Table of Contents

 

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


 

FORM 10-Q

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2014

 

or

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                  to                 .

 

Commission File Number: 001-32269

 

EXTRA SPACE STORAGE INC.

(Exact name of registrant as specified in its charter)

 

Maryland

 

20-1076777

(State or other jurisdiction of incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

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):

 

Large accelerated filer x

 

Accelerated filer o

 

 

 

Non-accelerated filer o

 

Smaller reporting company o

(Do not check if a smaller reporting company)

 

 

 

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, 2014, was 116,018,391.

 

 

 



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

24

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

35

ITEM 4. CONTROLS AND PROCEDURES

36

 

 

PART II. OTHER INFORMATION

36

ITEM 1. LEGAL PROCEEDINGS

36

ITEM 1A. RISK FACTORS

36

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

36

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

37

ITEM 4. MINE SAFETY DISCLOSURES

37

ITEM 5. OTHER INFORMATION

37

ITEM 6. EXHIBITS

38

SIGNATURES

39

 

2



Table of Contents

 

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 estimates 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”), tenant reinsurance and other aspects of our business, which could adversely affect our results;

 

·                  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.

 

3



Table of Contents

 

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

 

 

June 30, 2014

 

December 31, 2013

 

 

 

(Unaudited)

 

 

 

 

 

 

 

 

 

Assets:

 

 

 

 

 

Real estate assets, net

 

$

3,941,042

 

$

3,636,544

 

 

 

 

 

 

 

Investments in unconsolidated real estate ventures

 

86,794

 

88,125

 

Cash and cash equivalents

 

53,945

 

126,723

 

Restricted cash

 

20,651

 

21,451

 

Receivables from related parties and affiliated real estate joint ventures

 

12,640

 

7,542

 

Other assets, net

 

93,818

 

96,755

 

Total assets

 

$

4,208,890

 

$

3,977,140

 

 

 

 

 

 

 

Liabilities, Noncontrolling Interests and Equity:

 

 

 

 

 

Notes payable

 

$

1,794,049

 

$

1,588,596

 

Premium on notes payable

 

4,775

 

4,948

 

Exchangeable senior notes

 

250,000

 

250,000

 

Discount on exchangeable senior notes

 

(14,787

)

(16,487

)

Notes payable to trusts

 

119,590

 

119,590

 

Lines of credit

 

10,000

 

 

Accounts payable and accrued expenses

 

65,539

 

60,601

 

Other liabilities

 

49,016

 

37,997

 

Total liabilities

 

2,278,182

 

2,045,245

 

 

 

 

 

 

 

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, 500,000,000 shares authorized, 116,017,391 and 115,755,527 shares issued and outstanding at June 30, 2014 and December 31, 2013, respectively

 

1,160

 

1,157

 

Paid-in capital

 

1,981,186

 

1,973,159

 

Accumulated other comprehensive income

 

2,073

 

10,156

 

Accumulated deficit

 

(247,871

)

(226,002

)

Total Extra Space Storage Inc. stockholders’ equity

 

1,736,548

 

1,758,470

 

Noncontrolling interest represented by Preferred Operating Partnership units, net of $100,000 note receivable

 

102,799

 

80,947

 

Noncontrolling interests in Operating Partnership

 

90,332

 

91,453

 

Other noncontrolling interests

 

1,029

 

1,025

 

Total noncontrolling interests and equity

 

1,930,708

 

1,931,895

 

Total liabilities, noncontrolling interests and equity

 

$

4,208,890

 

$

3,977,140

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

4



Table of Contents

 

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,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

Revenues:

 

 

 

 

 

 

 

 

 

Property rental

 

$

138,778

 

$

107,340

 

$

270,779

 

$

210,263

 

Tenant reinsurance

 

14,508

 

12,110

 

27,971

 

22,331

 

Management fees

 

6,954

 

6,796

 

13,670

 

12,974

 

Total revenues

 

160,240

 

126,246

 

312,420

 

245,568

 

 

 

 

 

 

 

 

 

 

 

Expenses:

 

 

 

 

 

 

 

 

 

Property operations

 

42,294

 

33,462

 

85,776

 

67,899

 

Tenant reinsurance

 

2,636

 

2,202

 

5,203

 

4,112

 

Acquisition related costs

 

1,393

 

683

 

3,449

 

1,135

 

General and administrative

 

14,985

 

13,739

 

30,287

 

26,508

 

Depreciation and amortization

 

28,271

 

22,785

 

56,646

 

45,810

 

Total expenses

 

89,579

 

72,871

 

181,361

 

145,464

 

 

 

 

 

 

 

 

 

 

 

Income from operations

 

70,661

 

53,375

 

131,059

 

100,104

 

 

 

 

 

 

 

 

 

 

 

Gain (loss) on sale of real estate and earnout from prior acquisition

 

(7,785

)

800

 

(7,785

)

800

 

Interest expense

 

(20,658

)

(18,362

)

(40,256

)

(35,728

)

Non-cash interest expense related to amortization of discount on equity component of exchangeable senior notes

 

(663

)

(113

)

(1,325

)

(113

)

Interest income

 

712

 

133

 

981

 

317

 

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

 

43,479

 

37,045

 

85,099

 

67,805

 

 

 

 

 

 

 

 

 

 

 

Equity in earnings of unconsolidated real estate ventures

 

2,604

 

2,914

 

5,023

 

5,537

 

Equity in earnings of unconsolidated real estate ventures - purchase of joint venture partners’ interests

 

3,438

 

 

3,438

 

2,556

 

Income tax expense

 

(3,513

)

(2,858

)

(6,343

)

(4,866

)

Net income

 

46,008

 

37,101

 

87,217

 

71,032

 

Net income allocated to Preferred Operating Partnership noncontrolling interests

 

(2,812

)

(1,745

)

(5,304

)

(3,462

)

Net income allocated to Operating Partnership and other noncontrolling interests

 

(1,531

)

(890

)

(2,908

)

(1,679

)

Net income attributable to common stockholders

 

$

41,665

 

$

34,466

 

$

79,005

 

$

65,891

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.36

 

$

0.31

 

$

0.68

 

$

0.59

 

Diluted

 

$

0.36

 

$

0.31

 

$

0.68

 

$

0.59

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of shares

 

 

 

 

 

 

 

 

 

Basic

 

115,653,489

 

110,731,153

 

115,546,341

 

110,523,974

 

Diluted

 

121,254,222

 

113,962,981

 

121,161,292

 

114,247,520

 

 

 

 

 

 

 

 

 

 

 

Cash dividends paid per common share

 

$

0.47

 

$

0.40

 

$

0.87

 

$

0.65

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

5



Table of Contents

 

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,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

46,008

 

$

37,101

 

$

87,217

 

$

71,032

 

 

 

 

 

 

 

 

 

 

 

Other comprehensive income (loss):

 

 

 

 

 

 

 

 

 

Change in fair value of interest rate swaps

 

(5,701

)

18,469

 

(8,448

)

20,040

 

Total comprehensive income

 

40,307

 

55,570

 

78,769

 

91,072

 

Less: comprehensive income attributable to noncontrolling interests

 

4,097

 

3,237

 

7,847

 

5,800

 

Comprehensive income attributable to common stockholders

 

$

36,210

 

$

52,333

 

$

70,922

 

$

85,272

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

6



Table of Contents

 

Extra Space Storage Inc.

