<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
---------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___ TO ___
--------------------
Commission File Number 0-22935
PEGASUS SYSTEMS, INC.
(Exact Name of Registrant as specified in its charter)
DELAWARE 75-2605174
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
3811 TURTLE CREEK BOULEVARD, SUITE 1100, DALLAS, TEXAS 75219
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (214) 528-5656
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 [ ]
The number of shares of the registrant's common stock outstanding as of November
5, 1999 was 13,464,369.
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PEGASUS SYSTEMS, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 1999
INDEX
<TABLE>
<CAPTION>
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (unaudited)
PAGE
----
<S> <C>
a) Consolidated Balance Sheets
as of September 30, 1999 and December 31, 1998.......................3
b) Consolidated Statements of Operations
for the Three Months and Nine Months
Ended September 30, 1999 and 1998....................................4
c) Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 1999 and 1998................5
d) Notes to Consolidated Financial Statements................................6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations ......................................9
PART II. OTHER INFORMATION
Item 2. Changes in Securities and Use of Proceeds.....................................17
Item 6. Exhibits and Reports on Form 8-K..............................................17
SIGNATURES.....................................................................................18
</TABLE>
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PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
PEGASUS SYSTEMS, INC.
CONSOLIDATED BALANCE SHEETS
(UNAUDITED)
<TABLE>
<CAPTION>
SEPTEMBER 30, 1999 DECEMBER 31, 1998
------------------ -----------------
<S> <C> <C>
ASSETS
Cash and cash equivalents $ 88,234,679 $ 25,002,185
Restricted cash 2,440,593 2,106,676
Short-term investments 47,658,828 15,768,400
Accounts receivable, net 5,316,292 3,687,518
Other current assets 4,156,980 3,689,254
------------- -------------
Total current assets 147,807,372 50,254,033
Capitalized software, net 1,361,325 869,619
Property and equipment, net 3,704,811 2,635,068
Goodwill, net 3,906,312 4,238,071
Other noncurrent assets 2,345,581 2,323,620
------------- -------------
Total assets $ 159,125,401 $ 60,320,411
============= =============
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued liabilities $ 6,720,981 $ 4,715,018
Unearned income 818,423 258,667
Customer deposits 415,358 347,422
Current portion of capital lease obligations 119,335 535,072
------------- -------------
Total current liabilities 8,074,097 5,856,179
Other noncurrent liabilities 115,686 142,380
Capital lease obligations, net of current portion -- 57,634
Stockholders' equity:
Preferred stock, $.01 par value; 2,000,000 shares authorized;
zero shares issued and outstanding -- --
Common stock, $.01 par value; 50,000,000 shares authorized;
13,548,452 and 10,653,371 shares issued, respectively 135,484 106,533
Additional paid-in capital 154,261,031 63,383,905
Unearned compensation (334,058) (615,636)
Accumulated deficit (3,100,501) (8,584,246)
Less treasury stock (116,484 shares, at cost) (26,338) (26,338)
------------- -------------
Total stockholders' equity 150,935,618 54,264,218
------------- -------------
Total liabilities and stockholders' equity $ 159,125,401 $ 60,320,411
============= =============
</TABLE>
See accompanying notes to consolidated financial statements
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PEGASUS SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ------------------------------
1999 1998 1999 1998
------------ ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net revenues $ 10,074,763 $ 7,802,819 $ 27,635,790 $ 20,751,479
Cost of services 3,390,883 2,516,873 8,907,363 7,091,049
Research and development 657,969 741,272 1,887,572 1,966,738
Write-off of purchased in-process R&D -- 1,480,085 -- 1,480,085
General and administrative expenses 1,320,403 1,109,292 3,995,745 3,202,457
Marketing and promotion expenses 1,526,658 1,190,380 4,499,515 3,610,230
Depreciation and amortization 614,297 565,573 1,852,800 2,081,309
------------ ------------ ------------ ------------
Operating income 2,564,553 199,344 6,492,795 1,319,611
Other income (expense):
Interest income 1,579,013 632,136 3,241,254 1,929,184
Write-off of minority interest investment -- -- (1,100,110) --
Interest expense (7,381) (33,561) (36,612) (122,000)
------------ ------------ ------------ ------------
Income before income taxes 4,136,185 797,919 8,597,327 3,126,795
Income taxes 1,406,303 26,248 3,113,582 58,152
------------ ------------ ------------ ------------
Net income $ 2,729,882 $ 771,671 $ 5,483,745 $ 3,068,643
============ ============ ============ ============
Net income per share:
Basic $ 0.20 $ 0.07 $ 0.46 $ 0.29
============ ============ ============ ============
Diluted $ 0.20 $ 0.07 $ 0.43 $ 0.27
============ ============ ============ ============
Weighted average shares outstanding:
Basic 13,366,188 10,508,023 12,016,077 10,441,834
============ ============ ============ ============
Diluted 13,943,674 11,195,206 12,804,850 11,168,105
============ ============ ============ ============
</TABLE>
See accompanying notes to consolidated financial statements
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PEGASUS SYSTEMS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
<TABLE>
<CAPTION>
Nine Months Ended
September 30,
------------------------------
1999 1998
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 5,483,745 $ 3,068,643
