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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-Q



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(Mark One)

|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------



For the quarterly period ended MARCH 31, 2004



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: 000-20997



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SRI/Surgical Express, Inc.

(Exact name of Registrant as specified in its Charter)



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|                         |  |                                     
|------------------------ |  | ------------------------------------
|Florida                  |  | 59-3252632                          
|(State of Incorporation) |  | (I.R.S. Employer Identification No.)



12425 Race Track
Road

Tampa, Florida 33626

(Address of Principal Executive Offices)



(813) 891-9550

(Registrants Telephone Number)



---



Indicate by
check 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 whether the Registrant is an accelerated filer (as defined in Rule 12-b-2 of the Securities Exchange Act of 1934).    Yes ̈No  x



Number of outstanding shares of each class of Registrants Common Stock as of April 30, 2004:



Common Stock, par value $.001  6,262,524



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##### Table of Contents

INDEX



|           |  |                                                                                                               |  |     
|---------- |  | ------------------------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                                               |  | Page
|PART I     |  | FINANCIAL INFORMATION                                                                                         |  |     
|           |  |                                                                                                              
|Item 1     |  | Financial Statements                                                                                          |  |     
|           |  |                                                                                                              
|           |  | Statements of Operations for the three months ended March 31, 2004 (unaudited) and March 31, 2003 (unaudited) |  | 1   
|           |  |                                                                                                              
|           |  | Balance Sheets as of March 31, 2004 (unaudited) and December 31, 2003                                         |  | 2   
|           |  |                                                                                                              
|           |  | Statements of Cash Flows for the three months ended March 31, 2004 (unaudited) and March 31, 2003 (unaudited) |  | 3   
|           |  |                                                                                                              
|           |  | Notes to Financial Statements (unaudited)                                                                     |  | 4   
|           |  |                                                                                                              
|Item 2     |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                         |  | 7   
|           |  |                                                                                                              
|Item 3     |  | Quantitative and Qualitative Disclosures About Market Risk                                                    |  | 11  
|           |  |                                                                                                              
|Item 4     |  | Controls and Procedures                                                                                       |  | 12  
|           |  |                                                                                                              
|PART II    |  | OTHER INFORMATION                                                                                             |  |     
|           |  |                                                                                                              
|Item 1     |  | Legal Proceedings                                                                                             |  | 13  
|           |  |                                                                                                              
|Item 2     |  | Changes in Securities and Use of Proceeds                                                                     |  | 13  
|           |  |                                                                                                              
|Item 3     |  | Defaults Upon Senior Securities                                                                               |  | 13  
|           |  |                                                                                                              
|Item 4     |  | Submission of Matters to a Vote of Security Holders                                                           |  | 13  
|           |  |                                                                                                              
|Item 5     |  | Other Information                                                                                             |  | 13  
|           |  |                                                                                                              
|Item 6     |  | Exhibits and Reports on Form 8-K                                                                              |  | 13  
|           | 
|SIGNATURES |  | 14                                                                                                           



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##### Table of Contents

PART I  FINANCIAL INFORMATION



Item 1. Financial Statements



SRI/SURGICAL EXPRESS, INC.

STATEMENTS OF OPERATIONS

(In thousands, except per share data)

(unaudited)



|                                            |  |                             |        |      |   |       
|------------------------------------------- |  | --------------------------- | ------ | ---- | - | ------
|                                            |  | Three Months EndedMarch 31,
|                                            |  | 2004                        |        | 2003
|Revenues                                    |  | $                           | 23,869 |      | $ | 21,460
|Cost of revenues                            |  |                             | 17,888 |      |   | 15,636
|                                            |  |                             |        |      |   |       
|Gross profit                                |  |                             | 5,981  |      |   | 5,824 
|                                            |  |                            
|Distribution expenses                       |  |                             | 1,622  |      |   | 1,535 
|Selling and administrative expenses         |  |                             | 3,917  |      |   | 3,662 
|                                            |  |                             |        |      |   |       
|Income from operations                      |  |                             | 442    |      |   | 627   
|                                            |  |                            
|Interest expense, net                       |  |                             | 241    |      |   | 319   
|                                            |  |                             |        |      |   |       
|Income before income taxes                  |  |                             | 201    |      |   | 308   
|                                            |  |                            
|Income tax expense                          |  |                             | 76     |      |   | 116   
|                                            |  |                             |        |      |   |       
|Net income                                  |  | $                           | 125    |      | $ | 192   
|                                            |  |                             |        |      |   |       
|Earnings per share:                         |  |                             |        |      |   |       
|Basic                                       |  | $                           | 0.02   |      | $ | 0.03  
|                                            |  |                             |        |      |   |       
|Diluted                                     |  | $                           | 0.02   |      | $ | 0.03  
|                                            |  |                             |        |      |   |       
|Weighted average common shares outstanding: |  |                             |        |      |   |       
|Basic                                       |  |                             | 6,263  |      |   | 6,269 
|                                            |  |                             |        |      |   |       
|Diluted                                     |  |                             | 6,334  |      |   | 6,274 
|                                            |  |                             |        |      |   |       



The accompanying notes
are an integral part of these financial statements.



1



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##### Table of Contents

SRI/SURGICAL EXPRESS, INC.

