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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
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FORM 10-K
<Table>
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
</Table>
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COMMISSION FILE NUMBER 0-22935
PEGASUS SOLUTIONS, INC.
(Exact name of Registrant as specified in its charter)
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CAMPBELL CENTER ONE,
8350 NORTH CENTRAL EXPRESSWAY,
SUITE 1900
DALLAS, TEXAS 75206
DELAWARE (Address of principal executive 75-2605174
(State or other jurisdiction of office (I.R.S. Employer
incorporation or organization) including zip code) Identification No.)
</Table>
REGISTRANT'S TELEPHONE NUMBER, INCLUDING AREA CODE:
(214) 234-4000
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
NONE
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
COMMON STOCK, PAR VALUE $0.01 PER SHARE
RIGHTS TO PURCHASE SERIES A PREFERRED STOCK
(Title of class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). Yes [X] No [ ]
The aggregate market value of the registrant's voting stock held by
nonaffiliates on June 28, 2002, based on the closing price for the registrant's
common stock on such date as reported on the NASDAQ National Market was
$432,088,037.
The number of shares of the registrant's common stock, par value $0.01 per
share, outstanding as of March 11, 2003 was 24,750,751.
DOCUMENTS INCORPORATED BY REFERENCE
Selected portions of our definitive proxy statement for the 2003 annual
meeting of stockholders to be held on May 6, 2003 are incorporated by reference
into Part III of this Form 10-K. We disclaim incorporation by reference of
information contained on any Internet site.
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PART I
ITEM 1. BUSINESS
Except where expressly indicated or the context otherwise requires, the
"Company," "Pegasus," "we," "our" or "us" when used in this annual report refers
to Pegasus Solutions, Inc., a Delaware corporation, and its predecessors and
consolidated subsidiaries. This report contains forward-looking statements
within the meaning of the federal securities laws, including statements using
terminology such as "may," "will," "expects," "plans," "intends," "anticipates,"
"believes," "estimates," "potential," or "continue," or a similar negative
phrase or other comparable terminology regarding beliefs, plans, expectations or
intentions for the future. Forward-looking statements may involve risks and
uncertainties such as adverse changes in general market conditions for business
and leisure travel as a result of additional terrorist activities, action by
U.S. military forces, changes in hotel room rates, capacity adjustments by
airlines, trends in the overall demand for travel, and the inherent difficulty
in making projections during this period of uncertainty, as well as other risks
and uncertainties described in this report. Actual results and the timing of
events could differ materially from those projected in or contemplated by the
forward-looking statements due to a number of factors, including those listed
herein under "Risk Factors."
OVERVIEW
Pegasus is a leading provider of hotel room reservation services,
reservation technology systems and hotel representation services for the global
hospitality industry. Our customers and distribution channels include:
- Tens of thousands of travel agency locations around the world, including
the 10 largest U.S.-based travel agencies based on revenues;
- More than 48,000 hotel properties around the globe, including the 50
largest hotel brands in the world based on total number of guest rooms;
and
- Thousands of Web sites that have their hotel reservations "Powered by
Pegasus"(TM).
We are organized into two business segments -- technology and hospitality.
Our technology segment provides central reservation system, or CRS, electronic
distribution, travel agent commission processing and property management
systems, or PMS, to the global hotel industry. Our hospitality segment provides
hotel representation services offered under the Utell brand name. Hotel
representation services include marketing programs, sales representation, a
voice reservation network with local language capabilities in 41 countries, and
distribution through all global distribution systems, or GDSs, and a proprietary
Internet booking site, www.Utell.com, with thousands of linked third-party
Internet sites. For the year ended December 31, 2002, approximately 64 percent
and 36 percent of our consolidated service revenues were derived from the
technology and hospitality segments, respectively.
On February 4, 2003, we announced a strategic reorganization to integrate
our technology and hospitality segments into one operating unit. The single
operating unit will have integrated support functions including consolidated
sales and marketing, product development, service delivery, reservation/data
management, information technology, finance and human resources functions. The
integration plan continues our existing strategy of better aligning our
businesses with our customer needs, thus allowing for future revenue growth and
the realization of further synergies as one fully integrated company. This plan,
which is expected to take approximately six months to substantially complete,
includes the elimination of redundant positions and the consolidation of some
facilities. Beginning in 2004, the estimated annual cost savings from the
integration are expected to range from $9 million to $11 million.
STRATEGY
Our goal is to be the leading provider of transaction processing services
and technology solutions in hotel room distribution and to be the leading
provider of hotel representation and marketing services to independent
1
hotels and small hotel chains. We believe our central role as a service provider
to the hospitality industry positions us well to achieve this goal. Key elements
of our strategy include the following:
- Develop Leading Technologies. We strive to develop new technologies,
services and solutions to meet the changing needs of our current and
prospective customers. Our web-based PMS PegasusCentral(TM) offers a
comprehensive suite of hotel management, reservation processing and
customer relationship management tools. This technology is currently
operating in limited-service hotels, and we continue development efforts
to expand its functionality, including a European offering. We also
developed PegsPay, an ASP-based service that provides new merchant model
payment services to travel distributors.
- Maintain World Class Operations. Pegasus is committed to providing world
class technology solutions to its customers. As part of this commitment,
Pegasus invested in significant enhancements to its data center in
Scottsdale, Arizona during 2002. These enhancements include multiple
levels of redundancy for all of our mission critical systems as well as
backup for both electrical and communication services.
- Expand Hotel Room Distribution Channels. We intend to expand our hotel
information database and increase the number of distribution channels
providing hotel room reservation services for individual travelers over
the Internet, for convention and other large meeting organizers and for
corporate travel departments. We also expect to further expand the use of
our online distribution service by third-party Web sites such as
Expedia.com, Orbitz.com and Travelweb.com. Our goal is to create
recurring transaction fee revenue opportunities through virtually all of
the distribution channels through which electronic hotel room
reservations occur.
- Build Strategic Alliances and Pursue Acquisition Opportunities. To
enhance the functionality and market presence of our services, we seek to
build strategic alliances with other participants in the hotel industry,
including those providing information technology services and
travel-related Internet-based services. We believe that these
relationships increase brand recognition of our services and help to
expand our customer base. We may also seek to acquire assets, technology
and businesses that provide complementary services to our existing
customers or access to other new travel related markets and customers.
- Expand Our Revenue Base. We intend to expand our revenue base
domestically and internationally by adding customers and by cross-selling
new and existing services to our current and future customers. New
services such as PegasusCentral and PegsPay will provide us with
opportunities to sell new services to existing customers. Additionally,
we can increase our revenue base by bundling our services to provide
comprehensive solutions for both new and existing customers.
- Grow Hotel Representation Business. We plan to increase the number of
reservations made on behalf of existing customers by focusing on travel
agency relationships. Through initiatives such as automating the
commission payment process, classifying hotels to facilitate the
selection process and offering inventory to key gateway locations, we
hope to entice travel agents to make more reservations at Utell member
hotels. We also plan to strategically add new hotels to our Utell
portfolio to better align room rates offered with demand.
SERVICES
Throughout the year 2002, Pegasus was organized into two business
segments -- technology and hospitality. See Note 16 to the Consolidated
Financial Statements for financial information by segment and geographic
location.
TECHNOLOGY
Our technology segment provides hotel room reservation services, travel
agent commission processing and PMS services to the global hotel industry.
Reservation Services includes the travel agency GDS, Internet distribution and
CRS services.
2
Reservation Services. We were formed in 1989 by 16 of the world's leading
hotel and travel-related companies to be the world's premier service provider of
a streamlined and automated hotel reservation process. Our UltraSwitch(R)
technology provides a seamless electronic connection between a hotel's CRS and
the GDSs that travel agents use to book airline reservations. Our electronic
distribution service supports a variety of distribution channels including the
following:
- GDS connectivity -- Our electronic distribution service is linked to the
four major GDSs and therefore connects our hotel customers to travel
agents around the world.
- Third-party Internet sites -- We provide travel-related Internet sites
access to our hotel information database containing more than 45,000
properties and on-line hotel reservation capability. We provide this
service to several of the leading travel Internet sites such as
Expedia.com, HotWire.com, Lastminute.com, Amadeus' e-Travel,
Continental.com, Orbitz.com, Travelweb.com and our own Utell.com.
- Hotel Internet sites -- Our NetBooker(TM) service provides hotel
companies with a hotel information database and Internet-based
reservation capabilities. Hotel Internet sites that are "Powered by
Pegasus" offer brand-loyal Internet shoppers real-time rates,
availability and booking capabilities.
Our CRS is provided on an application service provider, or ASP, basis to
approximately 8,000 hotel properties, representing over 2.1 million hotel rooms
worldwide. During 2002, we processed approximately 30 million hotel bookings
through our CRS. Pegasus also provides CRS software licenses to an additional 20
hotel brands, representing 13,000 properties.
Our CRS service provides hotel customers with a license for our RezView(TM)
CRS software, as well as the hardware and facilities necessary to process
reservations. Our CRS service also includes the following support and
outsourcing services:
- System administration
- Database administration
- Electronic distribution channel management
- Telecommunications management
- Private-label voice reservation services
Financial Services. Financial Services provides comprehensive commission
processing and payment solutions to hotels, other travel suppliers and travel
agencies in more than 200 countries. Key services include commission processing,
commission reconciliation and tracking for member agencies, global commission
solutions for participating hotels and PegsPay, our payment processing service
targeted at travel distributors. More information on PegsPay is provided below
under the heading "Management's Discussion and Analysis of Financial Condition
and Results of Operations -- Recent Developments."
Each month, Pegasus consolidates, distributes, reconciles, tracks and
reports millions of dollars in commission payments to travel agency locations
worldwide on behalf of more than 35,000 participating hotel properties.
Traditionally, the process of reconciling and paying hotel commissions to travel
agencies was based on transaction-specific hotel data and consisted of a number
of relatively small payments to travel agencies, often including payments in
multiple currencies. Our value-added commission consolidation and reporting
service facilitates more efficient and effective operation for both hotel and
travel agency participants by providing a single, monthly commission payment to
member travel agencies from participating hotels in their choice of currency.
Our commission processing service processed over $486 million in hotel
commissions in 2002.
Property Systems and Services. PegasusCentral is our Internet-based PMS
service. Six Continents Hotels, Inc. has named it as one of two preferred PMS
standards for its 2,500-plus Holiday Inn and Holiday Inn Express properties.
Traditionally, hotel CRSs and PMSs had separate databases that communicated only
intermittently, often resulting in unbalanced inventories. With PegasusCentral,
when a hotel reservation is
3
made from a central reservations office, via the Internet, or at the property,
only one database is accessed. This centralized inventory stores all pertinent
information for both the central reservation and property management functions
and provides consistent, real-time access to rates, availability and other
detailed property information. PegasusCentral benefits both hotel chains and
independent properties by assisting in the management and operation of many
hotel functions, including:
- Enhanced property management
- Multi-property central reservations
- Customer relationship management
- Sales and catering
- Point-of-sale
- Back-office modules such as receivables, payables and purchasing
Particularly in today's economic climate, hotel companies can realize the
benefits of PegasusCentral through the following:
- Reduced capital equipment expenditures -- Other PMS services typically
require significant capital expenditures. Because PegasusCentral is
Internet-based, hotel properties will incur only the cost of a computer
with Internet access to operate this system. Centrally hosted hardware
and data services are located at Pegasus' data center, providing secure
central storage for applications and data.
- Reduced employee training costs -- PegasusCentral's Internet-based
technology is easy to use, offering convenient pull-down menus,
substantially reducing the customer's learning curve. In addition, users
can take advantage of interactive online training modules.
- Reduced IT staffing costs -- PegasusCentral performs system upgrades from
a centralized facility resulting in instant product rollouts to all
locations. This reduces the need for on-site technical experts and
eliminates long rollout schedules and complex system upgrades.
- Available per-transaction pricing -- With available per-transaction
pricing, hotels pay transaction fees only as their rooms are occupied,
better aligning technology costs with room revenues.
In addition to PegasusCentral, we obtained two proprietary software
solutions as part of the acquisitions of REZ, Inc., or REZ, and Global
Enterprise Technology Solutions, LLC, or GETS. Revenues for 2002 consisted of
maintenance and support fees related to these acquired PMS software solutions,
as well as revenues from our PegasusCentral service.
HOSPITALITY
Our hospitality segment includes hotel representation, marketing and
financial services offered under the Utell brand. In order to sell their rooms
in the marketplace, many independent hotels and small hotel chains associate
themselves with our hotel representation service and use our systems and
infrastructure to market and make reservations for their rooms. Hotels typically
utilize our hotel representation service for the following reasons:
- To achieve a cost-effective presence in the primary electronic
distribution channels -- GDSs and the Internet.
- To obtain a global voice reservation capability through which travel
agents can book their rooms over the telephone via a local call with
local language capabilities.
- To enhance the market image of the hotel by affiliation with a well-known
name in hotel distribution.
- To benefit from worldwide sales and marketing support.
Utell is the oldest, largest and most diverse hotel representation company
in the world providing hotel sales, marketing, voice reservation and GDS and
Internet services for over 4,500 hotels in 147 countries. Utell
4
uses Pegasus' CRS, which offers advanced electronic distribution capabilities,
and provides both a GDS and an Internet presence for member hotels.
In addition, Utell offers two financial services, Paytell and TravelCom. In
some international markets, it is customary for travelers to prepay for hotel
rooms and other travel arrangements. Paytell is a service that allows travelers
to prepay reservations, with Pegasus remitting amounts to hotels when the guest
stay occurs. TravelCom is our Internet-based proprietary system that allows
member hotels to expedite commission payments to travel agents.
OTHER SERVICES
Pegasus regularly seeks to develop new services to capitalize on its
existing technology and customer base, and to provide additional electronic
hotel reservation capabilities and information services to its existing
customers and to other participants in the travel distribution process. 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.
COMPETITION
Both of our business segments face competition from within their respective
markets. To compete successfully, we must develop new technological solutions to
meet the changing needs of the hospitality industry. There can be no assurance
that any of our services will compete successfully.
TECHNOLOGY
Reservation Services. Our CRS business competes with hotel companies that
develop and host their own CRSs and third parties that provide CRS and related
services under a license agreement or as an ASP. Our CRS competitors include
Computer Sciences Corporation, Trust International, SynXis Corporation and
MICROS Systems, Inc.
Pegasus' electronic distribution service supports a variety of distribution
channels, each with its own competition. For example:
- GDS connectivity -- Our GDS connectivity service competes primarily with
WizCom International, Ltd. Customers may change their electronic
reservation interface to WizCom or to another similar service. Also, some
hotels have established a direct connection to one or more GDSs rather
than through an intermediary, such as Pegasus or WizCom. Other hotels may
choose to take the same action. If hotels establish this direct
connection, they would bypass our intermediary position and eliminate the
need to pay our fees.
- Third-party and hotel Web sites -- Our online distribution services face
competition in the online hotel room reservation business from current
competitors as well as potential new entrants, including other Web sites.
Several competitors have Web-based reservation services offering a more
comprehensive range of travel opportunities than we do, such as air, car
rental and vacation packages. These competitors include Hotels.com,
Travelocity.com, Orbitz.com and Expedia.com. Other potential competitors
are Web site development companies that could develop an interface
directly between a hotel's property system and a travel Web site, or an
interface between a hotel company's CRS and a travel Web site. The cost
of entry into the Internet hotel room reservation business is relatively
low.
Financial Services. Our commission processing service faces competition
principally from Perot Systems, Inc. In addition, hotels that are current or
prospective customers of Pegasus Financial Services can decide to process
commission payments on their own, or in competition with our commission
processing service. Our new PegsPay service competes with credit card
processors.
Property Systems and Services. Our PMS business competes with hotel
companies that sell their own PMSs and third parties that provide PMSs. Our
primary PMS competitors include MICROS Systems, Inc., Hotel Information Systems,
AremisSoft Hospitality and Ramesys Hospitality.
5
HOSPITALITY
Our hotel representation services compete with hotel groups, franchisers,
consortia, reservation companies and other travel or hotel representation
companies. Utell's principal competitors are Lexington Services Corporation, VIP
International Corporation, SHS-WorldHotels, Supranational Hotels, SynXis
Corporation, Unirez, Inc. and Sceptre Hospitality Resources.
SEASONALITY
Our business, particularly our hotel representation business, is sensitive
to seasonal changes in the demand for hotel rooms. The demand for business and
leisure travel is typically lower in the first and fourth quarters of the year;
therefore, these quarters have historically generated lower revenue than the
second and third quarters. Because the majority of our operating expenses are
fixed, fluctuations in revenue from quarter to quarter may have a material
effect on operating income for the respective quarters.
INTERNATIONAL OPERATIONS
We derive approximately 40 percent of our revenue from customers located
outside the United States, particularly in Europe. Fluctuations in the value of
foreign currencies relative to the U.S. Dollar directly impact our revenues and
expenses. More information regarding specific risks associated with our foreign
operations and our exposure to movements in foreign currency exchange rates is
available under the heading "Risk Factors" and Item 7A of this annual report
"Quantitative and Qualitative Disclosures about Market Risk."
INTELLECTUAL PROPERTY
We are continually developing new technology and enhancing existing
proprietary technology. We do not currently have any registered patents.
However, we are pursuing patent protection with respect to two matters. We
primarily rely on a combination of trademark, copyright, trade secrets,
confidentiality procedures and contractual provisions to protect our technology
and other intellectual property rights. Despite these protections, it may be
possible for unauthorized parties to copy, obtain or use certain portions of our
proprietary technology. Any misappropriation of our intellectual property could
have a material adverse effect on our competitive position.
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. Our total research and
development expense was $5.8 million, $7.8 million and $16.0 million for 2002,
2001 and 2000, respectively. Research and development expenses for 2000 included
an $8.0 million write-off of purchased in-process research and development
related to the acquisition of REZ. The decrease in research and development
expenses in 2002 is primarily due to the increase in capitalized payroll costs
associated with software development efforts, such as PegasusCentral.
EMPLOYEES
At February 28, 2003, we had 1,389 employees, 929 of which are located in
the United States. We had 317 persons performing information technology
functions, 851 persons performing sales and marketing, customer relations and
business development functions and the remainder performing corporate, finance
and administrative functions. The number of employees will decrease as a result
of our recently announced strategic reorganization. We have no unionized
employees. We believe that our employee relations are satisfactory.
6
AVAILABLE INFORMATION
Our Internet address is www.pegs.com. Select Company SEC reports are
available free of charge on our website as soon as reasonably practicable after
electronic filing or furnishing with the SEC. Our code of ethics, amendments
thereto and waivers thereof will be published and maintained on our Web site.
Once published, any waiver will be posted for at least twelve months after it is
granted.
RISK FACTORS
RISKS RELATED TO OUR INDUSTRY:
TERRORIST ATTACKS AND THE CONTINUING THREAT OF TERRORISM MAY ADVERSELY AFFECT
OUR STOCK PRICE, OPERATIONS AND FINANCIAL PERFORMANCE.
Recent terrorist attacks, the continued threat of terrorism and
retaliations for such acts have and may continue to adversely affect the travel
industry. These events have caused business and leisure travel to be curtailed,
thus reducing the demand for hotel rooms and resulting in a decline in the
number of hotel reservations and the average daily rate for hotel rooms. Any
reduction in the number of hotel reservations or the average daily rate
adversely affects our financial performance. The duration or extent of these
events is uncertain but their continued existence is likely to have a material
adverse effect on our operations, financial performance and stock price.
THE PROSPECT OF WAR WITH IRAQ OR ANOTHER COUNTRY IS LIKELY TO ADVERSELY AFFECT
OUR STOCK PRICE, OPERATIONS AND FINANCIAL PERFORMANCE.
The prospect of war with Iraq or another country or the actual occurrence
of war is likely to have a dampening effect on the economy in general and the
travel industry in particular. More specifically, the threat of war curtails
both business and leisure travel. If a war does occur, the adverse effect on the
travel industry will likely increase. These circumstances reduce demand for
hotel rooms, thus resulting in a decline in the number of hotel room
reservations and the average daily rate. Any reduction in the number of hotel
reservations or the average daily rate adversely affects our financial
performance. The duration or extent of these events is uncertain but their
continued existence is likely to have a material adverse effect on our
operations, financial performance and stock price.
AS NEARLY ALL OF OUR REVENUES ARE DERIVED FROM THE HOTEL INDUSTRY, A DOWNTURN
IN THE HOTEL INDUSTRY WOULD LIKELY ADVERSELY AFFECT OUR BUSINESS.
Nearly all of our revenues are directly or indirectly dependent on the
hotel industry, which is highly sensitive to any change in the economic
conditions affecting business and leisure travel as well as the matters
addressed in the preceding risk factors. The hotel industry is susceptible to
rapid and unexpected downturns, as experienced after the events of September 11,
2001. In the event of any further downturn in the hotel industry, we would
likely experience significantly reduced revenues, as the use of our services and
the demand for our future services and solutions would decline. Any downturn in
the hotel industry or any reduction in the demand for hotel rooms and travel
generally, would negatively impact our business, operating results and financial
condition. Many factors affect the hotel industry, most of which are beyond our
control. The hotel industry and demand for hotel rooms or travel may be affected
by, among other things:
- General economic conditions including recession, inflation and currency
fluctuations
- Political instability
- Regional hostilities
- Regional health issues
- Gasoline and aviation fuel price escalation
7
- Labor strikes
- Instability in the airline industry
We may experience substantial period-to-period fluctuations in our results
of operations as a consequence of these factors and others and the general
economic conditions affecting the demand for hotel rooms and travel.
REDUCTIONS IN ROOM RATES AND HOTEL COMMISSION PAYMENTS WOULD REDUCE OUR
REVENUES AND NET INCOME.
Pegasus Financial Services, which includes our commission processing
service, derives revenues based on the dollar value of travel agency commissions
paid by hotels. The dollar value of these commissions is based on the number of
reservations, the length of stay and the room rate. Approximately 17 percent of
our service revenue in 2002 was attributable to Pegasus Financial Services. If
there is any decline in average daily room rates, change in the commission
payment process, reduction in the amount of commissions paid to travel agencies
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 industry customary commission rate of
10 percent, limit the maximum commission generally paid for a hotel room
reservation or eliminate commissions entirely. Hotels increasingly utilize other
direct distribution channels, like the Internet, or offering negotiated rates to
major corporate customers that are non-commissionable to travel agencies.
