tax-exempt organizations principally formed to support research and education for specified health problems.

Hervé de Kergrohen, M.D.since August 2002 has been a Partner with CDC IxisEnterprises 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, ExonhitPraxim SA and EntomedExonhit in France since September 2002, and Clearant, Inc. since December 2001. From February 1999 to December 2001 he was Head Analyst for Darier Hentsch & Co., then the third largest Geneva private bank and manager of its CHF 700 million health care fund. From February 1997 to February 1998 he was the Head Strategist for the international health care sector with UBS Brinson of Chicago, a Manager of CHF 700 billion for UBS AG,AGin Zurich. Dr. de Kergrohen started his involvement with financial institutions in 1995 with Bellevue Asset Management in Zug, Switzerland, the fund manager of BB Biotech and BB Medtech, where he covered the healthcare services sector. He was previously Marketing Director with large U.S. pharmaceutical companies such as Sandoz USA and G.D. Searle, specialized in managed care. Dr. de Kergrohen received his M.D. from Université Louis Pasteur, Strasbourg, and holds an M.B.A. from Insead, Fontainebleau.

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

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

Juan José Legarda, Ph.D.has extensive experience in the biotechnology and pharmaceutical industries, and is the principal inventor of the company’s HANDS Treatment Protocols™. Since 1988, Dr. Legarda has been Founder and President of a healthcare company specializing in 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 dependence and cocaine addictions, filing patent applications which he has licensed 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, 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.

Marc G. Cumminsis a Managing Partner of Catterton Partners, a private equity investor in consumer products and service companies with over $1 billion of assets under management. Prior to joining Catterton in 1988,1998, Mr. Cummins spent fourteen years at Donaldson, Lufkin & Jenrette Securities Corporation where he was Managing Director of the Consumer Products and Specialty Distribution Group, and was also involved in leveraged buyouts,private equity and high yield financings. He currently serves on the boards of several private companies including Case Logic Inc., Floorgraphics Inc., Titan Outdoor, LLC and DoveBid,Petroleum Place, Inc. Mr. Cummins received a B.A. in Economics, magna cum laude, from Middlebury College, where he was honored as a Middlebury College Scholar and is a member of Phi Beta Kappa. He also received an M.B.A. in Finance with honors from The Wharton School at the University of Pennsylvania.

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Options.Directors are eligible to receive options under our 2003 Stock Incentive Plan. On September 29, 2003, we granted each non-employee director options to purchase the following number of shares of common stock at an exercise price of $2.50 per share, vesting 25% per year over four years from the date of the grant: 200,000 shares to Dr. Lieberburg, 120,000 shares to Mr. Anderson, 100,000 shares to Mr. Bell and Dr. Kergrohen,Kergrohen. On July 2, 2004, we granted Mr. Cummins options to purchase up to 100,000 shares at $2.80 per share, vesting 25% per year over four years. On January 20, 2005, we granted Dr. Lieberburg and Mr. Bell options to purchase up to 50,000 shares to Dr. Legarda. In addition, onat $5.72 per share, vesting 25% per year over four years.

On September 29, 2003, we granted Mr. LaMacchia options to purchase 400,000 shares of common stock at an exercise price of $2.50 per share and Mr. Peizer options to purchase 1,000,000 shares of common stock at an exercise price of $2.75 per share, each vesting 25%20% per year over fourfive years. On April 28, 2005, we granted Mr. Anderson options to purchase 255,000 shares at $7.34 per share, vesting 20% per year over five years.

All of the options described above were granted at or above the fair market value on the date of grant.

How often did the Board meet during 2003?2004?

     During 2003, theThe board of directors held two meetings. During 2003, each director attendedfour meetings during 2004.

Which directors are independent?

     After review of all of the meetingsrelevant transactions or relationships of theeach director (and his family members), our board of directors held during the period he served on the Board and all of the meetings of committees of the board of directors held during the period he served on such committees.

Which directors are independent?

     The Board has determined that Drs. de Kergrohen Lieberburg and LegardaLieberburg and Messrs. Bell and Cummins are independent as that term is used in Item 7(d)(3)(iv) of Schedule 14A underdefined by the Exchange Act.applicable Nasdaq rules. There are no family relationships among any of our directors, executive officers or key employees.

