PEGASUS SYSTEMS INC, 424B4, 1999-05-07

PEGASUS SYSTEMS INC
424B4, 1999-05-07
COMPUTER PROCESSING & DATA PREPARATION

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Filed Pursuant to Rule 424(B)(4)
Registration Number 333-77071
PROSPECTUS
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2,000,000 SHARES

[PEGASUS SYSTEMS, INC. LOGO]

COMMON STOCK

Pegasus Systems, Inc. is offering 2,000,000 shares of common stock.
Pegasus' common stock is traded on the Nasdaq National Market under the symbol
"PEGS." On May 6, 1999, the last reported sale price for the common stock on the
Nasdaq National Market was $39.00 per share. See "Price Range of Common Stock."

------------------

INVESTING IN THE COMMON STOCK INVOLVES A HIGH DEGREE OF RISK.
SEE "RISK FACTORS" BEGINNING ON PAGE 5.

------------------

NEITHER THE SECURITIES AND EXCHANGE COMMISSION NOR ANY STATE SECURITIES
COMMISSION HAS APPROVED OR DISAPPROVED OF THESE SECURITIES OR PASSED UPON THE
ADEQUACY OR ACCURACY OF THIS PROSPECTUS. ANY REPRESENTATION TO THE CONTRARY IS A
CRIMINAL OFFENSE.

<TABLE>
<CAPTION>
PER SHARE TOTAL
--------- -----
<S> <C> <C>
Public offering price....................................... $38.88 $77,750,000
Underwriting discounts and commissions...................... $ 2.00 $ 4,000,000
Proceeds to Pegasus, before expenses........................ $36.88 $73,750,000
</TABLE>

Pegasus has granted the underwriters an option for a period of 30 days to
purchase up to 300,000 additional shares of common stock.

HAMBRECHT & QUIST

BEAR, STEARNS & CO. INC.

DONALDSON, LUFKIN & JENRETTE

VOLPE BROWN WHELAN & COMPANY

MAY 6, 1999
<PAGE> 2

GRAPH

1. Consumer makes a hotel reservation through a travel agent, who
books the reservation on a global distribution system. The reservation
request is sent from the global distribution system to the hotel via the
Pegasus electronic distribution technology.

2. Consumer makes a hotel reservation using a global distribution
system Internet site. The global distribution system sends the reservation
to the hotel via the Pegasus electronic distribution technology.

3. Consumer makes a hotel reservation on TravelWeb.com, which sends
the reservation request to the hotel via the Pegasus electronic
distribution technology.

4. Consumer makes a hotel reservation on a website that uses Pegasus
private-label reservation service, which sends the reservation request to
the hotel via the Pegasus electronic distribution technology.

5. Consumer makes a hotel reservation through a corporate travel
system or meeting planner that uses Pegasus' private-label reservation
service, which sends the reservation request to the hotel via the Pegasus
electronic distribution technology.

6. Hotels send booking data to Pegasus Commission Processing, which
consolidates the commissions and sends a commission check to the travel
agency.

7. Pegasus Business Intelligence gathers data from the hotels that are
connected to the Pegasus electronic distribution technology and/or use
Pegasus Commission Processing.

PEGASUS SYSTEMS, INC. IS A LEADING PROVIDER OF TRANSACTION PROCESSING AND
ELECTRONIC COMMERCE SERVICES TO THE HOTEL INDUSTRY WORLDWIDE

Pegasus Electronic Distribution serves as a gateway to approximately 28,000
hotels around the world. When a reservation is made via any of the distribution
channels shown above, the Pegasus electronic distribution technology translates
the reservation request into the hotel's unique computer format and queries the
hotel's central reservation system. Pegasus then returns a confirmation through
the distribution channel. Typically, this entire process occurs in a matter of
seconds. Hotel reservations can be transmitted through global distribution
systems, TravelWeb.com or third-party websites, or systems designed for
corporate travel departments or meeting and convention planners.

Pegasus Commission Processing completes the hotel reservation process for
the travel agent by collecting and consolidating hotel room commissions for
travel agencies from approximately 23,500 hotels around the world. More than
81,000 travel agency locations in 206 countries participate in the service.

Pegasus Business Intelligence leverages our central position in the hotel
industry for the processing of reservations and commissions. 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.
<PAGE> 3

TABLE OF CONTENTS

<TABLE>
<CAPTION>
PAGE
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<S> <C>
Prospectus Summary.......................................... 1
Risk Factors................................................ 5
Forward-Looking Statements.................................. 14
Use of Proceeds............................................. 14
Price Range of Common Stock................................. 14
Dividend Policy............................................. 15
Corporate Information....................................... 15
Capitalization.............................................. 16
Selected Consolidated Financial Data........................ 17
Management's Discussion and Analysis of Financial Condition
and Results of Operations................................. 19
Business.................................................... 28
Management.................................................. 41
Principal Stockholders...................................... 43
Underwriting................................................ 44
Legal Matters............................................... 45
Experts..................................................... 45
Additional Information...................................... 46
Information Incorporated by Reference....................... 46
Index to Consolidated Financial Statements.................. F-1
</TABLE>

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<PAGE> 4

PROSPECTUS SUMMARY

This summary highlights selected information contained elsewhere in this
prospectus. This summary may not contain all of the information that you should
consider before investing in our common stock. You should read the entire
prospectus carefully, including "Risk Factors" and our consolidated financial
statements and notes thereto before making an investment decision. Unless we
state otherwise, the information we present in this prospectus assumes no
exercise of the underwriters' over-allotment option.

OUR BUSINESS

We are a leading provider of transaction processing and electronic commerce
services to the hotel industry worldwide. We are organized into three
businesses: Pegasus Electronic Distribution, Pegasus Commission Processing and
Pegasus Business Intelligence.

- PEGASUS ELECTRONIC DISTRIBUTION includes our GDS distribution service and
Internet-based distribution services. These services improve the
efficiency and effectiveness of the hotel reservation process by enabling
travel agents and individual travelers to electronically access hotel
room inventory information and conduct reservation transactions. Pegasus
Electronic Distribution customers include nine of the ten largest hotel
companies based on the total number of guest rooms. In 1998, Pegasus
Electronic Distribution generated approximately 42% of our consolidated
revenues.

-- Our GDS distribution service provides an electronic interface between
a hotel's central reservation system and the global distribution
systems that travel agents use to book hotel and airline
reservations. Global distribution systems are electronic travel
information and reservation systems such as Sabre and Galileo. Over
28,000 hotel properties worldwide utilize our GDS distribution
service. Our GDS distribution service has been referred to
historically as THISCO.

-- Our Internet-based distribution services include TravelWeb.com and
our private-label reservation service. These services enable
travelers to make reservations electronically at approximately 27,000
properties in 170 countries. Our TravelWeb.com service provides hotel
and airline reservation capabilities to individual travelers through
our Internet website, www.travelweb.com. During February 1999,
TravelWeb.com received an average of 68,000 visitors per day. Our
private-label reservation service, formerly known as NetBooker,
offers comprehensive hotel information and reservation capabilities
to third-party websites. These websites include six of the ten most
popular websites according to information from Relevant Knowledge,
Inc., including Preview Travel and Microsoft's MSN(TM) Expedia.(TM)
During 1998, Pegasus estimates that approximately $150 million in net
reservations for hotel rooms were made using our Internet-based
distribution services.

- PEGASUS COMMISSION PROCESSING, the global leader in hotel commission
payment processing, improves the efficiency and effectiveness of the
commission payment process for participating hotels and travel agencies.
We consolidate commissions paid by participating hotels to a
participating travel agency into a single monthly payment and provide
comprehensive transaction reports. Over 23,500 hotel properties and over
81,000 travel agencies worldwide utilize Pegasus Commission Processing to
increase efficiency and reduce costs associated with preparing, paying
and reconciling hotel room reservation commissions. In 1998, Pegasus
processed over $268 million in gross commission payments, compared to
$175 million in 1997 and $112 million in 1996. Pegasus Commission
Processing has been referred to historically as HCC. In 1998, Pegasus
Commission Processing generated approximately 55% of our consolidated
revenues.

- PEGASUS BUSINESS INTELLIGENCE is our new data warehousing and marketing
research and information service. This service 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. Pegasus Business Intelligence has been
referred to historically as Pegasus IQ and Driving Revenue L.L.C. In
1998, Pegasus Business Intelligence generated approximately 3% of our
consolidated revenues.

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THE OPPORTUNITY

The hotel industry includes a wide variety of participants processing
complex transactions and detailed information. Hotel companies pay many types of
costs associated with reserving and distributing hotel rooms. These costs
include commissions and fees paid to intermediaries, such as traditional and
Internet-based travel agencies as well as global distribution systems, staffing
costs for hotel reservation personnel and information technology expenses for
hotel reservation systems. We believe these costs represent a significant
portion of a hotel company's total operating costs.

Our services simplify the processing of room reservation information and
transaction flows and reduce room distribution costs for the hotel industry.
These services benefit many of the participants in the hotel room distribution
process, including hotels, hotel representation firms, global distribution
systems, travel agencies, convention and other large travel-related meeting
organizers, corporate travel departments and websites with travel-related
features. Our strategic position as a gateway in the hotel room distribution
chain, our transaction processing capabilities and our reputation for
reliability and neutrality enable us to offer a range of services delivering
industry-wide benefits that are difficult for an industry participant to achieve
individually. Because we process transactions from a wide variety of sources, we
are well positioned to capitalize on the overall growth in electronic hotel
reservations, whether made through global distribution systems, the Internet or
other means.

We believe that we will benefit from the following significant trends in
the global hotel industry:

- Hotels and travel agencies increasingly are making room reservations
electronically rather than manually.

- Individual travelers increasingly are making their hotel reservations
over the Internet.

- Independent hotels and smaller hotel chains increasingly are affiliating
with larger chains. Many of these chains are our customers. As
affiliations involving our customers occur, the number of hotel
properties using our services increases.

- Travel agencies are placing more importance on hotel reservation
commission revenues.

- Participants in the travel industry increasingly desire detailed,
customized information regarding hotel room distribution that can be
delivered in a timely manner.

OUR STRATEGY

Our goal is to be the leading provider of information services and
technology in the distribution of hotel rooms. We believe our central role in
the hotel industry room reservation process positions us to achieve this goal.
The following are key elements of our strategy:

- Increase our services to include additional hotel room distribution
channels

- Continue to develop and expand Pegasus Business Intelligence

- Pursue acquisition opportunities of complementary businesses

- Build our strategic alliances

- Expand our customer base, including international expansion

RECENT DEVELOPMENTS

We recently announced our unaudited financial results for the period ended
March 31, 1999. For the three month period ended March 31, 1999, our net
revenues increased 35.8% over the same period in the prior year to $8.4 million.
Net income in the three months ended March 31, 1999 was $1.5 million. Diluted
net income per share in this period was $0.13 based on 11.5 million weighted
average shares outstanding.

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THE OFFERING

Common stock offered by Pegasus..... 2,000,000 shares

Common stock to be outstanding after
this offering..................... 12,623,334 shares(1)

Use of proceeds..................... For working capital and other general
corporate purposes, including possible
acquisitions of complementary
businesses.

Nasdaq National Market symbol....... PEGS

SUMMARY CONSOLIDATED FINANCIAL DATA
(IN THOUSANDS, EXCEPT FOR PER SHARE DATA)

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1994 1995 1996 1997 1998
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<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS
DATA(2):
Net revenues................................. $ 4,666 $ 9,296 $15,869 $20,903 $29,064
Operating income (loss)...................... 168 (2,809) (2,585) 224 3,238
Net income (loss)............................ $ (423) $(3,571) $(3,485) $ 589 $ 5,396
Net income (loss) per share(3):
Basic...................................... $ (0.56) $ (1.30) $ (0.66) $ 0.08 $ 0.52
Diluted.................................... $ (0.56) $ (1.30) $ (0.66) $ 0.07 $ 0.48
Weighted average shares outstanding(3):
Basic...................................... 762 2,752 5,247 7,200 10,461
Diluted.................................... 762 2,752 5,247 8,676 11,197
</TABLE>

<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998
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ACTUAL AS ADJUSTED(4)
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<S> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Cash and cash equivalents................................... $27,109 $100,459
Working capital............................................. 44,398 117,748
Total assets................................................ 60,320 133,670
Total stockholders' equity.................................. 54,264 127,614
</TABLE>

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(1) Based on the number of shares outstanding as of March 31, 1999. Excludes as
of March 31, 1999:

- 742,050 shares of common stock reserved for issuance under our 1996
Amended Stock Option Plan, of which options to purchase 735,622 shares
were outstanding at a weighted average exercise price of $3.59 per share

- 572,562 shares of common stock reserved for issuance under our 1997
Amended Stock Option Plan, as amended, of which options to purchase
506,602 shares were outstanding at a weighted average exercise price of
$13.28 per share

- 488,354 shares of common stock reserved for issuance under our 1997
Employee Stock Purchase Plan

- Warrants to purchase up to 345,723 shares of common stock issued to
Holiday Inn Worldwide exercisable at any time through May 12, 1999 at an
exercise price of $7.20 per share

Pursuant to our stockholder rights plan, Pegasus has issued preferred stock
purchase rights that accompany the outstanding shares of common stock,
including the shares to be sold in the offering.

(2) Our statement of operations data for 1994 consist of the accounts of The
Hotel Industry Switch Company (THISCO), our wholly owned subsidiary.
Statement of operations data for subsequent periods reflects our operations,
including the depreciation and amortization of the following:

- Acquisition of 83.3% of the outstanding capital stock of The Hotel
Clearing Corporation (HCC) in July 1995

- Acquisition of the remaining 16.7% of the outstanding capital stock of HCC
in June 1996

- Acquisition of Driving Revenue in August 1998

Notes continued on following page

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Amortization applicable to the acquisition of HCC totaled approximately
$645,000, $1,412,000, $1,534,000 and $798,000 in 1995, 1996, 1997 and 1998,
respectively. Amortization applicable to the acquisition of Driving Revenue
totaled approximately $125,000 in 1998. See Notes 1, 2 and 3 of Notes to
Consolidated Financial Statements.

(3) 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.

(4) Adjusted to reflect the sale of 2,000,000 shares of our common stock offered
by us in this prospectus at an offering price of $38.88 per share and
application of the net proceeds. See "Use of Proceeds" and "Capitalization."

Our principal executive offices are located at 3811 Turtle Creek Boulevard,
Suite 1100, Dallas, Texas, 75219, and our telephone number is (214) 528-5656.

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RISK FACTORS

You should carefully consider the following risk factors and all other
information contained in this prospectus before purchasing our common stock.
Investing in our common stock involves a high degree of risk. Any of the
following risks could materially adversely affect our business, operating
results and financial condition and could result in a complete loss of your
investment.

WE MAY LOSE MARKET SHARE AND BE REQUIRED TO REDUCE PRICES AS A RESULT OF OUR
INTENSELY COMPETITIVE MARKETS

We compete in markets that are rapidly evolving, intensely competitive and
involve continually changing technology and industry standards. We may not be
successful in competing against our current and future competitors. Our
competitors may be able to respond more quickly than we can to new or emerging
technology, services or changes in customer requirements. We may experience
increased competition from current and potential competitors, many of which have
significantly greater financial, technical, marketing and other resources that
we do. Other participants in the hotel room distribution process, commission
processing or business information industries as well as new competitors, could
create services that are more attractive than our services. Competitive
pressures could reduce our market share or require us to reduce the prices of
our services. Our inability to compete effectively with these services could
have a material adverse effect on our business, operating results and financial
condition.

Each of our services faces unique competition from within its respective
market.

PEGASUS ELECTRONIC DISTRIBUTION

GDS distribution service

Our GDS distribution service competes with WizCom International Ltd.
Customers may change their electronic reservation interface to WizCom or to
another similar service. Also, certain hotels have established their own direct
connection to one or more global distribution systems. Other hotels may choose
to take the same action. If hotels establish this direct connection, they would
bypass the Pegasus electronic distribution technology and eliminate the need to
pay our fees. Several factors affecting the competitive success of our GDS
distribution service include:

- Our reliability

- Our pricing structure

- The number of hotel properties using our system

- Our ability to provide a neutral, comprehensive interface between
hotels and other participants in the distribution of hotel rooms

- Our ability to develop new technological solutions

Internet-based reservation services

Our TravelWeb.com service, private-label reservation service and other
Internet-based distribution services face competition in the online hotel room
reservation business from our current competitors as well as potential new
entrants, including other websites. Several of our competitors have websites
offering a more comprehensive range of travel opportunities than we do. These
websites include Preview Travel, Travelocity and Microsoft's MSN(TM)
Expedia(TM). The costs of entry into the Internet hotel room reservation
business are relatively low. There can be no assurance that our Internet-based
distribution services will compete successfully.

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PEGASUS COMMISSION PROCESSING

Pegasus Commission Processing faces competition principally from National
Processing Company, REZsolutions, Inc. and Citicorp. National Processing Company
has traditionally provided car rental and cruise line commission processing
services. REZsolutions and Citicorp provide commission consolidation services to
hotel chains. In addition, hotels that are current or potential customers of
Pegasus Commission Processing can decide to process commission payments without,
or in competition with, Pegasus Commission Processing. Furthermore, while
Pegasus Commission Processing has written agreements with substantially all of
its hotel customers, most of its travel agency customers are not bound by any
written agreement with us. If a significant portion of these customers stop
using Pegasus Commission Processing, it could have a material adverse effect on
our business, operating results and financial condition.

PEGASUS BUSINESS INTELLIGENCE

Pegasus Business Intelligence principally competes with Smith Travel
Research, which currently provides information services to hotels. Additionally,
accounting firms and other businesses currently or may in the future provide
information services similar to our current or future service offerings. Our
competitors may have existing customer relationships that create an obstacle to
us acquiring new customers. The current or future information service offerings
of our existing competitors or new competitors may reduce the attractiveness of
our services.

RAPID CONSOLIDATION AND ECONOMIC CHANGES IN THE HOTEL INDUSTRY COULD LOWER THE
VALUE OF OUR SERVICES

Since we derive most of our revenues either directly or indirectly from the
hotel industry, our revenues may be harmed by events that result in a decrease
in hotel room use. The hotel industry is highly sensitive to any change in the
economic conditions affecting business or leisure travel. The hotel industry is
also highly susceptible to unforeseen events, including 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 our
business, operating results and financial condition.

We offer volume-based discounting of our fees. The recent consolidation of
the hotel industry has resulted in a higher percentage of discounted fees, and
this trend could continue. In addition, the global distribution system industry
has consolidated into four major global distribution systems. If further
consolidation occurs, the value of our services and the benefits to hotel
operators of utilizing the GDS distribution service would be reduced. Any
potential decrease in our customer base or any potential increase in the
percentage of discounted fees may have a material adverse effect on our
business, operating results and financial condition.

BECAUSE OUR EXPENSES ARE LARGELY FIXED AND WE CANNOT ACCURATELY PREDICT OUR
COMPETITIVE ENVIRONMENT, UNEXPECTED REVENUE SHORTFALLS AND QUARTERLY VARIATIONS
MAY ADVERSELY AFFECT OUR BUSINESS

Our expense levels are based primarily on our estimate of future revenues
and are largely fixed. In the future, we may not accurately predict the
introduction of new or enhanced services by us or our competitors or the degree
of customer acceptance of new services. We may also be unable to adjust spending
rapidly enough to compensate for any unexpected revenue shortfall. In addition,
our past and future operating results vary significantly from quarter to quarter
due to a variety of factors, many of which are outside our control. It is likely
that in one or more future quarters our results may fall below the expectations
of securities analysts and investors. Any significant shortfall in revenues in
relation to our planned expenditures would reduce, and possibly eliminate, any
operating income. Due to the fixed nature of our costs, and because operating
costs are based on anticipated revenues, a decline in revenue from even a
limited number of transactions, failure to achieve expected revenue in any
fiscal quarter or unanticipated variation in the recognition of revenues can
cause significant variations in operating results from quarter to quarter. This
could result in losses in some future quarter or have a material adverse effect
on our

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business, operating results and financial condition. We believe that
period-to-period comparisons of our operating results should not be relied upon
as an indication of future performance.

REDUCTIONS IN HOTEL COMMISSION PAYMENTS WOULD REDUCE OUR REVENUES AND NET INCOME

Pegasus Commission Processing derives revenues based on the dollar value of
travel agency commissions paid by hotels. A substantial portion of our revenues
and net income is attributable to Pegasus Commission Processing. If there is any
change in the commission payment process or any increase in the direct
distribution of rooms by hotels, our revenues and net income could substantially
decrease. Hotels typically are under no contractual obligation to pay room
reservation commissions to travel agencies. Hotels could elect to reduce the
current customary commission rate of 10%, limit the maximum commission generally
paid for a hotel room reservation or eliminate commissions entirely. 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. Any change in the process affecting the
way Pegasus Commission Processing derives revenues could have a material adverse
effect on our business, operating results and financial condition.

OUR FUTURE ACQUISITIONS MAY BE DIFFICULT AND DISRUPTIVE, AND WE MAY NOT REALIZE
EXPECTED BENEFITS

We regularly evaluate acquisition opportunities and have made and in the
future may make acquisitions of other companies or technologies. We have limited
experience in integrating newly acquired organizations into our operations.
Acquisitions expose us to many risks, including:

- Difficulty in assimilating technologies, products, personnel and
operations

- Diversion of management's attention from other business concerns

- Large write-offs and amortization expenses related to goodwill and other
intangible assets

- Loss of key employees of acquired organizations

- Risks of entering markets in which we have no or limited prior experience

- Payments of cash, incurrence of debt or assumption of other liabilities
to acquire other businesses

The result of one or more of these factors could have a material adverse
effect on our business, operating results and financial condition.

WE ARE GROWING RAPIDLY AND WE MAY NOT HAVE THE RESOURCES TO EFFECTIVELY MANAGE
ADDITIONAL GROWTH

Our recent growth and potential future growth has placed significant
demands on management as well as on our administrative, operational and
financial resources. The expansion of our business to take advantage of new
market opportunities will require significant management attention and financial
resources. To manage additional growth we must:

- Expand our sales, marketing and customer support organizations

- Attract and retain additional qualified personnel

- Expand our physical facilities

- Invest in the development or enhancement of our current services and
develop new services that meet changing industry needs

- Develop systems, procedures or controls to support the expansion of our
operations

Our inability to sustain or manage any additional growth could have a
material adverse effect on our business, operating results and financial
condition.

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WE ARE DEPENDENT ON INTERNET COMMERCE FOR OUR FUTURE GROWTH

The success and growth of TravelWeb.com, our private-label reservation
service and our other Internet-based distribution services depend on the
viability of the Internet as a channel for distributing services and products.
Our services depend on the expansion of the Internet infrastructure to enable
the Internet to support the future demands created by expected growth.
Participants in the Internet industry may fail to develop necessary
infrastructure or complementary services and products, such as high speed modems
and high speed communication lines. In addition, there are critical issues
concerning the commercial use of the Internet that remain unresolved, including
issues relating to security, reliability, cost, ease of use, accessibility and
quality of service. If the issues concerning the commercial use of the Internet
are not resolved favorably, it could have a material adverse effect on our
business, operating results and financial condition.

