<PAGE> 1
Filed Pursuant to Rule 424(b)(4)
Registration Number 333-28595
PROSPECTUS
3,573,044 SHARES
[PEGASUS SYSTEMS, INC. LOGO]
PEGASUS SYSTEMS, INC.
COMMON STOCK
Of the 3,573,044 shares of Common Stock offered hereby, 3,000,000 shares
are being sold by the Company and 573,044 shares are being sold by the Selling
Stockholders. The Company will not receive any of the proceeds from the sale of
shares by the Selling Stockholders. See "Principal and Selling Stockholders."
Prior to this offering, there has been no public market for the Common
Stock of the Company. See "Underwriting" for a discussion of the factors to be
considered in determining the initial public offering price. The Common Stock
has been approved for quotation on the Nasdaq National Market under the symbol
PEGS.
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THE SHARES OFFERED HEREBY INVOLVE A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" COMMENCING ON PAGE 7.
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THESE SECURITIES HAVE NOT BEEN APPROVED OR DISAPPROVED BY THE SECURITIES AND
EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION NOR HAS
THE SECURITIES AND EXCHANGE COMMISSION OR ANY STATE SECURITIES COMMISSION PASSED
UPON THE ACCURACY OR ADEQUACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE
CONTRARY IS A CRIMINAL OFFENSE.
<TABLE>
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====================================================================================================================
PRICE TO UNDERWRITING PROCEEDS TO PROCEEDS TO SELLING
PUBLIC DISCOUNT(1) COMPANY(2) STOCKHOLDERS
- --------------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C>
Per Share.............. $13.00 $0.91 $12.09 $12.09
- ------------------------------------------------------------------------------------------------------------------
Total(3)............... $46,449,572 $3,251,470 $36,270,000 $6,928,102
==================================================================================================================
</TABLE>
(1) See "Underwriting" for indemnification arrangements with the several
Underwriters.
(2) Before deducting expenses payable by the Company estimated at $750,000.
(3) The Company and a Selling Stockholder have granted to the Underwriters a
30-day option to purchase up to 535,956 additional shares of Common Stock
solely to cover over-allotments, if any. If all such shares are purchased,
the total Price to Public, Underwriting Discount, Proceeds to Company and
Proceeds to Selling Stockholders will be $53,417,000, $3,739,190,
$41,710,500 and $7,967,310, respectively. See "Underwriting."
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The shares of Common Stock are offered by the several Underwriters subject
to prior sale, receipt and acceptance by them and subject to the right of the
Underwriters to reject any order in whole or in part and certain other
conditions. It is expected that certificates for such shares will be made
available for delivery on or about August 12, 1997, at the office of the agent
of Hambrecht & Quist LLC in New York, New York.
HAMBRECHT & QUIST
MONTGOMERY SECURITIES
VOLPE BROWN WHELAN & COMPANY
August 6, 1997
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DESCRIPTION OF INSIDE FRONT COVER WITH FOLD-OUT
Caption reading:
Leading worldwide provider of hotel reservation and commission processing
services.
Pegasus Systems, Inc. logo with caption reading:
Through its services and systems - THISCO, TravelWeb, Netbooker, UltraRes,
UltraDirect and HCC - Pegasus Systems provides the technology that
facilitates the electronic booking of hotel rooms worldwide. Regardless
of whether the reservation comes from a travel agent, a meeting planner or
conventions and visitors bureau, a corporate travel department, or directly
from an individual traveler via the Internet, Pegasus Systems' services can
facilitate the transaction.
Pictures and logos depicting the following transaction flows:
1. Consumer to Travel Agent to Global Distribution System ("GDS") to
UltraSwitch-THISCO to Hotel.
2. Consumer to GDS Internet Travel Sites to GDS to UltraSwitch-THISCO to
Hotel.
3. Consumer to TravelWeb to UltraSwitch-THISCO to Hotel.
4. Consumer to Partner Web Sites to Pegasus Systems NetBooker to
UltraSwitch-THISCO to Hotel.
5. Consumer to Corporate Travel to Pegasus Systems-UltraDirect to
UltraSwitch-THISCO to Hotel.
6. Consumer to Conventions, Meetings, Housing to Pegasus Systems-UltraRes
to UltraSwitch-THISCO to Hotel.
7. Hotel to HCC-Hotel Clearing Corporation to Travel Agent.
THISCO logo with caption reading:
THISCO's service is a gateway to more than 25,000 hotels around the world.
When a reservation is made via any of the distribution vehicles shown
above, THISCO translates the reservation request into the hotel's unique
computer format and queries the hotel's database. A confirmed reservation
is then transmitted back through THISCO's service and sent to the traveler
via the distribution channel. This entire process occurs in a matter of
seconds.
TravelWeb logo with caption reading:
TravelWeb is a leading Internet travel booking service that has quickly
established its niche as one of the largest interactive sites in which
consumers can freely research and reserve hotel rooms around the world.
Connecting to approximately 13,000 hotels via the THISCO service, TravelWeb
enables travelers to directly access hotel central reservation systems to
check room rates, features and availability, and to make reservations.
Other features on the site, including airline flight reservations, hotel
photos, maps, weather and special discount programs, make TravelWeb a
"one-stop" travel site for both the leisure and business traveler.
HCC logo with caption reading:
HCC completes the room reservation transaction for more than 64,000
participating travel agencies by collecting and consolidating hotel
booking commissions due to each agency from more than 11,000 participating
hotel properties worldwide. The value-added consolidation and reporting
services that HCC provides to both its hotel and travel agency participants
help both parties operate more efficiently and effectively.
<PAGE> 3
DESCRIPTION OF PAGE 2
Pegasus Systems Inc. logo with caption reading:
Created by the hotel industry, for the hotel industry.
THISCO logo with caption reading:
Provides electronic interface between hotel central reservations systems
and Global Distribution Systems
o Leading provider of electronic hotel room reservation processing
services
o Connects 25,000 hotel properties around the world to GDSs and other
electronic distribution channels
TravelWeb logo with caption reading:
Internet hotel information and reservation service
o A leading Internet travel booking service
o Offers consumers direct reservation access to approximately 13,000
hotels in 140 countries.
HCC logo with caption reading:
Provides commission processing services for hotels and travel agencies
o 64,000 travel agencies worldwide participate
o Processed over $110 million in commissions in 1996
Caption reading: Pegasus Systems' Stockholders include many of the world's
leading hotel companies
Logos of the following stockholders and customers:
Inter-continental Hotels
Best Western
Hilton Hotels and Resorts
Forte Hotels
Marriott
Choice Hotels International
La Quinta Inn
ITT Sheraton
Hyatt Hotels & Resorts
Utell International
Reed Travel Group
Anasazi
Promus Hotel Corporation
Westin Hotels & Resorts
<PAGE> 4
[GRAPHIC]
CERTAIN PERSONS PARTICIPATING IN THIS OFFERING MAY ENGAGE IN TRANSACTIONS
THAT STABILIZE, MAINTAIN OR OTHERWISE AFFECT THE PRICE OF THE COMMON STOCK,
INCLUDING BY ENTERING STABILIZING BIDS, EFFECTING SYNDICATE COVERING
TRANSACTIONS OR IMPOSING PENALTY BIDS. FOR A DESCRIPTION OF THESE ACTIVITIES,
SEE "UNDERWRITING."
2
<PAGE> 5
PROSPECTUS SUMMARY
The following summary is qualified in its entirety by the more detailed
information and the Consolidated Financial Statements and Notes thereto
appearing elsewhere in this Prospectus. The Common Stock offered hereby involves
a high degree of risk. See "Risk Factors." The terms "Company" and "Pegasus"
when used in this Prospectus refer to Pegasus Systems, Inc., a Delaware
corporation, and, unless the context requires otherwise, its predecessors and
consolidated subsidiaries.
THE COMPANY
Pegasus is a leading provider of transaction processing services to the
hotel industry worldwide. The Company's THISCO(TM) and TravelWeb(R) hotel room
reservation services improve the efficiency and effectiveness of the reservation
process by enabling travel agents and individual travelers to electronically
access hotel room inventory information and conduct reservation transactions.
The Company's HCC service, the global leader in hotel commission payment
processing, improves the efficiency and effectiveness of the commission payment
process for participating hotels and travel agencies by consolidating payments
and providing comprehensive transaction reports.
The Company's electronic interface business for hotel room reservations was
established in 1989 by 16 leading hotel and travel-related companies to address
the need for a neutral, reliable third-party source of hotel reservation
information and transaction processing services. The Company's commission
processing business was founded by substantially the same stockholder group in
1991. Today, the Company's stockholders include 11 of the 15 leading hotel
chains in the world based on 1996 total revenues as reported by Business Travel
News. The Company's strategic position as a gateway in the hotel room
distribution chain, transaction processing capabilities and reputation for
reliability and neutrality enable it to offer a range of services delivering
industry-wide benefits that would be difficult for any industry participant to
achieve individually.
The Company's THISCO service provides an electronic interface from hotel
central reservation systems to travel agencies through Global Distribution
Systems ("GDSs"), which are electronic travel information and reservation
systems such as SABRE. Over 25,000 hotel properties worldwide, including
those of 13 of the 15 leading hotel chains based on 1996 total revenues,
utilize the THISCO service.
The Company's TravelWeb service provides individual travelers direct access
to more than 40,000 dynamically served pages of online hotel information
and the ability to make reservations electronically at approximately 13,000
properties in 140 countries. In January 1997, TravelWeb was ranked the
second most popular travel-related Web site, according to PC Meter, L.P., a
market research service. In June 1997, a daily average of approximately
30,000 Internet users visited the TravelWeb site, located at
www.travelweb.com. In addition, through its recently introduced NetBooker
service, the Company offers TravelWeb's comprehensive hotel database and
Internet hotel reservation capabilities to third-party Web sites.
The Company's HCC service consolidates commissions paid by participating
hotels to a participating travel agency into a single monthly payment and
provides participants with comprehensive transaction reports. Over 11,000
hotel properties and 64,000 travel agencies worldwide utilize the HCC
service to increase the efficiency and reduce costs associated with
preparing, paying and reconciling hotel room reservation commissions.
Pegasus has structured its service offerings so that it has the opportunity
to process and gain fee revenues from most electronic hotel room reservation and
commission transactions. The Company derives THISCO and TravelWeb revenues by
charging its hotel participants a fee based on the number of reservations made
less the number canceled ("net reservations"). The Company derives HCC revenues
by charging its travel agency customers a percentage of the dollar amount of
commissions paid to the travel agencies and by generally charging hotels a
transaction fee. The Company's revenues have grown at a compound annual rate of
54.4% to $15.9 million in 1996 from $2.8 million in 1992, excluding 1992
revenues from the HCC service which was acquired in 1995. The Company has
entered into contracts with terms generally ranging from two to five years with
most of its THISCO, HCC and TravelWeb hotel customers, many of which are Company
stockholders.
3
<PAGE> 6
The operations of the global hotel industry include a wide variety of
participants and a series of complex information and transaction flows.
According to the International Hotel Association, the global hotel industry
generated $247 billion in revenues in 1994. The Company believes that costs
associated with reserving and distributing hotel rooms, including commissions
and fees paid to intermediaries such as travel agencies and GDSs, hotel
reservation-related staffing costs and reservation system information technology
expenses, represent a significant proportion of total operating costs. The
Company's services simplify the complexity of room reservation information and
transaction flows, thereby reducing the distribution costs of rooms for the
hotel industry.
The Company believes that it will benefit from four significant trends in
the global hotel industry. First, as hotels and travel agencies increasingly
shift from manual to electronic means of making room reservations, the Company
can provide them with reservation and commission processing services. Second, as
individual travelers increasingly make their hotel reservations over the
Internet, the Company is positioned to process these reservations through its
own TravelWeb site or through third-party Web sites that use the Company's
NetBooker hotel room reservation service, including Web sites operated by
Preview Travel, Inc. and Internet Travel Network. Third, as independent hotels
and smaller hotel chains increasingly affiliate with large chains, many of which
are the Company's customers, the number of hotel properties for which Pegasus
processes electronic reservations and commissions increases. Fourth, as travel
agencies recognize the importance of hotel reservation commission revenues, the
Company believes that travel agencies will generate an increasing volume of
electronic hotel room reservations and will increasingly rely on the Company to
process hotel commissions.
The Company's objective is to capitalize on its central position in the
hotel industry information and transaction flow in order to become the leading
provider of services and technology that enable the efficient and effective
distribution of hotel rooms. To achieve this objective, the Company intends to
employ a strategy that includes the following key elements: (i) expanding its
customer base; (ii) expanding its service offerings to include virtually all of
the electronic hotel room distribution channels; (iii) developing an information
service to provide hotels and other industry participants with hotel transaction
information for use in strategic analysis, market tracking, improved target
marketing and revenue optimization; and (iv) building strategic alliances and
pursuing acquisition opportunities.
The Company was incorporated in Delaware in 1995, and holds directly or
indirectly all of the outstanding capital stock of (i) The Hotel Industry Switch
Company ("THISCO"), a Delaware corporation formed in 1988 to operate the
electronic interface business between hotel reservation systems and major GDSs;
(ii) The Hotel Clearing Corporation ("HCC"), a Delaware corporation formed in
1991 to operate the commission payment processing business; and (iii) TravelWeb,
Inc., a Delaware corporation formed in 1995 to operate the online hotel
reservation business. The Company's principal executive office is located at
3811 Turtle Creek Boulevard, Suite 1100, Dallas, Texas 75219. The Company's
telephone number is (214) 528-5656.
RECENT DEVELOPMENTS
In June 1997, Marriott International, Inc. ("Marriott"), which is a
customer of the Company's THISCO and TravelWeb services, also became a customer
of the Company's HCC service.
In May 1997, HFS Incorporated ("HFS") renewed its participation in the
Company's HCC service by entering into a new long-term agreement with the
Company.
In May 1997, the Company entered into a Distribution Services Agreement
with Holiday Inn Worldwide ("Holiday Inn") under which Holiday Inn, currently a
customer of the Company's HCC service, also will become a customer of the
Company's THISCO, TravelWeb, NetBooker, UltraDirect and UltraRes services
commencing in 1998. In May 1997, the Company issued to Holiday Inn warrants to
purchase 345,723 shares of Common Stock. The warrants are exercisable at any
time during the two year period ending May 12, 1999 at an exercise price equal
to the lower of $7.20 per share or 85.0% of the price per share for the Common
Stock offered hereby.
4
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THE OFFERING
<TABLE>
<S> <C>
Common Stock offered by the Company........................ 3,000,000 shares
Common Stock offered by the Selling Stockholders........... 573,044 shares
Common Stock to be outstanding after the offering.......... 9,729,712 shares(1)
Use of proceeds............................................ To repay indebtedness payable to certain
stockholders of the Company and for
working capital and other general
corporate purposes. See "Use of Proceeds"
and "Certain Transactions."
Nasdaq National Market symbol.............................. PEGS
</TABLE>
SUMMARY CONSOLIDATED FINANCIAL INFORMATION
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
THREE MONTHS
YEAR ENDED DECEMBER 31, ENDED MARCH 31,
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1992 1993 1994 1995 1996 1996 1997
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<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF
OPERATIONS DATA(2):
Net revenues.......................... $ 2,792 $ 3,938 $ 4,666 $ 9,296 $15,869 $ 3,803 $ 4,377
Operating income (loss)............... (613) 198 168 (2,809) (2,585) (707) (232)
Net loss.............................. $(1,179) $ (398) $ (423) $(3,571) $(3,485) $ (967) $ (388)
Pro forma net loss per share(3)....... $ (0.48) $ (0.05)
Shares used in pro forma net loss per
share calculation(3)............... 7,203 7,481
</TABLE>
<TABLE>
<CAPTION>
MARCH 31, 1997
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ACTUAL AS ADJUSTED(4)
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<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents............. $ 2,441 $ 32,739
Working capital....................... 1,405 32,508
Total assets.......................... 13,601 43,898
Long-term obligations, net of current
portion............................ 5,957 1,540
Accumulated deficit................... (14,959) (14,959)
Total stockholders' equity............ 1,600 37,120
</TABLE>
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(1) Based on the number of shares outstanding as of March 31, 1997. Excludes as
of March 31, 1997 (i) 866,667 shares of Common Stock reserved for issuance
under the Company's 1996 Stock Option Plan (the "1996 Plan"), of which
options to purchase 771,733 shares of Common Stock were outstanding at a
weighted average exercise price of $2.39 per share and (ii) 333,333 shares
of Common Stock reserved for issuance under the Company's 1997 Stock Option
Plan (the "1997 Plan"), which will become effective upon the completion of
this offering. In May 1997, the Company issued to Holiday Inn warrants to
purchase up to 345,723 shares of Common Stock. The warrants are exercisable
at any time during the two year period ending May 12, 1999 at an exercise
price equal to the lower of $7.20 per share or 85.0% of the price per share
for the Common Stock offered hereby. See "Business -- Recent Developments"
and "Management -- 1996 and 1997 Stock Option Plans."
(2) The Company's statement of operations data for 1992, 1993 and 1994 consist
of the accounts of THISCO. Statement of operations data for periods
thereafter reflect the operations of the Company, including the acquisition
of 83.3% of the outstanding capital stock of HCC in July 1995 and the
acquisition of the remaining 16.7% of the outstanding capital stock of HCC
in June 1996, together with the depreciation and amortization applicable to
such acquisitions. Amortization applicable to the acquisition of HCC totaled
$645,419, $1,412,499 and $383,511 in 1995, 1996 and the three months ended
March 31, 1997, respectively. See Notes 1, 2 and 3 of Notes to Consolidated
Financial Statements.
(3) See Note 1 of Notes to Consolidated Financial Statements for information
concerning the calculation of pro forma net loss per share.
(4) Adjusted to reflect the sale of the 3,000,000 shares of Common Stock offered
by the Company hereby at an initial public offering price of $13.00 per
share and application of the estimated net proceeds. See "Use of Proceeds"
and "Capitalization."
5
<PAGE> 8
Except as set forth in the Consolidated Financial Statements and the Notes
thereto or as otherwise indicated, the information contained in this Prospectus
assumes no exercise of the Underwriters' over-allotment option and gives effect,
concurrently with this offering, to (i) a 4-for-3 split of the Company's
outstanding Common Stock and Series A Preferred Stock, (ii) the conversion of
all outstanding shares of Series A Preferred Stock into shares of Common Stock
and (iii) certain amendments to the Company's Certificate of Incorporation and
By-laws. This Prospectus contains forward-looking statements that involve risks
and uncertainties. The Company's actual results and the timing of certain events
could differ materially from those discussed in the forward-looking statements
as a result of certain factors, including those set forth under "Risk Factors"
and elsewhere in this Prospectus.
UltraSwitch(R), TravelWeb(R) and HCC Hotel Clearing Corporation(R) are
registered trademarks of the Company. This Prospectus also includes trademarks
and tradenames of companies other than the Company, which are the property of
their respective owners.
6
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RISK FACTORS
This Prospectus contains forward-looking statements that involve risks and
uncertainties. The Company's actual results and the timing of certain events
could differ materially from those discussed in the forward-looking statements
as a result of certain factors, including those set forth below and elsewhere in
this Prospectus. The following risk factors should be considered carefully in
evaluating the Company and an investment in the Common Stock offered hereby.
Substantial Net Losses. The Company has experienced substantial net losses,
including a net loss of $3.5 million in 1996, and had an accumulated deficit of
approximately $14.6 million as of December 31, 1996. The Company's HCC and
THISCO services have accounted for the majority of the Company's revenues to
date, and the Company expects no significant revenues in 1997 from its other
services, which are relatively new in their respective markets. Any decrease in
the revenues from the HCC or THISCO services, or any increase in expenses
related to any of the Company's services substantially above the amounts
budgeted therefor, could have a material adverse effect on the Company's
financial condition and results of operations. The Company anticipates that its
budgeted operating expenses will increase in the foreseeable future as it
continues to develop its services, increase its sales and marketing activities
and expand its distribution channels. To achieve profitability, the Company must
successfully implement its business strategy and increase its revenues while
controlling expenses. There can be no assurance as to when or if the Company
will achieve profitability. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
Competition.
-- Electronic Hotel Room Reservation Processing Service. The Company faces
significant competition in connection with its THISCO hotel room reservation
processing service. The principal competitor of the Company's THISCO service is
WizCom International, Ltd. ("WizCom"), which was a wholly owned indirect
subsidiary of Avis, Inc. ("Avis"). As a result of the acquisition of Avis by
HFS, a stockholder and customer of the Company, in September 1996, WizCom became
a wholly owned indirect subsidiary of HFS. Although HFS has recently renewed its
participation in the Company's HCC service, HFS has notified the Company that it
is moving its electronic hotel room reservation processing from THISCO to
WizCom. The Company has an agreement with HFS which requires HFS to pay for a
certain minimum level of THISCO processing services annually for the life of the
agreement. In 1996, revenues from HFS for electronic hotel room processing
services were $517,905 above the annual minimum fee under the agreement, which
was $182,700. HFS historically has generated more revenues for the Company than
any other hotel chain that is a customer and a stockholder of Pegasus. See
"Certain Transactions." HFS accounted for 12.3%, 9.5% and 4.7% of the Company's
revenues during 1994, 1995 and 1996, respectively. HFS is a Selling Stockholder
in this offering. See "Principal and Selling Stockholders." HFS currently uses
and in the future could use the WizCom technology to compete with certain of the
Company's current and future services. There can be no assurance that any
additional customers will not change their electronic reservation interface to
WizCom or to another similar service. Also, hotels can choose to connect
directly to one or more GDSs, thereby bypassing the THISCO service and
eliminating the need to pay fees to the Company. Such competitors or their
affiliates may have greater financial and other resources than the Company.
Factors affecting the competitive success of an electronic hotel room
reservation processing service include reliability, levels of fees, number of
hotel properties on the system, ability to provide a neutral comprehensive
interface between hotels and other participants in the distribution of hotel
rooms and ability to develop new technological solutions. There can be no
assurance that another participant in the hotel room distribution process or a
new competitor will not create services with features that would reduce the
attractiveness of the Company's services. The Company's inability to compete
effectively with respect to these services could have a material adverse effect
on the Company's financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations," "Business -- Recent Developments" and " -- Competition."
The Company charges hotel participants certain fees for processing status
messages from hotel central reservation systems to GDSs. Status messages are
electronic messages sent by hotels to GDSs to update room rates, features and
availability information in GDS databases. The Company intends to reduce certain
status
7
<PAGE> 10
message fees beginning in the third quarter of 1997. In addition, a hotel
participant can choose to use the Company's UltraSelect service to provide
travel agencies direct access through GDSs to its central reservation system,
thereby reducing the need to send status messages through the Company's THISCO
service. There can be no assurance that the volume of, and fees generated from,
status message processing will remain at the same or a higher level in the
future. Any significant decrease in the volume of status messages processed or
in the amount of status message fees generated could have a material adverse
effect on the Company's financial condition and results of operations. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business -- Services."
-- Internet Hotel Room Reservation Service. The market for the Company's
TravelWeb and NetBooker services is highly competitive. Current competition
includes traditional telephone or travel agency reservation methods and other
Internet travel reservation services. There are a large number of Internet
travel-related services offered by the Company's competitors, and many of these
competitors are larger and have significantly greater financial resources and
name recognition than the Company. Several competitive Web sites such as
Travelocity (a site operated by The SABRE Group Holdings, Inc.) and Expedia (a
site operated by Microsoft Corporation) offer a more comprehensive range of
travel services than TravelWeb or NetBooker. The Company faces competition in
the online hotel room reservation business not only from its current competitors
but also from possible new entrants, including other Web sites. The costs of
entry into the Internet hotel room reservation business are relatively low.
There can be no assurance that the Company's Internet hotel room reservation
services will compete successfully. The failure of these services to compete
successfully could have a material adverse effect on the Company's financial
condition and results of operations. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" and "Business -- Competition."
-- Commission Processing Service. The market for the Company's HCC service
is competitive. The Company's competitors in the commission processing business
include National Processing Company ("NPC"), WizCom and Citicorp. NPC, a company
that has traditionally provided car rental and cruise line commission processing
services, recently began offering its services to hotels and travel agencies.
WizCom has recently announced its intention to offer a service that may be
competitive with the Company's HCC service. Citicorp provides commission
consolidation services to hotel chains. In addition, hotels that are current or
prospective customers of the HCC service can decide to process commission
payments without, or in competition with, the HCC service. Some of these current
or potential competitors have substantially greater financial and other
resources than the Company. Furthermore, while the Company has agreements with
all of its hotel customers for the HCC service, most of the Company's travel
agency customers are not obligated by any agreement with the Company. If a
significant percentage of these travel agencies were to cease using the HCC
commission processing service, the Company's financial condition and results of
operations could be materially adversely affected. See "Management Discussion
and Analysis of Financial Condition and Results of Operations" and
"Business -- Competition."
Dependence on Hotel Industry; Consolidation Trends. The Company derives
substantially all of its revenues directly and indirectly from the hotel
industry. The hotel industry is sensitive to changes in economic conditions that
affect business and leisure travel and is highly susceptible to unforeseen
events, such as political instability, regional hostilities, recession, gasoline
price escalation, inflation or other adverse occurrences that result in a
significant decline in the utilization of hotel rooms. Any event that results in
decreased travel or increased competition among hotels may lower hotel room
reservation volumes, the average daily rates for hotel rooms or both and could
have a material adverse effect on the Company's financial condition and results
of operations.
The hotel industry recently has witnessed a period of consolidation in
which hotel chains have acquired or merged with other chains. Such activities
may reduce the Company's customer base. Similar consolidation trends have
occurred in the GDS industry. After the recent merger between Amadeus and System
One, the GDS industry has consolidated to four major GDSs. If further
consolidation were to take place, the value provided by the Company to
participants in the hotel room distribution process and the benefits to hotel
operators of utilizing the THISCO service would be reduced. The Company
typically offers volume-based discounting of its fees, which could result in a
higher percentage of discounted fees if the consolidation trends
8
<PAGE> 11
in the hotel and GDS industries continue. There can be no assurance that any
potential decrease in the Company's customer base or any potential increase in
the percentage of discounted fees will not have a material adverse effect on the
Company's financial condition and results of operations.
Fluctuations in Quarterly Operating Results. The Company has experienced in
the past and expects to experience in the future significant fluctuations in
quarterly operating results. Such fluctuations may be caused by many factors,
including but not limited to the introduction of new or enhanced services by the
Company or its competitors, the degree of customer acceptance of new services,
competitive conditions in the industry, seasonal factors, reduction in client
base, changes in pricing, the extent of international expansion, the mix of
international and domestic sales and general economic conditions. Because the
Company's expense budget is set early in a fiscal year and a significant portion
of the Company's operating expenses are relatively fixed in nature, fluctuations
in revenues may cause substantial variation in the Company's results of
operations from quarter to quarter. Due to the foregoing factors, many of which
are beyond the Company's control, quarterly revenues and operating results are
difficult to forecast, and the Company believes that period-to-period
comparisons of its operating results will not necessarily be meaningful and
should not be relied upon as any indication of future performance. It is likely
that the Company's future quarterly operating results from time to time will not
meet the expectations of securities analysts or investors, which could have a
material adverse effect on the market price of the Company's Common Stock. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Potential Adverse Changes in Hotel Commission Payments. Absent any express
arrangement in individual cases, hotels currently 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. In 1995, the airline industry placed a maximum limit on
the amount of commissions payable to travel agencies for any domestic airline
ticket issued. Recently, certain airlines have capped the dollar amount that
they will pay to travel agencies for airline reservations made online. In
addition, hotels increasingly are utilizing other direct distribution channels,
such as the Internet, or offering negotiated rates to major corporate customers
that are non-commissionable to travel agencies. Because a substantial portion of
the Company's revenues are dependent on the dollar volume of travel agency
commissions paid by hotels, any change in the hotel commission payment system
that reduces the commissions payable to travel agencies and any acceleration of
the trend towards direct distribution of rooms by hotels could have a material
adverse effect on the Company's financial condition and results of operations.
See "Business -- Services."
Control by Existing Stockholders; Conflicts of Interest. Prior to this
offering, a substantial majority of the outstanding shares of the Company's
Common Stock was owned by certain hotel industry companies that are customers of
the Company. Upon the completion of this offering, the stockholders of the
Company before this offering will beneficially own approximately 65.3% of the
outstanding Common Stock, including 39.5% that will be owned either by hotel
companies or hotel representation firms. As a result, these stockholders, if
they act together, will be able to exercise significant influence over all
matters requiring stockholder approval, including the election of directors and
approval of significant corporate transactions. Such concentration of ownership
could have the effect of delaying, preventing or deferring a change in control
of the Company. The Company's interest in achieving profitability from its
services to the hotel industry conflicts with the interests of some of its
existing stockholders or their affiliates to lower their costs of utilizing the
Company's services. In 1996, services provided by Pegasus to its stockholders
directly and indirectly accounted for 75.4% of the Company's revenues. See Note
14 of Notes to Consolidated Financial Statements. Additionally, to the extent
TravelWeb and other Web-based services, including the third-party Web sites
using the Company's NetBooker service, are successful in causing consumers to
shop for and reserve hotel rooms directly, such success could adversely affect
the role of travel agencies and correspondingly could materially adversely
affect future HCC revenues of the Company. Reed Travel Group, a division of Reed
Elsevier Inc. and a stockholder of the Company ("Reed"), holds certain license
rights to use the Company's UltraSwitch technology for applications unrelated to
the hotel industry, which may limit or otherwise conflict with the Company's
ability to expand its service offerings. Any of these conflicts could result in
a material adverse effect on the
9
<PAGE> 12
Company's financial condition and results of operations. See
"Business -- Technology and Operations," "Certain Transactions" and "Principal
and Selling Stockholders."
Dependence on Growth of Internet Commerce. The market for electronic hotel
reservation services over the Internet is rapidly evolving and depends upon
market acceptance of novel methods for distributing services and products, which
involves a high degree of uncertainty. The success of the Company's TravelWeb
and NetBooker services will depend upon the adoption of the Internet by
consumers as a widely used medium for commerce. The Internet may not prove to be
a viable commercial marketplace for any number of reasons, including inadequate
development of the necessary infrastructure or the lack of complementary
services and products, such as high speed modems and high speed communication
lines. The Internet has experienced, and is expected to continue to experience,
significant growth in the number of users and amount of traffic. There can be no
assurance that the Internet infrastructure will continue to be able to support
the demands placed on it by this continued growth. Moreover, critical issues
concerning the commercial use of the Internet (including security, reliability,
cost, ease of use, accessibility and quality of service) remain unresolved and
may negatively affect the growth or attractiveness of commerce conducted on the
Internet. If critical issues concerning the commercial use of the Internet are
not favorably resolved, if the necessary infrastructure is not developed or if
the Internet does not become a viable commercial marketplace, the Company's
financial condition and results of operations could be materially adversely
affected. See "Business -- Industry Background" and "-- Services."
System Interruption and Security Risks. The Company's operations are
dependent on its ability to protect its computer systems and databases against
damage or system interruptions from fire, earthquake, power loss,
telecommunications failure, unauthorized entry or other events beyond the
Company's control. A significant amount of the Company's computer equipment is
located at a single site in Phoenix, Arizona. There can be no assurance that
unanticipated problems will not cause a significant system outage or data loss.
Despite the implementation of security measures, the Company's infrastructure
may also be vulnerable to break-ins, computer viruses or other disruptions
caused by its customers or others. Any damage to the Company's databases,
failure of communication links or security breach or other loss that causes
interruptions in the Company's operations could have a material adverse effect
on the Company's financial condition and results of operations. See
"Business -- Systems Maintenance and Disaster Recovery."
Impact of Technological Advances; Delays in Introduction of New
Services. The Company's future success will depend, in part, on its ability to
develop leading technology, enhance its existing services, develop and introduce
new services that address the increasingly sophisticated and varied needs of its
current and prospective customers and respond to technological advances and
emerging industry standards and practices on a timely and cost effective basis.
Although the Company strives to be a technological leader, there can be no
assurance that future advances in technology will be beneficial to, or
compatible with, the Company's business or that the Company will be able to
economically incorporate such advances into its business. In addition, keeping
abreast of technological advances in the Company's business may require
substantial expenditures and lead time. There can be no assurance that the
Company will be successful in effectively using new technologies, adapting its
services to emerging industry standards or developing, introducing and marketing
service enhancements or new services, or that it will not experience
difficulties that could delay or prevent the successful development,
introduction or marketing of these services. If the Company incurs increased
costs or is unable, for technical or other reasons, to develop and introduce new
services or enhancements of existing services in a timely manner in response to
changing market conditions or customer requirements, or if new services do not
achieve market acceptance, the Company's financial condition and results of
operations could be materially adversely affected. See "Business -- Services"
and "-- Technology and Operations."
Dependence on Key Customers and Third-Party Service Arrangements. The
Company's business is dependent upon customer arrangements with its hotel
stockholders or their affiliates, other hotel chains and hotel representation
firms, travel agencies, travel agency consortia and GDSs. The Company has not
entered into written agreements with certain travel agencies relating to the HCC
service. There can be no assurance that the Company will be able to continue or
renew these arrangements on equal or better terms or initiate new arrangements.
Any cancelation or non-renewal of these arrangements that results in a
significant
10
<PAGE> 13
reduction in the Company's customer base or revenue sources could materially
adversely affect the Company's financial condition and results of operations. In
addition, the Company relies on third parties to provide consolidation,
remittance and worldwide currency exchange services for its HCC service and
facility maintenance and disaster recovery services for computer and
communications systems used in all of the Company's services. There can be no
assurance that these service contracts will be successfully extended upon
expiration or that Pegasus can enter into contracts with alternate service
providers at the same or lower cost. Any failure by the Company to extend these
contracts or to secure alternate service providers could have a material adverse
effect on the Company's financial condition and results of operations. See
"Business -- Services," "-- Customers," "-- Technology and Operations" and
"-- Systems Maintenance and Disaster Recovery."
Government Regulation. The Company's primary customers are hotel chains and
hotel representation firms. The Company currently has as its stockholders 11 of
the 15 leading hotel chains in the world based on 1996 total revenues. While the
Company believes that it has been acting since its inception as an entity
independent of its stockholders, and its stockholders have not engaged in any
anti-competitive activities through or in connection with the Company, there can
be no assurance that federal, state or foreign governmental authorities, the
Company's competitors or its consumers will not raise anti-competitive concerns
regarding the Company's close relationship with its hotel stockholders. Any such
action by federal, state or foreign governmental authorities or allegations by
third parties could have a material adverse effect on the Company's financial
condition and results of operations. While certain aspects of the travel
industry are heavily regulated by the United States Government, the services
currently offered by the Company, including electronic room reservation
processing services, commission processing services and online reservation
services, have not been subject to any material industry-specific government
regulation. However, there can be no assurance that federal, state or foreign
governmental authorities will not attempt to regulate one or more of the
Company's current or future services. Due to the increasing popularity of the
Internet, it is possible that laws and regulations may be adopted with respect
to the Internet, covering issues such as privacy, pricing, content and quality
of products and services. The adoption of laws or regulations affecting the
Company's lines of business could reduce the rate of growth of the Company or
could otherwise have a material adverse effect on the Company's financial
condition and results of operations. See "Business -- Government Regulation."
Risks Associated with Management of Growth. The Company has in recent years
experienced significant growth and anticipates that significant expansion will
continue to be required in order to address potential market opportunities. The
Company anticipates significantly increasing the size of its Information
Technology Group and sales and marketing staff following the completion of this
offering. There can be no assurance that if the Company continues to expand,
management will be effective in attracting and retaining additional qualified
personnel, expanding the Company's physical facilities, integrating acquired
businesses or otherwise managing growth. In addition, there can be no assurance
that the Company's systems, procedures or controls will be adequate to support
any expansion of the Company's operations. The Company's inability to manage
growth effectively could have a material adverse effect on the Company's
financial condition and results of operations.
Risks Associated with International Expansion and Operations. Pursuit of
international growth opportunities may require significant investments for an
extended period before returns on such investments, if any, are realized. There
can be no assurance as to the extent, if at all, that the Company's plans to
expand in international markets will be successful. The Company's current
international activities and prospects may be adversely affected by factors such
as policies of the United States and foreign governments affecting foreign
trade, privacy issues, investment and taxation, exchange controls, political
risks and currency risks. One or more of these factors could materially
adversely affect the Company's financial condition and results of operations.
See "Business -- Strategy."
Dependence on Key Personnel. The Company believes that its success will
continue to be dependent upon its ability to attract and retain skilled managers
and other key personnel, including its President, John F. Davis, III, its Chief
Information Officer, Joseph W. Nicholson, and its other present officers. The
loss of the services of any of its present officers could have a material
adverse effect on the Company's financial condition and results of operations.
Although the Company currently has "key-man" insurance covering Messrs. Davis
11
<PAGE> 14
and Nicholson, there can be no assurance that the amount of such insurance would
be adequate to compensate for the loss of the services of the insured officers.
The Company believes that its future business results will also depend in
significant part upon its ability to identify, attract, motivate and retain
additional highly skilled technical personnel. Competition for such personnel in
the information technology industry is intense. There can be no assurance that
the Company will be successful in identifying, attracting, motivating and
retaining such personnel, and the failure to do so could have a material adverse
effect on the Company's financial condition and results of operations. See
"Management."
Dependence on Proprietary Technology; Risk of Infringement. The Company's
success depends upon its proprietary technology, consisting of both its software
and its hardware designs. The Company relies upon a combination of copyright,
trade secrets, confidentiality procedures and contractual provisions to protect
its proprietary technology. There can be no assurance that the Company's present
protective measures will be enforceable or adequate to prevent misappropriation
of its technology or independent third-party development of the same or similar
technology. Many foreign jurisdictions offer less protection of intellectual
property rights than the United States, and there can be no assurance that the
protection provided to the Company's proprietary technology by the laws of the
United States or foreign jurisdictions will be sufficient to protect the
Company's technology. In addition, litigation may be necessary in the future to
enforce the Company's intellectual property rights, to protect the Company's
trade secrets, to determine the validity and scope of the proprietary rights of
others, or to defend against claims of infringement or invalidity. Such
litigation, whether successful or unsuccessful, could result in substantial cost
and diversion of management resources, and a successful claim could effectively
block the Company's ability to use or license its technology in the United
States or abroad or otherwise have a material adverse effect on the Company's
financial condition and results of operations.
The Company has found and may in the future find it necessary or desirable
to procure licenses from third parties relating to current or future services or
technology, but there can be no assurance that the Company will continue to be
able to obtain such licenses or other rights or, if it is able to obtain them,
that it will be able to do so on commercially acceptable terms. The Company
could be placed at a disadvantage if its competitors obtain licenses with lower
royalty fee payments or other terms more favorable than those received by the
Company. If the Company or its suppliers were unable to obtain licenses relating
to current or future services or technology, the Company could be forced to
market services without certain technological features. The Company's inability
to obtain licenses necessary to use certain technology or its inability to
obtain such licenses on competitive terms could have a material adverse effect
on the Company's financial condition and results of operations. See
"Business -- Proprietary Rights."
Risks Associated with Potential Acquisitions. While the Company has no
current agreements or negotiations underway with respect to any potential
acquisitions, the Company regularly evaluates such opportunities and may make
acquisitions of other companies or technologies in the future. Acquisitions
involve numerous risks, including difficulties in assimilating acquired
operations and products, diversion of management's attention from other business
concerns, amortization of acquired intangible assets and potential loss of key
employees of acquired companies. The Company has no experience in assimilating
acquired nonaffiliated organizations into the Company's operations. There can be
no assurance as to the ability of the Company to integrate successfully any
operations, personnel or services that might be acquired in the future, and a
failure by the Company to do so could have a material adverse effect on the
Company's financial condition and results of operations. See
"Business -- Strategy."
Year 2000 Compliance. The Company has implemented a program designed to
ensure that all software used in connection with the Company's services will
manage and manipulate data involving the transition of dates from 1999 to 2000
without functional or data abnormality and without inaccurate results related to
such dates. However, with regard to travel reservations beginning in the year
2000, any failure on the part of the Company, or its travel-related customers to
ensure that any such software complies with year 2000 requirements, regardless
of when such travel reservations occur, could have a material adverse effect on
the financial condition and results of operations of the Company.
12
<PAGE> 15
Management's Discretion as to Use of Unallocated Net Proceeds; Benefits to
Existing Stockholders. The Company has designated only limited specific use for
the net proceeds to the Company from the sale of Common Stock in this offering.
