UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

FORM 10-K

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)

Securities registered pursuant to Section 12(b) of the Act:

Securities registered pursuant to Section 12(g) of the Act:

Common Stock, $.01 par value per share
(Title of Class)

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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES [X] NO [  ]

The aggregate market value of the shares of the Registrant’s Common Stock held by non-affiliates of the Registrant on June 30, 2003 was approximately $379.4 million, based upon the last reported sale price per share of the Registrant’s Common Stock as reported on the New York Stock Exchange on June 30, 2003.

As of March 10, 2004, there were approximately 50,094,000 outstanding shares of the Registrant’s Common Stock.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Registrant’s definitive Proxy Statement relating to the Annual Meeting of Stockholders of the Registrant to be held during 2004 are incorporated by reference into Part III of this Report.

Table of Contents

PART I

ITEM 1. BUSINESS

OVERVIEW

     Orthodontic Centers of America, Inc. (“OCA,” “we” or “our”) is a leading provider of integrated business services. Since our founding in 1985, we have focused on providing business services to orthodontic and pediatric dental practices. As of December 31, 2003, we were providing business services to 362 orthodontic and pediatric dental practices throughout the United States and parts of Japan, Mexico, Spain and Puerto Rico.

     We offer practices a full range of business, operational and marketing services, as well as complementary Internet-based practice management systems. These services and systems enable practices to focus on providing quality patient care, while increasing productivity and profitability. Currently, our services include:

	•		capital to open new practice locations;
	•		proprietary business and clinical systems that provide timely information that allows practitioners to operate more efficiently;
	•		proprietary financial and operating systems to enhance operational and accounting controls;
	•		effective advertising and marketing plans to help generate new patients; and
	•		proprietary on-line purchasing system and purchasing power to reduce clinical and supply costs.

     To complement our existing focus on orthodontic and pediatric dental practices, we recently initiated a new division called OCA Outsource, through which we intend to provide business services to general dental practices and other dental and medical practices. We believe that general dentists and other healthcare providers, which far outnumber the orthodontists and pediatric dentists in the United States, provide us with an expansive opportunity for growth. We anticipate that OCA Outsource will offer its services in exchange for a monthly fee based on a percentage of the practice’s cash collections. These arrangements would differ from our traditional affiliations.

DESCRIPTION OF SERVICES

     OCA provides a comprehensive suite of business services to support practice activities. We are not a healthcare provider and we are not involved in the clinical operations of a practice. The practitioners maintain full control over their practices and set their own standards of practice. OCA handles the business operations of the practice, which allows the practitioner to focus on patient care. Our proprietary business and financial systems provide readily accessible information about the practice in an easy-to-understand format. The following is a summary of the services provided by OCA:

Marketing and Advertising

     OCA develops and implements marketing and advertising programs for practices using television, radio, and print media advertising, as well as direct mail campaigns. We tailor the advertising to the particular market and prominently feature the names and locations of the affiliated practice. We also offer a 1-800-4BRACES toll-free telephone number by which calls are automatically routed to an affiliated center located near the caller and a www.4braces.com Internet website where prospective patients can locate an affiliated practice in a specific area. In addition, to supplement the various advertising programs offered, we provide internal marketing programs to assist practices in increasing patient referrals from their existing patients, staff and other dentists.

Financial and Statistical Reporting

     Practices can use our Internet-based financial and statistical system to view their operating and financial data. The system provides customized reports for financial and clinical data and performance measures for each practice. Performance statistics and financial data are updated continually. This information is accessible by the

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practitioner from any computer connected to the Internet. A practitioner can view his or her practice’s financial information in real-time, 24 hours a day. We provide practices with monthly and quarterly financial data, including analyses of the financial results and recommended changes to improve financial and operating performance.

Centralized Collections

     OCA has developed a centralized billing and collection system that frees practices from the day-to-day function of billing and collecting patient fees. This service includes billing patients, as well as insurance companies and other third-party payors.

Purchasing

     OCA is one of the single largest purchasers of orthodontic and dental supplies. By leveraging the combined purchasing power of our affiliated practice base, we are able to make bulk purchases of equipment, office furniture, clinical supplies and office supplies in order to reduce costs and associated administrative expenses for practices. OCA negotiates arrangements with suppliers that provide cost savings to practices. We have also implemented an online inventory ordering system that allows practices to order supplies directly from vendors through our private computer network. Our online inventory ordering system contains approximately 35,000 products from over 375 vendors. We charge no additional fees on items sold through our system.

Staffing

     OCA employs the support staff for most of its affiliated practices. We do not employ the orthodontists, dentists or other licensed healthcare professionals. Our employees generally include the center manager, front desk personnel and other center support staff, and, except where prohibited by law, the orthodontic and dental assistants. Unlike OCA, we anticipate that OCA Outsource will not employ the practice’s staff.

Other Operational Services

     We also employ a number of personnel in our corporate office who provide services for our affiliated practices on a centralized basis. These services include the following:

     Operations. Managers in our operations department respond to various questions and requests from practices located within an assigned geographic region, including those relating to inventory, supplies, equipment and financial matters. We provide assistance with the development and expansion of practices, as well as assistance with ownership transitions and recruiting associate-level practitioners. Our operations department also assesses the financial performance of practices and advises practices on how to improve their operations. In addition, our operations department also provides support for our management information systems.

     Training. Practice personnel receive initial training regarding our management information systems at our training office in Metairie, Louisiana. We also provide various training programs for our support staff aimed at promoting efficient use of our systems and educating our affiliated practices about best practices in operating their practices. In addition, we offer courses to support staff when we upgrade our software. We also employ training teams which travel to new centers to train a practice’s clinical and business staff with respect to these systems.

     Office Leasing and Construction. OCA’s real estate department provides a range of office leasing, construction and other commercial real estate services. Our services include strategically locating office space, procuring favorable leases for office space, designing and arranging for build-outs of state-of-the-art facilities, and providing ongoing service and consultation on facilities management, lease renewal and remodeling.

     Information Technology Support. We provide person-to-person technology support for our management information systems and other information technology related support through a call center staffed by support technicians. The center is open from early in the morning to late in the evening to assist practices throughout the country. Technicians are also available during the weekends as needed.

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Management and Doctor Information Systems

     OCA has developed several proprietary Internet-based information applications to increase the efficiency of practices and enhance our business services. Our information systems improve the frequency, quality, accuracy and efficiency of our affiliated practices’ financial and operational data. We have established a highly efficient and flexible proprietary information technology platform that allows us to actively track and report practice profitability and efficiency, practice performance, consumer trends and marketing/advertising effectiveness. We continue to upgrade our systems so we can continue to provide practices with efficient and effective business services. All of our systems are Internet-based and access is password-protected. These applications were designed and are supported by our information technology department. Each of our information technology systems is described below.

     Practice Management System. OCA has developed a full-featured practice management system that allows practices to efficiently schedule patients to optimize practitioner time and to maximize the contribution of the clinical staff. This system is also a patient accounting system that tracks patient billing and collections, and monitors the patients’ treatment. This system provides clinical charting and stores digital images as part of the clinical records of the patient. This system also provides practices with important feedback on a daily, real-time basis with respect to key operating data, such as case starts, patient attendance rates, patient conversions and patient past-due amounts.

     Payroll System and Employee Benefits. OCA has also developed a system that centralizes payroll-related functions for employees. The system allows us to efficiently manage all the payroll-related functions from one centralized location, and allows employees to review and/or change their personal information. Supervisors can monitor, add and revise employee data, allowing for a virtually paperless wage and benefits system. We also use a biometric fingerprint time clock system through which employees record time and attendance.

     Online Purchasing System. OCA developed an online purchasing system, which allows practices to order supplies and equipment directly from vendors. The ordering system is designed to reduce supply costs, associated administrative costs, shipping time and storage requirements, and to improve the accuracy of orders placed and the flow of information between vendors and practices. The system reduces the time that staff would typically devote to inventory management and ordering. This system also provides for images of invoices to be viewed by the practitioner over the Internet, rather than cumbersome paper invoice mailings.

     Centralized Collection System. OCA has developed a centralized collection system that frees the practices from the day-to-day function of collecting patient fees. This system also includes working with insurance companies and other third-party payors. We believe that collection of patient fees is often a practice’s area of greatest inefficiency.

     Financial and Statistical System. OCA has also developed a practice financial accounting and reporting system that analyzes and reports information gathered through our other information systems. This system provides practices with secure access to real-time performance and financial data about their respective practice from anywhere they can access the Internet. A practitioner can view his or her practice’s financial information in real-time, 24 hours a day. As a management tool, OCA uses this system to identify potential problems with specific practices, to advise the practices in a timely and efficient way and to facilitate decisions about expansion and new locations in particular markets.

CUSTOMERS AND LOCATIONS

     Our customer base is currently comprised of orthodontic and pediatric dental practices operating in 46 states and in international locations. We believe our diversified market scope limits our exposure to events or trends that may occur in any individual state or region.

     We provide comprehensive business services to these practices under long-term service, consulting and management service agreements in exchange for monthly service fees generally based on a percentage of a practice’s operating profit or patient revenue, plus reimbursement of practice-related expenses. As of December 31, 2003, OCA was providing business services to affiliated practices in the following locations:

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     Of the 362 affiliated practices as of December 31, 2003, 334 were orthodontic practices and 28 were pediatric dental practices.

     The total number of affiliated practices excludes 62 orthodontic and pediatric dental practices that were engaged in litigation with us and for which we had generally ceased to record fee revenue as of December 31, 2003. We were also engaged in litigation with one practice for which we were still recording fee revenue because this practice was still paying service fees to us at December 31, 2003. The total number of affiliated practices above includes 38 other practices that were not engaged in litigation with us but for which we had generally ceased to record fee revenue at December 31, 2003.

     We believe that our affiliated pediatric dental practices complement our core affiliated orthodontic practices. They provide a referral source for orthodontic treatment and can operate in an orthodontic center on days that orthodontic treatment is not being provided.

     We have expanded our international operations to include Japan, Spain, Mexico and Puerto Rico. We operate our international operations through local management located in each country and business systems that are linked to our corporate headquarters in the United States. Fee revenue from international operations as a percentage of our total fee revenue was 4.0%, 2.1% and 2.4% for 2003, 2002 and 2001, respectively. Long-lived assets located in foreign countries as a percentage of our total long-lived assets was 4.6%, 4.0% and 3.4% as of December 31, 2003, 2002 and 2001, respectively.

GROWTH STRATEGY

     Our growth strategy has evolved during our history. During much of the 1990’s, we focused on providing business services exclusively to orthodontic practices in the United States and grew through a combination of affiliations with established practices and development of de novo centers. In the past few years, we have added affiliated pediatric dental practices, as well as international operations. Beginning in 2000, we began to de-emphasize affiliations with established practices, which generally required significant investments in affiliation payments to the practice. We instead began to focus on internal growth of existing affiliated practices and development of de novo centers for existing and new affiliated practices. We also grew by acquiring a competing company, OrthAlliance, Inc., in 2001 and by acquiring certain assets of a former competitor, Apple Orthodontix, Inc., in 2000.

     In early 2004, we launched our newest vehicle for growth, OCA Outsource, to complement our core business of providing business services to affiliated orthodontic and pediatric dental practices. Through OCA Outsource, we intend to capitalize on our experience and expertise to provide business services to general dentists and other dental and medical practices. Initially, OCA Outsource will focus on general dental practices and other dental specialties. OCA Outsource provides us with an opportunity to leverage our proprietary systems and services platform over a significantly larger base of practices in diverse areas of dental and medical specialties.

     At the same time, we continue to focus on strengthening our market position by expanding our existing affiliated practices. We believe investing resources in our existing affiliated practices will provide a higher return on our investment than affiliating with new practices. We will no longer focus on capital intensive affiliations with established practices in the United States and will only consider entering into these types of affiliations in very limited situations.

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     OCA’s key strategies for growth are:

Internal Growth From Expanding Affiliated Practices

     We are pursuing growth in comparable fee revenue for our existing affiliated practices through the following means:

     De Novo Centers, Center Expansions and Center Renovations. We believe that many of our affiliated practices are operating below their potential capacity, which provides opportunities to increase productivity and profitability of existing affiliated practices. We have experienced increased demand among our affiliated practices for more clinical capacity through building new centers and use of licensed professionals. OCA has developed and opened 388 new or de novo centers through December 31, 2003, of which 41 centers opened during 2003. Most of these de novo centers were developed for existing affiliated practitioners seeking to expand their practices. We are currently experiencing significant growth in the development of de novo centers by affiliated practices. We believe that developing new centers provides an opportunity for a favorable return for our affiliated practices and us. We intend to continue to develop additional de novo centers with our existing affiliated practices, and when necessary, to help recruit licensed professionals to practice in these centers.

     Our affiliated practices generally experience increased patient volume when facilities undergo a major renovation or expansion. It has been our experience that maintaining a modern and appealing facility, equipped with appropriate and up-to-date equipment, contributes to profitability. We plan to increase the pace of our investment in this area during 2004.

     Recruiting. We actively assist with recruiting licensed professionals for our existing affiliated practices. These associates are often recent graduates of orthodontic or pediatric dental specialist residencies who desire experience in an affiliated practice, under the guidance of a successful practitioner who owns his or her practice. These associates also desire a stable salary before they seek an ownership position in these practices. We have observed a growing interest among new graduates for associate-level positions. These associates find OCA particularly appealing because of the opportunities throughout the country available to them with an identifiable path to practice ownership. During 2003, we and our affiliated practices recruited 15 new associate practitioners. We will continue to recruit more associates to meet the demand for additional professionals for our existing affiliated practices.

Expansion in International Markets

     We believe that there are large, untapped markets for dental and healthcare business outsourcing services outside the United States. We believe that Japan and other foreign countries are underserved markets that offer significant opportunities to grow our business. In 1998, we entered the Japanese market and were affiliated with 26 orthodontic practices in Japan as of December 31, 2003. We began operating in Mexico and Puerto Rico in 1999, and were affiliated with four orthodontic practices in Mexico and three orthodontic practices in Puerto Rico as of December 31, 2003. Since our first affiliation in Spain in 2001, we have grown to three affiliated orthodontic practices as of December 31, 2003. We have focused our international expansion on providing business services to orthodontic practices.

     During 2003, our Japanese affiliated practices began advertising their services in broadcast media. Because Japan is densely populated, the advertising has created an untapped demand for orthodontics. These marketing campaigns generated prospective patients in areas in which our Japanese affiliated practices do not currently operate. As a result, we are providing our marketing services to practices that currently do not use our comprehensive business services, under a concept that we call “OCAJ Lite”. Under this arrangement, we earn a fee based on the number of patients generated for these practices through our marketing services. We only provide marketing services to these practices, which are not affiliated with us, and do not provide capital or our other business services. These services are provided under agreements that generally have a one year term, with an automatic extension of the term unless earlier terminated. As of December 31, 2003, we were providing OCAJ Lite marketing services to 50 practices in Japan. We expect to continue providing these OCAJ Lite marketing services to Japanese practices until we determine that there is a more favorable return in developing a center in their markets.

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     We intend to continue expanding our operations in Japan, Mexico, Puerto Rico and Spain and are currently in negotiations to expand into China, Brazil and other countries. Our expansion into any particular country depends upon its regulatory environment, market demographics, advertising media and economic conditions, as well as our ability to attract quality professionals, a management team and other business personnel in that market.

Expansion of Business Services to New Specialties through OCA Outsource

     We recently began marketing our suite of business services to practices outside of our traditional customer base of orthodontic and pediatric dental practices through our division called OCA Outsource. Initially, OCA Outsource is focusing on the general dental industry, which includes more than 150,000 general dentists in the United States, and other dental specialties. We intend to eventually begin offering OCA Outsource’s business services to medical practices. We believe expanding into these markets complements our existing markets of orthodontists and pediatric dentists, and provides an opportunity to build upon our 10-year investment in our services platform. In exchange for providing these outsourced business services, OCA would receive a monthly fee based on a percentage of the practice’s cash collections. These arrangements would differ from our traditional affiliations in that the agreements would be for a shorter term (as short as one year) and, among other things, we would not:

	•		employ the staff of the practice,
	•		own the fixed assets used by the practice,
	•		bear practice-related expenses,
	•		engage in mass media advertising on behalf of the practice, or
	•		provide capital funding for expansion to the practice unless we find the terms favorable and the practice agrees to utilize our services during the term of the financing.