What committees has the Board established?

     The board of directors has a standing audit committee, compensation committee,Audit Committee, Compensation Committee, and nominatingNominations and corporate governance committee.Corporate Governance Committee. The board also has adopted written corporate governance guidelines for the board and a written committee charter for each of the board’s committees, describing the authority and responsibilities delegated to each committee by the board.

Audit Committee

     The audit committeeAudit Committee consists of three directors. The audit committeeDuring 2004, the Audit Committee consisted of Mr. Bell (Chairman), Dr. de Kergrohen and Mr. Anderson, and it currently consists of Mr. Bell (Chairman), Dr. de Kergrohen and Mr. Anderson. The board has determined that membership on the audit committee by Mr. Anderson is in the best interests of the corporation and its stockholders, because he has significant experience in finance and accounting.Cummins. The board of directors has determined that each of Dr. de Kergrohen and Messrs. Bell and AndersonCummins are independent as defined by the applicable Nasdaq rules, meet the applicable requirements for audit committee members, including Rule 10A-3(b) under the Securities and Exchange Act of 1934, as amended, and qualify as audit committee financial experts as that term is defined inby Item 401(h)(1)(i)(A)(2) of Regulation S-K under the Exchange Act.S-K. The audit committeeAudit Committee held twofive meetings during 2003.2004. The duties and responsibilities of the audit committeeAudit Committee include (i) recommending to the board the appointment of our auditors and any termination of engagement, (ii) reviewing the plan and scope of audits, (iii) reviewing our significant accounting policies and internal controls and (iv) having general responsibility for all related auditing matters. A copy of the current audit committee charter is included as Appendix A hereto.

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meetings during 2004. The compensation committeeCompensation Committee reviews and recommends to the board of directors for approval the compensation of our executive officers .officers.

Nominations and Governance Committee

     The nominationNominations and governanceGovernance Committee consists of two directors who are independent as defined by the applicable Nasdaq rules. The committee consists of two independent directors. The nominations and governance committee currently consists of Drs.Dr. de Kergrohen (Chairman) and Legarda.Mr. Cummins, and held one meeting during 2004. The nominations and governance committee nominates new directors and oversees corporate governance matters. It is anticipated that if he is elected Mr. Cummins will replace Dr. Legarda on

     The charter of the Nominations and Governance Committee.Committee, a copy of which is attached as an appendix to this proxy statement, 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 Regulation��14A under the Exchange Act, and other applicable rules and regulations. Recommendation materials are required to be sent to the Nominations and Governance Committee c/o Hythiam, Inc., 11150 Santa Monica Blvd., Suite 1500, Los Angeles, California 90025. There are no specific 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 Governance Committee 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 regard 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.

Does the CompanyAnnual Meeting Attendance

     Three of our directors attended our 2004 annual meeting of stockholders. We have a codeadopted a policy for attendance by the board of ethics?directors at our annual stockholder meetings which encourages directors, if practicable and time permitting, to attend our annual stockholder meetings.

Do we have a Code of Ethics?

     We have adopted a Code of Conduct and Ethics that applies to all company directors, officers and employees. We have also adopted a Code of Ethics for CEO and Senior Financial Officers that applies to our chief executive officer and senior financial officers, including our principal financial officer and principal accounting officer. Copies of these codes of ethics are attached as exhibits 14.1 and 14.2 to our most recent Annual Report on Form 10-K filed with the SEC.

How can stockholders communicate with our board of directors?

     Our board of directors believes that it is important for our stockholders to have a process to send communications to the board. Accordingly, stockholders desiring to send a communication to the board or a specific director may do so by sending a letter addressed to the Board of Directors or any individual

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director at the address listed in this proxy statement. All such letters must identify the author as a stockholder. Our corporate Secretary will open the communications, make copies and circulate them to the appropriate director or directors.

