UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

For the quarterly period ended September 30, 2015

or

For the transition period from                      to                     

Commission File Number: 001-36412

 

La Quinta Holdings Inc.

(Exact name of registrant as specified in its charter)

 

 

909 Hidden Ridge, Suite 600

Irving, Texas 75038

(Address of principal executive offices) (Zip Code)

(214) 492-6600

(Registrant’s telephone number, including area code)

 

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  o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

 

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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date:

The registrant had outstanding 129,638,534 shares of Common Stock, par value $0.01 per share as of October 23, 2015.

 

 

 

 

---

LA QUINTA HOLDINGS INC.

FORM 10-Q TABLE OF CONTENTS

FOR THE PERIOD ENDED SEPTEMBER 30, 2015

 

 

2

---

SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

In addition to historical information, this Quarterly Report on Form 10-Q may contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which are subject to the “safe harbor” created by those sections. All statements, other than statements of historical facts included in this Form 10-Q, including statements concerning our plans, objectives, goals, beliefs, business strategies, future events, business conditions, results of operations, financial position, business outlook, business trends and other information, may be forward-looking statements. Words such as “estimates,” “expects,” “contemplates,” “will,” “anticipates,” “projects,” “plans,” “intends,” “believes,” “forecasts,” “may,” “should” and variations of such words or similar expressions are intended to identify forward-looking statements. The forward-looking statements are not historical facts, and are based upon our current expectations, beliefs, estimates and projections, and various assumptions, many of which, by their nature, are inherently uncertain and beyond our control. Our expectations, beliefs, estimates and projections are expressed in good faith and we believe there is a reasonable basis for them. However, there can be no assurance that management’s expectations, beliefs, estimates and projections will result or be achieved and actual results may vary materially from what is expressed in or indicated by the forward-looking statements.

There are a number of risks, uncertainties and other important factors, many of which are beyond our control, that could cause our actual results to differ materially from the forward-looking statements contained in this Form 10-Q. Such risks, uncertainties and other important factors that could cause actual results to differ include, among others, the risks, uncertainties and factors set forth under “Risk Factors” in the Company’s Annual Report on Form 10-K, as amended, as filed with the Securities and Exchange Commission (the “SEC”), as such risk factors may be updated from time to time in our periodic filings with the SEC, and are accessible on the SEC’s website at www.sec.gov, and also include the following:

3

---

We caution you that the risks, uncertainties and other factors referenced above may not contain all of the risks, uncertainties and other factors that are important to you. In addition, we cannot assure you that we will realize the results, benefits or developments that we expect or anticipate or, even if substantially realized, that they will result in the consequences or affect us or our business in the way expected. There can be no assurance that (i) we have correctly measured or identified all of the factors affecting our business or the extent of these factors’ likely impact, (ii) the available information with respect to these factors on which such analysis is based is complete or accurate, (iii) such analysis is correct or (iv) our strategy, which is based in part on this analysis, will be successful. All forward-looking statements in this report apply only as of the date of this report or as of the date they were made and, except as required by applicable law, we undertake no obligation to publicly update any forward-looking statement, whether as a result of new information, future developments or otherwise.

All references to “we”, “us”, “our”, “Company” or “La Quinta” in this Quarterly Report on Form 10-Q mean La Quinta Holdings Inc., the La Quinta Predecessor Entities (as defined below) and their respective subsidiaries, unless the context otherwise requires.

 

 

4

---

PART I—FINANCIAL INFORMATION

 

 

La Quinta Holdings Inc.

Condensed Consolidated Balance Sheets (Unaudited)

As of September 30, 2015 and December 31, 2014

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

5

---

La Quinta Holdings Inc.

Condensed Consolidated Statements of Operations (Unaudited)

For the three and nine months ended September 30, 2015 and 2014

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

6

---

La Quinta Holdings Inc.

Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)

For the three and nine months ended September 30, 2015 and 2014

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

7

---

La Quinta Holdings Inc.

Condensed Consolidated Statements of Equity (Unaudited)

For the nine months ended September 30, 2015 and 2014

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

8

---

La Quinta Holdings Inc.

Condensed Consolidated Statements of Cash Flows (Unaudited)

For the nine months ended September 30, 2015 and 2014

 

9

---

 

 

The accompanying notes are an integral part of these unaudited condensed consolidated financial statements.

 

 

10

---

La Quinta Holdings Inc.

Notes to Condensed Consolidated Financial Statements (Unaudited)

As of and for the three and nine months ended September 30, 2015

 

NOTE 1. ORGANIZATION AND BASIS OF PRESENTATION

Organization

Effective April 14, 2014 (the “IPO Effective Date”), La Quinta Holdings Inc. (“Holdings”) completed its initial public offering (“IPO”) in which Holdings issued and sold 44.0 million shares of common stock. Holdings was incorporated in the state of Delaware on December 9, 2013 and, prior to the IPO Effective Date, had no operations. In connection with the IPO, we completed certain transactions including, among others, refinancing our existing debt, acquiring 14 previously managed hotels (the “Previously Managed Hotels”), and contributing the La Quinta Predecessor Entities (as defined below) into Holdings, which resulted in the La Quinta Predecessor Entities becoming owned by a “C” corporation for federal income tax purposes.

Lodge Holdco I L.L.C. (“Holdco I”) and Lodge Holdco II L.L.C. (“Holdco II”), each a Delaware limited liability company, were formed on January 4, 2006. Lodge Holdco III L.L.C. (“Holdco III”), a Delaware limited liability company, was formed March 17, 2006. We refer collectively to Holdco I, Holdco II, and Holdco III as the “La Quinta Predecessor Entities”. Since those dates and prior to the completion of our IPO, the La Quinta Predecessor Entities were owned and controlled by Blackstone Real Estate Partners IV L.P. and affiliates (“BREP IV”) and Blackstone Real Estate Partners V L.P. and affiliates (“BREP V”). BREP IV and BREP V are affiliates of The Blackstone Group L.P. (collectivity, the “Funds” or “Blackstone”).

As it pertains to the periods prior to completion of our IPO, the accompanying condensed consolidated financial statements include the accounts of each of the La Quinta Predecessor Entities, and all related wholly and majority owned subsidiaries and a consolidated Variable Interest Entity (“VIE”). For these periods, the La Quinta Predecessor Entities have been presented on a combined historical basis due to their prior common ownership and control. In connection with the IPO, the Funds and other pre-IPO owners contributed their equity interests in the La Quinta Predecessor Entities to Holdings in exchange for an aggregate of 81.06 million shares of common stock of Holdings. Holdings then transferred such equity interests to its wholly-owned subsidiary which pledged these interests as security for borrowings under a new credit agreement. As a result, as it pertains to the period subsequent to completion of our IPO, the accompanying condensed consolidated financial statements also include the accounts of Holdings, the Previously Managed Hotels, and all other wholly and majority owned subsidiaries created in connection with the IPO. The combined or consolidated entity presented may also be referred to herein as “La Quinta”, “we”, “us”, “our”, or the “Company”, as the context requires, when we refer to our historical operations and financial performance.

In November 2014 and in April 2015, Blackstone completed two secondary offerings in which it registered and sold 23.0 million and 23.9 million shares of Holdings common shares, respectively. As of September 30, 2015, Blackstone beneficially owned 27.1% of Holdings’ common shares outstanding.

We own and operate hotels, some of which are subject to a land lease, located in the United States under the La Quinta brand. We also franchise and, until the acquisition of the Previously Managed Hotels upon completion of our IPO, managed hotels under the La Quinta brand, with franchised hotels currently operating in the United States (“US”), Canada, Mexico and Honduras. As of September 30, 2015 and 2014, total owned and franchised hotels, and the approximate number of associated rooms were as follows:

 

 

 

⁽¹⁾ During the second quarter of 2015, we sold one of our Owned Hotels for $3.0 million, net of transaction costs. We recorded a loss on sale of $4.0 million related to this transaction. The purchaser subsequently signed a franchise agreement for this hotel to remain in our system. At September 30, 2015, Owned Hotels includes 24 hotels designated as assets held for sale, which are subject to a definitive purchase agreement.

11

---

Basis of Presentation and Use of Estimates

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information, the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all information or footnotes required by GAAP for complete annual financial statements. Although we believe the disclosures made are adequate to prevent the information presented from being misleading, these financial statements should be read in conjunction with Holdings’ consolidated financial statements and notes thereto for the years ended December 31, 2014, 2013 and 2012, which are included in our Annual Report on Form 10-K, filed by Holdings with the Securities and Exchange Commission on February 25, 2015. All intercompany transactions have been eliminated. In our opinion, the accompanying condensed consolidated financial statements reflect all adjustments, including normal recurring items, considered necessary for a fair presentation of the interim periods. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported and, accordingly, ultimate results could differ from those estimates. Interim results are not necessarily indicative of full year performance because of the impact of seasonal and short-term variations.

Effective April 14, 2014, we acquired 100% of the ownership interests of LQ Management L.L.C. (“LQM”) for $0.8 million in cash. Prior to April 14, 2014, LQM was a VIE, in which the La Quinta Predecessor Entities had a significant variable financial interest, and were the primary beneficiary. LQM received no member or other capital contribution, or equity investment upon formation or thereafter. LQM’s sole purpose is to manage all of our day-to-day operations, as well as to provide, prior to the IPO, day to day management of the Previously Managed Hotels. In return for providing these management services, we and, prior to the IPO, the Previously Managed Hotels pay LQM a management fee and reimburse LQM for costs incurred on our behalf, and, prior to the IPO, on behalf of the Previously Managed Hotels, in accordance with management and service agreements in place prior to the IPO. The La Quinta Predecessor Entities were the primary beneficiary of LQM as the management and service agreements in place provided for the La Quinta Predecessor Entities to reimburse LQM for its expenses in a manner that allowed LQM to realize a reasonable profit. We have not provided financial or other support to LQM during the periods presented that we were not contractually required to provide, and LQM’s agreements with its vendors are structured as non-recourse to our general credit. On April 14, 2014, LQM became a wholly owned subsidiary of Holdings and, as a result, is no longer a VIE.

 

 

NOTE 2. SIGNIFICANT ACCOUNTING POLICIES AND RECENTLY ISSUED ACCOUNTING STANDARDS

Revenue Recognition — Revenues primarily consist of room rentals, franchise fees and other hotel revenues. We defer a portion of our revenue from franchisees at the time the franchise agreement is signed and recognize the remainder upon hotel opening.

Room revenues are derived from room rentals at our owned hotels. We recognize room revenue on a daily basis based on an agreed-upon daily rate after the guest has stayed at one of our hotels. Customer incentive discounts, cash rebates, and refunds are recognized as a reduction of room revenues. Occupancy, hotel, and sales taxes collected from customers and remitted to the taxing authorities are excluded from revenues in the accompanying condensed consolidated statements of operations.

Included in franchise and other fee-based revenues are franchise fee revenues, which primarily consist of revenues from franchisees for application and initial fees, royalty, reservations, and training, as well as fees related to our guest loyalty program (“Returns”). We recognize franchise fee revenue on a gross basis because we (1) are the primary obligor in these arrangements, (2) have latitude in establishing rates, (3) perform the services delivered, (4) have some discretion over supplier selection, and (5) determine the specification of services delivered. The different types of franchise fee revenues are described as follows:

12

---

Included in franchise and other fee-based revenues are management fees of approximately $0.1 million for the three months ended September 30, 2014 and approximately $0.7 million for the nine months ended September 30, 2014, which represent fees earned from the Previously Managed Hotels, prior to their acquisition on April 14, 2014. Management fees from hotels include a base fee, which is generally a percentage of hotel revenues. (See Note 9)

Other hotel revenues include revenues generated by the incidental support of hotel operations for owned hotels and other rental income. We record rental income from operating leases associated with leasing space for restaurants, billboards, and cell towers. Rental income is recognized on a straight-line basis over the life of the respective lease agreement.

Brand marketing fund revenues from franchise and managed properties represent fees collected from franchised and managed hotels related to maintaining our Brand Marketing Fund (“BMF”). We maintain the BMF on behalf of all La Quinta branded hotel properties, including our owned hotels, from which national marketing and advertising campaign expenses are paid. Each La Quinta branded hotel is charged a percentage of its room revenue from which the expenses of the fund are covered. The corresponding expenditures of the BMF fees collected from franchised and managed hotels are presented as brand marketing fund expenses from franchised and managed hotels in our condensed consolidated statements of operations, resulting in no net impact to operating income or net loss.

Lodging operations are particularly sensitive to adverse economic and competitive conditions and trends, which could adversely affect the Company’s business, financial condition, and results of operations.

Assets held for sale—Long-lived assets are classified as held for sale when all of the following criteria are met:

When we identify a long-lived asset as held for sale, depreciation of the asset is discontinued and the carrying value is reduced, if necessary, to the estimated sales price less costs to sell by recording a charge to current earnings. All assets held for sale are monitored through the date of sale for potential adjustments based on offers we are willing to take under serious consideration and continued review of facts and circumstances. Losses on sales are recorded to the extent that the amounts ultimately received for the sale of assets differ from the adjusted book values of the assets. Gains on sales are recognized at the time the assets are sold, provided there is reasonable assurance the sales price will be collected and any future activities to be performed by the Company relating to the assets sold are expected to be insignificant.

Derivative Instruments — We use derivative instruments as part of our overall strategy to manage our exposure to market risks associated with fluctuations in interest rates. We regularly monitor the financial stability and credit standing of the counterparties to our derivative instruments. We do not enter into derivative financial instruments for trading or speculative purposes.

We record all derivatives at fair value. On the date the derivative contract is entered, we designate the derivative as one of the following: a hedge of a forecasted transaction or the variability of cash flows to be paid (“cash flow hedge”), a hedge of the fair value of a recognized asset or liability (“fair value hedge”), or an undesignated hedge instrument. Changes in the fair value of a derivative that is qualified, designated and highly effective as a cash flow hedge or net investment hedge are recorded in the condensed consolidated statements of comprehensive income (loss) until they are reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Changes in the fair value of a derivative that is qualified, designated and highly effective as a fair value hedge, along with the gain or loss on the hedged asset or liability that is attributable to the hedged risk, are recorded in current period earnings. Changes in the fair value of undesignated derivative instruments and the ineffective portion of designated derivative instruments are reported in current period earnings. Cash flows from designated derivative financial instruments are classified within the same category as the item being hedged in the condensed consolidated statements of cash flows.