Adjustments to reconcile net income to net cash from operating activities:
Windfall tax benefit from employee exercise of non-qualified stock options 2,573,150 281,692
Depreciation and amortization 1,852,800 2,081,309
Write-off of minority interest investment 1,100,110 --
Write-off of purchased in-process R & D -- 1,480,085
Recognition of stock option compensation 231,582 203,942
Amortization of premiums on short-term investments 64,807 17,816
Net loss on sales of property and equipment 13,260 4,821
Changes in assets and liabilities:
Restricted cash (333,917) (740,759)
Accounts receivable (1,628,774) (1,735,014)
Other current and noncurrent assets (1,489,687) (125,524)
Accounts payable and accrued liabilities 2,073,898 845,233
Unearned income 559,756 176,108
Other noncurrent liabilities (26,694) 17,928
------------ ------------
Net cash provided by operating activities 10,474,036 5,576,280
------------ ------------
Cash flows from investing activities:
Purchase of software, property and equipment (3,095,750) (1,268,726)
Purchase of marketable securities (54,536,121) (22,553,383)
Proceeds from maturity of marketable securities 22,580,886 19,763,985
Purchase of Driving Revenue L.L.C -- (5,998,366)
Purchase of minority interest investments (100,110) (1,500,000)
Proceeds from sale of property and equipment -- 29,887
------------ ------------
Net cash used in investing activities (35,151,095) (11,526,603)
------------ ------------
Cash flows from financing activities:
Net proceeds from issuance of stock 88,382,924 4,392,387
Repayment of capital leases (473,371) (850,166)
------------ ------------
Net cash provided by financing activities 87,909,553 3,542,221
------------ ------------
Net increase in cash and cash equivalents 63,232,494 (2,408,102)
Cash and cash equivalents, beginning of period 25,002,185 30,166,793
------------ ------------
Cash and cash equivalents, end of period $ 88,234,679 $ 27,758,691
============ ============
Supplemental disclosure of cash flow information:
Interest paid $ 25,944 $ 124,257
============ ============
Income taxes paid $ 140,288 $ 191,288
============ ============
</TABLE>
See accompanying notes to consolidated financial statements
5
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. BASIS OF PRESENTATION
In July 1995, Pegasus Systems, Inc. (Pegasus or the Company) was formed
as a Delaware holding company to combine the operations of two existing
companies operating in the same industry, The Hotel Industry Switch
Company (THISCO) and The Hotel Clearing Corporation (HCC). For accounting
purposes, the combination was recorded as a purchase of HCC.
The accompanying financial statements include the consolidated accounts
of Pegasus and its wholly owned subsidiaries, THISCO, HCC, Pegasus IQ,
Inc. (Pegasus IQ) and Driving Revenue L.L.C. (Driving Revenue)
(collectively, Pegasus or the Company). 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). All significant intercompany balances have been
eliminated in consolidation.
In the opinion of management, the unaudited consolidated financial
statements presented herein reflect all adjustments necessary to fairly
state the financial position, operating results and cash flows for the
periods presented. Such adjustments are of a normal recurring nature. The
results for interim periods are not necessarily indicative of results
expected for the entire fiscal year. The accompanying unaudited
consolidated financial statements and the notes thereto should be read in
conjunction with the consolidated financial statements and notes thereto
contained in our annual report for the year ended December 31, 1998 on
Form 10-K. Pegasus management believes that the disclosures are adequate
for interim financial reporting purposes.
2. EARNINGS PER SHARE
Basic net income per share for the three and nine months ended September
30, 1999 and 1998 has been computed in accordance with Statement of
Financial Accounting Standards No. 128, "Earnings per Share" (FAS 128)
using the weighted average number of common shares outstanding.
Diluted net income per share for the three and nine months ended
September 30, 1999 and 1998 gives effect to all dilutive potential common
shares that were outstanding during the respective periods. Outstanding
options and warrants with strike prices below the average fair market
value of Pegasus common stock for the three and nine months ended
September 30, 1999 and 1998 were included in the diluted earnings per
share (EPS) calculations for the respective periods. Options for 1,000
shares of Pegasus common stock at a strike price of $40.88 were excluded
from the diluted EPS calculation for the three months ended March 31,
1999 because they were antidilutive. Options for 6,000 shares of Pegasus
common stock at strike prices from $40.88 to $46.75 were excluded from
the diluted EPS calculation for the three months ended June 30, 1999
because they were antidilutive. Options for 71,000 shares of Pegasus
common stock at strike prices from $37.88 to $46.75 were excluded from
the diluted EPS calculation for the three months ended September 30, 1999
because they were antidilutive. The options excluded in 1999 expire from
December 2005 to September 2009. All outstanding options and warrants
were included in the diluted EPS calculation for the three and six months
ended June 30, 1998. Options for 54,000 shares of Pegasus
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common stock at strike prices from $19.44 to $22.74 were excluded from
the diluted EPS calculation for the three months ended September 30, 1998
because they were antidilutive. The options excluded in 1998 expire from
December 2005 to December 2006.
