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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 JUNE 30, 2004, OR[   ]
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROMTO.
 Commission File No.: 001-13457 ORTHODONTIC CENTERS OF AMERICA, INC.  Delaware
    
    72-1278948(State or other jurisdiction of incorporation or organization)
    
    (I.R.S. Employer Identification No.)
 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)    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 August 4, 2004 there were approximately 50,102,000 outstanding shares of the
Registrants Common Stock, $.01 par value per share.




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ORTHODONTIC CENTERS OF AMERICA, INC. TABLE OF CONTENTS PagePART I. FINANCIAL INFORMATION
    
    
    3ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS
    
    
    3Condensed Consolidated Balance Sheets 
June 30, 2004 (Unaudited) and December 31, 2003
    
    
    3Condensed Consolidated Statements of Income (Loss) and
Comprehensive Income (Loss)  Three and Six Months ended June 30, 2004
and 2003 (Unaudited)
    
    
    4Condensed Consolidated Statements of Cash Flows 
Six Months ended June 30, 2004 and 2003 (Unaudited)
    
    
    5Notes to Condensed Consolidated Financial Statements 
June 30, 2004 (Unaudited)
    
    
    6ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
    
    
    16ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
    
    
    36ITEM 4. CONTROLS AND PROCEDURES
    
    
    36PART II. OTHER INFORMATION
    
    
    39ITEM 1. LEGAL PROCEEDINGS
    
    
    39ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
    
    
    39ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
    
    
    40EX-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,
accounting and legal costs relating to requirements under the Sarbanes-Oxley
Act of 2002, 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, repayment of outstanding indebtedness, capital expenditures and
operating losses for development of de novocenters, capital expenditures for
remodeling of existing centers, investment activities, marketing of
services of 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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PART I. FINANCIAL INFORMATION 
 ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS Orthodontic Centers of America, Inc. 
 Condensed Consolidated Balance Sheets
 (in thousands, except share amounts)
 June 30,
    
    December 31,2004
    
    2003(Unaudited)ASSETSCurrent assets:Cash and cash equivalents
    
    $
    8,572
    
    
    $
    7,391Patient receivables, net of allowance for uncollectible amounts of $8,582 at June 30, 2004
    
    
    128,733
    
    
    
    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 June 30, 2004 and $1,438 at December 31, 2003
    
    
    12,610
    
    
    
    16,544Deferred income taxes
    
    
    37,787
    
    
    
    43,346Supplies inventory
    
    
    14,206
    
    
    
    13,726Prepaid expenses and other assets
    
    
    2,823
    
    
    
    4,979Total current assets
    
    
    204,731
    
    
    
    182,706Financed 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
    
    
    91,090
    
    
    
    89,458Assets associated with inactive practices, net of allowance for uncollectible amounts of
$3,024 at June 30, 2004 and $2,544 at December 31, 2003
    
    
    35,374
    
    
    
    26,682Deferred tax assets, net
    
    
    17,052
    
    
    
    Identifiable intangible assets, net
    
    
    
    
    
    
    201,163Goodwill
    
    
    285,704
    
    
    
    87,641Other assets
    
    
    14,164
    
    
    
    13,547TOTAL ASSETS
    
    $
    648,115
    
    
    $
    665,676LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilities:Accounts payable
    
    $
    9,318
    
    
    $
    8,985Accrued salaries and other accrued liabilities
    
    
    12,297
    
    
    
    13,977Service fee prepayments
    
    
    
    
    
    
    1,157Deferred revenue
    
    
    96,913
    
    
    
    Amounts payable to practitioners
    
    
    5,934
    
    
    
    5,373Current portion of notes payable to practitioners
    
    
    1,925
    
    
    
    2,122Current portion of long-term debt
    
    
    8,333
    
    
    
    8,333Total current liabilities
    
    
    134,720
    
    
    
    39,947Deferred income tax liability, net
    
    
    
    
    
    
    41,268Notes payable to practitioners, less current portion
    
    
    3,167
    
    
    
    4,050Long-term debt, less current portion
    
    
    83,557
    
    
    
    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 51,358,000
shares issued and outstanding at June 30, 2004 and 51,341,000 shares issued and
outstanding at December 31, 2003
    
    
    513
    
    
    
    513Additional paid-in capital
    
    
    218,624
    
    
    
    218,530Retained earnings
    
    
    224,841
    
    
    
    289,976Accumulated other comprehensive loss
    
    
    (1,094
    )
    
    
    (119
    )Less cost of approximately 1,256,000 shares of treasury stock at June 30, 2004 and
December 31, 2003
    
    
    (16,213
    )
    
    
    (16,213
    )Total shareholders equity
    
    
    426,671
    
    
    
    492,687TOTAL LIABILITIES AND SHAREHOLDERS EQUITY
    
    $
    648,115
    
    
    $
    665,676
 See accompanying notes to condensed consolidated financial statements. 3




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Orthodontic Centers of America, Inc. 
 Condensed Consolidated Statements of Income (Loss) and Comprehensive Income (Loss)
 (in thousands, except per share data)
 Three months ended
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(Unaudited)Patient revenue
    
    $
    104,316
    
    
    $
    
    
    
    $
    215,214
    
    
    $
    Fee revenue
    
    
    
    
    
    
    100,214
    
    
    
    
    
    
    
    200,853Practice-related expenses:Amounts retained by practitioners
    
    
    29,307
    
    
    
    
    
    
    
    62,000
    
    
    
    Salaries and benefits
    
    
    23,084
    
    
    
    25,732
    
    
    
    46,388
    
    
    
    52,195Clinical supplies and lab fees
    
    
    9,442
    
    
    
    9,728
    
    
    
    18,591
    
    
    
    20,324Rent
    
    
    6,788
    
    
    
    9,159
    
    
    
    13,507
    
    
    
    18,357Marketing and advertising
    
    
    6,388
    
    
    
    7,178
    
    
    
    11,637
    
    
    
    13,420Other operating costs
    
    
    9,781
    
    
    
    9,335
    
    
    
    18,366
    
    
    
    18,110Total practice-related expenses
    
    
    84,790
    
    
    
    61,132
    
    
    
    170,489
    
    
    
    122,406General and administrative
    
    
    9,326
    
    
    
    9,416
    
    
    
    18,152
    
    
    
    16,242Depreciation
    
    
    3,887
    
    
    
    3,462
    
    
    
    7,678
    
    
    
    6,994Amortization
    
    
    
    
    
    
    2,789
    
    
    
    190
    
    
    
    5,214Loss (gain) on sale of assets
    
    
    1,628
    
    
    
    (343
    )
    
    
    1,547
    
    
    
    148Asset impairments
    
    
    
    
    
    
    1,111
    
    
    
    
    
    
    
    1,815Operating income
    
    
    4,685
    
    
    
    22,647
    
    
    
    17,158
    
    
    
    48,034Other income (expense), net:Interest expense, net
    
    
    (1,083
    )
    
    
    (1,120
    )
    
    
    (2,248
    )
    
    
    (2,549
    )Non-controlling interest in subsidiary
    
    
    
    
    
    
    (15
    )
    
    
    94
    
    
    
    (29
    )Income before income taxes and cumulative effect of
change in accounting principle
    
    
    3,602
    
    
    
    21,512
    
    
    
    15,004
    
    
    
    45,456Income taxes
    
    
    1,315
    
    
    
    8,121
    
    
    
    5,476
    
    
    
    17,160Income before cumulative effect of change in
accounting principle
    
    
    2,287
    
    
    
    13,391
    
    
    
    9,528
    
    
    
    28,296Cumulative effect of change in accounting principle,
net of income tax benefit
    
    
    
    
    
    
    
    
    
    
    (74,661
    )
    
    
    Net income (loss)
    
    $
    2,287
    
    
    $
    13,391
    
    
    $
    (65,133
    )
    
    $
    28,296Net income (loss) per share:Basic before cumulative effect of change in
accounting principle
    
    $
    0.05
    
    
    $
    0.27
    
    
    $
    0.19
    
    
    $
    0.56Cumulative effect of change in accounting principle,
net of income tax benefit
    
    
    
    
    
    
    
    
    
    
    (1.49
    )
    
    
    Basic
    
    $
    0.05
    
    
    $
    0.27
    
    
    $
    (1.30
    )
    
    $
    0.56Diluted before cumulative effect of change in
accounting principle
    
    $
    0.05
    
    
    $
    0.27
    
    
    $
    0.19
    
    
    $
    0.56Cumulative effect of change in accounting principle,
net of income tax benefit
    
    
    
    
    
    
    
    
    
    
    (1.49
    )
    
    
    Diluted
    
    $
    0.05
    
    
    $
    0.27
    
    
    $
    (1.30
    )
    
    $
    0.56Average shares outstanding:Basic
    
    
    50,084
    
    
    
