UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_______________
FORM 10-Q
(Mark one)
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2005
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ___ TO ___
____________________
Commission File Number 0-22935
PEGASUS SOLUTIONS, INC.
(Exact Name of Registrant as specified in its charter)
DELAWARE 75-2605174
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
CAMPBELL CENTRE I, 8350 NORTH CENTRAL EXPRESSWAY, SUITE 1900, DALLAS, TEXAS
75206
(Address of principal executive office)
(Zip Code)
Registrant's telephone number, including area code: (214) 234-4000
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 whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
Yes X No
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
Yes No X
The number of shares of the registrant's common stock, par value $0.01 per
share, outstanding as of
November 1, 2005 was 20,766,199.
PEGASUS SOLUTIONS, INC.
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2005
INDEX
Page
----
Part I. Financial Information
Item 1. Financial Statements (Unaudited) 3
a) Condensed Consolidated Balance Sheets
as of September 30, 2005 and December 31, 2004 3
b) Condensed Consolidated Statements of Operations
and Comprehensive Income (Loss) for the three and
nine months ended September 30, 2005 and 2004 4
c) Condensed Consolidated Statements of Cash Flows
for the nine months ended September 30, 2005 and 2004 5
d) Notes to Condensed Consolidated Financial Statements 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations 12
Item 4. Controls and Procedures 20
Part II. Other Information
Item 1. Legal Proceedings 20
Item 6. Exhibits 20
Signatures 21
2
Part I. Financial Information
Item 1. Financial Statements (Unaudited)
PEGASUS SOLUTIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT FOR SHARE AMOUNTS)
(UNAUDITED)
September 30, December 31,
2005 2004
--------- ---------
ASSETS
Cash and cash equivalents $ 27,175 $ 17,599
Auction rate securities 3,000 5,650
Short-term investments - 6,001
Accounts receivable, net 27,402 28,551
Other current assets 8,292 9,061
--------- ---------
Total current assets 65,869 66,862
Goodwill 163,585 163,585
Intangible assets, net 4,667 5,827
Property and equipment, net 61,185 80,326
Other noncurrent assets 17,919 12,614
--------- ---------
Total assets $313,225 $329,214
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Accounts payable and accrued liabilities $ 28,411 $ 29,531
Unearned revenue 6,926 6,763
Other current liabilities 6,809 5,621
--------- ---------
Total current liabilities 42,146 41,915
Noncurrent uncleared commission checks 5,387 5,576
Other noncurrent liabilities 16,228 19,407
Convertible debt 75,000 75,000
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; 20,765,199 and 21,105,815 shares issued
and outstanding, respectively 208 211
Additional paid-in capital 237,570 242,112
Unearned compensation (339) (408)
Accumulated other comprehensive loss (930) (995)
Accumulated deficit (62,045) (53,604)
--------- ---------
Total stockholders' equity 174,464 187,316
--------- ---------
Total liabilities and stockholders' equity $313,225 $329,214
========= =========
See accompanying notes to condensed consolidated financial statements.
3
PEGASUS SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF
OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
(UNAUDITED)
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2005 2004 2005 2004
-------- -------- --------- ---------
Revenues:
Service revenues $41,278 $44,470 $120,883 $129,419
Customer reimbursements 4,397 3,929 13,111 11,549
-------- -------- --------- ---------
Total revenues 45,675 48,399 133,994 140,968
Costs of services:
Cost of services (exclusive of
depreciation and amortization shown
separately below) 20,822 21,422 62,930 66,229
Customer reimbursements 4,397 3,929 13,111 11,549
-------- -------- --------- ---------
Total costs of services 25,219 25,351 76,041 77,778
Research and development 879 676 2,462 3,039
General and administrative expenses 5,775 5,797 17,721 18,223
Marketing and promotion expenses 4,860 4,815 15,809 14,509
Depreciation and amortization 4,955 4,156 13,890 13,447
-------- -------- --------- ---------
Operating income 3,987 7,604 8,071 13,972
Other income (expense):
Gain on sale of Travelweb, LLC - - - 1,961
Interest expense, net (323) (498) (1,050) (1,523)
Other 129 159 268 (134)
-------- -------- --------- ---------
Income from continuing operations
before income taxes 3,793 7,265 7,289 14,276
Income tax expense (1,361) (2,383) (2,647) (5,073)
-------- -------- --------- ---------
Income from continuing operations 2,432 4,882 4,642 9,203
Discontinued operations, net of tax (226) (1,096) (13,083) (2,993)
-------- -------- --------- ---------
Net income (loss) $ 2,206 $ 3,786 $ (8,441) $ 6,210
======== ======== ========= =========
Other comprehensive income (loss):
Change in unrealized gain (loss) on
investments, net of tax 24 8 65 (4)
-------- -------- --------- ---------
Comprehensive income (loss) $ 2,230 $ 3,794 $ (8,376) $ 6,206
======== ======== ========= =========
Basic income (loss) per common share:
Continuing operations $ 0.12 $ 0.22 $ 0.22 $ 0.39
Discontinued operations $ (0.01) $ (0.05) $ (0.63) $ (0.12)
-------- -------- --------- ---------
Net income (loss) $ 0.11 $ 0.17 $ (0.41) $ 0.27
======== ======== ========= =========
Diluted income (loss) per common share:
Continuing operations $ 0.12 $ 0.20 $ 0.22 $ 0.39
Discontinued operations $ (0.01) $ (0.04) $ (0.62) $ (0.11)
-------- -------- --------- ---------
Net income (loss) $ 0.11 $ 0.16 $ (0.40) $ 0.28
======== ======== ========= =========
Weighted average shares outstanding:
Basic 20,758 22,131 20,743 23,355
======== ======== ========= =========
Diluted 20,941 26,224 20,973 27,406
======== ======== ========= =========
See accompanying notes to condensed consolidated financial statements.
4
PEGASUS SOLUTIONS, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
(UNAUDITED)
Nine Months Ended
September 30,
-------------
2005 2004
-------- ---------
Cash flows from operating activities:
Net income (loss) $(8,441) $ 6,210
Adjustments to reconcile net loss to net cash provided by
operating activities:
Depreciation and amortization 16,407 17,077
Non-cash asset impairment discontinued operations 16,630 -
Gain on sale of Travelweb, LLC - (1,961)
Deferred income taxes (6,696) 1,185
Other 973 2,016
Changes in assets and liabilities:
Accounts receivable 583 (7,292)
Other current and noncurrent assets 164 (1,028)
Accounts payable and accrued liabilities 288 3,868
Unearned revenue 853 (83)
Other current and noncurrent liabilities 405 (362)
Landlord paid tenant improvements - 799
-------- ---------
Net cash provided by operating activities 21,166 20,429
Cash flows from investing activities:
Proceeds from sale of Travelweb, LLC - 4,167
Proceeds from maturity of marketable securities, including
auction rate securities 25,458 43,439
Purchase of marketable securities, including
auction rate securities (15,652) (23,915)
Purchase of property and equipment (17,317) (15,036)
Other 753 742
Landlord paid tenant improvements - (799)
-------- ---------
Net cash provided by (used in) investing activities (6,758) 8,598
Cash flows from financing activities:
Repurchase of common stock (6,245) (48,004)
Proceeds from issuance of common stock 1,480 5,138
Other (67) (386)
-------- ---------
Net cash used in financing activities (4,832) (43,252)
Net increase (decrease) in cash and cash equivalents 9,576 (14,225)
Cash and cash equivalents, beginning of period 17,599 42,039
-------- ---------
Cash and cash equivalents, end of period 27,175 27,814
======== =========
See accompanying notes to condensed consolidated financial statements.
