PEGASUS SYSTEMS INC, S-3/A, 1999-05-03

PEGASUS SYSTEMS INC
S-3/A, 1999-05-03
COMPUTER PROCESSING & DATA PREPARATION

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AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION ON MAY 3, 1999

REGISTRATION NO. 333-77071

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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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AMENDMENT NO. 1

FORM S-3
REGISTRATION STATEMENT
UNDER
THE SECURITIES ACT OF 1933
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PEGASUS SYSTEMS, INC.
(Exact name of registrant as specified in its charter)

<TABLE>
<S> <C> <C>
DELAWARE 7389 75-2605174
(State or other jurisdiction of (Primary Standard Industrial (I.R.S. Employer
incorporation or organization) Classification Code Number) Identification No.)
</TABLE>

3811 TURTLE CREEK BOULEVARD, SUITE 1100
DALLAS, TEXAS 75219
(214) 528-5656
(Address, including zip code, telephone number,
including area code, of registrant's principal executive office)

JOHN F. DAVIS, III
PEGASUS SYSTEMS, INC.
3811 TURTLE CREEK BOULEVARD, SUITE 1100
DALLAS, TEXAS 75219
(214) 528-5656
(Name, address, including zip code, telephone number,
including area code, of agent for service)
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Copies to:

<TABLE>
<S> <C>
GUY KERR ERIC J. LOUMEAU
WHIT ROBERTS DENNIS A. CALDERON
Locke Liddell & Sapp LLP Cooley Godward LLP
2200 Ross Avenue, Suite 2200 4365 Executive Drive, Suite 1100
Dallas, Texas 75201 San Diego, California 92121
(214) 740-8000 (619) 550-6000
</TABLE>

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APPROXIMATE DATE OF COMMENCEMENT OF PROPOSED SALE TO THE PUBLIC:
AS SOON AS PRACTICABLE AFTER THE EFFECTIVE DATE OF THIS REGISTRATION STATEMENT.
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If the only securities being registered on this form are being offered
pursuant to dividend or interest reinvestment plans, please check the
following. [ ]

If any of the securities being registered on this Form are to be offered on
a delayed or continuous basis pursuant to Rule 415 under the Securities Act of
1933, other than securities offered only in connection with dividend or interest
reinvestment plans, check the following box. [ ]

If this Form is filed to register additional securities for an offering
pursuant to Rule 462(b) under the Securities Act, please check the following box
and list the Securities Act registration statement number of the earlier
effective registration statement for the same offering. [ ]

If this Form is a post-effective amendment filed pursuant to Rule 462(c)
under the Securities Act, check the following box and list the Securities Act
registration statement number of the earlier effective registration statement
for the same offering. [ ]

If delivery of the prospectus is expected to be made pursuant to Rule 434,
please check the following box. [ ]
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THE REGISTRANT HEREBY AMENDS THIS REGISTRATION STATEMENT ON SUCH DATE OR
DATES AS MAY BE NECESSARY TO DELAY ITS EFFECTIVE DATE UNTIL THE REGISTRANT SHALL
FILE A FURTHER AMENDMENT WHICH SPECIFICALLY STATES THAT THIS REGISTRATION
STATEMENT SHALL THEREAFTER BECOME EFFECTIVE IN ACCORDANCE WITH SECTION 8(a) OF
THE SECURITIES ACT OF 1933 OR UNTIL THE REGISTRATION STATEMENT SHALL BECOME
EFFECTIVE ON SUCH DATE AS THE COMMISSION, ACTING PURSUANT TO SAID SECTION 8(a),
MAY DETERMINE.

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The information in this prospectus is not complete and may be changed.
Underwriters may not confirm sales of these securities until the registration
statement filed with the Securities and Exchange Commission becomes effective.
This prospectus is not an offer to sell these securities and it is not
soliciting offers to buy these securities in any state where the offer or sale
is not permitted.

SUBJECT TO COMPLETION, DATED MAY 3, 1999

PROSPECTUS
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1,750,000 SHARES

PEGASUS SYSTEMS, INC. LOGO

COMMON STOCK

Pegasus Systems, Inc. is offering 1,750,000 shares of common stock.
Pegasus' common stock is traded on the Nasdaq National Market under the symbol
"PEGS." On April 30, 1999, the last reported sale price for the common stock on
the Nasdaq National Market was $46.75 per share. See "Price Range of Common
Stock."

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INVESTING IN THE COMMON STOCK INVOLVES A HIGH DEGREE OF RISK.

SEE "RISK FACTORS" BEGINNING ON PAGE 5.

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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
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<S> <C> <C>
Public offering price....................................... $ $
Underwriting discounts and commissions...................... $ $
Proceeds to Pegasus, before expenses........................ $ $
</TABLE>

Pegasus has granted the underwriters an option for a period of 30 days to
purchase up to 262,500 additional shares of common stock.

HAMBRECHT & QUIST

BEAR, STEARNS & CO. INC.

DONALDSON, LUFKIN & JENRETTE

VOLPE BROWN WHELAN & COMPANY

, 1999
<PAGE> 3

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.
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TABLE OF CONTENTS

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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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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, 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..... 1,750,000 shares

Common stock to be outstanding after
this offering....................... 12,373,334 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,
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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 $104,431
Working capital............................................. 44,398 121,720
Total assets................................................ 60,320 137,642
Total stockholders' equity.................................. 54,264 131,586
</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
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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 1,750,000 shares of our common stock offered
by us in this prospectus at an assumed offering price of $46.75 per share
and application of the estimated net proceeds. See "Use of Proceeds" and
"Capitalization."

4
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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.
8
<PAGE> 13

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> 14

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> 15

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> 16

- 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> 17

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> 18

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 an estimated $77.3 million in net proceeds from its
sale of 1,750,000 shares of common stock at an assumed public offering price of
$46.75 per share, after deducting underwriting discounts and commissions and
estimated expenses. If the underwriters exercise their over-allotment option in
full, Pegasus will receive an estimated $11.7 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 April 30, 1999)................... $46.91 $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 April 30, 1999, the last reported sale price of our common stock on the
Nasdaq National Market was $46.75 per share. See "Risk Factors -- Our stock
price has been and may continue to be extremely

14
<PAGE> 19

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

15
<PAGE> 20

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 estimated net proceeds
from the sale of 1,750,000 shares of common stock offered by us at an
assumed public offering price of $46.75 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);
12,403,371 shares issued (as adjusted)................. 106 124
Additional paid-in capital................................ 63,384 140,688
Unearned compensation..................................... (616) (616)
Accumulated deficit....................................... (8,584) (8,584)
Less treasury stock (116,484 shares, at cost)............. (26) (26)
------- --------
Total stockholders' equity........................ 54,264 131,586
------- --------
Total capitalization.............................. $54,322 $131,644
======= ========
</TABLE>

16
<PAGE> 21

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> 22

<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> 23

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> 24

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> 25

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> 26

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> 27

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> 28

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> 29

<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> 30

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> 31

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.

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<PAGE> 32

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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<PAGE> 33

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> 34

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> 35

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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<PAGE> 36

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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<PAGE> 38

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,
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> 39

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> 40

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> 41

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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<PAGE> 42

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 23
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.

38
<PAGE> 43

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 83 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> 44

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 83 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> 45

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> 46

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> 47

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 10,980 11,424 *
Michael R. Donahue(1)....................................... -- 3,334 3,334 *
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)..................................... 64,085 373,588 437,673 4.0
</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> 48

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.......................................
Bear, Stearns & Co. Inc.....................................
Donaldson, Lufkin & Jenrette Securities Corporation.........
Volpe Brown Whelan & Company, LLC...........................
--------
Total.............................................
========
</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 $ per share. The underwriters may allow and such dealers may reallow, to
certain other dealers, a concession not in excess of $ 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 262,500 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..............................................
</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> 49

Executive officers and directors are expected to agree 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,
directors and certain stockholders is expected to agree 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> 50

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> 51

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> 52

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> 53

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> 54

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> 55

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> 56

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> 57

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> 58

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> 59
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> 60
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> 61
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> 62
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> 63
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> 64
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> 65
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> 66
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> 67
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> 68
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> 69
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> 70
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> 71
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> 72
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>

F-21
<PAGE> 73
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.

F-22
<PAGE> 74
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.

F-23
<PAGE> 75

Pegasus Systems, Inc. Logo
<PAGE> 76

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

1,750,000 SHARES

PEGASUS SYSTEMS, INC. LOGO

COMMON STOCK

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

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

HAMBRECHT & QUIST

BEAR, STEARNS & CO. INC.

DONALDSON, LUFKIN & JENRETTE

VOLPE BROWN WHELAN & COMPANY

, 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.

- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
<PAGE> 77

PART II

ITEM 14. OTHER EXPENSES OF ISSUANCE AND DISTRIBUTION

The following table indicates the estimated expenses to be incurred by
Pegasus in connection with the offering described in the Registration Statement:

<TABLE>
<S> <C>
Securities and Exchange Commission filing fee............... $ 20,107
NASD filing fee............................................. 7,732
Nasdaq National Market Additional listing fee............... 17,500
Blue Sky fees and expenses.................................. 5,000*
Printing and engraving fees................................. 140,000*
Accountants' fees and expenses.............................. 75,000*
Legal fees and expenses..................................... 125,000*
Transfer Agent's fees and expenses.......................... 5,000*
Miscellaneous............................................... 4,661
--------
Total............................................. $400,000
========
</TABLE>

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

* Estimated

ITEM 15. INDEMNIFICATION OF DIRECTORS AND OFFICERS

Section 145 of the Delaware General Corporation Law (the "DGCL") provides,
in effect, that any person made a party to any action by reason of the fact that
he is or was a director, officer, employee or agent of Pegasus may and, in
certain cases, must be indemnified by Pegasus against, in the case of a non-
derivative action, judgments, fines, amounts paid in settlement and reasonable
expenses (including attorney's fees) incurred by him as a result of such action,
and in the case of a derivative action, against expenses (including attorney's
fees), if in either type of action he acted in good faith and in a manner he
reasonably believed to be in or not opposed to the best interests of Pegasus.
This indemnification does not apply, in a derivative action, to matters as to
which it is adjudged that the director, officer, employee or agent is liable to
Pegasus, unless upon court order it is determined that, despite such
adjudication of liability, but in view of all the circumstances of the case, he
is fairly and reasonably entitled to indemnity for expenses, and, in a
non-derivative action, to any criminal proceeding in which such person had
reasonable cause to believe his conduct was unlawful.

