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TABLE OF CONTENTS
Item 8. Financial Statements and Supplementary Data



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549


FORM 10-K

(Mark One)  

ý

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

For the fiscal year ended December 31, 2005

OR

o

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

For the transition period from                               to                                .

Commission File Number: 001-32269

EXTRA SPACE STORAGE INC.
(Exact name of registrant as specified in its charter)

Maryland
(State or other jurisdiction of
incorporation or organization)
  20-1076777
(I.R.S. Employer
Identification No.)

2795 East Cottonwood Parkway
Salt Lake City, Utah 84121
(Address of principal executive offices and zip code)

Registrant's telephone number, including area code: (801) 562-5556

Securities Registered Pursuant to Section 12(b) of the Act:

Title of Each Class
  Name of exchange on which registered
Common Stock, $.01 par value   New York Stock Exchange, Inc.

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

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

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

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o

        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 of this Form 10-K. Yes o No ý

        Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of "accelerated filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.

Large accelerated filer o   Accelerated filer ý   Non-accelerated filer o

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

        The aggregate market value of the voting stock held by non-affiliates of the registrant at February 28, 2006 was $704,845,245 based upon the closing price on the New York Stock Exchange reported for such date. This calculation does not reflect a determination that persons whose shares are excluded from the computation are affiliates for any other purpose.

        The number of shares outstanding of the registrant's common stock, par value $0.01 per share, as of February 28, 2006 was 51,766,584.

Documents Incorporated by Reference

        Portions of the registrant's definitive proxy statement to be issued in connection with the registrant's annual stockholders' meeting to be held in 2006 are incorporated by reference into Part III of this Annual Report on Form 10-K.




EXTRA SPACE STORAGE INC.
Table of Contents

 
   
PART I

Item 1.

 

Business

Item 1A.

 

Risk Factors

Item 1B.

 

Unresolved Staff Comments

Item 2.

 

Properties

Item 3.

 

Legal Proceedings

Item 4.

 

Submission of Matters to a Vote of Security Holders

PART II

Item 5.

 

Market for Registrant's Common Equity and Related Stockholder Matters

Item 6.

 

Selected Financial Data

Item 7.

 

Managements Discussion and Analysis of Financial Condition and Results of Operations

Item 7A.

 

Quantitative and Qualitative Disclosures About Market Risk

Item 8.

 

Financial Statements and Supplementary Data

Item 9.

 

Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

Item 9A.

 

Controls and Procedures

Item 9B.

 

Other Information

PART III

Item 10.

 

Directors and Executive Officers of the Registrants

Item 11.

 

Executive Compensation

Item 12.

 

Security Ownership of Certain Beneficial Owners and Management

Item 13.

 

Certain Relationships and Related Transactions

Item 14.

 

Principal Accountant Fees and Services

PART IV

Item 15.

 

Exhibits and Financial Statement Schedules

SIGNATURES

Explanatory Note

        The financial statements covered in this report for the period from January 1, 2004 to August 16, 2004 contain the results of operations and financial condition of Extra Space Storage LLC and its subsidiaries, the predecessor to Extra Space Storage Inc. and its subsidiaries, prior to the consummation of Extra Space Storage Inc.'s initial public offering on August 17, 2004, and various formation transactions. In addition, the financial statements covered in this report contain the results of operations and financial condition of Extra Space Storage Inc. for the period from August 17, 2004 to December 31, 2005. Amounts are in thousands (except per share data and unless otherwise stated).

Statements Regarding Forward-Looking Information

        This annual report on Form 10-K contains or may contain forward-looking statements within the meaning of Section 27-A of the Securities Act of 1933, as amended (the "Securities Act"), and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). When used within this document, the words "may," "will," "believes," "anticipates," "continues," "should," "likely," "estimates," "expects," and similar expressions are intended to identify "forward-looking statements" Such forward-looking statements involve known and unknown risks, uncertainties, and other factors, which may cause the actual results, performance or achievements of our company to be materially different from those expressed or implied in the forward-looking statements. Such factors include, but are not limited to:

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

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

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

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

the impact of the regulatory environment as well as national, state, and local laws and regulations including, without limitation, those governing Real Estate Investment Trusts, which could increase our expenses and reduce the our cash available for distribution;

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

delays in the development and construction process, which could adversely affect our profitability; and economic uncertainty due to the impact of war or terrorism which could adversely affect our business plan.

        The forward-looking statements are based on our beliefs, assumptions and expectations of our future performance, taking into account all information currently available to us. These beliefs, assumptions and expectations are subject to risks and uncertainties and can change as a result of many possible events or factors, not all of which are known to us. If a change occurs, our business, financial condition, liquidity and results of operations may vary materially from those expressed in our forward-looking statements. You should carefully consider these risks before you make an investment decision with respect to our common stock.

        We disclaim any duty or obligation to update or revise any forward-looking statements set forth in this Annual Report on Form 10-K to reflect new information, future events or otherwise.

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PART I

Item 1.    Business

General

        Extra Space Storage Inc. ("we," "our," "us" or the "Company") is a self-administered and self-managed real estate investment trust ("REIT") formed as a Maryland corporation on April 30, 2004 to own, operate, acquire, develop and redevelop professionally managed self-storage facilities. We closed our initial public offering ("IPO") on August 17, 2004 (the "Offering Date"). Our common stock is traded on the New York Stock Exchange under the symbol "EXR."

        We were formed to continue the business of Extra Space Storage LLC and its subsidiaries (the "Predecessor"), which had engaged in the self-storage business since 1977. These companies were reorganized after the consummation of our IPO and various formation transactions. As of December 31, 2005, we held ownership interests in 546 properties located in 34 states, including Washington D.C. with an aggregate of approximately 38 million square feet of net rentable space and greater than 275,000 customers. Of these 546 properties, 192 are wholly owned, and 354 are owned in joint-venture partnerships. An additional 85 properties are owned by franchisees or third parties and operated by us in exchange for a management fee.

        We operate in two distinct segments: (1) property management and development and (2) rental operations. Our property management and development activities include acquiring, managing, developing and selling self-storage facilities. The rental operations activities include rental operations of self-storage facilities.

        Substantially all of our business is conducted through Extra Space Storage LP (the "Operating Partnership"), and through our wholly-owned Massachusetts business trust subsidiaries, our primary assets are general partner and limited partner interests in the Operating Partnership. This structure is commonly referred to as an umbrella partnership REIT, or UPREIT. We have elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended (the "Internal Revenue Code"). To the extent we continue to qualify as a REIT, we will not be subject to tax, with certain exceptions, on our net taxable income that is distributed to our stockholders.

        We file our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports with the Securities and Exchange Commission (the "SEC"). You may obtain copies of these documents by visiting the SEC's Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549, by calling the SEC at 1-800-SEC-0330 or by accessing the SEC's website at http://www.sec.gov. In addition, as soon as reasonably practicable, after such materials are furnished to the SEC, we make copies of these documents available to the public free of charge through our website at www.extraspace.com, or by contacting our Secretary at our principal offices, which are located at 2795 Cottonwood Parkway, Suite 400, Salt Lake City, Utah 84121, telephone number (801) 562-5556.

Management

        Members of our executive management team have significant experience in all aspects of the self-storage industry, and have an average of more than ten years of industry experience. The senior management team has collectively acquired and/or developed more than 650 properties during the past 25 years for the Company, the Predecessor and other entities. Kenneth M. Woolley, Chairman and Chief Executive Officer, and Richard S. Tanner, Senior Vice President Development, have worked in the self-storage industry since 1977 and led two of the earliest self-storage facility development projects in the United States.

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        The remainder of our executive management team and their years of experience are as follows: Kent Christensen, Senior Vice President, Chief Financial Officer, 8 years; Charles Allen, Senior Vice President, Senior Legal Counsel, 8 years; and Karl Haas, Senior Vice President Operations, 18 years.

        Members of the executive management team have guided the Company through substantial growth, developing and acquiring over $2.75 billion in assets since 1996. This growth has been funded through equity offerings and more than $2.0 billion in private equity capital since 1998. This private equity capital has come primarily from sophisticated, high net-worth individuals and institutional investors such as affiliates of Prudential Financial, Inc. and Fidelity Investments.

        Our executive management and board of directors have a significant ownership position in the Company with executive officers and directors owning approximately 5.3 million shares or 10.3% of our outstanding common stock as of February 28, 2006.

Industry & Competition

        Self-storage properties refer to properties that offer do-it-yourself, month-to-month storage space rental for personal or business use. Self-storage offers a cost-effective and flexible storage alternative. Tenants rent fully enclosed spaces that can vary in size according to their specific needs and to which they have unlimited, exclusive access. Tenants have responsibility for moving their items into and out of their units. Self-storage unit sizes typically range from five feet by five feet to 20 feet by 20 feet, with an interior height of eight to 12 feet. Properties generally have on-site managers who supervise and run the day-to-day operations, providing tenants with assistance as needed.

        Self-storage provides a convenient way for individuals and businesses to store their possessions, whether due to a life-change, or simply because of a need for storage space. The mix of residential tenants using a self-storage property is determined by a property's local demographics and often includes people who are looking to downsize their living space or others who are not yet settled in large homes.

        Items that residential tenants place in self-storage properties range from cars, boats and recreational vehicles, to furniture, household items and appliances. Commercial tenants tend to include small business owners who require easy and frequent access to their goods, records or extra inventory or storage for seasonal goods.

        Our research has shown that tenants choose a self-storage property based primarily on the convenience of the site to their home or business, making high-density, high-traffic population centers ideal locations for locating a self-storage property. A property's perceived security and the general professionalism of the site managers and staff are also contributing factors to a site's ability to successfully secure rentals. Although most self-storage properties are leased to tenants on a month-to-month basis, tenants tend to continue their leases for extended periods of time.

        Self-storage does have seasonal fluctuations in occupancy rates for self-storage properties. Based on our experience, generally, there is increased leasing activity at self-storage properties during the summer months due to the higher number of people who relocate during this period. The highest level of occupancy is achieved in July and August, while the lowest level of occupancy is seen in February and March.

        Since inception in the early 1970's the self-storage industry has experienced significant growth. In the past ten years, there has been even greater growth. According to the 2006 Self-Storage Almanac (the "Almanac"), in 1995 there were only 23,972 self-storage properties in the United States, with an average occupancy rate of 88.5% of net rentable square feet compared to 41,122 self-storage properties in 2005 with an average occupancy rate of 83.0% of net rentable square feet. As population densities have increased in the United States, there has been an increase in self-storage awareness and corresponding development, which we expect will continue in the future.

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        Our research indicates that the factors most important to tenants when choosing a self-storage site are a convenient location, a clean environment, friendly service and a professional helpful staff. Our experience also indicates that successfully competing in the self-storage industry requires an experienced and dedicated management team that is supported by an efficient and flexible operating platform that is responsive to tenants' needs and expectations.

