Extra Space Storage Inc. - Quarter Report: 2013 June (Form 10-Q)

Table of Contents

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

(Mark One)

 

 

For the quarterly period ended June 30, 2013

 

or

 

 

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, 2013, was 111,223,834.

 

 

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	35
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS	35
ITEM 3. DEFAULTS UPON SENIOR SECURITIES	35
ITEM 4. MINE SAFETY DISCLOSURES	36
ITEM 5. OTHER INFORMATION	36
ITEM 6. EXHIBITS	36
SIGNATURES	37

 

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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”), 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, 2013			December 31, 2012
		(Unaudited)
Assets:
Real estate assets, net		$	3,027,654		$	2,991,722
Investments in unconsolidated real estate ventures		101,698			106,313
Cash and cash equivalents		206,932			30,785
Restricted cash		20,502			16,976
Receivables from related parties and affiliated real estate joint ventures		3,258			11,078
Other assets, net		72,572			66,603
Total assets		$	3,432,616		$	3,223,477
Liabilities, Noncontrolling Interests and Equity:
Notes payable		$	1,409,982		$	1,369,690
Premium on notes payable		2,546			3,319
Exchangeable senior notes		250,000			—
Discount on exchangeable senior notes		(18,133		)	—
Notes payable to trusts		119,590			119,590
Lines of credit		—			85,000
Accounts payable and accrued expenses		46,982			52,299
Other liabilities		31,858			48,248
Total liabilities		1,842,825			1,678,146
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, 111,223,460 and 110,737,205 shares issued and outstanding at June 30, 2013 and December 31, 2012, respectively		1,112			1,107
Paid-in capital		1,765,577			1,740,037
Accumulated other comprehensive income (deficit)		5,108			(14,273		)
Accumulated deficit		(241,391		)	(235,064		)
Total Extra Space Storage Inc. stockholders’ equity		1,530,406			1,491,807
Noncontrolling interest represented by Preferred Operating Partnership units, net of $100,000 note receivable		30,033			29,918
Noncontrolling interests in Operating Partnership		28,877			22,492
Other noncontrolling interests		475			1,114
Total noncontrolling interests and equity		1,589,791			1,545,331
Total liabilities, noncontrolling interests and equity		$	3,432,616		$	3,223,477

 

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,
		2013			2012			2013			2012
Revenues:
Property rental		$	107,340		$	79,284		$	210,263		$	155,128
Tenant reinsurance		12,110			9,008			22,331			17,565
Management fees		6,796			6,659			12,974			13,245
Total revenues		126,246			94,951			245,568			185,938
Expenses:
Property operations		33,462			26,012			67,899			52,608
Tenant reinsurance		2,202			1,424			4,112			3,272
Acquisition related costs		683			469			1,135			1,078
General and administrative		13,739			12,545			26,508			25,185
Depreciation and amortization		22,785			16,626			45,810			33,150
Total expenses		72,871			57,076			145,464			115,293
Income from operations		53,375			37,875			100,104			70,645
Gain on sale of real estate assets		800			—			800			—
Interest expense		(18,362		)	(15,854		)	(35,728		)	(33,925		)
Non-cash interest expense related to amortization of discount on equity component of exchangeable senior notes		(113		)	—			(113		)	(444		)
Interest income		133			448			317			723
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 unconsolidated real estate ventures and income tax expense		37,045			23,681			67,805			39,424
Equity in earnings of unconsolidated real estate ventures		2,914			2,698			5,537			4,994
Equity in earnings of unconsolidated real estate ventures - gain on sale of real estate assets and purchase of joint venture partners’ interests		—			—			2,556			5,429
Income tax expense		(2,858		)	(1,634		)	(4,866		)	(2,584		)
Net income		37,101			24,745			71,032			47,263
Net income allocated to Preferred Operating Partnership noncontrolling interests		(1,745		)	(1,654		)	(3,462		)	(3,303		)
Net income allocated to Operating Partnership and other noncontrolling interests		(890		)	(678		)	(1,679		)	(1,333		)
Net income attributable to common stockholders		$	34,466		$	22,413		$	65,891		$	42,627
Net income per common share
Basic		$	0.31		$	0.22		$	0.59		$	0.43
Diluted		$	0.31		$	0.22		$	0.59		$	0.43
Weighted average number of shares
Basic		111,137,437			102,107,535			110,974,504			98,497,788
Diluted		115,359,245			106,653,965			115,237,500			103,063,565
Cash dividends paid per common share		$	0.40		$	0.20		$	0.65		$	0.40

 

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,
		2013			2012			2013			2012
Net income		$	37,101		$	24,745		$	71,032		$	47,263
Other comprehensive income (loss):
Change in fair value of interest rate swaps		18,469			(3,517		)	20,040			(3,732		)
Total comprehensive income		55,570			21,228			91,072			43,531
Less: comprehensive income attributable to noncontrolling interests		3,237			2,198			5,800			4,493
Comprehensive income attributable to common stockholders		$	52,333		$	19,030		$	85,272		$	39,038

 

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
																			Accumulated
		Preferred																	Other
		Operating			Operating											Paid-in			Comprehensive			Accumulated			Total
		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		—			—			—			369,363		4			5,548			—			—			5,552
Restricted stock grants issued		—			—			—			130,302		1			—			—			—			1
Restricted stock grants cancelled		—			—			—			(13,410	)	—			—			—			—			—
Compensation expense related to stock-based awards		—			—			—			—		—			2,585			—			—			2,585
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 for interest in real estate assets		—			6,130			—			—		—			—			—			—			6,130
Redemption of Operating Partnership units for cash		—			(41		)	—			—		—			—			—			—			(41		)
Net income		3,462			1,656			23			—		—			—			—			65,891			71,032
Other comprehensive income		171			488			—			—		—			—			19,381			—			20,040
Tax effect from vesting of restricted stock grants and stock option exercises		—			—			—			—		—			3,426			—			—			3,426
Distributions to Operating Partnership units held by noncontrolling interests		(3,518		)	(1,848		)	—			—		—			—			—			—			(5,366		)
Distributions to other noncontrolling interests		—			—			(27		)	—		—			—			—			—			(27		)
Dividends paid on common stock at $0.65 per share		—			—			—			—		—			—			—			(72,218		)	(72,218		)
Balances at June 30, 2013		$	30,033		$	28,877		$	475		111,223,460		$	1,112		$	1,765,577		$	5,108		$	(241,391	)	$	1,589,791

 

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,
		2013			2012
Cash flows from operating activities:
Net income		$	71,032		$	47,263
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		45,810			33,150
Amortization of deferred financing costs		3,035			3,370
Non-cash interest expense related to amortization of discount on exchangeable senior notes		113			444
Non-cash interest expense related to amortization of premium on notes payable		(773		)	(631		)
Compensation expense related to stock-based awards		2,585			2,321
Gain on purchase of joint venture partners’ interests		(2,556		)	—
Distributions from unconsolidated real estate ventures in excess of earnings		1,924			186
Changes in operating assets and liabilities:
Receivables from related parties and affiliated real estate joint ventures		5,561			2,541
Other assets		1,948			1,161
Accounts payable and accrued expenses		(5,317		)	2,044
Other liabilities		3,189			772
Net cash provided by operating activities		126,551			92,621
Cash flows from investing activities:
Acquisition, development and redevelopment of real estate assets		(62,036		)	(46,497		)
Proceeds from sale of real estate assets		929			—
Investments in unconsolidated real estate ventures		(955		)	(702		)
Return of investment in unconsolidated real estate ventures		—			1,848
Change in restricted cash		(3,526		)	(11,466		)
Purchase of notes receivable		—			(7,875		)
Purchase of equipment and fixtures		(1,478		)	(1,223		)
Net cash used in investing activities		(67,066		)	(65,915		)
Cash flows from financing activities:
Proceeds from the sale of common stock, net of offering costs		—			226,698
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		267,960			326,481
Principal payments on notes payable and lines of credit		(319,790		)	(290,069		)
Deferred financing costs		(5,658		)	(4,791		)
Redemption of Operating Partnership units held by noncontrolling interest		(41		)	(155		)
Net proceeds from exercise of stock options		5,552			6,138
Dividends paid on common stock		(72,218		)	(39,829		)
Distributions to noncontrolling interests		(5,393		)	(4,498		)
Net cash provided by financing activities		116,662			132,312
Net increase in cash and cash equivalents		176,147			159,018
Cash and cash equivalents, beginning of the period		30,785			26,484
Cash and cash equivalents, end of the period		$	206,932		$	185,502

 

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,
		2013			2012
Supplemental schedule of cash flow information
Interest paid, net of amounts capitalized		$	32,548		$	31,215
Income taxes paid		1,198			473
Supplemental schedule of noncash investing and financing activities:
Tax effect from vesting of restricted stock grants and stock option exercises:
Other assets		$	3,426		$	2,238
Paid-in capital		(3,426		)	(2,238		)
Acquisitions of real estate assets
Real estate assets, net		$	15,503		$	429
Notes payable assumed		(7,122		)	—
Operating Partnership units issued		(6,130		)	(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.

 

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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, 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 June 30, 2013, the Company had direct and indirect equity interests in 732 operating storage facilities.  In addition, the Company managed 242 properties for third parties, bringing the total number of operating properties which it owns and/or manages to 974.  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. 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 redeveloping 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, 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.

 

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 June 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 June 30, 2013, aggregated by the level in the fair value hierarchy within which those measurements fall.

 

					Fair Value Measurements at Reporting Date Using
Description		June 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		$	9,687		$	—		$	9,687		$	—
Other liabilities - Cash Flow Hedge Swap Agreements		$	(5,037	)	$	—		$	(5,037	)	$	—

 

There were no transfers of assets and liabilities between Level 1 and Level 2 during the six months ended June 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 six months ended June 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 June 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, 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 approximated current market rates for loans, or groups of loans, with similar maturities and credit quality.

 

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

 

		June 30, 2013						December 31, 2012
		Fair			Carrying			Fair			Carrying
		Value			Value			Value			Value
Note receivable from Preferred Operating Partnership unit holder		$	104,276		$	100,000		$	108,138		$	100,000
Fixed rate notes payable and notes payable to trusts		$	1,258,731		$	1,257,954		$	1,342,957		$	1,275,605
Exchangeable senior notes		$	231,250		$	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 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

 

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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 June 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 June 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 six months ended June 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 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, 2013 and 2012, options to purchase 52,471 and 66,042 shares of common stock, respectively, and for the six months ended June 30, 2013 and 2012, options to purchase 39,171 and 48,980 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 June 30,						For the Six Months Ended June 30,
		2013			2012			2013			2012
Net income attributable to common stockholders		$	34,466		$	22,413		$	65,891		$	42,627
Add: Income allocated to noncontrolling interest - Preferred Operating Partnership and Operating Partnership		2,624			2,325			5,118			4,625
Subtract: Fixed component of income allocated to noncontrolling interest - Preferred Operating Partnership		(1,438		)	(1,437		)	(2,875		)	(2,875		)
Net income for diluted computations		$	35,652		$	23,301		$	68,134		$	44,377
Weighted average common shares outstanding:
Average number of common shares outstanding - basic		111,137,437			102,107,535			110,974,504			98,497,788
Operating Partnership units		2,898,510			3,060,467			2,898,510			3,060,467
Preferred Operating Partnership units		989,980			989,980			989,980			989,980
Shares related to dilutive and cancelled stock options		333,318			495,983			374,506			515,330
Average number of common shares outstanding - diluted		115,359,245			106,653,965			115,237,500			103,063,565
Net income per common share
Basic		$	0.31		$	0.22		$	0.59		$	0.43
Diluted		$	0.31		$	0.22		$	0.59		$	0.43

 

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5.              PROPERTY ACQUISITIONS AND DISPOSITIONS

 

The following table summarizes the Company’s acquisitions of operating properties for the six months ended June 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			Loan Assumed			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		(1)
Illinois		1		2/13/2013		11,083			7,592			—			341			2,251			1,173			(274		)	—			—		1,318			9,485			190			90			(1)
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
2013 Totals		6				$	71,756		$	50,826		$	7,122		$	2,556		$	2,251		$	3,446		$	(575	)	$	6,130		143,860		$	12,109		$	58,226		$	974		$	447

 

(1) Acquired from an affiliated joint venture

 

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 June 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.

 

The following table compares the Company’s liability balance to the VIE JV and the maximum exposure to loss as of June 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		$	—		$	(1,064	)	$	4,307		$	6,044		$	9,287		$	(9,287	)

 

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.

 

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