5
PEGASUS SOLUTIONS, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Overview and basis of presentation
Pegasus Solutions, Inc. is a global leader in providing technology and services
to hotels and travel distributors. Pegasus was 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.
Pegasus' services include central reservation systems, electronic distribution
services, commission processing and payment services, and marketing
representation services, including the consumer Web site hotelbook.com. The
unaudited condensed consolidated financial statements include the accounts of
Pegasus Solutions, Inc. and its wholly owned subsidiaries ("Pegasus" or the
"Company"). All significant intercompany balances have been eliminated in
consolidation. The Company operates under one reportable segment. Pegasus'
common stock is traded on the Nasdaq National Market under the symbol PEGS.
In the opinion of management, the unaudited condensed consolidated financial
statements presented herein reflect all adjustments necessary to fairly state
the financial position, operating results, and cash flows for the periods
presented. Such adjustments are of a normal recurring nature. The results for
interim periods are not necessarily indicative of results expected for the
entire fiscal year. The accompanying unaudited condensed consolidated financial
statements and the notes thereto should be read in conjunction with the
consolidated financial statements and notes thereto contained in the Company's
Annual Report on Form 10-K for the year ended December 31, 2004.
Reclassifications
In 2004, the Company concluded that it was appropriate to classify certain
auction rate securities that had been previously classified as cash and cash
equivalents as a separately stated current asset. The Company has made
adjustments to the Condensed Consolidated Statement of Cash Flows for the nine
months ended September 30, 2004 to reflect the gross purchases and sales of
these securities as investing activities rather than a component of cash and
cash equivalents. This change in classification does not affect previously
reported cash flows from operations or from financing activities in the
Condensed Consolidated Statements of Cash Flows or in previously reported
Condensed Consolidated Statements of Operations for any period. The Company has
also made an adjustment to the Condensed Consolidated Statement of Cash Flows
for the nine months ended September 30, 2004 to reflect landlord paid tenant
improvements as a cash inflow in net cash provided by operating activities and a
cash outflow in net cash provided by investing activities, rather than a noncash
investing activity.
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 stock
option awards because the exercise prices of employee stock options equal or
exceed the market prices of the underlying stock on the dates of grant. The
Company maintains stock incentive and employee stock purchase plans. Total
compensation expense for these plans was $31,000 and $30,000 for the three
months ended September 30, 2005 and 2004, respectively, and $93,000 and $161,000
for the nine months ended September 30, 2005 and 2004, respectively.
The following table represents the effect on net income (loss) and net income
(loss) per share if the Company had applied the fair value based method and
recognition provisions of Statement of Financial Accounting Standards (SFAS) No.
123, "Accounting for Stock-Based Compensation," to stock-based employee
compensation (in thousands, except per share amounts):
6
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2005 2004 2005 2004
------- -------- --------- --------
Net income (loss), as reported $2,206 $ 3,786 $ (8,441) $ 6,210
Add: Stock-based employee
compensation expense included in
reported income (loss), net of
related tax effects 19 18 57 99
Deduct: Total stock-based employee
compensation expense determined
under fair value based methods for all
awards, net of related tax effects (473) (1,034) (2,072) (3,751)
------- -------- --------- --------
Pro forma net income (loss) $1,752 $ 2,770 $(10,456) $ 2,558
======= ======== ========= ========
Net income (loss) per share, as reported:
Basic $ 0.11 $ 0.17 $ (0.41) $ 0.27
======= ======== ========= ========
Diluted $ 0.11 $ 0.16 $ (0.40) $ 0.28
======= ======== ========= ========
Net income (loss) per share, pro forma:
Basic $ 0.08 $ 0.13 $ (0.50) $ 0.11
======= ======== ========= ========
Diluted $ 0.08 $ 0.12 $ (0.50) $ 0.11
======= ======== ========= ========
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 incentive awards. For purposes of pro forma
disclosures, the estimated fair value of stock-based compensation awards is
amortized over the vesting period.
2. DISCONTINUED OPERATIONS AND ASSETS HELD FOR SALE
In June 2005, the Board of Directors of the Company approved and committed to a
formal plan to exit the property management systems (PMS) business by selling
the Company's PMS operations. These operations included the PegasusCentral PMS
and two other private-label property management products, Guestview and
NovaPlus, that support both hotel chains and independent customers.
The Company also reached an agreement with its primary PegasusCentral customer,
InterContinental Hotel Group (IHG), to discontinue the use of PegasusCentral.
Accordingly, the PegasusCentral PMS will no longer be used in the Holiday Inn
Express properties currently using the system, and there will be no new
installations. The decision to exit the PMS business was made considering the
termination of the IHG agreement and the overall expected profitability of the
remaining PMS operations.
The PMS operations have been classified as discontinued operations for all
periods presented and the PMS assets are classified as assets held for sale at
September 30, 2005. In classifying the PMS assets as held for sale, the Company
concluded that the carrying amount of these assets exceeded the estimated fair
value less cost to sell such assets. Accordingly, in the second quarter of
2005, the Company recognized a $16.6 million pre-tax impairment charge to write
down the assets to an estimated net realizable value of $1.9 million. In
addition, the Company recorded an approximately $1.0 million pre-tax charge for
exit and transition costs, which were paid during the third quarter of 2005.
These charges are included in the Condensed Consolidated Statements of
Operations and Comprehensive Income (Loss) as discontinued operations, net of
tax. Assets held for sale of $1.9 million are included in other noncurrent
assets in the Condensed Consolidated Balance Sheet as of September 30, 2005.
The Company will continue to analyze whether the PMS operations meet the
criteria to be presented as discontinued operations for one year.
7
During October 2005, the Company completed the disposition of the Guestview and
NovaPlus operations to Multi-Systems, Inc. The sale price was approximately
$1.3 million, including $605,000 paid upon closing and $722,000 due under a full
recourse promissory note, payable in three annual installments of $270,000,
including interest at 6%. The Company expects to record a gain on the sale of
approximately $370,000 in the fourth quarter of 2005, which will be included in
discontinued operations. The Company expects to sell the remaining
PegasusCentral PMS business by the end of the second quarter of 2006.
Condensed income statement data for the discontinued operations is presented
below (in thousands). The income tax benefit is calculated using a discrete
statutory tax rate approach for discontinued operations.
