution of a general release he will receive a lump sum equal to eighteen months salary, 150% of the targeted bonus, and will receive continued medical benefits for eighteen months unless he becomes eligible for coverage under another employer's plan.

    Chief financial officer

    We entered into an employment agreement with Maurice Hebert on November 12, 2008, which provided for Mr. Hebert to receive an annual base salary of $240,000, with annual bonuses targeted at 40% of his base salary based on his performance and the operational and our financial performance. Mr. Hebert received executive benefits including group medical and dental insurance, and long-term disability insurance and participation in our 401(k) plan and employee stock purchase plan. On the date of the employment agreement, Mr. Hebert was granted options to purchase 100,000 shares of our common stock at an exercise price of $2.50$0.59 per share, the fair market value on the date of grant, vesting 25% per yearmonthly over fourthree years from the date of the grant: 200,000grant. Mr. Hebert resigned as our chief financial officer in January 2010.

    Mr. Peter Donato joined Catasys on an “at-will” basis in August 2010 with an annual salary of $220,000.  He was granted options to purchase 400,000 shares to Dr. Lieberburg, 120,000 shares to Mr. Anderson, 100,000 shares to Mr. Bell and Dr. Kergrohen, and 50,000 shares to Dr. Legarda.

         The board has determined that Mr. Bell and Drs. de Kergrohen, Lieberburg and Legarda are independent and that Messrs. Peizer, LaMacchia and Anderson are not independent as that term is used in Item 7(d)(3)(iv) of Schedule 14A under the Exchange Act. There are no family relationships among any of our directors, executive officers or key employees.

    Audit Committee and Financial Experts

         The company’s boardcommon stock at an exercise price of directors has established a separately-designated standing audit committee, consisting of three directors. The members$0.11 per share, the fair market value on the date of the audit committee are Mr. Bell (Chairman), Dr. de Kergrohengrant, vesting monthly over three years with one year cliff and Mr. Anderson. The board has determined that membership onmonthly thereafter, effective from the audit committee by Mr. Anderson is in the best interestsdate of the corporation and its stockholders, because he has significant experience in finance and accounting. The board of directors has determined that Dr. de Kergrohen and Messrs. Bell and Anderson meet the requirements of audit committee financial experts as that term is used in Item 401(h)(1)(i)(A) of Regulation S-K under the Exchange Act.

    Codes of Ethics

         We have adopted a Code of Conduct and Ethics that appliesgrant.  On December 9, 2010, Mr. Donato was granted options 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. Copies of these codes of ethics are attached as exhibits to our annual report.

    Governance Guidelines and Committee Charters

         The company’s board of directors has established separately-designated standing compensation committee and nominating and corporate governance committee, each consisting of two independent directors.

         We have also adopted written governance guidelines for the board of directors and a written committee charter for eachpurchase 7,749,000 shares of our audit committee, compensation committee,common stock at $0.04 per share, the fair market value of the date of the grant. The December 2010 options vest over 3 years with a eight month cliff, 22% vesting after 8 months and nominating and corporate governance committee.

    EXECUTIVE COMPENSATION

    monthly thereafter.

    46
    Outstanding Equity Awards at Last Fiscal Year End

    The following table sets forth certain annual and long-term compensation, for eachall outstanding equity awards held by our named executive officers as of the last three fiscal years, paid to the company’s Chief Executive Officer and certain other officers. None of our officers earned compensation in excess of $100,000 during these years. We did not grant any restricted stock awards or stock appreciation rights during these years.

    50

    Summary Compensation Table

        Annual compensationLong-term compensation     
        
    		 
    		    
              Restricted Securities     
            Other annual stock underlying All other
    Name & Principal Fiscal Salary Bonus compensation awards(s) options compensation
    Position year ($) ($) ($) ($) (#)(1) ($)
    		 
    		 
    		 
    		 
    		 
    		 
    		 
    		 
    Terren S. Peizer,   2003      $75,000      $—       $—       $—       1,000,000                 —(2)    
    Chairman & Chief Executive Officer 2002  — — — — —  —(3)
     2001  — — — — —  —(3)
    Anthony LaMacchia, 2003  88,463 — — — 400,000  —(4)
    Chief Operating Officer 2002  — — — — —  —(3)
      2001  �� — — — —  —(3)
    Chuck Timpe, 2003  97,692 — — — 300,000  —(5)
    Chief Financial Officer 2002  — — — — —  —(3)
      2001  — — — — —  —(3)

    December 31, 2010.


    ___________
     Option Awards Stock Awards
                      Equity
                      Incentive
                    Equity Plan
                    Incentive Awards:
                  Market Plan Market
          Equity     Number Value Awards: or Payout
          Incentive    of of Number Value of
          Plan     Shares Shares of Unearned
          Awards:     or or Unearned Shares,
          No. of     Units Units Shares, Units, or
      Number of Number of Securities    of of Units, or Other
      Securities Securities Underlying    Stock Stock Other Rights
      Underlying Underlying Unexer-     That That Rights That
      Unexercised Unexercised cised Option   Have Have That Have
      Options (#) Options (#) Unearned Exercise Option Not Not Have Not Not
      Exercisable Unexer- Options Price Expiration Vested Vested Vested Vested
    Name (1) cisable (#) ($) Date (#) ($) (#) (#)
    Terren S. Peizer1,000,000  -          -  $             0.31 09/29/13               -              -       -          -
      460,000 -    - 0.31 02/07/18               -              -     -       -
      525,000 15,000       - 0.31 06/20/18               -              -    -     -
      506,139 452,861      - 0.48 10/27/19               -              -     -   -
      48,147,000 11,253,000 - 0.044 12/06/20        
      50,638,139 11,720,816                     -      
                       
    Richard A. Anderson120,000     -       - 0.28 09/29/13               -              -     -       -
      255,000 -      - 0.28 04/28/15               -              -     -       -
      15,000 10,000       - 0.28 07/27/16               -              -     -     -
      293,000 -        - 0.28 02/07/18               -              -   -      -
      334,915 9,585       -  0.28 06/20/18               -              -    -   -
      262,833 235,167        - 0.44 10/27/19               -              -      -    -
      46,113,917 13,286,083 - 0.04 12/06/20        
      47,394,665 13,540,835              
                       
    Christopher S. Hassan240,000 160,000      - 4.77 07/27/16               -              -      -   -
      165,410 29,590         -           2.65 02/07/18               -              -      -     -
      127,780 102,220         - 2.63 06/20/18               -              -    -      -
      533,190  291,810              
                       
    Maurice Hebert 54,000 36,000         - 0.28 11/15/16               -              -       -       -
      52,216   10,284         - 0.28 02/07/18               -              -        -       -
      36,756  36,744         -  0.28 06/20/18               -              -        -       -
      36,114 63,886         -  0.59 11/10/18               -              -       -          -
       6,667  113,333            -    0.44 10/27/19               -              -       -         -
      185,753 260,247              
                       
    Peter Donato - 400,000  -  0.11 08/15/20  -  -  -  -
      - 7,749,000  -  0.04 12/06/20  -  -  -  -
      - 8,149,000              

    Notes to Summary Compensation Table:

    (1)
             		OptionsThe unvested stock options granted pursuant toon February 7, 2008, June 20, 2008, November 10, 2008, and October 29, 2009 vest monthly over a thirty-six month period from the 2003 Stock Incentive Plan on September 29, 2003. Optionsdate of grant. All other awards vest 20% pereach year over five years.
    (2)
    		Mr. Peizer commenced receiving compensationyears from the company on September 29, 2003 at an annual salarydate of $325,000.
    (3)
    		Was not employed by the company during this year.
    (4)
    		Mr. LaMacchia was hired by Hythiam, Inc. as an employee on July 14, 2003 at an annual salary of $200,000 plus a guaranteed bonus of $50,000.
    (5)
    		Mr. Timpe was hired by Hythiam, Inc. as an employee on June 26, 2003 at an annual salary of $200,000.
    grant.

    51


    47

    Options Exercised in 2010

    There were no options exercised by any of our named executive officers, and no restricted stock vested, in 2010.

    Potential Payments Upon Termination or Change-In-Control

    Potential payments upon termination

    The following table summarizes options granted in 2003 to the executive officers named in the Summary Compensation Table above:

    Option Grants in Last Fiscal Year

              Potential realizable value at
              assumed annual rates of
              stock price appreciation for
     Individual grants   option term(1)
     
    		   
     Number of Percent of        
     securities total options        
     underlying granted to Exercise      
     options granted employees in price Expiration    
     (#)(2) fiscal year ($/Sh) date 5% ($) 10% ($)
     
    		 
    		 
    		 
    		 
    		 
    Terren S. Peizer1,000,000      31.7%      $2.75      9/29/08           $440,704                 $1,276,275
    Anthony LaMacchia400,000 12.7%  2.50 9/29/13   628,895   1,593,742
    Chuck Timpe300,000 9.5%  2.50 9/29/13   471,671   1,195,307

    ___________
    Notes to Option Grants in Last Fiscal Year Table:

    (1)
    		The amounts are based on the 5% and 10% annual rates of return prescribed by the Securities and Exchange Commission and are not intended to forecast future appreciation, if any, of the company’s common stock nor reflect actual gains, if any, realizable upon exercise.
    (2)
    		Does not include options granted in the current fiscal year.

         The following table summarizes options exercised in 2003 bypayments that the named executive officers would have received if their employment had terminated on December 31, 2010.


    If Mr. Peizer's employment had terminated due to disability, he would have received insurance and other fringe benefits for a period of one year thereafter, with a value equal to $5,600.  If Mr. Peizer had been terminated without good cause or resigned for good reason, he would have received a lump sum payment of $2,717,000, based upon: (i) three years of additional salary at $450,000 per year; (ii) three years of additional bonus of $450,000 per year; and (iii) three years of fringe benefits, with a value equal to $17,000.

    If either Mr. Hassan or Mr. Anderson had been or are terminated without good cause or resigned for good reason, he would have received a lump sum of $525,000 for Mr. Anderson and $453,566 for Mr. Hassan, based upon one year's salary plus the full targeted bonus of 50% of base salary.  In addition, medical benefits would continue for up to one year, with a value equal to $17,000 each.

    Potential payments upon change in control

    Upon a change in control, the unvested stock options of each of our named executive officers would have vested, with the unexercised in-the-money options held by those executives,values set forth above.

    If Mr. Peizer had been terminated without good cause or resigned for good reason within twelve months following a change in control, he would have received a lump sum payment of $2,717,000, as described above, plus a tax gross up of $713,000.

    If either Mr. Hassan or Mr. Anderson had been terminated without good cause or resigned for good reason within twelve months following a change in control, he would have received a lump sum of $787,500 for Mr. Anderson and $680,348 for Mr. Hassan, based onupon one-and-a-half year's salary plus one-and-a-half the full targeted bonus of 50% of base salary.  In addition, medical benefits would continue for up to one-and-a-half years, with a $7.16 per share closing price on Amex at 2003 year-end:

    Aggregated Option Exercisesvalue equal to $25,000 each.


    If Mr. Hebert had resigned for good reason following a change in Last Fiscal Yearcontrol, he would have received a lump sum of $336,000, based upon one year's salary plus the full targeted bonus of 40% of base salary.  In addition, medical benefits would continue for up to one year, provided that medical insurance coverage will terminate sooner if Mr. Hebert becomes eligible for coverage under another employer’s plan.
    48
    Director Compensation

    and Fiscal Year-End Option Values

        Number of shares underlying Value of unexercised in the
        unexercised options at fiscal year-end money options at fiscal year-end
     Shares  
    		 
     acquired on ValueExercisableUnexercisable Exercisable Unexercisable
     exercise (#) realized ($)(#)(#)(2) ($) ($)
     
    		 
    		 
    		 
    Terren S. Peizer—      $——1,000,000      $—      $4,410,000
    Anthony LaMacchia—  ——400,000  —  1,864,000
    Chuck Timpe—  ——300,000  —  1,398,000

    The following table sets forth certainprovides information regarding compensation that was earned or paid to the individuals who served as ofnon-employee directors during the year ended December 31, 2003 with respect2010. Except as set forth in the table, during 2010, directors did not earn nor receive cash compensation or compensation in the form of stock awards, option awards or any other form.

            Non- Non-    
      Fees     equity qualified    
      earned     incentive deferred All  
      or paid   Option plan compen- other  
      in cash  Stock awards compen- sation compen-  
    Name (1) awards (2)(3) sation earnings sation Total
    Marc Cummins $13,750 $- $97,683 $- $- $- $111,433
    Andrea Grubb Barthwell, MD  -  -  251,329  -  -  -  251,329
    Jay Wolf  -  816,000  236,398  -  -  -  1,052,398
    Kelly McCrann  -  -  6,126  -  -  -  6,126

    Notes to our equitydirector compensation plans (including individual compensation arrangements) under which our equity securities are authorized for issuance, aggregated by (i) all compensation plans previously approved by our security holders, and (ii) all compensation plans not previously approved by our security holders.

    52

    table:

    (1)       These are fees earned in 2009 but not yet paid.
    (2)  
    Amounts reflect the compensation expense recognized in our Company's financial statements in 2010 for non-employee director stock options granted in 2010 and in previous years, in accordance with FASB accounting rules. As such, these amounts do not correspond to the compensation actually realized by each director for the period. See notes to consolidated financial statements in this report for further information on the assumptions used to value stock options granted to non-employee directors.
    (3)  There were a total of 33,900,000 stock options granted to non-employee directors outstanding at December 31, 2010 with an aggregate grant date fair value of $2,539,509, the last of which will vest in December 2013.  A total of 32,400,000 options to purchase common stock (10,800,000 per director), as well as 20,400,000 shares of restricted stock to Mr. Wolf in consideration of his services as lead director were granted to all non-employee directors on December 9, 2010. Outstanding equity awards by non-employee directors as of December 31, 2010 were as follows:


        Aggregate 
       grant date 
       fair market 
     Options value options 
     outstanding outstanding 
    Marc Cummins  500,000  $662,190 
    Andrea Grubb Barthwell, MD  11,300,000   953,350 
    Jay Wolf  11,300,000   619,071 
    Kelly McCrann  10,800,000   304,897 
             
       33,900,000   2,539,509 

    49
         Number of securities remaining 
     Number of securities to Weighted average available for future issuance 
     be issued upon exercise exercise price of under equity compensation 
     of outstanding options, outstanding options, plans (excluding securities 
    Plan Categorywarrants and rights warrants and rights referenced in the first column) 
    		 
    		 
    		 
       Equity compensation plans       
          approved by security holders3,940,000      $2.56      1,060,000 
       Equity compensation plans not       
          approved by security holders—  — — 
     
    		 
    		 
    		 
       Total3,940,000 $2.56 1,060,000 
     
    		 
    		 
    		 

         On September 29, 2003, immediately following the merger, our board of directors adopted, and a majority of our stockholders approved, a 2003 Stock Incentive Plan, with 5,000,000 shares of common stock reserved for issuance thereunder. Options to purchase approximately 3,940,000 shares were outstanding as of December 31, 2003.


    SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT


    The following table sets forth certain information regarding the shares of common stock beneficially owned or deemed to be beneficially owned as of December 31, 2003March 28, 2011 by: (i) each person known to the Companyus to be the beneficial owner of more than 5% of theour common stock, of the Company, (ii) each director of the Company,our directors, (iii) each executive officer named in the Summary Compensation Table set forth in the Executive Compensation section, and (iv) all such directors and officers as a group:

       Name(1) Common stock
    beneficially
    owned(2)    		 Percent of class(3) 
    		 
    		 
    		 
       Terren S. Peizer(4)         13,740,000       55.8%
       Juan José Legarda(5) 835,916 3.4%
       Anthony LaMacchia — — 
       Chuck Timpe — — 
       Leslie F. Bell — — 
       Hervé de Kergrohen — — 
       Richard Anderson — — 
       Ivan M. Lieberburg — — 
      
    		 
    		 
    All directors and executive officers as a group (8 persons) 14,575,916 59.2%
      
    		 
    		 

    ___________group.


    Notes to Beneficial Ownership Table:

            Total    
      Common  Options &  common    
      stock  warrants  stock  Percent 
      beneficially  exercisable  beneficially  of 
    Name of beneficial owner (1) owned (2)   (3)  owned  class (3) 
    Terren S. Peizer (4)  242,862,552   50,638,139   293,500,691   33.2%
    Richard A. Anderson (5)  -   47,394,665   47,394,665   5.4%
    Peter Donato  -   -   -   * 
    Andrea Barthwell, M.D. (6)  -   8,265,250   8,265,250   * 
    Jay A. Wolf (7)  48,327,099   6,765,900   55,092,999   6.5%
    Esousa Holdings LLC (8)  51,895,376   25,000,000   76,895,376   8.9%
    Dave Smith (9)  208,867,397   23,460,000   232,327,397   27.1%
    Maurice Hebert (10)  -   185,753   185,753   * 
    Christoper Hassan (11)  -   533,190   533,190   * 
    Superload Ltd. (12)  67,234,490   -   67,234,490   8.1%
                     
    * Less than 1%                
    All directors and named executive officers as a group (8 persons)  292,630,785   113,415,482   406,046,267   42.8%

    (1)
               		The mailing address of all individuals listed is c/o Hythiam,Catasys, Inc., 11150 Santa Monica Boulevard, Suite 1500, Los Angeles, California 90025.
    (2)
    		The number of shares beneficially owned includes shares of common stock in which a person has sole or shared voting power and/or sole or shared investment power. Except as noted below, each person named reportedly has sole voting and investment powers with respect to the common stock beneficially owned by that person, subject to applicable community property and similar laws.
    (3)
    		On December 31, 2003,March 28, 2011, there were 24,606,885834,419,950 shares of common stockCommon Stock outstanding. Common stockStock not outstanding but which underlies options and rights (including warrants) vested as of or vesting within 60 days after December 31, 2003March 28, 2011 is deemed to be outstanding for the purpose of computing the percentage of the common stockCommon Stock beneficially owned by each named person (and the directors and executive officers as a group), but is not deemed to be outstanding for any other purpose.

    53

    (4)
    		SharesConsists of 242,862,552 shares and 50,638,139 shares issuable upon exercise of options to purchase common stock, 13,600,000, 207,045,924 and 22,216,628 shares are held of record by  Reserva  Capital LLC, which is ownedSocius LLC and controlled byBonmore, LLC,   respectively, where Mr. Peizer.
    Peizer serves as Managing Director and may be deemed to beneficially own or control. Mr. Peizer disclaims beneficial ownership of any such securities.
    (5)
    		Shares areIncludes 47,394,665 options to purchase common stock.
    (6)Includes 8,265,250 options to purchase common stock.
    (7) Consists of 41,086,740 shares and 6,765,900 options held by Jay Wolf. Family members, David Wolf and Mary Wolf, hold 2,068,674  shares and 5,171,685 shares, respectively.
    (8)Consists of record by Tratamientos Avanzados de la Adicción S.L., which50,895,376 shares, 25,000,000 shares issuable upon warrants to purchase common stock. The address for Esousa Holdings LLC is owned and controlled by Dr. Legarda.
    317 Madison Ave, Suite 1621, New York, NY 10017.
    (9) Consists of 208,867,397 shares, 23,460,000 shares issuable upon exercise of warrants to purchase common stock .The address for Mr. Smith is c/o Coast Asset Management, LLC, 2450 Colorado Avenue, Suite 100 E. Tower, Santa Monica, California 90404.
    (10)Includes 185,753 shares issuable upon exercise of options to purchase common stock.
    (11)Includes 533,190 shares issuable upon exercise of options to purchase common stock.
    (12) Consists of 67,234,490 shares of common stock.  The address for Superload Ltd. is c/o C. M. Hui & Co, Unit C, 7/F, Nathan Commercial Building, 430-436 Nathan Road, Kowloon, Hong Kong

    CERTAIN RELATIONSHIPS AND


    50
    RELATED PARTY TRANSACTIONS

         Our predecessor Hythiam, Inc. obtained


    Review and Approval of Transactions with Related Persons

    Either the rightsaudit committee or the Board approves all related party transactions. The procedure for the review, approval or ratification for related party transactions involves discussing the transaction with management, discussing the transaction with the external auditors, reviewing financial statements and related disclosures and reviewing the details of major deals and transactions to exploitensure that they do not involve related transactions. Members of management have been informed and understand that they are to bring related party transactions to the audit committee or the Board for approval. These policies and procedures are evidenced in the audit committee charter and our patent pending alcoholcode of ethics.

    On December 9, 2010, the Board approved a related-party sublease of approximately one-third of our principal corporate offices located at 11150 Santa Monica Blvd., Los Angeles, CA to Reserva LLC, an affiliate of our Chairman and cocaine addiction treatment proceduresCEO.
    Certain Transactions

    Lawrence Weinstein, M.D., senior vice president – medical affairs, is the sole shareholder of Weinstein Medical Group dba Center To Overcome Addiction (the Center), a California professional corporation. Under the terms of a management services agreement with the Center, we provide and perform all non-medical management and administrative services for the medical group. We also agreed to provide a working capital loan to the Center to allow for the medical group to pay for its obligations, including our management fees, equipment, leasehold build-out and start-up costs. As of December 31, 2010, the amount of loan outstanding was approximately $10.4 million, with interest at the prime rate plus 2%. Payment of our management fee is subordinate to payments of the obligations of the medical group, and repayment of the working capital loan is not guaranteed by the stockholder or other third party.

    In October 2010, our Company entered into Securities Purchase Agreements with certain accredited investors, including Socius Capital Group, LLC (“Socius”), an affiliate of our Chairman and Chief Executive Officer, pursuant to which such investors purchased $500,000 of senior secured convertible notes (the “Bridge Notes”) and warrants to purchase an aggregate of 12,500,000 shares of our common stock (the “Bridge Warrants”). Socius purchased a Technology Purchase$250,000 senior secured convertible note.

    The Bridge Notes were scheduled to mature January 2011 and License Agreement, as amended,interest was payable in cash at maturity or upon prepayment or conversion.  The Bridge Notes and any accrued interest were convertible at the holders’ option into common stock or exchangeable for the securities issued in the next financing our Company entered into that resulted in gross proceeds to our Company of at least $3,000,000.  The Bridge Warrants were exercisable for 5 years at $0.04 per share subject to adjustment for financings and share issuances below the initial exercise price. The Bridge Warrants for the non-affiliated investors limit the amount of common stock that the holders may acquire through an exercise to no more than 4.99% of all Company Securities, defined as common stock, voting stock, or other Company securities. All the holders exchanged the Bridge Notes plus interest for securities issued in our Company’s November 2010 financing (see below).
    51

    In November 2010, our Company completed a private placement with certain accredited investors, including Socius and Jay Wolf, a company now known as Tratamientos Avanzados de la Adicción S.L, a Spanish corporation, on March 12, 2003. Underdirector of the agreement, we agreedCompany, for gross proceeds of $6.9 million (the “Offering”). Of the gross proceeds, $503,000 represented the exchange of the Bridge Notes and accrued interest and $215,000 represented the cancellation of an accrued compensation liability to grant 835,916our Chairman and CEO. Our Company incurred approximately $364,000 in financial advisory, legal and other fees in relation to the offering. In addition, our Company issued warrants to purchase 5,670,000 shares of common stock as well as options to acquire up to 531,518 additional shares at $2.50an exercise price $0.01 per share and to pay continuing royalties of 3% of gross sales of the licensed procedures. Dr. Juan José Legarda, who serves as a director and member of our clinical advisory board, is the principal of Tratamientos Avanzados de la Adicción S.L.

    financial advisors. Our predecessor Hythiam, Inc. obtained the rights to exploit our patented opiate treatment procedures at a foreclosure sale conducted by Reserva, LLC, a California limited liability company, in exchange for $313,196 in cash and an agreement to issue 360,000Company issued 100,000,000 shares of common stock at a price of $0.01 per share and sold $5.9 million in aggregate principal of 12% senior secured convertible notes (the “Notes”) to the investors on a company now known as Xino Corporation under certain terms and conditions. Terren S. Peizer, who serves as our chairmanpro rata basis. The Notes were to mature on the second anniversary of the boardclosing.  The Notes were secured by a first priority security interest in all of our Company’s assets. The Notes and any accrued interest convert automatically into common stock either (a) if and when sufficient shares become authorized or (ii) upon a reverse stock split at a conversion price of $0.01 per share, subject to certain adjustments, including certain share issuances below $0.01 per share. Our Company agreed to use its best efforts to file a proxy statement seeking shareholder approval to increase the number of authorized shares or effect a reverse stock split within 30 days of closing. Our Company filed a proxy statement in January 2011 and the stockholders approved both proposals listed above and the Board of Directors decided to implement the increase in authorized shares of common stock. Our Company filed an amendment to its Certificate of Incorporation, effective March 17, 2011, which increased the authorized shares of common stock and the Notes with accrued interest automatically converted to common stock. In addition, each non-affiliated investor in the Offering investing $2,000,000 or more also received five-year warrants to purchase an aggregate of 21,960,000 shares of our Company common stock at an exercise price of $0.01 per share. One investor received such warrants. The net cash proceeds to our Company from the Offering were estimated to be $6.4 million inclusive of the October transaction and after offering expenses. Socius investment in the transaction was approximately $2.2m and Mr. Wolf's envestment was approximately $270,000.

