10-Q 1 q1201910qexrdocument.htm 10-Q Document


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 March 31, 2019
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 300
Salt Lake City, Utah 84121
(Address of principal executive offices)

Registrant’s telephone number, including area code: (801) 365-4600

Securities registered pursuant to Section 12(b) of the Securities Exchange Act of 1934
Title of each class
Trading symbol
Name of each exchange on which registered
 
 
 
Common Stock, $0.01 par value
EXR
New York Stock Exchange

 
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 every Interactive Data File required to be submitted 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 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, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act:
Large accelerated filer
 
x
  
Accelerated filer
 
o
Non-accelerated filer
 
o 
  
Smaller reporting company
 
o
 
 
 
 
Emerging growth company
 
o






If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. 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, 2019, was 127,453,654.




EXTRA SPACE STORAGE INC.

TABLE OF CONTENTS
 


3



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 and developments on expected terms, or at all;
the effect of competition from new and existing stores or other storage alternatives, which could cause rents and occupancy rates to decline;
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;
reductions in asset valuations and related impairment charges;
our lack of sole decision-making authority with respect to our joint venture investments;
the effect of recent or future changes to U.S. tax laws;
the failure to maintain our REIT status for U.S. federal income tax purposes; and
economic uncertainty due to the impact of natural disasters, war or terrorism, which could adversely affect our business plan.
The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. You should carefully consider these risks before you make an investment decision with respect to our securities.

We disclaim any duty or obligation to update or revise any forward-looking statements set forth in this report to reflect new information, future events or otherwise.

4



PART I.     FINANCIAL INFORMATION

ITEM 1.
FINANCIAL STATEMENTS

Extra Space Storage Inc.
Condensed Consolidated Balance Sheets
(amounts in thousands, except share data)
 
 
March 31, 2019
 
December 31, 2018
 
(Unaudited)
 
 
Assets:
 
 
 
Real estate assets, net
$
7,688,617

 
$
7,491,831

Real estate assets - operating lease right-of-use assets
94,198

 

Investments in unconsolidated real estate ventures
161,029

 
125,326

Cash and cash equivalents
38,988

 
57,496

Restricted cash
7,840

 
15,194

Other assets, net
141,842

 
158,131

Total assets
$
8,132,514

 
$
7,847,978

Liabilities, Noncontrolling Interests and Equity:
 
 
 
Notes payable, net
$
4,101,958

 
$
4,137,213

Exchangeable senior notes, net
564,136

 
562,374

Notes payable to trusts

 
30,928

Revolving lines of credit
335,000

 
81,000

Operating lease liabilities
103,578

 

Cash distributions in unconsolidated real estate ventures
44,570

 
45,197

Accounts payable and accrued expenses
99,302

 
101,461

Other liabilities
110,158

 
104,383

Total liabilities
5,358,702

 
5,062,556

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, 127,392,050 and 127,103,750 shares issued and outstanding at March 31, 2019 and December 31, 2018, respectively
1,274

 
1,271

Additional paid-in capital
2,648,723

 
2,640,705

Accumulated other comprehensive income
11,807

 
34,650

Accumulated deficit
(277,655
)
 
(262,902
)
Total Extra Space Storage Inc. stockholders' equity
2,384,149

 
2,413,724

Noncontrolling interest represented by Preferred Operating Partnership units, net
176,264

 
153,096

Noncontrolling interests in Operating Partnership, net and other noncontrolling interests
213,399

 
218,602

Total noncontrolling interests and equity
2,773,812

 
2,785,422

Total liabilities, noncontrolling interests and equity
$
8,132,514

 
$
7,847,978


See accompanying notes to unaudited condensed consolidated financial statements.

5



Extra Space Storage Inc.
Condensed Consolidated Statements of Operations
(amounts in thousands, except share data)
(unaudited)
 
For the Three Months Ended March 31,
 
2019
 
2018
Revenues:
 
 
 
Property rental
$
271,003

 
$
247,886

Tenant reinsurance
29,797

 
27,034

Management fees and other income
10,746

 
10,565

Total revenues
311,546

 
285,485

Expenses:
 
 
 
Property operations
78,765

 
72,753

Tenant reinsurance
6,967

 
5,607

General and administrative
22,678

 
21,464

Depreciation and amortization
54,659

 
51,749

Total expenses
163,069

 
151,573

Income from operations
148,477

 
133,912

Interest expense
(47,360
)
 
(40,966
)
Non-cash interest expense related to amortization of discount on equity component of exchangeable senior notes
(1,162
)
 
(1,209
)
Interest income
1,388

 
1,438

Income before equity in earnings of unconsolidated real estate ventures and income tax expense
101,343

 
93,175

Equity in earnings of unconsolidated real estate ventures
2,630

 
3,597

Income tax expense
(1,813
)
 
(1,342
)
Net income
102,160

 
95,430

Net income allocated to Preferred Operating Partnership noncontrolling interests
(3,163
)
 
(3,390
)
Net income allocated to Operating Partnership and other noncontrolling interests
(4,227
)
 
(3,784
)
Net income attributable to common stockholders
$
94,770

 
$
88,256

Earnings per common share
 
 
 
Basic
$
0.74

 
$
0.70

Diluted
$
0.74

 
$
0.70

Weighted average number of shares
 
 
 
Basic
127,037,247

 
125,772,439

Diluted
134,289,716

 
132,682,560

Cash dividends paid per common share
$
0.86

 
$
0.78


See accompanying notes to unaudited condensed consolidated financial statements.

6



Extra Space Storage Inc.
Condensed Consolidated Statements of Comprehensive Income
(amounts in thousands)
(unaudited)
 
For the Three Months Ended March 31,
 
2019
 
2018
Net income
$
102,160

 
$
95,430

Other comprehensive income/(loss):
 
 
 
   Change in fair value of interest rate swaps
(23,993
)
 
23,063

Total comprehensive income
78,167

 
118,493

   Less: comprehensive income attributable to noncontrolling interests
6,240

 
8,256

Comprehensive income attributable to common stockholders
$
71,927

 
$
110,237



See accompanying notes to unaudited condensed consolidated financial statements.

7



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
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Series A
 
Series B
 
Series C
 
Series D
 
Operating Partnership
 
Other
 
Shares
 
Par Value
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income
 
Accumulated Deficit
 
Total Noncontrolling Interests and Equity
Balances at December 31, 2017
$
14,940

 
$
41,902

 
$
10,730

 
$
92,064

 
$
213,301

 
$
119

 
126,007,091

 
$
1,260

 
$
2,569,485

 
$
33,290

 
$
(253,284
)
 
$
2,723,807

Issuance of common stock upon the exercise of options

 

 

 

 

 

 
31,525

 

 
799

 

 

 
799

Restricted stock grants issued

 

 

 

 

 

 
31,136

 

 

 

 

 

Restricted stock grants cancelled

 

 

 

 

 

 
(770
)
 

 

 

 

 

Compensation expense related to stock-based awards

 

 

 

 

 

 

 

 
2,726

 

 

 
2,726

Repayment of receivable for preferred operating units pledged as collateral on loan

 

 
495

 

 

 

 

 

 

 

 

 
495

Redemption of Operating Partnership units for cash

 

 

 

 
(1,126
)
 

 

 

 
(1,432
)
 

 

 
(2,558
)
Noncontrolling interest in consolidated joint venture

 

 

 

 

 
120

 

 

 

 

 

 
120

Repurchase of equity portion of 2013 exchangeable senior notes

 

 

 

 

 

 

 

 
(21,000
)
 

 

 
(21,000
)
Net income
1,156

 
629

 
676

 
929

 
3,784

 

 

 

 

 

 
88,256

 
95,430

Other comprehensive income
144

 

 

 

 
938

 

 

 

 

 
21,981

 

 
23,063

Distributions to Operating Partnership units held by noncontrolling interests
(1,254
)
 