13

---

If we determine that we qualify for and will designate a derivative as a hedging instrument at the designation date, we formally document all relationships between hedging activities, including the risk management objective and strategy for undertaking various hedge transactions. This process includes matching all derivatives that are designated as cash flow hedges to specific forecasted transactions, linking all derivatives designated as fair value hedges to specific assets and liabilities in our condensed consolidated balance sheets, and determining the foreign currency exposure of net investment of the foreign operation for a net investment hedge.

On a quarterly basis, we assess the effectiveness of our designated hedges in offsetting the variability in the cash flows or fair values of the hedged assets or obligations via use of a statistical regression approach. Additionally, we measure ineffectiveness using the hypothetical derivative method. This method compares the cumulative change in fair value of each hedging instrument to the cumulative change in fair value of a hypothetical hedging instrument, which has terms that identically match the critical terms of the respective hedged transactions. Thus, the hypothetical hedging instrument is presumed to perfectly offset the hedged cash flows. Ineffectiveness results when the cumulative change in the fair value of the hedging instrument exceeds the cumulative change in the fair value of the hypothetical hedging instrument. We discontinue hedge accounting prospectively when the derivative is not highly effective as a hedge, the underlying hedged transaction is no longer probable, or the hedging instrument expires, is sold, terminated or exercised.

Equity Based Compensation — We recognize the cost of services received in an equity based payment transaction with an employee as services are received and record either a corresponding increase in equity or a liability, depending on whether the instruments granted satisfy the equity or liability classification criteria.

The measurement objective for these equity awards is the estimated fair value at the grant date of the equity instruments that we are obligated to issue when employees have rendered the requisite service and satisfied any other conditions necessary to earn the right to benefit from the instruments. The compensation cost for an award classified as an equity instrument is recognized ratably over the requisite service period, including an estimate of forfeitures. The requisite service period is the period during which an employee is required to provide service for an award to vest.

Compensation cost for awards with performance conditions is recognized over the requisite service period if it is probable that the performance condition will be satisfied. If such performance conditions are not considered probable until they occur, no compensation expense for these awards is recognized.

Income Taxes — The accompanying condensed consolidated financial statements include taxable entities, limited liability companies, and, through April 14, 2014, REIT entities. Limited liability companies and REITs generally are not subject to federal income taxes at the entity level. For our taxable subsidiaries, we account for income taxes using the asset and liability approach for financial accounting and reporting purposes. For financial reporting purposes, income tax expense or benefit is based on reported financial accounting income or loss before non-controlling interests and income taxes related to our taxable subsidiaries. Deferred tax assets and liabilities reflect the temporary differences between assets and liabilities recognized for financial reporting and the analogous amounts recognized for tax purposes using the statutory tax rates expected to be in effect for the year in which the differences are expected to reverse, within the taxable subsidiaries.

Prior to the IPO, certain of our subsidiaries had elected to be treated as REITs for federal income tax purposes under the United States Internal Revenue Code. To qualify as REITs, these subsidiaries had to meet all of the required organizational and operational requirements, including a requirement that the REIT distribute at least 90% of its regular taxable income to its shareholders as dividends eligible for the dividends paid deduction. Prior to the IPO, the REIT subsidiaries adhered to these requirements. If the REIT subsidiaries failed to qualify as REITs in any taxable year, they would be subject to federal income taxes at regular corporate rates (including any applicable alternative minimum tax) and might not qualify as REITs for the four subsequent taxable years. For this reason, one of our REITs formed taxable subsidiaries to hold certain assets that could have otherwise adversely affected its REIT status. These taxable subsidiaries are or were subject to federal and state income taxes.

On April 14, 2014, the La Quinta Predecessor Entities were contributed to Holdings, a “C” corporation, the shares of capital stock held by third-party shareholders of our REIT entities were redeemed for cash totaling approximately $3.9 million, and our REITs were converted into limited liability companies. As a result of these transactions, we have become subject to additional entity-level taxes and, as of April 14, 2014, we recorded a one-time net deferred tax expense of $321.1 million, which reflects the establishment of the associated net deferred tax liability.

Newly Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09. The new guidance on revenue from contracts with customers will supersede most current revenue recognition guidance, including industry-specific guidance. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. The guidance provides a five-step analysis of transactions to determine when and how revenue is recognized. Other major provisions include capitalization of

14

---

certain contract costs, consideration of time value of money in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. The guidance also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. The guidance is effective for the interim and annual periods beginning on or after December 15, 2017; early adoption is permitted for annual reporting periods beginning after December 15, 2016. The guidance permits the use of either a retrospective or cumulative effect transition method. We have not yet selected a transition method and are currently evaluating the impact of the amended guidance on our consolidated financial position, results of operations and related disclosures.

In January 2015, the FASB issued ASU No. 2015-01, “Income Statement – Extraordinary and Unusual Items (Subtopic 225-20).” The amendments in this ASU eliminate the requirement of Extraordinary Items to be separately classified on the income statement. This will alleviate uncertainty for preparers, auditors, and regulators because auditors and regulators no longer will need to evaluate whether a preparer treated an unusual and/or infrequent item appropriately. The update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively or retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. We do not anticipate that the adoption of this standard will have a material impact on our financial position, results of operations and related disclosures.

In February 2015, the FASB issued ASU No. 2015-02, “Consolidation (Topic 810)—Amendments to the Consolidation Analysis.” The update primarily amends the criteria used to evaluate whether certain variable interest entities should be consolidated and modifies the criteria used to determine whether partnerships and similar entities are variable interest entities. The update is effective for interim and annual periods beginning after December 15, 2015 with early adoption permitted, including in the interim periods. We do not anticipate that the adoption of this standard will have a material impact on our financial position, results of operations and related disclosures.

In April 2015, the FASB issued ASU No. 2015-03, “Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” This ASU requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the debt liability rather than as an asset, which is consistent with the presentation of debt discounts or premiums. The provisions of ASU No. 2015-03 are effective for reporting periods beginning after December 31, 2015 and is required to be adopted retroactively; early adoption is permitted. We do not anticipate that the adoption of this standard will have a significant impact on our financial position, results of operations and related disclosures.

Newly Adopted Accounting Standards

In April 2014, the FASB issued ASU No. 2014-08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” Under the new guidance, only a disposal of a component that represents a major strategic shift of an organization qualifies for discontinued operations reporting. The guidance also requires expanded disclosures about discontinued operations and new disclosures in regards to individually significant disposals that do not qualify for discontinued operations reporting. This guidance is effective for the first interim or annual period beginning on or after December 15, 2014. We adopted this standard as of January 1, 2015. This adoption impacts the comparability of our financial statements as disposals of individual owned hotels will generally no longer qualify as discontinued operations.

From time to time, new accounting standards are issued by FASB or other standards setting bodies, which we adopt as of the specified effective date. Unless otherwise discussed, we believe the impact of recently issued standards that are not yet effective will not have a material impact on our consolidated financial statements upon adoption.

 

 

NOTE 3. ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS

During the third quarter of 2015, 24 of our hotels and one additional restaurant parcel were classified as assets held for sale. The sale of these assets does not represent a major strategic shift and does not qualify for discontinued operations reporting.  

As of September 30, 2015, the carrying amounts of the major classes of assets for assets held for sale were as follows:

 

 

15

---

During the second quarter of 2013, 44 of our hotels were classified as assets held for sale, and the results of their operations, in accordance with accounting rules in place at that time, have been presented within discontinued operations for all affected periods presented in the accompanying condensed consolidated statements of operations.

During the third and fourth quarters of 2013, 40 of these hotels were sold. On February 6, 2014, the four remaining hotels were sold. In accordance with the terms of our loan agreements existing at the time of such sales, all proceeds associated with the sale of these hotels were used to make principal payments on our long-term debt.

The following table summarizes the operating results of the discontinued operations:

 

 

 

 

NOTE 4. ACQUISITIONS

In connection with the acquisitions described below, we recorded the assets acquired and liabilities assumed at fair value as of the acquisition date. Furthermore, acquisition-related costs, such as due diligence, legal and accounting fees, were expensed in the period incurred and were not capitalized or applied in determining the fair value of the acquired assets.

Acquisition of the Previously Managed Hotels and LQ Management L.L.C.

On April 14, 2014, we acquired BRE/Prime Mezz L.L.C. and BRE/Wellesley Properties L.L.C., which owned the Previously Managed Hotels, for a total purchase price of $161.7 million. Total net consideration paid was $150.8 million, which equals the total purchase price of $161.7 million less $10.9 million owed by the parent of BRE/Prime Mezz L.L.C. and BRE/Wellesley Properties L.L.C. to the La Quinta Predecessor Entities. The total net consideration was paid in the form of $76.9 million of cash and $73.9 million of equity in the form of common stock of Holdings. Of the total $161.7 million purchase price, significant assets acquired consist of $166.5 million of property and equipment and $1.4 million in intangible assets for favorable leasehold interests. Other significant long term liabilities acquired include unfavorable leasehold interests of $5.3 million. Additionally on April 14, 2014, we acquired 100% of the ownership interests of LQM for $0.8 million in cash.

The following unaudited pro forma results of operations reflect our results as if the acquisition of the Previously Managed Hotels had occurred on January 1, 2014. In our opinion, all significant adjustments necessary to reflect the effects of the acquisitions have been made (in thousands, except per share data):

 

 

 

16

---

NOTE 5. PROPERTY AND EQUIPMENT

The following is a summary of property and equipment as of September 30, 2015 and December 31, 2014:

 

 

Depreciation and amortization expense related to property and equipment was $42.2 million and $43.1 million for the three months ended September 30, 2015 and 2014, respectively. Depreciation and amortization expense related to property and equipment was $126.0 million and $124.1 million for the nine months ended September 30, 2015 and 2014, respectively. Construction in progress includes capitalized costs for ongoing projects that have not yet been put into service.

 

 

NOTE 6. LONG-TERM DEBT

Long-term debt as of September 30, 2015 and December 31, 2014 was as follows:

 

 

17

---

Term Facility

On April 14, 2014, Holdings’ wholly owned subsidiary, La Quinta Intermediate Holdings L.L.C. (the “Borrower”), entered into a new credit agreement (the “Agreement”) with JPMorgan Chase Bank, N.A. (“JPM”), as administrative agent, collateral agent, swingline lender and L/C issuer, J.P. Morgan Securities LLC, Morgan Stanley Senior Funding, Inc., Merrill Lynch, Pierce, Fenner & Smith Incorporated, Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Deutsche Bank Securities Inc., Goldman Sachs Bank USA, and Wells Fargo Securities, LLC, as joint lead arrangers and joint book runners, and the other agents and lenders from time to time party thereto.

The credit agreement provides for senior secured credit facilities (collectively the “Senior Facilities”) consisting of:

We incurred $28.7 million of debt issuance costs for the Senior Facilities, which is being amortized over the terms of the underlying debt agreement. As of September 30, 2015, the net balance of these debt issuance costs included in our condensed consolidated balance sheet was $23.3 million.

Interest Rate and Fees—Borrowings under the Term Facility bear interest, at the Borrower’s option, at a rate equal to a margin over either (a) a base rate determined by reference to the highest of (1) the JPM prime lending rate, (2) the Federal Funds Effective Rate plus 1/2 of 1.00% and (3) the adjusted LIBOR rate for a one-month interest period plus 1.00% or (b) a LIBOR rate determined by reference to the Reuters LIBOR rate for the interest period relevant to such borrowing. The margin for the Term Facility is 2.00%, in the case of base rate loans, and 3.00%, in the case of LIBOR rate loans, subject to one step-down of 0.25% upon the achievement of a consolidated first lien net leverage ratio (as defined in the Agreement) of less than or equal to 4.50 to 1.00, subject to a base rate floor of 2.00% and a LIBOR floor of 1.00%.  As of July 31, 2015, we achieved a consolidated first lien net leverage ratio of less than 4.50 to 1.00, and, as a result we realized the step-down of 0.25% after that date.

Borrowings under the Revolving Facility bear interest, at the Borrower’s option, at a rate equal to a margin over either (a) a base rate determined by reference to the highest of (1) the JPM prime lending rate, (2) the Federal Funds Effective Rate plus 1/2 of 1.00% and (3) the adjusted LIBOR rate for a one-month interest period plus 1.00% or (b) a LIBOR rate determined by reference to the Reuters LIBOR rate for the interest period relevant to such borrowing. The margin for the Revolving Facility is 1.50%, in the case of base rate loans, and 2.50%, in the case of LIBOR rate loans, subject to three step-downs of 0.25% each upon the achievement of a consolidated first lien net leverage ratio of less than or equal to 5.00 to 1.00, 4.50 to 1.00 and 4.00 to 1.00, respectively. As of March 2, 2015, we achieved a consolidated first lien net leverage ratio of less than 5.00 to 1.00, and after March 2, 2015 we realized the first step-down in margin of 0.25%.

In addition, the Borrower is required to pay a commitment fee to the lenders under the Revolving Facility in respect of the unutilized commitments thereunder. The commitment fee rate is 0.50% per annum subject to a step-down to 0.375%, upon achievement of a consolidated first lien net leverage ratio less than or equal to 5.00 to 1.00. As of March 2, 2015, we achieved a consolidated first lien net leverage ratio of less than 5.00 to 1.00, and after March 2, 2015, the commitment fee rate is 0.375%. The Borrower is also required to pay customary letter of credit fees.

Amortization—Beginning September 2014, the Borrower was required to repay installments on the Term Facility in quarterly installments equal to 0.25% of the original principal amount less any voluntary prepayments on the Term Facility, with the remaining amount payable on the applicable maturity date with respect to the Term Facility.

The Senior Facilities contain certain representations and warranties, affirmative and negative covenants and events of default. If an event of default occurs, the lenders under the Senior Facilities will be entitled to take various actions, including the acceleration of amounts due under the Senior Facilities and actions permitted to be taken by a secured creditor. As of September 30, 2015, we were in compliance with all applicable covenants under the Senior Facilities.

