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, 2017

Commission File Number:

1-13820 (Life Storage, Inc.)

0-24071 (Life Storage LP)

 

LIFE STORAGE, INC.

LIFE STORAGE LP

(Exact name of Registrant as specified in its charter)

 

 

Maryland (Life Storage, Inc.)

Delaware (Life Storage LP)

 

16-1194043 (Life Storage, Inc.)

16-1481551 (Life Storage LP)

(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.

 

Life Storage, Inc.

  

Yes      No  

Life Storage LP

  

Yes      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.

 

Life Storage, Inc.

  

Yes      No  

Life Storage LP

  

Yes      No  

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.

 

Life Storage, Inc.

  

Yes      No  

Life Storage LP

  

Yes      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).

 

Life Storage, Inc.

  

Yes      No  

Life Storage LP

  

Yes      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.

 

Life Storage, Inc.

  

Life Storage LP

  

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

 

Life Storage, Inc.:

Large accelerated filer

 

  

Accelerated filer

 

Non-accelerated filer

 

  (Do not check if a small reporting company)

  

Smaller reporting company

 

Emerging growth company

 

Life Storage LP:

Large accelerated filer

 

  

Accelerated filer

 

Non-accelerated filer

 

  (Do not check if a small reporting company)

  

Smaller reporting company

 

Emerging growth company

 

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Life Storage, Inc.

  

Yes      No  

Life Storage LP

  

Yes      No  

As of June 30, 2017, 46,565,213 shares of Life Storage, Inc.’s Common Stock, $.01 par value per share, were outstanding, and the aggregate market value of the Common Stock held by non-affiliates of Life Storage, Inc. was approximately $3,450,482,283 (based on the closing price of the Common Stock on the New York Stock Exchange on June 30, 2017). As of February 12, 2018, 46,515,831 shares of Common Stock, $.01 par value per share, were outstanding.

As of June 30, 2017, the aggregate market value of the 217,481 units of limited partnership (the “OP Units”) held by non-affiliates of Life Storage LP was $16,115,342 (based on the closing price of the Common Stock of Life Storage, Inc. on the New York Stock Exchange on June 30, 2017). (For this calculation, the market value of all OP Units beneficially owned by Life Storage, Inc. has been excluded.)

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s Proxy Statement for the 2018 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 registrants’ fiscal year ended December 31, 2017.

 

 

 

 


 

EXPLANATORY NOTE

This report combines the annual reports on Form 10-K for the year ended December 31, 2017 of Life Storage, Inc. (the “Parent Company”) and Life Storage LP (the “Operating Partnership”). The Parent Company is a real estate investment trust, or REIT, that owns its assets and conducts its operations through the Operating Partnership, a Delaware limited partnership, and subsidiaries of the Operating Partnership.  The Parent Company, the Operating Partnership and their consolidated subsidiaries are collectively referred to in this report as the “Company.” In addition, terms such as “we,” “us,” or “our” used in this report may refer to the Company, the Parent Company and/or the Operating Partnership.

Life Storage Holdings, Inc., a wholly-owned subsidiary of the Parent Company (“Holdings”), is the sole general partner of the Operating Partnership; the Parent Company is a limited partner of the Operating Partnership, and through its ownership of Holdings and its limited partnership interest, controls the operations of the Operating Partnership, holding a 99.5% ownership interest therein as of December 31, 2017. The remaining ownership interests in the Operating Partnership are held by certain former owners of assets acquired by the Operating Partnership. As the owner of the sole general partner of the Operating Partnership, the Parent Company has full and complete authority over the Operating Partnership’s day-to-day operations and management.

Management operates the Parent Company and the Operating Partnership as one enterprise. The management teams of the Parent Company and the Operating Partnership are identical.

There are few differences between the Parent Company and the Operating Partnership, which are reflected in the note disclosures in this report. The Company believes it is important to understand the differences between the Parent Company and the Operating Partnership in the context of how these entities operate as a consolidated enterprise. The Parent Company is a REIT, whose only material asset is its ownership of the partnership interests of the Operating Partnership. As a result, the Parent Company does not conduct business itself, other than acting as the owner of the sole general partner of the Operating Partnership, issuing public equity from time to time and guaranteeing the debt obligations of the Operating Partnership. The Operating Partnership holds substantially all the assets of the Company and, directly or indirectly, holds the ownership interests in the Company’s real estate ventures. The Operating Partnership conducts the operations of the Company’s business and is structured as a partnership with no publicly traded equity. Except for net proceeds from equity issuances by the Parent Company, which are contributed to the Operating Partnership in exchange for partnership units, the Operating Partnership generates the capital required by the Company’s business through the Operating Partnership’s operations, by the Operating Partnership’s direct or indirect incurrence of indebtedness or through the issuance of partnership units of the Operating Partnership.

The substantive difference between the Parent Company’s filings and the Operating Partnership’s filings is the fact that the Parent Company is a REIT with public equity, while the Operating Partnership is a partnership with no publicly traded equity. In the financial statements, this difference is primarily reflected in the equity (or capital for the Operating Partnership) section of the consolidated balance sheets and in the consolidated statements of shareholders’ equity (or partners’ capital). Apart from the different equity treatment, the consolidated financial statements of the Parent Company and the Operating Partnership are nearly identical.

The Company believes that combining the annual reports on Form 10-K of the Parent Company and the Operating Partnership into a single report will:

 

facilitate a better understanding by the investors of the Parent Company and the Operating Partnership by enabling them to view the business as a whole in the same manner as management views and operates the business;

 

remove duplicative disclosures and provide a more straightforward presentation in light of the fact that a substantial portion of the disclosure applies to both the Parent Company and the Operating Partnership; and

 

create time and cost efficiencies through the preparation of one combined report instead of two separate reports.

In order to highlight the differences between the Parent Company and the Operating Partnership, the separate sections in this report for the Parent Company and the Operating Partnership specifically refer to the Parent Company and the Operating Partnership. In the sections that combine disclosures of the Parent Company and the Operating Partnership, this report refers to such disclosures as those of the Company. Although the Operating Partnership is generally the entity that directly or indirectly enters into contracts and real estate ventures and holds assets and debt, reference to the Company is appropriate because the business is one enterprise and the Parent Company operates the business through the Operating Partnership.

2


 

As the owner of the general partner with control of the Operating Partnership, the Parent Company consolidates the Operating Partnership for financial reporting purposes, and the Parent Company does not have significant assets other than its investment in the Operating Partnership. Therefore, the assets and liabilities of the Parent Company and the Operating Partnership are the same on their respective financial statements. The separate discussions of the Parent Company and the Operating Partnership in this report should be read in conjunction with each other to understand the results of the Company’s operations on a consolidated basis and how management operates the Company.

This report also includes separate Item 9A - Controls and Procedures sections, signature pages and Exhibit 31 and 32 certifications for each of the Parent Company and the Operating Partnership in order to establish that the Chief Executive Officer and the Chief Financial Officer of the Parent Company and the Chief Executive Officer and the Chief Financial Officer of the Operating Partnership have made the requisite certifications and that the Parent Company and the Operating Partnership are compliant with Rule 13a-15 or Rule 15d-15 of the Securities Exchange Act of 1934, as amended and 18 U.S.C. §1350.

