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SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2004

OR

For the transition period from              to             

Commission file number: 33-20323

Royal BodyCare, Inc.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: 972-893-4000

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 Act of 1934 during the past 12 months and (2) has been subject to such filing requirements for the past 90 days.    x  YES    ¨  NO

Shares of common stock, par value $0.001, outstanding at May 1, 2004:

19,956,294

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Item 1. FINANCIAL STATEMENTS

ROYAL BODYCARE, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)

See notes to condensed consolidated financial statements.

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ROYAL BODYCARE, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

See notes to condensed consolidated financial statements.

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ROYAL BODYCARE, INC. and SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

See notes to condensed consolidated financial statements.

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ROYAL BODYCARE, INC. AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

Note A – Unaudited Condensed Consolidated Financial Statements:

The accompanying unaudited condensed consolidated financial statements of Royal BodyCare, Inc. (“RBC” or the “Company”) have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X, and accordingly, certain financial information has been condensed and certain footnote disclosures have been omitted. Such information and disclosures are normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America. However, the Company believes that the disclosures made are adequate to make the information presented not misleading. Nevertheless, it is suggested that these financial statements be read in conjunction with the summary of significant accounting policies and notes to the financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2003.

In the opinion of management, all adjustments (consisting solely of normal recurring accruals) considered necessary for a fair presentation of the Company’s results for the interim periods have been included. The Condensed Consolidated Balance Sheet as of December 31, 2003 was derived from the Company’s audited financial statements included in the Company’s Form 10-K for the year ended December 31, 2003. The preparation of consolidated 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 at the date of the consolidated financial statements and reported amounts of revenues and expenses during the period. Actual results could differ from those estimates. The results of operations for the interim periods presented are not necessarily indicative of the results to be expected for the full year.

Note B – Nature of Operations and Organization:

RBC is principally engaged in the marketing of nutritional supplements and personal care products in the United States, Canada and Japan. The Company’s products are marketed through a network marketing system in which distributors, who are independent contractors, purchase products for resale to retail customers or for personal use.

RBC has also entered into arrangements to license the exclusive rights to sell its nutritional supplements and personal care products in certain international markets through third party licensees in the respective countries. RBC has entered into three such arrangements to market its products. Under these arrangements, distributors in these countries are compensated by the third party licensees according to the same or a similar compensation plan as the one used by RBC for its independent distributors in the United States, Canada and Japan.

Through its wholly-owned subsidiary, MPM Medical, Inc., a Texas corporation (“MPM Medical”), the Company also distributes wound care and oncology products in the United States under the MPM Medical trade name. The wound care products are distributed directly to hospitals, nursing homes and home health care agencies through medical/surgical supply dealers. The oncology products are distributed to hospitals, cancer treatment clinics and pharmacies through pharmaceutical distributors.

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Discontinued Operations

In December 2000, RBC created a new subsidiary named BizAdigm, Inc. (“BizAdigm”) to offer various internet products through a network of independent distributors similar in approach to the marketing of RBC’s nutritional and personal care products. Due to low sales volume, RBC discontinued the operations of BizAdigm during the second quarter of 2002. Consequently, the operating results of BizAdigm are classified as discontinued operations. Liabilities of BizAdigm are included in “Liabilities of Discontinued Operations” at December 31, 2003. Liabilities of discontinued operations represent the remaining obligations under certain capital lease arrangements that matured during the first quarter of 2004.

Note C – Restatement of Financial Statements:

In connection with the preparation of the Company’s financial statements for fiscal 2003, the audit committee requested that management and the Company’s independent accountants review the revenue recognition policy with regard to the Company’s licensee in the former Soviet Union, Coral Club International, Inc. (“CCI”). Until September 2002, sales were recorded when products were shipped to CCI. In September 2002, the Company and CCI reached an agreement that provided the Company would store products for CCI in its warehouse and then ship them at a later date to locations designated by CCI in accordance with its business needs. As part of this agreement, CCI agreed to accept ownership of and pay for the products as they were segregated in the Company’s warehouse for CCI’s account. Upon entering into this agreement, the Company began to recognize sales to CCI at the time products were billed and segregated in the Company’s warehouse for CCI’s account.

After reviewing this policy in light of authoritative accounting literature, management, in consultation with the Company’s independent accountants, concluded that sales should have been recognized at the time products were shipped rather than when such products were segregated in the Company’s warehouse for CCI’s account. As a result, the Company has restated its previously reported audited financial statements for the year ended December 31, 2002, and the unaudited results for the quarters ended September 30, 2003, June 30, 2003, March 31, 2003, December 31, 2002, and September 30, 2002.