Reductions in room rates as well as efforts to reduce hotel reservation
commissions could adversely affect our business, operating results and financial
condition.
CONSOLIDATION IN THE HOTEL INDUSTRY AND ELECTRONIC RESERVATIONS INDUSTRY COULD
RESULT IN REDUCED REVENUES.
We offer volume-based discounting for some of our fees. The recent
consolidation in the hotel industry has resulted in a higher percentage of
discounted fees, and this trend could continue. In addition, the GDS industry
has consolidated into four major GDSs. If further consolidation occurs, the
value of our services and the benefits to hotel operators of utilizing our GDS
electronic distribution service would be reduced. Any potential decrease in our
customer base or any potential increase in the percentage of discounted fees may
adversely affect the profitability of our business.
RISKS RELATED TO THE COMPANY:
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,
independent hotels, hotel representation firms, travel management companies,
travel agencies, travel agency consortia, global distribution systems,
travel-related Web sites and Internet-based information and reservation systems.
In the future, our customers may elect to perform certain functions themselves,
may circumvent our services, may select the services of competing companies or
we may otherwise be unable to continue or renew these arrangements on favorable
terms or initiate new arrangements. If we are unable to renew, continue or
initiate 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 remittance and worldwide currency
exchange services for our commission processing service and for facility
maintenance, SAP hosting and disaster recovery services for the computer and
voice/data communications systems used in all of our services. If we are unable
to renew or extend our contracts with existing third-party service providers or
enter into contracts with alternate service providers on favorable terms, it
could adversely affect our business, operating results and financial condition.
8
UNEXPECTED COSTS AND BUSINESS INTERRUPTIONS MAY IMPACT THE EXPECTED BENEFITS
AND COST SAVINGS OF OUR RECENTLY ANNOUNCED RESTRUCTURING AND MAY ADVERSELY
AFFECT OUR OPERATIONS AND FINANCIAL PERFORMANCE.
We recently announced a strategic reorganization plan designed to operate
our business in the most cost efficient manner. To do so may require significant
management attention and financial resources, possibly impacting our existing
operations. Additionally, even if we are able to realize the cost savings and
other benefits expected from the restructuring, we may have other unexpected
expenses which may adversely effect our financial performance.
IF WE DO NOT DEVELOP NEW TECHNOLOGIES AND SERVICES THAT MEET THE CHANGING
NEEDS OF PARTICIPANTS IN THE HOTEL INDUSTRY OR THE NEW TECHNOLOGIES AND
SERVICES WE DEVELOP ARE NOT UTILIZED, WE MAY BE UNABLE TO COMPETE EFFECTIVELY
AND OUR CONTINUING OPERATIONS MAY BE ADVERSELY AFFECTED.
Our future success depends 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 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 or introduction of these services. It is also possible
that a new service, while achieving a technological success, may fail to be
accepted and utilized by prospective customers. 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 adversely affect our ability to compete in the marketplace and negatively
affect our business, operating results and financial condition.
OUR COMPUTER SYSTEMS AND DATABASES MAY SUFFER SYSTEM FAILURES, BUSINESS
INTERRUPTIONS OR SECURITY BREACHES THAT COULD IMPEDE OUR ABILITY TO SERVICE
OUR CUSTOMERS AND COULD NEGATIVELY IMPACT OUR BUSINESS.
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 in Scottsdale
and 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. Our infrastructure may also fail
to provide consistent dependable service as a result of circumstances both in
and out of our control. Any damage to our databases, failure of communication
links, security breach or other loss that causes interruptions in our operations
could adversely affect our business, operating results and financial condition.
IF WE ARE UNABLE TO COMPETE SUCCESSFULLY IN DELIVERING SERVICES AND SOLUTIONS
TO THE HOTEL INDUSTRY, WE MAY LOSE MARKET SHARE AND BE FORCED TO REDUCE THE
PRICES OF OUR SERVICES.
We compete in markets that are rapidly evolving, intensely competitive and
involve continually changing technology and industry standards. We may
experience increased competition from current and potential competitors, many of
which have significantly greater financial, technical, marketing and other
resources than we have. 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 adversely affect our business, operating
results and financial condition.
9
WE MAY NOT HAVE THE RESOURCES TO MANAGE EFFECTIVELY OUR GROWTH, AND OUR
LIMITED EXPERIENCE IN MANAGING AND INTEGRATING ORGANIZATIONS MAY CAUSE FUTURE
ACQUISITIONS OR JOINT VENTURES TO DISRUPT OUR OPERATIONS AND IMPEDE OUR
OPERATING RESULTS.
Our potential future growth may place significant demands on management as
well as on our administrative, operational and financial resources. Expanding
our business to take advantage of new market opportunities will require
significant management attention and financial resources, possibly adversely
impacting our existing operations.
In addition, we regularly evaluate acquisition and joint venture
opportunities and in the future may make acquisitions of other companies or
technologies or enter into joint ventures, which will involve many risks
including:
- Difficulty in integrating or otherwise assimilating technologies,
products, personnel and operations
- Diversion of management's attention from other business concerns
- Issuance of dilutive equity securities and the incurrence of debt or
contingent liabilities
- Large write-offs and amortization expense related to identifiable
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 and the assumption of liabilities of other businesses
Our inability to manage growth or to integrate any future acquisitions or
joint ventures could adversely affect our business, operating results and
financial condition.
BECAUSE OUR EXPENSES ARE LARGELY FIXED IN THE SHORT-TERM 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 short-term. 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. In the short-term, we may
also be unable to adjust spending rapidly enough to compensate for any
unexpected revenue shortfall. This could adversely impact our business,
operating results and financial condition.
It is possible that in one or more future quarters our results may fall
below the expectations of securities analysts or investors. In addition, our
operating results may vary significantly from quarter to quarter due to a
variety of factors, many of which are outside of our control. We believe that
period-to-period comparisons of our operating results should not be relied upon
as an indication of future performance.
OUR INTERNATIONAL OPERATIONS MAKE US SUSCEPTIBLE TO CURRENCY FLUCTUATIONS,
GLOBAL ECONOMIC FACTORS, FOREIGN TAX LAW ISSUES, INFORMATION PRIVACY LAWS AND
FOREIGN BUSINESS PRACTICES, WHICH COULD REDUCE OUR REVENUES, INCREASE OUR COST
OF DOING BUSINESS AND ERODE OUR PROFIT MARGINS.
We derive approximately 40 percent of our revenue from customers located
outside the United States, primarily in Europe. If the value of foreign
currencies relative to the U.S. Dollar decreases, our revenues translate to a
lower U.S. Dollar amount.
Our international operations are also subject to other risks, including:
- Impact of possible adverse political and economic conditions
- Potentially adverse tax consequences
- Impact of the policies of the United States and foreign governments on
foreign trade
- Compliance with information privacy laws and related enforcement actions
10
- Reduced protection for intellectual property rights in some countries
- Changes in regulatory requirements
- Cost of adapting our services to foreign markets
- High costs associated with office closures and personnel reductions
If we do not realize our expected results from international operations or
if the value of foreign currencies decrease relative to the U.S. Dollar, our
business, operating results and financial condition would be adversely affected.
WE ARE EXPOSED TO CREDIT RISK FROM HOTELS, TRAVEL-RELATED WEB SITES AND OTHER
CUSTOMERS.
Many of our customers are independent hotels, travel-related Web sites and
other travel industry participants that are particularly exposed to any downturn
in the economy and other factors that adversely impact the hotel industry. Some
of these customers may have inadequate financial strength to make current
payments to us or remain as going concerns. In some instances we may be unable
to collect payments from these customers or we may extend credit to them in the
form of unsecured promissory notes or otherwise. Even though we have policies in
place to reduce our exposure to credit risk and have not experienced any
degradation in overall collectibility of accounts receivable, our inability to
collect payments from these customers in the future could result in a material
adverse effect on our business, operating results and financial condition.
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 and other intellectual
property rights. We currently rely upon a combination of trademark, patents,
copyright, trade secrets, confidentiality procedures and contractual provisions
to protect our proprietary technology and other intellectual property. Despite
our current efforts to protect our proprietary rights, these protective measures
may not be enforceable or adequate to prevent misappropriation or infringement
of our technology. 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
and other intellectual property in the United States or abroad. If we cannot
adequately protect our proprietary rights, it could adversely affect our
competitive edge in the marketplace and consequently our business, operating
results and financial condition.
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 service of our executive officers and
other key personnel. Even though we currently have "key-man" insurance covering
some of our executives, this insurance amount may not adequately compensate us
for the loss of their services. We cannot guarantee that we will be able to
successfully identify, attract, motivate and retain other highly skilled
personnel in a timely and effective manner. Our failure to retain our officers
and key personnel or to recruit new personnel could adversely affect our
business, operating results and financial condition.
GOVERNMENT REGULATION AND LEGAL UNCERTAINTIES COULD FORCE US TO CHANGE OUR
OPERATIONS.
Our primary customers are hotel chains, independent hotels, hotel
representation firms and travel agencies. We also participate in a venture with
five large hotel industry participants. As a result of these relationships, any
federal, state or foreign governmental authorities, competitors or consumers
could raise anti-competitive concerns regarding our relationship with our
customers or otherwise. Any such action or similar allegations by third parties
could have a material adverse effect on our business, operating results and
financial condition.
11
OUR MINORITY INTEREST INVESTMENTS COULD ADVERSELY AFFECT OUR FINANCIAL
CONDITION AND RESULTS OF OPERATIONS.
We have in the past and may in the future make strategic investments in
other companies and ventures. In doing so, we may have little or no control over
the success of the company or venture. There can be no assurance of the success
of any such investment.
WE HAVE DETERRENTS THAT MAY DISCOURAGE A THIRD PARTY FROM ACQUIRING CONTROL OF
PEGASUS, AND SUCH DETERRENTS MAY PREVENT AN ACQUISITION OF PEGASUS THAT MAY BE
IN YOUR BEST INTEREST.
Provisions in our certificate of incorporation and bylaws could make it
more difficult for a third party to acquire us. These provisions include the
staggered terms of our board of directors, the exclusive right of the board of
directors to fill vacancies on the board, and restrictions on the right of
stockholders to remove members of the board of directors. We are also subject to
the provisions of Delaware law that restrict certain business combinations with
interested stockholders even if such a combination would be beneficial to
stockholders. 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. In addition, we have a stockholder rights plan. The rights are
exercisable only if a person or group of affiliated persons acquires, or has
announced the intent to acquire, 20 percent or more of our common stock.
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.
LITIGATION OR OTHER PROCEEDINGS COULD RESULT IN SUBSTANTIAL COSTS AND DIVERT
OUR MANAGEMENT'S TIME AND ATTENTION.
From time to time, Pegasus is involved in legal and other regulatory
proceedings. Pegasus intends to defend its rights vigorously during any of these
proceedings. Regardless of the merits of any issues raised in any of these
proceedings, our involvement could result in substantial costs and divert
management's time and attention from our business, which could adversely affect
our business, financial condition and results of operations.
WE COULD BE SUBJECT TO NEW LAWS AND REGULATIONS RELATING TO THE INTERNET.
We are subject to the same federal, state and local laws as other companies
conducting business on the Internet. Many of these laws and regulations are new
and have not yet been thoroughly interpreted by the courts. Accordingly, we face
numerous risks related to conducting business on the Internet that include:
- The applicability and reach of various laws and regulations is uncertain.
- Changes to existing laws or the passage of new laws intended to address
privacy issues could directly affect the way we do business and could
create uncertainty in the marketplace.
- Since our services are accessible worldwide via the Internet, foreign
jurisdictions may require that we comply with their laws. Our failure to
comply with foreign laws could subject us to penalties 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 a company
engaging in Internet-based commerce, it is unclear in which states we are
actually doing 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 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.
12
OUR STOCK PRICE HAS BEEN AND MAY CONTINUE TO BE EXTREMELY VOLATILE DUE TO MANY
FACTORS.
Several factors have caused, and may in the future cause, our stock price
to be extremely volatile. Our stock price could be subject to wide fluctuations
in response to a variety of factors including the following:
- Acts of terrorism, retaliation for such acts and the prospect of war.
- Actual or anticipated variations in our quarterly operating results.
- Our ability to successfully develop, introduce and gain acceptance of new
or enhanced products and services to the hotel industry on a timely
basis.
- Unexpected changes in demand for our services and solutions.
- Unpredictable volume and timing of customer revenues due to seasonality
in the travel industry, the terms of customer contracts and other
factors.
- Purchasing and payment patterns, as well as pricing policies, of our
competitors.
- 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.
- Announcements by us or our competitors of significant acquisitions,
strategic partnerships, joint ventures or capital commitments.
- Market fluctuations and performance of the hotel industry.
- Unscheduled system downtime.
In addition, the trading prices of hospitality and technology stocks in
general have historically experienced extreme price and volume fluctuations. Any
negative changes in the public's perception of the prospects of hospitality or
electronic commerce companies or other broad market and industry factors could
depress our stock price 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.
ITEM 2. PROPERTIES
Our corporate headquarters is located in a leased facility with
approximately 81,000 square feet of space in Dallas, Texas. We also have
regional hubs in Scottsdale, London and Singapore with approximately 125,000,
47,000 and 11,000 square feet of leased office space, respectively. In total, we
have 20 offices in 11 countries, all of which are leased facilities. We believe
that our existing facilities are well maintained and in good operating
condition. We believe that our planned and existing facilities are adequate for
our anticipated levels of operations.
ITEM 3. LEGAL PROCEEDINGS
We are a party from time to time to certain routine legal proceedings
arising in the ordinary course of our business. Although the outcome of any
legal proceeding cannot be predicted accurately, we do not believe any liability
that might result from such proceedings could have a material adverse effect on
our business, operating results and financial condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matter was submitted to a vote of our stockholders during the fourth
quarter of the fiscal year ended December 31, 2002.
13
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Our common stock has been traded on the NASDAQ National Market under the
symbol "PEGS" since August 7, 1997. At March 11, 2003, there were approximately
385 record holders of our common stock although we believe that the number of
beneficial owners of our common stock is substantially greater.
The following table shows the range of quarterly high and low sales prices
for Pegasus' common stock.
<Table>
<Caption>
HIGH LOW
------ ------
2002
Fourth quarter.............................................. $12.65 $ 8.89
Third quarter............................................... $17.83 $10.30
Second quarter.............................................. $21.22 $12.99
First quarter............................................... $19.30 $13.66
2001
Fourth quarter.............................................. $14.80 $ 8.25
Third quarter............................................... $13.31 $ 7.67
Second quarter.............................................. $13.35 $ 7.53
First quarter............................................... $12.56 $ 5.88
2000
Fourth quarter.............................................. $19.31 $ 5.81
Third quarter............................................... $21.00 $ 9.94
Second quarter.............................................. $20.75 $10.50
First quarter............................................... $40.67 $14.25
</Table>
We intend to retain any future earnings for use in our business and do not
intend to pay cash dividends in the foreseeable future. The payment of future
dividends, if any, will be at the discretion of our board of directors and will
depend, among other things, upon future earnings, operations, capital
requirements, restrictions in financing agreements, our general financial
condition and general business conditions.
On September 28, 1998, our board of directors 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 one-thousand five
hundredth (1/1,500th) of a share of our Series A Preferred Stock for each share
of our common stock held at a price of $60. The rights are exercisable only if a
person or group of affiliated persons acquires, or has announced the intent to
acquire, 20 percent or more of our common stock.
SECURITIES AUTHORIZED FOR ISSUANCE UNDER EQUITY COMPENSATION PLANS
The following table provides information as of December 31, 2002 regarding
compensation plans (including individual compensation arrangements) under which
equity securities of Pegasus are authorized for
14
issuance. See Note 11 to the Consolidated Financial Statements for information
regarding the material features of these plans.
<Table>
<Caption>
NUMBER OF SECURITIES
REMAINING AVAILABLE FOR
NUMBER OF SECURITIES TO WEIGHTED-AVERAGE FUTURE ISSUANCE UNDER EQUITY
BE ISSUED UPON EXERCISE EXERCISE PRICE OF COMPENSATION PLANS(2)
OF OUTSTANDING OPTIONS, OUTSTANDING OPTIONS, (EXCLUDING SECURITIES
WARRANTS AND RIGHTS(1) WARRANTS AND RIGHTS REFLECTED IN COLUMN (A))
----------------------- -------------------- ----------------------------
(IN THOUSANDS) (IN THOUSANDS)
Plan Category (a) (b) (c)
Equity Compensation Plans
Approved by Security
Holders...................... 4,370 $12.88 945
Equity Compensation Plans not
Approved by Security
Holders...................... -- -- --
----- ---
Total.......................... 4,370 $12.88 945
===== ===
</Table>
- ---------------
(1) The Company's stock option plan provides that the number of shares which may
be awarded as options under the 2002 Plan will be replenished by an amount
equal to 4 percent of the number of shares outstanding, as defined, the last
day of the immediately preceding year. The applicable number of shares
outstanding as of December 31, 2002 was approximately 29.4 million.
(2) Includes shares of common stock available for issuance under the Company's
Employee Stock Purchase Plan.
ITEM 6. SELECTED FINANCIAL DATA
The following selected consolidated financial data as of and for the years
ended December 31, 2002 and 2001, and for the year ended December 31, 2000 are
derived from the consolidated financial statements of Pegasus that have been
audited by PricewaterhouseCoopers LLP, independent accountants, and are included
as Item 8 of this annual report on Form 10-K. Selected consolidated financial
data as of December 31, 2000 and as of and for the years ended December 31, 1999
and 1998 are derived from Pegasus' financial statements that have been audited
by PricewaterhouseCoopers LLP, but are not included herein.
The following data should be read in conjunction with "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
with Pegasus' consolidated financial statements and notes thereto.
Revenues have been reclassified to conform to the current year presentation
and to give effect to the adoption of the Emerging Issues Task Force, or EITF,
Issue 01-14, "Income Statement Characterization of Reimbursements Received for
'Out-of-Pocket' Expenses Incurred." For more information on this
reclassification, see Revenues in "Management's Discussion and Analysis of
Financial Condition and Results of
15
Operations". Effective January 1, 2002, in accordance with Statement of
Financial Accounting Standards No. 142, "Goodwill and Other Intangibles" ("FAS
142") we ceased to record goodwill amortization.
<Table>
<Caption>
YEAR ENDED DECEMBER 31
-------------------------------------------------------------
2002(1),(2),(3) 2001(1),(2) 2000(1) 1999 1998
--------------- ----------- -------- -------- -------
(IN THOUSANDS, EXCEPT PER SHARE DATA)
Service revenues..................... $178,769 $180,668 $162,199 $ 38,036 $29,064
Customer reimbursements.............. 11,181 12,079 10,452 682 644
-------- -------- -------- -------- -------
Total revenues....................... 189,950 192,747 172,651 38,718 29,708
Net income (loss).................... (3,519) (29,737) (26,582) 8,666 5,396
Net income (loss) per share(4)
Basic.............................. (0.14) (1.21) (1.14) 0.47 0.34
Diluted............................ (0.14) (1.21) (1.14) 0.44 0.32
Working capital (deficit)............ 16,995 (5,541) 9,049 145,787 46,248
Total assets......................... 288,095 305,668 357,705 163,540 60,320
Long-term debt, net of current
portion............................ -- -- 20,000 -- 58
Total stockholders' equity........... 225,890 231,201 260,572 156,772 54,264
</Table>
- ---------------
(1) Pegasus' selected consolidated financial data includes the operating results
and purchase accounting amortization related to the acquisition of REZ in
April 2000.
(2) Pegasus' selected consolidated financial data includes the operating results
of GETS following the acquisition in September 2001.
(3) Effective January 1, 2002, in accordance with FAS 142, Pegasus ceased to
record goodwill amortization.
(4) Certain net income per share amounts were retroactively adjusted for a three
for two stock split that occurred in January 2000.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion and analysis should be read in conjunction with
the selected consolidated financial data included as Item 6 of this annual
report on Form 10-K and the consolidated financial statements and notes thereto
included as Item 8 of this annual report on Form 10-K. This discussion and
analysis contains forward-looking statements including statements using
terminology such as "may," "will," "expects," "plans," "intends," "anticipates,"
"believes," "estimates," "potential," or "continue," or a similar negative
phrase or other comparable terminology regarding beliefs, plans, expectations or
intentions for the future. This discussion and analysis contains forward-looking
statements that may involve risks and uncertainties, such as adverse changes in
general market conditions for business and leisure travel as a result of
additional terrorist activities, action by U.S. military forces, changes in
hotel room rates, capacity adjustments by airlines, trends in the overall demand
for travel, and the inherent difficulty in making projections during this period
of uncertainty, as well as other risks and uncertainties described in this
annual report. Pegasus' actual results and the timing of certain events could
differ materially from those discussed in the forward-looking statements as a
result of many factors including those set forth in Pegasus' filings with the
Securities and Exchange Commission, specifically including the risk factors set
forth under Item 1 of this annual report on Form 10-K.
DEPENDENCE ON THE HOTEL INDUSTRY AND IMPACT OF THE ECONOMIC RECESSION AND
SEPTEMBER 11, 2001 EVENTS
Our business, particularly our hospitality segment, is sensitive to changes
in the demand for and average daily rates associated with hotel rooms. The
travel industry has been adversely impacted by the current economic recession
and other world events, predicated in part by the terrorist attacks of September
11, 2001, the following retaliation, the continuing terrorist threat alerts, and
the possibility of war with Iraq and other military actions. The overall
long-term impact of these events on Pegasus and the travel industry is
uncertain. Both the number of reservations and the average daily rate charged
for hotel rooms sharply declined following September 11, 2001 primarily due to
the decrease in demand. Although the recovery in the number of
16
reservations was quicker than anticipated, transatlantic business travel and
average daily rates have not yet fully recovered and continue to lag behind the
recovery in transaction volumes. Since our electronic distribution and CRS
revenues are primarily transaction-based, revenues for these services, which had
sharp decreases immediately following September 11, 2001, recovered relatively
quickly and, for 2002, were close to the levels seen prior to September 11,
2001. However, since our hospitality and commission processing services are
based in large part on a combination of reservation volume and average daily
rates, their recovery has been somewhat slower. In addition, we experienced an
increase in the sales cycle for some of our services, as new customers were
hesitant to sign new contracts given the uncertain economic environment.