Letters of Credit

As of September 30, 2015 and December 31, 2014, we have $10.6 million in letters of credit obtained through our Revolving Facility. We were required to pay a fee of 2.63% per annum related to these letters of credit. As of March 2, 2015, we achieved a consolidated first lien net leverage ratio of less than 5.00 to 1.00, and after March 2, 2015 we realized the first step-down in rate of 0.25%, for a margin of 2.38%.

18

---

Interest Expense, Net

Net interest expense, including the impact of our interest rate swap (see Note 7), consisted of the following for the three and nine months ended September 30, 2015 and 2014:

 

 

 

 

NOTE 7. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

During the three and nine months ended September 30, 2015 and 2014, derivatives were used to hedge the interest rate risk associated with our variable-rate debt.

Term Facility Interest Rate Swap

On April 14, 2014, the Borrower entered into an interest rate swap agreement with an aggregate notional amount of $850.0 million that expires on April 14, 2019. This agreement swaps the LIBOR rate in effect under the new credit agreement for this portion of the loan to a fixed-rate of 2.0311%, which includes a 1% LIBOR floor. Management has elected to designate this interest rate swap as a cash flow hedge for accounting purposes.

Interest Rate Caps

Pursuant to the terms of the Holdco I Loans and the Holdco III Mortgage Loan, we were required to maintain interest rate caps. The effect of these interest rate cap agreements was to limit our maximum interest rate exposure with respect to increases in LIBOR. We purchased and maintained these interest rate caps until July 2014 when they expired, and the related gain or loss on these investments is reflected within other income (loss) in the accompanying condensed consolidated statements of operations. We did not elect to designate any of these interest rate caps as effective hedging instruments.

Fair Value of Derivative Instruments

The effects of our derivative instruments on our condensed consolidated balance sheets were as follows:

 

 

19

---

Earnings Effect of Derivative Instruments

The effects of our derivative instruments on our condensed consolidated statements of operations and condensed consolidated statements of comprehensive income, net of the effect for income taxes, were as follows:

 

 

 

 

 

NOTE 8. FAIR VALUE MEASUREMENTS

The carrying amount and estimated fair values of our financial assets and liabilities, which include related current portions, were as follows:

 

 

We believe the carrying amounts of our cash and cash equivalents and restricted cash approximated fair value as of September 30, 2015 and December 31, 2014, as applicable. Our estimates of the fair values were determined using available market information and valuation methods appropriate in the circumstances. Considerable judgment is necessary to interpret market data and develop estimated fair values. Proper placement of fair value measurements within the valuation hierarchy is considered each reporting period. Third-party information received for calculating Level 3 fair value measurements is reviewed to ensure it is in accordance with GAAP. The use of different market assumptions or estimation methods may have a material effect on the estimated fair value amounts.

The fair values of interest rate swaps are determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each instrument. This analysis reflects the contractual terms of the agreements, including the period to maturity, and uses observable market-based inputs, including forward interest rate curves. We incorporate credit valuation adjustments to appropriately reflect both our own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements.

We estimate the fair value of our long-term debt using discounted cash flow analysis based on current market inputs for similar types of arrangements. The primary sensitivity in these calculations is based on the selection of appropriate discount rates. We estimated the discount rate to be approximately 4.3% and 4.4%, as of September 30, 2015 and December 31, 2014, respectively. Fluctuations in these assumptions will result in different estimates of fair value.

We test long-lived assets for impairment annually or more frequently if events or changes in circumstances indicate that the asset might be impaired. In the second quarter of 2015, we identified a portfolio of 24 hotels where it became more likely than not the hotels would be sold significantly before the end of the previously estimated useful life. We recorded an impairment charge of $42.5 million to adjust the carrying value of these assets to their estimated fair value. During the third quarter of 2015, these assets met the criteria for classification as assets held for sale. The fair value estimate is considered to be Level 3 within the fair value measurement hierarchy. The inputs used in determining the fair value of these 24 hotels are based on estimated selling price, less selling costs.

20

---

In the third quarter of 2015, we identified a restaurant parcel where it became more likely than not the restaurant would be sold significantly before the end of the previously estimated useful life. We recorded an impairment charge of $1.6 million to adjust the carrying value of this restaurant parcel to its estimated fair value. During the third quarter of 2015, this restaurant parcel met the criteria for classification as assets held for sale. The fair value estimate is considered to be Level 3 within the fair value measurement hierarchy. The inputs used in determining the fair value these assets are based on estimated selling price, less selling costs.

The following fair value hierarchy table presents information about assets measured at fair value on a nonrecurring basis during the nine months ended September 30, 2015:

 

 

In June 2014 we determined that the long-lived assets associated with one of our owned hotels were partially impaired primarily due to unfavorable expected terms of the upcoming underlying ground lease renewal and the likelihood of the Company abandoning the hotel upon expiration of the ground lease. As a result, we recorded an impairment loss of approximately $5.2 million for the nine months ended September 30, 2014. Subsequent to September 30, 2014, the Company reached an agreement with the landlord and renewed the lease. For this purpose, fair value of the property was estimated primarily using expected present value of future cash flows. The fair value estimate is considered to be Level 3 within the fair value measurement hierarchy.

The following fair value hierarchy table presents information about assets measured at fair value on a nonrecurring basis during as of December 31, 2014:

 

 

 

NOTE 9. RELATED PARTY TRANSACTIONS

Arrangements Relating to Previously Managed Hotels

We maintain various agreements and enter into certain transactions with affiliates of the Funds. Prior to April 14, 2014, these affiliates owned the Previously Managed Hotels (see Note 4), which were managed by LQM. The following is a discussion of these arrangements and resulting transactions from January 1, 2014 to April 14, 2014:

Management and Service Agreements

Hotel Management Agreements — Pursuant to hotel management agreements with affiliates of the Funds in existence prior to the IPO (“LQM Management Agreements”), LQM provided management services to the Previously Managed Hotels until the IPO, including supervision, direction, operation, management and promotion. The LQM Management Agreements would have expired in July 2027, but were terminable by either party at any time and for any reason, and were terminated in connection with the IPO. Under the terms of the LQM Management Agreements, LQM was entitled to recover a management fee of 1.67% of gross operating revenue from the Previously Managed Hotels, as well as reimbursement for certain shared group costs.

Management fees earned by LQM from the Previously Managed Hotels, for the periods from April 1, 2014 to April 14, 2014 and from January 1, 2014 to April 14, 2014 were $0.1 million and $0.2 million, respectively. These management fees are included within franchise and other fee-based revenues in the accompanying condensed combined statements of operations.

In addition, in accordance with the LQM Management Agreements, LQM also provided certain group services for hotels it managed, including group and administrative services, information systems support, training, and other field services and was reimbursed for the cost of providing these services. For the periods from April 1, 2014 to April 14, 2014 and from January 1, 2014 to April 14, 2014, LQM earned group services reimbursements from the Previously Managed Hotels of approximately $0.1 million and $0.2 million, respectively. These fees are included within franchise and other fee-based revenues in the accompanying condensed consolidated statements of operations.

21

---

Other Fees and Funding

Brand Marketing Fund (BMF) — We maintain the BMF on behalf of our franchisees and the hotel properties we own and manage, and we charge these hotels a fee of 2.5% of gross room revenue, which is then used by the BMF to fund national advertising promotions and campaigns. BMF fees collected from franchised and managed hotels, and the related expenses, are reflected as brand marketing fund revenues and expenses from franchise and managed hotels in the accompanying condensed consolidated statements of operations.

Customer Loyalty Program — We administer a customer loyalty program, La Quinta Returns (“Returns”), and charge participating hotels a fee to administer the program equal to 5% of the Returns members’ eligible room rate per night. Returns fees collected from franchised and managed hotels are reflected within franchise and other fees-based revenues in the accompanying condensed consolidated statements of operations. We recorded revenues related to Returns from the Previously Managed Hotels of approximately $0.1 million and $0.3 million for the periods from April 1, 2014 to April 14, 2014 and from January 1, 2014 to April 14, 2014, respectively.

Trademark Licenses — In accordance with our management agreements with the Previously Managed Hotels existing until their acquisition on April 14, 2014, we charged a royalty fee of 0.33% of the Previously Managed Hotels’ gross room revenues. For the periods from April 1, 2014 to April 14, 2014 and from January 1, 2014 to April 14, 2014, royalty fees charged to the Previously Managed Hotels under these agreements were approximately $0.1 million for each of the periods. These royalty fees are reflected within franchise and other fee-based revenues in the accompanying condensed consolidated statements of operations.

Other Arrangements

As of September 30, 2015 and December 31, 2014, approximately $31.2 million and $43.9 million, respectively, of the aggregate principal amount of our Term Facility was owned by affiliates of Blackstone. We make periodic interest and principal payments on such debt in accordance with its terms.

We engaged Blackstone Advisory Partners L.P. to provide certain financial consulting services in connection with the public offering of our common stock by certain stockholders in April 2015 for a fee of approximately $0.4 million.

We also purchase products and services from entities affiliated with or owned by Blackstone. The fees paid for these products and services were approximately $0.6 million and $0.8 million during the three months ended September 30, 2015 and 2014, respectively. The fees paid for these products and services were approximately $2.1 million and $2.3 million during the nine month periods ended September 30, 2015 and 2014, respectively.

 

 

NOTE 10. COMMITMENTS AND CONTINGENCIES

Environmental — We are subject to certain requirements and potential liabilities under various federal, state and local environmental laws, ordinances, and regulations. Such requirements often impose liability without regard to whether the current or previous owner or operator knew of, or was responsible for, the presence of such hazardous or toxic substances. Although we have incurred and expect to incur remediation and other environmental costs during the ordinary course of operations, we anticipate that such costs will not have a material effect on our financial condition, results of operations, or cash flows.

Litigation — We are party to a number of pending claims and lawsuits arising in the normal course of business. We maintain general and other liability insurance; however, certain costs of defending lawsuits, such as those below the insurance retention or deductible amount, are not covered by or are only partially covered by insurance policies, or the insurance carriers could refuse to cover certain claims in whole or in part. We regularly evaluate ultimate liability costs with respect to such claims and lawsuits. We accrue costs incurred from defending litigation as they become determinable. We do not consider our ultimate liability with respect to any single claim or lawsuit, or the aggregate of such claims and lawsuits, to be material in relation to our condensed consolidated balance sheets, results of operations, or cash flows taken as a whole.

Casualty Losses — We maintain insurance for property and casualty damage, subject to deductibles and policy terms and conditions, attributable to wind, flood, and earthquakes. We also maintain business interruption insurance.

Tax Contingencies — We are subject to regular audits by federal and state tax authorities. These audits may result in additional tax liabilities. The Internal Revenue Service (the “IRS”) is currently auditing the tax returns of La Quinta Corporation, one of our former REITs prior to the Pre-IPO Transactions, and BRE/LQ Operating Lessee Inc., one of our former taxable REIT subsidiaries prior to the Pre-IPO Transactions, in each case for the tax years ended December 31, 2010 and 2011. We received a draft notice of proposed adjustment from the IRS on January 9, 2014, and the notice of proposed adjustment was issued to us on June 2, 2014. We submitted a timely response to the notice of proposed adjustment and, on July 7, 2014, we received an IRS 30-Day Letter proposing to impose a

22

---

100% tax on the REIT totaling $158 million for the periods under audit in which the IRS has asserted that the rent charged for these periods under the lease of hotel properties from the REIT to the taxable REIT subsidiary exceeded an arm’s length rent. In addition, the IRS proposed to eliminate $89 million of net operating loss carryforwards for the taxable REIT subsidiary for the tax years 2006 through 2009; however, in an IRS rebuttal received on September 26, 2014, the IRS conceded its proposed adjustment on this point was incorrect. We disagree with the IRS’ position with respect to rents charged by the REIT to its taxable REIT subsidiary and have appealed the proposed tax and adjustments to the IRS Appeals Office. In determining amounts payable by our taxable REIT subsidiary under the lease, we engaged a third party to prepare a transfer pricing study contemporaneous with the lease which concluded that the lease terms were consistent with an arm’s length rent as required by relevant provisions of the Internal Revenue Code of 1986 (the “Internal Revenue Code”) and applicable Treasury Regulations. Attorneys and others representing the Company conducted preliminary discussions regarding the appeal with the IRS Appeals Office team on March 31, 2015 and April 1, 2015. In response to a supplemental analysis submitted by the IRS economist to the Appeals Officer and provided to us on August 18, 2015, we submitted responses dated September 3, 2015 and October 1, 2015.  No additional response or requests from the Appeals Officer have been received. We believe the IRS transfer pricing methodologies applied in the audits contain flaws and that the IRS proposed tax and adjustments are inconsistent with the U.S. federal tax laws related to REITs. We have concluded that the positions reported on our tax returns under audit by the IRS are, based on their technical merits, more-likely-than-not to be sustained upon examination. Accordingly, as of September 30, 2015, we have not established any reserves related to this proposed adjustment or any other issues reflected on the returns under examination.

On November 25, 2014, we were notified that the IRS intended to examine the tax returns of the same entities subject to the 2010 and 2011 audit in each case for the tax years ended December 31, 2012 and 2013. That examination is in process; as of September 30, 2015, we have not been advised of any proposed adjustments.

Purchase Commitments — As of September 30, 2015, we had approximately $20.8 million of purchase commitments primarily related to certain continuing redevelopment and renovation projects and information technology enhancements.

Franchise Commitments — Under certain franchise agreements, we are committed to provide certain incentive payments, reimbursements, rebates, and other payments to help defray certain costs. Our obligation to fund these commitments is contingent upon certain conditions set forth in the respective franchise agreement. The franchise agreements generally require that, in the event that the franchise relationship is terminated, the franchisee is required to repay any outstanding balance plus any unamortized portion of any incentive payment. As of September 30, 2015, we had $8.1 million in outstanding commitments owed to various franchisees for such financial assistance.