Article Eight of our Third Amended and Restated Certificate of
Incorporation provides that no director of Pegasus shall be liable to Pegasus or
its stockholders for monetary damages for breach of fiduciary duty as a director
to the fullest extent permitted by the DGCL.

Article Eight of our Third Amended and Restated Certificate of
Incorporation also provides that Pegasus may indemnify to the fullest extent
permitted by Delaware law any person made or threatened to be made a party to an
action or proceeding, whether criminal, civil, administrative or investigative,
by reason of the fact that he, his estate or legal representative is or was a
director, officer, employee or agent of Pegasus or any predecessor of Pegasus or
serves or served at any other enterprise as a director, officer, employee or
agent at the request of Pegasus or any other predecessor to Pegasus. In
addition, Section 7.7 of our Amended and Restated Bylaws provides that Pegasus
shall indemnify to the fullest extent authorized or permitted by law any current
or former director or officer of Pegasus (or his or her testator or estate) made
or threatened to be made a party to any threatened, pending, or completed
action, suit, or proceeding, whether criminal, civil administrative, or
investigative, by reason of the fact that he or she is or was a director or
officer of Pegasus or is or was serving, at the request of Pegasus, as a
director, officer, employee, or agent of another corporation, partnership, joint
venture, trust, employee benefit plan, or other enterprise and that, subject to
applicable law, Pegasus may indemnify an employee or agent of Pegasus to the
extent that and with respect to such proceedings as, the Board of Directors may
determine by resolution, in its discretion.

II-1
<PAGE> 78

Reference is made to the Underwriting Agreement filed or incorporated by
reference as Exhibit 1.1 hereto, pursuant to which Pegasus has agreed to
indemnify the underwriters against certain liabilities under the Securities Act
of 1933. Reference is also made to the Rights Agreement filed as Exhibit 4.3
hereto, pursuant to which certain holders of capital stock of Pegasus named
therein have agreed to indemnify officers and directors of Pegasus against
certain liabilities under the Securities Act of 1933 or the Securities Exchange
Act of 1934 in the event Registrable Securities (as defined therein) held by
such holders are included in the securities to be registered pursuant to a
public offering by Pegasus.

Pegasus has purchased directors' and officers' liability insurance. Subject
to conditions, limitations and exclusions in the policy, the insurance covers
amounts required to be paid for a claim or claims made against directors and
officers for any act, error, omission, misstatement, misleading statement or
breach of duty by directors and officers in their capacity as directors and
officers of Pegasus.

ITEM 16.(A) EXHIBITS AND FINANCIAL STATEMENT SCHEDULE

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
+1.1 -- Underwriting Agreement by and between Pegasus Systems,
Inc. and the Under-
writers.
2.1 -- Contribution and Restructuring Agreement dated effective
as of July 21, 1995 by and among Pegasus Systems, Inc.
and all of the stockholders of Pegasus Systems, Inc.
++3.1 -- Third Amended and Restated Certificate of Incorporation,
as amended
3.2 -- Second Amended and Restated Bylaws
3.3 -- Form of Certification of Designation, Preferences and
Rights of Series A Preferred Stock of Pegasus Systems,
Inc. (incorporated by reference from Exhibit 2 of Pegasus
Systems, Inc.'s Form 8-A filed with the Commission on
October 9, 1998).
4.1 -- Specimen of Common Stock Certificate
4.2 -- Third Amended and Restated Certificate of Incorporation
and Second Amended and Restated Bylaws (see Exhibits 3.1
and 3.2)
4.3 -- Rights Agreement dated June 25, 1996 by and among Pegasus
Systems, Inc. and certain holders of capital stock of
Pegasus Systems, Inc. named therein
4.4 -- Common Stock Purchase Warrant issued to Holiday
Hospitality Corporation
4.5 -- Rights Agreement dated as of September 28, 1998 by and
between Pegasus Systems, Inc. and American Securities
Transfer & Trust, Inc. (incorporated by reference from
Exhibit 4 of Pegasus Systems, Inc.'s Current Report on
Form 8-K filed with the Commission on October 9, 1998)
4.6 -- Form of Rights Certificate (incorporated by reference
from Exhibit 3 of Pegasus Systems, Inc.'s Form 8-A filed
with the Commission on October 9, 1998)
**5.1 -- Opinion of Locke Liddell & Sapp LLP
10.1 -- Employment Agreement dated June 25, 1996 between Pegasus
Systems, Inc. and John F. Davis, III
10.2 -- Employment Agreement dated June 25, 1996 between Pegasus
Systems, Inc. and Joseph W. Nicholson
10.3 -- Employment Agreement dated August 29, 1996 between
Pegasus Systems, Inc. and Jerome L. Galant
10.4 -- Employment Agreement dated May 18, 1996 between Pegasus
Systems, Inc. and Michael R. Donahue
++10.5 -- 1996 Stock Option Plan, as amended
</TABLE>

II-2
<PAGE> 79

<TABLE>
<CAPTION>
EXHIBIT NO. DESCRIPTION
----------- -----------
<C> <S>
10.6 -- 1997 Stock Option Plan, as amended (incorporated by
reference from Pegasus Systems, Inc.'s Proxy Statement
for its 1999 Annual Stockholders meeting filed with the
Commission on April 12, 1999)
10.7 -- Citibank Global Payments Service Agreement dated July 24,
1998 between the Hotel Clearing Corporation and Citibank,
N.A. (incorporated by reference to Exhibit 10.1 of
Pegasus Systems, Inc.'s 10-Q for the quarter ended
October 31, 1998, filed with the Commission on November
16, 1998)
10.8 -- Facilities Management Agreement dated January 1, 1996
between Pegasus Systems, Inc. and Anasazi, Inc.,
currently known as REZsolutions, Inc.
10.9 -- Service Agreement dated December 13, 1996 between Pegasus
Systems, Inc. and Comdisco, Inc.
10.10 -- Service Agreement dated January 17, 1997 between Pegasus
Systems, Inc. and Genuity, Inc.
++10.11 -- 1997 Employee Stock Purchase Plan, as amended
++10.12 -- Office Lease dated October 1, 1995, First Amendment to
Office Lease dated February 25, 1998 and Second Amendment
to Office Lease dated November 2, 1998 between Pegasus
Systems, Inc. and the Utah State Retirement Investment
Fund relating to property located at 3811 Turtle Creek
Blvd., Suite 1100, Dallas, Texas 75219
++21.1 -- Subsidiaries of Pegasus Systems, Inc.
+23.1 -- Consent of PricewaterhouseCoopers LLP
+23.2 -- Consent of Belew Averitt LLP
**23.3 -- Consent of Locke Liddell & Sapp LLP ( included in its
opinion filed as Exhibit 5.1)
**24.1 -- Power of Attorney
++27.1 -- Financial Data Schedule for the year ended December 31,
1998
</TABLE>

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

Unless otherwise indicated, exhibits are incorporated by reference to our
Registration Statement (File No. 333-28595) on Form S-1 declared effective by
the Commission on August 6, 1997.

+ Filed herewith.

** Previously filed in connection with this Registration Statement.

++ Incorporated by reference to our Form 10-K for the fiscal year ended December
31, 1998.

Pegasus will furnish a copy of any exhibit listed above to any shareholder
without charge upon written request to Mr. Ric L. Floyd, Secretary, 3811 Turtle
Creek Blvd., Suite 1100, Dallas, Texas 75219.

(b) Financial Data Schedules Incorporated by reference to our Form 10-K for
the fiscal year ended December 31, 1998.

ITEM 17. UNDERTAKINGS

The undersigned Pegasus hereby undertakes to provide the representatives of
the Underwriters at the closing specified in the Underwriting Agreement
certificates in such denominations and registered in such names as required by
the Underwriters to permit prompt delivery to each purchaser.

Insofar as indemnification for liabilities arising under the Securities Act
of 1933 (the "Securities Act") may be permitted to directors, officers and
controlling persons of Pegasus, Pegasus has been advised that in the opinion of
the Securities and Exchange Commission such indemnification is against public
policy as expressed in the Securities Act and is, therefore, unenforceable. In
the event that a claim for indemnification against such liabilities (other than
the payment by Pegasus of expenses incurred or paid by a director, officer or
controlling person of Pegasus in the successful defense of any action, suit or

II-3
<PAGE> 80

proceeding) is asserted by any director, officer or controlling person in
connection with the securities being registered, Pegasus will, unless in the
opinion of its counsel the matter has been settled by controlling precedent,
submit to a court of appropriate jurisdiction the question whether such
indemnification by it is against public policy as expressed in the Securities
Act and will be governed by the final adjudication of such issue.

Pegasus hereby undertakes that:

(1) For purposes of determining any liability under the Securities
Act, the information omitted from the form of Prospectus filed as part of
this Registration Statement in reliance upon Rule 430A and contained in a
form of prospectus filed by Pegasus pursuant to Rule 424(b)(1) or (4) or
497(h) under the Securities Act shall be deemed to be part of this
Registration Statement as of the time it was declared effective.

(2) For the purpose of determining any liability under the Securities
Act, each post-effective amendment that contains a form of Prospectus shall
be deemed to be a new registration statement relating to the securities
offered therein, and the offering of such securities at that time shall be
deemed to be the initial bona fide offering thereof.

II-4
<PAGE> 81

SIGNATURES

Pursuant to the requirements of the Securities Act of 1933, the Registrant
certifies that it has reasonable grounds to believe that it meets all of the
requirements for filing on Form S-3 and has duly caused this Amendment No. 1 to
Registration Statement to be signed on its behalf by the undersigned, thereunto
duly authorized, in the City of Dallas, State of Texas, on this 3rd day of May,
1999.

PEGASUS SYSTEMS, INC.

By: /s/ JEROME L. GALANT

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

Jerome L. Galant

Attorney-in-Fact

Pursuant to the requirements of the Securities Act of 1933, this Amendment
No. 1 to Registration Statement has been signed by the following persons in the
capacities and on May 3, 1999.

<TABLE>
<CAPTION>
SIGNATURES TITLE
---------- -----
<C> <S>

/s/ JOHN F. DAVIS, III* Chief Executive Officer, President and
- ----------------------------------------------------- Director (Principal Executive Officer)
John F. Davis, III

/s/ JEROME L. GALANT* Chief Financial Officer (Principal Financial
- ----------------------------------------------------- and Accounting Officer)
Jerome L. Galant

/s/ MICHAEL A. BARNETT* Director
- -----------------------------------------------------
Michael A. Barnett

/s/ ROBERT B. COLLIER* Director
- -----------------------------------------------------
Robert B. Collier

/s/ WILLIAM C. HAMMETT, JR.* Director
- -----------------------------------------------------
William C. Hammett, Jr.

