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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________
FORM 10-Q
(Mark one)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2003
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___ TO ___
____________________
Commission File Number 0-22935
PEGASUS SOLUTIONS, 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.)
CAMPBELL CENTRE I, 8350 NORTH CENTRAL EXP., STE 1900, DALLAS, TEXAS 75206
(Address of principal executive office)
(Zip Code)
Registrant's telephone number, including area code: (214) 234-4000
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities 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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
The number of shares of the registrant's common stock, par value $0.01 per
share, outstanding as of November 11, 2003 was 25,014,744.
PEGASUS SOLUTIONS, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2003
INDEX
Page
----
Part I. Financial Information
Item 1. Financial Statements (Unaudited) 3
a) Condensed Consolidated Balance Sheets as of September 30, 2003
and December 31, 2002 3
b) Condensed Consolidated Statements of Operations and
Comprehensive Income (Loss) for the Three and Nine months
Ended September 30, 2003 and 2002 4
c) Condensed Consolidated Statements of Cash Flows for the
Nine months Ended September 30, 2003 and 2002 5
d) Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations 10
Item 4. Controls and Procedures 20
Part II. Other Information
Item 1. Legal Proceedings 21
Item 6. Exhibits and Reports on Form 8-K 21
Signatures 22
2
Part I. Financial Information
Item 1. Financial Statements
PEGASUS SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT FOR SHARE AMOUNTS)
(UNAUDITED)
ASSETS
SEPTEMBER 30, DECEMBER 31,
2003 2002
------------- ------------
Cash and cash equivalents $ 89,514 $ 19,893
Short-term investments 5,071 4,033
Accounts receivable, net 23,622 25,886
Other current assets 9,028 8,368
--------- ---------
Total current assets 127,235 58,180
Goodwill, net 139,533 139,533
Intangible assets, net 1,206 6,013
Property and equipment, net 70,727 71,442
Other noncurrent assets 24,322 12,927
--------- ---------
Total assets $363,023 $288,095
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued liabilities $ 21,327 $ 26,574
Unearned income 9,243 7,812
Other current liabilities 7,035 6,799
--------- ---------
Total current liabilities 37,605 41,185
Noncurrent uncleared commission checks 5,389 4,641
Other noncurrent liabilities 18,570 16,379
Convertible debt 75,000 -
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.01 par value; 2,000,000 shares authorized;
zero shares issued and outstanding - -
Common stock, $0.01 par value; 50,000,000 shares authorized;
25,014,244 and 24,747,165 shares issued, respectively 250 247
Additional paid-in capital 290,107 287,676
Unearned compensation - (571)
Accumulated other comprehensive loss (1,694) (1,705)
Accumulated deficit (62,204) (59,757)
--------- ---------
Total stockholders' equity 226,459 225,890
--------- ---------
Total liabilities and stockholders' equity $363,023 $288,095
========= =========
See accompanying notes to condensed consolidated financial statements.
3
PEGASUS SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
2003 2002 2003 2002
-------- -------- --------- ---------
Revenues:
Service revenues $42,868 $46,614 $121,362 $138,105
Customer reimbursements 2,892 2,556 8,242 8,401
-------- -------- --------- ---------
Total revenues 45,760 49,170 129,604 146,506
Costs of services:
Cost of services 21,141 21,810 64,283 68,777
Customer reimbursements 2,892 2,556 8,242 8,401
-------- -------- --------- ---------
Total costs of services 24,033 24,366 72,525 77,178
Research and development 949 1,215 3,545 4,503
General and administrative expenses 5,543 6,070 17,925 18,676
Marketing and promotion expenses 3,531 4,316 11,946 13,378
Depreciation and amortization 5,185 12,058 22,459 36,452
Restructure costs 80 - 5,949 -
-------- -------- --------- ---------
Operating income (loss) 6,439 1,145 (4,745) (3,681)
Other income (expense):
Interest income (expense), net (254) 360 346 917
Other 240 (139) 270 (405)
-------- -------- --------- ---------
Income (loss) before income taxes 6,425 1,366 (4,129) (3,169)
Income tax benefit (expense) (2,578) (694) 1,682 1,124
Net income (loss) $ 3,847 $ 672 $ (2,447) $ (2,045)
======== ======== ========= =========
Other comprehensive income (loss):
Change in unrealized gain (loss), net of tax 11 1 11 (21)
-------- -------- --------- ---------
Comprehensive income (loss) $ 3,858 $ 673 $ (2,436) $ (2,066)
======== ======== ========= =========
Basic and diluted net income (loss) per share $ 0.15 $ 0.03 $ (0.10) $ (0.08)
======== ======== ========= =========
Basic weighted average shares outstanding 24,986 24,880 24,803 24,817
======== ======== ========= =========
Diluted weighted average shares outstanding 25,711 25,642 24,803 24,817
======== ======== ========= =========
See accompanying notes to condensed consolidated financial statements.
4
PEGASUS SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
2003 2002
--------- ---------
Cash flows from operating activities:
Net loss $ (2,447) $ (2,045)
Adjustments to reconcile net loss to net cash provided by operating activities:
Depreciation and amortization 22,460 36,452
Other 1,344 3,035
Changes in assets and liabilities:
Accounts receivable 2,264 (1,253)
Other assets (3,908) (1,130)
Accounts payable and accrued liabilities (5,247) (8,627)
Unearned income 1,432 475
Other liabilities 2,040 4,673
--------- ---------
Net cash provided by operating activities 17,938 31,580
Cash flows from investing activities:
Purchase of marketable securities (12,212) (8,786)
Proceeds from maturity of marketable securities 3,000 16,400
Purchase of property and equipment (14,959) (25,267)
Proceeds from sale of property and equipment 110 38
Investment in Travelweb, LLC - (2,143)
Collections of notes receivable 1,655 207
--------- ---------
Net cash used in investing activities (22,406) (19,551)
Cash flows from financing activities:
Proceeds from issuance of common stock 1,770 1,770
Purchase of treasury stock - (1,213)
Proceeds from convertible debt issuance 75,000 -
Debt issuance costs (2,540) -
Other (141) (92)
--------- ---------
Net cash provided by financing activities 74,089 465
Net increase in cash and cash equivalents 69,621 12,494
Cash and cash equivalents, beginning of period 19,893 13,438
--------- ---------
Cash and cash equivalents, end of period $ 89,514 $ 25,932
========= =========
Supplemental schedule of noncash investing and financing activities:
Landlord paid tenant improvements $ 524 $ 2,063
========= =========
See accompanying notes to condensed consolidated financial statements.
5
PEGASUS SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
Pegasus Solutions, Inc. is a leading provider of hotel room reservation
services, reservation technology systems and hotel representation services for
the global hospitality industry. The unaudited condensed consolidated financial
statements include the accounts of Pegasus Solutions, Inc. and its wholly owned
subsidiaries ("Pegasus" or "the Company"). All significant intercompany
balances have been eliminated in consolidation. Pegasus' common stock is traded
on the Nasdaq National Market under the symbol PEGS.
On February 4, 2003, the Company announced a strategic reorganization to
integrate its technology and hospitality segments into one operating unit. As a
result, the Company's operations have integrated support functions including
consolidated sales and marketing, product development, service delivery,
reservation and data management, information technology, finance and human
resources. Because the Company has changed its management approach,
organizational structure, operating performance assessment and reporting, and
operational decision making from a segment perspective (technology and
hospitality) to a single company perspective, the Company no longer reports
separate segment information.