 

 

NOTE 11. INCOME TAXES

Prior to our IPO on April 14, 2014, we operated primarily as limited liability companies treated as partnerships for U.S. federal income tax purposes, REIT entities, and taxable entities. As a result, we were not subject to U.S. federal and most state income taxes for our limited liability companies and our REIT entities. Our partnership and REIT status terminated in connection with the IPO, as the La Quinta Predecessor Entities were contributed to Holdings, a “C” corporation, the shares of capital stock held by third-party shareholders of our REIT entities were redeemed for cash totaling approximately $3.9 million, and our REITs were converted into limited liability companies. As a result of these transactions, we have become subject to additional entity-level taxes and, during the second quarter of the year ended December 31, 2014, we recorded a one-time net deferred tax expense of $321.1 million, which established the associated net deferred tax liability on our balance sheet, and reflects the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases at the estimated blended statutory U.S. federal and state income tax rate of 38.1%. More specifically, this initial deferred tax expense is driven by (1) the recognition of deferred tax liabilities of approximately $462.3 million, primarily related to differences between the book and tax basis for our fixed and intangible assets and related depreciation, (2) the recognition of deferred tax assets of approximately $14 million primarily related to tax-only intangibles, and (3) as a result of the change in the Company’s tax status, a tax benefit of $127.2 million related to the reduction in valuation allowance, primarily associated with La Quinta Predecessor Entities’ net operating losses and tax credits.

The Company recorded a provision for federal, state and foreign income tax expense of approximately $15.4 million and $17.4 million for the three and nine months ended September 30, 2015, respectively. The Company recorded a provision for federal, state and foreign income tax expense of approximately $16.1 million and $21.9 million during the three and nine month periods ended September 30, 2014, respectively. The provisions for the three and nine month periods ended September 30, 2015 and 2014 reflect certain equity compensation charges that are not deductible for income tax purposes.

 

 

23

---

NOTE 12. EMPLOYEE BENEFIT PLANS

We maintain a deferred savings plan covering substantially all of our employees that qualified under Section 401(k) of the Internal Revenue Code. Our deferred savings plan has an employer matching contribution of 100% of the first 3% and 50% of the next 2% of an employee’s eligible earnings, which vests immediately. We paid employer contributions of approximately $0.6 million during both the three month periods ended September 30, 2015 and 2014. We paid employer contributions of approximately $1.8 million and $1.5 million, during the nine month periods ended September 30, 2015 and 2014, respectively.

 

 

NOTE 13. EQUITY-BASED COMPENSATION

Promote Plan

Prior to the IPO Effective Date, certain members of our management and others (the “Promote Participants”) were eligible to receive long-term incentives evidenced by units (the “Units”) in LQ Services L.L.C. (“LQ Services”), which indirectly held interests in the Company, which Units were intended to be treated as “profits interests” for U.S. tax purposes (the “Promote Plan”). Units were typically granted by our Chief Executive Officer, in consultation with Blackstone, to key employees upon hire. Unit levels could also be adjusted to recognize changing job responsibilities. All of the Units were subject to exit-based vesting on the date when there was a sale, transfer or disposition of all or substantially all of the assets of the La Quinta Predecessor Entities to an unaffiliated entity which resulted in distributions being payable to the holders of the Units (a “Liquidity Event”), subject to a Promote Participant’s continued employment on such date. The value in respect of Units would have been determined based upon the amounts received by Blackstone pursuant to a Liquidity Event, net of certain debt repayments and return of equity to Blackstone. As payments in respect of the Units were contingent on occurrence of a Liquidity Event, which was not assessed to be probable prior to the date of our IPO, no expense was accrued or recognized for the Units prior to April 14, 2014.

On the IPO Effective Date, Units that were outstanding under the Promote Plan at the time of the offering were exchanged for 3.1 million vested and unvested shares of common stock of Holdings of equivalent economic value, using a grant date fair value equal to the initial public offering price of Holdings shares of $17.00 per share and issued as follows: (1) 40% of the shares received were vested shares of common stock; (2) 40% of the shares received were unvested shares of restricted stock that vested on the first anniversary of the IPO Effective Date, contingent upon continued employment through that date; and (3) 20% of the shares received were unvested shares of restricted stock that vest on the earlier of the date that Blackstone and its affiliates cease to own 50% or more of Holdings or the seventh anniversary of the IPO Effective Date, contingent upon continued employment at that date. Blackstone and its affiliates ceased to own 50% of Holdings’ common stock, effective November 25, 2014. The Promote Plan became fully vested on April 14, 2015.

Total compensation expense under the Promote Plan was $5.6 million during the nine months ended September 30, 2015. During the three and nine months ended September 30, 2014, total compensation expense under the Promote Plan was $5.4 million and $31.7 million, respectively. As of September 30, 2015, 9,658 shares have been forfeited from the Promote Plan.

2014 Omnibus Incentive Plan

In connection with, and prior to completion of, the IPO, our Board of Directors adopted, and our stockholders approved, the La Quinta Holdings Inc. 2014 Omnibus Incentive Plan (the “2014 Omnibus Incentive Plan”). The 2014 Omnibus Incentive Plan provides for the granting of stock options, restricted stock and other equity based or performance-based awards denominated in cash or in stock to directors, officers, employees, consultants and advisors and our affiliates.

2014 Grant I — Effective on the IPO Effective Date, we issued 0.35 million shares of Holdings common stock under our 2014 Omnibus Incentive Plan with a grant date fair value of $16.65 per share to certain of our employees as follows: (1) 50% of the shares granted were vested shares of common stock; (2) 40% of the shares granted were unvested shares of restricted stock that vested on the first anniversary of the IPO Effective Date, contingent upon continued employment through that date; and (3) 10% of the shares granted were unvested shares of restricted stock that vest on the earlier of the date that Blackstone and its affiliates cease to own 50% or more of Holdings or the seventh anniversary of the IPO Effective Date, contingent upon continued employment through that date. Blackstone and its affiliates ceased to own 50% of Holdings’ common stock, effective November 25, 2014. The 2014 Grant I became fully vested on April 14, 2015.

2014 Grant II — On June 11, 2014, we issued 1.01 million shares of Holdings common stock under our 2014 Omnibus Incentive Plan with a grant date fair value of $18.70 per share to certain of our employees. 2014 Grant II is a time-based vesting award with multiple tranches that vest on various dates with a remaining weighted average life of 1.1 years as of September 30, 2015. The fair value of 2014 Grant II will be recognized on a straight-line basis over the requisite service period of each tranche included in the award.

24

---

Director Unit Grants — On June 11, 2014, November 25, 2014, January 20, 2015, June 11, 2015, and July 24, 2015 we granted a total of 40,965 restricted stock units (“RSUs”) to our independent directors under our 2014 Omnibus Incentive Plan, as part of our regular annual compensation of our independent directors. The Director Unit Grants vests in three equal installments on the first, second and third anniversaries of the grant dates. The grant date fair value was $18.70 per RSU for the June 11, 2014 grant, $21.48 for the November 25, 2014 grant, $20.57 for the January 20, 2015 grant, $24.30 for the June 11, 2015 grant and $22.09 for the July 24, 2015 grant. The fair value of the RSUs will be recognized on a straight-line basis over the requisite service period for the entire award. Vested RSUs will be settled with shares of our common stock.

2014 Performance Unit Grant — On June 11, 2014, we issued 109 performance-based RSUs (the “PSUs”), which represent 0.5 million shares at target value of common stock to certain of our employees. The performance period for the 2014 Performance Unit Grant ends December 31, 2016, with a remaining life of 1.3 years as of September 30, 2015. The calculation of the value of the units granted under the 2014 Performance Unit Grant is weighted as follows: 70% based on our total shareholder return (“TSR”) relative to the total shareholder returns of a defined set of peer companies (“Relative Shareholder Return”); and 30% based on our absolute TSR compound annual growth rate (“TSR CAGR”). The number of common shares issued in exchange for each PSU at the end of the performance period is determined based on a calculated multiple of defined target amounts for TSR CAGR and Relative Shareholder Return. Possible payout multiples range from 33% of target, which represents the threshold and below which no payout is given, and 167% of target, which represents the maximum payout. The 2014 Performance Unit Grant PSUs will be settled with shares of our common stock.

The grant date fair value of the 2014 Performance Unit Grant was $19.80 per share, which was determined using a Monte Carlo simulation valuation model with the following assumptions:

 

 

2015 Grant I — In January 2015, February 2015 and May 2015, we issued a total of 0.2 million shares of Holdings common stock under our 2014 Omnibus Incentive Plan with a grant date weighted average price of $21.86 per share to certain of our employees. 2015 Grant I is a time-based vesting award with multiple tranches that vest on various dates with a remaining weighted average life of 1.3 years as of September 30, 2015. The fair value of 2015 Grant I will be recognized on a straight-line basis over the requisite service period of each tranche included in the award.

2015 Performance Unit Grant — On February 19, 2015, we issued PSUs, which represents 0.3 million shares of common stock at target value to certain of our employees. The performance period for the 2015 Performance Unit Grant ends December 31, 2017, with a remaining life of 2.3 years as of September 30, 2015. The calculation of the value of the units granted under the 2015 Performance Unit Grant is based solely on our TSR relative to the Relative Shareholder Return. The number of common shares issued in exchange for each PSU at the end of the performance period is determined based on defined target amounts for Relative Shareholder Return. Possible payout multiples range from 33% of target, which represents the threshold and below which no payout is given, and 200% of target, which represents the maximum payout. The 2015 Performance Unit Grant PSUs will be settled with shares of our common stock.

The grant date fair value of the 2015 Performance Unit Grant was $25.35 per share, which was determined using a Monte Carlo simulation valuation model with the following assumptions:

 

25

---

 

During the three and nine months ended September 30, 2015, total compensation expense for awards under the 2014 Omnibus Incentive Plan was $6.2 million and $13.6 million, respectively, excluding related taxes. During the three and nine months ended September 30, 2014, total compensation expense for awards under the 2014 Omnibus Incentive Plan was $3.2 million and $7.9 million, respectively, excluding related taxes. Unrecognized compensation expense as of September 30, 2015 was $17.7 million. As of September 30, 2015, 35,773 shares have been forfeited from awards made under the 2014 Omnibus Incentive Plan.

As of September 30, 2015, there were approximately 11.8 million shares of common stock available for future issuance under the 2014 Omnibus Incentive Plan, including the units granted under our restricted stock unit awards.

During September 2015, pursuant to a Separation and Release Agreement (the “Separation and Release Agreement”), dated effective as of September 15, 2015, that the Company entered into with its former President and Chief Executive Officer in connection with his departure, the Company accelerated the vesting of 0.3 million shares issued to him under the 2014 Omnibus Incentive Plan and incurred a corresponding non-cash severance charge of $3.0 million. In addition, pursuant to the benefits to which the Company’s former President and Chief Executive Officer was entitled under the Separation and Release Agreement, the Company accrued a cash severance related charge of $7.6 million that was paid subsequent to period end.

 

NOTE 14. EARNINGS PER SHARE

Basic earnings (loss) per share is computed by dividing net income (loss) available to common stockholders by the weighted average number of shares of common stock outstanding. Diluted earnings per share is computed by dividing net income available to common stockholders by the weighted average number of shares of the Company’s common stock outstanding plus other potentially dilutive securities. Dilutive securities include equity based awards issued under long-term incentive plans.

As discussed in Note 1, on April 14, 2014, the Company completed its IPO. For purposes of computing earnings per share, it is assumed that our IPO and ownership reorganization had occurred for all periods presented and therefore the outstanding shares have been adjusted to reflect the conversion of shares that took place in connection with the IPO. Accordingly, the denominators in the computations of basic and diluted net earnings (loss) per share reflect our IPO and ownership reorganization for all periods presented.

The calculations of basic and diluted earnings per share are as follows:

 

26

---

 

For the three and nine month period ended September 30, 2015, immaterial amount of shares were anti-dilutive. Approximately 0.3 million shares and 1.2 million shares for the three months and nine months ended September 30, 2014, respectively, were excluded from the computation of diluted shares, as their impact would have been anti-dilutive.

 

During September 2015, Company's board of directors authorized a program to repurchase an aggregate of up to $100 million of the Company’s common stock (the “Repurchase Program”). These repurchases may be made from time to time in the open market, in privately negotiated transactions, or otherwise, including pursuant to a Rule 10b5-1 plan, at prices that the Company deems appropriate and subject to market conditions, applicable law and other factors deemed relevant in the Company's sole discretion. The Repurchase Program does not obligate the Company to repurchase any dollar amount or number of shares of common stock and the program may be suspended or discontinued at any time.

 

Through September 30, 2015, the Company repurchased 999,452 shares of common stock. These shares were repurchased at a weighted-average price of $16.03 per share, for an aggregate purchase price of $16.0 million. Of the $16.0 million aggregate purchase price through September 30, 2015, $10.0 million was settled in cash during the period, with the remainder settled in ordinary course subsequent to September 30, 2015. The shares repurchased through September 30, 2015 represented approximately 1% of the Company's total shares of common stock outstanding as of December 31, 2014. The shares of common stock that were repurchased were placed in treasury stock. As of September 30, 2015, $84 million remained under this share repurchase authorization.

 

 

NOTE 15. SEGMENTS

Our operating segments are components of the business which are managed discretely and for which discrete financial information is reviewed regularly by our Chief Executive Officer, who is our chief operating decision maker, to assess performance and make decisions regarding the allocation of resources. Our operating and reportable segments are defined as follows:

Corporate and other includes revenues generated and operating expenses incurred in connection with the overall support and brand management of our owned, managed, and franchised hotels and operations.

The performance of our operating segments is evaluated primarily based upon Adjusted EBITDA, which should not be considered an alternative to net income (loss) or other measures of financial performance or liquidity derived in accordance with GAAP. We define Adjusted EBITDA as our net income (exclusive of non-controlling interests) before interest expense, income tax expense (benefit), and depreciation and amortization, further adjusted to exclude certain items, including, but not limited to: gains, losses, and expenses in connection with: (i) asset dispositions; (ii) debt modifications/retirements; (iii) non-cash impairment charges; (iv) discontinued operations; (v) equity based compensation and (vi) other items.

27

---

The table below shows summarized consolidated financial information by segment for the three and nine months ended September 30, 2015 and 2014:

 

 

 

28

---

The table below provides a reconciliation of Adjusted EBITDA to EBITDA and EBITDA to net income (loss) attributable to La Quinta Holdings’ stockholders for the three and nine months ended September 30, 2015 and 2014:

 

 

The following table presents assets for our reportable segments, reconciled to consolidated amounts as of September 30, 2015 and December 31, 2014:

 

 

The following table presents capital expenditures for our reportable segments, reconciled to our consolidated amounts for the nine month periods ended September 30, 2015 and 2014:

 

************

 

29

---

The following discussion contains management’s discussion and analysis of our financial condition and results of operations and should be read together with the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q. This discussion contains forward-looking statements that reflect our plans, estimates and beliefs and involve numerous risks and uncertainties, including but not limited to those described in the “Risk Factors” section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2014, as amended (the “2014 Form 10-K”), as filed with the Securities and Exchange Commission (the “SEC”), as such risk factors may be updated from time to time in our periodic filings with the SEC. Actual results may differ materially from those contained in any forward-looking statements. You should carefully read “Special Note Regarding Forward-Looking Statements” in this Quarterly Report on Form 10-Q.

Effective April 14, 2014, La Quinta Holdings Inc. (“Holdings” or the “Company”) completed its initial public offering (“IPO”). In the IPO, Holdings issued approximately 44.0 million shares of common stock, including the full exercise of the underwriters’ option to purchase additional shares.

Prior to the IPO, our business was conducted, and our hotel properties were owned, and franchised through multiple entities including (i) Lodge Holdco I L.L.C., Lodge Holdco II L.L.C., and Lodge Holdco III L.L.C., and their consolidated subsidiaries, (collectively, the “La Quinta Predecessor Entities”) and (ii) entities that owned the 14 La Quinta Hotels (the “Previously Managed Portfolio” and, together with the La Quinta Predecessor Entities, the “Pre-IPO Entities”) managed by LQ Management L.L.C. (“LQM”, a consolidated variable interest entity). The Pre-IPO Entities were owned (directly and indirectly) by certain investment funds affiliated with The Blackstone Group, L.P. (“Blackstone”), members of our management, and other pre-existing owners (together, the “Pre-IPO Owners”) and certain subsidiaries of the Pre-IPO Entities operated as real estate investment trusts, or REITs, for U.S. federal income tax purposes. In connection with the IPO, (i) the La Quinta Predecessor Entities purchased the Previously Managed Portfolio for a net amount equal to $76.9 million in cash and 4,348,284 shares of common stock of Holdings, (ii) the equity interests in the La Quinta Predecessor Entities held by the Pre-IPO Owners were exchanged by the Pre-IPO Owners for an aggregate of 81,060,034 shares of common stock of Holdings, (iii) we effected the refinancing transactions described below under “Liquidity and Capital Resources—Debt” and (iv) we effected certain other transactions, including a grant of vested shares of Holdings common stock and unvested shares of Holdings restricted stock to certain employees in an aggregate amount equal to 349,522 shares pursuant to the La Quinta Holdings Inc. 2014 Omnibus Incentive Plan (the transactions described in (i) – (iv), the “IPO Transactions”).

The information in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations” reflects the following: (1) as it pertains to periods prior to the completion of the IPO, the accounts of each of the La Quinta Predecessor Entities, LQM, and all related wholly and majority owned subsidiaries. For these periods, the La Quinta Predecessor Entities have been presented on a combined historical basis due to their prior common ownership and control; and (2) as it pertains to the periods subsequent to the completion of the IPO, the accounts of Holdings, as well as its wholly owned subsidiaries which include, among others, the La Quinta Predecessor Entities, the Previously Managed Portfolio, LQM, and all other subsidiaries created in connection with the IPO.

Our business

We are a leading owner, operator and franchisor of select-service hotels primarily serving the midscale and upper-midscale segments under the La Quinta brand. Our system-wide portfolio, as of September 30, 2015, consisted of 884 hotels representing approximately 87,600 rooms located predominantly across 47 U.S. states, as well as in Canada, Mexico and Honduras, of which 352 hotels were owned and operated and 532 were franchised. We also have a pipeline of 221 franchised hotels in the United States, Mexico, Canada, Colombia, Nicaragua, Guatemala and Chile. We primarily derive our revenues from owned hotel operations and fees generated from franchised hotels.

All of our long-lived assets are located in the United States and, during the nine months ended September 30, 2015, we derived over 99% of our revenue from within the United States.

Segments

Our operating segments are components of the business which are managed discretely and for which discrete financial information is reviewed regularly by our Chief Executive Officer, who is our chief operating decision maker, to assess performance and make decisions regarding the allocation of resources. We define our reportable segments as follows:

30

---

Our segment information also reflects corporate and other, which includes revenues generated by and related to operating expenses incurred in connection with the overall support and brand management of our owned, managed and franchised hotels and operations. The franchise agreements we entered into with our owned hotels upon effectiveness of the IPO also includes a reservation fee of 2.0% of gross room revenues, which is reflected in corporate and other from the period for April 14, 2014 to September 30, 2015.

We have a business model that involves both ownership of properties and franchising of third-party owned properties. This provides us with diversified revenue and income streams that balance both the advantages and risks associated with these lines of business.

As an owner of hotels, we can capture the full benefit of increases in operating profits during periods of increasing demand or ADR. The cost structure of our typical hotel is more fixed than variable, so as demand and ADR increase over time, the pace of increase in operating profits typically is higher than the pace of increase of revenues. Hotel ownership is, however, more capital intensive than granting franchise agreements to third-party hotel owners, as we are responsible for the costs and capital expenditures for our owned hotels. The profits realized by us in our Owned Hotels segment are generally more significantly affected by economic downturns and declines in revenues than the results of our Franchise and Management segment. See also “—Key components and factors affecting our results of operations—Expenses” and “Risk Factors—Risks related to our business and industry” in our 2014 Form 10-K.

As a franchisor of hotels, growth in the number of franchised hotels and earnings from franchises typically results in higher overall returns on invested capital because the capital required to build and maintain franchised hotels is typically provided by the owner of the respective property with minimal or no capital required by us, as franchisor. During periods of increasing demand, we do not, however, share in most of the benefits of increases in profits from franchised hotels because franchisees do not pay us fees based on profits. A principal component of our current growth strategy is to focus our expansion on our franchise business.

For purposes of this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” the following table sets forth the number of net owned and franchised La Quinta branded hotels as of September 30, 2015 and 2014.

 

 

31

---

⁽¹⁾  Owned Hotels includes 18 properties that are subject to ground leases; we include these 18 properties as “Owned Hotels” throughout this Management’s Discussion and Analysis of Financial Condition and Results of Operations. Owned Hotels also includes one hotel owned via a joint venture in which we have a controlling interest. At September 30, 2015, Owned Hotels includes 24 hotels designated as assets held for sale, which are subject to a definitive purchase agreement.

The following table summarizes our owned, franchised and managed hotels as of September 30, 2015 and 2014:

 

 ⁽¹⁾  Of the 24 Owned hotels designated as assets held for sale, five are La Quinta Inn & Suites (interior corridor), seven are La Quinta Inns (interior corridor) and 12 are La Quinta Inns (exterior corridor).

Seasonality

The hotel industry is seasonal in nature. Generally, our revenues are greater in the second and third quarters than in the first and fourth quarters. The timing of holidays can also impact our quarterly results. The periods during which our properties experience higher revenues vary from property to property and depend principally upon location. This seasonality can be expected to cause quarterly fluctuations in revenue, profit margins and net earnings. Additionally, our quarterly results may be further affected by the timing of certain of our marketing production expenditures. Further, the timing of opening of newly constructed or franchised hotels and the timing of any hotel acquisitions or dispositions may cause a variation of revenue and earnings from quarter to quarter.

Inflation

We do not believe that inflation had a material effect on our business during the three and nine month periods ended September 30, 2015 and 2014. Although we believe that increases in the rate of inflation will generally result in comparable increases in hotel room rates, severe inflation could contribute to a slowing of the U.S. economy. Such a slowdown could result in a reduction in room rates and occupancy levels, negatively impacting our revenues and net income.

Key components and factors affecting our results of operations

Revenues

We primarily derive our revenues from the following sources:

32

---

Consumer demand for our services is closely linked to the performance of the general economy on both a national and regional basis and is sensitive to business and personal discretionary spending levels. Declines in consumer demand due to adverse general economic conditions, risks affecting or reducing travel patterns, lower consumer confidence and adverse political conditions can lower the revenues and profitability of our owned hotels and the amount of franchise fee revenues we are able to generate from our franchised hotels. As a result, changes in consumer demand and general business cycles can subject, and have subjected, our revenues to significant volatility. See “Risk Factors—Risks related to our business and industry” in our 2014 Form 10-K.

In addition to general economic conditions, our guest satisfaction scores, the location of our hotels, the expenditures that we and our franchisees incur to improve our hotels, our loyalty program and the quality of our service impact our ADR, occupancy rates, RevPAR and RevPAR Index performance (each of which is described below under “—Key indicators of financial condition and operating performance”). Changes in ADR, occupancy, RevPAR and RevPAR Index performance significantly impact our revenues.

Expenses

We primarily incur the following expenses:

Fluctuations in operating expenses at our owned hotels can be related to various factors, including changes in occupancy rates, which directly impact certain variable expenses including labor, supplies, utilities and other operating expenses. However, certain of our expenses are relatively fixed, including rent, property taxes, liability insurance and, to a certain extent, payroll. As market

33

---

conditions dictate, we take steps to reduce both our variable and fixed costs to levels we feel are appropriate to maximize profitability and respond to market conditions without jeopardizing the overall guest experience or the value of our hotels or brand. In addition, changes in depreciation expenses may be impacted by renovations of existing hotels or the disposition of existing hotels through sale or closure. For other factors affecting our costs and expenses, see “Risk factors—Risks related to our business and industry” in our 2014 Form 10-K.

Key indicators of financial condition and operating performance

We use a variety of financial and other information in monitoring the financial condition and operating performance of our business. Some of this information is financial information that is prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, while other information may be financial in nature and may not be prepared in accordance with GAAP. Our management also uses other information that may not be financial in nature, including statistical information and comparative data that are commonly used within the lodging industry to evaluate hotel financial and operating performance. Our management uses this information to measure the performance of hotel properties and/or our business as a whole. Historical information is periodically compared to our internal budgets, as well as against industry-wide information. We use this information for planning and monitoring our business, as well as in determining management and employee compensation.

Average daily rate (“ADR”) represents hotel room revenues divided by total number of rooms sold in a given period. ADR measures the average room price attained by a hotel or group of hotels, and ADR trends provide useful information concerning pricing policies and the nature of the guest base of a hotel or group of hotels. Changes in room rates have an impact on overall revenues and profitability.

Occupancy represents the total number of rooms sold in a given period divided by the total number of rooms available at a hotel or group of hotels. Occupancy measures the utilization of our hotels’ available capacity. Management uses occupancy to gauge demand at a specific hotel or group of hotels in a given period. Occupancy levels also help us determine achievable ADR levels as demand for hotel rooms increases or decreases.

Revenue per available room (“RevPAR”) is defined as the product of the ADR charged and the average daily occupancy achieved. RevPAR does not include other ancillary, non-room revenues, such as food and beverage revenues or parking, telephone or other guest service revenues generated by a hotel, which are not significant for the Company.

As it pertains to owned hotels, RevPAR changes that are driven predominately by occupancy have different implications for overall revenue levels and incremental hotel operating profit than changes driven predominately by ADR. For example, increases in occupancy at a hotel would lead to increases in room revenues, as well as incremental operating costs (including, but not limited to, housekeeping services, utilities and room amenity costs). RevPAR increases due to higher ADR, however, would generally not result in additional operating costs, with the exception of those charged or incurred as a percentage of revenue, such as credit card fees and commissions. As a result, changes in RevPAR driven by increases or decreases in ADR generally have a greater effect on operating profitability at our owned hotels than changes in RevPAR driven by occupancy levels. Changes in RevPAR for our franchised hotels, whether driven by occupancy or ADR, directly impact our franchise revenues, as these revenues are generally based on a percentage of the franchised hotels’ room revenues. Due to seasonality in our business, we review RevPAR by comparing current periods to budget and period-over-period.

RevPAR Index measures a hotel’s or group of hotels’ fair market share of a competitive set’s revenue per available room. RevPAR Index is stated as a percentage and is calculated for each hotel by comparing the hotel’s RevPAR to the aggregate RevPAR of a group of competing hotels generally in the same market. RevPAR Index is a weighted average of the individual property results. We subscribe to STR, which collects and compiles the data used to calculate RevPAR Index, and STR may calculate ADR and RevPAR differently than we and our competitors do. The owner of each La Quinta hotel exercises its discretion in identifying the competitive set of properties for such hotel, considering, subject to STR’s guidelines, such factors as physical proximity, competition for similar customers, services and amenities, quality and average daily rate. We initially review the competitive set makeup of each new hotel that enters our system and review the continuing appropriateness of each hotel’s competitive set on an ongoing basis. Accordingly, while the hotel brands included in the competitive set for any individual La Quinta hotel depend heavily on market-specific conditions, the competitive sets for La Quinta hotels most often include one or more of Comfort, Holiday Inn Express and Hampton. Management uses RevPAR Index and changes in RevPAR Index, particularly year-over-year percentage changes, to evaluate the performance of individual or groups of hotels relative to other competing hotels.

Comparable hotels are defined as hotels that: (i) were active and operating in our system for at least one full calendar year as of the end of the applicable period and were active and operating as of January 1st of the previous year; and (ii) have not sustained substantial property damage, business interruption, or for which comparable results are not available. Management uses comparable hotels as the basis upon which to evaluate ADR, occupancy and RevPAR on a system-wide basis and for each of our reportable segments. We report variances in ADR, occupancy and RevPAR between periods for the set of comparable hotels existing at the

34

---

reporting date versus the results of same set of hotels in the prior period. Of the 884 in our system as of September 30, 2015, 813 have been classified as comparable hotels.

EBITDA and Adjusted EBITDA. Earnings before interest, taxes, depreciation and amortization (“EBITDA”) is a commonly used measure in many industries. We adjust EBITDA when evaluating our performance because we believe that the adjustment for certain items, such as restructuring and acquisition transaction expenses, impairment charges related to long-lived assets, non-cash equity-based compensation, discontinued operations, and other items not indicative of ongoing operating performance, provides useful supplemental information to management and investors regarding our ongoing operating performance. We believe that EBITDA and Adjusted EBITDA provide useful information to investors about us and our financial condition and results of operations for the following reasons: (i) EBITDA and Adjusted EBITDA are among the measures used by our management team to evaluate our operating performance and make day-to-day operating decisions; and (ii) EBITDA and Adjusted EBITDA are frequently used by securities analysts, investors, lenders and other interested parties as a common performance measure to compare results or estimate valuations across companies in our industry.

