Extra Space Storage Inc. annual report, FY2016

Extra Space Storage Inc. — FY2016 Form 10-K Summary

Business Context and Reporting Period

Extra Space Storage Inc. is a self-managed, self-administered REIT focused on owning, operating, acquiring, developing and managing self-storage properties. This Form 10-K covers the fiscal year ended December 31, 2016, with comparative information for 2015 and 2014. The filing is an annual report rather than a standalone fourth-quarter filing.

• At year-end, the Company owned or held interests in 1,016 stores, including 836 wholly owned and 180 held through joint ventures.
• It managed an additional 411 third-party stores, for a total of 1,427 owned and/or managed stores across 38 states, Washington, D.C. and Puerto Rico.
• The portfolio contained approximately 107 million rentable square feet, 960,000 units and 850,000 tenants.
• The Company operates through rental operations, tenant reinsurance, and property management, acquisition and development segments.

Financial Performance and Key Metrics

Metric	2016	2015	Change
Total revenue	$991.9 million	$782.3 million	26.8%
Property rental revenue	$864.7 million	$676.1 million	27.9%
Income from operations	$449.8 million	$294.7 million	52.7%
Net income attributable to common stockholders	$366.1 million	$189.5 million	93.2%
Basic diluted EPS	$2.92 / $2.91	$1.58 / $1.56	Significant increase
FFO attributable to common stockholders and unit holders	$494.7 million	$331.3 million	49.3%
Net cash provided by operating activities	$539.3 million	$367.3 million	46.8%
Cash dividends paid per common share	$2.93	$2.24	30.8%

Income from operations represented approximately 45.3% of revenue, while net income attributable to common stockholders represented approximately 36.9% of revenue. Same-store net operating income increased 9.2% to $518.1 million, despite same-store occupancy declining to 92.0% from 92.8% at year-end 2015. Stabilized store occupancy was 91.4% at December 31, 2016, compared with 91.0% on a pro forma basis for 2015.

• Average annual rent per square foot for existing customers at stabilized stores increased to $15.88 from $14.92.
• Average annual rent per square foot for new leases increased to $17.02 from $15.91.
• Achieved rental rates for new tenants at wholly owned properties increased approximately 7.0% year over year.
• Management fees and other income increased 16.6% to $39.8 million; tenant reinsurance revenue increased 21.3% to $87.3 million.

Cash Flow, Debt and Liquidity

• Operating cash flow was $539.3 million. Investing cash flow was an outflow of $1.032 billion, primarily reflecting $1.087 billion of real estate acquisitions and $23.3 million of development and redevelopment spending.
• Financing cash flow was $460.8 million. Year-end cash and cash equivalents were $43.9 million, down from $75.8 million.
• Debt consisted of approximately $4.364 billion of face-value indebtedness, or approximately $4.306 billion net on the balance sheet. Total assets were $7.091 billion and stockholders’ equity was $2.245 billion.
• Debt to total enterprise value was 29.6%; 70.0% of debt was fixed-rate or economically fixed through interest-rate swaps, and the weighted-average interest rate was 3.0%.
• Approximately $1.3 billion, or 30.0% of debt, was exposed to variable rates excluding debt with swaps. A 100-basis-point increase in applicable rates was estimated to increase annual interest expense by approximately $13.1 million.
• Revolving credit capacity was $600 million, of which $365 million was drawn at year-end, leaving approximately $235 million of stated capacity before other limitations.
• The Company was in compliance with all financial covenants at December 31, 2016, but expects to rely on operating cash flow, additional borrowings, joint ventures and future debt or equity offerings to fund acquisitions, distributions and maturities.

Material Changes and Unusual Items

• The Company acquired 99 stores in 2016 compared with 171 in 2015. Real estate acquisition spending declined substantially from the prior year, which included the SmartStop acquisition.
• Revenue growth was driven primarily by acquisitions completed in 2016 and 2015, higher rents at stabilized stores and increased occupancy at lease-up properties.
• Acquisition-related costs declined to $12.1 million from $69.4 million. The 2015 amount included approximately $63.1 million of SmartStop-related costs, including debt defeasance, professional fees, severance and other expenses.
• The Company completed step acquisitions from joint ventures involving 40 stores and recognized substantial gains, including a $30.8 million gain on the sale of its remaining PRISA II interest and other remeasurement gains. Total equity-method gains on real estate transactions and partner-interest purchases were $69.2 million in 2016 versus $2.9 million in 2015.
• The Company sold nine stores during 2016 and recognized a total gain of $11.4 million on related dispositions, partially offset by a $4.3 million increase in an acquisition earnout liability.
• A California store damaged by fire in 2014 reopened in 2016 and remained in lease-up.
• Legal proceedings resulted in a recorded liability of $5.6 million for claims including alleged wrongful foreclosure, self-storage statute violations and consumer fraud matters. The filing states that potential exposure could exceed accrued amounts.
• Spencer F. Kirk served as CEO through December 31, 2016. Joseph D. Margolis became CEO effective January 1, 2017.

Outlook, Management Commentary and Risks

Management intends to maximize store performance through revenue-management technology, pursue disciplined acquisitions and expand the management business. The Company expects higher interest rates could increase capitalization rates and reduce acquisition prices, but it states that it will acquire properties only when expected to enhance stockholder value. No specific earnings, revenue or FFO guidance is provided in the filing.

• Self-storage demand, rents and occupancy are seasonal, with stronger activity generally from May through September.
• Competition from public and private operators may pressure rents, occupancy and acquisition pricing.
• Growth depends on successfully financing, integrating, operating and leasing acquired and developed properties.
• Higher interest rates could increase debt service, reduce cash flow and impair acquisition capacity. Debt maturities and contractual obligations total approximately $5.058 billion, including $4.364 billion of principal and $573.4 million of interest.
• The Company faces risks relating to real estate valuations, environmental liabilities, uninsured losses, natural disasters, regulatory changes, tenant defaults, information security, joint venture partners and retention of key personnel.
• Maintaining REIT status requires compliance with complex asset, income, ownership and distribution tests, including distributing at least 90% of REIT taxable income.
• The Company had commitments to acquire four operating stores and 12 stores under construction for a total purchase price of $183.6 million, plus commitments for 16 stores with joint venture partners involving a net investment of $74.7 million.

Important Facts for Investors to Verify

• Reconcile reported net income and EPS with FFO, including the effect of the $69.2 million of joint-venture transaction gains and other nonrecurring items.
• Review same-store occupancy, rental-rate growth, discounts, bad debt and expense trends to assess whether rent growth can offset occupancy pressure.
• Assess debt maturities, refinancing requirements, variable-rate exposure, covenant headroom and the availability of the revolving facilities.
• Evaluate the return and lease-up risk of acquired, developed and newly reopened stores, particularly the 118 lease-up stores with 60.4% occupancy at year-end.
• Review the $5.6 million accrued litigation liability and the potential for additional losses, as well as environmental, insurance and regulatory contingencies.
• Consider the funding needs for dividends, committed acquisitions and future growth, including the potential dilution or increased leverage from new equity or debt issuance.
• Confirm the Company’s continued REIT qualification, joint-venture economics and the terms of redeemable or exchangeable Operating Partnership units.