        Increased competition has affected our business and has led to both pricing and discount pressure. This has limited our ability to increase revenues in many markets in which we operate. Many markets have been able to absorb the increase in self-storage development due to superior demographics and density. However, select markets have not been able to absorb the new facilities and have not performed as well.

        We have encountered competition when we seek to acquire properties, especially for brokered portfolios. Aggressive bidding practices have been commonplace between both public and private entities, and this competition has limited our ability to grow at a more consistent pace.

        Increased development within the self-storage industry has also led to an increased emphasis on site location, property design, innovation and functionality. We strive to have a creative and flexible approach to our development projects and we are open to a broad array of opportunities because of this flexibility. This is especially true for new sites slated for high-density population centers, to accommodate the requirements and tastes of local planning and zoning boards, and to distinguish a facility from other offerings in the market. Due to the attractive architecture of many of our development properties, we have been able to eliminate a typical barrier of entry for most self-storage developers in areas usually reserved for more traditional retail and commercial users.

        The industry is also characterized by fragmented ownership. According to the Almanac, the top five self-storage companies in the United States owned approximately 10.0% of total U.S. self-storage properties, and the top 50 self-storage companies owned approximately 15.3% of the total U.S. properties. We believe this fragmentation will contribute to continued consolidation at some level into the future. We also believe we are well positioned to be able to compete for acquisitions given our enhanced ability to access capital as a public company and our historical reputation for closing deals.

        After our acquisition of the Storage USA properties on July 14, 2005, we became the second largest self-storage owner and operator in the United States. We are now one of five public self-storage REITS along with Public Storage Inc. (NYSE: PSA), Shurgard Storage Centers, Inc. (NYSE: SHU), Sovran Self-Storage, Inc. (NYSE: SSS), and U-Store-It Inc. (NYSE: YSI).

Growth and Investment Strategies

        Our primary business objectives are to maximize cash flow available for distribution to our stockholders and to achieve sustainable long-term growth in cash flow per share in order to maximize long-term stockholder value. Our business strategy to achieve these objectives consists of the following elements:


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Financing of Our Growth Strategies

4


Regulation

        Generally, self-storage properties are subject to various laws, ordinances and regulations, including regulations relating to lien sale rights and procedures. Changes in any of these laws or regulations, as well as changes in laws, such as the Comprehensive Environmental Response and Compensation Liability Act, or CERCLA, which increase the potential liability for environmental conditions or circumstances existing or created by tenants or others on properties, or laws affecting development, construction, operation, upkeep, safety and taxation may result in significant unanticipated expenditures, loss of self-storage sites or other impairments to operations, which would adversely affect our financial position, results of operations or cash flows.

        Under the American Disabilities Act (the "ADA"), all places of public accommodation are required to meet certain federal requirements related to access and use by disabled persons. These requirements became effective in 1992. A number of additional U.S. federal, state and local laws also exist that may require modifications to the properties, or restrict further renovations thereof, with respect to access thereto by disabled persons. Noncompliance with the ADA could result in the imposition of fines or an award of damages to private litigants and also could result in an order to correct any non-complying feature, thereby requiring substantial capital expenditures. To the extent our properties are not in compliance, we are likely to incur additional costs to comply with the ADA.

        Insurance activities are subject to state insurance laws and regulations as determined by the particular insurance commissioner for each state in accordance with the McCarran-Ferguson Act, and are subject to the Gramm-Leach-Bliley Act and the privacy regulations promulgated by the Federal Trade Commission pursuant thereto.

        Property management activities are often subject to state real estate brokerage laws and regulations as determined by the particular real estate commission for each state.

        Changes in any of the laws governing our conduct could have an adverse impact on our ability to conduct our business or could materially affect our financial position, results of operations or cash flows.

Employees

        As of February 28, 2006, we had 1,943 employees and believe our relationship with our employees to be good. Our employees are not represented by a collective bargaining agreement.


Item 1A.    Risk Factors

        An investment in our securities involves various risks. All investors should carefully consider the following risk factors in conjunction with the other information contained in this Annual Report before trading in our securities. If any of the events set forth in the following risks actually occur, our business, operating results, prospects and financial condition could be harmed.

        Our performance is subject to risks associated with real estate investments. We are a real estate company that derives our income from operation of our properties. There are a number of factors that may adversely affect the income that our properties generate, including the following:

Risks Related to Our Properties and Operations

If we are unable to promptly re-let our units or if the rates upon such re-letting are significantly lower than expected, then our business and results of operations would be adversely affected.

        Virtually all of our leases are on a month-to-month basis. Any delay in re-letting units as vacancies arise would reduce our revenues and harm our operating results. In addition, lower than expected rental rates upon re-letting could impede our growth.

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We face increasing competition for the acquisition of self-storage properties and other assets, which may impede our ability to make future acquisitions or may increase the cost of these acquisitions.

        We compete with many other entities engaged in real estate investment activities for acquisitions of self-storage properties and other assets, including national, regional and local operators and developers of self-storage properties. These competitors may drive up the price we must pay for self-storage properties or other assets we seek to acquire or may succeed in acquiring those properties or assets themselves. In addition, our potential acquisition targets may find our competitors to be more attractive suitors because they may have greater resources, may be willing to pay more or may have a more compatible operating philosophy. In addition, the number of entities and the amount of funds competing for suitable investment properties may increase. This competition will result in increased demand for these assets and therefore increased prices paid for them. Because of an increased interest in single-property acquisitions among tax-motivated individual purchasers, we may pay higher prices if we purchase single properties in comparison with portfolio acquisitions. If we pay higher prices for self-storage properties or other assets, our profitability will be reduced.

Our investments in development and redevelopment projects may not yield anticipated returns, which would harm our operating results and reduce the amount of funds available for distributions.

        A key component of our growth strategy is exploring new asset development and redevelopment opportunities through strategic joint ventures. To the extent that we engage in these development and redevelopment activities, they will be subject to the following risks normally associated with these projects:

        In deciding whether to develop or redevelop a particular property, we make certain assumptions regarding the expected future performance of that property. We may underestimate the costs necessary to bring the property up to the standards established for its intended market position or may be unable to increase occupancy at a newly acquired property as quickly as expected or at all. Any substantial unanticipated delays or expenses could adversely affect the investment returns from these development or redevelopment projects and harm our operating results, liquidity and financial condition, which could result in a decline in the value of our securities.

        We may in the future develop self-storage properties in geographic regions where we do not currently have a significant presence and where we do not possess the same level of familiarity with development, which could adversely affect our ability to develop such properties successfully or at all or to achieve expected performance.

        We rely to a large extent on the investments of our joint venture partners for funding our development and redevelopment projects. If our reputation in the self-storage industry changes or the number of investors considering us an attractive strategic partner is otherwise reduced, our ability to develop or redevelop properties could be affected, which would limit our growth.

We may not be successful in identifying and consummating suitable acquisitions that meet our criteria, which may impede our growth and negatively affect our stock price.

        Our ability to expand through acquisitions is integral to our business strategy and requires us to identify suitable acquisition candidates or investment opportunities that meet our criteria and are

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compatible with our growth strategy. We may not be successful in identifying suitable properties or other assets that meet our acquisition criteria or in consummating acquisitions or investments on satisfactory terms or at all. Failure to identify or consummate acquisitions will slow our growth, which could in turn adversely affect our stock price.

        Our ability to acquire properties on favorable terms and successfully integrate and operate them may be constrained by the following significant risks:

        In addition, strategic decisions by us, such as acquisitions, may adversely affect the price of our common stock.

We may not be successful in integrating and operating acquired properties.

        We expect to make future acquisitions of self-storage properties. If we acquire any self-storage properties, we will be required to integrate them into our existing portfolio. The acquired properties may turn out to be less compatible with our growth strategy than originally anticipated, may cause disruptions in our operations or may divert management's attention away from day-to-day operations, which could impair our results of operations as a whole.

We depend upon our on-site personnel to maximize tenant satisfaction at each of our properties, and any difficulties we encounter in hiring, training and maintaining skilled field personnel may harm our operating performance.

        We have 1,628 field personnel as of February 28, 2006 in the management and operation of our properties. The general professionalism of our site managers and staff are contributing factors to a site's ability to successfully secure rentals. We also rely upon our field personnel to maintain clean and secure self-storage properties. If we are unable to successfully recruit, train and retain qualified field personnel, the quality of service we strive to provide at our properties could be adversely affected which could lead to decreased occupancy levels and reduced operating performance.

Other self-storage operators may employ STORE or a technology similar to STORE, which could enhance their ability to compete with us.

        We rely on STORE to support all aspects of our business operations and to help us implement new development and acquisition opportunities and strategies. If other self-storage companies obtain a license to use STORE, or employ or develop a technology similar to STORE, their ability to compete with us could be enhanced.

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Uninsured losses or losses in excess of our insurance coverage could adversely affect our financial condition and our cash flow.

        We maintain comprehensive liability, fire, flood, earthquake, wind (as deemed necessary or as required by our lenders), extended coverage and rental loss insurance with respect to our properties with policy specifications, limits and deductibles customarily carried for similar properties. Certain types of losses, however, may be either uninsurable or not economically insurable, such as losses due to earthquakes, hurricanes, tornadoes, riots, acts of war or terrorism. Should an uninsured loss occur, we could lose both our investment in and anticipated profits and cash flow from a property. In addition, if any such loss is insured, we may be required to pay a significant deductible on any claim for recovery of such a loss prior to our insurer being obligated to reimburse us for the loss, or the amount of the loss may exceed our coverage for the loss. As a result, our operating results may be adversely affected.

Increases in taxes and regulatory compliance costs may reduce our income.

        Costs resulting from changes in real estate tax laws generally are not passed through to tenants directly and will affect us. Increases in income, property or other taxes generally are not passed through to tenants under leases and may reduce our net income, FFO, cash flow, financial condition, ability to pay or refinance our debt obligations, ability to make distributions to stockholders, and the trading price of our common stock. Similarly, changes in laws increasing the potential liability for environmental conditions existing on properties or increasing the restrictions on discharges or other conditions may result in significant unanticipated expenditures, which could similarly adversely affect our business and results of operations.

We did not always obtain independent appraisals of our properties, and thus the consideration paid for these properties may exceed the value that may be indicated by third-party appraisals.

        We do not always obtained third-party appraisals of the properties in connection with our acquisitions of properties and the consideration being paid by us in exchange for those properties may exceed the value as determined by third-party appraisals. In such cases, the terms of any agreements and the valuation methods used to determine the value of the properties were determined by our senior management team.

Environmental compliance costs and liabilities associated with operating our properties may affect our results of operations.