Certain prior year amounts have been reclassified to conform to current year
presentation. In the opinion of management, the unaudited condensed
consolidated financial statements presented herein reflect all adjustments
necessary to fairly state the financial position, operating results, and cash
flows for the periods presented. Such adjustments are of a normal recurring
nature. The results for interim periods are not necessarily indicative of
results expected for the entire fiscal year. The accompanying unaudited
condensed consolidated financial statements and the notes thereto should be read
in conjunction with the consolidated financial statements and notes thereto
contained in the Company's Annual Report on Form 10-K for the year ended
December 31, 2002.
2. NET INCOME (LOSS) PER SHARE
Basic net income (loss) per share is computed by dividing net income (loss)
available to common stockholders by the weighted average number of common shares
outstanding for the reporting period. The potential effect of the Company's
convertible debt is not included in calculations of net income (loss) per share,
as those securities are contingently convertible. For the three months ended
September 30, 2003 and 2002, the weighted average shares used to compute income
per share include approximately 725,000 and 762,000 shares,respectively,
representing the dilutive effect of stock options. Excluded from the
calculations of dilutive income per share for the three months ending September
30, 2003 and 2002 were 4.8 million and 3.7 million shares, respectively, as
their effect would be anti-dilutive. The effect of stock options is not
included in the calculations of diluted net loss per share for the nine months
ended September 30, 2003 and 2002, as their effect would be anti-dilutive.
Shares issuable upon the exercise of stock options that were excluded from
the calculations were 5.5 million and 4.4 million for the nine months ended
September 30, 2003 and 2002, respectively.
3. STOCK-BASED COMPENSATION
The Company accounts for stock-based compensation utilizing the intrinsic value
method in accordance with the provisions of Accounting Principles Board Opinion
No. 25 (APB 25), "Accounting for Stock Issued to Employees" and related
Interpretations. Accordingly, no compensation expense is recognized for fixed
option plans because the exercise prices of employee stock options equal or
exceed the market prices of the underlying stock on the dates of grant. The
Company maintains stock incentive and employee stock purchase plans.
Compensation expense recorded for the stock incentive plan was zero and $357,000
for the three months ended September 30, 2003 and 2002, respectively, and
$571,000 and $464,000 for the nine months ended September 30, 2003 and 2002,
respectively.
6
The following table represents the effect on net income (loss) and net income
(loss) per share if the Company had applied the fair value based method and
recognition provisions of Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation," to stock-based employee compensation
(In thousands, except per share amounts):
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
--------------------------------------------------
2003 2002 2003 2002
-------- -------- ---- ----
Net income (loss), as reported $3,847 $ 672 ($2,447) ($2,045)
Add: Stock-based employee
compensation expense included
in reported loss, net of
related tax effects - 232 347 302
Deduct: Total stock-based
employee compensation expense
determined under fair value
based methods for all awards,
net of related tax effects (1,482) (1,610) (4,573) (4,015)
------ ------- -------- -------
Pro forma net income (loss) $2,365 ($706) ($6,673) ($5,758)
Net income (loss) per share,
basic and diluted:
As reported $0.15 $0.03 ($0.10) ($0.08)
Pro forma $0.09 ($0.03) ($0.27) ($0.23)
The pro forma disclosures provided may not be representative of the effects on
reported net income (loss) for future years due to future grants and the vesting
requirements of the Company's stock incentive plan. For purposes of pro forma
disclosures, the estimated fair value of stock-based compensation plans is
amortized over the vesting period.
4. RESTRUCTURE COSTS
On February 4, 2003, the Company announced a strategic reorganization to
integrate its technology and hospitality divisions into one operating unit. The
integration plan, which is complete, included the elimination of redundant
positions and consolidation of certain facilities. The elimination of redundant
positions represented approximately 10 percent of the Company's workforce,
primarily due to the integration of support functions.
For the three and nine months ended September 30, 2003, the Company recorded
restructure charges of $80,000 and $5.9 million, respectively. Restructure
costs are comprised of one-time termination benefits totaling $4.4 million and
facilities-related and other charges totaling $1.5 million. As of September 30,
2003, unpaid restructure costs of $1.2 million are included in other current and
noncurrent liabilities and are primarily facilities-related costs.
5. CONVERTIBLE DEBT
On July 21, 2003, the Company issued convertible senior notes totaling $75
million in principal through a private placement. The Company expects to use
the net proceeds from the offering for working capital and other general
corporate purposes.
These notes bear interest at an annual rate of 3.875 percent, payable
semi-annually, through the maturity date of July 15, 2023. Each note is
convertible into Pegasus' common stock at a conversion price of approximately
$20.13 per share (equal to an initial conversion rate of approximately 49.6808
shares per $1,000 principal amount of notes), subject to adjustment in certain
circumstances. Holders of the notes may convert their notes only if (i) the
price of Pegasus' common stock reaches specified thresholds; (ii) the notes have
been called for redemption; or (iii) specified corporate transactions occur.
The Company may redeem all or some of the notes for cash at any time on or after
July 15, 2008, at a redemption price equal to the principal amount of the notes
plus any accrued and unpaid interest at the redemption date. Holders may require
the Company to purchase the notes on July 16 of 2008, 2013 and 2018, or in other
specified circumstances, at a purchase price equal to the principal amount due
plus any accrued and unpaid interest at the purchase date and additional
amounts, if any.
7
Concurrent with the issuance of the notes, the Company terminated its $30
million revolving credit facility with Chase Bank of Texas, Compass Bank and
Wells Fargo Bank (Texas). Prior to termination, there were no amounts
outstanding under this credit facility.
The Company has two existing irrevocable standby letter of credit agreements
with JPMorgan Chase Bank totaling $2.1 million, securing the leases for the
Dallas and Scottsdale offices. In July 2003, the Company amended its letter of
credit agreements and funded $2.1 million as collateral for these letters of
credit.
6. RECENTLY ISSUED ACCOUNTING STANDARDS
In November 2002, the Emerging Issues Task Force ("EITF") reached a consensus on
Issue No. 00-21, "Revenue Arrangements with Multiple Deliverables." EITF Issue
No. 00-21 provides guidance on how to account for arrangements that involve the
delivery or performance of multiple products, services and/or rights to use
assets. The provisions of EITF Issue No. 00-21 will apply to revenue
arrangements entered into in fiscal periods beginning after June 15, 2003. The
adoption of EITF Issue No. 00-21 did not have any impact on the Company's
results of operations or financial condition.
Financial Accounting Standards Board ("FASB") Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"), was issued in January
2003. FIN 46 requires that if an entity is the primary beneficiary of a
variable interest entity, the assets, liabilities and results of operations of
the variable interest entity should be included in the consolidated financial
statements of the entity. The provisions of FIN 46 were effective for all
arrangements entered into after January 31, 2003. The Company has not invested
in any variable interest entities after January 31, 2003. As amended by FASB
Staff Position ("FSP") No. FIN 46-6, for arrangements entered into prior to
January 31, 2003, the provisions of FIN 46 are effective at the end of the first
interim or annual period ending after December 15, 2003.
As discussed in Note 4 to the Consolidated Financial Statements contained in the
Company's Annual Report on Form 10-K for the year ended December 31, 2002, the
Company sold its Summit Hotels and Resorts and Sterling Hotels & Resorts brand
business to Indecorp Corporation ("Indecorp") on January 10, 2001. The sale
agreement, as amended, provided for a $1.0 million and a $6.0 million promissory
note from Indecorp. The $1.0 million promissory note accrued interest at an
annual rate equal to prime plus 2 percent, and was repaid in August 2003. The
$6.0 million note requires monthly payments for a period of eight years
commencing July 1, 2002, and bears interest at an annual rate of 7 percent. The
Company also accepted a $2.8 million promissory note that replaced existing
outstanding trade receivables. The $2.8 million promissory note requires
monthly payments for a period of eight years commencing July 1, 2002 and bears
interest at an annual rate of 7 percent. During 2001, the Company recognized a
$4.8 million pre-tax gain on the sale of Summit and Sterling.
