The accompanying unaudited interim condensed consolidated financial statements for Hythiam, Inc. (referred to herein as the Company, Hythiam, we, us or our) and our subsidiaries have been prepared in accordance with the Securities and Exchange Commission (SEC) rules for interim financial information and do not include all information and notes required for complete financial statements. In theour 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 our most recent Annual Report on Form 10-K, from which the December 31, 2007 balance sheet has been derived.

Our consolidated financial statements include our accounts and the accounts of our wholly-owned subsidiaries, our controlled subsidiary Comprehensive Care Corporation (CompCare), and our company-managed professional medical corporations.

On January 12, 2007, we acquired all of the outstanding membership interest of Woodcliff Healthcare Investment Partners, LLC (Woodcliff), which owns 1,739,130 shares of common stock and 14,400 shares of Series A Convertible Preferred Stock of CompCare. The conversion of the preferred stock would result in us owning approximately 49.53% of the outstanding shares of CompCare based on shares outstanding as of March 31,June 30, 2008. The preferred stock has voting rights and, combined with the common shares held by us, gives us voting control over CompCare. We have anti-dilution protection and the right to designate a majority of the board of directors of CompCare. In addition, CompCare is required to obtain our consent for a sale or merger involving a material portion of CompCare's assets or business, and prior to entering into any single or series of related transactions exceeding $500,000 or incurring any debt in excess of $200,000. We began consolidating CompCare’s accounts on January 13, 2007.

All intercompany transactions and balances have been eliminated in consolidation. Certain amounts in the consolidated financial statements for the three and six months ended March 31,June 30, 2007 have been reclassified to conform to the presentation for the three and six months ended March 31,June 30, 2008.

Managed care activities are performed by CompCare under the terms of agreements with health maintenance organizations (HMOs), preferred provider organizations, and other health plans or payers to provide contracted behavioral healthcare services to subscribing participants. Revenue under a substantial portion of these agreements is earned monthly based on the number of qualified participants regardless of services actually provided (generally referred to as capitation arrangements).  The information regarding qualified participants is supplied by CompCare’s clients and CompCare reviews membership eligibility records and other reported information to verify its accuracy in determining the amount of revenue to be recognized. Capitation agreements accounted for 97% of CompCare’s revenue, or $9.1$9.3 million and $7.4$18.3 million, respectively, for the three and six months ended June 30, 2008, compared to $8.8 million and $16.2 million, respectively for the three months ended March 31, 2008June 30, 2007 and the period January 13 through March 31,June 30, 2007. The remaining CompCare revenues arerevenue is earned on a fee-for-service basis and areis recognized as services are rendered.

Under CompCare’s major Indiana contract, approximately $200,000 of monthly revenue is dependent on CompCare’s satisfaction of various monthly performance criteria and is recognized only after verification that the specified performance targets have been achieved.

Managed care operating expense is recognized in the period in which an eligible member actually receives services and includes an estimate of the cost of behavioral health services that have been incurred but not yet reported (IBNR).  See “Accrued Claims Payable” for a discussion

The accrued claims payable liability represents the estimated ultimate net amounts owed by CompCare for all behavioral health managed care services provided through the respective balance sheet dates, including estimated amounts for IBNR claims to CompCare.  The accrued claims payable liability is estimated using an actuarial paid completion factor methodology and other statistical analyses and is continually reviewed and adjusted, if necessary, to reflect any change in the estimated liability. These estimates are subject to the effects of trends in utilization and other factors.  However, actual claims incurred could differ from the estimated claims payable amount reported. Although considerable variability is inherent in such estimates, CompCare management believes, based on an internal review, that the unpaid claims liability of $5.6$6.7 million as of March 31,June 30, 2008 is adequate.

Losses are accrued under capitated managed care contracts when it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. The loss accrual analysis is performed internally on a specific contract basis taking into consideration such factors as future contractual revenue, projected future healthcare and maintenance costs, and each contract's specific terms related to future revenue increases as compared to expected increases in healthcare costs. The projected future healthcare and maintenance costs are estimated based on historical trends and estimates of future cost increases.

