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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
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COMMISSION FILE NUMBER 0-22935
PEGASUS SYSTEMS, INC.
(Exact Name of Registrant as specified in its charter)
DELAWARE 75-2605174
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3811 TURTLE CREEK BOULEVARD, SUITE 1100, DALLAS, TEXAS 75219
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (214) 528-5656
Securities Registered Pursuant to Section 12(b) of the Act:
NONE
Securities Registered Pursuant to Section 12(g) of the Act:
COMMON STOCK, PAR VALUE $0.01 PER SHARE
RIGHTS TO PURCHASE SERIES A PREFERRED STOCK
(TITLE OF CLASS)
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. [ ]
The aggregate market value on March 9, 2000 of voting stock held by
non-affiliates of the registrant was $468,575,654.
The number of shares of the registrant's common stock, par value $0.01 per
share, outstanding as of March 9, 2000 was 20,353,135.
DOCUMENTS INCORPORATED BY REFERENCE
Selected portions of our definitive proxy statement for the 2000 annual
meeting of stockholders to be held on May 2, 2000 are incorporated by reference
into Part III of this Form 10-K. We disclaim incorporation by reference of
information contained on any Internet site.
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PART I
ITEM 1. BUSINESS
Except as expressly indicated or the context otherwise requires, the
"Company," "Pegasus," "we," "our" or "us" when used in this report refers to
Pegasus Systems, Inc., a Delaware corporation, and its predecessors and
consolidated subsidiaries. This report contains forward-looking statements
within the meaning of the federal securities laws. Actual results and the timing
of events could differ materially from those projected in or contemplated by the
forward-looking statements due to a number of factors, including those listed
herein under "Risk Factors".
OVERVIEW
Pegasus is a leading provider of transaction processing and electronic
commerce services to the hotel industry worldwide. Pegasus is organized into
three businesses: Pegasus Electronic Distribution, Pegasus Commission Processing
and Pegasus Business Intelligence.
- Pegasus Electronic Distribution improves the efficiency and effectiveness
of the hotel reservation process by enabling travel agents and individual
travelers to electronically access hotel room inventory information and
conduct reservation transactions. Pegasus Electronic Distribution
consists of our GDS distribution service and Internet-based distribution
services, which include TravelWeb.com, the private-label reservation
service and other Internet-based distribution services.
- Pegasus Commission Processing improves the efficiency and effectiveness
of the commission payment process for participating hotels and travel
agencies by consolidating payments in the customer's currency of choice
and providing comprehensive transaction reports.
- Pegasus Business Intelligence provides database marketing and consulting
services and is being expanded to provide services that search and
organize data into meaningful information for competitive analysis and
strategic planning for the hotel industry.
In 1999, approximately 47%, 48% and 5% of Pegasus' consolidated revenue was
derived from Pegasus Electronic Distribution, Pegasus Commission Processing and
Pegasus Business Intelligence, respectively.
INDUSTRY BACKGROUND
The room reservation and commission payment processes in the hotel industry
are complex and information intensive. Making a hotel room reservation requires
significant amounts of data, such as room rates, features and availability. This
complexity is compounded by the need to confirm, revise or cancel room
reservations, which generally requires that multiple parties have ongoing access
to real-time reservation information. Similarly, the process of reconciling and
paying hotel commissions to travel agencies is based on transaction-specific
hotel data. Furthermore, this process consists of a number of relatively small
payments to travel agencies that often include payments in multiple currencies.
In addition, information regarding guest cancellations and "no-shows" needs to
be accurately communicated between hotels and travel agencies in order to
reconcile commission payments.
Reservations for hotel rooms are made either directly by individual
travelers or indirectly through intermediaries. Individual travelers typically
make direct reservations by traditional methods such as telephoning or faxing a
hotel to ascertain room rates, features and availability and to make
reservations. Increasingly, individual travelers are conducting all aspects of
this transaction through hotel and travel-related websites. Intermediaries for
hotel room reservations, including travel agencies, convention and other large
meeting organizers and corporate travel departments, access hotel information
either by telephone or fax or through a global distribution system. Global
distribution systems, such as Sabre and Galileo, are primarily mainframe-based
systems that are connected through communications links to travel agencies and
other intermediaries. Global distribution systems maintain databases of room
rates, features and availability information provided by hotels to which they
are connected. Because each global distribution system has a
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unique electronic interface to hotel reservation systems, each global
distribution system can be used to obtain room information and book rooms only
at hotels that have developed protocols and message formats compatible with that
particular global distribution system.
Hotels depend upon room distribution information to assist in marketing and
pricing hotel rooms. However, much of the information currently available
regarding hotel room distribution does not contain current information or
in-depth detail about guest behavior. It also is not customized to contain the
information that is valuable to a particular user. Furthermore, it may reflect
events or industry patterns that occurred months in the past and as a result may
not be as useful.
A number of current trends are affecting the hotel industry:
- The hotel industry has been shifting from manual to electronic means of
making hotel room reservations. As more hotels become electronically
bookable, Pegasus expects that electronic hotel room reservations will
grow substantially in the United States and internationally over the next
several years.
- A growing number of individual travelers are making hotel room
reservations electronically on the Internet.
- Smaller hotel chains and independent hotels increasingly have affiliated
with larger hotel chains through a process known in the industry as
"branding" or "reflagging." This global consolidation process produces
economies of scale and increases the global penetration of larger hotel
chains, many of which are Pegasus customers.
- Hotel commissions are becoming increasingly important to travel agencies
as a source of revenue. Travel agencies are looking to increase their
revenue by making more hotel room reservations to offset the effects of
increased competition among travel agencies, new competition from
emerging travel service distribution channels such as the Internet and
ceilings on commissions for airline reservations, which historically have
been the leading revenue source for travel agencies.
- Participants in the travel industry increasingly desire detailed,
customized information regarding hotel room distribution that can be
delivered in a timely manner.
PEGASUS SOLUTION
Pegasus provides information and transaction processing services that
improve the efficiency and effectiveness of the hotel room reservation and
commission payment processes. Pegasus Electronic Distribution enhances the
electronic hotel room reservation process by providing a single electronic
communication interface that enables individual travelers and intermediaries to
access hotel room inventory information and conduct reservation transactions.
Pegasus Commission Processing improves the efficiency and effectiveness of the
commission payment process for hotels and travel agencies by consolidating
commissions into one payment in the travel agency's currency of choice and by
providing comprehensive transaction reports. Pegasus Business Intelligence is
intended to provide detailed and timely hotel information that is valuable to a
wide variety of audiences in the global hotel industry from hotel chains to
travel industry marketing groups to corporate travel departments.
Our services benefit many of the participants in the hotel room
distribution process. Travel industry participants that benefit from these
services range from hotels to travel agencies and hotel representation firms, to
global distribution systems, convention and other large meeting organizers,
corporate travel departments and websites with travel-related features. Hotel
representation firms are companies that assist hotels in marketing and sales.
Our strategic position as a gateway in the hotel room distribution chain, our
transaction processing capabilities and our reputation for reliability and
neutrality enable us to offer a range of services delivering industry-wide
benefits that are difficult for industry participants to achieve individually.
Because we process transactions from a wide variety of sources, we are well
positioned to capitalize on the overall growth in electronic hotel reservations,
whether made through global distribution systems, the Internet or other means.
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STRATEGY
Our goal is to be the leading provider of information services and
technology in the distribution of hotel rooms. We believe that our central role
in the hotel industry room reservation process positions us to achieve this
goal. Key elements of our strategy include the following:
- Expand Hotel Room Distribution Channels. We are expanding our service
offerings to include additional distribution channels, such as hotel room
reservation services for individual travelers over the Internet, for
convention and other large meeting organizers and for corporate travel
departments. We are addressing this online distribution opportunity
through increasing the capability and consumer awareness of our
TravelWeb.com website and expanding the use by third-party websites of
our private-label reservation service. Our services are intended to
provide transaction fee revenue opportunities through virtually all of
the distribution channels by which electronic hotel room reservations
occur.
- Develop and Expand Pegasus Business Intelligence. We intend to continue
to develop and expand Pegasus Business Intelligence. This service is
intended to provide hotel and other industry participants with hotel
transaction information for use in strategic analysis, market tracking,
improved target marketing and revenue optimization. We recently acquired
and are developing software and technology to enhance our ability to
gather and process hotel checkout data for Pegasus Business Intelligence.
- Build Strategic Alliances and Pursue Acquisition Opportunities. To
enhance the functionality and market presence of our services, we intend
to build strategic alliances with other participants in the hotel
industry, including those providing financial information services,
information technology services and travel related Internet-based
services. We believe that these relationships will increase brand
recognition of our services and help to expand our customer base. We will
also seek to acquire assets, technology and businesses that provide
complementary services or access to new markets and customers.
- Expand Customer Base. Our established customer base includes hotels,
hotel representation firms, travel agencies, global distribution systems
and third-party websites. We intend to expand our customer base
domestically and internationally by adding customers and by cross-selling
new and existing services to our current and future customers. Because of
the fixed nature of many of our costs, the addition of new customers and
the increase in transaction volumes of new and existing customers would
enhance the profitability of our services.
SERVICES
Pegasus is organized into three businesses: Pegasus Electronic
Distribution, Pegasus Commission Processing and Pegasus Business Intelligence.
PEGASUS ELECTRONIC DISTRIBUTION
Pegasus Electronic Distribution consists of the GDS distribution service
and Internet-based distribution services.
GDS distribution service
Our GDS distribution service provides an electronic interface for
communications concerning hotel reservation information between major global
distribution systems and reservation systems maintained by hotels and hotel
chains. These reservation systems, consisting of both hardware and software, are
commonly referred to as central reservation systems. This electronic interface
enables a hotel to connect to major global distribution systems without having
to build and maintain a separate interface for each global distribution system.
Without Pegasus' GDS distribution service or a similar service, hotel chains
that desire their room inventory to be accessible to travel agencies
electronically on a global distribution system must develop protocols and
message formats compatible with each global distribution system, a process that
entails significant time and expense. Alternatively, hotels may rely more
heavily on less-automated means, such as traditional toll-free telephone
reservation centers with higher processing costs. The technology underlying the
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GDS distribution service enables the processing of hotel room reservations and
transmits daily millions of electronic status messages, which are used to update
room rates, features and availability on global distribution system databases.
Many participating hotels also utilize our GDS distribution service to provide
travel agencies with direct access to a hotel's central reservation system,
bypassing the global distribution system databases to obtain the most complete
and up-to-date hotel room information available.
Hotels using the GDS distribution service improve the efficiency of their
central reservation systems and reduce costs by not having to develop and
maintain separate hardware and software that is compatible with each global
distribution system. Through the GDS distribution service, participating hotels
gain access to a wide audience of travel agencies worldwide that are connected
to global distribution systems. Participating hotels also can provide better
customer service due to the ability to frequently update hotel room information
on global distribution system databases in a fast and reliable manner. The GDS
distribution service benefits travel agencies that use global distribution
systems by providing real-time access to detailed hotel room information and
enabling them to make reservations and receive confirmations in seconds from
over 29,000 hotel properties worldwide.
Pegasus charges its hotel customers a fee based on the number of net
reservations processed through the GDS distribution service. In addition, hotels
pay fees for status messages sent to global distribution systems through the GDS
distribution service. New participants in the GDS distribution service may be
charged one-time set-up fees for work associated with the implementation of the
interface with the GDS distribution service. Pegasus also charges some global
distribution systems a fee based on the number of net reservations or the number
of hotel links in place as compensation for Pegasus' management and
consolidation of multiple interfaces. Pegasus electronic distribution technology
enables Pegasus to enhance its revenue base by providing the information and
reservation capabilities for its other hotel reservation services, including
TravelWeb.com, private-label reservation, meeting and convention and corporate
travel services.
Internet-based distribution services
Our Internet-based distribution services include TravelWeb.com, the
private-label reservation service, the meetings and conventions service and the
corporate travel service. These services enable travelers to make reservations
electronically at approximately 32,000 properties in 180 countries as of
December 31, 1999.
TravelWeb.com. Located at www.travelweb.com, TravelWeb.com provides
individual travelers direct access to online hotel information and the ability
to make reservations on the Internet. Individual travelers traditionally obtain
information or reserve a room by contacting a hotel directly by telephone or fax
or indirectly through intermediaries, such as travel agencies, convention and
other large meeting organizers and corporate travel departments. As a result, an
individual traveler cannot easily obtain information from a wide range of hotel
properties in a timely manner. TravelWeb.com provides travelers with detailed
information regarding a wide array of hotel properties. Furthermore, through the
use of Pegasus electronic distribution technology, TravelWeb.com allows
travelers to reserve a hotel room and receive a confirmation in seconds. In
addition to hotel room reservations, TravelWeb.com offers airline booking
capabilities.
TravelWeb.com benefits hotels, hotel representation firms and individual
travelers. TravelWeb.com reduces hotel room reservation costs for hotels and
hotel representation firms compared to traditional hotel room reservation
methods. TravelWeb.com also enables access to an emerging low cost distribution
channel. In addition, TravelWeb.com provides an inexpensive method of publishing
and distributing comprehensive and up-to-date hotel marketing information with
an attractive presentation format featuring visual images and graphics. Hotels
can easily add, delete and update information using the "remote author" feature.
This feature enables hotels to take advantage of the real-time nature of the
Internet to offer flexible pricing and to reach individual travelers on a
worldwide basis quickly and inexpensively. TravelWeb.com benefits individual
travelers by providing electronic access, 24 hours a day, seven days a week, to
shop for and reserve a hotel room in one or more of the thousands of hotel
properties online. Furthermore, individual travelers are able to gain detailed
information about a hotel property and its special promotional offers through
the rich information content available on TravelWeb.com.
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Pegasus derives its TravelWeb.com revenues by charging participating hotels
a fee for subscribing to the service and a combination of transaction fees or
commissions. Transaction fees are based on the number of net reservations made
at participating properties through TravelWeb.com, and commissions are based on
the value of the guest stay for reservations booked through TravelWeb.com.
Private-label reservation service. Our private-label reservation service is
a service targeted to customers that are operators of travel-related websites,
such as Expedia.com and TravelNow.com. This service provides websites with our
online distribution database and electronic hotel room reservation
functionality. To conduct Internet-based electronic commerce successfully,
website operators must offer a content set that is sufficiently broad, accurate,
up-to-date, graphically appealing and useful to attract buyers to the website.
Typically, the development of such a content set is expensive and time
consuming. Furthermore, in addition to providing individual travelers with
access to useful and graphically appealing information, the website operator
must offer individual travelers the capability to make a reservation in order to
generate a transaction fee. The private-label reservation service offers website
operators a detailed and comprehensive set of hotel information and a simple and
fast method of making a hotel room reservation online. The private-label
reservation service provides a customized hotel database that appears to the
user to be the database of the third-party website. Additionally, the
third-party website establishes a connection to the Pegasus electronic
distribution technology that enables users of the website to shop and query room
availability, electronically make a reservation and receive a confirmation in
seconds.
Pegasus' hotel customers benefit from the private-label reservation service
because it more broadly disseminates, through the Internet at a lower cost, the
same marketing information available on TravelWeb.com. As a result, hotels need
only incur the effort and expense of creating and maintaining their information
on a single website to reach multiple Internet distribution points and achieve
increased visibility. Furthermore, the private-label reservation service
provides hotel customers an inexpensive means to distribute and publish visually
attractive marketing information and Internet-specific promotions. Hotels
offering their own brand-specific websites also can have their own content
delivered to their websites from Pegasus' online distribution database and
process reservation requests from their websites through Pegasus' booking
engine. Third-party website users and operators benefit from the private-label
reservation service through immediate access to the rich content of
TravelWeb.com. Furthermore, because users of the third-party websites can book
hotel rooms and receive confirmations in seconds through the Pegasus electronic
distribution technology, this service affords third-party website operators the
opportunity to generate a transaction fee revenue stream.
For reservations that originate on websites using the private-label
reservation service, Pegasus charges transaction fees based on the number of net
reservations made at participating properties. Private-label reservation
customers also pay initial development fees and either monthly maintenance or
subscription fees. Initial development fees are for establishing an electronic
communication link between the hotel's central reservation system and
third-party websites. Maintenance fees are for managing the communication link
and the online distribution database. Subscription fees are based on the number
of properties listed on Pegasus' online distribution database.
Other Internet-based distribution services. Our meetings and conventions
service automates the processing of hotel reservations for conventions and large
meetings. The manual process traditionally used to reserve hotel rooms for these
events is information-intensive and inefficient and frequently leads to
inaccurate and delayed information and overbooking or underbooking. With our
meetings and conventions service, convention and other large meeting organizers
are able to electronically transfer reservation requests through Pegasus to book
a room in each hotel central reservation system. Pegasus' meetings and
conventions service eliminates the need to deliver rooming lists for manual
entry on a hotel's reservation system and allows hotels to deliver reservations
and confirmations electronically in a fast and reliable manner.
Pegasus' meetings and conventions service benefits all parties involved in
hotel room distribution for conventions and large meetings. Since reservations
are made through the Pegasus electronic distribution technology rather than
manually, reservations, modifications and cancellations are received earlier and
updated more frequently and efficiently. The meetings and conventions service
provides convention and other large meeting organizers a single connection to
multiple hotel properties and enables them to make fast,
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accurate and reliable hotel room reservations and receive confirmations at
reduced cost. The meetings and conventions service also assists hotels in
controlling their room inventory by reducing the risk of overbooking or
underbooking and allows hotels to reduce the booking costs related to convention
reservations. Pegasus estimates that the majority of these types of reservations
are made at five major hotel chains. These hotel chains include Hilton, Hyatt,
Marriott, Sheraton and Westin, and their facilities are designed for and cater
to large conventions and meetings. Because all five of these chains are GDS
distribution service customers, Pegasus is positioned to take advantage of the
existing connectivity with these chains to facilitate the development and
marketing of the meetings and conventions service.
Pegasus' corporate travel service provides corporate travel departments
with electronic hotel room inventory information and room reservation capability
by connecting these features with corporate intranet travel management software.
With the corporate travel service, corporate travelers are able to check
availability and make hotel reservations within seconds at hotel chains or
properties with which the traveler's employer has negotiated rates. Our
corporate travel service enables corporate travel departments to have access to
the customized information negotiated with hotel chains and properties to
facilitate hotel room reservations. Furthermore, this information can be fully
integrated into other components of the intranet site and facilitate the
creation of passenger name records and detailed profile information.
Pegasus' corporate travel service will benefit hotels by providing an
additional hotel room distribution channel and enabling targeted marketing
efforts directed at corporate travel departments. Hotels will also be able to
reduce distribution costs for corporate room sales and better update information
and respond to reservation requests from corporate travelers compared to
traditional hotel room reservation methods, such as telephone or facsimile.
Pegasus markets this service to developers of corporate travel software programs
and to travel agencies that operate intranet travel management services. Our
corporate travel service is intended to provide benefits to travel agencies and
companies by decreasing the amount of time necessary to arrange a business trip,
improving travel information reporting and helping to ensure that employees
comply with company travel policies.
Pegasus has not received a material amount of revenue from the
private-label reservation service for corporate travel or the meetings and
conventions service to date, and there can be no assurance that these services
will produce material revenues in the future.
PEGASUS COMMISSION PROCESSING
Pegasus Commission Processing is the largest provider of travel agency
commission processing services in the hotel industry having as its customers
four of the five largest travel agencies according to Travel Weekly and nine of
the ten largest hotel chains based on total number of rooms. Over 25,000
properties and over 85,000 travel agencies are registered as Pegasus Commission
Processing participants as of December 31, 1999.
Typically, a hotel pays to the travel agency that made the hotel
reservation a commission of approximately 10% of the room rate paid by a hotel
guest. However, the payment process related to these commissions historically
has been costly and inefficient. The process has consisted of numerous checks in
small amounts and little information regarding the basis from which the
commission was calculated. Furthermore, communication between hotels and travel
agencies regarding payable commissions generally has not been effective. Often
guest cancellations or "no-shows" would not be reported, and travel agencies
would expect a commission when in fact none was due. As a result, travel
agencies lacked the necessary resources to reconcile commission payments
effectively.
