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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2012

Commission File Number: 1-13820

 

 

SOVRAN SELF STORAGE, INC.

(Exact name of Registrant as specified in its charter)

 

 

 

Maryland   16-1194043
(State of incorporation or organization)   (I.R.S. Employer Identification No.)

6467 Main Street

Williamsville, NY 14221

(Address of principal executive offices) (Zip code)

(716) 633-1850

(Registrant’s telephone number including area code)

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Securities

 

Exchanges on which Registered

Common Stock, $.01 Par Value   New York Stock Exchange

Securities registered pursuant to section 12(g) of the Act: None

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  x    No  ¨

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.    Yes  ¨    No  x

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  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer   x    Accelerated filer   ¨
Non-accelerated filer   ¨      Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of June 30, 2012, 29,396,351 shares of Common Stock, $.01 par value per share, were outstanding, and the aggregate market value of the Common Stock held by non-affiliates was approximately $1,436,073,237 (based on the closing price of the Common Stock on the New York Stock Exchange on June 30, 2012).

As of February 15, 2013, 30,459,820 shares of Common Stock, $.01 par value per share, were outstanding.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement for the 2013 Annual Meeting of Shareholders are incorporated herein by reference in Part III of this Annual Report on Form 10-K to the extent stated herein. Such proxy statement will be filed with the Securities and Exchange Commission within 120 days of the registrant’s fiscal year ended December 31, 2012.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

Part I

  

Item 1. Business

     3   

Item 1A. Risk Factors

     10   

Item 1B. Unresolved Staff Comments

     15   

Item 2. Properties

     16   

Item 3. Legal Proceedings

     17   

Item 4. Mine Safety Disclosures

     17   

Part II

  

Item  5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

     18   

Item 6. Selected Financial Data

     21   

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     22   

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

     36   

Item 8. Financial Statements and Supplementary Data

     37   

Item 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

     61   

Item 9A. Controls and Procedures

     61   

Item 9B. Other Information

     63   

Part III

  

Item 10. Directors, Executive Officers and Corporate Governance

     63   

Item 11. Executive Compensation

     63   

Item  12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     63   

Item 13. Certain Relationships and Related Transactions, and Director Independence

     63   

Item 14. Principal Accountant Fees and Services

     63   

Part IV

  

Item 15. Exhibits, Financial Statement Schedules

     63   

SIGNATURES

     68   

EX-12.1

  

EX-21.1

  

EX-23.1

  

EX-31.1

  

EX-31.2

  

EX-32.1

  

EX-101

  

 

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Part I

When used in this discussion and elsewhere in this document, the words “intends,” “believes,” “expects,” “anticipates,” and similar expressions are intended to identify “forward-looking statements” within the meaning of that term in Section 27A of the Securities Act of 1933 and in Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause the actual results, performance or achievements of the Company to be materially different from those expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the effect of competition from new self-storage facilities, which would cause rents and occupancy rates to decline; the Company’s ability to evaluate, finance and integrate acquired businesses into the Company’s existing business and operations; the Company’s ability to effectively compete in the industry in which it does business; the Company’s existing indebtedness may mature in an unfavorable credit environment, preventing refinancing or forcing refinancing of the indebtedness on terms that are not as favorable as the existing terms; interest rates may fluctuate, impacting costs associated with the Company’s outstanding floating rate debt; the Company’s ability to comply with debt covenants; any future ratings on the Company’s debt instruments; regional concentration of the Company’s business may subject it to economic downturns in the states of Florida and Texas; the Company’s reliance on its call center; the Company’s cash flow may be insufficient to meet required payments of operating expenses, principal, interest and dividends; and tax law changes that may change the taxability of future income.

 

Item 1. Business

Sovran Self Storage, Inc. together with its direct and indirect subsidiaries and its consolidated joint ventures, to the extent appropriate in the applicable context, (the “Company,” “We,” “Our,” or “Sovran”) is a self-administered and self-managed real estate investment trust (“REIT”) that acquires, owns and manages self-storage properties. We refer to the self-storage properties in which we have an ownership interest and are managed by us as “Properties.” We began operations on June 26, 1995. We were formed to continue the business of our predecessor company, which had engaged in the self-storage business since 1985. At December 31, 2012, we held ownership interests in and/or managed 461 Properties consisting of approximately 31.2 million net rentable square feet, situated in 25 states. Among our 461 self-storage properties are 25 properties that we manage for an unconsolidated joint venture of which we are a 20% owner, 30 properties that we manage for an unconsolidated joint venture of which we are a 15% owner, one property that we manage for a consolidated joint venture of which we have a 20% common ownership interest and a preferred interest, and 15 properties that we manage and have no ownership interest. We believe we are the fourth largest operator of self-storage properties in the United States based on square feet owned and managed. Our Properties conduct business under the user-friendly name Uncle Bob’s Self-Storage®.

We own an indirect interest in each of the Properties through a limited partnership (the “Partnership”). In total, we own a 99.3% economic interest in the Partnership and unaffiliated third parties own collectively a 0.7% limited partnership interest at December 31, 2012. We believe that this structure, commonly known as an umbrella partnership real estate investment trust (“UPREIT”), facilitates our ability to acquire properties by using units of the Partnership as currency. By utilizing interests in the Partnership as currency in facility acquisitions, we may partially defer the seller’s income tax liability which in turn may allow us to obtain more favorable pricing.

We were incorporated on April 19, 1995 under Maryland law. Our principal executive offices are located at 6467 Main Street, Williamsville, New York 14221, our telephone number is (716) 633-1850 and our web site is www.unclebobs.com.

We seek to enhance shareholder value through internal growth and acquisition of additional storage properties. Internal growth is achieved through aggressive property management: optimizing rental rates, increasing occupancy levels, controlling costs, maximizing collections, and strategically expanding and improving the Properties. Should economic conditions warrant, we may develop new properties. We believe that there continue to be opportunities for growth through acquisitions, and constantly seek to acquire self-storage properties that are

 

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susceptible to realization of increased economies of scale and enhanced performance through application of our expertise.

Industry Overview

We believe that self-storage facilities offer inexpensive storage space to residential and commercial users. In addition to fully enclosed and secure storage space, many facilities also offer outside storage for automobiles, recreational vehicles and boats. Better facilities, such as those owned and/or managed by the Company, are usually fenced and well lighted with automated access systems, and surveillance cameras, and have a full-time manager. Our customers rent space on a month-to-month basis and typically have access to their storage space up to 15 hours a day and in certain circumstances are provided with 24-hour access. Individual storage spaces are secured by the customer’s lock, and the customer has sole control of access to the space.

According to the 2013 Self-Storage Almanac, of the approximately 51,000 facilities in the United States, approximately 11% are managed by the ten largest operators. The remainder of the industry is characterized by numerous small, local operators. The scarcity of capital available to small operators for acquisitions and expansions, internet marketing, and call centers, and the potential for savings through economies of scale are factors that are leading to consolidation in the industry. We believe that, as a result of this trend, significant growth opportunities exist for operators with proven management systems and sufficient capital resources to grow either through acquisitions or third party management platforms.

Property Management

We have over 25 years experience managing self storage facilities and the combined experience of our key personnel has made us one of the leaders in the industry. All of our stores operate under the user-friendly name of Uncle Bob’s Self Storage®, and we employ the following strategies with respect to our property management:

Our People:

We recognize the importance of quality people to the success of an organization. Our store personnel are held to high standards for customer service, store appearance, financial performance, and overall operations. They are supported with state of the art training tools including an online learning management system, a company intranet, and an extensive network of certified training personnel. Every store team also has frequent, and sometimes daily, interaction with an Area Manager, a Regional Vice President, an Accounting Representative, and other support personnel.

Training & Development:

Our employees benefit from a wide array of training and development opportunities. New store employees undergo a comprehensive, proprietary training program designed to drive sales and operational results while ensuring the delivery of quality customer service. Each new hire is assigned a Certified Training Manager as a mentor during their initial training period. To supplement their initial training, employees enjoy continuing edification, coaching, and performance feedback throughout their tenure.

All learning and development activities are facilitated through our online Learning and Performance Management System internally named eBOB. eBOB delivers and tracks hundreds of on-demand computer based training and compliance courses; it also administers tests, surveys, and the employee appraisal process. Sovran’s training and development program encompasses the tools and support we deem essential to the success of our employees and business.

Marketing and Advertising:

We believe the avenues for attracting and capturing new customers have changed dramatically over the years. As such, we have implemented the following strategies to market our properties and increase profitability:

 

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We employ a Customer Care Center (call center) that services over 31,000 rental inquiries per month. Our highly skilled Sales Representatives answer incoming sales calls for all of our stores, 361 days a year. The team undertakes continuous training in effective storage sales techniques, which we believe results in higher conversions of inquiries to rentals.

 

   

The once predominant advertising vehicle - yellow pages - has lost favor to a wide range of other opportunities. Our aggressive internet marketing and websites provide customers with real-time pricing, online reservations, online payments, and support for mobile devices. Our advertising and marketing strategies employ a mix of web media to ensure the Uncle Bob’s name is found wherever customers search for storage.

 

   

We believe we were the first self storage operator to develop a Mobile App that allows potential customers to search for and reserve a storage space electronically or connect directly to a Customer Care Rep with a touch of the screen. Further, the App allows existing customers to manage their account and pay their rent via smart phone.

 

   

Since the need for storage is largely based on timing, the ultimate goal is to create as much positive brand recognition as possible. When the time comes for a customer to select a storage company, we want the Uncle Bob’s brand to be on the top of their mind. That said, we employ a variety of different strategies to create brand awareness including our Uncle Bob’s rental trucks, branded merchandise such as moving and packing supplies, and extensive regional marketing in the communities in which we operate. We strive to gain the most exposure as possible for the longest period of time.

 

   

Dri-guard humidity-controlled spaces are a premium storage feature intended to protect metal, electronics, furniture, fabrics and paper from moisture. We became the first self-storage operator to utilize this humidity protection technology and we believe it helps to differentiate us from other operators.

 

   

We also have a fleet of rental trucks that serve as an added incentive to choose our storage facilities. The truck rental charge is waived for new move-in customers and we believe it provides a valuable service and added incentive to choose us. Further, the prominent display of our logo turns each truck into a moving billboard.

Ancillary Income:

We know that our 220,000 customers require more than just a storage space. With that in mind, we offer a wide range of other products and services that fulfill their needs while providing us ancillary income. Whereas our Uncle Bob’s trucks are available with no rental charge for new move-in customers, they are available for rent to non-customers and existing customers. We also rent moving dollies and blankets, and we carry a wide assortment of moving and packing supplies including boxes, tape, locks, and other essential items. For those customers who do not carry storage insurance, we make available renters insurance through a third party carrier, on which we earn a commission. We also earn incidental income from billboards and cell towers.

Information Systems:

Each of our primary business functions are linked through our customized computer applications. This system provides for a consistent, timely and accurate flow of information.

 

   

It performs the functions necessary for our store personnel to efficiently and effectively run their property. This includes customer account management, automatic imposition of late fees, move-in and move-out analysis, generation of essential legal notices, and marketing reports to aid in regional marketing efforts.

 

   

It is linked with each of our primary sales channels (customer care center, web, store) allowing for real time access to space type and inventory, pricing, promotions, and other pertinent store information. This robust flow of information facilitates our commitment to capturing prospective customers from all channels.

 

   

It provides our revenue management team with raw data on historical pricing, move-in and move-out activity, specials and occupancies, etc. This data is then utilized in the various algorithms that form the foundation of our revenue management program.

 

   

It generates financial reports for each property that provide our accounting and audit departments with the necessary oversight of transactions; this allows us to maintain proper control of receipts.

 

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Revenue Management:

Our proprietary revenue management system is constantly evolving through the efforts of our revenue management group and our partnership with Veritec Solutions. We have the ability to change pricing instantaneously for any one unit type, at any single location, based on occupancy, competition, and forecasted changes in demand. By analyzing current customer rent tenures, we are able to implement rental rate increases at optimal times to increase revenues. Advanced pricing analytics enable us to reduce the amount of concessions, attracting a more stable customer base and discouraging short term price shoppers. We believe this will lead to revenue growth.

Property Maintenance:

We take great pride in the appearance and structural integrity of our Properties. All of our Properties go through a thorough annual inspection performed by qualified Project Managers. Those inspections provide the basis for short and long term planned projects which are all performed under a standardized set of specifications. Routine maintenance such as landscaping, pest control, etc. is contracted through local providers who have a clear understanding of our standards. As with many other aspects of our Company, our size has allowed us to enjoy relatively low maintenance costs because we have the benefit of economies of scale in purchasing, travel, and overhead absorption. Further, we continually look to green alternatives and implement energy saving alternatives as new technology becomes available. Most recently we have begun installation of solar panels which are both environmentally friendly and have the potential to substantially reduce energy consumption (thereby reducing costs) in the buildings in which they are installed.

Environmental and Other Regulations

We are subject to federal, state, and local environmental regulations that apply generally to the ownership of real property. We have not received notice from any governmental authority or private party of any material environmental noncompliance, claim, or liability in connection with any of the Properties, and are not aware of any environmental condition with respect to any of the Properties that could have a material adverse effect on our financial condition or results of operations.

The Properties are also generally subject to the same types of local regulations governing other real property, including zoning ordinances. We believe that the Properties are in substantial compliance with all such regulations.

Insurance

Each of the Properties is covered by fire and property insurance (including comprehensive liability), and all-risk property insurance policies, which are provided by reputable companies and on commercially reasonable terms. In addition, we maintain a policy insuring against environmental liabilities resulting from tenant storage on terms customary for the industry, and title insurance insuring fee title to the Company-owned Properties in an amount that we believe to be adequate.

Federal Income Tax

We operate, and intend to continue to operate, in such a manner as to continue to qualify as a REIT under the Internal Revenue Code of 1986 (the “Code”), but no assurance can be given that we will at all times so qualify. To the extent that we continue to qualify as a REIT, we will not be taxed, with certain limited exceptions, on the taxable income that is distributed to our shareholders. We have elected to treat one of our subsidiaries as a taxable REIT subsidiary. In general, our taxable REIT subsidiary may perform additional services for customers and generally may engage in certain real estate or non-real estate related business. Our taxable REIT subsidiary is subject to corporate federal and state income taxes. See Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - REIT Qualification and Distribution Requirements.”

 

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Competition

The primary factors upon which competition in the self-storage industry is based are location, rental rates, suitability of the property’s design to prospective customers’ needs, and the manner in which the property is operated and marketed. We believe we compete successfully on these bases. The extent of competition depends significantly on local market conditions. We seek to locate facilities in a manner in which we can increase market share while not adversely affecting any of our existing locations in that market. However, the number of self-storage facilities in a particular area could have a material adverse effect on the performance of any of the Properties.

Several of our competitors, including Public Storage and U-Haul, are larger and have substantially greater financial resources than we do. These larger operators may, among other possible advantages, be capable of greater leverage and the payment of higher prices for acquisitions.

Investment Policy

While we emphasize equity real estate investments, we may, at our discretion, invest in mortgage and other real estate interests related to self-storage properties in a manner consistent with our qualification as a REIT. We may also retain a purchase money mortgage for a portion of the sale price in connection with the disposition of Properties from time to time. Should investment opportunities become available, we may look to acquire self-storage properties via a joint-venture partnership or similar entity. We may or may not elect to have a significant investment in such a venture, but would use such an opportunity to expand our portfolio of branded and managed properties.

Subject to the percentage of ownership limitations and gross income tests necessary for REIT qualification, we also may invest in securities of entities engaged in real estate activities or securities of other issuers, including for the purpose of exercising control over such entities.

Disposition Policy

Any disposition decision of our Properties is based on a variety of factors, including, but not limited to, the (i) potential to continue to increase cash flow and value, (ii) sale price, (iii) strategic fit with the rest of our portfolio, (iv) potential for, or existence of, environmental or regulatory issues, (v) alternative uses of capital, and (vi) maintaining qualification as a REIT.

During 2012, we sold 17 non-strategic storage facilities in Maryland, Michigan, and Texas for net proceeds of approximately $47.7 million resulting in a gain of approximately $4.5 million. Although we sold no stores in 2011, during 2010 we sold ten non-strategic storage facilities located in Georgia, Michigan, North Carolina and Virginia for net cash proceeds of $23.7 million resulting in a gain of $6.9 million.

Distribution Policy

We intend to pay regular quarterly distributions to our shareholders. However, future distributions by us will be at the discretion of the Board of Directors and will depend on the actual cash available for distribution, our financial condition and capital requirements, the annual distribution requirements under the REIT provisions of the Code and such other factors as the Board of Directors deems relevant. In order to maintain our qualification as a REIT, we must make annual distributions to shareholders of at least 90% of our REIT taxable income (which does not include capital gains). Under certain circumstances, we may be required to make distributions in excess of cash available for distribution in order to meet this requirement.

Financing Policy

Our Board of Directors currently limits the amount of debt that may be incurred by us to less than 50% of the sum of the market value of our issued and outstanding Common and Preferred Stock plus our debt. We,

 

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however, may from time to time re-evaluate and modify our borrowing policy in light of then current economic conditions, relative costs of debt and equity capital, market values of properties, growth and acquisition opportunities and other factors. In addition to our Board of Directors’ debt limits, our most restrictive debt covenants limit our leverage. However, we believe cash flow from operations, access to the capital markets and access to our credit facility, as described below, are adequate to execute our current business plan and remain in compliance with our debt covenants.

We have a $175 million (expandable to $250 million) revolving line of credit bearing interest at a variable rate equal to LIBOR plus a margin based on the Company’s credit rating (at December 31, 2012 the margin was 2.0%). At December 31, 2012, there was $70 million available on the unsecured line of credit without considering the additional availability under the expansion feature. The revolving line of credit has a maturity date of August 2016, but can be extended for 2 one year periods at the Company’s option with the payment of an extension fee equal to 0.125% of the total line of credit commitment.

In 2011 and 2012, the Company utilized a continuous equity offering program (“Equity Program”) pursuant to which we could sell from time to time up to $125 million in aggregate offering price of shares of our common stock. During 2012 we issued 1.39 million shares under the Equity Program for net proceeds of approximately $75.3 million. During 2011 we issued 1.17 million shares under the Equity Program for net proceeds of approximately $46.4 million. The Company has no further availability for issuance of shares under such Equity Program. The Company expects to enter into another continuous equity offering program in 2013.

To the extent that we desire to obtain additional capital to pay distributions, to provide working capital, to pay existing indebtedness or to finance acquisitions, expansions or development of new properties, we may utilize amounts available under the line of credit, common or preferred stock offerings, floating or fixed rate debt financing, retention of cash flow (subject to satisfying our distribution requirements under the REIT rules) or a combination of these methods. Additional debt financing may also be obtained through mortgages on our Properties, which may be recourse, non-recourse, or cross-collateralized and may contain cross-default provisions. We have not established any limit on the number or amount of mortgages that may be placed on any single Property or on our portfolio as a whole, although certain of our existing term loans contain limits on overall mortgage indebtedness. For additional information regarding borrowings, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources” and Note 7 to the Consolidated Financial Statements filed herewith.