OUR FUTURE SUCCESS DEPENDS ON OUR ABILITY TO DEVELOP NEW TECHNOLOGIES AND
SERVICES TO MEET THE CHANGING NEEDS OF OUR CURRENT AND FUTURE CUSTOMERS

Our future success depends, in part, on our ability to develop leading
technologies, enhance our existing services and develop and introduce new
services. In particular, our technologies and services must meet the needs of
our current and prospective customers. They also must continue to meet the
demands of technological advances and emerging industry standards and practices
on a timely and cost-effective basis. Although we strive to be a technological
leader, future technology advances may not complement or be compatible with our
services. In addition, we may be unable to economically and timely incorporate
technology changes and technology advances into our business. We may be
unsuccessful in effectively using new technologies, adapting our services to
emerging industry standards or developing, introducing and marketing service
enhancements or new services. We may also experience difficulties that could
delay or prevent the successful development, introduction or marketing of these
services. If we are unable to develop and introduce new services or enhance
existing services on a timely and cost-effective basis or if new services do not
achieve market acceptance, it could have a material adverse effect on our
business, operating results and financial condition.

LOSS OF OUR ARRANGEMENTS WITH KEY CUSTOMERS AND THIRD-PARTY SERVICE ARRANGEMENTS
COULD ADVERSELY AFFECT OUR BUSINESS

Our business is dependent upon our customer arrangements with hotel chains,
hotel representation firms, travel agencies, travel agency consortia and global
distribution services. We have not entered into any written agreements with most
of our travel agencies relating to Pegasus Commission Processing. In the future,
we may be unable to continue or renew these arrangements on favorable terms or
initiate new arrangements. If we are unable to renew or continue our customer
arrangements on a favorable basis, it could result in a significant reduction in
our customer base and revenue sources. We also rely on third parties to provide
consolidation, remittance and worldwide currency exchange services for Pegasus
Commission Processing and for facility maintenance and disaster recovery
services for the computer and communications systems used in all of our
services. If we are unable to renew, extend or enter into contracts with
alternate service providers on favorable terms, it could have a material adverse
effect on our business, operating results and financial condition.

OUR COMPUTER SYSTEMS AND DATABASES MAY SUFFER SYSTEM FAILURES, BUSINESS
INTERRUPTIONS OR SECURITY RISKS

Our operations depend on our ability to protect our computer systems and
databases against damage or system interruptions from fire, earthquake, power
loss, telecommunications failure, unauthorized entry or other events beyond our
control. A significant amount of our computer equipment is located at a single
site in Phoenix, Arizona. Any unanticipated problems may cause a significant
system outage or data loss. Despite the implementation of security measures, our
infrastructure may also be vulnerable to break-ins, computer viruses or other
disruptions caused by our customers or others. Any damage to our databases,
failure of communication links, security breach or other loss that causes
interruptions in our operations could have a material adverse effect on our
business, operating results and financial condition.
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WE HAVE LITTLE CONTROL OVER THE BUSINESS OPERATIONS OF THE COMPANIES IN WHICH WE
OWN A MINORITY INTEREST

In June 1998, we purchased a minority interest in Customer Analytics, Inc.,
a new venture aimed at providing services to companies in the field of data
warehousing and data mining. In September 1998, we also purchased a minority
interest in Intermezzo, Inc., a developer of hotel reservation and property
management systems and software. We have little or no control over the success
of Customer Analytics or Intermezzo and we cannot guarantee the success of
either of these investments. Pegasus purchased its minority interest in
Intermezzo for $1.0 million. Intermezzo has incurred operating losses in excess
of its plan and as a result has experienced liquidity problems. Pegasus has lent
an additional $100,000 as part of an investor bridge loan to Intermezzo which is
seeking additional long-term financing. We can give no assurances that
Intermezzo will obtain additional financing or what the terms of any financing
might be. If Intermezzo fails to obtain additional financing or the terms of any
new financing are unfavorable to the original stockholders, Pegasus could suffer
significant impairment of the value of its investments in Intermezzo. The
failure of a minority interest investment in these or other companies could have
an adverse effect on our business, operating results and financial condition.

GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES COULD FORCE US TO CHANGE OUR
OPERATIONS

Although certain aspects of the travel industry are heavily regulated by
the United States government, the services we currently offer are not currently
subject to any material industry-specific government regulation. Any future
regulations implemented by federal, state or foreign governmental authorities
affecting one or more of our current or future services could have a material
adverse effect on our business, operating results and financial condition.

Our primary customers consist of hotel chains, hotel representation firms
and travel agencies. Although some of our stockholders are our customers, we
believe that we operate as an entity independent from our stockholders and that
our stockholders have engaged in no anti-competitive activities through or in
connection with us. Any federal, state or foreign governmental authorities, our
competitors or our consumers raising any anti-competitive concerns regarding our
relationship with stockholders that are customers could institute an action
against us. Any such action by federal, state or foreign governmental
authorities or allegations by third parties could have a material adverse effect
on our business, operating results and financial condition.

We are subject to the same federal, state and local laws as other companies
conducting business on the Internet. Today there are relatively few laws
specifically directed towards online services. However, due to the increasing
popularity and use of the Internet and online services, it is possible that laws
and regulations will be adopted with respect to the Internet or online services.
These laws and regulations could cover issues such as online contracts, user
privacy, freedom of expression, pricing, fraud, content and quality of products
and services, taxation, advertising, intellectual property rights and
information security. Applicability to the Internet of existing laws governing
issues such as property ownership, copyrights and other intellectual property
issues, taxation, libel, obscenity and personal privacy is uncertain. The vast
majority of these laws were adopted prior to the advent of the Internet and
related technologies and, as a result, do not contemplate or address the unique
issues of the Internet and related technologies. Those laws that do reference
the Internet have not yet been thoroughly interpreted by the courts and their
applicability and reach are therefore uncertain.

Several states have proposed legislation that would limit the uses of
personal user information gathered online or require online services to
establish privacy policies. The Federal Trade Commission also has recently
settled a proceeding with one online service regarding the manner in which
personal information is collected from users and provided to third parties.
Changes to existing laws or the passage of new laws intended to address these
issues could directly affect the way we do business and could create uncertainty
in the marketplace. This could reduce demand for our services, increase the cost
of doing business as a result of litigation costs or increased service delivery
costs, or otherwise harm our business. In addition, because our services are
accessible worldwide, foreign jurisdictions may claim that we are required to
comply with their laws. Our failure to comply with foreign laws could subject us
to penalties

9
<PAGE> 13

ranging from fines to bans on our ability to offer our services. In the United
States, companies are required to qualify as foreign corporations in states
where they are conducting business. As an Internet company, it is unclear in
which states we are actually conducting business. Our failure to qualify as a
foreign corporation in a jurisdiction where we are required to do so could
subject us to taxes and penalties for the failure to qualify and could result in
our inability to enforce contracts in those jurisdictions. Any new legislation
or regulation, or the application of laws or regulations from jurisdictions
whose laws do not currently apply to our business, could adversely affect our
business, operating results and financial condition.

OUR PLANNED EXPANSION OF INTERNATIONAL OPERATIONS MAY MAKE US SUSCEPTIBLE TO
GLOBAL ECONOMIC FACTORS, FOREIGN TAX LAW ISSUES, FOREIGN BUSINESS PRACTICES AND
CURRENCY FLUCTUATIONS

Our pursuit of international growth opportunities may require significant
investments for an extended period of time before we realize returns on these
investments, if any. Our international operations are subject to particular
risks, including:

- Difficulties and costs of managing and staffing foreign operations

- Impact of possible adverse political and economic conditions

- Fluctuations in the value of the U.S. dollar relative to other currencies

- Potentially adverse tax consequences

- Impact of the policies of the United States and foreign governments on
foreign trade

- Reduced protection for intellectual property rights in some countries

- Unexpected changes in regulatory requirements

- Cost of adapting our services to foreign markets

If we do not realize our expected results from international operations, it
could have a material adverse effect on our business, operating results and
financial position.

OUR SUCCESS SIGNIFICANTLY DEPENDS ON THE EXPERIENCE OF OUR KEY PERSONNEL AND OUR
ABILITY TO ATTRACT AND RETAIN ADDITIONAL PERSONNEL

Our success depends on the continued services of our executive officers and
other key personnel, including our President, John F. Davis, III, and our Chief
Operating Officer, Joseph W. Nicholson. Even though we currently have "key-man"
insurance covering Messrs. Davis and Nicholson, this insurance amount may not
adequately compensate us for the loss of their services. We believe that our
future business results also depend on our ability to identify, attract,
motivate and retain skilled technical personnel. Competition for personnel in
the electronic commerce industry is intense. We cannot assure you that we will
be able to successfully identify, attract, hire and retain other highly-skilled
personnel in a timely and effective manner. The failure to retain our officers
and key personnel or to recruit new personnel could have a material adverse
effect on our business, financial condition and results of operations.

WE MAY BE UNABLE TO ADEQUATELY PROTECT OUR PROPRIETARY RIGHTS OR PREVENT THEIR
UNAUTHORIZED USE, WHICH COULD DIVERT OUR FINANCIAL RESOURCES AND HARM OUR
BUSINESS

Our success depends upon our proprietary technology, consisting of both of
our software and hardware designs. We rely upon a combination of copyright,
trade secrets, confidentiality procedures and contractual provisions to protect
this proprietary technology. Despite our current efforts to protect our
proprietary rights, these protective measures may not be adequate to prevent
misappropriation or independent third-party development of our technology. Many
foreign jurisdictions offer less protection of intellectual property rights than
the United States. Effective copyright, trademark and trade secret protection
may not

10
<PAGE> 14

be available in other jurisdictions. In addition, we may need to litigate claims
against third parties to enforce our intellectual property rights, protect our
trade secrets, determine the validity and scope of the proprietary rights of
others or defend against claims of infringement or invalidity. This litigation
could result in substantial cost and diversion of management resources. A
successful claim against us could effectively block our ability to use or
license our technology in the United States or abroad. If we cannot adequately
protect our proprietary rights, it could have a material adverse effect on our
business, operating results and financial condition.

WE RELY ON TECHNOLOGY LICENSES FROM THIRD PARTIES, THE LOSS OF WHICH MAY HARM
OUR ABILITY TO DEVELOP AND SELL OUR SERVICES

We currently and in the future may procure licenses from third parties
relating to our services or technology. Our inability to obtain or maintain
these licenses could impair our ability to develop and sell our services. Our
competitors may obtain licenses with lower royalty obligations or other terms
more favorable than those received by us. If we or our suppliers are unable to
obtain licenses, we could be forced to market services without certain
technological features. Our inability to obtain licenses or our inability to
obtain such licenses on competitive terms could have a material adverse effect
on our business, operating results and financial condition.

POTENTIAL YEAR 2000 ISSUES MAY EXPOSE US TO LIABILITY OR LOSS

We utilize a significant number of computer software programs and operating
systems in our internal operations. If these programs or systems are unable to
appropriately interpret dates occurring in the upcoming calendar year 2000, some
level of modification or replacement of this software may be necessary. We are
currently evaluating our information technology and non-information technology
systems for year 2000 compliance. This evaluation includes reviewing what
actions are required to make these systems year 2000 compliant as well as
actions necessary to make us less vulnerable to year 2000 compliance problems
associated with third parties' systems.

Even though we have implemented a program designed to ensure that all
software used in connection with our services is year 2000 compliant, we may
fail to identify all year 2000 problems or correct these problems in a timely
manner. We derive nearly all of our revenues from processing electronic
reservations or consolidating hotel commissions electronically. Our inability to
effectively process electronic hotel reservations or consolidate hotel
commissions as a result of year 2000 problems could have a material adverse
affect on our business, operating results and financial condition.

We have no control over services, functions and data provided by
third-party vendors and others which may result in our inability to provide
services. We are currently working with our material customers and vendors to
verify their degree of year 2000 compliance. However, we have no control over
third parties and cannot assure that they will be year 2000 compliant. The
extent to which third-party customers and vendors do not become year 2000
compliant on a timely basis may have a material adverse effect on our business,
operating results and financial condition.

OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE EXTREMELY VOLATILE

The trading price of our common stock has been and is likely to be
extremely volatile. Our stock price could be subject to wide fluctuations in
response to a variety of factors, including the following:

- Actual or anticipated variations in our quarterly operating results

- Announcements of technological innovations or new services by us or our
competitors

- Changes in financial estimates by securities analysts

- Conditions or trends in the Internet and online commerce industries

- Changes in the market valuations of other similarly situated companies

11
<PAGE> 15

- Developments in Internet regulations

- Announcements by us or our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments

- Unscheduled system downtime

- Additions or departures of key personnel

- Sales of our common stock or other securities in the open market

- Other events or factors that may be beyond our control

We believe that factors such as quarterly fluctuations in financial results
or announcements by us, our competitors, travel agencies, hotel operators or
other hotel industry participants could cause the market price of our common
stock to fluctuate substantially. In addition, the stock market may experience
extreme price and volume fluctuations that often are unrelated to the operating
performance of specific companies. Market fluctuations or perceptions regarding
the hotel industry and general economic or political conditions may adversely
affect the market price of the common stock.

In addition, the trading prices of Internet stocks in general have
experienced extreme price and volume fluctuations in recent months. Any negative
change in the public's perception of the prospects of Internet or e-commerce
companies could depress our stock price regardless of our results. Other broad
market and industry factors may decrease the market price of our common stock,
regardless of our operating performance. Market fluctuations, as well as general
political and economic conditions, such as recession or interest rate or
currency rate fluctuations, also may decrease the market price of our common
stock. In the past, following declines in the market price of a company's
securities, securities class-action litigation often has been instituted against
that company. Litigation of this type, if instituted against us, could result in
substantial costs and a diversion of management's attention and resources, which
could have a material adverse effect on our business, operating results and
financial condition. See "Price Range of Common Stock."

OUR MANAGEMENT HAS BROAD DISCRETION AS TO THE USE OF THE PROCEEDS FROM THIS
OFFERING, INCLUDING POTENTIAL ACQUISITIONS

Our management has broad discretion as to the use of the proceeds from this
offering. We intend to use the net proceeds over time for working capital and
other general corporate purposes. We may also use a portion of the net proceeds
to acquire or invest in businesses, products, services or technologies that are
complementary to our business. We cannot assure you that management will apply
such funds effectively, nor can we assure you that the proceeds will be invested
to yield a favorable return. See "Use of Proceeds."

PROVISIONS IN OUR CHARTER DOCUMENTS MAY DETER POTENTIAL ACQUISITION BIDS FOR OUR
BUSINESS, INCLUDING BIDS WHICH MAY BE BENEFICIAL TO OUR STOCKHOLDERS

Provisions of our certificate of incorporation and bylaws could make it
more difficult for a third party to acquire us, even if doing so would be
beneficial to our stockholders. Our certificate of incorporation and bylaws
provide for a classified board of directors serving staggered terms of three
years, prevent stockholders from calling a special meeting of stockholders and
prohibit stockholder action by written consent. Our certificate of incorporation
also authorizes only the board of directors to fill director vacancies,
including newly created directorships, and states that directors may be removed
only for cause and only by the affirmative vote of holders of at least
two-thirds of the outstanding shares of our voting stock voting together as a
single class. These provisions could discourage potential acquisition proposals
and could delay or prevent a change in control transaction. They could also
discourage others from making tender offers for our shares. As a result, these
provisions may prevent the market price of our common stock from reflecting the
effects of actual or rumored takeover attempts. These provisions may also
prevent significant changes in our board of directors and our management.
12
<PAGE> 16

On September 28, 1998, our board of directors adopted a stockholder rights
plan and declared a dividend distribution of one right for each outstanding
share of our common stock to stockholders of record at the close of business on
October 13, 1998. Each right entitles the registered holder to purchase from us
one-thousandth of a share of our Series A Preferred Stock for each share of our
common stock held, at a price of $90. The rights are exercisable only if a
person or group of affiliated persons acquires, or has announced the intent to
acquire, 20% or more of our common stock. These rights could make it more
difficult for a third party to acquire or could discourage a third party from
acquiring control of us.

DELAWARE LAW MAY DETER POTENTIAL ACQUISITION BIDS FOR OUR BUSINESS, INCLUDING
BIDS WHICH MAY BE BENEFICIAL TO OUR STOCKHOLDERS

We are subject to the provisions of Delaware law which restrict certain
business combinations with interested stockholders even if such a combination
would be beneficial to stockholders. These provisions may inhibit a
non-negotiated merger or other business combination. The anti-takeover
provisions of the Delaware General Corporation Law prevent us from engaging in a
"business combination" with any "interested stockholder" for three years
following the date that the stockholder became an interested stockholder. For
purposes of Delaware law, a "business combination" includes a merger or
consolidation involving us and the interested stockholder and the sale of more
than 10% of our assets. In general, Delaware law defines an "interested
stockholder" as any entity or person beneficially owning more than 15% of the
outstanding voting stock of a corporation and any entity or person affiliated
with or controlling or controlled by such entity or person. Under Delaware law,
a Delaware corporation may opt out of the anti-takeover provisions. We do not
intend to opt out of these anti-takeover provisions.

13
<PAGE> 17

FORWARD-LOOKING STATEMENTS

This prospectus contains forward-looking statements under the captions
"Prospectus Summary," "Risk Factors," "Use of Proceeds," "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
"Business" as well as elsewhere in this prospectus. These forward looking
statements, include but are not limited to, statements about our plans,
objectives, expectations, intentions and other statements contained in this
prospectus that are not historical facts. You can identify these statements by
forward-looking words, such as "expect," "anticipate," "intend," "plan,"
"believe," "seek," "estimate," "may," "will" and "continue" or similar words.
You should read statements that contain these words carefully because they
discuss our future expectations, contain projections of our future results of
operations or of our financial condition or state other forward-looking
information. However, there may be events in the future that we are not able to
accurately predict or control. The factors listed in the sections captioned
"Risk Factors" and "Management's Discussion and Analysis of Financial Condition
and Results of Operations," as well as any cautionary language in this
prospectus, provide examples of risks, uncertainties and events that may cause
our actual results to differ materially from the expectations we describe in our
forward-looking statements. Before you invest in our common stock, you should be
aware that the occurrence of the events described in the "Risk Factors" section
and the "Management's Discussion and Analysis of Financial Condition and Results
of Operations" section and elsewhere in this prospectus could have a material
adverse effect on our business, operating results and financial condition.

USE OF PROCEEDS

Pegasus will receive approximately $73.4 million in net proceeds from its
sale of 2,000,000 shares of common stock at a public offering price of $38.88
per share, after deducting underwriting discounts and commissions and estimated
expenses. If the underwriters exercise their over-allotment option in full,
Pegasus will receive approximately $11.1 million in additional net proceeds.

We intend to use the net proceeds from this offering for working capital
and other general corporate purposes. In addition, we may use the net proceeds
to acquire complementary businesses, products, services or technologies;
however, we currently have no commitments or agreements regarding any such
transaction. Pending these uses, we intend to invest the net proceeds in
interest-bearing, investment-grade securities.

PRICE RANGE OF COMMON STOCK

Our common stock trades on the Nasdaq National Market under the symbol
"PEGS." The following table sets forth for the quarters indicated the high and
low sale prices per share of our common stock as reported on the Nasdaq National
Market.

<TABLE>
<CAPTION>
HIGH LOW
------ ------
<S> <C> <C>
1999
Second quarter (through May 6, 1999)...................... $49.38 $34.00
First quarter............................................. 46.00 25.00
1998
Fourth quarter............................................ 36.25 8.88
Third quarter............................................. 26.88 10.75
Second quarter............................................ 31.00 22.00
First quarter............................................. 27.13 13.63
1997
Fourth quarter............................................ 20.75 12.50
Third quarter (from August 7, 1997)....................... 19.25 15.50
</TABLE>

On May 6, 1999, the last reported sale price of our common stock on the
Nasdaq National Market was $39.00 per share. See "Risk Factors -- Our stock
price has been and may continue to be extremely

14
<PAGE> 18

volatile." As of April 15, 1999, there were approximately 68 record holders of
our common stock, although we believe that the number of beneficial owners of
our common stock is substantially greater.

DIVIDEND POLICY

Pegasus has never declared or paid any cash dividends on shares of its
common stock. We intend to retain any future earnings for future growth and do
not anticipate paying any cash dividends in the foreseeable future. Any future
determination as to the payment of dividends will be at the discretion of the
Board of Directors.

CORPORATE INFORMATION

References in this prospectus to "Pegasus Systems, Inc.," "Pegasus," "we,"
"our," and "us" refer to Pegasus Systems, Inc. and our consolidated
subsidiaries. Our World Wide Web address is www.pegsinc.com. Information
contained in our website does not constitute part of this prospectus.

Pegasus was incorporated in Delaware in 1995. Pegasus holds all of the
outstanding capital stock of The Hotel Industry Switch Company, a Delaware
corporation formed in 1988 to operate the electronic distribution business
between hotel reservation systems and global distribution systems. Pegasus holds
all of the outstanding capital stock of The Hotel Clearing Corporation, a
Delaware corporation formed in 1991 to operate the commission payment processing
business. Pegasus indirectly holds all of the outstanding capital stock of
TravelWeb, Inc., a Delaware corporation formed in 1995 to operate the online
hotel reservation business. Pegasus holds all of the outstanding capital stock
of Pegasus IQ, Inc., a Delaware corporation formed in 1997 to operate the
information service business. Pegasus holds all of the equity securities of
Driving Revenue L.L.C., a Maryland limited liability company acquired in August
1998 that operates a hotel database and marketing business and constitutes part
of Pegasus Business Intelligence. Pegasus indirectly holds all of the
outstanding capital stock of Pegasus Systems, Inc. (UK) Ltd., a company formed
to operate our United Kingdom-based business.

We have registered "UltraSwitch," "TravelWeb," "UltraAccess," "HCC Hotel
Clearing Corporation," "HCC Link," "HCC Cash", "UltraRes," "Click-It," "Pegasus"
and "Chain Link" as United States federal trademarks, and an application to
register "Powered by Pegasus" is pending with the United States Patent and
Trademark Office. Trademark applications for "TravelWeb" and "Powered by
Pegasus" also have been filed in Canada and Europe. This prospectus also
includes trademarks and tradenames of companies other than us, which are the
property of their respective owners. Each trademark, tradename or service mark
of any other company appearing in this prospectus belongs to its holder.

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<PAGE> 19

CAPITALIZATION

The following table sets forth the capitalization of Pegasus as of December
31, 1998:

- On an actual basis

- On an adjusted basis to reflect our receipt of the net proceeds from the
sale of 2,000,000 shares of common stock offered by us at a public
offering price of $38.88 per share and the application of the net
proceeds in the manner described in "Use of Proceeds."