The adverse impact of both the economy in the United States and
internationally and the September 11, 2001 events has resulted in a decrease in
the demand for and a reduction in the average daily rates for hotel rooms and,
therefore, has negatively impacted our revenues. We expect this trend to
continue at least through 2003.
REVENUES
The classification of service revenues and customer reimbursements has been
reflected in the financial statements to conform with current-year presentation
and to give effect to the 2002 adoption of EITF 01-14. Under EITF 01-14,
Pegasus' billings for out-of-pocket expenses, such as third-party vendor GDS and
telecommunication charges, are now classified as customer reimbursements, which
is a component of total revenues, and the related costs are classified as
customer reimbursements, which is a component of total costs of services. The
adoption of EITF 01-14 had no effect on our financial position, operating loss,
cash flows or per-share results.
Revenues applicable to customer reimbursements are primarily related to GDS
fees that we pay on behalf of and subsequently bill our customers. In the
future, if our customers decide to pay their bills directly, our customer
reimbursements revenue and customer reimbursements cost of services will
decrease accordingly.
TECHNOLOGY
Reservation Services. CRS revenues consist of transaction fees as well as
license, maintenance and support fees related to our RezView software.
Electronic distribution revenues primarily consist of transaction fees,
commissions and monthly subscription or maintenance fees. In addition, new hotel
customers pay a one-time fee for establishing the connection between the hotel's
central reservation system and the electronic distribution technology. New
third-party Web site customers typically pay a one-time fee for establishing the
connection between the third-party Web site and our electronic distribution
technology. Reservation Services revenues represented approximately 44 percent
of service revenues for 2002.
Financial Services. Financial Services revenues primarily consist of both
travel agency and hotel fees. Travel agency fees are based on a percentage of
the value of hotel commissions processed by Pegasus on behalf of participating
travel agencies. 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. In addition, participating hotels generally
pay fees based on the number of commissionable transactions that Pegasus
processes for the hotel. Financial Services revenues represented approximately
17 percent of service revenues for 2002.
Property Systems and Services. Property Systems and Services revenues for
2002 primarily consisted of maintenance and support fees related to the REZ and
GETS acquisitions. In addition, Property System revenues include fees from our
PegasusCentral product, which are recognized monthly. Property Systems and
Services represented approximately 3 percent of service revenues for 2002.
HOSPITALITY
Hotel Representation. Hotel Representation service revenues consist of
reservation processing fees, membership fees and fees for various marketing
services. Our hotel representation services represented
17
approximately 36 percent of service revenues for 2002. In addition, Pegasus
allows international travelers, who book rooms at hotels for which we provide
representation services, to prepay for their hotel rooms in the traveler's local
currency. When a traveler arrives at the hotel, Pegasus remits the amount to the
hotel in the hotel's local currency. Revenues for this service are derived from
the difference in the exchange rate between the date the traveler pays and the
date the guest stay occurs. See Item 7A "Quantitative and Qualitative
Disclosures about Market Risk" for information regarding our exposure to
movements in foreign currency exchange rates.
OTHER SERVICES
Pegasus regularly seeks to develop new services to capitalize on its
existing technology and customer base and to provide additional electronic hotel
reservation capabilities and information services to its existing customers and
to other participants in the travel distribution process. 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.
COSTS
Pegasus' cost of services consists principally of personnel costs relating
to information technology, customer service, telemarketing, facilities and
equipment maintenance costs. Cost of services also includes the cost of customer
reimbursements. Research and development costs consist principally of personnel
costs, related overhead costs and fees paid to outside consultants. General and
administrative expenses are primarily personnel, legal and accounting related.
Marketing and promotion expenses consist primarily of personnel costs,
advertising, public relations and participation in trade shows and other
industry events. Depreciation and amortization expense includes depreciation of
computer equipment, office furniture, office equipment and leasehold
improvements, as well as amortization of software, and other intangible assets
and, for years prior to 2002, goodwill. Interest expense through June 2001
includes interest on a note payable to Reed Elsevier plc.
FLUCTUATION OF FOREIGN CURRENCIES
Pegasus, particularly our hospitality segment, derives a significant
portion of its revenue from customers located outside the United States.
Particularly in Europe, fluctuations of foreign currencies such as the Euro and
the British Pound relative to the U.S. Dollar result in Pegasus earning more or
less revenue than it otherwise might have earned if currency rates had remained
stable.
RECENT DEVELOPMENTS
TRAVELWEB, LLC, FORMERLY KNOWN AS HOTEL DISTRIBUTION SYSTEM, LLC
On February 11, 2002, Pegasus and five hotel chains -- Hilton Hotels, Hyatt
Corporation, Marriott International, Six Continents Hotels and Starwood
Hotels -- announced the formation of Travelweb, LLC, formerly known as Hotel
Distribution System, LLC. This new venture was formed to distribute discounted
hotel rooms over the Internet through multiple Internet sites using a merchant
business model. Under the merchant model, Travelweb receives hotel room
inventory from suppliers at wholesale or "net" rates. Travelweb then sets the
retail price for the hotel room and processes the transaction as the merchant of
record, which enables Travelweb to receive a higher level of gross profit per
transaction than in a fee-per-booking arrangement. Under the merchant model,
Travelweb generally is not obligated to pay suppliers for unsold inventory.
Travelweb utilizes our technology to create a direct connection between hotel
reservation systems and Internet sites. Travelweb has signed an agreement with
Orbitz, LLC to distribute the room inventory on a non-exclusive basis, and our
Utell subsidiary was one of the first hotel suppliers to distribute room
inventory through Travelweb.
On April 4, 2002 we entered into a three-year technology agreement with
Travelweb to develop technology and provide services that automate the net-rate
reservation and merchant model processes for Travelweb and participating hotels.
18
During the year ended December 31, 2002, we contributed $1.8 million in
cash and $361,000 in development costs to Travelweb, LLC. In addition, we
transferred our consumer Internet site, TravelWeb.com, as part of our capital
contribution to the venture. Because we are equal partners with five hotel
companies and do not exercise significant influence, our investment in Travelweb
is accounted for under the cost method. As a result, we will not recognize any
income or loss related to this investment unless we receive dividends or we
determine the investment to be impaired.
PEGSPAY
In June 2002, we launched PegsPay, an ASP-based service for travel
businesses that operate under the merchant model. PegsPay automates the exchange
of funds and incentives between travel distributors such as tour operators,
online net rate providers, consolidators and wholesalers, and any type of travel
supplier, including hotels, car rental companies, airlines, railways and cruise
lines. PegsPay provides an automated, more efficient process for both the travel
distributor and the travel supplier, providing confidence that the financial
transactions supporting their relationship will be complete, dependable and
supported by quality service and information.
The new service allows the travel distributor to pay each travel supplier
via one consolidated payment in the travel supplier's choice of currency and in
the manner in which the supplier wishes to be paid (e.g., check or direct
deposit). Additionally, the travel supplier receives detailed reservation
reporting that allows them to better manage their net rate distribution
programs.
STRATEGIC INTEGRATION PLAN
On February 4, 2003, Pegasus announced a strategic reorganization to
integrate its technology and hospitality segments into one operating unit. The
single operating unit will have integrated support functions that will be
customer-driven and will have consolidated sales and marketing, product
development, service delivery, reservation/data management, information
technology, finance and human resources functions.
The integration plan, which includes the elimination of redundant positions
and consolidation of certain facilities, is expected to be substantially
completed during the first half of 2003. Beginning in 2004, the estimated annual
cost savings are expected to range from $9 million to $11 million. As a result
of the plan, Pegasus expects to incur restructure and asset impairment costs
ranging from $5 million to $6 million, which will be recorded over several
quarters in 2003.
YEARS ENDED DECEMBER 31, 2002 AND 2001
Pegasus' service revenues are predominantly transaction-based. In addition
to these service revenues, Pegasus bills some customers for certain reimbursable
expenses, primarily GDS fees for those customers who do not pay these fees
directly. The classification of service revenues and customer reimbursements has
been adjusted to conform with the current-year presentation and to give effect
to the 2002 adoption of EITF 01-14.
Pegasus completed the acquisition of GETS on September 1, 2001.
Accordingly, GETS's results of operations subsequent to the acquisition date are
included in the accompanying consolidated financial statements.
On September 4, 2001, Pegasus announced the reorganization of its
operations from a business unit structure into distinct functional areas. The
restructuring plan included the elimination of approximately 15 percent of our
workforce determined to be duplicative and the consolidation of certain
facilities and functions. During the year ended December 31, 2001, Pegasus
incurred a total of $7.7 million in restructuring charges, primarily consisting
of severance, outplacement and redundant facilities costs. As of December 31,
2002, total unpaid costs were approximately $517,000 and were classified as
accrued liabilities.
REVENUES
Year over year revenue comparisons are impacted by the economic recession
and the events of September 11, 2001, which had a direct and immediate negative
impact on the general economy and
19
hospitality industry. Total revenues in 2002 decreased to $190.0 million from
$192.7 million in 2001. Revenues for 2002 included a $3.5 million termination
fee received from a customer following the termination of its contract in March
2002. Service revenues totaled $178.8 million and $180.7 million for 2002 and
2001, respectively, reflecting a decrease of $1.9 million. Excluding the results
of businesses sold or discontinued, and the termination fee described above,
service revenues increased approximately $1.6 million.
Other changes in the business are described in the paragraphs that follow
the presentation of revenues, below (In thousands).
<Table>
<Caption>
2002 2001
-------- --------
Technology services:
Reservation Services...................................... $ 78,250 $ 73,699
Financial Services........................................ 29,904 28,548
Property Systems & Services............................... 6,544 4,650
Business Intelligence..................................... -- 258
-------- --------
Total technology services................................. 114,698 107,155
Continuing operations(1).................................. 111,164 106,897
Technology customer reimbursements.......................... 5,729 5,765
Total technology revenues................................... 120,427 112,920
Hospitality services:
Utell..................................................... 64,071 66,778
Golden Tulip.............................................. -- 6,735
-------- --------
Total hospitality services................................ 64,071 73,513
Continuing operations(2).................................. 64,071 66,778
Hospitality customer reimbursements......................... 5,452 6,314
Total hospitality revenues.................................. 69,523 79,827
Total service revenues...................................... $178,769 $180,668
======== ========
Total customer reimbursements............................... $ 11,181 $ 12,079
======== ========
Total revenues.............................................. $189,950 $192,747
======== ========
Total continuing operations, excluding revenues for customer
reimbursements............................................ $175,235 $173,675
======== ========
</Table>
- ---------------
(1) Excludes a $3.5 million termination fee, included in Reservation Services,
recognized in March, 2002 and Business Intelligence Operations in 2001.
(2) Excludes revenues in 2001 applicable to Golden Tulip.
Revenues for technology services increased $7.5 million, or 7 percent, to
$114.7 million in 2002, compared to $107.2 million in 2001.
Reservation Services revenues increased $4.6 million or 6 percent, to $78.3
million in 2002, compared to $73.7 million in 2001. Excluding the impact of the
termination fee noted above, reservation services revenues increased $1.1
million, primarily due to a 46 percent increase in Internet transactions.
Financial Services revenues increased $1.4 million, or 5 percent, to $29.9
million in 2002, compared to $28.5 million in 2001. The increase in revenue was
primarily attributable to increases in the average travel agent fee earned and
member transaction volume as a result of new travel agency locations added to
the customer base, partially offset by a decline in average hotel daily room
rates.
Property Systems and Services generated revenues of $6.5 million in 2002,
compared to $4.7 million in 2001. The increase was primarily due to the
September 1, 2001 acquisition of GETS, which contributed
20
approximately $1.0 million of incremental revenue during 2002. The remainder of
the increase was due to revenue generated by PegasusCentral services.
Technology-related revenue for customer reimbursements, which are primarily
related to GDS fees, were $5.7 million in 2002, compared to $5.8 million in
2001.
Revenues for hospitality services decreased $9.4 million, or 13 percent, to
$64.1 million in 2002, compared to $73.5 million in 2001. The sale of the Golden
Tulip brand accounted for approximately $6.7 million of the decrease in
revenues. Excluding the effect of the Golden Tulip sale, hotel representation
revenues decreased by $2.7 million, or 4 percent, primarily due to the 14
percent decrease in the number of hotels Utell represents as a result of a
strategic initiative to upgrade Utell's hotel portfolio with a focus on
maximizing revenue and margins on a per-hotel basis.
Hospitality-related revenue for customer reimbursements decreased
approximately $860,000 to $5.5 million in 2002 compared to $6.3 million in 2001,
due to a decrease in our customers' GDS transaction volume.
Cost of services. Cost of services, including customer reimbursements,
decreased $11 million, or 10 percent, to $99.9 million in 2002, compared to
$110.9 million in 2001. Excluding customer reimbursements, cost of services
totaled $88.7 million and $98.8 million for 2002 and 2001, respectively,
representing a 10 percent decrease. This decrease is primarily a result of cost
reduction initiatives enacted as part of the third quarter 2001 restructuring,
consisting primarily of a reduction in personnel and facilities, and the absence
of costs related to the Golden Tulip brand. As a percent of service revenues,
cost of services decreased to 50 percent in 2002, compared to 55 percent in
2001.
Research and development. Research and development expenses decreased $2
million, or 26 percent, to $5.8 million in 2002, compared to $7.8 million for
the same period in 2001. The decrease is primarily due to the increase in
capitalized payroll costs associated with software development efforts in 2002,
such as PegasusCentral. As a percent of service revenues, research and
development costs decreased to 3 percent in 2002, compared to 4 percent in 2001.
General and administrative expenses. General and administrative expenses
were essentially flat at $25.1 million in 2002, compared to $25.2 million in
2001. As a percentage of service revenues, general and administrative expenses
was 14 percent in both 2002 and 2001.
Marketing and promotion expenses. Marketing and promotion expenses
decreased $3.7 million, or 17 percent, to $18.0 million in 2002, compared to
$21.7 million in 2001. Marketing and promotion expenses decreased due to a
reduction of discretionary spending and the sale of Golden Tulip. As a percent
of service revenues, marketing and promotion expenses decreased to 10 percent in
2002, compared to 12 percent in 2001.
Depreciation and amortization. Depreciation and amortization expenses
decreased $17.6 million, or 27 percent, to $48.1 million in 2002, compared to
$65.7 million in 2001. The decrease was primarily due to Pegasus' adoption of
FAS 142, which resulted in the January 1, 2002 cessation of amortization of
goodwill from the REZ acquisition. Goodwill amortization totaled $16.2 million
in 2001.
Restructure costs. For the year ended 2002, Pegasus did not incur
restructuring costs. During 2001, Pegasus incurred $7.7 million of restructuring
charges, primarily consisting of severance, outplacement and redundant
facilities costs related to reorganizing its operations from a business unit
structure into distinct functional areas, the consolidation of reservation
centers and the winding down of Business Intelligence operations.
Interest income. Interest income decreased $378,000 in 2002, compared to
2001. This was due to a smaller investment in marketable securities and a
reduction in the interest rates earned on marketable securities during 2002.
Interest expense. Interest expense decreased $834,000 in 2002, compared to
2001, primarily due to the June 2001 payment of our $20 million note payable to
Reed Elsevier.
21
Equity in loss of investee. Prior to September 1, 2001, when the Company
acquired the remaining 80 percent interest in GETS, Pegasus recognized $39,000
as its share of GETS' net losses and $595,000 as amortization of associated
goodwill for total equity in loss of investee of $634,000.
Gains on sales of business units. In January 2001, Pegasus sold its Summit
Hotels & Resorts and Sterling Hotels & Resorts brand businesses to IndeCorp
Corporation for approximately $12 million and recognized a pre-tax gain on this
transaction of approximately $4.8 million. In June 2001, Pegasus sold its Golden
Tulip brand and licensing business, recognizing a pre-tax gain of $749,000
related to this transaction.
Provision for income taxes. Pegasus recorded an income tax benefit of $2.1
million in 2002, representing an effective tax rate of 38 percent. Pegasus
recorded an income tax benefit of $8.9 million in 2001, representing an
effective tax rate of 23 percent of pretax loss. The effective tax rate for 2001
differed from the statutory rate primarily due to large non-deductible expenses
related to purchase accounting, partially offset by tax-exempt interest income.
YEARS ENDED DECEMBER 31, 2001 AND 2000
Pegasus' service revenues are predominantly transaction-based. In addition
to these service revenues, Pegasus bills its customers for certain reimbursable
expenses, primarily GDS fees. The classification of service revenues and
customer reimbursements has been adjusted to conform with the current-year
presentation and to give effect to the 2002 adoption of EITF 01-14.
Pegasus completed the acquisition of REZ on April 3, 2000 and the
acquisition of GETS on September 1, 2001. Accordingly, REZ's and GETS's results
of operations subsequent to the acquisition dates are included in the
accompanying consolidated financial statements.
REVENUES
Year over year revenue comparisons are impacted by the events of September
11, 2001, which had a direct and immediate negative impact in 2001. Total
revenues in 2001 increased to $192.7 million from $172.7 million in 2000.
Excluding customer reimbursements, service revenues of $180.7 million and $162.2
million for 2001 and 2000, respectively, reflecting an increase of $18.5
million. This increase was primarily attributable to the acquisitions of REZ and
GETS, as well as the addition of new CRS customers and growth in our Financial
Services business. The overall increase was net of lost revenues from the sale
of the Summit, Sterling and Golden Tulip brands and the discontinued business
intelligence operations, a reduction in hotel reservations and a decline in the
average daily room rates subsequent to the terrorist attacks of September 11,
2001. Other changes in the business are described in the paragraphs that follow
the presentation of revenues below (In thousands).
<Table>
<Caption>
2001 2000
-------- --------
Technology services:
Reservation Services...................................... $ 73,699 $ 56,216
Financial Services........................................ 28,548 25,471
Property Systems & Services............................... 4,650 2,193
Business Intelligence..................................... 258 1,455
-------- --------
Total technology services................................. 107,155 85,335
Continuing operations(1).................................. 106,897 83,880
Technology customer reimbursements.......................... 5,765 4,590
Total technology revenues................................... 112,920 89,925
</Table>
22
<Table>
<Caption>
2001 2000
-------- --------
Hospitality services:
Utell..................................................... $ 66,778 $ 56,254
Golden Tulip.............................................. 6,735 8,915
Sterling.................................................. -- 5,000
Summit.................................................... -- 6,695
-------- --------
Total hospitality services................................ 73,513 76,864
Continuing operations(2).................................. 66,778 56,254
Hospitality customer reimbursements......................... 6,314 5,862
Total hospitality revenues.................................. 79,827 82,726
Total service revenues...................................... $180,668 $162,199
======== ========
Total customer reimbursements............................... $ 12,079 $ 10,452
======== ========
Total revenues.............................................. $192,747 $172,651
======== ========
Total continuing operations, excluding revenues for customer
reimbursements............................................ $173,675 $140,134
======== ========
</Table>
- ---------------
(1) Excludes Business Intelligence operations.
(2) Excludes Golden Tulip, Sterling and Summit operations.
Revenues for technology services increased $21.8 million, or 26 percent, to
$107.2 million in 2001, compared to $85.3 million in 2000.
Reservation services revenues increased $17.5 million, or 31 percent, to
$73.7 million in 2001, compared to $56.2 million in 2000. While a substantial
portion of the increase was attributable to a full year's revenues from REZ, the
remaining increase is primarily due to providing more services to existing
customers and adding new customers, such as Kimpton Hotels, IndeCorp and
Universal Studios.
Financial Services revenues increased $3.1 million, or 12 percent, to $28.5
million in 2001, compared to $25.5 million in 2000. The increase was primarily
due to growth in our reconciliation and tracking service revenue, which
contributed to higher average travel agency fees. Revenues were also enhanced by
a slight increase in gross commissions processed due to a 3.5 percent increase
in transactions.
Property Systems and Services generated revenues of $4.7 million in 2001,
compared to $2.2 million in 2000. Of the $2.5 million increase, $1.3 million was
attributable to revenues from GETS, subsequent to the September 1, 2001
acquisition. Other property system revenues consisted of an agreement with
Marriott to maintain GuestView, the PMS product obtained in the REZ acquisition.
Technology-related revenue for customer reimbursements was $5.8 million in
2001, compared to $4.6 million in 2000.
Revenues for hospitality services decreased $3.4 million, or 4 percent, to
$73.5 million in 2001, compared to $76.9 million in 2000. The sale of our
Summit, Sterling and Golden Tulip brands accounted for approximately $13.9
million of the decrease in revenues. Excluding the effect of the Summit,
Sterling and Golden Tulip sales, hotel representation revenues increased by
$10.5 million, or 19 percent, primarily due to the inclusion of a full year's
revenues from the REZ acquisition.
Hospitality-related revenue for customer reimbursements increased
approximately $450,000 to $6.3 million in 2001, compared to $5.9 million in 2000
due to an increase in our customers' transaction volume.
Costs of services. Total costs of services increased $20.1 million, or 22
percent, to $110.9 million in 2001, compared to $90.8 million in 2000. Excluding
customer reimbursements, cost of services of $98.8 million and $80.4 million for
2001 and 2000, respectively, representing a 23 percent increase. This increase
was
23
primarily the result of the inclusion of a full twelve months of costs from the
REZ acquisition and four months of costs from the GETS acquisition. These costs
were partially offset by cost-containment efforts implemented during 2001 and
the absence of costs related to the Summit, Sterling and Golden Tulip
businesses. As a percent of service revenues, cost of services increased to 55
percent in 2001, compared to 50 percent in 2000. This increase was primarily due
to realizing a lower gross margin on REZ revenues.
