UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

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) 562-5556

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 is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer x

Accelerated filer o

Non-accelerated filer o

 

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 April 30, 2007 was 64,375,757.

EXTRA SPACE STORAGE INC.

TABLE OF CONTENTS

STATEMENT ON FORWARD-LOOKING INFORMATION		3
PART I. FINANCIAL INFORMATION		4
ITEM 1. FINANCIAL STATEMENTS		4
EXTRA SPACE STORAGE INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) AMOUNTS IN THOUSANDS, EXCEPT SHARES AND PER SHARE DATA		8
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS		20
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. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS		33
ITEM 5. OTHER INFORMATION		33
ITEM 6. EXHIBITS		33
SIGNATURES		34

 

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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:

·                  changes in general economic conditions and in the markets in which we operate;

·                  the effect of competition from new self-storage facilities or other storage alternatives, which could cause rents and occupancy rates to decline;

·                  our ability to effectively compete in the industry in which we do business;

·                  difficulties in our ability to evaluate, finance and integrate acquired and developed properties into our existing operations and to lease up those properties, which could adversely affect our profitability;

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

·                  difficulties in raising capital at reasonable rates, which could impede our ability to grow;

·                  delays in the development and construction process, which could adversely affect our profitability; and

·      economic uncertainty due to the impact of war or terrorism, which could adversely affect our business plan.

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PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

Extra Space Storage Inc.
Condensed Consolidated Balance Sheets
(in thousands, except share data)

		March 31, 2007			December 31, 2006
		(unaudited)
Assets:
Real estate assets:
Net operating real estate assets		$	1,419,774		$	1,382,055
Real estate under development		31,423			35,336
Net real estate assets		1,451,197			1,417,391
Investments in real estate ventures		92,515			88,115
Cash and cash equivalents		35,111			70,801
Short-term investments		286,360			—
Restricted cash		46,094			44,282
Receivables from related parties and affiliated real estate joint ventures		5,966			15,880
Other assets, net		34,367			33,356
Total assets		$	1,951,610		$	1,669,825
Liabilities, Minority Interests, and Stockholders’ Equity:
Notes payable		$	873,710		$	828,584
Notes payable to trusts		119,590			119,590
Exchangeable senior notes		250,000			—
Line of credit		—			—
Accounts payable and accrued expenses		6,941			10,840
Other liabilities		30,138			32,098
Total liabilities		1,280,379			991,112
Minority interest in Operating Partnership		34,322			34,841
Other minority interests		333			317
Commitments and contingencies
Stockholders’ equity:
Preferred stock, $0.01 par value, 50,000,000 shares authorized, no shares issued or outstanding		—			—
Common stock, $0.01 par value, 200,000,000 shares authorized, 64,304,353 and 64,167,098 shares issued and outstanding at March 31, 2007 and December 31, 2006, respectively		644			642
Paid-in capital		823,348			822,181
Accumulated deficit		(187,416		)	(179,268		)
Total stockholders’ equity		636,576			643,555
Total liabilities, minority interests, and stockholders’ equity		$	1,951,610		$	1,669,825

 

See accompanying notes to unaudited condensed consolidated financial statements.

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Extra Space Storage Inc.
Condensed Consolidated Statements of Operations
(in thousands, except share data)
(unaudited)

		Three months ended March 31,
		2007			2006
Revenues:
Property rental		$	46,231		$	39,175
Management and franchise fees		5,208			5,159
Tenant insurance		2,143			921
Development fees		55			50
Other income		139			65
Total revenues		53,776			45,370
Expenses:
Property operations		16,896			14,742
Tenant insurance		973			633
Unrecovered development and acquisition costs		250			318
General and administrative		9,240			9,245
Depreciation and amortization		8,796			9,276
Total expenses		36,155			34,214
Income before interest, minority interests and equity in earnings of real estate ventures		17,621			11,156
Interest expense		(13,396		)	(11,985		)
Interest income		1,448			482
Minority interest - Operating Partnership		(384		)	(54		)
Minority interests - Other		(16		)	—
Equity in earnings of real estate ventures		1,197			1,139
Net income		$	6,470		$	738
Net income per common share
Basic		$	0.10		$	0.01
Diluted		$	0.10		$	0.01
Weighted average number of shares
Basic		64,058,756			51,593,729
Diluted		68,786,185			55,709,430
Cash dividends paid per common share		$	0.23		$	0.23

 

See accompanying notes to unaudited condensed consolidated financial statements.

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Extra Space Storage Inc.
Condensed Consolidated Statement of Stockholders’ Equity
(in thousands, except share data)
(unaudited)

		Common Stock					Paid-in			Deferred			Accumulated			Total Stockholders’
		Shares		Par Value			Capital			Compensation			Deficit			Equity
Balances at December 31, 2005		51,765,795		$	518		$	626,123		$	(2,374	)	$	(144,139	)	$	480,128
Reclassification of deferred compensation upon adoption of SFAS 123R		—		—			(2,374		)	2,374			—			—
Issuance of common stock, net of offering costs		12,075,000		121			194,780			—			—			194,901
Issuance of common stock upon the exercise of options		98,003		1			545			—			—			546
Issuance of common stock to board members		12,000		—			—			—			—			—
Restricted stock grants issued		49,800		—			—			—			—			—
Restricted stock grants cancelled		(33,500	)	—			—			—			—			—
Compensation expense related to stock-based awards		—		—			1,725			—			—			1,725
Conversion of Operating Partnership units to common stock		200,000		2			1,809			—			—			1,811
Other adjustments		—		—			(427		)	—			—			(427		)
Net income		—		—			—			—			14,876			14,876
Dividends paid on common stock at $0.91 per share		—		—			—			—			(50,005		)	(50,005		)
Balances at December 31, 2006		64,167,098		642			822,181			—			(179,268		)	643,555
Issuance of common stock upon the exercise of options		54,106		1			731			—			—			732
Restricted stock grants issued		30,800		—			—			—			—			—
Conversion of Contigent Conversion Shares to common stock		52,349		1			—			—			—			1
Compensation expense related to stock-based awards		—		—			436			—			—			436
Net income		—		—			—			—			6,470			6,470
Dividends paid on common stock at $0.2275 per share		—		—			—			—			(14,618		)	(14,618		)
Balances at March 31, 2007		64,304,353		$	644		$	823,348		$	—		$	(187,416	)	$	636,576

 

See accompanying notes to unaudited condensed consolidated financial statements.