        Under various U.S. federal, state and local laws, ordinances and regulations, owners and operators of real estate may be liable for the costs of investigating and remediating certain hazardous substances or other regulated materials on or in such property. Such laws often impose such liability without regard to whether the owner or operator knew of, or was responsible for, the presence of such substances or materials. The presence of such substances or materials, or the failure to properly remediate such substances, may adversely affect the owner's or operator's ability to lease, sell or rent such property or to borrow using such property as collateral. Persons who arrange for the disposal or treatment of hazardous substances or other regulated materials may be liable for the costs of removal or remediation of such substances at a disposal or treatment facility, whether or not such facility is owned or operated by such person. Certain environmental laws impose liability for release of asbestos-containing materials into the air and third parties may seek recovery from owners or operators of real properties for personal injury associated with asbestos-containing materials.

        Certain environmental laws also impose liability, without regard to knowledge or fault, for removal or remediation of hazardous substances or other regulated materials upon owners and operators of contaminated property even after they no longer own or operate the property. Moreover, the past or present owner or operator from which a release emanates could be liable for any personal injuries or

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property damages that may result from such releases, as well as any damages to natural resources that may arise from such releases.

        Certain environmental laws impose compliance obligations on owners and operators of real property with respect to the management of hazardous materials and other regulated substances. For example, environmental laws govern the management of asbestos-containing materials and lead-based paint. Failure to comply with these laws can result in penalties or other sanctions.

        No assurances can be given that existing environmental studies with respect to any of our properties reveal all environmental liabilities, that any prior owner or operator of our properties did not create any material environmental condition not known to us, or that a material environmental condition does not otherwise exist as to any one or more of our properties. There also exists the risk that material environmental conditions, liabilities or compliance concerns may have arisen after the review was completed or may arise in the future. Finally, future laws, ordinances or regulations and future interpretations of existing laws, ordinances or regulations may impose additional material environmental liability.

Adverse economic or other conditions in the markets in which we do business could negatively affect our occupancy levels and rental rates and therefore our operating results.

        Our operating results are dependent upon our ability to maximize occupancy levels and rental rates in our self-storage properties. Adverse economic or other conditions in the markets in which we operate may lower our occupancy levels and limit our ability to increase rents or require us to offer rental discounts. If our properties fail to generate revenues sufficient to meet our cash requirements, including operating and other expenses, debt service and capital expenditures, our net income, funds from operations ("FFO"), cash flow, financial condition, ability to make distributions to stockholders and common stock trading price could be adversely affected. The following factors, among others, may adversely affect the operating performance of our properties:


Risks Related to Our Organization and Structure

Our business could be harmed if key personnel with long-standing business relationships in the self-storage industry terminate their employment with us.

        Our success depends, to a significant extent, on the continued services of our Chairman and Chief Executive Officer and the other members of our executive management team. Our executive

9



management team has substantial experience in the self-storage industry. In addition, our ability to continue to develop properties depends on the significant relationships our executive management team has developed with our institutional joint venture partners such as affiliates of Prudential Financial, Inc. There is no guarantee that any of them will remain employed by us. We do not maintain key person life insurance on any of our officers. The loss of services of one or more members of our executive management team, particularly our Chairman and Chief Executive Officer, could harm our business and our prospects.

We may change our investment and financing strategies and enter into new lines of business without stockholder consent, which may subject us to different risks.

        We may change our investment and financing strategies and enter into new lines of business without stockholder consent, which may subject us to different risks. We may change our investment and financing strategies and enter into new lines of business at any time without the consent of our stockholders, which could result in our making investments and engaging in business activities that are different from, and possibly riskier than, the investments and businesses described in this document. A change in our investment strategy or our entry into new lines of business may increase our exposure to other risks or real estate market fluctuations.

If other self-storage companies convert to an UPREIT structure or if tax laws change, we may no longer have an advantage in competing for potential acquisitions.

        Because we are structured as an UPREIT, we are a more attractive acquirer of property to tax-motivated sellers than our competitors that are not structured as UPREITs. However, if other self-storage companies restructure their holdings to become UPREITs, this competitive advantage will disappear. In addition, new legislation may be enacted or new interpretations of existing legislation may be issued by the Internal Revenue Service ("IRS"), or the U.S. Treasury Department that could affect the attractiveness of our UPREIT structure so that it may no longer assist us in competing for acquisitions.

Tax indemnification obligations may require the operating partnership to maintain certain debt levels.

        In connection with the formation transactions, we agreed to make available to each of Kenneth M. Woolley, our Chairman and Chief Executive Officer, Richard S. Tanner, our Senior Vice President, Development, and other third parties, the following tax protections: for nine years, with a three-year extension if the applicable party continues to own at least 50% of the OP units received by it in the formation transactions at the expiration of the initial nine-year period, the opportunity to (1) guarantee debt or (2) enter into a special loss allocation and deficit restoration obligation, in an aggregate amount, with respect to the foregoing contributors, of at least equal to $60.0 million. We agreed to these provisions in order to assist these contributors in preserving their tax position after their contributions. These obligations may require us to maintain certain indebtedness than we would not otherwise require for our business.

Our joint venture investments could be adversely affected by our lack of sole decision-making authority.

        As of December 31, 2005, we held interests in 354 properties through joint ventures. All of these arrangements could be adversely affected by our lack of sole decision-making authority, our reliance on co-venturers' financial conditions and disputes between us and our co-venturers. We expect to continue our joint venture strategy by entering into more joint ventures for the purpose of developing new self-storage properties and acquiring existing properties. In such event, we would not be in a position to exercise sole decision-making authority regarding the property, partnership, joint venture or other entity. The decision-making authority regarding the properties we currently hold through joint ventures is either vested exclusively with our joint venture partners, is subject to a majority vote of the joint

10



venture partners or equally shared by us and the joint venture partners. In addition, investments in partnerships, joint ventures or other entities may, under certain circumstances, involve risks not present were a third party not involved, including the possibility that partners or co-venturers might become bankrupt or fail to fund their share of required capital contributions. Partners or co-venturers may have economic or other business interests or goals which are inconsistent with our business interests or goals, and may be in a position to take actions contrary to our policies or objectives. Such investments may also have the potential risk of impasses on decisions, such as a sale, because neither we nor the partner or co-venturer would have full control over the partnership or joint venture. Disputes between us and partners or co-venturers may result in litigation or arbitration that would increase our expenses and prevent our officers and/or directors from focusing their time and efforts on our business. Consequently, actions by or disputes with partners or co-venturers might result in subjecting properties owned by the partnership or joint venture to additional risk. In addition, we may in certain circumstances be liable for the actions of our third-party partners or co-venturers, which could harm our financial condition.

Kenneth M. Woolley, our Chairman and Chief Executive Officer, Spencer F. Kirk, one of our directors, Richard S. Tanner, Senior Vice President, Development, Kent W. Christensen, Senior Vice President, Chief Financial Officer, and Charles L. Allen, Senior Vice President, Senior Legal Counsel, members of our senior management team, have outside business interests which could divert their time and attention away from us, which could harm our business.

        Kenneth M. Woolley, our Chairman and Chief Executive Officer, as well as one of our directors and certain other members of our senior management team, have outside business interests. These business interests include the ownership of a self-storage property located in Pico Rivera, California, which as of December 31, 2005 was in lease-up, and the ownership of Extra Space Development LLC. Other than this property and Extra Space Development, LLC, the members of our senior management are not currently engaged in any other self-storage activities outside the company. In addition, Mr. Woolley's employment agreement includes an exception to his non-competition covenant pursuant to which he is permitted to devote a portion of his time to the management and operations of RMI Development, LLC, a multi-family business in which he has a majority ownership. Although Mr. Woolley's employment agreement requires that he devote substantially his full business time and attention to us, this agreement also permits him to devote time to his outside business interests. These outside business interests could interfere with his ability to devote time to our business and affairs and as a result, our business could be harmed.

Conflicts of interest could arise as a result of our relationship with our operating partnership.

        Conflicts of interest could arise in the future as a result of the relationships between us and our affiliates, on the one hand, and our operating partnership or any partner thereof, on the other. Our directors and officers have duties to our company under applicable Maryland law in connection with their management of our company. At the same time, we, through our wholly owned subsidiary, have fiduciary duties, as a general partner, to our operating partnership and to the limited partners under Delaware law in connection with the management of our operating partnership. Our duties, through our wholly owned subsidiary, as a general partner to our operating partnership and its partners may come into conflict with the duties of our directors and officers to our company. The partnership agreement of our operating partnership does not require us to resolve such conflicts in favor of either our company or the limited partners in our operating partnership.

        Unless otherwise provided for in the relevant partnership agreement, Delaware law generally requires a general partner of a Delaware limited partnership to adhere to fiduciary duty standards under which it owes its limited partners the highest duties of good faith, fairness, and loyalty and which generally prohibit such general partner from taking any action or engaging in any transaction as to which it has a conflict of interest.

11



        Additionally, the partnership agreement expressly limits our liability by providing that neither we, our direct wholly owned Massachusetts business trust subsidiary, as the general partner of the operating partnership, nor any of our or their trustees, directors or officers, will be liable or accountable in damages to our operating partnership, the limited partners or assignees for errors in judgment, mistakes of fact or law or for any act or omission if we, or such trustee, director or officer, acted in good faith. In addition, our operating partnership is required to indemnify us, our affiliates and each of our respective trustees, officers, directors, employees and agents to the fullest extent permitted by applicable law against any and all losses, claims, damages, liabilities (whether joint or several), expenses (including, without limitation, attorneys' fees and other legal fees and expenses), judgments, fines, settlements and other amounts arising from any and all claims, demands, actions, suits or proceedings, civil, criminal, administrative or investigative, that relate to the operations of the operating partnership, provided that our operating partnership will not indemnify for (1) willful misconduct or a knowing violation of the law, (2) any transaction for which such person received an improper personal benefit in violation or breach of any provision of the partnership agreement, or (3) in the case of a criminal proceeding, the person had reasonable cause to believe the act or omission was unlawful.

        The provisions of Delaware law that allow the common law fiduciary duties of a general partner to be modified by a partnership agreement have not been resolved in a court of law, and we have not obtained an opinion of counsel covering the provisions set forth in the partnership agreement that purport to waive or restrict our fiduciary duties that would be in effect under common law were it not for the partnership agreement.

Our management's ownership of contingent conversion shares, or CCSs, and contingent conversion units, or CCUs, may cause them to devote a disproportionate amount of time to the performance of the 14 wholly owned early-stage lease-up properties, which could cause our overall operating performance to suffer.

        In connection with our IPO, we issued to certain contributors, which included certain members of our senior management, CCSs and/or a combination of OP units and CCUs. The terms of the CCSs and CCUs provide that they will convert into our common stock and OP units, respectively, only if the relevant 14 lease-up properties identified at the time of the initial public offering achieve specified performance thresholds prior to December 31, 2008. As a result, our directors and officers who own CCSs and CCUs may have an incentive to devote a disproportionately large amount of their time and attention to these properties in comparison with our remaining properties, which could harm our operating results.

We may pursue less vigorous enforcement of terms of contribution and other agreements because of conflicts of interest with certain of our officers.