/s/ THOMAS F. O'TOOLE* Director
- -----------------------------------------------------
Thomas F. O'Toole

/s/ MARK C. WELLS* Director
- -----------------------------------------------------
Mark C. Wells

/s/ BRUCE W. WOLFF* Director
- -----------------------------------------------------
Bruce W. Wolff

*By: /s/ JEROME L. GALANT
-------------------------------------------------
Jerome L. Galant
Attorney-in-Fact
</TABLE>

II-5
<PAGE> 82

EXHIBIT INDEX

(A) EXHIBITS

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
+1.1 -- Underwriting Agreement by and between Pegasus Systems,
Inc. and the Underwriters.
2.1 -- Contribution and Restructuring Agreement dated effective
as of July 21, 1995 by and among Pegasus Systems, Inc.
and all of the stockholders of Pegasus Systems, Inc.
++3.1 -- Third Amended and Restated Certificate of Incorporation,
as amended
3.2 -- Second Amended and Restated Bylaws
3.3 -- Form of Certification of Designation, Preferences and
Rights of Series A Preferred Stock of Pegasus Systems,
Inc. (incorporated by reference from Exhibit 2 of Pegasus
Systems, Inc.'s Form 8-A filed with the Commission on
October 9, 1998)
4.1 -- Specimen of Common Stock Certificate
4.2 -- Third Amended and Restated Certificate of Incorporation
and Second Amended and Restated Bylaws (see Exhibits 3.1
and 3.2)
4.3 -- Rights Agreement dated June 25, 1996 by and among Pegasus
Systems, Inc. and certain holders of capital stock of
Pegasus Systems, Inc. named therein
4.4 -- Common Stock Purchase Warrant issued to Holiday
Hospitality Corporation
4.5 -- Rights Agreement dated as of September 28, 1998 by and
between Pegasus Systems, Inc. and American Securities
Transfer & Trust, Inc. (incorporated by reference from
Exhibit 4 of Pegasus Systems, Inc.'s Current Report on
Form 8-K filed with the Commission on October 9, 1998)
4.6 -- Form of Rights Certificate (incorporated by reference
from Exhibit 3 of Pegasus Systems, Inc.'s Form 8-A filed
with the Commission on October 9, 1998)
**5.1 -- Opinion of Locke Liddell & Sapp LLP
10.1 -- Employment Agreement dated June 25, 1996 between Pegasus
Systems, Inc. and John F. Davis, III
10.2 -- Employment Agreement dated June 25, 1996 between Pegasus
Systems, Inc. and Joseph W. Nicholson
10.3 -- Employment Agreement dated August 29, 1996 between
Pegasus Systems, Inc. and Jerome L. Galant
10.4 -- Employment Agreement dated May 18, 1996 between Pegasus
Systems, Inc. and Michael R. Donahue
++10.5 -- 1996 Stock Option Plan, as amended
10.6 -- 1997 Stock Option Plan, as amended (incorporated by
reference from Pegasus Systems, Inc.'s Proxy Statement
for its 1999 Annual Stockholders meeting filed with the
Commission on April 12, 1999)
10.7 -- Citibank Global Payments Service Agreement dated July 24,
1998 between the Hotel Clearing Corporation and Citibank,
N.A. (incorporated by reference to Exhibit 10.1 of
Pegasus Systems, Inc.'s 10-Q for the quarter ended
October 31, 1998, filed with the Commission on November
16, 1998)
10.8 -- Facilities Management Agreement dated January 1, 1996
between Pegasus Systems, Inc. and Anasazi, Inc.,
currently known as REZsolutions, Inc.
10.9 -- Service Agreement dated December 13, 1996 between Pegasus
Systems, Inc. and Comdisco, Inc.
10.10 -- Service Agreement dated January 17, 1997 between Pegasus
Systems, Inc. and Genuity, Inc.
++10.11 -- 1997 Employee Stock Purchase Plan, as amended
</TABLE>

<PAGE> 83

<TABLE>
<CAPTION>
EXHIBIT
NUMBER DESCRIPTION
------- -----------
<C> <S>
++10.12 -- Office Lease dated October 1, 1995, First Amendment to
Office Lease dated February 25, 1998 and Second Amendment
to Office Lease dated November 2, 1998 between Pegasus
Systems, Inc. and the Utah State Retirement Investment
Fund relating to property located at 3811 Turtle Creek
Blvd., Suite 1100, Dallas, Texas 75219
++21.1 -- Subsidiaries of Pegasus Systems, Inc.
+23.1 -- Consent of PricewaterhouseCoopers LLP
+23.2 -- Consent of Belew Averitt LLP
**23.3 -- Consent of Locke Liddell & Sapp LLP (included in its
opinion filed as Exhibit 5.1)
**24.1 -- Power of Attorney
++27.1 -- Financial Data Schedule for the year ended December 31,
1998
</TABLE>

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

Unless otherwise indicated, exhibits are incorporated by reference to our
Registration Statement (File No. 333-28595) on Form S-1 declared effective by
the Commission on August 6, 1997.

+ Filed herewith.

** Previously filed in connection with this Registration Statement.

++ Incorporated by reference to our Form 10-K for the fiscal year ended December
31, 1998.

<PAGE> 1
EXHIBIT 1.1

PEGASUS SYSTEMS, INC.

1,750,000 SHARES(1)

COMMON STOCK

UNDERWRITING AGREEMENT

May _____, 1999

HAMBRECHT & QUIST LLC
BEAR, STEARNS & CO., INC.
DONALDSON, LUFKIN & JENRETTE
SECURITIES CORPORATION
VOLPE BROWN WHELAN & COMPANY, LLC
c/o Hambrecht & Quist LLC
One Bush Street
San Francisco, CA 94104

Ladies and Gentlemen:

Pegasus Systems, Inc., a Delaware corporation (herein called the
Company), proposes to issue and sell 1,750,000 shares of its authorized but
unissued Common Stock, $.01 par value (herein called the Underwritten Stock).
The Company proposes to grant to the Underwriters (as hereinafter defined) an
option to purchase up to 262,500 additional shares of Common Stock (herein
called the Option Stock and with the Underwritten Stock herein collectively
called the Stock). The Common Stock is more fully described in the Registration
Statement and the Prospectus hereinafter mentioned.

The Company hereby confirms the agreements made with respect to the
purchase of the Stock by the several underwriters, for whom you are acting,
named in Schedule I hereto (herein collectively called the Underwriters, which
term shall also include any underwriter purchasing Stock pursuant to Section
3(b) hereof). You represent and warrant that you have been authorized by each of
the other Underwriters to enter into this Agreement on its behalf and to act for
it in the manner herein provided.

1. REGISTRATION STATEMENT. The Company has filed with the Securities
and Exchange Commission (herein called the Commission) a registration statement
on Form S-3 (No. 333-77071), including the related preliminary prospectus, for
the registration under the Securities Act of 1933, as amended (herein called the
Securities Act) of the Stock. Copies of such registration statement and of each
amendment thereto, if any, including the related preliminary prospectus (meeting
the requirements of Rule 430A of the rules and regulations of

- --------
(1) Plus an option to purchase from the Company up to 262,500 additional shares
to cover over-allotments.

<PAGE> 2

the Commission) heretofore filed by the Company with the Commission have been
delivered to you.

The term Registration Statement as used in this agreement shall mean
such registration statement, including all exhibits and financial statements,
all information omitted therefrom in reliance upon Rule 430A and contained in
the Prospectus referred to below, in the form in which it became effective, and
any registration statement filed pursuant to Rule 462(b) of the rules and
regulations of the Commission with respect to the Stock (herein called a Rule
462(b) registration statement), and, in the event of any amendment thereto after
the effective date of such registration statement (herein called the Effective
Date), shall also mean (from and after the effectiveness of such amendment) such
registration statement as so amended (including any Rule 462(b) registration
statement). The term Prospectus as used in this Agreement shall mean the
prospectus relating to the Stock first filed with the Commission pursuant to
Rule 424(b) and Rule 430A (or if no such filing is required, as included in the
Registration Statement) and, in the event of any supplement or amendment to such
prospectus after the Effective Date, shall also mean (from and after the filing
with the Commission of such supplement or the effectiveness of such amendment)
such prospectus as so supplemented or amended. The term Preliminary Prospectus
as used in this Agreement shall mean each preliminary prospectus included in
such registration statement prior to the time it becomes effective. Any
reference to the Registration Statement or the Prospectus shall be deemed to
refer to and include the documents incorporated by reference therein pursuant to
Item 12 of Form S-3 under the Act, as of the date of the Registration Statement
or the Prospectus, as the case may be, and any reference to any amendment or
supplement to the Registration Statement or the Prospectus shall be deemed to
refer to and include any documents filed after such date under the Securities
Exchange Act of 1934, as amended (herein called the Exchange Act), which, upon
filing, are incorporated by reference therein, as required by paragraph (b) of
Item 12 of Form S-3. As used in this Agreement, the term "Incorporated
Documents" means the documents which at the time are incorporated by reference
in the Registration Statement, the Prospectus or any amendment or supplement
thereto.

The Registration Statement has been declared effective under the
Securities Act, and no post-effective amendment to the Registration Statement
has been filed as of the date of this Agreement. The Company has caused to be
delivered to you copies of each Preliminary Prospectus, including all documents
incorporated by reference therein, and has consented to the use of such copies
for the purposes permitted by the Securities Act.

2. REPRESENTATIONS AND WARRANTIES OF THE COMPANY. The Company hereby
represents and warrants as follows:

(a) Each of the Company and its subsidiaries has been duly
incorporated and is validly existing as a corporation in good standing under the
laws of the jurisdiction of its incorporation, has full corporate power and
authority to own or lease its properties and conduct its business as described
in the Registration Statement and the Prospectus and as being conducted, and is
duly qualified as a foreign corporation and in good standing in all
jurisdictions in which the character of the property owned or leased or the
nature of the business transacted by it makes qualification necessary (except
where the failure to be so qualified would not have a material adverse effect on
the business, properties, financial condition or results of operations of the
Company and its subsidiaries, taken as a whole).

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<PAGE> 3

(b) Since the respective dates as of which information is given in
the Registration Statement and the Prospectus and in any Incorporated Document,
there has not been any materially adverse change in the business, properties,
financial condition or results of operations of the Company and its
subsidiaries, taken as a whole, whether or not arising from transactions in the
ordinary course of business, other than as set forth in the Registration
Statement and the Prospectus and in any Incorporated Document, and since such
dates, except in the ordinary course of business, neither the Company nor any of
its subsidiaries has entered into any material transaction not referred to in
the Registration Statement and the Prospectus and in any Incorporated Document
which is required to be so referred to.