Research and development. Research and development expenses decreased
$191,000, or 2 percent, to $7.8 million in 2001, compared to $8.0 million for
the same period in 2000. The decrease is primarily the result of more research
and development costs meeting the criteria for capitalization in 2001. As a
percent of service revenues, research and development costs decreased to 4
percent in 2001, compared to 5 percent in 2000.
General and administrative expenses. General and administrative expenses
increased $4.8 million, or 24 percent, to $25.2 million in 2001, compared to
$20.4 million in 2000. General and administrative expenses increased primarily
due to the inclusion of a full twelve months of costs from the REZ acquisition.
In addition, an increase in the use of professional services related to our
enterprise-wide accounting and information system and our restructuring plan
also resulted in increased general and administrative expenses and were
partially offset by a decrease in travel expense and other controllable costs.
As a percent of service revenues, general and administrative expenses increased
to 14 percent in 2001, compared to 13 percent in 2000.
Marketing and promotion expenses. Marketing and promotion expenses
decreased $3.1 million, or 13 percent, to $21.7 million in 2001, compared to
$24.8 million in 2000. Marketing and promotion expenses decreased primarily due
to the sales of Summit, Sterling and Golden Tulip, a reduction in headcount and
a decrease in travel and other controllable costs. In addition, Utell is now
outsourcing some of its marketing functions thereby resulting in lower costs. As
a percent of service revenues, marketing and promotion expenses decreased to 12
percent in 2001, compared to 15 percent in 2000.
Depreciation and amortization. Depreciation and amortization expenses
increased $14.1 million, or 27 percent, to $65.7 million in 2001, compared to
$51.5 million in 2000. The increase was primarily due to the inclusion of a full
twelve months of depreciation and amortization expenses related to assets
obtained in the REZ acquisition. This increase was partially offset by a
reduction in purchased intangible assets associated with the sales of our
Summit, Sterling and Golden Tulip brand businesses.
Restructure costs. During 2001, Pegasus incurred $7.7 million of
restructuring charges, primarily consisting of severance, outplacement and
redundant facilities costs related to reorganizing its operations from a
business unit structure into distinct functional areas and the consolidation of
reservation centers. During 2000, Pegasus incurred $3.4 million of restructuring
charges, primarily attributable to the winding down of Business Intelligence
operations.
Interest income. Interest income decreased $1.8 million in 2001, compared
to 2000 as we had a smaller investment in marketable securities during 2001. The
smaller investment in marketable securities was due to the utilization of our
marketable securities to fund the REZ and GETS acquisitions and the early
payment of our $20 million note payable to Reed Elsevier.
Interest expense. Interest expense decreased $800,000 in 2001, compared to
2000, primarily due the June 2001 payment of our $20 million note payable to
Reed Elsevier.
Equity in loss of investee. Prior to September 1, 2001, when the Company
acquired the remaining 80 percent interest in GETS, Pegasus recognized $39,000
as its share of GETS' net losses and $595,000 as amortization of associated
goodwill for total equity in loss of investee of $634,000.
Gains on sales of business units. In January 2001, Pegasus sold its Summit
Hotels & Resorts and Sterling Hotels & Resorts brand businesses to IndeCorp for
approximately $12.0 million and recognized a pre-tax gain on this transaction of
approximately $4.8 million. In June 2001, Pegasus sold its Golden Tulip brand
and licensing business, recognizing a pre-tax gain of $749,000 related to this
transaction.
Provision for income taxes. Pegasus recorded an income tax benefit of $8.9
million in 2001, representing an effective tax rate of 23 percent. The effective
rate differed from the statutory rate primarily due to large non-deductible
expenses related to purchase accounting. Pegasus recorded an income tax benefit
of
24
$5.9 million in 2000, representing an effective tax rate of 18 percent of pretax
income. The effective tax rate for 2000 differed from the statutory rate
primarily due to large non-deductible expenses related to purchase accounting,
partially offset by tax-exempt interest income.
LIQUIDITY AND CAPITAL RESOURCES
Pegasus' principal sources of liquidity at December 31, 2002 included cash
and cash equivalents of $19.9 million, short-term investments of $4 million and
an unused revolving credit facility of $30.0 million.
Effective March 31, 2002, Pegasus amended and renewed its $30.0 million
revolving credit facility with Chase Bank of Texas, Compass Bank and Wells Fargo
Bank (Texas) through March 31, 2004. The credit facility has an interest rate
based on Prime or LIBOR rates, as defined, adjusted upwards depending on
calculated financial ratios. Amounts available under the credit facility are
also subject to debt covenants, some of which are calculated using Pegasus'
financial position and results of operations. There was no amount outstanding
under the credit facility at December 31, 2002 or 2001.
Pegasus has entered into two irrevocable standby letter of credit
agreements with Chase Manhattan Bank totaling $2.6 million related to the leases
for its new Dallas and Scottsdale offices. On January 14, 2003, the $2.6 million
letters of credit were reduced to $2.1 million as a result of the annual
$450,000 decrease to one of the letters of credit. The amount available to
Pegasus under the $30 million credit facility is reduced by these letters of
credit.
Pegasus had positive working capital of $17.0 million at December 31, 2002
compared to a working capital deficit of $5.5 million at December 31, 2001.
Working capital increased primarily as a result of cash flows from operations,
which increased to $38.3 million in 2002 from $25.4 million in 2001, the
Company's 2001 restructuring which reduced headcount 15 percent, and a continued
focus on cost containment. Pegasus has satisfied its cash requirements for
investing and financing activities primarily through cash generated from
operations.
Net cash used in investing activities rose slightly in 2002 to $29.5
million, from $28.4 million in 2001. This increase occurred as the result of
increased capital expenditures, partially offset by the absence of acquisition
costs in 2002. Capital expenditures consisted of purchases of software,
furniture, leasehold improvements and computer equipment, as well as internally
developed software costs, and amounted to $30.3 million in 2002, compared to
$14.4 million in 2001. The increase was primarily due our new Dallas and
Scottsdale offices as well as costs associated with our new data center in
Phoenix, and an increase in capitalized software development. The increase in
capital expenditures is expected to result in additional depreciation expense in
2003, as compared to 2002. In 2002, capital expenditures included funded tenant
improvement allowances totaling approximately $2.7 million, which represent
improvements reimbursed to us by the lessor.
Net cash used in financing activities decreased to $2.3 million in 2002,
compared to $20.7 million in 2001, primarily because of the June 2001 repayment
of the $20 million note payable to Reed Elsevier plc.
25
Operating leases continue to be the only off-balance sheet financing
arrangements Pegasus engages in. The following is a schedule of our future
contractual cash obligations as of December 31, 2002 (In thousands):
<Table>
<Caption>
OTHER
OPERATING PURCHASE LONG-TERM
YEAR ENDED DECEMBER 31, LEASES OBLIGATIONS LIABILITIES TOTAL
- ----------------------- --------- ----------- ----------- -------
2003........................................ $ 9,148 $ 8,128 $1,236 $18,512
2004........................................ 8,041 6,261 2,225 16,527
2005........................................ 6,866 1,006 2,004 9,876
2006........................................ 6,667 -- 415 7,082
2007........................................ 6,382 -- -- 6,382
Thereafter.................................. 28,113 -- 50 28,163
------- ------- ------ -------
$65,217 $15,395 $5,930 $86,542
======= ======= ====== =======
</Table>
Operating leases represent our cash obligations associated with agreements
to use equipment or facilities that are enforceable and legally binding for
fixed terms. Purchase obligations include cash obligations associated with
agreements to purchase services or equipment that are enforceable and legally
binding for fixed terms, or estimated cash obligations for agreements with
variable pricing provisions. Other long-term liabilities include commission
checks to be refunded to hotels, as well as Pegasus' estimated cash obligations
associated with funding its employee retirement plans.
On June 5, 2002, the Board of Directors authorized the repurchase of up to
2.5 million shares of Pegasus' common stock. During 2002, 404,000 shares were
repurchased for an aggregate purchase price of $4.6 million. The aggregate
shares repurchased under Board approved plans through December 31, 2002 have
been cancelled.
On February 4, 2003, Pegasus announced a strategic reorganization to
integrate its technology and hospitality divisions into one operating unit. The
integration plan, which includes the elimination of redundant positions and
consolidation of certain facilities, should be substantially completed during
the first half of 2003. Pegasus estimates restructure and asset impairment costs
to total from $5 million to $6 million. Beginning in 2004, the estimated annual
cost savings expected to result from the integration range from $9 million to
$11 million.
Our future liquidity and capital requirements will depend on numerous
factors, including:
- Our profitability
- Operational cash requirements, including payments for severance and
redundant facilities related to our restructuring
- Competitive pressures
- Development of new services and applications
- Acquisition of and investment in complementary businesses or technologies
- Common stock repurchases
- Response to unanticipated cash requirements
Pegasus believes its cash flows from operations, together with funds
available from debt financing, will be sufficient to meet its foreseeable
operating and capital requirements through at least the next twelve months.
Pegasus may consider other financing alternatives to fund its requirements,
including possible public or private debt or equity offerings. However, there
can be no assurance that any financing alternatives sought by Pegasus will be
available or will be on terms that are attractive to Pegasus. Further, any debt
financing may involve restrictive covenants, and any equity financing may be
dilutive to stockholders.
26
INFLATION
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 its results of operations to the
extent such increases are not passed along to customers.
CRITICAL ACCOUNTING POLICIES
Preparation of our financial statements in conformity with accounting
principles generally accepted in the United States requires us to make estimates
and judgments that affect the reported financial position and results of
operations during the reporting period. Our estimates and judgments are
continually evaluated based on available information and experience. Because the
use of estimates is inherent in the financial reporting process, actual results
could differ from estimates. If there is a significant unfavorable change to
current conditions, it will likely result in a material adverse impact to our
business, operating results and financial condition.
Certain accounting policies require higher degrees of judgment than others
in their application. Pegasus considers the following to be critical accounting
policies due to the estimation processes involved in each. For a detailed
discussion of the Company's accounting policies, see Note 1 to the Consolidated
Financial Statements in Item 8 of this annual report on Form 10-K.
ACCOUNTS AND NOTES RECEIVABLES
As of December 31, 2002, Pegasus had accounts receivable as a result of its
ongoing operations of approximately $30 million. Additionally, Pegasus has notes
receivable totaling $9.4 million at December 31, 2002, related to the sale of
business units. These receivables are monitored by management for
collectibility. Pegasus maintains allowances for doubtful accounts for estimated
losses resulting from the inability of its customers to make required payments.
These estimates of losses require judgments that are based on available
information and experience, such as the payment histories and known financial
conditions of the parties. These estimates are significant because Pegasus may
incur additional expense to increase its allowance for doubtful accounts and may
receive less cash than expected if the financial condition of the parties was to
deteriorate, resulting in an impairment of their ability to make payments.
Pegasus' allowances for doubtful accounts totaled approximately $3.6 million as
of December 31, 2002.
IMPAIRMENT OF ASSETS
As of December 31, 2002, Pegasus has goodwill related to its acquisitions
of REZ and GETS totaling approximately $139.5 million. Under the guidance of FAS
142, goodwill is allocated to the two operating segments of Pegasus and goodwill
for each segment is periodically analyzed for impairment. These practices
require significant estimates and judgments by management, involving the
carrying value of each segment and the estimated fair value of each segment. The
estimated fair value of each segment requires significant judgment in estimating
future cash flows from operations for the various services provided by Pegasus.
While the most-recent periodic impairment analysis indicated that no impairment
of goodwill exists, variances in actual growth rates, operating margins, or
other assumptions may impact the impairment analysis and affect the carrying
values of goodwill for the operating segments.
As of December 31, 2002, Pegasus has unamortized capitalized software costs
totaling $43.9 million, which requires periodic analysis for impairment. This
impairment analysis requires the comparison of unamortized carrying values to
estimated net realizable values. The estimated net realizable value is based on
significant judgments such as estimated future cash flows from the related
services, or expected benefits of the software and are based on available
information and experience. While the most-recent periodic impairment analyses
indicated that no impairment of capitalized software costs exists, changes in
strategy, market conditions or other assumptions may significantly impact these
judgments and affect the carrying values of capitalized software costs.
27
Our senior management has discussed the development and selection of these
critical accounting estimates, and the disclosure in this section of this report
regarding them, with our Audit Committee.
EMPLOYEE BENEFIT PLANS
In the United States and the United Kingdom, Pegasus sponsors defined
benefit plans for certain employees. Our employee pension costs and obligations
are dependent upon our assumptions used by actuaries in calculating such
amounts. These assumptions include salary growth, long-term return on plan
assets, discount rates and other factors. The salary growth assumptions are
either stated in the plan or reflect our long-term actual experience and future
and near-term outlook. Long-term return on plan assets is determined based on
historical results of the portfolio and management's expectation of the current
economic environment. Specific to the plan provided in the United Kingdom, which
is a funded plan, a one percent change in expected returns on plan assets would
result in a $77,000 change to Pegasus' annual expense associated with this plan.
We base the discount rate assumption on current investment yields, including
applicable corporate long-term bond yields. Actual results that differ from our
assumptions are accumulated and amortized over the future working life of the
plan participants. While we believe that the assumptions used are appropriate,
significant differences in actual experience or significant changes in
assumptions would affect our pension costs and obligations. Additionally,
Pegasus' recently announced strategic integration plan could have an effect on
the assumptions used in accounting for our employee benefit plans.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2002, the Financial Accounting Standards Board, or FASB, issued
Statement of Financial Accounting Standards No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities," or FAS 146. FAS 146 addresses
financial accounting and reporting for costs associated with exit or disposal
activities and replaces Emerging Issues Task Force Issue No. 94-3, "Liability
Recognition for Certain Employee Termination Benefits and Other Costs to Exit an
Activity (including Certain Costs Incurred in a Restructuring)." FAS 146
requires a liability for a cost associated with an exit or disposal activity to
be recognized when incurred -- not when an entity commits to an exit plan, as
under Issue No. 94-3. The provisions of FAS 146 are effective, on a prospective
basis, for exit or disposal activities initiated by companies after December 31,
2002.
In November 2002, the EITF reached a consensus on Issue No. 00-21, "Revenue
Arrangements with Multiple Deliverables." EITF Issue No. 00-21 provides guidance
on how to account for arrangements that involve the delivery or performance of
multiple products, services and/or rights to use assets. The provisions of EITF
Issue No. 00-21 will apply to revenue arrangements entered into in fiscal
periods beginning after June 15, 2003. Pegasus is currently evaluating the
effect that the adoption of EITF Issue No. 00-21 will have on its results of
operations and financial condition.
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation -- Transition and
Disclosure," or FAS 148. FAS 148 amends FAS 123 "Accounting For Stock-Based
Compensation" to provide alternative methods of transitioning to a fair-value
method of accounting for stock-based compensation. FAS 148 also amends
disclosure requirements, regardless of the accounting method used for
stock-based compensation. Pegasus has complied with the disclosure provisions of
FAS 148. Pegasus is currently evaluating SFAS No. 148 to determine if it will
adopt SFAS No. 123 to account for employee stock options using the fair value
method and, if so, how to transition to that method.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Pegasus is exposed to certain market risks, including the effects of
movements in foreign currency exchange rates, and uses derivative financial
instrument contracts to manage foreign exchange risks. Pegasus has established a
control environment that includes policies and procedures for risk assessment
and the approval, reporting and monitoring of derivative financial instrument
activities. Company policy prohibits holding or issuing derivative financial
instruments for trading purposes.
28
To reduce the impact of changes in foreign exchange rates on consolidated
results of operations and future foreign currency denominated cash flows, the
Company was a party to various forward exchange contracts at December 31, 2002.
These contracts reduce exposure to currency movements affecting existing foreign
currency denominated assets and liabilities primarily trade receivables and
payables.
A summary of forward exchange contracts in place at December 31, 2002
follows (In thousands):
<Table>
<Caption>
SELL PURCHASE
------- --------
Australian Dollar........................................... $ 193 $ --
Canadian Dollar............................................. 193 --
Swiss Franc................................................. 98 --
Danish Krone................................................ -- 257
Euro........................................................ 11,565 --
British Pound............................................... 1,247 --
Hong Kong Dollar............................................ -- 33
Japanese Yen................................................ -- 145
Norwegian Krona............................................. -- 28
Swedish Krona............................................... 729 --
Singapore Dollar............................................ 89 --
South African Rand.......................................... -- 15
------- ----
Total.................................................. $14,114 $478
======= ====
</Table>
All contracts matured no later than February 2003. Because of the
short-term nature of these contracts, the fair value approximates the contract
value. The difference between the fair value and contract value is included in
the consolidated balance sheet as accounts receivable and was not material at
December 31, 2002. During the fiscal year ended December 31, 2001, Pegasus used
similar forward exchange contracts and had either sell or purchase forward
exchange contracts of a similarly short-term nature in place on December 31,
2001. As of December 31, 2001, Pegasus had approximately $7.5 million in sell
forward exchange contracts and $779,000 in purchase forward exchange contracts.
Pegasus' positions with respect to these forward exchange contracts differed as
of December 31, 2002 compared to December 31, 2001 because of changes in
Pegasus' non-U.S. denominated trade payables and receivables. For more
information on derivative financial instruments see Notes 1 and 7 to the
consolidated financial statements included in Item 8 to this annual report on
Form 10-K.
29
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of Pegasus Solutions, Inc.:
In our opinion, the accompanying consolidated balance sheets and the
related consolidated statements of operations and comprehensive loss, changes in
stockholders' equity and cash flows present fairly, in all material respects,
the financial position of Pegasus Solutions, Inc. and its subsidiaries at
December 31, 2002 and 2001, and the results of their operations and their cash
flows for each of the three years in the period ended December 31, 2002 in
conformity with accounting principles generally accepted in the United States of
America. 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 auditing standards generally accepted in the United States of
America, 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 our opinion.
As discussed in Note 1 to the consolidated financial statements, the
Company changed its method of accounting for goodwill and other intangible
assets in connection with its adoption of Statement of Financial Accounting
Standards No. 142, Goodwill and Other Intangible Assets, effective January 1,
2002.
PRICEWATERHOUSECOOPERS LLP
Dallas, Texas
February 4, 2003
30
PEGASUS SOLUTIONS, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2002 AND 2001
(IN THOUSANDS, EXCEPT FOR SHARE AMOUNTS)
<Table>
<Caption>
2002 2001
-------- --------
ASSETS
Cash and cash equivalents................................... $ 19,893 $ 13,438
Short-term investments...................................... 4,033 9,167
Accounts receivable, net of allowance for doubtful accounts
of $3,639 and $5,790, respectively........................ 25,886 29,228
Prepaid expenses............................................ 3,400 3,558
Other current assets........................................ 4,968 1,751
-------- --------
Total current assets................................... 58,180 57,142
Goodwill, net of accumulated amortization of $40,225 and
$28,544, respectively..................................... 139,533 136,921
Intangible assets, net of accumulated amortization of
$50,231 and $43,939, respectively......................... 6,013 32,505
Property and equipment, net................................. 71,442 67,365
Other noncurrent assets..................................... 12,927 11,735
-------- --------
Total assets...................................... $288,095 $305,668
======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable............................................ $ 11,308 $ 19,018
Accrued liabilities......................................... 8,838 13,280
Deferred tax liability...................................... -- 12,301
Unearned income............................................. 7,812 8,585
Accrued payroll and benefits................................ 6,428 6,905
Customer deposits........................................... 3,031 2,170
Other current liabilities................................... 3,768 424
-------- --------
Total current liabilities.............................. 41,185 62,683
Noncurrent uncleared commission checks...................... 4,641 4,004
Noncurrent accrued rent..................................... 7,345 36
Other noncurrent liabilities................................ 9,034 7,744
Commitments and contingencies
Stockholders' equity:
Preferred stock, $0.01 par value; 2,000,000 shares
authorized; zero shares issued and outstanding......... -- --
Common stock, $0.01 par value; 50,000,000 shares
authorized; 24,747,165 and 24,694,479 shares issued,
respectively........................................... 247 247
Additional paid-in capital................................ 287,676 287,205
Unearned compensation..................................... (571) (34)
Accumulated other comprehensive income (loss)............. (1,705) 21
Accumulated deficit....................................... (59,757) (56,238)
-------- --------
Total stockholders' equity........................ 225,890 231,201
-------- --------
Total liabilities and stockholders' equity........ $288,095 $305,668
======== ========
</Table>
See accompanying notes to consolidated financial statements.
31
PEGASUS SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<Table>
<Caption>
2002 2001 2000
-------- -------- --------
Revenues:
Service revenues.......................................... $178,769 $180,668 $162,199
Customer reimbursements................................... 11,181 12,079 10,452
-------- -------- --------
Total revenues......................................... 189,950 192,747 172,651
Costs of services:
Cost of services.......................................... 88,717 98,838 80,377
Customer reimbursements................................... 11,181 12,079 10,452
-------- -------- --------
Total costs of services................................ 99,898 110,917 90,829
Research and development.................................... 5,821 7,842 8,033
General and administrative expenses......................... 25,146 25,201 20,404
Marketing and promotion expenses............................ 17,998 21,709 24,843
Depreciation and amortization............................... 48,075 65,651 51,549
Restructure and asset impairment costs...................... -- 7,696 3,421
Write-off of purchased in-process research and
development............................................... -- -- 8,000
-------- -------- --------
Operating loss.............................................. (6,988) (46,269) (34,428)
Other income (expense):
Interest income........................................... 1,277 1,655 3,464
Interest expense.......................................... (53) (887) (1,687)
Equity in loss of investee, including amortization of
excess purchase price of $595.......................... -- (634) --
Gains on sale of business units........................... -- 5,538 --
Other..................................................... 130 1,914 151
-------- -------- --------
Loss before income taxes.................................... (5,634) (38,683) (32,500)
Income tax benefit.......................................... 2,115 8,946 5,918
-------- -------- --------
Net loss.................................................... $ (3,519) $(29,737) $(26,582)
======== ======== ========
Other comprehensive income (loss):
Change in unrealized gain (loss), net of tax of $12, $185
and $171, respectively................................. (20) 286 (240)
Minimum pension liability adjustment, net of tax of
$896................................................... (1,706) -- --
-------- -------- --------
Comprehensive loss.......................................... $ (5,245) $(29,451) $(26,822)
======== ======== ========
Net loss per share:
Basic and diluted......................................... $ (0.14) $ (1.21) $ (1.14)
======== ======== ========
Weighted average shares outstanding:
Basic and diluted......................................... 24,818 24,570 23,380
======== ======== ========
</Table>
See accompanying notes to consolidated financial statements.
