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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _________ to _________
Commission file number 000-22935
PEGASUS SYSTEMS, INC.
(Exact name of registrant as specified in its charter)
DELAWARE 75-2605174
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3811 TURTLE CREEK BOULEVARD, SUITE 1100 75219
DALLAS, TEXAS (ZIP CODE)
(Address of principal executive offices)
Registrant's telephone number, including area code: (214) 528-5656
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock, par value $0.01 per share
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ____.
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value on March 26, 1998 of the registrant's
voting securities held by non-affiliates was $246,113,033.
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Number of shares of registrant's Common Stock, par value $0.01 per
share, outstanding as of March 26, 1998: 10,484,654.
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DOCUMENTS INCORPORATED BY REFERENCE
(a) Selected portions of the Registrant's Annual Report to Stockholders
for the fiscal year ended December 31, 1997.-Part II
(b) Selected portions of the Registrant's definitive Proxy Statement
for the 1998 Annual Meeting of Stockholders.-Part III
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PART I
ITEM 1. BUSINESS.
Unless the context otherwise requires, the term "Company" or "Pegasus"
when used in this report refers to Pegasus Systems, Inc., a Delaware
corporation, and its predecessors and consolidated subsidiaries. This report
contains certain forward-looking statements within the meaning of the federal
securities laws. Actual results and the timing of certain events could differ
materially from those projected in or contemplated by the forward-looking
statements due to a number of factors, including without limitation those listed
herein under "Risk Factors".
Pegasus is a provider of transaction processing services to the hotel
industry worldwide. The Company's THISCO and its TravelWeb and other
Internet-based 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 improves the
efficiency and effectiveness of the commission payment process for participating
hotels and travel agencies by consolidating payments and providing comprehensive
transaction reports. In addition, the Company is developing an information
service to provide hotel industry participants with transaction specific
information on industry trends and guest behavior. 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. For the
fiscal year ending December 31, 1997, approximately 47.2% of the Company's
consolidated revenues was derived from its electronic hotel reservation
processing services, including approximately 41.0% from the THISCO service and
approximately 6.2% from the TravelWeb and other Internet-based services, and
approximately 52.8% of the Company's consolidated revenues was derived from its
HCC service.
SERVICES
The Company's services generally fall into three categories: electronic
hotel room reservations services, commission payment processing services and
information services.
HOTEL ROOM RESERVATION SERVICES
THISCO.
The Company's THISCO service is an electronic hotel room reservation
processing service that interfaces communications concerning hotel reservation
information between all major GDSs and hotel central reservation systems. 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 daily millions of electronic status messages, which are used 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.
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Internet-based Services.
TravelWeb. Located at www.travelweb.com, TravelWeb provides individual
travelers direct access to online hotel information and the ability to make
reservations electronically over the Internet. Individual travelers
traditionally obtain information or reserve a room by contacting a hotel
directly by telephone or fax or indirectly through intermediaries, such as
travel agencies, convention and other large meeting organizers and corporate
travel departments. As a result, an individual traveler cannot easily obtain
information from a wide range of hotel properties in a timely manner. TravelWeb
provides travelers with detailed information regarding a wide array of hotel
properties and, through its connection to the Company's THISCO service, allows
travelers to reserve a hotel room and receive a confirmation in seconds. In
addition to hotel room reservations, the TravelWeb service offers airline
booking capability through Internet Travel Network, Inc. Additionally, TravelWeb
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. The Company also began to sell advertising space on TravelWeb
during 1996, focusing on advertisers that target travelers.
NetBooker. NetBooker is a service provided to other 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 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 provides Web sites with the same information
contained on TravelWeb and 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 the database and booking capability of the third-party Web site. In
connection with this service, there is 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.
UltraRes. The Company's UltraRes service automates the processing of
hotel room reservations for conventions and large meetings. The manual process
traditionally used to reserve hotel rooms for these events is information-
intensive and inefficient and frequently leads to inaccurate and delayed
information and overbooking or underbooking. With the Company's UltraRes
service, convention and other large meeting organizers are able to transfer
reservation requests to the THISCO service, which electronically delivers the
information to each hotel central reservation system. The UltraRes service
eliminates the need to manually transmit and enter rooming lists and allows
hotels to deliver reservations and confirmations electronically in a fast and
reliable manner.
UltraDirect. The Company's UltraDirect service provides the corporate
travel management industry with a direct real-time link to the Company's THISCO
service through corporate intranet travel management software. With the
UltraDirect service, corporate travelers are able to check availability and make
hotel reservations within seconds at hotel chains or properties with which the
traveler's employer has negotiated rates. The UltraDirect service enables
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.
Corporate TravelWeb. The Company is developing its Corporate TravelWeb
service to provide corporate travel departments with Web-based electronic hotel
room and car reservation capabilities. This service is intended to benefit
corporate travel departments by providing low-cost access to comprehensive
travel information and on-line reservation functionality, reducing the time and
effort required in making travel reservations, and improving travel information
reporting, the enforcement of corporate travel policies and the use of
negotiated or preferred rates.
The Company has not received a material amount of revenues for certain
of these electronic hotel room reservation services to date, and there can be no
assurance that such services will produce material revenues to the Company in
the future. See "Risk Factors -- Impact of Technological Advances; Delays in
Introduction of New Services."
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COMMISSION PROCESSING SERVICES
The Company's HCC service gathers commission payment information,
processes that information and transmits 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. 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. The HCC service streamlines the commission payment process and
consolidates 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,
saving costly exchange fees. 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 effectively to those travel agencies that provide
the hotel with the majority of its guests. The hotel also benefits from HCC's
Customer Relations Center, which allows travel agency inquiries regarding
commissions to be addressed by HCC rather than by the hotel itself.
INFORMATION SERVICES
The Company's Pegasus IQ service is being developed to provide hotel
information to a wide variety of audiences in the travel and travel-related
industries, from hotel chains to travel industry marketing groups to
travel-related service companies. The service intends to compile data regarding
hotel guests and their use of hotels in transaction-specific detail and to
organize that data into meaningful information. The Pegasus IQ service intends
to provide industry trend reports and guest behavior data in an automated,
timely format for hotels and hotel marketing companies. The Pegasus IQ service
also is intended to provide benchmark information services that compare a
hotel's daily room and occupancy rates with that of its competition.
Furthermore, Pegasus IQ intends to provide data in an electronic format to
individual travelers, corporate travel departments or other travel service
providers regarding a particular stay at a hotel, together with information
provided by payment card companies, to facilitate automated expense reporting or
to ensure travel policy adherence.
INDUSTRY
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 cancellations and "no-shows" needs to be
accurately communicated between hotels and travel agencies in order to reconcile
commission payments.
Reservations for hotel rooms are made either directly by individual
travelers or indirectly through intermediaries. Individual travelers typically
make direct reservations by telephoning or faxing a hotel to ascertain room
rates, features and availability and to make reservations. Increasingly,
individual travelers can 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. GDS's 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. 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
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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.
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 International, Ltd. ("Wizcom"), which was a
wholly owned indirect subsidiary of Avis, Inc. ("Avis"). As a result of the
acquisition of Avis by HFS Incorporated ("HFS"), in September 1996, WizCom
became a wholly owned indirect subsidiary of HFS. While HFS utilized the
Company's THISCO service through 1997, HFS has moved its electronic hotel room
reservation processing from THISCO to WizCom in 1998. 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.
The market for the Company's TravelWeb, NetBooker and other
Internet-based services is highly competitive. Current competition includes
traditional telephone or travel agency reservation methods and other
Internet-based travel reservation services. There are a large number of
Internet-based 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.com (a site operated by Microsoft Corporation) offer a more
comprehensive range of travel services than those provided by the Company. 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-based hotel room reservation
business is relatively low. There can be no assurance that the Company's
Internet-based 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.
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 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, many of the Company's travel agency
customers are not obligated by any long-term 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.
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INTELLECTUAL PROPERTY
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," "UltraAccess,"
"HCC Hotel Clearing Corporation," "HCC Link," "HCC Cash" and "Chain Link" as
United States federal trademarks and applications to register "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.
RESEARCH AND DEVELOPMENT
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. As of February 28, 1998,
the Company employed 59 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 $2.1 million, $2.2 million and $2.5
million for 1995, 1996 and 1997, respectively.
EMPLOYEES
At February 28, 1998, the Company had 104 employees, 99 of which were
located in the United States, with 59 persons in the Information Technology
Group, 30 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.
RISK FACTORS
SUBSTANTIAL NET LOSSES. The Company has experienced substantial net losses,
including a net loss of $3.5 million in 1996. The Company's HCC and THISCO
services have accounted for the majority of the Company's revenues to date.
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
continued profitability, the Company must successfully implement its business
strategy and increase its revenues while controlling expenses.
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, which was a wholly owned indirect subsidiary of Avis. As a result of
the acquisition of Avis by
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HFS, a stockholder and customer of the Company, in September 1996, WizCom
became a wholly owned indirect subsidiary of HFS. While HFS utilized the
Company's THISCO's service through 1997, HFS has moved its electronic hotel room
reservation processing from THISCO to WizCom in 1998. 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.
Internet Hotel Room Reservation Service. The market for the Company's
TravelWeb, NetBooker and other Internet-based services is highly competitive.
Current competition includes traditional telephone or travel agency reservation
methods and other Internet-based travel reservation services. There are a large
number of Internet based 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-based hotel
room reservation business are relatively low. There can be no assurance that
the Company's Internet-based 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.