(c) The Registration Statement and the Prospectus comply, and on the
Closing Date (as hereinafter defined) and any later date on which Option Stock
is to be purchased, the Prospectus will comply, in all material respects, with
the provisions of the Securities Act and the rules and regulations of the
Commission thereunder; on the Effective Date, the Registration Statement did not
contain any untrue statement of a material fact and did not omit to state any
material fact required to be stated therein or necessary in order to make the
statements therein not misleading; and, on the Effective Date the Prospectus did
not and, on the Closing Date and any later date on which Option Stock is to be
purchased, will not contain any untrue statement of a material fact or omit to
state any material fact necessary in order to make the statements therein, in
the light of the circumstances under which they were made, not misleading;
provided, however, that none of the representations and warranties in this
subparagraph (c) shall apply to statements in, or omissions from, the
Registration Statement or the Prospectus made in reliance upon and in conformity
with information herein or otherwise furnished in writing to the Company by or
on behalf of the Underwriters for use in the Registration Statement or the
Prospectus.

(d) The Incorporated Documents heretofore filed, when they are filed
(or, if any amendment with respect to any such document was filed, when such
amendment was filed), conformed in all material respects with the requirements
of the Exchange Act and the rules and regulations of the Commission thereunder;
any further Incorporated Documents so filed will, when they are filed, conform
in all material respects with the requirements of the Exchange Act and the rules
and regulations of the Commission thereunder; no such document when it was filed
(or, if an amendment with respect to any such document was filed, when such
amendment was filed), contained any untrue statement of a material fact or
omitted to state a material fact required to be stated therein or necessary to
make the statements therein not misleading; and no such further amendment will
contain any untrue statement of a material fact or omit to state a material fact
required to be stated therein or necessary to make the statements therein not
misleading.

(e) The Stock is duly and validly authorized, is (or, in the case of
shares of the Stock to be sold by the Company, will be, when issued and sold to
the Underwriters against payment therefor as provided herein) duly and validly
issued, fully paid and nonassessable and conforms to the description thereof in
the Prospectus. No further approval or authority of the stockholders or the
Board of Directors of the Company will be required for the issuance and sale of
the Stock as contemplated herein.

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<PAGE> 4

(f) Prior to the Closing, the Common Stock will be authorized for
listing on the Nasdaq National Market.

3. PURCHASE OF THE STOCK BY THE UNDERWRITERS.

(a) On the basis of the representations and warranties and subject
to the terms and conditions herein set forth, the Company agrees to issue and
sell 1,750,000 shares of the Underwritten Stock to the several Underwriters and
each of the Underwriters agrees to purchase from the Company the respective
aggregate number of shares of Underwritten Stock set forth opposite its name in
Schedule I. The price at which such shares of Underwritten Stock shall be sold
by the Company and purchased by the several Underwriters shall be $______ per
share. The obligation of each Underwriter to the Company shall be to purchase
from the Company that number of shares of the Underwritten Stock which
represents the same proportion of the total number of shares of the Underwritten
Stock to be sold by the Company pursuant to this Agreement as the number of
shares of the Underwritten Stock set forth opposite the name of such Underwriter
in Schedule I hereto represents of the total number of shares of the
Underwritten Stock to be purchased by all Underwriters pursuant to this
Agreement, as adjusted by you in such manner as you deem advisable to avoid
fractional shares. In making this Agreement, each Underwriter is contracting
severally and not jointly; except as provided in paragraphs (b) and (c) of this
Section 3, the agreement of each Underwriter is to purchase only the respective
number of shares of the Underwritten Stock specified in Schedule I.

(b) If for any reason one or more of the Underwriters shall fail or
refuse (otherwise than for a reason sufficient to justify the termination of
this Agreement under the provisions of Section 8 or 9 hereof) to purchase and
pay for the number of shares of the Stock agreed to be purchased by such
Underwriter or Underwriters, the Company shall immediately give notice thereof
to you, and the non-defaulting Underwriters shall have the right within 24 hours
after the receipt by you of such notice to purchase, or procure one or more
other Underwriters to purchase, in such proportions as may be agreed upon
between you and such purchasing Underwriter or Underwriters and upon the terms
herein set forth, all or any part of the shares of the Stock which such
defaulting Underwriter or Underwriters agreed to purchase. If the non-defaulting
Underwriters fail so to make such arrangements with respect to all such shares
and portion, the number of shares of the Stock which each non-defaulting
Underwriter is otherwise obligated to purchase under this Agreement shall be
automatically increased on a pro rata basis to absorb the remaining shares and
portion which the defaulting Underwriter or Underwriters agreed to purchase;
provided, however, that the non-defaulting Underwriters shall not be obligated
to purchase the shares and portion which the defaulting Underwriter or
Underwriters agreed to purchase if the aggregate number of such shares of the
Stock exceeds 10% of the total number of shares of the Stock which all
Underwriters agreed to purchase hereunder. If the total number of shares of the
Stock which the defaulting Underwriter or Underwriters agreed to purchase shall
not be purchased or absorbed in accordance with the two preceding sentences, the
Company shall have the right, within 24 hours next succeeding the 24-hour period
above referred to, to make arrangements with other underwriters or purchasers
satisfactory to you for purchase of such shares and portion on the terms herein
set forth. In any such case, either you or the Company shall have the right to
postpone the Closing Date determined as provided in Section 5 hereof for not
more than seven business days after the date originally fixed as the Closing
Date pursuant to said Section 5 in order that any necessary

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<PAGE> 5

changes in the Registration Statement, the Prospectus or any other documents or
arrangements may be made. If neither the non-defaulting Underwriters nor the
Company shall make arrangements within the 24-hour periods stated above for the
purchase of all the shares of the Stock which the defaulting Underwriter or
Underwriters agreed to purchase hereunder, this Agreement shall be terminated
without further act or deed and without any liability on the part of the Company
to any non-defaulting Underwriter and without any liability on the part of any
non-defaulting Underwriter to the Company. Nothing in this paragraph (b), and no
action taken hereunder, shall relieve any defaulting Underwriter from liability
in respect of any default of such Underwriter under this Agreement.

(c) On the basis of the representations, warranties and covenants
herein contained, and subject to the terms and conditions herein set forth, the
Company grants an option to the several Underwriters to purchase, severally and
not jointly, up to 262,500 shares in the aggregate of the Option Stock from the
Company at the same price per share as the Underwriters shall pay for the
Underwritten Stock. Said option may be exercised only to cover over-allotments
in the sale of the Underwritten Stock by the Underwriters and may be exercised
in whole or in part at any time (but not more than once) on or before the
thirtieth day after the date of this Agreement upon written or telegraphic
notice by you to the Company setting forth the aggregate number of shares of the
Option Stock as to which the several Underwriters are exercising the option and
the date on which such shares of the Option Stock are to be delivered, as
determined by you but in no event earlier than the date that the Underwritten
Stock is delivered hereunder. Delivery of certificates for the shares of Option
Stock, and payment therefor, shall be made as provided in Section 5 hereof. The
number of shares of the Option Stock to be purchased by each Underwriter shall
be the same percentage of the total number of shares of the Option Stock to be
purchased by the several Underwriters as such Underwriter is purchasing of the
Underwritten Stock, as adjusted by you in such manner as you deem advisable to
avoid fractional shares.

4. OFFERING BY UNDERWRITERS.

(a) The terms of the public offering by the Underwriters of the
Stock to be purchased by them hereunder shall be as set forth in the Prospectus.
The Underwriters may from time to time change the public offering price after
the closing of the public offering and increase or decrease the concessions and
discounts to dealers as they may determine.

(b) The information set forth under "Underwriting" in the
Registration Statement, any Preliminary Prospectus and the Prospectus relating
to the Stock filed by the Company (insofar as such information relates to the
Underwriters) constitutes the only information furnished by the Underwriters to
the Company for inclusion in the Registration Statement, any Preliminary
Prospectus, and the Prospectus, and you on behalf of the respective Underwriters
represent and warrant to the Company that the statements made therein are
correct.

5. DELIVERY OF AND PAYMENT FOR THE STOCK.

(a) Delivery of certificates for the shares of the Underwritten
Stock and the Option Stock (if the option granted by Section 3(c) hereof shall
have been exercised not later than 7:00 a.m., San Francisco time, on the date
two business days preceding the Closing Date),

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<PAGE> 6

and payment therefor, shall be made at the offices of Locke Liddell & Sapp LLP,
2200 Ross Avenue, Suite 2200, Dallas, Texas, at 9:00 a.m., Dallas time, on the
fourth business day after the date of this Agreement, or at such time on such
other day, not later than seven full business days after such fourth business
day, as shall be agreed upon in writing by the Company and you. The date and
hour of such delivery and payment (which may be postponed as provided in Section
3(b) hereof) are herein called the Closing Date.

(b) If the option granted by Section 3(c) hereof shall be exercised
after 7:00 a.m., San Francisco time, on the date two business days preceding the
Closing Date, delivery of certificates for the shares of Option Stock, and
payment therefor, shall be made at the offices of Locke Liddell & Sapp LLP, 2200
Ross Avenue, Suite 2200, Dallas, Texas, at 9:00 a.m., Dallas time, on the third
business day after the exercise of such option; provided that any such payment
and delivery that under the terms of this subsection 5(b) should occur on the
first or second business day immediately following the Closing Date shall occur
on the third business day following the Closing Date, unless otherwise agreed by
the parties hereto.

(c) Payment for the Stock purchased from the Company shall be made
to the Company or its order, by one or more certified or official bank check or
checks in same day funds. Such payment shall be made upon delivery of
certificates for the Stock to you for the respective accounts of the several
Underwriters against receipt therefor signed by you. Certificates for the Stock
to be delivered to you shall be registered in such name or names and shall be in
such denominations as you may request at least one business day before the
Closing Date, in the case of Underwritten Stock, and at least one business day
prior to the purchase thereof, in the case of the Option Stock. Certificates for
the Underwritten Stock will be made available to the Underwriters for
inspection, checking and packaging at the offices of Lewco Securities
Corporation, 2 Broadway, New York, New York 10004 on the business day prior to
the Closing Date or, in the case of the Option Stock, by 3:00 p.m., New York
time, on the business day preceding the date of purchase.

It is understood that you, individually and not on behalf of the
Underwriters, may (but shall not be obligated to) make payment to the Company
for shares to be purchased by any Underwriter whose check shall not have been
received by you on the Closing Date or any later date on which Option Stock is
purchased for the account of such Underwriter. Any such payment by you shall not
relieve such Underwriter from any of its obligations hereunder.

