-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, AW88X1Ntf4T+W6LQ0RoxNcLad0YTMtW1CMXJdjV/8DDf5zqj+6KQ7J1pE9vecvJE WRQnSMHP07IgP9ZqbBpROA== 0000950134-99-002301.txt : 19990402 0000950134-99-002301.hdr.sgml : 19990402 ACCESSION NUMBER: 0000950134-99-002301 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 10 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990331 FILER: COMPANY DATA: COMPANY CONFORMED NAME: PEGASUS SYSTEMS INC CENTRAL INDEX KEY: 0001040261 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER PROCESSING & DATA PREPARATION [7374] IRS NUMBER: 752605174 STATE OF INCORPORATION: DE FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22935 FILM NUMBER: 99580052 BUSINESS ADDRESS: STREET 1: 3811 TURTLE CREEK BLVD STREET 2: STE 1100 CITY: DALLAS STATE: TX ZIP: 75219 BUSINESS PHONE: 2145285656 MAIL ADDRESS: STREET 1: 3811 TURTLE CREEK BLVD STREET 2: STE 1100 CITY: DALLAS STATE: TX ZIP: 75219 10-K 1 FORM 10-K FOR FISCAL YEAR END DECEMBER 31, 1998 1 =============================================================================== SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------------------------------------------------------- (MARK ONE) FORM 10-K [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1998 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _______________ to ___________ Commission file number 000-22935 PEGASUS SYSTEMS, INC. (Exact name of registrant as specified in its charter) DELAWARE 75-2605174 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification No.) 3811 TURTLE CREEK BOULEVARD, SUITE 1100 75219 DALLAS, TEXAS (Zip Code) (Address of principal executive offices) Registrant's telephone number, including area code: (214) 528-5656 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: None SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: Common Stock, par value $0.01 per share Rights to Purchase Series A Preferred Stock (Title of class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value on March 15, 1999 of voting stock held by non-affiliates of the registrant was $454,626,984. ----------------- The number of shares of the registrant's common stock, par value $0.01 per share, outstanding as of March 15, 1999 was 10,606,160. 2 DOCUMENTS INCORPORATED BY REFERENCE 1. Selected portions of the Registrant's Annual Report to Stockholders for the fiscal year ended December 31, 1998 are incorporated by reference into Part II of this Form 10-K. 2. Selected portions of the Registrant's definitive Proxy Statement for the 1999 Annual Meeting of Stockholders to be held on May 13, 1999 are incorporated by reference into Part III of this Form 10-K. ================================================================================ 3 PART I ITEM 1. BUSINESS. Unless the context otherwise requires, the term "Company" or "Pegasus" when used in this report refers to Pegasus Systems, Inc., a Delaware corporation, and its predecessors and consolidated subsidiaries. This report contains certain forward-looking statements within the meaning of the federal securities laws. Actual results and the timing of certain events could differ materially from those projected in or contemplated by the forward-looking statements due to a number of factors, including those listed herein under "Risk Factors". GENERAL Pegasus is a provider of transaction processing services to the hotel industry worldwide. The Company's services are currently divided into three operating segments: Pegasus Electronic Distribution, Pegasus Commission Processing and Pegasus Business Intelligence. Pegasus Electronic Distribution improves the efficiency and effectiveness of the hotel reservation process by enabling travel agents and individual travelers to electronically access hotel room inventory information and conduct reservation transactions. Pegasus Electronic Distribution includes what was historically referred to as THISCO's UltraSwitch service, and the Company's Internet-based services known as TravelWeb, NetBooker and UltraRes. Pegasus Commission Processing improves the efficiency and effectiveness of the commission payment process for participating hotels and travel agencies by consolidating payments and providing comprehensive transaction reports. Pegasus Commission Processing includes what historically was referred to as The Hotel Clearing Corporation or "HCC". In addition, Pegasus Business Intelligence began providing information services to hotel industry participants with transaction specific information on industry trends and guest behavior. The Company's services benefit many of the participants in the hotel room distribution process, including hotels, hotel representation firms, Global Distribution Systems ("GDSs"), travel agencies, convention and other large meeting organizers, corporate travel departments and Web sites with travel-related features. For the fiscal year ending December 31, 1998, approximately 42% of the Company's consolidated revenues was derived from Electronic Distribution services, approximately 55% of the Company's consolidated revenues was derived from Commission Processing services and approximately 3% of the Company's consolidated revenue was derived from Business Intelligence services. In August 1998, the Company supplemented its Business Intelligence services by acquiring all of the equity interest in Driving Revenue L.L.C., a hotel database marketing and consulting firm, for approximately $6 million. In addition, in June 1998 the Company purchased a minority interest in Customer Analytics, Inc., a new venture aimed at providing services to companies in the fields of data warehousing and data mining. The Company also purchased in September 1998 a minority interest in Intermezzo, Inc., a developer of hotel reservation and property management systems and software. The Company was incorporated in Delaware in 1995, and holds directly or indirectly all of the outstanding equity securities of (i) The Hotel Industry Switch Company ("THISCO"), a Delaware corporation formed in 1988 to operate the electronic distribution business ; (ii) The Hotel Clearing Corporation ("HCC"), a Delaware corporation formed in 1991 to operate the commission processing business; (iii) TravelWeb, Inc., a Delaware corporation formed in 1995 to operate the online electronic distribution business; (iv) Pegasus IQ, Inc., a Delaware corporation formed in 1997 to operate Pegasus Business Intelligence services and (v) Driving Revenue L.L.C., a Maryland limited liability company acquired in August 1998 that operates a hotel database and marketing business and constitutes part of Pegasus Business Intelligence. 3 4 SERVICES PEGASUS ELECTRONIC DISTRIBUTION GDS Interfaces. Pegasus Electronic Distribution provides an electronic hotel room reservation processing service that interfaces communications concerning hotel reservation information between all major GDSs and hotel central reservation systems. The interface, which is referred to as the "UltraSwitch", enables a hotel to connect to all major GDSs without having to build and maintain a separate interface for each GDS. Without the UltraSwitch interface or a similar service, hotel chains that desire their room inventory to be accessible to travel agencies electronically on a GDS must develop protocols and message formats compatible with each GDS, a process that entails significant time and expense. Alternatively, hotels may rely more heavily on less-automated means, such as traditional toll-free telephone reservation centers with higher processing costs. The UltraSwitch enables the processing of hotel room reservations and also transmits daily millions of electronic status messages, which are used to update room rates, features and availability on GDS databases. Many participating hotels also have chosen to utilize the Company's UltraSelect service, which provides travel agencies using GDSs with direct access through the UltraSwitch to a hotel's central reservation system bypassing the GDS databases to obtain the most complete and up-to-date hotel room information available. Internet-based Electronic Distribution Services. TravelWeb. Located at www.travelweb.com, TravelWeb provides individual travelers direct access to online hotel information and the ability to make reservations electronically. Individual travelers traditionally obtain information or reserve a room by contacting a hotel directly by telephone or fax or indirectly through intermediaries, such as travel agencies, convention and other large meeting organizers and corporate travel departments. As a result, an individual traveler cannot easily obtain information from a wide range of hotel properties in a timely manner. TravelWeb provides travelers with detailed information regarding a wide array of hotel properties and, through its connection to the UltraSwitch interface, allows travelers to reserve a hotel room and receive a confirmation in seconds. In addition to hotel room reservations, the TravelWeb service offers airline booking through Microsoft's Expedia.com. Additionally, TravelWeb offers "The Resources Center", which provides information and links for a variety of travel-related services, such as weather, food, shopping, area attractions and business services, and "Click-It! Weekends"(R), a section offering special rates on hotels for each upcoming weekend. NetBooker. NetBooker is a service for the operators of third-party Web sites which combines the Company's hotel information database and the UltraSwitch interface capability to make hotel room reservations. To conduct Internet-based electronic commerce successfully, Web site operators must offer a content set which is sufficiently broad, accurate, up-to-date, graphically appealing and useful to attract buyers to the Web site. Typically, the development of such a content set is expensive and time consuming. Furthermore, in addition to providing individual travelers with access to useful and graphically appealing information, the operator of a Web site must offer individual travelers the capability to effect a transaction in order to generate a transaction fee. The Company's NetBooker service offers operators of Web sites an extensive and comprehensive set of hotel information and a simple and fast method of making a hotel room reservation online. The Company's NetBooker service utilizes advanced technology applications to customize the hotel database so that it appears to the user to be an integral part of the third-party Web site. In connection with this service, the operator of the third-party Web site establishes an interface to the Company's UltraSwitch, which enables users of the Web site to shop and query room availability, electronically make a reservation and receive a confirmation in seconds. 4 5 UltraRes. The Company's UltraRes service automates the processing of hotel room reservations for conventions and large meetings. The manual process traditionally used to reserve hotel rooms for these events is information-intensive and inefficient and frequently leads to inaccurate and delayed information and overbooking or underbooking. With the Company's UltraRes service, convention and other large meeting organizers are able to transfer reservation requests to the UltraSwitch, which translates the information to electronically book a room in each hotel central reservation system. The UltraRes service eliminates the need to transfer rooming lists for manual entry at the hotel and allows hotels to deliver reservations and confirmations electronically in a fast and reliable manner. UltraDirect. The Company's UltraDirect service provides the corporate travel management industry with a direct real-time link to the Company's UltraSwitch through corporate intranet travel management software. With the UltraDirect service, corporate travelers are able to check availability and make hotel reservations within seconds at hotel chains or properties with which the traveler's employer has negotiated rates. The UltraDirect service enables corporate travel departments of companies to have access to the customized information negotiated with hotel chains and properties to facilitate hotel room reservations. Furthermore, this information can be fully integrated into other components of the intranet site and facilitate the creation of passenger name records and detailed profile information. The Company has not received a material amount of revenues for certain of these electronic hotel room reservation services to date, and there can be no assurance that such services will produce material revenues to the Company in the future. See "Risk Factors -- Impact of Technological Advances; Delays in Introduction of New Services." PEGASUS COMMISSION PROCESSING Pegasus Commission Processing gathers commission payment information, processes that information and transmits to travel agencies one consolidated check in the travel agency's currency of choice, together with an information statement that enables the travel agency to reconcile its hotel commission activity. Typically, a hotel pays to the travel agency that made the hotel reservation a commission of approximately 10% of the room rate paid by a hotel guest. However, the payment process related to these commissions historically has been costly and inefficient, consisting of numerous checks in small amounts and little information regarding the basis from which the commission was calculated. Pegasus Commission Processing service streamlines the commission payment process and consolidates into a single payment the aggregate commission owed by a participating hotel to all participating travel agencies. Additionally, the service provides an incentive to travel agencies to make reservations at hotels participating in the service in countries other than their own because Pegasus Commission Processing disburses checks denominated in each travel agency's currency of choice. Furthermore, the monthly and quarterly marketing reports and statistics prepared for the hotel as part of the Company's service allow the hotel to identify and market more effectively to those travel agencies that provide the hotel with the majority of its guests. The hotel also benefits from the Customer Relations Center, which allows travel agency inquiries regarding commissions to be resolved by the Company rather than by the hotel itself. PEGASUS BUSINESS INTELLIGENCE Pegasus Business Intelligence provides hotel database marketing and consulting and is being expanded to provide hotel information to a wide variety of audiences in the global hotel industry, from hotel chains to travel industry marketing groups to corporate travel departments. The service compiles data regarding hotel guests and their use of hotels and organizes that data into meaningful information. Pegasus Business Intelligence intends to provide industry trend reports and guest behavior data in an automated, 5 6 timely format for hotels and hotel marketing companies. The service also is intended to provide benchmark information services that compare a hotel's daily room and occupancy rates with that of its competition. Furthermore, Pegasus Business Intelligence intends to provide data in an electronic format to individual travelers or corporate travel departments regarding a particular stay at a hotel, together with information provided by payment card companies, to facilitate automated expense reporting or to ensure travel policy adherence. INDUSTRY The room reservation and commission payment processes in the hotel industry are complex and information intensive. Making a hotel room reservation requires significant amounts of data, such as room rates, features and availability. This complexity is compounded by the need to confirm, revise or cancel room reservations, which generally requires multiple parties to have ongoing access to real-time reservation information. Similarly, the process of reconciling and paying hotel commissions to travel agencies is based on transaction-specific hotel data and consists of a number of relatively small payments to travel agencies, often including payments in multiple currencies. In addition, information regarding guest cancellations and "no-shows" needs to be accurately communicated between hotels and travel agencies in order to reconcile commission payments. Reservations for hotel rooms are made either directly by individual travelers or indirectly through intermediaries. Individual travelers typically make direct reservations by telephoning or faxing a hotel to ascertain room rates, features and availability and to make reservations. Increasingly, individual travelers can conduct all aspects of this transaction through hotel and travel-related Web sites. Intermediaries for hotel room reservations, including travel agencies, convention and other large meeting organizers and corporate travel departments, access hotel information either by telephone or fax or through a GDS. GDS's maintain databases of room rate, feature and availability information provided by hotels to which they are connected. Because each GDS has a unique electronic interface to hotel reservation systems, each GDS can obtain room information and book rooms only at hotels that have developed protocols and message formats compatible with that particular GDS. A number of current trends are affecting the hotel industry. First, the hotel industry has been shifting from manual to electronic means of making hotel room reservations. As more hotels become electronically bookable, the Company expects that electronic hotel room reservations will grow substantially in the United States and internationally over the next several years. Second, a growing number of individual travelers are making hotel room reservations electronically on the Internet. Third, smaller hotel chains and independent hotels increasingly have affiliated with large hotel chains through a process known in the industry as "branding" or "reflagging." This global consolidation process produces economies of scale and increases the global penetration of larger hotel chains, many of whom are the Company's stockholders and customers. Fourth, hotel commissions are becoming increasingly important to travel agencies as a source of revenue. Travel agencies are looking to increase their revenue by making more hotel room reservations to offset the effects of increased competition among travel agencies, new competition from emerging travel service distribution channels and caps on commissions for airline reservations, which historically have been the leading revenue source for travel agencies. COMPETITION The Company faces significant competition in connection with its electronic distribution service. The principal competitor of Pegasus Electronic Distribution is WizCom International, Ltd. ("WizCom"), which is a wholly owned indirect subsidiary of HFS Incorporated ("HFS"). Although HFS has continued its participation in Pegasus Commission Processing, HFS currently uses WizCom for its electronic hotel room 6 7 reservation processing. There can be no assurance that any additional customers will not change their electronic reservation interface to WizCom or to another similar service. Also, hotels can choose to connect directly to one or more GDSs, thereby bypassing the UltraSwitch and eliminating the need to pay fees to the Company. In addition, one or more GDSs can choose to bypass the UltraSwitch and develop and operate a new common electronic interface to hotel central reservation systems. Such competitors or their affiliates may have greater financial and other resources than the Company. Factors affecting competitive success of the electronic hotel room reservation processing service include reliability, levels of fees, number of hotel properties on the system, ability to provide a neutral, comprehensive interface between hotels and other participants in the distribution of hotel rooms and ability to develop new technological solutions. There can be no assurance that another participant in the hotel room distribution process or a new competitor will not create services with features that would reduce the attractiveness of the Company's services. The Company's inability to compete effectively with respect to these services could have a material adverse effect on the Company's financial condition and results of operations. The market for the Company's TravelWeb, NetBooker and other Internet-based services is highly competitive. Current competition includes traditional telephone or travel agency reservation methods and other Internet travel reservation services. There are a large number of Internet travel-related services offered by the Company's competitors, and many of these competitors are larger and have significantly greater financial resources and name recognition than the Company. Several competitive Web sites such as Travelocity (a site operated by The SABRE Group Holdings, Inc.) and Expedia.com (a site operated by Microsoft Corporation) offer a more comprehensive range of travel services than those provided by the Company. The Company faces competition in the hotel room reservation business not only from its current competitors but also from possible new entrants including other Web sites. The costs of entry into the Internet hotel room reservation business is relatively low. There can be no assurance that the Company's Internet hotel room reservation services will compete successfully. The failure of these services to compete successfully could have a material adverse effect on the Company's financial condition and results of operations. The market for the Company's Commission Processing service is competitive. The Company's competitors in the Commission Processing business include National Processing Company ("NPC"), WizCom and Citicorp. NPC is a company that has traditionally provided car rental and cruise line commission processing services. Citicorp provides commission consolidation services to hotel chains. In addition, hotels that are current or prospective customers of the Company's Commission Processing service could decide to process commission payments without, or in competition with, the Company's Commission Processing service. Some of these current or potential competitors have substantially greater financial and other resources than the Company. Furthermore, while the Company has agreements with all of its hotel customers for the Company's Commission Processing service, most of the Company's travel agency customers are not obligated by any agreement with the Company. If a significant percentage of these travel agencies were to cease using the Company's Commission Processing service, the Company's financial condition and results of operations could be materially adversely affected. The Company faces significant competition in connection with its Business Intelligence service. The Company's principal competitor is Smith Travel Research ("Smith"). Smith currently provides information services to hotels. Accounting firms and other businesses do currently or may in the future provide information services similar to the Company's current or future service offerings. Such competitors or their affiliates may have existing customer relationships that create an impediment to the Company acquiring new customers. Such competitors may also have greater financial resources than the Company. There can be no assurance that current or future information service offerings of such competitors or new competitors will not reduce the attractiveness of the Company's services. The Company's inability to compete effectively with respect to these services could have a material adverse effect on the Company's financial condition and results of operations. 7 8 INTELLECTUAL PROPERTY The Company is continually developing new processing technology and enhancing existing proprietary technology. The Company has no patents. The Company primarily relies on a combination of copyright, trade secrets, confidentiality procedures and contractual provisions to protect its technology. Despite these protections, it may be possible for unauthorized parties to copy, obtain or use certain portions of the Company's proprietary technology. While any misappropriation of the Company's intellectual property could have a material adverse effect on the Company's competitive position, the Company believes that protection of proprietary rights is less significant to the Company's business than the continued pursuit of its operating strategies and other factors, such as the Company's relationship with industry participants and the experience and abilities of its key personnel. The Company has registered "UltraSwitch," "TravelWeb," "UltraAccess," "HCC Hotel Clearing Corporation," "HCC Link," "HCC Cash", "UltraRes," "Click-It," "Pegasus" and "Chain Link" as United States federal trademarks, and an application to register "Powered by Pegasus" is pending with the United States Patent and Trademark Office. Trademark applications for "TravelWeb" and "Powered by Pegasus" also have been filed in Canada and Europe. RESEARCH AND DEVELOPMENT The Company's research and development activities primarily consist of software development, development of enhanced communication protocols and custom user interfaces and database design and enhancement. As of February 26, 1999, the Company employed 83 people in its Information Technology Group and from time to time, supplements their efforts with the use of independent consultants and contractors. This group is comprised of information technology, services development, technical services and product support personnel. The Company's total research and development expense was $2.2 million, $2.5 million and $4.2 million for 1996, 1997 and 1998, respectively. The research and development expenses for 1998 included a $1.5 million write down for in process research and development. EMPLOYEES At February 26, 1999, the Company had 137 employees, 132 of which were located in the United States, with 83 persons in the Information Technology Group, 22 persons performing sales and marketing, customer relations and business development functions and the remainder performing corporate, finance and administrative functions. The Company had 5 employees in England performing international sales activities. The Company has no unionized employees. The Company believes that its employee relations are satisfactory. RISK FACTORS SUBSTANTIAL NET LOSSES. In years before fiscal 1997, the Company experienced substantial net losses. Pegasus Commission Processing and Pegasus Electronic Distribution services have accounted for the majority of the Company's revenues to date, and the Company expects no significant revenues in 1999 from many of its other services, which are relatively new in their respective markets. Any decrease in the revenues from Pegasus Commission Processing or Pegasus Electronic Distribution, or any increase in expenses related to any of the Company's services substantially above the amounts budgeted therefor, could have a material adverse effect on the Company's financial condition and results of operations. The Company anticipates that its budgeted operating expenses will increase in the foreseeable future as it continues to 8 9 develop its services, increase its sales and marketing activities and expand its distribution channels. To continue its profitability, the Company must continue to successfully implement its business strategy and increase its revenues while controlling expenses. The Company can give no assurances regarding the successful completion of these measures. COMPETITION. Pegasus Electronic Distribution. The Company faces significant competition in connection with its electronic distribution service. The principal competitor of Pegasus Electronic Distribution is WizCom, which is a wholly owned indirect subsidiary of HFS. Although HFS has continued its participation in Pegasus Commission Processing, HFS currently uses Wizcom for its electronic hotel room reservation processing. There can be no assurance that any additional customers will not change their electronic reservation interface to WizCom or to another similar service. Also, hotels can choose to connect directly to one or more GDSs, thereby bypassing the UltraSwitch and eliminating the need to pay fees to the Company. Such competitors or their affiliates may have greater financial and other resources than the Company. Factors affecting the competitive success of an electronic hotel room reservation processing service include reliability, levels of fees, number of hotel properties on the system, ability to provide a neutral comprehensive interface between hotels and other participants in the distribution of hotel rooms and ability to develop new technological solutions. There can be no assurance that another participant in the hotel room distribution process or a new competitor will not create services with features that would reduce the attractiveness of the Company's services. The Company's inability to compete effectively with respect to these services could have a material adverse effect on the Company's financial condition and results of operations. The market for the Company's TravelWeb, NetBooker and other Internet services is highly competitive. Current competition includes traditional telephone or travel agency reservation methods and other Internet travel reservation services. There are a large number of Internet travel-related services offered by the Company's competitors, and many of these competitors are larger and have significantly greater financial resources and name recognition than the Company. Several competitive Web sites such as Travelocity (a site operated by The SABRE Group Holdings, Inc.) and Expedia (a site operated by Microsoft Corporation) offer a more comprehensive range of travel services than TravelWeb or NetBooker. The Company faces competition in the online hotel room reservation business not only from its current competitors but also from possible new entrants, including other Web sites. The costs of entry into the Internet hotel room reservation business are relatively low. There can be no assurance that the Company's Internet hotel room reservation services will compete successfully. The failure of these services to compete successfully could have a material adverse effect on the Company's financial condition and results of operations. Pegasus Commission Processing. The market for Pegasus Commission Processing is competitive. The Company's competitors in the commission processing business include NPC, WizCom and Citicorp. NPC is a company that has traditionally provided car rental and cruise line commission processing services. Citicorp provides commission consolidation services to hotel chains. In addition, hotels that are current or prospective customers of Pegasus Commission Processing can decide to process commission payments without, or in competition with, Pegasus Commission Processing. Some of these current or potential competitors have substantially greater financial and other resources than the Company. Furthermore, while the Company has agreements with all of its hotel customers for Pegasus Commission Processing, most of the Company's travel agency customers are not obligated by any agreement with the Company. If a significant percentage of these travel agencies were to cease using Pegasus Commission Processing, the Company's financial condition and results of operations could be materially adversely affected. 9 10 Pegasus Business Intelligence. The Company faces significant competition in connection with its Business Intelligence service. The Company's principal competitor is Smith. Smith currently provides information services to hotels. Accounting firms and other businesses do currently or may in the future provide information services similar to the Company's current or future service offerings. Such competitors or their affiliates may have existing customer relationships that create an impediment to the Company acquiring new customers. Such competitors may also have greater financial resources than the Company. There can be no assurance that current or future information service offerings of such competitors or new competitors will not reduce the attractiveness of the Company's services. The Company's inability to compete effectively with respect to these services could have a material adverse effect on the Company's financial condition and results of operations. DEPENDENCE ON HOTEL INDUSTRY; CONSOLIDATION TRENDS. The Company derives substantially all of its revenues directly and indirectly from the hotel industry. The hotel industry is sensitive to changes in economic conditions that affect business and leisure travel and is highly susceptible to unforeseen events, such as political instability, regional hostilities, recession, gasoline price escalation, inflation or other adverse occurrences that result in a significant decline in the utilization of hotel rooms. Any event that results in decreased travel or increased competition among hotels may lower hotel room reservation volumes, the average daily rates for hotel rooms or both and could have a material adverse effect on the Company's financial condition and results of operations. The hotel industry recently has witnessed a period of consolidation in which hotel chains have acquired or merged with other chains. Such activities may reduce the Company's customer base. Similar consolidation trends have occurred in the GDS industry. The GDS industry has consolidated to four major GDSs. If further consolidation were to take place, the value provided by the Company to participants in the hotel room distribution process and the benefits to hotel operators of utilizing the UltraSwitch would be reduced. The Company typically offers volume-based discounting of its fees, which could result in a higher percentage of discounted fees if the consolidation trends in the hotel and GDS industries continue. There can be no assurance that any potential decrease in the Company's customer base or any potential increase in the percentage of discounted fees will not have a material adverse effect on the Company's financial condition and results of operations. FLUCTUATIONS IN QUARTERLY OPERATING RESULTS. The Company has experienced in the past and expects to experience in the future significant fluctuations in quarterly operating results. Such fluctuations may be caused by many factors, including but not limited to the introduction of new or enhanced services by the Company or its competitors, the degree of customer acceptance of new services, competitive conditions in the industry, seasonal factors, reduction in client base, changes in pricing, the extent of international expansion, the mix of international and domestic sales and general economic conditions. Because the Company's expense budget is set early in a fiscal year and a significant portion of the Company's operating expenses are relatively fixed in nature, fluctuations in revenues may cause substantial variation in the Company's results of operations from quarter to quarter. Due to the foregoing factors, many of which are beyond the Company's control, quarterly revenues and operating results are difficult to forecast, and the Company believes that period-to-period comparisons of its operating results will not necessarily be meaningful and should not be relied upon as any indication of future performance. It is likely that the Company's future quarterly operating results from time to time will not meet the expectations of securities analysts or investors, which could have a material adverse effect on the market price of the Company's common stock. POTENTIAL ADVERSE CHANGES IN HOTEL COMMISSION PAYMENTS. Absent any express arrangement in individual cases, hotels currently 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%, limit the 10 11 maximum commission generally paid for a hotel room reservation or eliminate commissions entirely. In 1995, the airline industry placed a maximum limit on the amount of commissions payable to travel agencies for any domestic airline ticket issued. Recently, certain airlines have capped the dollar amount that they will pay to travel agencies for airline reservations made online. In addition, hotels increasingly are utilizing other direct distribution channels, such as the Internet, or offering negotiated rates to major corporate customers that are non-commissionable to travel agencies. Because a substantial portion of the Company's revenues are dependent on the dollar volume of travel agency commissions paid by hotels, any change in the hotel commission payment system that reduces the commissions payable to travel agencies and any acceleration of the trend towards direct distribution of rooms by hotels could have a material adverse effect on the Company's financial condition and results of operations. DEPENDENCE ON GROWTH OF INTERNET COMMERCE. The market for electronic hotel reservation services over the Internet is rapidly evolving and depends upon market acceptance of novel methods for distributing services and products, which involves a high degree of uncertainty. The success of the Company's TravelWeb, NetBooker and other Internet services will depend upon the adoption of the Internet by consumers as a widely used medium for commerce. The Internet may not prove to be a viable commercial marketplace for any number of reasons, including inadequate development of the necessary infrastructure or the lack of complementary services and products, such as high speed modems and high speed communication lines. The Internet has experienced, and is expected to continue to experience, significant growth in the number of users and amount of traffic. There can be no assurance that the Internet infrastructure will continue to be able to support the demands placed on it by this continued growth. Moreover, critical issues concerning the commercial use of the Internet (including security, reliability, cost, ease of use, accessibility and quality of service) remain unresolved and may negatively affect the growth or attractiveness of commerce conducted on the Internet. If critical issues concerning the commercial use of the Internet are not favorably resolved, if the necessary infrastructure is not developed or if the Internet does not become a viable commercial marketplace, the Company's financial condition and results of operations could be materially adversely affected. SYSTEM INTERRUPTION AND SECURITY RISKS. The Company's operations are dependent on its ability to protect its computer systems and databases against damage or system interruptions from fire, earthquake, power loss, telecommunications failure, unauthorized entry or other events beyond the Company's control. A significant amount of the Company's computer equipment is located at a single site in Phoenix, Arizona. There can be no assurance that unanticipated problems will not cause a significant system outage or data loss. Despite the implementation of security measures, the Company's infrastructure may also be vulnerable to break-ins, computer viruses or other disruptions caused by its customers or others. Any damage to the Company's databases, failure of communication links or security breach or other loss that causes interruptions in the Company's operations could have a material adverse effect on the Company's financial condition and results of operations. IMPACT OF TECHNOLOGICAL ADVANCES; DELAYS IN INTRODUCTION OF NEW SERVICES. The Company's future success will depend, in part, on its ability to develop leading technologies, enhance its existing services, develop and introduce new services that address the increasingly sophisticated and varied needs of its current and prospective customers and respond to technological advances and emerging industry standards and practices on a timely and cost effective basis. Although the Company strives to be a technological leader, there can be no assurance that future advances in technology will be beneficial to, or compatible with, the Company's business or that the Company will be able to economically incorporate such advances into its business. In addition, keeping abreast of technological advances in the Company's business may require substantial expenditures and lead time. There can be no assurance that the Company will be successful in effectively using new technologies, adapting its services to emerging industry standards or developing, introducing and marketing service enhancements or new services, or that it will not experience 11 12 difficulties that could delay or prevent the successful development, introduction or marketing of these services. If the Company incurs increased costs or is unable, for technical or other reasons, to develop and introduce new services or enhancements of existing services in a timely manner in response to changing market conditions or customer requirements, or if new services do not achieve market acceptance, the Company's financial condition and results of operations could be materially adversely affected. DEPENDENCE ON KEY CUSTOMERS AND THIRD-PARTY SERVICE ARRANGEMENTS. The Company's business is dependent upon customer arrangements with its hotel stockholders or their affiliates, other hotel chains and hotel representation firms, travel agencies, travel agency consortia and GDSs. The Company has not entered into written agreements with certain travel agencies relating to Pegasus Commission Processing. There can be no assurance that the Company will be able to continue or renew these arrangements on equal or better terms or initiate new arrangements. Any cancellation or non-renewal of these arrangements that results in a significant reduction in the Company's customer base or revenue sources could materially adversely affect the Company's financial condition and results of operations. In addition, the Company relies on third parties to provide consolidation, remittance and worldwide currency exchange services for Pegasus Commission Processing and facility maintenance and disaster recovery services for computer and communications systems used in all of the Company's services. There can be no assurance that these service contracts will be successfully extended upon expiration or that the Company can enter into contracts with alternate service providers at the same or lower cost. Any failure by the Company to extend these contracts or to secure alternate service providers could have a material adverse effect on the Company's financial condition and results of operations. GOVERNMENT REGULATION. The Company's primary customers are hotel chains and hotel representation firms. The Company currently has as its stockholders many of the leading hotel chains in the world based on revenues. While the Company believes that it has been acting since its inception as an entity independent of its stockholders, and its stockholders have not engaged in any anti-competitive activities through or in connection with the Company, there can be no assurance that federal, state or foreign governmental authorities, the Company's competitors or its consumers will not raise anti-competitive concerns regarding the Company's close relationship with its hotel stockholders. Any such action by federal, state or foreign governmental authorities or allegations by third parties could have a material adverse effect on the Company's financial condition and results of operations. While certain aspects of the travel industry are heavily regulated by the United States Government, the services currently offered by the Company, including electronic room reservation processing services, commission processing services and online reservation services, have not been subject to any material industry-specific government regulation. However, there can be no assurance that federal, state or foreign governmental authorities will not attempt to regulate one or more of the Company's current or future services. Due to the increasing popularity of the Internet, it is possible that laws and regulations may be adopted with respect to the Internet, covering issues such as privacy, pricing, content and quality of products and services. The adoption of laws or regulations affecting the Company's lines of business could reduce the rate of growth of the Company or could otherwise have a material adverse effect on the Company's financial condition and results of operations. RISKS ASSOCIATED WITH MANAGEMENT OF GROWTH. The Company has in recent years experienced significant growth and anticipates that significant expansion will continue to be required in order to address potential market opportunities. There can be no assurance that if the Company continues to expand, management will be effective in attracting and retaining additional qualified personnel, expanding the Company's physical facilities, integrating acquired businesses or otherwise managing growth. In addition, there can be no assurance that the Company's systems, procedures or controls will be adequate to support any expansion of the Company's operations. The Company's inability to manage growth effectively could have a material adverse effect on the Company's financial condition and results of operations. 12 13 RISKS ASSOCIATED WITH INTERNATIONAL EXPANSION AND OPERATIONS. Pursuit of international growth opportunities may require significant investments for an extended period before returns on such investments, if any, are realized. There can be no assurance as to the extent, if at all, that the Company's plans to expand in international markets will be successful. The Company's current international activities and prospects may be adversely affected by factors such as policies of the United States and foreign governments affecting foreign trade, privacy issues, investment and taxation, exchange controls, political risks and currency risks. One or more of these factors could materially adversely affect the Company's financial condition and results of operations. DEPENDENCE ON KEY PERSONNEL. The Company believes that its success will continue to be dependent upon its ability to attract and retain skilled managers and other key personnel, including its President, John F. Davis, III, its Chief Operating Officer, Joseph W. Nicholson, and its other present officers. The loss of the services of any of its present officers could have a material adverse effect on the Company's financial condition and results of operations. Although the Company currently has "key-man" insurance covering Messrs. Davis and Nicholson, there can be no assurance that the amount of such insurance would be adequate to compensate for the loss of the services of the insured officers. The Company believes that its future business results will also depend in significant part upon its ability to identify, attract, motivate and retain additional highly skilled technical personnel. Competition for such personnel in the information technology industry is intense. There can be no assurance that the Company will be successful in identifying, attracting, motivating and retaining such personnel, and the failure to do so could have a material adverse effect on the Company's financial condition and results of operations. DEPENDENCE ON PROPRIETARY TECHNOLOGY; RISK OF INFRINGEMENT. The Company's success depends upon its proprietary technology, consisting of both its software and its hardware designs. The Company relies upon a combination of copyright, trade secrets, confidentiality procedures and contractual provisions to protect its proprietary technology. There can be no assurance that the Company's present protective measures will be enforceable or adequate to prevent misappropriation of its technology or independent third-party development of the same or similar technology. Many foreign jurisdictions offer less protection of intellectual property rights than the United States, and there can be no assurance that the protection provided to the Company's proprietary technology by the laws of the United States or foreign jurisdictions will be sufficient to protect the Company's technology. In addition, litigation may be necessary in the future to enforce the Company's intellectual property rights, to protect the Company's trade secrets, to determine the validity and scope of the proprietary rights of others, or to defend against claims of infringement or invalidity. Such litigation, whether successful or unsuccessful, could result in substantial cost and diversion of management resources, and a successful claim could effectively block the Company's ability to use or license its technology in the United States or abroad or otherwise have a material adverse effect on the Company's financial condition and results of operations. The Company has found and may in the future find it necessary or desirable to procure licenses from third parties relating to current or future services or technology, but there can be no assurance that the Company will continue to be able to obtain such licenses or other rights or, if it is able to obtain them, that it will be able to do so on commercially acceptable terms. The Company could be placed at a disadvantage if its competitors obtain licenses with lower royalty fee payments or other terms more favorable than those received by the Company. If the Company or its suppliers were unable to obtain licenses relating to current or future services or technology, the Company could be forced to market services without certain technological features. The Company's inability to obtain licenses necessary to use certain technology or its inability to obtain such licenses on competitive terms could have a material adverse effect on the Company's financial condition and results of operations. 13 14 RISKS ASSOCIATED WITH YEAR 2000 COMPLIANCE. The Company utilizes a significant number of computer software programs and operating systems in its internal operations. If these programs or systems are unable to appropriately interpret dates occurring in the upcoming calendar year 2000, some level of modification or replacement of such software may be necessary. The Company is currently evaluating its information technology ("IT") and non-IT Systems for year 2000 compliance. This evaluation includes reviewing what actions are required to make such systems year 2000 compliant as well as actions necessary to make the Company less vulnerable to year 2000 compliance problems associated with third parties' systems. Even though the Company has implemented a program designed to ensure that all software used in connection with the Company's services are year 2000 compliant, the Company may fail to identify all year 2000 problems or correct such problems in a timely manner. Since the Company derives nearly all of its revenues from processing electronic reservations or consolidating hotel commissions electronically, the inability or limitation of its ability to process electronic hotel reservations or consolidate hotel commissions as a result of year 2000 problems would have a material adverse impact on the Company's revenues and cash flow. The Company has no control over services, functions and data provided by third party vendors and others which may result in the inability for the Company to provide services. The Company has contacted and is working with its material customers and vendors to verify their degree of year 2000 compliance. However, the Company has no control over third parties and if they will be year 2000 compliant. The extent to which third party customers and vendors do not become year 2000 compliant on a timely basis may have a material adverse effect on the Company's cash flow and results of operations. RISKS ASSOCIATED WITH ACQUISITIONS. The Company regularly evaluates acquisition opportunities and has made and may in the future make acquisitions of other companies or technologies. Acquisitions involve numerous risks, including difficulties in assimilating acquired operations and products, diversion of management's attention from other business concerns, amortization of acquired intangible assets and potential loss of key employees of acquired companies. In August 1998, the Company acquired all of the equity interest in Driving Revenue L.L.C. Otherwise, the Company has little experience in assimilating acquired nonaffiliated organizations into the Company's operations. There can be no assurance as to the ability of the Company to integrate successfully any operations, personnel or services that might be acquired in the future, and a failure by the Company to do so could have a material adverse effect on the Company's financial condition and results of operations. RISKS ASSOCIATED WITH MINORITY INVESTMENTS IN OTHER BUSINESSES. In June 1998, the Company purchased a minority interest in Customer Analytics, Inc. a new venture aimed at providing services to companies in the field of data warehousing and data mining. In September 1998, the Company also purchased a minority interest in Intermezzo, Inc., a developer of hotel reservation and property management systems and software. The Company has little or no control over the success of Customer Analytics, Inc. or Intermezzo, Inc., and there can be no assurance of the success of either of these investments. The failure of either of these companies could have a material adverse effect on the Company's financial condition and results of operations. ANTI-TAKEOVER MATTERS. The Company's Third Amended and Restated Certificate of Incorporation ("Certificate") and Second Amended and Restated By-laws ("By-laws") contain provisions that may have the effect of delaying, deterring or preventing a potential takeover of the Company. The Certificate and By-laws provide for a classified Board of Directors serving staggered terms of three years, prevent stockholders from calling a special meeting of stockholders and prohibit stockholder action by written consent. The Certificate also authorizes only the Board of Directors to fill vacancies, including newly created directorships, and 14 15 states that directors of the Company may be removed only for cause and only by the affirmative vote of holders of at least two-thirds of the outstanding shares of the voting stock, voting together as a single class. In addition, the Certificate grants the Board of Directors the authority to issue up to 2,000,000 shares of preferred stock, having such rights, preferences and privileges as designated by the Board. The issuance of preferred stock could, among other things, adversely affect the voting power or other rights of the holders of common stock and, under certain circumstances, make it more difficult for a third party to acquire, or discourage a third party from acquiring, control of the Company. Section 203 of the Delaware General Corporation Law, which is applicable to the Company, contains provisions that restrict certain business combinations with interested stockholders, which may have the effect of inhibiting a non-negotiated merger or other business combination involving the Company. On September 28, 1998, the Board of Directors of the Company adopted a stockholder rights plan (the "Rights Plan") and declared a dividend distribution of one right (the "Right") for each outstanding share of the Company's common stock to stockholders of record at the close of business on October 13, 1998. Each Right entitles the registered holder to purchase from the Company one-thousandth of a share of the Company's Series A Preferred Stock for each share of the Company's common stock held, at a price of $90. The Rights are exercisable only if a person or group of affiliated persons acquires, or has announced the intent to acquire, 20% or more of the Company's common stock. These Rights could make it more difficult for a third party to acquire, or discourage a third party from acquiring, control of the Company. POTENTIAL VOLATILITY OF STOCK PRICE. The market price for the common stock may be highly volatile. The Company believes that factors such as quarterly fluctuations in financial results or announcements by the Company or by its competitors, travel agencies, hotel operators or other hotel industry participants could cause the market price of the common stock to fluctuate substantially. In addition, the stock market may experience extreme price and volume fluctuations which often are unrelated to the operating performance of specific companies. Market fluctuations or perceptions regarding the hotel industry, as well as general economic or political conditions, may adversely affect the market price of the common stock. In the past, following periods of volatility in the market price for a company's securities, securities class action litigation has often been instituted. Such litigation could result in substantial costs and a diversion of management attention and resources, which could have a material adverse effect on the Company's financial condition and results of operations. ITEM 2. PROPERTIES. The Company's principal executive office is a leased facility with approximately 39,750 square feet of space in Dallas, Texas as of February 26, 1999. The Company leases this space under a lease agreement that expires December 2002. The Company also maintains an administrative and sales office in a leased facility with approximately 2,255 square feet of space near London, England. The lease agreement for the office in England expires in February 2006. Under an agreement with REZsolutions, Inc. certain of the equipment owned by the Company is housed at a site owned by REZsolutions, Inc. in Phoenix, Arizona. The Company believes that its existing facilities are well maintained and in good operating condition and are adequate for its present and anticipated levels of operations. ITEM 3. LEGAL PROCEEDINGS. The Company is a party from time to time to certain routine legal proceedings arising in the ordinary course of its business. Although the outcome of any legal proceeding cannot be predicted accurately, the Company does not believe any liability that might result from such proceedings could have a material adverse effect on the Company's financial condition and results of operations. 15 16 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS. No matter was submitted to a vote of the stockholders of the Company during the fourth quarter of the fiscal year ending December 31, 1998. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS. (a) The Company's common stock has traded on the Nasdaq National Market under the symbol "PEGS" since August 7, 1997. At February 26, 1999, there were approximately 76 record holders of the Company's common stock, although the Company believes that the number of beneficial owners of its common stock is substantially greater. The table below sets forth for the fiscal quarters indicated the high and low sale prices for the common stock.
Fiscal Year Ending December 31, 1998 HIGH LOW - ------------------------------------ --------- ---------- Fourth quarter ......................... $ 36.25 $ 8.88 Third quarter .......................... $ 26.88 $ 10.75 Second Quarter ......................... $ 31.00 $ 22.00 First Quarter .......................... $ 27.13 $ 13.63
Fiscal Year Ending December 31, 1997 HIGH LOW - ------------------------------------ --------- ---------- Fourth quarter ......................... $ 20.75 $ 12.50 Third quarter (from August 7, 1997) .... $ 19.25 $ 15.50
The Company intends to retain any future earnings for use in its business and does not intend to pay cash dividends in the foreseeable future. The payment of future dividends, if any, will be at the discretion of the Company's Board of Directors and will depend, among other things, upon future earnings, operations, capital requirements, restrictions in future financing agreements, the general financial condition of the Company and general business conditions. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Liquidity and Capital Resources." On September 28, 1998, the Board of Directors of the Company declared a dividend distribution of one right (the "Right") for each outstanding share of the Company's common stock to stockholders of record at the close of business on October 13, 1998. Each Right entitles the registered holder to purchase from the Company one-thousandth of a share of the Company's series A Preferred Stock for each share of the Company's common stock held, at a price of $90. The Rights are exercisable only if a person or group of affiliated persons acquires, or has announced the intent to acquire, 20% or more of the Company's common stock. (b) The Securities and Exchange Commission on August 6, 1997 declared effective the Registration Statement on Form S-1 (File No. 333-28595) relating to the initial public offering (IPO) of the Company's common stock. 16 17 ITEM 6. SELECTED FINANCIAL DATA. This information required by this item is set forth under the caption "Selected Consolidated Financial Data" of the Company's 1998 Annual Report to Stockholders, which portion of such Annual Report is filed herewith as Exhibit 13.1 and incorporated herein by reference. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. This information required by this item is set forth under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" of the Company's 1998 Annual Report to Stockholders, which portion of such Annual Report is filed herewith as Exhibit 13.1 and incorporated herein by reference. ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK None. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA. The financial statements of the Company including the independent accountant's report thereon of the Company's 1998 Annual Report to Stockholders, which financial statements are filed herewith as Exhibit 13.1, are incorporated herein by reference. ITEM 9. CHANGE IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT. The information required by this item appears in the Company's definitive Proxy Statement for its 1999 Annual Meeting of Stockholders under the captions "Election of Directors" and "Executive Officers of the Company," which information is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION. The information required by this item appears in the Company's definitive Proxy Statement for its 1999 Annual Meeting of Stockholders under the caption "Executive Compensation and Other Matters," which information is incorporated herein by reference. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT. The information required by this item appears in the Company's definitive Proxy Statement for its 1999 Annual Meeting of Stockholders under the caption "Outstanding Capital Stock and Stock Ownership of Directors, Certain Executive Officers and Principal Stockholders," which information is incorporated herein by reference. 17 18 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS. The information required by this item appears in the Company's definitive Proxy Statement for its 1999 Annual Meeting of Stockholders under the caption "Certain Transactions," which information is incorporated herein by reference. PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K. (a) 1. The following financial statements are incorporated by reference from the Company's 1998 Annual Report to Stockholders, which financial statements are filed herein as Exhibit 13.1 and incorporated herein by reference: Report of Independent Accountants. Consolidated Balance Sheets as of December 31, 1998 and 1997. Consolidated Statements of Operations for the years ended December 31, 1998, 1997 and 1996. Consolidated Statements of Changes in Stockholders' Equity (Deficit) for the years ended December 31, 1998, 1997 and 1996. Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996. Notes to Consolidated Financial Statements. 2. The following Financial Statement Schedules of the Company are filed as part of this Report: Consolidated Financial Statement Schedule Page Report of Independent Accountants on Financial Statement Schedule. S-1 Consolidated Valuation and Qualifying Accounts. S-2 All other schedules for which provision is made in the applicable accounting regulations of the Securities and Exchange Commission are not required under the related instructions or are inapplicable and therefore have been omitted. 18 19 3. The following documents are filed or incorporated by reference as exhibits to this Report: EXHIBIT NO. DESCRIPTION - ----------- ----------- 2.1 Contribution and Restructuring Agreement dated effective as of July 21, 1995 by and among the Company and all of the stockholders of the Company +3.1 Third Amended and Restated Certificate of Incorporation, as amended 3.2 Second Amended and Restated Bylaws 3.3 Form of Certification of Designation, Preferences and Rights of Series A Preferred Stock of Pegasus Systems, Inc. (incorporated by reference from Exhibit 2 of the Company's Form 8-A filed with the Commission on October 9, 1998). 4.1 Specimen of Common Stock Certificate 4.2 Third Amended and Restated Certificate of Incorporation and Second Amended and Restated Bylaws (see Exhibits 3.1 and 3.2) 4.3 Rights Agreement dated June 25, 1996 by and among the Company and certain holders of capital stock of the Company named therein 4.4 Common Stock Purchase Warrant issued to Holiday Hospitality Corporation 4.5 Rights Agreement dated as of September 28, 1998 by and between the Company and American Securities Transfer & Trust, Inc. (incorporated by reference from Exhibit 4 of the Company's Current Report on Form 8-K filed with the Commission on October 9, 1998) 4.6 Form of Rights Certificate (incorporated by reference from Exhibit 3 of the Company's Form 8-A filed with the Commission on October 9, 1998) *10.1 Employment Agreement dated June 25, 1996 between the Company and John F. Davis, III *10.2 Employment Agreement dated June 25, 1996 between the Company and Joseph W. Nicholson *10.3 Employment Agreement dated August 29, 1996 between the Company and Jerome L. Galant *10.4 Employment Agreement dated May 18, 1996 between the Company and Michael R. Donahue +*10.5 1996 Stock Option Plan, as amended +*10.6 1997 Stock Option Plan, as amended 10.7 Citibank Global Payments Service Agreement dated July 24, 1998 between the Hotel Clearing Corporation and Citibank, N.A. (incorporated by reference to Exhibit 10.1 of the Company's 10-Q for the quarter ended October 31, 1998, filed with the Commission on November 16, 1998) 10.8 Facilities Management Agreement dated January 1, 1996 between the Company and Anasazi, Inc., currently known as REZsolutions, Inc. 10.9 Service Agreement dated December 13, 1996 between the Company and Comdisco, Inc. 10.10 Service Agreement dated January 17, 1997 between the Company and Genuity, Inc. +*10.11 1997 Employee Stock Purchase Plan, as amended +10.12 Office Lease dated October 1, 1995, First Amendment to Office Lease dated February 25, 1998 and Second Amendment to Office Lease dated November 2, 1998 between the Company and the Utah State Retirement Investment Fund relating to property located at 3811 Turtle Creek Blvd., Suite 1100, Dallas, Texas 75219 19 20 +13.1 Selected portions of the Company's Annual Report to Stockholders for fiscal year ended December 31, 1998 16.1 Letter regarding Change in Certifying Accountant +21.1 Subsidiaries of the Company +23.1 Consent of PricewaterhouseCoopers LLP +24.1 Power of Attorney (included on signature page) +27.1 Financial Data Schedule - ------------------- Unless otherwise indicated, exhibits are incorporated by reference to the Company's Registration Statement (File No. 333-28595) on Form S-1 declared effective by the Commission on August 6, 1997. + Filed herewith. * Management contract or compensatory plan or arrangement. The Company will furnish a copy of any exhibit listed above to any shareholder without charge upon written request to Mr. Ric L. Floyd, Secretary, 3811 Turtle Creek Blvd., Suite 1100, Dallas, Texas 75219. (b) REPORTS ON FORM 8-K The following report on Form 8-K was filed during the quarter ended December 31, 1998:
Financial Statements Item Description Filing Date Filed - ---- ----------- ----------- ------------------- 7 A report announcing a dividend distribution October 9, 1998 No declared by the Board of Directors relating to the Company's Stockholder Rights Plan.
20 21 Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized, in the City of Dallas, State of Texas, on this 30th day of March, 1999. PEGASUS SYSTEMS, INC. By: /s/ John F. Davis, III -------------------------------------- John F. Davis, III Chief Executive Officer, President and Director Pursuant to the requirements of the Securities Act of 1933, this Registration Statement 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, Jerome L. Galant 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 Report, 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.