Pegasus Commission Processing streamlines the commission payment process by
consolidating into a single payment the aggregate commissions owed by
participating hotels to each participating travel agency during a payment
period. Additionally, Pegasus Commission Processing offers a service to pay
commissions on behalf of hotels to travel agencies that are not Pegasus
Commission Processing participants.
Pegasus Commission Processing benefits hotels by providing an incentive to
travel agencies to make reservations at participating hotels in countries other
than their own because Pegasus Commission Processing disburses checks
denominated in each travel agency's currency of choice. However, Pegasus does
not receive
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significant revenues or incur significant expenses in foreign currencies.
Furthermore, Pegasus Commission Processing provides monthly and quarterly
marketing reports and statistics that allow the hotel to identify and market
more effectively to those travel agencies that provide the hotel with the
majority of its guests. The hotel also benefits from Pegasus Commission
Processing's customer relations center, which allows travel agency inquiries
regarding commissions to be resolved by Pegasus rather than by the hotel itself.
Additionally, Pegasus Commission Processing benefits travel agency
participants. The single check that Pegasus Commission Processing delivers for a
particular payment period reduces the staff time spent processing multiple
checks and deposit slips, eliminates bank fees for multiple deposits and
currency exchanges for checks issued in foreign currency. Pegasus Commission
Processing also is designed to improve the travel agency's ability to manage
cash flow. Pegasus Commission Processing delivers a monthly report that allows
the travel agency to confirm commissions paid, follow customers' reservation
habits and reduce expenses associated with collection and with tracking
cancellations and "no-shows." Pegasus Commission Processing's customer relations
center provides prompt responses to agency inquiries and can substantially
reduce the time and cost of reconciling outstanding commissions. Our optional
services for electronic payment and reconciliation of commissions provide travel
agencies with immediate access to funds and further reduce commission
reconciliation costs.
Pegasus Commission Processing maintains a website that provides a
comprehensive description of its services. The website also provides a complete
listing of all of the hotels that have committed to paying hotel commissions
through Pegasus Commission Processing. Moreover, travel agencies can subscribe
to an executive summary report that can be used to evaluate the travel agency's
activity with a particular hotel to assist with commission negotiations, among
other matters.
Pegasus charges each participating travel agency a service fee based on a
percentage of the commissions paid by hotels and hotel chains that are processed
by Pegasus on behalf of the travel agency. Pegasus also generally charges a
participating hotel a fee based on the number of commissionable transactions
processed by Pegasus for that hotel.
PEGASUS BUSINESS INTELLIGENCE
Pegasus Business Intelligence provides hotel database marketing and
consulting services. Pegasus Business Intelligence also is being expanded to
provide services that search and organize data into meaningful information for
competitive analysis and strategic planning for the hotel industry. Pegasus
Business Intelligence is intended to provide information for a wide variety of
audiences in the global hotel industry, from hotel chains to travel industry
marketing groups to corporate travel departments. This service compiles data
regarding hotel guests and their use of hotels and organizes that data into
meaningful information. Pegasus Business Intelligence intends to provide other
information services, including comparing a hotel's daily room and occupancy
rates with that of its competition. Pegasus Business Intelligence also intends
to provide industry trend reports and guest behavior data in an automated,
timely format for hotels and hotel marketing companies. Furthermore, Pegasus
Business Intelligence intends to provide data in an electronic format to
individual travelers or corporate travel departments regarding a particular stay
at a hotel, together with information provided by payment card companies, to
facilitate automated expense reporting or to ensure travel policy adherence.
COMPETITION
We compete in a market for hotel-related transaction processing and
electronic commerce services that is rapidly evolving, intensely competitive and
characterized by continually changing technology and industry standards.
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PEGASUS ELECTRONIC DISTRIBUTION
GDS distribution service
Our GDS distribution service competes with third-party service providers
such as WizCom International, Ltd. Customers may change their electronic
reservation interface to WizCom, to another similar service or to hotels
directly. Also, some hotels have established a direct connection to one or more
global distribution systems rather that through an intermediary, such as Pegasus
or WizCom. Other hotels may choose to take the same action. If hotels establish
this direct connection, they would bypass Pegasus' intermediary position and
eliminate the need to pay our fees. Other hotel room distribution services such
as the growing Internet-based services also have a competitive impact. Several
factors affecting the competitive success of our GDS distribution service
include:
- Reliability
- Pricing structure
- The number of hotel properties using the service
- The ability to provide a neutral, comprehensive interface between hotels
and other participants in the distribution of hotel rooms
- The ability to develop new technological solutions
Internet-based distribution services
Our TravelWeb.com, private-label reservation service and other
Internet-based services face competition in the online hotel room reservation
business from current competitors as well as potential new entrants, including
other websites. Several competitors have websites offering a more comprehensive
range of travel opportunities than we do. These websites include Preview Travel,
Travelocity, Expedia.com and TravelNow.com. The costs of entry into the Internet
hotel room reservation business are relatively low. There can be no assurance
that our Internet-based distribution services will compete successfully.
PEGASUS COMMISSION PROCESSING
Pegasus Commission Processing faces competition principally from National
Processing Company, Citicorp and Perot Systems, Inc. National Processing Company
has traditionally provided car rental and cruise line commission processing
services. Citicorp and Perot Systems, Inc. have provided commission
consolidation services to hotel chains. In addition, hotels that are current or
prospective customers of Pegasus Commission Processing can decide to process
commission payments without, or in competition with, Pegasus Commission
Processing. Furthermore, while Pegasus Commission Processing has agreements with
all of its hotel customers, most of its travel agency customers are not bound by
any written agreement with us. If a significant portion of these customers stop
using Pegasus Commission Processing, it could have a material adverse effect on
our business, operating results and financial condition.
PEGASUS BUSINESS INTELLIGENCE
Pegasus Business Intelligence principally competes with Smith Travel
Research, Global Marketing Services and Group 1 Software, Inc., each of which
currently provides information services to hotels. Additionally, accounting
firms and other businesses currently or may in the future provide information
services similar to our current or future service offerings. Competitors may
have existing customer relationships that create an obstacle to our acquiring
new customers. The current or future information service offerings of existing
competitors or new competitors may reduce the attractiveness of Pegasus Business
Intelligence services.
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INTELLECTUAL PROPERTY
We are continually developing new processing technology and enhancing
existing proprietary technology. We have no patents. We primarily rely on a
combination of copyright, trade secrets, confidentiality procedures and
contractual provisions to protect our technology. Despite these protections, it
may be possible for unauthorized parties to copy, obtain or use certain portions
of our proprietary technology.
While any misappropriation of our intellectual property could have a
material adverse effect on our competitive position, we believe that protection
of proprietary rights is less significant to our business than the continued
pursuit of our operating strategies and other factors, such as our relationship
with industry participants and the experience and abilities of our key
personnel.
We have registered "UltraSwitch," "TravelWeb," "UltraAccess," "HCC Hotel
Clearing Corporation," "HCC Link," "HCC Cash," "UltraRes," "Click-It Weekends,"
"Pegasus Systems, Inc." and "Chain Link" as United States federal trademarks,
and an application to register "Powered by Pegasus" is pending with the United
States Patent and Trademark Office. Trademark applications for "TravelWeb" and
"Powered by Pegasus" also have been filed in Canada and Europe.
RESEARCH AND DEVELOPMENT
Our research and development activities primarily consist of software
development, development of enhanced communication protocols and custom user
interfaces and database design and enhancement. As of February 29, 2000, we
employed 110 people in our information technology group and from time to time,
supplement their efforts by using independent consultants and contractors. This
group is comprised of information technology, services development, technical
services and product support personnel. Our total research and development
expense was $2.4 million, $4.2 million and $2.5 million for 1999, 1998 and 1997,
respectively. The research and development expenses for 1998 included a $1.5
million write-off of purchased in-process research and development related to
the acquisition of Driving Revenue L.L.C.
EMPLOYEES
At February 29, 2000, we had 172 employees, 165 of which were located in
the United States, with 110 persons in the information technology group, 39
persons performing sales and marketing, customer relations and business
development functions and the remainder performing corporate, finance and
administrative functions. We had 7 employees in England performing international
sales activities. We have no unionized employees. We believe that our employee
relations are satisfactory.
RISK FACTORS
WE ARE GROWING RAPIDLY AND MAY NOT HAVE THE RESOURCES TO EFFECTIVELY MANAGE
ADDITIONAL GROWTH.
Our recent growth and potential future growth have placed significant
demands on management as well as on our administrative, operational and
financial resources. Expanding our business to take advantage of new market
opportunities will require significant management attention and financial
resources. To manage additional growth we must:
- Expand our sales, marketing and customer support organizations
- Attract and retain additional qualified personnel
- Expand our physical facilities
- Invest in the development or enhancement of our current services and
develop new services that meet changing industry needs
- Develop systems, procedures or controls to support the expansion of our
operations
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Our inability to manage any additional growth could have a material adverse
effect on our business, operating results and financial condition.
BECAUSE OUR EXPENSES ARE LARGELY FIXED AND WE CANNOT ACCURATELY PREDICT OUR
COMPETITIVE ENVIRONMENT, UNEXPECTED REVENUE SHORTFALLS AND QUARTERLY
VARIATIONS MAY ADVERSELY AFFECT OUR BUSINESS.
Our expense levels are based primarily on our estimate of future revenues
and are largely fixed. In the future, we may not accurately predict the
introduction of new or enhanced services by us or our competitors or the degree
of customer acceptance of new services. We may also be unable to adjust spending
rapidly enough to compensate for any unexpected revenue shortfall. In addition,
our past and future operating results vary significantly from quarter to quarter
due to a variety of factors, many of which are outside of our control. It is
likely that in one or more future quarters our results may fall below the
expectations of securities analysts or investors. Any significant shortfall in
revenues in relation to our planned expenditures would reduce, and possibly
eliminate, any operating income. Due to the fixed nature of our costs, and
because operating costs are based on anticipated revenues, a decline in revenue
from even a limited number of transactions, failure to achieve expected revenue
in any fiscal quarter or unanticipated variation in the recognition of revenues
can cause significant variations in operating results from quarter to quarter.
This could result in losses in some future quarter or have a material adverse
effect on our business, operating results and financial condition. We believe
that period-to-period comparisons of our operating results should not be relied
upon as an indication of future performance.
LOSS OF OUR ARRANGEMENTS WITH KEY CUSTOMERS OR THIRD-PARTY SERVICE
ARRANGEMENTS COULD ADVERSELY AFFECT OUR BUSINESS.
Our business is dependent upon our customer arrangements with hotel chains,
hotel representation firms, travel agencies, travel agency consortia and global
distribution systems. In the future, we may be unable to continue or renew these
arrangements on favorable terms or initiate new arrangements. If we are unable
to renew, continue or initiate customer arrangements on a favorable basis, it
could result in a significant reduction in our customer base and revenue
sources. We have not entered into any written agreements with most of our travel
agency customers relating to Pegasus Commission Processing. We also rely on
third parties to provide consolidation, remittance and worldwide currency
exchange services for Pegasus Commission Processing and for facility maintenance
and disaster recovery services for the computer and communications systems used
in all of our services. If we are unable to renew or extend our contracts with
current third-party service providers or enter into contracts with alternate
service providers on favorable terms, it could have a material adverse effect on
our business, operating results and financial condition.
OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP NEW TECHNOLOGIES AND
SERVICES TO MEET THE CHANGING NEEDS OF THE PARTICIPANTS IN THE INTENSELY
COMPETITIVE HOTEL INDUSTRY.
Our future success depends on our ability to develop leading technologies,
enhance our existing services and develop and introduce new services. In
particular, our technologies and services must meet the needs of our current and
prospective customers. They also must continue to meet the demands of
technological advances and emerging industry standards and practices on a timely
and cost-effective basis. Although we strive to be a technological leader,
future technology advances may not complement or be compatible with our
services. In addition, we may be unable to economically and timely incorporate
technology changes and advances into our business. We may be unsuccessful in
effectively using new technologies, adapting our services to emerging industry
standards or developing, introducing and marketing service enhancements or new
services. We may also experience difficulties that could delay or prevent the
successful development, introduction or marketing of these services. If we are
unable to develop and introduce new services or enhance existing services on a
timely and cost-effective basis or if new services do not achieve market
acceptance, it could have a material adverse effect on our business, operating
results and financial condition.
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OUR SUCCESS SIGNIFICANTLY DEPENDS ON THE EXPERIENCE OF OUR KEY PERSONNEL AND
OUR ABILITY TO ATTRACT AND RETAIN ADDITIONAL PERSONNEL.
Our success depends on the continued service of our executive officers and
other key personnel, including our President, John F. Davis, III, and our Chief
Operating Officer, Joseph W. Nicholson. Even though we currently have "key-man"
insurance covering Messrs. Davis and Nicholson, this insurance amount may not
adequately compensate for the loss of their services. We believe that our future
business results also depend on our ability to identify, attract, motivate and
retain skilled technical personnel. Competition for personnel in the electronic
commerce industry is intense. We cannot guarantee that we will be able to
successfully identify, attract, motivate and retain other highly-skilled
personnel in a timely and effective manner. Our failure to retain our officers
and key personnel or to recruit new personnel could have a material adverse
effect on our business, operating results and financial condition.
AS NEARLY ALL OF OUR REVENUES ARE DERIVED FROM THE HOTEL INDUSTRY, A DOWNTURN
IN THE HOTEL INDUSTRY WOULD LIKELY ADVERSELY AFFECT OUR BUSINESS.
Nearly all of our revenues are directly or indirectly dependent on the
hotel industry. The hotel industry could experience rapid and unexpected
downturns. In the event of a downturn in the hotel industry, we would likely
experience significantly reduced demand for our services and solutions. Any
significant downturn in the hotel industry or any reduction in the demand for
hotel rooms and travel generally, would negatively impact our revenues and
financial condition. For instance, the hotel industry is highly sensitive to any
change in the economic conditions affecting business and leisure travel as well
as other unforeseen events. Many factors affect the hotel industry, most of
which are beyond our control. The hotel industry and demand for hotel rooms or
travel may be affected by, among other things:
- Political instability
- Regional hostilities
- Recession
- Gasoline price escalation
- Inflation
- Any event resulting in significant decreases in demand for hotel rooms or
travel
- Any decrease in hotel room reservation volumes, which may result from
increased competition among hotels
- A decrease in the average hotel room rate
We may experience substantial period-to-period fluctuations in our results of
operations as a consequence of any of these events or the general economic
conditions affecting the demand for hotel rooms and travel.
REDUCTIONS IN HOTEL COMMISSION PAYMENTS WOULD REDUCE OUR REVENUES AND NET
INCOME.
Pegasus Commission Processing derives revenues based on the dollar value of
travel agency commissions paid by hotels. A substantial portion of our revenues
and net income is attributable to Pegasus Commission Processing. If there is any
change in the commission payment process or any increase in the direct
distribution of rooms by hotels, our revenues and net income could substantially
decrease. Hotels typically are under no contractual obligation to pay room
reservation commissions to travel agencies. Hotels could elect to reduce the
current industry customary commission rate of 10%, limit the maximum commission
generally paid for a hotel room reservation or eliminate commissions entirely.
For example, Marriott Hotels, a significant customer, has required travel
agencies to complete a training course and to sign an agreement in order to
continue to receive a 10% commission after November 15, 1999. Failure to do so
may result in the travel agency receiving reduced commissions. Hotels
increasingly are utilizing other direct distribution channels, like the
Internet, or offering negotiated rates to major corporate customers that are
non-commissionable to travel agencies. Although we
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have not to date experienced any material reduction in revenues due to these
initiatives, there can be no assurance that these initiatives or any other
initiative to reduce hotel reservation commissions would not adversely effect on
our revenues or net income.
RAPID CONSOLIDATION IN THE HOTEL INDUSTRY COULD LOWER THE VALUE OF OUR
SERVICES.
We offer volume-based discounting of our fees. The recent consolidation in
the hotel industry has resulted in a higher percentage of discounted fees, and
this trend could continue. In addition, the global distribution system industry
has consolidated into four major global distribution systems. If further
consolidation occurs, the value of our services and the benefits to hotel
operators of utilizing our GDS distribution service would be reduced. Any
decrease in our customer base or any increase in the percentage of discounted
fees may have a material adverse effect on our business, operating results and
financial condition.
OUR LIMITED EXPERIENCE IN MANAGING AND INTEGRATING ORGANIZATIONS MAY RESULT IN
FUTURE ACQUISITIONS OR JOINT VENTURES BEING DIFFICULT AND DISRUPTIVE.
We regularly evaluate acquisition and joint venture opportunities and in
the future expect to make acquisitions of other companies or technologies or
enter into joint ventures. On November 16, 1999, we entered into a definitive
agreement to acquire REZ, Inc., formerly known as REZsolutions, Inc. The
agreement is described more fully in this annual report under "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Recent Developments". These acquisitions or joint ventures may
divert the time and resources of our management. Further, we have limited
experience in integrating newly acquired organizations into our operations.
Acquisitions involve many risks including:
- Difficulty in integrating or otherwise assimilating technologies,
products, personnel and operations
- Diversion of management's attention from other business concerns
- Issuance of dilutive equity securities and incurrence of debt or
contingent liabilities
- Large write-offs and amortization expense related to goodwill and other
intangible assets
- Loss of key employees
- Risks of entering markets in which we have no or limited prior experience
- Payments of cash, incurrence of debt or assumption of other liabilities
to acquire other businesses
The result of one or more of these factors could have a material adverse effect
on our business, operating results and financial condition.
OUR COMPUTER SYSTEMS AND DATABASES MAY SUFFER SYSTEM FAILURES, BUSINESS
INTERRUPTIONS OR SECURITY RISKS.
Our operations depend on our ability to protect our computer systems and
databases against damage or system interruptions from fire, earthquake, power
loss, telecommunications failure, unauthorized entry or other events beyond our
control. A significant amount of our computer equipment is located at a single
site in Phoenix, Arizona. Any unanticipated problems may cause a significant
system outage or data loss. Despite the implementation of security measures, our
infrastructure may also be vulnerable to break-ins, computer viruses or other
disruptions caused by our customers or others. Any damage to our databases,
failure of communication links, security breach or other loss that causes
interruptions in our operations or compromises the integrity of our systems
could have a material adverse effect on our business, operating results and
financial condition.
WE ARE DEPENDENT TO A SUBSTANTIAL DEGREE ON INTERNET COMMERCE FOR OUR FUTURE
GROWTH.
The future growth of our Internet-based distribution services depends on
the viability of the Internet as a channel for distributing services and
products. Our services depend on the expansion of the Internet infrastructure to
enable the Internet to support the future demand created by expected growth.
Participants in the Internet industry may fail to develop necessary
infrastructure or complementary services and products,
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such as high speed modems and high speed communications lines. In addition,
there are critical issues concerning the commercial use of the Internet that
remain unresolved, including issues relating to security, reliability, cost,
ease of use, accessibility and quality of service. If the issues concerning the
commercial use of the Internet are not resolved favorably, it could have a
material adverse effect on our business, operating results and financial
condition.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES COULD FORCE US TO CHANGE OUR
OPERATIONS.
Although several aspects of the travel industry are heavily regulated by
the United States and other governments, we do not believe the services we offer
are currently subject to any material industry-specific government regulation.
Any future regulations implemented by federal, state or foreign governmental
authorities or affecting one or more of our current or future services could
have a material adverse effect on our operations.
Our primary customers are hotel chains, hotel representation firms and
travel agencies. Although some of our stockholders are customers, we believe
that we operate as an entity independent from our stockholders. Any federal,
state or foreign governmental authorities, our competitors or our consumers
raising anti-competitive concerns regarding our relationship with stockholders
that are customers could institute action against us. Any action by federal,
state or foreign governmental authorities or allegations by third parties could
have a material adverse effect on our business, operating results and financial
condition.