        Kenneth M. Woolley, our Chairman and Chief Executive Officer, Spencer F. Kirk, who serves as director, Kent W. Christensen, Senior Vice President, Chief Financial Officer, Charles L. Allen, Senior Vice President, Senior Legal Counsel, and Richard S. Tanner, Senior Vice President, Development had direct or indirect ownership interests in certain properties that were contributed to our operating partnership in the formation transactions. Following the completion of the formation transactions, we, under the agreements relating to the contribution of such interests, became entitled to indemnification and damages in the event of breaches of representations or warranties made by the contributors. In addition, Kenneth M. Woolley's employment agreement includes an exception to his non-competition covenant pursuant to which he is permitted to devote time to the management and operations of RMI Development, LLC, a multi-family business. None of these contribution and non-competition agreements was negotiated on an arm's-length basis. We may choose not to enforce, or to enforce less vigorously, our rights under these contribution and non-competition agreements because of our desire to maintain our ongoing relationships with the individuals party to these agreements.

12



Certain provisions of Maryland law and our organizational documents, including the stock ownership limit imposed by our charter, may inhibit market activity in our stock and could prevent or delay a change in control transaction.

        Our charter, subject to certain exceptions, authorizes our directors to take such actions as are necessary and desirable to preserve our qualification as a REIT and to limit any person to actual or constructive ownership of no more than 7.0% (by value or by number of shares, whichever is more restrictive) of our outstanding common stock or 7.0% (by value or by number of shares, whichever is more restrictive) of our outstanding capital stock. Our board of directors, in its sole discretion, may exempt a proposed transferee from the ownership limit. However, our board of directors may not grant an exemption from the ownership limit to any proposed transferee whose ownership could jeopardize our qualification as a REIT. These restrictions on ownership will not apply if our board of directors determines that it is no longer in our best interests to attempt to qualify, or to continue to qualify, as a REIT. The ownership limit may delay or impede a transaction or a change of control that might involve a premium price for our common stock or otherwise be in the best interests of our stockholders. Different ownership limits apply to the family of Kenneth M. Woolley, certain of his affiliates, family members and estates and trusts formed for the benefit of the foregoing and Spencer F. Kirk, certain of his affiliates, family members and estates and trusts formed for the benefit of the foregoing and certain designated investment entities (as defined in our charter).

Our board of directors has the power to issue additional shares of our stock in a manner that may not be in the best interest of our stockholders.

        Our charter authorizes our board of directors to issue additional authorized but unissued shares of common stock or preferred stock and to increase the aggregate number of authorized shares or the number of shares of any class or series without stockholder approval. In addition, our board of directors may classify or reclassify any unissued shares of common stock or preferred stock and set the preferences, rights and other terms of the classified or reclassified shares. Our board of directors could issue additional shares of our common stock or establish a series of preferred stock that could have the effect of delaying, deferring or preventing a change in control or other transaction that might involve a premium price for our common stock or otherwise be in the best interests of our stockholders.

Our rights and the rights of our stockholders to take action against our directors and officers are limited.

        Maryland law provides that a director or officer has no liability in that capacity if he or she performs his or her duties in good faith, in a manner he or she reasonably believes to be in our best interests and with the care that an ordinarily prudent person in a like position would use under similar circumstances. In addition, our charter eliminates our directors' and officers' liability to us and our stockholders for money damages except for liability resulting from actual receipt of an improper benefit in money, property or services or active and deliberate dishonesty established by a final judgment and which is material to the cause of action. Our bylaws require us to indemnify our directors and officers for liability resulting from actions taken by them in those capacities to the maximum extent permitted by Maryland law. As a result, we and our stockholders may have more limited rights against our directors and officers than might otherwise exist under common law. In addition, we may be obligated to fund the defense costs incurred by our directors and officers.

To the extent our distributions represent a return of capital for U.S. federal income tax purposes, our stockholders could recognize an increased capital gain upon a subsequent sale of common stock.

        Distributions in excess of our current and accumulated earnings and profits and not treated by us as a dividend will not be taxable to a U.S. stockholder under current U.S. federal income tax law to the extent those distributions do not exceed the stockholder's adjusted tax basis in his, her, or its common stock, but instead will constitute a return of capital and will reduce such adjusted basis. If distributions

13



result in a reduction of a stockholder's adjusted basis in such holder's common stock, subsequent sales of such holder's common stock will result in recognition of an increased capital gain or realized capital loss due to the reduction in such adjusted basis.

Risks Related to the Real Estate Industry

Our primary business involves the ownership, operation and development of self-storage properties.

        Our current strategy is to own, operate and develop only self-storage properties. Consequently, we are subject to risks inherent in investments in a single industry. Because investments in real estate are inherently illiquid, this strategy makes it difficult for us to diversify our investment portfolio and to limit our risk when economic conditions change. Decreases in market rents, negative tax, real estate and zoning law changes and changes in environmental protection laws may also increase our costs, lower the value of our investments and decrease our income, which would adversely affect our business, financial condition and operating results.

Any negative perceptions of the self-storage industry generally may result in a decline in our stock price.

        To the extent that the investing public has a negative perception of the self-storage industry, the value of our common stock may be negatively impacted, which could result in our common stock trading below the inherent value of our assets.

Costs associated with complying with the Americans with Disabilities Act of 1990 may result in unanticipated expenses.

        Under the ADA, all places of public accommodation are required to meet certain federal requirements related to access and use by disabled persons. These requirements became effective in 1992. A number of additional U.S. federal, state and local laws may also require modifications to our properties, or restrict certain further renovations of the properties, with respect to access thereto by disabled persons. Noncompliance with the ADA could result in the imposition of fines or an award of damages to private litigants and also could result in an order to correct any non-complying feature, which could result in substantial capital expenditures. We have not conducted an audit or investigation of all of our properties to determine our compliance and we cannot predict the ultimate cost of compliance with the ADA or other legislation. If one or more of our properties is not in compliance with the ADA or other legislation, then we would be required to incur additional costs to bring the facility into compliance. If we incur substantial costs to comply with the ADA or other legislation, our financial condition, results of operations, cash flow, per share trading price of our common stock and our ability to satisfy our debt service obligations and to make distributions to our stockholders could be adversely affected.

Illiquidity of real estate investments could significantly impede our ability to respond to adverse changes in the performance of our properties.

        Because real estate investments are relatively illiquid, our ability to promptly sell one or more properties in our portfolio in response to changing economic, financial and investment conditions is limited. The real estate market is affected by many factors, such as general economic conditions, availability of financing, interest rates and other factors, including supply and demand, that are beyond our control. We cannot predict whether we will be able to sell any property for the price or on the terms set by us or whether any price or other terms offered by a prospective purchaser would be acceptable to us. We also cannot predict the length of time needed to find a willing purchaser and to close the sale of a property.

        We may be required to expend funds to correct defects or to make improvements before a property can be sold. We cannot assure you that we will have funds available to correct those defects or

14



to make those improvements. In acquiring a property, we may agree to transfer restrictions that materially restrict us from selling that property for a period of time or impose other restrictions, such as a limitation on the amount of debt that can be placed or repaid on that property. These transfer restrictions would impede our ability to sell a property even if we deem it necessary or appropriate.

Any investments in unimproved real property may take significantly longer to yield income-producing returns, if at all, and may result in additional costs to us to comply with re-zoning restrictions or environmental regulations.

        We have invested in the past, and may invest in the future, in unimproved real property. Unimproved properties generally take longer to yield income-producing returns based on the typical time required for development. Any development of unimproved property may also expose us to the risks and uncertainties associated with re-zoning the land for a higher use or development and environmental concerns of governmental entities and/or community groups. Any unsuccessful investments or delays in realizing an income-producing return or increased costs to develop unimproved real estate could restrict our ability to earn our targeted rate of return on an investment or adversely affect our ability to pay operating expenses which would harm our financial condition and operating results.

Risks Related to Our Debt Financings

Required payments of principal and interest on borrowings may leave us with insufficient cash to operate our properties or to pay the distributions currently contemplated or necessary to maintain our qualification as a REIT and may expose us to the risk of default under our debt obligations.

        As of December 31, 2005, we had approximately $866.8 million of outstanding indebtedness. We expect to incur additional debt in connection with future acquisitions. We may borrow under our line of credit or borrow new funds to acquire these future properties. Additionally, we do not anticipate that our internally generated cash flow will be adequate to repay our existing indebtedness upon maturity and, therefore, we expect to repay our indebtedness through refinancings and equity and/or debt offerings. Further, we may need to borrow funds to make distributions required to maintain our qualification as a REIT or to meet our expected distributions.

        If we are required to utilize our line of credit for purposes other than acquisition activity, this will reduce the amount available for acquisitions and could slow our growth. Therefore, our level of debt and the limitations imposed on us by our debt agreements could have significant adverse consequences, including the following:

15


We could become highly leveraged in the future because our organizational documents contain no limitation on the amount of debt we may incur.

        Our organizational documents contain no limitations on the amount of indebtedness that we or our operating partnership may incur. We could alter the balance between our total outstanding indebtedness and the value of our portfolio at any time. If we become more highly leveraged, then the resulting increase in debt service could adversely affect our ability to make payments on our outstanding indebtedness and to pay our anticipated distributions and/or the distributions required to maintain our REIT qualification, and could harm our financial condition.

Increases in interest rates may increase our interest expense and adversely affect our cash flow and our ability to service our indebtedness and make distributions to our stockholders.

        As of December 31, 2005 we had approximately $866.8 million of debt outstanding, of which approximately $94.2 million, or 10.9% will be subject to variable interest rates (including $61.8 million on which we had a reverse interest rate swap). This variable rate debt had a weighted average interest rate of approximately 5.7% per annum. Increases in interest rates on this variable rate debt would increase our interest expense, which could harm our cash flow and our ability to pay distributions. For example, if market rates of interest on this variable rate debt increased by 100 basis points, the increase in interest expense would decrease future earnings and cash flows by approximately $1.0 million annually.

Failure to hedge effectively against interest rate changes may adversely affect our results of operations.

        In certain cases we may seek to manage our exposure to interest rate volatility by using interest rate hedging arrangements. Hedging involves risks, such as the risk that the counterparty may fail to honor its obligations under an arrangement. Failure to hedge effectively against interest rate changes may adversely affect our financial condition, results of operations and ability to make distributions to our stockholders.

Risks Related to Qualification and Operation as a REIT

To maintain our qualification as a REIT, we may be forced to borrow funds on a short-term basis during unfavorable market conditions.

        To qualify as a REIT, we generally must distribute to our stockholders at least 90% of our net taxable income each year, excluding net capital gains, and we are subject to regular corporate income taxes to the extent that we distribute less than 100% of our net taxable income each year. In addition, we are subject to a 4% nondeductible excise tax on the amount, if any, by which distributions made 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. In order to maintain our REIT qualification and avoid the payment of income and excise taxes, we may need to borrow funds on a short-term basis, or possibly long-term, to meet the REIT distribution requirements even if the then prevailing market conditions are not favorable for these borrowings. These borrowing needs could result from a difference in timing between the actual receipt of cash and inclusion of income for U.S. federal income tax purposes, or the effect of non-deductible capital expenditures, the creation of reserves or required debt amortization payments.