EBITDA and Adjusted EBITDA are not recognized terms under GAAP, have limitations as analytical tools and should not be considered either in isolation or as a substitute for net income (loss), cash flow or other methods of analyzing our results as reported under GAAP. Some of these limitations are:

Because of these limitations, EBITDA and Adjusted EBITDA should not be considered as discretionary cash available to us to reinvest in the growth of our business or as measures of cash that will be available to us to meet our obligations.

Effect of the IPO Transactions

The completion of the IPO had material effects on our results of operations and financial condition. In connection with the IPO Transactions, we incurred, in the quarter ended June 30, 2014, a one-time net tax expense of $321.1 million, which reflects the impact of the La Quinta Predecessor Entities becoming owned by a “C” corporation and establishing the related net deferred tax liability on our books. Also in connection with the IPO Transactions, we recorded, in the quarter ended June 30, 2014, a one-time compensation expense of approximately $20.8 million related to the exchange of ownership units awards outstanding under our long-term cash incentive plan for vested shares of common stock of the Company, and have recorded and will record additional compensation expense for the unvested shares of restricted stock of the Company received in this exchange. See note 13 to our unaudited condensed consolidated financial statements included elsewhere in this report for more information. Since the consummation of the IPO, our results of operations have been and will be affected by other one-time costs and recurring costs of being a public company, including increases in executive and board compensation (including equity based compensation), increased insurance, accounting, legal and investor relations costs, the costs of compliance with the Sarbanes-Oxley Act of 2002, and the costs of complying with the other rules and regulations of the SEC and the NYSE. Additionally, as a result of becoming owned by a “C” corporation, we are taxed as a “C” corporation at the federal and state level. These costs are not reflected in our historical results for the periods prior to April 14, 2014, but are included in our results for periods following the consummation of the IPO.

 

 

35

---

Results of operations

The following table presents hotel operating statistics for our system-wide (owned, franchised and managed) comparable hotels for the applicable periods ⁽¹⁾:

 

 

In addition, the following table presents RevPAR Index for our system-wide (owned, franchised and managed) hotels for the applicable periods:

 

 

We experienced a decline in RevPAR Index during the three months ended September 30, 2015. We are working to identify steps we can take to improve our revenue and RevPAR index performance. One possible outcome is a heightened effort to enhance the consistency of the brand experience across our platform, which will likely require incremental expenditures.

From September 30, 2014 to September 30, 2015, our total number of owned, franchised and managed La Quinta hotels has grown from 854, or 85,500 rooms, to 884, or 87,600 rooms, with franchised hotels increasing from 501 to 532. At September 30, 2014, our franchise pipeline numbered 196 hotels, or 16,100 rooms, and has grown to 221 hotels, or 19,500 rooms, at September 30, 2015, while we have opened a net total of 31 hotels over that time period. Each of our pipeline hotels is represented by an executed franchise agreement, and approximately 35% of the conversions and new construction projects have commenced as of September 30, 2015.

Three months ended September 30, 2015 compared with three months ended September 30, 2014

For the three months ended September 30, 2015, we experienced system-wide improvement at our comparable hotels in ADR, and RevPAR, compared to the three months ended September 30, 2014. Despite the adverse impact on RevPAR from declines in occupancy, challenges in specific markets, including markets in Texas, the residual impact to RevPAR of a transition of our reservations call center, and the ongoing unexpected closure of one of our largest hotels for structural repairs, improved ADR from the three months ended September 30, 2014, drove a system-wide RevPAR increase of 2.1 percent in the three months ended September 30, 2015, compared to the three months ended September 30, 2014. We were able to increase ADR in markets where demand outpaced supply and successfully manage room rate availability, resulting in a 3.0 percent increase in system-wide ADR in the three months ended September 30, 2015, compared to the three months ended September 30, 2014. System-wide occupancy decreased 64 basis points in the three months ended September 30, 2015, compared to the three months ended September 30, 2014 as a result of weaker demand during August and September.

36

---

The following tables present our overall operating performance, and system-wide and segment occupancy, ADR and RevPAR rates on a comparable hotel statistic basis, in each case, for the three months ended September 30, 2015 and 2014, including the amount and percentage change in these results between the periods:

 

 

37

---

 

 

Revenues

Owned hotels

As of September 30, 2015, we had 352 owned hotels, comprising approximately 44,800 rooms, located in the United States. Room revenues at our owned hotels for the three months ended September 30, 2015 and 2014 totaled $238.8 million and $234.7 million, respectively. The increase of $4.1 million, or 1.7 percent, was primarily driven by an increase in RevPAR at our comparable owned hotels of 2.0 percent, which was due to an increase in ADR of 4.0 percent, partially offset by a decrease in occupancy of 142 basis points.

The increase in RevPAR, subject to the factors described above, was driven by a combination of factors, including the continued low level of new hotels being built in our competitive markets allowing for enhanced pricing power in certain of our markets, the introduction of new distribution and selling channels and continuous enhancements to our brand experience through capital expenditures and staff training, offset by a decrease in occupancy driven by reduced demand in our markets experienced primarily in August and September of 2015.

Other hotel revenues at our owned hotels for each of the three months ended September 30, 2015 and 2014 totaled $5.2 million and $5.1 million, respectively. These revenues are related to ancillary hotel services.

Franchise and other fee-based revenues

As of September 30, 2015, we had 532 franchised hotels, comprising approximately 42,800 rooms, located in the United States, Canada, Mexico and Honduras. Franchise and other fee-based revenues for the three months ended September 30, 2015 and 2014 totaled $28.5 million and $25.2 million, respectively. The increase of $3.3 million, or 13.0 percent, was primarily driven by an increase in RevPAR at our comparable franchised hotels of 2.3 percent, which was due to increases in ADR and occupancy of 1.8 percent and 30 basis points, respectively. The increase in RevPAR, subject to the factors described above, was driven by a combination of factors, including an increased demand for hotel rooms due in part to the continued low level of new hotels being built in our franchised hotels’ competitive markets, the continued expansion of our franchise footprint into higher-rated markets, and enhanced pricing power in certain of our franchisees’ markets.

The addition of new hotels to our franchise system also contributed to the growth in revenue. From September 30, 2014 to September 30, 2015, we added 31 franchised hotels on a net basis, providing an additional 2,300 rooms to our system.

Operating expenses

 

 

38

---

In total, direct lodging and other lodging and operating expenses for our owned hotels totaled $122.5 million and $116.7 million, respectively, for the three months ended September 30, 2015 and 2014, resulting in an increase of $5.8 million, or 5.0 percent. This overall increase was primarily the result of increases in direct lodging expenses for our owned hotels driven primarily by: (1) increases in salaries and benefits at our owned hotels including increased health care costs related to compliance with the Affordable Care Act, (2) increased travel agency commission costs due to (a) increased volume driven through Expedia.com’s Expedia Traveler’s Preference, which allows the guest a choice to pay for a reservation at the time of booking resulting in Expedia retaining its margin before paying us after the guest’s stay, or to pay us directly, resulting in the recognition of a commission after the guest departs based on actual consumed revenue. Many of our guests chose to pay us directly under this program, resulting in commission expense; and (b) increased volume driven through Booking.com, and (3) an increase in credit card fees. These expense increases were partially offset by the effects of continued cost mitigation strategies and the impact of operational efficiencies employed at our owned hotels. In addition, the overall increase included increases in other lodging and operating expenses for certain of our owned hotels primarily in the costs of property insurance, partially offset by decreases in general liability and auto insurance.

 

 

Depreciation and amortization expense for our owned hotels totaled $44.4 million and $45.1 million, respectively, for the three months ended September 30, 2015 and 2014. The decrease of $0.7 million, or 1.6 percent, was the result of the suspension of depreciation for 24 Owned Hotels that are subject to a definitive purchase agreement, and which were designated as assets held for sale in September 2015. This decrease was partially offset by $87.2 million in capital expenditures between September 30, 2014 and September 30, 2015, which drove additional depreciation on certain owned assets in 2015.

 

 

General and administrative expenses totaled $31.8 million and $32.3 million, respectively, for the three months ended September 30, 2015 and 2014. For the three months ended September 30, 2015, general and administrative expenses included $8.0 million in cash and $3.0 million in non-cash charges related to the departure of our former CEO.  For the three months ended September 30, 2014 general and administrative expenses included equity based compensation expense of $5.4 million related to the shares of common stock and restricted stock received in exchange for long-term incentive ownership units held by certain members of the Company’s management in connection with our IPO. Excluding the severance and IPO related equity based compensation expense, general and administrative expenses decreased primarily as the result of a significant reduction in corporate bonus expense and a decrease in healthcare costs.  These decreases are partially offset by increases in non-executive salaries and fees for professional services, primarily legal, related to the Company operating as a public company. 

 

 

 

Marketing, promotional and other advertising expenses, not funded by the BMF collected from our hotels, totaled $19.2 million and $16.6 million, respectively, for the three months ended September 30, 2015 and 2014. The increase of $2.6 million, or 15.6 percent, was primarily driven by the timing of spending under certain brand programs and increased spending in broadcast, online and print media outlets in order to enhance brand awareness and bookings. In addition, we spent $6.7 million and $6.2 million of BMF fees collected from franchised and managed hotels on similar brand management and other advertising expenses for the three months ended September 30, 2015 and 2014, respectively which increased for similar reasons.

 

 

The Company entered into discussions to sell a restaurant parcel during the third quarter. Due to the potential reduced holding period of the assets related to the restaurant, the Company recorded an impairment charge of $1.6 million in the three months ended

39

---

September 30, 2015 to adjust the value of these assets to their estimated fair value. In addition, the Company recorded an additional $0.2 million in impairment related to 24 Owned Hotels designated as assets held for sale, which are subject to a definitive purchase agreement.

 

Other Income (Expenses)

 

 

Interest expense, net, totaled $21.0 million and $24.5 million, respectively, for the three months ended September 30, 2015 and 2014. The decrease of $3.5 million, or 14.4 percent, was driven by the reduction in the principal balance of our term loan facility with the application of the voluntary prepayments and the realization of a 25 basis point reduction in the applicable interest rate when the Company achieved a net leverage ratio of less than or equal to 4.50 to 1.00 during the third quarter.  

 

The provision for the three month periods ended September 30, 2015 and 2014 reflects our operation as a “C” corporation, including the impact of equity compensation charges that are not deductible for income tax purposes. See “—Critical accounting policies and estimates—Income taxes” previously disclosed in our 2014 Form 10-K.

Segment results

We evaluate our segments’ operating performance using segment Adjusted EBITDA, as described in Note 15: “Segments” in the unaudited condensed consolidated financial statements, included elsewhere in this report. Refer to those financial statements for a reconciliation of Adjusted EBITDA to net income. For a discussion of our definitions of EBITDA and Adjusted EBITDA, how management uses them to manage our business and material limitations on their usefulness, refer to “—Key indicators of financial condition and operating performance.” The following table sets forth revenues and Adjusted EBITDA by segment, reconciled to consolidated amounts, for the three months ended September 30, 2015 and 2014.

 

 

40

---

Owned hotels

Owned Hotels segment revenues increased primarily due to an improvement in RevPAR of 2.0 percent at our comparable owned hotels. Refer to “Revenues—Owned hotels” within this section for further discussion on the increase in revenues from our comparable owned hotels. Our Owned Hotels segment’s Adjusted EBITDA increase is a result of increased Owned Hotels segment revenues of approximately $4.3 million, which were partially offset by increases in direct lodging expenses of $4.2 million and increases in other lodging and operating expenses of $1.6 million. Refer to “Operating expenses—Owned hotels” within this section for further discussion on the increase in operating expenses at our owned hotels.

Franchise and management

Franchise and Management segment revenues increased by $2.4 million primarily as a result of the increases in RevPAR of 2.3 percent at our comparable franchised and owned hotels and the net addition of hotels added to our franchise system. Refer to “Revenues—Franchise and other fee-based revenues” within this section for further discussion on the increase in revenues from our comparable franchised hotels. Our Franchise and Management segment’s Adjusted EBITDA increased as a result of the overall increase in Franchise and Management segment revenues.

Nine months ended September 30, 2015 compared with nine months ended September 30, 2014

For the nine months ended September 30, 2015, we experienced system-wide improvement at our comparable hotels in occupancy, ADR, and RevPAR, compared to the nine months ended September 30, 2014. Despite the adverse impacts to RevPAR of historically high levels of rainfall and flooding in Texas, the transition of our reservations call center, and the unexpected closure of one of our largest owned hotels for structural repairs, as well as other challenges in specific markets, including markets in Texas, a combination of improved occupancy and ADR from the nine months ended September 30, 2015 drove a system-wide RevPAR increase of 4.5 percent for the nine months ended September 30, 2015, compared to the nine months ended September 30, 2014. We were able to increase ADR in markets where demand outpaced supply and successfully manage room rate availability, resulting in a 3.3 percent increase in system-wide ADR in the nine months ended September 30, 2015, compared to the nine months ended September 30, 2014. System-wide occupancy increased 79 basis points for the nine months ended September 30, 2015, compared to the nine months ended September 30, 2014.

41

---

The following tables present our overall operating performance, and system-wide and segment occupancy, ADR and RevPAR rates on a comparable hotel statistic basis, in each case, for the nine months ended September 30, 2015 and 2014, including the amount and percentage change in these results between the periods:

 

 

42

---

 

 

Revenues

Owned hotels

As of September 30, 2015, we had 352 owned hotels, comprising approximately 44,800 rooms, located in the United States. Room revenues at our owned hotels for the nine months ended September 30, 2015 and 2014 totaled $692.9 million and $649.2 million, respectively. The increase of $43.7 million, or 6.7 percent, was primarily driven by an increase in RevPAR at our comparable owned hotels of 4.8 percent, which was due to increases in ADR and occupancy of 3.9 percent and 59 basis points, respectively.

The increase in RevPAR, subject to the factors described above, was driven by a combination of factors, including, an increased demand for hotel rooms due in part to the continued low level of new hotels being built in our competitive markets allowing for enhanced pricing power in certain of our markets, the introduction of new distribution and selling channels and continuous enhancements to our brand experience through capital expenditures and staff training.

Other hotel revenues at our owned hotels for the nine months ended September 30, 2015 and 2014 totaled $14.7 million and $14.8 million, respectively. The decrease of $0.1 million, or 0.8 percent, was primarily a result of a decrease in demand for ancillary hotel services.

Franchise and other fee-based revenues

As of September 30, 2015, we had 532 franchised hotels, comprising approximately 42,800 rooms, located in the United States, Canada, Mexico and Honduras. Franchise and other fee-based revenues for the nine month periods ended September 30, 2015 and 2014 totaled $75.6 million and $68.2 million, respectively. The increase of $7.4 million, or 10.8 percent, was primarily driven by an increase in RevPAR at our comparable franchised hotels of 4.3 percent, which was due to increases in ADR and occupancy of 2.7 percent and 105 basis points, respectively. The increase in RevPAR, subject to the factors described above, was driven by a combination of factors, including an increased demand for hotel rooms due in part to the continued low level of new hotels being built in our franchised hotels’ competitive markets, the continued expansion of our franchise footprint into higher-rated markets, and enhanced pricing power in certain of our franchisees’ markets.

The addition of new hotels to our franchise system also contributed to the growth in revenue. From September 30, 2014 to September 30, 2015, we added 31 franchised hotels on a net basis, providing an additional 2,300 rooms to our system.

43

---

Operating expenses

 

 

In total, direct lodging and other lodging and operating expenses for our owned hotels totaled $351.9 million and $331.5 million, respectively, for the nine month periods ended September 30, 2015 and 2014, resulting in an increase of $20.4 million, or 6.2 percent. This overall increase was primarily the result of increases in direct lodging expenses for our owned hotels driven primarily by: (1) an occupancy increase of 59 basis points; (2) increases in salaries and benefits at our owned hotels including increased health care costs related to compliance with the Affordable Care Act, (3) increased travel agency commission costs due to (a) increased volume driven through Expedia.com’s Expedia Traveler’s Preference, which allows the guest a choice to pay for a reservation at the time of booking resulting in Expedia retaining its margin before paying us after the guest’s stay, or to pay us directly, resulting in the recognition of a commission after the guest departs based on actual consumed revenue. Many of our guests chose to pay us directly under this program, resulting in commission expense; and (b) increased volume driven through Booking.com, (4) increased utilities costs, specifically electricity and water, and (5) and increased expenses related to the acquisition of the 14 Previously Managed Hotels on April 14, 2014, particularly ground lease rental and employee compensation costs. These expense increases were partially offset by the effects of continued cost mitigation strategies and the impact of operational efficiencies employed at our owned hotels. In addition, the overall increase was driven by increases in other lodging and operating expenses for certain of our owned hotels primarily in the cost for property, general liability and auto insurance, as well as property taxes related to increased valuation assessments for certain of our owned hotels.

 

 

Depreciation and amortization expense for our owned hotels totaled $132.3 million and $129.9 million, respectively, for the nine month period ended September 30, 2015 and 2014. The increase of $2.4 million, or 1.8 percent, was the result of $87.2 million in capital expenditures between September 30, 2015 and September 30, 2014, which drove additional depreciation on certain owned assets in 2015, as well as $166.5 million in additions to property and equipment as a result of the acquisition of the Previously Managed Hotels on April 14, 2014.  The increase was partially offset by of the suspension of depreciation for 24 Owned Hotels that are subject to a definitive purchase agreement, and which were designated as assets held for sale in September 2015.

 

 

General and administrative expenses totaled $92.7 million and $100.9 million, respectively, for the nine month periods ended September 30, 2015 and 2014. The decrease of $8.2 million, or 8.1 percent, was primarily the result of a decrease in equity based compensation expense of $20.2 million. For the nine months ended September 30, 2015 and 2014, equity based compensation expense included $5.6 million and $31.7 million, respectively, related to the shares of common stock and restricted stock received in exchange for long-term incentive ownership units held by certain members of the Company’s management in connection with our IPO. These shares became fully vested on April 14, 2015. Equity based compensation amounts also include amounts related to certain grants made under the La Quinta Holdings Inc. 2014 Omnibus Incentive Plan at the time of, and subsequent to, our IPO, including grants made in 2015. The decrease also includes a significant reduction in corporate bonus expense. This decrease in general and administrative expenses is partially offset by $8.0 million in cash and $3.0 million in non-cash charges related to the departure of our former CEO, in addition to other factors including increases in executive and director compensation and fees for professional services, primarily accounting and legal, related to the Company operating as a public company. Additionally, we (1) had a significant favorable legal accrual reversal in 2014, (2) incurred expenses in connection with a secondary offering of common stock in 2015, and (3) had increased costs related to the transition of our call center to a new provider in 2015.

 

44

---

 

Marketing, promotional and other advertising expenses, not funded by the BMF collected from our franchised and managed hotels, totaled $57.0 million and $50.2 million, respectively, for the nine month periods ended September 30, 2015 and 2014. The increase of $6.8 million, or 13.7 percent, was primarily driven by the timing of spending under certain brand programs and increased spending to enhance brand awareness and bookings via broadcast, online and print media outlets. In addition, we spent $18.0 million and $16.5 million of BMF fees collected from franchised and managed hotels on similar brand management and other advertising expenses for the nine months ended September 30, 2015 and 2014, respectively which increased for similar reasons.

 

 

Due to the potential reduced holding period of 24 Owned Hotels, the Company recorded an impairment charge of $42.7 million in the nine month period ended September 30, 2015 to adjust the value of these assets to their estimated fair value. The Company entered into a definitive purchase and sale agreement to sell these 24 Owned Hotels during the third quarter. Additionally, during the third quarter the Company entered into discussions to sell a restaurant parcel. Due to the potential reduced holding period of the restaurant assets, the Company recorded an impairment charge of $1.6 million in the three months ended September 30, 2015 to adjust the value of these assets to their estimated fair value.

In June 2014, we determined that the long-lived assets associated with one of our Owned Hotels were partially impaired primarily due to unfavorable expected terms of the upcoming underlying ground lease renewal and the likelihood of the Company abandoning the hotel upon expiration of the ground lease. As a result, we recorded an impairment loss of approximately $5.2 million for the three months ended September 30, 2014. Subsequent to September 30, 2014, we reached an agreement with the landlord and renewed the ground lease.

 

 

On April 13, 2015, we entered into an agreement to sell one of our Owned Hotels for approximately $3.0 million. We closed the sale prior to September 30, 2015 and recorded a loss on sale of approximately $4.0 million related to this transaction. During the third quarter of 2015, we sold a restaurant parcel for a loss on sale of $0.1 million.

Other Income (Expenses)

 

 

Interest expense, net, totaled $65.9 million and $97.3 million, respectively, for the nine months ended September 30, 2015 and 2014. The decrease of $31.4 million, or 32.2 percent, was primarily driven by a decrease in the overall interest rate on our new senior debt facility entered into at the time of the IPO as compared to our historical debt and the lower average outstanding balances of debt. The decrease, was also driven by the Company’s realization of a 25 basis point reduction in interest rate, when the Company achieved a net leverage ratio of less than or equal to 4.50 to 1.00 during the third quarter. Also, interest expense for the nine months ended September 30, 2015 and 2014 included $6.6 million and $4.1 million, respectively, of interest expense related to an interest rate swap agreement covering a portion of our outstanding long-term debt entered into on April 14, 2014.

 

 

45

---

In connection with the refinancing of our debt during the nine months ended September 30, 2014, we recorded a $2.0 million loss on extinguishment of debt, representing the write-off of unamortized debt issuance costs and associated fees.

 

 

Prior to our IPO on April 14, 2014, we operated within legal structures that are disregarded for federal and most state income tax purposes. Accordingly, in those jurisdictions that recognize disregarded status, items of income and expense have been allocated to the owners of our legal entities. The provision for the nine month period ended September 30, 2015 reflects our operation as a “C” corporation, including the impact of equity compensation charges that are not deductible for income tax purposes. See “—Critical accounting policies and estimates—Income taxes” previously disclosed in our 2014 Form 10-K.

 

 

During June 2013, we finalized the decision to dispose of 44 of our owned hotels. Prior to December 31, 2013, 40 of the 44 hotels were sold, with the remaining 4 being sold in February 2014. As such, these hotels were classified as assets held for sale, and the results of their operations are presented within discontinued operations, in accordance with accounting rules in place at that time, for the nine month period ended September 30, 2014.

Segment results

We evaluate our segments’ operating performance using segment Adjusted EBITDA, as described in Note 15: “Segments” in the unaudited condensed consolidated financial statements, included elsewhere in this report. Refer to those financial statements for a reconciliation of Adjusted EBITDA to net income. For a discussion of our definitions of EBITDA and Adjusted EBITDA, how management uses them to manage our business and material limitations on their usefulness, refer to “—Key indicators of financial condition and operating performance.” The following table sets forth revenues and Adjusted EBITDA by segment, reconciled to consolidated amounts, for the nine months ended September 30, 2015 and 2014. The comparison of the nine month period ended September 30, 2015 to the nine month period ended September 30, 2014 is impacted by the purchase of the Previously Managed Hotels at the time of the IPO and the change in certain intercompany agreements which went into effect on April 14, 2014 – refer to the footnotes to the table below for a more detailed discussion:

 

46

---

 

Owned hotels

Owned Hotels segment revenues increased primarily due to the inclusion of the Previously Managed Hotels post-IPO and an improvement in RevPAR of 4.8 percent at our comparable owned hotels. Refer to “Revenues—Owned hotels” within this section for further discussion on the increase in revenues from our comparable owned hotels. Our Owned Hotels segment’s Adjusted EBITDA increased as a result of an increase in Owned Hotels segment revenues of approximately $43.9 million. This increase is partially offset by the establishment of new franchise and management agreements at the time of our IPO, which resulted in increased franchise, reservation, and management fee expense for Owned Hotels. In addition, direct lodging expenses increased $17.4 million, and other lodging and operating expenses increased $3.0 million. Refer to “Operating expenses—Owned hotels” within this section for further discussion on the increase in operating expenses at our owned hotels.

Franchise and management

Franchise and Management segment revenues increased by $18.4 million primarily as a result of the establishment of new franchise and management agreements at the time of our IPO which resulted in increased franchise and management fee income from Owned Hotels. In addition, franchise and management segment revenues increased as a result of the increases in RevPAR of 4.3 percent at our comparable franchised and owned hotels and the net addition of hotels added to our franchise system. Refer to “Revenues—Franchise and other fee-based revenues” within this section for further discussion on the increase in revenues from our comparable franchised hotels. Our Franchise and Management segment’s Adjusted EBITDA increased as a result of the overall increase in Franchise and Management segment revenues.

 

 

Liquidity and Capital Resources

Overview

As of September 30, 2015, we had total cash and cash equivalents of $117.6 million. Our known liquidity requirements primarily consist of funds necessary to pay for operating expenses and other expenditures, including corporate expenses, taxes, payroll and related benefits, legal costs, operating costs associated with the operation of hotels, interest and scheduled principal payments on our outstanding indebtedness, potential payments related to our interest rate swap, capital expenditures for renovations and maintenance at our owned hotels, and other purchase commitments. During September 2015, the Company's board of directors authorized a program to repurchase an aggregate of up to $100 million of the Company’s common stock (the “Repurchase Program”). The Repurchase Program represented an acceleration of a portion of the $200 million repurchase program that the Company’s board of directors had previously approved for the Company to move forward with once the Company’s net debt to Pro Forma Adjusted EBITDA ratio falls below 4.0 times. Through September 30, 2015, the Company repurchased 999,452 shares of common stock. These shares were repurchased at a weighted-average price of $16.03 per share, for an aggregate purchase price of $16.0 million.

Concurrently with the consummation of the IPO, we entered into a new credit agreement to refinance all of our then existing secured debt, which was to mature in July 2014. The new credit agreement provides for senior secured credit facilities consisting of a then existing $2.1 billion senior secured term loan facility (of which approximately $1.7 billion was outstanding as of September 30, 2015), which will mature in 2021, and a $250.0 million senior secured revolving credit facility, $50.0 million of which is available in the form of letters of credit, which will mature in 2019. See “—Debt” for a further discussion of our new credit agreement. In addition, following consummation of the IPO, for federal income tax purposes, our partnership and REIT status terminated and we became subject to additional entity-level taxes at the federal and state level and, in our second quarter of 2014, we established the

47

---

related net deferred tax liability in our books equal to $321.1 million. Accordingly, we expect that in the future, our cash taxes, after utilization of net operating losses (“NOLs”), currently expected to be utilized in 2015 and 2016, will exceed the income tax provision in our financial statements. We currently estimate that this excess could be approximately $19 million to $21 million per year beginning in 2017, which amount may vary based on taxable income among other factors. In November 2014, Blackstone completed a secondary offering in which it registered and sold 23.0 million of the Company’s shares, bringing its ownership percentage to 45.2%, and creating an ownership change for federal income tax purposes. As a result of this secondary offering, and the resulting ownership change the Company’s federal net operating losses will be limited under Internal Revenue Code Section 382 with annual limitations that become applicable each year from 2015 through 2019. State net operating loss carryforwards are also available for use subject to similar limitations in many cases. We do not believe that the Section 382 limitations will prevent the Company from using its total pre-ownership change NOL carryforwards although we may be subject to annual limitations.

We finance our business activities primarily with existing cash and cash generated from our operations. We believe that this cash will be adequate to meet anticipated requirements for operating expenses and other expenditures, including corporate expenses, payroll and related benefits, legal costs, and purchase commitments for the foreseeable future. The objectives of our cash management policy are to maintain the availability of liquidity and minimize operational costs. We currently expect, in 2015, to use a significant portion of our available cash flow from operations to make prepayments on our outstanding indebtedness.

The following table summarizes our net cash flows and key metrics related to our liquidity:

 

 

Our ratio of current assets to current liabilities, excluding the current portion of long-term debt, was 1.62 and 1.50 as of September 30, 2015 and December 31, 2014, respectively.