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Extra Space Storage Inc.
Condensed Consolidated Statements of Cash Flows
(in thousands)
(unaudited)

		Three months ended March 31,
		2007			2006
Cash flows from operating activities:
Net income		$	6,470		$	738
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		8,796			9,276
Amortization of deferred stock compensation		—			186
Amortization of deferred financing costs		632			608
Stock compensation expense		436			200
Gain allocated to minority interests		400			54
Distributions from real estate ventures in excess of earnings		681			1,303
Accrued interest on notes receivable		—			(251		)
Changes in operating assets and liabilities:
Receivables from related parties		9,914			7,093
Other assets		4,095			3,035
Accounts payable		(3,899		)	(5,935		)
Other liabilities		(1,863		)	(1,277		)
Net cash provided by operating activities		25,662			15,030
Cash flows from investing activities:
Acquisition of real estate assets		(34,709		)	(42,910		)
Development and construction of real estate assets		(6,926		)	(5,543		)
Proceeds from sale of real estate assets		—			728
Investments in real estate ventures		(5,583		)	(57		)
Purchase of short-term investments		(286,360		)	—
Change in restricted cash		(1,812		)	1,615
Principal payments received on notes receivable		—			364
Purchase of equipment and fixtures		(259		)	(241		)
Net cash used in investing activities		(335,649		)	(46,044		)
Cash flows from financing activities:
Proceeds from exchangeable senior notes		250,000			—
Proceeds from notes payable, notes payable to trusts and line of credit		45,454			30,635
Principal payments on notes payable and line of credit		(692		)	(4,049		)
Deferred financing costs		(5,676		)	(608		)
Net proceeds from exercise of stock options		732			91
Dividends paid on common stock		(14,618		)	(11,777		)
Distributions to Operating Partnership units held by minority interests		(903		)	(870		)
Net cash provided by financing activities		274,297			13,422
Net decrease in cash and cash equivalents		(35,690		)	(17,592		)
Cash and cash equivalents, beginning of the period		70,801			28,653
Cash and cash equivalents, end of the period		$	35,111		$	11,061
Supplemental schedule of cash flow information
Interest paid, net of amounts capitalized		$	12,018		$	10,964
Supplemental schedule of noncash investing and financing activities:
Acquisitions:
Real estate assets		$	502		$	—
Investment in real estate ventures		(502		)	—

 

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 shares and per share data

1.              ORGANIZATION

Extra Space Storage Inc. (the “Company”) is a fully-integrated, self-administered and self-managed real estate investment trust (“REIT”), formed as a Maryland corporation on April 30, 2004 to own, operate, manage, acquire and develop 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 or developing wholly-owned facilities or facilities held through a joint venture with third parties. At March 31, 2007, the Company had direct and indirect equity interests in 571 storage facilities located in 32 states and Washington, D.C.

The Company operates in two distinct segments: (1) property management, acquisition and development; and (2) rental operations. The Company’s property management and development activities include acquiring, managing, 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.

2.              BASIS OF PRESENTATION

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared 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 do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2007 are not necessarily indicative of results that may be expected for the year ended December 31, 2007. The Condensed Consolidated Balance Sheet as of December 31, 2006 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, 2006 as filed with the Securities and Exchange Commission (“SEC”).

Reclassifications

Certain amounts in the 2006 financial statements and supporting note disclosures have been reclassified to conform to the current year presentation.  Such reclassification did not impact previously reported net income or accumulated deficit.

3.              NET INCOME PER SHARE

Basic earnings per common share is computed by dividing net income by the weighted average common shares outstanding, less non-vested restricted stock. 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 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 the treasury stock method. Potential common shares are securities (such as options, warrants, convertible debt, Contingent Conversion Shares (“CCS”), Contingent Conversion Units (“CCU”) and convertible Operating Partnership 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 or loss 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

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shares that are dilutive, those that reduce earnings per share, are included.  For the three months ended March 31, 2007 and 2006, options outstanding of 420,456 and 281,988, Operating Partnership units of 3,810,261 and 3,825,787 and CCS/CCU shares of 471,047 and zero were dilutive, respectively.

4.              REAL ESTATE ASSETS

The components of real estate assets are summarized as follows:

		March 31, 2007			December 31, 2006
Land		$	374,453		$	361,569
Buildings and improvements		1,118,028			1,085,269
Intangible assets - tenant relationships		25,829			25,436
Intangible lease rights		3,400			3,400
		1,521,710			1,475,674
Less: accumulated depreciation and amortization		(101,936		)	(93,619		)
Net operating real estate assets		1,419,774			1,382,055
Real estate under development		31,423			35,336
Net real estate assets		$	1,451,197		$	1,417,391

 

5.              PROPERTY ACQUISITIONS

The following table shows the Company’s acquisition of operating properties for the current year and does not include purchases of raw land or improvements made to existing assets:

										Loans				Other (Assets)				Number of
		Number of		Date of		Total		Cash		Receivable		Loan		or Liabilities		Value of OP		OP Units		Source of
Property Location(s)		Properties		Acquisition		Consideration		Paid		Settled		Assumed		Assumed, net		Units Issued		Issued		Acquisition
Tennessee		1		1/5/2007		3,684		3,672		—		—		12		—		—		Unrelated franchisee
Arizona		1		1/2/2007		4,693		4,527		—		—		166		—		—		Related joint venture
Maryland		1		1/11/2007		14,334		14,348		—		—		(14	)	—		—		Unrelated franchisee
Florida		1		3/27/2007		6,320		6,257		—		—		63		—		—		Unrelated franchisee

 

