Extra Space Storage Inc. - Quarter Report: 2012 June (Form 10-Q)

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 June 30, 2012

 

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)

 

 

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):

 

 

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 July 31, 2012, was 104,150,848

 

 

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	10
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	32
ITEM 4. CONTROLS AND PROCEDURES	32
PART II. OTHER INFORMATION	33
ITEM 1. LEGAL PROCEEDINGS	33
ITEM 1A. RISK FACTORS	33
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	33
ITEM 3. DEFAULTS UPON SENIOR SECURITIES	33
ITEM 4. MINE SAFETY DISCLOSURES	33
ITEM 5. OTHER INFORMATION	33
ITEM 6. EXHIBITS	34
SIGNATURES	35

 

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STATEMENT ON FORWARD-LOOKING INFORMATION

 

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:

 

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

 

·                  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”), which could increase our expenses and reduce our cash available for distribution;

 

·                  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.

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

Extra Space Storage Inc.

Condensed Consolidated Balance Sheets

(amounts in thousands, except share data)

 

		June 30, 2012			December 31, 2011
		(Unaudited)
Assets:
Real estate assets, net		$	2,278,331		$	2,263,795
Investments in real estate ventures		125,729			130,410
Cash and cash equivalents		185,502			26,484
Restricted cash		37,234			25,768
Receivables from related parties and affiliated real estate joint ventures		15,976			18,517
Other assets, net		65,571			51,276
Total assets		$	2,708,343		$	2,516,250
Liabilities, Noncontrolling Interests and Equity:
Notes payable		$	1,088,413		$	937,001
Premium on notes payable		3,958			4,402
Notes payable to trusts		119,590			119,590
Exchangeable senior notes		—			87,663
Lines of credit		100,000			215,000
Accounts payable and accrued expenses		47,123			45,079
Other liabilities		38,616			33,754
Total liabilities		1,397,700			1,442,489
Commitments and contingencies
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, 104,136,770 and 94,783,590 shares issued and outstanding at June 30, 2012, and December 31, 2011, respectively		1,041			948
Paid-in capital		1,527,332			1,290,021
Accumulated other comprehensive deficit		(11,525		)	(7,936		)
Accumulated deficit		(261,288		)	(264,086		)
Total Extra Space Storage Inc. stockholders’ equity		1,255,560			1,018,947
Noncontrolling interest represented by Preferred Operating Partnership units, net of $100,000 note receivable		29,692			29,695
Noncontrolling interests in Operating Partnership		24,279			24,018
Other noncontrolling interests		1,112			1,101
Total noncontrolling interests and equity		1,310,643			1,073,761
Total liabilities, noncontrolling interests and equity		$	2,708,343		$	2,516,250

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Extra Space Storage Inc.

Condensed Consolidated Statements of Operations

(amounts in thousands, except share data)

(unaudited)

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
		2012			2011			2012			2011
Revenues:
Property rental		$	79,284		$	64,300		$	155,128		$	125,790
Management and franchise fees		6,659			6,144			13,245			12,111
Tenant reinsurance		9,008			7,596			17,565			14,620
Total revenues		94,951			78,040			185,938			152,521
Expenses:
Property operations		26,012			22,712			52,608			46,056
Tenant reinsurance		1,424			1,382			3,272			2,997
Acquisition related costs		469			1,570			1,078			1,819
General and administrative		12,545			12,432			25,185			24,090
Depreciation and amortization		16,626			14,092			33,150			27,677
Total expenses		57,076			52,188			115,293			102,639
Income from operations		37,875			25,852			70,645			49,882
Interest expense		(15,854		)	(16,261		)	(33,925		)	(32,675		)
Non-cash interest expense related to amortization of discount on exchangeable senior notes		—			(440		)	(444		)	(868		)
Interest income		448			189			723			371
Interest income on note receivable from Preferred Operating Partnership unit holder		1,212			1,212			2,425			2,425
Income before equity in earnings of real estate ventures and income tax expense		23,681			10,552			39,424			19,135
Equity in earnings of real estate ventures		2,698			2,376			4,994			4,187
Equity in earnings of real estate ventures - gain on sale of real estate assets		—			—			5,429			—
Income tax expense		(1,634		)	(411		)	(2,584		)	(665		)
Net income		24,745			12,517			47,263			22,657
Net income allocated to Preferred Operating Partnership noncontrolling interests		(1,654		)	(1,552		)	(3,303		)	(3,084		)
Net income allocated to Operating Partnership and other noncontrolling interests		(678		)	(356		)	(1,333		)	(663		)
Net income attributable to common stockholders		$	22,413		$	10,609		$	42,627		$	18,910
Net income per common share
Basic		$	0.22		$	0.12		$	0.43		$	0.21
Diluted		$	0.22		$	0.12		$	0.43		$	0.21
Weighted average number of shares
Basic		102,107,535			91,439,042			98,497,788			89,733,518
Diluted		106,653,965			96,010,848			103,063,565			94,336,141
Cash dividends paid per common share		$	0.20		$	0.14		$	0.40		$	0.28

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Extra Space Storage Inc.

Condensed Consolidated Statements of Comprehensive Income

(amounts in thousands)

(unaudited)

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
		2012			2011			2012			2011
Net income		$	24,745		$	12,517		$	47,263		$	22,657
Comprehensive income:
Change in fair value of interest rate swap		(3,517		)	(1,837		)	(3,732		)	(674		)
Total comprehensive income		21,228			10,680			43,531			21,983
Less: comprehensive income attributable to noncontrolling interests		2,198			1,829			4,493			3,722
Comprehensive income attributable to common stockholders		$	19,030		$	8,851		$	39,038		$	18,261

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Extra Space Storage Inc.

Condensed Consolidated Statement of Equity

(amounts in thousands, except share data)

(unaudited)

 

		Noncontrolling Interests									Extra Space Storage Inc. Stockholders’ Equity
		Preferred Operating			Operating											Paid-in			Accumulated Other Comprehensive			Accumulated			Total Noncontrolling Interests and
		Partnership			Partnership			Other			Shares		Par Value			Capital			Deficit			Deficit			Equity
Balances at December 31, 2011		$	29,695		$	24,018		$	1,101		94,783,590		$	948		$	1,290,021		$	(7,936	)	$	(264,086	)	$	1,073,761
Issuance of common stock upon the exercise of options		—			—			—			465,035		4			6,134			—			—			6,138
Restricted stock grants issued		—			—			—			168,052		2			—			—			—			2
Restricted stock grants cancelled		—			—			—			(14,592	)	—			—			—			—			—
Issuance of common stock, net of offering costs		—			—			—			8,050,000		80			226,618			—			—			226,698
Issuance of common stock related to settlement of exchangeable senior notes		—			—			—			684,685		7			—			—			—			7
Compensation expense related to stock-based awards		—			—			—			—		—			2,321			—			—			2,321
New issuance of Operating Partnership units		—			429			—			—		—			—			—			—			429
Redemption of Operating Partnership units for cash		—			(155		)	—			—		—			—			—			—			(155		)
Net income		3,303			1,322			11			—		—			—			—			42,627			47,263
Other comprehensive loss		(35		)	(108		)	—			—		—			—			(3,589		)	—			(3,732		)
Tax effect from vesting of restricted stock grants and stock option exercises		—			—			—			—		—			2,238			—			—			2,238
Distributions to Operating Partnership units held by noncontrolling interests		(3,271		)	(1,227		)	—			—		—			—			—			—			(4,498		)
Dividends paid on common stock at $0.40 per share		—			—			—			—		—			—			—			(39,829		)	(39,829		)
Balances at June 30, 2012		$	29,692		$	24,279		$	1,112		104,136,770		$	1,041		$	1,527,332		$	(11,525	)	$	(261,288	)	$	1,310,643

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Extra Space Storage Inc.

Condensed Consolidated Statements of Cash Flows

(amounts in thousands)

(unaudited)

 

		For the Six Months Ended June 30,
		2012			2011
Cash flows from operating activities:
Net income		$	47,263		$	22,657
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		33,150			27,677
Amortization of deferred financing costs		3,370			2,233
Non-cash interest expense related to amortization of discount on exchangeable senior notes		444			868
Non-cash interest expense related to amortization of premium on notes payable		(631		)	—
Compensation expense related to stock-based awards		2,321			2,711
Distributions from real estate ventures in excess of earnings		186			5,169
Changes in operating assets and liabilities:
Receivables from related parties and affiliated real estate joint ventures		2,541			1,393
Other assets		1,161			4,960
Accounts payable and accrued expenses		2,044			(1,498		)
Other liabilities		772			(977		)
Net cash provided by operating activities		92,621			65,193
Cash flows from investing activities:
Acquisition of real estate assets		(44,685		)	(82,071		)
Development and construction of real estate assets		(1,812		)	(4,494		)
Investments in real estate ventures		(702		)	(3,405		)
Return of investment in real estate ventures		1,848			—
Change in restricted cash		(11,466		)	(2,202		)
Purchase of notes receivable		(7,875		)	—
Purchase of equipment and fixtures		(1,223		)	(3,463		)
Net cash used in investing activities		(65,915		)	(95,635		)
Cash flows from financing activities:
Proceeds from the sale of common stock, net of offering costs		226,698			112,532
Repurchase of exchangeable senior notes		(87,663		)	—
Proceeds from notes payable and lines of credit		326,481			264,686
Principal payments on notes payable and lines of credit		(290,069		)	(335,693		)
Deferred financing costs		(4,791		)	(3,200		)
Redemption of Operating Partnership units held by noncontrolling interest		(155		)	(271		)
Net proceeds from exercise of stock options		6,138			10,505
Dividends paid on common stock		(39,829		)	(25,575		)
Distributions to noncontrolling interests		(4,498		)	(4,105		)
Net cash provided by financing activities		132,312			18,879
Net increase (decrease) in cash and cash equivalents		159,018			(11,563		)
Cash and cash equivalents, beginning of the period		26,484			46,750
Cash and cash equivalents, end of the period		$	185,502		$	35,187

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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Extra Space Storage Inc.

Condensed Consolidated Statements of Cash Flows

(amounts in thousands)

(unaudited)

 

		For the Six Months Ended June 30,
		2012			2011
Supplemental schedule of cash flow information:
Interest paid, net of amounts capitalized		$	31,215		$	30,400
Supplemental schedule of noncash investing and financing activities:
Redemption of Operating Partnership units held by noncontrolling interests for common stock:
Noncontrolling interests in Operating Partnership		$	—		$	2,344
Common stock and paid-in capital		—			(2,344		)
Tax effect from vesting of restricted stock grants and stock option exercises:
Other assets		$	2,238		$	2,091
Paid-in capital		(2,238		)	(2,091		)
Acquisitions of real estate assets:
Real estate assets, net		$	429		$	8,660
Notes payable assumed		—			(8,660		)
Operating Partnership units issued		(429		)	—
Receivable from sale of interest in real estate ventures:
Other assets		$	3,349		$	—
Investments in real estate ventures		(3,349		)	—

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

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EXTRA SPACE STORAGE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

Amounts in thousands, except property and share data

 

1.              ORGANIZATION

 

Extra Space Storage Inc. (the “Company”) is a self-administered and self-managed real estate investment trust (“REIT”), formed as a Maryland corporation on April 30, 2004, to own, operate, manage, acquire, 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 (“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 or developing wholly-owned facilities or by acquiring an equity interest in real estate entities.  At June 30, 2012, the Company had direct and indirect equity interests in 703 operating storage facilities.  In addition, the Company managed 179 properties for franchisees and third parties, bringing the total number of operating properties which it owns and/or manages to 882.  These properties are located in 34 states and Washington, D.C.

 

The Company operates in three distinct segments: (1) property management, acquisition and development; (2) rental operations; and (3) tenant reinsurance. 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.  Tenant reinsurance activities include the reinsurance of risks relating to the loss of goods stored by tenants in the Company’s 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 six months ended June 30, 2012, are not necessarily indicative of results that may be expected for the year ended December 31, 2012. The condensed consolidated balance sheet as of December 31, 2011, 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, 2011, as filed with the Securities and Exchange Commission.

 

3.              FAIR VALUE DISCLOSURES

 

Assets and Liabilities Measured at Fair Value on a Recurring Basis

 

The following table provides information for each major category of assets and liabilities that are measured at fair value on a recurring basis:

 

					Fair Value Measurements at Reporting Date Using
Description		June 30, 2012			Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Other liabilities - cash flow hedge swap agreements		$	(12,043	)	$	—		$	(12,043	)	$	—

 

The fair value of our derivatives is based on quoted market prices of similar instruments from various banking institutions or an independent third-party provider for similar instruments. In determining the fair value, we consider our non-performance risk and that of our counterparties.

 

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There were no transfers of assets and liabilities between Level 1 and Level 2 during the three or six months ended June 30, 2012.  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 three or six months ended June 30, 2012.

 

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.

 

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 June 30, 2012 and December 31, 2011 approximate fair value. The fair value of the Company’s note receivable from Preferred Operating Partnership unit holder is based on the discounted estimated future cash flows of the note (categorized within Level 3 of the fair value hierarchy); the discount rate used approximates the current market rate for loans with similar maturities and credit quality.  The fair values of the Company’s fixed-rate notes payable, notes payable to trusts and exchangeable senior notes, 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 approximate current market rates for loans, or groups of loans, with similar maturities and credit quality.

 

The fair values of the Company’s note receivable from Preferred Operating Partnership unit holder, fixed-rate notes payable and notes payable to trusts, and exchangeable senior notes are as follows:

 

		June 30, 2012						December 31, 2011
		Fair			Carrying			Fair			Carrying
		Value			Value			Value			Value
Note receivable from Preferred Operating Partnership unit holder		$	106,421		$	100,000		$	104,049		$	100,000
Fixed-rate notes payable and notes payable to trusts		$	1,148,576		$	1,072,355		$	1,008,039		$	938,681
Exchangeable senior notes		$	—		$	—		$	92,265		$	87,663

 

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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 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 (those that reduce earnings per share) are included.

 

The Company’s Operating Partnership had $87,663 of exchangeable senior notes (the “Notes”) issued and outstanding prior to April 2012, when all of the outstanding Notes were surrendered for exchange. Prior to their exchange, the Notes could potentially have had a dilutive effect on the Company’s earnings per share calculations. The Notes were exchangeable by holders into shares of the Company’s common stock under certain circumstances per the terms of the indenture governing the Notes and at the time prior to surrender had an exchange price of $23.20 per share. The Company had 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 obligations in excess of the accreted principal amount in cash and/or common stock. Though the Company retained that right, Accounting Standards Codification (“ASC”) 260, “Earnings Per Share,” required an assumption that shares would be used to pay the exchange obligations in excess of the accreted principal amount, and required 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 for the three or six months ended June 30, 2011 as the stock price during this time did not exceed the exchange price.  No shares were included for the three or six months ended June 30, 2012, as the Notes were no longer outstanding at June 30, 2012.

 

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 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 ASC 260-10-45-46.

 

For the three months ended June 30, 2012 and 2011, options to purchase 66,042 and 122,321 shares of common stock, and for the six months ended June 30, 2012 and 2011, options to purchase 48,980 and 99,482  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 is as follows:

 

		For the Three Months Ended June 30,						For the Six Months Ended June 30,
		2012			2011			2012			2011
Net income attributable to common stockholders		$	22,413		$	10,609		$	42,627		$	18,910
Add: Income allocated to noncontrolling interest - Preferred Operating Partnership and Operating Partnership		2,325			1,910			4,625			3,754
Subtract: Fixed component of income allocated to noncontrolling interest - Preferred Operating Partnership		(1,437		)	(1,437		)	(2,875		)	(2,875		)
Net income for diluted computations		$	23,301		$	11,082		$	44,377		$	19,789
Weighted average number of common shares outstanding - basic		102,107,535			91,439,042			98,497,788			89,733,518
Operating Partnership units		3,060,467			3,049,935			3,060,467			3,049,935
Preferred Operating Partnership units		989,980			989,980			989,980			989,980
Shares related to Dilutive and Cancelled Stock Options		495,983			531,891			515,330			562,708
Weighted average number of common shares outstanding - diluted		106,653,965			96,010,848			103,063,565			94,336,141
Net income per common share
Basic		$	0.22		$	0.12		$	0.43		$	0.21
Diluted		$	0.22		$	0.12		$	0.43		$	0.21

 

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5.              PROPERTY ACQUISITIONS

 

The following table summarizes the Company’s acquisitions of operating properties for the six months ended June 30, 2012, and does not include improvements made to existing assets:

 

						Consideration Paid														Acquisition Date Fair Value
Property Location		Number of Properties		Date of Acquisition		Total Paid			Cash Paid			Net Liabilities/ (Assets) Assumed			Value of OP Units Issued			Number of OP Units Issued		Land			Building			Intangible			Closing costs - expensed			Source of Acquisition
Texas		1		2/29/2012		$	9,405		$	9,323		$	82		$	—		—		$	1,036		$	8,133		$	187		$	49		Unrelated third party
Maryland		1		3/7/2012		6,284			5,886			21			377			14,193		465			5,600			128			91			Unrelated third party
Florida		3		5/2/2012		14,942			14,792			150			—			—		1,933			12,682			321			6			Unrelated third party
Maryland		1		5/31/2012		6,501			6,438			11			52			1,814		1,185			5,051			147			118			Unrelated third party

 

6.              VARIABLE INTERESTS

 

The Company has interests in two unconsolidated joint ventures with unrelated third parties which are variable interest entities (“VIEs”). The Company holds 18% and 39% of the equity interests in the VIE joint ventures (“VIE JVs”), and has 50% of the voting rights in each of the VIE JVs. Qualification of each VIE JV as a VIE was based on the determination that the equity investments at risk for each of these joint ventures were not sufficient based on a qualitative and quantitative analysis performed by the Company. The Company performed a qualitative analysis for these joint ventures to determine which party was the primary beneficiary of each VIE. The Company determined that since the powers to direct the activities most significant to the economic performance of these entities are shared equally by the Company and its joint venture partners, there is no primary beneficiary. Accordingly, these interests are recorded using the equity method.

 

The VIE JVs each own a single self-storage property. These joint ventures are financed through a combination of (1) equity contributions from the Company and its joint venture partners, (2) mortgage notes payable and (3) payables to the Company. The payables to the Company consist of amounts owed for expenses paid on behalf of the joint ventures by the Company as manager and mortgage notes payable to the Company. The Company performs management services for the VIE JVs in exchange for a management fee of approximately 6% of cash collected by the properties. Except as disclosed, the Company has not provided financial or other support during the periods presented to the VIE JVs that it was not previously contractually obligated to provide.

 

The Company guarantees the mortgage notes payable for the VIE JVs. The Company’s maximum exposure to loss for these joint ventures as of June 30, 2012 is the total of the guaranteed loan balances, the payables due to the Company and the Company’s investment balances in the joint ventures. The Company believes that the risk of incurring a material loss as a result of having to perform on the loan guarantees is unlikely and, therefore, no liability has been recorded related to these guarantees. The Company believes the payables to the Company are collectible. Additionally, repossessing and/or selling the self-storage facility and land that collateralize the loans could provide funds sufficient to reimburse the Company.

 

In addition to the VIEs mentioned above, on May 1, 2012, the Company purchased two notes receivable from Capmark Bank for a total of $7,875.  These receivables are due from Spacebox Land O’Lakes, LLC and Spacebox North Fort Myers, LLC (collectively, “Spacebox”), a third party.  The notes bear interest at 15% per annum and are due April 30, 2013.  Spacebox owns two self-storage properties located in Florida, which are collateral for the notes. The Company began performing management services for these two properties at the time of the purchase of the notes receivable, for a management fee of approximately 6% of the cash collected by the properties.  These notes receivable are included in other assets on the condensed consolidated balance sheet.

 

The Company determined that the two Spacebox entities qualify as VIEs because the equity investments at risk for each of these entities were not sufficient based on a qualitative and quantitative analysis performed by the Company. The Company is not the primary beneficiary of either VIE. As of June 30, 2012, the Company’s maximum exposure to loss for these entities is equal to the balance of the notes receivable, accrued interest on the notes receivable, and payables due to the Company.  The payables to the Company consist of amounts owed for expenses paid on behalf of Spacebox by the Company as manager.  The Company believes the notes receivable are collectible.  Also, repossessing and/or selling the self-storage properties that collateralize the loans could provide funds sufficient to reimburse the Company.

 

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The following table compares the Company’s liability balance to the respective VIEs and the maximum exposure to loss related to each VIE as of June 30, 2012, after netting such liability balance:

 

								Balance of						Maximum
		Liability			Investment			Guaranteed			Payables to			Exposure
		Balance			Balance			Loan			Company			to Loss			Difference
Extra Space of Montrose Avenue LLC		$	—		$	1,148		$	5,120		$	2,205		$	8,473		$	(8,473	)
Extra Space of Sacramento One LLC		—			(964		)	4,307			6,131			9,474			(9,474		)
Spacebox Land O’ Lakes LLC		—			—			—			3,684			3,684			(3,684		)
Spacebox North Fort Myers, LLC		—			—			—			4,378			4,378			(4,378		)
		$	—		$	184		$	9,427		$	16,398		$	26,009		$	(26,009	)

 

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 to be 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 June 30, 2012:

 

		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 three or six months ended June 30, 2012 or 2011.

 

7.              DERIVATIVES

 

GAAP requires the recognition of all derivative instruments as either assets or liabilities on the balance sheet at fair value.  The accounting for changes in fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship, and further, on the type of hedging relationship.  A company must designate each qualifying hedging instrument, based upon the exposure being hedged, as a fair value hedge, cash flow hedge, or a hedge of a net investment in foreign operations.

 

The Company is exposed to certain risks relating to its ongoing business operations.  The primary risk managed by using derivative instruments is interest rate risk.  Interest rate swaps are entered into to manage interest rate risk associated with the Company’s fixed- and variable-rate borrowings.  The Company designates certain interest rate swaps as cash flow hedges of variable-rate borrowings and the remainder as fair value hedges of fixed-rate borrowings.

 

For derivatives designated as fair value hedges, changes in the fair value of the derivative and the hedged item related to the hedged risk are recognized in the statement of operations.  For derivatives designated as cash flow hedges, the effective portion of changes in

 

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