##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




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Form 10-K

|   |  |                                                                                             
|-- |  | --------------------------------------------------------------------------------------------
|þ  |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934    
|  
|   |  | For the Fiscal Year Ended December 31,
    2003                                             
|  
|OR
|  
|o  |  | TRANSITION REPORT PURSUANT TO SECTION 13
    OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|  
|   |  | For the Transition period
    from           to                                             



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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
    incorporation or organization) |  | (I.R.S. Employer
    Identification No.)

Campbell Center One, 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


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 þ     No o

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.     o

Indicate by check mark whether the registrant is
an accelerated filer (as defined in Exchange Act
Rule 12b-2).     Yes þ     No o

The aggregate market value of the
registrants voting stock held by non-affiliates on
June 30, 2003, based on the closing price of the
registrants common stock on such date as reported on the
NASDAQ national market, was $402,844,842.

The number of shares of the registrants
common stock, par value $0.01 per share, outstanding as of
March 9, 2004 was 24,411,563.

Portions of the Registrants definitive
proxy statement for its 2004 annual meeting of stockholders to
be held on May 3, 2004 are incorporated by reference into
Part III of this Form 10-K.



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TABLE OF CONTENTS

|                                           |          |  |                                                                                           |      |  |    | 
|------------------------------------------ | -------- |  | ----------------------------------------------------------------------------------------- | ---- |  | -- | 
|                                           |          |  |                                                                                           | Page
|                                           |          |  |                                                                                           |     
|PART I                                    
|                                           | Item 1.  |  | Business                                                                                  |      |  | 2  | 
|                                           | Item 2.  |  | Properties                                                                                |      |  | 16 | 
|                                           | Item 3.  |  | Legal proceedings                                                                         |      |  | 16 | 
|                                           | Item 4.  |  | Submission of matters to a
    vote of security holders                                   |      |  | 16 | 
|PART II                                   
|                                           | Item 5.  |  | Market for registrants
    common equity and related stockholder matters                 |      |  | 16 | 
|                                           | Item 6.  |  | Selected financial data                                                                   |      |  | 17 | 
|                                           | Item 7.  |  | Managements discussion
    and analysis of financial condition and results of operations |      |  | 17 | 
|                                           | Item 7A  |  | Quantitative and qualitative
    disclosures about market risk                            |      |  | 28 | 
|                                           | Item 8.  |  | Financial statements and
    supplementary data                                           |      |  | 30 | 
|                                           | Item 9.  |  | Change in and disagreements
    with accountants on accounting and financial disclosure   |      |  | 60 | 
|                                           | Item 9A  |  | Controls and procedures                                                                   |      |  | 60 | 
|PART III                                  
|                                           | Item 10. |  | Directors and executive
    officers of the registrant                                    |      |  | 60 | 
|                                           | Item 11. |  | Named executive officers
    compensation                                                 |      |  | 60 | 
|                                           | Item 12. |  | Security ownership of
    certain beneficial owners and management                        |      |  | 60 | 
|                                           | Item 13. |  | Certain relationships and
    related transactions                                        |      |  | 61 | 
|                                           | Item 14. |  | Principal accountant fees
    and services                                                |      |  | 61 | 
|PART IV                                   
|                                           | Item 15. |  | Exhibits, financial
    statement schedules and reports on Form 8-K                       |      |  | 62 | 
|Signatures                                 |          |  | 66                                                                                        |     
|Subsidiaries of the Company               
|Consent of PricewaterhouseCoopers LLP     
|Certification of Chief Executive Officer  
|Certification of Chief Financial Officer  
|Certification of CEO and CFO - Section 906



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##### Table of Contents






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, 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 or 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, as well as
other risks and uncertainties, including those appearing in this
report under the caption Risk Factors.

Overview

Pegasus is a leading global provider of hotel
reservations-related services and technology. Founded in 1989,
Pegasus customers include a majority of the worlds
travel agencies and more than 50,000 hotel properties around the
globe. Pegasus services include central reservation
systems, electronic distribution services, commission processing
and payment services, property management systems, and marketing
representation services. The companys representation
services are used by approximately 7,000 member hotels in
approximately 40 countries, making Pegasus the hotel
industrys largest third-party marketing and reservations
provider. Pegasus has 17 offices in 12 countries, including
regional hubs in London, Scottsdale and Singapore.

The year ended December 31, 2003 was a
challenging year for the travel industry and Pegasus. The weak
economic climate in the United States, the war in Iraq and the
continuing threat of terrorism resulted in a decrease in the
demand for hotel rooms and, therefore, negatively impacted our
revenues. In addition, financial crises in the airline industry
and Severe Acute Respiratory Syndrome, or SARS, negatively
impacted the hospitality industry and Pegasus in 2003. These
events had the most impact on our representation service, which
also experienced increased competition from lower cost
distribution channels domestically. Offsetting these revenue
declines, our revenues were favorably impacted by
$6.0 million due to stronger foreign currencies than what
had been experienced in the prior year, particularly the Euro
and the British Pound. In June, we began to see a gradual
recovery in transaction volume but did not notice improving
average daily rates.

We were able to offset a large portion of the
revenue decline by reducing our expenses. We began realizing
synergies from our strategic integration during the third
quarter, and we had strict controls over discretionary spending
such as advertising, marketing and travel the entire year.
Despite the revenue decline, a more efficient cost structure
allowed Pegasus to invest in initiatives that we believe
position the company well for producing new business when travel
returns to higher levels.



| |                      
| | ---------------------
| | Strategic Integration

Previously, our services were organized into two
business segments  technology and hospitality. During
2003, we completed a strategic reorganization to integrate our
technology and hospitality segments into one operating unit. As
a result, we have integrated support functions, including sales
and marketing, product development, service delivery,
reservation/data management, information technology, finance and
human

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resources functions. The integration plan
continues our existing strategy of better aligning our
businesses with our customers needs, thus allowing for
future revenue growth and the realization of further synergies
as one fully integrated company.




| |                                
| | -------------------------------
| | Acquisition of
    Unirez, Inc.

On December 1, 2003, we completed the
acquisition of all of the outstanding securities of
Unirez, Inc., or Unirez, a hotel reservations services
company. The acquisition was consummated pursuant to a Stock
Purchase Agreement dated October 2003 and an Amendment to the
Stock Purchase Agreement dated November 24, 2003. In
consideration for the acquisition, Pegasus delivered to the
securityholders of Unirez, on a pro rata basis, $35 million
in cash and will deliver an additional cash amount estimated at
$2.5 million on December 1, 2004, subject to certain
conditions and post-closing adjustments. Pegasus utilized cash
proceeds from its previously completed convertible debt offering
to fund the acquisition. Unirez serves independent properties
and small hotel groups by providing central reservation services
that enable distribution of room inventory through global
distribution systems, or GDSs, and Internet channels.
Unirezs primary assets include its software and intangible
assets such as customer service agreements.



| |                             
| | ----------------------------
| | Issuance of convertible debt

On July 21, 2003, Pegasus issued
$75 million aggregate principal amount of convertible
senior notes through a private placement. The notes bear
interest at an annual rate of 3.875 percent, payable
semi-annually, through the maturity date of July 15, 2023.
Pegasus used a portion of the proceeds to acquire Unirez, as
described above, and expects to use the remaining net proceeds
from the offering for working capital and other general
corporate purposes, including stock repurchases.

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 hotels and
small hotel groups. 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:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Improve Customer
    Satisfaction.During 2003, we launched
    an extensive customer satisfaction initiative beginning with a
    comprehensive customer satisfaction survey. The survey results
    laid the groundwork for developing a customer service vision and
    the metrics and tools to help us measure our performance against
    our customers expectations. In 2004, we are embarking on a
    company-wide campaign to embrace customer satisfaction as part
    of our corporate culture. To emphasize the importance of
    customer satisfaction, a portion of our employees
    compensation will be tied to customer satisfaction benchmarks.
    We plan to implement initiatives to continually monitor and
    evaluate our performance.
|
| |  | 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. We believe that by bundling our existing
    services with new services such as our connectivity
    representation service  Unirez by
    PegasusTM, PegasusCentralTM,
    PegsPayTM and PegsTourTM, we can increase
    our revenue base and provide comprehensive solutions for both
    new and existing customers.                                                                                                                                                                                                                    
|
| |  | Pursue New Hospitality and Travel
    Markets.We intend to pursue new
    hospitality markets, such as the wholesale and leisure tour
    operator markets. This market is very fragmented and has a high
    degree of manual processes which can benefit from the automation
    of our distribution services. To expedite our entry into this
    market, we acquired a developer of tour operator software during
    2003. We plan to introduce our new group and tour service
    offering PegsTour within the next year. We also plan to expand
    the use of our services, particularly our financial services,
    into other travel markets, such as car rental and cruises.                                                                           

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Develop Leading Technologies and Expedite the
    Speed to Market on New Products.We
    strive to develop new technologies, services and solutions to
    meet the changing needs of our current and prospective
    customers. Under new information technology leadership, we are
    currently improving the organizational structure and processes
    of our information technology department with a focus on
    expediting the time to market of new product development.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|
| |  | Grow Hotel Representation
    Business.Independent hotels and small
    hotel groups have historically been more prominent
    internationally with the larger hotel chains being more
    recognized in the United States. We believe consumers
    demand for a unique hotel experience, combined with lower cost
    distribution channels such as the Internet, will increase the
    presence of independent hotels and small hotel companies
    internationally and in the United States. Our strategy is to
    offer this hotel segment services ranging from a basic central
    reservation system, or CRS, connection to full service
    representation, which includes marketing and voice reservation
    outsourcing. In December 2003, we acquired Unirez, which offered
    a connectivity-only service and fulfilled our multi-tiered
    representation strategy for independent hotels and small hotel
    groups. We also plan to continue focusing on travel agency
    relationships by automating the commission payment process and
    encouraging our hotel customers to pay commissions.
|
| |  | Build Strategic Alliances and
    Partnerships.We seek to build
    strategic alliances and partnerships, particularly related to
    sales distribution and product packaging. We believe that these
    relationships will broaden the brand recognition and market
    presence 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         

Services

Through our comprehensive and integrated service
offerings we can provide one or more of the following services
to the global hospitality industry:

Reservation
Services.We provide CRS services on
an application service provider, or ASP, basis to approximately
7,500 hotel properties, representing approximately
1.3 million hotel rooms worldwide (including properties in
our full-service representation portfolio). During 2003, we
processed approximately 12 million hotel bookings through
our CRS.

Reservation services provides hotel companies and
hotel representation companies with a complementary suite of
included and optional service components. At the core of
reservation services is the RezViewTM CRS, which is
fully hosted, maintained and managed by Pegasus. Optional
reservation services components include:



| |   |                                           
| | - | ------------------------------------------
| |  | Electronic distribution channel management



| |   |                                    
| | - | -----------------------------------
| |  | Internet distribution              
|
| |  | Private-label Internet distribution
|
| |  | Global distribution services       



| |   |                                         
| | - | ----------------------------------------
| |  | Private-label voice reservation services
|
| |  | Database administration                 
|
| |  | Third-party systems interfacing         

Distribution
Services.Distribution services
provides the connections and interfaces that enable hotels to
distribute their rates and inventory to  and receive
reservations from  the four GDSs used by travel
agencies worldwide, a growing number of tour operators,
wholesalers, and a wide variety of Powered by Pegasus
TM Internet sites. During 2003, distribution services
processed over 25 million transactions. Distribution
services offered to hotel companies include:



| |   |                                                                                                                                                                                                                     
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | GDS distribution  We connect hotel
    companies to the traditional distribution systems used by travel
    agencies around the world for the distribution of hotel room
    rates and inventory. These systems are

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| |   |                                                                                                                                                                                                                                                                                                                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | known as global distribution systems, and there
    are currently four major ones: Sabre, Galileo, Amadeus and
    Worldspan.                                                                                                                                                                                                                                                                            
|
| |  | Third-party Internet sites  We provide
    travel-related Internet sites access to our hotel information
    database containing content and images on more than 50,000
    properties and on-line hotel reservation capability. We provide
    this service to several of the leading travel Internet sites
    such as Expedia.com, Orbitz.com, our affiliate Travelweb.com and
    our own Utell.com.
|
| |  | Hotel Internet sites  Our
    NetBooker 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.                                                                                 

Representation
Services.We offer a variety of hotel
representation services to independent hotels and small hotel
groups. With the Unirez acquisition, Pegasus now represents
approximately 7,000 independent and small hotel group properties
around the world, including more than 3,000 in the Americas.

In order to sell their rooms in the marketplace,
many independent hotels and small hotel groups associate
themselves with our representation services and use our systems
and infrastructure to accept reservations for their rooms.
Hotels typically utilize our representation services to obtain a
presence in the primary electronic distribution channels (GDSs
and the Internet) through our CRSs and global voice reservation
capability.

Our basic representation service, Unirez by
Pegasus, provides a connection to all GDSs and thousands of
linked third-party Internet sites through a leading Web-based
CRS. The advanced technology offers a user-friendly interface
whereby our hotel customers can upload or modify hotel data,
including room rates, availability and descriptions, at any time.

In addition to a CRS connection, our full service
offering, Utell by Pegasus, includes marketing programs,
sales representation, a voice reservation call center network
covering over 40 countries and enhanced account management
support. Hotels using our full service representation offering
benefit from the enhanced market image created by affiliation
with Utell, a well-known name in hotel distribution, as well as
worldwide sales and marketing support.

Full service representation customers also have
the option to utilize our payment processing solutions,
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 for reservations, with Pegasus remitting
amounts to hotels when the guest stay occurs. TravelCom is an
Internet-based proprietary system that allows member hotels to
expedite commission payments to travel agents.

Property Services.PegasusCentral is a full-featured Internet-based property
management system, or PMS. PegasusCentral benefits both hotel
chains and independent properties by assisting in the management
and operation of many hotel functions from a single location.
Its intuitive user interface also works with existing Pegasus
products, and its superior training capability makes
PegasusCentral a cost-effective solution for the hotel industry.
PegasusCentral assists in the management and operation of many
hotel functions, including:



| |   |                                                                     
| | - | --------------------------------------------------------------------
| |  | Enhanced property management                                        
|
| |  | Customer relationship management                                    
|
| |  | Group management                                                    
|
| |  | Back-office modules such as receivables, payables
    and purchasing
|
| |  | RezView interface for two way reservation
    transmission          
|
| |  | Pegasus commission processing interface                             

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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 E-learning solution is easy to use,
    offering convenient pull-down menus, substantially reducing the
    customers learning curve. New employees, as well as
    existing employees will be able to access E-learning from any
    location to learn or refresh their skills.                                                                                               
|
| |  | 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.
    Systems backups are regularly scheduled through our professional
    data center to ensure that the most accurate data is secured.  
|
| |  | 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 2003 consisted of
maintenance and support fees related to these PMS software
solutions, as well as revenues from our PegasusCentral service.

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; and global commission solutions
for participating hotels.

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
benefits 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 approximately
$473 million in hotel commissions in 2003.

PegsPay is our payment processing service
targeted at travel distributors that operate under the merchant
model. Under the merchant model, travel distributors receive
hotel room inventory from suppliers at wholesale, or
net, rates. Travel distributors then set the retail
price for rooms and process transactions as the merchant of
record, but are generally not obligated to pay suppliers for
unsold inventory.

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

Our service offerings face competition from
within their respective markets. Principal factors affecting our
customers purchasing decisions for our services include
pricing, product functionality and product performance. To
compete successfully, we must meet our customers
expectations and 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.

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Reservation
Services.Our reservation service
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 reservation service
competitors include Trust International, SynXis Corporation
and MICROS Systems, Inc.

Distribution
Services.Pegasus distribution
services support 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. However, the cost to
    maintain a separate connection to each GDS is typically more
    costly than maintaining a single connection to Pegasus.                                                                                                                                                                                                
|
| |  | Third-party and hotel Web sites  Our
    online distribution services face competition in the online
    hotel room reservation business from GDSs, middleware providers
    and Web sites establishing direct connections. 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. These companies
    are known as middleware providers. The cost of entry into the
    Internet hotel room reservation business is relatively low.

Representation
Services.Our hotel representation
services compete with other providers of distribution, sales and
marketing services, including hotel groups, franchisers,
reservation companies and other travel or hotel representation
companies. Our largest competitors for hotel representation are
VIP International Corporation, SHS-WorldHotels, Supranational
Hotels, SynXis Corporation and Sceptre Hospitality Resources.

Property Services.Our property services compete with hotel companies that sell
their own PMSs and third parties that provide PMSs. Our primary
property service competitors include MICROS Systems, Inc.,
Hotel Information Systems, Northwinds Maestro PMS and
Ramesys Hospitality.

Financial Services.Our commission processing service faces competition principally
from Perot Systems, Inc. In addition, current or
prospective hotel customers can decide to process commission
payments on their own. Our new PegsPay service competes with
credit card processors.

Seasonality

Our business, particularly our representation
services, 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 39 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.
Quantitative and Qualitative Disclosures about Market Risk.

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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 $5.2 million, $5.8 million and
$7.8 million for 2003, 2002 and 2001, respectively. The
decrease in research and development expenses in 2003 is
primarily due to the increase in capitalized payroll costs
associated with software development efforts.

Employees

At February 29, 2004, we had 1,320
employees, 950 of which are located in the United States. We had
306 persons performing information technology functions, 775
persons performing sales and marketing, customer relations and
business development functions, and the remainder performing
corporate, finance and administrative functions. We have no
unionized employees. We believe that our employee relations are
satisfactory.

Available Information

The public may read and copy any materials filed
with the SEC at the SECs Public Reference Room at 450
Fifth Street, N.W., Washington, D.C. 20549. Information on the
operation of the Public Reference Room may be obtained by
calling the SEC at 1-800-SEC-0330. As an electronic filer,
Pegasus reports, proxy and information statements, and
other information is available at the SECs Internet site,
http://www.sec.gov.

Our Internet address is www.pegs.com. Select
Company SEC reports, including Reports on Form 10-K,
Form 10-Q and Form 8-K (and amendments to those
reports), are available free of charge on our Web site as soon
as reasonably practicable after electronic filing or furnishing
with the SEC. Our Code of Ethics for Senior Financial Officers,
amendments thereto and waivers thereof are published and
maintained on our Web site. Once published, any waiver will be
posted for at least twelve months after it is granted. We
disclaim incorporation by reference of information contained on
any Internet site.

Risk Factors

Risks related to our industry



| |                                                                                                                                       
| | --------------------------------------------------------------------------------------------------------------------------------------
| | A weakened economic climate and other world
    events may adversely affect our stock price, operations and
    financial performance.

A weakened economic climate and the other world
events, such as the continuing threat of terrorism, the war in
Iraq, health epidemics and continuing geopolitical uncertainty,
have adversely impacted the travel industry and our business.
These events were preceded by the terrorist attacks of
September 11, 2001, which resulted in sharp declines in
both the number of hotel room reservations and the average daily
rate charged for hotel rooms. The overall long-term impact of
these events on Pegasus and the travel industry is uncertain,
but their continued existence is likely to have a material
adverse effect on our business, operating results and financial
condition.

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| |                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 factor. The hotel industry is susceptible to
rapid and unexpected downturns, as experienced after the events
of September 11, 2001, the war in Iraq, and the SARS health
crisis. 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. A continued
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                                                                   
|
| |  | Increased government regulation and enforcement                                         
|
| |  | Global or regional health issues                                                        
|
| |  | Gasoline and aviation fuel price escalation                                             
|
| |  | 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. 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 offer negotiated rates to major corporate
customers that are non-commissionable to travel agencies. If
there is any decline in average daily room rates, change in the
commission payment process, reduction in the amount of
commissions paid for reservations or any increase in the direct
distribution of rooms by hotels, our revenues and net income
could substantially decrease.



| |                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------
| | Consolidation in the hotel industry and
    electronic reservations industry could result in reduced
    revenues.

We offer volume-based discounted fees for some of
our services. 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 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.

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Risks Related to the Company



| |                                                                                     
| | ------------------------------------------------------------------------------------
| | Loss of our arrangements with key customers
    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. In addition,
customers may elect to utilize our lower cost service offerings
over our higher-priced offerings that provide us with greater
revenue. For example, our representation customers may switch
from our full service offering Utell by Pegasus to our
connectivity only offering Unirez by Pegasus, resulting in less
revenue to us. 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.



| |                                                                                  
| | ---------------------------------------------------------------------------------
| | Loss of third party service arrangements
    could adversely affect our business.

We rely on third parties for many services,
including remittance and worldwide currency exchange services
for our commission processing service and for facility
maintenance and SAP hosting. 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.



| |                                                                                                                                                                                                                                                                                                                                                                   
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we do not develop new technologies and
    services in a timely manner with acceptable performance levels
    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 a timely manner and with
acceptable performance levels. 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 in a timely manner and with acceptable performance
levels.

We also may 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.

We also rely increasingly on third party
arrangements for the development and provision of our services.
Such outsourcing presents a number of risks
primarily relating to our reduced control of the operations that
are outsourced. Further, because much outsourcing occurs outside
of the U.S., these activities are subject to the risks of
international operations, including the risk of increased
governmental regulation of these activities.

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.

10



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| |                                                                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 possess. 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.



| |                                                                                                                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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, 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.



| |                                                                                                                                                                                                                                                       
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may not have the resources to
    effectively manage our growth, and difficulties 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 Company resources, possibly
adversely impacting our existing operations.