    Independence of the Board of Directors

    Our common stock is traded on the OTC Bulletin Board. The Board has determined that a majority of the members of the Board qualify as “independent,” as defined by the listing standards of the NASDAQ. Consistent with these considerations, after review of all relevant transactions and relationships between each director, or any of his family members, and Catasys, its senior management and its independent auditors, the Board has determined further that Mr. Wolf, Mr. McCrann, and Dr. Barthwell are independent under the listing standards of NASDAQ. In making this determination, the Board considered that there were no new transactions or relationships between its current independent directors and chief executive officer,Catasys, its senior management and its independent auditors since last making this determination.

    LEGAL MATTERS

    Validity of the securities offered by this prospectus will be passed upon for us by Mintz, Levin, Cohn, Ferris, Glovsky, and Popeo, P.C., New York, New York

    EXPERTS

    The financial statements included in this prospectus have been audited by Rose, Snyder & Jacobs ,who is an independent registered public accounting firm, to the sole principalextent and for the periods set forth in their reports appearing elsewhere herein, and are included herein in reliance upon such reports given upon the authority of Reserva, LLC.

    said firm as experts in auditing and accounting.


    INDEMNIFICATION UNDER OUR CERTIFICATE OF INCORPORATION AND BYLAWS


    The Certificate of Incorporation of our companyCompany provides that no director will be personally liable to the companyour Company or its stockholders for monetary damages for breach of a fiduciary duty as a director, except to the extent such exemption or limitation of liability is not permitted under the Delaware General Corporation Law (“GCL”).Law. The effect of this provision in the Certificate of Incorporation is to eliminate the rights of the company and its stockholders, either directly or through stockholders’ derivative suits brought on behalf of the company,our Company, to recover monetary damages from a director for breach of the fiduciary duty of care as a director except in those instances described under the Delaware GCL.General Corporation Law. In addition, we have adopted provisions in our Bylaws and entered into indemnification agreements that require the companyour Company to indemnify its directors, officers, and certain other representatives of the companyour Company against expenses and certain other liabilities arising out of their conduct on behalf of the companyour Company to the maximum extent and under all circumstances permitted by law.


    Indemnification may not apply in certain circumstances to actions arising under the federal securities laws. Insofar as indemnification for liabilities arising under the Securities Act of 1933, as amended (the “Securities Act”) may be permitted to directors, officers or persons controlling the registrantour Company pursuant to the foregoing provisions, the registrantour Company has been informed that in the opinion of the Securities and Exchange Commission (“SEC”) such indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable.

    52
    WHERE YOU CAN FIND ADDITIONALMORE INFORMATION

    We have filed a registration statement on Form S-1file annual, quarterly and special reports and other information with the Securities and Exchange Commission relating to the common stock offered bySEC. These filings contain important information that does not appear in this prospectus. This prospectus does not contain all of the information set forth in the registration statement and the exhibits and schedules to the registration statement. Statements contained in this prospectus as to the contents of any contract or other document referred to are not necessarily complete and in each instance we refer you to the copy of the contract or other document filed as an exhibit to the registration statement, each such statement being qualified in all respects by such reference. For further information with respect to Hythiamabout us, you may read and the common stock offered by this prospectus, we refer you to the registration statement, exhibits and schedules.

    We are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended. In accordance with the Exchange Act, we filecopy any reports, proxy statements and other information wit the Securities and Exchange Commission. Anyone may inspect a copy of the registration statement without chargefiled by us at the public reference facilities maintained by the SEC inSEC’s Public Reference Room 1024, 450 Fifthat 100 F Street, N.W.N.E., Room 1580, Washington, D.C. 20549; Northeast Regional Office, 233 Broadway, New York, New York 10279; Southeast Regional Office, 801 Brickell Avenue, Suite 1800, Miami, Florida; Midwest Regional Office, 175 West Jackson Boulevard, Suite 900, Chicago, Illinois 60604; Central Regional Office, 1801 California Street, Suite 1500, Denver, Colorado 80202; and Pacific Regional Office, 5670 Wilshire Boulevard, 11th Floor, Los Angeles, California 90036. Copies of all or any part of the registration statement20549-0102. You may be obtained from the Public Reference Section of the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549, upon payment of the prescribed fees. The public may obtain further information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. TheOur SEC maintains a Webfilings are also available on the SEC Internet site athttp://www.sec.gov, that which contains reports, proxy and information statements, and other information regarding registrantsissuers that file electronically with the SEC.

    53
    CATASYS, INC. AND SUBSIDIARIES
    Index to Financial Statements and Financial Statement Schedules

    PART I - FINANCIAL INFORMATION

    INDEX TO FINANCIAL STATEMENTS

    Financial Statements for the Last Two Fiscal Years

    Page
    Three Months Ended March 31, 2004
    Balance Sheets as of March 31, 2004 (unaudited) and December 31, 2003F-2
    Statements of Operations (unaudited) for the Three Months Ended March 31, 2004 and the Period from February 13, 2003F-3
       (Inception) through March 31, 2004
    Statement of Stockholders’ Equity for the Period from February 13, 2003 (Inception) through March 31, 2004 (unaudited forF-4
       the Three Months Ended March 31, 2004)
    Statements of Cash Flows (unaudited) for the Three Months Ended March 31, 2004 and the Period from February 13, 2003F-5
       (Inception) through March 31, 2004
    Notes to Financial StatementsF-6
    Year Ended December 31, 2003
    Report of Independent Registered Public Accounting FirmF-9F-2
    Consolidated Balance SheetSheets as of December 31, 20032010 and 2009F-10F-3
    Statement
    Consolidated Statements of Operations for the Period from February 13, 2003 (Inception) throughYears Ended December 31, 20032010 and 2009F-11F-4
    Statement
    Consolidated Statements of Stockholders’ Equity for the Period from February 13, 2003 (Inception) throughYears Ended December 31, 20032010 and 2009F-12F-5
    Statement
    Consolidated Statements of Cash Flows for the Period from February 13, 2003 (Inception) throughYears Ended December 31, 20032010 and 2009F-13F-6
    Notes to Consolidated Financial StatementsF-14F-8

    F-1

    HYTHIAM, INC.


    (a Development Stage Company)
    Financial Statement Schedules

    BALANCE SHEETS

    (Dollars in thousands, except share data)March 31, December 31, 
     2004 2003 
     
    		 
    		 
    ASSETS(Unaudited)    
           
    Current assets      
       Cash and cash equivalents$1,670         $3,444 
       Marketable securities 12,231  13,196 
       Receivables 413  455 
       Prepaids and other current assets 397  249 
     
    		 
    		 
          Total current assets 14,711  17,344 
    Long-term assets      
       Property and equipment, net 2,321  1,981 
       Intellectual property, net 2,751  2,772 
       Deposits and other assets 352  483 
     
    		 
    		 
     $20,135 $22,580 
     
    		 
    		 
    LIABILITIES AND STOCKHOLDERS' EQUITY      
           
    Current liabilities      
       Accounts payable$874 $1,259 
       Accrued compensation and benefits 586  318 
       Other accrued liabilities 534  451 
     
    		 
    		 
       Total current liabilities 1,994  2,028 
     
    		 
    		 
    Long-term liabilities      
       Deferred rent liability 71  64 
    Commitments and contingencies      
           
    Stockholders' equity      
       Preferred stock, $.0001 par value; 50,000,000 shares authorized; no shares issued      
          and outstanding —  — 
       Common stock, $.0001 par value; 200,000,000 shares authorized; 24,615,000 and      
          24,607,000 issued and outstanding, respectively 3  3 
       Additional paid-in-capital 24,707  24,113 
       Deficit accumulated during the development stage (6,640) (3,628)
     
    		 
    		 
    Total stockholders' equity 18,070  20,488 
     
    		 
    		 
     $20,135 $22,580 
     
    		 
    		 

    See accompanying notes to

    All financial statements.

    F-2

    HYTHIAM, INC.
    (a Development Stage Company)
    STATEMENTS OF OPERATIONS

    (Unaudited)

       Period From 
      February 13, 
     Three 2003 
     Months (Inception) 
     Ended through 
     March 31, March 31, 
    (In thousands, except per share amounts)2004 2004 
     
    		 
    		 
           
    Revenues$67         $142 
    Operating Expenses      
       General and administrative      
          Salaries and benefits 1,288  2,905 
          Other expenses, including $568 and $913,      
             respectively, related to stock-based expense 1,686  3,614 
       Depreciation and amortization 143  218 
     
    		 
    		 
          Total operating expenses 3,117  6,737 
     
    		 
    		 
    Loss from operations (3,050) (6,595)
    Interest income 40  81 
     
    		 
    		 
    Loss before provision for income taxes (3,010) (6,514)
    Provision for income taxes 2  2 
     
    		 
    		 
    Net loss$(3,012)$(6,516)
     
    		 
    		 
    Basic and diluted loss per share$(0.12)   
     
    		    

    See accompanying notes to financial statements.

    Note:Corresponding comparative information for the period ended March 31, 2003 isstatement schedules are omitted because they are not included because it was immaterial for the prior period and would provide no useful information to the investor since business activity hadapplicable, not yet commenced.

    F-3

    HYTHIAM, INC.
    (a Development Stage Company)
    STATEMENT OF STOCKHOLDERS' EQUITY
    For the Period from Inception through March 31, 2004
    (Unaudited for the Three Months Ended March 31, 2004)

                Deficit   
    (In thousands)Preferred Stock Common Stock  Accumulated   
     
    		 
    		 Additional During   
              Paid-in- Development   
     Shares  Amount Shares Amount Capital Stage Total 
     
    		 
    		 
    		 
    		 
    		 
    		 
    		 
    Common stock issued at inception—      $—      13,740      $—      $1      $—      $1 
    Common stock issued in merger                   
       transaction—  — 1,120  1  (1) —  — 
    Preferrred stock and warrants                   
       issued for cash1,876  2 —  —  4,688  —  4,690 
    Beneficial conversion feature of                   
       preferred stock—  — —  —  124  (124) — 
    Common stock issued in private                   
       placement offering, net of expenses—  — 7,035  7  16,647  —  16,654 
    Conversion of preferred stock to                   
       common stock(1,876) (2)1,876  2  —  —  — 
    Par value change from $0.001                   
       to $0.0001—  — —  (8) 8  —  — 
    Common stock and options issued                   
       for intellectual property acquired—  — 836  1  2,280  —  2,281 
    Stock options and warrants issued for                   
       outside services—  — —  —  366  —  366 
    Net loss—  — —  —  —  (3,504) (3,504)
     
    		 
    		 
    		 
    		 
    		 
    		 
    		 
    Balance at December 31, 2003—  — 24,607  3  24,113  (3,628) 20,488 
    Common stock, options and warrants                   
       issued for outside services—  — 8  —  65  —  65 
    Stock-based compensation—  — —  —  529  —  529 
    Net loss—  — —  —  —  (3,012) (3,012)
     
    		 
    		 
    		 
    		 
    		 
    		 
    		 
    Balance at March 31, 2004— $— 24,615 $3 $24,707 $(6,640)$18,070 
     
    		 
    		 
    		 
    		 
    		 
    		 
    		 

    See accompanying notes to financial statements.

    Note:Corresponding comparative information for the period ended March 31, 2003 is not included because it was immaterial for the prior period and would provide no useful information to the investor since business activity had not yet commenced.

    F-4

    HYTHIAM, INC.
    (a Development Stage Company)
    STATEMENTS OF CASH FLOWS
    (Unaudited)

       Period From 
       February 13, 
       2003 
     Three Months (Inception) 
     Ended through 
    (In thousands)March 31, 2004 March 31, 2004 
     
    		 
    		 
    Operating activities      
       Net loss$(3,012)         $(6,516)
       Adjustments to reconcile net loss to net cash used in operating activities:      
          Depreciation and amortization 143  218 
          Deferred rent liability 7  71 
          Stock-based expense 568  913 
          Changes in current assets and liabilities:      
             Decrease (increase) in receivables 42  (413)
             Increase in prepaids and other current assets (122) (350)
             (Decrease) increase in accounts payable (385) 874 
             Increase in accrued compensation and benefits 268  586 
             Increase in accrued liabilities 83  534 
     
    		 
    		 
           
    Net cash used in operating activities (2,408) (4,083)
     
    		 
    		 
    Investing activities      
       Purchases of marketable securities (6,535) (24,775)
       Proceeds from sales and maturities of marketable securities 7,500  12,544 
       Purchases of property and equipment (309) (2,451)
       Cash deposited as collateral for letter of credit —  (350)
       Cost of intellectual property (22) (560)
     
    		 
    		 
    Net cash provided by (used in) investing activities 634  (15,592)
     
    		 
    		 
    Financing activities      
       Net proceeds from the sale of common and preferred stock and warrants —  21,345 
     
    		 
    		 
    Net cash provided by financing activities —  21,345 
     
    		 
    		 
    Net (decrease) increase in cash and cash equivalents (1,774) 1,670 
    Cash and cash equivalents at beginning of period 3,444  — 
     
    		 
    		 
    Cash and cash equivalents at end of period$1,670 $1,670 
     
    		 
    		 
    Supplemental disclosure of non-cash activity      
       Common stock and options issued for intellectual property$— $2,281 
       Common stock and warrants issued to consultants 65  204 
       Common stock and warrants issued as commissions on private placement —  265 
     
    		 
    		 

    See accompanying notes to financial statements.

    F-5

    Hythiam, Inc.
    Notes to Financial Statements
    (Unaudited)

    Note 1. Basis of Presentation

            The accompanying unaudited interim condensed financial statements for Hythiam, Inc. (“Hythiam”required, or the “Company”), a development stage company, have been prepared in accordance with accounting principles generally acceptedinformation is shown in the United StatesFinancial Statements or Notes thereto.

    F-1
    Report of America for interim financial information and do not include all information and notes required for complete financial statements.  In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included.   Interim results are not necessarily indicative of the results that may be expected for the entire fiscal year. The accompanying financial information should be read in conjunction with the financial statements and the notes thereto in the Company’s most recent Annual Report on Form 10-K. The December 31, 2003 balance sheet has been derived from the audited financial statements on Form 10-K. All share data has been restated to reflect stock splits.

            The Company is considered a development stage company since revenues earned to date from operations have not been significant.

    Note 2. Basic and Diluted Loss per Share

            In accordance with SFAS 128, “Computation of Earnings Per Share,” basic earnings (loss) per share is computed by dividing the net earnings (loss) available to common stockholders for the period by the weighted average number of common shares outstanding during the period.  Diluted earnings (loss) per share is computed by dividing the net earnings (loss) for the period by the weighted average number of common and dilutive common equivalent shares outstanding during the period.

            Common equivalent shares, consisting of 5,817,000 of incremental common shares as of March 31, 2004, issuable upon the exercise of stock options and warrants have been excluded from the diluted earnings per share calculation because their effect is anti-dilutive.

            A summary of the net loss and shares used to compute net loss per share is as follows:

     Three Months 
     Ended 
     March 31, 2004 
     
    		 
       
    Net loss$(3,012,000)
     
    		 
    Basic and diluted loss per share$(0.12)
     
    		 
    Weighted average common shares used to compute basic net loss per share 24,613,000 
    Effect of dilutive securities — 
     
    		 
    Weighted average common shares used to compute diluted net loss per share 24,613,000 
     
    		 

    Note 3. Stock Options

            Under the 2003 Stock Incentive Plan, the Company has granted options to employees and directors as well as to non-employees for outside consulting services.

            The Company accounts for the issuance of employee stock options using the intrinsic value method underIndependent Registered Public Accounting Principles Board Opinion No. (“APB”) 25, “Accounting for Stock Issued to Employees.” During the quarter ended March 31, 2004 the Company did not recognize any compensation costs for options granted to employees as the exercise price equaled the fair value of the Company’s common stock on the date of grant. Had the Company determined compensation cost based on the fair value at the grant date for its employee stock options under SFAS No. 123, “Accounting for Stock-Based Compensation”, the pro forma effect on net loss and net loss per share would have been as follows:

    F-6

     Three Months 
     Ended March 31, 
     2004 
     
    		 
    Net loss:   
       As reported$(3,012,000)
       Less: Stock based compensation expense determined under fair value method (82,000)
     
    		 
          Pro forma net loss$(3,094,000)
     
    		 
        
    Net loss per share:   
       As reported – basic$(0.12)
       Pro forma – basic$(0.13)
        
       As reported – diluted$(0.12)
       Pro forma – diluted$(0.13)

    The estimated fair value of options granted to employees in the first quarter was $4.29 per share calculated using the Black-Scholes pricing model with the following assumptions:

    Expected volatility61%
    Weighted average risk-free interest rate3.84%
    Expected lives10 years
    Expected dividend yield0%

            Activity under the 2003 Stock Incentive Plan during the three months ended March 31, 2004 is as follows:

       Weighted 
       Average Exercise 
     Shares Price 
     
    		 
    		 
    Balance, December 31, 20033,940,000 $2.56 
       Granted643,000  5.86 
       Exercised—  — 
       Less:Cancelled(150,000) (2.50)
     
    		 
    		 
    Balance, March 31, 20044,433,000 $3.04 
     
    		 
    		 

            Included in the balance outstanding as of March 31, 2004 are options for 520,000 shares granted to consultants and directors providing consulting services. These options vest over periods ranging from three to four years and are being charged to expense as services are provided using the variable accounting method. During the three months ended March 31, 2004, stock-based expense relating to such stock options amounted to $265,000. These options have an estimated fair value of approximately $2,428,000 as of March 31, 2004, using the Black-Scholes pricing model.  75,000 of such options were granted to consultants during the quarter ended March 31, 2004.

    Note 4. Warrants

            The Company accounts for the issuance of warrants for services from non-employees in accordance with SFAS 123, by estimating the fair value of warrants issued using the Black-Scholes pricing model.  This model’s calculations include the warrant exercise price, the market price of shares on grant date, the weighted average information for risk-free interest, expected life of warrant, expected volatility of the Company’s stock and expected dividends.

    F-7

            If warrants issued as compensation to non-employees for services are fully vested and non-forfeitable at the time of issuance, the estimated value is recorded in equity and expensed when the services are performed and benefit is received as provided by Financial Accounting Standards Board (“FASB”) Emerging Issues Task Force No. (“EITF”) 96-18.  If warrants are issued for consideration in an acquisition of assets, the value of the warrants are recorded in equity at the time of issuance and included in the purchase price to be allocated.

            During the three months ended March 31, 2004, warrants to purchase 150,000 shares of common stock at $7.00 per share were issued to a management advisor for investor relations services. These warrants vest monthly over a 12-month period and expire five years from date of issue. The warrants have an estimated value of approximately $417,000 using the Black-Scholes pricing model. Warrant activity for the three months ended March 31, 2004 is summarized as follows:

     
    Weighted
    		 
     
    Average
    		 
     
    Remaining
    Weighted
    		 
     
    Contractual
    Average
    		 
     
    Shares
    Life (yrs)
    Exercise Price
    		 
     
    		 
    		 
    		 
           
    Warrants outstanding, December 31, 20031,234,000 5.7 $2.54 
       Issued150,000 5.0 $7.00 
     
    		 
    		 
    		 
    Warrants outstanding, March 31, 20041,384,000 5.4 $3.02 
     
    		 
    		 
    		 

            During the three months ended March 31, 2004, stock-based expense relating to warrants amounted to $263,000.

    F-8

    REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

    Firm

    To the Stockholders and Board of Directors and Stockholders of Hythiam,Catasys, Inc.
    Los Angeles, California

    We have audited the accompanying consolidated balance sheetsheets of Hythiam,Catasys, Inc. (a Development Stage Company)and Subsidiaries (the “Company”) as of December 31, 20032010 and 2009 and the related consolidated statements of operations, stockholders’ equity and cash flows for the period from February 13, 2003 (inception) to December 31, 2003.years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on thethese consolidated financial statements based on our audit.

    audits.


    We conducted our auditaudits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includesstatements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit providesaudits provide a reasonable basis for our opinion.


    In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial positionpositions of Hythiam,Catasys, Inc. (a Development Stage Company) atand Subsidiaries as of December 31, 20032010 and 2009, and the consolidated results of itstheir operations and itstheir cash flows for the period from February 13, 2003 (inception) to December 31, 2003,years then ended in conformity with accounting principles generally accepted in the United States of America.

    /s/ BDO SEIDMAN, LLP

    Los Angeles, California


    March 24, 2004

    F-9

    HYTHIAM, INC.
    (

    The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a Development Stage Company)
    BALANCE SHEET
    going concern. As ofdiscussed in Note 1 to the financial statements, the Company has incurred significant operating losses and negative cash flows from operations during the year ended December 31, 2003
    (Dollars in thousands, except per share data)
    		  
    ASSETS
    		    
         
    Current assets
    		    
    Cash and cash equivalents $3,444 
    Marketable securities  13,196 
    Receivables  455 
    Prepaids and other current assets  249 
      
    		 
    Total current assets  17,344 
    Long-term assets
    		    
    Property and equipment, net  1,981 
    Intellectual property, net  2,772 
    Deposits and other assets  483 
      
    		 
      $22,580 
      
    		 
    LIABILITIES AND STOCKHOLDERS' EQUITY
    		    
         
    Current liabilities
    		    
    Accounts payable $1,259 
    Accrued compensation and benefits  318 
    Other accrued liabilities  451 
      
    		 
    Total current liabilities  2,028 
      
    		 
    Long-term liabilities
    		    
    Deferred rent liability  64 
     
    Commitments and contingencies
    		    
         
    Stockholders' equity
    		    
    Preferred stock, $.0001 par value; 50,000,000 shares authorized, no shares issued and outstanding  — 
    Common stock, $.0001 par value; 200,000,000 shares authorized, and 24,607,000 issued and    
    outstanding  3 
    Additional paid-in capital  24,113 
    Deficit accumulated during the development stage  (3,628)
      
    		 
    Total stockholders' equity  20,488 
      
    		 
      $22,580 
      
    		 

    See2010. These conditions raise substantial doubt about the Company's ability to continue as a going concern. Management's plans regarding those matters also are described in Note 1. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.