BALANCE SHEETS

(In thousands)



|                                                                                                                                           |  |               |        |                  |   |       
|------------------------------------------------------------------------------------------------------------------------------------------ |  | ------------- | ------ | ---------------- | - | ------
|                                                                                                                                           |  | March 31,2004 |        | December 31,2003
|                                                                                                                                           |  | (unaudited)   |        |                 
|ASSETS                                                                                                                                     |  |               |        |                  |   |       
|                                                                                                                                           |  |              
|Cash and cash equivalents                                                                                                                  |  | $             | 221    |                  | $ | 627   
|Accounts receivable, net                                                                                                                   |  |               | 11,574 |                  |   | 10,416
|Inventories, net                                                                                                                           |  |               | 6,098  |                  |   | 6,030 
|Prepaid expenses and other assets, net                                                                                                     |  |               | 2,316  |                  |   | 2,676 
|Reusable surgical products, net                                                                                                            |  |               | 21,086 |                  |   | 22,035
|Property, plant and equipment, net                                                                                                         |  |               | 37,586 |                  |   | 38,539
|Goodwill, net                                                                                                                              |  |               | 5,244  |                  |   | 5,244 
|                                                                                                                                           |  |               |        |                  |   |       
|Total assets                                                                                                                               |  | $             | 84,125 |                  | $ | 85,567
|                                                                                                                                           |  |               |        |                  |   |       
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                       |  |               |        |                  |   |       
|                                                                                                                                           |  |              
|Notes payable to bank                                                                                                                      |  | $             | 7,276  |                  | $ | 7,009 
|Accounts payable                                                                                                                           |  |               | 5,740  |                  |   | 6,921 
|Employee related accrued expenses                                                                                                          |  |               | 1,041  |                  |   | 1,149 
|Other accrued expenses                                                                                                                     |  |               | 1,229  |                  |   | 1,577 
|Obligation under capital lease                                                                                                             |  |               | 4,483  |                  |   | 4,515 
|Bonds payable                                                                                                                              |  |               | 9,535  |                  |   | 9,700 
|Deferred tax liability, net                                                                                                                |  |               | 2,384  |                  |   | 2,384 
|                                                                                                                                           |  |               |        |                  |   |       
|Total liabilities                                                                                                                          |  |               | 31,688 |                  |   | 33,255
|                                                                                                                                           |  |              
|Shareholders equity                                                                                                                       |  |               |        |                  |   |       
|                                                                                                                                           |  |              
|Preferred stock-authorized 5,000,000 shares of $0.001 par value; no shares issued and outstanding at March 31, 2004 and December 31,
2003. |  |               |       |                  |   |      
|Common stock-authorized 30,000,000 shares of $0.001 par value; issued and outstanding 6,262,524 at March 31, 2004 and December 31,
2003.   |  |               | 6      |                  |   | 6     
|                                                                                                                                           |  |              
|Additional paid-in capital                                                                                                                 |  |               | 29,389 |                  |   | 29,389
|Retained earnings                                                                                                                          |  |               | 23,042 |                  |   | 22,917
|                                                                                                                                           |  |               |        |                  |   |       
|Total shareholders equity                                                                                                                 |  | $             | 52,437 |                  | $ | 52,312
|                                                                                                                                           |  |               |        |                  |   |       
|Total liabilities and shareholders equity                                                                                                 |  | $             | 84,125 |                  | $ | 85,567
|                                                                                                                                           |  |               |        |                  |   |       



The accompanying notes
are an integral part of these financial statements.



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SRI/SURGICAL EXPRESS, INC.

STATEMENTS OF CASH FLOWS

(In thousands)

(unaudited)