The Company expects to use approximately $5.2 million of such net proceeds to
retire outstanding indebtedness to certain existing stockholders of the Company
and to pay down certain capital lease obligations and the remainder for working
capital and other general corporate purposes. Consequently, the Board of
Directors and management of the Company will have broad discretion in allocating
a significant portion of the net proceeds to the Company from this offering. In
addition to the repayment of outstanding indebtedness, existing stockholders
will benefit from this offering as a result of an increase in the market value
and liquidity of their investments in the Company. See "Use of Proceeds,"
"Certain Transactions" and "Principal and Selling Stockholders."
Future Capital Needs; Uncertainty of Additional Financing. The Company
currently anticipates that its available cash resources combined with the net
proceeds to the Company from this offering will be sufficient to meet its
presently anticipated working capital and capital expenditure requirements for
at least the next twelve months. However, the Company may need or choose to
raise additional funds in order to support more rapid expansion, develop new or
enhanced services, respond to competitive pressures, acquire complementary
businesses or technologies or respond to unanticipated requirements. If
additional funds are raised through the issuance of equity securities, the
percentage ownership of the stockholders of the Company will be reduced,
stockholders may experience additional dilution in net book value per share, and
such equity securities may have rights, preferences or privileges senior or
similar to those of the holders of the Company's Common Stock. There can be no
assurance that additional financing will be available when needed on terms
favorable to the Company, if at all. If adequate funds are not available on
acceptable terms, the Company may be unable to develop or enhance its services,
take advantage of future opportunities or respond to competitive pressures or
unanticipated requirements, any of which could have a material adverse effect on
the Company's financial condition and results of operations. See "Dilution" and
"Management's Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources."
Shares Eligible for Future Sale. Sales of substantial amounts of shares in
the public market following this offering could materially adversely affect the
market price of the Common Stock. Immediately following the offering, the
Company will have 9,729,712 shares of Common Stock outstanding. Of these shares,
6,156,668 shares will be "restricted securities" as defined by Rule 144 ("Rule
144") adopted under the Securities Act of 1933, as amended (the "Securities
Act"). These shares may be sold in the public market only if registered or if
they qualify for an exemption from registration under Rule 144 or Rule 701
("Rule 701") adopted under the Securities Act. The Company is unable to predict
the effect that future sales made under Rule 144, Rule 701 or otherwise will
have on the market price of the Common Stock prevailing at that time. The
Company, its executive officers and directors who are stockholders, and certain
other stockholders including the Selling Stockholders have agreed, subject to
certain limited exceptions, not to offer, sell, contract to sell, grant any
option to purchase or otherwise dispose of any shares of Common Stock for a
period of 180 days after the date of this Prospectus, without the prior written
consent of Hambrecht & Quist LLC. Any shares subject to these lock-up agreements
may be released at any time by Hambrecht & Quist LLC with or without notice.
Pursuant to an agreement between the Company and the holders (or their permitted
transferees) of approximately 6,156,668 shares of Common Stock, these holders
will be entitled to certain registration rights with respect to such shares. In
addition, the Company intends to register the shares of Common Stock reserved
for issuance under the Company's 1996 Plan and 1997 Plan. See "Management --
1996 and 1997 Stock Option Plans," "Description of Capital Stock -- Registration
Rights," "Shares Eligible for Future Sale" and "Underwriting."
Immediate and Substantial Dilution. Purchasers of Common Stock in this
offering will incur immediate and substantial dilution in the amount of $9.54
per share, at an initial public offering price of $13.00 per share. To the
extent that outstanding options or warrants to purchase the Common Stock are
exercised, there will be further dilution. See "Dilution."
Anti-Takeover Matters. The Company's Second Amended and Restated
Certificate of Incorporation ("Certificate") and Second Amended and Restated
By-laws ("By-laws"), each of which become effective contemporaneously with the
completion of this offering, contain provisions that may have the effect of
13
<PAGE> 16
delaying, deterring or preventing a potential takeover of the Company that
stockholders purchasing shares in this offering may consider to be in their best
interests. The Certificate and By-laws 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. The Certificate also authorizes only the Board of Directors to
fill vacancies, including newly created directorships and states that directors
of the Company 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. In addition, the Certificate grants the Board
of Directors the authority to issue up to 2,000,000 shares of preferred stock,
having such rights, preferences and privileges as designated by the Board of
Directors, without stockholder approval. Section 203 of the Delaware General
Corporation Law, which is applicable to the Company, contains provisions that
restrict certain business combinations with interested stockholders, which may
have the effect of inhibiting a non-negotiated merger or other business
combination involving the Company. See "Description of Capital
Stock -- Anti-Takeover Provisions."
Absence of a Prior Public Market; Potential Volatility of Stock
Price. Prior to this offering, there has been no public market for the Common
Stock, and there can be no assurance that an active trading market will develop
or be sustained. The initial public offering price of the Common Stock was
determined through negotiations between the Company, the Selling Stockholders
and the Underwriters and may not be indicative of the market price for the
Common Stock after this offering. See "Underwriting" for a discussion of the
factors considered in determining the initial public offering price.
The market price for the Common Stock may be highly volatile. The Company
believes that factors such as quarterly fluctuations in financial results or
announcements by the Company or by its competitors, travel agencies, hotel
operators or other hotel industry participants could cause the market price of
the Common Stock to fluctuate substantially. In addition, the stock market may
experience extreme price and volume fluctuations which often are unrelated to
the operating performance of specific companies. Market fluctuations or
perceptions regarding the hotel industry, as well as general economic or
political conditions, may adversely affect the market price of the Common Stock.
In the past, following periods of volatility in the market price for a company's
securities, securities class action litigation has often been instituted. Such
litigation could result in substantial costs and a diversion of management
attention and resources, which could have a material adverse effect on the
Company's financial condition and results of operations.
14
<PAGE> 17
USE OF PROCEEDS
The net proceeds to the Company from the sale of the 3,000,000 shares of
Common Stock offered by the Company hereby at an initial public offering price
of $13.00 per share are estimated to be $35,520,000 ($40,960,500 if the
Underwriters' over-allotment option is exercised in full), after deducting the
underwriting discount and estimated offering expenses payable by the Company.
The Company will not receive any of the proceeds from the sale of Common Stock
by the Selling Stockholders. See "Principal and Selling Stockholders."
The principal purposes of this offering are to repay certain indebtedness,
to obtain additional capital, to create a public market for the Common Stock and
to facilitate future access by the Company to the public equity markets. The
Company anticipates that approximately $5.2 million of the net proceeds of this
offering will be used to repay indebtedness outstanding under notes payable to
certain stockholders of the Company (the "Stockholder Debt") and to pay down
certain capital lease obligations. The Stockholder Debt bears interest at such
rates and matures on such dates as are set forth in "Certain Transactions." The
Company has no specific plans for the remainder of the net proceeds but expects
that such proceeds from this offering will be used for general corporate
purposes, including working capital, increased staffing expenses, increased
promotional expenses and the purchase of additional equipment. The amounts and
timing of the Company's actual expenditures will depend upon numerous factors,
including the Company's research and development efforts, competition and
marketing and sales activities. Pending application of the net proceeds as
described above, the Company intends to invest such proceeds in short-term
marketable securities. See "Risk Factors -- Management's Discretion as to Use of
Unallocated Net Proceeds; Benefits to Existing Stockholders," "Management's
Discussion and Analysis of Financial Condition and Results of
Operations -- Liquidity and Capital Resources" and "Certain Transactions."
DIVIDEND POLICY
To date, the Company has neither declared nor paid any cash dividends on
shares of its Common Stock. The Company currently intends to retain its earnings
in the future to support operations and finance its growth and, therefore, does
not intend to pay cash dividends on the Common Stock in the foreseeable future.
The payment of cash dividends in the future will be at the discretion of the
Board of Directors and subject to certain limitations under the Delaware General
Corporation Law and will depend upon factors such as the Company's earnings
levels, capital requirements, financial condition and other factors deemed
relevant by the Board of Directors. There can be no assurance that the Company
will pay any dividends in the future.
15
<PAGE> 18
CAPITALIZATION
The following table sets forth the capitalization of the Company as of
March 31, 1997 (i) on an actual basis, (ii) on a pro forma basis adjusted to
reflect the conversion of all shares of outstanding Series A Preferred Stock
into shares of Common Stock and (iii) as adjusted to give effect to the sale by
the Company of the 3,000,000 shares of Common Stock offered hereby at an initial
public offering price of $13.00 per share and the application of the estimated
net proceeds therefrom as set forth in "Use of Proceeds." This table should be
read in conjunction with the Consolidated Financial Statements and Notes thereto
and "Management's Discussion and Analysis of Financial Condition and Results of
Operations" included elsewhere in this Prospectus.
<TABLE>
<CAPTION>
MARCH 31, 1997
------------------------------
PRO AS
ACTUAL FORMA ADJUSTED
-------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C>
Current portion of long-term obligations(1)................. $ 1,896 $ 1,896 $ 1,090
======== ======== ========
Long-term obligations, net of current portion(1)............ 5,957 5,957 1,540
-------- -------- --------
Stockholders' equity:
Preferred Stock, $.01 par value, 2,000,000 shares
authorized; 1,538,463 shares issued and outstanding
(actual); no shares outstanding (pro forma and as
adjusted).............................................. 15 -- --
Common Stock, $.01 par value, 100,000,000 shares
authorized; 5,307,733 shares issued (actual); 6,846,196
shares issued (pro forma); 9,846,196 shares issued (as
adjusted)(2)........................................... 53 68 98
Additional paid-in capital................................ 16,968 16,968 52,458
Unearned compensation expense............................. (451) (451) (451)
Accumulated deficit....................................... (14,959) (14,959) (14,959)
Less treasury stock (116,484 shares, at cost)............. (26) (26) (26)
-------- -------- --------
Total stockholders' equity........................... 1,600 1,600 37,120
-------- -------- --------
Total capitalization.............................. $ 7,557 $ 7,557 $ 38,660
======== ======== ========
</TABLE>
- ------------------------------
(1) See "Certain Transactions" and Notes 6 and 7 of Notes to Consolidated
Financial Statements.
(2) Excludes as of March 31, 1997 (i) 866,667 shares of Common Stock reserved
for issuance under the Company's 1996 Plan, of which options to purchase
771,733 shares of Common Stock were outstanding at a weighted average
exercise price of $2.39 per share and (ii) 333,333 shares of Common Stock
reserved for issuance under the Company's 1997 Plan, which will become
effective upon the completion of this offering. In May 1997, the Company
issued to Holiday Inn warrants to purchase 345,723 shares of Common Stock.
The warrants are exercisable at any time during the two year period ending
May 12, 1999 at an exercise price equal to the lower of $7.20 per share or
85.0% of the price per share for the Common Stock offered hereby. See
"Business -- Recent Developments" and "Management -- 1996 and 1997 Stock
Option Plans."
16
<PAGE> 19
DILUTION
As of March 31, 1997, the Company had a net tangible book deficiency of
approximately $1.8 million or $0.27 per share on a pro forma basis. Pro forma
net tangible book deficiency per share is determined by dividing the net
tangible book deficiency (tangible assets less liabilities) of the Company by
the number of shares of Common Stock outstanding on a pro forma basis, after
giving effect to (i) a 4-for-3 split of the Company's outstanding Common Stock
and Series A Preferred Stock to be effected concurrently with this offering and
(ii) the conversion of all shares of outstanding Series A Preferred Stock into
an equal number of shares of the Company's Common Stock. After giving effect to
the issuance and sale of the 3,000,000 shares of Common Stock offered by the
Company hereby (at an initial public offering price of $13.00 per share) and
after deduction of the underwriting discounts and estimated offering expenses
payable by the Company and the application of the estimated net proceeds
therefrom as set forth in "Use of Proceeds," the adjusted net tangible book
value of the Company as of March 31, 1997 would have been approximately $33.7
million or $3.46 per share. This represents an immediate increase in net
tangible book value of $3.73 per share to existing stockholders and an immediate
dilution of $9.54 per share to new investors purchasing shares of Common Stock
in this offering. The following table illustrates this per share dilution:
<TABLE>
<S> <C> <C>
Initial public offering price per share..................... $13.00
Pro forma net tangible book deficiency per share as of
March 31, 1997......................................... $(0.27)
Increase per share attributable to new investors.......... 3.73
------
Adjusted net tangible book value per share after the
offering.................................................. 3.46
------
Dilution per share to new investors......................... $ 9.54
======
</TABLE>
The following table summarizes, on a pro forma basis as of March 31, 1997,
the differences between the number of shares of Common Stock purchased from the
Company, the aggregate consideration paid and the average price per share paid
by existing stockholders and new investors purchasing shares of Common Stock in
this offering (based upon an initial public offering price of $13.00 per share):
<TABLE>
<CAPTION>
SHARES
PURCHASED(1) TOTAL CONSIDERATION
-------------------- ---------------------- AVERAGE PRICE
NUMBER PERCENT AMOUNT PERCENT PER SHARE
--------- -------- ----------- -------- -------------
<S> <C> <C> <C> <C> <C>
Existing
stockholders(2)....... 6,729,712 69.2% $17,010,488 30.4% $ 2.53
New investors(2)........ 3,000,000 30.8% 39,000,000 69.6% 13.00
--------- ----- ----------- -----
Total......... 9,729,712 100.0% $56,010,488 100.0%
========= ===== =========== =====
</TABLE>
- ------------------------------
(1) The foregoing computations assume no exercise of outstanding stock options
or warrants. As of March 31, 1997, options to purchase 771,733 shares of
Common Stock were outstanding under the Company's 1996 Plan at a weighted
average exercise price of $2.39 per share. In May 1997, the Company issued
to Holiday Inn warrants to purchase 345,723 shares of Common Stock. The
warrants are exercisable at any time during the two year period ending May
12, 1999 at an exercise price equal to the lower of $7.20 per share or 85.0%
of the price per share for the Common Stock offered hereby. To the extent
these options or warrants are exercised, there will be further dilution to
new investors. See "Business -- Recent Developments" and "Management -- 1996
and 1997 Stock Option Plans."
(2) Sales by the Selling Stockholders in this offering will reduce the number of
shares held by existing stockholders to 6,156,668 shares, or approximately
63.3% of the total shares of Common Stock outstanding after this offering,
and will increase the number of shares held by new investors to 3,573,044,
or approximately 36.7% of the total shares of Common Stock outstanding after
this offering. See "Principal and Selling Stockholders."
17
<PAGE> 20
SELECTED CONSOLIDATED FINANCIAL DATA
The following selected consolidated financial data as of and for the year
ended December 31, 1996 are derived from the Consolidated Financial Statements
of the Company that have been audited by Price Waterhouse LLP, independent
accountants, and are included elsewhere in this Prospectus. The selected
consolidated financial data as of and for the year ended December 31, 1995 and
the selected consolidated financial data for the year ended December 31, 1994
are derived from the financial statements of the Company that have been audited
by Belew Averitt LLP, independent accountants, and are included elsewhere in
this Prospectus. The selected financial data as of December 31, 1994 and as of
and for the year ended December 31, 1993 are derived from the Company's
financial statements that have been audited by Belew Averitt LLP, but are not
included herein. The selected financial data as of and for the year ended
December 31, 1992 are derived from the Company's financial statements that were
audited by other independent accountants, but are not included herein.
The selected consolidated financial data as of and for the three months
ended March 31, 1996 and 1997 are derived from unaudited consolidated financial
statements and are included elsewhere in this Prospectus. The unaudited
consolidated financial statements include all adjustments, consisting of normal
recurring accruals, which the Company considers necessary for a fair
presentation of the financial position and the results of operations for these
periods. Operating results for the three months ended March 31, 1997 are not
necessarily indicative of the results that may be expected for all of 1997. The
data should be read in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and with the Company's
Consolidated Financial Statements and Notes thereto.
<TABLE>
<CAPTION>
THREE
MONTHS
ENDED
YEAR ENDED DECEMBER 31, MARCH 31,
--------------------------------------------- ---------------
1992 1993 1994 1995 1996 1996 1997
------- ------ ------ ------- ------- ------ ------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENT OF OPERATIONS DATA(1):
Net revenues................................. $ 2,792 $3,938 $4,666 $ 9,296 $15,869 $3,803 $4,377
Operating expenses:
Cost of services........................... 1,172 1,266 1,546 3,883 6,199 1,638 1,558
Research and development................... 303 397 238 840 1,961 627 623
Write-off of purchased in-process research
and development.......................... -- -- -- 1,223 245 -- --
General and administrative expenses........ 652 709 1,065 2,770 3,799 692 856
Marketing and promotion expenses........... 66 17 130 912 2,824 644 865
Depreciation and amortization.............. 1,212 1,351 1,519 2,477 3,426 909 707
------- ------ ------ ------- ------- ------ ------
Total operating expenses.............. 3,405 3,740 4,498 12,105 18,454 4,510 4,609
------- ------ ------ ------- ------- ------ ------
Operating income (loss)...................... (613) 198 168 (2,809) (2,585) (707) (232)
Other (income) expense:
Interest expense........................... 568 597 591 815 893 212 212
Interest income............................ (2) (1) -- -- (114) -- (56)
------- ------ ------ ------- ------- ------ ------
Loss before income taxes and minority
interest................................... (1,179) (398) (423) (3,624) (3,364) (919) (388)
Income taxes................................. -- -- -- -- 15 -- --
------- ------ ------ ------- ------- ------ ------
Loss before minority interest................ (1,179) (398) (423) (3,624) (3,379) (919) (388)
Minority interest............................ -- -- -- 53 (106) (48) --
------- ------ ------ ------- ------- ------ ------
Net loss..................................... $(1,179) $ (398) $ (423) $(3,571) $(3,485) $ (967) $ (388)
======= ====== ====== ======= ======= ====== ======
Pro forma net loss per share(2).............. $ (0.48) $(0.05)
======= ======
Weighted average shares used in the pro forma
net loss per share calculation(2).......... 7,203 7,481
Supplemental pro forma net loss per
share(2)................................... $ (0.38) $(0.03)
======= ======
Weighted average shares used in the
supplemental pro forma net loss per share
calculation(2)............................. 7,744 8,006
</TABLE>
18
<PAGE> 21
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31,
------------------------------------------------ ---------------------------
1992 1993 1994 1995 1996 1997 AS ADJUSTED(3)
---- ---- ---- ---- ---- ---- ----------------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET
DATA:
Working capital
(deficit).............. $ (103) $ (126) $ (844) $(1,560) $ 2,068 $ 1,405 $ 32,508
Total assets............. 5,490 4,872 4,150 10,316 13,892 13,601 43,898
Accounts payable and
accrued liabilities.... 423 415 690 1,941 2,689 2,640 2,640
Short-term borrowings,
including current
portion of long-term
debt................... 407 459 1,392 1,049 1,834 1,896 1,090
Long-term obligations,
net of current
portion................ 6,488 6,224 4,718 6,994 6,353 5,957 1,540
Minority interest........ -- -- -- 1,340 -- -- --
Accumulated deficit...... (6,693) (7,091) (7,514) (11,085) (14,570) (14,959) (14,959)
Total stockholders'
equity (deficit)....... (1,828) (2,226) (2,649) (2,380) 1,954 1,600 37,120
</TABLE>
- ------------------------------
(1) The Company's statement of operations data for 1992, 1993 and 1994 consist
of the accounts of THISCO. Statement of operations data for periods
thereafter reflect the operations of the Company, including the acquisition
of 83.3% of the outstanding capital stock of HCC in July 1995 and the
acquisition of the remaining 16.7% of the outstanding capital stock of HCC
in June 1996, together with the depreciation and amortization applicable to
such acquisitions. Amortization applicable to the acquisition of HCC totaled
$645,419, $1,412,499 and $383,511 in 1995, 1996 and the three months ended
March 31, 1997, respectively. See Notes 1, 2 and 3 of Notes to Consolidated
Financial Statements.
(2) See Note 1 of Notes to Consolidated Financial Statements for information
concerning the calculation of pro forma net loss per share and supplemental
pro forma net loss per share.
(3) Adjusted to reflect the sale of 3,000,000 shares of Common Stock offered by
the Company hereby at an offering price of $13.00 per share and the
application of the estimated net proceeds therefrom. See "Use of Proceeds"
and "Capitalization."
19
<PAGE> 22
MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with
"Selected Consolidated Financial Data" and the Consolidated Financial Statements
and Notes thereto included elsewhere in this Prospectus. This Prospectus
contains certain forward-looking statements that involve risks and
uncertainties. The Company's actual results and the timing of certain events
could differ materially from those discussed in the forward-looking statements
as a result of certain factors including those set forth under "Risk Factors"
and elsewhere in this Prospectus.
OVERVIEW
Pegasus is a leading provider of transaction processing services to the
hotel industry worldwide. The Company's THISCO and TravelWeb hotel room
reservation 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. The Company's HCC service, the global leader in hotel commission
payment processing, improves the efficiency and effectiveness of the commission
payment process for participating hotels and travel agencies by consolidating
payments and providing comprehensive transaction reports. Historically, the
Company has derived a majority of its revenues from its THISCO and HCC services.
In 1996, approximately 51.3% of the Company's consolidated revenues was derived
from its electronic hotel reservation processing services, including 42.5% from
the THISCO service and 8.8% from the TravelWeb service, and approximately 48.7%
of the Company's consolidated revenues was derived from its HCC service. The
Company has experienced substantial growth since its inception. Revenues
increased at a compound annual rate of 54.4% to $15.9 million in 1996 from $2.8
million in 1992, excluding 1992 revenues from the HCC service which was acquired
in 1995. However, there can be no assurance that the Company 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 the Company's
financial condition and results of operations.
Of the hotel customers for the Company's THISCO and HCC services in 1995,
all continued to be customers in 1996. Hotels generally enter into long-term
contracts for the Company's THISCO service that specify minimum annual
transaction and payment commitments.
The Company's revenues are predominantly transaction-based. The Company
derives its revenues from its THISCO service by charging its hotel participants
a fee based on the number of reservations made, less the number canceled ("net
reservations"), and a fee for "status messages" processed through the THISCO
service. Status messages are electronic messages sent by hotels to GDSs to
update room rates, features and availability information in GDS 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 expected
fee per transaction to be earned for services to be provided to the customer
during the entire year. This process of recognizing revenues results in a
deferred revenue balance being created during early periods of the year, which
will be reflected in interim balance sheets and be fully utilized and eliminated
by the end of each year. Additionally, Pegasus generally charges new
participants in the THISCO service a one-time set-up fee for work associated
with the implementation of the interface with the THISCO service. The Company
also charges certain GDSs a fee based on the number of net reservations to
compensate for the management and consolidation of multiple interfaces.
Beginning in the third quarter of 1997, the Company intends to reduce certain of
the fees that it charges hotels for transmitting status messages. See "Risk
Factors -- Competition --Electronic Hotel Room Reservation Processing Service."
Pegasus derives its revenues from its HCC service by charging a
participating travel agency a fee based on a percentage of the dollar amount of
commissions paid to that agency through the HCC service. The Company also
generally charges a participating hotel a fee based on the number of
commissionable transactions arising from that hotel. Revenues from HCC travel
agency fees can vary substantially from period
20
<PAGE> 23
to period based on the fluctuations of the average daily room rates. Pegasus
recognizes revenues from its HCC service in the month in which the hotel stay
occurs and collects and pays commissions to travel agencies by the 15th business
day of the following month. If a hotel fails to deliver funds to the Company,
the Company is not obligated to deliver commission payments on behalf of the
hotel to travel agencies. HCC revenues also include amortization of a $2.0
million payment received by the Company in June 1993 in exchange for a five-year
noncancelable data processing contract. This payment was initially recorded as
unearned income and is being recognized as revenue over the life of the
contract. The amount recognized in 1996 was $431,000. See Note 11 of Notes to
Consolidated Financial Statements.
The Company offers two services, TravelWeb and NetBooker, that provide
hotel reservation capability to individual travelers through the Internet.
During 1996, Pegasus derived the substantial majority of its TravelWeb revenues
from fees related to the creation of Web pages for hotels and for maintaining
these pages on the TravelWeb site. During 1997, the Company is transitioning its
fee structure to begin charging participating hotels subscription fees based on
the number of their properties included in the database and transaction fees
based on the number of net reservations made at their properties through the
TravelWeb service. The Company is not in a position to forecast the effect that
this change in fee structure will have on its TravelWeb revenues. There can be
no assurance that such a change will not have a material adverse effect on the
Company's financial condition and results of operations. The Company also
derives revenues through the sale of advertising space on the TravelWeb site.
Pegasus realizes revenues from NetBooker, the Company's hotel room reservation
service provided to third-party Web sites, by charging third-party Web sites an
initial development and licensing fee and by charging hotels a fee based on the
number of net reservations made through the NetBooker service. The Company has
not received a material amount of revenues for the TravelWeb service or the
NetBooker service to date, and there can be no assurance that either of these
services will produce a material amount of revenues in the future. See "Risk
Factors -- Competition" and "-- Dependence on Growth of Internet Commerce."
The Company has developed or is in the process of developing several new
services, including UltraRes, UltraDirect and Pegasus Information Services, to
capitalize on its existing technology and customer base to provide additional
electronic hotel reservation capabilities and information services to existing
Pegasus customers and to other participants in the hotel room distribution
process. The Company intends to derive revenues from UltraRes, a service that
automates the processing of hotel bookings for large meetings and conventions,
by charging participating hotels and meeting organizers transaction-based fees
for net reservations made. The Company intends to derive revenues from
UltraDirect, a service that automates the hotel room reservation process for
corporate travelers, by charging hotels transaction-based fees for net
reservations. The Company has not received any material revenues for any of
these services, and there can be no assurance that any of these services will
produce a material amount of revenues in the future. See "Risk Factors --
Competition" and "-- Impact of Technological Advances; Delays in Introduction of
New Services."
The Company's future success will depend, in part, on its ability to
develop leading technology, enhance its existing services, develop and introduce
new services that address the increasingly sophisticated and varied needs of its
current and prospective customers, and respond to technological advances and
emerging industry standards and practices on a timely and cost-effective basis.
Although the Company strives to be a technological leader, there can be no
assurance that future advances in technology will be beneficial to, or
compatible with, the Company's business or that the Company will be able to
economically incorporate such advances into its business. In addition, keeping
abreast of technological advances in the Company's business may require
substantial expenditures and lead time. There can be no assurance that the
Company will be successful in effectively using new technologies, adapting its
services to emerging industry standards or developing, introducing and marketing
service enhancements or new services, or that it will not experience
difficulties that could delay or prevent the successful development,
introduction or marketing of these services. If the Company incurs increased
costs or is unable, for technical or other reasons, to develop and introduce new
services or enhancements of existing services in a timely manner in response to
changing market conditions or customer requirements, or if new services do not
achieve market acceptance, the Company's financial condition and results of
operations could be materially adversely affected. See "Risk Factors -- Impact
of Technological Advances; Delays in Introduction of New Services."
21
<PAGE> 24
The Company's cost of services consists principally of: (i) personnel costs
relating to information technology; (ii) facilities and equipment maintenance
costs; and (iii) fees paid to Citicorp for the processing of 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. Most of these expenses, by their nature, do not fluctuate directly with
net revenues on a short-term basis. Marketing and promotion expenses consist
primarily of personnel costs, advertising, public relations and participation in
trade shows and other industry events. The Company anticipates that it will
incur substantially higher marketing costs in the foreseeable future due to the
Company's plan to spend heavily on promotional activities in support of its
TravelWeb service. Depreciation and amortization expense includes: (i) computer
equipment depreciation; (ii) office furniture, equipment and leasehold
improvement depreciation expense; (iii) amortization of software, including
software acquired as part of the acquisition of HCC; and (iv) goodwill
amortization. Interest expense includes notes payable to certain stockholders of
the Company and payments made under capital equipment leases. Minority interest
represents certain former minority interests in subsidiaries that have been
wholly owned by the Company since June 1996. See Notes 1, 2, 3 and 7 of Notes to
Consolidated Financial Statements.
All costs incurred in the internal development of computer software used in
the delivery of the Company's services are expensed until a product design and a
working model of the software have been tested and completed. Thereafter, any
further development or production costs are capitalized. Maintenance and
customer support costs are expensed as incurred. Prior to 1996, the capitalized
development 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 internally and externally developed computer software to three years. The
result of such change in estimated life was to increase net losses for 1996 by
approximately $292,000. See Note 1 of Notes to Consolidated Financial
Statements.
In July 1995, the Company acquired 83.3% of outstanding capital stock of
HCC in exchange for 2,242,800 shares of the Common Stock for an aggregate
purchase price of $2.7 million, resulting in a $6.5 million excess of purchase
price over net assets acquired. At the time of the acquisition, $1.2 million was
allocated to research and development that had not reached technological
feasibility and had no probable alternative future use, and this amount was
expensed in the quarter ending September 30, 1995. At the time of the
acquisition, $3.5 million was allocated to software which is being amortized
over a three year period ending in June 1998, and the balance of the purchase
price, $1.7 million, was recorded as excess of cost over the fair value of net
assets acquired (goodwill) and is being amortized on a straight line basis
through June 2010. In June 1996, the Company purchased the remaining 16.7% of
outstanding capital stock of HCC in exchange for $2.0 million and 89,733 shares
of Common Stock, resulting in an $833,000 excess of purchase price over net
assets acquired. At the time of the acquisition of this minority interest,
$245,000 was allocated to research and development that had not reached
technological feasibility and had no probable alternative future use, and this
amount was expensed in the quarter ending June 30, 1996. At the time of the
acquisition of the 16.7% interest in June 1996, $469,000 was allocated to
software which is being amortized over a two year period ending in June 1998 to
correspond to the amortization period of the software relating to the
acquisition that occurred in July 1995, and the balance of the purchase price,
$119,000, was recorded as excess of cost over the fair value of net assets
acquired (goodwill) and is being amortized on a straight line basis through June
2010 to correspond to the amortization period of the goodwill relating to the
acquisition that occurred in July 1995. See Notes 1, 2 and 3 of Notes to
Consolidated Financial Statements.
The Company has recorded unearned compensation and compensation expense for
the difference between the exercise price and the deemed fair value of the
Company's Common Stock with respect to 503,333 shares issuable upon exercise of
options granted in 1996. These amounts are initially recorded as unearned
compensation and amortized to cost of services and general and administrative
expense over the vesting periods of the options, generally four years. Unearned
compensation amortized to expense in 1996 was $65,000. Amortization of unearned
compensation will adversely affect the Company's reported operating results
through the third quarter of 2000. See Note 9 of Notes to Consolidated Financial
Statements.
As of December 31, 1996, the Company had net operating loss carryforwards
for federal income tax purposes of approximately $14.6 million, which expire in
various years beginning in 2003. The net deferred tax
22
<PAGE> 25
asset is fully reserved because of uncertainty regarding its realizability. See
Note 10 of Notes to Consolidated Financial Statements.
In connection with its efforts to continue its growth, in both its
traditional and recently introduced service offerings, the Company anticipates
significantly increasing the size of its information technology and sales and
marketing organizations. Because certain of the costs related to the
introduction of such new service offerings are largely fixed in nature, and as a
result of spending on development and marketing of such new service offerings,
the Company has not realized in the past, and anticipates that it will not
realize in the foreseeable future, gross margins on the provision of such
recently introduced services comparable to the gross margins it realizes on its
THISCO and HCC service offerings. Such lower gross margin contribution from
newly introduced service offerings and the associated marketing and development
expenses have been significant components of the losses incurred by the Company
and are expected to continue to have a detrimental effect on the Company's
operating results for the foreseeable future. The Company has experienced
substantial net losses, including a net loss of $3.5 million in 1996, and had an
accumulated deficit of approximately $14.6 million as of December 31, 1996. The
Company anticipates that its operating expenses will increase substantially in
the foreseeable future as it continues the development of its services,
increases its sales and marketing activities and expands its distribution
channels. To achieve profitability, the Company must successfully implement its
business strategy and increase its revenues while controlling expenses. There
can be no assurance as to when or if the Company will achieve profitability.
There also can be no assurance that if the Company continues to expand,
management will be effective in attracting and retaining additional qualified
personnel, expanding the Company's physical facilities or otherwise managing
growth. In addition, there can be no assurance that the Company's systems,
procedures or controls will be adequate to support any expansion of the
Company's operations. The Company's inability to manage growth effectively could
have a material adverse effect on the Company's financial condition and results
of operations. See "Risk Factors -- Substantial Net Losses," "-- Risks
Associated with Management of Growth" and "-- Dependence on Key Personnel."
All statements contained in this Prospectus other than statements of
historical fact, including statements in this "Management's Discussion and
Analysis of Financial Condition and Results of Operations" concerning the
Company's financial position and liquidity, results of operations, prospects for
continued growth, ability to maintain or improve transaction volumes, net sales
or profit margins and other matters are forward-looking statements. Although the
Company believes that the expectations reflected in such forward-looking
statements are reasonable, no assurance can be given that such expectations will
prove correct. Factors that could cause the Company's results to differ
materially from the results discussed in or contemplated by such forward-looking
statements include the risks described under "Risk Factors," including without
limitation substantial net losses, competition, dependence on the hotel
industry, consolidation trends, fluctuations in quarterly operating results,
potential adverse changes in hotel commission payments, control by existing
stockholders, conflicts of interest, dependence on growth of Internet commerce,
system interruption and security risks, impact of technological advances, delays
in introduction of new services, dependence on key customers and third-party
service arrangements, government regulation, management of growth, international
expansion and operations, dependence on key personnel, dependence on proprietary
technology, infringement, potential acquisitions, year 2000 compliance,
management's discretion as to use of unallocated net proceeds, benefits to
existing stockholders, future capital needs, uncertainty of additional
financing, shares eligible for future sale, immediate and substantial dilution,
anti-takeover matters, absence of a prior public market and potential volatility
of stock price. All forward-looking statements in this Prospectus are expressly
qualified in their entirety by the cautionary statements in this paragraph, in
"Risk Factors" and elsewhere in this Prospectus.
23
<PAGE> 26
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the percentage
relationship of certain items from the Company's statement of operations to net
revenues:
<TABLE>
<CAPTION>
PERCENTAGE OF NET REVENUES
-----------------------------------------
THREE MONTHS
YEAR ENDED ENDED
DECEMBER 31, MARCH 31,
----------------------- --------------
1994 1995 1996 1996 1997
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Net revenues............................... 100.0% 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Cost of services......................... 33.1 41.8 39.1 43.1 35.6
Research and development................. 5.1 9.0 12.4 16.5 14.2
Write-off of purchased in-process
research and development.............. -- 13.2 1.5 -- --
General and administrative expenses...... 22.8 29.8 23.9 18.2 19.5
Marketing and promotion expenses......... 2.8 9.8 17.8 16.9 19.8
Depreciation and amortization............ 32.6 26.6 21.6 23.9 16.2
----- ----- ----- ----- -----
Total operating expenses......... 96.4 130.2 116.3 118.6 105.3
----- ----- ----- ----- -----
Operating income (loss).................... 3.6 (30.2) (16.3) (18.6) (5.3)
Other (income) expense:
Interest expense......................... 12.7 8.8 5.6 5.6 4.9
Interest income.......................... -- -- (0.7) -- (1.3)
----- ----- ----- ----- -----
Loss before income taxes and minority
interest................................. (9.1) (39.0) (21.2) (24.2) (8.9)
Income taxes............................... -- -- 0.1 -- --
----- ----- ----- ----- -----
Loss before minority interest.............. (9.1) (39.0) (21.3) (24.2) (8.9)
Minority interest.......................... -- 0.6 (0.7) (1.2) --
----- ----- ----- ----- -----
Net loss................................... (9.1)% (38.4)% (22.0)% (25.4)% (8.9)%
===== ===== ===== ===== =====
</TABLE>
RECENT OPERATING RESULTS
Net revenues increased by $1.1 million, or 26.9%, to $5.1 million in the
three months ended June 30, 1997 from $4.0 million in the three months ended
June 30, 1996. Net revenues increased as a result of growth in revenues of the
THISCO and HCC services. This increase in net revenues was offset by a decline
in revenues from the TravelWeb service resulting primarily from the Company's
transitioning its hotels participating in the TravelWeb service to a
subscription fee arrangement and the Company's increasing reliance on
subscription fees and recurring transaction fees in the TravelWeb service rather
than page building and set-up fees. Operating expenses increased $214,000, or
4.5%, to $5.0 million in the three months ended June 30, 1997 from $4.8 million
in the three months ended June 30, 1996. This increase was primarily a result of
higher research and development expenses relating to the development of
TravelWeb and higher marketing and promotion expenses relating to the promotion
of the TravelWeb service and to a lesser extent the promotion of the THISCO and
HCC services. Net loss decreased $928,000, or 91.0%, to $93,000 in the three
months ended June 30, 1997 from $1.0 million in the three months ended June 30,
1996. For the three months ended June 30, 1997, net cash provided by operating
activities amounted to $643,000. The Company's principal sources of liquidity at
June 30, 1997 included cash and cash equivalents of $2.9 million, short term
investments of $493,000 and restricted cash of $1.0 million, which represents
funds for travel agency commission checks that have not cleared HCC's processing
bank and are returned to HCC. Any such amounts which are not remitted to travel
agencies will be escheated to the appropriate state, as required.
24
<PAGE> 27
THREE MONTHS ENDED MARCH 31, 1996 AND 1997
Net revenues. Net revenues increased by $573,000, or 15.1%, to $4.4 million
in the three months ended March 31, 1997 from $3.8 million in the three months
ended March 31, 1996. THISCO revenues increased as a result of a 17.8% increase
in net reservations made in the three months ended March 31, 1997 as compared to
the three months ended March 31, 1996. Additionally, the average fee paid by
hotels using the THISCO service increased during the three months ended March
31, 1997 as a result of an increase in total status messages processed. HCC
revenues grew as a result of a 12.3% increase in hotel commission transactions
processed during the three months ended March 31, 1997 as compared to the three
months ended March 31, 1996 due in part to the addition of hotel properties and
travel agencies participating in the HCC service. The net revenues to the
Company per commissionable transaction increased in the three months ended March
31, 1997 because of an increase in overall hotel average daily rates. Revenues
contributed by the TravelWeb service declined 51.5% in the three months ended
March 31, 1997 as compared to the three months ended March 31, 1996. This
decrease resulted primarily from the Company's transitioning its hotels
participating in the TravelWeb service to a subscription fee arrangement and the
Company's increasing reliance on subscription fees and recurring transaction
fees rather than page building and set-up fees.
Cost of services. Cost of services was consistent at $1.6 million in the
three months ended March 31, 1997 compared to the three months ended March 31,
1996. Costs of services related to the Company's THISCO and HCC services did not
change materially for the period, reflecting the relatively high fixed-cost
component of providing these services.
Research and development. Research and development expenses decreased
$4,000, or 0.7%, to $623,000 in the three months ended March 31, 1997 from
$627,000 in the three months ended March 31, 1996.
General and administrative expenses. General and administrative expenses
increased $164,000, or 23.6%, to $856,000 in the three months ended March 31,
1997 from $692,000 in the three months ended March 31, 1996. This increase was
due to greater office related costs and personnel costs.
Marketing and promotion expenses. Marketing and promotion expenses
increased $221,000, or 34.4%, to $865,000 in the three months ended March 31,
1997 from $644,000 in the three months ended March 31, 1996. Marketing and
promotion expenses grew primarily due to the promotion of the TravelWeb service
and to a lesser degree the promotion of the THISCO and HCC services.
Depreciation and amortization. Depreciation and amortization expenses
decreased $202,000, or 22.2%, to $707,000 in the three months ended March 31,
1997 from $909,000 in the three months ended March 31, 1996. This decrease was
primarily due to the completion in 1996 of the amortization of previously
capitalized software.
Interest expense. Interest expense remained unchanged at $212,000. The
expense reflects interest accrued on promissory notes payable to certain
stockholders of the Company and payments made under capital equipment leases.
Interest income. During the three months ended March 31, 1997 the Company
realized $56,000 in interest income as a result of short term investments of
operating cash balances on the proceeds from the sale of shares of the Company's
Series A Preferred Stock in June 1996.
YEARS ENDED DECEMBER 31, 1995 AND 1996
Net revenues. Net revenues increased by $6.6 million, or 70.7%, to $15.9
million in 1996 from $9.3 million in 1995. THISCO revenues increased as a result
of a 27.0% increase in net reservations made in 1996 as compared to 1995.
