UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

Commission File No.: 001-13457

ORTHODONTIC CENTERS OF AMERICA, INC.

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.

ORTHODONTIC CENTERS OF AMERICA, INC.

TABLE OF CONTENTS

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 novo centers, 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.

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PART I. FINANCIAL INFORMATION

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

Orthodontic Centers of America, Inc.

See accompanying notes to condensed consolidated financial statements.

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Orthodontic Centers of America, Inc.

See accompanying notes to condensed consolidated financial statements.

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Orthodontic Centers of America, Inc.

See accompanying notes to condensed consolidated financial statements.

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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.

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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.

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

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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.

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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):

     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

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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.

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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.

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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:

     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.

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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):

     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

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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.

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:

     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

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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.

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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

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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:

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     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.

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     The table below provides the impact to our condensed consolidated balance sheet at January 1, 2004, including elimination of intercompany transactions, as a result of our adoption of FIN 46R (in thousands).

     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.

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     (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.

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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.”

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     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.

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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

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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:

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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 novo centers, which typically incur operating losses during their first 12 to 18 months of operation.

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