PROPOSAL 2: INCREASING SHARES UNDER 2003 STOCK INCENTIVE PLAN

2003 Stock Incentive Plan

     Our 2003 Stock Incentive Plan was adopted by our board of directors and approved by our stockholders on September 29, 2003. A copy of the plan is attached as Exhibit 99.1 to our Current Report on Form 8-K filed with the SEC on September 30, 2003.

     The purpose of the plan is to attract and retain the services of key management, employees, outside directors and consultants, and to align long-term pay-for-performance incentive compensation with stockholders’ interests. Fixed-price stock options align employees’ interests with those of our stockholders, because an increase in stock price after the date of award is necessary for employees to realize any value, thus rewarding employees only upon improved stock price performance. Stock option grants under the 2003 plan may be intended to qualify as incentive stock options under Section 422 of the Tax Code or may be non-qualified stock options governed by Section 83 of the Tax Code. Subject to earlier termination by our board of directors, the plan will remain in effect until all awards have been satisfied or terminated under the terms of the plan.

     There are currently 5,000,0006,000,000 shares of common stock authorized for issuance under the plan. Options to purchase approximately 4,483,0005,144,000 shares were outstanding as of March 31, 2004.2005.

Amendment to Increase Shares

     Subject to approval by our stockholders, our board has approved a 1,000,000 share increase in the maximum number of shares of our common stock issuable under the plan, from 5,000,0006,000,000 to 6,000,000.7,000,000. We are requesting that the stockholders vote in favor of increasing the number of shares available under the 2003 Stock Incentive Plan.

     We believe that a broad-based stock option program is a powerful employee incentive and retention tool that benefits all of our stockholders, and that an increase in the number of available shares is necessary in order to provide appropriate incentives for achievement of company performance objectives and to continue to attract and retain the most qualified employees, directors and consultants in light of our ongoing growth and expansion. Without sufficientstocksufficient stock options available for grant, we may be forced to consider cash replacement alternatives to provide a market-competitive total compensation package necessary to attract, retain and motivate the employee talent critical to the future success of the company. These cash replacement alternatives would then reduce the cash available for investment in innovation and technology.

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Recommendation of the Board

     The board of directors unanimously recommends that you vote "FOR"“FOR” Proposal 2, increasing by 1,000,000 shares the number of shares available for issuance under the 2003 Stock Incentive Plan.

REPORT OF THE COMPENSATION COMMITTEE REPORT

     The following report of the compensation committee and the performance graph included elsewhere in this proxy statement doCompensation Committee does not constitute soliciting material and should not be deemed filed or incorporated by reference into any of our other filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended, except to the extent we specifically incorporate this report or the performance graph by reference therein.

Executive Compensation

     The compensation committeeCompensation Committee of the boardBoard of directorsDirectors reviews and determines or recommends to the Board of Directors for determination the compensation provided to ourthe Company’s executive officers, including stock compensation. In addition, the compensation committeeCompensation Committee reviews and makes recommendations on stock compensation arrangements for all of our employees.

What is our policy regarding executive officer compensation?Compensation Policy

     OurThe Company’s executive compensation policy is designed to enable usit to attract, motivate and retain highly qualified executive officers. The key components of ourthe compensation program are

• base salary;
  
  
• annual incentive bonus awards; and
  
  
• equity participation in the form of stock options or other equity-based awards under our equity incentive plan.
  

	•	base salary;
	•	annual incentive bonus awards; and
	•	equity participation in the form of stock options or other equity-based awards under the equity incentive compensation plan.

     In arriving at specific levels of compensation for executive officers, the committee has relied on

• the recommendations of management;
  
  
• benchmarks provided by generally available compensation surveys;
  
  
• the experience of committee members and their knowledge of compensation paid by comparable companies or companies of similar size or generally engaged in the healthcare services business; and
  
  
• the advice and counsel of experts and advisors with broad experience in the field of executive compensation.
  

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	•	the recommendations of management;
	•	benchmarks provided by generally available compensation surveys;
	•	the experience of committee members and their knowledge of compensation paid by comparable companies or companies of similar size or generally engaged in the healthcare services business; and
	•	the advice and counsel of experts and advisors with broad experience in the field of executive compensation.