SIGNATURES TITLE DATE ---------- ----- ---- /s/ JOHN F. DAVIS, III Chief Executive Officer, President March 30, 1999 ---------------------------------- and Director (Principal Executive John F. Davis, III Officer) /s/ JEROME L. GALANT Chief Financial Officer March 30, 1999 ---------------------------------- Jerome L. Galant (Principal Financial and Accounting Officer) /s/ MICHAEL A. BARNETT Director March 30, 1999 ---------------------------------- Michael A. Barnett /s/ ROBERT B. COLLIER Director March 30, 1999 ---------------------------------- Robert B. Collier /s/ WILLIAM C. HAMMETT, JR. Director March 30, 1999 ---------------------------------- William C. Hammett, Jr. /s/ THOMAS F. O'TOOLE Director March 30, 1999 ---------------------------------- Thomas F. O'Toole /s/ MARK C. WELLS Director March 30, 1999 ---------------------------------- Mark C. Wells /s/ BRUCE W.WOLFF Director March 30, 1999 ---------------------------------- Bruce W. Wolff
21 22 REPORT OF INDEPENDENT ACCOUNTANTS ON FINANCIAL STATEMENT SCHEDULE To the Board of Directors of Pegasus Systems, Inc. Our audits of the consolidated financial statements referred to in our report dated February 2, 1999 appearing in the 1998 Annual Report to Stockholders of Pegasus Systems, Inc. (which report and consolidated financial statements are incorporated by reference in this Annual Report on Form 10-K) also included an audit of the Financial Statement Schedule, for each of the three years in the period ended December 31, 1998, listed in Item 14(a) of this Form 10-K. In our opinion, this Financial Statement Schedule presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. PricewaterhouseCoopers LLP Dallas, Texas February 2, 1999 S-1 23 SCHEDULE II PEGASUS SYSTEMS, INC. VALUATION AND QUALIFYING ACCOUNTS For the years ended December 31, 1996, 1997 and 1998 (In thousands)
Additions Additions Balance at Charged to from Balance Beginning Costs and Acquired at End Classification of Period Expenses Companies Deductions of Period --------- ---------- --------- ---------- --------- December 31, 1996 Allowance for doubtful accounts $ 20 $ 25 $ -- $ -- $ 45 Income tax valuation allowances $ 3,528 $ 1,060 $ -- $ (39) $ 4,549 ------- ------- ----- ------- ------- Total reserves and allowances $ 3,548 $ 1,085 $ -- $ (39) $ 4,594 ======= ======= ======= ======= ======= December 31, 1997 Allowance for doubtful accounts $ 45 $ 81 $ -- $ (48) $ 78 Income tax valuation allowances $ 4,549 $ -- $ -- $ (237) $ 4,312 ------- ------- ----- ------- ------- Total reserves and allowances $ 4,594 $ 81 $ -- $ (285) $ 4,390 ======= ======= ======= ======= ======= December 31, 1998 Allowance for doubtful accounts $ 78 $ 35 $ 7 $ (21) $ 99 Income tax valuation allowances $ 4,312 $ 270 $ -- $(4,312) $ 270 ------- ------- ----- ------- ------- Total reserves and allowances $ 4,390 $ 305 $ 7 $(4,333) $ 369 ======= ======= ======= ======= =======
- -------------- (a) This schedule should be read in conjunction with the Company's audited consolidated financial statements and related notes thereto. 24 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION - ----------- ----------- 2.1 Contribution and Restructuring Agreement dated effective as of July 21, 1995 by and among the Company and all of the stockholders of the Company +3.1 Third Amended and Restated Certificate of Incorporation, as amended 3.2 Second Amended and Restated Bylaws 3.3 Form of Certification of Designation, Preferences and Rights of Series A Preferred Stock of Pegasus Systems, Inc. (incorporated by reference from Exhibit 2 of the Company's Form 8-A filed with the Commission on October 9, 1998). 4.1 Specimen of Common Stock Certificate 4.2 Third Amended and Restated Certificate of Incorporation and Second Amended and Restated Bylaws (see Exhibits 3.1 and 3.2) 4.3 Rights Agreement dated June 25, 1996 by and among the Company and certain holders of capital stock of the Company named therein 4.4 Common Stock Purchase Warrant issued to Holiday Hospitality Corporation 4.5 Rights Agreement dated as of September 28, 1998 by and between the Company and American Securities Transfer & Trust, Inc. (incorporated by reference from Exhibit 4 of the Company's Current Report on Form 8-K filed with the Commission on October 9, 1998) 4.6 Form of Rights Certificate (incorporated by reference from Exhibit 3 of the Company's Form 8-A filed with the Commission on October 9, 1998) *10.1 Employment Agreement dated June 25, 1996 between the Company and John F. Davis, III *10.2 Employment Agreement dated June 25, 1996 between the Company and Joseph W. Nicholson *10.3 Employment Agreement dated August 29, 1996 between the Company and Jerome L. Galant *10.4 Employment Agreement dated May 18, 1996 between the Company and Michael R. Donahue +*10.5 1996 Stock Option Plan, as amended +*10.6 1997 Stock Option Plan, as amended 10.7 Citibank Global Payments Service Agreement dated July 24, 1998 between the Hotel Clearing Corporation and Citibank, N.A. (incorporated by reference to Exhibit 10.1 of the Company's 10-Q for the quarter ended October 31, 1998, filed with the Commission on November 16, 1998) 10.8 Facilities Management Agreement dated January 1, 1996 between the Company and Anasazi, Inc., currently known as REZsolutions, Inc. 10.9 Service Agreement dated December 13, 1996 between the Company and Comdisco, Inc. 10.10 Service Agreement dated January 17, 1997 between the Company and Genuity, Inc. +*10.11 1997 Employee Stock Purchase Plan, as amended +10.12 Office Lease dated October 1, 1995, First Amendment to Office Lease dated February 25, 1998 and Second Amendment to Office Lease dated November 2, 1998 between the Company and the Utah State Retirement Investment Fund relating to property located at 3811 Turtle Creek Blvd., Suite 1100, Dallas, Texas 75219
25 +13.1 Selected portions of the Company's Annual Report to Stockholders for fiscal year ended December 31, 1998 16.1 Letter regarding Change in Certifying Accountant +21.1 Subsidiaries of the Company +23.1 Consent of PricewaterhouseCoopers LLP +24.1 Power of Attorney (included on signature page) +27.1 Financial Data Schedule
- ------------------- Unless otherwise indicated, exhibits are incorporated by reference to the Company's Registration Statement (File No. 333-28595) on Form S-1 declared effective by the Commission on August 6, 1997. + Filed herewith. * Management contract or compensatory plan or arrangement. The Company will furnish a copy of any exhibit listed above to any shareholder without charge upon written request to Mr. Ric L. Floyd, Secretary, 3811 Turtle Creek Blvd., Suite 1100, Dallas, Texas 75219. EX-3.1 2 3RD AMENDED/RESTATED CERTIFICATION OF INC. 1 EXHIBIT 3.1 THIRD AMENDED AND RESTATED CERTIFICATE OF INCORPORATION OF PEGASUS SYSTEMS, INC. --O0O-- This Third Amended and Restated Certificate of Incorporation amends and restates the Certificate of Incorporation of Pegasus Systems, Inc., a corporation originally incorporated in Delaware as "Pegasus Systems, Inc." on July 10, 1995. This Third Amended and Restated Certificate of Incorporation has been duly adopted pursuant to Sections 242 and 245 of the Delaware General Corporation Law. ARTICLE I The name of this corporation is Pegasus Systems, Inc. (the "Corporation"). ARTICLE II The address of the registered office of the Corporation in the State of Delaware is 1013 Centre Road, New Castle County, Wilmington, Delaware 19805-1297. The name of the registered agent of the Corporation at that address is The Prentice-Hall Corporation Systems, Inc. ARTICLE III The nature of the business or purposes to be conducted or promoted by the Corporation is to engage in any lawful business, act or activity for which corporations may be organized under the General Corporation Law of the State of Delaware. The private property of the stockholders shall not be subject to the payment of corporate debts to any extent whatsoever. ARTICLE IV This Corporation is authorized to issue two classes of stock, designated "Common Stock" and "Preferred Stock". The total number of shares which this Corporation is authorized to issue is 52,000,000 shares. The number of shares of Common Stock which this Corporation is authorized to issue is 50,000,000 shares, par value $0.01 per share. The number of shares of Preferred Stock which this Corporation is authorized to issue is 2,000,000 shares, par value $0.01 per share, which shall initially be undesignated as to series. Any Preferred Stock not previously designated as to series may be issued from time to time in one or more series pursuant to a resolution or resolutions providing for such -1- 2 issue duly adopted by the Board of Directors (authority to do so being hereby expressly vested in the Board), and such resolution or resolutions shall also set forth the voting powers, full or limited or none, of each such series of Preferred Stock and shall fix the designations, preferences and relative, participating, optional or other special rights and qualifications, limitations or restrictions of each such series of Preferred Stock. The Board of Directors is authorized to alter the designation, rights, preferences, privileges and restrictions granted to or imposed upon any wholly unissued series of Preferred Stock and, within the limits and restrictions stated in any resolution or resolutions of the Board of Directors originally fixing the number of shares constituting any series of Preferred Stock, to increase or decrease (but not below the number of shares of any such series then outstanding) the number of shares of any such series subsequent to the issue of shares of that series. Each share of Preferred Stock issued by the Corporation, if reacquired by the Corporation (whether by redemption, repurchase, conversion to Common Stock or other means), shall upon such reacquisition resume the status of authorized and unissued shares of Preferred Stock, undesignated as to series and available for designation and issuance by the Corporation in accordance with the immediately preceding paragraph. The relative rights, preferences, privileges and restrictions granted to or imposed upon the Common Stock or the holders thereof are as follows: (a) Dividend Rights. Subject to the prior rights of holders of all classes of stock at the time outstanding having prior rights as to dividends, the holders of the Common Stock shall be entitled to receive, when and as declared by the Board of Directors, out of any assets of the Corporation legally available therefor, such dividends as may be declared from time to time by the Board of Directors. (b) Liquidation Rights. In the event of any voluntary or involuntary liquidation, dissolution or winding up of the affairs of the Corporation, after payment or provision for payment of the debts and other liabilities of the Corporation and of any amounts to which the holders of all classes of stock at the time outstanding having prior rights as to liquidation are entitled, the holders of all outstanding shares of Common Stock shall be entitled to share ratably in the remaining assets of the Corporation. (c) Redemption. The Common Stock is not redeemable. (d) Voting Rights. The holder of each share of Common Stock shall have the right to one vote, and shall be entitled to notice of any shareholders' meeting in accordance with the Bylaws of this Corporation, and shall be entitled to vote upon such matters and in such manner as may be provided by law. (e) Residual Rights. All rights accruing to the outstanding shares of this -2- 3 Corporation not expressly provided for to the contrary herein shall be vested in the Common Stock. ARTICLE V The Corporation is to have perpetual existence. ARTICLE VI Elections of directors need not be by written ballot unless a stockholder demands election by written ballot at the meeting and before voting begins or unless the Bylaws of the Corporation shall so provide. ARTICLE VII In furtherance and not in limitation of the powers conferred by statute, the Board of Directors of the Corporation is expressly authorized to make, alter, amend or repeal the Bylaws of the Corporation. ARTICLE VIII (a) To the fullest extent permitted by the General Corporation Law of the State of Delaware as the same exists or as may hereafter be amended, a director of the Corporation shall not be personally liable to the Corporation or its stockholders for monetary damages for breach of fiduciary duty as a director. (b) The Corporation may indemnify to the fullest extent permitted by law any person made or threatened to be made a party to an action or proceeding, whether criminal, civil, administrative or investigative, by reason of the fact that he, his estate or legal representative is or was a director, officer, employee or agent of the Corporation or any predecessor of the Corporation or serves or served at any other enterprise as a director, officer, employee or agent at the request of the Corporation or any other predecessor to the Corporation. (c) No amendment nor repeal of this Article VIII, nor the adoption of any provision of this Corporation's Certificate of Incorporation inconsistent with this Article VIII, shall eliminate or reduce the effect of this Article VIII, in respect of any matter occurring, or any action or proceeding accruing or arising or that, but for this Article VIII, would accrue or arise, prior to such amendment, repeal or adoption of an inconsistent provision. -3- 4 ARTICLE IX Meetings of stockholders may be held within or without the State of Delaware, as the Bylaws may provide. The books of the Corporation may be kept (subject to any provision contained in the statutes) outside of the State of Delaware at such place or places as may be designated from time to time by the Board of Directors or in the Bylaws of the Corporation. ARTICLE X Advance notice of new business and stockholder nominations for the election of directors shall be given in the manner and to the extent provided in the Bylaws of the Corporation. ARTICLE XI The business and affairs of the Corporation shall be managed by or under the direction of the Board of Directors. The Board of Directors may exercise all such authority and powers of the Corporation and do all such lawful acts and things as are not by statute or this Certificate of Incorporation directed or required to be exercised or done by the stockholders. 1. Number of Directors The number of directors of the Corporation shall be fixed from time to time only by action of not less than a majority of the members of the Board of Directors then in office. The number of directors comprising the Board of Directors of the Corporation shall not be less than two (2) or more than twenty-five (25). 2. Classes Subject to the rights, if any, of any series of Preferred Stock then outstanding, the directors shall be divided into three classes, designated Class I, Class II and Class III. The number of directors in each class shall be the whole number contained in the quotient arrived at by dividing the authorized number of directors by three, and if a fraction is also contained in such quotient then if such fraction is one-third (1/3) the extra director shall be a member of Class III and if the fraction is two-thirds (2/3) then one of the extra directors shall be a member of Class III and the other shall be a member of Class II. The term of office of directors in each class shall expire as follows: Class I shall expire at the 1998 annual meeting of stockholders, Class II shall expire at the 1999 annual meeting of stockholders, Class III shall expire at the 2000 annual meeting of stockholders. At each such meeting of stockholders, directors shall be elected to succeed those directors whose terms expire for a term of office to expire at the third succeeding annual meeting of stockholders after their election. All directors shall hold office until the annual meeting of -4- 5 stockholders for the year in which their term expires and until their successors are duly elected and qualified, or until their earlier death, resignation, disqualification or removal. 3. Vacancies Subject to the rights, if any, of the holders of any series of Preferred Stock then outstanding, newly created directorships resulting from any increase in the authorized number of directors or any vacancies in the Board of Directors resulting from death, resignation, disqualification or removal may be filled only by a majority vote of the directors then in office, though less than a quorum, and directors so chosen shall hold office for a term expiring at the annual meeting of stockholders at which the term of office of the class to which they have been elected expires and until such director's successor shall have been duly elected and qualified. 4. Removal Any director or the entire Board of Directors may be removed only for cause and only by the vote of the holders of two-thirds (2/3) of the securities of the Corporation then entitled to vote at an election of directors voting together as a single class. ARTICLE XII Any action required or permitted to be taken at any annual or special meeting of stockholders may only be taken upon the vote of the stockholders at an annual or special meeting duly called and may not be taken by written consent of the stockholders. Special meetings of the stockholders, unless otherwise prescribed by statute, may be called at any time only by the Chairman of the Board or the Chief Executive Officer of the Corporation or the Board of Directors. ARTICLE XIII The Corporation reserves the right to amend, alter, change or repeal any provision contained in this Certificate of Incorporation, in the manner now or hereafter prescribed by statute, and all rights conferred upon stockholders herein are granted subject to this reservation. In addition to any affirmative vote required by applicable law or any other provision of this Certificate of Incorporation or specified in any agreement, the affirmative vote of the holders of not less than two-thirds (2/3) of the voting power of all securities of the Corporation entitled to vote generally in the election of directors shall be required to amend, add, alter, change, repeal or adopt any provisions inconsistent with Sections 1, 2 or 3 of Article XI, Article XII or this Article XIII of this Certificate of Incorporation and the affirmative vote of not less than eighty percent (80%) of the voting power of all securities of the Corporation entitled to vote generally in the election of directors shall be required to amend, add, alter, change, repeal or adopt any provisions inconsistent with Section 4 of Article XI or this Article XIII with respect to Section 4 of Article XI. -5- 6 IN WITNESS WHEREOF, the Corporation has caused this Third Amended and Restated of Certificate to be duly executed this 26th day of May, 1998. By: /s/ JOHN F. DAVIS, III --------------------------------------- John F. Davis, III President and Chief Executive Officer ATTEST: /s/ RIC L. FLOYD - --------------------------- Ric L. Floyd, Secretary EX-10.5 3 1996 STOCK OPTION PLAN, AS AMENDED 1 EXHIBIT 10.5 PEGASUS SYSTEMS, INC AMENDED 1996 STOCK OPTION PLAN 1. Purposes of the Plan. The purposes of this Stock Option Plan are to attract and retain the best available personnel for positions of substantial responsibility, to provide additional incentive to Employees and Consultants of the Company and any Parent or Subsidiary and to promote the success of the Company's business. Options granted under the Plan may be Incentive Stock Options or Nonstatutory Stock Options, as determined by the Administrator at the time of grant of an option and subject to the applicable provisions of Section 422 of the Code and the regulations promulgated thereunder. 2. Definitions. As used herein, the following definitions shall apply: (a) "Administrator" means the Board or the Compensation Committee appointed by the Board. (b) "Board" means the Board of Directors of the Company. (c) "Code" means the Internal Revenue Code of 1986, as amended. (d) "Committee" means the Compensation Committee appointed by the Board of Directors. (e) "Common Stock" means the Common Stock of the Company. (f) "Company" means Pegasus Systems, Inc. (g) "Consultant" means any person who is engaged by the Company or any Parent or Subsidiary to render consulting or advisory services and is compensated for such services, and any director of the Company whether compensated for such services or not. If and in the event the Company registers any class of any equity security pursuant to the Exchange Act, the term Consultant shall thereafter not include directors who are not compensated for their services or are paid only a director's fee by the Company. (h) "Continuous Status as an Employee or Consultant" means that the employment or consulting relationship with the Company, any Parent or Subsidiary is not interrupted or terminated. Continuous Status as an Employee or Consultant shall not be considered interrupted in the case of (i) any leave of absence approved by the Company or (ii) transfers between locations of the Company or between the Company, its Parent, any Subsidiary, or any successor. A leave of absence approved by the Company shall include sick leave, military leave, or any other personal leave. For purposes of Incentive Stock Options, no such leave may exceed 90 days, unless reemployment upon expiration of such leave is guaranteed by statute or contract, including Company policies. If reemployment upon expiration of a leave of absence approved by the Company is not so guaranteed, on the 181st day of such leave any Incentive Stock Option held by the Optionee shall cease to be treated as an Incentive Stock Option and shall be treated for tax purposes as a Nonstatutory Stock Option. (i) "Disability" means total and permanent disability as defined in Section 22(e)(3) of the Code. (j) "Employee" means any person, including officers and directors, employed by the Company or any Parent or Subsidiary of the Company. The payment of a director's fee by the Company shall not be sufficient to constitute "employment" by the Company. (k) "Exchange Act" means the Securities Exchange Act of 1934, as amended. (l) "Fair Market Value" means, as of any date, the value of Common Stock determined as follows: 2 (i) If the Common Stock is listed on any established stock exchange or a national market system, including without limitation the Nasdaq National Market or The Nasdaq SmallCap Market of The Nasdaq Stock Market, its Fair Market Value shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such exchange or system for the last market trading day prior to the time of determination, as reported in The Wall Street Journal or such other source as the Administrator deems reliable; (ii) If the Common Stock is regularly quoted by a recognized securities dealer but selling prices are not reported, its Fair Market Value shall be the mean between the high bid and low asked prices for the Common Stock on the last market trading day prior to the day of determination; or (iii) In the absence of an established market for the Common Stock, the Fair Market Value shall be determined in good faith by the Administrator. (m) "Incentive Stock Option" means an Option intended to qualify as an incentive stock option within the meaning of Section 422 of the Code. (n) "Nonstatutory Stock Option" means an Option not intended to qualify as an Incentive Stock Option. (o) "Option" means a stock option granted pursuant to the Plan. (p) "Optioned Stock" means the Common Stock subject to an Option. (q) "Optionee" means an Employee or Consultant who receives an Option. (r) "Parent" means a "parent corporation," whether now or hereafter existing, as defined in Section 424(e) of the Code. (s) "Permitted Transferee" means a member of a holder's immediate family, trusts for the benefit of such immediate family members, and partnerships in which the holder and such immediate family members are the only partners, provided that no consideration is provided for the transfer. (t) "Plan" means this Amended 1996 Stock Option Plan. (u) "Section 16(b)" means Section 16(b) of the Securities Exchange Act of 1934, as amended. (v) "Share" means a share of the Common Stock, as adjusted in accordance with Section 11 below. (w) "Subsidiary" means a "subsidiary corporation," whether now or hereafter existing, as defined in Section 424(f) of the Code. 3. Stock Subject to the Plan. Subject to the provisions of Section 12 of the Plan, the maximum aggregate number of Shares which may be optioned and sold under the Plan is 866,667 Shares. The Shares may be authorized, but unissued, or reacquired Common Stock. If an Option expires or becomes unexercisable without having been exercised in full, or is surrendered pursuant to an option exchange program authorized by the Administrator, the unpurchased Shares which were subject thereto shall become available for future grant or sale under the Plan (unless the Plan has terminated); provided, however, that Shares that have actually been issued under the Plan shall not be returned to the Plan and shall not become available for future distribution under the Plan, except that if unvested Shares are repurchased by the -2- 3 Company at their original purchase price, such Shares shall become available for future grant under the Plan. 4. Administration of the Plan. (a) Initial Plan Procedure. Prior to the date, if any, upon which the Company becomes subject to the Exchange Act, the Plan shall be administered by the Board or the Compensation Committee appointed by the Board. (b) Plan Procedure after the Date, if any, upon Which the Company becomes Subject to the Exchange Act. With respect to Option grants made to Employees or Consultants, the Plan shall be administered by (A) the Board or (B) the Compensation Committee designated by the Board, which committee shall be constituted to satisfy the legal requirements, if any, relating to the administration of incentive stock option plans of state corporate and securities laws, of the Code, and of any stock exchange or national market system upon which the Common Stock is then listed or traded (the "Applicable Laws"). Once appointed, such Committee shall serve in its designated capacity until otherwise directed by the Board. The Board may increase the size of the Committee and appoint additional members, remove members (with or without cause) and substitute new members, fill vacancies (however caused), and remove all members of the Committee and thereafter directly administer the Plan, all to the extent permitted by Applicable Laws. (c) Powers of the Administrator. Subject to the provisions of the Plan and approval of any relevant authorities, including the approval, if required, of any stock exchange or national market system upon which the Common Stock is then listed, the Administrator shall have the authority, in its discretion: (i) to determine the Fair Market Value of the Common Stock, in accordance with Section 2(l) of the Plan; (ii) to select the Consultants and Employees to whom Options may from time to time be granted hereunder; (iii) to determine whether and to what extent Options are granted hereunder; (iv) to determine the number of shares of Common Stock to be covered by each such award granted hereunder; (v) to approve forms of agreement for use under the Plan; (vi) to determine the terms and conditions, not inconsistent with the terms of the Plan, of any award granted hereunder. Such terms and conditions may include, but are not limited to, the exercise price, the time or times when Options may be exercised, any vesting, acceleration or waiver of forfeiture and any restriction or limitation regarding any Option or the Shares relating thereto, based in each case on such factors as the Administrator, in its sole discretion, shall determine; (vii) to determine whether and under what circumstances an Option may be settled in cash under Section 9(e)1 instead of Common Stock; (viii) to reduce the exercise price of any Option to the then current Fair Market Value only in the event the reduction of the exercise price (i) affects less than ten percent (10%) of the Shares authorized for grant under the Plan, (ii) is for a legitimate corporate purpose such as retention of one or more key persons, and (iii) is for the purpose of maintaining option value due to extreme circumstances beyond management's control; -3- 4 (ix) to provide for the early exercise of Options for the purchase of unvested Shares, subject to such terms and conditions as the Administrator may determine; and (x) to construe and interpret the terms of the Plan and awards granted pursuant to the Plan. (d) Effect of Administrator's Decision. All decisions, determinations and interpretations of the Administrator shall be final and binding on all Optionees and any other holders of any Options. 5. Eligibility. (a) Nonstatutory Stock Options may be granted to Employees and Consultants. Incentive Stock Options may be granted only to Employees. An Employee or Consultant who has been granted an Option may, if otherwise eligible, be granted additional Options. (b) Each Option shall be designated in the written option agreement as either an Incentive Stock Option or a Nonstatutory Stock Option. However, notwithstanding such designation, to the extent that the aggregate Fair Market Value of the Shares with respect to which Incentive Stock Options are exercisable for the first time by the Optionee during any calendar year (under all plans of the Company and any Parent or Subsidiary) exceeds $100,000, such Options shall be treated as Nonstatutory Stock Options. For purposes of this Section 5(b), Incentive Stock Options shall be taken into account in the order in which they were granted, and the Fair Market Value of the Shares shall be determined as of the time the Option with respect to such Shares is granted. (c) The Plan shall not confer upon any Optionee any right with respect to the continuation of the Optionee's employment or consulting relationship with the Company, nor shall it interfere in any way with the Optionee's right or the Company's right to terminate the Optionee's employment or consulting relationship at any time, with or without cause. 6. Term of Plan. The Plan shall become effective upon the earlier to occur of its adoption by the Board of Directors or its approval by the stockholders of the Company, as described in Section 18 of the Plan. It shall continue in effect for a term of ten (10) years unless sooner terminated under Section 14 of the Plan. 7. Term of Option. The term of each Option shall be the term stated in the Option Agreement; provided, however, that the term shall be no more than ten (10) years from the date of grant thereof. However, in the case of an Incentive Stock Option granted to an Optionee who, at the time the Option is granted, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the term of the Option shall be five (5) years from the date of grant thereof or such shorter term as may be provided in the Option Agreement. 8. Option Exercise Price and Consideration. (a) The per share exercise price for the Shares to be issued pursuant to exercise of an Option shall be such price as is determined by the Administrator, but shall be subject to the following: (i) In the case of an Incentive Stock Option (A) granted to an Employee who, at the time of the grant of such Incentive Stock Option, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the per Share exercise price shall be no less than 110% of the Fair Market Value per Share on the date of grant. -4- 5 (B) granted to any Employee other than an Employee described in the preceding paragraph, the per Share exercise price shall be no less than 100% of the Fair Market Value per Share on the date of grant. (ii) In the case of a Nonstatutory Stock Option, the per share exercise price shall be determined by the Administrator but shall not be less than one hundred percent (100%) of the Fair Market Value per Share on the date of grant; provided, however, that a per share exercise price of no less than eighty-five percent (85%) of the Fair Market Value per Share on the date of grant shall be permitted for a Nonstatutory Stock Option expressly awarded to an Employee in lieu of a reasonable amount of salary or cash bonus. (b) The consideration to be paid for the Shares to be issued upon exercise of an Option, including the method of payment, shall be determined by the Administrator (and, in the case of an Incentive Stock Option, shall be determined at the time of grant) and may consist entirely of (1) cash, (2) check, (3) promissory note, (4) other Shares which (x) in the case of Shares acquired upon exercise of an Option have been owned by the Optionee for more than six months on the date of surrender and (y) have a Fair Market Value on the date of surrender equal to the aggregate exercise price of the Shares as to which such Option shall be exercised, (5) delivery of a properly executed exercise notice together with such other documentation as the Administrator and the broker, if applicable, shall require to effect an exercise of the Option and delivery to the Company of the sale or loan proceeds required to pay the exercise price, or (6) any combination of the foregoing methods of payment. In making its determination as to the type of consideration to accept, the Administrator shall consider if acceptance of such consideration may be reasonably expected to benefit the Company. 9. Exercise of Option. (a) Procedure for Exercise; Rights as a Stockholder. Any Option granted hereunder shall be exercisable at such times and under such conditions as determined by the Administrator, including performance criteria with respect to the Company and/or the Optionee, and as shall be permissible under the terms of the Plan. An Option may not be exercised for a fraction of a Share. An Option shall be deemed to be exercised when written notice of such exercise has been given to the Company in accordance with the terms of the Option by the person entitled to exercise the Option and full payment for the Shares with respect to which the Option is exercised has been received by the Company. Full payment may, as authorized by the Administrator, consist of any consideration and method of payment allowable under Section 8(b) of the Plan. Until the issuance (as evidenced by the appropriate entry on the books of the Company or of a duly authorized transfer agent of the Company) of the stock certificate evidencing such Shares, no right to vote or receive dividends or any other rights as a stockholder shall exist with respect to the Optioned Stock, notwithstanding the exercise of the Option. The Company shall issue (or cause to be issued) such stock certificate promptly upon exercise of the Option. No adjustment will be made for a dividend or other right for which the record date is prior to the date the stock certificate is issued, except as provided in Section 12 of the Plan. Exercise of an Option in any manner shall result in a decrease in the number of Shares which thereafter may be available, both for purposes of the Plan and for sale under the Option, by the number of Shares as to which the Option is exercised. (b) Termination of Employment or Consulting Relationship. Upon termination of an Optionee's Continuous Status as an Employee or Consultant, other than upon the Optionee's death or Disability, the Optionee may exercise his or her Option, but only within such period of time as is specified in the Notice of Grant, and only to the extent that the Optionee was entitled to exercise it at the date of termination (but in no event later than the expiration of the term of such Option as set forth in the Notice of Grant). In the absence of a specified time in the Notice of Grant, the Option shall remain exercisable for three (3) months following the Optionee's termination. In the -5- 6 case of an Incentive Stock Option, such period of time for exercise shall not exceed three (3) months from the date of termination. If, on the date of termination, the Optionee is not entitled to exercise the Optionee's entire Option, the Shares covered by the unexercisable portion of the Option shall revert to the Plan. If, after termination, the Optionee does not exercise his or her Option within the time specified by the Administrator, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan. Notwithstanding the above, in the event of an Optionee's change in status from Consultant to Employee or Employee to Consultant, an Optionee's Continuous Status as an Employee or Consultant shall not automatically terminate solely as a result of such change in status. However, in such event, an Incentive Stock Option held by the Optionee shall cease to be treated as an Incentive Stock Option and shall be treated for tax purposes as a Nonstatutory Stock Option three months and one day following such change of status. (c) Disability of Optionee. In the event of termination of an Optionee's Continuous Status as an Employee or Consultant as a result of his or her Disability, the Optionee may, but only within twelve (12) months from the date of such termination (and in no event later than the expiration date of the term of his or her Option as set forth in the Option Agreement), exercise the Option to the extent the Optionee was otherwise entitled to exercise it on the date of such termination. To the extent that the Optionee is not entitled to exercise the Option on the date of termination, or if the Optionee does not exercise the Option to the extent so entitled within the time specified herein, the Option shall terminate, and the Shares covered by the Option shall revert to the Plan. (d) Death of Optionee. In the event of the death of an Optionee, the Option may be exercised at any time within twelve (12) months following the date of death (but in no event later than the expiration of the term of such Option as set forth in the Notice of Grant), by the Optionee's estate or by a person who has acquired the right to exercise the Option by bequest or inheritance, but only to the extent that the Optionee was entitled to exercise the Option at the date of death. If, at the time of death, the Optionee was not entitled to exercise his or her entire Option, the Shares covered by the unexercisable portion of the Option shall immediately revert to the Plan. If, after death, the Optionee's estate or a person who acquires the right to exercise the Option by bequest or inheritance does not exercise the Option within the time specified herein, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan. (e) Buyout Provisions. The Administrator may at any time offer to buy out for a payment in cash or Shares, an Option previously granted, based on such terms and conditions as the Administrator shall establish and communicate to the Optionee at the time that such offer is made. (f) Rule 16b-3. Options granted to persons subject to Section 16(b) of the Exchange Act must comply with Rule 16b-3 and shall contain such additional conditions or restrictions as may be required thereunder to qualify for the maximum exemption from Section 16 of the Exchange Act with respect to Plan transactions. 10. Stock Withholding to Satisfy Withholding Tax Obligations. At the discretion of the Administrator, Optionees may satisfy withholding obligations as provided in this Section 10. When an Optionee incurs tax liability in connection with an Option which tax liability is subject to tax withholding under applicable tax laws, and the Optionee is obligated to pay the Company an amount required to be withheld under applicable tax laws, the Optionee may satisfy the withholding tax obligation by electing to have the Company withhold from the Shares to be issued upon exercise of the Option that number of Shares having a Fair Market Value equal to the amount required to be withheld. The Fair Market Value of the Shares to be withheld shall be determined on the date that the amount of tax to be withheld is to be determined (the "Tax Date"). All elections by an Optionee to have Shares withheld for this purpose shall be made in writing in a form acceptable to the Administrator and shall be subject to the following restrictions: (a) the election must be made on or prior to the applicable Tax Date; -6- 7 (b) once made, the election shall be irrevocable as to the particular Shares of the Option as to which the election is made; (c) all elections shall be subject to the consent or disapproval of the Administrator. In the event the election to have Shares withheld is made by an Optionee and the Tax Date is deferred under Section 83 of the Code because no election is filed under Section 83(b) of the Code, the Optionee shall receive the full number of Shares with respect to which the Option is exercised but such Optionee shall be unconditionally obligated to tender back to the Company the proper number of Shares on the Tax Date. 11. Transferability of Options and Rights. Incentive Stock Options granted under the Plan shall not be transferable otherwise than by will or the laws of descent and distribution, or pursuant to a qualified domestic relations order as defined by the Code or Title I of the Employee Retirement Income Security Act of 1974, as amended, or the rules thereunder. Incentive Stock Options shall be exercisable during the lifetime of the Employee only by the Employee or by the Employee's guardian or legal representative (unless such exercise would disqualify it as an Incentive Stock Option). Unless the Committee otherwise provides in an agreement regarding the award of non-qualified stock options or rights (not granted in connection with an Incentive Stock Option), non-qualified stock options or rights (not granted in connection with Incentive Stock Options) may be transferred by the holder to Permitted Transferees, provided that there cannot be any consideration for the transfer. 12. Adjustments Upon Changes in Capitalization or Merger. (a) Changes in Capitalization. Subject to any required action by the stockholders of the Company, the number of shares of Common Stock covered by each outstanding Option, and the number of shares of Common Stock which have been authorized for issuance under the Plan but as to which no Options have yet been granted or which have been returned to the Plan upon cancellation or expiration of an Option, as well as the price per share of Common Stock covered by each such outstanding Option, shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been "effected without receipt of consideration." Such adjustment shall be made by the Board, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an Option. (b) Dissolution or Liquidation. In the event of the proposed dissolution or liquidation of the Company, the Administrator shall notify each Optionee as soon as practicable prior to the effective date of such proposed transaction. The Administrator in its discretion may provide for an Optionee to have the right to exercise his or her Option until ten (10) days prior to such transaction as to all of the Optioned Stock covered thereby, including Shares as to which the Option would not otherwise be exercisable. In addition, the Administrator may provide that any Company repurchase option applicable to any Shares purchased upon exercise of an Option shall lapse as to all such Shares, provided the proposed dissolution or liquidation takes place at the time and in the manner contemplated. To the extent it has not been previously exercised, an Option will terminate immediately prior to the consummation of such proposed action. -7- 8 (c) Acquisition Events (1) Consequences of Acquisition Events. Upon the occurrence of an Acquisition Event (as defined below), or the execution by the Company of any agreement with respect to an Acquisition Event, the Board shall take any one or more of the following actions with respect to then outstanding Options: (i) provide that outstanding Options shall be assumed or equivalent Options shall be substituted by the acquiring or succeeding entity (or an affiliate thereof), provided that any such Options substituted for Incentive Stock Options shall satisfy, in the determination of the Board, the requirements of Section 424(a) of the Code; (ii) upon written notice to the Optionees, provide that all then unexercised Options will become exercisable in full as of a specified date (the "Acceleration Date") prior to the Acquisition Event and will terminate immediately prior to the consummation of such Acquisition Event, except to the extent exercised by the Optionees between the Acceleration Date and the consummation of the Acquisition Event or (iii) in the event of an Acquisition Event under the terms of which holders of Common Stock will receive upon consummation thereof a cash payment for each share of Common Stock surrendered pursuant to such Acquisition Event (the "Acquisition Price") provide that all outstanding Options shall terminate upon consummation of such Acquisition Event and each Optionee shall receive, in exchange therefor, a cash payment equal to the amount (if any) by which (A) the Acquisition Price multiplied by the number of shares of Common Stock subject to such outstanding Options (whether or not then exercisable), exceeds (B) the aggregate exercise price of such Options. An "Acquisition Event" shall mean: (a) any merger or consolidation which results in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving or acquiring entity) less than 60% of the combined voting power of the voting securities of the Company or such surviving or acquiring entity outstanding immediately after such merger or consolidation; (b) any sale of all or substantially all of the assets of the Company; (c) the complete liquidation of the Company; or (d) the acquisition of "beneficial ownership" (as defined in Rule 13d-3 under the Exchange Act) of securities of the Company representing 50% or more of the combined voting power of the Company's then outstanding securities (other than through a merger or consolidation or an acquisition of securities directly from the Company) by any "person", as such term is used in Sections 13(d) and 14(d) of the Exchange Act other than the Company, any trustee or other fiduciary holding securities under an employee benefit plan of the Company, or any entity owned directly or indirectly by the stockholders of the Company in substantially the same proportion as their ownership of stock of the Company. (2) Assumption of Options Upon Certain Events. The Board may grant options under the Plan in substitution for stock and stock-based awards held by employees of another entity who become Employees as a result of a merger or consolidation of the employing entity with the Company or the acquisition by the Company of property or stock of the employing entity. The substitute options shall be granted on such terms and conditions as the Board considers appropriate in the circumstances. 13. Time of Granting Options. The date of grant of an Option shall, for all purposes, be the date on which the Administrator makes the determination granting such Option, or such other date as is determined by the Administrator. Notice of the determination shall be given to each Employee or Consultant to whom an Option is so granted within a reasonable time after the date of such grant. 14. Amendment and Termination of the Plan. (a) Amendment and Termination. The Board may at any time amend, alter, suspend or discontinue the Plan, but no amendment, alteration, suspension or discontinuation shall be made which would impair the rights of any Optionee under any grant theretofore made, without his or her consent. In addition, to the extent necessary and desirable to comply with Rule 16b-3 under the Exchange Act or with Section 422 of the Code (or any other applicable law or regulation, including the requirements of any stock exchange or national market system upon which the Common Stock is then listed), the Company shall obtain stockholder approval of any Plan amendment in such a manner and to such a degree as required. -8- 9 (b) Effect of Amendment or Termination. Any such amendment or termination of the Plan shall not affect Options already granted, and such Options shall remain in full force and effect as if this Plan had not been amended or terminated, unless mutually agreed otherwise between the Optionee and the Board, which agreement must be in writing and signed by the Optionee and the Company. 15. Conditions Upon Issuance of Shares. Shares shall not be issued pursuant to the exercise of an Option unless the exercise of such Option and the issuance and delivery of such Shares pursuant thereto shall comply with all relevant provisions of law, including, without limitation, the Securities Act of 1933, as amended, the Exchange Act, the rules and regulations promulgated thereunder, and the requirements of any stock exchange or national market system upon which the Common Stock is then listed or traded, and shall be further subject to the approval of counsel for the Company with respect to such compliance. As a condition to the exercise of an Option, the Company may require the person exercising such Option to represent and warrant at the time of any such exercise that the Shares are being purchased only for investment and without any present intention to sell or distribute such Shares if, in the opinion of counsel for the Company, such a representation is required by any of the aforementioned relevant provisions of law. 16. Reservation of Shares. The Company, during the term of this Plan, shall at all times reserve and keep available such number of Shares as shall be sufficient to satisfy the requirements of the Plan. The inability of the Company to obtain authority from any regulatory body having jurisdiction, which authority is deemed by the Company's counsel to be necessary to the lawful issuance and sale of any Shares hereunder, shall relieve the Company of any liability in respect of the failure to issue or sell such Shares as to which such requisite authority shall not have been obtained. 17. Agreements. Options shall be evidenced by written agreements in such form as the Administrator shall approve from time to time. 18. Stockholder Approval. Continuance of the Plan shall be subject to approval by the stockholders of the Company within twelve (12) months before or after the date the Plan is adopted. Such stockholder approval shall be obtained in the degree and manner required under applicable state and federal law and the rules of any stock exchange or national market system upon which the Common Stock is then listed or traded. -9- EX-10.6 4 1997 STOCK OPTION PLAN, AS AMENDED 1 EXHIBIT 10.6 PEGASUS SYSTEMS, INC. AMENDED 1997 STOCK OPTION PLAN 1. Purposes of the Plan. The purposes of this Stock Option Plan are to attract and retain the best available personnel for positions of substantial responsibility, to provide additional incentive to Employees and Consultants of the Company and any Parent or Subsidiary, to compensate Non-Employee Directors of the Company and to promote the success of the Company's business. Options granted under the Plan may be Incentive Stock Options or Nonstatutory Stock Options, as determined by the Administrator at the time of grant of an option and subject to the applicable provisions of Section 422 of the Code and the regulations promulgated thereunder. 2. Definitions. As used herein, the following definitions shall apply: (a) "Administrator" means the Board or the Compensation Committee appointed by the Board. (b) "Board" means the Board of Directors of the Company. (c) "Code" means the Internal Revenue Code of 1986, as amended. (d) "Committee" means the Compensation Committee appointed by the Board of Directors. (e) "Common Stock" means the Common Stock of the Company. (f) "Company" means Pegasus Systems, Inc. (g) "Consultant" means any person who is engaged by the Company or any Parent or Subsidiary to render consulting or advisory services and is compensated for such services. (h) "Continuous Status as an Employee or Consultant" means that the employment or consulting relationship with the Company, any Parent or Subsidiary is not interrupted or terminated. Continuous Status as an Employee or Consultant shall not be considered interrupted in the case of (i) any leave of absence approved by the Company or (ii) transfers between locations of the Company or between the Company, its Parent, any Subsidiary, or any successor. A leave of absence approved by the Company shall include sick leave, military leave, or any other personal leave. For purposes of Incentive Stock Options, no such leave may exceed 90 days, unless reemployment upon expiration of such leave is guaranteed by statute or contract, including Company policies. If reemployment upon expiration of a leave of absence approved by the Company is not so guaranteed, on the 181st day of such -1- 2 leave any Incentive Stock Option held by the Optionee shall cease to be treated as an Incentive Stock Option and shall be treated for tax purposes as a Nonstatutory Stock Option. (i) "Disability" means total and permanent disability as defined in Section 22(e)(3) of the Code. (j) "Employee" means any person, including officers and directors, employed by the Company or any Parent or Subsidiary of the Company. The payment of a director's fee by the Company shall not be sufficient to constitute "employment" by the Company. (k) "Exchange Act" means the Securities Exchange Act of 1934, as amended. (l) "Fair Market Value" means, as of any date, the value of Common Stock determined as follows: (i) If the Common Stock is listed on any established stock exchange or a national market system, including without limitation the Nasdaq National Market or The Nasdaq SmallCap Market of The Nasdaq Stock Market, its Fair Market Value shall be the closing sales price for such stock (or the closing bid, if no sales were reported) as quoted on such exchange or system for the last market trading day prior to the time of determination, as reported in The Wall Street Journal or such other source as the Administrator deems reliable; (ii) If the Common Stock is regularly quoted by a recognized securities dealer but selling prices are not reported, its Fair Market Value shall be the mean between the high bid and low asked prices for the Common Stock on the last market trading day prior to the day of determination; or (iii) In the absence of an established market for the Common Stock, the Fair Market Value shall be determined in good faith by the Administrator. (m) "Incentive Stock Option" means an Option intended to qualify as an incentive stock option within the meaning of Section 422 of the Code. (n) "Non-Employee Director" means any person who is a member of the Board who is not an Employee. (o) "Nonstatutory Stock Option" means an Option not intended to qualify as an Incentive Stock Option. (p) "Option" means a stock option granted pursuant to the Plan. (q) "Optioned Stock" means the Common Stock subject to an Option. -2- 3 (r) "Optionee" means an Employee, Consultant or Non-Employee Director who receives an Option. (s) "Parent" means a "parent corporation," whether now or hereafter existing, as defined in Section 424(e) of the Code. (t) "Permitted Transferee" means a member of a holder's immediate family, trusts for the benefit of such immediate family members, and partnerships in which the holder and such immediate family members are the only partners, provided that no consideration is provided for the transfer. (u) "Plan" means this Amended 1997 Stock Option Plan. (v) "Section 16(b)" means Section 16(b) of the Securities Exchange Act of 1934, as amended. (w) "Share" means a share of the Common Stock, as adjusted in accordance with Section 13 below. (x) "Subsidiary" means a "subsidiary corporation," whether now or hereafter existing, as defined in Section 424(f) of the Code. 3. Stock Subject to the Plan. Subject to the provisions of Section 13 of the Plan, the maximum aggregate number of Shares which may be optioned and sold under the Plan is 700,000 Shares, increased, as of the first day of each fiscal year commencing January 1, 2000, by one percent (1%) of the number of Shares outstanding as of the date that the Plan is approved by the stockholders of the Company; provided, however, that the total number of Shares available under the Plan, when aggregated with all other stock option plans sponsored by the Company, shall not exceed fifteen percent (15%) of the number of Shares outstanding as of the first day of each fiscal year. The maximum number of Shares with respect to which Options may be awarded under the Plan during any fiscal year to any Employee shall be 500,000. The Shares may be authorized, but unissued, or reacquired Common Stock. If an Option expires or becomes unexercisable without having been exercised in full, or is surrendered pursuant to an option exchange program authorized by the Administrator, the unpurchased Shares which were subject thereto shall become available for future grant or sale under the Plan (unless the Plan has terminated); provided, however, that Shares that have actually been issued under the Plan shall not be returned to the Plan and shall not become available for future distribution under the Plan, except that if unvested Shares are repurchased by the Company at their original purchase price, such Shares shall become available for future grant under the Plan. 4. Administration of the Plan. With respect to Option grants awarded to Employees, Consultants or Non-Employee Directors, the Plan shall be administered by (A) the Board or -3- 4 (B) the Compensation Committee designated by the Board, which committee shall be constituted to satisfy the legal requirements, if any, relating to the administration of incentive stock option plans of state corporate and securities laws, of the Code, and of any stock exchange or national market system upon which the Common Stock is then listed or traded (the "Applicable Laws"). Once appointed, such Committee shall serve in its designated capacity until otherwise directed by the Board. The Board may increase the size of the Committee and appoint additional members, remove members (with or without cause) and substitute new members, fill vacancies (however caused), and remove all members of the Committee and thereafter directly administer the Plan, all to the extent permitted by Applicable Laws. (n) Powers of the Administrator. Subject to the provisions of the Plan and approval of any relevant authorities, including the approval, if required, of any stock exchange or national market system upon which the Common Stock is then listed, the Administrator shall have the authority, in its discretion: (i) to determine the Fair Market Value of the Common Stock, in accordance with Section 2(l) of the Plan; (ii) to select the Consultants and Employees to whom Options may from time to time be granted hereunder; (iii) to determine whether and to what extent Options are granted hereunder; (iv) to determine the number of shares of Common Stock to be covered by each such award granted hereunder; (v) to approve forms of agreement for use under the Plan; (vi) to determine the terms and conditions, not inconsistent with the terms of the Plan, of any award granted hereunder. Such terms and conditions may include, but are not limited to, the exercise price, the time or times when Options may be exercised, any vesting acceleration or waiver of forfeiture restrictions, and any restriction or limitation regarding any Option or the Shares relating thereto, based in each case on such factors as the Administrator, in its sole discretion, shall determine; (vii) to determine whether and under what circumstances an Option may be settled in cash under Section 10(e) instead of Common Stock; (viii) to reduce the exercise price of any Option to the then current Fair Market Value only in the event the reduction of the exercise price (i) affects less than ten percent (10%) of the Shares authorized for grant under the Plan, (ii) is for a legitimate corporate purpose such as retention of one or more key persons, and (iii) is for the purpose of maintaining option value due to extreme circumstances beyond management's control; -4- 5 (ix) to provide for the early exercise of Options for the purchase of unvested Shares, subject to such terms and conditions as the Administrator may determine; and (x) to construe and interpret the terms of the Plan and awards granted pursuant to the Plan. (o) Effect of Administrator's Decision. All decisions, determinations and interpretations of the Administrator shall be final and binding on all Optionees and any other holders of any Options. 5. Eligibility. (a) Nonstatutory Stock Options may be granted to Employees, Consultants and Non-Employee Directors. Incentive Stock Options may be granted only to Employees. An Employee, Consultant or Non-Employee Director who has been granted an Option may, if otherwise eligible, be granted additional Options. (b) Each Option shall be designated in the written option agreement as either an Incentive Stock Option or a Nonstatutory Stock Option. However, notwithstanding such designation, to the extent that the aggregate Fair Market Value of the Shares with respect to which Incentive Stock Options are exercisable for the first time by the Optionee during any calendar year (under all plans of the Company and any Parent or Subsidiary) exceeds $100,000, such Options shall be treated as Nonstatutory Stock Options. For purposes of this Section 5(b), Incentive Stock Options shall be taken into account in the order in which they were granted, and the Fair Market Value of the Shares shall be determined as of the time the Option with respect to such Shares is granted. (c) The Plan shall not confer upon any Optionee any right with respect to the continuation of the Optionee's employment or consulting relationship with the Company, nor shall it interfere in any way with the Optionee's right or the Company's right to terminate the Optionee's employment or consulting relationship at any time, with or without cause. 6. Term of Plan. The Plan shall become effective upon the earlier to occur of its adoption by the Board of Directors or its approval by the stockholders of the Company, as described in Section 15 of the Plan. It shall continue in effect for a term of ten (10) years unless sooner terminated under Section 15 of the Plan. 7. Term of Option. The term of each Option shall be the term stated in the Option Agreement; provided, however, that the term shall be no more than ten (10) years from the date of grant thereof. However, in the case of an Incentive Stock Option granted to an Optionee who, at the time the Option is granted, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the term of the -5- 6 Option shall be five (5) years from the date of grant thereof or such shorter term as may be provided in the Option Agreement. 8. Option Exercise Price and Consideration. (a) The per share exercise price for the Shares to be issued pursuant to exercise of an Option shall be such price as is determined by the Administrator, but shall be subject to the following: (i) In the case of an Incentive Stock Option (A) granted to an Employee who, at the time of the grant of such Incentive Stock Option, owns stock representing more than ten percent (10%) of the voting power of all classes of stock of the Company or any Parent or Subsidiary, the per Share exercise price shall be no less than 110% of the Fair Market Value per Share on the date of grant. (B) granted to any Employee other than an Employee described in the preceding paragraph, the per Share exercise price shall be no less than 100% of the Fair Market Value per Share on the date of grant. (ii) In the case of a Nonstatutory Stock Option, the per share exercise price shall be determined by the Administrator but shall not, except as otherwise provided in Section 9, be less than one hundred percent (100%) of the Fair Market Value per Share on the date of grant; provided, however, that a per share exercise price of no less than eighty-five percent (85%) of the Fair Market Value per Share on the date of grant shall be permitted for a Nonstatutory Stock Option expressly awarded to an Employee in lieu of a reasonable amount of salary or cash bonus. (b) The consideration to be paid for the Shares to be issued upon exercise of an Option, including the method of payment, shall be determined by the Administrator (and, in the case of an Incentive Stock Option, shall be determined at the time of grant) and may consist entirely of (1) cash, (2) check, (3) promissory note, (4) other Shares which (x) in the case of Shares acquired upon exercise of an Option have been owned by the Optionee for more than six months on the date of surrender and (y) have a Fair Market Value on the date of surrender equal to the aggregate exercise price of the Shares as to which such Option shall be exercised, (5) delivery of a properly executed exercise notice together with such other documentation as the Administrator and the broker, if applicable, shall require to effect an exercise of the Option and delivery to the Company of the sale or loan proceeds required to pay the exercise price, or (6) any combination of the foregoing methods of payment. In making its determination as to the type of consideration to accept, the Administrator shall consider if acceptance of such consideration may be reasonably expected to benefit the Company. 