Ontrak, Inc. - Quarter Report: 2004 March (Form 10-Q)

United States
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549
____________________________

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For The Quarterly Period Ended March 31, 2004

Commission File Number 333-58246
_______________________

HYTHIAM, INC.
(Exact name of registrant as specified in its charter)
_______________________

11150 Santa Monica Boulevard, Suite 1500, California 90025
(Address of principal executive offices, including zip code)

(310) 444-4300
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [ X ]   NO [    ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes [    ]    No [ X ]

As of May 13, 2004, there were 24,615,207 shares of registrant's common stock, $0.0001 par value, outstanding.

INDEX

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PART I - FINANCIAL INFORMATION

ITEM 1.   Financial Statements

HYTHIAM, INC.
(a Development Stage Company)
BALANCE SHEETS

See accompanying notes to financial statements.

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

See accompanying notes to financial statements.

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

See accompanying notes to financial statements.

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

See accompanying notes to financial statements.

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Hythiam, Inc.
Notes to Financial Statements
(Unaudited)

Note 1.   Basis of Presentation

     The accompanying unaudited interim condensed financial statements for Hythiam, Inc. (“Hythiam” or the “Company”), a development stage company, have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and do not include all information and notes required for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring accruals, considered necessary for a fair presentation have been included. Interim results are not necessarily indicative of the results that may be expected for the entire fiscal year. The accompanying financial information should be read in conjunction with the financial statements and the notes thereto in the Company’s most recent Annual Report on Form 10-K. The December 31, 2003 balance sheet has been derived from the audited financial statements on Form 10-K. All share data has been restated to reflect stock splits.

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

Note 2.   Basic and Diluted Loss per Share

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

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

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

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Note 3.   Stock Options

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

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

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

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

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

Note 4. Warrants

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

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

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

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

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ITEM 2.   Management's Discussion and Analysis of Financial Condition and Results of Operations

     The following discussion of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes, and the other financial information included in this report.

Forward-Looking Statements

     The forward-looking comments contained in this report involve risks and uncertainties. Our actual results may differ materially from those discussed here due to factors such as, among others, limited operating history, difficulty in developing, exploiting and protecting proprietary technologies, intense competition and substantial regulation in the healthcare industry. Additional factors that could cause or contribute to such differences can be found in the following discussion, as well as in the “Risks Factors” set forth in Item 1 of Part I of our Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 29, 2004.

Overview

     We are a development stage healthcare services management company. We have been unprofitable since our inception and we expect to incur substantial additional operating losses for at least the foreseeable future as we incur expenditures on business development, implement commercial operations and allocate significant and increasing resources to sales, marketing and other start-up activities. Accordingly, our activities to date are not as broad in depth or scope as the activities we may undertake in the future, and our historical operations and financial information are not necessarily indicative of the future operating results or financial condition or ability to operate profitably as a commercial enterprise.

The Merger

     The registrant, formerly known as Alaska Freightways, Inc., was incorporated in the state of Nevada on June 1, 2000, and previously provided transportation services. On September 29, 2003, the company sold all of its assets and liabilities to certain stockholders, entered into a reverse triangular merger with Hythiam, Inc., a development stage company incorporated in the state of New York on February 13, 2003, and reincorporated in Delaware. Because Hythiam was the sole operating company at the time of the merger with the registrant, the merger was accounted for as a reverse acquisition, with Hythiam deemed the acquirer for accounting purposes. As a result, references to “Hythiam,” the “Company,” “we” and “us,” and the discussion and analysis of financial condition and results of operations set forth in this report, refer to Hythiam, Inc., a New York corporation, prior to the merger and to the registrant, Hythiam, Inc., a Delaware corporation, following the merger.

Our Business

     We were formed for the purpose of researching, developing, licensing and commercializing innovative technology to improve the treatment of alcoholism and drug addiction. Our HANDS Treatment Protocol™ is designed for use by healthcare providers to treat addictions to alcohol, cocaine and other addictive stimulants—as well as combinations of these drugs. HANDS™ is a medically supervised treatment protocol for neurostabilization and detoxification from alcohol and/or addictive psychostimulants designed to simultaneously eliminate cravings, enhance cognitive function and facilitate a pain-free withdrawal, resulting in accelerated recovery. For the treatment of alcoholism, cocaine and other addictive stimulants, the HANDS Treatment Protocol consists of two to three consecutive days of treatment in a hospital or at a licensed healthcare facility. Our protocol eliminates the use of sedating medications, reduces inpatient treatment time and requires no tapering or washout period. Our limited initial results indicate that the protocol may significantly reduce or eliminate withdrawal symptoms, have significantly higher completion rates than conventional treatments and, reduce or eliminate the physical cravings that can be a major factor in relapse. We also provide hospitals and attending physicians with information and administrative services to facilitate continuing care services to help patients rebuild and refocus on life skills.