You should read the following information in conjunction with our
Consolidated Financial Statements and Notes thereto and "Management Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere in this prospectus. The following information regarding shares
outstanding is as of December 31, 1998. It excludes as of December 31, 1998:

- 810,640 shares of common stock reserved for issuance under our 1996
Amended Stock Option Plan, of which options to purchase 802,088 shares
were outstanding at a weighted average exercise price of $3.46 per share

- 587,707 shares of common stock reserved for issuance under our 1997
Amended Stock Option Plan, as amended, of which options to purchase
531,873 shares were outstanding at a weighted average exercise price of
$13.27 per share

- 488,354 shares of common stock reserved for issuance under our 1997
Employee Stock Purchase Plan

- Warrants to purchase up to 345,723 shares of common stock issued to
Holiday Inn Worldwide exercisable at any time through the period ending
May 12, 1999 at an exercise price of $7.20 per share.

<TABLE>
<CAPTION>
AS OF DECEMBER 31, 1998
-----------------------
ACTUAL AS ADJUSTED
-------- ------------
(IN THOUSANDS)
<S> <C> <C>
Current portion of long-term obligations.................... $ 535 $ 535
======= ========
Long-term obligations, net of current portion............... $ 58 $ 58
------- --------
Stockholders' equity:
Preferred Stock, $.01 par value, 2,000,000 shares
authorized; no shares issued and outstanding........... --
Common Stock, $.01 par value, 50,000,000 shares
authorized; 10,653,371 shares issued (actual);
12,653,371 shares issued (as adjusted)................. 106 127
Additional paid-in capital................................ 63,384 136,713
Unearned compensation..................................... (616) (616)
Accumulated deficit....................................... (8,584) (8,584)
Less treasury stock (116,484 shares, at cost)............. (26) (26)
------- --------
Total stockholders' equity........................ 54,264 127,614
------- --------
Total capitalization.............................. $54,322 $127,672
======= ========
</TABLE>

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<PAGE> 20

SELECTED CONSOLIDATED FINANCIAL DATA

The following selected consolidated financial data as of and for the years
ended December 31, 1998 and 1997 and for the year ended December 31, 1996 are
derived from our Consolidated Financial Statements that have been audited by
PricewaterhouseCoopers LLP, independent accountants, and are included elsewhere
in this prospectus. Selected consolidated financial data as of December 31, 1996
are derived from our consolidated financial statements that have been audited by
PricewaterhouseCoopers LLP but are not included in this prospectus. The selected
consolidated financial data as of and for the years ended December 31, 1995 and
1994 are derived from our consolidated financial statements that have been
audited by Belew Averitt LLP, independent accountants, but are not included in
this prospectus. The data should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
with our Consolidated Financial Statements and Notes thereto.

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------------------------------
1994 1995 1996 1997 1998
------- ------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS
DATA(1):
Net revenues................................. $ 4,666 $ 9,296 $15,869 $20,903 $29,064
Operating expenses:
Cost of services........................... 1,546 3,883 6,199 7,445 9,717
Research and development................... 238 840 1,961 2,504 2,673
Write-off of purchased in-process research
and development......................... -- 1,223 245 -- 1,480
General and administrative expenses........ 1,065 2,770 3,799 3,715 4,442
Marketing and promotion expenses........... 130 912 2,824 3,998 4,824
Depreciation and amortization.............. 1,519 2,477 3,426 3,017 2,690
------- ------- ------- ------- -------
Total operating expenses........... 4,498 12,105 18,454 20,679 25,826
------- ------- ------- ------- -------
Operating income (loss)...................... 168 (2,809) (2,585) 224 3,238
Other income (expense):
Interest income............................ -- -- 114 993 2,503
Interest expense........................... (591) (815) (893) (600) (147)
------- ------- ------- ------- -------
Income (loss) before income taxes and
minority interest....................... (423) (3,624) (3,364) 617 5,594
Income taxes................................. -- -- 15 28 198
------- ------- ------- ------- -------
Income (loss) before minority interest....... (423) (3,624) (3,379) 589 5,396
Minority interest............................ -- 53 (106) -- --
------- ------- ------- ------- -------
Net income (loss)............................ $ (423) $(3,571) $(3,485) $ 589 $ 5,396
======= ======= ======= ======= =======
Net income (loss) per share(2):
Basic...................................... $ (0.56) $ (1.30) $ (0.66) $ 0.08 $ 0.52
======= ======= ======= ======= =======
Diluted.................................... $ (0.56) $ (1.30) $ (0.66) $ 0.07 $ 0.48
======= ======= ======= ======= =======
Weighted average shares outstanding(2):
Basic...................................... 762 2,752 5,247 7,200 10,461
Diluted.................................... 762 2,752 5,247 8,676 11,197
</TABLE>

17
<PAGE> 21

<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------------------------------------
1994 1995 1996 1997 1998
------- ------- -------- ------- -------
(IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Working capital (deficit)................... $ (844) $(1,560) $ 2,068 $38,397 $44,398
Total assets................................ 4,150 10,316 13,892 49,923 60,320
Accounts payable and accrued liabilities.... 690 1,941 2,689 4,048 4,715
Short-term borrowings, including current
portion of long-term debt................. 1,392 1,049 1,834 1,048 535
Long-term obligations, net of current
portion................................... 4,718 6,994 6,353 661 58
Minority interest........................... -- 1,340 -- -- --
Accumulated deficit......................... (7,514) (11,085) (14,570) (13,981) (8,584)
Total stockholders' equity (deficit)........ (2,649) (2,380) 1,954 43,478 54,264
</TABLE>

- ---------------

(1) Our statement of operations data for 1994 consist of the accounts of THISCO,
our wholly owned subsidiary. Statement of operations data for subsequent
periods reflects our operations, including the depreciation and amortization
of the following:

- Acquisition of 83.3% of the outstanding capital stock of HCC in July 1995

- Acquisition of the remaining 16.7% of the outstanding capital stock of
HCC in June 1996

- Acquisition of Driving Revenue in August 1998.

(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.

18
<PAGE> 22

MANAGEMENT'S DISCUSSION AND ANALYSIS
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with
the Consolidated Financial Statements and the Notes thereto appearing elsewhere
in this prospectus.

GENERAL FINANCIAL INFORMATION RELATING TO PEGASUS

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 our Internet-based distribution services. These
services improve the efficiency and effectiveness of the hotel reservation
process by enabling travel agents and individual travelers to electronically
access hotel room inventory information and conduct reservation transactions.

Our GDS distribution service, formerly referred to as THISCO, provides an
electronic interface between a hotel's central reservation system and the global
distribution systems that travel agents use to book hotel and airline
reservations. Revenues from this service are derived by charging hotel
participants a fee based on the number of reservations made, less the number
cancelled ("net reservations"), and a fee for "status messages" processed
through our GDS distribution service. Status messages are electronic messages
sent by hotels to global distribution systems to update room rates, features and
availability information in global distribution system databases. As a hotel's
cumulative volume of net reservations increases during the course of the
calendar year, its fee per transaction decreases after predetermined transaction
volume hurdles have been met. As a result, for higher volume customers, unit
transaction fees are higher at the beginning of the year, when cumulative
transactions are lower. Pegasus recognizes revenues based on the fee per
transaction that a customer is expected to pay during the entire year. This
process of recognizing revenues creates a deferred revenue balance during early
periods of the year, which is reflected in interim balance sheets. The deferred
revenue balance created during the early periods of the year is fully utilized
and eliminated by the end of each year. We offer volume-based discounting of our
GDS distribution service fees. The recent consolidation in the hotel industry
has resulted in a lower average fee per transaction for the GDS distribution
service. Despite increases in the number of transactions, revenues generated
from our GDS distribution service has remained consistent with prior periods. We
expect this trend to continue. See "Risk Factors -- Rapid consolidation and
economic changes in the hotel industry could lower the value of our services."

Additionally, Pegasus generally charges new participants in our GDS
distribution service a one-time set-up fee for work associated with the
implementation of this 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. Pegasus
also charges certain global distribution systems a fee based on the number of
net reservations to compensate for the management and consolidation of multiple
interfaces.

Our Internet-based distribution services provide online hotel reservation
capabilities to travelers via our TravelWeb.com website (www.travelweb.com) and
our private-label reservation service, formerly referred to as NetBooker. To
participate in our Internet-based distribution services, hotels pay Pegasus
subscription fees based on the number of the hotel company's properties in our
online distribution database. For reservations that originate on our
TravelWeb.com website, Pegasus assesses either a transaction fee based on the
number of net reservations made at participating properties or a commission
based on the value of the guest stay. For reservations that originate on
websites using our private-label reservation service, Pegasus charges
transaction fees based on the number of net reservations made at participating
properties. Private-label reservation customers also pay initial development,
maintenance and licensing fees.

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<PAGE> 23

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
Commission Processing derives revenues by charging a participating travel agency
a fee based on a percentage of commissions paid to that agency. Pegasus also
generally charges a participating hotel a fee based on the number of
commissionable transactions arising from that hotel. Revenues from travel agency
fees can vary substantially from period to period based on the types of hotels
at which reservations are made and fluctuations in overall room rates. Pegasus
Commission Processing recognizes revenues in the month in which the hotel stay
occurs. In the following month, Pegasus collects commissions from the hotels by
the 12th business day of such month and pays commissions to travel agencies by
the 15th business day of such month. If a hotel fails to deliver funds to
Pegasus, Pegasus is not obligated to deliver commission payments on behalf of
the hotel to travel agencies.

Pegasus Business Intelligence. 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. Pegasus Business Intelligence revenues consist of fees
charged to hotels for the development of hotel databases and for consulting
services. Pegasus Business Intelligence was formerly referred to as Pegasus IQ
and Driving Revenue.

Historically, Pegasus has derived a majority of its revenues from our
electronic distribution and commission processing services. For the year ended
December 31, 1998, approximately 42% of our consolidated revenues was derived
from Pegasus Electronic Distribution, approximately 55% of our consolidated
revenues was derived from Pegasus Commission Processing and approximately 3% of
our consolidated revenues was derived from Pegasus Business Intelligence.
Pegasus has experienced substantial growth since its inception. Revenues
increased at a compound annual rate of approximately 48% to $29.1 million in
1998 from $2.8 million in 1992, excluding 1992 revenues from The Hotel Clearing
Corporation which was acquired in 1995. However, there can be no assurance that
Pegasus will experience the same rate of revenue growth in the future. Any
significant decrease in the rate of revenue growth could have a material adverse
effect on our financial condition and results of operations.

Pegasus has developed or is in the process of developing several new
services to capitalize on its existing technology and customer base and to
provide additional electronic hotel reservation capabilities and information
services to existing Pegasus customers and to other participants in the hotel
room distribution process. Pegasus Electronic Distribution intends to introduce
services that automate the processing of hotel bookings for large meetings and
conventions and for corporate travelers. Pegasus Business Intelligence intends
to introduce data mining and reporting services for benchmark analysis and
strategic planning for the hotel industry. Pegasus has not received a material
amount of revenue from these services, and there can be no assurance that any of
these services will produce a material amount of revenue in the future. See
"Risk Factors -- Our future success depends on our ability to develop new
technologies and services to meet the changing needs of our current and future
customers." Our future success will depend, in part, on our ability to:

- develop leading technologies

- enhance our existing services

- develop and introduce new services that address the increasingly
sophisticated and varied needs of our current and prospective customers

- respond to technological advances and emerging industry standards and
practices on a timely and cost-effective basis

Our cost of services consists principally of personnel costs relating to
information technology, facilities and equipment maintenance costs and fees paid
to our processing bank for the processing of travel agency commissions. Research
and development costs consist principally of personnel costs, related overhead
costs

20
<PAGE> 24

and fees paid to outside consultants. General and administrative expenses are
primarily personnel, office, legal and accounting related. Marketing and
promotion expenses consist primarily of personnel costs, advertising,
amortization of customer incentive contracts, public relations and participation
in trade shows and other industry events. Depreciation and amortization expense
includes depreciation of computer equipment, office furniture, office equipment
and leasehold improvements as well as amortization of software and goodwill.
Interest expense includes interest on notes payable to certain stockholders of
Pegasus and interest on payments made under capital equipment leases. Minority
interest represents certain former minority interests in our subsidiaries that
have been wholly owned by Pegasus since June 1996.

RECENT DEVELOPMENTS

RESULTS OF OPERATIONS

The following table sets forth, for the periods indicated, the percentage
relationship of certain items from our statement of operations to net revenues:

PERCENTAGE OF NET REVENUES

<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Net revenues................................................ 100.0% 100.0% 100.0%
Operating expenses:
Cost of services.......................................... 39.1 35.6 33.4
Research and development.................................. 12.4 12.0 9.2
Write-off of purchased in-process research and
development............................................ 1.5 -- 5.1
General and administrative expenses....................... 23.9 17.8 15.3
Marketing and promotion expenses.......................... 17.8 19.1 16.6
Depreciation and amortization............................. 21.6 14.4 9.3
----- ----- -----
Total operating expenses.......................... 116.3 98.9 88.9
----- ----- -----
Operating income (loss)..................................... (16.3) 1.1 11.1
Other income (expense):
Interest income........................................... 0.7 4.7 8.6
Interest expense.......................................... (5.6) (2.9) (0.5)
----- ----- -----
Income (loss) before income taxes and minority interest..... (21.2) 2.9 19.2
Income taxes................................................ 0.1 0.1 0.6
----- ----- -----
Income (loss) before minority interest...................... (21.3) 2.8 18.6
Minority interest........................................... (0.7) -- --
----- ----- -----
Net income (loss)........................................... (22.0)% 2.8% 18.6%
===== ===== =====
</TABLE>

Years Ended December 31, 1998 and 1997

Net revenues. Our net revenues for 1998 increased to $29.1 million from
$20.9 million in 1997, an increase of 39.0%. The increase in revenues was
primarily driven by higher transaction levels for Pegasus Electronic
Distribution and Pegasus Commission Processing as well as revenues derived from
Pegasus Business Intelligence.

21
<PAGE> 25

Pegasus Electronic Distribution revenues increased 24.8% in 1998 compared
to 1997 primarily due to an increase in the number of hotel reservations made
through our website on the Internet (www.travelweb.com) and an increase in the
average fee earned per transaction. In addition, there was an increase in the
number of hotel reservations made through other websites that use our
private-label reservation service. Also, more hotel companies paid fees to be
listed in our online distribution database. Net reservations made through our
GDS distribution service increased by 22.6% in 1998 compared to 1997, but this
increase was offset by a reduction in the average fee per reservation. As a
result, net revenues from the GDS distribution service remained consistent with
the prior year.

Pegasus Commission Processing revenues increased 43.6% in 1998 compared to
1997 as a result of a 34.4% increase in the number of hotel commission
transactions processed. The increase in the number of transactions was due in
part to an increase in the number of hotel properties and travel agencies
participating in Pegasus Commission Processing. The value of commissions paid to
travel agencies by Pegasus Commission Processing increased 48.5% in 1998
compared to 1997 because of an increase in the number of hotel commission
transactions processed combined with an increase in the average value of the
commissions processed. The average value of commissionable transactions
processed increased due to rising overall average daily rates for hotel rooms as
well as a higher proportion of transactions generated by full-service and luxury
hotel chains. Net revenues arising from the increase in commissions paid was
somewhat offset by a reduction in the average fee received from participating
travel agencies for consolidating and remitting hotel commission payments.

Pegasus Business Intelligence revenues were $903,000 for 1998 and consisted
of fees charged to hotels for the development and maintenance of hotel databases
and for consulting services.

Cost of services. Cost of services increased by $2.3 million, or 30.5%, to
$9.7 million in 1998 from $7.4 million in 1997. Cost of services increased due
to additional staffing, higher pay rates for technology personnel and the
increased number of Pegasus Commission Processing transactions, which added to
the processing fees paid to our processing bank.

Research and development; Write-off of purchased in-process research and
development. Research and development expenses increased $1.7 million, or 65.9%,
to $4.2 million in 1998 from $2.5 million in 1997. Excluding the effect of the
one-time charge taken in 1998 for in-process research and development expenses
relating to the acquisition of Driving Revenue, research and development
expenses increased $170,000, or 6.8%, to $2.7 million in 1998 from $2.5 million
in 1997. This increase was primarily due to expenditures relating to the
development of business intelligence services. Based on a third party valuation,
approximately $1.5 million of the Driving Revenue acquisition purchase price was
allocated to in-process research and development projects that at the time of
the Driving Revenue acquisition had not reached technological feasibility and
had no probable alternative future use.

General and administrative expenses. General and administrative expenses
increased $727,000, or 19.6%, to $4.4 million in 1998 from $3.7 million in 1997.
The increase was primarily due to higher legal, accounting, insurance, printing
and reporting costs associated with operating as a public company.

Marketing and promotion expenses. Marketing and promotion expenses
increased $826,000, or 20.7%, to $4.8 million in 1998 from $4.0 million in 1997.
Marketing and promotion expenses grew primarily due to the addition of sales and
marketing staff, the promotion of our other services in Pegasus Electronic
Distribution and Pegasus Commission Processing.

Depreciation and amortization. Depreciation and amortization expenses
decreased $327,000, or 10.8%, to $2.7 million in 1998 from $3.0 million in 1997.
This decrease was primarily due to the final amortization of capitalized
software related to our acquisition of 83.3% of HCC's outstanding capital stock
in 1995. The decrease was partially offset by the addition of amortization
related to software purchased from Wetherly International in December 1997 and
the addition of goodwill and software amortization related to the acquisition of
Driving Revenue in August 1998.

Interest income. Interest income increased $1.5 million to $2.5 million in
1998 from $994,000 in 1997. Interest income increased as a result of short-term
investment of operating cash balances and of a
22
<PAGE> 26

portion of the proceeds from our secondary public offering of common stock in
February 1998. In addition, 1998 included a full year of interest income earned
on proceeds from our initial public offering of common stock in August 1997.

Interest expense. Interest expense decreased $453,000, or 75.5%, to
$147,000 in 1998 from $600,000 in 1997. The 1998 expense reflects payments made
under capital equipment leases. The expense in 1997 consisted of interest
accrued on promissory notes payable to certain Pegasus stockholders as well as
interest accrued on payments made under capital equipment leases. Pegasus repaid
all of its promissory notes in August 1997 using a portion of the proceeds from
its initial public offering.

Income taxes. Income taxes for 1998 reflect state and foreign income taxes
payable as Pegasus was able to realize the benefit of its federal net operating
loss carryforwards. In the fourth quarter of 1998, Pegasus released a
significant portion of the valuation allowance as management believes it is more
likely than not that the net deferred tax asset will be realized. Income taxes
for 1997 reflect foreign income taxes payable with respect to the taxable
earnings of our United Kingdom subsidiary, which reports earnings on a cost-plus
basis. In 1997, the net deferred tax asset was fully reserved because of
uncertainty regarding our ability to realize the benefit of the asset in future
years.

Years Ended December 31, 1997 and 1996

Net revenues. Our net revenues for 1997 increased to $20.9 million from
$15.9 million in 1996, an increase of 31.7%. The increase in revenues was
primarily driven by higher transaction levels for Pegasus Electronic
Distribution and Pegasus Commission Processing.

Pegasus Electronic Distribution revenues increased 21.2% in 1997 compared
to 1996. Net reservations made through our GDS distribution service increased
25.7% in 1997 compared to 1996. Revenues contributed by our TravelWeb.com
website decreased by 7.7% in 1997 compared to 1996. This decrease was primarily
a result of the transition from revenues based on website page building and
maintenance fees to revenues based on monthly subscription fees and booking fees
per net reservation.

Pegasus Commission Processing revenues increased 42.8% as a result of a
38.0% increase in hotel commission transactions processed during 1997 compared
to 1996. The increase in the number of transactions was due in part to the
addition of hotel properties, including those of Marriott Corporation, and
travel agencies participating in Pegasus Commission Processing. The net revenues
per commissionable transaction increased in 1997 because of an increase in
overall average daily rates for hotel rooms.

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 our electronic distribution and commission
processing services and the increased number of commission processing
transactions, which added to the processing fees paid to our processing bank.

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. Excluding the effect of the
one-time charge taken in 1996 for in-process 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 our TravelWeb.com website
including the development of our online distribution database.

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 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 our TravelWeb.com website and, to a
lesser degree, the promotion of our other services in Pegasus Electronic
Distribution and Pegasus Commission Processing.

23
<PAGE> 27

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 1996 completion of amortization for a
number of software development projects that had been previously capitalized.

Interest income. During 1997, Pegasus realized $994,000 in interest income
as a result of short-term investment of operating cash balances and of the
proceeds from its initial public offering.

Interest expense. Interest expense decreased $293,000, or 32.8%, to
$600,000 in 1997 from $893,000 in 1996. The expense reflects interest accrued on
promissory notes payable to certain stockholders of Pegasus and interest accrued
on payments made under capital equipment leases. Interest expense decreased
primarily due to the repayment of all promissory notes in August 1997 using
proceeds from our initial public offering of common stock.

Income taxes. Income taxes reflect foreign income taxes payable with
respect to the taxable earnings of our United Kingdom subsidiary, which reports
earnings on a cost-plus basis.

SELECTED QUARTERLY RESULTS OF OPERATIONS

The following table sets forth certain unaudited statement of operations
data for each of our last eight quarters through December 31, 1998, as well as
such data expressed as a percentage of our total net revenues for the periods
indicated. This data has been derived from our unaudited financial statements
that, in management's opinion, include all adjustments (consisting only of
normal recurring adjustments) necessary for a fair presentation of such
information when read in conjunction with our audited Consolidated Financial
Statements and the Notes thereto appearing elsewhere in this prospectus. Pegasus
believes that quarter-to-quarter comparisons of its financial results are not
necessarily meaningful and should not be relied upon as any indication of future
performance.