32
PEGASUS SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2002, 2001 AND 2000
(IN THOUSANDS)
<Table>
<Caption>
ACCUMULATED
COMMON STOCK OTHER
------------------ ADDITIONAL COMPREHENSIVE RETAINED
NUMBER OF PAID-IN UNEARNED INCOME EARNINGS
SHARES AMOUNT CAPITAL COMPENSATION (LOSS) (DEFICIT) TOTAL
--------- ------ ---------- ------------ ------------- --------- --------
Balance at December 31,
1999..................... 20,340 $203 $156,954 $ (442) $ (25) $ 82 $156,772
Windfall tax benefit of
stock options............ -- -- 397 -- -- -- 397
Stock-based compensation
expense.................. -- -- (6) 285 -- -- 279
Exercise of stock
options.................. 116 1 504 -- -- -- 505
Issuance for stock purchase
plan..................... 72 1 809 -- -- -- 810
Issuance for REZ
acquisition.............. 3,990 40 126,742 -- -- -- 126,782
Issuance for GETS
acquisition.............. 180 2 2,998 -- -- -- 3,000
Shares received from REZ
escrow settlement........ (70) (1) (1,149) -- -- -- (1,150)
Change in unrealized gain
(loss) on marketable
securities............... -- -- -- -- (240) -- (240)
Dividend payable resulting
from stock split......... -- -- -- -- -- (1) (1)
Net loss................... -- -- -- -- -- (26,582) (26,582)
------ ---- -------- ------- ------- -------- --------
Balance at December 31,
2000..................... 24,628 246 287,249 (157) (265) (26,501) 260,572
Windfall tax benefit of
stock options............ -- -- 542 -- -- -- 542
Stock-based compensation
expense.................. -- -- -- 123 -- -- 123
Exercise of stock
options.................. 215 1 989 -- -- -- 990
Issuance for stock purchase
plan..................... 48 1 453 -- -- -- 454
Purchase of treasury
shares................... (196) (1) (2,066) -- -- -- (2,067)
Acquisition of GETS........ -- -- 38 -- -- -- 38
Change in unrealized gain
(loss) on marketable
securities............... -- -- -- -- 286 -- 286
Net loss................... -- -- -- -- -- (29,737) (29,737)
------ ---- -------- ------- ------- -------- --------
Balance at December 31,
2001..................... 24,695 247 287,205 (34) 21 (56,238) 231,201
Windfall tax benefit of
stock options............ -- -- 1,325 -- -- -- 1,325
Issuance of restricted
stock.................... 98 1 1,334 (1,335) -- -- --
Stock-based compensation
expense.................. -- -- -- 798 -- -- 798
Exercise of stock
options.................. 293 2 1,808 -- -- -- 1,810
Issuance for stock purchase
plan..................... 65 1 602 -- -- -- 603
Purchase of treasury
shares................... (404) (4) (4,598) -- -- -- (4,602)
Change in unrealized gain
(loss) on marketable
securities............... -- -- -- -- (20) -- (20)
Minimum pension liability
adjustment............... -- -- -- -- (1,706) -- (1,706)
Net loss................... -- -- -- -- -- (3,519) (3,519)
------ ---- -------- ------- ------- -------- --------
Balance at December 31,
2002..................... 24,747 $247 $287,676 $ (571) $(1,705) $(59,757) $225,890
====== ==== ======== ======= ======= ======== ========
</Table>
See accompanying notes to consolidated financial statements.
33
PEGASUS SOLUTIONS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2002, 2001, AND 2000
(IN THOUSANDS)
<Table>
<Caption>
2002 2001 2000
-------- -------- --------
Cash flows from operating activities:
Net loss.................................................. $ (3,519) $(29,737) $(26,582)
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization........................... 48,075 65,651 51,549
Write-off of purchased in-process research and
development............................................ -- -- 8,000
Equity in loss of investee.............................. -- 634 --
Gains on sale of business units......................... -- (5,538) --
Asset impairment........................................ -- -- 3,003
Bad debt expense........................................ 1,289 3,408 2,874
Deferred income taxes................................... (3,868) (9,934) (9,865)
Other................................................... 1,385 (1,140) 1,153
Changes in assets and liabilities, net of effects of
acquisitions:
Accounts receivable................................... 2,033 (3,963) 6,664
Other current and noncurrent assets................... (911) 574 2,438
Accounts payable and accrued liabilities.............. (12,489) 4,144 (12,403)
Unearned income....................................... (773) (843) (2,046)
Income tax receivable/payable......................... 2,000 (6,587) 1,827
Other noncurrent liabilities.......................... 5,077 8,730 (2,235)
-------- -------- --------
Net cash provided by operating activities........... 38,299 25,399 24,377
Cash flows from investing activities:
Purchase of marketable securities......................... (13,886) (16,375) --
Proceeds from maturity of marketable securities........... 16,492 7,225 35,294
Purchase of property and equipment........................ (30,340) (14,407) (16,678)
Proceeds from sale of property and equipment.............. 83 310 --
Investment in Travelweb, LLC.............................. (2,143) -- --
Collections of note receivable............................ 285 -- --
Purchase of REZ, net of cash acquired..................... -- 852 (93,115)
Purchase of GETS.......................................... -- (11,512) (2,000)
Proceeds from sale of business units...................... -- 4,033 --
Other..................................................... -- 1,500 (1,500)
-------- -------- --------
Net cash used in investing activities............... (29,509) (28,374) (77,999)
Cash flows from financing activities:
Proceeds from issuance of common stock.................... 2,413 1,444 1,301
Purchase of treasury stock................................ (4,602) (2,067) --
Proceeds from line of credit.............................. -- -- 10,000
Repayment of line of credit............................... -- -- (10,000)
Repayment of notes payable................................ -- (20,000) (18,021)
Other..................................................... (146) (114) (53)
-------- -------- --------
Net cash used in financing activities............... (2,335) (20,737) (16,773)
Net increase (decrease) in cash and cash equivalents........ 6,455 (23,712) (70,395)
Cash and cash equivalents, beginning of period.............. 13,438 37,150 107,545
-------- -------- --------
Cash and cash equivalents, end of period.................... $ 19,893 $ 13,438 $ 37,150
======== ======== ========
Supplemental disclosure of cash flow information:
Interest paid............................................. $ 47 $ 2,073 $ 449
Income taxes paid......................................... $ 857 $ 2,385 $ 1,167
Supplemental schedule of noncash investing and financing
activities:
Common stock issued for purchase of REZ................... $ -- $ -- $125,632
Note payable issued for purchase of REZ................... -- -- 20,000
Common stock issued for investment in GETS................ -- -- 3,000
Notes received from sale of Summit and Sterling Hotels &
Resorts................................................. -- 7,000 --
Landlord paid tenant improvements......................... 4,125 -- --
</Table>
See accompanying notes to consolidated financial statements.
34
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
Pegasus is a leading provider of hotel room reservation services,
reservation technology systems and hotel representation services for the global
hospitality industry. On April 3, 2000, Pegasus completed the acquisition of
REZ, Inc. ("REZ"), a leader in providing distribution services and solutions for
the hotel industry. The acquisition added hotel representation, central
reservation system, or CRS, and property management system, or PMS, services to
our existing electronic distribution and commission processing services. Pegasus
is organized primarily on the basis of services provided, with two reportable
segments -- technology and hospitality.
The technology segment provides reservation services, commission processing
services and property systems and services to the global hotel industry. The
hospitality segment provides hotel representation services offered under the
Utell brand name. Hotel representation services offered under the Summit Hotels
& Resorts and Sterling Hotels & Resorts brand names were sold in January 2001,
and the Golden Tulip brand was sold in June 2001.
The consolidated financial statements include the accounts of Pegasus
Solutions, Inc. and its wholly owned subsidiaries ("Pegasus" or "the Company").
All significant inter-company balances have been eliminated in consolidation.
Certain prior year amounts have been reclassified to conform to the current year
presentation. Pegasus' common stock is traded on the Nasdaq National Market
under the symbol PEGS.
MANAGEMENT ESTIMATES
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts of assets, liabilities,
revenues and expenses and disclosures of contingent assets and liabilities.
Actual results may differ from those estimates. Certain accounting policies
require higher degrees of judgment than others in their application. The
following accounting policies require significant estimates: accounts and notes
receivable, impairment of long-lived assets and employee benefit plans.
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.
INVESTMENTS IN DEBT AND EQUITY SECURITIES
Marketable securities consist of corporate debt and equity securities and
obligations issued by governments and agencies. By policy, the Company invests
primarily in high-grade marketable securities. All marketable securities are
defined as available-for-sale under the provisions of Statement of Financial
Accounting Standards No. 115, "Accounting for Certain Investments in Debt and
Equity Securities."
Management determines the appropriate classification of its investments in
marketable securities at the time of purchase and re-evaluates such
determination at each balance sheet date. Available-for-sale securities are
carried at fair value, with changes in the unrealized gain or loss reported as a
separate component of stockholders' equity, net of tax.
CAPITALIZED SOFTWARE COSTS
Software costs are accounted for in accordance with either Statement of
Financial Accounting Standards No. 86, "Accounting for the Costs of Computer
Software to Be Sold, Leased, or Otherwise Marketed," and with Statement of
Position No. 98-1, "Accounting for the Costs of Computer Software Developed or
35
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Obtained for Internal Use." Capitalized software costs are amortized on a
product-by-product basis using the straight-line method over a period, which
approximates the estimated economic life of the product. In the event
unamortized software costs exceed the net realizable value of the software, the
excess is written-off in the period the excess is determined. Amortization of
capitalized software costs in 2002, 2001 and 2000 totaled $20.6 million, $15.8
million and $11.3 million, respectively. At December 31, 2002 and 2001,
unamortized capitalized software was $43.9 million and $51.0 million,
respectively.
PROPERTY AND EQUIPMENT
Property and equipment are recorded at cost and depreciated using the
straight-line method over their estimated useful lives, ranging from three to
seven years. Leasehold improvements are amortized over the shorter of their
estimated useful lives or the life of the lease. Expenditures for maintenance
and repairs, as well as minor renewals, are charged to 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. 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. The Company believes that no impairment of property and
equipment existed at December 31, 2002 or 2001.
GOODWILL
Effective January 1, 2002, the Company adopted Statement of Financial
Accounting Standards No. 142, "Goodwill and Other Intangibles" ("FAS 142") and
Statement of Financial Accounting Standards No. 141, "Business Combinations"
("FAS 141"). FAS 142 addresses financial accounting and reporting for intangible
assets acquired individually or with a group of other assets (but not those
acquired in a business combination) at acquisition and for goodwill and other
intangible assets subsequent to their acquisition. The Company's consolidated
balance sheet at December 31, 2001 included goodwill, net of accumulated
amortization, totaling $136.9 million, which is related to the REZ, Inc. ("REZ")
and Global Enterprise Technology Solutions, LLC ("GETS") acquisitions. Pegasus
applied the provisions of FAS 142 on January 1, 2002 and discontinued
amortization of goodwill from the REZ acquisition. In accordance with FAS 141,
goodwill from the GETS acquisition was never amortized. In addition, as required
by FAS 141, effective January 1, 2002, workforce-in-place from the REZ
acquisition was reclassified as goodwill and is no longer be subject to
amortization. During 2002, purchase price adjustments for certain tax items
reduced goodwill by $2.6 million.
Amortization of goodwill was $16.2 million and $12.3 million for the years
ended December 31, 2001 and 2000, respectively. As of December 31, 2002 and
2001, goodwill totaled $139.5 million and $136.9 million, respectively. The
carrying value of goodwill is evaluated annually. The Company believes that no
impairment of goodwill existed at December 31, 2002 or 2001.
OTHER INVESTMENTS
As a result of the REZ acquisition, the Company received a $1.1 million
non-controlling equity investment in the SITA Foundation. The investment was
converted into 32,853 shares of France Telecom and disposed of by the Company
for a loss of approximately $280,000 in 2002.
On February 11, 2002, Pegasus and five hotel chains -- Hilton Hotels, Hyatt
Corporation, Marriott International, Six Continents Hotels and Starwood
Hotels -- announced the formation of Travelweb, LLC, ("Travelweb") formerly
known as Hotel Distribution System, LLC (See Note 15). This new venture was
36
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
formed to distribute discounted hotel rooms over the Internet through multiple
Internet sites using a merchant business model.
On April 4, 2002, Pegasus entered into a three-year technology agreement
with Travelweb to develop technology and provide services that automate the
net-rate reservation and merchant model processes for Travelweb and
participating hotels.
During the year ended December 31, 2002, Pegasus contributed $1.8 million
in cash and $361,000 in development costs to Travelweb. In addition, the Company
transferred its consumer Internet site, TravelWeb.com, as part of the capital
contribution to the venture. Because Pegasus is equal partners with five hotel
companies and does not exercise significant influence, the investment in
Travelweb is accounted for under the cost method.
STOCK-BASED EMPLOYEE COMPENSATION
The Company accounts for stock-based compensation utilizing the intrinsic
value method in accordance with the provisions of Accounting Principles Board
Opinion No. 25 (APB 25), "Accounting for Stock Issued to Employees" and related
Interpretations. Accordingly, no compensation expense is recognized for fixed
option plans because the exercise prices of employee stock options equal or
exceed the market prices of the underlying stock on the dates of grant. As
discussed in Note 11, the Company maintains stock option, restricted stock and
employee stock purchase plans. Total compensation expense for these plans was
$798,000, $123,000 and $280,000 for 2002, 2001 and 2000, respectively.
The following table represents the effect on net income and earnings per
share if the Company had applied the fair value based method and recognition
provisions of Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation," to stock-based employee compensation (In
thousands, except per share amounts):
<Table>
<Caption>
2002 2001 2000
------- -------- --------
Net loss, as reported................................. $(3,519) $(29,737) $(26,582)
Add: Stock-based employee compensation expense
included in reported income, net of related tax
effects............................................. 485 80 185
Deduct: Total stock-based employee compensation
expense determined under fair value based methods
for all awards, net of related tax effects.......... (5,020) (3,991) (3,870)
------- -------- --------
Pro forma net loss.................................... $(8,054) $(33,648) $(30,267)
Net loss per share, basic and diluted:
As reported......................................... $ (0.14) $ (1.21) $ (1.14)
Pro forma........................................... $ (0.32) $ (1.37) $ (1.29)
</Table>
The pro forma disclosures provided may not be representative of the effects
on reported net income (loss) for future years due to future grants and the
vesting requirements of the Company's stock option plans. For purposes of pro
forma disclosures, the estimated fair value of stock-based compensation plans
and other options is amortized to expense over the vesting period.
The weighted average fair value for options with exercise prices equal to
the market price of stock at the grant date was $7.83, $6.23 and $10.88 in 2002,
2001 and 2000, respectively. The fair value of each option
37
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
grant is estimated on the date of grant using the Black-Scholes option-pricing
model with the following weighted-average assumptions:
<Table>
<Caption>
2002 2001 2000
--------- --------- ---------
Dividend yield....................................... -- -- --
Expected volatility.................................. 73.2% 78.8% 83.0%
Risk-free rate of return............................. 3.9% 4.3% 6.4%
Expected life........................................ 4.0 years 4.0 years 4.0 years
</Table>
The pro forma disclosures for 2002, 2001 and 2000 include approximately
$267,000, $223,000 and $366,000 respectively, of compensation expense related to
the Company's Employee Stock Purchase Plan. The fair value of shares issued
under this plan was estimated using the Black-Scholes option-pricing model with
the following weighted-average assumptions:
<Table>
<Caption>
2002 2001 2000
--------- -------- --------
Dividend yield......................................... -- -- --
Expected volatility.................................... 62.0% 70.5% 83.0%
Risk-free rate of return............................... 2.18% 6.1% 6.3%
Expected life.......................................... 1.0 years 1.0 year 1.0 year
</Table>
See Note 11 for further discussion of the Company's stock-based employee
compensation.
REVENUES
In 2002, the Company adopted the provisions of Emerging Issues Task Force
Issue, EITF, 01-14 "Income Characterization of Reimbursements Received for
'Out-of-Pocket' Expenses Incurred." The Company's billings for out-of pocket
expenses, such as travel, and certain third-party vendor expenses such as global
distribution system and telecommunication charges are included in revenues. The
related costs are classified as customer reimbursements and are reflected as a
component of cost of services. Revenues and costs of services for prior periods
have been adjusted to give retroactive effect to the adoption of EITF 01-14. The
adoption of EITF 01-14 had no effect on the Company's financial position, cash
flows, operating loss or per share results.
Pegasus' service revenues are predominantly transaction-based. The
Company's technology segment derives its revenues from transaction fees,
commission fees, license fees and maintenance fees charged to participating
hotels and travel agencies. The Company's hospitality segment derives its
revenues from reservation processing fees, membership fees and fees for various
marketing services.
Reservation services. CRS revenues consist of transaction fees as well as
license, maintenance and support fees related to the Company's
RezView(TM)software. Transaction fees are recognized when the guest stay occurs
or at the transaction date depending on the contract terms. License, maintenance
and support fees are recognized ratably over the term of the customer contract.
Pegasus derives revenues from its electronic distribution service by
charging hotel customers a fee based on the number of reservations made, less
the number cancelled ("net reservations"). 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. The Company's interim balance sheets
reflect deferred revenue for the difference between the fee per transaction that
Pegasus actually bills a customer during the period and the average fee per
transaction that a customer is expected to pay for the entire year. The deferred
revenue created during the early periods of the
38
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
year is recognized by the end of the year as the fee per transaction that
Pegasus actually bills a customer falls below the average fee per transaction
for the entire year. The Company's quarterly operating results have historically
not been materially impacted as a result of this policy. Additionally, Pegasus
generally charges new participants in the electronic distribution service a
one-time fee for work performed to establish the connection between a hotel's
central reservation system and the Pegasus electronic distribution technology.
The Company recognizes these one-time fees over the life of the customer
contract. The Company also charges certain GDSs a fee based on either the number
of net reservations or the number of hotel chains connected to the GDS through
the Pegasus electronic distribution technology to compensate for the management
and consolidation of multiple interfaces.
Pegasus derives its Internet distribution revenues by charging
participating hotels transaction fees. For reservations that originate on Web
sites using our online distribution service, Pegasus charges hotels transaction
fees based on the number of net reservations made at participating properties.
Online distribution service customers also pay initial development fees and
monthly subscription or maintenance fees.
Financial Services. Pegasus derives commission processing revenues by
charging each participating travel agency a fee equal to a percentage of
commissions paid to that agency through the commission processing service. The
Company also generally charges participating hotels a fee based on the number of
commissionable transactions processed. Revenues from travel agency fees can vary
substantially from period to period based on the types of hotels at which
reservations are made, fluctuations in overall room rates and percentages or
fees determined by the travel supplier. Pegasus recognizes revenues from its
commission processing service when earned.
Property Systems. Property Systems revenues consist of maintenance and
support fees from PMS software obtained in the REZ and GETS acquisitions. In
addition, Property system revenues include fees from the PegasusCentral product,
which are recognized monthly. Maintenance, support and training fees are
recognized ratably over the term of the customer contract.
Hotel Representation. Hotel representation revenues consist of reservation
processing fees, membership fees and fees for various marketing services.
Reservation processing fees are recognized when the guest stay occurs or on the
transaction date depending on the contract terms. Membership fees are generally
billed quarterly and recognized ratably over the billing period. Marketing
service revenues are recognized as the marketing services are provided.
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 rate is recognized in income in the period that includes the
enactment date. Valuation allowances are established when necessary to reduce
deferred tax assets to the amounts more likely than not to be realized.
ADVERTISING COSTS
Advertising and promotion-related expenses are charged to operations when
incurred. Advertising expense for 2002, 2001 and 2000 was approximately $2.3
million, $3.8 million and $5.1 million, respectively.
39
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
RESEARCH AND DEVELOPMENT
Research and development expenses are charged to operations when incurred.
FOREIGN CURRENCY
The Company has various foreign operations, primarily in Europe, Canada,
Latin America and Asia. The U.S. dollar is the functional currency for the
Company's foreign operations. Gains and losses from foreign currency
transactions are recognized in the period in which they occur and are included
in other income (expense).
FINANCIAL INSTRUMENTS
The Company uses derivative financial instrument contracts to manage
foreign exchange risks. Amounts receivable or payable under derivative financial
instrument contracts are reported on the consolidated balance sheet. As exchange
rates fluctuate, gains and losses on contracts used to hedge existing assets and
liabilities are recognized in the statement of operations as other income
(expense).
The carrying amounts of the Company's financial instruments reflected in
the consolidated balance sheets at December 31, 2002 and 2001 approximate their
respective fair values.
CONCENTRATIONS OF CREDIT AND MARKET RISK
The Company's financial instruments exposed to concentrations of credit
risk consist primarily of cash, receivables and forward contracts to purchase or
sell foreign currencies.
Cash and Cash Equivalents. Cash balances exceeding the federally insured
limits are maintained in financial institutions. However, management believes
the institutions are of high credit quality.
Accounts and notes receivables. The Company's technology customers
primarily include well-established hotel chains and travel-related web sites.
The Company's representation customers primarily consist of independent hotels,
some of which are located outside the United States. Some of these customers may
not be financially viable. Even though the Company has policies in place to
limit exposure from concentrations of credit risks, management believes the
Company has moderate exposure to credit risk related to accounts receivable from
its customers. Additionally, Pegasus has notes receivable from one company
related to the sale of business units (see Note 4). These notes receivable are
monitored by management for collectibility, considering the payment history and
known financial condition of the party. If the financial condition of the party
was to deteriorate, resulting in an impairment of their ability to make
payments, Pegasus may incur an expense to increase its allowance for doubtful
accounts and may receive less cash than expected.