Additionally, the average fee paid by hotels using the THISCO service increased
during 1996 as a result of an increase in total status messages processed. HCC
revenues grew as a result of the acquisition by the Company of HCC in July 1995
and the subsequent growth in hotel commission transactions processed due, in
part, to the addition of hotel properties and travel agencies participating in
the HCC service. The net revenues to the Company per commissionable transaction
increased in 1996 because of a change in the hotel customer mix and an increase
in overall hotel average daily rates. To the extent that the total volume
25
<PAGE> 28
of commissions processed by the HCC service increases, the average ratio of net
revenue to total commissions collected will decrease. Revenues contributed by
the TravelWeb service increased 57.6% in 1996 as compared to 1995, which
resulted primarily from amounts charged to hotels for Web page building and
maintenance fees and less significantly from advertising and promotions and from
fees charged to hotels for net reservations processed through the TravelWeb
service. Beginning in 1997, Pegasus is transitioning its hotels participating in
the TravelWeb service to a subscription fee arrangement, whereby, in addition to
paying fees for net reservations made through this service, participating hotels
will remit monthly fees per property listing in the TravelWeb service. See
"-- Overview."
Cost of services. Cost of services increased $2.3 million, or 59.7%, to
$6.2 million in 1996 from $3.9 million in 1995. This increase was due to the
acquisition by the Company of HCC in July 1995 and operating expenses for
TravelWeb, including expenses for contract Web site page building, software
development and the employment of additional technical personnel.
Research and development; Write-off of purchased in-process research and
development. Research and development expenses increased $143,000, or 6.9%, to
$2.2 million in 1996 from $2.1 million in 1995. After eliminating the effect of
the one-time charges taken in 1995 and 1996 for research and development
expenses relating to the acquisition of HCC, research and development expenses
increased $1.2 million, or 133%, to $2.0 million in 1996 from $840,000 in 1995.
This increase was due to increased development expenses primarily related to
TravelWeb.
General and administrative expenses. General and administrative expenses
increased $1.0 million, or 37.1%, to $3.8 million in 1996 from $2.8 million in
1995. This increase was due to greater office-related costs, personnel costs,
legal and accounting fees and travel-related costs.
Marketing and promotion expenses. Marketing and promotion expenses
increased $1.9 million, or 209.6%, to $2.8 million in 1996 from $912,000 in
1995. As a percentage of net revenues, marketing and promotion expense increased
to 17.8% in 1996 from 9.8% in 1995. Marketing and promotion expenses grew
primarily due to the promotion of the TravelWeb service and to a lesser degree
the promotion of the THISCO and HCC services.
Depreciation and amortization. Depreciation and amortization expenses
increased $949,000, or 38.3%, to $3.4 million in 1996 from $2.5 million in 1995.
In 1996, the Company changed the estimated life of capitalized software from
five years to three years. The effect of this change was to increase
depreciation by $292,000 in 1996. Also, in 1996 the Company recognized a full
year of amortization of software and goodwill relating to the Company's
acquisition in July 1995 of 83.3% of the outstanding capital stock of HCC and
began to amortize software and goodwill that resulted from the purchase by the
Company in June 1996 of the remaining 16.7% of the outstanding capital stock of
HCC.
Interest expense. Interest expense increased $77,000, or 9.5%, to $893,000
in 1996 from $816,000 in 1995. The expense includes interest accrued on
promissory notes payable to certain stockholders of the Company and payments
made under capital equipment leases.
Interest income. During 1996, the Company realized $114,000 in interest
income as a result of short term investments of operating cash balances on the
proceeds from the sale of shares of the Company's Series A Preferred Stock in
June 1996.
Income taxes. Income taxes reflect foreign income taxes payable with
respect to the taxable earnings of the Company's United Kingdom subsidiary,
which reports earnings on a cost-plus basis. Currently, the United Kingdom
office reports taxable earnings equal to 10.0% of the total operating cost of
the office.
YEARS ENDED DECEMBER 31, 1994 AND 1995
Net revenues. Net revenues increased $4.6 million, or 99.2%, to $9.3
million in 1995 from $4.7 million in 1994. This increase was due in part to the
acquisition by the Company of HCC in July 1995 and its subsequent growth and to
the growth in the THISCO service. Revenues from the THISCO service increased
approximately 15.5% primarily as a result of growth in net reservations, which
was due to increased use of the
26
<PAGE> 29
service by the Company's existing customer base and the addition of new
customers. During 1995, the average fee paid per THISCO transaction by hotels
decreased as a result of a 15% reduction (effective July 1, 1994) in net
reservation fees charged to hotels. Revenues for the TravelWeb service increased
primarily as a result of Web page building and maintenance fees charged to
hotels in connection with the commencement of the TravelWeb service in July
1994.
Cost of services. Cost of services increased $2.4 million, or 151.1%, to
$3.9 million in 1995 from $1.5 million in 1994. Operating expense as a
percentage of sales increased to 41.8% in 1995 from 33.1% in 1994. This increase
was due to the acquisition by the Company of HCC in July 1995 greater personnel
costs from the growth in the number of technical personnel employed by Pegasus,
costs incurred in connection with an upgrade of hardware used in the Company's
UltraSwitch technology, expenses incurred with respect to Web page building and
costs related to the acquisition by the Company of HCC and other organizational
matters. See Note 2 of Notes to Consolidated Financial Statements.
Research and development; Write-off of purchased in-process research and
development. Research and development expenses increased $1.8 million, or
766.2%, to $2.1 million in 1995 from $238,000 in 1994. This increase was due to
a $1.2 million write-off of in-process research and development related to the
Company's acquisition of 83.3% of the outstanding capital stock of HCC and to
THISCO, TravelWeb and HCC software development.
General and administrative expenses. General and administrative expenses
increased $1.7 million, or 160.1%, to $2.8 million in 1995 from $1.1 million in
1994. This increase was due to acquisition by the Company of HCC and other
organizational matters, higher office costs and greater personnel costs arising
from increases in number of personnel.
Marketing and promotion expenses. Marketing and promotion expenses
increased $782,000, or 599.2%, to $912,000 in 1995 from $130,000 in 1994.
Marketing and promotion expenses grew primarily due to the promotion of the
TravelWeb service.
Depreciation and amortization. Depreciation and amortization increased
$958,000, or 63.1%, to $2.5 million in 1995 from $1.5 million in 1994. As a
percentage of sales, depreciation and amortization decreased to 26.6% in 1995
from 32.6% in 1994. The increase in depreciation and amortization is related to
new hardware purchased for the Company's UltraSwitch technology in 1995 and
amortization of software and goodwill related to the Company's acquisition of
83.3% of the outstanding capital stock of HCC in 1995.
Interest expense. Interest expense increased $225,000, or 38.0%, to
$816,000 in 1995 from $591,000 in 1994. Interest expense includes interest
accrued on certain promissory notes payable to stockholders of the Company and
payments made under capital equipment leases. The increase in interest expense
was primarily related to the new hardware purchased for the Company's
UltraSwitch technology, which was financed through a lease in 1995.
27
<PAGE> 30
SELECTED QUARTERLY RESULTS OF OPERATIONS
The following table sets forth certain unaudited statement of operations
data for each of the Company's last eight quarters ended March 31, 1997, as well
as such data expressed as a percentage of the Company's total net revenues for
the periods indicated. This data has been derived from the Company's unaudited
financial statements that, in management's opinion, include all adjustments
(consisting only of normal recurring adjustments) necessary for a fair
presentation of such information when read in conjunction with the audited
Consolidated Financial Statements of the Company and the Notes thereto appearing
elsewhere in this Prospectus. The Company believes that quarter-to-quarter
comparisons of its financial results are not necessarily meaningful and should
not be relied upon as any indication of future performance. See "Risk
Factors -- Fluctuations in Quarterly Operating Results."
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------------------------------------------
JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31,
1995 1995 1995 1996 1996 1996 1996 1997
-------- --------- -------- -------- -------- --------- -------- --------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues............................ $1,556 $ 2,966 $ 3,337 $3,803 $ 4,005 $3,976 $ 4,085 $4,377
Operating expenses:
Cost of services...................... 535 1,237 1,644 1,638 1,483 1,564 1,514 1,558
Research and development.............. 196 281 243 627 320 399 615 623
Write-off of purchased in-process
research and development............ -- 1,223 -- -- 245 -- -- --
General and administrative expenses... 442 1,009 1,008 692 1,120 913 1,074 856
Marketing and promotion expenses...... 34 426 387 644 693 647 840 865
Depreciation and amortization......... 445 797 849 909 924 769 824 707
------ ------- ------- ------ ------- ------ ------- ------
Total operating expenses........ 1,652 4,973 4,131 4,510 4,785 4,292 4,867 4,609
------ ------- ------- ------ ------- ------ ------- ------
Loss from operations.................... (96) (2,007) (794) (707) (780) (316) (782) (232)
Other (income) expense:
Interest expense...................... 217 195 218 212 188 221 272 212
Interest income....................... -- -- -- -- (4) (55) (55) (56)
------ ------- ------- ------ ------- ------ ------- ------
Loss before income taxes and minority
interest.............................. (313) (2,202) (1,012) (919) (964) (482) (999) (388)
Income taxes............................ -- -- -- -- -- -- 15 --
------ ------- ------- ------ ------- ------ ------- ------
Loss before minority interest........... (313) (2,202) (1,012) (919) (964) (482) (1,014) (388)
Minority interest....................... -- 65 (11) (48) (58) -- -- --
------ ------- ------- ------ ------- ------ ------- ------
Net loss................................ $ (313) $(2,137) $(1,023) $ (967) $(1,022) $ (482) $(1,014) $ (388)
====== ======= ======= ====== ======= ====== ======= ======
Pro forma net loss per share............ $(0.14) $ (0.15) $(0.06) $ (0.13) $(0.05)
====== ======= ====== ======= ======
Weighted average shares used in the pro
forma net loss per share
calculation........................... 6,826 6,834 7,572 7,572 7,481
Supplemental pro forma net loss per
share(1).............................. $(0.11) $ (0.12) $(0.04) $ (0.11) $(0.03)
====== ======= ====== ======= ======
Weighted average shares used in the
supplemental pro forma net loss per
share calculation(1).................. 7,360 7,371 8,111 8,113 8,006
</TABLE>
<TABLE>
<CAPTION>
Percentage of Net Revenues
---------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues............................ 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Cost of services...................... 34.4 41.7 49.3 43.1 37.0 39.3 37.0 35.6
Research and development.............. 12.6 9.5 7.3 16.5 8.0 10.0 15.0 14.2
Write-off of purchased in-process
research and development............ -- 41.2 -- -- 6.1 -- -- --
General and administrative expenses... 28.4 34.0 30.2 18.2 28.0 23.0 26.3 19.6
Marketing and promotion expenses...... 2.2 14.3 11.6 16.9 17.3 16.3 20.6 19.8
Depreciation and amortization......... 28.6 26.9 25.4 23.9 23.1 19.3 20.2 16.1
------ ------- ------- ------ ------- ------ ------- ------
Total operating expenses........ 106.2 167.6 123.8 118.6 119.5 107.9 119.1 105.3
------ ------- ------- ------ ------- ------ ------- ------
Loss from operations.................... (6.2) (67.6) (23.8) (18.6) (19.5) (7.9) (19.1) (5.3)
Other (income) expense:
Interest expense...................... 13.9 6.6 6.5 5.6 4.7 5.6 6.7 4.8
Interest income....................... -- -- -- -- (0.1) (1.4) (1.3) (1.2)
------ ------- ------- ------ ------- ------ ------- ------
Loss before income taxes and minority
interest.............................. (20.1) (74.2) (30.3) (24.2) (24.1) (12.1) (24.5) (8.9)
Income taxes............................ -- -- -- -- -- -- 0.3 --
------ ------- ------- ------ ------- ------ ------- ------
Loss before minority interest........... (20.1) (74.2) (30.3) (24.2) (24.1) (12.1) (24.8) (8.9)
Minority interest....................... -- 2.2 (0.3) (1.2) (1.4) -- -- --
------ ------- ------- ------ ------- ------ ------- ------
Net loss................................ (20.1)% (72.0)% (30.6)% (25.4)% (25.5)% (12.1)% (24.8)% (8.9)%
====== ======= ======= ====== ======= ====== ======= ======
</TABLE>
- ------------------------------
See footnote on following page.
28
<PAGE> 31
(1) Supplemental pro forma net loss per share is based on the weighted average
number of shares of Common Stock used in the calculation of pro forma net
loss per share, plus the shares that the Company would have had to issue in
the offering to repay indebtedness outstanding under notes payable to
certain stockholders of the Company. For purposes of computing supplemental
pro forma net loss per share, the pro forma net loss was reduced by the
elimination of related interest expense on such notes payable. See "Use of
Proceeds," Note 1 of Notes to Consolidated Financial Statements and Note 4
of Notes to Consolidated Interim Financial Statements (Unaudited).
The Company 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 the Company's results of operations
to the extent such increases are not passed along to customers.
LIQUIDITY AND CAPITAL RESOURCES
The Company has financed its cash requirements for operations and
investments in equipment primarily through private sales of capital stock,
borrowings from stockholders and capital lease financing. Cash flows from the
sale of capital stock amounted to $7.5 million in 1996, of which $2.0 million
was used to purchase a minority interest in a subsidiary and $235,000 was used
to repay notes payable to stockholders. Cash flows from the sale of capital
stock amounted to $571,000 in 1995.
Net cash provided by operating activities amounted to $979,000, $496,000
and $410,000 in 1994, 1995 and 1996, respectively, and net cash used by
operating activities amounted to $233,000 in the quarter ended March 31, 1997.
The negative cash flow experienced in the first quarter of the year is a result
of higher transaction fees charged to customers early in the year compared to
later in the year resulting in a greater receivable balance in early periods of
the year. See Note 1 of Notes to Consolidated Financial Statements. Net cash
used in investing activities for the purchase of software, furniture and
equipment amounted to $185,000, $639,000, $362,000 and $407,000 in 1994, 1995
and 1996 and the quarter ended March 31, 1997, respectively. In addition, the
Company purchased $2.7 million of marketable securities in 1996 and realized net
proceeds of $1.7 million in the three months ended March 31, 1997 from the
purchase and maturity of marketable securities.
The Company's principal sources of liquidity at December 31, 1996 included
cash and cash equivalents of $1.8 million, short term investments of $2.7
million and restricted cash of $690,000, which represents funds for travel
agency commission checks that have not cleared HCC's processing bank and are
returned to HCC. Any of such amounts which are not remitted to travel agencies
will be escheated to the appropriate state, as required.
The Company believes that the net proceeds from this offering, along with
current cash and cash equivalents, will be sufficient to fund its working
capital and capital expenditure requirements for at least the next twelve
months. Thereafter, if cash generated from operations is insufficient to satisfy
the Company's liquidity requirements, the Company may seek to issue additional
equity or debt securities or establish a credit facility. The issuance of
additional equity or convertible debt securities could result in additional
dilution to the Company's stockholders. There can be no assurance that financing
will be available to the Company in amounts or on terms acceptable to the
Company. Although the Company has no material commitments for capital
expenditures, it anticipates purchasing approximately $1.5 million of property
and equipment in 1997, primarily for computer equipment, furniture and fixtures.
Some portion of these capital expenditures may be financed through capital
leases. See "Risk Factors -- Future Capital Needs; Uncertainty of Additional
Financing."
RECENTLY ISSUED ACCOUNTING STANDARDS
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. 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. Accordingly, compensa-
29
<PAGE> 32
tion cost for stock options is measured as the excess, if any, of the fair
market value of the Company's stock at the date of the grant over the amount the
employee must pay to acquire the stock.
In February 1997, Statement of Financial Accounting Standards No. 128,
"Earnings per Share" (FAS 128), was issued. FAS 128 specifies the computation,
presentation and disclosure requirements for earnings per share ("EPS") for
entities with publicly held common stock or potential common stock. FAS 128
simplifies the standards for computing EPS previously found in Accounting
Principles Board Opinion No. 15, "Earnings per Share" (APB 15), and makes them
comparable to international EPS standards. It replaces the presentation of
primary EPS with a presentation of basic EPS. It also requires dual presentation
of basic and diluted EPS on the face of the statement of operations for all
entities with complex capital structures and requires a reconciliation of the
numerator and denominator of the basic EPS computation to the numerator and
denominator of the diluted EPS computation. FAS 128 is effective for financial
statements issued for periods ending after December 15, 1997, including interim
periods; earlier application is not permitted. FAS 128 requires restatement of
all prior-period EPS data presented. The Company will adopt FAS 128 in its
consolidated financial statements as of and for the year ending December 31,
1997 and, based on current circumstances, does not believe the effect of
adoption will be material.
30
<PAGE> 33
BUSINESS
OVERVIEW
Pegasus is a leading provider of transaction processing services to the
hotel industry worldwide. The Company's THISCO and TravelWeb hotel room
reservation 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. The Company's HCC service, the global leader in hotel commission
payment processing, improves the efficiency and effectiveness of the commission
payment process for participating hotels and travel agencies by consolidating
payments and providing comprehensive transaction reports. The Company's services
benefit many of the participants in the hotel room distribution process,
including hotels, hotel representation firms, Global Distribution Systems
("GDSs"), travel agencies, convention and other large meeting organizers,
corporate travel departments and Web sites with travel-related features. In 1996
approximately 51.3% of the Company's consolidated revenues was derived from its
hotel reservation processing services, including 42.5% from the THISCO service
and 8.8% from the TravelWeb service, and approximately 48.7% was derived from
its HCC service.
The Company's electronic interface business for hotel room reservations was
established in 1989 by 16 leading hotel and travel-related companies to address
the need for a neutral, reliable third-party source of hotel reservation
information and transaction processing services. The Company's commission
processing business was founded by substantially the same stockholder group in
1991. Today, the Company's stockholders include 11 of the 15 leading hotel
chains in the world based on 1996 total revenues. The Company's strategic
position as a gateway in the hotel room distribution chain, transaction
processing capabilities and reputation for reliability and neutrality enable it
to offer a range of services delivering industry-wide benefits that would be
difficult for any of the participants to achieve individually. Over the past
several years, the Company has expanded its services to include virtually all
electronic distribution channels through which hotel room reservations are made.
Over 25,000 hotel properties worldwide, including those of 13 of the 15
leading hotel chains in the world based on 1996 total revenues, currently
participate in the Company's THISCO service. The number of net reservations
booked through the THISCO service has increased to approximately 13.9 million in
1996 from 1.1 million in 1990.
TravelWeb provides individual travelers direct access to more than 40,000
dynamically served pages of online hotel information and the ability to make
reservations at approximately 13,000 hotel properties in 140 countries. In June
1997, a daily average of approximately 30,000 Internet users visited the
TravelWeb site. The Company's NetBooker service offers operators of third-party
Web sites the same comprehensive information contained on TravelWeb and a simple
and fast method of making a hotel reservation online.
The THISCO and TravelWeb services utilize the Company's UltraSwitch
technology. This technology can facilitate the distribution of hotel rooms
through virtually all of the automated distribution channels by offering hotels
a single, seamless electronic interface to:
- over 120,000 travel agencies through all of the leading GDSs;
- individual travelers directly through the Internet;
- third-party Web sites;
- convention and other large meeting organizers; and
- corporate travel departments through travel management software and
service providers.
Pegasus provides the HCC commission processing service to over 64,000
travel agencies and 11,000 hotel properties worldwide. In 1996, the Company
processed over $111.7 million in gross commission payments, an increase of 49.9%
as compared to 1995, including commission payments made in 1995 prior to the
acquisition of HCC by Pegasus.
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<PAGE> 34
The Company charges for its services generally on a per-transaction or
commission basis. The Company has increased its revenue at a compound annual
growth rate of 54.4% to $15.9 million in 1996 from $2.8 million in 1992,
excluding 1992 revenues from the HCC service which was acquired in 1995. The
revenue growth has reflected growth in the THISCO service, the introduction of
the TravelWeb service and the acquisition and growth of the HCC service. The
revenue growth in the THISCO service reflects the increasing number of
participating hotels and travel agencies that made reservations through the
THISCO service, the shift from manual to electronic hotel reservations and the
overall health in the hotel industry. The revenue growth in the HCC service
principally reflects growth in the dollar amount of hotel commission payments
processed by the Company as a result of an increase in the number of hotels and
travel agencies using the HCC service and higher average daily hotel room rates.
The Company believes it has numerous opportunities to continue its growth,
including: (i) adding members of the hotel and travel agency industries as
customers, in particular internationally where the Company's market share is
lower; (ii) addressing all of the emerging electronic distribution channels for
hotel rooms; (iii) providing customers access to comprehensive hotel industry
information and (iv) pursuing strategic relationships and acquisition
opportunities.
RECENT DEVELOPMENTS
In June 1997, Marriott, which is a customer of the Company's THISCO and
TravelWeb services, also became a customer of the Company's HCC service.
In May 1997, HFS renewed its participation in the Company's HCC service by
entering into a new long-term agreement with the Company.
In May 1997, the Company entered into a Distribution Services Agreement
with Holiday Inn, under which Holiday Inn, currently a customer in the Company's
HCC service, also will become a customer of the Company's THISCO, TravelWeb,
NetBooker, UltraDirect, and UltraRes services commencing in 1998. In May 1997,
the Company issued to Holiday Inn warrants to purchase 345,723 shares of Common
Stock. The warrants are exercisable at any time during the two year period
ending May 12, 1999 at an exercise price equal to the lower of $7.20 per share
or 85.0% of the price per share for the Common Stock offered hereby.
INDUSTRY BACKGROUND
The operations of the global hotel industry include a wide variety of
participants and a series of complex information and transaction flows.
According to the International Hotel Association, the global hotel industry
generated $247 billion in revenues in 1994. The Company believes that costs
associated with reserving and distributing hotel rooms, including commissions
paid to intermediaries, such as travel agencies and GDSs, hotel
reservation-related staffing costs and reservation system information technology
expenses, represent a significant proportion of total operating costs. The
Company's services simplify the complexity of room reservation information and
transaction flows, thereby reducing the distribution costs of rooms for the
hotel industry. The Company believes that revenues derived from electronically
booked hotel reservations will grow at a higher rate than overall hotel industry
revenues, as a greater number of hotels and travel agencies acquire electronic
booking capabilities.
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 multiple parties to 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 and consists of a number of relatively small payments to travel
agencies, often including payments in multiple currencies. In addition,
information regarding guest cancelations 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 telephoning or faxing a hotel to ascertain room
rates, features and availability and to make reservations. Increasingly,
individual travelers can
32
<PAGE> 35
conduct all aspects of this transaction through hotel and travel-related Web
sites. 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 GDS such as
SABRE, Galileo, System One or Worldspan. GDSs are global electronic travel
information and reservation systems that, among other things, maintain databases
of room rate, feature and availability information provided by hotels to which
they are connected. Because each GDS has a unique electronic interface to hotel
reservation systems, each GDS can obtain room information and book rooms only at
hotels that have developed protocols and message formats compatible with that
particular GDS.
A number of current trends are affecting the hotel industry. First, the
hotel industry has been shifting from manual to electronic means of making hotel
room reservations. According to a survey done for the Hotel Electronic
Distribution Network Association ("HEDNA") by Hospitality Technology Consulting,
30 million hotel room reservations were made electronically through GDSs in
1996. As more hotels become electronically bookable, the Company expects that
electronic hotel room reservations will grow substantially in the United States
and internationally over the next several years. Second, a small but growing
number of individual travelers are making hotel room reservations electronically
on the Internet. Third, smaller hotel chains and independent hotels increasingly
have affiliated with large 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 whom are the Company's stockholders and customers. Fourth, 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 and caps on commissions for airline reservations, which historically
have been the leading revenue source for travel agencies.
Because of the information-intensive and complex nature of the hotel room
reservation and commission payment processes, the Company believes a substantial
opportunity exists for an intermediary that can provide services to manage hotel
industry information and transaction flows among multiple parties. Effective,
neutral, third-party management of information and transaction flows improves
the ability of all participants in the hotel room distribution process to
conduct business on a seamless and automated basis by providing efficient and
real-time access to hotel information. To be effective in addressing the hotel
industry's needs, the provider of such services must have: (i) an in-depth
understanding of the business processes of participants involved in the
distribution of hotel rooms; (ii) a reputation for reliability and trusted
neutrality in the industry to bring otherwise competing constituencies together
for industry-wide benefits; (iii) participation by a critical mass of hotels and
participants in the electronic hotel room distribution process and (iv)
expertise in leading technology applications. By acting as a gateway for
information and transaction flows, such a provider of services would be well
positioned to improve the efficiency and effectiveness of the distribution of
hotel rooms, the processing of travel agency commission payments and the
gathering and distribution of hotel industry information.
THE PEGASUS SOLUTION
The Company provides information and transaction processing services that
improve the efficiency and effectiveness of the hotel room reservation and
commission payment processes. The Company's THISCO and TravelWeb services
enhance the electronic hotel room reservation process by providing a standard,
common electronic interface that enables individual travelers and intermediaries
to access hotel room inventory information and conduct reservation transactions.
The Company's HCC service 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
providing comprehensive transaction reports. The Company has developed an
in-depth understanding of the technical and business processes involved in hotel
room reservations and commission payment processing. The Company's strategic
position as a gateway in the hotel room distribution chain, transaction
processing capabilities and reputation for reliability and neutrality enable it
to offer a range of services delivering industry-wide benefits that would be
difficult for any industry participant to achieve individually.
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<PAGE> 36
The Company's current services and services in development generally fall
into three categories: electronic hotel room reservation services, commission
payment processing services and information services. Depicted in the following
diagram are the Company's electronic hotel room reservation services and
commission payment processing services that are currently offered or in
development.
[PRODUCT DIAGRAM]
The Company's THISCO service is a leading provider of room reservation
processing services that electronically connect hotel central reservation
systems with other participants in the hotel room distribution process. Over
25,000 hotel properties worldwide, including those of 13 of the 15 leading hotel
chains based on 1996 total revenues currently utilize the THISCO service.
Furthermore, because the THISCO service provides a connection to each major GDS,
and through them over 120,000 travel agencies worldwide, as well as with
convention and other large meeting organizers, corporate travel departments and
emerging Internet travel services, the Company offers hotels an effective and
low cost single point of contact with all the major participants in the hotel
room distribution process. The THISCO service provides travel agencies greater
and easier access to real-time hotel information and the ability to make a
reservation and receive a confirmation in seconds. The THISCO service also
allows GDSs to offer fast confirmation for hotel room reservations made through
their systems, improved efficiency because of a single interface, access to
25,000 hotel properties worldwide and real-time availability of information.
Convention and other large meeting organizers, corporate travel departments and
others also are able to utilize the THISCO service to automate their hotel room
reservation process. Additionally, individual travelers can shop in real-time
and reserve hotel rooms directly by using either TravelWeb, the Company's own
Web site, or through a Web site that utilizes NetBooker, the Company's hotel
reservation service provided to third-party Web sites.
The Company's HCC commission processing service simplifies the payment of
travel agency hotel room commissions by over 11,000 participating hotel
properties to over 64,000 participating travel agencies worldwide. By
consolidating the payment of commissions and providing comprehensive transaction
reports, HCC enables hotels and travel agencies to increase efficiency and
reduce costs associated with preparing, paying and reconciling commissions.
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<PAGE> 37
The Company generally charges for its services on a per-transaction or
commission basis. The Company has the opportunity to earn revenue by processing
transactions through virtually all of the means by which electronic hotel room
reservations occur, whether or not a GDS is involved in the transaction.
STRATEGY
The Company's objective is to capitalize on its central position in the
hotel industry information and transaction flow in order to become the leading
provider of services and technology that enable the efficient and effective
electronic distribution of hotel rooms. To achieve this objective, the Company
intends to employ a strategy that includes the following key elements:
Expand Customer Base. The Company's established customer base includes
hotels, hotel representation firms, travel agencies, GDSs and third-party Web
sites. The Company intends to expand its customer base domestically and
internationally by adding customers and by cross-selling its new and existing
services to its current and future customers. Because of the fixed nature of
many of the Company's costs, the addition of new customers and the increase in
transaction volumes with new and existing customers enhances the profitability
of all of the Company's services.
Expand Hotel Room Distribution Channels. The Company is expanding its
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 through corporate intranets. The Company is addressing this online
distribution opportunity through increasing the capability and consumer
awareness of its TravelWeb site, expanding the use by third-party Web sites of
the Company's NetBooker service and providing services to corporate travel
departments through its UltraDirect service. The Company plans to capitalize on
the opportunity with convention and other large meeting organizers by providing
these distribution participants electronic access to hotel central reservation
systems through its UltraRes service. The Company's services are intended to
provide transaction fee revenue opportunities through virtually all of the
distribution channels by which electronic hotel room reservations occur.
Develop Hotel Industry Information Service. The Company intends to develop
an information service which will provide hotels and other industry participants
with hotel transaction information for use in strategic analysis, market
tracking and improved target marketing and revenue optimization. The Company's
proposed service is intended to utilize both information to which it currently
has access through the other services it provides and information it would
compile using its network of hotel industry relationships.
Build Strategic Alliances and Pursue Acquisition Opportunities. The Company
intends to build strategic alliances with other participants in the hotel
industry, as well as members of the financial information services, Internet and
information technology industries, to enhance the functionality and market
presence of the Company's services. The Company believes that these
relationships will increase brand recognition of its services and help to expand
its customer base. The Company will also seek to acquire assets, technology and
businesses that provide complementary services or access to new markets and
customers.
SERVICES
The Company's current services and services in development generally fall
into three categories: electronic hotel room reservation services, commission
payment processing services and information services. In 1996 approximately
51.3% of the Company's consolidated revenues was derived from its hotel
reservation services, including 42.5% from the THISCO service and 8.8% from the
TravelWeb service, and approximately 48.7% was derived from its HCC service.
35
<PAGE> 38
Hotel Room Reservation Services
The following table summarizes the hotel room reservation services the
Company has developed or is developing (including year of introduction):
<TABLE>
<S> <C> <C> <C>
HOTEL ROOM RESERVATION SERVICES
----------------------------------------------------------------------------------------------------------------
Services Users Benefits
--------------------------------
THISCO (1989) - Hotels and hotel - Improved efficiency because of single
representation firms interface
- Single interface between hotel
central reservation systems - Improved customer service due to
and GDSs utilized by travel frequent hotel room inventory updates
agencies
- Improved accessibility to wide
audience of travel agencies via GDSs
- GDSs and participating travel - Improved efficiency because of single
agencies interface
- Rapid confirmations
- Access to over 25,000 hotel properties
worldwide
- Real-time availability of information
TravelWeb - Hotels and hotel - Access to emerging low cost electronic
representation firms distribution channel
- Electronic hotel property
catalog (1994) - Reduced distribution costs
- Web-based hotel room - Inexpensive publication and
reservations (1995) distribution of comprehensive and up-to-
date hotel information and promotions
- More attractive presentation of hotel
information
- Individual travelers - Around the clock electronic access to
hotel reservation capability
- Ability to shop and gain convenient
access to approximately 13,000 hotel
properties with rich information
content, including rate, feature and
availability information
- Access to special promotional offers
NetBooker (1997 -- in - Hotels and hotel - Access to emerging low cost electronic
development) representation firms distribution channel
- Comprehensive hotel database - Reduced distribution costs
and hotel room reservation
capability tailored and fully - Inexpensive publication and
integrated into third-party distribution of comprehensive and up-to-
Web sites date hotel information and promotions
- More attractive presentation of hotel
information
- Wider distribution of hotel
information and access to individual
travelers through presence on multiple
Web sites
- Third-party Web sites - Low cost access to comprehensive hotel
information and proven online hotel
reservation functionality
- Increased site value due to wider
scope of services provided
- Advertising and transaction-based
revenue opportunities
UltraRes (1996) - Hotels and hotel - Improved accuracy of convention and
representation firms large meeting reservations
- Electronic hotel room
reservation connectivity for - Reduced costs by eliminating manual
convention and other large group reservation process
bookings
- Improved tracking of room inventory
- Convention and visitors - Improved reservation and cancellation
bureaus tracking and reporting capabilities
- Meeting planners - Single connection to multiple hotel
properties
- Group housing reservation
providers - Reduced costs by eliminating manual
reservation process
UltraDirect (1997 -- in - Hotels and hotel - Target marketing
development) representation firms
- Broadened distribution channel
- Direct electronic hotel room
reservation capability for - Improved ability to update corporate
corporate travel departments rate and availability information and
respond to reservation requests
- Reduced distribution costs for
corporate room sales
- Corporate travel departments - Reduced time and effort in making
hotel reservations
- Enforcement of corporate travel
policies and utilization of preferred
rates
- Improved travel information reporting
- Corporate travel agencies and - Account retention
related Web sites
- Low cost access to hotel information
and online booking functionality
- Reduced time and effort in making
hotel reservations
- Enforcement of corporate travel
policies and utilization of preferred
rates
- Improved travel information reporting
</TABLE>
36
<PAGE> 39
THISCO. The Company's THISCO service is a leading electronic hotel room
reservation processing service that interfaces communications concerning hotel
reservation information between all major GDSs and hotel central reservation
systems. According to HEDNA, approximately 30.0 million hotel room reservations
were made electronically through GDSs during 1996. During 1996, approximately
13.9 million hotel room reservations were made through THISCO. THISCO currently
connects central reservation systems representing over 25,000 participating
hotel properties to each major GDS and through them over 120,000 travel agencies
worldwide. The following table sets forth the number of THISCO net reservations
in each of the years 1990 through 1996.
THISCO
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
1990 1991 1992 1993 1994 1995 1996
------ ------ ------ ------ ------ ------ ------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C> <C>
Net reservations............ 1,145 3,498 5,012 6,481 8,373 10,963 13,947
Year-over-year growth
rate...................... 206% 43% 29% 29% 31% 27%
</TABLE>
THISCO enables a hotel to connect to all major GDSs without having to build
and maintain a separate interface for each GDS. Without THISCO or a similar
service, hotel chains that desire their room inventory to be accessible to
travel agencies electronically on a GDS must develop protocols and message
formats compatible with each GDS, 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. THISCO enables the processing of hotel room reservations and
also transmits millions of status messages sent by participating hotels every
day to update room rates, features and availability on GDS databases. Many
participating hotels also have chosen to utilize the Company's UltraSelect
service, which provides travel agencies using GDSs with direct access through
THISCO to a hotel's central reservation system bypassing the GDS databases to
obtain the most complete and up-to-date hotel room information available. See
"-- Technology and Operations."
Hotels using THISCO improve the efficiency of their central reservation
systems and reduce costs by not having to develop and maintain separate
communications circuits and translation software for each GDS. Through THISCO,
participating hotels are able to gain improved access to a wide audience of
travel agencies worldwide that are connected to GDSs and to provide better
customer service due to the ability to frequently update hotel room information
on GDS databases in a fast and reliable manner. THISCO benefits travel agencies
that use GDSs by providing real-time access to comprehensive hotel room
information and enabling them to make reservations and receive confirmations in
seconds from over 25,000 hotel properties worldwide.
Pegasus charges its hotel customers a fee based on the number of net
reservations processed through THISCO. In addition, hotels pay certain fees for
status messages sent to GDSs through THISCO. New participants in THISCO may be
charged one-time set-up fees for work associated with the implementation of the
interface with THISCO. The Company also charges certain GDSs a fee based on the
number of net reservations to compensate for the management and consolidation of
multiple interfaces. The technology used by THISCO also enables the Company to
enhance its revenue base by providing the information and reservation interface
for its other hotel reservation services, including TravelWeb, NetBooker,
UltraRes and UltraDirect.
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<PAGE> 40
TravelWeb. Located at www.travelweb.com, TravelWeb provides individual
travelers direct access to more than 40,000 dynamically served pages of online
hotel information and the ability to make reservations at approximately 13,000
hotel properties in 140 countries. In January 1997, TravelWeb was ranked as the
second most popular travel-related Web site, according to the P.C. Meter, L.P.,
a market research service. In June 1997, a daily average of approximately 30,000
Internet users visited the TravelWeb site. The following table sets forth the
number of net reservations made using the TravelWeb service in each of the past
four quarters since the Company introduced online reservation capabilities in
December 1995.
TRAVELWEB
<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31,
1996 1996 1996 1996 1997
-------- -------- --------- -------- --------
<S> <C> <C> <C> <C> <C>
Net reservations..................... 1,782 5,557 10,294 14,571 21,201
Quarter-over-quarter growth rate..... 212% 85% 42% 46%
</TABLE>
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 provides detailed information regarding a wide array of
hotel properties and, through its connection to the Company's THISCO service,
allows individual travelers to reserve a hotel room and receive a confirmation
in seconds. See "-- Technology and Operations."
TravelWeb benefits hotels, hotel representation firms and individual
travelers. TravelWeb reduces distribution costs for hotels and hotel
representation firms. TravelWeb also enables access to an emerging low cost
electronic distribution channel. In addition, TravelWeb 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 such information
using the Company's "remote author" feature. Additionally, the "Click-it!
Weekends" feature highlights weekend specials, enabling hotels to take advantage
of the real-time nature of the Internet to offer flexible pricing and to reach
individual travelers on a world-wide basis quickly and inexpensively. TravelWeb
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.
In addition to hotel room reservations, TravelWeb offers airline booking
capability through a GDS. TravelWeb allows users to check air fares, flight
times and availability and purchase airline tickets while online. All TravelWeb
air bookings are routed to a partner travel agency and ticketed and shipped by
FedEx at no extra cost to the traveler. TravelWeb also offers "The Resources
Center" which provides information and links for a variety of travel-related
services, such as food, shopping, area attractions and business services.
Hotel participants in TravelWeb pay the Company a monthly subscription fee
based on the number of their properties included in the database and a fee based
on the number of net reservations made through TravelWeb. The Company also began
to sell advertising space on TravelWeb during 1996, focusing on advertisers that
cater to travelers. The Company has not received a material amount of
transaction-based revenues for the TravelWeb service to date, and there can be
no assurance that this service will produce a material amount of revenues in the
future. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
NetBooker. The Company recently introduced a service for the operators of
third-party Web sites which combines TravelWeb's hotel information database and
THISCO's electronic interface capability to make hotel room reservations. To
conduct Internet-based electronic commerce successfully, Web site operators must
offer a content set which is sufficiently broad, accurate, up-to-date,
graphically appealing and useful to
38
<PAGE> 41
attract buyers to the Web site. 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 operator of a Web site must offer individual travelers the
capability to effect a transaction in order to generate a transaction fee. The
Company's NetBooker service offers operators of Web sites the same information
contained on TravelWeb and a simple and fast method of making a hotel room
reservation online. The Company's NetBooker service utilizes advanced technology
applications to customize the TravelWeb hotel database so that it appears to the
user to be an integral part of the third-party Web site. In connection with this
service, the operator of the third-party Web site establishes an interface to
the Company's THISCO service, which enables users of the Web site to shop and
query room availability, electronically make a reservation and receive a
confirmation in seconds. In August 1996, the Company entered into an agreement
with Preview Travel Inc. to provide its America Online users, as well as its Web
site users, direct access to the TravelWeb database and direct connections to
hotel central reservation systems. Recently, the Company entered into a similar
agreement with Internet Travel Network. See "-- Technology and Operations."
The Company's hotel customers benefit from its NetBooker service because it
enables a broader dissemination through the emerging, low cost Internet
distribution channel of the same marketing information supplied to TravelWeb. As
a result, hotels need only incur the effort and expense of creating and
maintaining their information on a single site to reach multiple Internet
distribution points and achieve increased overall visibility. Furthermore, the
NetBooker 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 Web sites also can have
their own content delivered to their sites from TravelWeb's database and process
reservation requests from their Web sites through the THISCO service. Users and
operators of third-party Web sites benefit from the NetBooker service through
immediate access to the rich content of TravelWeb. Furthermore, because users of
the third-party Web sites can book hotel rooms and receive confirmations in
seconds through the THISCO service, the Company's service affords the operators
of third-party Web sites the opportunity to generate a transaction fee revenue
stream.
The Company charges third-party Web sites an initial development and
licensing fee for the NetBooker service. For reservations made through the
NetBooker third-party Web sites, hotels pay the Company the same fee per net
reservation as for reservations made through TravelWeb. The Company has not
received a material amount of revenues for this service to date, and there can
be no assurance that this service will produce a material amount of revenues in
the future. See "Management's Discussion and Analysis of Financial Condition and
Results of Operations."
UltraRes. The Company recently introduced its UltraRes service, which
automates the processing of hotel room reservations for conventions and large
meetings. The process traditionally used to reserve hotel rooms for these events
is information-intensive and inefficient. Typically, convention and meeting
organizers request hotel reservations for blocks of rooms by fax, mail or
telephone. Hotels manually enter these reservations into their central
reservation systems and send confirmation numbers to the convention or meeting
organizers, and the meeting organizers manually enter the confirmation and
reservation information into their own systems. This process frequently leads to
inaccurate and delayed information and overbooking or underbooking. With the
Company's UltraRes service, convention and other large meeting organizers are
able to transfer reservation requests to the THISCO service electronically,
which translates the information to electronically book a room in each hotel
central reservation system. The UltraRes service eliminates the need to transfer
rooming lists for manual entry at the hotel and allows hotels to deliver
reservations and confirmations electronically in a fast and reliable manner. In
January 1997, the Company's UltraRes service was endorsed by the International
Association of Convention and Visitors Bureaus as the preferred standard for
electronic transmission of convention hotel reservations. See "-- Technology and
Operations."