Employees

We currently employ a total of 1,228 employees, including 461 property managers, 28 area managers, and 562 associate managers and part-time employees. At our headquarters, in addition to our six senior executive officers, we employ 171 people engaged in various support activities, including accounting, human resources, customer care, and management information systems. None of our employees are covered by a collective bargaining agreement. We consider our employee relations to be excellent.

Available Information

We file with the U.S. Securities and Exchange Commission quarterly and annual reports on Forms 10-Q and 10-K, respectively, current reports on Form 8-K, and proxy statements pursuant to the Securities Exchange Act of 1934, in addition to other information as required. The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1 (800) SEC-0330. We file this information with the SEC electronically, and the SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at http://www.sec.gov. Our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports are available free of charge on our web site at http://www.unclebobs.com as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. In addition,

 

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our codes of ethics and Charters of our Governance Committee, Audit Committee, and Compensation Committee are available free of charge on our website at http://www.unclebobs.com.

Also, copies of our annual report and Charters of our Governance Committee, Audit Committee, and Compensation Committee will be made available, free of charge, upon written request to Sovran Self Storage, Inc., Attn: Investor Relations, 6467 Main Street, Williamsville, NY 14221.

 

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Item 1A. Risk Factors

You should carefully consider the risks described below, together with all of the other information included in or incorporated by reference into our Form 10-K, as part of your evaluation of the Company. If any of the following risks actually occur, our business could be harmed. In such case, the trading price of our securities could decline, and you may lose all or part of your investment.

Our Acquisitions May Not Perform as Anticipated

We have completed many acquisitions of self-storage facilities since our initial public offering of common stock in June 1995. Our strategy is to continue to grow by acquiring additional self-storage facilities. Acquisitions entail risks that investments will fail to perform in accordance with our expectations and that our judgments with respect to the prices paid for acquired self-storage facilities and the costs of any improvements required to bring an acquired property up to standards established for the market position intended for that property will prove inaccurate. Acquisitions also involve general investment risks associated with any new real estate investment.

We May Incur Problems with Our Real Estate Financing

Unsecured Credit Facility and Term Notes. We have a line of credit and term note agreements with a syndicate of financial institutions and other lenders. This unsecured credit facility and the term notes are recourse to us and the required payments are not reduced if the economic performance of any of the properties declines. The unsecured credit facility limits our ability to make distributions to our shareholders, except in limited circumstances.

Rising Interest Rates. Indebtedness that we incur under the unsecured credit facility and bank term notes bear interest at a variable rate. Accordingly, increases in interest rates could increase our interest expense, which would reduce our cash available for distribution and our ability to pay expected distributions to our shareholders. We manage our exposure to rising interest rates using interest rate swaps and other available mechanisms. If the amount of our indebtedness bearing interest at a variable rate increases, our unsecured credit facility may require us to enter into additional interest rate swaps.

Refinancing May Not Be Available. It may be necessary for us to refinance our term notes and our unsecured credit facility through additional debt financing or equity offerings. If we were unable to refinance this indebtedness on acceptable terms, we might be forced to dispose of some of our self-storage facilities upon disadvantageous terms, which might result in losses to us and might adversely affect the cash available for distribution. If prevailing interest rates or other factors at the time of refinancing result in higher interest rates on refinancings, our interest expense would increase, which would adversely affect our cash available for distribution and our ability to pay expected distributions to shareholders.

Covenants and Risk of Default. Our unsecured credit facility and term notes require us to operate within certain covenants, including financial covenants with respect to leverage, fixed charge coverage, minimum net worth, limitations on additional indebtedness and dividend limitations. If we violate any of these covenants or otherwise default under our unsecured credit facility or term notes, then our lenders could declare all indebtedness under these facilities to be immediately due and payable which would have a material adverse effect on our business and could require us to sell self-storage facilities under distress conditions and seek replacement financing on substantially more expensive terms.

Reduction in or Loss of Credit Rating. Certain of our debt instruments require us to maintain an investment grade rating from at least one and in some cases two debt ratings agencies. Should we fail to attain an investment grade rating from the agencies, the interest rate on our line of credit and $225 million of our bank term notes would increase by 0.25%, and the rate on our $150 million term note due 2016 and our $100 million term note due 2021 would increase by 1.750%.

 

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Our Debt Levels May Increase

Our Board of Directors currently has a policy of limiting the amount of our debt at the time of incurrence to less than 50% of the sum of the market value of our issued and outstanding common stock and preferred stock plus the amount of our debt at the time that debt is incurred. However, our organizational documents do not contain any limitation on the amount of indebtedness we might incur. Accordingly, our Board of Directors could alter or eliminate the current policy limitation on borrowing without a vote of our shareholders. We could become highly leveraged if this policy were changed. However, our ability to incur debt is limited by covenants in our bank credit arrangements.

We Are Subject to the Risks Posed by Fluctuating Demand and Significant Competition in the Self-Storage Industry

Our self-storage facilities are subject to all operating risks common to the self-storage industry. These risks include but are not limited to the following:

 

   

Decreases in demand for rental spaces in a particular locale;

 

   

Changes in supply of similar or competing self-storage facilities in an area;

 

   

Changes in market rental rates; and

 

   

Inability to collect rents from customers.

Our current strategy is to acquire interests only in self-storage facilities. Consequently, we are subject to risks inherent in investments in a single industry. Our self-storage facilities compete with other self-storage facilities in their geographic markets. As a result of competition, the self-storage facilities could experience a decrease in occupancy levels and rental rates, which would decrease our cash available for distribution. We compete in operations and for acquisition opportunities with companies that have substantial financial resources. Competition may reduce the number of suitable acquisition opportunities offered to us and increase the bargaining power of property owners seeking to sell. The self-storage industry has at times experienced overbuilding in response to perceived increases in demand. A recurrence of overbuilding might cause us to experience a decrease in occupancy levels, limit our ability to increase rents, and compel us to offer discounted rents.

Our Real Estate Investments Are Illiquid and Are Subject to Uninsurable Risks and Government Regulation

General Risks. Our investments are subject to varying degrees of risk generally related to the ownership of real property. The underlying value of our real estate investments and our income and ability to make distributions to our shareholders are dependent upon our ability to operate the self-storage facilities in a manner sufficient to maintain or increase cash available for distribution. Income from our self-storage facilities may be adversely affected by the following factors:

 

   

Changes in national economic conditions;

 

   

Changes in general or local economic conditions and neighborhood characteristics;

 

   

Competition from other self-storage facilities;

 

   

Changes in interest rates and in the availability, cost and terms of financing;

 

   

The impact of present or future environmental legislation and compliance with environmental laws;

 

   

The ongoing need for capital improvements, particularly in older facilities;

 

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Changes in real estate tax rates and other operating expenses;

 

   

Adverse changes in governmental rules and fiscal policies;

 

   

Uninsured losses resulting from casualties associated with civil unrest, acts of God, including natural disasters, and acts of war;

 

   

Adverse changes in zoning laws; and

 

   

Other factors that are beyond our control.

Illiquidity of Real Estate May Limit its Value. Real estate investments are relatively illiquid. Our ability to vary our portfolio of self-storage facilities in response to changes in economic and other conditions is limited. In addition, provisions of the Code may limit our ability to profit on the sale of self-storage facilities held for fewer than two years. We may be unable to dispose of a facility when we find disposition advantageous or necessary and the sale price of any disposition may not equal or exceed the amount of our investment.

Uninsured and Underinsured Losses Could Reduce the Value of our Self Storage Facilities. Some losses, generally of a catastrophic nature, that we potentially face with respect to our self-storage facilities may be uninsurable or not insurable at an acceptable cost. Our management uses its discretion in determining amounts, coverage limits and deductibility provisions of insurance, with a view to acquiring appropriate insurance on our investments at a reasonable cost and on suitable terms. These decisions may result in insurance coverage that, in the event of a substantial loss, would not be sufficient to pay the full current market value or current replacement cost of our lost investment. Inflation, changes in building codes and ordinances, environmental considerations, and other factors also might make it infeasible to use insurance proceeds to replace a property after it has been damaged or destroyed. Under those circumstances, the insurance proceeds received by us might not be adequate to restore our economic position with respect to a particular property.

Possible Liability Relating to Environmental Matters. Under various federal, state and local environmental laws, ordinances and regulations, a current or previous owner or operator of real property may be liable for the costs of removal or remediation of hazardous or toxic substances on, under, or in that property. Those laws often impose liability even if the owner or operator did not cause or know of the presence of hazardous or toxic substances and even if the storage of those substances was in violation of a customer’s lease. In addition, the presence of hazardous or toxic substances, or the failure of the owner to address their presence on the property, may adversely affect the owner’s ability to borrow using that real property as collateral. In connection with the ownership of the self-storage facilities, we may be potentially liable for any of those costs.

Americans with Disabilities Act. The Americans with Disabilities Act of 1990, or ADA, generally requires that buildings be made accessible to persons with disabilities. A determination that we are not in compliance with the ADA could result in imposition of fines or an award of damages to private litigants. If we were required to make modifications to comply with the ADA, our results of operations and ability to make expected distributions to our shareholders could be adversely affected.

There Are Limitations on the Ability to Change Control of Sovran

Limitation on Ownership and Transfer of Shares. To maintain our qualification as a REIT, not more than 50% in value of our outstanding shares of stock may be owned, directly or indirectly, by five or fewer individuals, as defined in the Code. To limit the possibility that we will fail to qualify as a REIT under this test, our Amended and Restated Articles of Incorporation include ownership limits and transfer restrictions on shares of our stock. Our Articles of Incorporation limit ownership of our issued and outstanding stock by any single shareholder to 9.8% of the aggregate value of our outstanding stock, except that the ownership by some of our shareholders is limited to 15%.

 

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These ownership limits may:

 

   

Have the effect of precluding an acquisition of control of Sovran by a third party without consent of our Board of Directors even if the change in control would be in the interest of shareholders; and

 

   

Limit the opportunity for shareholders to receive a premium for shares of our common stock they hold that might otherwise exist if an investor were attempting to assemble a block of common stock in excess of 9.8% or 15%, as the case may be, of the outstanding shares of our stock or to otherwise effect a change in control of Sovran.

Our Board of Directors may waive the ownership limits if it is satisfied that ownership by those shareholders in excess of those limits will not jeopardize our status as a REIT under the Code or in the event it determines that it is no longer in our best interests to be a REIT. Waivers have been granted to the former holders of our Series C preferred stock, FMR Corporation, Cohen & Steers, Inc. and Invesco Advisers, Inc. A transfer of our common stock and/or preferred stock to a person who, as a result of the transfer, violates the ownership limits may not be effective under some circumstances.

Other Limitations. Other limitations could have the effect of discouraging a takeover or other transaction in which holders of some, or a majority, of our outstanding common stock might receive a premium for their shares of our common stock that exceeds the then prevailing market price or that those holders might believe to be otherwise in their best interest. The issuance of additional shares of preferred stock could have the effect of delaying or preventing a change in control of Sovran even if a change in control were in the shareholders’ interest. In addition, the Maryland General Corporation Law, or MGCL, imposes restrictions and requires specific procedures with respect to the acquisition of stated levels of share ownership and business combinations, including combinations with interested shareholders. These provisions of the MGCL could have the effect of delaying or preventing a change in control of Sovran even if a change in control were in the shareholders’ interest. Our bylaws contain a provision exempting from the MGCL control share acquisition statute any and all acquisitions by any person of shares of our stock. However, this provision may be amended or eliminated at any time. In addition, under the Partnership’s agreement of limited partnership, in general, we may not merge, consolidate or engage in any combination with another person or sell all or substantially all of our assets unless that transaction includes the merger or sale of all or substantially all of the assets of the Partnership, which requires the approval of the holders of 75% of the limited partnership interests thereof. If we were to own less than 75% of the limited partnership interests in the Partnership, this provision of the limited partnership agreement could have the effect of delaying or preventing us from engaging in some change of control transactions.

Our Failure to Qualify as a REIT Would Have Adverse Consequences

We intend to operate in a manner that will permit us to qualify as a REIT under the Code. Qualification as a REIT involves the application of highly technical and complex Code provisions for which there are only limited judicial and administrative interpretations. Continued qualification as a REIT depends upon our continuing ability to meet various requirements concerning, among other things, the ownership of our outstanding stock, the nature of our assets, the sources of our income and the amount of our distributions to our shareholders.

If we were to fail to qualify as a REIT in any taxable year, we would not be allowed a deduction for distributions to shareholders in computing our taxable income and would be subject to federal income tax (including any applicable alternative minimum tax) on our taxable income at regular corporate rates. Unless entitled to relief under certain Code provisions, we also would be ineligible for qualification as a REIT for the four taxable years following the year during which our qualification was lost. As a result, distributions to the shareholders would be reduced for each of the years involved. Although we currently intend to operate in a manner designed to qualify as a REIT, it is possible that future economic, market, legal, tax or other considerations may cause our Board of Directors to revoke our REIT election.

 

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We May Pay Some Taxes, Reducing Cash Available for Shareholders

Even if we qualify as a REIT for federal income tax purposes, we are required to pay some federal, state and local taxes on our income and property. One of our subsidiaries has elected to be treated as a “taxable REIT subsidiary” of the Company for federal income tax purposes. A taxable REIT subsidiary is taxed as a regular corporation and is limited in its ability to deduct interest payments made to us in excess of a certain amount. In addition, if we receive or accrue certain amounts and the underlying economic arrangements among our taxable REIT subsidiary and us are not comparable to similar arrangements among unrelated parties, we will be subject to a 100% penalty tax on those payments in excess of amounts deemed reasonable between unrelated parties. Finally, some state and local jurisdictions may tax some of our income even though as a REIT we are not subject to federal income tax on that income because not all states and localities follow the federal income tax treatment of REITs. To the extent that the Company or any taxable REIT subsidiary is required to pay federal, foreign, state or local taxes, we will have less cash available for distribution to shareholders.

We May Change the Dividend Policy for Our Common Stock in the Future

In 2012, our board of directors authorized and we declared quarterly common stock dividends of $0.45 per share in January, April, July and October, the equivalent of an annual rate of $1.80 per share. In addition, our board of directors authorized and we declared an increased quarterly common stock dividend of $0.48 per share in January 2013. We can provide no assurance that our board will not reduce or eliminate entirely dividend distributions on our common stock in the future.

Our board of directors will continue to evaluate our distribution policy on a quarterly basis as they monitor the capital markets and the impact of the economy on our operations. The decisions to authorize and pay dividends on our common stock in the future, as well as the timing, amount and composition of any such future dividends, will be at the sole discretion of our board of directors in light of conditions then existing, including our earnings, financial condition, capital requirements, debt maturities, the availability of capital, applicable REIT and legal restrictions and the general overall economic conditions and other factors. Any change in our dividend policy could have a material adverse effect on the market price of our common stock.

Market Interest Rates May Influence the Price of Our Common Stock

One of the factors that may influence the price of our common stock in public trading markets or in private transactions is the annual yield on our common stock as compared to yields on other financial instruments. An increase in market interest rates will result in higher yields on other financial instruments, which could adversely affect the price of our common stock.

Regional Concentration of Our Business May Subject Us to Economic Downturns in the States of Texas and Florida

As of December 31, 2012, 181 of our 461 self-storage facilities are located in the states of Texas and Florida. For the year ended December 31, 2012, these facilities accounted for approximately 40% of store revenues. This concentration of business in Texas and Florida exposes us to potential losses resulting from a downturn in the economies of those states. If economic conditions in those states deteriorate, we will experience a reduction in existing and new business, which may have an adverse effect on our business, financial condition and results of operations.

Changes in Taxation of Corporate Dividends May Adversely Affect the Value of Our Common Stock

The maximum marginal rate of tax payable by domestic noncorporate taxpayers on dividends received from a regular “C” corporation under current federal law is 15% to 20% depending on the taxpayer’s tax bracket, as

 

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opposed to higher ordinary income rates. The reduced tax rate, however, does not apply to distributions paid to domestic noncorporate taxpayers by a REIT on its stock, except for certain limited amounts. The earnings of a REIT that are distributed to its stockholders generally remain subject to less federal income taxation than earnings of a non-REIT “C” corporation that are distributed to its stockholders net of corporate-level income tax. However, the lower rate of taxation to dividends paid by regular “C” corporations could cause domestic noncorporate investors to view the stock of regular “C” corporations as more attractive relative to the stock of a REIT, because the dividends from regular “C” corporations continue to be taxed at a lower rate while distributions from REITs (other than distributions designated as capital gain dividends) are generally taxed at the same rate as other ordinary income for domestic noncorporate taxpayers.

 

Item 1B. Unresolved Staff Comments

None.

 

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Item 2. Properties

At December 31, 2012, we held ownership interests in and/or managed a total of 461 Properties situated in twenty-five states. Among our 461 self-storage properties are 25 properties that we manage for an unconsolidated joint venture of which we are a 20% owner, 30 properties that we manage for an unconsolidated joint venture of which we are a 15% owner, one property that we manage for a consolidated joint venture of which we have a 20% common ownership interest and a preferred interest, and 15 properties that we manage and have no ownership interest.

Our self-storage facilities offer inexpensive, easily accessible, enclosed storage space to residential and commercial users on a month-to-month basis. Most of our Properties are fenced and well lighted with automated access systems and surveillance cameras. A majority of the Properties are single-story, thereby providing customers with the convenience of direct vehicle access to their storage spaces. Our stores range in size from 23,000 to 181,000 net rentable square feet, with an average of approximately 68,000 net rentable square feet. The Properties generally are constructed of masonry or steel walls resting on concrete slabs and have standing seam metal, shingle, or tar and gravel roofs. All Properties have a property manager on-site during business hours. Generally, customers have access to their storage space up to 15 hours a day, and some customers are provided 24-hour access. Individual storage spaces are secured by a lock furnished by the customer to provide the customer with control of access to the space.

All of the Properties conduct business under the user-friendly name Uncle Bob’s Self-Storage ®.

The following table provides certain information regarding the Properties in which we have an ownership interest or manage as of December 31, 2012:

 

     Number of                       
     Stores at                    Percentage  
     December 31,      Square      Number of      of Store  
     2012      Feet      Spaces      Revenue  

Alabama

     24         1,784,013         12,980         4.3

Arizona

     10         675,839         6,004         1.8

Colorado

     4         276,707         2,355         1.2

Connecticut

     5         295,338         2,788         1.7

Florida

     67         4,462,709         42,515         13.6

Georgia

     29         1,992,961         17,168         5.3

Illinois

     10         761,479         7,100         0.6

Kentucky

     2         144,930         1,323         0.5

Louisiana

     15         957,099         8,155         3.1

Maine

     2         113,000         1,008         0.4

Maryland

     3         138,714         1,620         0.7

Massachusetts

     12         656,186         6,071         2.9

Mississippi

     15         1,158,497         8,824         3.1

Missouri

     8         501,073         4,442         1.8

New Hampshire

     4         261,155         2,338         0.9

New Jersey

     22         1,756,737         18,025         7.7

New York

     28         1,677,277         15,336         7.4

North Carolina

     20         1,228,594         11,225         3.1

Ohio

     24         1,627,480         13,565         4.8

Pennsylvania

     7         438,615         3,579         1.4

Rhode Island

     4         207,421         1,926         0.7

South Carolina

     8         430,508         3,743         1.4

Tennessee

     4         291,244         2,418         0.9

Texas

     114         8,031,001         66,149         26.7

Virginia

     20         1,325,739         12,450         4.0
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     461         31,194,316         273,107         100.0
  

 

 

    

 

 

    

 

 

    

 

 

 

At December 31, 2012, the Properties had an average occupancy of 85.5% and an annualized rent per occupied square foot of $10.86.