In addition to our 2003 acquisitions of Total
Distribution System Limited, or TDS, and Unirez, we regularly
evaluate acquisition and joint venture opportunities and in the
future may make additional acquisitions of other companies or
technologies or enter into joint ventures. Acquisition and joint
ventures 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 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

11



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##### Table of Contents



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.



| |                                                                                             
| | --------------------------------------------------------------------------------------------
| | 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.

As of December 31, 2003, we had accounts
receivable as a result of our ongoing operations of
approximately $25.2 million. Additionally, we had notes
receivable of approximately $7.5 million at
December 31, 2003, primarily related to the sale of
business units to IndeCorp Corporation. Our receivables,
including the amounts due and payable to us by IndeCorp, are
monitored by management for collectibility. We maintain
allowances for doubtful accounts for estimated losses resulting
from the inability of parties to make required payments,
including the amounts payable by IndeCorp under promissory notes
payable to us. 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 we may incur additional
expense for past or future fiscal periods to increase our
allowance for doubtful accounts and we may receive less cash
than expected if the financial condition of the parties were to
deteriorate resulting in an impairment of their ability to make
payments.



| |                                                                                                                                                                                                                                                                                                            
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 a substantial portion 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 and regulations of the
    United States and foreign governments on foreign trade and
    commerce, such as the USA PATRIOT Act
|
| |  | Compliance with information privacy laws and
    related enforcement actions                                                                          
|
| |  | 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                                                                               

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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 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 our ability to retain the
services of our current executive officers and other key
personnel, and to manage effectively any transition in the event
of a change in such key personnel. Even though we currently have
key-man insurance covering our CEO, this insurance
amount may not adequately compensate us for the loss of his
services and does not cover other key personnel. 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, new or amended laws
    and other legal uncertainties could force us to change our
    operations.

Our operations are subject to the laws and
regulations of the United States and numerous states and
international jurisdictions. Changes regarding any of these laws
and regulations, their enforcement or our understanding of the
applicable requirements could force us to change our operations
or result in other uncertain consequences. Also, our primary
customers are hotel chains, independent hotels, hotel
representation firms and travel agencies, and we participate in
a venture with six other companies. 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. In addition, 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, have not yet been thoroughly interpreted by the courts, and
are subject to change by many jurisdictions, including federal,
state, municipal and international jurisdictions. Any change in
these laws or regulations, or any such actions or similar
allegations by third parties, could have a material adverse
effect on our business, operating results and financial
condition.



| |                                                                                                                                                                                                 
| | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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

13



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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, we are involved in legal and
other regulatory proceedings. We intend to defend our 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 increased our leverage as a result of
    the sale of the convertible notes in July 2003.

In connection with the sale of the convertible
notes, we incurred $75 million of indebtedness. As a result
of this indebtedness, our interest payment obligations have
increased. The degree to which we are leveraged could adversely
affect our ability to obtain further financing for working
capital, acquisitions or other purposes and could make us more
vulnerable to industry downturns and competitive pressures. Our
ability to meet our debt service obligations will be dependent
upon our future performance, which will be subject to the
financial, business and other factors affecting our operations,
many of which are beyond our control.



| |                                                                                               
| | ----------------------------------------------------------------------------------------------
| | We may be unable to generate sufficient
    cash flow to satisfy our debt service obligations.

Our ability to generate cash flow from operations
to make interest payments on the convertible notes will depend
on our future performance, which will be affected by a range of
economic, competitive and business factors. We cannot control
many of these factors, including general economic conditions and
the health of the hotel industry. If our operations do not
generate sufficient cash flow from operations to satisfy our
debt service obligations, we may need to borrow additional funds
to make these payments or undertake alternative financing plans,
such as refinancing or restructuring our debt, or reducing or
delaying capital investments and acquisitions. Additional funds
or alternative financing may not be available to us on favorable
terms, or at all. Our inability to generate sufficient cash flow
from operations or obtain additional funds or alternative
financing on acceptable terms could have a material adverse
effect on our business, financial condition and results of
operations.



| |                                                                                         
| | ----------------------------------------------------------------------------------------
| | We may be unable to repay or purchase the
    principal amount of the convertible notes.

At maturity, the entire outstanding principal
amount of the convertible notes will become due and payable by
us. In addition, on July 16, 2008, July 16, 2013 and
July 16, 2018 or if a fundamental change occurs, as defined
in the indenture relating to the convertible notes, each holder
of the convertible notes may require that we purchase all or a
portion of that holders notes. We cannot assure you that
we will have sufficient funds or will be able to arrange for
additional financing to pay the principal amount or purchase
price due. In that case, our failure to repay the convertible
notes at maturity or to purchase any tendered notes would
constitute an event of default under the indenture.



| |                                                                                                                                    
| | -----------------------------------------------------------------------------------------------------------------------------------
| | Our reported earnings per share may be
    lower and more volatile because of the contingent conversion
    provision of the notes.

Holders of the notes are entitled to convert the
notes into our common stock, among other circumstances, if the
closing sale price of our common stock for at least 20 trading
days in the 30 trading day period ending on the last day of the
immediately preceding calendar quarter is greater than or equal
to 120% of the conversion

14



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##### Table of Contents



price in effect on that 30th trade day. Until
this contingency or another conversion contingency is met, the
shares underlying the notes are not included in that calculation
of our basic or fully diluted earnings per share. Should this
contingency be met, fully diluted earnings per share would be
expected to decrease as a result of the inclusion of the
underlying shares in the fully diluted earnings per share
calculation. Volatility in our stock price could cause this
condition to be met in one quarter and not in a subsequent
quarter, increasing the volatility of our fully diluted earnings
per share.




| |                                                                                            
| | -------------------------------------------------------------------------------------------
| | 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                                                                                                                                
|
| |  | Lack of confidence in the Companys ability
    to execute on certain products or services                                                                 

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. Sales of substantial amounts of
shares of our common stock in the public market, or the
perception that those sales may occur, could cause the market
price of our common stock to decline.



| |                                                                                                                              
| | -----------------------------------------------------------------------------------------------------------------------------
| | Our minority interest and other investments
    could adversely affect our financial condition and results of
    operations.

We have in the past and may in the future make
investments in other companies and ventures. There can be no
assurance of the success of any such investment. Additionally,
Financial Accounting Standards Board Interpretation No. 46
may require us to consolidate entities with which we have an
affiliation but no voting or operational control. In doing so,
we may have little or no control over the success of the company
or venture and we may be required to record the losses of these
consolidated entities in our financial statements.

15



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##### Table of Contents








|        |           
|------- | ----------
|Item 2. | Properties

Our corporate headquarters is located in a leased
facility with approximately 100,000 square feet of space in
Dallas, Texas. We also have regional hubs in Scottsdale, London
and Singapore with approximately 145,000, 20,000 and
8,000 square feet of leased office space, respectively. In
total, we have 17 offices in 12 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, 2003.




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 9, 2004, there were
approximately 359 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.

|     |                |      |   |       |  |  |   |       | 
|---- | -------------- | ---- | - | ----- |  |  | - | ----- | 
|     |                | High |   | Low  
|     |                |      |   |      
|2003 |                |      |   |       |  |  |   |      
|     | Fourth quarter |      | $ | 14.06 |  |  | $ | 9.30  | 
|     | Third quarter  |      |   | 17.00 |  |  |   | 13.34 | 
|     | Second quarter |      |   | 17.00 |  |  |   | 10.70 | 
|     | First quarter  |      |   | 11.96 |  |  |   | 9.16  | 
|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 | 

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,
requirements related to our convertible debt offering, 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

16



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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.







|        |                        
|------- | -----------------------
|Item 6. | Selected Financial Data

The following selected consolidated financial
data as of and for the years ended December 31, 2003 and
2002, and for the year ended December 31, 2001 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, 2001 and as of and for the years ended
December 31, 2000 and 1999 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.

|                            |         |                                       |         |             |   |              |         |             |   |         |         |       |   |   |         |       |   |   |         |      | 
|--------------------------- | ------- | ------------------------------------- | ------- | ----------- | - | ------------ | ------- | ----------- | - | ------- | ------- | ----- | - | - | ------- | ----- | - | - | ------- | ---- | 
|                            |         |                                      
|                            |         | Year Ended December 31,              
|                            |         |                                      
|                            |         | 2003                                  |         | 2002        |   | 2001         |         | 2000        |   | 1999   
|                            |         | (1), (2), (3),(4)                     |         | (1),(2),(4) |   | (1), (2),(5) |         | (1),(5),(6) |   | (5),(6)
|                            |         |                                       |         |             |   |              |         |             |   |        
|                            |         |                                      
|                            |         | (In thousands, except per share data)
|Service revenues            |         | $                                     | 161,245 |             |   | $            | 178,769 |             |   | $       | 180,668 |       |   | $ | 162,199 |       |   | $ | 38,036  |     
|Customer reimbursements     |         |                                       | 11,485  |             |   |              | 11,181  |             |   |         | 12,079  |       |   |   | 10,452  |       |   |   | 682     |     
|                            |         |                                       |         |             |   |              |         |             |   |         |         |       |   |   |         |       |   |   |         |     
|Total revenues              |         |                                       | 172,730 |             |   |              | 189,950 |             |   |         | 192,747 |       |   |   | 172,651 |       |   |   | 38,718  |     
|Net income (loss)           |         |                                       | (1,832  | )           |   |              | (3,519  | )           |   |         | (29,737 | )     |   |   | (26,582 | )     |   |   | 8,666   |     
|Net income (loss) per share |         |                                       |         |             |   |              |         |             |   |         |         |       |   |   |         |       |   |   |         |     
|                            | Basic   |                                       |         | (0.07       | ) |              |         | (0.14       | ) |         |         | (1.21 | ) |   |         | (1.14 | ) |   |         | 0.47 | 
|                            | Diluted |                                       |         | (0.07       | ) |              |         | (0.14       | ) |         |         | (1.21 | ) |   |         | (1.14 | ) |   |         | 0.44 | 
|Working capital (deficit)   |         |                                       | 59,057  |             |   |              | 16,995  |             |   |         | (5,541  | )     |   |   | 9,049   |       |   |   | 145,787 |     
|Total assets                |         |                                       | 366,560 |             |   |              | 288,095 |             |   |         | 305,668 |       |   |   | 357,705 |       |   |   | 163,540 |     
|Long-term debt              |         |                                       | 75,000  |             |   |              |        |             |   |         |        |       |   |   | 20,000  |       |   |   |        |     
|Total stockholders equity  |         |                                       | 228,656 |             |   |              | 225,890 |             |   |         | 231,201 |       |   |   | 260,572 |       |   |   | 156,772 |     



---



|    |                                                                                                                                                                                                                                                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Pegasus selected consolidated financial
    data includes the operating results related to the acquisition
    of REZ, Inc. in April 2000.                                                                                                       
|   
|(2) | Pegasus selected consolidated financial
    data includes the operating results of GETS following the
    acquisition in September 2001.                                                                                                         
|   
|(3) | Pegasus selected consolidated financial
    data includes the operating results of Unirez following the
    acquisition in December 2003.                                                                                                        
|   
|(4) | Effective January 1, 2002, in accordance
    with Statement of Financial Accounting Standards No. 142,
    Goodwill and Other Intangibles, Pegasus ceased to
    record goodwill amortization.                                                  
|   
|(5) | Revenues have been reclassified to give effect to
    the 2002 adoption of the Emerging Issues Task Force, or
    EITF, Issue 01-14, Income Statement Characterization
    of Reimbursements Received for Out-of-Pocket
    Expenses Incurred.
|   
|(6) | Certain net income (loss) 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,

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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. This discussion and analysis contains forward-looking
statements that 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 or 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, as well as other
risks and uncertainties, including those appearing under the
caption Risk Factors set forth under Item 1 of
this annual report on Form 10-K.


Overview

The year ended December 31, 2003 was a
challenging year for the travel industry and Pegasus. The weak
economic climate in the United States, the war in Iraq and the
continuing threat of terrorism resulted in a decrease in the
demand for hotel rooms and, therefore, negatively impacted our
revenues. In addition, financial crises in the airline industry
and Severe Acute Respiratory Syndrome, or SARS, negatively
impacted the hospitality industry and Pegasus in 2003. These
events had the most impact on our representation service, which
also experienced increased competition from lower cost
distribution channels domestically. Offsetting these revenue
declines, our revenues were favorably impacted by
$6.0 million due to stronger foreign currencies than what
had been experienced in the prior year, particularly the Euro
and the British Pound. In June, we began to see a gradual
recovery in transaction volume but did not notice improving
average daily rates.

We were able to offset a large portion of the
revenue decline by reducing our expenses. We began realizing
synergies from our strategic integration during the third
quarter of 2003, and we had strict controls over discretionary
spending such as advertising, marketing and travel during the
entire year. Despite the revenue decline, a more efficient cost
structure allowed Pegasus to invest in initiatives that we
believe position the company well for producing new business
when travel returns to higher levels.

Late in 2003, we discovered stability issues with
our property management system PegasusCentral. Using both
internal and external resources, we performed a diagnostic
review and a detailed root-cause analysis. Together with our
consultant in this process, we have determined that by
remediating a small percentage of the code we could correct the
significant issues impacting our customers, and that by
developing additional functionality we could significantly
improve our product offering. For InterContinental Hotels Group,
our largest PegasusCentral customer, we currently expect to
complete software upgrades of the existing installed base during
the second quarter of 2004. During the fourth quarter of 2004,
we expect to deliver an enhanced version of PegasusCentral based
on customer requirements, perform acceptance testing and resume
installations at new hotel properties. PegasusCentral has not
yet contributed a material amount of revenues. However, we still
believe this service will contribute to the long-term growth of
Pegasus and are committed to delivering a stable product that
meets our customers expectations.

Dependence on the Hotel Industry

Our business is sensitive to changes in the
demand for, and average daily rates associated with, hotel
rooms. Historically, after periods of low demand for hotel
rooms, average daily rates have lagged behind the recovery in
transaction volumes. Since our distribution and reservation
services revenues are primarily transaction-based, revenues for
these services have recovered more quickly than our hotel
representation and financial services, which are based in large
part on a combination of reservation volume and average daily
rates. In addition, we have experienced a lengthening in the
sales cycle for some of our services, as new customers are
hesitant to sign new contracts in an uncertain economic
environment.

18



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##### Table of Contents



Revenues

Representation
Services.We offer a variety of hotel
representation services to independent hotels and small hotel
groups. Representation services revenues consist of reservation
processing fees, membership fees and fees for various marketing
services. In addition, the Paytell service allows international
travelers, who book rooms at hotels for which we provide
representation services, to prepay for their hotel rooms in the
hotel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 transaction fees and the difference in the exchange
rate between the date the traveler pays and the date the guest
stay occurs. Representation services revenues represented
approximately 36 percent of service revenues for 2003.

Reservation
Services.We provide CRS services on
an application service provider, or ASP, basis. Reservation
services revenues consist of transaction fees as well as
license, maintenance and support fees related to our RezView CRS
software. Reservation services revenues represented
approximately 23 percent of service revenues for 2003.

Financial Services.Our financial services offering provides comprehensive
commission processing and payment solutions to hotels, other
travel suppliers and travel agencies. Financial services
revenues 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 demand for
hotel rooms, the types of hotels (such as upscale or economy) 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 19 percent of service revenues for 2003.

Distribution
Services.Our distribution services
provide the connections and interfaces that enable hotels to
distribute their rates and inventory to  and receive
reservations from  the four GDSs used by travel
agencies worldwide, a growing number of four operators,
wholesalers, and a variety of Powered by Pegasus sites. During
2003 distribution services processed approximately
25 million transactions. Distribution services revenues
primarily consist of transaction fees, commissions and monthly
subscription or maintenance fees. In addition, new hotel
customers typically pay a one-time fee for establishing the
connection between the hotels central reservation system
and the electronic distribution technology. New third-party
Internet site customers typically pay a one-time fee for
establishing the connection between the third-party Internet
site and our electronic distribution technology, which is
amortized over the related contract period. Distribution
services revenues represented approximately 18 percent of
service revenues for 2003.

Property Services.Property services revenues primarily consist of maintenance and
support fees related to legacy PMSs acquired from REZ and GETS.
In addition, property services revenues include fees from our
PegasusCentral PMS, which are recognized monthly. Property
services represented approximately 4 percent of service revenues
for 2003.

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.

Customer
Reimbursements.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.

The classification of service revenues and
customer reimbursements has been reflected in the financial
statements to give effect to the 2002 adoption of the Emerging
Issues Task Force, or EITF, Issue 01-14 Income
Statement Characterization of Reimbursements Received for
Out-of-Pocket Expenses Incurred (EITF
01-14). Under EITF 01-14, Pegasus billings for
out-of-pocket expenses, such as third-party vendor

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GDS and telecommunication charges, are 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 or cash flows.


Costs

Pegasus costs of services consist
principally of personnel costs relating to information
technology, customer service and telemarketing; facilities; and
equipment maintenance costs. Costs of services also include 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,
and certain facilities costs. 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 intangible assets. Interest income primarily
includes income earned on the Companys investments.
Interest expense primarily includes interest and amortization of
capitalized issuance costs related to the $75 million
convertible debt offering.

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 Pegasus earning more or less revenue
and expending more or less in expenses than it otherwise might
have earned if currency rates had remained stable.

Recent Developments



| |                           
| | --------------------------
| | Strategic integration plan

Previously, our services were organized into two
business segments  technology and hospitality. During
2003, we completed a strategic reorganization to integrate our
technology and hospitality segments into one operating unit. As
a result, we have integrated support functions, including 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
customers needs, thus allowing for future revenue growth
and the realization of further synergies as one fully integrated
company. Because we have changed our management approach,
organizational structure, operating performance assessment and
reporting, and operational decision-making from a segment
perspective (technology and hospitality) to a single company
perspective, we do not report separate segment information.



| |                             
| | ----------------------------
| | Issuance of convertible debt

On July 21, 2003, Pegasus issued
$75 million aggregate principal amount of convertible
senior notes through a private placement. The notes bear
interest at an annual rate of 3.875 percent, payable
semi-annually, through the maturity date of July 15, 2023,
and are further described under Liquidity and Capital
Resources below. Pegasus used a portion of the proceeds to
acquire Unirez, as described above, and expects to use the
remaining net proceeds from the offering for working capital and
other general corporate purposes, including the stock
repurchases described under Liquidity and Capital
Resources below.



| |                                                     
| | ----------------------------------------------------
| | Acquisition of Total Distribution System
    Limited

In September 2003, Pegasus acquired all of the
stock of Total Distribution System Limited, a UK developer of
tour operator software applications, for approximately
$1.7 million. Pegasus accounted for the acquisition of
Total Distribution System Limited as a capital expenditure
because the acquired companys primary asset was its
internally developed software.

20



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##### Table of Contents





| |                                
| | -------------------------------
| | Acquisition of
    Unirez, Inc.

On December 1, 2003, Pegasus completed the
acquisition of all of the outstanding securities of Unirez, a
hotel reservations services company. Unirezs results of
operations are included in the accompanying consolidated
financial statements subsequent to the acquisition date. The
acquisition was consummated pursuant to a Stock Purchase
Agreement dated October 24, 2003 and an Amendment to the
Stock Purchase Agreement dated November 24, 2003. In
consideration for the acquisition, Pegasus delivered to the
securityholders of Unirez, on a pro rata basis, $35 million
in cash and will deliver an additional cash amount estimated at
$2.5 million on December 1, 2004, subject to certain
conditions and post-closing adjustments. Pegasus utilized cash
proceeds from its previously completed convertible debt offering
to fund the acquisition.

Unirez serves independent properties and small
hotel groups by providing central reservation services that
enable distribution of room inventory through GDSs and Internet
channels. Unirezs primary assets include its software and
intangible assets such as customer service agreements. Under
contractual agreements, Pegasus had provided distribution
services to Unirez since January 21, 2000.

Years Ended December 31, 2003 and
2002

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.

Revenues.As
reflected in the table below, total revenues in 2003 decreased
to $172.7 million from $190.0 million in 2002. Total
service revenues decreased $17.5 million, or
10 percent, to $161.2 million in 2003, compared to
$178.8 million in 2002. Excluding a $3.5 million
termination fee received from a customer following the
termination of its contract in March 2002, service revenues
decreased $14.0 million. The decrease in service revenues
was primarily due to the loss of two CRS customer contracts that
contributed $10.5 million of revenue in 2002. Additionally,
year-over-year revenue comparisons are impacted by general
factors discussed in the Overview, above.

Other changes in the business are described in
the paragraphs that follow the presentation of service line
revenues below (in thousands).

|                                                                                         |  |      |         |      |  |   |         |    
|---------------------------------------------------------------------------------------- |  | ---- | ------- | ---- |  | - | ------- | ---
|                                                                                         |  | 2003 |         | 2002
|                                                                                         |  |      |         |     
|Representation services                                                                  |  | $    | 57,409  |      |  | $ | 64,071  |    
|Reservation services                                                                     |  |      | 38,349  |      |  |   | 54,309  |    
|Financial services                                                                       |  |      | 30,244  |      |  |   | 29,904  |    
|Distribution services                                                                    |  |      | 28,764  |      |  |   | 23,941  |    
|Property services                                                                        |  |      | 6,479   |      |  |   | 6,544   |    
|                                                                                         |  |      |         |      |  |   |         |    
|Total service revenues                                                                   |  |      | 161,245 |      |  |   | 178,769 |    
|                                                                                         |  |      |         |      |  |   |         |    
|Customer reimbursements                                                                  |  |      | 11,485  |      |  |   | 11,181  |    
|                                                                                         |  |      |         |      |  |   |         |    
|Total revenues                                                                           |  | $    | 172,730 |      |  | $ | 189,950 |    
|                                                                                         |  |      |         |      |  |   |         |    
|Total service revenues from continuing
    operations, excluding customer reimbursements |  | $    | 161,245 |      |  | $ | 175,235 | (1)
|                                                                                         |  |      |         |      |  |   |         |    



---



|    |                                                                                            
|--- | -------------------------------------------------------------------------------------------
|(1) | Excludes a $3.5 million termination fee
    included in reservation services in March 2002.