The following table sets forth the basic and diluted EPS computation for
the three and nine months ended September 30, 1999 and 1998:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-----------------------------------------------------------
1999 1998 1999 1998
----------- ----------- ----------- -----------
<S> <C> <C> <C> <C>
Net income $ 2,729,882 $ 771,671 $ 5,483,745 $ 3,068,643
=========== =========== =========== ===========
Basic:
Weighted average number of shares
outstanding 13,366,188 10,508,023 12,016,077 10,441,834
----------- ----------- ----------- -----------
Net income per share $ 0.20 $ 0.07 $ 0.46 $ 0.29
=========== =========== =========== ===========
Diluted:
Weighted average number of shares
outstanding 13,366,188 10,508,023 12,016,077 10,441,834
Additional weighted average shares
from assumed exercise of dilutive
stock options and warrants, net of
shares to be repurchased with exercise
proceeds 577,486 687,183 788,773 726,271
----------- ----------- ----------- -----------
Weighted average number of shares
outstanding used in the diluted net
income per share calculation 13,943,674 11,195,206 12,804,850 11,168,105
----------- ----------- ----------- -----------
Net income per share $ 0.20 $ 0.07 $ 0.43 $ 0.27
=========== =========== =========== ===========
</TABLE>
3. SEGMENT INFORMATION
In 1998, Pegasus adopted Statement of Financial Accounting Standards No.
131, "Disclosures about Segments of an Enterprise and Related
Information". The prior year's segment information has been restated to
present the Company's three reportable segments:
o Pegasus Electronic Distribution - provides services that enable
travel agents and individual travelers to electronically access
hotel room inventory information and conduct reservation
transactions;
o Pegasus Commission Processing - provides commission payment
processing services to the hotel industry and travel agencies; and
o Pegasus Business Intelligence - provides database marketing and
consulting services and is being expanded to provide data mining
and reporting services for benchmark analysis and strategic
planning for the hotel industry.
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Pegasus is organized primarily on the basis of services provided. Segment
data includes a charge allocating all corporate costs to the operating
segments. Management evaluates performance of its segments based on
pretax income.
The following table presents information about reported segments for the
three months ended September 30:
<TABLE>
<CAPTION>
Electronic Commission Business Reconciling
Distribution Processing Intelligence Items Total
------------ ---------- ------------- ----------- -----
<S> <C> <C> <C> <C> <C>
1999
Net revenues $ 4,860,996 $ 4,646,794 $ 566,973 $ -- $10,074,763
Depreciation and amortization 304,492 98,528 211,277 -- 614,297
Income (loss) before taxes 1,787,001 1,904,407 (1,067,466) 1,512,243 4,136,185
1998
Net revenues 3,302,538 4,142,894 357,387 -- 7,802,819
Depreciation and amortization 334,517 127,627 103,429 -- 565,573
Income (loss) before taxes 245,999 1,846,531 (1,884,337) 589,726 797,919
</TABLE>
The following table presents information about reported segments for the
nine months ended September 30:
<TABLE>
<CAPTION>
Electronic Commission Business Reconciling
Distribution Processing Intelligence Items Total
------------ ---------- ------------- ----------- -----
<S> <C> <C> <C> <C> <C>
1999
Net revenues $13,168,449 $13,056,684 $ 1,410,657 $ -- $27,635,790
Depreciation and amortization 953,948 287,404 611,448 -- 1,852,800
Income (loss) before taxes 3,977,166 5,692,575 (3,053,206) 1,980,792 8,597,327
1998
Net revenues 8,994,253 11,399,839 357,387 -- 20,751,479
Depreciation and amortization 886,442 1,079,033 155,834 -- 2,081,309
Income (loss) before taxes 229,113 3,420,704 (2,335,801) 1,812,779 3,126,795
</TABLE>
Reconciling items for the three and nine months ended September 30, 1999
and 1998 include interest income earned on short-term investments.
Reconciling items for the nine months ended September 30, 1999 also
include a write-off of the Company's investment in Intermezzo Systems,
Inc.
4. SECONDARY PUBLIC OFFERING
In May 1999, Pegasus completed a secondary public offering of common
stock. The effective date of the registration statement on Form S-3 was
May 6, 1999. Pegasus sold 2,300,000 shares of common stock at a price of
$38.88. After deducting the underwriters' discounts and offering
expenses, net proceeds to Pegasus were approximately $84.4 million.
5. MINORITY INTEREST INVESTMENT
In September 1998, Pegasus purchased a minority interest in Intermezzo
Systems, Inc., a developer of enterprise software solutions for the
hospitality industry. The Intermezzo Board of Directors elected to cease
operations in July 1999 and entered into an orderly plan of liquidation.
As a
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result, Pegasus wrote-off $1,100,110 in the second quarter representing
the Company's entire investment in Intermezzo.