Condensed Consolidated Statement of Noncontrolling Interests and Equity

(amounts in thousands, except share data)

(unaudited)

 

 

 

Noncontrolling Interests

 

Extra Space Storage Inc. Stockholders’ Equity

 

 

 

 

 

Preferred Operating Partnership

 

Operating

 

 

 

 

 

 

 

 

 

Accumulated
Other
Comprehensive

 

Accumulated

 

Total
Noncontrolling
Interests and

 

 

 

Series A

 

Series B

 

Series C

 

Partnership

 

Other

 

Shares

 

Par Value

 

Paid-in Captial

 

Income

 

Deficit

 

Equity

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at December 31, 2013

 

$

30,202

 

$

33,568

 

$

17,177

 

$

91,453

 

$

1,025

 

115,755,527

 

$

1,157

 

$

1,973,159

 

$

10,156

 

$

(226,002

)

$

1,931,895

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock upon the exercise of options

 

 

 

 

 

 

169,940

 

2

 

2,549

 

 

 

2,551

 

Restricted stock grants issued

 

 

 

 

 

 

105,570

 

1

 

 

 

 

1

 

Restricted stock grants cancelled

 

 

 

 

 

 

(13,646

)

 

 

 

 

 

Compensation expense related to stock-based awards

 

 

 

 

 

 

 

 

2,799

 

 

 

2,799

 

Issuance of Operating Partnership units in conjunction with portfolio acquisition

 

 

8,334

 

13,783

 

 

 

 

 

 

 

 

22,117

 

Net income

 

3,539

 

1,129

 

636

 

2,904

 

4

 

 

 

 

 

79,005

 

87,217

 

Other comprehensive income

 

(68

)

 

 

(297

)

 

 

 

 

(8,083

)

 

(8,448

)

Tax effect from vesting of restricted stock grants and stock option exercises

 

 

 

 

 

 

 

 

2,679

 

 

 

2,679

 

Distributions to Operating Partnership units held by noncontrolling interests

 

(3,736

)

(1,129

)

(636

)

(3,728

)

 

 

 

 

 

 

(9,229

)

Dividends paid on common stock at $0.87 per share

 

 

 

 

 

 

 

 

 

 

(100,874

)

(100,874

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Balances at June 30, 2014

 

$

29,937

 

$

41,902

 

$

30,960

 

$

90,332

 

$

1,029

 

116,017,391

 

$

1,160

 

$

1,981,186

 

$

2,073

 

$

(247,871

)

$

1,930,708

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

7



Table of Contents

 

Extra Space Storage Inc.

Condensed Consolidated Statements of Cash Flows

(amounts in thousands)

(unaudited)

 

 

 

For the Six Months Ended June 30,

 

 

 

2014

 

2013

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

87,217

 

$

71,032

 

Adjustments to reconcile net income to net cash provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

56,646

 

45,810

 

Amortization of deferred financing costs

 

3,236

 

3,035

 

Loss on earnout related to prior acquisition

 

7,785

 

 

Non-cash interest expense related to amortization of discount on equity component of exchangeable senior notes

 

1,325

 

113

 

Non-cash interest benefit related to amortization of premium on notes payable

 

(1,585

)

(773

)

Compensation expense related to stock-based awards

 

2,799

 

2,585

 

Gain on purchase of joint venture partners’ interests

 

(3,438

)

(2,556

)

Distributions from unconsolidated real estate ventures in excess of earnings

 

3,427

 

1,924

 

Changes in operating assets and liabilities:

 

 

 

 

 

Receivables from related parties and affiliated real estate joint ventures

 

(791

)

5,561

 

Other assets

 

3,773

 

1,948

 

Accounts payable and accrued expenses

 

4,938

 

(5,317

)

Other liabilities

 

2,427

 

3,189

 

Net cash provided by operating activities

 

167,759

 

126,551

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Acquisition of real estate assets

 

(296,920

)

(59,704

)

Development and redevelopment of real estate assets

 

(5,958

)

(2,332

)

Proceeds from sale of real estate assets

 

 

929

 

Investments in unconsolidated real estate ventures

 

 

(955

)

Change in restricted cash

 

800

 

(3,526

)

Purchase of notes receivable

 

(9,028

)

 

Purchase of equipment and fixtures

 

(2,336

)

(1,478

)

Net cash used in investing activities

 

(313,442

)

(67,066

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Net proceeds from the issuance of exchangeable senior notes

 

 

246,250

 

Proceeds from notes payable and lines of credit

 

421,957

 

267,960

 

Principal payments on notes payable and lines of credit

 

(238,283

)

(319,790

)

Deferred financing costs

 

(3,217

)

(5,658

)

Redemption of Operating Partnership units held by noncontrolling interest

 

 

(41

)

Net proceeds from exercise of stock options

 

2,551

 

5,552

 

Dividends paid on common stock

 

(100,874

)

(72,218

)

Distributions to noncontrolling interests

 

(9,229

)

(5,393

)

Net cash provided by financing activities

 

72,905

 

116,662

 

Net (decrease) increase in cash and cash equivalents

 

(72,778

)

176,147

 

Cash and cash equivalents, beginning of the period

 

126,723

 

30,785

 

Cash and cash equivalents, end of the period

 

$

53,945

 

$

206,932

 

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

8



Table of Contents

 

Extra Space Storage Inc.

Condensed Consolidated Statements of Cash Flows

(amounts in thousands)

(unaudited)

 

 

 

For the Six Months Ended June 30,

 

 

 

2014

 

2013

 

Supplemental schedule of cash flow information

 

 

 

 

 

Interest paid

 

$

33,859

 

$

32,548

 

Income taxes paid

 

3,050

 

1,198

 

 

 

 

 

 

 

Supplemental schedule of noncash investing and financing activities:

 

 

 

 

 

Tax effect from vesting of restricted stock grants and option exercises

 

 

 

 

 

Other assets

 

$

2,679

 

$

3,426

 

Paid-in capital

 

(2,679

)

(3,426

)

Acquisitions of real estate assets

 

 

 

 

 

Real estate assets, net

 

$

55,308

 

$

15,503

 

Notes payable assumed

 

(33,190

)

(7,122

)

Operating Partnership units issued

 

(22,118

)

(6,130

)

Receivables from related parties and affiliated real estate joint ventures

 

 

(2,251

)

 

See accompanying notes to unaudited condensed consolidated financial statements.

