##### Table of Contents









UNITED STATES SECURITIES AND EXCHANGE
COMMISSION

Washington, D.C. 20549




---

Form 10-K

|           |  |                                                                                             
|---------- |  | --------------------------------------------------------------------------------------------
|(Mark One)
|þ          |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
    OF THE SECURITIES EXCHANGE ACT OF 1934    
|          
|           |  | For the Fiscal Year Ended December 31,
    2005                                             
|          
|OR        
|          
|o          |  | TRANSITION REPORT PURSUANT TO SECTION 13 OR
    15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|          
|           |  | For the Transition period
    from           to                                             



---

Commission file number 0-22935

Pegasus Solutions, Inc.

(Exact name of Registrant as specified in its
charter)


|                                                                   |  |                                         
|------------------------------------------------------------------ |  | ----------------------------------------
|Delaware                                                           |  | 75-2605174                              
|(State or other jurisdiction of
    incorporation or organization) |  | (I.R.S. Employer
    Identification No.)

Campbell Centre I, 8350 North Central
Expressway, Suite 1900 Dallas, Texas 75206

(Address of principal executive
office)


(Zip Code)


Registrants telephone number, including
area code:

(214)234-4000


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 if the registrant is a
well-known seasoned issuer, as defined in Rule 405 of the
Securities
Act.     YES o          NO þ

Indicate by check mark if the registrant is not
required to file reports pursuant to Section 13 or
Section 15(d) of the
Act.     YES o          NO þ

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
a large accelerated filer, an accelerated filer, or a
non-accelerated filer. See definition of accelerated filer
and large accelerated filer in Rule 12b-2 of the
Exchange Act. (Check one):



|                           |                      |                         
|-------------------------- | -------------------- | ------------------------
|Large accelerated filer  o | Accelerated filer  þ | Non-accelerated filer  o

Indicate by check mark whether the registrant is
a shell company (as defined in Rule 12b-2 of the Exchange
Act.).          YES o          NO þ

The aggregate market value of the
registrants voting stock held by non-affiliates on
June 30, 2005, based on the closing price of the
registrants common stock on such date as reported on the
NASDAQ national market, was $132,105,211.

The number of shares of the registrants
common stock, par value $0.01 per share, outstanding as of
March 9, 2006 was 20,804,229.



---






---



##### 












TABLE OF CONTENTS

|                                                         |          |  |                                                                                                                      |      |  |    | 
|-------------------------------------------------------- | -------- |  | -------------------------------------------------------------------------------------------------------------------- | ---- |  | -- | 
|                                                         |          |  |                                                                                                                      | Page
|                                                         |          |  |                                                                                                                      |     
|PART I                                                  
|                                                         | Item 1.  |  | Business                                                                                                             |      |  | 2  | 
|                                                         | Item 1A. |  | Risk factors                                                                                                         |      |  | 7  | 
|                                                         | Item 1B. |  | Unresolved staff comments                                                                                            |      |  | 15 | 
|                                                         | Item 2.  |  | Properties                                                                                                           |      |  | 15 | 
|                                                         | Item 3.  |  | Legal proceedings                                                                                                    |      |  | 15 | 
|                                                         | Item 4.  |  | Submission of matters to a
    vote of security holders                                                              |      |  | 15 | 
|PART II                                                 
|                                                         | Item 5.  |  | Market for registrants
    common equity, related stockholder matters and issuer purchases
    of equity securities |      |  | 15 | 
|                                                         | Item 6.  |  | Selected financial data                                                                                              |      |  | 16 | 
|                                                         | Item 7.  |  | Managements discussion
    and analysis of financial condition and results of operations                            |      |  | 17 | 
|                                                         | Item 7A  |  | Quantitative and qualitative
    disclosures about market Risk                                                       |      |  | 34 | 
|                                                         | Item 8.  |  | Financial statements and
    supplementary data                                                                      |      |  | 35 | 
|                                                         | Item 9.  |  | Changes in and disagreements
    with accountants on accounting and financial disclosure                             |      |  | 68 | 
|                                                         | Item 9A  |  | Controls and procedures                                                                                              |      |  | 68 | 
|                                                         | Item 9B  |  | Other information                                                                                                    |      |  | 69 | 
|PART III                                                
|                                                         | Item 10. |  | Directors and executive
    officers of the registrant                                                               |      |  | 69 | 
|                                                         | Item 11. |  | Executive compensation                                                                                               |      |  | 71 | 
|                                                         | Item 12. |  | Security ownership of
    certain beneficial owners and management and related stockholder
    matters               |      |  | 79 | 
|                                                         | Item 13. |  | Certain relationships and
    related transactions                                                                   |      |  | 82 | 
|                                                         | Item 14. |  | Principal accounting fees
    and services                                                                           |      |  | 82 | 
|PART IV                                                 
|                                                         | Item 15. |  | Exhibits and financial
    statement schedules                                                                       |      |  | 83 | 
|Signatures                                               |          |  | 88                                                                                                                   |     
|Employment Agreement - Michael Kistner                  
|First Amendment to Office Lease                         
|First Amendment to Office Lease                         
|Second Amendment to Office Lease                        
|Third Amendment to Office Lease                         
|Fourth Amendment to Office Lease                        
|Subsidiaries of the Company                             
|Consent of Independent Registered Public Accounting Firm
|Certification of CEO Pursuant to Section 302            
|Certification of CFO Pursuant to Section 302            
|Certification of CEO and CFO, Pursuant to Section 906   



1



---



##### 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, initiatives, intends,
anticipates, believes,
estimates, or potential, 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
future effect of plans, initiatives 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, the failure of the Company to complete the
transaction as contemplated by the Agreement and Plan of Merger
dated December 19, 2005 among Perseus Holding Corp., 406
Acquisition Corp., and the Company (the Merger
Agreement) (See Item 7 of the Annual Report on
Form 10-K under the caption The Merger
Agreement for more information) or delays with respect to
the Merger Agreement, changes in general economic conditions,
variation in demand for our products and services and in the
timing of our sales, changes in product and price competition
for existing and new competitors, changes in our level of
operating expenditures, delays in developing, marketing and
deploying new products and services, terrorist activities,
action by U.S. or other military forces, regional or 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, the inability of the Company to
sell the balance of its property management systems, or PMS
business, as well as other risks and uncertainties, including
those appearing in Item 1A of the Annual Report on
Form 10-K under the caption Risk Factors.

Pegasus is a global leader in providing
technology and services to hotels and travel distributors.
Founded in 1989, our customers include a majority of the
worlds travel agencies and more than 60,000 hotel
properties around the globe. Our services include central
reservation systems, electronic distribution services,
commission processing and payment services, and marketing
representation services, including the consumer Web site
hotelbook.com. Our representation services, including
Utell by Pegasus and Unirez by Pegasus, are used by
more than 7,000 hotels in more than 130 countries, making
Pegasus the hotel industrys largest third-party marketing
and reservations provider. We have 17 offices in
12 countries, including regional hubs in London, Scottsdale
and Singapore.

Strategy

Our vision is to be the world leader in providing
comprehensive and innovative solutions designed to transform
critical business processes for hotels and travel distributors.
Key elements of our strategy include the following:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Pursue Complete, Integrated Technology
    Solutions.We strive to bring together
    all of the reservation, distribution and commission processing
    technology needs of our customers instead of just a specific
    application. This includes providing services ranging from Web
    site integration to complete information technology outsourcing.                                                                                                                                       
|
| |  | Develop Leading Technologies and Expedite the
    Time to Market for New Products.We
    strive to develop new technologies, services and solutions to
    meet the changing needs of our current and prospective
    customers. During 2005, we defined service line strategies and
    related technology needs. We have also continued to implement
    new software development processes with a focus on expediting
    the time to market of new products and reducing development
    costs.
|
| |  | Capitalize on Our Extensive and Diverse
    Portfolio of Independent Hotels and Small Hotel
    Groups.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 groups                                                                                                                                                                        

2



---



##### Table of Contents



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |   | internationally and in the United States. With
    more than 7,000 hotels using our representation services, we
    have an opportunity to grow revenues by cross-selling our other
    services and by launching consumer channels to market our member
    hotels directly to consumers.                                                                                                                                                                                                                                                                  
|
| |  | Pursue Emerging Hospitality
    Markets.We believe emerging markets
    such as Asia  in particular, China 
    Eastern Europe, and Latin America present a significant
    opportunity for revenue growth. We plan to utilize business
    partners, including sales agent partners, to expedite
    penetration in emerging markets in a cost effective manner.                                                                                                                                                                                         
|
| |  | 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 partner or acquire assets, technology and
    businesses that provide complementary services to our existing
    customers or access to other new travel-related markets and
    customers.
|
| |  | Provide Outstanding Customer
    Service.In 2005, we continued our
    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 is tied to customer satisfaction benchmarks.                                                                                                                                                                                                                                     

Services

Through our comprehensive and integrated service
offerings we can provide one or more of the following services
to hotels and travel distributors worldwide:

Reservation
Services.Our award winning Central
Reservation Services (CRS) utilize our
RezView®
application at its core. Hotel chains and hotel representation
companies use a CRS to store information about all of their
properties in a central database and then use that information
to make and modify reservations and to generate various
operational, management and marketing reports.

Offered under the application service provider
(ASP) model, our CRS service is a cost effective
option for those hotel chains and hotel representation companies
that neither have, nor want, the overhead associated with
developing, implementing and maintaining the systems
infrastructure inherent to CRS ownership.

We provide CRS services on an ASP basis to
approximately 7,000 hotel properties, representing approximately
850,000 hotel rooms worldwide (including properties in our
Utell by Pegasus representation portfolio). We also offer call
center services to these clients. During 2005, we began offering
our call center services on a stand-alone basis to clients
requiring an outsourced solution for the entire operation or to
support expansion into select, strategic geographic regions.

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 global distribution
systems (GDSs) used by travel agencies worldwide, a
growing number of tour operators, wholesalers, and a wide
variety of Powered by
Pegasus®
Internet sites. During 2005, distribution services processed
approximately 29 million transactions. Distribution
services include:



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | GDS distribution  GDS distribution is
    offered to hotel customers. Our GDS distribution service
    offering automates hotel reservations through traditional GDS
    channels. The offering consists of connectivity to the four
    major GDSs (Sabre, Galileo, Amadeus and Worldspan) for
    reservation-related transactions, support of GDS maintenance
    activities, such as availability status and rate update
    functions, and standard reporting on transactional activity.
|
| |  | Third-party Internet sites  We provide
    travel-related Internet sites access to our hotel information
    database containing content and images on more than
    60,000 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, and our own
    hotelbook.com and Utell.com.                                                                                               

3



---



##### Table of Contents





| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
| | - | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Hotel Internet sites  A component of
    the online distribution environment,
    NetBooker®
    is a Pegasus developed and hosted online Internet booking engine
    available to hoteliers and travel portal companies who want a
    private label Internet site with integrated, seamless
    availability and booking engine but without the responsibilities
    and overhead of internal design, development and hosting. Hotel
    Internet sites that are Powered by Pegasus offer
    brand-loyal Internet shoppers real-time rates, availability and
    booking capabilities.
|
| |  | PegsTour  This new product
    provides a direct link between tour operators and travel
    suppliers that is a new alternative to the traditional facsimile
    method tour operators have used to book reservations.                                                                                                                                                                                                                                                                                                                                                                    

Representation
Services.We offer a variety of hotel
representation services to independent hotels and small hotel
groups. Pegasus represents more than 7,000 independent and small
hotel group properties around the world.

To market and sell their rooms, many independent
hotels and small hotel groups associate themselves with our
representation services and use our systems and infrastructure
to offer and 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 Unirez by Pegasus service provides a
connection to all GDSs and thousands of linked third-party
Internet sites through a leading Web-based CRS. Our advanced
technology offers a user-friendly interface that allows hotel
customers to upload or modify hotel data, including room rates,
availability and descriptions, at any time.

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

Utell representation customers also have the
option to utilize our financial services capabilities under the
names 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.

During 2005, we launched hotelbook.com,
which creates another way for independent hoteliers to compete
online with the major hotel brand Web sites. Hotelbook.com is
our website for independent hotels that participate in our
representation service. Hotelbook.com presents travelers with a
unique lodging option in todays increasingly complex
online travel arena. Hotelbook.com strives to provide travelers
with a place to find something different in a hotel. With
approximately 5,000 independent hotels in approximately
1,900 cities around the globe, hotelbook.com enables a user
to research independent hotels worldwide, make commissionable
bookings, get instant confirmations, check commissions and check
out the latest promotions.

Also during 2005, we opened an office in Beijing
to expand our presence in the emerging China market.

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 week, or on a monthly basis depending on the
participating hotels preference, 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

4



---



##### Table of Contents



participating hotels in their choice of currency.
Our commission processing service processed approximately
$479 million in hotel commissions in 2005.


Other Services.Pegasus regularly seeks to develop other new or enhanced
technologies, services and solutions to meet the changing needs
of our current and prospective customers. 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, product performance and the
breadth of service offerings. To compete successfully, we must
meet our customers expectations and develop new
technological solutions to meet the changing needs of the
hospitality industry. We cannot assure you that any of our
services will compete successfully. Please see the Risk Factors
section below which further discusses competitive pressures.

Reservation
Services.Our reservation services
compete 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 (subsidiary of Cendant
Corporation), SynXis Corporation (subsidiary of Sabre Holdings
Corporation), TravelCLICK Inc. 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.
    (subsidiary of Cendant Corporation). 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 Internet sites 
    Our online distribution services face competition in the online
    hotel room reservation business from GDSs, middleware providers
    and Internet sites establishing direct connections to a hotel
    chains CRS. Middleware provider competitors are Internet
    site development companies that could develop an interface
    directly between a hotels property system and a travel
    Internet site or an interface between a hotel companys CRS
    and a travel Internet site. Hotels have been increasingly
    promoting the use of their own Internet sites. The cost of entry
    into the Internet hotel room reservation business is relatively
    low. However, the cost to maintain a separate connection to each
    Internet site is typically more costly than maintaining a single
    connection to Pegasus.
|
| |  | PegsTour  Our PegsTour service
    faces competition primarily from tour operators who continue to
    maintain their current manual processes to manage this business
    versus the automated approach we offer with PegsTour. Cendant
    Corporation also offers a similar service.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            

Representation
Services.Our hotel representation
services compete with other providers of distribution, sales and
marketing services, including hotel groups, franchisors,
reservation companies and other travel or hotel representation
companies. Our primary competitors offering hotel representation
services are Vantis/ TravelCLICK Inc., SHS-WorldHotels,
Supranational Hotels, SynXis Corporation, Sceptre Hospitality
Resources, and TransHotel. Hotelbook.com competes primarily with
proprietary websites for independent hotel groups.

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.

5



---



##### Table of Contents



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 44 percent of our
revenue from customers located outside the United States,
primarily in the United Kingdom. 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. See enterprise-wide disclosures in
Note 17 to the consolidated financial statements included
in Item 8 of this Annual Report on Form 10-K.

Intellectual Property

We are continually developing new technology and
enhancing existing proprietary technology. Currently, one United
States patent has been issued to us, and a second United States
patent has been allowed and we expect that it will issue in the
second half of 2006. In addition, we have filed a total of six
patent applications in Australia, Canada and the European Union.
One patent application in China has been allowed but has not yet
issued, and the remainder are in various stages of the
application process. 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 related to continuing operations was $3.4 million,
$3.7 million and $4.5 million for 2005, 2004, and
2003, respectively.

Employees

At February 28, 2006, we had
1,049 employees, 671 of whom are located in the United
States. We had 150 people performing information technology
functions, 759 people performing sales and marketing,
customer relations and business development functions, and the
remainder performing corporate functions, such as finance,
legal, human resources and administrative. 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
100 F Street, N.E., Washington, D.C. 20549.
Information on the operation of the Public Reference Room may be
obtained by calling the SEC at 1-800-732-0330. 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.

6



---



##### Table of Contents



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.







|         |             
|-------- | ------------
|Item 1A. | Risk Factors

The following risk factors should be carefully
considered in conjunction with the other information included or
incorporated by reference in this report. If any of these risks
occur, our business, financial condition, operating results,
cash flows and securities market prices could be
materially adversely affected. Additional risks and
uncertainties not presently known to us or that we currently
deem immaterial also may impair our business, financial
condition or trading price of our securities.

Risks related to our industry



| |                                                                                                                                                        
| | -------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 general economic climate as well
as economic conditions affecting business and leisure travel in
particular. 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 future 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 hotel
reservation volume, average daily room rates, or the demand for
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                                      
|
| |  | The existence or threat of military conflict,
    terrorism or political instability                                          
|
| |  | Increased government regulation and enforcement                                                                               
|
| |  | Natural disasters, such as hurricanes,
    earthquakes, and tsunamis, and any other unfavorable weather
    events or patterns
|
| |  | 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

7



---



##### Table of Contents



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 travel industry,
    including hotels, travel agencies and electronic reservation
    providers, could result in reduced revenues.

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

Risks Related to the Company



| |                                                                                                                                                                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our failure to close the acquisition of the
    Company as contemplated by the Agreement and Plan of Merger
    dated December 19, 2005 among Perseus Holding Corp., 406
    Acquisition Corp. and the Company or delays with respect to such
    closing could adversely affect our business.

Our announcement in April 2005 of our intent to
explore strategic alternatives for the Company resulted in some
level of uncertainty amongst our employees and some of our
customers during the ensuing months the initiative was underway.
Our announcement of an agreement to sell the Company helped to
alleviate some of this uncertainty. If we fail to close the sale
of the Company as contemplated or the closing is delayed, it
likely would increase the level of uncertainty amongst our
employees and some of our customers. This development may result
in the following adverse effects upon our business, operating
results and financial condition:



| |   |                                                                                                                                 
| | - | --------------------------------------------------------------------------------------------------------------------------------
| |  | a less productive work force                                                                                                    
|
| |  | loss of employees                                                                                                               
|
| |  | delays in entering into or refusals to enter into
    contracts with some of our customers and third party service
    providers
|
| |  | continued management focus on the strategic
    alternative initiative rather than ongoing business initiatives                 
|
| |  | the incurrence of significant expenses relating
    to the failed transaction                                                   
|
| |  | possible litigation arising out of a failed
    transaction.                                                                    

If we fail to close the sale of the Company as
contemplated or the closing is delayed, it likely would result
in a drop and/or significant fluctuation in our stock price.



| |                                                                                                                                                                                                                                                                                                                
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we do not develop new technologies and
    services that meet the changing needs of participants in the
    hotel industry or if 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
successfully develop leading technologies, enhance our existing
services and develop and introduce new services. In particular,
our technologies and services must meet the demands of our
current and prospective customers on a timely and cost-effective
basis, staying abreast of technological advances and evolving
industry standards and practices.

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 developing and
implementing 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. For example, during 2005, we
discontinued our PMS services, a decision made in part because
of the

8



---



##### Table of Contents



termination of an agreement with our largest
PegasusCentral customer. We have completed the sale of two of
our PMS systems and plan to sell our PegasusCentral software by
June 30, 2006.


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.

If we are unable to successfully develop,
introduce and implement 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. Any such failures could have a material negative
impact on our operating results and financial condition,
including write-downs or write-offs related to impaired assets.



| |                                                                                                                                                                                                                                                                           
| | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | If we are unable to effectively deliver
    services and solutions to the hotel industry in a timely manner
    with acceptable performance levels, we may be unable to compete
    effectively, lose market share and be forced to reduce the
    prices of our services.

Service failures, delays in the implementation of
our service offerings or our failure to deliver services in a
timely manner with acceptable service levels could result in
reduced revenues, particularly since our transaction-based
revenues are dependent upon services being available, reduced
pricing for our services, a loss of customers, an inability to
effectively compete and breach of contract claims. Certain
service failures could also require us to credit customers
pursuant to service level agreements, which we intend to use
more frequently in the future.



| |                                              
| | ---------------------------------------------
| | We face significant competitive
    pressure.

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. Consolidation among our
competitors may result in economies of scale, or broader or more
comprehensive service offerings with which we may have
difficulty competing. Competitive pressures have contributed to
less profitable arrangements with some of our customers and
could reduce our market share or require us to reduce the prices
of our services. Consolidation among travel distribution
companies, such as Cendant and Expedia, may increase competitive
pressure with respect to our service offerings to travel
distribution companies and the hotels that may utilize our
distribution capabilities. Our inability to compete effectively
with alternative service providers could adversely affect our
business, operating results and financial condition.



| |                                                                                     
| | ------------------------------------------------------------------------------------
| | 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 Internet 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 Utell by Pegasus offering to our Unirez by Pegasus
offering, 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.



| |                                                                                                                                                                                               
| | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | Our reliance on third party service
    arrangements presents risks to our business and the loss of any
    of these third party service arrangements could adversely affect
    our business.

We rely on certain third party arrangements for
the provision of our services and increasingly for the
development and enhancement of our services. Such
outsourcing presents a number of risks primarily

9



---



##### Table of Contents



relating to our reduced control of the functions
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.


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 enterprise resource planning system 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.



| |                                                                                                                                                                                                                        
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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, malfunctions,
human error 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 factors that
cause 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 order to obtain
certain distribution, supply or operations capabilities, our
attempts to expand may involve an increased use of revenue
sharing arrangements, which may affect our profitability or
result in additional liabilities.

We plan to expand our presence in international
markets, particularly including the Asia-Pacific region in
general and specifically China. In addition to being subject to
the risks of international operations described below, it is
costly to establish new international operations and our net
sales from international market segments may not offset the
expense of establishing and maintaining the operations. We have
relatively little experience in marketing and distributing our
services in many of these international markets, and we may not
succeed in these efforts.

We also regularly evaluate acquisition and
strategic alliance opportunities and in the future may make
additional acquisitions of other companies or technologies or
enter into strategic alliances. Acquisitions and strategic
alliances 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         
|
| |  | 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                              

10



---



##### Table of Contents





| |   |                                                                 
| | - | ----------------------------------------------------------------
| |  | An inability to adequately protect our
    intellectual property
|
| |  | The failure of strategic alliances to perform as
    expected   

Our inability to manage growth or to integrate
any acquisitions or strategic alliances 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
transaction volumes and room rates that directly impact our
revenues, the introduction of new or enhanced services by us or
our competitors or the degree of customer acceptance of new
services. In the short-term, we may also be unable to adjust
spending rapidly enough to compensate for any unexpected revenue
shortfall. This could adversely impact our business, operating
results and financial condition. Accordingly, 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 agencies and other customers.

Many of our customers are independent hotels,
travel agencies 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. 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.



| |                                                                                                                                                                                                                                                                                                            
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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 into a lower
U.S. dollar amount.

Our international operations are also subject to
other risks, including:



| |   |                                                                                                                                                                                                                                
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Impact of possible adverse political and economic
    conditions, including difficulties in the repatriation of
    investments or profits                                                                                     
|
| |  | 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 and other laws enforced by
    the U.S. Office of Foreign Assets Control
|
| |  | 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                                                                                                                                                        



| |                                                                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | We may be unable to adequately protect our
    intellectual property or prevent its 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

11



---



##### Table of Contents



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 may not be adequate to
prevent misappropriation or infringement of our technology. In
addition, we may need to litigate claims against other 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. 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, taxes, 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 adverse consequences. Our efforts
to comply with the requirements of the Sarbanes-Oxley Act of
2002, particularly the provisions of Section 404 regarding
the certification and audit of our internal control over
financial reporting, have resulted in material expenditures of
financial and employee resources and may continue to do so in
the future. Also, as a result of our customer relationships and
our status as an intermediary with respect to certain services,
federal, state or foreign governmental authorities, competitors
or consumers could raise antitrust or anti-competitive concerns.

In addition, we are subject to the same federal,
state, local and foreign jurisdiction laws as other companies
conducting business on the Internet and in e-commerce, including
with respect to taxation, user privacy, data protection,
consumer protection, payment processing, electronic contracts
and other issues. 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, which could have a
material adverse effect on our business, operating results and
financial condition. Any change in tax laws, their
interpretation or our legal conclusions regarding the collection
of sales or similar taxes in connection with our services could
result in substantial tax liabilities for past sales and
decrease our profitability and revenues going forward.



| |                                                                                                                                                                                                            
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | 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
    a stockholders best interest.

We have provisions in our certificate of
incorporation and bylaws that are intended to 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. 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. We also have certain payment and other obligations
that are triggered by a change of control in connection with
agreements with certain third parties and employees.

12



---



##### Table of Contents



In connection with the Merger Agreement, our
board of directors approved and adopted the Merger Agreement in
a manner such that the restrictions imposed on business
combinations under Delaware law would not apply to the
applicable merger transaction. Additionally, on
December 19, 2005 Pegasus entered into an amendment to its
rights agreement that provides that none of the execution,
delivery or performance of the Merger Agreement or the closing
of the merger or any of the other transactions contemplated by
the merger agreement will trigger the separation or exercise of
the rights under the rights agreement or any adverse event under
the rights agreement.

Except for agreements or amendments described in
the preceding paragraph, these provisions will remain effective
and could discourage potential acquisition proposals or 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 other
liabilities not covered by insurance as well as divert
managements time and attention from our business, which
could adversely affect our business, financial condition and
results of operations.



| |                                                                    
| | -------------------------------------------------------------------
| | We have material indebtedness in the form
    of convertible notes.

In connection with the sale of the convertible
notes in July 2003, we incurred $75 million of indebtedness
which increased our interest payment obligations. The degree to
which we are leveraged could adversely affect our ability to
obtain further financing for working capital 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 operating costs and 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, many of which are
beyond our control. 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. We may secure a credit
facility as additional protection against short-term liquidity
concerns. However, such credit facility, other 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. The merger contemplated by
the Merger Agreement constitutes such a fundamental change.
While the debt financing anticipated in connection with this
Merger Agreement contemplates the repayment of the amounts owing
under the convertible notes, we

13



---



##### Table of Contents



cannot otherwise be assured 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 stock price has been and may continue
    to be significantly volatile due to many factors.

Several factors have caused, and may in the
future cause, our stock price to be significantly volatile,
which may be unrelated to our operating performance in certain
cases. Our stock price could be subject to wide fluctuations in
response to a variety of factors including the following:



| |   |                                                                                                                                                                                          
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Uncertainty relating to the closing of the sale
    of the Company as provided in the Merger Agreement                                                                                   
|
| |  | General economic conditions                                                                                                                                                              
|
| |  | Acts of terrorism, retaliation for such acts,
    political instability, health epidemics, natural disasters, war
    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                                                                                                                          
|
| |  | Adverse findings, conclusions or changes in
    requirements with respect to our internal controls assessment
    and audit pursuant to Section 404 of the Sarbanes-Oxley Act
    of 2002
|
| |  | Unpredictable volume and timing of customer
    revenues due to the terms of customer contracts, changes in the
    hotel industry 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, expectations and
    methodologies by securities analysts                                                                                                
|
| |  | Conditions, trends or perceived prospects in the
    Internet and online commerce industries                                                                                             
|
| |  | Changes in the market valuations of other
    similarly situated companies and hospitality and technology
    stocks in general                                                          
|
| |  | Announcements by us or our competitors of
    significant acquisitions, strategic partnerships, joint ventures
    or capital commitments                                                
|
| |  | Unscheduled system downtime                                                                                                                                                              
|
| |  | Lack of confidence in the Companys ability
    to execute on certain products or services                                                                                               
|
| |  | Sales of substantial amounts of shares of our
    common stock in the public market, or the perception that those
    sales may occur                                                    



| |                                                                                              
| | ---------------------------------------------------------------------------------------------
| | Our 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,
Consolidation of Variable Interest Entities, 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.

14



---



##### Table of Contents








|         |                          
|-------- | -------------------------
|Item 1B. | Unresolved Staff Comments

None.






|        |           
|------- | ----------
|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, 40,000 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

Pegasus is subject to certain legal proceedings,
claims and disputes that arise in the ordinary course of
business. Although management cannot predict the outcome of
these legal proceedings, we do not believe these actions will
have a material adverse effect on our financial position,
results of operations or liquidity.






|        |                                                        
|------- | -------------------------------------------------------
|Item 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, 2005.




PART II






|        |                                                                                                                     
|------- | --------------------------------------------------------------------------------------------------------------------
|Item 5. | Market for Registrants Common Equity,
    Related Stockholder Matters and Issuer Purchases of Equity
    Securities

Our common stock has been traded on the NASDAQ
National Market under the symbol PEGS since
August 7, 1997. At March 9, 2006, there were
approximately 320 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  
|     |                |      |   |      
|2005 |                |      |   |       |  |  |   |      
|     | Fourth quarter |      | $ | 9.50  |  |  | $ | 6.64  | 
|     | Third quarter  |      |   | 11.58 |  |  |   | 8.45  | 
|     | Second quarter |      |   | 12.03 |  |  |   | 9.99  | 
|     | First quarter  |      |   | 12.73 |  |  |   | 11.40 | 
|2004 |                |      |   |       |  |  |   |      
|     | Fourth quarter |      | $ | 12.98 |  |  | $ | 9.90  | 
|     | Third quarter  |      |   | 13.33 |  |  |   | 11.46 | 
|     | Second quarter |      |   | 13.38 |  |  |   | 10.55 | 
|     | First quarter  |      |   | 12.35 |  |  |   | 10.45 | 

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.

15



---



##### Table of Contents



Each right entitles the registered holder to
purchase from us one one-thousand five hundredth (1/1,500th) of
a share of our Series A Preferred Stock for each share of
our common stock held at a price of $60. The rights are
exercisable only if a person or group of affiliated persons
acquires, or has announced the intent to acquire,
20 percent or more of our common stock.


On December 19, 2005, concurrently with the
execution of the Merger Agreement, the Company and American
Stock Transfer & Trust Company, as Rights Agent, entered
into an amendment (the Rights Agreement Amendment)
to the Companys Rights Agreement dated as of
September 28, 1998 (the Rights Agreement). The
Rights Agreement Amendment provides that none of the execution,
delivery or performance of the Merger Agreement, the
consummation of the related merger or any of the other
transactions contemplated by and pursuant to the Merger
Agreement will trigger the separation or exercise of the
stockholder rights or any adverse event under the Rights
Agreement. In particular, none of Perseus Holding Corp.,
406 Acquisition Corp. or any of their affiliates shall be
deemed to be an Acquiring Person (as defined in the Rights
Agreement) solely by virtue of the execution, delivery or
performance of the Merger Agreement or the consummation of the
merger or any of the other transactions contemplated by and
pursuant to the Merger Agreement. The Rights Agreement Amendment
also provides that the Rights Agreement will terminate
immediately prior to the effective time of the merger
contemplated by the Merger Agreement.






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

The following selected consolidated financial
data as of and for the years ended December 31, 2005 and
2004, and for the year ended December 31, 2003 are derived
from the consolidated financial statements of Pegasus that have
been audited by PricewaterhouseCoopers LLP, an independent
registered public accounting firm, and are included as
Item 8 of this Annual Report on Form 10-K. Selected
consolidated financial data as of December 31, 2003, and as
of and for the years ended December 31, 2002 and 2001 are
derived from Pegasus audited financial statements that are
not included herein.

16



---



##### Table of Contents



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,
|                                             |                         |                        
|                                             |                         | 2005                    |         | 2004                |   | 2003                |         | 2002                |   | 2001               
|                                             |                         | (1),(2),(3),(4),(7)     |         | (1),(2),(3),(4),(7) |   | (1),(2),(3),(4),(7) |         | (1),(2),(4),(6),(7) |   | (1),(2),(5),(6),(7)
|                                             |                         |                         |         |                     |   |                     |         |                     |   |                    
|Service revenues                             |                         |                         | 158,127 |                     |   |                     | 170,159 |                     |   |                     | 154,745 |       |   |  | 172,225 |       |   |  | 176,018 |      
|Customer reimbursements                      |                         |                         | 17,355  |                     |   |                     | 15,253  |                     |   |                     | 11,485  |       |   |  | 11,181  |       |   |  | 12,079  |      
|                                             |                         |                         |         |                     |   |                     |         |                     |   |                     |         |       |   |  |         |       |   |  |         |      
|Total revenues                               |                         |                         | 175,482 |                     |   |                     | 185,412 |                     |   |                     | 166,230 |       |   |  | 183,406 |       |   |  | 188,097 |      
|Costs of services                            |                         |                         | 98,740  |                     |   |                     | 101,221 |                     |   |                     | 91,551  |       |   |  | 93,869  |       |   |  | 104,299 |      
|Net income (loss) from continuing operations |                         |                         | 5,229   |                     |   |                     | 12,460  |                     |   |                     | 536     |       |   |  | (1,430  | )     |   |  | (29,220 | )    
|Discontinued operations, net of tax          |                         |                         | (12,884 | )                   |   |                     | (4,475  | )                   |   |                     | (2,368  | )     |   |  | (2,089  | )     |   |  | (517    | )    
|Net income (loss)                            |                         |                         | (7,655  | )                   |   |                     | 7,985   |                     |   |                     | (1,832  | )     |   |  | (3,519  | )     |   |  | (29,737 | )    
|Basic income (loss) per share                |                         |                         |         |                     |   |                     |         |                     |   |                     |         |       |   |  |         |       |   |  |         |      
|                                             | Continuing operations   |                         |         | 0.25                |   |                     |         | 0.54                |   |                     |         | 0.02  |   |  |         | (0.06 | ) |  |         | (1.19 | )
|                                             | Discontinued operations |                         |         | (0.62               | ) |                     |         | (0.19               | ) |                     |         | (0.09 | ) |  |         | (0.08 | ) |  |         | (0.02 | )
|                                             |                         |                         |         |                     |   |                     |         |                     |   |                     |         |       |   |  |         |       |   |  |         |      
|                                             | Income (loss) per share |                         |         | (0.37               | ) |                     |         | 0.35                |   |                     |         | (0.07 | ) |  |         | (0.14 | ) |  |         | (1.21 | )
|Diluted income (loss) per share              |                         |                         |         |                     |   |                     |         |                     |   |                     |         |       |   |  |         |       |   |  |         |      
|                                             | Continuing operations   |                         |         | 0.25                |   |                     |         | 0.53                |   |                     |         | 0.02  |   |  |         | (0.06 | ) |  |         | (1.19 | )
|                                             | Discontinued operations |                         |         | (0.62               | ) |                     |         | (0.17               | ) |                     |         | (0.09 | ) |  |         | (0.08 | ) |  |         | (0.02 | )
|                                             |                         |                         |         |                     |   |                     |         |                     |   |                     |         |       |   |  |         |       |   |  |         |      
|                                             | Income (loss) per share |                         |         | (0.37               | ) |                     |         | 0.36                |   |                     |         | (0.07 | ) |  |         | (0.14 | ) |  |         | (1.21 | )
|Working capital (deficit)                    |                         |                         | 29,228  |                     |   |                     | 24,947  |                     |   |                     | 59,057  |       |   |  | 16,995  |       |   |  | (5,541  | )    
|Total assets                                 |                         |                         | 315,121 |                     |   |                     | 329,214 |                     |   |                     | 366,560 |       |   |  | 288,095 |       |   |  | 305,668 |      
|Long-term debt                               |                         |                         | 75,000  |                     |   |                     | 75,000  |                     |   |                     | 75,000  |       |   |  |        |       |   |  |        |      
|Total stockholders equity                   |                         |                         | 174,127 |                     |   |                     | 187,316 |                     |   |                     | 228,656 |       |   |  | 225,890 |       |   |  | 231,201 |      



---



|    |                                                                                                                                                                                                                                                   
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Pegasus selected consolidated financial
    data includes the operating results of REZ, Inc. following the
    acquisition 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) | In 2004 the Company reclassified bad debt expense
    to General and Administrative Expenses from Cost of Services.
    The reclassified amounts totaled $1.3 million and
    $3.4 million in 2002 and 2001, respectively.                        
|   
|(7) | The Company has reclassified its property
    management systems operations as discontinued operations for all
    periods presented.                                                                                                             

The Company has not paid any cash dividends
during the past five years.






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

17



---



##### Table of Contents



analysis contains forward looking statements
within the meaning of the federal securities laws, including
statements using terminology such as may,
will, expects, plans,
initiatives, intends,
anticipates, believes,
estimates, or potential, 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
future effect of plans, initiatives 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, the failure of the Company to complete the
transaction as contemplated by the Merger Agreement or delays
with respect to this Merger Agreement, changes in general
economic conditions, variation in demand for our products and
services and in the timing of our sales, changes in product and
price competition for existing and new competitors, changes in
our level of operating expenditures, delays in developing,
marketing and deploying new products and services, terrorist
activities, action by U.S. or other military forces, regional or
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, the inability of the Company to
sell the balance of its PMS business, as well as other risks and
uncertainties, including those appearing in this report under
the caption Risk Factors set forth under
Item 1A of this Annual Report on Form 10-K.