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Dividends payable by REITs generally do not qualify for reduced tax rates.

        The maximum U.S. federal income tax rate for dividends paid by domestic corporations to individual U.S. stockholders is 15% (through 2008). Dividends paid by REITs, however, are generally not eligible for the reduced rates. The more favorable rates applicable to regular corporate dividends could cause stockholders who are individuals to perceive investments in REITs to be relatively less attractive than investments in the stocks of non-REIT corporations that pay dividends, which could adversely affect the value of the stock of REITs, including our common stock.

        In addition, the relative attractiveness of real estate in general may be adversely affected by the favorable tax treatment given to corporate dividends, which could negatively affect the value of our properties.

Possible legislative or other actions affecting REITs could adversely affect our stockholders.

        The rules dealing with U.S. federal income taxation are constantly under review by persons involved in the legislative process and by the IRS and the U.S. Treasury Department. Changes to tax laws (which changes may have retroactive application) could adversely affect our stockholders. It cannot be predicted whether, when, in what forms, or with what effective dates, the tax laws applicable to us or our stockholders will be changed.

The power of our board of directors to revoke our REIT election without stockholder approval may cause adverse consequences to our stockholders.

        Our charter provides that our board of directors may revoke or otherwise terminate our REIT election, without the approval of our stockholders, if it determines that it is no longer in our best interests to continue to qualify as a REIT. If we cease to qualify as a REIT, we would become subject to U.S. federal income tax on our taxable income and would no longer be required to distribute most of our net taxable income to our stockholders, which may have adverse consequences on the total return to our stockholders.

Our failure to qualify as a REIT would have significant adverse consequences to us and the value of our stock.

        We operate in a manner that allows us to qualify as a REIT for U.S. federal income tax purposes under the Internal Revenue Code. If we fail to qualify as a REIT or lose our qualification as a REIT at any time, we will face serious tax consequences that would substantially reduce the funds available for distribution to you for each of the years involved because:

        In addition, if we fail to qualify as a REIT, we will not be required to make distributions to stockholders, and all distributions to stockholders will be subject to tax as regular corporate dividends to the extent of our current and accumulated earnings and profits. This means that our U.S. individual stockholders would be taxed on our dividends at capital gains rates, and our U.S. corporate stockholders would be entitled to the dividends received deduction with respect to such dividends, subject, in each case, to applicable limitations under the Internal Revenue Code. As a result of all these factors, our failure to qualify as a REIT also could impair our ability to expand our business and raise capital, and could adversely affect the value of our common stock.

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        Qualification as a REIT involves the application of highly technical and complex Internal Revenue Code provisions for which there are only limited judicial and administrative interpretations. The complexity of these provisions and of the applicable Treasury regulations that have been promulgated under the Internal Revenue Code is greater in the case of a REIT that, like us, holds its assets through a partnership. The determination of various factual matters and circumstances not entirely within our control may affect our ability to qualify as a REIT. In order to qualify as a REIT, we must satisfy a number of requirements, including requirements regarding the composition of our assets and sources of our gross income. Our ability to satisfy the asset tests depends upon our analysis of the fair market value of our assets, some of which are not susceptible to precise determination, and for which we will not obtain any independent appraisals. Also, we must make distributions to stockholders aggregating annually at least 90% of our net taxable income, excluding capital gains. In addition, legislation, new regulations, administrative interpretations or court decisions may adversely affect our investors, our ability to qualify as a REIT for U.S. federal income tax purposes or the desirability of an investment in a REIT relative to other investments.

We will pay some taxes.

        Even though we qualify as a REIT for U.S. federal income tax purposes, we will be required to pay some U.S. federal, state and local taxes on our income and property. Extra Space Management, Inc. manages self-storage properties for our joint venture properties and properties owned by third parties. We, jointly with Extra Space Management, Inc., elected to treat Extra Space Management, Inc. as a "taxable REIT subsidiary" of our Company for U.S. federal income tax purposes. A taxable REIT subsidiary is a fully taxable corporation, and may be limited in its ability to deduct interest payments made to us. In addition, we will be subject to a 100% penalty tax on certain amounts if the economic arrangements among our tenants, our taxable REIT subsidiary and us are not comparable to similar arrangements among unrelated parties or if we receive payments for inventory or property held for sale to customers in the ordinary course of business. To the extent that we are or our taxable REIT subsidiary is required to pay U.S. federal, state or local taxes, we will have less cash available for distribution to stockholders.

Complying with REIT requirements may cause us to forego otherwise attractive opportunities.

        To qualify as a REIT for U.S. federal income tax purposes, we must continually satisfy tests concerning, among other things, the sources of our income, the nature and diversification of our assets, the amounts we distribute to our stockholders and the ownership of our stock. In order to meet these tests, we may be required to forego attractive business or investment opportunities. Thus, compliance with the REIT requirements may adversely affect our ability to operate solely to maximize profits.


Item 1B.    Unresolved Staff Comments

        None.


Item 2.    Properties

        As of December 31, 2005, we owned or had ownership interests in 546 self-storage properties located in 34 states, including Washington D.C. Of these properties, 192 are wholly-owned and 354 are held in joint ventures. In addition, we managed an additional 85 properties for franchisees or third parties. The properties owned and operated before the Storage USA acquisition operate under the trade-marked Extra Space Storage brand name. We are currently implementing a re-branding program that will convert all of the Storage USA properties to the Extra Space Storage brand. As of December 31, 2005 we owned or had ownership interest in approximately 38 million square feet of space configured in approximately 370,000 separate storage units. Approximately 70% of our properties are clustered around the larger population centers, such as Baltimore/Washington D.C., Boston, Chicago, Dallas, Las Vegas, Los Angeles, Miami, New York City, Orlando, Philadelphia, Phoenix, St.

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Petersburg/Tampa and San Francisco. These markets contain above-average population and income demographics and high barriers to entry for new self-storage properties. The clustering of assets around these population centers enables us to reduce our operating costs through economies of scale. The Storage USA acquisition has given us the increased scale in many core markets as well as a foothold in many markets where we had no previous presence.

        We consider a property to be in the lease-up stage after it has been issued a certificate of occupancy, but before it has achieved stabilization. We also consider a property to be stabilized once it has achieved either an 80% occupancy rate or has been open for three years. These same rules have been applied to the recently acquired SUSA properties.

        As of December 31, 2005, greater than 100,000 tenants were leasing storage units at our 192 wholly-owned properties, primarily on a month-to-month basis, providing the flexibility to increase rental rates over time as market conditions permit. Although leases are short-term in duration, the typical tenant tends to remain at our properties for an extended period of time. For properties that were stabilized as of December 31, 2005, the median length of stay was approximately 11 months.

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        The following table sets forth additional information regarding the occupancy of the stabilized properties on a state-by-state basis as of December 31, 2005 and 2004. The information as of December 31, 2004 is on a pro forma basis as though all the properties owned at December 31, 2005 were under our control as of December 31, 2004.

Stabilized Property Data Based on Location

 
 
   
  Company
  Pro forma
  Company
  Pro forma
  Company
  Pro forma
 
Location

  Number of
Properties

  Number of
units at
December 31,
2005(1)

  Number of
units at
December 31,
2004

  Net rentable
square feet at
December 31,
2005(2)

  Net rentable
square feet at
December 31,
2004

  Square foot
occupancy %
December 31,
2005

  Square foot
occupancy %
December 31,
2004

 
Wholly-Owned Properties                              
Arizona   2   1,325   1,315   136,920   137,080   96.7 % 92.7 %
California   28   18,723   18,773   2,000,267   2,002,598   86.2 % 86.0 %
Colorado   5   2,408   2,411   301,581   301,181   82.1 % 79.6 %
Florida   23   15,373   15,292   1,619,586   1,596,819   92.7 % 92.1 %
Georgia   7   4,017   4,025   500,700   499,582   85.8 % 83.0 %
Illinois   3   2,144   2,147   196,077   185,939   77.2 % 74.8 %
Kentucky   3   1,567   1,582   194,340   194,215   88.0 % 78.2 %
Louisiana   2   1,411   1,411   147,900   147,900   97.4 % 85.8 %
Maryland   5   4,536   4,546   486,554   485,724   80.5 % 75.2 %
Massachusetts   23   11,963   11,985   1,287,963   1,290,471   81.5 % 78.2 %
Michigan   2   1,042   1,048   104,216   104,216   73.6 % 70.4 %
Missouri   3   1,340   1,335   159,647   159,672   75.6 % 78.9 %
Nevada   1   462   463   56,500   57,100   95.2 % 89.1 %
New Hampshire   1   623   623   72,600   72,600   85.1 % 86.9 %
New Jersey   17   13,896   13,934   1,353,403   1,357,937   83.4 % 87.0 %
New York   4   4,445   4,444   256,129   256,324   77.9 % 82.4 %
Ohio   4   2,070   2,078   260,590   261,262   79.1 % 78.1 %
Oregon   1   764   771   67,530   67,530   80.8 % 71.6 %
Pennsylvania   8   6,054   5,922   617,911   605,811   76.9 % 78.8 %
Rhode Island   1   726   717   75,836   76,111   89.2 % 81.3 %
South Carolina   4   2,082   2,088   246,819   246,969   89.5 % 86.9 %
Tennessee   4   2,701   2,689   314,574   315,024   87.8 % 80.2 %
Texas   11   6,447   6,445   724,434   722,356   82.8 % 80.8 %
Utah   3   1,523   1,520   209,520   208,850   88.5 % 82.3 %
Virginia   2   1,220   1,230   126,094   126,029   84.9 % 84.2 %
Washington   1   764   760   67,175   67,175   91.5 % 84.3 %
   
 
 
 
 
 
 
 
Total Wholly-Owned Properties   168   109,626   109,554   11,584,866   11,546,475   84.9 % 83.6 %
   
 
 
 
 
 
 