9. Grants to Non-Employee Directors. Notwithstanding any other provision of the Plan, each Non-Employee Director shall, on each date of election or re-election as a Board -6- 7 member be granted a Nonstatutory Stock Option for two thousand (2,000) Shares of Common Stock of the Company at an exercise price equal to eighty five percent (85%) of the Fair Market Value of the Shares at the end of the business day immediately preceding the date of election or re-election of the Non-Employee Director. Additionally, each Non-Employee Director serving more than a one (1) year term shall, on the date of each annual meeting of the Company's stockholders preceding each additional year of office, be granted an additional Nonstatutory Stock Option for two thousand (2,000) Shares of Common Stock of the Company at an exercise price equal to eighty five percent (85%) of the Fair Market Value of the Shares at the end of the business day immediately preceding the date of each meeting. Each such Option shall become fully vested on the date the director completes one year of service as a director following the date of grant. If a director's service terminates six (6) months or more following the date of grant, then the Option shall be partially vested upon termination, as follows: 50% following six (6) months of service, and an additional 8.33% for each additional completed month of service as a director following the date of grant. Each Non-Employee Director Option shall have a term of three (3) years. Expiration of a Non-Employee Director's term of office shall not affect a Non-Employee Director's right to exercise its Option to the extent such Option is vested or becomes vested at or prior to the expiration of the Director's term. 10. Exercise of Option. (a) Procedure for Exercise; Rights as a Stockholder. Any Option granted hereunder shall be exercisable at such times and under such conditions as determined by the Administrator, including performance criteria with respect to the Company and/or the Optionee, and as shall be permissible under the terms of the Plan. An Option may not be exercised for a fraction of a Share. An Option shall be deemed to be exercised when written notice of such exercise has been given to the Company in accordance with the terms of the Option by the person entitled to exercise the Option and full payment for the Shares with respect to which the Option is exercised has been received by the Company. Full payment may, as authorized by the Administrator, consist of any consideration and method of payment allowable under Section 8(b) of the Plan. Until the issuance (as evidenced by the appropriate entry on the books of the Company or of a duly authorized transfer agent of the Company) of the stock certificate evidencing such Shares, no right to vote or receive dividends or any other rights as a stockholder shall exist with respect to the Optioned Stock, notwithstanding the exercise of the Option. The Company shall issue (or cause to be issued) such stock certificate promptly upon exercise of the Option. No adjustment will be made for a dividend or other right for which the record date is prior to the date the stock certificate is issued, except as provided in Section 13 of the Plan. Exercise of an Option in any manner shall result in a decrease in the number of Shares which thereafter may be available, both for purposes of the Plan and for sale under the Option, by the number of Shares as to which the Option is exercised. -7- 8 (b) Termination of Employment or Consulting Relationship. Upon termination of an Optionee's Continuous Status as an Employee or Consultant, other than upon the Optionee's death or Disability, the Optionee may exercise his or her Option, but only within such period of time as is specified in the Notice of Grant, and only to the extent that the Optionee was entitled to exercise it at the date of termination (but in no event later than the expiration of the term of such Option as set forth in the Notice of Grant). In the absence of a specified time in the Notice of Grant, the Option shall remain exercisable for three (3) months following the Optionee's termination. In the case of an Incentive Stock Option, such period of time for exercise shall not exceed three (3) months from the date of termination. If, on the date of termination, the Optionee is not entitled to exercise the Optionee's entire Option, the Shares covered by the unexercisable portion of the Option shall revert to the Plan. If, after termination, the Optionee does not exercise his or her Option within the time specified by the Administrator, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan. Notwithstanding the above, in the event of an Optionee's change in status from Consultant to Employee or Employee to Consultant, an Optionee's Continuous Status as an Employee or Consultant shall not automatically terminate solely as a result of such change in status. However, in such event, an Incentive Stock Option held by the Optionee shall cease to be treated as an Incentive Stock Option and shall be treated for tax purposes as a Nonstatutory Stock Option three months and one day following such change of status. The provisions of this Section 10(b) shall not be applicable to Non-Employee Directors. (c) Disability of Optionee. In the event of termination of an Optionee's Continuous Status as an Employee or Consultant as a result of his or her Disability, the Optionee may, but only within twelve (12) months from the date of such termination (and in no event later than the expiration date of the term of his or her Option as set forth in the Option Agreement), exercise the Option to the extent the Optionee was otherwise entitled to exercise it on the date of such termination. To the extent that the Optionee is not entitled to exercise the Option on the date of termination, or if the Optionee does not exercise the Option to the extent so entitled within the time specified herein, the Option shall terminate, and the Shares covered by the Option shall revert to the Plan. (d) Death of Optionee. In the event of the death of an Optionee, the Option may be exercised at any time within twelve (12) months following the date of death (but in no event later than the expiration of the term of such Option as set forth in the Notice of Grant), by the Optionee's estate or by a person who has acquired the right to exercise the Option by bequest or inheritance, but only to the extent that the Optionee was entitled to exercise the Option at the date of death. If, at the time of death, the Optionee was not entitled to exercise his or her entire Option, the Shares covered by the unexercisable portion of the Option shall immediately revert to the Plan. If, after death, the Optionee's estate or a person who acquires the right to exercise the Option by bequest or inheritance does not exercise the Option within the time specified herein, the Option shall terminate, and the Shares covered by such Option shall revert to the Plan. -8- 9 (e) Buyout Provisions. The Administrator may at any time offer to buy out for a payment in cash or Shares, an Option previously granted, based on such terms and conditions as the Administrator shall establish and communicate to the Optionee at the time that such offer is made. (f) Rule 16b-3. Options granted to persons subject to Section 16(b) of the Exchange Act must comply with Rule 16b-3 and shall contain such additional conditions or restrictions as may be required thereunder to qualify for the maximum exemption from Section 16 of the Exchange Act with respect to Plan transactions. 11. Stock Withholding to Satisfy Withholding Tax Obligations. At the discretion of the Administrator, Optionees may satisfy withholding obligations as provided in this Section 11 . When an Optionee incurs tax liability in connection with an Option which tax liability is subject to tax withholding under applicable tax laws, and the Optionee is obligated to pay the Company an amount required to be withheld under applicable tax laws, the Optionee may satisfy the withholding tax obligation by electing to have the Company withhold from the Shares to be issued upon exercise of the Option that number of Shares having a Fair Market Value equal to the amount required to be withheld. The Fair Market Value of the Shares to be withheld shall be determined on the date that the amount of tax to be withheld is to be determined (the "Tax Date"). All elections by an Optionee to have Shares withheld for this purpose shall be made in writing in a form acceptable to the Administrator and shall be subject to the following restrictions: (a) the election must be made on or prior to the applicable Tax Date; (b) once made, the election shall be irrevocable as to the particular Shares of the Option as to which the election is made; (c) all elections shall be subject to the consent or disapproval of the Administrator. In the event the election to have Shares withheld is made by an Optionee and the Tax Date is deferred under Section 83 of the Code because no election is filed under Section 83(b) of the Code, the Optionee shall receive the full number of Shares with respect to which the Option is exercised but such Optionee shall be unconditionally obligated to tender back to the Company the proper number of Shares on the Tax Date. 12. Transferability of Options and Rights. Incentive Stock Options granted under the Plan shall not be transferable otherwise than by will or the laws of descent and distribution, or pursuant to a qualified domestic relations order as defined by the Code or Title I of the Employee Retirement Income Security Act of 1974, as amended, or the rules thereunder. Incentive Stock -9- 10 Options shall be exercisable during the lifetime of the Employee only by the Employee or by the Employee's guardian or legal representative (unless such exercise would disqualify it as an Incentive Stock Option). Unless the Administrator otherwise provides in an agreement regarding the award of non-qualified stock options or rights (not granted in connection with an Incentive Stock Option), non-qualified stock options or rights (not granted in connection with Incentive Stock Options) may be transferred by the holder to Permitted Transferees, provided that there cannot be any consideration for the transfer. 13. Adjustments Upon Changes in Capitalization or Merger. (a) Changes in Capitalization. Subject to any required action by the stockholders of the Company, the number of shares of Common Stock covered by each outstanding Option, and the number of shares of Common Stock which have been authorized for issuance under the Plan but as to which no Options have yet been granted or which have been returned to the Plan upon cancellation or expiration of an Option, as well as the price per share of Common Stock covered by each such outstanding Option, shall be proportionately adjusted for any increase or decrease in the number of issued shares of Common Stock resulting from a stock split, reverse stock split, stock dividend, combination or reclassification of the Common Stock, or any other increase or decrease in the number of issued shares of Common Stock effected without receipt of consideration by the Company; provided, however, that conversion of any convertible securities of the Company shall not be deemed to have been "effected without receipt of consideration." Such adjustment shall be made by the Board, whose determination in that respect shall be final, binding and conclusive. Except as expressly provided herein, no issuance by the Company of shares of stock of any class, or securities convertible into shares of stock of any class, shall affect, and no adjustment by reason thereof shall be made with respect to, the number or price of shares of Common Stock subject to an Option. (b) Dissolution or Liquidation. In the event of the proposed dissolution or liquidation of the Company, the Administrator shall notify each Optionee as soon as practicable prior to the effective date of such proposed transaction. The Administrator in its discretion may provide for an Optionee to have the right to exercise his or her Option until ten (10) days prior to such transaction as to all of the Optioned Stock covered thereby, including Shares as to which the Option would not otherwise be exercisable. In addition, the Administrator may provide that any Company repurchase option applicable to any Shares purchased upon exercise of an Option shall lapse as to all such Shares, provided the proposed dissolution or liquidation takes place at the time and in the manner contemplated. To the extent it has not been previously exercised, an Option will terminate immediately prior to the consummation of such proposed action. (c) Acquisition Events (1) Consequences of Acquisition Events. Upon the occurrence of an Acquisition Event (as defined below), or the execution by the Company of any agreement with respect to an Acquisition Event, the Board shall take any one or more of the following actions with respect to then outstanding Options: (i) provide that outstanding Options shall be assumed -10- 11 or equivalent Options shall be substituted by the acquiring or succeeding entity (or an affiliate thereof), provided that any such Options substituted for Incentive Stock Options shall satisfy, in the determination of the Board, the requirements of Section 422(a) of the Code; (ii) upon written notice to the Optionees, provide that all then unexercised Options will become exercisable in full as of a specified date (the "Acceleration Date") prior to the Acquisition Event and will terminate immediately prior to the consummation of such Acquisition Event, except to the extent exercised by the Optionees between the Acceleration Date and the consummation of the Acquisition Event or (iii) in the event of an Acquisition Event under the terms of which holders of Common Stock will receive upon consummation thereof a cash payment for each share of Common Stock surrendered pursuant to such Acquisition Event (the "Acquisition Price") provide that all outstanding Options shall terminate upon consummation of such Acquisition Event and each Optionee shall receive, in exchange therefor, a cash payment equal to the amount (if any) by which (A) the Acquisition Price multiplied by the number of shares of Common Stock subject to such outstanding Options (whether or not then exercisable), exceeds (B) the aggregate exercise price of such Options. An "Acquisition Event" shall mean: (a) any merger or consolidation which results in the voting securities of the Company outstanding immediately prior thereto continuing to represent (either by remaining outstanding or by being converted into voting securities of the surviving or acquiring entity) less than 60% of the combined voting power of the voting securities of the Company or such surviving or acquiring entity outstanding immediately after such merger or consolidation; (b) any sale of all or substantially all of the assets of the Company; (c) the complete liquidation of the Company; or (d) the acquisition of "beneficial ownership" (as defined in Rule 13d-3 under the Exchange Act) of securities of the Company representing 50% or more of the combined voting power of the Company's then outstanding securities (other than through a merger or consolidation or an acquisition of securities directly from the Company) by any "person", as such term is used in Sections 13 (d) and 14 (d) of the Exchange Act other than the Company, any trustee or other fiduciary holding securities under an employee benefit plan of the Company, or any entity owned directly or indirectly by the stockholders of the Company in substantially the same proportion as their ownership of stock of the Company. (2) Assumption of Options Upon Certain Events. The Board may grant options under the Plan in substitution for stock and stock-based awards held by employees of another entity who become Employees as a result of a merger or consolidation of the employing entity with the Company or the acquisition by the Company of property or stock of the employing entity. The substitute options shall be granted on such terms and conditions as the Board considers appropriate in the circumstances. 14. Time of Granting Options. The date of grant of an Option shall, for all purposes, be the date on which the Administrator makes the determination granting such Option, or such other date as is determined by the Administrator. Notice of the determination shall be given to each Employee or Consultant to whom an Option is so granted within a reasonable time after the date of such grant. -11- 12 15. Amendment and Termination of the Plan. (a) Amendment and Termination. The Board may at any time amend, alter, suspend or discontinue the Plan, but no amendment, alteration, suspension or discontinuation shall be made which would impair the rights of any Optionee under any grant theretofore made, without his or her consent. In addition, to the extent necessary and desirable to comply with Rule 16b-3 under the Exchange Act or with Section 422 of the Code (or any other applicable law or regulation, including the requirements of any stock exchange or national market system upon which the Common Stock is then listed), the Company shall obtain stockholder approval of any Plan amendment in such a manner and to such a degree as required. (b) Effect of Amendment or Termination. Any such amendment or termination of the Plan shall not affect Options already granted, and such Options shall remain in full force and effect as if this Plan had not been amended or terminated, unless mutually agreed otherwise between the Optionee and the Board, which agreement must be in writing and signed by the Optionee and the Company. 16. Conditions Upon Issuance of Shares. Shares shall not be issued pursuant to the exercise of an Option unless the exercise of such Option and the issuance and delivery of such Shares pursuant thereto shall comply with all relevant provisions of law, including, without limitation, the Securities Act of 1933, as amended, the Exchange Act, the rules and regulations promulgated thereunder, and the requirements of any stock exchange or national market system upon which the Common Stock is then listed or traded, and shall be further subject to the approval of counsel for the Company with respect to such compliance. As a condition to the exercise of an Option, the Company may require the person exercising such Option to represent and warrant at the time of any such exercise that the Shares are being purchased only for investment and without any present intention to sell or distribute such Shares if, in the opinion of counsel for the Company, such a representation is required by any of the aforementioned relevant provisions of law. 17. Reservation of Shares. The Company, during the term of this Plan, shall at all times reserve and keep available such number of Shares as shall be sufficient to satisfy the requirements of the Plan. The inability of the Company to obtain authority from any regulatory body having jurisdiction, which authority is deemed by the Company's counsel to be necessary to the lawful issuance and sale of any Shares hereunder, shall relieve the Company of any liability in respect of the failure to issue or sell such Shares as to which such requisite authority shall not have been obtained. 18. Agreements. Options shall be evidenced by written agreements in such form as the Administrator shall approve from time to time. -12- 13 19. Stockholder Approval. Continuance of the Plan shall be subject to approval by the stockholders of the Company within twelve (12) months before ore after the date the Plan is adopted. Such stockholder approval shall be obtained in the degree and manner required under applicable state and federal law and the rules of any stock exchange or national market system upon which the Common Stock is then listed or traded. -13- 14 PEGASUS SYSTEMS, INC. 1997 AMENDED STOCK OPTION PLAN NOTICE OF GRANT Unless otherwise defined herein, the terms defined in the Plan shall have the same defined meanings in this Notice of Grant. [Optionee's Name and Address] You have been granted an option to purchase Common Stock of the Company, subject to the terms and conditions of the Plan and this Stock Option Agreement, as follows: Grant Number --------------------- Date of Grant --------------------- Vesting Commencement Date --------------------- Exercise Price per Share $ --------------------- Total Number of Shares Granted Total Exercise Price $ --------------------- Type of Option: Incentive Stock Option ---- Nonstatutory Stock Option ----- Term/Expiration Date: --------------------- Vesting Schedule: This Option may be exercised, in whole or in part, in accordance with the following schedule: ------------------------------------------------- Termination Period: This Option may be exercised for three (3) months after termination of employment or consulting relationship, or such longer period as may be applicable upon death or Disability of Optionee as provided in the Plan, but in no event later than the Term/Expiration Date as provided above. EX-10.11 5 1997 EMPLOYEE STOCK PURCHASE PLAN, AS AMENDED 1 EXHIBIT 10.11 PEGASUS SYSTEMS, INC. 1997 AMENDED EMPLOYEE STOCK PURCHASE PLAN ARTICLE I-PURPOSE I.1. PURPOSE. The Pegasus Systems, Inc. 1997 Amended Employee Stock Purchase Plan (the "Plan") is intended to provide a method whereby employees of Pegasus Systems, Inc. and its subsidiary corporations (hereinafter referred to, unless the context otherwise requires, as the "Company") will have an opportunity to acquire a proprietary interest in the Company through the purchase of shares of the common stock of the Company. It is the intention of the Company to have the Plan qualify as an "employee stock purchase plan" under Section 423 of the Internal Revenue Code of 1986, as amended (the "Code"). The provisions of the Plan shall be construed so as to extend and limit participation in a manner consistent with the requirements of that section of the Code. ARTICLE II-DEFINITIONS II.1. BASE PAY "Base Pay" shall mean regular straight-time earnings excluding payments for overtime, shift premium, bonuses and other special payments, commissions and other marketing incentive payments. II.2. COMMITTEE "Committee" shall mean the individuals described in Article XI. II.3. EMPLOYEE "Employee" means any person who is customarily employed on a full-time or part-time basis by the Company or Subsidiary Corporation and is regularly scheduled to work more than 20 hours per week and five months per year. II.4. SUBSIDIARY CORPORATION "Subsidiary Corporation" shall mean any present or future corporation that (i) would be a "subsidiary corporation" of Pegasus Systems, Inc., as that term is defined in Section 424 of the Code, and (ii) is designated as a participating employer under the Plan by the Committee. 2 ARTICLE III-ELIGIBILITY AND PARTICIPATION III.1. INITIAL ELIGIBILITY. Any Employee who shall have completed 90 days' employment and shall be employed by the Company on the date his or her participation in the Plan is to become effective shall be eligible to participate in offerings under the Plan which commence on or after such 90-day period has concluded. III.2. LEAVE OF ABSENCE. For purposes of participation in the Plan, an Employee on leave of absence shall be deemed to remain an Employee for the first ninety (90) days of such leave of absence and such Employee's employment shall be deemed to have terminated at the close of business on the ninetieth day of such leave of absence unless such Employee shall have returned to regular full-time or part-time employment (as the case may be) prior to the close of business on such ninetieth day. Termination by the Company of any Employee's leave of absence, other than termination of such leave of absence on return to full-time or part-time employment, shall terminate an Employee's employment for all purposes of the Plan and shall terminate such Employee's participation in the Plan and right to exercise any option. III.3. RESTRICTIONS ON PARTICIPATION. Notwithstanding any provisions of the Plan to the contrary, no Employee shall be granted an option to participate in the Plan: (a) if, immediately after the grant, such Employee would own stock, and/or hold outstanding options to purchase stock, possessing five percent (5%) or more of the total combined voting power or value of all classes of stock of the Company (for purposes of this paragraph, the rules of Section 424(d) of the Code shall apply in determining stock ownership of any Employee); or (b) that permits such Employee's rights to purchase stock under all employee stock purchase plans of the Company to accrue at a rate which exceeds $25,000 in fair market value of the stock (determined at the time such option is granted) for each calendar year in which such option is outstanding. 2 3 III.4. COMMENCEMENT OF PARTICIPATION. An eligible Employee may become a participant by completing an authorization for a payroll deduction on the form provided by the Company and filing it with the Company on or before the date set therefor by the Committee, which date shall be prior to the Offering Commencement Date for the Offering (as such terms are defined below). Payroll deductions for a participant shall commence on the applicable Offering Commencement Date when the authorization for a payroll deduction becomes effective and shall end on the Offering Termination Date of the Offering to which such authorization is applicable unless sooner terminated by the participant as provided in Article VIII. This Section 3.04 is subject to the Company's right to terminate the Plan as provided in Section 12.05. ARTICLE IV-OFFERINGS IV.1. ANNUAL OFFERINGS. The Plan will be implemented by annual offerings of the Company's common stock (the "Offerings") beginning on each November 15 and terminating on the following November 14. As used in the Plan, "Offering Commencement Date" means the November 15 on which the particular Offering begins, and "Offering Termination Date" means the November 14 on which the particular Offering terminates. ARTICLE V-PAYROLL DEDUCTIONS AND OTHER FUNDING V.1. AMOUNT OF PAYROLL DEDUCTION. At the time of filing an authorization for payroll deduction, a participant shall elect to have deductions made from his or her pay on each payday while a participant in an Offering at the rate of any whole percentage (not to exceed 10%) of such Employee's Base Pay in effect at the Offering Commencement Date of such Offering. In the case of a part-time hourly Employee, such Employee's Base Pay during an Offering shall be determined by multiplying such Employee's hourly rate of pay in effect on the Offering Commencement Date by the number of regularly scheduled hours of work for such Employee during the Offering. V.2. PARTICIPANT'S ACCOUNT. All payroll deductions made for a participant shall be credited to such participant's account under the Plan. A participant may not make any separate cash payment into such account except when on leave of absence, and then only as provided in Section. 5.04. 3 4 V.3. CHANGES IN PAYROLL DEDUCTIONS. A participant may discontinue participation in the Plan as provided in Article VIII. In addition, a participant may, during the first ninety (90) days following the Offering Commencement Date of each Offering, make one change (either to increase or decrease) the amount of the participant's payroll deductions. No other change can be made during an Offering in the amount of payroll deductions for that Offering. V.4. LEAVE OF ABSENCE. If a participant goes on a leave of absence, such participant may elect to: (a) withdraw the balance in his or her account pursuant to Section 7.02, (b) discontinue contributions to the Plan but remain a participant in the Plan, or (c) remain a participant in the Plan during such leave of absence, authorizing deductions to be made from payments by the Company to the participant during such leave of absence and undertaking to make cash payments to the Plan at the end of each payroll period to the extent that amounts payable by the Company to such participant are insufficient to meet such participant's authorized Plan deductions. V.5. OTHER FUNDING DURING OFFERING PERIOD. During an Offering Period, the Company may permit eligible Employees to make lump sum contributions by check payable to the Company, subject to such uniform conditions and limitations as the Committee may direct from time to time; provided, that the total amount contributed during each Offering (from payroll deductions and other contributions) does not exceed 10% of an Employee's Base Pay in effect at the Offering Commencement Date of such Offering. ARTICLE VI-GRANTING OF OPTION VI.1. NUMBER OF OPTION SHARES. On the Commencement Date of each Offering, a participating Employee shall be deemed to have been granted an option to purchase a maximum number of shares of the stock of the Company equal to an amount determined as follows: an amount equal to (i) the percentage of the Employee's Base Pay that he or she elects to have withheld or otherwise contributes by check during the Offering Period but not in any case in excess of 10%) multiplied by (ii) the Employee's Base Pay during the period of the offering (iii) divided by 85% of the market value of the stock of the Company on the applicable Offering Commencement Date. The market value of the Company's stock shall be determined as provided in Section 6.02, below. An Employee's Base Pay during the period of an Offering shall be determined by multiplying his or her normal weekly rate of pay (as in effect on the last day prior to the Commencement Date of the particular Offering) by 52 or the hourly rate by 2080, as the case may be; provided that, in the case of a part-time 4 5 Employee, the Employee's Base Pay during the period of an Offering shall be determined by multiplying such Employee's hourly rate by the number of regularly scheduled hours of work for such Employee during the Offering (or, for a part-time salaried employee, by multiplying such Employee's normal weekly rate of pay by the number of weeks such Employee is expected to work during the period of the Offering). VI.2. OPTION PRICE. The option price of stock purchased during such Offering for a participant therein shall be the lower of: (a) 85% of the closing price of the Company's common stock on the Offering Commencement Date or the nearest prior business day on which trading occurred on Nasdaq or any other national stock exchange; or (b) 85% of the closing price of the Company's common stock on the Offering Termination Date or the nearest prior business day on which trading occurred on Nasdaq or any other national stock exchange. If the common stock of the Company is not admitted to trading on any of the aforesaid dates for which closing prices of the stock are to be determined, then reference shall be made to the fair market value of the stock on that date, as determined on such basis as shall be established or specified for the purpose by the Committee. ARTICLE VII-EXERCISE OF OPTION VII.1. EXERCISE. Unless a participant gives written notice to the Company as hereinafter provided, his or her option to purchase stock with payroll deductions and/or other contributions made during any Offering will be deemed to have been exercised automatically on the Offering Termination Date applicable to such Offering, for the purchase of the number of full shares of stock which the accumulated payroll deductions and other contributions credited to his or her account at that time will purchase at the applicable option price. Alternatively, the participant may make a lump-sum payment of the exercise price. In no case, however, shall the participant purchase more shares than were granted pursuant to Section 6.01. VII.2. WITHDRAWAL OF ACCOUNT. By written notice to the Company, at any time prior to the Offering Termination Date applicable to any Offering, a participant may elect to withdraw all the accumulated payroll deductions and other contributions at such time. 5 6 VII.3. FRACTIONAL SHARES. Fractional shares will not be issued under the Plan and any accumulated payroll deductions and other contributions which would have been used to purchase fractional shares will be retained in the account for the subsequent Offering unless the participant does not participate in the next Offering, and in such event, the balance will be refunded to the participant. VII.4. TRANSFERABILITY OF OPTION. During a participant's lifetime, options held by such participant shall be exercisable only by that participant. VII.5. DELIVERY OF STOCK. As promptly as practicable after the Offering Termination Date of each Offering, the Company will deliver to each participant, as appropriate, the stock purchased upon exercise of the option. ARTICLE VIII-WITHDRAWAL VIII.1. IN GENERAL. As indicated in Section 7.02, a participant may withdraw payroll deductions and other contributions credited to his or her account under the Plan at any time by giving written notice to the Company. All of the participant's payroll deductions and other contributions credited to such participant's account will be paid promptly after receipt of notice of withdrawal, and no further payroll deductions or other contributions will be allowed during such Offering. The Company may, at its option, treat any attempt to borrow by an Employee on the security of accumulated payroll deductions or other contributions as an election, under Section 7.02, to withdraw such account. VIII.2. EFFECT ON SUBSEQUENT PARTICIPATION. A participant's withdrawal from any Offering will not have any effect upon eligibility to participate in any succeeding Offering or in any similar plan which may hereafter be adopted by the Company. VIII.3. TERMINATION OF EMPLOYMENT. Upon termination of the participant's employment for any reason, including retirement (but excluding death while in the employ of the Company or continuation of a leave of absence for a period beyond 90 days), the payroll deductions and other contributions credited to such participant account will be 6 7 returned, or, in the case of death subsequent to the termination of employment, to the person or persons entitled thereto under Section 12.01. VIII.4. TERMINATION OF EMPLOYMENT DUE TO DEATH. Upon termination of the participant's employment because of death, his or her beneficiary (as defined in Section 12.01) shall have the right to elect, by written notice given to the Company prior to the earlier of the Offering Termination Date or the expiration of a period of sixty (60) days commencing with the date of the death of the participant, either to: (a) withdraw all of the payroll deductions and other contributions credited to the participant's account under the Plan, or (b) exercise the participant's option for the purchase of stock on the Offering Termination Date next following the date of the participant's death for the purchase of the number of full shares of stock which the accumulated payroll deductions and other contributions in the participant's account at the date of the participant's death will purchase at the applicable option price, and any excess in such account will be returned to said beneficiary. In the event that no such written notice of election shall be duly received by the office of the Company, the beneficiary shall automatically be deemed to have elected, pursuant to paragraph (b), to exercise the participant's option. VIII.5. LEAVE OF ABSENCE. A participant on leave of absence shall, subject to the election made by such participant pursuant to Section 5.04, continue to be a participant in the Plan so long as such participant is on continuous leave of absence. A participant who has been on leave of absence for more than ninety days and who therefore is not an Employee for the purpose of the Plan shall not be entitled to participate in any offering commencing after the ninetieth day of such leave of absence. Notwithstanding any other provisions of the Plan, unless a participant on leave of absence returns to regular full-time or part-time employment with the Company at the earlier of: (a) the termination of such leave of absence or (b) three months from the ninetieth day of such leave of absence, such participant's participation in the Plan shall terminate on whichever of such dates first occurs. ARTICLE IX-INTEREST IX.1. PAYMENT OF INTEREST. Interest shall be paid on amounts contributed to the Plan that were not used to purchase shares of the Company's common stock. Such amounts will be 7 8 deemed to have earned simple interest during the period from the date of withholding or contribution, as applicable, to the date of return at the regular passbook savings account rates per annum in effect at the NationsBank, during the applicable offering period or, if such rates are not published or otherwise available for such purpose, at the regular passbook savings account rates per annum in effect during such period at another major commercial bank selected by the Committee. ARTICLE X-STOCK X.1. MAXIMUM SHARES. The maximum number of shares which shall be issued under the Plan, subject to adjustment upon changes in capitalization of the Company as provided in Section 12.04 shall not to exceed 500,000 for all Offerings. If the total number of shares for which options are exercised on any Offering Termination Date in accordance with Article VI exceeds the maximum number of shares for the applicable offering, the Company shall make a pro rata allocation of the shares available for delivery and distribution in as nearly a uniform manner as shall be practicable and as it shall determine to be equitable, and the balance of payroll deductions and other contributions credited to the account of each participant under the Plan shall be returned to him or her as promptly as possible. X.2. PARTICIPANT'S INTEREST IN OPTION STOCK. The participant will have no interest in stock covered by an option until such option has been exercised. X.3. REGISTRATION OF STOCK. Stock to be delivered to a participant under the Plan will be registered in the name of the participant, or, if the participant so directs by written notice to the Company prior to the Offering Termination Date applicable thereto, in the names of the participant and one such other person as may be designate by the participant, as joint tenants with rights of survivorship or as tenants by the entireties, to the extent permitted by applicable law. X.4. RESTRICTIONS ON EXERCISE. The Board of Directors may, in its discretion, require as conditions to the exercise of any option that the shares of common stock reserved for issuance upon the exercise of the option shall have been duly listed, upon official notice of issuance, upon a stock exchange, and that either: 8 9 (a) a Registration Statement under the Securities Act of 1933, as amended, with respect to said shares shall be effective, or (b) the participant shall have represented at the time of purchase, in form and substance satisfactory to the Company, that such participant intends to purchase the shares for investment and not for resale or distribution. ARTICLE XI-ADMINISTRATION XI.1. APPOINTMENT OF COMMITTEE. The Board of Directors shall appoint a committee (the "Committee") to administer the Plan, which shall consist of no fewer than three members of the Board of Directors. No member of the Committee shall be eligible to purchase stock under the Plan. XI.2. AUTHORITY OF COMMITTEE. Subject to the express provisions of the Plan, the Committee shall have plenary authority in its discretion to interpret and construe any and all provisions of the Plan, to adopt rules and regulations for administering the Plan, and to make all other determinations deemed necessary or advisable for administering the Plan. The Committee's determination on the foregoing matters shall be conclusive. XI.3. RULES GOVERNING THE ADMINISTRATION OF THE COMMITTEE. The Board of Directors may from time to time appoint members of the Committee in substitution for or in addition to members previously appointed and may fill vacancies, however caused, in the Committee. The Committee may select one of its members as its Chairman and shall hold its meetings at such times and places as it shall deem advisable and may hold telephonic meetings. A majority of its members shall constitute a quorum. All determinations of the Committee shall be made by a majority of its members. The Committee may correct any defect or omission or reconcile any inconsistency in the Plan, in the manner and to the extent is shall deem desirable. Any decision or determination reduced to writing and signed by a majority of the members of the Committee shall be as fully effective as if it had been made by a majority vote at a meeting duly called and held. The Committee may appoint a secretary and shall make such rules and regulations for the conduct of its business as it shall deem advisable. 9 10 ARTICLE XII-MISCELLANEOUS XII.1. DESIGNATION OF BENEFICIARY. A participant may file a written designation of a beneficiary who is to receive any stock and/or cash. Such designation of beneficiary may be changed by the participant at any time by written notice to the Company. Upon the death of a participant and upon receipt by the Company of proof of identity and existence at the participant's death of a beneficiary validly designated by him under the Plan, the Company shall deliver such stock and/or cash to such beneficiary. In the event of the death of a participant and in the absence of a beneficiary validly designated under the Plan who is living at the time of such participant's death, the Company shall deliver such stock and/or cash to the executor or administrator of the estate of the participant, or if no such executor or administrator has been appointed (to the knowledge of the Company), the Company, in its discretion, may deliver such stock and/or cash to the spouse or to any one or more dependents of the participant as the Company may designate. No beneficiary shall, prior to the death of the participant by whom he has been designated, acquire any interest in the stock or cash credited to the participant under the Plan. XII.2. TRANSFERABILITY. Neither payroll deductions nor other contributions credited to a participant's account nor any rights with regard to the exercise of an option or to receive stock under the Plan may be assigned, transferred, pledged, or otherwise disposed of in any way by the participant other than by will or the laws of descent and distribution. Any such attempted assignment, transfer, pledge or other disposition shall be without effect, except that the Company may treat such act as an election to withdraw funds in accordance with Section 7.02. XII.3. USE OF FUNDS. All payroll deductions and other contributions received or held by the Company under this Plan may be used by the Company for any corporate purpose and the Company shall be not be obligated to segregate such payroll deductions or contributions. XII.4. ADJUSTMENT UPON CHANGES IN CAPITALIZATION. (a) If, while any options are outstanding, the outstanding shares of common stock of the Company have increased, decreased, changed into, or been exchanged for a different number or kind of shares or securities of the Company through reorganization, merger, recapitalization, reclassification, stock split, reverse stock split or similar transaction, appropriate and proportionate adjustments may be made by the Committee in the number and/or kind of shares 10 11 which are subject to purchase under outstanding options and on the option exercise price or prices applicable to such outstanding options. In addition, in any such event, the number and/or kind of shares which may be offered in the Offerings described in Article IV hereof shall also be proportionately adjusted. No adjustments shall be made for stock dividends. For the purposes of this paragraph, any distribution of shares to shareholders in an amount aggregating 20% or more of the outstanding shares shall be deemed a stock split and any distributions of shares aggregating less than 20% of the outstanding shares shall be deemed a stock dividend. (b) Upon the dissolution or liquidation of the Company, or upon a reorganization, merger or consolidation of the Company with one or more corporations as a result of which the Company is not the surviving corporation, or upon a sale of substantially all of the property or stock of the Company to another corporation, the holder of each option then outstanding under the Plan will thereafter be entitled to receive at the next Offering Termination Date upon the exercise of such option for each share as to which such option shall be exercised, as nearly as reasonably may be determined, the cash, securities and/or property which a holder of one share of the Common stock was entitled to receive upon and at the time of such transaction. The Board of Directors shall take such steps in connection with such transactions as the Board shall deem necessary to assure that the provisions of this Section 12.04 shall thereafter be applicable, as nearly as reasonably may be determined, in relation to the said cash, securities and/or property as to which such holder of such option might thereafter be entitled to receive. XII.5. AMENDMENT AND TERMINATION. The Board of Directors shall have complete power and authority to terminate or amend the Plan; provided, however, that the Board of Directors shall not, without the approval of the stockholders of the Corporation (i) increase the maximum number of shares which may be issued under any Offering (except pursuant to Section 12.04); or (ii) amend the requirements as to the class of employees eligible to purchase stock under the Plan or permit the members of the Committee to purchase stock under the Plan. No termination, modification, or amendment of the Plan may, without the consent of an Employee then having an option under the Plan to purchase stock, adversely affect the rights of such Employee under such option. 11 12 XII.6. EFFECTIVE DATE. The Plan shall be effective as of September 23, 1997, subject to approval by the holders of the majority of the common stock present and represented at a special or annual meeting of the shareholders (or by any other method of approval adequate under Texas sate law). If the Plan is not so approved within 12 months of the date the Plan is adopted by the Company's board of directors, the Plan shall be deemed to have not become effective. XII.7. NO EMPLOYMENT RIGHTS. The Plan does not, directly or indirectly, create any right for the benefit of any Employee or class of Employees to purchase any shares under the Plan, or create in any Employee or class of Employees any right with respect to continuation of employment by the Company, and it shall not be deemed to interfere in any way with the Company's right to terminate, or otherwise modify, an Employee's employment at any time. XII.8. EFFECT OF PLAN. The provisions of the Plan shall, in accordance with its terms, be binding upon, and inure to the benefit of, all successors of each Employee participating in the Plan, including, without limitation, such Employee's estate and the executors, administrators or trustees thereof, heirs and legatees, and any receiver, trustee in bankruptcy or representative of creditors of such Employee. XII.9. NOTICES. All notices or other communications by a participant to the Company under or in connection with the Plan shall be deemed to have been duly given when received in the form specified by the Company at the location, or by the person, that is designated by the Company from time to time for the receipt thereof, and, in the absence of such a designation, the Company's Human Resources Department. XII.10. GOVERNING LAW. The law of the State of Texas will govern all matters relating to this Plan except to the extent it is superseded by the laws of the United States. 12 EX-10.12 6 OFFICE LEASE DATED OCTOBER 1, 1995 1ST AMENDMENT 1 EXHIBIT 10.12 OFFICE LEASE This Lease is made and executed as of this 1st day of October, 1995, by the parties hereinafter identified as Landlord and Tenant and upon the following terms and conditions: ARTICLE 1. BASIC LEASE PROVISIONS For purposes of this Lease, the following terms shall have the meanings ascribed to them in this Article 1: 1.01 LANDLORD AND ADDRESS: The Utah State Retirement Investment Fund c/o CB Commercial Realty Advisors 533 S. Fremont Avenue Los Angeles, CA 90071 Attn: Director of Asset Management 1.02 TENANT AND CURRENT ADDRESS: The Hotel Industry Switch Company 3811 Turtle Creek Blvd., Suite 1100 Dallas, Texas 75219 1.03 GUARANTOR(S) AND CURRENT ADDRESS(ES): N/A 1.04 BUILDING: That certain property, building and other improvements located on the land described in EXHIBIT A, attached hereto and incorporated herein by this reference, with the street address of 3811 Turtle Creek Boulevard, Dallas, Texas 75219, and commonly referred to as Turtle Creek Centre. 1.05 PREMISES: Suites No. 1100 and 1200, Floors 11 and 12 of the Building as shown on the floor plan attached hereto as EXHIBIT 1. 1.06 AREA OF PREMISES: approximately 29,750 square feet, which number is the final agreement of the parties and not subject to adjustment. 1.07 TERM: 7 years and 1 month 1.08 COMMENCEMENT DATE: The later of December 1, 1995 or the date Tenant first occupies any portion of Floor 12, but in no event later than February 1, 1996. 1.09 EXPIRATION DATE: December 31, 2002 1.10 MONTHLY BASE RENT: Dates Monthly Base Rent ----- ----------------- Commencement Date - June 30, 1996 $29,964.00 ($20,453.13 as to Floor 11 and $9,510.87 as to Floor 12) July 1, 1996 - December 31, 1996 $35,435.13 January 1, 1997 - September 30, 1998 $40,906.25 October 1, 1998 - December 31, 2002 $45,864.58 The foregoing Monthly Base Rent amounts have been calculated based upon an annual Monthly Base Rent of $16.50 per rentable square foot for years 1 through 3 and $18.50 per rentable square foot for years 4 through the remainder of the Term, provided that the foregoing Monthly Base Rent has been reduced by $16.50 per rentable square foot for 7,958 square feet from Commencement Date through June 30, 1996, and by $16.50 per rentable square foot for 3,979 square feet from July 1, 1996 through December 31, 1996. Commencing January 1, 1997, Tenant will pay $16.50 per rentable square foot for all 29,750 square feet. 1.11 TOTAL MONTHLY BASE RENT FOR THE TERM: $3,620,483.61 1.12 TENANT'S SHARE: 10.038%, which is calculated by dividing the number of rentable square feet contained in the Premises, which is 29,750, by the number of rentable square feet contained in the Building, which is 296,378. -1- 2 1.13 BASE OPERATING YEAR: 1996 1.14 BASE EXPENSES: The total amount of Operating Expenses for the Base Operating Year 1.15 SECURITY DEPOSIT: $1,528.58 1.16 LEASING BROKER(S) (IF ANY) AND ADDRESS(ES): Fults Associates 1.17 LANDLORD'S MANAGEMENT AGENT AND ADDRESS: Compass Management, Inc. 3811 Turtle Creek Boulevard, Suite 240 Dallas, Texas 75219 or such other Management Agent as Landlord may designate from time to time. 1.18 RENT PAYMENT ADDRESS: The Utah State Retirement Investment Fund P.O. Box 910517 Dallas, Texas 75391-0517 1.19 PARKING SPACES: the sum of (a) 89 parking spaces located in the parking facilities located inside the Building's adjacent parking garage ("Adjacent Garage Parking Spaces") all of which shall be designated non-reserved parking spaces ("Non-Reserved Parking Spaces"), provided that up to 12 Non-Reserved Parking Spaces may be converted to executive non-reserved parking spaces ("Executive Non-Reserved Parking Spaces"), plus (b) 2 parking spaces ("Reserved Executive Parking Spaces") located in the parking facilities located inside the Building's executive parking garage beneath the Building ("Executive Garage"). In addition, upon Tenant's request, Landlord will temporarily make additional Non-Reserved Parking Spaces ("Additional Non-Reserved Parking Spaces") available to Tenant if and to the extent available for an amount equal to the number of employees of Tenant in excess of 89, Additional Non-Reserved Parking Spaces shall be deemed available to Tenant only to the extent such spaces have not been leased or committed to other tenants or potential tenants of the Building. Landlord may terminate Tenant's right to use any Additional Non-Reserved Parking Spaces that Landlord determines to lease or make available to other tenants of the Building, provided that Landlord shall be permitted to terminate Tenant's right to use spaces only to the extent necessary to provide another tenant of the Building up to but no more than one (1) parking space for every three hundred thirty-three (333) rentable square feet contained in such other tenant's premises. ARTICLE 2. DEMISE 2.01 INITIAL PREMISES. Landlord hereby leases to Tenant and Tenant hereby leases from Landlord the Premises for the Term and upon the terms, covenants and conditions set forth in this Lease. Subject to the provisions of Section 30.15 below, this Lease shall be in full force and effect from the date it is fully executed by both parties. Tenant covenants as a material part of the consideration for this Lease to keep and perform each and all of the terms, covenants and conditions by it to be kept and performed. This Lease is made upon the condition of such performance. 2.02 RIGHT OF FIRST REFUSAL. If the Lease is then in full force and effect and there is no Default hereunder, Tenant shall have the right of first refusal to lease an additional 6,917 square feet of rentable area located on the third (3rd) floor identified as such on Exhibit 2 attached hereto and incorporated herein for all purposes and all of the rentable area on the tenth (10th) and thirteenth (13th) floors of the Building ("ROFR Area").Such right of first refusal shall be exercisable at the following times and upon the following conditions: (a) If Landlord receives a bona fide offer from a prospective tenant (the "Prospective Tenant") to lease premises (the "Offered Premises") in the Building containing all or any part of the ROFR Area (other than an offer to renew the term of or expand the premises demised under an existing lease, as Tenant's right of first refusal shall be subordinate to any renewal of the term of and any expansion of premises demised under an existing lease) and Landlord desires to accept such offer, then Landlord shall notify Tenant of such fact. Tenant shall have a period of five (5) business days from the date of delivery of such notice to notify Landlord whether Tenant elects to exercise the right granted hereby to lease the Offered Premises. If Tenant fails to give any notice to Landlord within the required five (5) business day period, Tenant shall be deemed to have refused its right to lease all or any portion of the ROFR Area. (b) If Tenant refuses its right to lease the Offered Premises, either by giving written notice thereof or by failing to give any notice, Landlord shall thereafter have the right to lease the Offered Premises to the Prospective Tenant on such terms and provisions as may be acceptable to Landlord, provided such terms and provisions are not materially more favorable to the Prospective Tenant than the terms and provision set forth in the notice from Landlord to Tenant. If Landlord and the Prospective Tenant fail to enter into a lease, Tenant shall have the right of first refusal described herein with respect to any subsequent bona fide offers from other prospective tenants. -2- 3 (c) If Tenant exercises its right to lease the Offered Premises, Landlord and Tenant shall, within thirty (30) days after Tenant delivers to Landlord notice of its election, enter into a lease agreement with respect to the Offered Premises on the same terms, covenants, and conditions as are contained in this Lease, except as follows: (i) The rentable area of the Offered Premises shall be equal to the area offered to be leased by the Prospective Tenant. (ii) The Monthly Base Rent rate to be paid for the Offered Premises shall be equal to the Monthly Base Rent offered to be paid by the Prospective Tenant, including any offered increases from time to time in such rental rate. (iii) The additional rental relating the Operating Expenses for the Offered Premises shall be equal to the additional rental relating Operating Expenses offered to be paid by the Prospective Tenant, including any offered increases from time to time in such rate. (iv) The payment of monthly installments of Monthly Base Rent with respect to the Offered Premises shall continence on the effective date of the lease of the Offered Premises as offered to the Prospective Tenant, or in the event no specific effective date was so offered on the date mutually acceptable to Landlord and Tenant, and rent for any partial month shall be prorated. (v) Possession of such portion of the Offered Premises shall be delivered to Tenant on the basis offered to the Prospective Tenant, subject to paragraph (vii) below. Landlord will use reasonable diligence to make the Offered Premises available to Tenant as soon after the effective date stated above as it can, Landlord shall not be liable for the failure to give possession of the Offered Premises on said date by reason of the holding over or retention of possession of any tenant, tenants, or occupants, nor shall such failure impair the validity of this Lease, nor extend the term hereof, but the rent for the Offered Premises shall be abated until possession is delivered to Tenant and such abatement shall constitute full settlement of all claims that Tenant might otherwise have against Landlord by reason of said failure to give possession of the Offered Premises to Tenant on the scheduled effective date. (vi) The term of the lease of the Offered Premises shall commence on the date determined pursuant to subparagraph (c)(iv) above, and shall continue thereafter until the date on which the initial Term terminates. (vii) If the term of the lease offered to the Prospective Tenant exceeds the remainder of the then current Term, any and all allowances and credits offered to the Prospective Tenant (including, without limitation, any leasehold improvement allowances and expenses) shall be multiplied by a fraction, the numerator of which shall be the total number of months remaining in the then current Term, and the denominator of which shall be equal to the number of months in the term offered to the Prospective Tenant. (d) Any assignment or subletting of the Premises by Tenant, or any termination of the Lease, shall terminate the refusal right of Tenant hereby granted. 2.03 TERMINATION OF EXISTING LEASE. Tenant leases the eleventh floor and a portion of the third floor pursuant to an existing lease entered into by Landlord's predecessor in interest as previously amended. Effective upon the Commencement Date, the existing lease shall automatically terminate, except for Tenant's obligations thereunder that expressly survive such termination or Tenant's obligations thereunder that have not been, but should have been, performed prior to the Commencement Date. ARTICLE 3. TERM 3.01 INITIAL TERM. The term of this Lease shall commence on the Commencement Date and expire on the Expiration Date unless sooner terminated as provided in this Lease. If Landlord shall be unable to deliver possession of the Premises to Tenant on the Commencement Date for any reason whatsoever, this Lease shall not be void or voidable and Landlord shall not be subject to any liability for the failure to deliver possession on said date nor shall such failure to deliver possession on the Commencement Date affect the validity of this Lease or the obligations of Tenant hereunder, provided that Tenant shall be entitled to an abatement of rent applicable to Floor 12 if and to the extent Landlord delivers Floor 12 to Tenant after December 1, 1995. 