WE COULD BE SUBJECT TO NEW LAWS AND REGULATIONS RELATING TO THE INTERNET.
We are subject to the same federal, state and local laws as other companies
conducting business on the Internet. The vast majority of these laws were
adopted prior to the advent of the Internet and related technologies and, as a
result, do not contemplate or address the unique issues of the Internet and
related technologies. Those laws that do reference the Internet have not yet
been thoroughly interpreted by the courts and their applicability and reach are
therefore uncertain. Today there are relatively few laws specifically directed
towards online services. However, due to the increasing popularity and use of
the Internet and online services, it is possible that laws and regulations will
be adopted with respect to the Internet and online services. These laws and
regulations could cover issues like online contracts, user privacy, freedom of
expression, pricing, fraud, content and quality of products and services,
taxation, advertising, intellectual property rights and information security.
Applicability to the Internet of existing laws governing issues such as property
ownership, copyrights and other intellectual property issues, taxation, libel,
obscenity and personal privacy is uncertain.
NEW LEGISLATION AND GOVERNMENTAL REGULATION OF PRIVACY ISSUES RELATING TO THE
INTERNET COULD AFFECT OUR OPERATIONS.
Changes to existing laws or the passage of new laws intended to address
privacy issues could directly affect the way we do business and could create
uncertainty in the marketplace. The United States federal government and several
states within the United States have proposed legislation that would limit the
uses of personal user information gathered online or require online services to
establish privacy policies, and some foreign jurisdictions have adopted similar
legislation. The United States Federal Trade Commission also has recently
settled a proceeding with one online service regarding the manner in which
personal information is collected from users and provided to third parties. This
could reduce the demand for our services, increase the cost of doing business as
a result of litigation costs or increased service delivery costs, or otherwise
harm our business.
WE MAY BE SUBJECT TO PENALTIES FOR FAILING TO PROPERLY QUALIFY AS A FOREIGN
CORPORATION IN VARIOUS JURISDICTIONS DUE TO OUR OPERATIONS AS AN INTERNET
COMPANY.
Since our services will be accessible worldwide, foreign jurisdictions may
require that we comply with their laws. Our failure to comply with foreign laws
could subject us to penalties ranging from fines to bans on our ability to offer
our services. In the United States, companies are required to qualify as foreign
corporations
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in states where they are conducting business. As an Internet company, it is
unclear in which states we are actually doing business. Our failure to qualify
as a foreign corporation in a jurisdiction where we are required to do so could
subject us to taxes and penalties for the failure to qualify and could result in
our inability to enforce contracts in those jurisdictions. Any new legislation
or regulation, or the application of laws or regulations from jurisdictions
whose laws do not currently apply to our business, could adversely affect our
business, operating results and financial condition.
OUR PLANNED EXPANSION OF INTERNATIONAL OPERATIONS MAY MAKE US SUSCEPTIBLE TO
GLOBAL ECONOMIC FACTORS, FOREIGN TAX LAW ISSUES, FOREIGN BUSINESS PRACTICES
AND CURRENCY FLUCTUATIONS.
Our pursuit of international growth opportunities may require significant
investments for an extended period before we realize returns on these
investments, if any. Our international operations are subject to particular
risks, including:
- Difficulties and costs of managing and staffing foreign operations
- Inexperience in managing foreign operations
- Impact of possible adverse political and economic conditions
- Fluctuations in the value of the U.S. dollar relative to other currencies
- Potentially adverse tax consequences
- Impact of the policies of the United States and foreign governments on
foreign trade
- Reduced protection for intellectual property rights in some countries
- Unexpected changes in regulatory requirements
- Cost of adapting our services to foreign markets
If we do not realize our expected results from international operations, it
could have a material adverse effect on our business, operating results and
financial condition.
WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR PROPRIETARY RIGHTS OR PREVENT THEIR
UNAUTHORIZED USE, WHICH COULD DIVERT OUR FINANCIAL RESOURCES AND HARM OUR
BUSINESS.
Our success depends upon our proprietary technology, consisting of both our
software and hardware designs. We rely upon a combination of copyright, trade
secrets, confidentiality procedures and contractual provisions to protect our
proprietary technology. Despite our current efforts to protect our proprietary
rights, these protective measures may not be enforceable or adequate to prevent
misappropriation or independent third-party development of our technology. Many
foreign jurisdictions offer less protection of intellectual property rights than
the United States. Effective copyright, trademark and trade secret protection
may not be available in other jurisdictions. In addition, we may need to
litigate claims against third parties to enforce our intellectual property
rights, protect our trade secrets, determine the validity and scope of the
proprietary rights of others or defend against claims of infringement or
invalidity. This litigation could result in substantial cost and diversion of
management resources. A successful claim against us could effectively block our
ability to use or license our technology in the United States or abroad. If we
cannot adequately protect our proprietary rights, it could have a material
adverse effect on our business, operating results and financial condition.
WE RELY ON TECHNOLOGY LICENSES FROM THIRD PARTIES, THE LOSS OF WHICH MAY HARM
OUR ABILITY TO DEVELOP AND SELL OUR SERVICES.
We currently and in the future may procure licenses from third parties
relating to our services or technology. Our inability to obtain or maintain such
licenses could impair our ability to develop and sell our services. Our
competitors may obtain licenses with lower royalty obligations or other terms
more favorable than those received by us. If we or our suppliers are unable to
obtain licenses, we could be forced to market services without certain
technological features. Our inability to obtain licenses or to obtain such
licenses on
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competitive terms could have a material adverse effect on our business,
operating results and financial condition.
IF WE ARE UNABLE TO QUICKLY DEVELOP NEW TECHNOLOGIES AND NEW SERVICES TO MEET
THE NEEDS OF THE PARTICIPANTS IN THE INTENSELY COMPETITIVE HOTEL INDUSTRY, WE
MAY LOSE MARKET SHARE AND BE FORCED TO REDUCE THE PRICES OF OUR SERVICES.
We compete in a market that is rapidly evolving, intensely competitive and
involve continually changing technology and industry standards. We may not be
successful in competing against our current and future competitors. Competitors
may be able to respond more quickly than we can to new or emerging technologies,
services or changes in customer requirements. We may experience increased
competition from current and potential competitors, many of which have
significantly greater financial, technical, marketing and other resources than
we do. Other participants in the hotel room distribution process, commission
processing or business information industries as well as new competitors could
create services that are more attractive than our services. Competitive
pressures could reduce our market share or require us to reduce the prices of
our services. Our inability to compete effectively with these services could
have a material adverse effect on our business, operating results and financial
condition.
Each of our services faces unique competition from within its respective
market. For more information about the specific competitive forces facing our
services see the section entitled "Competition" on page 8 .
OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE EXTREMELY VOLATILE DUE TO MANY
FACTORS.
Many factors have caused our stock price to be volatile in the past and in
the future it may be extremely volatile. Our stock price could be subject to
wide fluctuations in response to a variety of factors including the following:
- Actual or anticipated variations in our quarterly operating results
- Our ability to successfully develop, introduce and market new or enhanced
products and services to the hotel industry on a timely basis
- Unexpected changes in demand for our services and solutions due to the
fixed nature of a large portion of our expenses
- Unpredictable volume and timing of customer revenues due to seasonality
in the travel industry, the terms of customer contracts and other factors
- Our purchasing and payment patterns
- Pricing policies of our competitors
- Announcements of technological innovations or new services by us or our
competitors
- Changes in financial estimates by securities analysts
- Conditions or trends in the Internet and online commerce industries
- Changes in the market valuations of other similarly situated companies
- Development in Internet regulations
- Announcements by us or our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments
- Market fluctuations and performance of the hotel industry
- Unscheduled system downtime
In addition, the trading prices of Internet stocks in general have experienced
extreme price and volume fluctuations in recent months. Any negative changes in
the public's perception of the prospects of Internet or
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electronic commerce companies or other negative broad market or industry factors
could depress our stock price regardless of our operating performance. Market
fluctuations, as well as general political and economic conditions, such as
recession or interest rate or currency rate fluctuations, also may decrease the
market price of our common stock.
LITIGATION MAY DIVERT OUR RESOURCES AND REDUCE THE MARKET PRICE OF OUR COMMON
STOCK.
In some instances, following declines in the market price of a company's
securities, securities class-action litigation often has been instituted against
that company. Litigation of this type, if instituted against us, could result in
substantial costs and a diversion of management's attention and resources, which
could have a material adverse effect on our business, operating results and
financial condition.
PROVISIONS IN OUR CHARTER AND BYLAWS MAY DETER POTENTIAL ACQUISITION BIDS,
INCLUDING BIDS WHICH MAY BE BENEFICIAL TO OUR STOCKHOLDERS.
Provisions in our certificate of incorporation and bylaws could make it
more difficult for a third party to acquire us, even if doing so would be
beneficial to our stockholders. Our certificate of incorporation and bylaws
provide for a classified board of directors serving staggered terms of three
years, prevent stockholders from calling a special meeting of stockholders and
prohibit stockholder action by written consent. Our certificate of incorporation
also authorizes only the board of directors to fill director vacancies,
including newly created directorships, and states that directors may be removed
only for cause and only by the affirmative vote of holders of at least
two-thirds of the outstanding shares of the voting stock voting together as a
single class. These provisions could discourage potential acquisition proposals
and could delay or prevent a change in control transaction. They could also
discourage others from making tender offers for our shares. As a result, these
provisions may prevent the market price of our common stock from reflecting the
effects of actual or rumored takeover attempts. These provisions may also
prevent significant changes in our board of directors and our management.
OUR STOCKHOLDER RIGHTS PLAN MAY DISCOURAGE A THIRD PARTY FROM ACQUIRING
CONTROL OF PEGASUS.
On September 28, 1998, our board of directors adopted a stockholder rights
plan and declared a dividend distribution of one right for each outstanding
share of our common stock to stockholders of record at the close of business on
October 13, 1998. The number of rights associated with shares of common stock
has been proportionally adjusted for the stock split effected in January 2000.
Each right entitles the registered holder to purchase from us one one-thousandth
of a share of our Series A Preferred Stock for each share of our common stock
held at a price of $90. The rights are exercisable only if a person or group of
affiliated persons acquires, or has announced the intent to acquire, 20% or more
of our common stock. These rights could make it more difficult for a third party
to acquire or could discourage a third party from acquiring control of us.
DELAWARE LAW MAY DETER POTENTIAL ACQUISITION BIDS FOR OUR BUSINESS, INCLUDING
BIDS THAT MAY BE BENEFICIAL TO OUR STOCKHOLDERS.
We are subject to the provisions of Delaware law which restrict certain
business combinations with interested stockholders even if such a combination
would be beneficial to stockholders. These provisions may inhibit a
non-negotiated merger or other business combination. The anti-takeover
provisions of the Delaware General Corporation Law prevent us from engaging in a
"business combination" with any "interested stockholder" for three years
following the date that the stockholder became an interested stockholder. For
purposes of Delaware law, a "business combination" includes a merger or
consolidation involving Pegasus and the interested stockholder and the sale of
more that 10% of our assets. In general, Delaware law defines an "interested
stockholder" as any entity or person beneficially owning more than 15% of the
outstanding voting stock of a corporation and any entity or person affiliated
with or controlling or controlled by such entity or person. Under Delaware law,
a Delaware corporation may opt out of the anti-takeover provisions. We do not
intend to opt out of these anti-takeover provisions.
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ITEM 2. PROPERTIES
Our principal executive office is a leased facility with approximately
58,886 square feet of space in Dallas, Texas as of March 1, 2000. We lease this
space under a lease agreement that expires December 2002. We also maintain an
administrative and sales office in a leased facility with approximately 2,255
square feet of space near London, England. The lease agreement for the office in
England expires in February 2006. Under an agreement with REZsolutions, Inc.
some equipment owned by us is housed at the facilities of REZsolutions, Inc. in
Phoenix, Arizona. Under an agreement with Genuity, Inc. some equipment owned by
us is housed at the facilities of Genuity, Inc. in Phoenix, Arizona. We believe
that our existing facilities are well maintained and in good operating condition
and are adequate for our present and anticipated levels of operations.
ITEM 3. LEGAL PROCEEDINGS
We are a party from time to time to certain routine legal proceedings
arising in the ordinary course of our business. Although the outcome of any
legal proceeding cannot be predicted accurately, we do not believe any liability
that might result from such proceedings could have a material adverse effect on
our business, operating results and financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of our stockholders during the fourth
quarter of the fiscal year ended December 31, 1999.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
(a) Our common stock has been traded on the Nasdaq National Market under
the symbol "PEGS" since August 7, 1997. At March 9, 2000, there were
approximately 20,353,135 record holders of our common stock although we believe
that the number of beneficial owners of our common stock is substantially
greater. The market prices set forth below have been adjusted to reflect a
three-for-two stock split effected on January 7, 2000 in the form of a stock
dividend to all stockholders of record on December 20, 1999.
HIGH LOW
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1999
Fourth quarter.............................................. $54.42 $24.17
Third quarter............................................... $29.75 $19.33
Second quarter.............................................. $32.92 $20.75
First quarter............................................... $30.67 $16.67
1998
Fourth quarter.............................................. $24.17 $ 5.92
Third quarter............................................... $17.92 $ 7.17
Second quarter.............................................. $20.67 $14.67
First quarter............................................... $18.08 $ 9.08
1997
Fourth quarter.............................................. $13.83 $ 8.33
Third quarter............................................... $12.83 $10.33
We intend to retain any future earnings for use in our business and do not
intend to pay cash dividends in the foreseeable future. The payment of future
dividends, if any, will be at the discretion of our board of directors and will
depend, among other things, upon future earnings, operations, capital
requirements, restrictions in future financing agreements, our general financial
condition and general business conditions.
On September 28, 1998, our board of directors declared a dividend
distribution of one right for each outstanding share of our common stock to
stockholders of record at the close of business on October 13, 1998. Each right
entitles the registered holder to purchase from us one one-thousandth of a share
of our series A preferred stock for each share of our common stock held at a
price of $90. The number of rights associated with shares of common stock has
been proportionally adjusted for the stock split effected in January 2000. The
rights are exercisable only if a person or group of affiliated persons acquires,
or has announced the intent to acquire, 20% or more of our common stock.
(b) The Securities and Exchange Commission on August 6, 1997 declared
effective the Registration Statement on Form S-1 (File No. 333-28595) relating
to the initial public offering ("IPO") of our common stock.
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ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data as of and for the years
ended December 31, 1999 and 1998 and for the year ended December 31, 1997 are
derived from the consolidated financial statements of Pegasus that have been
audited by PricewaterhouseCoopers LLP, independent accountants, and are included
as Item 8 of this annual report on Form 10-K. Selected consolidated financial
data as of December 31, 1997 and as of and for the year ended December 31, 1996
are derived from Pegasus' financial statements that have been audited by
PricewaterhouseCoopers LLP, but are not included herein. The selected
consolidated financial data as of and for the year ended December 31, 1995 are
derived from Pegasus' financial statements that have been audited by Belew
Averitt LLP, independent accountants, but are not included herein. The data
should be read in conjunction with Management's Discussion and Analysis of
Financial Condition and Results of Operations included as Item 7 of this annual
report on Form 10-K and with Pegasus' consolidated financial statements and
notes thereto.
1999 1998 1997 1996 1995
------- ------- ------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Net revenues................................ $38,036 $29,064 $20,903 $ 15,869 $ 9,296
Net income (loss)(1)........................ 8,666 5,396 589 (3,485) (3,571)
Net income (loss) per share(1)(2)
Basic..................................... 0.47 0.34 0.05 (0.44) (0.87)
Diluted................................... 0.44 0.32 0.05 (0.44) (0.87)
Working capital (deficit)................... 143,605 44,398 38,397 2,068 (1,560)
Total assets................................ 163,540 60,320 49,923 13,892 10,316
Long-term obligations, net of current
portion................................... -- 58 661 6,353 6,994
Total stockholders' equity (deficit)........ 156,771 54,264 43,478 1,954 (2,380)
- ---------------
(1) Pegasus' selected consolidated financial data includes the depreciation and
amortization of the following:
- Acquisition of 83.3% of the outstanding capital stock of The Hotel
Clearing Corporation ("HCC") in July 1995
- Acquisition of the remaining 16.7% of the outstanding capital stock of
HCC in June 1996
- Acquisition of Driving Revenue L.L.C. ("Driving Revenue") in August 1998
Amortization applicable to the acquisition of HCC totaled approximately
$798,000, $1,534,000, $1,412,000, $645,000 in 1998, 1997, 1996 and 1995,
respectively. Amortization applicable to Driving Revenue totaled
approximately $416,000 and $125,000 in 1999 and 1998, respectively.
(2) Certain net income (loss) per share amounts were retroactively adjusted for
a one hundred-for-one stock split that occurred in June 1996, a
four-for-three stock split that occurred in August 1997 and a three-for-
two stock split that occurred in January 2000. Such calculations reflect
the adoption of Statement of Financial Accounting Standards No. 128,
"Earnings per Share" ("FAS 128") in 1997. In accordance with FAS 128, all
prior periods presented were restated.
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the selected consolidated financial data included as Item 6 of this annual
report on Form 10-K and the consolidated financial statements and notes thereto
included as Item 8 of this annual report on Form 10-K. This discussion and
analysis contains certain forward-looking statements that involve risks and
uncertainties. Pegasus' actual results and the timing of certain events could
differ materially from those discussed in the forward-looking statements as a
result of several factors including those set forth in Pegasus' filings with the
Securities and Exchange Commission, specifically including the risk factors set
forth under Item 1 of this annual report on Form 10-K.
OVERVIEW
Pegasus is a leading provider of transaction processing and electronic
commerce services to the hotel industry worldwide. Pegasus is organized into
three businesses: Pegasus Electronic Distribution, Pegasus Commission Processing
and Pegasus Business Intelligence.
Pegasus Electronic Distribution. Pegasus Electronic Distribution includes
the GDS distribution service and Internet-based distribution services. These
services improve the efficiency and effectiveness of the hotel reservation
process by enabling travel agents and individual travelers to electronically
access hotel room inventory information and conduct reservation transactions.
Our GDS distribution service provides an electronic interface between a
hotel's central reservation system and the global distribution systems that
travel agents use to book hotel and airline reservations. Pegasus derives
revenues from this service by charging hotel participants a fee based on the
number of reservations made, less the number cancelled ("net reservations"), and
a fee for "status messages" processed through the GDS distribution service.
Status messages are electronic messages sent by hotels to global distribution
systems to update room rates, features and availability information in global
distribution system databases. As a hotel's cumulative volume of net
reservations increases during the course of the calendar year, its fee per
transaction decreases after predetermined transaction volume hurdles have been
met. As a result, for higher volume customers, unit transaction fees are higher
at the beginning of the year, when cumulative transactions are lower. Pegasus
recognizes revenues based on the fee per transaction that a customer is expected
to pay during the entire year. Pegasus' interim balance sheets reflect a
liability for the difference between the fee per transaction that Pegasus
actually bills a customer during the period and the average fee per transaction
that a customer is expected to pay for the entire year. The liability created
during the early periods of the year is eliminated by the end of each year as
the fee per transaction that Pegasus actually bills a customer falls below the
average fee per transaction for the entire year. Pegasus offers volume-based
discounting of the GDS distribution service fees. The recent consolidation in
the hotel industry has resulted in a lower average fee per transaction for the
GDS distribution service. Despite increases in the number of transactions,
revenues generated from the GDS distribution service have remained consistent
with prior periods. Pegasus expects this trend to continue.