 
Properties Held in Joint Ventures                              
Alabama   4   2,316   2,318   276,270   276,480   82.3 % 81.9 %
Arizona   12   7,426   7,413   725,904   728,134   91.9 % 84.5 %
California   70   50,707   50,789   4,972,092   4,987,713   86.8 % 84.0 %
Colorado   3   1,906   1,914   213,977   214,097   79.3 % 76.1 %
Connecticut   9   6,529   6,540   729,399   729,844   74.4 % 73.8 %
District of Columbia   1   1,536   1,535   105,592   105,592   78.3 % 81.5 %
Delaware   1   589   588   71,495   71,495   85.6 % 84.7 %
Florida   24   20,401   20,683   1,880,481   1,878,949   88.5 % 83.5 %
Georgia   3   1,918   1,919   227,748   227,748   76.7 % 79.4 %
Illinois   5   3,329   3,375   350,477   334,622   70.1 % 65.7 %
Indiana   9   3,739   3,797   453,731   448,769   81.2 % 82.3 %
Kansas   4   1,712   1,717   203,575   204,185   79.5 % 72.3 %
Kentucky   4   2,254   2,253   259,577   259,345   78.3 % 80.4 %
Maryland   14   10,932   11,018   1,056,421   1,065,786   81.3 % 79.9 %
Massachusetts   18   9,812   9,854   1,078,167   1,071,713   79.4 % 76.3 %
Michigan   10   5,957   5,997   725,847   726,838   73.8 % 77.5 %
Missouri   5   2,755   2,762   315,925   316,725   79.7 % 78.5 %
New Hampshire   2   801   801   83,675   83,675   84.8 % 86.9 %
New Jersey   18   13,421   13,427   1,326,460   1,327,261   84.2 % 83.5 %
New Mexico   9   4,473   4,496   484,737   485,677   86.1 % 84.7 %
New York   19   20,721   20,767   1,487,757   1,497,119   80.2 % 75.9 %
Nevada   7   4,628   4,649   491,409   492,043   87.0 % 92.7 %
Ohio   12   5,582   5,574   794,519   794,951   76.4 % 78.7 %
Oregon   2   1,279   1,262   134,960   134,985   87.0 % 83.6 %
Pennsylvania   8   5,119   5,123   549,142   549,400   80.1 % 85.0 %
Rhode Island   1   611   612   70,325   70,350   60.0 % 73.0 %
Tennessee   24   12,608   12,605   1,530,014   1,533,133   82.0 % 78.8 %
Texas   26   17,709   17,601   1,883,466   1,885,970   78.2 % 77.6 %
Utah   1   519   510   59,400   59,400   78.8 % 79.8 %
Virginia   15   10,359   10,360   1,081,161   1,081,591   79.9 % 80.2 %
Washington   1   551   551   62,730   62,730   92.7 % 82.4 %
   
 
 
 
 
 
 
 
Total Properties Held in Joint Ventures   341   232,199   232,810   23,686,433   23,706,320   82.4 % 80.7 %
   
 
 
 
 
 
 
 
Total Stabilized Properties   509   341,825   342,364   35,271,299   35,252,795   83.2 % 81.6 %
   
 
 
 
 
 
 
 

(1)
Represents unit count as of December 31, 2005 which may differ from December 31, 2004 unit count due to unit conversions or expansions.
(2)
Represents net rentable square feet as of December 31, 2005 which may differ from December 31, 2004 net rentable square feet due to unit conversions or expansions.

20


        The following table sets forth additional information regarding the occupancy of our lease-up properties on a state-by-state basis as of December 31, 2005 and 2004. The information as of December 31, 2004 is on a pro forma basis as though all the properties owned at December 31, 2005 were under our control as of December 31, 2004.

Lease-up Property Data Based on Location

 
 
   
  Company
  Pro forma
  Company
  Pro forma
  Company
  Pro forma
 
Location

  Number of
Properties

  Company
Number of
units at
December 31,
2005(1)

  Pro forma
Number of
units at
December 31,
2004

  Company
Net rentable
square feet at
December 31,
2005(2)

  Pro forma
Net rentable
square feet at
December 31,
2004

  Company
Square foot
occupancy %
December 31,
2005

  Pro forma
Square foot
occupancy %
December 31,
2004

 
Wholly-Owned Properties                              
California   3   1,672   1,708   193,127   192,977   77.8 % 68.8 %
Connecticut   2   1,364   1,360   123,465   123,290   62.5 % 61.0 %
Florida   1   388   388   37,985   38,005   84.5 % 69.1 %
Illinois   2   1,141   1,133   144,965   144,515   65.8 % 56.0 %
Massachusetts   6   3,771   3,736   381,205   384,255   69.3 % 53.2 %
Nevada   1   796     74,425     76.7 % 0.0 %
New Jersey   5   3,980   4,116   348,498   346,378   80.7 % 72.8 %
New York   3   2,522   2,522   198,043   198,110   80.3 % 76.0 %
Virginia   1   727   729   75,700   75,525   70.9 % 51.8 %
   
 
 
 
 
 
 
 
Total Wholly-Owned Properties   24   16,361   15,692   1,577,413   1,503,055   74.2 % 64.0 %
   
 
 
 
 
 
 
 
Properties Held in Joint Ventures                              
California   2   1,414   1,412   151,845   151,295   90.0 % 86.0 %
Illinois   1   689   682   74,025   71,925   55.5 % 56.3 %
New Jersey   3   2,259   2,247   227,485   227,485   77.0 % 71.6 %
New York   3   3,492   3,492   253,948   254,922   80.7 % 72.1 %
Pennsylvania   3   2,469   1,679   228,522   152,269   69.1 % 73.4 %
Rhode Island   1   878   887   85,025   85,025   47.7 % 9.3 %
   
 
 
 
 
 
 
 
Total Properties Held in Joint Ventures   13   11,201   10,399   1,020,850   942,921   74.1 % 67.5 %
   
 
 
 
 
 
 
 
Total Lease-up Properties   37   27,562   26,091   2,598,263   2,445,976   74.2 % 65.3 %
   
 
 
 
 
 
 
 

(1)
Represents unit count as of December 31, 2005 which may differ from December 31, 2004 unit count due to unit conversions or expansions.
(2)
Represents net rentable square feet as of December 31, 2005 which may differ from December 31, 2004 net rentable square feet due to unit conversions or expansions.

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

        Our properties are generally situated in convenient, highly visible locations clustered around large population bases; however, due to certain factors, we have a handful of locations outside the top Metropolitan Statistical Areas ("MSA's") that were developed or acquired based on the market, familiarity with the properties, or as part of a larger portfolio.

        In addition to our 192 wholly-owned properties and the 354 properties in which we have an ownership interest, we also manage 85 properties for third parties and franchisees as of December 31, 2005 bringing total properties which we own and/or manage to 631. We receive a management fee equal to approximately 6.0% of gross revenues to manage these joint ventures, third parties and franchisees sites.


Item 3.    Legal Proceedings

        We are involved in various litigation and proceedings in the ordinary course of business. We are not a party to any material litigation or legal proceedings, or to the best of our knowledge, any threatened litigation or legal proceedings which, in the opinion of management individually or in the aggregate, will have a material adverse effect on our financial condition or results of operations.


Item 4.    Submission of Matters to a Vote of Security Holders

        There were no matters submitted to a vote of our security holders during the fourth quarter ended December 31, 2005.

21



PART II

Item 5.    Market for Registrant's Common Equity and Related Stockholder Matters

Market Information

        Our common stock has been traded on the New York Stock Exchange ("NYSE") under the symbol "EXR" since our IPO on August 17, 2004. Prior to that time there was no public market for our common stock.

        The following table sets forth, for the periods indicated, the high and low bid price for our common stock as reported by the NYSE and the per share dividends declared:

 
  High
  Low
  Dividends
Declared

Period from August 17, 2004 to September 30, 2004   $ 14.38   $ 12.50   $ 0.1113
Quarter Ended December 31, 2004     14.55     12.60     0.2275
Quarter Ended March 31, 2005     14.30     12.55     0.2275
Quarter Ended June 30, 2005     14.75     12.19     0.2275
Quarter Ended September 30, 2005     16.71     14.32     0.2275
Quarter Ended December 31, 2005     15.90     13.00     0.2275

        On February 28, 2006, the closing price of our common stock as reported by the NYSE was $15.00. At February 28, 2006, we had 166 holders of record of our common stock.

        Holders of shares of common stock are entitled to receive distributions when declared by our board of directors out of any assets legally available for that purpose. As a REIT, we are required to distribute at least 90% of our "REIT taxable income" is generally equivalent to our net taxable ordinary income, determined without regard to the deduction for dividends paid, to our stockholders annually in order to maintain our REIT qualifications for U.S. federal income tax purposes.

Unregistered Sales of Equity Securities and Use of Proceeds

        On June 20, 2005, we completed the sale of 6,200,000 shares of our common stock, $.01 par value, for $83,514, which we reported in a Current Report on Form 8-K filed with the Securities and Exchange Commission on June 24, 2005. We used the proceeds for general corporate purposes, including debt repayment. The shares were issued pursuant to an exemption from registration under the Securities Act of 1933, as amended.

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Item 6.    Selected Financial Data

        The following table sets forth the selected financial data and should be read in conjunction with the Financial Statements and notes thereto included in Item 8, "Financial Statements and Supplementary Data" and Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Form 10-K.

 
  Company
  Predecessor
 
 
  Year Ended December 31,
 
 
  2005
  2004
  2003
  2002
  2001
 
Revenues:                                
  Property rental   $ 120,640   $ 62,656   $ 33,054   $ 28,811   $ 19,374  
  Fees and other income     14,088     3,064     2,762     2,747     3,440  
   
 
 
 
 
 
    Total revenues     134,728     65,720     35,816     31,558     22,814  
   
 
 
 
 
 
Expenses:                                
  Property operations     45,963     26,066     14,858     11,640     8,152  
  Tenant insurance expense     1,023                  
  Unrecovered development/acquisition costs and support payments     302     739     4,937     1,938     2,227  
  General and administrative     24,081     12,465     8,297     5,916     6,748  
  Depreciation and amortization     31,005     15,552     6,805     5,652     3,105  
   
 
 
 
 
 
    Total expenses     102,374     54,822     34,897     25,146     20,232  
   
 
 
 
 
 
Income before interest, loss on debt extinguishments, minority interests, equity in earnings of real estate ventures and gain on sale of real estate assets     32,354     10,898     919     6,412     2,582  
Interest expense     (42,549 )   (28,491 )   (18,746 )   (13,894 )   (11,477 )
Interest income     1,625     251     445     828     184  
Loss on debt extinguishments         (3,523 )            
Minority interests     434     (733 )   (2,701 )   (3,859 )   (995 )
Equity in earnings of real estate ventures     3,170     1,387     1,465     971     105  
   
 
 
 
 
 
Loss before gain on sale of real estate assets     (4,966 )   (20,211 )   (18,618 )   (9,542 )   (9,601 )
Gain on sale of real estate assets         1,749     672         4,677  
   
 
 
 
 
 
Net loss   $ (4,966 ) $ (18,462 ) $ (17,946 ) $ (9,542 ) $ (4,924 )
   
 
 
 
 
 
Preferred return on Class B, C, and E units         (5,758 )   (5,336 )   (4,525 )    
Loss on early redemption of Fidelity minority interest         (1,478 )            
   
 
 
 
 
 
Net loss attributable to common shareholders   $ (4,966 ) $ (25,698 ) $ (23,282 ) $ (14,067 ) $ (4,924 )
   
 
 
 
 
 

Per Common Share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Distribution(1)   $ 0.91   $ 0.34   $   $        
Net loss—Basic and Diluted(2)   $ (0.14 ) $ (1.68 ) $ (5.62 ) $ (3.84 )      
Weighted average common shares—Basic and Diluted     35,481,538     15,282,725     4,141,959     3,665,743        

Balance Sheet Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Total assets   $ 1,420,192   $ 748,484   $ 383,751   $ 332,290   $ 270,266  
Total notes payable, notes payable to trusts and lines of credit     866,783     472,977     273,808     231,025     178,552  
Minority interest     36,235     21,453     22,390     22,265     28,558  
Redeemable units and members' and shareholders' equity   $ 480,128   $ 243,607   $ 21,701   $ 27,516   $ 35,465  

Other Data:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 
Net cash provided by (used in) operating activities   $ 14,771   $ (6,158 ) $ (8,526 ) $ 1,613   $ (4,460 )
Net cash used in investing activities   $ (614,834 ) $ (261,298 ) $ (59,206 ) $ (69,249 ) $ (11,383 )
Net cash provided by financing activities   $ 604,387   $ 280,039   $ 73,017   $ 66,863   $ 21,441  

(1)
Based on annual dividend of $.91 per common share
(2)
The basic loss per share does not include the potential effects of the contingent conversion shares and contingent conversion units, both distributed in connection with the initial public offering, as such securitites would not have participated in earnings for any of the periods presented. These securities will not participate in distributions until they are converted, which cannot occur prior to March 31, 2006.

23



Item 7.    Managements Discussion and Analysis of Financial Condition and Results of Operations

        The following discussion should be read in conjunction with the financial statements and notes thereto appearing elsewhere in this report. We make statements in this section that are forward-looking statements within the meaning of the federal securities laws. For a complete discussion of forward-looking statements, see the section in this Form 10-K entitled "Statements Regarding Forward-Looking Information." Certain risk factors may cause actual results, performance or achievements to differ materially from those expressed or implied by the following discussion. For a discussion of such risk factors, see the section in this Form 10-K entitled "Statements Regarding Forward-Looking Information."

Overview

        We are a fully integrated, self-administered and self-managed real estate investment trust, or REIT, formed to continue the business commenced in 1977 by our predecessor companies to own, operate, acquire, develop and redevelop professionally managed self-storage properties. Since 1996, our fully integrated development and acquisition teams have completed the development or acquisition of more than 600 self-storage properties.

        In July 2005, we, along with joint-venture partner Prudential Real Estate Investors ("PREI"), acquired Storage USA ("SUSA") from GE Commercial Finance for approximately $2.3 billion in cash. The transaction, the largest to date in the self-storage industry, made us the second largest operator of self-storage facilities in the United States with 631 properties owned or managed in 34 states including Washington, D.C. As of December 31, 2005, 192 of our properties were wholly owned, we held joint venture interests in 354 properties, and our taxable REIT subsidiary, Extra Space Management, Inc., operated an additional 85 properties that are owned by franchisees or third parties in exchange for a management fee. The properties that we own or in which we hold an ownership interest contain approximately 38 million square feet of rentable space contained in approximately 370,000 units and currently serve a customer base of 275,000 tenants.

        The SUSA acquisition gives us a national platform upon which to leverage operational, advertising and other economic efficiencies. The acquisition also creates a built-in acquisition pipeline through various joint-venture, franchise and third-party management partners from which we can grow in the future. We have also been able to retain several key executives from the SUSA organization, as well as the majority of its field operations team.

        To maximize the performance of our properties, we employ a state-of-the-art, proprietary, web-based tracking and yield management technology called STORE. Developed by our management team, STORE enables us to analyze, set and adjust rental rates in real time across our portfolio in order to respond to changing market conditions. As part of the SUSA acquisition, we gained access to SUSA's industry leading revenue management team ("RevMan"), which managed SUSA's rental rate and discount strategies. We believe that the combination of STORE's yield management capabilities and the systematic processes developed by RevMan will allow us to more proactively manage revenue in the future.

        We derive substantially all of our revenues from rents received from tenants under existing leases on each of our self-storage properties and from management fees on the properties we manage for joint-venture partners, franchisees and unaffiliated third parties. This management fee is equal to approximately 6% of total revenues generated by the managed properties.

        We operate in competitive markets, often where consumers have multiple self-storage properties from which to choose. Competition has impacted, and will continue to impact our property results. We experience minor seasonal fluctuations in occupancy levels, with occupancy levels generally higher in the summer months due to increased moving activity. Our operating results, therefore, depend materially on our ability to lease available self-storage space, to actively manage unit rental rates, and

24



on the ability of our tenants to make required rental payments. We believe that we are able to respond quickly and effectively to changes in local, regional and national economic conditions by adjusting rental rates through the use of STORE, the operating management software employed at the properties and through the use of the process developed by RevMan.

        We continue to evaluate and implement a range of new initiatives and opportunities in order to enable us to maximize stockholder value. Our strategies to maximize stockholder value include:

Maximize Cash Flow at Our Properties—We seek to maximize revenue-generating opportunities by responding to changing local market conditions through interactive yield management of the rental rates at our properties.

Pursue Opportunities to Acquire Self-Storage Portfolios—We intend to continue to selectively acquire, for cash or by utilizing OP units as acquisition currency, privately-held self-storage portfolios and single self-storage assets in high population density areas.

Strategically Select and Develop Sites—We plan to continue to expand by selecting and developing new self-storage properties through joint ventures.

Continue Our Joint Venture Strategy to Pursue Development Opportunities and Enhance Returns—We plan to grow by continuing our development activities in conjunction with our joint venture partners thus mitigating the risks normally associated with early-stage development and lease-up activities. Where appropriate, we plan to also seek to acquire properties in a capital-efficient manner in conjunction with our joint venture partners.

        During 2005 we acquired 70 wholly-owned properties and minority equity interests in 336 additional properties. We completed the development of six properties in our core markets including two expansions of wholly-owned properties. One of these development properties is owned by us in a joint venture, and the other three properties are owned by Extra Space Development, an entity in which we do not have any ownership interest, but which is owned by certain members of senior management. These joint venture and third party development properties provide us with a potential acquisition pipeline in the future. Thirteen properties are scheduled for completion in 2006, eight of which will be owned by us in a joint-venture format.

        As of December 31, 2005, we operated 631 properties located in 34 states including Washington, D.C. Of the 631 properties, 192 are wholly owned, 354 are held in joint ventures with third parties, and an additional 85 properties are owned by franchisees or third parties and managed by us in exchange for a management fee. The properties are generally situated in convenient, highly visible locations clustered around large population centers such as Baltimore/Washington D.C., Boston, Chicago, Dallas, Las Vegas, Los Angeles, Miami, New York City, Orlando, Philadelphia, Phoenix, St. Petersburg/Tampa and San Francisco. These areas all enjoy above average population growth and income levels and high barriers to entry for new self-storage properties. The clustering of our assets around these population centers, which has intensified following the SUSA acquisition, enables us to reduce our operating costs through economies of scale. We consider a property to be in the lease-up stage after it has been issued a certificate of occupancy, but before it has achieved stabilization. A property is considered to be stabilized once it has achieved an 80% occupancy rate or has been open for three years.

        In the Results of Operations discussion below, we will compare the results of our operations for the year ended December 31, 2005 with historical results of operations for the Predecessor for the period from January 1, 2004 through August 16, 2004 and with our historical results of operations for the period from August 17, 2004 through December 31, 2004. Comparisons to any prior periods are to the historical results of the operations of the Predecessor.

25



CRITICAL ACCOUNTING POLICIES AND ESTIMATES

        Our financial statements have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities at the date of the financial statements and the reported amount of revenues and expenses during the reporting period. On an ongoing basis, we evaluate our estimates and assumptions, including those that impact our most critical accounting policies. We base our estimates and assumptions on historical experience and on various other factors that we believe are reasonable under the circumstances. Actual results may differ from these estimates. We believe the following are our most critical accounting policies.

26


27


28


RESULTS OF OPERATIONS

Comparison of the Year Ended December 31, 2005 to the Year Ended December 31, 2004

Overview

        Results for the year ended December 31, 2005 included the operations of 546 properties (192 of which were consolidated and 354 of which were in joint ventures accounted for using the equity method) compared to the results for the year ended December 31, 2004, which included operations of 147 properties, seven of which were deconsolidated during 2004, (128 of which were consolidated and 19 of which were in joint ventures accounted for using the equity method). Results for the year ended December 31, 2004 include the results of six properties in which we did not own any interest and one where we sold our joint venture interest in 2004. These six properties were consolidated as a result of guarantees and/or puts for which we were liable. Five of the six properties were deconsolidated on August 16, 2004 upon the release of all guarantees and puts, and the other property was deconsolidated on December 31, 2004. Results for both periods also included equity in earnings of real estate ventures, third-party management and franchise fees, acquisition fees and development fees.

Revenues

        The following table sets forth information on revenues earned for the years indicated:

 
  Year ended December 31,
   
   
 
 
   
  % Change
 
 
  2005
  2004
  $ Change
 
Property rental   $ 120,640   $ 62,656   $ 57,984   92.5 %
Management and franchise fees     10,650     1,651     8,999   545.1 %
Tenant insurance     1,882         1,882   100.0 %
Acquisition and development fees     992     1,200     (208 ) (17.3 )%
Other income     564     213     351   164.8 %
   
 
 
 
 
  Total revenues   $ 134,728   $ 65,720   $ 69,008   105.0 %
   
 
 
 
 

        Property Rental—The increase in property rental revenues consists of $24,703 associated with the acquisition of 61 wholly-owned properties in conjunction with the SUSA acquisition in July 2005, $23,827 associated with other acquisitions, $6,953 from the buyout of certain joint venture interests previously accounted for using the equity method of accounting, and $2,880 from increases in occupancy at lease-up properties. These increases were offset by a decrease of $379 due primarily to the deconsolidation of certain properties in 2004.

        Management and Franchise Fees—Our taxable REIT subsidiary, Extra Space Management, Inc., manages properties owned by our joint ventures and third parties. Management fees generally represent 6.0% of cash collected from properties owned by third parties and unconsolidated joint ventures. The increase in management fees is due mainly to new fees associated with the SUSA acquisition. Through this acquisition we obtained equity interests in joint ventures which own a total of 336 properties. We obtained management contracts for these new joint venture properties, and also

29



obtained over 50 new third party and franchise management contracts in conjunction with the SUSA acquisition.

        Tenant Insurance—Tenant insurance revenue relates to a new tenant insurance program adopted in 2005. This program was started in conjunction with the SUSA acquisition to replace SUSA's tenant insurance program.

        Acquisition and Development Fees—The decrease in acquisition and development fee revenue was due to the decreased volume of development relating to joint ventures in 2005 compared to prior years.

        Other Income—Other income represents primarily income from truck rentals. The increase in other income is associated with to the SUSA acquisition and other acquisitions made in 2005.