Commission Processing Service. 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. 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, many of the Company's travel agency customers are
not obligated by any long-term 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.
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 in the hotel
and GDS industries continue. There can be no assurance that any potential
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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.
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.
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,
NetBooker and other Internet based 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.
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 natural disasters, 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
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interruptions in the Company's operations could have a material adverse effect
on the Company's financial condition and results of operations.
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.
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
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. 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.
GOVERNMENT REGULATION. The Company's primary customers are hotel chains and
hotel representation firms. The Company currently has as its stockholders many
of the leading hotel chains in the world based on 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.
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.
There
-8-
<PAGE> 10
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.
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
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.
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.
RISKS ASSOCIATED WITH POTENTIAL ACQUISITIONS. While the Company has no current
agreements or negotiations underway with respect to any potential acquisitions,
-9-
<PAGE> 11
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.
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, other participants in the travel industry have announced that
their software may experience such abnormalities unless significant resources
are devoted to the problem. 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.
ANTI-TAKEOVER MATTERS. The Company's Second Amended and Restated Certificate of
Incorporation ("Certificate") and Second Amended and Restated By-laws
("By-laws") contain provisions that may have the effect of 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.
POTENTIAL VOLATILITY OF STOCK 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.
ITEM 2. 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 current office in England expires in May 1998. The Company
expects to move its England office during the second quarter of 1998 to another
leased facility consisting of approximately 2,200 square feet. The Company has
signed a lease agreement for the new office space in England, which extends
through February 2006. Under an agreement with REZsolutions, Inc. certain of the
equipment owned by the Company is housed at a site owned by REZsolutions, Inc.
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.
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<PAGE> 12
ITEM 3. 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.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
No matter was submitted to a vote of the Company's stockholders during
the fourth quarter of fiscal 1997.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
The Company's Common Stock has traded on the Nasdaq National Market
under the symbol "PEGS" since August 7, 1997. At February 28, 1998, there were
approximately 26 record holders of the Company's Common Stock, although the
Company believes that the number of beneficial owners of its Common Stock is
substantially greater. The table below sets forth for the fiscal quarters
indicated the high and low sale prices for the Common Stock.
<TABLE>
<CAPTION>
HIGH LOW
---- ---
<S> <C> <C>
Fiscal 1997
Fourth quarter................................... $20.75 $12.50
Third quarter (from August 7, 1997).............. $19.25 $15.50
</TABLE>
The Company intends to retain any future earnings for use in its
business and does not intend to pay cash dividends in the foreseeable future.
The payment of future dividends, if any, will be at the discretion of the
Company's Board of Directors and will depend, among other things, upon future
earnings, operations, capital requirements, restrictions in future financing
agreements, the general financial condition of the Company and general business
conditions.
The following information relates to all securities issued or sold by
the Company within the past three years and not registered under the Securities
Act.
Effective in July 1995, the Company issued 4,934,667 shares of Common
Stock in exchange for all of the outstanding capital stock of The Hotel Industry
Switch Company ("THISCO") and 83.3% of the outstanding capital stock of The
Hotel Clearing Corporation ("HCC") (the "Reorganization") in accordance with
Section 4(2) of the Securities Act of 1933, as amended (the "Securities Act").
In connection with the Reorganization, the Company granted to Lodging Network,
Inc. ("LNI") an option (the "LNI Option") to exchange the remaining 16.7% of
capital stock of HCC, which was held by LNI, for 448,667 shares of the Company's
Common Stock. In addition, certain members of HCC management agreed to forfeit
their rights to participate in a special HCC bonus plan in return for a cash
payment and the opportunity to purchase an aggregate of 283,333 shares of Common
Stock for $570,874. These shares were issued in accordance with Section 4(2) of
the Securities Act.
In June 1996, the Company issued to Information Associates, L.P. and
Information Associates, C.V. an aggregate of 1,538,462 shares of Series A
Preferred Stock for $4.88 per share in accordance with Section 4(2) of the
Securities Act. In June 1996, the Company issued in accordance with Section 4(2)
of the Securities Act 89,733 shares of the Common Stock and paid $2.0 million to
LNI for the remaining outstanding capital stock of HCC held by LNI, and in
connection therewith, the LNI Option was cancelled. In May 1997, the Company
issued in accordance with Section 4(2) of the Securities Act warrants to
purchase 345,723 shares of the Common Stock to Holiday Inn in connection with
the Distribution Services Agreement between the Company and Holiday Inn.
In June 1996, the Company adopted its 1996 Stock Option Plan, and the
Company has issued to participants in such plan under Section 4(2) of the
Securities Act and Rule 701 of the Securities Act options to purchase an
aggregate
-11-
<PAGE> 13
of 771,740 shares of Common Stock. A Registration Statement on Form S-8
covering the 1996 Stock Option Plan has been filed with the Securities and
Exchange Commission (the "Commission").
In August 1997, the Company completed the initial public offering of
its Common Stock (the "IPO"). The Commission declared the Registration Statement
(File No. 333-28595) relating to the IPO effective on August 6, 1997. In the
IPO, the Company issued and sold 3,450,000 shares for an aggregate price to the
public of $44,850,000 and certain selling stockholders sold 659,000 shares of
Common Stock for an aggregate offering price of $8,567,000. The IPO was a firm
commitment underwriting, and the managing underwriters of the IPO were Hambrecht
& Quist LLC, NationsBanc Montgomery Securities LLC and Volpe Brown Whelan &
Company, LLC. The underwriting discount incurred by the Company relating to the
IPO was $3,139,500, and as of December 31, 1997 other expenses incurred by the
Company relating to the IPO were approximately $1.2 million. Net offering
proceeds received by the Company from the IPO were approximately $40.5 million.
Approximately $5.2 million of the proceeds received by the Company from the IPO
were used to repay certain loans to stockholders and to repay certain lease
obligations. Certain of the Company's current directors, including William C.
Hammett, Jr., I. Malcolm Highet, Paul J. Travers, Mark C. Wells and Bruce Wolff,
serve as officers or directors or both of certain of the stockholders whose
loans were repaid. Pending final application, the Company has invested the
proceeds received by it from the IPO (other than the proceeds used to repay the
stockholder loans described above) in short term marketable securities.
ITEM 6. SELECTED FINANCIAL DATA.
This information is set forth under the caption "Selected Consolidated
Financial Data" for each of the five years in the period ended December 31,
1997, of the Company's 1997 Annual Report to Stockholders, which portion of such
Annual Report is filed herein as Exhibit 13.1 and incorporated herein by
reference.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS.
This information is set forth under the caption "Management's
Discussion and Analysis" of the Company's 1997 Annual Report to Stockholders,
which portion of such Annual Report is filed herein as Exhibit 13.1 and
incorporated herein by reference.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not Applicable.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
The financial statements of the Company including the independent
accountant's report thereon of the Company's 1997 Annual Report to Stockholders,
which financial statements are filed herein as Exhibit 13.1, are incorporated
herein by reference.
ITEM 9. DISAGREEMENTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.
Not Applicable.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
The information set forth under the captions "Election of Directors"
and "Executive Officers of the Company" of the Company's definitive Proxy
Statement for the Company's 1998 Annual Meeting of Stockholders is incorporated
herein by reference.
-12-
<PAGE> 14
ITEM 11. EXECUTIVE COMPENSATION.
The information set forth under the caption "Executive Compensation and
Other Matters" of the Company's definitive Proxy Statement for the Company's
1998 Annual Meeting of Stockholders is incorporated herein by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT.
The information set forth under the caption "Outstanding Capital Stock
and Stock Ownership of Directors, Certain Executive Officers and Principal
Stockholders" of the Company's definitive Proxy Statement for the Company's 1998
Annual Meeting of Stockholders is incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS.
The information set forth under the caption "Certain Transactions" of
the Company's definitive Proxy Statement for the Company's 1998 Annual Meeting
of Stockholders is incorporated herein by reference.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K.
<TABLE>
<S> <C>
(a) 1. The following financial statements are incorporated by
reference from the Company's 1997 Annual Report to
Stockholders, which financial statements are filed herein as
Exhibit 13.1:
Report of Independent Accountants.
Consolidated Balance Sheets dated December
31, 1997 and 1996.
Consolidated Statements of Operations for the
three years ended December 31, 1997.
Consolidated Statements of Changes in Shareholders'
Equity (Deficit) for the three years ended
December 31, 1997.
Consolidated Statements of Cash Flows for the three years
ended December 31, 1997.
Notes to Consolidated Financial Statements.
</TABLE>
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
2. Consolidated Financial Statement Schedule
Report of Independent Accountants on Financial Statement Schedule. S-1
Consolidated Valuation and Qualifying Accounts. S-2
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchange Commission
are not required under the related instructions or are
inapplicable and therefore have been omitted.
