| HYTHIAM INC ITEM 1A RISK FACTORS You should carefully consider and evaluate all of the information in this report, including the risk factors listed below |
| Risks and uncertainties in addition to those we describe below, that may not be presently known to us, or that we currently believe are immaterial, may also harm our business and operations |
| If any of these risks occurs, our business, results of operations and financial condition could be harmed, the price of our common stock could decline, and future events and circumstances could differ significantly from those anticipated in the forward-looking statements contained in this report |
| Risks Related to Our Business We have a limited operating history, making it difficult to evaluate our future performance We have a limited history of operations |
| We were formed in February 2003 and commenced operations in June 2003 |
| Investors have limited substantive financial information on prior operations to evaluate the company as an investment |
| Our potential must be viewed in light of the problems, expenses, difficulties, delays and complications often encountered in the operation of a new business |
| We will be subject to the risks inherent in the ownership and operation of a company with a limited operating history such as regulatory setbacks and delays, fluctuations in expenses, competition, the general strength of regional and national economies, and governmental regulation |
| Any failure to successfully address these risks and uncertainties would seriously harm our business and prospects |
| We expect to continue to incur operating losses, and if we are not able to raise necessary additional funds we may have to reduce or stop operations We have not generated significant revenues or become profitable, may never do so, and may not generate sufficient working capital to cover the cost of operations |
| Our revenues since commencement of operations in June 2003 were dlra1dtta4 million through December 31, 2005 |
| Our accumulated deficit through December 31, 2005 was dlra39dtta4 million |
| We anticipate that operating deficits will continue for at least the next twelve months of our operations |
| Because many of our costs generally will increase, the cost of operating the company will exceed the income therefrom during this period |
| No party has guaranteed to advance additional funds to us to provide for any such operating deficits |
| Our cash and marketable securities totaled approximately dlra47 million as of December 31, 2005 |
| Our fourth quarter 2005 net cash burn rate was approximately dlra2dtta6 million per month |
| We expect to increase our monthly expenditures over the next twelve months as we increase staff, commence marketing activities, expand the number of licensees and provide funding for research studies |
| If our revenues do not meet expectations and our expenses continue to increase, our cash reserves will be exhausted in fifteen to eighteen months, and we will be required to seek additional funds |
| We may seek additional funding through public or private financings or collaborative arrangements |
| If we obtain additional capital through collaborative arrangements, these arrangements may require us to relinquish greater rights to our technologies and protocols than we might otherwise have done |
| If we raise additional capital through the sale of equity, or securities convertible into equity, further dilution to our then existing stockholders will result |
| If we raise additional capital through the incurrence of debt, our business may be affected by the amount of leverage we incur, and our borrowings may subject us to restrictive covenants |
| Additional funding may not be available to us on acceptable terms, or at all |
| If we are unable to obtain adequate financing on a timely basis, we may be required to delay, reduce or stop operations, any of which would have a material adverse effect on our business |
| We are dependent on third party healthcare providers licensing and using our protocols, and if they delay or fail to do so our revenues and earnings could be adversely affected Only a physician may treat or supervise the treatment of patients using the PROMETA^™ protocols, which requires us to enter into licenses with physicians, hospitals, properly equipped outpatient settings or other treatment facilities in order to provide convenient treatment access points for patients |
| Our revenues are therefore dependent to a significant degree upon the relationships we can establish with physicians, hospitals and other healthcare facilities to license our protocols for treating their patients |
| In 2005, approximately 63prca of our revenues were derived from only three licensees |
| As of December 31, 2005, we had entered into licensing agreements for 32 sites throughout the 20 _________________________________________________________________ [67]Table of Contents United States, of which 25 were added in 2005 |
| The number of patients who were treated by our licensees in 2005 was approximately 215, and in the last six months of 2005 was approximately 135 |
| Additional rollout is anticipated to be dependent on our ability to negotiate and conclude licensing agreements with such healthcare providers across the country and their ability to generate patients |
| If we are unable to enter into similar arrangements with these additional healthcare providers for any reason, that would significantly limit our growth potential and negatively impact our business prospects |
| In addition, if physicians, hospitals and healthcare providers do not attract sufficient patient volume and revenue they may not be willing to continue to offer our protocols |
| The success of our protocols is largely dependent upon referrals of patients to facilities that license our technology and upon the use of our protocols by physicians in treating their patients |
| There is no requirement for physicians to refer their patients to facilities that license our protocols, or to use our protocols in treating their patients |
| They are free to refer patients to any other substance dependence treatment service, program or facility, and to treat their patients using whatever method they determine to be in the patients’ best interests |
| The failure of physicians to treat a sufficient number of patients using our protocols, or to refer patients to facilities that use our protocols, or the loss of physicians that use our protocols would have a material adverse effect on our operations and could adversely affect our revenues and earnings |