Additionally, Pegasus generally charges new participants in the GDS
distribution service a one-time set-up fee for work performed to establish the
connection between a hotel's central reservation system and the Pegasus
electronic distribution technology. Revenue for these one-time set-up fees is
recognized ratably over the set-up period, which generally ranges from two to
four months. During the set-up period, Pegasus establishes an electronic
communication link with the hotel's central reservation system and performs
testing to ensure proper delivery of data and transactions between the hotel and
each distribution channel. Pegasus also charges some global distribution systems
a fee based on either the number of net reservations or the number of hotels
connected to the global distribution system to compensate for the management and
consolidation of multiple interfaces.
Our Internet-based distribution services provide online hotel reservation
capabilities to travelers via our TravelWeb.com website (www.travelweb.com) and
our private-label reservation service. To participate in the Internet-based
distribution services, hotels pay Pegasus subscription fees based on the number
of the hotel company's properties in Pegasus' online distribution database. For
reservations that originate on the
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TravelWeb.com website, Pegasus charges either a transaction fee based on the
number of net reservations made at participating properties or a commission
based on the value of the guest stay. For reservations that originate on
websites using the private-label reservation service, Pegasus charges
transaction fees based on the number of net reservations made at participating
properties. Private-label reservation customers also pay initial development
fees and either monthly subscription or maintenance fees. Initial development
fees are for establishing an electronic communication link between the hotel's
central reservation system and third-party websites. Maintenance fees are for
the management of the communication link and the online distribution database.
Pegasus Commission Processing. Pegasus Commission Processing provides hotel
commission payment processing. Pegasus Commission Processing improves the
efficiency and effectiveness of the commission payment process for participating
hotels and travel agencies by consolidating payments, paying in local currency
and providing comprehensive transaction reports. Pegasus Commission Processing
derives revenues by charging a participating travel agency a fee based on a
percentage of the commissions paid by hotels and hotel chains that are processed
by Pegasus on behalf of that agency. Pegasus also generally charges a
participating hotel a fee based on the number of commissionable transactions
arising from that hotel that are processed by Pegasus. Revenues from travel
agency fees can vary substantially from period to period based on the types of
hotels at which reservations are made and fluctuations in overall room rates.
Pegasus Commission Processing recognizes revenues in the month in which the
hotel stay occurs. In the following month, Pegasus collects commissions from the
hotels by the 12th business day of the month and pays commissions to travel
agencies by the 15th business day of the month. If a hotel fails to deliver
funds to Pegasus, Pegasus is not obligated to deliver commission payments on
behalf of the hotel to travel agencies. During 1999, Pegasus processed
approximately $321 million in commissions for participating agencies. Pegasus
typically retains as its commission processing fee approximately 5% of the
commissions processed on behalf of the participating agency.
Pegasus Business Intelligence. Pegasus Business Intelligence provides
database marketing and consulting services. Pegasus Business Intelligence also
is being expanded to provide services that search and organize data into
meaningful information for competitive analysis and strategic planning for the
hotel industry. Pegasus Business Intelligence revenues consist of fees charged
to hotels for the development of hotel databases and for consulting services.
Historically, Pegasus has derived a majority of its revenues from its
electronic distribution and commission processing services. For the year ended
December 31, 1999, approximately 47% of consolidated revenues were derived from
Pegasus Electronic Distribution, approximately 48% of consolidated revenues were
derived from Pegasus Commission Processing and approximately 5% of consolidated
revenues were derived from Pegasus Business Intelligence. Pegasus has
experienced substantial growth since its inception. However, there can be no
assurance that Pegasus will experience the same rate of revenue growth in the
future. Any significant decrease in the rate of revenue growth could have a
material adverse effect on Pegasus' operating results and financial condition.
Pegasus has developed or is in the process of developing several new
services to capitalize on its existing technology and customer base and to
provide additional electronic hotel reservation capabilities and information
services to its existing customers and to other participants in the hotel room
distribution process. Pegasus Electronic Distribution has introduced services
that automate the processing of hotel bookings for large meetings and
conventions and for corporate travelers. Pegasus Business Intelligence intends
to introduce data mining and reporting services for benchmark analysis and
strategic planning for the hotel industry. Pegasus has not received a material
amount of revenue from these services, and there can be no assurance that any of
these services will produce a material amount of revenue in the future.
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Pegasus' future success will depend, in part, on its ability to:
- Develop leading technologies
- Enhance existing services
- Develop and introduce new services that address the increasingly
sophisticated and varied needs of current and prospective customers
- Respond to technological advances and emerging industry standards and
practices on a timely and cost-effective basis
Pegasus' cost of services consists principally of personnel costs relating to
information technology, facilities and equipment maintenance costs and fees paid
to the processing bank for processing travel agency commissions. Research and
development costs consist principally of personnel costs, related overhead costs
and fees paid to outside consultants. General and administrative expenses are
primarily personnel, office, legal and accounting related. Marketing and
promotion expenses consist primarily of personnel costs, advertising,
amortization of customer incentive contracts, public relations and participation
in trade shows and other industry events. Depreciation and amortization expense
includes depreciation of computer equipment, office furniture, office equipment
and leasehold improvements as well as amortization of software and goodwill.
Interest expense includes interest on notes payable to certain stockholders of
Pegasus and interest on payments made under capital equipment leases.
RECENT DEVELOPMENTS
On November 16, 1999, Pegasus entered into a definitive agreement to
acquire Phoenix-based REZ, Inc., formerly known as REZsolutions, Inc., a leader
in providing distribution services and solutions for the hotel industry. Under
the terms of the agreement, Pegasus will issue 3.99 million shares of common
stock, pay $115.0 million in cash and agree to a $20.0 million note payable to
Utell International Ltd., a subsidiary of Reed Elsevier plc, a substantial REZ
stockholder. Based on a five day average stock price of $31.775, the transaction
is valued at approximately $260 million subject to closing balance sheet
adjustments. The average stock price was determined using two days before, the
day of and two days after the agreement was announced. The acquisition is
expected to close during the first quarter of 2000 and will be recorded under
the purchase method of accounting. For more information regarding this
transaction, refer to our Registration Statement on Form S-4, as amended (File
No. 333-72683).
YEARS ENDED DECEMBER 31, 1999 AND 1998
Net revenues. Net revenues for 1999 increased to $38.0 million from $29.1
million in 1998, an increase of 30.9%. The increase in revenues was primarily
driven by higher transaction levels for Pegasus Electronic Distribution and
Pegasus Commission Processing as well as the acquisition of Driving Revenue in
August 1998, which provided the majority of Pegasus Business Intelligence
revenues for 1999.
Pegasus Electronic Distribution revenues increased $5.6 million, or 45.3%,
in 1999 compared to 1998. The increase resulted primarily from a 28.2% increase
in the number of hotel reservations made through the GDS and Internet-based
distribution services. Although GDS revenue per transaction decreased in 1999
compared to 1998, total transaction revenue per transaction increased 7.2% due
to a higher percentage of Internet-based transactions, which generate more
revenue per transaction. A $1.7 million increase in non-transaction related
revenues also contributed to the increase in total electronic distribution
revenues. Non-transaction related revenues include implementation fees,
subscription fees and advertising revenues.
Pegasus Commission Processing revenues increased 14.7% in 1999 compared to
1998 as a result of a 22.4% increase in the number of hotel commission
transactions processed. The increase in the number of transactions was due in
part to an increase in the number of hotel properties and travel agencies
participating in Pegasus Commission Processing. The value of commissions paid by
Pegasus increased 25.6% in 1999 compared to 1998 because of an increase in the
number of hotel commission transactions processed combined with an increase in
the average value of commissions processed. Net revenues arising from the
increase in
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commissions paid was somewhat offset by a reduction in the average fee received
from participating travel agencies for consolidating and remitting hotel
commission payments. Pegasus expects this trend to continue.
Pegasus Business Intelligence revenues increased $1.1 million to $2.0
million in 1999 from $0.9 million for 1998. The increase was due to the
acquisition of Driving Revenue L.L.C. in August 1998. Pegasus Business
Intelligence revenues consisted of fees charged to hotels for the development
and maintenance of hotel databases and for consulting services.
Pegasus Business Intelligence had net pretax losses of approximately $4.0
million and $2.8 million for 1999 and 1998, respectively. During 1999, Pegasus
continued to invest in technology and personnel to grow this segment. During
1999, Pegasus also invested heavily in the development of marketing and sales
personnel to increase customer awareness of Pegasus Business Intelligence
services and products. Pegasus expects this segment to continue to have losses
in the foreseeable future. However, Pegasus expects the losses to decline as
this segment develops new products, builds its customer base and increases
revenues.
Cost of services. Cost of services increased by $2.5 million, or 25.4%, to
$12.2 million in 1999 from $9.7 million in 1998. Cost of services increased due
to additional staffing primarily related to new business intelligence services.
The number of technology personnel increased 25.6% at December 31, 1999 compared
to December 31, 1998. In addition, Pegasus incurred approximately $104,000 in
1999 for enhancing its infrastructure. These enhancements included upgrades to
e-mail and wide area networks. This increase was partially offset by a $727,000
decrease in costs associated with Pegasus Commission Processing during the first
half of 1999 as some functions that were previously outsourced were brought
in-house at a lower cost during the third quarter of 1998.
Research and development. Research and development expenses decreased $0.3
million, or 11.5%, to $2.4 million in 1999 from $2.7 million in 1998. In 1999,
research and development expenses were primarily related to the development of
business intelligence services while 1998 expenses included a major commission
processing project, which was completed in the third quarter 1998. This
commission processing project was comprised of internally developed software and
procedures to sort and consolidate commissions by travel agency. Prior to the
completion of this project, this process was outsourced.
Write-off of purchased in-process research and development. During 1998,
Pegasus incurred a charge of $1.5 million to write-off purchased in-process
research and development related to the acquisition of Driving Revenue in August
1998.
Based on a third party valuation, approximately $1.5 million of the
purchase price was allocated to in-process research and development projects
that at the time of the acquisition had not reached technological feasibility
and had no probable alternative future use. In determining the valuation Pegasus
identified eight projects as in-process research and development. Of these
eight, three were associated with a market planner product, three with a
database product and two were Internet-enabled query tools. Each project was
estimated to have a specific revenue stream that was assumed to generate a 20%
cash flow margin over a ten-year period. Each project was determined to be at a
certain stage of completion ranging from 10% to 70%, and these factors were
applied to the present value of each project's future cash flows using a 30%
discount rate. The resulting $1.5 million valuation was charged to operations in
1998.
Subsequent to the Driving Revenue acquisition, Pegasus re-evaluated the
role of the market planner product. Since the market planner is a stand-alone
software sale that does not fit with Pegasus' business strategy, Pegasus has
elected to stop selling it and terminated work on the development of the three
market planner projects. Pegasus has elected to focus its efforts on projects
that better fit with its strategy of producing recurring revenues from
customers. Pegasus management believes that the decision not to develop the
acquired technology will have no impact on future results of operations or
financial position.
Pegasus has continued developing new database tools and has completed the
major elements of the new database project as of January 2000. The cost to
complete the project was approximately $1.0 million, which is roughly consistent
with Pegasus' earlier projections. The new database capability is being rolled
out to Pegasus' customer base.
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Pegasus is continuing to work on Internet-enabled query tools and expects
that these will be available in future years as estimated in the original cash
flows used in determining the purchased in-process research and development
charge in 1998.
General and administrative expenses. General and administrative expenses
increased $1.0 million, or 23.0%, to $5.5 million in 1999 from $4.4 million in
1998. The increase was primarily due to higher personnel expenses and office
costs including rent, telephone, travel and supplies associated with increased
headcount. Personnel and office costs increased approximately $841,000 in 1999
compared to 1998. In addition, accounting and legal expenses increased
approximately $113,000 as a result of additional reporting and consulting
services necessary due to increasingly complex tax, legal and reporting issues
associated with Pegasus' growth over the past year.
Marketing and promotion expenses. Marketing and promotion expenses
increased $1.1 million, or 23.1%, to $5.9 million in 1999 from $4.8 million in
1998. Marketing and promotion expenses increased primarily due to a 26.1%
increase in the number marketing and sales personnel and the related recruiting
and relocation costs. The additional sales and marketing personnel were needed
to promote commission processing services, Internet-based distribution services
and new business intelligence services.
Depreciation and amortization. Depreciation and amortization expenses
decreased $0.3 million, or 9.4%, to $2.4 million in 1999 from $2.7 million in
1998. Amortization expense decreased $507,000 in 1999 as compared to 1998
because goodwill and capitalized software associated with the purchase
accounting transaction that formed Pegasus was fully amortized as of the
beginning of the fourth quarter of 1998. The related amortization expense was
$798,000 in 1998. The decrease in amortization expense was somewhat offset of by
an additional $291,000 for the amortization of goodwill and software related to
the acquisition of Driving Revenue in August 1998. Depreciation expense
increased $253,000 in 1999 as compared to 1998 due to additions of property and
equipment. The increase in depreciation expense was partially offset because the
former computing platform for Pegasus Electronic Distribution was fully
depreciated and replaced in 1999 with less expensive equipment resulting in
lower depreciation expense.
Interest income. Interest income increased $2.3 million, or 92.9%, to $4.8
million in 1999 from $2.5 million in 1998. Interest income increased as Pegasus
had additional cash available for short-term investment as a result of the
secondary public offering of common stock in May 1999. The increase was
partially offset by a decline in the prevailing interest rate level for
short-term investments during the first three quarters of 1999 combined with a
shift in the investment portfolio to include tax-exempt securities with lower
pre-tax yields.
Interest expense. Interest expense decreased $120,000, or 81.8%, to $27,000
in 1999 from $147,000 in 1998. Interest expense reflects payments made under
capital equipment leases, and the decrease is due to the expiration of some
leases.
Write-off of minority interest investment. In September 1998, Pegasus
purchased a minority interest in Intermezzo, Inc. The Intermezzo board of
directors elected to cease operations in July 1999 and entered into an orderly
plan of liquidation. Pegasus wrote-off $1.1 million in the second quarter of
1999 representing its entire investment in Intermezzo.
Income taxes. Income taxes for 1999 reflect federal, state and foreign
income taxes payable. Income taxes for 1998, include only state and foreign
taxes as Pegasus was able to realize the benefit of its federal net operating
loss carryforwards in 1998. The effective tax rate of approximately 35.1% for
1999 increased from the effective tax rate of approximately 3.5% for 1998. The
lower effective tax rate in 1998 was due to Pegasus' ability to realize the
benefit of net operating loss carryforwards.
YEARS ENDED DECEMBER 31, 1998 AND 1997
Net revenues. Net revenues for 1998 increased to $29.1 million from $20.9
million in 1997, an increase of 39.0%. The increase in revenues was primarily
driven by higher transaction levels for Pegasus Electronic Distribution and
Pegasus Commission Processing as well as revenue derived from Pegasus Business
Intelligence.
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Pegasus Electronic Distribution revenues increased 24.8% in 1998 compared
to 1997 primarily due to an increase in the number of hotel reservations made
through TravelWeb.com and an increase in the average fee earned per transaction.
In addition, there was an increase in the number of hotel reservations made
through other Internet sites that use the private-label distribution service.
Also, more hotel companies paid fees to be listed in the online distribution
database. Net reservations made through the GDS and Internet-based distribution
services increased by 22.6% in 1998 compared to 1997, but this increase was
offset by a 5.9% reduction in the total transaction revenue per reservation. As
a result of the lower average fee per reservation, net revenues from the GDS
distribution service remained consistent with the prior year.
Pegasus Commission Processing revenues increased 43.6% in 1998 compared to
1997 as a result of a 34.4% increase in the number of hotel commission
transactions processed. The increase in the number of transactions was due in
part to an increase in the number of hotel properties and travel agencies
participating in Pegasus Commission Processing. The value of commissions paid to
travel agencies by Pegasus increased 48.5% in 1998 compared to 1997 because of
an increase in the number of hotel commission transactions processed combined
with an increase in the average value of the commissions processed. The average
value of commissionable transactions processed increased due to rising overall
average daily rates for hotel rooms as well as a higher proportion of
transactions generated by full-service and luxury hotel chains. Net revenues
arising from the increase in commissions paid was somewhat offset by a reduction
in the average fee received from participating travel agencies for consolidating
and remitting hotel commission payments.
Pegasus Business Intelligence revenues were $903,000 for 1998 and consisted
of fees charged to hotels for the development and maintenance of hotel databases
and for consulting services. Pegasus Business Intelligence had pretax losses of
approximately $2.8 million and $570,000 in 1998 and 1997, respectively. As a
start-up business, this segment had technology development costs and no revenues
until Pegasus acquired Driving Revenue in August 1998. In 1998, Pegasus incurred
additional technology development costs as well as a write-off of purchased
in-process research and development and goodwill amortization related to the
Driving Revenue acquisition. Pegasus expects this segment to have significant
losses in the foreseeable future as it continues to invest in technology and
personnel to grow this business.
Cost of services. Cost of services increased by $2.3 million, or 30.5%, to
$9.7 million in 1998 from $7.4 million in 1997. Cost of services increased due
to additional staffing, higher pay rates for technology personnel and the
increased number of Pegasus Commission Processing transactions, which added to
the fees paid to the processing bank.
Research and development. Research and development expenses increased
$170,000, or 6.8%, to $2.7 million in 1998 from $2.5 million in 1997. This
increase was primarily due to expenditures relating to the development of
business intelligence services.
Write-off of purchased in-process research and development. During 1998,
Pegasus incurred a charge of $1.5 million to write-off purchased in-process
research and development related to the acquisition of Driving Revenue in August
1998. Based on a third-party valuation, approximately $1.5 million of the
purchase price was allocated to in-process research and development projects
that at the time of the acquisition had not reached technological feasibility
and had no probable alternative future use.
General and administrative expenses. General and administrative expenses
increased $727,000, or 19.6%, to $4.4 million in 1998 from $3.7 million in 1997.
The increase was primarily due to additional costs associated with operating as
a public company. These costs increased approximately $190,000 in 1998 as
compared to 1997 and include legal, accounting, insurance, printing and
reporting costs. In addition, office costs, which include rent, telephone,
travel and supplies, increased approximately $288,000 in 1998 as compared to
1997. Personnel expenses also increased approximately $165,000 in 1998 as
compared to 1997. Office and personnel expenses increased because of an increase
in headcount.
Marketing and promotion expenses. Marketing and promotion expenses
increased $826,000, or 20.7%, to $4.8 million in 1998 from $4.0 million in 1997.
Marketing and promotion expenses grew primarily due to the addition of sales and
marketing staff, which were needed to promote Pegasus Electronic Distribution
and Pegasus Commission Processing.
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Depreciation and amortization. Depreciation and amortization expenses
decreased $327,000, or 10.8%, to $2.7 million in 1998 from $3.0 million in 1997.
Amortization expense decreased $611,000 in 1998 as compared to 1997 because
goodwill and capitalized software associated with the purchase accounting
transaction that formed Pegasus was fully amortized as of the beginning of the
fourth quarter of 1998. The decrease in amortization was somewhat offset by an
additional $125,000 for the amortization of goodwill and software related to the
acquisition of Driving Revenue in August 1998. Depreciation expense increased
$285,000 in 1998 as compared to 1997 due to additions of property and equipment.
Interest income. Interest income increased $1.5 million to $2.5 million in
1998 from $994,000 in 1997. Interest income increased as a result of short-term
investment of operating cash balances and of a portion of the proceeds from
Pegasus' secondary offering of common stock in February 1998. In addition, 1998
included a full year of interest income earned on proceeds from Pegasus' initial
public offering of common stock in August 1997.
Interest expense. Interest expense decreased $453,000, or 75.5%, to
$147,000 in 1998 from $600,000 in 1997. The 1998 expense reflects payments made
under capital equipment leases. The 1997 expense consisted of interest accrued
on promissory notes payable to some Pegasus stockholders as well as interest
accrued on payments made under capital equipment leases. Pegasus repaid all of
its promissory notes in August 1997 using a portion of the proceeds from its
initial public offering.