6.              INVESTMENTS IN REAL ESTATE VENTURES

Investments in real estate ventures consisted of the following:

		Excess Profit		Equity		Investment balance at
		Participation %		Ownership %		March 31, 2007			December 31, 2006
Extra Space West One LLC (“ESW”)		40	%	5	%	$	1,830		$	1,918
Extra Space Northern Properties Six, LLC (“ESNPS”)		35	%	10	%	1,677			1,757
PRISA Self Storage LLC (“PRISA”)		17	%	2	%	13,558			13,393
PRISA II Self Storage LLC (“PRISA II”)		17	%	2	%	10,920			10,821
PRISA III Self Storage LLC (“PRISA III”)		20	%	5	%	4,561			4,534
VRS Self Storage LLC (“VRS”)		20	%	5	%	4,614			4,547
WCOT Self Storage LLC (“WCOT”)		20	%	5	%	5,343			5,287
Storage Portfolio I, LLC (“SP I”)		40	%	25	%	19,281			19,260
Storage Portfolio Bravo II (“SPB II”)		45	%	20	%	15,089			15,264
Other minority owned properties		10-50	%	10-50	%	15,642			11,334
						$	92,515		$	88,115

 

On March 1, 2007, the Company acquired a 39.5% interest in U-Storage de Mexico S.A., an existing Mexican corporation (“U-Storage”), which currently manages, develops, owns and operates self storage facilities in Mexico.  Included in Other Minority Owned Properties is $5,083 relating to the Company’s investment in Mexico.  Kenneth T. Woolley, a former Senior Vice President of the Company and son of Kenneth M. Woolley, the CEO of the Company, also acquired a 0.5% interest in U-Storage de Mexico S.A.

In these joint ventures, the Company and the joint venture partner generally receive a preferred return on their invested

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capital. To the extent that cash/profits in excess of these preferred returns are generated through operations or capital transactions, the Company would receive a higher percentage of the excess cash/profits than its equity interest.

The components of equity in earnings of real estate ventures consist of the following:

		Three months ended March 31,
		2007			2006
Equity in earnings of ESW		$	348		$	340
Equity in earnings of ESNPS		46			36
Equity in earnings of PRISA		170			125
Equity in earnings of PRISA II		130			110
Equity in earnings of PRISA III		63			23
Equity in earnings of VRS		61			34
Equity in earnings of WCOT		70			33
Equity in earnings of SP I		204			224
Equity in earnings of SPB II		189			189
Equity in earnings of other minority owned properties		(84		)	25
		$	1,197		$	1,139

 

Equity in earnings of SP I and SPB II includes the amortization of the Company’s excess purchase price of approximately $22 million of these equity investments over its original basis. The excess basis is amortized over 40 years.

7.              SHORT-TERM INVESTMENTS

The Company accounts for its investments in debt and equity securities according to the provisions of Statement of Financial Accounting Standards (“SFAS”) No. 115, Accounting for Certain Investments in Debt and Equity Securities, which requires securities classified as “available-for-sale” to be stated at fair value. Adjustments to fair value of available-for-sale securities are recorded as a component of other comprehensive income (loss).  A decline in the market value of equity securities below cost, that is deemed to be other than temporary, results in a reduction in the carrying amount to fair value.  The impairment is charged to earnings and a new cost basis for the security is established.  At March 31, 2007, we had $286.4 million in highly-liquid auction rate securities (“ARS”) and variable rate demand notes classified as available-for-sale securities. Although these securities have long-term stated contractual maturities, they can be presented for redemption at auction when rates are reset which is typically every 7, 28 or 35 days.  We had no realized or unrealized gains or losses related to these securities during the period ended March 31, 2007.  All income related to these investments was recorded as interest income. In accordance with our investment policy, we only invest in ARS with high credit quality issuers and limit the amount of investment exposure to any one issuer.

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8.              NOTES PAYABLE

The components of notes payable are summarized as follows:

		March 31, 2007			December 31, 2006
Fixed Rate
Mortgage and construction loans with banks bearing interest at fixed rates between 4.65% and 7.50%. The loans are collateralized by mortgages on real estate assets and the assignment of rents. Principal and interest payments are made monthly with all outstanding principal and interest due between March 1, 2008 and February 11, 2017.		$	787,066		$	743,511
Variable Rate
Mortgage and construction loans with banks bearing floating interest rates (including loans subject to interest rate swaps) based on LIBOR. Interest rates based on LIBOR are between LIBOR plus 0.66% (5.97% and 6.01% at March 31, 2007 and December 31, 2006, respectively) and LIBOR plus 2.75% (8.07% and 8.10% at March 31, 2007 and December 31, 2006, respectively). The loans are collateralized by mortgages on real estate assets and the assignment of rents. Principal and interest payments are made monthly with all outstanding principal and interest due between October 25, 2007 and October 31, 2009.		86,644			85,073
		$	873,710		$	828,584

 

Real estate assets are pledged as collateral for the notes payable. The Company is subject to certain restrictive covenants relating to the outstanding notes payable. The Company was in compliance with all covenants at March 31, 2007.

In October 2004, the Company entered into a reverse interest rate swap agreement (“Swap Agreement”) to float $61,770 of 4.30% fixed interest rate secured notes due in September 2009. Under this Swap Agreement, the Company will receive interest at a fixed rate of 4.30% and pay interest at a variable rate equal to LIBOR plus 0.66%. The Swap Agreement matures at the same time the notes are due. This Swap Agreement is a fair value hedge, as defined by SFAS No. 133, and the fair value of the Swap Agreement is recorded as an asset or liability, with an offsetting adjustment to the carrying value of the related note payable. Monthly variable interest payments are recognized as an increase or decrease in interest expense.

The estimated fair value of the Swap Agreement at March 31, 2007 and December 31, 2006 was reflected as an other liability of $1,561 and $1,925, respectively. For the three months ended March 31, 2007 and 2006, interest expense has been increased by $261 and $96 as a result of the Swap Agreement.