Representation services revenues decreased
$6.7 million, or 10 percent, to $57.4 million in
2003, compared to $64.1 million in 2002. The decrease was
primarily due to a decline in domestic and transatlantic
bookings for our full-service offering  Utell by
Pegasus, caused primarily by the global economic climate and
other world events, as well as an 8 percent decrease in the
number of hotels Utell represents, as a result of pricing
pressure from lower cost distribution channels. These decreases
were partially offset by the favorable

21



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##### Table of Contents



impact from a strong Euro and British Pound
relative to the U.S. dollar and the results of operations
of Unirez subsequent to the December 1, 2003 acquisition,
which contributed $874,000 to revenues.


Reservation services revenues decreased
$16.0 million, or 29 percent, to $38.3 million in
2003, compared to $54.3 million in 2002. Excluding the
impact of the $3.5 million termination fee noted above,
reservation services revenues decreased $12.4 million, or
24 percent. The decrease was primarily due to the
termination of two customer contracts that provided
$10.5 million of revenue in 2002, with the remaining
decrease caused by lower transaction volumes and pricing
pressure on contract renewals.

Financial services revenues increased $340,000 to
$30.2 million in 2003, compared to $29.9 million in
2002. The increased revenue was primarily attributable to an
increase in electronic reconciliation and tracking services of
$816,000 and an increase in fees for our PegsPay service of
$522,000. These increases were offset by a 3 percent
decrease in gross commissions, resulting from decreased
transaction volumes and lower average daily rates charged by
hotels.

Distribution services revenues increased
$4.8 million, or 20 percent, to $28.8 million in
2003, compared to $23.9 million in 2002. The increase was
primarily due to a 32 percent increase in Internet
transactions in 2003, compared to 2002.

Property services revenues were essentially flat
at $6.5 million in 2003 and 2002, due to delays in the
rollout of PegasusCentral because of stability issues.

Customer reimbursements increased to
$11.5 million in 2003, compared to $11.2 million in
2002, due to an increase in our customers GDS costs.

Cost of services.Cost of services, excluding customer reimbursements, was
$85.2 million in 2003, compared to $88.7 million in
2002. The decrease was primarily due to a $4.0 million
reduction in payroll and related expenses, mostly due to the
Companys 2003 restructuring. Additionally, the Company
experienced a $1.3 million reduction in bad debt expense
due to an overall improvement in the collectibility of the
Companys accounts receivable. These decreases were offset
by non-recurring costs of $1.4 million incurred in 2003 for
moving the Companys Arizona office and data center to new
facilities and transition activities resulting from the
Companys strategic integration. Cost of services as a
percentage of service revenues was 53 percent and
50 percent in 2003 and 2002, respectively.

Research and
development.Research and development
expenses were $5.2 million in 2003, compared to
$5.8 million in 2002. The decrease was primarily due to an
increase in capitalized payroll costs associated with an
increase in the number of projects that are eligible for
capitalization. Research and development expenses as a
percentage of service revenues were 3 percent in 2003 and
2002.

General and administrative
expenses.General and administrative
expenses were $23.3 million in 2003, compared to
$25.1 million in 2002. The decrease was primarily due to
lower payroll and operating expenses, due to the Companys
2003 restructuring, as well as reductions in discretionary
spending in light of the challenging operating environment.
These decreases were slightly offset by higher employee-related
and insurance costs in 2003. General and administrative expenses
as a percentage of service revenues were 14 percent in 2003
and 2002.

Marketing and promotion
expenses.Marketing and promotion
expenses were $16.5 million in 2003, compared to
$18.0 million in 2002. The decrease was primarily due to
lower payroll expenses due to the Companys 2003
restructuring, as well as an increased focus on reducing
discretionary spending. Marketing and promotion expenses as a
percentage of service revenues were 10 percent in 2003 and
2002.

Depreciation and
amortization.Depreciation and
amortization expenses were $28.0 million in 2003, compared
to $48.1 million in 2002. The decrease is primarily because
in March 2003, we completed the amortization for certain
purchased intangible assets related to the REZ acquisition. This
resulted in a $21.3 million decrease.

22



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##### Table of Contents



Restructure costs.During 2003, the Company incurred restructure charges of
$5.9 million, composed of one-time termination benefits and
facilities-related charges related to reorganizing its
operations from a business unit structure into distinct
functional areas.

Interest income.Interest income increased $146,000 in 2003, compared to 2002,
primarily from investing a portion of the proceeds from the July
2003 convertible debt offering.

Interest expense.Interest expense was $1.6 million in 2003, compared to
$53,000 in 2002, primarily due to the July 2003 convertible debt
offering for $75 million in aggregate principal at
3.875% per annum.

Income tax benefit.Pegasus recorded an income tax benefit of $905,000 in 2003,
representing an effective tax rate of 33 percent. Pegasus
recorded an income tax benefit of $2.1 million in 2002,
representing an effective tax rate of 38 percent. The
effective tax rate for 2003 differed from the statutory rate
primarily due to the detriment of nondeductible expenses, offset
by the benefit of lower foreign tax rates.

Years Ended December 31, 2002 and
2001

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. None
of those costs remain unpaid at December 31, 2003.

Revenues.Year over
year revenue comparisons were 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
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 service line
revenues, below (in thousands).

|                                                                                         |  |      |         |      |  |   |         |    
|---------------------------------------------------------------------------------------- |  | ---- | ------- | ---- |  | - | ------- | ---
|                                                                                         |  | 2002 |         | 2001
|                                                                                         |  |      |         |     
|Representation services                                                                  |  | $    | 64,071  |      |  | $ | 73,513  |    
|Reservation services                                                                     |  |      | 54,309  |      |  |   | 54,067  |    
|Financial services                                                                       |  |      | 29,904  |      |  |   | 28,548  |    
|Distribution services                                                                    |  |      | 23,941  |      |  |   | 19,632  |    
|Property services                                                                        |  |      | 6,544   |      |  |   | 4,650   |    
|Business intelligence                                                                    |  |      |        |      |  |   | 258     |    
|                                                                                         |  |      |         |      |  |   |         |    
|Total service revenues                                                                   |  |      | 178,769 |      |  |   | 180,668 |    
|Customer reimbursements                                                                  |  |      | 11,181  |      |  |   | 12,079  |    
|                                                                                         |  |      |         |      |  |   |         |    
|Total revenues                                                                           |  | $    | 189,950 |      |  | $ | 192,747 |    
|                                                                                         |  |      |         |      |  |   |         |    
|Total service revenues from continuing
    operations, excluding customer reimbursements |  | $    | 175,235 | (1)  |  | $ | 173,675 | (2)
|                                                                                         |  |      |         |      |  |   |         |    



---



|    |                                                                                                    
|--- | ---------------------------------------------------------------------------------------------------
|(1) | Excludes a $3.5 million termination fee
    included in reservation services in March 2002.        
|   
|(2) | Excludes business intelligence and Golden Tulip
    operations included in representation services.

23



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##### Table of Contents



Representation services revenues 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.

Reservation services revenues increased $242,000
to $54.3 million in 2002, compared to $54.1 million in
2001. Excluding the impact of the termination fee noted above,
reservation services revenues decreased $3.3 million, or 6
percent, primarily due to the absence of ongoing revenues from
the terminated customer.

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.

Distribution services revenues increased
$4.3 million, or 22 percent, to $23.9 million in
2002, compared to $19.6 million in 2001. The increase was
primarily due to a 46 percent increase in Internet
transactions in 2002, compared to 2001.

Property 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 approximately
$1.0 million of incremental revenue during 2002. The
remainder of the increase was due to revenue generated by
PegasusCentral services.

Customer reimbursements decreased approximately
$900,000 to $11.2 million in 2002, compared to
$12.1 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

24



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##### Table of Contents



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.

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.

Liquidity and Capital Resources

Pegasus principal sources of capital at
December 31, 2003 included cash and cash equivalents of
$59.0 million, short-term marketable securities of
$4.0 million and long-term marketable securities of
$7.3 million. Pegasus had working capital of
$59.1 million at December 31, 2003, compared to
working capital of $17.0 million at December 31, 2002.
This increase in working capital from December 31, 2002 to
December 31, 2003 was primarily due to the net proceeds of
the convertible debt offering remaining after the
December 1, 2003 acquisition of Unirez.

In 2003, net cash provided by operating
activities decreased to $24.1 million, from
$38.3 million in 2002, primarily due to a reduction in
service revenues and the impact of restructure costs paid in
2003.

Net cash used in investing activities increased
to $59.7 million in 2003, compared to $29.5 million in
2002. This increase was primarily the result of the
December 1, 2003 acquisition of Unirez, as well as a
decrease in proceeds from maturities of marketable securities.
These items were offset by a decrease in property and equipment
purchases associated with finalizing of our Dallas and Phoenix
office relocations. Net cash provided by financing activities
was $74.7 million in 2003, compared to cash used in
financing activities of $2.3 million in 2002. This increase
was primarily the result of the July 2003 convertible debt
offering, described below, as well as the absence of treasury
stock purchases in 2003, which totaled $4.6 million in 2002.



| |                 
| | ----------------
| | Convertible debt

On July 21, 2003, Pegasus issued
$75 million aggregate principal amount of convertible
senior notes through a private placement. Pegasus utilized a
portion of the proceeds of the offering to effect the
December 1, 2003 acquisition of Unirez. Pegasus expects to
use the remaining net proceeds from the offering for working
capital and other general corporate purposes, including the
stock repurchases described below.

The notes bear interest at an annual rate of
3.875 percent, payable semi-annually through the maturity
date of July 15, 2023. Each note is convertible into
Pegasus common stock at a conversion price of
approximately $20.13 per share (equal to an initial
conversion rate of approximately 49.6808 shares per $1,000
principal amount of notes), subject to adjustment in certain
circumstances. Holders of the notes may convert

25



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##### Table of Contents



their notes only if (i) the price of
Pegasus common stock reaches specified thresholds;
(ii) the notes have been called for redemption; or
(iii) specified corporate transactions occur.


Pegasus may redeem all or some of the notes for
cash at any time on or after July 15, 2008, at a redemption
price equal to the principal amount of the notes plus any
accrued and unpaid interest to the redemption date. As noted
above, holders may require Pegasus to purchase the notes on
July 16 of 2008, 2013 and 2018, or in other specified
circumstances, at a purchase price equal to the principal amount
due plus any accrued and unpaid interest to the purchase date
and additional amounts, if any.

Concurrent with the issuance of the convertible
senior notes discussed below, Pegasus terminated its
$30.0 million revolving credit facility. Prior to
termination, there were no amounts outstanding under this credit
facility.

Pegasus has two existing irrevocable standby
letter of credit agreements with JPMorgan Chase Bank totaling
$2.1 million collateralizing the leases for the Dallas and
Scottsdale offices. In July 2003, the Company amended its letter
of credit agreements and funded $2.1 million as collateral
for these letters of credit.



| |                                                        
| | -------------------------------------------------------
| | Off-balance sheet arrangements and future
    liquidity

Pegasus currently has no off-balance sheet
financing arrangements. The following table identifies material
future contractual cash obligations of the Company as of
December 31, 2003. 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. Convertible debt represents scheduled principal and
interest payments for the Companys July 2003 convertible
debt offering, described above. 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.

|                            |  |                        |         |           |  |         |        |         |  |           |        |  |  |   |        |  |  |   |         | 
|--------------------------- |  | ---------------------- | ------- | --------- |  | ------- | ------ | ------- |  | --------- | ------ |  |  | - | ------ |  |  | - | ------- | 
|                            |  |                       
|                            |  | Payments due by period
|                            |  |                       
|                            |  |                        |         | Less than |  | 1      |        | 3      |  | More than
|Contractual obligations     |  | Total                  |         | 1 Year    |  | 3 years |        | 5 Years |  | 5 Years  
|                            |  |                        |         |           |  |         |        |         |  |          
|                            |  |                       
|                            |  | (in thousands)        
|Convertible debt            |  | $                      | 131,794 |           |  | $       | 2,906  |         |  | $         | 5,813  |  |  | $ | 5,813  |  |  | $ | 117,262 | 
|Operating lease obligations |  |                        | 62,550  |           |  |         | 8,476  |         |  |           | 15,080 |  |  |   | 14,140 |  |  |   | 24,854  | 
|Purchase obligations        |  |                        | 20,903  |           |  |         | 12,869 |         |  |           | 8,034  |  |  |   |       |  |  |   |        | 
|Other long term liabilities |  |                        | 53,094  |           |  |         | 4,923  |         |  |           | 7,414  |  |  |   | 8,653  |  |  |   | 32,104  | 
|                            |  |                        |         |           |  |         |        |         |  |           |        |  |  |   |        |  |  |   |         | 
|Total                       |  | $                      | 268,341 |           |  | $       | 29,174 |         |  | $         | 36,341 |  |  | $ | 28,606 |  |  | $ | 174,220 | 
|                            |  |                        |         |           |  |         |        |         |  |           |        |  |  |   |        |  |  |   |         | 

Pegasus expects to continue to incur capital
expenditures related to adding capacity to existing systems and
software development, which it estimates will total from
$18 million to $20 million for 2004.

On November 5, 2003, the Board of Directors
renewed its authorization for the repurchase of up to
2.5 million shares of Pegasus common stock. No shares
were repurchased in 2003, but the Company repurchased
1.0 million shares for an aggregate purchase price of
$11.7 million from January 1, 2004 through
March 9, 2004 under a corporate 10b5-1 stock
repurchase plan. On March 9, 2004, the Board of Directors
approved a second corporate 10b5-1 stock repurchase plan,
which will allow us to repurchase the remaining 1.5 million
shares, subject to certain conditions, even during blackout
periods. Once approved by the Board, any future repurchases are
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.

26



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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                                                                                  

We believe that the Companys financial
condition is strong and that its cash and cash flows from
operations will be sufficient to meet its foreseeable operating
and capital requirements through at least the next twelve
months. Although we do not expect to raise any external capital
in the next year, Pegasus could in the future 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.

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 Estimates

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 Pegasus accounting policies, including
recently issued accounting standards, see Note 1 to the
Consolidated Financial Statements in Item 8 of this annual
report on Form 10-K.

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.



| |                                   
| | ----------------------------------
| | Accounts and notes
    receivables

As of December 31, 2003, Pegasus had
accounts receivable as a result of its ongoing operations of
approximately $25.2 million. Additionally, Pegasus has
notes receivable totaling $7.5 million at December 31,
2003, 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,

27



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##### Table of Contents



resulting in an impairment of their ability to
make payments. Pegasus allowances for doubtful accounts
totaled approximately $2.9 million as of December 31,
2003.




| |                     
| | --------------------
| | Impairment of assets

As of December 31, 2003, Pegasus has
goodwill totaling approximately $164.1 million related to
its acquisitions of REZ in 2000, GETS in 2001 and Unirez in
2003. Under the guidance of FAS 142, goodwill is
periodically analyzed for impairment. These practices require
significant estimates and judgments by management, involving the
carrying value and the estimated fair value of the Company. The
estimate of fair value 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 future impairment analyses and
affect the carrying values of goodwill.

As of December 31, 2003, Pegasus has
unamortized capitalized software costs totaling
$48.6 million, which we review periodically 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.



| |                       
| | ----------------------
| | 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 $98,000 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, the
recent changes in Pegasus executive management could have
an effect on the assumptions used in accounting for our
U.S. defined benefit plan.






|         |                                                               
|-------- | --------------------------------------------------------------
|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.

To reduce the impact of changes in foreign
exchange rates on consolidated results of operations and future
foreign currency denominated cash flows, Pegasus was a party to
various forward exchange contracts at December 31, 2003.
These contracts reduce exposure to currency movements affecting
existing foreign currency denominated assets and liabilities,
primarily trade receivables and payables.

28



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##### Table of Contents



A summary of forward exchange contracts in place
at December 31, 2003 follows (in thousands):

|                   |       |      |        |          |  |   |     |     | 
|------------------ | ----- | ---- | ------ | -------- |  | - | --- | --- | 
|                   |       | Sell |        | Purchase
|                   |       |      |        |         
|Euro               |       | $    | 11,213 |          |  | $ |    |    
|Swedish Krona      |       |      | 1,116  |          |  |   |    |    
|British Pound      |       |      |       |          |  |   | 663 |    
|Japanese Yen       |       |      | 634    |          |  |   |    |    
|Swiss Franc        |       |      | 317    |          |  |   |    |    
|Canadian Dollar    |       |      | 289    |          |  |   |    |    
|Singapore Dollar   |       |      | 274    |          |  |   |    |    
|Hong Kong Dollar   |       |      | 231    |          |  |   |    |    
|Australian Dollar  |       |      | 130    |          |  |   |    |    
|South African Rand |       |      | 75     |          |  |   |    |    
|Norwegian Krona    |       |      | 47     |          |  |   |    |    
|Czech Krone        |       |      | 6      |          |  |   |    |    
|Danish Krone       |       |      |       |          |  |   | 2   |    
|New Zealand Dollar |       |      |       |          |  |   | 1   |    
|                   |       |      |        |          |  |   |     |    
|                   | Total |      | $      | 14,332   |  |   | $   | 666 | 
|                   |       |      |        |          |  |   |     |    

All contracts matured no later than February
2004.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, 2003.
During the fiscal year ended December 31, 2002, 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, 2002. As of
December 31, 2002, Pegasus had approximately
$14.1 million in sell forward exchange contracts and
$478,000 in purchase forward exchange contracts. Pegasus
positions with respect to these forward exchange contracts
differed as of December 31, 2003 compared to
December 31, 2002 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



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##### Table of Contents








|        |                                                
|------- | -----------------------------------------------
|Item 8. | Financial Statements and Supplementary
    Data

Report of Independent Auditors

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, 2003 and 2002, and the results
of their operations and their cash flows for each of the three
years in the period ended December 31, 2003 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 3, 2004, except as to Note 10


which is as of March 9, 2004


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##### Table of Contents



PEGASUS SOLUTIONS, INC.

CONSOLIDATED BALANCE SHEETS

December 31, 2003 and 2002


(In thousands, except for share
amounts)


|                                                                                                   |                                                                                                                            |                                            |         |         |         |   |         |         |         | 
|-------------------------------------------------------------------------------------------------- | -------------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ------- | ------- | ------- | - | ------- | ------- | ------- | 
|                                                                                                   |                                                                                                                            | 2003                                       |         | 2002   
|                                                                                                   |                                                                                                                            |                                            |         |        
|ASSETS                                                                                            
|Cash and cash equivalents                                                                          |                                                                                                                            | $                                          | 58,983  |         |         | $ | 19,893  |        
|Short-term investments                                                                             |                                                                                                                            |                                            | 4,046   |         |         |   | 4,033   |        
|Accounts receivable, net of allowance for
    doubtful accounts of $2,924 and $4,632, respectively |                                                                                                                            |                                            | 22,298  |         |         |   | 25,886  |        
|Other current assets                                                                               |                                                                                                                            |                                            | 11,092  |         |         |   | 8,368   |        
|                                                                                                   |                                                                                                                            |                                            |         |         |         |   |         |        
|                                                                                                   |                                                                                                                            | Total current assets                       |         |         | 96,419  |   |         |         | 58,180  | 
|Goodwill, net of accumulated amortization of
    $40,225                                           |                                                                                                                            |                                            | 164,120 |         |         |   | 139,533 |        
|Intangible assets, net of accumulated
    amortization of $55,333 and $50,231, respectively        |                                                                                                                            |                                            | 7,831   |         |         |   | 6,013   |        
|Property and equipment, net                                                                        |                                                                                                                            |                                            | 75,474  |         |         |   | 71,442  |        
|Other noncurrent assets                                                                            |                                                                                                                            |                                            | 22,716  |         |         |   | 12,927  |        
|                                                                                                   |                                                                                                                            |                                            |         |         |         |   |         |        
|                                                                                                   |                                                                                                                            | Total assets                               |         | $       | 366,560 |   |         | $       | 288,095 | 
|                                                                                                   |                                                                                                                            |                                            |         |         |         |   |         |        
|LIABILITIES AND STOCKHOLDERS
    EQUITY                                                          
|Accounts payable                                                                                   |                                                                                                                            | $                                          | 10,176  |         |         | $ | 11,308  |        
|Accrued liabilities                                                                                |                                                                                                                            |                                            | 12,089  |         |         |   | 8,838   |        
|Unearned income                                                                                    |                                                                                                                            |                                            | 7,213   |         |         |   | 7,812   |        
|Customer deposits                                                                                  |                                                                                                                            |                                            | 3,122   |         |         |   | 3,031   |        
|Accrued payroll and benefits                                                                       |                                                                                                                            |                                            | 2,407   |         |         |   | 6,428   |        
|Other current liabilities                                                                          |                                                                                                                            |                                            | 2,355   |         |         |   | 3,768   |        
|                                                                                                   |                                                                                                                            |                                            |         |         |         |   |         |        
|                                                                                                   |                                                                                                                            | Total current liabilities                  |         |         | 37,362  |   |         |         | 41,185  | 
|Noncurrent uncleared commission checks                                                             |                                                                                                                            |                                            | 4,545   |         |         |   | 4,641   |        
|Noncurrent accrued rent                                                                            |                                                                                                                            |                                            | 7,050   |         |         |   | 7,345   |        
|Other noncurrent liabilities                                                                       |                                                                                                                            |                                            | 13,947  |         |         |   | 9,034   |        
|Convertible debt                                                                                   |                                                                                                                            |                                            | 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; 25,091,248 and
    24,747,165 shares issued, respectively |                                            |         | 251     |         |   |         | 247     |        
|                                                                                                   | Additional paid-in capital                                                                                                 |                                            |         | 290,828 |         |   |         | 287,676 |        
|                                                                                                   | Unearned compensation                                                                                                      |                                            |         |        |         |   |         | (571    | )      
|                                                                                                   | Accumulated other comprehensive loss                                                                                       |                                            |         | (834    | )       |   |         | (1,705  | )      
|                                                                                                   | Accumulated deficit                                                                                                        |                                            |         | (61,589 | )       |   |         | (59,757 | )      
|                                                                                                   |                                                                                                                            |                                            |         |         |         |   |         |        
|                                                                                                   |                                                                                                                            | Total stockholders equity                 |         |         | 228,656 |   |         |         | 225,890 | 
|                                                                                                   |                                                                                                                            |                                            |         |         |         |   |         |        
|                                                                                                   |                                                                                                                            | Total liabilities and stockholders equity |         | $       | 366,560 |   |         | $       | 288,095 | 
|                                                                                                   |                                                                                                                            |                                            |         |         |         |   |         |        

See accompanying notes to consolidated financial
statements.

