Ontrak Inc (OTRK) 2006 Q2 法說會逐字稿

Greetings, ladies and gentlemen, and welcome to the Hythiam Inc. second-quarter fiscal 2006 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Sanjay Sabnani. Thank you, Mr. Sabnani, you may begin.

Thank you, operator. Good afternoon, everyone, and thank you for participating in our fiscal second-quarter conference call. As the operator mentioned, my name is Sanjay Sabnani. I am an EVP at Hythiam. In a moment I will turn the call over to our CEO, Terren Peizor, who will introduce the other participants.

Before that I would like to call your attention to the following Safe Harbor statement. The statements which will be made during the course of this call that are not historical in facts are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current expectations, forecasts, and assumptions that are subject to risks and uncertainties that could cause actual results to differ materially from those set forth in or implied by the forward-looking statements. Similarly statements herein that describe the Company's business strategy, prospects, opportunities, outlook, objectives, plans, intentions, or goals are also forward-looking statements. Actual results may differ materially from those indicated by such forward-looking statements as a result of various important factors that are detailed in the Company's SEC filings.

In addition, the statements in this call are made as of August 9, 2006. The Company expects that subsequent events or developments will cause its views to change. The Company undertakes no obligation to update any of the forward-looking statements made herein whether as a result of new information, future events, changes and expectations, or otherwise. These forward-looking statements should not be relied upon as representing the Company's views as of any date subsequent to August 9, 2006.

With that, I would like to turn it over to our CEO, Terren Peizor.

Thank you, Sanjay. Welcome to Hythiam's second-quarter conference call. Presenting with me on the call today are Chuck Timpe, our Chief Financial Officer, and Tony LaMacchia, Hythiam's Senior Executive Vice President.

Things have changed for our Company in a very significant way in the past few months. For the first time since our inception, we have third-party validated data for our protocols for stimulants including methamphetamine, crack cocaine, and powder cocaine. This has led us to dramatically improve visibility into how, where and when we will be able to generate revenue. I will discuss the specifics later in my discussion, but let me just highlight for you what has occurred as a result of the achievement of these recent milestones.

We are currently in some level of discussions with programs in more than 25 states with approximately half of those having advanced to later stage discussions. We are in licensing discussion with the largest treatment providers within many individual states, those who receive large allocations of states and federal treatment dollars. We are in advanced talks with residential treatment providers to embed the PROMETA protocols in their standard treatment offering as a transition to more of a hybrid outpatient model. Ahead of our expectations, we are seeing relationships develop with major insurers as a near-term possibility.

I will first discuss the significant milestones that occurred during the quarter before turning it over to Chuck for the financials. Next, Tony LaMacchia will discuss second-quarter operations and licensing activities. Finally I will conclude by giving you the assumptions by which you can begin to model our baseline revenue expectations for fiscal 2007. We will also share key learnings with you that will guide your understanding of what we can achieve in the balance of 2006. However we are not giving specific revenue guidance for the rest of this fiscal year.

As I will share with you, the recent addition of key executives gives us the depth of management and the leadership strength and gives us the confidence to accelerate our business model and to more confidently articulate visions for growth since we now believe that we have the necessary elements in place to accomplish our business objectives.

We believe the tools are in place to continue our revenue growth during 2006 which we expect to accelerate in 2007 after the basic platform for our private pay growth has been established through the end of this year. We can however assure we will have solid growth and also give you comfort on our future net cash burn, which by the way will be far lower than is currently modeled by some of our analysts. We are not in need of capital at the present time.

At the end of the second quarter, we had cash, cash equivalents, and marketable securities of just under $33 million. To the extent that we do need additional capital in the future to execute on valid business opportunities, we anticipate that it will be minimal and actually may involve strategic alternatives without us needing to go back to the capital markets.

We are excited to announce our first seven figure quarter. In fact, revenues for the three-month period in our fiscal second quarter are on par with what we achieved for the entire 12 months of 2005. Keep in mind that the growth we are experiencing is entirely from our initial business segment, which is the private pay or self pay. While you can see on this call private pay will generate tremendous growth in revenues, ultimately however the opportunities for the institutional segment of our business are even greater.

We expect operating expenses for 2007 to model 2006, adjusted modestly upwards to reflect increased business opportunities. Keep in mind the assumptions I will provide to you later in the call are based upon our actual second-quarter results for our outpatient licenses and our company managed PROMETA Center. We expect that growth will greatly accelerate as government third-party segments such as criminal justice and the state health agencies such as Medicaid potentially come on line and as we begin to receive reimbursement from leading insurance companies, managed behavior health entities, and large self-insured employers.