 

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Item 3. Legal Proceedings

In the normal course of business, we are subject to various claims and litigation. While the outcome of any litigation is inherently unpredictable, we do not believe that any matters currently pending against the Company will have a material adverse impact on our financial condition, results of operations or cash flows.

 

Item 4. Mine Safety Disclosures

Not Applicable

 

 

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Part II

 

Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

Our Common Stock is traded on the New York Stock Exchange under the symbol “SSS.” Set forth below are the high and low sales prices for our Common Stock for each full quarterly period within the two most recent fiscal years.

 

Quarter 2011

   High      Low  

1st

   $ 40.00       $ 36.19   

2nd

     43.55         38.05   

3rd

     42.99         33.37   

4th

     44.98         35.34   

 

Quarter 2012

   High      Low  

1st

   $ 50.15       $ 42.75   

2nd

     53.73         46.93   

3rd

     58.99         49.92   

4th

     63.32         55.66   

As of February 15, 2013, there were approximately 1,063 holders of record of our Common Stock.

We have paid quarterly dividends to our shareholders since our inception. Reflected in the table below are the dividends paid in the last two years.

For federal income tax purposes, distributions to shareholders are treated as ordinary income, capital gain, return of capital or a combination thereof. Distributions to shareholders for 2012 represent 100% ordinary income.

History of Dividends Declared on Common Stock

 

January 2011

   $ 0.450 per share   

April 2011

   $ 0.450 per share   

July 2011

   $ 0.450 per share   

October 2011

   $ 0.450 per share   

January 2012

   $ 0.450 per share   

April 2012

   $ 0.450 per share   

July 2012

   $ 0.450 per share   

October 2012

   $ 0.450 per share   

 

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EQUITY COMPENSATION PLAN INFORMATION

The following table sets forth certain information as of December 31, 2012, with respect to equity compensation plans under which shares of the Company’s Common Stock may be issued.

 

Plan Category

   Number of
securities to  be
issued upon
exercise of
outstanding
options, warrants
and rights (#)
     Weighted average
exercise price of
outstanding
options, warrants
and rights ($)
     Number of
securities
remaining available
for future issuance
(#)
 

Equity compensation plans approved by shareholders:

        

2005 Award and Option Plan

     242,413       $ 43.49         817,436   

2009 Outside Directors’ Stock Option and Award Plan

     21,000       $ 40.83         104,371   

1995 Outside Directors’ Stock Option Plan

     9,835       $ 48.07         0   

Deferred Compensation Plan for Directors (1)

     39,394         N/A         8,161   

Equity compensation plans not approved by shareholders:

     N/A         N/A         N/A   

 

(1) Under the Deferred Compensation Plan for Directors, non-employee Directors may defer all or part of their Directors’ fees that are otherwise payable in cash. Directors’ fees that are deferred under the Plan will be credited to each Directors’ account under the Plan in the form of Units. The number of Units credited is determined by dividing the amount of Directors’ fees deferred by the closing price of the Company’s Common Stock on the New York Stock Exchange on the day immediately preceding the day upon which Directors’ fees otherwise would be paid by the Company. A Director is credited with additional Units for dividends on the shares of Common Stock represented by Units in such Directors’ Account. A Director may elect to receive the shares in a lump sum on a date specified by the Director or in quarterly or annual installments over a specified period and commencing on a specified date.

 

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CORPORATE PERFORMANCE GRAPH

The following chart and line-graph presentation compares (i) the Company’s shareholder return on an indexed basis since December 31, 2007 with (ii) the S&P Stock Index and (iii) the National Association of Real Estate Investment Trusts Equity Index.

 

 

 

LOGO

CUMULATIVE TOTAL SHAREHOLDER RETURN

SOVRAN SELF STORAGE, INC.

DECEMBER 31, 2007 - DECEMBER 31, 2012

 

     Dec. 31,
2007
     Dec. 31,
2008
     Dec. 31,
2009
     Dec. 31,
2010
     Dec. 31,
2011
     Dec. 31,
2012
 

S&P

     100.00         63.00         79.68         91.68         93.61         108.59   

NAREIT

     100.00         62.27         79.70         101.98         110.42         132.18   

SSS

     100.00         95.56         103.03         111.62         105.96         159.45   

The foregoing item assumes $100.00 invested on December 31, 2007, with dividends reinvested.

 

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Item 6. Selected Financial Data

The following selected financial and operating information should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and the financial statements and related notes included elsewhere in this Annual Report on Form 10-K:

 

     At or For Year Ended December 31,  
(dollars in thousands, except per share data)    2012     2011     2010     2009     2008  

Operating Data

        

Operating revenues

   $ 236,007     $ 202,719     $ 183,701     $ 182,301     $ 187,608  

Income from continuing operations

     48,948       28,098       31,547       16,740       32,363  

Income from discontinued operations (1)

     6,693       3,431       10,994       4,914       7,320  

Net income

     55,641       31,529       42,541       21,654       39,683  

Net income attributable to common shareholders

     55,128       30,592       40,642       19,916       37,399  

Income from continuing operations per common share attributable to common shareholders– diluted

     1.64       0.98       1.08       0.63       1.38  

Net income per common share attributable to common shareholders – basic

     1.88       1.11       1.48       0.84       1.72  

Net income per common share attributable to common shareholders – diluted

     1.87       1.10       1.48       0.84       1.72  

Dividends declared per common share (2)

     1.80       1.80       1.80       1.54       2.54  

Balance Sheet Data

          

Investment in storage facilities at cost

   $ 1,755,954     $ 1,538,595     $ 1,362,932     $ 1,308,147     $ 1,287,922  

Total assets

     1,484,441       1,343,674       1,184,491       1,184,032       1,212,333  

Total debt

     684,251       625,423       488,954       481,219       623,261  

Total liabilities

     743,041       673,669       527,348       518,973       691,186  

Other Data

          

Net cash provided by operating activities

   $ 99,004     $ 80,310     $ 73,671     $ 59,143     $ 77,132  

Net cash used in investing activities

     (175,906     (190,292     (32,605     (4,448     (82,711

Net cash provided by (used in) financing activities

     76,836       111,537       (46,010     (48,471     6,055  

 

(1) In 2012 we sold seventeen stores, in 2010 we sold ten stores, in 2009 we sold five stores, and in 2008 we sold one store whose results of operations and gain (loss) on disposal are classified as discontinued operations for all previous years presented.
(2) In 2009 we declared dividends in March, July, and October. On January 4, 2010 we declared a dividend of $0.45 per common share, and therefore it is not included in the 2009 column. In 2010, 2011 and 2012 we declared regular quarterly dividends of $0.45 in January, April, July and October.

 

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of the consolidated financial condition and results of operations should be read in conjunction with the financial statements and notes thereto included elsewhere in this report.

Disclosure Regarding Forward-Looking Statements

When used in this discussion and elsewhere in this document, the words “intends,” “believes,” “expects,” “anticipates,” and similar expressions are intended to identify “forward-looking statements” within the meaning of that term in Section 27A of the Securities Act of 1933 and in Section 21E of the Securities Exchange Act of 1934. Such forward-looking statements involve known and unknown risks, uncertainties and other factors, which may cause our actual results, performance or achievements to be materially different from those expressed or implied by such forward-looking statements. Such factors include, but are not limited to, the effect of competition from new self-storage facilities, which would cause rents and occupancy rates to decline; the Company’s ability to evaluate, finance and integrate acquired businesses into the Company’s existing business and operations; the Company’s ability to effectively compete in the industry in which it does business; the Company’s existing indebtedness may mature in an unfavorable credit environment, preventing refinancing or forcing refinancing of the indebtedness on terms that are not as favorable as the existing terms; interest rates may fluctuate, impacting costs associated with the Company’s outstanding floating rate debt; the Company’s ability to comply with debt covenants; any future ratings on the Company’s debt instruments; the regional concentration of the Company’s business may subject it to economic downturns in the states of Florida and Texas; the Company’s reliance on its call center; the Company’s cash flow may be insufficient to meet required payments of operating expenses, principal, interest and dividends; and tax law changes that may change the taxability of future income.

Business and Overview

We believe we are the fourth largest operator of self-storage properties in the United States based on square feet owned and managed. All of our stores are operated under the user-friendly name “Uncle Bob’s Self-Storage”®.

Operating Strategy

Our operating strategy is designed to generate growth and enhance value by:

A. Increasing operating performance and cash flow through aggressive management of our stores:

 

   

We seek to differentiate our self-storage facilities from our competition through innovative marketing and value-added product offerings including:

 

   

Our Customer Care Center, established in 2000, answers sales inquires and makes reservations for all of our Properties on a centralized basis. Further, our call center and customer contact software was developed in-house and is 100% supported by our in-house experts. This brings us flexibility well beyond that of any operator using off the shelf software;

 

   

The Uncle Bob’s truck move-in program, under which, at present, 336 of our stores offer a free Uncle Bob’s truck to assist our customers moving into their spaces, and acts as a moving billboard further supporting our branding efforts;

 

   

Our dehumidification system, known as Dri-guard, which provides our customers with a better environment to store their goods and improves yields on our Properties;

 

   

Aggressive and efficient Web and Mobile marketing which rank our websites highly and make Uncle Bob’s stand out among the competitors;

 

   

Regional marketing which creates effective brand awareness in the cities where we do business.

 

   

Our customized computer applications link each of our primary sales channels (customer care center, web, and store) allowing for real time access to space type and inventory, pricing, promotions, and

 

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other pertinent store information. This also provides us with raw data on historical and current pricing, move-in and move-out activity, specials and occupancies, etc. This data is then used within the advanced pricing analytics programs employed by our revenue management team.

 

   

Our store managers are better qualified and receive a high level of training. New store employees are assigned a Certified Training Manager as a mentor during their initial training period. In addition, all employees have access to our online Learning and Performance Management System internally named eBOB for initial training as well as continuing education. Finally, we have a company intranet that acts as a communications portal for company policy and procedures, online ordering, incentive rankings, etc.

B. Acquiring additional stores:

 

   

Our objective is to acquire new stores in markets in which we currently operate. This is a proven strategy we have employed over the years as it facilitates our branding efforts, grows market share, and allows us to achieve improved economies of scale through shared advertising, payroll, and other services.

 

   

We also look to enter new markets that are in the top 50 MSA by acquiring established multi-property portfolios. With this strategy we are then able to seek out additional acquisition or third party management opportunities to continue to grow market share, branding and enhance economies of scale.

C. Expanding our management business:

 

   

We see our management business as a source of future acquisitions. In 2011 we entered into another joint venture in which we retained a 15% ownership interest and manage the 20 self storage facilities owned by this joint venture. In 2012, that same joint venture acquired 10 additional self storage facilities, bringing the total stores owned by the joint venture to 30 as of December 31, 2012. In addition, we manage 15 self-storage facilities for which we have no ownership. We may enter into additional management agreements and develop additional joint ventures in the future. The joint venture agreements will give us first right of refusal to purchase the managed properties in the event they are offered for sale.

D. Expanding and enhancing our existing stores:

 

   

Over the past 5 years we have undertaken a program of expanding and enhancing our Properties. In 2009, we completed construction of a new 78,000 square foot facility in Richmond, Virginia, added 175,000 square feet to other existing Properties, and converted 64,000 square feet to premium storage for a total cost of approximately $18 million; in 2010, we added 162,000 square feet to existing Properties, and converted 6,500 square feet to premium storage for a total cost of approximately $9 million; in 2011, we added 118,000 square feet to existing Properties and converted 2,000 square feet to premium storage for a total cost of approximately $7 million; and in 2012, we added 372,000 square feet to existing Properties and converted 35,000 square feet to premium storage for a total cost of approximately $22.5 million. In 2011 and 2012, we also installed solar panels at eight locations for a total cost of approximately $2.6 million. Our solar panel initiative has reduced energy consumption and operating cost at those installed locations.

Supply and Demand / Operating Trends

We believe the supply and demand model in the self-storage industry is micro market specific in that a majority of our business comes from within a five mile radius of our stores. The recent economic conditions and the credit market environment have resulted in a decrease in new supply on a national basis in the last five years. With the recent loosening of the debt and equity markets, we have seen capitalization rates on quality acquisitions

 

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(expected annual return on investment) decrease from approximately 6.75% to 6.25%.

We believe our industry weathered the recent recession very well. Although our industry experienced softness in 2008 through 2011, our same store sales showed positive increases save for 2009, when we showed a 3.1% decrease in same store revenue. That was the first time in recent history that we recorded lower same store sales. We feel our recent performance further supports the notion that the self-storage industry holds up well through recessions.

We believe our same-store move-ins in 2012 were higher than 2011 for several reasons. First, we increased spending on internet advertising which we believe allowed us to capture more demand than the smaller operators who have a difficult time competing against the larger operators on the internet. Second, our revenue management system was fully operational in 2012, which we believe set prices at optimal levels. Lastly, the housing industry began to improve which increased demand for self-storage, not only from homeowners, but for the people working in the construction trades (trades people are a measurable part of our usual customer base.)

 

     2012      2011      Change  

Same store move ins

     147,397        137,986        9,411   

Same store move outs

     137,458        133,842        3,616  
  

 

 

    

 

 

    

 

 

 

Difference

     9,939        4,144        5,795   

We expect conditions in most of our markets to continue the recovery that we saw in 2011 and 2012 and are forecasting 4% to 5% revenue growth on a same store basis in 2013.

We were able to maintain relatively flat expenses at the store operating level from 2009 through 2012. We do expect same store expense growth in 2013 to be above the levels seen over the last few years, mainly because we had very unusual weather in 2012 that reduced our utility and snow removal costs, new legislation reduced our credit card fees for a portion of 2011 and 2012, and we significantly reduced yellow page advertising over the last two years. We do believe the expense increases will be at a manageable level of between 4% and 6%.

Critical Accounting Policies and Estimates

The discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the amounts reported in our financial statements and the accompanying notes. On an on-going basis, we evaluate our estimates and judgments, including those related to carrying values of storage facilities, bad debts, and contingencies and litigation. We base these estimates on experience and on various other assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Assigning purchase price to assets acquired: The purchase price of acquired storage facilities is assigned primarily to land, land improvements, building, equipment, and in-place customer leases based on the fair values of these assets as of the date of acquisition. We use significant unobservable inputs in our determination of the fair values of these assets. The determination of these inputs involves judgments and estimates that can vary for each individual property based on a number of factors specific to the properties and the functional, economic and other factors affecting each property. To determine the fair value of land, we use prices per acre derived from observed transactions involving comparable land in similar locations. To determine the fair value of buildings, equipment and improvements, we use current replacement cost based on information derived from construction industry data by geographic region as adjusted for the age, condition, and economic obsolescence associated with these assets. The fair values of in-place customer leases is based on the rent lost due to the amount of time required to replace existing customers which is based on our historical experience with turnover in our facilities.

Carrying value of storage facilities: We believe our judgment regarding the impairment of the carrying

 

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value of our storage facilities is a critical accounting policy. Our policy is to assess any impairment of value whenever events or circumstances indicate that the carrying value of a storage facility may not be recoverable. Such events or circumstances would include negative operating cash flow, significant declining revenue per storage facility, significant damage sustained from accidents or natural disasters, or an expectation that, more likely than not, a property will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. Impairment is evaluated based upon comparing the sum of the expected undiscounted future cash flows to the carrying value of the storage facility, on a property by property basis. If the sum of the undiscounted cash flow is less than the carrying amount, an impairment loss is recognized for the amount by which the carrying amount exceeds the fair value of the asset. If cash flow projections are inaccurate and in the future it is determined that storage facility carrying values are not recoverable, impairment charges may be required at that time and could materially affect our operating results and financial position. Estimates of undiscounted cash flows could change based upon changes in market conditions, expected occupancy rates, etc. During 2011 we recorded an impairment charge at one of our stores as of a result of a structural deficiency that we decided to address by demolishing the buildings in 2012. See further discussion in the analysis of the 2011 results compared to 2010 that follows. No assets had been determined to be impaired under this policy in 2012.

Estimated useful lives of long-lived assets: We believe that the estimated lives used for our depreciable, long-lived assets is a critical accounting policy. We periodically evaluate the estimated useful lives of our long-lived assets to determine if any changes are warranted based upon various factors, including changes in the planned usage of the assets, customer demand, etc. Changes in estimated useful lives of these assets could have a material adverse impact on our financial condition or results of operations. We have not made significant changes to the estimated useful lives of our long-lived assets in the past and we don’t have any current expectation of making significant changes in 2013.

Consolidation and investment in joint ventures: We consolidate all wholly owned subsidiaries. Partially owned subsidiaries and joint ventures are consolidated when we control the entity or have the power to direct the activities most significant to the economic performance of the entity. Investments in joint ventures that we do not control but for which we have significant influence over are reported using the equity method. Under the equity method, our investment in joint ventures are stated at cost and adjusted for our share of net earnings or losses and reduced by distributions. Equity in earnings of real estate ventures is generally recognized based on our ownership interest in the earnings of each of the unconsolidated real estate ventures.

Revenue and Expense Recognition: Rental income is recognized when earned pursuant to month-to-month leases for storage space. Promotional discounts are recognized as a reduction to rental income over the promotional period, which is generally during the first month of occupancy. Rental income received prior to the start of the rental period is included in deferred revenue.

Qualification as a REIT: We operate, and intend to continue to operate, as a REIT under the Code, but no assurance can be given that we will at all times so qualify. To the extent that we continue to qualify as a REIT, we will not be taxed, with certain limited exceptions, on the taxable income that is distributed to our shareholders. If we fail to qualify as a REIT, any requirement to pay federal income taxes could have a material adverse impact on our financial conditions and results of operations.

Recent Accounting Pronouncements

In July 2011, the FASB issued ASU No. 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.” The amendment eliminates the option to present other comprehensive income and its components in the statement of stockholders’ equity. The amendment requires all nonowner changes in stockholders’ equity be presented in either a single continuous statement of comprehensive income or in two separate but consecutive statements. The amendment, which must be applied retrospectively, is effective for interim and annual periods beginning after December 15, 2011, with early adoption permitted. The Company adopted ASU No. 2011-05 in 2011. The adoption of ASU No. 2011-05 did not have a material impact on the Company’s consolidated financial statements.