6. STOCK WARRANT
In May 1999, a customer exercised a warrant to purchase 345,723 shares of
Pegasus common stock at $7.20 per share. The warrant was issued in May
1997 as part of a five-year contract involving a wide range of Pegasus
services. At issuance, Pegasus used the Black-Scholes option pricing
model to value the warrant, and a $238,000 contract asset was recorded.
The contract asset is being amortized ratably over the five-year contract
period.
7. RECENTLY ISSUED ACCOUNTING PRONOUNCEMENTS
In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position No. 98-1, "Accounting for the Costs of
Computer Software Developed or Obtained for Internal Use" (SOP 98-1). SOP
98-1 requires that certain costs related to the development or purchase
of internal-use software be capitalized and amortized over the estimated
useful life of the software. SOP 98-1 is effective for financial
statements for fiscal years beginning after December 15, 1998.
Accordingly, the Company adopted SOP 98-1 effective January 1, 1999.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (FAS 133). FAS 133 requires that all
derivative instruments be recorded on the balance sheet at fair value.
Changes in the fair value of derivatives are recorded each period in
current earnings or other comprehensive income, depending on whether the
derivative is designated as part of a hedge transaction. FAS 133, as
amended by Statement of Financial Accounting Standards No. 137,
"Accounting for Derivative Instruments and Hedging and Activities --
Deferral of Effective Date of FAS 133", is effective for the Company's
first quarter financial statements in fiscal 2001. Pegasus is not
currently involved in derivative instruments or hedging activities, and
therefore, will measure the impact of this statement as it becomes
necessary.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
FORWARD-LOOKING STATEMENTS
This Form 10-Q, including the following discussion, contains certain
forward-looking statements that involve risks and uncertainties. Actual results
and the timing of certain events could differ materially from those discussed in
the forward-looking statements as a result of certain factors, including those
set forth under the heading "Risk Factors" in our filings with the Securities
and Exchange Commission, including our Form 10-K for the fiscal year ended
December 31, 1998.
OVERVIEW
Pegasus is a leading provider of transaction processing and electronic commerce
services to the hotel industry worldwide. Pegasus is organized into three
businesses: Pegasus Electronic Distribution, Pegasus Commission Processing and
Pegasus Business Intelligence.
Pegasus Electronic Distribution. Pegasus Electronic Distribution includes our
GDS distribution service and Internet-based distribution services. These
services improve the efficiency and effectiveness of the
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hotel reservation process by enabling travel agents and individual travelers to
electronically access hotel room inventory information and conduct reservation
transactions.
Our GDS distribution service, formerly referred to as THISCO, provides an
electronic interface between hotel central reservation systems and the global
distribution systems that travel agents use to book hotel and airline
reservations. This interface enables the processing of hotel reservations as
well as the transmission of electronic status messages, which are used to update
room rates, features and availability information on global distribution system
databases.
Pegasus offers volume-based discounting for GDS distribution fees. The recent
consolidation in the hotel industry has resulted in a lower average fee per
transaction for our GDS distribution service. Pegasus expects this trend to
continue.
Our Internet-based distribution services provide online hotel reservation
capabilities to travelers via our TravelWeb.com website (www.travelweb.com) and
our private-label reservation service, formerly referred to as NetBooker. In
addition, Pegasus is developing services that will automate the hotel
reservation process for conventions and large meetings as well as for corporate
travel departments.
Pegasus Commission Processing. Pegasus Commission Processing, formerly referred
to as HCC, is the global leader in hotel commission payment processing. Pegasus
Commission Processing improves the efficiency and effectiveness of the
commission payment process for participating hotels and travel agencies by
consolidating payments and providing comprehensive transaction reports.
Pegasus Business Intelligence. Pegasus Business Intelligence, formerly referred
to as Pegasus IQ and Driving Revenue, provides database marketing and consulting
services and is being expanded to provide data mining and reporting services for
benchmark analysis and strategic planning for the hotel industry.
THREE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Net revenues. Net revenues for the three months ended September 30, 1999
increased to $10.1 million from $7.8 million for the three months ended
September 30, 1998, an increase of 29.1%. This increase in revenues was
primarily driven by higher transaction levels for Pegasus Electronic
Distribution and Pegasus Commission Processing as well as the acquisition of
Driving Revenue in August 1998, which provided the majority of Pegasus Business
Intelligence revenues for the three months ended September 30, 1999.
Pegasus Electronic Distribution revenues increased 47.2% for the three months
ended September 30, 1999 as compared to the same period in 1998. This increase
resulted primarily from a 16.4% increase in the number of hotel reservations
made through our GDS and Internet-based distribution services. Although GDS
revenue per transaction decreased as compared to the prior year quarter, total
electronic distribution revenue per transaction increased. The overall increase
in revenue per transaction was due to a higher percentage of Internet-based
transactions, which generate more revenue per transaction. An increase in
subscription fees, implementation fees, advertising and other non-transaction
related revenues also contributed to the increase in total revenues.