3


 

TABLE OF CONTENTS

 

Part I

 

 

5

 

Item 1. Business

 

 

5

 

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

 

 

18

 

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

 

 

18

 

Item 6. Selected Financial Data

 

 

20

 

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

 

 

23

 

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

 

 

33

 

Item 8. Financial Statements and Supplementary Data

 

 

33

 

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

 

 

66

 

Item 9A. Controls and Procedures

 

 

66

 

Item 9B. Other Information

 

 

70

 

 

 

Part III

 

 

70

 

Item 10. Directors, Executive Officers and Corporate Governance

 

 

70

 

Item 11. Executive Compensation

 

 

70

 

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

 

 

70

 

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

 

 

70

 

Item 14. Principal Accountant Fees and Services

 

 

70

 

 

 

Part IV

 

 

71

 

Item 15. Exhibits, Financial Statement Schedules

 

 

71

 

Item 16. Form 10-K Summary

 

 

76

 

 

 

SIGNATURES

 

 

77

 

 

 

EX-3.1

 

EX-10.19

 

 

 

 

EX-10.24

 

 

 

 

EX-10.25

 

 

 

 

EX-10.27

 

 

 

 

EX-12.1

 

 

 

 

EX-21.1

 

 

 

 

EX-23.1

 

 

 

 

EX-23.2

 

 

 

 

EX-31.1

 

 

 

 

EX-31.2

 

 

 

 

EX-31.3

 

 

 

 

EX-31.4

 

 

 

 

EX-32.1

 

 

 

 

EX-32.2

 

 

 

 

EX-101

 

 

 

 

 

 

 

 

 

 

4


 

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

The Company is a self-administered and self-managed real estate company that acquires, owns and manages self-storage properties. We refer to the self-storage properties in which we have an ownership interest, lease, and/or 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, 2017, we had an ownership interest in and/or managed 706 self-storage properties in 28 states under the name Life Storage ®. Among our 706 self-storage properties are 98 properties that we manage for unconsolidated joint ventures, 42 properties that we manage and have no ownership interest, and two properties that we lease. We believe we are the fifth largest operator of self-storage properties in the United States based on square feet owned and managed. Our Properties conduct business under the customer-friendly name Life Storage ®.

At December 31, 2017, the Parent Company owned a direct or indirect interest in 662 of the Properties through the Operating Partnership, which includes 564 wholly-owned properties and 98 properties owned by unconsolidated joint ventures. In total, we own a 99.5% economic interest in the Operating Partnership and unaffiliated third parties collectively own a 0.5% limited partnership interest at December 31, 2017. 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 Operating Partnership as currency. By utilizing interests in the Operating 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.

The Parent Company was incorporated on April 19, 1995 under Maryland law. The Operating Partnership was formed on June 1, 1995 as a Delaware limited partnership and has engaged in virtually all aspects of the self-storage business, including the development, acquisition, management, ownership and operation of self-storage facilities. Our principal executive offices are located at 6467 Main Street, Williamsville, New York 14221, our telephone number is (716) 633-1850 and our website is www.lifestorage.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 enhancing the Properties. Should demographic and economic conditions warrant, we may develop new properties. We believe that there continues to be opportunities for growth through acquisitions, including acquisitions through unconsolidated joint ventures of the Company. We seek to acquire self-storage properties that are susceptible to realization of increased economies of scale and improved 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. Modern facilities, such as those owned and/or managed by the Company, are usually fenced and well lighted with automated access systems, 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 control of access to the space.

According to the 2018 Self-Storage Almanac, of the estimated 44,000 core self-storage facilities in the United States (those properties identified as having self-storage operated as the core business at the address), approximately 19.2% are managed by the ten largest operators. This results in a highly fragmented industry as 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, 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.

5


 

Property Management

We have over 30 years of experience acquiring and managing self-storage facilities, and the combined experience of our key personnel makes us one of the leaders in the industry. 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. Accordingly, we hire and train to ensure that associates can reach their full potential. We strive to ensure that each associate conducts themselves in accordance with our core values: Teamwork, Respect, Accountability, Integrity, and Innovation. In turn, we support them with state of the art training tools including an online learning management system, a company intranet and a 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. As such, our store associates are held to high standards for customer service, store appearance, financial performance, and overall operations.

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. To supplement their initial training, employees enjoy continuing edification, coaching, and performance feedback, including customer satisfaction surveying, throughout their tenure.

All learning and development activities are facilitated through our online training and development portal. This portal delivers and tracks hundreds of computer-based training and compliance courses; it also administers tests, surveys, and the employee appraisal process. The Company’s training and development program encompasses the tools and support we deem essential to the success of our employees and business.

Marketing and Advertising:

The digital age has changed consumer behavior – the way people shop, their expectations, and the way we communicate with them. As such, we utilize the following strategies to market our properties and products:

 

We employ a Customer Care Center (call center) that services an average of 43,000 rental inquiries per month. Our Sales Representatives answer incoming sales calls for all of our locations, 364 days a year, 24 hours a day. In addition, they respond to email inquiries and serve as overnight customer service agents to assist customers outside of regular office hours. The team undergoes continuous training and coaching in effective storage sales techniques and best practices in customer service, which we believe results in higher conversions of inquiries to rentals.

 

We maintain a website and involve internal and external expertise to manage our internet presence and leverage a search engine and social media marketing strategy to attract customers and gain rentals online, through our call center and at our stores.  Precise targeting and tracking through campaign management and analysis allows us to attract the right customers, at the right time, for reasonable costs of acquisition.

 

Since the need for storage is largely based on timing, the goal is to create positive brand recognition through a variety of channels, both digital and traditional. When the time comes for a customer to select a storage company, we want the Life Storage brand to be on the top of their mind. We employ a variety of different strategies to create brand awareness; this includes our Life Storage rental trucks, branded merchandise such as moving and packing supplies, extensive regional marketing in the communities in which we operate, and digital targeting using search, social media and remarketing campaigns. We strive to introduce storage solutions early and often to gain the most exposure as possible for the longest amount of time.

 

Approximately 47% of our self-storage space is comprised of units with temperature and/or humidity control capabilities which we market to corporate, retail and residential customers seeking storage solutions for valuable, sentimental, or otherwise sensitive items.

 

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

Ancillary Income:

We know that our 393,000 customers require more than just a storage space. Knowing this, we offer a wide range of other products and services that fulfill their needs while providing us with ancillary income. Whereas our Life Storage 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 an administrative fee. We also receive incidental income from billboards and cell towers.

6


 

Information Systems:

Each of our primary business functions is linked to our customized computer applications, many of which are proprietary. These systems provide for consistent, timely and accurate flow of information throughout our critical platforms:

 

Our proprietary operating software (“ubOS”) is installed at all locations and performs the functions necessary for field personnel to efficiently and effectively run a 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. Financial reports are automatically transmitted to our Corporate Offices overnight to allow for strict accounting oversight.

 

ubOS is linked with each of our primary sales channels (customer care center, internet, 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.

 

ubOS provides our revenue management team with raw data on historical pricing, move-in and move-out activity, specials and occupancies, etc. This data is utilized in the various algorithms that form the foundation of our revenue management program. Changes to pricing and specials are “pushed out” to all sales channels instantaneously.

 

ubOS 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.