    50,219
    
    
    
    50,080
    
    
    
    50,209Diluted
    
    
    50,270
    
    
    
    50,370
    
    
    
    50,080
    
    
    
    50,395Comprehensive income (loss):Net income (loss)
    
    $
    2,287
    
    
    $
    13,391
    
    
    $
    (65,133
    )
    
    $
    28,296Other comprehensive loss:Foreign currency translation adjustment
    
    
    (603
    )
    
    
    (134
    )
    
    
    (975
    )
    
    
    (344
    )Comprehensive income (loss)
    
    $
    1,684
    
    
    $
    13,257
    
    
    $
    (66,108
    )
    
    $
    27,952
 See accompanying notes to condensed consolidated financial statements. 4




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Orthodontic Centers of America, Inc. 
 Condensed Consolidated Statements of Cash Flows
 (in thousands)
 Six months endedJune 30,2004
    
    2003(Unaudited)Operating activities:Net income (loss)
    
    $
    (65,133
    )
    
    $
    28,296Adjustments 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
    
    
    1,399
    
    
    
    2,779Depreciation and amortization
    
    
    7,868
    
    
    
    12,208Asset impairments
    
    
    
    
    
    
    1,815Loss on sale of assets
    
    
    1,547
    
    
    
    148Deferred income taxes
    
    
    4,999
    
    
    
    17,430Changes in operating assets and liabilities:Patient receivables
    
    
    (11,512
    )
    
    
    Service fees receivable
    
    
    
    
    
    
    (25,656
    )Deferred revenue
    
    
    7,853
    
    
    
    Service fee prepayments
    
    
    
    
    
    
    (5,561
    )Accounts payable and other current liabilities
    
    
    (1,347
    )
    
    
    (4,397
    )Amounts payable to practitioners
    
    
    561
    
    
    
    Prepaid expenses and other
    
    
    2,118
    
    
    
    1,392Supplies inventory
    
    
    (480
    )
    
    
    (941
    )Net cash provided by operating activities
    
    
    22,534
    
    
    
    27,513Investing activities:Purchases of property, equipment and improvements
    
    
    (10,154
    )
    
    
    (7,511
    )Advances to practitioners, net
    
    
    (3,592
    )
    
    
    (2,598
    )Proceeds from sale of assets
    
    
    2,363
    
    
    
    Notes receivable
    
    
    (2,614
    )
    
    
    (2,059
    )Amounts due from inactive practices and other
    
    
    (1,505
    )
    
    
    (338
    )Net cash used in investing activities
    
    
    (15,502
    )
    
    
    (12,506
    )Financing activities:Repayment of notes payable to practitioners
    
    
    (803
    )
    
    
    (3,698
    )Repayment of long-term debt
    
    
    (4,166
    )
    
    
    (117,050
    )Proceeds from long-term debt
    
    
    
    
    
    
    109,900Issuance of common stock
    
    
    93
    
    
    
    678Net cash used in financing activities
    
    
    (4,876
    )
    
    
    (10,170
    )Effect of exchange rate changes on cash and cash equivalents
    
    
    (975
    )
    
    
    (344
    )Change in cash and cash equivalents
    
    
    1,181
    
    
    
    4,493Cash and cash equivalents at beginning of period
    
    
    7,391
    
    
    
    7,522Cash and cash equivalents at end of period
    
    $
    8,572
    
    
    $
    12,015Supplemental cash flow information:Cash paid during period for:Interest
    
    $
    2,827
    
    
    $
    2,749Income taxes
    
    $
    608
    
    
    $
    147Supplemental disclosures of non-cash investing and financing activities:Notes payable and common stock issued to obtain Service Agreements
    
    $
    
    
    
    $
    284
 See accompanying notes to condensed consolidated financial statements. 5




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Orthodontic Centers of America, Inc. 
 Notes to Condensed Consolidated Financial Statements (Unaudited) June 30, 2004 1. DESCRIPTION OF BUSINESS Orthodontic Centers of America, 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 46 states and four foreign markets. 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 a Service Agreement
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, 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 one year. 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 it generally enables practitioners to focus on providing quality
care, while increasing their profitability and keeping them better informed
about the financial performance of their practice. At June 30, 2004, OCA
OutSource was providing business services to two general dental practices and
one pediatric dental practice, all of which are located in the United States.
OCA Outsource intends to continue to market its services to general and
pediatric dentists practices during 2004 at association meetings and through
direct mail and open houses at OCAs corporate headquarters in Metairie,
Louisiana. OCA OutSource also intends to begin marketing its services to
medical practices by the end of 2004. 6




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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 June 30, 2004. Number of Affiliated PracticesAs of June 30, 2004
    
    As of June 30, 2003Pediatric andLocation
    
    Orthodontic
    
    General Dental
    
    Total
    
    Orthodontic
    
    Pediatric Dental
    
    TotalUnited States
    
    
    254
    
    
    
    15
    
    
    
    269
    
    
    
    279
    
    
    
    23
    
    
    
    302Japan
    
    
    24
    
    
    
    
    
    
    
    24
    
    
    
    25
    
    
    
    
    
    
    
    25Mexico
    
    
    7
    
    
    
    
    
    
    
    7
    
    
    
    4
    
    
    
    
    
    
    
    4Puerto Rico
    
    
    2
    
    
    
    1
    
    
    
    3
    
    
    
    3
    
    
    
    
    
    
    
    3Spain
    
    
    3
    
    
    
    
    
    
    
    3
    
    
    
    3
    
    
    
    
    
    
    
    3Total
    
    
    290
    
    
    
    16
    
    
    
    306
    
    
    
    314
    
    
    
    23
    
    
    
    337
 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 six-month periods ended
June 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 periods in order to
conform to the current period presentation. This 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). Adoption of New Accounting Standard Effective January 1, 2004, OCA was required to, and did, adopt 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 7




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losses, receives a majority of the VIEs expected residual returns, or
both, as a result of contractual or 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. 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 in 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
Affiliated Practices services performed for their patients rather than the
services that OCA performs 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 provides 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 third-party payors, as calculated
under the Companys revenue recognition policy (as discussed below). They
reflect amounts yet to be received after being recognized as patient revenue.
These amounts 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 9




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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 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 identifiable intangible assets related to Service Agreements with
Affiliated Practices as goodwill. Prior to the Companys adoption of FIN 46R,
it recorded these amounts as identifiable intangible assets and amortized these
assets. 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 Statement of Financial
Accounting Standards (SFAS) No. 142, Goodwill and Other Intangible Assets.
As a result of the Companys adoption of FIN 46R during the three months ended
March 31, 2004, the Company determined that an interim impairment test was
required under SFAS No. 142. Accordingly, with the assistance of an outside
consultant, the Company determined that no impairment was warranted as of the
test date. However, the Companys fair value assessment is sensitive to a
decrease in the market price of OCA common stock. As a result, if the market
price per share of OCA common stock were to decrease materially, it could
result in an impairment of all or a portion of the carrying value of goodwill.
See Note 4 for a discussion of the Companys annual impairment test. (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 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, a reclassification of certain advances to Affiliated
Practices as amounts retained by practitioners (as described above) and
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 Orthodontic Centers of America, 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. 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 amounts 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 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. 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. Goodwill and Identifiable Intangibles Pursuant to the consolidation provisions of FIN 46R, effective January 1,
2004, the Company 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. See
Note 4 for a discussion of the Companys goodwill and impairment tests. Assets Associated with Inactive Practices Assets associated with inactive practices consist of identifiable
intangible assets, property, equipment, and improvements, service fees
receivable and advances from 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 June 30,
2004. The Company assesses the recoverability of these assets on a quarterly
basis based on certain factors, primarily the uncertainty of litigation, the
lack of financial information provided to OCA from these practices, the
uncertainty of these practices fulfilling their contractual
obligations to OCA and estimated amounts expected to be received from these practices under the
terms of their Service Agreements. The Company estimates the amounts to be
received from these practices using historical data, experience in resolving
these situations and the practitioners willingness to resolve the matter. 11




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Segment Reporting Operating segments are components of a business enterprise to which its
chief operating decision maker (CODM) applies his decisions to allocate the
resources to its different segments and to make assessments on their
performances. The Companys CODM, as defined by SFAS No. 131, Disclosures
about Segments of an Enterprise and Related Information, is OCAs Chief
Executive Officer. The CODM assesses the performance of the Company based on
revenues and overall profitability. By this definition, the Company operates
only in one operating segment: the provision of 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. 3. PROPERTY, EQUIPMENT AND IMPROVEMENTS Property, equipment and improvements consisted of the following as of the
dates indicated: June 30,
    
    December 31,2004
    
    2003(in thousands)Leasehold improvements
    
    $
    80,475
    
    
    $
    75,664Furniture, fixtures and equipment
    
    
    70,340
    
    
    
    68,712150,815
    
    
    
    144,376Less accumulated depreciation and amortization
    
    
    59,725
    
    
    
    54,918Property, equipment and improvements, net
    
    $
    91,090
    
    
    $
    89,458
 Depreciation expense on property, equipment and improvements was $3.9
million and $7.7 million for the three and six months ended June 30, 2004,
respectively, compared to $3.5 million and $7.0 million for the three and six
months ended June 30, 2003, respectively. 4.IDENTIFIABLE INTANGIBLE ASSETS AND GOODWILL The consolidation provisions under FIN 46R 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 these identifiable intangible assets associated with
Affiliated Practices to goodwill. 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 thereafter, with interim testing
required if circumstances warrant. The Company performs its annual impairment
analysis during the second quarter of its fiscal year. During the
three months
ended June 30, 2004, the Company performed its annual impairment analysis with
the assistance of a third-party advisor and determined that goodwill was not
impaired. In addition, the Companys adoption of FIN 46R during the first
quarter of 2004 resulted in significant changes to the Companys condensed
consolidated balance sheet and qualified as a significant event warranting an
interim goodwill impairment test. The fair value of the reporting unit was
determined with the assistance of a third-party advisor, and the Company
determined that goodwill was not impaired. As of December 31, 2003, the
Companys goodwill related solely to the OrthAlliance merger. 12




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5. INACTIVE PRACTICES At June 30, 2004 and December 31, 2003, the Company recorded the following
assets in its condensed consolidated balance sheets related to Inactive Practices (in
thousands): June 30, 2004
    
    December 31, 2003Service fees receivable, net
    
    $
    3,535
    
    
    $
    3,535Advances to
inactive practices, net
    
    
    6,919
    
    
    
    4,287Notes receivable
    
    
    
    
    
    
    199Property, equipment and improvements, net
    
    
    3,091
    
    
    
    2,699Identifiable intangible assets, net
    
    
    21,829
    
    
    
    15,962Total
    
    $
    35,374
    
    
    $
    26,682
 At June 30, 2004 and December 31, 2003, there were 108 and 100 Inactive
Practices, respectively, including (A) 61 and 62 Inactive Practices,
respectively, that were parties to Service Agreements but were engaged in
litigation with OCA or OrthAlliance and had ceased paying service fees, and (B)
47 and 38 Inactive Practices, respectively, that were parties to Service
Agreements and were not engaged in litigation with OCA or OrthAlliance but had
ceased paying service fees. 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. The Company performed an assessment
of the recoverability of these assets at June 30, 2004, and has established an
allowance for these amounts in the amount of $3.0 million. The Company believes
the net amounts recorded at June 30, 2004 are realizable. However, adverse
changes in litigation pending between Inactive Practices and OCA or
OrthAlliance could significantly affect the recoverability of
these assets and may require us to write off all or a portion of these assets
in the future. At December 31, 2003, the Company had an allowance of $2.5
million associated with these assets. 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 June 30,
2004, approximately $79.6 million was outstanding on the revolving line of
credit and $12.3 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 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 (as defined in the credit facility) on the Company,
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. At June 30, 2004, the Company was in
compliance with the covenants and restrictions under the credit facility. 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 13




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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. Six months ended June 30,2004
    
    2003(in thousands, except per share data)Income before cumulative effect of change in
accounting principal
    
    $
    9,528
    
    
    $
    28,296Less: stock-based employee compensation expense
determined under fair value based method for
all awards, net of related tax effect
    
    
    283
    
    
    
    297Pro forma net income before cumulative effect of
change in accounting principle
    
    $
    9,245
    
    
    $
    27,999Income before cumulative effect of change in
accounting principle per share:Basic, as reported
    
    $
    0.19
    
    
    $
    0.56Basic, pro forma
    
    
    0.18
    
    
    
    0.56Diluted, as reported
    
    
    0.19
    
    
    
    0.56Diluted, pro forma
    
    
    0.18
    
    
    
    0.56
 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. The Company expects that the
remaining net operating loss carryforwards will substantially 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. 9. 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
    
    Six months endedJune 30,
    
    June 30,2004
    
    2003
    
    2004
    
    2003(in thousands)Numerator:Net income (loss) for basic and diluted
earnings per share
    
    $
    2,287
    
    
    $
    13,391
    
    
    $
    (65,133
    )
    
    $
    28,296Denominator:Denominator for basic earnings (loss) per share
    
    
    50,084
    
    
    
    50,219
    
    
    
    50,080
    
    
    
    50,209Effect of dilutive securities
    
    
    186
    
    
    
    151
    
    
    
    
    
    
    
    186Denominator for diluted earnings (loss) per share
    
    
    50,270
    
    
    
    50,370
    
    
    
    50,080
    
    
    
    50,395
 No options to purchase shares of OCAs common stock were included in the
computation of diluted loss per share for the six months ended June 30, 2004,
because the effects would have been anti-dilutive. Options to purchase
approximately 2.1 million shares of common stock at exercise prices ranging
from $8.25 to $33.13 were outstanding at June 30, 2004 but not included in the
computation of diluted earnings per share for the three months ended June 30,
2004, because the exercise prices were 14




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greater than the average market price of OCAs common stock during the period.
Options to purchase approximately 2.3 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 six months ended June 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 $7.0 to $33.13. These options expire between
2009 and 2012. 10. CONTINGENCIES OCA and its subsidiary OrthAlliance are parties to litigation with a
number of Inactive Practices. Before OCA entered into the merger agreement with
OrthAlliance in 2001, it anticipated that some portion of OrthAlliances
affiliated practices would oppose such a merger. 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 10, 2003, Ilena and Guiseppe Chiaretti filed an action in the
United States District Court for the Eastern District of Louisiana against OCA
and Bartholomew F. Palmisano, Sr., OCAs Chairman of the Board, President and
Chief Executive Officer, Bartholomew F. Palmisano, Jr., OCAs Chief Operating
Officer, and Thomas J. Sandeman, OCAs then Chief Financial Officer. Similar
actions were filed in the same court by other plaintiffs. On August 28, 2003,
the lawsuits were consolidated and John A. Matis, Trustee was appointed as lead
plaintiff. The consolidated action purported to be filed as a class action on
behalf of the plaintiffs and other purchasers of shares of OCA common stock
from November 14, 2002 to March 18, 2003, and alleged that OCA and the other
defendants violated Section 10(b) of the Securities Exchange Act of 1934, as
amended, and Rule 10b-5 thereunder, by allegedly making false and misleading
statements, and/or omitting to state material facts necessary to make the
statements made not misleading. On April 6, 2004, the court granted OCAs
motion and ordered that the lawsuit be dismissed. The court found that the
plaintiffs had failed to state a claim that OCA or its officers violated
federal securities laws. On May 6, 2004, the court entered a judgment
dismissing the case. The plaintiffs have indicated that they will not appeal
the dismissal and the time period for such an appeal has expired. Because litigation is inherently uncertain, the Company cannot assure you
that it 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 Affiliated
Practices are, and from time to time may become, party to other litigation or
administrative proceedings which arise in the normal course of their business.
Regardless of the outcome of such litigation and proceedings, they could be
costly, time-consuming and could divert the time and attention of OCAs senior
management. 15




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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 June 30,
2004 and results of operations for the three and six months ended June 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 Orthodontic Centers of America, Inc. and its
subsidiaries and references to us or we are to OCA and its affiliated
practices required to be consolidated pursuant to FIN 46R (as defined below),
unless the context otherwise requires. OVERVIEW Founded in 1985, OCA is the leading provider of business services to
orthodontic and pediatric dental practices. It provides 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.
Excluding reimbursement of practice-related expenses, service fees for our
traditional affiliations generally equal about 40% to 50% of a practices
operating profit or about 17% of a practices revenue. At June 30, 2004, OCA was affiliated with 306 practices located throughout
the United States and parts of Japan, Spain, Puerto Rico and Mexico, including
two general dental practices and one pediatric dental practice affiliated with OCA OutSource. This number
excludes 108 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 June 30, 2004. We had generally ceased to record patient
revenue with respect to all of these Inactive Practices at or before June 30,
2004. 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 one year. OCA OutSource currently charges its affiliated practices a
monthly service fee based on a percentage of the practices cash collections.
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 it
generally enables practitioners to focus on providing quality care, while
increasing their profitability and keeping them better informed about the
financial performance of their practice. At June 30, 2004, OCA OutSource was
providing business services to two general dental practices and one pediatric
dental practice, all of which are located in the United States. OCA OutSource
intends to continue to market its services to general and pediatric dentists
during 2004 at association meetings and through direct mail and open houses at
OCAs corporate headquarters in Metairie, Louisiana. OCA OutSource also
intends to begin marketing its services to medical practices by the end of
2004. 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 16




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approximately 30% to 35% of the total expense of treating a patient during
the first month of the patients treatment. 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 six months ended June 30, 2004, our affiliated orthodontic
practices generated new patient contracts totaling $333.0 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). 17




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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 record amounts
paid to practices to affiliate or amend Service Agreements as
goodwill, rather than 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 a receivable. These primarily relate
to funding of practitioner compensation and additional funding
related to the practices. Repayment of the cash advances now reduce
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 tracking 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. 18




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##### Table of Contents



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, 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 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. 19




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##### Table of Contents



(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 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 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. 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. As a result of our
adoption of FIN 46R during the three months ended March 31, 2004, we determined that an interim impairment test was required
under SFAS No. 142. Accordingly, with the assistance of an outside consultant,
we determined that no impairment was warranted as of the test date. However,
our fair value assessment is sensitive to a decrease in the market price of OCA
common stock. As a result, if the market price per share of OCA common stock
were to decrease materially, it could result in an impairment of all or a
portion of the carrying value of goodwill. (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 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 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, a reclassification of certain
advances to Affiliated Practices as amounts retained by practitioners (as
described above) and reversal of previously-recorded amortization of
identifiable intangible assets. 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. 20




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##### Table of Contents



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 a reconsideration event occurs. We do not consolidate the assets,
liabilities, equity and financial results of the Inactive Practices and
OutSource Practices. The laws of each of the jurisdictions in which we operate prohibit us from
owning orthodontic or pediatric dental practices. We enter into exclusive
Service Agreements with practitioners and professional entities that operate
orthodontic and pediatric dental practices. We do not have any ownership
interest in 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. 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, 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 amounts 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 amounts 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. 21




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##### Table of Contents



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. Recoverability of Assets Related to Inactive Practices At June 30, 2004, we had approximately $35.4 million of assets recorded in
our condensed consolidated balance sheets associated with Inactive Practices,
which consisted of $21.8 million of identifiable intangible assets, $3.1
million of property, equipment, and improvements, net of accumulated
amortization and depreciation, $3.5 million of service fees receivable and $6.9
million of advances to affiliated practices, net of allowances for
uncollectible amounts. The assessment of the recoverability of these assets is
complex and requires significant judgment by management due to certain factors,
primarily the uncertainty of litigation, evaluation of the outcome of pending
litigation, the lack of financial information provided to us from these
practices, the uncertainty of these practices fulfilling their contractual
obligations to us and estimated amounts expected to be received from these
practices under terms of their Service Agreements. Management estimates the
amounts to be received from these practices using historical data, experience
in resolving these situations and the practitioners willingness to resolve the
matter. We have established allowances on certain amounts due from these
practices and believe the net amounts recorded are realizable as of June 30,
2004. OrthAlliance has resolved disputes with some Inactive Practices by
permitting the practices to buy out their Service Agreements for amounts in
excess of the net book value of the identifiable intangible and other assets
attributable to these practices; however, adverse litigation results could
significantly affect the recoverability of these assets and may require us to
write off 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 six 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 June 30, 2004, and the diminishing impact of Inactive Practices on total
patient fees collected by affiliated practices during 2003 and the first six
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. 22




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##### Table of Contents



(LINE 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 cease 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 June 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 June 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 the first and second 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 23




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##### Table of Contents



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 upon a percentage of the
practices operating profit or practice revenue and reimbursement of
practice-related expenses. Excluding reimbursement of practice-related
expenses, these service fees generally equal about 40% to 50% of a practices
operating profit or about 17% of a practices revenue. OCA
OutSource provides business services to a practice under
agreements with terms as short as one year. Under an OutSource Agreement,
affiliated practices currently are charged a monthly service fee based on a
percentage of the practices cash collections. RESULTS OF OPERATIONS The following tables provide information about (1) the percentage of
patient revenue or fee 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 six
months ended June 30, 2003 on a pro forma basis calculated as if our adoption
of FIN 46R was effective as of January 1, 2003, and (3) the percentage increase
or decrease in those items from period to period on an actual and pro forma
basis: 24




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##### Table of Contents



Three Months
    
    Pro Forma
    
    PercentageendedJune 30,
    
    Three Monthsended
    
    Increase/(Decrease)June 30,
    
    2004 to 2003
    
    2004 to 20032004
    
    2003
    
    2003 (1)
    
    Actual
    
    Pro FormaPatient revenue and fee revenue, respectively
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    N/A
    
    
    
    (6.0
    )%Practice-related expenses:Amounts retained by practitioners
    
    
    28.1
    
    
    
    
    
    
    
    27.1
    
    
    
    N/A
    
    
    
    (2.5
    )Salaries and benefits
    
    
    22.1
    
    
    
    25.7
    
    
    
    23.2
    
    
    
    (10.3
    )%
    
    
    (10.3
    )Clinical supplies and lab fees
    
    
    9.1
    
    
    
    9.7
    
    
    
    8.8
    
    
    
    (2.9
    )
    
    
    (2.9
    )Rent
    
    
    6.5
    
    
    
    9.1
    
    
    
    8.2
    
    
    
    (25.9
    )
    
    
    (25.9
    )Marketing and advertising
    
    
    6.1
    
    
    
    7.2
    
    
    
    6.5
    
    
    
    (11.0
    )
    
    
    (11.0
    )Other operating costs
    
    
    9.4
    
    
    
    9.3
    
    
    
    8.4
    
    
    
    4.8
    
    
    
    4.8Total practice-related expenses
    
    
    81.3
    
    
    
    61.0
    
    
    
    82.1
    
    
    
    38.7
    
    
    
    (7.0
    )General and administrative
    
    
    8.9
    
    
    
    9.4
    
    
    
    7.2
    
    
    
    (1.0
    )
    
    
    17.2Depreciation
    
    
    3.7
    
    
    
    3.5
    
    
    
    3.1
    
    
    
    12.3
    
    
    
    12.3Amortization
    
    
    
    
    
    
    2.8
    
    
    
    
    
    
    
    N/A
    
    
    
    0.0Loss (gain) on sale of assets
    
    
    1.6
    
    
    
    (0.3
    )
    
    
    (0.3
    )
    
    
    574.6
    
    
    
    574.6Asset impairments
    
    
    
    
    
    
    1.1
    
    
    
    1.0
    
    
    
    N/A
    
    
    
    N/AOperating income
    
    
    4.5
    
    
    
    22.6
    
    
    
    6.9
    
    
    
    (79.3
    )
    
    
    (38.6
    )Income before income taxes
    
    
    3.5
    
    
    
    21.5
    
    
    
    5.9
    
    
    
    (83.3
    )
    
    
    (44.6
    )Net income
    
    
    2.2
    %
    
    
    13.4
    %
    
    
    3.6
    %
    
    
    (82.9
    )%
    
    
    (43.5
    )%
 Six Months
    
    Pro Forma
    
    PercentageendedJune 30,
    
    Six Monthsended
    
    Increase/(Decrease)June 30,
    
    2004 to 2003
    
    2004 to 20032004
    
    2003
    
    2003 (1)
    
    Actual
    
    Pro FormaPatient revenue and fee revenue, respectively
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    100.0
    %
    
    
    N/A
    
    
    
    (3.9
    )%Practice-related expenses:Amounts retained by practitioners
    
    
    28.8
    
    
    
    
    
    
    
    25.8
    
    
    
    N/A
    
    
    
    7.2Salaries and benefits
    
    
    21.6
    
    
    
    26.0
    
    
    
    23.3
    
    
    
    (11.1
    )%
    
    
    (11.1
    )Clinical supplies and lab fees
    
    
    8.6
    
    
    
    10.1
    
    
    
    9.1
    
    
    
    (8.5
    )
    
    
    (8.5
    )Rent
    
    
    6.3
    
    
    
    9.1
    
    
    
    8.2
    
    
    
    (26.4
    )
    
    
    (26.4
    )Marketing and advertising
    
    
    5.4
    
    
    
    6.7
    
    
    
    6.0
    
    
    
    (13.3
    )
    
    
    (13.3
    )Other operating expenses
    
    
    8.5
    
    
    
    9.0
    
    
    
    8.1
    
    
    
    1.4
    
    
    
    1.4Total practice-related expenses
    
    
    79.3
    
    
    
    60.9
    
    
    
    80.5
    
    
    
    39.3
    
    
    
    (5.4
    )General and administrative
    
    
    8.4
    
    
    
    8.1
    
    
    
    6.5
    
    
    
    11.8
    
    
    
    24.4Depreciation
    
    
    3.6
    
    
    
    3.5
    
    
    
    3.1
    
    
    
    9.8
    
    
    
    9.8Amortization
    
    
    0.1
    
    
    
    2.6
    
    
    
    0.1
    
    
    
    (96.4
    )
    
    
    0.0Loss (gain) on sale of assets
    
    
    0.7
    
    
    
    0.1
    
    
    
    0.1
    
    
    
    945.5
    
    
    
    945.5Asset impairments
    
    
    
    
    
    
    0.9
    
    
    
    0.8
    
    
    
    N/A
    
    
    
    N/AOperating income
    
    
    8.0
    
    
    
    23.9
    
    
    
    8.9
    
    
    
    (64.3
    )
    
    
    (14.1
    )Income before income taxes and cumulative
effect
    
    
    7.0
    
    
    
    22.6
    
    
    
    7.7
    
    
    
    (67.0
    )
    
    
    (13.1
    )Income before cumulative effect of change in
accounting principle
    
    
    4.4
    
    
    
    14.1
    
    
    
    4.8
    
    
    
    (66.3
    )
    
    
    (11.4
    )Cumulative effect, net of income
tax benefit
    
    
    (34.7
    )
    
    
    0.0
    
    
    
    0.0
    
    
    
    N/A
    
    
    
    N/ANet income (loss)
    
    
    (30.3
    )%
    
    
    14.1
    %
    
    
    4.8
    %
    
    
    (330.2
    )%
    
    
    N/A
   (1)
    
    Presented on a pro forma basis as if our adoption of FIN 46R was
effective as of January 1, 2003. 25




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##### Table of Contents



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 six months ended June 30, 2004 and 2003, and for the three
and six months ended June 30, 2003 on a pro forma basis as if our adoption of
FIN 46R was effective as of January 1, 2003. Base Practices are affiliated
practices for which we were recording patient revenue as of June 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 June 30, 2004. At June 30, 2004, there were 306
Base Practices and 108 Inactive Practices that were parties to Service
Agreements. At June 30, 2003, there were 337 Base Practices and 82 Inactive
Practices that were parties to Service Agreements. As reflected in the following tables, during the three and six months
ended June 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 half of 2004 was
significantly less than during the first half of 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. Base Practices (1)Mature
    
    De Novo
    
    InactiveCenters (2)
    
    Centers (3)
    
    Practices(4)
    
    Corporate (5)
    
    TotalFor the three months ended June
30, 2004 (as reported):Patient revenue
    
    $
    103,003
    
    
    $
    657
    
    
    $
    656
    
    
    $
    
    
    
    $
    104,316Practice-related expenses (6)
    
    
    81,873
    
    
    
    1,895
    
    
    
    1,022
    
    
    
    
    
    
    
    84,790General and administrative (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,326
    
    
    
    9,326Depreciation
    
    
    2,633
    
    
    
    263
    
    
    
    543
    
    
    
    448
    
    
    
    3,887Operating income (loss) before
loss on sale of assets
    
    
    18,497
    
    
    
    (1,501
    )
    
    
    (909
    )
    
    
    (9,774
    )
    
    
    6,313Loss on sale of assets
    
    
    
    
    
    
    
    
    
    
    1,628
    
    
    
    
    
    
    
    1,628Operating income (loss)
    
    
    18,497
    
    
    
    (1,501
    )
    
    
    (2,537
    )
    
    
    (9,774
    )
    
    
    4,685Interest expense (net) (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,083
    
    
    
    1,083Non-controlling interest (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Income before income taxes (5)
    
    
    18,497
    
    
    
    (1,501
    )
    
    
    (2,537
    )
    
    
    (10,857
    )
    
    
    3,602Income taxes (5)
    
    
    6,751
    
    
    
    (548
    )
    
    
    (926
    )
    
    
    (3,962
    )
    
    
    1,315Net income (loss) (5)
    
    $
    11,746
    
    
    $
    (953
    )
    
    $
    (1,611
    )
    
    $
    (6,895
    )
    
    $
    2,287For the three months ended June
30, 2003 (as reported):Fee revenue
    
    $
    88,219
    
    
    $
    432
    
    
    $
    11,563
    
    
    $
    
    
    
    $
    100,214Practice-related expenses (6)
    
    
    48,148
    
    
    
    1,099
    
    
    
    11,885
    
    
    
    
    
    
    
    61,132General and administrative (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9,416
    
    
    
    9,416Depreciation and amortization
    
    
    5,327
    
    
    
    117
    
    
    
    421
    
    
    
    386
    
    
    
    6,251Operating income (loss) before
gain on sale of assets and
asset impairments
    
    
    34,744
    
    
    
    (784
    )
    
    
    (743
    )
    
    
    (9,802
    )
    
    
    23,415Gain on sale of assets
    
    
    
    
    
    
    
    
    
    
    343
    
    
    
    
    
    
    
    343Asset impairments
    
    
    
    
    
    
    
    
    
    
    1,111
    
    
    
    
    
    
    
    1,111Operating income (loss)
    
    
    34,744
    
    
    
    (784
    )
    
    
    (1,511
    )
    
    
    (9,802
    )
    
    
    22,647Interest expense (net) (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,120
    
    
    
    1,120Non-controlling interest (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15
    
    
    
    15Income before income taxes (5)
    
    
    34,744
    
    
    
    (784
    )
    
    
    (1,511
    )
    
    
    (10,937
    )
    
    
    21,512Income taxes (5)
    
    
    13,115
    
    
    
    (296
    )
    
    
    (570
    )
    
    
    (4,128
    )
    
    
    8,121Net income (loss) (5)
    
    $
    21,629
    
    
    $
    (488
    )
    
    $
    (941
    )
    
    $
    (6,809
    )
    
    $
    13,391
 26




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##### Table of Contents



Base Practices (1)Mature
    
    De Novo
    
    InactiveCenters (2)
    
    Centers (3)
    
    Practices (4)
    
    Corporate (5)
    
    TotalFor the three months ended June
30, 2003 (pro forma):Patient revenue
    
    $
    94,069
    
    
    $
    582
    
    
    $
    16,372
    
    
    $
    
    
    
    $
    111,023Practice-related expenses (6)
    
    
    72,732
    
    
    
    1,249
    
    
    
    17,219
    
    
    
    
    
    
    
    91,200General and administrative (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,960
    
    
    
    7,960Depreciation and amortization
    
    
    2,538
    
    
    
    117
    
    
    
    421
    
    
    
    386
    
    
    
    3,462Operating income (loss) before
gain on sale of assets and
asset impairments
    
    
    18,799
    
    
    
    (784
    )
    
    
    (1,268
    )
    
    
    (8,346
    )
    
    
    8,401Asset impairments
    
    
    
    
    
    
    
    
    
    
    1,111
    
    
    
    
    
    
    
    1,111Gain on sale of assets
    
    
    
    
    
    
    
    
    
    
    343
    
    
    
    
    
    
    
    343Operating income (loss)
    
    
    18,799
    
    
    
    (784
    )
    
    
    (2,036
    )
    
    
    (8,346
    )
    
    
    7,633Interest expense (net) (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,120
    
    
    
    1,120Non-controlling interest (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    15
    
    
    
    15Income before income taxes (5)
    
    
    18,799
    
    
    
    (784
    )
    
    
    (2,036
    )
    
    
    (9,481
    )
    
    
    6,498Income taxes (5)
    
    
    7,097
    
    
    
    (296
    )
    
    
    (769
    )
    
    
    (3,579
    )
    
    
    2,453Net income (loss) (5)
    
    $
    11,702
    
    
    $
    (488
    )
    
    $
    (1,267
    )
    
    $
    (5,902
    )
    
    $
    4,045For the six months ended June
30, 2004 (as reported):Patient revenue
    
    $
    210,455
    
    
    $
    1,106
    
    
    $
    3,653
    
    
    $
    
    
    
    $
    215,214Practice-related expenses (6)
    
    
    163,606
    
    
    
    2,932
    
    
    
    3,951
    
    
    
    
    
    
    
    170,489General and administrative (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18,152
    
    
    
    18,152Depreciation and amortization
    
    
    5,852
    
    
    
    407
    
    
    
    718
    
    
    
    891
    
    
    
    7,868Operating income (loss) before
loss on sale of assets
    
    
    40,997
    
    
    
    (2,233
    )
    
    
    (1,016
    )
    
    
    (19,043
    )
    
    
    18,705Loss on sale of assets
    
    
    
    
    
    
    
    
    
    
    1,547
    
    
    
    
    
    
    
    1,547Operating income (loss)
    
    
    40,997
    
    
    
    (2,233
    )
    
    
    (2,563
    )
    
    
    (19,043
    )
    
    
    17,158Interest expense (net) (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,248
    
    
    
    2,248Non-controlling interest (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (94
    )
    
    
    (94
    )Income before income taxes (5)
    
    
    40,997
    
    
    
    (2,233
    )
    
    
    (2,563
    )
    
    
    (21,197
    )
    
    
    15,004Income taxes (5)
    
    
    14,964
    
    
    
    (815
    )
    
    
    (935
    )
    
    
    (7,738
    )
    
    
    5,476Income (loss) before
cumulative effect of change in
accounting principle (5)
    
    $
    26,033
    
    
    $
    (1,418
    )
    
    $
    (1,628
    )
    
    $
    (13,459
    )
    
    $
    9,528For the six months ended June
30, 2003 (as reported):Fee revenue
    
    $
    170,738
    
    
    $
    568
    
    
    $
    29,547
    
    
    $
    
    
    
    $
    200,853Practice-related expenses (6)
    
    
    98,173
    
    
    
    1,750
    
    
    
    22,483
    
    
    
    
    
    
    
    122,406General and administrative (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    16,242
    
    
    
    16,242Depreciation
    
    
    9,173
    
    
    
    212
    
    
    
    2,021
    
    
    
    802
    
    
    
    12,208Operating income before loss
on sale of assets and
impairments
    
    
    63,392
    
    
    
    (1,394
    )
    
    
    5,043
    
    
    
    (17,044
    )
    
    
    49,997Loss on sale of assets
    
    
    
    
    
    
    
    
    
    
    148
    
    
    
    
    
    
    
    148Asset impairments
    
    
    
    
    
    
    
    
    
    
    1,815
    
    
    
    
    
    
    
    1,815Operating income (loss)
    
    
    63,392
    
    
    
    (1,394
    )
    
    
    3,080
    
    
    
    (17,044
    )
    
    
    48,034Interest expense (net) (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,549
    
    
    
    2,549Non-controlling interest (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29
    
    
    
    29Income before income taxes (5)
    
    
    63,392
    
    
    
    (1,394
    )
    
    
    3,080
    
    
    
    (19,622
    )
    
    
    45,456Income taxes (5)
    
    
    23,930
    
    
    
    (526
    )
    
    
    1,163
    
    
    
    (7,407
    )
    
    
    17,160Net income (loss) (5)
    
    $
    39,462
    
    
    $
    (868
    )
    
    $
    1,917
    
    
    $
    (12,215
    )
    
    $
    28,296
 27




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##### Table of Contents



Base Practices (1)Mature
    
    De Novo
    
    InactiveCenters (2)
    
    Centers (3)
    
    Practices (4)
    
    Corporate (5)
    
    TotalFor the six months ended June
30, 2003 (pro forma):Patient revenue
    
    $
    190,920
    
    
    $
    778
    
    
    $
    32,242
    
    
    $
    
    
    
    $
    223,940Practice-related expenses (6)
    
    
    149,642
    
    
    
    1,960
    
    
    
    28,616
    
    
    
    
    
    
    
    180,218General and administrative (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    14,592
    
    
    
    14,592Depreciation and amortization
    
    
    5,295
    
    
    
    212
    
    
    
    874
    
    
    
    803
    
    
    
    7,184Operating income (loss) before
loss on sale of assets and
impairments
    
    
    35,983
    
    
    
    (1,394
    )
    
    
    2,752
    
    
    
    (15,395
    )
    
    
    21,946Loss on sale of assets
    
    
    
    
    
    
    
    
    
    
    148
    
    
    
    
    
    
    
    148Asset impairments
    
    
    
    
    
    
    
    
    
    
    1,815
    
    
    
    
    
    
    
    1,815Operating income (loss)
    
    
    35,983
    
    
    
    (1,394
    )
    
    
    789
    
    
    
    (15,395
    )
    
    
    19,983Interest expense (net) (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,684
    
    
    
    2,684Non-controlling interest (5)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    29
    
    
    
    29Income before income taxes (5)
    
    
    35,983
    
    
    
    (1,394
    )
    
    
    789
    
    
    
    (18,108
    )
    
    
    17,270Income taxes (5)
    
    
    13,583
    
    
    
    (526
    )
    
    
    298
    
    
    
    (6,836
    )
    
    
    6,519Net income (loss) (5)
    
    $
    22,400
    
    
    $
    (868
    )
    
    $
    491
    
    
    $
    (11,272
    )
    
    $
    10,751
   (1)
    
    Represents operating results attributable to Base Practices for which we
were recording patient revenue as of June 30, 2004.(2)
    
    Represents centers that had been operating and affiliated with us for
more than 18 months as of June 30, 2004, or that had been operating for
less than 18 months as of June 30, 2004 but had begun to generate
operating profits on a cash basis.(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.(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 six months ended June 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 Six Months Ended June 30, 2003 and
2004 The following discussion provides an analysis of our results of operations
for the three and six months ended June 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 six months ended
June 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 six months ended June 30, 2004 to pro forma
results for the three and six months ended June 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 the OutSource Practices) to their respective
line items within Practice-related expenses. Net Income (Loss). Net income for the three months ended June 30, 2004
was $2.3 million compared to net income of $13.4 million for the same period in
2003. Net loss for the six months ended June 30, 2004 was $65.1 million
compared to net income of $28.3 million for the same period in 2003. Our net
loss during the first six months of 2004 was primarily related to a cumulative
effect of a change in 28




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##### Table of Contents



accounting principle of $74.7 million, net of income tax benefit of $41.4
million, recorded during the first quarter of 2004. Our net income during the three and six months ended June 30, 2004 also
was negatively impacted by operating losses and other expenses incurred in
connection with the development of de novocenters. During the three months
ended June 30, 2004, we incurred operating losses associated with de novo
centers of approximately $1.5 million, compared to $0.8 million during the same
period in 2003. During the six months ended June 30, 2004, we incurred
operating losses associated with de novocenters of approximately $2.2 million,
compared to $1.4 million for the same period in 2003. The development of de
novocenters 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 novocenters
typically generate initial operating losses during their first 12 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 novopractices 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 novocenter becomes profitable. We expect
operating losses associated with the de novocenters 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 will continue to invest in our existing
affiliated practices and develop additional de novocenters for the remainder
of 2004 to grow our business. In addition, net income (loss) was affected by the following significant
factors: 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. Fee revenue
represented amounts related to services provided to affiliated practices and
recorded under our revenue recognition policy prior to January 1, 2004. Fee
revenue was $100.2 million and $200.9 million for the three and six months
ended June 30, 2003, respectively. Patient revenue for the three months ended June 30, 2004 decreased $6.7
million, or 6.0%, to $104.3 million from $111.0 million for the same period in
2003 on a pro forma basis, calculated as if our adoption of FIN 46R was
effective as of January 1, 2003. Patient revenue for the six months ended June
30, 2004 decreased $8.7 million, or 3.8%, to $215.2 million from $223.9 million
for the same period in 2003 on a pro forma basis, calculated as if our adoption
of FIN 46R was effective as of January 1, 2003. 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: 29




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Increase/Three months endedJune 30,
    
    (Decrease)2004
    
    2003
    
    Dollar Amount
    
    PercentageAs reported
    
    Pro forma (3)
    
    Actual
    
    Pro forma
    
    Actual
    
    Pro forma(in thousands, except percentage data)Base Practices (1)
    
    $
    103,660
    
    
    $
    88,651
    
    
    $
    94,651
    
    
    $
    15,009
    
    
    $
    9,009
    
    
    
    16.9
    %
    
    
    9.5
    %Inactive Practices (2)
    
    
    656
    
    
    
    11,563
    
    
    
    16,372
    
    
    
    (10,907
    )
    
    
    (15,716
    )
    
    
    (94.3
    )%
    
    
    (96.0
    )%Total patient revenue
or fee revenue
    
    $
    104,316
    
    
    $
    100,214
    
    
    $
    111,023
    
    
    $
    4,102
    
    
    $
    (6,707
    )
    
    
    4.0
    %
    
    
    (6.0
    )%
 Increase/Six months endedJune 30,
    
    (Decrease)2004
    
    2003
    
    Dollar Amount
    
    PercentageAs reported
    
    Pro forma (3)
    
    Actual
    
    Pro forma
    
    Actual
    
    Pro forma(in thousands, except percentage data)Base Practices (1)
    
    $
    211,561
    
    
    $
    171,306
    
    
    $
    191,698
    
    
    $
    40,255
    
    
    $
    19,863
    
    
    
    23.4
    %
    
    
    10.4
    %Inactive Practices (2)
    
    
    3,653
    
    
    
    29,547
    
    
    
    32,242
    
    
    
    (25,894
    )
    
    
    (28,589
    )
    
    
    (87.6
    )%
    
    
    (88.7
    )%Total patient revenue
or fee revenue
    
    $
    215,214
    
    
    $
    200,853
    
    
    $
    223,940
    
    
    $
    14,361
    
    
    $
    (8,726
    )
    
    
    (7.2
    )%
    
    
    (3.9
    )%
   (1)
    
    Represents patient revenue of Base Practices for which we were
recording patient revenue as of June 30, 2004.(2)
    
    Represents patient revenue attributable to Inactive Practices during
the three and six months ended June 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 June 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 June 30,
2004, the $9.0 million or 9.5% increase in patient revenue attributable to Base
Practices was offset by a $15.7 million or 96.0% 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 an increase in patient revenue for comparable
Base Practices during the period. Patient revenue for Base Practices for which
we recorded patient revenue throughout the three months ended June 30, 2004 and
2003 increased 8.9% during the three months ended June 30, 2004, compared to
the same period of 2003 on a pro forma basis, calculated on a pro forma basis
as if our change in accounting principle occurred on January 1, 2003.
Similarly, during the six months ended June 30, 2004, the $19.9 million or
10.4% increase in patient revenue attributable to Base Practices was offset by
a $28.6 million or 88.6% 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
an increase in patient revenue for comparable Base Practices during the period.
Patient revenue for Base Practices for which we recorded patient revenue
throughout the entire six months ended June 30, 2004 and 2003 increased 10.1%
during the six months ended June 30, 2004, compared to the same period of 2004
on a pro forma basis, calculated on a pro forma basis as if our change in
accounting principle occurred on January 1, 2003. These decreases in patient
revenue attributable to Inactive Practices resulted as we ceased to record
patient revenue during the first half of 2004 for Inactive Practices for which
we recorded fee revenue during the first half of 2003. We expect some
continued fluctuations in patient revenue as affiliated practices may buy out
of their Service 30




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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 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, and
    
    Marketing and advertising expense, which represents costs
associated with television, radio and print media advertising for
affiliated practices. During the three months ended June 30, 2004, practice-related expenses
increased $23.7 million, or 38.7%, to $84.8 million from $61.1 million for the
same period in 2003. This overall increase during the three months ended June
30, 2004 was primarily due to amounts retained by affiliated practices. On a
pro forma basis, calculated as if our adoption of FIN 46R was effective as of
January 1, 2003, practice-related expenses decreased $6.4 million, or 7.0%, to
$84.8 million for the three months ended June 30, 2004 from $91.2 million for
the three months ended June 30, 2003. Amounts retained by practitioners totaled $29.3 million, or 28.1% of
patient revenue, for the three months ended June 30, 2004. On a pro forma
basis, calculated as if our adoption of FIN 46R was effective as of January 1,
2003, amounts retained by practitioners was $30.1 million, or 27.1% of patient
revenue, for the three months ended June 30, 2003. Amounts retained by
practitioners totaled $62.0 million, or 28.8% of patient revenue, for the six
months ended June 30, 2004. On a pro forma basis, calculated as if our adoption
of FIN 46R was effective as of January 1, 2003, amounts retained by
practitioners was $57.8 million, or 25.8% of patient revenue, for the six
months ended June 30, 2003. The $4.2 million increase on a pro forma basis in
amounts retained by practitioners during the six months ended June 30, 2004 was
primarily due to the growth in patient revenue for Base 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. 31




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All other practice-related expenses, excluding amounts retained by
practitioners, decreased $5.6 million or 9.2% to $55.5 million for the three
months ended June 30, 2004 from $61.1 million for the three months ended June
30, 2003. These other practice-related expenses decreased $13.9 million or
11.3% to $108.5 million for the six months ended June 30, 2004 from $122.4
million for the six months ended June 30, 2003. During the three months ended June 30, 2004, salaries and benefits
decreased $2.6 million, or 10.1%, to $23.1 million from $25.7 million for the
same period in 2003. During the six months ended June 30, 2004, salaries and benefits decreased $5.8 million, or 11.1%, to
$46.4 million from $52.2 million for the same period in 2003. During the three
months ended June 30, 2004, rent decreased $2.4 million, or 26.0%, to $6.8
million from $9.2 million for the same period in 2003. During the six months
ended June 30, 2004, rent decreased $4.9 million, or 26.6%, to $13.5 million
from $18.4 million for the same period in 2003. 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 six months ended June
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
June 30, 2003. Our adoption of FIN 46R did not affect our direct expenses
other than amounts retained by affiliated 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 June 30, 2004, general
and administrative expense was $9.3 million, compared to $9.4 million during
the same period of 2003. During the six months ended June 30, 2004, general
and administrative expense was $18.2 million, which represented a $2.0 million
or 12.3% increase from $16.2 million during the same period of 2003. These
increases were primarily due to increased accounting and legal costs associated
with our change in independent auditors, our annual audit and our change in
accounting principle as a result of adopting FIN 46R. 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, including preparation
for managements assessment of our internal control over financial reporting
and a related attestation report by our independent auditors. Partially
offsetting the increase in accounting and legal expenses during the three and
six months ended June 30, 2004 was a decrease in the provision for
uncollectible amounts. 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 provide an allowance associated with these
advances. At June 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. We continue to provide a provision for uncollectible amounts
associated with advances to Inactive Practices. Amortization.Amortization represented the amortization expense recorded
in connection with the amortization of our identifiable intangible assets. 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 a business combination,
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. Amortization expense was $0
during the three months ended June 30, 2004, compared to $2.8 million for the
three months ended June 30, 2003. For the six months ended June 30, 2004,
amortization expense was $0.2 million compared to $5.2 million for the same
period in 2003. The decreases in amortization expense during the three and six
months ended June 30, 2004 compared to the same periods in 2003 were primarily
due to our adoption of FIN 46R. 32




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Asset Impairments. We recorded no asset impairments during the three and
six months ended June 30, 2004. During the three and six months ended June 30,
2003, we recorded impairments of approximately $0.9 million and $1.3 million,
respectively, related to property, equipment and improvements for offices
closed during 2003 and approximately $0.3 million and $0.6 million,
respectively, related to intangible assets. Gain (Loss) on Sale of Assets. During the three and six months ended June
30, 2004, we incurred loss on sale of assets of approximately $1.6 million and
$1.5 million ($1.0 million and $1.0 million, net of income tax benefit),
respectively, as a result of practices buying out of their Service Agreements.
We received an aggregate of $2.4 million in cash from these buyouts. Income Taxes.Our effective income tax rate was 36.5% for the three and
six months ended June 30, 2004, compared to 37.8% for the three and six months
ended June 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 six months ended June 30, 2004. Cumulative Effect.During the six months ended June 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 $8.6 million at June 30, 2004 and $7.4
million at December 31, 2003. Our working capital (total current assets less
total current liabilities) was $70.0 million at June 30, 2004, compared to
$142.8 million at December 31, 2003. Our current ratio (total current assets
divided by total current liabilities) was 1.5 at June 30, 2004, compared to 4.6
at December 31, 2003. The decrease in working capital at June 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 $96.9 million in deferred
revenue, offset by an increase of $128.7 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. During the six
months ended June 30, 2004, we did not borrow under our credit facility but
generated excess cash from operations to fund our capital expenditures and to
reduce our debt. At June 30, 2004, we had $20.4 million available to borrow
under our credit facility. We expect to continue generating excess cash to meet
our capital requirements and liquidity needs during the remainder of 2004. 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 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 novocenters 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 33




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obtaining financing for their share of these costs by providing a guaranty
of loans from our primary lender. We generally no longer guarantee new debt for
our affiliated practices. During our rapid growth in the 1990s, we expended a disproportionately
high amount of our capital investment on the development of de novocenters
relative to expenditures on existing centers. During recent years, however, our
capital expenditures have been increasingly directed toward remodeling,
refurbishing, improving and expanding our existing affiliated centers to
facilitate internal growth. During recent years, we also invested significantly
in computer systems infrastructure and other technology for our affiliated
centers, such as advanced digital cameras or DSL data delivery capability. In
addition, we continue to invest in the development of de novocenters in our
international operations. 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
$15.9 million of capital expenditures, which we expect to incur in the second
half of 2004 and in 2005. We may commit to additional developments and
remodelings as well. We expect to fund these capital expenditures using cash
generated from operations. 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, (b) provide additional funds to affiliated practices for
certain practice-related matters or other unsecured financing or (c) finance
the acquisition of another practice. 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, (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 or (3) not receiving all service fees due from
certain affiliated practices that collect their own patient fees. 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. 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 and 2005. If all conditions are met under these programs
during 2004, we would pay participants an aggregate of $6.1 million for amounts
earned in 2004. At June 30 2004, we had current maturities of $8.3 million
under our credit facility and $1.9 million due to our affiliated practices. We
expect cash flow from operations to fund these payments during 2004. 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. 34




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Sources of Capital We currently believe that we will be able to meet our anticipated funding
requirements for at least the next 12 months. However, 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 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.We expect to fund our cash needs primarily from
cash flows from our operations. During the six months ended June 30, 2004, we
used our deferred tax assets relating to net operating loss carryforwards to
offset our tax provision for the first two 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 Internal Revenue Service 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 substantially 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. During the six months ended June 30, 2004, we decreased the amounts of
service fees charged to certain of our affiliated practices which negatively
affected our cash flow from operations. Beginning in 2003, we implemented an
incentive program whereby we reduced service fees charged to certain practices
that achieve certain performance levels. For the six months ended June 30,
2004, this incentive program resulted in a $1.9 million reduction in service
fees charged to these practices compared to a $1.0 million reduction for the
same period in 2003. We have also reduced service fees charged to certain other
practices, which resulted in lower service fees collected from these practices
compared to the six months ended June 30, 2003. In addition, we have phased out
75% of the reimbursement of corporate-level expense allocation among certain
affiliated practices as of June 30, 2004. We have sustained our growth and
capital needs using cash generated from operations and not from borrowings
under our credit facility. We expect to continue using cash generated
operations 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 June 30, 2004, $79.6 million was
outstanding under the revolving line of credit and $12.3 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 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 35




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such a waiver or amendment, which could have a material adverse impact on
our liquidity and capital resources. At June 30, 2004, we were in compliance
with the covenants and restrictions under the credit facility. Cash Flows The following table summarizes cash flow information for the six months ended
June 30, 2004 and 2003: Six months endedJune 30,2004
    
    2003Net cash provided by operating activities
    
    $
    22,534
    
    
    $
    27,513Net cash used in investing activities
    
    
    (15,502
    )
    
    
    (12,506
    )Net cash used in financing activities
    
    
    (4,876
    )
    
    
    (10,170
    )Change in cash and cash equivalents
    
    
    1,181
    
    
    
    4,493
 Operating Activities.See our discussion of net income in the section
above captioned - Results of Operations. Our working capital decreased 50.7%
to $70.3 million at June 30, 2004 from $142.8 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
six months ended June 30, 2004 was $15.5 million compared to $12.5 million
during the same period in 2003. We used $10.2 million and $7.5 million in cash
to purchase property, equipment and improvements during the six months ended
June 30, 2004 and 2003, respectively. These expenditures primarily related to
the development of new or de novocenters in the United States and abroad and
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. Financing Activities.Net cash used in financing activities was $4.9
million and $10.2 million for the six months ended June 30, 2004 and 2003,
respectively. We repaid $5.9 million less on our credit facility during the
six months ended June 30, 2004 compared to the same period in 2003. During the
six months ended June 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. We have committed to
develop additional de novocenters and remodel existing centers for affiliated
practices. We currently estimate that these developments and remodeling will
require approximately $15.9 million of capital expenditures, which we expect to
incur in the second half of 2004 and in 2005. We may commit to additional
developments and remodeling as well. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK During the six months ended June 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. 
 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 36




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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. 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 and the members of its Audit
Committee are developing a plan to address the items cited in the letter from
Ernst & Young. Certain items in the letter from Ernst & Young may no longer be
applicable due to our adoption of FIN 46R and change in revenue recognition
policy effective January 1, 2004. Among other things, 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 recognizable as fee revenue. These calculations are
not applicable under our new revenue recognition policy. Since March 31, 2004, we have taken certain steps to enhance our internal
control over financial reporting. These enhancements include increased
automation in determining our patient revenue and patient receivables. We
intend to continue to hire additional personnel in our financial accounting
area, which we believe will improve segregation of duties with respect to our
financial accounting. We also are taking 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 those
practices. In addition, we have engaged outside consultants to advise our
management in evaluating, documenting and testing our internal controls. We
continue to further document and enhance our controls and procedures. In addition, we are in the process of evaluating, documenting and testing
our internal control over financial reporting in anticipation of disclosure
that will be required to be included in our Annual Reports on Form 10-K
(beginning with our Annual Report on Form 10-K for 2004) under rules adopted
by the SEC under Section 404 of the Sarbanes-Oxley Act of 2002. These SEC
rules require that we include a report by OCAs management regarding its
assessment of the effectiveness of our internal control over financial
reporting as of the end of the fiscal year, including a statement as to
whether or not our internal control over financial reporting is effective, as
well as an attestation report by our independent auditors on managements
assessment. 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 by management. During this evaluation, documentation and testing 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
managements assessment. We cannot assure you that our management will
conclude that our internal control over financial reporting is effective. In
addition, 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, they could lessen investor confidence in the
reliability of our financial statements, which could negatively impact the
market price of OCA common stock. They could also negatively impact our
ability to affiliate with 37




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additional practices. We also expect that the evaluation, documentation
and testing process and any required remediation will increase our accounting,
legal and other expenses and will divert some of the time and attention of
members of our management. 38




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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, it 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 10, 2003, Ilena and Guiseppe Chiaretti filed an action in the
United States District Court for the Eastern District of Louisiana against OCA
and Bartholomew F. Palmisano, Sr., OCAs Chairman of the Board, President and
Chief Executive Officer, Bartholomew F. Palmisano, Jr., OCAs Chief Operating
Officer, and Thomas J. Sandeman, OCAs then Chief Financial Officer. Similar
actions were filed in the same court by other plaintiffs. On August 28, 2003,
the lawsuits were consolidated and John A. Matis, Trustee was appointed as lead
plaintiff. The consolidated action purported to be filed as a class action on
behalf of the plaintiffs and other purchasers of shares of OCA common stock
from November 14, 2002 to March 18, 2003, and alleged that OCA and the other
defendants violated Section 10(b) of the Securities Exchange Act of 1934, as
amended, and Rule 10b-5 thereunder, by allegedly making false and misleading
statements, and/or omitting to state material facts necessary to make the
statements made not misleading. On April 6, 2004, the court granted OCAs
motion and ordered that the lawsuit be dismissed. The court found that the
plaintiffs had failed to state a claim that OCA and its officers violated
federal securities laws. On May 6, 2004, the court entered a judgment
dismissing the case. The plaintiffs have indicated that they will not appeal
the dismissal and the time period for such an appeal has expired. Because litigation is inherently uncertain, we cannot assure you that we
or our 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,
time-consuming and could divert the time and attention of our senior
management. 
 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS The annual meeting of OCA stockholders was held on May 27, 2004. At this
meeting, the following matters were voted upon by OCA stockholders:  (a)
    
    Election of Class I Directors Each of Dr. Dennis J.L. Buchman, Kevin M. Dolan, Linda C. Girard and David
W. Vignes was elected to serve as a Class I director until the annual meeting
of stockholders in 2007 or until his or her successor is elected and qualified.
The vote was as follows: Votes Cast
    
    VotesName
    
    In Favor
    
    WithheldDennis J.L. Buchman,
D.M.D., M.S.
    
    
    44,113,957
    
    
    
    1,234,570Kevin M. Dolan
    
    
    44,900,830
    
    
    
    447,697Linda C. Girard
    
    
    44,899,030
    
    
    
    449,497David W. Vignes
    
    
    44,901,612
    
    
    
    446,915
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The terms of the following directors continued following the meeting: Name
    
    Term ExpiresAshton J. Ryan, Jr.
    
    
    2005W. Dennis Summers
    
    
    2005Edward J. Walters, Jr.
    
    
    2005Bartholomew F. Palmisano, Sr.
    
    
    2006Hector M. Bush, D.M.D.
    
    
    2006Jack P. Devereux, Jr., D.D.S., M.S.
    
    
    2006
  (b)
    
    Selection of Independent Auditors Our stockholders ratified the appointment of PricewaterhouseCoopers LLP as
independent auditors for the fiscal year ending December 31, 2004 by the
following vote: Votes Cast
    
    Votes Cast
    
    Abstentions/In Favor
    
    Against
    
    Non-Votes45,029,297
    
    
    
    308,379
    
    
    
    10,851
 
 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)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))
 40




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##### Table of Contents



Exhibit number
    
    Description4.4
    
    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)31.1
    
    Certification of the Chief Executive Officer of Orthodontic
Centers of America, 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 Orthodontic Centers of America, 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 Orthodontic
Centers of America, 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 Orthodontic Centers of America, 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 April 27, 2004, we filed a current report on Form 8-K, and an amendment
to that 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. During the three months ended June 30, 2004, we also
furnished a current report on Form 8-K on May 20, 2004 reporting information
under Item 7. Financial Statements and Exhibits and Item 12. Results of
Operations and Financial Condition. 41




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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. Orthodontic Centers of America, Inc.(Registrant)Date: August 9, 2004
    
    /s/ Bartholomew F. Palmisano, Sr.Bartholomew F. Palmisano, Sr.Chairman of the Board, President
and Chief Executive Officer/s/ David E. VerretDavid E. VerretSenior Vice President of Finance and
Chief Financial Officer
 42




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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)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)31.1
    
    Certification of the Chief Executive Officer of Orthodontic
Centers of America, 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 Orthodontic Centers of America, 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 2002
 43




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Exhibit number
    
    Description32.1
    
    Certification of the Chief Executive Officer of Orthodontic
Centers of America, 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 Orthodontic Centers of America, Inc.
pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002
 44