ORTHODONTICS, PEDIATRIC DENTISTRY AND OTHER HEALTHCARE PRACTICES

     Orthodontics. Orthodontics is a branch of dentistry that specializes in the diagnosis, prevention and treatment of dental misalignment, and typically involves the use of braces or other corrective appliances. Based on data compiled by the American Association of Orthodontists and data published in the 2003 Journal of Clinical Orthodontic Practice Study (the “2003 JCO Study”), a biennial study of the U.S. orthodontic industry, we estimate that the U.S. orthodontic industry generates in excess of $10 billion in annual gross revenues. Multiple studies conducted in the orthodontic industry have concluded that many more persons could benefit from orthodontic treatment than are receiving it. Based on the findings of a study published by the U.S. Public Health Service in 2000, approximately 25% to 32% of the U.S. population could have benefited from orthodontic treatment in 2000.

     Orthodontics is generally an elective procedure, with about 75% of payments for orthodontic services made directly by the patient and standard dental insurance covering about 25%. Managed care represents a small percentage of revenues generated in the orthodontic industry.

     According to the 2003 JCO Study, the number of orthodontists practicing in the United States has remained at about 9,000 for the past 10 years. Orthodontists must complete up to three years of postgraduate studies following completion of dental programs. Many dentists who are not orthodontists also perform certain orthodontic services. According to a study published in 1996 by the University of Michigan Department of Orthodontics and Pediatric Dentistry, approximately 76% of the dentists who responded to a survey reported that they provided some orthodontic services to their patients, and 19% of the responding dentists reported that they provided comprehensive orthodontic treatment. This study concluded that slightly less than one third of all U.S. orthodontic patients received orthodontic treatment from general dentists. According to the 2003 JCO Study, 4.7% of orthodontists practicing in the United States are affiliated with a practice management company or other management services organization.

     We believe our marketing and advertising strategy has allowed our affiliated orthodontists to generate significantly greater patient volume than the average orthodontist. Our recommended affordable payment plan, which includes no down payment and affordable monthly payments, has enabled our affiliated orthodontic practices

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generally to charge lower fees than the average orthodontist. Our systems and office designs, and the efficient use of orthodontic assistants, have enabled our affiliated orthodontists to treat more patients per day than the average orthodontists.

     Pediatric Dentistry. Pediatric dentistry is a dental specialty involving comprehensive, preventative and therapeutic oral healthcare for infants and children through adolescence, including those with special healthcare needs. In 2002, there were approximately 3,800 active pediatric dentists in the United States. Pediatric dentists must complete a specialty degree program following dental school, which is typically two years in length. Approximately 200 students are admitted each year to 62 pediatric dental specialty training programs in the United States. Approximately one-third of the programs are hospital-based with an emphasis on primary care dentistry for well and ill children. The remaining approximately two-thirds are based in dental schools.

     The American Academy of Pediatric Dentistry reports that pediatric dentistry training opportunities have increased from approximately 142 per year in 1989 to approximately 200 per year in 2001, primarily due to additional funding from the U.S. Health Resources and Services Administration. At present, some states have fewer than 10 pediatric dentists. The U.S. Bureau of Census projects that between 1998 and 2025, the number of children under the age of 15 in the United States will increase by 8.9 million. We believe that there will be an increased demand for the services of pediatric dentists in the future.

     General Dentistry and Other Healthcare Practices. Dentistry involves the diagnosis and treatment of diseases, injuries and malformations of the teeth and mouth. The practice of dentistry includes improving a patient’s appearance by using a variety of cosmetic dental procedures, and the performance of surgical procedures such as implants and extractions. There are approximately 150,000 dentists in private practice in the United States. More than 80% of dentists are general practitioners. About 20% are dental specialists who limit their practices to one of the nine recognized dental specialty areas: public health dentistry, endodontics, oral and maxillofacial pathology, oral and maxillofacial radiology, oral and maxillofacial surgery, orthodontics and dentofacial orthopedics, pediatric dentistry, periodontics and prosthodontics.

     Physicians diagnose and treat medical conditions. There are about 800,000 physicians practicing in the United States. The two general kinds of physicians are primary care physicians and specialists. About 33% of physicians are primary care physicians. If a patient has a specific problem that the primary care doctor does not have the knowledge or expertise to fully treat, he or she will refer the patient to a specialist. Specialists make up the remaining 66% of physicians. Specialties include general surgery, cardiology, orthopedics, pediatrics, obstetrics and gynecology, ophthalmology, gastroenterology and many others. Physicians typically work in clinics, hospitals or private practices. Physicians also become members of medical groups or independent practice associations.

SERVICE AGREEMENTS WITH AFFILIATED PRACTICES

     OCA provides business services to an affiliated practice under an agreement with an affiliated orthodontist or pediatric dentist and/or his or her wholly-owned professional entity. The form of agreement used for a particular affiliated practice is based upon the dental regulatory provisions of the state in which the affiliated practice is located. In most states, we use a form of service agreement, with some minor variations from state to state. In a small number of states with particularly stringent laws relating to the practice of dentistry, we use a consulting agreement, which also varies somewhat from state to state. OrthAlliance and its affiliated practices are parties to service, management service and consulting agreements that differ in some respects from the service and consulting agreements that OCA has historically used. The terms of these agreements typically range from 20 to 40 years, with most ranging from 20 to 25 years.

     During 2003, approximately 95% of our fee revenue was attributable to service and management service agreements, with the remainder being attributable to consulting agreements. None of our affiliated practices accounted for more than 10% of our fee revenue in 2003.

OCA Service and Consulting Agreements

     OCA Service Agreements. OCA’s general form of service agreement is generally between one of our subsidiaries and an affiliated practitioner and their wholly-owned professional entity. Under these service agreements, we provide affiliated practices with a comprehensive range of business services in exchange for

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monthly service fees. Monthly service fees represent reimbursement of practice-related expenses that we incur in providing services to an affiliated practice, a portion of the practice’s operating profit and, in some cases, hourly-based service fees. We are also to be reimbursed for the affiliated practice’s share of operating losses for newly-developed or de novo centers and depreciation expense related to property, equipment and improvements used in the operation of the practice. Excluding reimbursement of practice-related expenses and any hourly-based service fees, service fees based on the operating profits of the affiliated practice generally range from 40% to 50% of a mature practice’s cash operating profits. In some cases, this is after reduction for any hourly-based service fees or hourly-based amounts retained by the affiliated practice. The terms of OCA’s service agreements range from 20 to 40 years, with most terms ranging from 20 to 25 years.

     If a service agreement terminates prior to the end of its term due to either our or the affiliated practice’s breach, the non-breaching party generally has the option of purchasing the breaching party’s interest in the practice-related assets, including all equipment and improvements, for a purchase price determined under a formula provided for in the agreement. Under circumstances where, following termination, we purchase the affiliated practice’s interest in the practice assets and convey the assets to another practice, the original practice is generally prohibited from competing with the new practice within a specified area. In addition, if termination is due to the affiliated practice’s breach, the service agreement generally provides that the affiliated practice must refund us the unamortized portion of any amounts that we paid in consideration of the practice’s affiliation with us, generally based on a straight-line 25 year amortization period. In some cases, an affiliated practice may terminate a service agreement without cause after a specified period of time, subject to substitution of another affiliated practitioner and an obligation not to compete within a specified area.

     OCA Consulting Agreements. OCA’s form of consulting agreement is generally between one of our subsidiaries and an affiliated practitioner and their wholly-owned professional entity. The types of services we provide to an affiliated practice under OCA’s general form of consulting agreements are generally similar to the services we provide under OCA’s form of service agreements. The service fees paid to us by the affiliated practice under the consulting agreements are a combination of cost-based types of fees, flat monthly fees and hourly fees. Some consulting agreements have shorter terms than the service agreements. Some do not give us a right to purchase the practice’s interest in the practice assets following termination, and some require more limited non-competition agreements from the affiliated practice after termination of the consulting agreement than do most of the service agreements. In addition, the consulting agreements emphasize that the affiliated practitioner has ultimate control and authority over his or her practice’s business management, including such matters as advertising, the hiring and termination of staff and the purchase of equipment and supplies.

OrthAlliance Agreements

     OrthAlliance Service Agreements. OrthAlliance’s form of service agreement is generally between OrthAlliance or one of its subsidiaries and a professional entity that is owned by an affiliated practitioner. Under OrthAlliance’s service agreements, OrthAlliance generally must provide or arrange for certain services for its affiliated practices, and advise and assist the practices with respect to certain other services. These services are generally similar to those provided under OCA’s service agreements. OrthAlliance is generally responsible for paying certain practice expenses, for which it is to be reimbursed by the affiliated practice. If the practice’s collections are insufficient to fund the practice’s current practice expenses, then OrthAlliance is generally obligated to fund these expenses.

     Under these service agreements, OrthAlliance earns service fees that are generally based on one of the following three fee structures. The first fee structure is based on a designated percentage (generally about 17.0%) of the applicable practice’s practice revenue, less any adjustments for uncollectible accounts, professional courtesies and other activities, contractual allowances and discounts that do not generate a fee. These fees are to be earned by OrthAlliance on an accrual basis of accounting and received on a cash basis. The fees are subject, in some cases, to a minimum dollar amount of annual service fees during the first five years of the agreement. The second fee structure is based on a designated percentage (generally about 17.0%) of the applicable practice’s practice revenue, less any adjustments for uncollectible accounts, professional courtesies and other activities, contractual allowances and discounts that do not generate a fee. These fees are to be earned by OrthAlliance on an accrual basis of accounting and received on a cash basis. The fees are subject to annual adjustments based upon improvements in the affiliated practice’s operating margin in the most recent calendar year as compared with the immediately preceding calendar year. In some cases, the fees are subject to a minimum dollar amount of annual service fees

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during the first five years of the agreement. The third fee structure is based on a fixed dollar fee with annual fixed dollar increases for each year of the term of the service agreement.

     The terms of OrthAlliance’s service agreements are generally for 20, 25 or 40 years. Either party generally may terminate a service agreement if the other party materially breaches the agreement, subject to a cure period. Upon the expiration or termination of the service agreement, the affiliated practice may, and in certain circumstances must, repurchase for cash, at net book value, certain assets, including all equipment, and assume certain liabilities of OrthAlliance related to the affiliated practice.

     OrthAlliance Consulting Agreements. OrthAlliance’s form of consulting agreement is generally between OrthAlliance or one of its subsidiaries and a professional entity that is owned by an affiliated practitioner. Under OrthAlliance’s consulting agreements, OrthAlliance generally must provide certain specified services to its affiliated practices, provide other services at the request of the practices and consult with or advise the affiliated practices with respect to other services. These services are generally similar to those provided under OCA’s service agreements. Under these consulting agreements, OrthAlliance earns a consulting fee based on one of the three fee structures described above with respect to OrthAlliance’s service agreements.

     Certain provisions of OrthAlliance’s consulting agreements are substantially similar to those of OrthAlliance service agreements, including those provisions relating to OrthAlliance’s obligation to pay and advance funds for practice expenses, assignment, indemnification, termination of the consulting agreement, repurchase of assets and assumption of liabilities by the affiliated practice upon expiration or termination.

     OrthAlliance Management Service Agreements. OrthAlliance’s general form of management service agreement is generally between OrthAlliance or one of its subsidiaries and a professional corporation or other entity that is owned by an affiliated practitioner. Under OrthAlliance’s management service agreements, OrthAlliance is generally to provide for a wide range of services for its affiliated practices, including providing facilities, equipment, support personnel, utilities, supplies, bookkeeping, marketing and billing and collections services.

     OrthAlliance’s management service agreements generally provide for a service fee that varies from month to month depending on the particular practice’s practice revenue and operating expenses. Service fees are calculated based on two grids set forth in the management service agreement that determine the portion of practice revenue, on a cash basis, that is to be retained by the affiliated practice. One grid determines a percentage of practice revenue, on a cash basis, to be retained by the affiliated practice based on the amount of such practice revenue during the prior calendar quarter. Pursuant to this grid, OrthAlliance’s service fees generally decrease as a percentage of practice revenue if the affiliated practice’s practice revenue increases, and the service fees generally increase as a percentage of practice revenue if the affiliated practice’s practice revenue decreases. The other grid determines an offsetting or additional percentage of such practice revenue to be retained by the affiliated practice, based on the practice’s operating expenses during the prior calendar quarter. Pursuant to this grid, OrthAlliance’s service fees generally increase as a percentage of practice revenue if the affiliated practice’s operating expenses increase, and the service fees generally decrease as a percentage of practice revenue if the affiliated practice’s operating expenses decrease. The management service agreements generally provide for maximum service fees of 19.5% of the practice’s practice revenue on a cash basis. A few of OrthAlliance’s management service agreements provide for a fixed percentage service fee.

     Certain provisions of OrthAlliance’s management service agreements are substantially similar to those of OrthAlliance’s service agreements, including those provisions relating to repurchase of assets and assumption of liabilities by the affiliated practice upon expiration or termination, assignment, indemnification and termination of the management service agreement, except that the agreement generally does not terminate upon a change of control of OrthAlliance. The management service agreement also generally provides that the affiliated practice will maintain the confidentiality of certain information and not compete against OrthAlliance for a specified period of years within a specified geographic area based on the location of the affiliated practices. The affiliated practice is also required to enforce the terms of its employment agreements with affiliated orthodontists, as to which OrthAlliance is to be a third party beneficiary.

     OrthAlliance Employment Agreements. OrthAlliance’s affiliated practices are generally required to enter into employment agreements with each orthodontist or pediatric dentist who owns or becomes an owner of an affiliated practice or who provides orthodontic or dental services through an affiliated practice for more than 10 days

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a month. These employment agreements generally provide that the affiliated practitioner will perform professional services for the affiliated practice for a period of at least five years, subject to prior termination for cause. The affiliated practice may generally terminate the employment agreement for cause upon the practitioner’s death, incapacity, willful misconduct, conviction for a felony, or chronic alcoholism or drug addiction. An affiliated practitioner may generally terminate an employment agreement for cause in the event of a material breach by the affiliated practice. The terms of these employment agreements generally renew automatically for additional one-year terms unless a party provides the other party with at least one year’s prior written notice of termination. The employment agreements also generally provide that, following termination or expiration of the employment agreement, the affiliated practitioner will not compete for a period of two years in the market in which the affiliated practice operates an office and will limit the methods of advertising in the area in which an affiliated practice is located.

     OrthAlliance Amendments. In connection with the OrthAlliance merger and subsequent integration of the OrthAlliance affiliated practices, we entered into amendments to our service, consulting and management service agreements with many of OrthAlliance’s affiliated practices. As of December 31, 2003, 57 OrthAlliance affiliated practices had entered into amendments to their service, consulting or management service agreements with OrthAlliance and their employment agreements with affiliated practitioners. These amendments provide that the affiliated practice will use our proprietary computer software and business systems in connection with the business functions of the practice. In addition, the affiliated practices are to maintain the current status of the advertisement or non-advertisement, as the case may be, of the practice to the general public, unless we otherwise agree. The affiliated practices also agreed to continue to employ the affiliated orthodontists or pediatric dentists for a minimum period following the OrthAlliance merger. The affiliated practitioners also agreed to guarantee the performance of his or her professional corporation under the service, consulting and management service agreement during the term of his or her employment. Some of the amendments provide for an enhanced covenant not to compete, require that the affiliated practice will take certain actions to transition the practice to another orthodontist or pediatric dentist upon departure of the affiliated practitioner and extend the term of the OrthAlliance service, consulting or management service agreement. The amendments to the employment agreements include OrthAlliance as a third party beneficiary of the covenant not to compete, and provide for continued employment of the affiliated practitioner for a period of at least three years following the OrthAlliance merger.

     In connection with these amendments, we offered certain incentives to these affiliated practitioners, through which they may be granted shares of our common stock or promissory notes. For additional information about those incentive programs, please see Note 10 to our Consolidated Financial Statements included elsewhere in this Report.

Patient Fees Receivable

     We generally earn service fees under our service and consulting agreements as a percentage of the operating profits of OCA’s affiliated practices or as a percentage of patient revenue of OrthAlliance’s affiliated practices, plus reimbursement of practice-related expenses. We generally collect service fees as patient fees are collected on behalf of our affiliated practices and deposited into a bank account we establish and maintain.

     Many of our affiliated practices pledge their patient fees receivable arising from providing orthodontic or pediatric dental services. These patient fees receivable include billed receivables, which represent amounts owed for orthodontic and pediatric dental services for which the patient has been billed, and unbilled receivables, which represent amounts owed for services that have been provided but for which the patient has not yet been billed. Laws governing the practice of dentistry (including orthodontics and pediatric dentistry) and the policies of state dental boards in states in which we operate generally restrict our ability to own these patient fees receivable. These laws and policies require that patient fees receivable be billed and collected in the name of the affiliated practice and that, at least initially, collections from patient fees receivable belong to the practice. This restricts our ability to sell, factor or transfer these pledged patient fees receivable.