I am pleased to say that a foundation for capitalizing on these business segments is already in place and our job now is to continue building and executing towards increasing adoption of the PROMETA protocols.

Let me summarize the developments from clinical studies, progress in our government business, then an update on the great progress we have made with our private pay PROMETA Center and licensing model. In June, the detailed findings of the first clinical study on the PROMETA protocol for methamphetamine were presented by Dr. Harold C. Urschel at the College of Problems of Drug Dependence annual meeting in Scottsdale, Arizona. According to Dr. Urschel's presentation, more than 80% of the study participants experienced a significant clinical benefit with no adverse events.

Clinical benefit was measured through decreasing cravings, reduction of methamphetamine use, and treatment retention. Dr. Urschel concluded that the study, which contained no active drug abuse counseling support, had demonstrated clinical utility with chronic relapsing methamphetamine dependent patients to help them attain and maintain abstinence demonstrated a decrease in cravings and was found to be safely administered in this outpatient setting. Of note was the fact that all of the end points in Dr. Urschel's study pointed in a positive direction with very meaningful statistical significance.

Dr. Urschel had initially expressed his concern that the outpatient setting of the study would mean that subjects would drop out of the study early. Instead what he found was that he had a high percentage of subjects complete both the treatment phase and the follow-up phase of this study even though the subjects received limited psych social interaction and did not have additional treatment incentive to return weekly for two months post-treatment completion. He found the high rate of patient adherence to completing treatment especially noteworthy in a patient population that is known by addiction treatment providers to inconsistently comply with treatment regimens.

As you also may know from recent announcements, there has been tremendous news from our partners in the criminal justice field. Just recently, Judge Diedre Monroe discussed six-month outcomes from individuals treated with PROMETA protocol for stimulants in her jurisdiction's drug court program at the American Probation and Parole Association, APPA, 31st annual training institute. You will remember that the PROMETA protocol for stimulants was adopted in May as a treatment by the City Court of Gary, Indiana when a pilot was terminated early because initial results of stimulant dependant court participants overwhelmingly surpassed the court's historical success rates.

At the National Association of Drug Court Professionals conference in Seattle, which to place in June, Judge Monroe had originally discussed outcomes from 90 days after the initiation of treatment. At the APPA Conference, she presented outcomes after six months from initiation of treatment. I will share with you some of her findings.

Among the City Court of Gary's addicted and chronically relapsing criminal offenders, Judge Monroe reported that 80% of the participants are still currently doing well with an aggregate negative urine drug testing rate of 95% for those patients. Among individuals treated with PROMETA protocol importantly over 75% are employed with many finding jobs more rapidly than her experience would anticipate. She also reported that the re-arrest rate for the PROMETA protocol treated population has been much lower than their historical recidivism rate.

Keep in mind that this location and population was selected as a test for Hythiam because this was a socio-economically disadvantaged minority population. Gary, Indiana is over 90% African-American and Judge Monroe and Justice Freeman Wilson felt that positive results in this community would demonstrate that the PROMETA protocol could be a powerful treatment tool irrespective of class standing or ethnicity.

What does this mean for Hythiam? Well, nationwide we estimate that there are more than 5 million drug and alcohol dependent lives that impact criminal justice, probation, and parole. Capturing even a small percentage of this opportunity at anywhere close to our current government rate of $2500 per treatment would be a very significant number.

Additionally, we believe that treatment of these individuals can result in a direct benefit to family and society and a significant reduction of direct and indirect costs to society in the programs that use the protocols. This motivates us and as a result makes this a very important segment of the substance dependent population for Hythiam.

The PROMETA protocol for stimulants was adopted by a provider in another area heavily affected by methamphetamine, Pierce County in the State of Washington. Like the City Court of Gary, the Pierce County Alliance terminated its pilot early to begin implementation of the protocol. According to a 2005 report on drug trends, Pierce County had seven times the number of methamphetamine incidents than the state's largest County by population, King County. Pierce County Alliance is the largest substance abuse treatment provider for criminal justice in Pierce County, Washington and currently services approximately 2000 individuals each year.

Additionally, both Judge Monroe and Dr. Terree Schmidt-Whelan presented their respective findings to an audience of 2500 drug court practitioners from the U.S. and abroad at the NADCP conference. Following the NADCP conference, Hythiam and the PROMETA protocols were prominently featured in the Seattle Times and numerous local news outlets in Washington.

Having study outcomes from Dr. Urschel and references such as Gary City Court and PCA will allow us to rapidly showcase the PROMETA protocols and templates for implementation to other agencies. The result is anticipated increased adoption or pilots towards adoption in key geographic regions among the relevant health and criminal justice agencies. Any state, county, or city facing a crisis with methamphetamine, crack, or cocaine can now look at the PROMETA protocol for stimulants as a viable alternative that can be rapidly implemented.