Foreign currency contracts. The counterparties to the Company's foreign
exchange contracts are substantial and creditworthy multinational commercial
banks or other financial institutions that are recognized market makers. Neither
the risks of counterparty nonperformance nor the economic consequences of
counterparty nonperformance associated with these contracts are considered by
the Company to be material.
The Company is exposed to certain market risks, including the effects of
movements in foreign currency exchange rates. Forty percent of 2002 revenue was
derived from customers located outside the United States, particularly in
Europe. Fluctuations in the value of foreign currencies relative to the U.S.
Dollar directly impact our revenues. The Company uses derivative financial
instrument contracts to manage foreign exchange risks. The Company has
established a control environment that includes policies and procedures for risk
assessment and the approval, reporting and monitoring of derivative financial
instrument activities. Company policy prohibits holding or issuing derivative
financial instruments for trading purposes.
40
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
NET LOSS PER SHARE
Basic loss per share is computed by dividing net loss available to common
stockholders by the weighted average number of common shares outstanding for the
reporting period, after giving retroactive effect to stock splits. The effect of
stock options is not included in the calculation of diluted net loss per share
for the years ended December 31, 2002, 2001 and 2000, as the effect would be
anti-dilutive. Shares issuable upon the exercise of stock options that were
excluded from the calculation were 4.4 million, 3.8 million and 3.1 million in
2002, 2001 and 2000, respectively. As of December 31, 2002, the Company also has
98,400 shares of restricted stock, which vest in 2003 that have not been
included in the calculation of diluted net loss for the year ended December 31,
2002, as the effect would be anti-dilutive.
RECENTLY ISSUED ACCOUNTING STANDARDS
In June 2002, the FASB issued Statement of Financial Accounting Standards
No. 146, "Accounting for Costs Associated with Exit or Disposal Activities," or
FAS 146. FAS 146 addresses financial accounting and reporting for costs
associated with exit or disposal activities and replaces Emerging Issues Task
Force Issue No. 94-3, "Liability Recognition for Certain Employee Termination
Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred
in a Restructuring)." FAS 146 requires a liability for a cost associated with an
exit or disposal activity to be recognized when incurred -- not when an entity
commits to an exit plan, as under Issue No. 94-3. The provisions of FAS 146 are
effective, on a prospective basis, for exit or disposal activities initiated by
companies after December 31, 2002.
In November 2002, the EITF reached a consensus on Issue No. 00-21, "Revenue
Arrangements with Multiple Deliverables." EITF Issue No. 00-21 provides guidance
on how to account for arrangements that involve the delivery or performance of
multiple products, services and/or rights to use assets. The provisions of EITF
Issue No. 00-21 will apply to revenue arrangements entered into in fiscal
periods beginning after June 15, 2003. Pegasus is currently evaluating the
effect that the adoption of EITF Issue No. 00-21 will have on its results of
operations and financial condition.
In December 2002, the FASB issued Statement of Financial Accounting
Standards No. 148, "Accounting for Stock-Based Compensation -- Transition and
Disclosure," or FAS 148. FAS 148 amends FAS 123 "Accounting For Stock-Based
Compensation" to provide alternative methods of transitioning to a fair-value
method of accounting for stock-based compensation. FAS 148 also amends
disclosure requirements, regardless of the accounting method used for
stock-based compensation. The Company has complied with the disclosure
provisions of FAS 148. The Company is currently evaluating SFAS No. 148 to
determine if it will adopt SFAS No. 123 to account for employee stock options
using the fair value method and, if so, how to transition to that method.
2. RESTRUCTURE COSTS
During the years ended December 31, 2001 and 2000, the Company reorganized
its operations from a business unit structure into distinct functional areas,
consolidated its reservation centers outside of the United States and ceased
operations of its Business Intelligence division, resulting in restructuring
charges of $7.7 million and $3.4 million, respectively.
41
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
During the years ended December 31, 2001 and 2000, Pegasus recognized $7.7
million and $3.4 million of restructuring charges, respectively. The composition
of those charges follows (In thousands):
<Table>
<Caption>
2001 2000
------ ------
Reorganization by business function:
Severance and outplacement costs.......................... $3,910 $ --
Redundant facilities and other costs...................... 2,392 --
------ ------
6,302 --
Consolidation of reservation centers:
Severance costs........................................... 821 --
Redundant facilities and other costs...................... 352 419
------ ------
1,173 419
Winding-down of business intelligence services:
Write-down of goodwill and other assets................... -- 3,002
Severance costs........................................... 221 --
------ ------
221 3,002
------ ------
Total restructuring charges................................. $7,696 $3,421
====== ======
</Table>
Pegasus conducted a reorganization of its reportable segments by business
function in the third quarter of 2001, incurring $6.3 million of restructuring
charges. These charges included $3.9 million of severance and outplacement costs
and $2.4 million of redundant facilities and other costs. As a result of the
reorganization plan, Pegasus eliminated approximately 15 percent of its
workforce determined to be duplicative and consolidated certain facilities and
functions. The positions eliminated were primarily related to call center and
administrative functions and included both domestic and international locations.
The Company consolidated reservation centers outside the U.S. during the
fourth quarter of 2000 and the first and fourth quarters of 2001, incurring $1.6
million of restructuring charges. These charges included $821,000 of severance
costs and $771,000 of redundant facilities and other costs. As a result of the
reservation center consolidation, Pegasus eliminated approximately five percent
of its workforce determined to be duplicative and consolidated certain
facilities and functions.
Pegasus' business intelligence division ceased operations during the fourth
quarter of 2000, incurring $3.2 million of restructuring charges. These charges
included $221,000 of severance costs and $3.0 million to write-down goodwill and
other assets associated with business intelligence services. Approximately one
percent of the Company's workforce was eliminated by the winding-down of these
services.
As of December 31, 2002, total unpaid costs were $517,000 and were
classified as accrued liabilities.
On February 4, 2003, the Company announced a strategic reorganization to
integrate its technology and hospitality divisions into one operating unit. The
integration plan, which includes the elimination of redundant positions and
consolidation of certain facilities, should be substantially completed during
the first half of 2003. The restructure will be accounted for under the
provisions of FAS 146 and Pegasus estimates restructure and asset impairment
costs ranging from $5 million to $6 million.
42
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
3. ACQUISITIONS
REZ, INC.
On April 3, 2000, Pegasus completed the acquisition of REZ, which was
accounted for under the purchase method of accounting. Accordingly, REZ's
results of operations subsequent to the acquisition date are included in the
Company's consolidated financial statements.
The $245.3 million purchase price includes approximately $11 million in
acquisition costs and was allocated to assets acquired and liabilities assumed
based on estimated fair value at the acquisition date. The approximate fair
value of assets acquired and liabilities assumed at the acquisition date,
excluding a write-off of purchased in-process research and development
("IPR&D"), is summarized below (In thousands):
<Table>
Estimated fair value of net tangible assets purchased....... $ 996
Deferred tax liability associated with the intangibles
acquired.................................................. (42,179)
Customer relationships...................................... 59,600
Software.................................................... 33,300
Workforce in-place.......................................... 20,200
Non-compete agreement....................................... 3,700
Goodwill.................................................... 161,708
</Table>
The allocation of the purchase price to intangibles was based upon an
independent, third party appraisal and management's estimates. The carrying
value of customer relationships was reduced by $7.2 million during 2001, due to
the sale of Summit, Sterling and Golden Tulip representation services -- see
Note 4.
A charge of $8.0 million was taken in 2000 to write off purchased IPR&D
projects. The value assigned to purchased IPR&D was determined by identifying
research projects in areas for which technological feasibility had not yet been
established. These projects included a customer reporting system and Corporate
Direct, a program for discounted corporate room rates on the Internet. The value
was determined by estimating the expected cash flows from the projects once
commercially viable, discounting the net cash flows back to their present value
and then applying a percentage of completion to the calculated value.
GLOBAL ENTERPRISE TECHNOLOGY SOLUTIONS, LLC
On September 1, 2001, Pegasus acquired the remaining 80 percent of the
outstanding common stock of GETS, a Tempe, Arizona-based provider of hotel
property management systems, for $11.5 million in cash. Pegasus acquired the
initial 20 percent interest on November 1, 2000 for $5.0 million in cash and
stock, which was accounted for under the equity method. The final purchase price
totaled $22.6 million and was comprised of:
- $16.5 million in total cash and common stock exchanged in November 2000
and September 2001,
- $6.0 million of software development costs funded by Pegasus prior to
acquisition, and
- $90,000 of acquisition costs.
The acquisition was accounted for under the purchase method of accounting.
Accordingly, GETS' results of operations subsequent to the acquisition date are
included in the Company's consolidated financial statements. Allocation of the
purchase price to assets acquired and liabilities assumed was based upon an
43
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
independent, third party appraisal and management's estimates. The approximate
fair value of assets acquired and liabilities assumed at the acquisition date is
summarized below (In thousands):
<Table>
Estimated fair value of net tangible liabilities assumed.... $(1,380)
Software.................................................... 18,120
Other intangible assets..................................... 120
Goodwill.................................................... 5,730
</Table>
Acquired software and intangible assets that are depreciable totaled $18.2
million and have a weighted average useful life of 4.9 years. Software was not
amortized during 2001, as it was not available for general release to customers.
Goodwill related to the 20 percent share of GETS acquired in November 2000 was
amortized through the September 2001 acquisition of the remaining 80 percent of
GETS and was included in equity in loss of investee.
At August 31, 2001, amortization included in equity in loss of investee
totaled $595,000. Pursuant to the issuance of FAS 141 and FAS 142, goodwill
obtained with the September 2001 GETS acquisition is not subject to
amortization.
4. SALE OF BUSINESS UNITS
SUMMIT AND STERLING HOTELS & RESORTS
On January 10, 2001, Pegasus sold its Summit Hotels & Resorts and Sterling
Hotels & Resorts brand businesses to IndeCorp Corporation ("IndeCorp") for
approximately $12 million, including a $1.0 million promissory note and
scheduled future payments due upon member hotel contract renewals. The $1.0
million promissory note bears interest at Prime plus 2 percent annually and is
scheduled to mature on July 31, 2003, as amended.
In addition, IndeCorp signed a five-year technology services agreement and
a three-year hotel representation agreement with Pegasus. As part of the
agreements, Pegasus is the exclusive provider of reservation technology,
electronic reservation processing and commission processing services to the
IndeCorp brands, which includes all Preferred Hotels & Resorts, Summit Hotels &
Resorts and Sterling Hotels & Resorts member hotels.
On November 9, 2001, Pegasus and IndeCorp amended the original sale
agreement to provide for a $6.0 million promissory note that replaces the
scheduled future payments under the original agreement. The $6.0 million
promissory note requires monthly payments for a period of eight years commencing
July 1, 2002 and bears interest at 7 percent. In conjunction with amending the
original sale agreement, Pegasus also received from IndeCorp a $2.8 million
promissory note to replace existing outstanding trade receivables, and extended
the term of the existing technology services and hotel representation agreements
with IndeCorp for an additional 1 1/2 years. The $2.8 million promissory note
requires monthly payments for a period of eight years commencing July 1, 2002
and bears interest at 7 percent. During 2001, Pegasus recognized a $4.8 million
pre-tax gain on the sale of the Summit Hotels & Resorts and Sterling Hotels &
Resorts brands.
GOLDEN TULIP
On June 29, 2001, Pegasus sold its Golden Tulip brand and licensing
business to Madrid-based NH Hoteles ("NH") for $2.0 million. As a result of this
transaction, Pegasus recognized a pre-tax gain of $749,000. In addition, NH
signed one-year agreements with Pegasus for reservation and Utell services. As
part of the agreements, Pegasus is the exclusive provider of reservations
technology, voice and electronic reservation processing and commission
processing services to all Golden Tulip Hotels and Tulip Inns.
44
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
5. GOODWILL AND INTANGIBLE ASSETS
Pegasus is organized in two business segments -- technology and
hospitality. In accordance with FAS 142, goodwill is subject to an annual
impairment test, conducted at the business segment level. Based on the periodic
impairment test conducted as of September 30, 2002, the Company does not believe
goodwill for either business segment is impaired. The following table presents
goodwill by business segment, net of accumulated amortization, and reflecting
the reclassification of workforce-in-place (In thousands):
<Table>
<Caption>
TECHNOLOGY HOSPITALITY TOTAL
---------- ----------- --------
December 31, 2002.................................... $128,271 $11,262 $139,533
December 31, 2001.................................... $124,379 $12,542 $136,921
</Table>
Pegasus' adoption of FAS 142 had no effect on the Company's acquired
identifiable intangible assets that are subject to amortization. The following
table presents those intangible assets at December 31, 2002 and December 31,
2001 (In thousands):
<Table>
<Caption>
DECEMBER 31, 2002 DECEMBER 31, 2001
----------------------- -----------------------
CARRYING ACCUMULATED CARRYING ACCUMULATED
VALUE AMORTIZATION VALUE AMORTIZATION
-------- ------------ -------- ------------
Customer relationships.................... $52,376 $(48,146) $52,376 $(30,942)
Non-compete agreements.................... 3,820 (2,067) 3,820 (1,305)
Other..................................... 48 (18) 48 (11)
------- -------- ------- --------
Total..................................... $56,244 $(50,231) $56,244 $(32,258)
</Table>
During the years ended December 31, 2002, 2001 and 2000 the Company
recorded amortization expense in relation to the above-listed intangible assets
of $18.0 million, $16.5 million and $15.8 million, respectively. The following
table presents the estimated amortization expense for these intangible assets
for the years ended December 31 (In thousands):
<Table>
2003........................................................ $4,999
2004........................................................ 769
2005........................................................ 216
Thereafter.................................................. 29
</Table>
45
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following pro forma financial information compares the Company's net
losses for the years ended December 31, 2002 and 2001 had the provisions of FAS
142 been applied on January 1, 2001 (In thousands, except per share amounts):
<Table>
<Caption>
YEAR ENDED
DECEMBER 31,
------------------
2002 2001
------- --------
Reported net loss........................................... $(3,519) $(29,737)
Goodwill amortization....................................... -- 10,415
Workforce in-place amortization............................. -- 4,225
------- --------
Adjusted net loss........................................... $(3,519) $(15,097)
======= ========
Basic and diluted earnings per share:
Reported net loss......................................... $ (0.14) $ (1.21)
Goodwill amortization..................................... -- 0.42
Workforce in-place amortization........................... -- 0.17
------- --------
Adjusted net loss......................................... $ (0.14) $ (0.62)
======= ========
Weighted average shares outstanding:
Basic and diluted......................................... 24,818 24,570
======= ========
</Table>
6. MARKETABLE SECURITIES
Marketable securities held by the Company at December 31, 2002 and 2001 are
classified as available-for-sale and consist of corporate debt and equity
securities and obligations issued by governments and agencies. Approximately
$3.1 million of corporate debt securities held at December 31, 2002, have
contractual maturities exceeding one year. All other debt securities held at
December 31, 2002 mature in 2003. Realized gains and losses are determined on a
specific identification basis. In 2001, the Company recognized a $484,000
write-down of the carrying value of equity securities. The amortized cost and
fair value of marketable securities at December 31, 2002 and 2001 are as follows
(In thousands):
<Table>
<Caption>
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
December 31, 2002
Corporate debt............................ $5,107 $17 $ -- $5,124
Government and agency obligations......... 2,014 2 (2) 2,014
Equity securities......................... 16 -- (15) 1
------ --- ---- ------
Total marketable securities............... $7,137 $19 $(17) $7,139
====== === ==== ======
December 31, 2001
Corporate debt............................ $5,976 $32 $ (4) $6,004
Government and agency obligations......... 3,141 6 -- 3,147
Equity securities......................... 16 -- -- 16
------ --- ---- ------
Total marketable securities............... $9,133 $38 $ (4) $9,167
====== === ==== ======
</Table>
46
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
7. DERIVATIVE FINANCIAL INSTRUMENTS
To reduce the impact of changes in foreign exchange rates on consolidated
results of operations and future foreign currency denominated cash flows, the
Company was a party to various forward exchange contracts at December 31, 2002.
These contracts reduce exposure to currency movements affecting existing foreign
currency denominated assets and liabilities -- primarily trade receivables and
payables.
A summary of forward exchange contracts in place at December 31, 2002
follows (In thousands):
<Table>
<Caption>
SELL PURCHASE
------- --------
Australian Dollar........................................... $ 193 $ --
Canadian Dollar............................................. 193 --
Swiss Franc................................................. 98 --
Danish Krone................................................ -- 257
Euro........................................................ 11,565 --
British Pound............................................... 1,247 --
Hong Kong Dollar............................................ -- 33
Japanese Yen................................................ -- 145
Norwegian Krona............................................. -- 28
Swedish Krona............................................... 729 --
Singapore Dollar............................................ 89 --
Thai Baht................................................... -- 15
------- ----
Total..................................................... $14,114 $478
======= ====
</Table>
All contracts mature no later than February 2003. Because of the short-term
nature of these contracts, the fair value approximates the contract value. The
difference between the fair value and contract value is included in the
consolidated balance sheet as accounts receivable and was not material at
December 31, 2002.
8. PROPERTY AND EQUIPMENT
Property and equipment at December 31 consisted of the following (In
thousands):
<Table>
<Caption>
ESTIMATED
2002 2001 USEFUL LIFE
-------- -------- ------------
Software........................................... $ 91,330 $ 87,738 3 to 5 years
Computer equipment................................. 24,980 22,905 3 to 4 years
Furniture and equipment............................ 5,130 4,377 7 years
Office equipment................................... 4,448 3,929 4 years
Leasehold improvements............................. 12,521 2,766 Lease term
-------- --------
138,409 121,715
Less: accumulated depreciation..................... (66,967) (54,350)
-------- --------
Property and equipment, net........................ $ 71,442 $ 67,365
======== ========
</Table>
Depreciation expense for property and equipment was $29.6 million, $23.3
million and $18.6 million for 2002, 2001 and 2000, respectively.
47
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
9. DEBT
As part of the consideration paid for REZ, the Company entered into a $20.0
million, 8 percent note payable to Reed Elsevier plc, the majority REZ
shareholder, which was due on April 3, 2002. On June 15, 2001, the Company
repaid the entire principal balance of $20.0 million, plus accrued interest of
$2.0 million.
In April 2000, the Company entered into a $30.0 million revolving credit
facility with Chase Bank of Texas, Compass Bank and Wells Fargo Bank (Texas).
Effective March 31, 2002, the Company amended and renewed its $30.0 million
revolving credit facility through March 31, 2004. The credit facility has an
interest rate based on Prime or LIBOR rates, as defined, adjusted upwards
depending on calculated financial ratios. Amounts available under the credit
facility are also subject to debt covenants, some of which are calculated using
the Company's financial position and results of operations. There was no amount
outstanding under the credit facility at December 31, 2002 or 2001.
The Company has entered into two irrevocable standby letter of credit
agreements with Chase Manhattan Bank totaling $2.6 million related to the leases
for its new Dallas and Scottsdale offices. The amount available under the $30.0
million credit facility is reduced by these letters of credit.
On January 14, 2003, the $2.6 million letter of credit with Chase Manhattan
Bank was reduced by approximately $0.5 million to $2.1 million.
10. STOCKHOLDERS' EQUITY
On August 9, 2000, the Board of Directors authorized the repurchase of up
to 2 million shares of the Company's common stock. During 2001, 196,000 shares
were repurchased for an aggregate purchase price of $2.1 million. On June 5,
2002, the Board of Directors authorized the repurchase of up to 2.5 million
shares of the Company's common stock. The repurchase is at the discretion of the
board of directors' Stock Repurchase Committee and may be made on the open
market, in privately negotiated transactions or otherwise, depending on market
conditions, price, share availability and other factors. During 2002, 404,000
shares were repurchased at an aggregate purchase price of $4.6 million. The
aggregate shares repurchased under Board approved plans through December 31,
2002 have been cancelled.
11. STOCK-BASED COMPENSATION
In accordance with the Company's 1996 stock option plan ("1996 Plan"),
amended and approved by stockholders in March 1997, options to purchase 1.3
million shares of the Company's common stock may be granted to Company
employees. In accordance with the Company's 1997 stock option plan ("1997
Plan"), approved by stockholders in March 1997, options to purchase shares of
the Company's common stock may be granted to Company employees, non-employee
directors and consultants. The 1997 Plan was amended and renamed the Pegasus
Solutions, Inc. 2002 Stock Incentive Plan (the "2002 Plan"). The 2002 Plan
provides that the number of shares, reserved for issuance as options or
restricted stock will be replenished by an amount equal to 4 percent of the
number of shares of Company stock, as defined, outstanding as of the last day of
the immediately preceding year. The applicable number of shares outstanding as
of December 31, 2002 was approximately 29.4 million. The 2002 Plan also
authorizes the grant of restricted stock each year, not to exceed 2.5 percent of
the number of shares reserved for issuance under the 2002 Plan.
In June 2002, the Compensation Committee of the Board of Directors granted
98,400 shares of restricted stock to certain executives and members of the Board
of Directors. Based on the market value of the Company's common stock, the
restricted stock grant was valued at $1.3 million. Compensation expense related
to the restricted stock grant is being recognized ratably over the one year
vesting period.
Options granted under the 1996 and 2002 Plans (collectively "the Plans")
may be in the form of incentive stock options or nonqualified stock options. The
Compensation Committee of the board of directors
48
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
("Committee") administers the Plans and determines grant prices. Options granted
to Company employees generally vest over a four-year period. Options granted to
non-employee directors and consultants vest and expire as determined by the
Committee. Options granted under the 1996 Plan before September 15, 1999 expire
in December 2005. Options granted to Company employees under the 2002 Plan
before September 15, 1999 expire in December 2006. Options granted to Company
employees on or after September 15, 1999 under the Plans expire ten years from
the date of grant. The Company's authorized but unissued common stock is used
for issuance of shares as stock options are exercised.