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2005 2004 2005 2004
------- --------- ---------- ---------
Revenues . . . . . . . . . . . . . . . . $ 552 $ 1,104 $ 1,882 $ 3,860
======= ========= ========== =========
Operating loss . $ (368) $ (1,784) $ (21,299) $ (4,872)
Income tax benefit . . . . . . . . . . . 142 688 8,216 1,879
------- --------- ---------- ---------
Loss related to discontinued operations,
net of tax
$ (226) $ (1,096) $ (13,083) $ (2,993)
======= ========= ========== =========
3. STRATEGIC ALTERNATIVES
On April 11, 2005, the Company announced that its board of directors is
exploring various strategic alternatives to enhance shareholder value. Some
possible alternatives include joint ventures, divestitures, alliances with
strategic partners, taking the Company private, selling the Company to a third
party, or merging with another company. The Company's board of directors has
retained Bear, Stearns & Co. Inc. as its financial advisor to assist in this
effort. There can be no assurance that this process will result in any specific
transaction.
4. INTANGIBLE ASSETS
Pegasus has acquired identifiable intangible assets that are subject to
amortization. The following table presents carrying values of those intangible
assets at September 30, 2005 and December 31, 2004 (in thousands):
September 30, 2005 December 31, 2004
------------------ -----------------
Carrying Accumulated Carrying Accumulated
Value Amortization Value Amortization
------- ------------- ------- -------------
Customer relationships $56,996 $(53,587) $56,996 $(53,091)
Non-compete agreements 6,000 (4,754) 6,120 (4,215)
Other. . . . . . . . . 48 (36) 48 (31)
------- ------------- ------- -------------
Total $63,044 $(58,377) $63,164 $(57,337)
======= ============= ======= =============
Amortization expense for those intangible assets was $310,000 and $501,000 for
the three months ended September 30, 2005 and 2004, respectively, and was $1.0
million and $1.5 million for the nine months ended September 30, 2005 and 2004,
respectively.
8
5. NET INCOME (LOSS) PER SHARE
The following table sets forth the computation of basic and diluted income
(loss) per common share (in thousands, except per share data):
Three Months Ended Nine Months Ended
September 30, September 30,
------------- -------------
2005 2004 2005 2004
-------- -------- --------- --------
Income from continuing operations (a) $ 2,432 $ 4,882 $ 4,642 $ 9,203
Discontinued operations, net of tax (b) (226) (1,096) (13,083) (2,993)
-------- -------- --------- --------
Net income (loss) (c) $ 2,206 $ 3,786 $ (8,441) $ 6,210
======== ======== ========= ========
Income from continuing operations (a) $ 2,432 $ 4,882 $ 4,642 $ 9,203
Adjustment for interest on convertible
debt, net of tax - 444 - 1,383
------- -------- -------- ---------
Income from continuing operations,
as adjusted (d) $ 2,432 $ 5,326 $ 4,642 $10,586
======== ======== ========= ========
Net income (loss) (c) $ 2,206 $ 3,786 $ (8,441) $ 6,210
Adjustment for interest on convertible
debt, net of tax - 444 - 1,383
------- -------- -------- ---------
Net income (loss), as adjusted (e) $ 2,206 $ 4,230 $ (8,441) $ 7,593
======== ======== ========= ========
Basic income (loss) per share:
Continuing operations (a)/(f) $ 0.12 $ 0.22 $ 0.22 $ 0.39
Discontinued operations (b)/(f) $ (0.01) $ (0.05) $ (0.63) $ (0.12)
-------- -------- --------- --------
Net income (loss) (c)/(f) $ 0.11 $ 0.17 $ (0.41) $ 0.27
======== ======== ========= ========
Diluted income (loss) per share:
Continuing operations (d)/(g) $ 12 $ 0.20 $ 0.22 $ 0.39
Discontinued operations (b)/(g) $ (0.01) $ (0.04) $ (0.62) $ (0.11)
-------- -------- --------- --------
Net income (loss) (e)/(g) $ 0.11 $ 0.16 $ (0.40) $ 0.28
======== ======== ========= ========
Basic weighted average shares
Outstanding (f) 20,758 22,131 20,743 23,355
Dilutive effect of stock options (1) 183 367 230 325
Dilutive effect of convertible debt (2) - 3,726 - 3,726
------- -------- -------- ---------
Dilutive weighted average shares
outstanding (g) 20,941 26,224 20,973 27,406
======== ======== ========= ========
(1) Weighted average shares issuable upon exercise of stock options that were
excluded from the calculation as their effect would have been anti-dilutive to
income from continuing operations were 3.5 million and 1.8 million for the
quarters ended September 30, 2005 and 2004, respectively, and 3.2 million and
2.4 million for the nine months ended September 30, 2005 and 2004, respectively.
(2) Subject to certain conditions, the Company's convertible debt is
convertible into common stock at a conversion price of approximately $20.13 per
share, equal to approximately 3.7 million shares. No dilution for convertible
debt was included in the calculation for the three months and nine months ended
September 30, 2005 as the effect would be anti-dilutive to income from
continuing operations for these periods.
9
6. STOCKHOLDERS' EQUITY
On November 5, 2004, the Board of Directors approved a share buy-back plan for
the repurchase of up to 1.5 million shares of Pegasus' common stock. Share
buy-backs under this plan have been made under a Securities and Exchange Act of
1934 Rule 10b5-1 share repurchase plan, which allowed Pegasus to repurchase
shares, subject to certain limitations, even during blackout periods. During
2005, the Company purchased approximately 518,000 shares for an aggregate cost
of $6.2 million. On April 12, 2005, the Rule 10b5-1 stock repurchase plan was
terminated. The Company had total repurchases under the plan of approximately
1.2 million shares for a total aggregate value of $13.9 million. Shares
repurchased under Board-approved plans have all been cancelled.
7. EMPLOYEE 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 Executive Retirement Plan ("SERP"). The SERP became effective on
January 1, 2000 and provides supplemental retirement benefits to certain
officers of the Company based on their compensation and years of service, as
defined under the SERP. As a result of changes in executive management, during
the first quarter 2004, Pegasus recognized a curtailment gain of $162,000 for
the SERP under Statement of Financial Accounting Standards No. 88, "Employers'
Accounting for Settlements and Curtailments of Defined Benefit Pension Plans and
for Termination Benefits" ("SFAS 88"). The Company has made cash contributions
of approximately $460,000 to a trust associated with the SERP during the nine
months ended September 30, 2005.
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. The Company expects to make cash contributions of
approximately $250,000 to the Utell Defined Benefit Plan during 2005. For the
nine months ended September 30, 2005, cash contributions of approximately
$187,000 were made.
The following table provides the components of net periodic benefit costs for
the three months and nine months ended September 30, 2005 and 2004 (in
thousands):
SERP Utell Defined Benefit Plan
--------------------------- ---------------------------
Three months Nine months Three months Nine months
ended ended ended ended
September 30, September 30, September 30, September 30,
-------------- ------------- ------------- ------------
2005 2004 2005 2004 2005 2004 2005 2004
------ ------ ------ ------ ----- ----- ----- -----
Service cost $ 50 $ 50 $ 150 $ 151 $ 90 $ 72 $ 270 $ 216
Interest cost 64 58 192 175 185 134 557 402
Expected return on plan assets. . . - - - - (206) (172) (618) (514)
Amortization of prior service cost. (11) (11) (31) (33) - - - -
Recognized net actuarial loss. 33 30 97 91 - - - -
Curtailment gain. - - - (162) - - - -
-------------- -------------- ------------ ------------
Net periodic benefit cost $ 136 $ 127 $ 408 $ 222 $ 69 $ 34 $ 209 $ 104
====== ====== ====== ====== ===== ===== ===== =====
In response to new tax regulations, the Company is evaluating its executive
retirement program, which consists of the SERP and the Pegasus Solutions, Inc.