 

9



Table of Contents

 

EXTRA SPACE STORAGE INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

Amounts in thousands, except property and share data, unless otherwise stated

 

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, 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 (“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, 2014, the Company had direct and indirect equity interests in 807 operating storage facilities.  In addition, the Company managed 264 properties for third parties, bringing the total number of operating properties which it owns and/or manages to 1,071.  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 in which we have an ownership interest. 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 selling 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 six months ended June 30, 2014, are not necessarily indicative of results that may be expected for the year ending December 31, 2014. The condensed consolidated balance sheet as of December 31, 2013 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, 2013, as filed with the Securities and Exchange Commission.

 

Certain amounts in the Company’s 2013 consolidated financial statements and supporting note disclosures have been reclassified to conform to the current period presentation.  Such reclassifications did not impact previously reported net income or accumulated deficit.

 

Recently Issued Accounting Standards

 

In May 2014, the Financial Accounting Standards Board issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”). ASU 2014-09 amends the guidance for revenue recognition to replace numerous, industry-specific requirements and converges areas under this topic with those of the International Financial Reporting Standards.  ASU 2014-09 outlines a five-step process for customer contract revenue recognition that focuses on transfer of control, as opposed to transfer of risk and rewards. The amendment also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenues and cash flows from contracts with customers. ASU 2014-09 is effective for reporting periods beginning after December 15, 2016, and early adoption is prohibited. Entities can transition to the standard either retrospectively or as a cumulative-effect adjustment as of the date of adoption. Management is currently assessing the impact of the adoption of ASU 2014-09 on the Company’s condensed consolidated financial statements.

 

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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 Financial Accounting Standards Board’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, 2014, 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, 2014, aggregated by the level in the fair value hierarchy within which those measurements fall.

 

 

 

 

 

Fair Value Measurements at Reporting Date Using

 

Description

 

June 30, 2014

 

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

 

$

4,691

 

$

 

$

4,691

 

$

 

Other liabilities - Cash Flow Hedge Swap Agreements

 

$

(3,194

)

$

 

$

(3,194

)

$

 

 

There were no transfers of assets and liabilities between Level 1 and Level 2 during the six months ended June 30, 2014.  The Company did not have any significant assets or liabilities that are re-measured on a recurring basis using significant unobservable inputs as of June 30, 2014 or December 31, 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.

 

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.

 

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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, 2014 and December 31, 2013 approximate fair value.

 

The fair value of the Company’s note receivable from Preferred Operating Partnership unit holders 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 and notes payable to trusts 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 value of the Company’s exchangeable senior notes was estimated using an average market price for similar securities obtained from a third party.

 

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

 

 

 

June 30, 2014

 

December 31, 2013

 

 

 

Fair

 

Carrying

 

Fair

 

Carrying

 

 

 

Value

 

Value

 

Value

 

Value

 

Note receivable from Preferred Operating Partnership unit holders

 

$

102,045

 

$

100,000

 

$

103,491

 

$

100,000

 

Fixed rate notes payable and notes payable to trusts

 

$

1,379,655

 

$

1,351,136

 

$

1,365,290

 

$

1,368,885

 

Exchangeable senior notes

 

$

269,525

 

$

250,000

 

$

251,103

 

$

250,000

 

 

4.              EARNINGS PER COMMON SHARE

 

Basic earnings per common share is computed using the two-class method by dividing net income attributable to common stockholders by the weighted average number of common shares outstanding during the period.  All outstanding unvested restricted stock awards contain rights to non-forfeitable dividends and participate in undistributed earnings with common stockholders; accordingly, they are considered participating securities that are included in the two-class method.  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 two-class, treasury stock or as if-converted method, whichever is most dilutive. Potential common shares are securities (such as options, convertible debt, Series A Participating Redeemable Preferred Units (“Series A Units”), Series B Redeemable Preferred Units (“Series B Units”), Series C Convertible Redeemable Preferred Units (“Series C Units”) and common Operating Partnership units (“OP Units”)) that do not have a current right to participate in earnings of the Company but could do so in the future by virtue of their option, redemption 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 potential common shares. In computing diluted earnings per common share, only potential common shares that are dilutive (those that reduce earnings per common share) are included.  For the three months ended June 30, 2014 and 2013, options to purchase approximately 33,059 and 52,471 shares of common stock, respectively, and for the six months ended June 30, 2014 and

 

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2013, options to purchase approximately 25,068 and 39,171 shares of common stock, respectively, were excluded from the computation of earnings per common share as their effect would have been anti-dilutive.

 

The Operating Partnership had $250,000 of its 2.375% Exchangeable Senior Notes due 2033 (the “Notes”) issued and outstanding as of June 30, 2014.  The Notes could potentially have a dilutive effect on the Company’s earnings per common 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 $55.62 per share as of June 30, 2014, 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 common share computation.  For the three and six months ended June 30, 2014, no shares related to the Notes were included in the computation for diluted earnings per common 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 common share of the potential exchange of Series A Units for common shares upon redemption, 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 Series A 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 common share as allowed by ASC 260-10-45-46.

 

For the purposes of computing the diluted impact on earnings per common share of the potential exchange of Series B Units for common shares upon redemption, where the Company has the option to redeem in cash or shares and where the Company has the ability to settle the redemption in shares, the Company divided the total weighted value of the Series B Units outstanding as of June 30, 2014 of $37,666 by the average closing price of the Company’s common stock for the six months ended June 30, 2014 of $48.99 per share.   The resulting 768,853 shares were excluded from the computation of earnings per common share as their effect would have been anti-dilutive.

 

For the purposes of computing the diluted impact on earnings per common share of the potential exchange of Series C Units for common shares upon redemption, where the Company has the option to redeem in cash or shares and where the Company has the ability to settle the redemption in shares, the Company divided the total weighted value of the Series C Units outstanding as of June 30, 2014 of $21,255 by the average closing price of the Company’s common stock for the six months ended June 30, 2014 of $48.99 per share.  The resulting 433,854 shares were excluded from the computation of earnings per common share as their effect would have been anti-dilutive.