    /s/ Rose, Snyder & Jacobs
    A Corporation of Certified Public Accountants

    Encino, California

    March 31, 2011
    F-2
     CATASYS, INC.  AND SUBSIDIARIES
    CONSOLIDATED BALANCE SHEETS

    (In thousands)December 31, 
     2010  2009 
    ASSETS     
    Current assets     
    Cash and cash equivalents$4,605  $4,595 
    Marketable securities, at fair value -   9,468 
    Receivables, net 73   308 
    Prepaids and other current assets 183   989 
    Total current assets 4,861   15,360 
    Long-term assets       
    Property and equipment, net of accumulated depreciation of       
    $5,864 and $6,697, respectively 194   877 
    Intangible assets, net of accumulated amortization of       
    $1,938 and $1,702, respectively 2,423   2,658 
    Deposits and other assets 466   210 
    Total Assets$7,944  $19,105 
            
    LIABILITIES AND STOCKHOLDERS' EQUITY       
    Current liabilities       
    Accounts payable$1,665  $2,266 
    Accrued compensation and benefits 706   941 
    Other accrued liabilities 1,036   2,431 
    Short-term debt -   9,643 
    Total current liabilities 3,407   15,281 
    Long-term liabilities       
    Long-term debt 5,824   - 
    Deferred rent and other long-term liabilities -   46 
    Warrant liabilities 8,890   1,089 
    Capital lease obligations -   48 
    Total liabilities 18,121   16,464 
            
    Stockholders' equity       
    Preferred stock, $.0001 par value; 50,000,000 shares authorized;       
    no shares issued and outstanding -   - 
    Common stock, $.0001 par value; 200,000,000 shares authorized;       
    181,711,000 and 65,283,000 shares issued and outstanding       
    at December 31, 2010 and December 31, 2009, respectively 18   7 
    Additional paid-in-capital 192,578   184,715 
    Accumulated other comprehensive income -   696 
    Accumulated deficit (202,773)  (182,777)
    Total Stockholders' Equity (10,177 )  2,641 
    Total Liabilities and Stockholders' Equity$7,944  $19,105 
    The accompanying notesNotes to financial statements

    F-10

    Consolidated Financial Statements are an integral part of these statements.
    F-3

    HYTHIAM,

    CATASYS, INC.
    (a Development Stage Company)
    STATEMENT AND SUBSIDIARIES
     CONSOLIDATED STATEMENTS OF OPERATIONS
     Year Ended December 31, 
    (In thousands, except per share amounts)2010  200 
          
    Revenues     
    Healthcare services$28  $- 
    License and Management Revenue 420   1,530 
    Total revenues 448   1,530 
            
    Operating expenses       
    Cost of healthcare services$255  $509 
    General and administrative expenses 12,784   18,034 
    Impairment losses -   1,113 
    Depreciation and amortization 882   1,248 
    Total operating expenses 13,921   20,904 
            
    Loss from operations$(13,473) $(19,374)
            
    Non-operating income (expenses)       
    Interest & other income 131   941 
    Interest expense (1,025)  (1,142)
    Loss on extinguishment of debt -   (330) 
    Gain on the sale of marketable securities 696   160 
    Other than temporary impairment of       
    marketable securities -   (185)
    Change in fair value of warrant liabilities (6,303 )  341 
            
    Loss from continuing operations before       
    provision for income taxes (19,974)  (19,589)
    Provision for income taxes 22   18 
    Loss from continuing operations$(19,996) $(19,607)
            
    Discontinued operations:       
    Results of discontinued operations, net of tax -   10,449 
            
    Net loss$(19,996) $(9,158)
            
    Basic and diluted net income (loss) per share:       
    Continuing operations$(0.23) $(0.34)
    Discontinued operations -   0.18 
    Net loss per share$(0.23) $(0.16)
            
    Weighted number of shares outstanding 86,862   57,947 

    For the period from February 13, 2003 (Inception) through December 31, 2003
    (In thousands except per share amounts)
     
    		    
    Revenues
    		 $75 
    Operating expenses
    		    
    General and administrative    
    Salaries and benefits  1,617 
    Other expenses, including $337 related to stock-based payments  1,928 
             Depreciation and amortization  75 
      
    		 
    Total operating expenses  3,620 
      
    		 
    Loss from operations
    		  (3,545)
    Interest income  41 
      
    		 
    Loss before provision for income taxes
    		  (3,504)
    Provision for income taxes  — 
      
    		 
    Net loss
    		 $(3,504)
      
    		 
    Basic and diluted loss per share
    		 $(0.21)
      
    		 

    See

    The accompanying notesNotes to financial statements

    F-11

    Consolidated Financial Statements are an integral part of these statements.
    F-4

    HYTHIAM,CATASYS, INC.
    (a Development Stage Company)
    STATEMENT  AND SUBSIDIARIES
    CONSOLIDATED STATEMENTS OF STOCKHOLDERS’STOCKHOLDERS' EQUITY

    For the period from February 13, 2003 (Inception) through December 31, 2003
    (In thousands)
    		        
           
      
    Preferred stock
    Common stock
    Additional 
    paid-in-

    Deficit
    accumulated
    during
    development

    		 
      
    Shares
    Amount
    Shares
    Amount
    capital
    stage
    Total
      

     

     

     

     

     

    Common stock issued at inception  — $—  13,740 $— $1 $— $1 
    Common stock issued in merger transaction  —  —  1,120  1  (1) —  — 
    Preferred stock and warrants issued for cash  1,876  2  —  —  4,688  —  4,690 
    Beneficial conversion feature of preferred stock  —  —  —  —  124  (124) — 
    Common stock issued in private placement offering, net of expenses  —  —  7,035  7  16,647  —  16,654 
    Conversion of preferred stock to common stock  (1,876) (2) 1,876  2  —  —  — 
    Par value change from $0.001 to $0.0001  —  —  —  (8) 8  —  — 
    Common stock and options issued for intellectual property acquired  —  —  836  1  2,280  —  2,281 
    Stock options and warrants issued for outside services  —  —  —  —  366  —  366 
    Net loss  —  —  —  —  —  (3,504) (3,504)
      
    		 
    		 

     

    		 
    		 

     

    		 

     

    		 

     

    		 
    Balance at December 31, 2003  — $—  24,607 $3 $24,113 $(3,628)$20,488 
      
    		 
    		 
    		 
    		 
    		 
    		 
    		 
    (Dollars in thousands) Common Stock  
    Additional
    Paid-In
    		 
    Other
    Comprehensive
    		 Accumulated    
      Shares  Amount  Capital Income Deficit  Total 
                      
    Balance at December 31, 2008  54,965,000   6   174,721   -  (173,619)  1,108 
                           
    Common stock issued for outside
        services
    		  971,000   -   265   -  -   265 
    Common stock issued in registered
        direct placement, net of expenses
    		  9,333,000   1   5,261   -      5,262 
    Options and warrants issued for
        employee and outside services
    		  -   -   4,422   -  -   4,422 
    Exercise of options and warrants          16   -      16 
    Common stock issued for employee
        stock purchase plan
    		  14,000   -   30   -  -   30 
    Net unrealized gain/(loss) on marketable
        securities available for sale
    		  -   -   -  696      696 
    Net loss  -   -   -    -  (9,158)  (9,158)
    Balance at December 31, 2009  65,283,000   7  $184,715 $  696 $(182,777)��$2,641 
                           
    Common stock issued for outside
        services
    		  695,000   1   270    -  -   271 
    Common stock issued in registered
        direct placement, net of expenses
    		  110,288,000   10   1,789    -      1,799 
    Common stock issued for settlemnt
        on liabilities
    		  5,445,000   -   1,234    -      1,234 
    Options and warrants issued for
        employee and outside services
    		  -   -   4,570    -  -   4,570 
    Exercise of options and warrants                    - 
    Common stock issued for employee
        stock purchase plan
    		      -         -   - 
    Net realized gain (loss) on marketable
        securities available for sale
    		  -   -   -  (696)     (696) 
    Net loss  -   -   -    -  (19,996)  (19,996)
    Balance at December 31, 2010  181,711,000   18  $192,578 $  - $(202,773) $(10,177)

    See

    The accompanying notesNotes to financial statements

    F-12

    Consolidated Financial Statements are an integral part of these statements.
    F-5

    HYTHIAM,

    CATASYS, INC.
    (a Development Stage Company)
    STATEMENT AND SUBSIDIARIES
    CONSOLIDATED STATEMENTS OF CASH FLOWS

    Period from February 13, 2003 (Inception) through December 31, 2003
    (In thousands)
     
    		    
    Operating activities
    		    
    Net loss $(3,504)
    Adjustments to reconcile net loss to net cash used in operating activities:    
    Depreciation and amortization  75 
    Deferred rent liability  64 
    Stock-based expense  337 
    Changes in current assets and liabilities:    
    Increase in receivables  (455)
    Increase in prepaids and other current assets  (220)
    Increase in accounts payable  1,259 
    Increase in accrued compensation and benefits  318 
    Increase in accrued liabilities  451 
      
    		 
    Net cash used in operating activities  (1,675)
      
    		 
    Investing activities
    		    
    Purchases of marketable securities  (18,240)
    Proceeds from sales and maturities of marketable securities  5,044 
    Purchase of property and equipment  (2,009)
    Cash deposited as collateral for letter of credit  (350)
    Deposits made on equipment  (133)
    Cost of intellectual property  (538)
      
    		 
    Net cash used in investing activities  (16,226)
      
    		 
    Financing activities
    		    
    Net proceeds from the sale of common and preferred stock and warrants  21,345 
      
    		 
    Net cash provided by financing activities  21,345 
      
    		 
    Net increase in cash and cash equivalents
    		  3,444 
         
    Cash and cash equivalentsat beginning of period
    		  — 
      
    		 
    Cash and cash equivalentsat end of period
    		 $3,444 
      
    		 
    Supplemental disclosure of non-cash activity
    		    
    Common stock and options issued for intellectual property $2,281 
    Common stock and warrants issued to consultants  139 
    Common stock and warrants issued as commissions on private placement  265 
      
    		 

    See

    (Dollars in thousands)Year ended December 31, 
     2010  2009 
    Operating activities     
    Net loss$(19,996) $(9,158)
    Adjustments to reconcile net loss to net cash used in     
    operating activities:       
    (Income)/Loss from Discontinued Operations -   (10,449 )
    Depreciation and amortization 882   1,247 
    Amortization of debt discount and issuance costs included in 
    interest expense 761   798 
    Other than temporary impairment of marketable securities -   185 
    Gain on sale of marketable securities (696)  (159 )
    Provision for doubtful accounts 36   526 
    Deferred rent (362 )  151 
    Share-based compensation expense 4,969   4,621 
    Unrealized gain on Put Option -   (758 )
    Other impairment loss -   1,113 
    Loss on extinguishment of debt -   230 
    Fair value adjustment on warrant liability 6,303   (341)
    Loss on disposition of property and equipment 34   16 
    Changes in current assets and liabilities, net of business acquired: 
    Receivables 199   (88 )
    Prepaids and other current assets 164   284 
    Accounts payable and other accrued liabilities (728)  (1,617 )
    Net cash used in operating activities of continuing operations (8,434)  (13,399)
    Net cash (used in) provided by operating activities of     
    discontinued operations -   (1,103)
    Net cash used in operating activities (8,434)  (14,502)
    Investing activities       
    Purchases of marketable securities 10,225   1,420 
    Proceeds from sales of property and equipment 5   13 
    Proceeds from disposition of CompCare -   1,500 
    Restricted cash -   24 
    Purchases of property and equipment (1)  (20)
    Deposits and other assets (246)   16 
    Net cash (used in) provided by investing activities 9,983   2,953 
    Net cash (used in) provided by investing activities of     
    discontinued operations -   39 
    Net cash (used in) provided by investing activities 9,983   2,992 

    (continued on next page)
    F-6
    CATASYS, INC. AND SUBSIDIARIES
    CONSOLIDATED STATEMENTS OF CASH FLOWS

    (continued)

    (Dollars in thousands)Year ended December 31,
     2010 2009 
    Financing activities     
         
    Proceeds from the isssuanc of common stock and warrants 3,153   7,000 
    Cost related to the issuance of common stock and warrants (623)  (689 )
    Proceeds from line of credit 450   2,072 
    Proceeds from financing note 5,465   - 
    Costs related to issuance of notes (151)  - 
    Proceeds from bridge loan 500   - 
    Paydown on line of credit (6,908)  (1,348 )
    Paydown on senior secured note (3,332 )  (1,668 )
    Capital lease obligations (93)  (98)
    Exercises of stock options and warrants -   16 
    Net cash provided by financing activities (1,539)   5,285 
    Net cash (used in) provided by financing activities of     
    discontinued operations -   (73 )
    Net cash provided by financing activities (1,539)   5,212 
            
    Net increase (decrease) in cash and cash equivalents for     
    continuing operations 10   (5,161 )
    Net increase (decrease) in cash and cash equivalents for     
    discontinued operations -   (1,137)
    Net increase (decrease) in cash and cash equivalents 10   (6,298)
    Cash and cash equivalents at beginning of period 4,595   10,893 
    Cash and cash equivalents at end of period$4,605  $4,595 
    Supplemental disclosure of cash paid       
    Interest$154  $247 
    Income taxes 52   93 
    Supplemental disclosure of non-cash activity       
          
    Common stock issued for outside services$371  $266 
    Common stock issued for settlement of payables 1,235  $- 
    Property and equipment acquired through capital leases
    and other financing
    		 -   22 

     The accompanying notes to financial statements

    F-13

    HYTHIAM, INC.
    Notes to Consolidated Financial Statements

    are an integral part of these statements.

    F-7
    CATASYS, INC. AND SUBSIDIARIES
    Notes to Consolidated Financial Statements

    Note 1. Basis of Presentation

            Hythiam, Inc. (“Hythiam NY”), 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 company was formed to research, develop, license and commercialize innovative technology to improve the treatment of alcoholism and drug addiction. 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.

            On September 29, 2003, Hythiam NY merged with and into Hythiam Acquisition Corp., a wholly-owned subsidiary of Alaska formed for the purpose of effectuating the merger, by the exchange of all of Hythiam NY’s outstanding common stock for an equal number of restricted shares of Alaska’s common stock. The stockholders of Alaska immediately prior to the merger owned approximately 4.5% of the outstanding shares upon completion of the merger. Alaska then reincorporated in Delaware on that same date by merging with and into Hythiam, Inc., a Delaware corporation (“Hythiam DE”). On October 14, 2003, Hythiam Acquisition Corp. changed its name to Hythiam, Inc., and on October 16, 2003 merged with and into Hythiam DE. Following these merger, reincorporation and consolidation transactions, the registrant, Hythiam DE, is now the sole surviving entity. The Company is considered a development stage company since revenues earned to date from planned operations have not been significant.

            Immediately prior to the merger described above, Alaska sold all of its assets and liabilities to certain of its stockholders in exchange for cancellation of 3,010,000 of its 3,568,033 then outstanding shares, and the remaining outstanding 558,033 shares were forward split 2.007-to-one into 1,119,969 shares, effective September 29, 2003. As a result, at the time of the merger, the registrant had substantially no operating assets, liabilities or operations.

            Because Hythiam NY was the sole operating company at the time of the merger with Alaska, the merger was accounted for as a reverse acquisition, with Hythiam NY deemed the acquirer for accounting purposes. As a result, references to “Hythiam,” the “Company,” “we” and “us,” and the discussion and analysis of financial condition and results of operations set forth in this report, are based upon the financial condition and operations of Hythiam NY prior to the merger and of the newly-constituted registrant, Hythiam DE, following the merger.

    Note 2.  Summary of Significant Accounting Policies


    Description of Business

    We are a healthcare services company, providing specialized behavioral health services for substance abuse to health plans, employers and unions through a network of licensed healthcare providers and its employees.  The Catasys substance dependence program (OnTrak), was designed to address substance dependence as a chronic disease. The program seeks to lower costs and improve member health through the delivery of integrated medical and psychosocial interventions combining elements of traditional disease management and ongoing “care coaching”, including our proprietary PROMETA® Treatment Program for alcoholism and stimulant dependence.  The PROMETA Treatment Program, which integrates behavioral, nutritional and medical components, is also available on a private-pay basis through licensed treatment providers and a company managed treatment center that offers the PROMETA Treatment Program, as well as other treatments for substance dependencies.

    From January 2007 until the sale of CompCare in January 2009, we operated within two reportable segments: healthcare services and behavioral health managed care services. Subsequent to the sale of CompCare, we revised our segments to reflect the disposal of CompCare. Our behavioral health managed care services segment, which had been comprised entirely of the operations of CompCare, is now presented in discontinued operations and is not a reportable segment. We now manage and report our operations through two business segments: license and management and healthcare services. Our license and management services segment focuses on providing licensing, administrative and management services to licensees that administer PROMETA and other treatment programs, including the managed treatment center that is licensed and managed by us. Our healthcare services segment combines innovative medical and psychosocial treatments with elements of traditional disease management and ongoing member support to help organizations treat and manage substance dependent populations, and is designed to lower both the medical and behavioral health costs associated with substance dependence and the related co-morbidities. Prior year financial statements have been restated to reflect this revised presentation. Substantially all of our consolidated revenues and assets are earned or located within the United States.

    Basis of Consolidation and Presentation and Going Concern

    Our consolidated financial statements include the accounts of the company, our wholly-owned subsidiaries, CompCare (discontinued operations), and company managed professional medical corporations. Based on the provisions of management services agreements between us and the medical corporations, we have determined that the medical corporations are variable interest entities (VIEs), and that we are the primary beneficiary as defined in the Financial Accounting Standards Board (FASB) rules for accounting for variable interest entities. Accordingly, we are required to consolidate the revenues and expenses of the managed medical corporations.

    All inter-company transactions have been eliminated in consolidation. Certain amounts in the consolidated financial statements and notes thereto for the years ended December 31, 2009 have been reclassified to conform to the presentation for the year ended December 31, 2010.

    Our financial statements have been prepared on the basis that we will continue as a going concern. At December 31, 2010, cash and cash equivalents amounted to $4.6 million and we had a working capital of approximately $1.4 million. We have incurred significant operating losses and negative cash flows from operations since our inception. During the year ended December 31, 2010, our cash used in operating activities amounted $8.4 million. We anticipate that we could continue to incur negative cash flows and net losses for the next twelve months. The financial statements do not include any adjustments relating to the recoverability of the carrying amount of the recorded assets or the amount of liabilities that might result from the outcome of this uncertainty. As of December 31, 2010, these conditions raised substantial doubt as to our ability to continue as a going concern.

    Our ability to fund our ongoing operations and continue as a going concern is dependent on signing and generating revenue from new contracts for our Catasys managed care programs and the success of management’s plans to increase revenue and continue to control expenses. We are currently in the process of implementing our recent Catasys contracts in Nevada , Kansas, and Massachusetts, and we expect that contract to become operational in the second quarter of 2011 Beginning in the fourth quarter of 2008, and continuing in each of the quarters during 2010, management took actions that have resulted in reducing annual operating expenses.  We have renegotiated certain leasing and vendor agreements to obtain more favorable pricing and to restructure payment terms with vendors, and have paid some expenses through the issuance of common stock. We amended the lease on premises which resulted in deferring payments and agreed to settle a lawsuit filed by a landlord in March 2010 related to a facility that is no longer in use. This amendment and the legal settlement required payments aggregating $234,000 between July 1, 2010 and February 2011. The settlement has since been settled in full as of the date of this report.
    F-8
    Use of Estimates

    The preparation of financial statements in conformity with generally accepted accounting principles (GAAP) in the United States requires management to make estimates and assumptions that affect the reported amounts in the financial statements and disclosed in the accompanying notes. Significant areas requiring the use of management estimates include expense accruals, accounts receivable allowances, patient continuing care reserves, accrued claims payable, premium deficiencies, the useful life of depreciable assets, the evaluation of asset impairment, the valuation of warrant liabilities, put option related to auction rate securities, and shared-based compensation. Actual results could differ from those estimates.

    Revenue Recognition

    License and Management Services

    Our license and management services revenues to date have been primarily derived from licensing our PROMETA Treatment Program and providing administrative services to hospitals, treatment facilities and other healthcare providers, and from revenues generated by our managed treatment centers.  We record revenues earned based on the terms of our licensing and management contracts, which requires the use of judgment, including the assessment of the collectability of receivables. Licensing agreements typically provide for a fixed fee on a per-patient basis, payable to us following the providers’ commencement of the use of our program to treat patients.  For revenue recognition purposes, we treat the program licensing and related administrative services as one unit of accounting.  We record the fees owed to us under the terms of the agreements at the time we have performed substantially all required services for each use of our program, which for of our license agreements is in the period in which the provider begins using the program for medically directed and supervised treatment of a patient.

    The revenues of our managed treatment centers, which we include in our consolidated financial statements, are derived from charging fees directly to patients for medical treatments, including the PROMETA Treatment Program.  Revenues from patients treated at our managed treatment center are recorded based on the number of days of treatment completed during the period as a percentage of the total number treatment days for the PROMETA Treatment Program.  Revenues relating to the continuing care portion of the PROMETA Treatment Program are deferred and recorded over the period during which the continuing care services are provided.

    Healthcare Services

    Our Catasys contracts are generally designed to provide revenues to us monthly basis based on enrolled members. To the extent our contracts may include a minimum performance guarantee, we reserve a portion of the monthly fees that may be at risk until the performance measurement period in completed.

    Cost of Services

    License and Management  Services

    License and management services represent direct costs that are incurred in connection with licensing our treatment programs and providing administrative services in accordance with the various technology license and services agreements, and are associated directly with the revenue that we recognize. Consistent with our revenue recognition policy, the costs associated with providing these services are recognized when services have been rendered, which for our license agreements is in the period in which patient treatment commences, and for our managed treatment center is in the periods in which medical treatment is provided. Such costs include royalties paid for the use of the PROMETA Treatment Program for patients treated by all licensees, and direct labor costs, continuing care expense, medical supplies and program medications for patients treated at our managed treatment center.

    Healthcare Services

    Healthcare services cost of services is recognized in the period in which an eligible member actually receives services. Our Catasys subsidiary contracts with various healthcare providers, including licensed behavioral healthcare professionals, on a contracted rate basis.  We determine that a member has received services when we receive a claim within the contracted timeframe with all required billing elements correctly completed by the service provider. We then determine whether the member is eligible to receive such services and whether the services provided are covered by the benefit plan. If all these requirements are met, we authorize the services and the claim is processed for payment.

    Share-Based Compensation

    Under our 2003, 2007, and 2010 Stock Incentive Plans (“the Plans”), we have granted incentive stock options under Section 422A of the Internal Revenue Code and non-qualified options to executive officers, employees, members of our Board of Directors and certain outside consultants. We grant all such share-based compensation awards at no less than the fair market value of our stock on the date of grant. Employee and Board of Director awards generally vest on a straight-line basis over three years. Total share-based compensation expense on a consolidated basis amounted to $5 million and $4.6 million for the years ended December 31, 2010 and 2009, respectively.
    F-9

    Stock Options – Employees and Directors

    We measure and recognize compensation expense for all share-based payment awards made to employees and directors based on estimated fair values on the date of grant. We estimate the fair value of share-based payment awards using the Black Scholes option-pricing model. The value of the portion of the award that is ultimately expected to vest is recognized as expense over the requisite service periods in the consolidated statements of operations.

    The estimated weighted average fair values of options granted during 2010 and 2009  were $0.04, $0.43 per share, respectively, and were calculated using the Black-Scholes pricing model based on the following assumptions:
     2010 2009
    Expected volatility112% 82%
    Risk-free interest rate1.76% 2.16-2.78%
    Weighted average expected lives in years5-6 5-6
    Expected dividend0% 0%

    The expected volatility assumption for 2010 was based on the historical volatility of our stock, measured over a period generally commensurate with the expected term. The weighted average expected lives in years for 2010 and 2009 reflect the application of the simplified method set out in Security and Exchange Commission (SEC) Staff Accounting Bulletin (SAB) 107 (and as amended by SAB 110), which defines the life as the average of the contractual term of the options and the weighted average vesting period for all option tranches.  We use historical data to estimate the rate of forfeitures assumption for awards granted to employees, which was 32% in 2010 and 24% in 2009.