What are the componentsComponents of executivecompensation?Executive Compensation

Base salary.In addition to complying with the executive compensation policy and to the requirements of applicable employment agreements, compensation for each of the executive officers for 20032004 was based on the executive’s duties and responsibilities, the performance of the Company, both financial and otherwise, and the success of the executive in developing and executing our business development, sales and marketing, financing and strategic plans, as appropriate.

Bonus.Executive officers are eligible to receive cash bonuses based on the degree of ourthe Company’s achievement of our financial and other objectives and the degree of achievement by each such officer of his or her individual objectives.

Stock options.Equity participation is a key component of ourthe Company’s executive compensation program. Under our stock optionthe incentive compensation plan, we arethe Company is permitted to grant stock options to our officers, directors, employees and consultants. To date, stock options have been the sole means of providing equity participation. Stock options are granted to executive officers primarily based on the officer’s actual and expected contribution to ourthe Company’s development. Options are designed to retain executive officers and motivate them to enhance stockholder value by aligning their financial interests with those of ourthe stockholders. Stock options are intended to enable usthe Company to attract and retain key personnel and provide an effective incentive for management to create stockholder value over the long term since the option value depends on appreciation in the price of ourthe Company’s common stock.

How is our chief executive officer compensated?Chief Executive Officer Compensation

     The compensation committeeCompensation Committee annually reviews and recommends to the boardBoard of Directors the compensation of Terren S. Peizer, our chief executive officer,Chief Executive Officer, in accordance with the terms of his employment agreement, as well as any variations in his compensation the committee feels are warranted. Mr. Peizer, as a member of the board, abstains from all discussions and decisions of the board with regard to his compensation. The compensation committeeCompensation Committee believes that in the highly competitive healthcare industry in which the Company operates, it is important that Mr. Peizer receive compensation consistent with compensation received by chief executive officers of our competitors. Mr. Peizer received a base salary of $325,000 and was awarded a bonus of $154,000 for 2004. His base salary for 2005 is $365,000. See “Employment Agreements” for a description of the material terms and conditions of Mr. Peizer’s employment agreement.

How are we addressing Internal Revenue Code limitsLimits on deductibilityDeductibility of compensation?Compensation

     Section 162(m) of the Internal Revenue Code of 1986, as amended, generally disallows a federal income tax deduction to public companies for certain compensation in excess of $1 million paid to a corporation’s chief executive officer or any of its four other most highly compensated executive officers. Qualifying performance-based compensation will not be subject to the deduction limit if certain requirements are met. We areThe Compensation Committee is of the opinion that our equity-basedthe Company’s incentive compensation plans (i.e., obtained stockholder approval of the equity incentive plan) haveplan has been structured to qualify the compensation income deemed to be received upon the exercise of stock options granted under the plans as performance-based compensation. The compensation committeeCompensation Committee will review the potential effects of Section 162(m) periodically and in the future may decide to structure additional portions of our compensation programs in a manner designed to permit unlimited deductibility for federal income tax purposes. We are

     The Company is not currently subject to the limitations of Section 162(m) because none of ourno executive officers received cash payments from us during 20032004 in excess of $1 million. To the extent that we arethe Company is subject to the Section 162(m) limitation in the future, the effect of this limitation on our earnings may be mitigated by our net operating losses, although the amount of any deduction disallowed under Section 162(m) could increase our alternative minimum tax by a portion of such disallowed amount. For information relating to our

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the Company’s net operating losses, see ourthe consolidated financial statements included in our 2003 annual reportthe 2004 Annual Report to stockholders.

