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 March 31, 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, or a non-accelerated filer, or a smaller reporting company. See definition 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 April 30, 2008 was 66,449,472.
TABLE OF CONTENTS
STATEMENT ON FORWARD-LOOKING INFORMATION
3
PART I. FINANCIAL INFORMATION
4
ITEM 1. FINANCIAL STATEMENTS
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
8
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
36
ITEM 4. CONTROLS AND PROCEDURES
PART II. OTHER INFORMATION
37
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
ITEM 5. OTHER INFORMATION
ITEM 6. EXHIBITS
SIGNATURES
38
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 would 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)
March 31, 2008
December 31, 2007
(unaudited)
Assets:
Real estate assets:
Net operating real estate assets
$
1,788,625
1,791,377
Real estate under development
64,533
49,945
Net real estate assets
1,853,158
1,841,322
Investments in real estate ventures
94,711
95,169
Cash and cash equivalents
21,010
17,377
Investments available for sale
—
21,812
Restricted cash
34,213
34,449
Receivables from related parties and affiliated real estate joint ventures
9,529
7,386
Other assets, net
36,663
36,560
Total assets
2,049,284
2,054,075
Liabilities, Minority Interests and Stockholders’ Equity:
Notes payable
951,402
950,181
Notes payable to trusts
119,590
Exchangeable senior notes
250,000
Line of credit
Accounts payable and accrued expenses
34,787
31,346
Other liabilities
17,969
18,055
Total liabilities
1,373,748
1,369,172
Minority interest represented by Preferred Operating Partnership units, net of $100,000 note receivable
29,612
30,041
Minority interest in Operating Partnership
33,371
35,135
Other minority interests
(333
)
(194
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, 66,437,222 and 65,784,274 shares issued and outstanding at March 31, 2008 and December 31, 2007, respectively
664
658
Paid-in capital
827,474
826,026
Other comprehensive deficit
(1,415
Accumulated deficit
(215,252
(205,348
Total stockholders’ equity
612,886
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 March 31,
2008
2007
Revenues:
Property rental
57,024
46,231
Management and franchise fees
5,077
5,208
Tenant insurance
3,478
2,143
Other income
128
194
Total revenues
65,707
53,776
Expenses:
Property operations
20,641
16,896
1,162
973
Unrecovered development and acquisition costs
164
250
General and administrative
10,179
9,240
Depreciation and amortization
11,581
8,796
Total expenses
43,727
36,155
Income before interest, equity in earnings of real estate ventures, loss on investments available for sale and minority interests
21,980
17,621
Interest expense
(16,354
(13,396
Interest income
425
1,448
Interest income on note receivable from Preferred Unit holder
1,213
Equity in earnings of real estate ventures
1,222
1,197
Loss on sale of investments available for sale
Minority interest - Operating Partnership
(510
(384
Minority interests - other
139
(16
Net income
6,700
6,470
Net income per common share
Basic
0.10
Diluted
Weighted average number of shares
65,825,022
64,058,756
71,359,324
68,786,185
Cash dividends paid per common share
0.25
0.23
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
Income (Deficit)
Deficit
Equity
Balances at December 31, 2007
65,784,274
Issuance of common stock upon the exercise of options
49,125
634
Restricted stock grants issued
171,800
Restricted stock grants cancelled
(860
Conversion of Contingent Conversion shares to common stock
432,883
Compensation expense related to stock-based awards
800
Comprehensive income:
1,415
Total comprehensive income
8,115
Tax benefit from exercise of common stock options
14
Dividends paid on common stock at $0.25 per share
(16,604
Balances at March 31, 2008
66,437,222
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
861
632
Stock compensation expense
436
Income allocated to minority interests
371
400
Distributions from real estate ventures in excess of earnings
1,224
681
Changes in operating assets and liabilities:
Receivables from related parties
(2,143
9,914
Other assets
(947
4,095
Accounts payable
3,441
(3,899
896
(1,863
Net cash provided by operating activities
24,199
25,662
Cash flows from investing activities:
Acquisition of real estate assets
(8,327
(34,709
Development and construction of real estate assets
(14,588
(6,926
(766
(5,583
Net proceeds from (purchases of) investments available for sale
(286,360
Change in restricted cash
236
(1,812
Purchase of equipment and fixtures
(347
(259
Net cash used in investing activities
(1,980
(335,649
Cash flows from financing activities:
Proceeds from exchangeable senior notes
Proceeds from notes payable, notes payable to trusts and line of credit
1,182
45,454
Principal payments on notes payable and line of credit
(1,082
(692
Deferred financing costs
(13
(5,676
Net proceeds from exercise of stock options
732
Dividends paid on common stock
(14,618
Distributions to Operating Partnership units held by minority interest
(2,703
(903
Net cash (used in) provided by financing activities
(18,586
274,297
Net increase (decrease) in cash and cash equivalents
3,633
(35,690
Cash and cash equivalents, beginning of the period
70,801
Cash and cash equivalents, end of the period
35,111
Supplemental schedule of cash flow information
Interest paid, net of amounts capitalized
11,271
12,018
Supplemental schedule of noncash investing and financing activities:
Acquisitions:
Real estate assets
502
Investment in real estate ventures
(502
7
Extra Space Storage Inc. Notes to Condensed Consolidated Financial Statements (unaudited) Amounts in thousands, except property, share and per 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 March 31, 2008, the Company had direct and indirect equity interests in 607 storage facilities located in 33 states and Washington, D.C. In addition, the Company managed 47 properties for franchisees and third parties, bringing the total number of properties which it owns and/or manages to 654.
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 (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 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 future acquisitions after the effective date.
In December 2007, the FASB issued Statement No. 160, “Noncontrolling 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 is effective for fiscal years beginning on or after December 15, 2008. The Company does not currently expect the adoption of FAS 160 to have a material impact on its financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivatives 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 adoptions. The Company is currently evaluating whether the adoption of FAS 161 will have an impact on its financial statements.
In December 2007, the Securities and Exchange Commission (“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.
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:
9
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)
Other assets (liabilities) - Swap Agreement
997
Total
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 March 31, 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 March 31, 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 months ended March 31, 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 March 31, 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 months ended March 31, 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 months ended March 31, 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 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
10
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 $23.45 per share at March 31, 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 first quarter of 2008; therefore holders of the exchangeable senior notes may not elect to convert them during the second 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 March 31, 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 14 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 March 31, 2008 and 2007, options to purchase approximately 1,441,469 and 89,642 shares of common stock, respectively, were excluded from the computation of earnings per share as their effect would have been anti-dilutive.
The computation of net income per share is as follows:
For the Three Months EndedMarch 31,
Add:
Income allocated to minority interest - Operating Partnership
510
384
Net income for diluted computations
7,210
6,854
Weighted average common shares oustanding:
Average number of common shares outstanding - basic
Operating Partnership units
4,072,857
3,810,261
Preferred Operating Partnership units
989,980
Dilutive stock options, restricted stock and CCS/CCU conversions
471,465
917,168
Average number of common shares outstanding - diluted
11
4. REAL ESTATE ASSETS
The components of real estate assets are summarized as follows:
Land
471,002
464,624
Buildings and improvements
1,422,185
1,420,235
Intangible assets - tenant relationships
32,173
Intangible lease rights
6,150
1,931,510
1,923,182
Less: accumulated depreciation and amortization
(142,885
(131,805
5. 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”)
%
40
1,750
1,804
Extra Space West Two LLC (“ESW II”)
4,976
5,019
Extra Space Northern Properties Six, LLC (“ESNPS”)
35
1,588
1,642
Extra Space of Santa Monica LLC (“ESSM”)
41
5,203
5,138
Clarendon Storage Associates Limited Partnership (“Clarendon”)
50
4,185
4,189
PRISA Self Storage LLC (“PRISA”)
17
12,686
12,732
PRISA II Self Storage LLC (“PRISA II”)
10,573
10,608
PRISA III Self Storage LLC (“PRISA III”)
20
4,341
4,405
VRS Self Storage LLC (“VRS”)
4,489
4,515
WCOT Self Storage LLC (“WCOT”)
5,393
5,211
Storage Portfolio I, LLC (“SP I”)
25
18,288
18,567
Storage Portfolio Bravo II (“SPB II”)
25-45
14,615
14,785
U-Storage de Mexico S.A. and related entities (“U-Storage”)
35-40
5,290
4,891
Other minority owned properties
10-50
1,334
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.
The components of equity in earnings of real estate ventures consist of the following:
12
Equity in earnings of ESW
322
348
Equity in earnings (losses) of ESW II
(17
Equity in earnings of ESNPS
55
46
Equity in earnings of Clarendon
91
98
Equity in earnings of PRISA
176
170
Equity in earnings of PRISA II
148
130
Equity in earnings of PRISA III
72
63
Equity in earnings of VRS
64
61
Equity in earnings of WCOT
75
70
Equity in earnings of SP I
260
204
Equity in earnings of SPB II
172
189
Equity in earnings (losses) of U-Storage
(73
Equity in earnings (losses) of other minority owned properties
(123
(182
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.
6. 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 fair value of available for sale securities are recorded as a component of other comprehensive loss. 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.
The recent uncertainties in the credit markets had prevented the Company and other investors from liquidating their holdings of ARS in recent auctions for these securities because the amount of securities submitted for sale has 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 March 31, 2008.
7. OTHER ASSETS
The components of other assets are summarized as follows:
Equipment and fixtures
12,246
11,899
Accumulated depreciation
(8,871
(8,364
Deferred financing costs, net
14,679
15,534
Prepaid expenses and deposits
5,277
5,162
Accounts receivable, net
8,234
8,516
Fair value of interest rate swap
Investments in Trusts
3,590
Other
511
223
13
8. 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 8.33%. 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 March 21, 2009 and January 1, 2023.
824,274
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 0.66% (3.35% and 5.25% at March 31, 2008 and December 31, 2007, respectively) and LIBOR plus 2.50% (5.20% and 7.10% at March 31, 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 July 11, 2008 and March 1, 2011.
127,128
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 March 31, 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 0.66%. 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 March 31, 2008 was reflected as an other asset of $997. 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. For the three months ended March 31, 2008 and 2007, interest expense has been increased by $112 and $261, respectively, as a result of the Swap Agreement.
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 March 31, 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.
9. 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.
10. 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 $5,100. These costs are being amortized over five years, which represents the estimated term of the Notes, and are included in other assets in the condensed consolidated balance sheet as of March 31, 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 beginning 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 42.5822 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
15
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.
11. LINE OF CREDIT
On October 19, 2007, the Operating Partnership entered into a new $100,000 revolving line of credit (the “Credit Line”) that matures October 31, 2010. 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 March 31, 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 March 31, 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 March 31, 2008.
12. OTHER LIABILTIES
The components of other liabilities are summarized as follows:
Deferred rental income
12,212
11,805
Security deposits
362
383
SUSA lease obligation liability
2,603
2,592
125
Other miscellaneous liabilities
2,792
3,150
13. 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:
Entity
Type
ESW
Affiliated real estate joint ventures
108
109
ESW II
ESNPS
114
107
PRISA
1,263
1,301
PRISA II
1,031
1,042
PRISA III
443
468
VRS
292
285
WCOT
381
SP I
320
310
SPB II
255
262
Various
Franchisees, third parties and other
792
943
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
16
Company) in all aspects of the Company’s property acquisition, development, redevelopment and operational activities. The Company paid Centershift $169 and $189 for the three months ended March 31, 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
1,498
1,501
Other receivables from properties
8,031
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 March 31, 2008 or December 31, 2007.
14. 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 114.5 million Preferred OP units prior to the maturity date of the loan. If any redemption in excess of 114.5 million 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 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 (“ASR”) 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.
15. 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 92.92% majority ownership interest therein as of March 31, 2008. The remaining ownership interests in the Operating Partnership (including Preferred OP units) of 7.08% are held by certain former owners of assets acquired by the Operating Partnership, which include a director and officers of the Company.
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 March 31, 2008 was $16.51 and there were 4,072,857 OP units outstanding. Assuming that all of the unit holders exercised their right to redeem all of their OP units on March 31, 2008 and the Company elected to pay the non-controlling members cash, the Company would have paid $67,243 in cash consideration to redeem the OP units.
As of March 31, 2008, the Operating Partnership had 4,072,857 and 107,163 OP units and CCUs outstanding, respectively.
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 March 31, 2008, there were 92,883 CCUs converted to OP units. Based on the performance of the properties as of March 31, 2008, an additional 17,915 CCUs became eligible for conversion. The board of directors approved the conversion of these CCUs on May 1, 2008 as per the Company’s charter, and the OP units were issued on May 5, 2008.
18
16. 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 March 31, 2008, 66,437,222 shares of common stock were issued and outstanding, 2,083,232 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.
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 March 31, 2008, there were 1,805,611 CCSs converted to common stock. Based on the performance of the properties as of March 31, 2008, an additional 348,274 CCSs became eligible for conversion. The board of directors approved the conversion of these CCSs on May 1, 2008 as per the Company’s charter, and the shares were issued on May 5, 2008.
17. STOCK-BASED COMPENSATION
The Company has the following two stock option plans under which shares were available for grant at March 31, 2008: 1) the 2004 Long-Term Incentive Compensation Plan, 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.
Option Grants to Employees
As of March 31, 2008, 5,023,743 shares were available for issuance under the Plans. A summary of stock option activity is as follows:
19
Options
Number ofShares
WeightedAverage ExercisePrice
Weighted AverageRemainingContractual Life
Aggregate IntrinsicValue as of March31, 2008
Outstanding at December 31, 2007
2,651,718
14.54
Granted
215,000
14.61
Exercised
(49,125
12.92
Forfeited
(19,500
14.11
Outstanding at March 31, 2008
2,798,093
14.58
7.38
5,537
Vested and Expected to Vest
2,489,428
14.42
7.24
5,190
Ending Exercisable
1,359,207
13.85
6.81
3,370
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 first 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 March 31, 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:
Three Months Ended March 31,
Expected volatility
Dividend yield
6.5
6.0
Risk-free interest rate
2.7
4.6
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 March 31, 2008, is adjusted periodically based on the extent to which actual forfeitures differ, or are expected to differ, from the previous estimates.
The Company recorded $262 and $223, respectively, of compensation expense relating to outstanding options during the three months ended March 31, 2008 and 2007. Exercise of options during the three months ended March 31, 2008 and 2007 resulted in cash receipts of $666 and $838, respectively. At March 31, 2008, there was $1,071 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 1.93 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 compensation expense at March 31, 2008, noted above does not necessarily represent the expen se that will ultimately be realized by the Company in the Statement of Operations.
Common Stock Granted to Employees and Directors
For the three months ended March 31, 2008 and 2007, the Company granted 171,800 and 30,800 shares, respectively of common stock to certain employees, without monetary consideration under the Plans. The Company recorded $538 and $213 of compensation expense related to outstanding shares of common stock granted to employees during the three months ended March 31, 2008 and 2007, respectively.
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, 2007
211,972
17.23
Released
(42,775
16.15
Cancelled
17.96
Unreleased at March 31, 2008
340,137
16.07
18. 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
387,378
385,394
1,661,906
1,668,681
21
Statement of Operations
8,683
7,545
Operating expenses, including depreciation and amortization
11,856
10,725
31,871
25,430
Income (loss) before interest, loss on sale of investments available for sale, minority interests and equity in earnings of real estate ventures
(3,173
(3,180
25,153
20,801
(348
(162
(16,006
(13,234
Minority interests - Operating Partnership and other
(371
(400
Net income (loss)
(3,669
(2,294
10,369
8,764
Depreciation and amortization expense
351
11,230
8,534
Statement of Cash Flows
22
19. 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 March 31, 2008, the total amount of guaranteed mortgage debt relating to these joint ventures was $17,862. These mortgage loans mature December 1, 2008, July 28, 2008 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 March 31, 2008 is $23,108. The Company has recorded no liability in relation to these guarantees as of March 31, 2008, as the fair value of the guarantees are 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.
The Company has been involved in routine litigation arising in the ordinary course of business. As of March 31, 2008, the Company was not involved in any material litigation nor, to its knowledge, was any material litigation threatened against it, or its properties.
20. 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 March 31, 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 March 31, 2008, the Company had no interest and 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.
23
Extra Space Storage Inc.Management’s Discussion and AnalysisAmounts in thousands, except property and per 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, share and per 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.
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. We 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. We have reviewed each major category of assets and liabilities that are measured at fair value and made the necessary disclosures in the notes to our financial statements relating to our investments available for sale and the value of the swap agreement.
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. We 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. We 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 future acquisitions after the effective date.
In December 2007, the FASB issued Statement No. 160, “Noncontrolling 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 is effective for fiscal years beginning on or after December 15, 2008. We do not currently expect the adoption of FAS 160 to have a material impact on our financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivatives Instruments and Hedging Activities”, an amendment of FASB Statement No. 133, “Accounting for Derivative Instruments and Hedging Activities”. SFAS No. 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. SFAS No. 161 requires that objectives for using derivative instruments be disclosed in terms of underlying risk and accounting designation. SFAS No. 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. SFAS No. 161 also encourages but does not require comparative disclosures for earlier periods at initial adoptions. We are currently evaluating whether the adoption of SFAS No. 161 will have an impact on our financial statements.
In December 2007, the Securities and Exchange Commission (“SEC”) staff issued Staff Accounting Bulletin (“SAB”) No. 110, which, effective January 1, 2008, 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 our financial statements.
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 several 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 24 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.
PROPERTIES
As of March 31, 2008, we owned or had ownership interests in 607 operating self-storage properties located in 33 states and Washington, D.C. Of these properties, 260 are wholly-owned and consolidated, two are held in joint ventures and consolidated and 345 are held in joint ventures accounted for using the equity method. In addition, we managed 47 properties for franchisees or third parties bringing the total numbers of properties which we own and/or manage to 654. We receive a management fee equal to approximately 6% of gross revenues to manage the joint venture, third party and franchise sites. As of March 31, 2008, we owned or had ownership interests in approximately 45 million square feet of space and had greater 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 March 31, 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 March 31, 2008 and 2007. The information as of March 31, 2007 is on a pro forma basis as though all the properties owned and/or managed at March 31, 2008 were under our control as of March 31, 2007.
26
Stabilized Property Data Based on Location
Company
Pro forma
Location
Number ofProperties
Number of Units asof March 31,2008(1)
Number of Unitsas of March 31,2007
Net RentableSquare Feet as ofMarch 31, 2008(2)
Net RentableSquare Feet as ofMarch 31, 2007
Square FootOccupancy %March 31, 2008
Square FootOccupancy %March 31, 2007
Wholly-owned properties
Alabama
1
585
597
76,125
76,355
79.6
71.7
Arizona
2,264
2,261
279,893
279,300
89.3
92.9
California
44
36,272
36,308
3,474,873
3,468,228
83.4
81.3
Colorado
3,289
3,329
419,644
418,419
85.6
85.5
Connecticut
1,353
1,357
123,265
123,065
76.3
Florida
28
18,617
18,629
1,953,213
1,951,499
82.1
84.9
Georgia
6,446
6,456
835,486
835,578
86.8
Hawaii
2,873
2,856
150,036
154,426
80.5
80.7
Illinois
3,268
3,260
339,389
342,244
80.3
79.4
Indiana
589
62,250
87.3
84.5
Kansas
503
49,940
89.1
Kentucky
1,592
1,585
194,470
194,351
87.8
88.1
Louisiana
1,409
1,407
148,155
147,490
86.5
93.3
7,444
7,447
795,494
794,631
83.1
81.0
Massachusetts
14,872
14,854
1,575,894
1,585,629
83.0
80.1
Michigan
1,034
1,046
133,346
134,722
88.0
81.2
Missouri
3,156
3,158
375,557
375,452
85.7
Nevada
1,257
1,238
132,365
130,915
86.6
83.2
New Hampshire
1,006
125,909
125,609
New Jersey
18,865
18,835
1,834,418
1,832,338
84.2
82.9
New Mexico
535
534
68,090
67,850
77.3
93.0
New York
7,178
7,247
487,073
487,329
79.2
78.0
Ohio
2,025
2,040
273,392
275,131
82.3
85.1
Oregon
765
763
103,450
103,290
92.3
89.9
Pennsylvania
6,148
6,130
635,950
641,800
84.8
Rhode Island
728
731
75,361
75,241
81.7
South Carolina
1,554
178,719
178,689
91.4
88.7
Tennessee
3,511
3,534
476,212
477,847
85.8
Texas
11,846
11,943
1,338,185
1,343,016
86.2
Utah
1,534
1,532
210,640
210,650
92.7
93.5
Virginia
2,891
2,890
272,699
272,713
82.6
Washington
2,538
2,535
305,815
305,795
85.4
96.7
Total Wholly-Owned Stabilized
244
167,946
168,154
17,505,308
17,521,792
84.0
83.6
Joint-venture properties
1,708
1,702
205,613
205,473
86.9
87.1
6,902
6,907
751,486
751,201
76
54,526
54,604
5,591,916
5,592,062
86.1
1,332
1,335
158,213
158,113
81.8
81.9
5,985
5,980
691,342
689,764
Delaware
71,655
87.4
19,246
19,296
1,940,323
1,940,876
1,889
1,896
246,926
247,126
75.0
3,998
4,032
430,797
433,252
82.8
79.1
3,153
3,141
406,503
405,903
1,216
1,214
163,105
164,200
2,285
2,280
268,553
268,459
10,218
10,219
1,013,143
1,012,798
84.4
82.7
9,258
9,291
1,047,155
1,045,870
80.6
5,952
5,961
784,013
783,612
86.0
952
954
118,195
118,235
87.2
4,642
4,645
620,649
620,678
1,321
1,323
137,554
137,754
15,694
15,712
1,654,843
1,652,868
81.1
83.3
4,689
4,705
537,660
530,904
22,146
22,089
1,718,274
1,715,086
5,018
5,031
748,217
752,042
84.1
1,292
1,290
136,980
137,140
92.0
7,216
7,239
762,894
764,724
85.0
610
611
73,880
73,905
73.5
67.9
11,786
11,848
1,547,978
1,548,633
11,810
11,865
1,533,782
1,520,206
78.9
77.4
520
516
59,500
59,550
92.5
11,284
11,267
1,191,948
1,190,989
551
62,730
Washington, DC
1,536
102,003
101,990
91.0
Total Stabilized Joint-Ventures
334
229,324
229,629
24,777,830
24,757,798
83.5
27
Managed properties
3,910
3,941
488,785
489,735
76.5
75.9
513
56,240
89.6
94.2
1,227
1,225
108,941
108,675
89.5
5,854
5,281
644,938
555,835
3,242
3,135
278,877
258,601
78.4
434
439
61,235
81.6
1,102
1,093
131,707
131,492
90.6
1,576
171,555
87.7
886
130,750
91.3
88.5
2,279
2,311
260,615
260,080
90.0
46,955
98.8
99.4
2,124
2,117
211,437
211,257
76.4
1,255
111,759
77.2
Total Stabilized Managed Properties
24,773
24,152
2,703,794
2,594,169
82.0
82.2
Total Stabilized Properties
615
422,043
421,935
44,986,932
44,873,759
(1) Represents unit count as of March 31, 2008, which may differ from March 31, 2007 unit count due to unit conversions or expansions.
(2) Represents net rentable square feet as of March 31, 2008, which may differ from March 31, 2007 net rentable square feet due to unit conversions or expansions.
The following table sets forth additional information regarding the occupancy of our lease-up properties on a state-by-state basis as of March 31, 2008 and 2007. The information as of March 31, 2007 is on a pro forma basis as though all the properties owned and/or managed at March 31, 2008 were under our control as of March 31, 2007.
Lease-up Property Data Based on Location
586
595
67,375
62.0
2,720
2,066
331,941
262,231
63.2
52.4
683
689
54,840
55,160
75.4
62.4
1,259
1,254
157,338
156,770
73.3
64.4
718
79,250
17.9
0.0
635
79,958
15.1
2,450
2,442
209,704
211,052
58.4
38.2
422
424
46,930
47,060
74.4
65.6
67,045
88.9
91.2
617
64,650
55.2
Total Wholly-Owned Lease-up
10,603
8,600
1,159,031
931,343
61.8
56.1
3,582
3,002
380,701
298,612
50.8
36.3
772
940
113,485
115,425
56.2
9.2
2,493
2,525
264,397
264,832
70.0
54.4
939
957
73,672
73,666
35.9
57,360
56,885
24.7
4.0
1,574
1,578
115,840
116,235
79.5
74.7
500
501
55,645
55,670
44.1
34.7
Total Lease-up Joint-Ventures
10,495
10,138
1,061,100
981,325
58.3
40.6
1,547
646
134,729
59,245
39.6
57.3
978
115,240
115,365
77.7
68.4
545
68,690
68,890
66.1
2,796
2,150
260,919
190,244
47.6
56.4
862
863
78,030
78,195
34.9
7.0
1,129
104,850
15.3
Total Lease-up Managed
7,857
5,285
762,458
511,939
48.3
53.0
Total Lease-up Properties
39
28,955
24,023
2,982,589
2,424,607
57.1
49.2
RESULTS OF OPERATIONS
Comparison of the three months ended March 31, 2008 and 2007
Overview
Results for the three months ended March 31, 2008 include the operations of 607 properties (262 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 months ended March 31, 2007, which included the operations of 571 properties (224 of which were consolidated and 347 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 Ended March31,
$ Change
% Change
10,793
23.3
(131
(2.5
)%
62.3
(66
(34.0
11,931
22.2
Property Rental — The increase in property rental revenue consists of $9,254 associated with acquisitions completed during 2007, $1,122 from rental rate increases at stabilized properties, and $417 from increases in occupancy and rental rates at lease-up properties.
Management and Franchise Fees — The decrease in management fees is due to a decrease in the total number of properties that we now manage, offset by an increase in revenues at our joint venture, franchise, and third-party managed sites related to rental rate and occupancy increases. The decrease in the number of properties managed is primarily due to our acquisition of third party managed properties.
Tenant Insurance —The increase in tenant insurance revenues is due to the successful promotion of the tenant insurance program at our sites during 2007 and the first quarter of 2008. Customer participation increased to approximately 38% at March 31, 2008 compared to approximately 23% at March 31, 2007.
Expenses
The following table sets forth information on expenses for the periods indicated:
3,745
19.4
(86
(34.4
10.2
2,785
31.7
7,572
20.9
29
Property Operations—The increase in property operations expense was due to increases of $3,242 associated with acquisitions of new properties during 2007 and $503 at existing stabilized and lease-up properties primarily from increases in snow removal and property insurance.
Tenant Insurance—The increase in tenant insurance expense is due to the successful promotion of the tenant insurance program at our sites during 2007 and the first quarter of 2008. Customer participation increased to approximately 38% at March 31, 2008 compared to approximately 23% at March 31, 2007.
Unrecovered Development/Acquisition Costs—These costs relate to unsuccessful development and acquisition activities during the periods indicated.
General and Administrative—The increase in general and administrative expenses was primarily due to the increased costs associated with the management of the 42 additional properties that were added through acquisitions and development in 2007. In addition, approximately $200 of the increase related to the immediate vesting of a restricted stock grant.
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.
Other Revenues and Expenses
The following table sets forth information on other revenues and expenses for the periods indicated:
Other revenue and expenses:
(2,958
22.1
(1,023
(70.6
100.0
2.1
(100.0
(126
32.8
Minority interest - other
155
(968.8
Total other expense
(15,280
(11,151
(4,129
37.0
Interest Expense—The increase in interest expense consists of $1,855 associated with the $250,000 of exchangeable senior notes issued on March 27, 2007, and $1,402 associated with new loans obtained on properties acquired in 2007, offset by a decrease in interest on corporate and other debt as a result of decreases in interest rates.
Interest Income—The decrease in interest income was due primarily to the fact that we held more than $250,000 of investments available for sale at March 31, 2007 versus having no investments available for sale at March 31, 2008. The investments available for sale were purchased with cash that was generated primarily by the exchangeable senior notes offering in March 2007.
Interest Income on Note Receivable from Preferred 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 months ended March 31, 2008 is primarily due to increases in property net income from stabilized joint venture properties offset by losses from lease up properties in certain joint ventures.
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
30
units) represents 7.07% and 5.60% of the net income before minority interest for the three months ended March 31, 2008 and 2007, respectively. The increase in the amount allocated to the minority interest in 2008 is due to the addition of the Preferred OP units and the increase in net income.
Minority Interest—Other—Income allocated to the other minority interest represents the losses allocated to partners in consolidated joint ventures on two 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 (dollars are in thousands, except for share data):
Adjustments:
Real estate depreciation
9,760
7,585
Amortization of intangibles
1,278
807
Joint venture real estate depreciation and amortization
1,052
1,062
Distributions paid on Preferred Operating Partnership units
(1,438
Income allocated to Operating Partnership minority interest
Funds from operations
17,862
16,308
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.
31
Percent
Change
2006
Same-store rental revenues
45,804
44,682
2.5
38,909
36,768
5.8
Same-store operating expenses
16,326
15,899
13,704
13,522
1.3
Same-store net operating income
29,478
28,783
2.4
25,205
23,246
8.4
Non same-store rental revenues
11,220
1,549
624.3
7,322
2,407
204.2
Non same-store operating expenses
4,315
332.8
3,192
1,220
161.6
Total rental revenues
39,175
18.0
Total operating expenses
14,742
14.6
Same-store square foot occupancy as of quarter end
84.7
84.6
Properties included in same-store
211
181
The increase in same-store rental revenue for the three months ended March 31, 2008 over the prior year was due to increased rental rates to existing customers and our ability to maintain occupancy. Expenses increased when compared to the prior year due to higher snow removal costs and property insurance.
CASH FLOWS
Cash flows provided by operating activities were $24,199 and $25,662, respectively, for the three months ended March 31, 2008 and 2007. The decrease over 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 $1,980 and $335,649, respectively, for the three months ended March 31, 2008 and 2007. The decrease relates primarily to the change in investments available for sale. For the three months ended March 31, 2008, there were proceeds from the sale of investments available for sale of $21,812 and for the three months ended March 31, 2007, there were proceeds used for the purchase of investments available for sale of $286,360.
Cash used in financing activities was $18,586 for the three months ended March 31, 2008 versus the cash provided by financing activities of $274,297 for the three months ended March 31, 2007. The reduction in cash provided by financing activities over the prior period relates primarily to the issuance of the exchangeable senior notes for $250,000 on March 27, 2007 and the issuance of other notes related to property acquisitions.
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 March 31, 2008, 1,805,611 CCSs and 92,883 CCUs have converted to common stock and OP units, respectively. Based on the performance of the properties as of March 31, 2008, an additional 348,274 CCSs and 17,915 CCUs became eligible for conversion. The board of directors approved the conversion of these CCSs and CCUs on May 1, 2008 as per our charter, and the shares and units were issued on May 5, 2008.
The table below outlines the performance of the properties for the three months ended March 31, 2008 and 2007:
32
CCS/CCU rental revenues
2,886
14.0
2,382
21.2
CCS/CCU operating expenses
1,341
1,298
3.3
1,325
-2.0
CCS/CCU net operating income
1,948
22.7
1,057
50.2
Non CCS/CCU rental revenues
53,735
43,345
24.0
36,793
17.8
Non CCS/CCU operating expenses
19,300
15,598
23.7
13,417
16.3
CCS/CCU square foot occupancy as of quarter end
76.1
73.0
71.3
Properties included in CCS/CCU
The increase in CCS/CCU rental revenues was primarily due to increased rental rates and increased occupancy.
OPERATIONAL SUMMARY
For the three months ended March 31, 2008, we continued our same-store property revenue growth with a revenue increase of 2.5% compared to the same period in 2007. Occupancy at our stabilized properties was fairly consistent on a year-to-year basis, reaching 84.0% as of March 31, 2008 compared to 83.5% as of March 31, 2007.
For the three months ended March 31, 2008, the markets of Chicago, Columbus, Dallas, Detroit, Houston, Nashville and San Francisco/Oakland were the top performers among our stabilized properties. Markets performing below the our portfolio average in revenue growth included Las Vegas, Orlando, Philadelphia, Phoenix and West Palm Beach.
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 property insurance.
OUTLOOK
In the first quarter of 2008, we continued to see a generally positive climate for self-storage in the United States. Rental activity was flat overall when compared with the first quarter of 2007. 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 positive self-storage fundamentals to continue in our core markets. We believe that the ability exists to increase revenues in 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 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.
33
LIQUIDITY AND CAPITAL RESOURCES
As of March 31, 2008, we had $21,010 available in cash and cash equivalents. We intend to use this cash to purchase additional self-storage properties and 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.
On October 19, 2007, we entered into a new $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. There were no amounts outstanding under the Credit Line as of March 31, 2008 or December 31, 2007.
As of March 31, 2008, we had $1,320,992 of debt, resulting in a debt to total capitalization ratio of 53.3%. As of March 31, 2008, the ratio of total fixed rate debt and other instruments to total debt was 90.4% ($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 March 31, 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 March 31, 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.
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
34
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.
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 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 or intent 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 senior exchangeable notes.
CONTRACTUAL OBLIGATIONS
The following table summarizes our contractual obligations as of March 31, 2008:
Payments due by Period:
Less Than
After
1 Year
1-3 Years
4-5 Years
5 Years
Operating leases
60,918
5,365
10,115
7,821
37,617
Notes payable, exchangeable senior notes and notes payable to trusts
Interest
413,696
60,367
93,603
66,969
192,757
Principal
1,320,992
71,540
388,355
83,847
777,250
Total contractual obligations
1,795,606
137,272
492,073
158,637
1,007,624
At March 31, 2008, the weighted-average interest rate for all fixed rate loans was 5.1%, and the weighted-average interest rate for all variable rate loans was 4.0%.
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 March 31, 2008, we had $1,320,992 in total debt, of which $127,128 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 $1,271 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 fixed rate notes payable, exchangeable senior notes and notes payable to trusts at March 31, 2008 was $1,335,050. The carrying value of these fixed rate notes payable, exchangeable senior notes and notes payable to trusts at March 31, 2008 was $1,193,864.
(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 March 31, 2008, 1,805,611 CCSs and 92,883 CCUs had converted to common shares and OP units, respectively. Based on the performance of the properties as of March 31, 2008, an additional 348,274 CCSs and 17,915 CCUs became eligible for conversion. The board of directors approved the conversion of these CCSs and CCUs on May 1, 2008 as per our charter, and the shares and OP units were issued on May 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.
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.
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: May 7, 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)