Revenue Management:

Our proprietary revenue management system is constantly evolving through the efforts of our revenue management team comprised of a group of analysts. We have the ability to change pricing instantaneously for any single unit type, at any single location, based on the occupancy, competition, and forecasted changes in demand. By analyzing current customer rent tenures, we can implement rental rate increases at optimal times to increase revenues. Advanced pricing analytics enables us to reduce the amount of concessions, attracting a more stable customer base and discouraging short-term price shoppers. This system continues to drive revenue stability and/or growth throughout our portfolio.

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 experienced project managers. These inspections provide the basis for short and long term planned projects that are all performed under a standardized set of specifications. Routine maintenance such as landscaping, pest control, and snowplowing is contracted to local providers to whom we clearly communicate our standards. Further, our software tracks repairs, monitors contractor performance and measures the useful life of assets. 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. In addition, we continually look to green alternatives and implement energy saving alternatives as new technology becomes available. This includes the installation of solar panels, LED lighting, energy efficient air conditioning units, and cool roofs which are all environmentally friendly and have the potential to reduce energy consumption (thereby reducing costs) in the buildings in which they are installed. We continue to implement and expand the Company’s solar panel initiative which has reduced energy consumption and costs at those installed locations.

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 business interruption), 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.

7


 

Federal Income Tax

We operate, and we 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.”

The Tax Cuts and Jobs Act

The Tax Cuts and Jobs Act (the “TCJA”) was passed by Congress on December 20, 2017 and signed into law by President Trump on December 22, 2017. The TCJA significantly changed the U.S. federal income tax laws applicable to businesses and their owners, including REITs and their shareholders. Technical corrections or other amendments to the TCJA or administrative guidance interpreting the TCJA may be forthcoming at any time. We cannot predict the long-term effect of the TCJA or any future law changes on us or our shareholders. A brief summary of the key changes from the TCJA that directly impact us and, potentially, our shareholders is set forth below. The changes described are effective for taxable years beginning after December 31, 2017, unless otherwise noted.

 

Under the TCJA, the corporate income tax rate is reduced from a maximum rate of 35% to a flat 21% rate. The reduced corporate income tax rate, which is effective for taxable years beginning after December 31, 2017, will apply to income earned by our taxable REIT subsidiary. This reduced rate also applies to the amount that we must withhold from our distributions to non-U.S. shareholders that are designated as capital gain dividends (or that could have been designated as capital gain dividends). The TCJA also repeals the alternative minimum tax imposed on C corporations.

 

The TCJA reduces the highest marginal income tax rate applicable to U.S. individuals from 39.6% to 37% (excluding the 3.8% Medicare tax on net investment income). Domestic non-corporate taxpayers continue to pay a maximum 20% rate on long-term capital gains and qualified dividend income. However, the TCJA also will allow domestic non-corporate taxpayers to deduct 20% of their dividends from REITs, excluding capital gain dividends and qualified dividend income (which continue to be subject to the 20% rate). As a result, dividend income received by our domestic non-corporate shareholders will be subject to a maximum effective federal income tax rate of 29.6% (plus the 3.8% Medicare tax on net investment income). The cumulative amount that a domestic non-corporate taxpayer may deduct for any taxable year with respect to ordinary REIT dividends from all sources (together with certain other categories of income that are eligible for such 20% deduction) may not exceed 20% of such person’s total taxable income (excluding any net capital gain). The income tax rate changes applicable to domestic non-corporate taxpayers and the 20% deduction for ordinary REIT dividends apply for taxable years beginning after December 31, 2017 and before January 1, 2026.

 

The TCJA generally limits the deduction for net business interest to 30% of adjusted taxable income (excluding non-business income, net operating losses, business interest income, and, for taxable years beginning before January 1, 2022, computed without regard to depreciation and amortization). This limitation on the deductibility of net business interest could result in additional taxable income for us and our taxable REIT subsidiary.

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 how the property is operated and marketed. We believe we compete successfully on these factors. The extent of competition depends significantly on local market conditions. We seek to locate where 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 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 additional self-storage properties via new or existing joint-venture partnerships or similar entities. 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.

8


 

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 2017, the Company sold two non-strategic properties and received net cash proceeds of $16.9 million, resulting in a loss of a approximately $3.5 million. The Company has subsequently leased one of the properties sold during 2017 and will continue to operate the property through March 2020. Due to the Company’s continuing involvement in this property, the related gain on the sale of this property has been deferred and will be recognized by the Company upon termination of this lease. During 2016, we sold eight non-strategic properties in Alabama, Georgia, Mississippi, Texas and Virginia for net proceeds of approximately $34.1 million, resulting in a gain of approximately $15.3 million. During 2015, we sold three non-strategic storage facilities in Missouri and South Carolina for net proceeds of approximately $4.6 million, resulting in a loss of approximately $0.5 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 or losses). Under certain circumstances, we may be required to make distributions in excess of cash available for distribution in order to meet the minimum requirements.

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, however, may from time to time re-evaluate and modify our borrowing policy considering 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.

The following sets forth certain financing activities during the year ended December 31, 2017.

On December 7, 2017, the Operating Partnership issued $450 million in aggregate principal of 3.875% unsecured senior notes due December 15, 2027 (the “2027 Senior Notes”). The 2027 Senior Notes were issued at a 0.477% discount to par value. Interest on the 2027 Senior Notes is payable semi-annually on June 15 and December 15, beginning on June 15, 2018. The 2027 Senior Notes are fully and unconditionally guaranteed by the Parent Company. Proceeds received upon issuance, net of discount to par of $2.1 million and underwriting and other offering expenses totaling $4.0 million, totaled $443.9 million. The proceeds were primarily used to repay $225.0 million of the Company’s then existing variable rate term notes and to repay $210.0 million of the then outstanding balance on the Company’s line of credit.  

Amounts outstanding on the Company’s line of credit at December 31, 2017 totaled $105.0 million.

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 and equity activities, see Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” and Notes 5 and 6 to the Consolidated Financial Statements filed herewith.

Employees

We currently employ a total of 1,792 employees, including 706 property managers, 47 area managers, and 785 associate managers and part-time employees. At our headquarters, in addition to our five senior executive officers, we employ 249 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.

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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.lifestorage.com as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. In addition, 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.lifestorage.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 Life Storage, Inc., Attn: Investor Relations, 6467 Main Street, Williamsville, NY 14221.

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 hundreds of acquisitions of self-storage facilities since our initial public offering of common stock in June 1995. One of our strategies 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. 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 our standards may prove to be 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, Term Notes and Senior Notes. We have a line of credit and term note agreements with a syndicate of financial institutions and other lenders, along with senior debt of $1,050 million. This indebtedness is recourse to us and the required payments are not reduced if the economic performance of any of the properties declines. The facilities limit 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 bears 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 indebtedness 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 any 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 loan instruments 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 these instruments, 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 distressed 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 receive a reduction in our credit rating from the agencies, the interest rate on our line of credit would increase by up to 0.50% and the interest rate on $100 million of our bank term notes would increase by up to 0.65%. Should we fail to attain an investment grade rating from the agencies, the interest rates on our $100 million term note due 2021 and our $175 million term note due 2024 would each 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 debt instruments.

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. Due to 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;

 

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.

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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 the Company

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 (“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%.

These ownership limits may:

 

Have the effect of precluding an acquisition of control of the Company 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 the Company.

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 shares of preferred stock could have the effect of delaying or preventing a change in control of the Company 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 Life Storage 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 Operating 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 Operating 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 Operating 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.