     We generate revenues by charging fees to licensed healthcare providers for access to our proprietary protocols for use in treating their patients, and for providing administrative management services in connection with such treatments. The administrative services offered by us include provision of an on-site liaison, client and hospital education, continuing care information, marketing and sales support, data collection and aggregation, patient registration and patient follow-up data collection.

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Results of Operations

     We have a limited history of operations, have not commenced substantial marketing activities, and have not generated significant revenues from operations. We did not include a comparison to the same quarter of last year because we are a development stage company, and did not have any business activities during the period from February 13, 2003 (inception) to March 31, 2003.

Revenues

     In the quarter ended March 31, 2004 we recognized revenues for a limited number of patients who have been treated at one hospital in the Los Angeles area using the HANDS Patient Protocol™. As we implement commercial operations and allocate significant and increasing resources to sales and marketing, we intend to enter into similar agreements with additional hospitals and licensed healthcare providers and increase the number of patients treated.

     We will generate revenues from fees charged to hospitals, healthcare facilities and other healthcare providers that license our HANDS^TM protocols. Revenues are generally related to the number of patients treated. Key indicators of our financial performance in the future will be the number of facilities and healthcare providers that we are able to license our technology to, and the number of patients that are treated by those providers using the HANDS protocols.

Expenses

     We have devoted a substantial portion of our resources to the payment of salaries and benefits, legal and professional fees, and other general and administrative expenses during our start-up period.

     In the quarter ended March 31, 2004, our total operating expenses were $3,117,000, an increase of $585,000 or 23% over the prior quarter ended December 31, 2003. Salaries and benefits costs increased by $98,000 from the prior quarter due to a net increase in staffing. We expect salaries and benefit costs to continue to increase by 10 to 15% per quarter as we add staff to support our anticipated growth. Stock-based expense was $568,000, a net increase of $223,000 over the prior quarter primarily due to the issuance of 225,000 options and warrants to consultants during the quarter. Rent expense increased by $53,000 over the prior quarter as a result of the commencement of our new office lease at the beginning of the quarter. Accounting, auditing and legal fees increased by $128,000 from the prior quarter primarily due to costs related to completing our annual audit and filing our annual report on Form 10-K and amended registration statement on Form S-1/A during the quarter ended March 31, 2004. There were no other material changes in operating expenses from the prior quarter.

Liquidity and Capital Resources

     We have financed our operations since inception primarily through the sale of shares of our stock. Last year we received net proceeds of approximately $21 million from the private placement of equity securities. During 2003 and through March 31, 2004, we used approximately $4 million in operations and approximately $3 million in capital expenditures and acquisition of intellectual property, leaving a balance of approximately $14 million in cash, cash equivalents and marketable security investments at March 31, 2004.

     Since we are a developing business, our prior operating costs are not representative of our expected on-going costs. In the first quarter of 2004 we have focused on completing the hiring of our senior management team and supporting staff, and have begun to devote resources to marketing and business development. As we implement commercial operations and allocate significant and increasing resources to sales, marketing and other start-up activities, we expect our monthly cash operating expenses in 2004 to increase to an average of approximately $1.1 million per month for the remainder of the year, excluding operating costs related to planned treatment sites.

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

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     Our future capital requirements will depend upon many factors, including progress with marketing our technologies, the time and costs involved in preparing, filing, prosecuting, maintaining and enforcing patent claims and other proprietary rights, the necessity of, and time and costs involved in obtaining, regulatory approvals, competing technological and market developments, and our ability to establish collaborative arrangements, effective commercialization, marketing activities and other arrangements. We expect to continue to incur negative cash flows and net losses for at least the next twelve months. Based upon our current plans, we believe that our existing capital resources will be sufficient to meet our operating expenses and capital requirements until we achieve profitability. However, changes in our business strategy, technology development or marketing plans or other events affecting our operating plans and expenses may result in the expenditure of existing cash before that time. If this occurs, our ability to meet our cash obligations as they become due and payable will depend on our ability to sell securities, borrow funds or some combination thereof. We may not be successful in raising necessary funds on acceptable terms, or at all.