     We are generally responsible for the billing and collecting of patient fees receivable for many of our affiliated practices, which services are done in the name of the affiliated practice. Once funds are collected in payment of patient fees receivable, the funds are generally deposited into a bank account we establish and maintain. We generally have sole signatory authority over these bank accounts and the exclusive responsibility for any disbursements; however, in certain cases, the affiliated practice also has signatory power over a bank account. Many

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of our affiliated practices agree that they will not modify, close or withdraw any funds from these bank accounts. We routinely sweep funds deposited into these accounts into our central bank account on a regular basis.

     Under OCA’s general form of service agreement, collections from patient fees receivable are included in determining a practice’s cash operating profits for purposes of calculating amounts retained by an affiliated practice under the terms of the applicable service agreement. Generally, under these service agreements an affiliated practice retains 50% to 60% of the practice’s cash operating profits (in some cases after reduction for any hourly-based service fees earned by OCA or hourly-based amounts retained by the affiliated practice).

GOVERNMENT REGULATION

     Dentistry, including the specialties of orthodontics and pediatric dentistry, is a highly regulated profession. In general, regulation of healthcare, including dentistry, is increasing.

     Each state and country in which we operate has laws which impose licensing requirements on dentists, including orthodontists and pediatric dentists. While the requirements and prohibitions relative to the practice of dentistry under such laws generally apply equally to the practice of orthodontics and pediatric dentistry, in order for a dentist to hold him or herself out to the public as an orthodontic or pediatric dental specialist, in many jurisdictions the dentist must meet additional requirements providing for certification as a specialist.

     The dental practice laws of virtually all states prohibit non-dentists (such as us) from engaging in the practice of any branch of dentistry, including pediatric dentistry and orthodontics. In many states, the practice of dentistry is defined to include the employment of dentists, and in states with laws of that type, we are prohibited from employing dentists of any type (which would include orthodontists and pediatric dentists). In some states, the practice of dentistry is defined to include managing, maintaining or operating any kind of dental office. In states with laws of that type, non-dentists (such as us) may provide business services to a dentist, but, depending on how the legal authorities in the applicable state interpret the law, the dentist may be required to retain control over and responsibility for the management, maintenance and operations of his or her dental practice. A number of states define the practice of dentistry to include the ownership of a dental office and/or dental equipment, or may allow a non-dentist (such as us) to lease a dental office and/or dental equipment to a dentist only under a bona-fide lease agreement under which the office and/or equipment remain under the care, custody and control of the dentist throughout the term of the lease. The dental practice laws of many states also prohibit dentists and orthodontists from splitting fees with non-dentists and non-orthodontists. In some states, these laws have been interpreted to prohibit dentists from paying fees to management companies that are based on a percentage of patient revenues or collections. The dental practice laws of some states also prohibit entities that are classified as dental referral services from being reimbursed by dentists on a per referral basis.

     Some state dental practice laws or regulations specifically regulate agreements between dentists (including orthodontists and pediatric dentists) and practice management companies. In general, these laws and regulations allow dentists and orthodontists to enter into such agreements only if the practice management company does not directly or indirectly interfere with the dentist’s exercise of his or her independent professional judgment and if the dentist has control over all clinical aspects of his or her practice, as well as business decisions that closely relate to clinical issues. Some states require that the management or service fees paid under such agreements be reasonable and not be based on the management company’s referral of patients to the dentist or orthodontist.

     Advertising by dentists is also regulated under many states’ dental practice laws. The laws of some states prohibit advertising of orthodontic and dental services under a trade or corporate name and require that all advertisements be in the name of the practitioner. In addition, the laws of a number of states have specific requirements that pertain to the advertising of a dental specialty, including orthodontics and pediatric dentistry. A number of states also regulate the use of promotional gift items, the use of models in advertisements, the advertising of prices and discounts and the use of testimonials in advertising.

     In addition to the state dental practice laws, the practice of dentistry, including the specialties of orthodontics and pediatric dentistry, is regulated by various state and federal laws and regulations that are applicable to healthcare providers and healthcare operations in general. A number of states have enacted anti-kickback laws that prohibit payments or other remuneration for the referral of patients to all types of licensed healthcare providers, including orthodontists (which laws are in addition to the similar prohibitions found in some state dental practice

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laws). In addition, federal and state laws regulate health maintenance organizations and other managed care organizations, for which orthodontists and pediatric dentists may be providers.

     There are currently numerous laws at the state and federal levels addressing patient privacy concerns. Federal regulations issued pursuant to the Health Insurance Portability and Accountability Act of 1996, or HIPAA, contain, among other measures, provisions that require many organizations, including dental practices, to implement very significant and potentially expensive new computer systems, employee training programs and business procedures. The federal regulations are intended to encourage electronic commerce in the healthcare industry.

     On August 14, 2002, the Department of Health and Human Services published final revisions to standards for the privacy of individually identifiable information. The final revisions did not alter the compliance date of April 14, 2003 for the majority of the requirements in the privacy regulations. These privacy standards apply to all health plans, all health care clearinghouses and health care providers that transmit health information in an electronic form in connection with the standard transactions. Several of our affiliated practices are covered entities under the final rule. The privacy standards apply to individually identifiable information held or disclosed by a covered practice in any form, whether communicated electronically, on paper or orally. These standards impose extensive new administrative requirements on these practices. They require compliance with rules governing the use and disclosure of health information. They create new rights for patients in their health information, such as the right to amend their health information, and they require these practices to impose these rules, by contract, on any business associate to whom they disclose such information in order to perform functions on their behalf including us. In addition, these practices will continue to remain subject to any state laws that are more restrictive than the privacy regulations issued under HIPAA. These state laws vary by state and could impose additional penalties.

     On February 20, 2003, the Department of Health and Human Services finalized a rule that establishes, in part, standards to protect the confidentiality, availability and integrity of health information by health plans, health care clearinghouses and health care providers that receive, store, maintain or transmit health and related financial information in electronic form, regardless of format. These security standards require dental practices to establish and maintain reasonable and appropriate administrative, technical and physical safeguards to ensure the integrity, confidentiality and the availability of electronic health and related financial information. The security standards were designed to protect electronic information against reasonably anticipated threats or hazards to the security or integrity of the information and to protect the information against unauthorized use or disclosure. Although the security standards do not reference or advocate a specific technology, and covered health care providers, plans and clearinghouses have the flexibility to choose their own technical solutions, the security standards will require dental practices to implement significant new systems, business procedures and training programs. Dental practices must comply with these security regulations by April 21, 2005.

     A violation of these regulations could result in civil monetary penalties of $100 per incident, up to a maximum of $25,000 per person per year per standard. HIPAA also provides for criminal penalties of up to $50,000 and one year in prison for knowingly and improperly obtaining or disclosing protected health information, up to $100,000 and five years in prison for obtaining protected health information under false pretenses, and up to $250,000 and ten years in prison for obtaining or disclosing protected health information with the intent to sell, transfer or use such information for commercial advantage, personal gain or malicious harm. Because there is no history of enforcement efforts by the federal government at this time, it is not possible to ascertain the likelihood of enforcement efforts in connection with the HIPAA regulations or the potential for fines and penalties which may result from the violation of the regulations.

     We expect that compliance with these standards will require significant commitment and action by us and certain of our affiliated practices. Because some of the regulations are proposed regulations, we cannot predict the total financial impact of the regulations on us or our affiliated practices.

     Some of our affiliated practices receive payment of fees through Medicaid programs. The Social Security Act includes provisions addressing false statements, illegal remuneration and other fraud, including a statute commonly referred to as the federal anti-kickback statute. The federal anti-kickback statute prohibits providers and others from, among other things, soliciting, receiving, offering or paying, directly or indirectly, any remuneration in return for either making a referral for a service or item covered by Medicaid or other federal health care program or ordering or arranging for or recommending the order of any covered service or item. Violations of the federal anti-kickback statute are punishable by a fine of up to $50,000 or imprisonment for each violation, as well as damages up to three times the total amount of remuneration. The U.S. government is authorized

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to impose criminal, civil and administrative penalties on any person or entity that files a false claim for payment from Medicaid programs. Claims filed with private insurers can also lead to criminal and civil penalties. While the criminal statutes are generally reserved for instances of fraudulent intent, the U.S. government is applying its criminal, civil and administrative penalty statutes in an ever-expanding range of circumstances. For example, the government has taken the position that a pattern of claiming reimbursement for unnecessary services violates these statutes if the claimant merely should have known the services were unnecessary, even if the government cannot demonstrate actual knowledge. In addition, over the past several years, the U.S. government has accused an increasing number of health care providers of violating the federal False Claims Act. The False Claims Act prohibits a person from knowingly presenting, or causing to be presented, a false or fraudulent claim to the U.S. government. The statute defines “knowingly” to include not only actual knowledge of a claim’s falsity, but also reckless disregard for or intentional ignorance of the truth or falsity of a claim. Under the “qui tam,” or whistleblower, provisions of the False Claims Act, private parties may bring actions on behalf of the U.S. government. These private parties, are entitled to share in any amounts recovered by the government through trial or settlement. Both direct enforcement activity by the government and whistleblower lawsuits have increased significantly in recent years.

     We are also subject to various state insurance statutes and regulations that prohibit us from submitting inaccurate, incorrect or misleading claims on behalf of our affiliated practices. We believe that our affiliated practices are in compliance with all state insurance laws and regulations regarding the submission of claims. We cannot assure you, however, that none of our practices’ insurance claims will ever be challenged. If we were found to be in violation of a state’s insurance laws or regulations, we could be forced to discontinue the violative practice, which could have an adverse effect on our business and operating results, and we could be subject to fines and criminal penalties.

     Based on our familiarity with the operations of our affiliated practices, we believe that our activities do not violate the dental practice laws or regulations of the states in which we operate, as those laws have been interpreted by the applicable legal authorities in the past, or other state or federal laws or regulations generally applicable to healthcare providers and operations, as such laws and regulations relate to our activities. We regularly monitor developments in these laws and regulations, and note that, in two states, courts have ruled that OrthAlliance’s service agreements with certain affiliated practices violated the dental practice laws of those states. We are appealing each of these decisions. Future changes in the interpretation of these laws and regulations, the enactment of more stringent laws and regulations or other changes in the business and regulatory environment could require us to change the structure and terms of our existing contractual relationships with our affiliated practices, how the services of our affiliated practices are marketed and advertised, or other aspects of our operations. In addition, the laws and regulations of some states and countries could restrict expansion of our operations in those jurisdictions. While we plan to structure all of our future agreements, operations and marketing in accordance with applicable laws and regulations, our arrangements could be successfully challenged and any required changes could have a material adverse effect on our operations, prospects or profitability.

     The operations of our affiliated practices must also meet federal, state and local regulatory standards related to the safety and health of clinic employees and the maintenance of safe premises (in addition to laws and regulations related to the practice of dentistry and to healthcare providers in general). Historically, those standards have not had an adverse effect on the operations of our affiliated practices. Based on our familiarity with the operations of our affiliated practices, we believe that our affiliated practices generally comply in all material respects with applicable federal, state and local laws and regulations relating to safety and health.

COMPETITION

     We believe that our experienced management team and our broad, integrated suite of business services and systems provides us with a competitive advantage. A few smaller or regional companies also provide business or

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support services to orthodontic practices. Several companies provide business services to general dental practices, including some practices that include orthodontic and pediatric dental components. We also compete with providers of individual business services for orthodontic, dental and other healthcare practices, such as information technology and software vendors and providers of personnel and payroll services, billing and collections services, patient financing services, clinic fixed asset financing, purchasing systems and other business services. Other companies could enter our industry and compete with us.

     Our affiliated practices compete with orthodontists and pediatric dentists who operate in single and multiple offices. Our affiliated practices also compete with general dentists who provide certain orthodontic services and dental treatment to children. The provision of orthodontic services by general dentists has increased in recent years.

EMPLOYEES

     At December 31, 2003, we employed 3,092 persons in the United States, including 2,589 full-time employees and approximately 140 employees in our corporate offices. In addition, we employed 204 persons, including 152 full-time employees, in locations outside the United States. Our employees are not represented by a collective bargaining agreement. We consider our relationship with our employees to be good. We do not employ our affiliated practitioners or other licensed professionals.

INSURANCE

     We maintain general liability and property insurance. The cost of insurance coverage varies, and the availability of some coverage has fluctuated in recent years. While we believe, based upon our claims experience, that our current insurance coverage is adequate for our current operations, our coverage may not be sufficient for all future claims and may not continue to be available in adequate amounts or at reasonable rates. Our affiliated practices purchase and maintain their own malpractice liability insurance coverage. Many of our affiliated practices are contractually required to use reasonable efforts to have us named as an additional insured party on their respective insurance policies.

SERVICE AND TRADEMARKS

     We registered the service mark “Orthodontic Centers of America”, in both typed form and with design, on the Supplemental Register of the U.S. Patent and Trademark Office in 1998. We also have applications pending before the U.S. Patent and Trademark Office to register the mark “Orthodontic Centers of America”, the mark “OCA” and the mark “OCA Outsource”, each in both typed form and with design, on the Principal Register of the U.S. Patent and Trademark Office.

     We also own a number of other trademarks and service marks that are registered, or for which applications for registration are pending, with the U.S. Patent and Trademark Office, including: “Dial 4-Braces”, “FAAB”, “Finishing Touch”, “First Impressions”, “Kids-Smile Pediatric Dental Centers”, “Orthodontic Centers of America Share A Smile!”, “Professional Smile Salon”, “Single-Source Business Services”, “Thank You For Making Me Smile”, “1-800-4BRACES” and “4braces.com”.

     Registrations of trademarks and service marks with the U.S. Patent and Trademark Office generally may be renewed and continue indefinitely, provided that we continue to use these trademarks or service marks and file appropriate maintenance and renewal documentation with the U.S. Patent and Trademark Office at times required by the federal trademark laws and regulations.

EXECUTIVE OFFICERS

     For information about our executive officers, please see “Item 10. Directors and Executive Officers of the Registrant.”

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AVAILABLE INFORMATION

     Our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished pursuant to Sections 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our website at www.4braces.com. These reports are accessible under the “Investors” caption of the Company’s website and are available as soon as reasonably practicable after such reports are electronically filed with or furnished to the Securities and Exchange Commission. Our Internet website and the information contained in or connected to that website are not incorporated into this Report.

RECENT DEVELOPMENT

     On March 3, 2004, our Board of Directors adopted a stockholder rights plan. To implement the rights plan, the Board of Directors declared a dividend distribution of one preferred stock purchase right per outstanding share of common stock, payable to all stockholders of record as of March 3, 2004. The rights were distributed as a non-taxable dividend and will expire on March 2, 2014. The rights will automatically trade with our underlying common stock and no separate preferred stock certificates will be distributed. The rights to acquire preferred stock are not immediately exercisable and will become exercisable only if a person or group acquires or commences a tender offer for 20% or more of our common stock. If a person or group acquires or commences a tender offer for 20% or more of our common stock, each holder of these rights, except the acquirer, will be entitled to exercise a right for one one-thousandth of a share of our newly-created Series A Junior Participating Preferred Stock at an exercise price of $40.00 or a number of shares of our common stock equal to twice the exercise price of the rights divided by the market value of our common stock at the time of such acquisition. In addition, in the event of certain business combinations, the rights permit their holders to purchase the number of shares of the acquirer’s common stock equal to twice the exercise price of the rights divided by the market value of the acquirer’s common stock at the time of such acquisition. Our Board of Directors may terminate the rights plan at any time or redeem the rights for $0.00001 per right at any time before a person acquires 20% or more of our common stock.

ITEM 2. PROPERTIES

     We generally lease an average of between 2,000 and 2,500 square feet of office space for each of our affiliated centers. The typical lease for center space is for a term of approximately five years, and generally provides for renewal options for additional years. The average rental payment is approximately $3,500 per month. As demand for orthodontic services has increased in a particular market, we generally have leased and developed new affiliated orthodontic centers in that market rather than expanding existing orthodontic centers. This allows us to take advantage of new areas of high development and growth, provide more convenience for patients and facilitate practice growth.

     We maintain a corporate office in approximately 29,000 square feet of office space in Metairie, Louisiana under a lease which expires in April 2009. We also maintain a corporate office in Japan, in approximately 2,800 square feet of office space under a lease expiring in November 2005.