3. The following documents are filed or incorporated by reference as
exhibits to this Report:
2.1 Contribution and Restructuring Agreement dated effective as of
July 21, 1995 by and among the Company and all of the stockholders
of the Company
3.1 Second Amended and Restated Certificate of Incorporation
3.2 Second Amended and Restated Bylaws
4.1 Specimen of Common Stock Certificate
4.2 Second Amended and Restated Certificate of Incorporation and
Second Amended and Restated Bylaws (see Exhibits 3.1 and 3.2)
4.3 Rights Agreement dated June 25, 1996 by and among the
Company and certain holders of capital stock of the Company
named therein
4.4 Common Stock Purchase Warrant issued to Holiday Hospitality
Corporation
</TABLE>
-13-
<PAGE> 15
<TABLE>
<S> <C>
*10.1 Employment Agreement dated June 25, 1996 between the
Company and John F. Davis, III
*10.2 Employment Agreement dated June 25, 1996 between the Company and
Joseph W. Nicholson
*10.3 Employment Agreement dated August 29, 1996 between the Company and
Jerome L. Galant
*10.4 Employment Agreement dated May 18, 1997 between the Company and
Michael R. Donahue
*10.5 1996 Stock Option Plan, as amended (incorporated by reference to
Exhibit 99.1 of Registration Statement on Form S-8 (File No. 333-
40039) filed with the Commission on November 12, 1997)
*10.6 1997 Stock Option Plan, as amended (incorporated by reference
to Exhibit 99.1 of Registration Statement on Form S-8 (File No.
333-40033) filed with the Commission on November 12, 1997)
10.7 Client Service Agreement, as amended, between the Company and
Citibank, N.A.
10.8 Facilities Management Agreement dated January 1,
1996 between the Company and Anasazi, Inc., currently known as
REZsolutions, Inc.
10.9 Service Agreement dated December 13, 1996 between the Company and
Comdisco, Inc.
10.10 Service Agreement dated January 17, 1997 between the Company and
Genuity, Inc.
*10.11 1997 Employee Stock Purchase Plan (incorporated by reference to
Exhibit 99.1 of Registration Statement on Form S-8 (File No.
333-40035) filed with the Commission on November 12, 1997)
10.13 Office Lease dated October 1, 1995 between the Company and the
Utah State Retirement Investment fund relating to property
located at 3811 Turtle Creek Blvd., Suite 1100, Dallas, Texas
75219
+13.1 Selected portions of the Company's Annual Report to Stockholders
for fiscal year ended December 31, 1997
16.1 Letter regarding Change in Certifying Accountant
21.1 Subsidiaries of the Company (incorporated by reference to the
Company's Registration Statement on Form S-1 (Registration No.
333-44927))
+23.1 Consent of Price Waterhouse LLP
+23.2 Consent of Belew Averitt LLP
+24.1 Power of Attorney (included on signature page)
+27.1 Financial Data Schedule
</TABLE>
- ----------------
Unless otherwise indicated, exhibits are incorporated by reference to the
Company's Registration Statement (File No. 333-28595) on Form S-1 declared
effective by the Commission on August 6, 1997.
+ Filed herewith.
* Management contract or compensatory plan or arrangement. The Company
will furnish a copy of any exhibit listed above to any shareholder without
charge upon written request to Mr. Ric L. Floyd, Secretary, 3811 Turtle Creek
Blvd., Suite 1100, Dallas, Texas 75219.
(b) No reports on Form 8-K were filed during the last quarter of the period
covered by this Report.
-14-
<PAGE> 16
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Company has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized, in the City of
Dallas, State of Texas, on this 31st day of March, 1998.
PEGASUS SYSTEMS, INC.
By: /s/ JOHN F. DAVIS, III
-----------------------------------------------
John F. Davis, III
Chief Executive Officer, President and Director
POWER OF ATTORNEY
KNOW ALL MEN AND WOMEN BY THESE PRESENTS that each person whose
signature appears below constitutes and appoints John F. Davis, III, Jerome L.
Galant and Ric L. Floyd, and each of them, such individual's true and lawful
attorneys-in-fact and agents, with full power of substitution and
resubstitution, for such individual and in his or her name, place and stead, in
any and all capacities, to sign any and all amendments to this Report, with all
exhibits thereto, and to file the same with all exhibits thereto, and all
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises as fully and to intents and
purposes as he might or could do in person, hereby ratifying and confirming all
that said attorneys-in-fact and agents, or any of them, or their substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
<TABLE>
<CAPTION>
SIGNATURES TITLE DATE
---------- ----- ----
<S> <C> <C>
/s/ JOHN F. DAVIS, III Chief Executive Officer, March 31, 1998
------------------------------- President and Director
John F. Davis, III (Principal Executive Officer)
/s/ JEROME L. GALANT Chief Financial Officer March 31, 1998
------------------------------- (Principal Financial and
Jerome L. Galant Accounting Officer)
/s/ JOHN W. BIGGS Director March 31, 1998
-------------------------------
John W. Biggs
/s/ DONALD R. DIXON Director March 31, 1998
-------------------------------
Donald R. Dixon
/s/ WILLIAM C. HAMMETT, JR. Director March 31, 1998
-------------------------------
William C. Hammett, Jr.
/s/ IAN MALCOLM HIGHET Director March 31, 1998
-------------------------------
Ian Malcolm Highet
/s/ ROCKWELL A. SCHNABEL Director March 31, 1998
-------------------------------
Rockwell A. Schnabel
/s/ PAUL J. TRAVERS Director March 31, 1998
-------------------------------
Paul J. Travers
/s/ MARK C. WELLS Director March 31, 1998
-------------------------------
Mark C. Wells
/s/ BRUCE WOLFF Director March 31, 1998
-------------------------------
Bruce Wolff
</TABLE>
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<PAGE> 17
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors
of Pegasus Systems, Inc.
Our audits of the consolidated financial statements referred to in our
report dated March 12, 1998 appearing in the 1997 Annual Report to Shareholders
of Pegasus Systems, Inc. (which report and consolidated financial statements are
incorporated by reference in this Annual Report on Form 10-K) also included an
audit of the Financial Statement Schedule, for the years ended December 31,
1996 and 1997, listed in Item 14(a) of this Form 10-K. In our opinion, this
Financial Statement Schedule presents fairly, in all material respects, the
information set forth therein when read in conjunction with the related
consolidated financial statements.
PRICE WATERHOUSE LLP
Dallas, Texas
March 12, 1998
To the Board of Directors
of Pegasus Systems, Inc.
Our audit of the consolidated financial statements referred to in our report
dated March 2, 1996, except for Note 8, as to which the date is August 6, 1997
and Note 15, as to which the date is January 26, 1998 appearing in the 1997
Annual Report to Shareholders of Pegasus, Systems, Inc. (which report and
consolidated financial statements are incorporated by reference in this Annual
Report on Form 10-K) also included an audit of the Financial Statement
Schedule, for the year ended December 31, 1995, listed under Item 14(a) of this
Form 10-K. In our opinion, this Financial Statement Schedule, when considered
in relation to the consolidated financial statements taken as a whole, presents
fairly, in all material respects, the information stated therein.
BELEW AVERITT LLP
Dallas, Texas
March 2, 1996
S-1
<PAGE> 18
SCHEDULE II
PEGASUS SYSTEMS, INC.
VALUATION AND QUALIFYING ACCOUNTS
For the years ended December 31, 1995, 1996 and 1997
(In thousands)
<TABLE>
<CAPTION>
Additions Additions
Balance at Charged to from Balance
Beginning Costs and Acquired at End
Classification of Period Expenses Companies Deduction of Period
-------------- ----------- ----------- --------- --------- ---------
<S> <C> <C> <C> <C> <C>
December 31, 1995
Allowance for doubtful accounts $ -- $ 20 $ -- $ -- $ 20
Income tax valuation allowances $ 2,532 $ 289 $ 707 $ -- $ 3,528
------- ------- ----- ------ -------
Total reserves and allowances $ 2,532 $ 309 $ 707 $ -- $ 3,548
======= ======= ===== ====== =======
December 31, 1996
Allowance for doubtful accounts $ 20 $ 25 $ -- $ -- $ 45
Income tax valuation allowances $ 3,528 $ 1,060 $ -- $ (39) $ 4,549
------- ------- ----- ------ -------
Total reserves and allowances $ 3,548 $ 1,085 $ -- $ (39) $ 4,594
======= ======= ===== ====== =======
December 31, 1997
Allowance for doubtful accounts $ 45 $ 81 $ -- $ (48) $ 78
Income tax valuation allowances $ 4,549 $ -- $ -- $ (237) $ 4,312
------- ------- ----- ------ -------
Total reserves and allowances $ 4,594 $ 81 $ -- $ (285) $ 4,390
======= ======= ===== ====== =======
</TABLE>
- ----------------
(a) This schedule should be read in conjunction with the Company's audited
consolidated financial statements and related notes thereto.
S-2
<PAGE> 19
EXHIBIT INDEX
<TABLE>
<S> <C>
2.1 Contribution and restructuring Agreement dated effective as
of July 21, 1995 by and among the Company and all of the
stockholders of the Company
3.1 Second Amended and Restated Certificate of Incorporation
3.2 Second Amended and Restated Bylaws
4.1 Specimen of Common Stock Certificate
4.2 Second Amended and Restated Certificate of Incorporation
and Second Amended and Restated Bylaws (see Exhibits 3.1
and 3.2)
4.3 Rights Agreement dated June 25, 1996 by and among the
Company and certain holders of capital stock of the Company
named therein
4.4 Common Stock Purchase Warrant issued to Holiday Hospitality
Corporation
*10.1 Employment Agreement dated June 25, 1996 between the
Company and John F. Davis, III
*10.2 Employment Agreement dated June 25, 1996 between the
Company and Joseph W. Nicholson
*10.3 Employment Agreement dated August 29, 1996 between the
Company and Jerome L. Galant
*10.4 Employment Agreement dated May 18, 1997 between the
Company and Michael R. Donahue
*10.5 1996 Stock Option Plan, as amended (incorporated by reference to Exhibit 99.1 of Registration Statement on Form
S-8 (File No. 333-40039) filed with the Commission on November 12, 1997)
*10.6 1997 Stock Option Plan, as amended (incorporated by reference to Exhibit 99.1 of Registration Statement on Form
S-8 (File No. 333-40033) filed with the Commission on November 12, 1997)
10.7 Client Service Agreement, as amended, between the Company
and Citibank, N.A.