A summary of the significant effects of the restatement on the quarter ended March 31, 2003 is set forth below:

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Note D – Inventories:

Inventories at March 31, 2004 and December 31, 2003 consist of the following:

Note E – Property and Equipment:

Property and equipment at March 31, 2004 and December 31, 2003 consists of the following:

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Note F – Goodwill and Other Intangible Assets:

The Company measures its goodwill for impairment at the end of each fiscal year or in the event of an impairment indicator. No impairment losses have been recognized as a result of this testing. Goodwill consists of the following:

Other intangible assets consist of the following:

Amortization expense related to other intangible assets totaled $10,600 for the quarters ended March 31, 2004 and 2003. The aggregate estimated amortization expense for intangible assets remaining as of March 31, 2004 is as follows:

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Note G – Accrued Liabilities:

Accrued liabilities at March 31, 2004 and December 31, 2003 consist of the following:

Note H – Stock-Based Compensation:

On July 1, 1998, the Company’s shareholders adopted the 1998 Stock Option Plan (the “Plan”) and reserved 500,000 shares of common stock for issuance under the Plan. Effective September 4, 2003, the Company’s shareholders adopted an amendment and restatement of the Plan in the form of the 2003 Stock Incentive Plan. The purpose of this amendment and restatement was, among other things, to increase the number of shares issuable under the Plan to 3,500,000 shares of common stock and to add restricted stock as available for awards under the Plan. The Plan, in both the original form and the amended and restated form, provides for the issuance of both nonqualified and incentive stock options, and permits grants to employees, non-employee directors and consultants of the Company.

The Company accounts for the Plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related Interpretations. No stock-based employee compensation cost is reflected in net earnings (loss), as all options granted under this plan had an exercise price equal to or greater than the quoted market price of the underlying common stock on the date of grant. The following table illustrates the effect on net earnings (loss) and earnings (loss) per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

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Note I – Long Term Obligations:

At March 31, 2004 and December 31, 2003 long-term debt consists of the following:

Certain purchases of equipment have been financed through capital leases. Such leases have terms ending in 2004 and have various interest rates approximating 15%.

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Note J – Segments and Geographic Area:

The Company’s segments are based on the organization structure that is used by management for making operating and investment decisions and for assessing performance. Based on this management approach, the Company has two operating segments: Nutritional Products and Medical Products. The Nutritional Products segment manufactures and distributes a line of over 75 nutritional supplements and personal care products, including herbs, vitamins and minerals, as well as natural skin, hair and body care products. These products are marketed under the Royal BodyCare^® trade name and are distributed by a network of independent distributors operating primarily in North America and by licensees operating in certain other countries outside of North America. The Medical Products segment markets a line of approximately 25 wound care and oncology products in the United States under the MPM Medical trade name. The wound care products are distributed directly to hospitals, nursing homes and home health care agencies through medical/surgical supply dealers. The oncology products are distributed to hospitals, cancer treatment clinics and pharmacies through pharmaceutical distributors.

The Company evaluates the performance of its segments primarily based on operating profit. All intercompany transactions have been eliminated, and intersegment revenues are not significant. In calculating operating profit for these two segments, administrative expenses incurred that are common to the two segments are allocated on a usage basis.

Segment information is as follows (in thousands):

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Financial information summarized geographically for the quarters ended March 31, 2004 and 2003 is listed below (in thousands):

Significant Customers

The Company recorded sales to its licensee in the former Soviet Union in the amount of $813,000 and $522,000 during the quarters ended March 31, 2004 and 2003, respectively. These sales accounted for more than ten percent of net sales in the quarters ended March 31, 2004 and 2003. In no other case did a customer of the Company account for more than ten percent of net sales during the quarters ended March 31, 2004 or 2003.

Note K – Earnings (Loss) Per Share:

Summarized basic and diluted earnings per common share were calculated as follows:

For the quarters ended March 31, 2004 and 2003, the number of stock options that were outstanding but not included in the computation of diluted earnings per common share because their exercise price was greater than the average market price of the common stock and, therefore anti-dilutive, was 444,000 and 784,580, respectively.

The assumed conversion of the convertible notes would have an anti-dilutive effect on diluted earnings per common share for the quarters ended March 31, 2004 and 2003, and accordingly have been excluded from the computation.