In Arizona, Maricopa County-based Community Bridges a Hythiam licensee, is currently conducting a pilot to assess PROMETA protocols in Medicaid eligible population of those who are methamphetamine dependent or polyaddicted to methamphetamine and alcohol. Arizona has already committed significant resources toward treating the growing number of methamphetamine dependent individuals who represent a costly burden for the state. We believe that without treatment to address both physiological and psychological effects of this disease, many of these individuals will continue to place financial strain on state medical resources or they will end up incarcerated in a state correctional facility. We believe that the state of Arizona will find that PROMETA protocol is a viable treatment option not only for methamphetamine dependence but eventually for cocaine and alcohol dependent individuals as well. Community Bridges treats 15,500 people per year. It is the largest provider of medical addiction treatment for the state of Arizona and was recently selected to develop a center of excellence for methamphetamine treatment by the state.

Our profile keeps increasing in regards to the methamphetamine crisis that is plaguing our country. Hythiam was invited to present testimony on the PROMETA protocol before the U.S. House of Representatives Committee on Government Reform Subcommittee on Criminal Justice, Drug Policy, and Human Resources on the availability and effectiveness of programs to treat victims of the country's methamphetamine epidemic.

Hythiam's international private pay operations also saw significant development since our last call as well. Later in this call, Tony LaMacchia will go into details about our PROMETA Center strategy. I will tell you a bit about our international subsidiaries launch into the European market. Privatklinik Meiringen, a private hospital with 180 beds in Switzerland, has been signed as the third European licensee for PROMETA protocols. The addition of the site to our existing European licensee is near Geneva and in Lugano, completes our initial network of treatment destinations servicing the French, Italian, and German-speaking populations of Europe. Additionally, Switzerland is well-regarded worldwide as a destination for and creator of high-quality innovative medical treatment.

I would now like to turn the call over to Chuck Timpe, our CFO, to briefly review our financial highlights. Following Chuck's comments, you will hear an update of our business operations from Hythiam's senior Executive Vice President, Tony LaMacchia. Chuck?

Thank you, Terren. For the 2006 second quarter, our net revenues were $1.2 million, an increase of $942,000 or 410% over the $230,000 reported for the three months ended June 30, 2005 and an increase of 79% over the first quarter of 2006. These increases were primarily due to an increase in the number of patients treated and the expansion of the number of revenue contributing licensees.

In the second quarter of 2006, 175 patients were treated by 20 licensee sites, compared to 40 patients treated by six sites in the comparable period last year. Our average revenue per patient treated increased by 17% to $6700 in the current quarter compared to $5750 for the same period last year. This increase was primarily attributable to patients treated by the newly opened PROMETA Center, which generate higher average revenues per patient than other licensee sites due to consolidation of its gross revenues in our financial statements as well as other -- as lower average discounts granted by other licensee in the current quarter than in the same period last year.

We ended the quarter with cash, cash equivalents, and marketable securities of $32.8 million, a reduction in cash reserves of $6.5 million for the second quarter and $14.2 million since year-end. Our operating expenses during the three- and six-month periods ended June 30, 2006 were $10.6 million and $20.4 million versus $5.1 million and $9.8 million for the same periods last year. Non-cash charges for depreciation, amortization, and share-based expense were $652,000 and $2.1 million for the three- and six-month periods in 2006, compared to $433,000 and $1.7 million last year.

The increase operating expenses in 2006 over the prior year reflects the continued development of our Company and the execution of our business plan including a national and international expansion strategy, hiring of key management personnel, spending for clinical research, and the expansion of marketing efforts.

In the first half of 2006, we increased spending for Sarbanes-Oxley compliance, international expansion activities, and new initiatives for expanding our business to managed care, statewide agencies, and criminal justice systems. For the six months ended June 30, 2006, the most significant components of other operating expenses were marketing and advertising, legal and accounting fees, rent and occupancy costs, and public relations expense.

Now I would like to turn it over to Tony.

Thank you, Chuck. Terren is going to drill down in great detail about our private pay business model, so I will keep my comments relatively brief. Let me begin by catching everyone up on the status of our business development and licensing activities.

As most of you are aware, we have brought up two points in the past calls. The first was that our initial licensees may not be the best candidates for delivering a new modality of treatment like the PROMETA protocols. The other consistent theme was that we were going to focus on clustering licensees in major metropolitan regions in order to maximize our return on marketing investment. We have decided to let a few of our early licensees go inactive and have terminated several of our license agreements due to marketing and support costs associated with maintaining them or due to the fact they were in markets we have decided not to target at this stage.

As a net result, you can look at the 40 license locations we had on hand at June 30 and consider around 10 of those to be inactive. Of the remaining 30 license locations, 20 are contributing already; five are strategic nature. That means they are licensed for purposes other than the immediate generation of private pay revenue or are additionally locations where existing licensees have the ability to bring online rapidly once we mutually agree to expand our relationship. The remaining five are new licensees scheduled for training and should come on line shortly.

Now let me provide you with some idea how well the regional strategy is working for us. Keep in mind that this discussion is to provide you with some color but we do not traditionally view our business in this way. I'm only sharing this with you to provide you with some alternative metrics to the ones that Terren will present later and so you'll see the logic behind our regional strategy.

If you've been following our announcements, you'll see that we have established footprints of providers in two major markets, Southern California and Florida. Behind these two we have emerging presence in San Francisco Bay Area. Let me break down the number of treatments by region for illustrative purposes. Of the 271 total treatments for the six months ended June 30, 2006, 119 were from Southern California; 83 were from Florida; and 21 were from the Bay Area. The remaining 48 came from all of our other markets combined. Contrast this to the first six months of 2005 and you'll see that of our 80 last year to date treatments at the point of 46 were from Florida, 25 are from Southern California, zero from the Bay Area, and nine treatments from all other markets.

We began to notice a definite advantage to having more licensees in each region and immediately began adding providers to Southern California and Florida. Southern California with 119 treatments was able to surpass the performance of Florida in these first six months, when for the same period in 2005 Southern California and Florida combined delivered 80 total treatments. The big difference is the addition of the PROMETA Center to the Southern California market, coupled with greater brand awareness.

Based on this early success with the inaugural PROMETA Center in Los Angeles, we entered into an agreement with an entity for the purpose of allowing them to own and manage two PROMETA Centers. Since the centers operated by this group will also operate under the name PROMETA Center, we will subsequently refer to them as third-party financed PROMETA Centers versus our Company managed PROMETA Center. The third-party financed PROMETA Centers will be opened in northern New Jersey and in southern Florida. In addition to licensing fees, Hythiam will receive equity participation via a 10% profit share from these centers. Additionally we also plan to open a Company managed PROMETA Center in San Francisco.

Our experience in managing the flagship PROMETA Center in Los Angeles has led us to believe that a dedicated facility affords us the ultimate advantage and potential for growth. In just six months of managing the first PROMETA Center as a demonstration site and center of excellence, it has achieved profitability for us while also becoming our highest volume licensee. This result should be exceeded when a full-time effort is devoted towards the execution of this strategy by a committed party whose entire focus will be build and operate these facilities. We believe the third-party operated PROMETA Centers will afford us greater leverage in dedicating our existing resources towards the larger institutional opportunities for licensing the PROMETA protocols to government agencies, large employer groups, and third-party payers.

Our experience in Southern California has shown us that the smaller licensees benefit greatly from the visibility created by the PROMETA brand through the presence of a dedicated center of excellence. We will bolster the business of our existing licensees in the Bay Area with the opening of our San Francisco location and also build a strong network of licensees to complement each PROMETA Center so that we can re-create and scale our existing model for each new market.

The Company managed PROMETA -- San Francisco PROMETA Center will benefit greatly from the involvement of Dr. David Smith, who is one of the early pioneers of addiction treatment. As a founder of the Haight-Ashbury Free Clinic, which treats approximately 14,000 patients per year, Dr. Smith has been a fixture in the addiction treatment community of the Bay Area for almost five decades.

As we move toward the end of this year, we intend to build out Florida and the Bay Area further through the addition of more licensees and a PROMETA Center in each location. Florida will ultimately be split into two regions for us because of the big market opportunity that is present in that state.

With the planned opening of a PROMETA Center in northern New Jersey coupled with the existing licensees -- coupled with our existing and scheduled licensees in the New York City and New Jersey area, we will convert the area into multiple regions as afforded by its significant population density.

Additional areas that you'll see us regionalize include Atlanta, Chicago, Washington State, the Washington D.C./Baltimore region, and markets in Texas and Atlanta. We expect to sign 35 to 40 additional licensees by year end, all of them highly qualified based upon significant learnings and all of them tied into our regional strategy. In 2007, we have targeted another 50 new licensees and in addition to the three new PROMETA Centers currently in the pipeline, we have budgeted for another three managed PROMETA Centers. Keep in mind that we will be able to significantly accelerate the rollout of the PROMETA Centers based upon the success of the initial few.

We are currently beginning to see legs on our private pay business and our focus on the remainder of 2006 is putting into place the necessary elements to achieve or exceed the numbers that Terren will lay out for you next.

A final vote on seasonality. In order to give you an idea of what to expect for the next six months, we have learned from new industry data that addiction treatment episodes tend to be greatest in Q4 and relatively flat for the first three quarters of the calendar year. There may be a component of wanting to get sober for family events. Irrespective of the reason, the trend is pretty clear. If you overlay the fact that our greatest new licensing additions will come in the second half of this year beginning with the end of the third quarter, you can see the Q3 should model after Q2 with an expected slowdown for July and August but a big pickup in September leading into a robust fourth quarter. Beyond that we expect to have sequential increases next year. Thus far prices do not appear to be a limiting factor. Terren?

Thanks, Tony. Since we last spoke, the PROMETA protocols were featured in an article in the New York Times magazine on Sunday, June 25 titled an anti-addiction pill by Benoit Denizet-Lewis. Impressively, this very complementary article was written prior to and without the benefit of third-party data on the PROMETA protocols released by research across America and Pierce County Alliance. The article discussed the neuropathology of addiction and potential solutions including the PROMETA protocols.

The story discussed Hythiam's treatment and the importance of the GABA-urgic system in relation substance dependence noting that "addiction medicine doctors around the country who have administered the protocol report encouraging results." Additionally Hythiam has brought on two key additions to our senior management team that will be instrumental as we prepare to further expand our network of licensed providers and begin to help our third-party payer partners with their initial introduction of the PROMETA protocols into their criminal justice and substance dependence disease management programs.

We have changed our title structure to more accurately mirror our organizational strategy. Tony LaMacchia, Rick Anderson, and Chris Hassan are all now senior Executive Vice Presidents of the Company and will all report to me directly. On a functional basis, Tony's focus will be the rapid expansion of the PROMETA Centers and the training and operations of our licensees. Rick handles international, managed care, and government business. And Chris will oversee all business development and marketing.

A little background. Chris Hassan was a founding member and vice president of sales of Reckitt Benckiser Pharmaceuticals, a subsidiary of Reckitt Benckiser, a $25 billion enterprise. At Reckitt Benckiser Pharmaceuticals, he helped to build a $200 million business and established an emerging industry standard in only three years of marketing the innovative treatment for opiate dependence, Suboxone. While at the company, Hassan was instrumental in developing a large network of over 3000 U.S. physicians utilizing Suboxone as well as leading sales and business development.

With initial data on the PROMETA protocols in hand, Chris will be instrumental in helping Hythiam to reach out to physicians looking to complement their existing practice by offering treatment for alcohol, still the most commonly abused substance, cocaine, and methamphetamines.

As Hythiam prepares for anticipated broader institutional utilization of its PROMETA protocols, Dr. Lawrence Weinstein, Hythiam's New Senior Vice President of Medical Affairs, will have several responsibilities including developing substance dependence treatment programs for third-party payers, providing clinical support to Hythiam's institutional business development and marketing teams, and providing support to criminal justice, Medicaid, and commercial payers on the use and implementation of the PROMETA protocols and refining the protocols themselves. Dr. Weinstein has been an executive with leading behavioral health organizations including PacifiCare Behavioral Health, United Behavioral Health, and Magellan Behavior Health. His relationships with the leading Managed Behavioral Healthcare Organizations and understanding of the costs and challenges that they face in providing treatment for alcoholism and substance dependence will provide Hythiam with the insight and advantage in developing tailored disease management solutions.

The addition of these two individuals to our management team speaks to our increasing stature in the field of addiction treatment. We are delighted that they have joined us and we welcome them to our team.

Let us turn now our attention to Hythiam's private pay business model. As I promised, I'm going to walk you through some assumptions that will give you an idea of where we expect the self pay business to be for the next fiscal year. Keep in mind, this discussion does not include the institutional business opportunities which we also believe will start to contribute in a very meaningful fashion next year.

As you heard Chuck and Tony mention, there are 20 licensees that are online and contributing in some fashion. Not including the PROMETA Center, there are 19 contributing licensees with six of them already at a steady rate of an average of three to five treatments per month. While the remaining 13 sites will reach this level very shortly, we have no way to forecast the impact on the remaining half of the year, but we can assume that we will have all 19 licensees doing approximately four treatments per month for fiscal 2007. Let's call this 76 treatments per month or 912 treatments for the year.

Our business development target for the remainder of the year is to bring on 40 new licensees of the same or greater caliber than the ones that comprise these 20 that I mentioned. Based upon the natural stagger from training and startup, we expect that they will all come online and contribute an average of three treatments per month for the fiscal year, bringing the total to 1,440 treatments for this group. This makes a total of 2,352 non PROMETA Center treatments for 2007.

So let's now discuss PROMETA Centers and their contribution. Again, the specific timings of launch will vary, but I wanted to give you a model for the aggregate number of treatments for next year. We expect our initial Los Angeles PROMETA Center will average 30 treatments per month or 360 for the year. Our expectation for the remaining three PROMETA Centers is that they will come on line and generate an average of 15 treatments per month during their first year, which is 2007. This is 540 treatments which when added to the 360 for the PROMETA Center in L.A. and the 2352 for the other licensees brings the total to 3252 treatments for 2007. Assuming approximately $6400 per treatment, which is our alcoholism licensing fee since we have no way to forecast the mix of stimulant to alcoholism treatment and you come up with approximately $21 million in private pay business.

Very importantly, several points to note. First, our model does not account for the momentum we expect to receive when double-blind placebo-controlled study data is available on our protocol possibly beginning in the first quarter of '07. The release of these results will be watershed events for our Company and we should see a pickup along all business segments as a result in a very meaningful way. These basic private pay assumptions also do not include the addition of Chris Hassan to our team and the benefit of his ability to build a network of licensed treatment providers for us like the 3000 plus position network that is currently in place for Suboxone treatment. This could greatly increase our total number of licensees both for the remainder of this year as well as for next year.

We have also discounted the potential for increased increase in existing "same licensee’s sales" by limiting it to the four per month level. Also while it is an unlikely scenario, we have not factored in any contribution in the safe line model for the new licensees that will be added in 2007. Moreover, discussions currently underway with Residential Treatment Centers to embed the PROMETA protocols into their primary treatment offering could also result in business that is significantly additive to these baseline assumptions. Additionally now that we have three sites in Europe we will also at guidance at a later point as the contribution from Europe as this is a very exciting market for us.

It is premature for us to forecast our government and self-insured employer revenue opportunities for 2007 at the time of this call, but we do expect that things will fall into place shortly and we will be able to add to these baseline assumptions in a meaningful way once budgets are in place. We are in constant dialogue with providers to government and state agencies and third-party payers and we expect to land initial licensing relationships that will contribute to our 2007 revenues. Keep in mind each 400 treatments at our government rate of $2500 will result in $1 million in revenue. At these levels, even initial volumes can accrue quite rapidly.

As we have discussed in the past, we are partnering with Managed Behavioral Healthcare Organizations in order to get access to larger aggregate number of lives. There are currently is significant number of state contracts that are in an RFP process. While we are limited at this time in what we can discuss at this point, we feel highly confident that Hythiam and PROMETA will benefit from this activity. In fact, some initial designations have been made for lives on an at risk basis and we will report specifics when our partners disclose their wins and contract specifics of potentially hundreds of thousands of managed care lives. Once we see the details of the RFP outcomes funding provisions, we will be in a better position to project 2007 treatment volumes from this category.

Similarly when it comes to our government business opportunity, we are in motion with a few providers and if you look at Pierce County Alliance as an example, they have applied to both legislative and gubernatorial budgets for 2007 PROMETA protocol funding for the next budget cycle.

On a final note, I would like to mention that all studies pending on the PROMETA protocols including UCLA and the University of South Carolina have initiated enrollment and are actively treating patients. We will notify you when and as these studies are completed or at a major interim milestones to prior to completion, in that vein, we believe that will have exciting news in relation to randomized double-blind placebo-controlled studies and additional data on the PROMETA protocols in the very near future.

Let me close by reiterating the upcoming developments you can expect from us in the near future. Pilots with additional public and criminal justice populations that we are talking to now; pilots with state-level programs that we are currently in discussions with; signing volume licensing agreements with the largest government funded treatment providers; our first deals with Residential Treatment Centers to embed the PROMETA protocols as a standard treatment offering; initial relationships with major insurers.

We will now open for questions. Operator?

(OPERATOR INSTRUCTIONS) Don Hooker, UBS.

Thanks for the clarity with respect to the licensees. It seems like obviously your number of treatments per licensee has spiked up pretty dramatically in the quarter. I there any effect of the Farley advertisements? What are you seeing in terms of the consumer market? Are you doing any of their advertising? What is working and what is not?

Well, clearly we did receive a lot of publicity in the second quarter with respect to the Chris Farley billboard and advertisement. Going forward, we will as we are putting in our infrastructure and now with the management team in place and some other significant data points to come, at that point we will step up our marketing activities. But I would say relatively speaking besides that initial period it has been quite moderate.

Okay. Also with regards to your run rate expenses, can you break out the expense run rate for the PROMETA Center and the volumes at the PROMETA Center in L.A.?