TheSubmitted by the Compensation Committee
Committee:

Ivan M. Lieberburg, Ph.D., M.D. (Chairman) and , Chairman
Leslie F. Bell

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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. ElderMonica Alfaro Wellinghas more than 25over 15 years of experience in all areas of U.S. and global marketing, sales and new product planning within endocrinology, nephrology, osteoporosis, CNS, gastroenterology, and genitourology. Prior to joining the healthcare industry,company in March 2004, she was Senior Director Global Strategic Marketing for BOTOX™ for Allergan, Inc., where she directed market development, product development, and in business development, marketing andstrategic planning for a brand with annual sales of pharmaceuticals for the treatment of pain and substance abuse. From June 1978exceeding $360 million. Prior to Januaryjoining Allergan, from August 1989 to February 2000, and from June 2003 until joining Hythiam in September 2003, Mr. ElderMs. Welling held various positions at Mallinckrodt, Inc. related toNovo Nordisk A/S in Denmark, most recently as Head of International hGH Strategic Marketing. As the head of marketing, new business development and new product marketing for all growth hormone related products/devices and therapeutic areas, she was responsible for brands with annual global sales of 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 pharmaceuticalcompany 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$260 million. She received a B.A.B.S. in ChemistryBiology from the University of Missouri-ColumbiaCalifornia, Irvine and an M.B.A. in International Marketing from Southern Illinois University.South Danish University in Denmark.

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Summary Compensation Table

market value on the date of grant, vesting 20% each year over five years. The 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.

Chief OperatingAdministrative Officer

     We have entered into a four-year employment agreement with our Chief Administrative Officer, Richard A. Anderson, which provides for an annual base salary of $266,800, with annual bonuses targeted at 50% of his base salary based on achieving certain milestones. His compensation will be adjusted each year by an amount not less than the CPI. He receives executive benefits including group medical and dental insurance, term life insurance, accidental death and long-term disability insurance. Pursuant to the agreement, Mr. Anderson was granted options to purchase 255,000 shares of our common stock at the fair market value on the date of grant, vesting 20% each year over five years, in addition to the options previously granted to him as a member of our board of directors. The options will vest immediately in the event of a change in control, termination without cause or resignation with good reason. In the event that Mr. Anderson is terminated without good cause or resigns with good reason prior to the end of the term, upon execution of a mutual general release he 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 Operating Officer

     We entered into a four-year employment agreement with our Chief Operating Officer, Anthony M. LaMacchia, effective as of September 29, 2003. The agreement provides forMr. LaMacchia currently receives an annual base salary of $200,000,$206,400, with annual bonuses of at least $50,000 targeted at 50% of his base salary based on achieving certain milestones. His compensation will be adjusted each year by an amount not less than the CPI. Mr. LaMacchia will receivereceives executive benefits including group medical and dental insurance, $300,000 of term life insurance, accidental death and long-term disability insurance, and reimbursement for moving expenses. He was also granted options to purchase 400,000 shares of our common stock at the fair market value on the date of grant, vesting 20% each year over five years. The options vest immediately in the event of a change in control, termination without cause or resignation with good reason. In the event that Mr. LaMacchia is terminated without good cause or resigns with good reason prior to the end of the term, upon execution of a general release he 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 Mr. LaMacchia 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 have entered into a four-year employment agreement with our Chief Financial Officer, Chuck Timpe, effective as of September 29, 2003. The agreement provides forMr. Timpe currently receives an annual base salary of $200,000,$206,400, with annual bonuses targeted at 50% of his base salary based on achieving certain milestones. His compensation will be adjusted each year by an amount not less than the CPI. Mr. Timpe will receivereceives executive benefits including group medical and dental insurance, $300,000 of term life insurance, accidental death and long-term disability insurance. He was also granted options to purchase 300,000 shares of our common stock at the fair market value on the date of grant, vesting 20% each year over five

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years. The options vest immediately in the event of a change in control, termination without cause or resignation with good reason. In the event that Mr. Timpe is terminated without good cause or resigns with good reason prior to the end of the term, upon execution of a general release he 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 Mr. Timpe 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.

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     At present, there is no pending litigation or proceeding involving any of our directors, officers, employees or agents where indemnification will be required or permitted. We are not aware of any threatened litigation or proceeding that might result in a claim for such indemnification.

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LONG-TERM INCENTIVE PLANS

     The following table sets forth certain information as of December 31, 20032004 with respect to our long-term incentive 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.

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COMPARISON OF 15 MONTH CUMULATIVE TOTAL RETURN*
AMONG HYTHIAM, INC., THE RUSSELL 2000 INDEX
AND THE S & P HEALTH CARE INDEX

* $100 invested on 9/30/03 in stock or index-including reinvestment of dividends. Fiscal year ending December 31.