The Company has evaluated its relationship with Indecorp and has determined that
Indecorp is a variable interest entity under FIN 46. The Company has concluded
that it is the primary beneficiary of Indecorp as defined by FIN 46 and, as a
result, despite having no voting or operational control, the Company is required
to consolidate Indecorp.
As a result of the foregoing, the Company will account for Indecorp in
accordance with FIN 46 as if it had been consolidated since the sale of Summit
and Sterling on January 10, 2001. Accordingly, the Company will record a
cumulative-effect adjustment related to the adoption of FIN 46 in the fourth
quarter of 2003, which is anticipated to include the effects of the reversal of
the pre-tax gain of $4.8 million recognized on the initial sale. Additionally,
the Company will begin consolidating Indecorp's results of operations on January
1, 2004. Based solely on unaudited financial information provided to the
Company's management by Indecorp on a voluntary basis (which we have not, at
this point, taken any independent steps to verify), Indecorp's total assets,
liabilities, revenues, operating expenses, and net loss as of and for the
unaudited year ended June 30, 2003 on a stand-alone basis were $13.8 million,
$17.8 million, $24.3 million, $25.4 million, and $5.2 million, respectively.
Indecorp is actively pursuing options to obtain additional third-party capital
that may relieve the Company's requirement to consolidate its financial results.
However, there can be no assurance that such a transaction will occur. To the
extent that Indecorp is unsuccessful in obtaining a sufficient capital infusion,
and its shareholders' equity balance is less than zero, Indecorp's future losses
will be recognized by the Company. Any such losses recognized by the Company
would be equally offset to the extent that Indecorp has future income prior to
any allocations to minority interest holders.
8
In April 2003, the FASB issued Statement of Financial Accounting Standards No.
149, "Amendment of Statement 133 on Derivative Instruments and Hedging
Activities," ("FAS 149"). FAS 149 amends and clarifies financial accounting
and reporting for derivative instruments, including certain derivative
instruments embedded in other contracts (collectively referred to as
derivatives) and for hedging activities under FASB Statement No. 133, Accounting
for Derivative Instruments and Hedging Activities. This statement is effective
for contracts entered into or modified after June 30, 2003 and for hedging
relationships designated after June 30, 2003. The adoption of FAS 149 did not
have a significant impact on the Company's results of operations or financial
condition.
In May 2003, the FASB issued Statement of Financial Accounting Standards No.
150, "Accounting for Certain Financial Instruments with Characteristics of Both
Liabilities and Equity," ("FAS 150"). FAS 150 specifies that freestanding
financial instruments within its scope constitute obligations of the issuer and
that, therefore, the issuer must classify them as liabilities. Such
freestanding financial instruments include mandatorily redeemable financial
instruments, obligations to repurchase the issuer's equity shares by
transferring assets and certain obligations to issue a variable number of
shares. FAS 150 was effective immediately for all financial instruments entered
into or modified after May 31, 2003. For all other instruments, FAS 150 was
effective at the beginning of the third quarter of 2003. The Company adopted
FAS 150 effective July 1, 2003 with no material impact on its financial
condition or results of operations.
7. CONTINGENCIES
The Company is subject to certain legal proceedings, claims and disputes that
arise in the ordinary course of our business. Although management cannot predict
the outcomes of these legal proceedings, it does not believe these actions will
have a material adverse effect on the Company's financial position, results of
operations or liquidity.
8. OTHER EVENTS
In September 2003, the Company acquired all of the stock of Total Distribution
System Limited, a UK developer of tour operator software applications, for
approximately $1.7 million. The Company accounted for the acquisition as a
capital expenditure because the acquired company's primary asset was its
internally developed software.
On November 5, 2003, the Company announced that it had entered into a definitive
agreement to acquire the outstanding stock of Unirez, Inc., a hotel reservations
services company, for $38 million in cash, subject to certain post-closing
adjustments. The transaction is expected to generate approximately $10 million
in future tax deductions. Subject to the satisfaction or waiver of all closing
conditions, the Company expects to close the acquisition of Unirez in the fourth
quarter of 2003.
9
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Management's Discussion and Analysis of Financial Condition and Results of
Operations and the consolidated financial statements and notes thereto included
in our Annual Report on Form 10-K for the year ended December 31, 2002. This
discussion and analysis contains forward-looking statements including statements
using terminology such as "may," "will," "expects," "plans," "intends,"
"anticipates," "believes," "estimates," "potential," or "continue," or a similar
negative phrase or other comparable terminology regarding beliefs, hopes, plans,
expectations or intentions for the future. This discussion and analysis
contains forward-looking statements that involve various risks and
uncertainties. Our ability to predict results or the actual effect of future
plans or strategies is inherently uncertain and the actual results and timing of
certain events could differ materially from our current expectations. Factors
that could cause or contribute to such a difference include, but are not limited
to, changes in general economic conditions, variation in demand for our products
and services and in the timing of our sales, changes in product and price
competition for existing and new competitors, changes in our level or operating
expenditures, delays in developing, marketing and deploying new products and
services, terrorist activities, action by U.S. or other military forces, global
health epidemics, changes in hotel room rates, capacity adjustments by airlines,
negative trends in the overall demand for travel, other adverse changes in
general market conditions for business and leisure travel, the closing of the
acquisition of Unirez, Inc., as well as other risks and uncertainties described
in Pegasus' filings with the Securities and Exchange Commission, specifically
including those appearing under the caption Risk Factors in our 2002 Annual
Report on Form 10-K. We undertake no obligation to publicly update or revise any
forward-looking statements, whether as a result of new information, future
events or otherwise.
DEPENDENCE ON THE HOTEL INDUSTRY AND IMPACT OF THE ECONOMIC CLIMATE AND OTHER
WORLD EVENTS
Our business is sensitive to changes in the demand for and average daily rates
associated with hotel rooms. The weak economic climate and other world events,
such as continuing terrorist threat alerts, the war in Iraq and continuing
geopolitical uncertainty, have adversely impacted the travel industry and our
business. These events were preceded by the terrorist attacks of September 11,
2001, which resulted in sharp declines in both the number of hotel room
reservations and the average daily rate charged for hotel rooms. The overall
long-term impact of these events on Pegasus and the travel industry is
uncertain.
Subsequent to September 11, 2001, transatlantic business travel and average
daily rates have lagged behind the recovery in transaction volumes. Since our
electronic distribution and central reservation system, or CRS, revenues are
primarily transaction-based, revenues for these services, which had sharp
decreases immediately following September 11, 2001, recovered relatively quickly
and are close to the levels seen prior to September 11, 2001. However, the
recovery in transaction volumes stalled due to the weak economic environment,
continuing terrorist alerts and the war in Iraq. Further, since our hotel
representation and commission processing services are based in large part on a
combination of reservation volume and average daily rates, their recovery has
been somewhat slower. In addition, we have experienced a lengthening in the
sales cycle for some of our services, as new customers are hesitant to sign new
contracts given the uncertain economic environment.
The weak economic climate in the United States, the war in Iraq and ongoing
terrorist alerts have resulted in a decrease in the demand for hotel rooms and,
therefore, have negatively impacted our revenues. In addition, financial crises
in the airline industry and Severe Acute Respiratory Syndrome, or SARS, have
negatively impacted the hospitality industry in 2003. We do not expect hotel
reservation volume and average daily room rates to increase measurably until
corporate earnings start to show improvement and accordingly the general
corporate confidence drives business travel back to normal levels. Additional
terrorist activities, escalation of hostilities in the Middle East or elsewhere,
global health epidemics, or further delays in the economic recovery could have a
material adverse effect on our business, operating results and financial
condition.
