ROYAL BODYCARE INC/NV - 10-Q Quarterly Report

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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, 2002

OR

[ ] 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: 33-20323

Royal BodyCare, Inc.
--------------------
(Exact name of registrant as specified in its charter)

Nevada 91-2015186
- ------------------------ ----------
(State of Incorporation) (IRS Employer ID No.)

2301 Crown Court, Irving, Texas 75038
------------------------------- -----
(Address of principal executive offices) (Zip code)

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 August 1, 2002:

13,936,294

TABLE OF CONTENTS

ITEM 1. FINANCIAL STATEMENTS

ROYAL BODYCARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(UNAUDITED)

See notes to condensed consolidated financial statements.

-3-

ROYAL BODYCARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

See notes to condensed consolidated financial statements.

-4-

ROYAL BODYCARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

See notes to condensed consolidated financial statements.

-5-

ROYAL BODYCARE, INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

See notes to condensed consolidated financial statements.

-6-

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, 2001, and the Company's
Quarterly report for the quarterly period ended March 31, 2002.

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, 2001 was derived from the
Company's audited financial statements included in the Company's Form 10-K for
the year ended December 31, 2001. The preparation of consolidated financial
statements in conformity with generally accepted accounting principles in the
United States 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 engaged in the marketing of nutritional supplements and personal care
products in the United States and Canada. 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 entered into agreements to license the exclusive rights to sell its
nutritional and personal care products internationally through third party
licensees in the respective countries. RBC has entered into five such
arrangements to market these products. Under these agreements, 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 and Canada.

-7-

In August 2001, RBC, through a newly formed subsidiary, purchased substantially
all of the assets of MPM Medical, Inc., a Texas corporation ("MPM Medical"). MPM
Medical distributed wound care products throughout the United States. The
acquisition of MPM Medical enhances RBC's ability to market products through
broadened distribution channels. The acquisition of MPM Medical was not
significant to RBC's financial statements.

Discontinued Operations

In December 2000, RBC created a new subsidiary called 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.

In August 2001, the FASB issued Statement of Financial Accounting Standards No.
144 ("SFAS 144"), "Accounting for the Impairment of Long-Lived Assets", which
requires a single accounting model to be used for long-lived assets to be sold
and broadens the presentation of discontinued operations to include a "component
of an entity" (rather than a segment of a business). A component of an entity
comprises operations and cash flows that can be clearly distinguished,
operationally and for financial reporting purposes, from the rest of the entity.
A component of an entity that is classified as held for sale, or has been
disposed of, is presented as a discontinued operation if the operations and cash
flows of the component will be (or have been) eliminated from the ongoing
operations of the entity and the entity will not have any significant continuing
involvement in the operations of the component.

Consequently, the operating results of BizAdigm, which was written-off in the
second quarter of 2002, are included in discontinued operations. Assets and
liabilities of BizAdigm are included in "Assets of Discontinued Operations" and
"Liabilities of Discontinued Operations", at December 31, 2001 and June 30,
2002, respectively.

The assets of discontinued operations represent prepaid expenses; the
liabilities of discontinued operations represent accounts payable, accrued
commissions and the current portion of long-term liabilities. The long-term
liabilities of discontinued operations were capital lease and other long-term
borrowing arrangements that mature at various dates through 2004.

NOTE C - INVENTORIES:

Inventories at June 30, 2002 and December 31, 2001 consist of the following:

-8-

NOTE D - PROPERTY AND EQUIPMENT:

Property and equipment at June 30, 2002 and December 31, 2001 consists of the
following:

NOTE E - ACCRUED LIABILITIES:

Accrued liabilities at June 30, 2002 and December 31, 2001 consist of the
following:

NOTE F - LONG TERM OBLIGATIONS:

At June 30, 2002 and December 31, 2001 long-term obligations consist of the
following:

-9-

Note payable to bank bearing interest at prime
plus .5% (5.25% at June 30, 2002) due in
monthly installments of $7,474 through
March 2006 263,565 300,792
U. S. Small Business Administration note
bearing interest at prime plus 2.75% (7.5%
at June 30, 2002) due in monthly
installments of approximately $4,700
through July 2008 260,722 277,062
Notes payable to banks bearing interest at rates
ranging from 4.9% to 10.4%, payable
through 2005, collateralized by automobiles 44,799 67,333
Note payable to bank bearing interest at 9%,
due in monthly payments of $2,146 through
2002, collateralized by equipment 10,373 22,490
Convertible notes (original amount $730,000)
bearing interest at 10% payable quarterly,
originally due two years from the date of
issuance, notes are convertible into common
stock any time prior to maturity at the option
of the holder based on a per share conversion
price of $1.32 138,000 193,000
Settlement to former marketing consultant and
distributor, payable $5,000 per month
through April 2004, settlement is without
interest and has been discounted at 10% 100,126 124,406

Capital lease obligations 388,324 585,361
Other 15,000 25,000
---------- ----------
4,400,038 4,826,923
Less - current maturities 730,837 923,083
---------- ----------
$3,669,201 $3,903,840
========== ==========

Certain purchases of equipment have been financed through capital leases. Such
leases have terms ending in 2004 and have various interest rates approximating
14%.

NOTE G - SEGMENT INFORMATION:

The Company has three operating segments. These operating segments are
components of the Company for which separate information is available that is
evaluated regularly by management in deciding how to allocate resources and in
assessing performance. The Company evaluates performance based on operating
earnings (loss).

The Company's operating segments are based on geographic operations and include
a domestic segment (United States) and two international segments (Canada and
other regions). The segments have similar business characteristics and each
offers similar products

-10-

through similar methods of distribution as described in Note B. Inter-segment
sales, eliminated in consolidation, are not material.

Operating information related to MPM Medical, Inc. is included as part of
domestic operations. The Company will consider the significance of future
operations as part of the overall evaluation of the segments in which the
Company operates.

Financial information for continuing operations summarized by geographical
segment for the quarters ended June 30, 2002 and 2001 is listed below (in
thousands):

-11-

NOTE H - EARNINGS (LOSS) PER SHARE:

The assumed conversion of the convertible notes would have an anti-dilutive
effect on diluted earnings per common share for the quarters and six month
periods ended June 30, 2002 and 2001, and accordingly have been excluded from
the computation.

All stock options and warrants outstanding in the respective periods were
excluded from 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.

NOTE I - COMPREHENSIVE INCOME (LOSS):

Comprehensive income (loss) is net income (loss) 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 (loss):

-12-

NOTE J - INTANGIBLES:

The Company amortized goodwill and intangible assets acquired prior to July 1,
2001 until December 31, 2001. Beginning January 1, 2002, annual goodwill
amortization of approximately $156,000 will no longer be recognized. The Company
completed a transitional impairment test of all intangible assets by March 31,
2002, and a transitional fair value based impairment test of goodwill as of
January 1, 2002 by June 30, 2002. No impairment losses were recognized as a
result of this testing.

Intangible assets consist of the following:

-13-

Amortization expense related to intangible assets, excluding goodwill, totaled
$10,602 and $0 during the three months ended June 30, 2002 and 2001 and $21,203
and $0 during the six months ended June 30, 2002. The aggregate estimated
amortization expense for intangible assets remaining as of June 30, 2002 is as
follows:

Remainder of 2002 $ 21,203
2003 42,407
2004 42,407
2005 42,407
2006 42,407
Thereafter 194,173
--------
Total $385,004
========

Net loss and net loss per share for the quarters and six month periods ended
June 30, 2002 and 2001, adjusted to exclude amortization expense, is as follows:

-14-

NOTE K - LEGAL PROCEEDINGS:

On May 24, 2002, the sole source supplier of "silica hydride", the principal
ingredient in the Company's top selling product, Microhydrin(R), announced that
he had entered into an exclusive network marketing contract with an Arizona
Company, and that he would no longer supply silica hydride to the Company. This
supplier, a former director of the Company, took this action despite a written
unlimited supply agreement for the purchase of silica hydride between Flanagan
Technologies and the Company. On May 29, 2002, the Company filed suit against
this supplier requesting injunctive and monetary relief and alleging, amongst
other causes of actions, breach of contract, conspiracy, fraud, breach of
fiduciary duty, disparagement, tortuous interference and unlawful restraint of
trade. On July 26, 2002, the Court granted an Agreed Injunction that enjoins
Flanagan and other parties acting in concert with him from, among other things,
refusing to sell silica hydride in capsule form to the Company and disparaging
RBC and its officers, directors, employees or its products. As only minimal
discovery has been accomplished, and a final trial on the merits is not set
until September 15, 2003, the Company is unable to predict the ultimate
resolution of this case or to determine its materiality, if any, on the
Company's operations.

While Flanagan cannot refuse to supply silica hydride powder in capsule form to
the Company under the terms of the Agreed Injunction, the Company does not
anticipate the need to make further purchases of Flanagan's silica hydride
powder. In response to Flanagan's actions, the Company established a
manufacturing facility and is presently producing silica hydride powder using
its own proprietary process. The Company began shipping Microhydrin made with
its proprietary silica hydride powder on July 31, 2002.

-15-

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

FORWARD-LOOKING STATEMENTS

This Form 10-Q, including this Item 2, contains statements which, to the extent
they are not historical fact, constitute forward-looking statements within the
meaning of Section 27A of the Securities Act of 1933 and Section 21E of the
Securities and Exchange Act of 1934 (the "Safe Harbor Acts"). The
forward-looking statements in this Form 10-Q are intended to be subject to the
safe harbor protections provided by the Safe Harbor Acts.

Statements regarding the future financial positions, business strategy, budgets,
project cost, and plans and objectives for future operations are forward-looking
statements. Forward-looking statements generally can be identified by the use of
anticipatory or forward-looking terminology, including but not limited to,
"may", "will", "expect", "intend", "estimate", "anticipate" or "believe". We
believe that the expectations reflected in such forward-looking statements will
prove to be correct. However, we cannot assure you that such expectations will
occur. Our actual future performance could differ materially from such
statements. Factors or events that could cause or contribute to such differences
include, but are not limited to:

o general economic conditions

o general market acceptance of our products and distribution methods

o introduction of directly and indirectly competitive products

o pricing of directly and indirectly competitive products

o legislative and regulatory actions effecting the market of our products and
distribution methods

o reduction in demand for our products or the rate at which new distributors
are recruited to join us or an increased rate of attrition of our
distributors

o the Company's ability to obtain future financing to fund internal growth and
the Company's future capital requirements

o the market acceptance of the Company's newly developed proprietary versions
of silica hydride powder and other raw materials heretofore supplied by
Flanagan

-16-

RESULTS OF OPERATIONS

Quarter Ended June 30, 2002 Compared with the Quarter Ended June 30, 2001

Our sales for the quarter ended June 30, 2002 were $7,239,000 compared with
sales for same quarter of the prior year of $9,086,000, a decrease of $1,847,000
or 20%. The decline in second quarter sales resulted mainly from sales declines
of our traditional nutritional and personal care products in the U.S. and
Canadian markets of $1,889,000 and $486,000, respectively. Declines in these
markets were partially offset by a net sales increase in our international
licensee markets of $278,000 and sales related to MPM Medical products of
$250,000.

We believe the principal factor affecting our sales has been the actions of
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 gave
us the unfettered right to purchase silica hydride powder, the principal
ingredient in our top selling product, Microhydrin(R), and certain other
proprietary raw materials. Sales of products that contain Flanagan's proprietary
ingredients represent in excess of 50% of our sales volume. We were effectively
the exclusive distributor of products containing his proprietary ingredients
until December 2001 when Flanagan began marketing a product competitive with
Microhydrin on his web site and, on a limited basis, through certain health food
stores. Flanagan's actions disrupted the marketing efforts of our network of
independent distributors. To improve our competitive position, we developed a
proprietary, broad-based blend of antioxidants, including Microhydrin. This new
product, Microhydrin Plus, was introduced in late April 2002 and initial
acceptance of this product has been very positive.

Despite our written unlimited supply agreement, 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. As a result of the actions of
Flanagan and others, we estimate that North American sales of our nutritional
and personal care products have declined approximately 10% to 15%. In addition,
in breach of its license agreement with us, our European licensee announced its
alignment with Flanagan and discontinued purchasing products from us in May
2002. Sales to the European licensee were $93,000 in the second quarter of 2002
compared with $333,000 in the second quarter of 2001.

In response to Flanagan's actions, on May 29, 2002, we filed suit against
Flanagan and one former RBC distributor in the Dallas County, Texas District
Court (Cause Number DV02-04797) requesting injunctive and monetary relief and
alleging, amongst other causes of action, breach of contract, breach of
fiduciary duty and disparagement. On July 26, 2002, the Court granted an Agreed
Injunction enjoining Flanagan and other parties acting in concert with him from,
among other things, refusing to sell us silica hydride in capsule form and
disparaging RBC and its officers, directors, employees and its products. (Final
trial on the merits is set for September 15, 2003). In addition, since
Flanagan's announcement, we have refined an completed the development of our
proprietary version of silica hydride powder

-17-

and other raw materials formerly supplied by Flanagan. We began shipping
Microhydrin made with our silica hydride powder on July 31, 2002, and we will
begin shipping other products made with our proprietary raw materials as
existing supplies of products made with Flanagan's raw materials are exhausted.

We believe that the actions we have taken along with our present marketing
strategies and programs, will allow us, for the most part, to retain our present
distributor base, stabilize our present sales volume and provide a base from
which to grow during the latter part of 2002. 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.

Our cost of goods sold for the quarter ended June 30, 2002 was $2,515,000
compared with cost of goods sold in the same quarter of the prior year of
$2,857,000, a decrease of $342,000 or 12%. As a percentage of sales, cost of
goods sold was 35% in the second quarter of 2002 compared with 31% in the second
quarter of 2001. This percentage increase was mainly related to the increase in
sales to our international licensees and, to a lesser extent, increased freight
costs in the U.S. Cost of goods sold as a percentage of sales is higher for
products sold to international licensees because we do not pay distributor
commissions on sales of these products.

Our distributor commissions for the quarter ended June 30, 2002 were $2,337,000
compared with distributor commissions in the same quarter of 2001 of $3,314,000,
a decrease of $977,000 or 29%. As a percentage of sales, distributor commissions
in the first quarter of 2002 were 32% compared with 36% in the same period of
2001. This percentage decline was mainly related to the increase in sales to our
international licensees and sales of MPM Medical products because we do not pay
distributor commissions on sales of these products. In addition, distributor
commissions as a percentage of sales declined relative to North American sales
because fewer distributors qualified at the top levels of the distributor
compensation plan as a result of the decline in sales during the quarter.

Our general and administrative expenses for the quarter ended June 30, 2002,
were $2,605,000 compared with such expenses in the same quarter of 2001 of
$2,880,000, a decrease of $275,000 or 10%. 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 36% in
the second quarter of 2002 compared with 32% in the second quarter of 2001.

In the quarter ended June 30, 2001, we recorded goodwill amortization expense of
$39,000. As described in Note J to the financial statements, we recorded no
goodwill amortization expense in the quarter ended June 30, 2002.

Discontinued operations represent the operations of BizAdigm. BizAdigm's
operations were discontinued during the second quarter of 2002. BizAdigm had no
recognized sales in the second quarter of 2002. The loss represents certain
administrative expenses incurred in connection with close-down activities. The
loss in the second quarter of 2001 represents the excess of selling, general and
administrative expenses plus cost of goods sold and distributor

-18-

commissions over recognized sales of $435,000. The loss in the second quarter of
2001 is net of income tax benefits of $71,000.

Our net loss for the quarter ended June 30, 2002 was $236,000, or $.02 per
share, compared with a net loss in the comparable quarter of the prior year of
$98,000 or $.01 per share, an increase of $138,000. This increased net loss
resulted from the factors described above.

Six Months Ended June 30, 2002 Compared with the Six Months Ended June 30, 2001

Our sales for the six months ended June 30, 2002 were $14,501,000 compared with
sales for same period of the prior year of $18,078,000, a decrease of $3,577,000
or 20%. This decline in sales resulted mainly from sales declines of our
traditional nutritional and personal care products in the U.S. and Canadian
markets of $3,520,000 and $1,049,000, respectively. Declines in these markets
were partially offset by a net sales increase in our international licensee
markets of $471,000 and sales related to MPM Medical products of $521,000.

We believe the principal factor affecting our sales has been the actions of
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 gave
us the unfettered right to purchase silica hydride powder, the principal
ingredient in our top selling product, Microhydrin(R), and certain other
proprietary raw materials. Sales of products that contain Flanagan's proprietary
ingredients represent in excess of 50% of our sales volume. We were effectively
the exclusive distributor of products containing his proprietary ingredients
until December 2001 when Flanagan began marketing a product competitive with
Microhydrin on his web site and, on a limited basis, through certain health food
stores. Flanagan's actions disrupted the marketing efforts of our network of
independent distributors. To improve our competitive position, we developed a
proprietary, broad-based blend of antioxidants, including Microhydrin. This new
product, Microhydrin Plus, was introduced in late April 2002 and initial
acceptance of this product has been very positive.

Despite our written unlimited supply agreement, 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. As a result of the actions of
Flanagan and others, we estimate that North American sales of our nutritional
and personal care products have declined approximately 10% to 15%. In addition,
in breach of its license agreement with us, our European licensee announced its
alignment with Flanagan and discontinued purchasing products from us in May
2002. Sales to the European licensee were $291,000 in the first six months of
2002 compared with $589,000 in the same period of 2001.

In response to Flanagan's actions, on May 29, 2002, we filed suit against
Flanagan and one former RBC distributor in the Dallas County, Texas District
Court (Cause Number DV02-04797) requesting injunctive and monetary relief and
alleging, amongst other causes of action, breach of contract, breach of
fiduciary duty and disparagement. On July 26, 2002,

-19-

the Court granted an Agreed Injunction enjoining Flanagan and other parties
acting in concert with him from, among other things, refusing to sell us silica
hydride in capsule form and disparaging RBC and its officers, directors,
employees and its products. (Final trial on the merits is set for September 15,
2003). In addition, since Flanagan's announcement, we have refined and completed
the development of our 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 we will begin shipping
other products made with our proprietary raw materials as existing supplies of
products made with Flanagan's raw materials are exhausted.

We believe that the actions we have taken along with our present marketing
strategies and programs, will allow us, for the most part, to retain our present
distributor base, stabilize our present sales volume and provide a base from
which to grow during the latter part of 2002. 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.

Our cost of goods sold for the six months ended June 30, 2002 was $4,753,000
compared with cost of goods sold in the same period of the prior year of
$5,589,000, a decrease of $836,000 or 15%. As a percentage of sales, cost of
goods sold was 33% in the first six months of 2002 compared with 31% in the
first six months of 2001. This percentage increase was mainly related to the
increase in sales to our international licensees. Cost of goods sold as a
percentage of sales is higher for products sold to international licensees
because we do not pay distributor commissions on sales of these products.

Our distributor commissions for the six months ended June 30, 2002 were
$4,885,000 compared with distributor commissions in the same period of 2001 of
$6,682,000, a decrease of $1,797,000 or 27%. As a percentage of sales,
distributor commissions in the first six months of 2002 were 34% compared with
37% in the same period of 2001. This percentage decline was mainly related to
the increase in sales to our international licensees and sales of MPM Medical
products because we do not pay distributor commissions on sales of these
products. In addition, distributor commissions as a percentage of sales declined
relative to North American sales because fewer distributors qualified at the top
levels of the distributor compensation plan as a result of the decline in sales
during the period.

Our general and administrative expenses for the six months ended June 30, 2002,
were $5,076,000 compared with such expenses in the same period of 2001 of
$5,799,000, a decrease of $723,000 or 12%. 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 35% in
the first six months of 2002 compared with 32% in the first six months of 2001.

In the six months ended June 30, 2001, we recorded goodwill amortization expense
of $78,000. As described in Note J to the financial statements, we recorded no
goodwill amortization expense in the six months ended June 30, 2002.

-20-

Discontinued operations represent the operations of BizAdigm. BizAdigm's
operations were discontinued during the second quarter of 2002. BizAdigm had
recognized sales of $45,000 and $435,000 during in the first six months of 2002
and 2001, respectively. The loss in each of these periods represents the excess
of selling, general and administrative expenses plus cost of goods sold and
distributor commissions over recognized sales. The loss in the first six months
of 2001 is net of income tax benefits of $121,000.

Our net loss for the six months ended June 30, 2002 was $255,000, or $.02 per
share, compared with a net loss in the comparable period of the prior year of
$200,000 or $.01 per share, an increase of $55,000. This increased net loss
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 products 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.

LIQUIDITY AND CAPITAL RESOURCES

During the second quarter of 2002, we had a net decrease in cash of $28,000.
This decrease in cash resulted from net cash provided by operating activities of
$453,000 that was more than offset by the net cash used to purchase property and
equipment of $146,000 and net cash used by financing activities of $337,000. Net
cash used by financing activities was mainly related to the repayment of
long-term debt.

Our working capital declined during the second quarter of 2002 as a result of
the decline in sales and the net loss incurred during the period. As previously
described, we believe that the actions we have taken relative to Flanagan and
the raw materials he formerly provided, along with our present marketing
strategies and programs, will allow us to retain, for the most part, our
distributor base and ultimately reverse the declining sales trend we experienced
during the later part of 2001 and the first six months of 2002. 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 our sales. In addition, as part of our overall effort
to return to profitability we have implemented cost-cutting measures that we
believe will significantly reduce our operating expenses.

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.

-21-

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 before
returning to profitability, we may again 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 generally
accepted accounting principles in the United States 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.

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.
-22-

CONTRACTUAL CASH COMMITMENTS

The table below summarizes minimum cash obligations outstanding as of June 30,
2002:

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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 15% of net sales
during the first six months of 2002 and 17% of 2001 net sales. 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 $129,000 at June 30, 2002, a
10% adverse change in the currency rate would reduce earnings before tax by
approximately $12,900.

Interest rates

Our credit arrangements expose us to fluctuations in interest rates. At June 30,
2002, we had $1,017,000 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 June 30, 2002, a 10% increase in interest
rates would adversely affect our financial position, annual results of
operations, or cash flows by approximately $6,500.

-24-

PART II. OTHER INFORMATION

Item 1. Legal Proceedings.

ROYAL BODYCARE, INC. v. G. PATRICK FLANAGAN, Individually and as
authorized agent on behalf of FLANAGAN TECHNOLOGIES, INC., FLANAGAN
TECHNOLOGIES, INC. a/k/a and d/b/a FLANTECH and/or FLANTECH GROUP and
JOHN LLOYD, Cause Number DV02-04797, Dallas County, Texas, District
Court.

On May 24, 2002, the sole source supplier of "silica hydride", the
principal ingredient in our top selling product, Microhydrin(R),
announced that he had entered into an exclusive network marketing
contract with an Arizona Company, and that he would no longer supply
silica hydride to us. Our supplier, a former director of the Company,
took this action despite a written unlimited supply agreement for the
purchase of silica hydride between Flanagan Technologies and us. On May
29, 2002, we filed suit, cause number DV02-04797, in Dallas County,
Texas District Court against this supplier requesting injunctive and
monetary relief and alleging, amongst other causes of actions, breach
of contract, conspiracy, fraud, breach of fiduciary duty,
disparagement, tortuous interference and unlawful restraint of trade.
On July 26, 2002, the Court granted an Agreed Injunction that enjoins
Flanagan and other parties acting in concert with him from, among other
things, refusing to sell silica hydride in capsule form to us and
disparaging RBC and its officers, directors, employees or its products.
As only minimal discovery has been accomplished, and a final trial on
the merits is not set until September 15, 2003, we are unable to
predict the ultimate resolution of this case, and it is not possible to
determine materiality on our operations.

Item 2. Changes in Securities.

None

Item 3. Defaults Upon Senior Securities.

None

Item 4. Submission of Matters to a Vote of Security Holders.

We held our Annual Meeting of Shareholders on April 19, 2002. At this
meeting the following persons were elected to serve as directors until
the 2003 Annual Meeting of Shareholders:

-25-

Item 5. Other Information.

None

Item 6. Exhibits and Reports on Form 8-K.

(a) Exhibits

None.

(b) Reports on Form 8-K

We filed a report on Form 8-K dated May 25, 2002 providing
information and documentation relating to the dispute with the
sole source supplier of "silica hydride", the principal
ingredient of our top selling product, Microhydrin(R). We
filed suit against this supplier on May 29, 2002 alleging,
among other things, breach of contract, after the supplier
announced on May 25, 2002 that he would no longer sell silica
hydride to us in breach of an unlimited supply agreement
between the supplier and us.

-26-

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.

Royal BodyCare, Inc.
--------------------
Registrant

By: /s/ Clinton H. Howard
----------------------------------------
Its: President

DATE: August 12, 2002
Irving, Texas