Annual Report (Form 10-K), fiscal year 1994

ITEM 1. BUSINESS
La Quinta Inns, Inc. ("La Quinta" or the "Company") is a leader in the mid-priced segment of the lodging market. Founded in 1968, the La Quinta chain's 228 inns, one of which is under development, are located in 29 states and Mexico with concentrations in Texas, Florida and California. As of December 31, 1994, the Company owned interests in and operated all but two of its inns.
La Quinta is incorporated under the laws of Texas and maintains its executive offices at Weston Centre, 112 East Pecan Street, P.O. Box 2636, San Antonio, Texas 78299-2636, telephone (210) 302-6000.
PRODUCT
La Quinta inns appeal to guests who desire high-quality rooms and convenient locations at attractive prices and whose needs generally do not include banquet and convention facilities, in-house restaurants, cocktail lounges or room service. As a result of the cost savings associated with the elimination of these management intensive facilities and services, the Company believes it is able to offer its guests an excellent value -- convenient locations and room quality comparable to full service hotels at a lower price.
La Quinta inns contain an average of 130 spacious, quiet and comfortably furnished rooms with an average of 300 square feet. Each inn features a choice of rooms for non-smokers and smokers, complimentary continental breakfast, free unlimited local telephone calls, remote-control television with a premium movie channel, telecopy services, same day laundry and dry cleaning service, 24-hour front desk and message service and free parking. La Quinta inns are generally located near suburban office parks, major traffic arteries or destination areas such as airports and convention centers. Food service to La Quinta guests generally is provided by adjacent free-standing restaurants.
La Quinta's strategy is to continue its growth as a high-quality provider in the mid-priced segment of the hotel industry, focusing on enhancing revenues, cash flow and profitability. Specifically, the Company's strategy centers upon:
CONTINUED FOCUS ON MID-PRICED SEGMENT - Hotels in this price category provide cost-conscious business travelers with high-quality rooms and convenient locations at a moderate price. Because the Company competes primarily in the mid-priced segment, management's attention is totally focused on meeting the needs of La Quinta's target customers.
LA QUINTA OWNERSHIP AND MANAGEMENT OF INNS - In contrast to many of its competitors, La Quinta manages and has ownership interests in virtually all of its inns. La Quinta manages all but two of the 228 inns in the chain. At December 31, 1994, the Company owned 100% of 176 inns and 40% or more of an additional 50. As a result, the Company believes it is able to achieve a higher level of consistency in both product quality and service than its competition. In addition, La Quinta's position as one of the few primarily owner-operated chains enables La Quinta to offer new services, direct expansion, effect pricing and to make other marketing decisions on a system-wide or local basis as conditions dictate, usually without consulting third-party owners, management companies or franchisees as required of most other lodging chains. The Company's management of the inns also enables it to control costs and allocate resources effectively to provide excellent value to the consumer.
IMAGE ENHANCEMENT PROGRAM - In 1994, La Quinta completed a comprehensive chainwide image enhancement program intended to give its properties a new, fresh, crisp appearance while preserving their unique character. The program featured new signage displaying a new logo as
well as exterior and lobby upgrades including brighter colors, more extensive lighting, additional landscaping, enhanced guest entry and a full lobby renovation with contemporary furnishings and seating area for continental breakfast.
REGIONALLY FOCUSED GROWTH - La Quinta acquired its partners' ownership interest in ten La Quinta inns and additionally purchased six existing lodging facilities in 1994 and is converting each of them to a La Quinta. Although most inns remain open during conversion, one of the six inns purchased was closed for development and is expected to re-open during the second quarter of 1995. It is anticipated that the Company's growth in 1995 will continue to include acquisition and conversion of existing lodging facilities and selected new development in strategic markets.
COMPETITION
Inns operated and licensed by La Quinta are in competition with other major lodging brands. Each La Quinta inn competes in its market area with numerous full service lodging brands, especially in the mid-priced range, and with numerous other hotels, motels and other lodging establishments. Chains such as Hampton Inns, Red Roof Inns, Fairfield Inns and Drury Inns are direct competitors of La Quinta. Other well-known competitors include Holiday Inns, Ramada Inns and Comfort Inns. There is no single competitor or group of competitors of La Quinta that is dominant in the lodging industry. Competitive factors in the industry include reasonableness of room rates, quality of accommodations, degree of service and convenience of locations.
The lodging industry in general, including La Quinta, may be adversely affected by national and regional economic conditions and government regulations. The demand for accommodations at a particular inn may be adversely affected by many factors including changes in travel patterns, local and regional economic conditions and the degree of competition with other inns in the area.
STRUCTURE AND OWNERSHIP
The Company is a combined entity comprised of La Quinta Inns, Inc., which owns and operates 226 inns, eight subsidiaries, nine wholly-owned unincorporated partnerships and joint ventures and nine combined unincorporated partnerships and joint ventures. Of these 226 inns, 50 inns are owned by the combined unincorporated partnerships and joint ventures, one of which is under development.
On January 24, 1994, the Company concluded the acquisition of La Quinta Motor Inns Limited Partnership ("the Partnership" or "LQP"), which owned 31 La Quinta inns managed by the Company in 15 states. The operations of LQP were accounted for under the equity method until December 1, 1993, and were included in the combined financial statements of the Company thereafter. In July 1994, the Company purchased nine La Quinta inns previously held in two unincorporated joint ventures with CIGNA Investments, Inc. ("CIGNA") in which the Company held a 1% interest and also managed. Also, during the second quarter of 1994, the Company purchased the limited partners' interest in one of the Company's combined unincorporated joint ventures which owned one inn. The aggregate purchase price of these transactions was $53,255,000 of which a portion was financed through the Company's amended Secured Line of Credit and Secured Term Credit Facility (See note 2 of Notes to Combined Financial Statements).
During 1993, the Company acquired, in separately negotiated transactions, limited partners' interests in 14 of the Company's combined unincorporated partnerships and joint ventures which owned 44 La Quinta inns. The Company purchased the ownership interests for an aggregate purchase price of $87,897,000 which included cash at closing, the assumption of $22,824,000 of existing debt attributable to certain limited partners' interests, and $29,878,000 in notes to certain sellers.
The Board of Directors of the Company authorized three-for-two stock splits effective in October 1994, March 1994 and October 1993. References to the Company's common stock prior to the October 1993 split are
described herein as "pre-split" and references to the Company's common stock after the October 1994 split are described herein as "post-split".
The following table describes the composition of inns in the La Quinta chain at:
JOINT VENTURES AND PARTNERSHIPS. La Quinta historically financed its development, in part, through partnerships and joint ventures with large insurance companies or financial institutions. Under the terms of the joint venture and partnership agreements, available cash flow is generally used to pay debt and provide for capital improvements, with remaining cash flow being distributed to the partners in accordance with their respective ownership interests. Since 1993, the Company has purchased the interests in 17 unincorporated joint ventures including CIGNA, and partnerships. In addition, the Company successfully completed the acquisition of LQP in January 1994 (See note 14 of Notes to the Combined Financial Statements). At December 31, 1994, the Company had ownership interests between 40% and 67% in nine unincorporated joint ventures and partnerships, one of whose only asset is a note receivable which is secured by real property.
In March of 1990, the Company entered into the La Quinta Development Partners, L.P. ("LQDP" or the "Development Partnership") with AEW Partners, L.P. ("AEW Partners"). La Quinta Inns, Inc. is the general partner and owns a 40% ownership interest and AEW Partners is the limited partner and owns a 60% ownership interest. This partnership was established for the purpose of owning, operating, acquiring and developing inns. La Quinta originally contributed 18 inns with a deemed value of $44,000,000 (net of existing debt assumed by LQDP) and $4,000,000 in cash. AEW Partners contributed $3,000,000 and a promissory note ("the AEW Note") to the Development Partnership in the amount of $69,000,000. Under the terms of the agreement, proceeds from the AEW Note were used for the construction of inns or for the acquisition and conversion of existing inns into the La Quinta brand. In 1993, the AEW Partners fully paid the balance of the AEW Note. At December 31, 1994, the Development Partnership had acquired and converted 25 inns (six during 1994 with conversion to be completed during the first half of 1995). Under the terms of the Development Partnership agreement, AEW Partners
currently has the ability to convert 66 2/3% of its ownership interest in the Development Partnership to 5,289,801 (post-split) shares of the Company's common stock. Such number of shares is reduced as distributions are made out of the Development Partnership to AEW Partners. The partnership units may be converted at any time prior to December 31, 1998. As of December 31, 1994, no partnership units had been converted. Shares of the Company's common stock issuable upon conversion are antidilutive at December 31, 1994.
On June 1, 1994, the Development Partnership entered into a $35,000,000 Bank Unsecured Line of Credit Agreement, under which $21,850,000 was available at December 31, 1994. Borrowings under the Bank Unsecured Line of Credit, which matures January 31, 1997, may be made at varying interest rates of the prime rate, LIBOR, or certificate of deposit rate plus the Development Partnership's Applicable Margin, as defined in the related credit agreement. At December 31, 1994, borrowings under the Bank Unsecured Line of Credit bear interest at the prime rate, LIBOR plus 1% or certificate of deposit rate plus 1 1/8%. The Development Partnership's Applicable Margin is determined quarterly based upon predetermined levels of the Partnership's indebtedness to cash flows, as defined in the related credit agreement.
Under the terms of a management agreement between the Company and the Development Partnership, La Quinta earns management, national advertising, chain services and licensing fees for the use of its name and services. La Quinta is also entitled to receive acquisition and conversion fees for its services in finding inns suitable for acquisition and in managing the conversion of such inns. La Quinta is also entitled to receive fees on project costs of inns constructed for the Development Partnership.
LICENSING
The Company selectively licensed the name "La Quinta" to others for operations in the United States until February 1977, at which time La Quinta discontinued its domestic licensing program to unrelated third parties. One inn remains in operation under a licensing agreement.
During 1990, the Company entered into a development agreement with Desarrollos Turisticos Vanguardia S.A. de C.V. ("Desarrollos") for expansion of the La Quinta chain into Saltillo, Coahuila, Mexico. In February 1994, one inn developed under this agreement opened for operation. Under the arrangement, the inn is owned by the licensee and was managed by La Quinta under a separate management agreement through March 8, 1995.
During 1994, the Company entered into agreements with four Mexican investor groups (the "Development Accord") for the purpose of developing 22 La Quinta inns in 15 cities in Mexico. Each of the inns developed will be owned by the Mexican investor groups and managed by the Company under long-term management agreements.
On December 20, 1994, the Mexican government allowed the peso to trade freely against the U.S. dollar. As a result, the peso suffered an immediate devaluation against the U.S. dollar. These economic conditions have resulted in a delay of the start of construction of additional La Quinta inns in Mexico. The construction of the first La Quinta inn under the Development Accord is anticipated to begin when economic conditions in Mexico stabilize.
"La Quinta -R-" and "teLQuik -R-" have been registered as service marks by La Quinta with the U.S. Patent and Trademark Office and in Mexico, Canada and the United Kingdom.
OPERATIONS
Management of the La Quinta chain is coordinated from the Company's headquarters in San Antonio, Texas. Centralized corporate services and functions include marketing, accounting and reporting, purchasing, quality control, development, legal, reservations and training.
Inn operations are currently organized into Eastern, Western and Central divisions with each division headed by a Divisional Vice President. Regional Managers report to the Divisional Vice Presidents and are each responsible for approximately 12 inns. Regional Managers are responsible for the service, cleanliness and profitability of the inns in their regions.
Individual inns are typically managed by resident managers who live on the premises. Managers receive inn management training which includes an emphasis on service, cleanliness, cost controls, sales and basic repair skills. Because La Quinta's professionally trained managers are substantially relieved of responsibility for food service, they are able to devote their attention to assuring friendly guest service and quality facilities, consistent with chain-wide standards. On a typical day shift, they will supervise one housekeeping supervisor, eight room attendants, two laundry workers, two general maintenance persons and three front desk service representatives.
At February 28, 1995, La Quinta employed approximately 5,800 persons, of whom approximately 86% were compensated on an hourly basis. Approximately 260 individuals were employed at corporate and 5,540 were employed in inn management and services. The Company's employees are not currently represented by labor unions. Management believes its ongoing labor relations are good.
MARKETING
La Quinta's primary media focus is on business travelers, who account for over half of La Quinta's rooms rented. The Company's core market consists of business travelers who visit a given area several times per year. For example, typical customers include salespersons covering a regional territory, government and military personnel and technicians. The profile of a typical La Quinta customer is a college educated business traveler, age 25 to 54 who has a middle management, white collar occupation or upper level blue collar occupation. In addition, the Company's target markets include vacation travelers and retired travelers. The Company focuses on reaching its target markets by utilizing advertising, direct sales, programs which provide incentives to repeat travelers, and other marketing programs targeted at specific customer segments.
The Company advertises primarily through network and local radio, cable television networks and print advertisements which focus on value. The Company utilizes the same campaign concept throughout the country with minor modifications made to address regional differences. The Company also utilizes billboard advertisements along major highways which announce a La Quinta inn's presence in upcoming towns.
The Company markets directly to companies and other organizations through its direct sales force of 27 sales representatives and managers as well as 19 specific property sales persons. This sales force calls on companies which have a significant number of individuals traveling in the regions in which La Quinta operates and which are capable of producing a high volume of room nights.
La Quinta enjoys a large amount of repeat business. Based on internal surveys conducted since 1990, management estimates the average customer spent approximately 16 nights per year in a La Quinta inn. The Company focuses a number of marketing programs on maintaining the high number of repeat visits. La Quinta promotes a "Returns Club" for repeat guests. This club provides its members with preferred status and rates when checking into a La Quinta inn and offers rewards for frequent stays. The Returns Club currently has over 180,000 members.
The Company provides a reservation system, "teLQuik"-R-, which currently accounts for advance reservations for approximately 71% of room occupancy. The teLQuik system allows customers to make reservations toll free or from special reservations phones placed in all La Quinta inns. The teLQuik system enables guests to make their next night's reservations from their previous night's La Quinta inn. In 1994, the Company completed a new reservation center which is a part of its program to improve operating results by providing state-of-the-art technology in processing reservations more efficiently. La Quinta, through its national sales managers, markets its reservation services to travel agents and corporate travel planners who may access teLQuik through the five major airline reservation systems.
ASSET MANAGEMENT
La Quinta's asset management strategy is founded on the importance of ownership of all or a significant portion of each of its inns. See "Structure and Ownership" on this Form 10-K. Management believes that
Company ownership and management of La Quinta inns enables the Company to achieve more consistency in quality and service than its competitors.
Historically, the Company financed a large part of its development through partnerships and joint ventures with large insurance companies and other financial institutions, while managing the inns. However, since 1993, the Company has acquired in separately negotiated transactions limited partners' interests in 15 of the Company's combined unincorporated partnerships and joint ventures that owned 45 La Quinta inns. The Company also completed the acquisition of 100% of the limited partners' interests in an additional 31 La Quinta inns owned by a subsidiary of LQP in January of 1994, after acquiring 82% of LQP during December of 1993, and purchased CIGNA joint ventures which owned nine La Quinta inns. In addition, the Company acquired six existing lodging facilities during 1994, one of which is under development, and eleven existing lodging facilities during 1993 for conversion to a La Quinta. Currently, the Company owns 100% of 176 inns and between 40% and 67% of 50 other inns.
La Quinta's current development program focuses on the acquisition of existing lodging facilities. At current prices, acquisition and conversion of existing properties is more cost effective than new construction. However, the Company is currently considering new construction in those markets where acquisition and conversion of existing inns at a discount to replacement cost is not available.
ITEM 2.



ITEM 2. PROPERTIES
La Quinta inns appeal to guests who desire high-quality rooms and whose needs generally do not include banquet and convention facilities, in-house restaurants, cocktail lounges or room service. La Quinta inns contain an average of 130 rooms and provide spacious, quiet and comfortably furnished rooms with an average of 300 square feet, a choice of rooms for non-smokers and smokers, complimentary continental breakfast, free unlimited local telephone calls, remote-control television with a premium movie channel, telecopy services, same-day laundry and dry cleaning service, 24-hour front desk and message service and free parking.
To maintain the overall quality of La Quinta's inns and to remain competitive in its service-oriented environment, each inn undergoes refurbishments and capital improvements as needed. Typically, refurbishing has been provided at intervals of between five and seven years, based on an annual review of the condition of each inn. In each of the years ended December 31, 1994, 1993 and 1992, the Company spent approximately $75,200,000, $32,600,000 and $15,500,000, respectively, on capital improvements to existing inns. The amounts for 1994 and 1993 include expenditures related to the Company's image enhancement program. As a result of these expenditures, the Company believes it has been able to maintain a chainwide quality of rooms and common areas at its properties unmatched by any other national mid-priced hotel chain.
In 1994, the Company completed an image enhancement program which gave its properties a new, fresh, crisp appearance while preserving their unique character. It features new signage displaying a new logo as well as exterior and lobby upgrades including brighter colors, additional landscaping, enhanced guest entry and a full lobby renovation with contemporary furnishings and seating area for continental breakfast.
At December 31, 1994, there were 228 inns located in 29 states and Mexico, with concentrations in Texas, Florida and California. The states and cities in which the inns are located are set forth in the following table:
Typically, food service for La Quinta guests is provided by adjacent, free standing restaurants. At December 31, 1994, the Company had an ownership interest in 126 restaurant buildings adjacent to its inns. The 126 restaurant facilities are owned by the Company or its partnerships and joint ventures, which own the related inn. These restaurants generally are leased pursuant to build-to-suit leases that require the operator to pay, in addition to minimum and percentage rentals, all expenses, including building maintenance, taxes and insurance. At December 31, 1994, the Company's ownership interests in such restaurants were as follows:
The Company's inns and restaurants were substantially pledged to secure all long-term debt maturing in various years from 1995 to 2015 (See note 2 of Notes to Combined Financial Statements).
ITEM 3.

ITEM 3. LEGAL PROCEEDINGS
In September 1993, a former officer of the Company filed suit against the Company and certain of its directors and their affiliate companies (the "La Quinta Defendants"). The suit alleges breach of an employment agreement, misrepresentation, wrongful termination, self-dealing, breach of fiduciary duty, usurpation of corporate opportunity and tortious interference with contractual relations. Compensatory damages of $2,500,000 and exemplary damages of $5,000,000 are sought in the action. The Court has pending before it the La Quinta Defendants' motion for summary judgment. The parties subsequently filed a required, joint Pre Trial Order, in which the plaintiff has conceded a number of his claims. Currently, no trial date has been set for this action. The Company is vigorously defending against this suit.
Actions for negligence or other tort claims occur routinely as an ordinary incident to the Company's business. Several lawsuits are pending against the Company which have arisen in the ordinary course of the business, but none of these proceedings involves a claim for damages (in excess of applicable excess umbrella insurance coverages) involving more than 10% of current assets of the Company. The Company does not anticipate any amounts which it may be required to pay as a result of an adverse determination of such legal proceedings and the matter discussed above, individually or in the aggregate, or any other relief granted by reason thereof, will have a material adverse effect on the Company's financial position or results of operations.
The Company has established a paid loss program (the "Paid Loss Program") for inns owned and managed by the Company for commercial general liability insurance, automobile liability insurance and workers' compensation and employer's liability insurance. In addition to the Paid Loss Program, the Company has purchased excess umbrella liability policies and extended coverage property insurance and such other insurance as is customarily obtained for similar properties and which may be required by the terms of loan or similar documents with respect to the inns. In connection with the general liability, workers' compensation and automobile coverages, all inns participate in the Paid Loss Program, under which claims and expenses are shared pro rata, with excess umbrella insurance being maintained to cover losses, claims and costs in excess of the deductible limits per matter of $500,000 for general liability, $500,000 for workers' compensation and $250,000 for automobile coverage. All pro rata expenses and premiums under the Paid Loss Program and such other insurance as is customarily obtained with respect to inns owned by persons other than the Company constitute direct operating expenses of said inns under the terms of the respective management agreements. General liability is allocated pro rata based on the number of rooms at each respective inn. Worker's Compensation is allocated based on the amount of payroll and auto liability is allocated based on the number of vehicles at each respective inn.
ITEM 4.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of the year covered by this Annual Report on Form 10-K, no matter was submitted to a vote of Registrant's security holders through the solicitation of proxies or otherwise.
PART II
ITEM 5.

ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Company's Common Stock is listed on The New York Stock Exchange. The range of the high and low sale prices, as adjusted for the three-for-two stock splits in October 1994, March 1994, and October 1993, of the Company's Common Stock for each of the quarters during the years ended December 31, 1994 and 1993 is set forth below:
The Company paid cash dividends in all four quarters of 1994 and in both the third and fourth quarters of 1993 in the amount of $.025 per share under its quarterly dividend policy as authorized by the Board of Directors. For restrictions on the Company's present or future ability to pay cash dividends, see note 2 of Notes to Combined Financial Statements. The declaration and payment of dividends in the future will be determined by the Board of Directors based upon the Company's earnings, financial condition, capital requirements and such other factors as the Board of Directors may deem relevant.
As of February 28, 1995, the approximate number of holders of record of the Company's Common stock was 971.
ITEM 6.

ITEM 6. SELECTED FINANCIAL DATA
ITEM 7.

ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The Company's financial statements include the accounts of the Company's wholly-owned subsidiaries, wholly-owned partnerships and joint ventures and unincorporated partnerships and joint ventures in which the Company has at least a 40% interest and over which it exercises substantial legal, financial and operational control.
On January 24, 1994, the Company concluded the acquisition of LQP which owned 31 inns in 15 states managed by the Company. The operations of LQP were accounted for under the equity method until December 1, 1993, and were included in the Combined Financial Statements of the Company thereafter.
During the second quarter of 1994, the Company purchased the limited partners' interest in one of the Company's combined unincorporated joint ventures which owned one inn. Additionally, in July 1994, the Company purchased nine inns previously held by CIGNA.
In 1994, the Company completed the acquisition of six inns and began renovating and converting them to the La Quinta brand. All of these inns were purchased through the Development Partnership. Although most of these inns remained open for business during conversion construction, hotel operations are disrupted during the typical three-to-four month construction period. Conversion of these inns will be completed during the first half of 1995.
References to "Company Inns" are to inns owned by the Company or by unincorporated partnerships and joint ventures in which the Company owns at least a 40% interest. References to "Managed Inns" are to those inns in which the Company owns less than a 40% interest and which are managed by the Company under long-term management contracts. "Managed Inns" include nine inns held by CIGNA through July 1994 accounted for using the cost method and the 31 inns of the LQP through November 30, 1993 accounted for using the equity method.
The following chart shows certain historical operating statistics and revenue data. References to the percentages of occupancy and the average daily rate refer to Company Inns. Managed Inns and the La Quinta licensed inns are excluded from occupancy and average daily rate statistics for all periods for purposes of comparability. All financial data is related to Company Inns unless otherwise specified.
YEAR ENDED DECEMBER 31, 1994 COMPARED TO YEAR ENDED DECEMBER 31, 1993
TOTAL REVENUES increased to $362,242,000 in 1994 from $271,850,000 in 1993, an increase of $90,392,000, or 33.3%. Of the total revenues reported in 1994, 97.6% were revenues from inns, 2.1% were revenues from restaurant rentals and other revenue and 0.3% were revenues from management services.
INN REVENUES are derived from room rentals and other sources such as charges to guests for long-distance telephone calls, fax machine use and laundry services. Inn revenues increased to $353,348,000 in 1994 from $258,529,000 in 1993, an increase of $94,819,000, or 36.7%. The increase in inn revenues was due primarily to the acquisitions of LQP and CIGNA, an increase in average room rate and occupancy and an increase in the number of available rooms. The average room rate increased to $47.65 in 1994 from $46.36 in 1993, an increase of $1.29 or 2.8%, while occupancy increased 5 percentage points. The completion of the Company's image enhancement program contributed to the increases in average room rate and occupancy. Available rooms for 1994 were 10,188,000 as compared to 8,226,000 for 1993, an increase of 1,962,000 available rooms, or 23.9%. The increase in the number of available rooms was due to the acquisitions of five operating inns and CIGNA during 1994 and LQP in December of 1993.
RESTAURANT RENTAL AND OTHER REVENUES includes rental payments from restaurants owned by the Company and leased to and operated by third parties. Restaurant rental and other revenues also include the Company's interest in the earnings (accounted for using the equity method) of LQP through December 1, 1993, and miscellaneous other revenues, such as third party rental revenue from an office building which also housed the Company's corporate offices through May 1993. Restaurant rental and other increased to $7,675,000 in 1994 from $6,464,000 in 1993, an increase of $1,211,000, or 18.7%. This increase is primarily the result of an increase in the number of wholly-owned restaurants leased to and operated by third parties due to the acquisition of LQP.
MANAGEMENT SERVICES revenue is primarily related to fees earned by the Company for services rendered in conjunction with Managed Inns. Management service revenue decreased to $1,219,000 in 1994 from $6,857,000 in 1993. Management fees decreased due to the consolidation of LQP in December 1993 and the acquisition of the CIGNA in July 1994 eliminating the related management fees earned by the Company.
DIRECT EXPENSES include costs directly associated with the operation of Company Inns. In 1994, approximately 41.9% of direct expenses were represented by salaries, wages, and related costs. Other major categories of direct expenses include utilities, property taxes, repairs and maintenance and room supplies.
Direct expenses increased to $194,894,000 ($27.30 per occupied room) in 1994 compared to $148,571,000 ($27.72 per occupied room) in 1993, an increase of $46,323,000, or 31.2%. Direct expenses decreased to 53.8% in 1994 from 54.7% in 1993 as a percentage of total revenue primarily from a decrease in salaries and related benefit costs and property taxes. The acquisitions of LQP and CIGNA caused the increase of direct expense in total year over year .
CORPORATE EXPENSES include the costs of general management, office rent, training and field supervision of inn managers and other marketing and administrative expenses. The major components of corporate expenses are salaries, wages and related expenses and information systems. Corporate expenses decreased to $18,614,000 ($1.79 per available room, including Managed Inns) in 1994 from $19,450,000 ($1.96 per available room, including Managed Inns) in 1993, a decrease of $836,000, or 4.3%. As a percent of total revenues, corporate expenses decreased to 5.1% in 1994 from 7.2% in 1993.
PERFORMANCE STOCK OPTION relates to the costs of stock options which became exercisable when the average price of the Company's stock reached $30 per share (pre-split) for twenty consecutive days. In 1993, performance stock option expense and certain other options were accelerated as a result of this condition being met (See note 5 of Notes to the Combined Financial Statements). Currently, the Company has no options outstanding that require recognition of additional compensation expense.
DEPRECIATION, AMORTIZATION AND FIXED ASSET RETIREMENTS increased to $37,977,000 in 1994 from $24,055,000 in 1993 an increase of $13,992,000, or 57.9%. The increase in depreciation, amortization and fixed asset retirements is primarily due to the increase in depreciable assets resulting from the acquisitions of LQP, CIGNA, five existing inns in 1994 and 11 existing inns in the latter part of 1993 and the Company's image enhancement program. Depreciation, amortization and fixed asset retirements also includes asset retirements associated with the Company's refurbishment program and other capital improvements.
OPERATING INCOME increased to $110,757,000 in 1994 from $75,367,000 in 1993, an increase of $35,390,000, or 47.0%.
INTEREST INCOME primarily represents earnings on notes receivable and on the short-term investment of Company funds in money market instruments prior to their use in operations or acquiring inns. Interest income decreased to $1,421,000 in 1994 from $5,147,000 in 1993, a decrease of $3,726,000, or 72.4%. The decrease in interest income is primarily attributable to a decrease in interest earned on a note receivable from AEW Partners (the"AEW Note") due to the collection of the entire principal balance in December 1993.
INTEREST ON LONG-TERM DEBT increased to $38,860,000 in 1994 from $31,366,000 in 1993, an increase of $7,494,000, or 23.9%. The increase in interest expense is attributable to the debt incurred to acquire the LQP, CIGNA and certain of the limited partners' interests and debt assumed with the acquisition of LQP.
PARTNERS' EQUITY IN EARNINGS AND LOSSES reflects the interests of partners in the earnings and losses of the combined joint ventures and partnerships which are owned at least 40% and controlled by the Company. Partners' equity in earnings and losses decreased to $11,406,000 in 1994 from $12,965,000 in 1993, a decrease of $1,559,000, or 12.0%. The decrease in partners' equity in earnings and losses is attributable to the acquisition of various limited partners' interests in unincorporated partnerships and joint ventures partially offset by increases in the earnings of the Development Partnership. As of December 31, 1994, the Development Partnership operated 42 inns compared to 37 inns as of December 31, 1993.
NET (GAIN) LOSS ON PROPERTY TRANSACTIONS increased to a gain of ($79,000) in 1994 from a loss of $4,347,000 in 1993. The loss in 1993 includes a $4,900,000 loss related to the Company's conveyance to the mortgagee of the title on the property in which the Company's headquarters were located.
INCOME TAXES for 1994 were calculated using an estimated effective tax rate of 39%.
For the reasons discussed above, the Company reported EARNINGS BEFORE EXTRAORDINARY ITEMS AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE of $37,815,000 in 1994 compared with $19,420,000 in 1993, an increase of $18,395,000, or 94.7%.
The Company reported EXTRAORDINARY ITEMS, NET OF INCOME TAXES of ($619,000) in 1993. The 1993 extraordinary loss consisted of ($6,007,000), ($3,664,000) net of income taxes, related to the early extinguishment and refinancing of certain debt partially offset by an extraordinary gain of $4,991,000, $3,045,000 net of income taxes, resulting from the Company's transfer of ownership to the mortgagee of property in which the Company's headquarters were located.
The CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING FOR INCOME TAXES of $1,500,000, or $.03 per share in 1993 was the result of the implementation of Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes."
For the reasons discussed above, the Company reported NET EARNINGS of $37,815,000 in 1994 compared with $20,301,000 in 1993, an increase of $17,514,000, or 86.3%.
YEAR ENDED DECEMBER 31, 1993 COMPARED TO YEAR ENDED DECEMBER 31, 1992
TOTAL REVENUES increased to $271,850,000 in 1993 from $254,122,000 in 1992, an increase of $17,728,000, or 7.0%. Of the total revenues reported in 1993, 95.1% were revenues from inns, 2.4% were revenues from restaurant rentals and other revenue and 2.5% were revenues from management services.
INN REVENUES increased to $258,529,000 in 1993 from $239,826,000 in 1992, an increase of $18,703,000, or 7.8%. The increase in inn revenues was due primarily to an increase in average room rate, an increase in the number of available rooms and the acquisition of LQP. The average room rate increased to $46.36 in 1993 from $44.33 in 1992, an increase of $2.03, or 4.6%, while occupancy declined .5 percentage points. As anticipated, the Company's image enhancement program caused temporary construction related disruption in normal business operations and occupancies at properties which underwent the process. Also, management's decision to discontinue a coupon promotion used in 1992 had a positive impact on room rate and had the effect of reducing occupancy in 1993. Available rooms for 1993 were 8,226,000 as compared to 7,916,000 for 1992, an increase of 310,000 available rooms, or 3.9%. The increase in the number of available rooms was due to the acquisition of 11 inns during the year ended December 31, 1993 and the acquisition of LQP in December of 1993.
RESTAURANT RENTAL AND OTHER REVENUES decreased to $6,464,000 in 1993 from $7,208,000 in 1992, a decrease of $744,000, or 10.3%, primarily due to a reduction in earnings related to investments accounted for on the equity method.
MANAGEMENT SERVICES revenue decreased to $6,857,000 in 1993 from $7,088,000 in 1992, a decrease of $231,000, or 3.2%. Management fees decreased due to there being two less licensees and the consolidation of LQP in December 1993 eliminating the related management fees charged by the Company to LQP for that month.
DIRECT EXPENSES in 1993 primarily consisted of salaries, wages, and related costs. These costs accounted for approximately 42.4% of direct expenses. Other major categories of direct expenses include utilities, repairs and maintenance, property taxes, advertising and room supplies.
Direct expenses increased to $148,571,000 ($27.72 per occupied room) in 1993 compared to $135,474,000 ($26.11 per occupied room) in 1992, an increase of $13,097,000, or 9.7%. As a percentage of total revenues, direct expenses increased to 54.7% in 1993 from 53.3% in 1992. The increase in direct expense resulted primarily from the Company's implementation of a complimentary continental breakfast at all La Quinta inns during the first quarter of 1993, (which amounted to $1.08 per occupied room). The Company acquired 11 inns during 1993 and did not acquire or convert any inns during 1992.
CORPORATE EXPENSES decreased to $19,450,000 ($1.96 per available room, including Managed Inns) in 1993 from $23,961,000 ($2.46 per available room, including Managed Inns) in 1992 a decrease of $4,511,000, or 18.8%. As a percent of total revenues, corporate expenses decreased to 7.2% in 1993 from 9.4% in 1992. The 1992 corporate expenses included non-recurring charges to increase the allowance for certain notes receivable of $2,696,000 based upon estimates of the value of the real estate held as collateral for such notes and evaluations of the financial condition of certain borrowers and $210,000 related to other corporate expense items. The 1992 corporate expenses also include a provision related to the settlement of certain litigation of $775,000. The 1992
Corporate expenses, before non-recurring charges were $21,055,000 ($2.16 per available room, including Managed Inns). As a percent of total revenues, corporate expenses in 1992, before non-recurring charges, was 8.3%.
The PROVISION FOR WRITE-DOWN OF PARTNERSHIP INVESTMENTS, LAND AND OTHER in 1992 includes charges related to the write-down of certain joint venture interests, land previously held for future development, computer equipment and other assets (See note 8 of Notes to Combined Financial Statements).
SEVERANCE AND OTHER EMPLOYEE RELATED COSTS in 1992 consisted of costs related to the severance of certain executive officers and other employees, executive search fees and relocation costs for new officers.
PERFORMANCE STOCK OPTION relates to the costs of stock options which became exercisable when the average price of the Company's stock reached $30 per share (pre-split) for twenty consecutive days. Performance stock option expense and certain other options were accelerated as a result of this condition being met (See note 5 of Notes to Combined Financial Statements).
DEPRECIATION, AMORTIZATION AND FIXED ASSET RETIREMENTS decreased to $24,055,000 in 1993 from $24,793,000 in 1992, a decrease of $738,000 or 3.0%. The decrease in depreciation, amortization and fixed asset retirements was due to assets which became fully depreciated during 1993 and the write-off of computer equipment and signage in the prior year. Replacement and installation of new computer equipment and signs was substantially completed in the latter part of 1993.
OPERATING INCOME increased to $75,367,000 in 1993 from $34,575,000 in 1992, an increase of $40,792,000. Operating income before a non-recurring, non-cash charge of approximately $4,407,000 to recognize compensation expense related to the vesting of performance stock options, increased to $79,774,000 in 1993 from $73,112,000 in 1992 before write-downs, severance and employee related costs and other non-recurring charges, an increase of $6,662,000, or 9.1%.
INTEREST INCOME decreased to $5,147,000 in 1993 from $6,041,000 in 1992, a decrease of $894,000, or 14.8%. The decrease in interest income is primarily attributable to principal reductions on the AEW Note of $16,700,000 and $19,300,000 in September and December 1993 respectively, and the corresponding reduction in interest earned thereon. As of December 31, 1993, the AEW Note had been fully collected.
INTEREST ON LONG-TERM DEBT decreased to $31,366,000 in 1993 from $33,087,000 in 1992, a decrease of $1,721,000, or 5.2%. The decrease in interest expense is attributable to the early extinguishment of approximately $117,000,000 of certain high interest rate debt with proceeds from the 9 1/4% Senior Subordinated Notes due 2003 and bank financing which more than offset interest on borrowings to purchase limited partners' interests. In addition, certain Industrial Revenue Bond issues were refinanced to obtain more favorable interest rates.
PARTNERS' EQUITY IN EARNINGS AND LOSSES decreased to $12,965,000 in 1993 from $15,081,000 in 1992, a decrease of $2,116,000, or 14.0%. The decrease in partners' equity in earnings and losses is attributable to the acquisition of limited partners' interests in 14 combined unincorporated partnerships and joint ventures partially offset by increases in the earnings of the Development Partnership. As of December 31, 1993, the Development Partnership operated 37 inns compared to 28 inns as of December 31, 1992.
NET (GAIN) LOSS ON PROPERTY TRANSACTIONS decreased to a loss of $4,347,000 in 1993 from a gain of ($282,000) in 1992. The loss in 1993 includes a $4,900,000 loss related to the Company's conveyance to the mortgagee of the title on the property in which the Company's headquarters were located.
INCOME TAXES for 1993 were calculated using an estimated effective tax rate of 39%.
For the reasons discussed above, the Company reported EARNINGS (LOSS) BEFORE EXTRAORDINARY ITEMS AND CUMULATIVE EFFECT OF ACCOUNTING CHANGE of $19,420,000 in 1993 compared with ($7,796,000) in 1992, an increase of $27,216,000.
The Company reported EXTRAORDINARY ITEMS, NET OF INCOME TAXES of ($619,000) in 1993 compared with ($958,000) in 1992. The 1993 extraordinary loss consisted of ($6,007,000), ($3,664,0000) net of income taxes, related to the early extinguishment and refinancing of certain debt partially offset by an extraordinary gain of
$4,991,000, $3,045,000 net of income taxes, resulting from the Company's transfer of ownership to the mortgagee of property in which the Company's headquarters were located. The 1992 extraordinary loss was primarily a result of the refinancing of three industrial revenue bond issues totaling $12,910,000 in principal. In addition, the Company retired its 10% Convertible Subordinated Debentures due in 2002.
The CUMULATIVE EFFECT OF A CHANGE IN ACCOUNTING FOR INCOME TAXES of $1,500,000, or $.03 per share in 1993 was the result of the implementation of Statement of Financial Accounting Standards No. 109 "Accounting for Income Taxes."
For the reasons discussed above, the Company reported NET EARNINGS of $20,301,000 in 1993 compared with a net loss of ($8,754,000) in 1992, an increase of $29,055,000.
CAPITAL RESOURCES AND LIQUIDITY
The Company has historically financed its development program through partnerships with financial institutions, a public debt offering and borrowings under the Company's Credit Facilities. During the years ended December 31, 1994 and 1993, the Company funded a majority of its development program through the Development Partnership. The Company's inns and adjacent restaurant land and buildings are substantially pledged to secure long-term debt of the Company. Distributions of cash, if any, from the Company's joint ventures and partnerships are made from cash available after payment of operating expenses, debt service, capital expenditures and acquisition and development of new inns.
At December 31, 1994, the Company had $2,589,000 of cash and cash equivalents, a decrease of $21,259,000 from December 31, 1993. The decrease primarily was due to capital expenditures for the image enhancement program, purchase and conversion of inns, the acquisition of the remaining Units of LQP during January of 1994 and the acquisition of CIGNA.
At December 31, 1994, the Company had a $45,000,000 Secured Line of Credit and a $171,500,000 Secured Term Credit Facility with participating banks. At December 31, 1994, the Company had $21,300,000 available on its Secured Line of Credit, net of $6,350,000 of letters of credit collateralizing the Company's insurance programs, and was fully drawn on the Secured Term Credit Facility. Borrowings under the $45,000,000 Secured Line of Credit, which will expire May 30, 1997, bear interest at LIBOR, the prime rate, or certificate of deposit rate plus an Applicable Margin, as defined in the related credit agree- ment. At December 31, 1994, borrowings under the Secured Line of Credit bear interest at LIBOR plus 1 1/2%, the prime rate or the certificate of deposit rate plus 1 5/8%. Borrowings under the $171,500,000 Secured Term Credit Facility, which matures May 31, 2000 and bear interest at LIBOR, the prime rate, or certificate of deposit rate plus an Applicable Margin, as defined in the related credit agreement. At December 31, 1994, borrowings under the Secured Term Credit Facility bear interest at LIBOR plus 1 3/4%, the prime rate or certificate of deposit rate plus 1 7/8%. The Applicable Margin is determined quarterly based upon predetermined levels of indebtedness to cash flows, as defined in the related credit agreements. Amounts borrowed under the Secured Term Credit Facility require semi-annual principal payments through May 31, 2000.
On June 1, 1994, the Development Partnership entered a $35,000,000 Bank Unsecured Line of Credit of which $21,850,000 was available at December 31, 1994. Borrowings under the Bank Unsecured Line of Credit, which matures January 31, 1997, may be made at varying interest rates of the prime rate, LIBOR, or certificate of deposit rate plus the Development Partnership's Applicable Margin, as defined in the related credit agreement. At December 31, 1994, borrowings under the Bank Unsecured Line of Credit bear interest at the prime rate, LIBOR plus 1% or certificate of deposit rate plus 1 1/8%. The Development Partnership's Applicable Margin is determined quarterly based upon predetermined levels of the Partnership's indebtedness to cash flows, as defined in the related credit agreement.
On January 23, 1992 with the approval of the Company's Board of Directors, the Company entered two interest rate swap agreements (the "Agreements") which exchanged the Company's variable rate interest payments for the fixed rate interest payments of a major financial institution (the "Counterparty"). The debt ("Notional Amount") underlying the Agreements is $16,890,000 and $44,420,000. Under the Agreements, the Company effectively pays a fixed rate of interest at 6.50% and 5.26% and the Counterparty pays a percentage of prime interest rate and the variable rate demand note interest rate ("VRDN"). In the event the VRDN rate exceeds the fixed interest rate of 5.26% or the percentage of prime interest rate exceeds 6.5%, the Counterparty pays to the Company that difference times the Notional Amount, on a monthly basis. Should the fixed interest rate of 5.26% exceed the VRDN interest rate or the fixed interest rate of 6.5% exceeds the percentage of prime interest rate, the Company pays the difference times the Notional Amount to the Counterparty, on a monthly basis. These Agreements resulted in net payments to the Counterparty of $1,040,000, $1,427,000 and $1,184,000 in the years ended December 31, 1994, 1993 and 1992, respectively. The Agreements expire on February 1, 1997, and the Notional Amounts are reduced over the life of the Agreements by scheduled amortization payments. At December
31, 1994, the Notional Amounts of debt remaining under the Agreements are $11,107,000 and $36,150,000 which bear interest at a weighted average variable interest rate of 6.46% and 4.48%, respectively.
The Company is exposed to market risk associated with fluctuations in interest rates. By entering the interest rate swap agreements, described above, the Company reduced its exposure to rising interest rates on the aforementioned variable interest rate debt and has effectively fixed the rate on such debt at a level acceptable to the Company given the length of the Agreements and the risk of interest rate changes. The Company is exposed to credit risk to the extent that the Counterparty fails to perform under the Agreements. The Company has mitigated its credit risk by entering the Agreements with a major financial institution, which has received an "A" rating from Standard and Poor's Corporation and an "A2" rating from Moody's Investors Service on senior unsecured debt. The Company regularly monitors the credit ratings of the Counterparty and considers the risk of default remote.
As a result of the VRDN rate increasing from 2.55% at December 31, 1993 to 4.32% at December 31, 1994 and the increase in the prime rate during the year, the estimated fair value of the interest rate swap agreements changed from a net payable position of $2,276,000 at December 31, 1993, to a net receivable position of $494,000 at December 31, 1994.
Net cash provided by operating activities increased to $94,233,000 in 1994 from $78,043,000 in 1993, an increase of $16,190,000, or 20.7%. The increase was primarily due to increased inn revenues and an increase in accrued expenses due to the timing of payment. Net cash provided by operating activities increased to $78,043,000 in 1993 from $60,853,000 in 1992, an increase of $17,190,000, or 28.2%. The majority of the increase was due to an increase in inn revenues as a result of increased occupancy and average room rates.
Net cash used by investing activities increased to $156,492,000 in 1994 from $145,027,000 in 1993, an increase of $11,465,000. The increase was related to capital expenditures related to the image enhancement, purchase and conversion of inns, the purchase of the remaining units of LQP and the acquisition of CIGNA. Net cash used by investing activities increased to $145,027,000 in 1993 from $15,166,000 in 1992, an increase of $129,861,000. The increase was related to the acquisition of 82% of LQP, the acquisition of the partners' interest in 14 unincorporated joint ventures and partnerships, the acquisition of 11 inns and capital expenditures related to the Company's image enhancement program.
Net cash provided by financing activities was $41,000,000 in 1994 compared to $77,971,000 in 1993. The decrease in cash provided by financing activities was the result of the payments on the secured line of credit and long-term borrowings, dividends to shareholders and purchase of treasury stock. Net cash provided by financing activities in 1993 was $77,971,000 in 1993 compared to net cash used by financing activities of ($40,781,000) in 1992. The increase was a result of the issuance of the 9 1/4% Senior Subordinated Notes due 2003, the collection of the AEW Note and the decrease in distributions to partners partially offset by payments on long-term debt.
During 1994, the Company repurchased a total of 373,000 shares (post-split) of its common stock for approximately $7,115,000 under a plan approved by the Board of Directors to repurchase up to $10,000,000 of its common stock. Additional purchases will be made from time to time in the open market as deemed appropriate by the Company.
COMMITMENTS
In accordance with the unincorporated partnership or joint venture agreements executed by the Company, La Quinta is committed to advance funds necessary to cover operating expenses of joint ventures. Three unincorporated partnerships and joint ventures executed promissory notes in which the Company guaranteed to fund amounts not to exceed $740,000 in the aggregate.
The estimated additional cost to complete the conversion and renovation of inns for which commitments have been made is $4,000,000 at December 31, 1994. Funds on hand, committed and anticipated from cash flow are sufficient to complete these projects.
Under the terms of a Partnership agreement between the Company and AEW Partners, the Company maintains a reserve for renovating, remodeling and conversion of the inns in the Development Partnership based
on 5% of gross room revenue of the Partnership which includes certain amounts required by loan agreements. At December 31, 1994 and 1993 the Company had $900,000 and $3,833,000, respectively, of restricted cash which is classified as investments.
In accordance with the requirements of an escrow agreement related to a pool of mortgage notes executed by the Company and a third party lender, the Company is required to make annual deposits into an escrow account for the purpose of establishing a reserve for the replacement of furnishings, fixtures and equipment used on or incorporated into the mortgaged properties. The Company shall be relieved of its obligation to make such annual deposits for any year in which the escrow account has an aggregate balance of $2,431,000. At December 31, 1994 and 1993, the Company had reserved the full amount.
In 1993, the Company entered into a ten year operating lease for its corporate headquarters in San Antonio. In addition, the Company entered into a ten year lease in December 1993 to house the Company's reservation facilities.
Funds on hand, anticipated from future cash flows and available on the Company's Credit Facilities are sufficient to fund operating expenses, debt service and other capital requirements through at least the end of 1995. The Company will evaluate from time to time the necessity of other financing alternatives.
SEASONALITY
Demand, and thus room occupancy, is affected by normally recurring seasonal patterns and, in most La Quinta inns, is higher in the spring and summer months (March through August) than in the balance of the year.
INCOME TAXES
In February 1992, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes". This Statement requires the use of the asset and liability method of accounting for deferred income taxes and was implemented in 1993. The impact of the Statement's implementation has been disclosed in note 4 of Notes to Combined Financial Statements.
INFLATION
The rate of inflation as measured by changes in the average consumer price index has not had a material effect on the revenues or net earnings (loss) of the Company in the three most recent years.
ITEM 8.


ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
LA QUINTA INNS, INC.
COMBINED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
See accompanying notes to combined financial statements.
LA QUINTA INNS, INC.
COMBINED BALANCE SHEETS (IN THOUSANDS, EXCEPT SHARE DATA)
See accompanying notes to combined financial statements.
LA QUINTA INNS, INC.
COMBINED STATEMENTS OF OPERATIONS (IN THOUSANDS, EXCEPT PER SHARE DATA)
See accompanying notes to combined financial statements.
LA QUINTA INNS, INC.
COMBINED STATEMENTS OF SHAREHOLDERS' EQUITY (IN THOUSANDS)
See accompanying notes to combined financial statements.
LA QUINTA INNS, INC.
COMBINED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See accompanying notes to combined financial statements.
LA QUINTA INNS, INC.
COMBINED STATEMENTS OF CASH FLOWS (IN THOUSANDS)
See accompanying notes to combined financial statements.
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BUSINESS AND BASIS OF PRESENTATION
The Company develops, owns and operates inns. The combined financial statements include the accounts of subsidiaries (all wholly-owned) and unincorporated partnerships and joint ventures in which the Company has at least a 50% interest and in one case a 40% interest and exercises substantial legal, financial and operational control. All significant intercompany accounts and transactions have been eliminated in combination. Certain reclassifications of prior period amounts have been made to conform with the current period presentation.
PROPERTY AND EQUIPMENT
Depreciation and amortization of property and equipment is computed using the straight-line method over the following estimated useful lives:
Maintenance and repairs are charged to operations as incurred. Expenditures for improvements are capitalized.
The Company recognizes impairment losses on property and equipment whenever events or changes in circumstances indicate that the carrying amount of long-lived assets may not be recoverable. Such losses are determined by comparing the sum of the expected future undiscounted net cash flows to the carrying amount of the asset. Impairment losses are recognized in operating income as they are determined.
CASH EQUIVALENTS
All highly liquid investments with a maturity of three months or less at the date of acquisition are considered cash equivalents.
DEFERRED CHARGES
Deferred charges consist primarily of issuance costs related to Senior Subordinated Notes due 2003, Industrial Development Revenue Bonds ("IRB"), loan fees, closing fees and organizational costs. Issuance costs are amortized over the life of the related debt using the interest method. Organizational costs are amortized over five years. Loan fees and closing fees are amortized over the respective terms of the loans using the straight-line method.
SELF-INSURANCE PROGRAMS
The Company uses a paid loss retrospective self-insurance plan for general and auto liability and workers' compensation. Predetermined loss limits have been arranged with insurance companies to limit the Company's per occurrence cash outlay.
The Company maintains a self-insurance program for major medical and hospitalization coverage for employees and dependents which is partially funded by payroll deductions. Payments for major medical and hospitalization to individual participants less than specified amounts are self-insured by the Company. Claims for benefits in excess of these amounts are covered by insurance purchased by the Company.
Provisions have been made in the combined financial statements which represent the expected future payments based on estimated ultimate cost for incidents incurred through the balance sheet date.
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
INCOME TAXES
Effective January 1, 1993, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109, "Accounting for Income Taxes" ("SFAS 109"). SFAS 109 requires recognition of deferred tax liabilities and assets for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred tax liabilities and assets are determined based on the difference between the financial statement and tax basis of assets and liabilities using currently enacted tax rates in effect for the years in which the differences are expected to reverse. In 1993, the Company recorded an adjustment to income of $1,500,000 which represents the net decrease of the deferred tax liability at January 1, 1993. Such amount has been reflected in the combined statement of operations for the year ended December 31, 1993 as the cumulative effect of an accounting change. Prior years' financial statements have not been restated to apply the provisions of SFAS 109. The deferred method under APB Opinion 11 was applied in 1992 and prior years.
EARNINGS (LOSS) PER SHARE
Earnings (loss) per share are computed on the basis of the weighted average number of common and common equivalent (dilutive stock options) shares outstanding in each year after giving retroactive effect to the stock splits effected as stock dividends as discussed in note 5 of these Combined Financial Statements. Shares of the Company's common stock issuable upon conversion of the La Quinta Development Partners, L.P. (the "Development Partners") units are antidilutive at December 31, 1994 and prior years. Primary and fully diluted earnings (loss) per share are not significantly different.
PROPERTIES HELD FOR SALE
Properties held for sale are stated at the lower of cost or estimated net realizable value. Charges to reduce the carrying amounts of properties held for sale to estimated net realizable value are recognized in income. The Company recorded in the statements of operations charges of $9,926,000 in 1992 related to the write-down of properties held for sale.
LICENSING AGREEMENTS
Initial licensing fees related to development are recognized as revenue when the related property opens and all obligations with respect to development have been satisfied by the Company. Monthly licensing fees are based on gross room sales and are accrued as earned.
ADVERTISING
The costs of advertising, promotion and marketing programs are charged to operations in the year incurred. These costs were $8,859,000, $7,025,000 and $5,233,000 for the years ended December 31, 1994, 1993 and 1992, respectively.
INTEREST RATE SWAPS
The accounting treatment for the Company's off balance sheet interest rate swaps is to record net interest received or paid as an adjustment to interest expense.
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(2) LONG-TERM DEBT
At December 31, 1994, the Company had a $45,000,000 Secured Line of Credit and a $171,500,000 Secured Term Credit Facility with participating banks. At December 31, 1994, the Company had $21,300,000 available on its Secured Line of Credit, net of $6,350,000 of letters of credit which collateralize the Company's insurance programs, and was fully drawn on the Secured Term Credit Facility. Borrowings under the $45,000,000 Secured Line of Credit, which will expire May 30, 1997 will be made at LIBOR, the prime rate, or certificate of deposit rate plus an Applicable Margin, as defined in the related credit agreement. At December 31, 1994, borrowings under the Secured Line of Credit bear interest at LIBOR plus 1 1/2%, the prime rate or the certificate of deposit rate plus 1 5/8%. Borrowings under the $171,500,000 Secured Term Credit Facility require semi-annual principal payments through May 31, 2000 and bear interest at varying interest rates of LIBOR, the prime rate, or certificate of deposit rate plus an Applicable Margin, as defined in the related credit agreement. At December 31, 1994, borrowings under the Secured Term Credit Facility bear interest at LIBOR plus 1 3/4%, the prime rate or certificate of deposit rate plus 1 7/8%. The Applicable Margin is determined quarterly based upon predetermined levels of indebtedness to cash flows, as defined in the related credit agreements. The Company pays a commitment fee of .375% per annum on the undrawn portion of the line of credit. Commitment fees totaled $95,000, $164,000 and $105,000 for the years ended December 31, 1994, 1993 and 1992, respectively.
On June 1, 1994, La Quinta Development Partners, L.P. (the "Development Partnership") entered a $35,000,000 Bank Unsecured Line of Credit of which $21,850,000 was available at December 31, 1994. Borrowings under the Bank Unsecured Line of Credit, which expires January 31, 1997, may be made at varying interest rates of the prime rate, LIBOR, or certificate of deposit rate plus the Development Partnership's Applicable Margin, as defined in the related credit agreement. At December 31, 1994, borrowings under the Bank Unsecured Line of Credit bear interest at LIBOR plus 1%, the prime rate or certificate of deposit rate plus 1 1/8%. The Development Partnership's Applicable Margin is determined quarterly based upon predetermined levels of the Partnership's indebtedness to cash flows, as defined in the related credit agreement. The Development Partnership pays a commitment fee of .375% per annum on the undrawn portion of the Bank Unsecured Line of Credit. Commitment fees totaled $56,000 for the year ended December 31, 1994.
Annual maturities for the four years subsequent to December 31, 1995 are as follows:
Interest paid during the years ended December 31, 1994, 1993 and 1992 amounted to $40,105,000, $27,913,000 and $32,523,000, respectively.
In May 1993, the Company conveyed title to the property in which its corporate headquarters was located to the lender holding a $10.1 million non-recourse mortgage on the property. Completion of this transaction resulted in the elimination of the liability for the non-recourse mortgage on the Company's balance sheet. The Company recognized a loss on property transactions of $4,900,000 related to the write-down of the property to its estimated fair value and an extraordinary gain of $4,991,000, $3,045,000 net of income taxes, for the difference between the carrying amount of the debt and the estimated fair value of the building.
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
The Company recognizes gains and losses on extinguishments of debt as extraordinary items in the period in which the debt is extinguished. The Company reported extraordinary items, net of income taxes, of $3,664,000, and $958,000 in 1993 and 1992, respectively, related to these refinancings and retirements.
The Company is obligated by agreements relating to eighteen issues of IRBs in an aggregate amount of $54,375,000 to purchase the bonds at face value prior to maturity under certain circumstances. The bonds have floating interest rates which are indexed periodically. Bondholders may, when the rate is changed, put the bonds to the designated remarketing agent. If the remarketing agent is unable to resell the bonds, it may draw upon an irrevocable letter of credit which secure the IRBs. In such event, the Company would be required to repay the funds drawn on the letters of credit within 24 months.
As of December 31, 1994 no draws had been made upon any such letters of credit. The schedule of annual maturities shown above includes these IRBs as if they will not be subject to repayment prior to maturity. Assuming all bonds under such IRB arrangements are presented for payment prior to December 31, 1995 and the remarketing agents are unable to resell such bonds, the maturities of long-term debt shown above would increase by $39,340,000 for the year ending December 31, 1996.
On January 23, 1992 with the approval of the Company's Board of Directors, the Company entered two interest rate swap agreements (the "Agreements") which exchanged the Company's variable rate interest payments for the fixed rate interest payments with a major financial institution (the "Counterparty"). The debt ("Notional Amounts") underlying the Agreements is $16,890,000 and $44,420,000. Under the Agreements, the Company effectively pays a fixed rate of interest at 6.50% and 5.26% and the Counterparty pays a percentage of prime interest rate and the variable rate demand note interest rate ("VRDN"). In the event the VRDN rate exceeds the fixed interest rate of 5.26% or the percentage of prime interest rate exceed 6.5%, the Counterparty pays to the Company that difference times the Notional Amount, on a monthly basis. Should the fixed interest rate of 5.26% exceed the VRDN interest rate or the fixed interest rate of 6.5% exceeds the percentage of prime interest rate, the Company pays the difference times the Notional Amount to the Counterparty, on a monthly basis. These Agreements resulted in net payments to the Counterparty of $1,040,000, $1,427,000 and $1,184,000 in the years ended December 31, 1994, 1993 and 1992, respectively. The Agreements expire on February 1, 1997, and the Notional Amounts are reduced over the life of the Agreements by scheduled amortization payments. At December 31, 1994, the Notional Amounts of debt remaining under the Agreements are $11,107,000 and $36,150,000 which bear interest at a weighted average variable interest rate of 6.46% and 4.48%, respectively.
The Company is exposed to market risk associated with fluctuations in interest rates. By entering the interest rate swap agreements, described above, the Company reduced its exposure to rising interest rates on the aforementioned variable interest rate debt and has effectively fixed the rate on such debt at a level acceptable to the Company given the length of the Agreements and the risk of interest rate changes. The Company is exposed to credit risk to the extent that the Counterparty fails to perform under the Agreements. The Company has mitigated its credit risk by entering the Agreements with a major financial institution, which has received an "A" rating from Standard and Poor's Corporation and an "A2" rating from Moody's Investors Service on senior unsecured debt. The Company regularly monitors the credit ratings of the Counterparty and considers the risk of default remote.
As a result of the VRDN rate increasing from 2.55% at December 31, 1993, to 4.32% at December 31, 1994 and the increase in the prime rate during the year, the estimated fair value of the interest rate swap agreements changed from a net payable position of $2,276,000 at December 31, 1993, to a net receivable position of $494,000 at December 31, 1994 (See Note 13).
The Secured Line of Credit, Secured Term Credit Facility and certain agreements associated with IRBs are governed by a uniform covenant agreement. The most restrictive covenants preclude the following: payment of cash dividends in excess of defined limits, limitations on the incurrence of debt, mergers, sales of substantial assets, loans and advances, certain investments or any material changes in character of business. The agreement contains provisions to limit the total dollar amounts of certain investments and capital expenditures.
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
The Development Partnership's $35,000,000 Bank Unsecured Line of Credit agreement contains certain covenants including limitations on the incurrence of debt by the Development Partnership, certain investments, mergers or disposition of assets and distributions to partners in excess of certain limits. The agreement also requires maintenance of certain financial ratios.
The Company's 9 1/4% Senior Subordinated Notes are governed by a Trust Indenture dated May 15, 1993. The Trust Indenture contains certain covenants for the benefit of holders of the notes, including, among others, covenants placing limitations on the incurrence of debt, dividend payments, certain investments, transactions with related persons, asset sales, mergers and the sale of substantially all the assets of the Company.
At December 31, 1994, the Company was in compliance with all restrictions and covenants.
(3) UNINCORPORATED VENTURES AND PARTNERSHIPS
At December 31, 1994, the Company had an ownership interest between 40% and 67% in nine unincorporated joint ventures and partnerships. Summary financial information with respect to unincorporated ventures and partnerships included in the combined financial statements is provided below in order to provide further understanding of the Company's structure and to present the financial position and results of operations of the partnerships and joint ventures included in the combined financial statements. Cost and equity investments are not included in other summarized data as such investments are not considered significant.
The following financial information includes the activity of the acquired unincorporated joint ventures and partnerships through the date of acquisition (See Note 14).
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(Continued)
(4) INCOME TAXES
As discussed in note 1, the Company adopted SFAS 109 effective January 1, 1993. Income tax expense attributable to income from continuing operations consists of:
The effective tax rate varies from the statutory rate for the following reasons:
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
The following are cash transactions relating to the Company's income taxes:
For the year ended December 31, 1992, deferred income tax expense resulted from timing differences in the recognition of income and expense for income tax and financial reporting purposes. The sources and tax effects of those timing differences are presented below:
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities as of December 31, 1994 and 1993 are presented below:
In 1994, the valuation allowance decreased $277,000 and in 1993, it decreased $6,816,000 as a result of partnership acquisitions. The Company anticipates that the reversal of existing taxable temporary differences will more likely than not provide sufficient taxable income to realize the tax benefits of the remaining deferred tax assets.
At December 31, 1993, the Company had targeted jobs tax credit carryforwards for Federal income tax purposes of approximately $411,000 and alternative minimum tax credit carryforwards of approximately $2,781,000. These credits have been fully utilized during 1994.
(5) SHAREHOLDERS' EQUITY
The Board of Directors authorized three-for-two stock splits effective in October 1994, March 1994 and October 1993. Earnings per share, the weighted average number of shares outstanding, shareholders' equity and the following information have been adjusted to give effect to each of these distributions. During 1994, the Company repurchased a total of 373,000 shares (post-split) of its common stock for approximately $7,115,000 under a plan approved by the Board of Directors to repurchase up to $10,000,000 of its common stock. Additional purchases will be made from time to time in the open market as deemed appropriate by the Company.
The Company's stock option plans cover the granting of options to purchase an aggregate of 8,036,565 common shares. Options granted under the plans are issuable to certain officers, employees and Board Members
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
generally at prices not less than fair market value at date of grant. Options are generally exercisable in four equal installments on successive anniversary dates of the date of grant and are exercisable thereafter in whole or in part. Outstanding options not exercised expire ten years from the date of grant.
Upon exercise, the excess of the option price received over the par value of the shares issued, net of expenses, is credited to additional paid-in capital.
The exercise of non-qualified stock options results in state and federal income tax benefits to the Company related to the difference between market price at the date of exercise and the option price. During 1994, 1993 and 1992, $7,480,000, $679,000 and $310,000, respectively was credited to additional paid-in capital for the tax benefits of options exercised.
In 1993, the Company recognized compensation expense of $4,407,000 related to performance stock options for the difference between the option price at the date of grant and a predetermined level of $30 per share (pre-split) when it became probable that the Company's stock would trade at that predetermined level. During 1992, the Company recognized $367,000 in compensation expense for the difference between the market price and option price on date of grant related to a portion of these options which vested in annual increments. Currently, the Company has no options outstanding that require recognition of additional compensation expense.
Under the terms of the La Quinta Development Partners, L.P. ("LQDP" or the "Development Partnership") partnership agreement, AEW Partners, L.P. ("AEW Partners") has the ability to convert 66 2/3% of its 60% ownership in the Development Partnership currently to 5,289,801 shares of the Company's common stock after giving retroactive effect to the stock splits effected as stock dividends. Such number of shares is reduced as distributions are made out of the Development Partnership to AEW Partners. Shares of the Company's common stock issuable upon conversion of the Development Partnership Units are antidilutive at December 31, 1994. AEW partner's units in LQDP may be converted over the seven year period beginning December 31, 1991. As of December 31, 1994, AEW Partners had not converted any of its ownership in the Development Partnership into the Company's common stock.
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(6) PENSION PLAN AND OTHER
The Retirement Plan and Trust of La Quinta Inns, Inc. (the "Plan") is a defined benefit pension plan covering all employees. The Plan was amended in 1993 to allow highly compensated employees to rejoin the Retirement Plan as active participants. Benefits accruing under the Plan are determined according to a career average benefit formula which is integrated with Social Security benefits. For each year of service as a participant in the Plan, an employee accrues a benefit equal to one percent of his or her annual compensation plus .65 percent of compensation in excess of the Social Security covered compensation amount. The Company's funding policy for the Retirement Plan is to annually contribute the minimum amount required by federal law.
The Supplemental Executive Retirement Plan and Trust ("SERP") continues to cover a select group of management employees. Benefits under the SERP are determined by a formula which considers service and total compensation; the results of the formula-derived benefit are then reduced by the participant's pension entitlement from the qualified Retirement Plan.
In accordance with the provisions of Statement of Financial Accounting Standards No. 87 - Employer's Accounting for Pensions, the Company has recorded an additional minimum liability of $3,945,000 at December 31, 1994. This liability represents the excess of the accumulated benefit obligation over the fair value of plan assets and accrued pension liability at the measurement date. An amount of $1,528,000 was recognized as an intangible asset to the extent of unrecognized prior service cost and the balance of $2,417,000 ($1,474,000 net of income tax) is recorded as a reduction of shareholders' equity.
The following table sets forth the funded status and amounts recognized in the Company's combined financial statements for the Plan at December 31, 1994 and 1993.
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
The following table sets forth the funded status of the SERP and amounts recognized in the Company's financial statements for the SERP:
The Company maintains a trust account intended for use in settling benefits due under the SERP. The SERP funds are invested primarily in equity investments. At December 31, 1994, the Company had no funds accumulated in the trust account and at December 31, 1993, the balance was $1,144,000.
Net pension cost includes the following components:
The assumptions used in the calculations shown above were:
In addition, to providing pension benefits, the Company has established a 401(K) Savings Plan and Trust (the "Savings Plan") effective January 1, 1994. The Savings Plan is designed to be a qualified plan under sections 401 and 410 through 417 of the Internal Revenue Code. Under the Savings Plan, eligible employees are allowed to defer income on a pre-tax basis through contributions to the Savings Plan and the Company matches a portion of such contributions. The Company's matching contributions totaled $131,000 in 1994.
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(7) OPERATING LEASES
LESSEE
The Company leases a portion of the real estate and equipment used in operations. Certain ground lease arrangements contain contingent rental provisions based upon revenues and also contain renewal options at fair market values at the conclusion of the initial lease terms. In 1993, the Company entered into two ten year operating leases for its corporate headquarters in San Antonio and its reservation facilities.
Future annual minimum rental payments required under operating leases that have initial or remaining noncancelable lease terms in excess of one year at December 31, 1994 follow:
Total rental expense for operating leases was $3,196,000, $2,840,000 and $1,976,000 for the years ended December 31, 1994, 1993 and 1992, respectively.
LESSOR
The Company leases 114 restaurants it owns to third parties. The leases are accounted for as operating leases expiring during a period from 1995 to 2016 and provide for minimum rentals and contingent rentals based on a percentage of annual sales in excess of stipulated amounts. The following is a summary of restaurant property leased at December 31, 1994.
Minimum future rentals to be received under the noncancelable restaurant leases in effect at December 31, 1994 follow:
Contingent rental income amounted to $1,025,000, $811,000 and $854,000 for the years ended December 31, 1994, 1993 and 1992, respectively.
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
(8) NON-RECURRING, CASH AND NON-CASH CHARGES
During 1992, the Company recognized charges of $39,751,000 ($27,946,000 net of income taxes and partners' equity) resulting from certain changes made in the Company's operations and organization based on a review by the Company's senior management team.
Of those charges, $28,383,000 related to the write-down of certain joint venture interests, land, computer equipment, and other assets. During the third quarter of 1992, the senior management team re-evaluated the Company's investments in joint venture arrangements and shortly thereafter completed negotiations that resulted in amendments to the agreements related to certain joint venture arrangements and the write-down of the Company's investments in those ventures. The write-down of the land, computer equipment and other assets resulted primarily from the Company's decisions to sell certain land that had previously been held for future development and to replace the Company's existing computer systems and certain other assets.
In addition, the Company recognized $6,936,000 in the year ended December 31, 1992, in severance and other employee related charges. Those charges related to severance benefits for certain terminated employees, costs of hiring and relocating new management and other employee related costs resulting from personnel changes.
The remaining $4,432,000 of the charges recognized in 1992 consisted of a $2,696,000 increase in the allowance for certain notes receivable related to inns sold by the Company prior to 1985, a $1,214,000 adjustment to reallocate losses of a joint venture to the Company as a result of settlement negotiations, a $312,000 write-off of equipment and $210,000 related to other corporate expense items.
(9) COMMITMENTS
In accordance with the unincorporated partnership or joint venture agreements executed by the Company, La Quinta is committed to advance funds necessary to cover operating expenses of joint ventures. Three unincorporated partnerships and joint ventures executed promissory notes in which the Company guaranteed to fund amounts not to exceed $740,000 in aggregate.
The estimated additional cost to complete the conversion and renovation of inns for which commitments have been made is $4,000,000 at December 31, 1994. Funds on hand, committed and anticipated from cash flow are sufficient to complete these projects.
Under the terms of a Partnership agreement between the Company and AEW Partners, the Company maintains a reserve for renovating, remodeling and conversion of the inns in the Development Partnership based on 5% of gross room revenue of the Partnership which includes certain amounts required by loan agreements. At December 31, 1994 and 1993 the Company had $900,000 and $3,833,000, respectively, of restricted cash which is classified as investments.
In accordance with the requirements of an escrow agreement related to a pool of mortgage notes executed by the Company and a third party lender, the Company is required to make annual deposits into an escrow account for the purpose of establishing a reserve for the replacement of furnishings, fixtures and equipment used on or incorporated into the mortgaged properties. The Company shall be relieved of its obligation to make such annual deposits for any year in which the escrow account has an aggregate balance of $2,431,000. At December 31, 1994 and 1993, the Company had reserved the full amount.
(10) CONTINGENCIES
LITIGATION
In September 1993, a former officer of the Company filed suit against the Company and certain of its directors and their affiliate companies (the "La Quinta Defendants"). The suit alleges breach of an employment agreement, misrepresentation, wrongful termination, self-dealing, breach of fiduciary duty, usurpation of corporate opportunity and tortious interference with contractual relations. Compensatory damages of $2,500,000 and
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
exemplary damages of $5,000,000 are sought in the action. The Court has pending before it the La Quinta Defendants' motion for summary judgment. The parties subsequently filed a required, joint Pre Trial Order, in which the plaintiff has conceded a number of his claims. Currently, no trial date has been set for this action. The Company is vigorously defending against this suit.
The Company is also party to various lawsuits and claims generally incidental to its business. The ultimate disposition of these and the above discussed matter are not expected to have a significant adverse effect on the Company's financial position or results of operations.
SEVERANCE AND EMPLOYMENT AGREEMENTS
The Company has entered into a five year employment agreement which includes a severance provision granting an executive the right to receive certain benefits, including among others, his annual base salary and bonus if there occurs a termination (as defined in the respective agreement) within the five year term of the agreement, or resignation (as defined in the agreement). The maximum contingent liability under the severance provision of this agreement is approximately $1,627,000.
(11) QUARTERLY FINANCIAL DATA (UNAUDITED)
The unaudited combined results of operations by quarter are summarized below:
In the fourth quarter of 1993, the Company recorded an adjustment of $1,273,000 ($777,000 net of income taxes) to decrease its expense related to the self-insurance program for major medical and hospitalization coverage due to decreases in actual claims and estimates of incurred but not reported claims.
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
The decrease in net earnings in the second quarter of 1993 is primarily a result of $4,407,000 in performance stock option expense related to the vesting of certain contingent stock options, that became exercisable in May 1993. This expense was partially offset by an increase in operating income.
The loss in the third quarter of 1992 resulted from charges of $26,908,000, net of income taxes and partners' equity which resulted from a review of the Company's operations and organization, as described in note 8 of these Combined Financial Statements.
(12) RELATED PARTY TRANSACTIONS
MANAGEMENT SERVICES FEE
All inns owned by LQP (through November 30, 1993) and by the two joint ventures ("CIGNA") between the Company and investment partnerships managed by CIGNA Investments, Inc. (through June 30, 1994) (collectively the "Managed Inns") operated under the La Quinta name and were managed by the Company in accordance with long-term management agreements. The Company earned management and licensing fees as well as fees for chain services such as bookkeeping, national advertising and reservations.
OTHER RECURRING TRANSACTIONS
La Quinta pays all direct operating expenses on behalf of the partnerships and joint ventures and is reimbursed for all such payments.
EMPLOYMENT AGREEMENT
In October 1991, the Company and its Chairman of the Board entered into an Employment Agreement (the "Employment Agreement"), providing for his employment as the Chairman of the Board of the Company for five years from the date thereof. As a result of changes in management and reorganization of duties, the remaining compensation of $1,760,000 related to this Employment Agreement was included in the 1992 non-recurring cash and non-cash charges, described in note 8 to these Combined Financial Statements. In March 1994, the Chairman retired from the Company and resigned from the Board of Directors and received certain compensation and benefits as defined in the Employment Agreement.
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used to estimate the value of each class of financial instruments for which it is practical to estimate that value:
NOTES RECEIVABLE
The carrying value for notes receivable approximates the fair value based on the estimated underlying value of the collateral.
INVESTMENTS
The fair value of some investments is estimated based on quoted market prices for these or similar investments. For other securities, the carrying amount is a reasonable estimate of fair value.
LONG-TERM DEBT
The fair value of the Company's long-term debt is estimated based on the current market prices for the same or similar issues or on the current rates available to the Company for debt of the same maturities.
INTEREST RATE SWAP AGREEMENTS
The fair value of interest rate swap agreements represents the estimated amount the Company would receive (pay) to terminate the agreements, taking into consideration current interest rates and the current creditworthiness of the counterparties (See Note 2).
LA QUINTA INNS, INC. NOTES TO COMBINED FINANCIAL STATEMENTS (Continued)
The estimated fair values of the Company's financial instruments are summarized as follows:
(14) ACQUISITION OF PARTNERS' INTERESTS
On January 24, 1994, the Company concluded the acquisition of La Quinta Motor Inns Limited Partnership ("the Partnership or LQP") as discussed below. Additionally, in July 1994, the Company purchased nine La Quinta inns previously held by CIGNA and during the second quarter of 1994, the Company purchased the limited partners' interest in one of the Company's combined unincorporated joint ventures which owned one inn. The aggregate purchase price of these transactions was $53,255,000 of which a portion was financed through the Company's amended Secured Line of Credit and Secured Term Credit Facility.
On October 27, 1993, the Company entered into a definitive Partnership Acquisition Agreement (the "Merger Agreement") with LQP and other parties, pursuant to which the Company, through wholly-owned subsidiaries, would acquire all units of the Partnership (the "Units") that it did not beneficially own at a price of $13.00 net per Unit in cash. The Merger Agreement provided for a tender offer (the "Offer") for all of the Partnership's outstanding Units at a price of $13.00 net per Unit in cash, which Offer commenced on November 1, 1993 and expired at midnight on November 30, 1993. The Offer resulted in the purchase of 2,805,190 Units (approximately 70.6% of the outstanding Units) by the Company through its wholly-owned subsidiary, LQI Acquisition Corporation. As a result of a contribution of additional units previously owned by the Company subsequent to the Offer, LQI Acquisition Corporation beneficially owned 3,257,890 Units (approximately 82% of the Units) at December 31, 1993. Pursuant to the Merger Agreement, a Special Meeting of Unitholders was then held on January 24, 1994 to approve the merger of a subsidiary of LQI Acquisition Corporation with and into the Partnership, with the Partnership as the surviving entity. As a result of this merger which was approved by the requisite vote of Unitholders on January 24, 1994, all of the Partnership's outstanding Units other than Units owned by the Company or any direct or indirect subsidiary of the Company were converted into the right to receive $13.00 net in cash without interest. The acquisition has been accounted for as a purchase and the results of LQP's operations have been included in the Company's combined results of operations since December 1, 1993.
LQI Acquisition Corporation obtained funds to acquire the Units as a result of a capital contribution by La Quinta. In order to make such a capital contribution to LQI Acquisition Corporation, the Company borrowed approximately $45.9 million under its existing credit facility as more fully described in Note 2.
During 1993, the Company purchased in separately negotiated transactions, the limited partners' interests in 14 of the Company's combined unincorporated partnerships and joint ventures, which own 44 inns, for an aggregate price of $87,897,000 which included cash at closing, the assumption of $22,824,000 of existing debt attributable to the limited partners' interest, and $29,878,000 of notes to the sellers. The Company was the general partner and owned the remainder of the ownership interests in each of these partnerships and ventures. The Company intends to continue to operate the properties as La Quinta inns.
The following unaudited pro forma information reflects the combined results of operations of the Company as if the 1993 acquisitions of the 82% interest in LQP and the limited partners' interests in the 14 combined partnerships and joint ventures had occurred at the beginning of 1993 and 1992. The pro forma
LA QUINTA INNS, INC.
NOTES TO COMBINED FINANCIAL STATEMENTS--(CONTINUED)
information gives effect to certain adjustments, including additional depreciation expense on property and equipment based on their fair values, increased interest expense on additional debt incurred, elimination of related party revenues and expenses, and extraordinary losses on early extinguishment of debt. The pro forma results are not necessarily indicative of operating results that would have occurred had the acquisitions been consummated as of the beginning of 1993 and 1992, nor are they necessarily indicative of future operating results.
(UNAUDITED)
INDEPENDENT AUDITORS' REPORT
The Board of Directors and Shareholders La Quinta Inns, Inc.:
We have audited the combined balance sheets of La Quinta Inns, Inc. as of December 31, 1994 and 1993 and the related combined statements of operations, shareholders' equity, and cash flows for each of the years in the three-year period ended December 31, 1994. These combined financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these combined financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the combined financial statements referred to above present fairly, in all material respects, the financial position of La Quinta Inns, Inc. as of December 31, 1994 and 1993 and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 1994, in conformity with generally accepted accounting principles.
As discussed in Note 1 to the combined financial statements, the Company adopted the provisions of Statement of Financial Accounting Standards No. 109 in 1993.
KPMG PEAT MARWICK LLP
San Antonio, Texas January 23, 1995
ITEM 9.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable
PART III
ITEM 10.



ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
(A) DIRECTORS OF REGISTRANT
There is incorporated in this Item 10 by reference that portion of the Company's definitive Proxy Statement, dated on or about April 14, 1995, which Registrant intends to file not later than 120 days after the end of the fiscal year covered by this Form 10-K, appearing under the captions "Election of Directors," and "Meetings and Committees of the Board of Directors."
(B) EXECUTIVE OFFICERS OF THE REGISTRANT
Certain information is set forth below concerning the executive officers of the Company, each of whom has been elected to serve until the regular annual meeting of the Board of Directors following the next Annual Meeting of Shareholders and until his/her successor is duly elected and qualified.
Gary L. Mead has been Director, President and Chief Executive Officer of the Company since March 1992. He served as Executive Vice President - Finance of Motel 6 G.P., Inc., the managing general partner of Motel 6, L.P., from October 1987 to January 1991.
Michael A. Depatie has been Senior Vice President - Finance, Chief Financing Officer of the Company since July 1992. He served as Senior Vice President, Summerfield Hotel from May 1989 to July 1992. He served as Managing General Partner of PacWest Capital Partners from April 1988 to April 1989. He served as Vice President - Finance of The Residence Inn Company from July 1984 to July 1986 and Senior Vice President - Finance from July 1986 to March 1988.
William C. Hammett, Jr. has been Senior Vice President - Accounting and Administration since June 1992. He served as Executive Vice President - Finance of Motel 6 G.P., Inc., from February 1991 to June 1992. He served as Vice President-Controller of Motel 6 G.P., Inc. from September 1988 to February 1991. He served as Controller of Spartan Food Systems from August 1973 to September 1988.
Thomas W. Higgins has been Senior Vice President - Operations of the Company since September 1992. He served as Vice President - Human Resources of the Company from June 1992 to September 1992. He served as Vice President - - Human Resources of Motel 6 G.P., Inc. from May 1988 to June 1992. He served as Director of Training/Employment of General Mills from October 1986 to May 1988.
R. John Kaegi has been Senior Vice President - Marketing of the Company since July 1992. He served as Senior Vice President - Marketing and Strategic Planning of KinderCare Learning Centers, Inc. from December 1989 to July 1992. He served as Vice President - Marketing of KinderCare Learning Centers, Inc. from July 1987 to December 1989. He served as Director Field Marketing of Holiday Inns, Inc. from November 1985 to July 1987.
Steven T. Schultz has been Senior Vice President - Development of the Company since June 1992. He served as Senior Vice President - Development of Embassy Suites from October 1986 to June 1992.
John F. Schmutz has been Vice President - General Counsel and Secretary of the Company since June 1992. He served as Vice President - General Counsel of Sbarro, Inc. from May 1991 to June 1992. He served as Vice President - Legal of Hardee's Food Systems, Inc. from April 1983 to May 1991.
ITEM 11.

ITEM 11. EXECUTIVE COMPENSATION
There are incorporated in this Item 11 by reference those portions of the Company's definitive Proxy Statement, dated on or about April 14, 1995, which Registrant intends to file not later than 120 days after the end of the fiscal year covered by this Form 10-K, appearing under the captions "Executive Compensation," "Compensation Pursuant to Plans," "Other Compensation," "Compensation of Directors," and "Termination of Employment and Change of Control Arrangements."
ITEM 12.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
There are incorporated in this Item 12 by reference those portions of the Company's definitive Proxy Statement, dated on or about April 14, 1995, which Registrant intends to file not later than 120 days after the end of the fiscal year covered by this Form 10-K, appearing under the captions "Principal Shareholders" and "Security Ownership of Management."
ITEM 13.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
There is incorporated in this Item 13 by reference that portion of the Company's definitive Proxy Statement, dated on or about April 14, 1995, which Registrant intends to file not later than 120 days after the end of the fiscal year covered by this Form 10-K, appearing under the caption "Certain Relationships and Related Transactions."
PART IV
ITEM 14.

ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) The following documents are filed as part of this report:
(b) Reports on Form 8-K.
Not applicable.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
LA QUINTA INNS, INC. (Registrant)
By: /s/ William C. Hammett, Jr. ------------------------------------ William C. Hammett, Jr. Senior Vice President Chief Accounting Officer
By: /s/ Michael A. Depatie ------------------------------------ Michael A. Depatie Senior Vice President Chief Financing Officer
Date: March 15, 1995
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant, and in the capacities and on the date indicated.
Date: March 15, 1995
EXHIBIT INDEX