3.02 RENEWAL OPTION. Provided this Lease is then in full force and effect and if there is no Default by Tenant under this Lease, Tenant shall have the right to renew the Term, for an (1) additional period of five (5) years upon the same terms, conditions and provisions applicable to the preceding Term of this Lease (unless otherwise expressly provided herein), except that the Monthly Base Rent for the additional term of five (5) year shall be the product of (i) the number of rentable square feet then contained in the Premises multiplied by (ii) an amount equal to the then prevailing market base rental rate per rentable square foot per annum, as reasonably determined by Landlord, charged for comparable office space in comparable buildings located north of Woodall Rogers Freeway, south of Fitzhugh, west of McKinney Avenue and east of Oak Lawn Avenue. Tenant shall exercise its right of renewal by delivering to Landlord written notice ("Tenant's Notice") of Tenant's desire to renew the term of this Lease as aforesaid at least nine (9) months (but not more than twelve (12) -3- 4 Landlord shall deliver to Tenant a written notice ("Landlord's Notice") specifying the Monthly Base Rent rate per square foot per annum for the additional term of five (5) years. Tenant shall have until thirty (30) days following delivery of Landlord's Notice in which to notify Landlord of Tenant's continued exercise of its rights to renew the Term. Failure to notify Landlord within such period or to timely deliver Tenant's Notice shall automatically extinguish Tenant's rights to renew. ARTICLE 4. RENT 4.01 DEFINITIONS. For purposes of this Lease, the following terms shall have the meanings ascribed to them in this Section 4.01: (a) "ADJUSTMENT YEAR" shall mean each calendar year or part thereof during the Term exclusive of the Base Year. (b) "OPERATING EXPENSES" shall mean and include all amounts, expenses and costs of whatever nature that Landlord incurs or pays because of or in connection with the ownership, control, operation, repair, management, replacement or maintenance of the Building, all related improvements thereto or thereon and all machinery equipment, landscaping, fixtures and other facilities, including personal property, as may now or hereafter exist in or on the Building. Except as otherwise provided below, Operating Expenses shall be determined in accordance with generally accepted accounting principles consistently applied and shall include, but shall not be limited to, the following: (1) Wages, salaries, fees, related taxes, insurance costs, benefits (including amounts payable under medical, pension and welfare plans and any amounts payable under collective bargaining agreements) and reimbursement of expenses of and relating to all personnel engaged in operating, repairing, managing, replacing and maintaining the Property; (2) All supplies and materials for the Building, including sales tax imposed in connection with the purchase thereof; (3) Legal and accounting fees and expenses (except for legal fees incurred in connection with the negotiation of, or the collection of amounts due under, leases); (4) Cost of all utilities for the Building, including, without limitation, water, sewer, and fuel, exclusive of electrical service; (5) Fees and other charges payable under or in respect of all maintenance, repair, janitorial and other service agreements for or pertaining to the Building; (6) Cost of all insurance, including all deductibles thereunder, relating to the Building, or the ownership, its occupancy or operations thereof; (7) Cost of repairs and maintenance of the Building, excluding only such costs which are paid by the proceeds of insurance, by Tenant or by other third parties (other than payment by Tenant or other tenants of the Operating Expenses); (8) Amortization of the cost (plus interest at the then current market rate on the unamortized portion of such cost from time to time) of purchasing and installing capital investment items (including "retrofitting" or capital replacements) that are for the purpose of reducing costs includable in the definition of Operating Expenses or that may be required by governmental authority, including but not limited to, pursuant to the Americans with Disabilities Act. All such costs shall be amortized over the reasonable life of the capital investment items, with the reasonable life and amortization schedule being determined in accordance with sound management accounting principles; (9) Management fees and reimbursed expenses of Landlord's Management Agent (not to exceed a market management fee for comparable buildings in the Dallas metropolitan area) and administrative expenses not borne by the Landlord's Management Agent; (10) Fees and charges under any declaration of covenants, easements or restrictions affecting the Building; and (11) All federal, state and local government taxes, assessments and charges of any kind or nature, whether general, special, ordinary or extraordinary, paid by Landlord in a calendar year with respect to the Building ("Taxes"); provided, real estate taxes and special assessments (except as provided below) shall be included in Operating Expenses for a calendar year only to the extent such taxes and assessments are paid during such calendar year, regardless of when assessed. In addition, "Taxes" shall include, without limitation, real estate and transit district taxes and assessments, sales and use taxes, ad valorem taxes, personal property taxes, any lease or lease transaction tax and all taxes, assessments and charges in lieu of, substituted for, or in addition to, any or all of the foregoing taxes, assessments and charges. Taxes shall not include any federal, state or local government income, franchise, capital stock, inheritance or estate taxes, except to the extent such taxes are in lieu of or a substitute for any of the taxes, -4- 5 assessments and charges previously described in this Section 4.01 (b). "Taxes" shall also include the amount of all fees, costs and expenses (including, without limitation, attorneys' fees and court costs) paid or incurred by Landlord each calendar year in seeking or obtaining any refund or reduction of Taxes or for contesting or protesting any imposition of Taxes, whether or not successful and whether or not attributable to Taxes assessed, paid or incurred in such calendar year. If any special assessment payable in installments is levied against all or any part of the Property, then at the Landlord's discretion, Taxes for the calendar year in which such assessment is levied and for each calendar year thereafter shall include only the amount of any installments of such assessment plus interest thereon paid or payable during such calendar year (without regard to any right to pay, or payment of, such assessment in a single payment). Notwithstanding the foregoing, Operating Expenses shall not include: (1) Principal or interest payments with respect to mortgages against the Building; (2) Ground lease payments; (3) Depreciation; (4) The cost of replacement of capital investment items (except as provided in Section 4.01(b)(8)); (5) Charges for special items or services billed separately to (and in addition to Expense Adjustment Statements) and paid by tenants of the Building; (6) Leasing commissions or other expenses solely related to marketing space in the Building; (7) The cost of electrical service; or (8) For purposes of determining the Base Expenses only, any Operating Expense incurred during the Base Year which is not an ordinary, typical year-to-year Operating Expense for the Building. If at any time the Building is less than ninety-five percent (95%) occupied or Landlord is not supplying services to ninety-five percent (95%) of all rentable areas of the Building during an entire calendar year, then Landlord may adjust that portion of each element of actual Operating Expenses that vary with occupancy of the Building to Landlord's estimate of that amount which would have been paid or incurred by the Landlord as Operating Expenses had the Building been ninety-five percent (95%) occupied or serviced, and the Operating Expenses as so adjusted shall be deemed to be the actual Operating Expenses for such calendar year. If Landlord does not furnish during any Adjustment Year any particular work or service (the cost of which, if performed by Landlord, would constitute an Operating Expense) to a tenant which has undertaken to perform such work or service in lieu of the performance thereof by Landlord, then Operating Expenses shall be deemed to be increased by an amount equal to the additional expense which would reasonably have been incurred during such Adjustment Year by Landlord if it had, at its cost, furnished such work or service to such tenant. The provisions of the preceding sentences will apply only to those Operating Expenses that either vary with occupancy or by reason of one or more tenants not receiving goods or services the cost of which constitutes all or part or such Operating Expenses. If the Property is not assessed as fully improved for any calendar year or part thereof, Landlord may make an adjustment to the amount of Taxes for each such calendar year to reflect the amount of Taxes which would have been assessed if the Property had been assessed as fully improved, and the amount of any such adjustment shall be included in the amount of Taxes for such calendar year. If the Building is not fully leased and occupied by tenants during all or any portion of a calendar year, then Landlord may make an adjustment to the amount of Taxes for such calendar year to reflect the amount of Taxes which would have been assessed if the Building had been fully leased and occupied by tenants during such calendar year, and the amount of any such adjustment shall be included in the amount of Taxes for such calendar year. Landlord shall calculate Operating Expenses (and any adjustment thereto as provided above) during 1996 in the same manner as, and consistent with, calculations to be made during subsequent years. 4.02 PAYMENT OF RENT. Tenant shall pay to Landlord's Management Agent, at the address set forth in Article I above as the Rent Payment Address or to such other person or entity and/or at such other place as Landlord may from time to time direct in writing, all amounts due Landlord from Tenant hereunder, including, without limitation, Monthly Base Rent, Expense Adjustment and Electrical Cost (all amounts due hereunder being referred to collectively as "Rent"). Except as specifically provided in this Lease, Rent shall be paid without abatement, deduction or setoff of any kind, it being the intention of the parties that, to the full extent permitted by law, Tenant's covenant to pay Rent shall be independent of all other covenants contained in this Lease, including Tenant's continued occupancy of the Premises. Tenant's obligation hereunder to pay Rent accruing during the Term (whether or not the amount thereof is determined or determinable as of the date of termination or expiration of this Lease) shall survive the termination of this Lease, except as otherwise provided herein. 4.03 PAYMENT OF MONTHLY BASE RENT. Monthly Base Rent shall be payable monthly, in advance, on the first day of each calendar month during the Term, except that Monthly Base Rent for the first full calendar month of the Term for which Monthly Base Rent is due shall be paid concurrently with the execution of this Lease by Tenant. If the Term commences on a day other than the first day of a calendar month, then Monthly Base Rent for such month will be prorated on a per diem basis based on a 30 day month and the excess of the installment or Monthly Base Rent paid concurrently with the execution of this Lease by Tenant over such prorated amount for the first calendar month of the Term shall be applied against Monthly Base Rent for the first full calendar month of the Term. -5- 6 4.04 EXPENSE ADJUSTMENT. In addition to Monthly Base Rent, Tenant shall pay with respect to each Adjustment Year an amount equal to Tenant's Share of Operating Expenses for the Adjustment Year in excess of the Base Expenses ("Expense Adjustment"). As to any Adjustment Year during the Term which does not begin on January 1st or does not end on December 31st, Expense Adjustment with respect to such Adjustment Year shall be prorated on a per diem basis. Notwithstanding anything contained herein to the contrary, Operating Expenses shall be deemed not to increase more than $.50 per rentable square foot per calendar year (determined on a cumulative basis throughout the Term of the Lease); provided that the foregoing cap on Operating Expenses shall not apply to the following components of Operating Expenses: taxes, insurance, and utilities. 4.05 PAYMENT OF ADJUSTMENTS. The Expense Adjustment with respect to each Adjustment Year shall be paid in monthly installments in advance on the first day of each calendar month during such Adjustment Year in amounts sufficient to satisfy payment of the Expense Adjustment for such Adjustment Year as reasonably estimated by Landlord from time to time prior to or during any Adjustment Year and communicated to Tenant by written notice ("Estimated Expense Adjustment"). If Landlord does not deliver such a notice ("Estimate") prior to commencement of any Adjustment Year, Tenant shall continue to pay Estimated Expense Adjustment as provided in the most recently received Estimate (or Updated Estimate, as defined below) or the latest determined Expense Adjustment, whichever is greater, until the Estimate for such Adjustment Year is delivered to Tenant. If, during any Adjustment Year, Landlord reasonably determines that Operating Expenses for such Adjustment Year have increased or will increase, Landlord may deliver to Tenant an updated Estimate ("Updated Estimate") for such Adjustment Year. Monthly installments of Estimated Expense Adjustment paid subsequent to Tenant's receipt of the Estimate or Updated Estimate for any Adjustment Year shall be in the amounts provided in such Estimate or Updated Estimate, as the case may be. In addition, Tenant shall pay to Landlord within thirty (30) days after receipt of such Estimate or Updated Estimate, the amount, if any, by which the aggregate installments or the Estimated Expense Adjustment provided in such Estimate or Updated Estimate, as the case may be, with respect to prior months in such Adjustment Year exceed the aggregate installments of the Estimated Expense Adjustment paid by Tenant with respect to such prior months. Within one hundred twenty (120) days after the end of each Adjustment Year, or as soon thereafter as practicable, Landlord shall send to Tenant a statement ("Final Adjustment Statement") showing (i) the calculation of the Expense Adjustment for such Adjustment Year, (it) the aggregate amount of the Estimated Expense Adjustment previously paid by Tenant for such Adjustment Year, and (iii) the amount, if any, by which the aggregate amount of the installments of Estimated Expense Adjustment paid by Tenant with respect to such Adjustment Year exceeds or is less than the Expense Adjustment for such Adjustment Year. Tenant shall pay the amount of any deficiency to Landlord within thirty (30) days after the date of such statement. Any excess shall be refunded by Landlord, provided Tenant is not then in default under this Lease, within thirty (30) days after the delivery of the Final Adjustment Statement to Tenant. In addition, Tenant shall have the right, within three (3) months after Tenant's receipt of the Final Adjustment Statement, on written notice to Landlord, to have Landlord's books and records relating to Operating Expenses audited by a qualified professional selected by Tenant and approved by Landlord. Landlord shall have an opportunity to verify the findings of the audit. If such audit, as verified by Landlord, reveals any errors, Tenant's payments of its share of Operating Expenses shall be adjusted, and appropriate payments shall be made by Landlord or Tenant, as the case may be, within forty-five (45) days after completion of such audit. If the audit reveals that Operating Expenses reflected in the Final Adjustment Statement were overstated by more than five percent (5%), then Landlord shall pay the costs of such audit. Otherwise all costs incurred by Tenant in connection with such audit shall be paid by Tenant. 4.06 ELECTRICAL SERVICE. In addition to Monthly Base Rent and Tenant's Share of Operating Expenses, Tenant shall pay with respect to the Base Year and each Adjustment Year, as additional rental, (i) Tenant's Share of all electrical service to the common areas of the Building ("Common Area Electrical Service") and (ii) the cost of electrical service to the Premises ("Premises Electrical Service") (the cost of the Common Area Electrical Service and the Premises Electrical Service, the "Electrical Cost"). In the event the electrical service to the Premises is submetered or otherwise measured in accordance with the provisions of Section 8.03, Tenant shall pay to Landlord the cost of such electrical service based upon rates determined by Landlord from time to time (which shall not exceed the amount Tenant would have been charged for such service by the local utility company furnishing such service). In the event electrical service to the Premises is not measured by a submeter or periodic determination by Landlord's engineers or other competent consultants selected by Landlord (or a combination of such methods), then Tenant shall pay to Landlord Tenant's Share of the cost of all electrical service to tenants in the Building which does not exceed Building standard consumption as established from time to time by Landlord. Tenant's Share shall be based upon the statements therefor received by Landlord from the electrical utility company providing such service, adjusted as Landlord determines appropriate to eliminate over-standard consumption. In the event that other tenants of the Building pay directly either to Landlord or third parties for electricity supplied to their respective premises (e.g. separately metered electricity), then Landlord shall adjust Tenant's Share by excluding from its calculation the rentable area of all tenants making such payments. The cost of electrical service shall include without limitation all fuel adjustment charges, demand charges, and taxes. If, during any period of time, the area of the Building is not ninety-five percent (95%) occupied, then, for purposes of this Section 4.06, Landlord may adjust the actual costs of electrical service that vary with the occupancy of the Building to Landlord's estimate of that amount which would have been paid or incurred by Landlord for electrical service had the Building been ninety-five percent (95%) occupied, and the costs of electrical service as so adjusted shall be deemed to be actual electrical costs for such calendar year. Landlord shall calculate the costs of electrical service (and any adjustment thereto as provided above) during 1996 in the same manner as, and consistent with, calculations to be made during subsequent years. 4.07 ESTIMATED PAYMENTS. Tenant's Share of Electrical Costs with respect to the Base Year and each Adjustment Year shall be paid in monthly installments in advance on the first day of each calendar month during the Base Year and each such Adjustment Year in amounts sufficient to satisfy payment of Tenant's Share of Electrical Costs for the Base Year and each such Adjustment Year as reasonably estimated by Landlord from time to time prior to or during the Base Year and any -6- 7 Adjustment Year and communicated to Tenant by written notice ("Estimated Electrical Cost Payments"). If Landlord does not deliver such a notice ("Electrical Estimate") prior to the commencement of any Adjustment Year, Tenant shall continue to pay Estimated Electrical Cost Payments as provided in the most recently received Electrical Estimate (or Updated Electrical Estimate, as defined below) or the latest determined Estimated Electrical Cost Payment, whichever is greater, until the Electrical Estimate for such Adjustment Year is delivered to Tenant. If, during the Base Year or any Adjustment Year, Landlord reasonably determines that the Electrical Costs for such Adjustment Year have increased or will increase, Landlord may deliver to Tenant an updated Electrical Estimate ("Updated Electrical Estimate") for the Base Year or such Adjustment Year. Monthly installments of Estimated Electrical Cost Payments paid subsequent to Tenant's receipt of the Electrical Estimate or Updated Electrical Estimate for the Base Year or any Adjustment Year shall be in amounts provided in such Electrical Estimate or Updated Electrical Estimate, as the case may be. In addition, Tenant shall pay to landlord within thirty (30) days after receipt of such Electrical Estimate or Updated Electrical Estimate, the amount, if any, by which the aggregate installments of the Estimated Electrical Cost Payments provided in such Electrical Estimate or Updated Electrical Estimate, as the case may be,with respect to prior months in the Base Year or such Adjustment Year exceed the aggregate installments of the Estimated Electrical Cost Payments paid by Tenant with respect to such prior months. Within one hundred twenty (120) days after the end of each Adjustment year, or as soon thereafter as practicable, Landlord shall send to Tenant a statement ("Final Electrical Cost Statement") showing (i) the calculation of Tenant's Share of Electrical Cost for the Base Year or such Adjustment Year, (ii) the aggregate amount of the Estimated Electrical Cost Payments previously paid by Tenant with respect to such Adjustment Year, and (iii) the amount, if any, by which the aggregate amount of the installments of the Estimated Electrical Cost Payments paid by Tenant with respect to such Adjustment Year exceeds or is less than Tenant's share of the Electrical Costs for the Base Year or such Adjustment Year. Tenant shall pay the amount of any deficiency to Landlord within thirty (30) days after the date of such statement. Any excess shall be refunded by Landlord, provided Tenant is not then in default under this lease within thirty (30) days after the delivery of the final Adjustment Statement to Tenant. ARTICLE 5. SECURITY DEPOSIT As security for the performance of its obligations under this Lease, Tenant, on execution of this Lease, shall deposit with Landlord a security deposit in the amount set forth in Article I hereof ("Security Deposit"), and agrees from time to time to pay Landlord within three (3) business days following receipt of a request therefor, any sum or sums of money paid or deducted therefrom by Landlord pursuant to the provisions of this Lease, in order that at all times during the Term there shall be continually deposited with the Landlord, a sum which shall never be less than the amount originally deposited. The Security Deposit shall not be deemed an advance payment of Rent, nor a measure of damages for any default by Tenant under this Lease, nor shall the Security Deposit be a bar or a defense to any action that Landlord may commence against Tenant. In the event of any default by Tenant hereunder, Landlord shall have the right, but shall not be obligated, to apply or retain all or any portion of the Security Deposit in payment of Tenant's obligations hereunder, but any such application or retention shall not be obligated to hold the Security Deposit as a separate fund, but may commingle the same with its other funds. Upon expiration of the Term hereof, the Security Deposit (or the balance thereof remaining after payment out of the same or deductions therefrom as provided above) shall be returned to the Tenant within a reasonable period of time following such expiration. No interest shall be payable with respect to the Security Deposit. Landlord may commingle the Security Deposit with other monies of Landlord. Landlord or any owner of the Building may transfer or assign the Security Deposit to any new owner of the Building or to any assignee or transferee of this Lease or may credit the Security Deposit against the purchase price of the Building and upon such transfer or credit all liability of the transferor or assignor of such security shall cease and come to an end. No Mortgagee (as hereinafter defined) or person or entity who acquires legal or beneficial title to the Building from such Mortgagee shall be liable for the return of the Security Deposit unless such funds are actually received by such Mortgagee or purchaser. ARTICLE 6. USE OF PREMISES; PARKING 6.01 PERMITTED USE. Tenant shall use and occupy the Premises solely for general office purposes and for no other use or purpose. Notwithstanding anything to the contrary in this Lease, the Premises shall not be used for any purpose which would (i) adversely affect the appearance of the Building, (ii) be visible from the exterior of, or the public areas of, the Building, (iii) adversely affect ventilation in other areas of the Building (including without limitation, the creation of offensive odors), (iv) create unreasonable elevator loads, (v) cause structural loads to be exceeded, (vi) create unreasonable noise levels, (vii) otherwise unreasonable interfere with Building operations or other tenants of the Building, or (viii) violate legal requirements. In all events, Tenant shall not engage in any activity which is not in keeping with the first-class standards of the Building. Without limiting the foregoing, Tenant will not use any part of the Premises for the following uses: health care services, telephone or telegraph agency, radio, television or other communication station, employment agency, public restaurant or bar, retail, wholesale or discount shop for the sale of merchandise, retail service shop, school or classroom (except as incidental to office uses but not as the principal use thereof), or governmental or quasi-governmental bureau, department or agency. 6.02 NO NUISANCE. Tenant shall not commit, or suffer to be committed, any annoyance, waste, nuisance,act or thing against public policy, or which may disturb the quiet enjoyment of Landlord or any other tenant or occupant of the building. Tenant agrees not to deface or damage the Building in any manner. 6.03 PARKING. Landlord shall provide and Tenant shall lease and pay for, from the commencement Date until expiration of the Term, the Parking Spaces. Tenant does not have the right to use any specific parking spaces but only has the right to use the number of Parking Spaces located in the parking facilities generally. Tenant may not use additional -7- 8 parking spaces without the prior written consent of Landlord, in its sole discretion. Tenant and its agents, employees, contractors, invitees or licensees shall not interfere with the rights of Landlord or others entitled to similar use of the parking facilities. All parking facilities furnished by Landlord shall be subject to the reasonable control and management of Landlord, who may, from time to time, establish, modify and enforce reasonable rules and regulations with respect thereto. Landlord further reserves the right to change, reconfigure, or rearrange the parking areas, to construct or repair any portion thereof, and to restrict or eliminate the use of any parking areas and do such other acts in and to such areas as Landlord deems necessary or desirable without such actions being deemed an eviction of Tenant or a disturbance of Tenant's use of the Premises and without Landlord being deemed in default hereunder. Landlord may, in its sole discretion, convert the parking facilities to a reserved and/or controlled parking facility. If specific parking spaces are not assigned pursuant to the terms of this Lease, Landlord reserves the right at any time to assign specific parking spaces and Tenant shall thereafter be responsible to insure that its employees park in the specifically designated parking spaces. Tenant shall, if requested by Landlord, furnish to Landlord a complete list of the license plate numbers of all vehicles operated by Tenant, Tenant's employees and agents. Landlord shall not be liable for any damage of any nature to, or any theft of, vehicles, or contents thereof, in or about such parking facility. At Landlord's request, Tenant shall cause its employees and agents using Tenant's parking spaces to execute an agreement confirming the foregoing. Excessive use of the parking facilities by another tenant shall not be a default or breach of this Lease by Landlord, and shall not suspend or terminate any of Tenant's obligations under this Lease, and shall not entitle Tenant to exercise any other right or remedy it may be afforded hereunder or at law or in equity. For the Parking Spaces, Tenant shall pay Landlord during the term additional rental hereunder (a) the sum of $0 per month during the first five years of the Term of this Lease and thereafter $40.00 per month (plus any applicable sales tax) for each Non-Reserved Parking Space, (b) if Tenant elects to convert a Non-Reserved Parking Space to an Executive Non-Reserved Parking Space, then the sum of $60.00 per month (plus any applicable sales tax) for each Executive Non-Reserved Parking Space, (c) the sum of $100.00 per month (plus any applicable sales tax) for each Reserved Executive Parking Space, and (d) the sum of $40.00 per month (plus any applicable sales tax) for each Additional Non-Reserved Parking Space, such sums to be payable monthly in advance on the first day of each and every month during the Term, and a pro rata portion of such sum shall be payable for any partial calendar month in the event this Lease commences or ends on a date other than the first or last day of a calendar month. Tenant's obligation to pay the above described parking rental shall be considered an obligation to pay Rent for all purposes hereunder and shall be secured in a like manner as is Tenant's obligation to pay any other Rent. If the Parking Spaces are not available to Tenant during any portion of the term of this Lease due to causes beyond the control of Landlord (including casualty or condemnation), this Lease shall continue without abatement of Rent and Landlord shall use reasonable efforts to make available to Tenant sufficient substitute parking spaces within a one-half (.5) mile radius of the Building until the Parking Spaces are again made available to Tenant at a rental rate not to exceed the above described rental rate. Tenant shall have the right at any time to convert up to twelve (12) Non-Reserved Parking Spaces to twelve (12) Executive Non-Reserved Parking Spaces, provided Tenant provides Landlord fifteen (15) days prior written notice. The sums described above payable for each Executive Non-Reserved Parking Space shall be prorated for any partial month. ARTICLE 7. RULES AND REGULATIONS Tenant agrees to observe the reservations and rights reserved to Landlord in this Lease. Tenant shall comply, and shall cause its employees, agents, clients, customers, guests and invitees to comply, with the rules and regulations attached hereto as EXHIBIT 3, and such revised or additional rules and regulations adopted by Landlord during the Term and applied generally to all office tenants of the Building. Any violation by Tenant or any of its employees, agents, clients, customers, guests or invitees of any of the rules and regulations so adopted by Landlord shall be a default by Tenant under this Lease and may be restrained by court injunction; but whether or not so restrained, Tenant acknowledges and agrees that it shall be and remain liable for all damages, loss, costs and expense resulting from any violation by Tenant or such other persons of any of said rules and regulations. Landlord shall use reasonable efforts to cause tenants to comply with said rules and regulations on a non-discriminatory basis, provided nothing in this Lease contained shall be construed to impose upon Landlord any duty or obligation to enforce said rules and regulations or the terms, covenants and conditions of any other lease against any other tenant or any other persons, and Landlord shall not be liable to Tenant for violation of the same by any other tenant, its employees, agents, guests, invitees, licensees, customers, clients, family members, or by any other person. ARTICLE 8. SERVICES PROVIDED 8.01 LANDLORD'S SERVICES. Landlord shall furnish: (a) Cooled or heated air in season to provide a temperature condition required, in Landlord's reasonable judgment, for comfortable occupancy of the Premises under normal business operations and in the absence of the use of equipment which affects the temperature or humidity which would otherwise be maintained in the Premises, daily from 7:00 A.M. to 6:00 P.M. (Saturdays 8:00 A.M. to 1:00 P.M.), Sundays and Holidays (as defined below) excepted. If Tenant shall request, at least one (1) business day in advance, Landlord shall provide after hours cooled or heated air for the Premises; provided, that the Tenant shall pay Landlord's charges for such service currently in the amount of Landlord's cost (including reasonable overhead) per hour with a two (2) hour minimum charge (which hourly or minimum charges are subject to change from time to time without notice) within ten (10) days after receipt of Landlord's invoices therefor. Further, if the use of heat generating equipment in the Premises different from that already maintained in the Premises already occupied by Tenant as of the date hereof, affects the temperatures otherwise maintained by the air conditioning system for normal business operations, and thereby requires, in the sole judgment of Landlord, the modification of the air conditioning or ventilation systems (including installation of supplementary air conditioning units in the Premises) Landlord may elect to perform such modification, and the cost thereof shall be paid by Tenant to Landlord at the time of completion of such modification, or Landlord may elect to require Tenant to perform such modification, at Tenant's sole cost and expense. Any increased -8- 9 expense in maintaining or operating the system resulting, in Landlord's sole opinion, from such modification shall be paid by Tenant. In addition, Tenant shall, at Tenant's expense, perform all maintenance on any supplementary air conditioning units installed in accordance with this Section 8.01(a) unless, in the exercise of its right hereby expressly reserved, Landlord elects to perform part or all of such maintenance at Tenant's expense. Tenant agrees to keep and cause to be kept closed all windows in the Premises and at all times to cooperate fully with Landlord in the operation of said system and to abide by all reasonable regulations and requirements which Landlord may prescribe to permit the proper functioning and protection of said heating, ventilation and air conditioning systems. For purposes of this Lease, "Holidays" means those federal or state holidays or such other days which Landlord, in its reasonable discretion, designates to Tenant as "Holidays" for purposes of this Lease, such designation being subject to change from time to time; (b) Washroom facilities, not within the Premises (unless Tenant leases an entire floor), for use by Tenant in common with other tenants in the Building; (c) Janitor service in and about the Premises as customarily provided in similar office buildings in the submarket area that the Building is located within; (d) Passenger elevator service in common with other tenants and occupants, daily from 8:00 A.M. to 6:00 P.M., Saturdays, Sundays and Holidays excepted. Such normal passenger elevator service, if furnished at other times, shall be optional with Landlord and shall never be deemed a continuing obligation. Landlord, however, shall provide limited passenger service daily at all times such normal passenger service is not furnished. Landlord shall provide limited freight elevator service at such times as Landlord shall determine; and (e) Replacement of fluorescent lamps, bulbs, ballasts, and starters in the building with standard ceiling mounted fixtures installed by Landlord and incandescent bulb replacements in all public areas. 8.02 GOVERNMENT RESTRICTIONS. Tenant agrees that compliance with any mandatory or voluntary energy conservation measures or other legal requirements instituted by any appropriate governmental authority shall not be considered a violation of any terms of this Lease and shall not entitle Tenant to terminate this Lease or require abatement or reduction of Rent hereunder. 8.03 ELECTRICAL CONSUMPTION. Landlord shall provide or cause to be provided to the Premises all electrical current required by Tenant in the normal use and occupancy of the Premises. Without Landlord's prior written consent, Tenant shall not install any equipment which would result in Tenant's connected load exceeding, either in voltage, rated capacity, or overall load, that which Landlord deems to be standard for the Building ("Building Standard Load") or which would generate sufficient heat to affect the temperature otherwise maintained in the Premises by the normal operation of the Building air conditioning equipment serving the Premises. The obligation of Landlord to provide or cause to be provided electrical service shall be subject to the rules and regulations of the supplier of such electricity and of any municipal or other governmental authority regulating the business of providing electrical utility service. Except to the extent of Landlord's gross negligence, Landlord shall not be liable or responsible to Tenant for any loss, damage or expense which Tenant may sustain or incur if either the quantity or character of the electric service is changed or is no longer available or no longer suitable for Tenant's requirements. At any time when Landlord is furnishing electric current to the Premises, Landlord may, at its option, upon not less than thirty (30) days prior written notice to Tenant, discontinue the furnishing of such electric current. If Landlord gives such notice of discontinuance, Landlord shall make all reasonably necessary arrangements with the public utilities supplying the electric current with respect to connecting electric current to the Premises, but tenant shall contract directly with such public utility with respect to supplying such service. Landlord shall have the right to measure electrical usage in the Premises (1) by installing a submeter, (2) by periodic determinations by Landlord's engineers or other competent consultants selected by Landlord, or (3) by any combination of such methods. If Tenant's electrical usage exceeds Building Standard Load, the cost of purchase and installation of a submeter in the Premises shall be borne by Tenant. If Tenant's connected load for electrical design exceeds the Building Standard Load, Tenant shall pay as Additional Rent a surcharge of a proportionate part of all electrical service costs which are attributable to the aggregate over-standard electrical consumption by all tenants in the Building. Such proportion shall be equal to the product of the aggregate cost of all over-standard electrical consumption in the Building (as determined by Landlord) times a fraction in which the numerator is Tenant's electrical design load in excess of the Building Standard Load and the denominator is the aggregate of the total electrical design load of all tenants in the Building in excess of the Building Standard Load. Tenant's proportionate share of such sums shall be due within ten (10) days after the date of receipt of a statement therefor from Landlord setting forth the amount of the charges involved and calculating Tenant's proportionate share thereof. If the electrical current consumed relative to the Premises shall be separately metered, Tenant shall pay for all such electrical current directly to the utility company supplying said service. Tenant agrees to purchase from Landlord all replacement lamps, bulbs, ballasts and starters used in the Premises and to pay Landlord a standard charge for furnishing and replacing such lamps, bulbs, ballasts and starters. At no time shall Tenant permit the use of electricity consumed in the Premises to exceed the capacity of feeders to the Building or the risers or wiring installation. Landlord does not warrant or represent that such capacity shall be adequate for Tenant's purposes. 8.04 ADDITIONAL SERVICES. Landlord shall in no event be obligated to furnish any services or utilities, other than those specified in Article 8. Tenant acknowledges that it shall be responsible for making arrangements for and shall pay the cost of the installation, repair and maintenance of its own telephone system. If Landlord elects to furnish services or utilities requested by Tenant in addition to those specified herein (including utility services at times other than those specified), Tenant shall pay to Landlord, Landlord's then prevailing rates for such services and utilities within ten (10) days after receipt of Landlord's invoices therefor. If Tenant shall fail to make any such payment, Landlord may, without notice to Tenant, and in addition to Landlord's other remedies under this Lease, discontinue any or all of the additional services. Failure by Landlord to any extent to furnish any of the aforementioned services to Tenant, the Premises or the Building, or any cessation -9- 10 Landlord to any extent to furnish any of the aforementioned services to Tenant, the Premises or the Building, or any cessation (including any partial curtailment) thereof, shall not render Landlord liable in any respect for damages to person, property or otherwise, nor to be construed as an eviction of Tenant, nor work an abatement of Rent, nor relieve Tenant from fulfillment of any covenant or agreement hereof. Should any of the equipment or machinery utilized in supplying the services listed herein break down, or for any cause cease to function properly, such failure shall not work as an abatement of Rent, nor be construed as an eviction of Tenant, nor relieve Tenant from fulfilling any covenant or agreement contained herein, nor render Landlord liable for damages; however, Landlord shall use reasonable diligence to repair same promptly. Notwithstanding the foregoing, if Tenant is prevented from making reasonable use of the Premises for more than fifteen (15) consecutive days, as its exclusive remedy therefor, Tenant shall be entitled to a reasonable abatement of rent for each consecutive day (after such fifteen (15) day period) that Tenant is so prevented from making reasonable use of the Premises. In addition, and notwithstanding the foregoing, if Tenant is unable to operate its business in the Premises as a result of such unavailability of such services, and such unavailability is due to Landlord's gross negligence or willful misconduct, then, if such unavailability continues for five (5) consecutive business days, Tenant shall have the right, as its sole and exclusive remedy, to a reasonable abatement of rent for each consecutive day (after such five (5) day period) that Tenant is unable to operate its business in the Premises. 8.05 MONUMENT SIGNAGE. The monument sign currently located on Blackburn Driveway is encumbered by the rights of another tenant. Landlord also may use such monument sign for purposes of identifying the Building generally. Tenant shall be entitled to the non-exclusive use of the Tenant Portion of such sign as identified on Exhibit 5, provided all uses thereof, including the signage placed thereon, are approved by Landlord in all respects in Landlord's reasonable discretion. In addition, to the extent of the portion of the sign used by Tenant (but in no event less than 50%), Tenant shall pay its proportionate share (but in no event less than 50%) of all costs in connection therewith, provided Landlord will pay the costs of causing the monument sign to comply with applicable law, Tenant acknowledging that such sign or the use thereof may not currently comply with such laws and may have to be moved or reconfigured to so comply. Landlord shall have the right to add the names of other tenants and signage identifying the Building generally to such monument sign before or after Tenant uses such monument sign and/or causes such monument sign to comply with applicable laws, provided Tenant shall be entitled to use at least 50% of the Tenant Portion of the signage surface area. Landlord shall have the right to use the Landlord Portion of such sign, as identified on Exhibit 5, to identify the Building generally. Landlord shall have the right to determine whether the names of Tenant and other tenants are side by side (horizontal), on top of each other (vertical), and the order of names. ARTICLE 9. LEASEHOLD IMPROVEMENTS; ALTERATIONS 9.01 ALTERATIONS. Except as may be otherwise provided in this Lease as to initial Tenant improvements in accordance with Exhibit 4. Tenant shall not, without Landlord's prior written consent, permit any alteration, improvement, addition or installation in or to the Premises (all of which is collectively referred to as "Work"), including installation of telephone, computer or internal sound or paging systems or other similar systems, or the performance of any decorating, painting and other similar work in the Premises. In the event Landlord consents to any Work, Landlord reserves the right to cause such Work to be performed by contractors and subcontractors designated by Landlord. Tenant shall pay the cost of preparation of the plans for the Work, all permit fees and the fees of said contractors and subcontractors. Except with respect to Work performed by Landlord's designated contractor as general contractor, Tenant shall pay to Landlord's then applicable construction supervision fee. Before commencement of any Work or delivery of any materials into the Premises or the Building, Tenant shall furnish to Landlord, for its prior written approval, which approval shall not be unreasonably withheld or delayed, architectural plans and specifications certified by a licensed architect or engineer reasonably acceptable to Landlord, and such other documentation as Landlord shall reasonably request. Tenant agrees to hold Landlord, its beneficiaries and their respective agents, partners, officers, servants and employees forever harmless against all claims and liabilities of every kind, nature and description which may arise out of or in any way be connected with any such Work, except to the extent caused by Landlord's gross negligence. At the request of Landlord, Tenant will deliver a written indemnity against claims or damages to tenants or occupants of any other premises affected by such Work. Tenant shall pay Landlord's reasonable costs of reviewing plans and materials submitted to Landlord for approval. Tenant shall pay the cost of all such Work and the cost of decorating and altering the Premises and the Building occasioned by any such Work. Landlord shall have the right to require Tenant to deliver to Landlord cash or other security in an amount and form acceptable to Landlord be held in escrow by Landlord to assure prompt payment for the cost of any such Work and to require Tenant's contractors to evidence workman's compensation, general liability and other insurance coverage, as reasonably required by Landlord. All alterations, improvements, additions and installations to or in the Premises shall become part of the Premises at the time of installation. 9.02 TENANT'S WORK. In the event that Landlord permits Tenant to hire its own contractors for the performance of any Work, then in addition to the provisions of Section 9.01, the following shall apply: (i) prior to the commencement of the Work or the delivery of any materials to the Building, Tenant shall submit to Landlord for Landlord's approval, the names and addresses of all contractors, contracts, necessary permits and licenses, certificates of insurance (including, without limitation, Workmen's Compensation, comprehensive general liability and adequacy of design insurance) and instruments of indemnification and waivers of lien against any and all claims, costs, expenses, damages and liabilities which may arise in connection with the Work, all in such form and amount as shall be satisfactory to Landlord; (ii) all such Work shall be done only by contractors or mechanics approved by Landlord and at such time and in such manner as Landlord may from time to time designate; (iii) upon completion of any Work, Tenant shall furnish Landlord with as-built plans, contractors' affidavits, full and final waivers of lien, receipted bills covering all labor and materials expended and used in connection with such Work, and (iv) all such Work shall comply with all insurance requirements, all laws, ordinances, rules and regulations -10- 11 good and workmanlike manner and with the use of new, quality grade materials. 9.03 NO MECHANIC'S LIENS. Without limitation of the provisions of Section 9.01, Tenant agrees not to suffer or permit any lien on any mechanic or materialman to be placed or filed against the Premises or the Building. In case any such lien shall be filed, Tenant shall immediately satisfy and release such lien of record. If Tenant shall fail to have such lien satisfied, released of record, or bonded around within thirty (30) days after its filing, Landlord may, on behalf of Tenant, without being responsible for making any investigation as to the validity of such lien and without limiting or affecting any other remedies Landlord may have, pay the same and Tenant shall pay Landlord on demand the amount so paid by Landlord. 9.04 REMOVAL OF TENANT'S PROPERTY. Subject to the rules and regulations, Tenant, at any time Tenant is not in default hereunder, may remove from the Premises its movable trade fixtures and personal property. Tenant shall repair any damage to the Premises caused by such removal, failing which Landlord may remove the same and repair the Premises and Tenant shall pay the cost thereof to Landlord on demand. 9.05 INITIAL TENANT IMPROVEMENT. Initial Tenant improvements shall be made to the Premises in accordance with Exhibit 4. 9.06 REFURBISHMENT ALLOWANCE. On December 1, 2000, Landlord shall pay to Tenant a refurbishment allowance not to exceed $2.00 per rentable square foot in the Premises of $59,500.00, for use by Tenant to refurbish the Premises, upon satisfaction of the same conditions as set forth in Section 9.05. ARTICLE 10. CONDITION OF PREMISES 10.01 PREMISES CONDITION. No agreements or representations, except such as are expressly contained herein and in the Work Letter attached hereto, if any, have been made to Tenant respecting the condition of the Premises. By taking possession, except as provided in the Work Letter, Tenant conclusively waives all claims relating to the condition of the Premises and accepts the Premises as being free from defects and in good, clean and sanitary order, condition and repair, and agrees to keep the Premises in such condition, ordinary wear and tear excepted. Landlord shall be responsible to cause restrooms and elevator lobbies on each floor of the Premises to comply with applicable ADA standards for handicapped persons, provided Tenant does not make alterations that require changes to the elevator lobbies or restrooms, in which case Tenant shall then be responsible for causing compliance. 10.02 CARE OF THE PREMISES. Subject to Article 12, and ordinary wear and tear excepted, Tenant shall, at its own expense, keep the Premises clean and safe and in as good repair and condition as when all of the work described in the Work Letter was completed (or as to subsequent Work, as and when such Work was completed) and shall promptly and adequately repair all damage to the Premises and the Building caused by Tenant or any of its employees, agents, guests or invitees, including replacing or repairing all damaged or broken glass, fixtures and appurtenances resulting from any such damage, under the supervision and with the approval of Landlord. If Tenant does not promptly and adequately make such repairs or replacements, Landlord may, but need not, make such repairs and replacements and Tenant shall pay Landlord the cost thereof on demand. Tenant, at its sole expense, shall comply with all laws, orders and regulations of federal, state, county and municipal authorities and with any directive of any public officer or officers pursuant to law which shall impose any violation, order or duty upon Landlord or Tenant with respect to the Premises or the use, condition, or occupation thereof, including all handicapped access laws. Tenant shall not do or permit to be done any act or thing in, on or about the Premises or store anything therein which (i) will in any way conflict with any law, statute, ordinance or governmental rule or regulation now in force or which may hereafter be enacted or promulgated, (ii) is not appropriate to the permitted use of the Premises, or (iii) will in any way increase the existing rate of, or adversely affect, or cause a cancellation of, any fire or other insurance policies covering the Building or any of its contents. 10.03 CARE OF THE BUILDING. Landlord, subject to Articles 12 and 14, shall be obligated only to maintain and make necessary repairs to the structural elements of the Building, the public corridors, public washrooms and lobby of the Building, the exterior windows of the Building, and subject to the provisions of Articles 8, 12 and 14, the electrical, plumbing, heating, ventilation and air conditioning systems of the Building. ARTICLE 11. SURRENDER OF THE PREMISES 11.01 SURRENDER. At the termination of this Lease, by lapse of time or otherwise, Tenant shall surrender possession of the Premises to Landlord and deliver all keys to the Premises and all locks therein to Landlord and make known to the Landlord the combination of all combination locks in the Premises, and shall, subject to Articles 12 and 13, return the Premises and all equipment and fixtures of the Landlord therein to Landlord in broom clean condition and in as good condition as when Tenant originally took possession, ordinary wear and tear excepted, failing which Landlord may restore the Premises and such equipment and fixtures to such condition and the Tenant shall pay the cost thereof to Landlord on demand. 11.02 REMOVAL OF FIXTURES. Upon termination of this Lease or of Tenant's right to possession of the Premises, by lapse of time or otherwise, all installations, additions, partitions, hardware, light fixtures, floor coverings, non-trade fixtures and improvements, temporary or permanent, whether placed there by Tenant or Landlord, shall be Landlord's property and shall remain upon the Premises, all without compensation, allowance or credit to Tenant. 11.03 SURVIVAL. All obligations of Tenant under this Article II shall survive the expiration or earlier termination of this -11- 12 Lease. ARTICLE 12. DAMAGE OR DESTRUCTION 12.01 DAMAGE BY FIRE OR OTHER CASUALTY. If, during the Term, more than twenty-five percent (25%) of either of the Premises or the Building is damaged or made untenantable by fire or other casualty, cause, condition or thing whatsoever, Landlord may, by written notice to Tenant given within sixty (60) days after such damage, terminate this Lease. Such termination shall become effective as of the date of such damage. Unless this Lease is terminated, if the Premises are made partially or wholly untenantable as aforesaid, Landlord, subject to the provisions of this Article 12 shall restore the same at Landlord's expense with reasonable promptness. If, as a result of a fire or other casualty, the Premises are made partially or wholly untenantable, Tenant may terminate this Lease if (A) Landlord fails to commence such restoration within sixty (60) days after Landlord is able to take possession of the damaged space in the Premises and fails to reasonably diligently complete the restoration of the Premises, by giving notice thereof to Landlord (i) not later than seventy (70) days after Landlord is able to take possession if Landlord has not theretofore commenced such restoration or (ii) prior to the substantial completion of such restoration, if Landlord commences such restoration within said sixty (60) day period, but fails to complete the restoration of the Premises within one hundred eighty (180) days from the date of casualty, and such termination shall be effective as of the fifth (5) day after receipt of said notice by Landlord, or (B) the restoration will take more than one hundred eighty (180) days to complete by giving notice thereof to Landlord prior to Landlord's commencement of restoration and within twenty (20) days after Landlord notifies Tenant in writing of the estimated time necessary to complete such restoration determined by an architect selected by Landlord, provided Tenant shall have the right to select an architect to make such determination if Landlord has not done so within thirty (30) days after such casualty, and Tenant's termination right, if applicable shall be exercised within twenty (20) days after Tenant's receipt of such architect's estimate. In the event of termination of this Lease, Monthly Base Rent and Adjustments shall be prorated on a per diem basis and paid only the effective date of such termination. If all of the Premises are untenantable but this Lease is not terminated, all Monthly Base Rent and Adjustments shall abate from the date of the fire or other casualty until the Premises are ready for occupancy and reasonably accessible to Tenant; if part of the Premises is untenantable, Monthly Base Rent and Adjustments shall be prorated on a per diem basis and apportioned in accordance with the part of the Premises which is usable by Tenant until the damaged part is ready for Tenant's occupancy. In all cases, with respect to Landlord's obligations under this Article 12, such obligations shall be adjusted and all time periods extended by the period on account of delay caused by adjustment or insurance loss, strikes, governmental approvals, labor difficulties or any cause beyond Landlord's reasonable control. Notwithstanding anything to the contrary in this Section 12.01, Tenant shall not have the right to terminate this Lease and Rent shall in no event abate if such fire or other casualty, cause, condition or thing was caused by the act or neglect of Tenant, its employees or agents. 12.02 RENT CONCESSION AND CASUALTY. This following provision shall apply if, as an economic concession set forth in the Rider hereto, Landlord has granted Tenant a credit against Monthly Base Rent, Expense Adjustment, or Electrical Cost, or has granted Tenant an abatement period with respect to Monthly Base Rent, Expense Adjustment, or Electrical Cost (such credits or the amount of Monthly Base Rent, Expense Adjustment, or Electrical Cost, which would have accrued but for such abatement period being hereinafter referred to as "Rent Concession"): In the event that, pursuant to any provision of this Lease, Monthly Base Rent, Expense Adjustment, or Electrical Cost abate, in whole or in part, by reason of the occurrence of a fire or other casualty ("Casualty Abatement") and this Lease is not terminated, then to the extent that the period of any Casualty Abatement coincides with any period that a Rent Concession would otherwise have been applicable, the Rent Concession or such portion thereof as would otherwise have been applicable if the Casualty Abatement had not occurred ("Rent Concession Balance") will be deferred until the Casualty Abatement period expires and the Rent Concession Balance will be effective and applied at the rate set forth in the Rider during the period immediately following the expiration of the Casualty Abatement. Notwithstanding the foregoing, (a) the Rent Concession Balance will not be applicable to the extent it exceeds the amount of rent loss insurance proceeds recovered by Landlord with respect to the Casualty Abatement, (b) Tenant will not be entitled to any cash refund or credit against any other amounts due Landlord by reason of the foregoing provision and (c) the Term will not be extended by reason of the applicability of the foregoing provision. 12.03 RESTORATION. If Landlord repairs and restores the Premises as provided in Section 12.01 above, Landlord shall repair or restore any decorations (excluding personal property), alterations or improvements to the Premises installed or approved by Landlord; provided, and to the extent, Landlord's and/or Tenant's casualty insurance proceeds, as hereinafter provided under Article 15.02, applicable to such decorations, alterations and improvements are received by or provided to Landlord for such purposes. Tenant shall be responsible for repair and replacement of trade fixtures, furnishings, equipment, personalty property or leasehold improvements belonging to Tenant. Notwithstanding any provision of this Article 12 to the contrary, Landlord shall not be obligated to make any restorations or repairs to the Premises, the cost of which would exceed the proceeds of insurance received by Landlord with respect thereto. ARTICLE 13. EMINENT DOMAIN 13.01 CONDEMNATION OF THE PREMISES. In the event that the whole or a substantial part of the Building or the Premises shall be condemned or taken in any manner for any public or quasi-public use (or sold under threat of such taking), and as a result thereof, the remainder of the Premises cannot be used for the same purpose as prior to such taking, the Lease shall terminate as of the date possession is taken. 13.02 PARTIAL CONDEMNATION OF THE PREMISES. If less than a substantial part of the Premises shall be so condemned or taken (or sold under threat thereof) and after such taking the Premises can be used for the same purposes as prior thereto, the Lease shall cease only as to the part so taken as of the date possession shall be taken by such authority, and Tenant shall -12- 13 pay full Rent up to that date (with appropriate refund by Landlord of such Rent attributable to the part so taken as may have been paid in advance for any period subsequent to the date possession is taken) and thereafter Monthly Base Rent, Expense Adjustment, and Electrical Cost shall be equitably adjusted to reflect the reduction in the Premises by reason of such taking. Landlord shall, at its expense, make all necessary repairs or alterations to the Building so as to constitute the remaining Premises a complete architectural unit, provided that Landlord shall not be obligated to undertake any such repairs or alterations if the cost thereof exceeds the award actually received by Landlord resulting from such taking. 13.03 BUILDING CONDEMNATION. If part of the Building shall be so condemned or taken (or sold under threat thereof), or if any adjacent property or street shall be condemned or improved by a public or quasi-public authority in such a manner as to alter the use of any part of the Premises or the Building and, in the opinion of Landlord, the Building or any part thereof should be altered, demolished or restored in such a way as to materially alter the Premises, Landlord may terminate this Lease by notifying Tenant of such termination within sixty (60) days following the taking of possession by such public or quasi-public authority, and this Lease shall expire on the date of the taking, as fully and completely as if such date were the date hereinbefore set forth as the expiration of the Term, and the Monthly Base Rent and Adjustments hereunder shall be apportioned as of such date. 13.04 AWARD. Landlord shall be entitled to receive the entire award, including the damages for the property taken and damages to the remainder, with respect to any condemnation proceedings affecting the Building. Tenant agrees not to make any claim against Landlord or the condemning authority for any portion of such award or compensation, whether attributable to the value of any unexpired portion of the Term, the loss of profits, goodwill, leasehold improvements or otherwise, Tenant irrevocably assigning any and all such claims to Landlord. ARTICLE 14. WAIVER OF CERTAIN CLAIMS 14.01 RELEASE. To the extent not expressly prohibited by law, Tenant releases Landlord, its mortgage, stockholders, agents, partners, officers, servants and employees, and their respective stockholders, agents, partners, officers, servants and employees (collectively, "Related Parties"), from and waives all claims for damages to person or property sustained by Tenant or by any occupant of the Premises, the Building, or by any other person, resulting directly or indirectly from fire or other casualty, any existing or future condition, defect, matter or thing in the Premises, the Building, or any portions thereof, or from any equipment or appurtenance therein, or from any accident in or about the Building, or from any act of neglect of any tenant or other occupant of the Building or of any other person, other than Landlord or its agents. The foregoing provision shall not limit or reduce Landlord's maintenance and repair obligations contained herein. 14.02 INDEMNIFICATION. Except as provided otherwise in this Lease, Tenant agrees to hold harmless and indemnify Landlord and Landlord's Related Parties against claims and liabilities, including reasonable attorneys' fees, from any damage to person or property caused by the negligence or intentional torts of Tenant or its agents. Landlord may, at its option, repair such damage or replace such loss, and Tenant shall upon demand by Landlord reimburse Landlord for all costs of such repairs, replacement and damages in excess of amounts, if any, paid to Landlord under insurance covering such damages. In the event any action or proceeding is brought against Landlord or Landlord's Related Parties by reason of any such claims, then, upon notice from Landlord, Tenant covenants to defend such action or proceeding by counsel reasonably satisfactory to Landlord. In addition, except as provided otherwise in this Lease, Landlord agrees to hold harmless and indemnify Tenant against claims and liabilities, including reasonable attorneys' fees, from any damage to person or property caused by the negligence or intentional torts of Landlord or its agents. 14.03 TENANT'S FAULT. If any damage to the Building or any equipment or appurtenance therein, whether belonging to Landlord or to other tenants in the Building, results from any act or neglect of Tenant, its agents, employees, guests or invitees, Tenant shall be liable therefor and Landlord may, at Landlord's option repair such damage, and Tenant shall, upon demand by Landlord, reimburse Landlord the total cost of such repairs and damages to the Building. If Landlord elects not to repair such damage, Tenant shall promptly repair such damages at its own cost and in accordance with the provisions of Sections 9.02 and 9.03 as if such repair constituted Work under such Sections. If Tenant occupies space in which there is exterior glass, then Tenant shall be responsible for the damage, breakage or repair of such glass, except to the extent such loss or damage is recoverable under Landlord's insurance, if any. ARTICLE 15. INSURANCE; WAIVER OF SUBROGATION 15.01 TENANT'S INSURANCE. Tenant shall procure and maintain at its own cost policies of comprehensive general public liability and property damage insurance with contractual liability coverage for the agreements of indemnity provided for under this Lease and a broad form general liability endorsement to afford protection with such limits as may be reasonably requested by Landlord from time to time (which as of the date hereof shall be not less than $3,000,000 under a combined single limit of coverage) insuring Landlord and Landlord's Related Parties from all claims, demands or actions for injury to or death of any person or persons and for damage to property made by, or on behalf of, any person or persons, firm or corporation, arising from, related to or connected with the Premises. The insurance shall be issued by companies and be in form and substance satisfactory to Landlord and any mortgagee of the Building and shall name Landlord and Landlord's Managing Agent (and, if requested by Landlord or any mortgagee, include any mortgagee) and their respective agents and employees as additional insureds. The aforesaid insurance policies shall provide that they shall not be subject to cancellation except after at least thirty (30) days' prior written notice to Landlord and all such mortgagees (unless such cancellation is due to non-payment of premiums, in which event ten (10) days' prior written notice shall be required). The original insurance policies (or certificates thereof satisfactory to Landlord), together with satisfactory evidence of payment of the premium thereof, shall be deposited with Landlord prior to the commencement of the Term and renewals thereof not less -13- 14 than fifteen (15) days prior to the end of the term of each such coverage. 15.02 CASUALTY INSURANCE. Tenant shall carry fire and extended coverage insurance of the type typically referred to as "all risk" insurance, including water damage, insuring its interest in the tenant improvements in the Premises (to the extent not covered by Landlord's property insurance) and its interest in all its personal property and trade fixtures located on or within the Building, including, without limitation, its office furniture, equipment and supplies. 15.03 WAIVER OF SUBROGATION. NOTWITHSTANDING ANY OTHER PROVISION OF THIS LEASE TO THE CONTRARY, LANDLORD AND TENANT EACH HEREBY WAIVE ALL RIGHTS OF ACTION AGAINST THE OTHER FOR LOSS OR DAMAGE TO THE PREMISES, OR THE BUILDING AND PROPERTY OF LANDLORD AND TENANT IN THE BUILDING, WHICH LOSS OR DAMAGE IS INSURED OR IS REQUIRED PURSUANT TO THIS LEASE TO BE INSURED BY VALID AND COLLECTIBLE INSURANCE POLICIES TO THE EXTENT OF THE PROCEEDS COLLECTED OR COLLECTIBLE UNDER SUCH INSURANCE POLICIES, SUBJECT TO THE CONDITION THAT THIS WAIVER SHALL BE EFFECTIVE ONLY WHEN THE WAIVER IS PERMITTED BY SUCH INSURANCE POLICIES OR WHEN, BY THE USE OF GOOD FAITH EFFORT, SUCH WAIVER COULD HAVE BEEN PERMITTED IN THE APPLICABLE INSURANCE POLICIES, EVEN IF CAUSED BY THE NEGLIGENCE OF SUCH OTHER PARTY. THE POLICIES OF INSURANCE REQUIRED TO BE MAINTAINED BY TENANT UNDER THE TERMS OF THIS LEASE SHALL CONTAIN WAIVER OF SUBROGATION CLAUSES IN FORM AND CONTENT SATISFACTORY TO LANDLORD. 15.04 INCREASED COSTS. Tenant shall not conduct or permit to be conducted by its employees, agents guests or invitees any activity, or place any equipment in or about the Premises or the Building that will in any way increase the cost of fire insurance or other Landlord insurance on the Building. If any increase in the cost of fire insurance or other insurance is stated by any insurance company or by the applicable Insurance Rating Bureau, if any, to be due to any activity or equipment of Tenant in or about the Premises or the Building, such statement shall be conclusive evidence that the increase in such cost is due to such activity or equipment and, as a result thereof, Tenant shall be liable for the amount of such increase. Tenant shall reimburse Landlord for such amount upon written demand from Landlord and any such sum shall be considered additional Rent payable hereunder. Tenant, at its sole expense, shall comply with any and all requirements of any insurance organization or company necessary for the maintenance of reasonable fire and public liability insurance covering the Premises and the Building. ARTICLE 16. LANDLORD'S RIGHT OF ACCESS 16.01 ENTRY INTO PREMISES. Landlord and its contractors and representatives shall have the right to enter the Premises at all reasonable times to perform janitorial, cleaning, security, and other services and, after reasonable verbal notice (except in the case of emergencies), to inspect the same, to make repairs, alterations and improvements, to maintain the Premises and the Building, specifically including, but without limiting the generality of the foregoing, to make repairs, additions or alterations within the Premises to mechanical, electrical and other facilities serving other premises in the Building, to post such reasonable notices as Landlord may desire to protect its rights, to exhibit the Premises to mortgagees and purchasers, and, during the one hundred eighty (180) days prior to the expiration of the term, to exhibit the Premises to prospective tenants. In the event the Premises are vacant, Landlord may place upon the doors or in the windows of the Premises any usual or ordinary ""To Let,'' "To Lease," or "For Rent" signs. To the extent that Tenant's conduct of its business from the Premises is not materially interfered with, Tenant shall permit Landlord to erect, use, maintain and repair pipes, cables, conduit, plumbing, vents and wires, in, to and through the Premises to the extent Landlord may now or hereafter deem necessary or appropriate for the proper operation, maintenance and repair of the Building and any portion of the Premises. 16.02 LANDLORD'S REPAIRS. Landlord shall also have the right to take all material into the Premises that may be required for the purposes set forth in the foregoing Section 16.01 without the same constituting a constructive eviction of Tenant, in whole or in part, and, except as otherwise provided in this Lease, Rent shall not abate (except as provided in Article 12) while said repairs, alterations, improvements or additions are being made, by reason of loss or interruption of business of Tenant, or otherwise. If Tenant shall not be personally present to open and permit entry into the Premises, at any time, when for any reason entry therein shall be reasonably necessary under the circumstances, such as in an emergency or to make repairs, Landlord or Landlord's agents may enter the Premises by a master key, or may forcibly enter the same, without rendering Landlord or such agents liable therefor (if during such entry Landlord or Landlord's agents shall accord reasonable care to Tenant's property), and without in any manner affecting the obligations and covenants of this Lease. 16.03 MINIMIZE INTERFERENCE. In exercising its rights under this Article 16, Landlord will use reasonable efforts in minimize any interference with Tenant's use or occupancy of the Premises, provided that Landlord will not be obligated to provide overtime labor or perform work after regular Building hours. ARTICLE 17. RIGHTS RESERVED TO LANDLORD Landlord shall have the following rights exercisable without notice and without liability to Tenant for damage or injury to property, person or business (all claim's for damage being hereby waived and released by Tenant) and without effecting an eviction or disturbance of Tenant's use or possession giving rise to any claim for set-offs or abatement of Rent: (a) To change the name or street address of the Building (but not the suite number of the Premises); (b) To install and maintain signs on the exterior and interior of the Building (without adversely affecting -14- 15 Tenant's signage rights granted in this Lease); (c) To designate all sources furnishing sign painting and lettering, towels, coffee cart service, vending machines or toilet supplies used or consumed on the Premises and the Building; (d) To have pass keys to the Premises; (e) To grant to anyone the exclusive right to conduct any business or render any service in the Building, provided such exclusive right shall not operate, to exclude Tenant from the use expressly permitted by this Lease; (f) To make repairs, additions or alterations to the Building which may change, eliminate or remove common areas, parking areas, if any, or the method of ingress to or egress from the Building and such areas, to convert common areas into leasable areas, or otherwise alter, repair or reconstruct the common areas or change the use thereof, to change the arrangement or location of entrances or passageways, doors and doorways, corridors, elevators, stairs, toilets or other public parts of the Building, and to close entrances, doors, corridors, elevators, plaza or other facilities, and to perform any acts related to the safety, protection, preservation, reletting, sale or improvement of the Premises or the Building; (g) To have access to all mail chutes or boxes according to the rules of the United States Postal Service; (h) To require all persons entering or leaving the Building during such hours as Landlord may from time to time reasonably determine to identify themselves to security personnel by registration or otherwise, and to establish their right to enter or leave and to exclude or expel any peddler, solicitor or beggar at any time from the Premises or the Building; (i) To close the Building at 7:00 p.m. on weekdays, 1:00 p.m. on Saturdays, and all day on Sundays and Holidays, or at such other reasonable times as Landlord may determine, subject, however, to Tenant's right to admittance under such regulations as shall be prescribed from time to time by Landlord in its sole discretion. ARTICLE 18. ABANDONMENT Tenant shall not abandon the Premises at any time during the Term. Any re-entry by Landlord following abandonment by Tenant shall not, unless Landlord so elects in a written notice to Tenant, constitute or be deemed to constitute acceptance by Landlord of a surrender of this Lease, but rather, upon such abandonment, Tenant's right to possession of the Premises shall cease, but Tenant shall remain liable for all of its obligations under this Lease. Without limitation of the foregoing, upon any such abandonment, Landlord shall have the remedies provided for in Article 21 below. If Tenant shall abandon or surrender the Premises or be dispossessed by process of law or otherwise during the Term or at termination of the Term, any personal property left on the Premises shall be deemed to be abandoned at the option of Landlord, and title thereto shall pass to Landlord under this Lease as a bill of sale. For purposes of this Lease, and at the option of Landlord, the Premises shall be deemed vacated or abandoned if Tenant, or an agent or employee of Tenant, shall not have conducted Tenant's ordinary business upon the Premises during any period of fifteen (15) consecutive days or shall have transferred all or substantially all of its personnel, furniture and fixtures from the Premises without replacement. ARTICLE 19. TRANSFER OF LANDLORD'S INTEREST As used in this Lease, the term "Landlord" means only the current owner of the fee title to the Building or the leasehold estate under a ground lease of the Building at the time in question. Each Landlord is obligated to perform the obligations of Landlord under this Lease only during the time such Landlord owns such interest or title. Any Landlord who transfers its title or interest in the Building is relieved of all liabilities for the obligations of Landlord under this Lease to be performed on or after the date of transfer. Tenant agrees to look solely to the transferee with respect to all matters in connection with this Lease. ARTICLE 20. TRANSFER OF TENANT'S INTEREST 20.01 LANDLORD'S CONSENT. Tenant shall not sell, assign, encumber, mortgage or transfer this Lease or any interest therein, sublet or permit the occupancy or use by others of the Premises or any part thereof, or allow any transfer hereof of any lien upon Tenant's interest by operation of law or otherwise (collectively, a "Transfer") without the prior written consent of Landlord in its sole discretion. Any Transfer which is not in compliance with the provisions of this Article 20 shall, at the option of Landlord, be void and of no force or effect. Tenant shall, by written notice in the form specified in the following sentence, advise Landlord of Tenant's intention on a stated date (which shall not be less than sixty (60) days after the date of Tenant's notice) to sublet, assign, mortgage or otherwise Transfer any part or all of the Premises or its interest therein for the balance or any part of the Term, and, in such event, Landlord shall have the right, to be exercised by giving written notice to Tenant within thirty (30) days after receipt of Tenant's notice, to recapture the space described in Tenant's notice and such recapture notice shall, if given, cancel and terminate this Lease with respect to the space therein described as of the date stated in Tenant's notice. Tenant's notice shall state the name and address of the proposed subtenant, assignee, pledgee, mortgage or transferee, and a true and complete copy of the proposed sublease, assignment, pledge, mortgage or other conveyance and all related documentation, executed by both parties, shall be delivered to Landlord with said notice. If Tenant's notice shall cover all of the space hereby demised, and Landlord shall elect to give the aforesaid recapture notice -15- 16 with respect thereto, then the Term shall expire and end on the date stated in Tenant's notice as fully and completely as if that date had been herein definitely fixed for the expiration of the Term. If, however, this Lease is terminated pursuant to the foregoing with respect to less than the entire Premises, the Monthly Base Rent, Expense Adjustment, and Electrical Cost then in effect shall be adjusted on the basis of the number of rentable square feet retained by Tenant in proportion to the original Area of the Premises, and this Lease as so amended shall continue thereafter in full force and effect. In such event, Tenant shall pay the cost of erecting demising walls and public corridors and making other required modifications to physically separate the portion of the Premises remaining subject to this Lease from the rest of the Premises. If Landlord, upon receiving Tenant's notice that it intends to sublet or assign any such space, shall not exercise its right to recapture the space described in Tenant's notice. Landlord will, as hereinabove provided, determine whether to approve the Tenant's request to sublet or assign the space covered by its notice. Notwithstanding the foregoing provisions, Landlord will not unreasonably withhold such consent to an assignment or sublease if the following conditions are satisfied: (a) In the reasonable judgment of Landlord, the subtenant or assignee (A) is of a character or engaged in a business or proposes to use the Premises in a manner which is in keeping with the standards of Landlord for the Building, (B) will not violate the provisions of any lease or agreement affecting the Building, and (C) does not have an unfavorable reputation or credit standing; (b) Either the area of the Premises to be sublet or the remaining area of the Premises is regular in shape with appropriate means of ingress or egress suitable for normal renting purposes; (c) Tenant is not in default under this Lease; (d) The proposed sublease or assignee is not a person or entity with whom Landlord is then negotiating to lease space in the Building; (e) The amount of the aggregate rent to be paid by the proposed assignee or subtenant is not less than the current prevailing rent for comparable direct lease space in the Building; (f) The use of the Premises by such proposed assignee or sublessee is permitted under this Lease; and (g) In no event shall the following be considered as suitable assignees or sublessees under this subsection; any governmental body, agency or bureau (of the United States, any state, county, municipality or any subdivision thereof); any foreign government or subdivision thereof; any health care professional or health care service organization; schools or similar organizations; employment agencies; radio; television or other communication stations; restaurants; and retailers offering retail services from the Premises. If Landlord consents to such sublet or assignment, such consent shall be expressly contingent upon Tenant's payment to Landlord, as Rent, the Landlord's costs and expenses incurred in connection therewith, including, but not limited to, attorney's fees and Landlord's construction supervision fee, if applicable. Without limiting the foregoing, in no event shall the following be considered suitable assignees or sublessees under this Section 20.01: any governmental body, agency or bureau (of the United States, any state, county, municipality or any subdivision thereof); any foreign government or subdivision thereof; any health care professional or health care service organization; schools or similar organizations; employment agencies; radio, television or other communication stations; restaurants; and retailers. 20.02 EXCESS RENT. If Tenant individually, or as debtor or debtor in possession or if a trustee in bankruptcy acting on behalf of Tenant pursuant to the Bankruptcy Code, 11 U.S.C. 101 et seq., shall sublet or assign the Premises or any part thereof or assign any interest in this Lease at a rental rate (or additional consideration) in excess of the then current Monthly Base Rent, Expense Adjustment, and Electrical Cost per rentable square foot, said excess Rent (or additional consideration) shall be and become the property of Landlord and shall be paid to Landlord as it is received by Tenant, less the Tenant's reasonable brokerage (excluding commissions paid to brokers who are Tenant's affiliates), legal and other expenses ("Tenant's Costs") incurred in connection with such assignment or, in the case of a sublease, less the monthly pro rata share of such Tenant's Costs as determined by dividing such Tenant's Costs by the number of months in the term of such sublease. If Tenant shall sublet the Premises or any part thereof, Tenant shall be responsible for all actions and neglect of the subtenant and its officers, partners, employees, agents, guests and invitees as if such subtenant and such persons were employees of Tenant. Nothing in this Section 20.02 shall be construed to relieve Tenant from the obligation to obtain Landlord's prior written consent to any proposed sublease. 20.03 NO WAIVER. The consent by Landlord to any Transfer shall not be construed as a waiver or release of Tenant from liability for the performance of all covenants and obligations to be performed by Tenant under this Lease, and Tenant shall remain liable therefor, nor shall the collection or acceptance of Rent from any assignee, subtenant or occupant constitute a waiver or release of Tenant from any of its obligations or liabilities under this Lease. Any consent given pursuant to this Article 20 shall not be construed as relieving Tenant from the obligation of obtaining Landlord's prior written consent to any subsequent assignment or subletting. 20.04 INCLUDED TRANSFERS. If Tenant is a partnership, a withdrawal or change, whether voluntary, involuntary or by operation of law or in one or more transactions, of partners owning a controlling interest in Tenant shall be deemed a voluntary assignment of this Lease and subject to the provisions of this Article 20. If Tenant is a corporation, any dissolution, merger, consolidation or other reorganization of Tenant, or the sale, transfer or redemption of a controlling interest of the capital stock of Tenant in one or more transactions, shall be deemed a voluntary assignment of this Lease and subject to the provisions of this Article 20. However, the preceding sentence shall not apply to corporations the stock of which is traded through a national or regional exchange or over-the-counter. Neither this Lease nor any interest therein nor any estate -16- 17 created thereby shall pass by operation of law or otherwise to any trustee, custodian or receiver in bankruptcy of Tenant or any assignee for the assignment of the benefit of creditors of Tenant. ARTICLE 21. DEFAULT: LANDLORD'S RIGHTS AND REMEDIES 21.01 DEFAULT. The occurrence of any one or more of the following matters constituted a default ("Default") by Tenant under this Lease: (a) Failure by Tenant to pay any Rent or any other amounts due and payable by Tenant under this Lease and such failure continues for five (5) days after the giving of written notice of such failure by Landlord to Tenant provided Landlord shall not be obligated to give more than two (2) notices in any calendar year, and Tenant shall for all subsequent failures to pay be in default immediately without the requirement of Landlord to give notice of such failure to Tenant; (b) Failure by Tenant to observe or perform any of the covenants in this Lease in respect to assignment and subletting; (c) Abandonment of the Premises as prohibited in Article 18; (d) Failure by Tenant to cure forthwith, after notice thereof from Landlord or another tenant acquiring knowledge thereof, any hazardous condition that Tenant has created in violation of law or of this Lease; (e) Failure by Tenant to observe or perform any other covenant, agreement, condition or provision of this Lease, if such failure shall continue for twenty (20) days after written notice thereof to Tenant by Landlord; (f) The levy upon execution of the attachment by legal process of the leasehold interest of Tenant, or the filing or creation of a lien in respect of such leasehold interest; (g) Tenant or any guarantor of this Lease becomes insolvent or bankrupt or admits in writing its inability to pay its debts as they mature, makes an assignment for the benefit of creditors, or applies for or consents to the appointment of a trustee or receiver for itself or for all or a part of its property; (h) Proceedings for the appointment of a trustee, custodian or receiver of Tenant or any guarantor of this Lease or for all or a part of Tenant's or such guarantor's property are filed against Tenant or such guarantor and are not dismissed within thirty (30) days; (i) Proceedings in bankruptcy, or other proceedings for relief under any law for the relief of debtors, are instituted by or against Tenant or any guarantor of this Lease, and, if instituted against Tenant or such guarantor, are allowed against either or are consented to by either or are not dismissed within sixty (60) days thereof; (j) Tenant shall repeatedly default in the timely payment of Rent or any other charges required to be paid, or shall repeatedly default in keeping, observing or performing any other covenant, agreement, condition or provision of this Lease, whether or not Tenant shall timely cure any such payment or other default. For the Purposes of this subsection, the occurrence of similar defaults three (3) times during any twelve (12) month period shall constitute a repeated default. Any notice periods provided for under this Article 21.01 shall run concurrently with any statutory notice periods, and any notice given hereunder may be given simultaneously with or incorporated into any such statutory notice. 21.02 LANDLORD'S REMEDIES. If a Default occurs, Landlord shall have the following rights and remedies, which shall be distinct, separate and cumulative, and which may be exercised by Landlord concurrently or consecutively in any combination and which shall not operate to exclude or deprive Landlord of any other right or remedy which Landlord may have in law or equity: (a) Landlord may terminate this Lease by giving to Tenant notice of the Landlord's intention to do so, in which event the Term shall end, and all right, title and interest of Tenant hereunder shall expire, on the date stated in such notice; (b) Landlord may terminate the right of Tenant to possession of the Premises without terminating this Lease by giving notice to Tenant that Tenant's right of possession shall end on the date stated in such notice, whereupon the right of Tenant to possession of the Premises or any part thereof shall cease on the date stated in such notice but Tenant's obligations under this Lease shall continue in full force and effect; and (c) Landlord may enforce the provisions of this Lease and may enforce and protect the rights or Landlord hereunder by a suit or suits in equity or at law for the specific performance of any covenant or agreement contained herein, or for the enforcement of any other appropriate legal or equitable remedy, including injunctive relief and recovery of all moneys due or to become due from Tenant under any of the provisions of this Lease. 21.03 SURRENDER OF POSSESSION. If Landlord exercises either of the remedies provided for in subparagraphs (a) and (b) of Article 21.02, Tenant shall surrender possession and vacate the Premises immediately and deliver possession thereof to -17- 18 Landlord, and Landlord may then, or at any time thereafter, re-enter and take complete and peaceful possession of the Premises, full and complete license so to do being granted to Landlord, and Landlord may remove all property therefrom, without being deemed in any manner guilty of trespass, eviction or forcible entry and detainer and without relinquishing Landlord's right to Rent or any other right given to Landlord hereunder or by operation of law. 21.04 DAMAGES. If Landlord terminates the right of Tenant to possession of the Premises without terminating this Lease, such termination of possession shall not release Tenant, in whole or in part, from Tenant's obligation to pay the Rent hereunder for the full stated Term, and Landlord shall have the right to the immediate recovery of all such amounts. Alternatively, at Landlord's option, Landlord shall have the right, from time to time, to recover from Tenant, and Tenant shall remain liable for, all Monthly Base Rent, Expense Adjustment, Electrical Cost and any other sums then due under this Lease during the period from the date of such notice or termination of possession to the end of the Term. Landlord may file suit from time to time to recover any such sums and no suit or recovery by Landlord of any such sums or portion thereof shall be a defense to any subsequent suit brought for any other sums due under this Lease. Alternatively, if Landlord elects to terminate this Lease, Landlord shall be entitled to recover from Tenant all Monthly Base Rent, Expense Adjustment, and Electrical Cost accrued and unpaid for the period up to and including such termination date, as well as all other additional sums payable by Tenant hereunder. In addition, Landlord shall be entitled to recover, as damages for loss of the benefit of its bargain and not as a penalty, the sum of (x) the unamortized cost to Landlord, computed and determined in accordance with generally accepted accounting principles, of any tenant improvements provided by Landlord at its expense, (y) the aggregate sum which at the time of such termination represents the excess, if any, of the present value of the aggregate Monthly Base Rent, Expense Adjustment, and Electrical Cost (as reasonably estimated by Landlord) for the remainder of the Term over the then present value of the then aggregate fair rental value of the Premises for the balance of the Term, immediately prior to such termination, such present worth to be computed in each case on the basis of a six percent (6%) per annum discount from the respective dates upon which rentals would have been payable hereunder had the Term not been terminated, and (z) any damages in addition thereto, including reasonable attorney's fees and court costs, which Landlord shall have sustained by reason of the breach of any of the covenants of this Lease other than for the payment of Rent. 21.05 RELETTING. In the event Landlord terminates the right of Tenant to possession of the Premises without terminating this Lease as aforesaid, Landlord shall have no obligation to, but may relet the Premises or any part thereof for the account of Tenant for such rent, for such time (which may be for a term extending beyond the Term) and upon such terms as Landlord in Landlord's sole discretion shall determine, and Landlord shall not be required to accept any tenant offered by Tenant or to observe any instructions given by Tenant relative to such reletting and may give the leasing of any unleased space in the Building priority over the reletting of the Premises. Also, in any such event, Landlord may make repairs, alterations and additions in or to the Premises and redecorate (using only Building standard materials in substantially the same configuration as the Premises) the same to the extent deemed by Landlord necessary or desirable, and, in connection therewith, change the locks to the Premises, and Tenant shall upon demand pay the cost thereof together with Landlord's expenses of reletting. Landlord may collect the rents from any such reletting and apply the same first to the payment of the expenses of re-entry, redecoration, repair and alterations and the expense of reletting (including without limitation brokers' commissions and attorneys' fees) and second to the payment of Rent herein provided to be paid by Tenant. Any excess of residue shall operate only as an offsetting credit against the amount of Rent as the same theretofore became or thereafter becomes due and payable hereunder, but the use of such offsetting credit to reduce the amount of Rent due Landlord, if any, shall not be deemed to give Tenant any right, title or interest in or to such excess or residue and any such excess or residue shall belong solely to Landlord. No such re-entry or repossession, repairs, alterations and additions, or reletting shall be construed as an eviction or ouster of Tenant, an election on Landlord's part to terminate this Lease or an acceptance of a surrender of this Lease, unless a written notice of such intention be given to Tenant, or shall operate to release Tenant in whole or in part from any of Tenant's obligations hereunder. Landlord may, at any time and from time to time, sue and recover judgment for any deficiencies remaining after the application of the proceeds of any such reletting. 21.06 REMOVAL OF TENANT'S PROPERTY. All property removed from the Premises by Landlord pursuant to any provisions of this Lease or of law shall be handled, removed or stored by Landlord at the cost, expense and risk of Tenant, and Landlord, shall in no event be responsible for the value, preservation or safekeeping thereof. Tenant shall pay Landlord upon demand for all expenses incurred by Landlord in such removal and storage. 21.07 COSTS. Tenant shall pay all costs, charges and expenses, including court costs and reasonable attorneys' fees incurred by Landlord or its beneficiaries in enforcing Tenant's obligations under this Lease, in the exercise by Landlord of any of its remedies in the event of a default, in any litigation, negotiation or transactions in which Tenant causes Landlord, without Landlord's fault, to become involved or concerned, or in consideration of any request for approval of or consent to any action by Tenant which is prohibited by this Lease or which may be done only with Landlord's approval or consent, whether or not such approval or consent is given. 21.08 CUMULATIVE RIGHTS. All of Landlord's rights and remedies under this Lease shall be cumulative with and in addition to any and all rights and remedies which Landlord may have at law or equity. Any specific remedy provided for in any provision of this Lease shall not preclude the concurrent or consecutive exercise of a remedy provided for in any other provision hereof. 21.09 LOCK-OUT. If a Default occurs, Landlord is entitled and is hereby authorized, without any notice to Tenant whatsoever, to enter upon the Premises by use of a master key, a duplicate key, picking the locks, or other peaceable means, and to change, alter, and/or modify the door locks on all entry doors of the Premises, thereby excluding Tenant, and its officers, principals, agents, employees, visitors and representatives therefrom. In the event that Landlord has either terminated Tenant's right of possession to the Premises pursuant to the foregoing provisions of this Lease, or has terminated this Lease by reason of the Default, Landlord shall not thereafter be obligated to provide Tenant with a key to the Premises at any time; provided, however, that in any such instance, during Landlord's normal business hours and at the convenience -18- 19 of Landlord, and upon the written request of Tenant accompanied by such written waivers and releases as Landlord may require, Landlord will escort Tenant or its authorized personnel to the Premises to retrieve any personal belongings or other property of Tenant not subject to Landlord's liens or security interests described in this Lease or available under applicable laws. If Landlord elects to exclude Tenant from the Premises without permanently repossessing the Premises or terminating this Lease pursuant to the foregoing provisions of this Lease, then Landlord (at any time prior to permanent repossession or termination) shall not be obligated to provide Tenant a key to re-enter the Premises until such time as all delinquent Rent has been paid in full and all other Defaults, if any, have been completely cured to Landlord's satisfaction, and Landlord has been given assurance reasonably satisfactory to Landlord evidencing Tenant's ability to satisfy its remaining obligations under this Lease. During any such temporary period of exclusion, Landlord will, during Landlord's regular business hours and at Landlord's convenience, upon written request by Tenant, escort Tenant or its authorized personnel to the Premises to retrieve personal belongings of Tenant or its employees, and such other property of Tenant as is not subject to Landlord's liens and security interests described in this Lease or available under applicable laws. The provisions hereof shall override and control any conflicting provisions of Section 93.002 of the Texas Property Code (as amended). ARTICLE 22. LIMITATION OF LIABILITY 22.01 LIMITATION. If Tenant obtains a money judgment against Landlord resulting from any default or other claim arising under this Lease, that judgment shall be satisfied only out of the rents, issues, profits, and other income thereafter actually received on account of Landlord's right, title and interest in the Building, and no other real, personal or mixed property of Landlord (or of any of the partners which comprise Landlord, or of partners, officers, shareholders, directors or principals of such partners comprising Landlord, if any, or of Landlord's officers, shareholders, directors, or owners, if any) wherever situated, shall be subject to levy, attachment or execution, or otherwise used to satisfy any such judgment. Tenant hereby waives any right to satisfy a judgment against Landlord except from the rents, issues, profits and other income thereafter actually received on account of Landlord's right, title and interest in the Building. ARTICLE 23. HOLDING OVER If Tenant retains possession of the Premises or any part thereof after the termination of the Term or any extension thereof, by lapse of time or otherwise, Tenant, unless Landlord otherwise elects, shall become a tenant at sufferance and shall pay Landlord monthly Rent, at one and one-half times the rate of Monthly Base Rent, Expense Adjustment, and Electrical Cost in effect for the month immediately preceding said holding over, computed on a per month basis, for each month or part thereof (without reduction for any such partial month) that Tenant thus remains in possession. Alternatively, at the election of Landlord expressed in a written notice to Tenant and not otherwise, such retention of possession shall constitute a renewal of this Lease for one (1) year, requiring the payment by Tenant of Monthly Base Rent, Expense Adjustment, and Electrical Cost then in effect, as adjusted for said year as if said year were an extension of the Term. The provisions of this Article 23 do not exclude Landlord's right of reentry or any other right hereunder. ARTICLE 24. SUBORDINATION AND ATTORNMENT 24.01 SUBORDINATION. Landlord may have heretofore encumbered or may hereafter encumber with a mortgage or trust deed the Building, or any interest therein, and may have heretofore sold and leased back or may hereafter sell and lease back the land on which the Building is located, and may have heretofore encumbered or may hereafter encumber the leasehold estate under such lease with a mortgage or trust deed. (Any such mortgage or trust deed is herein called a "Mortgage" and the holder of any such mortgage or the beneficiary under any such trust deed is herein called a "Mortgagee." Any such lease of the underlying land is herein called a "Ground Lease", and the lessor under any such lease is herein called a "Ground Lessor." Any Mortgage which is a first lien against the Building, the land on which the Building is located, the leasehold estate or the lessor under a Ground Lease (if the property is not then subject to an unsubordinated mortgage) is herein called a "First Mortgage" and the holder or beneficiary of or Ground Lessor under any First Mortgage is herein called a "First Mortgagee.") This Lease is, or shall be, subject and subordinate to any First Mortgage now or hereafter encumbering the Building. This provision shall be self-operative, and no further instrument of subordination shall be required to effectuate such subordination. If requested by a First Mortgagee, Tenant will either (i) subordinate its interest in this Lease to said First Mortgage, and to any and all advances made thereunder and to the interest thereon, and to all renewals, replacements, supplements, amendments, modifications and extensions thereof, or (ii) make certain of Tenant's rights and interest in this Lease superior thereto; and Tenant will promptly execute and deliver such agreement or agreements as may be reasonably required by such Mortgagee or Ground Lessor, provided, however, Tenant covenants it will not subordinate this Lease to any Mortgage or Ground Lease other than a First Mortgage (including a Ground Lease defined as a First Mortgage hereunder) without the prior written consent of the First Mortgagee. Tenant agrees that Landlord may assign the rents and interests in this Lease to the holder of any Mortgage or Ground Lease. In conjunction with the foregoing provisions, Tenant hereby acknowledges its agreement to execute the Subordination, Non-Disturbance and Attornment Agreement and/or the Lease Estoppel Certificate required by such Mortgagee and/or Ground Lessor within ten (10) days following the receipt of a written request therefor. Landlord shall attempt to obtain a non-disturbance agreement reasonably satisfactory to Tenant from any future First Mortgagee, provided Landlord's failure to obtain such an agreement shall not create any liability on the part of Landlord to Tenant, create a default by Landlord under this Lease, or create a defense, offset, or counterclaim to Tenant's obligations under this Lease. 24.02 ATTORNMENT. It is further agreed that (a) if any Mortgage shall be foreclosed, or if any Ground Lease be terminated, (i) the liability of the Mortgagee or purchaser at such foreclosure sale or the liability of a subsequent owner designated as Landlord under this Lease shall exist only so long as such Mortgagee, purchaser or owner is the owner of the Building or -19- 20 the land on which the Building is located, and such liability shall not continue or survive after further transfer of ownership; and (ii) upon request of the Mortgagee, if the Mortgage shall be foreclosed, Tenant will attorn, as Tenant under this Lease, to the purchaser at any foreclosure sale under any Mortgage or upon request of the Ground Lessor, if any Ground Lease shall be terminated, Tenant will attorn as Tenant under this Lease to the Ground Lessor, and Tenant will execute such instruments as may be necessary or appropriate to evidence such attornment; (b) this Lease may not be modified, amended, canceled or surrendered, without the prior written consent, in each instance, of the First Mortgagee; and (c) Tenant waives the provisions of any statute or rule of law, now or hereafter in effect, that may give or purport to give Tenant any right to terminate or otherwise adversely affect Landlord's interest in this Lease or reduce or limit the obligations of Tenant hereunder in the event of the prosecution or completion of any such foreclosure proceeding. No Mortgagee or any purchaser at a foreclosure sale shall be liable for any act or omission of the Landlord which occurred prior to such sale or conveyance, nor shall Tenant be entitled to any offset against or deduction from Rent due after such date by reason of any act or omission of the Landlord prior to such date. Further, Tenant agrees that no Mortgagee shall be bound by the prepayment of Rent made in excess of thirty days before the date on which such payment is due or any amendment or modification made with such Mortgagee's consent to the extent such consent is required as provided above. 24.03 MORTGAGEE REQUIREMENTS. Should any prospective First Mortgagee require a modification or modifications of this Lease, which modification or modifications will not cause an increased cost or expense to Tenant or in any other way materially and adversely change the rights and obligations of Tenant hereunder, in the reasonable judgment of Tenant, then and in such event, Tenant agrees that this Lease may be so modified and agrees to execute whatever documents are required therefor and deliver the same to Landlord within fifteen (15) days following the request therefor. Should any prospective Mortgagee or Ground Lessor require execution of a short form of lease for recording (containing, among other customary provisions, the names of the parties, a description of the Premises and the Term of this Lease), Tenant agrees to execute such short form of Lease and deliver the same to Landlord within fifteen (15) days following the request therefor. 24.04 POWER OF ATTORNEY. If Tenant fails within fifteen (15) days after written demand therefor to execute and deliver any instruments as may be necessary or proper to effectuate any of the covenants of Tenant set forth above in this Article, Tenant hereby makes, constitutes and irrevocably appoints any one of the Landlord or its representatives as its attorney-in-fact (such power of attorney being coupled with an interest) to execute and deliver any such instruments for and in the name of Tenant. ARTICLE 25. ESTOPPEL CERTIFICATE Tenant agrees that from time to time, upon not less than seven (7) days' prior written request by Landlord, Tenant will, and Tenant will cause any subtenant, licensee, concessionaire or other occupant of the Premises to, promptly complete, execute and deliver to Landlord or any party or parties designated by Landlord a statement in writing certifying: (i) that this Lease is unmodified and in full force and effect (or if there have been modifications that the same are in full force and effect as modified and identifying the modifications); (ii) the dates to which the Rent and other charges have been paid; (iii) that the Premises have been unconditionally accepted by the Tenant (or if not, stating with particularity the reasons why the Premises have not been unconditionally accepted); (iv) the amount of any Security Deposit held hereunder; (v) that, so far as the party making the certificate knows, Landlord is not in default under any provisions of this Lease, if such is the case, and if not, identifying all defaults with particularity; and (vi) any other matter reasonable requested by Landlord. Any purchaser or Mortgagee of any interest in the Building shall be entitled to rely on said statement. Failure to give such a statement within seven (7) days after said written request shall be conclusive evidence, upon which Landlord and any such purchaser or Mortgagee shall be entitled to rely that this Lease is in full force and effect and Landlord is not in default and Tenant shall be estopped from asserting against Landlord or any such purchaser or Mortgagee any defaults of Landlord existing at that time but Tenant shall not thereby be relieved of the affirmative obligation to give such statement. Moreover, if Tenant fails to deliver or cause to be delivered such statement within said seven (7) day period, Landlord shall be entitled to collect from Tenant upon demand, as liquidated damages occasioned by such delay and not as a penalty (the actual damages resulting from such delay being impossible to ascertain), a sum equal to one-fifteenth of the Monthly Base Rent for each day, up to fifteen (15) days, after the expiration of said seven (7) day period that Tenant fails to deliver such statement. If such failure persists after such fifteen (15) day period, Landlord shall be entitled to pursue any and all remedies it may have with respect to such Default, including termination of this Lease or Tenant's right to possession and collection of damages, including consequential damages, arising by reason for such Default. ARTICLE 26. INTENTIONALLY DELETED ARTICLE 27. NOTICES AND DEMANDS 27.01 PARTIES' NOTICES. All notices, demands, approvals, consents, requests for approval or consent or other writings in this Lease provided to be given, made or sent by either party hereto to the other ("Notice") shall be in writing and shall be deemed to have been fully given, made or sent when made by personal service or two (2) business days after deposit in the United States mail, certified or registered and postage prepaid and properly addressed as follows: To Landlord: The Utah State Retirement Investment Fund c/o CB Commercial Real Estate Group, Inc. 533 South Fremont Avenue Los Angeles, California 90071 -20- 21 Attn: Managing Director with a copy to: The Utah State Retirement Investment Fund c/o CB Commercial Realty Advisors, Inc. 533 South Fremont Avenue Los Angeles, California 90071 Attn: Director of Asset Management and a copy to: Compass Management, Inc. 3811 Turtle Creek Boulevard, Suite 240 Dallas, Texas 75219 Attn: Property Manager for Turtle Creek To Tenant: (i) If any Notice is to be given Tenant prior to occupancy, to the address set forth in Section 1.02. (ii) If any Notice is to be given Tenant after occupancy, to the Premises; provided, however, if the Premises shall have been vacated, Notice may be posted on the door to the Premises, except as Landlord may be otherwise notified in writing. The address to which any Notice should be given, made or sent to either party may be changed by written notice given by such party as above provided. 27.02 MORTAGEE'S NOTICE AND CURE RIGHTS. Tenant agrees to give any First Mortgagee, by registered or certified mail, a copy of any notice or claim of default served upon the Landlord by Tenant, provided that prior to such notice Tenant has been notified in writing (by way of service on Tenant of a copy or an assignment of Landlord's interests in leases, or otherwise) of the address of such First Mortgagee. Tenant further agrees that if Landlord shall have failed to cure such default within twenty (20) days after such notice to Landlord (or if such default cannot be cured or corrected within that time, then such additional time as may be necessary if Landlord has commenced within such twenty (20) days and is diligently pursuing the remedies or steps necessary to cure or correct such default), then the First Mortgagee shall have an additional thirty (30) days within which to cure or such default (or if such default cannot be cured or corrected within that time, then such additional time as may be necessary if such First Mortgagee has commenced within such thirty (30) days and is diligently pursuing the remedies or steps necessary to cure or correct such default, including the time necessary to obtain possession if ion is to cure or correct such default) before Tenant may exercise any right or remedy which it may have on account of any such default of Landlord. The foregoing provision shall not limit Tenant's right to abate rent under Sections 8.04, 12.01, and 13.02. 27.03 NOTICE TO TENANT. Any notice, demand, request or consent to be made by or required of Landlord, may be made and given by Landlord's Management Agent with the same force and effect as if made and given by Landlord. ARTICLE 28. CONSTRUCTION OF LEASE 28.01 CONSTRUCTION. The language in all parts of this Lease shall in all cases be construed as a whole according to its fair meaning and neither strictly for nor against either Landlord or Tenant. Article and Section headings in this Lease are for convenience only and are not to be construed as part of this Lease or in any way defining, limiting, amplifying, construing, or describing the provisions hereof. Time is of the essence of this Lease and every term, covenant and condition hereof. The words "Landlord" and "Tenant," as herein used, shall include the plural as well as the singular. The neuter gender includes the masculine and feminine. In the event there is more than one person or entity which executes this Lease as Tenant, the obligations to be performed and liability of all such persons and entities shall be joint and several. All of the covenants of Tenant here under shall be and deemed construed to be "conditions" as well as "covenants" as though the words specifically expressing or importing conditions were used in each separate instance. Landlord and Tenant agree that in the event any term, covenant or condition herein contained (other than with respect to the payment of Rent) is held to be invalid or void by any court of competent jurisdiction, the invalidity of any such term, covenant or condition shall in no way affect any other term, covenant or condition herein contained. 28.02 Amendments. This Lease contains and embodies the entire agreement of the parties hereto, and no representation, inducements or agreements, oral or otherwise, not contained in this Lease shall be of any force or effect. This Lease may not be modified in whole or in part in any manner other than by an instrument in writing duly signed by both parties hereto. ARTICLE 29. REAL ESTATE BROKERS Tenant represents and warrants unto Landlord that Tenant has directly dealt with and only with the Broker(s), if any, identified in Article 1 of this Lease as broker in connection with this Lease, and agrees to indemnify and hold harmless Landlord from and against any and all claims or demands, damages, liabilities and expenses of any type or nature whatsoever arising by reason of the incorrectness or breach of the aforesaid representation or warranty. Landlord shall pay, and agrees -21- 22 to indemnify and hold harmless Tenant from and against any claim by the Broker(s) for its commission arising out of the execution and delivery of this Lease pursuant to a separate agreement between Landlord and Broker. ARTICLE 30. MISCELLANEOUS 30.01 BENEFIT. Subject to the provisions of Articles 19 and 20 hereof, all terms, covenants and conditions on this Lease shall be binding upon and inure to the benefit of and shall apply to the respective heirs, executors, administrators, successors, assigns and legal representatives or Landlord and Tenant. 30.02 EXECUTION AND DELIVERY. The execution of this Lease by Tenant and delivery of the same to Landlord or Landlord's Management Agent do not constitute a reservation of or option to lease the Premises or an agreement by Landlord to enter into a Lease, and this Lease shall become effective only if and when Landlord executes and delivers a counterpart hereof to Tenant; provided, however, the execution and delivery by Tenant of this Lease to Landlord or Landlord's Management Agent shall constitute an irrevocable offer by Tenant to lease the Premises on the terms and conditions herein contained, which offer may not be withdrawn or revoked for thirty (30) days after such execution and delivery. If Tenant is a corporation, it shall deliver to Landlord concurrently with the delivery to Landlord of an executed Lease, a certified resolution of Tenant's directors authorizing execution and delivery of this Lease and the performance by Tenant of its obligations hereunder. If Tenant is a partnership, it shall deliver to Landlord concurrently evidence of execution and performance authority. Tenant shall not record this Lease or any memorandum or other evidence hereof. 30.03 DEFAULT UNDER OTHER LEASE. If the term of any lease (other than this Lease) made by Tenant for any demised premises in the Building shall be terminated or terminable after the making of this Lease, because of any default by Tenant under such other lease, such fact shall empower Landlord, at Landlord's sole option, to declare this Lease to be in default by written notice to Tenant. 30.04 APPLICABLE LAW. This Lease shall be governed by and construed in accordance with the laws of the state in which the Building is located. 30.05 LATE CHARGES AND DEFAULT INTEREST. At the option of Landlord, Landlord may impose a late payment fee equal to the lesser of five percent (5%) of the amount due or the maximum amount permitted by applicable law if any payment of Rent is paid more than five (5) days after its due date. In addition, any amount due hereunder shall bear interest after default in the payment thereof at the annual rate of the lesser of (i) the rate of eighteen percent (18%) per annum or (ii) the maximum lawful interest rate permitted by applicable law. 30.06 NON-WAIVER OF DEFAULTS. No waiver of any provision of this Lease shall be implied by any failure of Landlord to enforce any remedy on account or the violation of such provision, even if such violation be continued or repeated subsequently, and no express waiver shall affect any provision other than the one specified in such waiver and in that event only for the time and in the manner specifically stated. No receipt of monies by Landlord from Tenant after the termination of this Lease will in any way alter the length of the Term of Tenant's right of possession hereunder or, after the giving of any notice, shall reinstate, continue or extend the Term or affect any notice given Tenant prior to the receipt of such monies, it being agreed that after the service of notice or the commencement of a suit or after final judgment for possession of the Premises, Landlord may receive and collect any Rent due, and the payment of Rent shall not waive or affect said notice, suit or judgment, nor shall any such payment be deemed to be other than an account of the amount due, nor shall the acceptance of Rent be deemed a waiver of any breach by Tenant of any term, covenant or condition of this Lease. No endorsement or statement on any check or any letter accompanying any check or payment of Rent shall be deemed an accord and satisfaction. Landlord may accept any such check or payment without prejudice to Landlord's right to recover the balance due of any installment or payment of Rent or pursue any other remedies available to Landlord with respect to any existing Defaults. None of the terms, covenants or conditions of this Lease can be waived by either Landlord or Tenant except by appropriate written instrument. 30.07 FORCE MAJEURE. Neither Landlord nor Tenant shall not be deemed in default with respect to the failure to perform any of the terms, covenants and conditions of this Lease on its part to be performed, if such failure is due in whole or in part to any strike, lockout, labor dispute (whether legal or illegal), civil disorder, inability to procure materials, failure of power, restrictive governmental laws and regulations, riots, insurrections, war, fuel shortages, accidents, casualties, Acts of God, acts caused directly or indirectly by the other (or the other's agents, employees, guest or invitees), acts of other tenants or occupants of the Building or any other cause beyond reasonable control. In such event, the time for performance shall be extended by an amount of time equal to the period of the delay so caused. Except to extent such release is prohibited by law, Landlord shall not be liable to Tenant for any expense, injury, loss or damage resulting from work done in or upon, or the use of, any adjacent or nearby building, land, street, alley or underground vault or passageway. The foregoing shall not limit, reduce, or otherwise affect Tenant's obligation to make payments due under this Lease, except for abatement provided for in Sections 8.04, 12.01, and 13.02. 30.08 LANDLORD'S RIGHT TO PERFORM TENANT'S DUTIES. If Tenant fails timely to perform any of its duties under this Lease, Landlord shall have the right (but not the obligation), after the expiration of any grace period specifically provided by this Lease, to perform such duty on behalf and at the expense of Tenant without further notice to Tenant, and all sums expended or expenses incurred by Landlord in performing such duty shall be deemed to be Rent under this Lease and shall be due and payable to Landlord upon demand by Landlord. 30.09 RIDER, WORK LETTER AND EXHIBITS. Any Rider, Work Letter and/or Exhibit attached hereto are hereby -22- 23 incorporated in this Lease by reference. 30.10 FINANCIAL STATEMENTS. Tenant shall, when requested by Landlord from time to time, furnish a true and accurate audited statement of its financial condition prepared in conformity with generally accepted accounting principles and in a form reasonably satisfactory to Landlord. 30.11 RELATIONSHIP OF PARTIES. Nothing contained in this Lease shall create any relationship between the parties hereto other than that of Landlord and Tenant, and it is acknowledged and agreed that Landlord shall not be deemed to be a partner of Tenant in the conduct of its business, or a joint venturer or a member of a joint or common enterprise with Tenant. 30.12 NO RECORDING. Tenant shall not record this Lease or any memorandum thereof without the prior written consent of Landlord. 30.13 HAZARDOUS WASTE. During the term of the Lease, Tenant shall comply with all statutes, ordinances, rules, orders, regulations and requirements of the federal, state, county and city governments and all departments thereof applicable to the presence, storage, use, maintenance and removal of petroleum or petroleum products, natural or synthetic gas, urea formaldehyde foam insulation, radon gas, asbestos, PCB transformers, other toxic, hazardous, contaminated or pollutant substances, and underground storage tanks (collectively, "Hazardous Materials") in, on or about the Premises, which generation treatment, release, presence, storage, use, maintenance, removal or disposition is caused or permitted by Tenant. In no event shall the aforesaid be construed to mean that Landlord acquiesces, has given or will give its consent or that Tenant need not obtain Landlord's consent prior to Tenant's storing, using, maintaining, or removing Hazardous Materials in, on or about the Premises, and Tenant shall not store, use, maintain, or remove Hazardous Materials in, on or about the Premises. Tenant agrees to indemnify and forever hold harmless Landlord, its agents, successors, and assigns, and Landlord's Mortgagee(s), as their interest may appear, from all claims, losses, damages, expenses and costs, including, but not limited to, losses, damages, expenses and costs, incurred by reason of Tenant's use, storage, maintenance or removal of Hazardous Materials in, on, or about the Premises, or any part of the Property. 30.14 BANKRUPTCY. Landlord and Tenant understand that, notwithstanding certain provisions to the contrary contained herein, a trustee or debtor in possession under the United States Bankruptcy Code ("Code") may have certain rights to assume or assign this Lease. Landlord and Tenant further understand that, in such event, Landlord is entitled under the Code to adequate assurance of future performance of the terms and provisions of this Lease. The parties hereto agree that, with respect to any such assumption or assignment, the term "adequate assurance" shall include at least the following: (1) since the financial condition and resources of Tenant were a material inducement to Landlord in entering into this Lease, in order to assure Landlord that the proposed assignee will have the resources with which to pay all Rent payable pursuant to the terms hereof, any proposed assignee must have, as demonstrated to Landlord's satisfaction, a net worth (as defined in accordance with generally accepted accounting principles consistently applied) of not less than the net worth of tenant on the date this Lease became effective, increased by seven percent (7%), compounded annually, for each year from the Commencement Date through the date of the proposed assignment; (2) since Landlord's asset will be substantially impaired if the trustee in bankruptcy or any assignee of this Lease makes any use of the Premises other than the Permitted Use, any proposed assignee must have been engaged in the conduct of business for the five (5) years prior to any such proposed assignment, which business does not violate the Permitted Use, and such proposed assignee shall continue to engage in the Permitted Use; and (3) any proposed assignee of this Lease must assume and agree to be personally bound by the terms, covenants and provisions of this Lease. 30.15 LANDLORD'S CONTINGENCY. Tenant acknowledges and agrees that the terms and conditions of this Lease are specifically contingent upon the approval by Landlord's Mortgagee(s) of this Lease. Accordingly, in the event that Landlord's Mortgagee(s) fails to approve this Lease, this Lease shall automatically terminate and be of no further force or effect. 