Executive Deferred Compensation Plan (the "DCP"), a defined contribution plan
that provides supplemental retirement benefits to certain management employees
of the Company. The Company expects to come to a resolution of its alternatives
in the fourth quarter of 2005. While the program may be unchanged with no impact
to cash or the Company's results of operations, one alternative being evaluated
is an amendment to the SERP and DCP which would offer participants an election
to cash out their benefits that are vested at December 31, 2005 and cease future
participation in the plans. This alternative would result in a cash out payment
to participants of up to approximately $4.4 million, the liquidation of trust
assets, associated with benefits earned under the SERP and DCP, of approximately
$2.6 million, and the incurrence of a settlement charge under SFAS 88 of up to
approximately $2.7 million. Assuming future participation by all the
participants ceases, annual cost savings would be approximately $1.1 million.
10
8. COMMITMENTS AND CONTINGENCIES
The Company 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, it does not believe these
actions will have a material adverse effect on the Company's financial position,
results of operations or liquidity.
During the third quarter of 2005, the Company ceased the use of two office
spaces, one in New York and one in Australia, prior to the lease termination
dates and recorded lease termination costs of approximately $378,000 and
$133,000, respectively. These costs primarily represent the future lease
payments related to the vacated facilities net of estimated sublease income over
the remaining lease period of 37 months for the New York facility and 30 months
for the Australia facility. Concurrent, the Company leased office space in New
York at reduced rates, as compared to the previous lease.
9. NEW ACCOUNTING GUIDANCE
In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS
No. 123R, "Share-Based Payment" ("SFAS 123R"), which replaces SFAS No. 123,
"Accounting for Stock-Based Compensation" and supersedes APB Opinion No. 25,
"Accounting for Stock Issued to Employees." In March 2005, the Securities and
Exchange Commission (SEC) issued Staff Accounting Bulletin No. 107, "Share-Based
Payment," which provides interpretive guidance related to SFAS 123R. SFAS 123R
requires compensation costs related to share-based payment transactions to be
recognized in financial statements. With limited exceptions, the amount of
compensation cost is measured based on the fair value of the equity or liability
instrument issued on the grant date. SFAS 123R requires liability awards to be
remeasured each reporting period and compensation costs to be recognized over
the period that an employee provides service in exchange for the award. In
April 2005, the SEC delayed the effective date of SFAS 123R to the beginning of
the annual reporting period that begins after June 15, 2005. The Company
continues to evaluate SFAS 123R to determine the impact on its consolidated
financial statements and currently intends to adopt the modified prospective
transition method. SFAS 123R is expected to have a negative effect on
consolidated net income.
In May 2005, the FASB issued Statement of Financial Accounting Standards No.
154, "Accounting Changes and Error Corrections-A Replacement of APB Opinion No.
20 and FASB Statement No. 3" ("SFAS 154"). SFAS 154 requires retrospective
application to prior periods' financial statements of changes in accounting
principle. It also requires that the new accounting principle be applied to the
balances of assets and liabilities as of the beginning of the earliest period
for which retrospective application is practicable and that a corresponding
adjustment be made to the opening balance of retained earnings for that period
rather than being reported in an income statement. The statement will be
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. The Company does not expect the adoption of
SFAS 154 to have a material effect on the Company's consolidated financial
position or results of operations.
On October 22, 2004, the President of the United States signed the American Jobs
Creation Act of 2004 (the "Act"). The Act creates a temporary incentive for
United States corporations to receive repatriations of accumulated earnings of
foreign subsidiaries by providing an 85 percent dividends received deduction for
certain qualifying dividends from certain qualifying foreign corporations. The
Company does not presently intend to repatriate accumulated earnings of foreign
subsidiaries.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis should be read in conjunction with the
Management's Discussion and Analysis of Financial Condition and Results of
Operations and the consolidated financial statements and notes thereto included
in our Annual Report on Form 10-K for the year ended December 31, 2004. This
discussion and analysis 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, hopes, plans, expectations or
intentions for the future. Forward-looking statements involve various risks and
uncertainties. Our ability to predict results or the actual effect of future
plans or strategies is inherently uncertain and the actual results and timing of
certain events could differ materially from our current expectations. Factors
that could cause or contribute to such a difference include, but are not limited
to, changes in general economic conditions, variation in demand for our products
and services and in the timing of our sales, changes in product and price
competition for existing and new competitors, changes in our level of operating
expenditures, delays in developing, marketing and deploying new products and
services, terrorist activities, action by U.S. or other military forces, global
health epidemics, changes in hotel room rates, capacity adjustments by airlines,
negative trends in the overall demand for travel, other adverse changes in
general market conditions for business and leisure travel, any strategic
alternative undertaken by the Company, the inability of the Company to sell the
property management systems (PMS) operations, risks associated with a PMS sale
transaction and the inability of the Company to terminate the PMS service as
expected, as well as other risks and uncertainties, including those appearing in
under the caption "Risk Factors" in the Company's Annual Report on Form 10-K for
the year ended December 31, 2004.
OVERVIEW
Pegasus is a global leader in providing technology and services to hotels and
travel distributors. Founded in 1989, Pegasus' customers include a majority of
the world's travel agencies and more than 60,000 hotel properties around the
globe. Pegasus' services include central reservation systems, electronic
distribution services, commission processing and payment services, and marketing
representation services, including the consumer Web site, www.hotelbook.com(TM).
The Company's representation services, including Utell by Pegasus(TM) and Unirez
by Pegasus(TM), are used by nearly 7,000 member hotels in approximately 140
countries, making Pegasus the hotel industry's largest third-party marketing and
reservations provider. Pegasus has 18 offices in 13 countries, with corporate
headquarters in Dallas and regional hubs in London, Scottsdale and Singapore.
STRATEGIC ALTERNATIVES
On April 11, 2005, we announced that our board of directors is exploring various
strategic alternatives to enhance shareholder value. Some possible alternatives
include joint ventures, divestitures, alliances with strategic partners, taking
the company private, selling the company to a third party, or merging with
another company. Our board of directors has retained Bear, Stearns & Co. Inc. as
its financial advisor to assist in this effort. There can be no assurance that
this process will result in any specific transaction.
DISCONTINUED OPERATIONS
In June 2005, our Board of Directors approved and committed to a formal plan to
exit the property management systems (PMS) business by selling the PMS
operations. These operations include the PegasusCentral PMS and two other
private-label property management products, Guestview and NovaPlus, that support
both hotel chains and independent customers.
We also reached an agreement with our primary PegasusCentral customer,
InterContinental Hotel Group (IHG), to discontinue the use of PegasusCentral.
Accordingly, the PegasusCentral PMS will no longer be used in the Holiday Inn
Express properties currently using the system, and there will be no new
installations. The decision to exit the PMS business was made considering the
termination of the IHG agreement and the overall expected profitability of the
remaining PMS operations.