9.              NOTES PAYABLE TO TRUSTS

During July 2005, ESS Statutory Trust III (the “Trust III”), a newly formed Delaware statutory trust and a wholly-owned, unconsolidated subsidiary of the Operating Partnership, issued an aggregate of $40.0 million of preferred securities which mature on July 31, 2035. In addition, the Trust III issued 1,238 of Trust common securities to the Operating Partnership for a purchase price of $1.2 million. On July 27, 2005, the proceeds from the sale of the preferred and common securities of $41.2 million were loaned in the form of a note to the Operating Partnership (“Note 3”). Note 3 has a fixed rate of 6.91% through July 31, 2010, and then will be payable at a variable rate equal to the three-month LIBOR plus 2.40% per annum. The interest on Note 3, payable quarterly, will be used by the Trust III to pay dividends on the trust preferred securities. The trust preferred securities may be redeemed by the Trust with no prepayment premium after July 27, 2010.

During May 2005, ESS Statutory Trust II (the “Trust II”), a newly formed Delaware statutory trust and a wholly-owned, unconsolidated subsidiary of the Operating Partnership, issued an aggregate of $41.0 million of preferred securities which

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mature on June 30, 2035. In addition, the Trust II issued 1,269 of Trust common securities to the Operating Partnership for a purchase price of $1.3 million. On May 24, 2005, the proceeds from the sale of the preferred and common securities of $42.3 million were loaned in the form of a note to the Operating Partnership (“Note 2”). Note 2 has a fixed rate of 6.67% through June 30, 2010, and then will be payable at a variable rate equal to the three-month LIBOR plus 2.40% per annum. The interest on Note 2, payable quarterly, will be used by the Trust II to pay dividends on the trust preferred securities. The trust preferred securities may be redeemed by the Trust with no prepayment premium after June 30, 2010.

During April 2005, ESS Statutory Trust I (the “Trust”), a newly formed Delaware statutory trust and a wholly-owned, unconsolidated subsidiary of the Operating Partnership issued an aggregate of $35.0 million of trust preferred securities which mature on June 30, 2035. In addition, the Trust issued 1,083 of trust common securities to the Operating Partnership for a purchase price of $1.1 million. On April 8, 2005, the proceeds from the sale of the trust preferred and common securities of $36.1 million were loaned in the form of a note to the Operating Partnership (the “Note”). The Note has a variable rate equal to the three-month LIBOR plus 2.25% per annum. The interest on the Note, payable quarterly, will be used by the Trust to pay dividends on the trust preferred securities. The trust preferred securities may be redeemed by the Trust with no prepayment premium after June 30, 2010.

The Company follows Financial Accounting Standards Board (“FASB”) Intrepretation No. 46R, “Consolidation of Variable Interest Entities” (“FIN 46R”), which addresses the consolidation of variable interest entities (“VIEs”).  Under FIN 46R, Trust, Trust II and Trust III are VIEs that are not consolidated because the Company is not the primary beneficiary. A debt obligation has been recorded in the form of notes as discussed above for the proceeds, which are owed to the Trust, Trust II, and Trust III by the Company.

10.       EXCHANGEABLE SENIOR NOTES

On March 27, 2007, our Operating Partnership issued $250.0 million of its 3.625% Exchangeable Senior Notes due April 1, 2027 (the “Notes”). Costs incurred to issue the Notes were approximately $5.1 million. These costs are being amortized over five years, which represents the estimated term of the Notes, and are included in other assets in the condensed consolidated balance sheet as of March 31, 2007. The Notes are general unsecured senior obligations of the Operating Partnership and are fully guaranteed by the Company. Interest is payable on April 1 and October 1 of each year beginning October 1, 2007 until the maturity date of April 1, 2027. The Notes bear interest at 3.625% per annum and contain an exchange settlement feature, which provides that the Notes may, under certain circumstances, be exchangeable for cash (up to the principal amount of the Notes) and, with respect to any excess exchange value, for cash, shares of our common stock or a combination of cash and shares of our common stock at an initial exchange rate of approximately 42.5822 shares per $1,000 principal amount of Notes at the option of the Operating Partnership.

The Operating Partnership may redeem the Notes at any time to preserve the Company’s status as a REIT. In addition, on or after April 5, 2012, the Operating Partnership may redeem the Notes for cash, in whole or in part, at 100% of the principal amount plus accrued and unpaid interest, upon at least 30 days but not more than 60 days prior written notice to holders of the Notes.

The holders of the Notes have the right to require the Operating Partnership to repurchase the Notes for cash, in whole or in part, on each of April 1, 2012, April 1, 2017 and April 1, 2022, and upon the occurrence of a designated event, in each case for a repurchase price equal to 100% of the principal amount of the Notes plus accrued and unpaid interest. Certain events are considered “Events of Default,” as defined in the indenture governing the Notes, which may result in the accelerated maturity of the Notes.

The Operating Partnership and the Company entered into a registration rights agreement whereby we must register the shares of common stock which could be issued in the future upon exchange. If we fail to file a shelf registration statement with the SEC within 120 days of the issuance of the Notes, and such registration statement is not declared effective within 210 days of the issuance of the Notes, for the first 90 days following such failure, the annual interest rate of the Notes will increase to 3.875% per annum until the registration statement is declared effective. Thereafter, if such registration default is still not cured, the annual interest rate of the Notes will increase to 4.125% per annum until the registration statement is declared effective.

11.       LINE OF CREDIT

The Company, as guarantor, and its Operating Partnership have entered into a $100.0 million revolving line of credit, which

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includes a $10.0 million swingline subfacility (the “Credit Facility”).

The Credit Facility has an interest rate of 175 basis points over LIBOR (7.07% and 7.10% at March 31, 2007 and December 31, 2006, respectively). The Operating Partnership intends to use the proceeds of the Credit Facility for general corporate purposes. As of March 31, 2007, the Credit Facility had approximately $81.0 million of capacity based on the assets collateralizing the Credit Facility. No amounts were outstanding on the line of credit at March 31, 2007 or December 31, 2006. The maturity date on the line of credit is September 2007. The Credit Facility is collateralized by mortgages on certain real estate assets.

