Table of Contents
UNITED STATESSECURITIES AND EXCHANGE COMMISSIONWASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2008
Or
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to .
Commission File Number: 001-32269
EXTRA SPACE STORAGE INC.
(Exact name of registrant as specified in its charter)
Maryland
20-1076777
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
2795 East Cottonwood Parkway, Suite 400
Salt Lake City, Utah 84121
(Address of principal executive offices)
Registrant’s telephone number, including area code: (801) 562-5556
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer x
Accelerated filer o
Non-accelerated filer o(Do not check if a smaller reporting company)
Smaller reporting company o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No x
The number of shares outstanding of the registrant’s common stock, par value $0.01 per share, as of October 31, 2008 was 85,500,139.
TABLE OF CONTENTS
STATEMENT ON FORWARD-LOOKING INFORMATION
3
PART I. FINANCIAL INFORMATION
4
ITEM 1. FINANCIAL STATEMENTS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
9
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
25
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
36
ITEM 4. CONTROLS AND PROCEDURES
37
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
ITEM 1A. RISK FACTORS
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
38
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
SIGNATURES
39
2
Certain information set forth in this report contains “forward-looking statements” within the meaning of the federal securities laws. Forward-looking statements include statements concerning our plans, objectives, goals, strategies, future events, future revenues or performance, capital expenditures, financing needs, plans or intentions relating to acquisitions and other information that is not historical information. In some cases, forward-looking statements can be identified by terminology such as “believes,” “expects,” “estimates,” “may,” “will,” “should,” “anticipates,” or “intends” or the negative of such terms or other comparable terminology, or by discussions of strategy. We may also make additional forward-looking statements from time to time. All such subsequent forward-looking statements, whether written or oral, by us or on our behalf, are also expressly qualified by these cautionary statements.
All forward-looking statements, including without limitation, management’s examination of historical operating trends and estimate of future earnings, are based upon our current expectations and various assumptions. Our expectations, beliefs and projections are expressed in good faith and we believe there is a reasonable basis for them, but there can be no assurance that management’s expectations, beliefs and projections will result or be achieved. All forward-looking statements apply only as of the date made. We undertake no obligation to publicly update or revise forward-looking statements which may be made to reflect events or circumstances after the date made or to reflect the occurrence of unanticipated events.
There are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in or contemplated by this report. Any forward-looking statements should be considered in light of the risks referenced in “Part II. Item 1A. Risk Factors” below and in “Part I. Item 1A. Risk Factors” included in our most recent Annual Report on Form 10-K. Such factors include, but are not limited to:
·
changes in general economic conditions and in the markets in which we operate;
the effect of competition from new self-storage facilities or other storage alternatives, which could cause rents and occupancy rates to decline;
potential liability for uninsured losses and environmental contamination;
difficulties in our ability to evaluate, finance and integrate acquired and developed properties into our existing operations and to lease up those properties, which could adversely affect our profitability;
the impact of the regulatory environment as well as national, state, and local laws and regulations including, without limitation, those governing real estate investment trusts, or REITs, which could increase our expenses and reduce our cash available for distribution;
recent disruptions in credit and financial markets and resulting difficulties in raising capital at reasonable rates, which could impede our ability to grow;
delays in the development and construction process, which could adversely affect our profitability; and
economic uncertainty due to the impact of war or terrorism, which could adversely affect our business plan.
Extra Space Storage Inc.Condensed Consolidated Balance Sheets
(in thousands, except share data)
September 30, 2008
December 31, 2007
(unaudited)
Assets:
Real estate assets:
Net operating real estate assets
$
1,856,809
1,791,377
Real estate under development
48,447
49,945
Net real estate assets
1,905,256
1,841,322
Investments in real estate ventures
139,345
95,169
Cash and cash equivalents
112,076
17,377
Investments available for sale
—
21,812
Restricted cash
38,265
34,449
Receivables from related parties and affiliated real estate joint ventures
11,591
7,386
Other assets, net
37,153
36,560
Total assets
2,243,686
2,054,075
Liabilities, Minority Interests, and Stockholders’ Equity:
Notes payable
930,088
950,181
Notes payable to trusts
119,590
Exchangeable senior notes
250,000
Line of credit
Accounts payable and accrued expenses
36,484
31,346
Other liabilities
18,857
18,055
Total liabilities
1,355,019
1,369,172
Minority interest represented by Preferred Operating Partnership units, net of $100,000 note receivable
28,828
30,041
Minority interest in Operating Partnership and other minority interests
30,696
34,941
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.01 par value, 50,000,000 shares authorized, no shares issued or outstanding
Common stock, $0.01 par value, 300,000,000 shares authorized, 82,370,640 and 65,784,274 shares issued and outstanding at September 30, 2008 and December 31, 2007, respectively
824
658
Paid-in capital
1,063,411
826,026
Other comprehensive deficit
(1,415
)
Accumulated deficit
(235,092
(205,348
Total stockholders’ equity
829,143
619,921
Total liabilities, minority interests, and stockholders’ equity
See accompanying notes to unaudited condensed consolidated financial statements.
Extra Space Storage Inc.Condensed Consolidated Statements of Operations (in thousands, except share data)(unaudited)
Three months ended September 30,
Nine months ended September 30,
2008
2007
Revenues:
Property rental
59,997
55,209
174,906
149,832
Management and franchise fees
5,417
5,169
15,837
15,520
Tenant reinsurance
4,265
3,027
11,723
7,858
Other income
169
421
425
942
Total revenues
69,848
63,826
202,891
174,152
Expenses:
Property operations
21,367
19,607
62,871
53,855
1,426
1,397
3,958
3,587
Unrecovered development and acquisition costs
184
1,631
593
General and administrative
10,319
9,326
30,568
27,534
Depreciation and amortization
12,355
10,598
35,633
28,517
Total expenses
45,506
41,112
134,661
114,086
Income before interest, equity in earnings of real estate ventures, loss on sale of investments available for sale, Preferred Operating Partnership units and minority interests
24,342
22,714
68,230
60,066
Interest expense
(15,904
(16,079
(48,220
(44,912
Interest income
1,280
1,821
2,575
6,937
Interest income on note receivable from Preferred Operating Partnership unit holder
1,213
3,638
Equity in earnings of real estate ventures
2,015
1,304
4,610
3,693
Loss on sale of investments available for sale
Fair value adjustment of obligation associated with Preferred Operating Partnership units
1,054
Minority interest - Operating Partnership
(766
(869
(1,893
(1,768
Minority interests - other
147
113
403
153
Net income
12,327
11,338
27,928
26,503
Fixed distribution paid to Preferred Operating Partnership unit holder
(1,510
Net income attributable to common stockholders
9,828
24,993
Net income per common share
Basic
0.15
0.38
0.39
Diluted
Weighted average number of shares
81,736,986
64,901,249
73,668,700
64,461,353
87,263,018
70,567,078
79,226,236
69,702,837
Cash dividends paid per common share
0.25
0.23
0.75
0.68
5
Extra Space Storage Inc.Condensed Consolidated Statement of Stockholders’ Equity(in thousands, except share data)(unaudited)
Common Stock
Paid-in
AccumulatedOtherComprehensive
Accumulated
TotalStockholders’
Shares
Par Value
Capital
Deficit
Equity
Balances at December 31, 2007
65,784,274
Issuance of common stock upon the exercise of options
146,795
1
1,916
1,917
Restricted stock grants issued
358,139
Restricted stock grants cancelled
(4,760
Compensation expense related to stock-based awards
2,804
Conversion of Contingent Conversion Shares to common stock
1,136,192
11
Issuance of common stock, net of offering costs
14,950,000
150
232,568
232,718
Comprehensive income:
1,415
Total comprehensive income
29,343
Tax benefit from exercise of common stock options
97
Dividends paid on common stock at $0.75 per share
(57,672
Balances at September 30, 2008
82,370,640
6
Extra Space Storage Inc.Condensed Consolidated Statements of Cash Flows(in thousands)(unaudited)
Cash flows from operating activities:
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of deferred financing costs
2,640
2,457
(1,054
Stock compensation expense
1,611
Income allocated to minority interests
1,490
1,615
Distributions from real estate ventures in excess of earnings
4,001
3,454
Changes in operating assets and liabilities:
Receivables from related parties
(4,475
4,835
Other assets
(3,062
5,045
5,138
8,247
883
(2,378
Net cash provided by operating activities
74,395
78,852
Cash flows from investing activities:
Acquisition of real estate assets
(55,602
(144,347
Development and construction of real estate assets
(42,126
(31,495
Proceeds from sale of real estate assets
340
1,999
(48,941
(4,769
Return of investment in real estate ventures
764
Net proceeds from sale of (purchases of) investments available for sale
(49,200
Change in restricted cash
(3,816
7,640
Purchase of equipment and fixtures
(1,368
(835
Net cash used in investing activities
(128,937
(221,007
Cash flows from financing activities:
Proceeds from exchangeable senior notes
Proceeds from notes payable, notes payable to trusts and line of credit
4,063
50,102
Principal payments on notes payable and line of credit
(24,097
(31,135
Deferred financing costs
(740
(7,740
Loan to Preferred Operating Partnership unit holder
(100,000
Minority interest investments
1,174
Redemption of Operating Partnership units held by minority interest
(775
Proceeds from issuance of common shares, net
Net proceeds from exercise of stock options
1,339
Dividends paid on common stock
(44,218
Distributions to Operating Partnership units held by minority interest
(8,122
(4,389
Net cash provided by financing activities
149,241
113,184
Net increase (decrease) in cash and cash equivalents
94,699
(28,971
Cash and cash equivalents, beginning of the period
70,801
Cash and cash equivalents, end of the period
41,830
7
Supplemental schedule of cash flow information
Interest paid, net of amounts capitalized
44,988
37,756
Supplemental schedule of noncash investing and financing activities:
Acquisitions:
Real estate assets
190,185
Notes payable acquired
(54,350
Preferred Operating Partnership units issued as consideration
(131,499
Investment in real estate ventures
(502
Minority interest in Operating Partnership
(3,834
8
Extra Space Storage Inc. Notes to Condensed Consolidated Financial Statements (unaudited)
Amounts in thousands, except property and share data
1. ORGANIZATION
Extra Space Storage Inc. (the “Company”) is a self-administered and self-managed real estate investment trust (“REIT”), formed as a Maryland corporation on April 30, 2004 to own, operate, manage, acquire and develop self-storage facilities located throughout the United States. The Company continues the business of Extra Space Storage LLC and its subsidiaries, which had engaged in the self-storage business since 1977. The Company’s interest in its properties is held through its operating partnership, Extra Space Storage LP (the “Operating Partnership”), which was formed on May 5, 2004. The Company’s primary assets are general partner and limited partner interests in the Operating Partnership. This structure is commonly referred to as an umbrella partnership REIT, or UPREIT. The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the “Internal Revenue Code”). To the extent the Company continues to qualify as a REIT, it will not be subject to tax, with certain limited exceptions, on the taxable income that is distributed to its stockholders.
The Company invests in self-storage facilities by acquiring or developing wholly-owned facilities or by acquiring an equity interest in real estate entities. At September 30, 2008, the Company had direct and indirect equity interests in 617 storage facilities located in 33 states and Washington, D.C. In addition, the Company managed 67 properties for franchisees and third parties, bringing the total number of properties which it owns and/or manages to 684.
The Company operates in two distinct segments: (1) property management, acquisition and development; and (2) rental operations. The Company’s property management, acquisition and development activities include managing, acquiring, developing and selling self-storage facilities. The rental operations activities include rental operations of self-storage facilities. No single tenant accounts for more than 5% of rental income.
2. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements of the Company are presented on the accrual basis of accounting in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they may not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (including normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2008 are not necessarily indicative of results that may be expected for the year ended December 31, 2008. The Condensed Consolidated Balance Sheet as of December 31, 2007 has been derived from the Company’s audited financial statements as of that date, but does not include all of the information and footnotes required by GAAP for complete financial statements. For further information refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2007 as filed with the Securities and Exchange Commission (“SEC”).
Reclassifications
Certain amounts in the 2007 financial statements and supporting note disclosures have been reclassified to conform to the current year presentation. Such reclassification did not impact previously reported net income or accumulated deficit.
Recently Issued Accounting Standards
In September 2006, the Financial Accounting Standards Board (“FASB”) issued Statement No. 157, “Fair Value Measurements” (“FAS 157”). FAS 157 defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. FAS 157 applies under other accounting pronouncements that require or permit fair value measurements, and does not require any new fair value measurements. FAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years. In February 2008, the FASB issued FASB Statement of Position No. 157-2, “Effective Date of FASB Statement No. 157” (the “FSP”). The FSP amends FAS 157 to delay the effective date for FAS 157 for nonfinancial assets and nonfinancial liabilities, except for items that are recognized or disclosed at fair value in the financial statements on a recurring basis. For items within that scope, the FSP defers the effective date of FAS 157 to fiscal years beginning after November 15, 2008 and interim periods within those fiscal years. The Company adopted FAS 157 effective January 1, 2008, except as it relates to nonfinancial assets and liabilities that are not recognized or disclosed at fair value in the financial statements on a recurring basis as allowed under the FSP.
In February 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“FAS 159”). Under FAS 159, a company may elect to measure eligible financial assets and financial liabilities at fair value.
Unrealized gains and losses on items for which the fair value option has been elected are reported in earnings at each subsequent reporting date. This statement is effective for fiscal years beginning after November 15, 2007. The Company adopted FAS 159 effective January 1, 2008, but did not elect to measure any additional financial assets or liabilities at fair value.
In December 2007, the FASB issued revised Statement No. 141, “Business Combinations” (“FAS 141(R)”). FAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the assets acquired and liabilities assumed. Generally, assets acquired and liabilities assumed in a transaction will be recorded at the acquisition-date fair value with limited exceptions. FAS 141(R) will also change the accounting treatment and disclosure for certain specific items in a business combination. FAS 141(R) applies proactively to business combinations for which the acquisition date is on or after the beginning of the first fiscal year beginning on or after December 15, 2008. The Company will assess the impact of FAS 141(R) if and when future acquisitions occur. However, the application of FAS 141(R) will result in a significant change in accounting for acquisitions after the effective date.
In December 2007, the FASB issued Statement No. 160, “Non-controlling Interests in Consolidated Financial Statements – An Amendment of ARB No. 51” (“FAS 160”). FAS 160 establishes new accounting and reporting standards for the non-controlling interest in a subsidiary and for the deconsolidation of a subsidiary. FAS 160 requires a company to clearly identify and present ownership interests in subsidiaries held by parties other than the company in the consolidated financial statements within the equity section but separate from the company’s equity. FAS 160 also requires the amount of consolidated net income attributable to the parent and to the non–controlling interest to be clearly identified and presented on the face of the consolidated statement of operations and requires changes in ownershi p interest to be accounted for similarly as equity transactions. FAS 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests, with all other requirements applied prospectively. As of September 30, 2008 and 2007, minority interests in the accompanying consolidated balance sheets were $59,524 and $64,982, respectively. These amounts will be recharacterized as non-controlling interests as a component of equity when FAS 160 is adopted. FAS 160 is effective for fiscal years beginning on or after December 15, 2008.
In March 2008, the FASB issued Statement No. 161, “Disclosures about Derivative Instruments and Hedging Activities,” an amendment of FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“FAS 161”). FAS 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures stating how and why an entity uses derivative instruments; how derivative instruments and related hedged items are accounted for under SFAS No. 133 and its related interpretations; and how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. FAS 161 requires that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. FAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. FAS 161 also encourages but does not require comparative disclosures for earlier periods at initial adoption. The Company is currently evaluating whether the adoption of FAS 161 will have an impact on its financial statements.
In December 2007, the SEC staff issued Staff Accounting Bulletin (“SAB”) No. 110, which is effective January 1, 2008, and amends and replaces SAB No. 107, “Share-Based Payment.” SAB No. 110 expresses the views of the SEC staff regarding the use of a “simplified” method in developing an estimate of expected term of “plain vanilla” share options in accordance with SFAS No. 123(R), “Share-Based Payment.” Under the “simplified” method, the expected term is calculated as the midpoint between the vesting date and the end of the contractual term of the option. The use of the “simplified” method, which was first described in SAB No. 107, was scheduled to expire on December 31, 2007. SAB No. 110 extends the use of the “simplified” method for “plain vanilla” awards in certain situations. The SEC staff does not expect the “simplified” method to be used when sufficient information regarding exercise behavior, such as historical exercise data or exercise information from external sources, becomes available. The adoption of SAB No. 110 did not have a significant effect on the Company’s financial statements.
In May 2008, the FASB issued FASB Statement of Position No. APB 14-1, “Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement)” (“FSP APB 14-1”). Under FSP APB 14-1, entities with convertible debt instruments that may be settled entirely or partially in cash upon conversion should separately account for the liability and equity components of the instrument in a manner that reflects the issuer’s economic interest cost. The effect of the adoption of FSP APB 14-1 on the Company’s exchangeable senior notes is that the equity component will be included in the paid-in-capital section of stockholders’ equity on the consolidated balance sheet and the value of the equity component will be treated as original issue discount for purposes of accounti ng for the debt component. The original issue discount will be amortized over the period of the debt as additional interest expense. FSP APB 14-1 will be effective for fiscal years beginning after December 15, 2008, and for interim periods within those fiscal years, with retrospective application required. The Company is currently evaluating the impact that the adoption of FSP APB 14-1 will have on its financial statements, and expects a significant increase in interest expense as a result.
In May 2008, the FASB issued FASB Statement No. 162 (“FAS 162”), “The Hierarchy of Generally Accepted Accounting Principles.” FAS 162 identifies the sources of accou nting principles and the framework for selecting the principles used in the
10
preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. FAS 162 shall be effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” The Company does not believe the adoption will have a material impact on its consolidated financial condition or results of operations.
Fair Value Disclosures
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The following table provides information for each major category of assets and liabilities that are measured at fair value on a recurring basis:
Fair Value Measurements at Reporting Date Using
Description
Quoted Prices inActive Markets forIdentical Assets(Level 1)
Significant OtherObservable Inputs(Level 2)
SignificantUnobservable Inputs(Level 3)
Notes payable associated with Swap Agreement
(61,770
Other assets (liabilities) - Swap Agreement
87
Total
(61,683
Following is a reconciliation of the beginning and ending balances for the Company’s investments available for sale, which were the Company’s only material assets or liabilities that are remeasured on a recurring basis using significant unobservable inputs (Level 3):
Balance as of December 31, 2007
Total gains or losses (realized/unrealized)
Included in earnings
Included in other comprehensive income
Settlements received in cash
(21,812
Balance as of September 30, 2008
Amount of total gains or losses for the period included in earnings attributable to the change in unrealized gains or losses relating to assets still held at September 30, 2008
Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis
Long-lived assets held for use are evaluated for impairment when events or circumstances indicate there may be impairment. When such an event occurs, the Company compares the carrying value of these long-lived assets to the undiscounted future net operating cash flows attributable to the assets. An impairment loss is recorded if the net carrying value of the assets exceeds the undiscounted future net operating cash flows attributable to the asset. The impairment loss recognized equals the excess of net carrying value over the related fair value of the asset. The Company has determined that no property was impaired and therefore no impairment charges were recorded during the three or nine months ended September 30, 2008 or 2007.
When real estate assets are identified as held for sale, the Company discontinues depreciating the assets and estimates the fair value of the assets, net of selling costs. If the estimated fair value, net of selling costs, of the assets that have been identified as held for sale is less than the net carrying value of the assets, then a valuation allowance is established. The operations of assets held for sale or sold during the period are presented as discontinued operations for all periods presented. The Company did not have any properties classified as held for sale at September 30, 2008.
The Company assesses whether there are any indicators that the value of its investments in unconsolidated real estate ventures may be impaired when events or circumstances indicate there may be an impairment. An investment is impaired if the Company’s estimate of the fair value of the investment is less than its carrying value. To the extent impairment has occurred, and is considered to be other-than-temporary, the loss is measured as the excess of the carrying amount over the fair value of the investment. No impairment charges were recognized for the three or nine months ended September 30, 2008 or 2007.
There were no impaired properties or investments in unconsolidated real estate ventures or any real estate assets identified as held for sale during the three or nine months ended September 30, 2008. Therefore, the Company did not make any nonrecurring fair value measurements during the period.
3. NET INCOME PER SHARE
Basic earnings per common share is computed by dividing net income by the weighted average number of common shares outstanding, less non-vested restricted stock. Diluted earnings per common share measures the performance of the Company over the reporting period while giving effect to all potential common shares that were dilutive and outstanding during the period. The denominator includes the number of additional common shares that would have been outstanding if the potential common shares that were dilutive had been issued and is calculated using either the treasury stock or if-converted method. Potential common shares are securities (such as options, warrants, convertible debt, Contingent Conversion Shares (“CCSs”), Contingent Conversion Units (“CCUs”), exchangeable Series A Participating Redeemable Preferred Operating Partnership units (“Preferred OP units”) and exchangeable Operating Partnership units (“OP units”)) that do not have a current right to participate in earnings but could do so in the future by virtue of their option or conversion right. In computing the dilutive effect of convertible securities, net income is adjusted to add back any changes in earnings in the period associated with the convertible security. The numerator also is adjusted for the effects of any other non-discretionary changes in income or loss that would result from the assumed conversion of those potential common shares. In computing diluted earnings per share, only potential common shares that are dilutive, or reduce earnings per share, are included.
The Company’s Operating Partnership has $250,000 of exchangeable senior notes issued and outstanding that also can potentially have a dilutive effect on its earnings per share calculations. The exchangeable senior notes are exchangeable by holders into shares of the Company’s common stock under certain circumstances per the terms of the indenture governing the exchangeable senior notes. The exchangeable senior notes are not exchangeable unless the price of the Company’s common stock is greater than or equal to 130% of the applicable exchange price for a specified period during a quarter, or unless certain other events occur. The exchange price was $23.48 per share at September 30, 2008, and could change over time as described in the indenture. The price of the Company’s common stock did not exceed 130% of the exchange price for the specified period of time during the third quarter of 2008; therefore holders of the exchangeable senior notes may not elect to convert them during the fourth quarter of 2008.
The Company has irrevocably agreed to pay only cash for the accreted principal amount of the exchangeable senior notes relative to its exchange obligations, but has retained the right to satisfy the exchange obligations in excess of the accreted principal amount in cash and/or common stock. Though the Company has retained that right, FASB Statement No. 128 “Earnings per Share,” (“FAS 128”) requires an assumption that shares will be used to pay the exchange obligations in excess of the accreted principal amount, and requires that those shares be included in the Company’s calculation of weighted average common shares outstanding for the diluted earnings per share computation. No shares were included in the computation at September 30, 2008 because there was no excess over the accreted principal for the period.
For the purposes of computing the diluted impact on earnings per share of the potential conversion of Preferred OP units into common shares, where the Company has the option to redeem in cash or shares as discussed in Note 15 and where the Company has stated the positive intent and ability to settle at least $115,000 of the instrument in cash (or net settle a portion of the Preferred OP units against the related outstanding note receivable), only the amount of the instrument in excess of $115,000 is considered in the calculation of shares contingently issuable for the purposes of computing diluted earnings per share as allowed by paragraph 29 of FAS 128.
For the three months ended September 30, 2008 and 2007, options to purchase 1,356,592 and 1,184,978 shares of common stock, and for the nine months ended September 30, 2008 and 2007, options to purchase 903,180 and 256,506 shares of common stock, respectively, were excluded from the computation of earnings per share as their effect would have been anti-dilutive.
12
The computation of net income per common share is as follows:
Three Months Ended September 30,
Nine Months Ended September 30,
Add:
Income allocated to minority interest - Operating Partnership
766
869
1,893
1,768
Net income for diluted computations
13,093
10,697
29,821
26,761
Weighted average common shares oustanding:
Average number of common shares outstanding - basic
Operating Partnership units
4,109,034
4,025,332
Preferred Operating Partnership units
989,980
961,839
340,561
Dilutive stock options, restricted stock and CCS/CCU conversions
427,018
678,658
458,522
875,591
Average number of common shares outstanding - diluted
4. REAL ESTATE ASSETS
The components of real estate assets are summarized as follows:
Land - operating
434,826
411,946
Land - development
57,609
52,678
Buildings and improvements
1,494,641
1,420,235
Intangible assets - tenant relationships
32,471
32,173
Intangible lease rights
6,150
2,025,697
1,923,182
Less: accumulated depreciation and amortization
(168,888
(131,805
On June 19, 2008, the Company sold an undeveloped parcel of vacant land in Antelope, California for its book value of $340. There was no gain or loss recognized on the sale.
5. PROPERTY ACQUISITIONS
The following table shows the Company’s acquisitions of operating properties for the nine months ended September 30, 2008, and does not include purchases of raw land or improvements made to existing assets:
Property Location(s)
Number ofProperties
Date ofAcquisition
TotalConsideration
Cash Paid
NetLiabilities /(Assets)Assumed
Source of Acquisition
9/17/08
5,050
5,049
Unrelated third party
Florida
6/19/08
10,239
10,317
(78
California
5/2/08
7,759
7,744
15
23,048
23,110
(62
13
6. INVESTMENTS IN REAL ESTATE VENTURES
Investments in real estate ventures consisted of the following:
Excess Profit
Investment balance at
Ownership %
Participation %
Extra Space West One LLC (“ESW”)
5%
40%
1,582
1,804
Extra Space West Two LLC (“ESW II”)
4,906
5,019
Extra Space Northern Properties Six, LLC (“ESNPS”)
10%
35%
1,540
1,642
Extra Space of Santa Monica LLC (“ESSM”)
41%
5,314
Clarendon Storage Associates Limited Partnership (“Clarendon”)
50%
3,354
4,189
PRISA Self Storage LLC (“PRISA”)
2%
17%
12,524
12,732
PRISA II Self Storage LLC (“PRISA II”)
10,524
10,608
PRISA III Self Storage LLC (“PRISA III”)
20%
4,186
4,405
VRS Self Storage LLC (“VRS”)
45%
9%
48,016
4,515
WCOT Self Storage LLC (“WCOT”)
5,305
5,211
Storage Portfolio I, LLC (“SP I”)
25%
17,695
18,567
Storage Portfolio Bravo II (“SPB II”)
25-45%
14,293
14,785
U-Storage de Mexico S.A. and related entities (“U-Storage”)
35-40%
9,114
4,891
Other minority owned properties
10-50%
992
1,663
In these joint ventures, the Company and the joint venture partner generally receive a preferred return on their invested capital. To the extent that cash/profits in excess of these preferred returns are generated through operations or capital transactions, the Company would receive a higher percentage of the excess cash/profits than its equity interest.
On July 1, 2008, the Company purchased an additional 40.0% interest in VRS Self Storage LLC from Prudential Real Estate Investors for cash of $44,100, resulting in an increase in the Company’s total interest in the joint venture from 5.0% to 45.0%.
The components of equity in earnings of real estate ventures consist of the following:
Equity in earnings of ESW
333
411
1,027
1,106
Equity in earnings (losses) of ESW II
(12
(50
Equity in earnings of ESNPS
62
49
182
136
Equity in earnings of Clarendon
33
109
221
311
Equity in earnings of PRISA
183
166
526
521
Equity in earnings of PRISA II
154
451
430
Equity in earnings of PRISA III
77
86
204
220
Equity in earnings of VRS
648
67
779
190
Equity in earnings of WCOT
78
225
224
Equity in earnings of SP I
339
892
785
Equity in earnings of SPB II
146
189
467
560
Equity in earnings (losses) of U-Storage
(18
(141
(134
(221
Equity in earnings (losses) of other minority owned properties
(8
(195
(180
(569
Equity in earnings (losses) of ESW II, SP I and SPB II include the amortization of the Company’s excess purchase price of $25,713 of these equity investments over its original basis. The excess basis is amortized over 40 years.
7. INVESTMENTS AVAILABLE FOR SALE
The Company accounts for its investments in debt and equity securities according to the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” which requires securities classified as “available for sale” to be stated at fair value. Adjustments to the fair value of available for sale securities are recorded as a component of other comprehensive income. A decline in the market value of equity securities below cost, that is deemed to be other than temporary, results in a reduction in the carrying amount to fair value. The impairment is charged to earnings and a new cost basis for the security is established. The Company’s investments available for sale have generally consisted of non mortgage-backed auction rate securities (“ARS”). ARS are generally long-term debt instruments that provide liquidity through a Dutch auction process that resets the applicable interest rate at pre-determined calendar intervals, generally every 28 days. This mechanism allows existing investors to rollover their holdings and continue to own their respective securities or liquidate their holding by selling their securities at par.
14
Uncertainties in the credit markets had prevented the Company and other investors from liquidating their holdings of ARS in auctions for these securities because the amount of securities submitted for sale exceeded the amount of purchase orders. As a result, during the year ended December 31, 2007, the Company recognized an other-than-temporary impairment charge of $1,213 and temporary impairment charge of $1,415, which reduced the carrying value of the Company’s investments in ARS to $21,812 as of December 31, 2007. On February 29, 2008, the Company liquidated its holdings of ARS for $21,812 in cash. As a result of this settlement, the Company recognized $1,415 of the amount that was previously classified as a temporary impairment as loss on sale of investments available for sale through earnings. The Company had no investments in ARS as of September 30, 2008.
8. OTHER ASSETS
The components of other assets are summarized as follows:
Equipment and fixtures
9,705
11,899
Less: accumulated depreciation
(6,820
(8,364
Deferred financing costs, net
13,652
15,534
Prepaid expenses and deposits
6,616
5,162
Accounts receivable, net
9,319
8,516
Fair value of interest rate swap
Investments in Trusts
3,590
Other
1,004
223
9. NOTES PAYABLE
The components of notes payable are summarized as follows:
Fixed Rate
Mortgage and construction loans with banks bearing interest at fixed rates between 4.65% and 7.0%. The loans are collateralized by mortgages on real estate assets and the assignment of rents. Principal and interest payments are made monthly with all outstanding principal and interest due between April 2009 and February 2017.
819,342
825,326
Variable Rate
Mortgage and construction loans with banks bearing floating interest rates (including loans subject to interest rate swaps) based on LIBOR. Interest rates based on LIBOR are between LIBOR plus 0.65% (4.58% and 5.25% at September 30, 2008 and December 31, 2007, respectively) and LIBOR plus 2.25% (6.18% and 6.85% at September 30, 2008 and December 31, 2007, respectively). The loans are collateralized by mortgages on real estate assets and the assignment of rents. Principal and interest payments are made monthly with all outstanding principal and interest due between December 2008 and June 2011.
110,746
124,855
Real estate assets are pledged as collateral for the notes payable. The Company is subject to certain restrictive covenants relating to the outstanding notes payable. The Company was in compliance with all covenants at September 30, 2008.
In October 2004, the Company entered into a reverse interest rate swap agreement (“Swap Agreement”) to float $61,770 of 4.30% fixed interest rate secured notes due in September 2009. Under this Swap Agreement, the Company will receive interest at a fixed rate of 4.30% and pay interest at a variable rate equal to LIBOR plus 0.65%. The Swap Agreement matures at the same time the notes are due. This Swap Agreement is a fair value hedge, as defined by SFAS No. 133, and the fair value of the Swap Agreement is recorded as an asset or liability, with an offsetting adjustment to the carrying value of the related note payable. Monthly variable interest
payments are recognized as an increase or decrease in interest expense.
The estimated fair value of the Swap Agreement at September 30, 2008 was reflected as an other asset of $87. The estimated fair value of the Swap Agreement at December 31, 2007 was reflected as an other liability of $125. The fair value of the Swap Agreement is determined through observable prices in active markets for identical agreements. The Company recorded a reduction to interest expense relating to the Swap Agreement of $186 for the three months ended September 30, 2008 and additional interest expense of $273 for the three months ended September 30, 2007. Interest expense was decreased by $194 for the nine months ended September 30, 2008 and interest expense was increased by $798 for the nine months ended September 30, 2007.
On August 31, 2007, as part of the acquisition of a partner’s joint venture interest in seven properties, the Company assumed an interest rate cap agreement related to the assumption of the loan on these properties. The Company has designated the interest rate cap agreement as a cash flow hedge of the interest payments resulting from an increase in the interest rates above the rates designated in the interest rate cap agreement. The interest rate cap agreement will allow increases in interest payments based on an increase in the LIBOR rate above the capped rates (5.19% from 1/1/2007 to 12/31/2007 and 5.48% from 1/1/2008 through 12/31/2008) on $23,340 of floating rate debt to be offset by the value of the interest rate cap agreement. The estimated fair value of the interest rate cap at the assumption date was not material and no asset or liability was recorded. The fair value of the interest rate cap at September 30, 2008 and December 31, 2007 was also not material. The fair value of the interest rate cap is determined through observable prices in active markets for identical agreements.
On June 30, 2008, the Company entered into a loan agreement in the amount of $64,530 secured by certain properties. On September 30, 2008, $1,000 was drawn on the loan balance. As part of the loan agreement, the Company agreed to draw down at least 50% of the loan amount by February 1, 2009 with the remainder to be drawn by March 31, 2009. The loan bears interest at LIBOR plus 2%, maturing on June 30, 2011.
10. NOTES PAYABLE TO TRUSTS
During July 2005, ESS Statutory Trust III (the “Trust III”), a newly formed Delaware statutory trust and a wholly-owned, unconsolidated subsidiary of the Operating Partnership, issued an aggregate of $40,000 of preferred securities which mature on July 31, 2035. In addition, the Trust III issued 1,238 of Trust common securities to the Operating Partnership for a purchase price of $1,238. On July 27, 2005, the proceeds from the sale of the preferred and common securities of $41,238 were loaned in the form of a note to the Operating Partnership (“Note 3”). Note 3 has a fixed rate of 6.91% through July 31, 2010, and then will be payable at a variable rate equal to the three-month LIBOR plus 2.40% per annum. The interest on Note 3, payable quarterly, will be used by the Trust III to pay dividends on the trust preferred securities. The trust preferred securities may be redeemed by the Trust with no prepayment premium after July 27, 2010.
During May 2005, ESS Statutory Trust II (the “Trust II”), a newly formed Delaware statutory trust and a wholly-owned, unconsolidated subsidiary of the Operating Partnership, issued an aggregate of $41,000 of preferred securities which mature on June 30, 2035. In addition, the Trust II issued 1,269 of Trust common securities to the Operating Partnership for a purchase price of $1,269. On May 24, 2005, the proceeds from the sale of the preferred and common securities of $42,269 were loaned in the form of a note to the Operating Partnership (“Note 2”). Note 2 has a fixed rate of 6.67% through June 30, 2010, and then will be payable at a variable rate equal to the three-month LIBOR plus 2.40% per annum. The interest on Note 2, payable quarterly, will be used by the Trust II to pay dividends on the trust preferred securities. The trust preferred securities may be redeemed by the Trust with no prepayment premium after June 30, 2010.
During April 2005, ESS Statutory Trust I (the “Trust”), a newly formed Delaware statutory trust and a wholly-owned, unconsolidated subsidiary of the Operating Partnership issued an aggregate of $35,000 of trust preferred securities which mature on June 30, 2035. In addition, the Trust issued 1,083 of trust common securities to the Operating Partnership for a purchase price of $1,083. On April 8, 2005, the proceeds from the sale of the trust preferred and common securities of $36,083 were loaned in the form of a note to the Operating Partnership (the “Note”). The Note has a variable rate equal to the three-month LIBOR plus 2.25% per annum. The interest on the Note, payable quarterly, will be used by the Trust to pay dividends on the trust preferred securities. The trust preferred securities may be redeemed by the Trust with no prepayment premium after June 30, 2010.
The Company follows FASB Interpretation No. 46R, “Consolidation of Variable Interest Entities” (“FIN 46R”), which addresses the consolidation of variable interest entities (“VIEs”). Under FIN 46R, Trust, Trust II and Trust III are VIEs that are not consolidated because the Company is not the primary beneficiary. A debt obligation has been recorded in the form of notes as discussed above for the proceeds, which are owed to the Trust, Trust II, and Trust III by the Company.
11. EXCHANGEABLE SENIOR NOTES
On March 27, 2007, our Operating Partnership issued $250,000 of its 3.625% Exchangeable Senior Notes due April 1, 2027 (the “Notes”). Costs incurred to issue the Notes were approximately $5,700. These costs are being amortized over five years, which
16
represents the estimated term of the Notes, and are included in other assets in the condensed consolidated balance sheet as of September 30, 2008. The Notes are general unsecured senior obligations of the Operating Partnership and are fully guaranteed by the Company. Interest is payable on April 1 and October 1 of each year until the maturity date of April 1, 2027. The Notes bear interest at 3.625% per annum and contain an exchange settlement feature, which provides that the Notes may, under certain circumstances, be exchangeable for cash (up to the principal amount of the Notes) and, with respect to any excess exchange value, for cash, shares of our common stock or a combination of cash and shares of our common stock at an initial exchange rate of approximately 42.582 shares per one thousand dollars principal amount of Notes at the option of the Operating Partnership.
The Operating Partnership may redeem the Notes at any time to preserve the Company’s status as a REIT. In addition, on or after April 5, 2012, the Operating Partnership may redeem the Notes for cash, in whole or in part, at 100% of the principal amount plus accrued and unpaid interest, upon at least 30 days but not more than 60 days prior written notice to holders of the Notes.
The holders of the Notes have the right to require the Operating Partnership to repurchase the Notes for cash, in whole or in part, on each of April 1, 2012, April 1, 2017 and April 1, 2022, and upon the occurrence of a designated event, in each case for a repurchase price equal to 100% of the principal amount of the Notes plus accrued and unpaid interest. Certain events are considered “Events of Default,” as defined in the indenture governing the Notes, which may result in the accelerated maturity of the Notes.
The Company has considered whether the exchange settlement feature represents an embedded derivative within the debt instrument under the guidance of FASB Statement No. 133: “Accounting for Derivative Instruments and Hedging Activities” (“FAS 133”), EITF Issue 90-19: “Convertible Bonds with Issuer Option to Settle for Cash Upon Conversion,” and EITF Issue No. 01-6: “The Meaning of “Indexed to a Company’s Own Stock” that would require bifurcation (i.e. separate accounting of the note and the exchange settlement feature). The Company has concluded that the exchange settlement feature has satisfied the exemption in FAS 133 because it is indexed to the Company’s own common stock and would otherwise be classified in stockholders’ equity, among other considerations. Accordingly, the Notes are presented as a single debt instrument (often referred to as “Instrument C” in EITF 90-19) in accordance with APB 14: “Accounting for Convertible Debt and Debt Issued with Stock Purchase Warrants,” due to the inseparability of the debt and the exchange settlement feature. The Company is currently evaluating the impact that the adoption of FSP APB 14-1 will have on its financial statements and expects to have a significant increase in interest expense as a result.
12. LINE OF CREDIT
On October 19, 2007, the Operating Partnership entered into a $100,000 revolving line of credit (the “Credit Line”) that matures October 31, 2010 with two one-year extensions available. The Company intends to use the proceeds of the Credit Line for general corporate purposes. The Credit Line has an interest rate of between 100 and 205 basis points over LIBOR, depending on certain financial ratios of the Company. The Credit Line is collateralized by mortgages on certain real estate assets. As of September 30, 2008, the Credit Line had $100,000 of capacity based on the assets collateralizing the Credit Line. No amounts were outstanding on the Credit Line at September 30, 2008 or December 31, 2007. The Company is subject to certain restrictive covenants relating to the Credit Line. The Company was in compliance with all covenants as of September 30, 2008.
13. OTHER LIABILTIES
The components of other liabilities are summarized as follows:
Deferred rental income
12,438
11,805
Security deposits
322
383
SUSA lease obligation liability
2,876
2,592
125
Other miscellaneous liabilities
3,221
3,150
14. RELATED PARTY AND AFFILIATED REAL ESTATE JOINT VENTURE TRANSACTIONS
The Company provides management and development services for certain joint ventures, franchises, third parties and other related party properties. Management agreements provide generally for management fees of 6% of cash collected from properties for the management of operations at the self-storage facilities. Management fee revenues for related parties and affiliated real estate joint ventures are summarized as follows:
17
Entity
Type
ESW
Affiliated real estate joint ventures
107
110
325
328
ESW II
80
231
ESNPS
118
349
329
PRISA
1,289
1,273
3,810
3,868
PRISA II
1,053
1,052
3,110
3,142
PRISA III
448
475
1,329
1,417
VRS
298
292
881
860
WCOT
389
387
1,154
1,155
SP I
336
319
974
945
SPB II
247
254
753
770
Various
Franchisees, third parties and other
894
2,921
2,706
Effective January 1, 2004, the Company entered into a license agreement with Centershift, a related party software provider, to secure a perpetual right for continued use of STORE (the site management software used at all sites operated by the Company) in all aspects of the Company’s property acquisition, development, redevelopment and operational activities. The Company paid Centershift $274 and $225 for the three months ended September 30, 2008 and 2007, respectively, and $701 and $680 for the nine months ended September 30, 2008 and 2007, respectively, relating to the purchase of software and to license agreements.
Related party and affiliated real estate joint ventures balances are summarized as follows:
Receivables:
Development fees
1,506
1,501
Other receivables from properties
10,085
5,885
Other receivables from properties consist of amounts due for management fees and expenses paid by the Company on behalf of the managed properties. The Company believes that all of these related party and affiliated joint venture receivables are fully collectible. The Company did not have any payables to related parties at September 30, 2008 or December 31, 2007.
15. MINORITY INTEREST REPRESENTED BY PREFERRED OPERATING PARTNERSHIP UNITS
On June 15, 2007, the Operating Partnership entered into a Contribution Agreement with various limited partnerships affiliated with AAAAA Rent-A-Space to acquire ten self-storage facilities (the “Properties”) in exchange for the issuance of newly designated Preferred OP units of the Operating Partnership. The self-storage facilities are located in California and Hawaii.
On June 25 and 26, 2007, nine of the ten properties were contributed to the Operating Partnership in exchange for consideration totaling $137,800. Preferred OP units totaling 909,075, with a value of $121,700, were issued along with the assumption of approximately $14,200 of third-party debt, of which $11,400 was paid off at close. The final property was contributed on August 1, 2007 in exchange for consideration totaling $14,700. 80,905 Preferred OP units with a value of $9,800 were issued along with $4,900 of cash.
On June 25, 2007, the Operating Partnership loaned the holders of the Preferred OP units $100,000. The note receivable bears interest at 4.85%, and is due September 1, 2017. The loan is secured by the borrower’s Preferred OP units. The holders of the Preferred OP units can convert up to 114,500 Preferred OP units prior to the maturity date of the loan. If any redemption in excess of 114,500 Preferred OP units occurs prior to the maturity date, the holder of the Preferred OP units is required to repay the loan as of the date of that Preferred OP unit redemption. Preferred OP units are shown on the balance sheet net of the $100,000 loan under the guidance in EITF No. 85-1, “Classifying Notes Receivable for Capital,” because the borrower under the loan receivable is also the holder of the Preferred OP units.
The Operating Partnership entered into a Second Amended and Restated Agreement of Limited Partnership (the “Partnership Agreement”) which provides for the designation and issuance of the Preferred OP units. The Preferred OP units will have priority over all other partnership interests of the Operating Partnership with respect to distributions and liquidation.
Under the Partnership Agreement, Preferred OP units in the amount of $115,000 bear a fixed priority return of 5% and have a fixed liquidation value of $115,000. The remaining balance will participate in distributions with and have a liquidation value equal to that of the common OP units. The Preferred OP units will be redeemable at the option of the holder on or after September 1, 2008, which
18
redemption obligation may be satisfied, at the Company’s option, in cash or shares of its common stock.
At issuance, in accordance with SFAS 133: “Accounting for Derivative Instruments and Hedging Activities,” SFAS 150: “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” EITF 00-19: “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company’s Own Stock,” EITF Topic D-109: “Determining the Nature of a Host Contract Related to a Hybrid Financial Instrument Issued in the Form of a Share under FASB Statement No. 133:” and Accounting Series Release No. 268: “Presentation in Financial Statements of “Redeemable Preferred Stocks,” from inception through September 28, 2007 (the date of the amendment discussed below), the Preferred OP units were classified as a hybrid instrument such that the value of the units associated with the fixed return were classified in mezzanine after total liabilities on the balance sheet and before stockholders’ equity. The remaining balance that participates in distributions equal to that of common OP units had been identified as an embedded derivative and had been classified as a liability on the balance sheet and recorded at fair value on a quarterly basis with any adjustment being recorded through earnings. For the year ended December 31, 2007, the fair value adjustment associated with the embedded derivative was $1,054.
On September 28, 2007, the Operating Partnership entered into an amendment to the Contribution Agreement (the “Amendment”). Pursuant to the Amendment, the maximum number of shares that can be issued upon redemption of the Preferred OP units was set at 116 million, after which the Company will have no further obligations with respect to the redeemed or any other remaining Preferred OP units. As a result of the Amendment, and in accordance with the above referenced guidance, the Preferred OP units are no longer considered a hybrid instrument and the previously identified embedded derivative no longer requires bifurcation and is considered permanent equity of the Operating Partnership. The Preferred OP units are included on the consolidated balance sheet as the minority interest represented by Preferred OP units, and no recurring fair value measurements are required subsequent to the date of the Amendment.
On September 18, 2008, the Operating Partnership entered into a First Amendment to the Second Amended and Restated Agreement of Limited Partnership to clarify certain tax-related provisions relating to the Preferred OP units.
16. MINORITY INTEREST IN OPERATING PARTNERSHIP
The Company’s interest in its properties is held through the Operating Partnership. ESS Holding Business Trust I, a wholly owned subsidiary of the Company, is the sole general partner of the Operating Partnership. The Company, through ESS Holding Business Trust II, a wholly owned subsidiary of the Company, is also a limited partner of the Operating Partnership. Between its general partner and limited partner interests, the Company held a 94.17% majority ownership interest therein as of September 30, 2008. The remaining ownership interests in the Operating Partnership (including Preferred OP units) of 5.83% are held by certain former owners of assets acquired by the Operating Partnership, which include officers and a director of the Company. As of September 30, 2008, the Operating Partnership had 4,109,034 and 70,985 OP units and CCUs outstanding, respectively.
The minority interest in the Operating Partnership represents OP units that are not owned by the Company. In conjunction with the formation of the Company and as a result of subsequent acquisitions, certain persons and entities contributing interests in properties to the Operating Partnership received limited partnership units in the form of either OP units or CCUs. Limited partners who received OP units in the formation transactions or in exchange for contributions for interests in properties have the right to require the Operating Partnership to redeem part or all of their OP units for cash based upon the fair market value of an equivalent number of shares of the Company’s common stock (10 day average) at the time of the redemption. Alternatively, the Company may, at its option, elect to acquire those OP units in exchange for shares of its common stock on a one-for-one basis, subject to anti-dilution adjustments provided in the Partnership Agreement. The ten day average closing stock price at September 30, 2008 was $15.71 and there were 4,109,034 OP units outstanding. Assuming that all of the unit holders exercised their right to redeem all of their OP units on September 30, 2008 and the Company elected to pay the non-controlling members cash, the Company would have paid $64,553 in cash consideration to redeem the OP units.
Unlike the OP units, CCUs do not carry any voting rights. Upon the achievement of certain performance thresholds relating to 14 properties, all or a portion of the CCUs will be automatically converted into OP units. Initially, each CCU will be convertible on a one-for-one basis into OP units, subject to customary anti-dilution adjustments. Beginning with the quarter ended March 31, 2006, and ending with the quarter ending December 31, 2008, the Company will calculate the net operating income from the 14 wholly-owned properties over the 12-month period ending in such quarter. Within 35 days following the end of each quarter referred to above, some or all of the CCUs will be converted so that the total percentage (not to exceed 100%) of CCUs issued in connection with the formation transactions that have been converted to OP units will be equal to the percentage determined by dividing the net operating income for such period in excess of $5,100 by $4,600. If any CCU remains unconverted through the calculation made in respect of the 12-month period ending December 31, 2008, such outstanding CCUs will be cancelled.
While any CCUs remain outstanding, a majority of the Company’s independent directors must review and approve the net operating income calculation for each measurement period and also must approve any sales of any of the 14 wholly-owned properties.
As of September 30, 2008, there were 129,061 CCUs converted to OP units. Based on the performance of the properties as of
19
September 30, 2008, an additional 15,028 CCUs became eligible for conversion. The board of directors approved the conversion of these CCUs on October 30, 2008 as per the Company’s charter, and the OP units were issued on November 5, 2008.
17. STOCKHOLDERS’ EQUITY
The Company’s charter provides that it can issue up to 300,000,000 shares of common stock, $0.01 par value per share, 4,100,000 CCSs, $.01 par value per share, and 50,000,000 shares of preferred stock, $0.01 par value per share. As of September 30, 2008, 82,370,640 shares of common stock were issued and outstanding, 1,379,923 CCSs were issued and outstanding and no shares of preferred stock were issued and outstanding. All holders of the Company’s common stock are entitled to receive dividends and to one vote on all matters submitted to a vote of stockholders.
On May 19, 2008, the Company closed a public common stock offering of 14,950,000 shares at an offering price of $16.35 per share, for aggregate gross proceeds of $244,433. Transaction costs were $11,715 for net proceeds of $232,718. A portion of the proceeds were used for the repayment of mortgage debt and outstanding amounts under our Credit Line, and the remaining net proceeds will be used for general corporate purposes, including funding potential future acquisitions.
Unlike the Company’s shares of common stock, CCSs do not carry any voting rights. Upon the achievement of certain performance thresholds relating to 14 properties, all or a portion of the CCSs will be automatically converted into shares of the Company’s common stock. Initially, each CCS will be convertible on a one-for-one basis into shares of common stock, subject to customary anti-dilution adjustments. Beginning with the quarter ended March 31, 2006, and ending with the quarter ending December 31, 2008, the Company will calculate the net operating income from the 14 wholly-owned properties over the 12-month period ending in such quarter. Within 35 days following the end of each quarter referred to above, some or all of the CCSs will be converted so that the total percentage (not to exceed 100%) of CCSs issued in connection with the formation transactions that have been converted to common stock will be equal to the percentage determined by dividing the net operating income for such period in excess of $5,100 by $4,600. If any CCS remains unconverted through the calculation made in respect of the 12-month period ending December 31, 2008, such outstanding CCSs will be cancelled and restored to the status of authorized but unissued shares of common stock.
While any CCSs remain outstanding, a majority of the Company’s independent directors must review and approve the net operating income calculation for each measurement period and also must approve any sales of any of the 14 wholly-owned properties.
As of September 30, 2008, there were 2,508,920 CCSs converted to common stock. Based on the performance of the properties as of September 30, 2008, an additional 292,133 CCSs became eligible for conversion. The board of directors approved the conversion of these CCSs on October 30, 2008 as per the Company’s charter, and the shares were issued on November 5, 2008.
18. STOCK-BASED COMPENSATION
The Company has the following two stock option plans under which shares were available for grant at September 30, 2008: 1) the 2004 Long-Term Incentive Compensation Plan as amended and restated, effective March 25, 2008, and 2) the 2004 Non-Employee Directors’ Share Plan (together, the “Plans”). Option grants are issued at the closing price of stock on the date of grant. Each option will be exercisable after the period or periods specified in the award agreement (typically four years), which will generally not exceed 10 years from the date of grant. Options are exercisable at such times and subject to such terms as determined by the Compensation, Nominating and Governance Committee, but under no circumstances may be exercised if such exercise would cause a violation of the ownership limit in the Company’s charter. Unless otherwise determined by the Compensation, Nominating and Governance Committee at the time of grant, options shall vest ratably over a four-year period beginning on the date of grant.
Also as defined under the terms of the Plans, restricted stock grants may be awarded. The stock grants are subject to a performance or vesting period over which the restrictions are lifted and the stock certificates are given to the grantee. During the performance or vesting period, the grantee is not permitted to sell, transfer, pledge, encumber or assign shares of restricted stock granted under the Plans, however the grantee has the ability to vote the shares and receive dividends paid on the shares. The forfeiture and transfer restrictions on the shares lapse over a two to four-year period beginning on the date of grant. As of September 30, 2008, 4,693,804 shares were available for issuance under the Plans.
20
Option Grants to Employees
A summary of stock option activity is as follows:
Options
Number ofShares
WeightedAverage ExercisePrice
Weighted AverageRemainingContractual Life
Aggregate IntrinsicValue as ofSeptember 30, 2008
Outstanding at December 31, 2006
2,564,563
13.92
Granted
418,000
18.51
Exercised
(126,801
13.68
Forfeited
(204,044
14.71
Outstanding at December 31, 2007
2,651,718
14.54
380,000
15.57
(146,795
13.09
(37,000
14.06
Outstanding at September 30, 2008
2,847,923
14.76
7.08
3,428
Vested and Expected to Vest
2,592,996
14.60
6.92
3,356
Ending Exercisable
1,842,805
6.39
3,126
The aggregate intrinsic value in the table above represents the total value (the difference between the Company’s closing stock price on the last trading day of the third quarter of 2008 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on September 30, 2008. The amount of aggregate intrinsic value will change based on the fair market value of the Company’s stock.
The fair value of each option grant is estimated using the Black-Scholes option-pricing model with the following assumptions:
Expected volatility
30
%
24
Dividend yield
6.4
5.8
Risk-free interest rate
3.0
4.2
Average expected term (years)
The Black-Scholes model incorporates assumptions to value stock-based awards. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the estimated life of the option. The Company uses actual historical data to calculate the expected price volatility, dividend yield and average expected term. The forfeiture rate, which is estimated at a weighted-average of 19.72% of unvested options outstanding as of September 30, 2008, is adjusted annually based on the extent to which actual forfeitures differ, or are expected to differ, from the previous estimates.
The Company recorded compensation expense relating to outstanding options of $324 and $252 for the three months ended September 30, 2008 and 2007, respectively, and $819 and $670 for the nine months ended September 30, 2008 and 2007, respectively. The Company received cash from the exercise of options of $1,123 and $306 for the three months ended September 30, 2008 and 2007, respectively, and $2,063 and $1,339 for the nine months ended September 30, 2008 and 2007, respectively. At September 30, 2008, there was $873 of total unrecognized compensation expense related to non-vested stock options under the Company’s 2004 Long-Term Incentive Compensation Plan. That cost is expected to be recognized over a weighted-average period of 2.34 years. The valuation model applied in this calculation utilizes subjective assumptions that could potentially change over time, including the expected forfeiture rate. Therefore, the amount of unrecognized compens ation expense at September 30, 2008, noted above does not necessarily represent the expense that will ultimately be realized by the Company in the Statement of Operations.
Common Stock Granted to Employees and Directors
The Company granted 4,200 and 28,800 shares of common stock to certain employees, without monetary consideration under the Plans during the three months ended September 30, 2008 and 2007, respectively, and 358,139 and 119,329 shares for the nine months ended September 30, 2008 and 2007, respectively. The Company recorded compensation expense related to outstanding shares of common stock granted to employees of $496 and $485 during the three months ended September 30, 2008 and 2007, respectively, and $1,985 and $941 during the nine months ended September 30, 2008 and 2007, respectively.
21
The fair value of common stock awards is determined based on the closing trading price of the Company’s common stock on the grant date. A summary of the Company’s employee share grant activity is as follows:
Restricted Stock Grants
Weighted-Average Grant-Date Fair Value
Unreleased at December 31, 2006
156,300
15.94
120,729
18.17
Released
(61,975
15.90
Cancelled
(3,082
18.39
Unreleased at December 31, 2007
211,972
17.23
15.73
(117,706
16.41
17.34
Unreleased at September 30, 2008
447,645
16.27
19. SEGMENT INFORMATION
The Company operates in two distinct segments: (1) property management, acquisition and development and (2) rental operations. Financial information for the Company’s business segments is set forth below:
Balance Sheet
Rental operations
Property management, acquisition and development
506,195
385,394
1,737,491
1,668,681
22
Statement of Operations
9,851
8,617
27,985
24,320
Operating expenses, including depreciation and amortization
12,152
11,217
37,251
32,626
33,354
29,895
97,410
81,460
Income (loss) before interest, equity in earnings of real estate ventures, loss on sale of investments available for sale, Preferred Operating Partnership units and minority interests
(2,301
(2,600
(9,266
(8,306
26,643
25,314
77,496
68,372
(325
(376
(1,001
(940
(15,579
(15,703
(47,219
(43,972
Minority interests - Operating Partnership and other
(619
(756
(1,490
(1,615
Net income (loss)
(752
423
(6,959
(1,590
13,079
10,915
34,887
28,093
Depreciation and amortization expense
368
310
1,094
912
11,987
10,288
34,539
27,605
Statement of Cash Flows
20. COMMITMENTS AND CONTINGENCIES
The Company has guaranteed three construction loans for unconsolidated partnerships that own development properties in Baltimore, Maryland, Chicago, Illinois and Sacramento, California. These properties are owned by joint ventures in which the Company has between 10% and 50% equity interests. These guarantees were entered into in November 2004, July 2005 and August 2007, respectively. At September 30, 2008, the total amount of guaranteed mortgage debt relating to these joint ventures was $18,040. These mortgage loans mature December 1, 2008, July 29, 2009 and August 3, 2010, respectively. If the joint ventures default on the loans, the Company may be forced to repay the loans. Repossessing and/or selling the self-storage facilities and land that collateralize the loans could provide funds sufficient to reimburse the Company. The estimated fair market value of the encumbered assets at September 30, 2008 was $24,862. The Company recorded no liability in relation to these guarantees as of September 30, 2008, as the fair values of the guarantees were not material. To date, the joint ventures have not defaulted on their mortgage debt. The Company believes the risk of having to perform on the guarantees is remote.
23
The Company has been involved in routine litigation arising in the ordinary course of business. As of September 30, 2008, the Company was not involved in any material litigation nor, to its knowledge, was any material litigation threatened against it, or its properties.
21. INCOME TAXES
The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), an interpretation of FASB Statement No. 109 on January 1, 2007. The Company recognized no material adjustment in the liability for unrecognized income tax benefits as a result of the implementation of FIN 48. At September 30, 2008, there were no material uncertain tax positions.
Interest and penalties related to uncertain tax positions will be recognized in income tax expense, when incurred. As of September 30, 2008, the Company had no interest or penalties related to uncertain tax positions.
The tax years 2005-2007 remain open to examination by the major taxing jurisdictions to which the Company is subject.
22. SUBSEQUENT EVENTS
On September 29, 2008, the Company entered into a purchase agreement to sell 3.0 million shares of its common stock in a registered direct placement to certain clients of RREEF America L.L.C. The offering closed on October 3, 2008. The Company received proceeds from the offering of approximately $44,100.
On October 2, 2008, the Company purchased two properties located in New York for approximately $27,500.
On October 10, 2008, the Company purchased four properties in Indiana for approximately $18,300.
During October 2008, the Company repurchased approximately $40,300 of its exchangeable senior notes on the open market. The repurchase resulted in a gain of approximately $8,000 on early extinguishment of debt.
Extra Space Storage Inc.Management’s Discussion and AnalysisAmounts in thousands, except property and share data
CAUTIONARY LANGUAGE
The following discussion and analysis should be read in conjunction with our “Unaudited Condensed Consolidated Financial Statements” and the “Notes to Unaudited Condensed Consolidated Financial Statements” contained in this report and the “Consolidated Financial Statements,” “Notes to Consolidated Financial Statements”and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Form 10-K for the year ended December 31, 2007. The Company makes statements in this section that are forward-looking statements within the meaning of the federal securities laws. For a complete discussion of forward-looking statements, see the section in this Form 10-Q entitled “Statement on Forward-Looking Information.” Amounts are in thousands (except property and share data and unless otherwise stated).
CRITICAL ACCOUNTING POLICIES
Our discussion and analysis of our financial condition and results of operations are based on our unaudited condensed consolidated financial statements contained elsewhere in this report, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). Our notes to the unaudited consolidated financial statements contained elsewhere in this report and the audited financial statements contained in our Form 10-K for the year ended December 31, 2007 describe the significant accounting policies essential to our unaudited condensed consolidated financial statements. Preparation of our financial statements requires estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions which we have used are appropriate and correct based on information available at the time that they were made. These estimates, judgments and assumptions can affect our reported assets and liabilities as of the date of the financial statements, as well as the reported revenues and expenses during the period presented. If there are material differences between these estimates, judgments and assumptions and actual facts, our financial statements may be affected.
In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require our judgment in its application. There are areas in which our judgment in selecting among available alternatives would not produce a materially different result, but there are some areas in which our judgment in selecting among available alternatives would produce a materially different result. See the notes to the unaudited condensed consolidated financial statements that contain additional information regarding our accounting policies and other disclosures.
OVERVIEW
We are a fully integrated, self-administered and self-managed real estate investment trust, or REIT, formed to continue the business commenced in 1977 by our predecessor company to own, operate, manage, acquire and develop self-storage properties. We derive a majority of our revenues from rents received from tenants under existing leases at each of our self-storage properties. Additional revenue is derived from management and franchise fees from our joint venture, franchisee and managed properties.
We operate in competitive markets where consumers have multiple self-storage properties from which to choose. Competition has impacted, and will continue to impact our property results. We experience minor seasonal fluctuations in occupancy levels, with occupancy levels higher in the summer months due to increased moving activity. Our operating results depend materially on our ability to lease available self-storage space and on the ability of our tenants to make required rental payments. We believe we are able to respond quickly and effectively to changes in local, regional and national economic conditions by centrally adjusting rental rates through the combination of our revenue management team and our industry-leading technology systems.
We continue to evaluate a range of new initiatives and opportunities in order to enable us to maximize stockholder value. Our strategies to maximize stockholder value include the following:
Maximize the performance of properties through strategic, efficient and proactive management.We plan to pursue revenue generating and expense minimizing opportunities in our operations. Our revenue management team will seek to maximize revenue by responding to changing market conditions through our technology system’s ability to provide real-time, interactive rental rate and discount management. Our size allows greater ability than the majority of our competitors to implement national, regional and local marketing programs, which we believe will attract more customers to our stores at a lower net cost.
Focus on the acquisition of self-storage properties from strategic partners and third parties.Our acquisitions team will
continue to pursue the acquisition of single properties and multi-property portfolios that we believe can provide stockholder value. We have established a reputation as a reliable, ethical buyer, which we believe enhances our ability to negotiate and close acquisitions. In addition, our status as an UPREIT enables flexibility when structuring deals.
Develop new self-storage properties. We have joint venture and wholly-owned development properties and will continue to develop new self-storage properties in our core markets. Our development pipeline for the remainder of 2008 through 2009 includes 19 projects. The majority of the projects will be developed on a wholly-owned basis by the Company.
Expand our management business. We see our management business as a future acquisition pipeline. We expect to pursue strategic relationships with owners that should strengthen our acquisition pipeline through agreements which give us first right of refusal to purchase the managed property in the event of a potential sale. Nineteen of the 39 acquisitions completed by us in 2007 came from this channel.
Recent U.S. and international market and economic conditions have been unprecedented and challenging, with tighter credit conditions and slower growth through the third quarter of 2008. For the nine months ended September 30, 2008, continued concerns about the systemic impact of inflation, energy costs, geopolitical issues, the availability and cost of credit and other macro-economic factors have contributed to increased market volatility and diminished expectations for the global economy and increased market uncertainty and instability. Continued turbulence in U.S. and international markets and economies may adversely affect our liquidity and financial condition, and the financial condition of our customers. If these market conditions continue, they may result in an adverse effect on our financial condition and results of operations.
PROPERTIES
As of September 30, 2008, we owned or had ownership interests in 617 operating self-storage properties located in 33 states and Washington, D.C. Of these properties, 269 are wholly-owned and consolidated, three are held in joint ventures and consolidated and 345 are held in joint ventures accounted for using the equity method. In addition, we managed 67 properties for franchisees or third parties bringing the total numbers of properties which we own and/or manage to 684. We receive a management fee equal to approximately 6% of gross revenues to manage the joint venture, third party and franchise sites. As of September 30, 2008, we owned and/or managed approximately 50 million square feet of space with more than 300,000 customers.
Approximately 70% of our properties are clustered around the larger population centers, such as Atlanta, Baltimore/Washington, D.C., Boston, Chicago, Dallas, Houston, Las Vegas, Los Angeles, Miami, New York City, Orlando, Philadelphia, Phoenix, St. Petersburg/Tampa and San Francisco. These markets contain above-average population and income demographics for new self-storage properties. The clustering of assets around these population centers enables us to reduce our operating costs through economies of scale. Our acquisitions have given us increased scale in many core markets as well as a foothold in many markets where we had no previous presence.
We consider a property to be in the lease-up stage after it has been issued a certificate of occupancy, but before it has achieved stabilization. We consider a property to be stabilized once it has achieved either an 80% occupancy rate for a full year measured as of January 1, or has been open for three years. Although leases are short-term in duration, the typical tenant tends to remain at our properties for an extended period of time. For properties that were stabilized as of September 30, 2008, the median length of stay was approximately eleven months.
Our property portfolio is a made up of different types of construction and building configurations depending on the site and the municipality where it is located. Most often sites are what we consider “hybrid” facilities, a mix of both drive-up buildings and multi-floor buildings. We have a number of multi-floor buildings with elevator access only, and a number of facilities featuring ground-floor access only.
The following table sets forth additional information regarding the occupancy of our stabilized properties on a state-by-state basis as of September 30, 2008 and 2007. The information as of September 30, 2007 is on a pro forma basis as though all the properties owned and/or managed at September 30, 2008 were under our control as of September 30, 2007.
26
Stabilized Property Data Based on Location
Company
Pro forma
Location
Number of Unitsas of September30, 2008 (1)
Number of Unitsas of September30, 2007
Net RentableSquare Feet as ofSeptember 30,2008 (2)
Net RentableSquare Feet as ofSeptember 30,2007
Square FootOccupancy %September 30,2008
Square FootOccupancy %September 30,2007
Wholly-owned properties
Alabama
581
592
76,000
76,105
80.1
76.4
Arizona
2,262
2,263
280,038
279,540
87.4
94.8
44
35,779
36,419
3,457,280
3,481,223
86.1
83.4
Colorado
3,289
3,302
420,194
418,669
88.5
Connecticut
1,342
1,357
123,340
123,265
79.9
81.6
29
19,330
19,391
2,027,186
2,027,757
82.1
85.6
Georgia
6,430
6,445
835,632
835,386
87.1
87.5
Hawaii
2,869
2,890
149,922
150,536
85.0
81.4
Illinois
3,290
3,266
342,319
339,189
Indiana
591
589
62,250
93.9
Kansas
504
49,740
49,940
88.0
90.1
Kentucky
1,588
194,270
194,420
88.6
92.8
Louisiana
1,405
1,407
148,315
147,690
90.8
89.5
7,945
7,933
847,054
841,341
84.3
85.8
Massachusetts
14,859
14,870
1,575,597
1,581,181
85.3
83.6
Michigan
1,038
1,040
136,466
134,882
90.7
Missouri
3,148
3,177
374,357
375,582
86.0
85.9
Nevada
1,254
1,255
132,215
132,565
88.1
84.9
New Hampshire
1,006
1,007
125,909
88.7
80.2
New Jersey
18,860
18,844
1,836,691
1,833,013
85.1
New Mexico
538
503
68,310
61,690
86.4
89.8
New York
7,167
7,243
487,217
488,074
80.5
83.9
Ohio
2,026
2,031
273,492
273,876
86.8
Oregon
103,450
Pennsylvania
6,141
638,053
641,727
86.5
85.7
Rhode Island
729
728
75,521
75,601
South Carolina
1,554
178,719
178,689
89.3
93.7
Tennessee
3,502
3,533
474,327
477,227
84.7
Texas
11,809
11,874
1,337,758
1,337,314
87.7
Utah
1,537
1,533
210,526
210,540
92.6
96.2
Virginia
2,891
2,889
272,047
272,824
88.4
Washington
2,542
2,537
306,025
306,115
90.9
94.3
Total Wholly-Owned Stabilized
246
168,575
169,469
17,620,220
17,637,570
27
Square FootOccupancy % September 30,2007
Joint-venture properties
1,710
1,708
205,833
205,638
6,862
6,897
751,184
751,156
86.6
91.8
76
54,495
54,574
5,588,362
5,591,925
88.8
89.4
1,334
1,335
158,413
158,263
84.5
5,992
5,979
693,032
690,724
79.7
76.3
Delaware
588
71,655
90.3
93.5
19,240
19,310
1,938,665
1,950,791
84.2
1,889
1,887
246,926
246,406
3,998
4,020
430,117
432,517
81.5
3,151
405,269
406,503
1,215
1,214
161,500
163,030
2,286
2,285
268,358
268,427
10,218
10,224
1,013,488
1,013,413
86.3
88.2
9,246
9,277
1,047,458
1,047,450
82.8
5,947
5,959
787,118
783,993
88.9
952
951
117,715
118,195
4,611
4,629
618,818
620,299
90.5
1,320
1,322
138,234
137,714
84.4
15,675
15,711
1,647,956
1,655,758
84.1
82.0
4,698
4,693
537,802
539,566
86.7
22,132
22,154
1,716,903
1,719,892
5,023
754,657
750,287
82.7
84.6
1,294
1,292
136,980
137,140
86.9
91.4
7,228
7,225
764,980
764,354
607
610
73,880
77.0
73.6
11,792
11,817
1,547,659
1,548,693
11,744
11,835
1,549,866
1,519,536
83.2
520
59,300
59,500
81.1
94.9
11,278
11,282
1,191,543
1,190,933
87.6
551
62,730
83.1
94.2
Washington, DC
1,536
102,003
92.4
Total Stabilized Joint-Ventures
334
229,132
229,560
24,788,404
24,782,371
86.2
Managed properties
825
826
95,175
95,207
82.5
89.6
3,906
3,926
488,110
488,835
78.3
78.5
513
56,240
92.3
91.6
650
653
51,966
52,096
2,742
2,755
411,664
416,408
77.3
79.1
2,329
2,331
248,460
248,780
71.9
71.2
4,171
4,151
428,570
427,824
1,576
171,555
3,797
362,160
340,496
80.0
1,098
131,967
131,472
91.5
703
706
77,955
78,075
1,377
1,387
176,211
73.1
72.1
884
889
130,385
131,130
92.1
1,650
1,680
194,935
195,095
92.9
371
46,905
46,955
97.7
99.4
3,469
3,472
344,862
344,667
83.8
111,759
85.2
Total Stabilized Managed Properties
50
31,433
31,386
3,528,879
3,512,805
82.3
83.0
Total Stabilized Properties
630
429,140
430,415
45,937,503
45,932,746
(1) Represents unit count as of September 30, 2008, which may differ from September 30, 2007 unit count due to unit conversions or expansions.
(2) Represents net rentable square feet as of September 30, 2008, which may differ from September 30, 2007 net rentable square feet due to unit conversions or expansions.
28
The following table sets forth additional information regarding the occupancy of our lease-up properties on a state-by-state basis as of September 30, 2008 and 2007. The information as of September 30, 2007 is on a pro forma basis as though all the properties owned and/or managed at September 30, 2008 were under our control as of September 30, 2007.
Lease-up Property Data Based on Location
583
586
67,375
79.3
78.2
5,653
642,609
331,491
41.2
56.2
684
683
54,850
54,840
74.7
71.7
2,073
1,257
230,654
157,155
58.1
1,913
202,925
24.1
0.0
635
79,958
45.9
2,451
2,450
209,814
210,222
68.5
422
46,930
46,910
79.4
80.8
488
59,367
67,045
606
617
64,650
70.1
Total Wholly-Owned Lease-up
15,508
9,271
1,659,132
999,688
52.2
66.1
3,536
2,956
380,576
297,901
61.4
54.0
807
793
109,401
115,625
37.4
44.9
2,492
2,517
264,797
264,552
78.9
67.0
859
948
71,349
73,672
75.6
57.2
1,347
117,423
57,335
16.7
21.8
1,574
1,578
115,885
116,305
494
501
55,645
55,670
57.8
35.5
Total Lease-up Joint-Ventures
11,109
9,928
1,115,076
981,060
56.8
100,690
11.6
536
60,870
35.9
1,396
134,781
18.1
3,189
374,341
14.8
547
566
68,690
89.9
2,790
2,145
260,459
189,894
53.2
66.4
862
77,905
78,030
45.1
26.8
1,129
104,875
19.5
510
68,960
66,960
51.7
52.0
480
63,809
20.6
Total Lease-up Managed
12,490
4,083
1,315,380
403,574
31.8
59.3
Total Lease-up Properties
54
39,107
23,282
4,089,588
2,384,322
48.1
61.1
RESULTS OF OPERATIONS
Comparison of the three and nine months ended September 30, 2008 and 2007
Overview
Results for the three and nine months ended September 30, 2008 include the operations of 617 properties (272 of which were consolidated and 345 of which were in joint ventures accounted for using the equity method) compared to the results for the three and nine months ended September 30, 2007, which included the operations of 585 properties (252 of which were consolidated and 333 of which were in joint ventures accounted for using the equity method).
Revenues
The following table sets forth information on revenues earned for the periods indicated:
Three Months EndedSeptember 30,
Nine Months EndedSeptember 30,
$ Change
% Change
4,788
8.7
25,074
248
4.8
317
2.0
1,238
40.9
3,865
49.2
(252
(59.9
)%
(517
(54.9
6,022
9.4
28,739
16.5
Property Rental — The increase in property rental revenue for the three and nine months ended September 30, 2008 consists of $3,221 and $20,885, respectively, associated with acquisitions completed during 2007 and 2008, $1,112 and $2,863, respectively, from rental rate increases at stabilized properties, and $455 and $1,326, respectively, from increases in occupancy and rental rates at lease-up properties.
Management and Franchise Fees — Management and franchise fees represent approximately 6% of gross revenues under management.
Tenant Reinsurance —The increase in tenant reinsurance revenues is due to our continued success in promoting the tenant reinsurance program at our sites during the first three quarters of 2008. Overall customer participation increased to approximately 46% at September 30, 2008 compared to approximately 32% at September 30, 2007.
Expenses
The following table sets forth information on expenses for the periods indicated:
1,760
9.0
9,016
2.1
10.3
(145
(78.8
175.0
993
10.6
3,034
11.0
1,757
16.6
7,116
25.0
4,394
10.7
20,575
18.0
Property Operations—The increase in property operations expense during the three and nine months ended September 30, 2008 was due to increases of $1,446 and $7,771, respectively, associated with acquisitions of new properties during 2007 and 2008, and $314 and $1,245, respectively, at existing stabilized and lease-up properties due to increases in snow removal and utilities.
Tenant Reinsurance—The increase in tenant reinsurance expense is due to our continued success in promoting the tenant reinsurance program at our sites during the first three quarters of 2008. Overall customer participation increased to approximately 46% at September 30, 2008 compared to approximately 32% at September 30, 2007.
Unrecovered Development/Acquisition Costs—These costs relate to unsuccessful development and acquisition activities during the periods indicated. The increase for the nine months ended September 30, 2008 is primarily due to the write-off of costs related to an unsuccessful acquisition.
General and Administrative—The increase in general and administrative expenses was primarily due to the increased costs associated with the management of the additional properties that were added through acquisitions and development in 2007 and 2008.
Depreciation and Amortization—The increase in depreciation and amortization expense is a result of additional properties that were added through acquisitions and development in 2007 and 2008.
Other Revenues and Expenses
The following table sets forth information on other revenues and expenses for the periods indicated:
Other revenue and expenses:
175
(1.1
(3,308
7.4
(541
(29.7
(4,362
(62.9
(67
(5.2
2,358
184.2
711
54.5
917
24.8
100.0
(100.0
103
(11.9
(125
7.1
Minority interest - other
34
30.1
250
163.4
Total other expense
(12,015
(11,376
(639
5.6
(40,302
(33,563
(6,739
20.1
Interest Expense—The decrease in interest expense for the three months ended September 30, 2008 consists primarily of a decrease of $667 on corporate and other debt mainly as a result of an increase in capitalized interest, offset by an increase of $492 associated with new loans obtained on properties acquired in 2007 and 2008. The increase in interest expense for the nine months ended September 30, 2008 consists primarily of an increase of $2,989 associated with new loans obtained on properties acquired in 2007 and 2008 and an increase of approximately $617 on corporate debt related mainly to the $250,000 in exchangeable senior notes issued in March 2007, offset by a decrease of $298 related to an increase in capitalized interest.
Interest Income—For the three and nine months ended September 30, 2008, the decrease in interest income was due primarily to the fact that we held $49.2 million of investments available for sale at September 30, 2007 versus having no investments available for sale at September 30, 2008. The investments available for sale were purchased with cash that was generated by the exchangeable senior notes offering in March 2007. This decrease was partially offset by the additional interest generated from the proceeds from the common stock offering in May 2008 held in cash and cash equivalents.
Interest Income on Note Receivable from Preferred Operating Partnership Unit Holder—Represents interest on a $100,000 loan to the holders of the Preferred OP units.
Equity in Earnings of Real Estate Ventures—The increase in equity in earnings of real estate ventures for the three and nine months ended September 30, 2008 is due to the increase in our investment in the VRS joint venture from 5% to 45% on July 1, 2008.
Loss on Sale of Investments Available for Sale—Represents the amount of loss recorded on February 29, 2008 related to the liquidation of auction rates securities held in investments available for sale.
Minority Interest—Operating Partnership—Income allocated to the Operating Partnership (including the Preferred OP units) represents 5.83% and 7.14% of the net income before minority interest for the three months ended September 30, 2008 and 2007, respectively.
Minority Interest—Other—Income allocated to the other minority interest represents the losses allocated to partners in consolidated joint ventures on three properties that are in lease-up.
FUNDS FROM OPERATIONS
Funds from Operations (“FFO”) provides relevant and meaningful information about our operating performance that is necessary, along with net income and cash flows, for an understanding of our operating results. We believe FFO is a meaningful disclosure as a supplement to net earnings because net earnings assumes that the values of real estate assets diminish predictably over time as reflected through depreciation and amortization expenses. We believe that the values of real estate assets fluctuate due to market conditions and FFO more accurately reflects the value of our real estate assets. FFO is defined by the National Association of Real Estate Investment Trusts, Inc. (“NAREIT”) as net income computed in accordance with U.S. generally accepted accounting principles (“GAAP”), excluding gains or losses on sales of operating properties, plus depreciation and amortization and after adjustments to record unconsolidated partnerships and joint ventures on the same basis. We believe that to further understand our performance, FFO should be considered along with the reported net income and cash flows in accordance with GAAP, as presented in the consolidated financial statements.
The computation of FFO may not be comparable to FFO reported by other REITs or real estate companies that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently. FFO does not represent cash generated from operating activities determined in accordance with GAAP, and should not be considered as an alternative to net income as an indication of our performance, as an alternative to net cash flow from operating activities as a measure of our liquidity, or as an indicator of our ability to make cash distributions. The following table sets forth the calculation of FFO (amounts are in thousands, except for share data):
31
Adjustments:
Real estate depreciation
10,791
8,874
30,526
24,290
Amortization of intangibles
1,066
1,263
3,503
2,877
Joint venture real estate depreciation and amortization
1,534
3,644
3,091
Joint venture loss on sale of properties
Distributions paid on Preferred Operating Partnership units
(1,438
(4,313
Income allocated to Operating Partnership minority interest
Funds from operations
25,046
20,799
63,181
55,985
Weighted average number of shares - diluted
SAME-STORE STABILIZED PROPERTY RESULTS
We consider our same-store stabilized portfolio to consist of only those properties which were wholly-owned at the beginning and at the end of the applicable periods presented that have achieved stabilization as of the first day of such period. The following table sets forth operating data for our same-store portfolio. We consider the following same-store presentation to be meaningful in regards to the properties shown below. These results provide information relating to property-level operating changes without the effects of acquisitions or completed developments.
Three months endedSeptember 30,
Percent
Nine months endedSeptember 30,
Change
Same-store rental revenues
47,488
46,683
1.7
139,569
137,012
1.9
Same-store operating expenses
16,292
16,313
(0.1
48,564
48,266
0.6
Same-store net operating income
31,196
30,370
2.7
91,005
88,746
2.5
Non same-store rental revenues
12,509
8,526
46.7
35,337
12,820
175.6
Non same-store operating expenses
5,075
3,294
54.1
14,307
5,589
156.0
Total rental revenues
Total operating expenses
Same-store square foot occupancy as of quarter end
Properties included in same-store
211
181
The increase in same-store rental revenues for the three and nine months ended September 30, 2008 over the prior year was due to increased rental rates to existing customers and our ability to maintain occupancy. For the three and nine months ended September 30, 2008, operating expenses were similar to the same periods in the prior year.
CASH FLOWS
Cash flows provided by operating activities were $74,395 and $78,852, respectively, for the nine months ended September 30, 2008 and 2007. The decrease compared to the prior year primarily relates to the increase in receivables from related parties offset by the increase in depreciation and amortization and the loss on investments available for sale.
Cash used in investing activities was $128,937 and $221,007, respectively, for the nine months ended September 30, 2008 and 2007. The decrease relates primarily to the change in investments available for sale. For the nine months ended September 30, 2008, there were proceeds from the sale of investments available for sale of $21,812 compared to purchases of investments available for sale of $49,200 for the same period in the prior year. Additionally, for the nine months ended September 30, 2008, $55,602 was paid for the acquisition of real estate assets, compared to $144,347 for the nine months ended September 30, 2007.
32
These decreases were offset by an increase in cash paid for investments in real estate ventures, which was $48,941 for the nine months ended September 30, 2008, compared to $4,769 for the nine months ended September 30, 2007.
Cash provided by financing activities was $149,241 and $113,184, respectively, for the nine months ended September 30, 2008 and 2007. The increase in cash provided by financing activities over the prior period relates primarily to the proceeds from the sale of common stock in May 2008 of $232,718. In March 2007, we issued $250,000 in exchangeable senior notes and in June 2007 we issued a $100,000 loan to a Preferred OP unit holder.
COMMON CONTINGENT SHARES AND COMMON CONTINGENT UNIT PROPERTY PERFORMANCE
As described in the notes to our unaudited condensed consolidated financial statements, upon the achievement of certain levels of net operating income with respect to 14 of our properties, our CCSs and our Operating Partnership’s CCUs will convert into additional shares of common stock and OP units, respectively.
As of September 30, 2008, 2,508,920 CCSs and 129,061 CCUs have converted to common stock and OP units, respectively. Based on the performance of the properties as of September 30, 2008, an additional 292,133 CCSs and 15,028 CCUs became eligible for conversion. The board of directors approved the conversion of these CCSs and CCUs on October 30, 2008 as per our charter, and the shares and units were issued on November 5, 2008.
The table below outlines the performance of the properties for the three and nine months ended September 30, 2008 and 2007:
CCS/CCU rental revenues
3,373
3,094
9,951
8,946
11.2
CCS/CCU operating expenses
1,288
1,341
(4.0
3,878
3,973
(2.4
CCS/CCU net operating income
2,085
1,753
18.9
6,073
4,973
22.1
Non CCS/CCU rental revenues
56,624
52,115
164,955
140,886
17.1
Non CCS/CCU operating expenses
20,079
18,266
9.9
58,993
49,882
18.3
CCS/CCU square foot occupancy as of quarter end
79.0
80.7
Properties included in CCS/CCU
The increase in CCS/CCU rental revenues for the three and nine months ended September 30, 2008 was primarily due to increased rental rates and increased occupancy. The decrease in expenses for the three and nine months ended September 30, 2008 was primarily due to a reduction in advertising costs and payroll.
OPERATIONAL SUMMARY
For the nine months ended September 30, 2008, we continued our same-store property revenue growth with a revenue increase of 1.9% compared to the same period in 2007. Occupancy at our same-store properties was fairly consistent on a year-to-year basis, reaching 86.0% as of September 30, 2008 compared to 86.8% as of September 30, 2007.
For the nine months ended September 30, 2008, the markets of Chicago, Dallas, Houston, Sacramento and San Francisco/Oakland were the top performers among our stabilized properties. Markets performing below our portfolio average in revenue growth included Las Vegas, Miami/Fort Lauderdale, Philadelphia, and Phoenix.
Property revenue growth was evident in the majority of markets in which we operate. The growth in property revenue is the result of increases in occupancy and rental rates to both new and existing customers. Property expenses increased primarily as a result of increases in snow removal and utilities.
OUTLOOK
In the first nine months of 2008, we continued to see a generally stable climate for self-storage in the United States. Rental activity was flat overall when compared with the first nine months of 2007 and vacates increased slightly when compared to the same period. Despite the lack of increased demand, we were able to raise same-store and overall portfolio revenue through increased rental rates to existing customers. We continue to selectively discount certain sites and units based on occupancy, availability, and competitive parameters that are controlled through our centralized, real-time technology systems and revenue management team.
We anticipate generally stable self-storage fundamentals to continue in our core markets. We believe that the ability exists to increase revenues in the remainder of 2008 over levels achieved in 2007. We anticipate continued competition from all operators, both public and private, in all of the markets in which we operate. However, we believe that the quality and location of our property portfolio, our revenue management systems, and the strength of our self-storage fundamentals will provide opportunities to grow revenues in the remainder of 2008.
We are continually seeking to drive rental activity and revenue growth by actively managing both pricing and promotional strategies through our revenue management team and utilizing the yield management features of our technology system. In-house training, operational initiatives and marketing promotions, including national cable television advertising, continue to be implemented. These activities also provide support for increased rentals at the store level.
Property taxes are seen as a primary driver of expenses in the coming year. As we continue to acquire existing self-storage facilities, tax reassessments will continue to occur.
LIQUIDITY AND CAPITAL RESOURCES
As of September 30, 2008, we had $112,076 available in cash and cash equivalents. This cash resulted primarily from the issuance and sale of approximately 15.0 million shares of our common stock pursuant to a public offering in May 2008. Additionally, on September 29, 2008 we entered into a purchase agreement to sell 3.0 million shares of our common stock in a registered direct placement. The offering closed on October 3, 2008, and we received net proceeds of approximately $44,100 as a result. We intend to use our cash to purchase additional self-storage properties and for general corporate purposes, including repaying indebtedness as it comes due in 2009, and to fund other working capital needs during the remainder of 2008. Additionally, we are required to distribute at least 90% of our net taxable income, excluding net capital gains, to our stockholders on an annual basis to maintain our qualification as a REIT. Therefore, it is unlikely that we will have any substantial cash balances that could be used to meet our liquidity needs. Instead, these needs must be met from cash generated from operations and external sources of capital.
Our cash and cash equivalents are held in accounts managed by third party financial institutions and consist of invested cash and cash in our operating accounts. To date, we have experienced no loss or lack of access to our cash or cash equivalents; however, there can be no assurance that access to our cash and cash equivalents will not be impacted by adverse conditions in the financial markets.
On October 19, 2007, we entered into a $100,000 revolving line of credit (the “Credit Line”). We intend to use the proceeds from the Credit Line for general corporate purposes and acquisitions. The Credit Line has an interest rate of between 100 and 250 basis points over LIBOR, depending on certain of our financial ratios. The Credit Line is collateralized by mortgages on certain real estate assets. The Credit Line matures October 31, 2010 with two one-year extensions available. There were no amounts outstanding under the Credit Line as of September 30, 2008 or December 31, 2007.
As of September 30, 2008, we had $1,299,678 of debt, resulting in a debt to total capitalization ratio of 49.2%. As of September 30, 2008, the ratio of total fixed rate debt and other instruments to total debt was 91.5% ($61,770 on which we have a reverse interest rate swap has been included as variable rate debt). The weighted average interest rate of the total of fixed and variable rate debt at September 30, 2008 was 5.0%.
Real estate assets are pledged as collateral for our debt. We are subject to certain restrictive covenants relating to our outstanding debt. We were in compliance with all covenants at September 30, 2008.
We expect to fund our short-term liquidity requirements, including operating expenses, recurring capital expenditures, dividends to stockholders, distributions to holders of OP units and interest on our outstanding indebtedness out of our operating cash flow, cash on hand and borrowings under the Credit Line.
Our liquidity needs also consist of new facility development, property acquisitions, principal payments under our borrowings and non-recurring capital expenditures. In addition, we evaluate, on an ongoing basis, the merits of strategic acquisitions and other relationships, which may require us to raise additional funds. We do not expect that our operating cash flow will be sufficient to fund our liquidity needs and instead expect to fund such needs out of additional borrowings of secured or unsecured indebtedness, joint ventures with third parties and from the proceeds of public and private offerings of equity and debt. Additional capital may not be available on terms favorable to us, or at all. Any additional issuance of equity or equity–linked securities may result in dilution to our stockholders. In addition, any new securities we issue could have rights, preferences and privileges senior to holders of our common stock. We may also use OP units as currency to fund acquisitions from self-storage owners who desire tax-deferral in their exiting
transactions.
The U.S. credit markets have recently experienced significant dislocations and liquidity disruptions which have caused the spreads on prospective debt financings to widen considerably. These circumstances have materially impacted liquidity in the debt markets, making financing terms for borrowers less attractive, and in certain cases have resulted in the unavailability of certain types of debt financing. Continued uncertainty in the credit markets may negatively impact our ability to access additional debt financing or to refinance existing debt maturities on favorable terms (or at all), which may negatively affect our ability to make acquisitions and fund current and future development projects. In addition, the financial condition of the lenders under our credit facilities may worsen to the point they default on their obligations to make available to us the funds under those facilities. A prolonged downturn in the credit markets may cause us to seek alternative sources of potentially less attractive financing, and may require us to adjust our business plan accordingly. In addition, these factors may make it more difficult for us to sell properties or may adversely affect the price we receive for properties that we do sell, as prospective buyers may experience increased costs of debt financing or difficulties in obtaining debt financing. These events in the credit markets have also had an adverse effect on other financial markets in the United States, which may make it more difficult or costly for us to raise capital through the issuance of common stock, preferred stock or other equity securities. These disruptions in the financial markets may have other adverse effects on us or the economy generally.
FINANCING STRATEGY
We will continue to employ leverage in our capital structure in amounts determined from time to time by our board of directors. Although our board of directors has not adopted a policy which limits the total amount of indebtedness that we may incur, we will consider a number of factors in evaluating our level of indebtedness from time to time, as well as the amount of such indebtedness that will be either fixed or variable rate. In making financing decisions, we will consider factors including but not limited to:
· the interest rate of the proposed financing;
· the extent to which the financing impacts flexibility in managing our properties;
· prepayment penalties and restrictions on refinancing;
· the purchase price of properties acquired with debt financing;
· long-term objectives with respect to the financing;
· target investment returns;
· the ability of particular properties, and our Company as a whole, to generate cash flow sufficient to cover expected debt service payments;
· overall level of consolidated indebtedness;
· timing of debt and lease maturities;
· provisions that require recourse and cross-collateralization;
· corporate credit ratios including debt service coverage, debt to total capitalization and debt to undepreciated assets; and
· the overall ratio of fixed and variable rate debt.
Our indebtedness may be recourse, non-recourse or cross-collateralized. If the indebtedness is non-recourse, the collateral will be limited to the particular properties to which the indebtedness relates. In addition, we may invest in properties subject to existing loans collateralized by mortgages or similar liens on our properties, or may refinance properties acquired on a leveraged basis. We may use the proceeds from any borrowings to refinance existing indebtedness, to refinance investments, including the redevelopment of existing properties, for general working capital or to purchase additional interests in partnerships or joint ventures or for other purposes when we believe it is advisable.
We may from time to time seek to retire, repurchase or redeem our outstanding debt, shares of common stock or other securities in open market purchases, privately negotiated transactions or otherwise. Such repurchases or redemptions, if any, will depend on prevailing market conditions, our liquidity requirements, contractual restrictions and other factors.
OFF-BALANCE SHEET ARRANGEMENTS
Except as disclosed in the notes to our unaudited condensed consolidated financial statements, we do not currently have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special
35
purposes entities, which typically are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, except as disclosed in the notes to our unaudited condensed consolidated financial statements, we have not guaranteed any obligations of unconsolidated entities nor do we have any commitments to provide funding to any such entities. Accordingly, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.
The exchangeable senior notes provide for excess exchange value to be paid in shares of our common stock if our stock price exceeds a certain amount. See the notes to our financial statements for a further description of our exchangeable senior notes.
CONTRACTUAL OBLIGATIONS
The following table summarizes our contractual obligations as of September 30, 2008:
Payments due by Period:
Less Than
After
1 Year
1-3 Years
4-5 Years
5 Years
Operating leases
59,305
5,349
10,305
7,796
35,855
Notes payable, exchangeable senior notes and notes payable to trusts
Interest
559,003
56,820
92,912
81,326
327,945
Principal
1,299,678
282,584
226,974
30,483
759,637
Total contractual obligations
1,917,986
344,753
330,191
119,605
1,123,437
At September 30, 2008, the weighted-average interest rate for all fixed rate loans was 5.0%, and the weighted-average interest rate for all variable rate loans was 5.1%.
SEASONALITY
The self-storage business is subject to seasonal fluctuations. A greater portion of revenues and profits are realized from May through
September. Historically, our highest level of occupancy has been as of the end of July, while our lowest level of occupancy has been in late February and early March. Results for any quarter may not be indicative of the results that may be achieved for the full fiscal year.
Market Risk
Market risk refers to the risk of loss from adverse changes in market prices and interest rates. Our future income, cash flows and fair values of financial instruments are dependent upon prevailing market interest rates.
Interest Rate Risk
Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control.
As of September 30, 2008, we had $1,299,678 in total debt, of which $110,746 was subject to variable interest rates (including the $61,770 on which we have a reverse interest rate swap). If LIBOR were to increase or decrease by 100 basis points, the increase or decrease in interest expense on the variable rate debt would increase or decrease future earnings and cash flows by $1,107 annually.
Interest rate risk amounts were determined by considering the impact of hypothetical interest rates on our financial instruments. These analyses do not consider the effect of any change in overall economic activity that could occur. Further, in the event of a change of that magnitude, we may take actions to further mitigate our exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, these analyses assume no changes in our financial structure.
The fair value of our fixed rate notes payable, exchangeable senior notes and notes payable to trusts at September 30, 2008 was $1,280,751. The carrying value of these fixed rate notes payable, exchangeable senior notes and notes payable to trusts at September 30, 2008 was $1,188,932.
(i) Disclosure Controls and Procedures
We maintain disclosure controls and procedures to ensure that information required to be disclosed in the reports we file pursuant to the Securities Exchange Act of 1934, as amended, are recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure based on the definition of “disclosure controls and procedures” in Rule 13a-15(e) of the Exchange Act. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can only provide a reasonable assurance of achieving the desired control objectives, and in reaching a reasonable level of assurance, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.
We formed a disclosure committee to ensure that all disclosures made by the Company to its security holders or to the investment community will be accurate and complete and fairly present the Company’s financial condition and results of operations in all material respects, and are made on a timely basis as required by applicable laws, regulations and stock exchange requirements.
We carried out an evaluation, under the supervision and with the participation of management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of the end of the period covered by this report.
(ii) Changes in internal control over financial reporting
There were no changes in our internal control over financial reporting (as such term is defined in Exchange Act Rule 13a-15(f)) that occurred during our most recent quarter that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
We are involved in various litigation and proceedings in the ordinary course of business. We are not a party to any material litigation or legal proceedings, or to the best of our knowledge, any threatened litigation or legal proceedings, which, in the opinion of management, will have a material adverse effect on our financial condition or results of operations either individually or in the aggregate.
There have been no material changes in our risk factors from those disclosed in our 2007 Annual Report on Form 10-K.
As described in the notes to our unaudited condensed consolidated financial statements, upon the achievement of certain levels of net operating income with respect to 14 of our properties, our CCSs and our CCUs will convert into additional shares of common stock and OP units, respectively. Subject to certain lock-up periods and adjustments, the units are generally exchangeable for shares of common stock on a one-for-one basis or an equivalent amount of cash, at the option of the Company.
As of September 30, 2008, 2,508,920 CCSs and 129,061 CCUs have converted to common stock and OP units, respectively. Based on the performance of the properties as of September 30, 2008, an additional 292,133 CCSs and 15,028 CCUs became eligible for conversion. The board of directors approved the conversion of these CCSs and CCUs on October 30, 2008 as per our charter, and the shares and units were issued on November 5, 2008. The shares and units were issued in private placements in reliance on Section 3(a)(9) and Section 4(2) of the Securities Act of 1933, as amended, and the rules and regulations promulgated thereunder. We received no additional consideration for the conversions.
None.
10.1
Amended and Restated Employment Agreement, dated as of August 28, 2008, by and between Extra Space Storage Inc., Extra Space Storage LP and Kenneth M. Woolley (incorporated by reference to Exhibit 10.1 of Form 8-K filed on September 4, 2008).
10.2
Amended and Restated Employment Agreement, dated as of August 28, 2008, by and between Extra Space Storage Inc., Extra Space Storage LP and Kent W. Christensen (incorporated by reference to Exhibit 10.2 of Form 8-K filed on September 4, 2008).
Amended and Restated Employment Agreement, dated as of August 28, 2008, by and between Extra Space Storage Inc., Extra Space Storage LP and Karl Haas (incorporated by reference to Exhibit 10.3 of Form 8-K filed on September 4, 2008).
10.4
Amended and Restated Employment Agreement, dated as of August 28, 2008, by and between Extra Space Storage Inc., Extra Space Storage LP and Charles L. Allen (incorporated by reference to Exhibit 10.4 of Form 8-K filed on September 4, 2008).
10.5
First Amendment to Second Amended and Restated Agreement of Limited Partnership of Extra Space Storage LP, filed herewith.
31.1
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1*
Certifications of the Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
*These certifications are being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934 and are not to be incorporated by reference into any filing of Extra Space Storage Inc., whether made before or after the date hereof, regardless of any general incorporation language in such filing.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Registrant
Date: November 5, 2008
/s/ Kenneth M. Woolley
Kenneth M. Woolley
Chairman and Chief Executive Officer
(Principal Executive Officer)
/s/ Kent W. Christensen
Kent W. Christensen
Executive Vice President and Chief Financial Officer
(Principal Financial Officer)