The Company's UltraRes service can benefit all parties involved in the
distribution of hotel rooms for conventions and other large meetings. Since
reservations are made through the Company's THISCO service rather than manually,
reservations, modifications and cancellations can be received earlier and
updated more frequently and efficiently. The Company's UltraRes service provides
convention and other large meeting organizers a single connection to multiple
hotel properties and enables fast, accurate and reliable reservation
39
<PAGE> 42
and confirmation of hotel rooms at reduced cost. The Company's UltraRes service
also assists hotels in controlling their room inventory by reducing the risk of
overbooking or underbooking and allows hotels to reduce the cost of booking
related to convention reservations. The Company estimates that the majority of
these types of reservations were made at five major hotel chains (Hilton, Hyatt,
Marriott, Sheraton and Westin) whose facilities are designed for and cater to
large conventions and meetings. Because all five of these chains are THISCO
customers, the Company is positioned to take advantage of the existing
connectivity with these chains to facilitate the development and marketing of
the UltraRes service.
The Company will charge participating hotels and convention and other large
meeting organizers fees based on the number of net reservations made using the
UltraRes service. The Company introduced the UltraRes service in 1996 and since
then has processed approximately 35,000 hotel room reservations using this
service. The Company has not received a material amount of revenues for this
service to date, and there can be no assurance that this service will produce a
material amount of revenues in the future. See "Management's Discussion and
Analysis of Financial Condition and Results of Operations."
UltraDirect. The Company is developing its UltraDirect service for the
corporate travel management industry to provide a direct real-time link to the
Company's THISCO service through corporate intranet travel management software.
With the UltraDirect service, corporate travelers will be able to check
availability and make hotel reservations within seconds at hotel chains or
properties with which the traveler's employer has negotiated rates.
Traditionally, large companies have negotiated discounted hotel room rates with
hotel chains and properties to control their travel costs. However, because this
information at times is not available to a GDS, these rates frequently can only
be requested by a travel agency over the telephone. The UltraDirect service will
enable corporate travel departments of companies 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.
The UltraDirect 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. Pegasus markets this service to
developers of corporate travel software programs and to travel agencies that
operate intranet travel management services. UltraDirect 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 and utilize
hotels with whom the Company has negotiated rates.
The Company intends to charge hotels fees based on the number of net
reservations made using the UltraDirect service. The Company has reached an
agreement with TravelNet, Inc. (a division of Reed) that is designed to allow
users of TravelNet's Voyager travel management software system to access
UltraDirect for the purpose of making hotel reservations. When a corporate
traveler uses Voyager to make hotel arrangements, the Voyager system accesses
the UltraDirect service, which in turn connects to hotel central reservation
systems through the THISCO service. The Company has not received a material
amount of revenues for this service to date, and there can be no assurance that
this service will produce material revenues to the Company in the future. See
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
40
<PAGE> 43
Commission Processing Services
HCC. The Company's HCC service began operations in 1992 to process the
payment of hotel commissions to travel agencies. The following table summarizes
the commission processing and payment services offered by HCC:
<TABLE>
<S> <C> <C> <C>
- ------------------------------------------------------------------------------------------------------------------
COMMISSION PROCESSING SERVICE
- ------------------------------------------------------------------------------------------------------------------
Service Users Benefits
- ------------------------------------------------------------------------------------------------------------------
HCC (1992) - Travel agencies - Improved efficiency in reconciliation of commission
payments
- Commission processing
service: aggregates, - Reduced bookkeeping and banking costs
reports and disburses
hotel room reservation - Payment in preferred currency
commissions from hotels
to travel agencies - Improved information on customer reservation habits
- Assistance in reconciling commissions through
customer relation centers
- Hotels and hotel - Streamlined commission payment process
representation firms
- Reduced accounting, processing and bookkeeping costs
- Improved information regarding travel agency
bookings
- Encouragement of travel agency bookings at hotels
</TABLE>
The HCC service is the largest provider of travel agency commission and
processing services in the hotel industry. The Company has registered over
11,000 properties and over 64,000 travel agencies as HCC participants. During
1996, the Company processed more than six million commissionable transactions
using the HCC service, and the dollar amount of the commissions processed during
this period totaled approximately $111.7 million. The following table sets forth
the dollar amount of commissions processed during the year indicated:
HCC
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------
1992 1993 1994 1995 1996
-------- -------- -------- -------- --------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
Gross commissions processed......... $ 5,156 $ 23,559 $ 36,394 $ 74,547 $111,714
Year-over-year growth rate.......... 357% 54% 105% 50%
</TABLE>
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, consisting 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 because guest
cancellations or "no-shows" would frequently 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. In response to this problem, the Company developed the HCC service
to gather commission payment information, process that information and transmit
to travel agencies one consolidated check in the travel agency's currency of
choice, together with an information statement that enables the travel agency to
reconcile its hotel commission activity. See "-- Technology and Operations."
The Company's HCC service reduces a hotel's cost by streamlining the
commission payment process and consolidating into a single payment the aggregate
commission owed by a participating hotel to all participating travel agencies.
Additionally, the HCC service provides an incentive to travel agencies to make
reservations at HCC-participating hotels in countries other than their own
because the HCC service disburses checks denominated in each travel agency's
currency of choice. Furthermore, the monthly and quarterly marketing reports and
statistics prepared for the hotel by the HCC service allow the hotel to identify
and market more
41
<PAGE> 44
effectively to travel agencies that provide the hotel with its guests. The hotel
also benefits from HCC's Customer Relations Center, which allows travel agency
inquiries regarding commissions to be resolved by HCC rather than with the hotel
itself.
The Company's HCC service also provides benefits to its travel agency
participants. The consolidated check that the HCC service delivers in the travel
agency's currency of choice reduces the staff time spent processing multiple
checks and deposit slips, eliminates bank fees for multiple deposits and
currency exchanges and is designed to improve the travel agency's ability to
manage cash flow. The monthly report delivered by the HCC service allows the
travel agency to confirm commissions paid, follow customers' reservation habits
and reduce a travel agency's expenses for collection activity and for tracking
bookings that result in cancellations or "no-shows." The HCC Customer Relations
Center provides prompt responses to agency inquiries and can substantially
reduce the time and cost of reconciling outstanding commissions. The Company's
optional HCC Electronic service for electronic payment and reconciliation of
commissions enables travel agencies to reduce commission reconciliation costs
and provides travel agencies with immediate access to funds. Pegasus maintains a
Web site, HCCnet, that provides a comprehensive description of HCC services.
HCCnet provides a complete listing of all of the hotels that have committed to
paying hotel commissions through the HCC service. Moreover, travel agencies can
subscribe to receive an executive summary report that can be used to evaluate
the travel agency's activity with a particular hotel to assist with volume
negotiations, among other matters.
The Company charges each participating travel agency a service fee based on
the amount of commissions paid to the travel agency. The Company also generally
charges hotels a fee based on the number of commissionable transactions
processed.
Pegasus Information Services
The Company intends to develop a service to provide hotel information to a
wide variety of audiences in the global hotel industry, from hotel guests to
travel industry marketing groups to hotel chains. The Company believes that the
hotel industry has limited sources that provide transaction-specific hotel data
in a timely manner. Leveraging the existing databases used in its THISCO,
TravelWeb and HCC services and utilizing other data available through hotel
property management systems, the Company intends the new service to be able to
compile data regarding hotel guests and their use of hotels in
transaction-specific detail and to organize that data into meaningful
information, which will be made available in forms that protect an individual
traveler's privacy. The Company also intends to be able to produce data
regarding a hotel company's average daily room rate and occupancy rate to be
used by a hotel company to compare itself with its competitors in a manner
consistent with legal limitations. Furthermore, the Company intends that the new
service will be able to provide data in an electronic format to individual
travelers or corporate travel departments regarding a particular stay at a hotel
to facilitate automated expense reporting or to ensure travel policy adherence.
The Company believes that numerous participants in the travel industry will
desire the Company's data services, including hotel companies, travel agencies,
individual travelers, convention and other large meeting organizers, corporate
travel departments, hotel developers and hotel industry consultants.
The Company's future success will depend, in part, on its ability to
develop leading technology, enhance its existing services, develop and introduce
new services that address the increasingly sophisticated and varied needs of its
current and prospective customers, and respond to technological advances and
emerging industry standards and practices on a timely and cost-effective basis.
Although the Company strives to be a technological leader, there can be no
assurance that future advances in technology will be beneficial to, or
compatible with, the Company's business or that the Company will be able to
economically incorporate such advances into its business. In addition, keeping
abreast of technological advances in the Company's business may require
substantial expenditures and lead time. There can be no assurance that the
Company will be successful in effectively using new technologies, adapting its
services to emerging industry standards or developing, introducing and marketing
service enhancements or new services, or that it will not experience
difficulties that could delay or prevent the successful development,
introduction or marketing of these services. The services that the Company is in
the process of developing may require substantial expenditures. If the Company
incurs increased costs or is unable, for technical or other reasons, to develop
and introduce new
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<PAGE> 45
services or enhancements of existing services in a timely manner in response to
changing market conditions or customer requirements, or if new services do not
achieve market acceptance, the Company's financial condition and results of
operations could be materially adversely affected. See "Risk Factors -- Impact
of Technological Advances; Delays in Introduction of New Services."
CUSTOMERS
The Company markets and provides its services to a wide range of customers,
including but not limited to hotels, large travel agencies, travel agency
consortia comprised of smaller travel agencies, GDSs and independent hotels
represented by hotel representation firms such as Anasazi, Inc., Utell
International and Lexington Services Corporation. During 1996, no one customer
accounted for as much as 6% of the Company's revenues.
Pegasus includes as its customers 14 of the 15 largest hotel chains in the
world based on 1996 total revenues. As of August 4, 1997, the Company's
customers include the following hotels and hotel representation firms which have
a minimum of 10 properties, with stockholders (or affiliates thereof) of the
Company indicated by an asterisk:
ADAM'S MARK HOTELS & RESORTS
AMERIHOST INN HOTELS
*ANASAZI, INC.
- -- Anasazi Travel Resources
-- AmeriSuites
-- ARCOTEL Hotels & Resorts
-- Camberely Hotels
-- Copthorne Hotels
-- Fairmont Hotels
-- Four Seasons Hotels & Resorts
-- Grand Bay Hotels & Resorts
-- Grand Heritage
-- Grand Traditions
-- LRI
-- Loews Hotels
-- Millineum Hotels
-- New Otani Hotels
-- Nikko Hotels
-- Regent International Hotels
-- Registry Hotels
-- Rihga Royal Hotels
-- Shangri-La Hotels
-- Sonesta International
-- Station Casinos
-- Sterling International Hotels
-- Wellesley Inns
-- World Hotels & Resorts
-- Vacation Break Hotels
BENCHMARK HOSPITALITY
*BEST WESTERN INTERNATIONAL
*CHOICE HOTELS INTERNATIONAL
- -- Clarion Inns
-- Comfort Inns
-- Econo Lodge
-- Friendship Inns
-- Mainstay Suites
-- Quality Inns
-- Rodeway Inns
-- Sleep Inns
COASTAL HOTELS
DOUBLETREE HOTELS
- -- Red Lion Hotels & Inns
*FORTE
- -- Forte Hotels
-- Meridien
GLOBAL RESOURCES, INC.
- -- Global Resources Hotels
-- SCANRES
-- World Class Hotels
GUESTHOUSE ASSOCIATION OF SOUTH AFRICA
HAWTHORN SUITES
*HILTON HOTELS CORPORATION
HILTON INTERNATIONAL
HOLIDAY INN WORLDWIDE
*HFS INCORPORATED
- -- Days Inns of America
-- Howard Johnson
-- Knights Inn
-- Ramada
-- RCI Management, Inc.
-- Super 8 Motels
-- Travelodge Hotels
-- Villager Lodge
-- Wingate Inn
HOTEL OKURA
HOTKEY INTERNATIONAL
-- Regal Hotel Group U.K.
-- Romantik Hotels
*HYATT HOTELS
HYATT INTERNATIONAL
*INTER-CONTINENTAL HOTELS
- -- Inter-Continental Hotels and Resorts
-- Forum Hotels by Inter-Continental
-- Global Partner Hotels & Resorts
*ITT SHERATON
- -- Four Points
-- Global Connextions
-- ITT Sheraton Hotels & Resorts
-- Sheraton Luxury Collection
KIMPTON HOTELS
*LA QUINTA INNS
LEXINGTON SERVICES CORPORATION
- -- Bartells Hotels
-- Design Hotels
-- Harvey Hotels
-- Lexington Hotels & Suites
-- Suite Connection
-- Summerfield Suites
MANDARIN ORIENTAL HOTEL
MARITIM HOTELS
*MARRIOTT CORPORATION
- -- Courtyard Inns
-- Fairfield Inns
-- Marriott Hotels, Resorts and Suites
-- Marriott Vacation Club International
-- Renaissance Hotels & Resorts
-- Residence Inns
-- Ritz-Carlton
OBEROI GROUP OF HOTELS
ORBIS HOTELS
PAN PACIFIC HOTELS & RESORTS
POSADAS
- -- Fiesta Americana
-- Fiesta Inns
PREFERRED HOTELS & RESORTS WORLDWIDE
*PROMUS HOTELS CORPORATION
- -- Embassy Suites
-- Embassy Vacation Resorts
-- Hampton Inn & Suites
-- Hampton Inns
-- Hampton Vacation Resorts
-- Homewood Suites
RECONLINE
RED ROOF INNS
*REED TRAVEL GROUP
REGAL HOTELS
SCEPTRE HOTELS
SILVER MANOTEL MARKETING
SOL MELIA HOTELS
SOUTHERN PACIFIC
SWISSOTEL
TAJ GROUP OF HOTELS
TOKYU HOTELS
TRUST INTERNATIONAL
TRYP HOTELS
*UTELL INTERNATIONAL
- -- ANA Hotels
-- Airco
-- Beresford Hotels
-- Bildberg Hotels
-- Dan Hotels
-- Disneyland Paris
-- Dusit Hotels
-- Golden Tulip Hotels
-- Helmsley/Harley Hotels
-- Ian Schrager
-- Insignia Resorts
-- Jarvis Hotels
-- Jury's Hotels
-- Omni Hotels
-- Prince Hotels
-- Queens Moat Houses Hotels
-- Robert Reid
-- Scandic Hotels
-- Star Hotels
-- Summit International
-- Thistle/Mt. Charlotte Hotels
-- Top International Hotels
-- Warwick Hotels
VIP INTERNATIONAL
WALT DISNEY WORLD RESORTS & THEME
PARKS
*WESTIN HOTELS & RESORTS
WESTMARK HOTELS
WYNDHAM HOTELS & RESORTS
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<PAGE> 46
The Company has registered approximately 64,000 travel agencies as
participants in the HCC service. Of the 100 largest travel agencies in the
United States, according to Travel Weekly, a publication owned by a stockholder
of the Company, 66 are customers of the Company's HCC service. The following
travel agencies represent the 10 largest HCC customers based on 1996 revenues to
the Company:
<TABLE>
<S> <C>
AMERICAN EXPRESS MUTUAL TRAVEL
ASSOCIATED TRAVEL SERVICES OMEGA WORLD TRAVEL
BTI AMERICAS TRAVEL AND TRANSPORT
CARLSON WAGONLIT TRAVEL ONE
CUC TRAVEL WORLD TRAVEL PARTNERS
</TABLE>
The Company's business is dependent upon customer arrangements with its
hotel stockholders or their affiliates, other hotel chains and hotel properties
and hotel representation firms, travel agencies, travel agency consortia and
GDSs. There can be no assurance that the Company will be able to continue or
renew these arrangements on equal or better terms. Any cancellation or
non-renewal of these arrangements that results in a significant reduction in the
Company's customer base or revenue sources could materially adversely affect the
Company's financial condition and results of operations. See "Risk
Factors -- Dependence on Key Customers and Third-Party Service Arrangements."
SALES AND MARKETING
The Company sells all of its services to hotels through a direct sales
force in the Americas and in Europe and sells its HCC services directly to
travel agencies and through relationships with travel agency consortia and
franchisors. Additionally, as of August 4, 1997, the Company has a team of 23
technical support staff to supplement the efforts of the sales force and provide
comprehensive customer support services. The Company has a Chief Marketing
Officer, a Vice President for domestic sales and four salespersons based in
Dallas responsible for sales in the Americas and a Vice President for
international sales and a salesperson based in London responsible for sales
outside of the Americas. The Company organizes its hotel sales force in the
Americas into three geographic territories, each targeting hotels and UltraRes
service users. Each hotel salesperson seeks to establish ongoing relationships
with the reservations and marketing management personnel of hotels in that
representative's designated territory and to assist the hotels in achieving
increased efficiency and cost reduction in their hotel reservation systems
through the use of the Company's services. The Company's travel agency sales
force sells HCC services directly to large travel agencies. Additionally, the
Company offers its HCC service to smaller travel agencies organized in consortia
and to travel agency franchisees through preferred supplier programs. The terms
of these programs are set at the consortium or franchisor level, and the HCC
service is promoted to travel agency members of these organizations through
trade shows and consortium newsletters and magazines. The Company has made
arrangements with two of the four major GDSs to offer the HCC service to their
participating travel agencies in Europe through a joint promotional program. The
Company's London-based international sales personnel focus on both travel
agencies and hotels in different regions throughout the world. The Company also
has a salesperson devoted to promoting the UltraRes service to convention and
other large meeting organizers and hotels. The Company uses the services of a
third-party marketing organization to sell advertising on the TravelWeb site.
The Company believes that the THISCO, HCC and TravelWeb brand names are
important assets of the Company, signifying the quality and reliability of the
Company's services. A separate brand manager is responsible for marketing each
brand. Each brand manager is responsible for product development and
enhancement, customer sales support, development of promotional and other
collateral materials, identification and optimization of revenue sources, market
research and establishment of relationships with key vendors. The THISCO service
is marketed primarily through establishing contacts and relationships with hotel
management, GDSs and other major users of the services. In addition,
participation in industry organizations and trade conventions increases brand
recognition of the Company's services. The Company also has sought to market its
UltraDirect service to corporate travel management software developers so that
they will include an automatic connection to the THISCO service in their hotel
reservation system software. In marketing the TravelWeb service, brand managers
focus their efforts on site development and establishing links to existing
44
<PAGE> 47
third-party Web sites and related Internet content providers and aggregators.
Marketing efforts for the HCC service primarily are directed towards
participation in travel agency industry trade shows and promotion through travel
agency consortia and franchisors.
TECHNOLOGY AND OPERATIONS
THISCO. The THISCO service utilizes the Company's UltraSwitch technology to
automate hotel reservation transaction processing between a GDS and a hotel
chain's central reservation system. UltraSwitch utilizes a UNIX-based,
client/server architecture. GDSs are connected to UltraSwitch through either
point-to-point telecommunications lines or a multi-protocol frame relay network,
both of which are managed by the Company. Communication processors running
proprietary, UNIX-based software perform protocol conversions. The transaction
processing engine within UltraSwitch, which contains its own proprietary,
UNIX-based software, performs message formatting and field translation functions
between GDSs and hotels' central reservation systems. UltraSwitch also contains
an Informix relational database that stores transaction-specific information for
billing and marketing and translates specific hotel property information. The
Company believes that for a hotel to change from THISCO to another service, the
hotel would be required to change the protocol used by its central reservation
system, as well as substantially convert the message formats used by its central
reservation system. If a hotel desired to bypass UltraSwitch and connect its
central reservation system directly to one or more GDSs, the hotel would be
required to develop protocols and message formats compatible with each GDS with
which it established such a connection and bear the recurring costs required to
maintain each system. The Company believes that these costs may discourage a
hotel from changing to a competitor or to a direct connection with a GDS. See
"-- Competition."
When using the THISCO service, hotels provide and update room rates,
features and availability information in two ways: (i) by transmitting
information to GDS databases through status messages and (ii) by offering
continuous, direct access to the hotel central reservation system through
UltraSelect. Hotel status messages transmitted through UltraSwitch are processed
within seconds. UltraSwitch processed an average of 42 million status messages
per month during 1996. A GDS database, however, stores only a limited amount of
room rate, feature and availability information for a hotel, which may not be
synchronized with the hotel's central reservation system. The Company's
UltraSelect service allows travel agencies that use GDSs direct access through
UltraSwitch into a hotel's central reservation system to shop and browse for all
room types and room rates with the most complete and updated hotel room
information. To accomplish this process, UltraSwitch receives proprietary direct
access transaction requests from each GDS, translates those into one or more
UltraSelect transaction requests and forwards them to the hotels' central
reservation systems. To utilize the UltraSelect service, the hotel's central
reservation system must be modified to accept the transmission of transactions
and allow for the electronic processing of these transactions through
UltraSwitch in real-time. Approximately 50% of hotels that subscribe to the
THISCO service provide this type of access to their central reservation systems
through the Company's UltraSelect service.
Using the information provided through the UltraSwitch technology, a travel
agent is able to shop or browse for a hotel room that fits particular
specifications, such as location, room rates and features. Once a travel agent
determines the desired hotel and type of room, UltraSwitch enables the travel
agent to inquire about availability of the room. The UltraSwitch technology
interfaces the request from the travel agent through a GDS with the information
available in the hotel's central reservation system. If a hotel room fitting the
inquiry is available, UltraSwitch enables the travel agent to book the room and
receive a confirmation within a matter of seconds. In 1996, the average
UltraSwitch processing time for interactive transactions, such as reservations
and inquiry messages, was 0.22 seconds and the average uptime across the 84
distinct connections to UltraSwitch was 99.6%, including as downtime all
scheduled and emergency downtime.
Utilizing the existing technology of UltraSwitch, the Company has developed
UltraRes and UltraDirect, services that provide customized technological
interfaces for convention and other large meeting organizers and corporate
travel departments to enable direct access into the extensive database of
hotels' central reservation systems and reservation and confirmation of hotel
bookings in seconds.
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<PAGE> 48
In connection with the development of the UltraSwitch technology and
related financing provided by Reed, the Company licensed certain rights to Reed
to use the UltraSwitch technology on an exclusive, royalty free basis, for
applications not related in any way to the operations of the hotel industry. In
connection therewith, Reed agreed not to compete with the Company and its use of
the UltraSwitch technology in the hotel industry. See "Certain Transactions."
TravelWeb. The Company has created its TravelWeb service using a scalable
architecture that presents user-friendly hotel and travel information to
individual travelers. The TravelWeb service stores detailed information on
approximately 13,000 hotel properties on an Informix relational database. To
add, delete and update information on their properties, hotels can access the
information in the TravelWeb database either through electronic batch transfers
or using a standard Web browser through the Company's proprietary "remote
author" feature. The Company's secured server software prevents unauthorized use
of the "remote author" feature, and the Company's quality assurance personnel
review any updated information to assure consistency. TravelWeb communication
engines (called Web engines) manipulate the information contained in the
Informix database. TravelWeb's scalable architecture allows the TravelWeb
service to access and manipulate the information contained in its database using
multiple Web engines. A Web engine currently consists of a Sun UltraSparcII,
Netscape Enterprise server software and a Javascript application. Although the
Informix database currently resides on a single Sun E 3000 database server, the
architecture allows the addition of more database servers as demand requires.
This advanced technology enables the TravelWeb service to format data to appear
as part of the Web site on which the information is viewed. The TravelWeb
service connects its information database to the Company's UltraSwitch
technology, which allows a user of the TravelWeb service who has found a desired
hotel room to secure a hotel reservation and a confirmation. The Company's
proprietary software contains a number of features to protect reservation
systems from abusive booking practices and allows hotels to control and maintain
the number of reservations made through the TravelWeb service allowed at any
hotel property.
To assure a high level of Internet connectivity, the Company has entered
into an arrangement with Genuity, Inc., a "Tier 1" Internet service provider, to
connect the TravelWeb service to the Internet. Genuity is responsible for
maintaining the speed and reliability of communications conducted through the
TravelWeb service. Genuity also provides message routing assistance and dynamic
load balancing of communications to minimize bottlenecks in Internet
communications. Furthermore, the Company's databases and Web engines used with
the TravelWeb service are located at sites operated by Genuity.
NetBooker. The Company's NetBooker reservation service provides third-party
Web sites direct access to the extensive TravelWeb hotel database and
UltraSwitch's hotel reservation and confirmation capabilities. The technology
used in the NetBooker service is similar to the TravelWeb service technology.
The scalable architecture utilized by the TravelWeb service and the use of the
Javascript application create a template environment in which a Web engine can
manipulate information in the Informix database and present such information
under the distinct front-end format of the customer Web site. In addition, the
NetBooker reservation service allows a customer Web site to establish an
interface to the Company's UltraSwitch technology, which enables users of the
Web site to shop and query room availability and to electronically book a
reservation in seconds. As a result, users of the third-party Web site have full
access to TravelWeb's database and booking capabilities while visiting that
site.
HCC. The HCC service captures information derived from hotel property
management systems to process commission payments for travel agencies. The HCC
service provides a connection for hotels through the same communication network
that the Company provides for its THISCO service. Communication engines perform
protocol conversions. The Company's UNIX-based processing engine for the HCC
service uses proprietary software to process commission information. The
Company's Customer Relations Center can access the processing engine to answer
questions regarding commissions from travel agencies. The HCC service also
utilizes an Informix database that stores transaction-specific information
regarding hotel stays and information regarding required currency conversions,
cleared checks, the source of reservations and hotel and travel agency profiles.
46
<PAGE> 49
The HCC service gathers information from hotels monthly to process
commission payments and information statements. Participating hotels use the
Company's proprietary HCC software to either collect the data derived from a
hotel's property management system or compile data from each hotel property. In
some instances, hotels using an outside party's commission payment consolidation
service will pass on the information from the outside party to the HCC service.
As the information is gathered, the HCC service continually updates the
commissions payable and interfaces with Citibank regarding any required currency
conversions. The HCC service notifies participating hotels of the amount of
commissions payable generally on the tenth business day of each month. Those
hotels are required under contract to deliver funds to the Company within 48
hours, and Pegasus delivers the funds to Citicorp to process checks or
electronic wires to travel agencies. 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. Citicorp and Perot Systems prepare payments and
information statements for travel agencies, and the payments and information
statements generally are sent out on the 15th business day of each month.
Under its arrangement with Citicorp and Perot Systems, Citicorp performs
currency conversions, prepares checks and electronic wires and delivers funds
and information statements to travel agencies. Perot Systems prepares the
information statements that are sent by Citicorp on behalf of the Company. This
arrangement expires in December 1998. See "Risk Factors -- Dependence on Key
Customers and Third-Party Service Arrangements."
SYSTEMS MAINTENANCE AND DISASTER RECOVERY
Because large numbers of travel agencies, hotels and other customers depend
on the Company for real-time transaction processing services, system reliability
and uptime are critical to the Company's success. In 1996, the average uptime
across the 84 distinct connections to UltraSwitch was 99.6%, including as
downtime all scheduled and emergency downtime. The Company has entered into an
arrangement with Anasazi, Inc. ("Anasazi") a stockholder of the Company, to
manage and operate certain equipment owned by Pegasus, which is located at a
site owned by Anasazi in Phoenix, Arizona. An employee of the Company oversees
the services provided by Anasazi, such as equipment monitoring, assurance of
power supply and communications link back up support. The Company has entered
into an agreement with Pyramid Technologies Corporation for the provision of
computer hardware maintenance and replacement and mitigation of the potential
effects of system downtime. In addition, the Company has entered into an
agreement under which Comdisco, Inc. will provide disaster recovery services for
the restoration of the Company's services as soon as practicable. In connection
with this agreement, Comdisco, Inc. is making arrangements to provide full
system redundancy within 24 hours in the event of a site disaster. See "Risk
Factors -- System Interruption and Security Risks."
RESEARCH AND DEVELOPMENT
The Company recognizes that its ability to maintain its position and grow
depends upon continued expansion of its services. Investments in development are
crucial to obtaining new customers and retaining existing customers. The
Company's research and development activities primarily consist of software
development, development of enhanced communication protocols and custom user
interfaces and database design and enhancement. In its research and development
process, the Company works in close collaboration with its customers to address
their specific needs. As of August 4, 1997, the Company employed 56 people in
its Information Technology Group and from time to time, supplements their
efforts with the use of independent consultants and contractors. This group is
comprised of information technology, services development, technical services
and product support personnel. The Company's total research and development
expense was $238,000, $2.1 million and $2.2 million for 1994, 1995 and 1996,
respectively.
COMPETITION
The Company faces significant competition in connection with its THISCO
hotel room reservation processing service. The principal competitor of the
Company's THISCO service is WizCom, which was a wholly owned indirect subsidiary
of Avis. As a result of the acquisition of Avis by HFS, a stockholder and
customer of the Company, in September 1996, WizCom became a wholly owned
indirect subsidiary of HFS.
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<PAGE> 50
Although HFS has recently renewed its participation in the Company's HCC
service, HFS has notified the Company that it is moving its electronic hotel
room reservation processing from THISCO to WizCom. The Company has an agreement
with HFS which requires HFS to pay for a certain minimum level of THISCO
processing services annually for the life of the agreement. In 1996, revenues
from HFS for electronic hotel room processing services were $517,905 above the
annual minimum fee under the agreement, which was $182,700. HFS historically has
generated more revenues for the Company than any other hotel chain that is a
customer and a stockholder of Pegasus. See "Certain Transactions." HFS accounted
for 12.3%, 9.5% and 4.7% of the Company's total revenues during 1994, 1995 and
1996, respectively. HFS is a Selling Stockholder in this offering. See
"Principal and Selling Stockholders." HFS currently uses and in the future could
use the technology utilized by WizCom to compete with certain of the Company's
current and future services. There can be no assurance that any additional
customers will not change their electronic reservation interface to WizCom or to
another similar service. Also, hotels can choose to connect directly to one or
more GDSs, thereby bypassing THISCO and eliminating the need to pay fees to the
Company. In addition, one or more GDSs can choose to bypass the THISCO service
and develop and operate a new common electronic interface to hotel central
reservation systems. Such competitors or their affiliates may have greater
financial and other resources than the Company. Factors affecting competitive
success of the electronic hotel room reservation processing service include
reliability, levels of fees, number of hotel properties on the system, ability
to provide a neutral, comprehensive interface between hotels and other
participants in the distribution of hotel rooms and ability to develop new
technological solutions. There can be no assurance that another participant in
the hotel room distribution process or a new competitor will not create services
with features that would reduce the attractiveness of the Company's services.
The Company's inability to compete effectively with respect to these services
could have a material adverse effect on the Company's financial condition and
results of operations. See "Risk Factors -- Competition."
The Company charges hotel participants certain fees for processing status
messages from hotel central reservation systems to GDSs. The Company intends to
reduce certain status message fees in July 1997. In addition, a hotel
participant can choose to use the Company's UltraSelect service to provide
travel agencies direct access through GDSs to its central reservation system,
thereby reducing the need to send status messages through the Company's THISCO
service. There is no assurance that the volume of and fees generated from status
messages processing will remain at the same or a higher level in the future. Any
significant decrease in the volume of status messages processed or in the amount
of status message fees generated could have a material adverse effect on the
Company's financial condition and results of operations. See
"Business -- Services."
The Company believes that the costs involved in a hotel switching from
THISCO to another service may discourage any such decision. The Company believes
that WizCom, the Company's principal competitor in the provision of interfaces
between hotel reservation systems and GDSs, uses a single protocol that is
different from the multiple protocols employed by THISCO. Consequently, the
Company believes that to connect to WizCom, a hotel would be required to change
the protocol used by its central reservation system, as well as substantially
convert the message formats used by the hotel reservation system. If a hotel
desired to connect directly with GDSs, the protocols and the message formats of
the hotel's central reservation system would have to be revised to conform with
each separate GDS to which the hotel reservation system is connected. In
addition, the hotel would be responsible for the ongoing maintenance and
updating costs necessary to continue a direct connection with each GDS and would
have to absorb the costs to maintain a network with each GDS.
The market for the Company's TravelWeb and NetBooker services is highly
competitive. Current competition includes traditional telephone or travel agency
reservation methods and other Internet travel reservation services. There are a
large number of Internet travel-related services offered by the Company's
competitors, and many of these competitors are larger and have significantly
greater financial resources and name recognition than the Company. Several
competitive Web sites such as Travelocity (a site operated by The SABRE Group
Holdings, Inc.) and Expedia (a site operated by Microsoft Corporation) offer a
more comprehensive range of travel services than TravelWeb or NetBooker. The
Company faces competition in the hotel room reservation business not only from
its current competitors but also from possible new entrants including other Web
sites. The costs of entry into the Internet hotel room reservation business is
relatively low. There can be no assurance that the Company's Internet hotel room
reservation services will compete
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<PAGE> 51
successfully. The failure of these services to compete successfully could have a
material adverse effect on the Company's financial condition and results of
operations. See "Risk Factors -- Competition."
The market for the Company's HCC service is competitive. The Company's
competitors in the commission processing business include NPC, WizCom and
Citicorp. NPC, a company that has traditionally provided car rental and cruise
line commission processing services, recently began offering its services to
hotels and travel agencies as well. WizCom recently announced that it is
introducing a commissions payment service that may be competitive with the HCC
service. Citicorp provides commission consolidation services to hotel chains. In
addition, hotels that are current or prospective customers of the HCC service
could decide to process commission payments without, or in competition with, the
HCC service. Some of these current or potential competitors have substantially
greater financial and other resources than the Company. Furthermore, while the
Company has agreements with all of its hotel customers for the HCC service, most
of the Company's travel agency customers are not obligated by any agreement with
the Company. If a significant percentage of these travel agencies were to cease
using the HCC commission processing service, the Company's financial condition
and results of operations could be materially adversely affected. See "Risk
Factors -- Competition."
GOVERNMENT REGULATION
The Company's primary customers are hotel chains and hotel representation
firms. The Company currently has as its stockholders 11 of the 15 leading hotel
chains in the world based on 1996 total revenues. While the Company believes
that it has been acting since its inception as an entity independent of its
stockholders, and its stockholders have not engaged in any anti-competitive
activities through or in connection with the Company, there can be no assurance
that federal, state or foreign governmental authorities, the Company's
competitors or its consumers will not raise anti-competitive concerns regarding
the Company's close relationship with its hotel stockholders. Any such action by
federal, state or foreign governmental authorities or allegations by third
parties could have a material adverse effect on the Company's financial
condition and results of operations. While certain aspects of the travel
industry are heavily regulated by the United States Government, the services
currently offered by the Company, including electronic room reservation
processing services, commission processing services and Internet-based
reservation services, have not been subject to any material industry-specific
government regulation. However, there can be no assurance that federal, state or
foreign governmental authorities will not attempt to regulate one or more of the
Company's current or future services. Due to the increasing popularity of the
Internet, it is possible that laws and regulations may be adopted with respect
to the Internet, covering issues such as privacy, pricing, content and quality
of products and services. The adoption of laws or regulations affecting the
Company's lines of business could reduce the rate of growth of the Company or
could otherwise have a material adverse effect on the Company's financial
condition and results of operations. See "Risk Factors -- Government
Regulation."
PROPRIETARY RIGHTS
The Company is constantly developing new processing technology and
enhancing existing proprietary technology. The Company has no patents. The
Company primarily relies on a combination of copyright, trade secrets,
confidentiality procedures and contractual provisions to protect its technology.
Despite these protections, it may be possible for unauthorized parties to copy,
obtain or use certain portions of the Company's proprietary technology. While
any misappropriation of the Company's intellectual property could have a
material adverse effect on the Company's competitive position, the Company
believes that protection of proprietary rights is less significant to the
Company's business than the continued pursuit of its operating strategies and
other factors, such as the Company's relationship with industry participants and
the experience and abilities of its key personnel.
The Company has registered "UltraSwitch," "TravelWeb," "UltraAcess" and
"HCC Hotel Clearing Corporation" as United States federal trademarks and
applications to register "HCCLink," "ChainLink," "UltraRes," "Click-It" and
"Pegasus" are pending with the United States Patent and Trademark Office.
Trademark applications for "TravelWeb" also have been filed in Canada and
Europe. There can be no assurance that the Company's applications to register
such trademarks will be successful. The Company has
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<PAGE> 52
no knowledge of any infringement to or any prior claims of ownership of
trademarks that would materially adversely affect the Company's current
operation. The Company pursues and intends to continue to pursue registration of
its trademarks whenever possible and to vigorously defend its proprietary rights
against infringement or other threats to the greatest extent practicable under
the laws of the United States and other countries. See "Risk
Factors -- Dependence on Proprietary Technology; Risk of Infringement."
EMPLOYEES
At August 4, 1997, the Company had 101 employees, 96 of which were located
in the United States, with 56 persons in the Information Technology Group, 25
persons performing sales and marketing, customer relations and business
development functions and the remainder performing corporate, finance and
administrative functions. The Company has five employees in England performing
international sales activities. The Company has no unionized employees. The
Company believes that its employee relations are satisfactory.
PROPERTIES
The Company's principal executive office is a leased facility with
approximately 29,800 square feet of space in Dallas, Texas. The Company leases
this space under a lease agreement that expires December 2002. The Company also
maintains an administrative and sales office in a leased facility with
approximately 3,300 square feet of space near London, England. The lease
agreement for the office in England expires in May 1998. Under an agreement with
Anasazi, certain of the equipment owned by the Company is housed at a site owned
by Anasazi in Phoenix, Arizona. The Company believes that its existing
facilities are well maintained and in good operating condition and are adequate
for its present and anticipated levels of operations.
LEGAL PROCEEDINGS
The Company is a party from time to time to certain routine legal
proceedings arising in the ordinary course of its business. Although the outcome
of any such proceedings cannot be predicted accurately, the Company does not
believe any liability that might result from such proceedings could have a
material adverse effect on the Company's financial condition and results of
operations.
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MANAGEMENT
EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES
Executive officers, directors and other key employees of the Company, and
their ages as of July 31, 1997, are as follows:
<TABLE>
<CAPTION>
Name Age Position
---- --- --------
<S> <C> <C>
John F. Davis, III........................ 44 President, Chief Executive Officer, and
Director
Joseph W. Nicholson....................... 36 Chief Information Officer
Jerome L. Galant.......................... 47 Chief Financial Officer
Michael R. Donahue........................ 43 Chief Marketing Officer
Phillip A. Mytom-Hart..................... 43 Vice President, International Sales and
Marketing
M. Nicholas Jent.......................... 55 Vice President, Sales and Marketing
William S. Lush........................... 55 Vice President, Business Development
John W. Biggs(1).......................... 53 Director
Donald R. Dixon........................... 49 Director
William C. Hammett, Jr.(2)................ 50 Vice Chairman of the Board of Directors
I. Malcolm Highet(2)...................... 46 Director
Rockwell A. Schnabel(1)................... 60 Director
Paul J. Travers(1)(2)..................... 44 Chairman of the Board of Directors
Mark C. Wells............................. 48 Director
Bruce Wolff............................... 54 Director
</TABLE>
- ---------------
(1) Member of the Compensation Committee.
(2) Member of the Audit Committee.
John F. Davis, III has served as the President and Chief Executive Officer
of the Company since February 1989 and as a director of the Company since July
1995. Before joining Pegasus, Mr. Davis was the founder, President and director
of Advanced Telemarketing Company, a provider of inbound and outbound
telemarketing services. He was also one of the founders of 1-800-Flowers,
Limited, a company offering quality floral arrangements by telephone.
Joseph W. Nicholson has served as the Chief Information Officer of the
Company since 1989. Prior to joining Pegasus, he spent ten years at Texas
Instruments in various positions, including Systems Analyst and Systems Manager.
Jerome L. Galant has served as the Chief Financial Officer of the Company
since September 1996. From April 1996 to September 1996, Mr. Galant served as
the Chief Financial Officer of Personnel Security & Safety Systems, Inc., a
technology development company. From 1990 to February 1996, Mr. Galant served in
a variety of positions for The SABRE Group, including Managing Director,
Finance.
Michael R. Donahue has served as Chief Marketing Officer of the Company
since May 1997. From 1988 to May 1997, Mr. Donahue served as Vice President of
Marketing and Development for Lane Hospitality, a hotel management firm.
Phillip A. Mytom-Hart has served as the Vice President, International Sales
and Marketing of the Company since September 1993. From 1991 to September 1993,
Mr. Hart served as Vice President, Sales and Marketing for Hilton International.
M. Nicholas Jent has served as the Vice President, Sales and Marketing of
the Company since August 1992. From 1988 to March 1991, Mr. Jent served as
Senior Vice President, Sales and Marketing for Telesphere Communications, Inc.,
a long distance communications company.