Pegasus Commission Processing revenues increased 12.2% for the three months
ended September 30, 1999 compared to the same period in 1998 as a result of a
22.8% increase in the number of hotel commission transactions processed. The
increase in the number of transactions was due in part to an increase in the
number of hotel properties and travel agencies participating in Pegasus
Commission
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Processing. The value of commissions paid by Pegasus increased 24.9% for the
three months ended September 30, 1999 as compared to the same period in 1998
because of an increase in the number of hotel commission transactions processed
combined with an increase in the average value of commissions processed. Net
revenues arising from the increase in commissions paid was somewhat offset by a
reduction in the average fee received from participating travel agencies for
consolidating and remitting hotel commission payments. Pegasus expects this
trend to continue.
Pegasus Business Intelligence revenues increased to $567,000 for the three
months ended September 30,1999 from $357,000 for the three months ended
September 30, 1998. The increase in business intelligence revenues was due to
the acquisition of Driving Revenue in August 1998. Pegasus Business Intelligence
revenues consisted of fees charged to hotels for the development and maintenance
of hotel databases and for consulting services.
Cost of services. Cost of services increased $874,000, or 34.7%, to $3.4 million
for the three months ended September 30, 1999 from $2.5 million for the same
period in 1998. Cost of services increased due to additional staffing primarily
related to new business intelligence services. In addition, we incurred costs
during the current quarter for enhancing our infrastructure. These enhancements
included upgrades to our e-mail and local and wide area networks.
Research and development. Research and development expenses decreased $83,000,
or 11.2%, to $658,000 for the three months ended September 30, 1999, from
$741,000 for the same period in 1998. The decrease is primarily due to the
completion of a major commission processing project in the third quarter of
1998. Current quarter research and development expenses were primarily related
to the development of business intelligence services.
Write-off of purchased in-process research and development. During the three
months ended September 30, 1998, Pegasus incurred a charge of $1.5 million to
write-off purchased in-process research and development related to the
acquisition of Driving Revenue L.L.C. in August 1998.
General and administrative expenses. General and administrative expenses
increased $211,000, or 19.0%, to $1.3 million for the three months ended
September 30, 1999 from $1.1 million for the same period in 1998. This increase
was primarily due to higher office costs including rent, telephone, travel and
supplies associated with increased headcount. In addition, accounting and legal
expenses increased as a result of additional reporting and consulting services
necessary due to increasingly complex tax, legal and reporting issues associated
with our growth over the past year.
Marketing and promotion expenses. Marketing and promotion expenses increased
$336,000, or 28.3%, to $1.5 million for the three months ended September 30,
1999 from $1.2 million for the same period in 1998. Marketing and promotion
expenses increased primarily due to the promotion of our commission processing
and new business intelligence services. An increase in the number of marketing
and sales personnel as well as recruiting and relocation costs related to hiring
new employees contributed to higher marketing costs for the current quarter.
Depreciation and amortization. Depreciation and amortization expenses increased
$49,000, or 8.6%, to $614,000 for the three months ended September 30, 1999 from
$566,000 for the same period in 1998. Depreciation and amortization increased
primarily due to additions to property and equipment and additional amortization
of goodwill and software related to the acquisition of Driving Revenue in August
1998. This increase was somewhat offset because goodwill and capitalized
software associated with the purchase accounting transaction that formed Pegasus
was fully amortized as of the beginning of the
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fourth quarter of 1998. In addition, the former computing platform for Pegasus
Electronic Distribution was fully depreciated and replaced earlier this fiscal
year with less expensive equipment resulting in lower depreciation expense.
Interest income. Interest income increased $947,000, or 149.8%, to $1.6 million
for the three months ended September 30, 1999 from $632,000 for the same period
in 1998. Interest income increased as Pegasus had additional cash available for
short-term investment as a result of our secondary public offering of common
stock in May 1999. The increase was partially offset by a decline in the
prevailing interest rate level for short-term investments combined with a shift
in our investment portfolio to include tax-exempt securities with lower pre-tax
yields.
Interest expense. Interest expense decreased $26,000, or 78%, to $7,000 for the
three months ended September 30, 1999 from $34,000 for the same period in 1998.
The expense reflects payments made under capital equipment leases, and the
decrease is due to the expiration of certain leases.
Income taxes. Income taxes for the three months ended September 30, 1999 reflect
federal, state and foreign income taxes payable. Income taxes for the three
months ended September 30, 1998 include only state and foreign income taxes
payable as the Company was able to realize the benefit of its federal net
operating loss carryforwards in 1998. The effective tax rate of approximately
34% for the three months ended September 30, 1999 decreased from the effective
tax rate of approximately 38% for the six months ended June 30, 1999. Beginning
in the third quarter of 1999, our marketable securities portfolio included
tax-exempt securities which reduced our effective tax rate.
NINE MONTHS ENDED SEPTEMBER 30, 1999 AND 1998
Net revenues. Net revenues for the nine months ended September 30, 1999
increased to $27.6 million from $20.8 million for the nine months ended
September 30, 1998, an increase of 33.2%. This increase in revenues was
primarily driven by higher transaction levels for Pegasus Electronic
Distribution and Pegasus Commission Processing as well as the acquisition of
Driving Revenue in August 1998, which provided the majority of Pegasus Business
Intelligence revenues for the nine months ended September 30, 1999.
Pegasus Electronic Distribution revenues increased 46.4% for the nine months
ended September 30, 1999 as compared to the same period in 1998. This increase
resulted primarily from an increase in the number of hotel reservations made
through our GDS and Internet-based distribution services. Although GDS revenue
per transaction decreased as compared to the prior year period, total electronic
distribution revenue per transaction increased. The overall increase in revenue
per transaction was due to a higher percentage of Internet-based transactions,
which generate more revenue per transaction. An increase in subscription fees,
implementation fees, advertising and other non-transaction related revenues also
contributed to the increase in total revenues.
Pegasus Commission Processing revenues increased 14.5% for the nine months ended
September 30, 1999 compared to the same period in 1998 as a result of a 18.9%
increase in the number of hotel commission transactions processed. The increase
in the number of transactions was due in part to an increase in the number of
hotel properties and travel agencies participating in Pegasus Commission
Processing. The value of commissions paid by Pegasus increased 22.1% for the
nine months ended September 30, 1999 as compared to the same period in 1998
because of an increase in the number of hotel commission transactions processed
combined with an increase in the average value of commissions processed. Net
revenues arising from the increase in commissions paid was somewhat offset by a
12
<PAGE> 13
reduction in the average fee received from participating travel agencies for
consolidating and remitting hotel commission payments. Pegasus expects this
trend to continue.
Pegasus Business Intelligence revenues increased $1.0 million to $1.4 million
for the nine months ended September 30,1999 from $357,000 for the same period in
1998. The increase was due to the acquisition of Driving Revenue in August 1998.
Pegasus Business Intelligence revenues consisted of fees charged to hotels for
the development and maintenance of hotel databases and for consulting services.
Cost of services. Cost of services increased by $1.8 million, or 25.6%, to $8.9
million for the nine months ended September 30, 1999 from $7.1 million for the
same period in 1998. Cost of services increased due to additional staffing
primarily related to new business intelligence services. In addition, we
incurred costs during the current period for enhancing our infrastructure. These
enhancements included upgrades to our e-mail and local and wide area networks.
This increase was partially offset by reduced costs associated with Pegasus
Commission Processing during the first two quarters of 1999 as certain functions
that were previously outsourced were brought in-house at a lower cost during the
third quarter of 1998.
Research and development. Research and development expenses were $1.9 million
for the nine months ended September 30, 1999 and 1998. Current period research
and development expenses were primarily related to the development of business
intelligence services while the prior year period included a major commission
processing project, which was completed in the third quarter of 1998.
Write-off of purchased in-process research and development. During the nine
months ended September 30, 1998, Pegasus incurred a charge of $1.5 million to
write-off purchased in-process research and development related to the
acquisition of Driving Revenue L.L.C. in August 1998.
General and administrative expenses. General and administrative expenses
increased $793,000, or 24.8%, to $4.0 million for the nine months ended
September 30, 1999 from $3.2 million for the same period in 1998. This increase
was primarily due to higher office costs including rent, telephone, travel and
supplies associated with increased headcount. Pegasus also launched a new
corporate identity and branding strategy during the first quarter of 1999, which
resulted in additional costs for the transition to our new company logo. In
addition, accounting and legal expenses increased as a result of additional
reporting and consulting services necessary due to increasingly complex tax,
legal and reporting issues associated with our growth over the past year.
Marketing and promotion expenses. Marketing and promotion expenses increased
$889,000, or 24.6%, to $4.5 million for the nine months ended September 30, 1999
from $3.6 million for the same period in 1998. Marketing and promotion expenses
increased primarily due to the promotion of our commission processing services,
our Internet-based distribution services and our new business intelligence
services. An increase in the number of marketing and sales personnel as well as
the related recruiting and relocation costs contributed to higher marketing
costs for the nine months ended September 30, 1999.
Depreciation and amortization. Depreciation and amortization expenses decreased
$229,000, or 11.0%, to $1.9 million for the nine months ended September 30, 1999
from $2.1 million for the same period in 1998. Depreciation and amortization
decreased primarily because goodwill and capitalized software associated with
the purchase accounting transaction that formed Pegasus was fully amortized as
of the beginning of the fourth quarter of 1998. In addition, the former
computing platform for Pegasus Electronic Distribution was fully depreciated and
replaced earlier this fiscal year with less expensive equipment resulting in
lower depreciation expense. This decrease was somewhat offset by additions to
13
<PAGE> 14
property and equipment and additional amortization of goodwill and software
related to the acquisition of Driving Revenue in August 1998.
Interest income. Interest income increased $1.3 million, or 68.0%, to $3.2
million for the nine months ended September 30, 1999 from $1.9 million for the
same period in 1998. Interest income increased as Pegasus had additional cash
available for short-term investment as a result of our secondary public offering
of common stock in May 1999. The increase was partially offset by a decline in
the prevailing interest rate level for short-term investments combined with a
shift in our investment portfolio to include tax-exempt securities with lower
pre-tax yields.