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Our Failure to Qualify as a REIT Would Have Adverse Consequences

We intend to continue to operate in a manner that will permit us to qualify as a REIT under the Code. We have not requested and do not plan to request a ruling from the Internal Revenue Service (“IRS”) that we qualify as a REIT, and the statements in this Annual Report on Form 10-K are not binding on the IRS or any court. 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. The fact that we hold substantially all of our assets through our Operating Partnership and its subsidiaries and joint ventures further complicates the application of the REIT requirements for us. Even a technical or inadvertent mistake could jeopardize our REIT status and, given the highly complex nature of the rules governing REITs and the ongoing importance of factual determinations, we cannot provide any assurance that we will continue to qualify as a REIT. Furthermore, Congress and the IRS might make changes to the tax laws and regulations, and the courts and the IRS might issue new rulings, that make it more difficult, or impossible, for us to remain qualified as a REIT.

If we were to fail to qualify as a REIT in any taxable year and are unable to avail ourselves of certain savings provisions set forth in the Code, 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 possibly increased state and local taxes) 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 continue 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. If we fail to qualify as a REIT for federal income tax purposes and are able to avail ourselves of one or more of the statutory savings provisions in order to maintain our REIT status, we would nevertheless be required to pay penalty taxes of $50,000 or more for each such failure.

We Will Pay Some Taxes Even if We Qualify as a REIT, 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. For example, we will be subject to income tax to the extent we distribute less than 100% of our REIT taxable income (including capital gains). Additionally, we will be subject to a 4% nondeductible excise tax on the amount, if any, by which dividends paid by us in any calendar year are less than the sum of 85% of our ordinary income, 95% of our capital gain net income and 100% of our undistributed income from prior years. Moreover, if we have net income from “prohibited transactions,” that income will be subject to a 100% tax. In general, prohibited transactions are sales or other dispositions of property held primarily for sale to customers in the ordinary course of business. The determination as to whether a particular sale is a prohibited transaction depends on the facts and circumstances related to that sale. While we will undertake sales of assets if those assets become inconsistent with our long-term strategic or return objectives, we do not believe that those sales should be considered prohibited transactions, but there can be no assurance that the IRS would not contend otherwise. The need to avoid prohibited transactions could cause us to forego or defer sales of properties that might otherwise be in our best interest to sell.

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 to other limitations imposed on the deductibility of interest under the TCJA. In addition, if we receive or accrue certain amounts and the underlying economic arrangements between 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 we are 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.

Complying with REIT Requirements May Limit Our Ability to Hedge Effectively and May Cause Us to Incur Tax Liabilities

The REIT provisions of the Code may limit our ability to hedge our assets and operations. Under these provisions, any income that we generate from transactions intended to hedge our interest rate risk will be excluded from gross income for purposes of the REIT 75% and 95% gross income tests if the instrument hedges interest rate risk on liabilities used to carry or acquire real estate assets or manages the risk of certain currency fluctuations, and such instrument is properly identified under applicable Treasury Regulations. Income from hedging transactions that do not meet these requirements will generally constitute non-qualifying income for purposes of both the REIT 75% and 95% gross income tests. As a result of these rules, we may have to limit our use of hedging techniques that might otherwise be advantageous or implement those hedges through a taxable REIT subsidiary. This could increase the cost of our hedging activities because our taxable REIT subsidiary would be subject to tax on gains or expose us to greater risks associated with changes in interest rates than we would otherwise want to bear. In addition, losses in our taxable REIT subsidiary arising after December 31, 2017 will generally not provide any tax benefit, except for being carried forward against future taxable income in the taxable REIT subsidiary.

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Complying with the REIT Requirements May Cause Us to Forgo and/or Liquidate Otherwise Attractive Investments

To qualify as a REIT, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts that we distribute to our shareholders and the ownership of our shares. To meet these tests, we may be required to take or forgo taking actions that we would otherwise consider advantageous. For instance, in order to satisfy the gross income or asset tests applicable to REITs under the Code, we may be required to forgo investments that we otherwise would make. Furthermore, we may be required to liquidate from our portfolio otherwise attractive investments. In addition, we may be required to make distributions to shareholders at disadvantageous times or when we do not have funds readily available for distribution. These actions could reduce our income and amounts available for distribution to our shareholders. Thus, compliance with the REIT requirements may hinder our investment performance.

If the Operating Partnership Fails to Qualify as a Partnership for Federal Income Tax Purposes, We Could Fail to Qualify as a REIT and Suffer Other Adverse Consequences

We believe that the Operating Partnership is organized and operated in a manner so as to be treated as a partnership and not an association or a publicly traded partnership taxable as a corporation, for federal income tax purposes. As a partnership, the Operating Partnership is not subject to federal income tax on its income. Instead, each of the partners is allocated its share of the Operating Partnership’s income. No assurance can be provided, however, that the IRS will not challenge the Operating Partnership’s status as a partnership for federal income tax purposes, or that a court would not sustain such a challenge. If the IRS were successful in treating the Operating Partnership as an association or publicly traded partnership taxable as a corporation for federal income tax purposes, we would fail to meet the gross income tests and certain of the asset tests applicable to REITs and, accordingly, would cease to qualify as a REIT. Also, the failure of the Operating Partnership to qualify as a partnership would cause it to become subject to federal corporate income tax, which would reduce significantly the amount of its cash available for distribution to its partners, including us.

The Tax Cuts and Jobs Act May Impact the Attractiveness of an Investment in our Stock in Ways Difficult to Anticipate

The Tax Cuts and Jobs Act (the “TCJA”), signed into law in late 2017, significantly changed the U.S. federal income tax law applicable, and is generally for taxable years beginning after December 31, 2017. The TCJA reduced corporate and non-corporate income tax rates and changed numerous other provisions of the Code that may affect the taxation of REITs and their shareholders. These changes generally appear favorable to REITs; however, certain changes to the U.S. federal income tax laws pursuant to the TCJA could have a material and adverse effect on us. Some of these changes could reduce the relative competitive advantage of companies operating as REITs as opposed to companies not operating as REITs, including:

 

the reduction in tax rates applicable to individuals and C corporations, which could reduce the relative attractiveness of the generally single-level of taxation on REIT distributions;

 

the immediate expensing of capital expenditures, which could likewise reduce the relative attractiveness of the REIT structure; and

 

the limit on the deductibility of interest expense, which could increase the distribution requirement of REITs.

Many changes applicable to individual taxpayers are temporary – applying to taxable years beginning after December 31, 2017 and before January 1, 2026. The TCJA makes numerous other changes to the tax law that do not affect REITs directly, but these changes could impact our shareholders and, therefore, could indirectly affect us.

Furthermore, the TCJA was adopted in a short period of time without hearings. It is likely that Congress will have to review, and possibly modify, provisions of the TCJA in subsequent tax legislation. It is not possible to predict if or when Congress will address changes to the TCJA or when the Internal Revenue Service will issue administrative guidance on the changes made by the TCJA or how any such changes will impact us or an investment in our stock. It is possible that future changes to tax law or guidance promulgated thereunder could adversely impact us.

Shareholders are urged to consult with their tax advisors about the TCJA and any other regulatory or administrative developments and proposals with respect to taxes and their potential effect on investment in our stock.

U.S. Federal Income Tax Treatment of REITs and Investments in REITs May Change, Which May Result in the Loss of Our Tax Benefits of Operating as a REIT

Current U.S. federal income tax treatment of a REIT and an investment in a REIT may be modified by legislative, judicial or administrative action at any time, and we cannot predict when such action may occur. We cannot predict how changes in U.S. federal income tax law will affect us or our investors nor can we predict the long-term impact of tax reforms on REITs.

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

In 2017, our Board of Directors authorized and we declared quarterly common stock dividends of $0.95 per share in January, and $1.00 per share for April, July and October, for a total 2017 dividend per share annual rate of $3.95 per share. In addition, our Board of Directors authorized and we declared a quarterly common stock dividend of $1.00 per share in January 2018. We can provide no assurance that our Board of Directors will not reduce or eliminate entirely dividend distributions on our common stock in the future.

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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 given 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, 2017, 254 of our 706 self-storage facilities are located in the states of Texas and Florida. For the year ended December 31, 2017, these facilities accounted for approximately 36% 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 may experience a reduction in existing and new business, which may have an adverse effect on our business, financial condition and results of operations.

When We Acquire Properties in New Markets, We Will Be Subject to Increased Operational Risks

We may acquire self-storage properties in markets where we have little or no operational experience. When we enter into new markets, we will be subject to increased risks resulting from our lack of experience and infrastructure in these markets and may need to incur additional costs, both expected and unexpected, to develop our operating capabilities in these markets. These risks could materially and adversely affect us, including our growth prospects, 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 generally is 20%, as 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.

We are heavily dependent on computer systems, telecommunications and the Internet to process transactions, summarize results and manage our business. Security breaches or a failure of such networks, systems or technology could adversely impact our business and customer relationships.

We are heavily dependent upon automated information technology and Internet commerce, with many of our new customers coming from the Internet or the telephone, and the nature of our business involves the receipt and retention of personal information about them. We centrally manage significant components of our operations with our computer systems, including our financial information, and we also rely extensively on third-party vendors to retain data, process transactions and provide other systems services. These systems are subject to damage or interruption from power outages, computer and telecommunications failures, computer worms, viruses and other destructive or disruptive security breaches and catastrophic events.

As a result, our operations could be severely impacted by a natural disaster, terrorist attack or other circumstance that resulted in a significant outage of our systems or those of our third-party providers, despite our use of back up and redundancy measures. Further, viruses and other related risks could negatively impact our information technology processes. We could also be subject to a “cyber-attack” or other data security breach which would penetrate our network security, resulting in misappropriation of our confidential information, including customer personal information. System disruptions and shutdowns could also result in additional costs to repair or replace such networks or information systems and possible legal liability, including government enforcement actions and private litigation. In addition, our customers could lose confidence in our ability to protect their personal information, which could cause them to move out of rented storage spaces. Such events could lead to lost future sales and adversely affect our results of operations.

Item 1B.

Unresolved Staff Comments

None.

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Item 2.

Properties

At December 31, 2017, we held ownership interests in, leased, and/or managed a total of 706 Properties situated in 28 states. Among our 706 self-storage properties are 98 properties that we manage for unconsolidated joint ventures of which we have varying percentage ownership interests. For additional information regarding unconsolidated joint ventures, see Note 11 to the Consolidated Financial Statements filed herewith.

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 18,000 to 195,000 net rentable square feet, with an average of approximately 70,000 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.

The following table provides certain information regarding the Properties in which we have an ownership interest, lease, and/or manage as of December 31, 2017:

 

 

 

Number of

Stores at

December 31,

2017

 

 

Square

Feet

 

 

Number of

Spaces

 

 

Percentage

of Store

Revenue

 

Alabama

 

 

21

 

 

 

1,581,503

 

 

 

12,157

 

 

 

2.35

%

Arizona

 

 

25

 

 

 

1,741,275

 

 

 

15,743

 

 

 

3.00

%

California

 

 

28

 

 

 

2,538,426

 

 

 

22,751

 

 

 

6.28

%

Colorado

 

 

11

 

 

 

769,437

 

 

 

6,828

 

 

 

1.80

%

Connecticut

 

 

11

 

 

 

834,952

 

 

 

8,705

 

 

 

2.16

%

Florida

 

 

95

 

 

 

6,422,451

 

 

 

63,243

 

 

 

13.49

%

Georgia

 

 

34

 

 

 

2,355,069

 

 

 

20,193

 

 

 

4.23

%

Illinois

 

 

45

 

 

 

3,348,867

 

 

 

33,810

 

 

 

7.40

%

Kentucky

 

 

2

 

 

 

142,764

 

 

 

1,322

 

 

 

0.28

%

Louisiana

 

 

16

 

 

 

954,965

 

 

 

8,088

 

 

 

1.66

%

Maine

 

 

5

 

 

 

233,136

 

 

 

2,295

 

 

 

0.61

%

Maryland

 

 

3

 

 

 

138,839

 

 

 

1,619

 

 

 

0.36

%

Massachusetts

 

 

15

 

 

 

817,298

 

 

 

8,244

 

 

 

2.06

%

Mississippi

 

 

12

 

 

 

885,381

 

 

 

6,614

 

 

 

1.48

%

Missouri

 

 

14

 

 

 

948,066

 

 

 

8,498

 

 

 

1.86

%

Nevada

 

 

22

 

 

 

1,633,278

 

 

 

13,708

 

 

 

2.81

%

New Hampshire

 

 

10

 

 

 

725,123

 

 

 

6,222

 

 

 

1.40

%

New Jersey

 

 

29

 

 

 

2,091,277

 

 

 

21,891

 

 

 

5.79

%

New York

 

 

46

 

 

 

2,827,529

 

 

 

28,684

 

 

 

6.77

%

North Carolina

 

 

22

 

 

 

1,361,090

 

 

 

12,632

 

 

 

2.20

%

Ohio

 

 

25

 

 

 

1,656,927

 

 

 

13,940

 

 

 

2.72

%

Pennsylvania

 

 

11

 

 

 

688,019

 

 

 

5,961

 

 

 

1.37

%

Rhode Island

 

 

4

 

 

 

205,871

 

 

 

1,922

 

 

 

0.49

%

South Carolina

 

 

14

 

 

 

901,444

 

 

 

7,974

 

 

 

1.67

%

Tennessee

 

 

7

 

 

 

510,619

 

 

 

4,231

 

 

 

0.85

%

Texas

 

 

159

 

 

 

11,745,044

 

 

 

97,320

 

 

 

22.51

%

Virginia

 

 

18

 

 

 

1,382,818

 

 

 

12,576

 

 

 

2.21

%

Wisconsin

 

 

2

 

 

 

169,595

 

 

 

1,726

 

 

 

0.19

%

Total

 

 

706

 

 

 

49,611,063

 

 

 

448,897

 

 

 

100.0

%

 

At December 31, 2017, the Properties had an average occupancy of 88.7% and an annualized rent per occupied square foot of $14.07.

16


 

Item 3.