| We may fail to successfully manage and maintain the growth of our business, which could adversely affect our results of operations As we continue expanding our operations, sales and marketing activities, this expansion could put significant strain on our management, operational and financial resources |
| To manage future growth, we will need to continue to hire, train and manage additional employees, particularly a specially-trained sales force to market our protocols |
| Concurrent with expanding our operational and marketing activities, we will also be increasing our research and development activities, including the development of protocols for other types of addictions, with the expectation of ultimately commercializing those products |
| We have maintained a small financial and accounting staff, and our reporting obligations as a public company, as well as our need to comply with the requirements of the Sarbanes-Oxley Act of 2002, the rules and regulations of the SEC and The Nasdaq National Market, will continue to place significant demands on our financial and accounting staff, on our financial, accounting and information systems and on our internal controls |
| As we grow, we will need to add additional accounting staff and continue to improve our financial, accounting and information systems and internal controls in order to fulfill our reporting responsibilities and to support expected growth in our business |
| Our current and planned personnel, systems, procedures and controls may not be adequate to support our anticipated growth or management may not be able to effectively hire, train, retain, motivate and manage required personnel |
| Our failure to manage growth effectively could limit our ability to achieve our marketing and commercialization goals or to satisfy our reporting and other obligations as a public company |
| Our treatment protocols may not be as effective as we believe them to be, which could limit or prevent us from maintaining revenues Our belief in the efficacy of our treatment protocols is based on a limited number of unpublished studies, primarily in Spain, and our limited initial experience with a small number of patients in the United States |
| Such results may not be statistically significant, have not been subjected to close scientific scrutiny, and may not be indicative of the long-term future performance and safety of our protocols |
| Controlled scientific studies, including those that have been announced and planned for the future, may yield results that are unfavorable or demonstrate that our protocols are not clinically effective or safe |
| While we have not experienced such problems to date, if the initially indicated results cannot be successfully replicated or maintained over time, utilization of our protocols could decline substantially |
| Our marketing efforts may not result in acceptance of our protocols in the marketplace, which could adversely affect our revenues and earnings While we have been able to generate initial interest in our protocols among a limited number of healthcare providers, there can be no assurance that our efforts or the efforts of others will be successful in fostering acceptance of our protocols in the target markets |
| If our marketing and promotional efforts are not as successful as we expect them to be, the likelihood of expending all of our funds prior to reaching a level of profitability will be increased |
| 21 _________________________________________________________________ [68]Table of Contents Marketplace acceptance of our protocols may largely depend upon healthcare providers’ interpretation of our limited data, the results of pending studies, or upon reviews and reports that may be given by independent researchers |
| We have awarded and are in the process of awarding additional unrestricted grants to academic and affiliated research institutions and other research organizations interested in conducting research studies of our PROMETA protocols |
| As of December 31, 2005, we have committed to spending approximately dlra4dtta4 million over the next twenty-four months to fund unrestricted grants |
| In the event such research does not give our treatment technology high approval ratings, it is unlikely we will be able to achieve significant market acceptance |
| Our industry is highly competitive, and we may not be able to compete successfully The healthcare business in general, and the substance dependence treatment business in particular, are highly competitive |
| Hospitals and healthcare providers that treat substance dependence are highly competitive, and we must convince them that they will benefit by use of our protocols |
| We will compete with many types of substance dependence treatment methods, treatment facilities and other service providers, many of whom are more established and better funded than we are |
| Many of these other treatment methods—most of which involve only a single drug—and facilities are well established in the same markets we will target, have substantial sales volume, and are provided and marketed by companies with much greater financial resources, facilities, organization, reputation and experience than we have |
| There are a number of companies developing or marketing medications for reducing craving in the treatment of alcoholism |
| These include: • The addiction medication naltrexone, an opiate receptor antagonist, is marketed by a number of generic pharmaceutical companies as well as under the trade name ReVia^® by Bristol Myers Squib, for treatment of alcohol dependence |
| However, naltrexone must be administered on a chronic or continuing basis and is associated with relatively high rates of side effects, including nausea |
| • Alkermes is developing a long-acting injectable form of naltrexone, VIVITROL™, intended to be administered by a physician via monthly injections |
| The company reported results from a phase III clinical study indicating that in the overall study population, patients treated with VIVITROL 380 mg experienced approximately a 25prca reduction in the rate of heavy drinking relative to placebo |
| Alkermes, in partnership with Cephalon, reports it intends to launch VIVITROL in the second quarter of 2006, pending final FDA approval |
| • Forest Laboratories holds the license in the US to market Campral^® Delayed-Release Tablets (acamprosate calcium), approved by the FDA in 2004 |
| Acamprosate is an NMDA receptor antagonist |
| The product must be taken two to three times per day on a chronic or long-term basis |
| Clinical studies supported the effectiveness in the maintenance of abstinence for alcohol-dependent patients who had undergone inpatient detoxification and were already abstinent from alcohol, but the product was not effective for patients who had not undergone detoxification and who were not abstinent prior to treatment |