    We have elected to adopt the detailed method prescribed in FASB’s accounting rules for share-based expense for calculating the beginning balance of the additional paid-in capital pool (APIC pool) related to the tax effects of employee share-based compensation, and to determine the subsequent impact on the APIC pool and consolidated statements of cash flows of the tax effects of employee share-based compensation awards that were outstanding upon adoption of such rules on January 1, 2006.

    Stock Options and Warrants – Non-employees

    We account for the issuance of stock options and warrants for services from non-employees by estimating the fair value of stock options and warrants issued using the Black-Scholes pricing model. This model’s calculations incorporate the exercise price, the market price of shares on grant date, the weighted average risk-free interest rate, expected life of the option or warrant, expected volatility of our stock and expected dividends.

    For options and warrants issued as compensation to non-employees for services that are fully vested and non-forfeitable at the time of issuance, the estimated value is recorded in equity and expensed when the services are performed and benefit is received. For unvested shares, the change in fair value during the period is recognized in expense using the graded vesting method.

    From time to time, we have retained terminated employees as part-time consultants upon their resignation from the company. Because the employees continue to provide services to us, their options continue to vest in accordance with the original terms. Due to the change in classification of the option awards, the options are considered modified at the date of termination. The modifications are treated as exchanges of the original awards in return for the issuance of new awards. At the date of termination, the unvested options are no longer accounted for as employee awards under FASB’s accounting rules for share-based expense but are instead accounted for as new non-employee awards. The accounting for the portion of the total grants that have already vested and have been previously expensed as equity awards is not changed. We recorded no expense in 2010 and $63,000 in 2009, associated with modified liability awards.

    Costs Associated with Streamlining our Operations

    Throughout 2009 and 2010 we continued to streamline our operations to increase our focus on managed care opportunities. The actions taken in 2009 also included renegotiation of certain leasing and vendor agreements to obtain more favorable pricing and to restructure payment terms with vendors, which included negotiating settlements for outstanding liabilities and has resulted in delays and reductions in operating expenses. In May 2009, we terminated our management services agreement (MSA) with a medical professional corporation and a managed treatment center located in Dallas, Texas.
    F-10

    During the years ended December 31, 2010 and 2009, we recorded $52,000 and $480,000, respectively, in costs associated with actions taken to streamline our operations. A substantial portion of these costs represent severance and related benefits. The costs incurred in 2009 also include impairment of assets and other costs related to termination of the management service agreements for our Dallas managed treatment center. The costs incurred in 2009 also include costs incurred to close the San Francisco managed treatment center. Expenses and accrued liabilities for such costs are recognized and measured initially at fair value in the period when the liability is incurred.

    Foreign Currency

    The local currency is the functional currency for all of our international operations. In accordance with FASB’s foreign currency translation accounting rules, assets and liabilities of our foreign operations are translated from foreign currencies into U.S. dollars at year-end rates, while income and expenses are translated at the weighted-average exchange rates for the year. The related translation adjustments are included in our consolidated statements of operations under the caption general and administrative expenses and are immaterial.

    Income Taxes

    We account for income taxes using the liability method in accordance with ASC 740 Income Taxes

    (formerly SFAS 109, Accounting for Income Taxes). To date, no current income tax liability has been recorded due to our accumulated net losses. Deferred tax assets and liabilities are recognized for temporary differences between the financial statement carrying amounts of assets and liabilities and the amounts that are reported in the tax returns. Deferred tax assets and liabilities are recorded on a net basis; however, our net deferred tax assets have been fully reserved by a valuation allowance due to the uncertainty of our ability to realize future taxable income and to recover our net deferred tax assets.


    In June 2006, the FASB issued FASB Interpretation No. 48 (FIN) 48, Accounting for Uncertainty in Income Taxes (incorporated into ASC 740), which clarifies the accounting for uncertainty in income taxes. FIN 48 requires that companies recognize in the consolidated financial statements the impact of a tax position if that position is more likely than not of being sustained on audit based on the technical merits of the position. FIN 48 also provides guidance on de-recognition, classification, interest and penalties, accounting in interim periods and disclosure. The provisions of FIN 48 are effective for fiscal years beginning after December 15, 2006. We adopted FIN 48 on January 1, 2007, with no impact to our consolidated financial statements.

    Comprehensive Income

    Comprehensive income generally represents all changes in stockholders’ equity during the period except those resulting from investments by, or distributions to, stockholders.  For the year ended December 31, 2010 we incurred a comprehensive loss of $20.7 million, of that amount $696,000 related to a net realized gain on marketable securities.

    For the year ended December 31, 2009, we have no comprehensive income or loss items that are not reflected in earnings and accordingly, our net loss equals comprehensive loss for that period.

    The components of total other comprehensive (loss) income for the years ended December 31, 2010 and 2009 are as follows:
    F-11
      For Year Ended 
    (In thousands) December 31,2010 
      2010  2009 
    Net income (loss) $(19,996) $(9,158)
    Other comprehensive gain:        
    Net unrealized gain (loss) on marketable securities
         available for sale
    		  -  $696 
    Net realized gain (loss) on marketable securities
         included in loss from continuing operations
    		 $(696) $- 
    Comprehensive income (loss) $(20,692) $(8,462)

    Basic and Diluted Loss per Share

    Basic loss per share is computed by dividing the net loss to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted loss per share is computed by dividing the net loss for the period by the weighted average number of common and dilutive common equivalent shares outstanding during the period.

    Common equivalent shares, consisting of approximately 302,407,323 and 19,965,179 of incremental common shares as of December 31, 2010 and 2009, respectively, issuable upon the exercise of stock options and warrants, have been excluded from the diluted loss per share calculation because their effect is anti-dilutive.

    Cash and Cash Equivalents and Marketable Securities

            The Company invests


    We invest available cash in short-term commercial paper and certificates of deposit and high grade short-term variable rate securities.deposit.  Liquid investments with an original maturity of three months or less when purchased are considered to be cash equivalents.


    Marketable Securities

    Investments include ARS and certificates of deposit with maturity dates greater than three months when purchased which have readily determined fair valuespurchased. These investments are classified as available-for-sale investments, andare reflected in current assets as marketable securities and are stated at fair market value. At December 31, 2003,value in accordance with FASB accounting rules related to investment in debt securities. Unrealized gains and losses are reported in stockholders’ equity in our consolidated balance sheet in “accumulated other comprehensive income (loss).” Realized gains and losses are recognized in the Company’sstatement of operations on the specific identification method in the period in which they occur. Declines in estimated fair value judged to be other-than-temporary are recognized as an impairment charge in the statement of operations in the period in which they occur.
    In making our determination whether losses are considered to be “other-than-temporary” declines in value, we consider the following factors at each quarter-end reporting period:

    ·How long and by how much the fair value of the securities have been below cost
    ·The financial condition of the issuers
    ·Any downgrades of the securities by rating agencies
    ·Default on interest or other terms
    ·Whether it is more likely than not that we will be required to sell the securities before they recover in value

    In accordance with current accounting rules for investments in debt securities and additional application guidance issued by the FASB in April 2009, other-than-temporary declines in value are reflected as a non-operating expense in our consolidated statement of operations if it is more likely than not that we will be required to sell the ARS before they recover in value, whereas subsequent increases in value are reflected as unrealized gains in accumulated other comprehensive income in stockholders’ equity in our consolidated balance sheet.
    F-12
    Our marketable securities consisted of the following investments with the following maturities:

      
     
    Original
    Cost
    		 
     
    Unrealized
    Gains and
    Losses
    		 
     
    Fair
    Market
    Value
    		 
     Less than
    1 Year
    		 
     1–5
    Years
    		 
    5-10
    Years     
    		 
    More than
    10 Years
      
    		  
    		 
    		 
    		 
    		 
    		 
    		 
    Short-term variable rate taxable municipal securities $8,955,000       $—       $8,955,000      $—      $            —      $            —      $8,955,000 
    Short-term variable rate auction preferred securities  4,000,000   —   4,000,000  4,000,000  —  —  — 
    Certificates of deposit  241,000   —   241,000  241,000  —  —  — 
      
    		  
    		 
    		 
    		 
    		 
    		 
    		 
      $13,196,000  $—  $13,196,000 $4,241,000  —  — $8,955,000 
      
    		  
    		 
    		 
    		 
    		 
    		 
    		 

    F-14

            Gross proceedsmaturities as of December 31, 2010 and 2009:

    (in thousands) Fair Market  Less than  More than 
      Value  1 Year  10 Years 
    Balance at December 31, 2009         
    Certificates of deposit $133  $133  $- 
    Auction-rate securities  9,468   9,468   - 
                 
    Balance at Dectember 31, 2010            
    Certificates of deposit $133  $133  $- 
    The carrying value of all securities presented above approximated fair market value at December 31, 2010 and 2009, respectively.

    Auction-Rate Securities

    Since February 2008, auctions for these securities had failed; meaning the parties desiring to sell securities could not be matched with an adequate number of buyers, resulting in our having to continue to hold these securities. The maturity dates of the underlying securities of our ARS investments ranged from sales of available-for-sale18 to 37 years.  In October 2008, our portfolio manager, UBS AG (UBS) made a rights offering to its clients, pursuant to which we are entitled to sell to UBS all ARS held by us in our UBS account. We subscribed to the rights offering in November 2008, which permitted us to require UBS to purchase our ARS for a price equal to original par value plus any accrued but unpaid interest beginning on June 30, 2010 and ending on July 2, 2012, if the securities were $5,044,000,not earlier redeemed or sold. During the year ended December 31, 2010, $10.2 million (par value) of ARS were redeemed at par by the issuer.

     The rights offering referred to above was effectively a put option agreement. Consequently, we recognized the put option agreement as a separate asset in the amount of approximately $758,000 in accordance with no gainsFASB accounting rules and it is included at fair market value in other current assets in our consolidated balance sheet at December 31, 2009. As the ARS were redeemed at par value we determined that the fair market value of the ARS at June 30, 2010 was the redemption amount, and as a result have written down the value of the put option to zero at June 30, 2010.  The related $758,000 reduction in the value of the put option is reflected as a charge to gain on sale of marketable securities in our consolidated income statement for the year ended December 31, 2010.

    Fair Value Measurements

    Fair value is defined as the price that would be received to sell an asset or losses realized,paid to transfer a liability in an orderly transaction between market participants at the measurement date. Assets and liabilities recorded at fair value in the consolidated balance sheets are categorized based upon the level of judgment associated with the inputs used to measure their fair value. The fair value hierarchy distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy are described below:

    Level Input:Input Definition:
    Level IInputs are unadjusted, quoted prices for identical assets or liabilities in active markets at the measurement date.
    Level IIInputs, other than quoted prices included in Level I, that are observable for the asset or liability through corroboration with market data at the measurement date.
    Level IIIUnobservable inputs that reflect management’s best estimate of what market participants would use in pricing the asset or liability at the measurement date.

    F-13
    The following tables summarize fair value measurements by level at December 31, 2010 and 2009 for assets and liabilities measured at fair value on a recurring basis:
      2009 
    (Dollars in thousands) Level I  Level II  Level III  Total 
    Variable auction-rate securities $-  $-  $9,468  $9,468 
    Put option  -   -   758   758 
    Certificates of deposit (1)  133   -   -   133 
    Total assets $133  $-  $10,226  $10,359 
                     
    Warrant liabilities $-  $-  $1,089  $1,089 
    Total liabilities $-  $-  $1,089  $1,089 
    (1) included in deposits and other assets on our consolidated balance sheets
    (Dollars in thousands) Level I  Level II  Level III  Total 
    Intangible assets  -   -   2,658   2,658 
    Total assets $-  $-  $2,658  $2,658 
      2010 
    (Dollars in thousands) Level I  Level II  Level III  Total 
    Certificates of deposit (1)  133   -   -   133 
    Total assets  133   -   -   133 
                     
    Warrant liabilities  -   -   8,890   8,890 
    Total liabilities  -   -   8,890   8,890 
    (1) included in deposits and other assets on consolidated balance sheets
    (Dollars in thousands)                
    Intangible assets  -   -   2,423   2,423 
    Total assets  -   -   2,423   2,423 
    Financial instruments classified as Level 3 in the fair value hierarchy as of December 31, 2009 represent our investment in ARS and a Put Option, in which management has used at least one significant unobservable input in the valuation model. See discussion above in Marketable Securities for additional information on our ARS, including a description of the securities, a discussion of the uncertainties relating to their liquidity and our accounting treatment. As discussed above, the market for ARS effectively ceased when the vast majority of auctions began to fail in February 2008. As a result, quoted prices for our ARS did not exist during the first half of 2010 and, accordingly, we concluded that Level 1 inputs were not available and unobservable inputs were used. We determined that use of a valuation model was the best available technique for measuring the fair value of our ARS portfolio and we based our estimates of the fair value using valuation models and methodologies that utilize an income-based approach to estimate the price that would be received to sell our securities in an orderly transaction between market participants. The estimated price was derived as the present value of expected cash flows over an estimated period of illiquidity, using a risk adjusted discount rate that was based on the credit risk and liquidity risk of the securities. While our valuation model was based on both Level II (credit quality and interest rates) and Level III inputs, we determined that the Level III inputs were the most significant to the overall fair value measurement, particularly the estimates of risk adjusted discount rates and estimated periods of illiquidity.
    As discussed above, there have been continued auction failures with our ARS portfolio and as a result, active markets for our ARS did not exist and we relied primarily on Level III inputs, for fair valuation measures as of December 31, 2009. On July 2, 2010, upon trade settlement, we collected the $2.2 million receivable related to the sale of the remainder of our ARS portfolio As of December 31, 2010, our ARS Portfolio was fully liquidated at par.
    F-14
    Liabilities measured at market value on a recurring basis include warrant liabilities resulting from a recent debt and equity financing. In accordance with current accounting rules, the warrant liabilities are being marked to market each quarter-end until they are completely settled. The warrants are valued using the specific identification cost basis method. ThereBlack-Scholes option pricing model, using both observable and unobservable inputs and assumptions consistent with those used in our estimate of fair value of employee stock options. See Warrant Liabilities below.

    The following table summarizes our fair value measurements using significant Level III inputs, and changes therein, for the year ended December 31, 2009:
    (Dollars in thousands) 
    Level III
    ARS & Put
    Option
    		    
    Level III
    Warrant
    Liabilities
    		  
    Balance as of December 31, 2008 $10,072  Balance as of December 31, 2008 $-  
    Change in value  758 (c)Transfers in/out of Level III  157  
    Net purchases (sales)  (1,275) Initial valuation of warrant liabilities  1,273 (b)
    Net unrealized gains (losses)  696  Change in fair value of warrant liabilities  (341) 
    Net realized gains (losses)  (25)(a)      
    Balance as of December 31, 2009 $10,226  Balance as of December 31, 2009 $1,089  
    (a)Includes other-than-temporary loss on auction-rate securities.
    (b)
    Represents initial valuation of warrants issued in conjunction with the Registered Direct Placement in September 2009 and adjustment related to the modification of the Highbridge Senior Secured Note in August 2009.
    (c)Auction Rate Securities Put Option recorded in prepaids and other current assets
    The following table summarizes our fair value measurements using significant Level III inputs, and changes therein, for the year ended December 31, 2010:

    (Dollars in thousands) 
    Level III
    ARS & Put
    		  
    Level III
    Warrant
    Liabilities
    		 
    Balance as of December 31, 2009 $10,226  $1,089 
    Transfers in/(out) of Level III  -   1,498 
    Change in Fair Value  -   6,303 
    Net purchases (sales)  (10,226)  - 
    Net unrealized gains (losses)  (696)  - 
    Net realized gains (losses)  696   - 
    Balance as of December 31, 2010 $-  $8,890 
    As reflected in the table above, net sales were no transfers$10.2 million as of securitiesDecember 31, 2010 and represent proceeds realized from the available-for-sale category intoredemption of a certain ARS at par by the trading category.

    issuer, resulting in a realized gain of approximately $696,000.


    Assets that are measured at fair value on a non-recurring basis include intellectual property, with a carrying amount of $2.4 million at December 31, 2010. In accordance with FASB’s accounting rules for intangible assets, we perform an impairment test each quarter and no impairment charges were recorded during the year ended December 31, 2010. See Intangible Assets below.
    F-15
    Fair Value ofInformation about Financial Instruments and ConcentrationNot Measured at Fair Value

    FASB rules regarding fair value disclosures of Credit Risk

    financial instruments requires disclosure of fair value information about certain financial instruments for which it is practical to estimate that value.  The carrying amounts reported in theour consolidated balance sheet for cash, cash equivalents, marketable securities, accounts receivable,  accounts payable and accrued liabilities approximate fair value because of the immediate or short-term maturity of these financial instruments.  AtThe carrying values of our outstanding short and long-term debt were $5.8 million and $9.6 million and the fair values were $5.0 million and $9.9 million as of December 31, 2003, all2010 and 2009, respectively.  Considerable judgment is required to develop estimates of fair value.  Accordingly, the estimates are not necessarily indicative of the Company’samounts we could realize in a current market exchange.  The use of different market assumptions and/or estimation methodologies may have a material effect on the estimated fair value amounts.


    Intangible Assets

    Intellectual Property

    Intellectual property consists primarily of the costs associated with acquiring certain technology, patents, patents pending, know-how and related intangible assets with respect to programs for treatment of dependence to alcohol, cocaine, methamphetamines and other addictive stimulants. These long-term assets are stated at cost and are being amortized on a straight-line basis over the life of the respective patents, or patent applications, which range from 10 to 15 years.

    Impairment of Long-Lived Assets

    Long-lived assets such as property, equipment and intangible assets subject to amortization are reviewed for impairment whenever events or circumstances indicate that the carrying amount of these assets may not be recoverable.  In reviewing for impairment, we compare the carrying value of such assets to the estimated undiscounted future cash equivalentsflows expected from the use of the assets and marketable securities were investedtheir eventual disposition.  When the estimated undiscounted future cash flows are less than their carrying amount, an impairment loss is recognized equal to the difference between the assets’ fair value and their carrying value.

    We performed an impairment test on intellectual property as of March 31, 2009. We considered numerous factors, including a valuation of the intellectual property by an independent third party, and determined that the carrying value of certain intangible assets was not recoverable and exceeded the fair value. We recorded an impairment charge totaling $355,000 for these assets as of March 31, 2009. These charges consisted of $122,000 for intangible assets related to our managed treatment center in highly liquid, high grade commercial paper, short-term variable rate securitiesDallas and certificates$233,000 related to intellectual property for additional indications for the use of deposit. Atthe PROMETA Treatment Program that are currently non-revenue generating. In its valuation, the independent third-party valuation firm relied on the “relief from royalty” method, as this method was deemed to be most relevant to our intellectual property assets. We determined that the estimated useful lives of the remaining intellectual property properly reflected the current remaining economic useful lives of the assets. We also performed additional impairment tests on intellectual property at December 31, 2003,2009 and determined that no additional impairment charges were necessary.

    We performed an impairment test on all cash equivalentsproperty and marketable securities were recorded atequipment as of March 31, 2009, including capitalized software costs related to our healthcare services segment, previously know as our behavioral health segment. As a result of this testing, we determined that the carrying value of the capitalized software was not recoverable and exceeded its fair market value, and we wrote off the $758,000 net book value of this software as of March 31, 2009. This impairment charge was recognized in operating expenses in our consolidated statement of operations. We also performed impairment tests on all property and equipment as of December 31, 2010 and determined that no single investment represented more than 7.5%additional impairment charge was necessary.

    For the year ended December 31, 2010, we relied upon the 2009 external valuation which provides an independent , comprehensive valuation analysis and report intended to provide us with guidance with respect to (i) the determination of the investment portfolio.

    fair value of certain patent rights (“PROMETA Rights”) or the (“Patents”) for the PROMETA Treatment Program (the “PROMETA Program”) and, (ii) appropriate useful lives over which the Patents should be amortized (the “Valuation Opinion and Report”).This Valuation Opinion and Report was and will be used by us to fulfill our obligations under FAS 157 to determine the fair value of intangible assets on our balance sheet for financial reporting purposes. In order to assist the third party in its valuation analysis: Management performed a comprehensive review of our business, operations, and prospects of the patents on a standalone basis, the historical performance of the Company in relation to the Patents, future expectations relating to the Patents and financial statement projections related to the Patents. Management provided revenue projections for the PROMETA Program, including revenue derived from Catasys Health which includes use of the PROMETA Program, over the remaining useful life of the Patents.

    F-16
    Additionally, it is important to note that our overall business model, business operations, and future prospects of our business have not changed materially since we conducted the reviews and analysis noted above with the exception of the timing and annualized amounts of the expected revenue.

    No other impairments were identified in our reviews at December 31, 2010 and 2009.

    Property and Equipment


    Property and equipment are stated at cost, less accumulated depreciation. Additions and improvements to property and equipment are capitalized at cost. Expenditures for maintenance and repairs are charged to expense as incurred. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, which range from two to seven years for furniture and equipment. Leasehold improvements are amortized over the lesser of the estimated useful lives of the assets or the related lease term, principallywhich is typically five to seven years.

    Construction in progress is not depreciated until the related asset is placed into service.


    Capital Leases

    Assets held under capital leases include furniture and computer equipment, and are recorded at the lower of the net present value of the minimum lease payments or the fair value of the leased asset at the inception of the lease. Depreciation expense is computed using the straight-line method over the estimated useful lives of the assets.  All lease agreements contain bargain purchase options at termination of the lease.

    Variable Interest Entities

    Generally, an entity is defined as a variable interest entity (VIE) under current accounting rules if it has (a) equity that is insufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, or (b) equity investors that cannot make significant decisions about the entity’s operations, or that do not absorb the expected losses or receive the expected returns of the entity. When determining whether an entity that is a business qualifies as a VIE, we also consider whether (i) we participated significantly in the design of the entity, (ii) we provided more than half of the total financial support to the entity, and (iii) substantially all of the activities of the VIE either involve us or are conducted on our behalf. A VIE is consolidated by its primary beneficiary, which is the party that absorbs or receives a majority of the entity’s expected losses or expected residual returns.

    IntellectualAs discussed in Note 2 – Management Services Agreements, we have entered into MSAs with professional medical corporations. Under these MSAs, the equity owner of the affiliated medical group has only a nominal equity investment at risk, and we absorb or receive a majority of the entity’s expected losses or expected residual returns. We participate significantly in the design of these management services agreements. We also agree to provide working capital loans to allow for the medical group to pay for its obligations. Substantially all of the activities of these managed medical corporations either involve us or are conducted for our benefit, as evidenced by the facts that (i) the operations of the managed medical corporations are conducted primarily using our licensed protocols and (ii) under the MSAs, we agree to provide and perform all non-medical management and administrative services for the respective medical group. Payment of our management fee is subordinate to payments of the obligations of the medical group, and repayment of the working capital loans is not guaranteed by the equity owner of the affiliated medical group or other third party. Creditors of the managed medical corporations do not have recourse to our general credit.

    Based on the design and provisions of these MSAs and the working capital loans provided to the medical groups, we have determined that the managed medical corporations are VIEs, and that we are the primary beneficiary as defined in current accounting rules. Accordingly, we are required to consolidate the revenues and expenses of such managed medical corporations.