Income taxes. Income taxes for 1998 reflect state and foreign income taxes
payable as Pegasus was able to realize the benefit of its federal net operating
loss carryforwards. In accordance with Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes," Pegasus released a significant
portion of the valuation allowance in the fourth quarter of 1998, as management
believed it was more likely than not that the net deferred tax asset would be
realized. The conclusion to release the valuation allowance was based on
Pegasus' historical trend of positive operating results as well as management's
earnings projections for 1999 and beyond. Income taxes for 1997 reflect foreign
income taxes payable with respect to the taxable earnings of Pegasus' United
Kingdom subsidiary, which reports earnings on a cost-plus basis. In 1997, the
net deferred tax asset was fully reserved because of uncertainty regarding
Pegasus' ability to realize the benefit of the asset in future years.
LIQUIDITY AND CAPITAL RESOURCES
Pegasus' principal sources of liquidity at December 31, 1999 included cash
and cash equivalents of $104.6 million, short-term investments of $35.3 million
and restricted cash of $2.9 million. Pegasus' principal sources of liquidity at
December 31, 1998 included cash and cash equivalents of $25.0 million,
short-term investments of $15.8 million and restricted cash of $2.1 million.
Restricted cash represents funds for travel agency commission checks that
were never submitted to the bank by travel agencies for payment within one year
of their original issuance. After one year, the bank places a stop on the
outstanding travel agency commission checks and returns the funds to Pegasus.
Pegasus records, in an accrued liability account, an amount equal to the
restricted cash recorded upon receipt of the funds from the bank. The reasons
for the checks not clearing include travel agencies going out of business,
change in address or the checks being lost. The returned funds are repaid to the
original travel agency if they can be located or if not then to their state of
residence as required by the unclaimed property laws of their state.
Working capital increased to $143.6 million in 1999 from $44.4 million in
1998, and net cash provided by operating activities increased to $13.9 million
in 1999 from $6.8 million in 1998 due to Pegasus' improved operating
performance.
Capital expenditures consisted of purchases of software, furniture and
computer equipment as well as internally developed software costs and amounted
to $3.4 million in 1999 compared to $1.7 million in 1998. Additional uses of
cash for investing activities in 1999 included the purchase of marketable
securities. Additional uses of cash for investing activities in 1998 included
the purchase of Driving Revenue, strategic minority equity investments and
marketable securities. Pegasus has financed its cash requirements for
investments primarily through cash generated from operations and the sale of
capital stock. Pegasus estimates
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that its capital expenditures during 2000 will approximate $3.0 million
primarily related to adding capacity to existing systems.
Proceeds from the exercise of stock options were $2.2 million and $0.3
million in 1999 and 1998, respectively.
Pegasus completed a secondary offering of its common stock in February
1998, raising net proceeds of $4.2 million. A portion of the proceeds was used
to repay certain lease obligations, with the remaining proceeds placed in
short-term marketable securities.
In May 1999, Pegasus completed a follow-on offering of common stock raising
net proceeds of $84.4 million. Pegasus is currently using the net proceeds from
this offering for working capital and other general corporate purposes, with the
remaining amount placed in short-term marketable securities.
On November 16, 1999, Pegasus entered into a definitive agreement to
acquire Phoenix-based REZ, Inc., formerly known as REZsolutions, Inc., a leader
in providing distribution services and solutions for the hotel industry. Under
the terms of the agreement, Pegasus will issue 3.99 million shares of common
stock, pay $115.0 million in cash and agree to a $20.0 million note payable to
Utell International Ltd., a subsidiary of Reed Elsevier plc, a substantial REZ
stockholder. Pegasus intends to liquidate its short-term marketable securities
to generate the cash needed for the transaction.
Our future liquidity and capital requirements will depend on numerous
factors, including:
- Our profitability
- Operational cash requirements
- Competitive pressures
- Development of new services and applications
- Acquisition of complimentary businesses or technologies
- Response to unanticipated cash requirements
Pegasus believes that the liquidity and cash flow from operations of the Company
after the closing of the merger, together with funds available from future debt
financing, will be sufficient to meet its foreseeable operating and capital
requirements through at least the end of 2000. Pegasus may consider other
financing alternatives to fund its requirements, including possible public or
private debt or equity offerings. However, there can be no assurance that any
financing alternatives sought by Pegasus will be available or will be on terms
that are attractive to Pegasus. Further, any debt financing may involve
restrictive covenants, and any equity financing may be dilutive to stockholders.
INFLATION
Pegasus does not believe that inflation has materially impacted results of
operations during the past three years. Substantial increases in costs and
expenses could have a significant impact on its results of operations to the
extent such increases are not passed along to customers.
RECENTLY ISSUED ACCOUNTING STANDARDS
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position No. 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 requires
that certain costs related to the development or purchase of internal-use
software be capitalized and amortized over the estimated useful life of the
software. SOP 98-1 is effective for financial statements for fiscal years
beginning after December 15, 1998. Accordingly, Pegasus adopted SOP 98-1
effective January 1, 1999 for costs incurred related to voice recognition
software and enhancements to the online distribution database.
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In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" ("FAS 133"). FAS 133 requires that all derivative
instruments be recorded on the balance sheet at fair value. Changes in the fair
value of derivative instruments are recorded each period in current earnings or
other comprehensive income, depending on whether a derivative is designated as
part of a hedge transaction. FAS 133, as amended by Statement of Financial
Accounting Standards No. 137, "Accounting for Derivative Instruments and Hedging
Activities-Deferral of Effective Date of FAS 133", is effective for Pegasus'
first quarter financial statements in fiscal 2001. Pegasus is not currently
involved in derivative instruments or hedging activities, and therefore, will
measure the impact of this statement as it becomes necessary.
On December 3, 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements," which summarizes some of the Staff's views in applying generally
accepted accounting principles to revenue recognition in financial statements.
The Staff is providing this guidance due, in part, to the large number of
revenue recognition issues that registrants encounter. The application of SAB
101 to revenue recognition for one-time set-up fees currently has an immaterial
effect on Pegasus' consolidated statement of operations. Pegasus will apply SAB
101 on a prospective basis for fiscal years beginning after December 31, 1999.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
None.
29
30
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Stockholders of Pegasus Systems, Inc.
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations and changes in stockholders'
equity and of cash flows present fairly, in all material respects, the financial
position of Pegasus Systems, Inc. and its subsidiaries at December 31, 1999 and
1998, and the results of their operations and their cash flows for each of the
three years in the period ended December 31, 1999 in conformity with accounting
principles generally accepted in the United States. These financial statements
are the responsibility of the Company's management; our responsibility is to
express an opinion on these financial statements based on our audits. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States, which 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,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits provide a reasonable basis for the opinion expressed
above.
PricewaterhouseCoopers LLP
Dallas, Texas
February 10, 2000
30
31
PEGASUS SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1999 AND 1998
ASSETS
1999 1998
------------ -----------
Cash and cash equivalents................................... $104,616,147 $25,002,185
Restricted cash............................................. 2,928,680 2,106,676
Short-term investments...................................... 35,282,524 15,768,400
Accounts receivable, net of allowance for doubtful accounts
of $81,701 and $98,633, respectively...................... 4,854,185 3,687,518
Other current assets........................................ 2,585,247 3,689,254
------------ -----------
Total current assets.............................. 150,266,783 50,254,033
Capitalized software, net................................... 1,287,422 869,619
Property and equipment, net................................. 3,568,212 2,635,068
Goodwill, net of accumulated amortization of $937,922 and
$522,018, respectively.................................... 2,890,077 4,238,071
Other noncurrent assets..................................... 5,527,274 2,323,620
------------ -----------
Total assets...................................... $163,539,768 $60,320,411
============ ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued liabilities.................... $ 6,162,314 $ 4,715,018
Unearned income............................................. 62,640 258,667
Current portion of capital lease obligations................ 52,564 535,072
Customer deposits........................................... 383,966 347,422
------------ -----------
Total current liabilities......................... 6,661,484 5,856,179
Capital lease obligations, net of current portion........... -- 57,634
Other noncurrent liabilities................................ 106,788 142,380
Commitments and contingencies (Note 11)..................... -- --
Stockholders' equity:
Preferred stock, $.01 par value; 2,000,000 shares
authorized; Zero shares issued and outstanding......... -- --
Common stock, $.01 par value; 50,000,000 shares
authorized, 20,515,050 and 15,980,056 shares issued,
respectively........................................... 205,151 159,801
Additional paid-in capital................................ 156,978,043 63,330,637
Unearned compensation..................................... (442,106) (615,636)
Accumulated comprehensive loss (Note 4)................... (24,905) --
Retained earnings (deficit)............................... 81,651 (8,584,246)
Less treasury stock (174,726 shares, at cost)............. (26,338) (26,338)
------------ -----------
Total stockholders' equity........................ 156,771,496 54,264,218
------------ -----------
Total liabilities and stockholders' equity........ $163,539,768 $60,320,411
============ ===========
See accompanying notes to consolidated financial statements.
31
32
PEGASUS SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1999 1998 1997
----------- ----------- -----------
Net revenues (Note 1)................................. $38,036,269 $29,064,467 $20,903,416
Cost of services...................................... 12,180,188 9,716,854 7,445,271
Research and development.............................. 2,367,107 2,673,628 2,504,074
Write-off of purchased in-process research and
development (Note 2)................................ -- 1,480,085 --
General and administrative expenses................... 5,462,895 4,442,557 3,715,547
Marketing and promotion expenses...................... 5,936,256 4,823,787 3,998,054
Depreciation and amortization......................... 2,437,410 2,689,867 3,016,619
----------- ----------- -----------
Operating income...................................... 9,652,413 3,237,689 223,851
Other income (expense):
Interest income..................................... 4,828,143 2,503,265 993,592
Interest expense.................................... (26,756) (146,879) (600,067)
Write-off of minority interest investment (Note
1)............................................... (1,100,110) -- --
----------- ----------- -----------
Income before income taxes............................ 13,353,690 5,594,075 617,376
Income taxes.......................................... 4,687,793 197,624 27,916
----------- ----------- -----------
Net income............................................ $ 8,665,897 $ 5,396,451 $ 589,460
=========== =========== ===========
Other comprehensive loss -- change in unrealized loss,
net of tax of $12,830 (Note 4)...................... (24,905) -- --
----------- ----------- -----------
Comprehensive income.................................. $ 8,640,992 $ 5,396,451 $ 589,460
=========== =========== ===========
Basic net income per share:
Basic............................................... $ 0.47 $ 0.34 $ 0.05
=========== =========== ===========
Diluted............................................. $ 0.44 $ 0.32 $ 0.05
=========== =========== ===========
Weighted average shares outstanding:
Basic............................................... 18,576,107 15,691,421 10,800,573
=========== =========== ===========
Diluted............................................. 19,689,387 16,795,343 13,014,078
=========== =========== ===========
See accompanying notes to consolidated financial statements.
32
33
PEGASUS SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
PREFERRED STOCK COMMON STOCK
--------------------- --------------------- ADDITIONAL
NUMBER OF NUMBER OF PAID-IN UNEARNED
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION
---------- -------- ---------- -------- ------------ ------------
Balance at December 31, 1996.... 2,307,694 $ 23,077 7,961,599 $ 79,616 $ 16,934,133 $(485,937)
---------- -------- ---------- -------- ------------ ---------
Conversion of preferred stock to
common stock.................. (2,307,694) (23,077) 2,307,694 23,077 -- --
Initial public offering......... -- -- 5,175,000 51,750 40,441,750 --
Warrants issued for contract.... -- -- -- -- 238,000 --
Issuance of compensatory stock
options....................... -- -- -- -- 450,847 (252,596)
Exercise of stock options....... -- -- 2,000 20 4,119 --
Net income...................... -- -- -- -- -- --
---------- -------- ---------- -------- ------------ ---------
Balance at December 31, 1997.... -- -- 15,446,293 154,463 58,068,849 (738,533)
---------- -------- ---------- -------- ------------ ---------
Secondary offering.............. -- -- 420,481 4,205 4,221,091 --
Windfall tax benefit of stock
options....................... -- -- -- -- 403,532 --
Issuance of compensatory stock
options....................... -- -- -- -- 240,928 28,176
Forfeitures of compensatory
stock options................. -- -- -- -- (94,721) 94,721
Exercise of stock options....... -- -- 95,813 958 330,273 --
Issuance for stock purchase
plan.......................... -- -- 17,469 175 160,685 --
Net income...................... -- -- -- -- -- --
---------- -------- ---------- -------- ------------ ---------
Balance at December 31, 1998.... -- -- 15,980,056 159,801 63,330,637 (615,636)
---------- -------- ---------- -------- ------------ ---------
Secondary offering.............. -- -- 3,450,000 34,500 84,408,000 --
Windfall tax benefit of stock
options....................... -- -- -- -- 4,195,736 --
Issuance of compensatory stock
options....................... -- -- -- -- 249,774 73,434
Forfeitures of compensatory
stock options................. -- -- -- -- (100,096) 100,096
Exercise of stock options....... -- -- 542,592 5,426 2,190,592 --
Issuance of stock warrant....... -- -- 518,584 5,186 2,484,020 --
Issuance for stock purchase
plan.......................... -- -- 23,850 238 219,380 --
Change in unrealized gain (loss)
on marketable securities...... -- -- -- -- -- --
Dividend payable................ -- -- (32) -- -- --
Net income...................... -- -- -- -- -- --
---------- -------- ---------- -------- ------------ ---------
Balance at December 31, 1999.... -- $ -- 20,515,050 $205,151 $156,978,043 $(442,106)
========== ======== ========== ======== ============ =========
TREASURY STOCK
-------------------- ACCUMULATED RETAINED
NUMBER OF COMPREHENSIVE EARNINGS
SHARES AMOUNT LOSS (DEFICIT) TOTAL
--------- -------- ------------- ------------ ------------
Balance at December 31, 1996.... (174,726) $(26,338) $ -- $(14,570,157) $ 1,954,394
-------- -------- ------------- ------------ ------------
Conversion of preferred stock to
common stock.................. -- -- -- -- --
Initial public offering......... -- -- -- -- 40,493,500
Warrants issued for contract.... -- -- -- -- 238,000
Issuance of compensatory stock
options....................... -- -- -- -- 198,251
Exercise of stock options....... -- -- -- -- 4,139
Net income...................... -- -- -- 589,460 589,460
-------- -------- ------------- ------------ ------------
Balance at December 31, 1997.... (174,726) (26,338) -- (13,980,697) 43,477,744
-------- -------- ------------- ------------ ------------
Secondary offering.............. -- -- -- -- 4,225,296
Windfall tax benefit of stock
options....................... -- -- -- -- 403,532
Issuance of compensatory stock
options....................... -- -- -- -- 269,104
Forfeitures of compensatory
stock options................. -- -- -- -- --
Exercise of stock options....... -- -- -- -- 331,231
Issuance for stock purchase
plan.......................... -- -- -- -- 160,860
Net income...................... -- -- -- 5,396,451 5,396,451
-------- -------- ------------- ------------ ------------
Balance at December 31, 1998.... (174,726) (26,338) -- (8,584,246) 54,264,218
-------- -------- ------------- ------------ ------------
Secondary offering.............. -- -- -- -- 84,442,500
Windfall tax benefit of stock
options....................... -- -- -- -- 4,195,736
Issuance of compensatory stock
options....................... -- -- -- -- 323,208
Forfeitures of compensatory
stock options................. -- -- -- -- --
Exercise of stock options....... -- -- -- -- 2,196,018
Issuance of stock warrant....... -- -- -- -- 2,489,206
Issuance for stock purchase
plan.......................... -- -- -- -- 219,618
Change in unrealized gain (loss)
on marketable securities...... -- -- (24,905) -- (24,905)
Dividend payable................ -- -- -- -- --
Net income...................... -- -- -- 8,665,897 8,665,897
-------- -------- ------------- ------------ ------------
Balance at December 31, 1999.... (174,726) $(26,338) $ (24,905) $ 81,651 $156,771,496
======== ======== ============= ============ ============
See accompanying notes to consolidated financial statements.
33
34
PEGASUS SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
1999 1998 1997
------------ ------------ ------------
Cash flows from operating activities:
Net income....................................... $ 8,665,897 $ 5,396,451 $ 589,460
Adjustments to reconcile net income to net cash
provided by operating activities:
Accrued interest reclassified to notes
payable..................................... -- -- 58,049
Windfall tax benefit from employee exercise of
non-qualified stock options................. 4,195,736 403,532 --
Write-off of in-process research and
development costs........................... -- 1,480,085 --
Loss (gain) on sale of equipment.............. 11,082 4,821 (53)
Depreciation and amortization................. 2,437,410 2,689,867 3,016,619
Write-off of minority interest investment..... 1,100,110 -- --
Deferred income taxes......................... (661,100) (2,084,625) --
Decrease goodwill due to release of valuation
allowance................................... -- 1,467,246 --
Recognition of stock option compensation...... 323,208 269,104 198,251
Other......................................... 90,722 27,615 3,359
Changes in assets and liabilities:
Restricted cash............................. (822,005) (820,644) (595,826)
Accounts receivable......................... (1,166,667) (1,566,348) (292,779)
Other current and noncurrent assets......... (1,493,627) (807,830) (1,203,609)
Accounts payable and accrued liabilities.... 1,483,841 794,456 1,425,801
Unearned income............................. (196,027) (413,840) (463,488)
Other noncurrent liabilities................ (35,592) 9,030 23,904
------------ ------------ ------------
Net cash provided by operating
activities............................. 13,932,988 6,848,920 2,759,688
------------ ------------ ------------
Cash flows from investing activities:
Purchase of software, property and equipment..... (3,388,233) (1,729,950) (1,594,401)
Proceeds from sale of software, property and
equipment..................................... 4,699 29,887 1,075
Purchase of marketable securities................ (54,536,121) (33,832,343) (11,486,932)
Proceeds from maturity of marketable
securities.................................... 34,893,540 27,416,378 4,808,599
Purchase of Driving Revenue L.L.C................ -- (5,998,366) --
Purchase of equity interest in investees......... (100,110) (1,500,000) --
------------ ------------ ------------
Net cash used in investing activities.... (23,126,225) (15,614,394) (8,271,659)
------------ ------------ ------------
Cash flows from financing activities:
Proceeds from issuance of stock.................. 89,347,342 4,717,387 40,497,639
Repayments on notes payable to affiliates........ -- -- (5,447,133)
Repayments of capital leases..................... (540,143) (1,116,521) (1,171,966)
Proceeds from capital leases..................... -- -- 3,913
------------ ------------ ------------
Net cash provided by financing
activities............................. 88,807,199 3,600,866 33,882,453
------------ ------------ ------------
Net increase (decrease) in cash and cash
equivalents...................................... 79,613,962 (5,164,608) 28,370,482
Cash and cash equivalents, beginning of year....... 25,002,185 30,166,793 1,796,311
------------ ------------ ------------
Cash and cash equivalents, end of year............. $104,616,147 $ 25,002,185 $ 30,166,793
============ ============ ============
Supplemental disclosure of cash flow information:
Interest paid.................................... $ 27,647 $ 144,833 $ 601,787
============ ============ ============
Income taxes paid................................ $ 1,116,557 $ 256,288 $ 17,916
============ ============ ============
Supplemental schedule of noncash investing and
financing activities:
Acquisition of equipment under capital leases.... $ -- $ -- $ 79,144
============ ============ ============
Common stock warrants issued in exchange for
customer contract asset....................... $ -- $ -- $ 238,000
============ ============ ============
See accompanying notes to consolidated financial statements.
34
35
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
Pegasus is a leading provider of transaction processing and electronic
commerce services to the hotel industry worldwide. Pegasus is organized into
three businesses: Pegasus Electronic Distribution, Pegasus Commission Processing
and Pegasus Business Intelligence. The consolidated financial statements include
the accounts of Pegasus Systems, Inc. and its wholly owned subsidiaries
("Pegasus" or "the Company"). All significant intercompany balances have been
eliminated in consolidation.
MANAGEMENT ESTIMATES
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses. Actual results may differ from those estimates.
CASH AND CASH EQUIVALENTS
The Company considers all highly liquid investments with maturities of
three months or less from the date of purchase to be cash equivalents.
RESTRICTED CASH
Funds for travel agency commission checks which have not cleared the
Company's processing bank after certain time periods are returned to the
Company. Any amounts which are not remitted to travel agents will be escheated
to the appropriate states, as required. A liability equal to the restricted cash
is recorded upon receipt of the funds from the bank and is included in accrued
liabilities on the balance sheet.
INVESTMENTS IN DEBT SECURITIES
Marketable securities consist of corporate debt securities. By policy, the
Company invests primarily in high-grade marketable securities. All marketable
securities are defined as available-for-sale or held-to-maturity under the
provisions of Statement of Financial Accounting Standards No. 115, "Accounting
for Certain Investments in Debt and Equity Securities."
Management determines the appropriate classification of its investments in
marketable securities at the time of purchase and re-evaluates such
determination at each balance sheet date. Debt securities that are bought with
the intent and ability to hold until maturity are classified as held-to-maturity
securities and are recorded at amortized cost. Debt securities that the Company
does not have the intent or ability to hold until maturity are classified as
available-for-sale. Available-for-sale securities are carried at fair value,
with the changes in the unrealized gain or loss reported as a separate component
of stockholders' equity, net of tax.
CAPITALIZED SOFTWARE
Software development costs are accounted for in accordance with either
Statement of Financial Accounting Standards No. 86, "Accounting for the Costs of
Computer Software to Be Sold, Leased, or Otherwise Marketed," or with Statement
of Position No. 98-1, "Accounting for the Costs of Computer Software Developed
or Obtained for Internal Use." Capitalized software development costs are
amortized on a product-by-product basis using the greater of the amount computed
by the ratio of current year net revenue to estimated future net revenue, or the
amount computed by the straight-line method over a period which approximates the
estimated economic life of the products. In the event unamortized software costs
exceed the net realizable value of the software, the excess is recognized in the
period the excess is determined.
35
36
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Additionally, capitalized software includes software purchased from third
parties used in the operations of the Company.
Prior to 1996, capitalized software costs were being amortized over three
to five years using the straight-line method. However, in 1996 the Company
changed the estimated life of all capitalized software costs to three years. The
effect of this change in 1999, 1998 and 1997 was to increase net income by
approximately $5,000, $144,000 and $142,000, respectively. This change had no
impact on basic and diluted income per share for 1999 and increased basic and
diluted income per share by $0.01 in 1998 and 1997. During 1999, 1998 and 1997,
the Company capitalized software costs of approximately $917,000, $646,000, and
$505,000, respectively. For 1999, capitalized software additions consisted of
internally developed software and software purchased from third parties. For
1998 and 1997, capitalized software additions consisted of software purchased
from third parties. During 1999, 1998 and 1997, amortization expense related to
capitalized software was approximately $499,000, $959,000 and $1,435,000,
respectively. Accumulated amortization of capitalized software was approximately
$9,633,000 and $9,134,000 at December 31, 1999 and 1998, respectively.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and depreciated over their
estimated useful lives, ranging from three to seven years. Leasehold
improvements are amortized over the life of the lease using the straight-line
method. Expenditures for maintenance and repairs, as well as minor renewals, are
charged to operations as incurred, while betterments and major renewals are
capitalized. Any gain or loss resulting from the retirement or sale of an asset
is credited or charged to operations.
The Company evaluates long-lived assets to be held and used in the
business, or to be disposed of, for impairment whenever events or changes in
circumstances indicate that the net book value of the asset may not be
recoverable. An impairment is determined by comparing expected future cash flows
(undiscounted and before interest) to the net book value of the assets. If
impairment exists, the amount of impairment is measured as the difference
between the net book value of the assets and the estimated fair value of the
related assets. Based on its most recent analysis, the Company believes that no
impairment of property and equipment existed at December 31, 1999 or 1998.
GOODWILL
Goodwill represents the excess of the purchase price of acquisitions over
the fair value of the net assets acquired. Goodwill is amortized on a
straight-line basis over ten to fifteen years. Unamortized goodwill at December
31, 1999 and 1998, was $2,890,077 and $4,238,071, respectively. The carrying
value of goodwill is evaluated periodically in relation to the operating
performance and anticipated future undiscounted net cash flows of the related
business. Based on its most recent analysis, the Company believes that no
impairment of goodwill existed at December 31, 1999 or 1998. Amortization of
goodwill was approximately $416,000, $218,000 and $125,000 in 1999, 1998 and
1997, respectively.
OTHER INVESTMENTS
In June 1998, the Company purchased 250,000 shares of Series A Convertible
Preferred Stock of Customer Analytics, Inc. for $500,000 representing
approximately 7.1% interest. Customer Analytics, Inc. is a database marketing
applications and solutions provider specializing in customer relationship
marketing. In November 1999, Customer Analytics merged with ActionSystems
Holdings, Inc. The Company's interest after the merger became approximately
1.4%. The investment is accounted for based on the lower of cost or fair value.
36
37
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In September 1998, the Company purchased 225,225 shares of Series B
Convertible Preferred Stock of Intermezzo Systems, Inc. for $1.0 million
representing approximately 10.6% interest. Intermezzo is a developer of
enterprise software solutions for the hospitality industry. The Intermezzo board
of directors elected to cease operations in July 1999 and entered into an
orderly plan of liquidation. As a result, Pegasus wrote-off $1.1 million in the
second quarter of 1999 representing the Company's entire investment in
Intermezzo.
REVENUES
Pegasus primarily derives its revenues from transaction fees and
commissions charged to participating hotels and travel agencies. The Company's
revenues are predominantly transaction-based.
Pegasus Electronic Distribution. Pegasus derives revenues from its GDS
distribution service by charging hotel customers a fee based on the number of
reservations made, less the number cancelled ("net reservations"). In addition,
hotels pay fees for status messages sent to global distribution systems through
the GDS distribution service. Status messages are electronic messages sent by
hotels to global distribution systems to update room rates, features and
availability information in global distribution system databases. As a hotel's
cumulative volume of net reservations increases during the course of the
calendar year, its fee per transaction decreases after predetermined transaction
volume hurdles have been met. As a result, for higher volume customers, unit
transaction fees are higher at the beginning of the year, when cumulative
transactions are lower. The Company recognizes revenues based on the fee per
transaction that a customer is expected to pay during the entire year. The
Company's interim balance sheets reflect a liability for the difference between
the fee per transaction that Pegasus actually bills a customer during the period
and the average fee per transaction that a customer is expected to pay for the
entire year. The liability created during the early periods of the year is
eliminated by the end of the year as the fee per transaction that Pegasus
actually bills a customer falls below the average fee per transaction for the
entire year. Additionally, Pegasus generally charges new participants in the GDS
distribution service a one-time set-up fee for work performed to establish the
connection between a hotel's central reservation system and the Pegasus
electronic distribution technology. Revenue for these one-time set-up fees is
recognized ratably over the set-up period, which generally ranges from two to
four months. The Company also charges certain global distribution systems a fee
based on either the number of net reservations or the number of hotel chains
connected to the global distribution system through the Pegasus electronic
distribution technology to compensate for the management and consolidation of
multiple interfaces.
Pegasus derives its TravelWeb.com revenues by charging participating hotels
a combination of transaction fees or commissions. For reservations that
originate on the TravelWeb.com website, Pegasus charges either a transaction fee
based on the number of net reservations made at participating properties or a
commission based on the value of the guest stay.
For reservations that originate on websites using the private-label
reservation service, Pegasus charges hotels transaction fees based on the number
of net reservations made at participating properties. Private-label reservation
customers also pay initial development fees and monthly subscription or
maintenance fees. Initial development fees are recognized ratably over the
set-up period.
Pegasus Commission Processing. Pegasus derives commission processing
revenues by charging each participating travel agency a fee based on a
percentage of commissions paid to that agency through the commission processing
service. The Company also generally charges participating hotels a fee based on
the number of commissionable transactions processed. Revenues from travel agency
fees can vary substantially from period to period based on the types of hotels
at which reservations are made and fluctuations in overall room rates. Pegasus
recognizes revenues from its commission processing service in the month in which
the hotel stay occurs. In the immediate following month, Pegasus collects
commissions from the hotels by the 12th business day of such month and pays
commissions to travel agencies by the 15th business day of such
37
38
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
month. If a hotel fails to deliver funds to the Company, Pegasus is not
obligated to deliver commission payments on behalf of the hotel to travel
agencies. For the years ended December 31, 1999, 1998 and 1997, Pegasus
Commission Processing revenues from hotels are presented net of commission
payments to travel agencies of approximately $352 million, $255 million, and
$165 million, respectively. Pegasus Commission Processing revenues for 1998 and
1997 also include amortization of a $2.0 million payment received by the Company
in June 1993 in exchange for a five-year non-cancelable data processing
contract. This payment was initially recorded as unearned income and was
recognized as revenue over the life of the contract, which terminated in 1998.
Pegasus Business Intelligence. Pegasus derives its business intelligence
revenues by charging hotels fees for the development and maintenance of hotel
databases and for consulting services. Pegasus Business Intelligence recognizes
as revenue the portion of the total contract price that the cost expended to
date bears to the anticipated final cost, based on current estimates to
complete. Contract costs include all direct labor and benefits and direct
materials. Additional billings are included in revenues when awarded or
received. Revisions in estimates of costs and earnings during the course of the
work are reflected in the accounting period in which the facts that require the
revision become known. At the time a loss becomes known, the entire amount of
the estimated ultimate loss is recognized in the financial statements.
INCOME TAXES
Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rate is recognized in income in the period that includes the
enactment date. A valuation allowance is provided for a portion or all of the
deferred tax assets when there is sufficient uncertainty regarding the Company's
ability to recognize the benefits of the assets in future years.
ADVERTISING COSTS
Advertising and promotion-related expenses are charged to operations when
incurred. Advertising expense for 1999, 1998 and 1997 was approximately
$982,000, $1,105,000 and $609,000, respectively.
FINANCIAL INSTRUMENTS
The carrying amounts of the Company's financial instruments reflected in
the consolidated balance sheets at December 31, 1999 and 1998 approximate their
respective fair values.
CONCENTRATIONS OF CREDIT RISK
The Company's financial instruments exposed to concentrations of credit
risk consist primarily of cash and receivables. Cash balances, exceeding the
federally insured limits, are maintained in financial institutions. However,
management believes the institutions are of high credit quality. The majority of
receivables are due from companies which are well-established entities in the
travel industry; therefore, management considers any exposure from
concentrations of credit risks to be limited.
ACCOUNTING FOR STOCK-BASED COMPENSATION
Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" ("FAS 123"), encourages, but does not require,
companies to record compensation cost for stock-based employee compensation
plans at fair value. Pro forma disclosure of net income based on the provisions
of FAS
38
39
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
123 is presented in Note 9. For financial reporting purposes, the Company has
elected to continue to account for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" ("APB 25"), and related
Interpretations.
STOCK SPLITS
In May 1997, the board of directors declared a four-for-three stock split
of the outstanding common and preferred stock effected in the form of a dividend
to stockholders of record on the effective date of the Registration Statement on
Form S-1 with respect to the Company's initial public offering ("IPO") (Note 8).
All references in the consolidated financial statements to shares, share prices,
per share amounts and stock plans have been adjusted retroactively for the
four-for-three stock split.
On December 8, 1999, the board of directors declared a three-for-two split
of common stock to be effected in the form of a stock dividend on January 7,
2000 to all Pegasus stockholders of record on December 20, 1999. All references
in the consolidated financial statements to shares, share prices, per share
amounts and stock plans have been adjusted retroactively for the three-for-two
stock split.
FOREIGN CURRENCY
The U.S. dollar is the functional currency for the Company's foreign
operation. Gains and losses from foreign currency transactions, such as
settlement of foreign payables and foreign payroll, are included in net income.
NET INCOME PER SHARE
In 1997, the Company adopted Statement of Financial Accounting Standards
No. 128, "Earnings per Share" ("FAS 128"). FAS 128 replaces primary and fully
dilutive earnings per share with basic and diluted earnings per share. Unlike
primary earnings per share, basic earnings per share excludes any dilutive
effect of potential common shares. Basic net income per share is based on the
weighted average outstanding common shares. Diluted net income per share is
based on the weighted average outstanding shares reduced by the effect of
potential common shares (Note 15).
COMPREHENSIVE INCOME
In 1998, the Company adopted Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income". This statement requires separate
financial statement disclosure of comprehensive income, which encompasses
changes in net asset values derived from activity from both owner and non-owner
sources. In 1999, the Company had marketable securities classified as
available-for-sale; therefore, the change in the unrealized gain (loss) is
included as a component of stockholders' equity and other comprehensive income,
net of taxes. There were no items that qualified for treatment as components of
other comprehensive income for 1998 and 1997.
SEGMENT INFORMATION
In 1998, the Company adopted Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
("FAS 131"). FAS 131 supercedes Statement of Financial Accounting Standards No.
14, "Financial Reporting for Segments of a Business Enterprise", replacing the
"industry" approach with the "management" approach. The management approach
designates the internal organization that is used by management for making
operating decisions and assessing performance as the source of the Company's
reportable segments. FAS 131 also requires disclosures about products and
services, geographic areas, and major customers. The adoption of FAS 131 did not
affect results of operations or financial position but did affect the disclosure
of segment information (Note 16).
39
40
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CHANGE IN ACCOUNTING POLICY
On December 3, 1999, the Securities and Exchange Commission released Staff
Accounting Bulletin No. 101 ("SAB 101"), "Revenue Recognition in Financial
Statements," which summarizes certain of the Staff's views in applying generally
accepted accounting principles to revenue recognition in financial statements.
The Staff is providing this guidance due, in part, to the large number of
revenue recognition issues that registrants encounter. The application of SAB
101 to revenue recognition for one-time set-up fees currently has an immaterial
effect on Pegasus' consolidated statement of operations. Pegasus will apply SAB
101 on a prospective basis for fiscal years beginning after December 31, 1999.
2. ACQUISITIONS
In August 1998, the Company acquired all of the equity interest in Driving
Revenue L.L.C. for approximately $6.0 million plus estimated expenses of less
than $100,000. Driving Revenue provides hotel database marketing and consulting
services.
The acquisition was recorded under the purchase method of accounting.
Accordingly, Driving Revenue's results of operations subsequent to the
acquisition date are included in the accompanying consolidated financial
statements. The purchase price has been allocated to assets acquired and
liabilities assumed based on estimated fair value at the date of acquisition.
The approximate fair value of assets acquired and liabilities assumed at the
date of acquisition, after giving effect to the write-off of certain purchased
research and development, is summarized as follows:
Current assets (including approximately $2,000 cash)..... $ 176,000
Software................................................. 344,000
Property and equipment................................... 42,000
Goodwill................................................. 4,296,000
Current liabilities...................................... 338,000
Approximately $1,480,000, based on a valuation performed by a third party, was
allocated to in-process research and development projects that at the time of
the acquisition had not reached technological feasibility and had no probable
alternative future use. Factors considered in determining the amount of the
purchase price allocated to in-process research and development included the
estimated stage of development for each project at the acquisition date, the
projected cash flows from the expected revenues to be generated from each
project and discounting the net cash flows. Such amount of in-process research
and development was charged to expense at the date of acquisition. The balance
of the purchase price, approximately $4,296,000, was recorded as goodwill and is
being amortized on a straight-line basis over a ten year period ending August
2008.
The following unaudited pro forma summary combines the consolidated results
of operations of Pegasus and Driving Revenue for the years ended December 31,
1998 and 1997 as if the acquisition had occurred at the beginning of 1998 and
1997 after giving effect to certain pro forma adjustments. The pro forma
adjustments include:
- amortization of excess purchase price allocated to software
- amortization of goodwill
- decreased interest income associated with acquisition funding during 1998
and for the period from the Company's initial public offering in 1997 to
the end of 1997
- interest expense associated with acquisition funding for the period from
the beginning of 1997 to the date of the Company's initial public
offering in 1997
- elimination of in-process research and development in 1998 due to its
nonrecurring nature
- related income tax effects
40
41
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
This pro forma financial information is provided for informational purposes only
and may not be indicative of the results of operations as they would have been
had the transaction been effected on the assumed dates nor is it indicative of
the results of operations which may occur in the future.
1998 1997
----------- -----------
(UNAUDITED)
Net revenues............................................... $29,737,000 $22,270,000
Net income (loss).......................................... 6,541,000 (232,000)
Net income (loss) per share................................ 0.39 (0.02)
3. ACCOUNTS RECEIVABLE
The Company collects travel agents' commissions from hotel chains and,
after retaining a portion of these commissions as a fee, remits the net
commissions to the travel agents. At December 31, 1999 and 1998, trade accounts
receivable were stated net of commissions of approximately $29,200,000 and
$21,505,000, respectively.
4. MARKETABLE SECURITIES
Marketable securities held by the Company at December 31, 1999 are
classified as available-for-sale and consisted of corporate debt securities. The
cost and fair value of marketable securities at December 31, 1999 were as
follows:
1999
-----------
Cost........................................................ $35,320,259
Gross unrealized holding gains.............................. 926
Gross unrealized holding losses............................. (38,661)
-----------
Fair value.................................................. $35,282,524
===========
Marketable securities held by the Company at December 31, 1998 were classified
as held-to-maturity. At December 31, 1998, the amortized cost of corporate debt
securities was $15,768,400. As of December 31, 1998, the aggregate fair market
value of the held-to-maturity securities was not materially different from their
carrying values, and the gross unrealized gains and losses by type of security
were not material.
Realized gains and losses are determined on a specific identification
basis. There were no realized gains or losses from investment transactions in
1999, 1998 or 1997.
5. PROPERTY AND EQUIPMENT
Property and equipment at December 31 consisted of the following:
1999 1998
----------- -----------
Computer equipment......................................... $ 6,086,212 $ 5,817,100
Furniture and equipment.................................... 1,032,240 890,334
Office equipment........................................... 1,795,334 1,320,239
Leasehold improvements..................................... 204,084 93,313
----------- -----------
9,117,870 8,120,986
Less: accumulated depreciation............................. (5,549,658) (5,485,918)
----------- -----------
Property and equipment, net................................ $ 3,568,212 $ 2,635,068
=========== ===========
41
42
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
6. CAPITAL LEASES
Assets recorded under capital leases, primarily consisting of computer
equipment, are recorded at the lower of the present value of future minimum
lease payments or the fair value of the asset. Total assets recorded under
capital leases in 1999 and 1998 were approximately $470,000 and $3,436,000,
respectively, net of accumulated amortization of $470,000 and $3,054,000,
respectively. Amortization of assets under capital leases is included in
depreciation and amortization expense.
Future minimum lease payments and related interest are as follows:
Aggregate minimum lease payments all of which are due in the
year 2000................................................. $ 54,237
Less: amount representing interest and taxes................ (1,673)
--------
52,564
Less current portion........................................ (52,564)
--------
$ --
========
Interest rates on capital leases range from approximately 7% to 14%. Interest
expense on capital leases for the years ended December 31, 1999, 1998 and 1997
was approximately $17,000, $144,000 and $277,000, respectively.
7. NOTES PAYABLE
In August 1997, the Company repaid all outstanding principal and accrued
interest on notes payable from the proceeds of the Company's initial public
offering (Note 8). Total principal and interest paid during 1997 was
approximately $5,711,000. Interest expense related to these notes was
approximately $322,000 during the year ended December 31, 1997.
8. STOCKHOLDERS' EQUITY
In August 1997, the stockholders amended the Company's certificate of
incorporation to increase the number of authorized shares of common stock from
20 million to 100 million.