<TABLE>
<CAPTION>
QUARTER ENDED
---------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1997 1997 1997 1997 1998 1998 1998 1998
-------- -------- --------- -------- -------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues......................... $4,377 $5,081 $5,778 $ 5,667 $ 6,167 $ 6,781 $ 7,803 $ 8,313
Operating expenses:
Cost of services................... 1,558 1,799 2,114 1,974 2,166 2,408 2,517 2,626
Research and development........... 623 609 586 686 601 625 741 707
Write-off of purchased in-process
research and development......... -- -- -- -- -- -- 1,480 --
General and administrative
expenses......................... 856 816 939 1,104 1,055 1,038 1,109 1,240
Marketing and promotion expenses... 865 1,053 1,068 1,012 1,242 1,178 1,191 1,213
Depreciation and amortization...... 707 721 863 726 753 762 566 609
------ ------ ------ ------- ------- ------- ------- -------
Total operating expenses..... 4,609 4,998 5,570 5,502 5,817 6,011 7,604 6,395
------ ------ ------ ------- ------- ------- ------- -------
Income (loss) from operations........ (232) 83 208 165 350 770 199 1,918
Other income (expense):
Interest income.................... 56 43 342 551 644 653 632 574
Interest expense................... (212) (203) (128) (56) (47) (41) (33) (25)
------ ------ ------ ------- ------- ------- ------- -------
Income (loss) before income taxes and
minority interest.................. (388) (77) 422 660 947 1,382 798 2,467
Income taxes......................... -- 16 10 2 7 25 26 140
------ ------ ------ ------- ------- ------- ------- -------
Income (loss) before minority
interest........................... (388) (93) 412 658 940 1,357 772 2,327
Minority interest.................... -- -- -- -- -- -- -- --
------ ------ ------ ------- ------- ------- ------- -------
Net income (loss).................... $ (388) $ (93) $ 412 $ 658 $ 940 $ 1,357 $ 772 $ 2,327
====== ====== ====== ======= ======= ======= ======= =======
Net income (loss) per share:
Basic.............................. $(0.07) $(0.02) $ 0.05 $ 0.06 $ 0.09 $ 0.13 $ 0.07 $ 0.22
====== ====== ====== ======= ======= ======= ======= =======
Diluted............................ $(0.07) $(0.02) $ 0.04 $ 0.06 $ 0.09 $ 0.12 $ 0.07 $ 0.21
====== ====== ====== ======= ======= ======= ======= =======
Weighted average shares outstanding:
Basic.............................. 5,191 5,191 8,173 10,180 10,325 10,491 10,508 10,518
Diluted............................ 5,191 5,191 9,380 10,907 11,038 11,269 11,195 11,282
</TABLE>

24
<PAGE> 28

<TABLE>
<CAPTION>
AS A PERCENTAGE OF REVENUES
---------------------------------------------------------------------------------------
MAR. 31, JUNE 30, SEPT. 30, DEC. 31, MAR. 31, JUNE 30, SEPT. 30, DEC. 31,
1997 1997 1997 1997 1998 1998 1998 1998
-------- -------- --------- -------- -------- -------- --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Net revenues......................... 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Operating expenses:
Cost of services................... 35.6 35.4 36.6 34.8 35.1 35.5 32.3 31.6
Research and development........... 14.2 12.0 10.1 12.1 9.7 9.2 9.5 8.5
Write-off of purchased in-process
research and development......... -- -- -- -- -- -- 19.0 --
General and administrative
expenses......................... 19.6 16.1 16.3 19.5 17.1 15.3 14.2 14.9
Marketing and promotion expenses... 19.8 20.7 18.5 17.9 20.2 17.4 15.3 14.6
Depreciation and amortization...... 16.1 14.2 14.9 12.8 12.2 11.2 7.2 7.3
------ ------ ------ ------- ------- ------- ------- -------
Total operating expenses..... 105.3 98.4 96.4 97.1 94.3 88.6 97.5 76.9
------ ------ ------ ------- ------- ------- ------- -------
Income (loss) from operations........ (5.3) 1.6 3.6 2.9 5.7 11.4 2.5 23.1
Other income (expense):
Interest income.................... 1.2 0.9 5.9 9.7 10.4 9.6 8.1 6.9
Interest expense................... (4.8) (4.0) (2.2) (1.0) (0.8) (0.6) (0.4) (0.3)
------ ------ ------ ------- ------- ------- ------- -------
Income (loss) before income taxes and
minority interest.................. (8.9) (1.5) 7.3 11.6 15.3 20.4 10.2 29.7
Income taxes......................... -- 0.3 0.2 -- 0.1 0.4 0.3 1.7
------ ------ ------ ------- ------- ------- ------- -------
Income (loss) before minority
interest........................... (8.9) (1.8) 7.1 11.6 15.2 20.0 9.9 28.0
Minority interest.................... -- -- -- -- -- -- -- --
------ ------ ------ ------- ------- ------- ------- -------
Net income (loss).................... (8.9)% (1.8)% 7.1% 11.6% 15.2% 20.0% 9.9% 28.0%
====== ====== ====== ======= ======= ======= ======= =======
</TABLE>

LIQUIDITY AND CAPITAL RESOURCES

Our principal sources of liquidity at December 31, 1998 included cash and
cash equivalents of $25.0 million, short-term investments of $15.8 million and
restricted cash of $2.1 million. Restricted cash represents funds for travel
agency commission checks that have not cleared the processing bank and are
returned to Pegasus. The portion of restricted cash not remitted to travel
agents will be escheated to the appropriate state, as required. Pegasus has
financed its cash requirements for investments in equipment primarily through
cash generated from operations, the sale of capital stock and capital lease
financing.

Working capital increased from $38.4 million in 1997 to $44.4 million in
1998, and net cash provided by operating activities increased from $2.8 million
in 1997 to $6.8 million in 1998 due to our improved operating performance.

Capital expenditures consist of purchases of software, furniture and
equipment and amounted to $1.7 million in 1998 compared to $1.6 million in 1997.
In addition, Pegasus acquired no equipment under capital leases in 1998 compared
with $79,000 in 1997. Additional uses of cash for investing activities in 1998
included the purchase of Driving Revenue, strategic equity investments and
marketable securities.

Pegasus completed an initial public offering of its common stock in August
1997, raising proceeds of $40.5 million, net of offering expenses. Approximately
$5.2 million of the proceeds was used to repay notes payable to stockholders and
to repay certain lease obligations. The remainder of the proceeds was placed in
short-term marketable securities. Pegasus completed a secondary offering of its
common stock in February 1998, raising net proceeds to Pegasus of $4.2 million.
A portion of the proceeds was used to repay certain lease obligations, with the
remaining proceeds placed in short-term marketable securities.

Pegasus does not believe that inflation has materially impacted results of
operations during the past three years. Substantial increases in costs and
expenses could have a significant impact on our results of operations to the
extent such increases are not passed along to customers.

Pegasus believes that there are sufficient funds available from operations
to adequately manage the expansion of the business in the foreseeable future.

25
<PAGE> 29

YEAR 2000 COMPLIANCE

The year 2000 computer issue is primarily the result of information
technology (IT) and 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 the services
provided to customers as well as any IT and non-IT internal systems supporting
our operations. Pegasus is currently in the process of testing and upgrading, if
necessary, its systems and processes to comply with the requirements of the year
2000 date transition. Pegasus personnel are researching internal IT and non-IT
hardware, software and data issues related to dates and date range processing,
and each product line is undergoing extensive internal and external testing. Any
non-compliant hardware or software discovered during testing will be upgraded or
replaced. This process includes 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.......................... 90% June 1999
Testing............................................. 85% June 1999
Contingency planning................................ 50% June 1999
</TABLE>

SUPPLIERS, CUSTOMERS AND THIRD-PARTY PROVIDERS

<TABLE>
<CAPTION>
PERCENT ESTIMATED
PHASE COMPLETE COMPLETION DATE
- ----- -------- ---------------
<S> <C> <C>
Awareness........................................... 100% Complete
Assessment questionnaires........................... 100% Complete
Detail assessment review with third-party
providers......................................... 75% June 1999
Contract review..................................... 75% June 1999
Contingency planning................................ 50% June 1999
Testing as applicable............................... 85% June 1999
</TABLE>

Costs. During 1998 and 1997, Pegasus expensed approximately $258,000 and
$108,000, respectively, in labor costs associated with its year 2000 efforts. In
1999, labor costs 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 current systems. Pegasus does
not anticipate incurring a material amount of additional costs related to the
purchase of IT or non-IT systems 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.

Risk/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

26
<PAGE> 30

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 of its revenues from processing electronic
reservations or consolidating hotel commissions electronically. The inability or
limitation of its 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 its business, any interruption or outage of telecommunications,
electricity or other basic utility services may also adversely impact our
ability to do business. As discussed above, Pegasus has begun its efforts to
evaluate the readiness of these critical suppliers.

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 also have a material adverse effect on our cash flows and
results of operations.

Pegasus is in the early phase of developing contingency plans and
determining the extent of such plans.

RECENTLY ISSUED ACCOUNTING STANDARDS

In March 1998, the American Institute of Certified Public Accountants
issued Statement of Position No. 98-1, "Accounting for the Costs of Computer
Software Developed or Obtained for Internal Use" (SOP 98-1). SOP 98-1 requires
that certain costs related to the development or purchase of internal-use
software be capitalized and amortized over the estimated useful life of the
software. SOP 98-1 is effective for financial statements for fiscal years
beginning after December 15, 1998. Accordingly, Pegasus will adopt SOP 98-1 in
its 1999 annual financial statements. Pegasus does not believe the adoption of
SOP 98-1 will have a material impact on our results of operations or financial
condition.

In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (FAS 133). FAS 133 requires that all derivative
instruments be recorded on the balance sheet at fair value. Changes in the fair
value of derivative instruments are recorded each period in current earnings or
other comprehensive income, depending on whether a derivative is designated as
part of a hedge transaction. FAS 133 is effective for our first quarter
financial statements in fiscal 2000. Pegasus is not currently involved in
derivative instruments or hedging activities, and therefore, will measure the
impact of this statement as it becomes necessary.

27
<PAGE> 31

BUSINESS

OVERVIEW

- Pegasus Electronic Distribution improves the efficiency and effectiveness
of the hotel reservation process by enabling travel agents and individual
travelers to electronically access hotel room inventory information and
conduct reservation transactions. Pegasus Electronic Distribution
includes our GDS distribution service, which was historically referred to
as the THISCO service, and our Internet-based distribution services,
which include TravelWeb.com, our private-label reservation service and
other Internet-based distribution services. Our private-label reservation
service was formerly referred to as NetBooker.

- Pegasus Commission Processing improves the efficiency and effectiveness
of the commission payment process for participating hotels and travel
agencies by consolidating payments in the customer's currency of choice
and providing comprehensive transaction reports. Pegasus Commission
Processing includes what historically was referred to as HCC.

- 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.

In 1998, approximately 42%, 55% and 3% of Pegasus' consolidated revenues
were derived from Pegasus Electronic Distribution, Pegasus Commission Processing
and Pegasus Business Intelligence, respectively.

INDUSTRY BACKGROUND

The room reservation and commission payment processes in the hotel industry
are complex and information intensive. Making a hotel room reservation requires
significant amounts of data, such as room rates, features and availability. This
complexity is compounded by the need to confirm, revise or cancel room
reservations, which generally requires 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. Furthermore, this process consists of a number of relatively small
payments to travel agencies that often include payments in multiple currencies.
In addition, information regarding guest cancellations and "no-shows" needs to
be accurately communicated between hotels and travel agencies in order to
reconcile commission payments.

Reservations for hotel rooms are made either directly by individual
travelers or indirectly through intermediaries. Individual travelers typically
make direct reservations by 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 websites. Intermediaries for hotel room reservations,
including travel agencies, convention and other large meeting organizers and
corporate travel departments, access hotel information either by telephone or
fax or through a global distribution system. Global distribution systems
maintain databases of room rates, features and availability information provided
by hotels to which they are connected. Because each global distribution system
has a unique electronic interface to hotel reservation systems, each global
distribution system can obtain room information and book rooms only at hotels
that have developed protocols and message formats compatible with that
particular global distribution system.

A number of current trends are affecting the hotel industry:

- The hotel industry has been shifting from manual to electronic means of
making hotel room reservations. As more hotels become electronically
bookable, Pegasus expects that electronic hotel
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room reservations will grow substantially in the United States and
internationally over the next several years.

- A growing number of individual travelers are making hotel room
reservations electronically on the Internet.

- Smaller hotel chains and independent hotels increasingly have affiliated
with 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 our customers.

- Hotel commissions are becoming increasingly important to travel agencies
as a source of revenue. Travel agencies are looking to increase their
revenue by making more hotel room reservations to offset the effects of
increased competition among travel agencies, new competition from
emerging travel service distribution channels and caps on commissions for
airline reservations, which historically have been the leading revenue
source for travel agencies.

- Participants in the travel industry increasingly desire detailed,
customized information regarding hotel room distribution that can be
delivered in a timely manner. Much of the information currently available
regarding hotel room distribution does not contain in-depth detail about
guest behavior. It also may not be customized to contain the information
that is valuable to a user. Furthermore, it may reflect events or
industry patterns that occurred months in the past and as a result may
not be as useful.

PEGASUS SOLUTION

Pegasus provides information and transaction processing services that
improve the efficiency and effectiveness of the hotel room reservation and
commission payment processes. Pegasus Electronic Distribution enhances the
electronic hotel room reservation process by providing a standard, common
electronic interface that enables individual travelers and intermediaries to
access hotel room inventory information and conduct reservation transactions.
Pegasus Commission Processing improves the efficiency and effectiveness of the
commission payment process for hotels and travel agencies by consolidating
commissions into one payment in the travel agency's currency of choice and
providing comprehensive transaction reports. Pegasus Business Intelligence is
intended to provide detailed and timely hotel information that is valuable to a
wide variety of audiences in the global hotel industry from hotel chains to
travel industry marketing groups to corporate travel departments.

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<PAGE> 33

Depicted in the following diagram are Pegasus Electronic Distribution,
Pegasus Commission Processing and Pegasus Business Intelligence.
LOGO

Depicted in the following diagram are Pegasus Systems' core services.

The drawing depicts the following transaction flows:

3. Consumer makes a hotel reservation on TravelWeb.com, which sends
the reservation request to the hotel via Pegasus electronic distribution
technology.

4. Consumer makes a hotel reservation on a website that uses Pegasus
private-label reservation service, which sends the reservation request to
the hotel via Pegasus electronic distribution technology.

6. Hotels send booking data to Pegasus Commission Processing, which
consolidates the commissions and sends a commission check to the travel
agency.

7. Pegasus Business Intelligence gathers data from the hotels that are
connected to the Pegasus electronic distribution technology and/or use
Pegasus Commission Processing.

Our services benefit many of the participants in the hotel room
distribution process, including hotels, hotel representation firms, global
distribution systems, travel agencies, convention and other large meeting
organizers, corporate travel departments and websites with travel-related
features. Our strategic position as a gateway in the hotel room distribution
chain, our transaction processing capabilities and our reputation for
reliability and neutrality enable us to offer a range of services delivering
industry-wide benefits that are difficult for industry participants to achieve
individually. Because Pegasus processes transactions from a wide variety of
sources, it is well positioned to capitalize on the overall growth in electronic
hotel reservations, whether made through global distribution systems, the
Internet or other means.

STRATEGY

Our goal is to be the leading provider of information services and
technology in the distribution of hotel rooms. We believe that our central role
in the hotel industry room reservation process positions us to achieve this
goal. The following are key elements of our strategy:

Expand Hotel Room Distribution Channels. Pegasus is expanding its service
offerings to include additional distribution channels, such as hotel room
reservation services for individual travelers over the Internet, for convention
and other large meeting organizers and for corporate travel departments. Pegasus
is addressing this online distribution opportunity through increasing the
capability and consumer awareness of our TravelWeb.com website and expanding the
use by third-party websites of our private-label reservation service. Our
services are intended to provide transaction fee revenue opportunities through
virtually all of the distribution channels by which electronic hotel room
reservations occur.

Develop and Expand Pegasus Business Intelligence. Pegasus intends to
continue the development and expansion of Pegasus Business Intelligence. This
service is intended to provide hotel and other industry

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<PAGE> 34

participants with hotel transaction information for use in strategic analysis,
market tracking, improved target marketing and revenue optimization. Pegasus
recently acquired and is developing software and technology to enhance our
ability to gather and process hotel checkout data for Pegasus Business
Intelligence.

Build Strategic Alliances and Pursue Acquisition Opportunities. Pegasus
intends to build strategic alliances with other participants in the hotel
industry, as well as members of the financial information services, Internet and
information technology industries, to enhance the functionality and market
presence of our services. Pegasus believes that these relationships will
increase brand recognition of our services and help to expand our customer base.
Pegasus will also seek to acquire assets, technology and businesses that provide
complementary services or access to new markets and customers.

Expand Customer Base. Our established customer base includes hotels, hotel
representation firms, travel agencies, global distribution systems and
third-party websites. Pegasus intends to expand our customer base domestically
and internationally by adding customers and by cross-selling our new and
existing services to our current and future customers. Because of the fixed
nature of many of our costs, addition of new customers and the increase in
transaction volumes with new and existing customers enhances the profitability
of all of our services.

SERVICES

Pegasus is organized into three businesses: Pegasus Electronic
Distribution, Pegasus Commission Processing and Pegasus Business Intelligence.

PEGASUS ELECTRONIC DISTRIBUTION

Pegasus Electronic Distribution consists of our GDS distribution service
and our Internet-based distribution services, including TravelWeb.com, our
private-label reservation service and our other Internet-based services.

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The following table summarizes the services of Pegasus Electronic
Distribution that Pegasus has developed or is developing (including year of
introduction):

<TABLE>
<S> <C> <C> <C>
PEGASUS ELECTRONIC DISTRIBUTION
----------------------------------------------------------------------------------------------------------------
Services Users Benefits
--------------------------------
GDS distribution service (1989) - Hotels and hotel - Improved efficiency because of single
representation firms interface
- Single electronic interface
between hotel central - Improved customer service due to
reservation systems and global frequent hotel room inventory updates
distribution systems utilized
by travel agencies - Improved accessibility to wide
audience of travel agencies via global
distribution systems
- Global distribution systems - Improved efficiency because of single
and participating travel interface
agencies
- Rapid confirmations
- Access to over 28,000 hotel properties
worldwide
- Real-time availability of information
TravelWeb.com - Hotels and hotel - Access to emerging low cost electronic
representation firms distribution channel
- Electronic hotel property
catalog (1994) - Reduced distribution costs
- Internet-based hotel room - Inexpensive publication and
reservations (1995) distribution of comprehensive and up-to-
date hotel information and promotions
- More attractive presentation of hotel
information
- Individual travelers - Around the clock electronic access to
hotel reservation capability
- Travel agents
- Ability to shop and gain convenient
access to approximately 27,000 hotel
properties with rich information
content, including rate, feature and
availability information and pictures
of properties
- Access to special promotional offers
Private-label reservation - Hotels and hotel - Access to emerging low cost electronic
service for third-party websites representation firms distribution channel
(1997)
- Reduced distribution costs
- Comprehensive hotel database
and hotel room reservation - Inexpensive publication and
capability tailored and fully distribution of comprehensive and up-to-
integrated into third-party date hotel information and promotions
websites
- More attractive presentation of hotel
information
- Wider distribution of hotel
information and access to individual
travelers through presence on multiple
websites
- Third-party websites - Low cost access to comprehensive hotel
information and proven on-line hotel
reservation functionality
- Increased site value due to wider
scope of services provided
- Advertising and transaction-based
revenue opportunities
Private-label reservation - Hotels - Access to emerging low cost electronic
service for hotel proprietary distribution channel
websites (1997)
- Reduced distribution costs
- Inexpensive publication and
distribution of comprehensive and up-to-
date hotel information and promotions
- More attractive presentation of hotel
information
Private-label reservations - Hotels and hotel - Broadened distribution channel
service for corporate travel representation firms
(1997) - Improved ability to update corporate
rate and availability information and
- Direct electronic access to respond to reservation requests
comprehensive hotel database
and hotel room reservation - Reduced distribution costs for
capability corporate room sales
- Corporate travel departments - Reduced time and effort in making
hotel reservations
- Enforcement of corporate travel
policies and utilization of preferred
rates
- Improved travel information reporting
- Third-party corporate travel - Account retention
management systems providers
- Low cost access to hotel information
- Corporate travel agencies and online booking functionality
- Reduced time and effort in making
hotel reservations
- Enforcement of corporate travel
policies and utilization of negotiated
rates at preferred hotels
- Improved travel information reporting
Meetings and conventions service - Hotels and hotel - Improved accuracy of convention and
(in development) representation firms large meeting reservations
- Single electronic interface - Reduced costs by eliminating manual
reservation process
- Improved tracking of room inventory
between hotel central - Convention and visitors - Improved reservation and cancellation
reservation systems and group bureaus tracking and reporting capabilities
reservation systems utilized
by meeting planners and - Meeting planners - Single connection to multiple hotel
convention housing organizers properties
- Group housing reservation
providers - Reduced costs by eliminating manual
reservation process
</TABLE>

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The following table sets forth the number of net reservations made through
Pegasus Electronic Distribution in each of the years 1994 through 1998.
Graph is titled: PEGASUS ELECTRONIC DISTRIBUTION
Net Reservations in Millions
Bar chart that shows the net reservations processed per year since 1994 by
Pegasus Electronic Distribution.

<TABLE>
<S> <C>
1994 8.4 million
1995 11.0 million
1996 13.9 million
1997 17.5 million
1998 21.5 million
</TABLE>

GDS distribution service

Our GDS distribution service provides an electronic interface for
communications concerning hotel reservation information between major global
distribution systems and hotel central reservation systems. The interface
enables a hotel to connect to all major global distribution systems without
having to build and maintain a separate interface for each global distribution
system. Without our GDS distribution service or a similar service, hotel chains
that desire their room inventory to be accessible to travel agencies
electronically on a global distribution system must develop protocols and
message formats compatible with each global distribution system, a process that
entails significant time and expense. Alternatively, hotels may rely more
heavily on less-automated means, such as traditional toll-free telephone
reservation centers with higher processing costs. The Pegasus electronic
distribution technology 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 global distribution system
databases. Many participating hotels also have chosen to utilize our service
that provides travel agencies with direct access through Pegasus to a hotel's
central reservation system, bypassing the global distribution system databases
to obtain the most complete and up-to-date hotel room information available.

Hotels using the GDS distribution service improve the efficiency of their
central reservation systems and reduce costs by not having to develop and
maintain separate communications circuits and translation software for each
global distribution system. Through the GDS distribution service, participating
hotels are able to gain improved access to a wide audience of travel agencies
worldwide that are connected to global distribution systems and to provide
better customer service due to the ability to frequently update hotel room
information on global distribution system databases in a fast and reliable
manner. The GDS distribution service benefits travel agencies that use global
distribution systems by providing real-time access to comprehensive hotel room
information and enabling them to make reservations and receive confirmations in
seconds from over 28,000 hotel properties worldwide.

Pegasus charges its hotel customers a fee based on the number of net
reservations processed through the GDS distribution service. In addition, hotels
pay certain fees for status messages sent to global distribution systems through
the GDS distribution service. New participants in the GDS distribution service
may be charged one-time set-up fees for work associated with the implementation
of the interface

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with the GDS distribution service. Pegasus also charges certain global
distribution systems a fee based on the number of net reservations to compensate
for the management and consolidation of multiple interfaces. Pegasus Electronic
Distribution technology enables Pegasus to enhance its revenue base by providing
the information and reservation interface for its other hotel reservation
services, including the TravelWeb.com, private-label reservation, meeting and
convention and corporate travel services.

Internet-based distribution services

Our Internet-based services include TravelWeb.com, our private-label
reservation service, our meetings and conventions service and our corporate
travel service. These services enable travelers to make reservations
electronically at approximately 27,000 properties in 170 countries. During 1998,
Pegasus estimates that approximately $150 million in net reservations for hotel
rooms were made using TravelWeb.com and our private-label reservation service.