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Note L – Comprehensive Income:

Comprehensive income is net earnings plus other comprehensive income (loss), which, for the periods presented, consists of the change in the foreign currency translation adjustment. The following table provides information regarding comprehensive income:

Note M – Legal Proceedings:

On May 29, 2002, the Company filed suit against a former supplier and member of its Board of Directors (G. Patrick Flanagan), and certain others (“Defendants”) requesting injunctive and monetary relief and alleging, among other causes of action, breach of contract, conspiracy, fraud, breach of fiduciary duty, disparagement, tortuous interference and unlawful restraint of trade. In connection with this suit, on August 16, 2002, the Defendants filed a counter claim against the Company alleging, among other causes of action, unfair competition, breach of contract and conspiracy.

On February 18, 2003, the parties entered into an agreement to settle all claims and causes of actions that existed between them, including those arising out of the transactions that formed the basis of the lawsuit. Under the terms of this settlement, G. Patrick Flanagan and/or Flantech Group, defendants in the original suit, agreed to pay to the Company an aggregate of $250,000, payable in monthly installments beginning in February 2003, calculated as a percentage of gross revenues, as defined, generated by G. Patrick Flanagan or certain entities to which he is related. Through March 31, 2004 the Company has received payments totaling approximately $133,000, of which $31,000 was received in the first quarter of 2004, pursuant to this settlement arrangement. Additional details are set forth below at RESULTS OF OPERATIONS.

The Company is from time to time engaged in routine litigation. The Company regularly reviews all pending litigation matters in which it is involved and establishes reserves deemed appropriate by management for these litigation matters.

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

FORWARD-LOOKING STATEMENTS

The statements, other than statements of historical facts included in this report are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements, other than statements of historical or present facts, that address activities, events, outcomes and other matters that we plan, expect, intend, assume, believe, budget, predict, forecast, project, estimate or anticipate (and other similar expressions) will, should or may occur in the future are forward looking statements. Forward-looking statements generally can be identified by the use of forward-looking terminology such as “may”, “will”, “expect”, “intend”, “estimate”, “anticipate” or “believe”. These forward-looking statements are based on management’s current belief, based on currently available information, as to the outcome and time of future events. We believe that the expectations reflected in such forward-looking statements are accurate. However, we cannot assure you that such expectations will occur. Our actual future performance could differ materially from such statements. When considering forward-looking statements, you should keep in mind the risk factors and other cautionary statements in this Form 10-Q. We do not undertake any obligation to publicly release any revisions to any forward-looking statement to reflect events or circumstances after the date of this report or to reflect the occurrence of unanticipated events. Factors that could cause or contribute to such differences include, but are not limited to:

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RESTATEMENT OF FINANCIAL STATEMENTS

In connection with the preparation of the our financial statements for fiscal 2003, our audit committee requested that management and our independent accountants review the revenue recognition policy with regard to our licensee in the former Soviet Union, Coral Club International, Inc. (“CCI”). Until September 2002, sales were recorded when products were shipped to CCI. In September 2002, CCI and we reached an agreement that provided that we would store products for CCI in our warehouse and then ship them at a later date to locations designated by CCI in accordance with its business needs. As part of this agreement, CCI agreed to accept ownership of and pay for the products as they were segregated in our warehouse for CCI’s account. Upon entering into this agreement, we began to recognize sales to CCI at the time products were billed and segregated in our warehouse for CCI’s account.

After reviewing this accounting practice in light of authoritative accounting literature, management, in consultation with our independent accountants, concluded that sales should have been recognized at the time products were shipped rather than when such products were segregated in our warehouse for CCI’s account. As a result, the Company has restated its previously reported audited financial statements for the year ended December 31, 2002, and the unaudited results for the quarters ended September 30, 2003, June 30, 2003, March 31, 2003, December 31, 2002, and September 30, 2002. The components of the restatement along with the related effect on previously filed financial statements are set forth in Note C to the consolidated financial statements. Management’s discussion and analysis of financial condition and results of operations incorporates the restated amounts.

OVERVIEW

We operate in two industry segments, Nutritional Products and Medical Products. The Nutritional Products segment represents our core product line, accounting for approximately 88% and 92% of our sales in the quarters ended March 31, 2004 and 2003, respectively. We have experienced declining sales in the Nutritional Products segment in North America, which, even with the decline, is still our primary market accounting for 67% and 80% of our sales in the quarters ended March 31, 2004 and 2003, respectively. At the same time, we have experienced sales growth in the Nutritional Products segment outside of North America, mainly through a licensee that distributes our Nutritional Products in the former Soviet Union. We have also experienced growth in the Medical Products segment, which distributes its products in the United States.

As described more fully below, we attribute the decline in North American sales of our core product line to the dispute with a former supplier and member of our Board of Directors, Patrick Flanagan. Since this dispute arose, we have developed replacement products for the products formerly supplied by Flanagan, developed and introduced new products, recreated our core marketing message eliminating our association with Flanagan, and introduced changes to our distributor compensation plan intended to stimulate sales and increase recruiting of new independent distributors. The most recent of these changes became effective in January 2004. While we believe these actions will ultimately reverse the declining sales trend, we can give no assurance of future sales growth.

While addressing the issues created by our dispute with Flanagan, we also engaged in a concerted effort to reduce operating expenses during this period of declining North American sales. In this regard, we reduced personnel, and reorganized and consolidated operating activities to increase efficiency and reduce operating expenses. This included reorganizing our international marketing department, which reduced expenses while improving efficiency, closing one of two Canadian

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distribution centers and moving a significant portion of the Canadian operations to our offices in the U.S. As described more fully below, we also obtained a favorable settlement of the litigation with Flanagan, pursuant to which he has paid us $133,000 through March 31, 2004.

These efforts produced an improvement in operating results during the first quarter of 2004. Our net earnings in the first quarter of 2004 were $80,000 compared with net earnings of $23,000 in 2003. Also, at March 31, 2004, our working capital deficit was $703,000, a $111,000 improvement from the working capital deficit of $814,000 at December 31, 2003.

RESULTS OF OPERATIONS

Quarter Ended March 31, 2004 Compared with the Quarter Ended March 31, 2003

Our sales for the quarter ended March 31, 2004 were $4,463,000 compared with sales for same quarter of the prior year of $4,891,000, a decrease of $428,000 or 9%. The decline in first quarter sales resulted mainly from sales declines in our Nutritional Products segment in the U.S. and Canada of $770,000 and $163,000, respectively. These declines were partially offset by a net sales increase in our Nutritional Products segment international markets, primarily the former Soviet Union, and our Medical Products segment of $308,000 and $197,000, respectively.

We believe that the principal factor affecting our U.S. and Canadian Nutritional Products sales has been the dispute with Patrick Flanagan, formerly a member of our Board of Directors, and the related entities through which his proprietary products are marketed (collectively “Flanagan”). We entered into a supply contract with Flanagan in 1998 that effectively gave us the exclusive right to market products containing Flanagan’s proprietary raw materials. One raw material, silica hydride powder, was the principal ingredient in our top selling product, Microhydrin^®, and sales of products containing Flanagan’s proprietary ingredients increased to a level that represented in excess of 50% of our sales volume. Reflecting the success of these products, our core marketing message was built around Flanagan and the proprietary ingredients he had developed.

In December 2001, Flanagan began marketing a product competitive with Microhydrin on his web site and, on a limited basis, through certain health food stores. Then on May 24, 2002, Flanagan informed us that he had signed an agreement with an Arizona-based company granting it exclusive rights for the distribution of his products through network marketing, and that he would no longer supply us his products. Concurrent with his announcement on May 24, Flanagan and two former RBC distributors launched an aggressive negative campaign to entice our distributors to leave us and join the Arizona-based company. In response to these actions, on May 29, 2002, we filed suit against Flanagan and one former RBC distributor in the Dallas County, Texas District Court. As described elsewhere in this report, we settled this litigation in February 2003. However, because Flanagan was at the center of the RBC “brand,” these actions severely damaged the marketing efforts of our network of independent distributors and caused many independent distributors to leave RBC.

To overcome the challenges we faced in the wake of Flanagan’s departure, we first completed the development of our own proprietary version of silica hydride powder and other raw materials formerly supplied by Flanagan. We began shipping Microhydrin made with our silica hydride powder on July 31, 2002, and other products made with our proprietary raw materials as existing supplies of products made with Flanagan’s raw materials were exhausted. We then began the process of redefining the RBC “brand” eliminating our association with Flanagan. This included the introduction of new products, including a new weight loss system, new marketing support materials and programs, and modifications to our distributor compensation plan to provide added financial incentives for sales and recruiting efforts. The most recent of these changes were implemented in January 2004.

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We believe that the actions we have taken along with our present marketing strategies and programs, will help us, for the most part, to improve retention of our present distributor base, stabilize our present sales volume and provide a base from which we can begin to grow our business. However, there can be no assurances that these efforts will be successful or that the introduction of products that directly compete with our Microhydrin will not cause a further decline in sales.

Cost of goods sold for the quarter ended March 31, 2004 was $1,303,000 compared with cost of goods sold in the same quarter of the prior year of $1,245,000, an increase of $58,000 or 5%. As a percentage of sales, cost of goods sold was 29% in the first quarter of 2004 compared with 25% in the first quarter of 2003. This decline in gross margin is primarily related to the increase in sales to our international licensees. The gross margin for products sold to international licensees is lower than the gross margin for products sold in other markets because we sell internationally at lower prices, as we do not pay distributor commissions on sales of products to international licensees.

Our distributor commissions declined significantly in the first quarter of 2004 as a result of the decline in our sales. Distributor commissions for the quarter ended March 31, 2004 were $1,210,000 compared with distributor commissions in the same quarter of 2003 of $1,597,000, a decrease of $387,000 or 24%. In the Nutritional Products segment, U.S. and Canadian market distributor commissions as a percentage of sales were unchanged at 41%.

On a consolidated basis, distributor commissions as a percentage of sales declined to 27% in the first quarter of 2004 compared with 33% in the same period of 2003. This percentage decline was primarily related to the increase in sales to our international licensees because we do not pay distributor commissions on sales of these products.

Our general and administrative expenses for the quarter ended March 31, 2004, were $1,688,000 compared with such expenses in the same quarter of 2003 of $1,802,000, a decrease of $114,000 or 6%. This decrease was mainly related to management’s efforts to reduce operating expenses in light of the decline in sales. As a percentage of sales, general and administrative expenses were 38% in the first quarter of 2004 compared with 37% in the first quarter of 2003.

Interest expense for the quarter ended March 31, 2004, was $68,000 compared with such expense in the same quarter of 2003 of $83,000, a decrease of $15,000 or 18%. This decrease was related to the repayment of long-term debt during 2003.

Other income of $31,000 and $19,000 recognized in the quarters ended March 31, 2004 and 2003, respectively, represents payments received pursuant to the settlement of our lawsuit with Flanagan in February 2003. Under the terms of the settlement, Flanagan is obligated to make monthly payments calculated as a percentage of his gross revenues, as defined, up to an aggregate of $250,000. Through March 31, 2004, we had received aggregate payments from Flanagan of $133,000.

Our net earnings for the quarter ended March 31, 2004 were $80,000, or $0.00 per share, compared with a net earnings in the comparable quarter of the prior year of $23,000 or $0.00 per share, an improvement of $57,000. This improvement resulted from the factors described above.

Other than those described above, there have been no economic events or changes that have affected our sales or operating results and we are not aware of any economic trends or uncertainties that would have a material impact on our future sales or operating results. We believe that we have purchased our inventories at the best price available and that any price increases in the foreseeable future will be small. Any such price increases would be passed through to our distributors. In addition, we do not believe at this time that inflation will have a material impact on our operating results.

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LIQUIDITY AND CAPITAL RESOURCES

During the first quarter of 2004, we had a net increase in cash of $358,000. This increase resulted from net cash provided by operating activities of $515,000, which was partially offset by cash used to purchase property and equipment and pay debt of $36,000 and $124,000, respectively. With regard to our operating activities, we had net earnings in the first quarter of $80,000, which was net of depreciation and amortization of $147,000. Cash flow from operating activities was also provided by an $899,000 increase in accounts payable and accrued liabilities, which was mainly related to an increase in deferred revenue for unshipped orders of $662,000. Our working capital deficit decreased to $703,000 at March 31, 2004, a $111,000 improvement from our working capital deficit of $814,000 at December 31, 2003.

Consistent with industry practice, most of our sales are paid by our distributors at the time of order. Therefore, our primary working capital need is to maintain inventory at a level commensurate with sales activities. Because our sales are generated through independent distributors who do not maintain a significant inventory, it is necessary for us to have products on hand when the distributors place their orders. During periods of sales growth we must purchase inventory in anticipation of sales, thereby creating the need for additional working capital.

We believe that we will be able to fund moderate sales increases through our operations. Should sales growth increase beyond our ability to finance our growth internally, or should we require additional working capital, we may seek outside sources of capital including bank borrowings, other types of debt or equity financings. There is no assurance, however, that, we would be able to obtain any additional outside financing or on terms we would find acceptable. We have no plans or requirements for any other significant capital expenditures during the next twelve months.

Other than those factors already described, we are not aware of any trends or uncertainties that would significantly affect our liquidity or capital resources in the future.

CRITICAL ESTIMATES, UNCERTAINTIES, OR ASSESSMENTS IN OUR FINANCIAL STATEMENTS

The preparation of our financial statements in conformity with accounting principles generally accepted in the United States of America requires us 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. In applying our accounting principles, we must often make individual estimates and assumptions regarding expected outcomes or uncertainties. As you might expect, the actual results or outcomes are generally different that the estimated or assumed amounts. These differences are usually minor and are included in our consolidated financial statements as soon as they are known. Our estimates, judgments and assumptions are continually evaluated based on available information and experience. Because of the use of estimates inherent in the financial reporting process, actual results could differ from those estimates.

We periodically review the carrying value of our goodwill and other intangible assets when events and circumstances warrant such a review. One of the methods used for this review is performed using estimates of future cash flows. If the carrying value of our goodwill or other intangible assets is considered impaired, an impairment charge is recorded for the amount by which the carrying value of the goodwill or intangible assets exceeds its fair value. We believe that the estimates of future cash flows and fair value are reasonable. Changes in estimates of such cash flows and fair value, however, could affect the evaluation.

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We record a valuation allowance to reduce our deferred tax assets to the amount that is more likely than not to be realized. While we have considered future taxable income and ongoing prudent and feasible tax planning strategies in assessing the need for the valuation allowance, in the event we were to determine that we would be able to realize our deferred tax assets in the future in excess of its net recorded amount, an adjustment to the deferred tax asset would increase income in the period such determination was made. Likewise, should we determine that we would not be able to realize all or part of our net deferred tax asset in the future, an adjustment to the deferred tax asset would be charged to income in the period such determination was made.

Based on the assessment of our accounting policies and the underlying judgments and uncertainties affecting the application of those policies, we believe that our condensed consolidated financial statements provide a meaningful and fair perspective of our company.

CONTRACTUAL CASH OBLIGATIONS

The table below summarizes contractual cash obligations outstanding as of March 31, 2004:

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

The following discussion about our market risk includes “forward-looking statements” that involve risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. We do not use derivative financial instruments for speculative or trading purposes. We are exposed to market risk from changes in foreign currency exchange rates and interest rates that could affect our future results of operations and financial condition. We manage our exposure to these risks through our regular operating and financing activities.

Foreign exchange

We have foreign-based operations in Canada that accounted for 14% of net sales during both the first quarter of 2004 and fiscal 2003. We make advances to our foreign subsidiary denominated in U.S. dollars, exposing the foreign subsidiary to the effect of changes in spot exchange rates of the Canadian dollar relative to the U.S. dollar. We do not regularly use forward-exchange contracts to hedge these exposures. Based on our foreign currency exchange rate exposure for intercompany advances of approximately $178,000 at March 31, 2004, a 10% adverse change in the currency rate would reduce earnings before tax by approximately $17,800.

Interest rates

Our credit arrangements expose us to fluctuations in interest rates. At March 31, 2004, we had $445,000 outstanding in indebtedness, which provided for interest to be paid monthly based on a variable rate. Thus, interest rate changes would result in a change in the amount of interest to be paid each month. Based upon the interest rates and borrowings at March 31, 2004, a 10% increase in interest rates would adversely affect our financial position, annual results of operations, or cash flows by approximately $3,000.

ITEM 4. CONTROLS AND PROCEDURES

An evaluation was performed under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures within 90 days before the filing of this report. Based on that evaluation, our management, including our Chief Executive Officer and our Chief Financial Officer, concluded that our disclosure controls and procedures were functioning effectively to provide reasonable assurance that the information required to be disclosed by us in reports filed under the Securities and Exchange Act of 1934, as amended, is recorded, processed, summarized and reported with the time periods specified in the SEC’s rules and forms. There have been no significant changes in our internal controls or in other factors that could significantly affect internal controls subsequent to their evaluation.

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PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

None

Item 2. Changes in Securities.

None

Item 3. Defaults 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.

The Exhibit Index filed herewith is incorporated herein by reference.

None

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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.

DATE: May 14, 2004

  Irving, Texas

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ROYAL BODYCARE, INC.

Exhibit Index

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