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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C.

FORM 10-K

(Mark one)

For the fiscal year ended December 31, 2003

or

For the transition period from              to             

Commission file number: 000-20997

SRI/SURGICAL EXPRESS, INC.

(Exact Name of Registrant as Specified in Its Charter)

Registrant’s telephone number, including area code:

(813) 891-9550

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

None

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

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

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

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

The aggregate market value of the voting common stock held by non-affiliates of the Registrant, based on the closing sale price of the Common Stock on June 30, 2003, as reported on the NASDAQ National Market, was approximately $42,968,584. For purposes of this determination, the Registrant excluded shares of Common Stock known to be held by officers and directors, because those persons might be deemed affiliates. This determination of affiliate status is not necessarily conclusive for other purposes.

The Registrant had 6,262,524 shares of Common Stock outstanding as of February 27, 2004.

DOCUMENTS INCORPORATED BY REFERENCE

The Registrant’s Definitive Proxy Statement for the 2004 Annual Meeting of Shareholders to be held on May 19, 2004 is incorporated by reference in Part III of this Annual Report on Form 10-K to the extent stated.

Table of Contents

SRI/SURGICAL EXPRESS, INC.

FORM 10-K

YEAR ENDED DECEMBER 31, 2003

Table of Contents

PART I

Item 1. Business

This report, other documents that we publicly disseminate, and oral statements that are made on our behalf might contain both statements of historical fact and forward-looking statements. These forward-looking statements do not guarantee future performance, and our actual results could differ materially from those indicated by the forward-looking statements. Examples of forward-looking statements include: (i) our projections of revenue, earnings, capital structure, and other financial items, (ii) statements of our plans and objectives, (iii) our statements of expected future economic performance, and (iv) our assumptions underlying statements regarding SRI/Surgical Express, Inc. and our business. Among the factors that could cause or contribute to differences are those discussed below under “Risk Factors That Might Affect Future Results.”

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. We believe that this combination of superior quality products, outsourcing services and flexible delivery solutions differentiates us from our competitors.

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. After we return used products to our processing facility, we sort, clean, inspect, package, sterilize, and ship them back to the health-care provider for use. This “closed-loop” system eliminates the need for health care providers to stock on-hand inventory and greatly simplifies our customers’ surgical supply chain process.

We believe that we offer a better alternative to entirely disposable custom procedure packs by combining reusable and disposable products. Our reusable products allow health care providers to reduce medical waste disposal costs and also increase the quality of surgical gowns used by their staff and physicians. Additionally, with our daily just-in-time delivery model, our customers’ working capital requirements should be favorably affected by their ability to carry less on-hand inventory to support their surgical procedures.

With the continued growth of managed care and reductions in procedure reimbursement, health care providers are under significant pressure to reduce operating costs while improving the quality of care. We are uniquely positioned to help with both objectives. To reduce operating costs, we offer comprehensive procedure bundling solutions and outsourcing of surgical instrument processing. By providing surgical instruments of superior functionality and bundling solutions that allow surgical staff to shift focus from supply management to patient management, we help our customers to improve the quality of care that they provide to their patients.

We maintain an internet website located at www.surgicalexpress.com. On our website we make available, free of charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, our current reports on form 8-K, and any amendments to those reports filed or furnished to the Securities and Exchange Commission (SEC). This information is made available as soon as reasonably practicable after we electronically file with or furnish to the SEC. Information contained in our website, whether currently posted or posted in the future, is not part of this document or any documents incorporated by reference in this document.

Our Code of Ethics and Corporate Compliance Policy is also posted at our website.

Market

The United States health care market includes approximately 6,000 acute care hospitals and 2,750 freestanding surgery centers. According to industry sources, these health care providers performed approximately 33 million surgical procedures in 2003.

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Prior to the 1970s, over 90% of all gowns and drapes used in surgery were made of reusable linen. These products were typically reprocessed by hospital personnel and were not of high quality or duration of life. In the late 1970s, vendors introduced disposable gowns and drapes as an alternative to then inferior performing reusable counterparts. Over the next 30 years, a market shift occurred and today approximately 90% of all gowns and drapes used in surgery are disposable.

In the 1980s, health care providers began requesting that vendors bundle single-use disposable items into custom procedure packs that are custom-designed for each surgical procedure and typically contain most of the disposable sterile products required for surgery. The packs offer increased convenience for the surgical staff. Growth of custom procedure packs continued through the 1990s to a market that we estimate to be $1.5 billion annually in the United States.

In the early 1990s, we successfully introduced reusable surgical gowns and drapes of exceptional quality for health care suppliers seeking an alternative to disposable products. We supplemented those reusable products with disposable custom packs that complete the product requirements of a surgical procedure. In recent years we introduced the supply and reprocessing of high quality surgical instruments, and can now manage our customers’ central processing and supply chain management for all products that they require for surgical procedures.

The following market conditions and strategies provide continuing opportunities for us:

Concern Regarding the Transmission of Infectious Diseases. The health care industry must manage the risk of infectious disease. These concerns increase the need for surgical barrier fabrics that protect surgeons and surgical staff from blood-borne pathogens. Our line of ComfortSure^™ gowns helps to prevent liquid and viral strike-through in critical areas during surgical procedures.

Concern Regarding the Handling and Disposal of Biohazardous Waste. The disposal of large volumes of infectious and hazardous waste generated by the health care industry continues to attract increased public awareness. Health care providers are under pressure to reduce their generation of biohazardous waste because of restrictions on incineration and limited access to dump sites. This market dynamic offers an advantage to companies that provide outsourced reusable alternatives to disposable surgical products.

Continued Pressure on Providers to Contain Costs and Improve Profitability. With growth of managed care and a decrease in surgical service reimbursements, economic constraints continue to require providers to become more efficient. To assist them in reducing their cost of operation, we offer products and services that help our customers eliminate inventory, reduce staff, capital expenditures and medical waste, and improve their overall supply chain efficiency.

Increased Outsourcing of Provider Functions That Do Not Involve Patient Care. Providers with significant staff, capital and space dedicated to in-house processing of reusable surgical products and surgical instruments are outsourcing these functions to qualified outsourcing providers. By enabling our customers to outsource non-core functions, we allow our customers to increasingly focus on patient care.

Leverage Infrastructure with Increased Penetration in Existing Markets. Our existing facilities combined currently operate at approximately 25- to 30% of their aggregate annual revenue capacity and provide ample room for business growth without incremental capital investment.

Customers

As of December 31, 2003, we serve a customer base of hospitals and surgery centers located in 21 states throughout the United States. Our strategy is to concentrate on the supply chain management needs of hospital operating rooms and surgery centers that are surgical procedure intensive.

We maintain agreements to supply several group purchasing organizations, including Novation, HealthTrust Purchasing Group (HPG), Premier, Inc., and MedAssets HSCA. Novation is the supply company for Voluntary

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Hospitals of America (VHA) and University HealthSystem Consortium (UHC). HealthTrust Purchasing Group (HPG) is a group purchasing organization representing over 600 hospitals and surgery centers. MedAssets is the largest independent purchasing group in the United States. With Novation, HPG, MedAssets and other agreements, our products and services are available to over 2,000 providers and surgery centers across the United States. We continue to pursue additional group purchasing organization contracts that would allow us opportunities to further penetrate the health care market.

Products

Our principal reusable surgical products are ComfortSure^™ surgical gowns. We also offer reusable towels, surgical drapes, and stainless steel basin sets as part of our reusable surgical product line. We provide these products in a variety of configurations for a provider’s specific needs. A major benefit of our reusable system is reduced medical waste because of the elimination of disposable, single-use products.

Our ComfortSure^™ Liquid Proof gown and the new ComfortSure^™ Premium Protection Liquid Resistance gown are both made from GORE^® Surgical Barrier Fabric materials that are highly breathable and provides excellent protection to the user. The added protection is critical to health care providers given continuing concerns of doctors, staff, and regulatory authorities regarding transmission of blood-borne pathogens, including HIV and hepatitis viruses. The Liquid Proof and Premium Protection Liquid Resistance gowns are ideal for procedures with high liquid volume and of longer duration. Our Standard Micro-Fiber Surgical gown is made from an advanced microfiber polyester fabric and is ideal for procedures with minimal fluid exposure and of shorter duration.

We contract with third-party vendors for weaving of microfiber fabric and cutting and sewing of gowns and drapes. In August 1998, we signed a ten-year sales and manufacturing agreement with Standard Textile Co., Inc., under which Standard Textile manufactures the bulk of our reusable textile products with fabric provided by W.L. Gore and other textile suppliers.

To complement our reusable surgical products, we offer disposable accessory packs containing single-use disposable products, such as needles, syringes, and tubing. These packs are developed to a customer’s specifications and in combination with our reusable line of surgical products, offer a cost-effective, high-quality alternative to custom procedure packs containing all disposable products.

Our instrument-processing program, called AccuSet^SM, offers our customers the benefit of consistently available surgical instruments processed at an FDA regulated facility. Our thorough inspection and cleaning process assures that surgical instruments are functional and meet rigorous quality standards. At this time, we offer general, laparoscopic, orthopedic, and labor and delivery instrument processing at our facilities. As of December 31, 2003, we serviced instrument programs at 36 hospitals from eight of our facilities.

We offer instruments pursuant to a ten-year Joint Marketing Agreement executed in April 2003 with Aesculap, Inc., one of the oldest and largest worldwide suppliers of surgical instruments. This agreement renewed our relationship initiated with Aesculap in April 2000. Aesculap furnishes and repairs surgical instruments that we deliver to our customers. Aesculap receives an agreed upon fee from each procedure based on the number and kinds of procedures performed with its instruments and the number and combination of instruments used for each procedure.

Our physician specific ReadyCase^SM case cart management system combines reusable products, disposable packs, surgical instruments, and physician preference items to provide all the products required for a surgical procedure. The system allows customers to develop and implement best practice protocols. We believe that ReadyCase^SM is the most complete case cart system available in the market. By delivering such a high percentage of surgical products and instruments used in a procedure, ReadyCase^SM seeks to reduce our customers’ supply chain management costs, improve their operational efficiency, and increase their revenue by improving throughput in their surgical area.

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We recently completed the implementation of Radio Frequency Identification (RFID) Technology in our ten processing facilities. RFID Technology is a method for identifying and tracking objects based on the use of a small tag that stores a unique code. We incorporated “multi-read” RFID tags into our reusable surgical gowns and drapes, which allows us to replace the use of labor intensive bar code scanning to track product usage. This technology offers us improved inventory control-and monitoring of product quality. See also “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview.”

Employees

As of December 31, 2003, we employed 922 people, consisting of 51 persons in management, administration and finance at our corporate office, and 871 people in various positions at our facilities. Our employees are not covered by a collective bargaining agreement. We consider our employee relations to be good.

Competition

We compete primarily with sellers of disposable gowns, drapes, basins and custom packs. Most of our competitors are substantially bigger than us and offer national coverage. Our principal competitors are Allegiance Corporation (a subsidiary of Cardinal Health, Inc.), Medline Industries, Inc., DeRoyal Industries, and Kimberly Clark Corporation.

The challenging health care environment in recent years has led to increasingly intense competition among suppliers and manufacturers of surgical products. As providers seek to reduce operating costs in response to pressure from governments, insurance companies, and health maintenance organizations, suppliers and manufacturers are being forced to compete on price, service, quality and delivery of innovative solutions that improve the health care supply chain. Even though competitive pressure will continue to intensify for the foreseeable future, we are well positioned to compete effectively due to our high-quality products and innovative outsourcing solutions.

Regulation

Substantially all of our products and services are subject to extensive government regulation in the United States by federal, state, and local governmental agencies, including the Food and Drug Administration (“FDA”), the Department of Transportation (“DOT”), and the Occupational Safety and Health Administration (“OSHA”).

Our reusable products are regulated as medical devices by the FDA, which regulates the development, production, distribution, and promotion of medical devices in the United States. Various states in which we do business also regulate medical devices. Pursuant to the Federal Food Drug and Cosmetics Act (the “FDA Act”), our medical devices are subject to general controls regarding FDA inspections of facilities, “Current Good Manufacturing Practices (“CGMP’s”)”, labeling, maintenance of records, and medical device reporting with the FDA. To the extent required, we have obtained FDA pre-market approval of our devices under Section 510(k) of regulations issued under the FDA Act, that provides for FDA approval on an expedited basis for products shown to be substantially equivalent to devices already cleared by the FDA and currently legally marketable in the United States. Products must be produced in establishments registered with the FDA and manufactured in accordance with CGMP’s, as defined under the FDA Act. In addition, our medical devices must be initially listed with the FDA, and our labeling and promotional activities are subject to scrutiny by the FDA and, in certain instances, by the Federal Trade Commission. The Medical Device Reporting regulation obligates us to provide information to the FDA on injuries or deaths alleged to have been associated with the use of a product or in connection with certain product failures that could have caused serious injury or death. If we fail to comply with the applicable provisions of the FDA Act, the FDA may institute proceedings to detain or seize products, impose fines, enjoin future company activities, impose product labeling restrictions, or enforce product recalls or withdrawals from the market.

Our hospital customers and ourselves also must comply with regulations of OSHA, including the bloodborne pathogen rule requiring standard “universal” precautions be observed to minimize exposure to blood

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and other bodily fluids. To comply with these requirements, our employees wear personal protective equipment when handling soiled linens in the facility’s decontamination area. Properly used, our products allow our hospital customers to protect their employees in compliance with these regulations. We must comply with local regulations governing the discharge of water used in our operations. We use local licensed contractors to dispose of any biohazardous waste generated by the hospital and received by us and therefore do not need to obtain permits for biohazardous waste disposal. We must comply with DOT and OSHA regulations governing the transportation of biohazardous materials, which include containing and labeling waste as well as reporting various discharges. We comply with these regulations by confining soiled products inside marked liquidproof bags for transport within locked, marked transfer carts. A third-party contractor provides sterilization of our disposable accessory packs. The use of ethylene oxide by the contractor in the sterilization of our disposable accessory packs is subject to regulation by FDA, OSHA, and the Environmental Protection Agency.

In addition, other federal, state and local regulatory authorities, including those enforcing laws which relate to the environment, fire hazard control, and working conditions, have jurisdiction to take actions that could have a material adverse effect on us. We make expenditures from time to time to comply with environmental regulations, but do not expect any material capital expenditures for environmental compliance in 2004.

Risk Factors That Might Affect Future Results

The cautionary statements set forth below discuss important factors that could cause actual results to differ materially from any 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 18 months in duration from initial contact to purchase commitment, because of 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 supply of reusable surgical products to a market that predominantly uses disposable products. We are also regularly developing new instrument 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 would have a material adverse effect on us. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” and “Note D of Notes to Financial Statements.”

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 these programs 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 secured alternative suppliers.

Dependence on Significant Customers. During 2003, Novation, HPG, and Premier, Inc. hospitals accounted for approximately 34%, 15%, and 10% of our sales, compared to 34%, 14%, and 11% in 2002, respectively. 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. No single health care provider accounts for more than 8% of our revenues.

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

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competitors possess substantially greater resources than the Company. 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 a greater number of 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. See “Business—Competition.”

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, 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, 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 and adversely affect us. See “Business—Regulation.”

Item 2. Properties

We operate ten processing facilities that range in size between 30,000 and 63,500 square feet in Baltimore, Chattanooga, Cincinnati, Dallas, Houston, Los Angeles, Raleigh, Salt Lake City, Stockton, and Tampa. Each facility has standardized processes and equipment, including computerized and fully automated heavy duty washers, dryers, and sterilizers to achieve consistent decontamination and sterilization of reusable surgical products and instruments. We use Good Manufacturing Practices at each facility, and regularly implement at all facilities efficiencies that have been developed and tested at one location.

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Our properties and the major markets that they serve are summarized below. We own our Chattanooga, Cincinnati, Houston, and Stockton processing facilities; we lease the remaining reprocessing facilities. We also lease our Disposable Accessory Pack facility in Plant City, Florida, where we assemble and package surgical products into customized disposable accessory packs. We transport these disposable accessory packs to a third party facility for sterilization before they are sent to our reprocessing facilities for final delivery. We believe our existing facilities adequately serve our current requirements. The table below summarizes our properties as of December 31, 2003:

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Item 3. Legal Proceedings

We are not subject to any litigation or other legal proceedings that we expect to have a material adverse effect on our business.

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

No matters were submitted to a vote of security holders during the fourth quarter of 2003.

PART II

Item 5. Market for Registrant’s Common Equity and Related Shareholder Matters

Our common stock trades publicly on the Nasdaq National Market system under the symbol “STRC.” The table below sets forth the high and low bid quotations for our common stock for fiscal years 2002 and 2003. These bid prices represent prices between dealers without adjustment for retail mark-ups, mark-downs, or commissions and do not necessarily represent actual transactions.

Common Stock Price Range

We have never declared or paid cash dividends on our common stock and do not anticipate paying dividends on our common stock in the foreseeable future. Additionally, financial covenants in our credit facility prohibit the payment of cash dividends. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” and “Notes to Financial Statements.”

On February 27, 2004, there were approximately 43 holders of record of our common stock.

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Item 6. Selected Financial Data

The following table contains certain selected financial data and is qualified by the more detailed Financial Statements and Notes thereto included elsewhere in this report. The selected financial data have been derived from our audited financial statements. The following information should be read in conjunction with the Financial Statements and Notes thereto and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included elsewhere in this report.

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The following selected unaudited quarterly information is being disclosed in accordance with Regulation S-K (Item 302):

Item 7. 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 Notes 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 this “Overview” section and in “Business—Risk Factors That Might Affect Future Results.”

We provide central processing and supply chain management services to hospitals and surgery centers throughout the United States. 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.

In 2003, our revenues were consistent with the prior two years. We experienced an adverse impact on our operating profit margins principally because of increased costs in several areas and pricing pressures from competitors offering disposable alternatives to our reusable products. Our successful efforts to add new customers and increase revenues at existing accounts were offset by customer losses in 2002 and 2003. Consequently, we suffered an annual loss for the first time since becoming a public company in 1996.

We responded last year with strategic measures designed to strengthen and build our customer relationships and upgrade our staff, facilities, and internal processes, efforts that we believe set the foundation for improved results in 2004 and coming years. These include the following:

Building existing customer relationships. With our full case-cart service, we have opportunities to expand the services that we furnish to existing customers so that we serve all of their surgical procedure needs. In June 2003, we joined with our strategic partner, Aesculap, in entering into a new Service and Supply Agreement with

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an existing customer Rex Healthcare, Inc., a major healthcare system in Raleigh, North Carolina. The agreement considerably increased the scope of our customer relationship with Rex Healthcare, especially with respect to instrument reprocessing. We provide supply chain management services, including surgical instruments processing and physician-specific procedure case cart delivery. Our case carts contain all medical supplies used during a surgical procedure including high-quality surgical instruments. Processing of all surgical instruments, provided by Aesculap, occurs at either our facility or in the Central Sterile Processing department at Rex Healthcare, which our employees manage. This agreement extends through June 30, 2010. We continue to seek and consider similar strategic relationships, including complementing our reusable surgical product offerings with instrument services and full case cart management at other existing customers.

Improved processes. In January 2004, we completed the successful implementation of Radio Frequency Identification (RFID) Technology in our ten processing facilities, a process commenced in the fourth quarter of 2003. We believe that this is among the first full integration of RFID Technology into Class II Medical Devices and among the largest uses to date of “multi-read” applications of RFID Technology. RFID Technology is a method for identifying and tracking objects in different 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. The incorporation of “multi-read” RFID tags into over one million of our reusable surgical gowns and drapes allows us to eliminate the use of labor intensive bar code scanning to track product usage. This technology offers us improved inventory control and monitoring of product quality. We anticipate realizing productivity enhancements over our bar code scanning results.

Facility consolidation. During the third and fourth quarters of 2003, we consolidated the operations of our Detroit facility into our Cincinnati facility. We converted the Detroit facility into a service center that distributes products to our customers in that market. We recognized exit costs totaling approximately $92,000 for employee severance and benefit costs and equipment impairment during 2003 in this consolidation. Approximately 45 production employees worked through the completion of the consolidation and received severance and benefits. We expect the consolidation to provide labor and other operational savings starting in 2004.

During the second quarter of 2003, we closed our Boston service center when we terminated service to our sole customer in that market, recognizing exit costs of approximately $104,000 for employee termination costs, contract termination costs, and inventory obsolescence to close this service center. Approximately eight production employees worked through the completion of the consolidation and received severance and benefits. We subleased the building to an unrelated third party for the remaining lease term. Although we have no immediate plans to consolidate or close any other facilities, we continue to evaluate ways to upgrade and improve our operations and our facilities to better serve our customers’ service and product needs.

Upgrade staff and facilities. In 2003, we determined that one of our most effective marketing programs would be to invite existing and potential customers to visit our operating facilities, review our production processes, and meet our employees. We dedicated resources for a one-time initiative to improve the appearance of our facilities, remove any poor quality gowns from our production process, and upgrade our personnel. We also added new leadership in sales, marketing, and operations at corporate, as well as, in our processing facilities. We believe that improvements to our sales and marketing organization in 2003 offer us good opportunities for revenue growth with new and existing customers in 2004. We believe that improvements to our operations organization will allow us to better leverage the capacity and functionality of our operating facilities. We continue to seek staff and facility improvement opportunities to complement our existing resources and make our business more effective and efficient.

Our principal strategic opportunity to improve our operating results is to leverage our considerable infrastructure by adding revenues from existing and new customers. Our existing facilities currently operate at approximately 25 to 30% of their aggregate annual revenue capacity and provide ample room for business growth without incremental capital investment.

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We incur most of our cost of revenues from processing the reusable surgical products (instruments and linens) at our processing facilities. We also amortize the cost of our reusable surgical products that we own and supply to customers over their expected useful life. Our instrument supply arrangements use instruments owned by Aesculap, which receives an agreed upon fee for each procedure based on the number and kinds of procedures performed with its instruments and the number and combination of instruments used for each procedure. This arrangement allows us to limit our cost of capital for instrument programs.

We substantially reduced the balance of our line of credit from $15.5 million as of December 31, 2002 to $7.0 million as of December 31, 2003, principally because of our management of accounts payable and inventory and unusually low expenditures for reusable surgical products. Our capital expenditures for property, plant and equipment were much lower than in previous years. We do not expect to sustain this cash benefit at these levels as capital expenditures and expenditures for reusable surgical products will return to levels prior to 2003. See “Liquidity and Capital Resources.”

Critical Accounting Policies and Estimates

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. On an on-going basis, 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. Note B to our financial statements describes the significant accounting policies and methods that we use in preparing our financial statements. 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 operation.

Amortization of Reusable 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, 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 operation.

Reserves for Shrinkage, Obsolescence and Scrap for Reusable Surgical Products. We determine our reserves for shrinkage, obsolescence and scrap of our reusable products by tracking those products with our bar-coding system or recently implemented RFID system. Based on historical experience, we believe that any products not scanned by the system for a 210-day period are lost. If actual losses exceed our estimates, our reserve for shrinkage, obsolescence and scrap would increase, which could adversely affect our results of operation.

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 operation.

Impairment of Goodwill and Other Intangible Assets. We review our goodwill and other intangible assets for impairment annually or more frequently if indicators of impairment arise using the process prescribed in

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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 indicated the percentage of revenues represented by certain items reflected in the statements of income of the Company:

Year Ended December 31, 2003 Compared to Year Ended December 31, 2002

Revenues

Revenues decreased $90,000, or 0.1%, to $86.5 million in 2003, from $86.6 million in 2002. The continued competitive market for our reusable products and services, including customer losses in 2002 and 2003, adversely affected our ability to grow revenue in 2003.

Gross Profit

Gross profit decreased $3.7 million, or 14.5%, to $21.8 million in 2003, from $25.5 million in 2002. As a percentage of revenues, gross profit decreased 4.2%, to 25.2% in 2003, from 29.4% in 2002. The decrease in gross profit reflects the impact of competitive pricing pressures and our inability to leverage the current operating capacity of our processing facilities by increasing revenues. Depreciation expense for 2003 increased approximately $630,000 over the prior year due to the elimination in December 2002 of the off balance sheet financing for two of our processing facilities. A reusable surgical products amortization credit of approximately $260,000 per quarter ($1,040,000 annually), from an acquisition in prior years, was fully utilized as of December 31, 2002. During 2003, we dedicated resources to complete an initiative to improve the appearance of our facilities and remove worn and poor quality gowns from our production process. The RFID technology we have implemented will offer us improved inventory control and monitoring of product quality which should improve our productivity and gross profit.

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Distribution Expenses

Distribution expenses increased $248,000, or 4.4%, to $5.9 million in 2003, from $5.7 million in 2002. As a percentage of revenues, distribution expenses increased 0.3%, to 6.9% in 2003, from 6.6% in 2002. The increase in distribution expenses as a percentage of revenues resulted primarily from higher insurance costs in 2003 and from higher vehicle lease expenses.

Selling and Administrative Expenses

Selling and administrative expenses increased $153,000, or 1.0%, to $15.1 million in 2003, from $14.9 million in 2002. As a percentage of revenues, selling and administrative expenses increased 0.3%, to 17.5% in 2003, from 17.2% in 2002. In 2003, we added new leadership in sales, marketing, and operations, as well as other sales and administrative support. Our selling and administrative expense also increased due to the impact of a new sales compensation program, recruiting and relocation costs, insurance costs, and marketing and administrative fees for group purchasing organization. We also incurred higher professional fees in 2003 due to one-year consulting arrangements with two of our former officers, which expired on December 31, 2003. These increases were offset to some extent by lower severance payments in 2003 and reduced legal fees as a result of the settlement of SEC and legal proceedings.

Derivative Instruments

We recognized current unrealized gains of $101,000 in 2002 for our guarantee of two interest rate swaps of a third party in 2002. We accounted for these costs pursuant to SFAS No. 133, Accounting for Derivative Instrument and Hedging Activities until the swaps terminated in April 2002. We did not have derivative instruments in 2003.

Interest Expense, Net

Interest expense increased $101,000, or 10.2%, to $1.1 million in 2003, from $1.0 million in 2002, primarily due to our elimination in December 2002 of an off balance sheet financing arrangement for two of our processing facilities. We now finance these facilities through bonds rather than as operating leases. This increase was partially offset by reduced interest expense related to our revolving line of credit due to reduced borrowings throughout 2003.

Income Tax Expense

Income tax expense decreased $1.3 million from $1.5 million in 2002 to $139,000 in 2003. Income tax expense is usually a function of our net income (loss) and effective tax rate. During 2003, certain state tax credits were deemed to be unrecoverable resulting in a valuation allowance being applied against our deferred tax assets. This negatively impacted our income tax expense and net loss by $379,000. See Note H—Income Taxes.

Net Income (loss) Per Common Share

We recorded a net loss per common share of $0.08 on a diluted and basic per share basis for 2003 compared with net income per common and diluted share of $0.38 in 2002. During 2003, certain state tax credits were deemed to be unrecoverable resulting in a valuation allowance being applied against our deferred tax assets which caused a $0.06 negative impact on our net loss per common share.

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

Revenues

Revenues increased $138,000, or 0.2%, to $86.6 million in 2002, from $86.4 million in 2001. Revenues were adversely affected by the competitive market for our products and services, including price reductions and the loss of some customer accounts, along with delays in prospective customers starting new business. These adverse impacts were partially offset by continued growth in our instrument programs.

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Gross Profit

Gross profit decreased $2.7 million, or 9.5%, to $25.5 million in 2002, from $28.1 million in 2001. As a percentage of revenues, gross profit decreased 3.1%, to 29.4% in 2002, from 32.5% in 2001. The decrease in gross profit reflects the impact of price reductions and customer account loss, and the impact of higher insurance and employee benefits and other expenses.

Distribution Expenses

Distribution expenses increased $141,000, or 2.5%, to $5.7 million in 2002, from $5.6 million in 2001. As a percentage of revenues, distribution expenses increased 0.2%, to 6.6% in 2002, from 6.4% in 2001. The increase in distribution expenses as a percentage of revenues resulted primarily from higher insurance costs and increased lease expense due to replacing older vehicles with new vehicles.

Selling and Administrative Expenses

Selling and administrative expenses increased $2.4 million, or 19.3%, to $14.9 million in 2002, from $12.5 million in 2001. As a percentage of revenues, selling and administrative expenses increased 2.7%, to 17.2% in 2002, from 14.5% in 2001. Our sales and administrative expenses increased due to marketing and administrative fees for group purchasing organization accounts, severance payments, higher insurance expenses, other professional expenses, and legal expenses, which were partially offset by reduced travel and other expenses as a result of cost savings initiatives.

Derivative Instruments

We guaranteed two interest rate swaps of a third party until the swaps’ termination in April 2002. Pursuant to SFAS No. 133, Accounting for Derivative Instrument and Hedging Activities, we recognized current unrealized gains of $101,000 in 2002, compared to an unrealized loss of $407,000 in 2001.

Interest Expense, Net

Interest expense decreased $392,000, or 28.4%, to $1.0 million in 2002, from $1.4 million in 2001, primarily due to lower borrowings and lower interest rates on our revolving credit facility.

Income Tax Expense

Income tax expense decreased $1.6 million to $1.5 million in 2002, from $3.1 million in 2001. Our effective tax rate is 37.5% for 2002 and 2001.

Cumulative Effect of Change in Accounting Principle

As a result of the adoption of SFAS No. 133 on January 1, 2001, we recognized a cumulative effect of change in accounting principle of $113,000, which is net of tax of $69,000 in 2001.

Net Income Per Common Share

We recorded net income per common share of $0.38 on a diluted and basic per share basis for 2002, compared with $0.76 on a diluted per share basis after effect of change in accounting principle, and $0.83 on a basic per share basis after effect of change in accounting principle in 2001.

Liquidity and Capital Resources

Our principal source of capital is 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.

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We generated $14.1 million of cash from operating activities during 2003, compared to $11.8 million in 2002. Our cash flow from operations increased during 2003 compared to 2002, principally due to decreases in inventory and increases in accounts payable, partially offset by reduced net earnings. In 2003, we dedicated resources to complete an initiative to remove worn and poor quality gowns from our production process, which negatively impacted amortization of reusable surgical products.

Our net cash used in investing activities decreased $3.8 million for the year ended December 31, 2003 to $5.5 million from $9.3 million in the year ended December 31, 2002. The decrease is due to a reduction in purchases of property, plant and equipment and reusable surgical products, because of sizable purchases of reusable surgical products in 2002.

We spent $2.3 million and $2.9 million in the years ended December 31, 2003 and 2002, respectively, to purchase property, plant and equipment. We spent $3.1 million and $5.6 million in the years ended December 31, 2003 and 2002, respectively, to purchase reusable surgical products. We estimate that our expenditures for property, plant and equipment (approximately $2 to $3 million) and reusable surgical products (approximately $8 to $9 million) will increase to approximately $11 to $12 million for the next twelve months as we resume normal purchases of reusable surgical products and capital expenditures in our facilities. This amount will fluctuate depending on the growth of our business, however.

Net cash used in financing activities increased $6.1 million for the year ended December 31, 2003 to $8.6 million from $2.5 million. During 2003, we repaid $8.4 million of our revolving credit facility to reduce the outstanding balance from $15.5 million to $7.0 million.

On June 26, 2003, we renewed and amended our existing revolving credit with Wachovia Bank and SouthTrust Bank. Based on anticipated future needs, we elected to decrease the facility amount from $45.0 million to $30.0 million. Our outstanding balance under our revolving credit facility was approximately $7.0 million and $15.5 million as of December 31, 2003 and 2002, respectively.

The credit facility is secured by substantially all of our 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 (3.76% as of December 31, 2003), depending on our consolidated leverage ratio. The credit facility requires us 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 us from paying dividends, incurring additional indebtedness, encumbering assets, and entering into merger, consolidation or liquidation transactions representing greater than 10.0% of consolidated assets. We complied with all requirements of the credit facility as of December 31, 2003.

Our credit facility allows us to repurchase our outstanding stock through open market purchases at prevailing market prices. During 2003, we repurchased 6,753 shares of our common stock at an aggregate cost of approximately $36,000. During 2002, we repurchased 154,400 shares of our common stock at an aggregate cost of approximately $948,000. During 2001, we repurchased 39,500 shares of our common stock at an aggregate cost of approximately $569,000.

Since their initial construction in 1999, we had leased two of our processing facilities through a form of off-balance sheet financing in which a third party (SRI Realty Trust) purchased the properties and leased the assets to us as lessee. In December 2002, we acquired all of the interest in SRI Realty Trust from an unrelated third party for approximately $881,000, eliminating the operating lease treatment and off-balance sheet financing. We now include on our balance sheet approximately $10.6 million in processing facilities’ property, plant and equipment, and $9.7 million in liabilities, primarily related to the bonds that financed the processing facilities.

We finance these facilities through letters of credits issued by Wachovia Bank. Interest expense adjusts based on rates that approximate LIBOR (1.26% at December 31, 2003). Starting in 2004, we will begin

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amortizing the bonds through quarterly payments of $165,000. Balloon principal payments of $3.1 million on the bonds are due in 2014. The bonds are collateralized by the two processing facilities.

In 2003, we recorded depreciation expense and interest expense of approximately $640,000 and $126,000, respectively, for the bonds and letter of credit financing. These amounts replace the lease expense previously recorded for operating leases of the facilities. As of December 31, 2003 and 2002, we had no off-balance sheet financing.

As of December 31, 2003, we had cash of $627,000, as well as an additional amount of approximately $6.0 to 7.0 million available under our revolving credit facility. The amount available under our revolving credit facility is limited by the consolidated leverage ratio of not more than 2.5 to 1.0 as of the end of each fiscal quarter. 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.

Our contractual cash obligations for future minimum payments, including interest, under our capital lease, operating leases, bonds payable, and notes payable to bank as of December 31, 2003, are as follows:

Contractual Obligations

We offer instruments pursuant to our Joint Marketing Agreement with Aesculap, Inc. Under the terms of this agreement, Aesculap furnishes and repairs all of the surgical instruments that we deliver to customers and receives an agreed upon fee for each procedure. We also have a procurement agreement with Standard Textile under which we agree to purchase 90% of our reusable surgical products from Standard Textile through August 2008. We are not bound to purchase any minimum quantity of products under these agreements, however, we expect to make payments under them to fulfill our requirements. We estimate that our payments under these agreements will be between $15.0 and $17.0 million in 2004. Amounts in subsequent years will be comparable, adjusted by changes in customer demand, amortization rates, product prices, and other variables affecting our business.

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Item 7A. Quantitative and Qualitative Disclosures about Market Risk

The outstanding balances under our revolving credit facility were approximately $7.0 million and $15.5 million on December 31, 2003 and December 31, 2002, respectively. The credit facility’s interest rate varies between 200 and 350 basis points over LIBOR (3.76% as of December 31, 2003), 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 $7.0 million, if LIBOR were to increase (decrease) by 100 basis points, our interest payments would increase (decrease) by $17,500 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 $9.7 million, if LIBOR were to increase (decrease) by 100 basis points, our interest payments would increase (decrease) by $24,250 per quarter.

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

Item 8. Financial Statements and Supplementary Data

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REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS

Board of Directors

SRI/Surgical Express, Inc.

We have audited the accompanying balance sheets of SRI/Surgical Express, Inc. as of December 31, 2003 and 2002, and the related statements of operations, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2003. Our audits also included the financial statement schedule listed in the index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

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

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

As discussed in Note B to the financial statements, the Company changed its method of accounting for goodwill effective January 1, 2002.

/s/    ERNST & YOUNG LLP

Tampa, Florida

February 18, 2004

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SRI/SURGICAL EXPRESS, INC.

STATEMENTS OF OPERATIONS

(in thousands, except per share data)

See accompanying notes to financial statements.

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SRI/SURGICAL EXPRESS, INC.

BALANCE SHEETS

(in thousands, except share data)

See accompanying notes to financial statements.

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SRI/SURGICAL EXPRESS, INC.

STATEMENTS OF SHAREHOLDERS’ EQUITY

(In thousands, except share data)