51
<PAGE> 54
William S. Lush has served as Vice President, Business Development of the
Company since May 1995. From 1990 to May 1995, Mr. Lush served as Vice
President, Service Development in the travel management services group of
American Express Travel Related Services.
John W. Biggs has served as a director of the Company since October 1995.
Mr. Biggs has served as Vice President, Travel and Hospitality for Computer
Sciences Corporation, a consulting firm, since August 1996. From April 1994 to
July 1996, Mr. Biggs served as Chief Operations Officer for Regency Systems
Solutions, an affiliate of Hyatt Hotels Corporation ("Hyatt"). From 1984 to
April 1994, Mr. Biggs served as Senior Vice President, Hotel Accounting and
Administration at Hyatt. Hyatt is a stockholder of the Company.
Donald R. Dixon has served as a director of the Company since June 1996.
Since 1993, Mr. Dixon has been associated with Trident Capital, L.P., a venture
capital firm ("Trident"), which he helped found. From 1988 to 1993, Mr. Dixon
served as Co-President of Partech International, a private equity fund manager
associated with Banque Paribas. Mr. Dixon serves on the Board of Directors of
Bank America Merchant Services, Inc., Platinum Software Corporation, Unison
Software, Inc. and several privately held companies. Trident manages Information
Associates, L.P. and Information Associates, C.V., both of which are
stockholders of the Company.
William C. Hammett, Jr. has served as a director and Vice Chairman of the
Board of the Company since October 1995. Since August 1996, Mr. Hammett has
served as Senior Vice President and Chief Financial Officer of La Quinta Inns,
Inc., which is a stockholder of the Company. From June 1992 to August 1996, Mr.
Hammett has served as Senior Vice President, Accounting and Administration of La
Quinta Inns, Inc.
I. Malcolm Highet has served as a director of the Company since October
1995. Mr. Highet has served as Executive Vice President, Corporate Development
for Reed Elsevier Inc. since October 1996. From 1989 through October 1996, Mr.
Highet served as Chief Financial Officer and later as Chief Operations Officer
for a major division of Reed. Reed and Utell International are both divisions of
Reed Elsevier Inc. and stockholders of the Company.
Rockwell A. Schnabel has served as a director of the Company since June
1996. Since 1993, Mr. Schnabel has been associated with Trident, which he helped
found. From 1989 to 1992, Mr. Schnabel served as acting Secretary of Commerce
and the Deputy Secretary of Commerce during the Bush Administration. Mr.
Schnabel serves on the Board of Directors of Cyprus Amax Minerals Company,
International Game Technology, Inc., CSG Systems, Inc., and Anasazi. Anasazi is
a stockholder of the Company. Trident manages Information Associates, L.P. and
Information Associates C.V., both of which are stockholders of the Company.
Paul J. Travers has served as a director and Chairman of the Board of the
Company since October 1995. Mr. Travers has served as the Senior Vice President,
Property Management for Inter-Continental Hotels Corporation
("Inter-Continental") since 1994. From 1990 to 1994. Mr. Travers served as Vice
President, Finance and Group Controller of Inter-Continental. Inter-Continental
is a stockholder of the Company.
Mark C. Wells has served as a director of the Company since September 1996.
Mr. Wells has served as Senior Vice President, Franchise Services for Promus
Hotel Corporation ("Promus") since February 1996. From April 1995 to February
1996, Mr. Wells served as Senior Vice President, Marketing for Promus. Promus is
a stockholder of the Company.
Bruce Wolff has served as a director of the Company since October 1995. Mr.
Wolff has served as Vice President, Distribution Sales and Marketing for
Marriott Lodging since 1986. Marriott Lodging is an affiliate of Marriott
International, Inc., which is a stockholder of the Company.
The Company currently has authorized nine directors. The current directors
were elected pursuant to the provisions of the Company's Amended and Restated
Certificate of Incorporation in effect prior to this offering, and pursuant to a
voting agreement that will expire upon the closing of this offering. Upon the
closing of this offering, the Second Amended and Restated Certificate of
Incorporation will provide for a classified Board of Directors. The terms of
office of the Board of Directors will be divided into three classes: Class I,
which will consist of Messrs. Biggs, Dixon and Hammett, will expire at the
annual meeting of stockholders to be held in
52
<PAGE> 55
1998; Class II, which will consist of Messrs. Highet, Wells and Wolff, will
expire at the annual meeting of stockholders to be held in 1999; and Class III,
which will consist of Messrs. Davis, Schnabel and Travers, will expire at the
annual meeting of stockholders to be held in 2000. At each annual meeting of
stockholders beginning with the 1998 annual meeting, the successors to directors
whose terms will then expire will be elected to serve from the time of election
and qualification until the third annual meeting following election and until
their successors have been duly elected and qualified, or until their earlier
resignation or removal. The officers of the Company are appointed by and serve
at the discretion of the Board of Directors. There are no family relationships
among the current directors and officers of the Company.
COMMITTEES OF THE BOARD OF DIRECTORS
The Board of Directors has a Compensation Committee, consisting of Messrs.
Biggs, Schnabel and Travers, and an Audit Committee, consisting of Messrs.
Hammett, Highet and Travers. The Compensation Committee makes recommendations to
the Board of Directors concerning salaries and incentive compensation for the
Company's officers and employees and administers the Company's 1996 Plan and
1997 Plan (when it comes into effect upon completion of this offering). Prior to
November 1996, decisions concerning the compensation of officers, including that
of Mr. Davis, were made by the Board of Directors as a whole. The Audit
Committee makes recommendations to the Board of Directors regarding the
selection of independent auditors, reviews the results and scope of the audit
and other accounting related services and reviews and evaluates the Company's
internal control functions.
DIRECTORS' COMPENSATION
Directors currently do not receive any cash compensation from the Company
for their service as members of the Board of Directors, although they are
reimbursed for all reasonable expenses incurred in connection with the
performance of their duties as directors of the Company.
53
<PAGE> 56
EXECUTIVE COMPENSATION
The following table sets forth the compensation earned by the Company's
Chief Executive Officer and the five other most highly compensated executive
officers (collectively, the "Named Executive Officers") whose salary and bonus
for the fiscal year ended December 31, 1996 were in excess of $100,000 for
services rendered in all capacities to the Company for that year:
SUMMARY COMPENSATION TABLE(1)
<TABLE>
<CAPTION>
1996 ANNUAL LONG-TERM
COMPENSATION AWARDS
----------------------------------------- ---------------------
OTHER ANNUAL SECURITIES UNDERLYING ALL OTHER
NAME AND PRINCIPAL POSITION SALARY($) BONUS($) COMPENSATION($)(2) OPTIONS(#) COMPENSATION($)(3)
- --------------------------- --------- -------- ------------------ --------------------- ------------------
<S> <C> <C> <C> <C> <C>
John F. Davis, III(4)........ $261,708 $302,208 $7,500 300,000 $10,511
President and Chief
Executive Officer
Joseph W. Nicholson(4)....... 164,000 56,292 7,500 150,000 3,335
Chief Information Officer
Jerome L. Galant(5).......... 45,313 14,014 1,889 53,333 --
Chief Financial Officer
M. Nicholas Jent............. 145,000 38,667 7,500 9,333 600
Vice President, Sales and
Marketing
William S. Lush.............. 115,838 32,000 5,677 46,666 495
Vice President, Business
Development
Phillip A. Mytom-Hart........ 134,655 38,577 6,739 12,133 600
Vice President, Sales and
Marketing, International
</TABLE>
- ---------------
(1) In accordance with the rules of the Securities and Exchange Commission (the
"Commission") the compensation described in this table does not include
medical, group life insurance or other benefits received by the Named
Executive Officers that are available generally to all salaried employees of
the Company, and certain perquisites and other personal benefits received by
the Named Executive Officers that do not exceed the lesser of $50,000 or 10%
of any such officer's salary and bonus disclosed in the table.
(2) For Messrs. Davis, Nicholson, Galant, Jent and Lush reflects for 1996
matching contributions made by the Company pursuant to its 401(k) Savings
Plan. For Mr. Mytom-Hart reflects for 1996 contributions made by the Company
to a plan maintained for his benefit in Great Britain.
(3) Includes premiums paid during 1996 for life insurance policies for the
benefit of the Named Executive Officers.
(4) The salaries of Messrs. Davis and Nicholson were paid in accordance with the
terms of their respective employment agreements. The bonus of Mr. Davis
includes a one time $200,000 employment agreement signing bonus. See
"-- Employment Agreements."
(5) The salary of Mr. Galant represents remuneration paid to him from September
1996 to December 1996. Mr. Galant commenced employment with the Company in
September 1996.
OPTION GRANTS IN LAST FISCAL YEAR
The following table sets forth each grant of stock options made during the
fiscal year ended December 31, 1996 to each of the Named Executive Officers:
<TABLE>
<CAPTION>
INDIVIDUAL GRANTS
-----------------------------------------------------------------
NUMBER OF SECURITIES % OF TOTAL EXERCISE MARKET PRICE GRANT DATE
UNDERLYING OPTIONS OPTIONS GRANTED PRICE PER ON DATE OF EXPIRATION PRESENT VALUE
NAME GRANTED(1) IN 1996(2) SHARE(3) GRANT(3) DATE(4) ($)(5)
---- -------------------- --------------- --------- ------------ ---------- -------------
<S> <C> <C> <C> <C> <C> <C>
John F. Davis, III.... 300,000 38.9% $2.01 $3.11 12/31/05 $465,750
Joseph W. Nicholson... 150,000 19.4 2.01 3.11 12/31/05 232,875
Jerome L. Galant...... 53,333 6.9 2.01 3.11 12/31/05 82,799
M. Nicholas Jent...... 9,333 1.2 3.11 3.11 12/31/05 6,650
William S. Lush....... 46,666 6.0 3.11 3.11 12/31/05 33,250
Phillip A.
Mytom-Hart.......... 12,133 1.6 3.11 3.11 12/31/05 8,645
</TABLE>
- ---------------
See footnotes on following page
54
<PAGE> 57
(1) Options were granted under the 1996 Plan. The options held by Messrs. Davis
and Nicholson vest over a four-year period, with 25% of the shares vesting
after one year and 1/48th of the shares vesting each month for the next 36
months. The options held by Messrs. Galant, Jent, Lush and Hart vest over a
four-year period with 25% of the shares vesting after one year and 1/16th of
the shares vesting each quarter for the next 12 quarters.
(2) Based on an aggregate of 771,733 shares subject to options granted in 1996.
(3) The exercise price of the options held by Messrs. Davis, Nicholson and
Galant are established by each of their employment agreements with the
Company. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Overview" and Note 9 of Notes to Consolidated
Financial Statements. The market price for the Common Stock set forth in the
table is based upon an appraisal performed by an independent consulting firm
engaged by the Company.
(4) Options may terminate before their expiration date upon the death,
disability or termination of employment of the optionee.
(5) These values are determined using the Black-Scholes Option Pricing Model.
The Black-Scholes Option Pricing Model is one of the methods permitted by
the Commission for estimating the present value of options. The
Black-Scholes Option Pricing Model is based on assumptions as to certain
variables as described below and it is not intended to estimate, and has no
direct correlation to, the value of stock options that an individual will
actually realize. The actual value of the stock options that a Named
Executive Officer may realize, if any, will depend on the excess of the
market price on the date of exercise over the exercise price. The values
listed above were based on the following assumptions: volatility -- 0.0;
risk free rate of return -- 6.5%; dividend yield -- 0.0%; and expected
life -- 4 years.
AGGREGATE FISCAL YEAR-END OPTION VALUES
The following table sets forth, for each of the Named Executive Officers,
information concerning the number and value of securities underlying unexercised
options held on December 31, 1996. No options were exercised by such persons
during 1996.
<TABLE>
<CAPTION>
VALUE OF
NUMBER OF SECURITIES IN-THE-MONEY
UNDERLYING OPTIONS OPTIONS AT
AT YEAR END YEAR-END (1)
-------------------- ------------
NAME UNEXERCISED UNEXERCISED
---- ----------- -----------
<S> <C> <C>
John F. Davis, III................................... 300,000 $3,297,000
Joseph W. Nicholson.................................. 150,000 1,648,500
Jerome L. Galant..................................... 53,333 586,130
M. Nicholas Jent..................................... 9,333 92,303
William S. Lush...................................... 46,666 461,527
Phillip A. Mytom-Hart................................ 12,133 119,995
</TABLE>
- ---------------
(1) There was no public trading market for the Common Stock as of December 31,
1996. Accordingly, these values have been calculated in accordance with the
rules of the Commission on the basis of an initial public offering price of
$13.00 per share of the Common Stock, minus the exercise price, multiplied
by the number of shares underlying the option.
1996 AND 1997 STOCK OPTION PLANS
Scope. The Company has a 1996 Stock Option Plan (the "1996 Plan"). The
Company has recently approved the creation of the 1997 Stock Option Plan (the
"1997 Plan") and an amendment (the "Amendment") to the 1996 Plan. The 1997 Plan
and the Amendment will take effect upon the completion of this offering. The
1996 Plan, as amended, and the 1997 Plan (collectively, the "Plans") are
designed to attract and retain qualified and competent personnel for positions
of substantial responsibility and to provide additional incentive to employees
and consultants of the Company. The Plans have substantially the same
provisions, which are set forth herein. Options granted under the Plans may be
Incentive Stock Options or Nonstatutory Stock Options, as determined by the
Administrator (as hereinafter defined) at the time of grant and subject to the
applicable provisions of the Internal Revenue Code of 1986, as amended (the
"Code"). The 1996 and 1997 Plans have reserved for issuance 866,667 shares and
333,333 shares of Common Stock, respectively. As of March 31, 1997, options
covering 771,733 shares of Common Stock have been granted
55
<PAGE> 58
under the 1996 Plan. No option has been granted under the 1997 Plan. If an
option granted under the Plans expires or becomes unexercisable without having
been exercised in full, or is surrendered pursuant to an option exchange
program, the unpurchased shares may be available for future grants or sale under
the Plans. The 1996 and 1997 Plans will terminate on June 24, 2006 and March 25,
2007, respectively.
Eligibility. Persons eligible to participate in the Plans include all
employees and all consultants of the Company. For purposes of describing the
Plans, the term employee means any person employed by the Company or any parent
or subsidiary of the Company. For purposes of describing the Plans, the term
consultant means any person who is engaged by the Company or any parent or
subsidiary of the Company to render consulting or advisory services and is
compensated for such services, and any director of the Company who is not
compensated for his or her services or is paid only a director's fee by the
Company. Non-Statutory Stock Options may be granted to employees and
consultants. Incentive Stock Options may be granted only to employees.
Administration. The Plans are administered by the Board of Directors or the
Committee appointed by the Board (the "Administrator"). The Administrator has
the authority to grant options under the Plans and to determine the vesting
schedule and the exercise price of the options. The Administrator also has full
power and authority to construe, interpret and administer the Plans.
Option Exercise Price. The exercise price per share for the shares to be
issued pursuant to exercise of an option under the Plans shall be such price as
is determined by the Administrator. In the case of an Incentive Stock Option
granted to an employee, who at the time of the grant owns stock representing
more than 10% of the voting power of all classes of stock of the Company or any
parent or subsidiary, the exercise price per share shall be no less than 110% of
the fair market value per share on the date of grant. In the case of an
Incentive Stock Option granted to any employee other than an employee described
in the foregoing sentence, the per share exercise price shall be no less than
100% of the fair market value per share on the date of grant. In the case of a
Non-Statutory Stock Option, the per-share exercise price shall be determined by
the Administrator and shall be no less than 50% of the fair market value.
Adjustments, Terminations and Amendment. In the event of any change in the
Company's capitalization, including any stock split, reverse stock split, stock
dividend, combination or reclassification of the Common Stock, or any other
increase or decrease in the number of issued shares of Common Stock effected
without receipt of consideration by the Company, appropriate adjustments will be
made to the number of shares available under the Plans as well as the price per
share of Common Stock covered by each outstanding option. Upon the occurrence of
an acquisition event ("Acquisition Event") which shall mean (i) certain mergers
or consolidations of the Company with or into another corporation; (ii) the sale
of substantially all of the assets of the Company; (iii) the complete
liquidation of the Company; or (iv) the acquisition by another entity of
beneficial ownership of the Company's securities representing 50% or more of the
combined voting power of the Company's then outstanding securities, the Board of
Directors of the Company may (i) provide that each outstanding option shall be
assumed and/or an equivalent option be substituted by the successor corporation
or an affiliate thereof; (ii) upon written notice to the optionees, provide that
all options then unexercised will become exercisable in full as of a specified
date prior to the Acquisition Event and will terminate immediately prior to the
consummation of such Acquisition Event; or (iii) in the event of an Acquisition
Event under the terms of which holders of Common Stock will receive a cash
payment for each share of Common Stock surrendered, provide that all outstanding
options shall terminate upon consummation of such Acquisition Event, and each
optionee shall receive, in exchange therefor, a cash payment equal to the amount
(if any) by which the acquisition price multiplied by the number of shares of
Common Stock subject to such outstanding Options (whether or not then
exercisable), exceeds the aggregate exercise price of such options. The Plans
may be suspended, terminated, altered or amended in any way by the Board of
Directors, provided that, stockholder approval of any plan amendment will be
required to the extent necessary and desirable to comply with applicable
provisions of the Exchange Act, the Code or other legal requirements. No
suspension, termination, alteration or amendment of the Plans may alter or
impair the rights of any optionee under options previously granted.
56
<PAGE> 59
401(k) SAVINGS PLAN
The Company sponsors a qualified defined contribution retirement plan,
called the Pegasus Systems, Inc. 401(k) Savings Plan (the "401(k) Savings Plan")
under which eligible employees may elect to defer their current compensation by
up to certain statutorily prescribed annual limits ($9,500 in 1997) and to
contribute such amount to the 401(k) Savings Plan. The 401(k) Savings Plan
permits, but does not require, additional matching contributions by the Company
on behalf of all participants in the 401(k) Savings Plan. In 1996, the Company
made matching contributions of approximately $160,000. The 401(k) Savings Plan
is intended to qualify under Section 401 of the Code, so that contributions by
employees or by the Company to the 401(k) Savings Plan, and income earned on
such contributions, are not taxable to employees until withdrawn, and so that
contributions by the Company will be deductible by the Company when made. The
trustee for the 401(k) Savings Plan is Standard Insurance Company. The 401(k)
Savings Plan permits employees to direct investment of their accounts in the
401(k) Savings Plan among a selection of five mutual funds.
EMPLOYMENT AGREEMENTS
The Company is a party to employment agreements with each of Messrs. Davis
and Nicholson. Each agreement has a term extending through June 25, 2000, and
automatically renews for additional one year terms if neither the Company nor
the employee has notified the other party 60 days prior to the date of renewal
of its intention to terminate the agreement. The agreements provide that Messrs.
Davis and Nicholson will receive base annual salaries of $275,000 and $175,000,
respectively, and will be eligible to receive incentive compensation determined
by the Compensation Committee of the Board of Directors based on the achievement
of performance objectives established by the Compensation Committee from time to
time. The base annual salaries are subject to increase annually at the
discretion of the Compensation Committee. The agreements also provide that
Messrs. Davis and Nicholson will receive options for a total of 300,000 and
150,000 shares of Common Stock, respectively, at an exercise price of $2.01 per
share. These options were granted on June 25, 1996. The options will fully vest
no later than June 25, 2000. Each agreement obligates the Company to the extent
commercially practicable to maintain life insurance with respect to Messrs.
Davis and Nicholson. In accordance with the employment agreement with Mr. Davis,
the Company currently maintains coverage with respect to Mr. Davis in the amount
of $2.5 million with the Company as the sole beneficiary. In accordance with the
employment agreement with Mr. Nicholson, the Company currently maintains
coverage with respect to Mr. Nicholson in the amount of $1.0 million with the
Company as the sole beneficiary.
Each employment agreement provides that either the Company or the employee
has the right to terminate the employment at any time during the term of the
agreement with or without cause by delivering written notice of termination to
the other 30 days prior to the date of termination. Each agreement provides for
a severance payment if the agreement is terminated by the Company without cause.
Under such circumstances, Messrs. Davis and Nicholson would receive their base
annual salary for a period of 12 months following the date of termination,
payable over such 12-month period at such times as executives of the Company
receive their regular salary payments; all accrued salary, any benefits under
any plans of the Company in which the employee is a participant to the full
extent of such employee's rights under such plans and any appropriate
out-of-pocket business expense reimbursements; and, vesting of the options
granted under the applicable employment agreement shall accelerate so that (i)
if termination of employment occurs prior to July 25, 1999, such employee's
options shall vest for an additional 75,000 and 37,500 shares of Common Stock,
respectively (in addition to shares vested as of the date of termination), or
(ii) if termination of employment occurs on or after July 25, 1999, such
employee's options shall fully vest. If the agreements are terminated
voluntarily either by the employee or by the Company with cause, or by reason of
death or disability, then Mr. Davis or Mr. Nicholson, as the case may be, or
their respective estate will be entitled to payment of all accrued salary,
vesting of the options granted through the date of termination only, any further
benefits under any plans of the Company in which such person is a participant to
the full extent of such person's rights under such plans through the date of
termination only, and any appropriate out-of-pocket business expense
reimbursements.
57
<PAGE> 60
The Company has entered into a letter agreement with Jerome L. Galant,
Chief Financial Officer. The agreement provides that Mr. Galant will receive
annual base salary of $145,000, plus a bonus of up to 30% of such annual base
salary. Pursuant to this agreement, Mr. Galant has been granted options to
purchase up to 53,333 shares of Common Stock at an exercise price of $2.01 per
share.
The Company has entered into a letter agreement with Michael R. Donahue,
Chief Marketing Officer. The agreement provides that Mr. Donahue will receive
annual base salary of $165,000, and will be eligible to receive incentive
compensation based on the achievement of certain performance objectives.
Pursuant to this agreement, Mr. Donahue has been granted options to purchase up
to 53,333 shares of Common Stock at an exercise price of $5.25 per share. These
options will vest over four years. In addition, under certain circumstances Mr.
Donahue will receive a severance payment equal to (i) six-months base salary if
the employment terminates after 12 months; (ii) nine-months base salary if
employment terminates after 24 months; and (iii) twelve-months base salary if
employment terminates after 36 months.
LIMITATION OF LIABILITY AND INDEMNIFICATION MATTERS
As permitted by the Delaware General Corporation Law, the Company's Second
Amended and Restated Certificate of Incorporation, which becomes effective upon
completion of this offering, provides that no director of the Company will be
personally liable to the Company or its stockholders for monetary damages for
breach of fiduciary duty as a director, except for (i) any breach of the
director's duty of loyalty to the corporation or its stockholders, (ii) acts or
omissions not in good faith or that involve intentional misconduct or a knowing
violation of the law, (iii) unlawful payments of dividends or unlawful stock
repurchases or redemptions, or (iv) any transaction from which the director
derived an improper personal benefit. In addition, the Company maintains
directors' and officers' liability insurance. There is no pending litigation or
proceeding involving a director, officer or employee of the Company regarding
which indemnification is sought, nor is the Company aware of any threatened
litigation that may result in claims for indemnification.
58
<PAGE> 61
CERTAIN TRANSACTIONS
Since its inception, the Company has relied in part on stockholder loans to
fund its capital needs. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources." The
following table sets forth certain information concerning the outstanding loans
made by each stockholder named therein and the amount of principal and interest
paid to such stockholders during the periods indicated.
<TABLE>
<CAPTION>
AMOUNT OF PRINCIPAL
AMOUNT OF LOANS AND INTEREST PAID IN
LARGEST AMOUNT OF OUTSTANDING YEAR ENDED DEC. 31,
LOANS OUTSTANDING (INCLUDING ACCRUED ------------------------------
(INCLUDING ACCRUED INTEREST) AS OF INTEREST
STOCKHOLDERS/LENDERS INTEREST)(1) MARCH 31, 1997 RATE(2) 1994 1995 1996
- -------------------- ------------------ ------------------ ---------- -------- -------- --------
<S> <C> <C> <C> <C> <C> <C>
Reed Travel Group(3)........... $4,536,482 $4,072,554 Prime + 2% $588,426 $463,363 $441,241
Best Western International,
Inc.......................... 185,878 128,540 Prime + 1% -- -- --
Choice Hotels International,
Inc.......................... 91,541 62,649 Prime + 1% -- -- --
Forte, Inc..................... 90,976 61,995 Prime + 1% -- -- --
HFS Incorporated............... 174,337 69,554 Prime + 1% 12,710 36,574 --
Hilton Hotels Corporation...... 86,093 46,559 Prime + 1% 3,116 10,263 --
Hyatt Hotels Corporation....... 180,790 101,067 Prime + 1% -- 22,628 --
Inter-Continental Hotels
Corporation.................. 177,039 114,332 Prime + 1% 2,653 9,267 --
La Quinta Inns, Inc............ 176,388 114,386 Prime + 1% 2,682 7,967 --
Marriott Corporation........... 86,044 27,081 Prime + 1% 6,012 23,629 --
Promus Hotels, Inc............. 167,504 103,945 Prime + 1% -- -- --
ITT Sheraton Corporation....... 185,311 127,882 Prime + 1% -- -- --
Utell International(3)......... 94,148 65,604 Prime + 1% -- -- --
Utell International(3)(4)...... 215,503 -- Prime + 3% -- 16,151 205,514
Westin Hotels & Resorts........ 184,215 126,679 Prime + 1% -- -- --
<CAPTION>
AMOUNT OF
PRINCIPAL
AND INTEREST PAID
IN THREE MONTHS
ENDED
STOCKHOLDERS/LENDERS MARCH 31, 1997
- -------------------- -----------------
<S> <C>
Reed Travel Group(3)........... $296,524
Best Western International,
Inc.......................... --
Choice Hotels International,
Inc.......................... --
Forte, Inc..................... --
HFS Incorporated............... --
Hilton Hotels Corporation...... --
Hyatt Hotels Corporation....... --
Inter-Continental Hotels
Corporation.................. --
La Quinta Inns, Inc............ --
Marriott Corporation........... --
Promus Hotels, Inc............. --
ITT Sheraton Corporation....... --
Utell International(3)......... --
Utell International(3)(4)...... --
Westin Hotels & Resorts........ --
</TABLE>
The Company derives a substantial portion of its revenue from stockholders
and their affiliated companies. See Note 14 of Notes to Consolidated Financial
Statements for information concerning related party transactions. The following
table sets forth the amount of revenues the Company received in 1994, 1995 and
1996 and the three months ended March 31, 1997 from its stockholders and their
affiliates with respect to services rendered by the Company in connection with
the THISCO, HCC and TravelWeb services:
<TABLE>
<CAPTION>
YEAR ENDED DEC. 31,
-------------------------------- THREE MONTHS ENDED
STOCKHOLDERS 1994 1995 1996 MARCH 31, 1997
------------ -------- -------- -------- ------------------
<S> <C> <C> <C> <C>
Anasazi, Inc............................ $120,560 $117,798 $169,190 $101,993
Best Western International, Inc......... 395,208 425,022 577,894 193,239
Choice Hotels International, Inc........ 349,943 397,340 516,666 130,994
Forte, Inc.............................. 155,766 217,563 429,098 70,399
HFS Incorporated........................ 574,401 887,377 741,549 222,042
Hilton Hotels Corporation............... 178,595 265,305 410,844 56,693
Hyatt Hotels Corporation................ 380,149 550,090 633,818 217,439
Inter-Continental Hotels Corporation.... 121,751 275,284 380,287 76,033
La Quinta Inns, Inc..................... 122,662 218,782 208,037 64,014
Marriott Corporation.................... 164,590 205,664 425,673 84,201
Promus Hotels, Inc...................... 451,901 533,629 644,815 215,851
ITT Sheraton Corporation................ 468,800 477,883 623,985 178,319
Utell International(3).................. 174,052 194,159 243,505 61,805
Westin Hotels & Resorts................. 114,080 164,889 453,020 71,552
</TABLE>
- ---------------
(1) Sets forth as of March 31, 1997 the largest aggregate amount of indebtedness
outstanding since January 1994. The maturity date for the loan from Reed is
June 30, 2001. The maturity date for each of the remaining loans is July 21,
2000.
(2) "Prime" means the prime rate of interest published in the Wall Street
Journal. As of March 31, 1997, such prime rate was 8.5% per annum.
(3) Reed and Utell International are divisions of Reed Elsevier Inc. and Reed
Electronic Publishing, Inc., respectively. In connection with the
development of the UltraSwitch technology and related financing provided by
Reed, the Company licensed Reed certain rights to use the UltraSwitch
technology for applications unrelated to the hotel industry. See
"Business -- Technology and Operations." I. Malcolm Highet is a director of
the Company and is affiliated with Reed Elsevier, Inc. and Reed Electronic
Publishing, Inc. See "Management" and "Principal and Selling Stockholders."
(4) Note was paid in full on March 28, 1996.
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<PAGE> 62
Effective in July 1995, the Company issued 4,934,667 shares of Common Stock
in exchange for all of the outstanding capital stock of THISCO and 83.3% of the
outstanding capital stock of HCC (the "Reorganization"). Lodging Network, Inc.
("LNI"), a stockholder of the Company, retained certain shares of HCC preferred
stock, representing 16.7% of the outstanding capital stock of HCC. In
conjunction with the Reorganization, LNI was granted an option (the "LNI
Option") expiring in July 1998 to exchange its interest in HCC for 448,667
shares of the Company's Common Stock. In June 1996, the Company purchased the
shares of HCC preferred stock held by LNI for $2.0 million and 89,733 shares of
Common Stock, and the LNI Option was canceled. See Notes 2 and 3 of Notes to the
Consolidated Financial Statements.
Prior to the Reorganization, HCC offered a special bonus plan for
management of HCC, including Messrs. Davis, Nicholson, Jent and Hart. As part of
the Reorganization in 1995, HCC management agreed to forfeit their rights to
participate in the bonus plan to HCC in return for a cash payment and the
opportunity to purchase an aggregate of 283,333 shares of the Company's Common
Stock for $570,874.
In June 1996, Information Associates, L.P. and Information Associates, C.V.
purchased 1,538,463 shares of the Company's Series A Preferred Stock for $4.88
per share or $7,500,005, representing 22.9% of the shares of the Company's
capital stock outstanding after the purchase. Information Associates, L.P. and
Information Associates, C.V. are affiliates of Trident. Donald R. Dixon and
Rockwell A. Schnabel, two directors of the Company, are associated with Trident.
See "Management" and Note 8 of Notes to the Consolidated Financial Statements.
Anasazi, a stockholder of the Company, provides services to the Company
which include facility management and maintenance, consulting and software
development. During 1994, 1995 and 1996 and during the three months ended March
31, 1997, the Company paid to Anasazi $526,641, $578,469 and $716,870 and
$103,143, respectively, for these services. In the past three fiscal years, the
Company has purchased furniture and interior design items from Right Angle, a
company owned by Mrs. Leah Davis, the spouse of Mr. John F. Davis, III, the
Chief Executive Officer, President and a director of the Company. Mrs. Davis
received commissions not in excess of 15% of the amount of such purchases. The
total payments made to Right Angle and Mrs. Davis for furniture, decorative
items and commissions in 1994, 1995 and 1996 were $88,149, $16,908 and $121,425,
respectively. With regard to its transactions with Anasazi and Right Angle, the
Company believes that the terms of such transactions were at least as favorable
to the Company as terms that could have been negotiated with an unrelated third
party.
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<PAGE> 63
PRINCIPAL AND SELLING STOCKHOLDERS
The following table sets forth certain information regarding the beneficial
ownership of the Company's Common Stock as of July 31, 1997 and as adjusted to
reflect the sale of shares in this offering by (i) each person known by the
Company to own beneficially more than 5% of the outstanding Common Stock, (ii)
each of the Company's directors, (iii) each of the Named Executive Officers,
(iv) all directors and executive officers of the Company as a group and (v) each
Selling Stockholder.
<TABLE>
<CAPTION>
SHARES BENEFICIALLY SHARES BENEFICIALLY
OWNED PRIOR TO OWNED AFTER THE
THE OFFERING(1) NUMBER OF OFFERING(1)(2)
------------------- SHARES -------------------
NAME NUMBER PERCENT BEING OFFERED NUMBER PERCENT
---- --------- ------- ------------- --------- -------
<S> <C> <C> <C> <C> <C>
Entities affiliated with Trident
Capital(3)............................ 1,538,463 22.9% -- 1,538,463 15.8%
Reed Travel Group (A division of Reed
Elsevier Inc.)(4)..................... 642,800 9.6 128,600 514,200 5.3
HFS Incorporated(5)..................... 507,200 7.5 421,244 85,956 *
Promus Hotels, Inc.(6).................. 493,364 7.3 -- 493,364 5.1
Best Western International(7)........... 426,204 6.3 -- 426,204 4.4
Hyatt Hotels Corporation(8)............. 420,607 6.3 -- 420,607 4.3
ITT Sheraton Corporation(9)............. 336,267 5.0 -- 336,267 3.5
Utell International (A division of Reed
Electronic Publishing, Inc.)(4)....... 115,920 1.7 23,200 92,720 1.0
John F. Davis, III(10).................. 259,750 3.8 -- 259,750 2.6
Joseph W. Nicholson(10)................. 92,208 1.4 -- 92,208 *
M. Nicholas Jent(10).................... 36,333 * -- 36,333 *
Phillip A. Mytom-Hart(10)............... 34,233 * -- 34,233 *
Michael Donahue......................... -- * -- -- *
Jerome L. Galant(10).................... 13,333 * -- 13,333 *
William S. Lush(10)..................... 11,666 * -- 11,666 *
John W. Biggs........................... -- * -- -- *
Donald R. Dixon(3)...................... -- * -- -- *
William C. Hammett, Jr. ................ -- * -- -- *
I. Malcolm Highet(4).................... -- * -- -- *
Rockwell A. Schnabel(3)................. -- * -- -- *
Paul J. Travers......................... -- * -- -- *
Mark C. Wells(6)........................ -- * -- -- *
Bruce Wolff............................. -- * -- -- *
Directors and executive officers as a
group (15 persons)(10)................ 447,523 6.5 -- 447,523 4.5
</TABLE>
- ---------------
* Less than 1%
(1) Beneficial ownership is determined in accordance with the rules of the
Commission and generally includes voting or investment power with respect
to securities. Except as indicated by footnote and subject to community
property law where applicable, the Company believes, based on information
furnished by such persons, that the persons named in the table above have
sole voting and investment power with respect to all shares of Common Stock
shown as beneficially owned by them. Percentage of beneficial ownership is
based on 6,729,712 shares of Common Stock outstanding as of July 31, 1997,
and 9,729,712 shares of Common Stock outstanding after the completion of
this offering. In computing the number of shares of Common Stock subject to
options held by that person that are exercisable within 60 days of July 31,
1997 are deemed outstanding. Such shares, however, are not deemed
outstanding for the purpose of computing the percentage ownership of any
other person.
(2) Assumes no exercise of the underwriters' over-allotment option.
(3) Of the total shares indicated as beneficially owned by entities affiliated
with Trident Capital, Information Associates, L.P. owns 1,496,693 shares
and Information Associates, C.V. owns 41,769 shares. Information
Associates, C.V. is a Netherlands Antilles limited partnership and Informa-
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<PAGE> 64
tion Associates, L.P. is a Delaware limited partnership. The general
partner of each of these entities is Trident Capital Management, L.L.C., a
Delaware limited liability company ("Trident Capital"), the members of
which include Donald R. Dixon and Rockwell A. Schnabel, directors of the
Company. The address of Trident Capital is 2480 Sand Hill Road, Suite 100,
Menlo Park, California 94025.
(4) Reed and Utell International are divisions of Reed Elsevier Inc. and Reed
Electronic Publishing, Inc., respectively. The address of Reed Elsevier
Inc. is 200 Park Avenue, 17th Floor, New York, New York 10166. The address
for Reed Electronic Publishing, Inc. is 500 Plaza Drive, Secaucus, New
Jersey 07094-3619. Mr. Highet, a director of the Company, is affiliated
with Reed Elsevier Inc. and Reed Electronic Publishing, Inc.
(5) The address of HFS Incorporated is 3838 E. Van Buren, Phoenix, Arizona
85008.
(6) The address of Promus Hotels, Inc. is 755 Crossover Lane, Memphis,
Tennessee 38117. Mr. Wells, a director of the Company, is affiliated with
Promus Hotels, Inc.
(7) The address of Best Western International is 6201 N. 24th Parkway, Phoenix,
Arizona 85016.
(8) The address of Hyatt Hotels Corporation is 200 West Madison, Chicago,
Illinois 60606.
(9) The address of ITT Sheraton Corporation is Sixty State Street, World
Headquarters, Boston, Massachusetts 02109.
(10) Includes exercisable options held by Mr. Davis and Mr. Nicholson to
purchase 75,000 and 37,500 shares of Common Stock, respectively, and
options exercisable within 60 days of July 31, 1997 held by Messrs. Davis,
Nicholson, Jent, Mytom-Hart, Galant and Lush of 18,750, 9,375, 2,333,
3,033, 13,333 and 11,666 shares of Common Stock, respectively.
DESCRIPTION OF CAPITAL STOCK
The Company's authorized capital stock consists of 100,000,000 shares of
Common Stock, $.01 par value per share ("Common Stock"), and 2,000,000 shares of
Preferred Stock, $.01 par value per share (the "Preferred Stock"), issuable in
series. As of August 4, 1997, there were outstanding 6,729,712 shares of Common
Stock held of record by 29 stockholders assuming the conversion of all
outstanding shares of Preferred Stock into Common Stock.
COMMON STOCK
The holders of Common Stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders. The holders of
Common Stock are not entitled to cumulate voting rights with respect to the
election of directors, and as a consequence, minority stockholders will not be
able to elect directors on the basis of their votes alone. Subject to
preferences that may be applicable to any then outstanding shares of Preferred
Stock, holders of Common Stock are entitled to receive ratably such dividends as
may be declared by the Board of Directors out of funds legally available
therefor. See "Dividend Policy." In the event of a liquidation, dissolution or
winding up of the Company, holders of the Common Stock are entitled to share
ratably in all assets remaining after payment of liabilities and the liquidation
preference of any then outstanding Preferred Stock. Holders of Common Stock have
no preemptive, conversion or other rights to subscribe for additional securities
of the Company. There are no redemption or sinking fund provisions applicable to
the Common Stock. All outstanding shares of Common Stock are, and all shares of
Common Stock to be outstanding upon completion of this offering will be, validly
issued, fully paid and nonassessable.
PREFERRED STOCK
The Board of Directors has the authority, without further action by the
stockholders, to issue up to 2,000,000 shares of Preferred Stock in one or more
series and to fix the rights, preferences, privileges and restrictions thereof,
including dividend rights, conversion rights, voting rights, terms of
redemption, liquidation preferences, sinking fund terms and the number of shares
constituting any series or the designation of such series, without any further
vote or action by stockholders. The issuance of Preferred Stock could adversely
affect the voting power of holders of Common Stock and the likelihood that such
holders will receive dividend payments and payments upon liquidation and could
have the effect of delaying, deferring or preventing a change in control of the
Company. Upon completion of this offering, there will be no shares of Preferred
Stock outstanding and the Company has no present plan to issue any shares of
Preferred Stock.
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<PAGE> 65
WARRANTS
In connection with the Distribution Services Agreement entered into in May
1997 between the Company and Holiday Inn, the Company issued to Holiday Inn
warrants for the purchase of up to 345,723 shares of the Company Common Stock.
The warrants are exercisable at any time during the two year period ending May
12, 1999 at an exercise price equal to the lower of $7.20 per share or 85.0% of
the price per share for the Common Stock offered hereby.
DELAWARE ANTI-TAKEOVER LAW AND CERTAIN CHARTER PROVISIONS
Delaware Anti-Takeover Statute. The Company is subject to the provisions of
Section 203 of the Delaware General Corporation Law, an anti-takeover law. In
general, the statute prohibits a publicly held Delaware corporation from
engaging in a "business combination" with an "interested stockholder" for a
period of three years after the date of the transaction in which the person
became an interested stockholder, unless the business combination is approved in
a prescribed manner. For purposes of Section 203, a "business combination"
includes a merger, asset sale or other transaction resulting in a financial
benefit to the interested stockholder, and an "interested stockholder" is a
person who, together with affiliates and associates, owns (or within three years
prior, did own) 15% or more of the corporation's voting stock.