Legal Proceedings

On or about August 25, 2014, a putative class action was filed against the Company in the Superior Court of New Jersey Law Division Burlington County. The action seeks to obtain declaratory, injunctive and monetary relief for a class of consumers based upon alleged violations by the Company of various statutory laws. On October 17, 2014, the action was removed from the Superior Court of New Jersey Law Division Burlington County to the United States District Court for the District of New Jersey. The Company brought a motion to partially dismiss the complaint for failure to state a claim, and on July 16, 2015, the Company’s motion was granted in part and denied in part. On October 20, 2016, the complaint was amended to add additional claims. The parties have entered into a memorandum of understanding to settle all claims for an aggregate amount of $8.0 million. In February 2018, the motion for the preliminary approval of the proposed class action settlement was granted. The aggregate settlement amount of $8.0 million ($6.0 million after considering income tax impact) has been recorded as a liability of in the Company’s consolidated balance sheet. A portion of the settlement expense relates to self-storage facilities that are managed by the Company through its taxable REIT subsidiary. There is an income tax impact to the Company on that portion of the settlement expense as a result. The settlement is subject to final approval by the court, a decision which is expected in 2018.

Item 4.

Mine Safety Disclosures

Not Applicable

17


 

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 “LSI”. 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 2016

 

High

 

 

Low

 

1st

 

$

118.18

 

 

$

98.80

 

2nd

 

$

117.81

 

 

$

98.93

 

3rd

 

$

107.71

 

 

$

86.45

 

4th

 

$

88.89

 

 

$

77.00

 

 

Quarter 2017

 

High

 

 

Low

 

1st

 

$

89.24

 

 

$

79.38

 

2nd

 

$

87.87

 

 

$

72.08

 

3rd

 

$

83.90

 

 

$

69.00

 

4th

 

$

91.75

 

 

$

77.88

 

 

As of February 12, 2018, there were approximately 590 holders of record of our Common Stock. These figures do not include common shares held by brokers and other institutions on behalf of shareholders.

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 2017 represent 83% ordinary income and 17% return of capital.

History of Dividends Declared on Common Stock

 

January 2016

$

0.85 per share

April 2016

$

0.95 per share

July 2016

$

0.95 per share

October 2016

$

0.95 per share

 

January 2017

$

0.95 per share

April 2017

$

1.00 per share

July 2017

$

1.00 per share

October 2017

$

1.00 per share

 

For each quarter in 2016 and 2017, the Operating Partnership paid a cash distribution per unit in an amount equal to the dividend paid on a share of common stock for such quarter.

 

The following table summarizes our purchases of our common stock for the year ended December 31, 2017.

 

18


 

Issuer Purchases of Equity Securities

 

Period

 

(a) Total number of shares purchased

 

 

(b) Average price paid per share

 

 

(c) Total number of shares purchased as part of publicly announced plans or programs (1)

 

 

(d) Approx. dollar value of shares that may yet be purchased under

the plans or

programs (1)

 

August 1, 2017 - August 31, 2017

 

 

92,150

 

 

$

72.98

 

 

 

92,150

 

 

$

193,274,647

 

September 1, 2017 - September 30, 2017

 

 

20,404

 

 

 

73.94

 

 

 

20,404

 

 

 

191,765,955

 

October 1, 2017 - December 31, 2017

 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

112,554

 

 

 

73.16

 

 

 

112,554

 

 

$

191,765,955

 

 

(1) On August 2, 2017, the Company’s Board of Directors authorized the repurchase of up to $200 million of the Company’s common stock. The program does not have an expiration date but may be suspended or discontinued at any time.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

EQUITY COMPENSATION PLAN INFORMATION

The following table sets forth certain information as of December 31, 2017, 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

 

 

76,106

 

 

$

45.59

 

 

 

 

2015 Award and Option Plan (2)

 

 

124,402

 

 

$

 

 

 

345,383

 

2009 Outside Directors’ Stock Option and Award Plan

 

 

18,500

 

 

$

79.58

 

 

 

67,871

 

Deferred Compensation Plan for Directors (1)

 

 

21,540

 

 

N/A

 

 

 

22,598

 

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.

(2)

Includes the maximum number of shares (124,402) that could be issued as part of 2015, 2016 and 2017 performance-based awards. The actual number of shares to be issued will be determined at the end of the three-year performance periods in 2018, 2019 and 2020. See Note 9 to our consolidated financial statements filed herewith.

19


 

CORPORATE PERFORMANCE GRAPH

The following chart and line-graph presentation compares (i) the Company’s shareholder return on an indexed basis since December 31, 2012 with (ii) the S&P Stock Index and (iii) the National Association of Real Estate Investment Trusts Equity Index.

 

 

 

CUMULATIVE TOTAL SHAREHOLDER RETURN

LIFE STORAGE, INC.

DECEMBER 31, 2012 - DECEMBER 31, 2017

 

 

 

Dec. 31,

2012

 

 

Dec. 31,

2013

 

 

Dec. 31,

2014

 

 

Dec. 31,

2015

 

 

Dec. 31,

2016

 

 

Dec. 31,

2017

 

S&P

 

 

100.00

 

 

 

132.39

 

 

 

150.51

 

 

 

152.59

 

 

 

170.84

 

 

 

208.14

 

NAREIT

 

 

100.00

 

 

 

102.47

 

 

 

133.35

 

 

 

137.61

 

 

 

149.33

 

 

 

157.14

 

LSI

 

 

100.00

 

 

 

108.13

 

 

 

150.19

 

 

 

191.34

 

 

 

157.66

 

 

 

173.11

 

 

The foregoing item assumes $100.00 invested on December 31, 2012, with dividends reinvested.

Item 6.

Selected Financial Data

LIFE STORAGE, INC.

The following table sets forth selected financial and operating data on an historical consolidated basis for the Parent Company. The selected historical financial data as of and for the five-year period ended December 31, 2017 are derived from the Parent Company’s consolidated financial statements, which have been audited by Ernst & Young LLP, an independent registered public accounting firm. The consolidated financial statements as of December 31, 2017 and 2016, and for each of the years in the three-year period ended December 31, 2017, and their report thereon, are included herein. The other data presented below is not derived from the financial statements.

20


 

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 consolidated financial statements and related notes thereto of the Parent Company included elsewhere in this Annual Report on Form 10-K:

 

 

 

At or For Year Ended December 31,

 

(dollars in thousands, except per share data)

 

2017

 

 

2016

 

 

2015

 

 

2014

 

 

2013

 

Operating Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

 

$

529,750

 

 

$

462,608

 

 

$

366,602

 

 

$

326,080

 

 

$

273,507

 

Income from continuing operations

 

 

96,809

 

 

 

84,956

 

 

 

113,077

 

 

 

89,057

 

 

 

71,472

 

Income from discontinued operations (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3,123

 

Net income

 

 

96,809

 

 

 

84,956

 

 

 

113,077

 

 

 

89,057

 

 

 

74,595

 

Net income attributable to common shareholders

 

 

96,365

 

 

 

85,225

 

 

 

112,524

 

 

 

88,531

 

 

 

74,126

 

Income from continuing operations per common share

   attributable to common shareholders – diluted

 

 

2.07

 

 

 

1.96

 

 

 

3.16

 

 

 

2.67

 

 

 

2.26

 

Net income per common share attributable to common

   shareholders – basic

 

 

2.08

 

 

 

1.97

 

 

 

3.18

 

 

 

2.68

 

 

 

2.37

 

Net income per common share attributable to common

   shareholders – diluted

 

 

2.07

 

 

 

1.96

 

 

 

3.16

 

 

 

2.67

 

 

 