ITEM 3. LEGAL PROCEEDINGS

OrthAlliance Related Litigation

     Before we entered into the merger agreement with OrthAlliance, we anticipated that some portion of OrthAlliance’s affiliated practices would oppose such a merger because of, among other things, disappointment with the market price of OrthAlliance’s common stock, unwillingness to affiliate with a competitor of OrthAlliance or perceived differences in the companies’ cultures and operating strategies. Accordingly, we factored the likelihood of a number of dissident practices into our analysis of the economic merits of the merger, and into the structure of the merger agreement and merger consideration. As of December 31, 2003, 53 OrthAlliance affiliated practices have filed actions against OrthAlliance that are currently pending in courts in a number of states, including 13 practices that filed lawsuits in 2003. One additional OrthAlliance affiliated practice filed suit in the first quarter of 2004. The names of the practitioners who are parties to these actions, and information about when and where these cases were filed, are contained in Exhibit 99.1 to this Report, which is incorporated herein by reference.

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     In these lawsuits pending against OrthAlliance, the plaintiffs have generally alleged that OrthAlliance breached their respective service, management service or consulting agreements with OrthAlliance, and that these agreements and the employment agreements between the practitioners and their professional corporations violate state laws prohibiting fee splitting and the corporate practice of dentistry. Certain of the plaintiffs have also alleged that OrthAlliance fraudulently induced the plaintiffs to enter into the service, management service or consulting agreements, that OrthAlliance breached a fiduciary duty allegedly owed to the plaintiffs and that OrthAlliance has been unjustly enriched under these agreements. The plaintiffs seek, among other things, actual or compensatory damages, an accounting of fees paid to OrthAlliance under their service, management service and consulting agreements and a recovery of amounts improperly paid, a declaratory judgment that their service, management service or consulting agreements and their employment agreements (including the covenants not to compete) are illegal or against public policy and therefore void and unenforceable, a declaratory judgment that the service, management service and consulting agreements are not assignable by OrthAlliance, rescission of those agreements, an award of attorneys fees and, in some cases, punitive damages. In one of the lawsuits, the plaintiffs also seek to revoke amendments to their respective employment agreements and service, management service or consulting agreements, which they executed in connection with the OrthAlliance merger, and to form a class of other OrthAlliance affiliated practices that entered into similar amendments in connection with the merger. The plaintiffs in this lawsuit also allege that they were wrongfully induced into signing the amendments based on misrepresentations about our business model, common stock and the benefits of being affiliated with us, and that the amendments were revocable until after the effective date of a registration statement relating to various incentive programs that we offered to OrthAlliance affiliated practices.

     OrthAlliance has filed counterclaims against the plaintiffs in these actions, in which OrthAlliance generally alleges that the plaintiffs have breached their service, management service and consulting agreements, that OrthAlliance detrimentally relied on the plaintiffs’ statements and actions in entering into these agreements, that the plaintiffs have been unjustly enriched under these agreements and that the individual plaintiffs have tortiously interfered with OrthAlliance’s contractual relations with the professional corporation plaintiffs. In these counterclaims, OrthAlliance generally seeks damages, specific performance of the agreements and attorneys fees. OrthAlliance intends to defend each of these lawsuits vigorously, and to continue to demand that these practices honor their commitments under their agreements with OrthAlliance.

     We believe that the plaintiffs’ claims in these lawsuits with OrthAlliance lack merit, and that OrthAlliance has meritorious claims against each of these plaintiffs. Based on our experience in favorably resolving some of the lawsuits filed by OrthAlliance affiliated practices and discussions with some of the other OrthAlliance affiliated practices who are parties to pending litigation or their representatives, we currently believe that some of these practices will settle their lawsuits by paying us an amount of cash in exchange for termination or modification of their service, management service and consulting agreements with OrthAlliance, depending upon the parties’ ability to reach an agreement as to the amount to be paid. We cannot assure you that such an agreement or settlement will be reached in any of these lawsuits. We also cannot, at this time, predict the outcome of these lawsuits or assure you that we will prevail in any of them, nor can we estimate at this time the amount of damages that we might incur or receive in these actions.

     On March 26, 2003, the U.S. District Court for the Northern District of Texas, in ruling on the plaintiffs’ motion for summary judgment in a case captioned Penny v. OrthAlliance, Inc., held that, when construed together, the purchase agreements and service agreements between the plaintiffs and OrthAlliance and the employment agreements between the individual plaintiffs and their practices violated Texas statutes prohibiting the unauthorized practice of dentistry and were therefore invalid. In the court’s view, the interrelationship among these agreements allowed OrthAlliance to own, maintain or operate an office or place of business in which it employs or engages the plaintiffs to practice dentistry, in violation of Texas law. In reaching its conclusion, the court noted that OrthAlliance leases or owns and maintains the office space and tangible assets used in the plaintiffs’ practices and provides comprehensive practice management services, and that the service agreements require that the practices enter into employment agreements with the individual plaintiffs. This ruling is limited to these plaintiffs and Texas law, and does not apply to the enforceability of service agreements or employment agreements with any other practices. OrthAlliance appealed the ruling in this case on January 21, 2004 and believes that it has meritorious grounds to overturn this ruling on appeal. We believe that the court erroneously disregarded a Texas statute and regulation that expressly contemplate agreements such as OrthAlliance’s service agreements. The court also disregarded language in the service agreements that limits OrthAlliance’s services to those that do not violate state laws governing the practice of dentistry, including sections of the agreement that provide for waiver, severance or amendment of any provisions

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that may violate those laws. We also believe that the court misconstrued OrthAlliance’s arrangements with the plaintiffs.

     On March 1, 2004, the U.S. District Court for the Western District of Washington, in ruling on the plaintiffs’ motion for summary judgment in a case captioned Engst v. OrthAlliance, Inc., held that the overall relationship between OrthAlliance and the orthodontic practices violated a Washington statute governing the corporate practice of dentistry and that OrthAlliance’s management service agreements with the practices, and the employment agreements between the orthodontists and their professional corporations were illegal. The court dismissed the orthodontists’ other claims and OrthAlliance’s counterclaims. The court relied on a series of Washington state court decisions to look beyond the express terms of the contracts, which the court viewed to be legal on their face, to the court’s view of the underlying effect and purpose of the contracts. OrthAlliance filed notice of appeal of the ruling in this case on March 4, 2004 and believes that it has meritorious grounds to overturn this ruling on appeal. We believe that the court disregarded language in the management service agreements that limits OrthAlliance’s services to those that do not violate state laws governing the practice of dentistry, including sections of the agreement that provide for waiver, severance or amendment of any provisions that may violate those laws. We also believe that the court misconstrued OrthAlliance’s arrangements with the plaintiffs. This ruling is limited to these plaintiffs and Washington law, and does not apply to the enforceability of service agreements or employment agreements with any other practices.

     On October 21, 2003, OrthAlliance filed an action in the Travis County, Texas District Court to seek a declaratory judgment that OrthAlliance’s service agreements with two Texas affiliated practices are valid under Texas law. In addition, OrthAlliance is seeking money damages from the two practices and their orthodontist-owners for breach of the service agreements. As required by a Texas statute, the Texas State Board of Dental Examiners has been included as a party to the action because it involves the validity or applicability of rules adopted by the Board. In the action, OrthAlliance seeks a judgment that its service agreements are valid under the Board’s rules and a Texas statute that protects a dentist’s right to contract with a management service organization, such as OrthAlliance. The lawsuit is at a very early stage and, at this time, we cannot predict whether OrthAlliance will prevail.

     On October 22, 2003, we filed a lawsuit in the Harris County, Texas District Court against a number of defendants for interfering with our contractual relationships with affiliated practices. The defendants include two law firms, Locke, Liddell & Sapp, L.L.P. of Houston, Texas, and Goldstein, Tanen & Trench, P.A. of Miami, Florida, and a number of orthodontists and pediatric dentists who are represented by those firms in other litigation with us or OrthAlliance. The complaint alleges that the defendants conspired to persuade affiliated practices to breach their service agreements with us and OrthAlliance in order to generate significant legal fees for the law firm defendants and force us to agree to more favorable settlement terms with the defendants. The complaint also alleges that the defendants used a series of letters, emails, meetings, personal solicitations and Internet message board postings to further their conspiracy. In addition, we allege that certain of the practitioner defendants breached their service agreements. We seek to enjoin the defendants from further interference with our contractual relationships with affiliated practices. We are also seeking an unspecified amount of compensatory and punitive damages. The lawsuit is at a very early stage and, at this time, we cannot predict whether we will prevail.

Securities Class Action

     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., our Chairman of the Board, President and Chief Executive Officer, Bartholomew F. Palmisano, Jr., our Chief Operating Officer, and Thomas J. Sandeman, our Chief Financial Officer. On April 22, 2003 and June 12, 2003, similar actions were filed in the United States District Court for the Eastern District of Louisiana against OCA and the other defendants by James A. Janette and Betty Suhadolnik, respectively. On August 28, 2003, the lawsuits were consolidated and a lead plaintiff was appointed. The consolidated action purports to be filed as a class action on behalf of the plaintiff and other purchasers of shares of our common stock from November 14, 2002 to March 18, 2003. A consolidated amended complaint was filed on November 3, 2003. In the consolidated amended complaint, the plaintiffs allege 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, about practices affiliated with OrthAlliance, and by allegedly recognizing

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revenue, failing to timely expense uncollectible receivables and failing to write-down certain long-lived assets in violation of generally accepted accounting principles, in order to inflate the market price of our common stock. The plaintiffs seek unspecified compensatory damages, interest and attorneys’ fees. On December 18, 2003, we filed a motion to dismiss the action, on which the court has not yet ruled. We cannot predict whether we will prevail in the action or estimate the amount of damages that we might incur. We are also unable to estimate any reimbursement that we may receive from insurance policies in the event that we incur any damages or costs in connection with this action. We deny these allegations and believe that this action lacks merit. We intend to defend this action vigorously.

General

     Because litigation is inherently uncertain, we cannot assure you that we will prevail in any of these actions, nor can we estimate with reasonable certainty the amount of damages we might incur or the amount of any award we might receive. We and our subsidiaries 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 our 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

     Not applicable.

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PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

     Our common stock is listed on the New York Stock Exchange under the symbol “OCA.” The following table sets forth, for the periods indicated, the range of high and low sale prices per share for our common stock, as reported on the New York Stock Exchange.

     At March 10, 2004, the number of holders of record of our common stock was approximately 303.

     We have never declared or paid cash dividends on our common stock. We expect that any future earnings will be retained for the growth and development of our business. Accordingly, we do not anticipate that we will declare or pay any cash dividends on our common stock for the foreseeable future. The declaration, payment and amount of future dividends, if any, will depend upon our future earnings, results of operations, financial position and capital requirements, among other factors. In addition, our credit facility does not permit us to pay cash dividends.

     In 1996, we established a stock purchase program that allowed participating affiliated orthodontists to acquire shares of our common stock from us. Under this program, a participating orthodontist contractually committed to purchase a certain amount of our common stock over a period of years. Shares under the program are purchased over a period of 12 years, with payments and issuance beginning two years after the participating orthodontist committed to purchase the shares. There are restrictions on transfer of shares purchased under this program, which lapse over a period of 12 years following the commitment to purchase. During 2003, 41,698 shares of our common stock were issued under the program, and participating orthodontists had committed to purchase a total of 1,312,760 additional shares of our common stock under the program at December 31, 2003. These transactions were conducted without registration under the Securities Act of 1933 on a non-public basis with a limited number of individuals who had an existing relationship with us, in reliance on an exemption from such registration in Section 4(2) of the Securities Act of 1933. We are no longer accepting any additional participants in this program.

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ITEM 6. SELECTED FINANCIAL AND OPERATING DATA

     The following selected financial and operating data should be read in conjunction with “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Item 8. Financial Statements and Supplementary Data” of this Report.

ITEM 7.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

range of business, operational and marketing services as well as complementary Internet-based proprietary information systems and capital for growth. We provide our products and services to affiliated practices under a service, consulting or management service agreement (“Service Agreement”), with terms that usually range from 20 to 25 years.

     Our fee revenue consists of amounts earned under our Service Agreements and recognized under our revenue recognition policy. We generally earn monthly service fees under the Service Agreements 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, our service fees generally equal about 40% to 50% of a practice’s operating profit or about 17% of a practice’s revenue. Affiliated practices reimbursed us for practice-related expenses that we incur on their behalf, including costs to treat patients of the affiliated practices. These practice-related expenses are recorded in our consolidated statements of income when incurred. Our affiliated practices generally incur approximately 30%-35% of their total costs to treat a patient in the first month of the patient’s treatment.

     Our affiliated practices have not generally accepted payment by Medicare for services provided. Approximately 0.9% of the patient revenue of our affiliated practices was paid by Medicaid in 2003, compared to 1.0% in 2002. During 2003, approximately 19.6% of the patients treated by our affiliated practices had some form of insurance coverage, a slight increase from 18.5% during 2002. Approximately 10.2% of the patient revenue of our affiliated practices was paid by a third-party payor in 2003, as compared to 14.1% during 2002. The patient is generally responsible for any portion of the fee that is not covered by insurance.

     In recent years, we have taken steps to increase our revenue stream by focusing on the growth of our affiliated practices and diversifying our customer base. Beginning in 2000, we began to focus on internal growth by assisting our existing affiliated practices to grow, by adding additional associate practitioners, developing de novo centers and refurbishing existing facilities. We are no longer targeting new, capital intensive affiliations with established practices. We have found that investing in the growth of our existing affiliated practices typically yields more consistent growth and higher satisfaction for affiliated practitioners. We also began an international expansion that has led to affiliations with 36 orthodontic practices in four countries outside the United States. In November 2001, in connection with the OrthAlliance merger, we also began providing business services to pediatric dental practices. During the first quarter of 2004, we began offering some of our business services to general dental practices through our new division, OCA Outsource, and plan to offer our services to other healthcare practices in the future. We believe that by diversifying our customer base and continuing to expand our existing affiliated practices, we will increase fee revenue and cash flow.

     Our financial success is dependent on the financial success of our affiliated practices. The primary source of our fee revenue is service fees earned under our Service Agreements with affiliated practices. We generally collect our service fees from affiliated practices as the practices collect patient fees from patients and third-party payors. As part of the services we provide, we are generally actively involved in the operational aspects of our affiliated practices. We monitor the financial performance of our practices by routinely reviewing, among other things, patient billings, collections and the amount of billed patient fees receivable of our practices. We believe that our involvement reduces the risk that our service fees will not be collected. In addition, through our management information systems, we are able to timely review critical practice financial data, including patient case starts and patient collections. This allows us to benchmark practices within a geographic area or to our entire affiliated practice base. We strive for practices to achieve approximately a 50% operating margin. We assist our affiliated practices in reaching this goal by providing practices with marketing programs, cost analysis and recommendations for changes, if needed. In addition, our affiliated practices operate in highly-regulated professions, which requires us to actively monitor developments in applicable state and federal laws.

     We believe that the dollar amount of new patient contracts of our affiliated practices is the greatest predictor of our future fee revenue, because our fee revenue is based in part on a percentage of practice operating profits or revenue. During 2003, our affiliated practices generated new patient contract balances of $680.8 million, which we expect to provide us with a future stream of fee revenue and cash flow.

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     Our results for 2003, 2002 and 2001 were significantly affected by changes in the number of OrthAlliance affiliated practices for which we recorded fee revenue during those periods. We included fee revenue for OrthAlliance affiliated practices for less than two months in 2001, following the merger on November 9, 2001. We have not recorded fee revenue for OrthAlliance affiliated practices that were engaged in litigation with OrthAlliance and had ceased paying service fees at the time of the merger. However, if the practices subsequently continued paying service fees, their operating results were included beginning on the date they continued paying service fees. At various times during 2003 and 2002, we stopped recording fee revenue for a number of other OrthAlliance affiliated practices that ceased paying service fees and providing the financial information we use to compute fee revenue. Also, during 2003 and 2002, we stopped recording fee revenue for several OrthAlliance affiliated practices when they bought out of their Service Agreements with OrthAlliance. The practices for which we ceased recording fee revenue during 2003 and 2002 were primarily OrthAlliance affiliated practices that did not enter into amendments to their Service Agreements with OrthAlliance in connection with the merger and subsequent integration of OrthAlliance.

     The following table provides components of certain information in our consolidated statements of income for 2003 and 2002. As reflected in the following table, fee revenue decreased 14.6% during 2003 compared to 2002, primarily due to a 74.7% decrease during 2003 in fee revenue from affiliated practices for which we had ceased recording fee revenue at the end of 2003. We ceased recording fee revenue for these practices because they bought out of their Service Agreements or ceased paying service fees and providing financial information to us. The vast majority are OrthAlliance affiliated practices. The decrease in fee revenue during 2003 related to these non-performing practices impacted our operating income for 2003, which decreased 18.4% during 2003 compared to 2002.