12
The PMS operations have been classified as discontinued operations for all
periods presented and the PMS assets are classified as assets held for sale at
September 30, 2005. In classifying the PMS assets as held for sale, we
concluded that the carrying amount of these assets exceeded the estimated fair
value less cost to sell such assets. Accordingly, in the second quarter of
2005, we recognized a $16.6 million pre-tax impairment charge to write down the
assets to an estimated net realizable value of $1.9 million. In addition, the
Company recorded an approximately $1.0 million pre-tax charge for exit and
transition costs, which were paid during the third quarter of 2005. We will
continue to analyze whether the PMS operations meet the criteria to be presented
as discontinued operations for one year.
During October 2005, we completed the disposition of the Guestview and NovaPlus
operations to Multi-Systems, Inc. The sale price was approximately $1.3
million, including $605,000 paid upon closing and $722,000 due under a full
recourse promissory note, payable in three annual installments of $270,000,
including interest at 6 percent. We expect to record a gain on the sale of
approximately $370,000 in the fourth quarter of 2005, which will be included in
discontinued operations. We expect to sell the remaining PegasusCentral PMS
business by the end of the second quarter of 2006.
For further information, please see Note 2 to the Condensed Consolidated
Financial Statements.
OPERATING TRENDS
The following are trends that we have experienced or anticipate. Certain of
these trends have or may have a negative impact on our revenues and
profitability.
- We have experienced a lengthening in the implementation cycle for our
services, and once implemented, contracts in some instances are taking
longer than anticipated to ramp up to expected transaction volumes.
- Revenues from new product offerings are lower than previously
anticipated. For instance, PegsTour , a new service which automates
hotel reservations by tour operators and wholesale travel
distributors, has experienced delays due to the implementation effort
required by travel distributors and hotels (including development of
an interface and business process changes).
- In many instances, our service offerings continue to experience lower
pricing on new contracts and contract renewals, arising from increased
competition from lower-cost competitors and hotel and travel agency
consolidations. However, this trend has begun to stabilize and is not
expected to erode future revenues.
- We continue to see an increase in the percentage of Internet
reservations made at hotel chain Internet sites versus third-party
Internet sites that utilize our services.
- We continue to experience losses in our portfolio of customers, as
some larger customers cease to outsource some of the services we offer
or outsource to our competitors. For our commission processing service
line, this trend has resulted in the loss of hotel participants, which
could affect whether our travel agent customers continue to use our
service. Further, we expect to cease providing commission processing
services to one of our largest hotel participants early in the first
quarter of 2006. For the trailing twelve months ended September 30,
2005, this hotel participant represented approximately 18 percent of
our financial services revenues, and we paid them approximately $1.2
million in incentive payments, which are recorded in cost of services.
- We are experiencing a year-over-year decline in our revenues.
Positive operating trends include:
- Average daily room rates (ADR) are improving.
- We are experiencing stability of foreign currency exchange rates.
- Pricing for Internet distribution is increasing.
- We have established business partners in key regions around the world
expanding our market reach in Latin America, Asia and Eastern Europe.
- We have been able to reduce the Internet distribution revenue share
that we pay out.
13
NEW PRODUCT DEVELOPMENT AND GROWTH INITIATIVES
Our future success depends on our ability to successfully develop leading
technologies, enhance our existing services and develop and introduce new
services to meet the changing needs of our current and prospective customers.
We rely on third party arrangements for much of the development and enhancement
of our services, including outsourcing outside of the U.S.
During the first quarter, we launched weekly commission processing. With this
enhancement to our commission processing service, both hotels and travel
agencies benefit from more efficient cash flow. During the second quarter, we
launched hotelbook.com, which creates another way for independent hoteliers to
compete online with the major hotel brand Web sites. We also expanded our
presence in China by opening an office in Beijing, which is a key part of our
strategy to expand our business in the Asia-Pacific region. Additionally, we
have delivered a new release of our internet booking engine, Netbooker, and a
new rate tracking service, as well as established a strategic relationship with
Open Hospitality for Web services.
We are in the development phase of an automated system that will enable us to
expand the use of our financial services into other travel markets, such as car
rental and cruises, enhance the functionality of our weekly commission
processing, and increase our financial services operating efficiency. We have
evaluated funding and development alternatives related to this technology,
including collaboration with outside parties. Such collaboration may result in
changes in the development, integration and deployment of this software and may
result in alternate financing arrangements such as future revenue sharing. We
are presently reevaluating this project and a decision on its future is not
likely until the strategic alternative initiative is completed. The carrying
value of this technology is $8.3 million as of September 30, 2005. Changes in
strategy, market condition, the outcome of our strategic alternative initiative,
or other assumptions may significantly impact our determinations regarding
whether an impairment exists and could significantly reduce the carrying value
associated with this project.
FLUCTUATION OF FOREIGN CURRENCIES
Pegasus 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 our earning more or less revenue and expending higher or lower
expenses than we otherwise might have earned or spent if currency exchange rates
had remained stable.
RESULTS OF OPERATIONS
THREE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
Revenues. The table and discussion below address revenues by service line for
the three months ended September 30, 2005 and 2004 (dollars in thousands).
Three Months Ended
September 30, Variance
---------------- ---------------
2005 2004 $ %
------- ------- --------- ----
Representation services $16,930 $18,652 $ (1,722) -9%
Reservation services 8,278 9,303 (1,025) -11%
Financial services 8,538 9,358 (820) -9%
Distribution services 7,532 7,157 375 5%
------- ------- --------- ----
Service revenues 41,278 44,470 (3,192) -7%
Customer reimbursements 4,397 3,929 468 12%
------- ------- --------- ----
Total revenues $45,675 $48,399 $ (2,724) -6%
======= ======= ========= ====
Representation services revenues decreased primarily due to continued impact of
reduced pricing and the transition of a significant Unirez by Pegasus customer
to our central reservation service. A slight increase in ADR for our Utell by
Pegasus offering was offset by a 5 percent decrease in reservation volumes and
the average commission earned percentage. On a sequential quarter basis, the
average commission earned has stabilized.
14
Reservation services revenues decreased primarily due to the loss of a customer
and continued pricing pressure on contract renewals. Partially offsetting these
decreases was the transition of one customer from Unirez by Pegasus to our
reservations services late in 2004. Net transactions decreased compared to the
same quarter last year; however, excluding these two customers, net transactions
processed increased 6 percent.
Financial services revenues were affected by reduced transactions and pricing,
resulting from travel agency consolidations, partially offset by the continued
benefit from improved ADR.
Distribution services revenues increased compared to the prior year quarter.
Total transactions increased 5 percent, with Global Distribution Services (GDS)
transactions increasing 10 percent and Internet transactions decreasing 8
percent. The decrease in Internet transactions reflects an increase in the
percentage of Internet bookings made at hotel companies' proprietary Web sites
that do not utilize Pegasus' Internet distribution service, as well as the
impact of a customer loss. Excluding this customer loss, Internet transactions
increased 9 percent.
Customer reimbursements increased due to an overall increase in our customers'
GDS costs because of an increase in GDS transactions and GDS pricing.
Operating Expenses. The table and discussion below address operating expenses
for the three months ended September 30, 2005 and 2004 (dollars in thousands).