Pegasus is a global leader in providing
technology and services to hotels and travel distributors.
Founded in 1989, our customers include a majority of the
worlds travel agencies and more than 60,000 hotel
properties around the globe. Our services include central
reservation systems, electronic distribution services,
commission processing and payment services, and marketing
representation services, including the consumer Web site
hotelbook.comTM. Our representation services,
including Utell by PegasusTM and Unirez by
PegasusTM, are used by more than 7,000 hotels in
more than 130 countries, making Pegasus the hotel
industrys largest third-party marketing and reservations
provider. We have 17 offices in 12 countries,
including regional hubs in London, Scottsdale and Singapore.

The Merger Agreement

As a result of our strategic alternative process,
which was announced in April 2005, Pegasus Solutions, Inc. has
entered into an Agreement and Plan of Merger, dated
December 19, 2005 (the Merger Agreement), with
Perseus Holding Corp. (Parent) and
406 Acquisition Corp., a direct wholly owned subsidiary of
Parent (Merger Sub). Parent and Merger Sub are
entities controlled by an investment group consisting of
entities affiliated with Prides Capital Partners, L.L.C. and
Tudor Investment Corporation.

The Merger Agreement contemplates that Merger Sub
will be merged with and into the Company, with the Company
continuing as the surviving corporation (the Surviving
Corporation) in such merger as a direct wholly owned
subsidiary of Parent (the Merger), and each
outstanding share of common stock of the Company owned by
stockholders other than those affiliated with the investment
group will be converted in the Merger into the right to receive
$9.50 per share in cash.

The Company has made various representations,
warranties and covenants in the Merger Agreement, including,
among others, not to (a) solicit proposals relating to
alternative business combination transactions or
(b) subject to certain exceptions which permit the board of
directors to comply with its fiduciary duties, enter into
discussions concerning, or provide confidential information in
connection with, alternative business combination transactions.
Subject to certain exceptions that permit the board of directors
to comply with its fiduciary duties, the Companys board of
directors has agreed to recommend that the Companys
stockholders vote in favor of and adopt and approve the Merger
and the Merger Agreement. The Merger Agreement also includes
covenants pertaining to the operation of the Companys
business between execution of the Merger Agreement and the
closing of the Merger.

Consummation of the Merger is subject to various
conditions, including, among others, the approval and adoption
of the Merger Agreement by the Companys stockholders, the
absence of certain legal impediments to consummation of the
Merger, the receipt of certain regulatory approvals and the
funding of debt to complete the Merger.

18



---



##### Table of Contents



The Merger Agreement contains certain termination
rights, including in the event the Company receives a superior
proposal, and provides that, upon the termination of the Merger
Agreement under specified circumstances, as defined therein, the
Company may be required to pay Parent a termination fee equal to
$8.25 million. In addition, in certain circumstances where
the Merger Agreement is terminated, including in the event the
Merger Agreement is terminated and the Company is required to
pay the termination fee to Parent, the Company is required to
reimburse Parent for its fees and expenses incurred in
connection with the Merger Agreement, up to a maximum of
$1 million.

In connection with the execution of the Merger
Agreement, an affiliate of Prides Capital Partners, L.L.C.
agreed to provide a limited guarantee of the liabilities of
Parent and Merger Sub under the Merger Agreement. In addition,
John F. Davis, III, Susan K. Conner and Robert J. Boles, Jr.
have agreed with Prides Capital Partners, L.L.C. to waive, for a
period of six months following the Merger, their rights to
severance pay in the event that they terminate employment during
that period. These individuals also have agreed to invest in the
Company following completion of the Merger.

Additionally, on December 19, 2005, the
Company and American Stock Transfer & Trust Company, as
Rights Agent, entered into an amendment (the Rights
Agreement Amendment) to the Rights Agreement, dated as of
September 28, 1998 (the Rights Agreement). The
Rights Agreement Amendment provides that none of the execution,
delivery or performance of the Merger Agreement, the
consummation of the Merger or any of the other transactions
contemplated by and pursuant to the Merger Agreement will
trigger the separation or exercise of the stockholder rights or
any adverse event under the Rights Agreement. In particular,
none of Parent, Merger Sub or any of their affiliates shall be
deemed to be an Acquiring Person (as defined in the Rights
Agreement) solely by virtue of the execution, delivery or
performance of the Merger Agreement or the consummation of the
Merger or any of the other transactions contemplated by and
pursuant to the Merger Agreement. The Rights Agreement Amendment
also provides that the Rights Agreement will terminate
immediately prior to the effective time of the Merger.

Discontinued Operations

In June 2005, our Board of Directors approved and
committed to a formal plan to exit the property management
systems (PMS) business by selling our PMS
operations. These operations included the PegasusCentral PMS and
two other private-label property management products, Guestview
and NovaPlus, that support both hotel chains and independent
customers.

We also reached an agreement with its primary
PegasusCentral customer, InterContinental Hotel Group
(IHG), to discontinue the use of PegasusCentral. The
transition of IHG properties off of Pegasus Central is
substantially complete, and there will be no new installations.
The decision to exit the PMS business was made considering the
termination of the IHG agreement, the overall expected
profitability of the remaining PMS operations, and the strategic
alternative process announced in April 2005.

The PMS operations have been classified as
discontinued operations for all periods presented and the PMS
assets are classified as assets held for sale at
December 31, 2005. In classifying the PMS assets as held
for sale, we concluded that the carrying amount of these assets
exceeded the estimated fair value less cost to sell such assets.
Accordingly, in the second quarter of 2005, we recognized a
$16.6 million pre-tax impairment charge to write down the
assets to an estimated net realizable value of
$1.9 million. In addition, we recorded an approximately
$1.0 million pre-tax charge for exit and transition costs,
which were paid during the third quarter of 2005. These charges
are included in the Consolidated Statements of Operations and
Comprehensive Income (Loss) as discontinued operations, net of
tax. Assets held for sale of approximately $1.0 million are
included in other noncurrent assets in the Consolidated Balance
Sheet as of December 31, 2005. The Company will continue to
analyze whether the PMS operations meet the criteria to be
presented as discontinued operations for one year.

During October 2005, we completed the disposition
of the Guestview and NovaPlus operations to Multi-Systems, Inc.
The sale price was approximately $1.3 million, including
$605,000 paid upon closing and $722,000 due under a full
recourse promissory note, payable in three annual installments
of $270,000, including interest at 6%. We recorded a gain on the
sale of approximately $371,000 in the fourth quarter of

19



---



##### Table of Contents



2005, which was included in discontinued
operations. We expect to sell the remaining PegasusCentral PMS
business by the end of the second quarter of 2006.


Revenues

Our business and particularly our revenues are
sensitive to changes in the demand for, and average daily rates
associated with, hotel rooms. Our distribution and reservation
services revenues are primarily attributable to
transaction-based activities, while our representation and
financial services revenues are based in large part on a
combination of reservation volume and average daily rates. Our
revenues are dependent on new contracts, and we have experienced
a lengthening in the sales and implementation cycle for some of
our services.

Representation Services.We offer a variety of hotel
representation services to independent hotels and small hotel
groups through our Utell by Pegasus and Unirez by Pegasus
services. Representation services revenues primarily consist of
reservation processing fees, membership fees and fees for
various marketing services. Representation services revenues
represented approximately 42 percent of service revenues
for 2005.

Reservation Services.We provide CRS services on an ASP
basis. Reservation services revenues consist of transaction fees
as well as maintenance, voice services, and support fees related
to our RezView CRS software. Reservation services revenues
represented approximately 21 percent of service revenues
for 2005.

Financial Services.Our financial services provide
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 us 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 and foreign currency exchange rates. In addition, some
participating hotels generally pay fees based on the number of
commissionable transactions that Pegasus processes for the
hotel. Financial services revenues represented approximately
20 percent of service revenues for 2005.

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 tour operators,
wholesalers, and a variety of Internet sites Powered by Pegasus.
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 17 percent of
service revenues for 2005.

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 we cannot assure you 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 these vendors directly, our customer
reimbursements revenue and customer reimbursements cost of
services will decrease accordingly. 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.

20



---



##### Table of Contents



Costs

Our costs of services, which exclude depreciation
and amortization, 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 and certain incentive-based payments. We make
incentive-based payments to some demand generators, including
third-party Internet sites, because they provide us with access
to higher transaction volumes for our services than we could
reach otherwise. We also make incentive-based payments to some
hotels because they generate high commission volumes for our
financial services. These incentive-based payments are generally
either based on transaction volumes that are expensed as
incurred or consist of lump sum payments that are accounted for
as an asset and expensed over the contract term.

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, bad debt
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 our earning more or less revenue and expending higher
or lower in expenses than we otherwise might have earned or
spent if currency exchange rates had remained stable.

Years Ended December 31, 2005 and
2004

Overview.During
2005, we experienced a decline in revenues, primarily due to
lower pricing on new and renewal contracts. This primarily
stemmed from delays in developing new technology and
enhancements to our existing technology, increased competition
from lower-cost competitors, and hotel and travel agency
consolidations. We believe this trend has stabilized. Our
operating costs remained consistent year over year, with the
benefits of tight control over discretionary spending being
offset by investments in marketing and sales and expenditures
related to our strategic alternative initiative.

We made a decision during 2005 to exit the PMS
business by selling these operations, which included the
PegasusCentral PMS and two other private-label property
management products, Guestview and NovaPlus, that support both
hotel chains and independent customers. The decision to exit the
PMS business was made considering the termination of the
agreement with our primary PegasusCentral customer, IHG, and the
overall expected profitability of the remaining PMS operations.

Other significant developments include the
following:



| |   |                                                                                                                                                                                                                  
| | - | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We launched weekly commission processing during
    the first quarter. With this enhancement to our commission
    processing service, both hotels and travel agencies benefit from
    more efficient cash flow.
|
| |  | During the second quarter, we launched
    hotelbook.com, which creates another way for independent
    hoteliers to compete online with the major hotel brand Web sites.                                        
|
| |  | We expanded our presence in China by opening an
    office in Beijing, which is a key part of our strategy to expand
    our business in the Asia-Pacific region.                                                

21



---



##### Table of Contents





| |   |                                                                                                                                                                                                              
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We have delivered a new release of our internet
    booking engine, Netbooker, and a new rate tracking service, and
    have established a strategic relationship with Open Hospitality
    for Web services.
|
| |  | We initiated transactions using our new PegsTour
    service.                                                                                                                                                

Operating Trends.The following trends have or may have
a negative impact on our revenues and profitability.



| |   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We have experienced a lengthening in the
    implementation cycle for our services, and once implemented,
    contracts in some instances are taking longer than anticipated
    to ramp up to expected transaction volumes.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | Revenues from new product offerings are lower
    than previously anticipated. For instance,
    PegsTourTM, a new service which automates hotel
    reservations by tour operators and wholesale travel
    distributors, has experienced delays due to the implementation
    effort required by travel distributors and hotels (including
    development of an interface and business process changes).                                                                                                                                                                                                                                                                                                                                                                                                           
|
| |  | In many instances, our service offerings continue
    to experience lower pricing on new contracts and contract
    renewals, arising from increased competition from lower-cost
    competitors and hotel and travel agency consolidations.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|
| |  | We continue to see an increase in the percentage
    of Internet reservations made at hotel chain Internet sites
    versus third-party Internet sites that utilize our services.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|
| |  | We continue to experience losses in our portfolio
    of customers, as some larger customers cease to outsource some
    of the services we offer or outsource to our competitors. For
    our commission processing service line, this trend has resulted
    in the loss of hotel participants, which could affect whether
    our travel agent customers continue to use our service. Further,
    we expect to cease providing commission processing services to
    one of our largest hotel participants late in the first quarter
    of 2006. For the year ended December 31, 2005, this hotel
    participant represented approximately 19 percent of our
    financial services revenues, and we paid them approximately
    $1.1 million in incentive payments, which are recorded in
    cost of services.
|
| |  | We experienced a year-over-year decline in our
    revenues.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          

Positive operating trends include:



| |   |                                                                                                                                                          
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We have increased our speed in providing new
    technologies and enhancements to our products.                                                          
|
| |  | Average daily room rates (ADR) are
    improving.                                                                                                      
|
| |  | We believe the trend of lower pricing on new
    contracts and contract renewals has begun to stabilize and is
    not expected to erode future revenues.
|
| |  | Pricing for Internet distribution is increasing.                                                                                                         

22



---



##### Table of Contents





| |   |                                                                                                                                                    
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------
| |  | We have established business partners in key
    regions around the world expanding our market reach in Latin
    America, Asia and Eastern Europe.
|
| |  | We have been able to reduce the Internet
    distribution revenue share that we pay out.                                                           

Revenues.The table
and discussion below address revenue by service line for the
years ended December 31, 2005 and 2004 (dollars in
thousands).

|                        |  |      |         |      |  |          |         |   |  |   |         |   |  |  |     |   
|----------------------- |  | ---- | ------- | ---- |  | -------- | ------- | - |  | - | ------- | - |  |  | --- | --
|                        |  |      |         |      |  |         
|                        |  |      |         |      |  | Variance
|                        |  |      |         |      |  |         
|                        |  | 2005 |         | 2004 |  | $        |         | %
|                        |  |      |         |      |  |          |         |  
|Representation services |  | $    | 66,368  |      |  | $        | 71,855  |   |  | $ | (5,487  | ) |  |  | (8  | )%
|Reservation services    |  |      | 32,846  |      |  |          | 37,275  |   |  |   | (4,429  | ) |  |  | (12 | )%
|Financial services      |  |      | 31,534  |      |  |          | 33,699  |   |  |   | (2,165  | ) |  |  | (6  | )%
|Distribution services   |  |      | 27,379  |      |  |          | 27,330  |   |  |   | 49      |   |  |  | 0   | % 
|                        |  |      |         |      |  |          |         |   |  |   |         |   |  |  |     |   
|Total service revenues  |  |      | 158,127 |      |  |          | 170,159 |   |  |   | (12,032 | ) |  |  | (7  | )%
|Customer reimbursements |  |      | 17,355  |      |  |          | 15,253  |   |  |   | 2,102   |   |  |  | 14  | % 
|                        |  |      |         |      |  |          |         |   |  |   |         |   |  |  |     |   
|Total revenues          |  | $    | 175,482 |      |  | $        | 185,412 |   |  | $ | (9,930  | ) |  |  | 5   | % 
|                        |  |      |         |      |  |          |         |   |  |   |         |   |  |  |     |   

Representation services revenues decreased
primarily due to the continued impact of reduced pricing and the
transition of a significant Unirez by Pegasus customer to our
central reservation service. A 2 percent increase in ADR
for our Utell by Pegasus offering was offset by a decrease in
reservation volumes and the average commission earned
percentage. The average commission earned stabilized in the
latter months of 2005.

Reservation services revenues decreased primarily
due to the effects of pricing pressure on contract renewals from
late 2004 and the loss of a customer. Partially offsetting these
decreases was the transition of one customer from Unirez by
Pegasus to our reservations services late in 2004. Net
transactions decreased compared to the same period last year.

Financial services revenues decreased primarily
due to an impact of approximately $1.5 million associated
with the initial implementation of weekly commission processing
in March 2005. While this enhancement to our commission
processing service will benefit both hotels and travel agencies,
its initial implementation impacted the timing of services we
normally would have performed in March 2005. Under the new
process and technology, once commission data is input into the
system, it is automatically included in the next weekly cycle.
Because of the timing of data submission and when we provided
our services, revenues for only approximately three weeks of
data were recognized in March 2005 related to hotels that
elected to utilize our weekly commission processing. Further,
revenues decreased related to hotels that elected to stay on a
monthly commission processing schedule because we were unable to
provide services to or process any of the data submitted by
these hotels until April 2005. Offsetting the first quarter 2005
negative impact to revenues of approximately $2.1 million
was the $600,000 positive impact in the second quarter of 2005,
representing incremental revenues earned in the month of
conversion, as hotel companies switched from monthly to weekly
commission processing. The financial impact of implementing
weekly commission processing was substantially complete by the
end of the second quarter of 2005, as the majority of expected
customer conversions to weekly commission processing were
completed.

Aside from this impact, financial services
revenues were affected by reduced transactions and pricing,
resulting from travel agency consolidations, partially offset by
the continued benefit from improved ADR.

Distribution services revenues in 2005 were
consistent with 2004. Improved pricing on premium channel
Internet transactions and a 9 percent increase in GDS
transactions was offset by a slight decrease in the number of
Internet transactions. The decrease in Internet transactions
reflects the trend of large customers operating their own
proprietary Web sites that do not utilize Pegasus Internet
distribution service, as well as the impact of a customer loss.
In addition, reduced pricing from the second quarter 2004 sale
of Travelweb LLC to Priceline.com negatively affected
year-over-year comparisons through May 2005.

23



---



##### Table of Contents



Customer reimbursements increased due to an
overall increase in our customers GDS costs because of an
increase in GDS transactions and GDS pricing.

Operating Expenses.The table and discussion below address
operating expenses for the year ended December 31, 2005
compared to the year ended December 31, 2004 (dollars in
thousands).

|                                    |  |      |         |      |  |          |         |   |  |   |        |   |  |  |    |   
|----------------------------------- |  | ---- | ------- | ---- |  | -------- | ------- | - |  | - | ------ | - |  |  | -- | --
|                                    |  |      |         |      |  |         
|                                    |  |      |         |      |  | Variance
|                                    |  |      |         |      |  |         
|                                    |  | 2005 |         | 2004 |  | $        |         | %
|                                    |  |      |         |      |  |          |         |  
|Cost of services                    |  | $    | 81,385  |      |  | $        | 85,968  |   |  | $ | (4,583 | ) |  |  | (5 | )%
|Customer reimbursements             |  |      | 17,355  |      |  |          | 15,253  |   |  |   | 2,102  |   |  |  | 14 | % 
|Total costs of services             |  |      | 98,740  |      |  |          | 101,221 |   |  |   | (2,481 | ) |  |  | (2 | )%
|Research and development            |  |      | 3,391   |      |  |          | 3,676   |   |  |   | (285   | ) |  |  | (8 | )%
|General and administrative expenses |  |      | 23,688  |      |  |          | 23,878  |   |  |   | (190   | ) |  |  | (1 | )%
|Marketing and promotion expenses    |  |      | 21,121  |      |  |          | 19,618  |   |  |   | 1,503  |   |  |  | 8  | % 
|Depreciation and amortization       |  |      | 18,963  |      |  |          | 17,516  |   |  |   | 1,447  |   |  |  | 8  | % 
|                                    |  |      |         |      |  |          |         |   |  |   |        |   |  |  |    |   
|Total operating expenses            |  | $    | 165,903 |      |  | $        | 165,909 |   |  | $ | (6     | ) |  |  | 0  | % 
|                                    |  |      |         |      |  |          |         |   |  |   |        |   |  |  |    |   

Overall, operating expenses for the year ended
December 31, 2005 were flat compared to the prior year. The
following factors contributed most significantly to the year
over year fluctuations in the operating expense line items:



| |   |                                                                                                                                                                                                                                                                             
| | - | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Prior year expenses included severance and
    related costs of $2.4 million related to a first quarter
    2004 strategic change in our information technology organization
    compared to $1.3 million of severance and lease termination
    costs incurred during 2005;
|
| |  | Headcount and employee-related expenses were
    lower year-over-year;                                                                                                                                                                                                      
|
| |  | All variable operating costs were carefully
    managed in 2005;                                                                                                                                                                                                            
|
| |  | We incurred costs of $1.6 million in 2005
    related to the strategic alternatives initiative,
    $1.3 million of which is included in general and
    administrative expenses; and                                                                                       
|
| |  | Marketing and promotion expenses increased as we
    remain committed to sales and marketing efforts, including the
    launch of hotelbook.com and promotional activities related to
    our representation services.                                                      

Cost of services expenses, excluding customer
reimbursements, in 2004 included severance and related costs of
$1.9 million related to a first quarter 2004 strategic
change in our information technology organization. Cost of
services also decreased as a result of the implementation of
weekly commission processing in our financial services offering.
Consistent with the change in timing of revenue recognition,
customer incentives were reduced by approximately $150,000
during 2005. The remainder of the decrease is due to lower
customer incentives, communications expenses, and processing
costs, commensurate with the decrease in revenues and
cost-saving initiatives. Cost of services, excluding customer
reimbursements, as a percentage of service revenues were
51 percent in 2005 and 2004.

Customer reimbursements in 2005 increased
primarily due to an overall increase in our customers GDS
costs because of an increase in GDS transactions and GDS pricing.

Research and development expenses were down year
over year, primarily due to lower headcount and employee-related
expenses. Research and development expenses as a percentage of
service revenues was 2 percent in both 2005 and 2004.

General and administrative expenses in 2005
decreased primarily due to lower third-party costs incurred,
primarily related to tax and audit professional services, and
prior year severance and related costs of $465,000 for the first
quarter 2004 strategic change in our information technology
organization. These decreases were partially offset by costs of
$1.3 million in 2005 related to the strategic alternatives
initiative, $378,000 of costs related to the closing of an
office, and a prior year curtailment gain of $162,000 for the
Supplemental

24



---



##### Table of Contents



Executive Retirement Plan due to changes in
executive management. General and administrative expenses as a
percentage of service revenues were 15 percent and
14 percent in 2005 and 2004, respectively.


Marketing and promotion expenses in 2005
increased primarily due to additional personnel and consultant
costs arising from a greater focus on sales, marketing and
promotion activities, including costs related to the launch of
our own travel Web site, hotelbook.com. Marketing and promotion
expenses as a percentage of service revenues were
13 percent and 12 percent in 2005 and 2004,
respectively.

Depreciation and amortization in 2005 increased
primarily due to depreciation and amortization related to
capital expenditures being put into production. This increase
was partially offset by completing the amortization of a
software asset in the second quarter of 2004, which accounted
for $921,000 in amortization in 2004.

Gain on Sale.On
May 3, 2004, Pegasus sold its interest in Travelweb, LLC to
an affiliate of Priceline.com, Inc. and received
$4.2 million in cash, recognizing a gain of approximately
$2.0 million.

Interest income.Interest income in 2005 increased from $1.1 million to
$1.6 million compared to 2004, due to higher interest rates
and higher cash balances.

Interest expense.Interest expense in 2005 decreased from $3.0 million to
$2.9 million compared to 2004 due to higher capitalization
of interest related to our software development efforts.

Income tax expense.Pegasus recorded income tax expense on continuing operations of
$3.2 million and $8.0 million in 2005 and 2004,
respectively, reflecting effective rates of 38 percent for
2005 and 39 percent for 2004. The effective rate for 2005
differed from the statutory rate of 35 percent, primarily
due to the geographic apportionment of profits and losses and
the impact of state income taxes, nondeductible expenses, and
foreign taxes.

Discontinued
operations.In June 2005, the Board of
Directors of the Company approved and committed to a formal plan
to exit the PMS business by selling the Companys PMS
operations. These operations included the PegasusCentral PMS and
two other private-label property management products, Guestview
and NovaPlus, that support both hotel chains and independent
customers. The Company also reached an agreement with its
primary PegasusCentral customer, IHG, to discontinue the use of
PegasusCentral. For further information regarding discontinued
operations, please see Note 3 to the Consolidated Financial
Statements.

Years Ended December 31, 2004 and
2003

Overview.After
several difficult years for the hotel industry, the year ended
December 31, 2004 showed gradual but steady recovery in
both reservation volumes and ADR. Pegasus benefited from both
the improved economic and industry environments as well as the
December 2003 strategic acquisition of Unirez, Inc. Strength in
foreign currencies, particularly the euro and the British pound,
also favorably impacted Pegasus. Offsetting these benefits,
increased competition resulted in reduced pricing on contract
renewals and new business. In addition, an increase in the
percentage of Internet reservations made at hotel chain Internet
sites versus third-party Internet sites negatively impacted our
distribution services revenues.

Due to the improved operating environment, we
increased discretionary spending in 2004 with a focus on
customer satisfaction, sales, marketing, product development and
employee retention activities intended to promote long-term
growth. We also incurred additional expenses related to
compliance with the Sarbanes-Oxley Act of 2002.

Organizationally, we made leadership changes in
key functions during 2004, particularly our information
technology and product management groups. We also established or
enhanced processes throughout the company with the goal of
expediting the time to market on new products and improving
customer satisfaction. During this transition period, we still
met our earnings goals and made significant progress on product
development priorities established at the beginning of the year.

25



---



##### Table of Contents



Revenues.The table
and discussion below address revenue by service line for the
years ended December 31, 2004 and 2003 (dollars in
thousands).

|                        |  |      |         |      |  |          |         |   |  |   |        |   |  |  |    |   
|----------------------- |  | ---- | ------- | ---- |  | -------- | ------- | - |  | - | ------ | - |  |  | -- | --
|                        |  |      |         |      |  |         
|                        |  |      |         |      |  | Variance
|                        |  |      |         |      |  |         
|                        |  | 2004 |         | 2003 |  | $        |         | %
|                        |  |      |         |      |  |          |         |  
|Representation services |  | $    | 71,855  |      |  | $        | 57,409  |   |  | $ | 14,446 |   |  |  | 25 | % 
|Reservation services    |  |      | 37,275  |      |  |          | 38,349  |   |  |   | (1,074 | ) |  |  | (3 | )%
|Financial services      |  |      | 33,699  |      |  |          | 30,244  |   |  |   | 3,455  |   |  |  | 11 | % 
|Distribution services   |  |      | 27,330  |      |  |          | 28,743  |   |  |   | (1,413 | ) |  |  | (5 | )%
|                        |  |      |         |      |  |          |         |   |  |   |        |   |  |  |    |   
|Total service revenues  |  |      | 170,159 |      |  |          | 154,745 |   |  |   | 15,414 |   |  |  | 10 | % 
|Customer reimbursements |  |      | 15,253  |      |  |          | 11,485  |   |  |   | 3,768  |   |  |  | 33 | % 
|                        |  |      |         |      |  |          |         |   |  |   |        |   |  |  |    |   
|Total revenues          |  | $    | 185,412 |      |  | $        | 166,230 |   |  | $ | 19,182 |   |  |  | 12 | % 
|                        |  |      |         |      |  |          |         |   |  |   |        |   |  |  |    |   

Representation services revenues increased
primarily due to the results of operations of Unirez by Pegasus,
which was acquired December 1, 2003 and contributed
$14.7 million to revenues in 2004, compared to $874,000 in
2003. Utell by Pegasus revenues increased $586,000, or
1 percent, over 2003 due to a 4 percent increase in
reservations and a 9 percent increase in ADR. The improved
ADR reflects a strong euro and British pound, which contributed
$3.9 million to the increase in representation service
revenues. Partially offsetting this increase was a decrease in
Utell by Pegasus membership fees due to fewer hotels in the
portfolio, and a 6 percent decrease in the average
commission percentage earned, resulting from lower pricing on
new contracts and contract renewals, as expected, arising out of
increased competition from lower-cost competitors.

Reservation services revenues decreased primarily
due to lower per unit pricing on contract renewals, despite a
6 percent increase in net transactions processed. Excluding
carryover revenue in early 2003 from three previously terminated
contracts, reservation service revenues increased 2 percent
over prior year.

Financial services revenues increased primarily
as a result of a 7 percent increase in gross commissions
processed and due to improved ADR and the trend of processing
more foreign currency payments, which earn additional fees.

Distribution services revenues decreased despite
a 10 percent increase in GDS transactions and a flat number
of Internet transactions. Internet transaction volumes reflect
an increase in the percentage of Internet bookings made at hotel
companies proprietary Internet sites; these transactions
do not utilize Pegasus Internet distribution services. In
addition, the decrease in revenue was primarily due to the loss
of Unirez as a distribution services customer, which provided
$1.5 million in revenue in 2003, reduced pricing on
Travelweb transactions, and a decrease in revenue per
transaction. In conjunction with Pricelines acquisition of
Travelweb, we extended terms of the services contract, but with
lower pricing.

Customer reimbursements increased primarily due
to operations of our new Unirez by Pegasus representation
service and an overall increase in our customers GDS costs
because of an increase in GDS transactions.

26



---



##### Table of Contents



Operating Expenses.The table and discussion below address
operating expenses for the year ended December 31, 2004
compared to the year ended December 31, 2003 (dollars in
thousands).

|                                    |  |      |         |      |  |          |         |   |  |   |        |   |  |  |      |   
|----------------------------------- |  | ---- | ------- | ---- |  | -------- | ------- | - |  | - | ------ | - |  |  | ---- | --
|                                    |  |      |         |      |  |         
|                                    |  |      |         |      |  | Variance
|                                    |  |      |         |      |  |         
|                                    |  | 2004 |         | 2003 |  | $        |         | %
|                                    |  |      |         |      |  |          |         |  
|Cost of services                    |  | $    | 85,968  |      |  | $        | 80,066  |   |  | $ | 5,902  |   |  |  | 7    | % 
|Customer reimbursements             |  |      | 15,253  |      |  |          | 11,485  |   |  |   | 3,768  |   |  |  | 33   | % 
|Total costs of services             |  |      | 101,221 |      |  |          | 91,551  |   |  |   | 9,670  |   |  |  | 11   | % 
|Research and development            |  |      | 3,676   |      |  |          | 4,547   |   |  |   | (871   | ) |  |  | (19  | )%
|General and administrative expenses |  |      | 23,878  |      |  |          | 23,348  |   |  |   | 530    |   |  |  | 2    | % 
|Marketing and promotion expenses    |  |      | 19,618  |      |  |          | 16,340  |   |  |   | 3,278  |   |  |  | 20   | % 
|Depreciation and amortization       |  |      | 17,516  |      |  |          | 23,571  |   |  |   | (6,055 | ) |  |  | (26  | )%
|Restructure costs                   |  |      |        |      |  |          | 5,949   |   |  |   | (5,949 | ) |  |  | (100 | )%
|                                    |  |      |         |      |  |          |         |   |  |   |        |   |  |  |      |   
|Total operating expenses            |  | $    | 165,909 |      |  | $        | 165,306 |   |  | $ | 603    |   |  |  | 0    | % 
|                                    |  |      |         |      |  |          |         |   |  |   |        |   |  |  |      |   

Operating expenses increased slightly in 2004
compared to 2003, as expected. The increase primarily related to
the following:



| |   |                                                                                                                                                             
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | The addition of Unirez by Pegasus operations;                                                                                                               
|
| |  | An increase in the number of and rates for
    incentive-based payments to third parties, as well as an
    increase in transaction volume;                 
|
| |  | An increase in employee related expenses due to
    merit increases and bonuses in 2004;                                                                    
|
| |  | An increase in sales and marketing efforts with a
    focus on increasing revenues and improving customer
    satisfaction; and                             
|
| |  | An increase in audit fees and other internal and
    external costs associated with the internal control requirements
    of the Sarbanes-Oxley Act of 2002.

These expense increases were partially offset by
the absence of restructure costs in 2004.

Cost of services, excluding customer
reimbursements, increased primarily due to $3.6 million in
added expenses for our Unirez by Pegasus representation service;
$1.9 million of severance and related costs incurred in the
first quarter of 2004 related to a strategic change in the
Companys information technology organization; a
$1.4 million increase in incentive based payments to third
parties because of new contracts and increases in transaction
volumes and rates; and $1.2 million in increased consulting
costs for IT initiatives. Cost of services, excluding customer
reimbursements, as a percentage of service revenues were
51 percent and 52 percent in 2004 and 2003,
respectively.

Customer reimbursements increased primarily due
to operations of our new Unirez by Pegasus representation
service and an overall increase in our customers GDS costs
because of an increase in GDS transactions.

Research and development expenses decreased in
2004 compared to 2003 primarily due to cost savings realized
from the 2003 restructuring, slightly offset by $593,000 in
additional expenses related to the Unirez acquisition. Research
and development expenses as a percentage of service revenues
were 2 percent and 3 percent in 2004 and 2003, respectively.

General and administrative expenses increased
slightly primarily due to $715,000 of bad debt expense in 2004,
as compared to zero in 2003, $465,000 in severance and related
costs incurred in the first quarter of 2004 related to a
strategic change in the Companys IT organization, $217,000
in added expenses of Unirez by Pegasus, and an increase of
approximately $900,000 for audit and other fees related to the
internal control requirements of the Sarbanes-Oxley Act. These
increases were partially offset by a decrease in payroll related
expenses and benefit plan costs because of decreased headcount
in 2004. General and administrative expenses as a percentage of
service revenues were 14 percent and 15 percent in
2004 and 2003, respectively.

27



---



##### Table of Contents



Marketing and promotion expenses increased due
primarily to increased personnel costs arising from Unirez by
Pegasus, a greater focus on marketing and promotion activities,
and the cost of a new sales incentive compensation program
launched in January 2004. Marketing and promotion expenses as a
percentage of service revenues were 12 percent and
11 percent in 2004 and 2003, respectively.

Depreciation and amortization expenses decreased
primarily because certain intangible assets related to the REZ
acquisition were fully amortized in March 2003. This was
partially offset by a $2.1 million increase in amortization
expense related to intangible assets from the December 2003
Unirez acquisition.

During 2003, the company incurred restructuring
charges of $5.9 million, related to the reorganization of
its operations from a business unit structure into distinct
functional areas.

Interest income.Interest income earned on the
companys investments decreased by $310,000 in 2004
compared to 2003 as the Companys funds available for
investment decreased in conjunction with the stock repurchase
plan cash outlays of $55.7 million in 2004.

Interest expense.Interest expense increased by
$1.4 million compared to 2003 primarily related to interest
and amortization of capitalized debt issuance costs for the July
2003 convertible debt offering.

Gain on sale.On
May 3, 2004, Pegasus sold its interest in Travelweb, LLC to
an affiliate of Priceline.com, Inc. (Priceline) and
received $4.2 million in cash, recognizing a gain of
approximately $2.0 million. The sale agreement contained a
contingent earn-out valued at approximately $4.7 million;
however, the required conditions to receive the shares of
Priceline common stock on the one-year anniversary of the
Closing Date were not met.

Income tax expense.Pegasus recorded income tax expense on
continuing operations of $8.0 million and $622,000 in 2004
and 2003, respectively, representing effective tax rates of
39 percent for 2004 and 54 percent for 2003. The
effective tax rate for 2004 differed from the statutory rate of
35 percent primarily due to the geographic apportionment of
profits and losses and the impact of state income taxes,
nondeductible expenses, and foreign taxes.

Discontinued
operations.In June 2005, the Board of
Directors of the Company approved and committed to a formal plan
to exit the PMS business by selling the Companys PMS
operations. These operations included the PegasusCentral PMS and
two other private-label property management products, Guestview
and NovaPlus, that support both hotel chains and independent
customers. The Company also reached an agreement with its
primary PegasusCentral customer, IHG, to discontinue the use of
PegasusCentral. For further information regarding discontinued
operations, please see Note 3 to the Consolidated Financial
Statements.

Liquidity and Capital Resources

Historically, Pegasus has primarily relied on
cash flows from operations to provide working capital for
current and future operations and for capital investments. From
time to time, we have also utilized proceeds from equity and
debt offerings to supplement our ability to fund operating cash
requirements, capital investments and acquisitions.

We assess our liquidity in terms of our ability
to generate cash to fund our operating and investing activities.
Key indicators we use to make this assessment are current
assets, current liabilities and net cash flow from operating
activities.

Our principal sources of capital during 2005
included cash and cash equivalents, which totaled
$32.3 million at year end, and auction rate securities,
which totaled $5.7 million at year end. Our cash flows from
operations of $30.6 million included $5.8 million
related to our commission processing service and were sufficient
to provide for working capital requirements. Other sources of
cash during 2005 were $7.1 million net proceeds from the
sale or maturity of marketable securities and $1.5 million
of proceeds from stock option exercises. Additionally, during
October 2005, we completed the disposition of the Guestview and
NovaPlus operations to Multi-Systems, Inc. The sale price was
approximately $1.3 million, including $605,000 paid

28



---



##### Table of Contents



upon closing and $722,000 due under a full
recourse promissory note, payable in three annual installments
of $270,000, including interest at 6%.