2.36

 

Dividends declared per common share (2)

 

 

3.95

 

 

 

3.70

 

 

 

3.20

 

 

 

2.72

 

 

 

2.02

 

Balance Sheet Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment in storage facilities at cost

 

$

4,321,410

 

 

$

4,243,308

 

 

$

2,491,702

 

 

$

2,177,983

 

 

$

1,864,637

 

Total assets

 

 

3,876,774

 

 

 

3,857,984

 

 

 

2,118,822

 

 

 

1,850,727

 

 

 

1,558,894

 

Total debt

 

 

1,726,763

 

 

 

1,653,552

 

 

 

827,643

 

 

 

797,054

 

 

 

623,273

 

Total liabilities

 

 

1,829,078

 

 

 

1,751,399

 

 

 

898,336

 

 

 

861,236

 

 

 

675,245

 

Other Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

248,580

 

 

$

225,550

 

 

$

186,198

 

 

$

146,068

 

 

$

120,646

 

Net cash used in investing activities

 

 

(156,510

)

 

 

(1,796,069

)

 

 

(328,689

)

 

 

(334,993

)

 

 

(114,345

)

Net cash (used in) provided by financing activities

 

 

(106,588

)

 

 

1,587,184

 

 

 

140,968

 

 

 

187,944

 

 

 

(4,032

)

 

(1)

In 2013 we sold four stores whose results of operations and gain on disposal are classified as discontinued operations for all previous years presented.

(2)

In 2013 we declared regular quarterly dividends of $0.48 in January and April, and $0.53 in July and October. In 2014 we declared regular quarterly dividends of $0.68 in January, April, July and October. In 2015 we declared regular quarterly dividends of $0.75 in January and April, and $0.85 in July and October. In 2016 we declared regular quarterly dividends of $0.85 in January and $0.95 in April, July and October. In 2017 we declared regular quarterly dividends of $0.95 in January and $1.00 in April, July and October.

21


 

LIFE STORAGE LP

The following table sets forth selected financial and operating data on an historical consolidated basis for the Operating Partnership. The selected historical financial data as of and for the five-year period ended December 31, 2017 are derived from the Operating Partnership’s consolidated financial statements, which have been audited by Ernst & Young LLP, an independent registered public accounting firm. The consolidated financial statements as of December 31, 2017 and 2016, and for each of the years in the three-year period ended December 31, 2017, and their report thereon, are included herein. The other data presented below is not derived from the financial statements.

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 consolidated financial statements and related notes thereto of the Operating Partnership included elsewhere in this Annual Report on Form 10-K:

 

 

 

At or For Year Ended December 31,

 

(dollars in thousands, except per unit data)

 

2017

 

 

2016

 

 

2015

 

 

2014

 

 

2013

 

Operating Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating revenues

 

$

529,750

 

 

$

462,608

 

 

$

366,602

 

 

$

326,080

 

 

$

273,507

 

Income from continuing operations

 

 

96,809

 

 

 

84,956

 

 

 

113,077

 

 

 

89,057

 

 

 

71,472

 

Income from discontinued operations (1)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

3,123

 

Net income

 

 

96,809

 

 

 

84,956

 

 

 

113,077

 

 

 

89,057

 

 

 

74,595

 

Net income attributable to common unitholders

 

 

96,365

 

 

 

85,225

 

 

 

112,524

 

 

 

88,531

 

 

 

74,126

 

Income from continuing operations per common unit

   attributable to common unitholders – diluted

 

 

2.07

 

 

 

1.96

 

 

 

3.16

 

 

 

2.67

 

 

 

2.26

 

Net income per common unit attributable to common

   unitholders – basic

 

 

2.08

 

 

 

1.97

 

 

 

3.18

 

 

 

2.68

 

 

 

2.37

 

Net income per common unit attributable to common

   unitholders – diluted

 

 

2.07

 

 

 

1.96

 

 

 

3.16

 

 

 

2.67

 

 

 

2.36

 

Distributions declared per common unit (2)

 

 

3.95

 

 

 

3.70

 

 

 

3.20

 

 

 

2.72

 

 

 

2.02

 

Balance Sheet Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Investment in storage facilities at cost

 

$

4,321,410

 

 

$

4,243,308

 

 

$

2,491,702

 

 

$

2,177,983

 

 

$

1,864,637

 

Total assets

 

 

3,876,774

 

 

 

3,857,984

 

 

 

2,118,822

 

 

 

1,850,727

 

 

 

1,558,894

 

Total debt

 

 

1,726,763

 

 

 

1,653,552

 

 

 

827,643

 

 

 

797,054

 

 

 

623,273

 

Total liabilities

 

 

1,829,078

 

 

 

1,751,399

 

 

 

898,336

 

 

 

861,236

 

 

 

675,245

 

Other Data

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net cash provided by operating activities

 

$

248,580

 

 

$

225,550

 

 

$

186,198

 

 

$

146,068

 

 

$

120,646

 

Net cash used in investing activities

 

 

(156,510

)

 

 

(1,796,069

)

 

 

(328,689

)

 

 

(334,993

)

 

 

(114,345

)

Net cash (used in) provided by financing activities

 

 

(106,588

)

 

 

1,587,184

 

 

 

140,968

 

 

 

187,944

 

 

 

(4,032

)

 

(1)

In 2013 we sold four stores whose results of operations and gain on disposal are classified as discontinued operations for all previous years presented.

(2)

In 2013 we declared regular quarterly distributions of $0.48 in January and April, and $0.53 in July and October. In 2014 we declared regular quarterly distributions of $0.68 in January, April, July and October. In 2015 we declared regular quarterly distributions of $0.75 in January and April, and $0.85 in July and October. In 2016 we declared regular quarterly distributions of $0.85 in January and $0.95 in April, July and October. In 2017 we declared regular quarterly distributions of $0.95 in January and $1.00 in April, July and October.

22


 

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 fifth largest operator of self-storage properties in the United States based on square feet owned and managed. All our stores conduct business under the customer-friendly name Life 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:

 

o

Strategic and efficient Web and Mobile marketing that places Life Storage in front of customers in search engines at the right time for conversion;

 

o

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

 

o

Our Customer Care Center, established in 2000, answers sales inquiries 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;

 

o

Our truck move-in program, under which, at present, 396 of our stores offer a free Life Storage truck to assist our customers moving into their spaces, and also serve as a moving billboard further supporting our branding efforts;

 

o

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

 

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 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;

 

All of our store employees receive a high level of training. New store associates are assigned a Certified Training Manager as a mentor during their initial training period. In addition, all employees have access to our online training and development portal 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.

23


 

 

We also look to enter new markets that are in the top 50 Metropolitan Statistical Area (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. We hold a minority interest in multiple joint ventures which hold a total of 98 properties that we manage. In addition, we manage 42 self-storage facilities for which we have no ownership. We may enter into additional management agreements and develop additional joint ventures in the future.

 

D.

