The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements including the related notes, and the other financial information included in this report. For ease of reference, "we," "us" or "our" refer to Hythiam, Inc., our wholly-owned subsidiaries and our managed treatment center unless otherwise stated.

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING INFORMATION

This report contains "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 with respect to the financial condition, results of operations, business strategies, operating efficiencies or synergies, competitive positions, growth opportunities for existing products, plans and objectives of management, markets for stock of Hythiam and other matters. Statements in this report that are not historical facts are hereby identified as "forward-looking statements" for the purpose of the safe harbor provided by Section 21E of the Exchange Act of 1934 and Section 27A of the Securities Act of 1933. Such forward-looking statements, including, without limitation, those relating to the future business prospects, revenue and income of Hythiam, wherever they occur, are necessarily estimates reflecting the best judgment of the senior management of Hythiam on the date on which they were made, or if no date is stated, as of the date of this report. These forward-looking statements are subject to risks, uncertainties and assumptions, including those described in the "Risk Factors" in Item 1 of Part I of our most recent Annual Report on Form 10-K, filed with the SEC, that may affect the operations, performance, development and results of our business. Because the factors discussed in this report could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any such forward-looking statements. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

OVERVIEW

General

We are a healthcare services management company, providing through our Catasys subsidiary behavioral health management services for substance abuse to health plans, employers and unions. Catasys is focused on offering integrated substance dependence solutions, including medical interventions such as our patented 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.

Segment Reporting

We currently operate within two reportable segments: Healthcare services and Behavioral Health. Our healthcare 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 Behavioral Health segment, through our Catasys subsidiary, 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. Currently, substantially all of our revenue from continuing operations and substantially all of our assets are earned or located within the United States.

Discontinued Operations

On January 20, 2009 we sold our entire interest in our controlled subsidiary CompCare 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 Results of Discontinued Operations in our Consolidated Statement of Operations for the nine months ended September 30, 2009. Additionally, we entered into an administrative services only (ASO)

agreement with CompCare to provide certain administrative services under CompCare's National Committee for Quality Assurance (NCQA) accreditation, including but not limited to case management and authorization services, in support of our newly launched specialty products and programs for autism and ADHD.

Prior to the sale, we reported the operations of CompCare in our behavioral health managed care segment. For detailed information regarding the impact of the sale of our interest in CompCare, see our consolidated financial statements and Note 5, Discontinued Operations, included with this report.

Operations

Healthcare Services

Licensing Operations

Under our licensing agreements, we provide physicians and other licensed treatment providers access to our PROMETA Treatment Program, education and training in the implementation and use of the licensed technology. The patient's physician determines the appropriateness of the use of the PROMETA Treatment Program. We receive
a fee for the licensed technology and related services generally on a per patient basis. As of September 30, 2009, we had active licensing agreements with physicians, hospitals and treatment providers for 62 sites throughout the United States, with 24 sites contributing to revenue in 2009. We will continue to enter into agreements on a selective basis with additional healthcare providers to increase the availability of the PROMETA Treatment Program, generally in markets we are presently operating or where such sites will provide support for our Catasys products. As such revenues are generally related to the number of patients treated, key indicators of our financial performance for the PROMETA Treatment Program will be the number of facilities and healthcare providers that license our technology, and the number of patients that are treated by those providers using our PROMETA Treatment Program. As discussed below in Recent Developments, we have reduced resources allocated to licensing activities and are currently evaluating and considering additional actions to streamline our operations that may impact the licensing operations.

Managed Treatment Center

We currently manage one treatment center under our licensing agreement, located in Santa Monica, California (dba The Center to Overcome Addiction, formerly named the PROMETA Center). In May 2009, we terminated the Management Services Agreements ("MSA") with a medical professional corporation and a managed treatment center in Dallas, Texas. We manage the business components of the Center to Overcome Addiction and license the PROMETA Treatment Program and use of the name in exchange for management and licensing fees under the terms of a full business service management agreement. This center offers treatment with the PROMETA Treatment Program for dependencies on alcohol, cocaine and methamphetamines and also offer medical interventions for other substance dependencies and psychiatric services. The revenues and expenses of this center are included in our consolidated financial statements under accounting standards applicable to variable interest entities. Revenues from licensed and managed treatment centers, including the Center to Overcome Addiction, accounted for approximately 54% and 56% of our healthcare services revenues for the three and nine months ended September 30, 2009, respectively. As discussed below in Recent Developments, we are currently evaluating and considering additional actions to streamline our operations that may impact our managed treatment center.