Cash outlays in 2005 included the repurchase of
approximately 518,000 shares of common stock for
$6.2 million. The common stock repurchases were made under
a Rule 10b5-1 stock repurchase plan that was approved on
November 5, 2004 and terminated effective April 12,
2005. During 2004, we repurchased approximately 4.7 million
shares of common stock for $55.7 million.

Another component of our cash outlays included
capital expenditures of $19.9 million consistent with our
capital strategy of investing in software development projects
meeting our return on investment criteria. In 2005,
$17.4 million of the capital expenditures related to
continuing operations and $2.5 million related to
discontinued operations. Our capital expenditures primarily
consist of personnel costs, interest expense and outside
consultant costs for software development, computer hardware,
furniture, fixtures and other office equipment.

We expect to continue incurring capital
expenditures related to software development and the addition of
capacity to existing systems. We estimate 2006 capital
expenditures will total approximately $15 to
$20 million.We may also collaborate with outside
parties for software development or other business needs. The
potential capital and financing arrangements required for such
arrangements is uncertain.

Our future liquidity and capital requirements
will depend on numerous factors, including:



| |   |                                                                              
| | - | -----------------------------------------------------------------------------
| |  | Our profitability;                                                           
|
| |  | Seasonality of our operations;                                               
|
| |  | Operational cash requirements;                                               
|
| |  | Competitive pressures;                                                       
|
| |  | Development of new services and applications;                                
|
| |  | Timing of capital expenditures;                                              
|
| |  | Response to unanticipated cash requirements; and                             
|
| |  | Completion of the merger under the Merger
    Agreement and related financing

We believe that we will be able to generate cash
flows from operations sufficient to meet our operating and
capital requirements through at least the next twelve months. If
the merger transaction is not completed, we may in the future
consider financing alternatives to fund our requirements,
including possible public or private debt or equity offerings.
However, there can be no assurance that any financing
alternatives sought by us will be available or will be on terms
that are attractive to us. Further, any debt financing may
involve restrictive covenants, and any equity financing may be
dilutive to stockholders.

Pegasus had two irrevocable standby letter of
credit agreements with JPMorgan Chase Bank totaling
$1.7 million at December 31, 2004, collateralizing the
leases for the Dallas and Scottsdale offices. During the first
quarter of 2005, we released one of these letters of credit,
replacing the $450,000 letter of credit for the Dallas facility
with a deposit of $181,000.

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 stock
repurchases.

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

29



---



##### 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. The notes and
the indenture in connection therewith contain no covenants by
the Company to maintain any minimum level of liquidity or any
financial ratios.


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 us 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.

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 that
holders notes. The merger contemplated by the Merger
Agreement constitutes such a fundamental change, and the debt
financing anticipated in connection with the Merger Agreement
contemplates the repayment of the amounts owing under the
convertible notes.

Off-balance
sheet arrangements and contractual obligations

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, 2005. 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 |        | 3  5 |  | More than
|Contractual obligations              |  | Total                  |         | 1 Year    |  | Years |        | Years |  | 5 Years  
|                                     |  |                        |         |           |  |       |        |       |  |          
|                                     |  |                       
|                                     |  | (In thousands)        
|Convertible debt, including interest |  | $                      | 125,981 |           |  | $     | 2,906  |       |  | $         | 5,813  |  |  | $ | 5,813  |  |  | $ | 111,449 | 
|Operating lease obligations          |  |                        | 49,257  |           |  |       | 8,097  |       |  |           | 14,720 |  |  |   | 14,333 |  |  |   | 12,107  | 
|Purchase obligations                 |  |                        | 4,310   |           |  |       | 3,198  |       |  |           | 941    |  |  |   | 171    |  |  |   |        | 
|Other long term liabilities          |  |                        | 8,031   |           |  |       | 2,116  |       |  |           | 3,254  |  |  |   | 2,661  |  |  |   |        | 
|                                     |  |                        |         |           |  |       |        |       |  |           |        |  |  |   |        |  |  |   |         | 
|Total                                |  | $                      | 187,579 |           |  | $     | 16,317 |       |  | $         | 24,728 |  |  | $ | 22,978 |  |  | $ | 123,556 | 
|                                     |  |                        |         |           |  |       |        |       |  |           |        |  |  |   |        |  |  |   |         | 

In addition to the contractual obligations
included in the table above, we also have funding requirements
related to our Executive Retirement Program and a United Kingdom
defined benefit plan, which is open to certain employees who
were part of the Reed Elsevier Pension Scheme in December 1997.
Pursuant to their employment agreements, certain company
officers are eligible to participate in the Executive Retirement
Program, consisting of (1) the Supplemental Executive
Retirement Plan (the SERP), as amended, a defined
benefit plan which provides supplemental retirement benefits to
certain officers of the Company based on their compensation and
years of service, as defined under the SERP, and (2) the
Pegasus Solutions, Inc. Executive Deferred Compensation Plan
(the DCP), as amended, a defined contribution plan
that provides supplemental retirement benefits to certain
management employees of the Company. Commencing in 2003, we are
obligated to make annual cash payments to a trust associated
with benefits earned under the Executive Retirement Program. The
amounts funded to the trust may be available to creditors of the
Company, but are generally not available for use in our ongoing
operations. Subsequent to year end 2005, the Company made
payments to the trust of $310,000 related to the SERP and
$256,000 related to the DCP in connection with benefits earned
in 2005. Also subsequent to year end 2005, the Company made SERP
benefit payments of $340,000 to an executive who terminated
participation in the SERP in 2004 using funds outside of the
trust.

30



---



##### Table of Contents



During 2006, we expect no further funding to the
trust related to the SERP and we expect funding to the trust
related to the 2006 DCP will total approximately $370,000;
provided however, in the event the merger contemplated by the
Merger Agreement closes, Pegasus will be obligated to make
further funding to the trust equal to all benefits under the
SERP and DCP.


We expect that contributions to the United
Kingdom defined benefit plan in 2006 will total approximately
$167,000.

Inflation

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

Critical Accounting Policies and
Estimates

Preparation of our financial statements in
conformity with accounting principles generally accepted in the
United States of America 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 significant 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 policies
and estimates, and this related disclosure in this report, with
our Audit Committee.

Accounts and
notes receivables

As of December 31, 2005, Pegasus had
accounts receivable as a result of its ongoing operations of
approximately $26.7 million. Additionally, we have notes
receivable totaling $6.3 million at December 31, 2005,
related to the sale of business units. These receivables are
monitored by management for collectibility. Pegasus maintains
allowances for doubtful accounts for estimated losses resulting
from the inability of its customers to make required payments.
These estimates of losses require judgments that are based on
available information and experience, such as the payment
histories and known financial conditions of the parties. These
estimates are significant because Pegasus may incur additional
expense to increase its allowance for doubtful accounts and may
receive less cash than expected if the financial condition of
the parties was to deteriorate, resulting in an impairment of
their ability to make payments. Pegasus allowances for
doubtful accounts and notes receivable totaled approximately
$3.9 million as of December 31, 2005.

Impairment of
long-lived assets, including goodwill

As of December 31, 2005, Pegasus has
goodwill totaling approximately $163.2 million related to
its acquisitions of REZ, Inc. (REZ) in 2000, Global
Enterprise Technology Solutions, LLC (GETS) in 2001
and Unirez, Inc. (Unirez) in 2003. Under the
guidance of SFAS 142, goodwill is analyzed for impairment at
least annually. This analysis requires significant estimates and
judgments by management, involving the carrying value and the
estimated fair value of the Company. Because Pegasus operates as
a single reportable unit, the company performs its analysis
using market capitalization as fair value. While the most recent
periodic impairment analysis performed as of September 30, 2005
indicated that no impairment of

31



---



##### Table of Contents



goodwill exists, variances in actual growth
rates, operating margins, or other assumptions may impact future
impairment analyses and reduce the carrying values of goodwill.


As of December 31, 2005, Pegasus has
unamortized capitalized software costs totaling
$40.9 million, which we review periodically for impairment
as triggering events occur. 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 is based on available information and experience. See Note 3
for information regarding impairment charges related to
discontinued operations in 2005.

We are in the development phase of an automated
system that represents the next generation of our financial
services offering that will provide hoteliers the ability to
customize their commission payment process options across
multiple travel agency segments and access real-time and
specialized reporting through a customer service portal. The
enhancements to this product are designed to add significant
functionality to hoteliers. We have evaluated funding and
development alternatives related to this technology, including
collaboration with outside parties. Such collaboration may
result in changes in the development, integration and deployment
of this software and may result in alternate financing
arrangements such as future revenue sharing. We are presently
reevaluating this project and the outcome of the development
alternatives and methodologies are not expected to be concluded
until after the close of the merger transaction. The carrying
value of this technology is $8.4 million as of
December 31, 2005. Because this system represents the next
generation of our current financial services operations, which
generates revenues of over $30 million per year, we believe
no impairment exists as of December 31, 2005. However,
changes in strategy, market condition, the outcome of our
strategic alternative initiative, or other assumptions may
significantly impact our determinations regarding whether an
impairment exists and could significantly reduce the carrying
value associated with this project.

Employee
benefit plans

Pegasus sponsors defined benefit plans for
certain employees, including the SERP in the United States and a
United Kingdom plan open only to employees who were part of the
Reed Elsevier Pension Scheme in December 1997 (the Utell
Defined Benefit Plan). 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. The long-term return on plan
assets for the Utell Defined Benefit Plan, which is a funded
plan, is determined based on expected returns as of the
accounting date, primarily based on equities which comprise the
majority of assets in the plan. Expected returns on equity plan
assets were determined to range between 6% and 9%. Specific to
the Utell Defined Benefit Plan, which is a funded plan, a one
percent change in expected returns on plan assets would result
in a $125,000 change to Pegasus annual expense associated
with this plan. The assumed discount rate for determining
obligations for the SERP is determined in reference to high
quality corporate bonds available in the market as of
December 31, 2005 (by reference to the Citigroup Corporate
High Quality Yield curve) and by determining the net effective
rate equivalent to discounting each future benefit payment by
the spot rate for that year. The assumed discount rate for the
Utell Defined Benefit Plan is determined in reference to the
annualized yield on a 15-year AA rated corporate bond (by
reference to the iBoxx). 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.



| |                    
| | -------------------
| | Deferred tax assets

Although realization is not assured, we have
concluded that it is more likely than not that the deferred tax
assets at December 31, 2005, for which a valuation
allowance was determined to be unnecessary, will be realized in
the ordinary course of operations based on the available
positive and negative evidence, primarily our projected
earnings. The amount of the net deferred tax assets are
considered realizable, however, they

32



---



##### Table of Contents



could be reduced in the near term if actual
future earnings or income tax rates are lower than estimated, or
if there are differences in the timing or amount of future
reversals of existing taxable or deductible temporary
differences. Net deferred tax assets totaled approximately
$7.1 million as of December 31, 2005 and are primarily
comprised of U.S. net operating losses that begin to expire
in 2019.


We will continue to assess the assumptions used
to determine the need for a valuation allowance. Should we
determine that we would not be able to realize all or part of
our components of the deferred tax asset in the future, an
adjustment to the deferred tax asset would be charged to
earnings in the period such determination were made.

StockBased
Compensation

In December 2004, the Financial Accounting
Standards Board (FASB) issued SFAS No. 123R,
Share-Based Payment (SFAS 123R), which
replaces SFAS No. 123, Accounting for Stock-Based
Compensation and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees. In March
2005, the Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin No. 107, Share-Based
Payment, which provides interpretive guidance related to
SFAS 123R. SFAS 123R requires compensation costs related to
share-based payment transactions to be recognized in financial
statements. With limited exceptions, the amount of compensation
cost is measured based on the fair value of the equity or
liability instrument issued on the grant date. SFAS 123R
requires liability awards to be remeasured each reporting period
and compensation costs to be recognized over the period that an
employee provides service in exchange for the award. The
requirements of SFAS 123R are effective for the
Companys first quarter beginning January 1, 2006. The
Company intends to use the modified prospective transition
method of adoption. Although the Company continues to evaluate
SFAS 123R to determine the impact on its consolidated
financial statements, SFAS 123R is expected to have a
negative effect on consolidated net income. In 2005, the Company
did not issue stock options to a large number of employees
through a broad-based stock option grant. Since the 2005 stock
option grants were significantly lower than preceding years and
no determination has been made in regards to future year grants,
the Company is unable to fully project future SFAS 123R
stock-based compensation expense. However, stock-based
compensation expense for 2006, without taking into account the
completion of the merger under the Merger Agreement, will at a
minimum approximate $1.9 million, net of tax. The
accounting treatment for the Companys restricted stock
awards will not change upon adoption of SFAS 123R and has
not been significant. No determination has been made regarding
future stock-based compensation awards.

At the effective time of the merger under the
Merger Agreement, if any, each outstanding stock option, whether
or not vested or exercisable, will terminate and thereafter
represent the right to receive an amount in cash, without
interest and less applicable tax withholding, equal to the
number of shares of our common stock subject to each option as
of the effective time of the merger, multiplied by the excess,
if any, of $9.50 over the exercise price per share of common
stock subject to such option. As of December 31, 2005,
there were 420,475 stock options outstanding with an exercise
price of less than $9.50 outstanding and a weighted-average
exercise price of $7.62. Also at the effective time of the
merger under the Merger Agreement, if any, each restricted stock
award (38,875 shares of restricted stock were outstanding
on December 31, 2005) granted under the Plans will be
converted into the right to receive $9.50 in cash per share,
without interest and less applicable tax withholding. From the
date of the Merger Agreement date until completion of the merger
under the Merger Agreement, if any, the Company has agreed,
subject to certain exceptions and unless Prides gives its prior
written consent, not to grant any equity or equity based awards.

Recently Issued Accounting Standards

Additional information regarding recently issued
accounting standards is included in Note 1 to the
Consolidated Financial Statements included in Item 8 of
this Annual Report on Form 10-K.

33



---



##### Table of Contents





|         |                                                               
|-------- | --------------------------------------------------------------
|Item 7A. | Quantitative and Qualitative Disclosures
    about Market Risk

Pegasus is exposed to certain market risks,
including the effects of foreign currency exchange rate
fluctuations, 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. We do not currently utilize hedge
accounting with regard to these derivatives.

To reduce the impact of foreign exchange rate
fluctuations on consolidated results of operations and future
foreign currency denominated cash flows, Pegasus was a party to
various forward exchange contracts at December 31, 2005.
These contracts reduce exposure to currency movements affecting
existing foreign currency denominated assets and liabilities,
primarily trade receivables and payables.

A summary of forward exchange contracts to sell
or purchase foreign currencies in place as of December 31,
2005 is as follows (in thousands):

|                   |       |      |        |          |  |   |       |       | 
|------------------ | ----- | ---- | ------ | -------- |  | - | ----- | ----- | 
|                   |       | Sell |        | Purchase
|                   |       |      |        |         
|Euro               |       | $    | 12,196 |          |  | $ | 3,039 |      
|Canadian dollar    |       |      | 800    |          |  |   | 369   |      
|Swiss franc        |       |      | 473    |          |  |   |      |      
|Swedish krona      |       |      | 289    |          |  |   |      |      
|Singapore dollar   |       |      | 235    |          |  |   |      |      
|Japanese yen       |       |      | 227    |          |  |   | 34    |      
|British pound      |       |      | 1,247  |          |  |   | 2,169 |      
|Australian dollar  |       |      | 90     |          |  |   |      |      
|South African rand |       |      | 40     |          |  |   |      |      
|New Zealand dollar |       |      | 27     |          |  |   |      |      
|Hong Kong dollar   |       |      | 23     |          |  |   |      |      
|Norweigan kroner   |       |      | 25     |          |  |   | 15    |      
|Danish krone       |       |      |       |          |  |   | 43    |      
|                   |       |      |        |          |  |   |       |      
|                   | Total |      | $      | 15,672   |  |   | $     | 5,669 | 
|                   |       |      |        |          |  |   |       |      

All contracts included above matured no later
than February 2006. 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, 2005. 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, 2004. As of December 31, 2004,
Pegasus had approximately $22.6 million in sell forward
exchange contracts and $4.6 million in purchase forward
exchange contracts. Pegasus positions with respect to
these forward exchange contracts differed as of
December 31, 2005 compared to December 31, 2004
because of changes in Pegasus non-U.S. denominated trade
payables and receivables. For more information on derivative
financial instruments see Notes 1 and 8 to the consolidated
financial statements included in Item 8 to this Annual
Report on Form 10-K.

34



---



##### Table of Contents








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

Report of Independent Registered Public
Accounting Firm

To the Board of Directors and Stockholders

of Pegasus Solutions, Inc.:


We have completed integrated audits of Pegasus
Solutions, Inc.s 2005 and 2004 consolidated financial
statements and of its internal control over financial reporting
as of December 31, 2005, and an audit of its 2003
consolidated financial statements in accordance with the
standards of the Public Company Accounting Oversight Board
(United States). Our opinions, based on our audits, are
presented below.

Consolidated financial statements and
financial statement schedule

In our opinion, the consolidated financial
statements listed in the index appearing under
Item 15(a)(1) present fairly, in all material respects, the
financial position of Pegasus Solutions, Inc. and its
subsidiaries at December 31, 2005 and 2004, and the results
of their operations and their cash flows for each of the three
years in the period ended December 31, 2005 in conformity
with accounting principles generally accepted in the United
States of America. In addition, in our opinion, the financial
statement schedule listed in the index appearing under
Item 15(a)(2) presents fairly, in all material respects,
the information set forth therein when read in conjunction with
the related consolidated financial statements. These financial
statements and financial statement schedule are the
responsibility of the Companys management. Our
responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits.
We conducted our audits of these statements in accordance with
the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatement. An
audit of financial statements 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 2 to the consolidated
financial statements, the Company has entered into an Agreement
and Plan of Merger, dated December 19, 2005, with an
investment group affiliated with Prides Capital Partners, L.L.C.
and Tudor Investment Corporation.

Internal control over financial
reporting

Also, in our opinion, managements
assessment, included in Managements Report on Internal
Control over Financial Reporting appearing under Item 9A,
that the Company maintained effective internal control over
financial reporting as of December 31, 2005 based on
criteria established in Internal Control 
Integrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO), is fairly
stated, in all material respects, based on those criteria.
Furthermore, in our opinion, the Company maintained, in all
material respects, effective internal control over financial
reporting as of December 31, 2005, based on criteria
established in Internal Control  Integrated
Framework issued by the COSO. The Companys management
is responsible for maintaining effective internal control over
financial reporting and for its assessment of the effectiveness
of internal control over financial reporting. Our responsibility
is to express opinions on managements assessment and on
the effectiveness of the Companys internal control over
financial reporting based on our audit. We conducted our audit
of internal control over financial reporting in accordance with
the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and
perform the audit to obtain reasonable assurance about whether
effective internal control over financial reporting was
maintained in all material respects. An audit of internal
control over financial reporting includes obtaining an
understanding of internal control over financial reporting,
evaluating managements assessment, testing and evaluating
the design and operating

35



---



##### Table of Contents



effectiveness of internal control, and performing
such other procedures as we consider necessary in the
circumstances. We believe that our audit provides a reasonable
basis for our opinions.


A companys internal control over financial
reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in
accordance with generally accepted accounting principles. A
companys internal control over financial reporting
includes those policies and procedures that (i) pertain to
the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions
of the assets of the company; (ii) provide reasonable
assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally
accepted accounting principles, and that receipts and
expenditures of the company are being made only in accordance
with authorizations of management and directors of the company;
and (iii) provide reasonable assurance regarding prevention
or timely detection of unauthorized acquisition, use, or
disposition of the companys assets that could have a
material effect on the financial statements.

Because of its inherent limitations, internal
control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions,
or that the degree of compliance with the policies or procedures
may deteriorate.

PRICEWATERHOUSECOOPERS LLP

Dallas, Texas

March 16, 2006


36



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.

CONSOLIDATED BALANCE SHEETS

December 31, 2005 and 2004


(In thousands, except for share
amounts)


|                                                                                                   |                                                                                                                        |                                            |                                          |         |         |   |         |         |         |  | 
|-------------------------------------------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------- | ------------------------------------------ | ---------------------------------------- | ------- | ------- | - | ------- | ------- | ------- |  | 
|                                                                                                   |                                                                                                                        | 2005                                       |                                          | 2004   
|                                                                                                   |                                                                                                                        |                                            |                                          |        
|ASSETS                                                                                             |                                                                                                                        |                                            |                                          |         |         |   |         |        
|Cash and cash equivalents                                                                          |                                                                                                                        | $                                          | 32,315                                   |         |         | $ | 17,599  |        
|Auction rate securities                                                                            |                                                                                                                        |                                            | 5,700                                    |         |         |   | 5,650   |        
|Short-term investments                                                                             |                                                                                                                        |                                            |                                         |         |         |   | 6,001   |        
|Accounts receivable, net of allowance for
    doubtful accounts of $2,900 and $3,184, respectively |                                                                                                                        |                                            | 23,786                                   |         |         |   | 28,551  |        
|Prepaid expenses                                                                                   |                                                                                                                        |                                            | 4,310                                    |         |         |   | 3,703   |        
|Other current assets                                                                               |                                                                                                                        |                                            | 5,661                                    |         |         |   | 5,358   |        
|                                                                                                   |                                                                                                                        |                                            |                                          |         |         |   |         |        
|                                                                                                   |                                                                                                                        | Total current assets                       |                                          |         | 71,772  |   |         |         | 66,862  | 
|Goodwill                                                                                           |                                                                                                                        |                                            | 163,156                                  |         |         |   | 163,585 |        
|Intangible assets, net                                                                             |                                                                                                                        |                                            | 4,357                                    |         |         |   | 5,827   |        
|Property, equipment and software, net                                                              |                                                                                                                        |                                            | 59,067                                   |         |         |   | 80,326  |        
|Other noncurrent assets                                                                            |                                                                                                                        |                                            | 16,769                                   |         |         |   | 12,614  |        
|                                                                                                   |                                                                                                                        |                                            |                                          |         |         |   |         |        
|                                                                                                   |                                                                                                                        | Total assets                               |                                          | $       | 315,121 |   |         | $       | 329,214 | 
|                                                                                                   |                                                                                                                        |                                            |                                          |         |         |   |         |        
|                                                                                                   |                                                                                                                        |                                            | LIABILITIES AND STOCKHOLDERS
    EQUITY |         |         |   |         |         |         |  | 
|Accounts payable                                                                                   |                                                                                                                        | $                                          | 17,396                                   |         |         | $ | 11,942  |        
|Accrued liabilities                                                                                |                                                                                                                        |                                            | 11,268                                   |         |         |   | 12,309  |        
|Unearned revenue                                                                                   |                                                                                                                        |                                            | 6,519                                    |         |         |   | 6,763   |        
|Accrued payroll and benefits                                                                       |                                                                                                                        |                                            | 2,814                                    |         |         |   | 5,280   |        
|Other current liabilities                                                                          |                                                                                                                        |                                            | 4,547                                    |         |         |   | 5,621   |        
|                                                                                                   |                                                                                                                        |                                            |                                          |         |         |   |         |        
|                                                                                                   |                                                                                                                        | Total current liabilities                  |                                          |         | 42,544  |   |         |         | 41,915  | 
|Benefit plan obligations                                                                           |                                                                                                                        |                                            | 9,336                                    |         |         |   | 6,665   |        
|Noncurrent accrued rent                                                                            |                                                                                                                        |                                            | 6,553                                    |         |         |   | 7,207   |        
|Noncurrent uncleared commission checks                                                             |                                                                                                                        |                                            | 5,915                                    |         |         |   | 5,576   |        
|Other noncurrent liabilities                                                                       |                                                                                                                        |                                            | 1,646                                    |         |         |   | 5,535   |        
|Convertible debt                                                                                   |                                                                                                                        |                                            | 75,000                                   |         |         |   | 75,000  |        
|Commitments and contingencies                                                                      |                                                                                                                        |                                            |                                          |         |         |   |         |        
|Stockholders equity:                                                                              |                                                                                                                        |                                            |                                          |         |         |   |         |        
|                                                                                                   | Preferred stock, $0.01 par value; 2,000,000
    shares authorized; zero shares issued and outstanding                  |                                            |                                          |        |         |   |         |        |        
|                                                                                                   | Common stock, $0.01 par value; 50,000,000 shares
    authorized; 20,777,887 and 21,105,815 shares issued, respectively |                                            |                                          | 208     |         |   |         | 211     |        
|                                                                                                   | Additional paid-in capital                                                                                             |                                            |                                          | 237,596 |         |   |         | 242,112 |        
|                                                                                                   | Unearned compensation                                                                                                  |                                            |                                          | (273    | )       |   |         | (408    | )      
|                                                                                                   | Accumulated other comprehensive loss                                                                                   |                                            |                                          | (2,145  | )       |   |         | (995    | )      
|                                                                                                   | Accumulated deficit                                                                                                    |                                            |                                          | (61,259 | )       |   |         | (53,604 | )      
|                                                                                                   |                                                                                                                        |                                            |                                          |         |         |   |         |        
|                                                                                                   |                                                                                                                        | Total stockholders equity                 |                                          |         | 174,127 |   |         |         | 187,316 | 
|                                                                                                   |                                                                                                                        |                                            |                                          |         |         |   |         |        
|                                                                                                   |                                                                                                                        | Total liabilities and stockholders equity |                                          | $       | 315,121 |   |         | $       | 329,214 | 
|                                                                                                   |                                                                                                                        |                                            |                                          |         |         |   |         |        

See accompanying notes to consolidated financial
statements.

37



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS AND
COMPREHENSIVE INCOME (LOSS)

Years Ended December 31, 2005, 2004 and
2003


(In thousands, except for share
amounts)


|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |         |         | 
|------------------------------------------------------------------------------------------ | -------------------------------------------------------------------------------------------------- | ----------------------- | ------- | ------- | ------- | ---- | ------ | ------- | ------- | - | ------ | ------- | ------- | 
|                                                                                           |                                                                                                    | 2005                    |         | 2004    |         | 2003
|                                                                                           |                                                                                                    |                         |         |         |         |     
|Revenues:                                                                                  |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|                                                                                           | Service revenues                                                                                   |                         | $       | 158,127 |         |      | $      | 170,159 |         |   | $      | 154,745 |        
|                                                                                           | Customer reimbursements                                                                            |                         |         | 17,355  |         |      |        | 15,253  |         |   |        | 11,485  |        
|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|                                                                                           |                                                                                                    | Total revenues          |         |         | 175,482 |      |        |         | 185,412 |   |        |         | 166,230 | 
|Costs of services (exclusive of depreciation and
    amortization shown separately below): |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|                                                                                           | Cost of services                                                                                   |                         |         | 81,385  |         |      |        | 85,968  |         |   |        | 80,066  |        
|                                                                                           | Customer reimbursements                                                                            |                         |         | 17,355  |         |      |        | 15,253  |         |   |        | 11,485  |        
|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|                                                                                           |                                                                                                    | Total costs of services |         |         | 98,740  |      |        |         | 101,221 |   |        |         | 91,551  | 
|Research and development                                                                   |                                                                                                    |                         | 3,391   |         |         |      | 3,676  |         |         |   | 4,547  |        
|General and administrative expenses                                                        |                                                                                                    |                         | 23,688  |         |         |      | 23,878 |         |         |   | 23,348 |        
|Marketing and promotion expenses                                                           |                                                                                                    |                         | 21,121  |         |         |      | 19,618 |         |         |   | 16,340 |        
|Depreciation and amortization                                                              |                                                                                                    |                         | 18,963  |         |         |      | 17,516 |         |         |   | 23,571 |        
|Restructure costs                                                                          |                                                                                                    |                         |        |         |         |      |       |         |         |   | 5,949  |        
|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|Operating income                                                                           |                                                                                                    |                         | 9,579   |         |         |      | 19,503 |         |         |   | 924    |        
|Other income (expense):                                                                    |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|                                                                                           | Interest income                                                                                    |                         |         | 1,557   |         |      |        | 1,113   |         |   |        | 1,423   |        
|                                                                                           | Interest expense                                                                                   |                         |         | (2,851  | )       |      |        | (2,975  | )       |   |        | (1,552  | )      
|                                                                                           | Gain on sale of investment in Travelweb, LLC                                                       |                         |         |        |         |      |        | 1,961   |         |   |        |        |        
|                                                                                           | Other                                                                                              |                         |         | 130     |         |      |        | 814     |         |   |        | 363     |        
|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|Income from continuing operations before income
    taxes                                  |                                                                                                    |                         | 8,415   |         |         |      | 20,416 |         |         |   | 1,158  |        
|Income tax expense                                                                         |                                                                                                    |                         | (3,186  | )       |         |      | (7,956 | )       |         |   | (622   | )      
|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|Income from continuing operations                                                          |                                                                                                    |                         | 5,229   |         |         |      | 12,460 |         |         |   | 536    |        
|Discontinued operations, net of tax                                                        |                                                                                                    |                         | (12,884 | )       |         |      | (4,475 | )       |         |   | (2,368 | )      
|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|Net income (loss)                                                                          |                                                                                                    | $                       | (7,655  | )       |         | $    | 7,985  |         |         | $ | (1,832 | )      
|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|Other comprehensive income (loss):                                                         |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|                                                                                           | Change in unrealized gain (loss) on
    investments, net of tax of $42, $(6), and $-, respectively |                         |         | 63      |         |      |        | (9      | )       |   |        |        |        
|                                                                                           | Minimum pension liability adjustment, net of tax
    of $762, $82, and ($357), respectively        |                         |         | (1,213  | )       |      |        | (152    | )       |   |        | 871     |        
|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|Comprehensive income (loss)                                                                |                                                                                                    | $                       | (8,805  | )       |         | $    | 7,824  |         |         | $ | (961   | )      
|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|Basic income (loss) per common share:                                                      |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|                                                                                           | Continuing operations                                                                              |                         | $       | 0.25    |         |      | $      | 0.54    |         |   | $      | 0.02    |        
|                                                                                           | Discontinued operations                                                                            |                         | $       | (0.62   | )       |      | $      | (0.19   | )       |   | $      | (0.09   | )      
|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|Net income (loss)                                                                          |                                                                                                    | $                       | (0.37   | )       |         | $    | 0.35   |         |         | $ | (0.07  | )      
|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|Diluted income (loss) per common share:                                                    |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|                                                                                           | Continuing operations                                                                              |                         | $       | 0.25    |         |      | $      | 0.53    |         |   | $      | 0.02    |        
|                                                                                           | Discontinued operations                                                                            |                         | $       | (0.62   | )       |      | $      | (0.17   | )       |   | $      | (0.09   | )      
|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|Net income (loss)                                                                          |                                                                                                    | $                       | (0.37   | )       |         | $    | 0.36   |         |         | $ | (0.07  | )      
|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|Weighted average shares outstanding:                                                       |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|                                                                                           | Basic                                                                                              |                         |         | 20,749  |         |      |        | 22,903  |         |   |        | 24,864  |        
|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        
|                                                                                           | Diluted                                                                                            |                         |         | 20,952  |         |      |        | 26,941  |         |   |        | 25,386  |        
|                                                                                           |                                                                                                    |                         |         |         |         |      |        |         |         |   |        |        

See accompanying notes to consolidated financial
statements.

38



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN
STOCKHOLDERS EQUITY

Years Ended December 31, 2005, 2004 and
2003


(In thousands)


|                             |                                                               |              |        |            |   |         |     |               |   |        |         |             |   |       |      |      |   |   |        |        |   |   |         |        |   |   |         |         |  
|---------------------------- | ------------------------------------------------------------- | ------------ | ------ | ---------- | - | ------- | --- | ------------- | - | ------ | ------- | ----------- | - | ----- | ---- | ---- | - | - | ------ | ------ | - | - | ------- | ------ | - | - | ------- | ------- | -
|                             |                                                               |              |        |            |   |         |     |               |   |        |         |            
|                             |                                                               | Common Stock |        |            |   |         |     | Other         |   |        |         |            
|                             |                                                               |              |        | Additional |   |         |     | Comprehensive |   |        |         |            
|                             |                                                               | Number of    |        |            |   | Paid-In |     | Unearned      |   | Income |         | Accumulated |   |      
|                             |                                                               | Shares       |        | Amount     |   | Capital |     | Compensation  |   | (Loss) |         | Deficit     |   | Total
|                             |                                                               |              |        |            |   |         |     |               |   |        |         |             |   |      
|Balance at December 31, 2002 |                                                               |              | 24,747 |            |   | $       | 247 |               |   | $      | 287,676 |             |   | $     | (571 | )    |   | $ | (1,705 | )      |   | $ | (59,757 | )      |   | $ | 225,890 |        
|                             | Windfall tax benefit of stock-based compensation              |              |        |           |   |         |     |              |   |        |         | 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 |        
|                             | Windfall tax benefit of stock-based compensation              |              |        |           |   |         |     |              |   |        |         | 1,011       |   |       |      |     |   |   |        |       |   |   |         |       |   |   |         | 1,011   |  
|                             | Issuance of restricted stock                                  |              |        |           |   |         |     |              |   |        |         | 477         |   |       |      | (477 | ) |   |        |       |   |   |         |       |   |   |         |        |  
|                             | Stock-based compensation expense                              |              |        |           |   |         |     |              |   |        |         | 121         |   |       |      | 69   |   |   |        |       |   |   |         |       |   |   |         | 190     |  
|                             | Exercise of stock options                                     |              |        | 622        |   |         |     | 6             |   |        |         | 4,827       |   |       |      |     |   |   |        |       |   |   |         |       |   |   |         | 4,833   |  
|                             | Issuance for stock purchase plan                              |              |        | 53         |   |         |     | 1             |   |        |         | 471         |   |       |      |     |   |   |        |       |   |   |         |       |   |   |         | 472     |  
|                             | Repurchase of common stock                                    |              |        | (4,660     | ) |         |     | (47           | ) |        |         | (55,623     | ) |       |      |     |   |   |        |       |   |   |         |       |   |   |         | (55,670 | )
|                             | Change in unrealized gain (loss) on
    marketable securities |              |        |           |   |         |     |              |   |        |         |            |   |       |      |     |   |   |        | (9     | ) |   |         |       |   |   |         | (9      | )
|                             | Minimum pension liability adjustment                          |              |        |           |   |         |     |              |   |        |         |            |   |       |      |     |   |   |        | (152   | ) |   |         |       |   |   |         | (152    | )
|                             | Net income                                                    |              |        |           |   |         |     |              |   |        |         |            |   |       |      |     |   |   |        |       |   |   |         | 7,985  |   |   |         | 7,985   |  
|                             |                                                               |              |        |            |   |         |     |               |   |        |         |             |   |       |      |      |   |   |        |        |   |   |         |        |   |   |         |        
|Balance at December 31, 2004 |                                                               |              | 21,106 |            |   |         | 211 |               |   |        | 242,112 |             |   |       | (408 | )    |   |   | (995   | )      |   |   | (53,604 | )      |   |   | 187,316 |        
|                             | Windfall tax benefit of stock-based compensation              |              |        |           |   |         |     |              |   |        |         | 212         |   |       |      |     |   |   |        |       |   |   |         |       |   |   |         | 212     |  
|                             | Issuance (forfeiture) of restricted stock                     |              |        |           |   |         |     |              |   |        |         | (33         | ) |       |      | 33   |   |   |        |       |   |   |         |       |   |   |         |        |  
|                             | Stock-based compensation expense                              |              |        |           |   |         |     |              |   |        |         |            |   |       |      | 102  |   |   |        |       |   |   |         |       |   |   |         | 102     |  
|                             | Exercise of stock options                                     |              |        | 142        |   |         |     | 1             |   |        |         | 1,061       |   |       |      |     |   |   |        |       |   |   |         |       |   |   |         | 1,062   |  
|                             | Issuance for stock purchase plan                              |              |        | 48         |   |         |     | 1             |   |        |         | 484         |   |       |      |     |   |   |        |       |   |   |         |       |   |   |         | 485     |  
|                             | Repurchase of common stock                                    |              |        | (518       | ) |         |     | (5            | ) |        |         | (6,240      | ) |       |      |     |   |   |        |       |   |   |         |       |   |   |         | (6,245  | )
|                             | Change in unrealized gain (loss) on
    marketable securities |              |        |           |   |         |     |              |   |        |         |            |   |       |      |     |   |   |        | 63     |   |   |         |       |   |   |         | 63      |  
|                             | Minimum pension liability adjustment                          |              |        |           |   |         |     |              |   |        |         |            |   |       |      |     |   |   |        | (1,213 | ) |   |         |       |   |   |         | (1,213  | )
|                             | Net loss                                                      |              |        |           |   |         |     |              |   |        |         |            |   |       |      |     |   |   |        |       |   |   |         | (7,655 | ) |   |         | (7,655  | )
|                             |                                                               |              |        |            |   |         |     |               |   |        |         |             |   |       |      |      |   |   |        |        |   |   |         |        |   |   |         |        
|Balance at December 31, 2005 |                                                               |              | 20,778 |            |   | $       | 208 |               |   | $      | 237,596 |             |   | $     | (273 | )    |   | $ | (2,145 | )      |   | $ | (61,259 | )      |   | $ | 174,127 |        
|                             |                                                               |              |        |            |   |         |     |               |   |        |         |             |   |       |      |      |   |   |        |        |   |   |         |        |   |   |         |        

See accompanying notes to consolidated financial
statements.