    Warrant Liabilities

    We have issued warrants in connection with the registered direct placements of our common stock in November 2007, September 2009, July 2010, September 2010, October, 2010, and November 2010 and the amended and restated senior secured note in July 2008. The warrant agreements include provisions that require us to record them as a liability, at fair value, pursuant to FASB accounting rules, including provisions in some warrants that protect the holders from declines in the our stock price and a requirement to deliver registered shares upon exercise, which is considered outside of our control. The warrant liabilities are marked to market each reporting period and changes in fair value are recorded as a non-operating gain or loss in our statement of operations, until they are completely settled or expire. The fair value of the warrants is determined each reporting period using the Black-Scholes option pricing model, and is affected by changes in inputs to that model including our stock price, expected stock price volatility, interest rates and expected term.
    F-17
    In October 2010, the we entered into Securities Purchase Agreements with certain accredited investors, including Socius for $500,000 of senior 12% secured convertible notes and warrants to purchase 12,500,000 shares of our common. The Bridge Notes were scheduled to mature January 2011 and interest was payable in cash at maturity or upon prepayment or conversion.  The Bridge Notes and any accrued interest were convertible at the holders' option into common stock or exchangeable for the securities issued in the next financing the Company entered into that results in gross proceeds to the Company of at least $3,000,000.  The Bridge Warrants were exercisable for 5 years at $.04 per share subject to adjustment for financings and share issuances below the initial exercise price. The Bridge Warrants for the non-affiliated investors limit the amount of common stock that the holders may acquire through an exercise to no more than 4.99% of all Company Securities, defined as common stock, voting stock, or other Company securities. All the holders exchanged the Bridge Notes plus interest for securities issued in the Company's November 2010 financing (see below). The 12.5 million warrants were re-priced at $0.01, resulting in an increase of shares to 50 million.

    In November 2010, the Company completed a private placement with certain accredited investors for gross proceeds of $6.9 million (the “Offering”). Of the gross proceeds, $503,000 represented the exchange of the Bridge Notes and accrued interest and $215,000 represented the cancellation of an accrued compensation liability to our Chairman and CEO. The Company incurred approximately $364,000 in financial advisory, legal and other fees in relation to the offering. In addition, the Company issued warrants to purchase 5,670,000 shares of common stock at an exercise price $.01 per share to the financial advisors. The Company issued 100,000,000 shares of common stock at a price of $0.01 per share and sold $5.9 million in aggregate principal of 12% senior secured convertible notes (the “Notes”) to the investors on a pro rata basis. The Notes were to mature on the second anniversary of the closing.  The Notes were secured by a first priority security interest in all of the Company’s assets. The Notes and any accrued interest convert automatically into common stock either (a) if and when sufficient shares become authorized or (ii) upon a reverse stock split at a conversion price of $0.01 per share, subject to certain adjustments, including certain share issuances below $0.01 per share. The Company agreed to use its best efforts to file a proxy statement seeking shareholder approval to increase the number of authorized shares or effect a reverse stock split within 30 days of closing. The Company filed a proxy statement in January 2011 and the stockholders approved both proposals listed above and the Board of Directors decided to implement the increase in authorized shares of common stock. The Company filed an amendment to its Certificate of Incorporation, effective March 17, 2011, which increased the authorized shares of common stock and the Notes with accrued interest automatically converted to common stock. In addition, each non-affiliated investor in the Offering investing $2,000,000 or more also received five-year warrants to purchase an aggregate of 21,960,000 shares of Company common stock at an exercise price of $0.01 per share. One investor received such warrants. The net cash proceeds to the Company from the Offering were estimated to be $6.4 million inclusive of the October transaction and after offering expenses.
    For the years ended December 31, 2010 and 2009, we recognized a loss (gain) of $6.3 million and ($341,000), respectively, related to the revaluation of our warrant liabilities.

    Concentration of Credit Risk

    Financial instruments, which potentially subject us to a concentration of risk, include cash, marketable securities and accounts receivable. Most of our customers are based in the United States at this time and we are not subject to exchange risk for accounts receivable.

    The Company maintains its cash in domestic financial institutions subject to insurance coverage issued by the Federal Deposit Insurance Corporation (FDIC). Under FDIC rules, the Company is entitled to aggregate coverage as defined by the Federal regulation per account type per separate legal entity per financial institution. The Company has incurred no losses as a result of any credit risk exposures.

    Recent Accounting Pronouncements

    Recently Adopted

    In February 2010, the FASB issued ASU 2010-09, “Subsequent Events, Amendments to Certain Recognition and Disclosure Requirements” which made a number of changes to the existing requirements to the FASB Accounting Standards Codification 855 Subsequent Events. The amended guidance was effective upon issuance and as a result of the amendments, SEC filers that file financial statements after February 24, 2010 are not required to disclose the date through which subsequent events have been evaluated. This ASU was adopted as of December 31, 2010 and did not have a material impact on our consolidated financial statements.
    F-18
    In January 2010, the FASB issued ASU 2010-06, “Fair Value Measurements and Disclosures: Improving Disclosures about Fair Value Measurements” which is intended to e,nhance the usefulness of fair value measurements by requiring both the disaggregation of the information in certain existing disclosures, as well as the inclusion of more robust disclosures about valuation techniques and inputs to recurring and non-recurring fair value measurements. The amended guidance is effective for interim and annual reporting periods beginning after December 15, 2009, except for the disaggregation requirement for the reconciliation disclosure of Level 3 measurements, which is effective for fiscal years beginning after December 31, 2010 and for interim periods within those years. This ASU was adopted as of December 31, 2010 and did not have a material impact on our consolidated financial statements.

    In January 2010, the FASB issued ASU 2010-02, “Accounting and Reporting for Decreases in Ownership of a Subsidiary – Scope Clarification” which is intended to clarify which transactions require a decrease in ownership provisions particularly for non-controlling interests in consolidated financial statements. In addition, it requires increased disclosures about deconsolidation of a subsidiary. It requires retrospective application and is effective for the first interim or annual periods ending on or after December 15, 2009. Adoption of this ASU did not have a material impact on our consolidated financial statements.

    In January 2010, the FASB issued ASU 2020-01 “Accounting for Distributions to Shareholders with Components of Stock and Cash” which is intended to clarify the accounting treatment for a stock portion of a shareholder distribution that (1) contains both cash and stock components, (2) allows shareholders to select their preferred form of distribution, and (3) limits the total amount of cash to be distributed. It defines a stock dividend as a dividend that takes nothing from the property of an entity and adds nothing to the interests of an entity’s shareholders because the proportional interest of each shareholder remains the same. The stock portion of the distribution must be treated as a stock issuance and be reflected in the EPS calculation prospectively. It requires retrospective application and is effective for annual periods ending on or after December 15, 2009. Adoption of this ASU did not have a material impact on our consolidated financial statements.

    In August 2009, the FASB issued ASU 2009-15, which changes the fair value accounting for liabilities. These changes clarify existing guidance that in circumstances in which a quoted price in an active market for the identical liability is not available, an entity is required to measure fair value using either a valuation technique that uses a quoted price of either a similar liability or a quoted price of an identical or similar liability when traded as an asset, or another valuation technique that is consistent with the principles of fair value measurements, such as an income approach (e.g., present value technique). This guidance also states that both a quoted price in an active market for the identical liability and a quoted price for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair value measurements. This ASU was adopted effective on January 1, 2010 and did not have a material impact on our consolidated financial statements.
    In June 2009, the FASB issued ASU 2009-17, “Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities,” the FASB issued changes to the accounting for variable interest entities. These changes require an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a variable interest entity; to require ongoing reassessments of whether an enterprise is the primary beneficiary of a variable interest entity; to eliminate the quantitative approach previously required for determining the primary beneficiary of a variable interest entity; to add an additional reconsideration event for determining whether an entity is a variable interest entity when any changes in facts and circumstances occur such that holders of the equity investment at risk, as a group, lose the power from voting rights or similar rights of those investments to direct the activities of the entity that most significantly impact the entity’s economic performance; and to require enhanced disclosures that will provide users of financial statements with more transparent information about an enterprise’s involvement in a variable interest entity. These changes became effective for us beginning on January 1, 2010. The adoption of this change did not have a material impact on our consolidated financial statements.
    In June 2009, the FASB issued ASU 2009-16, “Accounting for Transfers of Financial Assets,” which changes the accounting for transfers of financial assets. These changes remove the concept of a qualifying special-purpose entity and remove the exception from the application of variable interest accounting to variable interest entities that are qualifying special-purpose entities; limits the circumstances in which a transferor derecognizes a portion or component of a financial asset; defines a participating interest; requires a transferor to recognize and initially measure at fair value all assets obtained and liabilities incurred as a result of a transfer accounted for as a sale; and requires enhanced disclosure; among others. These changes became effective January 1, 2010 and did not have a material impact on our financial statements.
    Recently Issued

    The following Accounting Standards Updates were issued between December 31, 2009 and December 31, 2010 and contain amendments and technical corrections to certain SEC references in FASB's codification:
    F-19
    In April 2010, the FASB issued ASU 2010-13, “Share-based payment awards denominated in certain currencies” provides clarification on an employee share-based payment award that has an exercise price denominated in the currency of the market in which a substantial portion of the entity’s equity shares trades should not be considered to contain a condition that is not a market, performance, or service condition. Therefore, an entity should not classify such an award as a liability if it otherwise qualifies as equity. The amended guidance is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2010. The Company expects to adopt the amended guidance on January 1, 2011. The Company does not believe that the adoption of the amended guidance will have a significant effect on its consolidated financial statements.

    In April 2010, the FASB issued ASU 2010-17, “Milestone Method of Revenue Recognition” guidance to address accounting for research or development arrangements in which a vendor satisfies its performance obligations over time, with all or a portion of the consideration contingent on future events, referred to as milestones. The new guidance allows a vendor to adopt an accounting policy to recognize all of the arrangement consideration that is contingent on the achievement of a milestone in the period the milestone is achieved, if the milestone meets the criteria to be considered a substantive milestone. The milestone method described in the new guidance is not the only acceptable revenue attribution model for milestone consideration. However, other methods that result in the recognition of all of the milestone consideration in the period the milestone is achieved are precluded. A vendor is not precluded from electing to apply a policy that results in the deferral of some portion of the milestone consideration. The new guidance is effective on a prospective basis for milestones achieved in fiscal years, and interim periods within those fiscal years, beginning on or after June 15, 2010, with early adoption permitted. If an entity early adopts in a period that is not the beginning of its fiscal year, it must apply the guidance retrospectively from the beginning of the year of adoption. A vendor may elect to adopt the new guidance retrospectively for all prior periods, but is not required to do so. The Company is still evaluating the effect, if any; the amended guidance may have on its consolidated financial statements.
    Note 2.  Management Services Agreements

    We have executed MSAs with medical professional corporations and related treatment centers, with terms generally ranging from five to ten years and provisions to continue on a month-to-month basis following the initial term, unless terminated for cause. In May 2009, we terminated the MSAs with a medical professional corporation and a managed treatment center located in Dallas, Texas. As a result, we no longer consolidate these entities as VIEs.

    Under our one remaining MSA, we license to a treatment center in Santa Monica, California the right to use our proprietary treatment programs and related trademarks and provide all required day-to-day business management services, including, but not limited to:

    ·general administrative support services;
    ·information systems;
    ·recordkeeping;
    ·scheduling;
    ·billing and collection; marketing and local business development; and
    ·obtaining and maintaining all federal, state and local licenses, certifications and regulatory permits

    The treatment center retains the sole right and obligation to provide medical services to its patients and to make other medically related decisions, such as the choice of medical professionals to hire or medical equipment to acquire and the ordering of drugs.

    In addition, we provide medical office space to the treatment center on a non-exclusive basis, and we are responsible for all costs associated with rent and utilities. The treatment center pays us a monthly fee equal to the aggregate amount of (a) our costs of providing management services (including reasonable overhead allocable to the delivery of our services and including start-up costs such as pre-operating salaries, rent, equipment, and tenant improvements incurred for the benefit of the medical group, provided that any capitalized costs are being amortized over a five year period), (b) 10%-15% of the foregoing costs, and (c) any performance bonus amount, as determined by the treatment center at its sole discretion. The treatment center’s payment of our fee is subordinate to payment of the treatment center’s obligations, including physician fees and medical group employee compensation.

    We have also agreed to provide a credit facility to the treatment center to be available as a working capital loan, with interest at the prime rate plus 2%. Funds are advanced pursuant to the terms of the MSA described above. The notes are due on demand, or upon termination of the MSA. At December 31, 2010 and 2009, there was $10.4 million and $9.2 million respectively, outstanding under our credit facility with the treatment center. Our maximum exposure to loss could exceed this amount, and cannot be quantified as it is contingent upon the amount of losses incurred by the treatment center.

    We have determined that the managed medical corporations are VIEs and that we are the primary beneficiary as defined in the current accounting rules. Accordingly, we are required to consolidate the assets, liabilities, revenues and expenses of the managed treatment centers.

    The amounts and classification of assets and liabilities of the VIEs included in our consolidated balance sheets at December 31, 2010 and 2009 are as follows:
    F-20
    (in thousands) 
    December 31,
    2010
    		  
    December 31,
    2009
    		 
    Cash and cash equivalents $17   23 
    Receivables, net  7   - 
    Prepaids and other current assets  -   - 
    Total assets $24   23 
             
    Accounts payable  13   14 
    Note payable *  10,444   9,214 
    Accrued compensation and benefits  -   - 
    Accrued liabilities  -   6 
    Total liabilities $10,457   9,234 
             
    * Eliminated during consolidation 

    Note 3.  Accounts Receivable

    Accounts receivables consisted of the following as of December 31, 2010 and 2009:
    (in thousands) 2010  2009 
    License fees $97  $724 
    Patient fees receivable  7   50 
    Other  5   39 
    Total receivables  109   813 
    Less allowance for doubtful accounts  (36)  (505)
    Total receivables, net $73  $308 
    We use the specific identification method for recording the provision for doubtful accounts, which was $36,000 and $505,000 as of December 31, 2010 and 2009, respectively.  Accounts written off against the allowance for doubtful accounts totaled $523,000 and $921,000 for the years ended December 31, 2010 and 2009, respectively.

    Note 4.  Property and Other Intangibles

    Equipment


    Property and equipment consisted of the following as of December 31, 2010 and 2009:

    (in thousands) 2010  2009 
    Furniture and equipment $3,468  $4,624 
    Leasehold improvements  2,590   2,950 
    Total property and equipment  6,058   7,574 
    Less accumulated depreciation and amortization  (5,864)  (6,697)
    Total property and equipment, net $194  $877 
    Depreciation expense was $647,000 and $1.0 million for the years ended December 31, 2010 and 2009, respectively.

    Note 5.  Intangible Assets

    Intellectual property consists primarily of the costs associated with acquiring certain technology, patents, patents pending, know-how and related intangible assets with respect to programs for treatment protocols for addictionsof dependence to alcohol, cocaine, methamphetamine, and other addictive stimulants. These assets are stated at cost and areIntellectual property is being amortized on a straight-line basis from the date costs are incurred over the remaining life of the respective patents or patent applications, which range from thirteen11 to seventeen20 years.  

    ImpairmentAs of Long-Lived Assets

            In accordance with Statement of Financial Accounting Standards No. 144, “AccountingDecember 31, 2010 and 2009, intangible assets were as follows:

    F-21
    (in thousands) 2010  2009 
    Amortization
    Period
    (in years)
    Intellectual property $4,360  $4,360  10 to 15
              
    Less accumulated amortization  (1,937)  (1,702) 
              
    Total Intangibles, net $2,423  $2,658  
    Amortization expense for all intangible assets amounted to $235,000 and $243,000 for the Impairment or Disposal of Long-Lived Assets” (“SFAS 144”), long-lived assets such as property, equipment and intangibles subject to amortization are reviewed for impairment whenever events or circumstances indicate that the carrying amount of an asset may not be recoverable.

    Revenue Recognition

            The Company’s revenues are derived from licensing its technology and providing administrative services to hospitals, treatment facilities and other healthcare providers.  These fees are recognized after licensing fees are earned, the services are performed and collectibility is reasonably assured. The licensing fees relate the use of the Company’s proprietary treatment protocols for each patient completing treatment. Under the existing contract atyears ended December 31, 2003, administrative services consists of education services (initial training in the use of the protocols)2010 and data reports (principally pre-registration information, clinical screening data and patient satisfaction reports completed prior to or at the completion of treatment). The technology license, education services and data reports represent multiple service arrangements under the contract, as all of the fees2009, respectively. Estimated amortization expense for licensing and provision of services are included in one fee determined on a per patient basis. The per-patient fees have not been allocated to each of the multiple service elements, since substantially all of the licensing fees and other service elements are earned at the time of completion of patient treatment, and revenues are recognized only upon completion of patient treatment.

    Income Taxes

            The Company accounts for income taxes pursuant to SFAS 109, “Accounting for Income Taxes,” which uses the liability method to calculate deferred income taxes.  To date, the Company has not recorded any income tax liability due to its losses.  Also, no income tax benefit has been recorded due to the uncertainty of its realization.

    Basic and Diluted Loss Per Share

            In accordance with SFAS No. 128, “Computation of Earnings Per Share,” basic earnings (loss) per share is computed by dividing the net earnings (loss) available to common stockholdersintellectual property for the period by the weighted average number of common shares outstanding during the period.  Diluted earnings (loss) per share is computed by dividing the net earnings (loss) for the period by the weighted average number of common and dilutive common equivalent shares outstanding during the period.

    F-15

            Common equivalent shares, consisting of approximately 5,174,000 incremental common shares issuable upon the exercise of stock options and warrants have been excluded from the diluted earnings per share calculation because their effect is anti-dilutive.

            A summary of the net loss and shares used to compute net loss per share is as follows:

     
    Period from
    February 13, 2003
    (Inception)
    through
    December 31, 2003     
     
    Net loss        $(3,504,000)       
    Less: Beneficial conversion feature of preferred stock  (124,000)
      
    		 
    Net loss available to common stockholders $(3,628,000)
      
    		 
    Basic and diluted loss per share $(0.21)
      
    		 
    Weighted average common shares used to compute basic net loss per share  16,888,000 
    Effect of dilutive securities  — 
      
    		 
    Weighted average common shares used to compute diluted net loss per share  16,888,000 
      
    		 

            All share and per share data have been restated to reflect a stock split of 100 to 1 declared on July 1, 2003.

    Stock Options and Warrants

            The Company accounts for the issuance of employee stock options using the intrinsic value method under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). During the period from February 13, 2003 (inception) throughnext five years ending December 31, 2003 the Company did not recognize any compensation costs for options granted to employees as the exercise price equaled the fair value of the Company’s common stock on the date of grant.

            Had the Company determined compensation cost based on the fair value at the grant date for its employee stock options under SFAS No. 123, the pro forma effect on net loss and net loss per share would have been as follows:

    Net loss:

    As reported $(3,504,000)
    Less: Stock based compensation expense determined under fair value based method
    		  (73,000)
      
    		 
    Pro forma net loss  (3,577,000)
    Less: Beneficial conversion feature of preferred stock  (124,000)
      
    		 
    Net loss available to common stockholders $(3,701,000)
      
    		 

    Net loss per share:

    As reported – basic $(0.21)
    Pro forma – basic $(0.22)
    As reported – diluted $(0.21)
    Pro forma – diluted $(0.22)
         

    F-16

    The estimated fair value of options granted on September 29, 2003 was $0.83 per share calculated using the Black-Scholes pricing model with the following assumptions:

    Expected volatility
    		0%
    Risk-free interest rate4.09%
    Expected lives10 years
    Expected dividend yield0%

            The volatility was assumed to be zero, since all options were granted prior to the date the Company’s stock was first publicly traded.

            The Company accounts for the issuance of warrants for services from non-employees in accordance with SFAS 123, “Accounting for Stock-Based Compensation”, by estimating the fair value of warrants issued using the Black-Scholes pricing model.  This model’s calculations include the warrant exercise price, the market price of shares on grant date, the weighted average information for risk-free interest, expected life of warrant, expected volatility of the Company’s stock and expected dividends.

            If warrants issued as compensation to non-employees for services are fully vested and non-forfeitable at the time of issuance, the estimated value is recorded in equity and expensed when the services are performed and benefit is received as provided by Financial Accounting Standards Board Emerging Issues Task Force No. 96-18 (“EITF 96-18”).  If warrants are issued for consideration in an acquisition of assets, the value of the warrants are recorded in equity at the time of issuance and included in the purchase price to be allocated.

    approximately $1.2 million.


    PROMETA Treatment Program

    Accounting Estimates

            The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities, and the reported amounts of expenses.  Actual results could differ from those estimates.

    Recent Accounting Pronouncements

            In November 2002, the Financial Accounting Standards Board (“FASB”) issued FASB Interpretation No (“FIN”) 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, including Indirect Guarantees of Indebtedness of Others.” FIN 45 requires a guarantor to recognize a liability, at the inception of the guarantee, for the fair value of obligations it has undertaken in issuing the guarantee and also to include more detailed disclosures with respect to guarantees. FIN 45 is effective for guarantees issued or modified after December 31, 2002 and requires the additional disclosures for interim or annual periods ended after December 15, 2002. The initial recognition and measurement provisions of FIN 45 did not have an effect on the Company’s financial position or results of operations.

            In December 2002, the FASB issued Statement of Financial Accounting Standards (“SFAS”) 148, “Accounting for Stock-Based Compensation — Transition and Disclosure”.  SFAS 148 amends SFAS 123, “Accounting for Stock-Based Compensation” to provide alternative methods of transition to SFAS 123‘s fair value method of accounting for stock-based employee compensation.  It also amends and expands the disclosure provisions of APB 28, “Interim Financial Reporting,” to require disclosure in the summary of significant accounting policies of the effects of an entity’s accounting policy with respect to stock-based employee compensation on reported net income and earnings per share in annual and interim financial statements.  While SFAS 148 does not require companies to account for employee stock options using the fair-value method, the disclosure provisions apply to all companies for fiscal years ending after December 15, 2002 regardless of whether they account for stock options in accordance with the intrinsic value method of APB 25.  The Company has elected to use the intrinsic value method under APB 25 to account for stock options issued to employees and has incorporated the expanded disclosures under SFAS 148 into these Notes to Financial Statements.

            In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities (“FIN 46”).  The primary objectives of FIN 46 are to provide guidance on the identification and consolidation of variable interest entities.  Variable interest entities are entities that are controlled by means other than voting rights.  The guidance applies to variable interest entities created after January 31, 2003.  The Company holds no interest in variable interest entities.

    F-17

            In June 2003, the FASB issued SFAS 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity”.  SFAS 150 requires certain instruments, including mandatorily redeemable shares, to be classified as liabilities, not as part of stockholders’ equity or redeemable equity.  For instruments that are entered into or modified after May 31, 2003, SFAS 150 is effective immediately upon entering the transaction or modifying terms. For other instruments covered by SFAS 150 that were entered into before June 1, 2003, Statement 150 is effective for the first interim period beginning after June 15, 2003.  The implementation of SFAS 150 had no impact on the Company’s financial position or results of operations.

    Note 3. Acquisition of Intellectual Property

    In March 2003, the Companywe entered into a Technology Purchasetechnology purchase and License Agreement (the “Technology Agreement”)license agreement (Technology Agreement) with Tratamientos Avanzados de la AdiccióAdicciуn S.L. (Tavad), a Spanish corporation, (“Seller”) owned and controlled by Juan José Legarda, a member of the Company’s board of directors, to acquire, on an exclusive basis, all of the rights, title and interest to use and and/or sell the products and services andservices.  In addition, the Technology Agreement gave us the right to license the intellectual property owned by SellerTavad with respect to a method for the treatment of alcohol and cocaine dependence, known as the PROMETA Treatment Program, on a worldwide basis except in Spain (as amended in September 2003). The Company hasWe have granted SellerTavad a security interest in the intellectual property to secure the payments and performance obligations under the Technology Agreement. As consideration for the intellectual property acquired, the Companywe issued to SellerTavad approximately 836,000 shares of itsour common stock on the date of the mergerin September 2003 at a fair market value of $2.50 per share, plus stock optionswarrants to purchase approximately 532,000 shares of the Company’sour common stock at an exercise price of $2.50 per share, valued at approximately $191,000 using the Black-Scholes pricing model.  Options$192,000. Warrants for 160,000 shares arethat were exercisable at any time through September 29, 2008 have expired, and the remaining optionswarrants for 372,000 shares become exercisable equally over five years and expire ten years from date of grant.