 

The computation of earnings per common share was as follows for the periods presented:

 

 

 

For the Three Months Ended June 30,

 

For the Six Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

 

 

 

 

 

 

 

 

 

 

Net income attributable to common stockholders

 

$

41,665

 

$

34,466

 

$

79,005

 

$

65,891

 

Earnings and dividends allocated to participating securities

 

(125

)

(146

)

(242

)

(246

)

Earnings for basic computations

 

41,540

 

34,320

 

78,763

 

65,645

 

 

 

 

 

 

 

 

 

 

 

Earnings and dividends allocated to participating securities

 

 

 

 

246

 

Add: Income allocated to noncontrolling interest - Preferred Operating Partnership (Series A Units) and Operating Partnership

 

3,315

 

2,624

 

6,443

 

5,118

 

Subtract: Fixed component of income allocated to noncontrolling interest - Preferred Operating Partnership (Series A Units)

 

(1,437

)

(1,438

)

(2,875

)

(2,875

)

Net income for diluted computations

 

$

43,418

 

$

35,506

 

$

82,331

 

$

68,134

 

 

 

 

 

 

 

 

 

 

 

Weighted average common shares outstanding:

 

 

 

 

 

 

 

 

 

Average number of common shares outstanding - basic

 

115,653,489

 

110,731,153

 

115,546,341

 

110,523,974

 

Series A Units

 

989,980

 

 

989,980

 

 

Common OP Units

 

4,334,118

 

2,898,510

 

4,334,118

 

2,898,510

 

Unvested restricted stock awards included for treasury stock method

 

 

 

 

450,530

 

Dilutive stock options

 

276,635

 

333,318

 

290,853

 

374,506

 

Average number of common shares outstanding - diluted

 

121,254,222

 

113,962,981

 

121,161,292

 

114,247,520

 

 

 

 

 

 

 

 

 

 

 

Earnings per common share

 

 

 

 

 

 

 

 

 

Basic

 

$

0.36

 

$

0.31

 

$

0.68

 

$

0.59

 

Diluted

 

$

0.36

 

$

0.31

 

$

0.68

 

$

0.59

 

 

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5.              PROPERTY ACQUISITIONS

 

The following table summarizes the Company’s acquisitions of operating properties for the six months ended June 30, 2014, and does not include purchases of raw land 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

 

Previous
equity
interest

 

Net
Liabilities/
(Assets)
Assumed

 

Value of
OP Units
Issued

 

Number
of OP
Units
Issued

 

Land

 

Building

 

Intangible

 

Closing costs -
 expensed

 

Notes

 

Virginia

 

17

 

1/7/2014

 

$

200,588

 

$

200,525

 

$

 

$

 

$

 

$

63

 

$

 

 

$

53,878

 

$

142,840

 

$

2,973

 

$

897

 

 

 

Texas

 

1

 

2/5/2014

 

14,191

 

14,152

 

 

 

 

39

 

 

 

1,767

 

12,368

 

38

 

18

 

 

 

California

 

1

 

3/4/2014

 

7,000

 

6,974

 

 

 

 

26

 

 

 

2,150

 

4,734

 

113

 

3

 

(1)

 

Connecticut

 

1

 

3/17/2014

 

15,138

 

15,169

 

 

 

 

(31

)

 

 

1,072

 

14,028

 

 

38

 

 

 

Alabama

 

1

 

3/20/2014

 

13,813

 

13,752

 

 

 

 

61

 

 

 

2,381

 

11,224

 

200

 

8

 

 

 

Georgia

 

1

 

4/3/2014

 

23,649

 

15,158

 

 

 

 

157

 

8,334

 

333,360

 

2,961

 

19,819

 

242

 

627

 

 

 

Florida

 

1

 

4/15/2014

 

10,186

 

10,077

 

 

 

 

109

 

 

 

1,640

 

8,358

 

149

 

39

 

 

 

California

 

3

 

4/25/2014

 

35,275

 

2,726

 

19,111

 

3,438

 

129

 

(580

)

10,451

 

226,285

 

6,853

 

27,666

 

579

 

177

 

(2)

 

Washington

 

1

 

4/30/2014

 

4,388

 

4,388

 

 

 

 

 

 

 

437

 

3,808

 

102

 

41

 

 

 

California

 

1

 

5/28/2014

 

17,614

 

294

 

14,079

 

 

 

(92

)

3,333

 

69,735

 

4,707

 

12,604

 

265

 

38

 

 

 

North Carolina

 

1

 

6/18/2014

 

7,310

 

7,307

 

 

 

 

3

 

 

 

2,940

 

4,265

 

93

 

12

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

2014 Totals

 

29

 

 

 

$

349,152

 

$

290,522

 

$

33,190

 

$

3,438

 

$

129

 

$

(245

)

$

22,118

 

629,380

 

$

80,786

 

$

261,714

 

$

4,754

 

$

1,898

 

 

 

 


(1) This property was owned by Spencer F. Kirk, the Company’s Chief Executive Officer, and Kenneth M. Woolley, the Company’s Executive Chairman.  The Company acquired the building on March 4, 2014.  In a separate transaction on March 5, 2014, the Company acquired the land for $2,150 from a third party unrelated to the Company’s executives and terminated the existing ground lease.

 

(2) The Company previously held an equity interest in one of three properties acquired.  The Company acquired its joint venture partner’s 60% interest in an existing joint venture which held the one property in California, resulting in full ownership by the Company.  Prior to the acquisition date, the Company accounted for its 40% interest in this joint venture as an equity method investment.  The total acquisition date fair value of the previous equity interest was approximately $3,567 and is included as consideration transferred.  The Company recognized a non-cash gain of $3,438 as a result of re-measuring its prior equity interest in this joint venture held before the acquisition.  The three properties were acquired in exchange for approximately $2,726 of cash and 226,285 Series C Units valued at $10,451.

 

6.              GAIN (LOSS) ON SALE OF REAL ESTATE AND EARNOUT FROM PRIOR ACQUISITION

 

During 2012, the Company acquired a portfolio of ten self-storage properties located in New York and New Jersey.  As part of this acquisition, the Company agreed to make an additional cash payment to the sellers if the properties acquired exceeded a specified amount of net rental income after two years.  At the time of acquisition, the Company believed that it was unlikely that any significant payment would be made as a result of this earnout provision.  The rental income of the properties has been higher than expected, resulting in a payment due to the sellers of $7,785. This amount is included in “Gain (loss) on sale of real estate and earnout from prior acquisition” on the Company’s condensed consolidated statements of operations.

 

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.

 

7.              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 the 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 the entity are shared equally by the Company and its joint venture partner, there is no primary beneficiary. Accordingly, the 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 and (2) 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 mortgage notes 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. The Company completed the purchase of the VIE JV’s mortgage loan on April 3, 2014.  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.

 

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The Company’s maximum exposure to loss for this joint venture as of June 30, 2014 is the total of the 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 its investment in the property is unlikely and, therefore, no liability has been recorded. Also, repossessing and/or selling the self-storage facility and land that collateralize the amounts payable to the Company could provide funds sufficient to reimburse the Company.