12.                               RELATED PARTY AND AFFILIATED REAL ESTATE JOINT VENTURE TRANSACTIONS

The Company provides management and development services for certain joint ventures, franchise, third party and other related party properties. Management agreements provide generally for management fees of 6% of cash collected from properties for the management of operations at the self-storage facilities. The Company earns development fees of 4%-6% of budgeted costs on developmental projects.

Management fee revenue for related party and affiliated real estate joint ventures is summarized as follows:

				March 31,
Entity		Type		2007			2006
ESW		Affiliated real estate joint ventures		$	109		$	101
ESNPS		Affiliated real estate joint ventures		107			102
PRISA		Affiliated real estate joint ventures		1,301			1,232
PRISA II		Affiliated real estate joint ventures		1,042			1,000
PRISA III		Affiliated real estate joint ventures		468			452
VRS		Affiliated real estate joint ventures		285			273
WCOT		Affiliated real estate joint ventures		381			359
SP I		Affiliated real estate joint ventures		310			298
SPB II		Affiliated real estate joint ventures		262			256
Extra Space Development (“ESD”)		Related party		161			96
Various		Franchisees, third parties and other		782			990
				$	5,208		$	5,159

 

Development fee revenue for related party and affiliated real estate joint ventures is summarized as follows:

		March 31,
Type		2007			2006
Affiliated real estate joint ventures		$	55		$	25
Related party		—			25
		$	55		$	50

 

Effective January 1, 2004, the Company entered into a license agreement with Centershift, a related party software provider, to secure a perpetual right for continued use of STORE (the site management software used at all sites operated by the Company) in all aspects of the Company’s property acquisition, development, redevelopment and operational activities. The Company paid Centershift $189 and $178 for the three months ended March 31, 2007 and 2006, respectively, relating to the purchase of software and to license agreements.

Related party and affiliated real estate joint ventures balances are summarized as follows:

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		March 31, 2007			December 31, 2006
Receivables:
Development fees		$	2,678		$	2,633
Other receivables from properties		3,288			13,247
		$	5,966		$	15,880

 

Other receivables from properties consist of amounts due for management fees  and expenses paid by the Company on behalf of the managed properties.  The Company believes that all of these related party and affiliated joint venture receivables are fully collectible. The Company did not have any payables to related parties at March 31, 2007 or December 31, 2006.

13.       MINORITY INTEREST IN OPERATING PARTNERSHIP

The Company’s interest in its properties is held through the Operating Partnership. ESS Holding Business Trust I, a wholly owned subsidiary of the Company, is the sole general partner of the Operating Partnership. The Company, through ESS Holding Business Trust II, a wholly owned subsidiary of the Company, is also a limited partner of the Operating Partnership. Between its general partner and limited partner interests, the Company held a 94.40% majority ownership interest therein as of March 31, 2007. The remaining ownership interests in the Operating Partnership of 5.60% are held by certain former owners of assets acquired by the Operating Partnership, which include a director and officers of the Company.

The minority interest in the Operating Partnership represents Operating Partnership units that are not owned by the Company. In conjunction with the formation of the Company and as a result of subsequent acquisitions, certain persons and entities contributing interests in properties to the Operating Partnership received limited partnership units in the form of either Operating Partnership units or Contingent Conversion Units. Limited partners who received Operating Partnership units in the formation transactions or in exchange for contributions for interests in properties have the right to require the Operating Partnership to redeem part or all of their Operating Partnership units for cash based upon the fair market value of an equivalent number of shares of the Company’s common stock at the time of the redemption. Alternatively, the Company may, at its option, elect to acquire those Operating Partnership units in exchange for shares of its common stock on a one-for-one basis, subject to anti-dilution adjustments provided in the Operating Partnership agreement.

As of March 31, 2007, the Operating Partnership had 3,811,308 and 197,353 Operating Partnership units and CCUs outstanding, respectively.

Unlike the Operating Partnership units, CCUs do not carry any voting rights. Upon the achievement of certain performance thresholds relating to 14 early-stage lease-up properties, all or a portion of the CCUs will be automatically converted into Operating Partnership units. Initially, each CCU will be convertible on a one-for-one basis into Operating Partnership units, subject to customary anti-dilution adjustments. Beginning with the quarter ended March 31, 2006, and ending with the quarter ending December 31, 2008, the Company will calculate the net operating income from the 14 wholly-owned early-stage lease-up properties over the 12-month period ending in such quarter. Within 35 days following the end of each quarter referred to above, some or all of the CCUs will be converted so that the total percentage (not to exceed 100%) of CCUs issued in connection with the formation transactions that have been converted to Operating Partnership units will be equal to the percentage determined by dividing the net operating income for such period in excess of $5.1 million by $4.6 million. If any CCU remains unconverted through the calculation made in respect of the 12-month period ending December 31, 2008, such outstanding CCUs will be cancelled.

While any CCUs remain outstanding, a majority of the Company’s independent directors must review and approve the net operating income calculation for each measurement period and also must approve any sales of any of the 14 wholly-owned early-stage lease-up properties.

As of March 31, 2007, there were 2,693 CCUs converted to Operating Partnership units.  Based on the performance of the properties as of March 31, 2007, an additional 23,046 CCUs became eligible for conversion.  The board of directors approved the conversion of these CCUs on May 1, 2007 as per the Company’s charter, and the units were issued on May 4, 2007.

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14. STOCKHOLDERS’ EQUITY

The Company’s charter provides that it can issue up to 200,000,000 shares of common stock, $0.01 par value per share, 4,100,000 Contingent Conversion Shares, $.01 par value per share, and 50,000,000 shares of preferred stock, $0.01 par value per share. On September 25, 2006, the Company closed a public common stock offering of 12,075,000 shares at an offering price of $17.00 per share, for aggregate gross proceeds of $205,275. Transaction costs were $10,374, resulting in net proceeds of $194,901. As of March 31, 2007, 64,304,353 shares of common stock were issued and outstanding, 3,836,494 CCSs were issued and outstanding and no shares of preferred stock were issued and outstanding. All stockholders of the Company’s common stock are entitled to receive dividends and to one vote on all matters submitted to a vote of stockholders.