    In addition to the purchase price for the above intellectual property, Hythiamwe agreed to pay a royalty fee to SellerTavad equal to three percent (3%) (six percent (6%) in Europe) of gross revenues from the alcohol and cocaine detoxification processesPROMETA Treatment Program using the acquired intellectual property for so long as the Companywe (or any licensee) usesuse the acquired intellectual property. TheseFor purposes of the royalty calculations, gross revenue is defined as all payments made by patients for the treatment, including payments made to our licensees. Royalty fees, which totaled $5,000 and $43,000 for the years ended December 31, 2010 and 2009, respectively, are reflected in cost of services expense in our consolidated statements of operations as revenues are recognized.

            Under the Technology Agreement, the Company is obligated to allocate each year a minimum of 50% of the funds it expends on sales, marketing, research and development on such activities relating to the use of the intellectual property acquired.  If the Company does not expend at least the requisite percentage on such activities, the Seller has the right to have the intellectual property revert to the Seller. The Company may terminate Seller’s reversion rights by making an additional payment of an amount which, taken together with previously paid royalties and additional payments, would aggregate $1,000,000. In 2003 the Company met its obligations with respect to this requirement.


    The total cost of the assets acquired, plus additional costs incurred by the Companyus related to filing patentspatent applications on such assets, have been reflected in our consolidated balance sheets in long-term assets as intellectual property.  Amortizationintangible assets. Related amortization, which commenced on July 1, 2003, is being recorded on a straight-line basis over a 20-year estimated useful life.

    Note 6.  Debt Outstanding

    Senior Secured Note

    During the remaining 17.5 year lifeended December 31, 2010, we sold $10.2 million of par value ARS and settled in full. We drew down $450,000 on the UBS line of credit and paid our debt of $6.9 million in full according to the terms and conditions of our line of credit. On July 15, 2010, our senior secured note in the amount of $3.3 million matured and we paid from available funds.
    UBS Line of Credit

    In May 2008, our investment portfolio manager, UBS, provided us with a demand margin loan facility collateralized by our ARS, which allowed us to borrow up to 50% of the pending patents, commencing July 1, 2003.

    UBS-determined market value of our ARS.


    In August 2003,October 2008, UBS made a “Rights” offering to its clients pursuant to which we were entitled to sell to UBS all ARS held in our UBS account. As part of the offering, UBS provided us a line of credit (replacing the demand margin loan), subject to certain restrictions as described in the prospectus, equal to 75% of the market value of the ARS, until they are purchased by UBS. We accepted the UBS offer on November 6, 2008. Loans under the line of credit were subject to a rate of interest based upon the current 90-day U.S Treasury bill rate plus 120 basis points, payable monthly and were carried in short-term liabilities on our Consolidated Balance at December 31, 2009. As of June 30, 2010 all ARS were redeemed at par and the line of credit was paid in full.
    F-22

    In October 2010, the we entered into Securities Purchase Agreements with certain accredited investors, including Socius for $500,000 of senior 12% secured convertible notes and warrants to purchase 12,500,000 shares of our common. The Bridge Notes were scheduled to mature January 2011 and interest was payable in cash at maturity or upon prepayment or conversion.  The Bridge Notes and any accrued interest were convertible at the holders’ option into common stock or exchangeable for the securities issued in the next financing the Company acquiredentered into that results in gross proceeds to the Company of at least $3,000,000.  The Bridge Warrants were exercisable for 5 years at $.04 per share subject to adjustment for financings and share issuances below the initial exercise price. The Bridge Warrants for the non-affiliated investors limit the amount of common stock that the holders may acquire through an exercise to no more than 4.99% of all Company Securities, defined as common stock, voting stock, or other Company securities. All the holders exchanged the Bridge Notes plus interest for securities issued in the Company’s November 2010 financing (see below). The 12.5 million warrants were re-priced at $0.01, resulting in an increase of shares to 50 million.

    In November 2010, the Company completed a patentprivate placement with certain accredited investors for a treatment method for opiate addictiongross proceeds of $6.9 million (the “Offering”). Of the gross proceeds, $503,000 represented the exchange of the Bridge Notes and accrued interest and $215,000 represented the cancellation of an accrued compensation liability to our Chairman and CEO. The Company incurred approximately $364,000 in financial advisory, legal and other fees in relation to the offering. In addition, the Company issued warrants to purchase 5,670,000 shares of common stock at an exercise price $.01 per share to the financial advisors. The Company issued 100,000,000 shares of common stock at a foreclosure sale held by Reserva, LLC,price of $0.01 per share and sold $5.9 million in aggregate principal of 12% senior secured convertible notes (the “Notes”) to the investors on a company owned and controlled by Terren S. Peizer,pro rata basis. The Notes were to mature on the Company’s majority shareholder, Chief Executive Officer and Chairmansecond anniversary of the board of directors, through a foreclosure sale in satisfaction of debt owed to Reservaclosing.  The Notes were secured by a medical technology development company. The Company paid approximately $314,000first priority security interest in cash and agreed to issue 360,000 shares of its common stock to the technology development company at a future date conditional upon the occurrence of certain events, including the registrationall of the Company’s shares to be issuedassets. The Notes and a full release of claims by all of the technology development company’s creditors.  The total cash consideration, which equaled Reserva’s basis, is reflected in other assets as intellectual property and is being amortized over the remaining 13 year life of the patent commencing September 1, 2003. The value of theany accrued interest convert automatically into common stock either (a) if and when issued, will be accounted for as additional costsufficient shares become authorized or (ii) upon a reverse stock split at a conversion price of $0.01 per share, subject to certain adjustments, including certain share issuances below $0.01 per share. The Company agreed to use its best efforts to file a proxy statement seeking shareholder approval to increase the intellectual propertynumber of authorized shares or effect a reverse stock split within 30 days of closing. The Company filed a proxy statement in January 2011 and the stockholders approved both proposals listed above and the Board of Directors decided to implement the increase in authorized shares of common stock. The Company filed an amendment to its Certificate of Incorporation, effective March 17, 2011, which increased the authorized shares of common stock and the Notes  with accrued interest automatically converted to common stock. In addition, each non-affiliated investor in the Offering investing $2,000,000 or more also received 5-year warrants to purchase an aggregate of 21,960,000 shares of Company common stock at an exercise price of $0.01 per share. One investor received such warrants. The net cash proceeds to the time of issuance.

            Amortization expense for intellectual property was $47,000 forCompany from the period ended December 31, 2003, and isOffering were estimated to be $169,000 for each$6.4 million inclusive of the next five years.

    F-18

    Note 4. Receivables

            Receivables consistedOctober transaction and after offering expenses.


    The following table shows the total principal amount, related interest rates and maturities of the followingdebt outstanding as of December 31, 2003:

    2010 and 2009:
    License fees receivable $16,000 
    Payroll tax refunds  110,000 
    Tenant improvement allowance(1)
    		  301,000 
    Other receivables  42,000 
      
    		 
       469,000 
    Less-allowance for doubtful accounts  ( 14,000)
      
    		 
      $455,000 
      
    		 

        (1)        Amounts receivable from landlord upon completion

      
    December 31
    2010
    		  
    December 31,
    2009
    		 
    Short-term debt      
    Senior secured note due July 15, 2010; interest payable quarterly at prime
         plus 2.5% (5.75% at December 31, 2009). $3,332,000 principal net of $147,000
         unamortized discount at December 31, 2009.
    		        
             
    Debt fully eliminated in July 2010 $-  $3,185 
             
    UBS line of credit, payable on demand, interest payable monthly at 90-day
         T-bill rate plus 120 basis points 1.237% at December 31, 2009
    		        
             
    Debt fully eliminated in July 2010  -   6,458 
             
    Total Short-term debt $-  $9,643 
             
             
    (dollars in thousands, except where otherwise noted) 
    December 31
    2010
    		  
    December 31,
    2009
    		 
    Long-term debt        
    Secured Convertible Promissory Note due November 9, 2012; interest payable
         at maturity (12% at December 31, 2010). $5,965,000 principal net of $141,000
         unamortized discount at December 31,2010.
    		 $5,824  $- 
             
    Total Short-term debt $5,824  $- 
    F-23
    Note 7.  Capital Lease Obligations

    We lease certain furniture and computer equipment under agreements entered into during the period 2006 through 2010 that are classified as capital leases. The cost of lease build-out of new office space

    Note 5. Propertyfurniture and Equipment

            Propertycomputer equipment under capital leases is included in furniture and equipment consistedon our consolidated balance sheets and was $22,000 at December 31, 2010. Accumulated depreciation of the followingleased equipment at December 31, 2010 was approximately $7,000.


    The future minimum lease payments required under the capital leases and the present values of the net minimum lease payments, as of December 31, 2003:

    2010, are as follows:
    Leasehold improvements $1,080,000 
    Furniture and equipment  918,000 
      
    		 
       1,998,000 
    Less-accumulated depreciation  ( 17,000)
      
    		 
      $1,981,000 
      
    		 

            Depreciation expense was $28,000 for the period ended December 31, 2003.

    (in thousands) Amount 
    Year ending December 31,   
    2011 $15 
    2012  - 
    Total minimum lease payments  15 
    Less amounts representing interest  (1)
    Capital lease obligations, net of interest  14 
    Less current maturities of capital lease obligations  (14)
    Long-term capital lease obligations $- 

    Note 6.8.  Income Taxes


    As of December 31, 2003,2010, the Company had net federal operating loss carry forwards and net state operating loss carry forwards of approximately $3,009,000$151.3 million and $1,805,000,$141.2 million, respectively.  The net federal operating loss carry forwards begin to expire in 20232020, and net state operating loss carry forwards begin to expire in 2014.

    2011.  The majority of the foreign net operating loss carry forwards expire over the next seven years


    The primary components of temporary differences which give rise to our net deferred tax assets are as follows:
    (in thousands) 2010  2009 
    Federal, state and foreign net operating losses $59,551  $55,581 
    Stock-based compensation  5,797   4,062 
    Accrued liabilities  150   367 
    Other temporary differences  289   (734)
    Valuation allowance  (65,787)  (59,276)
      $-  $- 
    In addition to the temporary differences reflected above, we generated a capital loss of $3.5 million from the 2009 sale of CompCare, which we have established a full valuation allowance against as of December 31, 2009.

    We have provided a full valuation allowance on net deferred tax assets, in accordance with FASB ASC 740, Accounting for Income Taxes.  Because of our continued losses, management assessed the realizability of the Company’s net deferred tax areassets as follows:

    being less than the "more-likely-than-not" criterion set forth by FASB ASC 740.  Furthermore, Section 382 of the Internal Revenue Code limits the use of net operating loss and tax credit carryforwards in certain situations where changes occur in the stock ownership of a company.  In the event we have a change in ownership, utilization of the carryforward could be restricted. We have not provided deferred taxes on less than 80% owned subsidiaries or investments accounted for under SFAS No. 167, Amendments to FASB Interpretation No. 46(R) (ASC 810), as those investments have accumulated book losses and we do not believe we can realize those losses for tax purposes in the foreseeable future.
    Deferred tax asset    
    Net operating losses $1,182,000 
    Temporary differences  59,000 
    Valuation allowance  (1,241,000)
      
    		 
      $-  
      
    		 

            The difference

    A reconciliation between the effectivestatutory federal income tax rate and that computed under the federal statutoryeffective income tax rate for the years ended December 31 is as follows:

    follows
    Federal statutory rate(34%)
    State taxes( 9%)
    Stock-based expense4%
    Other3%
    Change in valuation allowance36%
    -  %

      2010  2009 
    Federal statutory rate  -34.0%  -34.0%
    Share-based compensation  0.8%  5.6%
    State taxes  -4.7%  -5.6%
    Other  2.8%  0.0%
    Nondeductible goodwill  0.0%  0.0%
    Change in valuation allowance  35.1%  34.0%
    Effective tax rate  0.0%  0.0%
    F-24
    Current accounting rules require that companies recognize in the consolidated financial statements the impact of a tax position, if that position is more likely than not of being sustained on audit, based on the technical merits of the position. We file income tax returns in the U.S. federal jurisdiction and various state and foreign jurisdictions. Tax years that remain subject to examinations by tax authorities are 2006 through 2009.  The federal and material foreign jurisdictions statutes of limitations began to expire in 2007. There are no current income tax audits in any jurisdictions for open tax years and, as of December 31, 2010, there have been no material changes to our tax positions.
    The Company has adopted guidance issued by the Financial Accounting Standards Board (“FASB”) that clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements and prescribes a recognition threshold of more likely than not and a measurement process for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In making this assessment, a company must determine whether it is more likely than not that a tax position will be sustained upon examination, based solely on the technical merits of the position and must assume that the tax position will be examined by taxing authorities. Our policy is to include interest and penalties related to unrecognized tax benefits in income tax expense. There were no interest and penalties for the years ended December 31, 2010 and 2009, respectively. The Company files income tax returns with the Internal Revenue Service (“IRS”) and various states. For jurisdictions in which tax filings are prepared, the Company is no longer subject to income tax examinations by state tax authorities for tax years through 2005, and by the IRS for tax years through 2006. The Company’s net operating loss carryforwards are subject to IRS examination until they are fully utilized and such tax years are closed

    Note 7.9.  Equity Financing

    Financings


    As described in Note 6, in October 2010, the Company entered into Securities Purchase Agreements with accredited investors, including Socius for $500,000 of senior secured convertible notes and warrants to purchase shares of our common stock.

    On September 29, 2003,17, 2009, we completed a registered direct placement with select institutional investors, in which we issued an aggregate of 9,333,000 shares of common stock at a price of $0.75 per share, for gross proceeds of approximately $7 million. We also issued three-year warrants to purchase an aggregate of approximately 2,333,000 additional shares of our common stock at an exercise price of $0.85 per share. The fair value of the warrants at the date of issue was estimated at $814,000, and this portion of the proceeds was accounted for as a liability since accounting rules require us to presume a cash settlement of the warrants because there is a requirement to deliver registered shares of stock upon exercise, which is considered outside of our control. We incurred approximately $883,000 in fees to placement agents and other transaction costs in connection with the transaction, which includes approximately $184,000 relating to 560,000 warrants issued to placement agents, representing the estimated fair value of such warrants on the date of issue. These warrants are also being accounted for as liabilities on our consolidated balance sheet.

    In November 2010, the Company completed a private placement offeringwith certain accredited investors for gross proceeds of $6.9 million (the “Offering”) for a total. Of the gross proceeds, $503,000 represented the exchange of $21,927,500 in proceeds from private investors.the Bridge Notes and accrued interest and $215,000 represented the cancellation of an accrued compensation liability to our Chairman and CEO. The Company raised $4,690,000 of these proceeds duringincurred approximately $364,000 in financial advisory, legal and other fees in relation to the period July through September 2003 in a bridge financing throughoffering. In addition, the issuance of 1,876,000 shares of convertible preferred stock at a price of $2.50 per share, plusCompany issued warrants for 385,200to purchase 5,670,000 shares of common stock at an exercise price of $2.50$.01 per share.  The remaining proceeds from the Offering were raised through the issuance of 6,895,000 restricted shares of the Company’s common stock at a price of $2.50 per share.  The preferred stock was converted into restricted shares of common stock on a one-to-one basis upon the completion of the Offering.  The warrants have a fair market value using the Black-Scholes pricing model of $124,000, which has been reflected as a beneficial conversion feature inshare to the financial statements. The warrants expire from three to five years after issuance. 

    F-19

            In connection with the Offering, the Company paid commissions to registered broker-dealers aggregating approximately $342,000 in cash, issued 100,000 shares of common stock valued at $2.50 per share and issued approximately 209,000 warrants for the purchase of common stock at exercise prices of $2.50 to $3.00 per share.advisors. The Company also paid approximately $70,000 in cash, issued 40,000100,000,000 shares of common stock valued at $2.50 per share and issued approximately 28,000 warrants for the purchase of common stock at a price of $2.50$0.01 per share and sold $5.9 million in aggregate principal of 12% senior secured convertible notes (the “Notes”) to financial consultants for services rendered in connection with the Offering andinvestors on a pro rata basis. The Notes were to mature on the merger. The warrants expire from three to four years from date of issue and have a combined fair market value of approximately $26,000 using the Black-Scholes pricing model.

    Note 8. Stock, Stock Options and Warrants

    Common Stock

            On July 2, 2003, the Company effected a stock split of 100 to 1, thereby increasing its shares then outstanding from 137,400 to 13,740,000.  On September 29, 2003, in connection with the merger, the Company reincorporated in Delaware and issued newly authorized common stock to all stockholders. The accompanying financial statements and loss per share have been adjusted retroactively to reflect the stock split.

    Preferred Stock

            In July 2003, 15,000,000 shares of preferred stock, $.001 par value, were authorized. During the Company’s third quarter, 2003, the Company issued 1,876,000 preferred shares in connection with the Offering. Upon completionsecond anniversary of the Offering,closing.  The Notes were secured by a first priority security interest in all of the outstanding preferredCompany’s assets. The Notes and any accrued interest convert automatically into common stock either (a) if and when sufficient shares were exchanged forbecome authorized or (ii) upon a reverse stock split at a conversion price of $0.01 per share, subject to certain adjustments, including certain share issuances below $0.01 per share. The Company agreed to use its best efforts to file a proxy statement seeking shareholder approval to increase the number of authorized shares or effect a reverse stock split within 30 days of closing. The Company filed a proxy statement in January 2011 and the stockholders approved both proposals listed above and the Board of Directors decided to implement the increase in authorized shares of common shares on a one-to-one basis. On September 29, 2003, thestock. The Company reincorporated in Delaware andfiled an amendment to its Certificate of Incorporation, effective March 17, 2011, which increased the authorized number of preferred shares to 50,000,000, $.0001 par value.

    Stock Options

            On September 29, 2003, the board of directors and a majority of outstanding shares approved the 2003 Stock Incentive Plan. Under the plan, 5,000,000 shares of common stock and the Notes  with accrued interest automatically converted to common stock. In addition, each non-affiliated investor in the Offering investing $2,000,000 or more also received 5-year warrants to purchase an aggregate of 21,960,000 shares of Company common stock at an exercise price of $0.01 per share. One investor received such warrants. The net cash proceeds to the Company from the Offering were reserved for issuanceestimated to employees, officers, directors and consultantsbe $6.4 million inclusive of the CompanyOctober transaction and providesafter offering expenses.


    Note 10.  Share-based Compensation

    The Catasys, Inc. 2003, 2007 and 2010 Stock Incentive Plans (the Plans) provide for the issuance of incentive and nonqualified options. The boardup to 231 million shares of directors determines the terms of stock option agreements, including vesting requirements. The exercise price of incentiveour common stock. Incentive stock options, must beunder Section 422A of the Internal Revenue Code, non-qualified options, stock appreciation rights, limited stock appreciation rights and restricted stock grants are authorized under the Plans. We grant all such share-based compensation awards at no less than the fair market value of our stock on the date of grant.grant, and have granted stock and stock options to executive officers, employees, members of our Board of Directors and certain outside consultants. The terms and conditions upon which options become exercisable vary among grants; however, option rights expire notno later than ten years from the date of grant.

            On September 29, 2003, the Company granted options for 4,000,000 shares to employees, officers, directorsgrant and consultants, at exercise prices ranging from $2.50 to $2.75 per shareemployee and with vestingBoard of Director awards generally vest over periods from three to five years fromon a straight-line basis.  At December 31, 2010, we had 207,914,510 vested and unvested stock options outstanding and 22,190,886 shares reserved for future awards. Total share-based compensation expense amounted to $5 million and $4.6 million for the dateyears ended December 31, 2010 and 2009, respectively.

    F-25
    Stock Options – Employees and Directors

    During 2010 and 2009, we granted options to employees and directors for 197,669,650 and 3,815,000 shares, respectively, at the weighted average per share exercise prices of grant. $0.05 and $0.43, respectively, the fair market value of our common stock on the dates of grants.  The estimated fair value of options granted to employees and directors during 2010 and 2009 was $6.8 million and $1.2 million, respectively, calculated using the Black-Scholes pricing model with the assumptions described in Note 1 – Summary of Significant Accounting Policies, Share-based Compensation.

    Stock option activity under the 2003 Stock Incentive Planfor employee and director grants is summarized as follows:

       
    Shares 
    		  
    Weighted Average
    Exercise Price
    		 
     
    		 
    		 
    Granted  4,000,000 $2.56 
    Exercised  —  — 
    Cancelled  (60,000) (2.50)
      
    		 
    		 
    Balance, December 31, 2003  3,940,000 $2.56 
      
    		 
    		 

    F-20

      Shares  Weighted Avg. Exercise Price 
    Balance, December 31, 2008  8,260,000  $3.07 
             
    2009        
    Granted  3,815,000   0.43 
    Transfered *  -     
    Exercised  (56,000)  0.28 
    Cancelled  (1,106,000)  5.10 
    Balance, December 31, 2009  10,913,000  $1.95 
             
    2010        
    Granted  197,670,000   0.04 
    Transfered *        
    Exercised        
    Cancelled  (2,164,400)  2.19 
    Balance, December 31, 2010  206,418,600  $0.11 
    The weighted average remaining contractual life and weighted average exercise price of options outstanding as of December 31, 20032010 were as follows:

      
    Options Outstanding
    Options Exercisable
      
    Range of
    Exercise Prices

     

     

     
    Options Outstanding

     

     

    Weighted Average Remaining Contractual Life

     

     

    Weighted
    Average Exercise Price

     

     

     
    Options Exercisable

     

     

    Weighted
    Average Exercise Price
    		 
    		 
    		 
    		 
    		 
    		 
    		 
    $ 2.50 to $ 2.75  3,940,000  8.1 years $2.56  25,000 $2.50 

            Included in

       Options Outstanding  Options Exercisable 
    Range of Exercise Prices  Shares  
    Weighted
    Average
    Remaining
    Life (yrs)
    		  
    Weighted
    Average
    Price
    		  Shares  
    Weighted
    Average
    Price
    		 
    $0.04 to $1.50   205,201,000   9.80  $0.05   5,418,000  $0.33 
    $1.51 to $2.50   550,000   7.80   0.60   388,000   0.60 
    $2.51 to $3.50   664,000   4.50   2.50   644,000   2.55 
    $7.51 to $8.56   3,000   6.10   8.00   2,200   7.41 
                          
        206,418,000   9.78  $0.06   6,452,200  $0.57 
    At December 31, 2010 and 2009, the above amounts arenumber of options for 445,000 sharesexercisable was 5,401,000 and 5,561,000, respectively, at weighted-average exercise prices of $0.88 and $1.09, respectively.

    Share-based compensation expense relating to stock options granted to consultantsemployees and directors providing consulting services. The options vest over periods from three to fourwas $4.5 million and $4.4 million for the years ended December 31, 2010 and are being charged to expense as services are provided using the variable accounting method. The options have an estimated fair value of approximately $2,447,000 as2009, respectively.
    As of December 31, 2003, using2010, there were $3.9 million of unrecognized compensation costs related to non-vested share-based compensation arrangements granted under the Black-Scholes pricing model. 

    Plans. These costs are expected to be recognized over a weighted-average period of 2.3 years.

    F-26

    Stock Options and Warrants

    – Non-employees


    In addition to stock options granted under the Plans, we have also granted options and warrants discussed in Note 7, on September 29, 2003, the Company issued an immediately-exercisable, five-year warrant to purchase 80,000our common stock to certain non-employees that have been approved by our Board of Directors.  During 2010 and 2009, we granted options and warrants for 0 and 60,000 shares, respectively.
    Stock option and warrant activity for non-employee grants for services is summarized as follows:
      Shares  
    Weighted avg.
    exercise price
    		 
    Balance, December 31, 2008  2,095,000  $3.91 
             
    2009        
    Granted  60,000   0.52 
    Transferred *  -     
    Exercised        
    Cancelled  (465,000)  4.68 
    Balance, December 31, 2009  1,690,000  $3.57 
             
    2010        
    Granted      - 
    Transferred *  -   - 
    Exercised  -   - 
    Cancelled  (153,000)  4.68 
    Balance, December 31, 2010  1,537,000  $3.46 
    Stock options and warrants granted to non-employees for services outstanding at December 31, 2010 are summarized as follows:
    Description Shares  Weighted Average Exercise Price 
    Warrants issued for intellectual property  372,000  $2.50 
    Warrants issued in connection with equity offering  90,825,000   0.17 
    Warrants issued in connection with debt agreement  3,260,000   0.28 
    Options and warrants issued to consultants  36,000   5.30 
       94,493,000  $0.18 
    Share-based compensation expense relating to stock options and warrants granted to non-employees amounted to $402,000 and $63,000 for the years ended December 31, 2010 and 2009, respectively.