 

The following table compares the liability balance and the maximum exposure to loss related to the Company’s VIE JV as of June 30, 2014:

 

 

 

 

 

 

 

Amounts

 

Maximum

 

 

 

 

 

Liability

 

Investment

 

Payable to the

 

Exposure

 

 

 

 

 

Balance

 

Balance

 

Company

 

to Loss

 

Difference

 

Extra Space of Sacramento One LLC

 

$

 

$

(1,203

)

$

10,819

 

$

9,616

 

$

(9,616

)

 

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.  The proceeds from the sale of the preferred and common securities were loaned in the form of notes to the Operating Partnership.  The Trusts are VIEs because the holders of the equity investment at risk (the trust preferred securities) do not have the power to direct the activities of the entities that most significantly affect the entities’ economic performance because of their lack of voting or similar rights.  Because the Operating Partnership’s investment in the Trusts’ common securities was financed directly by the Trusts as a result of its loan of the proceeds to the Operating Partnership, that investment is not considered an equity investment at risk.  The Operating Partnership’s investment in the Trusts is not a variable interest because equity interests are variable interests only to the extent that the investment is considered to be at risk, and therefore the Operating Partnership cannot be the primary beneficiary of the Trusts.  Since the Company is not the primary beneficiary of the Trusts, they have not been consolidated.  A debt obligation has been recorded in the form of notes for the proceeds as discussed above, which are owed to the Trusts.  The Company has also included its investment in the Trusts’ common securities in other assets on the condensed consolidated balance sheets.

 

The Company has not provided financing or other support during the periods presented to the Trusts that it was not previously contractually obligated to provide.  The Company’s maximum exposure to loss as a result of its involvement with the Trusts is equal to the total amount of the notes discussed above less the amounts of the Company’s investments in the Trusts’ common securities.  The net amount is the notes payable that the Trusts owe to third parties for their investments in the Trusts’ preferred securities.

 

Following is a tabular comparison of the liabilities the Company has recorded as a result of its involvement with the Trusts to the maximum exposure to loss the Company is subject to as a result of such involvement as of June 30, 2014:

 

 

 

Notes payable

 

Investment

 

Maximum

 

 

 

 

 

to Trusts

 

Balance

 

exposure to loss

 

Difference

 

Trust

 

$

36,083

 

$

1,083

 

$

35,000

 

$

 

Trust II

 

42,269

 

1,269

 

41,000

 

 

Trust III

 

41,238

 

1,238

 

40,000

 

 

 

 

$

119,590

 

$

3,590

 

$

116,000

 

$

 

 

The Company had no consolidated VIEs during the six months ended June 30, 2014.

 

8.              DERIVATIVES

 

The Company is exposed to certain risks arising from both its business operations and economic conditions. The Company principally manages its exposures to a wide variety of business and operational risks through management of its core business activities. The Company manages economic risks, including interest rate, liquidity and credit risk, primarily by managing the amount, sources and duration of its debt funding and by using derivative financial instruments. Specifically, the Company enters into derivative financial instruments to manage exposure that arises from business activities that result in the receipt or payment of future known and uncertain cash amounts, the value of which are determined by interest rates. The Company’s derivative financial instruments are used to manage differences in the amount, timing and duration of the Company’s known or expected cash receipts and its known or expected cash payments principally related to the Company’s investments and borrowings.

 

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Cash Flow Hedges of Interest Rate Risk

 

The Company’s objectives in using interest rate derivatives are to add stability to interest expense and to manage its exposure to interest rate movements. To accomplish these objectives, the Company primarily uses interest rate swaps as part of its interest rate risk management strategy. Interest rate swaps designated as cash flow hedges involve the receipt of variable amounts from a counterparty in exchange for the Company making fixed-rate payments over the life of the agreements without exchange of the underlying notional amount.

 

The effective portion of changes in the fair value of derivatives designated and that qualify as cash flow hedges is recorded in accumulated other comprehensive income (“OCI”) and is subsequently reclassified into earnings in the period that the hedged forecasted transaction affects earnings.  A portion of these changes is excluded from accumulated other comprehensive income as it is allocated to noncontrolling interests.  During the three and six months ended June 30, 2014 and 2013, such derivatives were used to hedge the variable cash flows associated with existing variable-rate debt.

 

The following table summarizes the terms of the Company’s 22 derivative financial instruments as of June 30, 2014:

 

Hedge Product

 

Current Notional
Amounts

 

Strike

 

Effective Dates

 

Maturity Dates

 

Swap Agreements

 

$4,718 - $95,372

 

2.79% - 6.32%

 

7/1/2009 - 1/1/2014

 

7/1/2014 - 4/1/2021

 

 

Fair Values of Derivative Instruments

 

The table below presents the fair value of the Company’s derivative financial instruments as well as their classification on the condensed consolidated balance sheets:

 

 

 

Asset (Liability) Derivatives

 

 

 

June 30, 2014

 

December 31, 2013

 

Derivatives designated as

 

Balance Sheet

 

Fair

 

Balance Sheet

 

Fair

 

hedging instruments:

 

Location

 

Value

 

Location

 

Value

 

Swap Agreements

 

Other assets

 

$

4,691

 

Other assets

 

$

13,630

 

Swap Agreements

 

Other liabilities

 

$

(3,194

)

Other liabilities

 

$

(3,684

)

 

Effect of Derivative Instruments

 

The tables below present the effect of the Company’s derivative financial instruments on the condensed consolidated statements of operations for the periods presented. No tax effect has been presented as the derivative instruments are held by the Company:

 

 

 

Classification of

 

For the Three Months Ended June 30,

 

For the Six Months Ended June 30,

 

Type

 

Income (Expense)

 

2014

 

2013

 

2014

 

2013

 

Swap Agreements

 

Interest expense

 

$

(2,317

)

$

(2,129

)

$

(4,610

)

$

(4,282

)

 

 

 

Gain (loss)
recognized in OCI

 

Location of amounts

 

Gain (loss) reclassified
from OCI

 

Type

 

June 30, 2014

 

reclassified from OCI
into income

 

For the Six Months
Ended June 30, 2014

 

Swap Agreements

 

$

(12,924

)

Interest expense

 

$

(4,610

)

 

 

 

Gain (loss)
recognized in OCI

 

Location of amounts

 

Gain (loss) reclassified
from OCI

 

Type

 

June 30, 2013

 

reclassified from OCI
into income

 

For the Six Months
Ended June 30, 2013

 

Swap Agreements

 

$

15,222

 

Interest expense

 

$

(4,282

)

 

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Credit-risk-related Contingent Features

 

The Company has agreements with some of its derivative counterparties that contain provisions pursuant to which, the Company could be declared in default of its derivative obligations if the Company defaults on any of its indebtedness, including default where repayment of the indebtedness has not been accelerated by the lender.

 

The Company also has an agreement with some of its derivative counterparties that incorporates the loan covenant provisions of the Company’s indebtedness with a lender affiliate of the derivative counterparty. Failure to comply with the loan covenant provisions would result in the Company being in default on any derivative instrument obligations covered by the agreement.

 

As of June 30, 2014, the fair value of derivatives in a net liability position, which includes accrued interest but excludes any adjustment for nonperformance risk related to these agreements, was $3,194. As of June 30, 2014, the Company had not posted any collateral related to these agreements. If the Company had breached any of these provisions as of June 30, 2014, it could have been required to settle its obligations under the agreements at their termination value of $3,533.

 

9.              EXCHANGEABLE SENIOR NOTES

 

On June 21, 2013, the Operating Partnership issued $250,000 of its 2.375% Exchangeable Senior Notes due 2033 at a 1.5% discount, or $3,750.  Costs incurred to issue the Notes were approximately $1,672.  These costs are being amortized as an adjustment to interest expense over five years, which represents the estimated term based on the first available redemption date, and are included in other assets in the condensed consolidated balance sheets.  The Notes are general unsecured senior obligations of the Operating Partnership and are fully guaranteed by the Company.  Interest is payable on January 1 and July 1 of each year beginning January 1, 2014, until the maturity date of July 1, 2033.  The Notes bear interest at 2.375% per annum and contain an exchange settlement feature, which provides that the Notes may, under certain circumstances, be exchangeable for cash (for the principal amount of the Notes) and, with respect to any excess exchange value, for cash, shares of the Company’s common stock, or a combination of cash and shares of the Company’s common stock, at the Company’s option.  The exchange rate of the Notes as of June 30, 2014 is approximately 17.98 shares of the Company’s common stock per $1,000 principal amount of the Notes.

 

The Operating Partnership may redeem the Notes at any time to preserve the Company’s status as a REIT.  In addition, on or after July 5, 2018, 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 the 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 July 1 of the years 2018, 2023, and 2028, and upon the occurrence of certain designated events, 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.

 

GAAP requires entities with convertible debt instruments that may be settled entirely or partially in cash upon conversion to separately account for the liability and equity components of the instrument in a manner that reflects the issuer’s economic interest cost.  The Company therefore accounts for the liability and equity components of the Notes separately.  The equity component is included in paid-in capital in stockholders’ equity in the condensed consolidated balance sheets, and the value of the equity component is treated as original issue discount for purposes of accounting for the debt component.  The discount is being amortized as interest expense over the remaining period of the debt through its first redemption date, July 1, 2018. The effective interest rate on the liability component is 4.0%.

 

Information about the carrying amount of the equity component, the principal amount of the liability component, its unamortized discount and its net carrying amount for the Notes was as follows for the periods indicated:

 

 

 

June 30, 2014

 

December 31, 2013

 

Carrying amount of equity component

 

$

(14,496

)

$

(14,496

)

 

 

 

 

 

 

Principal amount of liability component

 

$

250,000

 

$

250,000

 

Unamortized discount - equity component

 

(11,806

)

(13,131

)

Unamortized cash discount

 

(2,981

)

(3,356

)

Net carrying amount of liability component

 

$

235,213

 

$

233,513

 

 

The amount of interest cost recognized relating to the contractual interest rate and the amortization of the discount on the liability component of the Notes were as follows for the periods indicated:

 

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For the Three Months Ended June 30,

 

For the Six Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Contractual interest

 

$

1,484

 

$

146

 

$

2,968

 

$

146

 

Amortization of discount

 

663

 

113

 

1,325

 

113

 

Total interest expense recognized

 

$

2,147

 

$

259

 

$

4,293

 

$

259

 

 

10.       NONCONTROLLING INTEREST REPRESENTED BY PREFERRED OPERATING PARTNERSHIP UNITS

 

Classification of Noncontrolling Interests

 

GAAP requires a company to present ownership interests in subsidiaries held by parties other than the company in the consolidated financial statements within the equity section, but separate from the company’s equity.  It also requires the amount of consolidated net income attributable to the parent and to the noncontrolling interest to be clearly identified and presented on the face of the consolidated statement of operations and requires changes in ownership interest to be accounted for similarly as equity transactions.  If noncontrolling interests are determined to be redeemable, they are to be carried at their redemption value as of the balance sheet date and reported as temporary equity.

 

The Company has evaluated the terms of the Operating Partnership’s preferred units and classifies the noncontrolling interest represented by such preferred units as stockholders’ equity in the accompanying condensed consolidated balance sheets.  The Company will periodically evaluate individual noncontrolling interests for the ability to continue to recognize the noncontrolling interest as permanent equity in the condensed consolidated balance sheets.  Any noncontrolling interests that fail to qualify as permanent equity will be reclassified as temporary equity and adjusted to the greater of (1) the carrying amount and (2) the redemption value as of the end of the period in which the determination is made.

 

Series A Participating Redeemable Preferred Units

 

On June 15, 2007, the Operating Partnership entered into a Contribution Agreement with various limited partnerships affiliated with AAAAA Rent-A-Space to acquire ten self-storage facilities in exchange for 989,980 Series A Units of the Operating Partnership. The self-storage facilities are located in California and Hawaii.

 

On June 25, 2007, the Operating Partnership loaned the holders of the Series A Units $100,000. The note receivable bears interest at 4.85% and is due September 1, 2020.  The loan is secured by the borrower’s Series A Units. The holders of the Series A Units can redeem up to 114,500 Series A Units prior to the maturity date of the loan. If any redemption in excess of 114,500 Series A Units occurs prior to the maturity date, the holder of the Series A Units is required to repay the loan as of the date of that redemption. The Series A Units are shown on the condensed consolidated balance sheets net of the $100,000 loan because the borrower under the loan receivable is also the holder of the Series A Units.

 

The partnership agreement of the Operating Partnership (as amended, the “Partnership Agreement”) provides for the designation and issuance of the Series A Units. The Series A Units will have priority over all other partnership interests of the Operating Partnership with respect to distributions and liquidation.

 

Under the Partnership Agreement, Series A Units in the amount of $115,000 bear a fixed priority return of 5% and have a fixed liquidation value of $115,000. The remaining balance participates in distributions with, and has a liquidation value equal to, that of the OP Units. The Series A Units are redeemable at the option of the holder, which redemption obligation may be satisfied, at the Company’s option, in cash or shares of its common stock.

 

Series B Redeemable Preferred Units

 

On April 3, 2014, the Operating Partnership completed the purchase of a self-storage facility located in Georgia.  This property was acquired in exchange for $15,158 of cash and 333,360 Series B Units valued at $8,334.

 

On August 29, 2013, the Operating Partnership completed the purchase of 19 out of 20 self-storage facilities affiliated with All Aboard Mini Storage, all of which are located in California.  On September 26, 2013, the Operating Partnership completed the purchase of the remaining facility.  These properties were acquired in exchange for $100,876 of cash (including $98,960 of debt assumed and immediately defeased at closing), 1,342,727 Series B Units valued at $33,568, and 1,448,108 OP Units valued at $62,341.

 

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The Partnership Agreement provides for the designation and issuance of the Series B Units.  The Series B Units rank junior to the Series A Units, on parity with the Series C Units, and senior to all other partnership interests of the Operating Partnership with respect to distributions and liquidation.

 

The Series B Units have a liquidation value of $25.00 per unit for a fixed liquidation value of $41,902.  Holders of the Series B Units receive distributions at an annual rate of 6%.  These distributions are cumulative and accrue each quarter regardless of the declaration of dividends or distributions. The Series B Units will become redeemable at the option of the holder on the first anniversary of the date of issuance, which redemption obligation may be satisfied at the Company’s option in cash or shares of its common stock.

 

Series C Convertible Redeemable Preferred Units

 

On November 19, 2013, the Company entered into Contribution Agreements with various entities affiliated with Grupe Properties Co. Inc. (“Grupe”), under which the Company agreed to acquire 12 self-storage facilities, all of which are located in California.  The Company completed the purchase of these self-storage facilities between December 2013 and May 2014. The Company previously held 35% interests in five of these properties and a 40% interest in one property through six separate joint ventures with Grupe. These properties were acquired in exchange for a total of approximately $45,722 of cash, the assumption of $37,532 in existing debt, and the issuance of 704,016 Series C Units valued at $30,960.

 

The Partnership Agreement provides for the designation and issuance of the Series C Units. The Series C Units rank junior to the Series A Units, on parity with the Series B Units, and senior to all other partnership interests of the Operating Partnership with respect to distributions and liquidation.

 

The Series C Units have a liquidation value of $42.10 per unit for a fixed liquidation value of $29,639. From issuance to the fifth anniversary of issuance, each Series C Unit holder will receive quarterly distributions equal to the quarterly distribution per OP Unit plus $0.18.  Beginning on the fifth anniversary of issuance, each Series C Unit holder will receive a fixed quarterly distribution equal to the aggregate quarterly distribution payable in respect of such Series C Unit during the four quarters immediately preceding the fifth anniversary of issuance, divided by four. These distributions are cumulative. The Series C Units will become redeemable at the option of the holder one year from the date of issuance, which redemption obligation may be satisfied at the Company’s option in cash or shares of its common stock. The Series C Units will also become convertible into OP Units at the option of the holder one year from the date of issuance, at a rate of 0.9145 OP Units per Series C Unit converted. This conversion option expires upon the fifth anniversary of the date of issuance.

 

11.       NONCONTROLLING 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. ESS Holding Business Trust II, also a wholly-owned subsidiary of the Company, is a limited partner of the Operating Partnership. Between its general partner and limited partner interests, the Company held a 93.8% ownership interest in the Operating Partnership as of June 30, 2014. The remaining ownership interests in the Operating Partnership (including Preferred Operating Partnership units) of 6.2% are held by certain former owners of assets acquired by the Operating Partnership.

 

The noncontrolling interest in the Operating Partnership represents OP 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 interests in the form of OP Units. Limited partners who received OP 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 OP Units for cash based upon the fair market value of an equivalent number of shares of the Company’s common stock (based on the ten-day average trading price) at the time of the redemption. Alternatively, the Company may, in its sole discretion, elect to acquire those OP Units in exchange for shares of its common stock on a one-for-one basis, subject to anti-dilution adjustments provided in the Partnership Agreement.  The ten-day average closing stock price at June 30, 2014 was $53.45 and there were 4,334,118 OP Units outstanding. Assuming that all of the OP Unit holders exercised their right to redeem all of their OP Units on June 30, 2014 and the Company elected to pay the OP Unit holders cash, the Company would have paid $231,659 in cash consideration to redeem the units.

 

GAAP requires a company to present ownership interests in subsidiaries held by parties other than the company in the consolidated financial statements within the equity section, but separate from the company’s equity.  It also requires the amount of consolidated net income attributable to the parent and to the noncontrolling interest to be clearly identified and presented on the face of the consolidated statement of operations, and requires changes in ownership interest to be accounted for similarly as equity transactions.  If noncontrolling interests are determined to be redeemable, they are to be carried at their redemption value as of the balance sheet date and reported as temporary equity.

 

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Table of Contents

 

The Company has evaluated the terms of the OP Units and classifies the noncontrolling interest represented by the OP Units as stockholders’ equity in the accompanying condensed consolidated balance sheets.  The Company will periodically evaluate individual noncontrolling interests for the ability to continue to recognize the noncontrolling amount as permanent equity in the condensed consolidated balance sheets.  Any noncontrolling interests that fail to qualify as permanent equity will be reclassified as temporary equity and adjusted to the greater of (1) the carrying amount and (2) the redemption value as of the end of the period in which the determination is made.

 

12.       OTHER NONCONTROLLING INTERESTS

 

Other noncontrolling interests represent the ownership interests of various third parties in two consolidated joint ventures as of June 30, 2014.  One of these consolidated joint ventures owns one property which was under construction at June 30, 2014.  The second consolidated joint venture owns 19 operating properties.  The ownership interests of the third-party owners range from 1.0% to 3.3%.  Other noncontrolling interests are included in the stockholders’ equity section of the Company’s condensed consolidated balance sheets.  The income or losses attributable to these third-party owners based on their ownership percentages are reflected in net income allocated to Operating Partnership and other noncontrolling interests in the condensed consolidated statements of operations.

 

In February 2013, the Company purchased one of its joint venture partner’s 1.7% capital interest and 17% profit interest in one of these consolidated joint ventures for $200.  As a result, the Company’s capital interest percentage in this joint venture increased from 95.0% to 96.7%.  Since the Company retained its controlling financial interest in the subsidiary, this transaction was accounted for as an equity transaction.  The carrying amount of the noncontrolling interest was reduced to reflect the purchase and the difference between the price paid by the Company and the adjustment to the carrying value of the noncontrolling interest was recorded as an adjustment to equity attributable to the parent.

 

In May 2013, the Company purchased one of its joint venture partner’s 27.7% capital interest and 35.0% profit interest in a previously unconsolidated joint venture for $950. The partner’s interest was reported in other noncontrolling interests prior to the purchase. As a result of the acquisition, the property became wholly-owned by the Company. Since the Company retained its controlling financial interest in the subsidiary, this transaction was accounted for as an equity transaction. The carrying amount of the noncontrolling interest was reduced to zero to reflect the purchase, and the difference between the price paid by the Company and the carrying value of the noncontrolling interest was recorded as an adjustment to equity attributable to the parent.

 

13.       EQUITY IN EARNINGS OF UNCONSOLIDATED REAL ESTATE VENTURES — PURCHASE OF JOINT VENTURE PARTNERS’ INTERESTS

 

On April 25, 2014, as part of the Grupe acquisition, the Company acquired its joint venture partner’s 60% equity interest in Savi-Ranch SPC, LLC, which owned one self storage property located in California, resulting in full ownership by the Company.  Prior to the acquisition, the Company accounted for its 40% interest in this joint venture as an equity-method investment.  The total acquisition-date fair value of the previous equity interest was approximately $3,567, and is included as consideration transferred.  The Company recognized a non-cash gain of $3,438 as a result of re-measuring its prior equity interest in this joint venture held before the acquisition.  This property was acquired in exchange for approximately $1,785 of cash and 101,929 Series C Units valued at $4,291.

 

On February 13, 2013, the Company acquired its joint venture partner’s 48% equity interest in Extra Space of Eastern Avenue LLC (“Eastern Avenue”), which owned one self-storage property located in Maryland, for approximately $5,979. Prior to the acquisition, the remaining 52% interest was owned by the Company, which accounted for its investment in Eastern Avenue using the equity method. The Company recorded a non-cash gain of $2,215 related to this transaction, which represents the increase in fair value of the Company’s interest in Eastern Avenue from its formation to the acquisition date.

 

On February 13, 2013, the Company acquired its joint venture partner’s 61% equity interest in Extra Space of Montrose Avenue LLC (“Montrose”), which owned one self-storage property located in Illinois, for approximately $6,878. Prior to the acquisition, the remaining 39% interest was owned by the Company, which accounted for its investment in Montrose using the equity method. The Company recorded a non-cash gain of $341 related to this transaction, which represents the increase in fair value of the Company’s interest in the joint venture from its formation to the acquisition date.

 

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Table of Contents

 

14.       SEGMENT INFORMATION

 

The Company operates in three distinct segments: (1) rental operations; (2) tenant reinsurance; and (3) property management, acquisition and development. Management fees collected for wholly-owned properties are eliminated in consolidation.  Financial information for the Company’s business segments is presented below:

 

 

 

June 30, 2014

 

December 31, 2013

 

Balance Sheet

 

 

 

 

 

Investment in unconsolidated real estate ventures

 

 

 

 

 

Rental operations

 

$

86,794

 

$

88,125

 

 

 

 

 

 

 

Total assets

 

 

 

 

 

Rental operations

 

$

3,954,126

 

$

3,641,746

 

Tenant reinsurance

 

29,359

 

34,393

 

Property management, acquisition and development

 

225,405

 

301,001

 

 

 

$

4,208,890

 

$

3,977,140

 

 

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Table of Contents

 

 

 

For the Three Months Ended June 30,

 

For the Six Months Ended June 30,

 

 

 

2014

 

2013

 

2014

 

2013

 

Statement of Operations

 

 

 

 

 

 

 

 

 

Total revenues

 

 

 

 

 

 

 

 

 

Rental operations

 

$

138,778

 

$

107,340

 

$

270,779

 

$

210,263

 

Tenant reinsurance

 

14,508

 

12,110

 

27,971

 

22,331

 

Property management, acquisition and development

 

6,954

 

6,796

 

13,670

 

12,974

 

 

 

160,240

 

126,246

 

312,420

 

245,568

 

 

 

 

 

 

 

 

 

 

 

Operating expenses, including depreciation and amortization

 

 

 

 

 

 

 

 

 

Rental operations

 

68,620

 

54,904

 

138,562

 

110,872

 

Tenant reinsurance

 

2,636

 

2,202

 

5,203

 

4,112

 

Property management, acquisition and development

 

18,323

 

15,765

 

37,596

 

30,480

 

 

 

89,579

 

72,871

 

181,361

 

145,464

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from operations

 

 

 

 

 

 

 

 

 

Rental operations

 

70,158

 

52,436

 

132,217

 

99,391

 

Tenant reinsurance

 

11,872

 

9,908

 

22,768

 

18,219

 

Property management, acquisition and development

 

(11,369

)

(8,969

)

(23,926

)

(17,506

)

 

 

70,661

 

53,375

 

131,059

 

100,104

 

 

 

 

 

 

 

 

 

 

 

Gain (loss) on sale of real estate and earnout from prior acquisition

 

 

 

 

 

 

 

 

 

Property management, acquisition and development

 

(7,785

)

800

 

(7,785

)

800

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

 

 

 

 

 

 

 

 

Rental operations

 

(20,348

)

(18,069

)

(39,658

)

(35,049

)

Property management, acquisition and development

 

(310

)

(293

)

(598

)

(679

)

 

 

(20,658

)

(18,362

)

(40,256

)

(35,728

)

 

 

 

 

 

 

 

 

 

 

Non-cash interest expense related to the amortization of discount on equity component of exchangeable senior notes

 

 

 

 

 

 

 

 

 

Rental operations

 

(663

)

(113

)

(1,325

)

(113

)

 

 

 

 

 

 

 

 

 

 

Interest income

 

 

 

 

 

 

 

 

 

Tenant reinsurance

 

4

 

4

 

8

 

8

 

Property management, acquisition and development

 

708

 

129

 

973

 

309

 

 

 

712

 

133

 

981

 

317

 

 

 

 

 

 

 

 

 

 

 

Interest income on note receivable from Preferred Operating Partnership unit holder

 

 

 

 

 

 

 

 

 

Property management, acquisition and development

 

1,212

 

1,212

 

2,425

 

2,425

 

 

 

 

 

 

 

 

 

 

 

Equity in earnings of unconsolidated real estate ventures

 

 

 

 

 

 

 

 

 

Rental operations

 

2,604

 

2,914

 

5,023

 

5,537

 

 

 

 

 

 

 

 

 

 

 

Equity in earnings of unconsolidated real estate ventures - gain on purchase of joint venture partners’ interests

 

 

 

 

 

 

 

 

 

Rental operations

 

3,438

 

 

3,438

 

2,556

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

 

 

 

 

 

 

 

 

Rental operations

 

601

 

3,838

 

2,020

 

4,847

 

Tenant reinsurance

 

(3,856

)

(6,379

)

(7,671

)

(9,245

)

Property management, acquisition and development

 

(258

)

(317

)

(692

)

(468

)

 

 

(3,513

)

(2,858

)

(6,343

)

(4,866

)

 

 

 

 

 

 

 

 

 

 

Net income (loss)

 

 

 

 

 

 

 

 

 

Rental operations

 

55,790

 

41,006

 

101,715

 

77,169

 

Tenant reinsurance

 

8,020

 

3,533

 

15,105

 

8,982

 

Property management, acquisition and development

 

(17,802

)

(7,438

)

(29,603

)

(15,119

)

 

 

$

46,008

 

$

37,101

 

$

87,217

 

$

71,032

 

 

 

 

 

 

 

 

 

 

 

Depreciation and amortization expense

 

 

 

 

 

 

 

 

 

Rental operations

 

$

26,326

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