The Company completed an IPO in August 1997. The Company's Registration
Statement on Form S-1 (File No. 333-28595) with respect to the IPO was declared
effective on August 6, 1997, and the Company's stock began trading on the Nasdaq
National Market under the symbol PEGS on August 7, 1997. The Company sold
5,175,000 shares of common stock at a per share price of $8.67. Net proceeds to
the Company, after deduction of the underwriting discount and estimated IPO
expenses, were approximately $40.5 million. Selling stockholders also sold
988,500 shares at a per share price of $8.67. Net proceeds to the stockholders
after deduction of the underwriting discount were approximately $8.0 million.
The Company did not receive any proceeds from the sale of shares by the selling
stockholders. Concurrent with the completion of the Company's IPO, a
four-for-three split of the Company's outstanding common and Series A preferred
stock was effected (Note 1), and all outstanding shares of Series A preferred
stock were converted into shares of common stock. All references in the
consolidated financial statements to shares, share prices, per share amounts and
stock plans have been adjusted retroactively for the four-for-three stock split.
Effective February 11, 1998, the Company completed a secondary public
offering of common stock. The Company sold 420,481 shares of common stock at
$11.67 per share. Net proceeds, after deducting the underwriting discount and
estimated offering expenses, were approximately $4.2 million. Selling
stockholders also sold 3,202,019 shares at $11.67 per share. The Company did not
receive any proceeds from the sales of shares by the selling stockholders.
42
43
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In May 1998, stockholders amended the Company's certificate of
incorporation to reduce the number of authorized shares of common stock from 100
million to 50 million. The financial statements have been retroactively adjusted
to reflect the reduction in authorized shares.
In September 1998, the board of directors authorized the repurchase of up
to $6.0 million in aggregate of the Company's common stock from time to time. No
shares have been acquired as of December 31, 1999.
In September 1998, the board of directors declared a dividend distribution
of one preferred stock purchase right for each outstanding share of the
Company's common stock. Each right will entitle stockholders to buy one
one-thousandth of a share of the Company's Series A preferred stock for each
share of the Company's common stock held at a price of $90.00. The number of
rights associated with shares of common stock has been proportionally adjusted
for the stock split effected in January 2000. The rights will be exercisable
only if a person or group of affiliated or associated persons acquires, or has
announced the intent to acquire, 20% or more of the Company's common stock.
In May 1999, Pegasus completed a secondary public offering of common stock.
The effective date of the registration statement on Form S-3 was May 6, 1999.
Pegasus sold 3,450,000 shares of common stock at a price of $25.92 per share.
After deducting the underwriters' discounts and offering expenses, net proceeds
to Pegasus were approximately $84.4 million.
On December 8, 1999, the board of directors approved a three-for-two stock
split to be effected in the form of a stock dividend on January 7, 2000 to
stockholders of record on December 20, 1999. All references in the consolidated
financial statements to shares, share prices, per share amounts and stock plans
have been retroactively adjusted for the three-for-two stock split. In
connection with the stock split, $68,383 and $53,268 was reclassified to common
stock from additional paid-in capital in the December 31, 1999 and 1998 balance
sheets, respectively.
9. STOCK-BASED COMPENSATION
In accordance with the Company's 1996 stock option plan ("1996 Plan"),
amended and approved in March 1997, options to purchase 1,300,000 shares of the
Company's common stock may be granted to Company employees. Options granted
under the 1996 Plan before September 15, 1999 expire in December 2005. In
accordance with the Company's 1997 stock option plan ("1997 Plan"), approved in
March 1997 and amended in May 1999, options to purchase 1,050,000 shares of the
Company's common stock may be granted to Company employees and non-employee
directors and contractors. Options granted to Company employees under the 1997
Plan before September 15, 1999 expire in December 2006. Options granted to
Company employees on or after September 15, 1999 under both the 1996 and 1997
Plans (collectively, "Plans") expire ten years from the date of grant. Options
granted under the Plans may be in the form of incentive stock options or
nonqualified stock options. The compensation committee of the board of directors
("Committee") administers the Plans and determines grant prices. Options granted
to Company employees generally vest one-fourth after one year from the date of
grant and one-twelfth of the balance each quarter thereafter. Options granted to
non-employee directors and contractors vest and expire as determined by the
Committee. The Company's authorized but unissued or reacquired common stock is
used as stock options are exercised.
In accordance with APB 25, the Company recorded unearned compensation of
approximately $250,000, $241,000 and $451,000 in 1999, 1998 and 1997,
respectively, related to options. Unearned compensation is being recognized
ratably over the vesting period for stock option grants with exercise prices
which are less than fair market value of the stock at the date of grant.
Compensation expense of approximately $323,000, $269,000 and $198,000 was
charged to operations in 1999, 1998 and 1997, respectively.
As discussed in Note 1, the Company has adopted the disclosure-only
provision of FAS 123. Had compensation cost for the Company's stock option plans
been determined based on the fair value provisions of
43
44
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
FAS 123, the Company's net income and net income per share would have been
decreased to the pro forma amounts indicated below:
1999 1998 1997
---------- ---------- --------
Net income -- as reported......................... $8,665,897 $5,396,451 $589,460
Net income -- pro forma........................... $7,571,506 $4,859,692 $334,589
Net income per share -- as reported:
Basic........................................... $ 0.47 $ 0.34 $ 0.05
Diluted......................................... $ 0.44 $ 0.32 $ 0.05
Net income per share -- pro forma:
Basic........................................... $ 0.41 $ 0.31 $ 0.03
Diluted......................................... $ 0.38 $ 0.29 $ 0.03
The pro forma disclosures provided are not likely to be representative of the
effects on reported net income for future years due to future grants and the
vesting requirements of the Company's stock option plans.
The weighted average fair value for options with exercise prices equal to
the market price of stock at the grant date was $14.55 in 1999 and $4.54 in
1998. There were no options granted in 1997 with exercise prices equal to the
market price of stock at the grant date. The weighted average fair value for
options with exercise prices below the market price of stock at the grant date
was $13.72 in 1999, $8.99 in 1998 and $5.67 in 1997. The fair value of each
option grant is estimated on the date of grant using the Black-Scholes
option-pricing model with the following weighted-average assumptions:
1999 1998 1997
--------- --------- ---------
Dividend yield....................................... -- -- --
Expected volatility:
Pre-IPO grants..................................... -- -- 0.0%
Post-IPO grants.................................... 72.0% 72.8% 65.0%
Risk-free rate of return............................. 5.7% 4.6% 6.1%
Expected life........................................ 4.0 years 4.0 years 4.9 years
The following table summarizes activity under the Company's stock option plans
during the years ended December 31:
WEIGHTED AVERAGE EXERCISE
NUMBER OF COMPANY OPTIONS PRICE PER SHARE
--------------------------------- -------------------------
1999 1998 1997 1999 1998 1997
--------- --------- --------- ------- ------ ------
Options outstanding at
beginning of year......... 2,000,942 1,623,417 1,157,610 $ 4.91 $3.83 $1.59
Granted..................... 524,875 595,749 497,499 24.93 8.29 8.99
Exercised................... 543,322 100,480 2,000 4.02 3.73 2.07
Canceled.................... 123,322 117,744 29,692 6.64 8.13 2.89
--------- --------- --------- ------ ----- -----
Options outstanding at end
of year................... 1,859,173 2,000,942 1,623,417 $10.71 $4.91 $3.83
========= ========= ========= ====== ===== =====
Options exercisable at end
of year................... 706,978 735,784 395,151 $ 3.63 $2.95 $1.55
44
45
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes information for stock options outstanding at
December 31, 1999:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------- ---------------------------
WEIGHTED AVERAGE WEIGHTED WEIGHTED
NUMBER OF REMAINING AVERAGE NUMBER OF AVERAGE
EXERCISE PRICES OPTIONS CONTRACTUAL LIFE EXERCISE PRICE OPTIONS EXERCISE PRICE
- --------------- --------- ---------------- -------------- --------- ---------------
$1.34................... 514,250 6.0 years $ 1.34 414,874 $ 1.34
$2.07................... 144,098 5.8 years 2.07 91,871 2.07
$6.33-$8.93............. 396,397 6.9 years 7.03 88,704 6.93
$10.20-$15.09........... 278,053 6.2 years 10.94 111,519 10.82
$16.92-$25.25........... 427,375 8.0 years 24.34 -- --
$25.42-$31.17........... 99,000 6.5 years 27.25 -- --
--------- --------- ------ ------- ------
1,859,173 6.7 years $10.71 706,968 $ 3.63
========= ========= ====== ======= ======
The pro forma disclosures for 1999 include approximately $108,000 of
compensation expense related to the Company's Employee Stock Purchase Plan (Note
13). The fair value of shares issued under this plan was estimated using the
Black-Scholes option-pricing model with the following weighted-average
assumptions:
1999
--------
Dividend yield.............................................. --
Expected volatility......................................... 72.0%
Risk-free rate of return.................................... 4.5%
Expected life............................................... 1.0 year
10. INCOME TAXES
Pretax income from continuing operations for the years ended December 31
was taxed under the following jurisdictions:
1999 1998 1997
----------- ---------- --------
Domestic......................................... $13,260,045 $5,495,808 $519,459
Foreign.......................................... 93,645 98,267 97,917
----------- ---------- --------
$13,353,690 $5,594,075 $617,376
=========== ========== ========
45
46
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred taxes consisted of the following at December 31:
1999 1998
---------- ----------
Deferred tax assets:
Net operating loss carryforward........................... $1,721,136 $2,162,922
Capital loss.............................................. 374,037 --
Stock option compensation expense......................... 128,273 181,545
Depreciation and amortization............................. 844,814 --
Rent expense.............................................. 36,309 52,540
Various expense accruals.................................. 81,231 50,660
Charitable contributions.................................. 30,658 22,495
Bad debt reserves......................................... 25,399 36,396
Income tax credits........................................ 191,585 24,160
Other..................................................... 12,830 --
---------- ----------
Total gross deferred tax assets................... 3,446,272 2,530,718
Valuation allowance....................................... -- (270,000)
Deferred tax liability:
Software amortization..................................... -- (109,190)
Depreciation and amortization............................. -- (66,903)
---------- ----------
Net deferred tax assets..................................... $3,446,272 $2,084,625
========== ==========
In 1997, the net deferred tax asset was fully reserved because of uncertainty
regarding the Company's ability to recognize the benefit of the asset in future
years. In the fourth quarter of 1998, the Company released a significant portion
of the valuation allowance as management believed it was more likely than not
that the net deferred tax asset would be realized. The valuation allowance
remaining at December 31, 1998 related to state net operating loss
carryforwards. This valuation allowance was removed in 1999 because the related
state net operating loss carryforward expired. A portion of the deferred tax
asset was related to net operating loss carryforwards of The Hotel Clearing
Corporation ("HCC") that existed at the time HCC was acquired by the Company in
1995. Accordingly, approximately $1,467,000 of the valuation allowance released
in 1998 reduced the remaining goodwill related to the purchase of HCC.
At December 31, 1999 and 1998, the Company had federal net operating loss
carryforwards of approximately $5,062,000 and $5,567,000, respectively. The 1999
net operating loss carryforwards that existed at December 31, 1999 will begin to
expire in 2007. Utilization of the net operating loss carryforwards may be
limited by the separate return loss year rules and could be affected by
ownership changes which have occurred or could occur in the future. As of
December 31, 1999, management believes it is more likely than not that the net
deferred tax asset will be realized; therefore, no valuation allowance is
necessary.
In 1999, the Company determined that amortization expense related to the
Driving Revenue acquisition would be deductible for tax purposes. As a result,
the Company established a deferred tax asset in the amount of approximately
$932,000 and reduced goodwill accordingly.
46
47
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of the income tax provision for the years ended December 31
were as follows:
1999 1998 1997
---------- --------- --------
Current provision:
Federal.......................................... $4,791,986 $ 381,025 $ 51,525
State............................................ 519,907 462,413 --
Foreign.......................................... 37,000 38,100 27,916
---------- --------- --------
5,348,893 881,538 79,441
---------- --------- --------
Deferred benefit:
Federal.......................................... (579,243) (641,069) $(51,525)
State............................................ (81,857) (42,845) --
---------- --------- --------
(661,100) (683,914) (51,525)
---------- --------- --------
Provision for income taxes......................... $4,687,793 $ 197,624 $ 27,916
========== ========= ========
A reconciliation of taxes based on the federal statutory rate of 34.0% and the
provision for income taxes is summarized as follows for the years ended December
31:
1999 1998 1997
---- ----- -----
Expected income tax provision.............................. 34.0% 34.0% 34.0%
Valuation allowance........................................ -- (46.7)% (38.4)%
Permanent differences...................................... (2.0)% 10.9% 9.8%
State income taxes......................................... 2.2% 5.0% --
Rate change, state taxes................................... 0.5% -- --
Other, net................................................. 0.4% 0.3% (0.9)%
---- ----- -----
Provision for income taxes................................. 35.1% 3.5% 4.5%
==== ===== =====
11. COMMITMENTS AND CONTINGENCIES
The Company leases its corporate office space and certain office equipment
under non-cancelable operating leases. The Company incurred rent expense of
approximately $1,039,000, $731,000 and $720,000 in 1999, 1998 and 1997,
respectively.
Approximate future minimum lease payments at December 31, 1999, under
non-cancelable operating leases with original terms exceeding one year,
including the Pegasus UK operating lease translated at the rate in effect at
December 31, 1999, were as follows:
YEAR ENDING
DECEMBER 31,
- ------------
2000.................................................... $1,319,000
2001.................................................... 1,388,000
2002.................................................... 1,362,000
2003.................................................... 65,000
2004.................................................... 65,000
Thereafter.............................................. 75,000
----------
$4,274,000
==========
In May 1997, the Company issued a warrant to a customer for the purchase of
518,584 shares of the Company's common stock as part of a five year contract
involving a wide range of the Company's services. The warrant was exercised in
May 1999 at an exercise price of $4.80 per share. The Company used the Black-
47
48
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Scholes option pricing model to value the warrant. A contract asset of $238,000
was recorded in May 1997, which is being amortized ratably over the associated
five-year contract period.
12. EMPLOYEE BENEFIT PLAN
The Company sponsors a 401(k) defined contribution retirement plan ("401(k)
Plan") covering full-time employees who have attained the age of twenty-one. The
401(k) Plan allows eligible employees to defer receipt of up to fifteen percent
of their compensation and contribute such amounts to various investment funds.
Eligible employees may elect to participate at the beginning of any quarter
after their hire date. Employee contributions vest immediately.
The Company makes discretionary matching contributions of up to five
percent of employees' annual contributions. The Company's matching contributions
vest 20% a year for five years. After five years employment, an employee is
fully vested in all matching contributions. During 1999, 1998 and 1997, the
Company contributed approximately $363,000, $292,000 and $217,000, respectively,
to the 401(k) Plan.
13. STOCK PURCHASE PLAN
In May 1998, the Company's stockholders approved the Pegasus Systems, Inc.
1997 Employee Stock Purchase Plan ("Stock Plan"). The Company has reserved
750,000 shares of its common stock for purchase by employees pursuant to the
terms of the Stock Plan. Eligible participating employees of the Company may
elect to have an amount up to, but not in excess of, 10% of their regular salary
or wages withheld for the purpose of purchasing the Company's common stock.
Under the Stock Plan, an eligible participating employee will be granted an
option at the beginning of each plan year (the "Offering Commencement Date") to
purchase at the end of the plan year (the "Offering Termination Date") shares of
common stock using the amounts that have accumulated from the employee's payroll
deductions made during the plan year at a price that is 85% of the closing price
of the common stock on the Nasdaq National Market or any other national
securities exchange on the Offering Commencement Date or the Offering
Termination Date, whichever is lower.
14. RELATED PARTIES
Pegasus has entered into an arrangement with REZ, Inc. to manage and
operate equipment owned by Pegasus at REZ's facilities. In this arrangement, REZ
also provides equipment monitoring services, assurance of power supply and
communications link back-up support. During 1999, 1998 and 1997, Pegasus
recognized expense in the amount of approximately $578,000, $461,000 and
$488,000, respectively, for those services. Pegasus provides electronic
distribution, commission processing and Internet-based distribution services to
REZ. Revenues relating to these services were approximately $1,179,000, $796,000
and $751,000 during 1999, 1998 and 1997, respectively (Note 18).
Persons related to an officer of the Company have provided printing, design
and procurement services to the Company. During 1999, 1998 and 1997, the Company
paid approximately $34,000, $3,000 and $6,000, respectively, related to these
services, the majority of which related to capitalized furniture purchases.
Prior to the IPO, the Company derived a substantial portion of its revenues
from certain stockholders and stockholder-owned companies. For the year ended
December 31, 1997, revenue generated by stockholders and stockholder-owned
companies was approximately $15.7 million or 75.3%. Disclosing revenues
generated by stockholders and stockholder-owned companies was not considered
necessary for the years ended December 31, 1999 and 1998 since the ownership
percentage of these stockholders was reduced by the Company's IPO in August
1997, secondary offerings in February 1998 and May 1999 and subsequent open
market sales of their shares. The ownership percentage of these stockholders was
an aggregate of less than 10% of the
48
49
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Company's common shares outstanding at December 31, 1999 and 1998; therefore,
these stockholders were not considered affiliates as of and for the years ended
December 31, 1999 and 1998.
15. NET INCOME PER SHARE
Basic net income per share for the years ended December 31, 1999, 1998 and
1997 has been computed in accordance with FAS 128 using the weighted average
number of common shares outstanding after giving retroactive effect to stock
splits (Notes 1 and 8).
Diluted net income per share for the years ended December 31, 1999, 1998
and 1997 gives effect to all dilutive potential common shares that were
outstanding during the periods. Outstanding options and warrants with strike
prices below the average fair market value of the Company's common stock for the
years ended December 31, 1999, 1998 and 1997 were included in the diluted
earnings per share (EPS) calculations for the respective periods.
The following table sets forth the options excluded from the diluted EPS
calculations for the respective periods:
1999 1998 1997
------------------------ ------------------------ -----------------------
OPTIONS OPTIONS OPTIONS
THREE MONTHS ENDED EXCLUDED STRIKE PRICE EXCLUDED STRIKE PRICE EXCLUDED STRIKE PRICE
- ------------------ -------- ------------- -------- ------------- -------- ------------
March 31................ 1,500 $27.25 -- -- -- --
June 30................. 9,000 $27.25-$31.17 -- -- -- --
September 30............ 106,500 $25.25-$31.17 81,000 $12.96-$15.16 -- --
December 31............. -- -- 85,500 $12.96-$16.92 -- --
The options were excluded because they were anti-dilutive. The options excluded
in 1999 and 1998 expire from December 2005 to December 2006.
49
50
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table sets forth the basic and diluted net income per share
computation for the years ended December 31:
1999 1998 1997
----------- ----------- -----------
Net income.................................... $ 8,665,897 $ 5,396,451 $ 589,460
=========== =========== ===========
Basic:
Weighted average number of shares
outstanding.............................. 18,576,107 15,691,421 10,800,573
----------- ----------- -----------
Net income per share........................ $ 0.47 $ 0.34 $ 0.05
=========== =========== ===========
Diluted:
Weighted average number of shares
outstanding.............................. 18,576,107 15,691,421 10,800,573
Additional weighted average shares from
assumed conversion of dilutive
convertible preferred stock to common
stock, net of shares to be repurchased
with exercise proceeds................... -- -- 1,382,032
Additional weighted average shares from
assumed exercise of dilutive stock
options and warrants, net of shares to be
repurchased with exercise proceeds....... 1,113,280 1,103,922 831,473
----------- ----------- -----------
Weighted average number of shares
outstanding used in the diluted net
income per share calculation............. 19,689,387 16,795,343 13,014,078
----------- ----------- -----------
Net income per share........................ $ 0.44 $ 0.32 $ 0.05
=========== =========== ===========
16. SEGMENT INFORMATION
In 1998, the Company adopted FAS 131. The prior years' segment information
has been restated to present the Company's three reportable segments:
- Pegasus Electronic Distribution -- provides services that enable travel
agents and individual travelers to electronically access hotel room
inventory information and conduct reservation transactions;
- Pegasus Commission Processing -- provides commission payment processing
services to the hotel industry and travel agencies; and
- Pegasus Business Intelligence -- provides data mining and reporting
services for benchmark analysis and strategic planning for the hotel
industry.
The accounting policies of the segments are the same as those described in the
Note 1. Segment data includes a charge allocating all corporate costs to the
operating segments. The Company evaluates the performance of its segments based
on pretax income. The Company is organized primarily on the basis of services
provided.
50
51
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table presents information about reported segments for the
years ending December 31:
ELECTRONIC COMMISSION BUSINESS RECONCILING
DISTRIBUTION PROCESSING INTELLIGENCE ITEMS TOTAL
------------ ----------- ------------ ----------- -----------
1999
- -----
Net revenues.................. $17,888,157 $18,187,232 $1,960,880 $ -- $38,036,269
Interest income............... -- 158,325 44,322 4,625,496 4,828,143
Interest expense.............. 23,175 3,528 53 -- 26,756
Depreciation and
amortization................ 1,256,591 383,116 797,703 -- 2,437,410
Income(loss) before taxes..... 5,957,372 7,880,898 (3,993,490) 3,508,910 13,353,690
1998
- -----
Net revenues.................. 12,310,046 15,851,557 902,864 -- 29,064,467
Interest income............... 14,358 151,243 12 2,337,652 2,503,265
Interest expense.............. 112,988 33,788 103 -- 146,879
Depreciation and
amortization................ 1,258,152 1,175,451 256,264 -- 2,689,867
Write-off purchased in-process
R&D......................... -- -- 1,480,085 -- 1,480,085
Income(loss) before taxes..... 506,036 5,527,910 (2,777,523) 2,337,652 5,594,075
1997
- -----
Net revenues.................. 9,864,738 11,038,678 -- -- 20,903,416
Interest income............... 7,820 105,437 -- 880,335 993,592
Interest expense.............. 516,631 83,265 171 -- 600,067
Depreciation and
amortization................ 1,074,780 1,929,588 12,251 -- 3,016,619
Income(loss) before taxes..... (1,815,218) 2,122,436 (570,177) 880,335 617,376
Reconciling items for 1999, 1998 and 1997 include interest income earned on
short-term investments. Reconciling items for 1999 also include a write-off of
the Company's investment in Intermezzo Systems, Inc.
The Company's business is conducted principally in the United States. The
Company does not utilize or measure revenues by geographic location to evaluate
Pegasus Electronic Distribution or Pegasus Business Intelligence segments.
However, the Company does track the geographic source of travel agency and hotel
transactions that give rise to Pegasus Commission Processing revenues. For 1999,
1998 and 1997, approximately $3,300,000, $2,922,000 and $2,037,000 of Commission
Processing revenues were derived from customers based outside the United States.
51
52
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
17. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table summarizes the unaudited consolidated quarterly results
of operations for 1999 and 1998 after giving retroactive effect to a
three-for-two stock split (Note 8) (in thousands except per share amounts):
QUARTERS ENDED
-----------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
1999
Revenues................................. $ 8,372 $ 9,189 $10,075 $10,400
Income before provision for income
taxes.................................. $ 2,432 $ 2,029 $ 4,136 $ 4,756
Net income............................... $ 1,501 $ 1,253 $ 2,730 $ 3,182
Basic net income per share............... $ 0.09 $ 0.07 $ 0.14 $ 0.16
Diluted net income per share............. $ 0.09 $ 0.06 $ 0.13 $ 0.15
Basic weighted average shares
outstanding............................ 15,862 18,115 20,049 20,214
Diluted weighted average shares
outstanding............................ 17,304 19,363 20,916 21,120
1998
Revenues................................. $ 6,167 $ 6,781 $ 7,803 $ 8,313
Income before provision for income
taxes.................................. $ 947 $ 1,382 $ 798 $ 2,467
Net income............................... $ 940 $ 1,357 $ 772 $ 2,328
Basic net income per share............... $ 0.06 $ 0.09 $ 0.05 $ 0.15
Diluted net income per share............. $ 0.06 $ 0.08 $ 0.05 $ 0.14
Basic weighted average shares
outstanding............................ 15,487 15,736 15,762 15,776
Diluted weighted average shares
outstanding............................ 16,557 16,904 16,793 16,923
In accordance with FAS 128, earnings per share are computed independently for
each of the quarters presented; therefore, the sum of the quarterly earnings per
share may not equal the annual earnings per share.
18. SUBSEQUENT EVENT
On November 16, 1999, the Company entered into a definitive agreement to
acquire Phoenix-based REZsolutions, Inc., a leader in providing distribution
services and solutions for the hotel industry. Under the terms of the agreement,
Pegasus will issue 3.99 million shares of common stock, pay $115.0 million in
cash and agree to a $20.0 million note payable to Utell International Ltd., a
subsidiary of Reed Elsevier plc, a substantial REZ stockholder. Based on a five
day average stock price of $31.775, the transaction is valued at approximately
$260 million subject to closing balance sheet adjustments. The average stock
price was determined using two days before, the day of and two days after the
agreement was announced. The acquisition is expected to close during the first
quarter of 2000 and will be accounted for under the purchase method of
accounting.
52
53
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item appears in our definitive proxy
statement for our 2000 annual meeting of stockholders under the captions
"Nominees for Directors", "Directors Continuing in Office" and "Executive
Officers," which information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item appears in our definitive proxy
statement for its 2000 annual meeting of stockholders under the caption
"Executive Compensation," which information is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item appears in our definitive proxy
statement for its 2000 annual meeting of stockholders under the caption
"Directors' and Officers' Ownership of our Common Stock," which information is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item appears in our definitive proxy
statement for its 2000 annual meeting of stockholders under the caption "Certain
Transactions," which information is incorporated herein by reference.
53
54
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) 1. The following Financial Statement Schedule is filed as part of this
annual report:
Report of Independent Accountants on Financial Statement
Schedule.................................................. Page S-1
Consolidated Valuation and Qualifying Accounts.............. Page S-2
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchanges Commission are not
required under the related instructions or are inapplicable and therefore have
been omitted.
2. The following documents are filed or incorporated by reference as
exhibits to this annual report:
EXHIBIT
NUMBER DESCRIPTION
------- -----------
2.1 -- Contribution and Restructuring Agreement dated effective
as of July 21, 1995 by and among the Company and all of
the stockholders of the Company
2.2 -- Agreement and Plan of Merger dated November 16, 1999, as
amended, by and among Pegasus Systems, Inc., Pegasus
Worldwide, Inc., REZ, Inc. and the majority stockholder
of REZ, Inc. (incorporated by reference to the Company's
S-4, as amended, originally filed with the Commission on
December 14, 1999)
3.1 -- Third Amended and Restated Certificate of Incorporation,
as amended
3.2 -- Second Amended and Restated Bylaws
3.3 -- Form of Certification of Designation, Preferences and
Rights of Series A Preferred Stock of Pegasus Systems,
Inc. (incorporated by reference from Exhibit 2 of the
Company's Form 8-A filed with the Commission on October
9, 1998)
4.1 -- Specimen of Common Stock certificate
4.2 -- Third Amended and Restated Certificate of Incorporation
and Second Amended and Restated Bylaws (see Exhibits 3.1
and 3.2)
4.3 -- Rights Agreement dated June 25, 1996 by and among the
Company and certain holders of capital stock of the
Company named therein
4.4 -- Common Stock Purchase Warrant issued to Holiday
Hospitality Corporation
4.5 -- Rights Agreement dated as of September 28, 1998 by and
between the Company and American Securities Transfer &
Trust, Inc. (incorporated by reference from Exhibit 4 of
the Company's Current Report on Form 8-K filed with the
Commission on October 9, 1998)
4.6 -- Form of Rights Certificate (incorporated by reference
from Exhibit 3 of the Company's Form 8-A filed with
Commission on October 9, 1998)
*10.1 -- Employment Agreement dated January 1, 2000 between the
Company and John F. Davis, III (incorporated by reference
to the Company's S-4, as amended, originally filed with
Commission on December 14, 1999)
*10.2 -- Employment Agreement dated January 1, 2000 between the
Company and Joseph W. Nicholson (incorporated by
reference to the Company's S-4, as amended, originally
filed with Commission on December 14, 1999)
*10.3 -- Employment Agreement dated January 1, 2000 between the
Company and Jerome L. Galant (incorporated by reference
to the Company's S-4, as amended, originally filed with
Commission on December 14, 1999)
*10.5 -- 1996 Stock Option Plan, as amended
+*10.6 -- 1997 Stock Option Plan, as amended
54
55
EXHIBIT
NUMBER DESCRIPTION
------- -----------
10.7 -- Citibank Global Payments Service Agreement dated July 24,
1998 between The Hotel Clearing Corporation and Citibank,
N.A. (incorporated by reference to Exhibit 10.1 of the
Company's 10-Q for the quarter ended October 31, 1998,
filed with the Commission on November 16, 1998)
10.8 -- Facilities Management Agreement dated January 1, 1996
between the Company and Anasazi, Inc., currently know as
REZsolutions, Inc.
10.9 -- Service Agreement dated December 13, 1996 between the
Company and Comdisco, Inc.
10.1 -- Service Agreement dated January 17, 1997 between the
Company and Genuity, Inc.
*10.11 -- 1997 Employee Stock Purchase Plan, as amended
(incorporated by reference to the Company's 10-K for the
year ended December 31, 1998.)
10.12 -- Office Lease dated October 1, 1995, First Amendment to
Office Lease dated February 25, 1998, Second Amendment to
Office Lease dated November 2, 1998 and Third Amendment
to Office Lease dated November 8, 1999 between the
Company and the Utah State Retirement Investment Fund
relating to property located at 3811 Turtle Creek Blvd.,
Suite 1100, Dallas, Texas 75219 (incorporated by
reference to the Company's Form S-4, as amended,
originally filed with the Commission on December 14,
1999)
+10.13 -- Supplemental Employee Retirement Plan
+21.1 -- Subsidiaries of the Company
+23.1 -- Consent of PricewaterhouseCoopers LLP
+24.1 -- Power of Attorney (included on signature page)
+27.1 -- Financial Data Schedule
- ---------------
Unless otherwise indicated, exhibits are incorporated by reference to the
Company's Registration Statement (File No. 333-28595) on Form S-1 declared
effective by the Commission on August 6, 1997.
+ Filed herewith.
* Management contract or compensatory plan or arrangement -- The Company will
furnish a copy of any exhibit listed above to any stockholder without charge
upon written request to Mr. Ric Floyd, Secretary, 3811 Turtle Creed Blvd.,
Suite 1100, Dallas, Texas 75219.
(b) Reports on Form 8-K
The following report on Form 8-K was filed during the quarter ended
December 31, 1999:
FINANCIAL
STATEMENTS
ITEM DESCRIPTION FILING DATE FILED
- ---- ----------- ----------- ----------
5 A report announcing an Agreement and Plan of Merger with November 22, 1999 No
REZ, Inc.
55
56
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this annual report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized,
in the City of Dallas, State of Texas, on this tenth day of March, 2000.
PEGASUS SYSTEMS, INC.
By: /s/ JOHN F. DAVIS, III
----------------------------------
John F. Davis, III
Chief Executive Officer,
President and Director
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.
POWER OF ATTORNEY
KNOW ALL MEN AND WOMEN BY THESE PRESENTS that each person whose signature
appears below constitutes and appoints John F. Davis, III, Jerome L. Galant and
Ric L. Floyd, and each of them, such individual's true and lawful
attorneys-in-fact and agents, with full power of substitution and
resubstitution, for such individual and in his or her name, place and stead, in
any and all capacities, to sign any and all amendments to this Annual Report on
Form 10-K, with all exhibits thereto, and to file the same with all exhibits
thereto, and all documents in connection therewith, with the Securities and
Exchange Commission, granting unto said attorneys-in-fact and agents, and each
of them, full power and authority to do and perform each and every act and thing
requisite and necessary to be done in and about the premises as fully and to
intents and purposes as he might or could do in person hereby ratifying and
confirming all that said attorneys-in-fact and agents, or any of them, or their
substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
SIGNATURES TITLE DATE
---------- ----- ----
/s/ JOHN F. DAVIS, III Chief Executive Officer, President March 10, 2000
- ----------------------------------------------------- and Director (Principal
John F. Davis, III Executive Officer)
/s/ JEROME L. GALANT Chief Financial Officer (Principal March 10, 2000
- ----------------------------------------------------- Financial and Accounting
Jerome L. Galant Officer)
/s/ MICHAEL A. BARNETT Director March 10, 2000
- -----------------------------------------------------
Michael A. Barnett
/s/ PAUL J. BROWN Director March 10, 2000
- -----------------------------------------------------
Paul J. Brown
/s/ ROBERT B. COLLIER Director March 10, 2000
- -----------------------------------------------------
Robert B. Collier
/s/ WILLIAM C. HAMMETT, JR. Director March 10, 2000
- -----------------------------------------------------
William C. Hammett, Jr.
56
57
SIGNATURES TITLE DATE
---------- ----- ----
/s/ THOMAS F. O'TOOLE Director March 10, 2000
- -----------------------------------------------------
Thomas F. O'Toole
/s/ BRUCE W. WOLFF Director March 10, 2000
- -----------------------------------------------------
Bruce W. Wolff
57
58
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors
of Pegasus Systems, Inc.
Our audits of the consolidated financial statements referred to in our
report dated February 10, 2000 appearing in Item 8 of this annual report on Form
10-K of Pegasus Systems, Inc. also included an audit of the financial statement
schedule, for each of the three years in the period ended December 31, 1999,
listed in Item 14(a) of this Form 10-K. In our opinion, the financial statement
schedule presents fairly, in all material respects, the information set forth
therein when read in conjunction with the related consolidated financial
statements.
PricewaterhouseCoopers LLP
Dallas, Texas
February 10, 2000
S-1
59
SCHEDULE II
PEGASUS SYSTEMS, INC.
CONSOLIDATED VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999 (IN THOUSANDS)
ADDITIONS ADDITIONS
BALANCE AT CHARGED TO FROM BALANCE AT
BEGINNING COSTS AND ACQUIRED END OF
CLASSIFICATION OF PERIOD EXPENSES COMPANIES DEDUCTIONS PERIOD
- -------------- ---------- ---------- --------- ---------- ----------
December 31, 1997
Allowance for doubtful accounts....... $ 45 $ 81 $-- $ (48) $ 78
Income tax valuation allowance........ 4,549 -- -- (237) 4,312
------ ---- --- ------- ------
Total reserves and allowances......... 4,594 81 -- (285) 4,390
------ ---- --- ------- ------
December 31, 1998
Allowance for doubtful accounts....... 78 35 7 (21) 99
Income tax valuation allowance........ 4,312 270 -- (4,312) 270
------ ---- --- ------- ------
Total reserves and
allowances.................. 4,390 305 7 (4,333) 369
------ ---- --- ------- ------
December 31, 1999
Allowance for doubtful accounts....... 99 -- -- (17) 82
Income tax valuation allowance........ 270 -- -- (270) --
------ ---- --- ------- ------
Total reserves and
allowances.................. $ 369 $ -- $-- $ (287) $ 82
====== ==== === ======= ======
(a) This schedule should be read in conjunction with the Company's audited
consolidated financial statements and related notes thereto that appear in Item
8 of this annual report on Form 10-K.
S-2
60
EXHIBIT INDEX
EXHIBIT
NUMBER DESCRIPTION
------- -----------
2.1 -- Contribution and Restructuring Agreement dated effective
as of July 21, 1995 by and among the Company and all of
the stockholders of the Company
2.2 -- Agreement and Plan of Merger dated November 16, 1999, as
amended, by and among Pegasus Systems, Inc., Pegasus
Worldwide, Inc., REZ, Inc. and the majority stockholder
of REZ, Inc. (incorporated by reference to the Company's
S-4, as amended, originally filed with the Commission on
December 14, 1999)
3.1 -- Third Amended and Restated Certificate of Incorporation,
as amended
3.2 -- Second Amended and Restated Bylaws
3.3 -- Form of Certification of Designation, Preferences and
Rights of Series A Preferred Stock of Pegasus Systems,
Inc. (incorporated by reference from Exhibit 2 of the
Company's Form 8-A filed with the Commission on October
9, 1998)
4.1 -- Specimen of Common Stock certificate
4.2 -- Third Amended and Restated Certificate of Incorporation
and Second Amended and Restated Bylaws (see Exhibits 3.1
and 3.2)
4.3 -- Rights Agreement dated June 25, 1996 by and among the
Company and certain holders of capital stock of the
Company named therein
4.4 -- Common Stock Purchase Warrant issued to Holiday
Hospitality Corporation
4.5 -- Rights Agreement dated as of September 28, 1998 by and
between the Company and American Securities Transfer &
Trust, Inc. (incorporated by reference from Exhibit 4 of
the Company's Current Report on Form 8-K filed with the
Commission on October 9, 1998)
4.6 -- Form of Rights Certificate (incorporated by reference
from Exhibit 3 of the Company's Form 8-A filed with
Commission on October 9, 1998)
*10.1 -- Employment Agreement dated January 1, 2000 between the
Company and John F. Davis, III (incorporated by reference
to the Company's S-4, as amended, originally filed with
Commission on December 14, 1999)
*10.2 -- Employment Agreement dated January 1, 2000 between the
Company and Joseph W. Nicholson (incorporated by
reference to the Company's S-4, as amended, originally
filed with Commission on December 14, 1999)
*10.3 -- Employment Agreement dated January 1, 2000 between the
Company and Jerome L. Galant (incorporated by reference
to the Company's S-4, as amended, originally filed with
Commission on December 14, 1999)
*10.5 -- 1996 Stock Option Plan, as amended
+*10.6 -- 1997 Stock Option Plan, as amended
10.7 -- Citibank Global Payments Service Agreement dated July 24,
1998 between The Hotel Clearing Corporation and Citibank,
N.A. (incorporated by reference to Exhibit 10.1 of the
Company's 10-Q for the quarter ended October 31, 1998,
filed with the Commission on November 16, 1998)
10.8 -- Facilities Management Agreement dated January 1, 1996
between the Company and Anasazi, Inc., currently know as
REZsolutions, Inc.
10.9 -- Service Agreement dated December 13, 1996 between the
Company and Comdisco, Inc.
10.1 -- Service Agreement dated January 17, 1997 between the
Company and Genuity, Inc.
61
EXHIBIT
NUMBER DESCRIPTION
------- -----------
*10.11 -- 1997 Employee Stock Purchase Plan, as amended
(incorporated by reference to the Company's 10-K for the
year ended December 31, 1998.)
10.12 -- Office Lease dated October 1, 1995, First Amendment to
Office Lease dated February 25, 1998, Second Amendment to
Office Lease dated November 2, 1998 and Third Amendment
to Office Lease dated November 8, 1999 between the
Company and the Utah State Retirement Investment Fund
relating to property located at 3811 Turtle Creek Blvd.,
Suite 1100, Dallas, Texas 75219 (incorporated by
reference to the Company's Form S-4, as amended,
originally filed with the Commission on December 14,
1999)
+10.13 -- Supplemental Employee Retirement Plan
+21.1 -- Subsidiaries of the Company
+23.1 -- Consent of PricewaterhouseCoopers LLP
+24.1 -- Power of Attorney (included on signature page)
+27.1 -- Financial Data Schedule
- ---------------
Unless otherwise indicated, exhibits are incorporated by reference to the
Company's Registration Statement (File No. 333-28595) on Form S-1 declared
effective by the Commission on August 6, 1997.
+ Filed herewith.
* Management contract or compensatory plan or arrangement -- The Company will
furnish a copy of any exhibit listed above to any stockholder without charge
upon written request to Mr. Ric Floyd, Secretary, 3811 Turtle Creed Blvd.,
Suite 1100, Dallas, Texas 75219.