6. FURTHER AGREEMENTS OF THE COMPANY. The Company covenants and agrees
as follows:

(a) The Company will (i) prepare and timely file with the Commission
under Rule 424(b) a Prospectus containing information previously omitted at the
time of effectiveness of the Registration Statement in reliance on Rule 430A and
(ii) not file any amendment to the Registration Statement or Incorporated
Document, or supplement to the Prospectus of which you shall not previously have
been advised and furnished with a copy or to which you shall have promptly and
reasonably objected in writing or which is not in compliance with the Securities
Act, the Exchange Act, or the rules and regulations of the Commission.

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<PAGE> 7

(b) The Company will promptly notify each Underwriter in the event
of (i) the request by the Commission for amendment of the Registration Statement
or for supplement to the Prospectus or for any additional information, (ii) the
issuance by the Commission of any stop order suspending the effectiveness of the
Registration Statement, (iii) the institution or notice of intended institution
of any action or proceeding for that purpose, (iv) the receipt by the Company of
any notification with respect to the suspension of the qualification of the
Stock for sale in any jurisdiction, or (v) the receipt by it of notice of the
initiation or threatening of any proceeding for such purpose. The Company will
make every reasonable effort to prevent the issuance of such a stop order and,
if such an order shall at any time be issued, to obtain the withdrawal thereof
at the earliest possible moment.

(c) The Company will (i) on or before the Closing Date, deliver to
you a signed copy of the Registration Statement as originally filed and of each
amendment thereto filed prior to the time the Registration Statement becomes
effective and, promptly upon the filing thereof, a signed copy of each
post-effective amendment, if any, to the Registration Statement (together with,
in each case, all exhibits thereto unless previously furnished to you) and will
also deliver to you, for distribution to the Underwriters, a sufficient number
of additional conformed copies of each of the foregoing (but without exhibits)
so that one copy of each may be distributed to each Underwriter, (ii) as
promptly as practicable deliver to you and send to the several Underwriters, at
such office or offices as you may designate, as many copies of the Prospectus as
you may reasonably request, and (iii) thereafter from time to time during the
period in which a prospectus is required by law to be delivered by an
Underwriter or dealer, likewise send to the Underwriters as many additional
copies of the Prospectus and as many copies of any supplement to the Prospectus
and of any amended prospectus, filed by the Company with the Commission, as you
may reasonably request for the purposes contemplated by the Securities Act.

(d) If at any time during the period in which a prospectus is
required by law to be delivered by an Underwriter or dealer any event relating
to or affecting the Company, or of which the Company shall be advised in writing
by you, shall occur as a result of which it is necessary, in the reasonable
opinion of counsel for the Company or of counsel for the Underwriters, to
supplement or amend the Prospectus in order to make the Prospectus not
misleading in the light of the circumstances existing at the time it is
delivered to a purchaser of the Stock, the Company will forthwith prepare and
file with the Commission a supplement to the Prospectus or an amended prospectus
so that the Prospectus as so supplemented or amended will not contain any untrue
statement of a material fact or omit to state any material fact necessary in
order to make the statements therein, in the light of the circumstances existing
at the time such Prospectus is delivered to such purchaser, not misleading. If,
at any time during the period in which a prospectus is required by law to be
delivered by an Underwriter or a dealer, the Underwriters shall propose to vary
the terms of offering of the Stock by reason of changes in general market
conditions or otherwise, you will advise the Company in writing of the proposed
variation, and, if in the reasonable opinion either of counsel for the Company
or of counsel for the Underwriters such proposed variation requires that the
Prospectus be supplemented or amended, the Company will forthwith prepare and
file with the Commission a supplement to the Prospectus or an amended prospectus
setting forth such variation. The Company authorizes the Underwriters and all
dealers to whom any of the Stock may be sold by the several Underwriters to use
the Prospectus, as from time to time amended or supplemented, in connection with
the sale

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<PAGE> 8

of the Stock in accordance with the applicable provisions of the Securities Act
and the applicable rules and regulations thereunder for such period.

(e) Prior to the filing thereof with the Commission, the Company
will submit to you, for your information, a copy of any post-effective amendment
to the Registration Statement and any supplement to the Prospectus or any
amended prospectus or Incorporated Document proposed to be filed.

(f) The Company will cooperate, when and as requested by you, in the
qualification of the Stock for offer and sale under the securities or blue sky
laws of such jurisdictions as you may designate and, during the period in which
a prospectus is required by law to be delivered by an Underwriter or dealer, in
keeping such qualifications in good standing under said securities or blue sky
laws; provided, however, that the Company shall not be obligated to file any
general consent to service of process or to qualify as a foreign corporation in
any jurisdiction in which it is not so qualified. The Company will, from time to
time, prepare and file such statements, reports, and other documents as are or
may be required to continue such qualifications in effect for so long a period
as you may reasonably request for distribution of the Stock.

(g) During a period of five years commencing with the date hereof,
the Company will furnish to you, and to each Underwriter who may so request in
writing, copies of all periodic and special reports furnished to stockholders of
the Company and of all information, documents and reports filed with the
Commission.

(h) Not later than the 45th day following the end of the fiscal
quarter first occurring after the first anniversary of the Effective Date, the
Company will make generally available to its security holders an earnings
statement in accordance with Section 11(a) of the Securities Act and Rule 158
thereunder.

(i) The Company agrees to pay all costs and expenses incident to the
performance of the obligations of the Company under this Agreement, including
all costs and expenses incident to (i) the preparation, printing and filing with
the Commission and the National Association of Securities Dealers, Inc. ("NASD")
of the Registration Statement, any Preliminary Prospectus and the Prospectus and
the Incorporated Documents, (ii) the furnishing to the Underwriters of copies of
any Preliminary Prospectus and of the several documents required by paragraph
(c) of this Section 6 to be so furnished, (iii) the printing of this Agreement
and related documents delivered to the Underwriters, (iv) the preparation,
printing and filing of all supplements and amendments to the Prospectus and the
Incorporated Documents referred to in paragraph (d) of this Section 6, (v) the
furnishing to you and the Underwriters of the reports and information referred
to in paragraph (g) of this Section 6 and (vi) the printing and issuance of
stock certificates, including the transfer agent's fees.

(j) The Company agrees to reimburse you, for the account of the
several Underwriters, for blue sky fees and related disbursements (including
counsel fees and disbursements and cost of copying memoranda for the
Underwriters) paid by or for the account of the Underwriters or their counsel in
qualifying the Stock under state securities or blue sky laws and in the review
of the offering by the NASD.

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<PAGE> 9

(k) The provisions of paragraphs (i) and (j) of this Section are
intended to relieve the Underwriters from the payment of the expenses and costs
which the Company hereby agrees to pay and shall not affect any agreement which
the Company may make, or may have made, for the sharing of any such expenses and
costs.

(l) The Company hereby agrees that, without the prior written
consent of Hambrecht & Quist LLC on behalf of the Underwriters, the Company will
not, for a period of 90 days from the effective date of the Registration
Statement, directly or indirectly, sell, offer, contract to sell, transfer the
economic risk of ownership in, make any short sale, pledge or otherwise dispose
of any shares of Common Stock or any securities convertible into or exchangeable
or exercisable for or any other rights to purchase or acquire Common Stock. The
foregoing sentence shall not apply to (A) the Stock to be sold to the
Underwriters pursuant to this Agreement, (B) shares of Common Stock issued by
the Company upon the exercise of options granted under the stock option plans of
the Company (the "Option Plans") or upon the exercise of warrants outstanding as
of the date hereof, all as described under the caption "Capitalization" in the
Preliminary Prospectus, and (C) options to purchase Common Stock granted under
the Option Plans.

(m) The Company agrees to use all reasonable efforts to cause all
directors that are stockholders of the Company, officers, and beneficial holders
of more than 5% of the outstanding Common Stock to agree that, without the prior
written consent of Hambrecht & Quist LLC on behalf of the Underwriters, such
person or entity will not, for a period of 90 days from the effective date of
the Registration Statement, directly or indirectly, sell, offer, contract to
sell, transfer the economic risk of ownership in, make any short sale, pledge or
otherwise dispose of any shares of Common Stock or any securities convertible
into or exchangeable or exercisable for or any other rights to purchase or
acquire Common Stock; provided, that, individuals may transfer any shares of
Common Stock or securities convertible into or exchangeable or exercisable for
the Company's Common Stock either during his or her lifetime or on death by will
or intestacy to his or her immediate family or to a trust the beneficiaries of
which are exclusively such individual and/or a member or members of his or her
immediate family; provided, however, that prior to any such transfer each
transferee shall execute an agreement, satisfactory to Hambrecht & Quist LLC,
pursuant to which each transferee shall agree to receive and hold such shares of
Common Stock, or securities convertible into or exchangeable or exercisable for
the Common Stock, subject to the foregoing restrictions, and there shall be no
further transfer except in accordance with such restrictions.

7. INDEMNIFICATION AND CONTRIBUTION.

(a) Subject to the provisions of paragraph (f) of this Section 7,
the Company agrees to indemnify and hold harmless each Underwriter and each
person (including each partner or officer thereof) who controls any Underwriter
within the meaning of Section 15 of the Securities Act from and against any and
all losses, claims, damages or liabilities, joint or several, to which such
indemnified parties or any of them may become subject under the Securities Act,
the Exchange Act, or the common law or otherwise, and the Company agrees to
reimburse each such Underwriter and controlling person for any legal or other
expenses (including, except as otherwise hereinafter provided, reasonable fees
and disbursements of counsel) incurred by the respective indemnified parties in
connection with defending against any such losses, claims,

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<PAGE> 10

damages or liabilities or in connection with any investigation or inquiry of, or
other proceeding which may be brought against, the respective indemnified
parties, in each case arising out of or based upon (i) any untrue statement or
alleged untrue statement of a material fact contained in the Registration
Statement (including the Prospectus and all Incorporated Documents as part
thereof and any Rule 462(b) registration statement) or any post-effective
amendment thereto (including any Rule 462(b) registration statement), or the
omission or alleged omission to state therein a material fact required to be
stated therein or necessary to make the statements therein not misleading, or
(ii) any untrue statement or alleged untrue statement of a material fact
contained in any Preliminary Prospectus or the Prospectus (as amended or as
supplemented if the Company shall have filed with the Commission any amendment
thereof or supplement thereto) or the omission or alleged omission to state
therein a material fact necessary in order to make the statements therein, in
the light of the circumstances under which they were made, not misleading;
provided, however, that (1) the indemnity agreements of the Company contained in
this paragraph (a) shall not apply to any such losses, claims, damages,
liabilities or expenses if such statement or omission was made in reliance upon
and in conformity with information furnished as herein stated or otherwise
furnished in writing to the Company by or on behalf of any Underwriter for use
in any Preliminary Prospectus or the Registration Statement or the Prospectus or
any such amendment thereof or supplement thereto, and (2) the indemnity
agreement contained in this paragraph (a) shall not inure to the benefit of any
Underwriter from whom the person asserting any such losses, claims, damages,
liabilities or expenses purchased the Stock which is the subject of the
Preliminary Prospectus (or to the benefit of any person controlling such
Underwriter) if at or prior to the written confirmation of the sale of such
Stock a copy of the Prospectus (or the Prospectus as amended or supplemented)
was not sent or delivered to such person (excluding the documents incorporated
therein by reference) and the untrue statement or omission of a material fact
contained in such Preliminary Prospectus was corrected in the Prospectus (or the
Prospectus as amended or supplemented) unless the failure is the result of
noncompliance by the Company with clauses (ii) or (iii) of paragraph (c) of
Section 6 hereof. The indemnity agreements of the Company contained in this
paragraph (a) and the representations and warranties of the Company contained in
Section 2 hereof shall remain operative and in full force and effect regardless
of any investigation made by or on behalf of any indemnified party and shall
survive the delivery of and payment for the Stock.