Expanding and enhancing our existing stores:

 

Over the past five years we have undertaken a program of expanding and enhancing our Properties. In 2013, we added 295,000 square feet to existing Properties and converted 9,000 square feet to premium storage for a total cost of approximately $17.9 million; in 2014, we added 272,000 square feet to existing Properties and converted 9,000 square feet to premium storage for a total cost of approximately $18.3 million; in 2015, we added 256,000 square feet to existing Properties and converted 5,000 square feet to premium storage for a total cost of approximately $14.1 million; in 2016, we added 343,000 square feet to existing Properties and converted 55,000 square feet to premium storage for a total cost of approximately $22.4 million; and in 2017, we added 382,000 square feet to existing Properties and converted 122,000 square feet to premium storage for a total cost of approximately $35.2 million. From 2012 through 2017 we also installed solar panels on 23 buildings for a total cost of approximately $7.7 million. Our solar panel initiative, which began in 2011, has reduced energy consumption 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. Suppressed economic conditions and a tight credit market environment resulted in a decrease in new supply on a national basis from 2010-2015, but the out-performance of the sector compared to other real estate asset classes has drawn new capital to self-storage. The Company experienced significant new competition beginning in 2016, especially in its Texas markets, and expects noticeable growth in new supply at least through 2019. Despite the inflow of additional properties, we have seen capitalization rates on quality acquisitions in the top fifty major metropolitan markets (expected annual return on investment) remain stable at approximately 5.00% to 5.50%.

Beginning in 2010, subsequent to the economic recession in 2009, we have experienced annual same store sales increases up to and including the current year. We feel our recent performance further supports the notion that the self-storage industry holds up well regardless of the prevailing economic landscape.

We believe our same-store move-ins in 2017 were lower than 2016 due to the fact that our stores had higher occupancy in 2017, resulting in less space to rent. We believe the reduction in same store move-outs is a result of customers renting with us for longer periods.

 

 

 

2017

 

 

2016

 

 

Change

 

Same store move ins

 

 

162,980

 

 

 

167,856

 

 

 

(4,876

)

Same store move outs

 

 

160,007

 

 

 

165,193

 

 

 

(5,186

)

Difference

 

 

2,973

 

 

 

2,663

 

 

 

310

 

 

Elevated property tax increases is a trend that we experienced from 2014 through 2017. We expect same store expense growth resulting from increases in wages, health costs, property insurance and property tax increases in 2018, partially offset by decreased internet marketing costs. We believe the same store expense increases will be at manageable levels.

24


 

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: Upon adoption of Accounting Standards Update 2017-01, most of our self-storage facility acquisitions are not considered business combinations and are treated as asset acquisitions. As a result, the cost of acquired storage facilities is assigned primarily to land, land improvements, building, equipment, and in-place customer leases based on the relative 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 various 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 financial projections and applicable discount rates to estimate the fair values of properties acquired, as well as current replacement cost estimates 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 are based on the rent that would be lost due to the amount of time required to replace existing customers which is based on our historical experience with market demand and turnover in our facilities.

Carrying value of storage facilities: We believe our judgment regarding the impairment of the carrying value of our storage facilities is a critical accounting policy. Our policy is to assess the carrying value of our storage facilities for impairment 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. When indicators of impairment exist, 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 flows is less than the carrying value of the storage facility, an impairment loss is recognized for the amount by which the carrying amount exceeds the fair value of the asset group. 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. No assets had been determined to be impaired under this policy in 2017.

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. In 2017, the Company changed the useful lives of certain assets at self-storage facilities that were identified for replacement as part of the Company’s capital improvement efforts in 2017. Additionally, in 2016, the Company changed the useful lives of existing Uncle Bob’s Self Storage ® signs as a result of the change in the name of the Company’s storage facilities from Uncle Bob’s Self Storage ® to Life Storage ® which required replacement of the existing signage. These changes resulted in a combined increase in depreciation expense of approximately $4.4 million in 2017 as depreciation was accelerated over the new useful lives. The Company estimates that the change related to storage-facility asset replacement will result in an additional increase in depreciation expense of approximately $0.3 million in 2018. We have not made any other significant changes to the estimated useful lives of our long-lived assets and we do not have any current expectation of making significant changes in 2018 other than potentially on any assets identified for replacement in 2018.

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 over which we have significant influence 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 condition and results of operations.

25


 

Recent Accounting Pronouncements

See Note 2 to the financial statements.

YEAR ENDED DECEMBER 31, 2017 COMPARED TO YEAR ENDED DECEMBER 31, 2016

We recorded rental revenues of $485.3 million for the year ended December 31, 2017, an increase of $57.2 million or 13.4% when compared to 2016 rental revenues of $428.1 million. Of the increase in rental revenue, $5.6 million resulted from a 1.6% increase in rental revenues at the 430 core properties considered in same store sales (those properties included in the consolidated results of operations since January 1, 2016, excluding stores not yet stabilized, the properties we sold in 2016 and 2017, six stores significantly impacted by flooding in 2016 and 2017, and two stores that the Company began to fully replace in 2017). The increase in same store rental revenues was a result of a 30 basis point increase in average occupancy and a 0.8% increase in rental income per square foot. The remaining increase in rental revenue of $51.6 million resulted from the stores not included in the same store pool. Other operating income, which includes merchandise sales, insurance administrative fees, truck rentals, management fees and acquisition fees, increased by $9.9 million for the year ended December 31, 2017 compared to 2016 primarily due to increased administrative fees earned on customer insurance, increased management fees earned on managed properties, and increased acquisition fees earned on properties acquired by unconsolidated joint ventures.

Property operations and maintenance expenses increased $19.4 million or 18.8% in 2017 compared to 2016. The 430 core properties considered in the same store pool experienced a $2.3 million or 2.9% increase in such expenses as a result of increases in payroll and higher internet marketing costs in an effort to drive more traffic to the Company’s website as a result of our name change to Life Storage. In addition to the same store increase, property operations and maintenance expenses increased $17.1 million due to the net activity from the stores not included in the same store pool. Real estate tax expense increased $9.8 million or 20.4% in 2017 compared to 2016. The 430 core properties considered in the same store pool experienced a $2.5 million or 6.6% increase which is reflective of a net increase in property tax levies on those properties. In addition to the same store real estate expense increase, real estate taxes increased $7.3 million from the stores not included in the same store pool.

Our 2017 same store results consist of only those properties that have been owned by the Company and included in our consolidated results since January 1, 2016, excluding the stores not yet stabilized, the properties we sold in 2016 and 2017, six stores significantly impacted by flooding in 2016 and 2017, and two stores that the Company began to fully replace in 2017. We believe that same store results is a meaningful measure to investors in evaluating our operating performance because, given the acquisitive nature of the industry, same store results provide information about the overall business after removing the results from those properties that were not consistent from year-to-year. Additionally, same store results are widely used in the real estate industry and the self-storage industry to measure performance. Same store results should be considered in addition to, but not as a substitute for, consolidated results in accordance with GAAP.

The following table sets forth operating data for our 430 same store properties. These results provide information relating to property operating changes without the effects of acquisitions.

Same Store Summary

 

 

 

Year ended December 31,

 

 

Percentage

 

(dollars in thousands)

 

2017

 

 

2016

 

 

Change

 

Same store rental income

 

$

357,428

 

 

$

351,818

 

 

 

1.6

%

Same store other operating income

 

 

20,063

 

 

 

19,361

 

 

 

3.6

%

Total same store operating income

 

 

377,491

 

 

 

371,179

 

 

 

1.7

%

Payroll and benefits

 

 

32,112

 

 

 

30,857

 

 

 

4.1

%

Real estate taxes

 

 

40,459

 

 

 

37,960

 

 

 

6.6

%

Utilities