Behavioral Health

Beginning in 2007, we developed our Catasys integrated substance dependence solutions for third-party payors. We believe that our Catasys offerings will address a high cost segment of the healthcare market for substance dependence, and we are currently marketing our Catasys integrated substance dependence solutions to managed care health plans on 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. In addition, we may be launching other specialty behavioral health products and programs, including Autism and ADHD, that can leverage our existing infrastructure and sales force, but this effort is largely on hold due to current budget constraints.

Recent Developments

In September 2009, we entered into a three-year agreement with Ford Motor Company (Ford) to provide the Catasys Integrated Substance Dependence Solution to Ford's hourly employees in Michigan enrolled in their 'National PPO' and who meet certain criteria. The Company will conduct direct outreach to enroll qualified members, and will also work with UAW-Ford and Ford's EAP program to ensure the most beneficial treatment pathway for members. Contractual revenues from the agreement are based on a combination of monthly fees for the member population for Catasys, with additional monthly fees for members enrolled into the Catasys program. Operational implementation began immediately after signing, and the program is anticipated to launch late in the fourth quarter of 2009.

In September 2009, we completed a registered direct placement with select institutional investors, in which we issued an aggregate of approximately 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. We incurred approximately $883,000 in fees to placement agents and other transaction costs in connection with the transaction.

In August 2009, Dr. Anton's study on alcohol dependent subjects, entitled "Efficacy of a Combination of Flumazenil and Gabapenton in the Treatment of Alcohol Dependence", was published in the August issue of 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 the first three quarters of 2009, we took further actions to streamline our operations and increase the focus on managed care opportunities, which included significant reductions in field and regional sales personnel and related corporate support personnel, curtailment of our international operations, a reduction in outside consultant expense, termination of a clinical study and overall reductions in overhead and payroll costs. Additionally, we renegotiated certain leasing and vendor agreements to obtain more favorable pricing and to restructure payment terms with vendors, which included negotiating settlements for outstanding liabilities. In addition, we terminated the MSAs with a medical professional corporation and a managed treatment center in Dallas, Texas "for cause" and because the Company had met its funding requirement with respect to such MSAs. These efforts have resulted in delays and reductions in operating expenses, resulting in additional annual savings in operating expenses of approximately $5.7 million.

How We Measure Our Results

Our healthcare services revenues to date have been primarily generated from fees that we charge to hospitals, healthcare facilities and other healthcare providers that license our PROMETA Treatment Program, and from patient service revenues related to our licensing and MSAs with managed treatment centers. Our technology license and MSAs usually provide for an initial fee for training and other start-up related costs, plus a combined fee for the licensed technology and other related services, generally set on a per-treatment basis, and thus a substantial portion of our revenues is closely related to the number of patients treated. Patients treated by managed treatment centers generate higher average revenues per PROMETA patient than our other licensed sites due to consolidation of their gross patient revenues in our financial statements. Key indicators of our financial performance will be the number of health plans and other organizations that contract with us for our Catasys products, the number of managed care members enrolled in such programs, our ability to demonstrate the cost savings of our Catasys programs,, and the number of facilities and healthcare providers that contract with us to license our technology and the number of patients that are treated by those providers using the PROMETA Treatment Program. Additionally, our financial results will depend on our ability to expand the adoption of Catasys and the PROMETA Treatment Program, and our ability to effectively price these products, and manage general, administrative and other operating costs.

RESULTS OF OPERATIONS

Table of Summary Consolidated Financial Information

The table below and the discussion that follows summarize our results of
consolidated continuing operations for the three and nine months ended September
30, 2009 and 2008:

                                         Three Months Ended             Nine Months Ended
(In thousands, except per share
amounts)                                   September 30,                  September 30,
                                        2009            2008           2009           2008
Revenues
Healthcare services                  $       268     $    1,258     $    1,346     $    5,295
Total revenues                               268          1,258          1,346          5,295

Operating expenses
Cost of healthcare services          $        68     $      330     $      502     $    1,335
General and administrative expenses        3,878          9,351         14,007         29,466
Research and development                       -            713              -          2,986
Impairment losses                              -              -          1,113              -
Depreciation and amortization                273            510            979          1,419
Total operating expenses                   4,219         10,904         16,601         35,206