 

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YEAR ENDED DECEMBER 31, 2012 COMPARED TO YEAR ENDED DECEMBER 31, 2011

We recorded rental revenues of $219.7 million for the year ended December 31, 2012, an increase of $29.6 million or 15.6% when compared to 2011 rental revenues of $190.1 million. Of the increase in rental revenue, $10.8 million resulted from a 5.9% increase in rental revenues at the 333 core properties considered in same store sales (those properties included in the consolidated results of operations since January 1, 2011, excluding the one property we developed in 2009 and the 17 properties we sold in July and August of 2012). The increase in same store rental revenues was a result of a 520 basis point increase in average occupancy which was offset by a 1.4% decrease in rental income per square foot. The remaining increase in rental revenue of $18.8 million resulted from the continued lease-up of our Richmond, Virginia property constructed in 2009 and the revenues from the acquisition of 57 properties completed since January 1, 2011. Other operating income, which includes merchandise sales, insurance commissions, truck rentals, management fees and acquisition fees, increased by $3.7 million for the year ended December 31, 2012 compared to 2011 primarily as a result of increased commissions earned on customer insurance and from having a full year of fees for managing the properties in the joint venture (Sovran HHF Storage Holdings II LLC) which began operations in July 2011. We also earned a $0.1 million acquisition fee from this joint venture in 2012 compared to an acquisition fee of $0.7 million earned from the joint venture in 2011.

Property operations and maintenance expenses increased $3.4 million or 6.4% in 2012 compared to 2011. The 333 core properties considered in the same store pool experienced a $1.1 million or 2.3% decrease in operating expenses as a result of lower utilities due to a mild winter and energy savings initiatives. The same store pool also benefited from reduced yellow page advertising expense and reduced credit card fees. The decrease in same store operating expenses was offset by the $4.5 million increase in operating expenses resulting from the 57 properties acquired since January 1, 2011. Real estate tax expense increased $2.9 million as a result of a 2.3% increase in property taxes on the 333 same store pool and the inclusion of taxes on the properties acquired in 2012 and 2011.

Our 2012 same store results consist of only those properties that were included in our consolidated results since January 1, 2011, excluding the one property we developed in 2009 and the 17 properties we sold in July and August of 2012. The following table sets forth operating data for our 333 same store properties. These results provide information relating to property operating changes without the effects of acquisition.

Same Store Summary

 

      Year ended December 31,      Percentage
Change
 

(dollars in thousands)

   2012      2011     

Same store rental income

   $ 195,003      $ 184,200        5.9 %

Same store other operating income

     10,190        8,857        15.1 %
  

 

 

    

 

 

    

 

 

 

Total same store operating income

     205,193        193,057        6.3 %

Payroll and benefits

     20,741        20,339        2.0 %

Real estate taxes

     18,997        18,572        2.3 %

Utilities

     8,327        8,812        -5.5 %

Repairs and maintenance

     7,768        7,398        5.0 %

Office and other operating expenses

     7,635        7,866        -2.9 %

Insurance

     3,007        2,980        0.9 %

Advertising and yellow pages

     1,654        2,870        -42.4 %
  

 

 

    

 

 

    

 

 

 

Total same store operating expenses

     68,129        68,837        -1.0 %
  

 

 

    

 

 

    

 

 

 

Same store net operating income

   $ 137,064      $ 124,220        10.3 %
  

 

 

    

 

 

    

 

 

 

Net operating income increased $27.0 million or 20.6% as a result of a 10.3% increase in our same store net operating income and the acquisitions completed since January 1, 2011.

 

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Net operating income or “NOI” is a non-GAAP (generally accepted accounting principles) financial measure that we define as total continuing revenues less continuing property operating expenses. NOI also can be calculated by adding back to net income: interest expense, impairment and casualty losses, depreciation and amortization expense, acquisition related costs, general and administrative expense, and deducting from net income: income from discontinued operations, interest income, gain on sale of real estate, and equity in income of joint ventures. We believe that NOI is a meaningful measure of operating performance because we utilize NOI in making decisions with respect to capital allocations, in determining current property values, and in comparing period-to-period and market-to-market property operating results. NOI should be considered in addition to, but not as a substitute for, other measures of financial performance reported in accordance with GAAP, such as total revenues, operating income and net income. There are material limitations to using a measure such as NOI, including the difficulty associated with comparing results among more than one company and the inability to analyze certain significant items, including depreciation and interest expense, that directly affect our net income. We compensate for these limitations by considering the economic effect of the excluded expense items independently as well as in connection with our analysis of net income. The following table reconciles NOI generated by our self-storage facilities to our net income presented in the 2012 and 2011 consolidated financial statements.

 

     Year ended December 31,  

(dollars in thousands)

   2012     2011  

Net operating income

    

Same store

   $ 137,064     $ 124,220  

Other stores and management fee income

     20,956       6,777  
  

 

 

   

 

 

 

Total net operating income

     158,020       130,997  

General and administrative

     (32,313     (25,986

Acquisition related costs

     (4,328     (3,278

Impairment of storage facility

     —          (1,047

Depreciation and amortization

     (40,892     (35,167

Interest expense

     (33,166     (38,549

Interest income

     4       83  

Casualty loss

     —         (126

Gain on sale of real estate

     687       1,511  

Equity in income (losses) of joint ventures

     936       (340

Income from discontinued operations

     6,693       3,431  
  

 

 

   

 

 

 

Net income

   $ 55,641     $ 31,529  
  

 

 

   

 

 

 

General and administrative expenses increased $6.3 million or 24.3% from 2011 to 2012. The key drivers of the increase were a $3.9 million increase in salaries and performance incentives, and a $1.5 million increase in internet advertising. The remaining $0.9 million increase is the result of increases in various other administrative costs as a result of managing the increased number of stores in our portfolio as compared to 2011.

Acquisition related costs increased by $1.1 million as a result of the $189.1 million of stores acquired in 2012 compared to the $155.1 million of stores acquired in 2011.

Depreciation and amortization expense increased to $40.9 million in 2012 from $35.2 million in 2011, primarily as a result of depreciation on the 57 properties acquired in 2011 and 2012.

The 2011 impairment charge related to a building that was determined to have a structural deficiency. There were no such impairments in 2012.

Interest expense decreased from $38.5 million in 2011 to $33.2 million in 2012. The decrease was mainly due to expensing $5.5 million that was paid to terminate two interest rate swap agreements related to the $150

 

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million term note that we repaid as part of our debt refinancing in August 2011.

The casualty loss recorded in 2011 was the result of clean-up and repair costs incurred in excess of insurance proceeds received from two buildings that were damaged by fire.

During 2012, we sold a portion of one of our facilities and a parcel of land for net proceeds of $3.3 million resulting in a gain of $0.7 million. During 2011, we sold three parcels of land to various municipalities for their use as part of road widening projects for net cash proceeds of $2.0 million resulting in a gain on sale of $1.5 million.

In July and August of 2012, the Company sold 17 non-strategic storage facilities in Maryland (1), Michigan (4) and Texas (12) for net proceeds of approximately $47.7 million resulting in a gain of approximately $4.5 million. The 2012 and 2011 operations of these facilities are reported in income from discontinued operations for all periods presented.

Net income attributable to noncontrolling interest decreased from $0.9 million in 2011 to $0.5 million in 2012 primarily as a result of our May 2011 additional investment in Locke Sovran II, LLC in which we purchased the remaining noncontrolling interest in that entity. In addition, the redemption of Operating Partnership Units by a noncontrolling unitholder in 2012 resulted in a decrease in the attribution of net income to noncontrolling interests in 2012 as compared to 2011.

YEAR ENDED DECEMBER 31, 2011 COMPARED TO YEAR ENDED DECEMBER 31, 2010

We recorded rental revenues of $190.1 million for the year ended December 31, 2011, an increase of $15.3 million or 8.8% when compared to 2010 rental revenues of $174.8 million. Of the increase in rental revenue, $6.4 million resulted from a 3.7% increase in rental revenues at the 326 core properties considered in same store sales (those properties included in the consolidated results of operations since January 1, 2010, excluding the one property we developed in 2009 and the 17 properties we sold in July and August of 2012). The increase in same store rental revenues was a result of a 3% increase in average rental income per square foot as a result of our reduced use of move-in incentives. Average occupancy in 2011 was essentially flat to 2010. The remaining increase in rental revenue of $8.9 million resulted from the continued lease-up of our Richmond, Virginia property constructed in 2009 and the revenues from the acquisition of 36 properties completed between January 1, 2010 and December 31, 2011. Other operating income, which includes merchandise sales, insurance commissions, truck rentals, management fees and acquisition fees, increased by $3.6 million for the year ended December 31, 2011 compared to 2010 primarily as a result of increased commissions earned on customer insurance and from fees for managing the properties in the new joint venture which began operations in July 2011. We also earned a $0.7 million acquisition fee from the new joint venture in 2011.

Property operations and maintenance expenses increased $3.0 million or 6.2% in 2011 compared to 2010. $0.2 million of the increase resulted from increases in personnel and maintenance at the 326 core properties considered in same store pool. The remaining increase in operating expenses of $2.8 million resulted from the 36 properties acquired between January 1, 2010 and December 31, 2011. Real estate tax expense increased $1.3 million as a result of 1.7% increase in property taxes on the 326 same store pool and the inclusion of taxes on the properties acquired in 2010 and 2011.

Our 2011 same store results consist of only those properties that were included in our consolidated results since January 1, 2010, excluding the one property we developed in 2009 and the 17 properties we sold in July and August of 2012. The following table sets forth operating data for our 326 same store properties. These results provide information relating to property operating changes without the effects of acquisition.

 

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Same Store Summary

 

     Year ended December 31,      Percentage  

(dollars in thousands)

   2011      2010      Change  

Same store rental income

   $ 180,940      $ 174,545        3.7 %

Same store other operating income

     8,781        7,238        21.3 %
  

 

 

    

 

 

    

 

 

 

Total same store operating income

     189,721        181,783        4.4 %

Payroll and benefits

     19,913        19,687        1.1 %

Real estate taxes

     18,267        17,970        1.7 %

Utilities

     8,655        8,710        -0.6 %

Repairs and maintenance

     7,247        6,818        6.3 %

Office and other operating expenses

     7,657        7,718        -0.8 %

Insurance

     2,940        2,892        1.7 %

Advertising and yellow pages

     2,834        3,200        -11.4 %
  

 

 

    

 

 

    

 

 

 

Total same store operating expenses

     67,513        66,995        0.8 %
  

 

 

    

 

 

    

 

 

 

Same store net operating income

   $ 122,208      $ 114,788        6.5 %
  

 

 

    

 

 

    

 

 

 

Net operating income increased $14.7 million or 12.6% as a result of a 6.5% increase in our same store net operating income and the acquisitions completed since January 1, 2010.

The following table reconciles NOI generated by our self-storage facilities to our net income presented in the 2011 and 2010 consolidated financial statements.

 

     Year ended December 31,  

(dollars in thousands)

   2011     2010  

Net operating income

    

Same store

   $ 122,208     $ 114,788  

Other stores and management fee income

     8,789       1,549  
  

 

 

   

 

 

 

Total net operating income

     130,997       116,337  

General and administrative

     (25,986     (21,071

Acquisition related costs

     (3,278     (786

Impairment of storage facility

     (1,047     —    

Depreciation and amortization

     (35,167     (31,546

Interest expense

     (38,549     (31,711

Interest income

     83       84  

Casualty loss

     (126     —    

Gain on sale of real estate

     1,511       —    

Equity in (losses) income of joint ventures

     (340     240  

Income from discontinued operations

     3,431       10,994  
  

 

 

   

 

 

 

Net income

   $ 31,529     $ 42,541  
  

 

 

   

 

 

 

General and administrative expenses increased $4.9 million or 23.3% from 2010 to 2011. The key drivers of the increase were a $2.2 million increase in salaries and performance incentives, $0.8 million increase in internet advertising, and a $1.1 million increase in costs associated with training and onboarding new owned and/or managed stores.

Acquisition related costs increased by $2.5 million as a result of the 29 stores acquired in 2011 compared to seven stores acquired in 2010.

Depreciation and amortization expense increased to $35.2 million in 2011 from $31.5 million in 2010, primarily as a result of depreciation on the 36 properties acquired in 2010 and 2011.

 

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The 2011 impairment charge related to a building that was determined to have a structural deficiency. A decision was made to demolish and rebuild this building, and the net value of the building was written off in 2011.

Interest expense increased from $31.7 million in 2010 to $38.5 million in 2011 mainly due to $5.5 million that was paid and recorded as interest expense to terminate two interest rate swap agreements related to the $150 million term note that we repaid as part of our debt refinancing in August 2011.

The casualty loss recorded in 2011 was the result of clean-up and repair costs incurred in excess of insurance proceeds received for two buildings that were damaged by fire.

During 2011, we sold three parcels of land to various municipalities for their use as part of road widening projects for net cash proceeds of $2.0 million resulting in a gain on sale of $1.5 million.

Net income attributable to noncontrolling interest decreased from $1.9 million in 2010 to $0.9 million in 2011 as a result of our May 2011 additional investment in Locke Sovran II, LLC in which we purchased the remaining noncontrolling interest in that entity, and as a result of our lower net income.

FUNDS FROM OPERATIONS

We believe that Funds from Operations (“FFO”) provides relevant and meaningful information about our operating performance that is necessary, along with net earnings and cash flows, for an understanding of our operating results. FFO adds back historical cost depreciation, which assumes the value of real estate assets diminishes predictably in the future. In fact, real estate asset values increase or decrease with market conditions. Consequently, we believe FFO is a useful supplemental measure in evaluating our operating performance by disregarding (or adding back) historical cost depreciation.

FFO is defined by the National Association of Real Estate Investment Trusts, Inc. (“NAREIT”) as net income available to common shareholders computed in accordance with generally accepted accounting principles (“GAAP”), excluding gains or losses on sales of properties, plus impairment of real estate assets, plus depreciation and amortization and after adjustments to record unconsolidated partnerships and joint ventures on the same basis. We believe that to further understand our performance, FFO should be compared with our reported net income and cash flows in accordance with GAAP, as presented in our consolidated financial statements.

In October and November of 2011, NAREIT issued guidance for reporting FFO that reaffirmed NAREIT’s view that impairment write-downs of depreciable real estate should be excluded from the computation of FFO. This view is based on the fact that impairment write-downs are akin to and effectively reflect the early recognition of losses on prospective sales of depreciable property or represent adjustments of previously charged depreciation. Since depreciation of real estate and gains/losses from sales are excluded from FFO, it is NAREIT’s view that it is consistent and appropriate for write-downs of depreciable real estate to also be excluded. Our calculation of FFO excludes impairment write-downs of investments in storage facilities.

Our computation of FFO may not be comparable to FFO reported by other REITs or real estate companies that do not define the term in accordance with the current NAREIT definition or that interpret the current NAREIT definition differently. FFO does not represent cash generated from operating activities determined in accordance with GAAP, and should not be considered as an alternative to net income (determined in accordance with GAAP) as an indication of our performance, as an alternative to net cash flows from operating activities (determined in accordance with GAAP) as a measure of our liquidity, or as an indicator of our ability to make cash distributions.

 

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Reconciliation of Net Income to Funds From Operations

 

     For Year Ended December 31,  
(dollars in thousands)    2012     2011     2010     2009     2008  

Net income attributable to common shareholders

   $ 55,128     $ 30,592     $ 40,642     $ 19,916     $ 37,399  

Net income attributable to noncontrolling interests

     513       937       1,899       1,738       2,284  

Depreciation of real estate and amortization of intangible assets exclusive of deferred financing fees

     40,503       35,167       31,546       31,353       31,868  

Depreciation of real estate included in discontinued operations

     787       1,410       1,610       2,466       2,599  

Depreciation and amortization from unconsolidated joint ventures

     1,595       1,018       788       820       333  

Casualty and impairment loss

     —         1,173       —         —         —    

(Gain) loss on sale of real estate

     (5,185     (1,511     (6,944     509       (716

Funds from operations allocable to noncontrolling interest in Operating Partnership

     (881     (812     (885     (984     (1,366

Funds from operations allocable to noncontrolling interest in consolidated joint ventures

     —          (567     (1,360     (1,360     (1,564
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Funds from operations available to common shareholders

   $ 92,460     $ 67,407     $ 67,296     $ 54,458     $ 70,837  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

LIQUIDITY AND CAPITAL RESOURCES

Our line of credit and term notes require us to meet certain financial covenants measured on a quarterly basis, including prescribed leverage, fixed charge coverage, minimum net worth, limitations on additional indebtedness, and limitations on dividend payouts. At December 31, 2012, the Company was in compliance with all debt covenants. The most sensitive covenant is the leverage ratio covenant contained in certain of our term note agreements. This covenant limits our total consolidated liabilities to 55% of our gross asset value. At December 31, 2012, our leverage ratio as defined in the agreements was approximately 43.2%. The agreements define total consolidated liabilities to include the liabilities of the Company plus our share of liabilities of unconsolidated joint ventures. The agreements also define a prescribed formula for determining gross asset value which incorporates the use of a 9.25% capitalization rate applied to annualized earnings before interest, taxes, depreciation and amortization and other items (“Adjusted EBITDA”) as defined in the agreements. In the event that the Company violates its debt covenants in the future, the amounts due under the agreements could be callable by the lenders and could adversely affect our credit rating requiring us to pay higher interest and other debt-related costs. We believe that if operating results remain consistent with historical levels and levels of other debt and liabilities remain consistent with amounts outstanding at December 31, 2012, the entire availability under our line of credit could be drawn without violating our debt covenants.

Our ability to retain cash flow is limited because we operate as a REIT. In order to maintain our REIT status, a substantial portion of our operating cash flow must be used to pay dividends to our shareholders. We believe that our internally generated net cash provided by operating activities and the availability on our line of credit will be sufficient to fund ongoing operations, capital improvements, dividends and debt service requirements through September 2013, at which time $100 million of term notes mature. We also believe that our flexible capital structure provides for many options to refinance the $100 million of term note due in 2013, including a new term note, draws on our line of credit, or an equity issuance.

 

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Cash flows from operating activities were $99.0 million, $80.3 million and $73.7 million for the years ended December 31, 2012, 2011, and 2010, respectively. The increase in operating cash flows from 2011 to 2012 was primarily due to an increase in net income. The increase in operating cash flows from 2010 to 2011 was primarily due to an increase in accounts payable and other liabilities.

Cash used in investing activities was $175.9 million, $190.3 million, and $32.6 million for the years ended December 31, 2012, 2011, and 2010 respectively. The decrease in cash used from 2011 to 2012 was primarily due to $47.7 million in proceeds from the sale of storage facilities in 2012. No facilities were sold in 2011. The decrease in cash used as a result of the sales proceeds was partially offset by the $186.9 million spent in 2012 to purchase 28 storage facilities compared to the $150.4 million spent in 2011 on the acquisition of storage facilities. The increase in cash used from 2010 to 2011 was due to the purchase of 29 storage facilities in 2011 for $150.4 million and the $13.6 million investment in the new unconsolidated joint venture entered in 2011.

