##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
 FORM 10-Q [X]
    
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2004, OR[ ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM  TO.
 Commission File No.: 001-13457 OCA, INC.  Delaware
    
    72-1278948(State or other jurisdiction of
    
    (I.R.S. Employer Identification No.)incorporation or organization)
 3850 N. Causeway Boulevard, Suite 800
Metairie, Louisiana 70002
(504) 834-4392 (Address, including zip code, of principal executive offices and
Registrants telephone number, including area code) Orthodontic Centers of America, Inc. 
  Indicate by check mark whether the registrant: (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. YES [X] NO [ ] Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [X] NO [ ] At December 20, 2004
there were approximately 50,345,000 outstanding shares of
the Registrants Common Stock, $.01 par value per share.




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OCA, INC.
TABLE OF CONTENTS PagePART
I. FINANCIAL INFORMATION
    
    
    3ITEM
1. CONSOLIDATED FINANCIAL STATEMENTS
    
    
    3Condensed
Consolidated Balance Sheets  September 30, 2004
(Unaudited) and December 31, 2003
    
    
    3Condensed
Consolidated Statements of Income (Loss) and Comprehensive Income
(Loss)  Three and Nine Months Ended September 30, 2004 and
2003 (Unaudited)
    
    
    4Condensed
Consolidated Statements of Cash Flows  Three and Nine Months
Ended September 30, 2004 and 2003 (Unaudited)
    
    
    5Notes
to Condensed Consolidated Financial Statements 
September 30, 2004 (Unaudited)
    
    
    6ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
    
    
    19ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    42ITEM 4. CONTROLS AND PROCEDURES
    
    
    43PART II. OTHER INFORMATION
    
    
    44ITEM 1. LEGAL PROCEEDINGS
    
    
    44ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    
    
    45ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
    
    
    45EX-4.5  LEASE AGREEMENTEX-31.1  SECTION 302 CERTIFICATION OF THE CEOEX-31.2  SECTION 302 CERTIFICATION OF THE CFOEX-32.1  SECTION 906 CERTIFICATION OF THE CEOEX-32.2  SECTION 906 CERTIFICATION OF THE CFO
  FORWARD-LOOKING STATEMENTS Certain statements contained in this Report may not be based on historical
facts and are forward looking statements within the meaning of Section 27A of
the Securities Act of 1933, as amended, and Section 21E of the Securities
Exchange Act of 1934, as amended. These forward-looking statements may be
identified by reference to a future period(s) or by the use of forward looking
terminology, such as anticipate, estimate, believe, expect, foresee,
may, would, could or will. These forward-looking statements include,
without limitation, statements regarding the collection of patient receivables,
patient revenue, financial results attributable to base practices, critical
accounting policies, net operating loss carryforwards and income tax liability, effects of changes in accounting, amounts payable to affiliated
practices under incentive programs, liquidity, capital resources, cash needs,
use of the Companys services and payment of service fees by inactive
practices, buy-outs of Service Agreements, transitions of affiliated practices,
pending litigation, advancement of funds to affiliated practices,
recoverability of assets related to certain practices, updates to internal
controls and hiring additional personnel, results of internal controls testing,
preparation for and compliance with disclosure requirements under Section 404 of the Sarbanes-Oxley Act of
2002, repayment of outstanding indebtedness, future debt financing, capital expenditures and operating
losses for development of de novo centers, capital expenditures for remodeling
of existing centers, investment activities, OCA
OutSource, stock repurchases, deferred tax assets, future growth and operating
results. We caution you not to place undue reliance on these forward-looking
statements, in that they involve certain risks and uncertainties that could
cause actual results to differ materially from anticipated results. These risks
and uncertainties include potential adverse changes in the Companys financial
results and condition, disruption of the Companys relationships with its
affiliated practices or loss of a significant number of the Companys
affiliated practices, failure or delay in integrating OrthAlliances affiliated
practices, adverse outcomes of litigation pending against the Company and
OrthAlliance, competition, inability to effectively manage an increasing number
of affiliated practices, changes in the general economy of the United States
and the specific markets in which the Company operates, difficulties in
staffing and managing foreign offices, foreign currency exchange fluctuations
and other risks relating to international expansion and the Companys foreign
operations, changes in the Companys operating or expansion strategy, inability
of the Company to attract and retain qualified management, personnel and
affiliated practitioners, inability of the Company to effectively market its
services and those of its affiliated practices, changes in regulations
affecting the Companys business, and other factors identified in the Companys
Annual Report on Form 10-K for the year ended December 31, 2003, other filings
with the Securities and Exchange Commission or in other public announcements by
the Company. We undertake no obligation to update these forward-looking
statements to reflect events or circumstances that occur after the date of this
Report. 2




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##### Table of Contents



PART I. FINANCIAL INFORMATION 
 ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS OCA, Inc. 
 Condensed Consolidated Balance Sheets
(in thousands, except share amounts) (Unaudited)
 September 30,
    
    December 31,2004
    
    2003ASSETSCurrent assets:Cash and cash equivalents
    
    $
    10,701
    
    
    $
    7,391Patient receivables, net of allowance for uncollectible amounts of $8,289 at
September 30, 2004
    
    
    124,339
    
    
    
    Current portion of service fees receivable, net of allowance for uncollectible
amounts of $8,382 at December 31, 2003
    
    
    
    
    
    
    96,720Current portion of advances to practitioners, net of allowance for uncollectible
amounts of $0 at September 30, 2004 and $1,438 at December 31, 2003
    
    
    10,588
    
    
    
    16,544Deferred income taxes
    
    
    41,063
    
    
    
    43,346Supplies inventory
    
    
    11,018
    
    
    
    13,726Prepaid expenses and other assets
    
    
    1,260
    
    
    
    2,769Total current assets
    
    
    198,969
    
    
    
    180,496Financed practice-related expense portion of service fees receivable
    
    
    
    
    
    
    51,558Advances to affiliated practices, less current portion, net of allowance for
uncollectible amounts of $2,214 at December 31, 2003
    
    
    
    
    
    
    12,921Property, equipment and improvements, net
    
    
    94,402
    
    
    
    91,668Advances and other amounts due from OutSource Practices
    
    
    570
    
    
    
    Assets associated with inactive practices, net of allowance for uncollectible amounts
of $15,526 at September 30, 2004 and $2,249 at December 31, 2003
    
    
    30,237
    
    
    
    26,682Deferred tax assets, net
    
    
    17,101
    
    
    
    Goodwill and
identifiable intangible assets, net
    
    
    278,951
    
    
    
    288,804Other assets
    
    
    13,996
    
    
    
    13,547TOTAL ASSETS
    
    $
    634,226
    
    
    $
    665,676LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    5,702
    
    
    $
    8,985Accrued salaries and other accrued liabilities
    
    
    12,692
    
    
    
    13,977Service fee prepayments
    
    
    
    
    
    
    1,157Deferred revenue
    
    
    91,803
    
    
    
    Amounts payable to practitioners
    
    
    6,773
    
    
    
    5,373Current portion of notes payable to practitioners
    
    
    1,355
    
    
    
    2,122Current portion of long-term debt
    
    
    8,333
    
    
    
    8,333Total current liabilities
    
    
    126,658
    
    
    
    39,947Deferred income tax liability, net
    
    
    
    
    
    
    41,268Notes payable to practitioners, less current portion
    
    
    2,635
    
    
    
    4,050Long-term debt, less current portion
    
    
    81,473
    
    
    
    87,724Shareholders equity:Preferred stock, $.01 par value: 10,000,000 shares authorized; no shares outstanding
    
    
    
    
    
    
    Common stock, $.01 par value: 100,000,000 shares authorized; approximately
51,478,000 shares issued and outstanding at September 30, 2004 and 51,341,000 shares
issued and outstanding at December 31, 2003
    
    
    516
    
    
    
    513Additional paid-in capital
    
    
    219,033
    
    
    
    218,530Retained earnings
    
    
    221,303
    
    
    
    289,976Accumulated other comprehensive loss
    
    
    (1,179
    )
    
    
    (119
    )Less cost of approximately 1,256,000 shares of treasury stock at September 30, 2004
and December 31, 2003
    
    
    (16,213
    )
    
    
    (16,213
    )Total shareholders equity
    
    
    423,460
    
    
    
    492,687TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    634,226
    
    
    $
    665,676
 See accompanying notes to condensed consolidated financial statements. 3




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OCA, Inc.
 
 Condensed Consolidated Statements of Income (Loss) and Comprehensive Income (Loss)
(in thousands, except per share data) (Unaudited)
 Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003Patient revenue
    
    $
    103,958
    
    
    $
    
    
    
    $
    319,166
    
    
    $
    Service fees from OutSource Practices
    
    
    29
    
    
    
    
    
    
    
    35
    
    
    
    Fee revenue
    
    
    
    
    
    
    92,730
    
    
    
    
    
    
    
    293,583Total revenue
    
    
    103,987
    
    
    
    92,730
    
    
    
    319,201
    
    
    
    293,583Practice-related expenses:Amounts retained by practitioners
    
    
    29,738
    
    
    
    
    
    
    
    91,737
    
    
    
    Salaries and benefits
    
    
    22,873
    
    
    
    23,064
    
    
    
    69,261
    
    
    
    75,259Clinical supplies and lab fees
    
    
    9,157
    
    
    
    9,734
    
    
    
    27,748
    
    
    
    30,057Rent
    
    
    6,849
    
    
    
    6,953
    
    
    
    20,356
    
    
    
    25,310Marketing and advertising
    
    
    5,529
    
    
    
    5,500
    
    
    
    17,166
    
    
    
    18,919Other operating costs
    
    
    8,560
    
    
    
    9,168
    
    
    
    26,928
    
    
    
    27,278Total practice-related expenses
    
    
    82,706
    
    
    
    54,419
    
    
    
    253,196
    
    
    
    176,823General and administrative
    
    
    6,348
    
    
    
    10,861
    
    
    
    23,821
    
    
    
    27,104Depreciation
and amortization
    
    
    3,968
    
    
    
    6,380
    
    
    
    11,837
    
    
    
    18,588Loss (gain) on sale of assets, net
    
    
    1,704
    
    
    
    (12
    )
    
    
    3,251
    
    
    
    136Provision for assets associated with inactive practices
    
    
    13,540
    
    
    
    
    
    
    
    14,220
    
    
    
    Asset impairments
    
    
    
    
    
    
    767
    
    
    
    
    
    
    
    2,582Operating
income (loss)
    
    
    (4,279
    )
    
    
    20,315
    
    
    
    12,876
    
    
    
    68,350Other income (expense), net:Interest expense, net
    
    
    (1,277
    )
    
    
    (1,193
    )
    
    
    (3,524
    )
    
    
    (3,742
    )Non-controlling interest in subsidiary
    
    
    (15
    )
    
    
    4
    
    
    
    79
    
    
    
    (25
    )Income (loss) before income taxes and cumulative effect of change in
accounting principle
    
    
    (5,571
    )
    
    
    19,126
    
    
    
    9,431
    
    
    
    64,583Income taxes
    
    
    (2,033
    )
    
    
    7,221
    
    
    
    3,443
    
    
    
    24,381Income (loss) before cumulative effect of change in accounting principle
    
    
    (3,538
    )
    
    
    11,905
    
    
    
    5,988
    
    
    
    40,202Cumulative effect of change in accounting principle, net of income
tax benefit
    
    
    
    
    
    
    
    
    
    
    (74,661
    )
    
    
    Net income (loss)
    
    $
    (3,538
    )
    
    $
    11,905
    
    
    $
    (68,673
    )
    
    $
    40,202Net income (loss) per share:Basic before cumulative effect of change in accounting principle
    
    $
    (0.07
    )
    
    $
    0.24
    
    
    $
    0.12
    
    
    $
    0.80Cumulative effect of change in accounting principle, net of
income tax benefit
    
    
    
    
    
    
    
    
    
    
    (1.49
    )
    
    
    Basic
    
    $
    (0.07
    )
    
    $
    0.24
    
    
    $
    (1.37
    )
    
    $
    0.80Diluted before cumulative effect of change in accounting
principle
    
    $
    (0.07
    )
    
    $
    0.24
    
    
    $
    0.12
    
    
    $
    0.80Cumulative effect of change in accounting principle, net of
income tax benefit
    
    
    
    
    
    
    
    
    
    
    (1.49
    )
    
    
    Diluted
    
    $
    (0.07
    )
    
    $
    0.24
    
    
    $
    (1.37
    )
    
    $
    0.80Average shares outstanding:Basic
    
    
    50,145
    
    
    
    50,206
    
    
    
    50,102
    
    
    
    50,208Diluted
    
    
    50,145
    
    
    
    50,483
    
    
    
    50,102
    
    
    
    50,504Comprehensive income (loss):Net income (loss)
    
    $
    (3,538
    )
    
    $
    11,905
    
    
    $
    (68,673
    )
    
    $
    40,202Other comprehensive loss:Foreign currency translation adjustment
    
    
    (85
    )
    
    
    1,158
    
    
    
    (1,060
    )
    
    
    814Comprehensive income (loss)
    
    $
    (3,623
    )
    
    $
    13,063
    
    
    $
    (69,733
    )
    
    $
    41,016




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OCA, Inc. 
 Condensed Consolidated Statements of Cash Flows
(in thousands) (Unaudited
 Nine months endedSeptember 30,2004
    
    2003Operating activities:Net income (loss)
    
    $
    (68,673
    )
    
    $
    40,202Adjustments to reconcile net income (loss) to net cash provided by operating
activities:Cumulative effect of change in accounting principle, net of income tax benefit
    
    
    74,661
    
    
    
    Provision for bad debt expense
    
    
    426
    
    

    
    5,340Depreciation and amortization
    
    
    11,837
    
    
    
    18,588Provision for assets associated with inactive practices
    
    
    13,735
    
    
    
    Asset impairments
    
    
    
    
    
    
    2,582Loss on sale of assets, net
    
    
    3,251
    
    
    
    136Deferred income taxes
    
    
    1,674
    
    
    
    24,914Changes in operating assets and liabilities:Patient receivables
    
    
    (10,007
    )
    
    
    Service fees receivable
    
    
    
    
    
    
    (41,451
    )Deferred revenue
    
    
    2,743
    
    
    
    Service fee prepayments
    
    
    
    
    
    
    (6,740
    )Accounts payable and other current liabilities
    
    
    (5,582
    )
    
    
    (8,694
    )Advances to practitioners, net
    
    
    (4,614
    )
    
    
    (2,516
    )Amounts payable to practitioners
    
    
    1,400
    
    
    
    Prepaid expenses and other
    
    
    3,345
    
    
    
    2,271Supplies inventory
    
    
    1,981
    
    
    
    989Net cash provided by operating activities
    
    
    26,177
    
    
    
    35,621Investing activities:Purchases of property, equipment and improvements
    
    
    (16,187
    )
    
    
    (13,959
    )Proceeds from sale of assets
    
    
    2,458
    
    
    
    Notes receivable
    
    
    (410
    )
    
    
    (2,605
    )Other
    
    
    (1,429
    )
    
    
    (588
    )Net cash used in investing activities
    
    
    (15,568
    )
    
    
    (17,152
    )Financing activities:Repayment of notes payable to practitioners
    
    
    (1,509
    )
    
    
    (4,823
    )Repayment of long-term debt
    
    
    (6,251
    )
    
    
    (121,432
    )Proceeds from long-term debt
    
    
    
    
    
    
    109,900Purchase of treasury stock
    
    
    
    
    
    
    (773
    )Issuance of common stock
    
    
    506
    
    
    
    691Net cash used in financing activities
    
    
    (7,254
    )
    
    
    (16,437
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    (45
    )
    
    
    814Change in cash and cash equivalents
    
    
    3,310
    
    
    
    2,846Cash and cash equivalents at beginning of period
    
    
    7,391
    
    
    
    7,522Cash and cash equivalents at end of period
    
    $
    10,701
    
    
    $
    10,368Supplemental cash flow information:Cash paid during period for:Interest
    
    $
    3,835
    
    
    $
    3,688Income taxes
    
    $
    1,853
    
    
    $
    392Supplemental disclosures of non-cash investing and financing activities:Notes payable and common stock issued to obtain Service Agreements
    
    $
    
    
    
    $
    544
 See accompanying notes to condensed consolidated financial statements. 5




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OCA, Inc. 
 Notes to Condensed Consolidated Financial Statements (Unaudited) September 30, 2004 1. DESCRIPTION OF BUSINESS OCA, Inc. and its subsidiaries (OCA) provide purchasing, financial,
marketing, administrative and other business services to orthodontic, pediatric
and general dental practices operated by licensed practitioners and/or their
wholly-owned professional entities (Affiliated Practices) in 43 states and
five foreign markets. OCA changed its name from Orthodontic Centers of
America, Inc. in August 2004. References to the Company are to OCA and the
Affiliated Practices required to be consolidated pursuant to FIN 46R (as
defined below), unless the context otherwise requires. OCA does not hold any
ownership interest in the Affiliated Practices and does not employ the licensed
practitioners in the Affiliated Practices. OCA does not practice orthodontics
or other forms of dentistry, and is prohibited from doing so by the laws of
each jurisdiction in which it operates. OCA generally provides business services to Affiliated Practices under
long-term service, consulting and management service agreements (Service
Agreements), through which OCA obtained the exclusive right to provide
business services to the Affiliated Practices. OCA has affiliated with existing
orthodontic or pediatric dental practices by entering into Service Agreements
and acquiring substantially all of the non-professional assets of the
practices. The Service Agreements generally provide that the practitioner
and/or professional entity is responsible for providing orthodontic or
pediatric dental services and for employing all orthodontists or pediatric
dentists. The terms of the Service Agreements range from 20 to 40 years, with
most ranging from 20 to 25 years. In many cases, the practitioner has the
option to terminate the Service Agreement after a certain number of years
(typically seven) as prescribed in the Service Agreement. If the practitioner
terminates his or her affiliation with OCA, he or she generally is required to
pay OCA for the tangible and intangible assets associated with the practice at
their current book value or sell his or her interest in the practice to another
licensed practitioner who signs a similar agreement with OCA. Beginning in 2004, OCA began providing business services through its new
division, OCA OutSource. OCA OutSource is initially focusing on general dental
practices, and intends to expand to provide business services to other dental
specialties and medical practices as well. OCA OutSource provides business
services to its Affiliated Practices (OutSource Practices) under relatively
short-term agreements (OutSource Agreements), with terms as short as two
years. Unlike OCAs traditional affiliations, OCA OutSource does not acquire
the assets of an Affiliated Practice upon entering into an OutSource Agreement.
The services provided by OCA OutSource otherwise are similar to those provided
under OCAs traditional affiliations, tailored to the particular needs of the
practices dental or medical specialty. The Companys experience has been that
OCA OutSource generally enables practitioners to focus on quality care, while
increasing their profitability and providing better information about the
financial performance of their practice. OCA OutSource intends to continue to
market its services to general and pediatric dentists at association
meetings, through direct mail and through open houses at OCAs corporate
headquarters in Metairie, Louisiana. OCA OutSource also intends to begin
marketing its services to medical practices during 2005. The following table provides information about OCAs Affiliated Practices
(including OutSource Practices) as of the dates indicated. These amounts
exclude Inactive Practices, which are practices that were parties to Service
Agreements but were engaged in litigation with OCA or its subsidiary,
OrthAlliance, Inc., and/or had ceased paying service fees to OCA or
OrthAlliance as of September 30, 2004 or as of
September 30, 2003, respectively. 6




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Number of Affiliated PracticesAs of September 30, 2004
    
    As of September 30, 2003Pediatric andLocation
    
    Orthodontic
    
    General Dental
    
    Total
    
    Orthodontic
    
    Pediatric Dental
    
    TotalUnited States
    
    
    246
    
    
    