10.8 Facilities Management Agreement dated January 1, 1996
between the Company and Anasazi, Inc., currently known as
REZsolutions, Inc.
10.9 Service Agreement dated December 13, 1996 between the
Company and Comdisco, Inc.
10.10 Service Agreement dated January 17, 1997 between the
Company and Genuity, Inc.
*10.11 1997 Employee Stock Purchase Plan (incorporated by reference
to Exhibit 99.1 of Registration Statement on Form S-8 (File
No. 333-40035) filed with the Commission on November 12,
1997)
10.13 Office Lease dated October 1, 1995 between the Company and
the Utah State Retirement Investment fund relating to
property located at 3811 Turtle Creek Blvd., Suite 1100,
Dallas, Texas 75219
+13.1 Selected portions of the Company's Annual Report to
Stockholders for fiscal year ended December 31, 1997
16.1 Letter regarding Change in Certifying Accountant
21.1 Subsidiaries of the Company (incorporated by reference to
the Company's Registration Statement on Form S-1
(Registration No. 333-44927))
+23.1 Consent of Price Waterhouse LLP
+23.2 Consent of Belew Averitt LLP
+24.1 Power of Attorney (included on signature page)
+27.1 Financial Data Schedule
</TABLE>
Unless otherwise indicated, exhibits are incorporated by reference to the
Company's Registration Statement (File No. 333-28595) on Form S-1 declared
effective by the Commission on August 6, 1997.
+ Filed herewith.
* Management contract or compensatory plan or arrangement. The Company
will furnish a copy of any exhibit listed above to any shareholder without
charge upon written request to Mr. Ric L. Floyd, Secretary, 3811 Turtle Creek
Blvd., Suite 1100, Dallas, Texas 75219.
<PAGE> 1
EXHIBIT 13.1
Pegasus Systems Inc.
Selected Consolidated Financial Data(1)
The following selected consolidated financial data as of and for the years
ended December 31, 1997 and 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 Annual Report. The
selected consolidated financial data for the year ended December 31, 1995 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
Annual Report. The selected consolidated financial data as of December 31, 1995
and as of and for the years ended December 31, 1994 and 1993 are derived from
the Company's financial statements that have been audited by Belew Averitt LLP,
but are not included herein. The data should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and with the Company's Consolidated Financial Statements and Notes
thereto.
<TABLE>
<CAPTION>
(in thousands, except per share data) 1997 1996 1995 1994 1993
---- ---- ---- ---- ----
<S> <C> <C> <C> <C> <C>
Net revenues $20,903 $15,869 $ 9,296 $ 4,666 $ 3,938
Net income (loss) 589 (3,485) (3,571) (423) (398)
Net income (loss) per share:(2)
Basic 0.08 (0.66) (1.30) (0.56) (0.52)
Diluted 0.07 (0.66) (1.30) (0.56) (0.52)
Working capital (deficit) 38,397 2,068 (1,560) (844) (126)
Total assets 49,923 13,892 10,316 4,150 4,872
Long-term obligations,
net of current portion 661 6,353 6,994 4,718 6,224
Total stockholders' equity (deficit) $43,478 $ 1,954 $(2,380) $ (2,649) $(2,226)
</TABLE>
<PAGE> 2
(1) The Company's selected consolidated financial data for 1994 and 1993
consist of the accounts of THISCO. Selected consolidated financial 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
$1,534,044, $1,412,499 and $645,419 in 1997, 1996 and 1995 respectively. See
Notes 1, 2 and 3 of Notes to Consolidated Financial Statements.
(2) See Notes 1 and 15 of Notes to Consolidated Financial Statements for
information concerning the calculation of basic and diluted net income (loss)
per share. Such calculations reflect the adoption by the Company of Statement
of Financial Accounting Standards No. 128, "Earnings per Share" (FAS 128) for
the year ended December 31, 1997, which requires restatement of all periods
presented in the Company's Consolidated Financial Statements included herein.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Recently Issued Accounting Standards."
Management's Discussion and Analysis
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 Annual Report. This
Annual Report 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 in the
Company's filings with the Securities and Exchange Commission, including its
Form 10-K for the fiscal year ended December 31, 1997.
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
<PAGE> 3
Company has derived a majority of its revenues from its THISCO and HCC
services. For the year ended December 31, 1997, approximately 47.2% of the
Company's consolidated revenues was derived from its electronic hotel
reservation processing services, including 41.0% from the THISCO service and
6.2% from the TravelWeb and NetBooker services, and approximately 52.8% 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 49.6% to $20.9 million in 1997 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.
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 onetime setup 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. In the
third quarter of 1997, the Company reduced 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 fluctuations of the average
<PAGE> 4
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 amounts recognized in 1997 and
1996 were approximately $471,000 and $431,000, respectively. 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 transitioned its fee
structure to begin charging participating hotels subscription fees based on the
number of their properties included in the database and booking fees based on
the number of net reservations made at their properties through the TravelWeb
service. The Company is changing the method it uses to calculate booking fees
for the use of its TravelWeb service from a flat fee to a fee based on the rate
of the hotel room reserved. There can be no assurance that the fees generated
from the TravelWeb service will remain at the same or a higher level in the
future. Any significant decrease in the amount of fees received for the
TravelWeb service could 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 developed or is in the process of developing several new
services, including UltraRes, UltraDirect and Pegasus IQ, 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,
<PAGE> 5
by charging hotels transaction-based fees for net reservations. The Company has
not received a material amount of revenues from these services and there can be
no assurance that either of these services will produce a material amount of
revenues in the future. 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 and there can be no assurances that any of
these services will produce a material amount of revenues in the future.
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. Marketing and promotion expenses consist primarily of personnel costs,
advertising, public relations and participation in trade shows and other
industry events. Depreciation and amortization expense includes: (i) computer
equipment depreciation; (ii) office furniture, equipment and leasehold
improvement depreciation; (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 the net income for
1997 by approximately $142,000 and to increase the net loss for 1996 by
approximately $292,000. See Note 1 of Notes to Consolidated Financial
Statements.
Year 2000 Compliance.
The Company has implemented a program designed to ensure that all software used
in connection with the Company's services will
<PAGE> 6
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, other participants in the travel industry have
announced that their software may experience such abnormalities unless
significant resources are devoted to solving the problem. 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.
Years Ended December 31, 1997 and 1996
Net revenues.
The Company's net revenues for 1997 increased to $20.9 million from $15.9
million in 1996, an increase of 31.7%. This increase in revenues was primarily
driven by higher transactions levels for all of the Company's services
including THISCO, HCC and TravelWeb. THISCO revenues increased as a result of a
25.7% increase in net reservations made in 1997 as compared to 1996. HCC
revenues grew as a result of a 38.0% increase in hotel commission transactions
processed during 1997 as compared to 1996, due in part, to the addition of
hotel properties, including those of Marriott International, Inc., and travel
agencies participating in the HCC service. The net revenues to the Company per
commissionable transaction increased in 1997 because of an increase in overall
hotel average daily rates. Revenues contributed by the TravelWeb service
decreased by 7.7% in 1997 as compared to 1996. This decrease resulted primarily
as a result of the transition from a reliance on Web page building and
maintenance fees to revenues based on monthly subscription fees and booking
fees per net reservation.
Cost of Services.
Cost of services increased by $1.2 million, or 20.1%, to $7.4 million in 1997
from $6.2 million in 1996. Cost of services increased due to additional
staffing in support of the Thisco, TravelWeb and HCC services and the increased
number of transactions processed through the HCC service.
Research and Development; write-off of purchased in-process research and
development. Research and development expenses increased $298,000, or 13.5%, to
$2.5 million in 1997 from $2.2 million in 1996. After eliminating the effect of
the one-time charge taken in 1996 for research and development expenses
relating to the acquisition of HCC, research and development expenses increased
$543,000, or 27.7%, to $2.5 million in 1997 from $2.0 million in 1996. This
increase was primarily due to additional work on TravelWeb including the
development of the hotel database. See Note 3 of Notes to Consolidated
Financial Statements.
General and administrative expenses.
General and administrative expenses decreased $84,000, or 2.2%, to $3.7 million
in 1997 from $3.8 million in 1996. This
<PAGE> 7
decrease was primarily due to a number of non-recurring expenses incurred in
1996 associated with the closing of a financial transaction.
Marketing and promotion expenses.
Marketing and promotion expenses increased $1.2 million, or 41.5%, to $4.0
million in 1997 from $2.8 million in 1996. Marketing and promotion expenses
grew primarily due to the addition of Sales and Marketing staff, 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 $409,000, or 11.9%, to $3.0
million in 1997 from $3.4 million in 1996. This decrease was primarily due to
the completion in 1996 of the amortization of a number of software development
projects that had been previously capitalized.
Interest expense.
Interest expense decreased $293,000, or 32.8%, to $600,000 in 1997. The expense
reflects interest accrued on promissory notes payable to certain stockholders
of the Company and payments made under capital equipment leases. The Company
repaid all of these promissory notes in August 1997 using proceeds from its
initial public offering of common stock.
Interest income.
During 1997, the Company realized $994,000 in interest income as a result of
short term investment of operating cash balances, including the net proceeds of
its initial public offering.