(629
)
 
(676
)
 
(929
)
 
(4,421
)
 

 

 

 

 

 

 
(7,909
)
Dividends paid on common stock at $0.78 per share

 

 

 

 

 

 

 

 

 

 
(98,327
)
 
(98,327
)
Balances at March 31, 2018
$
14,986

 
$
41,902

 
$
11,225

 
$
92,064

 
$
212,476

 
$
239

 
126,068,982

 
$
1,260

 
$
2,550,578

 
$
55,271

 
$
(263,355
)
 
$
2,716,646







8





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
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Series A
 
Series B
 
Series C
 
Series D
 
Operating Partnership
 
Other
 
Shares
 
Par Value
 
Additional Paid-in Capital
 
Accumulated Other Comprehensive Income
 
Accumulated Deficit
 
Total Noncontrolling Interests and Equity
Balances at December 31, 2018
$
14,756

 
$
41,902

 
$
4,374

 
$
92,064

 
$
218,362

 
$
240

 
127,103,750

 
$
1,271

 
$
2,640,705

 
$
34,650

 
$
(262,902
)
 
$
2,785,422

Issuance of common stock upon the exercise of options

 

 

 

 

 

 
169,021

 
3

 
1,754

 

 

 
1,757

Restricted stock grants issued

 

 

 

 

 

 
35,022

 

 

 

 

 

Restricted stock grants cancelled

 

 

 

 

 

 
(1,244
)
 

 

 

 

 

Compensation expense related to stock-based awards

 

 

 

 

 

 

 

 
2,954

 

 

 
2,954

Redemption of Operating Partnership units for stock

 

 

 

 
(3,310
)
 

 
85,501

 

 
3,310

 

 

 

Issuance of Preferred D Units in the Operating Partnership in conjunction with acquisitions

 

 

 
23,447

 

 

 

 

 

 

 

 
23,447

Net income (loss)
1,194

 
629

 
308

 
1,033

 
4,235

 
(9
)
 

 

 

 

 
94,770

 
102,160

Other comprehensive income (loss)
(147
)
 

 

 

 
(1,003
)
 

 

 

 

 
(22,843
)
 

 
(23,993
)
Distributions to Operating Partnership units held by noncontrolling interests
(1,326
)
 
(629
)
 
(308
)
 
(1,033
)
 
(5,116
)
 

 

 

 

 

 

 
(8,412
)
Dividends paid on common stock at $0.86 per share

 

 

 

 

 

 

 

 

 

 
(109,523
)
 
(109,523
)
Balances at March 31, 2019
$
14,477

 
$
41,902

 
$
4,374

 
$
115,511

 
$
213,168

 
$
231

 
127,392,050

 
$
1,274

 
$
2,648,723

 
$
11,807

 
$
(277,655
)
 
$
2,773,812


See accompanying notes to unaudited condensed consolidated financial statements.

9




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

 
For the Three Months Ended March 31,
 
2019
 
2018
Cash flows from operating activities:
 
 
 
Net income
$
102,160

 
$
95,430

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Depreciation and amortization
54,659

 
51,749

Amortization of deferred financing costs
3,034

 
3,021

Non-cash interest expense related to amortization of discount on equity component of exchangeable senior notes
1,162

 
1,209

Compensation expense related to stock-based awards
2,954

 
2,726

Distributions from unconsolidated real estate ventures in excess of earnings
1,732

 
1,501

Changes in operating assets and liabilities:
 
 
 
Other assets
(305
)
 
(737
)
Accounts payable and accrued expenses
6,418

 
10,434

Other liabilities
(2,475
)
 
6,275

Net cash provided by operating activities
169,339

 
171,608

Cash flows from investing activities:
 
 
 
Acquisition of real estate assets
(212,552
)
 
(76,122
)
Development and redevelopment of real estate assets
(15,846
)
 
(11,106
)
Proceeds from sale of real estate assets, investments in real estate ventures and other assets

 
753

Investment in unconsolidated real estate ventures
(17,395
)
 
(438
)
Return of investment in unconsolidated real estate ventures

 
47,944

Principal payments received from notes receivable

 
9,172

Purchase of equipment and fixtures
(1,182
)
 
(1,131
)
Net cash used in investing activities
(246,975
)
 
(30,928
)
Cash flows from financing activities:
 
 
 
Proceeds from notes payable and revolving lines of credit
424,000

 
162,000

Principal payments on notes payable and revolving lines of credit
(225,020
)
 
(168,204
)
Principal payments on notes payable to trusts
(30,928
)
 

Deferred financing costs
(100
)
 
(117
)
Repurchase of exchangeable senior notes

 
(58,464
)
Net proceeds from exercise of stock options
1,757

 
799

Redemption of Operating Partnership units held by noncontrolling interests

 
(2,558
)
Contributions from noncontrolling interests

 
120

Dividends paid on common stock
(109,523
)
 
(98,327
)
Distributions to noncontrolling interests
(8,412
)
 
(7,909
)
Net cash provided by (used in) financing activities
51,774

 
(172,660
)
Net decrease in cash, cash equivalents, and restricted cash
(25,862
)
 
(31,980
)
Cash, cash equivalents, and restricted cash, beginning of the period
72,690

 
86,044

Cash, cash equivalents, and restricted cash, end of the period
$
46,828

 
$
54,064


10




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

 
For the Three Months Ended March 31,
 
2019
 
2018
Supplemental schedule of cash flow information
 
 
 
Interest paid
$
45,165

 
$
37,007

Income taxes paid (received)
(177
)
 
492

Supplemental schedule of noncash investing and financing activities:
 
 
 
Redemption of Operating Partnership units held by noncontrolling interests for common stock
 
 
 
Noncontrolling interests in Operating Partnership
$
(3,310
)
 
$

Common stock and paid-in capital
3,310

 

Establishment of operating lease right-of-use assets and lease liabilities
 
 
 
Real estate assets - operating lease right-of-use assets
$
95,506

 
$

Operating lease liabilities
(104,863
)
 

Accounts payable and accrued expenses
9,357

 

Acquisitions of real estate assets


 


Real estate assets, net
$
19,937

 
$
489

Notes payable assumed
(17,157
)
 

Investment in unconsolidated real estate ventures
(2,780
)
 
(489
)
Accrued construction costs and capital expenditures


 

Acquisition of real estate assets
$
780

 
$
526

Development and redevelopment of real estate assets

 
1,381

Accounts payable and accrued expenses
(780
)
 
(1,907
)
Contribution of Preferred OP Units to unconsolidated real estate venture


 


Investments in unconsolidated real estate ventures
$
23,447

 
$

Value of Preferred Operating Partnership units issued
(23,447
)
 


See accompanying notes to unaudited condensed consolidated financial statements.


11


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
Amounts in thousands, except store 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 properties ("stores") located throughout the United States. The Company was formed to continue 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 stores 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 invests in stores by acquiring wholly-owned stores or by acquiring an equity interest in real estate entities. At March 31, 2019, the Company had direct and indirect equity interests in 1,119 stores. In addition, the Company managed 577 stores for third parties, bringing the total number of stores which it owns and/or manages to 1,696. These stores are located in 40 states, Washington, D.C. and Puerto Rico. The Company also offers tenant reinsurance at its owned and managed stores that insures the value of goods in the storage units.
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 three months ended March 31, 2019 are not necessarily indicative of results that may be expected for the year ending December 31, 2019. The condensed consolidated balance sheet as of December 31, 2018 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, 2018, as filed with the Securities and Exchange Commission.

Recently Issued Accounting Standards

In February 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2016-02, “Leases (Topic 842),” which modifies the accounting for leases, intending to increase transparency and comparability of organizations by requiring balance sheet presentation of leased assets and increased financial statement disclosure of leasing arrangements. ASU 2016-02 requires entities to recognize a liability for their lease obligations and a corresponding asset representing the right to use the underlying asset over the lease term. Lease obligations are measured at their present value and accounted for using the effective interest method. The accounting for the leased asset differs slightly depending on whether the agreement is deemed to be a financing or operating lease. For financing leases, the leased asset is depreciated on a straight-line basis and is recorded separately from the interest expense in the statements of operations, resulting in higher expense in the earlier part of the lease term. For operating leases, the depreciation and interest expense components are combined, recognized evenly over the term of the lease, and presented as a reduction to operating income. ASU 2016-02 requires that assets and liabilities be presented or disclosed separately, and requires additional disclosure of certain qualitative and quantitative information related to these lease agreements. ASU 2016-02 is effective for annual and interim periods beginning after December 15, 2018. The Company adopted the standard using the modified retrospective approach as of January 1, 2019. The Company elected the package of practical expedients upon adoption, which allows for the application of the standard solely to the transition period in 2019 but does not require application to prior fiscal comparative periods presented. The Company also elected the practical expedient provided in a subsequent amendment to the standard that removed the requirement to separate lease and nonlease components. The Company did not record a significant cumulative catch-up adjustment to retained earnings upon adoption of ASU 2016-02. The primary impact was related to the Company's 21 operating ground leases and two corporate facility leases under which it serves as lessee. The Company recognized lease liabilities of $104,863 and right-of-use assets related to operating leases totaling $95,506 as of the adoption date. Refer to Note 13 for further discussion of the Company's leases.


12


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated

In August 2018, the FASB issued ASU 2018-15, "Intangibles - Goodwill and Other - Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That is a Service Contract." ASU 2018-15 amends the accounting for implementation costs incurred in a hosting arrangement that is a service contract, and aligns them with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. ASU 2018-15 also requires that entities amortize the capitalized implementation costs over the term of the hosting arrangement. ASU 2018-15 is effective for annual periods beginning after December 15, 2020, with early adoption permitted, including early adoption in any interim period. The Company adopted this standard on a prospective basis as of October 1, 2018. The adoption of this standard did not have a material impact on the Company's financial statements.

In June 2016, the FASB issued ASU 2016-13, "Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments." ASU 2016-13 changes how entities measure credit losses for most financial assets. This standard requires an entity to estimate its lifetime "expected credit loss" and record an allowance that, when deducted from the amortized cost basis of the financial asset, presents the net amount expected to be collected on the financial asset. The Company is evaluating the impact this new standard will have on its consolidated financial statements.

In November 2018, the FASB issued ASU 2018-19, "Codification Improvements to Topic 326, Financial Instruments - Credit Losses," which clarified that receivables arising from operating leases are within the scope of the leasing standard (ASU 2016-02). This new standard will be effective for the Company on January 1, 2020. The Company is evaluating the impact this new standard will have on its consolidated financial statements.

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 FASB’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 March 31, 2019, the Company 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 has determined that its derivative valuations in their entirety were classified in Level 2 of the fair value hierarchy.


13


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated

The table below presents the Company’s assets and liabilities measured at fair value on a recurring basis as of March 31, 2019, aggregated by the level in the fair value hierarchy within which those measurements fall. 
 
 
Fair Value Measurements at Reporting Date Using
Description
 
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
 
$

 
$
25,908

 
$

Other liabilities - cash flow hedge swap agreements
 
$

 
$
9,307

 
$


The Company did not have any significant assets or liabilities that are re-measured on a recurring basis using significant unobservable inputs as of March 31, 2019 or December 31, 2018.

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 store at least annually to determine if any such events or circumstances have occurred or exist. The Company focuses on stores where occupancy and/or rental income have decreased by a significant amount. For these stores, the Company determines whether the decrease is temporary or permanent, and whether the store will likely recover the lost occupancy and/or revenue in the short term. In addition, the Company reviews stores 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, the Company would recognize an impairment loss on the assets held for sale. The operations of assets held for sale or sold during the period are presented as part of normal operations for all periods presented. As of March 31, 2019, the Company had one operating store classified as held for sale and one parcel of land classified as held for sale which are included in real estate assets, net. The estimated fair value less selling costs for each of these assets is greater than the carrying value of the assets, and therefore no loss has been recorded.

The Company assesses annually whether there are any indicators that the value of the Company’s investments in unconsolidated real estate ventures may be impaired annually and when events or circumstances indicate that 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 of the investment over the fair value of the investment.

In connection with the Company’s acquisition of stores, the purchase price is allocated to the tangible and intangible assets and liabilities acquired based on their relative 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 stores. Any 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 capitalized as part of the purchase price.

14


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated


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 March 31, 2019 and December 31, 2018 approximate fair value. Restricted cash is comprised of letters of credit and escrowed funds deposited with financial institutions located throughout the United States relating to earnest money deposits on potential acquisitions, real estate taxes, insurance and capital expenditures.

The fair values of the Company’s notes receivable from Preferred Operating Partnership unit holders and other fixed rate notes receivable, which are recorded in other assets, net were based on the discounted estimated future cash flows of the notes (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:
 
March 31, 2019
 
December 31, 2018
 
Fair
Value
 
Carrying
Value
 
Fair
Value
 
Carrying
Value
Notes receivable from Preferred and Common Operating Partnership unit holders
$
116,957

 
$
119,735

 
$
115,467

 
$
119,735

Fixed rate notes payable and notes payable to trusts
$
3,057,072

 
$
3,051,171

 
$
2,985,731

 
$
3,022,414

Exchangeable senior notes
$
660,894

 
$
575,000

 
$
620,149

 
$
575,000

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”), Series D Redeemable Preferred Units (“Series D Units” and, together with
the Series A Units, Series B Units and Series C Units, the “Preferred OP 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 (i.e. those that reduce earnings per common share) are included. For the three months ended March 31, 2019, there were no anti-dilutive options. For the three months ended March 31, 2018, options to purchase an aggregate of approximately 40,956 shares of common stock were excluded from the computation of earnings per share as their effect would have been anti-dilutive.


15


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated

For the purposes of computing the diluted impact of the potential exchange of the Preferred Operating Partnership 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 intent and ability to settle the redemption in shares, the Company divided the total value of the Preferred Operating Partnership units by the average share price for the period presented. The average share price for the three months ended March 31, 2019 and 2018 was $96.05 and $84.11, respectively.

The following table presents the number of Preferred Operating Partnership units, and the potential common shares, that were excluded from the computation of earnings per share as their effect would have been anti-dilutive.
 
For the Three Months Ended March 31,
 
2019
 
2018
 
Equivalent Shares (if converted)
 
Equivalent Shares (if converted)
Series B Units
436,254

 
498,183

Series C Units
129,763

 
352,385

Series D Units
1,083,265

 
1,094,555

 
1,649,282

 
1,945,123


The Operating Partnership had no amounts issued and outstanding of its 2.375% Exchangeable Senior Notes due 2033 (the “2013 Notes”) as of March 31, 2019, as the remaining principal balance had been redeemed in July 2018. Prior to their redemption, the 2013 Notes could potentially have had a dilutive impact on the Company’s earnings per share calculations. The 2013 Notes were exchangeable by holders into shares of the Company’s common stock under certain circumstances per the terms of the indenture governing the 2013 Notes. The Company had irrevocably agreed to pay only cash for the accreted principal amount of the 2013 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.

The Operating Partnership had $575,000 of its 3.125% Exchangeable Senior Notes due 2035 (the “2015 Notes”) issued and outstanding as of March 31, 2019. The 2015 Notes could potentially have a dilutive impact on the Company’s earnings per share calculations. The 2015 Notes are exchangeable by holders into shares of the Company’s common stock under certain circumstances per the terms of the indenture governing the 2015 Notes. The exchange price of the 2015 Notes was $92.55 per share as of March 31, 2019, 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 2015 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.