Three Months Ended
September 30, Variance
------------- ------------
2005 2004 $ %
------- ------- ------- ---
Cost of services $20,822 $21,422 $ (600) -3%
Customer reimbursements 4,397 3,929 468 12%
------- ------- ------- ---
Total costs of services 25,219 25,351 (132) -1%
Research and development 879 676 203 30%
General and administrative expenses 5,775 5,797 (22) -
Marketing and promotion expenses 4,860 4,815 45 1%
Depreciation and amortization 4,955 4,156 799 19%
------- ------- ------- ---
Total operating expenses $41,688 $40,795 $ 893 2%
======= ======= ======= ===
Operating expenses for the quarter ended September 30, 2005, were two percent
higher that the prior year. The following factors contributed most
significantly to the year over year impact:
- $1.0 million of severance and lease termination costs incurred during
the third quarter of 2005;
- An increase in depreciation and amortization related to new capital
projects going into production; offset by
- Lower headcount and employee-related expenses; and
- Tight management of all variable operating costs.
Cost of services expenses, excluding customer reimbursements, decreased in the
third quarter 2005 primarily due to lower customer incentives, communications
expenses, and processing costs, commensurate with the decrease in revenues,
partially offset by severance of $256,000 and lease termination costs of
$133,000. Cost of services, excluding customer reimbursements, as a percentage
of service revenues was 50 percent and 48 percent for the three months ended
September 30, 2005 and 2004, respectively.
Customer reimbursements increased primarily due to an overall increase in our
customers' GDS costs because of an increase in GDS transactions and GDS pricing.
Research and development expenses were higher year over year, primarily due to a
decrease in capitalized payroll costs, as development efforts were focused on
projects that were not capitalizable. Research and development expenses as a
percentage of service revenues were 2 percent for the third quarter in both 2005
and 2004.
15
General and administrative expenses were flat with the prior year, with
increases related to lease termination costs of $378,000 being offset by lower
third-party service costs incurred, primarily related to tax and audit
professional services. General and administrative expenses as a percentage of
service revenues were 14 percent and 13 percent for the three months ended
September 30, 2005 and 2004, respectively.
Marketing and promotion expenses increased slightly primarily due to additional
personnel and consultant costs arising from a greater focus on sales, marketing
and promotion activities, including costs related to the launch of our own
travel Web site, hotelbook.com. Marketing and promotion expenses as a
percentage of service revenues were 12 percent and 11 percent for the three
months ended September 30, 2005 and 2004, respectively.
Depreciation and amortization expenses increased due to depreciation and
amortization related to capital expenditures being put into production.
Interest expense, net. Net interest expense decreased from $498,000 to $323,000
for the third quarter 2005 compared to the third quarter 2004 due to higher
capitalization of interest related to our software development efforts and
higher interest rates.
Income tax expense. Pegasus recorded income tax expense on continuing
operations of $1.4 million and $2.4 million for the third quarter 2005 and 2004,
respectively, reflecting year-to-date effective rates of 36 percent for both
years. The effective rate for 2005 differed from the statutory rate of 35
percent, primarily due to the geographic apportionment of profits and losses and
the impact of state income taxes, nondeductible expenses, and foreign taxes.
Tax expense (benefit) is calculated using the estimated annual effective tax
rate approach on continuing operations and a discrete statutory tax rate
approach on discontinued operations.
Discontinued operations. For information regarding discontinued operations,
please see Note 2 to the Condensed Consolidated Financial Statements.
NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
Revenues. The table and discussion below address revenues by service line for
the nine months ended September 30, 2005 and 2004 (dollars in thousands).
Nine Months Ended
September 30, Variance
------------------ ---------------
2005 2004 $ %
-------- -------- --------- ----
Representation services $ 51,063 $ 54,397 $ (3,334) -6%
Reservation services 25,501 27,794 (2,293) -8%
Financial services 22,939 25,704 (2,765) -11%
Distribution services 21,380 21,524 (144) -1%
-------- -------- --------- ----
Service revenues 120,883 129,419 (8,536) -7%
Customer reimbursements 13,111 11,549 1,562 14%
-------- -------- --------- ----
Total revenues $133,994 $140,968 $ (6,974) -5%
======== ======== ========= ====
Representation services revenues decreased primarily due to the continued impact
of reduced pricing and the transition of a significant Unirez by Pegasus
customer to our central reservation service. A 4 percent increase in ADR for
our Utell by Pegasus offering was offset by a decrease in reservation volumes
and the average commission earned percentage. On a sequential quarter basis,
the average commission earned has stabilized.
Reservation services revenues decreased primarily due to continued pricing
pressure on contract renewals and the loss of a customer. Partially offsetting
these decreases was the transition of one customer from Unirez by Pegasus to our
reservations services late in 2004. Net transactions decreased compared to the
same period last year; however, excluding these two customers, net transactions
processed increased 3 percent.
Financial services revenues decreased primarily due to an impact of
approximately $1.5 million associated with the initial implementation of weekly
commission processing in March 2005. While this enhancement to our commission
processing service will benefit both hotels and travel agencies, its initial
implementation impacted the timing of services we normally would have performed
16
in March. Under the new process and technology, once commission data is input
into the system, it is automatically included in the next weekly cycle. Because
of the timing of data submission and when we provided our services, revenues for
only approximately three weeks of data were recognized in March related to
hotels that elected to utilize our weekly commission processing. Further,
revenues decreased related to hotels that elected to stay on a monthly
commission processing schedule because we were unable to provide services to or
process any of the data submitted by these hotels until April. Offsetting the
first quarter negative impact to revenues of approximately $2.1 million was the
$600,000 positive impact in the second quarter of 2005, representing incremental
revenues earned in the month of conversion, as hotel companies switched from
monthly to weekly commission processing. The financial impact of implementing
weekly commission processing was substantially complete by the end of the second
quarter of 2005, as the majority of expected customer conversions to weekly
commission processing were completed. Aside from this impact, financial
services revenues were affected by reduced transactions and pricing, resulting
from travel agency consolidations, partially offset by the continued benefit
from improved ADR.
Distribution services revenues decreased primarily due to a 6% decrease in the
number of Internet transactions. The decrease in Internet transactions reflects
an increase in the percentage of Internet bookings made at hotel companies'
proprietary Web sites that do not utilize Pegasus' Internet distribution
service, as well as the impact of a customer loss. In addition, reduced pricing
from the second quarter 2004 sale of Travelweb LLC to Priceline.com negatively
affected year-over-year comparisons through May 2005. Improved pricing on
premium channel Internet transactions and an 8 percent increase in GDS
transactions partially offset these decreases.
Customer reimbursements increased due to an overall increase in our customers'
GDS costs because of an increase in GDS transactions and GDS pricing.
Operating Expenses. The table and discussion below address operating expenses
for the nine months ended September 30, 2005 and 2004 (dollars in thousands).
