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LQ > SEC Filings for LQ > Form 10-Q on 13-Aug-2014All Recent SEC Filings

Show all filings for LA QUINTA HOLDINGS INC.

Form 10-Q for LA QUINTA HOLDINGS INC.


13-Aug-2014

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

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 prospectus dated April 8, 2014 (the "prospectus"), as filed with the Securities and Exchange Commission (the "SEC") on April 9, 2014 pursuant to Rule 424(b)(4) under the Securities Act, and in this report, 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 at an initial public offering price of $17.00 per share, 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
LLC., Lodge Holdco II LLC., and Lodge Holdco III LLC., and their consolidated subsidiaries, (collectively, the "La Quinta Predecessor Entities") and
(ii) entities that owned the 14 La Quinta Hotels managed by LQ Management LLC. ("LQM", a consolidated variable interest entity) (the "Previously Managed Portfolio" and, together with the La Quinta Predecessor Entities, the "Pre-IPO Entities"). 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 the periods prior to 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. According to data provided by Smith Travel Research ("STR"), La Quinta is the fastest growing principal select-service hotel brand in the United States primarily serving these segments in terms of percentage growth of number of hotels over the last ten years ended December 31, 2013, significantly outpacing the percentage growth of our main STR competitive set (meaning Comfort, Holiday Inn Express and/or Hampton, the brands most often included in our STR competitive set) in percentage terms. Our system-wide portfolio, as of June 30, 2014, consisted of 848 hotels representing approximately 85,000 rooms located predominantly across 47 U.S. states, as well as in Canada and Mexico, of which 353 hotels were owned and operated and 495 were franchised. We also have a pipeline of 190 franchised hotels in the United States, Mexico, Canada, Colombia, Honduras, Nicaragua, and Guatemala. 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, in the six months ended June 30, 2014, 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 chief operating decision maker to assess performance and make decisions regarding the allocation of resources. We define our reportable segments as follows:

Owned hotels-This segment derives its earnings from the operation of owned hotel properties located in the United States.

Franchise and management-This segment derives its earnings primarily from fees earned under various license, franchise and management agreements relating to our owned, franchised and managed hotels. These agreements provide for us to earn compensation for the licensing of our brand to franchisees, for providing certain services (including hotel management services) and for providing access to certain shared services and marketing programs such as reservations, La Quinta Returns, and property management systems. Other than with respect to the Previously Managed Portfolio, which are reflected as managed hotels prior to their acquisition in connection with the IPO in this "Management's Discussion and Analysis of Financial Condition and Results of Operations" section, we do not currently generate, and did not generate over the periods presented, any revenue from the management of hotel operations for third parties. This segment includes intercompany fees, which are charged to our owned portfolio to reflect that certain functions, such as franchise, licensing and management, are included in the franchise and management segment. We have historically charged aggregate fees of 2.0% (0.33% license fee for trademark rights and 1.67% management fee for management services) to our owned hotels (as well as having certain cost reimbursement arrangements). Upon effectiveness of the IPO, we entered into new franchise and management agreements covering our owned portfolio, which covers certain services as well as trademark rights, and terminated the agreements that existed prior to the IPO. The new agreements provide for a franchise fee of 4.5% of gross room revenues and a management fee of 2.5% of gross operating revenue for our owned hotels. We set the franchise fee on a basis that reflects the services and rights covered by the new franchise agreement and because, as a public company with two segments that may be valued differently by investors, we believe it is meaningful to investors to show a franchise fee on our owned portfolio that is consistent with the franchise fee we charge our franchisees. We set the management fee on a basis that reflects current market rates for select service hotels and the current composition of our owned portfolio. For purposes of this "Management's Discussion and Analysis of Financial Condition and Results of Operations" section, we have reflected the historical aggregate intercompany fees of 2.0% prior to the IPO date, and the new rates for the period from April 14, 2014 to June 30, 2014.

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 agreement 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 from April 14, 2014 to June 30, 2014.


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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."

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, franchised and managed La Quinta branded hotels as of June 30, 2014 and 2013.

                                                           As of June 30,
                                                           2014        2013
         Owned Hotels:
         Owned Hotels (1)                                     353        383
         Discontinued Operations                                -        (44 )

         Net Owned Hotels                                     353        339

         Franchised/Managed Hotels:
         Franchised Hotels                                    495        452
         Managed Hotels                                         -         14

         Total Franchised/Managed Hotels                      495        466

         Total Net Owned and Franchised/Managed Hotels        848        805

(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.

The following table summarizes our owned, franchised and managed hotels as of June 30, 2014 and 2013:

                                                          As of June 30,
                                                          2014        2013
           Number of Hotels in Operation
           Company Owned Hotels
           La Quinta Inn & Suites (interior corridor)        184        170
           La Quinta Inn & Suites (exterior corridor)          3          3
           La Quinta Inns (interior corridor)                 56         56
           La Quinta Inns (exterior corridor)                110        110

           Total Owned                                       353        339

           Franchised/Managed Hotels
           La Quinta Inn & Suites (interior corridor)        396        368
           La Quinta Inn & Suites (exterior corridor)          3          3
           La Quinta Inns (interior corridor)                 84         90
           La Quinta Inns (exterior corridor)                 12          5

           Total Franchised/Managed                          495        466

           Total Hotels                                      848        805


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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 first or second quarter results may be further adversely affected by the timing of certain of our marketing production expenditures. Further, the timing of opening 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 six month periods ended June 30, 2014 and 2013. 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:

Room revenues. Represents revenues derived from hotel operations at owned hotels which are almost exclusively driven by room rentals. These revenues are primarily derived from three categories of guests: leisure, corporate and group.

Franchise fees. Represents revenues derived from franchise fees received in connection with the franchising of our brand, and other revenue generated by the incidental support of hotel operations for franchised hotels. Franchise fees consist of an initial fee upon the entry of a new hotel into the system and a monthly royalty fee, generally calculated as a percentage of gross room revenue. As new franchised hotels are established in our franchise system, we expect the franchise fees received from such hotels to increase over time as they establish their presence in the marketplace and stabilize their operations.

Management fees. Represents revenues derived from management fees received in connection with the management of day-to-day hotel operations, and other revenue generated by the incidental support of hotel operations for managed properties. Management fees are generally calculated as a percentage of gross room revenue. After the consummation of the IPO Transactions, we no longer have any management fees from third parties.

Other hotel revenues. Other hotel revenues include revenues generated by the incidental support of hotel operations for owned hotels, including charges to guests for vending commissions, meeting and banquet room revenue, laundry services, and other rental income from operating leases associated with leasing space for restaurants, billboards and cell towers.

Brand marketing fund revenues from franchised and managed properties. These revenues represent the fees collected from our franchised and managed hotels related to our Brand Marketing Fund ("BMF"), which are calculated as a percentage of gross room revenues. The corresponding expenses are presented as other expenses from franchised and managed properties in our condensed consolidated statements of operations, resulting in no impact to operating income or net income. After the consummation of the IPO Transactions, we no longer have BMF revenues from properties managed for third parties.

Consumer demand for our services is closely linked to the performance of the general economy 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 prospectus.

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.


Table of Contents

Expenses

We primarily incur the following expenses:

Direct lodging expenses and other lodging and operating expenses. Direct lodging and Other lodging and operating expenses reflect the operating expenses of our owned hotels, including both direct and indirect hotel operating expenses. Direct lodging expenses include items such as compensation costs for hotel level management, housekeeping, laundry and front desk staff, supply costs for guest room amenities and laundry, repairs and maintenance, utilities, sales and local marketing, bad debt expenses related to direct-bill corporate customers, and online and offline travel agency commissions. Other lodging and operating expenses include indirect property operating expenses, primarily property taxes and insurance.

Depreciation and amortization. Depreciation and amortization are non-cash expenses that primarily consist of depreciation of fixed assets such as buildings, furniture, fixtures and equipment at our owned hotels, as well as certain corporate assets. Amortization expense primarily consists of amortization of intangibles related to our franchise business and other leasehold interests, which are amortized over their estimated useful lives.

General and administrative expenses. General and administrative expenses consist primarily of compensation expense for our corporate staff and personnel supporting our business segments, professional fees (including consulting, audit and legal fees), travel and entertainment expenses, contractual performance obligations and office administrative and related expenses.

Impairment losses. We hold amortizing and non-amortizing intangible assets and long-lived assets. We evaluate these assets for impairment as further discussed in "-Critical accounting policies and estimates" previously disclosed in our prospectus. These evaluations have, in the past, resulted in impairment losses for certain of these assets based on the specific facts and circumstances surrounding those assets and our estimates of the fair value of those assets. Based on economic conditions or other factors at a hotel-specific or system-wide level, we may be required to take additional impairment losses to reflect further declines in our asset and/or investment values.

Brand marketing fund expenses from franchised and managed properties. These expenses represent the expenditure of BMF fees collected from our franchised and managed hotels for marketing and other support of the La Quinta brand. The corresponding revenues are presented as other revenues from franchised and managed properties in our condensed consolidated statements of operations, resulting in no impact to operating income or net income. After the consummation of the IPO Transactions, we no longer have BMF expenses from properties managed for third parties.

Marketing, promotional and other advertising expenses. These expenses include advertising costs associated with general promotion of the La Quinta brand and specific advertising and marketing support for our operation and for the operations of our franchisees, which are in addition to the expenditure of BMF fees collected from franchised and managed properties for the same purpose.

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 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 prospectus.

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.


Table of Contents

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. As a result, changes in RevPAR driven by increases or decreases in ADR generally have a greater effect on operating profitability 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 Indexmeasures 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, who 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 reporting date versus the results of same set of hotels in the . . .

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