Although the Company has retained the right to satisfy the exchange obligation in excess of the accreted principal amount of the 2013 Notes and 2015 Notes in cash and/or common stock, 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 share computation. For the three months ended March 31, 2019 and 2018, zero and 81,382 shares, respectively, related to the 2013 Notes were included in the computation for diluted earnings per share. For the three months ended March 31, 2019 and 2018, 226,527 and zero shares, respectively, related to the 2015 Notes were included in the computation for diluted earnings per share. The exchange price exceeded the average per share price of the Company’s common stock during the three months ended March 31, 2018.

For the purposes of computing the diluted impact on earnings per 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 $101,700 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 $101,700 is considered in the calculation of shares contingently issuable for the purposes of computing diluted earnings per share as allowed by ASC 260-10-45-46. Accordingly, the number of shares included in the computation for diluted earnings per share related to the Series A Units is equal to the number of Series A Units outstanding, with no additional shares included related to the fixed $101,700 amount.


16


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated

The computation of earnings per common share is as follows for the periods presented:
 
For the Three Months Ended March 31,
 
2019
 
2018
Net income attributable to common stockholders
$
94,770

 
$
88,256

Earnings and dividends allocated to participating securities
(167
)
 
(178
)
Earnings for basic computations
94,603

 
88,078

Earnings and dividends allocated to participating securities

 
178

Income allocated to noncontrolling interest - Preferred Operating Partnership Units and Operating Partnership Units
5,429

 
4,941

Fixed component of income allocated to noncontrolling interest - Preferred Operating Partnership (Series A Units)
(572
)
 
(572
)
Net income for diluted computations
$
99,460

 
$
92,625

 
 
 
 
Weighted average common shares outstanding:
 
 
 
Average number of common shares outstanding - basic
127,037,247

 
125,772,439

OP Units
5,960,981

 
5,663,370

Series A Units
875,480

 
875,480

Shares related to exchangeable senior notes and dilutive stock options
416,008

 
371,271

Average number of common shares outstanding - diluted
134,289,716

 
132,682,560

Earnings per common share


 


Basic
$
0.74

 
$
0.70

Diluted
$
0.74

 
$
0.70

5.    STORE ACQUISITIONS AND DISPOSITIONS

The following table shows the Company’s acquisitions of stores for the three months ended March 31, 2019 and 2018. The table excludes purchases of raw land and improvements made to existing assets. All acquisitions are considered asset acquisitions under ASU 2017-01, "Business Combinations (Topic 805): Clarifying the Definition of a Business."
 
 
 
Consideration Paid
 
Total
Quarter
Number of Stores
 
Total
 
Cash Paid
 
Loan Assumed
Investments in Real Estate Ventures
Net Liabilities/ (Assets) Assumed
 
Real estate assets
Q1 2019
14
(1) 
$
223,740

 
$
202,890

 
$
17,157

$
2,780

$
913

 
$
223,740

 
 
 
 
 
 
 
 
 
 
 
 
Q1 2018
5
(2) 
$
70,787

 
$
70,171

 
$

$
489

$
127

 
$
70,787


(1) Store acquisitions during the three months ended March 31, 2019 include the purchase of 12 stores previously held in joint ventures where the Company held a noncontrolling interest. The Company purchased its partners' remaining equity interests in the joint ventures, and the properties owned by the joint ventures became wholly owned by the Company. No gain or loss was recognized as a result of this acquisition.

(2) Store acquisitions during the three months ended March 31, 2018 include the acquisition of one store that had been owned by a joint venture in which the Company held a noncontrolling interest. No gain or loss was recognized as a result of this acquisition.



17


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated

6.
INVESTMENTS IN UNCONSOLIDATED REAL ESTATE VENTURES
Investments in unconsolidated real estate ventures represent the Company's noncontrolling interests in properties. The Company accounts for these investments using the equity method of accounting. The Company initially records these investments at cost and subsequently adjusts for cash contributions, distributions and net equity in income or loss, which is allocated in accordance with the provisions of the applicable partnership or joint venture agreement.
In these joint ventures, the Company and the joint venture partner generally receive a preferred return on their invested capital. To the extent that cash or 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 or profits than its equity interest.

The Company separately reports investments with net equity less than zero in cash distributions in unconsolidated real estate ventures in the condensed consolidated balance sheets. The net equity of certain joint ventures is less than zero because distributions have exceeded the Company's investment in and share of income from these joint ventures. This is generally the result of financing distributions, capital events or operating distributions that are usually greater than net income, as net income includes non‑cash charges for depreciation and amortization while distributions do not.

During the three months ended March 31, 2019, the Company contributed a total of $40,843 to its joint ventures for the purchase of one operating store and six stores acquired at the issuance of certificate of occupancy.
Net investments in unconsolidated real estate ventures and cash distributions in unconsolidated real estate ventures consist of the following:
 
Number of Stores
 
Equity Ownership %
 
Excess Profit % (1)
 
March 31,
 
December 31,
 
2019
 
2018
PRISA Self Storage LLC
85
 
4%
 
4%
 
$
9,292

 
$
9,334

Storage Portfolio II JV LLC
36
 
10%
 
30%
 
(4,539
)
 
(4,233
)
Storage Portfolio I LLC
24
 
34%
 
49%
 
(38,186
)
 
(38,129
)
VRS Self Storage, LLC
16
 
45%
 
54%
 
18,002

 
18,281

Extra Space Northern Properties Six LLC
10
 
10%
 
35%
 
(1,793
)
 
(1,700
)
WICNN JV LLC
9
 
10%
 
25%
 
32,859

 
26,885

Alan Jathoo JV LLC
9
 
10%
 
10%
 
8,132

 
8,180

ESS Bristol Investments LLC
8
 
10%
 
28%
 
3,025

 
2,331

GFN JV, LLC
5
 
10%
 
25%
 
12,429

 
10,586

Extra Space West Two LLC
 
5%
 
40%
 

(2 
) 
3,818

Extra Space West One LLC
 
5%
 
40%
 

(2 
) 
(1,038
)
Other minority owned stores
22
 
10-50%
 
19-50%
 
77,238

 
45,814

Net Investments in and Cash distributions in unconsolidated real estate ventures
224
 
 
 
 
 
$
116,459

 
$
80,129

(1) Includes pro-rata equity ownership share and promoted interest.
(2) In January 2019, the Company purchased its joint venture partners' 95% interests in the Extra Space West One LLC and Extra Space West Two LLC joint ventures, which owned a total of 12 stores. The Company paid $172,505 of cash to acquire the equity interests, and subsequent to this acquisition, the Company owned 100% of the joint ventures and the related stores.

On February 2, 2018, the Company and Teachers REA II LLC ("TIAA") entered into the Third Amendment to Amended and Restated Limited Liability Company Agreement of Storage Portfolio I LLC (the "Amendment"). The Amendment was deemed effective as of January 1, 2018. Under the Amendment, the Company's capital percentage in Storage Portfolio I LLC ("SP I") increased from 25.0% to 34.0%, and its excess profit participation percentage increased from 40.0% to 49.0%, among other changes. Additionally, SP I refinanced its mortgage loan and the Company received a financing distribution of $47,944, which was recorded as a reduction in the Company's investment in SP I. The Company continues to account for its investment in SP I under the equity method of accounting.

18


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated

 
7.    VARIABLE INTERESTS

The Operating Partnership had three wholly-owned unconsolidated subsidiaries (“Trust,” “Trust II” and “Trust III,” together, the “Trusts”) that had 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 were variable interest entities ("VIEs") because the holders of the equity investment at risk (the trust preferred securities) did 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 was not considered an equity investment at risk. The Operating Partnership’s investment in the Trusts was 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 was not the primary beneficiary of the Trusts, they were not consolidated. A debt obligation was recorded in the form of notes for the proceeds as discussed above, which were owed to the Trusts. The Company had also included its investment in the Trusts’ common securities in other assets on the condensed consolidated balance sheets.

During the year ended December 31, 2018, the Company repaid a total principal amount of $88,662, representing all of the notes payable to Trust III, all of the notes payable to Trust II, and all but $30,928 of the notes payable to Trust. The Trusts used the proceeds from these repayments to redeem their preferred and common securities. During the three months ended March 31, 2019, the Company repaid the remaining balance of $30,928 of notes payable to Trust.

During the time they were outstanding, the Company did not provide 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 was 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 was equal to the notes payable that the Trusts owed to third parties for their investments in the Trusts’ preferred securities.

The Company had no consolidated VIEs during the three months ended March 31, 2019.
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.

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 months ended March 31, 2019 and 2018, such derivatives were

19


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated

used to hedge the variable cash flows associated with existing variable-rate debt. In the coming 12 months, the Company estimates that $13,649 will be reclassified and reduce interest expense.

The Company held 28 derivative financial instruments which had a total combined notional amount of $2,287,824 as of March 31, 2019.

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
 
March 31, 2019
 
December 31, 2018
Derivatives designated as hedging instruments:
Fair Value
Other assets
$
25,908

 
$
42,324

Other liabilities
$
9,307

 
$
2,131


Effect of Derivative Instruments
The table below presents 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:

 
Gain (loss) recognized in OCI For the Three Months Ended March 31,
 
Location of amounts reclassified from OCI into income
 
Gain reclassified from OCI For the Three Months Ended March 31,
Type
2019
 
2018
 
2019
 
2018
Swap Agreements
$
(19,576
)
 
$
23,317

 
Interest expense
 
$
4,462

 
$
240


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 March 31, 2019, 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 $9,889. As of March 31, 2019, the Company had not posted any collateral related to these agreements. If the Company had breached any of these provisions as of March 31, 2019, it could have been required to cash settle its obligations under the agreements at their termination value of $9,889, including accrued interest.

20


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated

9.
EXCHANGEABLE SENIOR NOTES

In September 2015, the Operating Partnership issued $575,000 of its 3.125% Exchangeable Senior Notes due 2035. Costs incurred to issue the 2015 Notes were approximately $11,992, consisting primarily of a 2.0% underwriting fee. 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 exchangeable senior notes, net, in the condensed consolidated balance sheets. The 2015 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 April 1, 2016, until the maturity date of October 1, 2035. The 2015 Notes bear interest at 3.125% per annum and contain an exchange settlement feature, which provides that the 2015 Notes may, under certain circumstances, be exchangeable for cash (for the principal amount of the 2015 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 2015 Notes as of March 31, 2019 was approximately 10.81 shares of the Company’s common stock per $1,000 principal amount of the 2015 Notes.

The Operating Partnership may redeem the 2015 Notes at any time to preserve the Company’s status as a REIT. In addition, on or after October 5, 2020, the Operating Partnership may redeem the 2015 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 2015 Notes. The holders of the 2015 Notes have the right to require the Operating Partnership to repurchase the 2015 Notes for cash, in whole or in part, on October 1 of the years 2020, 2025 and 2030 (unless the Operating Partnership has called the 2015 Notes for redemption), and upon the occurrence of certain designated events, in each case for a repurchase price equal to 100% of the principal amount of the 2015 Notes plus accrued and unpaid interest. Certain events are considered “Events of Default,” as defined in the indenture governing the 2015 Notes, which may result in the accelerated maturity of
the 2015 Notes.

Additionally, the 2015 Notes can be exchanged during any calendar quarter, if the last reported sale price of the common stock of the Company is greater than or equal to 130% of the exchange price for at least 20 trading days during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter. The price of the Company’s common stock did not exceed 130% of the exchange price for the required time period for the 2015 Notes during the quarter ended March 31, 2019.

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, and costs incurred to issue the 2013 Notes were approximately $1,672. These costs were amortized as an adjustment to interest expense over five years, which represented the estimated term based on the first available redemption date. The 2013 Notes bore interest at 2.375% per annum and contained an exchange settlement feature. During the three months ended March 31, 2018, the Company repurchased a total principal amount of $37,704 of the 2013 Notes. The Company paid cash of $58,464 for the total of the principal amount and the exchange value in excess of the principal amount. The Operating Partnership redeemed all remaining outstanding 2013 Notes on July 5, 2018.

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 2013 Notes and 2015 Notes separately. The equity components are included in paid-in capital in stockholders’ equity in the condensed consolidated balance sheets, and the value of the equity components are treated as original issue discount for purposes of accounting for the debt components. The discounts are amortized as interest expense over the remaining period of the debt through its first redemption date: July 1, 2018 for the 2013 Notes, and October 1, 2020 for the 2015 Notes. The effective interest rate on the liability components of the 2013 Notes and the 2015 Notes is 4.0%, which approximated the market rate of interest of similar debt without exchange features (i.e. nonconvertible debt) at the time of issuance.

21


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated


Information about the Company’s 2015 Notes, including the total carrying amount of the equity component, the principal amount of the liability component, the unamortized discount and the net carrying amount was as follows for the periods indicated:
 
March 31, 2019
 
December 31, 2018
Carrying amount of equity component
$
22,597

 
$
22,597

Principal amount of liability component
$
575,000

 
$
575,000

Unamortized discount - equity component
(7,255
)
 
(8,417
)
Unamortized debt issuance costs
(3,609
)
 
(4,209
)
Net carrying amount of liability components
$
564,136

 
$
562,374


The amount of interest cost recognized relating to the contractual interest rate and the amortization of the discount on the liability component of the 2015 Notes were as follows for the periods indicated:
 
For the Three Months Ended March 31,
 
2019
 
2018
Contractual interest
$
4,492

 
$
4,561

Amortization of discount
1,162

 
1,209

Total interest expense recognized
$
5,654

 
$
5,770

10.
STOCKHOLDERS’ EQUITY

On May 6, 2016, the Company filed its $400,000 "at the market" equity program with the Securities and Exchange Commission using a shelf registration statement on Form S-3, and entered into separate equity distribution agreements with five sales agents. During the three months ended March 31, 2019, the Company did not issue any shares and had $257,929 available for issuance under the equity distribution agreements.
11.
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.

At March 31, 2019 and December 31, 2018, the noncontrolling interests represented by the Preferred OP Units qualified for classification as permanent equity on the Company's condensed consolidated balance sheets. The partnership agreement of the Operating Partnership (as amended, the "Partnership Agreement") provides for the designation and issuance of the OP Units. Noncontrolling interests in Preferred OP Units were presented net of notes receivable from preferred OP unit holders of $108,644 as of March 31, 2019 and December 31, 2018, as more fully described below.


22


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated

Series A Participating Redeemable Preferred Units

The Partnership Agreement provides for the designation and issuance of the Series A Units. The Series A Units have priority over all other partnership interests of the Operating Partnership with respect to distributions and liquidation.
The Series A Units were issued in June 2007. Series A Units in the amount of $101,700 bear a fixed priority return of 2.3% and originally had 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. As a result of the redemption of 114,500 Series A Units in October 2014, the remaining fixed liquidation value was reduced to $101,700, which represents 875,480 Series A Units. On April 18, 2017, the holder of the Series A Units and the Operating Partnership agreed to reduce the fixed priority return on the Series A Units from 5.0% to 2.3% in exchange for a reduction in the interest rate of the related loan, as more fully described below.

On June 25, 2007, the Operating Partnership loaned the holder of the Series A Units $100,000. On April 18, 2017, a loan amendment was signed modifying the maturity date of the loan to the later of the death of the Series A Unit holder or his spouse and also lowering the interest rate of the loan from 4.9% to 2.1%. The loan amendment was determined to be a loan modification under GAAP, and therefore no change in value was recognized. The loan is secured by the borrower’s Series A Units. No future redemption of Series A Units can be made unless the loan secured by the Series A Units is also repaid. The Series A Units are shown on the balance sheet net of the $100,000 loan because the borrower under the loan receivable is also the holder of the Series A Units.

Series B Redeemable Preferred Units

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 Series D Units, and senior to all other partnership interests of the Operating Partnership with respect to distributions and liquidation.

The Series B Units were issued in 2013 and 2014 and have a liquidation value of $25.00 per unit for a fixed liquidation value of $41,902, which represents 1,676,087 Series B Units. Holders of the Series B Units receive distributions at an annual rate of 6.0%. These distributions are cumulative. The Series B Units became 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

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 Series D Units, and senior to all other partnership interests of the Operating Partnership with respect to distributions and liquidation.

The Series C Units were issued in 2013 and 2014 and have a liquidation value of $42.10 per unit for a fixed liquidation value of $12,462, which represents 296,020 Series C Units. 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 became 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 are convertible into OP Units at the option of the holder 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.

In December 2014, the Operating Partnership loaned certain holders of the Series C Units $20,230. The loan receivable, which was collateralized by the Series C Units, bears interest at 5.0% per annum and matures on December 15, 2024. The Series C Units are shown on the balance sheet net of the loan balance because the borrower under the loan receivable is also the holder of the Series C Units.

On December 1, 2018, certain holders of the Series C Units converted their Series C Units into OP Units, with a total of 407,996 Series C Units being converted into a total of 373,113 OP Units. As part of this conversion, the holders of the Series C

23


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated

Units agreed to pledge the OP Units received in the conversion as collateral on the loan receivable to replace the Series C Units that were converted. As of March 31, 2019 and December 31, 2018, the total outstanding balance of the loan receivable was $19,735, of which $8,644 is shown as a reduction of the noncontrolling interests related to the Series C Units and $11,091 is shown as a reduction of the noncontrolling interests related to the OP Units on the Company's consolidated balance sheets. On April 25, 2019, subsequent to quarter-end, the remaining 296,020 Series C Units were converted into 270,710 OP Units.

Series D Redeemable Preferred Units

The Partnership Agreement provides for the designation and issuance of the Series D Units. The Series D Units rank junior to the Series A Units, on parity with the Series B Units and Series C Units, and senior to all other partnership interests of the Operating Partnership with respect to distributions and liquidation.
The Series D Units have been issued at various times from 2014 to 2017. In addition, during the three months ended March 31, 2019, the Operating Partnership issued 937,924 Series D Units valued at $23,447 in conjunction with joint venture acquisitions.
The Series D Units have a liquidation value of $25.00 per unit, for a fixed liquidation value of $115,511, which represents 4,620,445 Series D Units. Holders of the Series D Units receive distributions at an annual rate between 3.0% and 5.0%. These distributions are cumulative. The Series D Units 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. In addition, certain of the Series D Units are exchangeable for OP Units at the option of the holder until the tenth anniversary of the date of issuance, with the number of OP Units to be issued equal to $25.00 per Series D Unit, divided by the value of a share of common stock as of the exchange date.
12.
NONCONTROLLING INTEREST IN OPERATING PARTNERSHIP AND OTHER NONCONTROLLING INTERESTS

Noncontrolling Interest in Operating Partnership

The Company’s interest in its stores is held through the Operating Partnership. Between its general partner and limited partner interests, the Company held a 90.5% ownership interest in the Operating Partnership as of March 31, 2019. The remaining ownership interests in the Operating Partnership (including Preferred OP Units) of 9.5% 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. OP Units are redeemable at the option of the holder, which redemption may be satisfied at the Company's option in 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, or shares of the Company's common stock on a one-for-one basis, subject to anti-dilution adjustments provided in the Partnership Agreement. As of March 31, 2019, the ten-day average closing price of the Company's common stock was $100.76 and there were 5,908,750 OP Units outstanding. Assuming that all of the OP Unit holders exercised their right to redeem all of their OP Units on March 31, 2019 and the Company elected to pay the OP Unit holders cash, the Company would have paid $595,366 in cash consideration to redeem the units.

OP Unit activity is summarized as follows for the periods presented:
 
For the Three Months Ended March 31,
 
2019
 
2018
OP Units redeemed for common stock
85,501

 

OP Units redeemed for cash

 
30,000

Cash paid for OP Units redeemed
$

 
$
2,558


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.

24


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated


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.

Other Noncontrolling Interests

Other noncontrolling interests represent the ownership interests of third parties in two consolidated joint ventures as of March 31, 2019. One joint venture owns two operating stores in Texas, an operating store and a development store in Colorado, and the other joint venture owns one operating store in Pennsylvania and one development property in New Jersey. The voting interests of the third-party owners are between 5.0% and 20.0%.
13.
LEASES

The Company adopted ASC 842, "Leases," effective January 1, 2019 on a modified retrospective basis as allowed under the standard and prior periods have not been restated. The Company elected the package of transition practical expedients, and has therefore (1) not reassessed whether any expired or existing contracts are or contain leases, (2) not reassessed the lease classification for any expired or existing leases, and (3) not reassessed initial direct costs for any expired or existing leases.
Lessee Accounting
The Company recognized lease liabilities of $104,863 and right-of-use assets related to operating leases totaling $95,506 as of the adoption date. These are presented as “Operating lease liabilities” and “Real estate assets-operating lease right-of-use assets” on the Company’s consolidated balance sheets.
The Company is lessee under several types of lease agreements. Generally, these leases fall into the following categories:
Leases of real estate at 22 stores classified as wholly-owned. These leases generally have original lease terms between 10-67 years. Under these leases, the Company typically has the option to extend the lease term for additional terms of 5-35 years.
Leases of its corporate offices and call center. These leases have original lease terms between 5.3 and 12.1 years, with no extension options.
Leases of 12 regional offices. These leases have original lease terms between three and five years. The Company has the option on five of these leases to extend the lease term for three additional years.
Leases of small district offices. These leases generally have terms of 12 months or less. The Company has made an accounting election to account for these under the short-term lease exception outlined under ASC 842. Therefore, no lease assets or liabilities are recorded related to these leases, and the Company will recognize lease payments as expense on a straight-line basis over the related lease terms.

The Company has included lease extension options in the lease term for calculations of its right-of-use assets and liabilities related to the real estate asset leases at its stores when it is reasonably certain that the Company plans to extend these leases when the options arise.

Several of the leases of real estate at the Company’s stores include escalation clauses based on an index or rate, such as the Consumer Price Index (CPI). The Company included these lease payments in its calculations of right-of-use assets and liabilities based on the prevailing index or rate as of the adoption date. The Company will recognize changes to these variable lease payments in earnings in the period of the change.
One of the real estate leases includes variable lease payments that are based upon a percentage of gross revenues. Certain other leases include additional variable payments relating to a percentage of sales in excess of a specified amount, common area maintenance, property taxes, etc. These payments are variable lease payments that do not depend on an index or rate and are excluded from the measurement of the lease liabilities and right-of-use-assets for these leases. The Company will recognize costs from these variable lease payments in the period in which the obligation for those payments is incurred.

25


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated

The Company has signed a lease agreement for a store in New Jersey. The store is currently under construction by the lessor, and the Company will take possession of the leased asset upon completion of construction, which is estimated to be completed before the end of 2019. The lease term is 75 years from the lease commencement date, with three 10-year extension options. The Company has also signed a lease agreement for a store in California. The store is under construction by the lessor, and the Company will take possession of the leased asset upon completion of construction, which is estimated to be completed in mid-2020. The lease term is 15 years from the lease commencement date, with three 10-year extension options and one 5-year extension option. The Company has not recorded right-of-use assets or lease liabilities related to these leases as of March 31, 2019 as the lease term has not yet commenced for either lease. The lease commencement date will occur when the Company takes possession of the leased asset, and the Company will recognize a lease liability and right-of-use asset relating to the leases at that time.
As the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate based on the information available surrounding the Company’s unsecured borrowing rates and implied secured spread at the lease commencement date in determining the present value of lease payments. These discount rates vary depending on the term of the specific leases.
Following is information on our total lease costs as of the period(s) indicated:

March 31, 2019
Lease cost


Finance lease cost:


     Amortization of finance lease right-of-use assets
$
42

     Interest expense related to finance lease liabilities
70

Operating lease cost
2,079

Variable lease cost
912

Short-term lease cost
55

          Total lease cost
$
3,158





Cash paid for amounts included in the measurement of lease liabilities

    Operating cash outflows for finance lease payments
$
57

    Operating cash outflows for operating lease payments
3,267

Total cash paid for lease liability measurement
$
3,324

 
 
Right-of-use assets obtained in exchange for new operating lease liabilities
$
95,506

Right-of-use assets obtained in exchange for new finance lease liabilities
$
8,050

Weighted average remaining lease term - operating leases (years)
23.7

Weighted average remaining lease term - finance leases (years)
72.5

Weighted average discount rate - operating leases
4.05
%
Weighted average discount rate - finance leases
4.25
%

26


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated

Following is information about the Company’s undiscounted cash flows on an annual basis for operating and finance leases, including a reconciliation of the undiscounted cash flows to the finance lease and operating lease liabilities recognized in the Company’s consolidated balance sheets:
 
Operating 
 
Finance
 
Total
Year 1
$
8,281

 
$
232

 
$
8,513

Year 2
8,353

 
232

 
8,585

Year 3
8,264

 
241

 
8,505

Year 4
7,898

 
255

 
8,153

Year 5
7,828

 
255

 
8,083

Thereafter
130,052

 
35,062

 
165,114

Total
$
170,676

 
$
36,277

 
$
206,953

Present value adjustments
(67,098
)
 
(31,484
)
 
(98,582
)
Lease liabilities
$
103,578

 
$
4,793

 
$
108,371


Lessor Accounting

The Company's property rental revenue is primarily related to rents received from tenants at its operating stores. The Company's leases with its self-storage tenants are generally on month-to-month terms, include automatic monthly renewals, allow flexibility to increase rental rates over time as market conditions permit, and provide for the collection of contingent fees such as late fees. These leases do not include any terms or conditions that allow the tenants to purchase the leased space. All self-storage leases for which the Company acts as lessor have been classified as operating leases. The real estate assets related to the Company's stores are included in Real estate assets, net on the Company's condensed consolidated balance sheets and are presented at historical cost less accumulated depreciation and impairment, if any. Rental income related to these operating leases is included in Property rental revenue on the Company's condensed consolidated statements of operations, and is recognized each month during the month-to-month terms at the rental rate in place during each month.
14.    SEGMENT INFORMATION

The Company’s segment disclosures present the measure used by the chief operating decision makers ("CODMs") for purposes of assessing each segment’s performance. The Company’s CODMs are comprised of several members of its executive management team who use net operating income ("NOI") to assess the performance of the business for the Company’s reportable operating segments. NOI for the Company's self-storage operations represents total property revenue less direct property operating expenses. NOI for the Company's tenant reinsurance segment represents tenant reinsurance revenues less tenant reinsurance expense.

The Company has two reportable segments: (1) self-storage operations and (2) tenant reinsurance. The self-storage operations activities include rental operations of wholly-owned stores. The Company's consolidated revenues equal total segment revenues plus property management fees and other income. Tenant reinsurance activities include the reinsurance of risks relating to the loss of goods stored by tenants in the stores operated by the Company. Excluded from segment revenues and net operating income is property management fees and other income.

For all periods presented, substantially all of the Company's real estate assets, intangible assets, other assets, and accrued and other liabilities are associated with the self-storage operations segment. The prior periods have been restated to conform to the current presentation. Financial information for the Company’s business segments is set forth below:


For the Three Months Ended March 31,

2019
2018
Revenues:


     Self-Storage Operations
$
271,003

$
247,886

     Tenant Reinsurance
29,797

27,034

          Total segment revenues
$
300,800

$
274,920




Operating expenses:


     Self-Storage Operations
$
78,765

$
72,753

     Tenant Reinsurance
6,967

5,607

          Total segment operating expenses
$
85,732

$
78,360




Net operating income:


     Self-Storage Operations
$
192,238

$
175,133

     Tenant Reinsurance
22,830

21,427

          Total segment net operating income:
$
215,068

$
196,560




Other components of net income (loss):


Property management fees and other income
$
10,746

$
10,565

General and administrative expense
(22,678
)
(21,464
)
Depreciation and amortization expense
(54,659
)
(51,749
)
     Interest expense
(47,360
)
(40,966
)
Non-cash interest expense related to the amortization of discount on equity component of exchangeable senior notes
(1,162
)
(1,209
)
     Interest income
1,388

1,438

     Equity in earnings of unconsolidated real estate ventures
2,630

3,597

     Income tax expense
(1,813
)
(1,342
)
          Net income
$
102,160

$
95,430


15.
COMMITMENTS AND CONTINGENCIES

As of March 31, 2019, the Company was involved in various legal proceedings and was subject to various claims and complaints arising in the ordinary course of business. Because litigation is inherently unpredictable, the outcome of these matters cannot presently be determined with any degree of certainty. In accordance with applicable accounting guidance, management establishes an accrued liability for litigation when those matters present loss contingencies that are both probable and reasonably estimable. In such cases, there may be an exposure to loss in excess of any amounts accrued. The estimated loss, if any, is based upon currently available information and is subject to significant judgment, a variety of assumptions, and known and unknown uncertainties. The Company could in the future incur judgments or enter into settlements of claims that could have a material adverse effect on its results of operations in any particular period, notwithstanding the fact that the Company is currently vigorously defending any legal proceedings against it.


27


EXTRA SPACE STORAGE INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited) (continued)
Amounts in thousands, except store and share data, unless otherwise stated

As of March 31, 2019, the Company was under agreement to acquire six stores at a total purchase price of $67,028. Of these stores, three are scheduled to close in 2019 at a purchase price of $31,600, and three are scheduled to close in 2020 at a purchase price of $35,428. Additionally, the Company is under agreement to acquire six stores with joint venture partners, for a total investment of $25,346. Five of these stores are scheduled to close in 2019 and the remaining store is expected to close in 2020.

Although there can be no assurance, the Company is not aware of any material environmental liability, for which it believes it will be ultimately responsible, that could have a material adverse effect on its financial condition or results of operations. However, changes in applicable environmental laws and regulations, the uses and conditions of properties in the vicinity of the Company’s stores, the activities of its tenants and other environmental conditions of which the Company is unaware with respect to its stores could result in future material environmental liabilities.
16.     SUBSEQUENT EVENTS

Subsequent to March 31, 2019, the Company sold one store located in New York for a total purchase price of $11,781. The Company recognized a gain of approximately $1,200 related to this sale.

On April 25, 2019, all of the Company's 296,020 Series C Units were converted into 270,710 OP Units.

28



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

Amounts in thousands, except store and share data

CAUTIONARY LANGUAGE

The following discussion and analysis should be read in conjunction with our unaudited “Condensed Consolidated Financial Statements” and the “Notes to Condensed Consolidated Financial Statements (unaudited)” appearing elsewhere 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, 2018. We make 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.”

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 GAAP. Our notes to the unaudited condensed consolidated financial statements contained elsewhere in this report and the audited financial statements contained in our Form 10-K for the year ended December 31, 2018 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 that we have used are appropriate and correct based on information available at the time 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 revenues and expenses 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 (“REIT”), formed to own, operate, manage, acquire, develop and redevelop self-storage properties (“stores”). We derive substantially all of our revenues from our two segments: storage operations and tenant reinsurance. Primary sources of revenue for our storage operations segment include rents received from tenants under leases at each of our wholly-owned stores. Our operating results depend materially on our ability to lease available self-storage units, to actively manage unit rental rates, and on the ability of our tenants to make required rental payments. Consequently, management spends a significant portion of their time maximizing cash flows from our diverse portfolio of stores. Revenue from our tenant reinsurance segment consists of insurance revenues from the reinsurance of risks relating to the loss of goods stored by tenants in our stores.
Our stores are generally situated in highly visible locations clustered around large population centers. These areas enjoy above average population growth and income levels. The clustering of our assets around these population centers enables us to reduce our operating costs through economies of scale. To maximize the performance of our stores, we employ industry-leading revenue management systems. Developed internally, these systems enable us to analyze, set and adjust rental rates in real time across our portfolio in order to respond to changing market conditions. We believe our systems and processes allow us to more pro-actively manage revenues.
We operate in competitive markets, often where consumers have multiple stores from which to choose. Competition has impacted, and will continue to impact, our store results. We experience seasonal fluctuations in occupancy levels, with occupancy levels generally higher in the summer months due to increased moving activity. We believe that we are able to respond quickly and effectively to changes in local, regional and national economic conditions by adjusting rental rates through

29



the combination of our revenue management team and our proprietary pricing systems. We consider a store 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 store to be stabilized once it has achieved either an 80% occupancy rate for a full year measured as of January 1 of the current year, or has been open for three years prior to January 1 of the current year.

PROPERTIES

As of March 31, 2019, we owned or had ownership interests in 1,119 operating stores. Of these stores, 891 are wholly-owned, four are in consolidated joint ventures, and 224 are in unconsolidated joint ventures. In addition, we managed an additional 577 stores for third parties bringing the total number of stores which we own and/or manage to 1,696. These stores are located in 40 states, Washington, D.C. and Puerto Rico. The majority of our stores are clustered around large population centers. The clustering of assets around these population centers enables us to reduce our operating costs through economies of scale. Our acquisitions have given us an increased scale in many core markets as well as a foothold in many markets where we had no previous presence.

As of March 31, 2019, approximately 930,000 tenants were leasing storage units at the operating stores that we own and/or manage, primarily on a month-to-month basis, providing the flexibility to increase rental rates over time as market conditions permit. Existing tenants generally receive rate increases at least annually, for which no direct correlation has been drawn to our vacancy trends. Although leases are short-term in duration, the typical tenant tends to remain at our stores for an extended period of time. For stores that were stabilized as of March 31, 2019, the average length of stay was approximately 15.2 months.

The average annual rent per square foot for our existing customers at stabilized stores, net of discounts and bad debt, was $16.31 for the three months ended March 31, 2019, compared to $15.65 for the three months ended March 31, 2018. Average annual rent per square foot for new leases was $18.50 for the three months ended March 31, 2019, compared to $17.48 for the three months ended March 31, 2018. The average discounts, as a percentage of rental revenues, at all stabilized properties during these periods were 3.4% and 4.3%, respectively.

Our store portfolio is made up of different types of construction and building configurations. Most often sites are what we consider “hybrid” stores, a mix of drive-up and multi-floor buildings. We have a number of multi-floor buildings with elevator access only, and a number of stores featuring ground-floor access only.


30


The following table presents additional information regarding net rentable square feet and the number of stores by state.

 
March 31, 2019
 
REIT Owned
Joint Venture Owned
Managed
Total
Location
Property Count
Net Rentable Square Feet
Property Count
Net Rentable Square Feet
Property Count
Net Rentable Square Feet
Property Count
Net Rentable Square Feet
Alabama
8

557,516

1

75,566

12

811,735

21

1,444,817

Arizona
23

1,622,735

7

467,320

12

948,118

42

3,038,173

California
158

12,195,525

41

3,025,712

64

5,879,157

263

21,100,394

Colorado
15

1,006,555

2

186,168

26

1,859,647

43

3,052,370

Connecticut
7

527,073

7

624,603

3

199,868

17

1,351,544

Delaware


1

76,945

1

68,701

2

145,646

Florida
86

6,599,932

22

1,715,499

81

6,125,434

189

14,440,865

Georgia
59

4,563,780

5

431,277

14

1,071,004

78

6,066,061

Hawaii
9

603,370



7

399,420

16

1,002,790

Idaho




4

420,636

4

420,636

Illinois
31

2,401,157

7

569,218

27

1,863,119

65

4,833,494

Indiana
15

949,675

1

57,286

12

768,938

28

1,775,899

Kansas
1

49,838

2

108,370

1

70,120

4

228,328

Kentucky
11

923,226

1

51,128

4

311,898

16

1,286,252

Louisiana
2

150,555



1

136,305

3

286,860

Maryland
32

2,586,980

8

618,498

24

1,725,335

64

4,930,813

Massachusetts
45

2,870,740

10

640,127

8

590,529

63

4,101,396

Michigan
7

558,759

4

313,245

1

102,247

12

974,251

Minnesota
4

301,405



9

610,773

13

912,178

Mississippi
3

215,912



4

254,990

7

470,902

Missouri
5

332,891

2

119,275

9

650,913

16

1,103,079

Nebraska




2

164,094

2

164,094

Nevada
14

1,034,772

4

472,891

6

773,862

24

2,281,525

New Hampshire
2

136,135

2

83,685

1

61,535

5

281,355

New Jersey
59

4,637,859

17

1,245,571

9

715,431

85

6,598,861

New Mexico
11

721,305

3

163,710

9

735,598

23

1,620,613

New York
23

1,706,869

13

1,118,845

15

846,553

51

3,672,267

North Carolina
18

1,319,420

5

367,375

19

1,505,249

42

3,192,044

Ohio
17

1,304,290

5

326,227

4

258,353

26

1,888,870

Oklahoma




19

1,574,532

19

1,574,532

Oregon
6

399,592

4

281,328

8

510,476

18

1,191,396

Pennsylvania
18

1,346,685

7

510,126

19

1,365,746

44

3,222,557

Rhode Island
2

130,846



1

84,665

3

215,511

South Carolina
23

1,755,709

7

497,303

15

1,146,492

45

3,399,504

Tennessee
17

1,419,101

12

803,011

12

903,941

41

3,126,053

Texas
99

8,523,539

10

706,130

68

5,527,913

177

14,757,582

Utah
10

709,653



15

992,310

25

1,701,963

Virginia
46

3,671,173

7

564,443

14

1,009,715

67

5,245,331

Washington
8

591,036

1

57,340

3

209,002

12

857,378

Washington, DC
1

99,664

1

104,070

2

139,173

4

342,907

Wisconsin


5

500,815

4

327,555

9

828,370

Puerto Rico




8

916,250

8

916,250

Totals
895

68,525,272

224

16,883,107

577

44,637,332

1,696

130,045,711



31



RESULTS OF OPERATIONS

Comparison of the three months ended March 31, 2019 and 2018

Overview
Results for the three months ended March 31, 2019 included the operations of 1,119 stores (891 wholly-owned, four in consolidated joint ventures, and 224 in joint ventures accounted for using the equity method) compared to the results for the three months ended March 31, 2018, which included the operations of 1,067 stores (851 wholly-owned, two in consolidated joint ventures, and 214 in joint ventures accounted for using the equity method).

Revenues
The following table presents information on revenues earned for the periods indicated: 
 
For the Three Months Ended March 31,
 

 

 
2019
 
2018
 
$ Change
 
% Change
Revenues:
 
 
 
 
 
 
 
Property rental
$
271,003

 
$
247,886

 
$
23,117

 
9.3
%
Tenant reinsurance
29,797

 
27,034

 
2,763

 
10.2
%
Management fees and other income
10,746

 
10,565

 
181

 
1.7
%
Total revenues