(b) Each Underwriter severally agrees to indemnify and hold harmless
the Company, each of its officers who signs the Registration Statement on his
own behalf or pursuant to a power of attorney, each of its directors, each other
Underwriter and each person (including each partner or officer thereof) who
controls the Company or any such other Underwriter within the meaning of Section
15 of the Securities Act, from and against any and all losses, claims, damages
or liabilities, joint or several, to which such indemnified parties or any of
them may become subject under the Securities Act, the Exchange Act, or the
common law or otherwise and to reimburse each of them for any legal or other
expenses (including, except as otherwise hereinafter provided, reasonable fees
and disbursements of counsel) incurred by the respective indemnified parties in
connection with defending against any such losses, claims, damages or
liabilities or in connection with any investigation or inquiry of, or other
proceeding which may be brought against, the respective indemnified parties, in
each case arising out of or based upon (i) any untrue statement or alleged
untrue statement of a material fact contained in the Registration Statement
(including the Prospectus as part thereof and any Rule 462(b) registration
statement) or any post-effective amendment thereto (including any Rule 462(b)

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<PAGE> 11

registration statement) or the omission or alleged omission to state therein a
material fact required to be stated therein or necessary to make the statements
therein not misleading or (ii) any untrue statement or alleged untrue statement
of a material fact contained in any Preliminary Prospectus the Prospectus (as
amended or as supplemented if the Company shall have filed with the Commission
any amendment thereof or supplement thereto) or the omission or alleged omission
to state therein a material fact necessary in order to make the statements
therein, in the light of the circumstances under which they were made, not
misleading, if such statement or omission was made in reliance upon and in
conformity with information furnished as herein stated or otherwise furnished in
writing to the Company by or on behalf of such indemnifying Underwriter for use
in the Registration Statement, any Preliminary Prospectus or the Prospectus or
any such amendment thereof or supplement thereto. The indemnity agreement of
each Underwriter contained in this paragraph (b) shall remain operative and in
full force and effect regardless of any investigation made by or on behalf of
any indemnified party and shall survive the delivery of and payment for the
Stock.

(c) Each party indemnified under the provision of paragraphs (a) and
(b) of this Section 7 agrees that, upon the service of a summons or other
initial legal process upon it in any action or suit instituted against it or
upon its receipt of written notification of the commencement of any
investigation or inquiry of, or proceeding against, it in respect of which
indemnity may be sought on account of any indemnity agreement contained in such
paragraphs, it will promptly give written notice (herein called the Notice) of
such service or notification to the party or parties from whom indemnification
may be sought hereunder. No indemnification provided for in such paragraphs
shall be available to any party who shall fail so to give the Notice if the
party to whom such Notice was not given was unaware of the action, suit,
investigation, inquiry or proceeding to which the Notice would have related and
was prejudiced by the failure to give the Notice, but the omission so to notify
such indemnifying party or parties of any such service or notification shall not
relieve such indemnifying party or parties from any liability which it or they
may have to the indemnified party for contribution or otherwise than on account
of the indemnification provided for herein. Any indemnifying party shall be
entitled at its own expense to participate in the defense of any action, suit or
proceeding against, or investigation or inquiry of, an indemnified party. Any
indemnifying party shall be entitled, if it so elects within a reasonable time
after receipt of the Notice by giving written notice (herein called the Notice
of Defense) to the indemnified party, to assume (alone or in conjunction with
any other indemnifying party or parties) the entire defense of such action,
suit, investigation, inquiry or proceeding, in which event such defense shall be
conducted, at the expense of the indemnifying party or parties, by counsel
chosen by such indemnifying party or parties and reasonably satisfactory to the
indemnified party or parties; provided, however, that (i) if the indemnified
party or parties reasonably determine that there may be a conflict between the
positions of the indemnifying party or parties and of the indemnified party or
parties in conducting the defense of such action, suit, investigation, inquiry
or proceeding or that there may be legal defenses available to such indemnified
party or parties different from or in addition to those available to the
indemnifying party or parties, then, upon prior written notice to the
indemnifying party or parties, counsel for the indemnified party or parties
shall be entitled to conduct the defense to the extent reasonably determined by
such counsel to be necessary to protect the interests of the indemnified party
or parties and (ii) in any event, upon prior written notice to the indemnifying
party or parties, the indemnified party or parties shall be entitled to have
counsel chosen by such indemnified party or parties participate in, but not
conduct, the

11
<PAGE> 12

defense. If, within a reasonable time after receipt of the Notice, an
indemnifying party gives a Notice of Defense and the counsel chosen by the
indemnifying party or parties is reasonably satisfactory to the indemnified
party or parties, the indemnifying party or parties will not be liable under
paragraphs (a) through (c) of this Section 7 for any legal or other expenses
subsequently incurred by the indemnified party or parties in connection with the
defense of the action, suit, investigation, inquiry or proceeding, except that
(A) the indemnifying party or parties shall bear the legal and other expenses
incurred in connection with the conduct of the defense as referred to in clause
(i) of the proviso to the preceding sentence and (B) the indemnifying party or
parties shall bear such other expenses as it or they have authorized to be
incurred by the indemnified party or parties. If, within a reasonable time after
receipt of the Notice, no Notice of Defense has been given, the indemnifying
party or parties shall be responsible for any legal or other expenses incurred
by the indemnified party or parties in connection with the defense of the
action, suit, investigation, inquiry or proceeding.

(d) If the indemnification provided for in this Section 7 is
unavailable or insufficient to hold harmless an indemnified party under
paragraph (a) or (b) of this Section 7, then each indemnifying party, in lieu of
indemnifying such indemnified party, shall contribute to the amount paid or
payable by such indemnified party as a result of the losses, claims, damages or
liabilities referred to in paragraph (a) or (b) of this Section 7 (i) in such
proportion as is appropriate to reflect the relative benefits received by each
indemnifying party from the offering of the Stock or (ii) if the allocation
provided by clause (i) above is not permitted by applicable law, in such
proportion as is appropriate to reflect not only the relative benefits referred
to in clause (i) above but also the relative fault of each indemnifying party in
connection with the statements or omissions that resulted in such losses,
claims, damages or liabilities, or actions in respect thereof, as well as any
other relevant equitable considerations. The relative benefits received by the
Company on the one hand and the Underwriters on the other shall be deemed to be
in the same respective proportions as the total net proceeds from the offering
of the Stock received by the Company and the total underwriting discount
received by the Underwriters, as set forth in the table on the cover page of the
Prospectus, bear to the aggregate public offering price of the Stock. Relative
fault shall be determined by reference to, among other things, whether the
untrue or alleged untrue statement of a material fact or the omission or alleged
omission to state a material fact relates to information supplied by each
indemnifying party and the parties' relative intent, knowledge, access to
information and opportunity to correct or prevent such untrue statement or
omission.

The parties agree that it would not be just and equitable if
contributions pursuant to this paragraph (d) were to be determined by pro rata
allocation (even if the Underwriters were treated as one entity for such
purpose) or by any other method of allocation which does not take into account
the equitable considerations referred to in the first sentence of this paragraph
(d). The amount paid by an indemnified party as a result of the losses, claims,
damages or liabilities, or actions in respect thereof, referred to in the first
sentence of this paragraph (d) shall be deemed to include any legal or other
expenses reasonably incurred by such indemnified party in connection with
investigation, preparing to defend or defending against any action or claim
which is the subject of this paragraph (d). Notwithstanding the provisions of
this paragraph (d), no Underwriter shall be required to contribute any amount in
excess of the underwriting discount applicable to the Stock purchased by such
Underwriter. No person guilty of fraudulent misrepresentation (within the
meaning of Section 11(f) of the Securities Act) shall be entitled to

12
<PAGE> 13

contribution from any person who was not guilty of such fraudulent
misrepresentation. The Underwriters' obligations in this paragraph (d) to
contribute are several in proportion to their respective underwriting
obligations and not joint.

Each party entitled to contribution agrees that upon the service of a
summons or other initial legal process upon it in any action instituted against
it in respect of which contribution may be sought, it will promptly give written
notice of such service to the party or parties from whom contribution may be
sought, but the omission so to notify such party or parties of any such service
shall not relieve the party from whom contribution may be sought from any
obligation it may have hereunder or otherwise (except as specifically provided
in paragraph (c) of this Section 7).

(e) The Company will not, without the prior written consent of each
Underwriter, settle or compromise or consent to the entry of any judgment in any
pending or threatened claim, action, suit or proceeding in respect of which
indemnification may be sought hereunder (whether or not such Underwriter or any
person who controls such Underwriter within the meaning of Section 15 of the
Securities Act or Section 20 of the Exchange Act is a party to such claim,
action, suit or proceeding) unless such settlement, compromise or consent
includes an unconditional release of such Underwriter and each such controlling
person from all liability arising out of such claim, action, suit or proceeding.