|                                                                                  |  |                    |        |   |                |   |        |  
|--------------------------------------------------------------------------------- |  | ------------------ | ------ | - | -------------- | - | ------ | -
|                                                                                  |  | Three Months Ended |       
|                                                                                  |  | March 31 2004      |        |   | March 31, 2003 |  
|Cash flows from operating activities                                              |  |                    |        |   |                |   |        |  
|Net Income                                                                        |  | $                  | 125    |   |                | $ | 192    |  
|Adjustments to reconcile net income to net cash provided by operating activities: |  |                    |        |   |                |   |        |  
|Depreciation and amortization                                                     |  |                    | 1,147  |   |                |   | 1,025  |  
|Amortization of and provision for reusable surgical products                      |  |                    | 1,670  |   |                |   | 1,587  |  
|Change in operating assets and liabilities:                                       |  |                    |        |   |                |   |        |  
|Accounts receivable, net                                                          |  |                    | (1,158 | ) |                |   | (294   | )
|Inventories, net                                                                  |  |                    | (68    | ) |                |   | 131    |  
|Prepaid expenses and other assets, net                                            |  |                    | 360    |   |                |   | (99    | )
|Accounts payable                                                                  |  |                    | (1,181 | ) |                |   | (506   | )
|Employee related accrued expenses                                                 |  |                    | (108   | ) |                |   | 119    |  
|Other accrued expenses                                                            |  |                    | (348   | ) |                |   | (148   | )
|                                                                                  |  |                    |        |   |                |   |        |  
|Net cash provided by operating activities                                         |  |                    | 439    |   |                |   | 2,007  |  
|                                                                                  |  |                    |        |   |                |   |        |  
|Cash flows from investing activities                                              |  |                    |        |   |                |   |        |  
|Purchases of property, plant and equipment                                        |  |                    | (194   | ) |                |   | (309   | )
|Purchases of reusable surgical products                                           |  |                    | (721   | ) |                |   | (204   | )
|                                                                                  |  |                    |        |   |                |   |        |  
|Net cash used in investing activities                                             |  |                    | (915   | ) |                |   | (513   | )
|                                                                                  |  |                    |        |   |                |   |        |  
|Cash flows from financing activities                                              |  |                    |        |   |                |   |        |  
|Net borrowing (repayment) of notes payable to bank                                |  |                    | 267    |   |                |   | (1,446 | )
|Net repayment of bonds payable                                                    |  |                    | (165   | ) |                |   |       |  
|Payments on obligation under capital lease                                        |  |                    | (32    | ) |                |   | (28    | )
|                                                                                  |  |                    |        |   |                |   |        |  
|Net cash provided by (used in) financing activities                               |  |                    | 70     |   |                |   | (1,474 | )
|                                                                                  |  |                    |        |   |                |   |        |  
|Increase (decrease) in cash and cash equivalents                                  |  |                    | (406   | ) |                |   | 20     |  
|Cash and cash equivalents at beginning of period                                  |  |                    | 627    |   |                |   | 537    |  
|                                                                                  |  |                    |        |   |                |   |        |  
|Cash and cash equivalents at end of period                                        |  | $                  | 221    |   |                | $ | 557    |  
|                                                                                  |  |                    |        |   |                |   |        |  
|Supplemental cash flow information                                                |  |                    |        |   |                |   |        |  
|Cash paid for interest                                                            |  | $                  | 264    |   |                | $ | 201    |  
|                                                                                  |  |                    |        |   |                |   |        |  
|Cash paid for income taxes                                                        |  | $                  | 36     |   |                | $ | 25     |  
|                                                                                  |  |                    |        |   |                |   |        |  
|Supplemental schedule of non-cash activities                                      |  |                    |        |   |                |   |        |  
|Assets acquired under capital lease                                               |  | $                  |       |   |                | $ | 179    |  
|                                                                                  |  |                    |        |   |                |   |        |  



The accompanying notes
are an integral part of these financial statements.



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SRI/SURGICAL EXPRESS, INC.

NOTES TO FINANCIAL STATEMENTS

(unaudited)



NOTE A  BASIS OF PRESENTATION



The accompanying unaudited financial statements of SRI/Surgical Express, Inc. (the Company) have been prepared in accordance with accounting
principles generally accepted in the United States of America for interim financial information and with the Securities and Exchange Commissions (the SEC) instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they omit or condense footnotes and certain other information normally included in complete financial statements prepared in accordance with accounting principles generally accepted in the United States of America. In the opinion of management, all
adjustments of a normal recurring nature that are necessary to present fairly the financial information for the interim periods reported have been made. The accompanying unaudited financial statements should be read in conjunction with the financial
statements and notes included in the Companys Form 10-K for the year ended December 31, 2003, filed with the SEC. The results of operations for the three months ended March 31, 2004, are not necessarily indicative of the results that can be
expected for the entire year ending December 31, 2004.



The
Company operates on a 52-53 week fiscal year ending the Sunday nearest December 31. The unaudited financial statements are reflected as of March 31, 2004 for presentation purposes. There are 14 weeks included for the three-month period ended March
31, 2004 and 13 weeks included for the three-month period ended March 31, 2003.



NOTE B  SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES



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 amounts reported in the financial statements and accompanying notes. Actual
results could differ from those estimates.



Accounts Receivable, Net



The Company has accounts receivable from hospitals and
surgery centers. The Company does not believe that there are substantial credit risks associated with those receivables. The Company does not require any form of collateral from the hospitals and surgery centers. The allowance for doubtful accounts
as of March 31, 2004, and December 31, 2003, was approximately $129,000 and $125,000, respectively. The Companys write-offs for uncollectable accounts have not been significant to its results of operations. The Company does not customarily
charge interest on accounts receivable.



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Inventories, Net



Inventories, consisting principally of consumables, supplies, and disposable surgical products, are valued at the lower of cost or market, with cost being
determined on the first-in, first-out method. As of March 31, 2004 and December 31, 2003, inventory consisted of the following:



|                        |  |                |       |   |                   |   |       |  
|----------------------- |  | -------------- | ----- | - | ----------------- | - | ----- | -
|Inventory Type          |  | March 31, 2004 |       |   | December 31, 2003 |  
|                        |  | (in 000s)     |      
|Raw materials           |  | $              | 2,708 |   |                   | $ | 2,812 |  
|Work in progress        |  |                | 174   |   |                   |   | 151   |  
|Finished goods          |  |                | 3,499 |   |                   |   | 3,322 |  
|                        |  |                |       |   |                   |   |       |  
|                        |  |                | 6,381 |   |                   |   | 6,285 |  
|Less: Inventory reserve |  |                | (283  | ) |                   |   | (255  | )
|                        |  |                |       |   |                   |   |       |  
|                        |  | $              | 6,098 |   |                   | $ | 6,030 |  
|                        |  |                |       |   |                   |   |       |  



Reusable Surgical Products, Net



Reusable surgical products, consisting principally of
gowns, towels, drapes and basins, are stated at cost. Amortization is computed on a basis similar to the units of production method. Estimated useful lives are based on the estimated total number of available uses for each product. The expected
total available usage for products using the three principal fabrics (accounting for 85% of the reusable surgical products) is 75, 100, and 125 uses, respectively, based on several factors including our actual experience with these products.
Accumulated amortization as of March 31, 2004, and December 31, 2003, was approximately $13.5 million and $13.3 million, respectively.