30.16 SECURITY. LANDLORD SHALL HAVE NO RESPONSIBILITY TO PREVENT, AND SHALL NOT BE LIABLE TO TENANT, ITS AGENTS, EMPLOYEES, CONTRACTORS, VISITORS OR INVITEES FOR, LOSSES DUE TO THEFT OR BURGLARY, OR FOR DAMAGES OR INJURY TO PERSONS OR PROPERTY DONE BY PERSONS GAINING ACCESS TO THE PREMISES OR THE BUILDING, AND TENANT HEREBY RELEASES LANDLORD FROM ALL LIABILITY FOR SUCH LOSSES, DAMAGES OR INJURY, EVEN IF CAUSED BY LANDLORD'S NEGLIGENCE, EXCEPT TO EXTENT SUCH WAIVER IS PROHIBITED BY LAW. 30.17 LIMITATION ON WARRANTIES. LANDLORD'S DUTIES AND WARRANTIES ARE LIMITED TO THOSE EXPRESSLY STATED IN THIS LEASE AND SHALL NOT INCLUDE ANY IMPLIED DUTIES OR IMPLIED WARRANTIES, NOW OR IN THE FUTURE. NO REPRESENTATIONS OR WARRANTIES HAVE BEEN MADE BY LANDLORD OTHER THAN THOSE CONTAINED IN THIS LEASE. TENANT HEREBY WAIVES ANY AND ALL WARRANTIES, EXPRESS OR IMPLIED, WITH RESPECT TO THE PREMISES WHICH MAY EXIST BY OPERATION OF LAW OR IN EQUITY, INCLUDING, WITHOUT LIMITATION, ANY WARRANTY OF HABITABILITY OR FITNESS FOR A PARTICULAR PURPOSE. IN WITNESS WHEREOF, the parties hereto have executed this Lease as of the day and year first above written. -23- 24 LANDLORD: TENANT: THE UTAH STATE RETIREMENT THE HOTEL INDUSTRY SWITCH COMPANY INVESTMENT FUND, an independent agency of the By: /s/ JOHN F. DAVIS, III State of Utah -------------------------------- Name: John F. Davis, III By: CB Commercial Realty Title: President Advisors, Inc., a Delaware corporation, Agent By: /s/ MATTHEW C. HURLBUT - -------------------------------- Name: Matthew C. Hurlbut Title Vice President By: /s/ JOSEPH W. MARKLING - -------------------------------- Name: Joseph W. Markling Title: First Vice President -24- 25 EXHIBIT A LEGAL DESCRIPTION BEING a tract of land situated in the City of Dallas, Dallas County, Texas, and being part of the W. Grigsby Survey, Abstract 501, and also being part of Block 1345 in the City of Dallas, and being the tracts of land conveyed to Turtle Creek Square Limited, an Illinois partnership, with Turtle Creek Square, Inc., a Texas corporation, sole general partner, by deed dated 8/31/79, and recorded in Volume 79172, Page 580, Deed Records, Dallas County, Texas, and being more particularly described as follows: BEGINNING at the intersection of the Northeasterly Line of Blackburn Street with the Northwesterly Line of Turtle Creek Boulevard; THENCE N 44 degrees 35' 00" W along said Northeasterly line of Blackburn Street a distance of 326.65 feet to an iron rod set for corner; THENCE N 45 degrees 25' 00" E departing along said Northeasterly Line of Blackburn Street a distance of 1.92 feet to an iron rod set for corner, said iron rod also being the beginning of a curve to the right; THENCE along said curve to the right having a central angle of 40 degrees 22' 00", a radius of 70.00 feet and an arc length of 49.32 feet to an iron rod set for corner; THENCE N 85 degrees 47' 00" E a distance of 110.25 feet to an iron rod set for corner, said iron rod also being the beginning of a curve to the left; THENCE along said curve to the left having a central angle of 74 degrees 47' 00", a radius of 110.00 feet, and an arc length of 143.57 feet to an iron rod set for corner; THENCE N 11 degrees 00' 00" E a distance of 438.38 feet to an iron rod set for corner; THENCE S 79 degrees 00' 00" E a distance of 132.75 feet to an iron rod set for corner; THENCE S 11 degrees 00' 00" W a distance of 92.16 feet to an iron rod set for corner; THENCE S 79 degrees 00' 00" E a distance of 13.00 feet to an iron rod set for corner; THENCE S 11 degrees 00' 00" W a distance of 17.60 feet to an iron rod set for corner; THENCE S 79 degrees 00' 00" E a distance of 364.33 feet to an iron rod set for corner situated in said Northwesterly Line of Turtle Creek Boulevard; THENCE S 22 degrees 44' 30" W along said Northwesterly Line of Turtle Creek Boulevard a distance of 212.69 feet to an iron rod set for corner; THENCE N 79 degrees 00' 00" W departing said Northwesterly Line of Turtle Creek Boulevard a distance of 309.80 feet to an iron rod set for corner; THENCE S 11 degrees 00' 00" W a distance of 16.00 feet to an iron rod set for corner; THENCE N 79 degrees 00' 00" W a distance of 33.0 feet to an iron rod set for corner; THENCE S 11 degrees 00' 00" W a distance of 102.00 feet to an iron rod set for corner; THENCE N 79 degrees 00' 00" W a distance of 12.99 feet to an iron rod set for corner; THENCE S 33 degrees 30' 00" W a distance of 92.76 feet to an iron rod set for corner; THENCE S 56 degrees 30' 00" E a distance of 113.36 feet to an iron rod set for corner; THENCE S 33 degrees 30' 00" W a distance of 57.96 feet to an iron rod set for corner; THENCE S 56 degrees 30' 00" E a distance of 39.57 feet to an iron rod set for corner; THENCE N 86 degrees 57' 48" E a distance of 53.17 feet to an iron rod set for corner; THENCE S 56 degrees 35' 49" E a distance of 30.82 feet to an iron rod set for corner; THENCE S 56 degrees 30' 00" E a distance of 90.43 feet to an iron rod set for corner situated in said Northwesterly Line of Turtle Creek Boulevard, said iron rod also the beginning of a curve to the right; THENCE along said Northwesterly Line of Turtle Creek Boulevard the following: -1- 26 Along said curve to the right having a central angle of 26 degrees 48' 58", a radius of 274.10 feet and an arc length of 128.13 feet to an iron rod set for corner; S 84 degrees 44' 30" W a distance of 56.00 feet to an iron rod set for corner, said iron rod the beginning of a curve to the left; Along said curve to the left having a central angle of 23 degrees 25' 02", a radius of 403.34 feet an arch length of 164.85 feet to the POINT OF BEGINNING and containing 5.0237 acres or 218,831 square feet of land, more or less. -2- 27 EXHIBIT 1 FLOOR PLAN [FLOOR PLAN] TURTLE CREEK CENTRE FLOOR 11 14,386 USF 2/21/92 14,875 RSF [FLOOR PLAN] TURTLE CREEK CENTRE FLOOR 12 12,498 USF 14,875 RSF -1- 28 EXHIBIT 2 THIRD FLOOR ROFR AREA [FLOOR PLAN] TURTLE CREEK CENTRE FLOOR 3 12,577 USF 14,653 RSF -2- 29 EXHIBIT 3 RULES AND REGULATIONS (1) Tenant shall not, whether temporarily, accidentally or otherwise, allow anything to remain in, place or store anything in, or obstruct in any way, any portion of the Building other than the Premises, including any sidewalk, plaza area, driveway, passageway, entrance, exit, stairway, lobby, corridor, hall, elevator, shipping platform, truck concourse or vault area in or about the Building. All passageways, entrances, exits, elevators, stairways, corridors, halls and roofs of the Building are not for the use of the general public, and Landlord shall in all cases retain the right to control and prevent access thereto by all persons in whose presence, in the judgment of Landlord, shall be prejudicial to the safety, character, reputation or other interests of the Building, its tenants or Landlord; provided, however, that nothing herein contained shall be construed to prevent ingress and egress to persons with whom Tenant deals within the normal course of Tenant's business. Tenant shall not enter nor permit its employees, agents, guests or invitees to enter into areas of the Building designated for the exclusive use of Landlord, its employees, guests or invitees. Tenant shall not use, nor permit the use by its employees, agents, guests or invitees, if any common area in the Building other than for access to and from the Premises. No bicycle or motorcycle shall be brought into the Building or kept on the Premises without the consent of Landlord. (2) No deliveries of any nature nor freight, furniture or bulky matter of any description will be received into the Building or carried into the elevators except in such a manner, during such hours and using only the freight elevators and those passageways as may be approved by Landlord, and then only upon having been scheduled in advance. Any hand trucks, carryalls or similar appliances used for the delivery or receipt of merchandise, supplies or equipment shall be equipped with rubber tires, side guards and such other safeguards as Landlord shall require. (3) Tenant, or the employees, agents, servants, visitors or licensees of Tenant shall not at any time place, leave or discard any rubbish, paper, articles, or objects of any kind whatsoever outside the doors of the Premises or in the corridors or passageways of the Building. No animals (except for guide dogs for sight impaired persons) of any kind shall be brought or kept in or about the Building. Tenant shall not permit any noise, odor or litter which is objectionable to Landlord or other tenants of the Building to emanate from the Premises. (4) Any person in the Building will be subject to identification by employees and agents of Landlord. All persons in or entering the Building shall be required to comply with the security policies of the Building. Tenant shall keep doors to unattended areas locked and shall otherwise exercise reasonable precautions to protect property from theft, loss, or damage. Tenant shall not attach or permit to be attached additional locks or similar devices to any door or window, change existing locks or the mechanism thereof, or make or permit to be made any keys for any door other than those provided by Landlord. If more than two keys for one lock area desired, Landlord will provide them upon payment therefor by Tenant. Upon termination of this Lease, or of the Tenant's possession, the Tenant shall surrender to Landlord all keys to the Premises. Landlord shall not be responsible for the theft, loss or damage of any property. Landlord may at all times keep a pass key to the Premises. Canvassing, soliciting or peddling in the Building is prohibited, and Tenant shall cooperate to prevent same. (5) Except for portions of the Premises specifically designated by Tenant and consented to in writing by Landlord in advance to be used for an employee kitchen or lounge area, Tenant shall not cook, sell, purchase or permit the preparation, sale or purchase of food on the Premises. (6) Tenant shall not mark, paint, drill into or in any way deface any part of the Building or Premises. No boring, driving of nails or screws, cutting or stringing of wires shall be permitted, except with the prior written consent of Landlord, and as Landlord may direct. Tenant shall not install any resilient tile or similar floor covering in the Premises except with the prior approval of Landlord. (7) Tenant shall give immediate notice to Landlord in case of theft, unauthorized solicitation or accident in the Premises or in the Building or of defects therein or in any fixtures or equipment, or of any known emergency in the Building. (8) Tenant shall not use the Premises or permit the Premises to be used for any other purpose than the Permitted Use, without Landlord's prior permission. (9) Tenant shall not advertise for laborers giving the Premises as an address, nor pay such laborers at a location in the Premises. (10) The requirements of Tenant will be attended to only upon application at the office of Landlord in the Building. Employees of Landlord shall not perform any Work or do anything outside of their regular duties, unless under special instructions from the office of Landlord. (11) Tenant shall at all times keep the Premises neat and orderly. (12) Tenant shall not make excessive noises, cause disturbances or vibrations or use or operate any electrical or mechanical devices that emit excessive sound or other waves or disturbances or create obnoxious odors, any of which may be offensive to the other tenants and occupants of the Building, or that would interfere with the operation of any device, equipment, radio, television broadcasting or reception from or within the Building or elsewhere and shall not place or install any projections, antennas, aerials or similar devices inside or outside of the Premises or on the Building without Landlord's -3- 30 prior written approval. (13) Tenant shall comply with all applicable federal, state and municipal laws, ordinances and regulations, and building rules and shall not directly or indirectly make any use of the Premises which may be prohibited by any of the foregoing or which may be dangerous to persons or property or may increase the cost of insurance or require additional insurance coverage. Tenant shall not use, suffer or permit the Premises or any part hereof to be used for the manufacture, sale or distribution by gift or otherwise of any spirituous, fermented or intoxicating liquors or any drugs. Tenant shall not bring or store firearms of any kind into the Building. Tenant shall not use the Premises for the manufacture, distribution or sale of any merchandise or other materials. Tenant shall not install any equipment utilizing an ammonia or other process necessitating venting. Tenant shall not permit any odors, acids, vapors or other gases or materials to be discharged from the Premises into the common areas, waste lines, vents, flues or other tenant spaces in the Building. Tenant shall not use, suffer or permit the use of the Premises or any part thereof for housing accommodations, for lodging or sleeping purposes or for any immoral or illegal purpose. (14) The water and wash closets, drinking fountains and other plumbing fixtures shall not be used for any purpose other then those for which they were constructed, and no sweepings, rubbish, rags, coffee grounds or other substances shall be thrown therein. All damages resulting from any misuse of the fixtures shall be borne by the Tenant who, or whose servants, employees, agents, visitors or licensees, shall have caused the same. No person shall waste water by interfering or tampering with the faucets or otherwise. (15) Tenant, its servants, employees, customers, invitees and guests shall, when using the parking facilities in and around the building, observe and obey all signs regarding fire lanes and no parking zones, and when parking always park between the designated lines. Landlord reserves the right to tow away, at the expense of the owner, any vehicle which is improperly parked or parked in a no-parking zone. All vehicles shall be parked at the sole risk of the owner, and Landlord assumes no responsibility for any damage to or loss of vehicles, except to the extent of Landlord's gross negligence. (16) Except as otherwise provided in the Lease, Tenant shall not employ persons to do janitor, repair or decorating work in the Premises, and no persons other than the janitors or contractors designated by Landlord shall clean, decorate, remodel or repair the Premises without prior written consent of Landlord. (17) Tenant shall not install or operate any refrigerating, heating or air-conditioning equipment, nor any equipment of any type or nature that will or may necessitate any changes, replacements or additions to, or in the use or, the water system heating system, plumbing system, air-conditioning system or electrical system of the Premises or the Building, without first obtaining the prior written consent of Landlord. Business machines and mechanical equipment belonging to or installed by or at the direction of Tenant that cause noise or vibration capable of being transmitted to the structure of the Building or to any space therein to such a degree as to be objectionable to Landlord or to any tenant in the Building shall be installed and maintained by Tenant, at Tenant's expense, on vibration eliminators or other devices sufficient to reduce such noise and vibration to a level satisfactory to Landlord and such other tenants. (18) Landlord reserves the right to prescribe and to approve the weight, size and location of safes, book shelves and other heavy equipment, fixtures and articles in and about the Premises and the Building and to require all such items to be moved in and out of the Building and the Premises only at such times and in such manner as Landlord shall direct and in all events at Tenant's sole risk and responsibility. Tenant shall not overload any floors. (19) Tenant shall not, without the prior written consent of Landlord, install any shades, draperies, blinds or other window covering, awning, sign, lettering, picture, notice, advertisement or object unacceptable to Landlord on or against glass partitions, doors or windows that would be visible outside the Premises or any sign, lettering, picture, notice or advertisement within the Premises that would be visible outside the Premises. Landlord shall have the right to prohibit any advertisement of or by Tenant in any public media, by direct solicitation or otherwise, which advertisement, in Landlord's opinion, tends to impair the reputation of Building or its desirability as a high-quality office building. Upon written notice from Landlord, Tenant shall immediately refrain from and discontinue any such advertisement. (20) Landlord reserves the right to rescind, add to and amend any rules or regulations, to add reasonable new rules or regulations, and to waive any rules or regulations with respect to any tenant or tenants. (21) The Building shall be a no-smoking building, with no smoking allowed in the Premises or in any other area of the Building, including any exterior portions thereof, provided that Landlord may provide for a smoking area, in which case Tenant shall ensure that its employees smoke only in such smoking area. 31 EXHIBIT 4 Work Letter The terms used herein shall have the meanings ascribed to them in the Lease, unless otherwise stated herein. 1. Construction of the Premises. The Landlord and the Tenant agree that their respective rights and obligations in reference to the construction of the Premises shall be as provided herein. Floor 11 either is complete or will be subject to a minor amount of work. None of such work will have an impact on the Commencement Date for Floor 11, which shall be the date provided in Section 1.08. The Allowance, as defined below, shall be determined based on the square footage of both Floor 11 and Floor 12, though Landlord and Tenant acknowledge and agree that Tenant need not spend it equally on the cost of work on Floor 11 and Floor 12, but may spend proportionally more on Floor 12. In addition, the Landlord's Work will be completed in phases and Tenant shall be entitled to apply those portions of the Allowance not spent in early phases to the cost of the work in later phases. 1.01 Tenant's Plans and Specifications. (a) Landlord shall cause to be prepared detailed architectural, telephone, mechanical and engineering plans including all dimensions and specifications for all work to be performed by Landlord in the Premises substantially in accordance with the space plan provided by Tenant or Tenant's architect and previously submitted to Landlord ("Plans"). (b) Tenant shall cooperate as necessary in connection with the preparation of the Plans, in a complete and timely manner, and without limiting the foregoing, shall provide to Landlord all information as shall be required by Landlord's engineers to prepare mechanical plans pursuant to Section 1.02 hereof, which information shall include, but not be limited to, the following: (1) any special floor-loading conditions which may exceed the structural weight limits of the floor. (2) specifications of any heat emanating equipment to be installed by Tenant which may require special air conditioning, (3) electrical specifications of any equipment that requires non-standard electrical power outlets, and (4) complete specifications of any data-line wiring required, including cable routing, conduit size, cable type and similar items (provided Landlord shall have the right to approve but shall not perform, and the Landlord's Work, as hereinafter defined, shall exclude all data-line wiring and cable routing in and to the Premises). (c) The Plans shall be delivered to Tenant for its review and consideration as soon as reasonably possible. Any change or modification of such Plans shall not be valid or binding unless consented to by Landlord in writing. 1.02 Landlord's Work. (a) Landlord shall furnish and install substantially in accordance with the Plans the materials and items described therein ("Landlord's Work"). The Plans, the costs of Tenant's space plan, Landlord's Work, and the installation of cable described in Section 1.01 (b)(4), shall be at Tenant's sole cost and expense, provided that Tenant shall be entitled to a credit against the cost of the Plans, the costs of Tenant's space plan, Landlord's Work, and the installation of cable described in Section 1.01(b)(4), in an amount up to the lesser of (a) $178,500, (i.e., $6.00, multiplied by the area of the Premises) or (b) the actual costs of the Plans and the Landlord's Work (the "Allowance"). (b) If Landlord determines that the cost of the Landlord's Work, will exceed the Allowance, then prior to commencement of the Landlord's Work, Landlord will submit to Tenant a cost estimate for the Landlord's Work ("Cost Estimate") which Tenant shall approve or reject within seven (7) days after receipt thereof. It is understood that the cost of Landlord's Work shall include Landlord's then applicable construction supervision fee which shall not exceed four percent (4%) of the total cost of the Landlord's Work, the cost of Tenant's space plan, the cost of the Plans, and the costs of the installation of the cable described in Section 1.01(b)(4). Tenant's failure to reject the Cost Estimate within said seven (7) day period shall be to be an acceptance thereof. If Tenant rejects the Cost Estimate, Tenant shall, together with such rejection, propose such changes to the Plans as will cause the Cost Estimate to be acceptable. If the accepted Cost exceeds the Allowance, then Tenant shall pay to Landlord the amount of such excess within ten (10) business days after receipt by Tenant of a bill therefor, but in no event later than the Commencement Date. 1.03 Extra Work. (a) Tenant may request substitutions, additional or extra work and/or materials over and above Landlord's Work ("Extra Work") to be performed by Landlord provided that the Extra Work, in Landlord's judgment, (1) shall not delay completion of Landlord's Work or the Commencement Date of the Lease; (2) shall be practicable and consistent with existing physical conditions in the Building and any other plans for the Building which have been filed with the appropriate municipality or other governmental authorities having jurisdiction thereover (3) shall not impair Landlord's ability to perform any of Landlord's obligation hereunder or under the Lease or any other lease of space in the Building; and (4) shall not affect any portion of the Building other than the Premises. -1- 32 (b) (1) In the event Tenant requests Landlord to perform Extra Work and if Landlord accedes to such request, then and in that event, prior to commencing such Extra Work, Landlord shall submit to Tenant a written estimate ("Estimate") for said Extra Work to be performed. Within seven (7) days after Landlord's submission of the Estimate, Tenant shall, in writing, either accept or reject the Estimate. Tenant's failure either to accept or reject the Estimate within said seven (7) day period shall be deemed rejection thereof. (2) In the event that Tenant rejects the Estimate or the Estimate is deemed rejected, Tenant shall within seven (7) days after such rejection propose to Landlord such necessary revisions of the Plans so as to enable Landlord to proceed as though no such Extra Work had been requested. Should Tenant fail to submit such proposals regarding necessary revisions of the Plans within said seven (7) day period, Landlord, in its sole discretion, may proceed to complete Landlord's Work in accordance with the Plans already submitted, with such variations as in Landlord's sole discretion may be necessary so as to eliminate the Extra Work. (c) (1) All Extra Work shall require the installation of new materials at least comparable to Building standards and any substitution shall be of equal or greater quality than that for which it is substituted. (2) Tenant may request the omission of an item of Landlord's Work, provided that such omission shall not delay the completion of Landlord's Work and Landlord thereafter shall not be obligated to install the same. Credits for items deleted or not installed shall be granted in amounts equal to credits obtainable from subcontractors or materialmen. In no event shall there be any cash credits. (d) In the event Landlord performs Extra Work hereunder, Tenant shall pay to Landlord, upon acceptance of the Estimate or submission of Landlord's bid therefor, as the case may be, a sum equal to twenty percent (20%) of the Estimate or bid price to the extent the Estimate together with the amount set forth in the Cost Estimate exceeds the Allowance. In the event of any such excess, Tenant shall pay to Landlord such excess cost for the Extra Work within seven (7) days after receipt by Tenant of a bill therefore or at such other time or times as agreed to, but in no event shall the entire balance be paid later than the completion of the Extra Work. 2. COMPLETION-PUNCH LIST. When the Landlord is of the opinion that the Landlord's Work is complete, then the Landlord shall so notify the Tenant. The Tenant agrees that upon such notification, the Tenant promptly (and not later than two (2) business days after the date of Landlord's said notice) will inspect the Premises and furnish to the Landlord a written statement that the Landlord's Work have been completed and are complete as required by the provisions of this EXHIBIT 4 and the Lease with the exception of certain specified and enumerated items (hereinafter referred to as the "Punch List"). The Tenant agrees that at the request of the Landlord from time to time thereafter, the Tenant will indicate in writing to Landlord whether any prior Punch List items have been completed. If the Punch List consists only of items which would not materially impair the Tenant's use or occupancy of the Premises, then, in such event, the Landlord's Work shall be deemed complete and Tenant shall be deemed to have accepted possession of the Premises, provided, Landlord shall promptly complete all such Punch List items; provided, however, that in no event shall Landlord be obligated to repair latent defects, not originally listed on the Punch List, beyond a period of six (6) months after the Completion Date. The date on which the Landlord's Work is complete, pursuant to the provisions of this subsection, is sometimes referred to as the "Date of Substantial Completion" or "Substantial Completion Date." The Landlord's Work shall be deemed to be substantially complete and the Date of Substantial Completion will be deemed to have occurred upon the issuance of a certificate of occupancy or other similar license, permit, or authorization. Promptly after the Substantial Completion Date, upon Landlord's request, Tenant will execute an instrument in the form attached hereto as EXHIBIT 4.1, setting forth the Commencement Date of the Lease, so that said date is certain and such instrument, when executed, is hereby made part of this Lease and incorporated herein by reference. 3. POSSESSION-EXTENSION OF TERM AND ACKNOWLEDGMENTS. (a) The Tenant will take possession of the Premises as of and on the Commencement Date which, as set forth in Section 1.08 of the Lease, shall be the later of (a) the date set forth in Section 1.08(a) or (b) the date which is two (2) days following the Date of Substantial Completion of the Landlord's Work as to 6917 rentable square foot area on Floor 12, but in no event later than February 1, 1996. Landlord has not agreed or represented that the Premises will be substantially ready for occupancy on the date specified in Section 1.08(a) of the Lease. If for any reason whatsoever the Landlord's Work as to such 6917 rentable square feet on Floor 12 is not complete on said date, this Lease shall nevertheless continue in full force and effect, and no liability shall arise against Landlord because of any such delay, provided, however, that all Rent due hereunder shall abate on a per diem basis and, as hereinabove provided, the Commencement Date shall be deferred until the Date of Substantial Completion of the Landlord's Work as to such 6917 rentable square foot area on Floor 12. Notwithstanding the foregoing, there shall be no abatement of Rent and no deferral of the Commencement Date if the Landlord's Work is not substantially complete due to any special equipment, fixtures or materials, changes, alterations or additions requested by Tenant, any delay of Tenant in submitting information necessary for the preparation of the Plans, the failure of Tenant to timely approve or reject the Cost Estimate, the failure of the Tenant to submit revisions following rejection or deemed rejection of the Estimate, the requirement of Tenant for any Extra Work, or the failure of the Tenant in supplying information of approving or authorizing plans, specifications, estimates or other matters, or any other act or omission of Tenant ("Tenant Delay"). If Tenant shall occupy all or any part of the Premises prior to the Commencement Date, all of the covenants and conditions of this Lease, including the obligation to pay Rent, shall be binding upon the parties hereto in respect to such occupancy as if the first day of the Term had been the date when Tenant began such occupancy. (b) In the event the Date of Substantial Completion of the Landlord's Work as to such 6917 rentable square foot area on Floor 12, or the date Landlord's Work would have been complete but for any Tenant Delays, is later than the date setforth in Section 1.08(a) of the Lease, (1) the Date of Substantial Completion of the Landlord's Work as to such -2- 33 6917 rentable square foot area on Floor 12, shall be modified to be the earlier of the Date of Substantial Completion of the Landlord's Work as to such 6917 rentable square foot area on Floor 12, or the date Landlord's Work would have been complete but for any Tenant Delays and Monthly Base Rent, Expense Adjustment, and Electrical Cost will commence accordingly, (2) the Expiration Date shall be on the last day of the calendar month in which the original Term as set forth in Article I would expire if it were measured from the earlier of the Date of Substantial Completion of the 6917 rentable square foot area on Floor 12, or the date Landlord's Work would have been complete but for any Tenant Delays, and (3) the Term shall be modified to be the period from the Date of Substantial Completion of the 6917 rentable square foot area on Floor 12 to the Expiration Date. Promptly after the Date of Substantial Completion of the 6917 rentable square foot area on Floor 12, the parties will execute an instrument in the form attached as Addendum 1 hereto, setting forth the Expiration Date of the Lease, as so modified, so that said dates are certain and such instrument, when executed, is hereby made a part of this Lease and incorporated herein by reference. 4. TENANT'S ENTRY PRIOR TO COMPLETION DATE. Landlord may permit Tenant or its agents or laborers to enter the Premises at Tenant's sole risk prior to the Commencement Date in order to perform through Tenant's own contractors such work as Tenant may desire, at the same time that Landlord's contractors are working in the Premises. The foregoing License to enter prior to the Commencement Date, however, is conditioned upon Tenant's labor not interfering with Landlord's contractors or with any other tenant or its labor. If at any time such entry shall cause disharmony. interference or union disputes of any nature whatsoever, or if Landlord shall, in Landlord's reasonable judgment, determine that such entry, such work or the continuance thereof shall interfere with, hamper or prevent Landlord from proceeding with the completion of the Building or Landlord's Work at the earliest possible date, this license may be withdrawn by Landlord immediately upon written notice to Tenant. Such entry shall be deemed to be under and subject to all of the terms, covenants and conditions of the Lease, and Tenant shall comply with all of the provisions of the Lease which are the obligations or covenants of the Tenant, including, but not limited to, the provisions of Section 9.01 of the Lease, except that the obligation to pay Rent shall not commence until the Commencement Date. In the event that Tenant's agents or laborers incur any charges from Landlord, including, but not limited to, charges for use of construction or hoisting equipment on the Building site, such charges shall be deemed an obligation of Tenant and shall be collectible as Rent pursuant to the Lease, and upon default in payment thereof, Landlord shall have the same remedies as for a default in payment of Rent pursuant to the Lease. 5. LANDLORD'S ENTRY AFTER SUBSTANTIAL COMPLETION. At any time after the Commencement Date, Landlord may enter the Premises to complete Punch List items, and such entry by Landlord, its agents, servants, employees or contractors for such purpose shall not constitute an actual or constructive eviction, in whole or in part, or entitle Tenant to any abatement or diminution of Rent, or relieve Tenant from any obligation under this Lease, or impose any liability upon Landlord or its agents. 6. DELAYS. Landlord and Tenant mutually acknowledge that the Landlord's construction process in order to complete the Premises requires a coordination of activities and a compliance by the Landlord and Tenant without delay of all obligations imposed upon the Landlord and Tenant pursuant to this EXHIBIT 4 and that time is of the essence in the performance of Landlord's and Tenant's obligations hereunder and Landlord's and Tenant's compliance with the terms and provisions or this EXHIBIT 4. 7. PROVISIONS SUBJECT TO LEASE. The provisions of this EXHIBIT 4 are specifically subject to the provisions of the Lease. -3- 34 EXHIBIT 4.1 NOTICE OF LEASE TERM DATES Re: Office Building Lease (the "Lease") dated _________,199__ between The Utah State Retirement Investment Fund, an independent agency of the State of Utah ("Landlord") and _______________ a ____________ corporation ("Tenant") for the premises located at 3811 Turtle Creek Boulevard, Suite _______, Dallas, Texas and commonly known as Turtle Creek Centre ("Premises") The undersigned, as Tenant, hereby confirms as of this _____ day of ______, 199_, the following: 1. The Substantial Completion Date for the Premises occurred on ______, 199_, and Tenant is currently occupying the same. 2. The Commencement Date, Expiration Date, and expiration date of the Abatement Period, as each is defined in the Lease, are as follows: Commencement Date:__________________ Expiration Date:____________________ 3. All alterations and improvements required to be performed by Landlord pursuant to the terms of the Lease to prepare the entire Premises for Tenant's initial occupancy have been satisfactorily completed. 4. As of the date hereof, Landlord has fulfilled all of its obligations under the Lease. 5. The Lease is in full force and effect and has not been modified, altered, or amended. 6. There are no offsets or credits against Rent. LANDLORD: THE UTAH STATE RETIREMENT INVESTMENT FUND, an independent agency of the State of Utah By: CB Commercial Realty Advisors, Inc. a Delaware corporation, Agent By: /s/ MATTHEW C. HURLBUT ----------------------------------------- Its: Vice President ----------------------------------------- By: ----------------------------------------- Its: ----------------------------------------- Date: ----------------------------------------- TENANT: ----------------------------------------- ----------------------------------------- By: /s/ JOHN F. DAVIS, III ----------------------------------------- Its: ----------------------------------------- Date: ----------------------------------------- -1- 35 FIRST AMENDMENT TO OFFICE LEASE THIS FIRST AMENDMENT TO OFFICE LEASE (this "Amendment") is effective as of the 25th day of February, 1998 (the "Effective Date"), by and between THE UTAH STATE RETIREMENT INVESTMENT FUND, an independent agency of the State of Utah ("Landlord"), and PEGASUS SYSTEMS, INC. ("Tenant"). W I T N E S S E T H: WHEREAS, Landlord and The Hotel Industry Switch Company ("Original Tenant") entered into that certain Office Lease (the "Lease") dated October 1, 1995, covering approximately 29,750 square feet of rentable area on the eleventh (11th) and twelfth (12th) floors in the building (the "Building") commonly known as Turtle Creek Centre in Dallas, Texas; WHEREAS, Original Tenant assigned all of its interests under the Lease to Tenant; and WHEREAS, Landlord and Tenant desire to modify the terms of the Lease to expand the Premises and to modify certain other provisions of the Lease as set forth herein but not otherwise. NOW, THEREFORE, for and in consideration of Ten and No/100 Dollars ($10.00) and other good and valuable consideration, the receipt and sufficiency of which are hereby mutually acknowledged and confessed, Landlord and Tenant, intending to be and being legally bound, do hereby agree as follows: 1. Defined Terms. All capitalized terms used herein and not defined herein shall have the meanings set forth in the Lease. 2. Expansion of Premises. Commencing on the earlier to occur of (a) July 1, 1998, or (b) two (2) days following the Date of Substantial Completion, as provided in the Work Letter attached hereto and made a part hereof as Exhibit B (the "Expansion Date"), Section 1.05 of the Lease shall be amended to expand the Premises to include an additional 4,585 rentable square feet on the fifth (5th) floor of the Building (the "Expansion Space") as shown on Exhibit A attached hereto and incorporated herein, such that the total rentable square footage of the Premises as of the Expansion Date shall be 34,335 rentable square feet. The Expansion Space shall be added to and become part of the Premises for all purposes of the Lease and shall be subject to all of the terms and conditions contained in the Lease (including, without limitation, the payment of Monthly Base Rent, Expense Adjustment, and Electrical Cost in accordance with Article 1 and Article 4 of the Lease as modified herein), subject to the modifications contained in this Amendment. 3. Lease Term for Expansion Space. The Term for the Expansion Space shall commence on the Expansion Date and shall terminate on the Expiration Date (as defined in Section 1.09 of the Lease), which is December 31, 2002, unless the Initial Term of the Lease is extended pursuant to Section 3.02 of the Lease and Tenant gives notice to Landlord in accordance with the provisions of Section 3.02 of the Lease that it intends to renew the Lease as to the Expansion Space, in which case the Term for the Expansion Space shall terminate on the last day of the renewal Term. If Tenant elects to exercise its renewal option set forth in Section 3.02 of the Lease, Tenant shall not be required to renew the Term of the Lease as to the Expansion Space but may, at Tenant's option, renew the Term of the Lease as to the Expansion Space in accordance with the provisions of Section 3.02 of the Lease and this Paragraph 3. 4. Monthly Base Rent. Commencing on the Expansion Date and continuing through and until the Expiration Date, Tenant's Monthly Base Rental for the Expansion Space only (which amounts shall be in addition to and not in lieu of the Monthly Base Rental as to the Existing Premises [defined below]) shall be determined in accordance with this Paragraph 4. With respect to the Expansion Space only, Tenant shall pay Monthly Base Rental in the following amounts: 36
Dates Annual Base Rent Monthly Base Rent ----- ---------------- ----------------- Expansion Date through $114,625.00 $9,552.08 the Expiration Date
The foregoing Annual Base Rent amount is calculated based upon an Annual Base Rent equal to the product of (x) $25.00, multiplied by (y) the rentable square feet comprising the Expansion Space. Such amount is subject to increase pursuant to Article 4 of the Lease. As used in this Amendment, "Existing Premises" means the Premises excluding the Expansion Space. Commencing on the Expansion Date and continuing through and until the Expiration Date, with respect to the Expansion Space only, Tenant shall be obligated to pay (a) Tenant's Share of the Common Area Electrical Service and the cost of electrical service to the Expansion Space in accordance with Article 4 of the Lease, (b) Tenant's Share of Operating Expenses in accordance with Article 4 of the Lease, and (c) other amounts payable under the Lease; provided that effective as of the Expansion Date (i) Tenant's Share (as defined in Section 1. 1 2 of the Lease) as to the Expansion Space only shall be 1.547% and (ii) the Base Operating Year (as defined in Section 1.13 of the Lease) as to the Expansion Space only shall be 1998. The Monthly Base Rent, Tenant's Share of Electrical Costs, and Tenant's Share of Operating Expenses shall be payable in accordance with the timing and procedures applicable thereto pursuant to Article 4 of the Lease. 5. Tenant Improvements. Tenant shall accept the Expansion Space in its current condition, as-is, without recourse to Landlord. ADDITIONALLY, LANDLORD SHALL MAKE NO WARRANTIES, EXPRESS OR IMPLIED, WITH RESPECT TO THE LEASEHOLD IMPROVEMENTS IN THE EXPANSION SPACE. ALL IMPLIED WARRANTIES WITH RESPECT THERETO, INCLUDING BUT NOT LIMITED TO THOSE OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE, ARE EXPRESSLY NEGATED AND WAIVED. Notwithstanding the foregoing, Landlord hereby authorizes Tenant to undertake certain improvements in the Expansion Space, and Landlord and Tenant each shall comply with the provisions of the Work Letter attached hereto as Exhibit B in the construction of such improvements to the Expansion Space. 6. Parking. Commencing on the Expansion Date and continuing through and until the Expiration Date, Section 1. 19 of the Lease shall be amended to provide that in addition to and not lieu of the Parking Spaces provided for therein, Landlord shall furnish to Tenant and Tenant shall lease from Landlord additional parking rights for (i) nineteen (19) Non-Reserved Parking Spaces, and (ii) at Tenant's discretion up to three (3) Reserved Executive Parking Spaces (collectively, the "Additional Parking Spaces"). The Additional Parking Spaces shall become part of the Parking Spaces for all purposes under the Lease and rental for the Additional Parking Spaces shall be due and payable in accordance with the provisions of and in the amounts provided under Section 6.03 of the Lease. 7. Address Changes. (a) As of the Effective Date, Section 1.01 of the Lease shall be deleted in its entirety and replaced with the following: The Utah State Retirement Investment Fund c/o Westmark Realty Advisors, LLC 865 South Figueroa Street, Suite 3500 Los Angeles, California 90017-2543 Attn: Director of Asset Management 2 37 (b) As of the Effective Date, Section 1.02 of the Lease shall be deleted in its entirety and replaced with the following: Pegasus Systems, Inc. 3811 Turtle Creek Boulevard Suite 1100 Dallas, Texas 75219 (c) As of the Effective Date, Section 1.16 of the Lease shall be deleted in its entirety and replaced with the following: Fults Realty Corporation 3811 Turtle Creek Boulevard, Suite 240 Dallas, Texas 75219 Cawley International 5420 LBJ Freeway Suite 740 Dallas, Texas 75240 (d) As of the Effective Date, the address provided in Section 1.17 of the Lease shall be deleted in its entirety and replace with the following: Bradford Management Company of Dallas, Inc. 3811 Turtle Creek Boulevard, Suite 240 Dallas, Texas 75219 (e) As of the Effective Date, Section 1. 1 8 of the Lease shall be deleted in its entirety and replaced with the following: The Utah State Retirement Investment Fund P.O. Box 730208 Dallas, Texas 75373-0208 (f) As of the Effective Date, Landlord's address for notice purposes in Section 27.01 of the Lease shall be deleted and replaced with the following: To Landlord: Westmark Realty Advisors, LLC 865 South Figueroa Street Suite 3500 Los Angeles, California 90017-2543 Attn: Director of Asset Management with a copy of each Notice to Landlord to be sent to: Westmark Realty Advisors, LLC 5400 LB Freeway Suite 1100 Dallas, Texas 75240-6249 Attn: Asset Manager and a copy to: Bradford Management Company of Dallas, Inc. 3811 Turtle Creek Boulevard, Suite 240 Dallas, Texas 75219 Attn: Property Manager for 3811 Turtle Creek 8. Brokerage Commission. Except for the commission payable to Cawley International ("Broker") which commission is Landlord's responsibility pursuant to a separate agreement signed by Landlord and Broker, Landlord and Tenant hereby represent and warrant to each other that no commission is due and payable to any broker or other leasing agent in connection with this Amendment as a result of its own dealings with any such broker or leasing 3 38 agent, and Landlord and Tenant hereby agree to indemnify and hold each other harmless from and against all loss, damage, cost and expense (including reasonable attorneys' fees) suffered by the other party as a result of a breach of the foregoing representation and warranty. 9. Full Force and Effect. In the event any of the terms of the Lease conflict with the terms of this Amendment, the terms of this Amendment shall control. Except as amended hereby, all terms and conditions of the Lease shall remain in full force and effect, and Landlord and Tenant hereby ratify and confirm the Lease as amended hereby. The Lease, as amended herein, constitutes the entire agreement between the parties hereto and no further modification of the Lease shall be binding unless evidenced by an agreement in writing signed by Landlord and Tenant. IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed on the day and year first written above. LANDLORD: THE UTAH STATE RETIREMENT INVESTMENT FUND, an independent agency of the State of Utah By: Westmark Realty Advisors, L.L.C., a Delaware limited liability company, its Agent By: /s/ Matthew C. Hurlburt ----------------------------------------------- Name: Matthew C. Hurlbut Its: Authorized Signatory By: /s/ Joseph W. Markling ----------------------------------------------- Name: Joseph W. Markling Its: Authorized Signatory TENANT: PEGASUS SYSTEMS, INC. By: /s/ John F. Davis ----------------------------------------------- Name: John F. Davis Its: President 4 39 EXHIBIT A EXPANSION SPACE A-1 40 EXHIBIT B WORK LETTER The terms used herein shall have the meanings ascribed to them in this Amendment, unless otherwise stated herein. 1. CONSTRUCTION OF THE EXPANSION SPACE. The Landlord and the Tenant agree that their respective rights and obligations in reference to the construction of the Expansion Space shall be as follows: 1.01 TENANT'S PLANS AND SPECIFICATIONS. (a) Landlord shall cause to be prepared detailed architectural, telephone, mechanical and engineering plans including all dimensions and specifications for all work to be performed by Landlord in the Expansion Space substantially in accordance with the space plan to be approved by the parties ("Plans"). (b) Tenant shall cooperate as necessary in connection with the preparation of the Plans, in a complete and timely manner, and without limiting the foregoing, shall provide to Landlord all information as shall be required by Landlord's engineers to prepare mechanical plans pursuant to Section 1.02 hereof, which information shall include, but not be limited to, the following: (1) any special floor-loading conditions which may exceed the structural weight limits of the floor, (2) specifications of any heat emanating equipment to be installed by Tenant which may require special air conditioning, (3) electrical specifications of any equipment that requires non-standard electrical power outlets, and (4) complete specifications of any data-line wiring required, including cable routing, conduit size, cable type and similar items (provided Landlord shall have the right to approve but shall not perform, and the Landlord's Work, as hereinafter defined, shall exclude all data-line wiring and cable routing in and to the Expansion Space). (c) The Plans shall be delivered to Tenant for its review and consideration as soon as reasonably possible. Any change or modification of such Plans shall not be valid or binding unless consented to by Landlord in writing. 1.02 LANDLORD'S WORK. (a) Landlord shall furnish and install substantially in accordance with the Plans the materials and items described therein ("Landlord's Work"). The Plans and Landlord's Work shall be at Tenant's sole cost and expense, provided that Tenant shall be entitled to a credit against the cost of the Plans and Landlord's Work in an amount up to the lesser of (a) $77,945.00 (i.e., $17.00, multiplied by the area of the Expansion Space) or (b) the actual costs of the Plans and the Landlord's Work (the "Allowance"). If the cost of the Landlord's Work is less than the Allowance, Landlord shall retain such excess and Tenant shall not be entitled to receive such excess. (b) If Landlord determines that the cost of the Landlord's Work, will exceed the Allowance, then prior to commencement of the Landlord's Work, Landlord will submit to Tenant a cost estimate for the Landlord's Work ("Cost Estimate") which Tenant shall approve or reject within seven (7) days after receipt thereof. It is understood that the cost of Landlord's Work shall include Landlord's construction supervision fee which shall be either (a) five percent (5%) of the Job Cost (defined below) between $50,000 and $100,000, or (b) four (4%) of the Job Cost that exceeds $100,000. Tenant's failure to reject the Cost Estimate within said seven (7) day period shall be deemed to be an acceptance thereof. If Tenant rejects the Cost Estimate, Tenant shall, together with such rejection, propose such changes to the Plans as will cause the Cost Estimate to be acceptable. If the accepted Cost Estimate exceeds the Allowance, then 41 Tenant shall pay to Landlord the amount of such excess within ten (10) business days after receipt by Tenant of a bill therefor, but in no event later than the Expansion Date. As used herein, "Job Cost" shall mean the actual costs of the Plans, Landlord's Work, and Extra Work (defined below), if any. 1.03 EXTRA WORK. (a) Tenant may request substitutions, additional or extra work and/or materials over and above Landlord's Work ("Extra Work") to be performed by Landlord provided that the Extra Work, in Landlord's judgment, (1) shall not delay completion of Landlord's Work or the Expansion Date of the Lease; (2) shall be practicable and consistent with existing physical conditions in the Building and any other plans for the Building which have been filed with the appropriate municipality or other governmental authorities having jurisdiction thereover; (3) shall not impair Landlord's ability to perform any of Landlord's obligation hereunder or under the Lease or any other lease of space in the Building; and (4) shall not affect any portion of the Building other than the Expansion Space. (b) (1) In the event Tenant requests Landlord to perform Extra Work and if Landlord accedes to such request, then and in that event, prior to commencing such Extra Work, Landlord shall submit to Tenant a written estimate ("Estimate") for said Extra Work to be performed. Within seven (7) days after Landlord's submission of the Estimate, Tenant shall, in writing, either accept or reject the Estimate. Tenant's failure either to accept or reject the Estimate within said seven (7) day period shall be deemed rejection thereof. (2) In the event that Tenant rejects the Estimate or the Estimate is deemed rejected, Tenant shall within seven (7) days after such rejection propose to Landlord such necessary revisions of the Plans so as to enable Landlord to proceed as though no such Extra Work had been requested. Should Tenant fail to submit such proposals regarding necessary revisions of the Plans Within said seven (7) day period, Landlord, in its sole discretion, may proceed to complete Landlord's Work in accordance with the Plans already submitted, with such variations as in Landlord's sole discretion may be necessary so as to eliminate the Extra Work. (c) (1) All Extra Work shall require the installation of new materials at least comparable to Building standards and any substitution shall be of equal or greater quality than that for which it is substituted. (2) Tenant may request the omission of an item of Landlord's Work, provided that such omission shall not delay the completion of Landlord's Work and Landlord thereafter shall not be obligated to install the same. Credits for items deleted or not installed shall be granted in amounts equal to credits obtainable from subcontractors or materialmen. In no event shall there be any cash credits. (d) In the event Landlord performs Extra Work hereunder, Tenant shall pay to Landlord, upon acceptance of the Estimate or submission of Landlord's bid therefor, as the case may be, a sum equal to twenty percent (20%) of the Estimate or bid price to the extent the Estimate together with the amount set forth in the Cost Estimate exceeds the Allowance. In the event of any such excess, Tenant shall pay to Landlord such excess cost for the Extra Work within seven (7) days after receipt by Tenant of a bill therefore or at such other time or times as agreed to, but in no event shall the entire balance be paid later than the completion of the Extra Work. 2. COMPLETION-PUNCH LIST. When the Landlord is of the opinion that the Landlord's Work is complete, then the Landlord shall so notify the Tenant. The Tenant agrees that upon such notification, the Tenant promptly (and not later than two (2) business days after the date of Landlord's said notice) will inspect the Expansion Space and furnish to the Landlord a written statement that the Landlord's Work have been completed and are complete as required by the provisions of this EXHIBIT B and the Lease with the exception of certain specified and enumerated items (hereinafter referred to as the "Punch List"). The Tenant agrees that at the request of the Landlord from time to time thereafter, the Tenant will indicate in writing to Landlord whether any prior Punch List items have been completed. If the Punch List consists B-2 42 only of items which would not materially impair the Tenant's use or occupancy of the Expansion Space, then, in such event, the Landlord's Work shall be deemed complete and Tenant shall be deemed to have accepted possession of the Expansion Space, provided, Landlord shall promptly complete all such Punch List items; provided, however, that in no event shall Landlord be obligated to repair latent defects, not originally listed on the Punch List, beyond a period of six (6) months after the Completion Date. The date on which the Landlord's Work is complete, pursuant to the provisions of this subsection, is sometimes referred to as the "Date of Substantial Completion" or "Substantial Completion Date." The Landlord's Work shall be deemed to be substantially complete and the Date of Substantial Completion will be deemed to have occurred upon the issuance of a certificate of occupancy or other similar license, permit, or authorization. Promptly after the Substantial Completion Date, upon Landlord's request, Tenant will execute an instrument in the form attached hereto as EXHIBIT B-1, setting forth the Expansion Date of the Expansion Space, so that said date is certain and such instrument, when executed, is hereby made part of this Amendment incorporated herein by reference. 3. POSSESSION-EXTENSION OF TERM AND ACKNOWLEDGMENTS. (a) The Tenant will take possession of the Expansion Space as of and on the Expansion Date which, as set forth in Paragraph 2 of this Amendment, shall be the earlier to occur of (a) July 1, 1998 or (b) the date which is two (2) days following the Date of Substantial Completion. Landlord has not agreed or represented that the Expansion Space will be substantially ready for occupancy on July 1, 1998; provided however that Landlord has agreed that Landlord will use its commercially reasonable efforts to cause the Expansion Space to be substantially ready for occupancy on July 1, 1998. If for any reason whatsoever the Landlord's Work is not complete on said date, this Amendment shall nevertheless continue in full force and effect, and no liability shall arise against Landlord because of any such delay, provided, however, that all Rent due hereunder as to the Expansion Space only shall abate on a per them basis and, as hereinabove provided, the Expansion Date shall be deferred until the Date of Substantial Completion. Notwithstanding the foregoing, there shall be no abatement of Rent and no deferral of the Expansion Date if the Landlord's Work is not substantially complete due to any special equipment, fixtures or materials, changes, alterations or additions requested by Tenant, any delay of Tenant in submitting information necessary for the preparation of the Plans, the failure of Tenant to timely approve or reject the Cost Estimate, the failure of the Tenant to submit revisions following rejection or deemed rejection of the Estimate, the requirement of Tenant for any Extra Work, or the failure of the Tenant in supplying information of approving or authorizing plans, specifications, estimates or other matters, or any other act or omission of Tenant ("Tenant Delay"). If Tenant shall occupy all or any part of the Expansion Space prior to the Expansion Date, all of the covenants and conditions of this Amendment, including the obligation to pay Rent, shall be binding upon the parties hereto in respect to such occupancy as if the first day of the term of the Expansion Space had been the date when Tenant began such occupancy. (b) In the event the Date of Substantial Completion or the date Landlord's Work would have been complete but for any Tenant Delays, is later than July 1, 1998, (1) the Date of Substantial Completion shall be modified to be the earlier of the Date of Substantial Completion or the date Landlord's Work would have been complete but for any Tenant Delays and Monthly Base Rent, Expense Adjustment, and Electrical Cost as to the Expansion Space will commence accordingly, and (2) the Expiration Date shall not be adjusted. 4. TENANT'S ENTRY PRIOR TO COMPLETION DATE. Landlord may permit Tenant or its agents or laborers to enter the Expansion Space at Tenant's sole risk prior to the Expansion Date in order to perform through Tenant's own contractors such work as Tenant may desire, at the same time that Landlord's contractors are working in the Expansion Space. The foregoing license to enter prior to the Expansion Date, however, is conditioned upon Tenant's labor not interfering with Landlord's contractors or with any other tenant or its labor. If at any time such entry shall cause disharmony, interference or union disputes of any nature whatsoever, or if Landlord shall, in Landlord's sole judgment, determine that such entry, such work or the continuance thereof shall interfere with, hamper or prevent Landlord from proceeding with the completion of the Building or Landlord's Work at the earliest possible date, this license may be withdrawn by Landlord immediately upon written notice to Tenant. Such entry shall be deemed to be under and subject to all of the terms, covenants and conditions of this Amendment and the Lease, and Tenant shall comply with all of the provisions of this Amendment and the Lease B-3 43 which are the obligations or covenants of the Tenant, including, but not limited to, the provisions of Section 9.01 of the Lease, except that the obligation to pay Rent as to the Expansion Space only shall not commence until the Expansion Date. In the event that Tenant's agents or laborers incur any charges from Landlord, including, but not limited to, charges for use of construction or hoisting equipment on the Building site, such charges shall be deemed an obligation of Tenant and shall be collectible as Rent pursuant to the Lease, and upon default in payment thereof, Landlord shall have the same remedies as for a default in payment of Rent pursuant to the Lease. 5. LANDLORD'S ENTRY AFTER SUBSTANTIAL COMPLETION. After the Expansion Date, Landlord may enter the Expansion Space (i) during normal business hours only after giving reasonable notice to Tenant, and (ii) at any time after normal business hours with no requirement for notice to Tenant to complete Punch List items, and such entry by Landlord, its agents, servants, employees or contractors for such purpose shall not constitute an actual or constructive eviction, in whole or in part, or entitle Tenant to any abatement or diminution of Rent, or relieve Tenant from any obligation under this Amendment or the Lease, or impose any liability upon Landlord or its agents. 6. DELAYS. Landlord and Tenant mutually acknowledge that the Landlord's construction process in order to complete the Expansion Space requires a coordination of activities and a compliance by the Tenant without delay of all obligations imposed upon the Tenant pursuant to this EXHIBIT B and that time is of the essence in the performance of Tenant's obligations hereunder and Tenant's compliance with the terms and provisions or this EXHIBIT B. 7. PROVISIONS SUBJECT TO LEASE. The provisions of this EXHIBIT B are specifically subject to the provisions of this Amendment and the Lease. B-4 44 EXHIBIT B-1 NOTICE OF AMENDED LEASE TERM DATES Re: Office Building Lease (the "Original Lease") dated October 1, 1995 (the "Original Lease"), as assigned by that certain Assignment and Assumption of Lease dated _____________, 1998 (the "Assignment"), as amended by that certain First Amendment to Office Lease dated ____________, 1998 (the "First Amendment"; together with the Original Lease and the Assignment, the "Lease") by and between The Utah State Retirement Investment Fund, an independent agency of the State of Utah ("Landlord") and Pegasus Systems, Inc., a corporation ("Tenant") for the premises located at 3811 Turtle Creek Boulevard, Suite 1100 & 1200, Dallas, Texas and commonly known as Turtle Creek Centre ("Premises"), including approximately 4,585 square feet of expansion space ("Expansion Space") added to the Premises pursuant to the First Amendment. The undersigned, as Tenant, hereby confirms as of this _____ day of ._____________., 19___, the following: 1. The Substantial Completion Date for the Expansion Space occurred on _________________, 199___, and Tenant is currently occupying the same. 2. The Expansion Date and Expiration Date, as each is defined in the First Amendment, are as follows: Expansion Date: ------------------------------------ Expiration Date: December 31, 2002 3. All alterations and improvements required to be performed by Landlord pursuant to the terms of the First Amendment to prepare the Expansion Space for Tenant's initial occupancy have been satisfactorily completed. 4. As of the date hereof, Landlord has fulfilled all of its obligations under the Lease. 5. The Lease is in full force and effect and has not been modified, altered, or amended (except by the First Amendment). 6. There are no offsets or credits against Rent. B-1-1 45 LANDLORD: THE UTAH STATE RETIREMENT INVESTMENT FUND, an independent agency of the State of Utah By: Westmark Realty Advisors, L.L.C., a Delaware limited liability company, its Agent By: ----------------------------------------- Name: Matthew C. Hurlbut Its: Authorized Signatory By: ----------------------------------------- Name: Joseph W. Markling Its: Authorized Signatory TENANT: PEGASUS SYSTEMS, INC. By: ----------------------------------------- Name: --------------------------------------- Title: -------------------------------------- B-1-2 46 SECOND AMENDMENT TO OFFICE LEASE THIS SECOND AMENDMENT TO OFFICE LEASE (this "Amendment") is effective as of 2 day of November, 1998 (the "Effective Date"), by and between THE UTAH STATE RETIREMENT INVESTMENT FUND, an independent agency of the State of Utah ("Landlord"), and PEGASUS SYSTEMS, INC. ("Tenant"). W I T N E S S E T H: WHEREAS, Landlord and The Hotel Industry Switch Company ("Original Tenant") entered into that certain Office Lease dated October 1, 1995, as amended by that certain First Amendment to Office Lease dated February 25, 1998, and as assigned by that certain Assignment and Assumption of Lease dated February 25, 1998 (as amended and assigned, the "Lease,") covering approximately 34,335 square feet of rentable area on the fifth (5th), eleventh (11th) and twelfth (12th) floors in the building (the "Building") commonly known as Turtle Creek Centre in Dallas, Texas; WHEREAS, Original Tenant assigned all of its interests under the Lease to Tenant; and WHEREAS, Landlord and Tenant desire to modify the terms of the Lease to expand the Premises and to modify certain other provisions of the Lease as set forth herein but not otherwise. NOW, THEREFORE, for and in consideration of Ten and No/100 Dollars ($10.00) and other good and valuable consideration, the receipt and sufficiency of which are hereby mutually acknowledged and confessed, Landlord and Tenant, intending to be and being legally bound, do hereby agree as follows: 1. Defined Terms. All capitalized terms used herein and not defined herein shall have the meanings set forth in the Lease. 2. Expansion of Premises. Commencing on the Expansion Date (as defined below) as to each portion of the Expansion Space (defined below) as set forth in this paragraph below, the Leased Premises shall be expanded to include the following space (collectively, the "Expansion Space"): (i) 10,000 rentable square feet on the seventeenth (17th) floor of the Building as shown on Exhibit A attached hereto ("First Space"); and (ii) 4,568 rentable square feet on the seventeenth (17th) floor of the Building as shown on Exhibit A attached hereto ("Second Space"). As used in this Amendment, the term "Applicable Expansion Space" shall mean the First Space or the Second Space, as applicable. As used in this Amendment, the term "Expansion Date" shall mean the date set forth below for the Applicable Expansion Space:
Applicable Expansion Space Expansion Date -------------------------- -------------- First Space January 1, 1999 Second Space April 1, 1999
The Expansion Space shall be added to and become part of the Premises for all purposes of the Lease and shall be subject to all of the terms and conditions contained in the Lease (including, without limitation, the payment of Monthly Base Rent, Expense Adjustment, and Electrical Cost in accordance with Article 1 and Article 4 of the Lease as modified herein), subject to the modifications contained in this Amendment. 3. Lease Term for Expansion Space. The Term for each Applicable Expansion Space shall commence on the Expansion Date set forth in Paragraph 2 above as to such space, 47 and shall terminate on the Expiration Date (as defined in Section 1.09 of the Lease), which is December 31, 2002, unless the Initial Term of the Lease is extended pursuant to Section 3.02 of the Lease, in which case the Term for the Expansion Space shall terminate on the last day of the renewal Term. If Tenant elects to exercise its renewal option set forth in Section 3.02 of the Lease, Tenant shall renew the Term of the Lease as to all of the Premises, including the Expansion Space. 4. Monthly Base Rent. Commencing on the Expansion Date as to each Applicable Expansion Space and continuing through and until the Expiration Date, Tenant's Monthly Base Rent for the Expansion Space only (which amounts shall be in addition to and not in lieu of the Monthly Base Rent as to the Existing Premises [defined below]) shall be determined in accordance with this Paragraph 4. With respect to the Expansion Space only, Tenant shall pay Monthly Base Rent in the following amounts:
Dates Annual Base Rent Monthly Base Rent ----- ---------------- ----------------- Expansion Date for the First $270,000.00 $22,500.00 Space through the Expiration Date Expansion Date for the Second $123,336.00 $10,278.00 Space through the Expiration Date