Nine Months Ended
September 30, Variance
------------------ ---------------
2005 2004 $ %
-------- -------- --------- ----
Cost of services $ 62,930 $ 66,229 $ (3,299) -5%
Customer reimbursements 13,111 11,549 1,562 14%
-------- -------- --------- ----
Total costs of services 76,041 77,778 (1,737) -2%
Research and development 2,462 3,039 (577) -19%
General and administrative expenses 17,721 18,223 (502) -3%
Marketing and promotion expenses 15,809 14,509 1,300 9%
Depreciation and amortization 13,890 13,447 443 3%
-------- -------- --------- ----
Total operating expenses $125,923 $126,996 $ (1,073) -1%
======== ======== ========= ====
Operating expenses for the nine months ended September 30, 2005 decreased 1
percent from the prior year. The following factors contributed most
significantly to the year over year impact:
- Prior year expenses included severance and related costs of $2.4
million related to a first quarter 2004 strategic change in our
information technology organization compared to $1.0 million of
severance and lease termination costs incurred during the third
quarter of 2005;
- Headcount and employee-related expenses were lower year-over-year;
- Tight management of all variable operating costs; and
- Marketing and promotion expenses increased as we remain committed to
sales and marketing efforts.
Cost of services expenses, excluding customer reimbursements, for the prior year
included severance and related costs of $1.9 million related to a first quarter
2004 strategic change in our information technology organization. Cost of
services also decreased as a result of the implementation of weekly commission
processing in our financial services offering. Consistent with the change in
timing of revenue recognition, customer incentives were reduced by approximately
$150,000 during the nine months ended September 30, 2005. The remainder of the
decrease is due to lower customer incentives, communications expenses, and
processing costs, commensurate with the decrease in revenues. Cost of services,
excluding customer reimbursements, as a percentage of service revenues were 52
percent and 51 percent for the nine months ended September 30, 2005 and 2004,
respectively.
17
Customer reimbursements increased primarily due to an overall increase in our
customers' GDS costs because of an increase in GDS transactions and GDS pricing.
Research and development expenses were down year over year, primarily due to
lower headcount and employee-related expenses. Research and development
expenses as a percentage of service revenues was 2 percent for the nine months
ended September 30, 2005 and 2004.
General and administrative expenses for the prior year included severance and
related costs of $465,000 related to a first quarter 2004 strategic change in
our information technology organization offset by a first quarter curtailment
gain of $162,000 for the Supplemental Executive Retirement Plan due to changes
in executive management. Expenses also decreased due to lower third-party costs
incurred, primarily related to tax and audit professional services. General and
administrative expenses as a percentage of service revenues were 15 percent and
14 percent for the nine months ended September 30, 2005 and 2004, respectively.
Marketing and promotion expenses increased primarily due to additional personnel
and consultant costs arising from a greater focus on sales, marketing and
promotion activities, including costs related to the launch of our own travel
Web site, hotelbook.com. Marketing and promotion expenses as a percentage of
service revenues were 13 percent and 11 percent for the nine months ended
September 30, 2005 and 2004, respectively.
Depreciation and amortization increased primarily due to depreciation and
amortization related to capital expenditures being put into production. This
increase was partially offset by completing the amortization of a software asset
in the second quarter of 2004, which accounted for $460,000 in amortization in
2004.
Gain on Sale. On May 3, 2004, Pegasus sold its interest in Travelweb, LLC to an
affiliate of Priceline.com, Inc. and received $4.2 million in cash, recognizing
a gain of approximately $2.0 million.
Interest expense, net. Net interest expense decreased from $1.5 million to $1.1
million for the nine months ended September 30, 2005 compared to the nine months
ended September 30, 2004 due to higher capitalization of interest related to our
software development efforts and higher interest rates.
Income tax expense. Pegasus recorded income tax expense on continuing
operations of $2.6 million and $5.1 million for the nine months ended September
30, 2005 and 2004, respectively, reflecting year-to-date effective rates of 36
percent for both years. The effective rate for 2005 differed from the statutory
rate of 35 percent, primarily due to the geographic apportionment of profits and
losses and the impact of state income taxes, nondeductible expenses, and foreign
taxes. Tax expense (benefit) is calculated using the estimated annual effective
tax rate approach on continuing operations and a discrete statutory tax rate
approach on discontinued operations.
Discontinued operations. For information regarding discontinued operations,
please see Note 2 to the Condensed Consolidated Financial Statements.
LIQUIDITY AND CAPITAL RESOURCES
Historically, Pegasus has primarily relied on cash flows from operations to
provide working capital for current and future operations and for capital
investments. From time to time, we have also utilized bank lines of credit,
proceeds from equity and debt offerings and private debt to supplement our
ability to fund operating cash requirements, capital investments and
acquisitions.
We assess our liquidity in terms of our ability to generate cash to fund our
operating and investing activities. Key indicators we use to make this
assessment are current assets, current liabilities and net cash flow from
operating activities.
Our principal source of capital during the first nine months of 2005 included
cash and cash equivalents of $27.2 million and auction rate securities of $3.0
million. Our cash flows from operations of $21.2 million included $5.8 million
related to our commission processing service. Excluding this factor, cash flows
from operations of $15.4 million were sufficient to provide for working capital
requirements. Other sources of cash during the first nine months of 2005 were
$9.8 million net proceeds from the sale or maturity of marketable securities and
$1.5 million of proceeds from stock option exercises.
18
Cash outlays in the first nine months of 2005 included the repurchase of
approximately 518,000 shares of common stock for $6.2 million. The common stock
repurchases were made under a Rule 10b5-1 stock repurchase plan that was
approved on November 5, 2004 and terminated effective April 12, 2005.
Another component of our cash outlays included capital expenditures of $17.3
million consistent with our capital strategy of investing in software
development projects meeting our return on investment criteria. Our capital
expenditures primarily consist of personnel costs, interest expense and outside
consultant costs for software development, computer hardware, furniture,
fixtures and other office equipment.
We expect to continue incurring capital expenditures related to software
development and the addition of capacity to existing systems. We estimate full
year 2005 capital expenditures will total approximately $19 to $20 million. We
may also collaborate with outside parties for software development or other
business needs. The potential capital and financing arrangements required for
such arrangements is uncertain.
On April 11, 2005, we announced that our board of directors is exploring various
strategic alternatives to enhance shareholder value. Some possible alternatives
include joint ventures, divestitures, alliances with strategic partners, taking
the Company private, selling the Company to a third party, or merging with
another company. There can be no assurance that this process will result in any
specific transaction.
Our future liquidity and capital requirements will depend on numerous factors,
including:
- Our profitability;
- Seasonality of our operations;
- Operational cash requirements;
- Competitive pressures;
- Development of new services and applications;
- Timing of capital expenditures;
- Response to unanticipated cash requirements; and
- Potential impact of strategic alternatives.
Further, in response to new tax regulations, we are evaluating our executive
retirement program, which consists of the Supplemental Executive Retirement Plan
("SERP"), a defined benefit plan which provides supplemental retirement benefits
to certain officers of the Company based on their compensation and years of
service, as defined under the SERP, and the Pegasus Solutions, Inc. Executive
Deferred Compensation Plan (the "DCP"), a defined contribution plan that
provides supplemental retirement benefits to certain management employees of the
company. We expect to come to a resolution of our alternatives in the fourth
quarter of 2005. While the program may be unchanged with no impact to cash or
our results of operations, one alternative being evaluated is an amendment to
the SERP and DCP which would offer participants an election to cash out their
benefits that are vested at December 31, 2005 and cease future participation in
the plans. This alternative would result in a cash out payment to participants
of up to approximately $4.4 million, the liquidation of trust assets, associated
with benefits earned under the SERP and DCP, of approximately $2.6 million, and
the incurrence of a settlement charge under SFAS No. 88, "Employers' Accounting
for Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits," of up to approximately $2.7 million. Assuming future
participation by all the participants ceases, annual cost savings would be
approximately $1.1 million.