    14
    
    
    
    260
    
    
    
    270
    
    
    
    21
    
    
    
    291Japan
    
    
    25
    
    
    
    
    
    
    
    25
    
    
    
    26
    
    
    
    
    
    
    
    26Mexico
    
    
    9
    
    
    
    
    
    
    
    9
    
    
    
    4
    
    
    
    
    
    
    
    4Puerto Rico
    
    
    2
    
    
    
    1
    
    
    
    3
    
    
    
    3
    
    
    
    
    
    
    
    3Spain
    
    
    3
    
    
    
    
    
    
    
    3
    
    
    
    3
    
    
    
    
    
    
    
    3Total
    
    
    285
    
    
    
    15
    
    
    
    300
    
    
    
    306
    
    
    
    21
    
    
    
    327
 2. BASIS OF PRESENTATION The accompanying unaudited consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. The preparation of
these financial statements requires management to make estimates and
assumptions that affect the amounts reported in the financial statements and
accompanying notes. The year-end condensed consolidated balance sheet was
derived from the audited financial statements, but does not include all of the
information and footnotes required by generally accepted accounting principles
in the United States for financial statements. In the opinion of management,
all normal and recurring adjustments, except for the adjustments resulting from
the adoption of FIN 46R (as defined below), considered necessary for a fair
presentation have been included. While all available information has been
considered, actual amounts could differ from those estimates. Operating results
for the three- and nine-month periods ended September 30, 2004 are not
necessarily indicative of the results that may be expected for the year ending
December 31, 2004. For further information, refer to the consolidated financial
statements and footnotes thereto included in OCAs Annual Report on Form 10-K
for the year ended December 31, 2003. Reclassifications Certain
reclassifications have been made to prior period asset and expense
categories in order to
conform the prior period presentation to the current period
presentation. This presentation primarily relates to the
reclassification of Assets associated with inactive practices (Note 5) and to
the reclassification of corporate expenses to General and Administrative and
all expenses directly associated with the operation of the practices in
practice-related expenses to their respective line items within
Practice-related expenses in the Companys condensed consolidated statements
of income (loss). The reclassifications had no impact on previously reported
shareholders equity, operating income or net income. Adoption of New Accounting Standard Effective January 1, 2004, OCA adopted, as required, the provisions of
Financial Accounting Standards Board (FASB) Interpretation No. 46R,
Consolidation of Variable Interest Entities  an Interpretation of ARB No. 51
(FIN 46R). FIN 46R was issued by the FASB on December 24, 2003 and replaced
Interpretation No. 46, which was issued in January 2003. FIN 46R requires the
consolidation of a variable interest entity (VIE), as defined in FIN 46R,
when an enterprise absorbs a majority of the VIEs expected losses, receives a
majority of the VIEs expected residual returns, or both, as a result of
ownership, contractual or other financial interests in the VIE. OCA evaluated its contractual and economic relationships with its
Affiliated Practices in light of FIN 46R, and concluded that the Affiliated
Practices (other than Inactive Practices and OutSource Practices) are VIEs for
purposes of FIN 46R. OCA also concluded that it is the primary beneficiary of
these Affiliated Practices for purposes of FIN 46R, in that OCA absorbs a
majority of the VIEs expected losses, receives a majority of the VIEs
expected residual returns, or both, as a result of contractual or 7




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other financial interests in the Affiliated Practices. Accordingly,
effective January 1, 2004, OCA is consolidating the assets, liabilities, equity
and financial results of the Affiliated Practices (other than Inactive
Practices and OutSource Practices) in the Companys consolidated financial
statements. OCA was not required to consolidate the Affiliated Practices for
financial reporting purposes prior to January 1, 2004, in accordance with
Emerging Issues Task Force (EITF) Issue No. 97-2. Under
FIN 46R, the Company is required to reevaluate whether it
continues to be the primary beneficiary of the Affiliated Practices
that it consolidates for financial reporting purposes in the event
that certain events occur. During 2004, certain practices that were
consolidated by the Company pursuant to FIN 46R ceased paying
service fees to OCA or OrthAlliance, initiated litigation against OCA
or OrthAlliance and/or alleged a breach by OCA or OrthAlliance of
their Service Agreement and gave notice of their intentions to
terminate the Service Agreement. (See Note 5). The Company
believes that these events required the Company to reconsider whether
it is the primary beneficiary of these practices under FIN 46R.
The Company determined that, under these circumstances, it was no
longer the primary beneficiary of these practices and ceased to
consolidate these practices. The Companys adoption of FIN 46R and consolidation of the Affiliated
Practices for financial reporting purposes does not change the legal and
contractual relationships between OCA and the Affiliated Practices. OCA does
not hold any ownership interest in the Affiliated Practices and does not employ
the orthodontists or other practitioners in the Affiliated Practices. The
patients who are parties to patient contracts with Affiliated Practices are the
patients of the Affiliated Practices, not patients of OCA. OCA does not
practice orthodontics or other forms of dentistry, and is prohibited from doing
so by the laws of each jurisdiction in which the Company operates. The Companys consolidation of Affiliated Practices for financial
reporting purposes effective January 1, 2004 has resulted in significant
changes to the Companys accounting policies and financial reporting. The
Company now presents patient revenues and patient receivables associated with
the activities of its Affiliated Practices in its consolidated financial
statements. The Companys revenue recognition policy now is reflective of the
services performed by the Affiliated Practices for their patients
rather than of the
services performed by OCA on behalf of and for the Affiliated Practices.
Service fees and service fees receivable now are eliminated upon consolidation
of the Affiliated Practices. In addition, the Company now presents as
practice-related expenses in its consolidated statements of income (loss) the
amounts retained by practitioners under its Service Agreements. The Company has
also changed its accounting for excess distributions to Affiliated Practices
that are consolidated under FIN 46R, as well as its accounting for identifiable
intangible assets and goodwill. The Companys new accounting policies effective
January 1, 2004 are summarized below following the analysis of the impact of
FIN 46R. 8




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The
table below presents the impact to the Companys condensed
consolidated balance sheet at January 1, 2004, including elimination of
intercompany transactions, as a result of the Companys adoption of FIN 46R (in
thousands): At January 1, 2004OCA
    
    Impact ofBalance Sheet
    
    Adopting FIN 46R
    
    ConsolidatedCash and cash equivalents
    
    $
    7,391
    
    
    $
    
    
    
    $
    7,391Patient receivables, net
    
    
    
    
    
    
    117,942
    (a)
    
    
    117,942Current portion of service fees receivable, net
    
    
    96,720
    
    
    
    (96,720
    ) (a)
    
    
    Current portion of advances to practitioners, net
    
    
    16,544
    
    
    
    (7,526
    ) (b)
    
    
    9,018Other current assets
    
    
    62,051
    
    
    
    
    
    
    
    62,051Total current assets
    
    
    182,706
    
    
    
    13,696
    
    
    
    196,402Financed practice-related expense portion of service
fees receivable
    
    
    51,558
    
    
    
    (51,558
    ) (a)
    
    
    Advances to practitioners, less current portion, net
    
    
    12,921
    
    
    
    (12,921
    ) (b)
    
    
    Assets associated with inactive practices
    
    
    26,682
    
    
    
    4,624
    
    
    
    31,306Deferred income taxes
    
    
    
    
    
    
    41,420
    
    
    
    41,420Property, equipment and improvements, net
    
    
    89,458
    
    
    
    
    
    
    
    89,458Identifiable intangible assets, net
    
    
    201,163
    
    
    
    (201,163
    ) (c)
    
    
    Goodwill
    
    
    87,641
    
    
    
    202,804
    (c)
    
    
    290,445Other assets
    
    
    13,547
    
    
    
    
    
    
    
    13,547Total assets
    
    $
    665,676
    
    
    $
    (3,098
    )
    
    $
    662,578Accounts payable
    
    $
    8,985
    
    
    $
    
    
    
    $
    8,985Accrued salaries and other current liabilities
    
    
    13,977
    
    
    
    
    
    
    
    13,977Amounts payable to practitioners
    
    
    5,373
    
    
    
    
    
    
    
    5,373Service fee prepayments
    
    
    1,157
    
    
    
    (1,157
    ) (d)
    
    
    Deferred revenue
    
    
    
    
    
    
    89,060
    (d)
    
    
    89,060Current portion of debt and notes payable
    
    
    10,455
    
    
    
    
    
    
    
    10,455Total current liabilities
    
    
    39,947
    
    
    
    87,903
    
    
    
    127,850Deferred income tax liability
    
    
    41,268
    
    
    
    (16,340
    )
    
    
    24,928Notes payable to practitioners, less current
    
    
    4,050
    
    
    
    
    
    
    
    4,050Long-term debt
    
    
    87,724
    
    
    
    
    
    
    
    87,724Shareholders equity
    
    
    492,687
    
    
    
    (74,661
    ) (e)
    
    
    418,026Total liabilities and shareholders equity
    
    $
    665,676
    
    
    $
    (3,098
    )
    
    $
    662,578
 The following discusses the more significant adjustments to certain line
items of the Companys condensed balance sheet as a result of adopting FIN 46R
effective January 1, 2004: (a) Patient Receivables and Service Fees Receivable. Effective January 1,
2004, the Company records patient receivables of Affiliated Practices in its
consolidated balance sheets. Patient receivables represent amounts owed to
Affiliated Practices by their patients or by third-party payors, as calculated
under the Companys revenue recognition policy (as discussed
below). Patient receivables reflects amounts yet to be received after being recognized as patient revenue.
These receivables are expected to be collected within 12 months. Because the
Company now consolidates Affiliated Practices, the Company no longer records
service fees receivable in its consolidated balance sheets, including the
current and financed practice-related expense portion of service fees
receivable. (b) Advances to Affiliated Practices and Amounts Payable to Affiliated
Practices. Effective January 1, 2004, the Company does not record in its
consolidated balance sheets cash advances to Affiliated Practices against
future distributions. Because the Company now consolidates Affiliated
Practices, at January 1, 2004, the Company made the following adjustments with
respect to advances to Affiliated Practices: (A) eliminated advances to
Affiliated Practices that related to cash advances to Affiliated Practices
against future distributions, (B) reclassified advances related to amounts due
under 9




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Service Agreements with Inactive Practices to assets associated with
inactive practices, and (C) eliminated advances to Affiliated Practices related
to amounts due under Service Agreements. The Company will continue to record
receivables and payables related to short-term differences between amounts
distributed as monthly or biweekly draws to practitioners and the amounts that
the practitioners are entitled to retain under their Service Agreements, until
those amounts are reconciled. (c) Goodwill and Identifiable Intangibles. Pursuant to the consolidation
provisions of FIN 46R, effective January 1, 2004, the Company accounts for
affiliations with practices as business combinations and therefore was required
to reclassify certain identifiable intangible assets related to Service Agreements with
Affiliated Practices as goodwill. Prior to the adoption of FIN 46R,
the Company recorded these amounts as identifiable intangible assets and amortized these
assets. In addition, the Company determined that Affiliated Practices
are its reporting units for purposes of Statement of Financial
Accounting Standards (SFAS) No. 142, Goodwill
and Other Intangible Assets. Therefore, the Company now allocates
goodwill, including goodwill associated with the OrthAlliance merger,
to its practice-level reporting units based on managements
estimate of the fair values of the reporting units. Also, as of January 1, 2004, the Company reclassified identifiable
intangible assets related to Inactive Practices into Assets associated with
inactive practices, because the Company does not consolidate these practices.
(See Note 5.) Goodwill and the identifiable intangible assets are not amortized
but are tested for impairment under provisions of SFAS No. 142 by assessing the carrying amount of
goodwill at the practice reporting unit level. (d) Deferred Revenue and Service Fee Prepayments. Effective January 1,
2004, the Company records deferred revenue in its condensed consolidated
balance sheets. Deferred revenue represents amounts which Affiliated Practices
receive from their patients or third party payors prior to the recognition of
the related patient revenue, as calculated under the Companys revenue
recognition policy. The Company no longer records related service fee
prepayments in its condensed consolidated balance sheets. (e) Cumulative Effect of Change in Accounting Principle. As a result of
adopting FIN 46R, the Company recorded a cumulative effect charge of $74.7
million, net of income tax benefit of $41.4 million, during the first quarter
of 2004. The charge was primarily due to the change in the Companys revenue
recognition policy, the reclassification of certain advances to Affiliated
Practices as amounts retained by practitioners (as described above) and
the reversal of previously-recorded amortization of identifiable intangible assets. Summary of Significant Accounting Policies For a summary of the Companys significant accounting policies, see OCAs
Annual Report on Form 10-K for the year ended December 31, 2003. New accounting
policies resulting from the adoption of FIN 46R are outlined below. Principles of Consolidation The accompanying condensed consolidated financial statements include the
accounts of OCA, Inc. and its subsidiaries and other entities required to be
consolidated pursuant to FIN 46R. Patient revenue is presented in the
accompanying condensed consolidated statements of income (loss) because the
Company consolidates the assets, liabilities, equity and financial results of
Affiliated Practices (other than Inactive Practices and OutSource Practices)
for financial reporting purposes. All significant intercompany accounts and
transactions, including service fees, have been eliminated in consolidation. 10




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Revenue Recognition The Company generally recognizes patient revenues related to services
provided to patients on a straight-line basis over the term of treatment (which
typically averages about 23 months). Revenues related to retainers (teeth
retention appliances) are recognized in the final month of treatment when
braces are removed and retainers are provided to the patients, in accordance
with EITF No. 00-21, Accounting for Revenue Arrangements with Multiple
Deliverables. The Company charges OutSource Practices a monthly service fee based on a
percentage of the practices cash collections or a fixed monthly service fee.
These amounts are recorded as revenue when earned. Amounts Retained by Practitioners Amounts retained by practitioners represents amounts retained in
accordance with contractual terms of the Service Agreements. Amounts retained
by practitioners includes cash advances provided to practitioners to fund
certain practice-related matters or to provide practices with unsecured
financing which will be repaid from future distributions and which are
reflected as an expense in the period such amounts are advanced. Amounts
retained by practitioners are reduced by repayments in the period in which
repaid. On a monthly or biweekly basis, the Company generally distributes cash
draws to practitioners that are intended to approximate calculated amounts
retained by the practitioners under their Service Agreements. At the end of
each quarter, the Company calculates the actual amounts which the practitioners are entitled to
retain in accordance with the Service Agreements. The Company then records a
receivable or payable, as applicable, for any overpayment or underpayment. To
the extent amounts are payable to the Company, the Company generally reduces
the next monthly or biweekly draw to the practitioners. Patient Receivables Effective January 1, 2004, patient receivables represent amounts owed to
Affiliated Practices by their patients or by third-party payors, as calculated
under the Companys revenue recognition policy. The Company provides an
allowance for uncollectible amounts based upon a percentage estimate of patient
receivables that may not be collected by Affiliated Practices. The allowance
percentage is based on the Companys historical experience in collecting
patient receivables on behalf of the Affiliated Practices and the Companys
write-off experience. Advances and Other Amounts Due from OutSource Practices Advances and other amounts due from OutSource Practices represent advances
relating to amounts due to OCA from OutSource Practices under OutSource
Agreements. These amounts primarily represent funds that OCA has paid to third
party vendors on behalf of OutSource Practices for capital expenditures and
expenses associated with the operations of the OutSource Practices. Deferred Revenue Deferred revenue represents down payments, prepayments and other cash
received under patient contracts prior to the related services being provided
by Affiliated Practices. The Company defers recognition of such amounts until
they are recognized under the Companys revenue recognition policy. 11




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Goodwill and Identifiable Intangibles Pursuant
to the consolidation provisions of FIN 46R, effective January 1,
2004, the Company generally accounts for affiliations with Affiliated Practices (other
than Inactive Practices and OutSource Practices) as business combinations and
has reclassified identifiable intangible assets as goodwill. Prior to the
adoption of FIN 46R, the Company amortized the identifiable intangible assets
over the lesser of the expected life of the Service Agreement or
25 years. In addition, the Company determined that Affiliated
Practices are its reporting units and, therefore, the Company now
allocates goodwill, including goodwill associated with the
OrthAlliance merger, to its practice-level reporting units based on
managements estimate of the fair values of the reporting units.
The Company now tests goodwill in accordance with SFAS
No. 142 by assessing the carrying amount of goodwill at the
practice reporting unit level. Assets Associated with Inactive Practices Assets
associated with inactive practices consist of goodwill and identifiable
intangible assets property, equipment, improvements, inventory, service fees
receivable and advances associated with practices that were parties to Service Agreements
but which were engaged in litigation with OCA or its subsidiary, OrthAlliance, Inc.
(OrthAlliance), and/or which had ceased paying service fees to OCA or OrthAlliance
as of September 30, 2004. The Company assesses the recoverability of these
assets on a quarterly basis based on, among other things, the status
and results of pending litigation, recent settlements and buyouts, the lack of financial information
about these
practices, the uncertainty of these practices fulfilling their contractual
obligations to OCA and the estimated amounts expected to be received from these
practices in a buyout, settlement or under the terms of their Service Agreements. The Company estimates
the amounts to be received from these practices using historical data,
such as the Companys experience in resolving these situations
and the particular practitioners willingness to
resolve the matter. Rent Expense Facilities for OCAs Affiliated Practices and administrative offices are
generally rented under long-term leases accounted for as operating leases.
These leases are not uniform and include varying provisions, including
scheduled rent increases. Rent expense is recorded on a straight-line basis
over the term of the original lease plus renewal terms. New Accounting
Pronouncement In
December 2003, the FASB issued revised SFAS No. 132,
Employers Disclosures about Pensions and Other Postretirement
Benefits an amendment of FASB Statements
No. 87, 88, and 106. This statement revises
employers disclosures about pension plans and other
postretirement benefit plans. It does not change the measurement or
recognition of those plans required by SFAS No. 87,
Employers Accounting for Pensions, SFAS
No. 88, Employers Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for Termination
Benefits and SFAS No. 106, Employers Accounting for
Postretirement Benefits Other Than Pensions. Except as noted,
this statement was effective for financial statements with fiscal
years ending after December 15, 2003. The adoption of revised
SFAS No. 132 on January 1, 2004 had no impact on the
Companys financial condition or results of operations. On December 16, 2004, the FASB issued SFAS No. 123R, Share-Based Payment, which requires that all
forms of share-based payments to employees, including employee stock options and employee stock
purchase plans, be treated the same as other forms of compensation by recognizing the related cost
in the income statement. This statement would replace the existing requirements under SFAS No. 123
and APB No. 25. This statement would also eliminate the ability to account for stock-based
compensation transactions using the intrinsic value method of APB No. 25 and generally would
require that such transactions be accounted for using a fair-value option pricing model, either a
binomial model or the Black-Scholes valuation model. The statement would apply
to awards that are granted, modified or settled in cash in interim or annual periods
beginning after June 15, 2005. The Company is currently
analyzing the impact that adoption of the
statement will have on its financial position and results of operations. 12




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3. PROPERTY, EQUIPMENT AND IMPROVEMENTS Property, equipment and improvements, net, consisted of the following as
of the dates indicated: September 30,
    
    December 31,2004
    
    2003(in thousands)Leasehold improvements
    
    $
    84,205
    
    
    $
    77,874Furniture, fixtures and equipment
    
    
    64,222
    
    
    
    62,286Computer equipment
    
    
    7,980
    
    
    
    6,426156,407
    
    
    
    146,586Less accumulated depreciation and amortization
    
    
    62,005
    
    
    