The foregoing Annual Base Rent amount is calculated based upon an Annual Base Rent equal to the product of (x) $27.00, multiplied by (y) the rentable square feet comprising the Expansion Space. Such amount is subject to increase pursuant to Article 4 of the Lease. As used in this Amendment, "Existing Premises" means the Premises excluding the Expansion Space. Commencing on the Expansion Date and continuing through and until the Expiration Date, with respect to the Expansion Space only, Tenant shall be obligated to pay (a) Tenant's Share of the Common Area Electrical Service and the cost of electrical service to the Expansion Space in accordance with Article 4 of the Lease, (b) Tenant's Share of Operating Expenses in accordance with Article 4 of the Lease, and (c) other amounts payable under the Lease; provided that effective as of the Expansion Date (i) Tenant's Share (as defined in Section 1.12 of the Lease) as to the First Space only shall be 3.374% and as to the Expansion Space only shall be 4.915%, and (ii) the Base Operating Year (as defined in Section 1.13 of the Lease) as to the Expansion Space only shall be 1999. The Monthly Base Rent, Tenant's Share of Electrical Costs, and Tenant's Share of Operating Expenses shall be payable in accordance with the timing and procedures applicable thereto pursuant to Article 4 of the Lease. 5. Tenant Improvements. Tenant shall accept the Expansion Space in its current condition, as-is, without recourse to Landlord. ADDITIONALLY, LANDLORD SHALL MAKE NO WARRANTIES, EXPRESS OR IMPLIED, WITH RESPECT TO THE LEASEHOLD IMPROVEMENTS IN THE EXPANSION SPACE. ALL IMPLIED WARRANTIES WITH RESPECT THERETO, INCLUDING BUT NOT LIMITED TO THOSE OF MERCHANTABILITY AND FITNESS FOR A PARTICULAR PURPOSE, ARE EXPRESSLY NEGATED AND WAIVED. Notwithstanding the foregoing, Landlord hereby authorizes Tenant to undertake certain improvements in the Expansion Space, and Landlord and Tenant each shall comply with the provisions of the Work Letter attached hereto as Exhibit B in the construction of such improvements to the Expansion Space. Notwithstanding the foregoing, Landlord represents to Tenant that the restrooms and utilities on the seventeenth (17th) floor are in good working order. 6. Right of First Notice. (a) After the first six (6) months of the initial Lease Term, if space on floor 18 of the Building (the "First Notice Space") is available for lease and Landlord receives an expression of interest in the First Notice Space from a prospective tenant, Landlord shall deliver a notice to Tenant offering to lease the First Notice Space to Tenant. Landlord's 2 48 notice must specify the First Notice Rate (defined below). The term "available for lease" means that the First Notice Space is not then subject to any existing rights of third parties, including, without limitation, rights of first notice, expansion rights, extension rights, options to lease, or other rights. (b) Tenant may elect to lease the First Notice Space by delivering a notice (the "Response Notice") to Landlord within 7 business days after the date of Landlord's notice specifying that Tenant elects either (i) to lease all, but not less than all, of the First Notice Space or (ii) to decline to lease the First Notice Space. (c) If (i) Landlord does not receive the Response Notice within the 7 business day period or (ii) in the Response Notice Tenant does not elect to lease all of the First Notice Space, Tenant is deemed to waive its right to lease the First Notice Space and Tenant has no further rights under this Paragraph 6. (d) If Tenant timely delivers a Response Notice electing to lease all of the First Notice Space, Tenant's lease of the First Notice Space commences not later than 90 days after Landlord's receipt of the Response Notice (unless Landlord and Tenant agree on an earlier commencement date) and is on the same terms as the Lease except that the Monthly Base Rent and other applicable terms for the First Notice Space adjust based on the First Notice Rate. Landlord shall prepare, and Landlord and Tenant will execute and deliver, within 10 days after Landlord's receipt of the Response Notice, an amendment to the Lease adding the First Notice Space to the Premises upon the terms specified in this Paragraph, Tenant shall execute and deliver the amendment to Landlord within 10 days after Tenant's receipt of the amendment, and Landlord will deliver to Tenant a counterpart of the amendment executed by Landlord. (e) Landlord is not obligated to offer the First Notice Space to Tenant, and Tenant may not exercise its option to lease the First Notice Space, if at the time Landlord would otherwise be obligated to give the Notice to Tenant, Tenant is in default under this Lease. (f) The terms "First Notice Rate" means the Base Rent, as determined by Landlord in its sole discretion to be the then market base rent for the First Notice Space. (g) Tenant may not assign this option to lease the First Notice Space to any assignee of the Lease, nor may any sublessee or assignee exercise this option. (h) Section 2.02 of the Lease is hereby amended to provide that Tenant shall have no further rights of refusal during the last two years of the then Term of this Lease. 7. Monument Signage. Section 8.05 of the Lease shall be amended to provide that in addition to and not in lieu of the Monument Signage provided for therein, for so long as (a) either (1) Tenant leases not less than three (3) full floors of the Building under the Lease, or (2) Tenant is the largest tenant in the Building, and (b) there is no uncured Default under the Lease, Tenant shall have the exclusive right to use and maintain the existing monument ("Monument") signage generally located at the comer of Turtle Creek Boulevard and Blackburn Street. The location, design, method of attachment, size, materials, coloring, lettering and lighting of all such Monument signage shall be subject to Landlord's approval, which approval shall not be unreasonably withheld if such signage is similar to Tenant's existing monument signage, and further subject to all other approvals as may be required including without limitation the City of Dallas or any applicable scenic district, and in any event to be consistent with the Building's design, signage and graphics program. If at any time it is necessary to remove the signage due to the requirements of applicable laws, rules or regulations, Landlord shall be entitled, at Landlord's cost, to replace the signage with another sign on or about the Building which provides substantially the same exposure for Tenant. Landlord shall at all times be entitled to make such changes in the signage as may be required by applicable laws as a condition of the continued use of the Monument at Landlord's cost. Any change in the names displayed on the Monument (i) shall be made by Landlord at Tenant's sole cost and expense, (ii) shall utilize the materials, colors, method of illumination and lettering type currently utilized, and (iii) must be approved by Landlord in its reasonable discretion. In the event Tenant's name is changed, Landlord will not unreasonably withhold approval of a change to the name displayed on the Monument. Upon the expiration or earlier termination of this Lease (as concerns all signage), or in the event Tenant no longer leases more than three (3) full floors of the Building pursuant to the Lease or is otherwise 3 49 not entitled to maintain such signage under the terms of the Lease, or if there is an uncured Default under the Lease, Landlord, at Landlord's expense, shall have the right to remove all such signage and make all necessary repairs to the Monument so as to return the Monument to its respective original condition. Tenant shall have no right to install any signage on the Building or in any other location except as expressly set forth in the Lease. In addition, Tenant's rights under this Paragraph shall terminate upon Tenant's assignment of this Lease or sublease of the Premises. 8. Premises Condition. Landlord shall be responsible as an Operating Expense to ensure the restrooms on the seventeenth (17th) floor of the Building comply with applicable ADA standards for handicapped persons and other accessibility requirements and laws, provided Tenant does not make alterations that require changes to the restrooms, in which case Tenant shall then be responsible for causing compliance. 9. Termination of Lease as to Fifth Floor Premises. Effective as of January 1, 1999 (the "Reduction Date"), the Premises shall be reduced by, and the Lease terminated as to, the 4,585 square feet of rentable area on the fifth (5th) floor of the Building (as added to the Premises pursuant to the First Amendment) as shown on Exhibit C attached hereto and incorporated herein (the "Terminated Space"). As of the Reduction Date and through and until the Expiration Date, the Premises shall consist of 39,750 square feet of rentable area on the eleventh (11th), twelfth (12th) and seventeenth (17th) floors of the Building (which square footage shall be increased by 4,568 square feet to 44,318 square feet of rentable area as of the Expansion Date for the Second Space pursuant to Paragraph 2 above) for all purposes of the Lease. From and after the Reduction Date, Tenant shall no longer have any rights (including the right of possession) in the Terminated Space, and Landlord and Tenant shall be released of all further obligations, covenants and agreements as to the Terminated Space accruing under the Lease after the Reduction Date. Notwithstanding the foregoing, in no event shall Landlord or Tenant be released from (i) any of its obligations, covenants or agreements with respect to the Terminated Space which accrue under the Lease prior to the Reduction Date (including, without limitation, Tenant's obligation to pay rent with respect to the Terminated Space for the period prior to the Reduction Date in accordance with the provisions of the Lease), or (ii) any other provisions of the Lease which by their terms survive the termination or expiration of the Lease. 10. Surrender of Terminated Space. Subject to Landlord delay of completion of construction of improvements to the First Space, Tenant agrees to surrender the Terminated Space to Landlord on the Reduction Date in the condition required by Section 11.01 of the Lease without any subleases or leases in effect with respect thereto, and free of occupancy by any person or entity. Tenant represents and warrants to Landlord that there are no agreements, written or oral, between Tenant and any other person or entity with respect to the occupancy of all or any portion of the Terminated Space after the Reduction Date. Subject to Landlord delay of completion of construction of improvements to the First Space, if Tenant fails to timely surrender the Terminated Space to Landlord in accordance with the provisions of this Amendment, the provisions of Article 23 of the Lease shall apply to any such holding over by Tenant with respect to the Terminated Space and Tenant shall not be released from its obligations, covenants and agreements under the Lease relating to the Terminated Space during such holdover period. From the date hereof until the Reduction Date, upon reasonable prior verbal notice to Tenant, Landlord shall have access to the Terminated Space for purposes of trying to lease the Terminated Space. 11. Parking. Commencing on the Expansion Date and continuing through and until the Expiration Date, Section 1.19 of the Lease shall be amended to provide that in lieu of (but not in addition to) the Parking Spaces provided for therein, (a) all parking spaces added pursuant to the First Amendment shall be terminated, Tenant no longer being entitled to such spaces, and (b) Landlord shall furnish to Tenant and Tenant shall lease from Landlord additional parking rights for (i) forty-four (44) Non-Reserved Parking Spaces, and (ii) four (4) Reserved Executive Parking Spaces (collectively, the "Additional Parking Spaces"). The Additional Parking Spaces shall become part of the Parking Spaces for all purposes under the Lease and rental for the Additional Parking Spaces shall be due and payable in accordance with the provisions of and in the amounts provided under Section 6.03 of the Lease. Additional Non-Reserved Parking Spaces may be available to Tenant on an as available basis ("Additional Temporary Spaces") at the same rates for Non-Reserved Parking 4 50 Spaces set forth in Section 6.03 of the Lease. Additional Temporary Spaces shall be made available on a month-to-month basis and may be terminated by Landlord at any time if Landlord determines that such Additional Temporary Spaces can no longer be made available to Tenant because Landlord needs such Additional Temporary Spaces to provide existing or new tenants of the Building parking spaces in the ratio of one (1) space for every three hundred (300) rentable square feet. 12. Brokerage Commission. Except for the commission payable to Cawley International ("Broker") which commission is Landlord's responsibility pursuant to a separate agreement signed by Landlord and Broker, Landlord and Tenant hereby represent and warrant to each other that no commission is due and payable to any broker or other leasing agent in connection with this Amendment as a result of its own dealings with any such broker or leasing agent, and Landlord and Tenant hereby agree to indemnify and hold each other harmless from and against all loss, damage, cost and expense (including reasonable attorneys' fees) suffered by the other party as a result of a breach of the foregoing representation and warranty. 13. In the event any of the terms of the Lease conflict with the terms of this Amendment, the terms of this Amendment shall control. Except as amended hereby, all terms and conditions of the Lease shall remain in full force and effect, and Landlord and Tenant hereby ratify and confirm the Lease as amended hereby. The Lease, as amended herein, constitutes the entire agreement between the parties hereto and no further modification of the Lease shall be binding unless evidenced by an agreement in writing signed by Landlord and Tenant. IN WITNESS WHEREOF, the parties hereto have caused this Amendment to be executed on the day and year first written above. LANDLORD: THE UTAH STATE RETIREMENT INVESTMENT FUND, an independent agency of the State of Utah By: CB Richard Ellis Investors, LLC, its Agent By: /s/ Matthew C. Hurlbut -------------------------------------- Name: Matthew C. Hurlbut By: /s/ Victor R. Moore -------------------------------------- Name: Victor R. Moore TENANT: PEGASUS SYSTEMS, INC. By: /s/ John F. Davis, III -------------------------------------- Name: John F. Davis, III Title: President 5 51 EXHIBIT A EXPANSION SPACE A-1 52 EXHIBIT B WORK LETTER The terms used herein shall have the meanings ascribed to them in the Lease, unless otherwise stated herein. 1. CONSTRUCTION OF THE PREMISES. The Landlord and the Tenant agree that their respective rights and obligations in reference to the construction of the Premises shall be as follows: 1.01 TENANT'S PLANS AND SPECIFICATIONS. (a) Landlord, shall cause to be prepared detailed architectural, telephone, mechanical and engineering plans including all dimensions and specifications for all work to be performed by Landlord in the Premises substantially in accordance with the space plan to be approved by Landlord and Tenant ("Plans"). (b) Tenant shall cooperate as necessary in connection with the preparation of the Plans, in a complete and timely manner, and without limiting the foregoing, shall provide to Landlord all information as shall be required by Landlord's engineers to prepare mechanical plans pursuant to Section 1.02 hereof, which information shall include, but not be limited to, the following: (1) any special floor-loading conditions which may exceed the structural weight limits of the floor, (2) specifications of any heat emanating equipment to be installed by Tenant which may require special air conditioning, (3) electrical specifications of any equipment that requires non-standard electrical power outlets, and (4) complete specifications of any data-line wiring required, including cable routing, conduit size, cable type and similar items (provided Landlord shall have the right to approve but shall not perform, and the Landlord's Work, as hereinafter defined, shall exclude all data-line wiring and cable routing in and to the Premises). (c) The Plans shall be delivered to Tenant for its review and consideration as soon as reasonably possible. Any change or modification of such Plans shall not be valid or binding unless consented to by Landlord in writing. 1.02 LANDLORD'S WORK. (a) Landlord shall furnish and install substantially in accordance with the Plans the materials and items described therein ("Landlord's Work"). The Plans and Landlord's Work shall be at Tenant's sole cost and expense, provided that Tenant shall be entitled to a credit against the cost of the Plans and Landlord's Work in an amount up to the lesser of (a) $116,544.00, (i.e., $8.00, multiplied by the area of the Premises) or (b) the actual costs of the Plans and the Landlord's Work (the "Allowance"). (b) If Landlord determines that the cost of the Landlord's Work will exceed the Allowance, then prior to commencement of the Landlord's Work, Landlord will submit to Tenant a cost estimate for the Landlord's Work ("Cost Estimate") which Tenant shall approve or reject within five (5) days after receipt thereof. It is understood that the cost of Landlord's Work shall include Landlord's then applicable construction supervision fee. Tenant's failure to reject the Cost Estimate within said five (5) day period shall be deemed to be an acceptance thereof. If Tenant rejects the Cost Estimate, Tenant shall, together with such rejection, propose such changes to the Plans as will cause the Cost Estimate to be acceptable. If the accepted Cost Estimate exceeds the Allowance, then Tenant shall pay to Landlord the amount of such excess within ten (10) business days after receipt by Tenant of a bill therefor, but in no event later than the Expansion Date for the Applicable Expansion Space. B-1 53 1.03 EXTRA WORK. (a) Tenant may request substitutions, additional or extra work and/or materials over and above Landlord's Work ("Extra Work") to be performed by Landlord provided that the Extra Work, in Landlord's judgment, (1) shall not delay completion of Landlord's Work or the Expansion Date for the Applicable Expansion Space pursuant to this Amendment; (2) shall be practicable and consistent with existing physical conditions in the Building and any other plans for the Building which have been filed with the appropriate municipality or other governmental authorities having jurisdiction thereover; (3) shall not impair Landlord's ability to perform any of Landlord's obligation hereunder or under the Lease or any other lease of space in the Building; and (4) shall not affect any portion of the Building other than the Premises. (b) (1) In the event Tenant requests Landlord to perform Extra Work and if Landlord accedes to such request, then and in that event, prior to commencing such Extra Work, Landlord shall submit to Tenant a written estimate ("Estimate") for said Extra Work to be performed. Within five (5) days after Landlord's submission of the Estimate, Tenant shall, in writing, either accept or reject the Estimate. Tenant's failure either to accept or reject the Estimate within said five (5) day period shall be deemed rejection thereof. (2) In the event that Tenant rejects the Estimate or the Estimate is deemed rejected, Tenant shall within five (5) days after such rejection propose to Landlord such necessary revisions of the Plans so as to enable Landlord to proceed as though no such Extra Work had been requested. Should Tenant fail to submit such proposals regarding necessary revisions of the Plans within said five (5) day period, Landlord, in its sole discretion, may proceed to complete Landlord's Work in accordance with the Plans already submitted, with such variations as in Landlord's sole discretion may be necessary so as to eliminate the Extra Work. (c) (1) All Extra Work shall require the installation of new materials at least comparable to Building standards and any substitution shall be of equal or greater quality than that for which it is substituted. (2) Tenant may request the omission of an item of Landlord's Work, provided that such omission shall not delay the completion of Landlord's Work and Landlord thereafter shall not be obligated to install the same. Credits for items deleted or not installed shall be granted in amounts equal to credits obtainable from subcontractors or materialmen. In no event shall there be any cash credits. (d) In the event Landlord performs Extra Work hereunder, Tenant shall pay to Landlord, upon acceptance of the Estimate or submission of Landlord's bid therefor, as the case may be, a sum equal to twenty percent (20%) of the Estimate or bid price to the extent the Estimate together with the amount set forth in the Cost Estimate exceeds the Allowance. In the event of any such excess, Tenant shall pay to Landlord such excess cost for the Extra Work within five (5) days after receipt by Tenant of a bill therefore or at such other time or times as agreed to, but in no event shall the entire balance be paid later than the completion of the Extra Work. 2. COMPLETION-PUNCH LIST. When the Landlord is of the opinion that the Landlord's Work is complete, then the Landlord shall so notify the Tenant. The Tenant agrees that upon such notification, the Tenant promptly (and not later than two (2) business days after the date of Landlord's said notice) will inspect the Premises and furnish to the Landlord a written statement that the Landlord's Work has been completed and is complete as required by the provisions of this EXHIBIT B, this Amendment and the Lease with the exception of certain specified and enumerated items (hereinafter referred to as the "Punch List"). The Tenant agrees that at the request of the Landlord from time to time thereafter, the Tenant will indicate in writing to Landlord whether any prior Punch List items have been completed. If the Punch List consists only of items which would not materially impair the Tenant's use or occupancy of the Premises, then, in such event, the Landlord's Work shall be deemed complete and Tenant shall be deemed to have accepted possession of the Premises, provided, Landlord shall promptly complete all such Punch List items; provided, however, that in no event shall Landlord be obligated to repair latent defects, not originally listed on the Punch List, beyond a period of six (6) months after the B-2 54 Completion Date. The date on which the Landlord's Work is complete, pursuant to the provisions of this subsection, is sometimes referred to as the "Date of Substantial Completion" or "Substantial Completion Date. " The Landlord's Work shall be deemed to be substantially complete and the Date of Substantial Completion will be deemed to have occurred upon the issuance of a certificate of occupancy or other similar license, permit, or authorization. Notwithstanding the foregoing, Tenant shall be obligated to pay Monthly Base Rent, Tenant's Share of Electrical Costs, Tenants' Share of Operating Expenses, and any other amounts pursuant to the Lease and this Amendment as of the Expansion Date for the Applicable Expansion Space. 3. POSSESSION-EXTENSION OF TERM AND ACKNOWLEDGMENTS. (a) The Tenant will take possession of the Premises as of and on the Expansion Date for the Applicable Expansion Space as set forth in Section 2 of this Amendment. Landlord has not agreed or represented that the Premises will be substantially ready for occupancy on the date specified in Section 2 of this Amendment. If for any reason whatsoever the Landlord's Work is not complete on said date, this Amendment shall nevertheless continue in full force and effect, and no liability shall arise against Landlord because of any such delay, provided, however, that all Rent due hereunder shall abate on a per them basis. Notwithstanding the foregoing, there shall be no abatement of Rent and no deferral of the Expansion Date for the Applicable Expansion Space if the Landlord's Work is not substantially complete due to any special equipment, fixtures or materials, changes, alterations or additions requested by Tenant, any delay of Tenant in submitting information necessary for the preparation of the Plans, the failure of Tenant to timely approve or reject the Cost Estimate, the failure of the Tenant to submit revisions following rejection or deemed rejection of the Estimate, the requirement of Tenant for any Extra Work, or the failure of the Tenant in supplying information of approving or authorizing plans, specifications, estimates or other matters, or any other act or omission of Tenant ("Tenant Delay"). If Tenant shall occupy all or any part of the Premises prior to the Expansion Date for the Applicable Expansion Space, all of the covenants and conditions of this Amendment, including the obligation to pay Rent, shall be binding upon the parties hereto in respect to such occupancy as if the first day of the Term had been the date when Tenant began such occupancy. 4. TENANT'S ENTRY PRIOR TO COMPLETION DATE. Landlord may permit Tenant or its agents or laborers to enter the Premises at Tenant's sole risk prior to the Expansion Date for the Applicable Expansion Space in order to perform through Tenant's own contractors such work as Tenant may desire, at the same time that Landlord's contractors are working in the Premises. The foregoing license to enter prior to the Expansion Date, however, is conditioned upon Tenant's labor not interfering with Landlord's contractors or with any other tenant or its labor. If at any time such entry shall cause disharmony, interference or union disputes of any nature whatsoever, or if Landlord shall, in Landlord's sole judgment, determine that such entry, such work or the continuance thereof shall interfere with, hamper or prevent Landlord from proceeding with the completion of the Building or Landlord's Work at the earliest possible date, this license may be withdrawn by Landlord immediately upon written notice to Tenant. Such entry shall be deemed to be under and subject to all of the terms, covenants and conditions of the Lease, and Tenant shall comply with all of the provisions of the Lease which are the obligations or covenants of the Tenant, including, but not limited to, the provisions of Section 9.01 of the Lease, except that the obligation to pay Rent shall not commence until the Expansion Date for the Applicable Expansion Space. In the event that Tenant's agents or laborers incur any charges from Landlord, including, but not limited to, charges for use of construction or hoisting equipment on the Building site, such charges shall be deemed an obligation of Tenant and shall be collectible as Rent pursuant to the Lease, and upon default in payment thereof, Landlord shall have the same remedies as for a default in payment of Rent pursuant to the Lease. 5. LANDLORD'S ENTRY AFTER SUBSTANTIAL COMPLETION. At any time after the Expansion Date for the Applicable Expansion Space, Landlord may enter the Premises to complete Punch List items, and such entry by Landlord, its agents, servants, employees or contractors for such purpose shall not constitute an actual or constructive eviction, in whole or in part, or entitle Tenant to any abatement or diminution of Rent, or relieve Tenant from any obligation under this Amendment or the Lease, or impose any liability upon Landlord or its agents. B-3 55 6. DELAYS. Landlord and Tenant mutually acknowledge that the Landlord's construction process in order to complete the Premises requires a coordination of activities and a compliance by the Tenant without delay of all obligations imposed upon the Tenant pursuant to this EXHIBIT B and that time is of the essence in the performance of Tenant's obligations hereunder and Tenant's compliance with the terms and provisions or this EXHIBIT B. 7. PROVISIONS SUBJECT TO LEASE. The provisions of this EXHIBIT B are specifically subject to the provisions of this Amendment. 56 EXHIBIT C FIFTH (5TH) FLOOR TERMINATED SPACE C-1 EX-13.1 7 PORTIONS OF THE COMPANY'S ANNUAL REPORT 1 EXHIBIT 13.1 SELECTED CONSOLIDATED FINANCIAL DATA(1) The following selected consolidated financial data as of and for the years ended December 31, 1998 and 1997 and for the year ended December 31, 1996 are derived from the Consolidated Financial Statements of the Company that have been audited by PricewaterhouseCoopers LLP, independent accountants, and are included elsewhere in this Annual Report. Selected consolidated financial data as of December 31, 1996 are derived from the Company's financial statements that have been audited by PricewaterhouseCoopers LLP, but are not included herein. The selected consolidated financial data as of and for the years ended December 31, 1995 and 1994 are derived from the Company's financial statements that have been audited by Belew Averitt LLP, independent accountants, but are not included herein. The data should be read in conjunction with "Management's Discussion and Analysis of Financial Condition and Results of Operations" and with the Company's Consolidated Financial Statements and Notes thereto.
(in thousands, except per share data) 1998 1997 1996 1995 1994 - ------------------------------------- -------- -------- -------- -------- -------- Net revenues $ 29,064 $ 20,903 $ 15,869 $ 9,296 $ 4,666 Net income (loss) 5,396 589 (3,485) (3,571) (423) Net income (loss) per share(2) Basic 0.52 0.08 (0.66) (1.30) (0.56) Diluted 0.48 0.07 (0.66) (1.30) (0.56) Working capital (deficit) 44,398 38,397 2,068 (1,560) (844) Total assets 60,320 49,923 13,892 10,316 4,150 Long-term obligations, net of current portion 58 661 6,353 6,994 4,718 Total stockholders' equity (deficit) 54,264 43,478 1,954 (2,380) (2,649)
(1) The Company's selected consolidated financial data for 1994 consist of the accounts of The Hotel Industry Switch Company (THISCO), a wholly owned subsidiary of the Company. Selected consolidated financial data for periods thereafter reflect the operations of the Company, including the depreciation and amortization of the following: o Acquisition of 83.3% of the outstanding capital stock of The Hotel Clearing Corporation (HCC) in July 1995; o Acquisition of the remaining 16.7% of the outstanding capital stock of HCC in June 1996; and o Acquisition of Driving Revenue L.L.C. (Driving Revenue) in August 1998. Amortization applicable to the acquisition of HCC totaled approximately $798,000, $1,534,000, $1,412,000 and $645,000 in 1998, 1997, 1996 and 1995, respectively. Amortization applicable to Driving Revenue totaled approximately $125,000 in 1998. (2) Certain net income (loss) per share amounts were retroactively adjusted for a one hundred-for-one stock split that occurred in June 1996 and a four-for-three stock split that occurred in August 1997. Such calculations reflect the adoption of Statement of Financial Accounting Standards No. 128, "Earnings per Share" (FAS 128) in 1997. In accordance with FAS 128, all prior periods presented were restated. 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis should be read in conjunction with "Selected Consolidated Financial Data" and the Consolidated Financial Statements and Notes thereto included elsewhere in this Annual Report. This Annual Report contains certain forward-looking statements that involve risks and uncertainties. The Company's actual results and the timing of certain events could differ materially from those discussed in the forward-looking statements as a result of certain factors including those set forth in the Company's filings with the Securities and Exchange Commission, including its Form 10-K for the fiscal year ended December 31, 1998. OVERVIEW Pegasus is a leading provider of transaction processing services to the hotel industry worldwide. The Company is organized based on the products and services offered through its three core businesses: Electronic Distribution, Commission Processing and Business Intelligence. Pegasus Electronic Distribution. Services provided by the Electronic Distribution segment, consisting of the THISCO, TravelWeb, NetBooker and other Internet-based hotel reservation services, improve the efficiency and effectiveness of the hotel reservation process by enabling travel agents and individual travelers to electronically access hotel room inventory information and conduct reservation transactions. THISCO provides an electronic interface between a hotel's central reservation system and the global distribution systems (GDS) that travel agents use to book hotel and airline reservations. Pegasus derives revenues from its THISCO service by charging its hotel participants a fee based on the number of reservations made, less the number cancelled ("net reservations"), and a fee for "status messages" processed through the THISCO service. Status messages are electronic messages sent by hotels to GDSs to update room rates, features and availability information in GDS databases. As a hotel's cumulative volume of net reservations increases during the course of the calendar year, its fee per transaction decreases after predetermined transaction volume hurdles have been met. As a result, for higher volume customers, unit transaction fees are higher at the beginning of the year, when cumulative transactions are lower. The Company recognizes revenues based on the fee per transaction that a customer is expected to pay during the entire year. This process of recognizing revenues creates a deferred revenue balance during early periods of the year, which is reflected in interim balance sheets. The deferred revenue balance created during the early periods of the year is fully utilized and eliminated by the end of each year. Additionally, Pegasus generally charges new participants in the THISCO service a one-time set-up fee for work associated with the implementation of the interface with the THISCO service. Revenue for these one-time set-up fees is recognized on a percentage of completion basis as the services are performed over the set-up period, which generally ranges from two to six months. The Company also charges certain GDSs a fee based on the number of net reservations to compensate for the management and consolidation of multiple interfaces. TravelWeb provides hotel and airline reservation capabilities to individual travelers through the Internet (www.travelweb.com). Pegasus derives its TravelWeb revenues by charging participating hotels subscription fees based on the number of their properties included in the database and a combination of transaction fees or commissions. Transaction fees are based on the number of net reservations made at participating properties through the TravelWeb service, and commissions are based on the value of the guest stay for reservations booked through the TravelWeb service. NetBooker is a private label version of the TravelWeb database and booking capability that Pegasus offers to third-party Web sites. Pegasus realizes revenues from NetBooker by charging third-party Web sites an initial development and licensing fee and by charging hotels a fee based on the number of net reservations made through the NetBooker service. Pegasus Commission Processing. The Commission Processing segment, formerly referred to as HCC, is the global leader in hotel commission payment processing. Commission Processing services improve the efficiency and effectiveness of the commission payment process for participating hotels and travel agencies by consolidating payments 1 3 and providing comprehensive transaction reports. Pegasus derives revenues from its Commission Processing service by charging a participating travel agency a fee based on a percentage of commissions paid to that agency through the HCC service. The Company also generally charges a participating hotel a fee based on the number of commissionable transactions arising from that hotel. Revenues from Commission Processing travel agency fees can vary substantially from period to period based on the types of hotels at which reservations are made and fluctuations in overall room rates. Pegasus recognizes revenues from its Commission Processing service in the month in which the hotel stay occurs. In the immediate following month, Pegasus collects commissions from the hotels by the 12th business day of such month and pays commissions to travel agencies by the 15th business day of such month. If a hotel fails to deliver funds to the Company, Pegasus is not obligated to deliver commission payments on behalf of the hotel to travel agencies. Pegasus Business Intelligence. The Business Intelligence segment, formerly referred to as the Pegasus IQ service, provides data mining and reporting services for benchmark analysis and strategic planning for the hotel industry. Pegasus derives its Business Intelligence revenues by charging hotels fees for the development of hotel databases and for consulting services. Historically, the Company has derived a majority of its revenues from Electronic Distribution and Commission Processing services. For the year ended December 31, 1998, approximately 42% of the Company's consolidated revenues was derived from Electronic Distribution services, approximately 55% of the Company's consolidated revenues was derived from Commission Processing services and approximately 3% of the Company's consolidated revenues was derived from Business Intelligence services. The Company has experienced substantial growth since its inception. Revenues increased at a compound annual rate of approximately 48% to $29.1 million in 1998 from $2.8 million in 1992, excluding 1992 revenues from the HCC service which was acquired in 1995. However, there can be no assurance that the Company will experience the same rate of revenue growth in the future. Any significant decrease in the rate of revenue growth could have a material adverse effect on the Company's financial condition and results of operations. The Company has developed or is in the process of developing several new services to capitalize on its existing technology and customer base and to provide additional electronic hotel reservation capabilities and information services to existing Pegasus customers and to other participants in the hotel room distribution process. New services for Electronic Distribution include services that automate the processing of hotel bookings for large meetings and conventions and for corporate travelers. New services for Business Intelligence include data mining and reporting services for benchmark analysis and strategic planning for the hotel industry. The Company 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. The Company's future success will depend, in part, on its ability to: o develop leading technologies; o enhance its existing services; o develop and introduce new services that address the increasingly sophisticated and varied needs of its current and prospective customers; and o respond to technological advances and emerging industry standards and practices on a timely and cost-effective basis. The Company's cost of services consists principally of personnel costs relating to information technology, facilities and equipment maintenance costs and fees paid to the Company's processing bank for the processing of travel agency commissions. 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, office, legal and accounting related. Marketing and promotion expenses consist primarily of personnel costs, advertising, amortization of customer incentive contracts, public relations and participation in trade shows and other industry events. Depreciation and amortization expense includes depreciation of computer equipment, office furniture, office equipment and leasehold improvements as well as amortization of software and goodwill. Interest expense includes interest on notes payable to certain stockholders of the Company and interest on payments made under capital equipment leases. Minority interest represents certain former minority interests in subsidiaries that have been wholly owned by the Company since June 1996. 2 4 YEARS ENDED DECEMBER 31, 1998 AND 1997 Net revenues. The Company's net revenues for 1998 increased to $29.1 million from $20.9 million in 1997, an increase of 39.0%. The increase in revenues was primarily driven by higher transaction levels for the Company's Electronic Distribution and Commission Processing services as well as revenue derived from new Business Intelligence services. Electronic Distribution revenues increased 24.8% in 1998 compared to 1997 primarily due to an increase in the number of hotel reservations made through the Company's site on the Internet (www.travelweb.com) and an increase in the average fee earned per transaction. In addition, there was an increase in the number of hotel reservations made through other Internet sites that use the Company's NetBooker service. Also, more hotel companies paid fees to be listed in the Company's hotel database. Net reservations made through the Company's THISCO service increased by 22.6% in 1998 compared to 1997, but this increase was offset by a reduction in the average fee per reservation. As a result, net revenues from the THISCO service remained consistent with the prior year. Commission Processing revenues increased 43.6% in 1998 compared to 1997 as a result of a 34.4% increase in the number of hotel commission transactions processed. The increase in the number of transactions was due in part to an increase in the number of hotel properties and travel agencies participating in the Commission Processing service. The value of commissions paid by the Company increased 48.5% in 1998 compared to 1997 because of an increase in the number of hotel commission transactions processed by the Company combined with an increase in the average value of the commissions processed. The average value of commissionable transactions processed by the Company increased due to rising overall average daily rates for hotel rooms as well as a higher proportion of transactions generated by full-service and luxury hotel chains. Net revenues arising from the increase in commissions paid was somewhat offset by a reduction in the average fee received from participating travel agencies for consolidating and remitting hotel commission payments. Business Intelligence revenues were $903,000 for 1998 and consisted of fees charged to hotels for the development and maintenance of hotel databases and for consulting services. Cost of services. Cost of services increased by $2.3 million, or 30.5%, to $9.7 million in 1998 from $7.4 million in 1997. Cost of services increased due to additional staffing, higher pay rates for technology personnel and the increased number of Commission Processing transactions, which added to the processing fees paid to the Company's processing bank. Research and development; Write-off of purchased in-process R&D. Research and development expenses increased $1.7 million, or 65.9%, to $4.2 million in 1998 from $2.5 million in 1997. Excluding the effect of the one-time charge taken in 1998 for in-process research and development expenses relating to the acquisition of Driving Revenue L.L.C. (Acquisition), research and development expenses increased $170,000, or 6.8%, to $2.7 million in 1998 from $2.5 million in 1997. This increase was primarily due to expenditures relating to the development of Business Intelligence services. Based on a third party valuation, approximately $1.5 million of the Acquisition purchase price was allocated to in-process research and development projects that at the time of the Acquisition had not reached technological feasibility and had no probable alternative future use. General and administrative expenses. General and administrative expenses increased $727,000, or 19.6%, to $4.4 million in 1998 from $3.7 million in 1997. The increase was primarily due to higher legal, accounting, insurance, printing and reporting costs associated with operating as a public company. Marketing and promotion expenses. Marketing and promotion expenses increased $826,000, or 20.7%, to $4.8 million in 1998 from $4.0 million in 1997. Marketing and promotion expenses grew primarily due to the addition of sales and marketing staff, the promotion of the TravelWeb service and amortization of new customer contract incentives. 3 5 Depreciation and amortization. Depreciation and amortization expenses decreased $327,000, or 10.8%, to $2.7 million in 1998 from $3.0 million in 1997. This decrease was primarily due to the final amortization of capitalized software related to the Company's acquisition of 83.3% of HCC's outstanding capital stock in 1995. The decrease was partially offset by the addition of amortization related to software purchased from Wetherly International in December 1997 and the addition of goodwill and software amortization related to the acquisition of Driving Revenue L.L.C. (Driving Revenue) in August 1998. Interest income. Interest income increased $1.5 million to $2.5 million in 1998 from $994,000 in 1997. Interest income increased as a result of short-term investment of operating cash balances and of a portion of the proceeds from the Company's secondary public offering of its common stock in February 1998. In addition, 1998 included a full year of interest income earned on proceeds from the Company's initial public offering of common stock in August 1997. Interest expense. Interest expense decreased $453,000, or 75.5%, to $147,000 in 1998 from $600,000 in 1997. The 1998 expense reflects payments made under capital equipment leases. The 1997 expense consisted of interest accrued on promissory notes payable to certain Company stockholders as well as interest accrued on payments made under capital equipment leases. The Company repaid all of its promissory notes in August 1997 using a portion of the proceeds from its initial public offering. Income taxes. Income taxes for 1998 reflect state and foreign income taxes payable as the Company was able to realize the benefit of its federal net operating loss carryforwards. In the fourth quarter of 1998, the Company released a significant portion of the valuation allowance as management believes it is more likely than not that the net deferred tax asset will be realized. Income taxes for 1997 reflect foreign income taxes payable with respect to the taxable earnings of the Company's United Kingdom subsidiary, which reports earnings on a cost-plus basis. In 1997, the net deferred tax asset was fully reserved because of uncertainty regarding the Company's ability to realize the benefit of the asset in future years. YEARS ENDED DECEMBER 31, 1997 AND 1996 Net revenues. The Company's net revenues for 1997 increased to $20.9 million from $15.9 million in 1996, an increase of 31.7%. The increase in revenues was primarily driven by higher transaction levels for the Company's Electronic Distribution and Commission Payment services. Electronic Distribution revenues increased 21.2% in 1997 compared to 1996. Net reservations made through the Company's THISCO service increased 25.7% in 1997 compared to 1996. Revenues contributed by the Company's TravelWeb service decreased by 7.7% in 1997 compared to 1996. This decrease was primarily a result of the transition from revenues based on Web page building and maintenance fees to revenues based on monthly subscription fees and booking fees per net reservation. Commission Processing revenues increased 42.8% as a result of a 38.0% increase in hotel commission transactions processed during 1997 compared to 1996. The increase in the number of transactions was due in part to the addition of hotel properties, including those of Marriott Corporation, and travel agencies participating in the Commission Processing service. The net revenues to the Company per commissionable transaction increased in 1997 because of an increase in overall average daily rates for hotel rooms. Cost of services. Cost of services increased by $1.2 million, or 20.1%, to $7.4 million in 1997 from $6.2 million in 1996. Cost of services increased due to additional staffing in support of the Company's Electronic Distribution and Commission Processing services and the increased number of Commission Processing transactions, which added to the processing fees paid to the Company's processing bank. Research and development; Write-off of purchased in-process R&D. Research and development expenses increased $298,000, or 13.5%, to $2.5 million in 1997 from $2.2 million in 1996. Excluding the effect of the one-time charge taken in 1996 for in-process research and development expenses relating to the acquisition of HCC, research and development expenses increased $543,000, or 27.7%, to $2.5 million in 1997 from $2.0 million in 1996. This increase was primarily due to additional work on TravelWeb including the development of the hotel database. 4 6 General and administrative expenses. General and administrative expenses decreased $84,000, or 2.2%, to $3.7 million in 1997 from $3.8 million in 1996. This decrease was primarily due to a number of non-recurring expenses incurred in 1996 associated with the closing of a financial transaction. Marketing and promotion expenses. Marketing and promotion expenses increased $1.2 million, or 41.5%, to $4.0 million in 1997 from $2.8 million in 1996. Marketing and promotion expenses grew primarily due to the addition of sales and marketing staff, the promotion of TravelWeb and, to a lesser degree, the promotion of the other Electronic Distribution services and Commission Processing services. Depreciation and amortization. Depreciation and amortization expenses decreased $409,000, or 11.9%, to $3.0 million in 1997 from $3.4 million in 1996. This decrease was primarily due to the 1996 completion of amortization for a number of software development projects that had been previously capitalized. Interest income. During 1997, the Company realized $994,000 in interest income as a result of short-term investment of operating cash balances and of the proceeds from its initial public offering. Interest expense. Interest expense decreased $293,000, or 32.8%, to $600,000 in 1997 from $893,000 in 1996. The expense reflects interest accrued on promissory notes payable to certain stockholders of the Company and interest accrued on payments made under capital equipment leases. Interest expense decreased primarily due to the repayment of all promissory notes in August 1997 using proceeds from the Company's initial public offering of common stock. Income taxes. Income taxes reflect foreign income taxes payable with respect to the taxable earnings of the Company's United Kingdom subsidiary, which reports earnings on a cost-plus basis. LIQUIDITY AND CAPITAL RESOURCES The Company's principal sources of liquidity at December 31, 1998 included cash and cash equivalents of $25.0 million, short-term investments of $15.8 million and restricted cash of $2.1 million. Restricted cash represents funds for travel agency commission checks that have not cleared the processing bank and are returned to the Company. The portion of restricted cash not remitted to travel agents will be escheated to the appropriate state, as required. The Company has financed its cash requirements for investments in equipment primarily through cash generated from operations, the sale of capital stock and capital lease financing. Working capital increased from $38.4 million in 1997 to $44.4 million in 1998, and net cash provided by operating activities increased from $2.8 million in 1997 to $6.8 million in 1998 due to the Company's improved operating performance. Capital expenditures consist of purchases of software, furniture and equipment and amounted to $1.7 million in 1998 compared to $1.6 million in 1997. In addition, the Company acquired no equipment under capital leases in 1998 compared with $79,000 in 1997. Additional uses of cash for investing activities in 1998 included the purchase of Driving Revenue, strategic equity investments and marketable securities. The Company completed an initial public offering of its common stock in August 1997, raising proceeds of $40.5 million, net of offering expenses. Approximately $5.2 million of the proceeds was used to repay notes payable to stockholders and to repay certain lease obligations. The remainder of the proceeds was placed in short-term marketable securities. The Company completed a secondary offering of its common stock in February 1998, raising net proceeds to the Company of $4.2 million. A portion of the proceeds was used to repay certain lease obligations, with the remaining proceeds placed in short-term marketable securities. 5 7 The Company 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 the Company's results of operations to the extent such increases are not passed along to customers. The Company believes that there are sufficient funds available from operations to adequately manage the expansion of the business in the foreseeable future. YEAR 2000 COMPLIANCE The Year 2000 computer issue is primarily the result of information technology (IT) and non-IT systems and programs with date sensitive devices, such as embedded chips or code, using only the last two digits to refer to a year. The failure of these devices to interpret dates beyond the year 1999 could cause a system failure or other errors, with the resultant disruption in the operation of such systems. State of readiness. Beginning in July 1997, the Company established internally staffed project teams to address Year 2000 issues related to the services provided to customers as well as any IT and non-IT internal systems supporting the Company's operations. The Company is currently in the process of testing and upgrading, if necessary, its systems and processes to comply with the requirements of the Year 2000 date transition. Company personnel are researching internal IT and non-IT hardware, software and data issues related to dates and date range processing, and each product line is undergoing extensive internal and external testing. Any non-compliant hardware or software discovered during testing will be upgraded or replaced. This process includes contacting material third-party suppliers and customers to assess their Year 2000 readiness. The following is a table showing the Company's state of Year 2000 readiness based on management's assessment: STATE OF READINESS Internal IT and Non-IT Systems and Equipment
Percent Estimated Phase Complete Completion Date ----- -------- --------------- Awareness............................................... 100% Complete Assessment of changes required.......................... 100% Complete Remediation or replacement.............................. 90% June 1999 Testing................................................. 85% June 1999 Contingency planning.................................... 50% June 1999
Suppliers, Customers and Third-Party Providers
Percent Estimated Phase Complete Completion Date ----- -------- --------------- Awareness............................................... 100% Complete Assessment questionnaires............................... 100% Complete Detail assessment review with third-party providers..... 75% June 1999 Contract review......................................... 75% June 1999 Contingency planning.................................... 50% June 1999 Testing as applicable................................... 85% June 1999
Costs. During 1998 and 1997, the Company expensed approximately $258,000 and $108,000, respectively, in labor 6 8 costs associated with its Year 2000 efforts. In 1999, labor costs related to Year 2000 efforts are expected to be less than those incurred in 1998 and comparable to those incurred in 1997. In addition, the Company anticipates incurring approximately $13,000 for the lease of additional testing hardware in 1999. In 1998, the Company capitalized $48,000 of computer equipment. This computer equipment was purchased to address the Year 2000 issue, and upon the completion of Year 2000 testing it is anticipated that such equipment will be used to support the growth of current systems. The Company does not anticipate incurring a material amount of additional costs related to the purchase of IT or non-IT systems hardware for the purpose of addressing the Year 2000 issue. Cash required to fund these matters is expected to be generated from operations. To date, no IT development projects have been delayed due to Year 2000 remediation efforts. Risk/Contingency Plans. Even though the Company is undertaking efforts to ensure that all its systems and programs are Year 2000 compliant, the Company has no control over services, functions and data provided by third-party vendors and others which may result in the inability to provide services. The Company has contacted and is working with its material customers and vendors to verify their degree of Year 2000 compliance. The Company has requested end-to-end testing with those systems that interface with the Company's systems. However, the Company has no control over Year 2000 compliance for third parties. To date, the Company has received responses from substantially all of its material third-party customers and vendors. The extent to which third-party customers and vendors do not become Year 2000 compliant in a timely manner may have a material adverse effect on the Company's cash flow and results of operations. The Company derives nearly all of its revenues from processing electronic reservations or consolidating hotel commissions electronically. The inability or limitation of its ability to process electronic reservations or consolidate hotel commissions due to Year 2000 problems would have a material impact on the Company's revenues and cash flow. Due to the electronic medium used by the Company to conduct the majority of its business, any interruption or outage of telecommunications, electricity or other basic utility services may also adversely impact the Company's ability to do business. As discussed above, the Company has begun its efforts to evaluate the readiness of these critical suppliers. The Company services the travel industry and is dependent on the continued health of the industry. Any general disruption of travel due to Year 2000 issues that adversely affects other travel vendors such as airlines, hotels and travel agency systems would also have a material adverse effect on the Company's cash flows and results of operations. The Company is in the early phase of developing contingency plans and determining the extent of such plans. RECENTLY ISSUED ACCOUNTING STANDARDS In March 1998, the American Institute of Certified Public Accountants issued Statement of Position No. 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" (SOP 98-1). SOP 98-1 requires that certain costs related to the development or purchase of internal-use software be capitalized and amortized over the estimated useful life of the software. SOP 98-1 is effective for financial statements for fiscal years beginning after December 15, 1998. Accordingly, the Company will adopt SOP 98-1 in its 1999 annual financial statements. The Company does not believe the adoption of SOP 98-1 will have a material impact on the Company's results of operations or financial condition. In June 1998, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 133, "Accounting for Derivative Instruments and Hedging Activities" (FAS 133). FAS 133 requires that all derivative instruments be recorded on the balance sheet at fair value. Changes in the fair value of derivative instruments are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction. FAS 133 is effective for the Company's first quarter financial statements in fiscal 2000. The Company is not currently involved in derivative instruments or hedging activities, and therefore, will measure the impact of this statement as it becomes necessary. 7 9 REPORT OF INDEPENDENT ACCOUNTANTS To the Board of Directors and Stockholders of Pegasus Systems, Inc. In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of operations and changes in stockholders' equity (deficit) and of cash flows present fairly, in all material respects, the financial position of Pegasus Systems, Inc. and its subsidiaries at December 31, 1998 and 1997, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 1998, in conformity with generally accepted accounting principles. These financial statements are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. PricewaterhouseCoopers LLP Dallas, Texas February 2, 1999 F-1 10 PEGASUS SYSTEMS, INC. CONSOLIDATED BALANCE SHEETS DECEMBER 31, 1998 AND 1997 ASSETS
1998 1997 ------------ ------------ Cash and cash equivalents ........................................ $ 25,002,185 $ 30,166,793 Restricted cash .................................................. 2,106,676 1,286,032 Short-term investments ........................................... 15,768,400 9,380,050 Accounts receivable, net of allowance for doubtful accounts of $98,633 and $77,860, respectively ................................ 3,687,518 1,972,135 Other current assets ............................................. 3,689,254 1,232,874 ------------ ------------ Total current assets ................................. 50,254,033 44,037,884 Capitalized software, net ........................................ 869,619 1,183,453 Property and equipment, net ...................................... 2,635,068 2,712,091 Goodwill, net of accumulated amortization of $522,018 and $303,815, respectively ......................................... 4,238,071 1,560,900 Other noncurrent assets .......................................... 2,323,620 428,981 ------------ ------------ Total assets ......................................... $ 60,320,411 $ 49,923,309 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Accounts payable and accrued liabilities ......................... $ 4,715,018 $ 4,048,343 Unearned income .................................................. 258,667 477,688 Current portion of capital lease obligations ..................... 535,072 1,048,179 Customer deposits ................................................ 347,422 66,694 ------------ ------------ Total current liabilities .............................. 5,856,179 5,640,904 Capital lease obligations, net of current portion ................ 57,634 661,049 Other noncurrent liabilities ..................................... 142,380 143,612 Commitments and contingencies (Note 11) .......................... -- -- Stockholders' equity: Preferred stock, $.01 par value; 2,000,000 shares authorized; Zero shares issued and outstanding ..................... -- -- Common stock, $.01 par value; 50,000,000 shares authorized, 10,653,371 and 10,297,529 shares issued, respectively ........................................... 106,533 102,975 Additional paid-in capital ................................. 63,383,905 58,120,337 Unearned compensation ...................................... (615,636) (738,533) Accumulated deficit ........................................ (8,584,246) (13,980,697) Less treasury stock (116,484 shares, at cost) .............. (26,338) (26,338) ------------ ------------ Total stockholders' equity ............................. 54,264,218 43,477,744 ------------ ------------ Total liabilities and stockholders' equity ............. $ 60,320,411 $ 49,923,309 ============ ============