Certificate of Incorporation. The Certificate of Incorporation to be
effective concurrently with this offering (the "Certificate") provides (i) for
the authorization of the Board of Directors to issue, without further action by
the stockholders, up to 2,000,000 shares of Preferred Stock in one or more
series and to fix the rights, preferences, privileges and restrictions thereof,
(ii) that any action required or permitted to be taken by stockholders of the
Company must be effected at a duly called annual or special meeting of the
stockholders and may not be effected by a consent in writing, (iii) that special
meetings of stockholders of the Company may be called only by the Chairman of
the Board, the Chief Executive Officer or a majority of the members of the Board
of Directors, (iv) for a classified Board of Directors, (v) that vacancies on
the Board of Directors, including newly created directorships, can be filled
only by a majority of the directors then in office, and (vi) that directors of
the Company may be removed only for cause and only by the affirmative vote of
holders of at least two-thirds of the outstanding shares of voting stock, voting
together as a single class.
These provisions are intended to enhance the likelihood of continuity and
stability in the composition of the Board of Directors and in the policies
formulated by the Board of Directors and to discourage certain types of
transactions that may involve an actual or threatened change of control of the
Company. These provisions are designed to reduce the vulnerability of the
Company to an unsolicited proposal for a takeover of the Company that does not
contemplate the acquisition of all of its outstanding shares, or an unsolicited
proposal for the restructuring or sale of all or part of the Company. Such
provisions, however, could discourage potential acquisition proposals and could
delay or prevent a change in control of the Company. Such provisions may also
have the effect of preventing changes in the management of the Company. See
"Risk Factors -- Anti-Takeover Matters."
LIMITATIONS ON DIRECTOR LIABILITY
The Certificate provides that, to the fullest extent permitted by the
General Corporation Law of the State of Delaware as the same exists or as may
hereafter be amended, directors of the Company will not be liable to the Company
or its stockholders for monetary damages for breach of fiduciary duty as a
director.
REGISTRATION RIGHTS
Pursuant to an agreement between the Company and the holders (the
"Holders") after the completion of this offering of approximately 6,156,668
shares of Common Stock (the "Registrable Securities"), the Holders are entitled
to certain rights with respect to the registration of such shares under the
Securities Act. If the Company proposes to register any of its securities under
the Securities Act (other than a registration on a Form S-3 or any successor
form), either for its own account or for the account of other Holders exercising
registration rights, the Holders are entitled to notice of such registration and
are entitled, subject to certain limitations, to include shares of Registrable
Securities therein. Additionally, the Holders are entitled to certain
63
<PAGE> 66
demand registration rights pursuant to which they may require the Company to
file a registration statement under the Securities Act (other than a
registration on a Form S-3 or any successor forms) at the Company's expense with
respect to their shares of Registrable Securities, and the Company is required
to use its best efforts to effect such registration. Subject to certain
limitations, the Holders may also require the Company to register their shares
on Form S-3 when such form becomes available to the Company. Generally, the
Company is required to bear all registration and selling expenses incurred in
connection with any such registrations. The rights are subject to certain
conditions and limitations, among them the right of the underwriters of an
offering to limit the number of shares included in such registration. Such
registration rights terminate as to any Holder at such time as the Holder holds
less then one percent (1%) of the Company's outstanding capital stock and may
sell all of such Holder's shares under rule 144 promulgated under the Securities
Act within a three-month period.
TRADING MARKET, TRANSFER AGENT AND REGISTRAR
The Common Stock has been approved for quotation on the Nasdaq National
Market subject to official notice of issuance under the symbol PEGS. The
Transfer Agent and Registrar for the Common Stock will be American Securities
Transfer & Trust, Inc.
SHARES ELIGIBLE FOR FUTURE SALE
Upon completion of this offering, the Company will have outstanding an
aggregate of 9,729,712 shares of Common Stock, assuming no exercise of the
Underwriters' over-allotment option and no exercise of outstanding options. Of
these shares, all of the shares sold in the offering will be freely tradeable by
persons other than "affiliates" or persons deemed to be acting as "underwriters"
(as such terms are defined under the Securities Act) of the Company. The
remaining 6,156,668 shares of Common Stock are "restricted shares" within the
meaning of Rule 144 under the Securities Act and may be sold only if they are
registered under the Securities Act or are sold pursuant to an applicable
exemption from registration, including pursuant to Rule 144. The Company has
granted certain registration rights to the holders of such shares. See
"Description of Capital Stock -- Registration Rights."
In general, under Rule 144, as currently in effect, a person (or persons
whose shares are required to be aggregated) who has beneficially owned, for at
least one year, shares of Common Stock that have not been registered under the
Securities Act or that were acquired from an "affiliate" of the Company is
entitled to sell within any three-month period the number of shares of Common
Stock which does not exceed the greater of one percent of the number of then
outstanding shares or the average weekly reported trading volume during the four
calendar weeks preceding the sale. Sales under Rule 144 are also subject to
certain notice and manner of sale requirements and to the availability of
current public information about the Company and must be made in unsolicited
brokers' transactions or to a market maker. A person (or persons whose shares
are aggregated) who is not an "affiliate" of the Company under the Securities
Act during the three months preceding a sale and who has beneficially owned such
shares for at least two years is entitled to sell such shares under Rule 144
without regard to the volume, notice, information and manner of sale provisions
of such rule. Rule 144 does not require the same person to have held the
securities for the applicable periods.
Any employee, officer or director of or consultant to the Company who
purchased or was awarded shares or options to purchase shares pursuant to a
written compensatory plan or contract is entitled to rely on the resale
provisions of Rule 701 under the Securities Act, which permits affiliates and
non-affiliates to sell such shares without having to comply with the holding
period restrictions of Rule 144, in each case commencing 90 days after the date
of this Prospectus. In addition, non-affiliates may sell such shares without
complying with the public information, volume and notice provisions of Rule 144.
Rule 701 is available for optionholders of the Company as to all shares issued
pursuant to the exercise of options granted prior to this offering.
After the offering, the Company intends to file a registration statement on
Form S-8 to register the shares of Common Stock issuable upon exercise of
options granted or to be granted pursuant to the Plans. Accordingly, shares
issued upon exercise of such options will be freely tradeable by holders who are
not affiliates of the Company and, subject to the volume and other limitations
of Rule 144, by holders who are affiliates of the Company.
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<PAGE> 67
The Company, its executive officers and directors who are stockholders,
certain holders of options to purchase Common Stock under the Plans and certain
other stockholders of the Company, all of which hold an aggregate of 6,156,668
shares of Common Stock, have agreed that, for a period of 180 days from the date
of this Prospectus, they will not offer, sell or otherwise dispose of any shares
of Common Stock or options to acquire Common Stock without the prior written
consent of Hambrecht & Quist LLC, except for the issuance by the Company of
options to purchase Common Stock or shares of Common Stock issuable upon the
exercise thereof, provided that such options shall not become exercisable and
such shares issuable upon exercise of options or pursuant to acquisitions shall
not be transferable prior to the end of the 180-day period and for certain
transfers by individuals signing such agreements to their immediate family
members.
Prior to the offering, there has been no market for the Common Stock. No
predictions can be made of the effect, if any, that market sales of shares of
Common Stock or the availability of such shares for sale will have on the market
price prevailing from time to time. Nevertheless, sales of significant amounts
of Common Stock could adversely affect the prevailing market price of the Common
Stock, as well as impair the ability of the Company to raise capital through the
issuance of additional equity securities. See "Risk Factors -- Absence of Prior
Public Market; Potential Volatility of Stock Price."
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<PAGE> 68
UNDERWRITING
Subject to the terms and conditions of the Underwriting Agreement, the
Underwriters named below (the "Underwriters"), through their representatives,
Hambrecht & Quist LLC, Montgomery Securities and Volpe Brown Whelan & Company,
LLC (the "Representatives"), have severally agreed to purchase from the Company
and the Selling Stockholders the following respective numbers of shares of
Common Stock:
<TABLE>
<CAPTION>
Number of
Name Shares
---- ---------
<S> <C>
Hambrecht & Quist LLC....................................... 1,107,218
Montgomery Securities....................................... 830,413
Volpe Brown Whelan & Company, LLC........................... 830,413
Bear Stearns & Co. Inc. .................................... 70,000
Alex. Brown & Sons Incorporated............................. 70,000
Lazard Freres & Co. LLC..................................... 70,000
Merrill Lynch & Co. ........................................ 70,000
Oppenheimer & Co., Inc. .................................... 70,000
Robertson, Stephens & Company LLC........................... 70,000
Smith Barney Inc. .......................................... 70,000
Allen & Company Incorporated................................ 35,000
First Albany Corporation.................................... 35,000
Morgan Keegan & Company, Inc. .............................. 35,000
Needham & Co. Inc. ......................................... 35,000
Rauscher Pierce Refsnes, Inc. .............................. 35,000
Robinson-Humphrey Company, Inc. ............................ 35,000
Sanders Morris Mundy Inc. .................................. 35,000
Sutro & Company Inc. ....................................... 35,000
Wedbush Morgan Securities................................... 35,000
---------
Total............................................. 3,573,044
=========
</TABLE>
The Underwriting Agreement provides that the obligations of the
Underwriters are subject to certain conditions precedent, including the absence
of any material adverse change in the Company's business and the receipt of
certain certificates, opinions and letters from the Company, its counsel and
independent auditors. The nature of the Underwriters' obligation is such that
they are committed to purchase all shares of Common Stock offered hereby if any
of such shares are purchased.
The Underwriters propose to offer the shares of Common Stock directly to
the public at the initial public offering price set forth on the cover page of
this Prospectus and to certain dealers at such price less a concession not in
excess of $0.53 per share. The Underwriters may allow and such dealers may
reallow a concession not in excess of $0.10 per share to certain other dealers.
After the offering, the offering price and other selling terms may be changed by
the Representatives. The Representatives have informed the Company that the
Underwriters do not intend to confirm sales to accounts over which they exercise
discretionary authority.
The Company and a Selling Stockholder have granted to the Underwriters an
option, exercisable not later than 30 days after the date of this Prospectus, to
purchase up to 535,956 additional shares of Common Stock at the offering price,
less the underwriting discount set forth on the cover page of this Prospectus.
To the extent the Underwriters exercise this option, each of the Underwriters
will have a firm commitment to purchase approximately the same percentage
thereof which the number of shares of Common Stock to be purchased by it shown
in the above table bears to the total number of shares of Common Stock offered
hereby. The Company will be obligated, pursuant to the option, to sell such
shares to the Underwriters to the extent the option is exercised. The
Underwriters may exercise such option only to cover over-allotments made in
connection with the sale of shares of Common Stock offered hereby.
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<PAGE> 69
The offering of the shares is made for delivery when, as and if accepted by
the Underwriters and subject to prior sale and to withdrawal, cancellation or
modification of the offering without notice. The Underwriters reserve the right
to reject an order for the purchase of shares in whole or in part.
The Company and the Selling Stockholders have agreed to indemnify the
Underwriters against certain liabilities, including liabilities under the
Securities Act, and to contribute to payments the Underwriters may be required
to make in respect thereof.
The officers and directors who are stockholders of the Company and certain
of the other stockholders and optionholders, who will own in the aggregate
6,156,668 shares of Common Stock after the offering, have agreed, subject to
certain exceptions, that they will not, without the prior written consent of
Hambrecht & Quist LLC, offer, sell or otherwise dispose of any shares of Common
Stock, options or warrants to acquire shares of Common Stock or securities
exchangeable for or convertible into shares of Common Stock owned by them during
the 180-day period following the date of this Prospectus. The Company has agreed
that it will not, without the prior written consent of Hambrecht & Quist LLC,
offer, sell or otherwise dispose of any shares of Common Stock, options or
warrants to acquire shares of Common Stock or securities exchangeable for or
convertible into shares of Common Stock during the 180-day period following the
date of this Prospectus, except that the Company may issue shares upon the
exercise of options granted prior to the date hereof, and may grant additional
options under its Plans, provided that, without the prior written consent of
Hambrecht & Quist LLC, such additional options shall not be exercisable during
such 180-day period.
Prior to the offering, there has been no public market for the Common
Stock. The initial public offering price for the Common Stock has been
determined by negotiations among the Company, the Selling Stockholders and the
Representatives. Among the factors considered in determining the initial public
offering price were prevailing market and economic conditions, revenues and
earnings of the Company, market valuations of other companies engaged in
activities similar to the Company, estimates of the business potential and
prospects of the Company, the present state of the Company's business
operations, the Company's management and other factors deemed relevant.
Certain persons participating in this offering may overallot or effect
transactions which stabilize, maintain or otherwise affect the market price of
the Common Stock at levels above those which might otherwise prevail in the open
market, including by entering stabilizing bids, effecting syndicate covering
transactions or imposing penalty bids. A stabilizing bid means the placing of
any bid or effecting of any purchase, for the purpose of pegging, fixing or
maintaining the price of the Common Stock. A syndicate covering transaction
means the placing of any bid on behalf of the underwriting syndicate or the
effecting of any purchase to reduce a short position created in connection with
the offering. A penalty bid means an arrangement that permits the Underwriters
to reclaim a selling concession from a syndicate member in connection with the
offering when shares of Common Stock sold by the syndicate member are purchased
in syndicate covering transactions. Such transactions may be effected on the
Nasdaq Stock Market, in the over-the-counter market, or otherwise. Such
stabilizing, if commenced, may be discontinued at any time.
LEGAL MATTERS
The validity of the issuance of the shares of Common Stock offered by this
Prospectus will be passed upon for the Company by Locke Purnell Rain Harrell (A
Professional Corporation), Dallas, Texas. Cooley Godward LLP, San Francisco,
California, will pass upon certain legal matters for the Underwriters.
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<PAGE> 70
EXPERTS
The consolidated financial statements of Pegasus Systems, Inc. as of
December 31, 1996 and for the year ended December 31, 1996 included in this
Prospectus and the related financial statement schedule for the year ended
December 31, 1996 included elsewhere in the Registration Statement have been so
included in reliance on the report of Price Waterhouse LLP, independent
accountants, given on the authority of said firm as experts in auditing and
accounting.
The consolidated financial statements of Pegasus Systems, Inc. (formerly
The Hotel Industry Switch Company in 1994) as of December 31, 1995 and for each
of the two years in the period ended December 31, 1995 and the consolidated
financial statements of The Hotel Clearing Corporation as of December 31, 1993
and 1994 and for each of the two years in the period ended December 31, 1994
included in this Prospectus and the related financial statement schedule for the
years ended December 31, 1994 and 1995 included elsewhere in the Registration
Statement have been so included in reliance on the reports of Belew Averitt LLP,
independent accountants, given on the authority of said firm as experts in
auditing and accounting.
In January 1997, the Company advised Belew Averitt LLP ("Belew Averitt")
that it would no longer retain the firm as independent accountants. The reports
of Belew Averitt on the Company, formerly The Hotel Industry Switch Company, and
The Hotel Clearing Corporation for the previous years (1993, 1994 and 1995) did
not contain an adverse opinion or a disclaimer of opinion, nor were they
qualified or modified as to uncertainty, audit scope or accounting principles.
The decision to change accountants was precipitated by the Company's plan to
complete an initial public offering in 1997 and was approved by the Board of
Directors on January 7, 1997. During the periods audited by Belew Averitt and
through January 7, 1997 there were no disagreements with Belew Averitt on any
matter of accounting principles or practices, financial statement disclosure or
auditing scope or procedure, which disagreement(s) if not resolved to the
satisfaction of Belew Averitt, would have caused it to make reference to the
subject matter of the disagreements in connection with its reports. Price
Waterhouse LLP was engaged by the Company as its independent accountants on
January 7, 1997.
ADDITIONAL INFORMATION
The Company has filed with the Securities and Exchange Commission,
Washington, D.C. 20549 (the "Commission"), a registration statement on Form S-1
(together with a registration statement filed pursuant to Rule 462(b), the
"Registration Statement") under the Securities Act with respect to the shares of
Common Stock offered hereby. This Prospectus does not contain all the
information set forth in the Registration Statement and the exhibits and
schedules thereto. For further information with respect to the Company and the
shares offered by this Prospectus, reference is made to the Registration
Statement, including the exhibits and schedules filed thereto. Statements
contained in this Prospectus as to the contents of any agreement, contract or
other document referred to are not necessarily complete, and in each instance
reference is made to the copy of such contract or other document filed as an
exhibit to the Registration Statement or such other document, each such
statement being qualified in all respects by such reference. A copy of the
Registration Statement may be inspected by anyone without charge at the
Commission's principal office in Washington, D.C. and copies of all or any part
thereof may be obtained upon payment of certain fees prescribed by the
Commission from the Public Reference Section of the Commission at the
Commission's principal office, 450 Fifth Street, N.W., Washington, D.C. 20549,
or at the Commission's Regional Offices in New York, located at 7 World Trade
Center, Suite 1300, New York, New York 10048, or in Chicago, located at 500 West
Madison Street, Suite 1400, Chicago, Illinois 60661. The Commission maintains a
World Wide Web site that contains reports, proxy and information statements and
other information regarding registrants that file electronically with the
Commission. The address of the Commission's World Wide Web site is
http://www.sec.gov.
68
<PAGE> 71
PEGASUS SYSTEMS, INC.
INDEX TO FINANCIAL STATEMENTS
<TABLE>
<S> <C>
PEGASUS SYSTEMS, INC.:
Consolidated Annual Financial Statements:
Reports of Independent Accountants........................ F-2
Consolidated Balance Sheets as of December 31, 1995 and
1996................................................... F-4
Consolidated Statements of Operations for the Years Ended
December 31, 1994, 1995 and 1996....................... F-5
Consolidated Statements of Changes in Shareholders' Equity
(Deficit) for the Years Ended December 31, 1994, 1995
and 1996............................................... F-6
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1994, 1995 and 1996....................... F-7
Notes to Consolidated Financial Statements................ F-8
Consolidated Interim Financial Statements (Unaudited):
Consolidated Balance Sheets as of December 31, 1996 and
March 31, 1997......................................... F-23
Consolidated Statements of Operations for the Three Months
Ended March 31, 1996 and 1997.......................... F-24
Consolidated Statement of Changes in Shareholders' Equity
for the Three Months Ended March 31, 1997.............. F-25
Consolidated Statements of Cash Flows for the Three Months
Ended March 31, 1996 and 1997.......................... F-26
Notes to Consolidated Interim Financial Statements........ F-27
THE HOTEL CLEARING CORPORATION:
Consolidated Annual Financial Statements:
Report of Independent Accountants......................... F-29
Consolidated Balance Sheets as of December 31, 1993 and
1994................................................... F-30
Consolidated Statements of Operations for the Years Ended
December 31, 1993 and 1994............................. F-31
Consolidated Statements of Shareholders' Deficit for the
Years Ended December 31, 1993 and 1994................. F-32
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1993 and 1994............................. F-33
Notes to Consolidated Financial Statements................ F-34
Consolidated Interim Financial Statements (Unaudited):
Consolidated Balance Sheet as of June 30, 1995............ F-40
Consolidated Statements of Operations for the Six Months
Ended June 30, 1994 and 1995........................... F-41
Consolidated Statement of Shareholders' Deficit for the
Six Months Ended June 30, 1995......................... F-42
Consolidated Statements of Cash Flows for the Six Months
Ended June 30, 1994 and 1995........................... F-43
Notes to Consolidated Interim Financial Statements........ F-44
</TABLE>
F-1
<PAGE> 72
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and
Shareholders of Pegasus Systems, Inc.
In our opinion, the accompanying consolidated balance sheet and the related
consolidated statements of operations and changes in shareholders' equity
(deficit) and of cash flows present fairly, in all material respects, the
financial position of Pegasus Systems, Inc. and its subsidiaries at December 31,
1996, and the results of their operations and their cash flows for the year then
ended, in conformity with generally accepted accounting principles. 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 audit. We conducted our audit of these statements in accordance with
generally accepted auditing standards 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 audit provides a reasonable basis for the opinion expressed
above.
PRICE WATERHOUSE LLP
Dallas, Texas
February 21, 1997, except as to Note 13,
which is as of May 12, 1997 and Note 15,
which is as of August 6, 1997.
F-2
<PAGE> 73
INDEPENDENT AUDITOR'S REPORT
To the Shareholders
Pegasus Systems, Inc.
We have audited the accompanying consolidated balance sheet of Pegasus Systems,
Inc. (formerly The Hotel Industry Switch Company in 1994) and its subsidiaries
(Company) as of December 31, 1995, and the related consolidated statements of
operations, changes in shareholders' equity (deficit) and cash flows for the
years ended December 31, 1994 and 1995. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of the Company as of
December 31, 1995, and the results of its operations and its cash flows for the
years ended December 31, 1994 and 1995 in conformity with generally accepted
accounting principles.
BELEW AVERITT LLP
Dallas, Texas
March 2, 1996, except for
Note 15, as to which the
date is August 6, 1997
F-3
<PAGE> 74
PEGASUS SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1995 AND 1996
ASSETS
<TABLE>
<CAPTION>
1995 1996
------------ ------------
<S> <C> <C>
Cash and cash equivalents................................... $ 93,831 $ 1,796,311
Restricted cash............................................. 330,177 690,206
Short-term investments...................................... -- 2,705,076
Accounts receivable, net of allowance for doubtful accounts
of $20,000 and $44,805, respectively...................... 739,496 924,951
Accounts receivable from affiliates......................... 655,756 754,405
Other current assets........................................ 41,990 190,976
------------ ------------
Total current assets.............................. 1,861,250 7,061,925
Software development costs.................................. 4,085,501 2,113,758
Property and equipment, net................................. 2,660,467 3,001,012
Goodwill, net of accumulated amortization of $58,219 and
$178,943, respectively.................................... 1,687,452 1,685,772
Other noncurrent assets..................................... 21,324 29,269
------------ ------------
Total assets...................................... $ 10,315,994 $ 13,891,736
============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
Accounts payable and accrued liabilities.................... $ 1,736,564 $ 2,574,186
Accounts payable to affiliates.............................. 204,188 115,049
Unearned income............................................. 431,373 470,588
Current portion of capital lease obligations................ 814,490 1,048,238
Current portion of notes payable to affiliates.............. 235,000 785,517
------------ ------------
Total current liabilities......................... 3,421,615 4,993,578
Capital lease obligations, net of current portion........... 1,696,570 1,749,899
Notes payable to affiliates, net of current portion......... 5,297,158 4,603,568
Unearned income............................................. 941,176 470,588
Other noncurrent liabilities................................ -- 119,709
Minority interest........................................... 1,339,682 --
Commitments and contingencies (Note 11)..................... -- --
Shareholders' equity (deficit):
Preferred stock, $.01 par value; 2,000,000 shares
authorized; zero and 1,538,463 shares issued and
outstanding, respectively.............................. -- 15,385
Common stock, $.01 par value; 100,000,000 shares
authorized, 5,218,000 and 5,307,733 shares issued,
respectively........................................... 52,180 53,077
Additional paid-in capital................................ 8,652,969 16,968,364
Unearned compensation..................................... -- (485,937)
Accumulated deficit....................................... (11,085,356) (14,570,157)
Less treasury stock (116,484 shares, at cost)............. -- (26,338)
------------ ------------
Total shareholders' equity (deficit).............. (2,380,207) 1,954,394
------------ ------------
Total liabilities and shareholders' equity
(deficit)....................................... $ 10,315,994 $ 13,891,736
============ ============
</TABLE>
See accompanying notes to consolidated financial statements.
F-4
<PAGE> 75
PEGASUS SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
<TABLE>
<CAPTION>
1994 1995 1996
---------- ----------- -----------
<S> <C> <C> <C>
Net revenues (Notes 1 and 14)
Shareholder........................... $4,491,985 $ 7,400,592 $11,961,445
Nonshareholder........................ 174,466 1,895,136 3,907,567
---------- ----------- -----------
Total revenues................ 4,666,451 9,295,728 15,869,012
Cost of services........................ 1,546,065 3,882,496 6,199,058
Research and development................ 238,116 839,588 1,961,055
Write-off of purchased in-process
research and development (Note 3)..... -- 1,223,000 244,600
General and administrative expenses..... 1,065,345 2,770,474 3,799,199
Marketing and promotion expenses........ 130,474 912,230 2,824,633
Depreciation and amortization........... 1,518,588 2,476,812 3,425,678
---------- ----------- -----------
Operating income (loss)................. 167,863 (2,808,872) (2,585,211)
Other (income) expense:
Interest expense...................... 591,076 815,560 893,177
Interest income....................... -- -- (114,150)
---------- ----------- -----------
Loss before income taxes and minority
interest.............................. (423,213) (3,624,432) (3,364,238)
Income taxes............................ -- -- 15,000
---------- ----------- -----------
Loss before minority interest........... (423,213) (3,624,432) (3,379,238)
Minority interest....................... -- 53,528 (105,563)
---------- ----------- -----------
Net loss................................ $ (423,213) $(3,570,904) $(3,484,801)
========== =========== ===========
Unaudited pro forma data (Note 1):
Pro forma net loss per share............ $ (0.48)
===========
Weighted average shares outstanding used
in the pro forma net loss per share
calculation........................... 7,202,992
===========
Supplemental pro forma net loss per
share................................. $ (0.38)
===========
Weighted average shares used in the
supplemental pro forma net loss per
share calculation..................... 7,744,488
===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-5
<PAGE> 76
PEGASUS SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK TREASURY STOCK
------------------- ------------------- ADDITIONAL --------------------
NUMBER OF NUMBER OF PAID-IN UNEARNED NUMBER OF
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION SHARES AMOUNT
--------- ------- --------- ------- ----------- ------------ --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance of THISCO at
December 31, 1993...... -- -- 762,000 $7,620 $ 4,857,478 -- -- --
Net loss................ -- -- -- -- -- -- -- --
--------- ------- --------- ------- ----------- --------- -------- --------
Balance of THISCO at
December 31, 1994...... -- -- 762,000 7,620 4,857,478 -- --
========= ======= ========= ======= =========== ========= ======== ========
Conversion of
shareholder loans...... -- -- -- -- 525,000 -- -- --
Exchange of THISCO
shares for Pegasus
shares................. -- -- (762,000) (7,620) 7,620 -- -- --
Formation of Pegasus.... -- -- 2,691,867 26,919 (26,919) -- -- --
Acquisition of HCC...... -- -- 2,242,800 22,428 2,721,749 -- -- --
Issuance of restricted
shares to management... -- -- 283,333 2,833 568,041 -- -- --
Net loss................ -- -- -- -- -- -- -- --
--------- ------- --------- ------- ----------- --------- -------- --------
Balance at December 31,
1995................... -- -- 5,218,000 52,180 8,652,969 -- -- --
========= ======= ========= ======= =========== ========= ======== ========
Issuance of Pegasus
preferred stock to
Information Associates,
L.P. and Information
Associates, C.V........ 1,538,463 $15,385 -- -- 7,484,620 -- -- --
Issuance of Pegasus
common stock for
purchase of minority
interest............... -- -- 89,733 897 277,725 -- -- --
Purchase of treasury
stock.................. -- -- -- -- -- -- (116,484) $(26,338)
Issuance of compensatory
stock options.......... -- -- -- -- 551,150 $(485,937) -- --
Proceeds from stock
subscription........... -- -- -- -- 1,900 -- -- --
Net loss................ -- -- -- -- -- -- -- --
--------- ------- --------- ------- ----------- --------- -------- --------
Balance at December 31,
1996................... 1,538,463 $15,385 5,307,733 $53,077 $16,968,364 $(485,937) (116,484) $(26,338)
========= ======= ========= ======= =========== ========= ======== ========
<CAPTION>
ACCUMULATED
DEFICIT TOTAL
------------ -----------
<S> <C> <C>
Balance of THISCO at
December 31, 1993...... $ (7,091,239) $(2,226,141)
Net loss................ (423,213) (423,213)
------------ -----------
Balance of THISCO at
December 31, 1994...... (7,514,452) (2,649,354)
============ ===========
Conversion of
shareholder loans...... -- 525,000
Exchange of THISCO
shares for Pegasus
shares................. -- --
Formation of Pegasus.... -- --
Acquisition of HCC...... -- 2,744,177
Issuance of restricted
shares to management... -- 570,874
Net loss................ (3,570,904) (3,570,904)
------------ -----------
Balance at December 31,
1995................... (11,085,356) (2,380,207)
============ ===========
Issuance of Pegasus
preferred stock to
Information Associates,
L.P. and Information
Associates, C.V........ -- 7,500,005
Issuance of Pegasus
common stock for
purchase of minority
interest............... -- 278,622
Purchase of treasury
stock.................. -- (26,338)
Issuance of compensatory
stock options.......... -- 65,213
Proceeds from stock
subscription........... -- 1,900
Net loss................ (3,484,801) (3,484,801)
------------ -----------
Balance at December 31,
1996................... $(14,570,157) $ 1,954,394
============ ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-6
<PAGE> 77
PEGASUS SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1994, 1995 AND 1996
<TABLE>
<CAPTION>
1994 1995 1996
--------- ----------- -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(423,213) $(3,570,904) $(3,484,801)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Minority interest....................................... -- (53,528) 105,563
Accrued interest reclassified to notes payable.......... -- 43,496 91,927
Reclassification of accrued interest to notes payable to
affiliates............................................ -- 255,203 --
Loss on write-down of equipment......................... -- 246,000 --
Write off of in-process research and development
costs................................................. -- 1,223,000 244,600
Adjustment for discontinued software projects........... -- -- 316,698
Loss (gain) on sale of equipment........................ (7,620) (14,553) 9,564
Depreciation and amortization........................... 1,518,588 2,476,812 3,425,678
Recognition of stock option compensation................ -- -- 65,213
Changes in assets and liabilities:
Restricted cash....................................... -- (157,307) (360,029)
Accounts receivable................................... (50,197) (182,998) (185,455)
Accounts receivable from affiliates................... (331,980) 80,785 (98,649)
Other current and noncurrent assets................... (1,966) (24,032) (156,931)
Accounts payable and accrued liabilities.............. 295,342 586,483 837,620
Accounts payable to affiliates........................ (20,403) (202,230) (89,139)
Unearned income....................................... -- (210,036) (431,373)
Other noncurrent liabilities.......................... -- -- 119,709
--------- ----------- -----------
Net cash provided by operating activities........... 978,551 496,191 410,195
--------- ----------- -----------
Cash flows from investing activities:
Purchase of software, property and equipment.............. (256,656) (639,461) (495,100)
Proceeds from sale of software, property and equipment.... 71,337 -- 133,134
Purchase of marketable securities......................... -- -- (2,705,076)
--------- ----------- -----------
Net cash used in investing activities............... (185,319) (639,461) (3,067,042)
--------- ----------- -----------
Cash flows from financing activities:
Proceeds from issuance of stock........................... -- 570,874 7,500,005
Purchase of minority interest............................. -- -- (2,000,000)
Repayments on notes payable to affiliates................. (234,165) (103,337) (235,000)
Repayments of capital leases.............................. (459,398) (578,271) (974,969)
Purchase of treasury stock................................ -- -- (26,338)
Proceeds from stock subscription.......................... -- -- 1,900
Proceeds from line of credit.............................. -- -- 175,000
Repayment of line of credit............................... -- -- (175,000)
Proceeds from capital leases.............................. -- -- 93,729
--------- ----------- -----------
Net cash provided (used) by financing activities........ (693,563) (110,734) 4,359,327
--------- ----------- -----------
Net increase (decrease) in cash and cash equivalents........ 99,669 (254,004) 1,702,480
Cash and cash equivalents, beginning year................... 248,166 347,835 93,831
--------- ----------- -----------
Cash and cash equivalents, end of year...................... $ 347,835 $ 93,831 $ 1,796,311
========= =========== ===========
Supplemental disclosure of cash flow information:
Interest paid............................................. $ 509,722 $ 706,842 $ 858,017
Income taxes paid......................................... -- -- --
--------- ----------- -----------
Supplemental schedule of noncash investing and financing
activities:
Acquisition of equipment under capital leases............. $ 120,252 $ 2,083,365 $ 1,045,988
========= =========== ===========
Conversion of notes payable to affiliates to additional
paid-in capital (Note 7)................................ $ -- $ 525,000 $ --
========= =========== ===========
Issuance of common stock for acquisitions (Notes 2, 3 and
8)...................................................... $ -- $ 2,744,177 $ 278,622
========= =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-7
<PAGE> 78
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1994, 1995 AND 1996
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
ORGANIZATION AND BACKGROUND
In July 1995, Pegasus Systems, Inc. (Pegasus or the Company) was formed as
a Delaware holding company to combine the operations of two existing companies
operating in the same industry, The Hotel Industry Switch Company (THISCO) and
The Hotel Clearing Corporation (HCC), as discussed in Note 2 below. For
accounting purposes, the combination was recorded as a purchase of HCC, as
discussed in Note 3 below.
CONSOLIDATION
The accompanying financial statements include the historical accounts of
THISCO for 1994. The financial statements for 1995 reflect the consolidated
balance sheets of THISCO and HCC and the consolidated operations of THISCO for
the year ended 1995 and HCC from the date of acquisition to December 31, 1995.
The 1996 consolidated financial statements include the accounts of Pegasus and
its wholly owned subsidiaries, THISCO and HCC. THISCO is consolidated with its
wholly owned subsidiary, TravelWeb, Inc. (TravelWeb), and HCC is consolidated
with its wholly owned subsidiary, Pegasus Systems Inc. (UK) Limited (Pegasus UK,
formerly The Hotel Clearing Corporation (UK) Limited), (collectively, the
Company). All significant intercompany balances have been eliminated in
consolidation.
THISCO was formed in September 1988 as a Delaware corporation. The
Company's THISCO service provides an electronic interface from hotel central
reservation systems to travel agencies through Global Distribution Systems
(GDSs), which are electronic travel information and reservation systems such as
SABRE.
HCC, acquired by the Company in July 1995 (see Note 3), was formed in July
1991 as a Delaware corporation. The Company's HCC service consolidates
commissions paid by participating hotels to a participating travel agency into a
single monthly payment and provides participants with comprehensive transaction
reports. Hotel properties and travel agencies worldwide utilize the HCC service
to increase the efficiency and reduce costs associated with preparing, paying
and reconciling hotel room reservation commissions.
TravelWeb was formed in October 1995 as a Delaware corporation. The
Company's TravelWeb service provides individual travelers direct access to
online hotel information and the ability to make reservations electronically at
hotel properties. In addition, through its recently introduced NetBooker
service, the Company offers TravelWeb's comprehensive hotel database and
Internet hotel reservation capabilities to third-party Web sites.
Pegasus UK, a wholly-owned subsidiary of HCC, was formed in September 1993
in England to market and provide services for travel agents and hotel chains
operating in Europe, Africa and Asia.
MANAGEMENT ESTIMATES
In preparing the consolidated financial statements in conformity with
generally accepted accounting principles, management is required 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.
F-8
<PAGE> 79
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RESTRICTED CASH
Funds for travel agency commission checks which have not cleared HCC's
processing bank after certain time periods are returned to HCC. Any amounts
which are not remitted to travel agents will be escheated to the appropriate
state, as required.
INVESTMENTS IN DEBT AND EQUITY SECURITIES
In 1996, the Company adopted Statement of Financial Accounting Standards
No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (FAS
115). In accordance with this Statement, prior period financial statements have
not been restated to reflect the change in accounting principle. The cumulative
effect of the adoption of FAS 115 did not have a material effect on the
Company's financial condition or results of operations.
As of December 31, 1994, 1995 and 1996, the status of the securities
accounted for under FAS 115, was as follows:
<TABLE>
<CAPTION>
AMORTIZED COST
------------------------------------
1994 1995 1996
---------- ---------- ----------
<S> <C> <C> <C>
Held to maturity:
Corporate debt................................... $ -- $ -- $ 992,621
U.S. government agencies......................... -- -- 1,712,455
---------- ---------- ----------
$ -- $ -- $2,705,076
========== ========== ==========
</TABLE>
As of December 31, 1994, 1995 and 1996, the aggregate fair market value of
the held-to-maturity securities was $0, $0 and $2,705,076, respectively. The
gross unrealized gains and losses by type of security were not material.
The contract maturities of the held-to-maturity securities are less than
one year.
SOFTWARE DEVELOPMENT COSTS
All costs incurred in the internal development of computer software used in
delivery of the Company's services are expensed until a product design and a
working model of the software have been tested and completed. Thereafter, any
further development or production costs are capitalized until the software is
placed into service. Maintenance and customer support costs are expensed when
incurred. 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. The amount by which unamortized
software costs exceed the net realizable value, if any, is recognized in the
period the excess is determined. Prior to 1996, capitalized costs were being
amortized over three to five years using the straightline method. However, in
1996 the Company changed the estimated life of all capitalized software costs to
three years. The effect of this change was to increase the net loss during 1996
by approximately $292,000 or $0.04 per share on a pro forma basis. During 1996,
the Company recorded a charge of $316,698 resulting from discontinued software
development projects. During 1995 and 1996, the Company capitalized a total of
approximately $3,840,000 and $470,000, respectively, of software development
costs, including the software acquired in connection with the acquisition of HCC
(See Note 3). During 1994, 1995 and 1996, the Company amortized approximately
$970,000, $1,532,000 and $2,125,000, respectively, of capitalized software
costs. Accumulated amortization of software development costs was $4,614,686 and
$6,739,465 at December 31, 1995 and 1996, respectively.
F-9
<PAGE> 80
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. Betterments and major renewals are
capitalized. Upon retirement or sale of an asset, the cost of the asset and the
related accumulated depreciation or amortization are removed from the accounts
and any resulting gain or loss is credited or charged to operations.
In March 1995, Statement of Financial Accounting Standards No. 121,
"Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to
Be Disposed Of" (FAS 121) was issued. Effective January 1, 1996, the Company
adopted FAS 121 which requires that long-lived assets held and used by an
entity, or to be disposed of, be reviewed for impairment whenever events or
changes in circumstances indicate that the net book value of the asset may not
be recoverable. An impairment loss will be recognized if the sum of the expected
future cash flows (undiscounted and before interest) from the use of the asset
is less than the net book value of the asset. The amount of the impairment loss
will generally be 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, 1995 or 1996.
GOODWILL
Goodwill represents the excess of the purchase price of acquisitions over
the fair value of the net assets acquired. Such excess costs are being amortized
on a straight-line basis over 15 years. Unamortized goodwill at December 31,
1995 and 1996, was $1,687,452 and $1,685,772, 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, 1996. Amortization of goodwill was $0, $58,219
and $120,724 in 1994, 1995 and 1996, respectively.
REVENUES
The Company primarily derives its revenues from transaction fees and
commissions charged to participating hotels and travel agencies. A substantial
portion of Company revenue is derived from shareholders and shareholder-owned
companies (see Note 14).
The Company's revenues are predominantly transaction-based. The Company
derives its revenues from its THISCO service by charging its 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 THISCO
service. Status messages are electronic messages sent by hotels to GDSs to
update room rates, features and availability information in GDS databases. As
cumulative volumes of net reservations increase during the course of the
calendar year, the 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 expected
fee per transaction to be earned for services to be provided to the customer
during the entire year. Because the Company's customer contracts are based on
calendar year terms, this process of recognizing revenues results in a deferred
revenue balance being created during early periods of the year, which will be
reflected in interim balance sheets and be fully utilized by the end of each
year. Additionally, Pegasus generally charges new participants in the THISCO
service a one-time set-up fee for work associated with the implementation of the
interface with the THISCO service. Revenue for these one-time set-up fees is
recognized on a percentage of completion basis as the services are performed
over the set-up period, which generally ranges from two to six months. The
Company also charges certain GDSs a fee based on the number of net reservations
to
F-10
<PAGE> 81
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
compensate for the management and consolidation of multiple interfaces. Revenue
recognized for GDS fees is based on the actual volume of transactions processed
through the specific GDS multiplied by the anticipated average fee per
transaction to be charged to the GDS for the entire calendar year. Since both
the amount of GDS fees and the volume sensitive pricing is far less pronounced
than is the case with hotel customers, the amount of deferred revenue associated
with GDS billings is considerably less than that of the hotels. The Company
intends to reduce certain of the fees that it charges hotels for transmitting
status messages.
Pegasus derives its revenues from its HCC service by charging a
participating travel agency a fee based on a percentage of the dollar amount of
commissions paid to that agency through the HCC service. The Company also
generally charges a participating hotel a fee based on the number of
commissionable transactions arising from that hotel. Revenues from HCC travel
agency fees can vary substantially from period to period based on the types of
hotels at which reservations are made and overall room rates. Pegasus recognizes
revenues from its HCC 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 month. If a hotel fails to deliver funds to the
Company, the Company is not obligated to deliver commission payments on behalf
of the hotel to travel agencies. HCC revenues also include amortization of a
$2.0 million payment received by the Company in June 1993 in exchange for a
five-year noncancelable data processing contract. This payment was initially
recorded as unearned income and is being recognized as revenue over the life of
the contract. The amount of revenue recognized in 1996 was $431,000 (See Note
11). For the period from acquisition to December 31, 1995 and the year ended
December 31, 1996, HCC revenues from hotels are presented net of commission
payments to travel agencies of approximately $39,820,000 and $105,000,000,
respectively.
The Company offers two services, TravelWeb and NetBooker, that provide
hotel reservation capability to individual travelers through the Internet.
During 1996, Pegasus derived the substantial majority of its TravelWeb revenues
from fees related to the creation of Web site pages for hotels and for
maintaining these pages on the TravelWeb site. During 1997, the Company is
transitioning its fee structure to begin charging participating hotels
subscription fees based on the number of their properties included in the
database and transaction fees based on the number of net reservations made at
their properties through the TravelWeb service. The Company is not in a position
to forecast the effect that this change in fee structure will have on its
TravelWeb revenues. There can be no assurance that such a change will not have a
material adverse effect on the Company's financial condition and results of
operations. The Company also derives revenues through the sale of advertising
space on the TravelWeb site. Pegasus realizes revenues from NetBooker, the
Company's hotel room reservation service provided to third-party Web sites, by
charging third-party Web sites an initial development and licensing fee and by
charging hotels a fee based on the number of net reservations made through the
NetBooker service. The Company has not received a material amount of revenues
for the TravelWeb service or the NetBooker service to date, and there can be no
assurance that either of these services will produce a material amount of
revenues in the future.
INCOME TAXES
The Company presents income taxes pursuant to Statement of Financial
Accounting Standards No. 109, "Accounting for Income Taxes" (FAS 109). FAS 109
uses an asset and liability approach to account for income taxes. In the event
differences between the financial reporting basis and the tax basis of the
Company's assets and liabilities result in deferred tax assets, an evaluation of
the probability of being able to realize the future benefits indicated by such
assets is required. 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.
F-11
<PAGE> 82
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
ADVERTISING COSTS
Advertising and promotion-related expenses are charged to operations when
incurred. Advertising expense for 1994, 1995 and 1996 was approximately $84,000,
$173,000 and $613,000, respectively.
FINANCIAL INSTRUMENTS
The carrying amounts of the Company's financial instruments reflected in
the consolidated balance sheets at December 31, 1995 and 1996 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. As a consequence, 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. 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. Accordingly, compensation cost for stock
options is measured as the excess, if any, of the fair market value of the
Company's stock at the date of grant over the amount the employee must pay to
acquire the stock. Pro forma disclosure of net loss based on the provisions of
FAS 123 is discussed at Note 9.
STOCK SPLITS
A one hundred-for-one stock split was effected in June 1996. All references
in the consolidated financial statements to shares, share prices, per share
amounts and stock plans have been adjusted retroactively for the one
hundred-for-one stock split. Additional information is presented in Note 8.
In May 1997, the board of directors approved a four-for-three stock split
to be effective concurrent with the effectiveness of the Registration Statement
on Form S-1. 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.
FOREIGN CURRENCY TRANSLATION
The U.S. dollar is the functional currency for the Company's foreign
operations. Gains and losses on the translation into U.S. dollars of amounts
denominated in foreign currencies are included in net income.
PRO FORMA NET LOSS PER SHARE (UNAUDITED)
Historical loss per share has been excluded from the Company's statements
of operations on the basis that it is irrelevant due to the planned conversion
of all outstanding Series A preferred stock to common stock on a one-for-one
basis concurrent with the effectiveness of the Company's initial public offering
(IPO). Pro forma net loss per share has been computed using the weighted average
number of common shares outstanding after giving retroactive effect to the
four-for-three stock split to be effected upon effectiveness of the Company's
Registration Statement on Form S-1 (see Note 15) and assuming that (i) all
shares of
F-12
<PAGE> 83
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Series A preferred stock have been converted to shares of common stock as of the
date of issuance and (ii) all shares, options and warrants issued subsequent to
June 1, 1996 at an exercise price less than the IPO price have been included in
the calculation as if they were outstanding for the entire period presented
using the treasury stock method and the IPO price.
SUPPLEMENTAL PRO FORMA NET LOSS PER SHARE (UNAUDITED)
Supplemental pro forma net loss per share is based on the weighted average
number of shares of common stock used in the calculation of pro forma net loss
per share, plus the number of shares (541,496 for the year ended December 31,
1996) that the Company would need to repay $5,389,085 of indebtedness
outstanding under notes payable to certain stockholders of the Company at
December 31, 1996. For purposes of computing supplemental pro forma net loss per
share (unaudited), the pro forma net loss for the year ended December 31, 1996
was reduced by $539,213, representing elimination of the related interest
expense on such notes payable.
EARNINGS PER SHARE
In February 1997, Statement of Financial Accounting Standards No. 128,
"Earnings per Share" (FAS 128), was issued. FAS 128 specifies the computation,
presentation and disclosure requirements for earnings per share (EPS) for
entities with publicly held common stock or potential common stock. FAS 128
simplifies the standards for computing EPS previously found in Accounting
Principles Board Opinion No. 15, "Earnings per Share" (APB 15), and makes them
comparable to international EPS standards. It replaces the presentation of
primary EPS with a presentation of basic EPS. It also requires dual presentation
of basic and diluted EPS on the face of the statement of operations for all
entities with complex capital structures and requires a reconciliation of the
numerator and denominator of the basic EPS computation to the numerator and
denominator of the diluted EPS computation. FAS 128 is effective for financial
statements issued for periods ending after December 15, 1997, including interim
periods; earlier application is not permitted. FAS 128 requires restatement of
all prior-period EPS data presented. The Company will adopt FAS 128 in its
consolidated financial statements as of and for the year ending December 31,
1997 and, based on current circumstances, does not believe the effect of
adoption will be material.
2. REORGANIZATION
Effective in July 1995, the Company issued 4,934,667 shares of its common
stock in exchange for all of the outstanding capital stock of THISCO and 83.3%
of the outstanding capital stock of HCC (the Reorganization). Lodging Network,
Inc. (LNI) retained 210 shares of HCC preferred stock, representing a 16.7%
minority ownership interest in HCC. In conjunction with the Reorganization, LNI
was granted an option (LNI Option), expiring in July 1998, to exchange its 16.7%
ownership interest in HCC for 448,667 shares of the Company's common stock. The
LNI Option was subsequently canceled in June 1996, as part of the purchase of
all of LNI's minority interest ownership in HCC by the Company (see Note 3). The
Company incurred expenses of approximately $194,000 related to the
Reorganization. Such expenses have been included in the general and
administrative expenses in the Company's statement of operations for the year
ended December 31, 1995.
The Reorganization brought THISCO and HCC together under the control of
Pegasus and was initiated to integrate and expand the existing businesses of
THISCO and HCC. Pegasus was formed immediately prior to the transaction for the
purpose of combining the two operations into a single operating entity. Prior to
the Reorganization, THISCO and HCC were primarily controlled by a common (though
not identical) group of shareholders and a common management group. For
accounting purposes, the Reorganization was treated as an acquisition of HCC and
accounted for as a purchase business combination. Accordingly, the HCC assets
acquired and liabilities assumed have been recorded at their fair values at the
date of acquisition. The amount
F-13
<PAGE> 84
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of the purchase price ($2.7 million) in excess of the fair value of net assets
acquired has been recorded as goodwill and will be amortized on a straight-line
basis over 15 years (see Note 3). The Company's consolidated financial
statements include the consolidated accounts and operations of THISCO and HCC
for all periods subsequent to the July 1995 acquisition date.
Prior to the Reorganization, HCC had a special bonus plan for the
management of HCC. As part of the Reorganization, management of HCC agreed to
forfeit its rights to participate in the bonus plan to HCC in return for a cash
payment and the opportunity to purchase an aggregate of 283,333 shares of the
Company's common stock for $570,874. Compensation expense in the amount of
$570,874 related to this transaction has been included in the net loss for the
year ended December 31, 1995. These shares are restricted and are subject to
repurchase upon termination of employment (see Note 8).
3. ACQUISITION
In July 1995, the Company acquired 83.3% of HCC (the Acquisition) in
exchange for 2,242,800 shares of the Company's common stock. HCC markets and
operates an automated commission payment service which settles electronic
bookings for travel agencies and hotel chains. HCC acts as a clearinghouse to
consolidate, collect and pay member travel agent commissions for participating
hotels.
The Acquisition was recorded under the purchase method of accounting, and
accordingly, the results of operations of HCC for all periods subsequent to the
Acquisition date are included in the accompanying consolidated financial
statements. The fair value of HCC was determined based on certain arm's length
equity transactions occurring shortly before the Reorganization. The purchase
price has been allocated to assets acquired and liabilities assumed based on
estimated fair value at the date of the 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:
<TABLE>
<S> <C>
Current assets.............................................. $ 505,000
Software.................................................... $ 3,523,000
Property and equipment...................................... $ 245,000
Goodwill.................................................... $ 1,746,000
Other noncurrent assets..................................... $ 18,000
Current liabilities......................................... $(1,034,000)
Long-term liabilities....................................... $(2,089,000)
Minority interest........................................... $(1,393,000)
</TABLE>
Approximately $1,223,000 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. Such
amount of in-process research and development was charged to expense at the date
of acquisition. In addition, as indicated above, $3,523,000 was allocated to
software and is being amortized over a three year period ending June 1998. The
balance of the purchase price paid, approximately $1,746,000, was recorded as
the excess of cost over the fair value of net assets acquired (goodwill) and is
being amortized on a straight-line basis over a 15 year period ending June 2010.
Results of operations after the date of the Acquisition are included in the
1995 Consolidated Statement of Operations. Assuming the Acquisition took place
at January 1, 1994 and 1995, the pro forma net revenues would have been
approximately $7,413,000 and $11,455,000, respectively, and the pro forma net
loss would have been approximately $3,199,400 and $4,071,000, respectively. The
pro forma information for 1994 and 1995 includes adjustments for additional
amortization based on the fair market value of the acquired software and the
goodwill arising from the transaction. The pro forma information for 1994 also
includes the reorganization costs incurred in 1995. The pro forma financial
information is not necessarily indicative of the operations as they would have
been had the transaction been effected on the assumed date.
F-14
<PAGE> 85
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In June 1996, the Company purchased 210 shares of HCC preferred stock from
LNI for $2,000,000 cash and 89,733 shares of Pegasus common stock. The 210 HCC
preferred shares purchased represented a 16.7% minority ownership of HCC. After
the purchase, Pegasus owned 100% of the outstanding shares of HCC. The
transaction was accounted for as a purchase. The price paid in excess of the
minority interest value of $1,445,245 on the date of purchase was approximately
$833,000 and was accounted for as $119,000 of goodwill to be amortized ratably
over a 15 year period with the remaining excess allocated to $245,000 of
in-process research and development costs and $469,000 of step-up in the fair
value of capitalized software costs. Such amount of in-process research and
development was charged to expense at the date of acquisition. The fair value of
the Company's common stock given as consideration was determined using an
independent valuation.
4. ACCOUNTS RECEIVABLE
HCC collects travel agents' commissions from hotel chains and, after
retaining a portion of these commissions as a fee for services, remits the net
commissions to the travel agents. At December 31, 1995 and 1996, trade accounts
receivable were stated net of commissions of $6,059,362 and $8,149,815,
respectively.
Net accounts receivable from affiliates included in the accompanying
consolidated balance sheets were as follows at December 31:
<TABLE>
<CAPTION>
1995 1996
-------- --------
<S> <C> <C>
Amounts due to HCC from hotel chains........................ $ 27,813 $ 34,606
Amounts due to THISCO from hotel chains..................... 380,573 702,612
Amounts due to TravelWeb from hotel chains.................. 239,002 11,152
Employee travel advances.................................... 8,368 6,035
-------- --------
Accounts receivable from affiliates......................... $655,756 $754,405
======== ========
</TABLE>
5. PROPERTY AND EQUIPMENT
Property and equipment at December 31 consisted of the following:
<TABLE>
<CAPTION>
1995 1996
---------- ----------
<S> <C> <C>
Computer equipment.......................................... $4,657,439 $4,261,482
Furniture and equipment..................................... 363,801 640,507
Office equipment............................................ 394,055 712,245
Leasehold improvements...................................... 87,061 93,777
---------- ----------
5,502,356 5,708,011
Less: accumulated depreciation.............................. (2,841,889) (2,706,999)
---------- ----------
Property and equipment, net................................. $2,660,467 $3,001,012
========== ==========
</TABLE>
In 1995, the Company purchased assets previously recorded as capital
leases. These capitalized assets were being amortized over the life of the
lease, which was due to expire in the first quarter of 1996. The Company
financed the purchase of the assets and extended the assets' estimated lives by
one year. The effect of these changes was to decrease the net loss during 1995
by approximately $108,000 and increase the net loss during 1996 by $72,000.
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. In 1995, the Company charged off
$246,000 related to switch equipment which was considered obsolete. The assets
were
F-15
<PAGE> 86
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
written down to the estimated salvage value of approximately $20,000. Total
assets recorded under capital leases in 1995 and 1996 were approximately
$4,664,000 and $3,829,000, respectively, net of accumulated amortization of
$2,392,000 and $1,591,000, respectively. Amortization of assets under capital
leases is included in depreciation and amortization expense.
Future minimum lease payments and related interest are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S> <C>
1997..................................................... $ 1,322,130
1998..................................................... 1,203,738
1999..................................................... 644,825
2000..................................................... 86,680
-----------
Aggregate minimum lease payments............................ 3,257,373
Less: amount representing interest.......................... (459,236)
-----------
2,798,137
Less current portion........................................ (1,048,238)
-----------
$ 1,749,899
===========
</TABLE>
Interest rates on capital leases range from approximately 7% to 15%.
Interest expense on capital leases for the years ended December 31, 1994, 1995
and 1996 was approximately $123,000, $238,000 and $351,000, respectively.
7. NOTES PAYABLE TO AFFILIATES
Notes payable to affiliates at December 31 consisted of the following:
<TABLE>
<CAPTION>
1995 1996
---------- ----------
<S> <C> <C>
Note payable to shareholder, bearing interest at prime plus
2.0% on the last day of the previous quarter (the prime
rate at September 30, 1995 and 1996 was 8.75% and 8.25%,
respectively); principal and accrued interest due in full
June 30, 2001 (see Note 13)............................... $4,261,482 $4,261,482
Notes and accrued interest payable to shareholders, bearing
interest at prime plus 1.0%; principal and accrued
interest due in full July 21, 2000, (the prime rate at
December 31, 1995 and 1996 was 8.5% and 8.25%,
respectively)............................................. 509,261 554,474
Notes and accrued interest payable to shareholders, bearing
interest at prime plus 1.0%; principal and accrued
interest due in full July 21, 2000 (the prime rate at
December 31, 1995 and 1996 was 8.5% and 8.25%,
respectively)............................................. 526,415 573,129
Note payable to shareholder, bearing interest at prime plus
2.0%; due March 29, 1996; uncollateralized; beginning
December 31, 1995 the interest rate increased to prime
plus 3.0%; paid in full in 1996........................... 200,000 --
Note payable to shareholder, bearing interest at prime plus
2.0%; due December 31, 1995; paid-in-full in 1996......... 35,000 --
---------- ----------
5,532,158 5,389,085
Less current portion........................................ (235,000) (785,517)
---------- ----------
$5,297,158 $4,603,568
========== ==========
</TABLE>
F-16
<PAGE> 87
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Maturities of notes and accrued interest payable to affiliates (including
the change in payment terms discussed in Note 13) as of December 31, 1996, were
as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31:
- ------------
<S> <C> <C>
1997.................................................................. $ 785,517
1998.................................................................. 869,924
1999.................................................................. 963,402
2000.................................................................. 2,194,528
2001.................................................................. 575,714
----------
$5,389,085
==========
</TABLE>
In 1995 and 1996, no principal or interest payments were due on the note
payable to shareholder of $4,261,482, according to the terms of the agreement,
as THISCO had not reported a consolidated net income. During 1995 and 1996, the
Company elected to make certain payments of interest totaling $465,000 and
$478,000, respectively. Interest expense related to these notes was
approximately $469,000, $578,000 and $539,000 during the years ended December
31, 1994, 1995 and 1996.
In July 1995, simultaneous with the Acquisition, the Company negotiated new
note agreements with all but one shareholder. The new note agreements,
representing obligations of subsidiaries guaranteed by Pegasus, converted
$450,000 in principal to additional paid-in capital, financed $255,203 of unpaid
interest, reduced the interest rate from prime plus two percent to prime plus
one percent and extended the due dates from December 31, 1995 to July 21, 2000.
The note agreement related to the one shareholder which was not renegotiated was
reduced in principal by $75,000 in exchange for Pegasus agreeing to guarantee
the remaining THISCO debt. The reduction of principal was recorded as a capital
contribution.
8. SHAREHOLDERS' EQUITY (DEFICIT)
During 1995, the Company issued 283,333 shares of restricted common stock
to certain members of management in connection with the termination of the HCC
special bonus plan (see Note 2). A compensation charge was recorded in 1995 for
the fair value of the shares issued. For a period of three years from date of
issuance, these shares cannot be sold. If an employee leaves the Company, the
Company has the right to repurchase the shares at the lesser of fifty percent of
the original purchase price or the current market value. During 1996, the
Company repurchased 25,467 shares from a terminated employee.
As a result of the Reorganization effective July 1995, certain shareholders
exchanged shares of THISCO for shares of Pegasus. Additionally, in order to
effect the purchase of HCC, the Company issued Pegasus shares to HCC
shareholders in exchange for 83.3% of the outstanding capital stock of HCC. Some
of the Pegasus shares exchanged for HCC shares were subject to repurchase. The
repurchase was based upon an agreement by the HCC shareholders that some value
for the HCC shares exchanged should be assigned based upon the number of
transactions that an HCC shareholder committed to process through HCC in 1996.
If a shareholder did not fulfill its commitment by processing the agreed number
of transactions through HCC in 1996, the Company had the option to repurchase
such shares for $0.01 per share. The total number of shares repurchased from
each shareholder is based upon the percentage of their transaction commitment
actually processed by HCC during 1996. Effective December 31, 1996, the Company
repurchased 91,017 shares of the 477,733 shares subject to repurchase.
In June 1996, the Company declared a one hundred-for-one stock split
effected in the form of a stock dividend to stockholders of record on that date.
The number of common shares the Company is authorized to issue was also
increased from 100,000 to 20 million and the number of authorized preferred
shares was increased from 10,000 to 2 million.
F-17
<PAGE> 88
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In June 1996, Information Associates, L.P. and Information Associates, C.V.
purchased 1,538,463 shares of the Company's Series A preferred stock (par value
$0.01) for $4.88 per share or $7,500,005. Total shares outstanding increased
from 5,191,249 (including the 89,733 issued to LNI as part of the purchase of
minority interest in HCC) to 6,729,712 shares, with the Information Associates,
L.P. and Information Associates, C.V. ownership representing 22.9% of the total
shares outstanding after the purchase. Additionally, the Company has reserved
866,667 shares as part of the Company's 1996 Stock Option Plan which after
issuance would reduce the 1,538,463 Series A preferred shares to 20.3% of the
total shares outstanding. The Series A preferred shares carry special provisions
which include: conversion rights to exchange one share of Series A preferred
stock for one share of Pegasus common stock; the right to elect two of nine
persons to the board of directors; preferred status as to the payment of any
dividends that are declared by the board of directors; and preferred status in
the event of any liquidation, dissolution or winding up of the corporation.
9. STOCK-BASED COMPENSATION
The Company's 1996 stock option plan was approved by the board of directors
in June 1996 and authorizes the grant of up to 866,667 shares of the Company's
common stock in the form of incentive stock options (ISOs) and nonqualified
stock options. The plan is administered and grant prices are determined by the
Stock Option Committee of the board of directors (Committee). Options normally
extend for a period of 10 years, and under Committee policy become exercisable
in installments of 25% per year commencing one year from the date of grant, or
over a vesting period determined by the Committee. Shares granted come from the
Company's authorized but unissued or reacquired common stock. In 1996, the
Company issued to executives and employees options to purchase an aggregate of
771,733 shares of common stock. These options will become exercisable over a
period of four years.
The Company's 1997 stock option plan was approved by the board of directors
in March 1997 and authorizes the grant of up to 333,333 shares of the Company's
common stock in the form of incentive stock options (ISOs) and nonqualified
stock options. The plan is administered and grant prices are determined by the
Committee. Options normally extend for a period of 10 years, and under Committee
policy become exercisable in installments of 25% per year commencing one year
from the date of grant, or over a vesting period determined by the Committee.
Shares granted come from the Company's authorized but unissued or reacquired
common stock. These options will become exercisable over a period of four years.
The Company has adopted the disclosure-only provisions of FAS 123. As
discussed in Note 1, the Company has elected to continue to account for
stock-based compensation using the intrinsic value method prescribed in APB 25.
Accordingly, unearned compensation of $551,150 related to options 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 $65,213 was charged to operations in 1996.
There were no stock option awards granted prior to 1996; however, had
compensation cost for the Company's stock option plan been determined based on
the fair value at the grant date for awards issued in 1996 consistent with the
provisions of FAS 123, the Company's net loss would have been increased to the
pro forma amounts indicated below:
<TABLE>
<CAPTION>
1996
-----------
<S> <C>
Net loss -- as reported..................................... $(3,484,801)
Net loss -- pro forma....................................... $(3,511,531)
Pro forma net loss per share -- as reported................. $ (0.48)
Pro forma net loss per share -- as adjusted for pro forma
impact of FAS 123......................................... $ (0.49)
</TABLE>
F-18
<PAGE> 89
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The weighted average fair value at date of grant for options granted during
1996 was $1.22 per option. 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 used:
<TABLE>
<S> <C>
Dividend yield.............................................. --
Expected volatility......................................... 0.0%
Risk-free rate of return.................................... 6.5%
Expected life............................................... 4 years
</TABLE>
The following table summarizes activity under the Company's stock option
plan during the year ended December 31, 1996:
<TABLE>
<CAPTION>
WEIGHTED
EXERCISE AVERAGE
PRICE EXERCISE
OPTIONS PER SHARE PRICE PER SHARE
-------- ----------- ---------------
<S> <C> <C> <C>
Outstanding at December 31, 1995................. -- -- --
Granted........................................ 771,733 $2.01-$3.11 $2.39
Canceled....................................... -- -- --
-------- ----------- -----
Outstanding at December 31, 1996................. 771,733 $2.01-$3.11 $2.39
======== =========== =====
Options exercisable at December 31, 1996......... -- -- --
</TABLE>
<TABLE>
<CAPTION>
OPTIONS
OUTSTANDING AT REMAINING
EXERCISE PRICES DECEMBER 31, 1996 CONTRACTUAL LIFE
- --------------- ----------------- ----------------
<C> <C> <C>
$2.01 503,333 9.5 years
$3.11 268,400 9.8 years
</TABLE>
In conjunction with the Reorganization described in Note 2, LNI was granted
an option, expiring in July 1998, to exchange its 210 shares of HCC preferred
stock for 448,667 shares of the Company's common stock. The option was canceled
in June 1996 in conjunction with the Company's purchase of LNI's minority
interest in HCC.
10. INCOME TAXES
Pretax income (loss) from continuing operations for the years ended
December 31 was taxed under the following jurisdictions:
<TABLE>
<CAPTION>
1994 1995 1996
--------- ----------- -----------
<S> <C> <C> <C>
Domestic..................................... $(423,213) $(3,527,122) $(3,528,503)
Foreign...................................... -- (43,782) 58,702
--------- ----------- -----------
$(423,213) $(3,570,904) $(3,469,801)
========= =========== ===========
</TABLE>
F-19
<PAGE> 90
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred taxes consisted of the following at December 31:
<TABLE>
<CAPTION>
1995 1996
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforward......................... $ 4,475,200 $ 4,975,949
Bad debt reserves....................................... 6,800 15,234
Depreciation and amortization........................... 36,623 1,896
Stock option compensation expense....................... -- 22,172
Rent expense............................................ -- 37,213
Various expense accruals................................ 7,248 53,793
Other................................................... 573 2,164
----------- -----------
Total gross deferred tax assets................. 4,526,444 5,108,421
Valuation allowance..................................... (3,528,272) (4,549,452)
Deferred tax liability:
Software amortization................................... (998,172) (558,969)
----------- -----------
Net deferred tax assets................................... $ -- $ --
=========== ===========
</TABLE>
The net deferred tax asset is fully reserved because of uncertainty
regarding the Company's ability to recognize the benefit of the asset in future
years. At December 31, 1994, 1995 and 1996, the Company had net operating loss
carryforwards of approximately $7,538,000, $13,162,000 and $14,635,000,
respectively, which begin to expire in 2003, if not previously utilized.
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.
The components of the income tax provision for the years ended December 31
were as follows:
<TABLE>
<CAPTION>
1994 1995 1996
------- ------- -------
<S> <C> <C> <C>
Current provision:
Federal............................................. $ -- $ -- $ --
State............................................... -- -- --
Foreign............................................. -- -- 15,000
------- ------- -------
$ -- $ -- $15,000
======= ======= =======
Deferred provision (benefit):
Federal............................................. $ -- $ -- $ --
State............................................... -- -- --
------- ------- -------
Provision for income taxes............................ $ -- $ -- $15,000
======= ======= =======
</TABLE>
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:
<TABLE>
<CAPTION>
1994 1995 1996
----- ----- -----
<S> <C> <C> <C>
Income taxes at the federal statutory rate.................. (34.0%) (34.0%) (34.0%)
Valuation allowance......................................... 31.8% 19.8% 29.4%
Permanent differences....................................... 2.2% 14.3% 5.1%
Other, net.................................................. 0.0% (0.1%) (0.5%)
----- ----- -----
Provision for income taxes.................................. 0.0% 0.0% 0.0%
===== ===== =====
</TABLE>
F-20
<PAGE> 91
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
11. COMMITMENTS AND CONTINGENCIES
The Company leases its corporate office space and certain office equipment
under noncancelable operating leases. The Company incurred rent expense of
approximately $146,000, $318,000 and $697,000 in 1994, 1995 and 1996,
respectively.
Approximate future minimum lease payments at December 31, 1996, under
noncancelable operating leases with original terms exceeding one year, including
the Pegasus UK operating lease translated at the rate in effect at December 31,
1996, were as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
- ------------
<S> <C> <C>
1997............................................................. $ 673,000
1998............................................................. 621,000
1999............................................................. 597,000
2000............................................................. 567,000
2001............................................................. 557,000
Thereafter.......................................................... 552,000
----------
$3,567,000
==========
</TABLE>
In June 1993, HCC received $2,000,000 from Citicorp in exchange for a
five-year noncancelable data processing contract and recorded the amount as
deferred income. The noncancelable contract requires Citicorp to process
transactions and generate various reports in exchange for a processing fee. The
contract requires HCC to maintain an annual minimum volume of transactions. If
the annual minimum volume is not attained, HCC is required to pay Citicorp an
additional processing fee for each transaction under the minimum volume. At the
date of the Acquisition there was approximately $1,583,000 of deferred income to
be amortized over the remaining life of the contract according to the volume of
guaranteed transactions, as defined by the contract. During 1995 and 1996, the
Company recognized approximately $210,000 and $431,000, respectively, of the
deferred income. However, because the Company did not meet its annual minimum
volume of transactions during 1995, it also recorded an additional processing
fee of approximately $44,700 for the year ended December 31, 1995. In 1996, the
Company exceeded the annual minimum volume requirement.
12. EMPLOYEE BENEFIT PLAN
The Company sponsors a 401(k) defined contribution retirement plan (401(k)
Plan) covering full-time employees who have completed one year of service and
attained the age of twenty-one.
Effective January 1, 1995, the 401(k) Plan was amended to change the pro
rata vesting schedule from two to five years. The sponsor can make discretionary
matching contributions up to five percent of employees' annual contributions.
During 1994, 1995 and 1996, the Company contributed approximately $34,000,
$101,000 and $160,000, respectively, to the 401(k) Plan.
Prior to the Acquisition of HCC by THISCO, both companies participated in
the 401(k) Plan. Accordingly, prior to the Acquisition, HCC contributed $20,000
and $18,000 in 1994 and 1995, respectively.
13. SUBSEQUENT EVENTS
The Company has a note payable to a shareholder with a principal balance
outstanding of $4,261,482 at December 31, 1995 and 1996. The original terms of
the note called for five equal payments of principal and interest beginning in
the year that THISCO generated a net profit, but due in full no later than June
30, 2001. Effective January 1997, the Company began remitting equal monthly
payments of principal and interest.
F-21
<PAGE> 92
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In May 1997, the Company issued a warrant to a customer for the purchase of
345,723 shares of the Company's common stock. The warrants are immediately
exercisable during the two year period ending May 12, 1999 at an exercise price
equal to the lower of $7.20 per share or 85.0% of the price per share.
14. RELATED PARTIES
As explained in Note 1, the Company derives a substantial portion of its
revenue from shareholders and shareholder-owned companies through the operation
of its international automated interface called Ultraswitch. Also, as a result
of the Acquisition of HCC in July 1995, a significant portion of the Company's
revenue is generated indirectly by shareholders as a function of the Company's
role as the consolidator and payor of commissions to travel agencies. The
Company receives a fee from hotels for consolidating and remitting commission
payments to travel agencies on behalf of the hotel properties and receives a fee
from travel agencies through the retention of a percentage of commission
payments remitted to travel agencies. A summary of revenues is as follows:
<TABLE>
<CAPTION>
1994 1995 1996
------------------ ------------------ -------------------
SOURCE OF REVENUE AMOUNT % AMOUNT % AMOUNT %
----------------- ---------- ----- ---------- ----- ----------- -----
<S> <C> <C> <C> <C> <C> <C>
Shareholders -- direct......... $3,772,458 80.9% $4,935,785 53.1% $ 6,458,380 40.7%
Shareholders -- indirect....... 719,527 15.4% 2,450,326 26.4% 5,503,065 34.7%
---------- ----- ---------- ----- ----------- -----
Total generated by shareholders
directly and indirectly...... 4,491,985 96.3% 7,386,111 79.5% 11,961,445 75.4%
All other revenue.............. 174,466 3.7% 1,909,617 20.5% 3,907,567 24.6%
---------- ----- ---------- ----- ----------- -----
Total................ $4,666,451 100.0% $9,295,728 100.0% $15,869,012 100.0%
========== ===== ========== ===== =========== =====
</TABLE>
A shareholder provides services to the Company, including facility
management, consulting and software development. During 1994, 1995 and 1996, the
Company recognized expense in the amount of approximately $454,000, $495,000 and
$774,000, respectively, for those services. Further, the Company capitalized
$42,000 and $210,000 related to software development and property and equipment
during 1994 and 1995, respectively.
Persons related to an officer of the Company have provided printing, design
and procurement services to the Company. During 1994, 1995 and 1996, the Company
paid approximately $95,000, $48,000 and $143,000, respectively, relating to
these services, the majority of which related to capitalized furniture
purchases.
15. STOCK SPLIT
The Company plans to proceed with an IPO in 1997. Consequently, the Company
approved the declaration of a four-for-three stock split of the outstanding
common and preferred stock effected in the form of a dividend to shareholders of
record on the effective date of the Registration Statement on Form S-1 with
respect to the IPO. The number of shares of common stock the Company is
authorized to issue will increase from 20 million to 100 million and the number
of authorized shares of preferred stock will remain 2.0 million. As stated in
Note 1, the financial statements have been adjusted retroactively for the
four-for-three split.
F-22
<PAGE> 93
PEGASUS SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
<TABLE>
<CAPTION>
DECEMBER 31, MARCH 31, PRO FORMA
1996 1997 (NOTE 7)
------------ ------------ ------------
(UNAUDITED) (UNAUDITED)
<S> <C> <C> <C>
Cash and cash equivalents.......................... $ 1,796,311 $ 2,441,474 $ 2,441,474
Restricted cash.................................... 690,206 845,665 845,665
Short-term investments............................. 2,705,076 983,604 983,604
Accounts receivable, net of allowance for doubtful
accounts of $44,805, $61,262 and $61,262,
respectively..................................... 924,951 1,189,889 1,189,889
Accounts receivable from affiliates................ 754,405 1,261,241 1,261,241
Other current assets............................... 190,976 248,199 248,199
------------ ------------ ------------
Total current assets..................... 7,061,925 6,970,072 6,970,072
Software development costs......................... 2,113,758 1,761,465 1,761,465
Property and equipment, net........................ 3,001,012 3,163,499 3,163,499
Goodwill, net of accumulated depreciation of
$178,943, $210,161 and $210,161, respectively.... 1,685,772 1,654,554 1,654,554
Other noncurrent assets............................ 29,269 51,074 51,074
------------ ------------ ------------
Total assets............................. $ 13,891,736 $ 13,600,664 $ 13,600,664
============ ============ ============
LIABILITIES AND SHAREHOLDERS' EQUITY
Accounts payable and accrued liabilities........... $ 2,574,186 $ 2,499,065 $ 2,499,065
Accounts payable to affiliates..................... 115,049 140,729 140,729
Unearned income.................................... 470,588 1,029,107 1,029,107
Current portion of capital lease obligations....... 1,048,238 1,090,121 1,090,121
Current portion of notes payable to affiliates..... 785,517 805,818 805,818
------------ ------------ ------------
Total current liabilities................ 4,993,578 5,564,840 5,564,840
Capital lease obligations, net of current
portion.......................................... 1,749,899 1,539,710 1,539,710
Notes payable to affiliates, net of current
portion.......................................... 4,603,568 4,417,010 4,417,010
Unearned income.................................... 470,588 352,941 352,941
Other noncurrent liabilities....................... 119,709 125,684 125,684
Minority interest.................................. -- -- --
Shareholders' equity:
Preferred stock, $.01 par value; 2,000,000 shares
authorized; 1,538,463 shares issued and
outstanding (actual); no shares outstanding (pro
forma)........................................... 15,385 15,385 --
Common stock, $.01 par value; 100,000,000 shares
authorized, 5,307,733 shares issued (actual);
6,846,196 shares issued (pro forma).............. 53,077 53,077 68,462
Additional paid-in capital......................... 16,968,364 16,968,364 16,968,364
Unearned compensation.............................. (485,937) (451,488) (451,488)
Accumulated deficit................................ (14,570,157) (14,958,521) (14,958,521)
Less treasury stock (116,484, at cost)............. (26,338) (26,338) (26,338)
------------ ------------ ------------
Total shareholders' equity............... 1,954,394 1,600,479 1,600,479
------------ ------------ ------------
Total liabilities and shareholders'
equity................................. $ 13,891,736 $ 13,600,664 $ 13,600,664
============ ============ ============
</TABLE>
See accompanying notes to consolidated interim financial statements.
F-23
<PAGE> 94
PEGASUS SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------
1996 1997
---------- ----------
<S> <C> <C>
Net revenues
Shareholder............................................... $3,052,212 $3,120,692
Nonshareholder............................................ 750,955 1,255,871
---------- ----------
Total revenues.................................... 3,803,167 4,376,563
Cost of services............................................ 1,637,870 1,557,656
Research and development.................................... 627,112 622,727
General and administrative expenses......................... 692,071 855,531
Marketing and promotion expenses............................ 643,884 865,307
Depreciation and amortization............................... 909,493 707,458
---------- ----------
Operating income (loss)..................................... (707,263) (232,116)
Other (income) expense:
Interest expense.......................................... 211,573 212,150
Interest income........................................... -- (55,902)
---------- ----------
Loss before income taxes and minority interest.............. (918,836) (388,364)
Income taxes................................................ -- --
---------- ----------
Loss before minority interest............................... (918,836) (388,364)
Minority interest........................................... (47,961) --
---------- ----------
Net loss.................................................... $ (966,797) $ (388,364)
========== ==========
Unaudited pro forma data (Notes 3 and 4):
Pro forma net loss per share................................ $ (0.05)
==========
Weighted average shares outstanding used in the pro forma
net loss per share calculation............................ 7,480,899
==========
Supplemental pro forma net loss per share................... $ (0.03)
==========
Weighted average shares used in the supplemental pro forma
net loss per share calculation............................ 8,005,689
==========
</TABLE>
See accompanying notes to consolidated interim financial statements.
F-24
<PAGE> 95
PEGASUS SYSTEMS, INC.
CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS' EQUITY
(UNAUDITED)
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK
------------------- ------------------- ADDITIONAL
NUMBER OF NUMBER OF PAID-IN UNEARNED
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION
--------- ------- --------- ------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1996............ 1,538,463 $15,385 5,307,733 $53,077 $16,968,364 $(485,937)
Compensation expense for vesting of
stock options......................... 34,449
Net loss................................ -- -- -- -- -- --
--------- ------- --------- ------- ----------- ---------
Balance at March 31, 1997............... 1,538,463 $15,385 5,307,733 $53,077 $16,968,364 $(451,488)
========= ======= ========= ======= =========== =========
<CAPTION>
TREASURY STOCK
--------------------
NUMBER OF ACCUMULATED
SHARES AMOUNT DEFICIT TOTAL
--------- -------- ------------ ----------
<S> <C> <C> <C> <C>
Balance at December 31, 1996............ (116,484) $(26,338) $(14,570,157) $1,954,394
Compensation expense for vesting of
stock options......................... 34,449
Net loss................................ -- -- (388,364) (388,364)
-------- -------- ------------ ----------
Balance at March 31, 1997............... (116,484) $(26,338) $(14,958,521) $1,600,479
======== ======== ============ ==========
</TABLE>
See accompanying notes to consolidated interim financial statements.
F-25
<PAGE> 96
PEGASUS SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED
MARCH 31,
------------------------
1996 1997
--------- -----------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(966,797) $ (388,364)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Minority share of net gain (loss)...................... 47,961 --
Loss (gain) on sale of equipment....................... 9,988 --
Depreciation and amortization.......................... 909,493 707,458
Adjustment for discontinued software................... 316,698 --
Proceeds from increase in long-term notes payable
accrued interest...................................... 21,229 22,671
Changes in assets and liabilities:
Restricted cash...................................... 1,254 (155,459)
Accounts receivable.................................. 59,349 (264,938)
Accounts receivable from affiliates.................. (777,980) (506,836)
Other current and noncurrent assets.................. (41,083) (79,028)
Accounts payable and accrued liabilities............. 676,004 (75,121)
Accounts payable to affiliates....................... 393,668 25,680
Unearned income...................................... (102,847) 440,872
Unearned compensation................................ -- 34,449
Other noncurrent liabilities......................... 25,867 5,976
--------- -----------
Net cash provided (used in) by operating
activities....................................... $ 572,804 $ (232,640)
========= ===========
Cash flows from investing activities:
Purchase of software, property and equipment.............. $(158,441) $ (407,291)
Proceeds from sale of software, property and equipment.... 132,328 --
Purchase of marketable securities......................... -- (983,605)
Proceeds from maturities of marketable securities......... -- 2,705,076
--------- -----------
Net cash provided by (used in) investing
activities....................................... (26,113) 1,314,180
--------- -----------
Cash flows from financing activities:
Repayments of notes payable............................... (235,000) (188,928)
Repayments of capital leases.............................. (168,833) (251,362)
Proceeds from capital leases.............................. -- 3,913
--------- -----------
Net cash used in financing activities............. (403,833) (436,377)
--------- -----------
Net increase in cash and cash equivalents................... 142,858 645,163
Cash and cash equivalents, beginning year................... 93,831 1,796,311
--------- -----------
Cash and cash equivalents, end of year...................... $ 236,689 $ 2,441,474
========= ===========
Supplemental schedule of noncash investing and financing
activities:
Acquisition of equipment under capital leases............. $ -- $ 79,144
========= ===========
</TABLE>
See accompanying notes to consolidated interim financial statements.
F-26
<PAGE> 97
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
In July 1995, Pegasus Systems, Inc. (Pegasus or the Company) was formed as
a Delaware holding company to combine the operations of two existing companies
operating in the same industry, The Hotel Industry Switch Company, Inc. (THISCO)
and The Hotel Clearing Corporation (HCC). For accounting purposes, the
combination was recorded as a purchase of HCC.
The accompanying financial statements include the consolidated accounts of
Pegasus and its wholly owned subsidiaries, THISCO and HCC. THISCO is
consolidated with its wholly owned subsidiary, TravelWeb, Inc. (TravelWeb), and
HCC is consolidated with its wholly owned subsidiary, Pegasus Systems Inc. (UK)
Limited (Pegasus UK, formerly The Hotel Clearing Corporation (UK) Limited),
(collectively, the Company). All significant intercompany balances have been
eliminated in consolidation.
THISCO was formed in September 1988 as a Delaware corporation. The
Company's THISCO service provides an electronic interface from hotel central
reservation systems to travel agencies through Global Distribution Systems
("GDSs"), which are electronic travel information and reservation systems such
as SABRE.
HCC, acquired by the Company in July 1995 (see Note 3), was formed in July
1991 as a Delaware corporation. The Company's HCC service consolidates
commissions paid by participating hotels to a participating travel agency into a
single monthly payment and provides participants with comprehensive transaction
reports. Hotel properties and travel agencies worldwide utilize the HCC service
to increase the efficiency and reduce costs associated with preparing, paying
and reconciling hotel room reservation commissions.
TravelWeb was formed in October 1995 as a Delaware corporation. The
Company's TravelWeb service provides individual travelers direct access to
online hotel information and the ability to make reservations electronically at
hotel properties. In addition, through its recently introduced NetBooker
service, the Company offers TravelWeb's comprehensive hotel database and
Internet hotel reservation capabilities to third-party Web sites.
Pegasus UK, a wholly-owned subsidiary of HCC, was formed in September 1993
in England to market and provide services for travel agents and hotel chains
operating in Europe, Africa and Asia.
The financial information presented herein should be read in conjunction
with the Company's annual consolidated financial statements for the year ended
December 31, 1996. The foregoing unaudited interim consolidated financial
statements reflect all adjustments (all of which are of a normal recurring
nature) which are, in the opinion of management, necessary for a fair
presentation of the results of the interim periods. The results for interim
periods are not necessarily indicative of results to be expected for the year.
2. STOCK SPLITS
A one hundred-for-one stock split was effected in June 1996. All references
in the consolidated financial statements to shares, share prices, per share
amounts and stock plans have been adjusted retroactively for the one
hundred-for-one stock split.
The Company plans to proceed with an IPO in 1997. Consequently, in May 1997
the Board of Directors approved the declaration of 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 IPO. The number of shares of common stock the
Company is authorized to issue will increase from 20 million to 100,000,000 and
the number of authorized shares of preferred stock will remain two million. 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.
F-27
<PAGE> 98
PEGASUS SYSTEMS, INC.
NOTES TO CONSOLIDATED INTERIM FINANCIAL STATEMENTS -- (CONTINUED)
3. PRO FORMA NET LOSS PER SHARE
Historical loss per share has been excluded from the Company's statements
of operations on the basis that it is irrelevant due to the planned conversion
of all outstanding Series A preferred stock to common stock on a one-for-one
basis concurrent with the effectiveness of the Company's initial public
offering. Pro forma net loss per share has been computed using the weighted
average number of common shares outstanding after giving retroactive effect to
the four-for-three stock split to be effected upon effectiveness of the
Company's Registration Statement on Form S-1 (see Note 7) and assuming that (i)
all shares of Series A preferred stock have been converted to shares of common
stock as of the date of issuance (see Note 8) and (ii) all shares, options and
warrants issued subsequent to June 1, 1996, at an exercise price less the
initial public offering (IPO) price have been included in the calculation as if
they were outstanding for the entire period presented using the treasury stock
method and the IPO price.
4. SUPPLEMENTAL PRO FORMA NET LOSS PER SHARE
Supplemental pro forma net loss per share is based on the weighted average
number of shares of common stock used in the calculation of pro forma net loss
per share, plus the number of shares (524,790 for the three months ended March
31, 1997) that the Company would need to repay $5,222,828 of indebtedness
outstanding under notes payable to certain stockholders of the Company at March
31, 1997. For purposes of computing supplemental pro forma net loss per share
(unaudited), the pro forma net loss for the three months ended March 31, 1997
was reduced by $130,639, representing elimination of the related interest
expense on such notes payable.
5. EARNINGS PER SHARE
In February 1997, Statement of Financial Accounting Standards No. 128,
"Earnings per Share" (FAS 128), was issued. FAS 128 specifies the computation,
presentation and disclosure requirements for earnings per share (EPS) for
entities with publicly held common stock or potential common stock. FAS 128
simplifies the standards for computing EPS previously found in Accounting
Principles Board Opinion No. 15, "Earnings per Share" (APB 15), and makes them
comparable to international EPS standards. It replaces the presentation of
primary EPS with a presentation of basic EPS. It also requires dual presentation
of basic and diluted EPS on the face of the statement of operations for all
entities with complex capital structures and requires a reconciliation of the
numerator and denominator of the basic EPS computation to the numerator and
denominator of the diluted EPS computation. FAS 128 is effective for financial
statements issued for periods ending after December 15, 1997, including interim
periods; earlier application is not permitted. FAS 128 requires restatement of
all prior-period EPS data presented. The Company will adopt FAS 128 in the year
ending December 31, 1997 and, based on current circumstances, does not believe
the effect of adoption will be material.
6. SUBSEQUENT EVENT
In May 1997, the Company issued a warrant to a customer for the purchase of
345,723 shares of the Company's common stock. The warrants are exercisable
during the two year period ended May 12, 1999 at an exercise price equal to the
lower of $7.20 per share or 85.0% of the IPO price per share.
7. PRO FORMA BALANCE SHEET
In conjunction with the Company's planned IPO, all outstanding shares of
Series A preferred stock will be converted on a one-for-one basis to common
stock concurrent with the effectiveness of the Company's Registration Statement
on Form S-1. Accordingly, the pro forma balance sheet at March 31, 1997 gives
effect to the conversion of the 1,538,463 shares of Series A preferred stock to
1,538,463 shares of Series A common stock as if such conversion had occurred as
of the balance sheet date.
F-28
<PAGE> 99
INDEPENDENT AUDITOR'S REPORT
To the Shareholders
The Hotel Clearing Corporation
We have audited the accompanying consolidated balance sheets of The Hotel
Clearing Corporation and its subsidiary as of December 31, 1993 and 1994, and
the related consolidated statements of operations, shareholders' deficit and
cash flows for the years then ended. 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 in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of The Hotel
Clearing Corporation as of December 31, 1993 and 1994, and the results of its
operations and its cash flows for the years then ended in conformity with
generally accepted accounting principles.
Belew Averitt LLP
Dallas, Texas
April 4, 1995, except for
Note 12, as to which the
date is August 21, 1995
F-29
<PAGE> 100
THE HOTEL CLEARING CORPORATION
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1993 AND 1994
ASSETS
<TABLE>
<CAPTION>
1993 1994
----------- -----------
<S> <C> <C>
Current assets:
Cash and cash equivalents................................. $ 37,835 $ 7,612
Accounts receivable, net (Note 3)......................... 215,382 194,493
Accounts receivable from affiliates....................... 14,496 17,732
Prepaid expenses.......................................... 21,230 15,923
----------- -----------
Total current assets.............................. 288,943 235,760
Property and equipment, net (Note 4)........................ 210,445 209,640
----------- -----------
Total assets...................................... $ 499,388 $ 445,400
=========== ===========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable and accrued liabilities.................. $ 368,920 $ 601,177
Accounts payable to affiliates............................ 29,126 187,472
Current portion of unearned income........................ 274,510 352,941
Line-of-credit (Note 6)................................... 180,000 --
Current portion of notes payable to affiliates (Note 6)... -- 786,478
Current portion of capital lease obligations (Note 5)..... 33,500 52,528
----------- -----------
Total current liabilities......................... 886,056 1,980,596
Capital lease obligations, net of current portion (Note
5)........................................................ 58,381 48,929
Notes payable to affiliates (Note 6)........................ 747,139 --
Unearned income, net of current portion (Note 12)........... 1,725,490 1,372,549
----------- -----------
Total liabilities................................. 3,417,066 3,402,074
Commitments and contingencies (Notes 8 and 12).............. -- --
Shareholders' deficit (Note 7):
Preferred stock:
Series A............................................... 2 2
Series B............................................... 1 1
Common stock.............................................. 10 10
Additional paid-in capital................................ 1,702,885 1,702,885
Accumulated deficit....................................... (4,620,576) (4,659,572)
----------- -----------
Total shareholders' deficit....................... (2,917,678) (2,956,674)
----------- -----------
Total liabilities and shareholders' deficit....... $ 499,388 $ 445,400
=========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-30
<PAGE> 101
THE HOTEL CLEARING CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1993 AND 1994
<TABLE>
<CAPTION>
1993 1994
----------- ----------
<S> <C> <C>
Net revenues (Note 8):
Shareholder............................................... $ 1,515,686 $2,397,236
Nonshareholder............................................ 8,691 349,255
----------- ----------
1,524,377 2,746,491
Operating expenses:
General and administrative expenses....................... 2,215,356 1,763,754
Other operating expenses.................................. 531,345 878,444
Depreciation and amortization............................. 113,064 65,216
----------- ----------
Total operating expenses.......................... 2,859,765 2,707,414
----------- ----------
Operating income (loss)..................................... (1,335,388) 39,077
Interest expense............................................ 97,448 78,073
----------- ----------
Loss before income taxes and extraordinary gain............. (1,432,836) (38,996)
Income taxes (Note 9)....................................... -- --
----------- ----------
Loss before extraordinary gain.............................. (1,432,836) (38,996)
Extraordinary gain (Note 11)................................ 269,310 --
----------- ----------
Net loss.................................................... $(1,163,526) $ (38,996)
=========== ==========
</TABLE>
See accompanying notes to consolidated financial statements.
F-31
<PAGE> 102
THE HOTEL CLEARING CORPORATION
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' DEFICIT
YEARS ENDED DECEMBER 31, 1993 AND 1994
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK
------------------ ------------------ ADDITIONAL
NUMBER OF NUMBER OF PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
--------- ------ --------- ------ ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance, December 31, 1992............. -- $-- 9 $ 1 $ 550,997 $(3,457,050) $(2,906,052)
105-for-1 stock split.................. -- -- 936 9 (9) -- --
Preferred stock issuance:
Series A............................. 210 2 -- -- 1,049,998 -- 1,050,000
Series B............................. 20 1 -- -- 1,899 -- 1,900
Conversion of note payable into common
stock................................ -- -- 105 -- 100,000 -- 100,000
Net loss............................... -- -- -- -- -- (1,163,526) (1,163,526)
--- --- ----- --- ---------- ----------- -----------
Balance, December 31, 1993............. 230 3 1,050 10 1,702,885 (4,620,576) (2,917,678)
Net loss............................... -- -- -- -- -- (38,996) (38,996)
--- --- ----- --- ---------- ----------- -----------
Balance, December 31, 1994............. 230 $ 3 1,050 $10 $1,702,885 $(4,659,572) $(2,956,674)
=== === ===== === ========== =========== ===========
</TABLE>
See accompanying notes to consolidated financial statements.
F-32
<PAGE> 103
THE HOTEL CLEARING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1993 AND 1994
<TABLE>
<CAPTION>
1993 1994
----------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net loss.................................................. $(1,163,526) $ (38,996)
Adjustments to reconcile net loss to cash provided (used)
by operating activities:
Loss on sale of equipment.............................. -- 125
Depreciation and amortization.......................... 113,064 65,216
Reclassification of accrued interest to notes payable
to affiliates......................................... 56,107 58,614
Gain on extinguishment of debt......................... (269,310) --
Deferred income recognition............................ -- (274,510)
(Increase) decrease in:
Accounts receivable, net............................. (166,190) 20,889
Accounts receivable from affiliates.................. (14,496) (3,236)
Prepaid expenses..................................... (6,230) 5,307
Increase (decrease) in:
Accounts payable and accrued liabilities............. (55,410) 232,257
Accounts payable to affiliate........................ (14,163) 158,346
----------- ---------
Net cash provided (used) by operating
activities...................................... (1,520,154) 224,012
Cash flows from investing activities:
Purchase of property and equipment........................ (34,266) (42,612)
Proceeds from sale of equipment........................... -- 21,152
----------- ---------
Net cash used by investing activities............. (34,266) (21,460)
Cash flows from financing activities:
Proceeds from issuance of stock........................... 1,900 --
Proceeds from installment payments on stock purchase...... 1,050,000 --
Proceeds from contract commitment -- deferred income...... 2,000,000 --
Proceeds (repayment) of line-of-credit.................... 180,000 (180,000)
Repayment of notes payable................................ (1,640,000) (19,275)
Repayment of capital leases............................... (14,437) (33,500)
----------- ---------
Net cash provided (used) by financing
activities...................................... 1,577,463 (232,775)
----------- ---------
Net increase (decrease) in cash and cash equivalents........ 23,043 (30,223)
Cash and cash equivalents, beginning of period.............. 14,792 37,835
----------- ---------
Cash and cash equivalents, end of period.................... $ 37,835 $ 7,612
=========== =========
Supplemental disclosures of cash flow information --Interest
paid...................................................... $ 70,789 $ 19,458
=========== =========
Supplemental schedule of noncash investing and financing
activities:
Issuance of capital lease obligation for computer
equipment.............................................. $ 106,318 $ 43,076
=========== =========
Conversion of note payable to common stock................ $ 100,000 $ --
=========== =========
</TABLE>
See accompanying notes to consolidated financial statements.
F-33
<PAGE> 104
THE HOTEL CLEARING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1993 AND 1994
1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization and background -- The Hotel Clearing Corporation (HCC) was
incorporated as a Delaware corporation on July 25, 1991, to market and operate
an automated commission payment processing service that consolidates commissions
paid by participating hotels to a participating travel agency into a single
monthly payment and provides participants with comprehensive transaction
reports. HCC collects commissions from participating hotel chains and remits
these commissions to participating travel agents.
Consolidation -- The consolidated financial statements include the accounts
of HCC and its wholly-owned subsidiary, The Hotel Clearing Corporation (U.K.)
Limited (HCC U.K.) (collectively, the Company). HCC U.K. commenced operations in
England on September 2, 1993 to market and provide related services for travel
agents and hotel chains operating in Europe. All significant intercompany
balances and transactions have been eliminated.
Cash and cash equivalents -- The Company considers all highly-liquid
investments with an original maturity of three months or less when purchased to
be cash equivalents.
Software development costs -- All costs incurred in the internal
development of computer software used in delivery of the Company's services are
expensed until a product design and a working model of the software have been
tested and completed. Thereafter, any further development or production costs
are capitalized. Maintenance and customer support costs are expensed when
incurred. Capitalized costs are being amortized over three to five years using
the straightline method. During 1993, the Company amortized approximately
$78,000 of capitalized software costs. No software development costs were
capitalized in 1993 or 1994.
Property and equipment -- Property and equipment are recorded at cost and
are depreciated using the straight-line method over their estimated useful
lives, ranging from five to seven years. Expenditures for maintenance and
repairs, as well as minor renewals, are charged to operations as incurred.
Betterments and major renewals are capitalized. Upon retirement or sale of an
asset, the cost of the asset and the related accumulated depreciation and
amortization are removed from the accounts and any resulting gain or loss is
credited or charged to operations.
Leasehold improvements -- Leasehold improvements are recorded at cost and
are amortized using the straight-line method over four years, which is the life
of the lease.
Revenues -- HCC's revenues are derived primarily from travel agencies. HCC
processes commission payments to travel agencies on behalf of both shareholder
and nonshareholder hotels. HCC also provides transaction detail reports and
hotel booking reconciliation services to travel agencies. For these services,
HCC receives a percentage of the travel agencies' commissions paid through HCC.
HCC also earns transaction fees from the participating hotels. These revenues
are recorded as earned throughout the year. Revenue related to term contracts
are deferred and amortized into income over the life of the contracts. For the
years ended December 31, 1993 and 1994, HCC's revenues from hotels are presented
net of commission payments to travel agencies of $22,211,781 and $34,218,496,
respectively.
Federal income taxes -- Effective January 1, 1993, the Company adopted
Statement of Financial Accounting Standards No. 109 (SFAS 109), "Accounting for
Income Taxes" which requires an asset and liability approach to financial
accounting for income taxes. In the event differences between the financial
reporting basis and the tax basis of HCC's assets and liabilities result in
deferred tax assets, SFAS 109 requires an evaluation of the probability of being
able to realize the future benefits indicated by such assets. A valuation
allowance is provided for a portion or all of the deferred tax assets when there
is an uncertainty regarding the Company's ability to recognize the benefits of
the assets in future years.
F-34
<PAGE> 105
THE HOTEL CLEARING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Concentration of credit risk -- The Company's financial instruments exposed
to concentration of credit risk consist primarily of its trade receivables. The
majority of receivables are due from shareholders who are well-established
entities in the travel industry. As a result, credit risk is considered limited.
Reclassifications -- Certain 1993 balances have been reclassified to
conform to the 1994 presentation.
2. OPERATIONS
During 1994, the Company increased revenues $1,222,114 to $2,746,491,
reduced operating expenses $152,351 to $2,707,414 and generated positive cash
flows of $224,012 from operations, yet the Company incurred a net loss of
$38,996 and has a shareholders' deficit of $2,956,674 at December 31, 1994. The
Company's business plan contemplates additional revenue increases through the
addition of more hotels and travel agents to its commission payment services
sufficient to meet current working capital needs to nonshareholders.
In addition, the Company has plans to negotiate an extension of payment
terms on existing short-term debt to shareholders of $655,725 and accrued
interest of $130,756. However, the Company may continue to require additional
capital contributions and borrowings from shareholders. Common stock agreements
contain provisions whereby the shareholders are required, as defined, to
contribute additional capital and lend additional amounts to the Company. There
can be no guarantee, however, that funds from these sources or any other source
will be available to the Company (see Note 13).
3. ACCOUNTS RECEIVABLE
The Company collects travel agents' commissions from hotel chains and,
after retaining a portion of these commissions, remits net commissions to the
travel agents. Net accounts receivable included in the accompanying consolidated
balance sheets were as follows:
<TABLE>
<CAPTION>
1993 1994
----------- -----------
<S> <C> <C>
Amounts due from hotel chains........... $ 2,256,086 $ 3,021,542
Net commissions due to travel agents.... (2,040,704) (2,827,049)
----------- -----------
$ 215,382 $ 194,493
=========== ===========
</TABLE>
The accounts receivable from affiliates results from transaction fees
charged to shareholder hotels.
4. PROPERTY AND EQUIPMENT
Property and equipment at December 31 consisted of the following:
<TABLE>
<CAPTION>
1993 1994
----------- -----------
<S> <C> <C>
Computer equipment...................... $ 111,587 $ 129,031
Furniture and equipment................. 85,105 112,697
Office equipment........................ 58,022 75,359
Leasehold improvements.................. 1,724 1,724
----------- -----------
256,438 318,811
Less accumulated depreciation........... (45,993) (109,171)
----------- -----------
$ 210,445 $ 209,640
=========== ===========
</TABLE>
F-35
<PAGE> 106
THE HOTEL CLEARING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. CAPITAL LEASES
Assets recorded under capital leases are recorded at the lower of present
value of future minimum lease payments or the fair value of the asset. Total
assets recorded under capital leases at December 31, 1993 and 1994 were $106,318
and $149,394, respectively, net of accumulated amortization of $11,375 and
$51,615, respectively. The assets are amortized using the straight-line method
over the shorter of their useful lives or the term of the related leases.
Amortization of assets under capital leases are included in depreciation and
amortization expense.
Future minimum lease payments and related interest are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S> <C>
1995.................................. $ 62,937
1996.................................. 37,404
1997.................................. 15,828
--------
Total minimum lease payments............ 116,169
Less interest........................... 14,712
--------
101,457
Less current portion.................... 52,528
--------
$ 48,929
========
</TABLE>
The interest rates on the capital leases range from 11.0% to 12.1%, which
were imputed at the inception of the leases.
6. NOTES PAYABLE
Notes payable consisted of the following:
<TABLE>
<CAPTION>
1993 1994
--------- ---------
<S> <C> <C>
Notes payable to shareholders, bearing interest at the prime
rate plus 2.0% due December 31, 1995; the prime rate at
December 31, 1994 was 8.5%; uncollateralized.............. $ 747,139 $ 786,478
Convertible line-of-credit to a preferred stock shareholder;
accruing interest at the prime rate plus 2.0%; expires
June 1, 1994; uncollateralized; paid on June 1, 1994...... 180,000 --
--------- ---------
927,139 786,478
Less current portion........................................ (180,000) (786,478)
--------- ---------
$ 747,139 $ --
========= =========
</TABLE>
7. SHAREHOLDERS' DEFICIT
In October, 1992, the Company entered into a non-refundable agreement with
an investment group to purchase 210 shares of the Company's preferred stock for
$1,500,000. The purchase was to be made in monthly installments of $150,000
which began October 1, 1992. On August 10, 1993, the investment group completed
the funding of $1,500,000, at which time the 210 shares of preferred stock were
issued.
On August 10, 1993, the Board of Directors amended the Articles of
Incorporation to increase the authorized number of common shares from 105,000 to
210,000 shares. In addition, the Board of Directors established a Series A and
Series B preferred stock with 52,500 shares authorized for each series at a par
value
F-36
<PAGE> 107
THE HOTEL CLEARING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of $.01 per share. Such shares have preferential dividend rights. The Board of
Directors' declared stock split of 105-for-1 for both common and preferred
shares has been reflected in the financial statements. In August, 1993, the
Company sold 20 shares of the Series B preferred stock to an officer of the
Company for $95 per share.
On December 31, 1993, a $100,000 note payable to a company was converted to
105 shares of common stock. The conversion did not result in a gain or loss.
At December 31, 1994, the Company had the following shares issued and
outstanding:
<TABLE>
<CAPTION>
STOCK STOCK PAR
AUTHORIZED ISSUED VALUE
---------- ------ -----
<S> <C> <C> <C>
Common stock.............................................. 210,000 1,050 $.01
Preferred stock:
Series A................................................ 52,500 210 $.01
Series B................................................ 52,500 20 $.01
</TABLE>
The Company has agreements with its common shareholders whereby it can
require them to make additional capital contributions. Also under the provisions
of the agreements, the Company can require all common shareholders to lend
additional funds to the Company in such amounts as determined by the Board of
Directors. In the event a shareholder fails to contribute capital or lend funds
to the Company, the Company can acquire the shareholder's shares at $.01 per
share.
8. RELATED PARTIES
The Company derives a substantial portion of its revenue from
shareholder-owned companies. Also, much of the revenue is generated indirectly
by shareholders as a function of HCC's role as the consolidator and payor of
commissions to travel agencies. HCC makes commission payments to travel agencies
on behalf of hotel properties and receives a percentage of the commission
payment from the travel agent for this service. A summary of revenues is as
follows:
<TABLE>
<CAPTION>
1993 1994
------------------- -------------------
REVENUES AMOUNT % AMOUNT %
-------- ---------- ----- ---------- -----
<S> <C> <C> <C> <C>
Shareholders -- direct..................... $ 168,749 11.0% $ 232,173 8.5%
Shareholders -- indirect................... 1,346,937 88.4% 2,165,063 78.8%
---------- ----- ---------- -----
Total generated by shareholders directly
and indirectly........................... 1,515,686 99.4% 2,397,236 87.3%
All other revenue.......................... 8,691 0.6% 349,255 12.7%
---------- ----- ---------- -----
Total............................ $1,524,377 100.0% $2,746,491 100.0%
========== ===== ========== =====
</TABLE>
The Company and The Hotel Industry Switch Company (THISCO) have management
and certain shareholders in common. The Company pays a management fee to THISCO,
which represents a portion of THISCO's management salaries and related benefits
attributable to the Company's operations. Management fees paid to THISCO during
1993 and 1994 were $156,928 and $290,465, respectively.
The Company utilizes THISCO's telecommunications network and various
equipment. During 1993 and 1994, the Company paid THISCO $101,490 and $46,096,
respectively, for the use of the network and this equipment. In 1993, THISCO
also transferred $22,537 of furniture and equipment and the related capital
lease obligation to HCC.
F-37
<PAGE> 108
THE HOTEL CLEARING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A shareholder provided services to the Company, including facility
management, consulting and software development. During 1993 and 1994, the
Company recognized expense in the amount of approximately $30,000 and $33,000,
respectively, for those services.
Persons related to an officer of the Company have provided printing, design
and procurement services to the Company. During 1993 and 1994, the Company paid
approximately $17,000 and $11,000, respectively, relating to these services.
The Company has an agreement to sublease office space from THISCO for a
four-year period under an operating lease agreement. Amounts paid to THISCO
under this agreement during 1993 and 1994 were $106,454 and $105,863,
respectively. Estimated future minimum lease payments due to THISCO at December
31, 1994 are as follows:
<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S> <C>
1995............................................ $119,000
1996............................................ 126,000
1997............................................ 21,000
--------
$266,000
========
</TABLE>
9. INCOME TAXES
During 1994, the Company recorded a long-term deferred tax asset of
approximately $1,514,000, derived from net operating loss carryforwards and
excess book depreciation over tax depreciation. The deferred tax asset is fully
reserved because of uncertainty regarding the Company's ability to recognize the
benefit of the asset in future years.
The components of deferred income tax assets (liabilities) are as follows:
<TABLE>
<CAPTION>
1993 1994
----------- -----------
<S> <C> <C>
Net operating loss carryforward........................... $ 1,542,591 $ 1,509,551
Depreciation and amortization............................. (4,619) 4,391
Valuation allowance....................................... (1,537,972) (1,513,942)
----------- -----------
Net deferred tax asset.................................... $ -- $ --
=========== ===========
</TABLE>
At December 31, 1994, the Company had net operating loss carryforwards for
tax reporting purposes of approximately $4,440,000. The net operating loss
carryforwards will expire beginning in the year 2006, if not previously
utilized.
The provision for income taxes is as follows:
<TABLE>
<CAPTION>
1993 1994
-------- --------
<S> <C> <C>
Current:
Federal................................................... $ -- $ --
State..................................................... -- --
-------- --------
Deferred.................................................... -- --
-------- --------
$ -- $ --
======== ========
</TABLE>
F-38
<PAGE> 109
THE HOTEL CLEARING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation between the statutory Federal income tax rate and the
effective income tax rates is as follows:
<TABLE>
<CAPTION>
1993 1994
------ ------
<S> <C> <C>
Statutory Federal income tax rate........................... 34.0% 34.0%
Valuation allowance......................................... (34.0%) (34.0%)
Provision for income taxes.................................. 0.0% 0.0%
</TABLE>
10. EMPLOYEE BENEFIT PLAN
The Company co-sponsors, with THISCO, a 401(k) defined contribution
retirement plan covering full-time employees who have completed one year of
service and obtained the age of twenty-one. According to the plan agreement, the
Company has committed to match employee contributions up to 3.0% of the
employee's qualified salary through December 31, 1994 and 5.0% thereafter. The
Company contributed $20,904 and $19,791 to the Plan during 1993 and 1994,
respectively.
11. EXTRAORDINARY GAIN
The 1993 extraordinary gain of $269,310 represents the Company's net gain
on the settlement of a note payable to a vendor.
12. CONTINGENCIES AND COMMITMENTS
In June, 1993, HCC received $2,000,000 from Citicorp in exchange for a
five-year non-cancelable data processing contract and recorded the amount as
deferred income. The non-cancelable contract requires Citicorp to process
transactions and generate various reports in exchange for a processing fee. The
contract requires HCC to maintain an annual minimum volume of transactions. If
the annual minimum volume is not attained, HCC is required to pay Citicorp an
additional processing fee for each transaction under the minimum volume. HCC is
recognizing the $2,000,000 of deferred income over the life of the contract,
according to the volume of guaranteed transactions, as defined by the contract.
During 1994, HCC recognized $274,510 of the $2,000,000 deferred income. However,
because HCC did not meet its annual minimum volume of transactions, it also
recorded an additional processing fee of $215,351.
13. SUBSEQUENT EVENTS
Subsequent to December 31, 1994, the Company issued an additional 105
shares of common stock for $250,000 and obtained a short-term loan from a
shareholder in the amount of $200,000. The short-term loan accrues interest at
the prime rate plus 2.0% and is due on or before December 30, 1995. In August,
1995 the Company repurchased the 105 shares for $250,000.
Pegasus Systems, Inc. (Pegasus) was formed to combine the operations of HCC
and THISCO. For accounting purposes, the combination was recorded as a purchase
of HCC. In July, 1995, Pegasus issued 4,934,667 shares of its common stock in
exchange for all of the outstanding capital stock of THISCO and 83.3% of the
ownership of HCC (the Reorganization). Lodging Network, Inc. (LNI) retained 210
shares of HCC preferred stock, representing a 16.7% minority ownership interest
in HCC. In conjunction with the Reorganization, LNI was granted an option (LNI
Option), expiring in July 1998, to exchange its 16.67% ownership interest in HCC
for 448,667 shares of Pegasus' common stock.
Also as part of this Reorganization, certain shareholders of the Company
agreed to contribute outstanding debt totaling $337,500 to capital, effective
immediately prior to closing. The remaining debt, after these contributions were
renewed and extended, expires five years from the Agreement's closing date at an
interest rate of prime plus 1.0%.
F-39
<PAGE> 110
THE HOTEL CLEARING CORPORATION
CONSOLIDATED BALANCE SHEET
(UNAUDITED)
ASSETS
<TABLE>
<CAPTION>
JUNE 30,
1995
-----------
<S> <C>
Current assets:
Cash and cash equivalents................................. $ 88,102
Accounts receivable, net.................................. 297,890
Accounts receivable from affiliates....................... 25,853
Prepaid expenses.......................................... 2,842
-----------
Total current assets.............................. 414,687
Property and equipment, net................................. 245,082
Other non-current assets.................................... 18,432
-----------
Total assets...................................... $ 678,201
===========
LIABILITIES AND SHAREHOLDERS' DEFICIT
Current liabilities:
Accounts payable and accrued liabilities.................. $ 454,136
Accounts payable to affiliates............................ 244,020
Current portion of unearned income........................ 425,722
Current portion of notes payable to affiliates............ 855,725
Current portion of capital lease obligations.............. 51,727
-----------
Total current liabilities......................... 2,031,330
Capital lease obligations, net of current portion........... 21,793
Unearned income, net of current portion..................... 1,156,863
-----------
Total liabilities................................. 3,209,986
Shareholders' deficit:
Preferred stock:
Series A............................................... 2
Series B............................................... 1
Common stock.............................................. 11
Additional paid-in capital................................ 1,953,834
Accumulated deficit....................................... (4,485,633)
-----------
Total shareholders' deficit....................... (2,531,785)
-----------
Total liabilities and shareholders' deficit....... $ 678,201
===========
</TABLE>
See accompanying notes to consolidated interim financial statements.
F-40
<PAGE> 111
THE HOTEL CLEARING CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
------------------------
1994 1995
---------- ----------
<S> <C> <C>
Net revenues:
Shareholder............................................... $1,122,007 $1,481,282
Nonshareholder............................................ 144,303 677,993
---------- ----------
Total revenues.................................... 1,266,310 2,159,275
Cost of services............................................ 245,760 674,880
Research and development.................................... 205,694 356,439
General and administrative expenses......................... 256,229 372,779
Marketing and promotion expenses............................ 406,199 486,555
Depreciation and amortization............................... 31,093 44,103
---------- ----------
Operating income............................................ 121,335 224,519
Other expense:
Interest expense............................................ 40,562 50,580
---------- ----------
Income before income taxes.................................. 80,773 173,939
Income taxes................................................ -- --
---------- ----------
Net income.................................................. $ 80,773 $ 173,939
========== ==========
</TABLE>
See accompanying notes to consolidated interim financial statements.
F-41
<PAGE> 112
THE HOTEL CLEARING CORPORATION
CONSOLIDATED STATEMENT OF SHAREHOLDERS' DEFICIT
(UNAUDITED)
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK
------------------ ------------------ ADDITIONAL
NUMBER OF NUMBER OF PAID-IN ACCUMULATED
SHARES AMOUNT SHARES AMOUNT CAPITAL DEFICIT TOTAL
--------- ------ --------- ------ ---------- ----------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31, 1994.......... 230 $ 3 1,050 $10 $1,702,885 $(4,659,572) $(2,956,674)
Issuance of common stock.............. -- -- 105 1 249,999 -- 250,000
Issuance of series B preferred stock,
par value $.01...................... 10 -- -- -- 950 -- 950
Net income............................ -- -- -- -- -- 173,939 173,939
--- --- ----- --- ---------- ----------- -----------
Balance at June 30, 1995.............. 240 $ 3 1,155 $11 $1,953,834 $(4,485,633) $(2,531,785)
=== === ===== === ========== =========== ===========
</TABLE>
See accompanying notes to consolidated interim financial statements.
F-42
<PAGE> 113
THE HOTEL CLEARING CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
SIX MONTHS ENDED
JUNE 30,
----------------------
1994 1995
--------- ---------
<S> <C> <C>
Cash flows from operating activities:
Net income............................ $ 80,773 $ 173,939
Adjustments to reconcile net income to
cash provided (used) by operating
activities:
Depreciation and amortization...... 31,093 44,103
Proceeds from increase in long-term
note payable accrued interest..... 27,109 --
Deferred income recognition........ (81,483) (142,905)
(Increase) decrease in:
Accounts receivable, net......... 15,087 (103,397)
Accounts receivable from
affiliates...................... (1,488) (8,121)
Prepaid expenses................. 21,230 (5,351)
Increase (decrease) in:
Accounts payable and accrued
liabilities..................... (190,688) (277,794)
Accounts payable to affiliates... 220,575 56,548
--------- ---------
Net cash provided (used) by
operating activities........ 122,208 (262,978)
--------- ---------
Cash flows used by investing
activities --
Purchase of property and equipment.... (3,060) (79,545)
--------- ---------
Cash flows from financing activities:
Proceeds from issuance of stock....... -- 250,950
Proceeds from line-of-credit.......... 120,000 200,000
Repayment of line-of-credit........... (250,000) --
Repayment of notes payable............ (10,732) --
Repayment of capital leases........... (16,251) (27,937)
--------- ---------
Net cash provided (used) by
financing activities........ (156,983) 423,013
--------- ---------
Net increase (decrease) in cash and cash
equivalents........................... (37,835) 80,490
Cash and cash equivalents, beginning of
period................................ 37,835 7,612
--------- ---------
Cash and cash equivalents, end of
period................................ $ -- $ 88,102
========= =========
</TABLE>
See accompanying notes to consolidated interim financial statements.
F-43
<PAGE> 114
THE HOTEL CLEARING CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
The accompanying financial statements include the consolidated accounts of
The Hotel Clearing Corporation (HCC) and its wholly owned subsidiary, The Hotel
Clearing Corporation (U.K.) Limited (HCC U.K.) (collectively, the Company). All
significant intercompany balances have been eliminated in consolidation.
HCC was formed in July 1991 as a Delaware corporation to market and operate
an international automated commission payment processing service that
consolidates commissions paid by participating hotels to a participating travel
agency into a single monthly payment and provides participants with
comprehensive transaction reports. HCC collects commissions from participating
hotel chains and remits these commissions to participating travel agents.
HCC U.K., a wholly-owned subsidiary of HCC, was formed in September 1993 in
England to market and provide services for travel agents and hotel chains
operating in Europe, Africa and Asia.
The financial information presented herein should be read in conjunction
with the Company's consolidated financial statements as of and for the year
ended December 31, 1994. The foregoing unaudited interim consolidated financial
statements have been prepared to comply with the format of Pegasus Systems, Inc.
(see Note 2) and reflect all adjustments (of a normal recurring nature) which
are, in the opinion of management, necessary for a fair presentation of the
results of the interim periods. The results for interim periods are not
necessarily indicative of results to be expected for the year.
2. SUBSEQUENT EVENTS
The accompanying unaudited interim consolidated financial statements
present the operations of HCC for the period from January 1, 1995 through June
30, 1995. In July 1995, Pegasus Systems, Inc. (Pegasus) was formed as a Delaware
holding company to combine the operations of HCC and The Hotel Industry Switch
Company (THISCO). THISCO was formed in September 1988 to market and operate an
international automated interface between travel agency, hotel and global travel
reservation systems.
Effective in July 1995, Pegasus issued 4,934,667 shares of its common stock
in exchange for all of the outstanding capital stock of THISCO and 83.3% of the
ownership of HCC (the Reorganization). Lodging Network, Inc. (LNI) retained 210
shares of HCC preferred stock, representing a 16.7% minority ownership interest
in HCC.
The Reorganization brought THISCO and HCC together under the control of
Pegasus and was initiated to integrate and expand the existing businesses of
THISCO and HCC. Pegasus was formed immediately prior to the transaction for the
purpose of combining the two operations into a single operating entity. Prior to
the Reorganization, THISCO and HCC were primarily controlled by a common (though
not identical) group of shareholders and a common management group. For
accounting purposes, the Reorganization was treated as an acquisition of HCC and
accounted for as a purchase business combination. Accordingly, the HCC assets
acquired and liabilities assumed were acquired at their fair values. The amount
of the purchase price ($2.7 million) in excess of the fair value of net assets
acquired has been recorded as goodwill and will be amortized on a straight-line
basis over 15 years.
Subsequent to June 30, 1995, the 105 shares issued during the six months
ended June 30, 1995 were reacquired and retired by the Company at the original
issuance price.
F-44
<PAGE> 115
DESCRIPTION OF INSIDE BACK COVER
Pegasus Systems Inc. logo.
Depiction of computer screens showing pages from the TravelWeb site. Pages
show a hotel's information and picture, resource information available from
TravelWeb, TravelWeb home page and information for Click-it! Weekends.
THISCO logo with caption reading:
The THISCO service improves the efficiency and effectiveness of the
hotel room reservation process by enabling travel agents to
electronically access hotel room inventory information and conduct
reservation transactions.
TravelWeb logo with caption reading:
The TravelWeb service enables consumers to access hotel room inventory
information and conduct reservation transactions over the Internet.
HCC logo with caption reading:
The HCC service improves the efficiency and effectiveness of the hotel
commission payment process for travel agents by consolidating payments
and providing comprehensive transaction reports.
<PAGE> 116
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NO DEALER, SALESPERSON OR OTHER PERSON HAS BEEN AUTHORIZED TO GIVE ANY
INFORMATION OR TO MAKE ANY REPRESENTATIONS OTHER THAN THOSE CONTAINED IN THIS
PROSPECTUS AND, IF GIVEN OR MADE, SUCH INFORMATION OR REPRESENTATIONS MUST NOT
BE RELIED UPON AS HAVING BEEN AUTHORIZED BY THE COMPANY, ANY SELLING STOCKHOLDER
OR THE UNDERWRITERS. THIS PROSPECTUS DOES NOT CONSTITUTE AN OFFER TO SELL OR A
SOLICITATION OF AN OFFER TO BUY TO ANY PERSON IN ANY JURISDICTION IN WHICH SUCH
OFFER OR SOLICITATION WOULD BE UNLAWFUL OR TO ANY PERSON TO WHOM IT IS UNLAWFUL.
NEITHER THE DELIVERY OF THIS PROSPECTUS NOR ANY OFFER OR SALE MADE HEREUNDER
SHALL, UNDER ANY CIRCUMSTANCES, CREATE ANY IMPLICATION THAT THERE HAS BEEN NO
CHANGE IN THE AFFAIRS OF THE COMPANY OR THAT THE INFORMATION CONTAINED HEREIN IS
CORRECT AS OF ANY TIME SUBSEQUENT TO THE DATE HEREOF.
------------------
TABLE OF CONTENTS
<TABLE>
<CAPTION>
Page
----
<S> <C> <C>
Prospectus Summary................ 3
Risk Factors...................... 7
Use of Proceeds................... 15
Dividend Policy................... 15
Capitalization.................... 16
Dilution.......................... 17
Selected Consolidated Financial
Data........................... 18
Management's Discussion and
Analysis of Financial Condition
and Results of Operations...... 20
Business.......................... 31
Management........................ 51
Certain Transactions.............. 59
Principal and Selling
Stockholders................... 61
Description of Capital Stock...... 62
Shares Eligible for Future Sale... 64
Underwriting...................... 66
Legal Matters..................... 67
Experts........................... 68
Additional Information............ 68
Index to Consolidated Financial
Statements..................... F-1
</TABLE>
------------------
UNTIL AUGUST 31, 1997 (25 DAYS AFTER THE DATE OF THIS PROSPECTUS), ALL DEALERS
EFFECTING TRANSACTIONS IN THE COMMON STOCK, WHETHER OR NOT PARTICIPATING IN THIS
DISTRIBUTION, MAY BE REQUIRED TO DELIVER A PROSPECTUS. THIS IS IN ADDITION TO
THE OBLIGATIONS OF DEALERS TO DELIVER A PROSPECTUS WHEN ACTING AS UNDERWRITERS
AND WITH RESPECT TO THEIR UNSOLD ALLOTMENTS OR SUBSCRIPTIONS.
- ------------------------------------------------------
======================================================
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3,573,044 SHARES
[PEGASUS SYSTEMS, INC. LOGO]
PEGASUS SYSTEMS, INC.
COMMON STOCK
---------------------------
PROSPECTUS
---------------------------
HAMBRECHT & QUIST
MONTGOMERY SECURITIES
VOLPE BROWN WHELAN
& COMPANY
AUGUST 6, 1997
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