Copyright © 2002, Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved. www.researchdatagroup.com/S&P.htm

CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

     Our predecessor Hythiam, Inc. obtained the rights to exploit our patent pending alcohol and cocaine addiction treatment procedures pursuant to a Technology Purchase and License Agreement, as amended, entered into with a company now known as Tratamientos Avanzados de la Adicción S.L, a Spanish corporation, on March 12, 2003. Under the agreement, we agreed to grant 835,916 shares of common stock, as well as options to acquire up to 531,518 additional shares at $2.50 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.

     Our predecessor Hythiam, Inc., a New York Corporation, 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 360,000 shares of common stock under certain terms and conditions. Terren S. Peizer, who serves as our Chairman of the Board of Directors and Chief Executive Officer, is the sole principal of Reserva, LLC.

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AUDIT COMMITTEE REPORT

     The following report of the audit committeeAudit Committee does not constitute soliciting material and should not be deemed filed or incorporated by reference into any of our other filings under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended.

     The Audit Committee has the sole authority to select, evaluate and, if appropriate, replace the Company’s independent registered public accounting firm, and to pre-approve all auditing and permitted non-auditing services performed by them for the Company including their fees and other terms. BDO Seidman, LLP was engaged as the independent registered public accounting firm for the Company in September 2003. During 2004, the Audit Committee consisted of Messrs. Bell, de Kergrohen and Anderson. In accordance with its written charter adopted by our boardApril 2005, Mr. Anderson resigned from the committee and the Board of directors, the audit committee’s role isDirectors elected Mr. Cummins to act on behalfreplace him. The Board of Directors has determined that all members of the boardAudit Committee are financially literate and independent within the requirements of directors inNasdaq, the oversight of our accounting, auditingSecurities and financial reporting practices. The audit committee presently consists of three members, two of whom have been determined inExchange Commission and the board’s business judgment to be “independent” in accordance with Section 7(d)(3)(iv) of Rule 14A-101 of the Exchange Act. A copy of the audit committee’s written charter is attached as Appendix A.Company’s Audit Committee Charter.

     Management is responsible for ourthe preparation, presentation and integrity of the Company’s financial statements, establishing, maintaining and evaluating the effectiveness of internal and disclosure controls and procedures; and evaluating any change in internal control over financial reporting process, including our systemthat has materially affected, or is reasonably likely to materially affect, internal control over financial reporting. The Company’s independent registered public accounting firm is responsible for performing an independent audit of internal controls, and for the preparation of ourCompany’s consolidated financial statements in accordanceand expressing an opinion as to their conformity with U.S. generally accepted accounting principles. Our independent auditors are responsible for auditing those financial statements. ItThe Audit Committee’s responsibility is the audit committee’s responsibility to reviewmonitor and oversee these processes. It is notMembers of the audit committee’s duty or responsibilitycommittee rely on the information provided to conduct auditing or accounting reviews or procedures. The audit committee does not consist of our employees and it may not be, and may not represent itself to be or serve as, accountants or auditors by profession or experts in the fields of accounting or auditing. Therefore, the audit committee has relied, without independent verification, on management’s written representation that the financial statements have been prepared with integrity and objectivity and in conformity with accounting principles generally accepted in the United Statesthem and on the representations of the independent auditors included in their report on our financial statements. The audit committee’s oversight does not provide it with an independent basis to determine that management has maintained appropriate accounting and financial reporting principles or policies, or appropriate internal controls and procedures designed to assure compliance with accounting standards and applicable laws and regulations. Furthermore, the audit committee’s considerations and discussions withmade by management and the independent auditors do not assure that our financial statements are presented in accordance with generally acceptedregistered public accounting principles, that the audit of our financial statements has been carried out in accordance with generally accepted auditing standards or that our independent accountants are in fact “independent.”firm.