See accompanying notes to consolidated financial statements. F-2 11 PEGASUS SYSTEMS, INC. CONSOLIDATED STATEMENTS OF OPERATIONS YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 ------------ ------------ ------------ Net revenues (Note 1) ................ $ 29,064,467 $ 20,903,416 $ 15,869,012 Cost of services ..................... 9,716,854 7,445,271 6,199,058 Research and development ............. 2,673,628 2,504,074 1,961,055 Write-off of purchased in-process research and development (Note 3) .. 1,480,085 -- 244,600 General and administrative expenses .. 4,442,557 3,715,547 3,799,199 Marketing and promotion expenses ..... 4,823,787 3,998,054 2,824,633 Depreciation and amortization ........ 2,689,867 3,016,619 3,425,678 ------------ ------------ ------------ Operating income (loss) .............. 3,237,689 223,851 (2,585,211) Other income (expense): Interest income .................... 2,503,265 993,592 114,150 Interest expense ................... (146,879) (600,067) (893,177) ------------ ------------ ------------ Income (loss) before income taxes and minority interest .............. 5,594,075 617,376 (3,364,238) Income taxes ......................... 197,624 27,916 15,000 ------------ ------------ ------------ Income (loss) before minority interest 5,396,451 589,460 (3,379,238) Minority interest .................... -- -- (105,563) ------------ ------------ ------------ Net income (loss) .................... $ 5,396,451 $ 589,460 $ (3,484,801) ============ ============ ============ Basic net income (loss) per share: Basic .............................. $ 0.52 $ 0.08 $ (0.66) ============ ============ ============ Diluted ............................ $ 0.48 $ 0.07 $ (0.66) ============ ============ ============ Weighted average shares outstanding: Basic .............................. 10,460,947 7,200,382 5,246,800 ============ ============ ============ Diluted ............................ 11,196,895 8,676,052 5,246,800 ============ ============ ============
See accompanying notes to consolidated financial statements. F-3 12 PEGASUS SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT) YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
PREFERRED STOCK COMMON STOCK ADDITIONAL NUMBER OF NUMBER OF PAID-IN UNEARNED SHARES AMOUNT SHARES AMOUNT CAPITAL COMPENSATION Balance at December 31, 1995 ............... -- $ -- 5,218,000 $ 52,180 $ 8,652,969 $ -- ---------- ------- ----------- -------- ----------- -------- Issuance of preferred stock to Information Associates, L.P. and Information Associates, C.V. ................ 1,538,463 15,385 -- -- 7,484,620 -- Issuance of common stock for purchase of minority interest ............ -- -- 89,733 897 277,725 -- Purchase of treasury stock....... -- -- -- -- -- -- Issuance of compensatory stock options ....... -- -- -- -- 551,150 (485,937) Proceeds from stock subscription ........ -- -- -- -- 1,900 -- Net loss .............. -- -- -- -- -- -- ---------- ------- ----------- -------- ----------- -------- Balance at December 31, 1996 ................ 1,538,463 15,385 5,307,733 53,077 16,968,364 (485,937) ---------- ------- ----------- -------- ----------- -------- Conversion of preferred stock to common stock ........ (1,538,463) (15,385) 1,538,463 15,385 -- -- Initial public offering ............ -- -- 3,450,000 34,500 40,459,000 --
TREASURY STOCK NUMBER OF ACCUMULATED SHARES AMOUNT DEFICIT TOTAL Balance at December 31, 1995 ................ -- $ -- $(11,085,356) $ (2,380,207) --------- ------- ------------ ------------ Issuance of preferred stock to Information Associates, L.P. and Information Associates, C.V. ............... -- -- -- 7,500,005 Issuance of common stock for purchase of minority interest ........... -- -- -- 278,622 Purchase of treasury stock ...... (116,484) (26,338) -- (26,338) Issuance of compensatory stock options ....... -- -- -- 65,213 Proceeds from stock subscription ........ -- -- -- 1,900 Net loss .............. -- -- (3,484,801) (3,484,801) Balance at December 31, 1996 ................ (116,484) (26,338) (14,570,157) 1,954,394 --------- ------- ------------ ------------ Conversion of preferred stock to common stock ........ -- -- -- -- Initial public offering ............ -- -- -- 40,493,500
F-4 13
Warrants issued for contract........ -- -- -- -- 238,000 -- Issuance of compensatory stock options....... -- -- -- -- 450,847 (252,596) Exercise stock options............. -- -- 1,333 13 4,126 -- Net income............ -- -- -- -- -- -- ----- ----- ---------- ------------ ------------ ------------ Balance at December 31, 1997.................. -- -- 10,297,529 102,975 58,120,337 (738,533) ----- ----- ---------- ------------ ------------ ------------ Secondary offering.............. -- -- 280,321 2,803 4,222,493 -- Windfall tax benefit of stock options......... -- -- -- -- 403,532 -- Issuance of compensatory stock options......... -- -- -- -- 240,928 28,176 Forfeitures of compensatory stock options......... -- -- -- -- (94,721) 94,721 Exercise stock options............... -- -- 63,875 639 330,592 -- Issuance for stock purchase plan.................. -- -- 11,646 116 160,744 -- Net income............ -- -- -- -- -- -- ----- ----- ---------- ------------ ------------ ------------ Balance at December 31, 1998.................. -- $ -- 10,653,371 $ 106,533 $ 63,383,905 $ (615,636) ===== ===== ========== ============ ============ ============
Warrants issued for contract.......... -- -- -- 238,000 Issuance of compensatory stock options......... -- -- -- 198,251 Exercise stock options............... -- -- -- 4,139 Net income.............. -- -- 589,460 589,460 -------- ------------ ------------ ------------ Balance at December 31, 1997.................. (116,484) (26,338) (13,980,697) 43,477,744 -------- ------------ ------------ ------------ Secondary offering.............. -- -- -- 4,225,296 Windfall tax benefit of stock options......... -- -- -- 403,532 Issuance of compensatory stock options......... -- -- -- 269,104 Forfeitures of compensatory stock options -- -- -- -- Exercise stock options............... -- -- -- 331,231 Issuance for stock purchase plan.................. -- -- -- 160,860 Net income.............. -- -- 5,396,451 5,396,451 -------- ------------ ------------ ------------ Balance at December 31, 1998.................. (116,484) $ (26,338) $ (8,584,246) $ 54,264,218 ======== ============ ============ ============
See accompanying notes to consolidated financial statements. 14 PEGASUS SYSTEMS, INC. CONSOLIDATED STATEMENTS OF CASH FLOWS YEARS ENDED DECEMBER 31, 1998, 1997 AND 1996
1998 1997 1996 ----------- ------------ ------------ Cash flows from operating activities: Net income (loss) ............................................... $ 5,396,451 $ 589,460 $ (3,484,801) Adjustments to reconcile net income (loss) to net cash provided by operating activities: Minority interest ............................................. -- -- 105,563 Accrued interest reclassified to notes payable ................ -- 58,049 91,927 Windfall tax benefit from employee exercise of non-qualified stock options .................................. 403,532 -- -- Write off of in-process research and development costs ........ 1,480,085 -- 244,600 Adjustment for discontinued software projects ................. -- -- 316,698 Loss (gain) on sale of equipment .............................. 4,821 (53) 9,564 Depreciation and amortization ................................. 2,689,867 3,016,619 3,425,678 Deferred income taxes ......................................... (2,084,625) -- -- Decrease goodwill due to release of valuation allowance ....... 1,467,246 -- -- Recognition of stock option compensation ...................... 269,104 198,251 65,213 Other ......................................................... 27,615 3,359 -- Changes in assets and liabilities: Restricted cash ............................................. (820,644) (595,826) (360,029) Accounts receivable ......................................... (1,566,348) (292,779) (284,104) Other current and noncurrent assets ......................... (807,830) (1,203,609) (156,931) Accounts payable and accrued liabilities .................... 794,456 1,425,801 748,481 Unearned income ............................................. (413,840) (463,488) (431,373) Other noncurrent liabilities ................................ 9,030 23,904 119,709 ------------ ------------ ------------ Net cash provided by operating activities ................. 6,848,920 2,759,688 410,195 ------------ ------------ ------------ Cash flows from investing activities: Purchase of software, property and equipment .................... (1,729,950) (1,594,401) (495,100) Proceeds from sale of software, property and equipment .......... 29,887 1,075 133,134 Purchase of marketable securities ............................... (33,832,343) (11,486,932) (2,705,076) Proceeds from sale of marketable securities ..................... 27,416,378 4,808,599 -- Purchase of Driving Revenue L.L.C. .............................. (5,998,366) -- -- Purchase of equity interest in investees ........................ (1,500,000) -- -- ------------ ------------ ------------ Net cash used in investing activities ..................... (15,614,394) (8,271,659) (3,067,042) ------------ ------------ ------------ Cash flows from financing activities: Proceeds from issuance of stock ................................. 4,717,387 40,497,639 7,500,005 Purchase of minority interest ................................... -- -- (2,000,000) Repayments on notes payable to affiliates ....................... -- (5,447,133) (235,000) Repayments of capital leases .................................... (1,116,521) (1,171,966) (974,969) Purchase of treasury stock ...................................... -- -- (26,338) Proceeds from stock subscription ................................ -- -- 1,900 Proceeds from line of credit .................................... -- -- 175,000 Repayment of line of credit ..................................... -- -- (175,000) Proceeds from capital leases .................................... -- 3,913 93,729 ------------ ------------ ------------ Net cash provided by financing activities ................... 3,600,866 33,882,453 4,359,327 ------------ ------------ ------------ Net increase (decrease) in cash and cash equivalents .............. (5,164,608) 28,370,482 1,702,480 Cash and cash equivalents, beginning year ......................... 30,166,793 1,796,311 93,831 ------------ ------------ ------------ Cash and cash equivalents, end of year ............................ $ 25,002,185 $ 30,166,793 $ 1,796,311 ============ ============ ============ Supplemental disclosure of cash flow information: Interest paid ................................................... $ 144,833 $ 601,787 $ 858,017 ============ ============ ============ Income taxes paid ............................................... $ 256,288 $ 17,916 $ -- ============ ============ ============ Supplemental schedule of noncash investing and financing activities: Acquisition of equipment under capital leases ................... $ -- $ 79,144 $ 1,045,988 ============ ============ ============ Issuance of common stock for acquisitions (Notes 3 and 8) ....... $ -- $ -- $ 278,622 ============ ============ ============ Common stock warrants issued in exchange for customer contract asset ............................................... $ -- $ 238,000 $ -- ============ ============ ============
See accompanying notes to consolidated financial statements. F-6 15 PEGASUS SYSTEMS, INC. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS DECEMBER 31, 1998, 1997 AND 1996 1. ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES ORGANIZATION AND BACKGROUND In July 1995, Pegasus Systems, Inc. (Pegasus or the Company) was formed as a Delaware holding company to combine the operations of two existing companies operating in the same industry, The Hotel Industry Switch Company (THISCO) and The Hotel Clearing Corporation (HCC). For accounting purposes, the combination was recorded as a purchase of HCC. CONSOLIDATION The accompanying financial statements include the consolidated accounts of Pegasus and its wholly owned subsidiaries: THISCO, HCC, Pegasus IQ, Inc. (Pegasus IQ) and Driving Revenue L.L.C. (Driving Revenue) (collectively, the Company or Pegasus) THISCO is consolidated with its wholly owned subsidiary, TravelWeb, Inc. (TravelWeb), and HCC is consolidated with its wholly owned subsidiary, Pegasus Systems Inc. (UK) Limited (Pegasus UK). All significant intercompany balances have been eliminated in consolidation. THISCO was formed in September 1988 as a Delaware corporation. The Company's THISCO service provides an electronic interface from hotel central reservation systems to travel agencies through Global Distribution Systems (GDSs), which are electronic travel information and reservation systems such as SABRE. HCC, acquired by the Company in July 1995, was formed in July 1991 as a Delaware corporation. The Company's HCC service consolidates commissions paid by participating hotels to a participating travel agency into a single monthly payment and provides participants with comprehensive transaction reports. Hotel properties and travel agencies worldwide utilize the HCC service to increase efficiency and reduce costs associated with preparing, paying and reconciling hotel room reservation commissions. Pegasus UK, a wholly-owned subsidiary of HCC, was formed in September 1993 in England to market and provide services for travel agents and hotel chains operating in Europe, Africa and Asia. TravelWeb was formed in October 1995 as a Delaware corporation. The Company's TravelWeb service provides individual travelers direct access to online hotel information and the ability to make reservations electronically at hotel properties. In addition, through its NetBooker service, the Company offers TravelWeb's comprehensive hotel database and Internet hotel reservation capabilities to third-party Web sites. Pegasus IQ was formed in November 1997 as a Delaware corporation. Pegasus IQ is expected to provide a wide array of hotel industry data, research and reporting services for benchmark analysis and strategic planning purposes. Driving Revenue, acquired by the Company in August 1998 (Note 3), is a hotel database marketing and consulting firm. MANAGEMENT ESTIMATES In preparing the consolidated financial statements in conformity with generally accepted accounting principles, management is required to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses. Actual results may differ from those estimates. F-7 16 CASH AND CASH EQUIVALENTS The Company considers all highly liquid investments with maturities of three months or less from the date of purchase to be cash equivalents. RESTRICTED CASH Funds for travel agency commission checks which have not cleared the Company's processing bank after certain time periods are returned to the Company. Any amounts which are not remitted to travel agents will be escheated to the appropriate state, as required. INVESTMENTS IN DEBT SECURITIES Marketable securities held by the Company at December 31, 1998 and 1997 are classified as held-to-maturity and consist of corporate debt securities that mature in less than one year. At December 31, 1998 and 1997 the amortized cost of corporate debt securities was $15,768,400 and $9,380,050, respectively. As of December 31, 1998 and 1997, the aggregate fair market value of the held-to-maturity securities was not materially different from their carrying values. The gross unrealized gains and losses by type of security were not material. CAPITALIZED SOFTWARE All costs incurred in the internal development of computer software used in delivery of the Company's services are expensed until a product design and a working model of the software have been tested and completed. Thereafter, any further development or production costs are capitalized until the software is placed into service. Maintenance and customer support costs are expensed when incurred. Capitalized software development costs are amortized on a product-by-product basis using the greater of the amount computed by the ratio of current year net revenue to estimated future net revenue, or the amount computed by the straight-line method over a period which approximates the estimated economic life of the products. In the event unamortized software costs exceed the net realizable value of the software, the excess is recognized in the period the excess is determined. Additionally, capitalized software includes software purchased from third parties used in the operations of the Company. Prior to 1996, capitalized costs were being amortized over three to five years using the straightline method. However, in 1996 the Company changed the estimated life of all capitalized software costs to three years. The effect of this change in 1998 and 1997 was to increase net income by approximately $144,000 and $142,000 and basic and diluted income per share by $0.01 and $0.02, respectively. The effect of this change in 1996 was to increase net loss by approximately $292,000 and basic or diluted loss per share by $0.06. During 1996, the Company recorded a charge of approximately $317,000 resulting from discontinued software development projects. During 1998, 1997 and 1996, the Company capitalized software costs of approximately $646,000, $505,000, and $470,000, respectively. For all periods presented capitalized software additions consist of software purchased from third parties. During 1998, 1997 and 1996, amortization expense related to capitalized software was approximately $959,000, $1,435,000 and $2,125,000, respectively. Accumulated amortization of capitalized software was approximately $9,134,000 and $8,174,000 at December 31, 1998 and 1997, respectively. PROPERTY AND EQUIPMENT Property and equipment are recorded at cost and depreciated over their estimated useful lives, ranging from three to seven years. Leasehold improvements are amortized over the life of the lease using the straight-line method. Expenditures for maintenance and repairs, as well as minor renewals, are charged to 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. F-8 17 The Company evaluates long-lived assets to be held and used in the business, or to be disposed of, for impairment whenever events or changes in circumstances indicate that the net book value of the asset may not be recoverable. An impairment is determined by comparing expected future cash flows (undiscounted and before interest) to the net book value of the assets. If impairment exists, the amount of impairment is measured as the difference between the net book value of the assets and the estimated fair value of the related assets. Based on its most recent analysis, the Company believes that no impairment of property and equipment existed at December 31, 1998 or 1997. GOODWILL Goodwill represents the excess of the purchase price of acquisitions over the fair value of the net assets acquired. Goodwill is amortized on a straight-line basis over ten to fifteen years. Unamortized goodwill at December 31, 1998 and 1997, was $4,238,071 and $1,560,900, respectively. The carrying value of goodwill is evaluated periodically in relation to the operating performance and anticipated future undiscounted net cash flows of the related business. Based on its most recent analysis, the Company believes that no impairment of goodwill existed at December 31, 1998 or 1997. Amortization of goodwill was approximately $218,000, $125,000 and $121,000 in 1998, 1997 and 1996, respectively. OTHER INVESTMENTS In June 1998, the Company purchased 250,000 shares of Series A Convertible Preferred Stock of Customer Analytics, Inc. for $500,000. Customer Analytics, Inc. is a new database marketing applications and solutions provider specializing in the area of customer relationship marketing. The investment is accounted for based on the lower of cost or fair value. In September 1998, the Company purchased 225,225 shares of Series B Convertible Preferred Stock of Intermezzo Systems, Inc. for $1,000,000. Intermezzo Systems, Inc. is a developer of hotel reservation and property management systems and software. The investment is accounted for based on the lower of cost or fair value. REVENUES Pegasus primarily derives its revenues from transaction fees and commissions charged to participating hotels and travel agencies. The Company's revenues are predominantly transaction-based. Pegasus derives its revenues from its THISCO service by charging its hotel participants a fee based on the number of reservations made, less the number cancelled ("net reservations"), and a fee for "status messages" processed through the THISCO service. Status messages are electronic messages sent by hotels to GDSs to update room rates, features and availability information in GDS databases. As a hotel's cumulative volume of net reservations increases during the course of the calendar year, its fee per transaction decreases after predetermined transaction volume hurdles have been met. As a result, for higher volume customers, unit transaction fees are higher at the beginning of the year, when cumulative transactions are lower. The Company recognizes revenues based on the fee per transaction that a customer is expected to pay during the entire year. This process of recognizing revenues creates a deferred revenue balance during early periods of the year, which is reflected in interim balance sheets. The deferred revenue balance created during the early periods of the year is fully utilized and eliminated by the end of each year. Additionally, Pegasus generally charges new participants in the THISCO service a one-time set-up fee for work associated with the implementation of the interface with the THISCO service. Revenue for these one-time set-up fees is recognized on a percentage of completion basis as the services are performed over the set-up period, which generally ranges from two to six months. The Company also charges certain GDSs a fee based on the number of net reservations to compensate for the management and consolidation of multiple interfaces. Pegasus derives its revenues from its HCC service by charging a participating travel agency a fee based on a percentage of commissions paid to that agency through the HCC service. The Company also generally charges a participating hotel F-9 18 a fee based on the number of commissionable transactions arising from that hotel. Revenues from HCC travel agency fees can vary substantially from period to period based on the types of hotels at which reservations are made and fluctuations in overall room rates. Pegasus recognizes revenues from its HCC service in the month in which the hotel stay occurs. In the immediate following month, Pegasus collects commissions from the hotels by the 12th business day of such month and pays commissions to travel agencies by the 15th business day of such month. If a hotel fails to deliver funds to the Company, Pegasus is not obligated to deliver commission payments on behalf of the hotel to travel agencies. For the years ended December 31, 1998, 1997 and 1996, HCC revenues from hotels are presented net of commission payments to travel agencies of approximately $255,000,000, $165,000,000, and $105,000,000, respectively. HCC revenues also include amortization of a $2.0 million payment received by the Company in June 1993 in exchange for a five-year non-cancelable data processing contract. This payment was initially recorded as unearned income and is being recognized as revenue over the life of the contract (Note 11). Pegasus derives its TravelWeb revenues by charging participating hotels subscription fees based on the number of their properties included in the database and a combination of transaction fees or commissions. Transaction fees are based on the number of net reservations made at participating properties through the TravelWeb service, and commissions are based on the value of the guest stay for reservations booked through the TravelWeb service. Pegasus realizes revenues from NetBooker, the Company's hotel room reservation service provided to third-party Web sites, by charging third-party Web sites an initial development and licensing fee and by charging hotels a fee based on the number of net reservations made through the NetBooker service. Pegasus derives its Business Intelligence revenues by charging hotels fees for the development and maintenance of hotel databases and for consulting services. INCOME TAXES Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance is provided for a portion or all of the deferred tax assets when there is sufficient uncertainty regarding the Company's ability to recognize the benefits of the assets in future years. ADVERTISING COSTS Advertising and promotion-related expenses are charged to operations when incurred. Advertising expense for 1998, 1997 and 1996 was approximately $1,105,000, $609,000 and $613,000, respectively. FINANCIAL INSTRUMENTS The carrying amounts of the Company's financial instruments reflected in the consolidated balance sheets at December 31, 1998 and 1997 approximate their respective fair values. CONCENTRATIONS OF CREDIT RISK The Company's financial instruments exposed to concentrations of credit risk consist primarily of cash and receivables. Cash balances, exceeding the federally insured limits, are maintained in financial institutions; however, management believes the institutions are of high credit quality. The majority of receivables are due from companies which are well-established entities in the travel industry. Therefore, management considers any exposure from concentrations of credit risks to be limited. F-10 19 ACCOUNTING FOR STOCK-BASED COMPENSATION Statement of Financial Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (FAS 123), encourages, but does not require, companies to record compensation cost for stock-based employee compensation plans at fair value. Pro forma disclosure of net income (loss) based on the provisions of FAS 123 is presented in Note 9. For financial reporting purposes, the Company has elected to continue to account for stock-based compensation using the intrinsic value method prescribed in Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25), and related Interpretations. STOCK SPLITS A one hundred-for-one stock split was effected in June 1996. All references in the consolidated financial statements to shares, share prices, per share amounts and stock plans have been adjusted retroactively for the one hundred-for-one stock split. Additional information is presented in Note 8. In May 1997, the Board of Directors approved the declaration of a four-for-three stock split of the outstanding common and preferred stock effected in the form of a dividend to stockholders of record on the effective date of the Registration Statement on Form S-1 with respect to the Company's initial public offering (IPO) (Note 8). All references in the consolidated financial statements to shares, share prices, per share amounts and stock plans have been adjusted retroactively for the four-for-three stock split. FOREIGN CURRENCY TRANSLATION The U.S. dollar is the functional currency for the Company's foreign operations. Gains and losses on the translation into U.S. dollars of amounts denominated in foreign currencies are included in net income (loss). NET INCOME (LOSS) PER SHARE In 1997, the Company adopted Statement of Financial Accounting Standards No. 128, "Earnings per Share" (FAS 128). FAS 128 replaces primary and fully dilutive earnings per share with basic and diluted earnings per share. Unlike primary earnings per share, basic earnings per share excludes any dilutive effect of potential common shares. Basic net income per share is based on the weighted average outstanding common shares. Diluted net income per share is based on the weighted average outstanding shares reduced by the effect of potential common shares. Net income (loss) for prior periods presented in the accompanying consolidated financial statements have been restated to comply with FAS 128 (Note 15). COMPREHENSIVE INCOME In 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income". This statement requires separate financial statement disclosure of comprehensive income, which encompasses changes in net asset values derived from activity from both owner and non-owner sources. There were no items that qualified for treatment as components of other comprehensive income for the periods presented. SEGMENT INFORMATION In 1998, the Company adopted Statement of Financial Accounting Standards No. 131, "Disclosures about Segments of an Enterprise and Related Information" (FAS 131). FAS 131 supercedes Statement of Financial Accounting Standards No. 14, "Financial Reporting for Segments of a Business Enterprise", replacing the "industry" approach with the "management" approach. The management approach designates the internal organization that is used by management for making operating decisions and assessing performance as the source of the Company's reportable segments. FAS 131 also requires disclosures about products and services, geographic areas, and major customers. The adoption of FAS 131 did not affect results of operations or financial position but did affect the disclosure of segment information (Note 16). F-11 20 2. REORGANIZATION In July 1995, the Company issued 4,934,667 shares of its common stock in exchange for all of the outstanding capital stock of THISCO and 83.3% of the outstanding capital stock of HCC (the Reorganization). Lodging Network, Inc. (LNI) retained 210 shares of HCC preferred stock, representing a 16.7% minority interest in HCC. The Reorganization brought THISCO and HCC together under the control of Pegasus and was initiated to integrate and expand the existing businesses of THISCO and HCC. Pegasus was formed immediately prior to the transaction for the purpose of combining the two operations into a single entity. For accounting purposes, the combination was recorded as a purchase of HCC. 3. ACQUISITIONS In June 1996, the Company purchased 210 shares of HCC preferred stock from LNI for $2,000,000 cash and 89,733 shares of Pegasus common stock. The 210 HCC preferred shares purchased represented a 16.7% minority ownership of HCC. After the purchase, Pegasus owned 100% of the outstanding shares of HCC. The transaction was accounted for as a purchase. The amount paid in excess of the minority interest value of $1,445,245 on the date of purchase was approximately $833,000 and was accounted for as $119,000 of goodwill to be amortized ratably over a 15 year period, $245,000 of in-process research and development costs and $469,000 of step-up in the fair value of capitalized software costs. Such amount of in-process research and development was charged to expense at the date of acquisition. The fair value of the Company's common stock given as consideration was determined using an independent valuation. In August 1998, the Company acquired all of the equity interest in Driving Revenue for approximately $6 million plus estimated expenses of less than $100,000 (Acquisition). Driving Revenue provides hotel database marketing and consulting services. The Acquisition was recorded under the purchase method of accounting, and accordingly, Driving Revenue's results of operations subsequent to the Acquisition date are included in the accompanying consolidated financial statements. The purchase price has been allocated to assets acquired and liabilities assumed based on estimated fair value at the date of Acquisition. The approximate fair value of assets acquired and liabilities assumed at the date of acquisition, after giving effect to the write-off of certain purchased research and development, is summarized as follows:
Current assets (including approximately $2,000 cash). $ 176,000 Software............................................. $ 344,000 Property and equipment............................... $ 42,000 Goodwill............................................. $ 4,296,000 Current liabilities.................................. $ 338,000
Approximately $1,480,000, based on a valuation performed by a third party, was allocated to in-process research and development projects that at the time of the Acquisition had not reached technological feasibility and had no probable alternative future use. Factors considered in determining the amount of the purchase price allocated to in-process research and development include the estimated stage of development for each project at the acquisition date, the projected cash flows from the expected revenues to be generated from each project and discounting the net cash flows. Such amount of in-process research and development was charged to expense at the date of acquisition. The balance of the purchase price, approximately $4,296,000, was recorded as the excess of cost over the fair value of net assets acquired (goodwill) and is being amortized on a straight-line basis over a ten year period ending August 2008. F-12 21 4. ACCOUNTS RECEIVABLE The Company collects travel agents' commissions from hotel chains and, after retaining a portion of these commissions as a fee for services, remits the net commissions to the travel agents. At December 31, 1998 and 1997, trade accounts receivable were stated net of commissions of approximately $21,505,000 and $14,309,000, respectively. Net accounts receivable from affiliates of approximately $772,000 was included in the accompanying consolidated balance sheet at December 31, 1997. Net accounts receivable from affiliates for 1997 primarily consisted of amounts due from certain stockholder hotel chains. Disclosing the amounts due from stockholder hotel chains was not considered necessary in 1998 since their ownership percentage was reduced due to the Company's IPO in August 1997, the secondary offering in February 1998 and subsequent open market sales of their shares. The ownership percentage of the stockholder hotel chains was an aggregate of less than 10% of the Company's common shares outstanding at December 31, 1998; therefore, the stockholder hotel chains were not considered affiliates as of and for the year ended December 31, 1998. 5. PROPERTY AND EQUIPMENT Property and equipment at December 31 consisted of the following:
1998 1997 ----------- ----------- Computer equipment ............... $ 5,817,100 $ 4,985,455 Furniture and equipment .......... 890,334 677,183 Office equipment ................. 1,320,239 974,851 Leasehold improvements ........... 93,313 97,379 ----------- ----------- 8,120,986 6,734,868 Less: accumulated depreciation ... (5,485,918) (4,022,777) ----------- ----------- Property and equipment, net ...... $ 2,635,068 $ 2,712,091 =========== ===========
6. CAPITAL LEASES Assets recorded under capital leases, primarily consisting of computer equipment, are recorded at the lower of the present value of future minimum lease payments or the fair value of the asset. Total assets recorded under capital leases in 1998 and 1997 were approximately $3,436,000 and $3,747,000, respectively, net of accumulated amortization of $3,054,000 and $2,531,000, respectively. Amortization of assets under capital leases is included in depreciation and amortization expense. F-13 22 Future minimum lease payments and related interest are as follows:
YEAR ENDING DECEMBER 31, - ------------ 1999............................................ $ 602,041 2000............................................ 60,170 --------- Aggregate minimum lease payments................ 662,211 Less: amount representing interest and taxes.... (69,505) --------- 592,706 Less: current portion........................... (535,072) --------- $ 57,634 =========
Interest rates on capital leases range from approximately 7% to 15%. Interest expense on capital leases for the years ended December 31, 1998, 1997 and 1996 was approximately $144,000, $277,000 and $351,000, respectively. 7. NOTES PAYABLE In August 1997, the Company repaid all outstanding principal and accrued interest on notes payable from the proceeds of the Company's IPO (Note 8). Total principal and interest paid during 1997 was approximately $5,254,000 and $457,000, respectively. During 1996, the Company paid interest totaling $478,000. Interest expense related to these notes was approximately $322,000 and $539,000 during the years ended December 31, 1997 and 1996, respectively. 8. STOCKHOLDERS' EQUITY In conjunction with the Reorganization, the Company issued 283,333 shares of restricted common stock to certain members of management in connection with the termination of a bonus plan for HCC's management (Note 2). During 1996, the Company repurchased 25,467 shares from a terminated employee. The restrictions on these shares expired when the Company completed its IPO in August 1997. As a result of the Reorganization, certain stockholders exchanged shares of THISCO for shares of Pegasus. Additionally, in order to effect the purchase of HCC, the Company issued Pegasus shares to HCC stockholders in exchange for 83.3% of the outstanding capital stock of HCC. Some of the Pegasus shares exchanged for HCC shares were subject to repurchase. The repurchase was based upon an agreement by the HCC stockholders that some value for the HCC shares exchanged should be assigned based upon the number of transactions that an HCC stockholder committed to process through HCC in 1996. If a stockholder did not fulfill its commitment by processing the agreed number of transactions through HCC in 1996, the Company had the option to repurchase such shares for $0.01 per share. The total number of shares repurchased from each stockholder is based upon the percentage of their transaction commitment actually processed by HCC during 1996. Effective December 31, 1996, the Company repurchased 91,017 shares of the 477,733 shares subject to repurchase. In June 1996, Information Associates, L.P. and Information Associates, C.V. purchased 1,538,462 shares of the Company's series A preferred stock for $4.88 per share or $7,500,005. Total shares outstanding increased from 5,191,249 (including the 89,733 issued to LNI as part of the purchase of minority interest in HCC) to 6,729,712 shares, with the Information Associates, L.P. and Information Associates, C.V. ownership. In June 1996, the Company issued 89,733 shares of Pegasus common stock in conjunction with the acquisition of the minority ownership interest of HCC (Note 3). F-14 23 In June 1996, the Company declared a one hundred-for-one stock split effected in the form of a stock dividend to stockholders of record on that date (Note 1). The number of common shares the Company is authorized to issue was also increased from 100,000 to 20 million and the number of authorized preferred shares was increased from 10,000 to 2 million. In August 1997, the stockholders amended the Company's certificate of incorporation to increase the number of authorized shares of common stock from 20 million to 100 million. The Company completed an IPO in August 1997. The Company's Registration Statement on Form S-1 (File No. 333-28595) with respect to the IPO was declared effective on August 6, 1997, and the Company's stock began trading on the Nasdaq National Market under the symbol PEGS on August 7, 1997. The Company sold 3,450,000 shares of common stock at a per share price of $13.00. Net proceeds to the Company, after deduction of the underwriting discount and estimated IPO expenses, were approximately $40.5 million. Selling stockholders also sold 659,000 shares at a per share price of $13.00. Net proceeds to the stockholders after deduction of the underwriting discount were approximately $8.0 million. The Company did not receive any proceeds from the sale of shares by the selling stockholders. Concurrent with the completion of the Company's IPO, a four-for-three split of the Company's outstanding common and series A preferred stock was effected (Note 1), and all outstanding shares of series A preferred stock were converted into shares of common stock. Effective February 11, 1998, the Company completed a secondary offering. The Company sold 280,321 shares of common stock at $17.50 per share. Net proceeds, after deducting the underwriting discount and estimated offering expenses, were approximately $4.2 million. Selling stockholders also sold 2,134,679 shares at $17.50 per share. The Company did not receive any proceeds from the sales of shares by the selling stockholders. In May 1998, stockholders amended the Company's certificate of incorporation to reduce the number of authorized shares of common stock from 100 million to 50 million. The financial statements have been retroactively adjusted to reflect the reduction in authorized shares. In September 1998, the Board of Directors authorized the repurchase of up to $6 million in aggregate of the Company's common stock from time to time. No shares have been acquired as of December 31, 1998. In September 1998, the Board of Directors declared a dividend distribution of one preferred stock purchase right for each outstanding share of the Company's common stock. Each right will entitle stockholders to buy one one-thousandth of a share of the Company's series A preferred stock for each share of the Company's common stock held at a price of $90.00. The rights will be exercisable only if a person or group of affiliated or associated persons acquires, or has announced the intent to acquire, 20% or more of the Company's common stock. 9. STOCK-BASED COMPENSATION In accordance with the Company's 1996 stock option plan (1996 Plan), amended and approved in March 1997, options to purchase 866,667 shares of Company common stock may be granted to Company employees. Options granted under the 1996 Plan expire in December 2005. In accordance with the Company's 1997 stock option plan (1997 Plan), approved in March 1997 and amended in May 1998, options to purchase 600,000 shares of Company common stock may be granted to Company employees and non-employee directors and contractors. Options granted under the 1997 Plan expire in December 2006. Options granted under both the 1996 Plan and the 1997 Plan (collectively, Plans) may be in the form of incentive stock options or nonqualified stock options. The Stock Option Committee of the Board of Directors (Committee) administers the Plans and determines grant prices. Options granted to Company employees generally become exercisable in installments of 25% per year commencing one year from the date of grant while options granted to non-employee directors and contractors become exercisable over a vesting period determined by the Committee. The Company's authorized but unissued or reacquired common stock is used as stock options are exercised. F-15 24 In accordance with APB 25, the Company recorded unearned compensation of approximately $241,000, $451,000 and $551,000 in 1998, 1997 and 1996, respectively, related to options. Unearned compensation is being recognized ratably over the vesting period for stock option grants with exercise prices which are less than fair market value of the stock at the date of grant. Compensation expense of approximately $269,000, $198,000 and $65,000 was charged to operations in 1998, 1997 and 1996, respectively. As discussed in Note 1, the Company has adopted the disclosure-only provision of FAS 123. Had compensation cost for the Company's stock option plans been determined based on the fair value provisions of FAS 123, the Company's net income (loss) and net income (loss) per share would have been decreased (increased) to the pro forma amounts indicated below:
1998 1997 1996 ------------- ------------- ------------- Net income (loss)-- as reported ................ $ 5,396,451 $ 589,460 $ (3,484,801) Net income (loss) -- pro forma ................. $ 4,859,692 $ 334,589 $ (3,511,531) Net income (loss) per share -- as reported: Basic ........................................ $ 0.52 $ 0.08 $ (0.66) Diluted ...................................... $ 0.48 $ 0.07 $ (0.66) Net income (loss) per share -- pro forma: Basic ........................................ $ 0.46 $ 0.05 $ (0.67) Diluted ...................................... $ 0.43 $ 0.04 $ (0.67)
The pro forma disclosures provided are not likely to be representative of the effects on reported net income for future years due to future grants and the vesting requirements of the Company's stock option plans. The weighted average fair value for options with exercise prices equal to the market price of stock at the grant date was $6.81 in 1998 and $0.82 in 1996. There were no options granted in 1997 with exercise prices equal to the market price of stock at the grant date. The weighted average fair value for options with exercise prices below the market price of stock at the grant date was $13.49 in 1998, $8.51 in 1997 and $1.66 in 1996. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used:
1998 1997 1996 ---- ---- ---- Dividend yield...................... -- -- -- Expected volatility: Pre-IPO grants................... -- 0.0% 0.0% Post-IPO grants.................. 72.8% 65.0% -- Risk-free rate of return............ 4.6% 6.1% 6.5% Expected life....................... 4.0 years 4.9 years 4.0 years
The following table summarizes activity under the Company's stock option plans during the years ended December 31:
WEIGHTED AVERAGE EXERCISE NUMBER OF COMPANY OPTIONS PRICE PER SHARE ------------------------------------------- ------------------------------------------- 1998 1997 1996 1998 1997 1996 --------- --------- ------- --------- --------- --------- Options outstanding at beginning of year.......... 1,082,278 771,740 -- $ 5.75 $ 2.39 $ -- Granted ..................... 397,166 331,666 771,740 12.44 13.49 2.39 Exercised ................... 66,987 1,333 -- 5.60 3.11 -- Canceled .................... 78,496 19,795 -- 12.20 4.34 -- --------- --------- ------- --------- --------- --------- Options outstanding at end of year ................... 1,333,961 1,082,278 771,740 $ 7.37 $ 5.75 $ 2.39 ========= ========= ======= ========= ========= ========= Options exercisable at end of year .................. 490,523 263,434 -- $ 4.27 $ 2.33 -- ========= ========= ======= ========= ========= =========
F-16 25 The following table summarizes information for stock options outstanding at December 31, 1998:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE ---------------------------------------------- --------------------------- NUMBER OF WEIGHTED AVERAGE WEIGHTED NUMBER OF WEIGHTED OPTIONS REMAINING AVERAGE OPTIONS AVERAGE EXERCISE PRICES CONTRACTUAL LIFE EXERCISE PRICE EXERCISE PRICE - -------------------- --------- ---------------- -------------- --------- -------------- $ 2.01 496,333 7.0 years $ 2.01 304,249 $ 2.01 $ 3.11 186,170 6.8 years 3.11 95,033 3.11 $ 5.25 53,333 7.0 years 5.25 19,999 5.25 $ 9.50 - $ 13.39 323,949 7.9 years 10.73 1,116 11.05 $ 15.30 - $ 22.74 271,176 7.3 years 16.31 70,126 15.30 $ 25.38 3,000 8.0 years 25.38 -- -- - ---------------------------------------------------------------------------------------------- 1,333,961 7.3 years $ 7.37 490,523 $ 4.27 ==============================================================================================
10. INCOME TAXES Pretax income (loss) from continuing operations for the years ended December 31 was taxed under the following jurisdictions:
1998 1997 1996 ---------- ----------- ----------- Domestic. $5,495,808 $ 519,459 $(3,528,503) Foreign.. 98,267 97,917 58,702 ---------- ----------- ----------- $5,594,075 $ 617,376 $(3,469,801) ========== =========== ===========
Deferred taxes consisted of the following at December 31:
1998 1997 ----------- ----------- Deferred tax assets: Net operating loss carryforward....... $ 2,162,922 $ 4,214,785 Bad debt reserves..................... 36,396 26,473 Stock option compensation expense..... 181,545 81,873 Rent expense.......................... 52,540 82,552 Various expense accruals.............. 50,660 42,160 Charitable contributions.............. 22,495 -- Other................................. 24,160 10,801 ----------- ----------- Total gross deferred tax assets..................... 2,530,718 4,458,644 Valuation allowance................... (270,000) (4,312,266) Deferred tax liability: Software amortization................. (109,190) (79,850) Depreciation and amortization........ (66,903) (66,528) ----------- ----------- Net deferred tax assets................. $ 2,084,625 $ -- =========== ===========
In 1997 and 1996, the net deferred tax asset was fully reserved because of uncertainty regarding the Company's ability to recognize the benefit of the asset in future years. In the fourth quarter of 1998, the Company released a significant portion of the valuation allowance as management believes it is more likely than not that the net deferred tax asset will be realized. The remaining valuation allowance at December 31, 1998 relates to state net operating loss carryforwards. A portion of the deferred tax asset was related to net operating loss carryforwards of HCC that existed at the time HCC was acquired by the Company in 1995. Accordingly, approximately $1,467,000 of the valuation allowance released in 1998 reduced the remaining goodwill related to the purchase of HCC. At December 31, 1998, 1997 and 1996, the Company had federal net operating loss carryforwards of approximately $5,567,000, $12,252,000 and $14,635,000, respectively. The 1998 net operating loss carryforwards that existed at December 31, 1998 will begin to expire in 2007. Utilization of the net operating loss carryforwards may be limited by the separate return loss year rules and could be affected by ownership changes which have occurred or could occur in the future. F-17 26 The components of the income tax provision for the years ended December 31 were as follows:
1998 1997 1996 --------- --------- --------- Current provision: Federal .................. $ 381,025 $ 51,525 $ -- State .................... 462,413 -- -- Foreign .................. 38,100 27,916 15,000 --------- --------- --------- $ 881,538 $ 79,441 $ 15,000 ========= ========= ========= Deferred benefit: Federal .................. $(641,069) $(51,525) $ -- State .................... (42,845) -- -- --------- --------- --------- Provision for income taxes . $ 197,624 $ 27,916 $ 15,000 ========= ========= =========
A reconciliation of taxes based on the federal statutory rate of 34.0% and the provision for income taxes is summarized as follows for the years ended December 31:
1998 1997 1996 ------ ----- ------ Expected income tax provision 34.0% 34.0% (34.0%) (benefit) ................... Valuation allowance ......... (46.7%) (38.4%) 29.4% Permanent differences ....... 10.9% 9.8% 5.1% State income taxes .......... 5.0% -- -- Other, net .................. 0.3% (0.9%) (0.5%) ---- ---- ---- Provision for income taxes .. 3.5% 4.5% 0.0% ==== ==== ====
11. COMMITMENTS AND CONTINGENCIES The Company leases its corporate office space and certain office equipment under non-cancelable operating leases. The Company incurred rent expense of approximately $731,000, $720,000 and $697,000 in 1998, 1997 and 1996, respectively. Approximate future minimum lease payments at December 31, 1998, under non-cancelable operating leases with original terms exceeding one year, including the Pegasus UK operating lease translated at the rate in effect at December 31, 1998, were as follows:
YEAR ENDING DECEMBER 31, - ------------- 1999 ....... $ 998,000 2000 ....... 1,024,000 2001 ....... 1,024,000 2002 ....... 1,012,000 2003 ....... 63,000 Thereafter..... 137,000 ---------- $4,258,000
In June 1993, the Company received $2,000,000 from its processing bank in exchange for a five-year non-cancelable data processing contract and recorded the amount as deferred income. The non-cancelable contract requires the Company's processing bank to process transactions and generate various reports in exchange for a processing fee. The contract requires Pegasus to maintain an annual minimum volume of transactions. If the annual minimum volume is not attained, Pegasus is required to pay its processing bank an additional processing fee for each transaction under the minimum volume. As of the date HCC was acquired by the Company, there was approximately $1,583,000 of deferred income to be amortized over the remaining life of the contract according to the volume of guaranteed transactions, as defined by the contract. During 1998, 1997 and 1996, the Company recognized approximately $471,000, $471,000 and $431,000, respectively, of the deferred income. In 1998, 1997 and 1996, the Company exceeded the annual minimum volume requirement. The deferred income was fully amortized as of December 31, 1998. F-18 27 In May 1997, the Company issued a warrant to a customer for the purchase of 345,723 shares of the Company's common stock as part of a five year contract involving a wide range of the Company's services. The warrant is exercisable during the two year period ended May 12, 1999 at an exercise price of $7.20 per share. The Company used the Black-Scholes option pricing model to value the warrant. A contract asset of $238,000 was recorded in May 1997, which will be amortized ratably over the associated five year contract period. As of December 31, 1998, the Company had a commitment to pay an affiliate $125,000 in 1999 for software development and modification. 12. EMPLOYEE BENEFIT PLAN The Company sponsors a 401(k) defined contribution retirement plan (401(k) Plan) covering full-time employees who have attained the age of twenty-one. The 401(k) Plan allows eligible employees to defer receipt of up to fifteen percent of their compensation and contribute such amounts to various investment funds. Eligible employees may elect to participate at the beginning of any quarter after their hire date. Employee contributions vest immediately. The Company makes discretionary matching contributions up to five percent of employees' annual contributions. The Company's matching contributions vest on a pro rata basis over five years. During 1998, 1997 and 1996, the Company contributed approximately $292,000, $217,000 and $160,000, respectively, to the 401(k) Plan. 13. STOCK PURCHASE PLAN In May 1998, the Company's stockholders approved the Pegasus Systems, Inc. 1997 Employee Stock Purchase Plan (Stock Plan). The Company has reserved 500,000 shares of its common stock for purchase by its employees pursuant to the terms of the Stock Plan. Eligible participating employees of the Company may elect to have an amount up to, but not in excess of, 10% of their regular salary or wages withheld for the purpose of purchasing the Company's common stock. Under the Stock Plan, an eligible participating employee will be granted an option at the beginning of each plan year (the "Offering Commencement Date") to purchase at the end of the plan year (the "Offering Termination Date") shares of common stock using the amounts that have accumulated from the employee's payroll deductions made during the plan year at a price that is 85% of the closing price of the common stock on the Nasdaq National Market or any other national securities exchange on the Offering Commencement Date or the Offering Termination Date, whichever is lower. 14. RELATED PARTIES Prior to the IPO, the Company derived a substantial portion of its revenue from certain stockholders and stockholder-owned companies. For the years ended December 31, 1997 and 1996, revenue generated by stockholders and stockholder-owned companies was approximately $15.7 million, or 75.3%, and $12.0 million, or 75.4%, respectively. Disclosing revenues generated by stockholders was not considered necessary for the year ended December 31, 1998 since the ownership percentage of these stockholders was reduced by the Company's IPO in August 1997, the secondary offering in February 1998 and subsequent open market sales of their shares. The ownership percentage of these stockholders was an aggregate of less than 10% of the Company's common shares outstanding at December 31, 1998; therefore, these stockholders were not considered affiliates as of and for the year ended December 31,1998. A stockholder provides services to the Company, including facility management, consulting and software development. During 1998, 1997 and 1996, the Company recognized expense in the amount of approximately $461,000, $488,000 and $774,000, respectively, for those services. F-19 28 Persons related to an officer of the Company have provided printing, design and procurement services to the Company. During 1998, 1997 and 1996, the Company paid approximately $3,000, $6,000 and $143,000, respectively, related to these services, the majority of which related to capitalized furniture purchases. 15. NET INCOME (LOSS) PER SHARE Basic net income (loss) per share for the years ended December 31, 1998, 1997 and 1996 has been computed in accordance with FAS 128 using the weighted average number of common shares outstanding after giving retroactive effect to stock splits (Notes 1 and 8). Diluted net income (loss) per share for the years ended December 31, 1998, 1997 and 1996 gives effect to all dilutive potential common shares that were outstanding during the periods. Outstanding options and warrants with strike prices below the average fair market value of the Company's common stock for the years ended December 31, 1998 and 1997 were included in the diluted earnings per share (EPS) calculations for the respective periods. None of the options outstanding at December 31, 1996 were included in the diluted EPS calculation for the year ended December 31, 1996 because the Company had a net loss. In 1998, all outstanding options and warrants were included in the diluted EPS calculation for the six months ended June 30, 1998. Options for 54,000 shares of the Company's common stock at strike prices from $19.44 to $22.74 were excluded for the diluted EPS calculation for the three months ended September 30, 1998 because they were anti-dilutive. Options for 57,000 shares of the Company's common stock at strike prices from $19.44 to $25.38 were excluded from the diluted EPS calculation for the three months ended December 31, 1998 because they were anti-dilutive. The options excluded in 1998 expire from December 2005 to December 2006. In 1997, all outstanding options and warrants were included in the calculation of diluted EPS. In 1996, 1,538,462 shares of Series A preferred stock and options for 771,733 shares of the Company's common stock at strike prices from $2.01 to $3.11 were excluded from the diluted EPS calculation because they were anti-dilutive. The options excluded in 1996 expire December 2005. The following table sets forth the basic and diluted net income (loss) per share computation for the years ended December 31:
1998 1997 1996 ----------- ----------- ----------- Net income (loss) ................................. $ 5,396,451 $ 589,460 $(3,484,801) =========== =========== =========== Basic: Weighted average number of shares outstanding .... 10,460,947 7,200,382 5,246,800 ----------- ----------- ----------- Net income (loss) per share ...................... $ 0.52 $ 0.08 $ (0.66) =========== =========== =========== Diluted: Weighted average number of shares outstanding .... 10,460,947 7,200,382 5,246,800 Additional weighted average shares from assumed conversion of dilutive convertible preferred stock to common stock, net of shares to be repurchased with exercise proceeds .............. -- 921,355 -- Additional weighted average shares from assumed exercise of dilutive stock options and warrants, net of shares to be repurchased with exercise proceeds ........................................ 735,948 554,315 -- ----------- ----------- ----------- Weighted average number of shares outstanding used in the diluted net income (loss) per share calculation ..................................... 11,196,895 8,676,052 5,246,800 ----------- ----------- ----------- Net income (loss) per share ...................... $ 0.48 $ 0.07 $ (0.66) =========== =========== ===========
F-20 29 16. SEGMENT INFORMATION In 1998, the Company adopted FAS 131. The prior years' segment information has been restated to present the Company's three reportable segments: o Electronic Distribution--provides services that enable travel agents and individual travelers to electronically access hotel room inventory information and conduct reservation transactions; o Commission Processing--provides commission payment processing services to the hotel industry and travel agencies; and o Business Intelligence--provides data mining and reporting services for benchmark analysis and strategic planning for the hotel industry. The accounting policies of the segments are the same as those described in Note 1. Segment data includes a charge allocating all corporate costs to the operating segments. The Company evaluates the performance of its segments based on pretax income. The Company is organized primarily on the basis of products and services. The Company's segments are strategic business units that offer different products and services. Two of the Company's strategic business units have been aggregated into the Electronic Distribution segment: THISCO and TravelWeb. The Commission Processing segment consists of the Company's HCC service. Pegasus IQ and Driving Revenue have been aggregated into the Business Intelligence segment. The following table presents information about reported segments for the years ended December 31:
ELECTRONIC COMMISSION BUSINESS RECONCILING DISTRIBUTION PROCESSING INTELLIGENCE ITEMS TOTAL ------------- ------------ ------------- ------------ ------------- 1998 Net revenues ....................... $ 12,310,046 $ 15,851,557 $ 902,864 $ -- $ 29,064,467 Interest income .................... $ 14,358 $ 151,243 $ 12 $ 2,337,652 $ 2,503,265 Interest expense ................... $ 112,988 $ 33,788 $ 103 $ -- $ 146,879 Depreciation and amortization ...... $ 1,258,152 $ 1,175,451 $ 256,264 $ -- $ 2,689,867 Write-off purchased in-process R&D.. $ -- $ -- $ 1,480,085 $ -- $ 1,480,085 Income(loss) before taxes .......... $ 506,036 $ 5,527,910 $ (2,777,523) $ 2,337,652 $ 5,594,075 1997 Net revenues ....................... $ 9,864,738 $ 11,038,678 $ -- $ -- $ 20,903,416 Interest income .................... $ 7,820 $ 105,437 $ -- $ 880,335 $ 993,592 Interest expense ................... $ 516,631 $ 83,265 $ 171 $ -- $ 600,067 Depreciation and amortization ...... $ 1,074,780 $ 1,929,588 $ 12,251 $ -- $ 3,016,619 Income(loss) before taxes .......... $ (1,815,218) $ 2,122,436 $ (570,177) $ 880,335 $ 617,376 1996 Net revenues ....................... $ 8,139,259 $ 7,729,753 $ -- $ -- $ 15,869,012 Interest income .................... $ -- $ 4,839 $ -- $ 109,311 $ 114,150 Interest expense ................... $ 768,730 $ 124,447 $ -- $ -- $ 893,177 Depreciation and amortization ...... $ 1,742,691 $ 1,682,987 $ -- $ -- $ 3,425,678 Write-off purchased in-process R&D.. $ -- $ 244,600 $ -- $ -- $ 244,600 Loss before taxes and minority interest ........................... $ (3,289,159) $ (184,390) $ -- $ 109,311 $ (3,364,238)
Reconciling items represent interest income earned as a result of short-term investment of operating cash balances and a portion of proceeds from the Company's IPO and secondary public offering of common stock. The Company's business is conducted principally in the United States. The Company does not utilize or measure revenues by geographic location to evaluate the Electronic Distribution and Business Intelligence segments. However, the Company does track the geographic source of travel agency and hotel transactions that give rise to Commission Processing revenues. For 1998, 1997 and 1996, approximately $2,922,000, $2,037,000 and $1,246,000 of Commission Processing revenues were derived from customers based outside the United States. EX-21.1 8 SUBSIDIARIES OF THE COMPANY 1 EXHIBIT 21.1 LIST OF SUBSIDIARIES The Hotel Industry Switch Company Delaware The Hotel Clearing Corporation Delaware Pegasus IQ, Inc. Delaware TravelWeb, Inc. Delaware Driving Revenue, L.L.C. Maryland Pegasus Systems, Inc. (UK) Limited UK EX-23.1 9 CONSENT OF PRICEWATERHOUSECOOPERS LLP 1 EXHIBIT 23.1 CONSENT OF INDEPENDENT OF ACCOUNTANTS We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (Nos. 333-40039, 333-40033, and 333-40035) of Pegasus Systems, Inc. of our report dated February 2, 1999 appearing in Pegasus Systems Inc.'s 1998 Annual Report to Stockholders which is incorporated by reference into Pegasus Systems, Inc.'s Annual Report on Form 10-K for the year ended December 31, 1998. We also consent to the incorporation by reference of our report on the Financial Statement Schedule, which appears on page S-1 of such Annual Report on Form 10-K. PricewaterhouseCoopers LLP Dallas, Texas March 30, 1999 EX-27.1 10 FINANCIAL DATA SCHEDULE
5 This schedule contains summary financial information extracted from Company's for 10-K for the 12 months ended December 31, 1998 filed March 30, 1999 with Securities and Exchange Commission and is qualified in its entirety by reference to such 10-K. 1,000 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 27,109 15,768 3,786 (99) 0 50,254 18,124 (14,620) 60,320 5,856 0 0 0 107 54,157 60,320 0 29,064 0 9,717 2,674 0 147 5,594 198 5,396 0 0 0 5,396 0.52 0.48
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