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, 1996 and 1995
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. 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
<PAGE> 8
and less significantly from advertising and promotions and from fees charged to
hotels for net reservations processed through the TravelWeb service. In 1997,
Pegasus transitioned 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.
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 onetime
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. See
Note 3 of Notes to Consolidated Financial Statements.
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 expenses 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 certain capitalized software from five years to three years.
The effect of this change was to increase amortization 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
<PAGE> 9
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.
Liquidity and Capital Resources
The Company has financed its cash requirements for operations and investments
in equipment primarily through the sale of capital stock, borrowings from
stockholders and capital lease financing.
Cash provided by operating activities was $2.8 million for the year ended
December 31, 1997 compared to $410,000 in 1996 due to the Company's improved
operating performance.
The Company completed an initial public offering of its common stock in August
1997, raising proceeds, net of offering expenses, of $40.5 million.
Approximately $5.2 million of these proceeds was used to repay notes payable to
stockholders and to repay certain lease obligations. The remainder of these
proceeds have been placed in short-term marketable securities.
Net cash used in investing activities for the purchase of software, furniture
and equipment amounted to $1.6 million in 1997 compared to $495,000 in 1996. In
addition, in 1997 the Company acquired equipment under capital leases with a
principal value of $79,000 compared with $1.0 million in 1996.
The Company's principal sources of liquidity at December 31,1997 included cash
and cash equivalents of $30.2 million, short-term investments of $9.4 million
and restricted cash of $1.3 million, which represents funds for travel agency
commission checks that have not cleared HCC's processing bank and are returned
to HCC. See Note 1 of Notes to Consolidated Financial Statements. Any
<PAGE> 10
of such amounts which are not remitted to travel agents will be escheated to
the appropriate state, as required.
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.
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, 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 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
adopted FAS 128 as of and for the year ended December 31, 1997.
In June 1997, Statement of Financial Accounting Standards No. 130, "Reporting
Comprehensive Income" (FAS 130) was issued. FAS 130 establishes standards for
reporting and display of comprehensive income and its components (revenues,
expenses, gains, and losses) in a full set of general-purpose financial
statements. It requires all items that are required to be recognized under
accounting standards as components of comprehensive income be reported in a
financial statement that is displayed with the same prominence as other
financial statements. FAS 130 is effective for fiscal years beginning after
December 15, 1997. The Company will adopt this Statement in the year ending
December 31, 1998. Reclassification of financial statements for earlier
periods provided for comparative purposes is required upon adoption.
In June 1997, Statement of Financial Accounting Standards No. 131, "Disclosure
About Segments of an Enterprise and Related Information" (FAS 131) was issued.
FAS 131 establishes standards for the way that public business enterprises
report information about operating segments in annual financial statements and
requires that those enterprises report selected information about operating
segments in interim financial reports issued to shareholders. FAS 131 is
effective for periods beginning after December 15, 1997. The Company will adopt
FAS 131 in the year ending December 31, 1998.
<PAGE> 11
Consolidated Balance Sheets
<TABLE>
<CAPTION>
December 31, 1997 and 1996 1997 1996
---- ----
<S> <C> <C>
Assets
Cash and cash equivalents $30,166,793 $ 1,796,311
Restricted cash 1,286,032 690,206
Short-term investments 9,380,050 2,705,076
Accounts receivable, net of allowance for doubtful accounts
of $77,860 and $44,805, respectively 1,200,162 924,951
Accounts receivable from affiliates 771,973 754,405
Other current assets 1,232,874 190,976
Total current assets 44,037,884 7,061,925
Capitalized software, net 1,183,453 2,113,758
Property and equipment, net 2,712,091 3,001,012
Goodwill, net of accumulated amortization of
$303,815 and $178,943, respectively 1,560,900 1,685,772
Other noncurrent assets 428,981 29,269
Total assets $49,923,309 $ 13,891,736
Liabilities and Shareholders' Equity
Accounts payable and accrued liabilities $ 4,072,919 $ 2,574,186
Accounts payable to affiliates 42,118 115,049
Unearned income 477,688 470,588
Current portion of capital lease obligations 1,048,179 1,048,238
Current portion of notes payable to affiliates - 785,517
Total current liabilities 5,640,904 4,993,578
Capital lease obligations, net of current portion 661,049 1,749,899
Notes payable to affiliates, net of current portion - 4,603,568
Unearned income - 470,588
Other noncurrent liabilities 143,612 119,709
Commitments and contingencies (Note 11) - -
Shareholders' equity:
Preferred stock, $.01 par value; 2,000,000 shares authorized;
Zero and 1,538,462 shares issued and outstanding, respectively - 15,385
Common stock, $.01 par value; 100,000,000 shares authorized,
10,297,529 and 5,307,733 shares issued, respectively 102,975 53,077
Additional paid-in capital 58,120,337 16,968,364
Unearned compensation (738,533) (485,937)
Accumulated deficit (13,980,697) (14,570,157)
Less treasury stock (116,484 shares, at cost) (26,338) (26,338)
Total shareholders' equity 43,477,744 1,954,394
Total liabilities and shareholders' equity $49,923,309 $ 13,891,736
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 12
Consolidated Statements of Operations
<TABLE>
<CAPTION>
Years Ended December 31, 1997, 1996 and 1995 1997 1996 1995
----------- ----------- -----------
<S> <C> <C> <C>
Net revenues (Notes 1 and 14):
Shareholder $15,744,011 $11,961,445 $ 7,386,111
Nonshareholder 5,159,405 3,907,567 1,909,617
Total net revenues 20,903,416 15,869,012 9,295,728
Cost of services 7,445,271 6,199,058 3,882,496
Research and development 2,504,074 1,961,055 839,588
Write-off of purchased in-process research and
development (Note 3) - 244,600 1,223,000
General and administrative expenses 3,715,547 3,799,199 2,770,474
Marketing and promotion expenses 3,998,054 2,824,633 912,230
Depreciation and amortization 3,016,619 3,425,678 2,476,812
Operating income (loss) 223,851 (2,585,211) (2,808,872)
Other (income) expense:
Interest expense 600,067 893,177 815,560
Interest income (993,592) (114,150) -
Income (loss) before income taxes
and minority interest 617,376 (3,364,238) (3,624,432)
Income taxes 27,916 15,000 -
Income (loss) before minority interest 589,460 (3,379,238) (3,624,432)
Minority interest - (105,563) 53,528
Net income (loss) $ 589,460 $(3,484,801) $(3,570,904)
Net income (loss) per share:
Basic $ 0.08 $ (0.66) $ (1.30)
Diluted $ 0.07 $ (0.66) $ (1.30)
Weighted average shares outstanding:
Basic 7,200,382 5,246,800 2,751,940
Diluted 8,676,052 5,246,800 2,751,940
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 13
Consolidated Statements of Changes
in Shareholders' Equity (Deficit)
<TABLE>
<CAPTION>
Additional
Preferred Common Paid-in Unearned
Years Ended December 31, 1997, 1996 and 1995 Stock Stock Capital Compensation
<S> <C> <C> <C> <C>
Balance of THISCO at December 31, 1994 - $7,620 $4,857,478 -
Conversion of shareholder loans - - 525,000 -
Exchange of THISCO shares for Pegasus shares - (7,620) 7,620 -
Formation of Pegasus - 26,919 (26,919) -
Acquisition of HCC - 22,428 2,721,749 -
Issuance of restricted shares to management - 2,833 568,041 -
Net loss - - - -
Balance at December 31, 1995 - 52,180 8,652,969 -
Issuance of Pegasus preferred stock to
Information Associates, L.P. and
Information Associates, C.V. $ 15,385 - 7,484,620 -
Issuance of Pegasus common stock for
purchase of minority interest - 897 277,725 -
Purchase of treasury stock - - - -
Issuance of compensatory stock options - - 551,150 $(485,937)
Proceeds from stock subscription - - 1,900 -
Net loss - - - -
Balance at December 31, 1996 15,385 53,077 16,968,364 (485,937)
Conversion of preferred stock to
common stock (15,385) 15,385 - -
Initial public offering - 34,500 40,459,000 -
Warrants issued for contract - - 238,000 -
Issuance of compensatory stock options - - 450,847 (252,596)
Exercise of stock options - 13 4,126 -
Net income - - - -
Balance at December 31, 1997 $ - $102,975 $58,120,337 $(738,533)
</TABLE>
<TABLE>
<CAPTION>
Treasury Accumulated
Years Ended December 31, 1997, 1996 and 1995 Stock Deficit Total
<S> <C> <C> <C>
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) - (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 (26,338) (14,570,157) 1,954,394
Conversion of preferred stock to
common stock - - -
Initial public offering - - 40,493,500
Warrants issued for contract - - 238,000
Issuance of compensatory stock options - - 198,251
Exercise of stock options - - 4,139
Net income - 589,460 589,460
Balance at December 31, 1997 $(26,338) $(13,980,697) $43,477,744
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 14
Consolidated Statements of Cash Flows
<TABLE>
<CAPTION>
Years Ended December 31, 1997, 1996 and 1995 1997 1996 1995
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss) $ 589,460 $(3,484,801) $(3,570,904)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Minority interest - 105,563 (53,528)
Accrued interest reclassified to notes payable 58,049 91,927 298,699
Loss on write-down of equipment - - 246,000
Write off of in-process research and development costs - 244,600 1,223,000
Adjustment for discontinued software projects - 316,698 -
Loss (gain) on sale of equipment (53) 9,564 (14,553)
Depreciation and amortization 3,016,619 3,425,678 2,476,812
Recognition of stock option compensation 198,251 65,213 -
Amortization of premiums on short-term investments 3,359 - -
Changes in assets and liabilities:
Restricted cash (595,826) (360,029) (157,307)
Accounts receivable (275,212) (185,455) (182,998)
Accounts receivable from affiliates (17,567) (98,649) 80,785
Other current and noncurrent assets (1,203,609) (156,931) (24,032)
Accounts payable and accrued liabilities 1,498,732 837,620 586,483
Accounts payable to affiliates (72,931) (89,139) (202,230)
Unearned income (463,488) (431,373) (210,036)
Other noncurrent liabilities 23,904 119,709 -
Net cash provided by operating activities 2,759,688 410,195 496,191
Cash flows from investing activities:
Purchase of software, property and equipment (1,594,401) (495,100) (639,461)
Proceeds from sale of software, property and equipment 1,075 133,134 -
Purchase of marketable securities (11,486,932) (2,705,076) -
Proceeds from sale of marketable securities 4,808,599 - -
Net cash used in investing activities (8,271,659) (3,067,042) (639,461)
Cash flows from financing activities:
Proceeds from issuance of stock 40,497,639 7,500,005 570,874
Purchase of minority interest - (2,000,000) -
Repayments on notes payable to affiliates (5,447,133) (235,000) (103,337)
Repayments of capital leases (1,171,966) (974,969) (578,271)
Proceeds from capital leases 3,913 93,729 -
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) -
Net cash provided (used) by financing activities 33,882,453 4,359,327 (110,734)
Net increase (decrease) in cash and cash equivalents 28,370,482 1,702,480 (254,004)
Cash and cash equivalents, beginning year 1,796,311 93,831 347,835
Cash and cash equivalents, end of year $ 30,166,793 $ 1,796,311 $93,831
Supplemental disclosure of cash flow information:
Interest paid $ 601,787 $ 858,017 $ 706,842
Income taxes paid $ 17,916 $ - $ -
Supplemental schedule of noncash investing and
financing activities:
Acquisition of equipment under capital leases $ 79,144 $ 1,045,988 $ 2,083,365
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) $ - $ 278,622 $ 2,744,177
Common stock warrants issued in exchange for customer
contract asset $ 238,000 $ - $ -
</TABLE>
See accompanying notes to consolidated financial statements.
<PAGE> 15
Notes to Consolidated Financial Statements
December 31, 1997, 1996 and 1995
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. For accounting purposes, the combination was recorded as a purchase
of HCC, as discussed in Note 3.
Consolidation
The consolidated financial statements for 1995 reflect the consolidated balance
sheets of THISCO and HCC at December 31, 1995 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
<PAGE> 16
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 or Pegasus). 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.
<PAGE> 17
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, 1997 and 1996, the classification of the securities
accounted for under FAS 115, was as follows:
<TABLE>
<CAPTION>
Amortized cost
-----------------------------
1997 1996
---------- -----------
<S> <C> <C>
Held to maturity:
Corporate debt $9,380,050 $ 992,621
U.S. government agencies - $ 1,712,455
$9,380,050 $ 2,705,076
</TABLE>
As of December 31, 1997 and 1996, the aggregate fair market value of the
held-to-maturity securities was not materially different from their carrying
values. 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.
Capitalized software
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. Additionally, capitalized software includes software purchased from
third parties used in the operations of the Company.
<PAGE> 18
Prior to 1996, capitalized software costs were being amortized over three to
five years using the straight-line method. However, in 1996, the Company
changed the estimated life of all capitalized software costs to three years.
The effect of this change was to increase the net income during 1997 by
approximately $142,000 or $0.02 basic and diluted income per share and increase
the net loss during 1996 by approximately $292,000 or $0.06 basic and diluted
loss per share. During 1996, the Company recorded a charge of $316,698
resulting from discontinued software development projects. During 1997, 1996
and 1995, the Company capitalized approximately $505,000, $470,000 and
$3,840,000, respectively, of software costs. During 1997, 1996 and 1995, the
Company amortized approximately $1,435,000, $2,125,000 and $1,532,000,
respectively, of capitalized software costs. Accumulated amortization of
capitalized software was $8,174,389 and $6,739,465 at December 31, 1997 and
1996, respectively.
Property and equipment
Property and equipment are recorded at cost and depreciated over their
estimated useful lives, ranging from three to seven years. Leasehold
improvements are amortized over the life of the lease using the straight-line
method. Expenditures for maintenance and repairs, as well as minor renewals,
are charged to operations as incurred; while, betterments and major renewals
are capitalized. 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.
Long-lived assets held and used by the Company, or to be disposed of, are
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
is 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,
1997 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,
1997 and 1996, was $1,560,900 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, 1997 or 1996. Amortization of goodwill was
$124,872, $120,724 and $58,219 in 1997, 1996 and 1995, respectively.
<PAGE> 19
Revenues
The Company primarily derives its revenues from transaction fees and
commissions charged to participating hotels and travel agencies. A substantial
portion of the Company's 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.
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 compensate for the management and consolidation of multiple interfaces
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 non-cancelable 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 1997 and 1996 was
approximately $471,000 and $431,000, respectively (See Note 11). For the years
ended December 31, 1997 and 1996 and the period from acquisition to December
31, 1995, HCC revenues from hotels are presented net of commission payments to
travel agencies of approximately $165,000,000, $105,000,000, and $39,820,000
respectively.
<PAGE> 20
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 transitioned 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. TravelWeb revenues declined by approximately $108,000 from
1996 to 1997 after this change. 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.
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.
Advertising costs
Advertising and promotion-related expenses are charged to operations when
incurred. Advertising expense for 1997, 1996 and 1995 was approximately
$609,000, $613,000 and $173,000, respectively.
Financial instruments
The carrying amounts of the Company's financial instruments reflected in the
consolidated balance sheets at December 31, 1997 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. Therefore, management considers the exposure from
concentrations of credit risks to be limited.
<PAGE> 21
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 issued to employees 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
income (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 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 Company's
initial public offering (IPO) (see Note 8). Concurrent with the IPO, the number
of authorized shares of common stock of the Company increased from 20 million
to 100 million while the number of authorized shares of preferred stock
remained 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.
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.
Net income (loss) per share
The Company has adopted Statement of Financial Accounting Standards No. 128,
"Earnings per Share" (FAS 128). FAS 128 simplifies the standards for computing
EPS previously found in Accounting Principles Board No. 15, "Earnings per
Share" (APB 15), and makes them comparable to international EPS standards by
replacing the presentation of primary EPS with a presentation of basic EPS. The
provisions and disclosure requirements for FAS 128 were required to be adopted
for interim and annual periods ending after December 15, 1997, with restatement
of EPS for prior
<PAGE> 22
periods. Accordingly, EPS data for all periods presented has been restated to
reflect the computation of EPS in accordance with the provisions of FAS 128.
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 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).
<PAGE> 23
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 of approximately $2,744,000 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 of HCC after the date of the Acquisition are included in
the 1995 Consolidated Statement of Operations. Assuming the Acquisition took
place at January 1, 1995, the pro forma net revenues would have been
approximately $11,455,000, and the pro forma net loss would have been
approximately $4,071,000. The pro forma information for 1995 includes
adjustments for additional amortization based on the fair market value of the
<PAGE> 24
acquired software and the goodwill arising from the transaction. 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.
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, 1997 and 1996, trade accounts
receivable were stated net of commissions of $14,309,063 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>
1997 1996
------ ------
<S> <C> <C>
Amounts due to THISCO from hotel chains $551,685 $702,612
Amounts due to TravelWeb from hotel chains 173,591 11,152
Amounts due to HCC from hotel chains 37,744 34,606
Employee travel advances 8,953 6,035
Accounts receivable from affiliates $771,973 $754,405
</TABLE>
5. Property and Equipment
Property and equipment at December 31 consisted of the following:
<TABLE>
<CAPTION>
1997 1996
------ ------
<S> <C> <C>
Computer equipment $ 4,985,455 $ 4,261,482
Furniture and equipment 677,183 640,507
Office equipment 974,851 712,245
Leasehold improvements 97,379 93,777
6,734,868 5,708,011
Less: accumulated depreciation (4,022,777) (2,706,999)
Property and equipment, net $ 2,712,091 $ 3,001,012
</TABLE>
<PAGE> 25
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 net income during 1997 by $36,000,
increase the net loss during 1996 by $72,000 and to decrease the net loss
during 1995 by approximately $108,000.
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 written down to the estimated salvage value of approximately $20,000.
Total assets recorded under capital leases in 1997 and 1996 were approximately
$3,747,000 and $3,829,000, respectively, net of accumulated amortization of
$2,531,000 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:
Year Ending December 31,
<TABLE>
<S> <C>
1998 $ 1,193,469
1999 635,214
2000 58,631
Aggregate minimum lease payments 1,887,314
Less: amount representing interest (178,086)
1,709,228
Less current portion (1,048,179)
$ 661,049
</TABLE>
Interest rates on capital leases range from approximately 7% to 15%. Interest
expense on capital leases for the years ended December 31, 1997, 1996 and 1995
was approximately $277,000, $351,000 and $238,000, respectively.
<PAGE> 26
7. Notes Payable to Affiliates
Notes payable to affiliates at December 31, 1996 consisted of the following:
<TABLE>
<CAPTION>
1996
----
<S> <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 $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) 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) 573,129
5,389,085
Less current portion (785,517)
$4,603,568
</TABLE>
In August 1997, the Company repaid all outstanding principal and accrued
interest of the notes payable from the proceeds of the Company's initial public
offering (see Note 8). Total principal and interest paid during 1997 was
$5,253,662 and $456,932, respectively. During 1996, the Company paid interest
totaling $478,000. Interest expense related to these notes was approximately
$322,000, $539,000 and $578,000 during the years ended December 31, 1997, 1996
and 1995, respectively.
In July 1995, simultaneous with the acquisition of HCC, 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
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
<PAGE> 27
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 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.
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 (See
Note 1). 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.
In June 1996, Information Associates, L.P. and Information Associates, C.V.
purchased 1,538,462 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. 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.
<PAGE> 28
The Company completed an initial public offering (IPO) in August 1997. The
Company's Registration Statement on Form S-1 (File No. 333-28595) with respect
to the IPO was declared effective on August 6, 1997, and the Company's stock
began trading on the Nasdaq National Market under the symbol PEGS on August 7,
1997. The Company sold 3,450,000 shares of common stock at a per share price of
$13.00. Net proceeds to the Company, after deduction of the underwriting
discount and estimated IPO expenses, were approximately $40.5 million. Selling
shareholders also sold 659,000 shares at a per share price of $13.00. Net
proceeds to the shareholders after deduction of the underwriting discount were
approximately $8.0 million. The Company did not receive any proceeds from the
sale of shares by the selling shareholders. Concurrent with the completion of
the Company's IPO, a 4-for-3 split of the Company's outstanding common and
Series A preferred stock was effected (See Note 1) and all outstanding shares
of Series A preferred stock were converted into shares of common stock.
9. Stock-Based Compensation
The Company's 1996 stock option plan, as amended and restated, was approved by
the board of directors and the shareholders in March 1997 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 771,740 shares of
common stock. These options will become exercisable over a period of four
years. In September 1997, options to purchase 44,000 shares of common stock at
an exercise price of $15.30 were issued under the 1996 plan to executives and
employees. The options will become exercisable over a period of four years.
The Company's 1997 stock option plan was approved by the board of directors and
shareholders in March 1997 and authorizes the issuance of up to 333,333 shares
of the Company's common stock in the form of ISO's and nonqualified stock
options to employees of the Company. The board of directors amended the 1997
stock option plan in September 1997, subject to shareholder approval which is
expected to occur at the 1998 annual shareholders meeting, to provide for the
annual grant to the Company's non-employee directors of options to purchase the
Company's common stock. In September 1997, options to purchase an aggregate of
203,000 shares of common stock at an exercise price of $15.30 were issued under
the 1997 plan to executives and employees. Also, options to
<PAGE> 29
purchase an aggregate of 16,000 shares of common stock at the same exercise
price of $15.30 were issued under the 1997 plan to non-employee directors. The
executive and employee options will become exercisable over a period of four
years. The non-employee director options will become exercisable at the 1998
annual shareholders meeting, which is a period of approximately eight months
from the date of grant.
The Company has accounted for options issued in 1997 and 1996 under the 1997
and 1996 plans, using the intrinsic value method prescribed in APB 25.
Accordingly, unearned compensation related to the options is being recognized
ratably over the related vesting periods
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, in 1997 and 1996 unearned compensation of $450,847 and $551,150,
respectively, 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
$198,251 and $65,213 was charged to operations in 1997 and 1996, respectively.
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 1997 and 1996 consistent
with the provisions of FAS 123, the Company's net income (loss) and net income
(loss) per share would have been increased to the pro forma amounts indicated
below:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Net income (loss) - as reported $589,460 $(3,484,801)
Net income (loss) - pro forma $334,589 $(3,511,531)
Net income (loss) per share - as reported:
Basic $0.08 $(0.66)
Diluted $0.07 $(0.66)
Net income (loss) per share - as adjusted
for pro forma impact of FAS 123:
Basic $0.05 $(0.67)
Diluted $0.04 $(0.67)
</TABLE>
The weighted average fair value at date of grant for options granted during
1997 and 1996 was $8.51 and $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:
<PAGE> 30
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Dividend yield -- --
Expected volatility:
Pre-IPO grants 0.0% 0.0%
Post-IPO grants 65.0% --
Risk-free rate of return 6.1% 6.5%
Expected life 4.9 years 4.0 years
</TABLE>
The following table summarizes activity under the Company's stock option plans
during the years ended December 31, 1997 and 1996:
<TABLE>
<CAPTION>
Weighted
Average
Price
Options Exercise Price Per Share
------- -------------- ---------
<S> <C> <C> <C>
Outstanding at December 31, 1995 -- -- --
Granted 771,740 $2.01 - $3.11 $2.39
Canceled -- -- --
Outstanding at December 31, 1996 771,740 $2.01 - $3.11 $2.39
Granted 331,666 $5.25 - $15.30 $13.49
Exercised 1,333 $3.11 $3.11
Canceled 19,795 $3.11 - $15.30 $4.34
Outstanding at December 31, 1997 1,082,278 $2.01 - $15.30 $5.75
Options exercisable at December 31, 1997 263,434 $2.01 - $3.11 $2.33
</TABLE>
<TABLE>
<CAPTION>
Options
Outstanding at Remaining
Exercise Prices December 31, 1997 Contractual Life
- --------------- ----------------- ----------------
<C> <C> <C>
$ 2.01 503,333 8.0 years
$ 3.11 249,279 8.0 years
$ 5.25 53,333 8.0 years
$11.05 - $15.30 276,333 8.8 years
</TABLE>
<PAGE> 31
10. Income Taxes
Pretax income (loss) from continuing operations for the years ended December 31
was taxed under the following jurisdictions:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Domestic $ 519,459 $(3,528,503) $(3,527,122)
Foreign 97,917 58,702 (43,782)
----------- ----------- -----------
$ 617,376 $(3,469,801) $(3,570,904)
</TABLE>
Deferred taxes consisted of the following at December 31:
<TABLE>
<CAPTION>
1997 1996
---- ----
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforward $ 4,214,785 $ 4,975,949
Bad debt reserves 26,473 15,234
Depreciation and amortization -- 1,896
Stock option compensation expense 81,873 22,172
Rent expense 82,552 37,213
Various expense accruals 42,160 53,793
Other 10,801 2,164
Total gross deferred tax assets 4,458,644 5,108,421
Valuation allowance (4,312,266) (4,549,452)
Deferred tax liabilities:
Software amortization (79,850) (558,969)
Depreciation and amortization (66,528) --
Net deferred tax asset $ -- $ --
</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, 1997, 1996 and 1995, the Company had net operating loss
carryforwards of approximately $12,396,000, $14,635,000, and $13,162,000,
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>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Current provision:
Federal $ 51,525 $ -- $ --
Foreign 27,916 15,000 --
79,441 15,000 --
Deferred provision (benefit):
Federal (51,525) -- --
Provision for income taxes $ 27,916 $15,000 $ --
</TABLE>
<PAGE> 32
A reconciliation of taxes based on the federal statutory rate of 34.0% and the
Company's effective rate for income taxes is summarized as follows for the
years ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Income taxes (benefit) at the
federal statutory rate 34.0% (34.0%) (34.0%)
Valuation allowance (38.4%) 29.4% 19.8%
Permanent differences 9.8% 5.1% 14.3%
Other, net (0.9%) (0.5%) (0.1%)
Provision for income taxes 4.5% 0.0% 0.0%
</TABLE>
11. Commitments and Contingencies
The Company leases its corporate office space and certain office equipment
under non-cancelable operating leases. The Company incurred rent expense of
approximately $720,000, $697,000 and $318,000 in 1997, 1996 and 1995,
respectively.
Approximate future minimum lease payments at December 31, 1997, under
non-cancelable operating leases with original terms exceeding one year,
including the Pegasus UK operating lease translated at the rate in effect at
December 31, 1997, were as follows:
<TABLE>
<C> <C>
Year Ending December 31,
1998 $ 612,000
1999 579,000
2000 557,000
2001 557,000
2002 552,000
Thereafter --
$2,857,000
</TABLE>
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. 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 1997, 1996 and
1995, the Company recognized approximately $471,000, $431,000 and $210,000,
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 1997 and 1996, the Company exceeded the annual minimum volume
requirement.
<PAGE> 33
In May 1997, the Company issued a warrant to a customer for the purchase of
345,723 shares of the Company's common stock as part of a five year contract
involving a wide range of the Company's services. The warrant is exercisable
during the two year period ended May 12, 1999 at an exercise price of $7.20 per
share. The Company used the Black-Scholes option pricing model to value the
warrant. A contract asset of $238,000 was recorded in May 1997, which is
amortized ratably over the associated five year contract period.
12. Employee Benefit Plan
The Company sponsors a 401(k) defined contribution retirement plan (401(k)
Plan) covering full-time employees who have attained the age of twenty-one.
Employees may elect to participate at the beginning of any calendar quarter
after their hire date.
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 1997, 1996 and 1995, the Company contributed approximately $217,000,
$160,000 and $101,000, 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 $18,000 in
1995.
13. Employee Stock Purchase Plan
In September 1997, the Company's Board of Directors adopted the Pegasus
Systems, Inc. 1997 Employee Stock Purchase Plan subject to shareholder
approval, which is expected to occur at the 1998 annual meeting of the
Company's shareholders. The Company has reserved 500,000 shares of its common
stock for purchase by its employees pursuant to the terms of this plan.
Eligible participating employees of the Company may elect to have an amount up
to, but not in excess of, 10% of their regular salary or wages withheld for the
purpose of purchasing the Company's common stock. Under the 1997 Employee Stock
Purchase Plan, an eligible employee who participates in the Plan will be
granted an option at the beginning of each year of the Plan (the "Offering
Commencement Date") to purchase at the end of that year (the "Offering
Termination Date") shares of common stock using the amounts that have
accumulated from the employee's payroll deductions made during that year at a
price that is 85% of the closing price of the common stock on the Nasdaq
National Market (or any other national securities exchange) on the Offering
Commencement Date or the Offering Termination Date, whichever is lower.
<PAGE> 34
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>
1997 1996 1995
----------------------- ----------------------- ----------------------
Source of Revenue Amount % Amount % Amount %
----------- ----- ----------- ----- ---------- -----
<S> <C> <C> <C> <C> <C> <C>
Shareholders - direct $7,428,143 35.5% $6,458,380 40.7% $4,935,785 53.1%
Shareholders - indirect 8,315,868 39.8% 5,503,065 34.7% 2,450,326 26.4%
Total generated by shareholders
directly and indirectly 15,744,011 75.3% 11,961,445 75.4% 7,386,111 79.5%
All other revenue 5,159,405 24.7% 3,907,567 24.6% 1,909,617 20.5%
Total $20,903,416 100.0% $15,869,012 100.0% $9,295,728 100.0%
</TABLE>
A shareholder provides services to the Company, including facility management,
consulting and software development. During 1997, 1996 and 1995, the Company
recognized expense in the amount of approximately $488,000, $774,000 and
$495,000, respectively, for those services.
Persons related to an officer of the Company have provided printing, design and
procurement services to the Company. During 1997, 1996 and 1995, the Company
paid approximately $6,000, $143,000 and $48,000, respectively, relating to
these services, the majority of which related to capitalized furniture
purchases.
15. Net Income (Loss) 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 is
effective for financial statements issued for periods ending after December 15,
1997, including interim periods; earlier application was not permitted. Once
adopted, FAS 128 requires restatement of all prior-period EPS data presented.
Basic net
<PAGE> 35
income (loss) per share for the years ended December 31, 1997, 1996 and 1995
has been computed in accordance with FAS 128 using the weighted average number
of common shares outstanding after giving retroactive effect to the stock
splits effected in August 1997 and June 1996.
Diluted net income per share for the year ended December 31, 1997 and diluted
net loss per share for the years ended December 31, 1996 and 1995 give effect
to all dilutive potential common shares that were outstanding during the
periods. The Company has a net income for the year ended December 31, 1997;
therefore, all options or warrants outstanding throughout the year were
included in the diluted net income per share calculations when they were
dilutive. The Company had a net loss for the years ended December 31, 1996 and
1995; therefore, none of the options outstanding at period ends were included
in the diluted net loss per share calculations for years ended December 31,
1996 and 1995, since they were anti-dilutive.
The following table sets forth the basic and diluted net income (loss) per
share computation for the year ended December 31:
<TABLE>
<CAPTION>
1997 1996 1995
---- ---- ----
<S> <C> <C> <C>
Net income (loss) $ 589,640 $(3,484,801) $(3,570,904)
Basic:
Weighted average number of shares outstanding 7,200,382 5,246,800 2,751,940
Net income (loss) per share $ 0.08 $ (0.66) $ (1.30)
Diluted:
Weighted average number of shares outstanding 7,200,382 5,246,800 2,751,940
Additional weighted average shares from assumed conversion
of dilutive convertible preferred stock to common stock,
net of shares to be repurchased with exercise proceeds 921,355 -- --
Additional weighted average shares from assumed exercise
of dilutive stock options and warrants, net of shares to be
repurchased with exercise proceeds 554,315 -- --
Weighted average number of shares outstanding used in
the diluted net income (loss) per share calculation 8,676,052 5,246,800 2,751,940
Net income (loss) per share $ 0.07 $ (0.66) $ (1.30)
</TABLE>
There were no options or warrants outstanding at December 31, 1995. There were
1,538,462 shares of Series A preferred stock outstanding at December 31, 1996
which were not included in the computation of diluted EPS. None of the options
<PAGE> 36
granted during 1997 or 1996 were excluded from the diluted EPS calculation for
the year ended December 31, 1997, as the average fair market value used in the
period calculations was higher than the strike price of the underlying options
or warrants. Options granted during 1996, which were not included in the
computation of diluted EPS for the year ended December 31, 1996, were as
follows:
<TABLE>
<CAPTION>
Exercise Price
Number of Options Per Share Date of Grant Expiration Date
- ----------------- --------- ------------- ---------------
<C> <C> <C> <C>
450,000 $2.01 June 1996 December 2005
53,333 $2.01 December 1996 December 2005
268,400 $3.11 December 1996 December 2005
</TABLE>
16. Subsequent Events
The Company completed a secondary offering ("Secondary") in February 1998. The
Company's Registration Statement on Form S-1 with respect to the Secondary was
declared effective February 11, 1998. The Company sold 280,321 shares of common
stock at a per share price of $17.50. Net proceeds to the Company, after
deduction of the underwriting discount and estimated Secondary expenses, were
approximately $4.2 million. Selling shareholders also sold 2,134,679 shares at
a per share price of $17.50. Net proceeds to the shareholders, after deduction
of the underwriting discount, were approximately $35.2 million. The Company did
not receive any proceeds from the sale of shares by the selling shareholders.
<PAGE> 37
Reports of Independent Accountants
To the Board of Directors and Shareholders of Pegasus Systems, Inc.
In our opinion, the accompanying consolidated balance sheets 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, 1997 and 1996, and the results of their operations and their cash flows for
the two years ended December 31, 1997, 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 audits. We conducted our audits 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 audits provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
Dallas, Texas
March 12, 1998
<PAGE> 38
To the Board of Directors and Shareholders of Pegasus Systems, Inc.
We have audited the accompanying consolidated statements of operations, changes
in shareholders' equity (deficit) and cash flows of Pegasus Systems, Inc. and
its subsidiaries (the Company) for the year ended December 31, 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 audit.
We conducted our audit 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 audit provides a reasonable basis for
our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the Company's results of operations and cash
flows for the year ended December 31, 1995 in conformity with generally
accepted accounting principles.
BELEW AVERITT LLP
Dallas, Texas
March 2, 1996, except for Note 8,
as to which the date is August 6, 1997
and Note 15, as to which the date is
January 26, 1998
<PAGE> 39
<PAGE> 1
EXHIBIT 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in this Annual Report on
Form 10-K of our report dated March 12, 1998, which appears in the 1997 Annual
Report to Shareholders of Pegasus Systems, Inc., which is incorporated by
reference in Pegasus Systems, Inc.'s Annual Report on Form 10-K for the year
ended December 31, 1997. We also consent to the incorporation by reference in
the Registration Statements on Form S-8 (Nos. 333-40039, 333-40033 and
333-40035) of Pegasus Systems, Inc. of our report dated March 12, 1998 appearing
in Pegasus System's Inc.'s 1997 Annual Report to Shareholders which is
incorporated by reference into Pegasus Systems, Inc.'s Annual Report on Form
10-K for the year ended December 31, 1997. We also consent to the incorporation
by reference of our report on the Financial Statement Schedule, which appears on
page S-1 of such Annual Report on Form 10-K.
PRICE WATERHOUSE LLP
Dallas, Texas
March 31, 1998
<PAGE> 1
EXHIBIT 23.2
CONSENT OF INDEPENDENT ACCOUNTANTS
We hereby consent to the incorporation by reference in this Annual Report (Form
10-K) of Pegasus Systems, Inc. of our report dated March 2, 1996, except for
Note 8, as to which the date is August 6, 1997 and Note 15, as to which the
date is January 26, 1998, included in the 1997 Annual Report to Shareholders of
Pegasus Systems, Inc. We also consent to the incorporation by reference of our
report on the Financial Statement Schedule, which appears on page S-1 of such
Annual Report on Form 10-K.
Belew Averitt LLP
Dallas, Texas
March 31, 1998
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
This schedule contains summary financial information extracted from Company's
form 10K for the year ended December 31, 1997 filed March 31, 1998 with
Securities and Exchange Commission and is qualified in its entirety by reference
to such 10K.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1997
<PERIOD-START> JAN-01-1997
<PERIOD-END> DEC-31-1997
<CASH> 31,453
<SECURITIES> 9,380
<RECEIVABLES> 2,050
<ALLOWANCES> 78
<INVENTORY> 0
<CURRENT-ASSETS> 44,038
<PP&E> 16,093
<DEPRECIATION> 12,197
<TOTAL-ASSETS> 49,923
<CURRENT-LIABILITIES> 5,641
<BONDS> 661
0
0
<COMMON> 103
<OTHER-SE> 43,375
<TOTAL-LIABILITY-AND-EQUITY> 49,923
<SALES> 0
<TOTAL-REVENUES> 20,903
<CGS> 0
<TOTAL-COSTS> 7,445
<OTHER-EXPENSES> 2,504
<LOSS-PROVISION> 81
<INTEREST-EXPENSE> 600
<INCOME-PRETAX> 617
<INCOME-TAX> 28
<INCOME-CONTINUING> 589
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 589
<EPS-PRIMARY> 0.08
<EPS-DILUTED> 0.07
</TABLE>