As of March 31, 2004, and December 31, 2003, the Company had reserves for shrinkage, obsolescence, and scrap of approximately $887,000 and $882,000
million, respectively.



Revenue Recognition



Revenues are recognized as the agreed upon products and services are
delivered, generally daily.Packing slips signed and dated by the customer evidence delivery of product. The Companys contractual relationships with its customers are primarily evidenced by purchase orders or service agreements with
terms varying from one to five years, which are generally cancelable by either party.



The Company owns substantially all of the reusable surgical products provided to customers. A third party provides the reusable surgical instruments that are included in the comprehensive surgical procedure-based
delivery and retrieval service and receives a fee from SRI. In accordance with Emerging Issues Task Force (EITF) No. 99-19, Reporting Revenue Gross as a Principal versus Net as an Agent, the Company has concluded that it is acting
as a principal in this arrangement and has reported the revenue gross for the comprehensive surgical procedure-based delivery and retrieval service. The third party agent fee charged to the Company is included in cost of revenues in the statements
of operations.



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Stock Based Compensation



The following table illustrates the effect on the Companys net income (loss) and earnings (loss) per share if the Company recognized compensation
expense based upon the fair value at the grant date for awards under its option plans consistent with the methodology prescribed by SFAS 123:



|                                     |  |                              |       |   |      |   |       |  
|------------------------------------ |  | ---------------------------- | ----- | - | ---- | - | ----- | -
|                                     |  | Three Months Ended March 31, |      
|                                     |  | 2004                         |       |   | 2003 |  
|Reported net income                  |  | $                            | 125   |   |      | $ | 192   |  
|Compensation expense, net of tax (1) |  |                              | (149  | ) |      |   | (209  | )
|                                     |  |                              |       |   |      |   |       |  
|Pro forma net loss                   |  | $                            | (24   | ) |      | $ | (17   | )
|                                     |  |                              |       |   |      |   |       |  
|Reported basic earnings per share    |  | $                            | 0.02  |   |      | $ | 0.03  |  
|Compensation expense, net of tax (1) |  |                              | (0.02 | ) |      |   | (0.03 | )
|                                     |  |                              |       |   |      |   |       |  
|Pro forma basic earnings per share   |  | $                            |      |   |      | $ |      |  
|                                     |  |                              |       |   |      |   |       |  
|Reported diluted earnings per share  |  | $                            | 0.02  |   |      | $ | 0.03  |  
|Compensation expense, net of tax (1) |  |                              | (0.02 | ) |      |   | (0.03 | )
|                                     |  |                              |       |   |      |   |       |  
|Pro forma diluted earnings per share |  | $                            |      |   |      | $ |      |  
|                                     |  |                              |       |   |      |   |       |  

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|(1) | Compensation expense determined at the grant date for stock option awards consistent with the methodology prescribed by SFAS 123
|--- | --------------------------------------------------------------------------------------------------------------------------------



Line of Credit



The Company has a $30.0 million revolving credit agreement with Wachovia Bank and SouthTrust Bank. The Companys
outstanding balances under the revolving credit facility were approximately $7.3 million and $7.0 million on March 31, 2004, and December 31, 2003, respectively.



The credit facility is secured by substantially all of the Companys assets and has a scheduled maturity date of June
30, 2006. The facilitys interest rate varies between 200 and 350 basis points over LIBOR (3.69% as of March 31, 2004), depending on the Companys consolidated leverage ratio. The credit facility requires the Company to maintain (a)
tangible net worth of not less than $45.0 million plus 75% of cumulative net income for each fiscal quarter beginning with the fiscal quarter ended June 30, 2003; (b) a consolidated leverage ratio of not more than 2.5 to 1.0 measured as of the end
of each fiscal quarter for the four fiscal quarters then ended; and (c) a funds flow coverage ratio of not less than 2.5 to 1.0 measured at the end of each fiscal quarter. The credit facility restricts the Company from paying dividends, incurring
additional indebtedness, encumbering its assets, and entering into merger, consolidation or liquidation transactions representing greater than 10% of consolidated assets. The Company complied with all requirements of the credit facility as of March
31, 2004.



The credit facility allows the Company to repurchase
its common stock through open market purchases at prevailing market prices. During the quarter ended March 31, 2004, the Company did not repurchase any shares of its common stock. During the year ended 2003, the Company repurchased 6,753 shares of
its common stock at an aggregate cost of approximately $36,000.



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NOTE C  EARNINGS PER SHARE



The following table sets forth the Companys computation of basic and diluted earnings per share:



|                                                       |  |                                      |       |      |   |      
|------------------------------------------------------ |  | ------------------------------------ | ----- | ---- | - | -----
|                                                       |  | Three Months Ended March 31,        
|                                                       |  | 2004                                 |       | 2003
|                                                       |  | (In thousands, exceptper share data)
|Basic                                                  |  |                                      |       |      |   |      
|Numerator:                                             |  |                                      |       |      |   |      
|Net income                                             |  | $                                    | 125   |      | $ | 192  
|                                                       |  |                                      |       |      |   |      
|Denominator:                                           |  |                                      |       |      |   |      
|Weighted average shares outstanding                    |  |                                      | 6,263 |      |   | 6,269
|                                                       |  |                                      |       |      |   |      
|Earnings per common share, basic                       |  | $                                    | 0.02  |      | $ | 0.03 
|                                                       |  |                                      |       |      |   |      
|Diluted                                                |  |                                      |       |      |   |      
|Numerator:                                             |  |                                      |       |      |   |      
|Net income                                             |  | $                                    | 125   |      | $ | 192  
|                                                       |  |                                      |       |      |   |      
|Denominator:                                           |  |                                      |       |      |   |      
|Weighted average shares outstanding                    |  |                                      | 6,263 |      |   | 6,269
|Effect of dilutive securities - employee stock options |  |                                      | 71    |      |   | 5    
|                                                       |  |                                      |       |      |   |      
|                                                       |  |                                      | 6,334 |      |   | 6,274
|                                                       |  |                                      |       |      |   |      
|Earnings per common share, diluted                     |  | $                                    | 0.02  |      | $ | 0.03 
|                                                       |  |                                      |       |      |   |      



Options to purchase
534,300 and 959,000 shares of common stock for the three-month periods ended March 31, 2004, and March 31, 2003, respectively, were not included for all or a portion of the computation of diluted earnings per common share, because the options
exercise prices were greater than the average market price of the common shares, and therefore, the effect would be anti-dilutive.



Item 2. Managements Discussion and Analysis of Financial Condition and Results of Operations



Overview



The following discussion and analysis should be read with our financial statements and the notes thereto included elsewhere in this report. This
discussion and analysis contains trend analysis and might contain forward-looking statements. These statements are based on current expectations, and actual results might differ materially. Among the factors that could cause actual results to vary
are those described in Critical Accounting Policies and Certain Considerations included in this report and Business-Risk Factors That Might Affect Future Results included in our 2003 Annual Report on Form 10-K filed
with the SEC.



We provide central processing and supply
chain management services to hospitals and surgery centers throughout the United States. We help health care providers balance their needs for quality, safety, efficiency and cost-effectiveness by providing a unique combination of outsourced
instrument supply and processing services, high-quality reusable products (including gowns, towels, drapes, and basins) disposable surgical products, and what we believe to be the industrys most comprehensive case cart management system.



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Our integrated closed-loop process starts with daily delivery of surgical supplies to the
health care provider. At the same time, we pick up used reusable textiles and surgical instruments for return to our processing facility. We operate from ten Food and Drug Administration regulated processing facilities and one disposable products
facility, strategically located throughout the United States of America. After we return used products to our processing facility, we sort, clean, inspect, package, sterilize, and ship them back to the health care providers to stock on-hand
inventory.



Our revenue growth is primarily determined by our
number of customers, the number and type of surgical procedures that we service for each customer, and pricing for our various types of surgical packs and procedures. Our revenue growth and efficiency in delivering products and services to customers
primarily determine our profitability.



We continue to
experience an adverse impact on our gross profit and net income principally because of pricing pressures from competitors offering disposable alternatives to our core products. We continue to develop strategic measures to strengthen and build our
customer relationships and upgrade our staff, facilities, and internal processes to improve results in 2004 and coming years.



During the first quarter of 2004 we completed implementation of Radio Frequency Identification (RFID) technology in all ten of our processing facilities
across the United States, a process commenced in the fourth quarter of 2003. RFID technology is a powerful method for identifying and tracking a wide range of objects in diverse environments based on the use of a small tag (or
transponder) that stores a unique code, together with additional information that the user may specify. A reader is used both to transmit a signal to a tag and retrieve stored information from it; no contact or line-of-sight
is required, and long operating ranges are possible. Our utilization of RFID tags replaces the use of labor intensive bar code scanning to track product usage and should benefit us with improved inventory control, better monitoring of quality and
enhancement of productivity. The total cost for us to implement RFID technology has been approximately $2.2 million. We are considering additional uses of RFID technology.



Critical Accounting Policies



The preparation of our financial statements and related disclosures in conformity with accounting principles generally accepted in the United States of
America requires management to make judgments, assumptions, and estimates that affect the amounts reported in our financial statements and accompanying notes. We evaluate our estimates and assumptions based upon historical experience and various
other factors and circumstances. Management believes that these estimates and assumptions are reasonable under the circumstances; however, actual results may vary from these estimates and assumptions. We identified the following critical accounting
policies that affect the more significant judgments, assumptions and estimates used in preparing our financial statements:



Allowance for Doubtful Accounts.Our allowance for doubtful accounts is based on our assessment of the collectibility of specific customer accounts
and the overall aging of our accounts receivable. If a major customers creditworthiness deteriorates or actual defaults run at a rate higher than historical experience, we would be required to increase this allowance, which could adversely
affect our results of operations.



Amortization of Reusable
Surgical Products.We state our reusable surgical products at cost and compute amortization on a basis similar to the units of production method. We estimate the useful lives for each product based on our estimate of the total number of
uses for which the product will be available. We estimate that our products using the three principal fabrics (accounting for 85% of the reusable surgical products) will be available for 75, 100, and 125 uses, respectively, based on
several factors, including our actual experience with these products. If our actual use experience with these products is shorter than these assumptions, our amortization rates for reusable products would increase, which could adversely affect our
results of operations.



Reserves for Shrinkage,
Obsolescence, and Scrap for Reusable Surgical Products.We determine our reserves for shrinkage and obsolescence of our reusable products by tracking those products with our radio frequency identification system (RFID). We determine our reserve
for scrap based upon quality assurance initiatives and historical evidence. Based on historical experience, we believe that any products not scanned by the system for a 210-day period are lost. If actual scrap and loss exceed our estimates, our
reserve for shrinkage, obsolescence, and scrap would increase, which could adversely affect our results of operations.



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Reserves for Shrinkage and Obsolescence for Inventories. We determine our reserves for shrinkage
and obsolescence of our inventories based on historical results, including the results of cycle counts performed during the year and the evaluation of the aging of finished goods of reusable surgical products and disposable packs. If actual losses
exceed our estimates and assumptions, our inventory reserves would increase, which could adversely affect our results of operations.



Impairment of Goodwill and Other Intangible Assets.We review our goodwill for impairment annually or more frequently if indicators of impairment
arise using the process prescribed in SFAS 142,Goodwill and Other Intangible Assets. The impairment analysis is based on assumptions of future results made by management, including revenues and cash flows. Circumstances that may lead to
impairment of goodwill include unforeseen decreases in future performance or demand, or the restructuring of our operations as a result of a change in our strategy. Any impairment could adversely affect our results of operations.



Results of Operations



The following table sets forth for the periods shown the percentage of
revenues represented by certain items reflected in the statements of income of the Company:



|                                    |  |                             |   |  |       |  
|----------------------------------- |  | --------------------------- | - |  | ----- | -
|                                    |  | Three Months EndedMarch 31, |  
|                                    |  | 2004                        |   |  | 2003  |  
|Revenues                            |  | 100.0                       | % |  | 100.0 | %
|Cost of revenues                    |  | 74.9                        |   |  | 72.9  |  
|                                    |  |                             |   |  |       |  
|Gross profit                        |  | 25.1                        |   |  | 27.1  |  
|                                    |  |                            
|Distribution expenses               |  | 6.8                         |   |  | 7.1   |  
|Selling and administrative expenses |  | 16.4                        |   |  | 17.1  |  
|                                    |  |                             |   |  |       |  
|Income from operations              |  | 1.9                         |   |  | 2.9   |  
|                                    |  |                            
|Interest expense, net               |  | 1.1                         |   |  | 1.5   |  
|                                    |  |                             |   |  |       |  
|Income before income taxes          |  | 0.8                         |   |  | 1.4   |  
|                                    |  |                            
|Income tax expense                  |  | 0.3                         |   |  | 0.5   |  
|                                    |  |                             |   |  |       |  
|Net income                          |  | 0.5                         | % |  | 0.9   | %
|                                    |  |                             |   |  |       |  



Three Months Ended March 31, 2004
Compared to Three Months Ended March 31, 2003



We operate
on a 52-53 week fiscal year ending the Sunday nearest December 31. There are 14 weeks included for the three-month period ended March 31, 2004 and 13 weeks included for the three-month period ended March 31, 2003.



Revenues. Revenues increased $2.4 million or 11.2%, to $23.9
million for the three months ended March 31, 2004, from $21.5 million for the three months ended March 31, 2003. The increase in revenues is primarily attributable to an extra week of operations and the growth in our instrument processing programs
from our quarter ended March 31, 2003 to our quarter ended March 31, 2004.



Gross Profit. Gross profit increased $157,000 or 2.7%, to $6.0 million for the three months ended March 31, 2004, from $5.8 million for the three months ended March 31, 2003. As a percentage of revenues,



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gross profit decreased by 2.0% to 25.1% for the three months ended March 31, 2004, from 27.1% for the three months ended
March 31, 2003. The decrease in gross profit percentage reflects the continued impact of competitive pricing pressures as well as increased costs of health insurance, depreciation and property taxes.



Distribution Expenses. Distribution expenses increased $87,000,
or 5.7%, to $1.6 million for the three months ended March 31, 2004, from $1.5 million for the three months ended March 31, 2003. As a percentage of revenues, distribution expenses decreased by 0.3 % to 6.8% for the three months ended March 31, 2004,
from 7.1% for the three months ended March 31, 2003. The decrease in distribution expenses as a percentage of revenues is a result of our leveraging distribution expenses associated with existing routes.



Selling and Administrative Expenses. Selling and administrative
expenses increased $255,000, or 7.0%, to $3.9 million for the three months ended March 31, 2004, from $3.7 million for the three months ended March 31, 2003. As a percentage of revenues, selling and administrative expenses decreased 0.7% to 16.4%
for the three months ended March 31, 2004, from 17.1% for the three months ended March 31, 2003. The percentage of selling and administrative expenses as a function of revenues decreased primarily due to lower professional, legal, accounting and
recruiting fees, partially offset by increased compensation costs.



Income from Operations. Income from operations decreased $185,000, or 29.5%, to $442,000 for the three months ended March 31, 2004, from $627,000 for the three months ended March 31, 2003. As a percentage of revenues, income
from operations decreased 1.0% to 1.9% for the three months ended March 31, 2004, from 2.9% for the three months ended March 31, 2003.



Interest Expense, Net. Interest expense decreased $78,000 to $241,000 for the three months ended March 31, 2004, from $319,000 for the three
months ended March 31, 2003. The decrease in interest expense was primarily due to the reduction of the outstanding balance of the line of credit from $14.0 million at March 31, 2003, to $7.3 million at March 31, 2004.



Income Tax Expense.Income tax expense decreased $40,000 to
$76,000 for the three months ended March 31, 2004, compared to $116,000 for the three months ended March 31, 2003. Income tax expense is a function of our net income and effective tax rate. The effective tax rate for the three months ended March 31,
2004 was 37.8%, compared to 37.7% for the same period last year.



Liquidity and Capital Resources



Our
principal source of capital has been cash flows from operations. We also borrow from our revolving line of credit from time to time to satisfy working capital and capital expenditure needs.



We generated $439,000 of cash from operating activities during the three
months ended March 31, 2004, compared to $2.0 million generated during the three months ended March 31, 2003. Our cash flow decreased during this time period in comparison to the prior period principally due to delays in collections for accounts
receivable and decreases in accounts payable to RFID vendors from December 31, 2003.



Net cash used in investing activities increased $402,000 for the three months ended March 31, 2004 to $915,000 from $513,000 for the three months ended March 31, 2003. The increase is due primarily to an increase in
purchases of reusable surgical products.



We spent $194,000 and
$309,000 in the three months ended March 31, 2004 and 2003, respectively, on purchases of property, plant and equipment. We spent $721,000 and $204,000 in the three months ended March 31, 2004 and 2003, respectively, on purchases of reusable
surgical products. We estimate that our expenditures for property, plant and equipment and reusable surgical products will be $10 to $11 million for the remainder of 2004, however, this amount will fluctuate depending on the growth of our business.



Our credit facility allows us to repurchase our outstanding
common stock through open market purchases at prevailing market prices. During the quarter ended March 31, 2004, we did not repurchase any shares of our common stock. During the year ended 2003, we repurchased 6,753 shares of our common stock at an
aggregate cost of approximately $36,000.



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As of March 31, 2004, we had cash of $221,000 as well as an additional $7.0 million available under our
revolving credit facility. Our outstanding balance under the revolving credit facility was approximately $7.3 million and $7.0 million on March 31, 2004, and December 31, 2003, respectively. The amount available under our revolving credit facility
is limited by a financial covenant requiring that we maintain a 2.5 to 1.0 consolidated leverage ratio at the end of each fiscal quarter. The credit facility is scheduled to mature on June 30, 2006. We believe that our cash flows from operating
activities and funds available under our credit facility will be sufficient to fund our growth and anticipated capital requirements for the next twelve months.



Item 3. Quantitative And Qualitative Disclosures About Market Risk



The outstanding balances under our $30.0 million revolving credit facility were approximately $7.3 million and $7.0 million on March 31, 2004 and December
31, 2003, respectively. The credit facilitys interest rate varies between 200 and 350 basis points over LIBOR (3.69% as of March 31, 2004), depending on our leverage ratio (earnings coverage of debt). We are subject to changes in our interest
expense on this facility based on fluctuations in interest rates. Assuming an outstanding balance of this facility of $7.3 million, if LIBOR were to increase (decrease) by 100 basis points, our interest payments would increase (decrease) by $18,250
per quarter.



Interest on our bonds that financed two of our
facilities is at a rate that approximates LIBOR. We are subject to changes in our interest expense on these bonds based on fluctuations in interest rates. Assuming an outstanding balance of these bonds of $9.5 million, if LIBOR were to increase
(decrease) by 100 basis points, our interest payments would increase (decrease) by $23,750 per quarter.



We do not have any other material market risk sensitive instruments.



Certain Considerations



This report, other documents that are publicly disseminated by the Company, and oral statements that are made on behalf of the Company contain or might
contain both statements of historical fact and forward-looking statements. Examples of forward-looking statements include: (a) projections of revenue, earnings, capital structure, and other financial items, (b) statements of the plans and objectives
of the Company and its management, (c) statements of future economic performance, and (d) assumptions underlying statements regarding the Company or its business. The statements set forth below discuss important factors that could cause actual
results to differ materially from any forward-looking statements. The Company assumes no obligation to update these forward-looking statements.



Sales Process and Market Acceptance of Products and Services. Our future performance depends on our ability to increase revenues to new and
existing customers. Our sales process to acquire new customers is typically between six and eighteen months in duration from initial contact to purchase commitment, due to industry factors such as the complicated approval process within hospitals
for purchases from new suppliers, the long duration of existing supply contracts, and implementation delays pending termination of a hospitals previous supply relationships. Our future performance also depends on market acceptance of our
product and service offerings, which emphasize the delivery and retrieval of reusable surgical products to a market that predominantly uses disposable products. We are also regularly developing new instrument processing programs. We are subject to a
risk that the market will not broadly accept these product offerings.



Need for Capital. Our business is capital intensive and requires annual capital expenditures for additional surgical products and equipment to achieve our operating plans. Our inability to obtain adequate capital could
have a material adverse effect on us. See  Liquidity and Capital Resources.



Dependence on Suppliers. We rely on Aesculap, Inc. as our major source of supply of instruments for our instrument processing programs. Any failure of Aesculap to furnish instruments for any
reason would materially and adversely affect our ability to service this program until we secured one or more alternative suppliers. We also have a procurement agreement with Standard Textile Co., Inc. as our supply source for our reusable surgical
products through August 2008. If Standard Textile were unable to perform under this agreement, we would be materially and adversely affected until we could secure alternative suppliers.



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Dependence on Significant Customers.During the three months ended March 31, 2004,
Novation, HPG, and Premier, Inc. hospitals accounted for approximately 34%, 15%, and 9% of our sales, compared to 35%, 15%, and 10%, respectively, for the three months ended March 31, 2003,respectively. No single hospital accounts for more
than 7% of our sales. Although each Novation, HPG, and Premier hospital currently makes its purchasing decisions on an individual basis, the loss of a substantial portion of the Novation, HPG, or Premier hospitals business would have a
material adverse effect on us.



Competition. Our
business is highly competitive. Competitors include a number of distributors and manufacturers, as well as the in-house reprocessing operations of hospitals. Certain of our existing and potential competitors possess substantially greater resources
than us. Some of our competitors, including Allegiance Corporation (a subsidiary of Cardinal Health, Inc.) and Medline Industries, Inc., serve as the sole supplier of a wide assortment of products to a significant number of hospitals. While we have
a substantial array of surgical products, many of our competitors have more products for the entire hospital, which in some instances is a competitive disadvantage for us. There is no assurance that we will be able to compete effectively with
existing or potential competitors.



Government
Regulation. Significant aspects of our businesses are subject to state and federal statutes and regulations governing, among other things, medical waste-disposal and workplace health and safety. In addition, most of the products
furnished or sold by us are subject to regulation as medical devices by the U.S. Food and Drug Administration (FDA), as well as by other federal and state agencies. Our facilities are subject to quality systems inspections by FDA officials. The FDA
has the power to enjoin future violations, seize adulterated or misbranded devices, and require the manufacturer to remove products from the market, and publicize relevant facts. Federal or state governments might impose additional restrictions or
adopt interpretations of existing laws that could materially adversely affect us.



Item 4. Controls and Procedures



Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of the design and operation of our disclosure
controls and procedures. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective in timely alerting them to material information required to be included in
our filings with the SEC.



We have also evaluated our internal
controls for financial reporting, and there have been no significant changes in our internal controls or in other factors that are reasonably likely to significantly affect internal controls subsequent to the date we carried out our evaluation.



Any system of disclosure controls and internal controls, even
if well-conceived, is inherently limited in detecting and preventing all errors and fraud and provides reasonable, not absolute, assurance that its objectives are met. The design of a control system must reflect resource constraints. Inherent
limitations include the potential for faulty judgments in decision-making, breakdowns because of simple error or mistake, and circumvention of controls by individual acts, collusion of two or more people, or management override of the controls. We
included certifications of our Chief Executive Officer and Chief Financial Officer as exhibits to this report as required by Section 302 of the Sarbanes-Oxley Act of 2002. The foregoing information concerning our evaluation of disclosure controls
referenced in the Section 302 certifications should be read with the Section 302 certifications to more completely understand them.



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PART II  OTHER INFORMATION



Item 1. Legal Proceedings



None.



Item 2. Changes in Securities and Use of Proceeds



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



|              |  |                                                                                                                                                                                                                                                                
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit Description                                                                                                                                                                                                                                            
|31            |  | Certifications by the Chief Executive Officer (CEO) and the Chief Financial Officer (CFO) of the Company pursuant to Rule 13a-14 under the Securities Exchange Act of 1934 (the Exchange Act)
in accordance with Section 302 of the Sarbanes-Oxley Act of 2002.
|              | 
|32            |  | Certification by the CEO and CFO of the Company pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. (Not deemed to be filed with the Securities and Exchange
Commission).                                                                             



Reports on Form 8-K



On March 1, 2004, we filed a report on Form 8-K
announcing our results of operations for the quarter and year ended December 31, 2003.



On March 5, 2004, we filed a report on Form 8-K announcing that James T. Boosales, a director of SRI, plans to enter into an individual sales plan complying with Rule 10b5-1 for trading shares of our common stock.



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SIGNATURES



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



|                   |  |  |  |                            |  |                         |  |                        
|------------------ |  |  |  | -------------------------- |  | ----------------------- |  | -----------------------
|                   |  |  |  | SRI/SURGICAL EXPRESS, INC.
|                   |  |  | 
|Date: May 11, 2004 |  |  |  | By:                        |  | /s/ Joseph A. Largey   
|                   |  |  |  |                            |  |                         |  | Chief Executive Officer
|                   |  |  | 
|Date: May 11, 2004 |  |  |  | By:                        |  | /s/ Charles L. Pope    
|                   |  |  |  |                            |  | Chief Financial Officer



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