    Common Stock

    During 2010 and 2009, we issued 700,000 and 914,000 shares of common stock, respectively, for consulting services valued at $2.50 per share,$272,000 and $287,000, respectively. Generally, these costs are amortized to share-based expense on a management advisorstraight-line basis over the related service periods, generally ranging from six months to one year. Share-based compensation expense relating to all common stock issued for investment relationconsulting services was $402,000 and $197,000 for the years ended December 31 2010 and 2009, respectively.

    Employee Stock Purchase Plan

    Our qualified employee stock purchase plan (ESPP), approved by our Board of Directors and shareholders and adopted in June 2006, provides that eligible employees (employed at least 90 days) have the option to purchase shares of our common stock at a price equal to 85% of the lesser of the fair market value as of the first day or the last day of each offering period. Purchase options are granted semi-annually and are limited to the number of whole shares that can be performed overpurchased by an amount equal to up to 10% of a one-year period. The warrant has an estimated value of approximately $29,000 using the Black-Scholes pricing model. 

            Warrants and non-plan options outstanding asparticipant’s annual base salary.  As of December 31, 20032010, there were no shares of our common stock issued pursuant to the ESPP. There was no share-based expense relating to the ESPP for the year ended  December 31, 2010 and $1,000 for the year ended December 31, 2009.


    Note 11.  Segment Information

    We manage and report our operations through two business segments: healthcare services and license and management. In 2009, we revised our segments to reflect the disposal of CompCare. Our behavioral health managed care services segment, which had been comprised entirely of the operations of CompCare, is now presented in discontinued operations and is not a reportable segment (see Note 12—Discontinued Operations). Catasys Health operations were previously reported as part of healthcare services, but is now segregated and reported separately in license and management services. Prior years have been restated to reflect this revised presentation.
    F-27

    Healthcare Services

    Catasys’s integrated substance dependence solutions combine innovative medical and psychosocial treatments with elements of traditional disease management and ongoing member support to help organizations treat and manage substance dependent populations to impact both the medical and behavioral health costs associated with substance dependence and the related co-morbidities.

    We are summarizedcurrently marketing our integrated substance dependence solutions to managed care health plans for a case rate or monthly fee, which involves educating third party payors on the disproportionately high cost of their substance dependent population and demonstrating the potential for improved clinical outcomes and reduced cost associated with using our Catasys programs.

    License and Management

    Our license and management segment is focused on delivering solutions for those suffering from alcohol, cocaine, methamphetamine and other substance dependencies by developing, licensing and commercializing innovative physiological, nutritional, and behavioral treatment programs. Treatment with our PROMETA Treatment Programs, which integrate behavioral, nutritional, and medical components, are available through physicians and other licensed treatment providers who have entered into licensing agreements with us for the use of our treatment programs. Also included in this segment is a licensed and managed treatment center, which offers a range of addiction treatment services, including the PROMETA Treatment Programs for dependencies on alcohol, cocaine and methamphetamines.

    Our license and management segment also comprises results from international operations in the prior periods; however, these operating segments are not separately reported as they did not meet any of the quantitative thresholds under current accounting rules regarding segment disclosures.

    We evaluate segment performance based on total assets, revenue and income or loss before provision for income taxes. Our assets are included within each discrete reporting segment. In the event that any services are provided to one reporting segment by the other, the transactions are valued at the market price. No such services were provided during the years ended December 31, 2010 and 2009. Summary financial information for our two reportable segments is as follows:

     
    Description

     

    Shares 

     

    Weighted Average Remaining
    Contractual Life     

     

    Weighted Average Exercise Price 
    		 
    		 
    		 
    		 
    		 
    Options issued for intellectual property  532,000  8.2 years $2.50 
    Warrants issued to preferred stockholders  385,000  4.0 years  2.50 
    Warrants issued in connection with equity offering  237,000  3.1 years  2.68 
    Warrants issued for future services  80,000  4.8 years  2.50 
      
    		 
    		 
    		 
       1,234,000  5.7 years $2.54 
      
    		 
    		 
    		 

      Twelve Months Ended 
    (in thousands) December 31, 
      2010  2009 
    License and Management services      
    Revenues $420  $1,530 
    Loss before provision for income taxes  (17,116)  (15,642)
    Assets *  7,944   19,105 
             
    Healthcare services        
    Revenues $28  $- 
    Loss before provision for income taxes  (2,272)  (3,947)
    Assets *  -   - 
             
    Consolidated continuing operations        
    Revenues $448  $1,530 
    Loss before provision for income taxes  (19,388)  (19,589)
    Assets *  7,944   19,105 
             
    * Assets are reported as of December 31.        

    F-28
    Note 9.12.  Discontinued Operations

    On January 20, 2009, we sold our interest in CompCare, in which we had acquired a controlling interest in January 2007 for $1.5 million in cash. The CompCare operations are now presented as discontinued operations in accordance with accounting rules related to the disposal of long-lived assets. Prior to the sale, the assets, and results of operations related to CompCare had constituted our behavioral health managed care services segment.

    We recognized a gain of approximately $11.2 million from this sale, which is included in income from discontinued operations in our Consolidated Statement of Operations for the three months ended March 31, 2009. The revenues and expenses of discontinued operations for the period January 1 through January 20, 2009 are as follows:
    (in thousands) 
    Period from
    January 1 to January 20,
    2009
    		 
    Revenues:   
    Behavioral managed health care revenues $710 
    Expenses:    
    Behavioral managed health care operating expenses $703 
    General and administrative expenses  711 
    Other  50 
    Income (loss) from discontinued operations before
         provision for income tax
    		 $(754)
    Provision for income taxes $1 
    Income (loss) from discontinued operations, net of tax $(755)
    Gain on sale $11.204 
    Results from discontinued operations, net of tax $10.449 

    Note 13.  Commitments and Contingencies


    Operating Lease Commitments

            The Company


    We incurred rent expense of approximately $82,000$600,000 and $1.2 million for the period from February 13, 2003 throughyears ended December 31, 2003. On July 30, 2003,2010 and 2009, respectively.  Our principal executive and administrative offices are located in Los Angeles, California and consist of leased office space totaling approximately 10,700 square feet. The initial term of the lease expired in December 2010. In December 2010, we amended and extended the lease for three years. Our base rent is currently approximately $33,000 per month, subject to annual adjustments, with aggregate minimum lease commitments at December 31, 2010, totaling approximately $1.2 million. Concurrent with the three year extension, the Board of Directors approved a sublease of approximately one-third of the office space to Reserva, LLC an affiliate of our Chairman and CEO. Reserva, LLC will pay the company pro-rata rent during the three-year lease period.

    In April 2005 we entered into a five-year lease for approximately 5,400 square feet of medical office space at an initial base rent of approximately $19,000 per month, commencing in August 2005.  The space is occupied by a managed medical practice, under a full business service management agreement.  As a condition to signing the lease, we secured a $90,000 letter of credit for the landlord as a security deposit, which, as of December 31, 2010 has been subsequently reduced to $45,000. The letter of credit is collateralized by a certificate of deposit in the amount of $45,000, which is included in deposits and other assets in our consolidated balance sheet as of   December 31, 2010. In August 2010, with all base and deferred rents paid in full, we entered into another amendment to our lease for a six-month extension after which it converts to a month-to-month lease. At December 31, 2010, the minimum base rent for the medical office in Santa Monica including aggregate minimum lease commitments was approximately $10,700, subject to annual adjustment.

    In August 2006, the Company entered into a month-to-month officefive-year lease agreement for its corporate officesapproximately 4,000 square feet of medical office space for a company managed treatment center in Los Angeles, California for approximately $14,000 per month.San Francisco, CA.  The Company ceased operations at the center in January 2008.  In September 2003,the first quarter of 2009, the Company signed a new officeceased making rent payments under the lease.  In March, 2010 the Company settled the outstanding lease commitment for $200,000 to be paid in monthly installments from March 2010 through February 2011. All payments under this settlement agreement for its corporate offices with the same landlord at an initial lease cost of approximately $33,000 per month, with increases scheduled annually over the lease term.  The term of the lease is seven years beginning on the lease commencement date, December 15, 2003, with a right to extend the lease for an additional five years.  have subsequently been paid in full.
    Rent expense is calculated using the straight-line method based on the total minimum lease payments over the initial term of the lease. RentLandlord tenant improvement allowances and rent expense exceeding actual rent payments isare accounted for as a deferred rent liability in the balance sheet. Assheet and amortized on a conditionstraight-line basis over the initial term of the respective leases.

    Future minimum payments, by year and in the aggregate, under non-cancelable operating leases with initial or remaining terms of one year or more, consist of the following at December 31, 2010:
    F-29

    (in thousands)   
    Year ending December 31, Amount 
    2011 $440 
    2012  413 
    2013  463 
      $1,316 
    Clinical Research Commitments

    In prior years, we committed to signing the lease, the Company secured a $350,000 letter of creditunrestricted grants for the landlord as a form of security deposit.  The letter of credit is collateralized by a certificate of depositclinical research study in the amount of $350,000.

    F-21

            Future minimum lease payments$400,000, payable based on the non-cancelable lease are as follows:

    Period ending December 31,
    		  
    Base Rental Payments
    		 
    		 
    		 
    2004 $392,000 
    2005  405,000 
    2006  417,000 
    2007  431,000 
    2008  443,000 
    Thereafter  904,000 
      
    		 
    Total $2,992,000 
      
    		 

            In addition to the above lease obligations, atachieving certain milestones. As of December 31, 2003 the Company2010, we had undertaken commitments of approximately $333,000$356,000 remaining commitment for completion of lease build-out costs (net of tenant improvement allowances provided by the landlord), computer hardware and software costs, telephone and communication systems, office furniture and other office equipment in connection with the relocation of the corporate offices to the new lease space.

    that for that clinical research study.


    Legal Proceedings

            The Company is subject


    From time to time, we may be involved in litigation relating to claims and lawsuitsarising out of our operations in itsthe normal course of business. As of the December 31, 2003, the Company was2010, we were not involved in any legal proceeding that we believe would have a material adverse effect on theour business, financial condition or operating results.

    Please see Item 3 Legal Proceedings for more information.


    Note 10. Interim Financial Information (Unaudited)

            Summarized quarterly supplemental financial information is as follows:

    14.  Subsequent Events
      
    Quarter Ended
     

    March 31 

    June 30

    September 30
    December 31
    Total 2003
      
    (In thousands, except per share) 
    Net revenues

     

    		$                   —   $—    $            44 $            31 $             75
    Operating loss — (201) (844) (2,500) (3,545)
    Net loss — (201) (841) (2,462) (3,504)
    Basic and diluted loss per share — (0.02) (0.06) (0.13) (0.21)

    F-22

    As previously disclosed in our definitive proxy statement on Schedule 14A with the Securities and Exchange Commission (SEC) on January 21, 2011, a special meeting was held on March 4, 2011 where the stockholders voted on the following matters: (1) approve the adoption of the proposed 2010 Stock Incentive Plan,  (2) approve a proposed amendment to our Certificate of Incorporation to increase the number of authorized shares of our common stock from 200,000,000 to 2,000,000,000, (3) approve a proposed amendment or amendments to our Certificate of Incorporation to effect one or more stock splits of our outstanding common stock and (4) approve a proposed amendment to our certificate of incorporation to change our name to from Hythiam, Inc. to Catasys, Inc.  On March 4, 2011, the special meeting was held and all of the proposals were approved.

    On March 17, 2011, we filed a Certificate of Amendment to our Certificate of Incorporation, pursuant to which we increased the authorized shares of common stock to 2,000,000,000 shares and changed our name to Catasys, Inc. Effective March 17, 2011, the common stock of the Company began trading under CATS.OB. In connection with the increase in the authorized shares of common stock, a number of the Company’s outstanding obligations were triggered, including, conversion of the Notes, which converted into 620,574,548 shares of common stock.
        
    On March 30, 2011, the Company entered into a consulting agreement with former director, Marc Cummins.  The agreement calls for Mr. Cummins to provide the following services: investor relations, financing advisory, board of director transitional and other services as mutually determined.  In consideration of such services, Mr. Cummins was granted 8,344,199 options to purchase our common stock at fair value ($0.071/share), vesting monthly over 4 years.  The agreement may terminate with thirty (30) days written notice by either party.
    F-30
    Dealer Prospectus Delivery Obligation

    Until ___________, 2011, all dealers that effect transactions in these securities, whether or not participating in this offering, may be required to deliver a prospectus. This is in addition to the dealers’ obligation to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.
    [_________] Shares of Common Stock
    and
    Warrants to Purchase Up to [_____] Shares of Common Stock






    PROSPECTUS DATED _______, 2011
    PART II
    INFORMATION NOT REQUIRED IN PROSPECTUS
    Item 13.
    Other Expenses of Issuance and Distribution
    You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. The Selling Shareholders are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock.
    TABLE OF CONTENTS
    Page
    Prospectus Summary1
    Risk Factors3
          Risks Related to Our Business3
                Risks Related to Our Intellectual
                   Property6
             Risks Related to Our Industry8
             Risks Related to Our Common Stock11
    Cautionary Statement Concerning
       Forward-Looking Information13
    Use of Proceeds13
    Dividend Policy13
    Selling Shareholders14
    Plan of Distribution26
    Description of Capital Stock27
    Legal Matters28
    Business28
    Property39
    Legal Proceedings39
    Market for Our Securities39
    Selected Financial Data41
    Management’s Discussion and Analysis of
       Financial Condition and Results of
       Operations42
    Quantitative and Qualitative Disclosures
       About Market Risk47
    Management47
    Executive Compensation50
    Security Ownership of Certain Beneficial
       Owners and Management53
    Certain Relationships and Related
       Transactions54
    Indemnification Under Our Certificate of
       Incorporation and Bylaws54
    Where You Can Find Additional Information54
    Index to Financial StatementsF-1
         Until __________, 2004, all dealers effecting transactions in the common stock offered hereby, whether or not participating in this distribution, may be required to deliver a prospectus. This is in addition to the obligations of dealers to deliver a prospectus when acting as underwriters and with respect to their unsold allotments or subscriptions.

    10,967,528 Shares

    Common Stock


    ______________

    PROSPECTUS
    ______________

    Hythiam, Inc.

    __________________, 2004

    PART II

    Information Not Required in Prospectus
    Item 13. Other Expenses of Issuance and Distribution

    The following table sets forth the various costs and expenses payable by the registrantus in connection with the sale of the common stocksecurities being registered. Any broker-dealer discountsAll such costs and commissions willexpenses shall be payableborne by the Selling Shareholders.us. Except for the SEC registration fee, all the amounts shown are estimates.

    SEC Registration Fee $10,617 
    Legal fees and expenses 100,000 
    Accounting fees and expenses 50,000 
    Printing and related expenses 25,000 
    Miscellaneous 14,383 
      
    		 
    Total $200,000 
      
    		 

    Item 14. Indemnification of Officers and Directors
     
    Under
      
    Amount 
    to be Paid
    SEC registration fee $1,161*
    Legal fees and expenses  1 
    Accounting fees and expenses  1 
    Printing and miscellaneous expenses  1 
    Total  1 
     
    * Previously paid
    1 To be provided by amendment.

    Item 14.Indemnification of Directors and Officers

    Section 145(a) of the Delaware General Corporation Law provides, in general, that a corporation may indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (other than an action by or in the right of the corporation), because he or she is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys’ fees), judgments, fines and amounts paid in settlement actually and reasonably incurred by the person in connection with such action, suit or proceeding, if he or she acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interests of the corporation and, with respect to any criminal action or proceeding, had no reasonable cause to believe his or her conduct was unlawful.

    Section 145(b) of the Delaware General Corporation Law provides, in general, that a corporation may indemnify any person who was or is a party or is threatened to be made a party to any threatened, pending or completed action or suit by or in the right of the corporation to procure a judgment in its favor because the person is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise, against expenses (including attorneys’ fees) actually and reasonably incurred by the person in connection with the defense or settlement of such action or suit if he or she acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interests of the corporation, except that no indemnification shall be made with respect to any claim, issue or matter as to which he or she shall have been adjudged to be liable to the corporation unless and only to the extent that the Court of Chancery or other adjudicating court determines that, despite the adjudication of liability but in view of all of the circumstances of the case, he or she is fairly and reasonably entitled to indemnity for such expenses which the Court of Chancery or other adjudicating court shall deem proper.

    Section 145(g) of the Delaware General Corporation Law provides, in general, that a corporation may purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the corporation, or is or was serving at the request of the corporation as a director, officer, employee or agent of another corporation, partnership, joint venture, trust or other enterprise against any liability asserted against such person and incurred by such person in any such capacity, or arising out of his or her status as such, whether or not the corporation would have the power to indemnify the person against such liability under Section 145 of the Delaware General Corporation Law.
    II-1

    The Certificate of Incorporation and the Bylaws of our Company provide that our Company will indemnify, to the fullest extent permitted by the Delaware General Corporation Law, each person who is or was a director, officer, employee or agent of our Company, or who serves or served any other enterprise or organization at the registrant has broad powersrequest of our Company. Pursuant to Delaware law, this includes elimination of liability for monetary damages for breach of the directors’ fiduciary duty of care to our Company and its stockholders. These provisions do not eliminate the directors’ duty of care and, in appropriate circumstances, equitable remedies such as injunctive or other forms of non-monetary relief will remain available under Delaware law. In addition, each director will continue to be subject to liability for breach of the director’s duty of loyalty to our Company, for acts or omissions not in good faith or involving intentional misconduct, for knowing violations of law, for any transaction from which the director derived an improper personal benefit, and for payment of dividends or approval of stock repurchases or redemptions that are unlawful under Delaware law. The provision also does not affect a director’s responsibilities under any other laws, such as the federal securities laws or state or federal environmental laws.

    We have entered into agreements with our directors and executive officers that require us to indemnify these persons against expenses, judgments, fines, settlements and other amounts actually and reasonably incurred (including expenses of a derivative action) in connection with any proceeding, whether actual or threatened, to which any such person may be made a party by reason of the fact that the person is or was a director or officer of our Company or any of our affiliated enterprises, provided the person acted in good faith and in a manner the person reasonably believed to be in or not opposed to our Company’s best interests and, with respect to any criminal proceeding, had no reasonable cause to believe that his or her conduct was unlawful. The indemnification agreements will also establish procedures that will apply if a claim for indemnification arises under the agreements.

    Our Company maintains a policy of directors’ and officers’ liability insurance that insures its directors and officers against liabilities they may incurthe cost of defense, settlement or payment of a judgment under some circumstances.

    Item 15.Recent Sales of Unregistered Securities

    In January 2010, the holder of certain claims against us in such capacities, including liabilities underthe amount of approximately $230,000, due for services provided to us which have not been paid, filed a complaint against us in California state court. In February 2010 the court approved our settlement of the complaint in exchange for issuing 445,000 shares of our common stock pursuant to Section 3(a)(10) of the Securities Act of 1933, as amended (the “Securities Act”). The registrant’s articles of incorporation and by-laws provide that the registrant shall indemnify its officers and directors to the fullest extent not prohibited by law.Act.

    Item 15. Recent Sales of Unregistered Securities
    On September 29, 2003, in connection with the merger with Hythiam, Inc., a New York corporation (“Hythiam NY”), the registrantIn February 2010, we issued 23,486,916 shares of its common stock to Hythiam NY’s stockholders in a one-for-one exchange for all of the outstanding650,000 restricted shares of common stock of Hythiam NY. No commissions were paid in connection with the issuance of the foregoing shares, which were issued without registration pursuant to the exemption afforded by Section 4(2) of the Securities Act of 1933.
    Priora consultant for investor relation services to the merger, Hythiam NY completed a private placement of its shares, which were offeredbe performed beginning February 22, 2010 and sold to accredited investors at $2.50 per share, resulting in proceeds to Hythiam NY (net of placement agent fees of $342,000 and offering expenses of $241,000) of $21.3 million.
    In connection with the private placement, the registrant issued warrants to purchase 385,200 shares of its common stock to purchasers of preferred stock that was converted into common stock immediately prior to the merger, and warrants to purchase 208,890 shares of its common stock to placement agents. Hythiam NY also issued 140,000 shares of its common stock and warrants to purchase 108,200 shares of its common stock to consultants and financial advisors. With the exception of warrants to purchase 86,800 shares of common stock at an exercise price of $3.00 per share, the exercise price of all warrants was $2.50 per share.
    In January 2004, the registrant issued to consultants and financial advisors 8,322 shares of its common stock and warrants to purchase 150,000 of common stock at an exercise price of $7.00 per share. The foregoingending May 22, 2010. These securities were issued without registration pursuant to the exemption afforded by Section 4(2) of the Securities Act of 1933.1933, as a transaction by us not involving any public offering.

    In April 2010, the holder of certain claims against us in the amount of $1,005,000, due for services provided to us which had not been paid, filed a complaint against us in California state court. On April 8, 2010 the court approved our settlement of the complaint in exchange for issuing 5,000,000 shares of our common stock pursuant to Section 3(a)(10) of the Securities Act of 1933 as amended. In accordance with the approved settlement the number of shares is subject to adjustment 180 days subsequent to the issuance of the shares.  In addition, the owner of the claims will not sell more than the greater of 49,000 shares or 10% of the daily trading volume during that 180 day period. Pursuant to the terms of  the agreement, the number of shares were adjusted and 605,000 shares were subsequently issued.

    In October 2010, our Company entered into Securities Purchase Agreements with certain accredited investors, for the Bridge Notes and the Bridge Warrants as described above in “Related Party Transactions.” These securities were issued without registration pursuant to the exemption afforded by Rule 506 of Regulation D promulgated under the Securities Act.

               In November 2010, our Company completed a private placement with certain accredited investors, for gross proceeds of $6.9 million. As consideration, our Company issued warrants to purchase 5,670,000 shares of common stock at $0.01 per share to the financial advisors. Our Company issued 100,000,000 shares of common stock at a purchase price of $0.01 per share and $5.9 million in aggregate principal of 12% senior secured convertible notes to the investors on a pro rata basis. In addition each non-affiliated investor investing $2,000,000 or more also received 5-year warrants to purchase an aggregate of 21,960,000 shares of company common stock at an exercise price of $0.01 per share. One investor received such warrants. These securities were issued without registration pursuant to the exemption afforded by Rule 506 of Regulation D promulgated under the Securities Act.

    In December, 2010, the board approved issuance of 10,000,000 shares of common stock to our investor relations firm in consideration for a previously recognized liability and future service to our Company. These securities were issued without registration pursuant to the exemption afforded by Section 4(2) of the Securities Act, as a transaction by us not involving any public offering. Additionally, the Board of directors approved issuance of 20,400,000 shares to  Jay Wolf as compensation for his newly appointed role of Lead Director. These securities were issued without registration pursuant to the exemption afforded by Section 4(2) of the Securities Act, as a transaction by us not involving any public offering.
     