Interest expense. Interest expense decreased $85,000, or 70.0%, to $37,000 for
the nine months ended September 30, 1999 from $122,000 for the same period in
1998. The expense reflects payments made under capital equipment leases, and the
decrease is due to the expiration of certain leases.
Write-off of minority interest investment. In September 1998, Pegasus purchased
a minority interest in Intermezzo. The Intermezzo Board of Directors elected to
cease operations in July 1999 and entered into an orderly plan of liquidation.
Pegasus wrote-off $1.1 million in the second quarter of 1999 representing our
entire investment in Intermezzo.
Income taxes. Income taxes for the nine months ended September 30, 1999 reflect
federal, state and foreign income taxes payable. Income taxes for the nine
months ended September 30, 1998 include only state and foreign income taxes
payable as the Company was able to realize the benefit of its federal net
operating loss carryforwards in 1998. The effective tax rate of approximately
36% for nine months ended September 30, 1999 decreased from the effective tax
rate of approximately 38% for the six months ended June 30, 1999. Beginning in
the third quarter of 1999, our marketable securities portfolio included
tax-exempt securities which reduced our effective tax rate.
LIQUIDITY AND CAPITAL RESOURCES
Pegasus' principal sources of liquidity at September 30, 1999 included cash and
cash equivalents of $88.2 million, short-term investments of $47.7 million and
restricted cash of $2.4 million. Restricted cash represents funds for travel
agency commission checks that have not cleared the processing bank and are
returned to Pegasus. The portion of restricted cash amounts not remitted to
travel agents is escheated to the appropriate state, as required. Pegasus has
financed its cash requirements for investments primarily through cash generated
from operations, sale of capital stock and capital lease financing.
Working capital increased to $139.7 million at September 30, 1999 from $44.4
million at December 31, 1998. Cash provided by operating activities was $10.5
million for the nine months ended September 30, 1999 compared to $5.6 million
for the same period in 1998 due to our improved operating performance.
Capital expenditures consist of purchases of software, furniture and computer
equipment as well as internally developed software costs and were $3.1 million
for the nine months ended September 30, 1999 compared to $1.3 million for the
same period in 1998.
In May 1999, Pegasus completed a secondary public offering of common stock,
raising net proceeds of $84.4 million. Pegasus is currently using the net
proceeds from this offering for working capital and other general corporate
purposes, with the remaining amount placed in short-term investments. In
addition, Pegasus may use the net proceeds to acquire complementary businesses,
products, services or
14
<PAGE> 15
technologies. The Company from time to time discusses possible transactions
with third parties which, if agreed to and consummated, could be material to
Pegasus and its liquidity position. We expect such discussions to continue for
the foreseeable future although there can be no assurance that any such
discussions will result in any definitive agreement(s) or completed
transaction(s).
Pegasus has had extensive discussions with a private company to acquire the
company for a combination of cash, Pegasus common stock and debt in a
transaction that would be material to Pegasus and its liquidity position.
Pegasus expects to enter into a definitive agreement and announce the
transaction in the near future although there can be no assurance that such an
agreement will be reached. Except for the impact of this transaction, Pegasus
believes that its existing cash and liquidity position combined with expected
operating cash flows are sufficient to adequately manage the operation of
Pegasus' currently owned business in the foreseeable future.
YEAR 2000 COMPLIANCE
The year 2000 computer issue is primarily the result of information technology
(IT) or non-IT systems and programs with date sensitive devices, such as
embedded chips or code using only the last two digits to refer to a year. The
failure of these devices to interpret dates beyond the year 1999 could cause a
system failure or other errors, with the resultant disruption in the operation
of such systems.
State of Readiness. Beginning in July 1997, Pegasus established internally
staffed project teams to address year 2000 issues related to services provided
to customers as well as any IT and non-IT internal systems supporting our
operations. Pegasus has tested and upgraded, if necessary, its systems and
processes to comply with the requirements of the year 2000 date transition.
Pegasus personnel have researched internal IT and non-IT hardware, software and
data issues related to dates and date range processing, and each product line
has undergone extensive internal and external testing. Any non-compliant
hardware or software discovered during testing has been upgraded or replaced.