Cash provided by financing activities was $76.8 million and $111.5 million in 2012 and 2011, respectively, compared to cash used in financing activities of $46.0 million in 2010. In 2012 we realized $78.9 million from the sale of our common stock through our at the market equity offering and stock option plans, and $59 million in net proceeds from draws on our line of credit to fund a portion of our acquisitions and capital improvements. In 2011, we realized $47.0 million from the sale of our common stock through our at the market equity offering and $211.0 million in proceeds, net of repayments, from our new credit agreements to fund our acquisitions, joint venture activity and mortgage payoffs of $77.0 million. In 2010, our financing activities were generally limited to a net $10.0 million draw on our line of credit as well as our recurring dividends, distributions, and mortgage principal payments.

On August 5, 2011, we entered into agreements relating to new unsecured credit arrangements, and received funds under those arrangements. As part of the agreements, we entered into a $125 million unsecured term note maturing in August 2018 bearing interest at LIBOR plus a margin based on the Company’s credit rating (at December 31, 2012 the margin is 2.0%). The agreements also provide for a $175 million (expandable to $250 million) revolving line of credit bearing interest at a variable rate equal to LIBOR plus a margin based on the Company’s credit rating (at December 31, 2012 the margin is 2.0%), and requires a 0.20% facility fee. The interest rate at December 31, 2012 on the Company’s available line of credit was approximately 2.21% (2.28% at December 31, 2011). The proceeds from this term note and draws on the new line of credit were used to repay the Company’s previous line of credit and the Company’s $150 million bank term note that was to mature June 2012. At December 31, 2012, there was $70 million available on the unsecured line of credit without considering the additional availability under the expansion feature. The revolving line of credit has a maturity date of August 2016, but can be extended for 2 one year periods at the Company’s option with the payment of an extension fee equal to 0.125% of the total line of credit commitment.

In addition, on August 5, 2011, we secured an additional $100 million term note with a delayed draw feature that was used to fund the Company’s mortgage maturities in December 2011. The delayed draw term note matures August 2018 and bears interest at LIBOR plus a margin based on the Company’s credit rating (at December 31, 2012 the margin is 2.0%).

On August 5, 2011, we also entered into a $100 million term note maturing August 2021 bearing interest at a fixed rate of 5.54%. The interest rate on the term note increases to 7.29% if the notes are not rated by at least one rating agency, the credit rating on the notes is downgraded or if the Company’s credit rating is downgraded. The proceeds from this term note were used to fund acquisitions and investments in unconsolidated joint ventures.

We also maintain an $80 million term note maturing September 2013 bearing interest at a fixed rate of 6.26%, a $20 million term note maturing September 2013 bearing interest at a variable rate equal to LIBOR plus 1.50%, and a $150 million unsecured term note maturing in April 2016 bearing interest at 6.38%. The interest rate on the $150 million unsecured term note increases to 8.13% if the notes are not rated by at least one rating agency, the credit rating on the notes is downgraded or the Company’s credit rating is downgraded. We expect to refinance the maturing $80 million and $20 million term notes due in 2013 with either a new 7 to 10 year unsecured term note,

 

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a draw on our line of credit, or we may issue common or preferred shares to pay the notes off at maturity.

The line of credit and term notes require us to meet certain financial covenants, measured on a quarterly basis, including prescribed leverage, fixed charge coverage, minimum net worth, limitations on additional indebtedness and limitations on dividend payouts. At December 31, 2012, the Company was in compliance with its debt covenants.

Our line of credit facility and term notes have an investment grade rating from Standard and Poor’s and Fitch Ratings (BBB-).

In addition to the unsecured financing mentioned above, our consolidated financial statements also include $4.3 million of mortgages payable that are secured by three storage facilities.

On September 14, 2011, the Company entered into a continuous equity offering program (“Equity Program”) with Wells Fargo Securities, LLC (“Wells Fargo”), pursuant to which the Company was permitted to sell from time to time up to $125 million in aggregate offering price of shares of the Company’s common stock.

During 2012, the Company issued 1,391,425 shares under this Equity Program at a weighted average issue price of $55.20 per share, generating net proceeds of $75.3 million after deducting $1.5 million of sales commissions payable to Wells Fargo. In addition to sales commissions paid to Wells Fargo, the Company incurred expenses of $58,000 in connection with the Equity Program during 2012. The Company used the proceeds from the Equity Program to reduce the outstanding balance under the Company’s revolving line of credit.

During 2011, the Company issued 1,166,875 shares of common stock under the Equity Program at a weighted average issue price of $40.59 per share, generating net proceeds of $46.4 million after deducting $0.9 million of sales commissions payable to Wells Fargo. In addition to sales commissions paid to Wells Fargo, the Company incurred expenses of $0.4 million in connection with the Equity Program during 2011. The Company used the proceeds from the Equity Program to reduce the outstanding balance under the Company’s revolving line of credit during 2011.

As of December 31, 2012, the Company had no availability for issuance under the Equity Program. The Company expects to enter into another continuous equity offering program in 2013.

During 2012 and 2011, we did not acquire any shares of our common stock via the Share Repurchase Program authorized by the Board of Directors. From the inception of the Share Repurchase Program through December 31, 2012, we have reacquired a total of 1,171,886 shares pursuant to this program. From time to time, subject to market price and certain loan covenants, we may reacquire additional shares.

Future acquisitions, our expansion and enhancement program, and share repurchases are expected to be funded with draws on our line of credit, issuance of common and preferred stock, the issuance of unsecured term notes, sale of properties, and private placement solicitation of joint venture equity. Should the capital markets deteriorate, we may have to curtail acquisitions, our expansion and enhancement program, and share repurchases as we approach September 2013, when certain term notes mature.

 

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CONTRACTUAL OBLIGATIONS

The following table summarizes our future contractual obligations:

 

     Payments due by period  

Contractual obligations

   Total      2013      2014-2015      2016-2017      2018 and thereafter  

Line of credit

   $ 105.0 million         —           —         $ 105.0 million         —     

Term notes

   $ 575.0 million       $ 100.0 million         —         $ 150.0 million       $ 325.0 million   

Mortgages payable

   $ 4.3 million       $ 1.1 million       $ 1.2 million       $ 0.3 million       $ 1.7 million   

Interest payments

   $ 120.8 million       $ 26.6 million       $ 45.8 million       $ 25.2 million       $ 23.2 million   

Interest rate swap payments

   $ 15.7 million       $ 4.9 million       $ 4.9 million       $ 4.9 million       $ 1.0 million   

Land lease

   $ 0.9 million       $ 0.1 million       $ 0.1 million       $ 0.1 million       $ 0.6 million   

Expansion and enhancement contracts

   $ 7.9 million       $ 7.9 million         —           —           —     

Building leases

   $ 2.2 million       $ 0.7 million       $ 1.0 million       $ 0.1 million       $ 0.4 million   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 831.8 million       $ 141.3 million       $ 53.0 million       $ 285.6 million       $ 351.9 million   

Interest payments include actual interest on fixed rate debt and estimated interest for floating-rate debt based on December 31, 2012 rates. Interest rate swap payments include estimated net settlements of swap liabilities based on forecasted variable rates.

ACQUISITION OF PROPERTIES

In 2012, we acquired 28 self storage facilities comprising 2.2 million square feet in Arizona (1), Florida (8), Georgia (5), Illinois (9), North Carolina (1), Texas (3), and Virginia (1) for a total purchase price of $189.1 million. Based on the trailing financials of the entities from which the properties were acquired, the weighted average capitalization rate was 5.2% on these purchases and ranged from 1.0% to 8.2%. In 2011, we acquired 29 self storage facilities comprising 2.0 million square feet in New Jersey (3), Florida (1), Georgia (1), Missouri (1), Texas (22), and Virginia (1) for a total purchase price of $155.1 million. During 2010, we used the proceeds from the sale of the ten Properties and borrowings pursuant to our line of credit to acquire seven Properties in North Carolina comprising 0.5 million square feet.

FUTURE ACQUISITION AND DEVELOPMENT PLANS

Our external growth strategy is to increase the number of facilities we own by acquiring suitable facilities in markets in which we already have operations, or to expand into new markets by acquiring several facilities at once in those new markets. We are actively pursuing acquisitions in 2013 and at December 31, 2012 we had one property under contract to be purchased for $2.4 million. The property was acquired in February 2013.

During 2012, we added 372,000 square feet to existing Properties, and converted 35,000 square feet to premium storage for a total cost of approximately $22.5 million. In 2011 and 2012, we also installed solar panels at eight locations for a total cost of approximately $2.6 million. In 2011, we added 118,000 square feet to existing Properties, and converted 2,000 square feet to premium storage for a total cost of approximately $7.2 million. In 2010, we added 162,000 square feet to existing Properties, and converted 6,500 square feet to premium storage for a total cost of approximately $9 million. Although we do not expect to construct any new facilities in 2013, we do plan to complete approximately $20 million in expansions and enhancements to existing facilities of which $5.7 million was paid prior to December 31, 2012.

In 2012, the Company spent approximately $17.7 million for recurring capitalized expenditures including roofing, paving, and office renovations. We expect to spend $15.8 million in 2013 on similar capital expenditures.

 

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DISPOSITION OF PROPERTIES

During 2012, we sold 17 non-strategic storage facilities in Maryland, Michigan, and Texas for net proceeds of approximately $47.7 million resulting in a gain of approximately $4.5 million. During 2010 we sold ten non-strategic storage facilities located in Georgia, Michigan, North Carolina and Virginia for net cash proceeds of $23.7 million resulting in a gain of $6.9 million.

We are seeking to sell additional Properties to third parties or joint venture programs in 2013.

OFF-BALANCE SHEET ARRANGEMENTS

Our off-balance sheet arrangements consist of our investment in two self storage joint ventures in which we have a 20% and 15% ownership, as well as our investment in the entity that owns the building that houses our corporate office in which we have a 49% ownership. We account for these real estate entities under the equity method. The debt held by the unconsolidated real estate entity is secured by the real estate owned by these entities, and is non-recourse to us. See Note 12 to our consolidated financial statements appearing elsewhere in this annual report on Form 10-K.

REIT QUALIFICATION AND DISTRIBUTION REQUIREMENTS

As a REIT, we are not required to pay federal income tax on income that we distribute to our shareholders, provided that the amount distributed is equal to at least 90% of our taxable income. These distributions must be made in the year to which they relate, or in the following year if declared before we file our federal income tax return, and if it is paid before the first regular dividend of the following year. The first distribution of 2013 may be applied toward our 2012 distribution requirement.

As a REIT, we must derive at least 95% of our total gross income from income related to real property, interest and dividends. In 2012, our percentage of revenue from such sources was approximately 96%, thereby passing the 95% test, and no special measures are expected to be required to enable us to maintain our REIT designation. Although we currently intend to operate in a manner designed to qualify as a REIT, it is possible that future economic, market, legal, tax or other considerations may cause our Board of Directors to revoke our REIT election.

INTEREST RATE RISK

The primary market risk to which we believe we are exposed is interest rate risk, which may result from many factors, including government monetary and tax policies, domestic and international economic and political considerations, and other factors that are beyond our control.

We have entered into interest rate swap agreements in order to mitigate the effects of fluctuations in interest rates on our variable rate debt. Upon renewal or replacement of the credit facility, our total interest may change dependent on the terms we negotiate with the lenders; however, the LIBOR base rates have been contractually fixed on $245 million of our debt through the interest rate swap termination dates. See Note 8 to our consolidated financial statements appearing elsewhere in this annual report on Form 10-K.

Through September 2013, $245 million of our $350 million of floating rate unsecured debt is on a fixed rate basis after taking into account our interest rate swap agreements. Based on our outstanding unsecured debt of $350 million at December 31, 2012, a 100 basis point increase in interest rates would have a $1.1 million effect on our interest expense. These amounts were determined by considering the impact of the hypothetical interest rates on our borrowing cost and our interest rate hedge agreements in effect on December 31, 2012. These analyses do not consider the effects of the reduced level of overall economic activity that could exist in such an environment. Further, in the event of a change of such magnitude, we would consider taking actions to further mitigate our exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their

 

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possible effects, the sensitivity analysis assumes no changes in our capital structure.

INFLATION

We do not believe that inflation has had or will have a direct effect on our operations. Substantially all of the leases at the facilities are on a month-to-month basis which provides us with the opportunity to increase rental rates as each lease matures.

SEASONALITY

Our revenues typically have been higher in the third and fourth quarters, primarily because self-storage facilities tend to experience greater occupancy during the late spring, summer and early fall months due to the greater incidence of residential moves and college student activity during these periods. However, we believe that our customer mix, diverse geographic locations, rental structure and expense structure provide adequate protection against undue fluctuations in cash flows and net revenues during off-peak seasons. Thus, we do not expect seasonality to affect materially distributions to shareholders.

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

The information required is incorporated by reference to the information appearing under the caption “Interest Rate Risk” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” above.

 

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Item 8. Financial Statements and Supplementary Data

Report of Independent Registered Public Accounting Firm

The Board of Directors and Shareholders of Sovran Self Storage, Inc.

We have audited the accompanying consolidated balance sheets of Sovran Self Storage, Inc. as of December 31, 2012 and 2011, and the related consolidated statements of operations, comprehensive income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2012. Our audits also included the financial statement schedule listed in the Index at Item 15(a). These financial statements and schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Sovran Self Storage, Inc. at December 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Sovran Self Storage, Inc.’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 27, 2013 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP

Buffalo, New York

February 27, 2013

 

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SOVRAN SELF STORAGE, INC.

CONSOLIDATED BALANCE SHEETS

 

     December 31,  
(dollars in thousands, except share data)    2012     2011  

Assets

    

Investment in storage facilities:

  

Land

   $ 299,544     $ 263,407  

Building, equipment, and construction in progress

     1,456,410       1,275,188  
  

 

 

   

 

 

 
     1,755,954       1,538,595  

Less: accumulated depreciation

     (328,952     (292,722
  

 

 

   

 

 

 

Investment in storage facilities, net

     1,427,002       1,245,873  

Cash and cash equivalents

     7,255       7,321  

Accounts receivable

     3,450       2,938  

Receivable from unconsolidated joint ventures

     856       589  

Investment in unconsolidated joint ventures

     34,255       31,939  

Prepaid expenses

     4,947       3,939  

Other assets

     6,676       7,373  

Net assets of discontinued operations

     —         43,702  
  

 

 

   

 

 

 

Total Assets

   $ 1,484,441     $ 1,343,674  
  

 

 

   

 

 

 

Liabilities

    

Line of credit

   $ 105,000     $ 46,000  

Term notes

     575,000       575,000  

Accounts payable and accrued liabilities

     36,667       31,414  

Deferred revenue

     6,416       6,084  

Fair value of interest rate swap agreements

     15,707       10,748  

Mortgages payable

     4,251       4,423  
  

 

 

   

 

 

 

Total Liabilities

     743,041       673,669  

Noncontrolling redeemable Operating Partnership Units at redemption value

     12,670       14,466  

Shareholders’ Equity

    

Common stock $.01 par value, 100,000,000 shares authorized, 30,446,620 shares outstanding at December 31, 2012 (28,952,356 at December 31, 2011)

     316       301  

Additional paid-in capital

     943,604       862,467  

Dividends in excess of net income

     (172,773     (169,799

Accumulated other comprehensive loss

     (15,242     (10,255

Treasury stock at cost, 1,171,886 shares

     (27,175     (27,175
  

 

 

   

 

 

 

Total Shareholders’ Equity

     728,730       655,539  
  

 

 

   

 

 

 

Total Liabilities and Shareholders’ Equity

   $ 1,484,441     $ 1,343,674  
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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SOVRAN SELF STORAGE, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

 

     Year Ended December 31,  
(dollars in thousands, except per share data)    2012     2011     2010  

Revenues

      

Rental income

   $ 219,730     $ 190,147     $ 174,775  

Other operating income

     16,277       12,572       8,926  
  

 

 

   

 

 

   

 

 

 

Total operating revenues

     236,007       202,719       183,701  

Expenses

      

Property operations and maintenance

     55,751       52,382       49,338  

Real estate taxes

     22,236       19,340       18,026  

General and administrative

     32,313       25,986       21,071  

Acquisition costs

     4,328       3,278       786  

Impairment loss

     —          1,047       —     

Depreciation and amortization

     40,892       35,167       31,546  
  

 

 

   

 

 

   

 

 

 

Total operating expenses

     155,520       137,200       120,767  
  

 

 

   

 

 

   

 

 

 

Income from operations

     80,487       65,519       62,934  

Other income (expenses)

      

Interest expense

     (33,166     (38,549     (31,711

Interest income

     4       83       84  

Casualty loss

     —          (126     —     

Gain on sale of real estate

     687       1,511       —     

Equity in income (losses) of joint ventures

     936       (340     240  
  

 

 

   

 

 

   

 

 

 

Income from continuing operations

     48,948       28,098       31,547  

Income from discontinued operations (including a gain on disposal of $4,498 in 2012 and $6,944 in 2010)

     6,693       3,431       10,994  
  

 

 

   

 

 

   

 

 

 

Net income

     55,641       31,529       42,541  

Net income attributable to noncontrolling interest

     (513     (937     (1,899
  

 

 

   

 

 

   

 

 

 

Net income attributable to common shareholders

   $ 55,128     $ 30,592     $ 40,642  
  

 

 

   

 

 

   

 

 

 

Earnings per common share attributable to common shareholders - basic

      

Continuing operations

   $ 1.65     $ 0.99     $ 1.08  

Discontinued operations

     0.23       0.12       0.40  
  

 

 

   

 

 

   

 

 

 

Earnings per share - basic

   $ 1.88     $ 1.11     $ 1.48  
  

 

 

   

 

 

   

 

 

 

Earnings per common share attributable to common shareholders - diluted

      

Continuing operations

   $ 1.64     $ 0.98     $ 1.08  

Discontinued operations

     0.23       0.12       0.40  
  

 

 

   

 

 

   

 

 

 

Earnings per share - diluted

   $ 1.87     $ 1.10     $ 1.48  
  

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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SOVRAN SELF STORAGE, INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

 

     Year Ended December 31,  
(dollars in thousands, except per share data)    2012     2011     2010  

Net income

   $ 55,641     $ 31,529     $ 42,541  

Other comprehensive income:

      

Change in fair value of derivatives net of reclassification to interest expense

     (4,987     (1     1,011  
  

 

 

   

 

 

   

 

 

 

Total comprehensive income

     50,654       31,528       43,552  

Comprehensive income attributable to noncontrolling interest

     (467     (937     (1,912
  

 

 

   

 

 

   

 

 

 

Comprehensive income attributable to common shareholders

   $ 50,187     $ 30,591     $ 41,640  
  

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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SOVRAN SELF STORAGE, INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

 

(dollars in thousands, except share data)    Common
Stock
Shares
    
Common
Stock
     Additional
Paid-in
Capital
    Dividends
in
Excess of
Net Income
    Accumulated
Other
Comprehensive
Income (loss)
    Treasury
Stock
    Total
Shareholders’
Equity
 

Balance January 1, 2010

     27,547,027        287        814,988        (139,863     (11,265     (27,175     636,972  