8. TERMINATION. This Agreement may be terminated by you at any time
prior to the Closing Date by giving written notice to the Company if after the
date of this Agreement trading in the Common Stock shall have been suspended, or
if there shall have occurred (i) the engagement in hostilities or an escalation
of major hostilities by the United States or the declaration of war or a
national emergency by the United States on or after the date hereof, (ii) any
outbreak of hostilities or other national or international calamity or crisis or
change in economic or political conditions if the effect of such outbreak,
calamity, crisis or change in economic or political conditions in the financial
markets of the United States would, in the Underwriters' reasonable judgment,
make the offering or delivery of the Stock impracticable, (iii) suspension of
trading in securities generally or a material adverse decline in value of
securities generally on the New York Stock Exchange, the American Stock
Exchange, or The Nasdaq Stock Market, or limitations on prices (other than
limitations on hours or numbers of days of trading) for securities on either
such exchange or system, (iv) the enactment, publication, decree or other
promulgation of any federal or state statute, regulation, rule or order of, or
commencement of any proceeding or investigation by, any court, legislative body,
agency or other governmental authority which in the Underwriters' reasonable
opinion materially and adversely affects or will materially or adversely affect
the business or operations of the Company, (v) declaration of a banking
moratorium by either federal or New York State authorities or (vi) the taking of
any action by any federal, state or local government or agency in respect of its
monetary or fiscal affairs which in the Underwriters' reasonable opinion has a
material adverse effect on the securities markets in the United States. If this
Agreement shall be terminated pursuant to this Section 8, there shall be no
liability of the Company to the Underwriters (including without limitation any
liability for loss of anticipated profit) and no liability of the Underwriters
to the Company (including without limitation any liability for loss of
anticipated profit); provided, however, that in the event of any such
termination the Company agrees to indemnify and hold harmless the Underwriters
from all costs or expenses incident to

13
<PAGE> 14

the performance of the obligations of the Company under this Agreement,
including all costs and expenses referred to in paragraphs (i) and (j) of
Section 6 hereof.

9. CONDITIONS OF UNDERWRITERS' OBLIGATIONS. The obligations of the
several Underwriters to purchase and pay for the Stock shall be subject to the
performance by the Company of all their respective obligations to be performed
hereunder at or prior to the Closing Date or any later date on which Option
Stock is to be purchased, as the case may be, and to the following further
conditions:

(a) The Registration Statement shall have become effective; and no
stop order suspending the effectiveness thereof shall have been issued and no
proceedings therefor shall be pending or threatened by the Commission.

(b) The legality and sufficiency of the sale of the Stock hereunder
and the validity and form of the certificates representing the Stock, all
corporate proceedings and other legal matters incident to the foregoing, and the
form of the Registration Statement and of the Prospectus (except as to the
financial statements contained therein), shall have been approved at or prior to
the Closing Date by Cooley Godward LLP, counsel for the Underwriters.

(c) You shall have received from Locke Liddell & Sapp LLP and other
counsel for the Company satisfactory to you, one or more opinions, addressed to
the Underwriters and dated the Closing Date, covering the matters set forth in
Annex A hereto, and if Option Stock is purchased at any date after the Closing
Date, additional opinions from each such counsel, addressed to the Underwriters
and dated such later date, confirming that the statements expressed as of the
Closing Date in such opinions remain valid as of such later date.

(d) You shall be satisfied that (i) as of the Effective Date, the
statements made in the Registration Statement and the Prospectus, including any
Incorporated Documents, were true and correct in all material respects and
neither the Registration Statement nor the Prospectus or the Incorporated
Documents omitted to state any material fact required to be stated therein or
necessary in order to make the statements therein, respectively, not misleading,
(ii) since the Effective Date, no event has occurred which should have been set
forth in a supplement or amendment to the Prospectus, or any Incorporated
Document, which has not been set forth in such a supplement or amendment, (iii)
since the respective dates as of which information is given in the Registration
Statement in the form in which it originally became effective and the Prospectus
contained therein, there has not been any material adverse change or any
development involving a prospective material adverse change in or affecting the
business, properties, financial condition or results of operations of the
Company and its subsidiaries, taken as a whole, whether or not arising from
transactions in the ordinary course of business, and, since such dates, except
in the ordinary course of business, neither the Company nor any of its
subsidiaries has entered into any material transaction not referred to in the
Registration Statement in the form in which it originally became effective and
the Prospectus contained therein, (iv) neither the Company nor any of its
subsidiaries has any material contingent obligations which are not disclosed in
the Registration Statement and the Prospectus and in the Incorporated Documents,
(v) there are not any pending or known threatened legal proceedings to which the
Company or any of its subsidiaries is a party or of which property of the
Company or any of its subsidiaries is the subject which are material and which
are not disclosed in the

14
<PAGE> 15

Registration Statement and the Prospectus and in the Incorporated Documents,
(vi) there are not any franchises, contracts, leases or other documents which
are required to be filed as exhibits to the Registration Statement which have
not been filed as required, (vii) the representations and warranties of the
Company herein are true and correct in all material respects as of the Closing
Date or any later date on which Option Stock is to be purchased, as the case may
be, and (viii) there has not been any material change in the market for
securities in general or in political, financial or economic conditions from
those reasonably foreseeable as to render it impracticable in your reasonable
judgment to make a public offering of the Stock, or a material adverse change in
market levels for securities in general (or those of companies in particular) or
financial or economic conditions which render it inadvisable to proceed.

(e) You shall have received on the Closing Date and on any later
date on which Option Stock is purchased a certificate, dated the Closing Date or
such later date, as the case may be, and signed by the President and the Chief
Financial Officer of the Company, stating that the respective signers of said
certificate have carefully examined the Registration Statement in the form in
which it originally became effective and the Prospectus contained therein and
Incorporated Documents and any supplements or amendments thereto, and that the
statements included in clauses (i) through (vii) of paragraph (d) of this
Section 9 are true and correct.

(f) You shall have received from PricewaterhouseCoopers LLP, a
letter or letters, addressed to the Underwriters and dated the Closing Date and
any later date on which Option Stock is purchased, confirming that they are
independent public accountants with respect to the Company within the meaning of
the Securities Act and the applicable published rules and regulations thereunder
and based upon the procedures described in their letter delivered to you
concurrently with the execution of this Agreement (herein called the Original
Letter), but carried out to a date not more than three business days prior to
the Closing Date or such later date on which Option Stock is purchased (i)
confirming, to the extent true, that the statements and conclusions set forth in
the Original Letter are accurate as of the Closing Date or such later date, as
the case may be, and (ii) setting forth any revisions and additions to the
statements and conclusions set forth in the Original Letter which are necessary
to reflect any changes in the facts described in the Original Letter since the
date of the Original Letter or to reflect the availability of more recent
financial statements, data or information. The letters shall not disclose any
change, or any development involving a prospective change, in or affecting the
business or properties of the Company or any of its subsidiaries which, in your
sole reasonable judgment, makes it impractical or inadvisable to proceed with
the public offering of the Stock or the purchase of the Option Stock as
contemplated by the Prospectus.

(g) You shall have received from PricewaterhouseCoopers LLP a letter
stating that their review of the Company's system of internal accounting
controls, to the extent they deemed necessary in establishing the scope of their
examination of the Company's financial statements as at __________, did not
disclose any weakness in internal controls that they considered to be material
weaknesses.

(h) You shall have been furnished evidence in usual written or
telegraphic form from the appropriate authorities of the several jurisdictions,
or other evidence satisfactory to you, of the qualification, if required,
referred to in paragraph (f) of Section 6 hereof.

15
<PAGE> 16

(i) Prior to the Closing Date, the Stock to be issued and sold by
the Company shall have been duly authorized for listing by the Nasdaq National
Market.

(j) On or prior to the Closing Date, you shall have received from
all directors that are stockholders of the Company, officers, and beneficial
holders of more than 5% of the outstanding Common Stock agreements, in form
reasonably satisfactory to Hambrecht & Quist LLC, stating that without the prior
written consent of Hambrecht & Quist LLC on behalf of the Underwriters, such
person or entity will not, for a period of 90 days from the effective date of
the Registration Statement, directly or indirectly, offer, contract to sell,
transfer the economic risk of ownership in, make any short sale, pledge or
otherwise dispose of any shares of Common Stock or any securities convertible
into or exchangeable or exercisable for or any other rights to purchase or
acquire Common Stock, subject to the applicable exceptions set forth in Section
6(l) and (m) hereof.

(k) All the agreements, opinions, certificates and letters mentioned
above or elsewhere in this Agreement shall be deemed to be in compliance with
the provisions hereof only if Cooley Godward LLP, counsel for the Underwriters,
shall be reasonably satisfied that they comply in form and scope.

In case any of the conditions specified in this Section 9 shall not be
fulfilled, this Agreement may be terminated by you by giving written notice to
the Company. Any such termination shall be without liability of the Company to
the Underwriters (including without limitation loss of anticipated profits) and
without liability of the Underwriters to the Company (including without
limitation loss of anticipated profits); provided, however, that (i) in the
event of such termination, the Company agrees to indemnify and hold harmless the
Underwriters from all costs or expenses incident to the performance of the
obligations of the Company under this Agreement, including all costs and
expenses referred to in paragraphs (i) and (j) of Section 6 hereof, and (ii) if
this Agreement is terminated by you because of any refusal, inability or failure
on the part of the Company to perform any agreement herein, to fulfill any of
the conditions herein (other than Section 9(d)(viii)), or to comply with any
provision hereof other than by reason of a default by any of the Underwriters,
the Company will reimburse the Underwriters severally upon demand for all
out-of-pocket expenses (including reasonable fees and disbursements of counsel)
that shall have been incurred by them in connection with the transactions
contemplated hereby.

10. CONDITIONS OF THE OBLIGATION OF THE COMPANY. The obligation of the
Company to deliver the Stock shall be subject to the conditions that (a) the
Registration Statement shall have become effective and (b) no stop order
suspending the effectiveness thereof shall be in effect and no proceedings
therefor shall be pending or threatened by the Commission.

In case either of the conditions specified in this Section 10 shall not
be fulfilled, this Agreement may be terminated by the Company by giving notice
to you. Any such termination shall be without liability of the Company to the
Underwriters (including without limitation any liability for loss of anticipated
profits) and without liability of the Underwriters to the Company (including
without limitation any liability for loss of anticipated profits); provided,
however, that in the event of any such termination the Company agrees to
indemnify and hold harmless the Underwriters from all costs or expenses incident
to the performance of the obligations of the

16
<PAGE> 17

Company under this Agreement, including all costs and expenses referred to in
paragraphs (i) and (j) of Section 6 hereof.

11. REIMBURSEMENT OF CERTAIN EXPENSES. In addition to their other
obligations under Section 7 of this Agreement, the Company hereby agrees to
reimburse on a quarterly basis the Underwriters for all reasonable legal and
other expenses incurred in connection with investigating or defending any claim,
action, investigation, inquiry or other proceeding arising out of or based upon
any statement or omission, or any alleged statement or omission, described in
paragraph (a) of Section 7 of this Agreement, notwithstanding the absence of a
judicial determination as to the propriety and enforceability of the obligations
under this Section 11 and the possibility that such payments might later be held
to be improper; provided, however, that (i) to the extent any such payment is
ultimately held to be improper, the persons receiving such payments shall
promptly refund them and (ii) such persons shall provide to the Company, upon
request, reasonable assurances of their ability to effect any refund, when and
if due.

