HARRELL HOSPITALITY GROUP, INC. 16475 North Dallas Parkway, Suite 410 Addison, Texas 75001 Form 10-KSB For the fiscal year ended: September 30, 2003 Submitted to SECURITIES AND EXCHANGE COMMISSION Washington, D. C. Commission File No. 0-2661 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D. C. 20549 FORM 10-KSB. [X] ANNUAL REPORT UNDER TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended: September 30, 2003 [ ] TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission File No.: 0-2661 HARRELL HOSPITALITY GROUP, INC. (Name of small business issuer in its charter) Delaware 13-1946181 (State of Incorporation) (I.R.S. Employer Id. No.) 16475 North Dallas Parkway, Suite 410, Addison, Texas 75001 (Address of principal executive offices) (Zip Code) Issuer's telephone number: (972) 380-0273 Securities registered pursuant to Section 12(b) of the Act: None Securities registered pursuant to Section 12(g) of the Act: Class A Common Stock, Par Value $.002 (Title of Class) Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the past 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. (1) YES X NO (2) YES X NO 1 Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-B is not contained in this form, and no disclosure will 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-KSB or any amendment to this Form 10-KSB. [ ] State issuer’s revenues for its most recent fiscal year: $4,557,415. The aggregate market value of the registrant's Class A Common Stock held by non- affiliates of the registrant, computed by reference to the average bid and asked prices of such stock as of December 16, 2003, the last available quotation date: Approximately $2,264,043. State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practical date. The number of shares of the registrant's Class A, $.002 par value Common Stock outstanding as of December 16, 2003 was 13,064,909. 2 PART I Forward-looking Statements In addition to historical information, this annual report may contain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are not based on historical facts, but rather reflect management’s current expectations concerning future results and events. These forward-looking statements generally can be identified by the use of phrases and expressions such as “believe”, “expect”, “anticipate”, “intend”, “plan”, “foresee”, “likely”, “will”, or other similar words or phrases. Forward-looking statements include, without limitation, statements related to the Company’s plans, objectives, expectations, and intentions, and market and general economic conditions. These forward-looking statements are subject to known and unknown risks and uncertainties that could cause actual results, performance or achievements to be different from any future results, performance and achievements expressed or implied by these statements. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s opinions only as of the date hereof. The Company undertakes no obligation to revise or publicly release the results of any revision to these forward-looking statements. Item I. Description of Business (A) Business Development: HARRELL HOSPITALITY GROUP, INC. (Formerly HARRELL INTERNATIONAL, INC.) (the "Company") is a Delaware corporation which was originally incorporated in 1959 in Massachusetts under the name of Formula 409, Inc. In 1967, the Company's name was changed to The Harrell Corporation and in 1968 to Harrell International, Inc. The Company changed its state of incorporation from Massachusetts to Delaware in March, 1987. The Company originally manufactured and sold a multi-purpose household spray cleaner under the registered trademark "Formula 409." In 1970, the Company sold the rights to "Formula 409" to Clorox Corporation. During the period 1970 to 1983 the Company was primarily engaged in the business of acquiring and operating food and non-food brokers which represented the products of various unrelated manufacturers to either the U. S. domestic civilian market or to the U. S. military resale system. In 1983, the Company completed the divestiture of its consumer products brokerage businesses and entered a phase during which its revenues were derived primarily from the collection of receivables acquired in connection with such divestitures. From 1983 to 1990 the Company was largely inactive, and Wilson Harrell, the president of the Company at that time, sought possible merger candidates. In 1991 and 1992 the Company entered into agreements with Xenex, Inc., now known as Businesship International (“BI”), to make an equity investment in the Company and fund certain loans to 3 the Company. The Company decided to move into the real estate management and acquisition business. On August 18, 1992, the Company entered into an Agreement with Hotel Management Group, Inc., a Texas corporation ("HMG"), wherein the Company acquired one hundred percent (100%) of HMG's issued and outstanding shares in exchange for 1,000,000 shares of the Company's Class A $0.002 par value common stock (the “Class A Common Stock”). The principals of HMG, Paul L. Barham and Norman L. Marks, had significant experience in hotel operations and management. Effective as of September 1, 1996 the Company and BI entered into a Preferred Stock Purchase and Release of Debt Agreement that replaced the debt obligation of the Company with 243,331 shares of $1.00 par value Class A preferred stock (the “Class A Preferred Shares”). The Class A Preferred Shares are nonconvertible, nonvoting, noncumulative dividend, with dividends of 10% of par value. The Company has the right, but not the obligation, to redeem the Class A Preferred Shares at any time at par value. The Class A Preferred Shares are not registered under federal securities laws or the laws of any state. On November 23, 1999, the Company entered into a Stock Acquisition and Option Agreement (the “Stock Agreement”) with Merchant Capital Holdings, Ltd. (“MCH”), a British Virgin Islands company, whereby MCH agreed to buy 5,000,000 shares of the Company’s Class A $0.002 Par Value Common Stock for US$0.20 per share, together with certain options to purchase additional shares. As part of the Stock Agreement, two advisors of MCH, Geoffrey Dart (“Dart”) and Gerard Thompson (“Thompson”) were appointed to the Board of Directors of the Company, with Dart appointed as Chairman of the Board. In connection with the transactions contemplated under the Stock Agreement, the Company, MCH, Norman L. Marks (and his family affiliates) and Paul L. Barham (and his family affiliates) entered into a Shareholders Agreement, providing for certain transfer restrictions and voting agreements, on the Class A Common Stock held by certain of the parties. Also, MCH required, as part of the Stock Agreement, that two employment agreements be entered into between the Company and Norman Marks and Paul Barham. On April 1, 2000, the Company changed its name to Harrell Hospitality Group, Inc. (“HHG”) The name of the Company was changed to reflect the focus of the Company on hotel related services and business. On September 1, 2000 the Board declared a five-for-one split of the Company’s Class A Common Stock. By amendment of the articles dated October 23, 2002 the par value of the Class A Common Stock was changed to $0.002 per share, and the number of authorized shares of Class A Common Stock was increased to 100,000,000. On April 12, 2001 the Board of Directors approved an amendment to the Stock Agreement to (i) exchange 842,000 shares of the Company’s Class A Common Stock for certain shares of Cybertec Holdings, PLC (now known as London & Boston, PLC) ("L&B"), 4 having a value at the date of the exchange of not less than $600,000 and (ii) issue to MCH the remaining 1,658,000 shares of the Company’s Class A Common Stock that were issuable under the Stock Agreement. Upon closing of the exchange of the L&B shares and in recognition of MCH’s business development efforts with Rotch Property Group, Ltd (“Rotch”) and other companies, MCH’s remaining obligations under the Stock Agreement were deemed satisfied and the remaining stock options under the Stock Agreement were issued to MCH . The exchange transaction with L&B was completed on May 30, 2001, and the Company received shares of L&B stock. Pursuant to the terms of the Stock Agreement, the board of directors was thereupon increased to a total of five (5) directors. On March 15, 2001 the Company entered into an agreement whereby the Company would acquire, as a member of a consortium, an interest in a majority of the outstanding common stock of Energy Technique, PLC (“ET”), a United Kingdom publicly-quoted energy related company. The Company used 3,323,120 shares of the L&B stock that the Company owned to acquire 11,077,066 shares in ET, equating to approximately 15% of the outstanding common stock of ET. The value of the L&B stock exchanged was equal to £333,000 at the time (approximately $480,000). The transaction was completed June 14, 2001, at which time, Geoffrey Dart, Chairman of the Company was appointed Executive Chairman of ET and Paul Barham, Director of the Company, was appointed as non-executive director of ET. In March 2003, Geoffrey Dart and Paul Barham resigned from the Board of Directors of ET, and Gerard Thompson, Director of the Company was appointed Director of ET. Through the board of directors, the Company has established contacts with companies in the United Kingdom, and it has also sought investment opportunities and capital from the United Kingdom. In furtherance of these efforts in the United Kingdom, the Company opened an office in London, England in November 1999. In the last three years, the Company has actively sought hotel investment in the United Kingdom and entered into a strategic alliance with Rotch Property Group, Ltd. (“Rotch”) in February 2001. Rotch is a privately held real estate company that currently owns several hundred commercial real estate properties, primarily in the United Kingdom and Europe. The agreement calls for Rotch to engage the Company in consulting, oversight, management and review functions relating to hotel assets, as well as Rotch assisting the Company in hotel acquisitions. On November 6, 2002, the Company, Rotch, and Vincent Tchenguiz (the Chairman of Rotch) entered into another agreement which further expanded the relationship between the companies in the U.S. and Europe and which provided for Rotch to acquire 225,000 shares of Class A Common Stock in the Company for the sum of $100,000. As of the date of this report, no hotel properties or management contracts through this relationship have been obtained. The Company also entered into a strategic alliance with Galway Financial Group (“Galway”) on December 10, 2001 and a Hotel Acquisition Agreement (“HAA”) on March 1, 2002, wherein Galway was to provide equity and assist the Company in securing hotel purchase, leasing and management opportunities. Under the HAA Galway was to receive a fee at the time of each hotel acquisition and upon closing of each hotel acquisition Galway will receive shares of Class A Common Stock in the Company. Under the terms of the HAA 5 the parties formed Harrell-Galway Associates, LLC, a Delaware limited liability company (“HGA”), and subsequently HGA entered into three separate contracts to purchase hotels and related amenities. Through HGA, the Company pursued hotel acquisitions in San Antonio, Texas, Fort Worth, Texas and West Columbia, Texas. Equity commitments were not obtained during the inspection periods, and the contracts on the San Antonio and West Columbia hotels were terminated. The Company and Galway, on August 22, 2002 terminated the HAA and entered into a new agreement which reflected the parties’ revised relationship. The agreement provides for the parties to pursue opportunities together although not under the same terms as the HAA, and to recognize the contribution of each party in the event that any of the three contracts entered into by HGA are subsequently closed. On December 14, 2001, the Company entered into an agreement with R P Corporate Strategy, Ltd. ("RPC"), a United Kingdom private company affiliated with Clive Russell, for RPC to provide certain consulting services for the Company in connection with potential hotel acquisitions. This agreement was modified and replaced in its entirety by a Hotel Acquisition and Services Agreement (the "RPC Agreement") dated July 1, 2003 between RPC and the Company. The goal under the RPC Agreement is for RPC to assist the Company in completing the acquisition of partial ownership in at least eight hotels within three years from the date of the modification. Pursuant to the RPC Agreement, the Company issued 987,772 shares of its Class A Common Stock to RPC. If the goal of eight hotels is not met within the three year period, the Company can require RPC to return the stock on a prorata basis in proportion that the actual number of hotel acquisitions bears to the goal of eight. (B) Business of the Issuer: HOTEL MANAGEMENT The primary focus of the Company is on hotel management and investment in hotels. At the present time a very high percentage of the Company’s revenue is derived from management contracts to manage two hotels in California. The Company is actively seeking and negotiating additional management contracts with other hotels. The Company has managed nationally recognized franchises, including Sheraton, Holiday Inn, and Ramada, and is approved as one of a small group of independent management companies accepted by Marriott as a franchise for its full service hotels. The Company has also been approved by Hilton Hotels to operate its Hilton Garden Inn hotel line. The Company believes that its approval as a franchisee by these major franchisers positions the Company ahead of many of its competitors for management opportunities where a franchise is of importance. The Company has and is continuing to pursue such 6 opportunities to capitalize on this advantage. The hotel management business is highly competitive, and the Company’s market share in the total industry is insignificant. The Company competes with larger corporations which have greater financial resources. Often, management of a hotel is coupled with some degree of ownership in the hotel, so the Company, to be competitive, must be prepared to make an equity investment in a hotel if necessary to comply with a condition to obtaining a management contract. The capital injections into the Company have been used in large part to locate and develop suitable hotel investments. The Company continues to seek additional sources of debt or equity to use for hotel investment. Executives of the Company have spent considerable time and effort towards the development of new hotels, the acquisition of management contracts of existing hotels, investment in hotels to be managed by the Company and the securing of equity and debt for these activities. HOTEL MANAGEMENT SUBSIDIARIES A. Hotel Management Group, Inc. (“HMG”) Harrell Hospitality Group - California, Inc.(“HHG California”) Effective January 1, 1994, Hotel Management Group, Inc. formed a wholly owned subsidiary, Hotel Management Group - California, Inc., (“HMG California”) to hold the management contract for the operations of the Biltmore Hotel and Suites in Santa Clara, California. The Biltmore Hotel is a 262 room full service hotel with 8,000 square feet of meeting space. HMG California’s management contract is a two-year renewable contract that began in January 1992 and has a current expiration of December 31, 2005. HMG California receives a management fee equal to ten percent (10%) of the hotel’s net income pre debt, after a 3% reserve for furniture, fixtures and equipment. HMG California entered into a management contract of the Rancho Santa Barbara Marriott in May 1995.The Marriott is a 149 room full service hotel with 8,000 square feet of meeting space and health and spa facilities. HMG California’s management contract is a two-year renewable contract that began in June 1995 and has a current expiration of December 31, 2005. HMG California receives a management fee equal to ten percent (10%) of the 7 hotel’s net income pre-debt, after a 3% reserve for furniture, fixtures and equipment. Revenues of HMG California for the year ending September 30, 2003 amounted to approximately $4,257,067 constituting approximately 93.0% of the Company’s total revenue. In March 2000, HMG California changed its name to Harrell Hospitality Group - California, Inc. Harrell Hospitality Group Texas, Inc. (“HHG Texas”) On June 24, 2002 HHG Texas assumed the management of the Hampton Inn Meacham in Fort Worth, Texas, a 66 room limited service hotel. The contract was on a month-to-month basis at a management fee of $3,750 per month. On January 16, 2003, the Company issued a 30-day notice of termination to the hotel’s owner for non-payment of management fees totaling $10,252. On January 23, 2003, the management contract was terminated. Demand has been made upon the owner for payment of the outstanding fees, which fees have not been paid at the time of the filing of this report. The Company believes that the hotel owner does not have sufficient funds to pay the obligation, and the Company has therefore elected not to incur additional legal costs for pursuing the debt at this time. On December 16, 2002, the Company assumed the management of the Ramada Plaza Hotel, in downtown Fort Worth, Texas pending the possible acquisition of the hotel by Harrell-Galway Associates (“HGA”), an affiliate of the Company. The Company has contracted to purchase the Ramada Plaza and has plans to remodel the hotel. The Company negotiated with the City of Fort Worth, Texas (“City”) for tax incentives and rebates to proceed with the acquisition and renovation of the Ramada Plaza, and reached agreement with the City on March 31, 2003. Pursuant to the Economic Development Agreement with the City, the City will rebate to HGA a portion of the real estate taxes and hotel occupancy taxes annually for a fifteen year period, with a total amount of rebates to HGA not to exceed $13,476,502 over such fifteen year period. With help provided by these future incentives from the City, HGA is currently negotiating with lenders to provide financing to permit the acquisition and renovation of the Ramada Plaza. If the equity and financing is obtained, HGA, through a partnership being formed with other equity partners, expects to close the acquisition of the Ramada Plaza in the first quarter of calendar year 2004. The Economic Development Agreement was amended on November 21, 2003, thereby providing HGA with more time to secure financing and close the purchase. The foregoing statements are forward-looking statements, and the Company may not secure long-term 8 management or a percentage of ownership, depending on the availability of debt, equity, City of Fort Worth concessions and franchise requirements that may be necessary to complete the transaction. B. Harrell Hotels (Europe) Ltd. In anticipation of potential hotel acquisitions in the United Kingdom (“UK”), in February 2002, HHG formed a United Kingdom subsidiary named Red Lion Hotels and Suites Limited. The corporation was formed under United Kingdom law as a private company. Other than its initial organization, no business was conducted in this newly formed subsidiary for nearly one year. In the second quarter of this year, the Company returned to this subsidiary with efforts to generate business from the UK and Europe. On February 20, 2003 the name was changed to Harrell Hotels (Europe) Ltd. Harrell Hotels Europe, Ltd. (“HHE”), whose operations are based in London, has goals of pursuing the acquisition of hotel properties with others and providing property management, asset management and consulting services to hospitality clients in the UK and Europe. The Company sold a total of 5,416,572 shares of ET, in two separate transactions on May 20, 2003 and June 5, 2003, at a stated price of 15 pence per share to HHE to capitalize HHE. Of those shares 4,215,000 secured a loan from Netcentric Systems Plc (“Netcentric”), which loan was assumed by HHE. Subsequent to the year end, on October 23, 2003, HHE issued 60,786,095 shares of HHE stock to HHG in partial payment of the ET shares. The remaining 20,462,485 shares needed to complete the capitalization transaction will be issued after the completion of a required administrative process by the Stamp Office of the Inland Revenue service of the UK. HHE is a wholly owned subsidiary of HHG. By Letter of Loan Agreement dated as of May 14, 2003 (the “Letter”), Michael Connell (“Connell”), an individual in Liverpool, England agreed to loan HHE the sum of £120,000 (approximately $193,000). HHE used the proceeds from this loan to repay the indebtedness owed by the Company to Netcentric. The Letter provided that the loan from Michael Connell to HHE was secured by the 4,215,000 shares of ET stock that the Company had pledged to Netcentric as collateral for that loan. The loan from Connell bore interest at twelve percent (12%) per annum, and the term of the loan was ninety days with an additional ninety day renewal possible. The Connell loan was paid off in July 2003. HHE has agreed upon terms to engage Blythe Hall Securities (“Blythe Hall”), a company with numerous contacts in the hospitality, banking, insurance, and investment industries in the UK, to help HHE move its plans forward to acquire hospitality operating assets in the UK. The arrangement provides for Blythe Hall to be paid 10% of the gross monthly management fee earned by HHE pursuant to any management agreement sourced by Blythe Hall, for up to 36 months. No such managment agreements have been sourced by Blythe Hall as of the date of this report. 9