Exercise of stock options

     25,650        —          603       —         —         —         603  

Issuance of non-vested stock

     78,152        1        616       —         —         —         617  

Earned portion of non-vested stock

     —          —          1,307       —         —         —         1,307  

Stock option expense

     —          —          354       —         —         —         354  

Deferred compensation outside directors

     —          —          239       —         —         —         239  

Carrying value less than redemption value on redeemed partnership units

     —          —          (1,121     —         —         —         (1,121

Adjustment to redemption value of noncontrolling redeemable Operating Partnership Units

     —          —          —         620        —         —         620   

Net income attributable to common shareholders

     —          —          —         40,642       —         —         40,642  

Change in fair value of derivatives

     —          —          —         —         1,011       —         1,011  

Dividends

     —          —          —         (49,663     —         —         (49,663
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance December 31, 2010

     27,650,829      $ 288      $ 816,986      $ (148,264   $ (10,254   $ (27,175   $ 631,581  

Net proceeds from the issuance of common stock

     1,166,875        12        46,022       —         —         —         46,034  

Exercise of stock options

     28,050        —          728       —         —         —         728  

Issuance of non-vested stock

     106,602        1        616       —         —         —         617  

Earned portion of non-vested stock

     —          —          1,492       —         —         —         1,492  

Stock option expense

     —          —          302       —         —         —         302  

Deferred compensation outside directors

     —          —          239       —         —         —         239  

Carrying value less than redemption value on redeemed noncontrolling interest

     —          —          (3,918     —         —         —         (3,918

Adjustment to redemption value of noncontrolling redeemable Operating Partnership Units

     —          —          —         (2,227     —         —         (2,227

Net income attributable to common shareholders

     —          —          —         30,592       —         —         30,592  

Change in fair value of derivatives

     —          —          —         —         (1 )     —         (1 )

Dividends

     —          —          —         (49,900     —         —         (49,900
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance December 31, 2011

     28,952,356      $ 301      $ 862,467      $ (169,799   $ (10,255   $ (27,175   $ 655,539  

Net proceeds from the issuance of common stock

     1,400,931        14        75,192       —         —         —         75,206  

Exercise of stock options

     91,520        1        3,735       —         —         —         3,736  

Issuance of non-vested stock

     1,813        —          —         —         —         —         —    

Earned portion of non-vested stock

     —          —          2,392       —         —         —         2,392  

Stock option expense

     —          —          280       —         —         —         280  

Deferred compensation outside directors

     —          —          122       —         —         —         122  

Carrying value less than redemption value on redeemed noncontrolling interest

     —          —          (584     —         —         —         (584

Adjustment to redemption value of noncontrolling redeemable Operating Partnership Units

     —          —          —         (5,088     —         —         (5,088

Net income attributable to common shareholders

     —          —          —         55,128       —         —         55,128  

Change in fair value of derivatives

     —          —          —         —         (4,987 )     —         (4,987 )

Dividends

     —          —          —         (53,014     —         —         (53,014
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance December 31, 2012

     30,446,620      $ 316      $ 943,604      $ (172,773   $ (15,242   $ (27,175   $ 728,730  
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements

 

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SOVRAN SELF STORAGE, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

 

     Year Ended December 31,  
(dollars in thousands)    2012     2011     2010  

Operating Activities

      

Net income

   $ 55,641     $ 31,529     $ 42,541  

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

      

Depreciation and amortization

     41,679       36,578       33,156  

Amortization of deferred financing fees

     836       1,184       1,030  

Gain on sale of storage facilities

     (4,498     —         (6,944

Gain on sale of real estate

     (687     (1,511     —    

Casualty loss

     —         126       —    

Impairment loss

     —         1,047       —    

Equity in (income) losses of joint ventures

     (936     340       (240

Distributions from unconsolidated joint venture

     2,184       944       494  

Non-vested stock earned

     2,513       1,492       1,307  

Stock option expense

     280       302       354  

Changes in assets and liabilities (excluding the effects of acquisitions):

      

Accounts receivable

     (451     (523     (21

Prepaid expenses

     (977     434       (72

Accounts payable and other liabilities

     4,240       7,988       2,257  

Deferred revenue

     (820     380       (191
  

 

 

   

 

 

   

 

 

 

Net cash provided by operating activities

     99,004       80,310       73,671  

Investing Activities

      

Acquisition of storage facilities

     (186,870     (150,444     (34,717

Improvements, equipment additions, and construction in progress

     (36,845     (28,064     (21,516

Net proceeds from the sale of storage facilities

     47,698       —         23,708  

Net proceeds from the sale of real estate

     3,298       2,019       —    

Casualty insurance proceeds received

     626       588       —    

Investment in unconsolidated joint venture

     (3,571     (13,571     —    

Advances to joint ventures

     (242     (413     (80

Property deposits

     —         (407     —    
  

 

 

   

 

 

   

 

 

 

Net cash used in investing activities

     (175,906     (190,292     (32,605

Financing Activities

      

Net proceeds from sale of common stock

     78,943       47,001       842  

Proceeds from line of credit

     154,000       198,000       32,000  

Proceeds from term notes

     —         325,000       —    

Repayment of line of credit

     (95,000     (162,000     (22,000

Repayment of term notes

     —         (150,000     —    

Financing costs

     —         (4,146     —    

Dividends paid - common stock

     (53,014     (49,900     (49,663

Distributions to noncontrolling interest holders

     (549     (1,177     (2,030

Redemption of operating partnership units

     (7,372     —         (2,894

Additional investment in Locke Sovran II LLC

     —         (14,199     —    

Mortgage principal payments

     (172     (77,042     (2,265
  

 

 

   

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     76,836       111,537       (46,010
  

 

 

   

 

 

   

 

 

 

Net (decrease) increase in cash

     (66 )     1,555       (4,944

Cash at beginning of period

     7,321       5,766       10,710  
  

 

 

   

 

 

   

 

 

 

Cash at end of period

   $ 7,255     $ 7,321     $ 5,766  
  

 

 

   

 

 

   

 

 

 

Supplemental cash flow information

      

Cash paid for interest, net of interest capitalized

   $ 32,402     $ 35,134     $ 30,698  

See notes to consolidated financial statements.

 

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SOVRAN SELF STORAGE, INC. - DECEMBER 31, 2012

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1. ORGANIZATION

Sovran Self Storage, Inc. (the “Company,” “We,” “Our,” or “Sovran”), a self-administered and self-managed real estate investment trust (a “REIT”), was formed on April 19, 1995 to own and operate self-storage facilities throughout the United States. On June 26, 1995, the Company commenced operations effective with the completion of its initial public offering. At December 31, 2012, we had an ownership interest in and/or managed 461 self-storage properties in 25 states under the name Uncle Bob’s Self Storage ®. Among our 461 self-storage properties are 25 properties that we manage for an unconsolidated joint venture (Sovran HHF Storage Holdings LLC) of which we are a 20% owner, 30 properties that we manage for an unconsolidated joint venture (Sovran HHF Storage Holdings II LLC) of which we are a 15% owner, one property that we manage for a consolidated joint venture (West Deptford JV LLC) of which we have a 20% common ownership interest and a preferred interest, and 15 properties that we manage and have no ownership interest. Approximately 40% of the Company’s revenue is derived from stores in the states of Texas and Florida.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation: All of the Company’s assets are owned by, and all its operations are conducted through, Sovran Acquisition Limited Partnership (the “Operating Partnership”). Sovran Holdings, Inc., a wholly-owned subsidiary of the Company (the “Subsidiary”), is the sole general partner of the Operating Partnership; the Company is a limited partner of the Operating Partnership, and through its ownership of the Subsidiary and its limited partnership interest controls the operations of the Operating Partnership, holding a 99.3% ownership interest therein as of December 31, 2012. The remaining ownership interests in the Operating Partnership (the “Units”) are held by certain former owners of assets acquired by the Operating Partnership subsequent to its formation.

We consolidate all wholly owned subsidiaries. Partially owned subsidiaries and joint ventures are consolidated when we control the entity. Our consolidated financial statements include the accounts of the Company, the Operating Partnership, Uncle Bob’s Management, LLC (the Company’s taxable REIT subsidiary), Locke Sovran I, LLC, Locke Sovran II, LLC and West Deptford JV LLC, a controlled joint venture. All intercompany transactions and balances have been eliminated. Investments in joint ventures that we do not control but for which we have significant influence over are accounted for using the equity method.

In May 2011, the Company acquired the remaining non-controlling interests in Locke Sovran II, LLC for $17.0 million. The Company has owned 100% of that entity since the date of this transaction. The purchase price in excess of the carrying value of the non-controlling interest in Locke Sovran II, LLC was $3.9 million and was recorded as a reduction of additional paid-in capital. In connection with this transaction, the noncontrolling interest holders settled an outstanding $2.8 million note receivable due to the Company, and the net cash paid by the Company to the noncontrolling interest holders was $14.2 million.

The following table sets forth the activity in the noncontrolling interest – consolidated joint venture:

 

(Dollars in thousands)

   2011  

Beginning balance noncontrolling interests – consolidated joint venture

   $ 13,082  

Net income attributable to noncontrolling interests – consolidated joint venture

     567  

Distributions

     (567

Additional investment in Locke Sovran II, LLC

     (13,082
  

 

 

 

Ending balance noncontrolling interests – consolidated joint venture

   $ —    
  

 

 

 

On June 30, 2011, the Company entered into a newly formed joint venture agreement with an owner of a self-storage facility in New Jersey (West Deptford JV LLC). As part of the agreement the Company contributed $4.2 million to the joint venture for a $2.8 million mortgage note at 8%, a 20% common interest, and a $1.4 million

 

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preferred interest with an 8% preferred return. Pursuant to the terms of the joint venture operating agreement, upon a liquidation of the joint venture the Company has the right to receive a return of its investment prior to any distributions to the common members. The Company also has the right to redeem its preferred interests in the joint venture upon a written election any time on or after June 30, 2016. The Company has concluded that this joint venture is a variable interest entity pursuant to the guidance in FASB ASC Topic 810, “Consolidation” on the basis that the total equity investment in the joint venture is not sufficient to permit the joint venture to finance its activities without additional subordinated financial support from its investors. The Company has determined that it is the primary beneficiary of the joint venture as it has the power to direct the activities of the joint venture that most significantly impact the joint venture’s economic performance. The Company also has the right to receive a significant amount of the benefits of the joint venture by virtue of its preferred interest and liquidation preferences. As a result of the above, the assets, liabilities and results of operations of West Deptford JV LLC since June 30, 2011 are included in the Company’s consolidated financial statements. Pursuant to the terms of the West Deptford JV LLC operating agreement, neither party to the joint venture is obligated to make additional capital contributions to the joint venture and shall not be held personally liable for any obligations of the joint venture. Should the joint venture be unable to meet its obligations as they come due or there be any other events or circumstances that have a significant adverse effect on West Deptford JV LLC, the Company could be exposed to losses on its investment in the joint venture and the Company could determine that it is necessary to make additional capital contributions to West Deptford JV LLC. At December 31, 2012 and 2011, West Deptford JV LLC had total assets of $3.9 million and $4.1 million, respectively, and total liabilities of $2.9 million and $2.9 million, respectively. For the years ended December 31, 2012 and 2011, West Deptford JV LLC generated total operating revenues of $0.6 million and $0.9 million, respectively, and net losses of $136,000 and $3,000, respectively.

Included in the consolidated balance sheets are noncontrolling redeemable operating partnership units. These interests are presented in the “mezzanine” section of the consolidated balance sheet because they do not meet the functional definition of a liability or equity under current accounting literature. These represent the outside ownership interests of the limited partners in the Operating Partnership. At December 31, 2012, there were 204,028 noncontrolling redeemable operating partnership Units outstanding (339,025 at December 31, 2011). The Operating Partnership is obligated to redeem each of these limited partnership Units in the Operating Partnership at the request of the holder thereof for cash equal to the fair market value of a share of the Company’s common stock, at the time of such redemption, provided that the Company at its option may elect to acquire any such Unit presented for redemption for one common share or cash. The Company accounts for these noncontrolling redeemable Operating Partnership Units under the provisions of EITF D-98, “Classification and Measurement of Redeemable Securities” which are included in FASB ASC Topic 480-10-S99. The application of the FASB ASC Topic 480-10-S99 accounting model requires the noncontrolling interest to follow normal noncontrolling interest accounting and then be marked to redemption value at the end of each reporting period if higher (but never adjusted below that normal noncontrolling interest accounting amount). The offset to the adjustment to the carrying amount of the noncontrolling redeemable Operating Partnership Units is reflected in dividends in excess of net income. Accordingly, in the accompanying consolidated balance sheet, noncontrolling redeemable Operating Partnership Units are reflected at redemption value at December 31, 2012 and 2011, equal to the number of Units outstanding multiplied by the fair market value of the Company’s common stock at that date. Redemption value exceeded the value determined under the Company’s historical basis of accounting at those dates.

 

(Dollars in thousands)

   2012     2011  

Beginning balance noncontrolling redeemable Operating Partnership Units

   $ 14,466     $ 12,480  

Redemption of Operating Partnership Units

     (7,432     —      

Redemption value in excess of carrying value

     584        —      

Net income attributable to noncontrolling interests – consolidated joint venture

     513       370  

Distributions

     (549     (611

Adjustment to redemption value

     5,088       2,227  
  

 

 

   

 

 

 

Ending balance noncontrolling redeemable Operating Partnership Units

   $ 12,670     $ 14,466  
  

 

 

   

 

 

 

Cash and Cash Equivalents: The Company considers all highly liquid investments purchased with maturities of three months or less to be cash equivalents. Cash and cash equivalents include $33,000 and $29,000

 

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held in escrow for encumbered properties at December 31, 2012 and 2011, respectively.

Accounts Receivable: Accounts receivable are composed of trade and other receivables recorded at billed amounts and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable uncollectible amounts in the Company’s existing accounts receivable. The Company determines the allowance based on a number of factors, including experience, credit worthiness of customers, and current market and economic conditions. The Company reviews the allowance for doubtful accounts on a regular basis. Account balances are charged against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. The allowance for doubtful accounts is recorded as a reduction of accounts receivable and amounted to $0.4 million, $0.5 million and $0.2 million at December 31, 2012, 2011 and 2010, respectively.

Revenue and Expense Recognition: Rental income is recognized when earned pursuant to month-to-month leases for storage space. Promotional discounts are recognized as a reduction to rental income over the promotional period, which is generally during the first month of occupancy. Rental income received prior to the start of the rental period is included in deferred revenue. Equity in earnings of real estate joint ventures that we have significant influence over is recognized based on our ownership interest in the earnings of these entities.

Cost of operations, general and administrative expense, interest expense and advertising costs are expensed as incurred. For the years ended December 31, 2012, 2011, and 2010, advertising costs were $4.6 million, $3.2 million, and $2.3 million, respectively. The Company accrues property taxes based on estimates and historical trends. If these estimates are incorrect, the timing and amount of expense recognition would be affected.

Other Operating Income: Consists primarily of sales of storage-related merchandise (locks and packing supplies), insurance commissions, incidental truck rentals, and management and acquisition fees from unconsolidated joint ventures.

Investment in Storage Facilities: Storage facilities are recorded at cost. The purchase price of acquired facilities is allocated to land, land improvements, building, equipment, and in-place customer leases based on the fair value of each component. The fair values of land are determined based upon comparable market sales information. The fair values of buildings are determined based upon estimates of current replacement costs adjusted for depreciation on the properties. For the years ended December 31, 2012, 2011, and 2010, $4.3 million, $3.3 million and $0.8 million of acquisition related costs were incurred and expensed, respectively.

Depreciation is computed using the straight-line method over estimated useful lives of forty years for buildings and improvements, and five to twenty years for furniture, fixtures and equipment. Expenditures for significant renovations or improvements that extend the useful life of assets are capitalized. Interest and other costs incurred during the construction period of major expansions are capitalized. Capitalized interest during the years ended December 31, 2012, 2011, and 2010 was $0.1 million, $0.1 million and $0.1 million, respectively. Repair and maintenance costs are expensed as incurred.

Whenever events or changes in circumstances indicate that the basis of the Company’s property may not be recoverable, the Company’s policy is to assess any impairment of value. Impairment is evaluated based upon comparing the sum of the expected undiscounted future cash flows to the carrying value of the property, on a property by property basis. If the sum of the undiscounted cash flow is less than the carrying amount, an impairment loss is recognized for the amount by which the carrying amount of the asset exceeds the fair value of the asset. At December 31, 2012, no assets had been determined to be impaired under this policy. At December 31, 2011, the Company determined that a building was impaired due to a structural deficiency. The Company recorded an impairment charge of $1.0 million in 2011 related to the write-off of the building value.

Other Assets: Included in other assets are net loan acquisition costs, property deposits, and the value placed on in-place customer leases at the time of acquisition. The loan acquisition costs were $5.9 million at December 31, 2012, and 2011, respectively. Accumulated amortization on the loan acquisition costs was approximately $2.3 million and $1.5 million at December 31, 2012, and 2011, respectively. Loan acquisition costs are amortized over

 

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the terms of the related debt. Property deposits at December 31, 2012 and 2011 were $0.2 million and $0.4 million, respectively.

The Company allocates a portion of the purchase price of acquisitions to in-place customer leases. The methodology used to determine the fair value of in-place customer leases is disclosed in Note 9. The Company amortizes in-place customer leases on a straight-line basis over 12 months (the estimated future benefit period).

Amortization expense related to financing fees was $0.8 million, $1.2 million and $1.0 million for the periods ended December 31, 2012, 2011 and 2010, respectively.

Investment in Unconsolidated Joint Ventures: The Company’s investment in unconsolidated joint ventures, where the Company has significant influence, but not control and joint ventures which are VIEs in which the Company is not the primary beneficiary, are recorded under the equity method of accounting in the accompanying consolidated financial statements. Under the equity method, the Company’s investment in unconsolidated joint ventures is stated at cost and adjusted for the Company’s share of net earnings or losses and reduced by distributions. Equity in earnings of unconsolidated joint ventures is generally recognized based on the Company’s ownership interest in the earnings of each of the unconsolidated joint ventures. For the purposes of presentation in the statement of cash flows, the Company follows the “look through” approach for classification of distributions from joint ventures. Under this approach, distributions are reported under operating cash flow unless the facts and circumstances of a specific distribution clearly indicate that it is a return of capital (e.g., a liquidating dividend or distribution of the proceeds from the joint venture’s sale of assets), in which case it is reported as an investing activity.

Accounts Payable and Accrued Liabilities: Accounts payable and accrued liabilities consists primarily of trade payables, accrued interest, and property tax accruals. The Company accrues property tax expense based on estimates and historical trends. Actual expense could differ from these estimates.

Income Taxes: The Company qualifies as a REIT under the Internal Revenue Code of 1986, as amended, and will generally not be subject to corporate income taxes to the extent it distributes at least 90% of its taxable income to its shareholders and complies with certain other requirements.

The Company has elected to treat one of its subsidiaries as a taxable REIT subsidiary. In general, the Company’s taxable REIT subsidiary may perform additional services for tenants and generally may engage in certain real estate or non-real estate related business. A taxable REIT subsidiary is subject to corporate federal and state income taxes. Deferred tax assets and liabilities are determined based on differences between financial reporting and tax bases of assets and liabilities.