10
OVERVIEW
Pegasus is a leading provider of hotel room reservation services, reservation
technology systems and hotel representation services for the global hospitality
industry. Our customers and distribution channels include:
- Tens of thousands of travel agency locations around the world, including
the 10 largest U.S.-based travel agencies based on revenues;
- More than 50,000 hotel properties around the globe, including the 50
largest hotel brands in the world based on total number of guest rooms;
and
- Thousands of Web sites that have their hotel reservations "Powered by
Pegasus" TM.
Previously, our services were organized into two business segments - technology
and hospitality. On February 4, 2003, we announced a strategic reorganization
to integrate our technology and hospitality segments into one operating unit.
As a result, we have integrated support functions, including sales and
marketing, product development, service delivery, reservation/data management,
information technology, finance and human resources functions. The integration
plan continues our existing strategy of better aligning our businesses with our
customers' needs, thus allowing for future revenue growth and the realization of
further synergies as one fully integrated company. This plan, which is
complete, includes the elimination of redundant positions and the consolidation
of some functions and facilities. During the nine months ended September 30,
2003, we recorded $5.9 million of restructure costs, including $4.7 million paid
in cash, which were primarily severance benefits for terminated employees.
SERVICES
Through our comprehensive and integrated service offerings we can provide one or
more of the following services to the global hospitality industry: CRS,
electronic distribution, hotel representation services, travel agent commission
processing, and property management systems, or PMS.
Reservation Services. We were formed in 1989 by 16 of the world's leading hotel
and travel-related companies to be the world's premier service provider of a
streamlined and automated hotel reservation process. Our UltraSwitch(R)
technology provides a seamless electronic connection between a hotel's CRS and
the global distribution systems, or GDSs, which travel agents use to book
airline reservations. This electronic distribution service supports a variety
of distribution channels including the following:
- GDS connectivity - Our electronic distribution service is linked to the
four major GDSs and therefore connects our hotel customers to travel
agents around the world.
- Third-party Internet sites - We provide travel-related Internet sites
access to our hotel information database containing more than 50,000
properties and on-line hotel reservation capability. We provide this
service to several of the leading travel Internet sites such as
Expedia.com, Orbitz.com, our affiliate Travelweb.com and our own
Utell.com.
- Hotel Internet sites - Our NetBookerTM service provides hotel companies
with a hotel information database and Internet-based reservation
capabilities. Hotel Internet sites that are "Powered by Pegasus" offer
brand-loyal Internet shoppers real-time rates, availability and booking
capabilities.
Our CRS is provided on an application service provider basis to approximately
8,000 hotel properties, representing approximately 1.4 million hotel rooms
worldwide. Pegasus also provides CRS software licenses to an additional 20
hotel brands, representing approximately 12,000 properties.
Our CRS service provides hotel customers with a license for our RezViewTM CRS
software as well as the hardware and facilities necessary to process
reservations. Our CRS service also includes the following support and
outsourcing services:
- System administration
- Database administration
11
- Electronic distribution channel management
- Telecommunications management
- Private-label voice reservation services
Hotel Representation Services. Hotel Representation Services, offered under the
Utell brand, include marketing programs, sales representation, a voice
reservation network in over 40 countries, and distribution through all GDSs and
a proprietary Internet booking site, www.Utell.com, with thousands of linked
third-party Internet sites. In order to sell their rooms in the marketplace,
many independent hotels and small hotel chains associate themselves with our
Utell brand, and use our systems and infrastructure to market and accept
reservations for their rooms. Hotels typically utilize our hotel representation
service for the following reasons:
- To achieve a cost-effective presence in the primary electronic
distribution channels - GDSs and the Internet.
- To obtain a global voice reservation capability through which travel
agents can book their rooms over the telephone via a local call with local
language capabilities.
- To enhance the market image of the hotel by affiliation with a well-known
name in hotel distribution.
- To benefit from worldwide sales and marketing support.
Utell is the oldest, largest and most diverse hotel representation service in
the world providing hotel sales, marketing, voice reservation and GDS and
Internet services for nearly 4,400 hotels in more than 140 countries. Utell
uses Pegasus' CRS, which offers advanced electronic distribution capabilities
and provides both a GDS and Internet presence for member hotels.
In addition, Utell has two financial service offerings, Paytell and TravelCom.
In some international markets, it is customary for travelers to prepay for hotel
rooms and other travel arrangements. Paytell is a service that allows travelers
to prepay for reservations, with Pegasus remitting amounts to hotels when the
guest stay occurs. TravelCom is an Internet-based proprietary system that
allows member hotels to expedite commission payments to travel agents.
Financial Services. Financial Services provides comprehensive commission
processing and payment solutions to hotels, other travel suppliers and travel
agencies in more than 200 countries. Key services include commission
processing, commission reconciliation and tracking for member agencies, global
commission solutions for participating hotels and PegsPay, our payment service
targeted at travel distributors that operate under the merchant model.
Each month, Pegasus consolidates, distributes, reconciles, tracks and reports
millions of dollars in commission payments to travel agency locations worldwide
on behalf of more than 35,000 participating hotel properties. Traditionally,
the process of reconciling and paying hotel commissions to travel agencies was
based on transaction-specific hotel data and consisted of a number of relatively
small payments to travel agencies, often including payments in multiple
currencies. Our value-added commission consolidation and reporting service
facilitates more efficient and effective operation for both hotel and travel
agency participants by providing a single, monthly commission payment to member
travel agencies from participating hotels in their choice of currency. Our
commission processing service processed over $350 million of hotel commissions
in the nine months ended September 30, 2003.
Property Systems and Services. PegasusCentralTM is our Internet-based PMS
service. Traditionally, hotel CRSs and PMSs had separate databases that
communicated only intermittently, often resulting in unbalanced inventories.
With PegasusCentral, when a hotel reservation is made from a central
reservations office, via the Internet, or at the property, only one database is
accessed. This centralized inventory stores all pertinent information for both
the central reservation and property management functions and provides
consistent, real-time access to rates, availability and other detailed property
information. PegasusCentral benefits both hotel chains and independent
properties by assisting in the management and operation of many hotel functions,
including:
- Enhanced property management
12
- Multi-property central reservation
- Customer relationship management
- Sales and catering
- Point-of-sale
- Back-office modules such as receivables, payables and purchasing
In 2002, Inter-Continental Hotel Group named PegasusCentral as one of two
preferred PMS standards for its 2,500-plus Holiday Inn and Holiday Inn Express
properties. Particularly in today's economic climate, these and other hotel
companies can realize the benefits of PegasusCentral through the following:
- Reduced capital equipment expenditures - Other PMS services typically
require significant capital expenditures. Because PegasusCentral is
Internet-based, hotel properties will incur only the cost of a computer
With Internet access to operate this system. Centrally hosted hardware
and data services are located at Pegasus' data center, providing secure
central storage for applications and data.
- Reduced employee training costs - PegasusCentral's Internet-based
technology is easy to use, offering convenient pull-down menus,
substantially reducing the customer's learning curve. In addition, users
can take advantage of interactive online training modules.
- Reduced IT staffing costs - PegasusCentral performs system upgrades from a
centralized facility resulting in instant product rollouts to all
locations. This reduces the need for on-site technical experts and
eliminates long rollout schedules and complex system upgrades.
- Available per-transaction pricing - With available per-transaction
pricing, hotels pay transaction fees only as their rooms are occupied,
better aligning technology costs with room revenues.
In addition to PegasusCentral, we obtained two proprietary software solutions as
part of the acquisitions of REZ, Inc., or REZ, in 2000, and Global Enterprise
Technology Solutions, LLC, or GETS, in 2001. Revenues for the first nine months
of 2003 consisted of maintenance and support fees related to these PMS software
solutions, as well as revenues from our PegasusCentral service.
REVENUES
The classification of service revenues and customer reimbursements has been
reflected in the financial statements to conform with current-year presentation
and to give effect to the 2002 adoption of the Emerging Issues Task Force, or
EITF, Issue 01-14. Under EITF 01-14, Pegasus' billings for out-of-pocket
expenses, such as third-party vendor GDS and telecommunication charges, are
classified as customer reimbursements, which is a component of total revenues,
and the related costs are classified as customer reimbursements, which is a
component of total costs of services. The adoption of EITF 01-14 had no effect
on our financial position, operating loss, cash flows or per-share results.
Revenues applicable to customer reimbursements are primarily related to GDS fees
that we pay on behalf of and subsequently bill our customers. In the future, if
our customers decide to pay their bills directly, our customer reimbursements
revenue and customer reimbursements cost of services will decrease accordingly.
Reservation Services. Reservation Services revenues consist of CRS and
electronic distribution revenues. CRS revenues consist of transaction fees as
well as license, maintenance and support fees related to our RezView software.
Electronic distribution revenues primarily consist of transaction fees,
commissions and monthly subscription or maintenance fees. In addition, new
hotel customers typically pay a one-time fee for establishing the connection
between the hotel's central reservation system and the electronic distribution
technology. New third-party Internet site customers typically pay a one-time
fee for establishing the connection between the third-party Internet site and
our electronic distribution technology, which is amortized over the related
contract period. Reservation Services revenues represented approximately 42
percent of service revenues for the nine months ending September 30, 2003.
13
Hotel Representation Services. Hotel Representation Services revenues consist
of reservation processing fees, membership fees and fees for various marketing
services. In addition, the Paytell service allows international travelers, who
book rooms at hotels for which we provide representation services, to prepay for
their hotel rooms in the hotel's local currency. When a traveler arrives at the
hotel, Pegasus remits the amount to the hotel in the hotel's local currency.
Revenues for this service are derived from transaction fees and the difference
in the exchange rate between the date the traveler pays and the date the guest
stay occurs. Hotel Representation Services revenues represented approximately
35 percent of service revenues for the nine months ending September 30, 2003.
Financial Services. Financial Services revenues consist of both travel agency
and hotel fees. Travel agency fees are based on a percentage of the value of
hotel commissions processed by Pegasus on behalf of participating travel
agencies. Revenues from travel agency fees can vary substantially from period
to period based on the demand for hotel rooms, the types of hotels (such as
upscale or economy) at which reservations are made and fluctuations in overall
room rates. In addition, participating hotels generally pay fees based on the
number of commissionable transactions that Pegasus processes for the hotel.
Financial Services revenues represented approximately 19 percent of service
revenues for the nine months ending September 30, 2003.
Property Systems and Services. Property Systems and Services revenues primarily
consist of maintenance and support fees related to the REZ and GETS
acquisitions. In addition, Property Systems and Services revenues include fees
from our PegasusCentral product, which are recognized monthly. Property Systems
and Services represented approximately 4 percent of service revenues for the
nine months ending September 30, 2003.
Other Services. Pegasus regularly seeks to develop 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 travel distribution process.
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.
COSTS
Pegasus' costs of services consist principally of personnel costs relating to
information technology, customer service and telemarketing, facilities and
equipment maintenance costs. Costs of services also include the cost of
customer reimbursements. 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, legal and
accounting-related, and certain facilities costs. Marketing and promotion
expenses consist primarily of personnel costs, advertising, 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 intangible assets. Net interest income (expense), primarily
includes interest expense and amortization of capitalized issuance costs related
to the $75 million convertible debt offering. These costs are offset by
interest income earned on the Company's investments.
FLUCTUATION OF FOREIGN CURRENCIES
Pegasus derives a significant portion of its revenue from customers located
outside the United States. Particularly in Europe, fluctuations of foreign
currencies such as the Euro and the British Pound relative to the U.S. Dollar
result in Pegasus earning more or less revenue and expending more or less in
expenses than it otherwise might have earned if currency rates had remained
stable.
RESULTS OF OPERATIONS
Pegasus' service revenues are predominantly transaction-based. In addition to
these service revenues, Pegasus bills some customers for certain reimbursable
expenses, primarily GDS fees for those customers who do not pay these fees
directly. The classification of service revenues and customer reimbursements
has been adjusted to conform with the current-year presentation and to give
effect to the 2002 adoption of EITF 01-14.
14
THREE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
Revenues. As reflected in the table below, total revenues for the three months
ended September 30, 2003 and 2002 were $45.8 million and $49.2 million,
respectively. Total service revenues decreased $3.7 million, or 8 percent to
$42.9 million for the three months ended September 30, 2003, compared to $46.6
million for the same period in 2002. Overall, year-over-year revenue
comparisons are impacted by the economic climate in the United States and
internationally, with reductions in business travel. These factors were
partially offset by the positive impact of foreign currency fluctuations.
Other changes in the business are described in the paragraphs that follow the
presentation of revenues below (In thousands):
Three months ended
September 30,
--------------------
2003 2002
---- ----
Reservation Services $18,365 $19,717
Hotel Representation Services 14,716 16,893
Financial Services 8,159 8,198
Property Systems & Services 1,628 1,806
Total service revenues 42,868 46,614
------ ------
Customer reimbursements 2,892 2,556
Total revenues $45,760 $49,170
------- -------
Reservation Services revenues decreased $1.4 million, or 7 percent, to $18.4
million for the three months ended September 30, 2003, compared to $19.7 million
for the same period in 2002. The decrease was primarily due to the termination
of a customer contract that provided $2.2 million of revenue for the three
months ended September 30, 2002 as well as a decrease in ongoing CRS customer
revenue of $587,000, due to pricing pressure. These decreases were offset by a
$1.4 million increase in electronic distribution revenues, primarily due to a 41
percent increase in Internet transactions. The increase in Internet
transactions was primarily driven by leisure travelers taking advantage of low
rates during the peak leisure travel months.
Hotel Representation Services revenues decreased by $2.2 million, or 13 percent,
to $14.7 million for the three months ended September 30, 2003, compared to
$16.9 million for the same period in 2002. The decrease was primarily due to a
decline in transatlantic bookings for Utell hotels, caused primarily by the
global economic climate and other world events, as well as an 11 percent
decrease in the number of hotels Utell represents, as a result of pricing
pressure from lower cost distribution channels. These items were partially
offset by the favorable impact of foreign currency fluctuations.
Financial Services revenues for the three months ended September 30, 2003 and
2002 were $8.2 million. Current-year revenues reflect an increase in electronic
reconciliation and tracking services of $480,000 and an increase in fees for our
PegsPay service of $180,000. These increases were offset by a 3 percent
decrease in gross commissions, resulting from a decrease in average daily rates
charged by hotels.
Property Systems and Services revenues decreased $180,000, or 10 percent, to
$1.6 million for the three months ended September 30, 2003 compared to $1.8
million for the same period in 2002. The decreased revenue was primarily due to
a customer incentive granted in the three months ended September 30, 2003,
related to a vendor's service outage. In addition, the Company's rollout of
PegasusCentral was delayed by stability issues.
Customer reimbursements increased approximately $340,000 to $2.9 million for the
three months ended September 30, 2003, compared to $2.6 million in the same
period in 2002 due to an increase in our customers' GDS transaction volume.
15
Cost of services. Cost of services, excluding customer reimbursements, was $21.1
million for the three months ended September 30, 2003, compared to $21.8 million
for the same period in 2002. The decrease was primarily due to lower payroll
expenses due to the Company's 2003 restructuring and lower variable costs, due
to a decline in transactions. Cost of services as a percentage of service
revenues was 49 percent and 47 percent for the three months ended September 30,
2003 and 2002, respectively.
Research and development. Research and development expenses were $949,000 for
the three months ended September 30, 2003, compared to $1.2 million in the same
period in 2002. The decrease was primarily due to an increase in the
capitalization of payroll costs associated with an increase in the number of
projects that are eligible for capitalization. Research and development
expenses as a percentage of service revenues were 2 percent and 3 percent for
the three months ended September 30, 2003 and 2002, respectively.
General and administrative expenses. General and administrative expenses were
$5.5 million for the three months ended September 30, 2003, compared to $6.1
million for the same period in 2002. The decrease was primarily due to lower
payroll expenses due to the Company's 2003 restructuring and cost-saving
measures initiated in 2003, as well as reductions in discretionary spending in
light of the challenging operating environment. General and administrative
expenses as a percentage of service revenues were 13 percent for the three
months ended September 30, 2003 and 2002.
Marketing and promotion expenses. Marketing and promotion expenses were $3.5
million for the three months ended September 30, 2003, compared to $4.3 million
for the same period in 2002. The decrease was primarily due to lower payroll
expenses, due to the Company's 2003 restructuring, as well as an increased focus
on reducing discretionary spending in light of the challenging operating
environment. Marketing and promotion expenses as a percentage of service
revenues were 8 percent and 9 percent for the three months ended September 30,
2003 and 2002, respectively.
Depreciation and amortization. Depreciation and amortization expenses were $5.2
million for the three months ended September 30, 2003, compared to $12.1 million
for the same period in 2002. The decrease is primarily due to a $7.0 million
impact as a result of the completion of amortization of certain intangible
assets in March 2003.
Restructure costs. During the three months ended September 30, 2003, Pegasus
incurred $80,000 of restructuring charges related to the reorganization of its
operations from a business unit structure into distinct functional areas.
Interest income (expense), net. Net interest expense of $254,000 for the
three months ended September 30, 2003 was the result of interest expense and
amortization of capitalized debt issuance costs related to the $75 million
convertible debt offering. These costs were offset by interest income on the
Company's investments, which resulted in net interest income for the three
months ended September 30, 2002.
Income tax expense. Pegasus recorded income tax expense of $2.6 million and
$694,000 for the three months ended September 30, 2003 and 2002, respectively,
reflecting effective rates of 40 percent and 51 percent, respectively. These
rates differed from the statutory rate of 35 percent, primarily due to
nondeductible expenses, offset by the benefit of lower foreign tax rates.
NINE MONTHS ENDED SEPTEMBER 30, 2003 AND 2002
Revenues. As reflected in the table below, total revenues for the nine months
ended September 30, 2003 and 2002 were $129.6 million and $146.5 million,
respectively. Total service revenues decreased $16.7 million, or 12 percent to
$121.4 million for the nine months ended September 30, 2003, compared to $138.1
million for the same period in 2002. Excluding a $3.5 million termination fee
received from a customer following the termination of its contract in March
2002, service revenues decreased $13.2 million. Overall, year-over-year revenue
comparisons are impacted by the economic climate in the United States and
internationally, the war in Iraq, foreign currency fluctuations, and financial
crises in the airline industry, as well as the effect the September 11, 2001
events had on the nine months ended September 30, 2002.
16
Other changes in the business are described in the paragraphs that follow the
presentation of revenues below (In thousands):
Nine months ended
June 30,
---------------------
2003 2002
---- ----
Reservation Services $51,729 $61,319
Hotel Representation Services 42,067 49,176
Financial Services 22,757 22,594
Property Systems & Services 4,809 5,016
Total service revenues 121,362 138,105
------- -------
Customer reimbursements 8,242 8,401
Total revenues $129,604 $146,506
-------- --------
Total service revenues from
continuing operations,
excluding revenues for customer
reimbursements $121,362 $134,571 (1)
-------- --------
(1) Excludes a $3.5 million termination fee included in Reservation Services in
March 2002.
Reservation Services revenues decreased $9.6 million, or 16 percent, to $51.7
million for the nine months ended September 30, 2003, compared to $61.3 million
for the same period in 2002. Excluding the impact of the $3.5 million
termination fee noted above, reservation services revenues decreased $6.1
million, or 10 percent. The decrease was primarily due to the termination of
two customer contracts that provided $8.7 million of revenue in the nine months
ended September 30, 2002, as well as a decrease in ongoing CRS customer revenue
of $1.3 million due to pricing pressure. These decreases were partially offset
by a $3.9 million increase in electronic distribution revenues, primarily due to
a 35 percent increase in Internet transactions.
Hotel Representation Services revenues decreased by $7.1 million, or 14 percent,
to $42.1 million for the nine months ended September 30, 2003, compared to $49.2
million for the same period in 2002. The decrease was primarily due to a
decline in domestic and transatlantic bookings for Utell hotels, caused
primarily by the global economic climate and other world events, as well as an
11 percent decrease in the number of hotels Utell represents as a result of
pricing pressure from lower cost distribution channels. These items were
partially offset by the favorable impact of foreign currency fluctuations.
Financial Services revenues increased approximately $160,000 to $22.8 million
for the nine months ended September 30, 2003, compared to $22.6 million for the
same period in 2002. The increased revenue was primarily attributable to an
increase in electronic reconciliation and tracking services of approximately
$1.5 million and an increase in fees for our PegsPay service of $380,000. These
increases were offset by a 6 percent decrease in gross commissions, resulting
from a decrease in transaction volume and the reduction in average daily rates
charged by hotels.
Property Systems and Services revenues decreased $200,000 or 4 percent to $4.8
million for the nine months ended September 30, 2003, compared to $5.0 million
for the same period in 2002. The decrease was primarily due to a customer
incentive granted in the three months ending September 30, 2003, related to a
vendor's service outage. In addition, the Company's rollout of PegasusCentral
was delayed by stability issues.
Customer reimbursements decreased to $8.2 million in the nine months ended
September 30, 2003, compared to $8.4 million in the same period in 2002 due to a
decrease in our customers' GDS transaction volume.
17
Cost of services. Cost of services, excluding customer reimbursements, was $64.3
million for the nine months ended September 30, 2003, compared to $68.8 million
for the same period in 2002. The decrease was primarily due to lower payroll
expenses due to the Company's 2003 restructuring and lower variable costs, due
to a decline in transactions. Additionally, the Company experienced a $1.3
million reduction in bad debt expense due to an overall improvement in the
collectibility of the Company's accounts receivable as compared to the prior
year, and a decline in consulting services of $760,000 for items that were
incurred in 2002 but not in 2003. These decreases were offset by non-recurring
costs of $1.4 million incurred in 2003 for the Company's move of the Arizona
office and data center and transition activities resulting from the Company's
strategic integration. Cost of services as a percentage of service revenues was
53 percent and 50 percent for the nine months ended September 30, 2003 and 2002,
respectively.
Research and development. Research and development expenses were $3.5 million
for the nine months ended September 30, 2003, compared to $4.5 million in the
same period in 2002. The decrease was primarily due to an increase in the
capitalization of payroll costs associated with an increase in the number of
projects that are eligible for capitalization. Research and development
expenses as a percentage of service revenues were 3 percent for the nine months
ended September 30, 2003 and 2002.
General and administrative expenses. General and administrative expenses were
$17.9 million for the nine months ended September 30, 2003, compared to $18.7
million for the same period in 2002. The decrease was primarily due to lower
payroll and operating expenses, due to the Company's 2003 restructuring, as well
as reductions in discretionary spending in light of the challenging operating
environment. These decreases were offset by higher employee-related and
insurance costs in 2003. General and administrative expenses as a percentage of
service revenues were 15 percent and 14 percent for the nine months ended
September 30, 2003 and 2002, respectively.
Marketing and promotion expenses. Marketing and promotion expenses were $11.9
million for the nine months ended September 30, 2003, compared to $13.4 million
for the same period in 2002. The decrease was primarily due to lower payroll
expenses, due to the Company's 2003 restructuring as well as an increased focus
of reducing discretionary spending in light of the challenging operating
environment. Marketing and promotion expenses as a percentage of service
revenues were 10 percent for the nine months ended September 30, 2003 and 2002.
Depreciation and amortization. Depreciation and amortization expenses were
$22.5 million for the nine months ended September 30, 2003, compared to $36.5
million for the same period in 2002. The decrease is primarily due to a $14.1
million impact as a result of the completion of amortization for certain
purchased intangible assets in March 2003.
Restructure costs. During the nine months ended September 30, 2003, Pegasus
incurred $5.9 million of restructuring charges, consisting of termination
benefits and facilities-related costs related to reorganizing its operations
from a business unit structure into distinct functional areas.
Income tax benefit. Pegasus recorded income tax benefit of $1.7 million and
$1.1 million for the nine months ended September 30, 2003 and 2002 respectively,
reflecting effective tax rates of 41 percent and 35 percent, respectively. The
effective tax rate for the nine months ended June 30, 2003 differed from the
statutory rate of 35 percent, primarily due to the benefit of lower foreign tax
rates, offset by nondeductible expenses.
LIQUIDITY AND CAPITAL RESOURCES
Pegasus' principal sources of liquidity at September 30, 2003 included cash and
cash equivalents of $89.5 million and short-term investments of $5.1 million.
Concurrent with the issuance of the convertible senior notes discussed below,
Pegasus terminated its $30.0 million revolving credit facility. Prior to
termination, there were no amounts outstanding under this credit facility.
Pegasus has two existing irrevocable standby letter of credit agreements with
JPMorgan Chase Bank totaling $2.1 million collateralizing the leases for the
Dallas and Scottsdale offices. In July 2003, the Company amended its letter of
credit agreements and funded $2.1 million as collateral for these letters of
credit.
18
On July 21, 2003, Pegasus issued convertible senior notes totaling $75 million
in principal through a private placement. Pegasus expects to use the net
proceeds from the offering for working capital and other general corporate
purposes.
These notes bear interest at an annual rate of 3.875 percent, payable
semi-annually through the maturity date of July 15, 2023. Each note is
convertible into Pegasus' common stock at a conversion price of approximately
$20.13 per share (equal to an initial conversion rate of approximately 49.6808
shares per $1,000 principal amount of notes), subject to adjustment in certain
circumstances. Holders of the notes may convert their notes only if (i) the
price of Pegasus' common stock reaches specified thresholds; (ii) the notes have
been called for redemption; or (iii) specified corporate transactions occur.
Pegasus may redeem all or some of the notes for cash at any time on or after
July 15, 2008, at a redemption price equal to the principal amount of the notes
plus any accrued and unpaid interest to the redemption date. As noted above,
holders may require Pegasus to purchase the notes on July 16 of 2008, 2013 and
2018, or in other specified circumstances, at a purchase price equal to the
principal amount due plus any accrued and unpaid interest to the purchase date
and additional amounts, if any.
Pegasus had working capital of $89.6 million at September 30, 2003, compared to
a working capital of $17.0 million at December 31, 2002. Net cash provided by
operating activities decreased to $17.9 million for the nine months ending
September 30, 2003, from $31.6 million for the same period in 2002, primarily
due to a reduction in service revenues and the impact of restructure costs
incurred in 2003.
Net cash used in investing activities increased to $22.4 million for the nine
months ended September 30, 2003, compared to $19.6 million for the same period
in 2002. This increase was primarily the result of a decrease in proceeds from
maturities of marketable securities, offset by a decrease in purchases of
property and equipment associated with the finalization of our Dallas office
relocation in 2002.
Pegasus expects to continue to incur capital expenditures related to adding
capacity to existing systems and software development, which it estimates will
total from $20 million to $23 million for 2003. Operating leases continue to be
the only off-balance sheet financing arrangements in which Pegasus engages.
On November 5, 2003 the Company announced that it had entered into a definitive
agreement to acquire the outstanding stock of Unirez, Inc., a hotel reservations
services company, for $38 million in cash, subject to certain post-closing
adjustments. The transaction is expected to generate approximately $10 million
in future tax deductions. Subject to the satisfaction or waiver of all closing
conditions, the Company expects to close the acquisition of Unirez in the fourth
quarter of 2003.
On November 5, 2003, the Board of Directors renewed its authorization for the
repurchase of up to 2.5 million shares of Pegasus' common stock. No shares were
repurchased during the nine months ended September 30, 2003, nor were there any
shares repurchased through the date of this filing. Any future repurchases are
at the discretion of the Board of Directors' Stock Repurchase Committee and may
be made on the open market, in privately negotiated transactions or otherwise,
depending on market conditions, price, share availability and other factors.
Our future liquidity and capital requirements will depend on numerous factors,
including:
- - Our profitability
- - Operational cash requirements, including payments for severance and
redundant facilities related to our restructuring
- - Competitive pressures
- - Development of new services and applications
- - Acquisition of and investment in complementary businesses or technologies
- - Common stock repurchases
- - Response to unanticipated cash requirements
19
We believe that the Company's financial condition is strong and that its cash
and cash flows from operations will be sufficient to meet its foreseeable
operating and capital requirements through at least the next twelve months.
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.
OTHER MATTERS
Financial Accounting Standards Board ("FASB") Interpretation No. 46,
"Consolidation of Variable Interest Entities" ("FIN 46"), was issued in January
2003. FIN 46 requires that if an entity is the primary beneficiary of a
variable interest entity, the assets, liabilities and results of operations of
the variable interest entity should be included in the consolidated financial
statements of the entity. The provisions of FIN 46 were effective for all
arrangements entered into after January 31, 2003. The Company has not invested
in any variable interest entities after January 31, 2003. As amended by FASB
Staff Position ("FSP") No. FIN 46-6, for arrangements entered into prior to
January 31, 2003, the provisions of FIN 46 are effective at the end of the first
interim or annual period ending after December 15, 2003.
As discussed in Note 4 to the Consolidated Financial Statements contained in the
Pegasus' Annual Report on Form 10-K for the year ended December 31, 2002,
Pegasus sold its Summit Hotels and Resorts and Sterling Hotels & Resorts brand
business to Indecorp Corporation on January 10, 2001. The sale agreement, as
amended, provided for a $1.0 million and a $6.0 million promissory note from
Indecorp. The $1.0 million promissory note accrued interest at an annual rate
equal to prime plus 2 percent, and was repaid in August 2003. The $6.0 million
note requires monthly payments for a period of eight years commencing July 1,
2002, and bears interest at an annual rate of 7 percent. Pegasus also accepted
a $2.8 million promissory note that replaced existing outstanding trade
receivables. The $2.8 million promissory note requires monthly payments for a
period of eight years commencing July 1, 2002 and bears interest at an annual
rate of 7 percent. During 2001, Pegasus recognized a $4.8 million pre-tax gain
on the sale of Summit and Sterling.
The Company has evaluated its relationship with Indecorp and has determined that
Indecorp is a variable interest entity under FIN 46. The Company has concluded
that it is the primary beneficiary of Indecorp as defined by FIN 46 and, as a
result, despite having no voting or operational control, the Company is required
to consolidate Indecorp.
As a result of the foregoing, Pegasus will account for Indecorp in accordance
with FIN 46 as if it had been consolidated since the sale of Summit and Sterling
on January 10, 2001. Accordingly, Pegasus will record a cumulative-effect
adjustment related to the adoption of FIN 46 in the fourth quarter of 2003,
which is anticipated to include the effects of the reversal of the pre-tax gain
of $4.8 million recognized on the initial sale. Additionally, Pegasus will
begin consolidating Indecorp's results of operations on January 1, 2004. Based
solely on unaudited financial information provided to Pegasus' management by
Indecorp on a voluntary basis (which we have not taken any independent steps to
verify), Indecorp's total assets, liabilities, revenues, operating expenses, and
net loss as of and for the unaudited year ended June 30, 2003 on a stand-alone
basis were $13.8 million, $17.8 million, $24.3 million, $25.4 million, and $5.2
million, respectively. Indecorp is actively pursuing options to obtain
additional third-party capital that may negate the Company's requirement to
consolidate its financial results. However, there can be no assurance that such
a transaction will occur. To the extent that Indecorp is unsuccessful in
obtaining a sufficient capital infusion, and its shareholders' equity balance is
less than zero, Indecorp's future losses will be recognized by Pegasus. Any
such losses recognized by Pegasus would be equally offset to the extent that
Indecorp has future income prior to any allocations to minority interest
holders.
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures designed to ensure that
it is able to collect the information it is required to disclose in the reports
it files with the Securities and Exchange Commission, or SEC, and to process,
summarize and disclose this information within the time periods specified in the
rules of the SEC. As of the end of the period covered by this report, Pegasus
carried out an evaluation, under the supervision and with the participation of
Pegasus' management, including its Chief Executive Officer and Chief Financial
Officer, of the effectiveness of Pegasus' disclosure controls and procedures.
Based upon that evaluation, Pegasus' Chief Executive Officer and Chief Financial
Officer concluded that Pegasus' disclosure controls and procedures, as defined
in Rules 13(a) -15(e) and 15(d)-15(e) under the Securities Exchange Act of 1934,
are effective in timely alerting them to material information required to be
included in Pegasus' periodic SEC reports.
20
In designing and evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives, and management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures.
The Company maintains a system of internal controls designed to provide
reasonable assurance that transactions are executed in accordance with
management's general or specific authorization and that transactions are
recorded as necessary:
- to permit preparation of financial statements in conformity with generally
accepted accounting principles, and
- to maintain accountability for assets.
Since the date of the most recent evaluation of the Company's internal controls
by the Chief Executive Officer and Chief Financial Officer, there have been no
significant changes in such controls or in other factors that could have
significantly affected those controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Pegasus is subject to certain legal proceedings, claims and disputes that arise
in the ordinary course of business. Although management cannot predict the
outcomes of these legal proceedings, we do not believe these actions will have a
material adverse effect on our financial position, results of operations or
liquidity.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
a) Exhibits
Exhibit 31.1 - Certification of Chief Executive Officer, Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
Exhibit 31.2 - Certification of Chief Financial Officer, Pursuant to Section 302
of the Sarbanes-Oxley Act of 2002.
Exhibit 32.1 - Certification of Chief Executive Officer, Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
Exhibit 32.2 - Certification of Chief Financial Officer, Pursuant to 18 U.S.C.
Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
b) Reports on Form 8-K filed
On October 28, 2003 Pegasus Solutions, Inc. filed a report on Form 8-K which
furnished information under Item 12 - Results of Operation and Financial
Condition for its press release announcing its financial results for the third
quarter ended September 30, 2003.
21
On November 5, 2003 Pegasus Solutions, Inc. filed a report on Form 8-K under
Item 5 - Other Events, and furnished information under Item 9 - Regulation FD
Disclosure, for its announcement of a definitive agreement to acquire the
outstanding stock of Unirez, Inc., for $38 million in cash, subject to certain
closing conditions and post-closing adjustments.
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PEGASUS SOLUTIONS, INC.
November 14, 2003 /s/ JOHN F. DAVIS, III
----------------------------------
John F. Davis, III,
Chairman, Chief
Executive Officer and President
November 14, 2003 /s/ SUSAN K. COLE
--------------------------------
Susan K. Cole,
Executive Vice President
and Chief Financial Officer
(Principal Accounting Officer)
22
EXHIBIT INDEX
Exhibit Number Description
- --------------- -----------
31.1 Certification of Chief Executive Officer, Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
31.2 Certification of Chief Financial Officer, Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
32.1 Certification of Chief Executive Officer, Pursuant to
18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer, Pursuant to
18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.
Exhibit 31.1
CERTIFICATION PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, John F. Davis, III, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Pegasus Solutions,
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make the
statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows
of the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant
and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known
to us by others within those entities, particularly during the period
in which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the
end of the period covered by this report based on such evaluation;
and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which are
reasonably likely to adversely affect the registrant's ability to
record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: November 14, 2003
/s/ JOHN F. DAVIS, III
- -------------------------------------------
John F. Davis, III
Chairman, Chief Executive Officer and President
Exhibit 31.2
CERTIFICATION PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, Susan K. Cole, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Pegasus Solutions,
Inc.;
2. Based on my knowledge, this report does not contain any untrue statement
of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered
by this report;
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in all material
respects the financial condition, results of operations and cash flows of
the registrant as of, and for, the periods presented in this report;
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the
registrant and have:
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
supervision, to ensure that material information relating to the
registrant, including its consolidated subsidiaries, is made known to
us by others within those entities, particularly during the period
in which this report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures and presented in this report our conclusions about the
effectiveness of the disclosure controls and procedures, as of the
end of the period covered by this report based on such evaluation;
and
c) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has materially
affected, or is reasonably likely to materially affect, the
registrant's internal control over financial reporting; and
5. The registrant's other certifying officer(s) and I have disclosed, based
on our most recent evaluation of internal control over financial
reporting, to the registrant's auditors and the audit committee of the
registrant's board of directors (or persons performing the equivalent
functions):
a) All significant deficiencies and material weaknesses in the design
or operation of internal control over financial reporting which
are reasonably likely to adversely affect the registrant's ability
to record, process, summarize and report financial information; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal control over financial reporting.
Date: November 14, 2003
/s/ SUSAN K. COLE
- -------------------------------------
Susan K. Cole
Executive Vice President and Chief Financial Officer
Exhibit 32.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Pegasus Solutions, Inc. (the
"Company") on Form 10-Q for the period ending September 30, 2003 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
John F. Davis, III, Chief Executive Officer of the Company, certify, pursuant to
18 U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley
Act of 2002, that:
1. The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d));
and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the
Company.
November 14, 2003 /s/ JOHN F. DAVIS, III
----------------------------------
John F. Davis, III,
Chairman, Chief
Executive Officer and President
Exhibit 32.2
CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Pegasus Solutions, Inc. (the
"Company") on Form 10-Q for the period ending September 30, 2003 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), I,
Susan K. Cole, Chief Financial Officer of the Company, certify, pursuant to 18
U.S.C. section 1350, as adopted pursuant to section 906 of the Sarbanes-Oxley
Act of 2002, that:
1. The Report fully complies with the requirements of section 13(a) or 15(d)
of the Securities Exchange Act of 1934 (15 U.S.C. 78m or 78o(d)); and
2. The information contained in the Report fairly presents, in all material
respects, the financial condition and results of operations of the Company.
November 14, 2003 /s/ SUSAN K. COLE
--------------------------------
Susan K. Cole,
Executive Vice President
and Chief Financial Officer
(Principal Accounting Officer)