| 22 _________________________________________________________________ [69]Table of Contents We see these products as being potentially useful during the continuing care phase of treatment following treatment using the PROMETA protocols, but not being directly competitive |
| To the best of our knowledge, there are no treatment protocols or medications approved, marketed or in development within the US that reduce the cravings for cocaine, methamphetamine or other additive prescription psychostimulants |
| However, our competitors may develop and introduce new processes and products that are equal or superior to our protocols in treating substance dependencies |
| Accordingly, we may be adversely affected by any new processes and technology developed by our competitors |
| There are approximately 13cmam000 facilities reporting to the Substance Abuse and Mental Health Services Administration that provide substance abuse treatment on an inpatient or outpatient basis |
| Well known examples of residential treatment programs include the Betty Ford Center, Caron Foundation, Hazelden and Sierra Tucson |
| In addition, individual physicians may provide substance dependence treatment in the course of their practices |
| There are several points of resistance to penetrating the substance dependence treatment market |
| First, there is the historical focus on the use of psychological or behavioral therapies as opposed to medical or physiological treatments for substance dependence |
| Healthcare providers and potential patients may be resistant to the transition of treating substance dependence as a disease rather than as a behavioral aberration |
| Second, healthcare providers may be reluctant to use our protocols due to the absence of published clinical studies supporting their efficacy |
| Research studies of the PROMETA protocols may not lead to acceptable results or the results may not be published |
| If we are unable to penetrate these substantial barriers to entry we may not be able to successfully implement our business plan |
| We depend on key personnel, the loss of which could impact the ability to manage our business Our future success depends on the performance of our senior management and our key professional personnel |
| It therefore depends to a significant extent on retaining the services of our key executive officers, in particular our Chairman and Chief Executive Officer, Terren S Peizer, our Director and Chief Administrative Officer, Richard Anderson, our Director and Chief Operating Officer, Anthony M LaMacchia, and our Chief Financial Officer, Chuck Timpe |
| Each of these key executives is party to an employment agreement which, subject to termination for cause or good reason, has a remaining term of two to three years |
| While we believe our relationships with our executives are good and do not anticipate any of them leaving in the near future, the loss of the services of Mr |
| While we have not experienced any problems in attracting and retaining desirable employees, our success is dependent upon our ability to continue to attract and retain qualified management, professional, administrative and sales personnel to support our future growth |
| We are subject to personal injury claims, which could result in substantial liabilities that may exceed our insurance coverage All significant medical treatments and procedures, including treatment utilizing our protocols, involve the risk of serious injury or death |
| Even under proper medical supervision, withdrawal from alcohol may cause severe physical reactions |
| While we do not treat patients or determine whether treatment using our protocols is appropriate for any particular patient, and have not been the subject of any personal injury claims for patients treated by providers using our protocols, our business entails an inherent risk of claims for personal injuries, which are subject to the attendant risk of substantial damage awards |
| We cannot control whether individual physicians will properly select patients, apply the appropriate standard of care, or conform to our protocols in determining how to treat their patients |
| A significant source of potential liability is negligence or alleged negligence by physicians treating patients using our protocols |
| While our agreements typically require them to indemnify us for their negligence, there can be no assurance they will be willing and financially able to do so if claims are made |
| In addition, our license agreements require us to indemnify physicians, hospitals or their affiliates for losses resulting from our negligence |
| There can be no assurance that a future claim or claims will not be successful or, including the cost of legal defense, will not exceed the limits of available insurance coverage |
| We currently have insurance coverage for up to dlra5 million per year for personal injury claims |
| We may not be able to maintain adequate liability insurance, in accordance with standard industry practice, with appropriate coverage based on the nature and risks of our business, at acceptable costs and on favorable terms |
| Insurance carriers are often reluctant to provide liability insurance for new healthcare services companies and products due to the 23 _________________________________________________________________ [70]Table of Contents limited claims history for such companies and products |
| In addition, based on current insurance markets, we expect that liability insurance will be more difficult to obtain and that premiums will increase over time and as the volume of patients treated with our protocols increases |
| In the event of litigation, regardless of its merit or eventual outcome, or an award against us during a time when we have no available insurance or insufficient insurance, we may sustain significant losses of our operating capital which may substantially impair or destroy the investments of stockholders |
| If government and third-party payors fail to provide coverage and adequate payment rates for treatment using our protocols, our revenue and prospects for profitability will be harmed Our future revenue growth will depend in part upon the availability of reimbursement from third-party payors for treatment providers using our protocols |
| Such third-party payors include government health programs such as Medicare and Medicaid, managed care providers, private health insurers and other organizations |
| These third-party payors are increasingly attempting to contain healthcare costs by demanding price discounts or rebates and limiting both coverage on which procedures they will pay for and the amounts that they will pay for new procedures |