We're not going to break out specific revenue and expenses to the PROMETA Center. Now, the initial PROMETA Center as it was a center of excellence and a demonstration site to really just enhance our business development activity obviously we are a little surprised that it registered profitability so quickly, when clearly it is not our number one -- it is not our only business function, clearly. It is fair to say relative to your question that there are other PROMETA Centers that will be coming on line and their initial upfront costs will be significantly less than what the L.A. PROMETA Center was number one.

And number two, their marketing costs will be significantly greater than ours. So that potentiates very well for their outcomes, particularly going forward for example in San Francisco, clearly we are going to be focused on maximizing the revenues of the site. Clearly a dedicated third-party financing vehicle like the ones we announced are going to be very dedicated to maximizing the revenue of their centers. We also will be fundamentally increasing our focus on the L.A. Center. But other than that, at this time we're not going to break out because there's just too few of centers to talk about.

Let me ask one more question, a little bit of a broader question. Now that you are in Europe I was curious if there was perhaps any cultural differences in terms of how clinicians look at addiction and treating addictive behavior? It seems like in the U.S. there's this heavy focus on spirituality and behavioral treatment, whereas -- do you find that the Europeans are perhaps more open to physiological treatment? Are there any differences there culturally?

Actually that is an excellent question. We know of many differences culturally. They are very focused on the physiological aspects of addiction treatment. There are also we should point out there are some fundamental differences in the laws in Europe versus in the U.S. For example, where in Europe you can actually pay for referrals where in the U.S. you cannot pay for referrals. So that gives it a little dimension that we don't really share in the U.S. market and so we are quite excited about that opportunity. I would say generally speaking that the European continent is more progressive with the acceptance of the physiological basis of treating addiction.

Okay, interesting. Thanks, guys.

Raymond Myers, Emerging Growth Equities.

Thank you, Terren, and everyone, for such a complete review of the exciting progress that is happening at Hythiam. My question is in regards to the patent protection. What progress are you making in finalizing patent protection for PROMETA both in the United States and in Europe?

Significant progress and we are extremely optimistic about the results and based on our interactions and we look forward to being allowed and issued in Europe towards the end of this year or January-ish of the coming year and in the U.S., it could happen sooner than what I am about to tell you, but as an outside we think probably sometime in the first quarter. But it could happen sooner.

What does that depend -- I know in Europe you already have an announcement of a pending allowance, so that is a pretty high likelihood that that will be awarded in January. But what does the U.S. patent approval depend upon?

Interesting question. I will tell you clearly there's only so much we can comment, but I will give you a general statement. Historically the European Patent Office is a lot more rigorous and stringent upon and circumspect on use applications and method of use applications than the U.S. Patent OFFICE. The early -- if we were to compare the comment on the European side with the U.S. side, I would say the comments in the initial phases of discussion with the patent offices were more rigorous, more extensive in the European office than the U.S. office which gives us a tremendous sense of the imminent issuance.

Okay, we will take that as a good sign. Question, a technical point on research and development expense. It has declined considerably over the past two quarters. Can you explain why that is and where do we expect R&D to trend in the future?

Yes, first of all the reason is if you recall there are certain progress payments made in each of the individual studies. There is a fairly large upfront payment, which is what you have experienced in the past. Then over time you will see kind of like completion payments. To answer your question, R&D will be greater in the second half than the first half. There is a lot of interesting opportunities looking out in 07 with respect to our research and development activity and we're looking forward to be able to report that at a later date.

Good. We look forward to that as well. When we are at the NADCP conference in Seattle, we noted quite a lot of grass-roots interest among the drug court professionals at the conference. What has been done since then to turn that into a pipeline and then turn that pipeline into new contracts?

Good question. Let's put it in perspective. Before the NADCP conference and before the Pierce County Alliance and the Urschel data, we were in conversations with approximately three states. Subsequent to the NADCP Conference and the Urschel data and Pierce County Alliance data as was mentioned earlier on the call we are in discussion now with 25 states with half of those at late stage discussion, leading obviously towards contracts. During -- what is also of interest, during the NADCP conference, what I find interesting is that some of the biggest skeptics at the time have turned around 180 degrees and are now very excited about working with the PROMETA protocols in their jurisdictions.

Great. Among the areas where you do have pilots, Indiana, Idaho in particular, Washington, you mentioned on the call Arizona. So we understand what is happening there, but what is happening in these other states and can you quantify what magnitude of revenue might possibly come from those opportunities?

At this time, as I stated earlier, we're not even going to guess the magnitude. If you add up -- I would be reluctant to because the numbers can be very large and very significant and when you think about the criminal justice, it's really important to think about probation and parole. But at this time I am not, as dictated by the call, not ready to break out an absolute number or relative number, just that we think an expect it to be quite significant.