This process included contacting material third-party suppliers and customers to
assess their year 2000 readiness. The following is a table showing our state of
year 2000 readiness based on management's assessment:
STATE OF READINESS
Internal IT and Non-IT Systems and Equipment
<TABLE>
<CAPTION>
Percent Estimated
Phase Complete Completion Date
----- -------- ---------------
<S> <C> <C>
Awareness 100% Complete
Assessment of changes required 100% Complete
Remediation or replacement 100% Complete
Testing 100% Complete
Contingency planning 100% Complete
Suppliers, Customers and Third-Party Providers
Percent Estimated
Phase Complete Completion Date
----- -------- ---------------
Awareness 100% Complete
Assessment questionnaires 100% Complete
Detail assessment review with third-party
providers 100% Complete
Contract review 100% Complete
Contingency planning 100% Complete
Testing as applicable 95% December 1999
</TABLE>
Costs. During the nine months ended September 30, 1999, the Company expensed
approximately $84,000 in labor costs associated with its year 2000 efforts. For
the years ended December 31, 1998
15
<PAGE> 16
and 1997, Pegasus expensed approximately $258,000 and $108,000, respectively, in
labor costs associated with year 2000 efforts. Total labor costs for 1999
related to year 2000 efforts are expected to be less than those incurred in 1998
and comparable to those incurred in 1997. In addition, Pegasus anticipates
incurring approximately $13,000 for the lease of additional testing hardware in
1999. In 1998, Pegasus capitalized $48,000 of computer equipment. This computer
equipment was purchased to address the year 2000 issue, and upon the completion
of year 2000 testing it is anticipated that such equipment will be used to
support the growth of the current systems. Pegasus does not anticipate incurring
a material amount of additional costs related to the purchase of IT and non-IT
hardware for the purpose of addressing the year 2000 issue. Cash required to
fund these matters is expected to be generated from operations. To date, no IT
development projects have been delayed due to year 2000 remediation efforts.
Risks/Contingency Plans. Even though Pegasus is undertaking efforts to ensure
that all its systems and programs are year 2000 compliant, Pegasus has no
control over services, functions and data provided by third-party vendors and
others which may result in the inability to provide services. Pegasus has
contacted and is working with its material customers and vendors to verify their
degree of year 2000 compliance. Pegasus has requested end-to-end testing with
those systems that interface with our systems. However, Pegasus has no control
over year 2000 compliance for third parties. To date, Pegasus has received
responses from substantially all of its material third-party customers and
vendors. The extent to which third-party customers and vendors do not become
year 2000 compliant in a timely manner may have a material adverse effect on our
cash flow and results of operations.
Pegasus derives nearly all revenues from processing electronic reservations or
consolidating hotel commissions electronically. Our inability or limitation of
our ability to process electronic reservations or consolidate hotel commissions
due to year 2000 problems would have a material impact on our revenues and cash
flow. Due to the electronic medium used by Pegasus to conduct the majority of
our business, any interruption or outage of telecommunications, electricity or
other basic utility services may also adversely impact our ability to do
business.
Pegasus services the travel industry and is dependent on the continued health of
the industry. Any general disruption of travel due to year 2000 issues that
adversely affects other travel vendors such as airlines, hotels and travel
agency systems would have a material adverse effect on our cash flows and
results of operations.
Pegasus has developed operational contingency and coverage plans for the
December 31, 1999 to January 1, 2000 date rollover. In addition, Pegasus will
have key staff members on site at both our Phoenix data center and our Dallas
headquarters to monitor and test systems during the date rollover.
16
<PAGE> 17
PART II - OTHER INFORMATION
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS --
The Securities and Exchange Commission on August 6, 1997 declared
effective the Registration Statement on Form S-1 (File No. 333-28595)
relating to the initial public offering of Pegasus common stock.
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) EXHIBITS
Exhibit 27 - Financial Data Schedule
(b) REPORTS ON FORM 8-K - Not applicable
17
<PAGE> 18
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PEGASUS SYSTEMS, INC.
November 15, 1999 /s/ JOHN F. DAVIS, III
----------------------
John F. Davis, III,
President and Chief
Executive Officer
November 15, 1999 /s/ JEROME L. GALANT
--------------------
Jerome L. Galant
Chief Financial Officer
(principal accounting officer)
18
<PAGE> 19
EXHIBIT INDEX
Exhibit
Number Description of Exhibits
------- -----------------------
27 - Financial Data Schedule
19
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE
COMPANY'S FORM 10-Q FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1999 FILED NOVEMBER
15, 1999 WITH SECURITIES AND EXCHANGE COMMISSION AND IS QUALIFIED IN ITS
ENTIRETY BY REFERENCE TO SUCH 10-Q.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 90,675
<SECURITIES> 47,659
<RECEIVABLES> 5,398
<ALLOWANCES> (82)
<INVENTORY> 0
<CURRENT-ASSETS> 147,807
<PP&E> 19,764
<DEPRECIATION> (14,698)
<TOTAL-ASSETS> 159,125
<CURRENT-LIABILITIES> 8,074
<BONDS> 0
0
0
<COMMON> 135
<OTHER-SE> 150,800
<TOTAL-LIABILITY-AND-EQUITY> 159,125
<SALES> 0
<TOTAL-REVENUES> 27,636
<CGS> 0
<TOTAL-COSTS> 8,907
<OTHER-EXPENSES> 1,888
<LOSS-PROVISION> 0
<INTEREST-EXPENSE> 37
<INCOME-PRETAX> 8,597
<INCOME-TAX> 3,114
<INCOME-CONTINUING> 5,484
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 5,484
<EPS-BASIC> 0.46
<EPS-DILUTED> 0.43
</TABLE>