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PEGASUS SOLUTIONS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE LOSS

Years Ended December 31, 2003, 2002 and
2001


(In thousands, except per share
amounts)


|                                       |                                                                                         |                         |        |         |         |      |        |         |         |   |         |         |         | 
|-------------------------------------- | --------------------------------------------------------------------------------------- | ----------------------- | ------ | ------- | ------- | ---- | ------ | ------- | ------- | - | ------- | ------- | ------- | 
|                                       |                                                                                         | 2003                    |        | 2002    |         | 2001
|                                       |                                                                                         |                         |        |         |         |     
|Revenues:                              |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        
|                                       | Service revenues                                                                        |                         | $      | 161,245 |         |      | $      | 178,769 |         |   | $       | 180,668 |        
|                                       | Customer reimbursements                                                                 |                         |        | 11,485  |         |      |        | 11,181  |         |   |         | 12,079  |        
|                                       |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        
|                                       |                                                                                         | Total revenues          |        |         | 172,730 |      |        |         | 189,950 |   |         |         | 192,747 | 
|Costs of services:                     |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        
|                                       | Cost of services                                                                        |                         |        | 85,207  |         |      |        | 88,717  |         |   |         | 98,838  |        
|                                       | Customer reimbursements                                                                 |                         |        | 11,485  |         |      |        | 11,181  |         |   |         | 12,079  |        
|                                       |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        
|                                       |                                                                                         | Total costs of services |        |         | 96,692  |      |        |         | 99,898  |   |         |         | 110,917 | 
|Research and development               |                                                                                         |                         | 5,199  |         |         |      | 5,821  |         |         |   | 7,842   |        
|General and administrative expenses    |                                                                                         |                         | 23,348 |         |         |      | 25,146 |         |         |   | 25,201  |        
|Marketing and promotion expenses       |                                                                                         |                         | 16,484 |         |         |      | 17,998 |         |         |   | 21,709  |        
|Depreciation and amortization          |                                                                                         |                         | 28,029 |         |         |      | 48,075 |         |         |   | 65,651  |        
|Restructure and asset impairment costs |                                                                                         |                         | 5,949  |         |         |      |       |         |         |   | 7,696   |        
|                                       |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        
|Operating loss                         |                                                                                         |                         | (2,971 | )       |         |      | (6,988 | )       |         |   | (46,269 | )      
|Other income (expense):                |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        
|                                       | Interest income                                                                         |                         |        | 1,423   |         |      |        | 1,277   |         |   |         | 1,655   |        
|                                       | Interest expense                                                                        |                         |        | (1,552  | )       |      |        | (53     | )       |   |         | (887    | )      
|                                       | Equity in loss of investee, including
    amortization of excess purchase price of $595 |                         |        |        |         |      |        |        |         |   |         | (634    | )      
|                                       | Gains on sale of business units                                                         |                         |        |        |         |      |        |        |         |   |         | 5,538   |        
|                                       | Other                                                                                   |                         |        | 363     |         |      |        | 130     |         |   |         | 1,914   |        
|                                       |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        
|Loss before income taxes               |                                                                                         |                         | (2,737 | )       |         |      | (5,634 | )       |         |   | (38,683 | )      
|Income tax benefit                     |                                                                                         |                         | 905    |         |         |      | 2,115  |         |         |   | 8,946   |        
|                                       |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        
|Net loss                               |                                                                                         | $                       | (1,832 | )       |         | $    | (3,519 | )       |         | $ | (29,737 | )      
|                                       |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        
|Other comprehensive income (loss):     |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        
|                                       | Change in unrealized gain (loss), net of tax                                            |                         |        |        |         |      |        | (20     | )       |   |         | 286     |        
|                                       | of $-, $12 and $185, respectively Minimum pension
    liability adjustment, net of tax  |                         |        | 871     |         |      |        | (1,706  | )       |   |         |        |        
|                                       | of ($357), $896 and $-, respectively                                                    |                         |        |         |         |      |        |         |         |   |         |         |        
|                                       |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        
|Comprehensive loss                     |                                                                                         | $                       | (961   | )       |         | $    | (5,245 | )       |         | $ | (29,451 | )      
|                                       |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        
|Net loss per share:                    |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        
|                                       | Basic and diluted                                                                       |                         | $      | (0.07   | )       |      | $      | (0.14   | )       |   | $       | (1.21   | )      
|                                       |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        
|Weighted average shares outstanding:   |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        
|                                       | Basic and diluted                                                                       |                         |        | 24,864  |         |      |        | 24,818  |         |   |         | 24,570  |        
|                                       |                                                                                         |                         |        |         |         |      |        |         |         |   |         |        

See accompanying notes to consolidated financial
statements.

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PEGASUS SOLUTIONS, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS EQUITY

Years Ended December 31, 2003, 2002 and
2001


(In thousands)


|                             |                                                               |              |        |            |   |         |     |               |   |             |         |             |   |       |      |        |   |   |        |        |   |   |         |         |   |   |         |         |  
|---------------------------- | ------------------------------------------------------------- | ------------ | ------ | ---------- | - | ------- | --- | ------------- | - | ----------- | ------- | ----------- | - | ----- | ---- | ------ | - | - | ------ | ------ | - | - | ------- | ------- | - | - | ------- | ------- | -
|                             |                                                               |              |        |            |   |         |     |               |   | Accumulated |         |             |   |      
|                             |                                                               |              |        |            |   |         |     |               |   | Other       |         |             |   |      
|                             |                                                               |              |        |            |   |         |     |               |   |             |         |            
|                             |                                                               | Common Stock |        |            |   |         |     | Comprehensive |   |             |         |            
|                             |                                                               |              |        | Additional |   |         |     |               |   |             |         |            
|                             |                                                               | Number of    |        |            |   | Paid-in |     | Unearned      |   | Income      |         | Accumulated |   |      
|                             |                                                               | Shares       |        | Amount     |   | Capital |     | Compensation  |   | (Loss)      |         | Deficit     |   | Total
|                             |                                                               |              |        |            |   |         |     |               |   |             |         |             |   |      
|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 |        
|                             | Windfall tax benefit of stock options                         |              |        |           |   |         |     |              |   |             |         | 687         |   |       |      |       |   |   |        |       |   |   |         |        |   |   |         | 687     |  
|                             | Stock-based compensation expense                              |              |        |           |   |         |     |              |   |             |         |            |   |       |      | 571    |   |   |        |       |   |   |         |        |   |   |         | 571     |  
|                             | Exercise of stock options                                     |              |        | 278        |   |         |     | 3             |   |             |         | 1,842       |   |       |      |       |   |   |        |       |   |   |         |        |   |   |         | 1,845   |  
|                             | Issuance for stock purchase plan                              |              |        | 66         |   |         |     | 1             |   |             |         | 623         |   |       |      |       |   |   |        |       |   |   |         |        |   |   |         | 624     |  
|                             | Minimum pension liability adjustment                          |              |        |           |   |         |     |              |   |             |         |            |   |       |      |       |   |   |        | 871    |   |   |         |        |   |   |         | 871     |  
|                             | Net loss                                                      |              |        |           |   |         |     |              |   |             |         |            |   |       |      |       |   |   |        |       |   |   |         | (1,832  | ) |   |         | (1,832  | )
|                             |                                                               |              |        |            |   |         |     |               |   |             |         |             |   |       |      |        |   |   |        |        |   |   |         |         |   |   |         |        
|                             | Balance at December 31, 2003                                  |              |        | 25,091     |   |         | $   | 251           |   |             | $       | 290,828     |   |       | $    |       |   |   | $      | (834   | ) |   | $       | (61,589 | ) |   | $       | 228,656 |  
|                             |                                                               |              |        |            |   |         |     |               |   |             |         |             |   |       |      |        |   |   |        |        |   |   |         |         |   |   |         |        

See accompanying notes to consolidated financial
statements.

33



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##### Table of Contents



PEGASUS SOLUTIONS, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

Years Ended December 31, 2003, 2002, and
2001


(In thousands)


|                                                                         |                                                                                     |                                                                        |                                                         |         |        |         |        |         |        |         |         |         |        |         |  
|------------------------------------------------------------------------ | ----------------------------------------------------------------------------------- | ---------------------------------------------------------------------- | ------------------------------------------------------- | ------- | ------ | ------- | ------ | ------- | ------ | ------- | ------- | ------- | ------ | ------- | -
|                                                                         |                                                                                     | 2003                                                                   |                                                         | 2002    |        | 2001   
|                                                                         |                                                                                     |                                                                        |                                                         |         |        |        
|Cash flows from operating activities:                                    |                                                                                     |                                                                        |                                                         |         |        |         |        |         |        |         |         |        
|                                                                         | Net loss                                                                            |                                                                        | $                                                       | (1,832  | )      |         | $      | (3,519  | )      |         | $       | (29,737 | )     
|                                                                         | Adjustments to reconcile net loss to net cash
    provided by operating activities: |                                                                        |                                                         |         |        |         |        |         |        |         |         |         |       
|                                                                         |                                                                                     | Depreciation and amortization                                          |                                                         |         | 28,029 |         |        |         | 48,075 |         |         |         | 65,651 |        
|                                                                         |                                                                                     | Equity in loss of investee                                             |                                                         |         |       |         |        |         |       |         |         |         | 634    |        
|                                                                         |                                                                                     | Gains on sale of business units                                        |                                                         |         |       |         |        |         |       |         |         |         | (5,538 | )      
|                                                                         |                                                                                     | Bad debt expense                                                       |                                                         |         |       |         |        |         | 1,289  |         |         |         | 3,408  |        
|                                                                         |                                                                                     | Deferred income taxes                                                  |                                                         |         | (1,351 | )       |        |         | (3,868 | )       |         |         | (9,934 | )      
|                                                                         |                                                                                     | Other                                                                  |                                                         |         | 1,660  |         |        |         | 1,385  |         |         |         | (1,140 | )      
|                                                                         |                                                                                     | Changes in assets and liabilities, net of effects
    of acquisitions: |                                                         |         |        |         |        |         |        |         |         |         |        |        
|                                                                         |                                                                                     |                                                                        | Accounts receivable                                     |         |        | 6,356   |        |         |        | 2,033   |         |         |        | (3,963  | )
|                                                                         |                                                                                     |                                                                        | Other current and noncurrent assets                     |         |        | (6,007  | )      |         |        | (911    | )       |         |        | 574     |  
|                                                                         |                                                                                     |                                                                        | Accounts payable and accrued liabilities                |         |        | (4,561  | )      |         |        | (12,489 | )       |         |        | 4,144   |  
|                                                                         |                                                                                     |                                                                        | Unearned income                                         |         |        | (599    | )      |         |        | (773    | )       |         |        | (843    | )
|                                                                         |                                                                                     |                                                                        | Other current and noncurrent liabilities                |         |        | 2,427   |        |         |        | 7,077   |         |         |        | 2,143   |  
|                                                                         |                                                                                     |                                                                        |                                                         |         |        |         |        |         |        |         |         |        
|                                                                         |                                                                                     |                                                                        | Net cash provided by operating activities               |         |        | 24,122  |        |         |        | 38,299  |         |         |        | 25,399  |  
|Cash flows from investing activities:                                    |                                                                                     |                                                                        |                                                         |         |        |         |        |         |        |         |         |        
|                                                                         | Purchase of marketable securities                                                   |                                                                        |                                                         | (12,212 | )      |         |        | (13,886 | )      |         |         | (16,375 | )     
|                                                                         | Proceeds from maturity of marketable securities                                     |                                                                        |                                                         | 4,000   |        |         |        | 16,492  |        |         |         | 7,225   |       
|                                                                         | Purchase of property and equipment                                                  |                                                                        |                                                         | (19,406 | )      |         |        | (30,340 | )      |         |         | (14,407 | )     
|                                                                         | Proceeds from sale of property and equipment                                        |                                                                        |                                                         | 140     |        |         |        | 83      |        |         |         | 310     |       
|                                                                         | Investment in Travelweb, LLC                                                        |                                                                        |                                                         |        |        |         |        | (2,143  | )      |         |         |        |       
|                                                                         | Collections of note receivable                                                      |                                                                        |                                                         | 1,881   |        |         |        | 285     |        |         |         |        |       
|                                                                         | Purchase of Unirez, net of cash acquired                                            |                                                                        |                                                         | (34,115 | )      |         |        |        |        |         |         |        |       
|                                                                         | Purchase of GETS                                                                    |                                                                        |                                                         |        |        |         |        |        |        |         |         | (11,512 | )     
|                                                                         | Purchase of REZ, net of cash acquired                                               |                                                                        |                                                         |        |        |         |        |        |        |         |         | 852     |       
|                                                                         | Proceeds from sale of business units                                                |                                                                        |                                                         |        |        |         |        |        |        |         |         | 4,033   |       
|                                                                         | Other                                                                               |                                                                        |                                                         |        |        |         |        |        |        |         |         | 1,500   |       
|                                                                         |                                                                                     |                                                                        |                                                         |         |        |         |        |         |        |         |         |        
|                                                                         |                                                                                     |                                                                        | Net cash used in investing activities                   |         |        | (59,712 | )      |         |        | (29,509 | )       |         |        | (28,374 | )
|Cash flows from financing activities:                                    |                                                                                     |                                                                        |                                                         |         |        |         |        |         |        |         |         |        
|                                                                         | Proceeds from issuance of common stock                                              |                                                                        |                                                         | 2,469   |        |         |        | 2,413   |        |         |         | 1,444   |       
|                                                                         | Purchase of treasury stock                                                          |                                                                        |                                                         |        |        |         |        | (4,602  | )      |         |         | (2,067  | )     
|                                                                         | Proceeds from convertible debt issuance                                             |                                                                        |                                                         | 75,000  |        |         |        |        |        |         |         |        |       
|                                                                         | Debt issuance costs                                                                 |                                                                        |                                                         | (2,579  | )      |         |        |        |        |         |         |        |       
|                                                                         | Repayment of notes payable                                                          |                                                                        |                                                         |        |        |         |        |        |        |         |         | (20,000 | )     
|                                                                         | Other                                                                               |                                                                        |                                                         | (210    | )      |         |        | (146    | )      |         |         | (114    | )     
|                                                                         |                                                                                     |                                                                        |                                                         |         |        |         |        |         |        |         |         |        
|                                                                         |                                                                                     |                                                                        | Net cash provided by (used in) financing
    activities |         |        | 74,680  |        |         |        | (2,335  | )       |         |        | (20,737 | )
|Net increase (decrease) in cash and cash
    equivalents                 |                                                                                     |                                                                        | 39,090                                                  |         |        |         | 6,455  |         |        |         | (23,712 | )      
|Cash and cash equivalents, beginning of period                           |                                                                                     |                                                                        | 19,893                                                  |         |        |         | 13,438 |         |        |         | 37,150  |        
|                                                                         |                                                                                     |                                                                        |                                                         |         |        |         |        |         |        |         |         |        
|Cash and cash equivalents, end of period                                 |                                                                                     | $                                                                      | 58,983                                                  |         |        | $       | 19,893 |         |        | $       | 13,438  |        
|                                                                         |                                                                                     |                                                                        |                                                         |         |        |         |        |         |        |         |         |        
|Supplemental disclosure of cash flow information:                        |                                                                                     |                                                                        |                                                         |         |        |         |        |         |        |         |         |        
|                                                                         | Income taxes paid                                                                   |                                                                        | $                                                       | 2,539   |        |         | $      | 857     |        |         | $       | 2,385   |       
|                                                                         | Interest paid                                                                       |                                                                        |                                                         | 82      |        |         |        | 47      |        |         |         | 2,073   |       
|Supplemental schedule of noncash investing and
    financing activities: |                                                                                     |                                                                        |                                                         |         |        |         |        |         |        |         |         |        
|                                                                         | Remaining amounts payable for purchases of Unirez
    and TDS                       |                                                                        | $                                                       | 3,299   |        |         | $      |        |        |         | $       |        |       
|                                                                         | Landlord paid tenant improvements                                                   |                                                                        |                                                         | 524     |        |         |        | 4,125   |        |         |         |        |       
|                                                                         | Notes received from sale of Summit and Sterling
    Hotels & Resorts                |                                                                        |                                                         |        |        |         |        |        |        |         |         | 7,000   |       

See accompanying notes to consolidated financial
statements.

34



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##### Table of Contents



PEGASUS SOLUTIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



|   |                                               
|-- | ----------------------------------------------
|1. | Summary of Significant Accounting
    Policies



| |         
| | --------
| | Overview

Pegasus is a leading global provider of hotel
reservations-related services and technology. 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 reservations
systems, electronic distribution services, commission processing
and payment services, property management systems, and marketing
representation services.



| |                      
| | ---------------------
| | Basis of Presentation

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. Pegasus common stock is traded on the
Nasdaq National Market under the symbol PEGS.

Previously Pegasus services were organized
into two business segments  technology and
hospitality. In 2003, Pegasus completed a strategic
reorganization to integrate its technology and hospitality
segments into one operating unit. As a result, Pegasus has
integrated support functions, including sales and marketing,
product development, service delivery, reservation/data
management, information technology, finance and human resources
functions. Because the Company has changed its management
approach, organizational structure, operating performance
assessment and reporting, and operational decision making from a
segment perspective (technology and hospitality) to a single
company perspective, the Company does not report separate
segment information.

Certain prior year amounts have been reclassified
to conform to the current year presentation.



| |                     
| | --------------------
| | 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.

35



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PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |                           
| | --------------------------
| | 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, or with
Statement of Position No. 98-1, Accounting for the
Costs of Computer Software Developed or 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. The Company believes that
no impairment of capitalized software costs existed at
December 31, 2003 or 2002. Amortization of capitalized
software costs in 2003, 2002 and 2001 totaled
$14.4 million, $20.6 million and $15.8 million,
respectively. At December 31, 2003 and 2002, unamortized
capitalized software was $48.6 million and
$43.9 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, 2003 or 2002.



| |         
| | --------
| | 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. Amortization of goodwill was $16.2 million for
the year ended December 31, 2001. As of December 31,
2003 and 2002, goodwill totaled $164.1 million and
$139.5 million, respectively. Goodwill is related to the
acquisitions of REZ, Inc. (REZ) in 2000, Global
Enterprise Technology Solutions, LLC (GETS) in 2001,
and Unirez, Inc. (Unirez) in 2003. Pegasus
applied the provisions of FAS 142 on January 1, 2002
and discontinued amortization of goodwill from the REZ
acquisition. 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.

The carrying value of goodwill is evaluated
annually. The Company believes that no impairment of goodwill
existed at December 31, 2003 or 2002.



| |                  
| | -----------------
| | 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.

