EXR

Business Context and Reporting Period

Company: Extra Space Storage Inc. (EXR)
Filing Type: Form 10-K (Annual Report)
Period Ended: December 31, 2007
Business Overview: Extra Space Storage is a self-administered and self-managed Real Estate Investment Trust (REIT) owning, operating, acquiring, and developing self-storage facilities. As of December 31, 2007, the Company owned or held ownership interests in 606 properties across 33 states and Washington, D.C., comprising approximately 44 million square feet of net rentable space. The portfolio includes 260 wholly-owned properties, 346 joint-venture properties, and 45 managed properties for third parties.

Key Financial Metrics

Material Changes vs. Prior Period

• Revenue Growth: Total revenues increased 21.1% to $238.9 million, driven primarily by a 20.7% increase in property rental revenues ($206.3 million). This growth was attributed to acquisitions completed in 2006 and 2007 ($28.3 million), rental rate increases at stabilized properties ($5.3 million), and occupancy gains at lease-up properties.
• Tenant Insurance: Tenant insurance revenues surged 155.9% to $11.0 million following the introduction of a captive insurance program in late 2006 and increased customer participation (34% in 2007 vs. 18% in 2006).
• Interest Expense: Interest expense rose 19.7% to $61.0 million, primarily due to $6.9 million in interest on exchangeable notes issued in March 2007 and $5.3 million on mortgage loans for recent acquisitions.
• Impairment Charges: The Company recorded a $1.2 million other-than-temporary impairment charge and a $1.4 million temporary impairment charge related to Auction Rate Securities (ARS) due to failed auctions in the credit markets.
• Same-Store Performance: On a same-store stabilized basis, rental revenues increased 3.9% and Net Operating Income (NOI) increased 5.3%. However, same-store occupancy decreased slightly to 84.1% from 85.1% in the prior year.

Guidance, Outlook, and Risks

Outlook: Management anticipates continued strength in self-storage fundamentals in core markets, citing low levels of new supply and continued demand. The Company expects to increase revenues in 2008 over 2007 levels. The development pipeline through 2009 includes 26 projects.

Liquidity and Capital Resources:

• The Company maintains a $100.0 million revolving line of credit with full capacity available as of year-end.
• Long-term liquidity needs (distributions, development, acquisitions) are expected to be funded through operating cash flow, additional borrowings, joint ventures, and equity/debt offerings.
• Approximately $24.5 million in par value of Auction Rate Securities (ARS) remains illiquid due to failed auctions, though management does not anticipate this affecting operations.

Key Risks and Contingencies:

• Credit Market Disruptions: Recent disruptions in credit markets have widened spreads and limited access to debt financing, potentially impacting growth and refinancing.
• Competition: Increased competition from new facilities and other operators has led to pricing pressure in certain markets.
• REIT Qualification: The Company must distribute at least 90% of net taxable income to maintain REIT status; failure to do so would result in corporate taxation.
• Interest Rate Risk: Approximately 9.5% of total debt is subject to variable interest rates. A 100 basis point increase in LIBOR would increase annual interest expense by approximately $1.2 million.

Investor Verification Checklist

• ARS Liquidity: Verify the status of the $24.5 million investment in Auction Rate Securities and potential for further impairment charges if auctions continue to fail.
• Debt Maturities: Review the schedule of debt maturities, noting $43.5 million due within one year and $415.0 million due within three years, to assess refinancing risks in a tight credit market.
• Occupancy Trends: Monitor same-store occupancy rates, which declined slightly in 2007, to ensure revenue growth is not solely driven by rate increases that may face resistance.
• Related Party Transactions: Review the December 31, 2007 acquisition of Extra Space Development (ESD), a related party entity, for valuation and terms.
• Dividend Sustainability: Confirm that operating cash flows remain sufficient to cover the increased dividend rate of $1.00 per share (announced Oct 2007) and REIT distribution requirements.