     In fulfilling its oversight responsibilities, the audit committeeAudit Committee met with management and BDO Seidman, including sessions at which management was not present, and reviewed and discussed with the independent auditorsunaudited financial statements contained in the overall scopeCompany’s Quarterly Reports on Form 10-Q for each of the quarters ended in 2004, and plan for the audit and reviewed the audited financial statements for the year 2003 with management, including a discussion of critical accounting policies and alternative accounting treatments, the quality of the accounting principles, the reasonableness of significant judgments and the clarity of disclosurescontained in the financial statements. The audit committee reviewed the financial statements for 20032004 Annual Report on Form 10-K, prior to their filing with the independent auditors, received copies of material written communications between the auditorsSecurities and management andExchange Commission. The Audit Committee discussed with them all ofBDO Seidman the matters required to be discussed by Statement ofon Auditing Standards No. 61, (CommunicationsCommunications with Audit Committees)Committees, as amended,currently in effect, including the auditors’ judgments as toindependent registered public accounting firm’s overall evaluations of the quality, not just the acceptability, of ourthe Company’s accounting principles. In addition,principles, the auditcritical accounting policies and practices used in the preparation of the financial statements, the reasonableness of significant judgments, and such other matters as are required to be discussed with the committee hasunder generally accepted auditing standards. The Audit Committee also received the written disclosures and the letter from the independent auditorsBDO Seidman required by Independence Standards Board Standard No. 1, (Independence DiscussionsIndependence Discussion with Audit Committees)Committees, and has discussedreviewed with the independent auditors the results of the auditors’ examination, their written report, their evaluation and recommendations regarding the overall quality of our financial reporting and systems, and their independence from our management and us. Finally, the audit committee has considered whether the provision by the independent auditors of non-audit services to us is compatible with maintaining the auditors’BDO Seidman its independence. The audit committee discussed with the independent accountants any relationships that may have an impact on their objectivity and independence and satisfied itself as to the accountants’ independence.

     The audit committee also discussed with management the process used to support certifications by our chief executive officer and chief financial officer that are required by the SEC and the Sarbanes-Oxley Act of 2002 to accompany our periodic filings with the SEC.

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INDEPENDENT REGISTERED PUBLIC ACCOUNTANTSACCOUNTING FIRM

     The firm of BDO Seidman, LLP has served as our independent registered public accountants since September 29, 2003. One or more representatives of BDO Seidman, LLP are expected to be present at the annual meeting and will be afforded the opportunity to make a statement if they so desire and to respond to appropriate stockholder questions.

RELATIONSHIP WITH INDEPENDENT AUDITORS

BDO Siedman, LLP were our independent auditors since our merger on September 29, 2003 and will serve in that capacityaccounting firm for the 2004 fiscal year, and will continue to serve as our independent registered public accounting firm for the 2005 fiscal year unless the board of directorsAudit Committee deems it advisable to make a substitution. We anticipate that representatives of BDO Seidman will attend the annual meeting, will have the opportunity to make a statement if they desire, and will be available to respond to appropriate questions.

     Aggregate fees billed to us for the fiscal years ended December 31, 20022003 and 20032004 by the our principal accounting firm, BDO Seidman and its affiliates are as follows:

STOCKHOLDER PROPOSALS

     Stockholders interested in presenting a proposal for consideration at our 20052006 annual meeting of stockholders may do so by following the procedures prescribed in Rule 14a-8 under the Securities Exchange Act of 1934, as amended. To be eligible for inclusion in our proxy statement and form of proxy relating to the meeting, stockholder proposals must be received in writing by our corporate Secretary, Hythiam, Inc., 11150 Santa Monica Blvd., Suite 1500, Los Angeles, California 90025, no later than January 18, 2005.25, 2006. If a stockholder proposal is received after April 3, 2005,18, 2006, we may vote in our discretion as to the proposal all of the shares for which we have received proxies for the meeting.

     Our 20052006 annual meeting of stockholders is expected to be held on Friday, June 17, 2005.16, 2006. If the date of next year’s annual meeting is changed by more than 30 days, then any proposal must be received not later than ten days after the new date is disclosed in order to be included in our proxy materials.

Los Angeles, California
May 18, 200425, 2005

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