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

Off-Balance Sheet Arrangements

      As of March 31, 2004, we had no off-balance sheet arrangements.

Critical Accounting Policies and Estimates

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

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

Revenue recognition

     The Company’s revenues are derived from licensing its technology and providing administrative services to hospitals, treatment facilities and other healthcare providers. These fees are recognized as licensing fees are earned or when services are performed and collectibility is reasonably assured. Under existing contracts, substantially all of the licensing fees and other service elements are earned at the time of completion of patient treatment.

Stock-based expense

     We account for the issuance of options and warrants for services from non-employees in accordance with SFAS 123, “Accounting for Stock-Based Compensation,” by estimating the fair value of options and warrants issued using the Black-Scholes pricing model. This model’s calculations include the exercise price, the market price of shares on grant date, the weighted average information for risk-free interest, expected life of the option or warrant, expected volatility of the company’s stock and expected dividends. The amounts recorded in the financial statements for stock-based compensation expense could vary significantly if we were to use different assumptions.

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Impairment of intangible assets

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

Accounting estimates

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

     Our critical accounting policies are more fully described in Note 2 to our financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2003.

Recent Accounting Pronouncements

     In December 2003, the Financial Accounting Standards Board (“FASB”) revised FASB Interpretation No. (“FIN”) 46, “Consolidation of Variable Interest Entities,” delaying the effective dates for certain entities and making other amendments to clarify application of the guidance. We have reviewed the provisions of FIN 46R and have determined that we have no variable interest entities; consequently, there was no impact on our financial statements.

ITEM 3.   Quantitative and Qualitative Disclosures About Market Risk

     There have been no material changes in market risks since the filing of our Annual Report on Form 10-K for the year ended December 31, 2003.

ITEM 4.   Controls and Procedures

     We have evaluated, under the supervision and with the participation of our Chief Executive Officer and our Chief Financial Officer, the effectiveness of our system of disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation our Chief Executive Officer and our Chief Financial Officer have determined that they are effective in connection with the preparation of this report. During the first quarter, our system of internal controls have evolved consistent with the development of the Company. There are no changes in our internal control over financial reporting during the quarter ended March 31, 2004 that have materially effected, or are reasonably likely to materially effect, our internal controls over financial reporting.

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PART II - OTHER INFORMATION

ITEM 1.   Legal Proceedings

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

ITEM 2.   Changes in Securities

     In January 2004 we issued to consultants and financial advisors 8,322 shares of common stock and warrants to purchase 150,000 of common stock at an exercise price of $7.00 per share. In addition, 643,000 options to purchase shares of common stock with a exercise price ranging from $5.56 to $7.50 were granted of which 75,000 were issued to consultants and 568,000 were issued to employees. The securities were issued without registration pursuant to the exemption afforded by Section 4(2) of the Securities Act of 1933.

ITEM 3.   Defaults upon Senior Securities

      Not Applicable.

ITEM 4.   Submission of Matters to a Vote of Security Holders

      Not Applicable.

ITEM 5.   Other Information

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 and Section 27A of the Securities Act. Such forward-looking statements, including, without limitation, those relating to the future business prospects, revenues and income of Hythiam, wherever they occur, are necessarily estimates reflecting the best judgment of the senior management of Hythiam on the date on which they were made, or if no date is stated, as of the date of this report. These forward-looking statements are subject to risks, uncertainties and assumptions, including those described in the “Risk Factors” in Item 1 of Part I of our most recent Annual Report on Form 10-K filed with the SEC, that may affect the operations, performance, development and results of our business. Because the factors discussed in this report could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any such forward-looking statements. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

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

• general economic conditions,
  
• the effectiveness of our planned advertising, marketing and promotional campaigns,
  
• physician and patient acceptance of our products and services, including newly introduced products,
  

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• competition among addiction treatment centers,
  
• anticipated trends and conditions in the industry in which we operate, including regulatory changes,
  
• development of new treatment modalities,
  
• our future capital needs and our ability to obtain financing, and
  
• other risks and uncertainties as may be detailed from time to time in our public announcements and filings with the SEC.

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

ITEM 6.   Exhibits and Reports on Form 8-K

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SIGNATURES

      Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

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EXHIBIT INDEX