Unlike the Company’s shares of common stock, CCSs do not carry any voting rights. Upon the achievement of certain performance thresholds relating to 14 early-stage lease-up properties, all or a portion of the CCSs will be automatically converted into shares of the Company’s common stock. Initially, each CCS will be convertible on a one-for-one basis into shares of common stock, subject to customary anti-dilution adjustments. Beginning with the quarter ended March 31, 2006, and ending with the quarter ending December 31, 2008, the Company will calculate the net operating income from the 14 wholly-owned early-stage lease-up properties over the 12-month period ending in such quarter. Within 35 days following the end of each quarter referred to above, some or all of the CCSs will be converted so that the total percentage (not to exceed 100%) of CCSs issued in connection with the formation transactions that have been converted to common stock will be equal to the percentage determined by dividing the net operating income for such period in excess of $5.1 million  by $4.6 million. If any CCS remains unconverted through the calculation made in respect of the 12-month period ending December 31, 2008, such outstanding CCSs will be cancelled and restored to the status of authorized but unissued shares of common stock.

While any CCSs remain outstanding, a majority of the Company’s independent directors must review and approve the net operating income calculation for each measurement period and also must approve any sales of any of the 14 wholly-owned early-stage lease-up properties.

As of March 31, 2007, there were 52,349 CCSs converted to common stock.  Based on the performance of the properties as of March 31, 2007, an additional 448,001 CCSs became eligible for conversion.  The board of directors approved the conversion of these CCSs on May 1, 2007 as per the Company’s charter, and the shares were issued on May 4, 2007.

15.       STOCK-BASED COMPENSATION

Effective January 1, 2006, the Company adopted SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which requires the measurement and recognition of compensation expense for all share-based payment awards to employees and directors based on estimated fair values. SFAS 123R supersedes SFAS No. 123, “Accounting for Stock-Based Compensation” and Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). The Company adopted SFAS 123R using the modified prospective application method of adoption which requires the Company to record compensation cost related to non-vested stock awards as of December 31, 2005 by recognizing the unamortized grant date fair value of these awards over their remaining service period with no change in historical reported earnings. Awards granted after December 31, 2005 are valued at fair value in accordance with provisions of SFAS 123R and recognized on a straight line basis over the service periods of each award. The forfeiture rate, which is estimated at a weighted average of 15.2% of unvested options outstanding as of March 31, 2007, is adjusted periodically based on the extent to which actual forfeitures differ, or are expected to differ, from the previous estimate.

Prior to 2006, the Company accounted for stock-based compensation in accordance with APB 25 using the intrinsic value method, which did not require that compensation cost be recognized for the Company’s stock options provided the option exercise price was established at 100% of the common stock fair value on the date of grant. Under APB 25, the Company was required to record expense over the vesting period for the value of restricted common stock granted. Prior to 2006, the Company provided pro forma disclosure amounts in accordance with SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (“SFAS 148”), as if the fair value method defined by SFAS 123 had been applied to its stock-based compensation.

Options

The Company has the following two stock option plans under which shares were available for grant at March 31, 2007: 1) the 2004 Long-Term Incentive Compensation Plan, and 2) the 2004 Non-Employee Directors’ Share Plan. Under the terms of the plans, the exercise price of an option is the fair value of the stock on the date of grant. Each option becomes exercisable after

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the period or periods specified in the award agreement, which generally do not exceed 10 years from the date of grant. Options are exercisable at such times and subject to such terms as determined by the Compensation, Nominating and Governance Committee; options may not be exercised if such exercise would cause a violation of the ownership limit in the Company’s charter. Unless otherwise determined by the Compensation, Nominating and Governance Committee at the time of grant, stock options vest ratably over a four-year period beginning on the date of grant.

The following assumptions were used to estimate the fair value of options granted during the three months ended March 31, 2007 and 2006 using the Black-Scholes option-pricing model:

		Three Months Ended March 31,
		2007		2006
Expected volatility		24	%	21	%
Dividend yield		6.0	%	6.9	%
Risk-free interest rate		4.6	%	3.7	%
Average expected term (years)		5		5

 

The Black-Scholes model incorporates assumptions to value stock—based awards. The risk-free rate is based on the U.S. Treasury yield curve in effect at the time of grant for the estimated life of the option. The Company uses actual historical data to calculate the expected price volatility and average expected term.

The following table summarizes the Company’s activities with respect to its stock option plans:

Options		Number of Shares		Weighted Average Exercise Price			Weighted Average Remaining Contractual Life		Aggregate Intrinsic Value as of March 31, 2007
Outstanding at December 31, 2004		1,568,000		12.50
Granted		1,659,049		15.17
Exercised		(35,651	)	12.50
Forfeited		(144,875	)	13.66
Outstanding at December 31, 2005		3,046,523		13.89
Granted		161,914		15.48
Exercised		(259,700	)	13.11
Forfeited		(384,174	)	14.92
Outstanding at December 31, 2006		2,564,563		$	13.92
Granted		223,000		19.24
Exercised		(54,106	)	13.53
Forfeited		(65,751	)	14.70
Outstanding at March 31, 2007		2,667,706		$	14.35		8.04		$	12,439,187
Vested and Expected to Vest		2,326,259		$	14.20		0.77		$	11,158,789
Ending Exercisable		810,860		$	13.51		7.73		$	4,405,411

 

The aggregate intrinsic value in the table above represents the total value (the difference between the Company’s closing stock price on the last trading day of the first quarter of 2007 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on March 31, 2007. The amount of aggregate intrinsic value will change based on the fair market value of the Company’s stock.

The Company recorded $223 and $200, respectively, of compensation expense relating to outstanding options during the three months ended March 31, 2007 and 2006.  Exercise of options during the three months ended March 31, 2007 and 2006, resulted in cash receipts of $838 and $162, respectively. At March 31, 2007, there was $1,880 of total unrecognized compensation expense related to non-vested stock options under the Company’s 2004 Long-Term Incentive Compensation Plan. That cost is expected to be recognized over a weighted-average period of 2.17 years. The valuation model applied in this calculation utilizes subjective assumptions that could potentially change over time, including the expected forfeiture rate. Therefore, the amount of unrecognized compensation expense at March 31, 2007, noted above does not necessarily represent the expense that will ultimately be realized by the Company in the Statement of Operations.

Common Stock Granted to Employees

Common stock is granted to certain employees without monetary consideration under the Company’s 2004 Long-Term Incentive Compensation Plan.  At the date of grant, the recipient has all rights of a stockholder including the right to vote and

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receive dividends subject to restrictions on transfer and forfeiture provisions. The forfeiture and transfer restrictions on the shares lapse over a two to four year period beginning on the date of grant. The Company recorded $213 and $186 of compensation expense related to outstanding shares of common stock granted to employees during the three months ended March 31, 2007 and 2006, respectively.

The fair value of common stock awards is determined based on the closing trading price of the Company’s common stock on the grant date. A summary of the Company’s employee share grant activity is as follows:

Restricted Stock Grants		Shares		Weighted- Average Grant- Date Fair Value
Unreleased at January 1, 2005		—
Granted		190,000		15.66
Released		(16,250	)	15.66
Unreleased at December 31, 2005		173,750		15.66
Granted		62,300		16.42
Released		(46,250	)	15.68
Cancelled		(33,500	)	15.71
Unreleased at December 31, 2006		156,300		15.94
Granted		30,300		19.85
Released		(10,000	)	15.66
Cancelled		—		—
Unreleased at March 31, 2007		176,600		$	16.64

 

16. SEGMENT INFORMATION

The Company operates in two distinct segments: (1) property management, acquisition and development and (2) rental operations. Financial information for the Company’s business segments is set forth below:

		March 31, 2007			December 31, 2006
Balance Sheet
Investment in real estate ventures
Rental operations		$	92,515		$	88,115
Total assets
Property management, acquisition and development		$	470,488		$	223,402
Rental operations		1,481,122			1,446,423
		$	1,951,610		$	1,669,825

 

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		Three months ended March 31,
		2007			2006
Statement of Operations
Total revenues
Property management, acquisition and development		$	7,545		$	6,195
Rental operations		46,231			39,175
		$	53,776		$	45,370
Operating expenses, including depreciation and amortization
Property management, acquisition and development		$	10,725		$	10,552
Rental operations		25,430			23,662
		$	36,155		$	34,214
Income (loss) before interest, minority interests and equity in earnings of real estate ventures
Property management, acquisition and development		$	(3,180	)	$	(4,357	)
Rental operations		20,801			15,513
		$	17,621		$	11,156
Interest expense
Property management, acquisition and development		$	(162	)	$	(200	)
Rental operations		(13,234		)	(11,785		)
		$	(13,396	)	$	(11,985	)
Interest income
Property management, acquisition and development		$	1,448		$	482
Minority interests - Operating Partnership and other
Property management, acquisition and development		$	(400	)	$	(54	)
Equity in earnings of real estate ventures
Rental operations		$	1,197		$	1,139
Net income (loss)
Property management, acquisition and development		$	(2,294	)	$	(4,129	)
Rental operations		8,764			4,867
		$	6,470		$	738
Depreciation and amortization expense
Property management, acquisition and development		$	262		$	183
Rental operations		8,534			9,093
		$	8,796		$	9,276
Statement of Cash Flows
Acquisition of real estate assets
Property management, acquisition and development		$	(34,709	)	$	(42,910	)
Development and construction of real estate assets
Property management, acquisition and development		$	(6,926	)	$	(5,543	)

 

17. COMMITMENTS AND CONTINGENCIES

The Company has guaranteed two construction loans for unconsolidated partnerships that own development properties in Baltimore, Maryland and Chicago, Illinois. These properties are owned by joint ventures in which the Company has 10% equity interests. These guarantees were entered into in November 2004 and July 2005, respectively. At March 31, 2007, the total amount of guaranteed mortgage debt relating to these joint ventures was $13,095. These mortgage loans mature December 1, 2007 and July 28, 2008, respectively. If the joint ventures default on the loans, the Company may be forced to repay the loans. Repossessing and/or selling the self-storage facilities and land that collateralize the loans could provide funds sufficient to reimburse the Company. The estimated fair market value of the encumbered assets at March 31, 2007, was $16,480. The Company has recorded no liability in relation to this guarantee as of March 31, 2007. The fair value of the guarantee is not material. To date, the joint ventures have not defaulted on their mortgage debt. The Company believes the risk of having to perform on the guarantee is remote.

The Company has been involved in routine litigation arising in the ordinary course of business. As of March 31, 2007, the Company was not involved in any material litigation nor, to its knowledge, was any material litigation threatened against it,

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or its properties.

18.  INCOME TAXES

The Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”), an interpretation of FASB Statement No. 109 (“SFAS 109”) on January 1, 2007. As a result of the implementation of FIN 48, the Company recognized no material adjustment in the liability for unrecognized income tax benefits. At the adoption date of January 1, 2007, there were no material unrecognized tax benefits.  At March 31, 2007, there were no material unrecognized tax benefits.

Interest and penalties related to uncertain tax positions will be recognized in income tax expense, when incurred. As of March 31, 2007, the Company had no interest and penalties related to uncertain tax positions.

The tax years 2003-2006 remain open to examination by the major taxing jurisdictions to which the Company is subject.

19. SUBSEQUENT EVENTS

On April 17, 2007, the Company purchased one self storage facility located in Annapolis, Maryland from a third party for approximately $12.5 million.

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Extra Space Storage Inc.
Management’s Discussion and Analysis
Amounts in thousands, except property and per share data

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

CAUTIONARY LANGUAGE

The following discussion and analysis should be read in conjunction with our “Unaudited Condensed Consolidated Financial Statements” and the “Notes to Unaudited Condensed Consolidated Financial Statements” contained in this report and the “Consolidated Financial Statements,” “Notes to Consolidated Financial Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Form 10-K for the year ended December 31, 2006. The Company makes statements in this section that are forward-looking statements within the meaning of the federal securities laws. For a complete discussion of forward-looking statements, see the section in this Form 10-Q entitled “Statement on Forward-Looking Information.” Amounts are in thousands (except per share data and unless otherwise stated).

CRITICAL ACCOUNTING POLICIES

Our discussion and analysis of our financial condition and results of operations are based on our unaudited Condensed Consolidated Financial Statements contained elsewhere in this report, which have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). Our notes to the Audited Consolidated Financial Statements contained in our Form 10-K for the year ended December 31, 2006 describe the significant accounting policies essential to our unaudited Condensed Consolidated Financial Statements. Preparation of our financial statements requires estimates, judgments and assumptions. We believe that the estimates, judgments and assumptions which we have used are appropriate and correct based on information available at the time that they were made. These estimates, judgments and assumptions can affect our reported assets and liabilities as of the date of the financial statements, as well as the reported revenue and expense during the period presented. If there are material differences between these estimates, judgments and assumptions and actual facts, our financial statements may be affected.

In many cases, the accounting treatment of a particular transaction is specifically dictated by GAAP and does not require our judgment in its application. There are areas in which our judgment in selecting among available alternatives would not produce a materially different result, but there are some areas in which our judgment in selecting among available alternatives would produce a materially different result. See the notes to the unaudited Condensed Consolidated Financial Statements that contain additional information regarding our accounting policies and other disclosures.

OVERVIEW

We are a fully integrated, self-administered and self-managed real estate investment trust formed to continue the business commenced in 1977 by our predecessor company to own, operate, manage, acquire and develop self-storage properties. We derive a majority of our revenues from rents received from tenants under existing leases at each of our self-storage properties. Additional revenue is derived from management and franchise fees from our joint venture and managed properties. We operate in competitive markets where consumers have multiple self-storage properties from which to choose. Competition has and will continue to impact our results. We experience minor seasonal fluctuations in occupancy levels, with occupancy levels higher in the summer months due to increased rental activity.

Our operating results depend materially on our ability to lease available self-storage space and on the ability of our tenants to make required rental payments. We believe we are able to respond quickly and effectively to changes in local, regional and national economic conditions by centrally adjusting rental rates through the combination of our revenue management team and our industry-leading technology systems.

We continue to evaluate a range of growth initiatives and opportunities including the following:

·                  Maximize the performance of properties through strategic, efficient and proactive management. We plan to pursue revenue generating and expense minimizing opportunities in our operations. Our revenue management team will seek to maximize revenue by responding to changing market conditions through our technology system’s ability to provide real-time, interactive rental rate and discount management. Our size allows greater ability than the majority

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of our competitors to implement national, regional and local marketing programs, which we believe will attract more customers to our stores at a lower net cost.

·                  Focus on the acquisition of self-storage properties from strategic partners and third parties. Our acquisitions team will continue to pursue the acquisition of single properties and multi-property portfolios that we believe can provide stockholder value. Our July 2005 acquisition of Storage USA has bolstered our reputation as a reliable, ethical buyer, which we believe enhances our ability to negotiate and close acquisitions. In addition, our status as an UPREIT enables flexibility when structuring deals.

·                  Develop new self-storage properties. We have several joint venture and wholly-owned development properties and will continue to develop new self-storage properties in our core markets. Our development pipeline for the remainder of 2007 through 2008 includes 17 projects. The majority of the projects will be developed on a wholly-owned basis by the Company. The construction of many of these properties has already begun.

·                  Expand the Company’s management business. We see the management business as a future acquisition pipeline and expect to pursue strategic relationships with owners that should strengthen our acquisition pipeline through agreements which give us first right of refusal to purchase the managed property in the event of a potential sale. Sixteen of the Company’s 2006 and 2007 acquisitions have come from this channel.

PROPERTIES

As of March 31, 2007, we owned or had ownership interests in 571 operating self-storage properties located in 32 states and Washington, D.C. Of these properties, 223 are wholly-owned and consolidated, one is held in joint venture and consolidated and 347 are held in joint ventures accounted for using the equity method.  In addition, we managed 64 properties for franchisees or third parties bringing the total numbers of properties which we own and/or manage to 635.  We receive a management fee equal to approximately 6% of gross revenues to manage the joint venture, third party and franchise sites.  As of March 31, 2007, we owned or had ownership interests in approximately 46 million square feet of space and had greater than 290,000 customers.

Approximately 70% of our properties are clustered around the larger population centers, such as Atlanta, Baltimore/Washington, D.C., Boston, Chicago, Dallas, Las Vegas, Los Angeles, Miami, New York City, Orlando, Philadelphia, Phoenix, St. Petersburg/Tampa and San Francisco.  These markets contain above-average population and income demographics for new self-storage properties.  The clustering of assets around these population centers enables us to reduce our operating costs through economies of scale.  The Storage USA acquisition has given us an increased scale in many core markets as well as a foothold in many markets where we had no previous presence.

We consider a property to be in the lease-up stage after it has been issued a certificate of occupancy, but before it has achieved stabilization.  We consider a property to be stabilized once it has achieved either an 80% occupancy rate or has been open for three years.  Although leases are short-term in duration, the typical tenant tends to remain at our properties for an extended period of time. For properties that were stabilized as of December 31, 2006, the median length of stay was approximately eleven months.

Our property portfolio is a made up of different types of construction and building configurations depending on the site and the municipality where it is located. Most often sites are what we consider “hybrid” facilities, a mix of both drive-up buildings and multi-floor buildings. We have a number of multi-floor buildings with elevator access only, and a number of  facilities featuring ground-floor access only.

The following table sets forth additional information regarding the occupancy of our stabilized properties on a state-by-state basis as of March 31, 2007 and 2006.  The information as of March 31, 2006 is on a pro forma basis as though all the properties owned at March 31, 2007 were under the Company’s control as of March 31, 2006.

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