The following table summarizes activity under the Company's stock option
plans during the years ended December 31 (In thousands, except per share
amounts):
<Table>
<Caption>
NUMBER OF WEIGHTED AVERAGE EXERCISE
COMPANY OPTIONS PRICE PER SHARE
--------------------- ---------------------------
2002 2001 2000 2002 2001 2000
----- ----- ----- ------- ------- -------
Options outstanding at beginning of
year............................... 3,830 3,069 1,859 $12.23 $13.53 $10.71
Granted.............................. 1,027 1,601 1,586 13.70 10.30 16.89
Exercised............................ (293) (216) (110) 6.02 4.59 4.26
Canceled............................. (194) (624) (266) 16.39 16.05 17.69
----- ----- -----
Options outstanding at end of year... 4,370 3,830 3,069 12.88 12.30 13.53
===== ===== ===== ====== ====== ======
Options exercisable at end of year... 1,810 1,376 1,073 $12.57 $10.70 $ 6.99
===== ===== ===== ====== ====== ======
</Table>
The following table summarizes information for stock options outstanding at
December 31, 2002 (In thousands, except per share amounts):
<Table>
<Caption>
OPTIONS OUTSTANDING
----------------------------------------------- OPTIONS EXERCISABLE
WEIGHTED AVERAGE ----------------------------
NUMBER OF REMAINING WEIGHTED AVERAGE NUMBER OF WEIGHTED AVERAGE
EXERCISE PRICES OPTIONS CONTRACTUAL LIFE EXERCISE PRICE OPTIONS EXERCISE PRICE
- --------------- --------- ---------------- ---------------- --------- ----------------
$ 1.34............... 287 3.0 years $ 1.34 287 $ 1.34
$ 2.07............... 43 3.0 years 2.07 43 2.07
$ 6.33 - $ 8.93...... 1,031 7.5 years 7.74 456 7.27
$ 9.69 - $14.17...... 1,797 8.9 years 12.75 295 11.72
$17.81 - $25.42...... 1,173 7.1 years 20.26 697 20.95
$27.25 - $29.02...... 39 3.0 years 28.95 32 28.94
----- -----
$ 1.34 - $29.02...... 4,370 7.6 years $12.88 1,810 $12.57
===== =====
</Table>
On January 2, 2003, the Company issued options to purchase 730,000 shares
of the Company's common stock to its executive officers. The options vest
ratably over four years.
In May 1998, the Company's stockholders approved the Pegasus Solutions,
Inc. 1997 Employee Stock Purchase Plan ("Stock Plan"). The Company has reserved
750,000 shares of its common stock for purchase by 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 percent 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 percent 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,
49
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
whichever is lower. During 2002, 2001 and 2000, approximately 65,000, 48,000 and
72,000 shares were issued under the Stock Plan, respectively.
Effective January 1, 2003, the Company will also offer its employees the
ability to participate in the Stock Plan on a semi-annual basis under similar
terms as described above.
12. EMPLOYEE BENEFIT PLANS
DEFINED CONTRIBUTION PLANS
In the United States, the Company sponsors a 401(k) defined contribution
retirement plan ("401(k) Plan") covering full-time employees who have attained
the age of 21. The 401(k) Plan allows eligible employees to defer receipt of up
to 17 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 for employees' annual
contributions of up to 5 percent of employees' compensation. The Company's
matching contributions vest one-third a year for three years. After three years
of employment, an employee is fully vested in all matching contributions.
In the United Kingdom, the Company sponsors a defined contribution
retirement plan known as the Utell Limited Group Personal Pension Plan ("Utell
Defined Contribution Plan"). The Utell Defined Contribution Plan covers all
full-time employees not covered within the defined benefit plan described below,
regardless of length of service, as well as temporary employees after more than
three months service. Eligible employees can contribute up to 17.5 percent of
their basic salary to various investment funds. Eligible employees may elect to
participate at any time during their employment. The Company makes discretionary
matching contributions for employees' annual contributions of 6 percent of the
employee's basic salary when the employee contribution levels are 3 percent or
above, and 4 percent when employee contributions are 2 percent. The Company's
matching contributions vest immediately for employees.
During 2002, 2001 and 2000, the Company contributed $1.9 million, $1.8
million and $1.1 million, respectively, to the 401(k) Plan. During 2002, and
2001, the Company contributed approximately $228,000 and $182,000, respectively,
to the Utell Defined Contribution Plan. During the year-ended December 31, 2000,
REZ and the Company contributed a total of $152,000 to the Utell Defined
Contribution Plan.
During 2002, the Company adopted a Deferred Compensation Plan (the "DCP")
to provide supplemental retirement benefits to certain management employees of
the Company. The Company recorded approximately $114,000 of expenses related to
the DCP in 2002.
DEFINED BENEFIT PLANS
Pursuant to their employment agreements, certain Company officers are
eligible for additional retirement benefits to be paid by the Company under the
Supplemental Employee Retirement Plan ("SERP"). The SERP was effective January
1, 2000 and provides supplemental retirement benefits to certain officers of the
Company based on their compensation, as defined.
During 2002, the Board of Directors adopted an Executive Retirement
Program, consisting of an amended and restated SERP and DCP. The amendment to
the SERP, which reduced the Company's benefit obligation, was accounted for as a
negative plan amendment in accordance with FAS 87, "Employers' Accounting for
Pensions." Annually, commencing in 2003, the Company is obligated to make cash
payments to a trust associated with benefits earned under the Executive
Retirement Plan. The amounts funded to the trust may be available to creditors
of the Company, but are generally not available for use in the Company's ongoing
operations.
50
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In the United Kingdom, the Company operates a defined benefit plan, which
is only open to employees who were part of the Reed Elsevier Pension Scheme in
December 1997 (the "Utell Defined Benefit Plan"). The Utell Defined Benefit Plan
provides supplemental retirement benefits to its members, based on final average
compensation.
At December 31, 2002, the Company recorded additional minimum liabilities
applicable to the SERP and Utell Defined Benefit Plan of approximately $1.1
million and $1.5 million, respectively, for the excess of the plans' unfunded
accumulated benefit obligation over the plans' unfunded accrued pension cost.
Accordingly, a loss of $1.7 million, net of tax, was recorded in other
comprehensive loss in 2002.
For each defined benefit plan, the following tables provide a statement of
funded status as of December 31, 2002 and 2001, and summaries of the changes in
the benefit obligation and fair value of assets for the years then ended (In
thousands):
<Table>
<Caption>
UTELL DEFINED
SERP BENEFIT PLAN
----------------- -----------------
2002 2001 2002 2001
------- ------- ------- -------
Benefit obligation at beginning of year........ $ 4,314 $ 2,514 $ 8,837 $ 7,889
Service cost................................... 511 365 704 777
Interest cost.................................. 289 198 486 473
Plan participants' contributions............... -- -- 148 155
Amendments..................................... (2,069) -- -- --
Actuarial loss (gain).......................... 285 1,237 459 (457)
------- ------- ------- -------
Benefit obligation at end of year.............. $ 3,330 $ 4,314 10,634 $ 8,837
======= ======= ======= =======
Fair value of plan assets at beginning of
year......................................... $ -- $ -- $ 7,662 $ 8,063
Actual return on plan assets................... -- -- (961) (942)
Employer contribution.......................... -- -- 371 386
Plan participants' contributions............... -- -- 148 155
------- ------- ------- -------
Fair value of plan assets at end of year....... $ -- $ -- $ 7,220 $ 7,662
======= ======= ======= =======
Funded status.................................. $(3,330) $(4,314) $(3,414) $(1,175)
Unrecognized actuarial loss.................... 1,640 1,446 3,390 710
Unrecognized prior service cost................ (549) 1,619 -- --
Additional minimum pension liability........... (1,091) -- (1,511) --
------- ------- ------- -------
Net amount recognized.......................... $(3,330) $(1,249) $(1,535) $ (465)
======= ======= ======= =======
</Table>
The assumptions used in the measurement of the Company's benefit
obligations as of December 31, 2002 and 2001 are as follows:
<Table>
<Caption>
UTELL DEFINED
SERP BENEFIT PLAN
----------------- -------------
2002 2001 2002 2001
---------- ---- ----- -----
Discount rate...................................... 6.75%-7.25% 7.25% 5.5% 6.0%
Expected return on plan assets..................... N/A N/A 7.0% 7.5%
Rate of compensation increase...................... 5.0% 5.0% 3.8% 4.0%
</Table>
51
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table provides the components of net periodic benefit costs
for the years ended December 31, 2002 and 2001 (In thousands):
<Table>
<Caption>
UTELL DEFINED
SERP BENEFIT PLAN
----------- -------------
2002 2001 2002 2001
---- ---- ----- -----
Service cost........................................... $511 $365 $ 704 $ 777
Interest cost.......................................... 289 198 486 473
Expected return on plan assets......................... -- -- (575) (605)
Amortization of prior service cost..................... 99 136 -- --
Recognized net actuarial loss.......................... 91 15 24 --
---- ---- ----- -----
Net periodic benefit cost.............................. $990 $714 $ 639 $ 645
==== ==== ===== =====
</Table>
13. INCOME TAXES
Pretax loss from continuing operations for the years ended December 31 was
taxed under the following jurisdictions (In thousands):
<Table>
<Caption>
2002 2001 2000
-------- -------- --------
Domestic............................................. $(12,849) $(39,332) $(34,325)
Foreign.............................................. 7,215 649 1,825
-------- -------- --------
$ (5,634) $(38,683) $(32,500)
======== ======== ========
</Table>
Deferred taxes consisted of the following at December 31 (In thousands):
<Table>
<Caption>
2002 2001
------- --------
Deferred tax assets:
Net operating loss carryforward........................... $ 5,551 $ 14,357
Bad debt reserves......................................... 897 1,514
Additional minimum pension liability...................... 896 --
Income tax credits........................................ 628 828
Various expense accruals.................................. 440 412
Stock option compensation expense......................... 530 252
Other..................................................... 308 100
------- --------
Gross deferred tax assets.............................. 9,250 17,463
Valuation allowance.................................... (444) (50)
------- --------
Gross deferred tax assets, net of valuation
allowance............................................ 8,806 17,413
------- --------
Deferred tax liabilities:
Acquired intangible assets................................ (3,391) (22,825)
Depreciation and amortization............................. (4,118) (4,891)
------- --------
Gross deferred tax liabilities......................... (7,509) (27,716)
------- --------
Net deferred tax assets (liabilities)....................... $ 1,297 $(10,303)
======= ========
</Table>
In assessing the realizability of deferred tax assets, management considers
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon generation of future taxable income during the periods in which
those temporary
52
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
differences become deductible. Management considers the scheduled reversal of
deferred tax liabilities, projected future taxable income, and tax planning
strategies in making this assessment. The valuation allowance at December 31,
2002 and 2001 is related to various deferred tax assets established with the
acquisition of REZ. The valuation allowance, if released, will decrease
goodwill.
At December 31, 2002 and 2001, the Company had federal net operating loss
carryforwards of approximately $25 million and $35 million, respectively. United
Kingdom and other foreign net operating loss carryforwards for the respective
periods were $3.0 million and $2.0 million as of such dates. The federal net
operating loss carryforwards that existed at December 31, 2002 will begin to
expire in 2019. The foreign net operating loss carryforwards that existed at
December 31, 2002 will begin to expire in 2004. 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 Company has not provided for foreign withholding taxes or United States
deferred income taxes on accumulated undistributed earnings of foreign
subsidiaries, as management does not intend to repatriate such earnings. If such
earnings were to be repatriated, such earnings could be subject to foreign
withholding tax and United States residual tax.
The components of the income tax benefit for the years ended December 31
were as follows (In thousands):
<Table>
<Caption>
2002 2001 2000
------- ------- -------
Current provision:
Federal............................................... $ -- $ -- $ 3,185
State................................................. -- -- 90
Foreign............................................... 1,753 988 672
------- ------- -------
1,753 988 3,947
------- ------- -------
Deferred benefit:
Federal............................................... (3,944) (7,840) (8,249)
State................................................. (818) (1,481) (1,616)
Foreign............................................... 894 (613) --
------- ------- -------
(3,868) (9,934) (9,865)
------- ------- -------
Benefit for income taxes................................ $(2,115) $(8,946) $(5,918)
======= ======= =======
</Table>
A reconciliation of taxes based on the federal statutory rate and the
benefit for income taxes is summarized as follows for the years ended December
31:
<Table>
<Caption>
2002 2001 2000
----- ----- -----
Expected income tax benefit................................. (35.0)% (35.0)% (35.0)%
Non-deductible amortization of goodwill..................... -- 14.7% 12.9%
Write-off of purchased in-process research and
development............................................... -- -- 8.6%
Other permanent differences................................. 6.9% 0.2% (1.6)%
State income taxes.......................................... (9.4)% (2.5)% (3.1)%
Other, net.................................................. -- (0.5)% --
----- ----- -----
Benefit for income taxes.................................... (37.5)% (23.1)% (18.2)%
===== ===== =====
</Table>
53
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
14. COMMITMENTS AND CONTINGENCIES
The Company leases its corporate office space and certain office equipment
under non-cancelable lease agreements. The Company incurred rent expense of
approximately $9.3 million, $9.8 million and $8.6 million in 2002, 2001 and
2000, respectively.
Approximate future minimum lease payments, including landlord paid tenant
improvements, at December 31, 2002, under non-cancelable lease agreements with
original terms exceeding one year, were as follows (In thousands):
<Table>
<Caption>
FISCAL YEAR ENDED DECEMBER 31,
- ------------------------------
2003........................................................ $ 9,148
2004........................................................ 8,041
2005........................................................ 6,866
2006........................................................ 6,667
2007........................................................ 6,382
Thereafter.................................................. 28,113
-------
$65,217
=======
</Table>
Future minimum lease payments due in foreign currencies were translated at
the rate in effect at December 31, 2002.
Funds for travel agency commission checks that have not cleared the
Company's processing bank after certain time periods are returned to the
Company. Any amounts that are not remitted to travel agents will be escheated to
the appropriate states, as required by the respective unclaimed property laws.
Liabilities are recorded upon the Company's receipt of the funds from the bank,
and total $6.9 million and $6.2 million at December 31, 2002 and 2001,
respectively.
Pegasus is subject to certain legal proceedings, claims and disputes that
arise in the ordinary course of our business. Although management cannot predict
the outcomes of these legal proceedings, we do not believe these actions will
have a material adverse effect on our financial position, results of operations
or liquidity.
15. RELATED PARTIES
One Director of the Company serves as a senior vice president within
Marriott International, Inc. In 2002, 2001 and 2000, the Company received $3.7
million, $3.7 million and $3.1 million, respectively, from Marriott and its
affiliates for reservation services and Utell services. During the same years,
the Company paid Marriott $1.5 million, $1.8 million and $1.8 million,
respectively, for consolidating commission data and funds from its properties.
At December 31, 2002, receivables from Marriott were $237,000.
Another Director of the Company serves as a senior vice president within
Hyatt Hotels Corporation. In 2002, 2001 and 2000, the Company received $639,000,
$970,000 and $1.2 million, respectively, from Hyatt for reservation services and
financial services. At December 31, 2002, receivables from Hyatt were $119,000.
In conjunction with the formation of Travelweb, the Company contributed its
Internet site, Travelweb.com, to Travelweb, and invested $2.2 million in
Travelweb, including $1.8 million of cash and $361,000 of technology development
costs. During 2002, the Company received $1.5 million for technology development
and $336,000 for reservation services and financial services from Travelweb. The
Company's Chief Executive Officer serves on the Board of Directors of Travelweb.
54
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
16. SEGMENT INFORMATION
As set forth in the criteria of Statement of Financial Accounting Standards
No. 131, "Disclosures about Segments of an Enterprise and Related Information,"
the Company is organized into two reportable segments -- technology and
hospitality.
The technology segment provides CRS, electronic distribution, commission
processing and property systems services to the global hotel industry. The
hospitality segment provides hotel representation services offered under the
Utell brand name. Hotel representation services offered under the Summit Hotels
& Resorts and Sterling Hotels & Resorts brand names were sold in January 2001,
while the Golden Tulip brand was sold in June 2001.
The Company is organized primarily on the basis of services provided. Prior
period segment information has been reclassified to conform to the current
period presentation. Segment data includes an allocation of all corporate costs
to the operating segments. Management evaluates the performance of its segments
based on earnings before interest, income tax, depreciation and amortization
("EBITDA"). The Company believes that EBITDA, which is widely used by analysts
and investors, is an appropriate measure of operating performance. Nevertheless,
this measure should not be considered in isolation of, or as a substitute for,
operating income, cash flows from operating activities or any other measure for
determining the Company's operating performance or liquidity that is calculated
in accordance with generally accepted accounting principles. In addition, the
Company's calculation of EBITDA is not necessarily comparable to similarly
titled measures reported by other companies.
The following table presents information about reported segments at and for
the years ending December 31 (In thousands):
<Table>
<Caption>
RECONCILING
TECHNOLOGY HOSPITALITY ITEMS TOTAL
---------- ----------- ----------- --------
2002
Total revenues............................ $120,427 $69,523 $ -- $189,950
EBITDA.................................... 27,677 13,410 -- 41,087
2001
Total revenues............................ 112,920 79,827 -- 192,747
EBITDA.................................... 18,233 1,149 -- 19,382
2000
Total revenues............................ 89,925 82,726 -- 172,651
EBITDA.................................... 14,338 10,884 (101) 25,121
</Table>
55
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Reconciling items for 2000 include acquisition costs that did not meet the
criteria for capitalization and certain bank charges. A reconciliation of total
segment EBITDA to total consolidated loss before income taxes for the years
ended December 31 is as follows (In thousands):
<Table>
<Caption>
2002 2001 2000
-------- -------- --------
Total EBITDA for reportable segments................. $ 41,087 $ 19,382 $ 25,121
Write-off of purchased in-process research and
development........................................ -- -- (8,000)
Equity in loss of investee........................... -- (634) --
Gain on sales of business units...................... -- 5,538 --
Depreciation and amortization........................ (48,075) (65,651) (51,549)
Interest income...................................... 1,277 1,655 3,464
Interest expense..................................... (53) (887) (1,687)
Other................................................ 130 1,914 151
-------- -------- --------
Consolidated loss before income taxes................ $ (5,634) $(38,683) $(32,500)
======== ======== ========
</Table>
The following table presents revenue by geographic location for the years
ended December 31, 2002, 2001 and 2000 (In thousands):
<Table>
<Caption>
2002 2001 2000
-------- -------- --------
Domestic............................................. $113,759 $112,479 $106,493
International........................................ 76,191 80,268 66,158
-------- -------- --------
Total revenue........................................ $189,950 $192,747 $172,651
======== ======== ========
</Table>
56
PEGASUS SOLUTIONS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
17. QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
The following table summarizes the consolidated quarterly results of
operations for 2002 and 2001 (In thousands):
<Table>
<Caption>
QUARTERS ENDED
-----------------------------------------------
MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31
-------- ------- ------------ -----------
2002
Service revenues........................ $ 45,907 $45,584 $ 46,614 $40,664
Customer reimbursements................. 2,803 3,042 2,556 2,780
-------- ------- -------- -------
Total Revenues........................ 48,710 48,626 49,170 43,444
Income (loss) before provision for
income taxes.......................... (1,334) (3,203) 1,366 (2,463)
Net Income (loss)....................... (801) (1,918) 672 (1,472)
Basic and diluted net income (loss) per
share................................. (0.03) (0.08) 0.03 (0.06)
Basic weighted average shares
outstanding........................... 24,732 24,837 24,880 24,822
Diluted weighted average shares
outstanding........................... 24,732 24,837 24,642 24,822
2001
Service revenues........................ 46,108 49,768 45,599 39,193
Customer reimbursements................. 2,800 3,174 3,282 2,823
-------- ------- -------- -------
Total Revenues........................ 48,908 52,942 48,881 42,016
Loss before provision for income
taxes................................. (13,244) (5,837) (14,687) (4,915)
Net loss................................ (11,083) (4,467) (10,851) (3,336)
Basic and diluted net loss per share.... (0.45) (0.18) (0.44) (0.14)
Basic and diluted weighted average
shares outstanding.................... 24,596 24,490 24,567 24,632
</Table>
Revenues for 2002 and 2001 have been reclassified to conform to the current
year presentation and to give effect to the adoption of EITF 01-14 (see Note 1).
In accordance with FAS 128, earnings per share are computed independently for
each of the quarters presented; therefore, the sum of the quarterly earnings per
share may not equal the annual earnings per share.
57
ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE
None.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item appears in our definitive proxy
statement for our 2003 annual meeting of Stockholders under the captions
"Nominees for Directors," "Directors Continuing in Office" and "Executive
Officers," which information is incorporated herein by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item appears in our definitive proxy
statement for our 2003 annual meeting of stockholders under the caption "Named
Executive Officers' Compensation," which information is incorporated herein by
reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by this item appears in our definitive proxy
statement for our 2003 annual meeting of stockholders under the caption
"Directors' and Officers' Ownership of Our Common Stock," which information is
incorporated herein by reference.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item appears in our definitive proxy
statement for our 2003 annual meeting of stockholders under the caption "Certain
Transactions," which information is incorporated herein by reference.
ITEM 14. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures designed to ensure
that it is able to collect the information it is required to disclose in the
reports it files with the SEC, and to process, summarize and disclose this
information within the time periods specified in the rules of the SEC. Within
the 90 days prior to the filing of this report, Pegasus carried out an
evaluation, under the supervision and with the participation of Pegasus'
management, including its Chief Executive Officer and Chief Financial Officer,
of the effectiveness of Pegasus' disclosure controls and procedures. Based upon
that evaluation, Pegasus' Chief Executive Officer and Chief Financial Officer
concluded that Pegasus' disclosure controls and procedures, as defined in Rules
13(a)-14(c) and 15(d)-14(c) under the Securities Exchange Act of 1934, are
effective in timely alerting them to material information required to be
included in Pegasus' periodic SEC reports.
In designing and evaluating the disclosure controls and procedures,
management recognized that any controls and procedures, no matter how well
designed and operated, can provide only reasonable assurance of achieving the
desired control objectives, and management necessarily was required to apply its
judgment in evaluating the cost-benefit relationship of possible controls and
procedures.
The Company maintains a system of internal controls designed to provide
reasonable assurance that transactions are executed in accordance with
management's general or specific authorization and that transactions are
recorded as necessary:
- to permit preparation of financial statements in conformity with
generally accepted accounting principles, and
- to maintain accountability for assets.
58
Since the date of the most recent evaluation of the Company's internal
controls by the Chief Executive and Chief Financial Officers, there have been no
significant changes in such controls or in other factors that could have
significantly affected those controls, including any corrective actions with
regard to significant deficiencies and material weaknesses.
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)1. The following Financial Statement Schedule is filed as part of this annual
report:
<Table>
Report of Independent Accountants on Financial Statement
Schedule.................................................. Page S-1
Consolidated Valuation and Qualifying Accounts.............. Page S-2
</Table>
All other schedules for which provision is made in the applicable
accounting regulations of the Securities and Exchanges Commission are
not required under the related instructions or are inapplicable and
therefore have been omitted.
2. The following documents are filed or incorporated by reference as exhibits
to this annual report:
<Table>
<Caption>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
2.1 Agreement and Plan of Merger dated November 16, 1999, as
amended and restated, among the Company, Pegasus Worldwide,
Inc., Rez, Inc., Reed Elsevier, Inc. and Utell International
Group, LTD. (incorporated by reference from Appendix A of
the Company's Registration Statement (File No. 333-92683) on
Form S-4 filed on December 14, 1999)
3.1 Fourth Amended and Restated Certificate of Incorporation
(incorporated by reference from Exhibit 3.1 of the Company's
Form 10-Q filed with the Commission on May 15, 2000)
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 the Company's
Form 8-A filed with the Commission on October 9, 1998)
4.1 Specimen of Common Stock certificate
4.2 Fourth Amended and Restated Certificate of Incorporation
(See Exhibit 3.1) Second Amended and Restated Bylaws (See
Exhibit 3.2)
4.3 Rights Agreement dated June 25, 1996 by and among the
Company and certain holders of capital stock of the Company
named therein
4.4 Rights Agreement dated as of September 28, 1998 by and
between the Company and American Securities Transfer &
Trust, Inc. (incorporated by reference from Exhibit 4 of the
Company's Current Report on Form 8-K filed with the
Commission on October 9, 1998)
4.5 Form of Rights Certificate (incorporated by reference from
Exhibit 3 of the Company's Form 8-A filed with Commission on
October 9, 1998)
*10.1 Employment Agreement dated August 1, 2001 between the
Company and John F. Davis III (incorporated by reference
from Exhibit 10.1 of the Company's Form 10-Q filed with the
Commission on May 1, 2002)
*10.2 Employment Agreement dated August 1, 2001 between the
Company and Joseph W. Nicholson (incorporated by reference
from Exhibit 10.2 of the Company's Form 10-Q filed with the
Commission on May 1, 2002)
*10.3 Employment Agreement dated August 1, 2001 between the
Company and Susan K. Cole (incorporated by reference from
Exhibit 10.4 of the Company's Form 10-Q filed with the
Commission on May 1, 2002)
*10.4 Employment Agreement dated August 1, 2001 between the
Company and Ric L. Floyd (incorporated by reference from
Exhibit 10.17 of the Company's Form 10-Q filed with the
Commission on May 1, 2002)
</Table>
59
<Table>
<Caption>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
*10.5 Employment Agreement dated August 1, 2001 between the
Company and Mark C. Wells (incorporated by reference from
Exhibit 10.18 of the Company's Form 10-Q filed with the
Commission on May 1, 2002)
+*10.6 Employment Agreement dated December 1, 2002 between the
Company and John F. Davis, III
+*10.7 Employment Agreement dated December 1, 2002 between the
Company and Susan K. Cole
+*10.8 Employment Agreement dated December 1, 2002 between the
Company and Ric L. Floyd
+*10.9 Employment Agreement dated December 1, 2002 between the
Company and Mark C. Wells
+*10.10 Employment Agreement dated December 1, 2002 between the
Company and Gary Siegel
*10.11 1996 Stock Option Plan, as amended
*10.12 2002 Amended Stock Option Plan, (incorporated by reference
from the Company's definitive proxy statement filed with the
Commission on March 21, 2002)
*10.13 1997 Employee Stock Purchase Plan, as amended
+*10.14 Amended and Restated Supplemental Executive Retirement Plan
+*10.15 Executive Deferred Compensation Plan
+*10.16 Deferred Compensation Trust Agreement dated February 28,
2003 between the Company and Charles Schwab Trust Company
10.17 Amended and Restated Credit Agreement dated August 31, 2001,
among the Company, Chase Bank of Texas, N.A., Compass Bank
and Wells Fargo (incorporated by reference from Exhibit
10.12 of the Company's Form 10-Q filed with the Commission
on May 1, 2002)
10.18 1st Amendment to the Amended and Restated Credit Agreement
with Chase Bank of Texas, Compass Bank and Wells Fargo Bank
(Texas), dated March 31, 2002 (incorporated by reference
from Exhibit 10.24 of the Company's Form 10-Q filed with the
Commission on May 1, 2002)
10.19 Form of Security Agreement dated April 17, 2000, among the
Company, Chase Bank of Texas, N.A. and certain guarantors
(incorporated by reference from Exhibit 10.15 of the
Company's Form 10-Q filed with the Commission on May 15,
2000)
10.20 Purchase Agreement dated October 31, 2000, among the
Company, Global Enterprise Technology Solutions, LLC,
Enterprise Hospitality Solutions, Inc., The Rivadalla Family
Trust and Christian Rivadalla (incorporated by reference
from Exhibit 10.16 of the Company's Form 10-Q filed with
Commission on November 14, 2000)
10.21 Office Lease dated January 31, 1997, First Amendment to
Office Lease dated August 7, 1997, Second Amendment to
Office Lease dated November 1, 1997 and Third Amendment to
Office Lease dated November 2, 1999 between the Company and
EastGroup Properties relating to property located at 11048
N. 23rd Avenue, Phoenix, Arizona 85029 (incorporated by
reference from Exhibit 10.18 of the Company's Form 10-K
filed with the Commission on March 22, 2001)
10.22 Office Lease dated September 1, 1987 and First Amendment to
Office Lease dated October 26, 1989 between the Company and
Bridger Properties relating to property located at 2 Kew
Bridge Road, Brentford Middlesex (incorporated by reference
from Exhibit 10.19 of the Company's Form 10-K filed with the
Commission on March 22, 2001)
10.23 Office lease dated September 17, 2001 between the Company
and Dallas RPFIV Campbell Centre Associates Limited
Partnership relating to property located at 8350 North
Central Expressway, Dallas, Texas 75206 (incorporated by
reference from 10.23 of the Company's Form 10-Q filed with
the Commission on November 15, 2001)
10.24 Office lease dated September 14, 2001 between the Company
and Ryan Companies US, Inc. relating to property located at
1400 North Pima Road, Scottsdale, Arizona 85260
(incorporated by reference from 10.23 of the Company's Form
10-Q filed with the Commission on November 15, 2001)
10.25 Form of Promissory Note agreement dated November 9, 2001
between the Company and IndeCorp Corporation (incorporated
by reference from 10.23 of the Company's Form 10-Q filed
with the Commission on November 15, 2001)
</Table>
60
<Table>
<Caption>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.26 Form of Promissory Note agreement dated November 9, 2001
between the Company and IndeCorp Corporation (incorporated
by reference from 10.23 of the Company's Form 10-Q filed
with the Commission on November 15, 2001)
+21.1 Subsidiaries of the Company
+23.1 Consent of PricewaterhouseCoopers LLP
+24.1 Power of Attorney (included on signature page)
+99.1 Certification of Chief Executive Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act 2002.
+99.2 Certification of Chief Financial Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act 2002.
</Table>
Unless otherwise indicated, exhibits are incorporated by reference to the
Company's Registration Statement (File No. 333-28595) on Form S-1 declared
effective by the Commission on August 6, 1997.
- ---------------
+ Filed herewith.
* Management contract or compensatory plan or arrangement -- The Company will
furnish a copy of any exhibit listed above to any stockholder without charge
upon written request to Mr. Ric Floyd, Executive Vice President and General
Counsel, Campbell Centre I, Suite 1900, 8350 North Central Expressway, Dallas,
Texas 75206.
(b) Reports on Form 8-K
There were no reports on Form 8-K that were filed during the quarter ended
December 31, 2002.
ITEM 16.
The information required by this item appears in our definitive proxy
statement for our 2003 annual meeting of stockholders under the caption
"Independent Accountants," which information is incorporated herein by
reference.
61
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this annual report on Form
10-K to be signed on its behalf by the undersigned, thereunto duly authorized,
in the City of Dallas, State of Texas, on this 17th day of March, 2003.
PEGASUS SOLUTIONS, INC.
By: /s/ JOHN F. DAVIS, III
------------------------------------
John F. Davis, III
Chief Executive Officer and Chairman
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed by the following persons in the capacities and on the
dates indicated.
POWER OF ATTORNEY
KNOW ALL MEN AND WOMEN BY THESE PRESENTS that each person whose signature
appears below constitutes and appoints John F. Davis, III, Susan K. Cole and Ric
L. Floyd, and each of them, such individual's true and lawful attorneys-in-fact
and agents, with full power of substitution and resubstitution, for such
individual and in his or her name, place and stead, in any and all capacities,
to sign any and all amendments to this annual report on Form 10-K, with all
exhibits thereto, and to file the same with all exhibits thereto, and all
documents in connection therewith, with the Securities and Exchange Commission,
granting unto said attorneys-in-fact and agents, and each of them, full power
and authority to do and perform each and every act and thing requisite and
necessary to be done in and about the premises as fully and to intents and
purposes as he might or could do in person hereby ratifying and confirming all
that said attorneys-in-fact and agents, or any of them, or their substitute or
substitutes, may lawfully do or cause to be done by virtue hereof.
<Table>
<Caption>
SIGNATURES TITLE DATE
---------- ----- ----
/s/ JOHN F. DAVIS, III Chief Executive Officer and March 17, 2003
------------------------------------------------ Chairman (Principal Executive
John F. Davis, III Officer)
/s/ SUSAN K. COLE Executive Vice President and Chief March 17, 2003
------------------------------------------------ Financial Officer (Principal
Susan K. Cole Financial and Accounting Officer)
/s/ WILLIAM C. HAMMETT, JR. Vice Chairman and Director March 17, 2003
------------------------------------------------
William C. Hammett, Jr.
/s/ MICHAEL A. BARNETT Director March 17, 2003
------------------------------------------------
Michael A. Barnett
/s/ ROBERT B. COLLIER Director March 17, 2003
------------------------------------------------
Robert B. Collier
/s/ THOMAS F. O'TOOLE Director March 17, 2003
------------------------------------------------
Thomas F. O'Toole
/s/ PAMELA H. PATSLEY Director March 17, 2003
------------------------------------------------
Pamela H. Patsley
/s/ JEFFREY A. RICH Director March 17, 2003
------------------------------------------------
Jeffrey A. Rich
/s/ BRUCE W. WOLFF Director March 17, 2003
------------------------------------------------
Bruce W. Wolff
</Table>
62
CERTIFICATIONS PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, John F. Davis, III, certify that:
1. I have reviewed this annual report on Form 10-K of Pegasus Solutions,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and
(c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
/s/ JOHN F. DAVIS, III
--------------------------------------
John F. Davis, III
Chairman and Chief Executive Officer
Date: March 17, 2003
63
CERTIFICATIONS PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, Susan K. Cole, certify that:
1. I have reviewed this annual report on Form 10-K of Pegasus Solutions,
Inc.;
2. Based on my knowledge, this annual report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements made, in light of the circumstances under which such statements
were made, not misleading with respect to the period covered by this annual
report;
3. Based on my knowledge, the financial statements, and other financial
information included in this annual report, fairly present in all material
respects the financial condition, results of operations and cash flows of the
registrant as of, and for, the periods presented in this annual report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined in
Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
(a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its consolidated
subsidiaries, is made known to us by others within those entities,
particularly during the period in which this annual report is being
prepared;
(b) Evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the filing
date of this annual report (the "Evaluation Date"); and
(c) Presented in this annual report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit committee
of registrant's board of directors (or persons performing the equivalent
function):
(a) All significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have identified
for the registrant's auditors any material weaknesses in internal controls;
and
(b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
annual report whether or not there were significant changes in internal controls
or in other factors that could significantly affect internal controls subsequent
to the date of our most recent evaluation, including any corrective actions with
regard to significant deficiencies and material weaknesses.
/s/ SUSAN K. COLE
--------------------------------------
Susan K. Cole
Executive Vice President and Chief
Financial Officer
Date: March 17, 2003
64
REPORT OF INDEPENDENT ACCOUNTANTS ON
FINANCIAL STATEMENT SCHEDULE
To the Board of Directors and Stockholders
of Pegasus Solutions, Inc.:
Our audits of the consolidated financial statements referred to in our
report dated February 4, 2003 appearing in this Annual Report on Form 10-K, also
included an audit of the financial statement schedule listed in Item 15(a)(1) of
this Form 10-K. In our opinion, this financial statement schedule presents
fairly, in all material respects, the information set forth therein when read in
conjunction with the related consolidated financial statements.
PricewaterhouseCoopers LLP
Dallas, Texas
February 4, 2003
S-1
SCHEDULE II
PEGASUS SOLUTIONS, INC.
VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 2000, 2001 AND 2002 (IN THOUSANDS)
<Table>
<Caption>
ADDITIONS ADDITIONS ADDITIONS
BALANCE AT CHARGED TO CHARGED FROM BALANCE AT
BEGINNING COSTS AND TO OTHER ACQUIRED END OF
CLASSIFICATION OF PERIOD EXPENSES ACCOUNTS COMPANIES DEDUCTIONS PERIOD
- -------------- ---------- ---------- --------- --------- ---------- ----------
December 31, 2000
Allowance for doubtful
accounts.................. $ 82 $2,874 $ -- $11,924 $(7,721) $7,159
Income tax valuation
allowance................. -- -- -- 50 -- 50
------ ------ ---- ------- ------- ------
Total reserves and
allowances................ 82 2,874 -- 11,974 (7,721) 7,209
December 31, 2001
Allowance for doubtful
accounts.................. 7,159 3,408 -- 214 (4,991) 5,790
Income tax valuation
allowance................. 50 -- -- -- -- 50
------ ------ ---- ------- ------- ------
Total reserves and
allowances................ 7,209 3,408 -- 214 (4,991) 5,840
December 31, 2002
Allowance for doubtful
accounts.................. 5,790 1,289 -- -- (3,440) 3,639
Income tax valuation
allowance................. 50 -- 394 -- -- 444
------ ------ ---- ------- ------- ------
Total reserves and
allowances................ $5,840 $1,289 $394 $ -- $(3,440) $4,083
====== ====== ==== ======= ======= ======
</Table>
- ---------------
(a) This schedule should be read in conjunction with the Company's audited
consolidated financial statements and related notes thereto that appear in
Item 8 of this annual report on Form 10-K.
S-2
EXHIBIT INDEX
<Table>
<Caption>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
2.1 Agreement and Plan of Merger dated November 16, 1999, as
amended and restated, among the Company, Pegasus Worldwide,
Inc., Rez, Inc., Reed Elsevier, Inc. and Utell International
Group, LTD. (incorporated by reference from Appendix A of
the Company's Registration Statement (File No. 333-92683) on
Form S-4 filed on December 14, 1999)
3.1 Fourth Amended and Restated Certificate of Incorporation
(incorporated by reference from Exhibit 3.1 of the Company's
Form 10-Q filed with the Commission on May 15, 2000)
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 the Company's
Form 8-A filed with the Commission on October 9, 1998)
4.1 Specimen of Common Stock certificate
4.2 Fourth Amended and Restated Certificate of Incorporation
(See Exhibit 3.1) Second Amended and Restated Bylaws (See
Exhibit 3.2)
4.3 Rights Agreement dated June 25, 1996 by and among the
Company and certain holders of capital stock of the Company
named therein
4.4 Rights Agreement dated as of September 28, 1998 by and
between the Company and American Securities Transfer &
Trust, Inc. (incorporated by reference from Exhibit 4 of the
Company's Current Report on Form 8-K filed with the
Commission on October 9, 1998)
4.5 Form of Rights Certificate (incorporated by reference from
Exhibit 3 of the Company's Form 8-A filed with Commission on
October 9, 1998)
*10.1 Employment Agreement dated August 1, 2001 between the
Company and John F. Davis III (incorporated by reference
from Exhibit 10.1 of the Company's Form 10-Q filed with the
Commission on May 1, 2002)
*10.2 Employment Agreement dated August 1, 2001 between the
Company and Joseph W. Nicholson (incorporated by reference
from Exhibit 10.2 of the Company's Form 10-Q filed with the
Commission on May 1, 2002)
*10.3 Employment Agreement dated August 1, 2001 between the
Company and Susan K. Cole (incorporated by reference from
Exhibit 10.4 of the Company's Form 10-Q filed with the
Commission on May 1, 2002)
*10.4 Employment Agreement dated August 1, 2001 between the
Company and Ric L. Floyd (incorporated by reference from
Exhibit 10.17 of the Company's Form 10-Q filed with the
Commission on May 1, 2002)
*10.5 Employment Agreement dated August 1, 2001 between the
Company and Mark C. Wells (incorporated by reference from
Exhibit 10.18 of the Company's Form 10-Q filed with the
Commission on May 1, 2002)
+*10.6 Employment Agreement dated December 1, 2002 between the
Company and John F. Davis, III
+*10.7 Employment Agreement dated December 1, 2002 between the
Company and Susan K. Cole
+*10.8 Employment Agreement dated December 1, 2002 between the
Company and Ric L. Floyd
+*10.9 Employment Agreement dated December 1, 2002 between the
Company and Mark C. Wells
+*10.10 Employment Agreement dated December 1, 2002 between the
Company and Gary Siegel
*10.11 1996 Stock Option Plan, as amended
*10.12 2002 Amended Stock Option Plan, (incorporated by reference
from the Company's definitive proxy statement filed with the
Commission on March 21, 2002)
*10.13 1997 Employee Stock Purchase Plan, as amended
+*10.14 Amended and Restated Supplemental Executive Retirement Plan
+*10.15 Executive Deferred Compensation Plan
+*10.16 Deferred Compensation Trust Agreement dated February 28,
2003 between the Company and Charles Schwab Trust Company
</Table>
<Table>
<Caption>
EXHIBIT NO. DESCRIPTION
- ----------- -----------
10.17 Amended and Restated Credit Agreement dated August 31, 2001,
among the Company, Chase Bank of Texas, N.A., Compass Bank
and Wells Fargo (incorporated by reference from Exhibit
10.12 of the Company's Form 10-Q filed with the Commission
on May 1, 2002)
10.18 1st Amendment to the Amended and Restated Credit Agreement
with Chase Bank of Texas, Compass Bank and Wells Fargo Bank
(Texas), dated March 31, 2002 (incorporated by reference
from Exhibit 10.24 of the Company's Form 10-Q filed with the
Commission on May 1, 2002)
10.19 Form of Security Agreement dated April 17, 2000, among the
Company, Chase Bank of Texas, N.A. and certain guarantors
(incorporated by reference from Exhibit 10.15 of the
Company's Form 10-Q filed with the Commission on May 15,
2000)
10.20 Purchase Agreement dated October 31, 2000, among the
Company, Global Enterprise Technology Solutions, LLC,
Enterprise Hospitality Solutions, Inc., The Rivadalla Family
Trust and Christian Rivadalla (incorporated by reference
from Exhibit 10.16 of the Company's Form 10-Q filed with
Commission on November 14, 2000)
10.21 Office Lease dated January 31, 1997, First Amendment to
Office Lease dated August 7, 1997, Second Amendment to
Office Lease dated November 1, 1997 and Third Amendment to
Office Lease dated November 2, 1999 between the Company and
EastGroup Properties relating to property located at 11048
N. 23rd Avenue, Phoenix, Arizona 85029 (incorporated by
reference from Exhibit 10.18 of the Company's Form 10-K
filed with the Commission on March 22, 2001)
10.22 Office Lease dated September 1, 1987 and First Amendment to
Office Lease dated October 26, 1989 between the Company and
Bridger Properties relating to property located at 2 Kew
Bridge Road, Brentford Middlesex (incorporated by reference
from Exhibit 10.19 of the Company's Form 10-K filed with the
Commission on March 22, 2001)
10.23 Office lease dated September 17, 2001 between the Company
and Dallas RPFIV Campbell Centre Associates Limited
Partnership relating to property located at 8350 North
Central Expressway, Dallas, Texas 75206 (incorporated by
reference from 10.23 of the Company's Form 10-Q filed with
the Commission on November 15, 2001)
10.24 Office lease dated September 14, 2001 between the Company
and Ryan Companies US, Inc. relating to property located at
1400 North Pima Road, Scottsdale, Arizona 85260
(incorporated by reference from 10.23 of the Company's Form
10-Q filed with the Commission on November 15, 2001)
10.25 Form of Promissory Note agreement dated November 9, 2001
between the Company and IndeCorp Corporation (incorporated
by reference from 10.23 of the Company's Form 10-Q filed
with the Commission on November 15, 2001)
10.26 Form of Promissory Note agreement dated November 9, 2001
between the Company and IndeCorp Corporation (incorporated
by reference from 10.23 of the Company's Form 10-Q filed
with the Commission on November 15, 2001)
+21.1 Subsidiaries of the Company
+23.1 Consent of PricewaterhouseCoopers LLP
+24.1 Power of Attorney (included on signature page)
+99.1 Certification of Chief Executive Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act 2002.
+99.2 Certification of Chief Financial Officer, pursuant to 18
U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act 2002.
</Table>
Unless otherwise indicated, exhibits are incorporated by reference to the
Company's Registration Statement (File No. 333-28595) on Form S-1 declared
effective by the Commission on August 6, 1997.
- ---------------
+ Filed herewith.
* Management contract or compensatory plan or arrangement -- The Company will
furnish a copy of any exhibit listed above to any stockholder without charge
upon written request to Mr. Ric Floyd, Executive Vice President and General
Counsel, Campbell Centre I, Suite 1900, 8350 North Central Expressway, Dallas,
Texas 75206.