| We might need to conduct studies in order to demonstrate the cost-effectiveness of treatment using our protocols to such payors’ satisfaction |
| Such studies might require us to commit a significant amount of management time and financial and other resources |
| Adequate third-party reimbursement might not be available to enable us to realize an appropriate return on investment in research and product development, and the lack of such reimbursement could have a material adverse effect on our operations and could adversely affect our revenues and earnings |
| Our planned international operations may be subject to foreign regulation, and the success of our foreign operations will depend on many factors |
| While we will establish policies and procedures that we believe will be sufficient to ensure that we operate in substantial compliance with applicable foreign laws, regulations and requirements, the criteria are often vague and subject to change and interpretation |
| Our international operations may become the subject of foreign regulatory, civil, criminal or other investigations or proceedings, and our interpretations of applicable laws and regulations may be challenged |
| The defense of any such challenge could result in substantial cost and a diversion of management’s time and attention |
| Thus, any such challenge could have a material adverse effect on our international business and our plan to expand our international operations, regardless of whether it ultimately is successful |
| If we fail to comply with any applicable international laws, or a determination is made that we have failed to comply with these laws, our financial condition and results of operations, including our domestic operations, could be adversely affected |
| In addition private pay healthcare system in Europe is not as developed as in the US and as a result it may be more difficult to convince patients in these countries to pay or to pay substantial amounts for treatment |
| We will be reliant on relationships that we establish with local companies, thought leaders and governments |
| There can be no assurance we will be able to establish these relationships, maintain them or that the partners will retain their influence in the market |
| It may take longer than we expect to commence operations or to operate our business at profitable levels as we do not have the established relationships and knowledge of the regulations and business practices in the markets we are entering |
| Risks Related to our Intellectual Property We may not be able to adequately protect the proprietary treatment protocols which are the core of our business We consider the protection of our proprietary treatment protocols to be critical to our business prospects |
| 24 _________________________________________________________________ [71]Table of Contents We obtained the rights to some of our most significant patent-pending technologies through a license agreement which is subject to a number of conditions and restrictions, and a breach or termination of that agreement could significantly impact our ability to use and develop our technologies |
| We currently have no issued US patents covering our PROMETA protocols |
| In addition, the patent applications we have filed and licensed may not issue as patents, and any issued patents may be too narrow in scope to provide us with a competitive advantage |
| Our patent position is uncertain and includes complex factual and legal issues, including the existence of prior art that may preclude or limit the scope of patent protection |
| Other inventors may have filed earlier patent applications of which we are unaware and which may prevent our applications from being granted |
| Patent examiners and third parties may object to the validity or scope of some or all of our claims |
| Any of the patents that may be issued to us will expire twenty years after they were first filed |
| Competitors or others may institute challenges against the validity or enforceability of any patent owned by us, and if successful our patents may be denied, rendered unenforceable, or invalidated |
| The cost of litigation to uphold the validity of patents, and to protect and prevent infringement of patents can be substantial |
| Maintaining, prosecuting, and enforcing a patent portfolio might require funds that may not be available |
| We may not be able to adequately protect the aspects of our treatment protocols that are not subject to patent protection, or are subject to only limited patent protection |
| Furthermore, competitors and others may independently develop similar or more advanced treatment protocols and technologies, may design around aspects of our technology, or may discover or duplicate our trade secrets and proprietary methods |
| To the extent we utilize processes and technology that constitute trade secrets under applicable laws, we must implement appropriate levels of security for those trade secrets to secure the protection of such laws, which we may not do effectively |
| For some of our proprietary rights, we may need to secure assignments of rights from independent contractors and third parties to perfect our rights, and if we fail to do so they may retain ownership rights in the intellectual property upon which our business is based |
| Policing compliance with our confidentiality agreements and unauthorized use of our technology is difficult, and we may be unable to determine whether piracy of our technology has occurred |
| In addition, the laws of many foreign countries do not protect proprietary rights as fully as the laws of the United States |
| While we have not had any significant issues to date, the loss of any of our trade secrets or proprietary rights which may be protected under the foregoing intellectual property safeguards may result in the loss of our competitive advantage over present and potential competitors |
| Confidentiality agreements with employees, licensees and others may not adequately prevent disclosure of trade secrets and other proprietary information In order to protect our proprietary technology and processes, we rely in part on confidentiality provisions in our agreements with employees, licensees, treating physicians and others |
| These agreements may not effectively prevent disclosure of confidential information and may not provide an adequate remedy in the event of unauthorized disclosure of confidential information |
| In addition, others may independently discover trade secrets and proprietary information |
| Costly and time-consuming litigation could be necessary to enforce and determine the scope of our proprietary rights, and failure to obtain or maintain trade secret protection could adversely affect our competitive business position |
| To date we have had one instance, in February 2004, in which it was necessary to send a formal demand to cease and desist using our protocols to treat patients to a consultant who had signed a confidentiality agreement |
| He subsequently complied with the demand and signed an innovation, proprietary information and confidentiality agreement, and an intellectual property assignment agreement |
| We may not be able to adequately protect our other intellectual property rights, which could limit our ability to compete While we believe we have proprietary ownership, assigned or licensed rights in intellectual property which is capable of protection under federal trademark, copyright and/or patent laws, and under state laws regarding trade secrets, we may not have taken, or in the future may not take, appropriate legal measures, and may not be able to adequately secure the necessary protections for our intellectual property |
| We currently have no issued US patents protecting our PROMETA protocols, and have not yet registered all of our trademarks or copyrights and, until we do 25 _________________________________________________________________ [72]Table of Contents so, we must rely on various state and common law rights for enforcement of the rights to exclusive use of our trade secrets, trademark and copyrights |
| Although Hythiam^^® is a registered trademark, our trademark applications for our PROMETA™ trademarks are pending before the US Patent and Trademark Office, and we have not yet been granted registration for these marks |
| If our trademark registrations are objected to or denied that may impact our ability to use and protect our brand names and company and product identity |
| Although we have applied for trademarks for some of our brand names, and patents on some of our technology, in the future we may decide not to secure federal protection of certain copyrights, trademarks or patents to which we may be entitled |
| Failure to do so, in the case of copyrights and trademarks, may reduce our access to the courts, and to certain remedies of statutory damages and attorneys’ fees, to which we may be entitled in the event of a violation of our proprietary and intellectual rights by third parties |
| Similarly, the failure to seek issuance of any patents to which we may be entitled may result in loss of patent protection should a third party copy the patentable technology |
| The loss of any proprietary rights which are protectable under any of the foregoing intellectual property safeguards may result in the loss of a competitive advantage over present or potential competitors, with a resulting decrease in revenues and profitability for us |
| There is no guarantee that such a loss of competitive advantage could be remedied or overcome by us at a price which we would be willing or able to pay, which could have a material adverse effect on our operations and could adversely affect our revenues and earnings |
| We may be subject to claims that we infringe the intellectual property rights of others, and unfavorable outcomes could harm our business Our future operations may be subject to claims, and potential litigation, arising from our alleged infringement of patents, trade secrets or copyrights owned by other third parties |
| We intend to fully comply with the law in avoiding such infringements |
| However, within the healthcare, drug and bio-technology industry, established companies have actively pursued such infringements, and have initiated such claims and litigation, which has made the entry of competitive products more difficult |
| Court-ordered injunctions may prevent us from bringing new products to market, and the outcome of litigation and any resulting loss of revenues and expenses of litigation may substantially affect our ability to meet our expenses and continue operations |
| Risks Related to our Industry The healthcare industry in which we operate is subject to substantial regulation by state and federal authorities, which could hinder, delay or prevent us from commercializing our protocols The healthcare industry is highly regulated and continues to undergo significant changes as third-party payors, such as Medicare and Medicaid, traditional indemnity insurers, managed care organizations and other private payors increase efforts to control cost, utilization and delivery of healthcare services |
| Although our licensees do not currently bill or seek reimbursement from Medicare, Medicaid or other governmental organizations for the treatment of patients using the PROMETA protocols, we are nevertheless subject to the overall effect of the changes created by increased cost control and financial pressures on the industry |
| Healthcare companies are subject to extensive and complex federal, state and local laws, regulations and judicial decisions governing various matters such as the licensing and certification of facilities and personnel, the conduct of operations, billing policies and practices, policies and practices with regard to patient privacy and confidentiality, and prohibitions on payments for the referral of business and self-referrals |
| There are federal and state laws, regulations and judicial decisions that govern patient referrals, physician financial relationships, submission of healthcare claims and inducement to beneficiaries of federal healthcare programs |
| Many states prohibit business corporations from practicing medicine, employing or maintaining control over physicians who practice medicine, or engaging in certain business practices, such as splitting fees with healthcare providers |
| Many healthcare laws and regulations applicable to our business are complex, applied broadly and subject to interpretation by courts and government agencies |
| Our failure, or the failure of our licensees, to comply with these healthcare laws and regulations could create liability for us and negatively impact our business |
| 26 _________________________________________________________________ [73]Table of Contents In addition, the Food and Drug Administration (FDA), regulates development, testing, labeling, manufacturing, marketing, promotion, distribution, record-keeping and reporting requirements for prescription drugs, medical devices and biologics |
| Other regulatory requirements apply to dietary supplements (including vitamins) |
| Compliance with laws and regulations enforced by the FDA and other regulatory agencies may be required relative to our protocols or any other medical products or services developed or used by us |
| Failure to comply with applicable laws and regulations may result in various adverse consequences, including withdrawal of our protocols from the market, the imposition of civil or criminal sanctions, or the required modification or redesign of our protocols |
| We may not have the financial resources to modify our protocols or implement new techniques |
| Accordingly, our ability to market our protocols in compliance with applicable laws and regulations may be a threshold test for our survival |
| We believe that this industry will continue to be subject to increasing regulation, political and legal action and pricing pressures, the scope and effect of which we cannot predict |
| Legislation is continuously being proposed, enacted and interpreted at the federal, state and local levels to regulate healthcare delivery and relationships between and among participants in the healthcare industry |
| Any such changes could prevent us from marketing some or all of our products and services for a period of time or permanently |
| We may be subject to regulatory and investigative proceedings, which may find that our policies and procedures do not fully comply with complex and changing healthcare regulations While we have established policies and procedures that we believe will be sufficient to ensure that we operate in substantial compliance with applicable laws, regulations and requirements, the criteria are often vague and subject to change and interpretation |
| We may become the subject of regulatory or other investigations or proceedings, and our interpretations of applicable laws and regulations may be challenged |
| The defense of any such challenge could result in substantial cost and a diversion of management’s time and attention |
| Thus, any such challenge could have a material adverse effect on our business, regardless of whether it ultimately is successful |
| If we fail to comply with any applicable laws, or a determination is made that we have failed to comply with these laws, our financial condition and results of operations could be adversely affected |
| The promotion of our protocols may be found to violate federal law concerning “off-label” uses of prescription drugs, which could prevent us from marketing our protocols The Food Drug & Cosmetic (FDC) Act, requires that prescription drugs be approved for a specific medical indication by the FDA prior to their marketing in interstate commerce |
| In addition, promotion of dietary supplements for uses beyond those permitted by law may be treated as the unlawful promotion of drugs absent FDA approval |
| Violations of the FDC Act may result in either civil (seizure or injunction) or criminal penalties |
| Our procedural medical protocols call for the use of prescription drugs for the treatment of chemical dependence and drug addiction, conditions not approved for use in the drugs’ official labeling, and physicians prescribe and use these drugs when treating patients using our protocols |
| In addition, our protocols include the use of nutritional supplements |
| While the FDA generally does not regulate licensed physicians who prescribe approved drugs for non-approved or “off-label” uses in the independent practice of medicine, our promotion of our protocols through advertising and other means may be found to violate FDA regulations or the FDC Act |
| The FDA has broad discretion in interpreting those regulations |
| If the FDA determines that our promotion of our medical treatment protocols violates the FDC Act or brings an enforcement action against us for violating the FDC Act or FDA regulations that is successful, our promotion of our protocols will have to stop and we may be unable to continue operating under our current business model |
| Even if we defeat any FDA challenge, the expenses associated with defending the claim or negative publicity concerning the off-label use of drugs in our protocols could adversely affect our business and results of operation |
| Treatment using our protocols may be found to require review or approval, which could delay or prevent the study or use of our protocols The FDA asserts jurisdiction over many clinical trials, or experiments, in which a drug is administered to human subjects |
| Hospitals and clinics have established Institutional Review Boards, or IRBs, to review and approve clinical trials using investigational treatments in their facilities |
| Certain investigations involving new drugs or off-label uses for approved drugs must be the subject of an FDA investigational New Drug exemption (IND) |
| Use of our 27 _________________________________________________________________ [74]Table of Contents treatment protocol by individual physicians in treating their patients may be found to constitute a clinical trial or investigation that requires IRB review or an IND FDA has broad authority in interpreting and applying its regulations, so it may find that use of our protocols by our licensees or collection of outcomes data on that use constitutes a clinical investigation subject to IRB and FDA jurisdiction and may take enforcement action against us |
| Individual hospitals and physicians may also submit their use of our protocols in treatment to their IRBs and individual IRBs may find that use to be a clinical trial that requires FDA approval or they may prohibit or place restrictions on that use |
| Any of these results may adversely affect our business and the ability of our customers to use our protocols |
| Failure to comply with the Federal Trade Commission Act or similar state laws could result in sanctions or limit the claims we can make The company’s promotional activities and materials, including advertising to consumers and physicians, and materials provided to licensees for their use in promoting our protocols, are regulated by the Federal Trade Commission (FTC) under the FTC Act, which prohibits unfair and deceptive acts and practices, including claims which are false, misleading or inadequately substantiated |
| The FTC typically requires competent and reliable scientific tests or studies to substantiate express or implied claims that a product or service is effective |
| If the FTC were to interpret our promotional materials as making express or implied claims that our protocols are effective for the treatment of alcohol, cocaine or methamphetamine addiction, it may find that we do not have adequate substantiation for such claims |
| Failure to comply with the FTC Act or similar laws enforced by state attorneys general and other state and local officials could result in administrative or judicial orders limiting or eliminating the claims we can make about our protocols, and other sanctions including fines |
| Our business practices may be found to constitute illegal fee-splitting or corporate practice of medicine, which may lead to penalties and adversely affect our business Many states, including California in which our principal executive offices are located, have laws that prohibit business corporations, such as us, from practicing medicine, exercising control over medical judgments or decisions of physicians, or engaging in certain arrangements, such as employment or fee-splitting, with physicians |
| Courts, regulatory authorities or other parties, including physicians, may assert that we are engaged in the unlawful corporate practice of medicine by providing administrative and ancillary services in connection with our protocols, or that licensing our technology for a portion of the patient fees, or subleasing space and providing turn-key business management to affiliated medical groups in exchange for management and licensing fees, constitute improper fee-splitting, in which case we could be subject to civil and criminal penalties, our contracts could be found legally invalid and unenforceable, in whole or in part, or we could be required to restructure our contractual arrangements |
| There can be no assurance that this will not occur or, if it does, that we would be able to restructure our contractual arrangements on favorable terms |
| Our business practices may be found to violate anti-kickback, self-referral or false claims laws, which may lead to penalties and adversely affect our business The healthcare industry is subject to extensive federal and state regulation with respect to financial relationships and “kickbacks” involving healthcare providers, physician self-referral arrangements, filing of false claims and other fraud and abuse issues |
| Federal anti-kickback laws and regulations prohibit certain offers, payments or receipts of remuneration in return for (i) referring patients covered by Medicare, Medicaid or other federal health care program, or (ii) purchasing, leasing, ordering or arranging for or recommending any service, good, item or facility for which payment may be made by a federal health care program |
| In addition, federal physician self-referral legislation, commonly known as the Stark law, generally prohibits a physician from ordering certain services reimbursable by Medicare, Medicaid or other federal healthcare program from any entity with which the physician has a financial relationship |
| While providers who license our protocols currently do not seek such third party reimbursement for treatment using our protocols, we anticipate they may do so in the future |
| In addition, many states have similar laws, some of which are not limited to services reimbursed by federal healthcare programs |
| Other federal and state laws govern the submission of claims for reimbursement, or false claims laws |
| One of the most prominent of these laws is the federal False Claims Act, and violations of other laws, such as the anti-kickback laws or the FDA prohibitions against promotion of off-label uses of drugs, may also be prosecuted as violations of the False Claims Act |
| 28 _________________________________________________________________ [75]Table of Contents While we believe we have structured our relationships to comply with all applicable requirements, federal or state authorities may claim that our fee arrangements, agreements and relationships with contractors, hospitals and physicians violate these anti-kickback, self-referral or false claims laws and regulations |
| These laws are broadly worded and have been broadly interpreted by courts |
| It is often difficult to predict how these laws will be applied, and they potentially subject many typical business arrangements to government investigation and prosecution, which can be costly and time consuming |
| Violations of these laws are punishable by monetary fines, civil and criminal penalties, exclusion from participation in government-sponsored health care programs and forfeiture of amounts collected in violation of such laws |
| If our business practices are found to violate any of these provisions, we may be unable to continue with our relationships or implement our business plans, which would have an adverse effect on our business and results of operations |
| We may be subject to healthcare anti-fraud initiatives, which may lead to penalties and adversely affect our business State and federal governments are devoting increased attention and resources to anti-fraud initiatives against healthcare providers, taking an expansive definition of fraud that includes receiving fees in connection with a healthcare business that is found to violate any of the complex regulations described above |
| While to our knowledge we have not been the subject of any anti-fraud investigations, if such a claim were made defending our business practices could be time consuming and expensive, and an adverse finding could result in substantial penalties or require us to restructure our operations, which we may not be able to do successfully |
| Our use and disclosure of patient information is subject to privacy and security regulations, which may result in increased costs In conducting research or providing administrative services to healthcare providers in connection with the use of our protocols, we may collect, use, maintain and transmit patient information in ways that will be subject to many of the numerous state, federal and international laws and regulations governing the collection, dissemination, use and confidentiality of patient-identifiable health information, including the federal Health Insurance Portability and Accountability Act (HIPAA) and related rules |
| The three rules that were promulgated pursuant to HIPAA that could most significantly affect our business are the Standards for Electronic Transactions, or Transactions Rule; the Standards for Privacy of Individually Identifiable Health Information, or Privacy Rule; and the Health Insurance Reform: Security Standards, or Security Rule |
| HIPAA applies to covered entities, which include most healthcare facilities and health plans that will contract for the use of our protocols and our services |
| The HIPAA rules require covered entities to bind contractors like us to compliance with certain burdensome HIPAA rule requirements |
| Other federal and state laws restricting the use and protecting the privacy of patient information also apply to our licensees directly and to us, either directly or indirectly |
| The HIPAA Transactions Rule establishes format and data content standards for eight of the most common healthcare transactions |
| When we perform billing and collection services on behalf of our licensees we may be engaging in one of more of these standard transactions and will be required to conduct those transactions in compliance with the required standards |
| The HIPAA Privacy Rule restricts the use and disclosure of patient information, requires entities to safeguard that information and to provide certain rights to individuals with respect to that information |
| The HIPAA Security Rule establishes elaborate requirements for safeguarding patient information transmitted or stored electronically |
| We may be required to make costly system purchases and modifications to comply with the HIPAA rule requirements that are imposed on us and our failure to comply may result in liability and adversely affect our business |
| Federal and state consumer protection laws are being applied increasingly by the FTC and state attorneys general to regulate the collection, use and disclosure of personal or patient information, through web sites or otherwise, and to regulate the presentation of web site content |
| Courts may also adopt the standards for fair information practices promulgated by the FTC, which concern consumer notice, choice, security and access |
| Numerous other federal and state laws protect the confidentiality of personal and patient information |
| These laws in many cases are not preempted by the HIPAA rules and may be subject to varying interpretations by courts and government agencies, creating complex compliance issues for us and our licensees and potentially exposing us 29 _________________________________________________________________ [76]Table of Contents to additional expense, adverse publicity and liability |
| Other countries also have, or are developing, laws governing the collection, use and transmission of personal or patient information and these laws could create liability for us or increase our cost of doing business |
| We may not be able to profitably adapt to the changing healthcare and substance dependence treatment industry, which may reduce or eliminate our commercial opportunity Healthcare organizations, public and private, continue to change the manner in which they operate and pay for services |
| In recent years, the healthcare industry has been subject to increasing levels of government regulation of reimbursement rates and capital expenditures, among other things |
| We cannot predict the likelihood of all future changes in the healthcare industry in general, or the substance dependence treatment industry in particular, or what impact they may have on our earnings, financial condition or business |
| Risks Related to our Common Stock Our stock price may be subject to substantial volatility, and you may lose all or a substantial part of your investment Our common stock is traded on The Nasdaq National Market |
| Over the last year, it traded between dlra4dtta26 and dlra9dtta30 per share on limited and sporadic volume ranging from approximately 14cmam900 to 1cmam449cmam400 shares per day |
| As a result, the current price for our common stock on the Nasdaq is not necessarily a reliable indicator of our fair market value |
| The price at which our common stock will trade may be highly volatile and may fluctuate as a result of a number of factors, including the number of shares available for sale in the market, quarterly variations in our operating results, actual or anticipated announcements of new data, studies, products or services by us or competitors, regulatory investigations or determinations, acquisitions or strategic alliances by us or our competitors, recruitment or departures of key personnel, the gain or loss of significant customers, changes in the estimates of our operating performance, market conditions in our industry and the economy as a whole |
| Over one-third of our stock is controlled by a single stockholder who has the ability to substantially influence the election of directors and the outcome of matters submitted to stockholders As of December 31, 2005, Reserva Capital, LLC, a limited liability company whose sole managing member is Terren S Peizer, our chairman and chief executive officer, directly owned 13cmam700cmam000 shares, which represent approximately 35prca of our 39cmam504cmam330 shares of outstanding common stock |
| Peizer presently and is expected to continue to have the ability to substantially influence the election of our board of directors and the outcome of all other issues submitted to our stockholders |
| The interests of this stockholder may not always coincide with our interests or the interests of other stockholders, and it may act in a manner that advances its best interests and not necessarily those of other stockholders |
| One consequence to this substantial stockholder’s interest is that it may be difficult for investors to remove management of the company |
| It could also deter unsolicited takeovers, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices |
| Provisions in our certificate of incorporation, bylaws and Delaware law could discourage a change in control, and adversely affect existing stockholders Our certificate of incorporation and the Delaware General Corporation Law contain provisions that may have the effect of making more difficult or delaying attempts by others to obtain control of our company, even when these attempts may be in the best interests of stockholders |
| Our certificate of incorporation also authorizes our board of directors, without stockholder approval, to issue one or more series of preferred stock, which could have voting and conversion rights that adversely affect or dilute the voting power of the holders of common stock |
| Delaware law also imposes conditions on certain business combination transactions with “interested stockholders |
| ” These provisions and others that could be adopted in the future could deter unsolicited takeovers or delay or prevent changes in our control or management, including transactions in which stockholders might otherwise receive a premium for their shares over then current market prices |
| These provisions may also limit the ability of stockholders to approve transactions that they may deem to be in their best interests |
| 30 _________________________________________________________________ [77]Table of Contents We have never paid cash dividends and do not intend to do so We have never declared or paid cash dividends on our common stock |
| We currently plan to retain any earnings to finance the growth of our business rather than to pay cash dividends |
| Payments of any cash dividends in the future will depend on our financial condition, results of operations and capital requirements, as well as other factors deemed relevant by our board of directors |