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CRITICAL ACCOUNTING POLICIES AND ESTIMATES

     OCA’s management is required to make estimates and assumptions in the preparation of the financial statements in accordance with accounting principles generally accepted in the United States. We believe that the following critical accounting policies are important in portraying our financial condition and results of operations. These policies require management’s difficult, subjective or complex judgments due to the sensitivity of the methods, assumptions and estimates used in preparing our consolidated financial statements. Actual results may differ from these estimates under different assumptions and estimates.

Impairment of Identifiable Intangible Assets

     When we have affiliated with an established practice, we entered into a long-term Service Agreement with the practice and/or the affiliated practitioner under which we earn service fees by providing business services to the practice. We allocated a portion of the related costs of acquiring that agreement to an intangible asset. At December 31, 2003, we had $217.1 million of identifiable intangible assets, net of accumulated amortization, on our consolidated balance sheets. Management assesses the carrying amount of the identifiable intangible assets quarterly based on projected future cash flows under the Service Agreements based on several factors, including current operational levels of the practice, expected growth in the practice based on management’s experience, the status of the affiliation of the practice and the recoverability of the asset from practices currently engaged in litigation with us. If the total projected undiscounted cash flows of the practice exceed the carrying amount of these assets, no impairment exists. If the cash flows are less than the carrying amount, management adjusts the carrying value of the asset to fair value based on the discounted cash flows method. Management’s estimates may change based on future events.

Revenue Recognition

     Based on our revenue recognition policy, fee revenue is recognized based upon a straight-line allocation of our affiliated practices’ patient contract balances over the terms of the patient contracts, less amounts retained or estimated to be retained by the affiliated practices during the term of treatment, plus reimbursement of certain practice-related expenses. Management estimates the amounts to be retained by our affiliated practices based on amounts historically retained by the practice and certain other operational aspects of the practice. In addition, in some instances, management is required to estimate service fees receivable from certain of our affiliated practices based upon information provided by those affiliated practices. Most of these service fees are collected currently as the patients pay the practice. However, most of the patients of our affiliated practices have a payment plan which requires a final payment before completion of treatment of an amount equal to four times the normal monthly installment. Management’s estimates may change based on future conditions and circumstances. We discuss our revenue recognition policy in greater detail in the following subsection.

Allowance for Uncollectible Amounts

     We provide an allowance for uncollectible amounts based on our estimate of service fees receivable that may not be paid by our affiliated practices. The allowance for uncollectible amounts of service fees receivable is generally calculated based upon an aging of affiliated practices’ patient fees receivable for 80% of amounts over 90 days past due, 100% of amounts over 120 days past due and 6.25% of amounts for which patients have not yet been billed but which have been earned by the practices on a straight-line basis. These amounts are derived from our

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experience in collecting patient fees receivable on behalf of affiliated practices. We also provide allowances for uncollectible amounts of advances to affiliated practices and notes receivable from affiliated practices based on management’s assessment of our affiliated practices’ inability to repay their obligations. If the financial circumstances of our affiliated practices deteriorate, or if practices ceased paying service fees or engage in litigation with us, additional allowances may be required.

Recoverability of Assets Related to Certain Practices

     At December 31, 2003, we were engaged in litigation with 61 practices for which we had generally ceased recording fee revenue. We were also affiliated with 38 other practices for which we had generally ceased recording fee revenue at December 31, 2003. At December 31, 2003, we had approximately $18.7 million of identifiable intangible assets and property, equipment and improvements, net of accumulated amortization and depreciation, and $8.0 million of service fees receivable, advances to affiliated practices and notes receivable from affiliated practices, net of allowances recorded, related to practices that are engaged in litigation and other practices for which we generally ceased recording fee revenue. 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. Management has favorably resolved some of the lawsuits filed by OrthAlliance where these practices have paid us cash in excess of the net book value of the assets attributable to these practices. We have established allowances on service fees receivable, advances and notes receivable from these practices in accordance with our policy discussed above and believe the net amounts recorded are realizable as of December 31, 2003. In addition, we believe that we may receive cash in excess of the net book value of the assets attributable to these practices; however, adverse results from litigation could significantly affect the recoverability of these assets and may require us to write off these assets in the future.

Valuation of Goodwill

     Goodwill is carried at cost and is not amortized. At December 31, 2003, our balance sheet reflected approximately $87.6 million of goodwill related to the OrthAlliance merger. Management assesses the carrying amount of goodwill under the requirements of Statement of Financial Accounting Standards (“SFAS”) No. 142. Management is required to determine the fair value of OCA’s reporting units by estimating the amount for which the units can be bought or sold. If the carrying amount of a reporting unit, including goodwill, exceeds the estimated fair value, then the assets, including identifiable intangible assets, and liabilities are estimated at fair value. The excess of the estimated fair value of liabilities over the estimated fair value of assets establishes the implied value of goodwill. The excess of the carrying amount of goodwill over the implied value is an impairment charge. SFAS No. 142 states that the best evidence of fair value is the quoted market price of OCA’s common stock and should be used if available. At December 31, 2003, OCA’s net book value exceeded its market capitalization by approximately $89.5 million. Although market capitalization is an indicator of impairment, management used additional valuation techniques allowed under SFAS No. 142 to test for impairment and determined that goodwill was not impaired as of December 31, 2003. We believe that the decline in the market value of our common stock is not permanent. However, if our market capitalization continues to be less than our net book value, we may be required to adjust all or a portion of the carrying value of goodwill in the future.

REVENUE RECOGNITION

     We earn our revenue by providing business services to affiliated practices, for which we are paid service fees. Under most of our Service Agreements, service fees are generally based upon a percentage of the affiliated practice’s operating profit or revenue, plus reimbursement of practice-related expenses. Our service fees generally represent the portion of related patient contract amounts that is not retained by affiliated practices.

     Our fee revenues consists of amounts earned under our Service Agreements and recognized under our revenue recognition policy. We recognize fee revenue based on a straight-line allocation of our service fees over the term of the related patient contracts of affiliated practices. This straight-line calculation differs from the contractual arrangements under

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most of OCA’s Service Agreements, which generally allocate a higher percentage of the patient contract balance during the first month of treatment — in which we incur a disproportionate amount of expenses as the patient initiates treatment and braces are applied. Because we record practice-related expenses when incurred and we recognize fee revenue based on a straight-line allocation of patient contract balances, we may recognize a portion of fee revenue after related expenses have been recorded and corresponding service fees have become contractually due under our Service Agreements.

     We generally recognize fee revenue as follows:

•		For each patient contract, the total contract amount is allocated on a straight-line basis over the term of the patient contract (which generally averages about 25 months). The term of treatment is determined by the practitioner based on the severity of the case.
•		This straight-line allocation is then reduced by amounts retained by affiliated practices, which consist of (a) amounts retained by affiliated practices under the contractual terms of their Service Agreements and (b) a percentage of billed and unbilled receivables that we estimate will be retained by affiliated practices in future periods.

     We also recognize fee revenue related to reimbursement of certain practice-related expenses that we incurred on behalf of affiliated practices and recorded as expenses in our consolidated statements of income. To the extent our practices have not reimbursed us for these practice-related expenses, we recognize these amounts only to the extent that the affiliated practices generate sufficient patient fees receivable to secure reimbursement of the expenses. This impacts the timing of when we recognize fee revenue related to these expenses.

     Until amounts related to these practice-related expenses are recognized as fee revenue under our revenue recognition policy, we do not record the reimbursement due for these expenses as service fees receivable on our balance sheet, even though our affiliated practices have contractual obligations to reimburse us for these expenses under their Service Agreements. Practice-related expenses that had been recorded as expenses in our consolidated statements of income, but had not yet been recognized as fee revenue or recorded as service fees receivable, totaled approximately $18.0 million and $19.2 million at December 31, 2003 and 2002, respectively. The $18.0 million of unreimbursed practice-related expenses at December 31, 2003 represents fee revenue that we may recognize in the future under our revenue recognition policy.

SERVICE FEES RECEIVABLE

     Service fees receivable represents fee revenue owed to us by our affiliated practices, as calculated under our revenue recognition policy. This may differ from amounts contractually due to us under our Service Agreements, because our revenue recognition policy differs in certain respects from the service fee provisions of our Service Agreements. We generally collect our service fees as affiliated practices collect related patient fees from patients and third-party payors.

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     Service fees receivable consist primarily of a current and long-term portion. The following table reflects the components of service fees receivable, which are described below:

Current Portion of Service Fees Receivable

     The current portion of our service fees receivable consists of two components, one related to fees billed directly to patients and the other related to fees that have not been billed or that have been billed to insurance companies or other third-party payors. We generally collect our service fees as affiliated practices collect related patient fees from patients and third-party payors.

     Most of our affiliated practices use our recommended payment plan for their patients, which provides for (a) no down payment, (b) an initial record fee, (c) equal monthly payments (ranging from $109 to $139 per month, with most at $129 per month) over the term of treatment and (d) a final payment (“Final Payment”) in the last month of treatment (which is typically four times the monthly payment). This results in a disproportionate amount of patient fees being billed and collected at the end of treatment. As the term of patient contracts ranges from 20-36 months (with an average of about 25 months), we will collect our service fees as practices collect funds from patients over the course of treatment. Most of the patients of our affiliated practices were using our recommended payment plan as of December 31, 2003.

     Billed Patient Receivables. This portion of service fees receivable relates to affiliated practices’ patient fees that have been billed directly to patients but are not yet collected (“billed patient receivables”). We generally collect our service fees from affiliated practices as they collect patient fees over the course of treatment.

     The increase in billed patient receivables was primarily due to (a) an increase in the average amount of the monthly payment charged to patients by affiliated practices using our recommended payment plan during 2003, (b) a decrease in the average term of patient contracts of affiliated practices during 2003, (c) an increase during 2003 in the number of OrthAlliance affiliated practices using our recommended payment plan with no down payment, and (d) an increase in the average number of days between billing and collection of patient fees by affiliated practices during 2003.

     Final Payment Accrued and Third-Party Payor Receivables. This portion of service fees receivable generally relates to (a) patient fees, including Final Payments, with respect to which we have recognized fee revenue but which have not been billed to patients or third-party payors, and (b) patient fees that have been billed to insurance companies and other third-party payors.

     As discussed above, most of our affiliated practices use our recommended payment plan, which provides for a relatively large Final Payment in the final month of a patient’s treatment. Under our revenue recognition policy, a portion of the unbilled Final Payment is recognized on a straight-line basis each month over the term of the patient’s treatment.

     For example, a typical patient contract might call for 25 months of treatment with a monthly billing of $129 for 25 months and a Final Payment before completion of $516. Accordingly, the total patient contract amount would be $3,741. For revenue recognition purposes, we straight-line this contract amount over the course of treatment and recognize a portion of it (less amounts retained or to be retained by the affiliated practice) as fee revenue. In this

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example, the straight-line amount would be $150 per month (the contract amount divided by 25 months), which includes a portion of the $516 Final Payment. Of this amount, only $129 will be billed to the patient each month. The remainder of $21 per month will not be billed to the patient or collected until the 25th month. Each month, that $21 per month accumulates until the patient is finally billed the Final Payment in the 25th month. Therefore, the portion of service fees receivable related to this Final Payment is expected to accumulate and grow until the $516 Final Payment is billed and collected.

     Fee revenue is recognized evenly over the course of the patient’s treatment, even though the Final Payment is generally billed and collected at the end of treatment. The Final Payment results in a service fee receivable because the Final Payment amount is allocated evenly and recognized as fee revenue over the term of treatment even though the Final Payment may not be received until the final month of treatment.

     The following chart illustrates how service fees receivable resulting from fee revenue increases over the term of a patient contract for practices that use our recommended payment plan:

     The increase during 2003 in the portion of service fees receivable related to the Final Payment was primarily due to:

•		an increase during 2003 in the number of patients of affiliated practices with a patient contract providing for a Final Payment,
•		an increase during 2003 in the average amount of the Final Payment charged to patients under patient contracts,
•		a decrease during 2003 in the average term of patient contracts of affiliated practices, and
•		an increase during 2003 in the average number of months for which we had recorded fee revenue related to the Final Payment per patient contract.

     Although the Final Payment will not be collected until the last month of treatment, affiliated practices historically have not experienced significant problems collecting the Final Payment because the patient’s orthodontic appliances, such as braces, must be periodically maintained and removed at the end of treatment. In addition, we have collection policies, collection systems and patient financial arrangements to assist our affiliated practices in collecting funds due from patients.

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Long-Term Portion of Service Fees Receivable

     Financed Practice-Related Expenses. This portion of service fees receivable relates to practice-related expenses financed by us (“financed practice-related expenses”). When new practices or centers are developed, we typically finance all of the costs of operating losses and fixed assets. The affiliated practice generally has an obligation to repay OCA the practice’s share of these costs plus accrued interest. We incur 100% of the depreciation and operating losses emanating from the new location and record them as expenses when incurred. We are typically repaid these expenses over a five year period.

     Under our revenue recognition policy, we recognize fee revenue relating to these financed practice-related expenses to the extent the affiliated practices generate sufficient patient fees receivable to secure reimbursement of these expenses. The financed practice-related expense portion of service fees receivable represents the cumulative amount of unreimbursed practice-related expenses recognized as fee revenue under our revenue recognition policy. The financed practice-related expense portion of service fees receivable generally increases primarily due to the timing difference in when the financed practice-related expenses are recognized as fee revenue and when the affiliated practices repay these expenses over a five-year period once the practices have achieved profitability on a cash basis.

     These practice-related expenses are recorded in our consolidated statements of income when incurred, but we do not record service fees receivable on our consolidated balance sheet until amounts are recognized as fee revenue according to our revenue recognition policy, even though affiliated practices have a contractual obligation to reimburse us. As these financed practice-related expenses are repaid over a five-year period, we have classified the financed practice-related expense portion of service fees receivable as non-current on our consolidated balance sheets.

     Financed practice-related expenses include:

     Operating Losses. Newly-developed or de novo centers typically generate operating losses during their first 12 months of operations. We defer reimbursement of the affiliated practice’s portion of the operating losses until the de novo center begins to generate operating profits. We generally charge the affiliated practice interest on those deferred amounts at market rates. After the de novo center becomes profitable, the affiliated practice usually begins to reimburse us for the operating losses, including accrued interest, over a five-year period.

     Depreciation Expense Relating To Property, Equipment and Improvements. We generally purchase and provide the property, equipment and improvements used in our affiliated practices. We retain ownership of these property, equipment and improvements and depreciate these assets over their estimated useful lives. Affiliated practices generally reimburse us for their portion of the costs of these property, equipment and improvements over a five-year period. We charge the affiliated practice interest on these amounts at market rates.

SERVICE AGREEMENTS WITH AFFILIATED PRACTICES

     We provide business services to an affiliated practice under an agreement with an affiliated orthodontist or pediatric dentist and/or his or her wholly-owned professional entity. The form of agreement used for a particular affiliated practice is based upon the dental regulatory provisions of the state in which the affiliated practice is located. In most states, we use a form of service agreement, with some minor variations from state to state. In a small number of states with particularly stringent laws relating to the practice of dentistry, we use a consulting agreement, which also varies somewhat from state to state. OrthAlliance and its affiliated practices are parties to service, management service and consulting agreements that differ in some respects from the service and consulting agreements that OCA has historically used. The terms of these agreements typically range from 20 to 40 years, with most ranging from 20 to 25 years.

     During 2003, approximately 95% of our fee revenue was attributable to service and management service agreements, with the remainder being attributable to consulting agreements. None of our affiliated practices accounted for more than 10% of our fee revenue in 2003.

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     We generally earn monthly service fees under the Service Agreements 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, our service fees generally equal about 40% to 50% of a practice’s operating profit or about 17% of a practice’s revenue.

ORTHALLIANCE AFFILIATED PRACTICES

     On November 9, 2001, OrthAlliance became our wholly-owned subsidiary in a stock-for-stock merger whereby our newly formed subsidiary merged into OrthAlliance. OrthAlliance was formed in October 1996 and provides management and consulting services to orthodontists and pediatric dentists located throughout the United States. The OrthAlliance merger was accounted for using the purchase method of accounting and the results of operations of OrthAlliance have been included in our consolidated financial statements since November 9, 2001.

     Before we entered into the merger agreement with OrthAlliance, we anticipated that a number of OrthAlliance practices would oppose the merger because of disappointment with OrthAlliance’s stock price, unwillingness to affiliate with a competing business services provider and perceived differences in the companies’ cultures and operating strategies. We factored these risks into the economics of the merger consideration. A number of OrthAlliance affiliated practices have filed lawsuits against OrthAlliance, alleging, among other things, that OrthAlliance breached their Service Agreements and that the agreements are illegal and unenforceable. This litigation is described in more detail in “Item 3. Legal Proceedings” above. The vast majority of these litigating practices ceased paying service fees to us. Other OrthAlliance affiliated practices have also ceased paying services fees to us but have not filed litigation.

     During the fourth quarter of 2002, we established a settlement task force comprised of key members of our executive management team to focus on potential settlements of litigation or disputes with OrthAlliance affiliated practices. At December 31, 2003, we were engaged in litigation with 52 OrthAlliance affiliated practices for which we had generally ceased to record fee revenue. In addition, we were affiliated with another 33 OrthAlliance practices for which we had generally ceased recording fee revenue at December 31, 2003. From January 1, 2002 to December 31, 2003, we engaged in the following transactions with OrthAlliance affiliated practices:

•

10 OrthAlliance affiliated practices agreed to buy out of their service or consulting agreements with OrthAlliance by paying us to terminate their affiliation with OrthAlliance;

•

six OrthAlliance affiliated practices transitioned their practice to another affiliated practice;

•

nine OrthAlliance affiliated practices amended their service or consulting agreements in connection with the incentive programs offered to OrthAlliance affiliated practitioners and continued to be affiliated with OrthAlliance; and

•

nine OrthAlliance affiliated practices entered into other amendments to their service or consulting agreements and continued to be affiliated with OrthAlliance.

     None of the above transactions had a material effect on our financial statements during 2003.

     Based on our experience in favorably resolving some of the lawsuits filed by OrthAlliance affiliated practices and discussions with some of the other OrthAlliance affiliated practices who are parties to pending litigation or their representatives, we currently believe that some of these practices will settle their lawsuits by paying us an amount of cash in exchange for termination or modification of their service, consulting and management service agreements with OrthAlliance, depending upon the parties’ ability to reach an agreement as to the amount to be paid. We cannot assure you that such an agreement or settlement will be reached in any of these lawsuits. We also cannot, at this time, predict the outcome of these lawsuits or assure you that we will prevail in any of them, nor can we estimate at this time the amount of damages that we might incur or receive in these actions.

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SEASONALITY

     Historically, our affiliated practices typically experience higher patient case starts resulting in higher revenue during the summer months, when most children are not in school. During the fourth quarter, which includes the Thanksgiving and Christmas season, our affiliated practices have experienced reduced volume.

EITF ISSUE NO. 97-2

     We do not have a controlling financial interest in our affiliated practices. In accordance with guidance in Emerging Issues Task Force Issue No. 97-2, we do not consolidate the patient revenue and other operations and accounts of our affiliated practices within our financial statements.

CONSOLIDATED RESULTS

     The following discussion provides an analysis of our consolidated results of operations for the years ended 2003, 2002 and 2001. The following table provides information about (a) the percentage of fee revenue represented by certain items in our consolidated statements of income for the periods indicated, and (b) the percentage increase or decrease in those items from period to period:

2003 Compared To 2002

     Net Income. Net income for 2003 was $49.1 million, a decrease of $9.1 million or 15.7% from $58.2 million for 2002. This decrease was primarily due to a decrease in fee revenue from affiliated practices for which we ceased recording fee revenue during 2002 and 2003. The overall decrease in fee revenue during 2003 was partially offset by a decrease in direct expenses in 2003 and a non-recurring recruiting expense of $12.8 million recorded in 2002 (for a discussion of this expense, see the section below captioned “— 2002 compared to 2001”).

     Fee Revenue. Fee revenue decreased $64.2 million, or 14.6%, to $375.4 million in 2003 from $439.6 million in 2002. This decrease was primarily related to a decrease in fee revenue from affiliated practices for which we ceased to record fee revenue during 2002 and 2003, including practices that bought out of their service or consulting agreements or that ceased paying service fees and providing financial information we use to compute fee revenue. This decrease offset an increase in fee revenue from other affiliated practices, including (a) practices for which we recorded fee revenue throughout 2002 and 2003 and (b) practices that affiliated with us during 2002 or 2003 and for which we were recording fee revenue at year-end.

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     At December 31, 2003, we were affiliated with 324 practices for which we were recording fee revenue, compared with 343 practices at December 31, 2002. This represents a net reduction of 19 affiliated practices for which we were recording fee revenue as of December 31, 2003, compared to December 31, 2002. Most of the practices for which we stopped recording fee revenue were affiliated with OrthAlliance. The affiliated practices for which we ceased recording fee revenue were generally mature orthodontic and pediatric dental practices with relatively high volume and operating margins. Because of the overall decrease in mature practices contributing to our results, our operating margins and expenses as a percentage of fee revenue were negatively affected during the periods discussed. We expect some continued fluctuations in fee revenue as OrthAlliance affiliated practices may buy out of their Service Agreements or stop paying service fees and providing certain financial information we use to compute fee 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 fee revenue from practices for which we discontinued recording fee revenue also contributed to a decline in direct expenses, as discussed below.

     In addition, fee revenue during 2003 was also negatively affected by a reduction in service fees charged to certain of our affiliated practices that achieved certain performance levels. During 2003, we reduced these practices’ services fees by approximately $1.8 million, which reduced fee revenue by the same amount. We expect to continue this program in 2004 and expect to reduce service fees charged to certain practices by approximately $2.7 million in 2004.

     Beginning in 2000, we shifted our focus away from new affiliations with existing mature practices and instead have focused on developing de novo practices and expanding our existing affiliated practices. We have historically experienced a better return on our investment with this strategy. During 2003, our fee revenues from practices for which we recorded fee revenue throughout 2003 and 2002 grew by 5.5%, compared to 13.9% for practices for which we recorded fee revenue throughout 2002 and 2001. Since January 1, 2002, we have affiliated with 24 de novo practices, which typically generate initial operating losses during their first 12 months of operations and experience relatively lower operating margins than mature practices. We will continue to invest in our existing practices by expanding their clinical capacity and developing de novo practices to increase fee revenue. We expect that the increase in fee revenue from these practices will offset the decrease in fee revenue from practices for which we ceased recording fee revenue over time.

     Currently, fee revenue attributable to most of the OCA affiliated practices includes reimbursement of a pro rata allocation of corporate overhead expense, as provided in the practices’ Service Agreements. However, beginning in the fourth quarter of 2003 and continuing through the first three quarters of 2004, we will phase-out the reimbursement of corporate overhead expense by OCA affiliated practices. Based on current corporate expense levels and current diluted average shares outstanding, we estimate that this change will reduce fee revenue by $4.4 million for 2004, resulting in a reduction in diluted earnings per share of approximately $0.05 for 2004. This estimate is preliminary and may differ materially from actual results. The effect on the fourth quarter of 2003 from this change did not have a material impact on our results.

     Direct Expenses. Direct expenses include all operating costs of our affiliated practices and our corporate office. The various direct expenses include:

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•		Salaries and benefits, including payroll and benefits costs for employees at our corporate headquarters and affiliated centers (which do not include the orthodontists, dentists and other licensed professionals),
•		Clinical supplies and lab fees, which primarily represent 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 corporate headquarters, and
•		Marketing and advertising expense, which represents costs associated with television, radio and print media advertising for affiliated practices.

     During 2003, direct expenses decreased $37.0 million, or 15.3%, to $204.9 million from $241.9 million in 2002. This overall decrease in 2003 was primarily due to the exclusion of direct expenses for practices that bought out of their Service Agreements or for which we generally ceased to record fee revenue during 2003 and 2002. Except for marketing and advertising expense, direct expenses during 2003 as a percentage of fee revenue were comparable to that in 2002. As a percentage of fee revenue, marketing and advertising decreased to 6.4% in 2003 from 7.7% in 2002, primarily due to (a) lower rates on annual media buying as a result of the slower economy, (b) payments made during 2002 for advertising arrangements for OrthAlliance affiliated practices that were not renewed for 2003 and (c) credits received during 2003 for advertising spots preempted by war coverage.

     General and Administrative. General and administrative expense represents other costs incurred in the operation of our business, including costs for telephone, utilities, accounting and legal services, office supplies, general liability and property insurance coverage and provisions for uncollectible amounts. During 2003, general and administrative expense decreased $1.3 million, or 2.2%, to $58.4 million from $59.7 million in 2002, primarily due to the exclusion of costs for practices that have bought out of their service or consulting agreements or for which we generally ceased to record fee revenue. As a percentage of fee revenue, general and administrative expense increased to 15.6% during 2003 from 13.6% in 2002, primarily due to an increase of $3.0 million in the provision for uncollectible amounts.

     Asset Impairments. During 2003, we recorded non-cash impairment charges of $5.9 million ($3.8 million, net of income tax benefit), related to our evaluation of certain long-lived assets and identifiable intangible assets. We recorded impairments of approximately $3.4 million of intangible assets and $2.5 million related to property, equipment and improvements for centers closed or relocated during 2003.

     Income Taxes. Our effective income tax rate was 35.5% and 37.8% for 2003 and 2002, respectively. 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. In the fourth quarter of 2003, based on our assessment, we reduced this liability by $1.7 million, which affected our effective tax rate for 2003.

     2002 Compared To 2001

     Net Income. Our results for 2002 compared to 2001 were primarily affected by our acquisition of OrthAlliance in November 2001. Because we acquired OrthAlliance in November 2001 and its results are included in our results for approximately two months in 2001 and all of 2002, OrthAlliance significantly affected the comparability of our 2002 results to 2001. In addition, we ceased recording fee revenue during 2002 for certain affiliated practices for which we were recording fee revenue at December 31, 2001.

     Net income for 2002 was $58.2 million, a decrease of $2.9 million, or 4.8%, compared to net income of $61.1 million for 2002. This decrease was primarily due to a non-recurring recruiting expense of $12.8 million ($8.0 million net of income tax benefit) and non-cash impairments of $2.8 million ($1.7 million, net of income tax benefit), as well as decreases in fee revenue from practices for which we ceased recording fee revenue during 2002 (which were offset by increases in fee revenue from other affiliated practices during 2002).

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Fee Revenue. Fee revenue in 2002 increased $88.7 million, or 25.3%, to $439.6 million from $351.0 million in 2001. This increase was primarily due to an increase in fee revenue from affiliated practices that were affiliated with us and for which we recorded fee revenue throughout 2001 and 2002 and an increase in fee revenue from other affiliated practices that affiliated with us during 2001 or 2002 and for which we were recording fee revenue at December 31, 2002. To a lesser extent, the increase in fee revenue was due to an increase in the average amount of fees that patients were charged for treatment by affiliated practices. The overall increase in fee revenue was partially offset by a decrease in fee revenue from affiliated practices for which we ceased to record fee revenue during 2002, including practices that bought out of their Service Agreements or that ceased paying service fees and providing financial information we use to compute fee revenue.

     The overall increase in fee revenue during 2002 was primarily due to the inclusion of OrthAlliance in our results for all of 2002, compared to approximately two months in 2001. During 2002, we initially experienced a positive impact on fee revenue from certain affiliated practices for which we later ceased to record fee revenue during 2002. During 2002, we ceased recording fee revenue for 29 practices for which we were recording fee revenue at December 31, 2001. Substantially all of the practices for which we stopped recording fee revenue were affiliated with OrthAlliance. We generally ceased to record fee revenue for affiliated practices that either bought out of their Service Agreements or that ceased paying service fees and providing the financial information we use to compute fee revenue. At December 31, 2002 we were affiliated with 343 practices for which we were recording fee revenue, compared to 372 practices at December 31, 2001.

     Direct Expenses. During 2002, direct expenses increased $54.1 million, or 28.8%, to $241.9 million from $187.8 million in 2001. The overall increase in direct expenses was primarily due to the inclusion of direct expenses for OrthAlliance affiliated practices for all of 2002, compared to less than two months during 2001. Except for orthodontic supplies, direct expenses during 2002 as a percentage of fee revenue were comparable to that in 2001. As a percentage of fee revenue, orthodontic supplies increased to 9.4% in 2002 from 8.4% in 2001, primarily due to: (a) increases in the price charged for orthodontic supplies by certain of our vendors in late 2001 and early 2002, (b) some OrthAlliance affiliated practices electing not to use our proprietary online purchasing system that provides cost savings on purchases of orthodontic supplies and (c) higher supply costs from providing Invisalign products to patients, which are generally more expensive than traditional orthodontic supplies.

     General and Administrative. During 2002, general and administrative expense increased $20.4 million, or 51.7%, to $59.7 million from $39.4 million in 2001. The overall increase in general and administrative expense for 2002 was primarily due to the inclusion of OrthAlliance for all of 2002 compared to less than two months in 2001, which resulted in (a) an increase of $2.8 million in telephone and utility costs, (b) an increase of $1.8 million in office supplies expense, (c) an increase of $5.4 million in accounting, legal, litigation and insurance costs and (d) an increase of $3.8 million in the provision for uncollectible service fees receivable and advances to affiliated practices.

     Asset Impairments. During 2002, we recorded non-cash asset impairment charges of $2.8 million ($1.7 million, net of income tax benefit) related to our evaluation of certain long-lived assets. We determined that approximately $0.5 million of identifiable intangible assets related to certain service agreements and $2.3 million of property, equipment and improvements were impaired and, accordingly, expensed such costs.

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     Non-Recurring Recruiting Expense. During 2002, we recorded a non-recurring charge of $12.8 million ($8.0 million, net of income tax benefit) for amounts paid to a former employee for past recruiting services. We reached an agreement with the former employee regarding the previously disputed amounts and, in accordance with our accounting policies for such costs, the amounts paid to the former employee were treated as a non-recurring recruiting expense. We do not have similar recruiting arrangements with any other employee or affiliated practitioner.

     Income Taxes. Our effective income tax rate was 37.8% for 2002 and 2001.

LIQUIDITY AND CAPITAL RESOURCES

     Cash and cash equivalents was $7.4 million at December 31, 2003 and $7.5 million at December 31, 2002. Our working capital (total current assets less total current liabilities) was $145.1 million at December 31, 2003, compared to $89.5 million at December 31, 2002. Our current ratio (total current assets divided by total current liabilities) was 5.2 at December 31, 2003, compared to 2.7 at December 31, 2002. The increase in working capital during 2003 compared to 2002 was primarily due to an increase of $35.6 million in the current portion of service fees receivable, including a $26.0 million increase in the final payment accrued and third-party payor receivables portion of service fees receivable. During 2003, we generated excess cash from operations to fund our capital expenditures, incentive payments and to reduce our debt. At December 31, 2003, we had $20.4 million available to borrow under our credit facility. We expect to generate excess cash to meet our capital requirements and liquidity needs during 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 novo centers and remodeling and maintenance expenditures at 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. These costs are shared by us and the particular affiliated practice. We generally bear an affiliated practice’s share of these costs until we are reimbursed by the practice. Under most of our Service Agreements, the affiliated practices repay these costs over a five-year period. In some cases, we have assisted our practices in obtaining financing for their share of these costs by providing a guaranty of loans from our primary lender. The outstanding balance of these amounts we guaranteed was approximately $0.3 million and $0.7 million at December 31, 2003 and December 31, 2002, respectively. 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 de novo centers relative to expenditures on existing centers. During recent years, however, our capital expenditures have been increasingly directed toward remodeling, 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 our international operations. We currently expect to incur capital expenditures of at least $14.2 million in 2004, primarily in connection with the development of de novo centers. 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 expansion phase of the practice, (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

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maintaining their compensation during the start up 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 do not reimburse us for those expenses or (3) certain affiliated practices collect their own patient fees and do not remit to us all service fees due.

     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.

     Incentive Program Payments, Notes Payable and Debt Obligations. Certain OrthAlliance affiliated practices earned $5.8 million in 2003 under incentive programs. Of this amount, we used funds generated from operations to pay $5.4 million to these practices in 2003, with the other $0.4 million paid during the first quarter of 2004. Participants in these programs are eligible to receive annual payments under these 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 December 31, 2003, we had current maturities of $8.3 million under our credit facility and $2.1 million due to our affiliated practices. We expect cash from operations to fund these payments during 2004.

     Stock Repurchase Program. In August 2002, our Board of Directors approved a common stock repurchase program that authorizes us to repurchase up to 2.0 million shares of our common stock from time to time until February 2004 in the open market at prevailing market prices or in privately negotiated transactions. As of December 31, 2003, we repurchased approximately 1.2 million shares of our common stock under this program for an aggregate purchase price of approximately $16.1 million, of which 150,000 shares of our common stock were repurchased during 2003 for an aggregate purchase price of $1.1 million. These shares were repurchased in the open market at prevailing market prices using cash from operations. We did not make any repurchases under this program in 2004. In August 2003, our Board of Directors approved another common stock repurchase program that authorizes us to repurchase up to 2.0 million shares of our common stock from time to time in the open market at prevailing market prices or in privately negotiated transactions. We anticipate making additional repurchases of our common stock in the future under this program. Repurchased shares are held in treasury, and may be available for use in connection with our stock option plans, stock programs and acquisitions, or for other corporate purposes.

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 2003 and 2002, we did not pay federal income taxes of approximately $27.4 million and $38.2 million, respectively, by monetizing our deferred tax assets relating to net operating loss carryforwards. 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 (“IRS”) in January 2003 and (b) a change in accounting method related to applicable class lives for certain long-lived assets. This change in accounting method related to long-lived assets was approved by the IRS when 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 in 2004. We expect to use the cash arising from this benefit to fund other operational needs during 2004.

     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

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credit facility generally bear interest at varying rates above the lender’s prime rate ranging from 0.50% to 1.50% or above the Eurodollar rate ranging from 1.50% to 2.50%. This margin is based on our leverage ratio as computed under the credit facility. Amounts borrowed under the credit facility are secured by a security interest in the capital stock of our operating subsidiaries. The revolving line of credit expires January 2, 2006. At December 31, 2003, $79.6 million was outstanding under the revolving line of credit and $16.5 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. At December 31, 2003, we were in compliance with these covenants.

     Other Sources. We are also exploring the possibility of monetizing certain of our assets through securitization and other forms of financing to raise capital. Funds generated from these activities would be used to repay indebtedness, to repurchase shares of our common stock and for working capital and general corporate purposes.

Cash Flows

     The following table summarizes cash flow information for the years ended December 31, 2003, 2002 and 2001, respectively:

2003 Compared To 2002

     Operating Activities. The decrease in net cash provided by operating activities in 2003 compared with 2002 was primarily due to a decrease in net income. See our discussion in the section above captioned “—Consolidated Results.” The following discusses the significant factors affecting net cash provided by operating activities for 2003 compared to 2002:

•

Deferred income taxes. We used deferred tax assets primarily related to net operating loss carryforwards to offset our income taxes of approximately $27.4 million in 2003, compared with $38.2 million during 2002.

•

Service fees receivable. For a discussion of service fees receivable, see the section above captioned “—Service Fees Receivable.” During 2003, the billed patient receivables portion of service fees receivable, net of allowance for uncollectible amounts, increased $12.9 million, or 33.8%, to $51.1 million at December 31, 2003 from $38.2 million at December 31, 2002. The increase in billed patient receivables was primarily due to (a) an increase in the average amount of the monthly payment charged to patients by affiliated practices using our recommended payment plan during 2003, (b) a decrease in the average term of patient contracts of affiliated practices during 2003, (c) an increase during 2003 in the number of OrthAlliance affiliated practices using our recommended payment plan with no down payment, and (d) an increase in the average number of days between billing and collection of patient fees by affiliated practices during 2003. The final payment accrued and third-party payor receivables portion of service fees receivable, net of allowance for uncollectible amounts, increased $26.0 million, or 85.8%, to $56.3 million at December 31, 2003 from $30.3 million at December 31, 2002. This increase was primarily related to an increase during 2003 in the number of patients of affiliated practices with a patient contract providing for a Final Payment, the average amount of the Final Payment charged to patients under patient contracts, and the average number of months for which we had recorded fee revenue related to the Final Payment per patient contract, as well as a decrease during 2003 in the average term of patient contracts of affiliated practices.

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The financed practice-related expense portion of service fees receivable increased $9.7 million, or 22.5%, to $52.8 million at December 31, 2003 from $43.1 million at December 31, 2002. This increase was primarily due to the timing difference in when the expense amounts were recognized as fee revenue under our revenue recognition policy and when affiliated practices are contractually obligated to reimburse us for these expenses (generally over a five-year period).

•

Service fee prepayments. Service fee prepayments represent service fees which we have not yet recognized for revenue recognition purposes, but for which we have received payment from affiliated practices. Because we recognize fee revenue based on a straight-line allocation of treatment fees, this results in us receiving cash before we incur certain practice-related expenses and recognize certain service fees as fee revenue. Service fee prepayments decreased $6.6 million, or 85.1% during 2003 to $1.2 million at December 31, 2003 from $7.7 million and December 31, 2002. This decrease was primarily due to certain OrthAlliance affiliated practices that switched from a service fee prepayment to a service fee receivable position under our revenue recognition policy, which resulted in a decrease of approximately $4.2 million in service fee prepayments, and the recognition under our revenue recognition policy of approximately $0.7 million in fee revenue during 2003.

•

Supplies inventory. Cash used for supplies inventory decreased $2.5 million to $1.2 million in 2003 from $3.7 million in 2002. This decrease was primarily due to the exclusion of supplies inventory for certain affiliated practices that bought out of their service, consulting or management service agreements or for which we generally ceased to record fee revenue after December 31, 2002. Purchases of supplies inventory increased in 2002, primarily due to an increased number of patients under treatment during this time and to sustain inventory levels for OrthAlliance affiliated practices.

•

Amounts payable to affiliated practices. There was no effect on cash flow from operating activities during 2003 related to amounts payable to affiliated practices. However, we reduced amounts payable to affiliated practices (primarily to OrthAlliance affiliated practices) by $5.8 million during 2002.

•

Accounts payable and other current liabilities. During 2003, we used less cash for accounting and legal fees as compared with 2002. We have paid significant legal fees in the past two years, primarily relating to litigation with OrthAlliance practices. During 2003, we engaged a law firm to represent us and OrthAlliance in pending litigation on a contingent fee basis. The firm is to be paid fees as lawsuits are settled or otherwise completed, based on a percentage of the proceeds from any settlement or award to us. This arrangement should reduce our use of cash related to legal fees during 2004.

     Investing Activities. This decrease in net cash used in investing activities was primarily due to a decrease of $11.5 million in advances to affiliated practices and a decrease of $5.3 million in amounts used to acquire and amend Service Agreements during 2003, compared to 2002. Partially offsetting these decreases was an increase of $4.6 million in purchases of property, equipment and improvements and an increase of $3.5 million in notes receivable during 2003 compared to 2002.

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Identifiable intangible assets. During 2003, we paid approximately $7.2 million to acquire and amend Service Agreements, pursuant to which we obtain the exclusive right to provide operations, financial, marketing and administrative services to the practice during the term of the agreement, compared to $10.4 million in 2002. Of the $7.2 million paid to acquire or amend Service Agreements during 2003, approximately 19.5% related to new affiliations and 80.5% related to existing affiliated practices to amend Service Agreements during 2003. Of the $10.4 million paid to acquire or amend Service Agreements during 2002, approximately 42.5% related to new affiliations and 57.5% related to

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existing affiliated practices to acquire or amend Service Agreements during 2002. The overall decrease in cash used to acquire identifiable intangible assets during 2003 results from our shift in focus from new affiliations to developing de novo practices and assisting existing affiliated practices to grow, which generally requires less capital investment. We may, from time to time, provide consideration to existing practices for amendments to their service agreements to include terms that are beneficial to us and/or to extend the service agreements to include newly acquired practices, centers or patient bases.

•

Purchases of property, equipment and improvements. We purchased $19.2 million and $ 14.6 million in property, equipment and improvements in 2003 and 2002, respectively. These expenditures primarily related to the development of new or de novo centers 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.

•

Advances to affiliated practices. We provided net advances of approximately $4.2 million to affiliated practices during 2003, compared to $15.8 million in 2002. This decrease in 2003 was primarily due to our increased efforts to obtain repayments on advances from our affiliated practices and a decrease in advances related to amounts due to us under Service Agreements with OrthAlliance affiliated practices. Of the net amount advanced during 2003, approximately $2.1 million related to cash advances against future distributions and approximately $1.9 million related to amounts due to us under Service Agreements. Of the net amount advanced during 2002, approximately $6.1 million related to cash advances against future distributions and approximately $9.7 million related to amounts due to us under Service Agreements.

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Notes receivable. Notes receivable increased by $3.5 million during 2003 primarily due to promissory notes from practices that have completed buy-outs of their service, consulting and management service agreements during 2003 as compared to 2002.

     Financing Activities. The decrease in cash used in financing activities during 2003 was primarily due to a decrease of $13.8 million in repurchases of shares of common stock and a decrease of $2.6 million from the issuance of our common stock related to the exercise of stock options during 2003, compared with 2002. Also during 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. Amounts repaid during 2003 to affiliated practices and under the new credit facility were consistent with amounts repaid to affiliated practices and under the prior credit facility during 2002.

2002 compared to 2001

     Operating Activities. Net cash provided by operating activities increased in 2002 compared with 2001 primarily due to the following:

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Noncash items. Non-cash items increased during 2002 primarily due to increases of $3.1 million in depreciation and amortization expense, $4.8 million in non-recurring recruiting expense, $2.8 million in asset impairments and $3.8 million in provision for bad debt expense, as compared to 2001. As discussed above in “—Consolidated Results,” we recorded $12.8 million in non-recurring recruiting expense during 2002 related to amounts paid to a former employee for his past recruiting

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services. Of this amount, $8.0 million was paid in cash and the remaining $4.8 million, which is included in noncash items, relates to forgiveness of debt owed by the former employee.

•

Deferred income taxes. During 2002, we reduced our long-term deferred tax assets for federal and state income tax liability for 2002 by $38.2 million. In addition, we received refunds of $10.2 million for a portion of the deferred income taxes recorded from the OrthAlliance acquisition.

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Service fees receivable. For a discussion of service fees receivable, see the section above captioned “—Service Fees Receivable.” During 2002, the billed patient receivables portion of service fees receivable, net of allowance for uncollectible amounts, increased $12.2 million, or 46.9%, to $38.2 million at December 31, 2002 from $26.0 million at December 31, 2001. This increase was primarily due to an increase in the overall number of patient contracts and in the average amount of treatment fees charged per patient by our affiliated practices during 2002. The increase was also due to an increase in the average number of days between billing and collection of patient fees during 2002. The final payment accrued and third-party payor receivables portion of service fees receivable, net of allowance for uncollectible amounts, increased $17.8 million, or 142.4%, to $30.3 million at December 31, 2002 from $12.5 million at December 31, 2001. This increase was primarily due to the accumulation of service fees receivable relating to the unbilled final payment as the average age of our affiliated practices’ patient contracts increased by approximately 1.5 months to 13.8 months at December 31, 2002 from 12.3 months at December 31, 2001. In addition, the increase in the number of patients being treated and the increase in the average total treatment fee also contributed to the overall increase in the final payment accrued and third-party payor portion of service fees receivable. The financed practice-related expense portion of service fees receivable increased $19.1 million, or 79.6%, to $43.1 million at December 31, 2002 from $24.0 million at December 31, 2001. This increase was primarily due to the timing difference in when the expense amounts were recognized as fee revenue under our revenue recognition policy and when affiliated practices are contractually obligated to reimburse us for these expenses (generally over a five-year period).

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Service fee prepayments. Service fee prepayments represent service fees which we have not yet recognized for revenue recognition purposes, but for which we have received payment from affiliated practices. Some of our affiliated practices require that their patients pay a down payment of approximately 25% of the total treatment fee at the commencement of treatment. Because we recognize fee revenue based on a straight-line allocation of treatment fees, this results in us receiving cash before we incurred certain practice-related expenses and recognize certain service fees as fee revenue. Service fee prepayments decreased $6.2 million or 44.6% in 2002 to $7.7 million at December 31, 2002 from $14.0 million at December 31, 2001. This decrease was primarily due to a decrease in new patient contracts initiated by OrthAlliance affiliated practices in 2002 as compared to 2001.

•

Supplies inventory. Purchases of supplies inventory increased $2.1 million or 140% to $3.7 million in 2002 from $1.5 million in 2001. This increase was primarily due to an increase in the number of patients being treated, the overall price increase charged by our vendors and purchases made to sustain inventory levels for OrthAlliance affiliated practices during 2002 as compared with 2001.

•

Accounts payable and other current liabilities. During 2002, cash used for accounts payable and other current liabilities increased $2.5 million, or 22.6%, to $13.3 million in 2002 from $10.9 million in 2001. This increase was primarily due to decreases of $1.2 million in deferred revenue and $1.4 million in income taxes payable. The decrease in accounts payable was mostly offset by an increase in accrued salaries and other current liabilities.

•

Amounts payable to affiliated practices. We reduced amounts payable to affiliated practices (primarily to OrthAlliance affiliated practices) by $5.8 million during 2002, compared to a reduction of $1.5 million during 2001.

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Investing Activities. Net cash used in investing activities decreased during 2002, primarily due to a decrease of $7.5 million used to purchase property, equipment and improvements and a decrease of $6.1 million used to acquire Service Agreements during 2002, compared to 2001. Partially offsetting this decrease was an increase of $12.0 million in cash used for advances to affiliated practices during 2002, compared to 2001.

•

Identifiable intangible assets. During 2002, we paid $10.4 million to acquire or amend Service Agreements, pursuant to which we obtain the exclusive right to provide operations, financial, marketing and administrative services to the practice during the term of the Service Agreement, compared to $16.5 million in 2001. Of the $10.4 million paid to acquire or amend Service Agreements during 2002, approximately 42.5% related to new affiliations and 57.5% related to existing affiliated practices to acquire or amend service or consulting agreements during 2002. Payments to existing practices during 2002 were primarily to certain OrthAlliance affiliated practitioners in connection with amendments to their Service Agreements under incentive programs initiated in connection with the OrthAlliance merger and integration of OrthAlliance’s affiliated practices. Of the $16.5 million to acquire or amend Service Agreements during 2001, approximately 77.0% related to new affiliations and 23.0% related to existing practices, excluding the effect of the OrthAlliance merger. Of the amount invested in new affiliations during 2001, a portion related to OCA affiliated practices that signed definitive agreements in 2000, but to which we did not remit consideration for the affiliation until 2001.

•

Purchases of property, equipment and improvements. We purchased $14.6 million and $22.1 million in property, equipment and improvements for 2002 and 2001, respectively. These expenditures primarily related to the development of new or de novo centers in the United States and abroad and the remodeling or refurbishing of existing centers.

•

Advances to affiliated practices. We provided net advances of approximately $15.8 million to affiliated practices during 2002, compared to $3.8 million for 2001. Of the net amount advanced during 2002, approximately $6.1 million related to cash advances against future distributions and approximately $9.7 million related to amounts due to us under service, consulting and management service agreements. Substantially all of the amounts advanced during 2001 related to cash advances against future distributions.

     Financing Activities. Net cash used in financing activities was $28.6 million for 2002, compared to $14.2 million of net cash provided by financing activities during 2001. The following activities contributed to the increase in net cash used during 2002 as compared to 2001:

•

repurchases of approximately 1.1 million shares of our common stock during 2002 for an aggregate purchase price of approximately $15.0 million;

•

an increase of $3.7 million in repayments on notes payable to affiliated practices during 2002 as compared to 2001;

•

a decrease of $11.6 million in issuance of our common stock related to the exercise of stock options in 2002 as compared to 2001; and

•

a decrease of $25.9 million in borrowings under our credit facilities during 2002 as compared to 2001.

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These activities were partially off-set by a decrease of $13.9 million in payments on long-term debt.

Contractual Obligations

     The following table summarizes our contractual obligations by period as of December 31, 2003:

RECENT ACCOUNTING PRONOUNCEMENTS

     In January 2003, the Financial Accounting Standards Board (“FASB”) issued Interpretation No. 46 (“FIN 46”), “Consolidation of Variable Interest Entities, an interpretation of Accounting Research Bulletin No. 51.” FIN 46 requires consolidation of entities when an enterprise absorbs a majority of the entity’s expected losses, receives a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interests in the entity. Currently, entities are generally consolidated by an enterprise when it has a controlling financial interest through ownership of a majority voting interest in the entity. In December 2003, the FASB issued FIN 46R which replaces FIN 46 and addresses consolidation of variable interest entities. Application of FIN 46R for variable interest entities commonly referred to as special-purpose entities is effective for the reporting period ending after December 15, 2003. All other provisions under FIN 46R are effective for the reporting period ending after March 15, 2004. The initial adoption of FIN 46R did not have an impact on us as we do not have an interest in any entity considered a special purpose entity. We believe the adoption of the other provisions of FIN 46R will not have a material impact on our financial position or results of operations.

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RISK FACTORS

     The following are some of the risks and uncertainties that could cause our actual financial condition, results of operations, business and prospects to differ materially from those contemplated by the forward-looking statements contained in this Report or our other filings with the SEC. These risks and uncertainties are also factors that you should consider before investing in our common stock. If any of the following risks actually occurred, our business, financial condition and operating results could suffer, and the trading price of our common stock could decline.