For the years ended December 31, 2012, 2011 and 2010, the Company recorded federal and state income tax expense of $1.3 million, $1.5 million and $1.1 million, respectively. The 2012 income tax expense includes current expense of $0.3 million and deferred expense of $1.0 million. At December 31, 2012 and 2011, there were no material unrecognized tax benefits. Interest and penalties relating to uncertain tax positions will be recognized in income tax expense when incurred. As of December 31, 2012 and 2011, the Company had no interest or penalties related to uncertain tax provisions. Net income taxes payable and the deferred tax liability of our taxable REIT subsidiary are classified within accounts payable and accrued liabilities in the consolidated balance sheet. As of December 31, 2012, the Company’s taxable REIT subsidiary has current prepaid taxes of $0.4 million and a deferred tax liability of $1.0 million. As of December 31, 2011, the Company’s taxable REIT subsidiary had current taxes payable of $0.2 million and a deferred tax liability of $0.1 million.

Derivative Financial Instruments: The Company accounts for derivatives in accordance with ASC Topic 815 “Derivatives and Hedging”, which requires companies to carry all derivatives on the balance sheet at fair value. The Company determines the fair value of derivatives using an income approach. The accounting for changes in the fair value of a derivative instrument depends on whether it has been designated and qualifies as part of a hedging relationship and, if so, the reason for holding it. The Company’s use of derivative instruments is limited to cash flow hedges of certain interest rate risks.

 

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Recent Accounting Pronouncements: In May 2011 the FASB issued ASU No. 2011-04, Fair Value Measurements (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in US GAAP and International Financial Reporting Standards (“IFRS”) (“ASU 2011-04”). ASU 2011-04 represents the converged guidance of the FASB and the IASB (the “Boards”) on fair value measurements. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” The Boards have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with GAAP and IFRS. The amendments in this ASU are required to be applied prospectively, and are effective for interim and annual periods beginning after December 15, 2011. The Company adopted the provisions of ASU 2011-04 in 2012 and there was no significant impact on the Company’s consolidated financial statements.

Stock-Based Compensation: The Company accounts for stock-based compensation under the provisions of ASC Topic 718, “Compensation - Stock Compensation”. The Company recognizes compensation cost in its financial statements for all share based payments granted, modified, or settled during the period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the related vesting period.

The Company recorded compensation expense (included in general and administrative expense) of $280,000, $302,000 and $354,000 related to stock options and $2.4 million, $1.5 million and $1.3 million related to amortization of non-vested stock grants for the years ended December 31, 2012, 2011 and 2010, respectively. The Company uses the Black-Scholes Merton option pricing model to estimate the fair value of stock options granted subsequent to the adoption of ASC Topic 718. The application of this pricing model involves assumptions that are judgmental and sensitive in the determination of compensation expense. The weighted average for key assumptions used in determining the fair value of options granted during 2012 follows:

 

     Weighted Average  

Expected life (years)

     4.50   

Risk free interest rate

     0.74

Expected volatility

     42.00

Expected dividend yield

     3.80

Fair value

   $ 12.40   

The weighted-average fair value of options granted during the years ended December 31, 2011 and 2010, were $10.09 and $8.34, respectively.

To determine expected volatility, the Company uses historical volatility based on daily closing prices of its Common Stock over periods that correlate with the expected terms of the options granted. The risk-free rate is based on the United States Treasury yield curve at the time of grant for the expected life of the options granted. Expected dividends are based on the Company’s history and expectation of dividend payouts. The expected life of stock options is based on the midpoint between the vesting date and the end of the contractual term.

During 2011, the Company issued performance based non-vested stock to certain executives. The fair value for the performance based non-vested shares granted in 2011 was estimated at the time the shares were granted using a Monte Carlo pricing model applying the following assumptions:

 

Expected life (years)

     2.1   

Risk free interest rate

     0.28

Expected volatility

     30.75

Fair value

   $ 28.66   

The Monte Carlo pricing model was not used to value any other 2012, 2011 and 2010 non-vested shares granted as no market conditions were present in these awards. The value of these other non-vested shares was equal to the stock price on the date of grant.

 

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Reclassification: Certain amounts from the 2011 and 2010 financial statements have been reclassified as a result of the sale of 17 storage facilities in 2012 that have been reclassified as discontinued operations.

Use of Estimates: The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

3. EARNINGS PER SHARE

The Company reports earnings per share data in accordance ASC Topic 260, “Earnings Per Share.” Effective January 1, 2009, FASB ASC Topic 260 was updated for the issuance of FASB Staff Position (“FSP”) EITF 03-6-1, “Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities”, or FSP EITF 03-6-1, with transition guidance included in FASB ASC Topic 260-10-65-2. Under FSP EITF 03-6-1, unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents, whether paid or unpaid, are participating securities and shall be included in the computation of earnings-per-share pursuant to the two-class method. The Company has calculated its basic and diluted earnings per share using the two-class method. The following table sets forth the computation of basic and diluted earnings per common share utilizing the two-class method.

 

     Year Ended December 31,  

(Amounts in thousands, except per share data)

   2012      2011      2010  

Numerator:

        

Net income from continuing operations attributable to common shareholders

   $ 48,497      $ 27,202      $ 29,792  

Denominator:

        

Denominator for basic earnings per share - weighted average shares

     29,358        27,674        27,472  

Effect of Dilutive Securities:

Stock options and non-vested stock

     131        51        42  
  

 

 

    

 

 

    

 

 

 

Denominator for diluted earnings per share - adjusted weighted average shares and assumed conversion

     29,489        27,725        27,514  

Basic Earnings per Common Share from continuing operations attributable to common shareholders

   $ 1.65      $ 0.99      $ 1.08  

Basic Earnings per Common Share attributable to common shareholders

   $ 1.88      $ 1.11      $ 1.48  

Diluted Earnings per Common Share from continuing operations attributable to common shareholders

   $ 1.64      $ 0.98      $ 1.08  

Diluted Earnings per Common Share attributable to common shareholders

   $ 1.87      $ 1.10      $ 1.48  

Not included in the effect of dilutive securities above are 31,375 stock options and 121,711 unvested restricted shares for the year ended December 31, 2012; 305,468 stock options and 157,903 unvested restricted shares for the year ended December 31, 2011; and 320,318 stock options and 159,763 unvested restricted shares for the year ended December 31, 2010, because their effect would be antidilutive.

 

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4. INVESTMENT IN STORAGE FACILITIES

The following summarizes activity in storage facilities during the years ended December 31, 2012 and December 31, 2011.

 

(Dollars in thousands)

   2012     2011  

Cost:

    

Beginning balance

   $ 1,538,595     $ 1,362,932  

Acquisition of storage facilities

     185,431       151,572  

Improvements and equipment additions

     42,557       21,280  

Increase (decrease) in construction in progress

     (6,031     6,371  

Dispositions and impairments

     (4,598     (3,560
  

 

 

   

 

 

 

Ending balance

   $ 1,755,954     $ 1,538,595  
  

 

 

   

 

 

 

Accumulated Depreciation:

    

Beginning balance

   $ 292,722     $ 260,335  

Additions during the year

     37,575       33,597  

Dispositions and impairments

     (1,345     (1,210
  

 

 

   

 

 

 

Ending balance

   $ 328,952     $ 292,722  
  

 

 

   

 

 

 

The assets and liabilities of the acquired storage facilities, which primarily consist of tangible and intangible assets, are measured at fair value on the date of acquisition in accordance with the principles of FASB ASC Topic 820, “Fair Value Measurements and Disclosures.” During 2012 and 2011, the Company acquired 28 and 29 self-storage facilities, respectively, and the purchase price of the facilities was assigned as follows:

 

(dollars in thousands)

            Consideration paid      Acquisition Date Fair Value  

State

   Number of
Properties
     Date of
Acquisition
     Purchase
Price
     Cash Paid      Loan
Assumed
     Liabilities
(Assets)
Assumed
     Land      Building,
Equipment,
and
Improvements
     In-Place
Customers
Leases
     Closing
Costs
Expensed
 

2012

                             

Florida

     1         5/16/2012       $ 15,340       $ 15,163       $ —         $ 177       $ 2,960       $ 12,077       $ 303       $ 457   

Illinois

     2         6/6/2012         20,750         20,304         —           446         3,871         16,486         393         420   

Virginia

     1         6/20/2012         6,920         6,884         —           36         911         5,862         147         196   

Georgia

     1         7/18/2012         8,500         8,442         —           58         1,560         6,766         174         49   

Florida

     3         9/18/2012         15,957         15,749         —           208         2,176         13,461         320         328   

Georgia

     4         9/18/2012         26,883         26,856         —           27         4,438         22,110         335         487   

North Carolina

     1         9/19/2012         7,400         7,374         —           26         2,337         4,900         163         221   

Illinois

     1         9/27/2012         4,435         4,365         —           70         1,213         3,129         93         143   

Illinois

     1         12/10/2012         7,100         6,939         —           161         1,051         5,893         156         221   

Arizona

     1         12/18/2012         4,650         4,639         —           11         910         3,657         83         83   

Illinois

     4         12/20/2012         32,250         31,747         —           503         7,080         24,589         581         598   

Forida

     4         12/21/2012         21,407         21,278         —           129         4,805         16,052         550         607   

Texas

     3         12/27/2012         14,050         13,956         —           94         2,652         11,091         307         425   

Illnois

     1         12/31/2012         3,450         3,404         —           46         268         3,126         56         93   
  

 

 

       

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total 2012

     28          $ 189,092       $ 187,100       $ —         $ 1,992       $ 36,232       $ 149,199       $ 3,661       $ 4,328   
        

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

2011

                             

New Jersey

     1         6/30/2011       $ 4,154       $ 4,131       $ —         $ 23       $ 626       $ 3,419       $ 109       $ 23   

New Jersey

     2         7/14/2011         14,571         14,439         —           132         1,681         12,540         350         467   

Missouri

     1         7/28/2011         2,400         2,350         —           50         197         2,132         71         95   

Georgia

     1         8/17/2011         9,500         9,399         —           101         1,043         8,252         205         226   

Texas

     22         9/22/2011         110,950         106,703         2,511         1,736         25,660         82,804         2,486         2,051   

Virginia

     1         9/29/2011         8,925         8,851         —           74         2,848         5,892         185         252   

Florida

     1         11/15/2011         4,600         4,571         —           29         197         4,281         122         164   
  

 

 

       

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total 2011

     29          $ 155,100       $ 150,444       $ 2,511       $ 2,145       $ 32,252       $ 119,320       $ 3,528       $ 3,278   
        

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

All of the properties acquired in 2012 and 2011 were purchased from unrelated third parties. The operating results of the acquired facilities have been included in the Company’s operations since the respective acquisition dates.

The Company measures the fair value of in-place customer lease intangible assets based on the Company’s experience with customer turnover. The Company amortizes in-place customer leases on a straight-line basis over

 

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12 months (the estimated future benefit period). In-place customer leases are included in other assets on the Company’s balance sheet as follows:

 

(Dollars in thousands)

   2012     2011  

In-place customer leases

   $ 13,228     $ 9,542  

Accumulated amortization

     (10,337     (7,019
  

 

 

   

 

 

 

Net carrying value at December 31,

   $ 2,891     $ 2,523  
  

 

 

   

 

 

 

Amortization expense related to in-place customer leases was $3.3 million, $1.6 million, and $0 for the years ended December 31, 2012, 2011, and 2010, respectively. Amortization expense in 2013 is expected to be $2.9 million.

5. DISCONTINUED OPERATIONS

In July and August of 2012, the Company sold 17 non-strategic storage facilities in Maryland (1), Michigan (4), and Texas (12) for net proceeds of approximately $47.7 million resulting in a gain of approximately $4.5 million. During 2010, the Company sold ten non-strategic storage facilities in Georgia, Michigan, North Carolina and Virginia for net proceeds of approximately $23.7 million resulting in a gain of $6.9 million. The operations of these facilities and the loss or gain on sale are reported as discontinued operations. Cash flows of discontinued operations have not been segregated from the cash flows of continuing operations on the accompanying consolidated statement of cash flows for the years ended December 31, 2012, 2011 and 2010. The following is a summary of the amounts reported as discontinued operations:

 

     Year Ended December 31,  

(dollars in thousands)

   2012     2011     2010  

Total revenue

   $ 5,143     $ 8,437     $ 9,774  

Property operations and maintenance expense

     (1,601 )     (2,532 )     (2,993 )

Real estate tax expense

     (560 )     (1,064 )     (1,121 )

Depreciation and amortization expense

     (787 )     (1,410 )     (1,610 )

Net realized gain (loss) on sale of property

     4,498       —         6,944  
  

 

 

   

 

 

   

 

 

 

Total income from discontinued operations

   $ 6,693     $ 3,431     $ 10,994  
  

 

 

   

 

 

   

 

 

 

Income from continuing operations attributable to common shareholders was $48.5 million, $27.2 million and $29.8 million in 2012, 2011 and 2010, respectively. Income from discontinued operations attributable to common shareholders was $6.6 million, $3.4 million and $10.9 million in 2012, 2011 and 2010, respectively.

6. UNSECURED LINE OF CREDIT AND TERM NOTES

On August 5, 2011, the Company entered into agreements relating to new unsecured credit arrangements, and received funds under those arrangements. As part of the agreements, the Company entered into a $125 million unsecured term note maturing August 3, 2018 bearing interest at LIBOR plus a margin based on the Company’s credit rating (at December 31, 2012 the margin is 2.0%). The agreements also provide for a $175 million (expandable to $250 million) revolving line of credit bearing interest at a variable rate equal to LIBOR plus a margin based on the Company’s credit rating (at December 31, 2012 the margin is 2.0%), and requires a 0.20% facility fee. The interest rate at December 31, 2012 on the Company’s available line of credit was approximately 2.21% (2.28% at December 31, 2011). At December 31, 2012, there was $70 million available on the unsecured line of credit without considering the additional availability under the expansion feature. The revolving line of credit has a maturity date of August 4, 2016, but can be extended for two one-year periods at the Company’s option with the payment of an extension fee equal to 0.125% of the total line of credit commitment.

In addition, on August 5, 2011, the Company secured an additional $100 million term note with a delayed draw feature that was used to fund the Company’s mortgage maturities in December 2011. The delayed draw term note matures August 3, 2018 and bears interest at LIBOR plus a margin based on the Company’s credit rating (at December 31, 2012 the margin is 2.0%).

 

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On August 5, 2011, the Company also entered into a $100 million term note maturing August 5, 2021 bearing interest at a fixed rate of 5.54%. The interest rate on the term note increases to 7.29% if the notes are not rated by at least one rating agency, the credit rating on the notes is downgraded or if the Company’s credit rating is downgraded. The proceeds from this term note were used to fund acquisitions and investments in unconsolidated joint ventures.

The Company also maintains an $80 million term note maturing September 4, 2013 bearing interest at a fixed rate of 6.26%, a $20 million term note maturing September 4, 2013 bearing interest at a variable rate equal to LIBOR plus 1.50%, and a $150 million unsecured term note maturing April 13, 2016 bearing interest at 6.38%. The interest rate on the $150 million unsecured term note increases to 8.13% if the notes are not rated by at least one rating agency, the credit rating on the notes is downgraded or the Company’s credit rating is downgraded.

The line of credit and term notes require the Company to meet certain financial covenants, measured on a quarterly basis, including prescribed leverage, fixed charge coverage, minimum net worth, limitations on additional indebtedness and limitations on dividend payouts. At December 31, 2012, the Company was in compliance with its debt covenants.

We believe that if operating results remain consistent with historical levels and levels of other debt and liabilities remain consistent with amounts outstanding at December 31, 2012 the entire availability on the line of credit could be drawn without violating our debt covenants.

The Company’s fixed rate term notes contain a provision that allows for the noteholders to call the debt upon a change of control of the Company at an amount that includes a make whole premium based on rates in effect on the date of the change of control.

7. MORTGAGES PAYABLE AND DEBT MATURITIES

Mortgages payable at December 31, 2012 and 2011 consist of the following:

 

(dollars in thousands)

   December 31,
2012
     December 31,
2011
 

6.76% mortgage note due September 11, 2013, secured by 1 self-storage facility with an aggregate net book value of $1.9 million, principal and interest paid monthly (effective interest rate 6.87%)

     896        925  

6.35% mortgage note due March 11, 2014, secured by 1 self-storage facility with an aggregate net book value of $3.5 million, principal and interest paid monthly (effective interest rate 6.45%)

     983        1,014  

5.99% mortgage notes due May 1, 2026, secured by 1 self-storage facility with an aggregate net book value of $4.3 million, principal and interest paid monthly (effective interest rate 6.17%)

     2,372        2,484  
  

 

 

    

 

 

 

Total mortgages payable

   $ 4,251      $ 4,423  
  

 

 

    

 

 

 

The table below summarizes the Company’s debt obligations and interest rate derivatives at December 31, 2012. The estimated fair value of financial instruments is subjective in nature and is dependent on a number of important assumptions, including discount rates and relevant comparable market information associated with each financial instrument. The fair value of the fixed rate term notes and mortgage notes were estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. These assumptions are considered Level 2 inputs within the fair value hierarchy as described in Note 9. The carrying values of our variable rate debt instruments approximate their

 

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fair values as these debt instruments bear interest at current market rates that approximate market participant rates. This is considered a Level 2 input within the fair value hierarchy. The use of different market assumptions and estimation methodologies may have a material effect on the reported estimated fair value amounts. Accordingly, the estimates presented below are not necessarily indicative of the amounts the Company would realize in a current market exchange.

 

     Expected Maturity Date Including Discount          

(dollars in thousands)

   2013      2014      2015      2016      2017      Thereafter      Total      Fair
Value
 

Line of credit - variable rate LIBOR + 2.0%
(2.21% at December 31, 2012)

     —          —          —        $ 105,000        —          —        $ 105,000       $ 105,000   

Notes Payable:

                    

Term note - variable rate LIBOR+1.50%
(2.21% at December 31, 2012)

   $ 20,000         —          —          —          —          —        $ 20,000       $ 20,000   

Term note - fixed rate 6.26%

   $ 80,000         —          —          —          —          —        $ 80,000       $ 82,422   

Term note - fixed rate 6.38%

     —          —          —        $ 150,000         —          —        $ 150,000       $ 162,265   

Term note - variable rate LIBOR+2.0%
(2.21% at December 31, 2012)

     —          —          —          —          —        $ 125,000       $ 125,000       $ 125,000   

Term note - variable rate LIBOR+2.0%
(2.21% at December 31, 2012)

     —          —          —          —          —        $ 100,000       $ 100,000       $ 100,000   

Term note - fixed rate 5.54%

     —          —          —          —          —        $ 100,000       $ 100,000       $ 96,972   

Mortgage note - fixed rate 6.76%

   $ 896         —          —          —          —          —        $ 896       $ 920   

Mortgage note - fixed rate 6.35%

   $ 34       $ 949         —          —          —          —        $ 983       $ 1,021   

Mortgage notes - fixed rate 5.99%

   $ 119       $ 126       $ 134      $ 142      $ 151      $ 1,700       $ 2,372       $ 2,549   

Interest rate derivatives - liability

     —          —          —          —          —          —          —        $ 15,707   

8. DERIVATIVE FINANCIAL INSTRUMENTS

Interest rate swaps are used to adjust the proportion of total debt that is subject to variable interest rates. The interest rate swaps require the Company to pay an amount equal to a specific fixed rate of interest times a notional principal amount and to receive in return an amount equal to a variable rate of interest times the same notional amount. The notional amounts are not exchanged. No other cash payments are made unless the contract is terminated prior to its maturity, in which case the contract would likely be settled for an amount equal to its fair value. The Company enters interest rate swaps with a number of major financial institutions to minimize counterparty credit risk.

The interest rate swaps qualify and are designated as hedges of the amount of future cash flows related to interest payments on variable rate debt. Therefore, the interest rate swaps are recorded in the consolidated balance sheet at fair value and the related gains or losses are deferred in shareholders’ equity as Accumulated Other Comprehensive Loss (“AOCL”). These deferred gains and losses are recognized in interest expense during the period or periods in which the related interest payments affect earnings. However, to the extent that the interest rate swaps are not perfectly effective in offsetting the change in value of the interest payments being hedged, the ineffective portion of these contracts is recognized in earnings immediately. Ineffectiveness was deminimus in 2012, 2011, and 2010.

The Company has six interest rate swap agreements in effect at December 31, 2012 as detailed below to effectively convert a total of $245 million of variable-rate debt to fixed-rate debt.

 

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Notional Amount

   Effective Date      Expiration Date      Fixed
Rate Paid
    Floating Rate
Received
 

$20 Million

     9/4/05         9/4/13         4.4350     6 month LIBOR   

$75 Million

     9/1/2011         8/1/18         2.3700     1 month LIBOR   

$50 Million

     9/1/2011         8/1/18         2.3700     1 month LIBOR   

$50 Million

     12/30/11         12/29/17         1.6125     1 month LIBOR   

$25 Million

     12/30/11         12/29/17         1.6125     1 month LIBOR   

$25 Million

     12/30/11         12/29/17         1.6125     1 month LIBOR   

The interest rate swap agreements are the only derivative instruments, as defined by FASB ASC Topic 815 “Derivatives and Hedging”, held by the Company. During 2012, 2011, and 2010, the net reclassification from AOCL to interest expense was $4.9 million, $10.5 million and $6.9 million, respectively, based on payments made under the swap agreements. Based on current interest rates, the Company estimates that payments under the interest rate swaps will be approximately $4.9 million in 2013. Payments made under the interest rate swap agreements will be reclassified to interest expense as settlements occur. The fair value of the swap agreements, including accrued interest, was a liability of $15.7 million and $10.7 million at December 31, 2012, and 2011 respectively.

 

(dollars in thousands)

   Jan. 1, 2012
to
Dec. 31, 2012
    Jan. 1, 2011
to
Dec. 31, 2011
    Jan. 1, 2010
to
Dec. 31, 2010
 

Adjustments to interest expense:

      

Realized loss reclassified from accumulated other comprehensive loss to interest expense

   $ (4,889   $ (10,516   $ (6,900
  

 

 

   

 

 

   

 

 

 

Adjustments to other comprehensive income (loss):

      

Realized loss reclassified to interest expense

     4,889       10,516       6,900  

Unrealized (loss) gain from changes in the fair value of the effective portion of the interest rate swaps

     (9,876     (10,517     (5,889
  

 

 

   

 

 

   

 

 

 

(Loss) Gain included in other comprehensive income (loss)

   $ (4,987   $ (1   $ 1,011   
  

 

 

   

 

 

   

 

 

 

In August 2011, the Company repaid $150 million in variable rate term notes. In August 2011, the Company also terminated two interest rate swap agreements that were designated as hedges of forecasted interest payments on variable rate debt. Realized losses recognized in interest expense in 2011 include $5.5 million in costs to terminate the interest rate swaps. The cost approximated the fair market values of the swaps at the dates of termination. No interest rate swap terminations occurred in 2012 or 2010.

9. FAIR VALUE MEASUREMENTS

The Company applies the provisions of ASC Topic 820 “Fair Value Measurements and Disclosures” in determining the fair value of its financial and nonfinancial assets and liabilities. ASC Topic 820 establishes a valuation hierarchy for disclosure of the inputs to valuation used to measure fair value. This hierarchy prioritizes the inputs into three broad levels as follows. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or liabilities. Level 2 inputs are quoted prices for similar assets and liabilities in active markets or inputs that are observable for the asset or liability, either directly or indirectly through market corroboration. Level 3 inputs are unobservable inputs based on our own assumptions used to measure assets and liabilities at fair value. A financial asset or liability’s classification within the hierarchy is determined based on the lowest level input that is significant to the fair value measurement.

In May 2011 the FASB issued ASU No. 2011-04, Fair Value Measurements (Topic 820): Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in US GAAP and International Financial Reporting Standards (“IFRS”) (“ASU 2011-04”). ASU 2011-04 represents the converged guidance of the FASB and the IASB (the “Boards”) on fair value measurements. The collective efforts of the Boards and their staffs, reflected in ASU 2011-04, have resulted in common requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “fair value.” The Boards

 

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have concluded the common requirements will result in greater comparability of fair value measurements presented and disclosed in financial statements prepared in accordance with GAAP and IFRS. The amendments in this ASU are required to be applied prospectively, and are effective for interim and annual periods beginning after December 15, 2011. The Company adopted the provisions of ASU 2011-04 on January 1, 2012 and its adoption did not have a significant impact on the Company’s current fair value measurements or disclosures. The adoption is not expected to have a significant effect on any future fair value measurements or disclosures.

Refer to Note 7 for presentation of the fair values of debt obligations which are disclosed at fair value on a recurring basis.

The following table provides the assets and liabilities carried at fair value measured on a recurring basis as of December 31, 2012 (in thousands):

 

     Asset
(Liability)
    Level 1      Level 2     Level 3  

Interest rate swaps

     (15,707     —          (15,707     —    

Interest rate swaps are over the counter securities with no quoted readily available Level 1 inputs, and therefore are measured at fair value using inputs that are directly observable in active markets and are classified within Level 2 of the valuation hierarchy, using the income approach.

During 2012, assets and liabilities measured at fair value on a non-recurring basis included the assets acquired and liabilities assumed in connection with the acquisition of 28 storage facilities (see note 4). To determine the fair value of land, the Company used prices per acre derived from observed transactions involving comparable land in similar locations, which is considered a Level 2 input. To determine the fair value of buildings, equipment and improvements, the Company used current replacement cost based on information derived from construction industry data by geographic region as adjusted for the age, condition, and economic obsolescence associated with these assets, which are considered Level 2 and 3 inputs. The fair value of in-place customer leases is based on the rent lost due to the amount of time required to replace existing customers which is based on the Company’s historical experience with turnover in its facilities, which is a Level 3 input. Other assets acquired and liabilities assumed in the acquisitions consist primarily of prepaid or accrued real estate taxes and deferred revenues from advance monthly rentals paid by customers. The fair values of these assets and liabilities are based on their carrying values as they typically turn over within one year from the acquisition date and these are Level 3 inputs.

During 2011, the Company measured a storage facility at fair value as a result of the determination that the structure of a building was deficient and would need to be demolished. The fair value of the facility was determined by assessing the future discounted cash flows of the facility, which is considered a level 3 input. An impairment charge of $1.0 million was recorded in 2011 as a result of the write-down of the facility to fair value. No such impairment charge was recorded in 2012.

10. STOCK BASED COMPENSATION

The Company established the 2005 Award and Option Plan (the “Plan”) which replaced the expired 1995 Award and Option Plan for the purpose of attracting and retaining the Company’s executive officers and other key employees. 1,500,000 shares were authorized for issuance under the Plan. Options granted under the Plan vest ratably over four and eight years, and must be exercised within ten years from the date of grant. The exercise price for qualified incentive stock options must be at least equal to the fair market value of the common shares at the date of grant. As of December 31, 2012, options for 242,413 shares were outstanding under the Plans and options for 817,436 shares of common stock were available for future issuance. The Company may also grant other stock-based awards under the Plan, including restricted stock and performance-based vesting restricted stock awards.

The Company also established the 2009 Outside Directors’ Stock Option and Award Plan (the “Non-employee Plan”) which replaced the 1995 Outside Directors’ Stock Option Plan for the purpose of attracting and

 

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retaining the services of experienced and knowledgeable outside directors. The Non-employee Plan provides for the initial granting of options to purchase 3,500 shares of common stock and for the annual granting of options to purchase 2,000 shares of common stock to each eligible director. Such options vest over a one-year period for initial awards and immediately upon subsequent grants. In addition, each outside director receives non-vested shares annually equal to 80% of the annual fees paid to them. During the restriction period, the non-vested shares may not be sold, transferred, or otherwise encumbered. The holder of the non-vested shares has all rights of a holder of common shares, including the right to vote and receive dividends. During 2012, 2,592 non-vested shares were issued to outside directors. Such non-vested shares vest over a one-year period. The total shares reserved under the Non-employee Plan is 150,000. The exercise price for options granted under the Non-employee Plan is equal to the fair market value at the date of grant. As of December 31, 2012, options for 30,835 common shares and 19,334 of non-vested shares were outstanding under the Non-employee Plans. As of December 31, 2012 options for 104,371 shares of common stock were available for future issuance.

A summary of the Company’s stock option activity and related information for the years ended December 31 follows:

 

     2012      2011      2010  
      Options     Weighted
average
exercise
price
     Options     Weighted
average
exercise
price
     Options     Weighted
average
exercise
price
 

Outstanding at beginning of year:

     364,268     $ 42.76        387,318     $ 41.72        397,468     $ 40.78  

Granted

     9,500       49.42        20,000       40.47        20,000       35.49  

Exercised

     (91,520     40.82        (28,050     25.96        (25,650     23.18  

Forfeited

     (9,000     39.23        (15,000     44.29        (4,500     36.86  
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Outstanding at end of year

     273,248     $ 43.45        364,268     $ 42.76        387,318     $ 41.72  

Exercisable at end of year

     165,667     $ 44.56        220,293     $ 44.25        197,447     $ 42.89  

A summary of the Company’s stock options outstanding at December 31, 2012 follows:

 

     Outstanding      Exercisable  

Exercise Price Range

   Options      Weighted
average
exercise
price
     Options      Weighted
average
exercise
price
 

$20.28 – 29.99

     18,500      $ 23.09        11,000      $ 23.02  

$30.00 – 39.99

     10,750      $ 35.51        4,750      $ 35.65  

$40.00 – 57.79

     243,998      $ 45.34        149,917      $ 46.43  
  

 

 

    

 

 

    

 

 

    

 

 

 

Total

     273,248      $ 43.45        165,667      $ 44.56  

 

Intrinsic value of outstanding stock options at December 31, 2012

   $  5,097,044  

Intrinsic value of exercisable stock options at December 31, 2012

   $ 2,905,357  

The intrinsic value of stock options exercised during the years ended December 31, 2012, 2011, and 2010, were $1,124,748, $396,532, and $382,576 respectively.

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying

 

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awards and the quoted price of the Company’s common stock at December 31, 2012, or the price on the date of exercise for those exercised during the year. As of December 31, 2012, there was approximately $0.5 million of total unrecognized compensation cost related to stock option compensation arrangements granted under our stock award plans. That cost is expected to be recognized over a weighted-average period of approximately 3.1 years. The weighted average remaining contractual life of all options is 5.6 years, and for exercisable options is 5.3 years.

Non-vested stock

The Company has also issued 535,299 shares of non-vested stock to employees which vest over one to nine year periods. During the restriction period, the non-vested shares may not be sold, transferred, or otherwise encumbered. The holder of the non-vested shares has all rights of a holder of common shares, including the right to vote and receive dividends. For issuances of non-vested stock during the year ended December 31, 2012, the fair market value of the non-vested stock on the date of grant was $49.42. During 2012, 2,592 shares of non-vested stock were issued to employees and directors with an aggregate fair value of $128,097. The Company charges additional paid-in capital for the market value of shares as they are issued. The unearned portion is then amortized and charged to expense over the vesting period. The Company uses the average of the high and low price of its common stock on the date the award is granted as the fair value for non-vested stock awards.

A summary of the status of unvested shares of stock issued to employees and directors as of and during the years ended December 31 follows:

 

     2012      2011      2010  
     
Non-
vested
Shares
    Weighted
average

grant date
fair value
    
Non-
vested
Shares
    Weighted
average

grant date
fair  value
    
Non-

vested
Shares
    Weighted
average

grant date
fair  value
 

Unvested at beginning of year:

     246,634     $ 37.93        192,776     $ 39.34        154,593     $ 39.79  

Granted

     2,592       49.42        106,602       35.02        78,152       37.03  

Vested

     (60,912     40.13        (52,744     37.19        (39,969     36.55  

Forfeited

     (779     41.07               —           —          —     
  

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Unvested at end of year

     187,535     $ 37.36        246,634     $ 37.93        192,776     $ 39.34  

Compensation expense of $2.4 million, $1.5 million and $1.3 million was recognized for the vested portion of non-vested stock grants in 2012, 2011 and 2010, respectively. The fair value of non-vested stock that vested during 2012, 2011 and 2010 was $2.4 million, $2.0 million and $1.5 million, respectively. The total unrecognized compensation cost related to non-vested stock was $5.5 million at December 31, 2012, and the remaining weighted-average period over which this expense will be recognized was 3.4 years.

Performance-based vesting restricted stock

The Company granted a total of 42,040 performance shares under the Plan during 2011 which are included above. Performance shares granted are based upon the Company’s performance over a three year period depending on the Company’s total shareholder return relative to a group of peer companies. Performance based nonvested shares are recognized as compensation expense based on fair value on date of grant, the number of shares ultimately expected to vest and the vesting period. For accounting purposes, the performance shares are considered to have a market condition. The effect of the market condition is reflected in the grant date fair value of the award and, thus compensation expense is recognized on this type of award provided that the requisite service is rendered (regardless of whether the market condition is achieved). The Company estimated the fair value of each performance share granted under the Plan on the date of grant using a Monte Carlo simulation that uses the assumptions noted in Note 2.

 

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During 2012, compensation expense of $0.6 million was recognized for the performance shares granted in 2011. The total unrecognized compensation cost related to non-vested performance shares was $0.6 million at December 31, 2012 and the weighted-average period over which this expense will be recognized is 1 year.

Deferred compensation plan for directors

Under the Deferred Compensation Plan for Directors, non-employee Directors may defer all or part of their Directors’ fees that are otherwise payable in cash. Directors’ fees that are deferred under this plan are credited to each Directors’ account under the plan in the form of Units. The number of Units credited is determined by dividing the amount of Directors’ fees deferred by the closing price of the Company’s Common Stock on the New York Stock Exchange on the day immediately preceding the day upon which Directors’ fees otherwise would be paid by the Company. A Director is credited with additional Units for dividends on the shares of Common Stock represented by Units in such Directors’ Account. A Director may elect to receive the shares in a lump sum on a date specified by the Director or in quarterly or annual installments over a specified period and commencing on a specified date. The Directors may not elect to receive cash in lieu of shares. Under this plan there were a total of 39,394 units outstanding at December 31, 2012. Fees that were earned and credited to Directors’ accounts are recorded as compensation expense which totaled $0.1 million, $0.2 million and $0.2 million in 2012, 2011 and 2010, respectively.

11. RETIREMENT PLAN

Employees of the Company qualifying under certain age and service requirements are eligible to be a participant in a 401(k) Plan. The Company contributes to the Plan at the rate of 10% of the first 4% of gross wages that the employee contributes. Total expense to the Company was approximately $69,000, $72,000, and $70,000 for the years ended December 31, 2012, 2011 and 2010, respectively.

12. INVESTMENT IN JOINT VENTURES

The Company has a 20% ownership interest in Sovran HHF Storage Holdings LLC (“Sovran HHF”), a joint venture that was formed in May 2008 to acquire self-storage properties that are managed by the Company. The carrying value of the Company’s investment at December 31, 2012 was $21.1 million. Twenty-five properties were acquired by Sovran HHF in 2008 for approximately $171.5 million and no additional properties have been acquired by Sovran HHF since then. In 2008, the Company contributed $18.6 million to the joint venture as its share of capital required to fund the acquisitions. In 2012 and 2011 the Company contributed an additional $1.2 million and $0.8 million, respectively, to the joint venture. As of December 31, 2012, the carrying value of the Company’s investment in Sovran HHF exceeds its share of the underlying equity in net assets of Sovran HHF by approximately $1.7 million as a result of the capitalization of certain acquisition related costs in 2008. This difference is included in the carrying value of the investment, which is assessed for other-than-temporary impairment on a periodic basis. No other-than-temporary impairments have been recorded on this investment.

The Company has a 15% ownership interest in Sovran HHF Storage Holdings II LLC (“Sovran HHF II”), a joint venture that was formed in 2011 to acquire self-storage properties that are managed by the Company. The carrying value of the Company’s investment at December 31, 2012 was $13.2 million. Twenty properties were acquired by Sovran HHF II during 2011 for approximately $166.1 million. During 2011, the Company contributed $12.8 million to the joint venture as its share of capital required to fund the acquisitions. Ten additional properties were acquired by Sovran HHF II during 2012 for approximately $29 million. During 2012, the Company contributed $2.4 million to the joint venture as its share of capital required to fund the acquisitions. The carrying value of this investment is assessed for other-than-temporary impairment on a periodic basis and no such impairments have been recorded on this investment.

As manager of Sovran HHF and Sovran HHF II, the Company earns a management and call center fee of 7% of gross revenues which totaled $3.0 million, $1.9 million, and $1.3 million for 2012, 2011, and 2010, respectively. The Company also received an acquisition fee of $0.1 million and $0.7 million, for securing purchases

 

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for Sovran HHF II in 2012 and 2011, respectively. The Company’s share of Sovran HHF and Sovran HHF II’s income (loss) for 2012, 2011 and 2010 was $0.9 million, ($0.4 million), and $0.3 million, respectively.

The Company also has a 49% ownership interest in Iskalo Office Holdings, LLC, which owns the building that houses the Company’s headquarters and other tenants. The Company’s investment includes a capital contribution of $196,049. The carrying value of the Company’s investment is a liability of $0.5 million at December 31, 2012 and 2011, and is included in accounts payable and accrued liabilities in the accompanying consolidated balance sheets. For the years ended December 31, 2012, 2011, and 2010, the Company’s share of Iskalo Office Holdings, LLC’s loss was ($18,000), ($82,000), and ($79,000), respectively. The Company paid rent to Iskalo Office Holdings, LLC of $704,000, $688,000 and $644,000 in 2012, 2011, and 2010, respectively. Future minimum lease payments under the lease are $0.7 million per year through 2015.

A summary of the unconsolidated joint ventures’ financial statements as of and for the year ended December 31, 2012 is as follows:

 

(dollars in thousands)

   Sovran HHF
Storage
Holdings LLC
    Sovran HHF
Storage
Holdings II LLC
    Iskalo Office
Holdings, LLC
 

Balance Sheet Data: