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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2004

[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the transition period from ________to________

Commission file number 0-28456

METROPOLITAN HEALTH NETWORKS, INC.

(Exact name of registrant as specified in its charter)

Florida

65-0635748

(State or other jurisdiction of

(I.R.S. Employer

Incorporation or organization)

Identification No.)

250 Australian Avenue, Suite 400, West Palm Beach, Fl.

33401

(Address of principal executive office)

(Zip Code)

(561) 805-8500

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all Reports required to be filed by section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [ X ]

No [  ]

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act)

Yes [  ]

No [ X ]

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

Class

Outstanding as of July 31, 2004

Common Stock par value $.001

45,793,833

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Metropolitan Health Networks, Inc.

Index

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METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1.  BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments considered necessary for a fair presentation have been included and such adjustments are of a normal recurring nature. Operating results for the three and six months ended June 30, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004.

The audited financial statements at December 31, 2003, which are included in the Company’s Form 10-K, should be read in conjunction with these condensed consolidated financial statements.

Unless otherwise indicated or the context requires, all references in this Form 10-Q to the “Company” refers to Metropolitan Health Networks, Inc. and our consolidated subsidiaries.

SEGMENT REPORTING

The Company applies Financial Accounting Standards Boards (“FASB”) statement No. 131, “Disclosure about Segments of an Enterprise and Related Information”. The Company has considered its operations and has determined that in 2003 it operated in two segments, PSN (managed care and direct medical services) and pharmacy, and in 2004 operates only the PSN segment for purposes of presenting financial information and evaluating performance, as the pharmacy operations were sold in November 2003.

As such, the accompanying financial statements present information in a format that is consistent with the financial information used by management for internal use.  See “Note 5.  Business Segment Information” for additional information regarding the Company’s business segments.

INCOME TAXES

The Company accounts for income taxes according to Statement of Financial Accounting Standards No. 109, which requires a liability approach to calculating deferred income taxes. Under this method, the Company records deferred taxes based on temporary differences between the tax bases of the Company’s assets and liabilities and their financial reporting bases. A valuation allowance is established when it is more likely than not that some or all of the deferred tax assets will not be realized.

The effective tax rate for the three and six months ended June 30, 2004 differed from the federal statutory rate due principally to a decrease in the deferred tax asset valuation allowance.

REVENUES

Revenues are recorded when services are rendered. Revenues from one health maintenance organization (“HMO”) accounted for approximately 99% of the Company’s total revenues for the three and six months ended June 30, 2004 and 2003.

Contracts with the HMO renew automatically unless cancelled by either party with 180-day notice.  These contracts are in effect through December 31, 2004 and the Company expects the contracts to continue for the foreseeable future.

RECLASSIFICATION

Certain amounts reported in the comparative financial statements have been reclassified to conform to the presentation for the periods ended June 30, 2004.

METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

USE OF ESTIMATES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

ACCOUNTS RECEIVABLE

Accounts receivable at June 30, 2004 and December 31, 2003 were as follows:

In the health care industry, estimates often change as a result of one or more future confirming events.  With regard to revenues, expenses and receivables arising from agreements with the HMO, the Company estimates amounts it believes will ultimately be realizable through the use of judgments and assumptions. It is possible that some or all of these estimates could change in the near term by an amount that could be material to the financial statements.

Direct medical costs are based in part upon estimates of claims incurred but not reported (“IBNR”) and estimates of retroactive adjustments or unsettled costs to be applied by the HMO. The IBNR estimates are made by the HMO utilizing actuarial methods and are continually evaluated by management of the Company, based upon its specific claims experience.  The estimates of retroactive adjustments or unsettled costs to be applied by the HMO are based upon current agreements and understandings with the HMO to modify certain amounts previously charged to the Company’s fund balances.  Management believes its estimates of IBNR claims and estimates of retroactive adjustments are reasonable, however, it is possible the Company's estimate of these costs could change in the near t erm, and those changes may be material.

From time to time the Company is charged for certain medical expenses which it believes it is not liable for under its contracts with the HMO. In connection therewith, the Company was contesting certain costs aggregating to approximately $4.2 million as of June 30, 2004. Management’s estimate of recovery on these contestations is determined based upon its judgment and its consideration of several factors including the nature of the contestations, historical recovery rates and other qualitative factors. Accordingly, accounts receivable due from the HMO include approximately $835,000, which represents estimated recovery of contestations outstanding at June 30, 2004.  It is possible the Company’s estimate of these recoveries could change in the near term, and those changes may be m aterial.

Non-HMO accounts receivable, aggregating to approximately $2.9 million at June 30, 2004 relate principally to medical services provided on a fee for service basis, and are reduced by amounts estimated to be uncollectible (approximately $2.7 million). Management’s estimate of uncollectible amounts is based upon its analysis of historical collections and other qualitative factors, however it is possible the Company’s estimate of uncollectible amounts could change in the near term, and those changes may be material.   Non-HMO accounts receivable included approximately $2.0 million from operations discontinued in prior years.  Although the Company seeks to collect such accounts receivable, it has previously established a reserve for these balances.

METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

Non-HMO accounts receivable are typically uncollateralized customer obligations due under normal trade terms requiring payment within 30-90 days from the invoice date.  The Company does not charge late fees or penalties on delinquent invoices, however it continually evaluates the need for a valuation allowance.  The allowance reflects management’s best estimate of the amounts that will not be collected.  Management reviews all non-current accounts receivable balances on an ongoing basis and, based on its assessment of current creditworthiness, estimates the portion, if any, that will not be collected.  It is possible that some or all of these estimates could change in the near term by an amount that could be material to the financial statements.

NET INCOME PER SHARE

The Company applies Statement of Financial Accounting Standards No. 128, “Earnings Per Share” (SFAS 128) which requires dual presentation of net income per share; Basic and Diluted. Basic earnings per share is computed using the weighted average number of common shares outstanding during the period.  Diluted earnings per share is computed using the weighted average number of common shares outstanding during the period adjusted for incremental shares attributed to outstanding options and warrants, convertible debt and preferred stock to purchase or convert into shares of common stock.

METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

STOCK COMPENSATION

In December 2002, the FASB issued SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure-an amendment of FASB Statement No. 123”. This statement provides alternative methods of transition for a voluntary change to the fair value based method of accounting for stock-based employee compensation.  

SFAS No. 148 amends the disclosure requirements of SFAS 123 to require disclosures in both annual and interim financial statements about the method of accounting for stock-based employee compensation and the effect of the method on reported results.

The Company adopted the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”).  The Company has elected to continue using Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” in accounting for employee stock options.

Accordingly, compensation expense for options granted to employees is recorded to the extent the market value of the underlying stock exceeds the exercise price at the date of grant.  If compensation cost had been determined based on the fair value at the grant date for awards in the three and six months ended June 30, 2004 and 2003, consistent with the provisions of SFAS 123, the Company's net income and income per share would have been reduced to the pro-forma amounts indicated below:

NEW ACCOUNTING PRONOUNCEMENTS

In December 2003, the FASB issued FIN 46R, "Consolidation of Variable Interest Entities," a revision to FIN 46, which was issued in January 2003.  Under FIN 46R, a variable interest entity must be consolidated by a company if that company is subject to a majority of the entity's expected losses or entitled to receive a majority of the entity's expected residual returns or both.  FIN 46R requires disclosures about variable interest entities that a company is not required to consolidate, but in which it has a significant variable interest.  The consolidation requirements apply to existing entities in the first reporting period that ends after March 15, 2004.  Adoption of FIN 46R did not have a material impact on the Company’s financial statements.

METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 2.  DEBT

As of June 30, 2004, the Company had $1,150,000 in principal amount of debt.  During the first six months of 2004, the Company repaid $763,000 of long-term debt and restructured a $1.2 million note due May 2004 (the “Note”).  

The new terms of the Note provide for monthly payments of $50,000 plus interest over twenty-four months beginning June 2004, with interest at 12%.  There is no prepayment penalty for early repayment of the Note.  Upon an uncured event of default, the Note will be automatically converted into 6% Convertible Debentures with a principal amount equal to the principal amount and accrued interest outstanding under the Note.  The Company issued 100,000 shares of common stock in conjunction with the restructuring of the Note.

NOTE 3.  STOCKHOLDERS’ EQUITY

In February 2004, the Company issued an aggregate of 5,004,999 shares of common stock (the “Private Placement Shares”) at a price of $0.60 per share to 24 accredited investors and 1 non-accredited investor.  The Company received $2,953,000 in net proceeds from the sale of these Private Placement Shares.

In January 2004, an investor exercised its option to convert the balance of a 6% Convertible Debenture dated May 24, 2002 in the amount of $715,000 into shares of the Company’s common stock. The stock was converted at $0.57 per share and 1,258,372 shares of common stock were issued.  

In March 2004, an investor exercised his option to convert a 6% Convertible Debenture dated August 16, 2002 in the amount of $168,000 into shares of the Company’s common stock. The stock was converted at $0.43 per share and 390,698 shares of common stock were issued.  

In March 2004, the Company issued 220,000 shares of common stock to an investor for $0.60 per share in satisfaction of a Promissory Note, dated August 16, 2002 issued by the Company to the investor in the principal amount of $132,000.

In March 2004, the Company issued 100,000 shares of common stock to an investor as a fee in connection with its agreement to extend a $1.2 million Promissory Note issued by the Company, due May 24, 2004 (the “Note”).

On February 4, 2004, the Company hired a new General Counsel and issued to him stock options to purchase an aggregate of 150,000 shares of Common Stock, subject to certain anti-dilution protections, exercisable at $0.67 per share and vesting over a three year period.  The options, if not exercised, will expire five years from the date of vesting.

In addition, during the first six months of 2004 the Company issued 277,264 shares of common stock relating to the exercise of stock options, warrants and board compensation.  Also, in June 2004 the Company repurchased warrants to acquire 427,500 common shares at $0.68 for an aggregate purchase price of $85,500.

NOTE 4.  COMMITMENTS AND CONTINGENCIES

LITIGATION

The Company is party to certain claims arising in the ordinary course of business. Management believes that the outcome of these matters will not have a material adverse effect on the financial position or the results of operations of the Company.

METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

PAYROLL TAXES PAYABLE

In February 2004, the Company was successful in negotiating a settlement with the IRS on its outstanding payroll tax liabilities for an amount totaling approximately $3.3 to $3.4 million.  To date, $3.3 million of this settlement has been paid with the balance to be paid once the IRS has determined the final settlement amount.

NOTE 5.  BUSINESS SEGMENT INFORMATION

The Company operates in one segment during 2004 for purposes of presenting financial information and evaluating performance, the PSN (managed care and direct medical services) division.  During 2003, the Company also operated a second segment, a pharmacy.   The Company allocated corporate overhead to the pharmacy during the period it was operational.  However, the overhead allocation is not included in the loss from operations of the discontinued business segments shown in the condensed consolidated statements of operations.  

The PSN segment also includes all costs related to the Company’s consideration and development of an HMO.

METROPOLITAN HEALTH NETWORKS, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 6.  SUBSEQUENT EVENTS

The Company acquired a seventh wholly-owned physician practice effective August 1, 2004. Located in Broward County, Florida, this multi-specialty practice serves approximately 1,100 Humana Medicare Advantage members and several hundred fee-for-service patients.  The Company assumed the ongoing operating expenses of the office and the full risk for the Medicare Advantage members, consistent with the Company’s business model.  No other consideration was involved in the transaction.

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Sections of this Quarterly Report contain statements that are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”), and we intend that such forward-looking statements be subject to the safe harbors created thereby. Statements in this Report containing the words “estimate,” “project,” “anticipate,” “expect,” “intend,” “believe,” “will,” “could,” “should,” “may,” and similar expressions may be deemed to create forward-looking statements. Accordingly, such statements, including without limitation, those relating to our future business, prospects, revenues, working capital, liquidity, capital needs, interest costs and income, wherever they may appear in this document or in other statements attributable to us, involve estimates, assumptions and uncertainties which could cause actual results to differ materially from those expressed in the forward-looking statements. Specifically, this Quarterly Report contains forward-looking statements, including the following:

The forward-looking statements reflect our current view about future events and are subject to risks, uncertainties and assumptions. We wish to caution readers that certain important factors may have affected and could in the future affect our actual results and could cause actual results to differ significantly from those expressed in any forward-looking statement. The following important factors could prevent us from achieving our goals and cause the assumptions underlying the forward-looking statements and the actual results to differ materially from those expressed in or implied by those forward-looking statements:

Additional information concerning these and other risks and uncertainties is contained in our filings with the Securities and Exchange Commission, including the section entitled “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2003.

We disclaim any intent or obligation to update “forward looking statements”.

OVERVIEW

The Company was incorporated in the State of Florida in January 1996, and began operations as a physician practice group.  During the late 1990’s Metcare acquired a number of physician practices and ancillary service providers.  In late 1999, the group practice strategy was abandoned, in favor of developing a managed care business.

The first managed care risk contract was secured with Humana in 1999.  In 2000, an additional contract was secured to manage all of Humana’s Medicare Advantage lives in the Daytona, Florida area (Flagler and Volusia Counties).   As of June 30, 2004 the Daytona contract accounted for over 19,000 lives or 77% of the Company’s total Medicare Advantage lives.  The balance of the Company’s Humana members, approximating 6,000 in number, resided in South Florida (Palm Beach, Broward and Miami-Dade Counties).

The Company is currently pursuing a business plan to develop and license its own Medicare Advantage HMO to operate in certain Florida markets underserved by this program.  Management does not intend to compete in markets in which it is contracted with Humana and views this growth strategy as an extension of its existing core competency and organization.  The current plan calls for operations to begin in 2005. Management believes that the proposed development efforts, required reserve requirements and start-up costs for the HMO can be funded by the Company’s current resources and projected cash flows from operations.

Although the Company has operated as a risk provider since 1999, it has not operated as a HMO.  To successfully operate a HMO the Company believes it will have to develop the following capabilities, among others: sales and marketing, customer service, claims administration and regulatory compliance. No assurances can be given that the Company will be successful in developing, licensing or operating the new plan.

CRITICAL ACCOUNTING POLICIES

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires the Company’s management to make a variety of estimates and assumptions.  These estimates and assumptions affect, among other things, the reported amounts of assets and liabilities, the disclosure of contingent liabilities and the reported amounts of revenues and expenses.  Actual results can differ from the amounts previously estimated, which were based on the information available at the time the estimates were made.

The critical accounting policies described below are those that the Company believes are important to the portrayal of the Company’s financial condition and results, and which require management to make difficult, subjective and/or complex judgments.  Critical accounting policies cover accounting matters that are inherently uncertain because the future resolution of such matters is unknown.  The Company believes that critical accounting policies include accounts receivable and revenue recognition, use of estimates and goodwill.

Accounts Receivable and Revenue Recognition

The Company is a party to certain managed care contracts and provides medical care to its patients through owned and non-owned medical practices.  In connection with its Provider Service Network (PSN) operations, the Company is exposed to losses to the extent of its share of deficits.  Accordingly, revenues under these contracts are reported as PSN revenue, and the cost of provider services under these contracts are reported as an operating expense.

The Company recognizes non-Humana revenues, net of contractual allowances, as medical services are provided. These services are typically billed to patients, Medicare, Medicaid, health maintenance organizations, insurance companies and other third parties. The Company provides an allowance for uncollectible amounts and for contractual adjustments relating to the difference between standard charges and agreed upon rates paid by certain third party payers.  

Use of Estimates-PSN

In HMO-PSN arrangements, accounts receivable estimates often change as a result of one or more future confirming events.  With regard to revenues, expenses and resulting accounts receivable arising from agreements with Humana, the Company estimates amounts it believes will ultimately be realizable through the use of judgments and assumptions. Contractual terms with an HMO are sometimes complex and at times subject to different interpretation by the Company and Humana. As a result, certain revenue, expense and accounts receivable estimates may change from amounts previously recorded in the financial statements and may require subsequent adjustments.  To assist in estimating and collecting amounts due from Humana, the Company has contracted with outside consultants that have worked closely with Humana or other HMOs for extended periods of time. &nb sp;These consultants provide numerous services including, but not limited to, revenue, expense and accounts receivable analysis, and monthly claims and contestation analysis.  However, it is possible that actual results may differ from the estimates.

Direct medical expenses include costs incurred directly by the Company and costs paid by the HMO on the Company’s behalf.  These costs also include estimates of claims incurred but not reported (“IBNR”), estimates of retroactive adjustments to be applied by Humana and adjustments for charges for which the Company believes it is not liable (“contestations”). The IBNR estimates are made by Humana utilizing actuarial methods and are continually evaluated and adjusted by management of the Company, based upon its specific claims experience and input from outside consultants.  The Company bases its estimates of retroactive adjustments on agreements with the HMO to modify previous charges.  Some of these adjustments have been quantified while others involve situations where Humana has agreed the charges were processed at in correct rates, but the amount of the correction has not yet been quantified.  Contestations involve charges where the Company, with the assistance of its consultants, contest certain expenses charged by the HMO.  The estimate of direct medical expense includes an estimated recovery of 20% of outstanding contestations with Humana.  It is possible that estimates of such recoveries could change and the effect of the change could be material.

Accounts receivable from Humana represents the Company’s interpretation of the contract with Humana and Humana’s payment patterns.  Collection times on these accounts often exceed normal collection periods.

Goodwill

The Company has made several acquisitions in the past that included a significant amount of goodwill.  Under accounting principles generally accepted in the United States of America in effect through December 31, 2001, these assets were amortized over their useful lives and tested periodically to determine if they were recoverable from operating earnings on a discounted basis over their useful lives.

Effective January 1, 2002, goodwill is accounted for under SFAS No. 142, “Goodwill and Other Intangible Assets”.  The new rules eliminate amortization of goodwill but subject these assets to impairment tests.  Management is required to make assumptions and estimates, such as the discount factor, in determining fair value.  Such estimated fair values might produce significantly different results if other reasonable assumptions and estimates were to be used.

RESULTS OF OPERATIONS

The Company recognized revenues of $38.6 million for the quarter ended June 30, 2004 compared to $35.9 million in the prior year quarter, an increase of $2.7 million, or 7.5%. Net income for the 2004 second quarter was $3.9 million compared to $948,000 for the quarter ended June 30, 2003, an improvement of $2.9 million.  The 2003 quarter included approximately $702,000 in losses related to the Company’s discontinued pharmacy operations, compared to $212,000 in the current year quarter.   Net income per share was $0.08 for the quarter ended June 30, 2004 compared to  $0.03 in the prior year quarter.  The increase in the net income per share for three months ended June 30, 2004 was partially offset by an increase in the number of weighted average shares outstanding, from 34,390,168 at June 30, 2003 to 45,741,056 in the current y ear.

The Company was credited with Medicare funding increases for 2004 in the second quarter, which were applied retroactive to January 1, 2004. While the Company included an estimate for the funding increase in the first quarter, approximately $600,000 and $400,000 of additional funding and profits, respectively, were received in excess of that estimate.

For the six months ended June 30, 2004, the Company recognized revenues of $77.1 million compared to $72.7 million in the prior year, an increase of $4.4 million or 6.0%.  Net income for the 2004 period was $5.3 million compared to $1.7 million for the six months ended June 30, 2003, an improvement of $3.6 million.  The 2003 period included approximately $951,000 in losses related to its discontinued pharmacy operations, compared to $258,000 in the current year period.   Net income per share was $0.12 for the six months ended June 30, 2004 compared to $0.05 in the prior year period.  The increase in the net income per share for six months ended June 30, 2004 was partially offset by an increase in the number of weighted average shares outstanding, from 33,337,802 at June 30, 2003 to 43,723,769 in the current year.

The Company operated two business segments in 2003, managed care and direct medical services (PSN) and pharmacy.  The Company disposed of its pharmacy division in November 2003 and, accordingly, the operations of the pharmacy division are reported as discontinued operations.  The remaining PSN segment, prior to allocation of corporate overhead, reported an increase in income as a percentage of revenue, from 9.2% in the second quarter of 2003 to 14.1% in the current year period, and from 7.7% in the first six months of 2003 to 10.5% in 2004.

Total Medicare Advantage lives declined approximately 1,100 members from June 30, 2003 to a membership of a 25,100 at June 30, 2004.  Approximately 500 of this decrease related to a Broward County physician practice which was terminated from the Company’s network in August 2003, the balance attributable to net attrition.    Attrition has slowed considerably in 2004, the result of the increased funding provided by the Medicare Modernization Act, or MMA, which was signed into law in December 2003, and the Company’s June 30, 2004 enrollment is virtually the same as its March 31, 2004 enrollment.  Management believes this improving trend will continue and expects net increases in enrollment over the balance of 2004.  The MMA funding increases are intended to both offset medical cost inflation and to allow enhanced plan b enefit design to encourage increased participation in Medicare Advantage plans.  

Quarter ended June 30, 2004

REVENUES

Revenues for the quarter ended June 30, 2004 increased $2.7 million, or 7.5%, over the prior year, from $35.9 million to $38.6 million.  PSN revenues from Humana increased 7.9%, from $35.5 million to $38.3 million.  Approximately $4.9 million in incremental revenues were generated by Medicare funding increases that averaged 11.7% in the Daytona market and 14.8% in South Florida.  These increases were partially offset by net declines in membership, resulting in approximately $1.4 million in reduced revenue.  In addition, effective August 1, 2003 the Company cancelled its risk arrangement with one of its South Florida centers due to noncompliance with the Company’s policies and procedures, resulting in a funding decrease of $725,000.

Non-Humana revenue for Metcare’s wholly owned physician practices in the second quarter of 2004 declined $102,000 over the same period in 2003, to a total of $238,000.  The Company operated six physician practices and an oncology center in both quarters.  

EXPENSES

Operating expenses for the quarter ended June 30, 2004 increased $555,000 over the prior year quarter, from $33.9 million to $34.4 million, but improved as a percentage of revenue from 94.5% in 2003 to 89.3% in the current year.  Direct medical costs, the largest component of expense, represents costs associated with providing services of the PSN operation including direct medical payments to physicians, hospitals and ancillary service providers on a capitated or fee for service basis. Direct medical costs for the second quarter of 2004 were $30.5 million compared to $30.0 million for 2003. As a percentage of PSN revenues, direct medical costs improved from 84.4% in 2003 quarter to 79.7% in the 2004 period.   While Humana enhanced its 2004 Medicare Advantage benefit plans in the Company’s markets, increased Medicare funding and favorabl e medical utilization more than offset the increased benefit costs.  In addition, there was an $807,000 decrease due to the cancellation of a South Florida center combined with decreases due to a decline in the number of patients in our network.

Salaries and benefits for the 2004 quarter was $2.4 million, an increase of $580,000 over the prior year’s total of $1.8 million.  As a result of the Company’s improved performance in 2004, the 2004 quarter included $500,000 in incremental accrued bonus and pension expenses, with salary increases and increased benefit costs accounting for the balance of the increase.

Medical supplies were $351,000 for the 2004 quarter, compared to $463,000 in 2003.  Medical supply costs are incurred in all the Company’s medical offices, but most prominently in the Company’s Daytona oncology offices, accounting for 96.6% of the 2004 expense.  The reduction correlates to the decline in the amount of Humana lives and fee-for-service billings, as indicated above.

Depreciation and amortization for the quarter ended June 30, 2004 totaled $91,000, a 47.6% decrease over the prior year total of $173,000, as many of the Company’s fixed assets are fully depreciated.

Rents and leases for the quarter ended June 30, 2004 increased $22,000 (8.4%) over the prior year quarter, resulting from annual rent increases as per the terms of the property leases.

Consulting expense for the quarter decreased approximately $211,000 (66.5%), from $318,000 in 2003 to $106,000 in 2004.  Of the reduction, $88,000 resulted from the hiring of an oncologist, whereas in the prior year a consultant was utilized.  In addition, approximately $108,000 in savings was realized through a reduction in marketing and administrative consultants.

General and administrative expenses for the 2004 quarter amounted to $670,000, a decrease of $216,000 (24.4%) over the prior year quarter.  This was due to a $212,000 reduction in legal and accounting expenses primarily related to the prior year’s restructuring activities.

Other income and expenses for the quarter included a decrease in interest expense of $294,000 from the prior year due to the decreased average amount of debt and IRS obligations carried by the Company in the 2004 quarter as compared to the prior year quarter.

Losses related to the discontinued pharmacy operations for the quarter, were $212,000 in 2004 as compared to $702,000 in 2003.  The pharmacy operations were sold in November 2003.  Discontinued operations for the 2004 quarter included a $200,000 reserve on the note receivable from the purchaser of the pharmacy operations.  This note was due in May 2004 and is currently in default.

Six months ended June 30, 2004

REVENUES

Revenues for the six months ended June 30, 2004 increased $4.4 million, or 6.0%, over the prior year, from $72.7 million to $77.1 million.  PSN revenues from Humana increased 6.3%, from $72.0 million to $76.6 million.  Approximately $9.4 million in incremental revenues were generated by Medicare funding increases that averaged 11.7% in Daytona and 14.8% in South Florida.  These increases were partially offset by a net decrease in Medicare Advantage membership, resulting in approximately $3.4 million in reduced funding.  In addition, effective August 1, 2003 the Company cancelled its risk arrangement with one of its South Florida centers due to noncompliance with the Company’s policies and procedures, resulting in a funding decrease of $1.4 million.

Non-Humana revenue for Metcare’s wholly owned physician practices in the first six months of 2004 declined $200,000 over the same period in 2003, to a total of $545,000.  The Company operated six physician practices and an oncology center in both quarters.  

EXPENSES

Operating expenses for the six months ended June 30, 2004 increased $2.0 million (2.8%) over the prior year, from $69.4 million to $71.4 million, but improved as a percentage of revenue from 95.4% in 2003 to 92.6% in the current year.  Direct medical costs, the largest component of expense, represents costs associated with providing services of the PSN operation including direct medical payments to physician providers, hospitals and ancillaries on a capitated or fee for service basis. Direct medical costs for the first six months of 2004 were $63.8 million compared to $61.8 million for 2003.  As a percentage of PSN revenues, direct medical costs improved from 85.8% in the 2003 period to 83.3% in the current year. While Humana enhanced its 2004 Medicare Advantage benefit plans in the Company’s markets, increased Medicare funding and favorable medical utilization more than offset the increased benefit costs, despite the effects of a flu season that was the most severe in four years, resulting in increased hospital admissions and lengths of stay.  Additionally, there was a $1.6 million decrease due to the cancellation of a South Florida center combined with decreases due to a decline in the number of patients in our network.  

Salaries and benefits for the six months of 2004 was $4.3 million, as compared to the prior year’s total of $3.7 million.  As a result of the Company’s improved performance in 2004, the 2004 period included $500,000 in incremental accrued bonus and pension expenses.  In addition, an increase of approximately $102,000 resulted from the hiring of an oncologist in late 2004, whereas in 2003 a consultant was utilized.  Savings of approximately $168,000 were realized through the closure of the Company’s hospitalist program in early 2003.  Salary increases combined with increased benefit costs accounted for the balance of the incremental expense.

Medical supplies were $862,000 for the 2004 period, compared to $891,000 in 2003.  Medical supply costs are incurred in all the Company’s medical offices, but most prominently in the Company’s Daytona oncology offices, accounting for 93.5% of the 2004 expense.  The reduction correlates to the decline in the amount of Humana lives and fee-for-service billings, as indicated above.

Depreciation and amortization for the six months ended June 30, 2004 totaled $213,000, a 37.4% decrease over the prior year total of $341,000, as many of the Company’s fixed assets are fully depreciated.

Rents and leases for the six months ended June 30, 2004 increased $82,000 over the prior year.  When the Company negotiated the lease for its new corporate office effective January 2003, it received certain rent concessions in the first quarter of 2003.  In addition, in 2004 the Company has incurred annual rent increases as per the terms of the property leases.

Consulting expense for the six months decreased approximately $476,000 (65.7%), from $725,000 in 2003 to $249,000 in 2004.  Of the reduction, $181,000 resulted from the hiring of an oncologist, whereas in the prior year a consultant was utilized.  In addition, approximately $283,000 in savings was realized through a reduction in marketing and administrative consultants and the closure of the Company’s hospitalist program in early 2003.

General and administrative expenses for the 2004 period amounted to $1.4 million, a decrease of $84,000 over the prior year.  Savings in legal and accounting expense of $45,000, combined with worker’s compensation insurance refunds of $62,000, were partially offset by increased insurance costs of $48,000.

Other income and expenses for the six months included a decrease in interest expense of $542,000 from the prior year due to the decreased average amount of debt and IRS obligations carried by the Company in the 2004 period as compared to the prior year.

Losses related to the discontinued pharmacy operations for the six months were $258,000 in 2004 as compared to $951,000 in 2003.  The pharmacy operations were sold in November 2003.  Discontinued operations for the 2004 period included a $200,000 reserve on the note receivable from the purchaser of the pharmacy operations.  This note was due in May 2004 and is currently in default.

LIQUIDITY AND CAPITAL RESOURCES

The Company reduced its current liabilities from $7.8 million to $2.6 million and its total liabilities from $9.7 million to $3.2 million during the six months ended June 30, 2004.  Most significantly, the Company settled its longstanding payroll tax obligation. The Company’s equity totaled $8.9 million at June 30, 2004 compared to a deficit of $503,000 at December 31, 2003.  Additionally, working capital improved from a deficit of $2.4 million at year-end 2003 to a surplus of $5.7 million at June 30, 2004, an improvement of $8.1 million.

In the six months ended June 30, 2004, the Company generated approximately $3.2 million of cash and equivalents.

Cash flows from operating activities constituted approximately $1.3 million of the $3.2 million. Net income of $5.3 million and accounts receivable, net of $606,000, were the largest sources of cash flow from operations. These sources of cash were partially offset by $3.3 million, $1.3 million and $466,000 of cash utilized for payroll taxes payable, accounts payable and accrued expenses, and other current assets.  In February 2004, the Company was successful in negotiating a settlement with the IRS on its outstanding payroll tax liabilities for an amount totaling approximately $3.3 to $3.4 million.  To date, $3.3 million of this settlement has been paid with the balance to be paid once the IRS has determined the final settlement amount.

Cash flow from investing activities had a minimal impact on the Company’s cash resources, utilizing only $68,000 for capital expenditures.

The Company’s financing activities provided the Company approximately $1.9 million of cash in the six months ended June 30, 2004.  The Company’s generation of approximately $2.9 million of cash from the issuance of stock was partially offset by the Company’s $1.0 million in loan, note and capital lease payments.  Substantially all of the cash generated by the Company from financing activities is attributable to approximately $2.9 million of net proceeds received by the Company in connection with a private placement of 5,005,000 shares of its common stock.  See Note 3 Stockholders’ Equity for a description of the private placement.

Although not reflected as a source or use of cash from financing activities on the Company’s consolidated statements of cash flow, in the six months ended June 30, 2004 the Company, at the election of debt holders, converted $1,015,000 in principal amount of long term debt into 1,869,070 shares of common stock.

Although not reflected as a source or use of cash from financing activities on the Company’s consolidated statements of cash flow, in the six months ended June 30, 2004 the Company successfully extended and modified the terms of a $1.2 in principal amount promissory note due May 2004 (the “Note”).  

The new terms of the Note provide for monthly payments in the amount of $50,000 plus interest each month over twenty-four months beginning June 2004, with interest at 12%.  There is no prepayment penalty for early repayment of the Note.  Upon an uncured event of default, the Note will be automatically converted into the Company’s 6% Convertible Debentures with a principal amount equal to the principal amount and accrued interest outstanding under the Note.  The Company issued 100,000 shares of common stock in conjunction with the restructuring.

As of June 30, 2004, the balance on the Note was the Company’s only outstanding long-term debt obligation.

The Company anticipates that the proposed development efforts, required reserve requirements and start-up costs for an HMO can be funded by the Company’s current resources and projected cash flows from operations.

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Market risk generally represents the risk of loss that may result from the potential change in value of a financial instrument as a result of fluctuations in interest rates and market prices.  We do not currently have any trading derivatives nor do we expect to have any in the future.  We have established policies and internal processes related to the management of market risks, which we use in the normal course of our business operations.

Interest Rate Risk

The fair market value of long-term debt is subject to interest rate risk.  While changes in market interest rates may affect the fair value of our fixed-rate long-term debt, we believe a change in interest rates would not have a material impact on our financial condition, future results of operations or cash flows.

Intangible Asset Risk

We have a substantial amount of intangible assets.  Although at June 30, 2004, we believe our intangible assets are recoverable, changes in the economy, the business in which we operate and our own relative performance could change the assumptions used to evaluate intangible asset recoverability.  We continue to monitor those assumptions and their consequent effect on the estimated recoverability of our intangible assets.

Equity Price Risk

We do not own any equity investments, other than in our subsidiaries. As a result, we do not currently have any direct equity price risk.

Commodity Price Risk

We do not enter into contracts for the purchase or sale of commodities. As a result, we do not currently have any direct commodity price risk.

ITEM 4. CONTROLS AND PROCEDURES

Our management, which includes our CEO and our CFO, has conducted an evaluation of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of the end of the fiscal quarter covered by this report.  Based upon that evaluation, our management has concluded that the design and operation of our disclosure controls and procedures are effective for timely gathering, analyzing and disclosing the information we are required to disclose in our reports filed under the Securities Exchange Act of 1934, as amended.  

There have been no significant changes made in our internal controls over financial reporting that occurred during our last fiscal quarter that has materially affected or is reasonably likely to materially affect our internal control over financial reporting.

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PART II   OTHER INFORMATION

ITEM 1.  SUMMARY OF LEGAL PROCEEDINGS

NONE

ITEM 2.   CHANGES IN SECURITIES AND USE OF PROCEEDS

In February 2004, the Company issued an aggregate of 5,004,999 shares of common stock (the “Private Placement Shares”) at a price of $0.60 per share to 24 accredited investors and 1 non-accredited investor (collectively, the “Investors”). The Company received $2,953,000 in net proceeds from the sale of these shares. The shares of common stock were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act. The Investors received current information about the Company and had the opportunity to ask questions about the Company.  

In January 2004, an accredited investor exercised its option to convert the balance of a 6% Convertible Debenture dated May 24, 2002 in the amount of $715,000 into shares of the Company’s common stock. The stock was converted at $0.57 per share and 1,258,372 shares of common stock were issued.  The shares of common stock were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act.  

In March 2004, an accredited investor exercised his option to convert a 6% Convertible Debenture dated August 16, 2002 in the amount of $168,000 into shares of the Company’s common stock. The stock was converted at $0.43 per shares and 390,698 shares of common stock were issued.  The shares of common stock were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act.  

In March 2004, the Company issued 220,000 shares of common stock to an accredited investor for $0.60 per share in satisfaction of a Promissory Note, dated August 16, 2002 issued by the Company to the investor in the principal amount of $132,000.  The shares of common stock were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act.  

In March 2004, the Company issued 100,000 shares of common stock (the “Note Extension Shares”) to an accredited investor as a fee in connection with its agreement to extend a $1.2 million Promissory Note issued by the Company to the investor, due May 24, 2004 (the “Note”). The new terms of the Note provide for monthly payments in the amount of $50,000 plus interest each month over twenty-four months beginning June 2004, with interest at 12%.  There is no prepayment penalty for early repayment of the Note.  Upon an uncured event of default, the Note will be automatically converted into the Company’s 6% Convertible Debentures with a principal amount equal to the principal amount and accrued interest outstanding under the Note.  The Note Extension Shares were issued pursuant to the exemption from registration provided by Section 4(2) of the Securities Act.  In May 2004, the Company filed a Registration Statement on Form S-1 registering the sale of the Note Extension Shares.

On February 4, 2004, the Company hired a new General Counsel and issued to him stock options to purchase an aggregate of 150,000 shares of Common Stock, subject to certain anti-dilution protections, exercisable at $0.67 per share and vesting over a three year period.  The options, if not exercised, will expire five years from the date of vesting.

ITEM 3.   DEFAULT UPON SENIOR SECURITIES

NONE

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

NONE

ITEM 5.  OTHER INFORMATION

NONE

ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K

(a)

Exhibits

------------------------

* filed herewith

(1)

Incorporated by reference to the Company's Registration Statement on Form SB-2 filed with the Commission on October 29, 1996 (No. 333-5884-A).

(2)

Incorporated by reference to the Company’s Registration Statement on Form SB-2 filed with the Commission on July 5, 2002 (No. 333-92046).

(3)

Incorporated by reference to the Company ‘s Registration Statement filed with the Commission on May 28, 2004 (No. 333-116018).

(4)

Incorporated by reference to the Company’s Registration Statement on Form SB-2 filed with the Commission on May 24, 2001 (No. 333-61566).

(5)

Portions of this document have been omitted and were filed separately with the SEC on or about August 2, 2001 pursuant to a request for confidential treatment.

(6)

Incorporated by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2003, as filed with the Commission on March 22, 2004.

(7)

Portions of this document have been omitted and were filed separately with the SEC on July 28, 2004 pursuant to a request for confidential treatment.

(8)

Incorporated by reference to Amendment No. 1 to the Company’s Annual Report on Form 10-K/A for the fiscal year ended December 31, 2003, as filed with the Commission on July 28, 2004.

(b)

Reports on Form 8-K:

The following current reports were filed on Form 8-K since the first quarter of 2004:

(1)

On July 28, 2004, a Current Report was filed under Item 5 and Item 7 related to the Company’s filing of an amendment to its Form 10-K for the year ended December 31, 2003.

(2)

On July 29, 2004, a Current Report was filed under Item 5 and Item 7 related to the Company’s entering into an agreement to operate a multi-specialty physician practice.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the Undersigned thereunto duly authorized.

METROPOLITAN HEALTH NETWORKS, INC.

Registrant

Date:  August 10, 2004

/s/ Michael M. Earley

Michael M. Earley

President and

Chief Executive Officer

Date:  August 10, 2004

 /s/ David S. Gartner

David S. Gartner

Chief Financial Officer

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EXHIBIT 31.1

SARBANES-OXLEY ACT SECTION 302 CERTIFICATIONS

I, Michael M. Earley, Chief Executive Officer of Metropolitan Health Networks, Inc., certify that:

1.

I have reviewed this Quarterly Report on Form 10-Q of Metropolitan Health Networks, Inc. (the “Registrant”);

2.

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report;

4.

The Registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Registrant and have:

(a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

(b)

Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and

(c)

Disclosed in this quarterly report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s second quarter that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

5.

The Registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditor and the audit committee of the Registrant’s board of directors (or persons performing the equivalent functions):

(a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and

(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Date:  August 10, 2004

  /s/ Michael M. Earley

Michael M. Earley

President and Chief Executive Officer

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EXHIBIT 31.2

SARBANES-OXLEY ACT SECTION 302 CERTIFICATIONS

I, David S. Gartner, Chief Financial Officer of Metropolitan Health Networks, Inc., certify that:

1.

I have reviewed this Quarterly Report on Form 10-Q of Metropolitan Health Networks, Inc. (the “Registrant”);

2.

Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.

Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the Registrant as of, and for, the periods presented in this quarterly report;

4.

The Registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the Registrant and have:

(a)

Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the Registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

(b)

Evaluated the effectiveness of the Registrant’s disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and

(c)

Disclosed in this quarterly report any change in the Registrant’s internal control over financial reporting that occurred during the Registrant’s second fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Registrant’s internal control over financial reporting; and

5.

The Registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the Registrant’s auditor and the audit committee of the Registrant’s board of directors (or persons performing the equivalent functions):

(a)

All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the Registrant’s ability to record, process, summarize and report financial information; and

(b)

Any fraud, whether or not material, that involves management or other employees who have a significant role in the Registrant’s internal control over financial reporting.

Date:  August 10, 2004

  /s/ David S. Gartner

David S. Gartner

Chief Financial Officer

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EXHIBIT 32.1

SECTION 1350 CERTIFICATIONS

CERTIFICATION PURSUANT TO\

18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Metropolitan Health Networks, Inc. (the “Company”) on Form 10-Q for the period ended June 30, 2004, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Michael M. Earley, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that based on my knowledge:

1.

The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2.

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: August 10, 2004

  /s/ Michael M. Earley_________________

Michael M. Earley

President and Chief Executive Officer

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EXHIBIT 32.2

SECTION 1350 CERTIFICATIONS

CERTIFICATION PURSUANT TO\

18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of Metropolitan Health Networks, Inc. (the “Company”) on Form 10-Q for the period ended June 30, 2004, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, David S. Gartner, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that based on my knowledge:

1.

The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

2.

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

Date: August 10, 2004

  /s/ David S. Gartner

David S. Gartner

Chief Financial Officer

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