At any time prior to the end of a contract or contract renewal, if a capitated contract is not meeting its financial goals, CompCare generally has the ability to cancel the contract with 60 to 90 days written notice.  Prior to cancellation, CompCare will submit a request for a rate increase accompanied by supporting utilization data. Although historically CompCare’s clients have been generally receptive to such requests, no assurance can be given that such requests will be fulfilled in the future.  If a rate increase is not granted, CompCare generally has the ability to terminate the contract as described above, limiting its risk to a short-term period.

On a quarterly basis, CompCare performs a review of the portfolio of its contracts for the purpose of identifying loss contracts (as defined in the American Institute of Certified Public Accountants Audit and Accounting Guide – Health Care Organizations) and developing a contract loss reserve, if applicable, for succeeding periods. As of March 31,June 30, 2008, CompCare’s review did not identify any contracts whereidentified the large Indiana HMO contract as a contract for which it wasis probable that a loss hadwill be incurred during the remaining contract term of July 2008 through December 2008.  Based on available information, CompCare has estimated the loss at $300,000, which has been incurredrecognized in the consolidated balance sheet at June 30, 2008 and the statement of operations for which a loss could reasonably be estimated.the three and six months ended   June 30, 2008.

Our comprehensive loss is as follows:

Common equivalent shares, consisting of 11,536,00013,393,000 and 7,467,0007,452,000 of incremental common shares as of March 31,June 30, 2008 and 2007, respectively, 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.

The Hythiam, Inc. 2003 Stock Incentive Plan as amended, and 2007 Stock Incentive Plan (the Plans), both as amended, provide for the issuance of up to 915 million shares of our common stock. Incentive stock options (ISOs) under Section 422A of the Internal Revenue Code and non-qualified options (NSOs) are authorized under the Plans. We have granted 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, but option rights expire no later than ten years from the date of grant and employee and board of director awards generally vest on a straight-line basis over three to five and four years, respectively, except for the 2008 grants to employees as discussed below.years. At March 31,June 30, 2008, we had 7,973,0009,830,000 vested and unvested stock optionsshares outstanding and 179,0004,322,000 shares available for future awards.

Total share-based compensation expense on a consolidated basis amounted to $2.3$1.9 million and $491,000$4.2 million, respectively, for the three and six months ended June 30, 2008, compared to $914,000 and $1.4 million, respectively, for the three months ended March 31, 2008June 30, 2007 and 2007, respectively.the period January 13 through June 30 2007.

We account for all share-based payment awards made to employees and directors in accordance with SFAS No. 123 (Revised 2004), “Share-Based Payment” (SFAS 123R), which requires the measurement and recognition of compensation expense based on estimated fair values. SFAS 123R requires companies to estimate the fair value of share-based payment awards to employees and directors on the date of grant using an 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. Prior to the adoption of SFAS 123R on January 1, 2006, we accounted for share-based awards to employees and directors using the intrinsic value method, in accordance with Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” as allowed under SFAS No. 123, “Accounting for Stock-Based Compensation” (SFAS 123). Under the intrinsic value method, no share-based compensation expense had been recognized in our consolidated statements of operations for awards to employees and directors because the exercise price of our stock options equaled the fair market value of the underlying stock at the date of grant.

We adopted SFAS 123R using the modified prospective method and in accordance with that method, our consolidated financial statements for prior periods are not required to be restated to reflect, and do not include, the impact of SFAS 123R.method. Share-based compensation expense recognized under SFAS 123R for employees and directors for the three and six months ended March 31,June 30, 2008 and 2007 was $2.1amounted to $1.2 million and $563,000, respectively.$3.3 million, compared to $576,000 and $1.1 million, respectively, for the three and six months ended June 30, 2007.

Share-based compensation expense recognized in our consolidated statements of operations for the threesix months ended March 31,June 30, 2008 and 2007 includes compensation expense for share-based payment awards granted prior to, but not yet vested, as of January 1, 2006 based on the grant date fair value estimated in accordance with the pro-forma provisions of SFAS 123, and for the share-based payment awards granted subsequent to January 1, 2006 based on the grant date fair value estimated in accordance with the provisions of SFAS 123R. For share-based awards issued to employees and directors, share-based compensation is attributed to expense using the straight-line single option method, which is consistent with our presentation of pro-forma share-based expense required under SFAS 123 for prior periods.method. Share-based compensation expense recognized in our consolidated statements of operations for the three and six months ended March 31,June 30, 2008 and 2007 is based on awards ultimately expected to vest, reduced for estimated forfeitures. SFAS 123R requires forfeitures to be estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

During the three and six months ended March 31,June 30, 2008 and 2007, we granted options to employees for 2.0 million2,125,000, 4,152,000, 42,000, and 332,000374,000 shares, respectively, at the weighted average per share exercise price of $2.65$2.62, $2.64, $7.34, and $8.29$8.18, respectively, the fair market value of our common stock at the dates of grants. Approximately 952,0001,023,000 of the options granted in 2008 vested immediately on the date of grant and approximately 824,0003,129,000 options vest monthly

The estimated fair value of options granted to employees during the three and six months ended March 31,June 30, 2008 and 2007 was $3.1$3.4 million, $6.5 million, $200,000 and $1.8$2.0 million, respectively, calculated using the Black-Scholes pricing model with the following assumptions:

The expected volatility assumptions have been based on the historical volatility of our stock and the stock of other public healthcare companies, measured over a period generally commensurate with the expected term. The weighted average expected option term for the three and six months ended March 31,June 30, 2008 reflects the application of the simplified method prescribed in SEC Staff Accounting Bulletin (SAB) No. 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 have elected to adopt the detailed method provided in SFAS 123R 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 are outstanding upon adoption of SFAS 123R.

As of March 31,June 30, 2008, there was $7.4$12.6 million of total unrecognized compensation costs related to non-vested share-based compensation arrangements granted under the Plan. That cost is expected to be recognized over a weighted-average period of threeapproximately 1.7 years.

We account for the issuance of options and 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 option or warrant 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 as provided by FASB Emerging Issues Task  Force (EITF) No. 96-18 “Accounting For Equity Instruments That Are Issued To Other Than Employees For Acquiring Or In Conjunction With Selling Goods Or Services.” For unvested shares, the change in fair value during the period is recognized in expense using the graded vesting method.

Non-employee stock option and warrant activity for the three and six months ended March 31,June 30, 2008 was as follows:

During the three and six months ended March 31,June 30, 2008, respectively, we issued 140,000 and 193,000 shares of common stock, for consulting services valued at $332,000 and  $471,000, respectively.  During the six months ended June 30, 2007, we issued 52,500 and 14,000 shares of common stock respectively, for consulting services valued at $139,000 and $111,000, respectively.$111,000. There were no shares issued for such services during the three months ended June 30, 2007. These costs are being amortized to share-based expense on a straight-line basis over the related six month to one year service periods. Share-basedFor the three and six month periods ended June 30, 2008 and 2007, share-based expense relating to all common stock issued for consulting services was $212,000$583,000, $794,000, $43,000 and $52,000 for the three month periods ended March 31, 2008 and 2007,$95,000, respectively.

We have a qualified employee stock purchase plan (ESPP), approved by our stockholders, which allows qualified employees to participate in the purchase of designated shares of our common stock at a price equal to 85% (ESPP discounted price) of the lower of the closing price at the beginning or end of each specified stock purchase period. As of March 31,June 30, 2008, there were 27,00036,000 shares of our common stock issued pursuant to the ESPP. Share-based expense relating to the ESPP discount price was $3,000$1,000, $2,000, $4,000 and $4,000,$8,000, respectively, for the three and six month periods ended March 31,June 30, 2008 and 2007.

CompCare’s 1995 Incentive Plan and 2002 Incentive Plan (the CompCare Plans) provide for the issuance of up to 1 million shares of CompCare common stock for each plan. ISOs, NSOs, stock appreciation rights, limited stock appreciation rights, and restricted stock grants to eligible employees and consultants are authorized under the CompCare Plans. CompCare issues stock options to its employees and non-employee directors allowing them to purchase common stock pursuant to the CompCare Plans.  Options for ISOs may be granted for terms of up to ten years and are generally exercisable in cumulative increments of 50% each six months.  Options for NSOs may be granted for terms of up to 13 years.  The exercise price for ISOs must equal or exceed the fair market value of the shares on the date of grant, and 65% of the fair market value of the shares in the case of other options.grant. The Plans also provide for the full vesting of all outstanding options under certain change of control events.  As of March 31,June 30, 2008, under the 2002 Incentive Plan, there were 465,000374,000 options available for grant and there were 495,000586,000 options outstanding, of which 300,000

CompCare also has a non-qualified stock option plan for its outside directors (the CompCare Directors’ Plan). Each non-qualified stock option is exercisable at a price equal to the average of the closing bid and asked prices of the common stock in the over-the-counter market for the last preceding day in which there was a sale of the stock prior to the grant date. Grants of options vest in accordance with vesting schedules established by CompCare’s Compensation and Stock Option Committee.  Upon joining the CompCare Board, directors receive an initial grant of 25,000 options.  Annually, directors are granted 15,000 options on the date of CompCare’s annual meeting.  As of March 31,June 30, 2008, under the

CompCare has adopted SFAS 123R, using the modified prospective method and used a Black-Scholes valuation model to determine the fair value of options on the grant date. Share-based compensation expense recognized for employees and directors for the three and six months ended March 31,June 30, 2008 was $47,000 and $82,000, respectively and for the three months ended June 30, 2007 and the period January 13, 2007 through March 31,June 30, 2007, share-based compensation expense was $35,000$9,000 and $20,000, respectively,$29,000, respectively.

CompCare stock option activity for the three and six month periodperiods ended March 31,June 30, 2008 was as follows:

Stock options totaling 185,000110,000 and 295,000 shares were granted to CompCare board of director members orand employees during the three and six month periodperiods ended March 31,June 30, 2008, at a weighted average exercise priceprices of $0.60.$0.43 and $0.54, respectively.  No stock options were granted to CompCare board of director members or employees during the period January 13 through March 31,June 30, 2007. A total of 37,500

No stock options were exercised during three months ended June 30, 2008 and 2007. During the six months ended June 30, 2008 and 2007, respectively, 125,000 and 38,000 stock options were exercised, which had total intrinsic values of $50,000 and $13,000, respectively. During the three and six months ended June 30, 2008, stock options expired or cancelled totaled 25,000 and 270,000 shares, respectively. During the three months ended June 30, 2007 and the period January 13 through March 31,June 30, 2007, which had a total intrinsic value of $13,000. During the three months ended March 31, 2008, 245,000 stock options granted to one employeerespectively, 40,000 and 120,000 shares expired unexercised. For the period January 13 through March 31, 2007, 80,000 stock options granted to certain CompCare board of director members and employees, respectively,or were cancelled. Expiration or cancelled shares were generally due to the recipients’ resignation from the CompCare or its board of directors or CompCare.directors.

The following table lists the assumptions utilized in applying the Black-Scholes valuation model.  CompCare uses historical data to estimate the expected term of the option.  Expected volatility is based on the historical volatility of the CompCare’s traded stock.  CompCare did not declare dividends in the past nor does it expect to do

Through February 13, 2008, all of our ARS held at December 31, 2007 had completed at least one auction successfully through the normal auction process, and we had reduced our total investments in ARS to $11.5 million. However, fromsince February 14, through May 5, 2008, auctions for these securities hadhave 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. Although the securities are Aaa/AAA rated and collateralized by portfolios of student loans guaranteed by the U.S. government, based on current market conditions it is likely that auctions will continue to be unsuccessful in the short-term, limiting the liquidity of these investments until the auction succeeds, the issuer calls the securities, or they mature. The remaining maturity periods range from nineteen to thirty-eight years. As a result, our ability to liquidate our investment and fully recover the carrying value of our investment in the near term may be limited or not exist. Accordingly, we recognized a temporary decline in the fair value of our ARS investments of approximately $566,000$776,000 as of March 31,June 30, 2008, based on estimates of the fair value using valuation models and methodologies provided bythat utilize an income-based approach to estimate the investment manager ofprice that would be received to sell our ARS.securities in an orderly transaction between market participants.

If the issuers are unable to successfully close future auctions or their credit ratings deteriorate, we may in the future record an impairment charge on these investments. In addition, these types of developments could cause us to reclassify our investments in ARS from a current asset to a long-term asset.  We believe that the higher reset interest rates on failed auctions for our investments provide sufficient incentive for the security issuers to address this lack of liquidity. While these failures in the auction process have affected our ability to access these funds in the short-term, we do not believe that the underlying securities or collateral have been materially affected.  At this time, we have not obtained sufficient evidence to conclude that these investments are impaired or that they will not be settled within the next twelve months, although the market for these investments is uncertain. We believe that we will not require access to these funds within the next twelve months or prior to restoration of liquidity in this market. It is our intention to hold our ARS until they can be liquidated in a market that facilitates orderly transactions and we believe that we have the ability to maintain our investment over that time frame. In May 2008, we obtained a demand margin loan facility from our investment portfolio manager, allowing us to borrow up to $5.4 million to provide additional cash liquidity if so needed, collateralized by the ARS. As of June 30, 2008, we have not drawn any funds against the facility. Any draw-downs would be subject to a rate of interest equal to the prevailing 30-day LIBOR rate plus 100 basis points. These securities will be analyzed each reporting period for other-than-temporary impairment factors. If the credit rating of the security issuers deteriorates, or we conclude that we cannot hold these securities prior to restoration of liquidity in the credit markets, weWe may be required to adjust the carrying value of these investments through an impairment charge.charge if any loss is considered to be other than temporary.

The following table summarizes fair value measurements by level at March 31,June 30, 2008 for assets and liabilities measured at fair value on a recurring basis:

The change in the carrying amount of goodwill by reporting unit is as follows:

Identified intangible assets acquired as part of the CompCare acquisition include the value of managed care contracts and marketing-related assets associated with its managed care business, including the value of the healthcare provider network and the professional designation from the National Council on Quality Association (NCQA). Such assets will beare being amortized on a straight-line basis over their estimated remaining lives, which approximate the rate at which we believe the economic benefits of these assets will be realized.

As of March 31,June 30, 2008, the gross and net carrying amounts of intangible assets that are subject to amortization are as follows:

Estimated remaining amortization expense for intangible assets for the current year and each of the next fourfive years ending December 31 is as follows (in thousands):follows:

In September 2006, the FASB issued SFAS 157, which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. The statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. In February 2008, FSP FAS 157-2 “Effective Date of FASB Statement No. 157” was issued, which delays the effective date of SFAS 157 to fiscal years and interim periods within those fiscal years beginning after November 15, 2008 for non-financial assets and non-financial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). We elected to defer the adoption of the standard for these non-financial assets and liabilities, and are currently evaluating the impact, if any, that the deferred provisions of the standard will have on our consolidated financial statements. The adoption of SFAS 157 for our financial assets and liabilities did not have an impact on our financial position or operating results.

The adoption of SFAS No. 159 did not have a material impact on our financial position, results of operations or cash flows.