Our financial success depends on the efforts and success of our affiliated practices, and our business and financial results could suffer if they do not succeed or if our service or consulting agreements with them are terminated.

     We receive fees for services we provide for orthodontic and pediatric dental practices under service, consulting and management service agreements. Under most of these agreements, our service fees are determined, at least in part, on the financial performance of the particular practice, so our success depends on the success of our affiliated practices. Orthodontics and pediatric dentistry are highly competitive businesses in each market in which our affiliated practices operate. Our affiliated practices face competition from other orthodontists, pediatric dentists and general dentists in the communities they serve. Many of these competing orthodontists, pediatric dentists and general dentists have more established practices. Changes in the healthcare industry, such as the growth of managed care organizations and provider networks, may result in lower compensation for the services of our affiliated practices. Our service agreements and some of our consulting agreements with affiliated practices have terms ranging from 20 to 40 years, with most ranging from 20 to 25 years. Affiliated practices may generally terminate those agreements for “cause,” which generally includes our material breach of the agreement. In some cases, an affiliated practice may terminate their agreement without cause after a specified period of time, subject to substitution of another affiliated practitioner and an obligation not to compete within a specified area. OrthAlliance’s service, consulting and management service agreements generally do not include affiliated practitioners as parties to the agreements; rather, the agreements are generally with a professional corporation that is owned by an affiliated practitioner, and the affiliated practitioner enters into an employment agreement with his or her professional corporation. These employment agreements generally provide for a shorter term (typically five years) than the service, consulting or management service agreement with OrthAlliance, and a covenant not to compete within a designated area for a period of time (typically two years) after that term. The terms of many of these employment agreements will be expiring during the next three years. In addition, an affiliated practice may successfully challenge the legality of our long-term service, consulting and management service agreements, and we may be unable to enforce non-competition and other provisions of those agreements. We are currently engaged in a number of lawsuits in which affiliated practices have alleged that their service, consulting and management service agreements and the non-competition provisions in those agreements and in the employment agreements are illegal and unenforceable. If an affiliated practice were to prevail in such a claim, it could adversely affect our agreements with that practice and our other affiliated practices. The loss of a substantial number of our agreements with affiliated practices or a material loss of revenue by our affiliated practices, for whatever reason, could materially and adversely affect our financial condition and results of operations, causing us to become less profitable.

Our affiliated practices are extensively regulated, which may adversely affect our business and limit how we can operate.

     Governmental authorities regulate the orthodontic and pediatric dental industry and orthodontic and pediatric dental practices extensively. These laws generally do not distinguish between the practice of general dentistry, orthodontics and pediatric dentistry, and the requirements and prohibitions relative to the practice of dentistry under such laws generally apply equally to the practice of orthodontics and pediatric dentistry. We do not control the practice of orthodontics and pediatric dentistry by our affiliated practices or their compliance with legal requirements that apply to orthodontists and pediatric dentists and their practices. Many states prohibit us, as a non-professional corporation, from:

•

practicing orthodontics and pediatric dentistry, which, in some states, includes managing or operating an orthodontic or pediatric dental office;

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•		splitting professional fees with orthodontists or pediatric dentists;
•		owning or controlling equipment used in orthodontic or pediatric dental practices;
•		employing orthodontists or pediatric dentists;
•		setting fees charged for orthodontic or pediatric dental services;
•		maintaining an orthodontist’s or pediatric dentist’s patient records; or
•		controlling the content of an orthodontist’s or pediatric dentist’s advertising.

     Many states also prohibit orthodontists and pediatric dentists from paying any portion of fees received for orthodontic or pediatric dental services in exchange for a patient referral. In addition, many states impose limits on the tasks an orthodontist or pediatric dentist may delegate to other staff members. These laws and their interpretation vary from state to state, and regulatory authorities enforce them with broad discretion. Some states have a relatively high number of our affiliated practices located in them. Adverse legal or regulatory developments in these states could have a significant impact on our results.

     If courts or regulatory authorities reviewing our business arrangements with affiliated practices decide that our arrangements do not comply with applicable law, we might have to change those arrangements in a way that adversely affects us. An affiliated practice may successfully challenge the legality of our service and consulting agreements, and we may be unable to enforce non-competition and other provisions of those agreements. We are currently engaged in a number of lawsuits in which affiliated practices have alleged that their service, consulting and management service agreements are illegal and unenforceable. The laws and regulations of states and countries in which we operate or seek to expand may restrict or adversely affect our relationships with orthodontists or pediatric dentists in those states and countries. The laws and regulations of states and countries in which we currently operate could change or be interpreted in a way that adversely affects our operations and relationships with affiliated practices. We may have to change our contractual relationships, alter our financial arrangements or restrict our operations in those states and countries. These laws and regulations could also prevent us from affiliating with, or providing business services to, orthodontic and pediatric dental practices practicing in those states and countries.

     In a recent court ruling, a federal court in Texas held that the agreements between OrthAlliance and certain affiliated practices in Texas violated the Texas Dental Practice Act, and were therefore illegal. The court reasoned that the interrelationship of the purchase and sale agreement, the service agreement, and the employment agreement permitted OrthAlliance to own, operate and maintain the dental offices in which it employed or engaged the orthodontist to practice dentistry, in violation of the Texas statute. In addition, a federal court in Washington state recently ruled that the overall relationship between OrthAlliance and the orthodontic practices violated a Washington statute governing the corporate practice of dentistry and that OrthAlliance’s management service agreements with the practices, and the employment agreements between the orthodontists and their professional corporations, were illegal. OrthAlliance has appealed these decisions. We believe that OrthAlliance has meritorious claims and that the rulings were wrongly decided. However, we cannot assure you that we will prevail in our appeals, or that we will not suffer an adverse outcome. If other courts decide to follow these decisions and declare the OrthAlliance and/or OCA service agreements illegal and/or invalid, this could have a material adverse effect on our business, financial condition or results of operations.

Our growth strategy may not succeed, which could have an adverse effect on our financial performance.

     We may be unable to continue to increase the productivity of our existing practices, maintain the growth that we have experienced in the past, or unable to expand our services to other markets. Our ability to grow will depend on a number of factors, including:

•

our ability to implement initiatives designed to increase the productivity of our affiliated practices;

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•		our ability to identify and affiliate with a sufficient number of orthodontists and pediatric dentists to open new orthodontic and pediatric dental centers or operate within our existing network of affiliated centers;
•		the ability of our affiliated practices to add new patients;
•		our ability to obtain quality locations for orthodontic and pediatric dental centers in suitable markets;
•		our ability to obtain adequate financing to fund our expansion strategy;
•		our ability to successfully operate under applicable government regulations; and
•		our ability to affiliate with orthodontic and pediatric dental practices in other countries and successfully operate in those markets.

     In general, it has become increasingly more difficult to recruit additional orthodontic and pediatric dental practices to affiliate with us. The number of practicing orthodontists in the United States has remained fairly constant in recent years, and only a very limited number of orthodontists and pediatric dentists graduate from graduate programs each year. Many orthodontists have expressed an unwillingness to affiliate with any practice management company, or with a management company that emphasizes advertising orthodontic services to the public. In addition, some orthodontists have had unsatisfactory experiences in affiliating with other practice management companies and are unwilling to affiliate with us.

     Our growth strategy may not succeed, and we may have to modify it. We may be unable to identify and recruit suitable orthodontists and pediatric dentists. A shortage of available orthodontists and pediatric dentists with the skills we require would have a material adverse effect on our ability to grow. In addition, many of our service agreements include covenants not to compete, in which we agreed that we would not affiliate with other orthodontic practices within a specified area and that we would limit the total number of orthodontic practices with which we affiliate within a particular market area. This could limit our ability to add orthodontists and orthodontic centers within the markets in which we have existing affiliated practices.

     Our ability to attract additional orthodontists and pediatric dentists, and our prospects for success and growth, depend on our ability to integrate an increasing number of affiliated practices and employees. If we fail to manage our growth, our business may suffer.

We are a party to various pending litigation, which could adversely affect our business.

     We are, and may from time to time become, engaged in various lawsuits, including disputes with our affiliated practices. As of December 31, 2003, we were engaged in litigation with 63 of our affiliated practitioners, in which the practices allege that we breached the terms of their service, consulting and management service agreements and that these agreements are illegal and unenforceable. A number of other practices have notified us that we breached their respective service, consulting and management service agreements, and additional lawsuits could be filed against us.

     Because litigation is inherently uncertain, we cannot assure you that we will prevail in any of these actions, nor can we estimate with reasonable certainty the amount of damages we might incur or the amount of any award we might receive. We and our subsidiaries 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 our 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.

Our information systems are critical to our business, and a failure of those systems could have a material adverse effect on us.

     Our business and success depends, in part, upon our ability to store, retrieve, process and manage a significant amount of information, and to provide our affiliated practices with efficient and effective inventory, accounting and scheduling systems. If our information systems fail to perform as expected, of if we suffer an

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interruption, malfunction or loss of information processing capabilities, it could have a material adverse effect on our business, results of operations, relationships with our affiliated practitioners and ability to affiliate with additional practices.

Our international activities expose us to operational challenges that we might not otherwise face.

     We operate in Japan, Spain, Puerto Rico and Mexico, and may expand into additional countries. As we increase our international activities, we will have to confront and manage a number of risks and expenses that we would not otherwise face if we conducted our operations solely in the United States, which could have a material adverse effect on our operating results. These risks and expenses include:

•		difficulties in staffing and managing foreign offices as a result of, among other things, language and cultural differences;
•		foreign currency exchange rate fluctuations;
•		protectionist laws and business practices that favor local companies;
•		political and economic instability in some international markets;
•		multiple, conflicting and changing government laws and regulations;
•		trade barriers;
•		reduced protection for intellectual property rights in some countries; and
•		potentially adverse tax consequences.

We depend on a few key employees, and, if we lose them, our business could suffer.

     Our success depends upon the continued active participation of our senior management. The loss of the services of any of these officers could have a material adverse effect on our business. Our success also depends on our ability to attract and retain other highly qualified managerial personnel.

Our financial results would be adversely affected if we write off identifiable intangible assets, fixed assets, receivables or goodwill.

     In connection with our affiliations with existing orthodontic and pediatric dental practices, we have significant amounts relating to identifiable intangible assets, fixed assets and goodwill recorded on our balance sheet. At December 31, 2003, we recorded a total of $217.1 million of identifiable intangible assets, net of accumulated amortization, $92.2 million of fixed assets, net of accumulated depreciation, and $87.6 million of goodwill. At December 31, 2003, we were engaged in litigation with 62 practices for which we had ceased recording fee revenue. We were also engaged in litigation with one practice for which we were still recording fee revenue at December 31, 2003 because the practice was still paying service fees to us. We were also affiliated with 38 other practices for which we had generally ceased recording fee revenue at December 31, 2003. At December 31, 2003, we had approximately $18.7 million of identifiable intangible assets and property, equipment and improvements, net of accumulated amortization and depreciation, and $8.0 million of service fees receivable, advances to affiliated practices and notes receivable from affiliated practices, net of allowances recorded, related to practices that are engaged in litigation with us and practices for which we have generally ceased recording fee revenue at December 31, 2003. Under current accounting standards, we evaluate on a regular basis whether events and circumstances have occurred that indicate that all or a portion of the carrying amount of these assets may no longer be recoverable, and is therefore impaired and charged to earnings. Such a write-off could have a material adverse effect on our financial condition and results of operations.

Our financial results may be damaged by successful claims against our affiliated practices.

     We provide business services to orthodontic and pediatric dental practices that provide orthodontic and pediatric dental treatment to the public and are exposed to the risk of professional liability and other claims. Those

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claims, if successful, could result in substantial damage awards. Those awards might exceed the limits of any applicable insurance coverage. Insurance against losses of this type can be expensive. Insurance rates vary from state to state. We do not control the practice of orthodontics or pediatric dentistry by our affiliated practices or their compliance with the legal and other requirements applicable to orthodontists and pediatric dentists and their practices. A successful malpractice claim against an affiliated practice or us could have a material adverse effect on our financial position and results of operations

Our business is subject to the risks of hurricanes, floods and other catastrophic events.

     Our corporate headquarters, including certain of our computer system and billing operations, are located in the New Orleans, Louisiana area, which has experienced hurricanes and flooding in the past. A significant natural disaster, such as a hurricane or a flood, could have a material adverse impact on our business, operating results and financial condition. In addition, despite our implementation of network security measures, our servers are vulnerable to computer viruses, break-ins, and similar disruptions from unauthorized tampering with our computer systems. Any such event could have a material adverse effect on our business, operating results, and financial condition. In addition, the effects of war or acts of terrorism could have a material adverse effect on our business, operating results and financial condition

Changes in accounting principles or SEC policies may affect your ability to compare our reported operating results.

     As a public company with securities registered under the Securities Exchange Act of 1934, we prepare our financial statements in accordance with generally accepted accounting principles. SEC Staff Accounting Bulletin No. 101, “Revenue Recognition in Financial Statements,” which summarizes the SEC staff’s views in applying generally accepted accounting principles to revenue recognition in financial statements, became effective in the fourth quarter of 2000 for companies, such as us, with fiscal years ending on December 31. We modified our revenue recognition policies to conform with the guidance in Staff Accounting Bulletin No. 101, which resulted in a cumulative charge to our earnings in 2000 to reflect the change in accounting principle effective January 1, 2000. This change may make it more difficult for investors to compare our historical operating results against our future operating results.

Antitrust laws could limit our ability to operate or expand.

     We are subject to a range of antitrust laws that prohibit anticompetitive conduct, including price fixing, concerted refusals to deal and divisions of markets. These laws may limit our ability to enter into service or consulting agreements with separate orthodontists or pediatric dentists who compete with one another in the same geographic market.

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

     The market risk inherent in our market risk sensitive instruments is the potential loss arising from adverse changes in interest rates and foreign currency exchange rates. All financial instruments that we hold described below we hold for purposes other than trading.

INTEREST RATE RISK

     Our revolving line of credit exposes our earnings to changes in short-term interest rates since the interest rates on the financial instruments are variable. For lines of credit, if (i) the variable rates on our financial instruments were to increase by 1% from the rate at December 31, 2003, and (ii) we borrowed the maximum amount available under our revolving line of credit ($100 million) for all of 2003, solely as a result of the increase in interest rates, our interest expense would increase, resulting in a $0.7 million decrease in net income, assuming an effective tax rate of approximately 37.8%.

     This analysis does not consider the effects of the reduced level of overall economic activity that could exist in such an environment, or the effect of such a change in interest rates as of another or future date. Further, in the event of a change of such magnitude, we would likely take actions to further mitigate our exposure to the change.

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FOREIGN CURRENCY EXCHANGE RISK

     We typically do not hedge our foreign currency exposure. Our foreign operations generated an immaterial loss during 2003. Funds generated from our foreign operations in 2003 were retained in those countries to fund operations. We believe that our exposure to foreign currency rate fluctuations is not currently material to our financial condition or results in operations.

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

REPORT OF INDEPENDENT AUDITORS

The Board of Directors
Orthodontic Centers of America, Inc.

     We have audited the accompanying consolidated balance sheets of Orthodontic Centers of America, Inc. as of December 31, 2003 and 2002, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the financial statement schedule listed in the Index to Exhibits in Item 15(a) to the Annual Report for the year ended December 31, 2003. These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

     We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

     In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Orthodontic Centers of America, Inc. at December 31, 2003 and 2002, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2003, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

/s/ Ernst & Young LLP

     New Orleans, Louisiana
     March 15, 2004

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Orthodontic Centers of America, Inc.
Consolidated Balance Sheets

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Orthodontic Centers of America, Inc.
Consolidated Statements of Income

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Orthodontic Centers of America, Inc.
Consolidated Statements of Shareholders’ Equity
(in thousands, except share amounts)

See accompanying notes to consolidated financial statements.

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Orthodontic Centers of America, Inc.
Consolidated Statements of Cash Flows

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Orthodontic Centers of America, Inc.

Notes to Consolidated Financial Statements

1. DESCRIPTION OF BUSINESS

     Orthodontic Centers of America, Inc. (the “Company”) provides business services to orthodontic and pediatric dental practices in 46 states and four foreign markets.

     The Company provides purchasing, financial, marketing and administrative services under service, consulting and management service agreements (“Service Agreements”). The Company provides services to orthodontic and pediatric dental practices operated by orthodontists and pediatric dentists and/or their wholly-owned professional entities (“Affiliated Practices”). Because the Company does not control the Affiliated Practices, it does not consolidate their financial results. The following table provides information about the Company’s Affiliated Practices: