Extra Space Storage Inc. quarterly report, Q3 FY2013

Extra Space Storage Inc. — 2013 Q3 Form 10-Q Summary

Business context and reporting period

Extra Space Storage Inc. is a fully integrated, self-managed REIT focused on owning, operating, acquiring, developing and managing self-storage facilities. This unaudited Form 10-Q covers the three and nine months ended September 30, 2013, compared with the corresponding 2012 periods.

At September 30, 2013, the company owned or held interests in 754 operating properties and managed 253 properties for third parties, for 1,007 total operating properties across 35 states, Washington, D.C. and Puerto Rico.
The portfolio included approximately 74.0 million square feet and 667,000 units; stabilized properties represented 88.8% square-foot occupancy versus 87.0% on a pro forma basis at September 30, 2012.
The company operates through rental operations, tenant reinsurance, and property management, acquisition and development.

Financial performance and key metrics

Metric	Three months ended September 30, 2013	Three months ended September 30, 2012	Nine months ended September 30, 2013	Nine months ended September 30, 2012
Total revenues	$133.1 million	$109.8 million	$378.7 million	$295.7 million
Income from operations	$56.1 million	$43.5 million	$156.2 million	$114.1 million
Net income	$32.4 million	$41.6 million	$103.4 million	$88.8 million
Net income attributable to common stockholders	$29.2 million	$38.6 million	$95.1 million	$81.2 million
Basic earnings per share	$0.26	$0.37	$0.86	$0.81
Diluted earnings per share	$0.26	$0.37	$0.84	$0.80
Funds from operations	$54.7 million	$47.2 million	$165.9 million	$121.3 million
Cash flow from operating activities	Not presented for the quarter	Not presented for the quarter	$198.6 million	$153.0 million

Third-quarter revenue increased 21.2%, while nine-month revenue increased 28.0%. Property rental revenue rose 21.1% in the quarter and 30.1% year to date, driven by acquisitions, higher occupancy and increased rental rates.
Third-quarter operating income increased 28.9%; the operating margin was approximately 42.1%, compared with 39.6% in the prior-year quarter. The nine-month operating margin was approximately 41.2%, compared with 38.6%.
Third-quarter net income attributable to common stockholders declined 24.2%, primarily because 2012 included a $13.6 million gain from unconsolidated real estate ventures, while 2013 included a $9.2 million loss on extinguishment of debt related to a portfolio acquisition.
Nine-month net income attributable to common stockholders increased 17.1%, and nine-month FFO increased 36.8%.
Same-store rental and tenant reinsurance revenue increased 7.8% in the quarter and 7.7% year to date. Same-store net operating income increased 9.7% and 10.3%, respectively.
Average annual rent per square foot for existing customers at stabilized properties increased to $14.12 from $13.44. New-lease rent increased to $14.32 from $13.98, while average discounts declined to 3.8% from 5.0%.

Cash flow, debt and liquidity

Cash and cash equivalents were $81.7 million at September 30, 2013, compared with $30.8 million at December 31, 2012.
Operating cash flow was $198.6 million for the first nine months, up from $153.0 million. Investing cash outflow was $100.3 million, including $86.9 million for acquisitions, development and redevelopment, versus $375.1 million of investing outflow in the prior-year period.
Financing activities used $47.4 million, compared with $239.2 million of financing inflow in the prior-year period. The change reflected lower equity and debt proceeds, higher principal repayments and dividends, partly offset by issuance of exchangeable senior notes.
Face value of debt, including lines of credit, was $1.772 billion. Debt to total market capitalization was 24.8%, the weighted-average interest rate was 3.8%, and 85.7% of debt and related instruments was fixed-rate or hedged.
The company had $250.0 million of unused secured credit capacity across four lines of credit. It was in compliance with all financial covenants at September 30, 2013.
On June 21, 2013, the Operating Partnership issued $250.0 million of 2.375% exchangeable senior notes due 2033. The notes had a net carrying amount of $232.7 million at quarter end after discounts and are guaranteed by the company.
Contractual obligations totaled $2.241 billion, including $1.772 billion of principal, $403.3 million of interest and $65.4 million of operating leases.

Material changes versus the prior comparable period

The company acquired 28 operating properties during the first nine months of 2013 for total consideration of $278.4 million, including a California portfolio acquired in August and September.
The California portfolio acquisition involved $100.9 million of cash, $33.6 million of Series B preferred Operating Partnership units and $62.3 million of common Operating Partnership units. The assumed debt was immediately defeased, resulting in a $9.2 million extinguishment loss.
Series B preferred Operating Partnership units totaling $33.6 million were issued in connection with the acquisition. The units carry a 6% annual distribution and become redeemable at the holder’s option on August 29, 2014.
Real estate assets, net, increased to $3.224 billion from $2.992 billion at December 31, 2012, while total assets increased to $3.518 billion from $3.223 billion.
Notes payable increased to $1.402 billion from $1.370 billion, exchangeable senior notes of $250.0 million were added, and previously outstanding lines of credit totaling $85.0 million at year-end were undrawn at September 30, 2013.
Tenant reinsurance expense increased 108.3% in the quarter and 50.2% year to date, partly because of claims related to fires at two properties and higher participation in the program.
Dividends paid per common share increased to $0.40 in the quarter and $1.05 year to date, compared with $0.20 and $0.60, respectively, in the prior-year periods.

Outlook, commentary, risks and unusual items

Management intends to continue maximizing property performance, pursuing acquisitions selectively, expanding the management platform and using its UPREIT structure to facilitate transactions.
Management stated that acquisition prices were increasing but that it remained a disciplined buyer. The filing provides no quantitative earnings or revenue guidance.
Near-term liquidity is expected to come from operating cash flow, cash on hand and credit facilities. Management expects additional secured or unsecured debt, joint ventures and equity or debt offerings may be needed to fund acquisitions and other liquidity needs.
The company is required to distribute at least 90% of annual taxable income, excluding net capital gains, to maintain REIT status.
Self-storage operations are seasonal, with a greater portion of revenues and profits generally realized from May through September.
Key risks include competition and potential declines in occupancy or rents, acquisition execution and integration, access to capital, higher interest rates and operating costs, asset impairment, regulatory and REIT qualification risks, uninsured losses, joint venture obligations and general economic weakness.
The company guaranteed a $4.3 million loan of an unconsolidated joint venture; management considered the likelihood of a material loss remote and recorded no liability.
As subsequent events, the company disclosed acquisitions in Georgia, North Carolina and other states, including a $94.0 million purchase of an additional 49% interest in a joint venture and a $96.4 million acquisition of 16 properties.
No material litigation was reported, no material changes to previously disclosed risk factors were identified, and disclosure controls were deemed effective.

Investor verification points

Verify the sustainability of same-store occupancy, rental-rate growth and the 9.7% quarterly same-store NOI increase.
Assess the impact of acquisitions and lease-up properties on future revenue, operating expenses and depreciation.
Review debt maturities, secured credit-line maturities, covenant compliance and sensitivity to interest-rate increases.
Evaluate the cash-flow coverage of common dividends, preferred-unit distributions, acquisition spending and scheduled debt obligations.
Understand the dilution and redemption implications of the exchangeable senior notes, Series B preferred units and common Operating Partnership units.
Monitor tenant reinsurance claims and the resulting increase in reinsurance expense.
Review the disclosed subsequent acquisitions and whether additional financing or equity issuance will be required.