39



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.

CONSOLIDATED STATEMENTS OF CASH
FLOWS

Years Ended December 31, 2005, 2004 and
2003


(In thousands)


|                                                                         |                                                                                              |                                                                                 |                                           |         |         |        |         |         |         |        |        |          |         |        |  
|------------------------------------------------------------------------ | -------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------- | ----------------------------------------- | ------- | ------- | ------ | ------- | ------- | ------- | ------ | ------ | -------- | ------- | ------ | -
|                                                                         |                                                                                              | 2005                                                                            |                                           | 2004    |         | 2003  
|                                                                         |                                                                                              |                                                                                 |                                           |         |         |       
|Cash flows from operating activities:                                    |                                                                                              |                                                                                 |                                           |         |         |        |         |         |         |        |        |         
|                                                                         | Net income (loss)                                                                            |                                                                                 | $                                         | (7,655  | )       |        | $       | 7,985   |         |        | $      | (1,832   | )      
|                                                                         | Adjustments to reconcile net income
    (loss) to net cash provided by operating activities: |                                                                                 |                                           |         |         |        |         |         |         |        |        |          |        
|                                                                         |                                                                                              | Depreciation and amortization                                                   |                                           |         | 21,480  |        |         |         | 22,362  |        |        |          | 28,029  |       
|                                                                         |                                                                                              | Non-cash asset impairment of discontinued
    operations                        |                                           |         | 16,630  |        |         |         |        |        |        |          |        |       
|                                                                         |                                                                                              | Gain on sale of discontinued property management
    systems and Travelweb, LLC |                                           |         | (371    | )      |         |         | (1,961  | )      |        |          |        |       
|                                                                         |                                                                                              | Bad debt expense                                                                |                                           |         | 700     |        |         |         | 787     |        |        |          |        |       
|                                                                         |                                                                                              | Deferred income taxes                                                           |                                           |         | (6,197  | )      |         |         | 3,572   |        |        |          | (1,351  | )     
|                                                                         |                                                                                              | Other                                                                           |                                           |         | 456     |        |         |         | 791     |        |        |          | 1,660   |       
|                                                                         |                                                                                              | Changes in assets and liabilities, net of effects
    of acquisitions:          |                                           |         |         |        |         |         |         |        |        |          |         |       
|                                                                         |                                                                                              |                                                                                 | Accounts receivable                       |         |         | 4,064  |         |         |         | (7,040 | )      |          |         | 6,356  |  
|                                                                         |                                                                                              |                                                                                 | Other current and noncurrent assets       |         |         | (36    | )       |         |         | (1,014 | )      |          |         | (6,007 | )
|                                                                         |                                                                                              |                                                                                 | Accounts payable and accrued liabilities  |         |         | 2,963  |         |         |         | 4,503  |        |          |         | (4,561 | )
|                                                                         |                                                                                              |                                                                                 | Unearned revenue                          |         |         | (244   | )       |         |         | (450   | )      |          |         | (599   | )
|                                                                         |                                                                                              |                                                                                 | Other current and noncurrent liabilities  |         |         | (1,142 | )       |         |         | (176   | )      |          |         | 2,427  |  
|                                                                         |                                                                                              |                                                                                 | Landlord paid tenant improvements         |         |         |       |         |         |         | 799    |        |          |         | 524    |  
|                                                                         |                                                                                              |                                                                                 |                                           |         |         |        |         |         |         |        |        |         
|                                                                         |                                                                                              |                                                                                 | Net cash provided by operating activities |         |         | 30,648 |         |         |         | 30,158 |        |          |         | 24,646 |  
|Cash flows from investing activities:                                    |                                                                                              |                                                                                 |                                           |         |         |        |         |         |         |        |        |         
|                                                                         | Purchase of marketable securities, including
    auction rate securities                     |                                                                                 |                                           | (52,652 | )       |        |         | (34,612 | )       |        |        | (140,837 | )      
|                                                                         | Proceeds from marketable securities, including
    auction rate securities                   |                                                                                 |                                           | 59,759  |         |        |         | 50,439  |         |        |        | 120,631  |        
|                                                                         | Purchase of property, equipment and software                                                 |                                                                                 |                                           | (19,892 | )       |        |         | (22,610 | )       |        |        | (19,406  | )      
|                                                                         | Collections of note receivable                                                               |                                                                                 |                                           | 1,013   |         |        |         | 945     |         |        |        | 1,881    |        
|                                                                         | Purchase of Unirez, net of cash acquired                                                     |                                                                                 |                                           |        |         |        |         | (1,310  | )       |        |        | (34,115  | )      
|                                                                         | Proceeds from sale of discontinued property
    management systems and Travelweb, LLC        |                                                                                 |                                           | 605     |         |        |         | 4,167   |         |        |        |         |        
|                                                                         | Landlord paid tenant improvements                                                            |                                                                                 |                                           |        |         |        |         | (799    | )       |        |        | (524     | )      
|                                                                         | Other                                                                                        |                                                                                 |                                           |        |         |        |         | 40      |         |        |        | 140      |        
|                                                                         |                                                                                              |                                                                                 |                                           |         |         |        |         |         |         |        |        |         
|                                                                         |                                                                                              | Net cash used in investing activities                                           |                                           |         | (11,167 | )      |         |         | (3,740  | )      |        |          | (72,230 | )     
|Cash flows from financing activities:                                    |                                                                                              |                                                                                 |                                           |         |         |        |         |         |         |        |        |         
|                                                                         | Proceeds from issuance of common stock                                                       |                                                                                 |                                           | 1,547   |         |        |         | 5,305   |         |        |        | 2,469    |        
|                                                                         | Repurchase of common stock                                                                   |                                                                                 |                                           | (6,245  | )       |        |         | (55,670 | )       |        |        |         |        
|                                                                         | Proceeds from convertible debt issuance                                                      |                                                                                 |                                           |        |         |        |         |        |         |        |        | 75,000   |        
|                                                                         | Debt issuance costs                                                                          |                                                                                 |                                           |        |         |        |         |        |         |        |        | (2,579   | )      
|                                                                         | Other                                                                                        |                                                                                 |                                           | (67     | )       |        |         | (493    | )       |        |        | (210     | )      
|                                                                         |                                                                                              |                                                                                 |                                           |         |         |        |         |         |         |        |        |         
|                                                                         |                                                                                              | Net cash provided by (used in) financing
    activities                         |                                           |         | (4,765  | )      |         |         | (50,858 | )      |        |          | 74,680  |       
|Net increase (decrease) in cash and cash
    equivalents                 |                                                                                              |                                                                                 | 14,716                                    |         |         |        | (24,440 | )       |         |        | 27,096 |         
|Cash and cash equivalents, beginning of period                           |                                                                                              |                                                                                 | 17,599                                    |         |         |        | 42,039  |         |         |        | 14,943 |         
|                                                                         |                                                                                              |                                                                                 |                                           |         |         |        |         |         |         |        |        |         
|Cash and cash equivalents, end of period                                 |                                                                                              | $                                                                               | 32,315                                    |         |         | $      | 17,599  |         |         | $      | 42,039 |         
|                                                                         |                                                                                              |                                                                                 |                                           |         |         |        |         |         |         |        |        |         
|Supplemental disclosure of cash flow information:                        |                                                                                              |                                                                                 |                                           |         |         |        |         |         |         |        |        |         
|                                                                         | Income taxes paid                                                                            |                                                                                 | $                                         | 460     |         |        | $       | 859     |         |        | $      | 2,539    |        
|                                                                         | Interest paid                                                                                |                                                                                 |                                           | 2,941   |         |        |         | 2,912   |         |        |        | 82       |        
|Supplemental schedule of noncash investing and
    financing activities: |                                                                                              |                                                                                 |                                           |         |         |        |         |         |         |        |        |         
|                                                                         | Noncash acquisition price related to Unirez and
    TDS                                      |                                                                                 | $                                         |        |         |        | $       | 277     |         |        | $      | 3,299    |        
|                                                                         | Noncash sale price related to sale of
    discontinued property management systems           |                                                                                 |                                           | 722     |         |        |         |        |         |        |        |         |        
|                                                                         | Acquisition of property and equipment                                                        |                                                                                 |                                           | 196     |         |        |         | 2,449   |         |        |        |         |        

See accompanying notes to consolidated financial
statements.

40



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.

NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS



|   |                                                                           
|-- | --------------------------------------------------------------------------
|1. | Description of Business and Summary of
    Significant Accounting Policies



| |                                       
| | --------------------------------------
| | Overview and Basis of
    Presentation

Pegasus Solutions, Inc. is a global leader in
providing technology and services to hotels and travel
distributors. Pegasus was formed in 1989 by 16 of the
worlds leading hotel and travel-related companies to be
the worlds premier service provider of a streamlined and
automated hotel reservation process. Pegasus services
include central reservation systems, electronic distribution
services, commission processing and payment services, and
marketing representation services, including the consumer Web
site hotelbook.com. The consolidated financial statements
include the accounts of Pegasus Solutions, Inc. and its wholly
owned subsidiaries (Pegasus or the
Company). All significant intercompany balances have
been eliminated in consolidation. The Company operates under one
reportable segment. Pegasus common stock is traded on the
Nasdaq National Market under the symbol PEGS. See
Note 2  Merger Agreement for a discussion of the
Companys pending merger.



| |                 
| | ----------------
| | Use of 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 judgments and estimates: accounts
and notes receivable, impairment of long lived assets, including
goodwill, 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
(SFAS 115).

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.



| |                        
| | -----------------------
| | Auction Rate Securities

At December 31, 2005 and 2004, the Company
held $5.7 million of auction rate securities included as a
separately stated current asset. Additionally, at
December 31, 2005 and 2004, the Company held
$1.2 million and $1.7 million, respectively, of
auction rate securities related to the Companys standby
letters of credit, which collateralize the leases for the Dallas
and Scottsdale offices that are classified as other noncurrent
assets. The Companys investments in these securities are
classified as available-for-sale securities under SFAS 115.
The securities are recorded at cost, which approximates fair
market value due to their variable interest rates, which
typically reset every 7 to 35 days, and, despite the
long-term nature of their stated contractual maturities, the
Company has the intent and ability to quickly liquidate these
securities. As a result,

41



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

the Company had no cumulative gross unrealized
holding gains (losses) or gross realized gains (losses) from
these investments. All income generated from these investments
were recorded as interest income.



| |                           
| | --------------------------
| | Capitalized software costs

Software costs are accounted for in accordance
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. Amortization of capitalized software costs in 2005,
2004 and 2003 totaled $14.3 million, $12.8 million,
and $14.4 million, respectively. At December 31, 2005
and 2004, unamortized capitalized software was
$40.9 million and $59.3 million, respectively, which
included software under development of $12.9 million and
$29.7 million, respectively. Interest of $587,000,
$511,000, and $67,000 was capitalized in 2005, 2004 and 2003,
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.



| |                                         
| | ----------------------------------------
| | Goodwill and other intangible
    assets

As of December 31, 2005 and 2004, goodwill
totaled $163.2 million and $163.6 million,
respectively. Goodwill and identifiable intangible assets are
related to the acquisitions of REZ, Inc. (REZ) in
2000, Global Enterprise Technology Solutions, LLC
(GETS) in 2001, and Unirez, Inc.
(Unirez) in 2003.



| |           
| | ----------
| | Impairment

The Company evaluates its capitalized software
costs, property and equipment, and identifiable intangible
assets 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 and is recorded in the period the impairment is
determined. The Company believes that no impairment of
capitalized software costs, property and equipment, or
identifiable intangible assets existed at December 31, 2005
or 2004. See Note 3 for more information regarding
impairment charges related to discontinued operations in 2005.

The carrying value of goodwill is evaluated at
least annually. The Company believes that no impairment of
goodwill existed at December 31, 2005 or 2004. See
Note 6 for further information.



| |                  
| | -----------------
| | Other investments

Pegasus and six other companies 
Hilton Hotels, Hyatt Corporation, Marriott International, Six
Continents Hotels, Starwood Hotels and Priceline.com
(Priceline)  were equal partners in
Travelweb, LLC, (Travelweb) formerly known as Hotel
Distribution System, LLC. This venture was formed in 2002 to
distribute discounted hotel rooms over the Internet through
multiple Internet sites using a merchant business model.

42



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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 was
equal partners with six other companies and did not exercise
significant influence, the investment in Travelweb was accounted
for under the cost method. The investment was included in other
noncurrent assets on the Consolidated Balance Sheet at
December 31, 2003.

On May 3, 2004 (the Closing
Date), Pegasus and four other parties (collectively the
Sellers) in Travelweb sold their interests to an
affiliate of Priceline. Among other provisions, the purchase
agreement provided that Pegasus and each other Seller
(1) assign to Priceline each of their 14.286% interests on
the Closing Date, and (2) receive, on the Closing Date,
approximately $4.2 million in cash. Pegasus
investment in Travelweb prior to sale was $2.2 million and
was included in other noncurrent assets. Pegasus recorded a gain
of approximately $2.0 million on the sale of its investment
in Travelweb during the second quarter 2004.



| |                                      
| | -------------------------------------
| | Stock-based employee
    compensation

The Company accounts for stock-based compensation
utilizing the intrinsic value method in accordance with the
provisions of Accounting Principles Board Opinion No. 25
(APB 25), Accounting for Stock Issued to
Employees and related Interpretations. Accordingly, no
compensation expense is recognized for stock option awards
because the exercise prices of employee stock options equal or
exceed the market prices of the underlying stock on the dates of
grant. As discussed in Note 12, the Company maintains stock
incentive and employee stock purchase plans. Total compensation
expense for these plans was $102,000, $190,000, and $571,000 for
2005, 2004, and 2003, respectively.

The following table represents the effect on net
income (loss) and net income (loss) per share if the Company had
applied the fair value based method and recognition provisions
of Statement of Financial Accounting Standards No. 123,
Accounting for Stock-Based Compensation, to
stock-based employee compensation (in thousands, except per
share amounts):

|                                                                                                                                                     |         |      |         |       |   |      |        |      |  |   |        |       |  
|---------------------------------------------------------------------------------------------------------------------------------------------------- | ------- | ---- | ------- | ----- | - | ---- | ------ | ---- |  | - | ------ | ----- | -
|                                                                                                                                                     |         | 2005 |         | 2004  |   | 2003
|                                                                                                                                                     |         |      |         |       |   |     
|Net income (loss), as reported                                                                                                                       |         | $    | (7,655  | )     |   | $    | 7,985  |      |  | $ | (1,832 | )    
|Add: Stock-based employee compensation expense
    included in reported income (loss), net of related tax effects                                    |         |      | 63      |       |   |      | 117    |      |  |   | 347    |      
|Deduct: Total stock-based employee compensation
    expense determined under fair value based methods for all
    awards, net of related tax effects |         |      | (3,075  | )     |   |      | (4,908 | )    |  |   | (6,288 | )    
|                                                                                                                                                     |         |      |         |       |   |      |        |      |  |   |        |      
|Pro forma net income (loss)                                                                                                                          |         | $    | (10,667 | )     |   | $    | 3,194  |      |  | $ | (7,773 | )    
|                                                                                                                                                     |         |      |         |       |   |      |        |      |  |   |        |      
|Net income (loss) per share, as reported:                                                                                                            |         |      |         |       |   |      |        |      |  |   |        |      
|                                                                                                                                                     | Basic   |      | $       | (0.37 | ) |      | $      | 0.35 |  |   | $      | (0.07 | )
|                                                                                                                                                     | Diluted |      | $       | (0.37 | ) |      | $      | 0.36 |  |   | $      | (0.07 | )
|Net income (loss) per share, pro forma:                                                                                                              |         |      |         |       |   |      |        |      |  |   |        |      
|                                                                                                                                                     | Basic   |      | $       | (0.51 | ) |      | $      | 0.14 |  |   | $      | (0.31 | )
|                                                                                                                                                     | Diluted |      | $       | (0.51 | ) |      | $      | 0.14 |  |   | $      | (0.31 | )

The pro forma disclosures provided may not be
representative of the effects on reported net income (loss) for
future years due to future grants and the vesting requirements
of the Companys stock incentive awards. For purposes of
pro forma disclosures, the estimated fair value of stock-based
compensation awards is amortized over the vesting period.

43



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The weighted average fair value for options with
exercise prices equal to the market price of stock at the grant
date was $4.84, $5.45, and $6.46 in 2005, 2004 and 2003,
respectively. The fair value of each option grant is estimated
on the date of grant using the Black-Scholes option-pricing
model with the following weighted-average assumptions:

|                         |  |      |            |      |  |      |            |   |  |  |            |  
|------------------------ |  | ---- | ---------- | ---- |  | ---- | ---------- | - |  |  | ---------- | -
|                         |  | 2005 |            | 2004 |  | 2003
|                         |  |      |            |      |  |     
|Dividend yield           |  |      |           |      |  |      |           |   |  |  |           |  
|Expected volatility      |  |      | 39.1- 54.5 | %    |  |      | 53.0- 59.3 | % |  |  | 59.3- 73.2 | %
|Risk-free rate of return |  |      | 3.8-4.4    | %    |  |      | 2.7-3.5    | % |  |  | 2.1-2.9    | %
|Expected life            |  |      | 4.0  years |      |  |      | 4.0  years |   |  |  | 4.0  years |  

The pro forma disclosures for 2005, 2004 and 2003
include approximately $102,000, $143,000 and $104,000,
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:

|                         |  |      |          |      |  |      |          |   |  |  |          |  
|------------------------ |  | ---- | -------- | ---- |  | ---- | -------- | - |  |  | -------- | -
|                         |  | 2005 |          | 2004 |  | 2003
|                         |  |      |          |      |  |     
|Dividend yield           |  |      |         |      |  |      |         |   |  |  |         |  
|Expected volatility      |  |      | 25.60    | %    |  |      | 37.50    | % |  |  | 45.00    | %
|Risk-free rate of return |  |      | 2.5-3.2  | %    |  |      | 1.30     | % |  |  | 1.10     | %
|Expected life            |  |      | 0.5 year |      |  |      | 0.5 year |   |  |  | 0.5 year |  

See Note 12 for further discussion of the
Companys stock-based employee compensation.



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

Pegasus service revenues are predominantly
transaction-based and include reservation and commission
processing fees charged to hotels and travel distributors,
including travel agencies. Other revenues that are not based on
transactions include membership, maintenance, marketing services
and implementation fees. The Company accounts for its revenues
under Staff Accounting Bulletin No. 104, Revenue
Recognition.

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
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. 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 commission percentages paid by hotels to travel
agencies. Pegasus recognizes revenues from its commission
processing service when earned.

44



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Distribution
services.Pegasus derives revenues
from its global distribution system (GDS)
distribution service by charging hotel customers a fee based on
the number of reservations made, less the number cancelled
(net reservations). As a hotels cumulative
volume of net reservations increases during the course of the
calendar year, its fee per transaction decreases after
predetermined transaction volume hurdles have been met. As a
result, for higher volume customers, unit transaction fees are
higher at the beginning of the year, when cumulative
transactions are lower. The Company recognizes revenues based on
the fee per transaction that a customer is expected to pay
during the entire year. The Companys balance sheets
reflect unearned revenue for the difference between the fee per
transaction that Pegasus actually bills a customer during the
period and the average fee per transaction that a customer is
expected to pay for the entire year. The unearned revenue
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. 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, as they
are not considered a separate unit of accounting. The Company
also charges certain GDSs a fee based on either the number of
net reservations or the number of hotel chains connected to the
GDS through the Pegasus electronic distribution technology to
compensate for the management and consolidation of multiple
interfaces.

Pegasus derives its Internet distribution
revenues by charging participating hotels transaction fees. For
reservations that originate on Internet 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
implementation 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 property management system (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. These operations are now classified as discontinued
operations (see Note 3).

Customer
Reimbursements.Revenues applicable to
customer reimbursements are primarily related to GDS fees that
Pegasus pays on behalf of and subsequently bill our customers.
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.



| |             
| | ------------
| | Income taxes

Income taxes are accounted for under the asset
and liability method. The remaining portion of income tax
(benefit) that remains after continuing operations is allocated
to discontinued operations for all years presented. 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.

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

45



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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
2005, 2004 and 2003 was approximately $3.2 million,
$2.4 million and $1.9 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 higher or lower expenses than it otherwise might
have earned or spent if currency rates had remained stable.



| |                      
| | ---------------------
| | Financial instruments

The Company uses derivative financial instrument
contracts to manage foreign exchange risks. The Company does not
currently utilize hedge accounting with regard to these
derivatives. Amounts receivable or payable under derivative
financial instrument contracts are reported net 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 statements of operations as
other income (expense).

The carrying amounts of the Companys
financial instruments, other than convertible debt, reflected in
the consolidated balance sheets at December 31, 2005 and
2004 approximate their respective fair values. The estimated
fair value of the Companys convertible debt at
December 31, 2005 and December 31, 2004, approximated
$73 million and $71 million, respectively, based on a
third party quote, 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
receivables.The Companys
customers primarily include well-established hotel chains and
travel agencies. The Companys representation services
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. The Companys accounts receivable are monitored
by management for collectibility, considering the payment
history and known financial condition of the debtors. Accounts
receivable are recorded net of an allowance for doubtful
accounts that represents an estimate of amounts considered
uncollectible. Expense for such uncollectible amounts related to
continuing operations, which is included in general and
administrative expenses, totaled approximately $566,000,
$717,000 and zero in 2005, 2004 and 2003, respectively.

46



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

Expense for uncollectible amounts related to the
Companys discontinued operations totaled approximately
$134,000, $70,000 and zero in 2005, 2004 and 2003, respectively.

Notes receivable.Pegasus has notes receivable related to the sale of business
units to Preferred Hotel Group in 2000, which resulted in an
agreement for a $6.0 million promissory note and a
$2.8 million promissory note. Both promissory notes require
monthly payments for a period of eight years commencing
July 1, 2002 and bear interest at 7 percent. Pegasus
also has notes receivable related to the sale of the Guestview
and NovaPlus PMS systems to Multi-Systems, Inc. in 2005, which
resulted in an agreement for a $722,000 promissory note, payable
in three annual installments of $270,000, including interest at
6 percent. The Companys notes receivable are
monitored by management for collectibility, considering the
payment history and known financial condition of the debtor. If
the financial condition of the debtor was to deteriorate,
resulting in an impairment of their ability to make payments,
Pegasus may incur an expense to increase its allowance for
doubtful accounts and may receive less cash than expected.

Foreign currency
contracts.The counterparties to the
Companys foreign exchange contracts are substantial and
creditworthy multinational commercial banks or other financial
institutions that are recognized market makers. Neither the
risks of counterparty nonperformance nor the economic
consequences of counterparty nonperformance associated with
these contracts are considered by the Company to be material.

The Company is exposed to certain market risks,
including the effects of movements in foreign currency exchange
rates. 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 income (loss) per share

The following table sets forth the computation of
basic and diluted income (loss) per common share (in thousands,
except per share data):

|                                    |                                                             |     |         |      |         |       |   |      |        |        |   |   |        |       |  
|----------------------------------- | ----------------------------------------------------------- | --- | ------- | ---- | ------- | ----- | - | ---- | ------ | ------ | - | - | ------ | ----- | -
|                                    |                                                             |     |         | 2005 |         | 2004  |   | 2003
|                                    |                                                             |     |         |      |         |       |   |     
|Income from continuing operations   |                                                             | (a) |         | $    | 5,229   |       |   | $    | 12,460 |        |   | $ | 536    |      
|Discontinued operations, net of tax |                                                             | (b) |         |      | (12,884 | )     |   |      | (4,475 | )      |   |   | (2,368 | )    
|                                    |                                                             |     |         |      |         |       |   |      |        |        |   |   |        |      
|Net income (loss)                   |                                                             | (c) |         | $    | (7,655  | )     |   | $    | 7,985  |        |   | $ | (1,832 | )    
|                                    |                                                             |     |         |      |         |       |   |      |        |        |   |   |        |      
|Income from continuing operations   |                                                             | (a) |         | $    | 5,229   |       |   | $    | 12,460 |        |   | $ | 536    |      
|                                    | Adjustment for interest on convertible debt, net
    of tax |     |         |      |         |      |   |      |        | 1,789  |   |   |        |      |  
|                                    |                                                             |     |         |      |         |       |   |      |        |        |   |   |        |      
|                                    | Income from continuing operations, as adjusted              |     | (d)     |      | $       | 5,229 |   |      | $      | 14,249 |   |   | $      | 536   |  
|                                    |                                                             |     |         |      |         |       |   |      |        |        |   |   |        |      
|Net income (loss)                   |                                                             | (c) |         | $    | (7,655  | )     |   | $    | 7,985  |        |   | $ | (1,832 | )    
|                                    | Adjustment for interest on convertible debt, net
    of tax |     |         |      |         |      |   |      |        | 1,789  |   |   |        |      |  
|                                    |                                                             |     |         |      |         |       |   |      |        |        |   |   |        |      
|Net income (loss), as adjusted      |                                                             | (e) |         | $    | (7,655  | )     |   | $    | 9,774  |        |   | $ | (1,832 | )    
|                                    |                                                             |     |         |      |         |       |   |      |        |        |   |   |        |      
|Basic income (loss) per share:      |                                                             |     |         |      |         |       |   |      |        |        |   |   |        |      
|                                    | Continuing operations                                       |     | (a)/(f) |      | $       | 0.25  |   |      | $      | 0.54   |   |   | $      | 0.02  |  
|                                    | Discontinued operations                                     |     | (b)/(f) |      | $       | (0.62 | ) |      | $      | (0.19  | ) |   | $      | (0.09 | )
|                                    |                                                             |     |         |      |         |       |   |      |        |        |   |   |        |      
|                                    | Net income (loss)                                           |     | (c)/(f) |      | $       | (0.37 | ) |      | $      | 0.35   |   |   | $      | (0.07 | )
|                                    |                                                             |     |         |      |         |       |   |      |        |        |   |   |        |      

47



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                             |                         |     |         |      |        |       |   |      |        |       |   |  |        |       |  
|-------------------------------------------- | ----------------------- | --- | ------- | ---- | ------ | ----- | - | ---- | ------ | ----- | - |  | ------ | ----- | -
|                                             |                         |     |         | 2005 |        | 2004  |   | 2003
|                                             |                         |     |         |      |        |       |   |     
|Diluted income (loss) per share:             |                         |     |         |      |        |       |   |      |        |       |   |  |        |      
|                                             | Continuing operations   |     | (d)/(g) |      | $      | 0.25  |   |      | $      | 0.53  |   |  | $      | 0.02  |  
|                                             | Discontinued operations |     | (b)/(g) |      | $      | (0.62 | ) |      | $      | (0.17 | ) |  | $      | (0.09 | )
|                                             |                         |     |         |      |        |       |   |      |        |       |   |  |        |      
|                                             | Net income (loss)       |     | (e)/(g) |      | $      | (0.37 | ) |      | $      | 0.36  |   |  | $      | (0.07 | )
|                                             |                         |     |         |      |        |       |   |      |        |       |   |  |        |      
|Basic weighted average shares Outstanding    |                         | (f) |         |      | 20,749 |       |   |      | 22,903 |       |   |  | 24,864 |      
|Dilutive effect of stock options(1)          |                         |     |         |      | 203    |       |   |      | 312    |       |   |  | 522    |      
|Dilutive effect of convertible debt(2)       |                         |     |         |      |       |       |   |      | 3,726  |       |   |  |       |      
|                                             |                         |     |         |      |        |       |   |      |        |       |   |  |        |      
|Dilutive weighted average shares outstanding |                         | (g) |         |      | 20,952 |       |   |      | 26,941 |       |   |  | 25,386 |      
|                                             |                         |     |         |      |        |       |   |      |        |       |   |  |        |      



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                           
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Weighted average shares issuable upon exercise of
    stock options that were excluded from the calculation as their
    effect would have been anti-dilutive to income from continuing
    operations were 3.4 million, 2.5 million and
    5.1 million for 2005, 2004 and 2003, respectively.                                                                                                           
|   
|(2) | Subject to certain conditions, the Companys
    convertible debt is convertible into common stock at a
    conversion price of approximately $20.13 per share, equal
    to approximately 3.7 million shares. No dilution for
    convertible debt was included in the calculation for 2005 and
    2003 as the effect would be anti-dilutive to income from
    continuing operations for these periods.



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

In December 2004, the Financial Accounting
Standards Board (FASB) issued
SFAS No. 123R, Share-Based Payment
(SFAS 123R), which replaces
SFAS No. 123, Accounting for Stock-Based
Compensation and supersedes APB Opinion No. 25,
Accounting for Stock Issued to Employees. In March
2005, the Securities and Exchange Commission (SEC) issued
Staff Accounting Bulletin No. 107, Share-Based
Payment, which provides interpretive guidance related to
SFAS 123R. SFAS 123R requires compensation costs
related to share-based payment transactions to be recognized in
financial statements. With limited exceptions, the amount of
compensation cost is measured based on the fair value of the
equity or liability instrument issued on the grant date.
SFAS 123R requires liability awards to be remeasured each
reporting period and compensation costs to be recognized over
the period that an employee provides service in exchange for the
award. The requirements of SFAS 123R are effective for the
Companys first quarter beginning January 1, 2006. The
Company intends to use the modified prospective transition
method of adoption. Although the Company continues to evaluate
SFAS 123R to determine the impact on its consolidated
financial statements, SFAS 123R is expected to have a
negative effect on consolidated net income. In 2005, the Company
did not issue stock options to a large number of employees
through a broad-based stock option grant. Since the 2005 stock
option grants were significantly lower than preceding years and
no determination has been made in regards to future year grants,
the Company is unable to fully project future SFAS 123R
stock-based compensation expense. However, stock-based
compensation expense for 2006 under SFAS 123R, without
taking into account the completion of the merger under the
Agreement and Plan of Merger dated December 19, 2005, among
Perseus Holding Corp., 406 Acquisition Corp., and the
Company, will at a minimum approximate $1.9 million, net of
tax. The accounting treatment for the Companys restricted
stock awards will not change upon adoption of SFAS 123R and
has not been significant. No determination has been made
regarding future stock-based compensation awards.

In May 2005, the FASB issued Statement of
Financial Accounting Standards No. 154, Accounting
Changes and Error Corrections  A Replacement of APB
Opinion No. 20 and FASB Statement No. 3
(SFAS 154). SFAS 154 requires
retrospective application to prior periods financial
statements of changes in accounting principle. It also requires
that the new accounting principle be applied to the balances of
assets

48



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

and liabilities as of the beginning of the
earliest period for which retrospective application is
practicable and that a corresponding adjustment be made to the
opening balance of retained earnings for that period rather than
being reported in an income statement. The statement will be
effective for accounting changes and corrections of errors made
in fiscal years beginning after December 15, 2005. The
Company does not expect the adoption of SFAS 154 to have a
material effect on the Companys consolidated financial
position or results of operations.



|   |                 
|-- | ----------------
|2. | Merger Agreement

As a result of the Companys strategic
alternative process, which was announced in April 2005, Pegasus
Solutions, Inc. has entered into an Agreement and Plan of
Merger, dated December 19, 2005 (the Merger
Agreement), with Perseus Holding Corp.
(Parent) and 406 Acquisition Corp., a direct wholly
owned subsidiary of Parent (Merger Sub). Parent and
Merger Sub are entities controlled by an investment group
consisting of entities affiliated with Prides Capital Partners,
L.L.C. and Tudor Investment Corporation.

The Merger Agreement contemplates that Merger Sub
will be merged with and into the Company, with the Company
continuing as the surviving corporation (the Surviving
Corporation) in such merger as a direct wholly owned
subsidiary of Parent (the Merger), and each
outstanding share of common stock of the Company owned by
stockholders other than those affiliated with the investment
group will be converted in the Merger into the right to receive
$9.50 per share in cash.

The Company has made various representations,
warranties and covenants in the Merger Agreement, including,
among others, not to (a) solicit proposals relating to
alternative business combination transactions or
(b) subject to certain exceptions which permit the board of
directors to comply with its fiduciary duties, enter into
discussions concerning, or provide confidential information in
connection with, alternative business combination transactions.
Subject to certain exceptions that permit the board of directors
to comply with its fiduciary duties, the Companys board of
directors has agreed to recommend that the Companys
stockholders vote in favor of and adopt and approve the Merger
and the Merger Agreement. The Merger Agreement also includes
covenants pertaining to the operation of the Companys
business between execution of the Merger Agreement and the
closing of the Merger.

Consummation of the Merger is subject to various
conditions, including, among others, the approval and adoption
of the Merger Agreement by the Companys stockholders, the
absence of certain legal impediments to consummation of the
Merger, the receipt of certain regulatory approvals and the
funding of debt to complete the Merger.

The Merger Agreement contains certain termination
rights, including in the event the Company receives a superior
proposal, and provides that, upon the termination of the Merger
Agreement under specified circumstances, the Company may be
required to pay Parent a termination fee equal to
$8.25 million. In addition, in certain circumstances where
the Merger Agreement is terminated, including in the event the
Merger Agreement is terminated and the Company is required to
pay the termination fee to Parent, the Company is required to
reimburse Parent for its fees and expenses incurred in
connection with the Merger Agreement, up to a maximum of
$1 million.

In connection with the execution of the Merger
Agreement, an affiliate of Prides Capital Partners, L.L.C.
agreed to provide a limited guarantee of the liabilities of
Parent and Merger Sub under the Merger Agreement. In addition,
John F. Davis, III, Susan K. Conner and Robert J.
Boles, Jr. have agreed with Prides Capital Partners, L.L.C.
to waive, for a period of six months following the Merger, their
rights to severance pay in the event that they terminate
employment during that period. These individuals also have
agreed to invest in the Company following completion of the
Merger.

Additionally, on December 19, 2005, the
Company and American Stock Transfer & Trust Company, as
Rights Agent, entered into an amendment (the Rights
Agreement Amendment) to the Rights Agreement,

49



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

dated as of September 28, 1998 (the
Rights Agreement). The Rights Agreement Amendment
provides that none of the execution, delivery or performance of
the Merger Agreement, the consummation of the Merger or any of
the other transactions contemplated by and pursuant to the
Merger Agreement will trigger the separation or exercise of the
stockholder rights or any adverse event under the Rights
Agreement. In particular, none of Parent, Merger Sub or any of
their affiliates shall be deemed to be an Acquiring Person (as
defined in the Rights Agreement) solely by virtue of the
execution, delivery or performance of the Merger Agreement or
the consummation of the Merger or any of the other transactions
contemplated by and pursuant to the Merger Agreement. The Rights
Agreement Amendment also provides that the Rights Agreement will
terminate immediately prior to the effective time of the Merger.

See Note 10 for information regarding impact
of the Merger Agreement on the Companys convertible debt.



|   |                                                     
|-- | ----------------------------------------------------
|3. | Discontinued Operations and Assets Held for
    Sale

In June 2005, the Board of Directors of the
Company approved and committed to a formal plan to exit the
property management systems (PMS) business by selling the
Companys PMS operations. These operations included the
PegasusCentral PMS and two other private-label property
management products, Guestview and NovaPlus, that support both
hotel chains and independent customers.

The Company also reached an agreement with its
primary PegasusCentral customer, InterContinental Hotel Group
(IHG), to discontinue the use of PegasusCentral. The transition
of IHG properties off of PegasusCentral is substantially
complete, and there will be no new installations. The decision
to exit the PMS business was made considering the termination of
the IHG agreement, the overall expected profitability of the
remaining PMS operations, and the strategic alternative process
announced in April 2005.

The PMS operations have been classified as
discontinued operations for all periods presented and the
remaining PMS assets are classified as assets held for sale at
December 31, 2005. In classifying the PMS assets as held
for sale, the Company concluded that the carrying amount of
these assets exceeded the estimated fair value less cost to sell
such assets. Accordingly, in the second quarter of 2005, the
Company recognized a $16.6 million pre-tax impairment
charge to write down the assets to an estimated net realizable
value of $1.9 million. In addition, the Company recorded an
approximately $1.0 million pre-tax charge for exit and
transition costs, which were paid during the third quarter of
2005. These charges are included in the Consolidated Statements
of Operations and Comprehensive Income (Loss) as discontinued
operations, net of tax. Assets held for sale of
$1.0 million are included in other noncurrent assets in the
Consolidated Balance Sheet as of December 31, 2005.

During October 2005, the Company completed the
disposition of the Guestview and NovaPlus operations to
Multi-Systems, Inc. The sale price was approximately
$1.3 million, including $605,000 paid upon closing and
$722,000 due under a full recourse promissory note, payable in
three annual installments of $270,000, including interest at
6 percent. The Company recorded a gain on the sale of
approximately $371,000 in the fourth quarter of 2005, which is
included in discontinued operations.

Condensed income statement data for the
discontinued operations is presented below (in thousands).

|                                                        |  |      |         |      |  |      |        |   |  |   |        |  
|------------------------------------------------------- |  | ---- | ------- | ---- |  | ---- | ------ | - |  | - | ------ | -
|                                                        |  | 2005 |         | 2004 |  | 2003
|                                                        |  |      |         |      |  |     
|Revenues                                                |  | $    | 2,453   |      |  | $    | 4,706  |   |  | $ | 6,500  |  
|                                                        |  |      |         |      |  |      |        |   |  |   |        |  
|Operating loss                                          |  | $    | (20,975 | )    |  | $    | (7,285 | ) |  | $ | (3,895 | )
|Income tax benefit                                      |  |      | 8,091   |      |  |      | 2,810  |   |  |   | 1,527  |  
|                                                        |  |      |         |      |  |      |        |   |  |   |        |  
|Loss related to discontinued operations, net of
    tax |  | $    | (12,884 | )    |  | $    | (4,475 | ) |  | $ | (2,368 | )
|                                                        |  |      |         |      |  |      |        |   |  |   |        |  

50



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|   |                  
|-- | -----------------
|4. | 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 was completed during 2003, 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. Information regarding the accruals
related to the restructure are presented below (amounts in
thousands). Accruals consisted primarily of facilities and
related costs and were included in other liabilities.

|     |  |                   |     |                 |  |            |      |                |  |   |     |  |  |   |     | 
|---- |  | ----------------- | --- | --------------- |  | ---------- | ---- | -------------- |  | - | --- |  |  | - | --- | 
|     |  | Accrued           |     |                 |  |            |      | Accrued       
|     |  | Restructure       |     | Amounts         |  |            |      | Restructure   
|     |  | Costs  Beginning |     | Paid in         |  | Additional |      | Costs  Ending
|     |  | Balance           |     | Cash or Settled |  | Accruals   |      | Balance       
|     |  |                   |     |                 |  |            |      |               
|2004 |  | $                 | 840 |                 |  | $          | (780 | )              |  | $ | 148 |  |  | $ | 208 | 
|2005 |  | $                 | 208 |                 |  | $          | (208 | )              |  | $ |    |  |  | $ |    | 



|   |             
|-- | ------------
|5. | 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
$38.0 million, which includes approximately $333,000 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 on the purchase date and
recorded an additional amount payable to Unirez shareholders of
$2.7 million. Pegasus paid $1.3 million of the amount
payable on December 1, 2004. 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.

51



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The 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                         |                           |                     | 589    |       
|                     |                                                |                           |                     |       
|                     |                                                | Total tangible assets     |                     |        | 10,275 |       
|Intangible assets:   |                                                |                           |                     |       
|                     | Customer relationships                         |                           |                     | 4,620  |       
|                     | Non-compete agreements                         |                           |                     | 2,300  |       
|                     | Goodwill                                       |                           |                     | 24,222 |       
|                     |                                                |                           |                     |       
|                     |                                                | Total intangible assets   |                     |        | 31,142 |       
|Liabilities assumed: |                                                |                           |                     |       
|                     | Accounts payable and other accrued liabilities |                           |                     | (3,079 | )     
|                     | Unearned revenue                               |                           |                     | (180   | )     
|                     | Other liabilities-long term                    |                           |                     | (116   | )     
|                     |                                                |                           |                     |       
|                     |                                                | Total liabilities assumed |                     |        | (3,375 | )     
|                     |                                                |                           |                     |       
|                     |                                                |                           | Net assets acquired |        | $      | 38,042 | 
|                     |                                                |                           |                     |       

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 year ended December 31, 2003 as if the
acquisition had occurred at the beginning of 2003 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 (in thousands, except per share
amounts).

|                   |  |           |         |  
|------------------ |  | --------- | ------- | -
|                   |  | Unaudited
|                   |  | 2003     
|                   |  |          
|Net revenues       |  | $         | 185,372 |  
|Net loss           |  |           | (1,389  | )
|Net loss per share |  |           | (0.06   | )

52



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



| |                                      
| | -------------------------------------
| | 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
$950,000 in cash on the closing date, and recorded a purchase
price obligation of approximately $750,000, which represents the
minimum additional purchase price payable at a future date
subject to certain conditions. Contingent upon certain
performance targets in the first and second year, as defined,
TDS shareholders could be entitled to cash payments of up to
$1.7 million in addition to the aforementioned $750,000.
The Company paid $250,000 of the remaining purchase price during
2004 and $500,000 during 2005. 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.



|   |                               
|-- | ------------------------------
|6. | Goodwill and Intangible Assets

As of December 31, 2005 and 2004, goodwill
totaled $163.2 million and $163.6 million,
respectively. In accordance with SFAS 142, goodwill is
subject to an annual impairment test. Based on the periodic
impairment test conducted as of September 30, 2005, the
Company does not believe goodwill is impaired. The decrease in
goodwill is related to tax-related matters associated with the
REZ acquisition.

The following table presents definite-lived
intangible assets at December 31, 2005 and
December 31, 2004 (in thousands):

|                       |  |                   |        |                   |  |          |         |              |  |   |        |  |  |   |         |  
|---------------------- |  | ----------------- | ------ | ----------------- |  | -------- | ------- | ------------ |  | - | ------ |  |  | - | ------- | -
|                       |  |                   |        |                  
|                       |  | December 31, 2005 |        | December 31, 2004
|                       |  |                   |        |                  
|                       |  | Carrying          |        | Accumulated       |  | Carrying |         | Accumulated 
|                       |  | Value             |        | Amortization      |  | Value    |         | Amortization
|                       |  |                   |        |                   |  |          |         |             
|Customer relationships |  | $                 | 56,996 |                   |  | $        | (53,751 | )            |  | $ | 56,996 |  |  | $ | (53,091 | )
|Non-compete agreements |  |                   | 6,000  |                   |  |          | (4,898  | )            |  |   | 6,120  |  |  |   | (4,215  | )
|Other                  |  |                   | 48     |                   |  |          | (38     | )            |  |   | 48     |  |  |   | (31     | )
|                       |  |                   |        |                   |  |          |         |              |  |   |        |  |  |   |         |  
|Total                  |  | $                 | 63,044 |                   |  | $        | (58,687 | )            |  | $ | 63,164 |  |  | $ | (57,337 | )
|                       |  |                   |        |                   |  |          |         |              |  |   |        |  |  |   |         |  

During the years ended December 31, 2005,
2004 and 2003 the Company recorded amortization expense in
relation to the above-listed intangible assets of
$1.4 million, $2.0 million and $5.1 million,
respectively. The following table presents the estimated
amortization expense for these intangible assets for the years
ended December 31 (in thousands):

|      |  |   |       | 
|----- |  | - | ----- | 
|2006  |  | $ | 1,244 | 
|2007  |  |   | 1,191 | 
|2008  |  |   | 660   | 
|2009  |  |   | 660   | 
|2010  |  |   | 602   | 
|      |  |   |       | 
|Total |  | $ | 4,357 | 
|      |  |   |       | 



|   |                      
|-- | ---------------------
|7. | Marketable Securities

Marketable securities held by the Company at
December 31, 2005 and 2004 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. At December 31, 2005 there were
$5.7 million of auction rate securities which are
classified as a separately stated current asset and
$1.2 million included in other noncurrent assets. At
December 31, 2004, $2.0 million of corporate debt

53



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

securities and $4.0 million of government
agency securities had contractual maturities in 2005 and are
classified as short-term investments; $5.7 million of
auction rate securities are classified as a separately stated
current asset; and all other marketable securities are
classified as other noncurrent assets. The amortized cost and
fair value of marketable securities at December 31, 2005
and 2004 are as follows (in thousands):

|                                                                                                   |                             |           |       |            |  |            |   |           |  |   |    |     |   |   |       |        | 
|-------------------------------------------------------------------------------------------------- | --------------------------- | --------- | ----- | ---------- |  | ---------- | - | --------- |  | - | -- | --- | - | - | ----- | ------ | 
|                                                                                                   |                             |           |       | Gross      |  | Gross      |   | Estimated
|                                                                                                   |                             | Amortized |       | Unrealized |  | Unrealized |   | Fair     
|                                                                                                   |                             | Cost      |       | Gains      |  | Losses     |   | Value    
|                                                                                                   |                             |           |       |            |  |            |   |          
|December 31, 2005                                                                                  |                             |           |       |            |  |            |   |           |  |   |    |     |   |   |       |       
|Auction rate securities                                                                            |                             | $         | 6,900 |            |  | $          |  |           |  | $ |   |     |   | $ | 6,900 |       
|                                                                                                   |                             |           |       |            |  |            |   |           |  |   |    |     |   |   |       |       
|December 31, 2004                                                                                  |                             |           |       |            |  |            |   |           |  |   |    |     |   |   |       |       
|Corporate debt securities                                                                          |                             | $         | 3,061 |            |  | $          |  |           |  | $ | (8 | )   |   | $ | 3,053 |       
|Debt securities issued by the U.S. Treasury or
    other U.S. Government Corporations and agencies |                             |           | 1,996 |            |  |            |  |           |  |   | (9 | )   |   |   | 1,987 |       
|Debt securities issued by states of the U.S. and
    political subdivisions of the states          |                             |           | 2,000 |            |  |            | 4 |           |  |   |   |     |   |   | 2,004 |       
|Auction rate securities                                                                            |                             |           | 7,300 |            |  |            |  |           |  |   |   |     |   |   | 7,300 |       
|                                                                                                   |                             |           |       |            |  |            |   |           |  |   |    |     |   |   |       |       
|                                                                                                   | Total marketable securities |           | $     | 14,357     |  |            | $ | 4         |  |   | $  | (17 | ) |   | $     | 14,344 | 
|                                                                                                   |                             |           |       |            |  |            |   |           |  |   |    |     |   |   |       |       



|   |                                 
|-- | --------------------------------
|8. | 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, 2005.
These contracts reduce exposure to currency movements affecting
existing foreign currency denominated assets and liabilities,
primarily trade receivables and payables.

A summary of forward exchange contracts to sell
or purchase foreign currencies in place as of December 31,
2005 is as follows (in thousands):

|                   |       |      |        |          |  |   |       |       | 
|------------------ | ----- | ---- | ------ | -------- |  | - | ----- | ----- | 
|                   |       | Sell |        | Purchase
|                   |       |      |        |         
|Euro               |       | $    | 12,196 |          |  | $ | 3,039 |      
|Canadian dollar    |       |      | 800    |          |  |   | 369   |      
|Swiss franc        |       |      | 473    |          |  |   |      |      
|Swedish krona      |       |      | 289    |          |  |   |      |      
|Singapore dollar   |       |      | 235    |          |  |   |      |      
|Japanese yen       |       |      | 227    |          |  |   | 34    |      
|British pound      |       |      | 1,247  |          |  |   | 2,169 |      
|Australian dollar  |       |      | 90     |          |  |   |      |      
|South African rand |       |      | 40     |          |  |   |      |      
|New Zealand dollar |       |      | 27     |          |  |   |      |      
|Hong Kong dollar   |       |      | 23     |          |  |   |      |      
|Norweigan kroner   |       |      | 25     |          |  |   | 15    |      
|Danish krone       |       |      |       |          |  |   | 43    |      
|                   |       |      |        |          |  |   |       |      
|                   | Total |      | $      | 15,672   |  |   | $     | 5,669 | 
|                   |       |      |        |          |  |   |       |      

54



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

All contracts included above matured no later
than February 2006. 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, 2005. During the fiscal year
ended December 31, 2004, Pegasus used similar forward
exchange contracts and had either sell or purchase forward
exchange contracts of a similarly short-term nature. As of
December 31, 2004, Pegasus had approximately
$22.6 million in sell forward exchange contracts and
$4.6 million in purchase forward exchange contracts.
Pegasus positions with respect to these forward exchange
contracts differed as of December 31, 2005 compared to
December 31, 2004 because of changes in Pegasus
non-U.S. denominated trade payables and receivables.



|   |                                 
|-- | --------------------------------
|9. | Property, Equipment and Software

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

|                                      |                                                 |      |         |          |   |             |         |          |   |  |               |  | 
|------------------------------------- | ----------------------------------------------- | ---- | ------- | -------- | - | ----------- | ------- | -------- | - |  | ------------- |  | 
|                                      |                                                 |      |         |          |   | Estimated  
|                                      |                                                 | 2005 |         | 2004     |   | Useful Life
|                                      |                                                 |      |         |          |   |            
|Software                              |                                                 | $    | 112,090 |          |   | $           | 131,434 |          |   |  | 3 to 7  years | 
|Computer equipment                    |                                                 |      | 24,917  |          |   |             | 24,269  |          |   |  | 3 to 4  years | 
|Leasehold improvements                |                                                 |      | 14,148  |          |   |             | 14,495  |          |   |  | Lease term    | 
|Furniture and equipment               |                                                 |      | 6,522   |          |   |             | 6,589   |          |   |  | 7 years       | 
|Office equipment                      |                                                 |      | 3,340   |          |   |             | 3,575   |          |   |  | 4 years       | 
|                                      |                                                 |      |         |          |   |             |         |          |   |  |               | 
|                                      |                                                 |      | 161,017 |          |   |             | 180,362 |          |   |  |               | 
|                                      | Less: accumulated depreciation and amortization |      |         | (101,950 | ) |             |         | (100,036 | ) |  |               |  | 
|                                      |                                                 |      |         |          |   |             |         |          |   |  |               | 
|Property, equipment and software, net |                                                 | $    | 59,067  |          |   | $           | 80,326  |          |   |  |               | 
|                                      |                                                 |      |         |          |   |             |         |          |   |  |               | 

Depreciation and amortization expense for
property, equipment and software related to continuing
operations was approximately $17.5 million,
$15.6 million and $18.5 million for 2005, 2004 and
2003, respectively. Depreciation and amortization expense for
property, equipment and software related to discontinued
operations was approximately $2.5 million,
$4.8 million and $4.4 million in 2005, 2004 and 2003,
respectively.



|    |                 
|--- | ----------------
|10. | Convertible 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 notes and
the indenture in connection therewith contain no covenants by
the Company to maintain any minimum level of liquidity or any
financial ratios.

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.

55



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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.

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 that
holders notes. The merger contemplated by the Merger
Agreement constitutes such a fundamental change, and the debt
financing anticipated in connection with the Merger Agreement
contemplates the repayment of the amounts owing under the
convertible notes.

Pegasus had two irrevocable standby letter of
credit agreements with JPMorgan Chase Bank totaling
$1.7 million at December 31, 2004, collateralizing the
leases for the Dallas and Scottsdale offices. During 2005, there
was a reduction of $450,000, releasing the letter of credit for
the Dallas facility in full and replacing it with a deposit of
$181,000.



|    |                     
|--- | --------------------
|11. | Stockholders Equity

During 2005, the Company purchased approximately
518,000 shares for an aggregate cost of $6.2 million under
a Board approved plan authorized on November 5, 2004 for
the repurchase of up to 1.5 million shares of Pegasus
common stock. Share buy-backs under this plan have been made
under a Securities and Exchange Act of 1934 Rule 10b5-1
share repurchase plan, which allowed Pegasus to repurchase
shares, subject to certain limitations, even during blackout
periods. On April 12, 2005, the Rule 10b5-1 stock
repurchase plan was terminated. The Company had total purchases
under the plan of approximately 1.2 million shares for a
total aggregate value of $13.9 million. During 2004 and
2005 there were three separate Board approved plans for the
repurchase of Pegasus stock. Under these plans the Company had
total repurchases in 2004 and 2005 of approximately
5.2 million shares for a total aggregate value of
$61.9 million.

Shares repurchased under Board-approved plans
were cancelled.



|    |                         
|--- | ------------------------
|12. | Stock-Based Compensation



| |                   
| | ------------------
| | Stock Option Plans

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 2002
stock incentive plan (2002 Plan), approved by
stockholders in May 2002, options to purchase shares of the
Companys common stock and restricted stock awards may be
granted to Company employees, non-employee directors and
consultants. The 2002 Plan provides that the number of shares
reserved for issuance under the plan will be replenished
annually by an amount equal to 4 percent of the fully
diluted 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, 2005 was
approximately 27.9 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, 2005, shares
available for grant under the Companys stock option plans
were approximately 3.0 million.

Options granted under the 1996 Plan and the 2002
Plan (collectively the Plans) may be in the form of
incentive stock options or nonqualified stock options. The
Compensation 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 vest and expire as determined by the Compensation
Committee. Options granted under the 1996 Plan before
September 15, 1999 expired on December 31, 2005, and
have been considered canceled in the following data. 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

56



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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.

As of December 31, 2005, 38,875 shares of
restricted stock granted to certain executives of the Company
are outstanding, 36,875 which were granted in May 2004 with a
fair value of approximately $420,000 and 2,000 which were
granted in February 2005 with a fair value of approximately
$24,000. The fair value of the restricted stock awards is
determined based on the market value of the Companys stock
on the date of grant. Compensation expense related to the
restricted stock awards is being recognized ratably over a four
year vesting period.

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          
|                                         |  |                   |       |                          
|                                         |  | 2005              |       | 2004                      |  | 2003 |        | 2005 |  | 2004 |       | 2003
|                                         |  |                   |       |                           |  |      |        |      |  |      |       |     
|Options outstanding at beginning of year |  |                   | 4,906 |                           |  |      | 5,262  |      |  |      | 4,370 |      |  | $ | 12.50 |  |  | $ | 12.75 |  |  | $ | 12.88 | 
|Granted                                  |  |                   | 273   |                           |  |      | 1,537  |      |  |      | 1,792 |      |  |   | 11.01 |  |  |   | 11.72 |  |  |   | 12.03 | 
|Exercised                                |  |                   | (142  | )                         |  |      | (622   | )    |  |      | (278  | )    |  |   | 7.48  |  |  |   | 7.77  |  |  |   | 6.65  | 
|Canceled                                 |  |                   | (890  | )                         |  |      | (1,271 | )    |  |      | (622  | )    |  |   | 12.14 |  |  |   | 14.61 |  |  |   | 16.95 | 
|                                         |  |                   |       |                           |  |      |        |      |  |      |       |      |  |   |       |  |  |   |       |  |  |   |       | 
|Options outstanding at end of year       |  |                   | 4,147 |                           |  |      | 4,906  |      |  |      | 5,262 |      |  | $ | 12.64 |  |  | $ | 12.50 |  |  | $ | 12.75 | 
|                                         |  |                   |       |                           |  |      |        |      |  |      |       |      |  |   |       |  |  |   |       |  |  |   |       | 
|Options exercisable at end of year       |  |                   | 2,725 |                           |  |      | 2,255  |      |  |      | 2,401 |      |  | $ | 13.09 |  |  | $ | 13.24 |  |  | $ | 13.44 | 
|                                         |  |                   |       |                           |  |      |        |      |  |      |       |      |  |   |       |  |  |   |       |  |  |   |       | 

The following table summarizes information for
stock options outstanding at December 31, 2005 (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   
|                |  |                     |       |                     |  |          |           |           |  |         
|$6.33-$8.90     |  |                     | 420   |                     |  |          | 4.4 years |           |  | $        | 7.62  |  |  |  | 419   |  |  | $ | 7.62  | 
|$9.69-$14.03    |  |                     | 3,190 |                     |  |          | 7.4 years |           |  |          | 12.03 |  |  |  | 1,770 |  |  |   | 12.23 | 
|$14.59-$18.63   |  |                     | 352   |                     |  |          | 4.5 years |           |  |          | 17.95 |  |  |  | 351   |  |  |   | 17.95 | 
|$24.50-$25.25   |  |                     | 185   |                     |  |          | 3.8 years |           |  |          | 24.53 |  |  |  | 185   |  |  |   | 24.53 | 
|                |  |                     |       |                     |  |          |           |           |  |          |       |  |  |  |       |  |  |   |       | 
|$6.33-$25.25    |  |                     | 4,147 |                     |  |          | 6.7 years |           |  | $        | 12.64 |  |  |  | 2,725 |  |  | $ | 13.09 | 
|                |  |                     |       |                     |  |          |           |           |  |          |       |  |  |  |       |  |  |   |       | 



| |                                                            
| | -----------------------------------------------------------
| | Effect of the Merger on Stock-Based
    Compensation Awards

At the effective time of the merger under the
Merger Agreement, if any, each outstanding stock option, whether
or not vested or exercisable, will terminate and thereafter
represent the right to receive an amount in cash, without
interest and less applicable tax withholding, equal to the
number of shares of our common stock subject to each option as
of the effective time of the merger, multiplied by the excess,
if any, of $9.50 over the exercise price per share of common
stock subject to such option. As of December 31, 2005,
there were 420,475 stock options outstanding with an exercise
price of less than $9.50 outstanding and a weighted-average
exercise price of $7.62. Also at the effective time of the
merger under the Merger Agreement, if any, each restricted stock
award (38,875 shares of restricted stock were outstanding
on December 31, 2005) granted under the Plans will be
converted into the right to receive $9.50 in cash per share,
without interest and less applicable tax withholding. From the
date of the Merger Agreement date until completion of the merger
under

57



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

the Merger Agreement, if any, the Company has
agreed, subject to certain exceptions and unless Parent gives
its prior written consent, not to grant any equity or equity
based awards.



| |                             
| | ----------------------------
| | Employee Stock Purchase Plan

At a meeting on December 12, 2005, the Board
of Directors approved the termination of the Pegasus Solutions,
Inc. 2002 Third Amended and Restated Employee Stock Purchase
Plan effective as of December 31, 2005. During 2005, 2004
and 2003, approximately 48,000, 53,000 and 66,000 shares,
respectively, were issued under the plan. In January 2006,
approximately 25,000 shares were issued representing the
final purchases under this plan.



|    |                       
|--- | ----------------------
|13. | 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. Through August 15, 2005, the Company made
discretionary matching contributions for employees annual
contributions of up to 100 percent of the first
5 percent of employees compensation contributed. No
further matching contributions were made from August 15,
2005 through the end of 2005. The 401(k) match was reinstated in
January 2006 at a rate of 4 percent. The Companys
matching contributions vest one-third per 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 (the 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 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. Inclusive of company matching contributions,
participants can contribute from 17.5 to 40 percent of
their total pensionable earnings (as defined in the plan) to
various investment funds.

During 2005, 2004 and 2003, the Company
contributed $1.1 million, $1.4 million and
$1.8 million, respectively, to the 401(k) Plan. During
2005, 2004, and 2003, the Company contributed approximately
$238,000, $331,000 and $160,000, 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. The Companys
projected 2006 contributions to the Utell Defined Benefit Plan
are approximately $167,000.



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

Pursuant to their employment agreements, certain
Company officers are eligible to participate in the Executive
Retirement Program, consisting of (1) the Supplemental
Executive Retirement Plan (the SERP), as amended, a
defined benefit plan which provides supplemental retirement
benefits to certain

58



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

officers of the Company based on their
compensation and years of service, as defined under the SERP,
and (2) the Pegasus Solutions, Inc. Executive Deferred
Compensation Plan (the DCP), as amended, a defined
contribution plan that provides supplemental retirement benefits
to certain management employees of the Company.

Commencing in 2003, the Company is obligated to
make annual cash payments to a trust associated with benefits
earned under the Executive Retirement Program. The amounts
funded to the trust may be available to creditors of the
Company, but are generally not available for use in our ongoing
operations. Subsequent to year end 2005, the Company made
payments to the trust of $310,000 related to the SERP and
$256,000 related to the DCP in connection with benefits earned
in 2005. Also subsequent to year end 2005, the Company made SERP
benefit payments of $340,000 to an executive who terminated
participation in the SERP in 2004 using funds outside of the
trust. During 2006, the Company expects no further funding to
the trust related to the SERP and expects funding to the trust
related to the 2006 DCP will total approximately $370,000.
Provided however, in the event the merger contemplated by the
Merger Agreement closes, Pegasus will be obligated to make
further funding to the trust equal to all benefits under the
SERP and DCP. During 2005, 2004, and 2003, the Company recorded
expenses of approximately $319,000, $600,000 and $656,000,
respectively, related to the DCP.



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

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, 2005 and 2004, 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 
|                                               |  |      |       |              
|                                               |  | 2005 |       | 2004          |  | 2005 |       | 2004
|                                               |  |      |       |               |  |      |       |     
|Benefit obligation at beginning of year        |  | $    | 4,383 |               |  | $    | 4,090 |      |  | $ | 13,770 |   |  | $ | 9,757  |  
|Service cost                                   |  |      | 200   |               |  |      | 172   |      |  |   | 341    |   |  |   | 297    |  
|Interest cost                                  |  |      | 256   |               |  |      | 269   |      |  |   | 742    |   |  |   | 536    |  
|Plan participants contributions               |  |      |      |               |  |      |      |      |  |   | 89     |   |  |   | 89     |  
|Actuarial loss (gain)                          |  |      | 466   |               |  |      | 381   |      |  |   | 2,850  |   |  |   | 2,259  |  
|Benefits paid                                  |  |      | (340  | )             |  |      | (340  | )    |  |   | (13    | ) |  |   | (13    | )
|Exchange rate loss (gain)                      |  |      |      |               |  |      |      |      |  |   | (1,532 | ) |  |   | 845    |  
|Curtailment                                    |  |      |      |               |  |      | (189  | )    |  |   |       |   |  |   |       |  
|Settlement                                     |  |      |      |               |  |      |      |      |  |   |       |   |  |   |       |  
|                                               |  |      |       |               |  |      |       |      |  |   |        |   |  |   |        |  
|Benefit obligation at end of year              |  | $    | 4,965 |               |  | $    | 4,383 |      |  | $ | 16,247 |   |  | $ | 13,770 |  
|                                               |  |      |       |               |  |      |       |      |  |   |        |   |  |   |        |  
|Fair value of plan assets at beginning of year |  | $    |      |               |  | $    |      |      |  | $ | 11,621 |   |  | $ | 9,646  |  
|Actual return on plan assets                   |  |      |      |               |  |      |      |      |  |   | 2,143  |   |  |   | 814    |  
|Employer contribution                          |  |      | 340   |               |  |      | 340   |      |  |   | 221    |   |  |   | 222    |  
|Plan participants contributions               |  |      |      |               |  |      |      |      |  |   | 89     |   |  |   | 89     |  
|Benefits paid                                  |  |      | (340  | )             |  |      | (340  | )    |  |   | (13    | ) |  |   | (13    | )
|Exchange rate loss (gain)                      |  |      |      |               |  |      |      |      |  |   | (1,463 | ) |  |   | 863    |  
|                                               |  |      |       |               |  |      |       |      |  |   |        |   |  |   |        |  
|Fair value of plan assets at end of year       |  | $    |      |               |  | $    |      |      |  | $ | 12,598 |   |  | $ | 11,621 |  

59



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                     |  |      |        |               |  |      |        |      |  |   |        |   |  |   |        |  
|------------------------------------ |  | ---- | ------ | ------------- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                     |  |      |        |               |  |     
|                                     |  |      |        | Utell Defined
|                                     |  | SERP |        | Benefit Plan 
|                                     |  |      |        |              
|                                     |  | 2005 |        | 2004          |  | 2005 |        | 2004
|                                     |  |      |        |               |  |      |        |     
|                                     |  |      |        |               |  |      |        |      |  |   |        |   |  |   |        |  
|Funded status                        |  | $    | (4,965 | )             |  | $    | (4,383 | )    |  | $ | (3,649 | ) |  | $ | (2,149 | )
|Unrecognized actuarial loss (gain)   |  |      | 2,363  |               |  |      | 2,027  |      |  |   | 2,404  |   |  |   | 806    |  
|Unrecognized prior service cost      |  |      | (345   | )             |  |      | (386   | )    |  |   |       |   |  |   |       |  
|Additional minimum pension liability |  |      | (1,933 | )             |  |      | (1,608 | )    |  |   | (1,650 | ) |  |   |       |  
|                                     |  |      |        |               |  |      |        |      |  |   |        |   |  |   |        |  
|Net amount recognized                |  | $    | (4,880 | )             |  | $    | (4,350 | )    |  | $ | (2,895 | ) |  | $ | (1,343 | )
|                                     |  |      |        |               |  |      |        |      |  |   |        |   |  |   |        |  

The accumulated benefit obligation for the SERP
was $4.9 million at December 31, 2005 and
$4.4 million at December 31, 2004. The accumulated
benefit obligation for the Utell Defined Benefit Plan was
$15.5 million at December 31, 2005 and
$12.9 million at December 31, 2004.

As a result of changes in executive management,
during the first quarter of 2004, Pegasus recognized a
curtailment gain of $162,000 for the SERP under Statement of
Financial Accounting Standards No. 88 (SFAS
88), Employers Accounting for Settlements and
Curtailments of Defined Benefit Pension Plans and for
Termination Benefits.

The Company had additional minimum liabilities
applicable to the SERP and the Utell Defined Benefit Plan for
the excess of the plans unfunded accumulated benefit
obligation over the plans unfunded accrued pension cost of
approximately $1.9 million, $1.6 million, and
$1.4 million as of December 31, 2005, 2004 and 2003,
respectively, applicable to the SERP, and $1.7 million as
of December 31, 2005 applicable to the Utell Defined
Benefit Plan. Other comprehensive income (loss) of
approximately ($1.2) million, ($152,000) and $871,000, net
of tax, was recorded for 2005, 2004 and 2003, respectively,
related to additional minimum liabilities.

The assumptions used in the measurement of the
Companys benefit obligations as of December 31, 2005
and 2004 are as follows:

|                               |  |      |      |               |  |      |      |      |  |  |     |   |  |  |     |  
|------------------------------ |  | ---- | ---- | ------------- |  | ---- | ---- | ---- |  |  | --- | - |  |  | --- | -
|                               |  |      |      |               |  |     
|                               |  |      |      | Utell Defined
|                               |  | SERP |      | Benefit Plan 
|                               |  |      |      |              
|                               |  | 2005 |      | 2004          |  | 2005 |      | 2004
|                               |  |      |      |               |  |      |      |     
|Discount rate                  |  |      | 5.50 | %             |  |      | 6.25 | %    |  |  | 4.7 | % |  |  | 5.3 | %
|Expected return on plan assets |  |      | N/A  |               |  |      | N/A  |      |  |  | 7.0 | % |  |  | 7.0 | %
|Rate of compensation increase  |  |      | 5.0  | %             |  |      | 5.0  | %    |  |  | 4.4 | % |  |  | 4.3 | %



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

The following table provides the components of
net periodic benefit costs for the three years ended
December 31, 2005 (in thousands):

|                                   |  |      |     |                            |  |      |      |      |  |      |     |      |  |   |      |   |  |   |      |   |  |   |      |  
|---------------------------------- |  | ---- | --- | -------------------------- |  | ---- | ---- | ---- |  | ---- | --- | ---- |  | - | ---- | - |  | - | ---- | - |  | - | ---- | -
|                                   |  |      |     |                           
|                                   |  | SERP |     | Utell Defined Benefit Plan
|                                   |  |      |     |                           
|                                   |  | 2005 |     | 2004                       |  | 2003 |      | 2005 |  | 2004 |     | 2003
|                                   |  |      |     |                            |  |      |      |      |  |      |     |     
|Service cost                       |  | $    | 200 |                            |  | $    | 173  |      |  | $    | 178 |      |  | $ | 341  |   |  | $ | 297  |   |  | $ | 474  |  
|Interest cost                      |  |      | 256 |                            |  |      | 269  |      |  |      | 225 |      |  |   | 742  |   |  |   | 536  |   |  |   | 585  |  
|Expected return on plan assets     |  |      |    |                            |  |      |     |      |  |      |    |      |  |   | (823 | ) |  |   | (685 | ) |  |   | (530 | )
|Amortization of prior service cost |  |      | (41 | )                          |  |      | (34  | )    |  |      | (49 | )    |  |   |     |   |  |   |     |   |  |   |     |  
|Recognized net actuarial loss      |  |      | 130 |                            |  |      | 128  |      |  |      | 116 |      |  |   |     |   |  |   | (26  | ) |  |   | 486  |  
|Curtailment gain                   |  |      |    |                            |  |      | (162 | )    |  |      |    |      |  |   |     |   |  |   |     |   |  |   | (508 | )
|Settlement loss                    |  |      |    |                            |  |      |     |      |  |      |    |      |  |   |     |   |  |   |     |   |  |   | 261  |  
|                                   |  |      |     |                            |  |      |      |      |  |      |     |      |  |   |      |   |  |   |      |   |  |   |      |  
|Net periodic benefit cost          |  | $    | 545 |                            |  | $    | 374  |      |  | $    | 470 |      |  | $ | 260  |   |  | $ | 122  |   |  | $ | 768  |  
|                                   |  |      |     |                            |  |      |      |      |  |      |     |      |  |   |      |   |  |   |      |   |  |   |      |  

60



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

The principal assumptions used in the measurement
of the net benefit costs for the three years ended
December 31, 2005 are as follows:

|                               |  |      |      |               |  |      |      |      |  |      |      |      |  |  |     |   |  |  |     |   |  |  |     |  
|------------------------------ |  | ---- | ---- | ------------- |  | ---- | ---- | ---- |  | ---- | ---- | ---- |  |  | --- | - |  |  | --- | - |  |  | --- | -
|                               |  |      |      |               |  |      |      |     
|                               |  |      |      | Utell Defined
|                               |  | SERP |      | Benefit Plan 
|                               |  |      |      |              
|                               |  | 2005 |      | 2004          |  | 2003 |      | 2005 |  | 2004 |      | 2003
|                               |  |      |      |               |  |      |      |      |  |      |      |     
|Discount rate                  |  |      | 6.25 | %             |  |      | 6.25 | %    |  |      | 6.75 | %    |  |  | 5.3 | % |  |  | 5.5 | % |  |  | 5.5 | %
|Expected return on plan assets |  |      | N/A  |               |  |      | N/A  |      |  |      | N/A  |      |  |  | 7.0 | % |  |  | 7.0 | % |  |  | 7.0 | %
|Rate of compensation increase  |  |      | 5.0  | %             |  |      | 5.0  | %    |  |      | 5.0  | %    |  |  | 4.3 | % |  |  | 3.8 | % |  |  | 3.8 | %



| |                                                                          
| | -------------------------------------------------------------------------
| | Investment Policy and Asset Allocation for
    Utell Defined Benefit Plan

The investment policy for the Utell Defined
Benefit Plan is to achieve an above average rate of return
compatible with an acceptable level of risk. The target asset
allocation reflects a profile that the Company determines will
best meet obligations and includes primarily equity securities.
The allocation of assets for the Utell Defined Benefit Plan as
of December 31, 2005 and 2004 follows:

|                  |       |      |      |       |   |  |      |       |  
|----------------- | ----- | ---- | ---- | ----- | - |  | ---- | ----- | -
|                  |       | 2005 |      | 2004 
|                  |       |      |      |      
|Equity securities |       |      | 87.7 | %     |   |  | 86.5 | %    
|Debt securities   |       |      | 6.6  | %     |   |  | 8.0  | %    
|Other             |       |      | 5.7  | %     |   |  | 5.5  | %    
|                  |       |      |      |       |   |  |      |      
|                  | Total |      |      | 100.0 | % |  |      | 100.0 | %
|                  |       |      |      |       |   |  |      |      

The long-term return on plan assets is determined
based on expected returns as of the accounting date, primarily
based on equities which comprise the majority of assets in the
plan. Expected returns on equity plan assets were determined to
range between 6% and 9%. A one percent change in expected
returns on plan assets would result in a $125,000 change to
Pegasus annual expense associated with this plan.



| |                                      
| | -------------------------------------
| | Estimated Future Benefits
    Payable

The Company estimates that the future benefits
payable are as follows at December 31, 2005 (in thousands):

|                                            |      |      |   |               |  |  |       |    | 
|------------------------------------------- | ---- | ---- | - | ------------- |  |  | ----- | -- | 
|                                            |      |      |   | Utell Defined
|                                            |      | SERP |   | Benefit Plan 
|                                            |      |      |   |              
|Fiscal year ended December 31:              |      |      |   |               |  |  |       |   
|                                            | 2006 |      | $ | 340           |  |  | $     | 12 | 
|                                            | 2007 |      |   | 340           |  |  |       | 12 | 
|                                            | 2008 |      |   |              |  |  |       | 22 | 
|                                            | 2009 |      |   |              |  |  |       | 22 | 
|                                            | 2010 |      |   |              |  |  |       | 22 | 
|Next five fiscal years to December 31, 2015 |      |      |  |               |  |  | 1,068 |   

61



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |             
|--- | ------------
|14. | Income Taxes

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

|                                    |  |      |       |      |  |      |        |  |  |   |       |  
|----------------------------------- |  | ---- | ----- | ---- |  | ---- | ------ |  |  | - | ----- | -
|                                    |  | 2005 |       | 2004 |  | 2003
|                                    |  |      |       |      |  |     
|Domestic income (loss) before taxes |  | $    | 3,882 |      |  | $    | 12,479 |  |  | $ | (617  | )
|Foreign income before taxes         |  |      | 4,533 |      |  |      | 7,937  |  |  |   | 1,775 |  
|                                    |  |      |       |      |  |      |        |  |  |   |       |  
|Total income before taxes           |  | $    | 8,415 |      |  | $    | 20,416 |  |  | $ | 1,158 |  
|                                    |  |      |       |      |  |      |        |  |  |   |       |  

The categories of income tax expense (benefit)
for years ended December 31 were as follows (in thousands):

|                        |  |      |        |      |  |      |        |   |  |   |        |  
|----------------------- |  | ---- | ------ | ---- |  | ---- | ------ | - |  | - | ------ | -
|                        |  | 2005 |        | 2004 |  | 2003
|                        |  |      |        |      |  |     
|Continuing operations   |  | $    | 3,186  |      |  | $    | 7,956  |   |  | $ | 622    |  
|Discontinued operations |  |      | (8,091 | )    |  |      | (2,810 | ) |  |   | (1,527 | )
|Shareholders equity    |  |      | (974   | )    |  |      | (1,011 | ) |  |   | (330   | )
|                        |  |      |        |      |  |      |        |   |  |   |        |  
|Total                   |  | $    | (5,879 | )    |  | $    | 4,135  |   |  | $ | (1,235 | )
|                        |  |      |        |      |  |      |        |   |  |   |        |  

The components of the income tax expense
(benefit) for years ended December 31 were as follows
(in thousands):

|                            |              |      |       |       |  |      |       |       |  |   |     |     |  
|--------------------------- | ------------ | ---- | ----- | ----- |  | ---- | ----- | ----- |  | - | --- | --- | -
|                            |              | 2005 |       | 2004  |  | 2003
|                            |              |      |       |       |  |     
|Current expense:            |              |      |       |       |  |      |       |       |  |   |     |    
|                            | Foreign      |      | $     | 1,388 |  |      | $     | 1,532 |  |   | $   | 446 |  
|Deferred expense (benefit): |              |      |       |       |  |      |       |       |  |   |     |    
|                            | U.S. Federal |      |       | 1,360 |  |      |       | 5,127 |  |   |     | 197 |  
|                            | State        |      |       | 242   |  |      |       | 966   |  |   |     | 39  |  
|                            | Foreign      |      |       | 196   |  |      |       | 331   |  |   |     | (60 | )
|                            |              |      |       |       |  |      |       |       |  |   |     |    
|                            |              |      | 1,798 |       |  |      | 6,424 |       |  |   | 176 |    
|                            |              |      |       |       |  |      |       |       |  |   |     |    
|Expense for income taxes    |              | $    | 3,186 |       |  | $    | 7,956 |       |  | $ | 622 |    
|                            |              |      |       |       |  |      |       |       |  |   |     |    

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

|                            |  |      |      |      |  |      |      |    |  |  |      |   
|--------------------------- |  | ---- | ---- | ---- |  | ---- | ---- | -- |  |  | ---- | --
|                            |  | 2005 |      | 2004 |  | 2003
|                            |  |      |      |      |  |     
|Expected income tax expense |  |      | 35.0 | %    |  |      | 35.0 | %  |  |  | 35.0 | % 
|State income taxes          |  |      | 2.1  | %    |  |      | 2.4  | %  |  |  | 2.2  | % 
|Permanent differences       |  |      | 1.5  | %    |  |      | 1.7  | %  |  |  | 18.0 | % 
|Other, net                  |  |      | (0.7 | )%   |  |      | (0.1 | )% |  |  | (1.5 | )%
|                            |  |      |      |      |  |      |      |    |  |  |      |   
|Expense for income taxes    |  |      | 37.9 | %    |  |      | 39.0 | %  |  |  | 53.7 | % 
|                            |  |      |      |      |  |      |      |    |  |  |      |   

62



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

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

|                                                                |                                   |                                |       |        |        |   |   |         |         |  
|--------------------------------------------------------------- | --------------------------------- | ------------------------------ | ----- | ------ | ------ | - | - | ------- | ------- | -
|                                                                |                                   | 2005                           |       | 2004  
|                                                                |                                   |                                |       |       
|Deferred tax assets:                                            |                                   |                                |       |        |        |   |   |        
|                                                                | Net operating loss carryforward   |                                | $     | 6,388  |        |   | $ | 5,573   |        
|                                                                | Bad debt reserves                 |                                |       | 804    |        |   |   | 833     |        
|                                                                | Benefit plan obligations          |                                |       | 2,342  |        |   |   | 1,659   |        
|                                                                | Income tax credits                |                                |       | 197    |        |   |   | 197     |        
|                                                                | Rent and other accruals           |                                |       | 3,433  |        |   |   | 3,672   |        
|                                                                | Stock option compensation expense |                                |       | 561    |        |   |   | 522     |        
|                                                                | Other                             |                                |       | 363    |        |   |   | 348     |        
|                                                                |                                   |                                |       |        |        |   |   |        
|                                                                |                                   | Gross deferred tax assets      |       |        | 14,088 |   |   |         | 12,804  |  
|Deferred tax liabilities:                                       |                                   |                                |       |        |        |   |   |        
|                                                                | Acquired intangible assets        |                                |       | (250   | )      |   |   | (341    | )      
|                                                                | Depreciation and amortization     |                                |       | (6,691 | )      |   |   | (12,459 | )      
|                                                                |                                   |                                |       |        |        |   |   |        
|                                                                |                                   | Gross deferred tax liabilities |       |        | (6,941 | ) |   |         | (12,800 | )
|                                                                |                                   |                                |       |        |        |   |   |        
|Deferred income tax assets, net of deferred tax
    liabilities |                                   | $                              | 7,147 |        |        | $ | 4 |        
|                                                                |                                   |                                |       |        |        |   |   |        

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. Management believes that
it is more likely than not that the remaining balance at
December 31, 2005 of deferred tax assets will be realized.
As of December 31, 2005, $1.6 million of deferred tax
assets are included in other current assets and
$5.5 million of deferred tax assets are included in other
noncurrent assets in the Consolidated Balance Sheet. As of
December 31, 2004, $1.7 million of deferred tax assets
are included in other current assets and $1.7 million of
deferred tax liabilities are included in other noncurrent
liabilities in the Consolidated Balance Sheet.

At December 31, 2005 and 2004, the Company
had federal net operating loss carryforwards of approximately
$29 million and $26 million, respectively. The
increase in the federal net operating loss carryforwards in 2005
is primarily due to the impact of discontinued operations.
Foreign net operating loss carry forwards for the respective
periods were approximately $214,000 and $745,000 as of such
dates. The federal net operating loss carryforwards that existed
at December 31, 2005 will begin to expire in 2019. The
foreign net operating loss carryforwards that existed at
December 31, 2005 may be carried forward indefinitely.
Utilization of the net operating loss carryforwards may be
limited by the separate return loss rules and could be affected
by ownership changes which have occurred or could occur in the
future.

On October 22, 2004, the President of the
United States signed the American Jobs Creation Act of 2004 (the
Act). The Act creates a temporary incentive through
2005 for United States corporations to receive repatriations of
accumulated earnings of foreign subsidiaries up to
$500 million by providing an 85 percent dividends
received deduction for certain qualifying dividends from certain
qualifying foreign corporations. The Company has evaluated the
potential effects of the repatriation provision and determined
not to repatriate earnings under this provision. If
undistributed earnings of foreign subsidiaries were to be
repatriated, such earnings could be subject to foreign
withholding taxes and residual income taxes.

63



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                              
|--- | -----------------------------
|15. | Commitments and Contingencies

The Company leases its corporate office space and
certain office equipment under non-cancelable lease agreements.
The Company incurred rent expense of approximately
$9.5 million, $8.9 million and $8.8 million in
2005, 2004 and 2003, respectively.

Approximate future minimum lease payments,
including landlord paid tenant improvements, at
December 31, 2005, under non-cancelable lease agreements
with original terms exceeding one year, were as follows (in
thousands):

|                               |  |   |        | 
|------------------------------ |  | - | ------ | 
|Fiscal Year Ended December 31, |  |  
|                               |  |  
|2006                           |  | $ | 8,097  | 
|2007                           |  |   | 7,283  | 
|2008                           |  |   | 7,437  | 
|2009                           |  |   | 7,270  | 
|2010                           |  |   | 7,063  | 
|Thereafter                     |  |   | 12,107 | 
|                               |  |   |        | 
|Total                          |  | $ | 49,257 | 
|                               |  |   |        | 

Future minimum lease payments due in foreign
currencies were translated at the rate in effect at
December 31, 2005.

During the third quarter of 2005, the Company
ceased the use of two office spaces, one in New York and one in
Australia, prior to the lease termination dates and recorded
lease termination costs of approximately $378,000 and $133,000,
respectively. These costs primarily represent the future lease
payments related to the vacated facilities net of estimated
sublease income over the remaining lease period of
37 months for the New York facility and 30 months for
the Australia facility.

Concurrent, the Company leased office space in
New York at reduced rates, as compared to the previous lease.

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 $7.6 million
and $7.4 million at December 31, 2005 and 2004,
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.



|    |                
|--- | ---------------
|16. | Related Parties

During 2005, one Director of the Company served
as an executive vice president within Marriott International,
Inc. (Marriott). Effective February 2006, the
director retired from Marriott. In 2005, 2004 and 2003, the
Company received $1.6 million, $3.4 million and
$4.5 million, respectively, from Marriott and its
affiliates for reservation, distribution and representation
services. During the same years, the Company paid Marriott
$1.4 million, $1.4 million and $1.6 million,
respectively, for consolidating commission data and funds from
its properties. At December 31, 2005 and 2004, receivables
from Marriott approximated $203,000 and $232,000, respectively.

A Director of the Company serves as a senior vice
president for both Hyatt Corporation, the parent company of
Hyatt Hotels Corporation, and AIC Holding Co., the parent
company of Hyatt International Corporation (Hyatt).
In 2005, 2004 and 2003, the Company received $683,000, $804,000
and $1.1 million, respectively, from Hyatt for reservation,
distribution and financial services. At December 31, 2005
and 2004, receivables from Hyatt approximated $160,000 and
$53,000, respectively.

64



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

A Director of the Company served as Chief
Executive Officer of Affiliated Computer Services, Inc.
(ACS) through September 2005. Through this date in
2005 and for 2004 and 2003, the Company paid ACS
$1.5 million, $1.1 million and $421,000, respectively,
for services provided in connection with our financial services
and, beginning in September 2004, enterprise resource planning
system support. At December 31, 2004, payables to ACS
approximated $83,000.



|    |                    
|--- | -------------------
|17. | Segment Disclosures

In 2003, Pegasus completed a restructure 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s management approach, organizational structure,
operating performance assessment and reporting, and operational
decision making are performed from a single company perspective,
the Company operates as one reportable segment.

The following summarizes required disclosures
about revenue by service line and geographic location.

During the years ended December 31, 2005,
2004 and 2003, service line revenues were (in thousands):

|                        |  |      |         |      |  |      |         |  |  |   |         | 
|----------------------- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------- | 
|                        |  | 2005 |         | 2004 |  | 2003
|                        |  |      |         |      |  |     
|Representation services |  | $    | 66,368  |      |  | $    | 71,855  |  |  | $ | 57,409  | 
|Reservation services    |  |      | 32,846  |      |  |      | 37,275  |  |  |   | 38,349  | 
|Financial services      |  |      | 31,534  |      |  |      | 33,699  |  |  |   | 30,244  | 
|Distribution services   |  |      | 27,379  |      |  |      | 27,330  |  |  |   | 28,743  | 
|                        |  |      |         |      |  |      |         |  |  |   |         | 
|Total service revenues  |  |      | 158,127 |      |  |      | 170,159 |  |  |   | 154,745 | 
|Customer reimbursements |  |      | 17,355  |      |  |      | 15,253  |  |  |   | 11,485  | 
|                        |  |      |         |      |  |      |         |  |  |   |         | 
|Total revenues          |  | $    | 175,482 |      |  | $    | 185,412 |  |  | $ | 166,230 | 
|                        |  |      |         |      |  |      |         |  |  |   |         | 

The following table presents revenue by
geographic location for the years ended December 31, 2005,
2004 and 2003 (in thousands):

|                                        |  |      |         |      |  |      |         |  |  |   |         | 
|--------------------------------------- |  | ---- | ------- | ---- |  | ---- | ------- |  |  | - | ------- | 
|                                        |  | 2005 |         | 2004 |  | 2003
|                                        |  |      |         |      |  |     
|Domestic                                |  | $    | 98,796  |      |  | $    | 106,537 |  |  | $ | 98,070  | 
|International, primarily United Kingdom |  |      | 76,686  |      |  |      | 78,875  |  |  |   | 68,160  | 
|                                        |  |      |         |      |  |      |         |  |  |   |         | 
|Total revenue                           |  | $    | 175,482 |      |  | $    | 185,412 |  |  | $ | 166,230 | 
|                                        |  |      |         |      |  |      |         |  |  |   |         | 

The following table presents net book value of
tangible long-lived assets by geographic location for the years
ended December 31, 2005 and 2004 (dollars in thousands):

|                                        |  |      |        |   |  |      |     |   |  |   |        |  |  |  |     |  
|--------------------------------------- |  | ---- | ------ | - |  | ---- | --- | - |  | - | ------ |  |  |  | --- | -
|                                        |  | 2005 |        | % |  | 2004 |     | %
|                                        |  |      |        |   |  |      |     |  
|Domestic                                |  | $    | 16,562 |   |  |      | 91  | % |  | $ | 18,912 |  |  |  | 91  | %
|International, primarily United Kingdom |  |      | 1,648  |   |  |      | 9   | % |  |   | 1,959  |  |  |  | 9   | %
|                                        |  |      |        |   |  |      |     |   |  |   |        |  |  |  |     |  
|Total long-lived assets                 |  | $    | 18,210 |   |  |      | 100 | % |  | $ | 20,871 |  |  |  | 100 | %
|                                        |  |      |        |   |  |      |     |   |  |   |        |  |  |  |     |  

65



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)



|    |                                                
|--- | -----------------------------------------------
|18. | Quarterly Results of Operations
    (unaudited)

The following table summarizes the consolidated
quarterly results of operations for 2005 and 2004 (in thousands):

|                                                                   |                         |                |        |         |   |              |         |             |   |   |        |        |   |   |        |        | 
|------------------------------------------------------------------ | ----------------------- | -------------- | ------ | ------- | - | ------------ | ------- | ----------- | - | - | ------ | ------ | - | - | ------ | ------ | 
|                                                                   |                         |               
|                                                                   |                         | Quarters Ended
|                                                                   |                         |               
|                                                                   |                         | March 31       |        | June 30 |   | September 30 |         | December 31
|                                                                   |                         |                |        |         |   |              |         |            
|2005                                                               |                         |                |        |         |   |              |         |             |   |   |        |        |   |   |        |       
|Service revenues                                                   |                         | $              | 37,090 |         |   | $            | 42,515  |             |   | $ | 41,278 |        |   | $ | 37,244 |       
|Customer reimbursements                                            |                         |                | 3,908  |         |   |              | 4,806   |             |   |   | 4,397  |        |   |   | 4,244  |       
|                                                                   |                         |                |        |         |   |              |         |             |   |   |        |        |   |   |        |       
|                                                                   | Total revenues          |                |        | 40,998  |   |              |         | 47,321      |   |   |        | 45,675 |   |   |        | 41,488 | 
|Costs of services (exclusive of depreciation and
    amortization) |                         |                | 24,883 |         |   |              | 25,939  |             |   |   | 25,219 |        |   |   | 22,699 |       
|Income (loss) from continuing operations
    before income taxes   |                         |                | (363   | )       |   |              | 3,859   |             |   |   | 3,793  |        |   |   | 1,126  |       
|Income (loss) from continuing operations                           |                         |                | (481   | )       |   |              | 2,691   |             |   |   | 2,432  |        |   |   | 587    |       
|Discontinued operations, net of tax                                |                         |                | (1,160 | )       |   |              | (11,697 | )           |   |   | (226   | )      |   |   | 199    |       
|Net income (loss)                                                  |                         |                | (1,641 | )       |   |              | (9,006  | )           |   |   | 2,206  |        |   |   | 786    |       
|Basic net income (loss) per common share:                          |                         |                |        |         |   |              |         |             |   |   |        |        |   |   |        |       
|                                                                   | Continuing operations   |                |        | (0.02   | ) |              |         | 0.13        |   |   |        | 0.12   |   |   |        | 0.03   | 
|                                                                   | Discontinued operations |                |        | (0.06   | ) |              |         | (0.56       | ) |   |        | (0.01  | ) |   |        | 0.01   | 
|                                                                   | Net income (loss)       |                |        | (0.08   | ) |              |         | (0.43       | ) |   |        | 0.11   |   |   |        | 0.04   | 
|Diluted net income (loss) per common share:                        |                         |                |        |         |   |              |         |             |   |   |        |        |   |   |        |       
|                                                                   | Continuing operations   |                |        | (0.02   | ) |              |         | 0.13        |   |   |        | 0.12   |   |   |        | 0.03   | 
|                                                                   | Discontinued operations |                |        | (0.06   | ) |              |         | (0.48       | ) |   |        | (0.01  | ) |   |        | 0.01   | 
|                                                                   | Net income (loss)       |                |        | (0.08   | ) |              |         | (0.35       | ) |   |        | 0.11   |   |   |        | 0.04   | 
|Basic weighted average shares outstanding                          |                         |                | 20,762 |         |   |              | 20,707  |             |   |   | 20,758 |        |   |   | 20,766 |       
|Diluted weighted average shares outstanding                        |                         |                | 20,762 |         |   |              | 24,639  |             |   |   | 20,941 |        |   |   | 20,890 |       
|2004                                                               |                         |                |        |         |   |              |         |             |   |   |        |        |   |   |        |       
|Service revenues                                                   |                         | $              | 40,451 |         |   | $            | 44,498  |             |   | $ | 44,470 |        |   | $ | 40,740 |       
|Customer reimbursements                                            |                         |                | 3,479  |         |   |              | 4,141   |             |   |   | 3,929  |        |   |   | 3,704  |       
|                                                                   |                         |                |        |         |   |              |         |             |   |   |        |        |   |   |        |       
|                                                                   | Total revenues          |                |        | 43,930  |   |              |         | 48,639      |   |   |        | 48,399 |   |   |        | 44,444 | 
|Costs of services (exclusive of depreciation and
    amortization) |                         |                | 26,188 |         |   |              | 26,239  |             |   |   | 25,351 |        |   |   | 23,443 |       
|Income (loss) from continuing operations
    before income taxes   |                         |                | (82    | )       |   |              | 7,093   |             |   |   | 7,265  |        |   |   | 6,140  |       
|Income (loss) from continuing operations                           |                         |                | (85    | )       |   |              | 4,406   |             |   |   | 4,882  |        |   |   | 3,257  |       
|Discontinued operations, net of tax                                |                         |                | (894   | )       |   |              | (1,003  | )           |   |   | (1,096 | )      |   |   | (1,482 | )     
|Net income (loss)                                                  |                         |                | (979   | )       |   |              | 3,403   |             |   |   | 3,786  |        |   |   | 1,775  |       

66



---



##### Table of Contents



PEGASUS SOLUTIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS  (Continued)

|                                            |                         |                |        |         |   |              |        |             |   |  |        |       |   |  |        |       |  
|------------------------------------------- | ----------------------- | -------------- | ------ | ------- | - | ------------ | ------ | ----------- | - |  | ------ | ----- | - |  | ------ | ----- | -
|                                            |                         |               
|                                            |                         | Quarters Ended
|                                            |                         |               
|                                            |                         | March 31       |        | June 30 |   | September 30 |        | December 31
|                                            |                         |                |        |         |   |              |        |            
|Basic net income (loss) per common share:   |                         |                |        |         |   |              |        |             |   |  |        |       |   |  |        |      
|                                            | Continuing operations   |                |        |        |   |              |        | 0.19        |   |  |        | 0.22  |   |  |        | 0.15  |  
|                                            | Discontinued operations |                |        | (0.04   | ) |              |        | (0.04       | ) |  |        | (0.05 | ) |  |        | (0.07 | )
|                                            | Net income (loss)       |                |        | (0.04   | ) |              |        | 0.15        |   |  |        | 0.17  |   |  |        | 0.08  |  
|Diluted net income (loss) per common share: |                         |                |        |         |   |              |        |             |   |  |        |       |   |  |        |      
|                                            | Continuing operations   |                |        |        |   |              |        | 0.18        |   |  |        | 0.20  |   |  |        | 0.14  |  
|                                            | Discontinued operations |                |        | (0.04   | ) |              |        | (0.04       | ) |  |        | (0.04 | ) |  |        | (0.05 | )
|                                            | Net income (loss)       |                |        | (0.04   | ) |              |        | 0.14        |   |  |        | 0.16  |   |  |        | 0.09  |  
|Basic weighted average shares outstanding   |                         |                | 24,717 |         |   |              | 23,230 |             |   |  | 22,131 |       |   |  | 21,556 |      
|Diluted weighted average shares outstanding |                         |                | 24,717 |         |   |              | 27,253 |             |   |  | 26,224 |       |   |  | 25,556 |      

In accordance with SFAS 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.

Subject to certain conditions, the Companys
convertible debt is convertible into common stock at a
conversion price of approximately $20.13 per share, equal to
approximately 3.7 million shares. No dilution for
convertible debt was included in the calculation for the
quarters ended March 31, 2005, September 30, 2005,
December 31, 2005, and March 31, 2004 as the effect
would be anti-dilutive to income from continuing operations for
these periods.

67



---



##### Table of Contents








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

None.






|         |                        
|-------- | -----------------------
|Item 9A. | Controls and Procedures

Disclosure Controls and Procedures.The Company maintains
(a) disclosure controls and procedures (as such term is
defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the Exchange
Act)) and (b) internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and
15d-15(f) under the Exchange Act). The Companys
management, with the participation of the Companys Chief
Executive Officer and Chief Financial Officer, has evaluated the
effectiveness of the Companys disclosure controls and
procedures as of the end of the period covered by this report.
Based on such evaluation, the Companys Chief Executive
Officer and Chief Financial Officer have concluded that, as of
the end of such period, the Companys disclosure controls
and procedures are effective.

Changes in Internal Control over Financial
Reporting.There have not been any
changes in the Companys internal control over financial
reporting during the fourth fiscal quarter of 2005 that have
materially affected, or are reasonably likely to materially
affect, the Companys internal control over financial
reporting.

Managements Report on Internal Control
over Financial Reporting.The Company
maintains a system of internal control over financial reporting,
as defined in Rules 13a-15(f) and 15d-15(f) under the
Securities Exchange Act, which is a process designed under the
supervision of the Companys Chief Executive Officer and
Chief Financial Officer and effected by the Companys Board
of Directors, management and other personnel, to provide
reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for
external purposes in accordance with generally accepted
accounting principles.

The Companys internal control over
financial reporting includes those policies and procedures that:



| |   |                                                                                                                                                                                                                                                                                                                                                                
| | - | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Pertain to the maintenance of records that in
    reasonable detail accurately and fairly reflect the transactions
    and dispositions of the assets of the Company;                                                                                                                                                                                          
|
| |  | Provide reasonable assurance that transactions
    are recorded as necessary to permit preparation of financial
    statements in accordance with generally accepted accounting
    principles, and that receipts and expenditures of the Company
    are being made only in accordance with authorizations of
    management and directors of the Company; and
|
| |  | Provide reasonable assurance regarding prevention
    or timely detection of unauthorized acquisition, use or
    disposition of the Companys assets that could have a
    material effect on the financial statements.                                                                                                                                       

Our management has responsibility for
establishing and maintaining adequate internal control over
financial reporting for the Company. Management, with the
participation of the Companys Chief Executive Officer and
Chief Financial Officer, conducted an evaluation of the
effectiveness of the Companys internal control over
financial reporting as of December 31, 2005 based on the
framework established by the Committee of Sponsoring
Organizations of the Treadway Commission (COSO).

Based on their evaluation of the Companys
internal control over financial reporting, the Companys
management along with the Chief Executive and Chief Financial
Officers concluded that the Companys internal control over
financial reporting is effective as of December 31, 2005.

Managements assessment of the effectiveness
of the Companys internal control over financial reporting
as of December 31, 2005 has been audited by
PricewaterhouseCoopers LLP, an independent registered public
accounting firm, as stated in its report which appears under
Item 8.

68



---



##### Table of Contents








|         |                  
|-------- | -----------------
|Item 9B. | Other Information

None




PART III






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

INFORMATION ABOUT PEGASUS DIRECTORS AND
EXECUTIVE OFFICERS

Set forth below are the positions with Pegasus
presently held by each director and executive officer of
Pegasus, and each such persons business experience for the
past five years. Each of the directors and executive officers is
a U.S. citizen, other than Mr. Collier who is a U.K.
citizen, and none has been convicted in a criminal proceeding
during the past five years, nor been a party to any judicial or
administrative proceeding, excluding traffic violations and
similar misdemeanors, during the past five years that resulted
in a judgment, decree or final order enjoining them from future
violations of, or prohibiting activities subject to, federal or
state securities laws, or finding of any violation of federal or
state securities laws.



| |          
| | ---------
| | Directors

Michael A. Barnett,age 52, has served as a Director of
Pegasus since February 1999. Mr. Barnett has served as
Chairman of the Board and Chief Executive Officer of Benchmark
Bank since 1988. Since 1983, Mr. Barnett has served as
President and Chairman of the Board of Barnett Interests, Inc.,
a diversified real estate management company. Since 1992,
Mr. Barnett has served as Chairman of the Board of Barnett
Lane Investments, Inc., a real estate investment and management
company. Since 1986, Mr. Barnett has served as President
and director of Quinlan Bancshares, Inc., a bank holding company

Robert B. Collier,age 66, has served as a Director of
Pegasus since July 1998. Mr. Collier currently serves on
the board of directors of United Kingdom based Daniel Thwaites
PLC.

John F. Davis, III,age 53, has served as Chief Executive
Officer of Pegasus since February 1989, as a Director since July
1995, as Chairman of the Board since March 2001 and as President
since January 2003. Mr. Davis also served as President of
Pegasus from February 1989 to January 2001. Mr. Davis is
also a director of TRX, Inc.

William C. Hammett,
Jr., age 59, has served as Vice
Chairman of the Board of Directors of Pegasus since May 2001 and
as a Director of Pegasus since October 1995. From May 1998 to
March 2001, Mr. Hammett served as Chairman of the Board of
Directors of Pegasus. From December 2001 to present,
Mr. Hammett has served as Senior Vice President and Chief
Financial Officer of Dave and Busters, Inc., a retail restaurant
and entertainment company.

Thomas F. OToole,age 48, has served as a Director of
Pegasus since May 1998. Since March 2003, Mr. OToole
has served as 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. From October 2000 to March 2003,
Mr. OToole served as Senior Vice President, Marketing
and Information Technology and from March 1999 to October 2000,
as Senior Vice President, Marketing for Hyatt Hotels Corporation.

Pamela H. Patsley,age 49, has served as a Director of Pegasus since May 2002.
Since March 2000, Ms. Patsley has served as Senior
Executive Vice President of First Data Corporation, a provider
of electronic commerce and payment services, and since May 2002,
as President of its subsidiary, First Data International,
responsible for all operations outside the United States within
the card issuing and merchant services businesses of First Data
Corporation. From March 2000 to May 2002, Ms. Patsley
served as the President of First Data Corporations
merchant transaction processing business unit. Ms. Patsley
served as President and Chief Executive Officer of Paymentech,
Inc., a processor of bankcard transactions and issuer of
commercial cards from 1991 to February 2000. Ms. Patsley is
also a director of Molson Coors Brewing Company and Texas
Instruments, Inc.

69



---



##### Table of Contents



Jeffrey A. Rich,age
45, has served as a Director of Pegasus since December 2000.
Mr. Rich currently serves as Chief Executive Officer of
Rich Capital LLC, a private investment firm. Mr. Rich
served as Chief Executive Officer of Affiliated Computer
Services, Inc. (ACS), a business process outsourcing
company, from February 1999 to September 2005 and as a director
of ACS from 1991 to September 2005.

Bruce W. Wolff,age
62, has served as a Director of Pegasus since October 1995.
Mr. Wolff served as Executive Vice President, Business
Development from November 2004 to February 2006, Executive Vice
President, Sales and Marketing Programs from February 2004 to
February 2006, and as Senior Vice President, Distribution Sales
and Strategy from July 1998 to February 2004, for the lodging
division of Marriott International, Inc. Mr. Wolff retired
from Marriott in February 2006.



| |                                                  
| | -------------------------------------------------
| | Executive Officers who are not also
    Directors

Robert J. Boles,
Jr., age 46, has served as Executive
Vice President, Chief Operating Officer of Pegasus since
December 2004. Mr. Boles served as Executive Vice
President, Sales and Marketing of Pegasus from May 2003 to
December 2004. From March 2000 to May 2003, Mr. Boles
served as President of AimNet Solutions, an Information
Technology network professional and managed services company.
From October 1982 through March 2000, Mr. Boles served in
various capacities at AT&T Global Network Services and its
predecessor, IBM Global Services, a global business solutions
company, most recently as Vice President of Sales and Support
from January 1999 through March 2000.

Susan K. Conner,age
42, has served as Executive Vice President and Chief Financial
Officer of Pegasus since May 2001. From May 1997 to April 2001,
Ms. Conner served as a partner in the Technology, Infocom,
Communication and Entertainment practice of
PricewaterhouseCoopers LLP, a global public accounting firm, in
the Dallas, Texas office.

Ric L. Floyd,age
54, has served as General Counsel of Pegasus since July 1995, as
Corporate Secretary since July 1997 and as Executive Vice
President since December 1999.

Michael H. Kistner,age 48, has served as Senior Vice President of Technology and
Operations of Pegasus since March 2005. From September 2000 to
February 2005, Mr. Kistner served as Chief Information
Officer and Senior Vice President of Distribution for Best
Western International, Inc. From June 1994 to August 2000,
Mr. Kistner served as a Senior Vice President at Cendant
Corp. Mr. Kistner has also served as Chairman of the Open
Travel Alliance (OTA) from 2000 to 2005 and continues to be
a board member of the OTA. He is also the Chairman of the
E-Business Committee of the American Hotel & Lodging
Association.

Andrew J. Stringer,age 38, has served as Vice President, Human Resources of Pegasus
since January 2004 and from September 1999 to January 2004 as
Director, Human Resources  Americas.

SECTION 16(A) BENEFICIAL OWNERSHIP
REPORTING COMPLIANCE

Section 16(a) of the Securities Exchange Act
of 1934 requires our executive officers, Directors and persons
who own more than 10% of our common stock to file reports of
ownership and changes in ownership with the Securities and
Exchange Commission. These persons are required to provide us
with copies of all Section 16(a) forms that they file.
Based solely on our review of these forms or written
representations from the executive officers and Directors, we
believe that all Section 16(a) filing requirements were met
during fiscal year 2005.

AUDIT COMMITTEE

The Audit Committee assists the Board of
Directors in connection with its oversight responsibilities
regarding the Companys financial reporting processes. The
Audit Committee is responsible for the appointment of the
Companys independent registered public accounting firm,
and has other responsibilities outlined in its charter. Members
of the Audit Committee are Michael A. Barnett, William C.
Hammett, Jr. and Pamela H. Patsley. Our Board of Directors has
determined that each member of the Audit Committee is an
audit committee financial expert as defined by the
Securities and Exchange Commissions rules and is

70



---



##### Table of Contents



independent as defined by the
National Association of Securities Dealers, Inc.s listing
standards and the Securities and Exchange Commissions
independence standards for Audit Committee members.


CODE OF ETHICS FOR FINANCIAL
PROFESSIONALS

We adopted a Code of Ethics for Senior Financial
Officers in 2003 and our CEO, CFO and Controller have each
certified as to their compliance with these ethical requirements
regarding company accounting and financial disclosure. Our Code
of Ethics for Senior Financial Officers are available under the
Corporate Governance page of the Investor
Center section of the Companys website, www.pegs.com.




Item 11. Executive
Compensation

NAMED EXECUTIVE OFFICERS
COMPENSATION

Summary Compensation Table.The following table sets forth the
compensation earned by our Chief Executive Officer and the four
other most highly compensated executive officers whose salary
and bonus for the fiscal year ended December 31, 2005, were
in excess of $100,000. These persons are collectively referred
to as the Named Executive Officers.

In accordance with the rules of the Securities
and Exchange Commission, the compensation described in the
following table does not include medical insurance, group life
insurance and certain other benefits received by the Named
Executive Officers that are available generally to all salaried
Pegasus employees.

Summary Compensation Table

|                            |                             |      |      |        |  |                     |         |                  |  |            |        |            |  |                 |        |        |  |   |        |         |  |  |        |         |  |   |         |         | 
|--------------------------- | --------------------------- | ---- | ---- | ------ |  | ------------------- | ------- | ---------------- |  | ---------- | ------ | ---------- |  | --------------- | ------ | ------ |  | - | ------ | ------- |  |  | ------ | ------- |  | - | ------- | ------- | 
|                            |                             |      |      |        |  |                     |         |                  |  |            |        |           
|                            |                             |      |      |        |  |                     |         | Long-Term Awards |  |           
|                            |                             |      |      |        |  | Annual Compensation |         |                  |  |           
|                            |                             |      |      |        |  |                     |         | Restricted       |  | Securities |        |           
|                            |                             |      |      |        |  |                     |         | Other Annual     |  | Stock      |        | Underlying |  | All Other      
|Name and Principal Position |                             | Year |      | Salary |  | Bonus(1)            |         | Compensation(2)  |  | Awards(3)  |        | Options    |  | Compensation(4)
|                            |                             |      |      |        |  |                     |         |                  |  |            |        |            |  |                
|John F. Davis, III(5)       |                             |      | 2005 |        |  | $                   | 447,834 |                  |  |            |       |            |  | $               | 45,000 |        |  |   |       |         |  |  |       |         |  | $ | 239,133 |        
|                            | President, Chief Executive  |      |      | 2004   |  |                     | $       | 424,008          |  |            | $      | 191,250    |  |                 | $      | 45,000 |  |   | $      | 148,125 |  |  |        | 150,000 |  |   | $       | 188,278 | 
|                            | Officer and Chairman of     |      |      | 2003   |  |                     | $       | 424,008          |  |            |        |           |  |                 | $      | 45,000 |  |   |        |        |  |  |        | 180,000 |  |   | $       | 204,170 | 
|                            | the Board                   |      |      |        |  |                     |         |                  |  |            |        |            |  |                 |        |        |  |   |        |         |  |  |        |         |  |   |         |         | 
|Robert J. Boles, Jr.(5)(6)  |                             |      | 2005 |        |  | $                   | 300,000 |                  |  |            |       |            |  | $               | 35,000 |        |  |   |       |         |  |  |       |         |  | $ | 125,773 |        
|                            | Executive Vice President    |      |      | 2004   |  |                     | $       | 280,000          |  |            | $      | 133,650    |  |                 | $      | 35,000 |  |   | $      | 111,094 |  |  |        | 112,500 |  |   | $       | 104,118 | 
|                            | and Chief Operating Officer |      |      | 2003   |  |                     | $       | 173,939          |  |            |        |           |  |                 | $      | 21,875 |  |   |        |        |  |  |        | 75,000  |  |   | $       | 63,335  | 
|Susan K. Conner(5)          |                             |      | 2005 |        |  | $                   | 284,350 |                  |  |            |       |            |  | $               | 35,000 |        |  |   |       |         |  |  |       |         |  | $ | 52,226  |        
|                            | Executive Vice President    |      |      | 2004   |  |                     | $       | 252,625          |  |            | $      | 64,625     |  |                 | $      | 35,000 |  |   | $      | 88,875  |  |  |        | 90,000  |  |   | $       | 40,481  | 
|                            | and Chief Financial Officer |      |      | 2003   |  |                     | $       | 235,000          |  |            |        |           |  |                 | $      | 35,000 |  |   |        |        |  |  |        | 90,000  |  |   | $       | 36,489  | 
|Ric L. Floyd(5)             |                             |      | 2005 |        |  | $                   | 254,678 |                  |  |            |       |            |  | $               | 35,000 |        |  |   |       |         |  |  |       |         |  | $ | 103,252 |        
|                            | Executive Vice President,   |      |      | 2004   |  |                     | $       | 239,663          |  |            | $      | 60,638     |  |                 | $      | 35,000 |  |   | $      | 88,875  |  |  |        | 90,000  |  |   | $       | 88,695  | 
|                            | General Counsel and         |      |      | 2003   |  |                     | $       | 231,000          |  |            |        |           |  |                 | $      | 35,000 |  |   |        |        |  |  |        | 100,000 |  |   | $       | 89,040  | 
|                            | Corporate Secretary         |      |      |        |  |                     |         |                  |  |            |        |            |  |                 |        |        |  |   |        |         |  |  |        |         |  |   |         |         | 
|Michael H. Kistner(5)(7)    |                             |      | 2005 |        |  | $                   | 200,000 |                  |  | $          | 59,200 |            |  | $               | 20,833 |        |  | $ | 24,300 |         |  |  | 75,000 |         |  | $ | 4,075   |        
|                            | Senior Vice President,      |      |      |        |  |                     |         |                  |  |            |        |            |  |                 |        |        |  |   |        |         |  |  |        |         |  |   |         |         | 
|                            | Operations and Technology   |      |      |        |  |                     |         |                  |  |            |        |            |  |                 |        |        |  |   |        |         |  |  |        |         |  |   |         |         | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Each bonus is reflected in the year in which it
    was earned, not the year in which it was paid.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   
|(2) | Other Annual Compensation represents payments to
    the Named Executive Officers under the Pegasus Solutions, Inc.
    Executive Perquisite Plan (Perquisite Plan),
    covering expenses allowable under the Perquisite Plan, which may
    include: automobiles, club memberships and financial, legal and
    investment counseling. Perquisite benefit amounts are allocated
    to participants in the Perquisite Plan on an annual basis and
    are paid to the participants in equal semi-monthly payments
    throughout the year. The Company has no basis for identifying
    Perquisite Plan expenses by type.
|   
|(3) | The restricted stock award value was calculated
    by multiplying the closing market price of the Companys
    stock on the date of grant by the number of restricted shares
    awarded. At December 31, 2005,                                                                                                                                                                                                                                                                                                                                                                                                            

71



---



##### Table of Contents



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    | Messrs. Davis, Boles, Floyd and Kistner and
    Ms. Conner each held an aggregate of 12,500, 9,375, 7,500,
    2,000 and 7,500 shares of restricted stock, respectively, with a
    value of $112,125, $84,094, $67,275, $17,940 and $67,275,
    respectively, based on the closing price of the Companys
    Common Stock on December 31, 2005 ($8.97 per share). The
    restricted stock awards vest in full on the fourth anniversary
    of the date of grant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   
|(4) | For the year ended December 31, 2005, All
    Other Compensation includes: (i) matching contributions
    made by the Company pursuant to its 401(k) plan for the accounts
    of Messrs. Davis, Boles, Floyd, Kistner and Ms. Conner
    in the amounts of $10,250, $10,250, $10,254, $4,075, and
    $10,250, respectively, (ii) contributions allocated by
    Pegasus under the Companys Executive Deferred Compensation
    Plan for the accounts of Messrs. Davis, Boles and Floyd and
    Ms. Conner in the amounts of $208,450, $30,863, $92,235 and
    $41,676, respectively, (iii) premiums paid for life
    insurance policies for the benefit of Messrs. Davis, Boles
    and Floyd and Ms. Conner and their designees in the amounts
    of $20,433, $470, $763 and $300, respectively, and
    (iv) expenses paid by the Company relating to
    Mr. Boles commuting, including airfare, temporary
    lodging and transportation, in the amount of $59,190 and a
    relocation bonus in the amount of $25,000. Mr. Davis is
    entitled to receive an interest in the cash surrender value of
    two life insurance policies for which the premiums are paid by
    the Company and are included in (iii) above.
|   
|(5) | The salaries of Messrs. Davis, Boles, Floyd,
    and Ms. Conner were established by the Compensation
    Committee and paid in accordance with the terms of their
    respective employment agreements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|   
|(6) | Mr. Boles became an employee of Pegasus on
    May 19, 2003.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|   
|(7) | Mr. Kistner became an employee of Pegasus on
    March 1, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       

Option Grants In Last Fiscal Year.The following table sets forth the
stock option grants made during the year ended December 31,
2005, to the Named Executive Officers.

|                     |  |                      |        |            |  |                |       |            |  |            |       |  |  |  |         |  |  |   |         | 
|-------------------- |  | -------------------- | ------ | ---------- |  | -------------- | ----- | ---------- |  | ---------- | ----- |  |  |  | ------- |  |  | - | ------- | 
|                     |  |                      |        | % of Total |  |                |       |            |  |           
|                     |  | Number of Securities |        | Options    |  |                |       |            |  | Grant Date
|                     |  | Underlying Options   |        | Granted in |  | Exercise Price |       | Expiration |  | Present   
|Name                 |  | Granted(1)           |        | 2005(2)    |  | per Share(3)   |       | Date(4)    |  | Value(5)  
|                     |  |                      |        |            |  |                |       |            |  |           
|John F. Davis, III   |  |                      |       |            |  |                |      |            |  |            |      |  |  |  |        |  |  |   |        | 
|Robert J. Boles, Jr. |  |                      |       |            |  |                |      |            |  |            |      |  |  |  |        |  |  |   |        | 
|Susan K. Conner      |  |                      |       |            |  |                |      |            |  |            |      |  |  |  |        |  |  |   |        | 
|Ric L. Floyd         |  |                      |       |            |  |                |      |            |  |            |      |  |  |  |        |  |  |   |        | 
|Michael H. Kistner   |  |                      | 60,000 |            |  |                | 21.99 | %          |  | $          | 11.92 |  |  |  | 3/01/15 |  |  | $ | 330,600 | 
|Michael H. Kistner   |  |                      | 15,000 |            |  |                | 5.50  | %          |  | $          | 10.47 |  |  |  | 5/12/15 |  |  | $ | 68,400  | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | On March 1, 2005 and May 12, 2005,
    options were granted to Mr. Kistner under the Pegasus
    Solutions, Inc. 2002 Stock Incentive Plan. These options vest
    over a four year period with 25% of the shares vesting on the
    first anniversary of the date of grant and 6.25% of the shares
    vesting after every three month period thereafter until fully
    vested. The vesting of these options may accelerate under
    certain circumstances, including upon an acquisition event as
    described in our stock option plans and as described in the
    executives employment agreements.
|   
|(2) | Based on options granted during 2005 to purchase
    an aggregate of 272,800 shares of common stock.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   
|(3) | The exercise price for the option is equal to the
    closing price of the common stock as quoted on the Nasdaq
    National Market on the date immediately preceding the grant date.                                                                                                                                                                                                                                                                                                                                                                                                                       
|   
|(4) | All options have a term of approximately ten
    (10) years, but may terminate before their expiration date
    in the event of the death, disability or termination of
    employment of the optionee.                                                                                                                                                                                                                                                                                                                                                                                                     
|   
|(5) | These values are determined using the
    Black-Scholes Option Pricing Model. The Black-Scholes Option
    Pricing Model is one of the methods permitted by the Securities
    and Exchange Commission for estimating the present value of
    options. The Black-Scholes Option Pricing Model is based on
    assumptions as to the variables described below, and it is not
    intended to estimate and has no direct correlation to the value
    of stock options that an individual will actually realize. The
    actual value of the stock options                                                  

72



---



##### Table of Contents



| |                                                                                                                                                                                                                                
| | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| | that a Named Executive Officer may realize, if
    any, will depend on the excess of the market price on the date
    of exercise over the exercise price. The values listed above
    were based on the following assumptions:

|                         |  |          |      |          |  |  |      |  
|------------------------ |  | -------- | ---- | -------- |  |  | ---- | -
|                         |  | Options  |      | Options 
|                         |  | Expiring |      | Expiring
|                         |  | 03/01/15 |      | 05/12/15
|                         |  |          |      |         
|Volatility               |  |          | 54.5 | %        |  |  | 50.4 | %
|Risk free rate of return |  |          | 3.85 | %        |  |  | 3.80 | %
|Dividend Yield           |  |          | 0    | %        |  |  | 0    | %
|Expected Life (years)    |  |          | 4    |          |  |  | 4    |  

Aggregate Option Exercises in Last Fiscal Year
and Fiscal Year-End Option Values.The
following table sets forth information concerning options
exercised during 2005 and options held on December 31,
2005, by our Named Executive Officers.

|                    |  |             |        |             |  |                        |         |                        |  |             |         |               |  |  |         |  |  |   |         |  |  |  |   | 
|------------------- |  | ----------- | ------ | ----------- |  | ---------------------- | ------- | ---------------------- |  | ----------- | ------- | ------------- |  |  | ------- |  |  | - | ------- |  |  |  | - | 
|                    |  |             |        |             |  |                        |         |                       
|                    |  |             |        |             |  | Number of Securities   |         | Value of Unexercised  
|                    |  |             |        |             |  | Underlying Unexercised |         | In-The-Money          
|                    |  | Shares      |        |             |  | Options at Year-End    |         | Options at Year-End(2)
|                    |  | Acquired on |        | Value       |  |                        |         |                       
|Name                |  | Exercise    |        | Realized(1) |  | Exercisable            |         | Unexercisable          |  | Exercisable |         | Unexercisable
|                    |  |             |        |             |  |                        |         |                        |  |             |         |              
|John F. Davis, III  |  |             | 13,000 |             |  | $                      | 139,624 |                        |  |             | 808,750 |               |  |  | 183,750 |  |  | $ | 443,150 |  |  |  |  | 
|Robert J. Boles, Jr |  |             |       |             |  |                        |        |                        |  |             | 89,062  |               |  |  | 98,438  |  |  |   |        |  |  |  |  | 
|Susan K. Conner     |  |             | 15,000 |             |  | $                      | 31,050  |                        |  |             | 118,750 |               |  |  | 101,250 |  |  |   |        |  |  |  |  | 
|Ric L. Floyd        |  |             | 15,600 |             |  | $                      | 33,462  |                        |  |             | 220,500 |               |  |  | 106,250 |  |  | $ | 2,535   |  |  |  |  | 
|Michael H. Kistner  |  |             |       |             |  |                        |        |                        |  |             |        |               |  |  | 75,000  |  |  |   |        |  |  |  |  | 



---



|    |                                                                                                                                                                                                                                                                                                                                   
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(1) | Based on the difference between the option
    exercise price and the fair market price of the shares on the
    exercise date.                                                                                                                                                                                                   
|   
|(2) | Based on the difference between the option
    exercise price and the closing sale price of $8.97 of
    Pegasus common stock as reported on the Nasdaq National
    Market on December 31, 2005, the last trading day prior to
    the closing of our fiscal year multiplied by the number of
    shares underlying the options.

Employment Agreements.Pegasus has entered into employment
agreements with Messrs. Davis, Boles, Floyd and
Ms. Conner. These employment agreements have been filed as
exhibits to the Companys Securities and Exchange
Commission filings. Mr. Kistner was hired in 2005 and the
company entered into an employment agreement with him.
Messrs. Davis and Floyds and
Ms. Conners employment agreements original
terms expired on January 1, 2004, January 1, 2004 and
May 7, 2005, respectively; however, such terms have
automatically extended indefinitely until the agreements are
terminated by either party. Mr. Boles employment
agreements original term expires on May 19, 2007,
however, such term automatically extends indefinitely until the
agreement is terminated. Mr. Kistners agreement will
expire on March 1, 2008 and will be renewed automatically
and extended for successive 30 day periods thereafter until
terminated. Each of the agreements with Messrs. Davis,
Boles, Floyd and Ms. Conner provide for annual base
salaries and eligibility to receive a discretionary annual bonus
in accordance with a bonus plan approved by the Compensation
Committee. Mr. Kistners agreement provides for annual
base salary adjustments and eligibility to receive a
discretionary annual bonus in accordance with the term and
conditions of the bonus plan approved by the Company.

The employment agreements of Messrs. Davis,
Boles, and Floyd and Ms. Conner provide for entitlement to
participate in Pegasus Executive Retirement Program
(described below).

The employment agreements of Messrs. Davis,
Boles, and Floyd and Ms. Conner provide that Pegasus may
terminate the executives employment with or without cause
(as that term is defined in each agreement) or upon death or
disability. Each of the executives may terminate the agreement
for good reason (as that term is defined in the agreement and
including a change of control of Pegasus) or voluntarily.
Mr. Kistners agreement provides that he may be
terminated with or without cause and that he may terminate
voluntarily.

73



---



##### Table of Contents



Under the employment agreements of
Messrs. Davis, Boles and Floyd and Ms. Conner, if the
executives employment is terminated by Pegasus for death
or disability, the executive is entitled to all accrued
compensation and a pro-rata bonus through the termination date,
base salary, perquisite plan and bonus for one year, options and
other incentive based awards vest for one additional year, and
payments as provided by the Executive Retirement Program (see
Executive Retirement Programbelow). If the
executives employment is terminated by Pegasus without
cause or by the executive for good reason, including a change of
control, the executive is entitled to all accrued compensation
and a pro rata bonus, base salary and bonus for 24 months,
continuation of customary and usual benefits for 12 months,
options and other incentive based awards vest for an additional
period or in full, and Messrs. Davis and Floyd continue to
accrue benefits and vesting of service for two years for
purposes of the Executive Retirement Program. Under
Mr. Kistners agreement, if his employment is
terminated by the company for reasons other than cause or by
Mr. Kistner, he is entitled to his base pay and perquisite
plan for one year following termination as well as expense
reimbursement for COBRA medical insurance, dental insurance and
including health care spending account coverage.

Executive Retirement Program.In 2002, the Board of Directors
retained the services of an independent executive compensation
consulting company to analyze our Executive Retirement Program
and to recommend a program commensurate with a peer group of
companies and consistent with the Compensation Committees
executive compensation policies. Based upon the recommendations
of the consulting company, effective July 1, 2002, the
Board of Directors adopted an Executive Retirement Program,
consisting of an amended and restated Supplemental Executive
Retirement Plan (the SERP) and a Deferred
Compensation Plan (the DCP). The purposes of the
Executive Retirement Program are to promote executive
managements interest in the successful operation of the
business and increased efficiency in their work, to align the
financial interests of such employees with those of Company
stockholders, to ensure competitive pay and benefits for those
individuals and to provide an opportunity for accumulation of
funds for their retirement. The Executive Retirement Program
provides supplemental retirement benefits to certain management
employees of Pegasus selected by the Compensation Committee in
its discretion, permits such employees to defer amounts of their
compensation, provides for employer contributions that exceed
the permitted employer matching contribution limits under the
Pegasus 401(k) plan, and rewards long-term service through
employer and supplemental contributions to a deferred account
for each participant. No person has an automatic right to become
a participant in the Executive Retirement Program.

Supplemental Executive Retirement Plan.Benefits under the SERP are computed
on a single-life annuity basis and become payable to the
participant or his or her beneficiary, as applicable, upon
retirement, death, total and permanent disability or termination
of employment (other than for cause). Upon retirement, total and
permanent disability or termination of employment (but following
disability or termination of employment, deferred until age 60),
the participant will receive monthly benefits equal to the
greater of (a) 3% of his or her monthly targeted base
salary and bonus as of July 1, 2002, multiplied by his or
her years of service as of July 1, 2002, increased by 5%
per annum until termination of employment (but not to exceed 60%
or, in the case of the Chief Executive Officer, 70%, of the
participants final average compensation; or if greater,
targeted July 1, 2002, compensation), or (b) one-half
percent (1/2%) of the participants final average
compensation multiplied by his or her years of service. In the
event of death, the participants beneficiary will receive
a lump-sum payment equal to an actuarially equivalent amount.
SERP benefits may also be paid, at the option of the
participant, in the form of an actuarially equivalent ten-year
fixed annuity, a joint and 50% or 100% survivor annuity, or, in
the Compensation Committees discretion, a partial or full
lump sum. Also, the participant may receive an actuarially
equivalent lump sum payment of his or her benefit if, within
twelve months following a change of control, (i) his or her
employment terminates or (ii) he or she elects to cease
further participation in the SERP.

During 2005, Pegasus recorded compensation
expense of approximately $545,000 for future payments under the
terms of the SERP. The current Named Executive Officers
participating in the SERP are Ms. Conner and
Messrs. Davis, Boles, and Floyd.

The estimated annual benefit payable under the
SERP upon retirement at age 60 is, for Ms. Conner,
$117,839, for Mr. Davis, $487,408, for Mr. Boles,
$74,351 and for Mr. Floyd $120,013.

74



---



##### Table of Contents



Deferred Compensation
Plan.Effective July 1, 2002, the
DCP permits each participant to defer up to 100% of his or her
compensation, to be credited to his or her account in the DCP.
Pegasus contributes to each participants account in the
DCP (a) a restoration contribution equal to the maximum
potential matching contribution under the Pegasus 401(k) Plan
(reduced by the actual match for the participant for the year),
(b) an employer contribution equal to 1% of compensation
multiplied by years of service (not to exceed 25% of
compensation), (c) for 2003, a supplemental contribution
equal to $10,000 multiplied by years of service determined as of
the end of the preceding year, and (d) for 2004 through
2006, a supplemental contribution equal to $5,000 multiplied by
years of service determined as of the end of the preceding year.
In 2006, the Board of Directors amended the DCP to change the
companys Restoration Contribution (as defined in the DCP),
effective January 1, 2006, to be equal to the
companys matching contribution for all employees under its
401(k) Plan.

During 2005, Pegasus recorded compensation
expense for the Named Executive Officers of approximately
$319,000 attributable to the DCP. The current Named Executive
Officers participating in the DCP are Messrs. Davis, Boles,
Floyd and Ms. Conner.

In response to proposed Internal Revenue Code
Section 409A, at a meeting on December 12, 2005, the
Board of Directors approved the adoption of new terms for
post-2004 benefits under our executive retirement program. The
Board elected to grandfather existing terms of the
plans with regard to amounts not subject to new
Section 409A (benefits that were accrued and vested at
December 31, 2004). The plans terms for these
grandfathered vested benefits remain unchanged. As
permitted by the transition rules under new Section 409A,
the plans were also amended to provide participants new payment
elections during 2005 with regard to benefits under the plans
that are subject to Section 409A. Generally, the payment
elections available under the plans are unchanged, except that
the Board amended the SERP to permit participants to elect lump
sum payments without requiring the consent of the Board of
Directors.

All Executive Retirement Program benefits are
paid from the general assets of Pegasus and the Executive
Retirement Program is an unfunded deferred compensation
arrangement, not subject to the annual reporting and disclosure
requirements of the Employee Retirement Income Security Act of
1974. Pegasus has created and is required to make deposits to a
grantor trust (the assets of which are available to its general
creditors in the event of insolvency). Cash payments to the
trust in 2005 totaled approximately $460,000 related to the SERP
and $192,000 related to the DCP. The amounts funded to the trust
are generally not available for use in the Companys
ongoing operations.

Equity Compensation Plans.The Companys 1996 Stock Option
Plan (1996 Plan), amended and approved by
stockholders in March 1997, provides that options to purchase
1.3 million shares of the Companys common stock may
be granted to Company employees. The Companys 2002 Stock
Incentive Plan (2002 Plan), approved by stockholders
in May 2002, provides that options to purchase shares of the
Companys common stock and restricted stock awards may be
granted to Company employees, non-employee Directors and
consultants. The number of shares reserved for issuance under
both plans as of December 31, 2005 (before the share
replenishment described in the following sentence) was
approximately 3.0 million. The 2002 Plan further provides
that the number of shares reserved for issuance as options or
restricted stock will be replenished annually by an amount equal
to four percent of the fully-diluted shares of the Company
outstanding as of the last day of the immediately preceding
year. As defined in the 2002 Plan, the applicable number of
shares outstanding as of December 31, 2005, was
approximately 27.9 million. The 2002 Plan authorizes the
grant of restricted stock, the amount of which, during any
fiscal year, shall not exceed 2.5 percent of the number of
shares reserved for issuance under the 2002 Plan.

Options granted under the 1996 Plan and the 2002
Plan (collectively the Plans) may be in the form of
incentive stock options or nonqualified stock options. The
Compensation Committee of the Board of Directors administers the
Plans. Options granted to Company employees generally vest over
a four-year period. Options granted to non-employee Directors
vest and expire as determined by the Compensation Committee.
Options granted under the 1996 Plan before September 15,
1999 expired on December 31, 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

75



---



##### Table of Contents



of grant. The Companys authorized but
unissued common stock is used for issuance of shares as stock
options are exercised.


DIRECTORS COMPENSATION

During 2005, the Companys standard
arrangements for Director compensation included an annual
payment of $15,000, payable in quarterly installments, for a
non-employee Chairman of the Board. All other non-employee
Directors receive $10,000 annually, payable quarterly.
Non-employee Audit Committee members receive annual retainer
fees of $5,000 per member and $10,000 for the Chairman.
Additionally, each non-employee Director receives $2,500 for
each Board of Directors meeting attended in person and $1,250
for each Board of Directors meeting attended telephonically.
Each non-employee Director also receives $1,000 for each
committee meeting attended in person and $500 for each committee
meeting attended telephonically. Each Committee Chairman
receives an additional $500 for each committee meeting attended
in person and an additional $250 for each committee meeting
attended telephonically. Personal attendance or telephonic
attendance at informal Board of Directors and committee
gatherings is compensated in the same manner as personal or
telephonic attendance at formal Board of Directors and committee
meetings, as the case may be. Directors are also reimbursed for
all reasonable expenses incurred while performing their duties
as Directors of Pegasus.

Non-employee Directors receive stock option
grants as follows:



| |   |                                                                                                                                                                                                                                                                                                                                
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | Options to purchase 20,000 shares of common stock
    of Pegasus at the closing price on the date immediately
    preceding election as a Director. These options have a ten-year
    term and vest over a three year period, with 1/12 of the option
    shares vesting each quarter during the Directors term of
    office;
|
| |  | An additional grant of 8,000 option shares at the
    closing price of the stock on the day preceding each subsequent
    anniversary date of election to office. These options have a
    ten-year term and vest 25% each quarter during the
    Directors term of office, vesting in full in one year; and                  
|
| |  | Such additional grants as may be awarded at the
    discretion of the Compensation Committee.                                                                                                                                                                                                                                  

COMPENSATION COMMITTEE INTERLOCKS AND INSIDER
PARTICIPATION

The Compensation Committee approves and makes
recommendations to the Board of Directors concerning salaries
and incentive compensation for Pegasus officers and
employees and administers our employee stock purchase plan and
stock option plans. Members of the Compensation Committee are
Michael A. Barnett, Robert B. Collier, William C. Hammett, Jr.
and Jeffrey A. Rich. These were the only members of such
committee during 2005, and none of them have ever been an
officer or employee of Pegasus. During 2005, no member of the
Compensation Committee had a relationship with any other company
that requires disclosure as a compensation committee
interlock as that term is defined by the Securities and
Exchange Commission rules.

COMPENSATION COMMITTEE REPORT

Each member of the Compensation Committee of the
Board of Directors is an independent non-employee director. The
Compensation Committee, among other activities described in its
charter (available at www.pegs.com):



| |   |                                                                                                                                                                                                                                            
| | - | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | discharges the Boards responsibilities
    relating to compensation of the Companys directors and
    executive officers;                                                                                                                
|
| |  | reviews and periodically approves a general
    compensation program and salary structure for management
    employees;                                                                                                                    
|
| |  | reviews and makes recommendations to the Board
    with respect to the adoption, amendment and termination of
    management incentive compensation and equity-compensation plans,
    as well as other benefit and compensation plans; and

76



---



##### Table of Contents





| |   |                                                                                                                                                                   
| | - | ------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |  | makes decisions with respect to awards under the
    Companys stock option and incentive plans for such awards
    to satisfy Securities Exchange Act Rule 16b-3.

The Compensation Committees executive
compensation policies are designed to:



| |   |                                                                                                                            
| | - | ---------------------------------------------------------------------------------------------------------------------------
| |  | provide competitive levels of compensation that
    integrate pay with Pegasus annual and long-term
    performance goals;
|
| |  | reward above average corporate performance;                                                                                
|
| |  | recognize individual initiative and achievements;
    and                                                                  
|
| |  | attract and retain qualified executives.                                                                                   

The Compensation Committee regularly reviews
executive officer compensation. In 2004, the Compensation
Committee retained the services of KPMG LLP as an independent
consultant to analyze and make recommendations with respect to
executive officer compensation. Included in the process was a
determination by the Compensation Committee and KPMG LLP of an
appropriate peer group to support the analysis. The Compensation
Committee also conducted a review during 2004 of the
Companys payment and other obligations pursuant to the
termination provisions of the employment agreements of the
Companys executive officers.

The Compensation Committee believes stock
ownership by management and performance-based compensation
arrangements are beneficial in aligning managements
interests with those of our stockholders. In addition to
stock-based awards in the form of restricted stock and stock
option grants, each of our executive officers receives an annual
base salary and is eligible to receive a discretionary annual
bonus. The Compensation Committee considers and approves
discretionary bonus plans and annual bonuses based on a
percentage of the executives annual salary and established
financial and other corporate goals, as well as individual
performance criteria for each executive. The amount of the
annual cash bonus is based on a percentage of each
executives annual salary, with the target amount per year
for each particular executive ranging from 25% to 100% of the
executives annual base salary (the Target
Bonus). The specific percentage of the Target Bonus to be
awarded an executive is based upon an adjusted earnings per
share (adjusted EPS) goal and the achievement of
individualized goals specific to each executive officer, such as
improving customer satisfaction, delivering key projects within
timing and budget goals, managing and reducing certain
expenditures, achieving specific revenue goals and achieving
specified growth goals with respect to certain service offerings
(the Individualized Targets). A percentage of the
Target Bonus is attributable to the adjusted EPS goal and each
Individualized Target. Failure of the Company to achieve the
adjusted EPS goal or failure of the executive to achieve the
Individualized Targets could result in elimination or reduction
of the bonus depending upon the percentage attributable to the
unmet performance criteria. The executive is eligible to receive
a specified percentage of the Target Bonus in excess of the
Target Bonus in the event the executive satisfies all of the
Individualized Targets and the Company exceeds its adjusted EPS
goal. The Company uses adjusted EPS in connection with the bonus
plan because it believes this measure enables a more thorough
evaluation of the Companys current performance as compared
to past performance and provides a better baseline for assessing
the Companys future earnings expectations. Each of the
current executive officers of the Company listed in this proxy
statement participate in the bonus plan. Targeted levels of
total executive compensation are generally set at levels we
believe to be consistent with other companies in Pegasus
industry. Actual compensation levels in any particular year may
be above or below those of our competitors depending on the
executives or Pegasus performance.

2005 Chief Executive Officer Compensation.Mr. Davis compensation for
2005 as Chief Executive Officer of Pegasus primarily consisted
of a base salary. The Compensation Committee determined
Mr. Davis 2005 base salary based upon the terms of
his employment agreement, information received from executive
compensation consultants and the factors discussed above
relating to executive compensation. Mr. Davis bonus
was determined by the Compensation Committee based upon Company
and personal performance criteria as more specifically described
above. Mr. Davis also received matching contributions under
Pegasus 401(k) plan and Pegasus pays for life insurance
premiums on Mr. Davis and his dependents
behalf. Additionally, in 2005, the Company recorded compensation
expense of approximately $517,000 under the

77



---



##### Table of Contents



Executive Retirement Program for
Mr. Davis benefit (See Executive Retirement
Program description on page 74). In 2005, the Compensation
Committee evaluated Mr. Davis performance as Chief
Executive Officer. Mr. Davis does not participate in the
Compensation Committees decisions regarding his
compensation.


Limit on Deductibility of Executive
Compensation.In 1993, Congress
amended the Internal Revenue Code to add Section 162(m).
This Section of the Internal Revenue Code limits the
deductibility of compensation paid to specified executive
officers to $1,000,000 per officer in any one year. Compensation
that qualifies as performance-based compensation is not taken
into account for the purposes of this limitation. Pegasus
obtained stockholder approval at the 1999 annual meeting of an
amendment to its 2002 Stock Incentive Plan to allow Pegasus to
deduct the compensation arising from the exercise of stock
options granted under the 2002 Plan even if the compensation
paid to any of the Named Executive Officers exceeds the
deductible limit. The Compensation Committee intends to
recommend further action in connection with Pegasus other
benefit plans and salary and bonus policies to address this
issue if and when circumstances arise.



| |                                                                        
| | -----------------------------------------------------------------------
| | Submitted by the Compensation Committee 
     of the Board of Directors
|
| | ROBERT B. COLLIER, Chairman                                            
| | MICHAEL A. BARNETT                                                     
| | WILLIAM C. HAMMETT, JR.                                                
| | JEFFREY A. RICH                                                        

78



---



##### Table of Contents



STOCK PERFORMANCE GRAPH

Research Data Group, Inc. prepared the following
graph. It shows how an initial investment of $100 in
Pegasus common stock on December 31, 2000, would have
compared to an equal investment in The Russell 2000 Composite
Stock Market Index and a peer group. Pegasus peer group is
comprised of Cendant Corporation, MICROS Systems, Inc., Sabre
Holdings Corporation and IAC InterActiveCorp (formerly USA
Interactive).

COMPARISON OF 5 YEAR CUMULATIVE TOTAL
RETURN*

AMONG PEGASUS SOLUTIONS, INC., THE RUSSELL 2000
INDEX AND A PEER GROUP


LOGO

CUMULATIVE TOTAL RETURN

|                        |  |       |        |       |  |       |        |       |  |       |        |       |  |  |        |  |  |  |        |  |  |  |        | 
|----------------------- |  | ----- | ------ | ----- |  | ----- | ------ | ----- |  | ----- | ------ | ----- |  |  | ------ |  |  |  | ------ |  |  |  | ------ | 
|                       
|                       
|                        |  | 12/00 |        | 12/01 |  | 12/02 |        | 12/03 |  | 12/04 |        | 12/05
|                       
|                       
|PEGASUS SOLUTIONS, INC. |  |       | 100.00 |       |  |       | 204.68 |       |  |       | 144.58 |       |  |  | 150.92 |  |  |  | 181.62 |  |  |  | 129.30 | 
|                       
|RUSSELL 2000            |  |       | 100.00 |       |  |       | 102.49 |       |  |       | 81.49  |       |  |  | 120.00 |  |  |  | 142.00 |  |  |  | 148.46 | 
|                       
|PEER GROUP              |  |       | 100.00 |       |  |       | 151.55 |       |  |       | 90.62  |       |  |  | 158.42 |  |  |  | 152.10 |  |  |  | 134.39 | 
|                       



| |   |                                                                                                                          | 
| | - | ------------------------------------------------------------------------------------------------------------------------ | 
| | * | $100 invested on 12/31/00 in stock or
    index-including reinvestment of dividends. Fiscal year ending
    December 31. | 






|         |                                                                                                       
|-------- | ------------------------------------------------------------------------------------------------------
|Item 12. | Security Ownership of Certain Beneficial
    Owners and Management and Related Stockholder
    Matters

The following table and the notes thereto set
forth certain information regarding the beneficial ownership of
the Companys common stock as of March 9, 2006, by:



| |   |                                                                              
| | - | -----------------------------------------------------------------------------
| |  | each current director of the Company;                                        
|
| |  | each of our Named Executive Officers;                                        
|
| |  | all Named Executive Officers and directors of the
    company as a group; and

79



---



##### Table of Contents





| |   |                                                                                                                           
| | - | --------------------------------------------------------------------------------------------------------------------------
| |  | each other person known to the Company to own
    beneficially more than five percent of the outstanding Common
    Stock.

Unless otherwise indicated, all stockholders set
forth below have the same principal business address as the
Company.

The Company has determined beneficial ownership
in accordance with the rules of the SEC. The number of shares
beneficially owned by a person includes shares of common stock
of the Company that are subject to stock options that are either
currently exercisable or exercisable within 60 days
following March 9, 2006. These shares are also deemed
outstanding for the purpose of computing the percentage of
outstanding shares owned by the person. However, these shares
are not deemed outstanding for the purpose of computing the
percentage ownership of any other person. Unless otherwise
indicated, to the Companys knowledge, each stockholder has
sole voting and dispositive power with respect to the securities
beneficially owned by that stockholder. Unless a footnote
indicates otherwise, the address of each person listed below is
c/o Pegasus Solutions, Inc., Campbell Centre I, 8350
North Central Expressway, Suite 1900, Dallas, Texas 75206.
As of March 9, 2006, there were 20,804,229 shares of
common stock of the Company outstanding.

|                                                             |  |                       |           |                      |  |  |       |  
|------------------------------------------------------------ |  | --------------------- | --------- | -------------------- |  |  | ----- | -
|                                                             |  | Number of Shares      |           | Percentage of Shares
|Name and Address of Beneficial Owner                         |  | Beneficially Owned(1) |           | Beneficially Owned  
|                                                             |  |                       |           |                     
|Blum Capital Partners, L.P.(2)                               |  |                       | 2,432,003 |                      |  |  | 11.69 | %
|Columbia Wanger Asset Management, L.P.(3)                    |  |                       | 2,323,500 |                      |  |  | 11.17 | %
|Prides Capital Partners, L.L.C.(4)                           |  |                       | 2,066,445 |                      |  |  | 9.93  | %
|Dimensional Fund Advisors Inc.(5)                            |  |                       | 1,767,277 |                      |  |  | 8.50  | %
|Barclays Global Investors, NA(6)                             |  |                       | 1,389,983 |                      |  |  | 6.68  | %
|Tudor Investment Corp.(7)                                    |  |                       | 1,233,800 |                      |  |  | 5.93  | %
|Michael A. Barnett                                           |  |                       | 108,198   |                      |  |  | *     |  
|Robert J. Boles, Jr.                                         |  |                       | 110,155   |                      |  |  | *     |  
|Robert B. Collier                                            |  |                       | 43,974    |                      |  |  | *     |  
|Susan K. Conner                                              |  |                       | 157,748   |                      |  |  | *     |  
|John F. Davis, III                                           |  |                       | 913,350   |                      |  |  | 4.21  | %
|Ric L. Floyd                                                 |  |                       | 258,625   |                      |  |  | 1.23  | %
|William C. Hammett, Jr.                                      |  |                       | 59,755    |                      |  |  | *     |  
|Michael H. Kistner                                           |  |                       | 17,000    |                      |  |  | *     |  
|Thomas F. OToole                                            |  |                       | 42,908    |                      |  |  | *     |  
|Pamela H. Patsley                                            |  |                       | 29,999    |                      |  |  | *     |  
|Jeffrey A. Rich                                              |  |                       | 49,000    |                      |  |  | *     |  
|Bruce W. Wolff                                               |  |                       | 44,574    |                      |  |  | *     |  
|Directors and executive officers as a group
    (12 persons) |  |                       | 1,835,286 |                      |  |  | 8.16  | %



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|*   | Represents beneficial ownership of less than 1%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   
|   
|(1) | The number of shares shown includes outstanding
    shares of common stock owned as of March 9, 2006 by the
    person indicated and shares underlying options owned by such
    person on March 9, 2006 that are exercisable within
    60 days of that date as follows. At the effective time of
    the merger, each outstanding stock option, whether or not vested
    or exercisable, will become fully exercisable and thereafter
    represent the right to receive an amount in cash, with interest
    and less applicable tax withholding, equal to the number of
    shares of our common stock subject to each option as of the
    effective time of the merger, multiplied by the excess, if any,
    of $9.50 over the exercise price per share of common stock
    subject to such option. Therefore, information is also provided
    regarding the number of shares underlying options with an
    exercise price of lower than $9.50: Michael A. Barnett
    (44,000 shares, none of which have an exercise price lower
    than $9.50), Robert J. Boles, Jr. (100,780 shares,
    none of which have an exercise price lower than $9.50), Robert
    B. Collier (40,999 shares, none of which have an exercise
    price lower

80



---



##### Table of Contents



|    |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|    | than $9.50), Susan K. Conner
    (146,875 shares, none of which have an exercise price lower
    than $9.50), John F. Davis, III (863,125 shares, of
    which 270,000 have an exercise price lower than $9.50), Ric L.
    Floyd (251,125 shares, of which 3,000 have an exercise
    price lower than $9.50), William C. Hammett, Jr.
    (42,333 shares, none of which have an exercise price lower
    than $9.50), Michael H. Kistner (15,000 shares, none of
    which have an exercise price lower than $9.50), Thomas F.
    OToole (42,333 shares, none of which have an exercise
    price lower than $9.50), Pamela H. Patsley (29,999 shares,
    none of which have an exercise price lower than $9.50), Jeffrey
    A. Rich (44,000 shares, none of which have an exercise
    price lower than $9.50), Bruce W. Wolff (40,999 shares,
    none of which have an exercise price lower than $9.50) and all
    Directors and executive officers as a group
    (1,661,568 shares, of which 273,000 have an exercise price
    lower than $9.50). The number of shares shown also includes
    shares of restricted stock as follows: Robert J. Boles, Jr.
    (9,375 shares), Susan K. Conner (7,500 shares), John
    F. Davis, III (12,500 shares), Ric L. Floyd
    (7,500 shares) and Michael H. Kistner (2,000 shares).
    The table does not reflect acquisitions or dispositions of
    shares of common stock, including grants or exercises of stock
    options, after March 9, 2006.
|   
|(2) | Information with respect to Blum Capital
    Partners, L.P. is based solely on the Form 4 filed with the
    Securities and Exchange Commission on January 18, 2006 by
    Blum Capital Partners, L.P. According to that Form 4, Blum
    Capital Partners, L.P. had shared dispositive and shared voting
    power with respect to 2,432,003 shares of common stock as
    of January 13, 2006. The address for Blum Capital Partners,
    L.P. is 909 Montgomery Street, Suite 400,
    San Francisco, California 94133.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|   
|(3) | Information with respect to Columbia Wanger Asset
    Management, L.P. is based solely on the Schedule 13G/A
    filed with the Securities and Exchange Commission on
    February 14, 2006 by Columbia Wanger Asset Management, L.P.
    According to that Schedule 13G/A, Columbia Wanger Asset
    Management, L.P. had sole voting and sole dispositive power with
    respect to 2,323,500 shares of common stock and WAM
    Acquisition GP, Inc., the general partner of Columbia Wanger
    Asset Management, L.P., had shared dispositive and shared voting
    power with respect to 2,323,500, shares of common stock as of
    December 31, 2005. The address for Columbia Wanger Asset
    Management, L.P. and WAM Acquisition GP, Inc. is 227 West
    Monroe Street, Suite 3000, Chicago, Illinois 60606.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|   
|(4) | Information with respect to Prides Capital
    Partners, L.L.C. is based solely on the Form 3 filed with
    the Securities and Exchange Commission on December 22, 2005
    by Prides Capital Partners, L.L.C., Kevin A.
    Richardson, II, Christian Pascasiu, Charles E. McCarthy,
    Henry J. Lawlor, Jr. and Murray A. Indick. The address for
    Prides Capital Partners, L.L.C. is 200 High Street,
    Suite 700, Boston, Massachusetts 02110. The Company has
    entered into the Merger Agreement with affiliates of Prides
    Capital Partners, LLC. See Managements Discussion
    and Analysis of Financial Condition and Results of Operations
     The Merger Agreement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              
|   
|(5) | Information with respect to Dimensional
    Fund Advisors Inc. is based solely on Schedule 13G
    filed with the Securities and Exchange Commission on
    February 6, 2006 by Dimensional Fund Advisors Inc.
    According to that Schedule 13G, Dimensional
    Fund Advisors Inc. has sole voting and sole dispositive
    power with respect to 1,767,277 shares of common stock as
    of December 31, 2005. Dimensional Fund Advisors Inc.
    disclaim beneficial ownership of these shares. The address for
    Dimensional Fund Advisors Inc. is 1299 Ocean Avenue,
    11th Floor, Santa Monica, California 90401.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
|   
|(6) | Information with respect to Barclays Global
    Investors, NA. is based solely on the Schedule 13G filed
    with the Securities and Exchange Commission on January 26,
    2006 by Barclays Global Investors, NA. According to that
    Schedule 13G, Barclays Global Investors, NA. and Barclays
    Global Fund Advisors had sole voting power with respect to
    794,434 and 471,145 shares of common stock, respectively,
    and sole dispositive power with respect to 918,838 and
    471,145 shares of common stock, respectively, as of
    December 31, 2005. The address for Barclays Global
    Investors, NA. is 45 Fremont Street, 17th Floor,
    San Francisco, California 94105.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   
|(7) | Information with respect to Tudor Investment
    Corp. is based solely on the Schedule 13D filed with the
    Securities and Exchange Commission on December 20, 2005 by
    Tudor Investment Corp. According to that Schedule 13D, Tudor
    Investment Corp. and Tudor Proprietary Trading, L.L.C. had
    shared dispositive and shared voting power with respect to
    1,147,803 and 85,997 shares of common stock,                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      

81



---



##### Table of Contents



| |                                                                                                                                              
| | ---------------------------------------------------------------------------------------------------------------------------------------------
| | respectively, as of December 16, 2005. The
    address for Tudor Investment Corp. is 1275 King Street,
    Greenwich, Connecticut 06831-2936.

Securities Authorized For Issuance under
Equity Compensation Plans

The following table provides information as of
December 31, 2005 regarding compensation plans (including
individual compensation arrangements) under which equity
securities of Pegasus are authorized for issuance. See
Note 12 to the Consolidated Financial Statements for
information regarding the material features of these plans.

|                                                               |  |                      |       |                   |  |                      |       |  |  |  |       | 
|-------------------------------------------------------------- |  | -------------------- | ----- | ----------------- |  | -------------------- | ----- |  |  |  | ----- | 
|                                                               |  |                      |       |                   |  | (c)                 
|                                                               |  |                      |       |                   |  |                     
|                                                               |  | (a)                  |       |                   |  | Number Of Securities
|                                                               |  |                      |       |                   |  | Remaining Available 
|                                                               |  | Number Of Securities |       | (b)               |  | For Future Issuance 
|                                                               |  | To Be Issued         |       |                   |  | Under Equity        
|                                                               |  | Upon Exercise Of     |       | Weighted-Average  |  | Compensation Plans  
|                                                               |  | Outstanding          |       | Exercise Price Of |  | (1),(2) (Excluding  
|                                                               |  | Options, Warrants    |       | Outstanding       |  | Securities Reflected
|                                                               |  | And Rights           |       | Options, Warrants |  | In Column(a))       
|Plan Category                                                  |  | (In Thousands)       |       | And Rights        |  | (In Thousands)      
|                                                               |  |                      |       |                   |  |                     
|Equity compensation plans approved by security
    holders     |  |                      | 4,147 |                   |  | $                    | 12.64 |  |  |  | 3,009 | 
|Equity compensation plans not approved by
    security holders |  |                      |      |                   |  |                      |      |  |  |  |      | 
|                                                               |  |                      |       |                   |  |                      |       |  |  |  |       | 
|Total                                                          |  |                      | 4,147 |                   |  | $                    | 12.64 |  |  |  | 3,009 | 
|                                                               |  |                      |       |                   |  |                      |       |  |  |  |       | 



---



|    |                                                                                                                                                                                                                                                                                                                                                                                                           
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(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,
    on the last day of the immediately preceding year. The
    applicable number of shares outstanding as of December 31,
    2005 was approximately 27.9 million.
|   
|(2) | Includes shares of common stock available for
    issuance under the Companys Employee Stock Purchase Plan.                                                                                                                                                                                                                                                                                              






|         |                                                   
|-------- | --------------------------------------------------
|Item 13. | Certain Relationships and Related
    Transactions

Mr. Wolff is a Director of Pegasus and
served during 2005 as an executive vice president within
Marriott International, Inc. (Marriott).
Mr. Wolff retired from Marriott in February 2006. In 2005,
the Company received $1.6 million from Marriott and its
affiliates for reservation, distribution and representation
services. During the same years, the Company paid Marriott
$1.4 million for consolidating commission data and funds
from its properties.

Mr. OToole is a Director of Pegasus
and serves as a senior vice president for both Hyatt
Corporation, the parent company of Hyatt Hotels Corporation, and
AIC Holding Co., the parent company of Hyatt International
Corporation (Hyatt). In 2005, the Company received
$683,000 from Hyatt for reservation, distribution and financial
services.

Mr. Rich is a Director of Pegasus and served
as Chief Executive Officer of Affiliated Computer Services, Inc.
(ACS) through September 2005. Through this date, the
Company paid ACS $1.5 million for services provided in
connection with our financial services and enterprise resource
planning system support.






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

PricewaterhouseCoopers LLP served as our
independent registered public accounting firm for the year ended
December 31, 2005.

82



---



##### Table of Contents



Principal Accountant Fees and
Services.Aggregate fees billed for
professional services rendered for the Company by
PricewaterhouseCoopers LLP as of and for the years ended
December 31, 2005 and 2004, were:

|               |  |      |         |      |  |   |           | 
|-------------- |  | ---- | ------- | ---- |  | - | --------- | 
|               |  | 2005 |         | 2004
|               |  |      |         |     
|Audit          |  | $    | 637,260 |      |  | $ | 1,175,315 | 
|Audit-Related  |  |      | 12,380  |      |  |   |          | 
|Tax            |  |      | 101,824 |      |  | $ | 42,288    | 
|All Other Fees |  |      | 17,056  |      |  |   |          | 
|               |  |      |         |      |  |   |           | 
|Total          |  | $    | 768,520 |      |  | $ | 1,217,603 | 
|               |  |      |         |      |  |   |           | 

Audit Fees.Audit
fees were for professional services rendered in connection with
audits and quarterly reviews of the consolidated financial
statements of the Company, including fees related to the
internal control requirements of the Sarbanes-Oxley Act, review
of and preparation of consents for registration statements filed
with the Securities and Exchange Commission, and for subsidiary
statutory audits.

Audit-Related Fees.Audit related fees were for assurance and related services
related to employee benefit plan audits and consultations
regarding financial accounting and reporting standards.

Tax Fees.Tax fees
related to services for tax compliance and consulting.

Audit Committee Pre-Approval Policies and
Procedures.At its regularly scheduled
and special meetings, the Audit Committee of the Board of
Directors considers and pre-approves any audit and non-audit
services to be performed by the Companys independent
registered public accounting firm. The Audit Committee has
delegated to its chairman, an independent member of the
Companys Board of Directors, the authority to grant
pre-approvals of non-audit services provided that any such
pre-approval by the chairman shall be reported to the Audit
Committee at its next regularly scheduled meeting.

All Other Fees.All
other fees relate to subscriptions to a technical accounting
research database and a diagnostic tool that provides key
operational and human capital
metrics.                    .

Pegasus Audit Committee has considered
whether the provision of the non-audit services provided by
PricewaterhouseCoopers LLP is compatible with maintaining their
independence.




PART IV






|         |                                               
|-------- | ----------------------------------------------
|Item 15. | Exhibits and Financial Statement
    Schedules

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

|                                                                |                                                                                                                              |  |           |         | 
|--------------------------------------------------------------- | ---------------------------------------------------------------------------------------------------------------------------- |  | --------- | ------- | 
|(1) Report of Independent Registered Public
    Accounting Firm |                                                                                                                              |  | Page 35   |        
|                                                                | Consolidated Balance Sheets 
    December 31, 2005 and 2004                                                                 |  |           | Page 37 | 
|                                                                | Consolidated Statements of Operations and
    Comprehensive Income (Loss)  Years ended
    December 31, 2005, 2004 and 2003 |  |           | Page 38 | 
|                                                                | Consolidated Statements of Changes in
    Stockholders Equity  Years ended
    December 31, 2005, 2004 and 2003            |  |           | Page 39 | 
|                                                                | Consolidated Statements of Cash Flows 
    Years ended December 31, 2005, 2004 and 2003                                     |  |           | Page 40 | 
|                                                                | Notes to Consolidated Financial Statements                                                                                   |  |           | Page 41 | 
|(2) Schedule of Valuation and Qualifying
    Accounts           |                                                                                                                              |  | Page  S-1 |        

83



---



##### Table of Contents



(b)     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 (Securities and Exchange Commission (SEC
    or the Commission) 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)                                            
|        | 2 | .3          |  | Agreement and Plan of Merger, dated as of
    December 19, 2005, among Perseus Holding Corp., 406
    Acquisition Corp. and Pegasus Solutions, Inc. (incorporated by
    reference from Exhibit 2.1 of the Companys Current
    Report on Form 8-K filed with the Commission on
    December 20, 2005)                                                                                                                                 
|        | 2 | .4          |  | Guaranty dated as of December 19, 2005 by
    and between Prides Capital Fund I, L.P. and Pegasus
    Solutions, Inc. (incorporated by reference from Exhibit 2.2
    of the Companys Current Report on Form 8-K filed with
    the Commission on December 20, 2005)                                                                                                                                                                   
|        | 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 (SEC 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 (SEC File No. 000-22935) filed
    with the Commission on October 9, 1998)                                                                                                                                                            
|        | 4 | .1          |  | Fourth Amended and Restated Certificate of
    Incorporation and Second Amended and Restated Bylaws (see 3.1
    and 3.2 above)                                                                                                                                                                                                                                                                                                         
|        | 4 | .2          |  | Specimen of Common Stock certificate
    (incorporated by reference from Exhibit 4.1 to the
    Companys Registration Statement on Form S-1 (SEC File
    No. 333-28595) declared effective by the Commission on
    August 6, 1997)                                                                                                                                                                                                   
|        | 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 (SEC 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 (SEC File No. 000-22935) filed with the Commission
    on October 9, 1998)                                                                                                                              
|        | 4 | .5          |  | Form of Rights Certificate (incorporated by
    reference from Exhibit 3 of the Companys
    Form 8-A (SEC File No. 000-22935) filed with
    Commission on October 9, 1998)                                                                                                                                                                                                                                                           
|        | 4 | .6          |  | Form of Note for the Companys
    3.875% Convertible Senior Notes due 2023 (incorporated by
    reference from Exhibit A to Exhibit 4.6 to the
    Companys Quarterly Report on Form 10-Q filed with the
    Commission on August 14, 2003)                                                                                                                                                                                           
|        | 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)                                                                                                                                                                           

84



---



##### Table of Contents



|        |     |             |  |                                                                                                                                                                                                                                                                                                                                              
|------- | --- | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |     |            
|Number  |     | Description
|        |     |            
|        | 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)                      
|        | 4   | .9          |  | Agreement of Substitution and Amendment
    No. 1 to Rights Agreement, dated as of
    December 19, 2005, between Pegasus Solutions, Inc. and
    American Stock Transfer & Trust Company (incorporated
    by reference from Exhibit 4.1 of the Companys Current
    Report on Form 8-K filed with the Commission on
    December 20, 2005)
|        | *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. Conner (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 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 | .5          |  | 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)                                                                                                                      
|        | *10 | .6          |  | First Amendment to Employment between the Company
    and Robert J. Boles, Jr. dated December 7, 2004.
    (incorporated by reference from Exhibit 10.6 of the
    Companys Form 10-K filed with the Commission on
    March 10, 2005)                                                                                                      
|        | *10 | .7          |  | Employment Agreement dated August 1, 2004
    between the Company and Andrew Stringer (incorporated by
    reference from Exhibit 10.1 of the Companys
    Form 10-Q filed with the Commission on August 9, 2004)                                                                                                                           
|        | 10 | .8          |  | Employment agreement dated March 1, 2005
    between the Company and Michael Kistner                                                                                                                                                                                                                                                         
|        | *10 | .10         |  | 1996 Stock Option Plan, as amended (incorporated
    by reference from Exhibit 10.5 of the Companys
    Form 10-K (SEC File No. 000-22935) filed with the
    Commission on March 31, 1999)                                                                                                                                                 
|        | *10 | .11         |  | 2002 Stock Incentive Plan, (incorporated by
    reference from the Companys definitive proxy statement
    filed with the Commission on March 21, 2002)                                                                                                                                                                                     
|        | *10 | .12         |  | 1997 Employee Stock Purchase Plan, as amended
    (incorporated by reference from Exhibit 10.11 of the
    Companys Form 10-K (SEC File No. 000-22935)
    filed with the Commission on March 31, 1999)                                                                                                                                     
|        | *10 | .13         |  | 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 | .14         |  | Amendment One to Pegasus Solutions, Inc.
    Supplemental Executive Retirement Plan dated December 12,
    2005 (incorporated by reference from Exhibit 99.1 of the
    Companys Current Report on Form 8-K filed with the
    Commission on December 16, 2005)                                                                             
|        | *10 | .15         |  | 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 | .16         |  | 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)                                                                                     

85



---



##### Table of Contents



|        |     |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|------- | --- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |     |            
|Number  |     | Description
|        |     |            
|        | *10 | .17         |  | Amendment One to Pegasus Solutions, Inc.
    Executive Deferred Compensation Plan dated December 12,
    2005 incorporated by reference from Exhibit 99.2 of the
    Companys Current Report on Form 8-K filed with the
    Commission on December 16, 2005)                                                                                                                                                               
|        | *10 | .18         |  | Amendment Two to Pegasus Solutions, Inc.
    Executive Deferred Compensation Plan dated February 17,
    2006 (incorporated by reference from Exhibit 99.1 of the
    Companys Current Report on Form 8-K filed with the
    Commission on February 22, 2006)                                                                                                                                                              
|        | *10 | .19         |  | 2005 Executive Officer Bonus Plan Summary
    (incorporated by reference from Exhibit 10.16 of the
    Companys Form 10-K filed with the Commission on
    March 10, 2005)                                                                                                                                                                                                                                                 
|        | *10 | .20         |  | 2005 Director Compensation Summary
    (incorporated by reference from Exhibit 10.17 of the
    Companys Form 10-K filed with the Commission on
    March 10, 2005)                                                                                                                                                                                                                                                        
|        | *10 | .21         |  | Pegasus Solutions, Inc. Executive Perquisite Plan
    (incorporated by reference from Exhibit 10.18 of the
    Companys Form 10-K filed with the Commission on
    March 10, 2005)                                                                                                                                                                                                                                         
|        | 10  | .22         |  | 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  | .23         |  | 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  | .24         |  | 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)                                                               
|        | +10 | .25         |  | First Amendment to office lease between the
    Company and Dallas RPFIV Campbell Centre Associates Limited
    Partnership relating to property located at 8350 North Central
    Expressway, Dallas, Texas 75206 dated August 7, 2003                                                                                                                                                                                     
|        | 10  | .26         |  | 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 10.24 of the
    Companys Form 10-Q filed with the Commission on
    November 15, 2001)                                                                                                          
|        | +10 | .27         |  | First Amendment to office lease between the
    Company and Ryan Companies US, Inc. relating to property located
    at 1400 North Pima Road, Scottsdale, Arizona 85260 dated
    June 28, 2002                                                                                                                                                                                                                             
|        | +10 | .28         |  | Second Amendment to office lease between the
    Company and Ryan Companies US, Inc. relating to property located
    at 1400 North Pima Road, Scottsdale, Arizona 85260 dated
    February 28, 2003                                                                                                                                                                                                                        
|        | +10 | .29         |  | Third Amendment to office lease between the
    Company and Ryan Companies US, Inc. relating to property located
    at 1400 North Pima Road, Scottsdale, Arizona 85260 dated
    September 30, 2003                                                                                                                                                                                                                        
|        | +10 | .30         |  | Fourth Amendment to office lease between the
    Company and Ryan Companies US, Inc. relating to property located
    at 1400 North Pima Road, Scottsdale, Arizona 85260 dated
    May 26, 2004                                                                                                                                                                                                                             
|        | 10  | .31         |  | Securities Purchase Agreement dated May 3,
    2004 between Lowestfare.com, Inc. (buyer) and Hilton
    Electronic Distribution Systems, LLC, HT-HDS, Inc., MI
    Distribution, LLC, Starwood Resventure, LLC and Pegasus Business
    Intelligence, LP (the sellers), and Travelweb, LLC.
    (incorporated by reference from Exhibit 10.1 of the
    Companys Form 10-Q filed with the Commission on
    August 9, 2004)
|        | 10  | .32         |  | Form of Promissory Note agreement dated
    November 9, 2001 between the Company and IndeCorp
    Corporation (incorporated by reference from Exhibit 10.25
    of the Companys Form 10-Q filed with the Commission
    on November 15, 2001)                                                                                                                                                                              

86



---



##### Table of Contents



|        |      |             |  |                                                                                                                                                                                                                                               
|------- | ---- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |            
|Number  |      | Description
|        |      |            
|        | 10   | .33         |  | Form of Promissory Note agreement dated
    November 9, 2001 between the Company and IndeCorp
    Corporation (incorporated by reference from Exhibit 10.26
    of the Companys Form 10-Q filed with the Commission
    on November 15, 2001)
|        | +21  | .1          |  | Subsidiaries of the Company                                                                                                                                                                                                                   
|        | +23  | .1          |  | Consent of Independent Registered Public
    Accounting Firm                                                                                                                                                                                  
|        | 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                                                    



---



|   |                    
|-- | -------------------
|+  | 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.

87



---



##### 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
15th day of March, 2006.



| |                        
| | -----------------------
| | 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. Conner 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 15, 2006
|                                                  
|/s/ SUSAN K CONNERSusan K. Conner                  |  | Executive Vice President and Chief
    Officer (Principal Financial and Accounting Officer) |  | March 15, 2006
|                                                  
|/s/ WILLIAM C. HAMMETT, JR.William C. Hammett, Jr. |  | Vice Chairman and Director                                                                  |  | March 15, 2006
|                                                  
|/s/ MICHAEL A. BARNETTMichael A. Barnett           |  | Director                                                                                    |  | March 15, 2006
|                                                  
|/s/ ROBERT B. COLLIERRobert B. Collier             |  | Director                                                                                    |  | March 15, 2006
|                                                  
|/s/ THOMAS F. OTOOLEThomas F. OToole             |  | Director                                                                                    |  | March 15, 2006

88



---



##### Table of Contents



|                                       |  |          |  |                |  | 
|-------------------------------------- |  | -------- |  | -------------- |  | 
|                                       |  |          |  |               
|Signature                              |  | Title    |  | Date          
|                                       |  |          |  |               
|                                      
|/s/ PAMELA H. PATSLEYPamela H. Patsley |  | Director |  | March 15, 2006
|                                      
|/s/ JEFFREY A. RICHJeffrey A. Rich     |  | Director |  | March 15, 2006
|                                      
|/s/ BRUCE W. WOLFFBruce W. Wolff       |  | Director |  | March 15, 2006

89



---



##### Table of Contents



EXHIBIT INDEX

|        |   |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                                         
|------- | - | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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 (Securities and Exchange Commission (SEC
    or the Commission) 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)                                            
|        | 2 | .3          |  | Agreement and Plan of Merger, dated as of
    December 19, 2005, among Perseus Holding Corp., 406
    Acquisition Corp. and Pegasus Solutions, Inc. (incorporated by
    reference from Exhibit 2.1 of the Companys Current
    Report on Form 8-K filed with the Commission on
    December 20, 2005)                                                                                                                                 
|        | 2 | .4          |  | Guaranty dated as of December 19, 2005 by
    and between Prides Capital Fund I, L.P. and Pegasus
    Solutions, Inc. (incorporated by reference from Exhibit 2.2
    of the Companys Current Report on Form 8-K filed with
    the Commission on December 20, 2005)                                                                                                                                                                   
|        | 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 (SEC 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 (SEC File No. 000-22935) filed
    with the Commission on October 9, 1998)                                                                                                                                                            
|        | 4 | .1          |  | Fourth Amended and Restated Certificate of
    Incorporation and Second Amended and Restated Bylaws (see 3.1
    and 3.2 above)                                                                                                                                                                                                                                                                                                         
|        | 4 | .2          |  | Specimen of Common Stock certificate
    (incorporated by reference from Exhibit 4.1 to the
    Companys Registration Statement on Form S-1 (SEC File
    No. 333-28595) declared effective by the Commission on
    August 6, 1997)                                                                                                                                                                                                   
|        | 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 (SEC 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 (SEC File No. 000-22935) filed with the Commission
    on October 9, 1998)                                                                                                                              
|        | 4 | .5          |  | Form of Rights Certificate (incorporated by
    reference from Exhibit 3 of the Companys
    Form 8-A (SEC File No. 000-22935) filed with
    Commission on October 9, 1998)                                                                                                                                                                                                                                                           
|        | 4 | .6          |  | Form of Note for the Companys
    3.875% Convertible Senior Notes due 2023 (incorporated by
    reference from Exhibit A to Exhibit 4.6 to the
    Companys Quarterly Report on Form 10-Q filed with the
    Commission on August 14, 2003)                                                                                                                                                                                           
|        | 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)                                                                                                                 



---



##### Table of Contents



|        |     |             |  |                                                                                                                                                                                                                                                                                                                                              
|------- | --- | ----------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |     |            
|Number  |     | Description
|        |     |            
|        | 4   | .9          |  | Agreement of Substitution and Amendment
    No. 1 to Rights Agreement, dated as of
    December 19, 2005, between Pegasus Solutions, Inc. and
    American Stock Transfer & Trust Company (incorporated
    by reference from Exhibit 4.1 of the Companys Current
    Report on Form 8-K filed with the Commission on
    December 20, 2005)
|        | *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. Conner (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 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 | .5          |  | 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)                                                                                                                      
|        | *10 | .6          |  | First Amendment to Employment between the Company
    and Robert J. Boles, Jr. dated December 7, 2004
    (incorporated by reference from Exhibit 10.6 of the
    Companys Form 10-K filed with the Commission on
    March 10, 2005)                                                                                                       
|        | *10 | .7          |  | Employment Agreement dated August 1, 2004
    between the Company and Andrew Stringer (incorporated by
    reference from Exhibit 10.1 of the Companys
    Form 10-Q filed with the Commission on August 9, 2004)                                                                                                                           
|        | +10 | .8          |  | Employment agreement dated March 1, 2005
    between the Company and Michael Kistner                                                                                                                                                                                                                                                         
|        | *10 | .10         |  | 1996 Stock Option Plan, as amended (incorporated
    by reference from Exhibit 10.5 of the Companys
    Form 10-K (SEC File No. 000-22935) filed with the
    Commission on March 31, 1999)                                                                                                                                                 
|        | *10 | .11         |  | 2002 Stock Incentive Plan, (incorporated by
    reference from the Companys definitive proxy statement
    filed with the Commission on March 21, 2002)                                                                                                                                                                                     
|        | *10 | .12         |  | 1997 Employee Stock Purchase Plan, as amended
    (incorporated by reference from Exhibit 10.11 of the
    Companys Form 10-K (SEC File No. 000-22935)
    filed with the Commission on March 31, 1999)                                                                                                                                     
|        | *10 | .13         |  | 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 | .14         |  | Amendment One to Pegasus Solutions, Inc.
    Supplemental Executive Retirement Plan dated December 12,
    2005 (incorporated by reference from Exhibit 99.1 of the
    Companys Current Report on Form 8-K filed with the
    Commission on December 16, 2005)                                                                             
|        | *10 | .15         |  | 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 | .16         |  | 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 | .17         |  | Amendment One to Pegasus Solutions, Inc.
    Executive Deferred Compensation Plan dated December 12,
    2005 (incorporated by reference from Exhibit 99.2 of the
    Companys Current Report on Form 8-K filed with the
    Commission on December 16, 2005)                                                                               



---



##### Table of Contents



|        |     |             |  |                                                                                                                                                                                                                                                                                                                                                                                                                             
|------- | --- | ----------- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |     |            
|Number  |     | Description
|        |     |            
|        | *10 | .18         |  | Amendment Two to Pegasus Solutions, Inc.
    Executive Deferred Compensation Plan dated February 17,
    2006 (incorporated by reference from Exhibit 99.1 of the
    Companys Current Report on Form 8-K filed with the
    Commission on February 22, 2006)                                                                                                                                                              
|        | *10 | .19         |  | 2005 Executive Officer Bonus Plan Summary
    (incorporated by reference from Exhibit 10.16 of the
    Companys Form 10-K filed with the Commission on
    March 10, 2005)                                                                                                                                                                                                                                                 
|        | *10 | .20         |  | 2005 Director Compensation Summary
    (incorporated by reference from Exhibit 10.17 of the
    Companys Form 10-K filed with the Commission on
    March 10, 2005)                                                                                                                                                                                                                                                        
|        | *10 | .21         |  | Pegasus Solutions, Inc. Executive Perquisite Plan
    (incorporated by reference from Exhibit 10.18 of the
    Companys Form 10-K filed with the Commission on
    March 10, 2005)                                                                                                                                                                                                                                         
|        | 10  | .22         |  | 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  | .23         |  | 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  | .24         |  | 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)                                                               
|        | +10 | .25         |  | First Amendment to office lease between the
    Company and Dallas RPFIV Campbell Centre Associates Limited
    Partnership relating to property located at 8350 North Central
    Expressway, Dallas, Texas 75206 dated August 7, 2003                                                                                                                                                                                     
|        | 10  | .26         |  | 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 10.24 of the
    Companys Form 10-Q filed with the Commission on
    November 15, 2001)                                                                                                          
|        | +10 | .27         |  | First Amendment to office lease between the
    Company and Ryan Companies US, Inc. relating to property located
    at 1400 North Pima Road, Scottsdale, Arizona 85260 dated
    June 28, 2002                                                                                                                                                                                                                             
|        | +10 | .28         |  | Second Amendment to office lease between the
    Company and Ryan Companies US, Inc. relating to property located
    at 1400 North Pima Road, Scottsdale, Arizona 85260 dated
    February 28, 2003                                                                                                                                                                                                                        
|        | +10 | .29         |  | Third Amendment to office lease between the
    Company and Ryan Companies US, Inc. relating to property located
    at 1400 North Pima Road, Scottsdale, Arizona 85260 dated
    September 30, 2003                                                                                                                                                                                                                        
|        | +10 | .30         |  | Fourth Amendment to office lease between the
    Company and Ryan Companies US, Inc. relating to property located
    at 1400 North Pima Road, Scottsdale, Arizona 85260 dated
    May 26, 2004                                                                                                                                                                                                                             
|        | 10  | .31         |  | Securities Purchase Agreement dated May 3,
    2004 between Lowestfare.com, Inc. (buyer) and Hilton
    Electronic Distribution Systems, LLC, HT-HDS, Inc., MI
    Distribution, LLC, Starwood Resventure, LLC and Pegasus Business
    Intelligence, LP (the sellers), and Travelweb, LLC.
    (incorporated by reference from Exhibit 10.1 of the
    Companys Form 10-Q filed with the Commission on
    August 9, 2004)
|        | 10  | .32         |  | Form of Promissory Note agreement dated
    November 9, 2001 between the Company and IndeCorp
    Corporation (incorporated by reference from Exhibit 10.25
    of the Companys Form 10-Q filed with the Commission
    on November 15, 2001)                                                                                                                                                                              
|        | 10  | .33         |  | Form of Promissory Note agreement dated
    November 9, 2001 between the Company and IndeCorp
    Corporation (incorporated by reference from Exhibit 10.26
    of the Companys Form 10-Q filed with the Commission
    on November 15, 2001)                                                                                                                                                                              
|        | +21 | .1          |  | Subsidiaries of the Company                                                                                                                                                                                                                                                                                                                                                                                                 



---



##### Table of Contents



|        |      |             |  |                                                                                                                                                                                           
|------- | ---- | ----------- |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit |      |            
|Number  |      | Description
|        |      |            
|        | +23  | .1          |  | Consent of Independent Registered Public
    Accounting Firm                                                                                                                              
|        | 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



---



|   |                    
|-- | -------------------
|+  | 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.



---



##### Table of Contents



SCHEDULE II

PEGASUS SOLUTIONS, INC.

VALUATION AND QUALIFYING ACCOUNTS

For the Years Ended December 31, 2003,
2004 and 2005


(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   
|     |                                            |                               |   |           |       |           |   |           |     |            |   |          
|2003 |                                            |                               |   |           |       |           |   |           |     |            |   |           |   |  |   |     |     |  |   |        |        |   |   |      
|     | Allowance for doubtful receivable accounts |                               | $ | 5,787     |       |           | $ |          |     |            | $ |          |   |  | $ | 375 |     |  | $ | (2,083 | )      |   | $ | 4,079 |      
|     | Income tax valuation allowance             |                               |   | 444       |       |           |   |          |     |            |   |          |   |  |   |    |     |  |   |       |        |   |   | 444   |      
|     |                                            |                               |   |           |       |           |   |           |     |            |   |           |   |  |   |     |     |  |   |        |        |   |   |      
|     |                                            | Total reserves and allowances |   |           | 6,231 |           |   |           |    |            |   |           |  |  |   |     | 375 |  |   |        | (2,083 | ) |   |       | 4,523 | 
|     |                                            |                               |   |           |       |           |   |           |     |            |   |           |   |  |   |     |     |  |   |        |        |   |   |      
|2004 |                                            |                               |   |           |       |           |   |           |     |            |   |           |   |  |   |     |     |  |   |        |        |   |   |      
|     | Allowance for doubtful receivable accounts |                               |   | 4,079     |       |           |   | 787       |     |            |   |          |   |  |   |    |     |  |   | (682   | )      |   |   | 4,184 |      
|     | Income tax valuation allowance             |                               |   | 444       |       |           |   |          |     |            |   |          |   |  |   |    |     |  |   | (444   | )      |   |   |      |      
|     |                                            |                               |   |           |       |           |   |           |     |            |   |           |   |  |   |     |     |  |   |        |        |   |   |      
|     |                                            | Total reserves and allowances |   |           | 4,523 |           |   |           | 787 |            |   |           |  |  |   |     |    |  |   |        | (1,126 | ) |   |       | 4,184 | 
|     |                                            |                               |   |           |       |           |   |           |     |            |   |           |   |  |   |     |     |  |   |        |        |   |   |      
|2005 |                                            |                               |   |           |       |           |   |           |     |            |   |           |   |  |   |     |     |  |   |        |        |   |   |      
|     | Allowance for doubtful receivable accounts |                               |   | 4,184     |       |           |   | 700       |     |            |   |          |   |  |   |    |     |  |   | (984   | )      |   |   | 3,900 |      
|     |                                            |                               |   |           |       |           |   |           |     |            |   |           |   |  |   |     |     |  |   |        |        |   |   |      
|     |                                            | Total reserves and allowances |   | $         | 4,184 |           |   | $         | 700 |            |   | $         |  |  |   | $   |    |  |   | $      | (984   | ) |   | $     | 3,900 | 
|     |                                            |                               |   |           |       |           |   |           |     |            |   |           |   |  |   |     |     |  |   |        |        |   |   |      



---



|    |                                                                                                                                                                                                         
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) | This schedule should be read in conjunction with
    the Companys audited consolidated financial statements and
    related notes thereto that appear in Item 8 of this Annual
    Report on Form 10-K.

S-1