TravelWeb.com. Located at www.travelweb.com, TravelWeb.com provides
individual travelers direct access to online hotel information and the ability
to make reservations electronically. Individual travelers traditionally obtain
information or reserve a room by contacting a hotel directly by telephone or fax
or indirectly through intermediaries, such as travel agencies, convention and
other large meeting organizers and corporate travel departments. As a result, an
individual traveler cannot easily obtain information from a wide range of hotel
properties in a timely manner. TravelWeb.com provides travelers with detailed
information regarding a wide array of hotel properties and, through its use of
Pegasus electronic distribution technology, allows travelers to reserve a hotel
room and receive a confirmation in seconds. In addition to hotel room
reservations, TravelWeb.com offers airline booking capabilities. In February
1999, TravelWeb.com hosted 12.8 million page views and during that month
received an average of 68,000 visitors per day.

TravelWeb.com benefits hotels, hotel representation firms and individual
travelers. TravelWeb.com reduces distribution costs for hotels and hotel
representation firms. TravelWeb.com also enables access to an emerging low cost
electronic distribution channel. In addition, TravelWeb.com provides an
inexpensive method of publishing and distributing comprehensive and up-to-date
hotel marketing information with an attractive presentation format featuring
visual images and graphics. Hotels can easily add, delete and update such
information using our "remote author" feature. This feature enables hotels to
take advantage of the real-time nature of the Internet to offer flexible pricing
and to reach individual travelers on a world-wide basis quickly and
inexpensively. TravelWeb.com benefits individual travelers by providing
electronic access, 24 hours a day, seven days a week, to shop for and reserve a
hotel room in one or more of the thousands of hotel properties online.
Furthermore, individual travelers are able to gain detailed information about a
hotel property and its special promotional offers through the rich information
content available on TravelWeb.com.

Pegasus derives its TravelWeb.com revenues by charging participating hotels
subscription fees based on the number of their properties included in the
database and a combination of transaction fees or commissions. Transaction fees
are based on the number of net reservations made at participating properties
through TravelWeb.com, and commissions are based on the value of the guest stay
for reservations booked through TravelWeb.com.

Private-label reservation service. Our private-label reservation service is
a service for the operators of third-party websites that combines our hotel
information database and the Pegasus electronic distribution technology to make
hotel room reservations. To conduct Internet-based electronic commerce
successfully, website operators must offer a content set that is sufficiently
broad, accurate, up-to-date, graphically appealing and useful to attract buyers
to the website. Typically, the development of such a content set is expensive
and time consuming. Furthermore, in addition to providing individual travelers
with access to useful and graphically appealing information, the operator of a
website must offer individual travelers the capability to effect a transaction
in order to generate a transaction fee. Our private-label reservation service
offers operators of websites an extensive and comprehensive set of hotel
information and a simple and fast method of making a hotel room reservation
online. Our private-label reservation service utilizes advanced

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<PAGE> 38

technology applications to customize the hotel database so that it appears to
the user to be an integral part of the third-party website. In connection with
this service, the operator of the third-party website establishes an interface
to the Pegasus electronic distribution technology, which enables users of the
website to shop and query room availability, electronically make a reservation
and receive a confirmation in seconds.

Our hotel customers benefit from our private-label reservation service
because it enables a broader dissemination through the emerging, low cost
Internet distribution channel of the same marketing information supplied to
TravelWeb.com. As a result, hotels need only incur the effort and expense of
creating and maintaining their information on a single site to reach multiple
Internet distribution points and achieve increased overall visibility.
Furthermore, our private-label reservation service provides hotel customers an
inexpensive means to distribute and publish visually attractive marketing
information and Internet-specific promotions. Hotels offering their own
brand-specific websites also can have their own content delivered to their sites
from our Internet database and process reservation requests from their websites
through our booking engine. Users and operators of third-party websites benefit
from our private-label service through immediate access to the rich content of
TravelWeb.com. Furthermore, because users of the third-party websites can book
hotel rooms and receive confirmations in seconds through our Pegasus electronic
distribution technology, our service affords the operators of third-party
websites the opportunity to generate a transaction fee revenue stream.

Pegasus realizes revenues from the private-label reservation service by
charging third-party websites initial development, maintenance and licensing
fees and by charging hotels a fee based on the number of net reservations made
through the private-label reservation service.

Other Internet-based services. Our meetings and conventions 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 our
meetings and conventions service, convention and other large meeting organizers
are able to transfer reservation requests to the Pegasus electronic distribution
technology, which translates the information to electronically book a room in
each hotel central reservation system. Our meetings and conventions service
eliminates the need to transfer rooming lists for manual entry at the hotel and
allows hotels to deliver reservations and confirmations electronically in a fast
and reliable manner. Pegasus recently entered into a strategic alliance with
Passkey.com to enhance the meeting and convention service.

Our meetings and conventions service can benefit all parties involved in
the distribution of hotel rooms for conventions and other large meetings. Since
reservations are made through our Pegasus electronic distribution technology
rather than manually, reservations, modifications and cancellations can be
received earlier and updated more frequently and efficiently. Our meetings and
conventions service provides convention and other large meeting organizers a
single connection to multiple hotel properties and enables fast, accurate and
reliable reservation and confirmation of hotel rooms at reduced cost. Our
meetings and conventions service also assists hotels in controlling their room
inventory by reducing the risk of overbooking or underbooking and allows hotels
to reduce the booking costs related to convention reservations. Pegasus
estimates that the majority of these types of reservations were made at five
major hotel chains (Hilton, Hyatt, Marriott, Sheraton and Westin) whose
facilities are designed for and cater to large conventions and meetings. Because
all five of these chains are GDS distribution service customers, Pegasus is
positioned to take advantage of the existing connectivity with these chains to
facilitate the development and marketing of the meeting and convention service.

Our corporate travel service provides the corporate travel management
industry with a direct real-time link to our online distribution database
through corporate intranet travel management software. With our corporate travel
service, corporate travelers are able to check availability and make hotel
reservations within seconds at hotel chains or properties with which the
traveler's employer has negotiated rates. Our corporate travel service enables
corporate travel departments to have access to the customized information
negotiated with hotel chains and properties to facilitate hotel room
reservations. Furthermore, this

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<PAGE> 39

information can be fully integrated into other components of the intranet site
and facilitate the creation of passenger name records and detailed profile
information.

The corporate travel service will benefit hotels by providing an additional
hotel room distribution channel and enabling targeted marketing efforts directed
at corporate travel departments. Hotels will also be able to reduce distribution
costs for corporate room sales and better update information and respond to
reservation requests from corporate travelers. Pegasus markets this service to
developers of corporate travel software programs and to travel agencies that
operate intranet travel management services. The corporate travel service is
intended to provide benefits to travel agencies and companies by decreasing the
amount of time necessary to arrange a business trip, improving travel
information reporting and helping to ensure that employees comply with company
travel policies and utilize hotels with whom a company has negotiated rates.

Pegasus 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 in the future. See
"Risk Factors -- Our future success depends on our ability to develop new
technologies and services to meet the changing needs of our current and future
customers."

PEGASUS COMMISSION PROCESSING

Pegasus Commission Processing began operations in 1992 to process the
payment of hotel commissions to travel agencies. The following table summarizes
the commission processing and payment services offered by Pegasus Commission
Processing:

<TABLE>
<S> <C> <C> <C>
- --------------------------------------------------------------------------------------------------------------------
PEGASUS COMMISSION PROCESSING
- --------------------------------------------------------------------------------------------------------------------
Services Users Benefits
- --------------------------------------------------------------------------------------------------------------------
Pegasus Commission - Travel agencies - Improved efficiency in reconciliation of commission
Processing (1992) payments
- Commission processing - Reduced bookkeeping and banking costs
service: aggregates,
reports and disburses - Improved information on customer reservation habits
hotel room reservation
commissions from hotels - Assistance in reconciling commissions through
to travel agencies customer relation centers
---------------------------
- Hotels and hotel - Streamlined commission payment process
representation firms
- Reduced accounting, processing and bookkeeping costs
- Improved information regarding travel agency
bookings
- Encouragement of travel agency bookings at hotels
- Commission payment - Hotels - Streamlined commission payment process
service: provides full
outsourcing on behalf of - Reduced accounting, processing and bookkeeping costs
hotels for all travel
agency hotel commission
payments
</TABLE>

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<PAGE> 40

Pegasus Commission Processing is the largest provider of travel agency
commission and processing services in the hotel industry. Pegasus has registered
over 23,500 properties and over 81,000 travel agencies as Pegasus Commission
Processing participants. During 1998, the dollar amount of the commissions
processed during this period totaled approximately $268 million. The following
table sets forth the dollar amount of commissions processed by Pegasus
Commission Processing during the periods indicated:
Graph is titled: TOTAL COMMISSIONS PAID
Dollars in Millions
Bar chart that shows the total commissions processed and paid per year by
Pegasus Commission Processing since 1994.

<TABLE>
<S> <C>
1994 $ 23.6 million
1995 $ 74.5 million
1996 $111.7 million
1997 $175.1 million
1998 $268.0 million
</TABLE>

Typically, a hotel pays to the travel agency that made the hotel
reservation a commission of approximately 10% of the room rate paid by a hotel
guest. However, the payment process related to these commissions historically
has been costly and inefficient. The process has consisted of numerous checks in
small amounts and little information regarding the basis from which the
commission was calculated. Furthermore, communication between hotels and travel
agencies regarding payable commissions generally has not been effective. Often,
guest cancellations or "no-shows" would not be reported and travel agencies
would expect a commission when in fact none was due. As a result, travel
agencies lacked the necessary resources to reconcile commission payments
effectively.

Pegasus Commission Processing streamlines the commission payment process by
consolidating into a single payment the aggregate commissions owed by
participating hotels to each participating travel agency. Additionally, Pegasus
Commission Processing offers a service to pay on behalf of hotels commissions
owed by a hotel to travel agencies that are not Pegasus Commission Processing
participants.

Pegasus Commission Processing provides an incentive to travel agencies to
make reservations at participating hotels in countries other than their own
because Pegasus Commission Processing disburses checks denominated in each
travel agency's currency of choice. Furthermore, Pegasus Commission Processing
provides monthly and quarterly marketing reports and statistics that allow the
hotel to identify and market more effectively to those travel agencies that
provide the hotel with the majority of its guests. The hotel also benefits from
Pegasus Commission Processing's customer relations center, which allows travel
agency inquiries regarding commissions to be resolved by Pegasus rather than by
the hotel itself.

Pegasus Commission Processing also provides benefits to its travel agency
participants. The consolidated check that Pegasus Commission Processing delivers
in the travel agency's currency of choice reduces the staff time spent
processing multiple checks and deposit slips, eliminates bank fees for multiple
deposits and currency exchanges and is designed to improve the travel agency's
ability to manage cash

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flow. Pegasus Commission Processing delivers a monthly report that allows the
travel agency to confirm commissions paid, follow customers' reservation habits
and reduce expenses associated with collection and tracking cancellations or
"no-shows." Pegasus Commission Processing's customer relations center provides
prompt responses to agency inquiries and can substantially reduce the time and
cost of reconciling outstanding commissions. Our optional service for electronic
payment and reconciliation of commissions enables travel agencies to further
reduce commission reconciliation costs and provides travel agencies with
immediate access to funds. Pegasus Commission Processing maintains a website
that provides a comprehensive description of its services. The site also
provides a complete listing of all of the hotels that have committed to paying
hotel commissions through Pegasus Commission Processing. Moreover, travel
agencies can subscribe to an executive summary report that can be used to
evaluate the travel agency's activity with a particular hotel to assist with
volume negotiations, among other matters.

Pegasus charges each participating travel agency a service fee based on the
amount of commissions paid to the travel agency. Pegasus also generally charges
hotels a fee based on the number of commissionable transactions processed.

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. Pegasus Business
Intelligence is intended to provide information for a wide variety of audiences
in the global hotel industry, from hotel chains to travel industry marketing
groups to corporate travel departments. This service compiles aggregate data
regarding hotel guests and their use of hotels and organizes that data into
meaningful information. Pegasus intends to provide other information services,
including comparing a hotel's daily room and occupancy rates with that of its
competition. Pegasus Business Intelligence also intends to provide industry
trend reports and aggregate guest behavior data in an automated, timely format
for hotels and hotel marketing companies. Furthermore, Pegasus Business
Intelligence intends to provide data in an electronic format to individual
travelers or corporate travel departments regarding a particular stay at a
hotel, together with information provided by payment card companies, to
facilitate automated expense reporting or to ensure travel policy adherence.

CUSTOMERS

Pegasus markets and provides services to a wide range of customers,
including but not limited to hotels, large travel agencies, travel agency
consortia comprised of smaller travel agencies, global distribution systems and
independent hotels represented by hotel representation firms, such as
REZsolutions, Inc. and Lexington Services Corporation. Pegasus includes as its
customers nine of the ten largest hotel chains in the world based on total
number of rooms. Pegasus has registered approximately 81,000 travel agencies as
participants in Pegasus Commission Processing and four of the top five travel
agencies in the United States, according to Travel Weekly. During 1998, no one
customer accounted for as much as 7% of our revenues.

SALES AND MARKETING

Pegasus sells its services to hotels through a direct sales force in the
Americas and in Europe and sells Pegasus Commission Processing directly to
travel agencies and through relationships with travel agency consortia and
franchisors. Additionally, as of March 31, 1999, Pegasus has a team of 25
technical support staff to supplement the efforts of the sales force and provide
comprehensive customer support services. Our travel agency sales force sells
Pegasus Commission Processing services directly to large travel agencies.
Additionally, Pegasus Commission Processing offers services to smaller travel
agencies organized in consortia and to travel agency franchisees through
preferred supplier programs. Pegasus uses the services of DoubleClick Inc., a
third-party marketing organization to sell advertising on the TravelWeb.com
website.

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TECHNOLOGY, SYSTEMS MAINTENANCE AND DISASTER RECOVERY

Our GDS distribution service utilizes a UNIX-based, client/server
architecture. Global distribution systems are connected to our interface by
either point-to-point telecommunications lines or a multi-protocol frame relay
network, both of which Pegasus manages. Communication processors running
proprietary, UNIX-based software perform protocol conversions. The transaction
processing engine contains its own proprietary, UNIX-based software. This engine
performs message formatting and field translation functions between global
distribution systems and hotels' central reservation systems. Our service also
contains an Informix relational database that stores transaction-specific
information for billing and marketing and translates specific hotel property
information. In 1998, the average processing time for interactive transactions,
such as reservations and inquiry messages, was 0.19 seconds and the average
uptime across the 76 distinct connections was 99.7%, including all scheduled and
emergency downtime. Sun Microsystems, Inc. provides computer hardware
maintenance and replacement and mitigation of the potential effects of system
downtime. In addition, Comdisco, Inc. provides disaster recovery services which
includes full system redundancy within 24 hours in the event of a site disaster.

Our Internet-based distribution services use a scalable architecture. The
information provided resides on an Informix relational database. To add, delete
and update information on their properties, hotels can access the information in
the database either through electronic batch transfers or using a standard Web
browser through our proprietary "remote author" feature. Our secured server
software prevents unauthorized use of the "remote author" feature. Our
communication engines called Web engines, currently consisting of a Sun
UltraSparcII, Netscape Enterprise server software and a Javascript application,
manipulate the information contained in the Informix database. The architecture
allows the addition of more database servers as demand requires. These services
provide a connection to our Pegasus electronic distribution technology, which
allows a user who has found a desired hotel room to secure a hotel reservation
and a confirmation. To assure a high level of Internet connectivity, GTE
Internetworking Incorporated, a "Tier 1" Internet service provider, maintains
our connections to the Internet. GTE is responsible for maintaining the speed
and reliability of communications. GTE also provides message routing assistance
and dynamic load balancing of communications to minimize bottlenecks in Internet
communications. Furthermore, our databases and Web engines are located at sites
operated by GTE.

Pegasus Commission Processing provides a connection for hotels through the
same communication network used by Pegasus Electronic Distribution.
Communication engines perform protocol conversions. Our UNIX-based processing
engine for Pegasus Commission Processing uses proprietary software to process
commission information. Pegasus Commission Processing also utilizes an Informix
database that stores transaction-specific information regarding hotel stays and
information regarding required currency conversions, cleared checks, the source
of reservations and hotel and travel agency profiles. Participating hotels use
our proprietary commission processing software to either collect the data
derived from a hotel's property management system or compile data from each
hotel property.

Pegasus Business Intelligence currently utilizes the software and services
of a third party to convert information received from hotels into a standardized
digital database. Once the standardized digital database is established,
third-party software is used to make specific inquiries of the database to
obtain usable analytical information. Pegasus holds a perpetual license to the
third-party software used to query the data. Pegasus is currently developing
proprietary software which will enhance and expand the gathering, manipulation
and analytical utilization of the hotel information.

RESEARCH AND DEVELOPMENT

Our research and development activities primarily consist of software
development, development of enhanced communication protocols and custom user
interfaces and database design and enhancement. At March 31, 1999, Pegasus
employed 82 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. Our total
research and development expense was $2.2 million, $2.5 million and $4.2 million
for 1996, 1997 and

39
<PAGE> 43

1998, respectively. The research and development expenses for 1998 included a
$1.5 million write-off of in-process research and development.

EMPLOYEES

At March 31, 1999, Pegasus had 137 employees, 131 of which were located in
the United States, with 82 persons in the information technology group, 27
persons performing sales and marketing, customer relations and business
development functions and the remainder performing corporate, finance and
administrative functions. Pegasus had 6 employees in England performing
international sales activities. Pegasus has no unionized employees. Pegasus
believes that its employee relations are satisfactory.

PROPERTIES

Our principal executive office is a leased facility with approximately
43,700 square feet of space in Dallas, Texas. Pegasus leases this space under a
lease agreement that expires December 2002. Pegasus also maintains an
administrative and sales office in a leased facility with approximately 2,255
square feet of space near London, England. The lease agreement for the office in
England expires in February 2006. Under an agreement with REZsolutions certain
of the equipment owned by Pegasus is housed at a site owned by REZsolutions in
Phoenix, Arizona. Pegasus believes that its existing facilities are well
maintained and in good operating condition and are adequate for its present and
anticipated levels of operations.

LEGAL PROCEEDINGS

Pegasus 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, Pegasus does not believe any
liability that might result from such proceedings could have a material adverse
effect on our financial condition and results of operations.

40
<PAGE> 44

MANAGEMENT

EXECUTIVE OFFICERS, DIRECTORS AND KEY EMPLOYEES

Executive officers, directors and other key employees of Pegasus, and their
ages as of March 31, 1999, are as follows:

<TABLE>
<CAPTION>
NAME AGE POSITION
- ---- --- --------
<S> <C> <C>
John F. Davis, III.................... 46 President, Chief Executive Officer,
and Director
Joseph W. Nicholson................... 38 Chief Operating Officer
Jerome L. Galant...................... 49 Chief Financial Officer
Steven L. Reynolds.................... 39 Chief Information Officer
Michael R. Donahue(1)................. 45 Senior Vice President, Commission
Processing Services
Gideon Dean........................... 34 Vice President, International
Operations
William S. Lush....................... 57 Vice President, Business Development
Michael A. Barnett.................... 46 Director
Robert B. Collier..................... 59 Director
William C. Hammett, Jr. .............. 52 Chairman of the Board of Directors
Thomas O'Toole........................ 41 Director
Mark C. Wells......................... 49 Director
Bruce Wolff........................... 55 Director
</TABLE>

- ---------------

(1) Mr. Donahue has resigned as an officer and employee of Pegasus effective May
21, 1999.

John F. Davis, III has served as the President and Chief Executive Officer
of Pegasus since February 1989 and as a director of Pegasus since July 1995.
Before joining Pegasus, Mr. Davis was the founder, President and a director of
Advanced Telemarketing Company, a provider of inbound and outbound telemarketing
services. He was also one of the founders of 1-800-Flowers, Limited, a company
offering quality floral arrangements by telephone.

Joseph W. Nicholson has served as the Chief Operating Officer since
September 1998. From September 1989 to September 1998, Mr. Nicholson served as
the Chief Information Officer of Pegasus.

Jerome L. Galant has served as the Chief Financial Officer of Pegasus since
September 1996. From April 1996 to September 1996, Mr. Galant served as the
Chief Financial Officer of Personnel Security & Safety Systems, Inc., a
technology development company. From 1990 to February 1996, Mr. Galant served in
a variety of positions for The SABRE Group, including Managing Director,
Finance.

Steven L. Reynolds has served as the Chief Information Officer of Pegasus
since September 1998. From April 1996 to September 1998, Mr. Reynolds served as
Vice President of Technology of Pegasus. From November 1992 to April 1996, Mr.
Reynolds served as Director of Systems Development of Pegasus.

Michael R. Donahue has served as Senior Vice President, Commission
Processing Services of Pegasus since June 1998. Mr. Donahue has resigned as an
officer and employee of Pegasus effective May 21, 1999. From May 1997 to June
1998, Mr. Donahue served as Chief Marketing Officer of Pegasus. From 1988 to May
1997, Mr. Donahue served as Vice President of Marketing and Development for Lane
Hospitality, a hotel management firm.

Gideon Dean has served in our London office as Vice President,
International Operations since January 1999. From January 1996 to January 1999,
Mr. Dean served as the Director of International Sales

41
<PAGE> 45

for Pegasus. Prior to joining Pegasus, Mr. Dean served as Regional Director for
Europe, the Middle East and Africa for Reed Electronic Travel Marketing from
February 1992 to December 1995.

William S. Lush has served as Vice President, Business Development of
Pegasus since May 1995. From 1990 to May 1995, Mr. Lush served as Vice
President, Service Development in the travel management services group of
American Express Travel Related Services.

Michael A. Barnett has served as a director of Pegasus since February 1999.
Mr. Barnett has served as Chairman of the Board and Chief Executive Officer of
Benchmark Bank since 1988. Since 1983, Mr. Barnett has served as President and
Chairman of the Board of Barnett Interest, Inc., a diversified real estate
management company. Since 1986, Mr. Barnett has served as President and Director
of Quinlan Bancshares, Inc., a bank holding company. Since 1994, Mr. Barnett has
served as Chairman of the Board of Barnett Lane Investments, Inc., a real estate
investment and management company. Mr. Barnett also served as a board member of
The Hotel Clearing Corporation, a predecessor of Pegasus, from 1993 to 1996.

Robert B. Collier has served as a director of Pegasus since July 1998.
Since September 1998, Mr. Collier has served as President of RBC Associates.
From January 1997 to September 1998, Mr. Collier held the position of Vice
Chairman of Saison Overseas Holdings, a majority shareholder of
Inter-Continental Hotels and Resorts. From January 1994 to January 1997, Mr.
Collier served as Joint Managing Director of Inter-Continental.

William C. Hammett, Jr. has served as a director of Pegasus since October
1995 and as Chairman of the Board of Directors since May 1998. From October 1995
to May 1998, Mr. Hammett also served as Vice Chairman of the Board of Directors
of Pegasus. Since July 1998, Mr. Hammett has served as President of Dogwood
Creek Food Systems, Inc., a private restaurant management company. From
September 1997 to July 1998, Mr. Hammett served as President of DB&K
Enterprises, Inc., a private investment company. From August 1996 through
September 1997, Mr. Hammett served as Senior Vice President and Chief Financial
Officer of La Quinta Inns, Inc. From June 1992 to August 1996, Mr. Hammett
served as Senior Vice President, Accounting and Administration of La Quinta.