Okay. Thank you, Terren, and the whole team for great results so far.

Glenn Garmont, First Albany Capital.

Just a quick question on the licensees that are no longer active. I believe there is 10 of them. I was wondering if you could give a little more detail behind the decision to inactivate those. I understand the geographic approach and the concentration in California and Florida, but why inactivate those sites versus maybe pursue additional licensees to up the concentration in those areas?

Actually I'm going to answer that in reverse order. First there was the decision into which regions would we concentrate, and that actually helped us make some of those decisions as to which ones to terminate. And it just so happened that several of those were not in areas that we had a robust pipeline at the time. In particular one licensee basically discontinued because they were in a shall we say a less affluent area and their treating physician had relocated to another facility in an affluent area, leaving them without a treating physician. So that discontinued. Another three were part of basically inactive with the Ardent takeover with Psychiatric Solutions and they were just in areas that were really not -- like Reno, Nevada for example where we were not going to concentrate our efforts at this point in time, so they are remaining inactive. They have not been terminated, but they are remaining inactive.

Then we had a couple of others where we had some one-off issues with the physicians coupled with the fact that we were not going to concentrate. So each one is a little bit different, but the majority of them fell into areas that we're not concentrating our efforts at this time.

Okay, fair enough. Terren, there is a lot of discussion on the call tonight about the PROMETA Center and your plans to open two more centers. It seems like the experience there has been much better than with most of the licensees any way in terms of treatment volume and also obviously revenue per treatment. So I guess my question is on a go forward basis do you anticipate opening many more of the PROMETA Centers and sort of gravitating toward more of a Company-managed model or are you satisfied with the way the licensee model is progressing at this point?

Well, let me say that clearly you are right. The PROMETA Center experiences greater treatment volume of third-party licensee. However I don't see a change in our strategy away from licensing the protocol everywhere. Remember our goal is to become an industry standard, so it is going to -- I don't think PROMETA Centers will be able to handle all the volume that is available, as well as if you look at our third-party reimbursement channels, we will be using their existing provider networks to administer the large patient volumes. So we will be licensing those third parties and -- but there can be no mistake about it. Do we expect to populate PROMETA Centers around the country based on the initial results we have seen to date as well as what we would anticipate in the newer announced PROMETA Centers? I would say most certainly yes.

Okay, thanks for the comments.

Operator, we will take one or two more questions. Before we wrap up, I just want to get back to Ray Myers question. I addressed the criminal justice aspect of his question, but clearly we have high expectations for Medicaid populations as well and other state agency populations outside of the criminal justice.

If there are any more questions, we will take one or two more.

Gene Mannheimer, Caris & Co.

Nice progress, guys. Terren, can you characterize for us what you think might be the time to profitability of the additional three PROMETA Centers in Florida, San Francisco, and New Jersey? In other words would it be six months similar to your experience in L.A. or more or less?

I still cannot help but to expect that with a focus on -- a dedicated focus to a center that the result won't be at least is good as the L.A. Center. Now that said we're holding the number at 15 per site, which the PROMETA Center has done well in access of that. That just goes to show you the assumptions that we are utilizing in creating this, the beginnings of this model for everyone. So I do expect the other centers to achieve profitability on a similar timeframe, perhaps even quicker than what we experienced here at our demonstration site.

Okay. You I think helped answer my other question, and that is in your assumptions you are forecasting 30 patients a month in Santa Monica. Has that been the historical experience as well? Patients treated to date there?

No. We're not consistently yet at the low, as Tony mentioned, there is some seasonality in July and August, but I think 30 patients a month for '07 is definitely achievable and I would be extremely disappointed if we did not achieve it.

Last question, Terren, in these assumptions am I correct that you are not including any drug court revenue in '07?

We have not included any revenue outside of what we included in the private pay model. And again, I think it is very important to focus on all the assumptions of what was left out of the private pay model, because I think that revenue number can go up dramatically when you start weighing in those aspects that were not included, but we hope in the very near future as the developments take place to now between now and year-end or whenever the next call is or whatever is to then begin to articulate the third-party reimbursement type numbers that we will expect to include.

So basically the drug court revenue, the third-party reimbursement all incremental to the assumptions you provided for us?

Correct.

Thanks again.

Okay. Certainly I want to on behalf of the entire management team want to thank everyone for their tremendous support. I want to thank the questioners for their interesting questions and thank you, everyone, for participating in our Company's fiscal second-quarter 2006 conference call. Have a nice night, everyone.

Thank you. This does conclude today's teleconference. You may disconnect your lines at this time.