    54,918Property, equipment and improvements, net
    
    $
    94,402
    
    
    $
    91,668
 Property, equipment and improvements are recorded at cost. All repair and
maintenance expenses are recognized and expensed as incurred. Depreciation
expense is provided using the straight-line method over the estimated useful
lives of the assets, which range from five to 10 years. Leasehold improvements
are amortized over the term of the original lease plus renewal terms, which
generally range from five to 15 years. Depreciation expense on property, equipment and improvements was $4.0
million and $11.6 million for the three and nine months ended September 30,
2004, respectively, compared to $3.8 million and $10.8 million for the three
and nine months ended September 30, 2003, respectively. 4. IDENTIFIABLE INTANGIBLE ASSETS AND GOODWILL The consolidation
 provisions under FIN 46R generally requires that the Company treat
affiliations with Affiliated Practices (other than Inactive Practices and
OutSource Practices) as business combinations for financial reporting purposes
from commencement of the affiliation. As a result, upon adoption of FIN 46R,
the Company reclassified certain identifiable intangible assets associated with
Affiliated Practices to goodwill. In addition, the Company determined that Affiliated
Practices are its reporting units and, therefore, the Company now
allocates goodwill, including goodwill associated with the
OrthAlliance merger, to its practice-level reporting units based on
managements estimate of the fair values of the reporting units. SFAS
No. 142 requires that goodwill and
intangible assets with indefinite lives, including such assets recorded in past
business combinations, not be amortized, but instead be tested for impairment
by measuring the reporting unit at fair value. SFAS No. 142 requires that the
impairment test be performed at least annually with interim testing
required if circumstances warrant. See
Note 5 for discussion on the provision the Company recorded
related to its review of assets associated with inactive practices. As of December 31, 2003, the Companys goodwill related solely to the
OrthAlliance merger. 13




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5. INACTIVE PRACTICES At September 30, 2004 and December 31, 2003, the Company recorded the
following assets in its condensed consolidated balance sheets related to
Inactive Practices (in thousands): September 30, 2004
    
    December 31, 2003Service fees receivable, net
    
    $
    3,283
    
    
    $
    3,535Patient receivables
    
    
    1,510
    
    
    
    Advances to inactive practices
    
    
    10,237
    
    
    
    6,536Notes receivable
    
    
    
    
    
    
    199Inventory
    
    
    731
    
    
    
    Property, equipment and improvements, net
    
    
    3,206
    
    
    
    2,699Goodwill and identifiable intangible assets, net
    
    
    26,796
    
    
    
    15,96245,763
    
    
    
    28,931Less allowance for assets associated with
inactive practices
    
    
    (15,526
    )
    
    
    (2,249
    )Total
    
    $
    30,237
    
    
    $
    26,682
 At September 30, 2004 and December 31, 2003, there were 112 and 100
Inactive Practices, respectively. The Company had generally ceased to record
patient revenue and fee revenue with respect to all of these Inactive Practices
as of the respective dates. OCA has commenced litigation and/or taken other
actions to recover the amounts due to OCA from these practices. At September 30, 2004, the Company provided an
allowance of $15.5 million
for potential impairment of assets associated with inactive practices.
At December 31, 2003, the allowance for these assets was $2.2 million. During the three
months ended September 30, 2004, the Company performed an
assessment of the recoverability of its assets associated with inactive
practices. The Company increased the allowance due in part to certain
recent settlement payments to OCA and a recent court award to OCA
that were significantly less
than the net book value of the goodwill, identifiable intangibles and other
assets associated with the relevant Inactive Practices. The increase also reflected the
Companys renewed efforts to attempt to resolve pending
litigation on mutually agreeable settlement terms. The Company has
resolved disputes with some other Inactive Practices by
permitting the practices to buy out of their Service Agreements for
amounts in excess of the net book value of the assets associated with
those practices. The
Company performs this assessment on a practice-by-practice basis to determine
whether the Companys carrying value of assets and relative fair
value of goodwill associated with a particular
Inactive Practice exceeds the estimated amounts to be recovered from that
practice. In performing this assessment, the Company is required to make
significant judgments and estimates, including the outcome of
litigation, settlements and buyouts and
amounts expected to be received from these Inactive Practices, among other
factors. Providing an allowance for assets associated with inactive practices
does not reflect a belief by management that Inactive Practices will ultimately
prevail in litigation pending between the practices and OCA or its subsidiary,
OrthAlliance, that the Inactive Practices claims and allegations in these
lawsuits have merit or that the Service Agreements with Inactive Practices are
not binding. OCA believes that generally it will receive payment from these
practices by either litigation settlement or permitting such practices to buy
out of their Service Agreements. However, adverse changes in litigation pending
between Inactive Practices and OCA or OrthAlliance could significantly affect
the recoverability of these assets and may result in additional
provisions related to these assets in the future. 6. DEBT The Company has a $125.0 million credit facility comprised of a $100.0
million revolving line of credit and a $25.0 million term loan. At September
30, 2004, approximately $79.6 million was outstanding under the revolving line
of credit and $10.2 million under the term loan. The credit facility requires
the Company to maintain certain financial and nonfinancial covenants under the
terms of the agreement, including a maximum leverage ratio, minimum fixed
charge coverage ratio, minimum 14




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consolidated net worth and maximum funded debt to total patient contract
balances. The credit facility also contains positive and negative covenants
that restrict certain activities of the Company, including limitations on the
payment of cash dividends, repurchases of OCA common stock, acquisitions,
investments, incurrence of other indebtedness and other transactions that may
affect the Companys liquidity. If the Company were to experience an event or
matter that has, or is reasonably likely to have, a material adverse
effect or an event of default (each as defined in the credit facility), then the Company would be
unable to borrow additional amounts under the credit facility without a waiver
by its lenders or an amendment to the credit facility. The Company cannot
assure you that it would be able to obtain such a waiver or amendment, which
could have a material adverse impact on the Companys liquidity and capital
resources. 7. STOCK COMPENSATION ARRANGEMENTS As permitted by SFAS No. 123, Accounting for Stock-Based Compensation,
the Company accounts for its stock compensation arrangements with employees
under the intrinsic value method prescribed by Accounting Principles Board
Opinion No. 25, Accounting for Stock Issued to Employees, and related
interpretations. No stock-based employee compensation cost is reflected in net
income, as all options granted under these plans have an exercise price equal
to the market value of the underlying common stock on the date of grant. The
Company accounts for stock options granted to non-employees, primarily
affiliated orthodontists, at fair value determined according to SFAS No. 123.
The Company accounts for the incentive programs implemented in connection with
the OrthAlliance merger in accordance with EITF Issue No. 96-18 and Issue No.
00-18. The Company accounts for its restricted stock purchase program for
affiliated orthodontists in accordance with EITF Issue
No. 00-19. Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(in thousands, except per share data)Net income (loss)
    
    $
    (3,538
    )
    
    $
    11,905
    
    
    $
    (68,673
    )
    
    $
    40,202Less: stock-based
employee compensation
expense determined
under fair value based
method for all awards,
net of related tax
effect
    
    
    129
    
    
    
    147
    
    
    
    412
    
    
    
    444Pro forma net income
(loss)
    
    $
    (3,667
    )
    
    $
    11,758
    
    
    $
    (69,085
    )
    
    $
    39,758Net income
(loss) per share:Basic, as reported
    
    $
    (0.07
    )
    
    $
    0.24
    
    
    $
    (1.37
    )
    
    $
    0.80Basic, pro forma
    
    
    (0.07
    )
    
    
    0.23
    
    
    
    (1.38
    )
    
    
    0.79Diluted, as reported
    
    
    (0.07
    )
    
    
    0.24
    
    
    
    (1.37
    )
    
    
    0.80Diluted, pro forma
    
    
    (0.07
    )
    
    
    0.23
    
    
    
    (1.38
    )
    
    
    0.79
 8. INCOME TAXES The Company has deferred tax assets primarily relating to net operating
loss carryforwards and the future tax benefit of the cumulative effect from the
adoption of FIN 46R. The net operating loss carryforwards primarily relate to
the cumulative effect of (A) a change in accounting method for recognizing
revenue for income tax purposes previously approved by the Internal Revenue
Service (IRS) and (B) a change in accounting method related to applicable
class lives for certain long-lived assets.
At September 30, 2004, the Company reduced the deferred tax assets by
the Companys income taxes for the first three quarterly
estimated tax installments for 2004, resulting in no current tax
liability recorded by the Company. The Company expects that the
remaining net operating loss carryforwards will offset the Companys income tax
liability in 2004. If the net operating loss carryforwards are not used, they
will expire between 2017 and 2023. 15




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9. SEGMENT INFORMATION OCA provides purchasing, financial, marketing, administrative and other business services under Service Agreements to Affiliated Practices operated by orthodontists, pediatric dentists and general dentists and/or their wholly-owned professional entities. OCAs reportable segments as of September 30, 2004 are U.S. and All
Other, which includes OCAs foreign subsidiaries. All costs
associated with OCAs corporate headquarters have been allocated to
U.S. The financial measures by which the Company evaluates segment performance and allocates
resources is based on operating income (loss) of the segments. The
Companys primary measures of profit by which it formulates
decisions and communicates to investors and analysts are net income
(loss) and net income (loss) per share. The accounting policies of the reportable
segments are the same as those described in Note 2. There are no
intersegment sales. The Companys segment financial
information for the three and nine months ended September 30, 2004 and 2003 is
as follows (in thousands): U.S.
    
    All Other
    
    Eliminations
    
    ConsolidatedThree months ended
September 30, 2004:Revenue from
external customers
    
    $
    96,845
    
    
    $
    7,142
    
    
    $
    
    
    
    $
    103,987Loss (gain) on sale of assets, net
    
    
    1,704
    
    
    
    
    
    
    
    
    
    
    
    1,704Provision for assets associated
with inactive practices
    
    
    13,346
    
    
    
    194
    
    
    
    
    
    
    
    13,540Depreciation
and amortization
    
    
    3,343
    
    
    
    625
    
    
    
    
    
    
    
    3,968Operating loss
    
    
    (3,847
    )
    
    
    (432
    )
    
    
    
    
    
    
    (4,279
    )Additions to
long-lived assets(1)
    
    
    4,238
    
    
    
    1,795
    
    
    
    
    
    
    
    6,033Three months ended
September 30, 2003:Revenue from
external customers
    
    $
    89,819
    
    
    $
    2,911
    
    
    $
    
    
    
    $
    92,730Loss (gain) on sale of assets, net
    
    
    (12
    )
    
    
    
    
    
    
    
    
    
    
    (12
    )Asset impairments
    
    
    767
    
    
    
    
    
    
    
    
    
    
    
    767Depreciation
and amortization
    
    
    5,940
    
    
    
    440
    
    
    
    
    
    
    
    6,380Operating income (loss)
    
    
    21,951
    
    
    
    (1,636
    )
    
    
    
    
    
    
    20,315Additions to
long-lived assets(1)
    
    
    5,941
    
    
    
    440
    
    
    
    
    
    
    
    6,381Nine months ended
September 30, 2004:Revenue from
external customers
    
    $
    301,744
    
    
    $
    17,457
    
    
    $
    
    
    
    $
    319,201Loss (gain) on sale of assets, net
    
    
    3,251
    
    
    
    
    
    
    
    
    
    
    
    3,251Provision for assets associated
with inactive practices
    
    
    14,026
    
    
    
    194
    
    
    
    
    
    
    
    14,220Depreciation
and amortization
    
    
    10,001
    
    
    
    1,836
    
    
    
    
    
    
    
    11,837Operating income (loss)
    
    
    17,615
    
    
    
    (4,739
    )
    
    
    
    
    
    
    12,876Cumulative effect of change in
accounting principle, net of
income
tax benefit
    
    
    (54,980
    )
    
    
    (19,681
    )
    
    
    
    
    
    
    (74,661
    )Total assets
    
    
    661,237
    
    
    

    18,757
    
    
    
    (45,768
    )
    
    
    634,226Additions to
long-lived assets(1)
    
    
    12,553
    
    
    
    3,634
    
    
    
    
    
    
    
    16,187Nine months ended
September 30, 2003:Revenue from
external customers
    
    $
    281,903
    
    
    $
    11,680
    
    
    $
    
    
    
    $
    293,583Loss (gain) on sale of assets, net
    
    
    136
    
    
    
    
    
    
    
    
    
    
    
    136Asset impairments
    
    
    2,582
    
    
    
    
    
    
    
    
    
    
    
    2,582Depreciation
and amortization
    
    
    17,267
    
    
    
    1,321
    
    
    
    
    
    
    
    18,588Operating income (loss)
    
    
    68,600
    
    
    
    (250
    )
    
    
    
    
    
    
    68,350Total assets
    
    
    657,602
    
    
    
    40,463
    
    
    
    (32,389
    )
    
    
    665,676Additions to
long-lived assets(1)
    
    
    11,145
    
    
    
    2,814
    
    
    
    
    
    
    
    13,959
 (1)  Long-lived assets represent net property, equipment and improvements. A
reconciliation of total segment operating income (loss) to total
income (loss) before income taxes and cumulative effect of change in accounting principle for the three and nine months ended September 30, 2004 and 2003 is as follows. Three monthsSeptember 30,
    
    Three monthsSeptember 30,2004
    
    2003
    
    2004
    
    2003Operating
income (loss) of the reportable segments
    
    $
    (4,279
    )
    
    $
    20,315
    
    
    $
    12,876
    
    
    $
    68,350Interest expense, net
    
    
    1,277
    
    
    
    1,193
    
    
    
    3,524
    
    
    
    3,742Non-controlling
interest in subsidiary
    
    
    15
    
    
    
    (4
    )
    
    
    (79
    )
    
    
    25Income (loss) before income taxes and
cumulative effect of change in accounting principle
    
    $
    (5,571
    )
    
    $
    19,126
    
    
    $
    9,431
    
    
    $
    64,583
 16




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10. NET INCOME (LOSS) PER SHARE The calculation of net income (loss) per share is performed using the
treasury stock method. Computations of basic and diluted earnings (loss) per
share are presented below: Three months ended
    
    Nine months endedSeptember 30,
    
    September 30,2004
    
    2003
    
    2004
    
    2003(in thousands)Numerator:Net income (loss) for basic and diluted earnings
per share
    
    $
    (3,538
    )
    
    $
    11,905
    
    
    $
    (68,673
    )
    
    $
    40,202Denominator:Denominator for basic earnings (loss) per share
    
    
    50,145
    
    
    
    50,206
    
    
    
    50,102
    
    
    
    50,208Effect of dilutive securities
    
    
    
    
    
    
    277
    
    
    
    
    
    
    
    296Denominator for diluted earnings (loss) per share
    
    
    50,145
    
    
    
    50,483
    
    
    
    50,102
    
    
    
    50,504
 No options to purchase shares of OCAs common stock were included in the
computation of diluted loss per share for the three and nine months ended September 30,
2004, because the effects would have been anti-dilutive. Options to purchase
approximately 2.2 million and approximately 2.1 million shares of common stock
were not included in the computation of diluted earnings per share for the
three and nine months ended September 30, 2003, respectively, because the
exercise prices were greater than the average market price of OCAs common
stock during these periods. The exercise prices for these options range from
$8.00 to $33.13. These options expire between 2009 and 2012. 11. CONTINGENCIES OCA and its subsidiary, OrthAlliance, are engaged in litigation with a
number of Inactive Practices. Before OCA agreed to acquire OrthAlliance in
November 2001, OCA anticipated that some portion of OrthAlliances affiliated
practices would oppose the transaction. A description of actions brought by
certain OrthAlliance affiliated practices and the claims in these actions is
contained in Item 3 of Part I to OCAs Annual Report on Form 10-K for the year
ended December 31, 2003. On April 23, 2002, Dr. David C. Hobson filed an action in the U.S.
District Court for the Eastern District of California against OCA and its
subsidiary, alleging that OCA breached its business services agreement with Dr.
Hobson, breached an alleged fiduciary duty to Dr. Hobson and committed
allegedly unfair business practices. On August 9, 2002, OCA filed a
counterclaim against Dr. Hobson seeking contract and equitable damages. The
case was tried from July 13 to August 13, 2004. The jury in the case rendered
a verdict in favor of OCA on Dr. Hobsons claim that OCA breached its fiduciary
duty, but found that OCA had breached a provision of Dr. Hobsons business
services agreement and awarded Dr. Hobson approximately $82,000 in damages. On
September 14, 2004, the court entered an amended judgment awarding $301,000 in
damages to OCA in connection with its counterclaims against Dr. Hobson.
On November 23, 2004, the court granted Dr. Hobsons
motion for attorneys fees in the amount of approximately $485,000,
and denied OCAs motions for attorneys fees and changes in the
amounts previously awarded to OCA and Dr. Hobson. The Company is
considering an appeal of these rulings. On September 28, 2004,
 the Company filed an action against Dr. Hobson seeking
payment of approximately $80,000 of indebtedness owed to the Company
by Dr. Hobson under three promissory notes. The Company has provided an allowance for assets associated with Dr.
Hobsons practice as part of its review of the recoverability of assets
associated with inactive practices (see Note 5) and believes it has
adequately reserved for the estimated outcome of this lawsuit. 17




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On May 22, 2001, Dr. T. Barry Clower, D.M.C. and his professional
corporation filed an action in the U.S. District Court for the Northern
District of Georgia against OrthAlliance, alleging OrthAlliance had breached
its service agreement with Dr. Clowers practice and that the agreement
violated Georgias prohibition of the corporate practice of dentistry. On
September 24, 2004, the court ruled in favor of OrthAlliance that the service
agreement between OrthAlliance and Dr. Clowers practice is legal and
enforceable and does not violate Georgia law governing the practice of
dentistry. The court also ruled that the parties covenants not to compete
were reasonable and enforceable against Dr. Clower. In addition, the court
held that Dr. Clowers practice breached his service agreement with
OrthAlliance and that OrthAlliance is owed damages for such breach. The court
rejected Dr. Clowers claim that OrthAlliance had breached his service
agreement. The court also held that OrthAlliance could enforce over $200,000
of promissory notes owed by Dr. Clowers practice to OrthAlliance. The Company
had previously adjusted the book value of assets associated with this
practice as part of the Companys
purchase accounting adjustments made in connection with the OrthAlliance merger
in November 2001. Because
litigation is inherently uncertain, the Company cannot assure you
that OCA
or its subsidiaries will prevail in any of these or other lawsuits,
nor can the Company
estimate with reasonable certainty the amount of damages it might incur or the
amount of any award it might receive. OCA and its affiliated practices are, and
from time to time may become, party to other litigation or administrative
proceedings which arise in the normal course of business. Regardless of the
outcome of such litigation and proceedings, they could be costly and
time-consuming and could divert the time and attention of OCAs senior
management. 18