Loss from operations                 $    (3,951 )   $   (9,646 )   $  (15,255 )   $  (29,911 )

Non-operating income (expenses)
Interest & other income                       19            113            142            738
Interest expense                            (221 )         (637 )         (999 )       (1,149 )
Loss on extinguishment of debt               (54 )            -           (330 )            -
Gain on the sale of marketable
securities                                   160              -            160              -
Other than temporary impairment of
marketablesecurities                         (25 )            -           (185 )            -
Change in fair value of warrant
liabilities                               (4,767 )        3,758         (4,683 )        4,713

Loss from continuing operations
before
provision for income taxes                (8,839 )       (6,412 )      (21,150 )      (25,609 )
Provision for income taxes                     3              6             13             23
Loss from continuing operations      $    (8,842 )   $   (6,418 )   $  (21,163 )   $  (25,632 )

Summary of Consolidated Operating Results

As we continue to streamline our operations and increase the focus on managed care opportunities, actions we have taken to reduce expenses have led to continued declines in loss from operations in our continuing operations, compared to the prior year. 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 managed 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 prior year.

Loss from continuing operations for the three months ended September 30, 2009 amounted to $8.8 million compared to $6.4 million in the same period in 2008. Excluding the change in fair value of warrant liabilities, which amounted to a loss of $4.8 million in 2009 compared to a gain of $3.8 million in 2008, the loss from continuing operations declined by $6.2 million. The improvement was driven by a $5.5 million decrease in general and administrative expenses, from the streamlining of operations as discussed above, a $713,000 decrease in research

and development costs, a $416,000 decrease in interest expense, a $262,000 decrease in cost of healthcare services and a $160,000 gain on the sale of marketable securities. These improvements were partially offset by the $990,000 decline in revenues.

Loss from continuing operations for the nine months ended September 30, 2009 amounted to $21.2 million compared to $25.6 million in the same period in 2008. Excluding the change in fair value of warrant liabilities, which amounted to a loss of $4.7 million in 2009 compared to a gain of $4.7 million in 2008, the loss from continuing operations declined by $13.8 million. The improvement was driven by a $15.5 million decrease in general and administrative expenses, from the streamlining of operations as discussed above, a $3.0 million decrease in research and development costs, a $833,000 decrease in cost of healthcare services and a $160,000 gain on the sale of marketable securities. These improvements were partially offset by the $3.9 million decline in revenues, $1.1 million in asset impairment charges, $330,000 of losses on extinguishment in debt and $160,000 in impairment charges for marketable securities.

Also included in the loss from continuing operations were consolidated non-cash charges for depreciation and amortization, debt discount amortization and stock-based compensation expense totaling $1.4 million and $5.2 million for three and nine months ended September 30, 2009, respectively, compared to $3.6 million and $9.0 million for the same periods in 2008, respectively.

Reconciliation of Segment Results

The following table summarizes and reconciles the loss before provision for
income taxes of our reportable segments in continuing operations to the loss for
continuing operations before provision for income taxes from our consolidated
statements of operations for the three and nine months ended September 30, 2009
and 2008:

                                          Three Months Ended           Nine Months Ended
 (In thousands)                              September 30,               September 30,
                                           2009          2008         2009          2008
 Healthcare services                    $   (7,978 )   $ (4,974 )   $ (17,963 )   $ (21,517 )
 Behavioral health                            (861 )     (1,438 )      (3,187 )      (4,092 )

 Loss from continuing operations before
  provision for income taxes            $   (8,839 )   $ (6,412 )   $ (21,150 )   $ (25,609 )

Healthcare Services

The following table summarizes the operating results for healthcare services for
the three and nine months ended September 30, 2009 and 2008:

                                              Three Months Ended                Nine Months Ended
(In thousands, except patient treatment
data)                                            September 30,                    September 30,
                                            2009               2008            2009           2008
Revenues
U.S. licensees                          $         123       $       527     $      459     $    2,514
Managed treatment centers (a)                     145               533            753          1,621
Other revenues                                      -               198            134          1,160
Total healthcare services revenues      $         268       $     1,258     $    1,346     $    5,295

Operating expenses
Cost of healthcare services             $          68       $       330     $      502     $    1,335
General and administrative expenses
Salaries and benefits                             899             2,464          5,285         12,736
Other expenses                                  2,118             5,449          6,376         12,638
Research and development                            -               713              -          2,986
Impairment losses                                   -                 -            355            447
Depreciation and amortization                     273               510            896            973
Total operating expenses                $       3,358       $     9,466     $   13,414     $   31,115

Loss from operations                    $      (3,090 )     $    (8,208 )   $  (12,068 )   $  (25,820 )

Interest and other income                          19               113            142            738
Interest expense                                 (221 )            (637 )         (999 )       (1,149 )
Loss on extinguishment of debt                    (54 )               -           (330 )            -
Gain on the sale of marketable
securities                                        160                 -            160              -
Other than temporary impairment on
marketable securities                             (25 )               -           (185 )            -
Change in fair value of warrant
liabilities                                    (4,767 )           3,758         (4,683 )        4,714
Loss before provision for income taxes  $      (7,978 )     $    (4,974 )   $  (17,963 )   $  (21,517 )

PROMETA patients treated
U.S. licensees                                     24                93             96            435
Managed treatment centers (a)                      22                33             78            117
Other                                               -                 8             11             60
                                                   46               134            185            612

Average revenue per patient treated (b)
U.S. licensees                          $       4,435       $     5,352     $    4,298     $    5,643
Managed treatment centers (a)                   4,206             9,033          5,957          9,586
Other                                               -             7,786         12,185          8,324
Overall average                                 4,326             6,404          5,466          6,659

(a) Includes managed and/or licensed PROMETA Centers.
(b) The average revenue per patient treated excludes administrative fees and other non-PROMETA patient revenues.

Revenue

Revenue decreased by $990,000 in the three months ended September 30, 2009 compared to the same period in 2008, primarily due to our decision to streamline our operations and focus on managed care opportunities in our Behavioral Health segment. We exited unprofitable markets and made significant reductions in field and regional sales personnel in our licensing operations, curtailed our managed treatment center operations (including terminating the management services agreements associated with our managed treatment center in Dallas, Texas) and shut-down our international operations. These actions resulted in a decline in licensed sites contributing to revenue and in the

number of patients treated. The number of licensed sites that contributed to revenues decreased from 36 to 14 and the number of patients treated decreased by 66% for the three months ended September 30, 2009, compared to the same period in 2008. The average revenue per patient treated at U.S. licensed sites and managed treatment centers decreased during the three months ended September 30, 2009 compared to the same period in 2008 due to higher average discounts granted because of the economic downturn.

Revenue decreased by $3.9 million in the nine months ended September 30, 2009 compared to the same period in 2008, consistent with the discussion above relating to our decision to streamline our operations and focus on managed care opportunities. The number of licensed sites that contributed to revenues on a year-to-date basis decreased from 50 to 24 and the number of patients treated decreased by 70% for the nine months ended September 30, 2009, compared to the same period in 2008. The average revenue per patient treated at U.S. licensed sites and managed treatment centers decreased during the nine months ended September 30, 2009 compared to the same period in 2008, due to higher average discounts granted because of the economic downturn. Our revenue may be further impacted in the fourth quarter of 2009 by market conditions due to the uncertain economy, impacting both the number of treatments and the average revenue per patient, and also as we maintain our commitment to reduce operating expenses in components of healthcare services that are revenue-generating, but unprofitable.

Cost of Healthcare Services

Cost of healthcare services consists of royalties we pay for the use of the PROMETA Treatment Program, and costs incurred by our consolidated managed treatment centers for direct labor costs for physicians and nursing staff, continuing care expense, medical supplies and treatment program medicine costs. The decrease in these costs primarily reflects the decrease in revenues from these treatment centers.

General and Administrative Expenses

General and administrative expense includes share-based compensation expense and costs associated with streamlining our operations, which amounted to $1.0 million and $1,000, respectively, for the three months ended September 30, 2009, compared to $2.8 million and $200,000, respectively for the same period in 2008. Excluding such costs, total general and administrative expense decreased by $2.9 million in 2009 when compared to 2008, due to reductions in all expense categories, but mainly to decreases in salaries and benefits and outside services, resulting from the continued streamlining of operations to focus on managed care opportunities in our Behavioral Health segment.

For the nine months ended September 30, 2009, share-based compensation expense and costs associated with streamlining our operations totaled $3.5 million and $275,000, respectively, compared to $7.0 million and $2.6 million, respectively for the same period in 2008. Excluding such costs, total general and administrative expense decreased by $7.9 million in 2009 when compared to 2008, . . .