Thomas O'Toole has served as a director of Pegasus since May 1998. Since
March 1999, Mr. O'Toole has served as Senior Vice President, Marketing for Hyatt
Hotels Corporation. From July 1995 to March 1999, Mr. O'Toole served as Vice
President, Marketing for Hyatt. From March 1993 through June 1995, Mr. O'Toole
served as Vice President, Marketing for Renaissance Hotels International.

Mark C. Wells has served as a director of Pegasus since September 1996.
Since May 1998, Mr. Wells has served as Senior Vice President, Marketing of
Choice Hotels International, Inc. From February 1996 to May 1998, Mr. Wells
served as Senior Vice President, Franchise Operations for Promus Hotel
Corporation. From April 1995 to February 1996, Mr. Wells served as Senior Vice
President, Marketing for Promus. From 1993 to April 1995, Mr. Wells served as
Senior Vice President, Marketing for Embassy Suites.

Bruce W. Wolff has served as a director of Pegasus since October 1995. Mr.
Wolff has served as Senior Vice President, Distribution Sales and Marketing for
the lodging division of Marriott International, Inc. since 1998. From 1986 to
1998, Mr. Wolff served as Vice President, Distribution, Sales and Marketing for
the lodging division of Marriott.

42
<PAGE> 46

PRINCIPAL STOCKHOLDERS

The following table sets forth as of March 31, 1999 certain information
regarding the beneficial ownership of Pegasus' outstanding common stock by:

- Each person known by Pegasus to own beneficially more than five percent
of the outstanding common stock

- Each director and our chief executive officer and the four other most
highly compensated executive officers whose salary and bonus for 1998
exceeded $100,000

- All directors and executive officers of Pegasus as a group

The following calculations of the percentage of outstanding shares are
based on 10,623,334 shares of Pegasus' common stock outstanding as of March 31,
1999, and assumes no exercise of the underwriters' over-allotment option.
Beneficial ownership is determined in accordance with the rules of the
Securities Exchange Commission and generally includes voting or investment power
with respect to securities, subject to community property laws, where
applicable. Information for each five percent stockholder was obtained from a
filing with the Commission with an effective date of December 31, 1998.

Shares of our common stock subject to options that are presently
exercisable or exercisable within 60 days of March 31, 1999 are deemed
outstanding and beneficially owned by the person holding such options for the
purpose of computing the percentage of ownership of such person but are not
treated as outstanding for the purpose of computing the percentage of any other
person. These options are separately set forth below in the column titled
"Options".

<TABLE>
<CAPTION>
AS OF MARCH 31, 1999
-----------------------------------------
NAME SHARES OPTIONS TOTAL PERCENT
- ---- --------- ------- --------- -------
<S> <C> <C> <C> <C>
FIVE PERCENT STOCKHOLDERS:
The TCW Group, Inc.......................................... 1,304,602 -- 1,304,602 12.3%
865 South Figueroa Street,
Los Angeles, California 90017
FMR Corp.................................................... 926,860 -- 926,860 8.7
82 Devonshire Street,
Boston, Massachusetts 02109
Provident Investment Counsel, Inc........................... 812,736 -- 812,736 7.7
300 Northlake Avenue,
Pasadena, California 91101
J.P. Morgan & Co. Incorporated.............................. 746,800 -- 746,800 7.0
60 Wall Street,
New York, New York, 10260
DIRECTORS AND OFFICERS:
John F. Davis, III.......................................... 14,072 218,750 232,822 2.1
Joseph W. Nicholson......................................... -- 84,375 84,375 *
Jerome L. Galant............................................ -- 27,180 27,180 *
William S. Lush............................................. 444 17,841 18,285 *
Michael R. Donahue(1)....................................... -- 19,166 19,166 *
Michael A. Barnett(2)....................................... 41,132 -- 41,132 *
Robert B. Collier........................................... 1,600 -- 1,600 *
William C. Hammett, Jr. .................................... 3,765 4,000 7,765 *
Thomas F. O'Toole........................................... -- 2,000 2,000 *
Mark C. Wells............................................... -- 4,000 4,000 *
Bruce Wolff................................................. -- 4,000 4,000 *
Directors and executive officers as a
group (13 persons)(3)..................................... 64,085 396,447 460,532 4.2
</TABLE>

- ---------------

* Less than one percent

(1) Mr. Donahue has resigned as an officer and employee of Pegasus effective May
21, 1999.

(2) Includes 41,132 shares of common stock held by Lodging Partners-Barnett
Joint Venture, a partnership controlled by Mr. Barnett.

(3) Includes 3,072 shares of common stock beneficially owned by Steven L.
Reynolds (Chief Information Officer) and options held by Messrs. Reynolds
and Gideon Dean (Vice President, International Operations) to purchase
14,969 shares of common stock.

43
<PAGE> 47

UNDERWRITING

Subject to the terms and conditions of the underwriting agreement, the
underwriters named below, through their representatives, Hambrecht & Quist LLC,
Bear, Stearns & Co. Inc., Donaldson, Lufkin & Jenrette Securities Corporation
and Volpe Brown Whelan & Company, LLC, have severally agreed to purchase from us
the following respective numbers of shares of common stock:

<TABLE>
<CAPTION>
NUMBER
UNDERWRITERS OF SHARES
- ------------ ---------
<S> <C>
Hambrecht & Quist LLC....................................... 900,000
Bear, Stearns & Co. Inc..................................... 500,000
Donaldson, Lufkin & Jenrette Securities Corporation......... 500,000
Volpe Brown Whelan & Company, LLC........................... 100,000
---------
Total............................................. 2,000,000
=========
</TABLE>

The underwriting agreement provides that the obligations of the
underwriters are subject to certain conditions that we must satisfy, including
the receipt of certain certificates, opinions and letters from us, our counsel
and independent auditors. The nature of the underwriters' obligations are such
that they are committed to purchase and accept all shares of common stock
offered in this prospectus if any of such shares are purchased, other than those
shares covered by the over-allotment option described below.

The underwriters propose to offer the shares of our common stock directly
to the public at the public offering price set forth on the cover page of this
prospectus and to certain dealers at such price less a concession not in excess
of $1.20 per share. The underwriters may allow and such dealers may reallow, to
certain other dealers, a concession not in excess of $0.10 per share. After the
public offering of the shares, the underwriters may change the offering price
and other selling terms at any time without notice. The underwriters do not
intend to confirm sales to any accounts over which they exercise discretionary
authority.

We have granted to the underwriters an option, exercisable no later than 30
days after the date of this prospectus, to purchase up to 300,000 additional
shares of our common stock at the public offering price, less the underwriting
discount, set forth on the cover page of this prospectus. To the extent that the
underwriters exercise this option, each underwriter will have a firm commitment,
subject to certain conditions, to purchase a number of shares that approximately
reflects the same percentage of total shares said underwriter purchased in the
above table. We will be obligated to sell shares to the underwriters to the
extent the option is exercised. The underwriters may exercise such option only
to cover over-allotments made in connection with the sale of common stock
offered in this prospectus.

The following table shows the per share and total underwriting discounts
and commissions that we will pay to the underwriters. These amounts are shown
assuming both no exercise and full exercise of the underwriters' option to
purchase additional shares of our common stock.

<TABLE>
<CAPTION>
TOTAL
-----------------------------
WITHOUT WITH
PER SHARE OVERALLOTMENT OVERALLOTMENT
--------- ------------- -------------
<S> <C> <C> <C>
Underwriting discounts and commissions paid by
us.............................................. $2.00 $4,000,000 $4,600,000
</TABLE>

The offering of the shares is made for delivery when, as and if accepted by
the underwriters and subject to prior sale and to withdrawal, cancellation or
modification of the offering without notice. The underwriters reserve the right
to reject an order for the purchase of shares in whole or in part.

We have agreed to indemnify the underwriters against certain liabilities,
including liabilities under the Securities Act of 1933, or to contribute to
payments that the underwriters may be required to make in respect thereof.

44
<PAGE> 48

Executive officers and directors have agreed that, with certain exceptions,
they will not, directly or indirectly, without the prior written consent of
Hambrecht & Quist LLC, sell, offer, contract to sell, transfer the economic risk
of ownership in, make any short sale, pledge or otherwise dispose of any shares
of our common stock during the 90-day period following the effective date of the
registration statement relating to this prospectus.

In addition, during such 90-day period, we have also agreed not to file any
registration statement with respect to, and each of our executive officers and
directors has agreed not to make any demand for, or exercise any right with
respect to, the registration of any shares of our common stock or any securities
convertible into or exercisable or exchangeable for common stock without the
prior written consent of Hambrecht & Quist LLC. However, Hambrecht & Quist LLC
may, in its sole discretion, release all or any portion of the securities
subject to the lock-up agreements.

Certain persons participating in this offering may over-allot or effect
transactions that stabilize, maintain or otherwise affect the market price of
the common stock at levels above those that might otherwise prevail in the open
market, including by entering stabilizing bids, effecting syndicate covering
transactions or imposing penalty bids. A stabilizing bid means the placing of
any bid or effecting of any purchase, for the purpose of pegging, fixing or
maintaining the price of the common stock. A syndicate covering transaction
means the placing of any bid on behalf of the underwriting syndicate or the
effecting of any purchase to reduce a short position created in connection with
the offering. A penalty bid means an arrangement that permits the underwriters
to reclaim a selling concession from a syndicate member in connection with the
offering when shares of common stock sold by the syndicate member are purchased
in syndicate covering transactions. Such transactions may be effected on the
Nasdaq National Market, in the over-the-counter market, or otherwise. Such
stabilizing, if commenced may be discontinued at any time.

In general, the rules of the Securities and Exchange Commission will
prohibit the underwriters from making a market in our common stock during the
"cooling off" period immediately preceding the commencement of sales in the
offering. The Commission has, however, adopted exemptions from these rules that
permit passive market making under certain conditions. These rules permit an
underwriter to continue to make a market subject to the conditions, among
others, that its bid not exceed the highest bid by a market maker not connected
with the offering and that its net purchases on any one trading day not exceed
prescribed limits. Pursuant to these exemptions, certain underwriters, selling
group members (if any) or their respective affiliates intend to engage in
passive market making in our common stock during the cooling off period.

LEGAL MATTERS

The validity of the issuance of the shares of common stock offered by this
prospectus will be passed upon for Pegasus by Locke Liddell & Sapp LLP, Dallas,
Texas. Cooley Godward LLP, San Diego, California, will pass upon certain legal
matters for the underwriters.

EXPERTS

The consolidated financial statements of Pegasus Systems, Inc. as of
December 31, 1998 and 1997 and for the years ended December 31, 1998, 1997 and
1996 included in this Prospectus and the related financial statement schedule
for the years ended December 31, 1998, 1997 and 1996 included or incorporated by
reference elsewhere in the Registration Statement have been so included in
reliance on the report of PricewaterhouseCoopers LLP, independent accountants,
given on the authority of said firm as experts in auditing and accounting.

In January 1997, Pegasus advised Belew Averitt LLP that it would no longer
retain the firm as independent accountants. The reports of Belew Averitt on
Pegasus, formerly The Hotel Industry Switch Company, and The Hotel Clearing
Corporation for the previous years (1993, 1994 and 1995) did not contain an
adverse opinion or a disclaimer of opinion, nor were they qualified or modified
as to uncertainty, audit scope or accounting principles. The decision to change
accountants was precipitated by
45
<PAGE> 49

our plan to complete an initial public offering in 1997 and was approved by our
board of directors on January 7, 1997. During the periods audited by Belew
Averitt and through January 7, 1997 there were no disagreements with Belew
Averitt on any matter of accounting principles or practices, financial statement
disclosure or auditing scope or procedure, which disagreement(s) if not resolved
to the satisfaction of Belew Averitt, would have caused it to make reference to
the subject matter of the disagreements in connection with its reports. Price
Waterhouse LLP was engaged by Pegasus as its independent accountants on January
7, 1997.

ADDITIONAL INFORMATION

We have filed with the Securities and Exchange Commission a registration
statement on Form S-3 under the Securities Act of 1933 with respect to the
shares of common stock offered in this prospectus. This prospectus does not
contain all the information set forth in the registration statement and the
exhibits and schedules thereto. For further information about us and our common
stock, we refer you to the registration statement and to the exhibits and
schedules filed with it. Statements contained in this prospectus as to the
contents of any contract or other document referred to are not necessarily
complete. We refer you to those copies of contracts or other documents that have
been filed as exhibits to the registration statement, and statements relating to
such documents are qualified in all respects by such reference. Anyone may
inspect a copy of the registration statement without charge at the Commission's
Public Reference Room at 450 Fifth Street, NW, Washington, D.C. 20549. You may
obtain copies of all or any portion of the registration statement by writing to
the Commission's Public Reference Room, 450 Fifth Street, N.W., Washington, D.C.
20549, and paying prescribed fees. You may obtain information on the operation
of the Public Reference Room by calling the Commission at 1-800-SEC-0300. In
addition, the Commission maintains a World Wide Web site that contains reports,
proxy and information statements and other information regarding registrants
that file electronically with the Commission. The address of the Commission's
World Wide Web site is www.sec.gov.

We are subject to the informational requirements of the Securities Exchange
Act of 1934 and therefore we file reports, proxy statements and other
information with the Commission. You can inspect and copy the reports, proxy
statements and other information that we file at the public reference facilities
maintained by the Commission at the Public Reference Room, 450 Fifth Street,
N.W., Washington, D.C. 20549 and at the Commission's regional offices located at
7 World Trade Center, Suite 1300, New York, New York 10048 and 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661. You can also obtain copies of such
material from the Commission's Public Reference Room at 450 Fifth Street, N.W.,
Washington, D.C. 20549, at prescribed rates. The Commission also makes
electronic filings publicly available on its website within 24 hours of
acceptance. Our common stock is quoted on the Nasdaq National Market under the
trading symbol "PEGS." Reports, proxy and information statements and other
information about us may be inspected at the National Association of Securities
Dealers, Inc. at 1735 K Street, N.W., Washington, D.C. 20006.

INFORMATION INCORPORATED BY REFERENCE

The following documents, which we have filed with the Commission, are
incorporated by reference into this prospectus: (1) our annual report on Form
10-K for the fiscal year ended December 31, 1998; (2) the description of our
capital stock contained in our registration statement on Form 8-A filed with the
Commission on August 9, 1997; and (3) the description of the rights to purchase
Series A Preferred Stock contained in our registration statement on Form 8-A
filed with the Commission on October 9, 1998.

All documents that we file with the Commission pursuant to Section 13(a),
13(c), 14 or 15(d) of the Securities Exchange Act of 1934 after the date of this
prospectus and before the termination of the offering of the common stock
offered in this prospectus shall be deemed incorporated by reference into this
prospectus and to be a part of this prospectus from the respective dates of
filing such documents.

46
<PAGE> 50

We will provide without charge to each person to whom a copy of this
prospectus is delivered, upon such person's written or oral request, a copy of
any or all of the information incorporated by reference in this prospectus
(other than exhibits to such documents, unless such exhibits are specifically
incorporated by reference into the information that this prospectus
incorporates). Requests should be directed to Pegasus Systems, Inc., 3811 Turtle
Creek Boulevard, Suite 1100, Dallas, Texas 75219, Attention: Ric Floyd,
telephone number (214) 528-5656.

Any statement contained in a document incorporated or deemed to be
incorporated by reference in this prospectus shall be deemed modified,
superseded or replaced for purposes of this prospectus to the extent that a
statement contained in this prospectus or in any subsequently filed document
that also is or is deemed to be incorporated by reference in this prospectus
modifies, supersedes or replaces such statement. Any statement so modified,
superseded or replaced shall not be deemed, except as so modified, superseded or
replaced, to constitute a part of this prospectus.

47
<PAGE> 51

PEGASUS SYSTEMS, INC.

INDEX TO FINANCIAL STATEMENTS

<TABLE>
<S> <C>
PEGASUS SYSTEMS, INC.:

Consolidated Financial Statements:
Report of Independent Accountants......................... F-2
Consolidated Balance Sheets as of December 31, 1998 and
1997................................................... F-3
Consolidated Statements of Operations for the Years Ended
December 31, 1998, 1997 and 1996....................... F-4
Consolidated Statements of Changes in Stockholders' Equity
(Deficit) for the Years Ended December 31, 1998, 1997
and 1996............................................... F-5
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1998, 1997 and 1996....................... F-6
Notes to Consolidated Financial Statements................ F-7
</TABLE>

F-1
<PAGE> 52

REPORT OF INDEPENDENT ACCOUNTANTS

To the Board of Directors and
Stockholders of Pegasus Systems, Inc.

In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations and changes in stockholders'
equity (deficit) and of cash flows present fairly, in all material respects, the
financial position of Pegasus Systems, Inc. and its subsidiaries at December 31,
1998 and 1997, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 1998, 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.

PricewaterhouseCoopers LLP

Dallas, Texas
February 2, 1999

F-2
<PAGE> 53

PEGASUS SYSTEMS, INC.

CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1998 AND 1997

ASSETS

<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Cash and cash equivalents................................... $25,002,185 $30,166,793
Restricted cash............................................. 2,106,676 1,286,032
Short-term investments...................................... 15,768,400 9,380,050
Accounts receivable, net of allowance for doubtful accounts
of $98,633 and $77,860, respectively...................... 3,687,518 1,972,135
Other current assets........................................ 3,689,254 1,232,874
----------- -----------
Total current assets.............................. 50,254,033 44,037,884
Capitalized software, net................................... 869,619 1,183,453
Property and equipment, net................................. 2,635,068 2,712,091
Goodwill, net of accumulated amortization of $522,018 and
$303,815, respectively.................................... 4,238,071 1,560,900
Other noncurrent assets..................................... 2,323,620 428,981
----------- -----------
Total assets...................................... $60,320,411 $49,923,309
=========== ===========

LIABILITIES AND STOCKHOLDERS' EQUITY

Accounts payable and accrued liabilities.................... $ 4,715,018 $ 4,048,343
Unearned income............................................. 258,667 477,688
Current portion of capital lease obligations................ 535,072 1,048,179
Customer deposits........................................... 347,422 66,694
----------- -----------
Total current liabilities......................... 5,856,179 5,640,904
Capital lease obligations, net of current portion........... 57,634 661,049
Other noncurrent liabilities................................ 142,380 143,612
Commitments and contingencies (Note 11)..................... -- --
Stockholders' equity:
Preferred stock, $.01 par value; 2,000,000 shares
authorized; Zero shares issued and outstanding......... -- --
Common stock, $.01 par value; 50,000,000 shares
authorized, 10,653,371 and 10,297,529 shares issued,
respectively........................................... 106,533 102,975
Additional paid-in capital................................ 63,383,905 58,120,337
Unearned compensation..................................... (615,636) (738,533)
Accumulated deficit....................................... (8,584,246) (13,980,697)
Less treasury stock (116,484 shares, at cost)............. (26,338) (26,338)
----------- -----------
Total stockholders' equity........................ 54,264,218 43,477,744
----------- -----------
Total liabilities and stockholders' equity........ $60,320,411 $49,923,309
=========== ===========
</TABLE>

See accompanying notes to consolidated financial statements.

F-3
<PAGE> 54

PEGASUS SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

<TABLE>
<CAPTION>
1998 1997 1996
----------- ----------- -----------
<S> <C> <C> <C>
Net revenues (Note 1)................................. $29,064,467 $20,903,416 $15,869,012
Cost of services...................................... 9,716,854 7,445,271 6,199,058
Research and development.............................. 2,673,628 2,504,074 1,961,055
Write-off of purchased in-process research and
development (Note 3)................................ 1,480,085 -- 244,600
General and administrative expenses................... 4,442,557 3,715,547 3,799,199
Marketing and promotion expenses...................... 4,823,787 3,998,054 2,824,633
Depreciation and amortization......................... 2,689,867 3,016,619 3,425,678
----------- ----------- -----------
Operating income (loss)............................... 3,237,689 223,851 (2,585,211)
Other income (expense):
Interest income..................................... 2,503,265 993,592 114,150
Interest expense.................................... (146,879) (600,067) (893,177)
----------- ----------- -----------
Income (loss) before income taxes and minority
interest............................................ 5,594,075 617,376 (3,364,238)
Income taxes.......................................... 197,624 27,916 15,000
----------- ----------- -----------
Income (loss) before minority interest................ 5,396,451 589,460 (3,379,238)
Minority interest..................................... -- -- (105,563)
----------- ----------- -----------
Net income (loss)..................................... $ 5,396,451 $ 589,460 $(3,484,801)
=========== =========== ===========
Net income (loss) per share:
Basic............................................... $ 0.52 $ 0.08 $ (0.66)
=========== =========== ===========
Diluted............................................. $ 0.48 $ 0.07 $ (0.66)
=========== =========== ===========
Weighted average shares outstanding:
Basic............................................... 10,460,947 7,200,382 5,246,800
=========== =========== ===========
Diluted............................................. 11,196,895 8,676,052 5,246,800
=========== =========== ===========
</TABLE>

See accompanying notes to consolidated financial statements.