    On May 17, 2004 the registrant In March 2011, we issued 360,0001,000,000 restricted shares in the name of Xino Corporation in connection with the acquisition of certain intellectual property as described under the section titled “Certain Relationshipscommon stock to a consultant for investor relation services to be performed beginning January 1, 2011 and Related Transactions” on page 54. Such shares have been pledged and are being held to secure Xino’s remaining obligations to the registrant and may not be released or sold until such obligations are satisfied. The foregoingending March 31, 2011. These securities were issued without registration pursuant to the exemption afforded by Section 4(2) of the Securities Act of 1933.1933, as a transaction by us not involving any public offering.
    II-2
     
    Item 16.Exhibits and Financial Statement Schedules

     (a)(3) 
    		 II-1
    Exhibits
    The following exhibits are filed as part of this report:
     
    Item 16. Exhibits and Financial Statement Schedules
    (a)Exhibits

    Exhibit
    No.
    		 
    Exhibit No.
    Description
    2.1AssetStock Purchase Agreement among Alaska Freightways,between WoodCliff Healthcare Investment Partners, LLC and Core Corporate Consulting Group, Inc., Donald E. Nelson, Richard L. Strahldated January 14, 2009, incorporated by reference to Exhibit 10.1 of the Catasys Inc.’s current report on Form 8-K/A filed with the Securities and Brady L. Strahl, datedExchange Commission on January 26, 2009.
    3.1Certificate of Incorporation of Catasys, Inc., filed with the Secretary of State of the State of Delaware on September 29, 2003(1)2003, incorporated by reference to exhibit of the same number of Catasys Inc.’s Form 8-K filed with the Securities and Exchange Commission on   September 30, 2003.
    2.23.2Agreement and PlanCertificate of Merger among Alaska Freightways,Amendment to Certificate of Incorporation of Catasys, Inc., Hythiam Acquisition Corporation, Hythiam,incorporated by reference to exhibit of the same number to Catasys, Inc., a New York corporation,’s annual report on Form 10-K filed with the Securities and certain Stockholders, dated September 29, 2003(1)Exchange Commission for the year ended December 31, 2010.
    2.33.3Agreement and PlanBy-Laws of Merger between Alaska Freightways, Inc. and Hythiam,Catasys, Inc., a Delaware corporation, datedincorporated by reference to exhibit of the same number of Catasys, Inc.’s Form 8-K filed with the Securities and Exchange Commission on September 29, 2003(1)
    3.1Articles of Incorporation(1)
    3.2Bylaws(1)30, 2003.
    4.1Specimen of Common Stock Certificate(2)Certificate, incorporated by reference to exhibit of the same number to Catasys Inc.’s annual report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2005.
    4.2Secured Convertible Promissory Note issued to Socius Capital Group, LLC, incorporated by reference to exhibit 4.1 of Catasys, Inc.’s current report on Form of Warrant(2)8-K filed with the Securities and Exchange Commission on October 20, 2010.
    4.3Secured Convertible Promissory Note issued to Esousa Holdings, LLC, incorporated by reference to exhibit 4.2 of Catasys, Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on October 20, 2010.
    4.4Form of Registration Rights Agreement(5)Warrant incorporated by reference to Exhibit 4.2 of Catasys, Inc.’s Registrations Statement on Form S-1/A filed with the Securities and Exchange Commission on May 17, 2010.
    5.14.5Warrant issued to Socius Capital Group, LLC, incorporated by reference to exhibit 4.3 of Catasys, Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on October 20, 2010.
    4.6Warrant issued to Esousa Holdings, LLC, incorporated by reference to exhibit 4.4 of Catasys, Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on October 20, 2010.
    4.7Warrant issued on November 16, 2010, incorporated by reference to exhibit of the same number of Catasys Inc.’s annual report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2010.
    5.1±Form of Opinion of Greenberg Traurig, LLP(2)counsel as to legality of securities being registered.
    10.110.1*2003 Stock Option Plan(1)Incentive Plan, incorporated by reference to Exhibit 99.1 of Catasys Inc.’s Form 8-K filed with the Securities and Exchange Commission on September 30, 2003.
    10.210.2*TechnologyEmployment Agreement between Catasys, Inc. and Terren S. Peizer, dated September 29, 2003, incorporated by reference to exhibit of the same number to Catasys Inc.’s annual report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2005.
    10.3*Employment Agreement between Catasys, Inc. and  Richard A. Anderson, dated April 19, 2005, incorporated by reference to exhibit of the same number to Catasys Inc.’s annual report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2005.

    II-3
    10.4*Employment Agreement between Catasys, Inc. and Christopher Hassan., dated July 26, 2006, incorporated by reference to exhibit of the same number to Catasys Inc.’s annual report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2006.
    10.5*2007 Stock Incentive Plan, incorporated by reference to the Catasys Inc.’s Revised Definitive Proxy on Form DEFR14A filed with the Securities and Exchange Commission on May 11, 2007.
    10.6Redemption Agreement between Catasys, Inc. and Highbridge International, LLC., dated November 7, 2007, incorporated by reference to exhibit of the same number to Catasys, Inc.’s annual report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2007.
    10.7Securities and Purchase Agreement between Catasys, Inc. and RoyaltyHighbridge International, LLC, dated January 17, 2007, incorporated by reference to Exhibit 10.4 of Catasys Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on January 18, 2007.
    10.8*Registration Rights Agreement between Catasys, Inc. and Highbridge International, LLC, dated January 17, 2007, incorporated by reference to Exhibit 10.5 of Catasys Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on  January 18, 2007.
    10.9Pledge Agreement between Catasys, Inc. and Highbridge International, LLC, dated January 17, 2007, incorporated by reference to Exhibit 10.8 of Catasys Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on January 18, 2007.
    10.10Security Agreement between Catasys, Inc. and Highbridge International, LLC, dated January 17, 2007, incorporated by reference to Exhibit 10.9 of Catasys Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on January 18, 2007.
    10.11Securities Purchase Agreement between Catasys, Inc. and Highbridge International, LLC, dated November 6, 2007, incorporated by reference to Exhibit 10.1 of Catasys Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on November 7, 2007.
    10.12*Amendment to Employment Agreement of Richard A. Anderson, dated July 16, 2008, incorporated by reference to Exhibit 10.1 of  Catasys Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on July 18, 2008.
    10.13Amendment and Exchange Agreement with Tratamientos Avanzados de la Adiccion S.L., as amended(5)Highbridge International LLC, dated July 31, 2008, incorporated by reference to Exhibit 10.1 of the Catasys Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on August 1, 2008.
    10.310.14AgreementAmended and Restated Senior Secured Note with Little CompanyHighbridge International LLC, dated July 31, 2008, incorporated by reference to Exhibit 10.2 of Mary – San Pedro Hospital(3)(5)the Catasys Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on August 1, 2008.
    10.410.15Amended and Restated Warrant to Purchase Common Stock with Highbridge International LLC, dated July 31, 2008, incorporated by reference to Exhibit 10.3 of the Catasys Inc.’s current  report on Form 8-K filed with the Securities and Exchange Commission on August 1, 2008.
    10.16*Employment Agreement between Catasys, Inc. and Maurice Hebert, dated November 12, 2008, incorporated by reference to Exhibit 10.1 of the Catasys Inc.’s current report on Form 8-K filed with Lake Chelan Community Hospitalthe Securities and Exchange Commission on November 14, 2008.
    10.17*Consulting Services Agreement between Catasys, Inc. and Chuck Timpe, dated November 12, 2008, incorporated by reference to Exhibit 10.2 of Washington(3)the Catasys Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on November 14, 2008.
    10.18Order for Settlement of Claims between Catasys, Inc. and The Trinity Group-I, Inc., dated January 21, 2010, incorporated by reference to exhibit of same number to Catasys Inc.’s annual report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2009.
    10.19Settlement Agreement between Catasys, Inc. and Lincoln PO FBOP Limited Partnership, dated March 23, 2010, incorporated by reference to exhibit of same number to Catasys Inc.’s annual report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2009.
    10.20Order Approving Stipulation for Settlement of Claims between Catasys, Inc. and The Trinity Group-I, Inc., dated April 8, 2010, incorporated by reference to exhibit of same number to Catasys Inc.’s annual report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2009.
    II-4
    10.212010 Stock Incentive Plan incorporated by reference to exhibit 10.1 of Catasys, Inc’s Form 8-K filed with the Securities and Exchange Commission on December 16, 2010.
    10.22Eighth Amendment to lease by and between Catasys, Inc. and the Irvine Company, LLC, incorporated by reference to exhibit of the same number to Catasys Inc.’s annual report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2010.
    10.23Securities Purchase Agreement between Catasys, Inc. and accredited investors dated October 19, 2010, incorporated by reference to Exhibit 4.1, 4.2, 4.3, 4.4, 10.1, 10.2, and 10.3 of Catasys Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on October 19, 2010.
    10.24Consulting Services Agreement between Catasys, Inc. and John V. Rigali, dated March 23, 2010, incorporated by reference to Exhibit 10.1 of Catasys, Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on March 29, 2010.
    10.25Seventh Amendment to Lease between Catasys, Inc. and The Irvine Company LLC, dated April 29, 2010, incorporated by reference to Exhibit 10.31 of Catasys Inc.’s quarterly report on Form 10-Q filed with the Securities and Exchange Commission on May 13, 2010.
    10.26Securities Purchase Agreement between Catasys, Inc. and investors, dated June 29, 2010, incorporated by reference to Exhibit 10.1 of Catasys, Inc.’s current report on Form 8-K filed with the Securities and Exchange Commission on June 30, 2010.
    10.27*Employment Letter between Catasys, Inc, and Peter Donato, dated August 19, 2010, incorporated by reference to Exhibit 10.33 of Catasys, Inc.’s current report on 8-K filed with the Securities and Exchange Commission on August 27, 2010.
    10.28Amendment No. 3 to Lease (3Net) between Catasys, Inc. and Lincoln Holdings, LLC, dated July 27, 2010, incorporated by reference to Exhibit 10.32 of Catasys. Inc.’s quarterly report filed with the Securities and Exchange Commission on August 16, 2010.
    10.29Consulting Services Agreement between Catasys, Inc. and Marc Cummins, incorporated by reference to exhibit of the same number to Catasys Inc.’s annual report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2010.
    21.1Subsidiaries of the Company, incorporated by reference to exhibit of the same number to Catasys Inc.’s annual report on Form 10-K filed with the Securities and Exchange Commission for the year ended December 31, 2010.
    23.1Consent of Greenberg Traurig, LLP (included in Exhibit 5.1 hereto)(2)Independent Registered Public Accounting Firm – Rose, Snyder & Jacobs.
    23.2Consent of BDO Seidman, LLP(4)
    23.3Consent of BDO Seidman, LLP(5)Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C. (included in exhibit 5.1)
    23.424.1ConsentPower of BDO Seidman, LLPAttorney (included on signature page).

    ___________
    (1)Previously filed exhibit of the same number to the Current Report on Form 8-K filed September 30, 2003, and incorporated herein by reference.

    (2)Previously filed exhibit of the same number to the registration statement on Form S-1 filed January 30, 2004, and incorporated by reference herein.

    (3)Portions of this exhibit have been redacted and separately filed with the Securities and Exchange Commission pursuant to a request for confidential treatment thereof.

    (4) Previously filed exhibit of the same number to the amended registration statement on Form S-1/A filed March 31, 2004, and incorporated herein by reference.

    (5) Previously filed exhibit of the same number to the amended registration statement on Form S-1/A filed May 19, 2004, and incorporated herein by reference.
     
    (b)*     Management contract or compensatory plan or arrangement.Financial Statement Schedules
    ±    To be filed by amendment.
     
    Not applicable.
     
    II-5

    Item 17. Undertakings

    The undersigned registrant hereby undertakes:

    (1)To file, during any period in which offers or sales are being made, a post-effective amendment to this registration statement:

         (i) To include any prospectus required by section 10(a)(3) of the Securities Act of 1933;
    (i)
         (ii) To reflect in the prospectus any facts or events arising after the effective date of the registration statement (or the most recent post-effective amendment thereof) which, individually or in the aggregate, represent a fundamental change in the information set forth in the registration statement. Notwithstanding the foregoing, any increase or decrease in volume of securities offered (if the total dollar value of securities offered would not exceed that which was registered) and any deviation from the low or high end of the estimated maximum offering range may be reflected in the form of prospectus filed with the Commission pursuant to Rule 424(b) if, in the aggregate, the changes in volume and price represent no more than 20 percent change in the maximum aggregate offering price set forth in the “Calculation of Registration Fee” table in the effective registration statement.

         (iii) To include any material information with respect to the plan of distribution not previously disclosed in the registration statement or any material change to such information in the registration statement;
    II-2 

    (2)That, for the purpose of determining any liability under the Securities Act of 1933, each such post-effective amendment shall be deemed to be a new registration statement relating to the securities offered herein,therein, and the offering of such securities at that time shall be deemed to be the initial bona fide offering thereof.

    (3)To remove from registration by means of a post-effective amendment any of the securities being registered which remain unsold at the termination of the offering.
     
    (4)That, for purposesthe purpose of determining any liability under the Securities Act each filingof 1933 to any purchaser:

         (i) If the registrant is relying on Rule 430B:
              (A) Each prospectus filed by the registrant pursuant to Rule 424(b)(3) shall be deemed to be part of the registrant’s annual reportregistration statement as of the date the filed prospectus was deemed part of and included in the registration statement; and

              (B) Each prospectus required to be filed pursuant to Section 13(a)Rule 424(b)(2), (b)(5), or Section 15(d)(b)(7) as part of a registration statement in reliance on Rule 430B relating to an offering made pursuant to Rule 415(a)(1)(i), (vii), or (x) for the purpose of providing the information required by section 10(a) of the ExchangeSecurities Act (and, where applicable, each filing of an employee benefit plan’s annual report pursuant1933 shall be deemed to section 15(d)be part of and included in the registration statement as of the Exchange Act)earlier of the date such form of prospectus is first used after effectiveness or the date of the first contract of sale of securities in the offering described in the prospectus. As provided in Rule 430B, for liability purposes of the issuer and any person that is incorporated by reference in the Registration Statementat that date an underwriter, such date shall be deemed to be a new effective date of the registration statement relating to the securities offered herein,in the registration statement to which that prospectus relates, and the offering of such securities at that time shall be
    deemed to be the initial bona fide offering thereof.Provided, however, that no statement made in a registration statement or prospectus that is part of the registration statement or made in a document incorporated or deemed incorporated by reference into the registration statement or prospectus that is part of the registration statement will, as to a purchaser with a time of contract of sale prior to such effective date, supersede or modify any statement that was made in the registration statement or prospectus that was part of the registration statement or made in any such document immediately prior to such effective date; or
     
    II-6

         (ii) If the registrant is subject to Rule 430C, each prospectus filed pursuant to Rule 424(b) as part of a registration statement relating to an offering, other than registration statements relying on Rule 430B or other than prospectuses filed in reliance on Rule 430A, shall be deemed to be part of and included in the registration statement as of the date it is first used after effectiveness. Provided, however, that no statement made in a registration statement or prospectus that is part of the registration statement or made in a document incorporated or deemed incorporated by reference into the registration statement or prospectus that is part of the registration statement will, as to a purchaser with a time of contract of sale prior to such first use, supersede or modify any statement that was made in the registration statement or prospectus that was part of the registration statement or made in any such document immediately prior to such date of first use.
    (5) That, for the purpose of determining liability of the registrant under the Securities Act of 1933 to any purchaser in the initial distribution of the securities:
    The undersigned registrant undertakes that in a primary offering of securities of the undersigned registrant pursuant to this registration statement, regardless of the underwriting method used to sell the securities to the purchaser, if the securities are offered or sold to such purchaser by means of any of the following communications, the undersigned registrant will be a seller to the purchaser and will be considered to offer or sell such securities to such purchaser:

         (i) Any preliminary prospectus or prospectus of the undersigned registrant relating to the offering required to be filed pursuant to Rule 424;

         (ii) Any free writing prospectus relating to the offering prepared by or on behalf of the undersigned registrant or used or referred to by the undersigned registrant;

         (iii) The portion of any other free writing prospectus relating to the offering containing material information about the undersigned registrant or its securities provided by or on behalf of the undersigned registrant; and

         (iv) Any other communication that is an offer in the offering made by the undersigned registrant to the purchaser.
    (6) The undersigned registrant hereby undertakes to supplement the prospectus, after the expiration of the subscription period, to set forth the results of the subscription offer, the transactions by the underwriters during the subscription period, the amount of unsubscribed securities to be purchased by the underwriters, and the terms of any subsequent reoffering thereof. If any public offering by the underwriters is to be made on terms differing from those set forth on the cover page of the prospectus, a post-effective amendment will be filed to set forth the terms of such offering.

    (7) The undersigned registrant hereby undertakes to deliver or cause to be delivered with the prospectus, to each person to whom the prospectus is sent or given, the latest annual report to security holders that is incorporated by reference in the prospectus and furnished pursuant to and meeting the requirements of Rule 14a-314a–3 or Rule 14c-314c–3 under the Securities Exchange Act of 1934; and, where interim financial information required to be presented by Article 3 of Regulation S-X isare not set forth in the prospectus, to deliver, or cause to be delivered to each person to whom the prospectus is sent or given, the latest quarterly report that is specifically incorporated by reference in the prospectus to provide such interim financial information.

    (8) The undersigned registrant hereby undertakes that:

          
    Insofar as indemnification for liabilities arising(1) For purposes of determining any liability under the Securities Act may be permitted to directors, officersof 1933, the information omitted from the form of prospectus filed as part of this registration statement in reliance upon Rule 430A and controlling personscontained in a form of prospectus filed by the registrant pursuant to the foregoing provisions,Rule 424(b) (1) or otherwise, the registrant has been advised that in the opinion of the Securities and Exchange Commission such indemnification is against public policy as expressed in(4) or 497(h) under the Securities Act and is, therefore, unenforceable. In the event that a claim for indemnification against such liabilities (other than the payment by the registrantshall be deemed to be part of expenses incurred or paid by a director, officer or controlling personthis registration statement as of the registrant intime it was declared effective.
          (2) For the successful defensepurpose of determining any action, suit or proceeding) is asserted by such director, officer or controlling person in connection with the securities being registered, the registrant will, unless in the opinion of our counsel the matter has been settled by controlling precedent, submit to a court of appropriate jurisdiction the question whether such indemnification by us is against public policy as expressed inliability under the Securities Act of 1933, each post-effective amendment that contains a form of prospectus shall be deemed to be a new registration statement relating to the securities offered therein, and will be governed by the final adjudicationoffering of such issue.
    SIGNATURESsecurities at that time shall be deemed to be the initial bona fide offering thereof.
     
    II-7

    SIGNATURES

    Pursuant to the requirements of the Securities Act of 1933, as amended, the registrant certifies that it has reasonable grounds to believe that it meets all of the requirements for filing on Form S-1 and has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Los Angeles, State of California, on the 8th21st day of June, 2004.April, 2011.

     
    HYTHIAM, INC.
    By:/s/ TERREN S. PEIZER
    Terren S. Peizer
    Chairman of the Board and
    Chief Executive Officer


    POWER OF ATTORNEY
    KNOW ALL PERSONSMEN BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Terren S. Peizer and Chuck Timpe,Peter Donato jointly and severally, his or any one of them, as hisher true and lawful attorney-in-factattorneys-in-fact and agent,agents, with full power of substitution and resubstitution, for him or her, and in his or her name, place and stead, in any and all capacities, to sign the Registration Statement on Form S-1 of Catasys, Inc. and any andor all amendments (including post-effective amendments) to thisthereto and any new registration statement with respect to the offering contemplated thereby filed pursuant to Rule 462(b) of the Securities Act, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-factattorney-in-fact and agents, and each of them,agent full power and authority to do and perform each and every act and thing requisite andor necessary to be done in connection therewith, as fully to all intents and purposes as he might or could do in person,about the premises hereby ratifying and confirming all that said attorneys-in-factattorney-in-fact and agents, or any of them, or theiragent, or his substitutessubstitute or substitute,substitutes, may lawfully do or cause to be done by virtue hereof.
     II-3

    Pursuant to the requirements of the Securities Act of 1933, as amended, this registration statementRegistration Statement has been signed by the following persons in the capacities and on the dates indicated.

    Signature
    		 
    Title(s)
    Title
    Date
    /s/ TERREN S. PEIZER
    Terren S. Peizer
    		 Chairman of the Board of Directors
    April 21, 2011
    Terren S. Peizer and Chief Executive OfficerOffice
      (Principal Executive Officer)June 8, 2004
    /s/ PETER DONATO
    		Chief Financial Officer
    April 21, 2011
    Peter Donato( Principal Financial Officer )
    /s/ RICHARD A. ANDERSON
    		President, Chief Operating Officer
    April 21, 2011
    Richard A. Andersonand Director
    /s/ JAY WOLF
    		Lead Director
    April 21, 2011
    Jay A. Wolf    
    /s/ CHUCK TIMPE
    KELLY MCCRANN
    Chuck Timpe
    		 Chief Financial Officer (Principal Financial and Accounting Officer)DirectorJune 8, 2004
    April 21, 2011
    Kelly McCrann    
    /s/ ANTHONY M. LAMACCHIA
    Anthony M. LaMacchia
    		Director and Chief Operating OfficerJune 8, 2004
       
    /s/ LESLIE F. BELL
    ANDREA GRUBB BARTHWELL, M.D
    Leslie F. Bell
    		 DirectorJune 8, 2004
    April 21, 2011
    Andrea Grubb Barthwell, M.D.
    /s/ HERVE DE KERGROHEN
    Herve de Kergrohen
    		DirectorJune 8, 2004
    /s/ RICHARD A. ANDERSON
    Richard A. Anderson
    		DirectorJune 8, 2004
    /s/ IVAN M. LIEBERBURG
    Ivan M. Lieberburg
    		DirectorJune 8, 2004
    /s/ JUAN JOSE LEGARDA 
    Juan Jose Legarda
    		DirectorJune 8, 2004
        


     

    II-4

    EXHIBIT INDEX
    Exhibit No.
    Description
    2.1Asset Purchase Agreement among Alaska Freightways, Inc., Donald E. Nelson, Richard L. Strahl and Brady L. Strahl, dated September 29, 2003(1)
    2.2Agreement and Plan of Merger among Alaska Freightways, Inc., Hythiam Acquisition Corporation, Hythiam, Inc., a New York corporation, and certain Stockholders, dated September 29, 2003(1)
    2.3Agreement and Plan of Merger between Alaska Freightways, Inc. and Hythiam, Inc., a Delaware corporation, dated September 29, 2003(1)
    3.1Articles of Incorporation(1)
    3.2Bylaws(1)
    4.1Specimen of Common Stock Certificate(2)
    4.2Form of Warrant(2)
    4.3Form of Registration Rights Agreement(5)
    5.1Opinion of Greenberg Traurig, LLP(2)
    10.12003 Stock Option Plan(1)
    10.2Technology Purchase and Royalty Agreement with Tratamientos Avanzados de la Adiccion S.L., as amended(5)
    10.3Agreement with Little Company of Mary – San Pedro Hospital(3)(5)
    10.4Agreement with Lake Chelan Community Hospital of Washington(3)
    23.1Consent of Greenberg Traurig, LLP (included in Exhibit 5.1 hereto)(2)
    23.2Consent of BDO Seidman, LLP(4)
    23.3Consent of BDO Seidman, LLP(5)
    23.4Consent of BDO Seidman, LLP

    ___________
    (1)Previously filed exhibit of the same number to the Current Report on Form 8-K filed September 30, 2003, and incorporated herein by reference.

    (2) Previously filed exhibit of the same number to the registration statement on Form S-1 filed January 30, 2004, and incorporated herein by reference.

    (3)Portions of this exhibit have been redacted and separately filed with the Securities and Exchange Commission pursuant to a request for confidential treatment thereof.

    (4) Previously filed exhibit of the same number to the amended registration statement on Form S-1/A filed March 31, 2004, and incorporated herein by reference.

    (5) Previously filed exhibit of the same number to the amended registration statement on Form S-1/A filed May 19, 2004, and incorporated herein by reference.