We believe that we will be able to generate cash flows from operations
sufficient to meet our operating and capital requirements through at least the
next twelve months. In addition to exploring strategic alternatives as discussed
above, we may in the future also consider financing alternatives to fund our
requirements, including possible public or private debt or equity offerings.
However, there can be no assurance that any financing alternatives sought by us
will be available or will be on terms that are attractive to us. Further, any
debt financing may involve restrictive covenants, and any equity financing may
be dilutive to stockholders.
19
Pegasus had two irrevocable standby letter of credit agreements with JPMorgan
Chase Bank totaling $1.7 million at December 31, 2004, collateralizing the
leases for the Dallas and Scottsdale offices. During the first quarter of 2005,
we released one of these letters of credit, replacing the $450,000 letter of
credit for the Dallas facility with a deposit of $181,000.
ITEM 4. CONTROLS AND PROCEDURES
Disclosure Controls and Procedures. The Company maintains disclosure controls
and procedures designed to ensure that it is able to record the information it
is required to disclose in the reports it files with the SEC, and to process,
summarize and report this information within the time periods specified in the
rules and forms of the SEC. The Company's Chief Executive and Chief Financial
Officers are responsible for establishing and maintaining these procedures, and,
as required by the rules of the SEC, evaluating their effectiveness. Based on
their evaluation of the Company's disclosure controls and procedures which took
place as of the end of the period covered by this report, the Chief Executive
and Chief Financial Officers concluded that the Company's disclosure controls
and procedures are effective to ensure that the Company is able to record,
process, summarize and report the information it is required to disclose in the
reports it files with the SEC within the required time periods and to ensure
that information required to be disclosed in the Company's Exchange Act reports
is accumulated and communicated to management, including the Chief Executive
Officer and Chief Financial Officer, as appropriate to allow timely decisions
regarding required disclosure.
Changes in Internal Control over Financial Reporting. During the quarter ended
September 30, 2005, there have been no changes in the Company's internal control
over financial reporting identified in connection with the evaluation described
above that have materially affected, or are reasonably likely to materially
affect, the Company's internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Pegasus is subject to certain legal proceedings, claims and disputes that arise
in the ordinary course of 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.
ITEM 6. EXHIBITS
a) Exhibits
*Exhibit 31.1 - Certification of Chief Executive Officer, Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
*Exhibit 31.2 - Certification of Chief Financial Officer, Pursuant to
Section 302 of the Sarbanes-Oxley Act of 2002.
**Exhibit 32.1 - Certification of Chief Executive Officer and Chief
Financial Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
* Filed herewith.
** Furnished herewith.
20
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
PEGASUS SOLUTIONS, INC.
November 9, 2005 /s/ JOHN F. DAVIS, III
-----------------------
John F. Davis, III,
President, Chief Executive Officer
and Chairman
(Principal Executive Officer)
November 9, 2005 /s/ SUSAN K. CONNER
----------------------
Susan K. Conner,
Executive Vice President
and Chief Financial Officer
(Principal Accounting Officer)
21
EXHIBIT INDEX
Exhibit Number Description
- ---------------- --------------------------------------------------------------
*31.1 Certification of Chief Executive Officer, Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
*31.2 Certification of Chief Financial Officer, Pursuant to Section
302 of the Sarbanes-Oxley Act of 2002.
**32.1 Certification of Chief Executive Officer and Chief Financial
Officer, Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant Section 906 of the Sarbanes-Oxley Act of 2002.
* Filed herewith.
** Furnished herewith.
Exhibit 31.1
CERTIFICATION PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, John F. Davis, III, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Pegasus
Solutions, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
b) Designed such internal control over financial reporting, or
caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally accepted accounting principles; and
c) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have
disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant's auditors
and the audit committee of the registrant's board of directors
(or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably likely to adversely affect
the registrant's ability to record, process, summarize and
report financial information; and
b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: November 9, 2005
/s/ JOHN F. DAVIS, III
- ----------------------
John F. Davis, III
President, Chief Executive Officer and Chairman
Exhibit 31.2
CERTIFICATION PURSUANT TO
SECTION 302 OF
THE SARBANES-OXLEY ACT OF 2002
I, John F. Davis, III, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Pegasus
Solutions, Inc.;
2. Based on my knowledge, this report does not contain any untrue
statement of a material fact or omit to state a material fact
3. Based on my knowledge, the financial statements, and other financial
information included in this report, fairly present in
4. The registrant's other certifying officer(s) and I are responsible for
establishing and maintaining disclosure controls and
a) Designed such disclosure controls and procedures, or caused such
disclosure controls and procedures to be designed under our
b) Designed such internal control over financial reporting, or
caused such internal control over financial reporting to be
designed under our supervision, to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally accepted accounting principles; and
c) Evaluated the effectiveness of the registrant's disclosure
controls and procedures and presented in this report our
conclusions about the effectiveness of the disclosure controls
and procedures, as of the end of the period covered by this
report based on such evaluation; and
d) Disclosed in this report any change in the registrant's internal
control over financial reporting that occurred during the
registrant's most recent fiscal quarter (the registrant's fourth
fiscal quarter in the case of an annual report) that has
materially affected, or is reasonably likely to materially
affect, the registrant's internal control over financial
reporting; and
5. The registrant's other certifying officer(s) and I have
disclosed, based on our most recent evaluation of internal
control over financial reporting, to the registrant's auditors
and the audit committee of the registrant's board of directors
(or persons performing the equivalent functions):
a) All significant deficiencies and material weaknesses in the
design or operation of internal control over financial
reporting which are reasonably likely to adversely affect
the registrant's ability to record, process, summarize and
report financial information; and
b) Any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal control over financial reporting.
Date: November 9, 2005
/s/ SUSAN K. CONNER
- ----------------------
Susan K. Conner
Executive Vice President and Chief Financial Officer
Exhibit 32.1
CERTIFICATION OF CHIEF EXECUTIVE OFFICER AND
CHIEF FINANCIAL OFFICER PURSUANT TO
18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Pegasus Solutions, Inc. (the
"Company") on Form 10-Q for the period ended September 30, 2005 as filed with
the Securities and Exchange Commission on the date hereof (the "Report"), we,
the undersigned, certify, pursuant to 18 U.S.C. section 1350, as adopted
pursuant to section 906 of the Sarbanes-Oxley Act of 2002, that:
1. The Report fully complies with the requirements of section 13(a) or
15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m or
78o(d)); and
2. The information contained in the Report fairly presents, in all
material respects, the financial condition and results of operations
of the Company.
November 9, 2005 /s/ JOHN F. DAVIS, III
----------------------
John F. Davis, III,
President, Chief Executive Officer
and Chairman
November 9, 2005 /s/ SUSAN K. CONNER
----------------------
Susan K. Conner,
Executive Vice President
and Chief Financial Officer