Operating activities

Net cash provided by operating activities was $241.3 million for the nine months ended September 30, 2015, compared to $227.7 million for the nine months ended September 30, 2014. The $13.6 million increase was primarily driven by increased operating income prior to the reduction for equity based compensation and the impairment loss. This increase was offset by the effects of timing in our various working capital components including accounts receivable and accrued payroll and employee benefits.

Investing activities

Net cash used in investing activities during the nine months ended September 30, 2015 was $64.3 million, compared to $32.4 million used in investing activities during the nine months ended September 30, 2014. The $31.9 million increase in cash used in investing activities was primarily attributable to the prior year acquisition of the Previously Managed Hotels funded by a decrease in cash released from restriction, and an increase in insurance proceeds on casualty disasters offset by increased capital expenditures and a decrease of $3.3 million in proceeds from sale of assets.

Financing activities

Net cash used in financing activities during the nine months ended September 30, 2015 was $169.3 million, compared to $120.2 million during the nine months ended September 30, 2014. The $49.1 million increase in cash used in financing activities was primarily attributable to current year repayments of long-term debt, including $135 million of voluntary principal payments, as compared to the net of various financing activities surrounding our debt refinancing and IPO in 2014. These 2014 financing activities included proceeds from our new senior debt facility of $2.1 billion, net proceeds from issuance of common stock of $698.0 million, and capital contributions of $21.5 million, offset by repayment of long-term debt of $2.9 billion, payment of deferred costs of $27.3 million, payment of original issue discount of $10.5 million, distributions to noncontrolling interest holders of $4.4 million, including $3.9 million for redemption of the capital stock held by third-party shareholders of our REIT entities.

Capital expenditures

During the nine months ended September 30, 2015 and 2014, we paid for capital expenditures of approximately $74.4 million and $65.8 million, respectively.

48

---

As of September 30, 2015, we had outstanding commitments under capital expenditure contracts of approximately $20.8 million for capital expenditures at certain owned hotels and for information technology enhancements. If cancellation of a contract occurred, our commitment would be any costs incurred up to the cancellation date, in addition to any costs associated with the discharge of the contract.

Debt

Concurrently with the consummation of the IPO, we refinanced all of our existing debt and accrued interest and related fees. As part of the refinancing, we entered into a credit agreement which provides for senior secured credit facilities consisting of:

In addition, the senior secured credit facilities also provide us with the option to raise incremental credit facilities, refinance the loans with debt incurred outside the credit agreement and extend the maturity date of the revolving credit facility and term loans, subject to certain limitations.

Borrowings under the term loans bear interest, at the Borrower’s option, at a rate equal to a margin over either (a) a base rate determined by reference to the highest of (1) the administrative agent’s prime lending rate, (2) the federal funds effective rate plus 1/2 of 1.00% and (3) the LIBOR rate for a one-month interest period plus 1.00% or (b) a LIBOR rate determined by reference to the Reuters LIBOR rate for the interest period relevant to such borrowing. The margin for the term loans is 2.00%, in the case of base rate loans, and 3.00% in the case of LIBOR rate loans, subject to one step-down of 0.25% upon the achievement of a consolidated first lien net leverage ratio (as defined in the credit agreement) of less than or equal to 4.50 to 1.00, subject to a base rate floor of 2.00%, and a LIBOR floor of 1.00%. As of July 31, 2015, we achieved a consolidated first lien net leverage ratio of less than 4.50 to 1.00, and, as a result we realized the step-down of 0.25% after that date.

Borrowings under the revolving credit facility bear interest, at the Borrower’s option, at a rate equal to a margin over either (a) a base rate determined by reference to the highest of (1) the administrative agent’s prime lending rate, (2) the federal funds effective rate plus 1/2 of 1.00% and (3) the LIBOR rate for a one-month interest period plus 1.00% or (b) a LIBOR rate determined by reference to the Reuters LIBOR rate for the interest period relevant to such borrowing. The margin for the revolving credit facility is 1.50%, in the case of base rate loans, and 2.50%, in the case of LIBOR rate loans, subject to three step-downs of 0.25% each upon the achievement of a consolidated first lien net leverage ratio of less than or equal to 5.00 to 1.00, 4.50 to 1.00 and 4.00 to 1.00, respectively. As of March 2, 2015, we achieved a consolidated first lien net leverage ratio of less than 5.00 to 1.00, and after March 2, 2015 we realized the first step-down in margin of 0.25%.

We used the net proceeds of the senior secured term loan facility, together with the net proceeds from the IPO and available cash, to repay all of our previous indebtedness. In 2014, we made voluntary prepayments of $195.0 million on the loan term facility and made quarterly scheduled principal payments of $9.8 million in the aggregate. As of September 2015, we have made voluntary prepayments of $135.0 million on the term loan facility and quarterly scheduled principal payments of $13.3 million.

On April 14, 2014, we entered into an interest rate swap agreement with an aggregate notional amount of $850.0 million that expires on April 14, 2019. This agreement swaps the LIBOR rate in effect under the new credit agreement for this portion of the loan to a fixed-rate of 2.0311%, which includes the 1% LIBOR floor. We have elected to designate this interest rate swap as a cash flow hedge for accounting purposes.

If we are unable to generate sufficient cash flow from operations in the future to service our debt, we may be required to reduce capital expenditures or refinance all or a portion of our existing debt. Our ability to make scheduled principal payments and to pay interest on our debt depends on the future performance of our operations, which is subject to general conditions in or affecting the hotel industry that are beyond our control. See “Risk Factors—Risks related to our business and industry” and “Risk Factors—Risks relating to our indebtedness” in our 2014 Form 10-K.

Contractual obligations

There have been no significant changes in our contractual obligations since December 31, 2014 and the discussion under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Contractual obligations” in our 2014 Form 10-K is incorporated herein by reference.

49

---

Off-balance sheet arrangements

We do not have off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources. Under certain franchise agreements, we have committed to provide certain incentive payments, reimbursements, rebates and other payments, to help defray the costs of construction, marketing and other costs associated with opening and operating a La Quinta hotel.

Newly Issued Accounting Standards

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09. The new guidance on revenue from contracts with customers will supersede most current revenue recognition guidance, including industry-specific guidance. The underlying principle is that an entity will recognize revenue to depict the transfer of goods or services to customers at an amount that the entity expects to be entitled to in exchange for those goods or services. The guidance provides a five-step analysis of transactions to determine when and how revenue is recognized. Other major provisions include capitalization of certain contract costs, consideration of time value of money in the transaction price, and allowing estimates of variable consideration to be recognized before contingencies are resolved in certain circumstances. The guidance also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenue and cash flows arising from an entity’s contracts with customers. The guidance is effective for the interim and annual periods beginning on or after December 15, 2017; early adoption is permitted for annual reporting periods beginning after December 15, 2016. The guidance permits the use of either a retrospective or cumulative effect transition method. We have not yet selected a transition method and are currently evaluating the impact of the amended guidance on our consolidated financial position, results of operations and related disclosures.

In January 2015, the FASB issued ASU No. 2015-01, “Income Statement – Extraordinary and Unusual Items (Subtopic 225-20).” The amendments in this ASU eliminate the requirement of Extraordinary Items to be separately classified on the income statement. This will alleviate uncertainty for preparers, auditors, and regulators because auditors and regulators no longer will need to evaluate whether a preparer treated an unusual and/or infrequent item appropriately. The update is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2015. A reporting entity may apply the amendments prospectively or retrospectively to all prior periods presented in the financial statements. Early adoption is permitted provided that the guidance is applied from the beginning of the fiscal year of adoption. We do not anticipate that the adoption of this standard will have a material impact on our financial position, results of operations and related disclosures.

In February 2015, the FASB issued ASU No. 2015-02, “Consolidation (Topic 810)—Amendments to the Consolidation Analysis.” The update primarily amends the criteria used to evaluate whether certain variable interest entities should be consolidated and modifies the criteria used to determine whether partnerships and similar entities are variable interest entities. The update is effective for interim and annual periods beginning after December 15, 2015 with early adoption permitted, including in the interim periods. We do not anticipate that the adoption of this standard will have a material impact on our financial position, results of operations and related disclosures.

In April 2015, the FASB issued ASU No. 2015-03, “Interest - Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs.” This ASU requires debt issuance costs related to a recognized debt liability to be presented in the balance sheet as a direct deduction from the debt liability rather than as an asset, which is consistent with the presentation of debt discounts or premiums. The provisions of ASU No. 2015-03 are effective for reporting periods beginning after December 31, 2015 and is required to be adopted retroactively; early adoption is permitted. We do not anticipate that the adoption of this standard will have a significant impact on our financial position, results of operations and related disclosures.

Newly Adopted Accounting Standards

In April 2014, the FASB issued ASU No. 2014-08, “Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” Under the new guidance, only a disposal of a component that represents a major strategic shift of an organization qualifies for discontinued operations reporting. The guidance also requires expanded disclosures about discontinued operations and new disclosures in regards to individually significant disposals that do not qualify for discontinued operations reporting. This guidance is effective for the first interim or annual period beginning on or after December 15, 2014. We adopted this standard as of January 1, 2015. This adoption impacts the comparability of our financial statements as disposals of individual owned hotels will generally no longer qualify as discontinued operations.

Critical accounting policies and estimates

The preparation of our financial statements in accordance with GAAP requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the financial statements, the reported amounts of revenues and expenses during the reporting periods and the related disclosures in the consolidated financial statements and accompanying footnotes. On an ongoing basis, we evaluate these estimates and judgments based on historical experiences and various other factors that are believed to

50

---

reflect the current circumstances. While we believe our estimates, assumptions and judgments are reasonable, they are based on information presently available. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2014 Form 10-K describes the critical accounting estimates used in preparation of our consolidated financial statements. Actual results may differ significantly from these estimates due to changes in judgments, assumptions and conditions as a result of unforeseen events or otherwise, which could have a material impact on financial position or results of operations. There have been no material changes to our significant accounting policies as compared to the significant accounting policies described in our 2014 Form 10-K.

 

 

We are exposed to market risk primarily from changes in interest rates, which may impact future income, cash flows and fair value of the Company, depending on changes to interest rates. In certain situations, we may seek to reduce cash flow volatility associated with changes in interest rates by entering into financial arrangements intended to provide a hedge against a portion of the risks associated with such volatility. We continue to have exposure to such risks to the extent they are not hedged. We enter into derivative financial arrangements to the extent they meet the objective described above, or are required by the terms of our debt facilities, and we do not use derivatives for trading or speculative purposes.

Interest rate risk

We are exposed to interest rate risk under our new credit agreement, as the interest is floating rate based on LIBOR, subject to a 1% LIBOR floor. On April 14, 2014, we entered into an interest rate swap agreement with an aggregate notional amount of $850.0 million that expires on April 14, 2019. This agreement swaps the LIBOR rate in effect under the new credit agreement for this portion of the loan to a fixed-rate of 2.0311%, which includes the 1% LIBOR floor. We have elected to designate this interest rate swap as a cash flow hedge for accounting purposes. The 30-day LIBOR rate increased from 0.16 percent per annum at December 31, 2014 to 0.20 percent at September 30, 2015. Changes in interest rates also affect the fair value of our debt.

The following table sets forth the scheduled maturities and the total fair value as of September 30, 2015 for our financial instruments that were materially affected by interest rate risks (in millions, excluding average interest rate):

 

 

Refer to our Note 6: “Fair Value Measurements” in the unaudited condensed consolidated financial statements included elsewhere in this report for further discussion of the fair value measurements of our financial assets and liabilities.

 

 

Evaluation of Disclosure Controls and Procedures

As of September 30, 2015, the Company’s management has evaluated, with the participation of the Company’s principal executive officer and principal financial officer, the Company’s disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e). Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired controls objectives. Based upon that evaluation, the Company’s principal executive officer and principal financial officer have concluded that, as of September 30, 2015, the Company’s disclosure controls and procedures were effective at a reasonable assurance level.

Changes in Internal Control over Financial Reporting

There were no changes in the internal control over financial reporting of the Company that occurred during the fiscal quarter covered by this report that have materially affected, or are reasonably likely to materially affect, the internal control over financial reporting of the Company.

 

 

51

---

PART II—OTHER INFORMATION

 

 

We are a party to a number of pending claims and lawsuits arising in the normal course of business, including proceedings involving tort and other general liability claims, workers’ compensation and other employee claims and intellectual property claims.

We maintain general and other liability insurance; however, certain costs of defending lawsuits, such as those below the retention or insurance deductible amount, are not covered by or are only partially covered by insurance policies, and our insurance carriers could refuse to cover certain claims in whole or in part. We regularly evaluate our ultimate liability costs with respect to such claims and lawsuits. We accrue costs from litigation as they become probable and estimable.

We do not consider our ultimate liability with respect to any single claim or lawsuit, or the aggregate of such claims and lawsuits, to be material in relation to our consolidated financial condition, results of operations or our cash flows taken as a whole.

 

 

There have been no material changes to our principal risks that we believe are material to our business, results of operations and financial condition from the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014, which is accessible on the SEC’s website at www.sec.gov.

 

 

 

(1) Includes repurchases pursuant to the Repurchase Program (as defined below); no additional shares were repurchased in the period.

(2) On September 17, 2015, the Company announced that our Board of Directors had authorized a program (the “Repurchase Program”) of indefinite duration to repurchase an aggregate of up to $100 million of the Company’s common stock, effective immediately.  The Repurchase Program represents the acceleration of a portion of the $200 million repurchase program that the Company had previously announced that our Board of Directors had approved for the Company to move forward with once our net debt to Pro Forma Adjusted EBITDA ratio falls below 4.0 times.

 

 

None.

 

 

Not applicable.

 

 

Pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012 (“ITRSHRA”), which added Section 13(r) of the Exchange Act, we hereby incorporate by reference herein Exhibit 99.1 of this report, which includes disclosures publicly filed and/or provided to Blackstone by Travelport Worldwide Limited, which may be considered our affiliates.

 

 

52

---

The following is a list of all exhibits filed or furnished as part of this report:

 

 

The agreements and other documents filed as exhibits to this report are not intended to provide factual information or other disclosure other than with respect to the terms of the agreements or other documents themselves, and you should not rely on them for that purpose. In particular, any representations and warranties made by us in these agreements or other documents were made solely within the specific context of the relevant agreement or document and may not describe the actual state of affairs as of the date they were made or at any other time.

 

 

53

---

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

54