F-4
<PAGE> 55

PEGASUS SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
<TABLE>
<CAPTION>
PREFERRED STOCK COMMON STOCK TREASURY STOCK
--------------------- --------------------- ADDITIONAL --------------------
NUMBER OF NUMBER OF PAID-IN UNEARNED NUMBER OF
SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION SHARES AMOUNT
---------- -------- ---------- -------- ----------- ------------ --------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Balance at December 31,
1995................... -- $ -- 5,218,000 $ 52,180 $ 8,652,969 $ -- -- $ --
Issuance of preferred
stock to Information
Associates, L.P. and
Information Associates,
C.V.................... 1,538,463 15,385 -- -- 7,484,620 -- -- --
Issuance of common stock
for purchase of
minority interest...... -- -- 89,733 897 277,725 -- -- --
Purchase of treasury
stock.................. -- -- -- -- -- -- (116,484) (26,338)
Issuance of compensatory
stock options.......... -- -- -- -- 551,150 (485,937) -- --
Proceeds from stock
subscription........... -- -- -- -- 1,900 -- -- --
Net loss................. -- -- -- -- -- -- -- --
---------- -------- ---------- -------- ----------- --------- -------- --------
Balance at December 31,
1996................... 1,538,463 15,385 5,307,733 53,077 16,968,364 (485,937) (116,484) (26,338)
---------- -------- ---------- -------- ----------- --------- -------- --------
Conversion of preferred
stock to common
stock.................. (1,538,463) (15,385) 1,538,463 15,385 -- -- -- --
Initial public
offering............... -- -- 3,450,000 34,500 40,459,000 -- -- --
Warrants issued for
contract............... -- -- -- -- 238,000 -- -- --
Issuance of compensatory
stock options.......... -- -- -- -- 450,847 (252,596) -- --
Exercise stock options... -- -- 1,333 13 4,126 -- -- --
Net income............... -- -- -- -- -- -- -- --
---------- -------- ---------- -------- ----------- --------- -------- --------
Balance at December 31,
1997................... -- -- 10,297,529 102,975 58,120,337 (738,533) (116,484) (26,338)
---------- -------- ---------- -------- ----------- --------- -------- --------
Secondary offering....... -- -- 280,321 2,803 4,222,493 -- -- --
Windfall tax benefit of
stock options.......... -- -- -- -- 403,532 -- -- --
Issuance of compensatory
stock options.......... -- -- -- -- 240,928 28,176 -- --
Forfeitures of
compensatory stock
options................ -- -- -- -- (94,721) 94,721 -- --
Exercise stock options... -- -- 63,875 639 330,592 -- -- --
Issuance for stock
purchase plan.......... -- -- 11,646 116 160,744 -- -- --
Net income............... -- -- -- -- -- -- -- --
---------- -------- ---------- -------- ----------- --------- -------- --------
Balance at December 31,
1998................... -- $ -- 10,653,371 $106,533 $63,383,905 $(615,636) (116,484) $(26,338)
========== ======== ========== ======== =========== ========= ======== ========

ACCUMULATED
DEFICIT TOTAL
------------ -----------
<S> <C> <C>
Balance at December 31,
1995................... $(11,085,356) $(2,380,207)
Issuance of preferred
stock to Information
Associates, L.P. and
Information Associates,
C.V.................... -- 7,500,005
Issuance of common stock
for purchase of
minority interest...... -- 278,622
Purchase of treasury
stock.................. -- (26,338)
Issuance of compensatory
stock options.......... -- 65,213
Proceeds from stock
subscription........... -- 1,900
Net loss................. (3,484,801) (3,484,801)
------------ -----------
Balance at December 31,
1996................... (14,570,157) 1,954,394
------------ -----------
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 stock options... -- 4,139
Net income............... 589,460 589,460
------------ -----------
Balance at December 31,
1997................... (13,980,697) 43,477,744
------------ -----------
Secondary offering....... -- 4,225,296
Windfall tax benefit of
stock options.......... -- 403,532
Issuance of compensatory
stock options.......... -- 269,104
Forfeitures of
compensatory stock
options................ -- --
Exercise stock options... -- 331,231
Issuance for stock
purchase plan.......... -- 160,860
Net income............... 5,396,451 5,396,451
------------ -----------
Balance at December 31,
1998................... $(8,584,246) $54,264,218
============ ===========
</TABLE>

See accompanying notes to consolidated financial statements.

F-5
<PAGE> 56

PEGASUS SYSTEMS, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996

<TABLE>
<CAPTION>
1998 1997 1996
------------ ------------ -----------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income (loss)......................................... $ 5,396,451 $ 589,460 $(3,484,801)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Minority interest....................................... -- -- 105,563
Accrued interest reclassified to notes payable.......... -- 58,049 91,927
Windfall tax benefit from employee exercise of
non-qualified stock options........................... 403,532 -- --
Write off of in-process research and development
costs................................................. 1,480,085 -- 244,600
Adjustment for discontinued software projects........... -- -- 316,698
Loss (gain) on sale of equipment........................ 4,821 (53) 9,564
Depreciation and amortization........................... 2,689,867 3,016,619 3,425,678
Deferred income taxes................................... (2,084,625) -- --
Decrease goodwill due to release of valuation
allowance............................................. 1,467,246 -- --
Recognition of stock option compensation................ 269,104 198,251 65,213
Other................................................... 27,615 3,359 --
Changes in assets and liabilities:
Restricted cash....................................... (820,644) (595,826) (360,029)
Accounts receivable................................... (1,566,348) (292,779) (284,104)
Other current and noncurrent assets................... (807,830) (1,203,609) (156,931)
Accounts payable and accrued liabilities.............. 794,456 1,425,801 748,481
Unearned income....................................... (413,840) (463,488) (431,373)
Other noncurrent liabilities.......................... 9,030 23,904 119,709
------------ ------------ -----------
Net cash provided by operating activities.......... 6,848,920 2,759,688 410,195
------------ ------------ -----------
Cash flows from investing activities:
Purchase of software, property and equipment.............. (1,729,950) (1,594,401) (495,100)
Proceeds from sale of software, property and equipment.... 29,887 1,075 133,134
Purchase of marketable securities......................... (33,832,343) (11,486,932) (2,705,076)
Proceeds from sale of marketable securities............... 27,416,378 4,808,599 --
Purchase of Driving Revenue L.L.C. ....................... (5,998,366) -- --
Purchase of equity interest in investees.................. (1,500,000) -- --
------------ ------------ -----------
Net cash used in investing activities.............. (15,614,394) (8,271,659) (3,067,042)
------------ ------------ -----------
Cash flows from financing activities:
Proceeds from issuance of stock........................... 4,717,387 40,497,639 7,500,005
Purchase of minority interest............................. -- -- (2,000,000)
Repayments on notes payable to affiliates................. -- (5,447,133) (235,000)
Repayments of capital leases.............................. (1,116,521) (1,171,966) (974,969)
Purchase of treasury stock................................ -- -- (26,338)
Proceeds from stock subscription.......................... -- -- 1,900
Proceeds from line of credit.............................. -- -- 175,000
Repayment of line of credit............................... -- -- (175,000)
Proceeds from capital leases.............................. -- 3,913 93,729
------------ ------------ -----------
Net cash provided by financing activities.......... 3,600,866 33,882,453 4,359,327
------------ ------------ -----------
Net increase (decrease) in cash and cash equivalents........ (5,164,608) 28,370,482 1,702,480
Cash and cash equivalents, beginning year................... 30,166,793 1,796,311 93,831
------------ ------------ -----------
Cash and cash equivalents, end of year...................... $ 25,002,185 $ 30,166,793 $ 1,796,311
------------ ------------ -----------
Supplemental disclosure of cash flow information:
Interest paid............................................. $ 144,833 $ 601,787 $ 858,017
============ ============ ===========
Income taxes paid......................................... $ 256,288 $ 17,916 $ --
============ ============ ===========
Supplemental schedule of noncash investing and financing
activities:
Acquisition of equipment under capital leases............. $ -- $ 79,144 $ 1,045,988
============ ============ ===========
Issuance of common stock for acquisitions (Notes 3 and
8)...................................................... $ -- $ -- $ 278,622
============ ============ ===========
Common stock warrants issued in exchange for customer
contract asset.......................................... $ -- $ 238,000 $ --
============ ============ ===========
</TABLE>

See accompanying notes to consolidated financial statements.

F-6
<PAGE> 57

PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1998, 1997 AND 1996

1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES

ORGANIZATION AND BACKGROUND

In July 1995, Pegasus Systems, Inc. (Pegasus or the Company) was formed as
a Delaware holding company to combine the operations of two existing companies
operating in the same industry, The Hotel Industry Switch Company (THISCO) and
The Hotel Clearing Corporation (HCC). For accounting purposes, the combination
was recorded as a purchase of HCC.

CONSOLIDATION

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, the
Company or Pegasus) 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.

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, 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
efficiency and reduce costs associated with preparing, paying and reconciling
hotel room reservation commissions.

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.

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 NetBooker service, the Company offers
TravelWeb's comprehensive hotel database and Internet hotel reservation
capabilities to third-party Web sites.

Pegasus IQ was formed in November 1997 as a Delaware corporation. Pegasus
IQ is expected to provide a wide array of hotel industry data, research and
reporting services for benchmark analysis and strategic planning purposes.

Driving Revenue, acquired by the Company in August 1998 (Note 3), is a
hotel database marketing and consulting firm.

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.

F-7
<PAGE> 58
PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CASH AND CASH EQUIVALENTS

The Company considers all highly liquid investments with maturities of
three months or less from the date of purchase to be cash equivalents.

RESTRICTED CASH

Funds for travel agency commission checks which have not cleared the
Company's processing bank after certain time periods are returned to the
Company. Any amounts which are not remitted to travel agents will be escheated
to the appropriate state, as required.

INVESTMENTS IN DEBT SECURITIES

Marketable securities held by the Company at December 31, 1998 and 1997 are
classified as held-to-maturity and consist of corporate debt securities that
mature in less than one year. At December 31, 1998 and 1997, the amortized cost
of corporate debt securities was $15,768,400 and $9,380,050, respectively. As of
December 31, 1998 and 1997, 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.

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. In the event unamortized software costs
exceed the net realizable value of the software, the excess is recognized in the
period the excess is determined. Additionally, capitalized software includes
software purchased from third parties used in the operations of the Company.

Prior to 1996, capitalized costs were being amortized over three to five
years using the straightline method. However, in 1996 the Company changed the
estimated life of all capitalized software costs to three years. The effect of
this change in 1998 and 1997 was to increase net income by approximately
$144,000 and $142,000 and basic and diluted income per share by $0.01 and $0.02,
respectively. The effect of this change in 1996 was to increase net loss by
approximately $292,000 and basic or diluted loss per share by $0.06. During
1996, the Company recorded a charge of approximately $317,000 resulting from
discontinued software development projects. During 1998, 1997 and 1996, the
Company capitalized software costs of approximately $646,000, $505,000, and
$470,000, respectively. For all periods presented capitalized software additions
consist of software purchased from third parties. During 1998, 1997 and 1996,
amortization expense related to capitalized software was approximately $959,000,
$1,435,000 and $2,125,000, respectively. Accumulated amortization of capitalized
software was approximately $9,134,000 and $8,174,000 at December 31, 1998 and
1997, 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

F-8
<PAGE> 59
PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

operations as incurred, while betterments and major renewals are capitalized.
Any gain or loss resulting from the retirement or sale of an asset is credited
or charged to operations.

The Company evaluates long-lived assets to be held and used in the
business, or to be disposed of, for impairment whenever events or changes in
circumstances indicate that the net book value of the asset may not be
recoverable. An impairment is determined by comparing expected future cash flows
(undiscounted and before interest) to the net book value of the assets. If
impairment exists, the amount of impairment is measured as the difference
between the net book value of the assets and the estimated fair value of the
related assets. Based on its most recent analysis, the Company believes that no
impairment of property and equipment existed at December 31, 1998 or 1997.

GOODWILL

Goodwill represents the excess of the purchase price of acquisitions over
the fair value of the net assets acquired. Goodwill is amortized on a
straight-line basis over ten to fifteen years. Unamortized goodwill at December
31, 1998 and 1997, was $4,238,071 and $1,560,900, 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, 1998 or 1997. Amortization of
goodwill was approximately $218,000, $125,000 and $121,000 in 1998, 1997 and
1996, respectively.

OTHER INVESTMENTS

In June 1998, the Company purchased 250,000 shares of Series A Convertible
Preferred Stock of Customer Analytics, Inc. for $500,000. Customer Analytics,
Inc. is a new database marketing applications and solutions provider
specializing in the area of customer relationship marketing. The investment is
accounted for based on the lower of cost or fair value.

In September 1998, the Company purchased 225,225 shares of Series B
Convertible Preferred Stock of Intermezzo Systems, Inc. for $1,000,000.
Intermezzo Systems, Inc. is a developer of hotel reservation and property
management systems and software. The investment is accounted for based on the
lower of cost or fair value.

REVENUES

Pegasus primarily derives its revenues from transaction fees and
commissions charged to participating hotels and travel agencies. The Company's
revenues are predominantly transaction-based.

Pegasus derives its revenues from its THISCO service by charging its hotel
participants a fee based on the number of reservations made, less the number
cancelled ("net reservations"), and a fee for "status messages" processed
through the THISCO service. Status messages are electronic messages sent by
hotels to GDSs to update room rates, features and availability information in
GDS databases. As a hotel's cumulative volume of net reservations increases
during the course of the calendar year, its fee per transaction decreases after
predetermined transaction volume hurdles have been met. As a result, for higher
volume customers, unit transaction fees are higher at the beginning of the year,
when cumulative transactions are lower. The Company recognizes revenues based on
the fee per transaction that a customer is expected to pay during the entire
year. This process of recognizing revenues creates a deferred revenue balance
during early periods of the year, which is reflected in interim balance sheets.
The deferred revenue balance created during the early periods of the year is
fully utilized and eliminated by the end of each year. Additionally, Pegasus
generally charges new participants in the THISCO service a one-time set-up fee
for work associated with the implementation of the interface with the THISCO
service. Revenue for these one-time set-up fees is recognized on a percentage of
completion basis as the services are performed

F-9
<PAGE> 60
PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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 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 fluctuations in 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, Pegasus is not obligated to deliver commission payments on behalf of
the hotel to travel agencies. For the years ended December 31, 1998, 1997 and
1996, HCC revenues from hotels are presented net of commission payments to
travel agencies of approximately $255,000,000, $165,000,000, and $105,000,000,
respectively. 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 (Note 11).

Pegasus derives its TravelWeb revenues by charging participating hotels
subscription fees based on the number of their properties included in the
database and a combination of transaction fees or commissions. Transaction fees
are based on the number of net reservations made at participating properties
through the TravelWeb service, and commissions are based on the value of the
guest stay for reservations booked through the TravelWeb service. 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.

Pegasus derives its Business Intelligence revenues by charging hotels fees
for the development and maintenance of hotel databases and for consulting
services.

INCOME TAXES

Income taxes are accounted for under the asset and liability method.
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which those temporary differences are expected to be
recovered or settled. The effect on deferred tax assets and liabilities of a
change in tax rates is recognized in income in the period that includes the
enactment date. A valuation allowance is provided for a portion or all of the
deferred tax assets when there is sufficient uncertainty regarding the Company's
ability to recognize the benefits of the assets in future years.

ADVERTISING COSTS

Advertising and promotion-related expenses are charged to operations when
incurred. Advertising expense for 1998, 1997 and 1996 was approximately
$1,105,000, $609,000 and $613,000, respectively.

FINANCIAL INSTRUMENTS

The carrying amounts of the Company's financial instruments reflected in
the consolidated balance sheets at December 31, 1998 and 1997 approximate their
respective fair values.

F-10
<PAGE> 61
PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

CONCENTRATIONS OF CREDIT RISK

The Company's financial instruments exposed to concentrations of credit
risk consist primarily of cash and receivables. Cash balances, exceeding the
federally insured limits, are maintained in financial institutions; however,
management believes the institutions are of high credit quality. The majority of
receivables are due from companies which are well-established entities in the
travel industry. Therefore, management considers any exposure from
concentrations of credit risks to be limited.

ACCOUNTING FOR STOCK-BASED COMPENSATION

Statement of Financial Accounting Standards No. 123, "Accounting for
Stock-Based Compensation" (FAS 123), encourages, but does not require, companies
to record compensation cost for stock-based employee compensation plans at fair
value. Pro forma disclosure of net income (loss) based on the provisions of FAS
123 is presented in Note 9. For financial reporting purposes, the Company has
elected to continue to account for stock-based compensation using the intrinsic
value method prescribed in Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (APB 25), and related
Interpretations.

STOCK SPLITS

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 stockholders of record on the effective
date of the Registration Statement on Form S-1 with respect to the Company's
initial public offering (IPO) (Note 8). All references in the consolidated
financial statements to shares, share prices, per share amounts and stock plans
have been adjusted retroactively for the four-for-three stock split.

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 (loss).

NET INCOME (LOSS) PER SHARE

In 1997, the Company adopted Statement of Financial Accounting Standards
No. 128, "Earnings per Share" (FAS 128). FAS 128 replaces primary and fully
dilutive earnings per share with basic and diluted earnings per share. Unlike
primary earnings per share, basic earnings per share excludes any dilutive
effect of potential common shares. Basic net income per share is based on the
weighted average outstanding common shares. Diluted net income per share is
based on the weighted average outstanding shares reduced by the effect of
potential common shares. Net income (loss) for prior periods presented in the
accompanying consolidated financial statements have been restated to comply with
FAS 128 (Note 15).

COMPREHENSIVE INCOME

In 1998, the Company adopted Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income". This statement requires separate
financial statement disclosure of comprehensive income, which encompasses
changes in net asset values derived from activity from both owner and non-owner
sources. There were no items that qualified for treatment as components of other
comprehensive income for the periods presented.
F-11
<PAGE> 62
PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

SEGMENT INFORMATION

In 1998, the Company adopted Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information"
(FAS 131). FAS 131 supercedes Statement of Financial Accounting Standards No.
14, "Financial Reporting for Segments of a Business Enterprise", replacing the
"industry" approach with the "management" approach. The management approach
designates the internal organization that is used by management for making
operating decisions and assessing performance as the source of the Company's
reportable segments. FAS 131 also requires disclosures about products and
services, geographic areas, and major customers. The adoption of FAS 131 did not
affect results of operations or financial position but did affect the disclosure
of segment information (Note 16).

2. REORGANIZATION

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
interest in HCC. The Reorganization brought THISCO and HCC together under the
control of Pegasus and was initiated to integrate and expand the existing
businesses of THISCO and HCC. Pegasus was formed immediately prior to the
transaction for the purpose of combining the two operations into a single
entity. For accounting purposes, the combination was recorded as a purchase of
HCC.

3. ACQUISITIONS

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 amount 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, $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.

In August 1998, the Company acquired all of the equity interest in Driving
Revenue for approximately $6 million plus estimated expenses of less than
$100,000 (Acquisition). Driving Revenue provides hotel database marketing and
consulting services.

The Acquisition was recorded under the purchase method of accounting, and
accordingly, Driving Revenue's results of operations subsequent to the
Acquisition date are included in the accompanying consolidated financial
statements. The purchase price has been allocated to assets acquired and
liabilities assumed based on estimated fair value at the date of Acquisition.
The approximate fair value of assets acquired and liabilities assumed at the
date of acquisition, after giving effect to the write-off of certain purchased
research and development, is summarized as follows:

<TABLE>
<S> <C>
Current assets (including approximately $2,000 cash)........ $ 176,000
Software.................................................... $ 344,000
Property and equipment...................................... $ 42,000
Goodwill.................................................... $4,296,000
Current liabilities......................................... $ 338,000
</TABLE>

F-12
<PAGE> 63
PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Approximately $1,480,000, based on a valuation performed by a third party,
was allocated to in-process research and development projects that at the time
of the Acquisition had not reached technological feasibility and had no probable
alternative future use. Factors considered in determining the amount of the
purchase price allocated to in-process research and development include the
estimated stage of development for each project at the acquisition date, the
projected cash flows from the expected revenues to be generated from each
project and discounting the net cash flows. Such amount of in-process research
and development was charged to expense at the date of acquisition. The balance
of the purchase price, approximately $4,296,000, was recorded as the excess of
cost over the fair value of net assets acquired (goodwill) and is being
amortized on a straight-line basis over a ten year period ending August 2008.

4. ACCOUNTS RECEIVABLE

The Company 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, 1998 and 1997, trade
accounts receivable were stated net of commissions of approximately $21,505,000
and $14,309,000, respectively.

Net accounts receivable from affiliates of approximately $772,000 was
included in the accompanying consolidated balance sheet at December 31, 1997.
Net accounts receivable from affiliates for 1997 primarily consisted of amounts
due from certain stockholder hotel chains. Disclosing the amounts due from
stockholder hotel chains was not considered necessary in 1998 since their
ownership percentage was reduced due to the Company's IPO in August 1997, the
secondary offering in February 1998 and subsequent open market sales of their
shares. The ownership percentage of the stockholder hotel chains was an
aggregate of less than 10% of the Company's common shares outstanding at
December 31, 1998; therefore, the stockholder hotel chains were not considered
affiliates as of and for the year ended December 31, 1998.

5. PROPERTY AND EQUIPMENT

Property and equipment at December 31 consisted of the following:

<TABLE>
<CAPTION>
1998 1997
----------- -----------
<S> <C> <C>
Computer equipment........................................ $ 5,817,100 $ 4,985,455
Furniture and equipment................................... 890,334 677,183
Office equipment.......................................... 1,320,239 974,851
Leasehold improvements.................................... 93,313 97,379
----------- -----------
8,120,986 6,734,868
Less: accumulated depreciation............................ (5,485,918) (4,022,777)
----------- -----------
Property and equipment, net............................... $ 2,635,068 $ 2,712,091
=========== ===========
</TABLE>

6. CAPITAL LEASES

Assets recorded under capital leases, primarily consisting of computer
equipment, are recorded at the lower of the present value of future minimum
lease payments or the fair value of the asset. Total assets recorded under
capital leases in 1998 and 1997 were approximately $3,436,000 and $3,747,000,
respectively, net of accumulated amortization of $3,054,000 and $2,531,000,
respectively. Amortization of assets under capital leases is included in
depreciation and amortization expense.

F-13
<PAGE> 64
PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Future minimum lease payments and related interest are as follows:

<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S> <C>
1999........................................................ $ 602,041
2000........................................................ 60,170
---------
Aggregate minimum lease payments............................ 662,211
Less: amount representing interest and taxes................ (69,505)
---------
592,706
Less: current portion....................................... (535,072)
---------
$ 57,634
=========
</TABLE>

Interest rates on capital leases range from approximately 7% to 15%.
Interest expense on capital leases for the years ended December 31, 1998, 1997
and 1996 was approximately $144,000, $277,000 and $351,000, respectively.

7. NOTES PAYABLE

In August 1997, the Company repaid all outstanding principal and accrued
interest on notes payable from the proceeds of the Company's IPO (Note 8). Total
principal and interest paid during 1997 was approximately $5,254,000 and
$457,000, respectively. During 1996, the Company paid interest totaling
$478,000. Interest expense related to these notes was approximately $322,000 and
$539,000 during the years ended December 31, 1997 and 1996, respectively.

8. STOCKHOLDERS' EQUITY

In conjunction with the Reorganization, the Company issued 283,333 shares
of restricted common stock to certain members of management in connection with
the termination of a bonus plan for HCC's management (Note 2). During 1996, the
Company repurchased 25,467 shares from a terminated employee. The restrictions
on these shares expired when the Company completed its IPO in August 1997.

As a result of the Reorganization, certain stockholders exchanged shares of
THISCO for shares of Pegasus. Additionally, in order to effect the purchase of
HCC, the Company issued Pegasus shares to HCC stockholders 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 stockholders that some value for the HCC shares exchanged
should be assigned based upon the number of transactions that an HCC stockholder
committed to process through HCC in 1996. If a stockholder 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 stockholder is based upon the
percentage of their transaction commitment actually processed by HCC during
1996. Effective December 31, 1996, the Company repurchased 91,017 shares of the
477,733 shares subject to repurchase.

In June 1996, Information Associates, L.P. and Information Associates, C.V.
purchased 1,538,462 shares of the Company's series A preferred stock 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.

In June 1996, the Company issued 89,733 shares of Pegasus common stock in
conjunction with the acquisition of the minority ownership interest of HCC (Note
3).

F-14
<PAGE> 65
PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

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
(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 August 1997, the stockholders amended the Company's certificate of
incorporation to increase the number of authorized shares of common stock from
20 million to 100 million.

