Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended September 30, 2013

 

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) 365-4600

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

 

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

 

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

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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

 

The number of shares outstanding of the registrant’s common stock, par value $0.01 per share, as of October 31, 2013, was 111,253,494.

 

 

 



Table of Contents

 

EXTRA SPACE STORAGE INC.

TABLE OF CONTENTS

 

STATEMENT ON FORWARD-LOOKING INFORMATION

3

 

 

PART I. FINANCIAL INFORMATION

4

ITEM 1. FINANCIAL STATEMENTS

4

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

10

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

23

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

34

ITEM 4. CONTROLS AND PROCEDURES

35

 

 

PART II. OTHER INFORMATION

35

ITEM 1. LEGAL PROCEEDINGS

35

ITEM 1A. RISK FACTORS

36

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

36

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

36

ITEM 4. MINE SAFETY DISCLOSURES

36

ITEM 5. OTHER INFORMATION

36

ITEM 6. EXHIBITS

36

SIGNATURES

37

 

2



Table of Contents

 

STATEMENT ON FORWARD-LOOKING INFORMATION

 

Certain information presented 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:

 

·                  adverse changes in general economic conditions, the real estate industry and the markets in which we operate;

 

·                  failure to close pending acquisitions on expected terms, or at all;

 

·                  the effect of competition from new and existing self-storage facilities or other storage alternatives, which could cause rents and occupancy rates to decline;

 

·                  difficulties in our ability to evaluate, finance, complete and integrate acquisitions and developments successfully and to lease up those properties, which could adversely affect our profitability;

 

·                  potential liability for uninsured losses and environmental contamination;

 

·                  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 (“REITs”), tenant reinsurance and other aspects of our business, which could adversely affect our results;

 

·                  disruptions in credit and financial markets and resulting difficulties in raising capital or obtaining credit at reasonable rates or at all, which could impede our ability to grow;

 

·                  increased interest rates and operating costs;

 

·                  reductions in asset valuations and related impairment charges;

 

·                  the failure of our joint venture partners to fulfill their obligations to us or their pursuit of actions that are inconsistent with our objectives;

 

·                  the failure to maintain our REIT status for federal income tax purposes;

 

·                  economic uncertainty due to the impact of war or terrorism, which could adversely affect our business plan; and

 

·                  difficulties in our ability to attract and retain qualified personnel and management members.

 

3



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

Extra Space Storage Inc.

Condensed Consolidated Balance Sheets

(amounts in thousands, except share data)

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

(Unaudited)

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

Real estate assets, net

 

$

3,223,672

 

$

2,991,722

 

 

 

 

 

 

 

Investments in unconsolidated real estate ventures

 

100,455

 

106,313

 

Cash and cash equivalents

 

81,699

 

30,785

 

Restricted cash

 

22,803

 

16,976

 

Receivables from related parties and affiliated real estate joint ventures

 

7,928

 

11,078

 

Other assets, net

 

81,682

 

66,603

 

Total assets

 

$

3,518,239

 

$

3,223,477

 

 

 

 

 

 

 

Liabilities, Noncontrolling Interests and Equity:

 

 

 

 

 

Notes payable

 

$

1,402,432

 

$

1,369,690

 

Premium on notes payable

 

2,336

 

3,319

 

Exchangeable senior notes

 

250,000

 

 

Discount on exchangeable senior notes

 

(17,299

)

 

Notes payable to trusts

 

119,590

 

119,590

 

Lines of credit

 

 

85,000

 

Accounts payable and accrued expenses

 

58,248

 

52,299

 

Other liabilities

 

34,052

 

48,248

 

Total liabilities

 

1,849,359

 

1,678,146

 

 

 

 

 

 

 

Commitments and contingencies

 

 

 

 

 

 

 

 

 

 

 

Noncontrolling interest represented by Series B Preferred Operating Partnership units

 

33,713

 

 

 

 

 

 

 

 

Noncontrolling Interests and Equity:

 

 

 

 

 

Extra Space Storage Inc. 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, 111,236,044 and 110,737,205 shares issued and outstanding at September 30, 2013 and December 31, 2012, respectively

 

1,112

 

1,107

 

Paid-in capital

 

1,766,691

 

1,740,037

 

Accumulated other comprehensive income (deficit)

 

3,146

 

(14,273

)

Accumulated deficit

 

(256,640

)

(235,064

)

Total Extra Space Storage Inc. stockholders’ equity

 

1,514,309

 

1,491,807

 

Noncontrolling interest represented by Series A Preferred Operating Partnership units, net of $100,000 note receivable

 

29,880

 

29,918

 

Noncontrolling interests in Operating Partnership

 

90,504

 

22,492

 

Other noncontrolling interests

 

474

 

1,114

 

Total noncontrolling interests and equity

 

1,635,167

 

1,545,331

 

Total liabilities, noncontrolling interests and equity

 

$

3,518,239

 

$

3,223,477

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

4



Table of Contents

 

Extra Space Storage Inc.

Condensed Consolidated Statements of Operations

(amounts in thousands, except share data)

(unaudited)

 

 

 

For the Three Months Ended September 30,

 

For the Nine Months Ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Property rental

 

$

113,881

 

$

94,065

 

$

324,144

 

$

249,193

 

Tenant reinsurance

 

12,294

 

9,495

 

34,625

 

27,060

 

Management fees

 

6,936

 

6,231

 

19,910

 

19,476

 

Total revenues

 

133,111

 

109,791

 

378,679

 

295,729

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Property operations

 

34,376

 

30,115

 

102,275

 

82,723

 

Tenant reinsurance

 

2,873

 

1,379

 

6,985

 

4,651

 

Acquisition related costs

 

2,427

 

2,486

 

3,562

 

3,564

 

General and administrative

 

13,943

 

12,559

 

40,451

 

37,744

 

Depreciation and amortization

 

23,428

 

19,768

 

69,238

 

52,918

 

Total expenses

 

77,047

 

66,307

 

222,511

 

181,600

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

56,064

 

43,484

 

156,168

 

114,129

 

 

 

 

 

 

 

 

 

 

 

Gain on sale of real estate assets

 

 

 

800

 

 

Loss on extinguishment of debt related to portfolio acquisition

 

(9,153

)

 

(9,153

)

 

Interest expense

 

(16,264

)

(18,423

)

(51,992

)

(52,348

)

Non-cash interest expense related to amortization of discount on equity component of exchangeable senior notes

 

(834

)

 

(947

)

(444

)

Interest income

 

202

 

461

 

519

 

1,184

 

Interest income on note receivable from Preferred Operating Partnership unit holder

 

1,213

 

1,213

 

3,638

 

3,638

 

Income before equity in earnings of unconsolidated real estate ventures and income tax expense

 

31,228

 

26,735

 

99,033

 

66,159

 

 

 

 

 

 

 

 

 

 

 

Equity in earnings of unconsolidated real estate ventures

 

3,405

 

2,854

 

8,942

 

7,848

 

Equity in earnings of unconsolidated real estate ventures - gain on sale of real estate assets and purchase of joint venture partners’ interests

 

 

13,620

 

2,556

 

19,049

 

Income tax expense

 

(2,281

)

(1,656

)

(7,147

)

(4,240

)

Net income

 

32,352

 

41,553

 

103,384

 

88,816

 

Net income allocated to Preferred Operating Partnership noncontrolling interests

 

(2,033

)

(1,805

)

(5,495

)

(5,108

)

Net income allocated to Operating Partnership and other noncontrolling interests

 

(1,074

)

(1,142

)

(2,753

)

(2,475

)

Net income attributable to common stockholders

 

$

29,245

 

$

38,606

 

$

95,136

 

$

81,233

 

 

 

 

 

 

 

 

 

 

 

Net income per common share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.26

 

$

0.37

 

$

0.86

 

$

0.81

 

Diluted

 

$

0.26

 

$

0.37

 

$

0.84

 

$

0.80

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares

 

 

 

 

 

 

 

 

 

Basic

 

111,231,452

 

104,252,227

 

111,060,997

 

100,429,840

 

Diluted

 

117,604,515

 

108,755,316

 

117,483,010

 

104,981,176

 

 

 

 

 

 

 

 

 

 

 

Cash dividends paid per common share

 

$

0.40

 

$

0.20

 

$

1.05

 

$

0.60

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

5



Table of Contents

 

Extra Space Storage Inc.

Condensed Consolidated Statements of Comprehensive Income

(amounts in thousands)

(unaudited)

 

 

 

For the Three Months Ended September 30,

 

For the Nine Months Ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

32,352

 

$

41,553

 

$

103,384

 

$

88,816

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Change in fair value of interest rate swaps

 

(2,073

)

(3,564

)

17,967

 

(7,296

)

Total comprehensive income

 

30,279

 

37,989

 

121,351

 

81,520

 

Less: comprehensive income attributable to noncontrolling interests

 

2,996

 

2,814

 

8,796

 

7,307

 

Comprehensive income attributable to common stockholders

 

$

27,283

 

$

35,175

 

$

112,555

 

$

74,213

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

6



Table of Contents

 

Extra Space Storage Inc.

Condensed Consolidated Statement of Equity

(amounts in thousands, except share data)

(unaudited)

 

 

 

Noncontrolling Interests

 

Extra Space Storage Inc. Stockholders’ Equity

 

 

 

 

 

Series B

 

 

Series A

 

 

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

Preferred

 

 

Preferred

 

 

 

 

 

 

 

 

 

 

 

Other

 

 

 

 

 

 

 

Operating

 

 

Operating

 

Operating

 

 

 

 

 

 

 

Paid-in

 

Comprehensive

 

Accumulated

 

Total

 

 

 

Partnership

 

 

Partnership

 

Partnership

 

Other

 

Shares

 

Par Value

 

Capital

 

Income (Deficit)

 

Deficit

 

Equity

 

Balances at December 31, 2012

 

$

 

 

$

29,918

 

$

22,492

 

$

1,114

 

110,737,205

 

$

1,107

 

$

1,740,037

 

$

(14,273

)

$

(235,064

)

$

1,545,331

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock upon the exercise of options

 

 

 

 

 

 

387,393

 

4

 

5,872

 

 

 

5,876

 

Restricted stock grants issued

 

 

 

 

 

 

132,802

 

1

 

 

 

 

1

 

Restricted stock grants cancelled

 

 

 

 

 

 

(21,356

)

 

 

 

 

 

Compensation expense related to stock-based awards

 

 

 

 

 

 

 

 

3,654

 

 

 

3,654

 

Purchase of additional equity interests in existing consolidated joint ventures

 

 

 

 

 

(635

)

 

 

(515

)

 

 

(1,150

)

Issuance of exchangeable senior notes - equity component

 

 

 

 

 

 

 

 

14,496

 

 

 

14,496

 

Issuance of Operating Partnership units in conjuction with portfolio acquisition

 

33,568

 

 

 

68,471

 

 

 

 

 

 

 

68,471

 

Redemption of Operating Partnership units for cash

 

 

 

 

(41

)

 

 

 

 

 

 

(41

)

Net income

 

335

 

 

5,160

 

2,715

 

38

 

 

 

 

 

95,136

 

103,049

 

Other comprehensive income

 

(22

)

 

153

 

417

 

 

 

 

 

17,419

 

 

17,989

 

Tax effect from vesting of restricted stock grants and stock option exercises

 

 

 

 

 

 

 

 

3,147

 

 

 

3,147

 

Distributions to Operating Partnership units held by noncontrolling interests

 

(168

)

 

(5,351

)

(3,550

)

 

 

 

 

 

 

(8,901

)

Distributions to other noncontrolling interests

 

 

 

 

 

(43

)

 

 

 

 

 

(43

)

Dividends paid on common stock at $1.05 per share

 

 

 

 

 

 

 

 

 

 

(116,712

)

(116,712

)

Balances at September 30, 2013

 

$

33,713

 

 

$

29,880

 

$

90,504

 

$

474

 

111,236,044

 

$

1,112

 

$

1,766,691

 

$

3,146

 

$

(256,640

)

$

1,635,167

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

7



Table of Contents

 

Extra Space Storage Inc.

Condensed Consolidated Statements of Cash Flows

(amounts in thousands)

(unaudited)

 

 

 

For the Nine Months Ended September 30,

 

 

 

2013

 

2012

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

103,384

 

$

88,816

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

69,238

 

52,918

 

Amortization of deferred financing costs

 

4,198

 

5,016

 

Loss on extinguishment of debt related to portfolio acquisition

 

9,153

 

 

Non-cash interest expense related to amortization of discount on exchangeable senior notes

 

947

 

444

 

Non-cash interest expense related to amortization of premium on notes payable

 

(983

)

(951

)

Compensation expense related to stock-based awards

 

3,654

 

3,318

 

Gain on purchase of joint venture partners’ interests

 

(2,556

)

(13,499

)

Distributions from unconsolidated real estate ventures in excess of earnings

 

3,538

 

1,642

 

Changes in operating assets and liabilities:

 

 

 

 

 

Receivables from related parties and affiliated real estate joint ventures

 

891

 

7,587

 

Other assets, net

 

(1,303

)

4,866

 

Accounts payable and accrued expenses

 

5,949

 

4,530

 

Other liabilities

 

2,474

 

(1,726

)

Net cash provided by operating activities

 

198,584

 

152,961

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Acquisition, development and redevelopment of real estate assets

 

(86,890

)

(368,753

)

Proceeds from sale of real estate assets

 

889

 

 

Investments in unconsolidated real estate ventures

 

(1,126

)

(1,053

)

Return of investment in unconsolidated real estate ventures

 

 

1,848

 

Change in restricted cash

 

(5,827

)

2,384

 

Issuance of notes receivable

 

(5,000

)

(7,875

)

Purchase of equipment and fixtures

 

(2,349

)

(1,620

)

Net cash used in investing activities

 

(100,303

)

(375,069

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Proceeds from the sale of common stock, net of offering costs

 

 

226,692

 

Net proceeds from issuance of exchangeable senior notes

 

246,250

 

 

Repurchase of exchangeable senior notes

 

 

(87,663

)

Proceeds from notes payable and lines of credit

 

364,855

 

640,655

 

Principal payments on notes payable and lines of credit, including defeasance

 

(532,348

)

(473,349

)

Deferred financing costs

 

(6,135

)

(8,427

)

Redemption of Operating Partnership units held by noncontrolling interest

 

(41

)

(155

)

Net proceeds from exercise of stock options

 

5,876

 

8,931

 

Dividends paid on common stock

 

(116,712

)

(60,693

)

Distributions to noncontrolling interests

 

(9,112

)

(6,759

)

Net cash provided by (used in) financing activities

 

(47,367

)

239,232

 

Net increase in cash and cash equivalents

 

50,914

 

17,124

 

Cash and cash equivalents, beginning of the period

 

30,785

 

26,484

 

Cash and cash equivalents, end of the period

 

$

81,699

 

$

43,608

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

8



Table of Contents

 

Extra Space Storage Inc.

Condensed Consolidated Statements of Cash Flows

(amounts in thousands)

(unaudited)

 

 

 

For the Nine Months Ended September 30,

 

 

 

2013

 

2012

 

Supplemental schedule of cash flow information

 

 

 

 

 

Interest paid

 

$

46,360

 

$

47,816

 

Income taxes paid

 

1,626

 

473

 

 

 

 

 

 

 

Supplemental schedule of noncash investing and financing activities:

 

 

 

 

 

Tax effect from vesting of restricted stock grants and stock option exercises:

 

 

 

 

 

Other assets

 

$

3,147

 

$

3,099

 

Paid-in capital

 

(3,147

)

(3,099

)

Acquisitions of real estate assets

 

 

 

 

 

Real estate assets, net

 

$

210,372

 

$

148,021

 

Notes payable assumed

 

(7,122

)

(147,592

)

Notes payable assumed and immediately defeased

 

(98,960

)

 

Value of Operating Partnership units issued

 

(102,039

)

(429

)

Receivables from related parties and affiliated real estate joint ventures

 

(2,251

)

 

Receivable from sale of interest in real estate ventures

 

 

 

 

 

Other assets

 

$

 

$

3,349

 

Investments in unconsolidated real estate ventures

 

$

 

 

$

 

(3,349

)

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

9



Table of Contents

 

EXTRA SPACE STORAGE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

Amounts in thousands, except property and share data

 

1.              ORGANIZATION

 

Extra Space Storage Inc. (the “Company”) is a fully-integrated, self-administered and self-managed real estate investment trust (“REIT”), formed as a Maryland corporation on April 30, 2004, to own, operate, manage, acquire, develop and redevelop professionally managed 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.  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 wholly-owned facilities or by acquiring an equity interest in real estate entities.  At September 30, 2013, the Company had direct and indirect equity interests in 754 operating storage facilities.  In addition, the Company managed 253 properties for third parties, bringing the total number of operating properties which it owns and/or manages to 1,007.  These properties are located in 35 states, Washington, D.C. and Puerto Rico.

 

The Company operates in three distinct segments: (1) rental operations; (2) tenant reinsurance; and (3) property management, acquisition and development. The rental operations activities include rental operations of self-storage facilities in which we have an ownership interest. No single tenant accounts for more than 5% of rental income.  Tenant reinsurance activities include the reinsurance of risks relating to the loss of goods stored by tenants in the Company’s self-storage facilities. The Company’s property management, acquisition and development activities include managing, acquiring, developing and selling self-storage facilities.

 

2.              BASIS OF PRESENTATION

 

The accompanying unaudited condensed consolidated financial statements of the Company are presented on the accrual basis of accounting in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information, and in accordance with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they may not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (including normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 2013, are not necessarily indicative of results that may be expected for the year ending December 31, 2013. The condensed consolidated balance sheet as of December 31, 2012 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, 2012, as filed with the Securities and Exchange Commission.

 

Certain amounts in the 2012 financial statements and supporting note disclosures have been reclassified to conform to the current period presentation.  Such reclassifications did not impact previously reported net income or accumulated deficit.

 

Recently Issued Accounting Standards

 

In February 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2013-02 “Comprehensive Income — Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income,” which supersedes and replaces the presentation requirements for reclassifications out of accumulated other comprehensive income in ASUs 2011-05 and 2011-12. The amendment requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under GAAP. For other amounts that are not required under GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under GAAP that provide additional detail about those amounts. ASU 2013-02 was effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. The Company adopted the amended standards beginning January 1, 2013 and presents accumulated other comprehensive income in accordance with the requirements of the standard.

 

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3.              FAIR VALUE DISCLOSURES

 

Derivative Financial Instruments

 

Currently, the Company uses interest rate swaps to manage its interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques, including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs, including interest rate curves. The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash payments and the discounted expected variable cash receipts. The variable cash receipts are based on an expectation of future interest rates (forward curves) derived from observable market interest rate forward curves.

 

The Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts, and guarantees. In conjunction with the FASB’s fair value measurement guidance, the Company made an accounting policy election to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.

 

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by the Company and its counterparties. However, as of September 30, 2013, the Company had assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and determined that the credit valuation adjustments were not significant to the overall valuation of its derivatives. As a result, the Company determined that its derivative valuations in their entirety were classified in Level 2 of the fair value hierarchy.

 

The table below presents the Company’s assets and liabilities measured at fair value on a recurring basis as of September 30, 2013, aggregated by the level in the fair value hierarchy within which those measurements fall.

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

Description

 

September 30, 2013

 

Quoted Prices in Active
Markets for Identical
Assets (Level 1)

 

Significant Other
Observable Inputs
(Level 2)

 

Significant
Unobservable Inputs
(Level 3)

 

Other assets - Cash Flow Hedge Swap Agreements

 

$

7,530

 

$

 

$

7,530

 

$

 

Other liabilities - Cash Flow Hedge Swap Agreements

 

$

(4,953

)

$

 

$

(4,953

)

$

 

 

There were no transfers of assets and liabilities between Level 1 and Level 2 during the nine months ended September 30, 2013.  The Company did not have any significant assets or liabilities that are re-measured on a recurring basis using significant unobservable inputs (Level 3) for the nine months ended September 30, 2013.

 

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.  The Company reviews each self-storage facility at least annually to determine if any such events or circumstances have occurred or exist. The Company focuses on facilities where occupancy and/or rental income have decreased by a significant amount.  For these facilities, the Company determines whether the decrease is temporary or permanent, and whether the facility will likely recover the lost occupancy and/or revenue in the short term.  In addition, the Company carefully reviews facilities in the lease-up stage and compares actual operating results to original projections.

 

When the Company determines that an event that may indicate impairment has occurred, the Company compares the carrying value of the related 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 assets.  The impairment loss recognized equals the excess of net carrying value over the related fair value of the assets.

 

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When real estate assets are identified by management 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 generally presented as discontinued operations for all periods presented.

 

The Company assesses whether there are any indicators that the value of its investments in unconsolidated real estate ventures may be impaired annually and when events or circumstances indicate there may be impairment.  An investment is impaired if management’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.

 

In connection with the Company’s acquisition of self-storage facilities, the purchase price is allocated to the tangible and intangible assets and liabilities acquired based on their fair values, which are estimated using significant unobservable inputs. The value of the tangible assets, consisting of land and buildings, is determined as if vacant. Intangible assets, which represent the value of existing tenant relationships, are recorded at their fair values based on the avoided cost to replace the current leases. The Company measures the value of tenant relationships based on the rent lost due to the amount of time required to replace existing customers, which is based on the Company’s historical experience with turnover in its facilities. Debt assumed as part of an acquisition is recorded at fair value based on current interest rates compared to contractual rates. Acquisition-related transaction costs are expensed as incurred.

 

Fair Value of Financial Instruments

 

The carrying values of cash and cash equivalents, restricted cash, receivables, other financial instruments included in other assets, accounts payable and accrued expenses, variable-rate notes payable, lines of credit and other liabilities reflected in the condensed consolidated balance sheets at September 30, 2013 and December 31, 2012 approximate fair value.

 

The fair value of the Company’s note receivable from Preferred Operating Partnership unit holder was based on the discounted estimated future cash flows of the note (categorized within Level 3 of the fair value hierarchy); the discount rate used approximated the current market rate for loans with similar maturities and credit quality.  The fair values of the Company’s fixed-rate notes payable and notes payable to trusts were estimated using the discounted estimated future cash payments to be made on such debt (categorized within Level 3 of the fair value hierarchy); the discount rates used approximated current market rates for loans, or groups of loans, with similar maturities and credit quality.  The fair value of the Company’s exchangeable senior notes was estimated using an average market price obtained from a third party.

 

The fair values of the Company’s fixed-rate assets and liabilities were as follows for the periods indicated:

 

 

 

September 30, 2013

 

December 31, 2012

 

 

 

Fair

 

Carrying

 

Fair

 

Carrying

 

 

 

Value

 

Value

 

Value

 

Value

 

Note receivable from Preferred Operating Partnership unit holder

 

$

104,299

 

$

100,000

 

$

108,138

 

$

100,000

 

Fixed rate notes payable and notes payable to trusts

 

$

1,272,278

 

$

1,269,205

 

$

1,342,957

 

$

1,275,605

 

Exchangeable senior notes

 

$

253,500

 

$

250,000

 

$

 

$

 

 

4.              NET INCOME PER COMMON SHARE

 

Basic net income per common share is computed by dividing net income by the weighted average common shares outstanding, including unvested share-based payment awards that contain a non-forfeitable right to dividends or dividend equivalents.  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 weighted average number of basic shares and 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 as if-converted method. Potential common shares are securities (such as options, convertible debt, exchangeable Series A Participating Redeemable Preferred Units (“Series A Units”) and Series B Redeemable Preferred Units (“Series B Units”) (together, “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

 

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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 (those that reduce earnings per share) are included.

 

The Operating Partnership had $250,000 of its 2.375% Exchangeable Senior Notes due 2033 (the “Notes”) issued and outstanding as of September 30, 2013.  The Notes could potentially have a dilutive effect on the Company’s earnings per share calculations.  The Notes are exchangeable by holders into shares of the Company’s common stock under certain circumstances per the terms of the indenture governing the Notes.  The exchange price of the Notes was $55.69 per share as of September 30, 2013, and could change over time as described in the indenture.  The Company has irrevocably agreed to pay only cash for the accreted principal amount of the Notes relative to its exchange obligations, but retained the right to satisfy the exchange obligation in excess of the accreted principal amount in cash and/or common stock.  Though the Company has retained that right, Accounting Standards Codification (“ASC”) 260, “Earnings per Share,” requires an assumption that shares would be used to pay the exchange obligation 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.  For the three and nine months ended September 30, 2013 no shares related to the Notes were included in the computation for diluted earnings per share as the per share price of the Company’s common stock during this period did not exceed the exchange price.

 

For the purposes of computing the diluted impact on earnings per share of the potential conversion of Series A Units into common shares, where the Company has the option to redeem in cash or shares 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 Series A 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 ASC 260-10-45-46.

 

For the purposes of computing the diluted impact on earnings per share of the potential conversion of Series B Units into common shares, where the Company has the option to redeem in cash or shares and where the Company has stated the intent and ability to settle the redemption in shares, the Company divided the total value of the Series B Units outstanding at September 30, 2013, or $33,568, by the closing price of $45.75 per share at September 30, 2013.  Assuming full conversion to common shares as of September 30, 2013, 733,731 shares would have been issued to holders of the Series B units.

 

For the three months ended September 30, 2013 and 2012, options to purchase 51,036 and 15,223 shares of common stock, respectively, and for the nine months ended September 30, 2013 and 2012, options to purchase 43,273 and 54,959 shares of common stock, respectively, were excluded from the computation of earnings per share as their effect would have been anti-dilutive.  All restricted stock grants have been included in basic and diluted shares outstanding because such shares earn a non-forfeitable dividend and carry voting rights.

 

The computation of net income per common share was as follows for the periods indicated:

 

 

 

For the Three Months Ended September 30,

 

For the Nine Months Ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Net income attributable to common stockholders

 

$

29,245

 

$

38,606

 

$

95,136

 

$

81,233

 

Add: Income allocated to noncontrolling interest - Preferred Operating Partnership and Operating Partnership

 

3,092

 

2,938

 

8,210

 

7,563

 

Subtract: Fixed component of income allocated to noncontrolling interest - Preferred Operating Partnership

 

(1,438

)

(1,438

)

(4,313

)

(4,313

)

Net income for diluted computations

 

$

30,899

 

$

40,106

 

$

99,033

 

$

84,483

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

Average number of common shares outstanding - basic

 

111,231,452

 

104,252,227

 

111,060,997

 

100,429,840

 

Operating Partnership units

 

4,346,618

 

3,060,467

 

4,346,618

 

3,060,467

 

Series A Preferred Operating Partnership units

 

989,980

 

989,980

 

989,980

 

989,980

 

Series B Preferred Operating Partnership units

 

733,731

 

 

733,731

 

 

Shares related to dilutive and cancelled stock options

 

302,734

 

452,642

 

351,684

 

500,889

 

Average number of common shares outstanding - diluted

 

117,604,515

 

108,755,316

 

117,483,010

 

104,981,176

 

 

 

 

 

 

 

 

 

 

 

Net income per common share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.26

 

$

0.37

 

$

0.86

 

$

0.81

 

Diluted

 

$

0.26

 

$

0.37

 

$

0.84

 

$

0.80

 

 

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5.              PROPERTY ACQUISITIONS AND DISPOSITIONS

 

The following table summarizes the Company’s acquisitions of operating properties for the nine months ended September 30, 2013, and does not include purchases of land, purchases of additional equity interests in existing consolidated joint ventures or improvements made to existing assets:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Consideration Paid

 

Acquisition Date Fair Value

 

 

 

Property
Location

 

Number of
Properties

 

Date of
Acquisition

 

Total

 

Cash Paid
(1)

 

Loans
Assumed
(1)

 

Non-cash
gain

 

Notes
Issued
to/from
Seller

 

Previous
equity
interest

 

Net
Liabilities/
(Assets)
Assumed

 

Value of
OP Units
Issued

 

Number of
OP Units
Issued

 

Land

 

Building

 

Intangible

 

Closing
costs -
expensed

 

Notes

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Maryland

 

1

 

2/13/2013

 

$

12,321

 

$

8,029

 

$

 

$

2,215

 

$

 

$

2,273

 

$

(196

)

$

 

 

$

1,266

 

$

10,789

 

$

260

 

$

6

 

(2)

 

Illinois

 

1

 

2/13/2013

 

11,083

 

7,592

 

 

341

 

2,251

 

1,173

 

(274

)

 

 

1,318

 

9,485

 

190

 

90

 

(2)

 

Hawaii

 

2

 

5/3/2013

 

27,560

 

27,648

 

 

 

 

 

(88

)

 

 

5,991

 

20,976

 

438

 

155

 

 

 

Texas

 

1

 

5/8/2013

 

7,104

 

7,057

 

 

 

 

 

47

 

 

 

1,374

 

5,636

 

86

 

8

 

 

 

Maryland

 

1

 

6/10/2013

 

13,688

 

500

 

7,122

 

 

 

 

(64

)

6,130

 

143,860

 

2,160

 

11,340

 

 

188

 

 

 

Arizona

 

2

 

7/25/2013

 

9,313

 

9,183

 

 

 

 

 

130

 

 

 

2,001

 

7,110

 

192

 

10

 

 

 

California

 

19

 

8/29/2013

 

186,427

 

96,085

 

 

 

 

 

 

 

519

 

89,823

 

2,613,728

 

100,446

 

81,830

 

2,997

 

1,154

 

 

 

California

 

1

 

9/26/2013

 

10,928

 

4,791

 

 

 

 

 

51

 

6,086

 

177,107

 

3,138

 

7,429

 

181

 

180

 

 

 

2013 Totals

 

28

 

 

 

$

278,424

 

$

160,885

 

$

7,122

 

$

2,556

 

$

2,251

 

$

3,446

 

$

125

 

$

102,039

 

2,934,695

 

$

117,694

 

$

154,595

 

$

4,344

 

$

1,791

 

 

 

 


(1) Loans assumed and immediately defeased at closing are excluded from loans assumed and included in cash paid.

(2) Acquired from an affiliated joint venture

 

On August 29, 2013, the Operating Partnership completed the purchase of 19 out of 20 self-storage facilities affiliated with All Aboard Mini Storage, all of which are located in California.  On September 26, 2013, the Operating Partnership completed the purchase of the remaining facility.  These properties were acquired in exchange for $100,876 in cash (including $98,960 of debt assumed and immediately defeased at closing), 1,342,727 Series B Units valued at $33,568 and 1,448,108 common OP Units valued at $62,341.  In accordance with ASC 805, “Business Combinations,” the assumed debt was recorded at its fair value as of the closing date.  The difference between the price paid to extinguish the debt, which included $9,153 of defeasance costs, and the carrying value of the debt was recorded as loss on extinguishment of debt related to portfolio acquisition on the Company’s Condensed Consolidated Statement of Operations.

 

In June 2013, the Company recorded a gain of $800 due to the condemnation of a portion of land at one self-storage property in California that resulted from eminent domain.

 

On May 16, 2013, the Company sold a property located in New York for $950.  No gain or loss was recorded as a result of the sale.

 

6.              VARIABLE INTERESTS

 

The Company has an interest in one unconsolidated joint venture with an unrelated third party which is a variable interest entity (“VIE”). The Company holds an 18% equity interest and a 50% profit interest in the VIE joint venture (“VIE JV”), and has 50% of the voting rights in the VIE JV. Qualification as a VIE was based on the determination that the equity investment at risk for this joint venture was not sufficient based on a qualitative and quantitative analysis performed by the Company. The Company performed a qualitative analysis for this joint venture to determine which party was the primary beneficiary. The Company determined that, since the powers to direct the activities most significant to the economic performance of this entity are shared equally by the Company and its joint venture partner, there is no primary beneficiary. Accordingly, this interest is recorded using the equity method.

 

The VIE JV owns a single self-storage property. This joint venture is financed through a combination of (1) equity contributions from the Company and its joint venture partner, (2) a primary mortgage note payable and (3) amounts payable to the Company. The amounts payable to the Company consist of expenses paid on behalf of the joint venture by the Company as manager and a secondary mortgage note payable to the Company. The Company performs management services for the VIE JV in exchange for a management fee of approximately 6% of cash collected by the property. Except as disclosed, the Company has not provided financial or other support during the periods presented to the VIE JV that it was not previously contractually obligated to provide.

 

The Company guarantees the primary mortgage note payable for the VIE JV. The Company’s maximum exposure to loss for this joint venture as of September 30, 2013 is the total of the guaranteed loan balance, amounts payable to the Company and the Company’s investment balance in the joint venture. The Company believes that the risk of incurring a material loss as a result of having to perform on the loan guarantee is unlikely and, therefore, no liability has been recorded related to this guarantee. Additionally, repossessing and/or selling the self-storage facility and land that collateralize the loan could provide funds sufficient to reimburse the Company.

 

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The following table compares the Company’s liability balance to the VIE JV and the maximum exposure to loss as of September 30, 2013:

 

 

 

 

 

 

 

Balance of

 

Amounts

 

Maximum

 

 

 

 

 

Liability

 

Investment

 

Guaranteed

 

Payable to

 

Exposure

 

 

 

 

 

Balance

 

Balance

 

Loan

 

the Company

 

to Loss

 

Difference

 

Extra Space of Sacramento One LLC

 

$

 

$

(1,077

)

$

4,307

 

$

6,033

 

$

9,263

 

$

(9,263

)

 

The Operating Partnership has three wholly-owned unconsolidated subsidiaries (“Trust,” “Trust II” and “Trust III,” together, the “Trusts”) that have issued trust preferred securities to third parties and common securities to the Operating Partnership.  The proceeds from the sale of the preferred and common securities were loaned in the form of notes to the Operating Partnership.  The Trusts are VIEs because the holders of the equity investment at risk (the trust preferred securities) do not have the power to direct the activities of the entities that most significantly affect the entities’ economic performance because of their lack of voting or similar rights.  Because the Operating Partnership’s investment in the Trusts’ common securities was financed directly by the Trusts as a result of its loan of the proceeds to the Operating Partnership, that investment is not considered an equity investment at risk.  The Operating Partnership’s investment in the Trusts is not a variable interest because equity interests are variable interests only to the extent that the investment is considered to be at risk, and therefore the Operating Partnership cannot be the primary beneficiary of the Trusts.  Since the Company is not the primary beneficiary of the Trusts, they have not been consolidated.  A debt obligation has been recorded in the form of notes for the proceeds as discussed above, which are owed to the Trusts.  The Company has also included its investment in the Trusts’ common securities in other assets on the condensed consolidated balance sheets.

 

The Company has not provided financing or other support during the periods presented to the Trusts that it was not previously contractually obligated to provide.  The Company’s maximum exposure to loss as a result of its involvement with the Trusts is equal to the total amount of the notes discussed above less the amounts of the Company’s investments in the Trusts’ common securities.  The net amount is the notes payable that the Trusts owe to third parties for their investments in the Trusts’ preferred securities.

 

The following is a tabular comparison of the liabilities the Company has recorded as a result of its involvement with the Trusts to the maximum exposure to loss the Company is subject to as a result of such involvement as of September 30, 2013:

 

 

 

Notes payable

 

Investment

 

Maximum

 

 

 

 

 

to Trusts

 

Balance

 

exposure to loss

 

Difference

 

Trust

 

$

36,083

 

$

1,083

 

$

35,000

 

$

 

Trust II

 

42,269

 

1,269

 

41,000

 

 

Trust III

 

41,238

 

1,238

 

40,000

 

 

 

 

$

119,590

 

$

3,590

 

$

116,000

 

$

 

 

The Company had no consolidated VIEs during the nine months ended September 30, 2013 or 2012.

 

7.              DERIVATIVES

 

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity, and credit risk primarily by managing the amount, sources and duration of its debt funding and by using derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposure that arises from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s investments and borrowings.

 

Cash Flow Hedges of Interest Rate Risk

 

The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable

 

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amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

 

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings.  A portion of these changes is excluded from accumulated other comprehensive income as it is allocated to noncontrolling interests.  During the nine months ended September 30, 2013 and 2012, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt.

 

The following table summarizes the terms of the Company’s 21 derivative financial instruments as of September 30, 2013:

 

Hedge Product

 

Current Notional
Amounts

 

Strike

 

Effective Dates

 

Maturity Dates

 

Swap Agreements

 

$4,873 - $97,211

 

2.79% - 6.32%

 

7/1/2009 - 7/25/2013

 

7/1/2014 - 4/1/2021

 

 

Fair Values of Derivative Instruments

 

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the condensed consolidated balance sheets:

 

 

 

Asset (Liability) Derivatives

 

 

 

September 30, 2013

 

December 31, 2012

 

Derivatives Designated as

 

Balance Sheet

 

Fair

 

Balance Sheet

 

Fair

 

Hedging Instruments:

 

Location

 

Value

 

Location

 

Value

 

Swap Agreements

 

Other assets

 

$

7,530

 

Other assets

 

$

 

Swap Agreements

 

Other liabilities

 

$

(4,953

)

Other liabilities

 

$

(15,228

)

 

Effect of Derivative Instruments

 

The tables below present the effect of the Company’s derivative financial instruments on the condensed consolidated statements of operations for the periods presented. No tax effect has been presented as the derivative instruments are held by the REIT:

 

 

 

Classification of

 

For the Three Months Ended September 30,

 

For the Nine Months Ended September 30,

 

Type

 

Income (Expense)

 

2013

 

2012

 

2013

 

2012

 

Swap Agreements

 

Interest expense

 

$

(2,307

)

$

(1,876

)

$

(6,589

)

$

(4,429

)

 

 

 

Gain (loss)
recognized in OCI

 

Location of amounts

 

Gain (loss) reclassified
from OCI

 

Type

 

September 30, 2013

 

reclassified from OCI
into income

 

For the Nine Months
Ended September 30, 2013

 

Swap Agreements

 

$

10,837

 

Interest expense

 

$

(6,589

)

 

Credit-risk-related Contingent Features

 

The Company has agreements with some of its derivative counterparties that contain provisions pursuant to which, the Company could be declared in default of its derivative obligations if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender.

 

The Company also has an agreement with some of its derivative counterparties that incorporates the loan covenant provisions of the Company’s indebtedness with a lender affiliate of the derivative counterparty. Failure to comply with the loan covenant provisions would result in the Company being in default on any derivative instrument obligations covered by the agreement.

 

As of September 30, 2013, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements, was $5,162. As of September 30, 2013, the Company

 

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had not posted any collateral related to these agreements. If the Company had breached any of these provisions as of September 30, 2013, it could have been required to settle its obligations under the agreements at their termination value of $5,162.

 

8.              EXCHANGEABLE SENIOR NOTES

 

On June 21, 2013, the Operating Partnership issued $250,000 of its 2.375% Exchangeable Senior Notes due 2033 at a 1.5% discount, or $3,750.  Costs incurred to issue the Notes were approximately $1,672.  These costs are being amortized as an adjustment to interest expense over five years, which represents the estimated term based on the first available redemption date, and are included in other assets in the condensed consolidated balance sheet.  The Notes are general unsecured senior obligations of the Operating Partnership and are fully guaranteed by the Company.  Interest is payable on January 1 and July 1 of each year beginning January 1, 2014, until the maturity date of July 1, 2033.  The Notes bear interest at 2.375% per annum and contain an exchange settlement feature, which provides that the Notes may, under certain circumstances, be exchangeable for cash (for the principal amount of the Notes) and, with respect to any excess exchange value, for cash, shares of the Company’s common stock or a combination of cash and shares of the Company’s common stock at the Company’s option.  The initial exchange rate of the Notes is approximately 17.96 shares of the Company’s common stock per $1,000 principal amount of the Notes.

 

The Operating Partnership may redeem the Notes at any time to preserve the Company’s status as a REIT.  In addition, on or after July 5, 2018, 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 the 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 July 1 of the years 2018, 2023, and 2028, and upon the occurrence of certain designated events, 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.

 

GAAP requires entities with convertible debt instruments that may be settled entirely or partially in cash upon conversion to separately account for the liability and equity components of the instrument in a manner that reflects the issuer’s economic interest cost.  The Company therefore accounts for the liability and equity components of the Notes separately.  The equity component is included in paid-in capital in stockholders’ equity in the condensed consolidated balance sheet, and the value of the equity component is treated as original issue discount for purposes of accounting for the debt component.  The discount is being amortized as interest expense over the remaining period of the debt through its first redemption date, July 1, 2018. The effective interest rate on the liability component is 4.0%.

 

Information about the carrying amount of the equity component, the principal amount of the liability component, its unamortized discount and its net carrying amount were as follows for the periods indicated:

 

 

 

September 30, 2013

 

December 31, 2012

 

Carrying amount of equity component

 

$

14,496

 

$

 

 

 

 

 

 

 

Principal amount of liability component

 

$

250,000

 

$

 

Unamortized discount - equity component

 

(13,720

)

 

Unamortized cash discount

 

(3,579

)

 

Net carrying amount of liability component

 

$

232,701

 

$

 

 

$87,663 of the Operating Partnership’s 3.625% Exchangeable Senior Notes due 2027 (“the 2007 Notes”) were issued and outstanding prior to April 2012, when all of the outstanding 2007 Notes were surrendered for exchange.

 

The amount of interest cost recognized relating to the contractual interest rate and the amortization of the discount on the liability component of the Notes and the 2007 Notes was as follows for the periods indicated:

 

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For the Nine Months Ended September 30,

 

 

 

2013

 

2012

 

Contractual interest

 

$

1,632

 

$

794

 

Amortization of discount on equity component

 

834

 

444

 

Total interest expense recognized

 

$

2,466

 

$

1,238

 

 

9.              NONCONTROLLING INTEREST REPRESENTED BY PREFERRED OPERATING PARTNERSHIP UNITS

 

Classification of Noncontrolling Interests

 

GAAP requires a company to present ownership interests in subsidiaries held by parties other than the company in the consolidated financial statements within the equity section, but separate from the company’s equity.  It also requires the amount of consolidated net income attributable to the parent and to the noncontrolling interest to be clearly identified and presented on the face of the consolidated statement of operations and requires changes in ownership interest to be accounted for similarly as equity transactions.  If noncontrolling interests are determined to be redeemable, they are to be carried at their redemption value as of the balance sheet date and reported as temporary equity.

 

The Company has evaluated the terms of the Preferred OP Units and classifies the noncontrolling interest represented by the Preferred OP units as stockholders’ equity in the accompanying condensed consolidated balance sheets.  The Company will periodically evaluate individual noncontrolling interests for the ability to continue to recognize the noncontrolling amount as permanent equity in the condensed consolidated balance sheets.  Any noncontrolling interests that fail to qualify as permanent equity will be reclassified as temporary equity and adjusted to the greater of (1) the carrying amount, or (2) its redemption value as of the end of the period in which the determination is made.

 

Series A Participating Redeemable Preferred 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 989,980 Series A Units of the Operating Partnership. The self-storage facilities are located in California and Hawaii.

 

On June 25, 2007, the Operating Partnership loaned the holders of the Series A 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 Series A Units. The holders of the Series A Units can convert up to 114,500 Series A Units prior to the maturity date of the loan. If any redemption in excess of 114,500 Series A Units occurs prior to the maturity date, the holder of the Series A Units is required to repay the loan as of the date of that redemption. Preferred OP Units are shown on the balance sheet net of the $100,000 loan because the borrower under the loan receivable is also the holder of the Series A Units.

 

The Operating Partnership entered into a Second Amended and Restated Agreement of Limited Partnership (as subsequently amended, the “Partnership Agreement”) which provides for the designation and issuance of the Series A Units. The Series A Units will have priority over all other partnership interests of the Operating Partnership with respect to distributions and liquidation.

 

Under the Partnership Agreement, Series A 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 participates in distributions with, and has a liquidation value equal to, that of the common OP units. The Series A Units became redeemable at the option of the holder on September 1, 2008, which redemption obligation may be satisfied, at the Company’s option, in cash or shares of its common stock.

 

Series B Redeemable Preferred Units

 

On August 29, 2013, the Operating Partnership completed the purchase of 19 out of 20 self-storage facilities affiliated with All Aboard Mini Storage, all of which are located in California.  On September 26, 2013, the Operating Partnership completed the purchase of the remaining facility.  These properties were acquired in exchange for $100,876 in cash (including $98,960 of debt assumed and immediately defeased at closing), 1,342,727 Series B Units valued at $33,568, and 1,448,108 common OP Units valued at $62,341.

 

The Operating Partnership entered into a Third Amended and Restated Agreement of Limited Partnership which provides for the designation and issuance of Series B Units.  The Series B Units rank junior to Series A Units but will have priority over all other partnership interests of the Operating Partnership with respect to distribution and liquidation.

 

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The Series B Units have a fixed value of $25 per unit for a fixed liquidation value of $33,568, and have limited voting rights.  Holders of the Series B Units receive distributions at an annual rate of 6%.  These distributions are cumulative and accrue each quarter regardless of the declaration of dividends or distributions. The Series B Units will become redeemable at the option of the holder on August 29, 2014, which redemption obligation may be satisfied at the Company’s option in cash or shares of its common stock.

 

As of September 30, 2013, the Company’s ability to issue stock upon redemption of the Series B Units was not solely within its control.  Therefore, the Company reported the Series B Units in temporary equity on the Condensed Consolidated Balance Sheet, as required by GAAP.

 

10.       NONCONTROLLING INTEREST IN OPERATING PARTNERSHIP

 

The Company’s interest in its properties is held through the Operating Partnership. ESS Holding Business Trust I, a wholly-owned subsidiary of the Company, is the sole general partner of the Operating Partnership. The Company, through ESS Holding Business Trust II, a wholly-owned subsidiary of the Company, is also a limited partner of the Operating Partnership. Between its general partner and limited partner interests, the Company held a 94.3% majority ownership interest therein as of September 30, 2013. The remaining ownership interests in the Operating Partnership (including Preferred OP units) of 5.7% are held by certain former owners of assets acquired by the Operating Partnership.  As of September 30, 2013, the Operating Partnership had 4,346,618 common OP units outstanding.

 

The noncontrolling interest in the Operating Partnership represents common 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 OP Units. 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 common OP units for cash based upon the fair market value of an equivalent number of shares of the Company’s common stock (ten-day average) at the time of the redemption. Alternatively, the Company may, at its option, elect to acquire those OP Units in exchange for shares of its common stock on a one-for-one basis, subject to anti-dilution adjustments provided in the Partnership Agreement.  The ten-day average closing stock price at September 30, 2013, was $46.02 and there were 4,346,618 common OP Units outstanding that were not owned by the Company. Assuming that all of the noncontrolling members exercised their right to redeem all of their common OP Units on September 30, 2013, and the Company elected to pay the noncontrolling members cash, the Company would have paid $200,031 in cash consideration to redeem the OP Units.

 

GAAP requires a company to present ownership interests in subsidiaries held by parties other than the company in the consolidated financial statements within the equity section, but separate from the company’s equity.  It also requires the amount of consolidated net income attributable to the parent and to the noncontrolling interest to be clearly identified and presented on the face of the consolidated statement of operations, and requires changes in ownership interest to be accounted for similarly as equity transactions.  If noncontrolling interests are determined to be redeemable, they are to be carried at their redemption value as of the balance sheet date and reported as temporary equity.

 

The Company has evaluated the terms of the common OP Units and classifies the noncontrolling interest in the Operating Partnership as stockholders’ equity in the accompanying condensed consolidated balance sheets.  The Company will periodically evaluate individual noncontrolling interests for the ability to continue to recognize the noncontrolling amount as permanent equity in the condensed consolidated balance sheets.  Any noncontrolling interests that fail to qualify as permanent equity will be reclassified as temporary equity and adjusted to the greater of (1) the carrying amount, or (2) the redemption value as of the end of the period in which the determination is made.

 

11.       OTHER NONCONTROLLING INTERESTS

 

Other noncontrolling interests represent the ownership interests of various third parties in two consolidated self-storage properties as of September 30, 2013.  One of these consolidated properties was undeveloped at September 30, 2013.  The ownership interests of the third-party owners range from 3.3% to 10.0%.  Other noncontrolling interests are included in the stockholders’ equity section of the Company’s condensed consolidated balance sheet.  The income or losses attributable to these third-party owners based on percentages outlined in the related agreements are reflected in net income allocated to Operating Partnership and other noncontrolling interests in the condensed consolidated statement of operations.

 

In February 2013, the Company purchased one of its joint venture partner’s 1.7% capital interest and 17% profit interest in one of these consolidated properties for $200.  As a result, the Company’s capital interest percentage in this joint venture increased from 95% to 96.7%.  Since the Company retained its controlling financial interest in the subsidiary, this transaction was accounted for as an equity transaction.  The carrying amount of the noncontrolling interest was reduced to reflect the

 

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purchase and the difference between the price paid by the Company and the adjustment to the carrying value of the noncontrolling interest was recorded as an adjustment to equity attributable to the parent.

 

In May 2013, the Company purchased one of its joint venture partner’s 27.65% capital interest and 35% profit interest in a previously unconsolidated joint venture for $950.  The partner’s interest was reported in other noncontrolling interests prior to the purchase.  As a result of the acquisition, the property became wholly-owned by the Company.  Since the Company retained its controlling financial interest in the subsidiary, this transaction was accounted for as an equity transaction.  The carrying amount of the noncontrolling interest was reduced to zero to reflect the purchase and the difference between the price paid by the Company and the carrying value of the noncontrolling interest was recorded as an adjustment to equity attributable to the parent.

 

12.       EQUITY IN EARNINGS OF UNCONSOLIDATED REAL ESTATE VENTURES — GAIN ON SALE OF REAL ESTATE ASSETS AND PURCHASE OF JOINT VENTURE PARTNERS’ INTERESTS

 

On February 13, 2013, the Company acquired its joint venture partner’s 48% equity interest in Extra Space of Eastern Avenue LLC (“Eastern Avenue”), which owned one self-storage property located in Maryland, for approximately $5,979. Prior to the acquisition, the remaining 52% interest was owned by the Company, which accounted for its investment in Eastern Avenue using the equity method. The Company recorded a non-cash gain of $2,215 related to this transaction, which represents the increase in fair value of the Company’s interest in Eastern Avenue from its formation to the acquisition date.

 

On February 13, 2013, the Company acquired its joint venture partner’s 61% equity interest in Extra Space of Montrose Avenue LLC (“Montrose”), which owned one self-storage property located in Illinois, for approximately $6,878. Prior to the acquisition, the remaining 39% interest was owned by the Company, which accounted for its investment in Montrose using the equity method. The Company recorded a non-cash gain of $341 related to this transaction, which represents the increase in fair value of the Company’s interest in the joint venture from its formation to the acquisition date.

 

On July 2, 2012, the Company completed the acquisition of Prudential Real Estate Investors’ 94.9% interest in the ESS PRISA III LLC joint venture (“PRISA III”).  PRISA III was formed in 2005 and owned 36 properties located in 18 states.  Prior to the acquisition, the remaining 5.1% interest was owned by the Company, which accounted for its investment in PRISA III using the equity method.  Subsequent to the acquisition, the Company had full ownership of PRISA III.  GAAP requires an entity that completes a business combination in stages to remeasure its previously held equity interest in the acquiree at its acquisition date fair value and recognize the resulting gain or loss, if any, in earnings.  The Company recorded a non-cash gain of $13,499 related to this transaction, which represents the increase in fair value of the Company’s 5.1% interest in PRISA III from the formation of the joint venture to the acquisition date.

 

On February 17, 2012, a joint venture in which the Company held a 40% equity interest sold its only self-storage property, which was located in New York. As a result of the sale, the joint venture was dissolved, and the Company received proceeds which resulted in a cash gain of $5,550.

 

On January 15, 2012, the Company sold its 40% equity interest in U-Storage de Mexico S.A. and related entities to its joint venture partners for $4,841. The Company received cash of $1,492 and a note receivable of $3,349. No gain or loss was recorded on the sale. At September 30, 2013, the balance of the note receivable was $1,500.  The note receivable is due December 31, 2014.

 

13.       SEGMENT INFORMATION

 

The Company operates in three distinct segments: (1) rental operations; (2) tenant reinsurance; and (3) property management, acquisition and development. Management fees collected for wholly-owned properties are eliminated in consolidation.  Financial information for the Company’s business segments is presented below:

 

 

 

September 30, 2013

 

December 31, 2012

 

Balance Sheet

 

 

 

 

 

Investment in unconsolidated real estate ventures

 

 

 

 

 

Rental operations

 

$

100,455

 

$

106,313

 

 

 

 

 

 

 

Total assets

 

 

 

 

 

Rental operations

 

$

3,209,347

 

$

2,981,927

 

Tenant reinsurance

 

30,057

 

27,645

 

Property management, acquisition and development

 

278,835

 

213,905

 

 

 

$

3,518,239

 

$

3,223,477

 

 

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For the Three Months Ended September 30,

 

For the Nine Months Ended September 30,

 

 

 

2013

 

2012

 

2013

 

2012

 

Statement of Operations

 

 

 

 

 

 

 

 

 

Total revenues

 

 

 

 

 

 

 

 

 

Rental operations

 

$

113,881

 

$

94,065

 

$

324,144

 

$

249,193

 

Tenant reinsurance

 

12,294

 

9,495

 

34,625

 

27,060

 

Property management, acquisition and development

 

6,936

 

6,231

 

19,910

 

19,476

 

 

 

133,111

 

109,791

 

378,679

 

295,729

 

 

 

 

 

 

 

 

 

 

 

Operating expenses, including depreciation and amortization

 

 

 

 

 

 

 

 

 

Rental operations

 

56,428

 

48,920

 

167,300

 

132,746

 

Tenant reinsurance

 

2,873

 

1,379

 

6,985

 

4,651

 

Property management, acquisition and development

 

17,746

 

16,008

 

48,226

 

44,203

 

 

 

77,047

 

66,307

 

222,511

 

181,600

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

 

 

 

 

 

 

 

 

Rental operations

 

57,453

 

45,145

 

156,844

 

116,447

 

Tenant reinsurance

 

9,421

 

8,116

 

27,640

 

22,409

 

Property management, acquisition and development

 

(10,810

)

(9,777

)

(28,316

)

(24,727

)

 

 

56,064

 

43,484

 

156,168

 

114,129

 

 

 

 

 

 

 

 

 

 

 

Gain on sale of real estate assets

 

 

 

 

 

 

 

 

 

Rental operations

 

 

 

800

 

 

 

 

 

 

 

 

 

 

 

 

Loss on extinguishment of debt related to portfolio acquisition

 

 

 

 

 

 

 

 

 

Property management, acquisition and development

 

(9,153

)

 

(9,153

)

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

Rental operations

 

(15,608

)

(17,575

)

(50,657

)

(50,949

)

Property management, acquisition and development

 

(656

)

(848

)

(1,335

)

(1,399

)

 

 

(16,264

)

(18,423

)

(51,992

)

(52,348

)

 

 

 

 

 

 

 

 

 

 

Non-cash interest expense related to amortization of discount on equity component of exchangeable senior notes

 

 

 

 

 

 

 

 

 

Property management, acquisition and development

 

(834

)

 

(947

)

(444

)

 

 

(834

)

 

(947

)

(444

)

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

 

 

 

 

 

 

Tenant reinsurance

 

5

 

2

 

13

 

8

 

Property management, acquisition and development

 

197

 

459

 

506

 

1,176

 

 

 

202

 

461

 

519

 

1,184

 

 

 

 

 

 

 

 

 

 

 

Interest income on note receivable from Preferred Operating Partnership unit holder

 

 

 

 

 

 

 

 

 

Property management, acquisition and development

 

1,213

 

1,213

 

3,638

 

3,638

 

 

 

 

 

 

 

 

 

 

 

Equity in earnings of unconsolidated real estate ventures

 

 

 

 

 

 

 

 

 

Rental operations

 

3,405

 

2,854

 

8,942

 

7,848

 

 

 

 

 

 

 

 

 

 

 

Equity in earnings of unconsolidated real estate ventures - gain on sale of real estate assets and purchase of partners’ interests

 

 

 

 

 

 

 

 

 

Rental operations

 

 

13,620

 

2,556

 

19,049

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

 

 

 

 

 

 

 

 

Rental operations

 

 

(169

)

 

(491

)

Tenant reinsurance

 

(3,300

)

(2,841

)

(12,545

)

(7,845

)

Property management, acquisition and development

 

1,019

 

1,354

 

5,398

 

4,096

 

 

 

(2,281

)

(1,656

)

(7,147

)

(4,240

)

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

 

 

 

 

 

 

 

 

Rental operations

 

45,250

 

43,875

 

118,485

 

91,904

 

Tenant reinsurance

 

6,126

 

5,277

 

15,108

 

14,572

 

Property management, acquisition and development

 

(19,024

)

(7,599

)

(30,209

)

(17,660

)