12. PERSONS ENTITLED TO BENEFIT OF AGREEMENT. This Agreement shall
inure to the benefit of the Company and the several Underwriters and, with
respect to the provisions of Section 7 hereof, the several parties (in addition
to the Company and the several Underwriters) indemnified under the provisions of
said Section 7, and their respective personal representatives, successors and
assigns. Nothing in this Agreement is intended or shall be construed to give to
any other person, firm or corporation any legal or equitable remedy or claim
under or in respect of this Agreement or any provision herein contained. The
term "successors and assigns" as herein used shall not include any purchaser, as
such purchaser, of any of the Stock from any of the several Underwriters.

13. NOTICES. Except as otherwise provided herein, all communications
hereunder shall be in writing or by facsimile (with written confirmation of
receipt) or telegraph and, if to the Underwriters, shall be mailed, faxed (with
written confirmation of receipt), telegraphed or delivered to Hambrecht & Quist
LLC, One Bush Street, San Francisco, California 94104; and if to the Company,
shall be mailed, faxed (with written confirmation of receipt), telegraphed or
delivered to it at its office, 3811 Turtle Creek Boulevard, Suite 1100, Dallas,
Texas 75219, Attention: John F. Davis, III, Fax: (214) 528-5675. All notices
given by telegraph shall be promptly confirmed by letter.

14. MISCELLANEOUS. The reimbursement, indemnification and contribution
agreements contained in this Agreement and the representations, warranties and
covenants in this Agreement shall remain in full force and effect regardless of
(a) any termination of this Agreement, (b) any investigation made by or on
behalf of any Underwriter or controlling person thereof, or by or on behalf of
the Company or its directors or officers, and (c) delivery and payment for the
Stock under this Agreement; provided, however, that if this Agreement is
terminated prior to the Closing Date, the provisions of paragraphs (l), (m) and
(n) of Section 6 hereof shall be of no further force or effect.

This Agreement may be executed in two or more counterparts, each of
which shall be deemed an original, but all of which together shall constitute
one and the same instrument.

<PAGE> 18

This Agreement shall be governed by, and construed in accordance with,
the laws of the State of California.

18
<PAGE> 19

Please sign and return to the Company in care of the Company the
enclosed duplicates of this letter, whereupon this letter will become a binding
agreement among the Company, and the several Underwriters in accordance with its
terms.

Very truly yours,

PEGASUS SYSTEMS, INC.

By
--------------------------------
John F. Davis, III
President and
Chief Executive Officer

The foregoing Agreement is hereby confirmed
and accepted as of the date first above written.

HAMBRECHT & QUIST LLC
BEAR, STEARNS & CO. INC.
DONALDSON, LUFKIN & JENRETTE SECURITIES CORPORATION
VOLPE BROWN WHELAN & COMPANY, LLC

By: HAMBRECHT & QUIST LLC

By
-----------------------------------------
Robert L. Hobart
Managing Director

Acting on behalf of the several Underwriters,
including themselves, named in Schedule I hereto.

<PAGE> 20

SCHEDULE I

UNDERWRITERS

<TABLE>
<CAPTION>
NUMBER OF
SHARES
TO BE
UNDERWRITERS PURCHASED
<S> <C>

Hambrecht & Quist LLC ..............................................
Bear Stearns & Co. Inc..............................................
Donaldson, Lufkin & Jenrette Securities Corporation.................
Volpe Brown Whelan & Company, LLC . ................................
---------
Total ........................................................
=========
</TABLE>

1
<PAGE> 21

ANNEX A

MATTERS TO BE COVERED IN THE OPINIONS OF
COUNSEL FOR THE COMPANY

(i) Each of the Company and its subsidiaries has been duly incorporated
and is validly existing as a corporation in good standing under the laws of the
jurisdiction of its incorporation, is duly qualified as a foreign corporation
and in good standing in each state of the United States of America in which its
ownership or leasing of property requires such qualification (except where the
failure to be so qualified would not have a material adverse effect on the
business, properties, financial condition or results of operations of the
Company and its subsidiaries, taken as a whole), and has full corporate power
and authority to own or lease its properties and conduct its business as
described in the Registration Statement; all the issued and outstanding capital
stock of each of the subsidiaries of the Company has been duly authorized and
validly issued and is fully paid and nonassessable, and is owned by the Company
free and clear of all liens, encumbrances and security interests, and to such
counsel's knowledge, no options, warrants or other rights to purchase,
agreements or other obligations to issue or other rights to convert any
obligations into shares of capital stock or ownership interests in such
subsidiaries are outstanding;

(ii) the authorized capital stock of the Company consists of two
million (2,000,000) shares of Preferred Stock, none of which are outstanding,
and fifty million (50,000,000) shares of Common Stock, $.01 par value, of which
_______________ (_________) shares are outstanding (including the Underwritten
Stock plus the number of shares of Option Stock issued on the date hereof);
proper corporate proceedings have been taken validly to authorize such
authorized capital stock; all of the outstanding shares of such capital stock
(including the Underwritten Stock and the shares of Option Stock issued, if any)
have been duly and validly issued and are fully paid and nonassessable; any
Option Stock purchased after the Closing Date, when issued and delivered to and
paid for by the Underwriters as provided in the Underwriting Agreement, will
have been duly and validly issued and be fully paid and nonassessable; and no
preemptive rights of, or rights of refusal in favor of, stockholders exist with
respect to the Stock, or the issue and sale thereof, pursuant to the Certificate
of Incorporation or Bylaws of the Company and, to the knowledge of such counsel,
there are no contractual preemptive rights that have not been waived, rights of
first refusal or rights of co-sale which exist with respect to the issue and
sale of the Stock;

(iii) the Registration Statement has become effective under the
Securities Act and, to such counsel's knowledge, no stop order suspending the
effectiveness of the Registration Statement or suspending or preventing the use
of the Prospectus is in effect and no proceedings for that purpose have been
instituted or are pending or contemplated by the Commission;

(iv) the Registration Statement and the Prospectus (except as to the
financial statements and schedules and other financial and statistical data
contained therein, as to which such counsel need express no opinion) comply as
to form in all material respects with the requirements of the Securities Act and
with the rules and regulations of the Commission thereunder;

1
<PAGE> 22

(v) such counsel have no reason to believe that the Registration
Statement (except as to the financial statements and schedules and other
financial and statistical data contained or incorporated by reference therein,
as to which such counsel need not express any opinion or belief) at the
Effective Date contained any untrue statement of a material fact or omitted to
state a material fact required to be stated therein or necessary to make the
statements therein not misleading, or that the Prospectus (except as to the
financial statements and schedules and other financial and statistical data
contained or incorporated by reference therein, as to which such counsel need
not express any opinion or belief) as of its date or at the Closing Date (or any
later date on which Option Stock is purchased), contained or contains any untrue
statement of a material fact or omitted or omits to state a material fact
necessary in order to make the statements therein, in light of the circumstances
under which they were made, not misleading;

(vi) the information required to be set forth or incorporated by
reference in the Registration Statement in answer to Items 9 and 10 (insofar as
it relates to such counsel) of Form S-3 is to such counsel's knowledge
accurately and adequately set forth therein in all material respects or no
response is required with respect to such Items, and the description of the
Company's stock option plans and stock purchase plan and the options granted and
which may be granted thereunder or incorporated by reference in the Prospectus
accurately and fairly presents the information required to be shown with respect
to said plans and options to the extent required by the Securities Act and the
rules and regulations of the Commission thereunder;

(vii) such counsel do not know of any franchises, contracts, leases or
documents which in the opinion of such counsel are of a character required to be
described in the Registration Statement or the Prospectus or to be filed as
exhibits to the Registration Statement, which are not described and filed as
required;

(viii) the Underwriting Agreement has been duly authorized, executed
and delivered by the Company;

(ix) the issue and sale by the Company of the shares of Stock sold by
the Company as contemplated by the Underwriting Agreement will not conflict
with, or result in a breach of, the Certificate of Incorporation or Bylaws of
the Company or any of its subsidiaries or, to such counsel's knowledge any
agreement or instrument to which the Company or any of its subsidiaries is a
party or any applicable law or regulation, or so far as is known to such
counsel, any order, writ, injunction or decree, of any jurisdiction, court or
governmental instrumentality;

(x) all holders of securities of the Company having rights to the
registration of shares of Common Stock, or other securities, because of the
filing of the Registration Statement by the Company have waived such rights or
such rights have expired by reason of lapse of time following notification of
the Company's intent to file the Registration Statement;

(xi) no consent, approval, authorization or order of any court or
governmental agency or body is required for the consummation of the transactions
contemplated in the Underwriting Agreement, except such as have been obtained
under the Securities Act and such as may be required under state securities or
blue sky laws in connection with the purchase and distribution of the Stock by
the Underwriters or as may be required by the NASD; and

<PAGE> 23

(xii) the Stock issued and sold by the Company is listed on the Nasdaq
National Market.

<PAGE> 1

EXHIBIT 23.1

CONSENT OF INDEPENDENT ACCOUNTANTS

We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-3 of Pegasus Systems, Inc. of our report dated
February 2, 1999, relating to the financial statements of Pegasus Systems, Inc.,
which appears in such Prospectus. We also consent to the application of such
report to the Financial Statement Schedule for the year ended December 31, 1998
listed under Item 16(b) of this Registration Statement when such schedule is
read in conjunction with the financial statements referred to in our report. The
audit referred to in such report also included this schedule. We also consent to
the references to us under the headings "Experts" and "Selected Consolidated
Financial Data" in such Prospectus. However, it should be noted that
PricewaterhouseCoopers LLP has not prepared or certified such "Selected
Consolidated Financial Data."

PricewaterhouseCoopers LLP

Dallas, Texas
May 3, 1999

<PAGE> 1
EXHIBIT 23.2

CONSENT OF INDEPENDENT ACCOUNTANTS

We hereby consent to the use in the Prospectus constituting part of this
Registration Statement on Form S-3 of Pegasus Systems, Inc. to the reference to
us under the heading of "Selected Consolidated Financial Data" in such
Prospectus. However, it should be noted that Belew Averitt LLP has not prepared
or certified such "Selected Consolidated Financial Data."

Belew Averitt LLP

Dallas, Texas
May 3, 1999