The Company completed an IPO in August 1997. The Company's Registration
Statement on Form S-1 (File No. 333-28595) with respect to the IPO was declared
effective on August 6, 1997, and the Company's stock began trading on the Nasdaq
National Market under the symbol PEGS on August 7, 1997. The Company sold
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 stockholders also sold
659,000 shares at a per share price of $13.00. Net proceeds to the stockholders
after deduction of the underwriting discount were approximately $8.0 million.
The Company did not receive any proceeds from the sale of shares by the selling
stockholders. Concurrent with the completion of the Company's IPO, a
four-for-three split of the Company's outstanding common and series A preferred
stock was effected (Note 1), and all outstanding shares of series A preferred
stock were converted into shares of common stock.

Effective February 11, 1998, the Company completed a secondary offering.
The Company sold 280,321 shares of common stock at $17.50 per share. Net
proceeds, after deducting the underwriting discount and estimated offering
expenses, were approximately $4.2 million. Selling stockholders also sold
2,134,679 shares at $17.50 per share. The Company did not receive any proceeds
from the sales of shares by the selling stockholders.

In May 1998, stockholders amended the Company's certificate of
incorporation to reduce the number of authorized shares of common stock from 100
million to 50 million. The financial statements have been retroactively adjusted
to reflect the reduction in authorized shares.

In September 1998, the Board of Directors authorized the repurchase of up
to $6 million in aggregate of the Company's common stock from time to time. No
shares have been acquired as of December 31, 1998.

In September 1998, the Board of Directors declared a dividend distribution
of one preferred stock purchase right for each outstanding share of the
Company's common stock. Each right will entitle stockholders to buy one
one-thousandth of a share of the Company's series A preferred stock for each
share of the Company's common stock held at a price of $90.00. The rights will
be exercisable only if a person or group of affiliated or associated persons
acquires, or has announced the intent to acquire, 20% or more of the Company's
common stock.

9. STOCK-BASED COMPENSATION

In accordance with the Company's 1996 stock option plan (1996 Plan),
amended and approved in March 1997, options to purchase 866,667 shares of
Company common stock may be granted to Company employees. Options granted under
the 1996 Plan expire in December 2005. In accordance with the Company's 1997
stock option plan (1997 Plan), approved in March 1997 and amended in May 1998,
options to purchase 600,000 shares of Company common stock may be granted to
Company employees and non-employee directors and contractors. Options granted
under the 1997 Plan expire in December 2006. Options granted under both the 1996
Plan and the 1997 Plan (collectively, Plans) may be in the form of incentive
stock options or nonqualified stock options. The Compensation Committee of the
Board of Directors (Committee) administers the Plans and determines grant prices
for employees. Options granted to Company employees generally become exercisable
in installments of 25% per year commencing
F-15
<PAGE> 66
PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

one year from the date of grant while options granted to non-employee directors
and contractors become exercisable over a vesting period provided by the Plan or
determined by the Committee. The Company's authorized but unissued or reacquired
common stock is used as stock options are exercised.

In accordance with APB 25, the Company recorded unearned compensation of
approximately $241,000, $451,000 and $551,000 in 1998, 1997 and 1996,
respectively, related to options. Unearned compensation is being recognized
ratably over the vesting period for stock option grants with exercise prices
which are less than fair market value of the stock at the date of grant.
Compensation expense of approximately $269,000, $198,000 and $65,000 was charged
to operations in 1998, 1997 and 1996, respectively.

As discussed in Note 1, the Company has adopted the disclosure-only
provision of FAS 123. Had compensation cost for the Company's stock option plans
been determined based on the fair value provisions of FAS 123, the Company's net
income (loss) and net income (loss) per share would have been decreased
(increased) to the pro forma amounts indicated below:

<TABLE>
<CAPTION>
1998 1997 1996
---------- -------- -----------
<S> <C> <C> <C>
Net income (loss) -- as reported................. $5,396,451 $589,460 $(3,484,801)
Net income (loss) -- pro forma................... $4,859,692 $334,589 $(3,511,531)
Net income (loss) per share -- as reported:
Basic.......................................... $ 0.52 $ 0.08 $ (0.66)
Diluted........................................ $ 0.48 $ 0.07 $ (0.66)
Net income (loss) per share -- pro forma:
Basic.......................................... $ 0.46 $ 0.05 $ (0.67)
Diluted........................................ $ 0.43 $ 0.04 $ (0.67)
</TABLE>

The pro forma disclosures provided are not likely to be representative of
the effects on reported net income for future years due to future grants and the
vesting requirements of the Company's stock option plans.

The weighted average fair value for options with exercise prices equal to
the market price of stock at the grant date was $6.81 in 1998 and $0.82 in 1996.
There were no options granted in 1997 with exercise prices equal to the market
price of stock at the grant date. The weighted average fair value for options
with exercise prices below the market price of stock at the grant date was
$13.49 in 1998, $8.51 in 1997 and $1.66 in 1996. The fair value of each option
grant is estimated on the date of grant using the Black-Scholes option-pricing
model with the following weighted-average assumptions used:

<TABLE>
<CAPTION>
1998 1997 1996
---- ---- ----
<S> <C> <C> <C>
Dividend yield.......................................... -- -- --
Expected volatility:
Pre-IPO grants........................................ -- 0.0% 0.0%
Post-IPO grants....................................... 72.8% 65.0% --
Risk-free rate of return................................ 4.6% 6.1% 6.5%
Expected life........................................... 4.0years 4.9years 4.0 year
</TABLE>

F-16
<PAGE> 67
PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table summarizes activity under the Company's stock option
plans during the years ended December 31:

<TABLE>
<CAPTION>
WEIGHTED AVERAGE EXERCISE
NUMBER OF COMPANY OPTIONS PRICE PER SHARE
------------------------------- --------------------------
1998 1997 1996 1998 1997 1996
--------- --------- ------- ------- ------- ------
<S> <C> <C> <C> <C> <C> <C>
Options outstanding at
beginning of year.......... 1,082,278 771,740 -- $ 5.75 $ 2.39 $ --
Granted...................... 397,166 331,666 771,740 12.44 13.49 2.39
Exercised.................... 66,987 1,333 -- 5.60 3.11 --
Canceled..................... 78,496 19,795 -- 12.20 4.34 --
--------- --------- ------- ------ ------ -----
Options outstanding at end of
year....................... 1,333,961 1,082,278 771,740 $ 7.37 $ 5.75 $2.39
========= ========= ======= ====== ====== =====
Options exercisable at end of
year....................... 490,523 263,434 -- $ 4.27 $ 2.33 --
========= ========= ======= ====== ====== =====
</TABLE>

The following table summarizes information for stock options outstanding at
December 31, 1998:

<TABLE>
<CAPTION>
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
--------------------------------------------- --------------------------
WEIGHTED AVERAGE WEIGHTED WEIGHTED
NUMBER OF REMAINING AVERAGE NUMBER OF AVERAGE
EXERCISE PRICES OPTIONS CONTRACTUAL LIFE EXERCISE PRICE OPTIONS EXERCISE PRICE
--------------- --------- ---------------- -------------- --------- --------------
<S> <C> <C> <C> <C> <C>
$2.01......................... 496,333 7.0 years $ 2.01 304,249 $ 2.01
$3.11......................... 186,170 6.8 years 3.11 95,033 3.11
$5.25......................... 53,333 7.0 years 5.25 19,999 5.25
$9.50 - $13.39................ 323,949 7.9 years 10.73 1,116 11.05
$15.30 - $22.74............... 271,176 7.3 years 16.31 70,126 15.30
$25.38........................ 3,000 8.0 years 25.38 -- --
--------- --------- ------ ------- ------
1,333,961 7.3 years $ 7.37 490,523 $ 4.27
========= ========= ====== ======= ======
</TABLE>

10. INCOME TAXES

Pretax income (loss) from continuing operations for the years ended
December 31 was taxed under the following jurisdictions:

<TABLE>
<CAPTION>
1998 1997 1996
---------- -------- -----------
<S> <C> <C> <C>
Domestic......................................... $5,495,808 $519,459 $(3,528,503)
Foreign.......................................... 98,267 97,917 58,702
---------- -------- -----------
$5,594,075 $617,376 $(3,469,801)
========== ======== ===========
</TABLE>

F-17
<PAGE> 68
PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

Deferred taxes consisted of the following at December 31:

<TABLE>
<CAPTION>
1998 1997
---------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforward........................... $2,162,922 $ 4,214,785
Bad debt reserves......................................... 36,396 26,473
Stock option compensation expense......................... 181,545 81,873
Rent expense.............................................. 52,540 82,552
Various expense accruals.................................. 50,660 42,160
Charitable contributions.................................. 22,495 --
Other..................................................... 24,160 10,801
---------- -----------
Total gross deferred tax assets................... 2,530,718 4,458,644
Valuation allowance....................................... (270,000) (4,312,266)
Deferred tax liability:
Software amortization..................................... (109,190) (79,850)
Depreciation and amortization............................. (66,903) (66,528)
---------- -----------
Net deferred tax assets..................................... $2,084,625 $ --
========== ===========
</TABLE>

In 1997 and 1996, the net deferred tax asset was fully reserved because of
uncertainty regarding the Company's ability to recognize the benefit of the
asset in future years. In the fourth quarter of 1998, the Company released a
significant portion of the valuation allowance as management believes it is more
likely than not that the net deferred tax asset will be realized. The remaining
valuation allowance at December 31, 1998 relates to state net operating loss
carryforwards. A portion of the deferred tax asset was related to net operating
loss carryforwards of HCC that existed at the time HCC was acquired by the
Company in 1995. Accordingly, approximately $1,467,000 of the valuation
allowance released in 1998 reduced the remaining goodwill related to the
purchase of HCC. At December 31, 1998, 1997 and 1996, the Company had federal
net operating loss carryforwards of approximately $5,567,000, $12,252,000 and
$14,635,000, respectively. The 1998 net operating loss carryforwards that
existed at December 31, 1998 will begin to expire in 2007. Utilization of the
net operating loss carryforwards may be limited by the separate return loss year
rules and could be affected by ownership changes which have occurred or could
occur in the future.

The components of the income tax provision for the years ended December 31
were as follows:

<TABLE>
<CAPTION>
1998 1997 1996
--------- -------- -------
<S> <C> <C> <C>
Current provision:
Federal............................................ $ 381,025 $ 51,525 $ --
State.............................................. 462,413 -- --
Foreign............................................ 38,100 27,916 15,000
--------- -------- -------
$ 881,538 $ 79,441 $15,000
========= ======== =======
Deferred benefit:
Federal............................................ $(641,069) $(51,525) $ --
State.............................................. (42,845) -- --
--------- -------- -------
Provision for income taxes........................... $ 197,624 $ 27,916 $15,000
========= ======== =======
</TABLE>

F-18
<PAGE> 69
PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

A reconciliation of taxes based on the federal statutory rate of 34.0% and
the provision for income taxes is summarized as follows for the years ended
December 31:

<TABLE>
<CAPTION>
1998 1997 1996
----- ----- -----
<S> <C> <C> <C>
Expected income tax provision (benefit)................... 34.0% 34.0% (34.0)%
Valuation allowance....................................... (46.7)% (38.4)% 29.4%
Permanent differences..................................... 10.9% 9.8% 5.1%
State income taxes........................................ 5.0% -- --
Other, net................................................ 0.3% (0.9)% (0.5)%
----- ----- -----
Provision for income taxes................................ 3.5% 4.5% 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 $731,000, $720,000 and $697,000 in 1998, 1997 and 1996,
respectively.

Approximate future minimum lease payments at December 31, 1998, 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, 1998, were as follows:

<TABLE>
<CAPTION>
YEAR ENDING
DECEMBER 31,
------------
<S> <C>
1999..................................................... $ 998,000
2000..................................................... 1,024,000
2001..................................................... 1,024,000
2002..................................................... 1,012,000
2003..................................................... 63,000
Thereafter............................................... 137,000
----------
$4,258,000
==========
</TABLE>

In June 1993, the Company received $2,000,000 from its processing bank in
exchange for a five-year non-cancelable data processing contract and recorded
the amount as deferred income. The non-cancelable contract requires the
Company's processing bank to process transactions and generate various reports
in exchange for a processing fee. The contract requires Pegasus to maintain an
annual minimum volume of transactions. If the annual minimum volume is not
attained, Pegasus is required to pay its processing bank an additional
processing fee for each transaction under the minimum volume. As of the date HCC
was acquired by the Company, 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 1998, 1997
and 1996, the Company recognized approximately $471,000, $471,000 and $431,000,
respectively, of the deferred income. In 1998, 1997 and 1996, the Company
exceeded the annual minimum volume requirement. The deferred income was fully
amortized as of December 31, 1998.

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 will be
amortized ratably over the associated five year contract period.

F-19
<PAGE> 70
PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

As of December 31, 1998, the Company had a commitment to pay an affiliate
$125,000 in 1999 for software development and modification.

12. EMPLOYEE BENEFIT PLAN

The Company sponsors a 401(k) defined contribution retirement plan (401(k)
Plan) covering full-time employees who have attained the age of twenty-one. The
401(k) Plan allows eligible employees to defer receipt of up to fifteen percent
of their compensation and contribute such amounts to various investment funds.
Eligible employees may elect to participate at the beginning of any quarter
after their hire date. Employee contributions vest immediately.

The Company makes discretionary matching contributions up to five percent
of employees' annual contributions. The Company's matching contributions vest on
a pro rata basis over five years. During 1998, 1997 and 1996, the Company
contributed approximately $292,000, $217,000 and $160,000, respectively, to the
401(k) Plan.

13. STOCK PURCHASE PLAN

In May 1998, the Company's stockholders approved the Pegasus Systems, Inc.
1997 Employee Stock Purchase Plan (Stock Plan). The Company has reserved 500,000
shares of its common stock for purchase by its employees pursuant to the terms
of the Stock Plan. Eligible participating employees of the Company may elect to
have an amount up to, but not in excess of, 10% of their regular salary or wages
withheld for the purpose of purchasing the Company's common stock. Under the
Stock Plan, an eligible participating employee will be granted an option at the
beginning of each plan year (the "Offering Commencement Date") to purchase at
the end of the plan year (the "Offering Termination Date") shares of common
stock using the amounts that have accumulated from the employee's payroll
deductions made during the plan year at a price that is 85% of the closing price
of the common stock on the Nasdaq National Market or any other national
securities exchange on the Offering Commencement Date or the Offering
Termination Date, whichever is lower.

14. RELATED PARTIES

Prior to the IPO, the Company derived a substantial portion of its revenue
from certain stockholders and stockholder-owned companies. For the years ended
December 31, 1997 and 1996, revenue generated by stockholders and
stockholder-owned companies was approximately $15.7 million, or 75.3%, and $12.0
million, or 75.4%, respectively. Disclosing revenues generated by stockholders
was not considered necessary for the year ended December 31, 1998 since the
ownership percentage of these stockholders was reduced by the Company's IPO in
August 1997, the secondary offering in February 1998 and subsequent open market
sales of their shares. The ownership percentage of these stockholders was an
aggregate of less than 10% of the Company's common shares outstanding at
December 31, 1998; therefore, these stockholders were not considered affiliates
as of and for the year ended December 31, 1998.

A stockholder provides services to the Company, including facility
management, consulting and software development. During 1998, 1997 and 1996, the
Company recognized expense in the amount of approximately $461,000, $488,000 and
$774,000, respectively, for those services.

Persons related to an officer of the Company have provided printing, design
and procurement services to the Company. During 1998, 1997 and 1996, the Company
paid approximately $3,000, $6,000 and $143,000, respectively, related to these
services, the majority of which related to capitalized furniture purchases.

F-20
<PAGE> 71
PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

15. NET INCOME (LOSS) PER SHARE

Basic net income (loss) per share for the years ended December 31, 1998,
1997 and 1996 has been computed in accordance with FAS 128 using the weighted
average number of common shares outstanding after giving retroactive effect to
stock splits (Notes 1 and 8).

Diluted net income (loss) per share for the years ended December 31, 1998,
1997 and 1996 gives effect to all dilutive potential common shares that were
outstanding during the periods. Outstanding options and warrants with strike
prices below the average fair market value of the Company's common stock for the
years ended December 31, 1998 and 1997 were included in the diluted earnings per
share (EPS) calculations for the respective periods. None of the options
outstanding at December 31, 1996 were included in the diluted EPS calculation
for the year ended December 31, 1996 because the Company had a net loss. In
1998, all outstanding options and warrants were included in the diluted EPS
calculation for the six months ended June 30, 1998. Options for 54,000 shares of
the Company's common stock at strike prices from $19.44 to $22.74 were excluded
for the diluted EPS calculation for the three months ended September 30, 1998
because they were anti-dilutive. Options for 57,000 shares of the Company's
common stock at strike prices from $19.44 to $25.38 were excluded from the
diluted EPS calculation for the three months ended December 31, 1998 because
they were anti-dilutive. The options excluded in 1998 expire from December 2005
to December 2006. In 1997, all outstanding options and warrants were included in
the calculation of diluted EPS. In 1996, 1,538,462 shares of Series A preferred
stock and options for 771,733 shares of the Company's common stock at strike
prices from $2.01 to $3.11 were excluded from the diluted EPS calculation
because they were anti-dilutive. The options excluded in 1996 expire December
2005.

The following table sets forth the basic and diluted net income (loss) per
share computation for the years ended December 31:

<TABLE>
<CAPTION>
1998 1997 1996
---------- ---------- -----------
<S> <C> <C> <C>
Net income (loss)............................. $5,396,451 $ 589,460 $(3,484,801)
========== ========== ===========
Basic:
Weighted average number of shares
outstanding.............................. 10,460,947 7,200,382 5,246,800
---------- ---------- -----------
Net income (loss) per share................. $ 0.52 $ 0.08 $ (0.66)
========== ========== ===========
Diluted:
Weighted average number of shares
outstanding.............................. 10,460,947 7,200,382 5,246,800
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....... 735,948 554,315 --
---------- ---------- -----------
Weighted average number of shares
outstanding used in the diluted net
income (loss) per share calculation...... 11,196,895 8,676,052 5,246,800
---------- ---------- -----------
Net income (loss) per share................. $ 0.48 $ 0.07 $ (0.66)
========== ========== ===========
</TABLE>

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PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

16. SEGMENT INFORMATION

In 1998, the Company adopted FAS 131. The prior years' segment information
has been restated to present the Company's three reportable segments:

- Electronic Distribution -- provides services that enable travel agents
and individual travelers to electronically access hotel room inventory
information and conduct reservation transactions;

- Commission Processing -- provides commission payment processing services
to the hotel industry and travel agencies; and

- Business Intelligence -- provides data mining and reporting services for
benchmark analysis and strategic planning for the hotel industry.

The accounting policies of the segments are the same as those described in
Note 1. Segment data includes a charge allocating all corporate costs to the
operating segments. The Company evaluates the performance of its segments based
on pretax income.

The Company is organized primarily on the basis of products and services.
The Company's segments are strategic business units that offer different
products and services. Two of the Company's strategic business units have been
aggregated into the Electronic Distribution segment: THISCO and TravelWeb. The
Commission Processing segment consists of the Company's HCC service. Pegasus IQ
and Driving Revenue have been aggregated into the Business Intelligence segment.

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<PAGE> 73
PEGASUS SYSTEMS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

The following table presents information about reported segments for the
years ended December 31:

<TABLE>
<CAPTION>
ELECTRONIC COMMISSION BUSINESS RECONCILING
DISTRIBUTION PROCESSING INTELLIGENCE ITEMS TOTAL
------------ ----------- ------------ ----------- -----------
<S> <C> <C> <C> <C> <C>
1998
Net revenues......... $12,310,046 $15,851,557 $ 902,864 $ -- $29,064,467
Interest income...... $ 14,358 $ 151,243 $ 12 $2,337,652 $ 2,503,265
Interest expense..... $ 112,988 $ 33,788 $ 103 $ -- $ 146,879
Depreciation and
amortization....... $ 1,258,152 $ 1,175,451 $ 256,264 $ -- $ 2,689,867
Write-off purchased
in-process R&D..... $ -- $ -- $ 1,480,085 $ -- $ 1,480,085
Income(loss) before
taxes.............. $ 506,036 $ 5,527,910 $(2,777,523) $2,337,652 $ 5,594,075
1997
Net revenues......... $ 9,864,738 $11,038,678 $ -- $ -- $20,903,416
Interest income...... $ 7,820 $ 105,437 $ -- $ 880,335 $ 993,592
Interest expense..... $ 516,631 $ 83,265 $ 171 $ -- $ 600,067
Depreciation and
amortization....... $ 1,074,780 $ 1,929,588 $ 12,251 $ -- $ 3,016,619
Income(loss) before
taxes.............. $(1,815,218) $ 2,122,436 $ (570,177) $ 880,335 $ 617,376
1996
Net revenues......... $ 8,139,259 $ 7,729,753 $ -- $ -- $15,869,012
Interest income...... $ -- $ 4,839 $ -- $ 109,311 $ 114,150
Interest expense..... $ 768,730 $ 124,447 $ -- $ -- $ 893,177
Depreciation and
amortization....... $ 1,742,691 $ 1,682,987 $ -- $ -- $ 3,425,678
Write-off purchased
in-process R&D..... $ -- $ 244,600 $ -- $ -- $ 244,600
Loss before taxes and
minority
interest........... $(3,289,159) $ (184,390) $ -- $ 109,311 $(3,364,238)
</TABLE>

Reconciling items represent interest income earned as a result of
short-term investment of operating cash balances and a portion of proceeds from
the Company's IPO and secondary public offering of common stock.

The Company's business is conducted principally in the United States. The
Company does not utilize or measure revenues by geographic location to evaluate
the Electronic Distribution and Business Intelligence segments. However, the
Company does track the geographic source of travel agency and hotel transactions
that give rise to Commission Processing revenues. For 1998, 1997 and 1996,
approximately $2,922,000, $2,037,000 and $1,246,000 of Commission Processing
revenues were derived from customers based outside the United States.

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<PAGE> 74

Pegasus Systems, Inc. Logo
<PAGE> 75

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2,000,000 SHARES

PEGASUS SYSTEMS, INC. LOGO

COMMON STOCK

-----------------------

PROSPECTUS
-----------------------

HAMBRECHT & QUIST

BEAR, STEARNS & CO. INC.

DONALDSON, LUFKIN & JENRETTE

VOLPE BROWN WHELAN & COMPANY

MAY 6, 1999

You should rely only on information contained in this prospectus. We have
not authorized anyone to provide you with information different from that
contained in this prospectus. We are offering to sell, and seeking offers to
buy, shares of common stock only in jurisdictions where offers and sales are
permitted. The information contained in this prospectus is accurate only as of
the date of this prospectus, regardless of the time of delivery of this
prospectus or of any sale of our common stock.

No action is being taken in any jurisdiction outside the United States to
permit a public offering of the common stock or possession or distribution of
this prospectus in any such jurisdiction. Persons who come into possession of
this prospectus in jurisdictions outside the United States are required to
inform themselves about and to observe any restrictions as to this offering and
the distribution of the prospectus applicable to that jurisdiction.

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