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ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS The following discussion summarizes our financial condition at September
30, 2004 and results of operations for the three and nine months ended
September 30, 2004, and should be read in conjunction with the condensed
consolidated financial statements and accompanying notes included elsewhere in
this Report. References to OCA are to OCA, Inc. and its subsidiaries and
references to us, we or our are to OCA and its affiliated practices required to
be consolidated pursuant to FIN 46R (as defined below), unless the context
otherwise requires. OCA changed its name from Orthodontic Centers of
America Inc. in August 2004. OVERVIEW Founded in 1985, OCA is the leading provider of business services to
orthodontic and pediatric dental practices. OCA provides affiliated
practices operated by licensed practitioners and/or wholly-owned
professional entities (affiliated practices) with a full
range of operational, purchasing,
financial, marketing, administrative and other business services, as well as
capital and proprietary information systems. It generally provides its
services to affiliated practices under long-term service, consulting or
management service agreements (Service Agreements), with terms that typically
range from 20 to 25 years. The Service Agreements generally provide that the
affiliated practices will pay OCA monthly service fees based upon a percentage
of the practices operating profit or practice revenue and reimbursement of
practice-related expenses. At September 30, 2004, OCA was affiliated with 300 practices located
throughout the United States and parts of Japan, Spain, Puerto Rico and Mexico.
This number excludes 112 Inactive Practices, which are practices that were
parties to Service Agreements but were engaged in litigation with OCA or its
subsidiary, OrthAlliance, Inc. (OrthAlliance), and/or had ceased paying
service fees to OCA or OrthAlliance as of September 30, 2004. We had generally
ceased to record patient revenue with respect to all of these Inactive
Practices at or before September 30, 2004. In October 2004, OCA
affiliated with an orthodontic practice in Brazil. During the first quarter of 2004, OCA began providing business services
through its new division, OCA OutSource. OCA OutSource is initially focusing on
general dental practices, but intends to expand to providing business services
for other dental specialties and medical practices as well. OCA OutSource
provides business services to its affiliated practices (OutSource Practices)
under relatively short-term agreements (OutSource Agreements), with terms as
short as two years. OCA OutSource currently charges the OutSource Practices a
monthly service fee generally based on a percentage of the practices cash
collections or a fixed monthly service fee. In addition, OCA OutSources
affiliations differ from OCAs traditional affiliations in that, among other
things, OCA OutSource generally does not lease the practice office space or own
the practices fixed assets. The services provided by OCA OutSource otherwise
are similar to those provided under OCAs traditional affiliations, tailored to
the particular needs of the practices dental or medical specialty. OCAs
experience has been that OCA Outsource generally enables practitioners to focus on
quality care, while increasing their profitability and providing
better information about the financial performance of their practice. OCA
OutSource intends to continue to market its services to general and pediatric
dentists at association meetings, through direct mail and through open houses at
OCAs corporate headquarters in Metairie, Louisiana. OCA OutSource also
intends to begin marketing its services to medical practices during 2005. Affiliated practices reimburse OCA for practice-related expenses that it
incurs on their behalf, including costs to treat patients of the affiliated
practices. These practice-related expenses are recorded in our condensed
consolidated statements of income (loss) when incurred. Affiliated practices
typically incur approximately 30% to 35% of the total expense of treating a
patient during the first month of the patients treatment. 19




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We believe that the dollar amount of new patient contracts of our
affiliated practices is the greatest predictor of our future patient revenue.
During the nine months ended September 30, 2004, our affiliated orthodontic
practices generated new patient contracts totaling approximately $496.5
million, which we expect to provide us with a future stream of patient revenue
and cash flow. ADOPTION OF FIN 46R We have made a number of changes in our accounting and financial statement
presentation effective as of January 1, 2004, in connection with our adoption
of Financial Accounting Standards Board (FASB) Interpretation No. 46R,
Consolidation of Variable Interest Entities  an Interpretation of ARB No. 51
(FIN 46R). FIN 46R was issued by the FASB in December 2003 and replaced
Interpretation No. 46, which was issued by the FASB in January 2003. FIN 46R requires that we consolidate the assets, liabilities, equity and
financial results of certain entities (known as variable interest entities or
VIEs) if we are the primary beneficiary of the VIEs. Under FIN 46R, we are
the primary beneficiary of a VIE if we absorb a majority of the VIEs expected
losses, receive a majority of the VIEs expected residual returns, or both, as
a result of ownership, contractual or other financial interests in the VIE. In connection with our required adoption of FIN 46R effective January 1,
2004, we evaluated our contractual and economic relationships with affiliated
practices, including an economic analysis of these relationships with the
assistance of third party consultants. We concluded that the affiliated
practices (other than Inactive Practices and OutSource Practices) are VIEs for
purposes of FIN 46R. We also concluded that we are the primary beneficiary of
these affiliated practices for purposes of FIN 46R, in that we absorb a
majority of the affiliated practices expected losses and/or receive a majority
of the affiliated practices expected residual returns, as a result of
contractual or other financial interests in the affiliated practices. Accordingly, effective January 1, 2004, we are consolidating the assets,
liabilities, equity and financial results of our affiliated practices (other
than Inactive Practices and OutSource Practices) in our consolidated financial
statements. We did not consolidate the affiliated practices for financial
reporting purposes prior to January 1, 2004, in accordance with EITF Issue No.
97-2. These changes resulted in a cumulative effect of change in accounting
principle charge of $74.7 million (net of an income tax benefit of $41.4
million), which was recorded during the first quarter of 2004. We believe that the changes required under FIN 46R enhance the
transparency and clarity of our financial reporting. With these changes, our
reported earnings more closely reflect the net cash provided by operating
activities reported on our consolidated statements of cash flows. These changes
are described in more detail below and in the notes to our condensed
consolidated financial statements included in this Report. Briefly, these changes include the following, effective as of January 1,
2004:  
    
    Patient revenue. We now record patient revenue under patient
contracts between affiliated practices (other than Inactive
Practices and OutSource Practices) and their patients, rather than
the fee revenue portion that represented our service fees, because
we are now consolidating the affiliated practices for financial
reporting purposes.  
    
    Amounts retained by practitioners. The portion of patient
revenue that is retained by practitioners of affiliated practices is
now reflected as an expense in our consolidated statements of income
(loss). 20




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##### Table of Contents




    
    Revenue recognition. We now reflect affiliated practices
patient activity in our consolidated financial statements. As a
result, we now recognize patient revenue based upon a straight-line
allocation of patient contract balances over the term of treatment
(which averages about 23 months), except that a portion relating to
retainers will be recognized in the final month of treatment when
braces are removed and retainers are provided to patients, in
accordance with EITF Issue No. 00-21, Accounting for Revenue
Arrangements with Multiple Deliverables. This change eliminated
the recognition of revenue related to retainers over the term of
treatment, which resulted in increasing amounts of unbilled service
fees receivable under our prior revenue recognition policy.  
    
    Patient receivables. We now record patient receivables owed
to affiliated practices (other than Inactive Practices and OutSource
Practices) under their patient contracts because we now consolidate
the affiliated practices for financial reporting purposes. We no
longer record service fees receivable, including service fees
receivable relating to retainers, from our affiliated practices.
This change caused our patient receivables to more closely match the
actual timing of billing and collection for retainers, which is
typically in the final month of treatment. We also no longer record
the financed practice-related expense portion of service fees
receivable. The impact of these expenses on our statements of
income (loss) more closely reflect the timing of payment and
reimbursement for these expenses.  
    
    Identifiable intangibles and goodwill. We now
generally record amounts
paid to practices to affiliate or to amend Service Agreements as
goodwill, rather than as identifiable intangibles. As a result, we test
goodwill for impairment under provisions of Statement of Financial
Accounting Standards (SFAS) No. 142, Goodwill and Other
Intangible Assets rather than record amortization expense relating
to our intangible investments in Service Agreements.  
    
    Advances to practitioners. We now record cash advances to
practitioners during the start-up or expansion phase of a new center
as expenses when incurred (in the line item Amounts retained by
practitioners), rather than as receivables. These advances primarily relate to funding of practitioner compensation and
additional funding related to the practices. Repayment of the cash
advances now reduces amounts retained by practitioners during the
period in which the advance is repaid. This change resulted in the
earnings impact of these advances more closing matching the actual
timing of the advance and repayment. Our adoption of FIN 46R and consolidation of affiliated practices for
financial reporting purposes did not change our business practices, nor did it
change our legal and contractual relationships with affiliated practices. We
continue to provide high-quality business services to orthodontic, pediatric
dental and other practices under service and consulting agreements. We do not
have any ownership interest in our affiliated practices and we do not employ
the orthodontists, dentists or other practitioners in the affiliated practices.
The patients who are parties to patient contracts with affiliated practices
remain the patients of the affiliated practices. 21




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The table below provides the impact to our condensed consolidated balance
sheet at January 1, 2004, including elimination of intercompany transactions,
as a result of our adoption of FIN 46R (in thousands). At January 1, 2004Impact ofOCA
    
    Adopting FINBalance Sheet
    
    46R
    
    ConsolidatedCash and cash equivalents
    
    $
    7,391
    
    
    $
    
    
    
    $
    7,391Patient receivables, net
    
    
    
    
    
    
    117,942
    (a)
    
    
    117,942Current portion of service fees receivable, net
    
    
    96,720
    
    
    
    (96,720
    ) (a)
    
    
    Current portion of advances to practitioners, net
    
    
    16,544
    
    
    
    (7,526
    ) (b)
    
    
    9,018Other current assets
    
    
    62,051
    
    
    
    
    
    
    
    62,051Total current assets
    
    
    182,706
    
    
    
    13,696
    
    
    
    196,402Financed practice-related expense portion of service
fees receivable
    
    
    51,558
    
    
    
    (51,558
    ) (a)
    
    
    Advances to practitioners, less current portion, net
    
    
    12,921
    
    
    
    (12,921
    ) (b)
    
    
    Assets associated with inactive practices
    
    
    26,682
    
    
    
    4,624
    
    
    
    31,306Deferred income taxes
    
    
    
    
    
    
    41,420
    
    
    
    41,420Property, equipment and improvements, net
    
    
    89,458
    
    
    
    
    
    
    
    89,458Identifiable intangible assets, net
    
    
    201,163
    
    
    
    (201,163
    ) (c)
    
    
    Goodwill
    
    
    87,641
    
    
    
    202,804
    (c)
    
    
    290,445Other assets
    
    
    13,547
    
    
    
    
    
    
    
    13,547Total assets
    
    $
    665,676
    
    
    $
    (3,098
    )
    
    $
    662,578Accounts payable
    
    $
    8,985
    
    
    $
    
    
    
    $
    8,985Accrued salaries and other current liabilities
    
    
    13,977
    
    
    
    
    
    
    
    13,977Amounts payable to practitioners
    
    
    5,373
    
    
    
    
    
    
    
    5,373Service fee prepayments
    
    
    1,157
    
    
    
    (1,157
    ) (d)
    
    
    Deferred revenue
    
    
    
    
    
    
    89,060
    (d)
    
    
    89,060Current portion of debt and notes payable
    
    
    10,455
    
    
    
    
    
    
    
    10,455Total current liabilities
    
    
    39,947
    
    
    
    87,903
    
    
    
    127,850Deferred income tax liability
    
    
    41,268
    
    
    
    (16,340
    )
    
    
    24,928Notes payable to practitioners, less current
    
    
    4,050
    
    
    
    
    
    
    
    4,050Long-term debt
    
    
    87,724
    
    
    
    
    
    
    
    87,724Shareholders equity
    
    
    492,687
    
    
    
    (74,661
    ) (e)
    
    
    418,026Total liabilities and shareholders equity
    
    $
    665,676
    
    
    $
    (3,098
    )
    
    $
    662,578
 The following discusses the more significant adjustments to certain line
items of our condensed balance sheet as a result of adopting FIN 46R. (a) Patient Receivables and Service Fees Receivable. Effective January 1,
2004, we record patient receivables of affiliated practices in our consolidated
balance sheets. Patient receivables represent amounts owed to affiliated
practices by their patients or third-party payors, as calculated under our
revenue recognition policy. They reflect amounts yet to be received after being
recognized as patient revenue. We no longer record service fees receivable in
our consolidated balance sheets, including the current and financed
practice-related expense portion of service fees receivable. (b) Advances to Practitioners and Amounts Payable to Practitioners.
Effective January 1, 2004, we do not record in our condensed consolidated
balance sheets cash advances to affiliated practices against future
distributions. At January 1, 2004, we made the following adjustments with
respect to advances to affiliated practices: (A) eliminated advances to
affiliated practices that related to cash 22




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##### Table of Contents



advances to affiliated practices against future distributions, (B)
reclassified advances related to amounts due under Service Agreements with
Inactive Practices to assets associated with Inactive Practices, and (C)
eliminated advances to affiliated practices related to amounts due under
Service Agreements. We will continue to record receivables and payables related
to short-term differences between amounts distributed as monthly or biweekly
draws to practitioners and the amounts that the practitioners are entitled to
retain under their Service Agreements, until those amounts are reconciled. (c) Goodwill and Identifiable Intangibles. Pursuant to the consolidation
provisions of FIN 46R, effective January 1, 2004, we account for affiliations
with practices (other than Inactive Practices and OutSource Practices) as
business combinations and reclassified certain identifiable intangible assets related
to Service Agreements with affiliated practices to goodwill. Prior to the
adoption of FIN 46R, we recorded these amounts as identifiable intangible
assets and amortized these assets. In addition, we determined that
affiliated practices are our reporting units for purposes of SFAS No.
142. Therefore, we now
allocate goodwill, including goodwill associated with the
OrthAlliance merger, to our practice-level reporting units based on
managements estimate of the fair values of the reporting units. Also, as of January 1, 2004, we
reclassified identifiable intangible assets related to Inactive Practices into
Assets associated with inactive practices, because we do not consolidate
these practices. Goodwill and identifiable intangibles are not amortized but
are tested for impairment under provisions of SFAS No. 142 by
assessing the carrying amount of goodwill at the practice reporting unit level. (d) Deferred Revenue and Service Fee Prepayments. Effective January 1,
2004, we record deferred revenue in our condensed consolidated balance sheets.
Deferred revenue represents amounts which affiliated practices receive from their
patients or third party payors prior to recognition of the related patient
revenue, as calculated under our revenue recognition policy. We no longer
record service fee prepayments in our condensed consolidated balance sheets. (e) Cumulative effect of change in accounting principle. As a result of
adopting FIN 46R, we recorded in the first quarter of 2004 a cumulative effect
charge of $74.7 million, net of income tax benefit of $41.4 million. The charge
was primarily due to the change in our revenue recognition policy,
the reclassification of certain advances to affiliated practices as amounts
retained by practitioners (as described above) and the reversal of
previously-recorded amortization of identifiable intangible assets. PATIENT RECEIVABLES AND DEFERRED REVENUE We
now record patient receivables of affiliated practices in our
condensed consolidated balance sheets, rather than service fee
receivable. Patient receivables represent amounts owed to affiliated
practices by their patients or third-party payors, as calculated
under our revenue recognition policy. They reflect amounts yet to be
received after being recognized as patient revenue under our revenue
recognition policy. Patient
receivables may occur due to several factors, including delay in
payment by patients, delay in payment by third party payors, and
timing differences between when the patient or third party payor is
contractually obligated to remit payment for services and the straight-line
calculation under our revenue recognition policy. Under our revenue
recognition policy, we recognize patient revenue based upon
a straight-line allocation of patient contract balances over the term of
treatment (which averages about 23 months), except that a portion
relating to retainers will be recognized in the final month of
treatment when braces are removed and retainers are provided to
patients. Most of our affiliated practices use our recommended
payment plan for their patients, which provides for (a) no down
payment, (b) an initial record fee, (c) equal monthly payments
(ranging from $109 to $139, with most practices using $129 per month) over the
term of treatment and (d) a final retainer payment that is
typically four times the monthly payment. 23




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##### Table of Contents



Deferred
revenue represents down payments, prepayments and other cash received
under patient contracts prior to the related services being provided
by affiliated practices and in advance of the straight-line calculation under our
revenue recognition policy. We defer recognition of these amounts
until they are recognized as patient revenue under our revenue
recognition policy. Because
patient receivables and deferred revenue generally relate to
different affiliated practices, we generally do not have a
right to offset amounts owed against amounts prepaid, and the patient
receivables and deferred revenue are recorded separately in our
condensed consolidated balance sheets and not on a net basis. At
September 30, 2004, we had a total of $124.3 million of
patient receivables and $91.8 million of deferred revenue. CRITICAL ACCOUNTING POLICIES AND ESTIMATES OCAs management is required to make estimates and assumptions in the
preparation of our condensed consolidated financial statements in accordance
with accounting principles generally accepted in the United States. The
following are critical accounting policies that resulted from our adoption of
FIN 46R effective January 1, 2004. See Item 7. Managements Discussion and
Analysis of Financial Condition and Results of Operations and Note 2 to our
consolidated financial statements in OCAs Annual Report on Form 10-K for the
year ended December 31, 2003 for information about other critical accounting
policies. These policies are important in portraying our financial condition and
results of operations, and require managements difficult, subjective or
complex judgments due to the sensitivity of the methods, assumptions and
estimates used in preparing our condensed consolidated financial statements.
Actual results may differ from these estimates under different assumptions and
estimates. Consolidation FIN 46R requires the consolidation of entities known as variable interest
entities (or VIEs) when an enterprise absorbs a majority of the VIEs expected
losses, receives a majority of the VIEs expected residual returns, or both, as
a result of ownership, contractual or other financial interests in the VIEs.
Management must make assessments whether our affiliated practices are VIEs and
whether we hold a controlling financial interest in the VIEs, as determined
under FIN 46R. Accordingly, we will consolidate the assets, liabilities, equity
and financial results of those affiliated practices in our consolidated
financial statements if we determine that we do hold a controlling financial
interest. We are required to reevaluate whether or not we consolidate our VIEs
when an event occurs that requires reconsideration of consolidation under
applicable accounting pronouncements. During 2004, certain practices
that we consolidated pursuant to FIN 46R ceased paying service fees
to OCA or OrthAlliance, initiated litigation against OCA or
OrthAlliance and/or alleged a breach by OCA or OrthAlliance of their
Service Agreement and gave notice of their intentions to terminate
the Service Agreement. We believe that these events required that we
reconsider whether OCA is the primary beneficiary of these practices
under FIN 46R. We determined that, under these circumstances,
OCA was no longer the primary beneficiary of these practices and we
ceased to consolidate these practices. We do not consolidate the assets,
liabilities, equity and financial results of the Inactive Practices and
OutSource Practices. 24




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##### Table of Contents



The laws of each of the jurisdictions
in which we operate prohibit OCA from
owning orthodontic or pediatric dental practices. OCA enters into exclusive
Service Agreements with practitioners and professional entities that operate
orthodontic and pediatric dental practices. OCA does not have any ownership
interest in affiliated practices and it does not employ the orthodontists,
dentists or other practitioners in the affiliated practices. The patients who
are parties to patient contracts with affiliated practices remain the patients
of the affiliated practices. Amounts Retained by Practitioners Amounts retained by practitioners represents amounts retained in
accordance with contractual terms of the Service Agreements. Amounts retained
by practitioners includes cash advances provided to practitioners to fund
certain practice-related matters or to provide practices with unsecured
financing which will be repaid from future distributions and which are
reflected as an expense in the period such amounts are advanced. Amounts
retained by practitioners is reduced by repayments in the period in which
repaid. On a monthly or biweekly basis, we generally distribute cash draws to
practitioners that are intended to approximate calculated amounts retained by
the practitioners under their Service Agreements. At the end of each quarter,
we calculate the actual amounts which the practitioners are entitled to retain in accordance
with the Service Agreements. We then record a receivable or payable, as
applicable, for any overpayment or under payment. To the extent amounts are
owed to us, we generally reduce the next monthly or biweekly draw to the
practitioners. Advances to Affiliated Practices We apply the provisions of Accounting Research Bulletin No. 51,
Consolidated Financial Statements, when assessing advances to affiliated
practices and amounts retained by affiliated practices. Accordingly, we do not
record cash advances against future distributions to affiliated practices in
our consolidated financial statements as advances to affiliated practices.
Such amounts are recorded as an expense, in amounts retained by affiliated
practices, in the period in which the distributions are made. However, as
these amounts are repaid from future earnings of the affiliated practices, we
record the repayments as a reduction of amounts retained by affiliated practices.
We record as advances to practitioners or amounts payable to practitioners the
short-term differences between amounts distributed as monthly or bi-weekly
draws to practitioners and the amounts that the practitioners are entitled to
retain under their Service Agreements. Revenue Recognition and Realization of Patient Receivables We generally recognize patient revenues related to services provided to
patients on a straight-line basis over the term of treatment (which averages
about 23 months). Revenues related to retainers, or teeth retention
appliances, are recognized in the final month of treatment when braces are
removed and retainers are provided to the patients, in accordance with EITF
Issue No. 00-21, Accounting for Revenue Arrangements with Multiple
Deliverables. Patient receivables represent amounts owed by patients or third-party
payors to affiliated practices, as calculated under our revenue recognition
policy. In addition, in some instances, management is required to estimate
patient receivables from certain affiliated practices based upon information
provided by those affiliated practices. Management provides an allowance for
uncollectible amounts based upon a percentage estimate of patient receivables
that may not be collected by affiliated practices. The allowance percentage is
determined based upon our experience in collecting patient receivables on
behalf of affiliated practices. Managements estimates may change based on
future conditions and circumstances. 25




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##### Table of Contents



We currently charge OutSource Practices a monthly service fee based on a
percentage of the practices cash collections or a fixed monthly service fee.
These amounts are recorded as revenue when earned. Impairment of Goodwill
and Identifiable Intangible Assets Typically,
when OCA has affiliated with an established practice, it has entered
into a long-term Service Agreement with the practice and/or the
affiliated practitioner under which it provides business services to
the practice in exchange for monthly service fee payments. We
generally allocated a portion of the related costs of acquiring the
Service Agreement to identifiable intangible assets. In addition,
OCAs balance sheet reflected approximately $87.6 million
of goodwill related to the OrthAlliance merger as of December 31, 2003. Upon
adopting the provisions of FIN 46R effective January 1,
2004, we now account for affiliations with practices as business
combinations and, therefore, reclassified certain identifiable
intangible assets related to Service Agreements as goodwill. In
addition, we determined that affiliated practices are our reporting
units for purposes of SFAS No. 142. Therefore, we now allocate the goodwill associated with
the practice affiliations to our practice-level reporting units based
on managements estimate of the fair values of the reporting
units. We now test goodwill in accordance with SFAS No. 142
by assessing the carrying amount of goodwill at the practice reporting unit level. For purposes of this assessment, fair value
is measured by estimating future cash flows under the Service
Agreements with the affiliated practices based on several factors,
including current operational levels of the practice, expected growth
in the practice based on managements experience, the status of
affiliation of the practice and the recoverability of assets
associated with Inactive Practices. If the total projected cash flows of the
affiliated practice exceed the carrying amount of goodwill
associated with that practice, there would be no impairment. If the
cash flows of the affiliated practice were to be less than the carrying amount of goodwill associated with that practice, the goodwill would be
considered impaired and management would adjust the carrying value of
the goodwill to estimated fair value. Managements estimate may
change based on future events, including adverse results in pending
litigation and lawsuits that may be filed by or against OCA or OrthAlliance
in the future. Recoverability of Assets Related to Inactive Practices At September 30, 2004, we had recorded in our condensed consolidated
balance sheets approximately $30.2 million of assets associated with Inactive
Practices, net of an allowance of $15.5 million. These assets consisted of
$26.8 million of goodwill and identifiable intangible assets, $3.2 million of property,
equipment, and improvements, net of accumulated amortization and depreciation,
$3.3 million of service fees receivable, $1.5 million of patient receivables,
$0.7 million of inventory and $10.2 million of advances to affiliated
practices. The assessment of the recoverability of these assets is complex and
requires significant judgment by management due to a number of factors,
including the status and results of pending litigation, recent
settlements and buyouts, the lack of
financial information about these practices, the uncertainty of these practices fulfilling their contractual
obligations to us and the estimated amounts expected to be received from these
practices in a buyout, settlement, judgment or under the terms of
their Service Agreements. Management estimates the amounts to be received from these practices
using, among other things, historical data and experience in resolving these
situations and the particular practitioners willingness to resolve the matter. We have
established allowances for assets associated with these practices and believe
the net amounts recorded as assets associated with inactive practices are
realizable as of September 30, 2004. However, adverse litigation results could
significantly affect the recoverability of these assets and may require us to
record additional provisions related to these assets in the future. PRACTICE COLLECTIONS AND RESULTS Our financial success is dependent on the financial success of our
affiliated practices. The following chart illustrates, by quarter, the
increases in patient fees collected by affiliated practices during 2003 and the
first nine months of 2004. The graph also illustrates the growth in collections
of patient fees by Base Practices for which we were recording patient revenue
at September 30, 2004, and the diminishing impact of Inactive Practices on
total patient fees collected by affiliated practices during 2003 and the first
nine months of 2004. The graph also illustrates patient revenue for these
periods, calculated on a pro forma basis as if our adoption of FIN 46R was
effective on January 1, 2003. As depicted in the graph below, our patient
revenue generally parallels the patient fees collected by affiliated practices. 26




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##### Table of Contents



(PERFORMANCE GRAPH)   (1)
    
    These amounts reflect patient fees collected from patients or third party
payors by or on behalf of affiliated practices during the respective
periods. These amounts do not include any collections by Inactive
Practices after we ceased recording fee revenue or patient revenue for the
practices.(2)
    
    Represents patient fees collected by or on behalf of Base Practices for
which we were recording patient revenue as of September 30, 2004.(3)
    
    Represents patient fees collected by or on behalf of Inactive Practices,
including practices that have bought out of or otherwise terminated their
Service Agreements, for which we recorded fee revenue or patient revenue
during the respective periods but for which we had ceased to record
revenue at or before September 30, 2004. Accordingly, we ceased to
include collections by these Inactive Practices in the graph above after
we ceased recording fee revenue or patient revenue for the practices.(4)
    
    Represents total patient fees collected by Base Practices and Inactive
Practices, including practices that have bought out of or otherwise
terminated their Service Agreements, during the periods.(5)
    
    Represents pro forma patient revenue for the respective quarters,
calculated as if our adoption of FIN 46R was effective as of January 1,
2003. Patient revenue for each of the three quarters of 2004 represent as
reported patient revenue as we adopted FIN 46R effective January 1, 2004. AGREEMENTS WITH AFFILIATED PRACTICES OCA provides business services to an affiliated practice under an
agreement with an affiliated licensed professional and/or his or her
wholly-owned professional entity. The form of agreement used for a particular
affiliated practice is based upon the dental regulatory provisions of the state
in which the affiliated practice is located. In most states, we use a form of
service agreement, with some minor variations from state to state. In a small
number of states with particularly stringent laws relating to the practice of
dentistry, we use a consulting agreement, which also varies somewhat from state
to state. OrthAlliance and its affiliated practices are parties to service,
management service and consulting agreements that differ in some respects from
the service and consulting agreements that OCA has historically used. The
terms of the Service Agreements typically range from 20 to 40 years, with most
ranging from 20 to 25 years. The Service Agreements generally provide for
monthly service fees based 27




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##### Table of Contents



upon a percentage of the practices operating profit or practice revenue
and reimbursement of practice-related expenses. OCA OutSource provides business services to a practice under agreements
with terms as short as two years. Under an OutSource Agreement, affiliated
practices currently are charged a monthly service fee based on a percentage of
the practices cash collections or fixed monthly fee. RESULTS OF OPERATIONS The following tables provide information about (1) the percentage of total
revenue represented by certain items in our condensed consolidated statements
of income (loss) for the periods indicated, (2) for those same items, the
percentage of patient revenue for the three and nine months ended September 30,
2003 on a pro forma basis calculated as if our adoption of FIN 46R was
effective as of January 1, 2003 (Pro Forma Basis), and (3) the percentage
increase or decrease in those items from period to period on an actual and pro
forma basis: Pro Forma
    
    PercentageThree Months EndedSeptember 30,
    
    ThreeMonths Ended
    
    Increase/(Decrease)September 30,
    
    2004 to 2003
    
    2004 to 20032004
    
    2003
    
    2003(1)
    
    Actual
    
    Pro FormaTotal revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    N/A
    
    
    
    (4.9
    )%Practice-related expenses:Amounts retained by practitioners
    
    
    28.6
    
    
    
    
    
    
    
    30.7
    
    
    
    N/A
    
    
    
    (11.4
    )Salaries and benefits
    
    
    22.0
    
    
    
    24.9
    
    
    
    21.1
    
    
    
    (0.8
    )%
    
    
    (0.8
    )Clinical supplies and lab fees
    
    
    8.8
    
    
    
    10.5
    
    
    
    8.9
    
    
    
    (5.9
    )
    
    
    (5.9
    )Rent
    
    
    6.6
    
    
    
    7.5
    
    
    
    6.4
    
    
    
    (1.5
    )
    
    
    (1.5
    )Marketing and advertising
    
    
    5.3
    
    
    
    5.9
    
    
    
    5.0
    
    
    
    0.5
    
    
    
    0.5Other operating costs
    
    
    8.2
    
    
    
    9.9
    
    
    
    8.4
    
    
    
    (6.6
    )
    
    
    (6.6
    )Total practice-related expenses
    
    
    79.5
    
    
    
    58.7
    
    
    
    80.5
    
    
    
    52.0
    
    
    
    (6.0
    )General and administrative
    
    
    6.1
    
    
    
    11.7
    
    
    
    7.9
    
    
    
    (41.6
    )
    
    
    (26.2
    )Depreciation
    
    
    3.8
    
    
    
    4.1
    
    
    
    3.5
    
    
    
    4.3
    
    
    
    4.3Amortization
    
    
    
    
    
    
    2.8
    
    
    
    
    
    
    
    N/A
    
    
    
    0.0Loss (gain) on sale of assets
    
    
    1.6
    
    
    
    
    
    
    
    
    
    
    
    (14,298.8
    )
    
    
    (14,298.8
    )Provision for assets associated with
inactive practices
    
    
    13.0
    
    
    
    
    
    
    
    
    
    
    
    N/A
    
    
    
    N/AAsset impairments
    
    
    
    
    
    
    0.8
    
    
    
    0.7
    
    
    
    N/A
    
    
    
    N/AOperating income (loss)
    
    
    (4.1
    )
    
    
    21.9
    
    
    
    7.4
    
    
    
    (124.8
    )
    
    
    (152.6
    )Income
(loss) before income taxes
    
    
    (5.4
    )
    
    
    20.6
    
    
    
    6.4
    
    
    
    (129.1
    )
    
    
    (180.2
    )Net income
(loss)
    
    
    (3.4
    )%
    
    
    12.8
    %
    
    
    4.0
    %
    
    
    (129.7
    )%
    
    
    (181.8
    )%
 28




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##### Table of Contents



Nine Months
    
    Pro Forma
    
    PercentageEnded
    
    Nine Months
    
    Increase/(Decrease)September 30,
    
    EndedSeptember 30,
    
    2004 to 2003
    
    2004 to 20032004
    
    2003
    
    2003(1)
    
    Actual
    
    Pro FormaTotal revenue
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    N/A
    
    
    
    (4.2
    )%Practice-related expenses:Amounts retained by practitioners
    
    
    28.7
    
    
    
    
    
    
    
    27.4
    
    
    
    N/A
    
    
    
    0.4Salaries and benefits
    
    
    21.7
    
    
    
    25.6
    
    
    
    22.6
    
    
    
    (8.0
    )%
    
    
    (8.0
    )Clinical supplies and lab fees
    
    
    8.7
    
    
    
    10.2
    
    
    
    9.0
    
    
    
    (7.7
    )
    
    
    (7.7
    )Rent
    
    
    6.4
    
    
    
    8.6
    
    
    
    7.6
    
    
    
    (19.6
    )
    
    
    (19.6
    )Marketing and advertising
    
    
    5.4
    
    
    
    6.4
    
    
    
    5.7
    
    
    
    (9.3
    )
    
    
    (9.3
    )Other operating expenses
    
    
    8.4
    
    
    
    9.3
    
    
    
    8.2
    
    
    
    (1.3
    )
    
    
    (1.3
    )Total practice-related expenses
    
    
    79.4
    
    
    
    60.2
    
    
    
    80.5
    
    
    
    43.2
    
    
    
    (5.6
    )General and administrative
    
    
    7.5
    
    
    
    9.2
    
    
    
    7.0
    
    
    
    (12.1
    )
    
    
    2.7Depreciation
    
    
    3.6
    
    
    
    3.7
    
    
    
    3.2
    
    
    
    7.9
    
    
    
    7.9Amortization
    
    
    0.1
    
    
    
    2.7
    
    
    
    0.1
    
    
    
    (97.6
    )
    
    
    0.0Loss (gain) on sale of assets
    
    
    1.0
    
    
    
    
    
    
    
    
    
    
    
    2,290.6
    
    
    
    2,290.6Provision for assets associated with
inactive practices
    
    
    4.5
    
    
    
    
    
    
    
    
    
    
    
    N/A
    
    
    
    N/AAsset impairments
    
    
    
    
    
    
    0.9
    
    
    
    0.8
    
    
    
    N/A
    
    
    
    N/AOperating income
    
    
    4.0
    
    
    
    23.3
    
    
    
    8.4
    
    
    
    (81.2
    )
    
    
    (63.4
    )Income before income taxes and cumulative
effect
    
    
    3.0
    
    
    
    22.0
    
    
    
    7.3
    
    
    
    (85.4
    )
    
    
    (61.0
    )Income before cumulative effect of
change in accounting principle
    
    
    1.9
    
    
    
    13.7
    
    
    
    4.5
    
    
    
    (85.1
    )
    
    
    (60.3
    )%Cumulative effect, net of income
tax benefit
    
    
    (23.4
    )
    
    
    
    
    
    
    
    
    
    
    N/A
    
    
    
    N/ANet income (loss)
    
    
    (21.5
    )%
    
    
    13.7
    %
    
    
    4.5
    %
    
    
    (270.8
    )%
    
    
    N/A
   (1)
    
    Presented on a pro forma basis as if our adoption of FIN 46R was effective
as of January 1, 2003. Financial Results Attributable to Base Practices and Inactive Practices The following tables provide information about financial results
attributable to Base Practices, Inactive Practices and our corporate operations
for the three and nine months ended September 30, 2004 and 2003, and for the
three and nine months ended September 30, 2003 on a Pro Forma Basis. Base
Practices are affiliated practices for which we were recording patient revenue
as of September 30, 2004. Inactive Practices are practices that were engaged
in litigation with OCA or OrthAlliance and/or had ceased paying service fees
and for which we had ceased to record patient revenue at September 30, 2004. At
September 30, 2004, there were 300 Base Practices and 112 Inactive Practices
that were parties to Service Agreements. At September 30, 2003, there were 327
Base Practices and 89 Inactive Practices that were parties to Service
Agreements. As reflected in the following tables, during the three and nine months
ended September 30, 2004, our financial results were almost entirely
attributable to Base Practices, as the amount of patient revenue, expense and
operating income (loss) attributable to Inactive Practices during the first
nine months of 2004 was significantly less than during the same period in 2003
on a Pro Forma Basis. The tables also indicate the impact of de novocenters,
which typically incur operating losses during their first 12 to 18 months of
operation. 29




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##### Table of Contents



Base Practices (1)Mature
    
    De Novo
    
    Inactive
    
    OutSourceCenters (2)
    
    Centers (3)
    
    Practices (4)
    
    Practices
    
    Corporate (5)
    
    TotalFor the three months ended
September 30, 2004:Patient revenue
    
    $
    101,989
    
    
    $
    1,144
    
    
    $
    825
    
    
    $
    
    
    
    $
    
    
    
    $
    103,958Service fees from OutSource
Practices
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29
    
    
    
    
    
    
    
    29Total revenue
    
    
    101,989
    
    
    
    1,144
    
    
    
    825
    
    
    
    29
    
    
    
    
    
    
    
    103,987Practice-related expenses (6)
    
    
    79,539
    
    
    
    2,059
    
    
    
    1,108
    
    
    
    
    
    
    
    
    
    
    
    82,706General and administrative (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    6,348
    
    
    
    6,348Depreciation
    
    
    2,773
    
    
    
    218
    
    
    
    521
    
    
    
    
    
    
    
    456
    
    
    
    3,968Provision for assets
associated with inactive
practices
    
    
    
    
    
    
    
    
    
    
    13,540
    
    
    
    
    
    
    
    
    
    
    
    13,540Loss on sale of assets
    
    
    
    
    
    
    
    
    
    
    1,704
    
    
    
    
    
    
    
    
    
    
    
    1,704Operating income (loss)
    
    
    19,677
    
    
    
    (1,133
    )
    
    
    (16,048
    )
    
    
    29
    
    
    
    (6,804
    )
    
    
    (4,279
    )Interest expense (net) (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,277
    
    
    
    1,277Non-controlling interest (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15
    
    
    
    15Income
(loss) before income taxes (5)
    
    
    19,677
    
    
    
    (1,133
    )
    
    
    (16,048
    )
    
    
    29
    
    
    
    (8,096
    )
    
    
    (5,571
    )Income taxes (5)
    
    
    7,183
    
    
    
    (414
    )
    
    
    (5,858
    )
    
    
    11
    
    
    
    (2,955
    )
    
    
    (2,033
    )Net income (loss) (5)
    
    $
    12,494
    
    
    $
    (719
    )
    
    $
    (10,190
    )
    
    $
    18
    
    
    $
    (5,141
    )
    
    $
    (3,538
    )For the three months ended
September 30, 2003:
    

ActualFee revenue
    
    $
    86,334
    
    
    $
    486
    
    
    $
    5,910
    
    
    $
    
    
    
    $
    
    
    
    $
    92,730Practice-related expenses (6)
    
    
    46,724
    
    
    
    787
    
    
    
    6,908
    
    
    
    
    
    
    
    
    
    
    
    54,419General and administrative (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    10,861
    
    
    
    10,861Depreciation and amortization
    
    
    4,987
    
    
    
    128
    
    
    
    584
    
    
    
    
    
    
    
    681
    
    
    
    6,380Gain on sale of assets
    
    
    
    
    
    
    
    
    
    
    12
    
    
    
    
    
    
    
    
    
    
    
    12Asset impairments
    
    
    
    
    
    
    
    
    
    
    767
    
    
    
    
    
    
    
    
    
    
    
    767Operating income (loss)
    
    
    34,623
    
    
    
    (429
    )
    
    
    (2,337
    )
    
    
    
    
    
    
    (11,542
    )
    
    
    20,315Interest expense (net) (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,193
    
    
    
    1,193Non-controlling interest (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )
    
    
    (4
    )Income
(loss) before income taxes (5)
    
    
    34,623
    
    
    
    (429
    )
    
    
    (2,337
    )
    
    
    
    
    
    
    (12,731
    )
    
    
    19,126Income taxes (5)
    
    
    13,071
    
    
    
    (162
    )
    
    
    (882
    )
    
    
    
    
    
    
    (4,806
    )
    
    
    7,221Net income (loss) (5)
    
    $
    21,552
    
    
    $
    (267
    )
    
    $
    (1,455
    )
    
    $
    
    
    
    $
    (7,925
    )
    
    $
    11,905
 30




---



##### Table of Contents



Base Practices (1)Mature
    
    De Novo
    
    Inactive
    
    OutSourceCenters (2)
    
    Centers (3)
    
    Practices (4)
    
    Practices
    
    Corporate (5)
    
    TotalFor the three months ended September 30, 2003:
    
    Pro FormaPatient revenue
    
    $
    98,859
    
    
    $
    334
    
    
    $
    10,098
    
    
    $
    
    
    
    $
    
    
    
    $
    109,291Practice-related expenses (6)
    
    
    76,020
    
    
    
    878
    
    
    
    11,096
    
    
    
    
    
    
    
    
    
    
    
    87,994General and administrative (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,603
    
    
    
    8,603Depreciation and amortization
    
    
    2,412
    
    
    
    128
    
    
    
    584
    
    
    
    
    
    
    
    681
    
    
    
    3,805Gain on sale of assets
    
    
    
    
    
    
    
    
    
    
    12
    
    
    
    
    
    
    
    
    
    
    
    12Asset impairments
    
    
    
    
    
    
    
    
    
    
    767
    
    
    
    
    
    
    
    
    
    
    
    767Operating income (loss)
    
    
    20,427
    
    
    
    (672
    )
    
    
    (2,337
    )
    
    
    
    
    
    
    (9,284
    )
    
    
    8,134Interest expense (net) (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,193
    
    
    
    1,193Non-controlling interest (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (4
    )
    
    
    (4
    )Income
(loss) before income taxes (5)
    
    
    20,427
    
    
    
    (672
    )
    
    
    (2,337
    )
    
    
    
    
    
    
    (10,473
    )
    
    
    6,945Income taxes (5)
    
    
    7,711
    
    
    
    (254
    )
    
    
    (882
    )
    
    
    
    
    
    
    (3,952
    )
    
    
    2,623Net income (loss) (5)
    
    $
    12,716
    
    
    $
    (418
    )
    
    $
    (1,455
    )
    
    $
    
    
    
    $
    (6,521
    )
    
    $
    4,322For the nine months ended
September 30, 2004:Patient revenue
    
    $
    310,018
    
    
    $
    2,250
    
    
    $
    6,898
    
    
    $
    
    
    
    $
    
    
    
    $
    319,166Service fees from OutSource
Practices
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    35
    
    
    
    
    
    
    
    35Total revenue
    
    
    310,018
    
    
    
    2,250
    
    
    
    6,898
    
    
    
    35
    
    
    
    
    
    
    
    319,201Practice-related expenses (6)
    
    
    240,111
    
    
    
    4,991
    
    
    
    8,094
    
    
    
    
    
    
    
    
    
    
    
    253,196General and administrative (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23,821
    
    
    
    23,821Depreciation and amortization
    
    
    8,608
    
    
    
    625
    
    
    
    1,257
    
    
    
    
    
    
    
    1,347
    
    
    
    11,837Provision for assets
associated with inactive
practices
    
    
    
    
    
    
    
    
    
    
    14,220
    
    
    
    
    
    
    
    
    
    
    
    14,220Loss on sale of assets
    
    
    
    
    
    
    
    
    
    
    3,251
    
    
    
    
    
    
    
    
    
    
    
    3,251Operating income (loss)
    
    
    61,299
    
    
    
    (3,366
    )
    
    
    (19,924
    )
    
    
    35
    
    
    
    (25,168
    )
    
    
    12,876Interest expense (net) (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,524
    
    
    
    3,524Non-controlling interest (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (79
    )
    
    
    (79
    )Income
(loss) before income taxes (5)
    
    
    61,299
    
    
    
    (3,366
    )
    
    
    (19,924
    )
    
    
    35
    
    
    
    (28,613
    )
    
    
    9,431Income taxes (5)
    
    
    22,375
    
    
    
    (1,229
    )
    
    
    (7,273
    )
    
    
    13
    
    
    
    (10,443
    )
    
    
    3,443Income (loss) before
cumulative effect of change in
accounting principle(5)
    
    $
    38,924
    
    
    $
    (2,137
    )
    
    $
    (12,651
    )
    
    $
    22
    
    
    $
    (18,170
    )
    
    $
    5,988For the nine months ended
September 30, 2003:
    
    ActualFee revenue
    
    $
    260,579
    
    
    $
    1,447
    
    
    $
    31,557
    
    
    $
    
    
    
    $
    
    
    
    $
    293,583Practice-related expenses (6)
    
    
    139,618
    
    
    
    2,537
    
    
    
    34,668
    
    
    
    
    
    
    
    
    
    
    
    176,823General and administrative (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    27,104
    
    
    
    27,104Depreciation
    
    
    15,277
    
    
    
    340
    
    
    
    1,488
    
    
    
    
    
    
    
    1,483
    
    
    
    18,588Loss on sale of assets
    
    
    
    
    
    
    
    
    
    
    136
    
    
    
    
    
    
    
    
    
    
    
    136Asset impairments
    
    
    
    
    
    
    
    
    
    
    2,582
    
    
    
    
    
    
    
    
    
    
    
    2,582Operating income (loss)
    
    
    105,684
    
    
    
    (1,430
    )
    
    
    (7,317
    )
    
    
    
    
    
    
    (28,587
    )
    
    
    68,350Interest expense (net) (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,742
    
    
    
    3,742Non-controlling interest (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25
    
    
    
    25Income
(loss) before income taxes (5)
    
    
    105,684
    
    
    
    (1,430
    )
    
    
    (7,317
    )
    
    
    
    
    
    
    (32,354
    )
    
    
    64,583Income taxes (5)
    
    
    39,896
    
    
    
    (540
    )
    
    
    (2,762
    )
    
    
    
    
    
    
    (12,213
    )
    
    
    24,381Net income (loss) (5)
    
    $
    65,788
    
    
    $
    (890
    )
    
    $
    (4,555
    )
    
    $
    
    
    
    $
    (20,141
    )
    
    $
    40,202
 31




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##### Table of Contents



Base Practices (1)Mature
    
    De Novo
    
    Inactive
    
    OutSourceCenters (2)
    
    Centers (3)
    
    Practices (4)
    
    Practices
    
    Corporate (5)
    
    TotalFor the nine months ended September 30, 2003:
    
    Pro FormaPatient revenue
    
    $
    287,730
    
    
    $
    1,112
    
    
    $
    44,389
    
    
    $
    
    
    
    $
    
    
    
    $
    333,231Practice-related expenses (6)
    
    
    217,875
    
    
    
    2,838
    
    
    
    47,499
    
    
    
    
    
    
    
    
    
    
    
    268,212General and administrative (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    23,194
    
    
    
    23,194Depreciation and amortization
    
    
    7,678
    
    
    
    340
    
    
    
    1,488
    
    
    
    
    
    
    
    1,483
    
    
    
    10,989Loss on sale of assets
    
    
    
    
    
    
    
    
    
    
    136
    
    
    
    
    
    
    
    
    
    
    
    136Asset impairments
    
    
    
    
    
    
    
    
    
    
    2,582
    
    
    
    
    
    
    
    
    
    
    
    2,582Operating income (loss)
    
    
    62,177
    
    
    
    (2,066
    )
    
    
    (7,316
    )
    
    
    
    
    
    
    (24,677
    )
    
    
    28,118Interest expense (net) (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,877
    
    
    
    3,877Non-controlling interest (5)
    
    
    

    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    25
    
    
    
    25Income
(loss) before income taxes (5)
    
    
    62,177
    
    
    
    (2,066
    )
    
    
    (7,316
    )
    
    
    
    
    
    
    (28,579
    )
    
    
    24,216Income taxes (5)
    
    
    23,472
    
    
    
    (780
    )
    
    
    (2,762
    )
    
    
    
    
    
    
    (10,788
    )
    
    
    9,142Net income (loss) (5)
    
    $
    38,705
    
    
    $
    (1,286
    )
    
    $
    (4,554
    )
    
    $
    
    
    
    $
    (17,791
    )
    
    $
    15,074
   (1)
    
    Represents operating results attributable to Base Practices for which we
were recording patient revenue as of September 30, 2004.(2)
    
    Represents centers that had been operating and affiliated with us for
more than 18 months as of the respective date, or that had been operating
for less than 18 months as of the respective date but had begun to
generate operating profits.(3)
    
    Represents recently-developed centers that had been operating for 18
months or less and that had not begun to generate operating profits on a
cash basis as of the respective date.(4)
    
    Represents operating results attributable to Inactive Practices,
including practices that have bought out of or otherwise terminated their
Service Agreements, during the three and nine months ended September 30,
2004 and 2003.(5)
    
    For purposes of this table only, in determining the expenses and
operating income, we did not allocate our corporate overhead costs,
interest expense (net) and non-controlling interest to these practices.
We did, however, allocate income taxes to the respective practices.(6)
    
    Practice-related expenses include all expenses directly associated with
the operations of the practice, including amounts retained by
practitioners. Comparison of Financial Results of Three and Nine Months Ended September 30,
2004 and 2003 The following discussion provides an analysis of our results of operations
for the three and nine months ended September 30, 2004 and 2003. As a result of
adopting the provisions of FIN 46R, the presentation of our condensed
consolidated statements of income (loss) for the three and nine months ended
September 30, 2004 and 2003 has changed. Our adoption of FIN 46R had a
significant impact on our results of operations and financial condition and
significantly impacts the comparability of our consolidated financial
statements for prior periods. As a result, we have included in our discussion
below a comparison of actual results for the three and nine months ended
September 30, 2004 to pro forma results for the three and nine months ended
September 30, 2003 assuming the adoption of FIN 46R was effective January 1,
2003. In addition, we now classify expenses associated with our corporate
headquarters into General and Administrative expense and classify expenses
directly associated with the operation of affiliated practices (except for
OutSource Practices) to their respective line items within Practice-related
expenses. Net Income (Loss). Net loss for the three months ended September 30, 2004
was $3.5 million compared to net income of $11.9 million for the same period in
2003. The $15.4 million decrease was 32




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##### Table of Contents



primarily due to an increase
of $13.5 million in provision for assets
associated with inactive practices, an increase of $1.7 million in loss on sale
of assets, and an increase of $29.7 million due to amounts retained by
practitioners. Partially offsetting these amounts was a decrease of
$4.5
million in general and administrative expense, a decrease of $2.6 million in
amortization expense and a net change of $11.3 million in revenue as a result
of the change in our revenue recognition policy. Net loss
for the nine months ended September 30, 2004 was $68.7 million
compared to net income of $40.2 million for the same period in 2003. Our net
loss during the nine months of 2004 was primarily related to a cumulative
effect of a change in accounting principle of $74.7 million, net of income tax
benefit of $41.4 million, recorded during the first quarter of 2004. Also
contributing to the net loss for the nine months ended September 30,
2004 was an increase of $14.2 million in
provision for assets associated with inactive practices, an increase
of $3.1
million in loss on sale of assets, and an increase of $91.7 million due to
amounts retained by practitioners. Partially offsetting these amounts was a
decrease of $3.3 million in general and administrative expense, a decrease of
$7.6 million in amortization expense and a net change of $25.6 million in
revenue as a result of the change in our revenue recognition policy. On a Pro Forma Basis, net income for the three months ended September 30,
2003 was $4.3 million. The decrease of $7.9 million in net
income during the third quarter of 2004 compared to the same period
in 2003 on a Pro
Forma Basis was primarily due to the following:  
    
    a decrease of $5.3 million in patient revenue;  
    
    an increase of $13.5 million in provision for assets associated with inactive practices; and  
    
    an increase of $1.7 million in loss on sale of assets. The overall decrease was partially offset by a decrease of $5.3 million in
practice-related expenses and a decrease of $2.3 million in general and
administrative expense. On a Pro Forma Basis, income before cumulative effect of change in
accounting principle for the nine months ended September 30, 2003 was $15.1
million. The $9.1 million decrease in income before cumulative effect of change
in accounting principle on a Pro Forma Basis was primarily due to the
following:  
    
    a decrease of $14.0 million in patient revenue,  
    
    an increase of $14.2 million in provision for assets associated with inactive practices; and  
    
    an increase of $3.1 million in loss on sale of assets. The overall decrease was partially offset by a decrease of $15.0 million in
practice-related expenses and a decrease of $2.6 million in asset impairments. 33




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##### Table of Contents



Our
net income (loss) during the three and nine months ended September 30, 2004
also was negatively impacted by operating losses and other expenses incurred in
connection with the development of de novo centers. During the three months
ended September 30, 2004, we incurred operating losses associated with de novo
centers of approximately $1.1 million, compared to $0.4 million during the same
period in 2003. During the nine months ended September 30, 2004, we incurred
operating losses associated with de novo centers of approximately $3.4 million,
compared to $1.4 million for the same period in 2003. The
development of de novo centers with new and existing affiliated practices provides us with
opportunities for future growth and increased revenue and profits in the
long-term, and we believe that it is more effective and less capital-intensive
than affiliating with established practices. However, these developments have a
negative impact on our net income in the short-term in that de novo centers
typically generate initial operating losses during their first 12 to 18 months
of operations and experience relatively lower operating margins than mature
centers. We typically finance all of the operating losses incurred in
connection with de novo practices and centers, and we typically fund a portion
of the compensation of affiliated practitioners during the startup or expansion
phase of their practices. We record these amounts as practice-related expenses
in our condensed consolidated statements of income (loss) when incurred. The
practices generally repay these amounts, including accrued interest, over a
five-year period when the de novo center becomes profitable. We expect
operating losses associated with the de novo centers to be short-term and that
these centers will have a positive contribution to our financial results after
their startup phase. Despite the short-term losses, we intend to continue to invest
in our existing affiliated centers and develop additional de novo centers to
grow our business. The following discussion relates to significant factors that affected our
consolidated net income (loss) during the three and nine months ended September 30, 2004: Patient Revenue and Fee Revenue. The consolidation provisions of FIN 46R
requires us to record patient revenue of affiliated practices in our
consolidated financial statements. Patient revenue is recognized on a
straight-line basis over the term of the patient contract, except for a portion
related to retainers, which is recognized in the final month of treatment when
braces are removed and a retainer is provided to the patient. Prior
to January 1, 2004, fee revenue
represented amounts related to services provided to affiliated practices and
recorded under our revenue recognition policy. Fee
revenue was $92.7 million and $293.6 million for the three and nine months
ended September 30, 2003, respectively. Service fees from OutSource Practices
are recognized as revenue when earned. We currently charge OutSource Practices
a monthly service fee based either on a percentage of the practices cash
collections or a fixed monthly service fee. 34




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##### Table of Contents



Patient revenue for the three months ended September 30, 2004 decreased
$5.3 million, or 4.9%, to $104.0 million from $109.3 million for the same
period in 2003 on a Pro Forma Basis. Patient revenue for the nine months ended
September 30, 2004 decreased $14.0 million, or 4.2%, to $319.2 million from
$333.2 million for the same period in 2003 on a Pro Forma Basis. These
decreases were primarily due to a significant decrease in the amount of patient
revenue attributable to Inactive Practices, as indicated in the following
table: Three months ended
    
    Increase/September 30,
    
    (Decrease)2004
    
    2003
    
    Dollar amount
    
    PercentageProActual
    
    Pro Forma (3)
    
    Actual
    
    Pro Forma
    
    Actual
    
    Forma(in thousands, except percentage data)Base Practices (1)
    
    $
    103,133
    
    
    $
    86,820
    
    
    $
    99,193
    
    
    $
    16,313
    
    
    $
    3,940
    
    
    
    18.8
    %
    
    
    4.0
    %OutSource Practices
    
    
    29
    
    
    
    
    
    
    
    
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/AInactive Practices (2)
    
    
    825
    
    
    
    5,910
    
    
    
    10,098
    
    
    
    (5,085
    )
    
    
    (9,273
    )
    
    
    (86.0
    )%
    
    
    (91.8
    )%Total revenue
    
    $
    103,987
    
    
    $
    92,730
    
    
    $
    109,291
    
    
    $
    11,257
    
    
    $
    (5,304
    )
    
    
    12.1
    %
    
    
    (4.9
    )%
 Nine months ended
    
    Increase/September 30,
    
    (Decrease)2004
    
    2003
    
    Dollar amount
    
    PercentageProActual
    
    Pro Forma (3)
    
    Actual
    
    Pro Forma
    
    Actual
    
    Forma(in thousands, except percentage data)Base Practices (1)
    
    $
    312,268
    
    
    $
    262,026
    
    
    $
    288,842
    
    
    $
    50,242
    
    
    $
    23,426
    
    
    
    19.2
    %
    
    
    8.1
    %OutSource Practices
    
    
    35
    
    
    
    
    
    
    
    
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/A
    
    
    
    N/AInactive Practices (2)
    
    
    6,898
    
    
    
    31,557
    
    
    
    44,389
    
    
    
    (24,659
    )
    
    
    (37,491
    )
    
    
    (78.1
    )%
    
    
    (84.5
    )%Total revenue
    
    $
    319,201
    
    
    $
    293,583
    
    
    $
    333,231
    
    
    $
    25,618
    
    
    $
    (14,030
    )
    
    
    8.7
    %
    
    
    (4.2
    )%
   (1)
    
    Represents patient revenue of Base Practices for which we were recording
patient revenue as of September 30, 2004.(2)
    
    Represents patient revenue attributable to Inactive Practices during the
three and nine months ended September 30, 2004 and 2003 for which we
recorded patient revenue or fee revenue during the respective period but
for which we had ceased to record patient revenue at September 30, 2004.(3)
    
    Represents patient revenue on a Pro Forma Basis as if our change in
accounting principle pursuant to FIN 46R was effective as of January 1,
2003. As indicated in the table above, during the three months ended September
30, 2004, patient revenue attributable to Base Practices increased $3.9 million
or 4.0%, which was offset by a $9.3 million or 91.8% decrease in patient revenue
attributable to Inactive Practices, as compared to the same period in 2003 on a
Pro Forma Basis. This increase in patient revenue attributable to Base
Practices was primarily due to a 2.6% increase in patient revenue during the
three months ended September 30, 2004, compared to the same period of 2003 on a
Pro Forma Basis, for comparable Base Practices for which we recorded patient
revenue throughout the three months ended September 30, 2004 and
2003. During the three months ended September 30, 2004, Florida
and the Gulf coast experienced several hurricanes, which disrupted
the operations of our affiliated practices located in those areas.
These disruptions resulted in lower than expected patient revenue for
these practices during the quarter. Similarly, during the nine months ended September 30, 2004, the $23.4
million or 8.1% increase in patient revenue attributable to Base Practices was
offset by a $37.5 million or 84.5% decrease in patient revenue attributable to
Inactive Practices, as compared to the same period in 2003 on a Pro Forma
Basis. This increase in patient revenue attributable to Base Practices was
primarily due to a 7.8% increase in patient revenue during the nine months
ended September 30, 2004, compared to the same 35




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period of 2003 on a Pro Forma Basis, for comparable Base Practices for
which we recorded patient revenue throughout the entire nine months ended
September 30, 2004 and 2003. These decreases in patient revenue attributable
to Inactive Practices resulted as we ceased to record patient revenue during
the nine months ended September 30, 2004 for Inactive Practices for which we
recorded fee revenue during the same period during 2003. We
expect some continued fluctuations in patient revenue as some affiliated
practices may buy out of their Service Agreements or stop paying service fees
and providing certain financial information which we use to compute patient
revenue. However, certain practices that are not currently included in our
results may begin utilizing our services and paying service fees in the future
or may be transitioned to another practice. The decline in patient revenue from
practices for which we discontinued recording revenue also contributed to a
decline in direct expenses, as discussed below. We expect the results
attributable to Base Practices to increase over time and to offset the decrease
in patient revenue from Inactive Practices for which we no longer record
patient revenue. Practice-Related Expenses. Practice-related expenses are expenses that
directly relate to the operation of affiliated practices (other than OutSource
Practices), including the following:  
    
    Amounts retained by practitioners, which represents amounts
that have been retained by practitioners under the contractual terms
of their Service Agreements. The consolidation provisions of FIN 46R
require us to record these amounts in our financial statements.
Amounts retained by practitioners primarily includes compensation of
owner-practitioners and associate-practitioners;  
    
    Salaries and benefits, which includes payroll and benefits
costs for employees at our affiliated centers (which do not include
the amounts retained by orthodontists, dentists and other practitioners);  
    
    Clinical supplies and lab fees, which primarily represents
the costs of bands, brackets, wires, retainers and other removable
or fixed appliances and laboratory costs incurred in treating
patients by our affiliated practices;  
    
    Rent expense, which primarily consists of costs of leasing
office space, including common area maintenance charges, for our
affiliated centers;  
    
    Marketing and advertising expense, which represents costs
associated with television, radio and print media advertising for
affiliated practices; and  
    
    Other operating costs, which represents other costs incurred
in the operation of our practices, including costs for telephone,
utilities, office supplies, general liability and property insurance
coverage. During the three months ended September 30, 2004, practice-related
expenses increased $28.3 million, or 52.0%, to $82.7 million from $54.4 million
for the same period in 2003. This overall increase during the three months
ended September 30, 2004 was primarily due to amounts retained by
practitioners. On a Pro Forma Basis, practice-related expenses decreased $5.3
million, or 6.0%, to $82.7 million for the three months ended September 30,
2004 from $88.0 million for the three months ended September 30, 2003. Amounts
retained by practitioners totaled $29.7 million, or 28.6% of patient revenue,
for the three months ended September 30, 2004. On a Pro Forma Basis, amounts
retained by practitioners was $33.6 million, or 30.7% of patient revenue, for
the three months ended September 30, 2003. The decrease of $3.8 million on a
Pro Forma Basis in amounts retained by practitioners during the 36




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three months ended September 30, 2004 was primarily due to a decrease in
amounts retained by practitioners from Inactive Practices. During the nine months ended September 30, 2004, practice-related expenses
increased $76.4 million, or 43.2%, to $253.2 million from $176.8 million for
the same period in 2003. Excluding amounts retained by practitioners, all
other practice-related expenses decreased $15.4 million or 8.7% to $161.5
million for the nine months ended September 30, 2004 from $176.8 million for
the same period in 2003. The decrease in all other practice-related expenses
was due to the following:  
    
    Salaries and benefits decreased $6.0 million, or 8.0%, to $69.3 million from $75.3 million;  
    
    Rent decreased $5.0 million, or 19.6%, to $20.4 million from $25.3 million;  
    
    Clinical supplies and lab fees decreased $2.3 million, or
7.7%, to $27.7 million from $30.1 million; and  
    
    Marketing and advertising expenses decreased $1.8 million, or
9.3%, to $17.2 million from $18.9 million. These decreases were primarily due to a net reduction in the number of
affiliated practices for which we recorded practice-related expenses during the
three and nine months ended September 30, 2004, as a result of practices that
bought out of their Service Agreements or for which we generally ceased to
record fee revenue or patient revenue after September 30, 2003. Our adoption
of FIN 46R did not affect practice-related expenses other than amounts retained
by affiliated practices. Offsetting the overall decrease in all other practice-related expenses is
amounts retained by practitioners which totaled $91.7 million, or 28.7% of
patient revenue, for the nine months ended September 30, 2004. On a Pro Forma
Basis, amounts retained by practitioners was $91.4 million, or 27.4% of patient
revenue, for the nine months ended September 30, 2003. During the nine months
ended September 30, 2004, we experienced an increase in amounts retained by
practitioners from our Base Practices primarily as a result from the growth in
patient revenue of these practices. The increase in amounts retained by
practitioners as a percentage of patient revenue on a Pro Forma Basis was
primarily due to an increase in the profitability of certain affiliated
practices, increased participation in our service fee rebate incentive program
for higher revenue producing practices, the phase-out of corporate-level
expense allocation among certain affiliated practices, and the increase in
compensation of practitioners as a result of changes in economic arrangements
with us. The decrease in amounts retained by practitioners from Inactive
Practices during the nine months ended September 30, 2004 more than offset the
increase in amounts retained by practitioners from our Base Practices. General and Administrative. General and administrative expense represents
all costs associated with the operation of our corporate headquarters,
including corporate overhead associated with providing centralized collections,
financial reporting and other business services to our affiliated practices.
These costs include salaries and benefits for corporate employees, rent of our
corporate office, telephone, utilities, accounting and legal services, office
supplies, general liability and property insurance coverage and provisions for
uncollectible amounts. During the three months ended September 30, 2004,
general and administrative expense decreased $4.5 million, or
41.6%, to $6.3
million, from $10.9 million during the same period of 2003. During the nine months ended
 September 30, 2004, general and
administrative expense was $23.8 million, which represented a
$3.3 million or
12.1% decrease from $27.1 million during the same period of
2003. These decreases during the three and nine months ended September
30, 2004 were primarily due to decreases in the provision for uncollectible
amounts of $3.1 million and $4.9 million, respectively. Partially offsetting the decrease in general
and administrative expense during the nine months ended September 30,
2004 was an increase in
accounting and legal expenses associated with our change in independent auditors,
our annual audit, our change in accounting principle as a result of adopting
FIN 46R and accounting and legal costs relating to the requirements under the Sarbanes-Oxley Act of
2002, including preparation for managements assessment of our internal control
over financial reporting and a related attestation report by our independent
auditors.
We expect to incur additional accounting and legal costs during the
remainder of 2004, relating to the requirements under the
Sarbanes-Oxley Act of 2002. As a result of our adoption of FIN 46R effective January 1, 2004, we no longer
record on our balance sheet cash advances to affiliated practices against
future distributions and amounts due under Service Agreements and, accordingly,
we no longer 37




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provide an allowance
associated with these advances, which decreased our provision for
uncollectible amounts for the three and nine months ended September
30, 2004. Also contributing to the decrease in our provision for
uncollectible amounts is our change in revenue recognition policy. We
changed our revenue recognition policy as a result of FIN 46R. We now
provide an allowance for uncollectible amounts based on a percentage
of patient receivables as compared to a percentage of service fees
receivable. At September 30,
2004, advances to practitioners primarily relate to short-term differences
between amounts distributed to practitioners and amounts that the practitioners
are entitled to retain under their Service Agreements. Gain (Loss) on Sale of Assets. During the three and nine months ended
September 30, 2004, we incurred loss on sale of assets of
approximately $1.7
million and $3.3 million ($1.1 million and $2.1 million, net of income tax
benefit), respectively, as a result of practices buying out of their Service
Agreements at amounts less than the book value of assets associated with those
practices. We received an aggregate of $0.1 million and $2.5 million in cash from these
buyouts during the three and nine months ended September 30, 2004. Provision for Assets Associated with Inactive Practices. During the three
months ended September 30, 2004, we recorded $13.5 million in provision for
assets associated with inactive practices to increase the allowance for these
assets and reduce the carrying value of these assets to estimated fair value.
For the nine months ended September 30, 2004, we recorded a
total of $14.2
million in provision for assets associated with inactive practices. At
September 30, 2004, we had a total of $30.2 million of assets associated with
inactive practices, net of an allowance of $15.5 million. These provisions were
based upon managements assessment of the recoverability of the
goodwill, identifiable intangibles and other assets
associated with inactive practices, which involved significant judgments and
estimates by management. We increased the allowance during the three months
ended September 30, 2004 due in part to certain recent
settlement payments to OCA and a recent court award to OCA that were significantly
less than the net book value of the goodwill, identifiable
intangibles and other assets associated with the relevant Inactive
Practices. The increase also
reflected our renewed efforts to attempt to resolve pending litigation on
mutually agreeable settlement terms. We have resolved disputes with
some other Inactive Practices by permitting the practices to buy out
of their Service Agreements for amounts in excess of the net book
value of the assets associated with those practices. Management evaluated the assets associated
with inactive practices on a practice-by-practice basis. Among other things,
management considered the amounts that we have received in recent settlements,
the
results of pending litigation since June 30, 2004, the estimated amount that a particular
practice could afford to pay in settlement based upon our knowledge of the
practices profitability, the age of the practitioner and the likelihood of
locating a replacement practitioner and the amount originally paid to the
practice in consideration for affiliating with us. We particularly focused on
practices that had relatively large goodwill and identifiable intangible
assets associated with them. We believe the net amounts recorded as assets associated with inactive
practices are realizable as of September 30, 2004. However, adverse litigation
results could significantly affect the recoverability of these assets and may
require us to record additional impairment of these assets in the future.
Providing an allowance for assets associated with inactive practices does not
reflect a belief by management that Inactive Practices will ultimately prevail
in litigation pending between the practices and OCA or OrthAlliance, that the
Inactive Practices claims and allegations or these lawsuits have merit or that
our Service Agreements with Inactive Practices are not binding. Depreciation and Amortization. We depreciate our property,
equipment and improvements using the straight-line method over their
useful lives. Amortization represented the amortization expense
recorded in connection with the amortization of our identifiable
intangible assets. Depreciation and amortization expense was $4.0
during the three months ended September 30, 2004, compared to $6.4
million for the three months ended September 30, 2003. For the nine
months ended September 30, 2004, depreciation and amortization
expense was $11.8 million compared to $18.6 million for the same
period in 2003. The consolidation provisions under FIN 46R required
us, for financial reporting purposes only, to recognize affiliations
with our affiliated practices (other than Inactive Practices and
OutSource Practices) as business combinations, which resulted in us
recording as goodwill the amount of affiliation payments to obtain or
amend Service Agreements that exceed the fair value of tangible
assets acquired. We do not amortize goodwill or identifiable
intangible assets but test them for impairment under SFAS No. 142 at
the practice reporting unit level. We believe that no events or circumstances arose during the
third quarter of 2004 that would warrant an interim impairment test
other than the provision recorded in connection with our review of the
assets associated with inactive practices.
Amortization expense during the three and nine months ended September
30, 2004 decreased compared to the same periods in 2003 due to our
adoption of FIN 46R. 38




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Asset Impairments. During
the three and nine months ended September 30,
2003, we recorded impairments of approximately $0.6 million and $1.8 million,
respectively, related to property, equipment and improvements for offices
closed during 2003 and approximately $0.2 million and $0.8 million,
respectively, related to intangible assets. Income Taxes. Our effective income tax rate was 36.5% for the three and
nine months ended September 30, 2004, compared to 37.8% for the three and nine
months ended September 30, 2003. We record a liability for matters of
uncertainty or dispute with tax authorities as a component of deferred taxes.
We assess this liability on a quarterly basis and reduced our effective rate
during the three and nine months ended September 30, 2004. Cumulative Effect. During the nine months ended September 30, 2004, we
recorded a cumulative effect of a change in accounting principle of $74.7
million, net of income tax benefit of $41.4 million, with respect to our
adoption of FIN 46R effective January 1, 2004. See the table under Adoption
of FIN 46R  Consolidated Balance Sheets above for additional information
about the components of this cumulative effect. LIQUIDITY AND CAPITAL RESOURCES Cash and cash equivalents was $10.7 million at September 30, 2004 and $7.4
million at December 31, 2003. Our working capital (total current assets less
total current liabilities) was $72.3 million at September 30, 2004, compared to
$140.5 million at December 31, 2003. Our current ratio (total current assets
divided by total current liabilities) was 1.6 at September 30, 2004, compared
to 4.5 at December 31, 2003. The decrease in working capital at September 30,
2004 compared to December 31, 2003 was primarily due to a decrease of $96.7
million in service fees receivable and an increase of $91.8 million in deferred
revenue, offset by an increase of $124.3 million in patient receivables. The
changes in these accounts were primarily due to our adoption of FIN 46R
effective January 1, 2004 and the impact these changes had on certain of our
balance sheet items, including the items mentioned above. Uses of Capital We believe that our cash needs will primarily relate to capital
expenditures for existing affiliated practices and for the development of
additional centers, repayment of indebtedness, incentive payments, repurchasing
shares of OCA common stock, and general corporate purposes. Our cash needs
could vary significantly depending upon our growth, results of operations and
new affiliations with additional practices, as well as the outcome of pending
litigation and other contingencies. Capital Expenditures. Our capital expenditures primarily consist of costs
related to developing de novo centers and remodeling, refurbishing and
maintaining existing centers for our affiliated practices. The average cost of
developing a new orthodontic center in the United States is about $350,000,
including the cost of equipment, leasehold improvements, working capital and
start-up losses associated with the initial operations of the orthodontic
center. We generally bear an affiliated practices portion of these costs until
we are reimbursed by the practice. Under most of our Service Agreements, the
affiliated practices repay these costs over a five-year period. In some cases,
we have assisted our practices in obtaining financing for their share of these
costs by providing a guaranty of loans from a third-party lender. We generally no
longer guarantee new debt for our affiliated practices. To facilitate growth in recent years, our capital expenditures have been
directed toward developing de novo centers for our affiliated practices and to
a lesser extent, remodeling and expanding 39




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our existing affiliated centers to increase potential capacity. We have
committed to develop additional de novo centers and remodel existing centers
for affiliated practices. We currently estimate that these developments and
remodelings will require approximately $6.0 million of capital expenditures,
which we expect to incur during the remainder of 2004 and in 2005. We may commit to
additional developments and remodelings as well. Advances to Affiliated Practices. We advance cash to affiliated practices
primarily against future distributions of the practice or provide advances
relating to amounts due to us under service agreements. We generally advance
cash to affiliated practices to (a) fund compensation for the practices
affiliated practitioners during the startup or expansion phase of a newly
developed center, or (b) provide additional funds to affiliated practices for
certain practice-related matters or other unsecured financing. Newly-developed
affiliated practices and existing affiliated practices that expand their
capacity by adding additional centers or practitioners typically experience
cash flow needs until they begin generating sufficient operating profits at the
newly-developed or newly-expanded centers. We may advance funds to affiliated
practices to assist them in maintaining their compensation during the startup
or expansion phase of their practices. We also provide advances related to
amounts due to us under Service Agreements by (1) remitting more funds during
the quarter to the affiliated practice than the practice was actually entitled
to retain under its service agreement, or (2) paying expenses to third parties
on behalf of certain affiliated practices that collect their own patient fees
and currently have not reimbursed us for those expenses. These advances are payable on demand and generally interest free and
unsecured. We intend to fund these advances and any continued financing using
cash from operations and borrowings under our credit facility, if needed. See
Adoption of FIN 46R regarding accounting treatment of these advances. Advances and other amounts due from OutSource Practices represent advances
relating to amounts due to OCA from OutSource Practices under OutSource
Agreements. These amounts primarily represent funds that OCA has paid to third
party vendors on behalf of OutSource Practices for capital expenditures and
expenses associated with the operations of the OutSource Practices. Incentive Program Payments, Notes Payable and Debt Obligations. Certain
OrthAlliance affiliated practices are eligible, in connection with amending or
extending Service Agreements, to receive annual payments under our incentive
programs. In 2004, participants under these incentive programs earned $6.0
million, of which we have paid $4.9 million to certain
participants after offsetting amounts due from these practices and will pay
$0.3 million to two participants in early 2005.
Participants in these programs are eligible to receive annual payments under
these programs in 2005. At September 30, 2004, we had current maturities of
$8.3 million under our credit facility and $1.4 million due to our affiliated
practices. Stock Repurchase Program. In August 2003, OCAs Board of Directors
approved a common stock repurchase program that authorizes us to repurchase up
to 2.0 million shares of OCA common stock from time to time in the open market
at prevailing market prices or in privately negotiated transactions. OCA
anticipates making repurchases of its common stock in the future under this
program. Repurchased shares are held in treasury, and may be available for use
in connection with OCAs stock option plans, stock programs and acquisitions or
for other corporate purposes. Our credit facility limits our ability to
repurchase shares of OCA common stock. Sources of Capital We currently believe that we will be able to meet our anticipated funding
requirements for at least the next 12 months. We may consider a
debt financing during 2005 to refinance our existing credit facility and fund the repurchase of shares of
our common stock. We cannot assure you, however, that we will be able
to obtain such debt financing or that such financing will be
available on favorable terms. Our ability to meet these funding needs could be
adversely affected if we were to suffer adverse results from our operations, or
lose a material portion of our affiliated practices, if our affiliated
practices were to suffer adverse results of operations or a material 40




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loss of patients, if we suffer adverse
outcomes from pending litigation and other contingencies or if we violate the
covenants and restrictions of our credit facility. Cash from Operations.
During the nine months ended September 30, 2004, we
used our deferred tax assets relating to net operating loss carryforwards to
offset our tax provision for the first three quarters of 2004. These net
operating loss carryforwards primarily related to the cumulative effect of (a)
a change in accounting method for recognizing revenue for income tax purposes
approved by the IRS in January 2003 and (b) a change in
accounting method related to applicable class lives for certain long-lived
assets filed during 2003 pursuant to IRS rules that provide for an automatic
change in accounting method. We expect that the remaining net operating loss
carryforwards will offset our income tax liability for the remainder of 2004.
We expect to use the cash arising from this benefit to fund other operational
needs for the remainder of 2004. We also have deferred tax assets of $41.4
million recorded as a result of the cumulative effect from the adoption of FIN
46R. We anticipate monetizing this deferred tax asset in the future. Our Service
Agreements generally provide that our service fees generally
equal about 40% to 50% of a practices operating profit or about 17% of a
practices revenue, excluding reimbursement of practice-related expenses.
Beginning in 2003, we implemented an incentive program whereby we reduced
service fees charged to certain practices that achieve certain performance
levels which negatively affected our cash flow from operations. For the nine
months ended September 30, 2004, this incentive program resulted in a
$2.2 million reduction in service fees charged to these practices compared to a
$1.4 million reduction for the same period in 2003. We expect to continue this
incentive program in 2005. We have also reduced service fees charged to
certain other practices, which resulted in lower service fees collected from
these practices compared to the nine months ended September 30, 2003. In
addition, we have phased out 100% of the reimbursement of corporate-level
expense allocation among certain affiliated practices as of September 30, 2004.
We expect to continue using cash generated from operations and borrowings
under our credit facility to fund our growth and capital needs. Credit Facility.
We maintain a $125.0 million credit facility with a
lending group that consists of Bank of America, N.A., Bank One, N.A., U.S. Bank
National Association, Hibernia National Bank and Whitney National Bank. The
credit facility is comprised of a $100.0 million revolving line of credit and a
$25.0 million term loan. The revolving line of credit provides funding for our
general working capital and expansion. Borrowings under the credit facility
generally bear interest at varying rates above the lenders prime rate ranging
from 0.50% to 1.50% or above the Eurodollar rate ranging from 1.50% to 2.50%.
This margin is based on our leverage ratio as computed under the credit
facility. Amounts borrowed under the credit facility are secured by a security
interest in the capital stock of our operating subsidiaries. The revolving
line of credit expires January 2, 2006. At December 20,
2004, $85.6 million
was outstanding under the revolving line of credit and $10.2 million was
outstanding under the term loan. The term loan is fully amortizing over three
years with level, quarterly principal payments of $2.1 million, plus interest. Our credit
facility requires that we maintain certain financial and
non-financial covenants under the terms of the credit agreement, including a
maximum leverage ratio, minimum fixed charge coverage ratio, minimum
consolidated net worth and maximum ratio of funded debt to total patient
contract balances. The credit agreement also imposes restrictions on our
acquisitions, investments, dividends, stock repurchases and other aspects of
our business. If we do not comply with these covenants and restrictions, the
lenders could demand immediate payment of all amounts borrowed under the credit
facility, and terminate or limit our ability to borrow funds under the credit facility.
If we were to experience an event or matter that has, or is reasonably likely
to have, a material adverse effect (as defined in the credit facility) on us,
we would be unable to borrow additional amounts under the credit facility
without a waiver by our lenders or an amendment to the credit facility. We
cannot assure you that we could obtain such a waiver or amendment, which could
have a material adverse impact on our liquidity and capital 41




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resources. Cash Flows The following table summarizes cash flow information for the nine months ended
September 30, 2004 and 2003: Nine months ended September 30,2004
    
    2003Net cash provided by operating activities
    
    $
    26,177
    
    
    $
    35,621Net cash used in investing activities
    
    
    (15,568
    )
    
    
    (17,152
    )Net cash used in financing activities
    
    
    (7,254
    )
    
    
    (16,437
    )Change in cash and cash equivalents
    
    
    3,310
    
    
    
    2,846
 Operating Activities.
See our discussion of net income in the section
above captioned  Results of Operations. Our working
capital decreased 48.5%
to $72.3 million at September 30, 2004 from $140.5 million at December 31,
2003, primarily as a result of our adoption of FIN 46R. Investing Activities.
Net cash used in investing activities during the
nine months ended September 30, 2004 was $15.6 million
compared to $17.2
million during the same period in 2003. The decrease in cash used was
primarily due to our receipt of $2.5 million in cash from practices that have bought out of their
Service Agreements during the nine months ended September 30,
2004 and a $2.2 million decrease in notes receivable. Partially
offsetting this decrease was an increase of $2.2 million in purchases of
property, equipment and improvements. We used
$16.2 million and $13.9 million in cash
to purchase property, equipment and improvements during the nine months ended
September 30, 2004 and 2003, respectively. These expenditures primarily
related to the development of new or de novo centers in the United States and
abroad and to a lesser extent, the remodeling or refurbishing of existing
centers. We expect to make additional purchases of property, equipment and
improvements in future periods as we open and refurbish additional
centers. We
have committed to develop additional de novo centers and remodel existing
centers for affiliated practices. We currently estimate that these developments
and remodeling will require approximately $6.0 million of capital expenditures,
which we expect to incur during the remainder of 2004 and during 2005. We may
commit to additional developments and remodeling as well. Financing Activities. Net cash used in financing activities was $7.3
million and $16.4 million for the nine months ended September 30, 2004 and
2003, respectively. During
the nine months ended September 30, 2004, we repaid $5.3 million
less of principal and interest under our credit facility compared to the same period in 2003.
During the nine months ended September 30, 2003, we obtained a new credit
facility under which we borrowed $109.9 million to retire our prior credit
facility and bridge credit facility and to pay related transaction
costs. At December 20, 2004, $85.6 million was outstanding under the
revolving line of credit and $10.2 million was outstanding under the
term loan components of the credit facility. We may incur additional
indebtedness to fund the development of additional de novo
centers and remodeling of existing centers. NEW ACCOUNTING
PRONOUNCEMENTS In
December 2003, the FASB issued revised SFAS No. 132,
Employers Disclosures about Pensions and Other Postretirement
Benefits an amendment of FASB Statements
No. 87, 88, and 106. This statement revises
employers disclosures about pension plans and other
postretirement benefit plans. It does not change the measurement or
recognition of those plans required by SFAS No. 87,
Employers Accounting for Pensions, SFAS
No. 88, Employers Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for Termination
Benefits and SFAS No. 106, Employers Accounting for
Postretirement Benefits Other Than Pensions. Except as noted,
this statement was effective for financial statements with fiscal
years ending after December 15, 2003. The adoption of revised
SFAS No. 132 on January 1, 2004 had no impact on OCAs
financial condition or results of operations. On December 16, 2004, the FASB issued SFAS No. 123R, Share-Based Payment, which requires
that all forms of share-based payments to employees, including employee stock options and employee
stock purchase plans, be treated the same as other forms of compensation by recognizing the related
cost in the income statement. This statement would replace the existing requirements under SFAS
No. 123 and APB No. 25. This statement would also eliminate the ability to account for stock-based
compensation transactions using the intrinsic value method of APB No. 25 and generally would
require that such transactions be accounted for using a fair-value option pricing model, either a
binomial model or the Black-Scholes valuation model. The statement would
apply to awards that are granted, modified or settled in cash in interim or
annual periods
beginning after June 15, 2005. We are currently analyzing the impact
that adoption of the statement
will have on our financial position and results of operations. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK During the nine months ended September 30, 2004, there were no material
changes to the quantitative and qualitative disclosures about market risks
presented in OCAs Annual Report on Form 10-K for the year ended December 31,
2003. 42




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ITEM 4. CONTROLS AND PROCEDURES Evaluation of Disclosure
Controls and Procedures OCA, with the participation of its management, including its Chief
Executive Officer and Chief Financial Officer, carried out an evaluation of the
effectiveness of the design and operation of its disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities
Exchange Act of 1934) as of the end of the period covered by this Report.
Based upon that evaluation and as of the end of the period covered by this
Report, OCAs Chief Executive Officer and Chief Financial Officer concluded
that its disclosure controls and procedures are effective in timely alerting
them to information required to be disclosed in reports that OCA files with or
submits to the Securities and Exchange Commission under the Securities Exchange
Act of 1934, subject to the matters discussed in the following subsections. Changes in Internal
Control Over Financial Reporting In April 2004, OCA received a letter dated March 15, 2004 from Ernst &
Young LLP, its former independent auditors, stating that they believed that
there were material weaknesses in internal controls over OCAs financial
statement close process. OCAs senior management has reviewed each of the items
cited as material weaknesses in the letter from Ernst & Young and discussed
these matters with our Audit Committee. Management determined that certain
items in the letter are no longer applicable due to our adoption of FIN 46R
and the change in revenue recognition policy effective January 1, 2004. Among other
results, these changes eliminated the need to calculate fee revenue and service
fees receivable, since these accounts are no longer recorded in our
consolidated financial statements. The determination of fee revenue under our
prior revenue recognition policy required complex and data-intensive
calculations by management, including determination of the portion of a
straight-line allocation of patient contract amounts estimated to be retained
by affiliated practices in future periods, and the portion of unreimbursed
practice-related expenses that was secured by patient fees receivable and
hence currently recognizable as fee revenue. These calculations are not applicable under our
new revenue recognition policy. In addition, some of the items cited in the
letter from Ernst & Young are being addressed in connection with our ongoing
efforts to prepare for the managements assessment of our internal control over
financial reporting and related attestation by our independent auditors to be
required under rules adopted by the SEC under Section 404 of the Sarbanes-Oxley
Act of 2002 (Section 404). Since June 30, 2004, we have taken certain steps to enhance our internal
control over financial reporting. We intend to add additional
resources in our financial accounting area, which we believe will improve
segregation of duties with respect to our financial accounting. We
have taken steps to improve communication between our operations and financial
accounting areas by having periodic meetings to discuss operational changes and
practice transitions, and by appointing representatives of both areas to our
Disclosure Committee that considers disclosure to be included in periodic
reports we file with the SEC. We also have formed a committee that includes
representatives of our operations, legal and financial accounting areas to
discuss and assess periodically our pending litigation with affiliated
practices and assets associated with inactive practices. We continue to further
document and enhance our controls and procedures, but we have not
yet completed the testing of their operating effectiveness. Section 404
Assessment and Attestation The SEC has adopted rules under Section 404 that require that we include in our Annual Report
 on Form 10-K (beginning with our 2004 Form 10-K) a report by OCAs management about its
 assessment of the effectiveness of our internal control over financial reporting as of the end
 of the fiscal year (the Management Assessment), including a statement as to whether or not our
 internal control over financial reporting is effective.  We must also include in the Form 10-K an
 attestation report by our independent auditors on the Management Assessment (the Attestation).
 Management is not permitted to conclude that our internal control over financial reporting is
 effective if there are one or more material weaknesses in our internal control over financial
 reporting, and we must disclose any material weaknesses identified. The SEC issued an exemptive
 order on November 30, 2004 that granted certain public companies, including OCA, up to an
 additional 45 days to file their Management Assessment and related Attestation in connection
 with their 2004 Annual Report on Form 10-K.  In order to take advantage of this extension, OCA
 must file its 2004 Form 10-K within the SECs prescribed time limit and note in the Form 10-K
 that the Management Assessment and Attestation have been omitted, and then file an amendment to
 the Form 10-K which includes the Management Assessment and
Attestation by May 2, 2005. We currently anticipate that we will seek
to take advantage of this extension in order to provide additional
time for us and our independent auditors to prepare for the Management
Assessment and Attestation. We are in the process of documenting and testing our internal control over financial reporting in
 connection with the Management Assessment and related Attestation for our 2004 Form 10-K. We have
 devoted significant resources to this process and have engaged outside consultants to advise us.
  We have not completed the testing of the operating effectiveness of these controls and
 procedures, which may indicate deficiencies and weaknesses that need to be remediated. We may be
unable to remediate these deficiencies and weaknesses before the deadline for the Management
Assessment. We have experienced delays in completing our preparations for the Management Assessment
and Attestation, and we have very limited time remaining to complete the preparations. Our current
plan and timeline for this project contains many time-critical milestones. We may not meet these
milestones, which could prevent us from achieving our goal. Our
 independent auditors advised us and our Audit Committee that they had serious concerns that we
 would not be in a position to complete our Management Assessment on a timely basis. If we do not
 timely complete the Management Assessment, our independent auditors might not have sufficient
 time to successfully test our internal control over financial reporting in connection with their
 Attestation before the filing deadline for the Management Assessment and Attestation.  We are
 working to meet these deadlines, but we cannot assure you that we will be able to do so. During the Section 404 process, we may identify one or more material weaknesses in our internal
 control over financial reporting, and we may be unable to remediate those weaknesses before the
 Management Assessment. We cannot assure you that our management will conclude that our internal
 control over financial reporting is effective. Our independent auditors may not be satisfied with
 our internal control over financial reporting or the level at which these controls are
 documented, designed, operated or reviewed, and they may decline to
attest to managements assessment or may issue a qualified attestation report. If any of these events were to occur, it
 could subject us to regulatory scrutiny and could lessen investor confidence in the reliability
 of our internal control over financial reporting.  We also expect that the evaluation,
 documentation and testing process and any required remediation will increase our accounting,
 legal and other expenses and will require a significant amount of
our managements time and attention. 43




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PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS OCA and its subsidiary OrthAlliance are engaged in litigation with a
number of Inactive Practices. Before OCA agreed to acquire OrthAlliance in
November 2001, OCA anticipated that some portion of OrthAlliances affiliated
practices would oppose the transaction. A description of actions brought by
certain OrthAlliance affiliated practices and the claims in these actions is
contained in Item 3 of Part I to OCAs Annual Report on Form 10-K for the year
ended December 31, 2003. On April 23, 2002, Dr. David C. Hobson filed an action in the U.S.
District Court for the Eastern District of California against OCA and its
subsidiary, alleging that OCA breached its business services agreement with Dr.
Hobson, breached an alleged fiduciary duty to Dr. Hobson and committed
allegedly unfair business practices. On August 9, 2002, OCA filed a
counterclaim against Dr. Hobson seeking contract and equitable damages. The
case was tried from July 13 to August 13, 2004. The jury in the case rendered
a verdict in favor of OCA on Dr. Hobsons claim that OCA breached its fiduciary
duty, but found that OCA had breached a provision of Dr. Hobsons business
services agreement and awarded Dr. Hobson approximately $82,000 in damages. On
September 14, 2004, the court entered an amended judgment awarding $301,000 in
damages to OCA in connection with its counterclaims against
Dr. Hobson. On November 23, 2004, the court granted
Dr. Hobsons motion for attorneys fees in the amount
of approximately $485,000, and denied OCAs motions for
attorneys fees and changes in the amounts previously awarded to OCA
and Dr. Hobson. OCA is considering an appeal of these rulings.
 On September 28, 2004, OCA filed an action against Dr. Hobson seeking payment of
approximately $80,000 of indebtedness owed to OCA by Dr. Hobson
under three promissory notes. On May 22, 2001, Dr. T. Barry Clower, and his professional corporation
filed an action in the U.S. District Court for the Northern District of Georgia
against OrthAlliance, alleging OrthAlliance had breached its service agreement
with Dr. Clowers practice and that the agreement violated Georgias
prohibition of the corporate practice of dentistry. On September 24, 2004, the
court ruled in favor of OrthAlliance that the service agreement between
OrthAlliance and Dr. Clowers practice is legal and enforceable and does not
violate Georgia law governing the practice of dentistry. The court also ruled
that the parties covenants not to compete were reasonable and enforceable
against Dr. Clower. In addition, the court held that Dr. Clowers practice
breached his service agreement with OrthAlliance and that OrthAlliance is owed
damages for such breach. The court rejected Dr. Clowers claim that
OrthAlliance had breached his service agreement. The court also held that
OrthAlliance could enforce over $200,000 of promissory notes owed by Dr.
Clowers practice to OrthAlliance. 44




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Because litigation
is inherently uncertain, we cannot assure you that OCA
or its subsidiaries will prevail in any of these or other lawsuits, nor can we
estimate with reasonable certainty the amount of damages we might incur or the
amount of any award we might receive. OCA and its affiliated practices are, and
from time to time may become, party to other litigation or administrative
proceedings which arise in the normal course of business. Regardless of the
outcome of such litigation and proceedings, they could be costly and time-consuming
and could divert the time and attention of our senior management. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS A special meeting of OCA stockholders was held on August 26, 2004. At this
meeting, the following matters were voted upon by OCA stockholders:  (a)
    
    Name change of Orthodontic Centers of America, Inc. to OCA, Inc. Votes Cast
    
    Votes Cast
    
    Abstentions/In Favor
    
    Against
    
    Non-Votes44,039,431
    
    
    320,843
    
    
    
    124,316
  (b)
    
    Stockholder proposal that OCA adopt a policy that independent directors
would constitute two-thirds of the Board of Directors. Votes Cast
    
    Votes Cast
    
    Abstentions/In Favor
    
    Against
    
    Non-Votes190,664
    
    
    15,511,842
    
    
    
    18,668,662
 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS Exhibit number
    
    Description3.1
    
    Bylaws of the Registrant (incorporated by reference to
exhibits filed with the Registrants Registration Statement
on Form S-1, Registration Statement No. 33-85326)3.2
    
    Restated Certificate of Incorporation of the Registrant
(incorporated by reference to exhibits filed with the
Registrants Registration Statement on Form S-1,
Registration Statement No. 33-85326)3.3
    
    Certificate of Ownership and Merger merging OCA, Inc., a
wholly-owned subsidiary of the Registrant, with and into
the Registrant (incorporated by reference to exhibits filed
with the Registrants Current Report on Form 8-K
filed on August 30, 2004 (File No. 001-13457))4.1
    
    Specimen Stock Certificate (incorporated by reference to
exhibits filed with the Registrants Registration Statement
on Form S-1, Registration Statement No. 33-85326)4.2
    
    Rights Agreement, dated as of March 3, 2004, including as
Exhibit A the form of
 45




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Exhibit number
    
    DescriptionCertificate of Designation of Series
A Junior Participating Preferred Stock of Orthodontic
Centers of America, Inc., as Exhibit B the form of Rights
Certificate and as Exhibit C the summary of Rights to
Purchase Preferred Shares (incorporated by reference to
exhibits filed with the Registrants Registration Statement
on Form 8-A filed on March 4, 2004 (File No. 001-13457))4.3
    
    Amendment to Rights Agreement, dated as of May 27, 2004,
between Orthodontic Centers of America, Inc. and EquiServe
Trust Company, N.A (incorporated by reference to exhibits
filed with the Registrants Amendment to Registration
Statement on Form 8-A/A filed on May 28, 2004 (File No.
001-13457))4.4
    
    Certificate of Designation of Series A Junior Participating
Preferred Stock of Orthodontic Centers of America, Inc.
(incorporated by reference to exhibits filed with the
Registrants Annual Report on Form 10-K for the year ended
December 31, 2003)10.1
    
    Lease Agreement, dated August 4, 2004, between Orthodontic
Centers of Florida, Inc. and CDB, LLC31.1
    
    Certification of the Chief Executive Officer of OCA, Inc.
pursuant to Rule 13a-14(a) or 15d-14(a) under the
Securities Exchange Act of 1934, as amended, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of the Senior Vice President of Finance and
Chief Financial Officer of OCA, Inc. pursuant to Rule
13a-14(a) or 15d-14(a) under the Securities Exchange Act of
1934, as amended, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 200232.1
    
    Certification of the Chief Executive Officer of OCA, Inc.
pursuant to 18 U.S.C. § 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification of the Senior Vice President of Finance and
Chief Financial Officer of OCA, Inc. pursuant to 18 U.S.C.
§ 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
 (b) REPORTS ON FORM 8-K On July 26, 2004, we filed a current report on Form 8-K/A, reporting
information under Item 4. Changes in Registrants Certifying Accountants and
Item 7. Financial Statements and Exhibits and on August 30, 2004, we filed a
current report on Form 8-K, reporting information under Item 8.01. Other
Events and Item 9.01. Financial Statements and Exhibits. During the three
months ended September 30, 2004, we also furnished a current report on Form 8-K
on August 10, 2004 reporting information under Item 7. Financial Statements
and Exhibits and Item 12. Results of Operations and Financial Condition. 46




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SIGNATURES Pursuant to
the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Report to be signed on its behalf by the
undersigned thereunto duly authorized. OCA, Inc.(Registrant)Date:
December 23, 2004
    
    /s/ Bartholomew F. Palmisano, Sr.Bartholomew F. Palmisano, Sr.Chairman of the Board, Presidentand Chief Executive Officer/s/ David E. VerretDavid E. VerretSenior Vice President of Finance andChief Financial Officer
 47




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##### Table of Contents



EXHIBIT INDEX Exhibit number
    
    Description3.1
    
    Bylaws of the Registrant (incorporated by reference to
exhibits filed with the Registrants Registration Statement
on Form S-1, Registration Statement No. 33-85326)3.2
    
    Restated Certificate of Incorporation of the Registrant
(incorporated by reference to exhibits filed with the
Registrants Registration Statement on Form S-1,
Registration Statement No. 33-85326)3.3
    
    Certificate of Ownership and Merger merging OCA, Inc., a
wholly-owned subsidiary of the Registrant, with and into
the Registrant (incorporated by reference to exhibits filed
with the Registrants Current Report on Form 8-K
filed on August 30, 2004 (File No. 001-13457))4.1
    
    Specimen Stock Certificate (incorporated by reference to
exhibits filed with the Registrants Registration Statement
on Form S-1, Registration Statement No. 33-85326)4.2
    
    Rights Agreement, dated as of March 3, 2004, including as
Exhibit A the form of Certificate of Designation of Series
A Junior Participating Preferred Stock of Orthodontic
Centers of America, Inc., as Exhibit B the form of Rights
Certificate and as Exhibit C the summary of Rights to
Purchase Preferred Shares (incorporated by reference to
exhibits filed with the Registrants Registration Statement
on Form 8-A filed on March 4, 2004 (File No. 001-13457))4.3
    
    Amendment to Rights Agreement, dated as of May 27, 2004,
between Orthodontic Centers of America, Inc. and EquiServe
Trust Company, N.A (incorporated by reference to exhibits
filed with the Registrants Amendment to Registration
Statement on Form 8-A/A filed on May 28, 2004 (File No.
001-13457))4.4
    
    Certificate of Designation of Series A Junior Participating
Preferred Stock of Orthodontic Centers of America, Inc.
(incorporated by reference to exhibits filed with the
Registrants Annual Report on Form 10-K for the year ended
December 31, 2003)10.1
    
    Lease Agreement, dated August 4, 2004, between Orthodontic
Centers of Florida, Inc. and CDB, LLC31.1
    
    Certification of the Chief Executive Officer of OCA, Inc.
pursuant to Rule 13a-14(a) or 15d-14(a) under the
Securities Exchange Act of 1934, as amended, as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of 200231.2
    
    Certification of the Senior Vice President of Finance and
Chief Financial Officer of OCA, Inc. pursuant to Rule
13a-14(a) or 15d-14(a) under the Securities Exchange Act of
1934, as amended, as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 200232.1
    
    Certification of the Chief Executive Officer of OCA, Inc.
pursuant to 18 U.S.C. §
 48




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Exhibit number
    
    Description1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 200232.2
    
    Certification of the Senior Vice President of Finance and
Chief Financial Officer of OCA, Inc. pursuant to 18 U.S.C.
§ 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002
 49