36



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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Pegasus and six other companies 
Hilton Hotels, Hyatt Corporation, Marriott International, Six
Continents Hotels, Starwood Hotels and Priceline.com 
are equal partners in Travelweb, LLC, (Travelweb)
formerly known as Hotel Distribution System, LLC (see
Note 15). This new venture was formed in 2002 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 six other companies and does not exercise
significant influence, the investment in Travelweb is accounted
for under the cost method. The investment is included in other
noncurrent assets on the Consolidated Balance Sheet.



| |                                      
| | -------------------------------------
| | 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 $571,000,
$798,000 and $123,000 for 2003, 2002 and 2001, 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):

|                                                                                                                                                     |             |      |        |       |   |      |        |       |   |   |         |       |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- | ----------- | ---- | ------ | ----- | - | ---- | ------ | ----- | - | - | ------- | ----- | -
|                                                                                                                                                     |             | 2003 |        | 2002  |   | 2001
|                                                                                                                                                     |             |      |        |       |   |     
|Net loss, as reported                                                                                                                                |             | $    | (1,832 | )     |   | $    | (3,519 | )     |   | $ | (29,737 | )    
|Add: Stock-based employee compensation expense
    included in reported income, net of related tax effects                                           |             |      | 347    |       |   |      | 485    |       |   |   | 80      |      
|Deduct: Total stock-based employee compensation
    expense determined under fair value based methods for all
    awards, net of related tax effects |             |      | (6,288 | )     |   |      | (5,020 | )     |   |   | (3,991  | )    
|                                                                                                                                                     |             |      |        |       |   |      |        |       |   |   |         |      
|Pro forma net loss                                                                                                                                   |             | $    | (7,773 | )     |   | $    | (8,054 | )     |   | $ | (33,648 | )    
|Net loss per share, basic and diluted:                                                                                                               |             |      |        |       |   |      |        |       |   |   |         |      
|                                                                                                                                                     | As reported |      | $      | (0.07 | ) |      | $      | (0.14 | ) |   | $       | (1.21 | )
|                                                                                                                                                     | Pro forma   |      | $      | (0.31 | ) |      | $      | (0.32 | ) |   | $       | (1.37 | )

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 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 $6.46, $7.83 and $6.23 in 2003, 2002 and 2001,
respectively. The fair value of each option grant

37



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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

is estimated on the date of grant using the
Black-Scholes option-pricing model with the following
weighted-average assumptions:

|                         |  |      |            |      |  |      |            |   |  |  |            |  
|------------------------ |  | ---- | ---------- | ---- |  | ---- | ---------- | - |  |  | ---------- | -
|                         |  | 2003 |            | 2002 |  | 2001
|                         |  |      |            |      |  |     
|Dividend yield           |  |      |           |      |  |      |           |   |  |  |           |  
|Expected volatility      |  |      | 59.3- 73.2 | %    |  |      | 73.2       | % |  |  | 78.8       | %
|Risk-free rate of return |  |      | 2.1-2.9    | %    |  |      | 2.7-4.2    | % |  |  | 4.0-4.7    | %
|Expected life            |  |      | 4.0  years |      |  |      | 4.0  years |   |  |  | 4.0  years |  

The pro forma disclosures for 2003, 2002 and 2001
include approximately $104,000, $267,000 and $223,000,
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:

|                         |  |      |           |      |  |      |           |   |  |  |           |  
|------------------------ |  | ---- | --------- | ---- |  | ---- | --------- | - |  |  | --------- | -
|                         |  | 2003 |           | 2002 |  | 2001
|                         |  |      |           |      |  |     
|Dividend yield           |  |      |          |      |  |      |          |   |  |  |          |  
|Expected volatility      |  |      | 45.0      | %    |  |      | 62.0      | % |  |  | 70.5      | %
|Risk-free rate of return |  |      | 1.10      | %    |  |      | 2.18      | % |  |  | 6.1       | %
|Expected life            |  |      | 0.5  year |      |  |      | 1.0  year |   |  |  | 1.0  year |  

See Note 11 for further discussion of the
Companys stock-based employee compensation.



| |         
| | --------
| | Revenues

Pegasus service revenues are predominantly
transaction-based. The Companys Representation Services
derive revenues from reservation processing fees, membership
fees and fees for various marketing services. The Companys
other services derive revenues from transaction fees, commission
fees, license fees and maintenance fees charged to participating
hotels and travel agencies.

Representation
services.Representation services
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.

Reservation
services.Reservation services
revenues consist of central reservation system, or CRS,
revenues. CRS revenues represent transaction fees as well as
license, maintenance and support fees related to the
Companys RezViewTM 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.

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.

Distribution
services.Distribution services
revenues consist of electronic distribution revenues. 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

38



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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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 unearned income 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 unearned
income created during the early periods of the 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 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 global distribution
systems (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, recognized ratably over the term of
the customer contract. Monthly subscription and maintenance fees
are recognized when earned.

Property services.Property services revenues consist of maintenance and support
fees from PMS software obtained in the REZ and GETS
acquisitions. In addition, property services 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.

Customer
Reimbursements.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.

The classification of service revenues and
customer reimbursements has been reflected in the financial
statements to give effect to the 2002 adoption of the Emerging
Issues Task Force, or EITF, Issue 01-14. Under EITF 01-14,
Pegasus billings for out-of-pocket expenses, such as
third-party vendor GDS and telecommunication charges, are
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.



| |             
| | ------------
| | 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.

39



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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The Companys income tax provision is based
on calculations and assumptions that will be subject to
examination by the Internal Revenue Service and other tax
authorities. The potential outcomes of these examinations are
regularly assessed in determining the adequacy of the provision
for income taxes. Should the actual results differ from our
estimates, the income tax provision would be adjusted in the
period in which the facts that give rise to the revision become
known. Tax law and rate changes are reflected in the income tax
provision in the period in which changes are enacted.



| |                  
| | -----------------
| | Advertising costs

Advertising and promotion-related expenses are
charged to operations when incurred. Advertising expense for
2003, 2002 and 2001 was approximately $1.9 million,
$2.3 million and $3.8 million, respectively.



| |                         
| | ------------------------
| | Research and development

Research and development expenses are charged to
operations when incurred.



| |                 
| | ----------------
| | Foreign currency

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 Pegasus earning more or less revenue
and expending more or less in expenses than it otherwise might
have earned if currency rates had remained stable.



| |                      
| | ---------------------
| | 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, 2003 and 2002 approximate their
respective fair values. The estimated fair value of the
Companys convertible debt at December 31, 2003
approximated $68 million based on a valuation model,
compared to a carrying amount of $75 million representing
face value.



| |                                             
| | --------------------------------------------
| | 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
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 related to
the sale of business units (see Note 4). The Companys
accounts and notes receivable are monitored by management for
collectibility, considering the payment history and known
financial condition of the debtors. If the financial condition
of the debtors 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.

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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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. 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.



| |                   
| | ------------------
| | 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, 2003, 2002
and 2001, as the effect would be anti-dilutive. Shares issuable
upon the exercise of stock options that were excluded from the
calculation were 5.3 million, 4.4 million and
3.8 million in 2003, 2002 and 2001, respectively. Also, for
the year ended December 31, 2002, 98,400 shares of
restricted stock that vested in 2003 were not included in the
calculation of diluted net loss, as the effect would be
anti-dilutive. No dilution for convertible debt was included in
the 2003 calculation, as it is contingently convertible.



| |                                         
| | ----------------------------------------
| | Recently issued accounting
    standards

Financial Accounting Standards Board
(FASB) Interpretation No. 46,
Consolidation of Variable Interest Entities
(FIN 46) was issued in January 2003.
FIN 46 requires that if an entity is the primary
beneficiary of a variable interest entity, the assets,
liabilities and results of operations of the variable interest
entity should be included in the consolidated financial
statements of the entity. The provisions of FIN 46 were
effective for all arrangements entered into after
January 31, 2003. Pegasus has not invested in any variable
interest entities after January 31, 2003. As amended by
FASB Staff Position (FSP) No. FIN 46-6,
FSP No. FIN 46-7 and FSP No. FIN 46-8, for
arrangements entered into prior to January 31, 2003, the
provisions of FIN 46 are effective at the end of the first
interim or annual period ending after March 15, 2004.

As discussed in Note 4 to the Consolidated
Financial Statements, Pegasus sold its Summit Hotels and Resorts
and Sterling Hotels & Resorts brand business to
Indecorp Corporation on January 10, 2001. The sale
agreement, as amended, provided for a $1.0 million and a
$6.0 million promissory note from Indecorp. The
$1.0 million promissory note accrued interest at an annual
rate equal to prime plus 2 percent, and was repaid in
August 2003. The $6.0 million note requires monthly
payments for a period of eight years commencing July 1,
2002, and bears interest at an annual rate of 7 percent.
Pegasus also accepted a $2.8 million promissory note that
replaced existing outstanding trade receivables. The
$2.8 million promissory note requires monthly payments for
a period of eight years commencing July 1, 2002 and bears
interest at an annual rate of 7 percent. During 2001,
Pegasus recognized a $4.8 million pre-tax gain on the sale
of Summit and Sterling.

Pegasus has evaluated its relationship with
Indecorp and has determined that Indecorp is a variable interest
entity under FIN 46. Pegasus has concluded that it is the
primary beneficiary of Indecorp as defined by FIN 46 and,
as a result, despite having no voting or operational control,
Pegasus is required to consolidate Indecorp.

As a result of the foregoing, Pegasus will
account for Indecorp in accordance with FIN 46 as if it had
been consolidated since the sale of Summit and Sterling on
January 10, 2001. Accordingly, Pegasus will

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PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

record a cumulative-effect adjustment related to
the adoption of FIN 46 in the first quarter of 2004, which
is anticipated to include the effects of the reversal of the
pre-tax gain of $4.8 million recognized on the initial
sale. Additionally, Pegasus will begin consolidating
Indecorps results of operations on April 1, 2004.
Based solely on unaudited financial information provided to
Pegasus management by Indecorp on a voluntary basis (which
we have not taken any independent steps to
verify), Indecorps total assets, liabilities,
revenues, operating expenses, and net loss as of and for the six
months ended December 31, 2003 on a stand-alone basis were
$13.0 million, $15.9 million, $12.4 million,
$10.4 million, and $1.1 million, respectively.
Indecorp may pursue options to obtain additional third-party
capital that may negate Pegasus requirement to consolidate
its financial results. However, there can be no assurance that
such a transaction will occur. To the extent that Indecorp is
unsuccessful in obtaining a sufficient capital infusion, and its
shareholders equity balance is less than
zero, Indecorps future losses will be recognized by
Pegasus. Any such losses recognized by Pegasus would be equally
offset to the extent that Indecorp has future income prior to
any allocations to minority interest holders.

In November 2002, the Emerging Issues Task Force
(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 apply to revenue
arrangements entered into after June 30, 2003. The adoption
of EITF Issue No. 00-21 did not have any impact on the
Companys results of operations or financial condition.

In April 2003, the FASB issued Statement of
Financial Accounting Standards (SFAS) No. 149,
Amendment of Statement 133 on Derivative Instruments and
Hedging Activities. SFAS 149 amends and clarifies
financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other
contracts (collectively referred to as derivatives) and for
hedging activities under FASB Statement No. 133, Accounting
for Derivative Instruments and Hedging Activities. This
statement is effective for contracts entered into or modified
after June 30, 2003 and for hedging relationships
designated after June 30, 2003. The adoption of
SFAS 149 did not have a significant impact on Pegasus
results of operations or financial condition. In May 2003, the
FASB issued SFAS No. 150, Accounting for Certain
Financial Instruments with Characteristics of Both Liabilities
and Equity. SFAS 150 specifies that freestanding
financial instruments within its scope constitute obligations of
the issuer and that, therefore, the issuer must classify them as
liabilities. Such freestanding financial instruments include
mandatorily redeemable financial instruments, obligations to
repurchase the issuers equity shares by transferring
assets and certain obligations to issue a variable number of
shares. SFAS 150 was effective immediately for all
financial instruments entered into or modified after
May 31, 2003. For all other instruments, SFAS 150 was
effective at the beginning of the third quarter of 2003. Pegasus
adopted SFAS 150 effective July 1, 2003 with no
material impact on its financial condition or results of
operations.

In December 2003, the Securities and Exchange
Commission (SEC) issued Staff Accounting Bulletin
(SAB) No. 104, Revenue Recognition.
SAB 104 supersedes SAB 101, Revenue Recognition
in Financial Statements. SAB 104s primary
purpose is to rescind accounting guidance contained in
SAB 101 related to multiple element revenue arrangements,
superseded as a result of the issuance of EITF 00-21,
Accounting for Revenue Arrangements with Multiple
Deliverables. Additionally, SAB 104 rescinds the
SECs Revenue Recognition in Financial Statements
Frequently Asked Questions and Answers (the FAQ)
issued with SAB 101 that had been codified in SEC Topic 13,
Revenue Recognition. Selected portions of the FAQ have been
incorporated into SAB 104. While the wording of
SAB 104 has changed to reflect the issuance of
EITF 00-21, the revenue recognition principles of
SAB 101 remain largely unchanged by the issuance of
SAB 104, which was effective upon issuance. The adoption of
SAB 104 did not impact the consolidated financial
statements.

42



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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

In December 2003, the FASB issued
SFAS No. 132 (revised 2003), Employers
Disclosures about Pensions and Other Postretirement Benefits, an
amendment of FASB Statements No. 87, 88 and 106, and a
revision of FASB Statement No. 132
(SFAS 132 (revised 2003)). This Statement
revises employers disclosures about pension plans and
other postretirement benefit plans. It does not change the
measurement or recognition of those plans required by
SFAS 87, Employers Accounting for
Pensions, No. 88, Employers Accounting
for Settlements and Curtailments of Defined Benefit Pension
Plans and for Termination Benefits and No. 106,
Employers Accounting for Postretirement Benefits
Other Than Pensions. The new rules require additional
disclosures about the assets, obligations, cash flows and net
periodic benefit cost of defined benefit pension plans and other
postretirement benefit plans. The required information will be
provided separately for pension plans and for other
postretirement benefit plans. This includes expanded disclosure
on an interim basis as well. SFAS 132 (revised 2003) is
effective for financial statements with fiscal years ended after
December 15, 2003, except that disclosure of information
about foreign plans required by this Statement is effective for
fiscal years ending after June 15, 2004. The interim-period
disclosures required by this Statement are effective for interim
periods beginning after December 15, 2003. The adoption of
SFAS 132 has been reflected in Note 12 to the
consolidated financial statements.



|   |                  
|-- | -----------------
|2. | Restructure Costs

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 is complete, included the elimination of redundant
positions and consolidation of certain facilities. The
elimination of redundant positions represented approximately
10 percent of the Companys workforce, primarily due
to the integration of support functions.

During 2003, the Company recorded restructure
charges of $5.9 million, composed of one-time termination
benefits totaling $4.4 million and facilities-related and
other charges totaling $1.5 million. As of
December 31, 2003, unpaid restructure costs of $840,000,
consisting primarily of facilities-related costs, are included
in other current and noncurrent liabilities.

During the year ended December 31, 2001, 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 in 2001. At
December 31, 2003, no amounts remain unpaid from the 2001
restructuring. Restructure charges for 2001 were composed of (in
thousands):

|                                                |                                      |   |       |       | 
|----------------------------------------------- | ------------------------------------ | - | ----- | ----- | 
|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   | 
|                                                |                                      |   |       |      
|Winding-down of business intelligence services: |                                      |   |       |      
|                                                | Severance costs                      |   |       | 221   | 
|                                                |                                      |   |       |      
|Total restructuring charges                     |                                      | $ | 7,696 |      
|                                                |                                      |   |       |      

43



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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



|   |             
|-- | ------------
|3. | Acquisitions



| |             
| | ------------
| | Unirez, Inc.

On December 1, 2003, Pegasus completed the
acquisition of all of the outstanding securities of Unirez,
which was accounted for under the purchase method of accounting.
Accordingly, Unirezs results of operations subsequent to
the acquisition date are included in the Companys
consolidated financial statements.

The purchase price was approximately
$37.8 million, which includes approximately $215,000 in
acquisition costs. Under the stock purchase agreement, Pegasus
delivered to the security holders of Unirez, on a pro-rata
basis, $35 million in cash and will deliver
$2.5 million in cash on December 1, 2004, subject to
certain conditions and post-closing adjustments. Pegasus
utilized cash proceeds from its previously completed convertible
debt offering to fund the acquisition. The Acquisition qualifies
for a joint election tax benefit under Section 338(h)(10),
which allows goodwill to be fully deductible for tax purposes
over a period of 15 years.

Unirez serves independent properties and small
hotel groups by providing central reservation services that
enable distribution of room inventory through GDSs and Internet
channels. Unirezs primary assets include its software and
intangible assets such as customer service agreements. Under
contractual agreements, Pegasus has provided distribution
services to Unirez since January 21, 2000.

The purchase price 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, is
summarized below (in thousands):

|                     |                                                |                           |                     |        |        |        | 
|-------------------- | ---------------------------------------------- | ------------------------- | ------------------- | ------ | ------ | ------ | 
|Tangible assets:     |                                                |                           |                     |       
|                     | Cash and cash equivalents                      |                           | $                   | 1,000  |       
|                     | Accounts receivable and other current assets   |                           |                     | 2,807  |       
|                     | Property and equipment  Software              |                           |                     | 5,480  |       
|                     | Property and equipment  Other, net            |                           |                     | 399    |       
|                     | Other assets-long term                         |                           |                     | 22     |       
|                     |                                                |                           |                     |       
|                     |                                                | Total tangible assets     |                     |        | 9,708  |       
|Intangible assets:   |                                                |                           |                     |       
|                     | Customer relationships                         |                           |                     | 4,620  |       
|                     | Non-compete agreements                         |                           |                     | 2,300  |       
|                     | Goodwill                                       |                           |                     | 24,313 |       
|                     |                                                |                           |                     |       
|                     |                                                | Total intangible assets   |                     |        | 31,233 |       
|Liabilities assumed: |                                                |                           |                     |       
|                     | Accounts payable and other accrued liabilities |                           |                     | (2,882 | )     
|                     | Unearned income                                |                           |                     | (180   | )     
|                     | Other liabilities-long term                    |                           |                     | (116   | )     
|                     |                                                |                           |                     |       
|                     |                                                | Total liabilities assumed |                     |        | (3,178 | )     
|                     |                                                |                           |                     |       
|                     |                                                |                           | Net assets acquired |        | $      | 37,763 | 
|                     |                                                |                           |                     |       

44



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PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

The purchase price allocations to intangible
assets and software have estimated useful lives and estimated
annual amortization as follows (in thousands):

|                       |  |        |       |           |  |              |         |  |  |   |       | 
|---------------------- |  | ------ | ----- | --------- |  | ------------ | ------- |  |  | - | ----- | 
|                       |  |        |       | Estimated |  | Calculated  
|                       |  |        |       | Useful    |  | Annual      
|                       |  | Amount |       | Life      |  | Amortization
|                       |  |        |       |           |  |             
|Customer relationships |  | $      | 4,620 |           |  |              | 7 years |  |  | $ | 660   | 
|Software               |  |        | 5,480 |           |  |              | 5 years |  |  |   | 1,096 | 
|Non-compete agreement  |  |        | 2,300 |           |  |              | 4 years |  |  |   | 575   | 

The following unaudited pro forma summary
combines the consolidated results of operations of Pegasus and
Unirez for the years ended December 31, 2003 and 2002 as if
the acquisition had occurred at the beginning of 2002 after
giving effect to certain pro forma adjustments. This pro forma
financial information is provided for informational purposes
only and may not be indicative of the results of operations as
they would have been had the transaction been effected on the
assumed dates nor is it indicative of the results of operations
which may occur in the future.

|                   |  |                       |         |      |  |   |         |  
|------------------ |  | --------------------- | ------- | ---- |  | - | ------- | -
|                   |  |                      
|                   |  | Unaudited            
|                   |  |                      
|                   |  | 2003                  |         | 2002
|                   |  |                       |         |     
|                   |  |                      
|                   |  | (In thousands, except
|                   |  | per share amounts)   
|Net revenues       |  | $                     | 203,639 |      |  | $ | 198,556 |  
|Net loss           |  |                       | (3,079  | )    |  |   | (4,769  | )
|Net loss per share |  |                       | (0.12   | )    |  |   | (0.19   | )



| |                                      
| | -------------------------------------
| | Total Distribution System
    Limited

In September 2003, Pegasus acquired all of the
stock of Total Distribution System Limited (TDS), a
UK developer of tour operator software applications, for
approximately $1.7 million. Pegasus delivered to the
security holders of TDS, on a pro-rata basis, approximately
$1 million in cash, with the remaining purchase price
payable at a future date subject to certain conditions. The
Company allocated the entire purchase price to the primary asset
acquired, TDS internally developed software. This
acquisition was not material to the Companys results of
operations for the year ended December 31, 2003.



| |                                                
| | -----------------------------------------------
| | Global Enterprise Technology Solutions,
    LLC

On September 1, 2001, Pegasus acquired the
outstanding common stock of GETS not already held by the
Company, 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 composed:



| |   |                                                                                                
| | - | -----------------------------------------------------------------------------------------------
| |  | $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

45



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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

statements. The approximate fair value of assets
acquired and liabilities assumed at the acquisition date is
summarized below (in thousands):

|                                                             |  |   |        |  
|------------------------------------------------------------ |  | - | ------ | -
|Estimated fair value of net tangible liabilities
    assumed |  | $ | (1,380 | )
|Software                                                     |  |   | 18,120 |  
|Other intangible assets                                      |  |   | 120    |  
|Goodwill                                                     |  |   | 5,730  |  

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 put into service. 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.



|   |                       
|-- | ----------------------
|4. | Sale of Business Units



| |             
| | ------------
| | 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.



| |                                         
| | ----------------------------------------
| | 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 accrued interest at an annual rate of Prime plus
2 percent, and was repaid in August 2003.

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. For further information, see Note 1.



|   |                               
|-- | ------------------------------
|5. | Goodwill and Intangible Assets

As of December 31, 2003 and 2002, goodwill
totaled $164.1 million and $139.5 million,
respectively. In accordance with FAS 142, goodwill is
subject to an annual impairment test. Based on the periodic
impairment test conducted as of September 30, 2003, the
Company does not believe goodwill is impaired.

46



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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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, 2003 and
December 31, 2002 (in thousands):

|                       |  |                   |        |                   |  |          |         |              |  |   |        |  |  |   |         |  
|---------------------- |  | ----------------- | ------ | ----------------- |  | -------- | ------- | ------------ |  | - | ------ |  |  | - | ------- | -
|                       |  |                   |        |                  
|                       |  | December 31, 2003 |        | December 31, 2002
|                       |  |                   |        |                  
|                       |  | Carrying          |        | Accumulated       |  | Carrying |         | Accumulated 
|                       |  | Value             |        | Amortization      |  | Value    |         | Amortization
|                       |  |                   |        |                   |  |          |         |             
|Customer relationships |  | $                 | 56,996 |                   |  | $        | (52,431 | )            |  | $ | 52,376 |  |  | $ | (48,146 | )
|Non-compete agreements |  |                   | 6,120  |                   |  |          | (2,878  | )            |  |   | 3,820  |  |  |   | (2,067  | )
|Other                  |  |                   | 48     |                   |  |          | (24     | )            |  |   | 48     |  |  |   | (18     | )
|                       |  |                   |        |                   |  |          |         |              |  |   |        |  |  |   |         |  
|Total                  |  | $                 | 63,164 |                   |  | $        | (55,333 | )            |  | $ | 56,244 |  |  | $ | (50,231 | )
|                       |  |                   |        |                   |  |          |         |              |  |   |        |  |  |   |         |  

During the years ended December 31, 2003,
2002 and 2001 the Company recorded amortization expense in
relation to the above-listed intangible assets of
$5.1 million, $18.0 million and $16.5 million,
respectively. The following table presents the estimated
amortization expense for these intangible assets for the years
ended December 31 (in thousands):

|           |  |   |       | 
|---------- |  | - | ----- | 
|2004       |  | $ | 2,004 | 
|2005       |  |   | 1,452 | 
|2006       |  |   | 1,262 | 
|2007       |  |   | 1,191 | 
|2008       |  |   | 660   | 
|Thereafter |  |   | 1,262 | 
|           |  |   |       | 
|Total      |  | $ | 7,831 | 
|           |  |   |       | 

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):

|                                      |                                 |                         |        |        |   |      |        |        |   |   |         |        |  
|------------------------------------- | ------------------------------- | ----------------------- | ------ | ------ | - | ---- | ------ | ------ | - | - | ------- | ------ | -
|                                      |                                 |                        
|                                      |                                 | Year Ended December 31,
|                                      |                                 |                        
|                                      |                                 | 2003                    |        | 2002   |   | 2001
|                                      |                                 |                         |        |        |   |     
|Reported net loss                     |                                 | $                       | (1,832 | )      |   | $    | (3,519 | )      |   | $ | (29,737 | )     
|Goodwill amortization                 |                                 |                         |       |        |   |      |       |        |   |   | 10,415  |       
|Workforce in-place amortization       |                                 |                         |       |        |   |      |       |        |   |   | 4,225   |       
|                                      |                                 |                         |        |        |   |      |        |        |   |   |         |       
|Adjusted net loss                     |                                 | $                       | (1,832 | )      |   | $    | (3,519 | )      |   | $ | (15,097 | )     
|                                      |                                 |                         |        |        |   |      |        |        |   |   |         |       
|Basic and diluted earnings per share: |                                 |                         |        |        |   |      |        |        |   |   |         |       
|                                      | Reported net loss               |                         | $      | (0.07  | ) |      | $      | (0.14  | ) |   | $       | (1.21  | )
|                                      | Goodwill amortization           |                         |        |       |   |      |        |       |   |   |         | 0.42   |  
|                                      | Workforce in-place amortization |                         |        |       |   |      |        |       |   |   |         | 0.17   |  
|                                      |                                 |                         |        |        |   |      |        |        |   |   |         |       
|                                      | Adjusted net loss               |                         | $      | (0.07  | ) |      | $      | (0.14  | ) |   | $       | (0.62  | )
|                                      |                                 |                         |        |        |   |      |        |        |   |   |         |       
|Weighted average shares outstanding:  |                                 |                         |        |        |   |      |        |        |   |   |         |       
|                                      | Basic and diluted               |                         |        | 24,864 |   |      |        | 24,818 |   |   |         | 24,570 |  
|                                      |                                 |                         |        |        |   |      |        |        |   |   |         |       

47



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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



|   |                      
|-- | ---------------------
|6. | Marketable Securities

Marketable securities held by the Company at
December 31, 2003 and 2002 are classified as
available-for-sale and consist of corporate debt and equity
securities and obligations issued by governments and agencies.
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. At
December 31, 2003, $2.0 million of corporate debt
securities and $2.0 million of government agency securities
have contractual maturities in 2004, while all other marketable
securities have maturities exceeding one year. The amortized
cost and fair value of marketable securities at
December 31, 2003 and 2002 are as follows (in thousands):

|                                                                                                  |                             |           |       |            |  |            |    |           |  |   |     |     |   |   |       |        | 
|------------------------------------------------------------------------------------------------- | --------------------------- | --------- | ----- | ---------- |  | ---------- | -- | --------- |  | - | --- | --- | - | - | ----- | ------ | 
|                                                                                                  |                             |           |       | Gross      |  | Gross      |    | Estimated
|                                                                                                  |                             | Amortized |       | Unrealized |  | Unrealized |    | Fair     
|                                                                                                  |                             | Cost      |       | Gains      |  | Losses     |    | Value    
|                                                                                                  |                             |           |       |            |  |            |    |          
|December 31, 2003                                                                                 |                             |           |       |            |  |            |    |           |  |   |     |     |   |   |       |       
|Corporate debt securities                                                                         |                             | $         | 5,238 |            |  | $          | 6  |           |  | $ |    |     |   | $ | 5,244 |       
|Debt securities issued by the U.S Treasury or
    other U.S. Government Corporations and agencies |                             |           | 4,000 |            |  |            | 14 |           |  |   | (3  | )   |   |   | 4,011 |       
|Debt securities issued by states of the U.S and
    political subdivisions of the states          |                             |           | 2,000 |            |  |            | 1  |           |  |   | (1  | )   |   |   | 2,000 |       
|Equity securities                                                                                 |                             |           | 16    |            |  |            |   |           |  |   | (15 | )   |   |   | 1     |       
|                                                                                                  |                             |           |       |            |  |            |    |           |  |   |     |     |   |   |       |       
|                                                                                                  | Total marketable securities |           | $     | 11,254     |  |            | $  | 21        |  |   | $   | (19 | ) |   | $     | 11,256 | 
|                                                                                                  |                             |           |       |            |  |            |    |           |  |   |     |     |   |   |       |       
|December 31, 2002                                                                                 |                             |           |       |            |  |            |    |           |  |   |     |     |   |   |       |       
|Corporate debt securities                                                                         |                             | $         | 4,105 |            |  | $          | 16 |           |  | $ |    |     |   | $ | 4,121 |       
|Debt securities issued by the U.S Treasury or
    other U.S. Government Corporations and agencies |                             |           | 2,014 |            |  |            | 2  |           |  |   | (2  | )   |   |   | 2,014 |       
|Debt securities issued by states of the U.S and
    political subdivisions of the states          |                             |           | 1,002 |            |  |            | 1  |           |  |   |    |     |   |   | 1,003 |       
|Equity securities                                                                                 |                             |           | 16    |            |  |            |   |           |  |   | (15 | )   |   |   | 1     |       
|                                                                                                  |                             |           |       |            |  |            |    |           |  |   |     |     |   |   |       |       
|                                                                                                  | Total marketable securities |           | $     | 7,137      |  |            | $  | 19        |  |   | $   | (17 | ) |   | $     | 7,139  | 
|                                                                                                  |                             |           |       |            |  |            |    |           |  |   |     |     |   |   |       |       



|   |                                 
|-- | --------------------------------
|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, Pegasus was a party to
various forward exchange contracts at December 31, 2003.
These contracts reduce exposure to currency movements affecting
existing foreign currency denominated assets and liabilities,
primarily trade receivables and payables.

48



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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

A summary of forward exchange contracts in place
at December 31, 2003 follows (in thousands):

|                   |       |      |        |          |  |   |     |     | 
|------------------ | ----- | ---- | ------ | -------- |  | - | --- | --- | 
|                   |       | Sell |        | Purchase
|                   |       |      |        |         
|Euro               |       | $    | 11,213 |          |  | $ |    |    
|Swedish Krona      |       |      | 1,116  |          |  |   |    |    
|British Pound      |       |      |       |          |  |   | 663 |    
|Japanese Yen       |       |      | 634    |          |  |   |    |    
|Swiss Franc        |       |      | 317    |          |  |   |    |    
|Canadian Dollar    |       |      | 289    |          |  |   |    |    
|Singapore Dollar   |       |      | 274    |          |  |   |    |    
|Hong Kong Dollar   |       |      | 231    |          |  |   |    |    
|Australian Dollar  |       |      | 130    |          |  |   |    |    
|South African Rand |       |      | 75     |          |  |   |    |    
|Norwegian Krona    |       |      | 47     |          |  |   |    |    
|Czech Krone        |       |      | 6      |          |  |   |    |    
|Danish Krone       |       |      |       |          |  |   | 2   |    
|New Zealand Dollar |       |      |       |          |  |   | 1   |    
|                   |       |      |        |          |  |   |     |    
|                   | Total |      | $      | 14,332   |  |   | $   | 666 | 
|                   |       |      |        |          |  |   |     |    

All contracts matured no later than February
2004. 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, 2003. During the fiscal year ended
December 31, 2002, 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, 2002. As of December 31, 2002, Pegasus
had approximately $14.1 million in sell forward exchange
contracts and $478,000 in purchase forward exchange contracts.
Pegasus positions with respect to these forward exchange
contracts differed as of December 31, 2003 compared to
December 31, 2002 because of changes in Pegasus
non-U.S. denominated trade payables and receivables.



|   |                       
|-- | ----------------------
|8. | Property and Equipment

Property and equipment at December 31
consisted of the following (in thousands):

|                            |                                |      |         |         |   |             |         |         |   |  |              |  | 
|--------------------------- | ------------------------------ | ---- | ------- | ------- | - | ----------- | ------- | ------- | - |  | ------------ |  | 
|                            |                                |      |         |         |   | Estimated  
|                            |                                | 2003 |         | 2002    |   | Useful Life
|                            |                                |      |         |         |   |            
|Software                    |                                | $    | 108,894 |         |   | $           | 91,330  |         |   |  | 3 to 5 years | 
|Computer equipment          |                                |      | 25,222  |         |   |             | 24,980  |         |   |  | 3 to 4 years | 
|Leasehold improvements      |                                |      | 13,646  |         |   |             | 12,521  |         |   |  | Lease term   | 
|Furniture and equipment     |                                |      | 6,655   |         |   |             | 5,130   |         |   |  | 7 years      | 
|Office equipment            |                                |      | 3,835   |         |   |             | 4,448   |         |   |  | 4 years      | 
|                            |                                |      |         |         |   |             |         |         |   |  |              | 
|                            |                                |      | 158,252 |         |   |             | 138,409 |         |   |  |              | 
|                            | Less: accumulated depreciation |      |         | (82,778 | ) |             |         | (66,967 | ) |  |              |  | 
|                            |                                |      |         |         |   |             |         |         |   |  |              | 
|Property and equipment, net |                                | $    | 75,474  |         |   | $           | 71,442  |         |   |  |              | 
|                            |                                |      |         |         |   |             |         |         |   |  |              | 

Depreciation and amortization expense for
property and equipment was $22.9 million,
$30.1 million and $23.3 million for 2003, 2002 and
2001, respectively.

49



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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



|   |     
|-- | ----
|9. | Debt

On July 21, 2003, the Company issued
convertible senior notes totaling $75 million in principal
through a private placement. These notes bear interest at an
annual rate of 3.875 percent, payable semi-annually in cash
in arrears, through the maturity date of July 15, 2023.
Each note is convertible into Pegasus common stock at a
conversion price of approximately $20.13 per share (equal
to an initial conversion rate of approximately
49.6808 shares per $1,000 principal amount of notes),
subject to adjustment in certain circumstances. Holders of the
notes may convert their notes only if (i) the price of
Pegasus common stock reaches specified thresholds;
(ii) the notes have been called for redemption; or
(iii) specified corporate transactions occur, including,
without limitation, certain acquisitions, mergers or asset sale
transactions.

The Company may redeem all or some of the notes
for cash at any time on or after July 15, 2008, at a
redemption price equal to the principal amount of the notes plus
any accrued and unpaid interest at the redemption date. Holders
may require the Company to purchase the notes on July 16 of
2008, 2013 and 2018, or in other specified circumstances, at a
purchase price equal to the principal amount due plus any
accrued and unpaid interest at the purchase date and additional
amounts, if any.

Concurrent with the issuance of the notes, the
Company terminated its $30 million revolving credit
facility with Chase Bank of Texas, Compass Bank and Wells Fargo
Bank (Texas). Prior to termination, there were no amounts
outstanding under this credit facility.

The Company has two existing irrevocable standby
letter of credit agreements with JPMorgan Chase Bank totaling
$2.1 million, securing the Companys leases for the
Dallas and Scottsdale offices. In July 2003, the Company amended
its letter of credit agreements and funded $2.1 million as
collateral for these letters of credit.

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.



|    |                     
|--- | --------------------
|10. | Stockholders Equity

On November 5, 2003, the Board of Directors
renewed its authorization for the repurchase of up to
2.5 million shares of Pegasus common stock. No shares
were repurchased during 2003, but the Company repurchased
1.0 million shares for an aggregate purchase price of
$11.7 million from January 1, 2004 through
March 9, 2004. Once approved by the Board, any future
repurchases are 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.

On June 5, 2002, the Board of Directors
authorized the repurchase of up to 2.5 million shares of
the Companys common stock. During 2002,
404,000 shares were repurchased at an aggregate purchase
price of $4.6 million. 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.

Shares repurchased under Board approved plans are
immediately 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

50



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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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, 2003 was approximately
30.8 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.
As of December 31, 2003, shares available for grant under
the Companys stock option plans were approximately 432,000.

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 was 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
(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):

|                                         |  |                   |       |                           |  |      |       |      |  |      |       |      |  |   |       |  |  |   |       |  |  |   |       | 
|---------------------------------------- |  | ----------------- | ----- | ------------------------- |  | ---- | ----- | ---- |  | ---- | ----- | ---- |  | - | ----- |  |  | - | ----- |  |  | - | ----- | 
|                                         |  |                   |       |                          
|                                         |  | Number of Company |       | Weighted Average Exercise
|                                         |  | Options           |       | Price Per Share          
|                                         |  |                   |       |                          
|                                         |  | 2003              |       | 2002                      |  | 2001 |       | 2003 |  | 2002 |       | 2001
|                                         |  |                   |       |                           |  |      |       |      |  |      |       |     
|Options outstanding at beginning of year |  |                   | 4,370 |                           |  |      | 3,830 |      |  |      | 3,069 |      |  | $ | 12.88 |  |  | $ | 12.23 |  |  | $ | 13.53 | 
|Granted                                  |  |                   | 1,792 |                           |  |      | 1,027 |      |  |      | 1,601 |      |  |   | 12.03 |  |  |   | 13.70 |  |  |   | 10.30 | 
|Exercised                                |  |                   | (278  | )                         |  |      | (293  | )    |  |      | (216  | )    |  |   | 6.65  |  |  |   | 6.02  |  |  |   | 4.59  | 
|Canceled                                 |  |                   | (622  | )                         |  |      | (194  | )    |  |      | (624  | )    |  |   | 16.95 |  |  |   | 16.39 |  |  |   | 16.05 | 
|                                         |  |                   |       |                           |  |      |       |      |  |      |       |      |  |   |       |  |  |   |       |  |  |   |       | 
|Options outstanding at end of year       |  |                   | 5,262 |                           |  |      | 4,370 |      |  |      | 3,830 |      |  | $ | 12.75 |  |  | $ | 12.88 |  |  | $ | 12.30 | 
|                                         |  |                   |       |                           |  |      |       |      |  |      |       |      |  |   |       |  |  |   |       |  |  |   |       | 
|Options exercisable at end of year       |  |                   | 2,401 |                           |  |      | 1,810 |      |  |      | 1,376 |      |  | $ | 13.44 |  |  | $ | 12.57 |  |  | $ | 10.70 | 
|                                         |  |                   |       |                           |  |      |       |      |  |      |       |      |  |   |       |  |  |   |       |  |  |   |       | 

The following table summarizes information for
stock options outstanding at December 31, 2003 (in
thousands, except per share amounts):

|                |  |                     |       |                     |  |          |           |           |  |          |       |  |  |  |       |  |  |   |       | 
|--------------- |  | ------------------- | ----- | ------------------- |  | -------- | --------- | --------- |  | -------- | ----- |  |  |  | ----- |  |  | - | ----- | 
|                |  |                     |       |                    
|                |  | Options Outstanding |       | Options Exercisable
|                |  |                     |       |                    
|                |  |                     |       | Weighted            |  |          |           |          
|                |  |                     |       | Average             |  | Weighted |           |           |  | Weighted
|                |  |                     |       | Remaining           |  | Average  |           |           |  | Average 
|                |  | Number of           |       | Contractual         |  | Exercise |           | Number of |  | Exercise
|Exercise Prices |  | Options             |       | Life                |  | Price    |           | Options   |  | Price   
|                |  |                     |       |                     |  |          |           |           |  |         
|$1.34           |  |                     | 227   |                     |  |          | 2.0 years |           |  | $        | 1.34  |  |  |  | 227   |  |  | $ | 1.34  | 
|$2.07           |  |                     | 23    |                     |  |          | 2.0 years |           |  |          | 2.07  |  |  |  | 23    |  |  |   | 2.07  | 
|$6.33-$8.90     |  |                     | 778   |                     |  |          | 6.4 years |           |  |          | 7.62  |  |  |  | 480   |  |  |   | 7.32  | 
|$9.69-$14.28    |  |                     | 3,178 |                     |  |          | 8.4 years |           |  |          | 12.35 |  |  |  | 775   |  |  |   | 12.48 | 
|$14.59-$18.63   |  |                     | 663   |                     |  |          | 6.1 years |           |  |          | 17.88 |  |  |  | 506   |  |  |   | 17.88 | 
|$22.67-$29.02   |  |                     | 393   |                     |  |          | 5.2 years |           |  |          | 24.78 |  |  |  | 390   |  |  |   | 24.79 | 
|                |  |                     |       |                     |  |          |           |           |  |          |       |  |  |  |       |  |  |   |       | 
|$1.34-$29.02    |  |                     | 5,262 |                     |  |          | 7.3 years |           |  | $        | 12.75 |  |  |  | 2,401 |  |  | $ | 13.44 | 
|                |  |                     |       |                     |  |          |           |           |  |          |       |  |  |  |       |  |  |   |       | 

51



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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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 period (the Offering Commencement
Date) to purchase at the end of the plan period, (the
Offering Termination Date) shares of common stock
using the amounts that have accumulated from the employees
payroll deductions made during the plan period 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, whichever is lower. Through 2003, the plan was
administered on an annual basis. Beginning in 2003, the Company
began offering its employees the ability to participate in the
Stock Plan on a semi-annual basis under similar terms as
described above. During 2003, 2002 and 2001, approximately
66,000, 65,000 and 48,000 shares were issued under the
Stock Plan, respectively.



|    |                       
|--- | ----------------------
|12. | Employee Benefit Plans



| |                                        
| | ---------------------------------------
| | Employee Defined Contribution
    Plans

In the United States, the Company sponsors a
401(k) defined contribution retirement plan (the 401(k)
Plan) covering all employees, with exceptions as defined
by the 401(k) Plan. The 401(k) Plan allows eligible employees to
defer receipt of up to 25 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. Each payroll period, the Company makes
discretionary matching contributions for employees annual
contributions of up to 100 percent of the first
5 percent of employees compensation contributed. 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 Company 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 and part-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 from 17.5 to
40 percent of their total pensionable earnings (as defined
in the plan) 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 2003, 2002 and 2001, the Company
contributed $1.8 million, $1.9 million and
$1.8 million, respectively, to the 401(k) Plan. During
2003, 2002, and 2001, the Company contributed approximately
$160,000, $228,000 and $182,000, respectively, to the Utell
Defined Contribution Plan.



| |                                        
| | ---------------------------------------
| | United Kingdom Defined Benefit
    Plan

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. During 2003,
payments from this plan totaled $106,000.

52



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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |                             
| | ----------------------------
| | Executive Retirement Program

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 was effective
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.

During 2002, the Board of Directors adopted an
Executive Retirement Program, consisting of an amended and
restated SERP and the new Pegasus Solutions, Inc. Executive
Deferred Compensation Plan (the 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. The DCP is a defined contribution plan that
provides supplemental retirement benefits to certain management
employees of the Company. During 2003 and 2002, the Company
recorded expenses of approximately $527,000 and $114,000,
respectively, related to the DCP.

Commencing in 2003, the Company is obligated to
make annual cash payments to a trust associated with benefits
earned under the Executive Retirement Program. Cash payments to
the trust in 2003 totaled $1.1 million related to the SERP
and $817,000 million related to the DCP. 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.



| |                                                               
| | --------------------------------------------------------------
| | Defined Benefit Obligations, Plan Assets
    and Funded Status

At December 31, 2002, the Company recorded
additional minimum liabilities applicable to the SERP and the
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. During 2003, the Company recorded an
additional minimum liability applicable to the SERP of $283,000
and reduced the additional minimum liability applicable to the
Utell Defined Benefit Plan by $1.5 million as a result of
the change in actuarial estimate discussed below. Accordingly,
income of $871,000, net of tax, was recorded in other
comprehensive loss in 2003.

During 2003, the benefit obligation for the Utell
Defined Benefit Plan was reduced by a $1.7 million
actuarial gain related to the estimated age at which benefits
will be paid to participants. Also during 2003, the Company
recognized a curtailment gain of $508,000 and a settlement loss
of $261,000 for the Utell Defined Benefit Plan under Statement
of Financial Accounting Standards No. 88,
Employers Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for
Termination Benefits. The curtailment and settlement were
the result of a significant decrease in the number of active
participants due to the Companys 2003 strategic
integration plan.

53



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##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

Pegasus uses a January 1 measurement date for the
SERP and the Utell Defined Benefit Plan. For each defined
benefit plan, the following tables provide a statement of funded
status as of December 31, 2003 and 2002, and summaries of
the changes in the benefit obligation and fair value of assets
for the years then ended (in thousands):

|                                               |  |      |        |               |  |      |        |      |  |   |        |   |  |   |        |  
|---------------------------------------------- |  | ---- | ------ | ------------- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                               |  |      |        |               |  |     
|                                               |  |      |        | Utell Defined
|                                               |  | SERP |        | Benefit Plan 
|                                               |  |      |        |              
|                                               |  | 2003 |        | 2002          |  | 2003 |        | 2002
|                                               |  |      |        |               |  |      |        |     
|Benefit obligation at beginning of year        |  | $    | 3,330  |               |  | $    | 4,314  |      |  | $ | 10,634 |   |  | $ | 8,837  |  
|Service cost                                   |  |      | 178    |               |  |      | 511    |      |  |   | 474    |   |  |   | 704    |  
|Interest cost                                  |  |      | 225    |               |  |      | 289    |      |  |   | 585    |   |  |   | 486    |  
|Plan participants contributions               |  |      |       |               |  |      |       |      |  |   | 132    |   |  |   | 148    |  
|Amendments                                     |  |      |       |               |  |      | (2,069 | )    |  |   |       |   |  |   |       |  
|Actuarial loss (gain)                          |  |      | 357    |               |  |      | 285    |      |  |   | (1,715 | ) |  |   | 459    |  
|Benefits paid                                  |  |      |       |               |  |      |       |      |  |   | (106   | ) |  |   |       |  
|Curtailment                                    |  |      |       |               |  |      |       |      |  |   | (508   | ) |  |   |       |  
|Settlement                                     |  |      |       |               |  |      |       |      |  |   | 261    |   |  |   |       |  
|                                               |  |      |        |               |  |      |        |      |  |   |        |   |  |   |        |  
|Benefit obligation at end of year              |  | $    | 4,090  |               |  | $    | 3,330  |      |  | $ | 9,757  |   |  | $ | 10,634 |  
|                                               |  |      |        |               |  |      |        |      |  |   |        |   |  |   |        |  
|Fair value of plan assets at beginning of year |  | $    |       |               |  | $    |       |      |  | $ | 7,220  |   |  | $ | 7,662  |  
|Actual return on plan assets                   |  |      |       |               |  |      |       |      |  |   | 2,072  |   |  |   | (961   | )
|Employer contribution                          |  |      |       |               |  |      |       |      |  |   | 328    |   |  |   | 371    |  
|Plan participants contributions               |  |      |       |               |  |      |       |      |  |   | 132    |   |  |   | 148    |  
|Benefits paid                                  |  |      |       |               |  |      |       |      |  |   | (106   | ) |  |   |       |  
|                                               |  |      |        |               |  |      |        |      |  |   |        |   |  |   |        |  
|Fair value of plan assets at end of year       |  | $    |       |               |  | $    |       |      |  | $ | 9,646  |   |  | $ | 7,220  |  
|                                               |  |      |        |               |  |      |        |      |  |   |        |   |  |   |        |  
|Funded status                                  |  | $    | (4,090 | )             |  | $    | (3,330 | )    |  | $ | (111   | ) |  | $ | (3,414 | )
|Unrecognized actuarial loss (gain)             |  |      | 1,875  |               |  |      | 1,640  |      |  |   | (1,234 | ) |  |   | 3,390  |  
|Unrecognized prior service cost                |  |      | (501   | )             |  |      | (549   | )    |  |   |       |   |  |   |       |  
|Additional minimum pension liability           |  |      | (1,374 | )             |  |      | (1,091 | )    |  |   |       |   |  |   | (1,511 | )
|                                               |  |      |        |               |  |      |        |      |  |   |        |   |  |   |        |  
|Net amount recognized                          |  | $    | (4,090 | )             |  | $    | (3,330 | )    |  | $ | (1,345 | ) |  | $ | (1,535 | )
|                                               |  |      |        |               |  |      |        |      |  |   |        |   |  |   |        |  

As of December 31, 2003 and 2002, the SERP
had an accumulated benefit obligation of $4.1 million and
$3.3 million, respectively. Including the impact of recent
changes in executive management, the Companys projected
contribution to the SERP in 2004 is approximately $235,000.
These changes could have an effect on the assumptions used in
accounting for the SERP during 2004.

The assumptions used in the measurement of the
Companys benefit obligations as of December 31, 2003
and 2002 are as follows:

|                               |  |      |      |               |  |      |             |      |  |  |     |   |  |  |     |  
|------------------------------ |  | ---- | ---- | ------------- |  | ---- | ----------- | ---- |  |  | --- | - |  |  | --- | -
|                               |  |      |      |               |  |     
|                               |  |      |      | Utell Defined
|                               |  | SERP |      | Benefit Plan 
|                               |  |      |      |              
|                               |  | 2003 |      | 2002          |  | 2003 |             | 2002
|                               |  |      |      |               |  |      |             |     
|Discount rate                  |  |      | 6.75 | %             |  |      | 6.75%-7.25% |      |  |  | 5.5 | % |  |  | 5.5 | %
|Expected return on plan assets |  |      | N/A  |               |  |      | N/A         |      |  |  | 7.0 | % |  |  | 7.0 | %
|Rate of compensation increase  |  |      | 5.0  | %             |  |      | 5.0%        |      |  |  | 3.8 | % |  |  | 3.8 | %

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PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)



| |                           
| | --------------------------
| | Net Periodic Benefit Costs

The following table provides the components of
net periodic benefit costs for the three years ended
December 31, 2003 (in thousands):

|                                   |  |      |     |               |  |      |     |      |  |      |     |      |  |   |      |   |  |   |      |   |  |   |      |  
|---------------------------------- |  | ---- | --- | ------------- |  | ---- | --- | ---- |  | ---- | --- | ---- |  | - | ---- | - |  | - | ---- | - |  | - | ---- | -
|                                   |  |      |     |               |  |      |     |     
|                                   |  |      |     | Utell Defined
|                                   |  | SERP |     | Benefit Plan 
|                                   |  |      |     |              
|                                   |  | 2003 |     | 2002          |  | 2001 |     | 2003 |  | 2002 |     | 2001
|                                   |  |      |     |               |  |      |     |      |  |      |     |     
|Service cost                       |  | $    | 178 |               |  | $    | 511 |      |  | $    | 365 |      |  | $ | 474  |   |  | $ | 704  |   |  | $ | 777  |  
|Interest cost                      |  |      | 225 |               |  |      | 289 |      |  |      | 198 |      |  |   | 585  |   |  |   | 486  |   |  |   | 473  |  
|Expected return on plan assets     |  |      |    |               |  |      |    |      |  |      |    |      |  |   | (530 | ) |  |   | (575 | ) |  |   | (605 | )
|Amortization of prior service cost |  |      | (49 | )             |  |      | 99  |      |  |      | 136 |      |  |   |     |   |  |   |     |   |  |   |     |  
|Recognized net actuarial loss      |  |      | 116 |               |  |      | 91  |      |  |      | 15  |      |  |   | 486  |   |  |   | 24   |   |  |   |     |  
|Curtailment gain                   |  |      |    |               |  |      |    |      |  |      |    |      |  |   | (508 | ) |  |   |     |   |  |   |     |  
|Settlement loss                    |  |      |    |               |  |      |    |      |  |      |    |      |  |   | 261  |   |  |   |     |   |  |   |     |  
|                                   |  |      |     |               |  |      |     |      |  |      |     |      |  |   |      |   |  |   |      |   |  |   |      |  
|Net periodic benefit cost          |  | $    | 470 |               |  | $    | 990 |      |  | $    | 714 |      |  | $ | 768  |   |  | $ | 639  |   |  | $ | 645  |  
|                                   |  |      |     |               |  |      |     |      |  |      |     |      |  |   |      |   |  |   |      |   |  |   |      |  

The principal assumptions used in the measurement
of the net benefit costs for the three years ended
December 31, 2003 are as follows:

|                               |  |      |      |               |  |      |      |      |  |      |      |      |  |  |     |   |  |  |     |   |  |  |     |  
|------------------------------ |  | ---- | ---- | ------------- |  | ---- | ---- | ---- |  | ---- | ---- | ---- |  |  | --- | - |  |  | --- | - |  |  | --- | -
|                               |  |      |      |               |  |      |      |     
|                               |  |      |      | Utell Defined
|                               |  | SERP |      | Benefit Plan 
|                               |  |      |      |              
|                               |  | 2003 |      | 2002          |  | 2001 |      | 2003 |  | 2002 |      | 2001
|                               |  |      |      |               |  |      |      |      |  |      |      |     
|Discount rate                  |  |      | 6.75 | %             |  |      | 6.75 | %    |  |      | 6.75 | %    |  |  | 5.5 | % |  |  | 5.5 | % |  |  | 6.0 | %
|Expected return on plan assets |  |      | N/A  |               |  |      | N/A  |      |  |      | N/A  |      |  |  | 7.0 | % |  |  | 7.0 | % |  |  | 7.5 | %
|Rate of compensation increase  |  |      | 5.0  | %             |  |      | 5.0  | %    |  |      | 5.0  | %    |  |  | 3.8 | % |  |  | 3.8 | % |  |  | 4.0 | %



|    |             
|--- | ------------
|13. | Income Taxes

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

|         |  |      |        |      |  |      |         |   |  |   |         |  
|-------- |  | ---- | ------ | ---- |  | ---- | ------- | - |  | - | ------- | -
|         |  | 2003 |        | 2002 |  | 2001
|         |  |      |        |      |  |     
|Domestic |  | $    | (4,512 | )    |  | $    | (12,849 | ) |  | $ | (39,332 | )
|Foreign  |  |      | 1,775  |      |  |      | 7,215   |   |  |   | 649     |  
|         |  |      |        |      |  |      |         |   |  |   |         |  
|         |  | $    | (2,737 | )    |  | $    | (5,634  | ) |  | $ | (38,683 | )
|         |  |      |        |      |  |      |         |   |  |   |         |  

Deferred taxes consisted of the following at
December 31 (in thousands):

|                     |                                   |                           |   |       |        |  |   |       |       | 
|-------------------- | --------------------------------- | ------------------------- | - | ----- | ------ |  | - | ----- | ----- | 
|                     |                                   | 2003                      |   | 2002 
|                     |                                   |                           |   |      
|Deferred tax assets: |                                   |                           |   |       |        |  |   |      
|                     | Net operating loss carryforward   |                           | $ | 5,596 |        |  | $ | 5,551 |      
|                     | Bad debt reserves                 |                           |   | 540   |        |  |   | 897   |      
|                     | Benefit plan obligations          |                           |   | 1,600 |        |  |   | 896   |      
|                     | Income tax credits                |                           |   | 197   |        |  |   | 628   |      
|                     | Rent and other accruals           |                           |   | 3,259 |        |  |   | 440   |      
|                     | Stock option compensation expense |                           |   | 955   |        |  |   | 530   |      
|                     | Other                             |                           |   | 342   |        |  |   | 308   |      
|                     |                                   |                           |   |       |        |  |   |      
|                     |                                   | Gross deferred tax assets |   |       | 12,489 |  |   |       | 9,250 | 

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PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

|                          |                               |                                                           |       |        |         |   |       |        |        |  
|------------------------- | ----------------------------- | --------------------------------------------------------- | ----- | ------ | ------- | - | ----- | ------ | ------ | -
|                          |                               | 2003                                                      |       | 2002  
|                          |                               |                                                           |       |       
|                          |                               | Valuation allowance                                       |       |        | (444    | ) |       |        | (444   | )
|                          |                               |                                                           |       |        |         |   |       |       
|                          |                               | Gross deferred tax assets, net of valuation
    allowance |       |        | 12,045  |   |       |        | 8,806  |  
|                          |                               |                                                           |       |        |         |   |       |       
|Deferred tax liabilities: |                               |                                                           |       |        |         |   |       |       
|                          | Acquired intangible assets    |                                                           |       | (673   | )       |   |       | (3,391 | )     
|                          | Depreciation and amortization |                                                           |       | (8,799 | )       |   |       | (4,118 | )     
|                          | Equity investment             |                                                           |       | (1,092 | )       |   |       |       |       
|                          |                               |                                                           |       |        |         |   |       |       
|                          |                               | Gross deferred tax liabilities                            |       |        | (10,564 | ) |       |        | (7,509 | )
|                          |                               |                                                           |       |        |         |   |       |       
|Net deferred tax assets   |                               | $                                                         | 1,481 |        |         | $ | 1,297 |       
|                          |                               |                                                           |       |        |         |   |       |       

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 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, 2003 and 2002 is related to various deferred
tax assets established with the acquisition of REZ. The
valuation allowance, if released, will decrease goodwill.

At both December 31, 2003 and 2002, the
Company had federal net operating loss carryforwards of
approximately $25 million. United Kingdom and other foreign
net operating loss carryforwards for the respective periods were
approximately $1.8 million and $3.0 million as of such
dates. The federal net operating loss carryforwards that existed
at December 31, 2003 will begin to expire in 2019. The
foreign net operating loss carryforwards that existed at
December 31, 2003 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):

|                         |         |      |        |        |   |      |        |        |   |   |        |        |  
|------------------------ | ------- | ---- | ------ | ------ | - | ---- | ------ | ------ | - | - | ------ | ------ | -
|                         |         | 2003 |        | 2002   |   | 2001
|                         |         |      |        |        |   |     
|Current provision:       |         |      |        |        |   |      |        |        |   |   |        |       
|                         | Foreign |      | $      | 446    |   |      | $      | 1,753  |   |   | $      | 988    |  
|Deferred benefit:        |         |      |        |        |   |      |        |        |   |   |        |       
|                         | Federal |      |        | (1,078 | ) |      |        | (3,944 | ) |   |        | (7,840 | )
|                         | State   |      |        | (213   | ) |      |        | (818   | ) |   |        | (1,481 | )
|                         | Foreign |      |        | (60    | ) |      |        | 894    |   |   |        | (613   | )
|                         |         |      |        |        |   |      |        |        |   |   |        |       
|                         |         |      | (1,351 | )      |   |      | (3,868 | )      |   |   | (9,934 | )     
|                         |         |      |        |        |   |      |        |        |   |   |        |       
|Benefit for income taxes |         | $    | (905   | )      |   | $    | (2,115 | )      |   | $ | (8,946 | )     
|                         |         |      |        |        |   |      |        |        |   |   |        |       

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PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

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:

|                                        |  |      |       |      |  |      |       |    |  |  |       |   
|--------------------------------------- |  | ---- | ----- | ---- |  | ---- | ----- | -- |  |  | ----- | --
|                                        |  | 2003 |       | 2002 |  | 2001
|                                        |  |      |       |      |  |     
|Expected income tax benefit             |  |      | (35.0 | )%   |  |      | (35.0 | )% |  |  | (35.0 | )%
|Non-deductible amortization of goodwill |  |      |      |      |  |      |      |    |  |  | 14.7  | % 
|Other permanent differences             |  |      | 7.9   | %    |  |      | 6.9   | %  |  |  | 0.2   | % 
|State income taxes                      |  |      | (5.0  | )%   |  |      | (9.4  | )% |  |  | (2.5  | )%
|Other, net                              |  |      | (0.9  | )%   |  |      |      |    |  |  | (0.5  | )%
|                                        |  |      |       |      |  |      |       |    |  |  |       |   
|Benefit for income taxes                |  |      | (33.0 | )%   |  |      | (37.5 | )% |  |  | (23.1 | )%
|                                        |  |      |       |      |  |      |       |    |  |  |       |   



|    |                              
|--- | -----------------------------
|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
$8.8 million, $9.3 million and $9.8 million in
2003, 2002 and 2001, respectively.

Approximate future minimum lease payments,
including landlord paid tenant improvements, at
December 31, 2003, under non-cancelable lease agreements
with original terms exceeding one year, were as follows (in
thousands):

|                               |  |   |        | 
|------------------------------ |  | - | ------ | 
|Fiscal year ended December 31, |  |  
|                               |  |  
|2004                           |  | $ | 8,476  | 
|2005                           |  |   | 7,658  | 
|2006                           |  |   | 7,422  | 
|2007                           |  |   | 7,068  | 
|2008                           |  |   | 7,072  | 
|Thereafter                     |  |   | 24,854 | 
|                               |  |   |        | 
|Total                          |  | $ | 62,550 | 
|                               |  |   |        | 

Future minimum lease payments due in foreign
currencies were translated at the rate in effect at
December 31, 2003.

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 $6.1 million
and $6.9 million at December 31, 2003 and 2002,
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.
(Marriott). In 2003, 2002 and 2001, the Company
received $4.5 million, $3.7 million and
$3.7 million, respectively, from Marriott and its
affiliates for reservation, distribution and representation
services. During the same years, the Company paid Marriott
$1.6 million, $1.5 million and $1.8 million,
respectively, for

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PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED
FINANCIAL STATEMENTS  (Continued)

consolidating commission data and funds from its
properties. At December 31, 2003, receivables from Marriott
were $345,000.

Another Director of the Company serves as a
Senior Vice President  Strategy and Systems for both
Hyatt Corporation, the parent company of Hyatt Hotels
Corporation, and AIC Holding Co., the parent company of Hyatt
International Corporation (Hyatt). In 2003, 2002 and
2001, the Company received $1.1 million, $639,000 and
$970,000, respectively, from Hyatt for reservation, distribution
and financial services. At December 31, 2003, receivables
from Hyatt were $77,000.

Another Director of the Company serves as Chief
Executive Officer of Affiliated Computer Services, Inc.
(ACS). In 2003, ACS billed Pegasus $421,000 for
services provided in connection with our financial services. At
December 31, 2003 payables to ACS approximated $130,000.

In conjunction with the formation of Travelweb
LLC (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 2003,
the Company received $2.0 million for distribution services
from Travelweb. 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 as Chairman of the
Board of Directors of Travelweb. At December 31, 2003,
receivables from Travelweb were $394,000.



|    |                                                    
|--- | ---------------------------------------------------
|16. | Revenue by Service Line and Geographic
    Location

The following summarizes required disclosures
about revenue by service line and geographic location. During
the years ended December 31, 2003, 2002 and 2001, service
line revenues were (in thousands):

|                        |  |      |         |      |  |      |         |  |  |   |         | 
|----------------------- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------- | 
|                        |  | 2003 |         | 2002 |  | 2001
|                        |  |      |         |      |  |     
|Representation services |  | $    | 57,409  |      |  | $    | 64,071  |  |  | $ | 73,513  | 
|Reservation services    |  |      | 38,349  |      |  |      | 54,309  |  |  |   | 54,067  | 
|Financial services      |  |      | 30,244  |      |  |      | 29,904  |  |  |   | 28,548  | 
|Distribution services   |  |      | 28,764  |      |  |      | 23,941  |  |  |   | 19,632  | 
|Property services       |  |      | 6,479   |      |  |      | 6,544   |  |  |   | 4,650   | 
|Business intelligence   |  |      |        |      |  |      |        |  |  |   | 258     | 
|                        |  |      |         |      |  |      |         |  |  |   |         | 
|Total service revenues  |  | $    | 161,245 |      |  | $    | 178,769 |  |  | $ | 180,668 | 
|Customer reimbursements |  |      | 11,485  |      |  |      | 11,181  |  |  |   | 12,079  | 
|                        |  |      |         |      |  |      |         |  |  |   |         | 
|Total revenues          |  | $    | 172,730 |      |  | $    | 189,950 |  |  | $ | 192,747 | 
|                        |  |      |         |      |  |      |         |  |  |   |         | 

The following table presents revenue by
geographic location for the years ended December 31, 2003,
2002 and 2001 (in thousands):

|              |  |      |         |      |  |      |         |  |  |   |         | 
|------------- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------- | 
|              |  | 2003 |         | 2002 |  | 2001
|              |  |      |         |      |  |     
|Domestic      |  | $    | 104,570 |      |  | $    | 113,759 |  |  | $ | 112,479 | 
|International |  |      | 68,160  |      |  |      | 76,191  |  |  |   | 80,268  | 
|              |  |      |         |      |  |      |         |  |  |   |         | 
|Total revenue |  | $    | 172,730 |      |  | $    | 189,950 |  |  | $ | 192,747 | 
|              |  |      |         |      |  |      |         |  |  |   |         | 

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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 2003 and 2002 (in thousands):

|                                                |                |                |        |         |  |              |        |             |  |   |        |        |  |   |        |        | 
|----------------------------------------------- | -------------- | -------------- | ------ | ------- |  | ------------ | ------ | ----------- |  | - | ------ | ------ |  | - | ------ | ------ | 
|                                                |                |               
|                                                |                | Quarters Ended
|                                                |                |               
|                                                |                | March 31       |        | June 30 |  | September 30 |        | December 31
|                                                |                |                |        |         |  |              |        |            
|2003                                            |                |                |        |         |  |              |        |             |  |   |        |        |  |   |        |       
|Service revenues                                |                | $              | 38,390 |         |  | $            | 40,104 |             |  | $ | 42,868 |        |  | $ | 39,883 |       
|Customer reimbursements                         |                |                | 2,523  |         |  |              | 2,827  |             |  |   | 2,892  |        |  |   | 3,243  |       
|                                                |                |                |        |         |  |              |        |             |  |   |        |        |  |   |        |       
|                                                | Total revenues |                |        | 40,913  |  |              |        | 42,931      |  |   |        | 45,760 |  |   |        | 43,126 | 
|Income (loss) before provision for income taxes |                |                | (9,951 | )       |  |              | (603   | )           |  |   | 6,425  |        |  |   | 1,392  |       
|Net income (loss)                               |                |                | (6,277 | )       |  |              | (17    | )           |  |   | 3,847  |        |  |   | 615    |       
|Basic and diluted net income (loss) per share   |                |                | (0.25  | )       |  |              | (0.00  | )           |  |   | 0.15   |        |  |   | 0.02   |       
|Basic weighted average shares outstanding       |                |                | 24,651 |         |  |              | 24,768 |             |  |   | 24,986 |        |  |   | 25,044 |       
|Diluted weighted average shares outstanding     |                |                | 24,651 |         |  |              | 24,768 |             |  |   | 25,711 |        |  |   | 25,404 |       
|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 |       

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.

59



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##### Table of Contents








|        |                                                                                        
|------- | ---------------------------------------------------------------------------------------
|Item 9. | Change in and Disagreements with
    Accountants on Accounting and Financial Disclosure

None.






|         |                        
|-------- | -----------------------
|Item 9A. | 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. 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 believe that these
procedures are effective to ensure that the Company is able to
collect, process and disclose the information it is required to
disclose in the reports it files with the SEC within the
required time periods.

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.                                                                                

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 III






|         |                                                       
|-------- | ------------------------------------------------------
|Item 10. | Directors and Executive Officers of the
    Registrant

The information required by this item appears in
our definitive proxy statement for our 2004 annual meeting of
Stockholders under the captions Nominees for
Directors, Directors Continuing in Office,
Executive Officers, Section 16(a)
Beneficial Ownership Reporting Compliance and
Statement of Corporate Governance, which information
is incorporated herein by reference.






|         |                                          
|-------- | -----------------------------------------
|Item 11. | Named Executive Officers
    Compensation

The information required by this item appears in
our definitive proxy statement for our 2004 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



| |                                                                       
| | ----------------------------------------------------------------------
| | Securities Authorized For Issuance Under
    Equity Compensation Plans

The following table provides information as of
December 31, 2003 regarding compensation plans (including
individual compensation arrangements) under which equity
securities of Pegasus are authorized for

60



---



##### Table of Contents



issuance. See Note 11 to the Consolidated
Financial Statements for information regarding the material
features of these plans.


|                                                               |  |                   |       |                  |  |                      |       |  |  |  |     | 
|-------------------------------------------------------------- |  | ----------------- | ----- | ---------------- |  | -------------------- | ----- |  |  |  | --- | 
|                                                               |  |                   |       |                  |  | (c)                 
|                                                               |  |                   |       |                  |  |                     
|                                                               |  |                   |       |                  |  | Number Of           
|                                                               |  | (a)               |       |                  |  | Securities          
|                                                               |  |                   |       | (b)              |  | Remaining Available 
|                                                               |  | Number Of         |       |                  |  | For Future Issuance 
|                                                               |  | Securities To Be  |       | Weighted-        |  | Under Equity        
|                                                               |  | Issued Upon       |       | Average Exercise |  | Compensation        
|                                                               |  | Exercise Of       |       | Price Of         |  | Plans(2)            
|                                                               |  | Outstanding       |       | Outstanding      |  | (Excluding          
|                                                               |  | Options, Warrants |       | Options,         |  | Securities Reflected
|                                                               |  | And Rights (1)    |       | Warrants And     |  | In Column (a)) (In  
|Plan Category                                                  |  | (In Thousands)    |       | Rights           |  | Thousands)          
|                                                               |  |                   |       |                  |  |                     
|Equity Compensation Plans Approved by Security
    Holders     |  |                   | 5,262 |                  |  | $                    | 12.75 |  |  |  | 939 | 
|Equity Compensation Plans not Approved by
    Security Holders |  |                   |      |                  |  |                      |      |  |  |  |    | 
|                                                               |  |                   |       |                  |  |                      |       |  |  |  |     | 
|Total                                                          |  |                   | 5,262 |                  |  | $                    | 12.75 |  |  |  | 939 | 
|                                                               |  |                   |       |                  |  |                      |       |  |  |  |     | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                        
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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, 2003 was
    approximately 30.8 million.
|   
|(2) | Includes shares of common stock available for
    issuance under the Companys Employee Stock Purchase Plan.                                                                                                                                                                                                                                                                                           

Other information required by this item appears
in our definitive proxy statement for our 2004 annual meeting of
stockholders under the caption Security Ownership of
Certain Beneficial Owners, Directors and Officers, 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 2004 annual meeting of
stockholders under the caption Certain Transactions,
which information is incorporated herein by reference.






|         |                                           
|-------- | ------------------------------------------
|Item 14. | Principal Accountant Fees and
    Services

The information required by this item appears in
our definitive proxy statement for our 2004 annual meeting of
stockholders under the caption Independent
Accountants, which information is incorporated herein by
reference.

61



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##### Table of Contents






PART IV






|    |                                                                     
|--- | --------------------------------------------------------------------
|15. | Exhibits, Financial Statement Schedules, and
    Reports on Form 8-K

(a) 1. The following financial statements
and schedules are filed as part of this report:

|                                                                                                                    |  |  |           | 
|------------------------------------------------------------------------------------------------------------------- |  |  | --------- | 
|Report of Independent Auditors                                                                                      |  |  | Page 30   | 
|Consolidated Balance Sheets 
    December 31, 2003 and 2002                                                        |  |  | Page 31   | 
|Consolidated Statements of Operations and
    Comprehensive Loss  Years ended December 31,
    2003, 2002 and 2001 |  |  | Page 32   | 
|Consolidated Statements of Changes in
    Stockholders Equity  Years ended
    December 31, 2003, 2002 and 2001   |  |  | Page 33   | 
|Consolidated Statements of Cash Flows 
    Years ended December 31, 2003, 2002 and 2001                            |  |  | Page 34   | 
|Notes to Consolidated Financial Statements                                                                          |  |  | Page 35   | 
|Report of Independent Auditor on Financial
    Statement Schedule                                                   |  |  | Page  S-1 | 
|Consolidated Valuation and Qualifying Accounts                                                                      |  |  | Page  S-2 | 

All other schedules for which provision is made
in the applicable accounting regulations of the Securities and
Exchange Commission are not required under the related
instructions or are inapplicable and therefore have been omitted.

(a) 2. The following documents are filed or
incorporated by reference as exhibits to this annual report:

|        |   |             |  |                                                                                                                                                                                                                                                                                                                                                                                                  
|------- | - | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |   |            
|Number  |   | 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)                            
|        | 2 | .2          |  | Stock Purchase Agreement by and among Pegasus
    Solutions, Inc., a Delaware corporation, and each
    Shareholder of Unirez, Inc. dated October 24, 2003,
    and the Amendment to the Stock Purchase Agreement dated
    November 24, 2003 (incorporated by reference from
    Exhibit 2.1 of the Companys Current Report on
    Form 8-K filed with the commission on December 3,
    2003).
|        | 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 (incorporated
    by reference from Exhibit 3.4 to the Companys
    Registration Statement on Form S-1 (File
    No. 333-28595) declared effective by the Commission on
    August 6, 1997)                                                                                                                                                                  
|        | 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
    (incorporated by reference from Exhibit 4.1 to the
    Companys Registration Statement on Form S-1 (File
    No. 333-28595) declared effective by the Commission on
    August 6, 1997)                                                                                                                                                                
|        | 4 | .2          |  | Fourth Amended and Restated Certificate of
    Incorporation (incorporated by reference from Exhibit 3.1
    of the Companys Quarterly Report on Form 10-Q filed
    with the Commission on May 15, 2000)                                                                                                                                                                                       
|        | 4 | .3          |  | Rights Agreement dated June 25, 1996 by and
    among the Company and certain holders of capital stock of the
    Company named therein (incorporated by reference from
    Exhibit 4.3 to the Companys Registration Statement on
    Form S-1 (File No. 333-28595) declared effective by
    the Commission on August 6, 1997)                                                                 
|        | 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)                                                                                                                    

62



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##### Table of Contents



|        |     |             |  |                                                                                                                                                                                                                                                                                                                                                              
|------- | --- | ----------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |     |            
|Number  |     | Description
|        |     |            
|        | 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)                                                                                                                                                                                                             
|        | 4   | .6          |  | Form of Note for the Companys
    3.875% Convertible Senior Notes due 2023 (included in
    Exhibit 4.7 below)                                                                                                                                                                                                                                              
|        | 4   | .7          |  | Indenture, dated as of July 21, 2003, by and
    between the Company and JPMorgan Chase Bank, as trustee
    (incorporated by reference from Exhibit 4.6 to the
    Companys Quarterly Report on Form 10-Q filed with the
    Commission on August 14, 2003)                                                                                                
|        | 4   | .8          |  | Registration Rights Agreement, dated as of
    July 21, 2003, by and between Bear, Stearns & Co.
    Inc., JPMorgan Securities Inc. and Thomas Weisel Partners LLC
    (incorporated by reference from Exhibit 4.7 to the
    Companys Quarterly Report on Form 10-Q filed with the
    Commission on August 14, 2003)                                      
|        | *10 | .1          |  | Employment Agreement dated December 1, 2002
    between the Company and John F. Davis, III (incorporated by
    reference from Exhibit 10.6 of the Companys
    Form 10-K filed with the Commission on March 18, 2003)                                                                                                                                      
|        | *10 | .2          |  | Employment Agreement dated December 1, 2002
    between the Company and Susan K. Cole (incorporated by reference
    from Exhibit 10.7 of the Companys Form 10-K
    filed with the Commission on March 18, 2003)                                                                                                                                           
|        | *10 | .3          |  | Employment Agreement dated December 1, 2002
    between the Company and Ric L. Floyd (incorporated by reference
    from Exhibit 10.8 of the Companys Form 10-K
    filed with the Commission on March 18, 2003)                                                                                                                                            
|        | *10 | .4          |  | Employment Agreement dated December 1, 2002
    between the Company and Mark C. Wells (incorporated by reference
    from Exhibit 10.9 of the Companys Form 10-K
    filed with the Commission on March 18, 2003)                                                                                                                                           
|        | *10 | .5          |  | 1996 Stock Option Plan, as amended (incorporated
    by reference from Exhibit 10.5 of the Companys
    Form 10-K filed with the Commission on March 31, 1999)                                                                                                                                                                                              
|        | *10 | .6          |  | 2002 Amended Stock Option Plan, (incorporated by
    reference from the Companys definitive proxy statement
    filed with the Commission on March 21, 2002)                                                                                                                                                                                                
|        | *10 | .7          |  | 1997 Employee Stock Purchase Plan, as amended
    (incorporated by reference from Exhibit 10.11 of the
    Companys Form 10-K filed with the Commission on
    March 31, 1999)                                                                                                                                                                              
|        | *10 | .8          |  | Amended and Restated Supplemental Executive
    Retirement Plan (incorporated by reference from
    Exhibit 10.14 of the Companys Form 10-K filed
    with the Commission on March 18, 2003)                                                                                                                                                                
|        | *10 | .9          |  | Executive Deferred Compensation Plan
    (incorporated by reference from Exhibit 10.15 of the
    Companys Form 10-K filed with the Commission on
    March 18, 2003)                                                                                                                                                                                       
|        | *10 | .10         |  | Deferred Compensation Trust Agreement dated
    February 28, 2003 between the Company and Charles Schwab
    Trust Company (incorporated by reference from Exhibit 10.16
    of the Companys Form 10-K filed with the Commission
    on March 18, 2003)                                                                                                     
|        | 10  | .11         |  | 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  | .12         |  | 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  | .13         |  | 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 Exhibit 10.23 of the Companys
    Form 10-Q filed with the Commission on November 15,
    2001)

63



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##### Table of Contents



|        |      |             |  |                                                                                                                                                                                                                                                                                                                   
|------- | ---- | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |            
|Number  |      | Description
|        |      |            
|        | 10   | .14         |  | 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 Exhibit 10.23 of the
    Companys Form 10-Q filed with the Commission on
    November 15, 2001)
|        | 10   | .15         |  | Form of Promissory Note agreement dated
    November 9, 2001 between the Company and IndeCorp
    Corporation (incorporated by reference from Exhibit 10.23
    of the Companys Form 10-Q filed with the Commission
    on November 15, 2001)                                                                    
|        | *10  | .16         |  | Employment agreement dated January 1, 2003
    between the Company and Joseph W. Nicholson (incorporated by
    reference from Exhibit 10.1 of the Companys
    Form 10-Q filed with the Commission on May 14, 2003)                                                                                             
|        | *10  | .17         |  | Employment agreement dated May 19, 2003
    between the Company and Robert J. Boles, Jr. (incorporated
    by reference from Exhibit 10.27 of the Companys
    Form 10-Q filed with the Commission on August 14, 2003)                                                                                           
|        | +21  | .1          |  | Subsidiaries of the Company                                                                                                                                                                                                                                                                                       
|        | +23  | .1          |  | Consent of PricewaterhouseCoopers LLP                                                                                                                                                                                                                                                                             
|        | +24  | .1          |  | Power of Attorney (included on signature page)                                                                                                                                                                                                                                                                    
|        | +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 to Section 906 of
    the Sarbanes-Oxley Act of 2002                                                                                                                        



---

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.



|   |                    
|-- | -------------------
|++ | Furnished 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

On October 28, 2003 Pegasus
Solutions, Inc. filed a report on Form 8-K which
furnished information under Item 12  Results of
Operation and Financial Condition for its press release
announcing its financial results for the third quarter ended
September 30, 2003.

On November 5, 2003 Pegasus
Solutions, Inc. filed a report on Form 8-K under
Item 5  Other Events, and furnished information
under Item 9  Regulation FD Disclosure, for
its announcement of a definitive agreement to acquire the
outstanding stock of Unirez, Inc., for $38 million in
cash, subject to certain closing conditions and post-closing
adjustments.

On December 3, 2003 Pegasus
Solutions, Inc. filed a report on Form 8-K under
Item 2  Acquisition or Disposition of Assets and
furnished information under Item 9 
Regulation FD Disclosure, for its announcement of the
completion of the acquisition of the outstanding stock of
Unirez, Inc.

On February 3, 2004 Pegasus
Solutions, Inc. filed a report on Form 8-K which
furnished information under Item 12  Results of
Operations and Financial Condition for its press release
announcing its final results for the fourth quarter and year
ended December 31, 2003.

On February 13, 2004 Pegasus
Solutions, Inc. filed Amendment No. 1 to the Current
Report on Form 8-K filed with the Commission on
December 3, 2003, under Item 7  Financial
Statements, Pro Forma

64



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##### Table of Contents



Financial Information and Exhibits for
(A) the audited financial statements of Unirez at and for
the years ended December 31, 2002 and 2001 and unaudited
financial statements of Unirez as of September 30, 2003 and
December 31, 2002 and for the nine months ended
September 30, 2003 and 2002, and for (B) the unaudited
pro forma financial information required to be filed pursuant to
Article 11 of Regulation S-X as of September 30,
2003 and for the nine months and year ended September 30,
2003 and December 31, 2002, respectively.


65



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##### Table of Contents






SIGNATURES

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 10th
day of March, 2004.



| |                        
| | -----------------------
| | 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.

|                                                   |  |                                                                                                       |  |                |  | 
|-------------------------------------------------- |  | ----------------------------------------------------------------------------------------------------- |  | -------------- |  | 
|                                                   |  |                                                                                                       |  |               
|Signature                                          |  | Title                                                                                                 |  | Date          
|                                                   |  |                                                                                                       |  |               
|                                                  
|/s/ JOHN F. DAVIS, IIIJohn F. Davis, III           |  | Chief Executive Officer and Chairman (Principal
    Executive Officer)                                |  | March 10, 2004
|                                                  
|/s/ SUSAN K. COLESusan K. Cole                     |  | Executive Vice President and Chief Financial
    Officer (Principal Financial and Accounting Officer) |  | March 10, 2004
|                                                  
|/s/ WILLIAM C. HAMMETT, JR.William C. Hammett, Jr. |  | Vice Chairman and Director                                                                            |  | March 10, 2004
|                                                  
|/s/ MICHAEL A. BARNETTMichael A. Barnett           |  | Director                                                                                              |  | March 10, 2004
|                                                  
|/s/ ROBERT B. COLLIERRobert B. Collier             |  | Director                                                                                              |  | March 10, 2004
|                                                  
|/s/ THOMAS F. OTOOLEThomas F. OToole             |  | Director                                                                                              |  | March 10, 2004

66



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|                                       |  |          |  |                |  | 
|-------------------------------------- |  | -------- |  | -------------- |  | 
|                                       |  |          |  |               
|Signature                              |  | Title    |  | Date          
|                                       |  |          |  |               
|                                      
|/s/ PAMELA H. PATSLEYPamela H. Patsley |  | Director |  | March 10, 2004
|                                      
|/s/ JEFFREY A. RICHJeffrey A. Rich     |  | Director |  | March 10, 2004
|                                      
|/s/ BRUCE W. WOLFFBruce W. Wolff       |  | Director |  | March 10, 2004

67



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##### Table of Contents



REPORT OF INDEPENDENT AUDITORS 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 3,
2004, except as to Note 10 which is as of March 9,
2004, 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 3, 2004


S-1



---



##### Table of Contents



SCHEDULE II

PEGASUS SOLUTIONS, INC.

VALUATION AND QUALIFYING ACCOUNTS

For the Years Ended December 31, 2001,
2002 and 2003


(In thousands)


|     |                                 |                               |   |           |       |           |   |           |       |            |   |           |     |  |   |     |     |  |   |        |        |   |   |       |       | 
|---- | ------------------------------- | ----------------------------- | - | --------- | ----- | --------- | - | --------- | ----- | ---------- | - | --------- | --- |  | - | --- | --- |  | - | ------ | ------ | - | - | ----- | ----- | 
|     |                                 |                               |   | Additions |       |           |   |           |       |            |   |          
|     |                                 | Balance                       |   | Charged   |       | Additions |   | Additions |       |            |   |          
|     |                                 | at                            |   | to Costs  |       | Charged   |   | from      |       |            |   | Balance  
|     |                                 | Beginning                     |   | and       |       | To Other  |   | Acquired  |       |            |   | at End of
|     |                                 | of Period                     |   | Expenses  |       | Accounts  |   | Companies |       | Deductions |   | Period   
|     |                                 |                               |   |           |       |           |   |           |       |            |   |          
|2001 |                                 |                               |   |           |       |           |   |           |       |            |   |           |     |  |   |     |     |  |   |        |        |   |   |      
|     | Allowance for doubtful accounts |                               | $ | 9,217     |       |           | $ | 3,408     |       |            | $ |          |     |  | $ | 214 |     |  | $ | (4,977 | )      |   | $ | 7,862 |      
|     | Income tax valuation allowance  |                               |   | 50        |       |           |   |          |       |            |   |          |     |  |   |    |     |  |   |       |        |   |   | 50    |      
|     |                                 |                               |   |           |       |           |   |           |       |            |   |           |     |  |   |     |     |  |   |        |        |   |   |      
|     |                                 | Total reserves and allowances |   |           | 9,267 |           |   |           | 3,408 |            |   |           |    |  |   |     | 214 |  |   |        | (4,977 | ) |   |       | 7,912 | 
|     |                                 |                               |   |           |       |           |   |           |       |            |   |           |     |  |   |     |     |  |   |        |        |   |   |      
|2002 |                                 |                               |   |           |       |           |   |           |       |            |   |           |     |  |   |     |     |  |   |        |        |   |   |      
|     | Allowance for doubtful accounts |                               |   | 7,862     |       |           |   | 1,289     |       |            |   |          |     |  |   |    |     |  |   | (4,519 | )      |   |   | 4,632 |      
|     | Income tax valuation allowance  |                               |   | 50        |       |           |   |          |       |            |   | 394       |     |  |   |    |     |  |   |       |        |   |   | 444   |      
|     |                                 |                               |   |           |       |           |   |           |       |            |   |           |     |  |   |     |     |  |   |        |        |   |   |      
|     |                                 | Total reserves and allowances |   |           | 7,912 |           |   |           | 1,289 |            |   |           | 394 |  |   |     |    |  |   |        | (4,519 | ) |   |       | 5,076 | 
|     |                                 |                               |   |           |       |           |   |           |       |            |   |           |     |  |   |     |     |  |   |        |        |   |   |      
|2003 |                                 |                               |   |           |       |           |   |           |       |            |   |           |     |  |   |     |     |  |   |        |        |   |   |      
|     | Allowance for doubtful accounts |                               |   | 4,632     |       |           |   |          |       |            |   |          |     |  |   | 375 |     |  |   | (2,083 | )      |   |   | 2,924 |      
|     | Income tax valuation allowance  |                               |   | 444       |       |           |   |          |       |            |   |          |     |  |   |    |     |  |   |       |        |   |   | 444   |      
|     |                                 |                               |   |           |       |           |   |           |       |            |   |           |     |  |   |     |     |  |   |        |        |   |   |      
|     |                                 | Total reserves and allowances |   | $         | 5,076 |           |   | $         |      |            |   | $         |    |  |   | $   | 375 |  |   | $      | (2,083 | ) |   | $     | 3,368 | 
|     |                                 |                               |   |           |       |           |   |           |       |            |   |           |     |  |   |     |     |  |   |        |        |   |   |      



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|(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.

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