Expenses

        The following table sets forth information on expenses for the years indicated:

 
  Year ended December 31,
   
   
 
 
   
  % Change
 
 
  2005
  2004
  $ Change
 
Property operations   $ 45,963   $ 26,066   $ 19,897   76.3 %
Tenant insurance     1,882         1,882   100.0 %
Unrecovered development/acquisition costs and support payments     302     739     (437 ) (59.1 )%
General and administrative     24,081     12,465     11,616   93.2 %
Depreciation and amortization     31,005     15,552     15,453   99.4 %
   
 
 
 
 
  Total expenses   $ 103,233   $ 54,822   $ 48,411   88.3 %
   
 
 
 
 

        Property Operations—The increase in property operations expense in 2005 was primarily due to increases of $9,045 associated with the SUSA acquisition, $8,852 associated with other acquisitions, and $1,873 from the buyout of certain joint venture interests (previously accounted for using the equity method of accounting). There were also increases in expenses of $733 at existing properties due to increases in utilities, repairs and maintenance and property taxes, which was partially offset by the decrease of $606 of property operating expenses due to the deconsolidation of certain properties in 2004. During the year ended December 31, 2004, we and the Predecessor opened five new properties and acquired 44 new properties. During the year ended December 31, 2005, we acquired 61 properties in connection with the SUSA acquisition, and 9 properties in other acquisitions.

        Tenant Insurance—Tenant insurance expense for 2005 relates to a new tenant insurance program adopted in 2005. This program was started in conjunction with the SUSA acquisition to replace SUSA's tenant insurance program.

        Unrecovered Development/Acquisition Costs and Support Payments—Unrecovered development costs for 2005 decreased when compared to 2004 due to lower level of development activity.

        General and Administrative—The significant increase in general and administrative expenses during the year ended December 31, 2005 was due mainly to the increased costs associated with the management of the additional properties that have been added through acquisitions and new joint venture arrangements entered into during 2005. We incurred approximately $1,500 of additional general and administrative expenses during 2005 relating to the integration of the SUSA properties and

30



administrative systems and $601 of amortization of deferred compensation expense related to stock grants.

        Depreciation and Amortization—The increase in depreciation and amortization expense results from more properties being open during the year ended December 31, 2005 than were open during the year ended December 31, 2004 due mainly to acquisitions of new properties. We acquired 70 properties during 2005, 61 of which were acquired in connection with the SUSA acquisition.

Other Income and Expenses

        The following table sets forth information on other income and expenses for the years indicated:

 
  Year ended December 31,
   
   
 
 
   
  % Change
 
 
  2005
  2004
  $ Change
 
Interest expense   $ (42,549 ) $ (28,491 ) $ (14,058 ) 49.3 %
Interest income     1,625     251     1,374   547.4 %
Loss on debt extinguishments         (3,523 )   3,523   (100.0 )%
Minority interest—Fidelity preferred return         (3,136 )   3,136   (100.0 )%
Minority interest—Operating Partnership     434     113     321   284.1 %
Loss allocated to other minority interests         2,290     (2,290 ) (100.0 )%
Equity in earnings of real estate ventures     3,170     1,387     1,783   128.6 %
Gain on sale of real estate assets         1,749     (1,749 ) (100.0 )%
   
 
 
 
 
  Total other income (expense)   $ (37,320 ) $ (29,360 ) $ (7,960 ) 27.1 %
   
 
 
 
 

        Interest Expense and Loss on Debt Extinguishments—The increase in interest expense for the year ended December 31, 2005 was due primarily to $4,312 of interest incurred on the new trust preferred debt and $7,977 of interest expense on the mortgage loans on the 61 properties acquired in connection with the SUSA acquisition. The remainder of the increase was due mainly to other new loans obtained in 2005 related to the SUSA acquisition and other acquisitions. During the year ended December 31, 2004, there was $3,523 paid to extinguish debt. There was no debt extinguishment expense in 2005. Capitalized interest during the years ended December 31, 2005 and 2004 was $459 and $1,213, respectively. During 2005, we acquired 70 new properties, which increased outstanding debt by $206,198 as of December 31, 2005.

        Interest Income—The significant increase in interest income for the year ended December 31, 2005 when compared to the prior year was mainly the result of the interest earned on the $37,667 of notes receivable that we acquired in connection with the SUSA acquisition. These notes receivable were paid down to $12,109 by December 31, 2005.

        Minority interest—Fidelity Preferred Return—Minority interest—Fidelity preferred return was $0 for the year ended December 31, 2005 as the Fidelity minority interest was redeemed September 9, 2004.

        Minority Interest—Operating Partnership—Loss allocated to the Operating Partnership represents 8.04% of the net loss for the year ended December 31, 2005. The amount allocated to minority interest was higher than in the prior year due mainly to the fact that the Operating Partnership was in place for a full year in 2005, compared to only the period subsequent to the IPO in 2004.

        Loss Allocated to Other Minority Interests—There were no losses allocated to other minority interests during the year ended December 31, 2005 because we redeemed or deconsolidated all other

31



minority interests in operating properties during the year ended December 31, 2004. The only other minority interest in place as of December 31, 2005 is an interest in a development property which has not yet begun operations.

        Equity in Earnings of Real Estate Ventures—The increase in equity in earnings of real estate ventures is due primarily to our purchase of new equity interests in joint ventures. As a result of the SUSA acquisition we own joint venture interests an additional 336 new properties.

        Gain on Sale of Real Estate Assets—The gain on sale of real estate assets was $0 for the year ended December 31, 2005 as there were no significant gains on the sale of assets during 2005. The gain on sale of real estate assets for the year ended December 31, 2004 was due primarily to a gain of $1,920 on the sale of our joint venture interest in a property in Laguna Hills, California in August 2004.

Comparison of the Year Ended December 31, 2004 to the Year Ended December 31, 2003

Overview

        Results for the year ended December 31, 2004 included the operations of 147 properties, seven of which were deconsolidated during 2004 (128 of which were consolidated and 19 of which were in joint ventures accounted for using the equity method) compared to the results for the year ended December 31, 2003, which included the operations of 94 properties (57 of which were consolidated and 37 of which were in joint ventures accounted for using the equity method). Results for the quarter and year ended December 31, 2004 include the results of six properties in which we did not own any interest and one where we sold our joint venture interest in 2004. These properties were consolidated as a result of guarantees and/or puts for which we were liable. Five of the six properties were deconsolidated on August 16, 2004 upon the release of all guarantees and puts, and the other property was deconsolidated on December 31, 2004. Results for both periods also included equity in earnings of real estate ventures, third-party management fees, acquisition fees and development fees.

Revenues

        The following table sets forth information on revenues earned for the years indicated:

 
  Company
  Predecessor
   
   
 
 
  Year ended December 31,
   
   
 
 
   
  % Change
 
 
  2004
  2003
  $ Change
 
Property rental   $ 62,656   $ 33,054   $ 29,602   89.6 %
Management and franchise fees     1,651     1,935     (284 ) (14.7 )%
Acquisition and development fees     1,200     654     546   83.5 %
Other income     213     173     40   23.1 %
   
 
 
 
 
  Total revenues   $ 65,720   $ 35,816   $ 29,904   83.5 %
   
 
 
 
 

        Property Rental—The increase in property rental revenues consisted primarily of $8,081 from the buyout of the certain joint venture interests (previously accounted for using the equity method of accounting), $16,777 from new acquisitions and $4,045 from increases in occupancy at lease-up properties. During the year ended December 31, 2004, the Company and the Predecessor opened five new properties, acquired 44 new properties, and continued to increase the occupancy at its other lease-up properties. The increase in stabilized property revenues consists primarily of increased rental rates.

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        Management and Franchise Fees—Management and franchise fees represented 6.0% of cash collected from properties owned by third parties and unconsolidated joint ventures. The decrease in management fees was due to the Company's purchase of our joint venture partner's interest in Extra Space East One, LLC in 2004.

        Acquisition and Development Fees—The increase in acquisition fees and development fees was due to the increased volume of development relating to joint ventures in 2004. While the Company and the Predecessor purchased 44 properties in 2004, we did not recognize any acquisition fees as these properties are wholly owned and are consolidated.

        Other Income—Other income represented primarily income from truck rentals.

Expenses

        The following table sets forth information on expenses for the years indicated:

 
  Company
  Predecessor
   
   
 
 
  Year ended December 31,
   
   
 
 
   
  % Change
 
 
  2004
  2003
  $ Change
 
Property operations   $ 26,066   $ 14,858   $ 11,208   75.4 %
Unrecovered development/acquisition costs and support payments     739     4,937     (4,198 ) (85.0 )%
General and administrative     12,465     8,297     4,168   50.2 %
Depreciation and amortization     15,552     6,805     8,747   128.5 %
   
 
 
 
 
  Total expenses   $ 54,822   $ 34,897   $ 19,925   57.1 %
   
 
 
 
 

        Property Operations—The increase in property operations expense was primarily due to increases of $2,654 from the buyout of certain joint venture interests (previously accounted for using the equity method of accounting), $6,306 from new acquisitions and $2,238 from lease-up properties. During the year ended December 31, 2004, the Company and the Predecessor opened five new properties, acquired 44 new properties, and continued to increase the occupancy at its other lease-up properties. Existing lease-up property expenses increased due to increases in utilities, office expenses, repairs and maintenance and property taxes due to reassessment. The increase in stabilized property expenses consisted primarily of payroll and property taxes.

        Unrecovered Development/Acquisition Costs and Support Payments—Unrecovered development costs for 2003 included $1,520 relating to final performance guarantee payments to the joint venture partner in Extra Space West One, LLC and Extra Space East One, LLC. In addition, the decrease was due to approximately $2,500 in costs relating to potential acquisitions, which were written off during the year ended December 31, 2003.

        General and Administrative—The increase in general and administrative expenses in 2004 compared to 2003 is due to fewer internal development expenses capitalized in 2004—$1,198, than were capitalized in 2003—$1,797, and to overhead added to prepare for growth, and our ongoing public company costs. In addition, we recognized $1,205 in compensation expense related to employee unit grants in 2004.

        Depreciation and Amortization—The increase in depreciation and amortization expense results from more properties being open due to development and acquisition during 2004, than were open

33



during the year ended December 31, 2003. The Company and the Predecessor acquired 44 properties, bought out joint venture partners on 22 properties and opened five properties in 2004.

Other Income and Expenses

        The following table sets forth information on other income and expenses for the years indicated:

 
  Company
  Predecessor
   
   
 
 
  Year ended December 31,
   
   
 
 
   
  % Change
 
 
  2004
  2003
  $ Change
 
Interest expense   $ (28,491 ) $ (18,746 ) $ (9,745 ) 52.0 %
Interest income     251     445     (194 ) (43.6 )%
Loss on debt extinguishments     (3,523 )       (3,523 ) (100.0 )%
Minority interest—Fidelity preferred return     (3,136 )   (4,132 )   996   (24.1 )%
Minority interest—Operating Partnership     113         113   100.0 %
Loss allocated to other minority interests     2,290     1,431     859   60.0 %
Equity in earnings of real estate ventures     1,387     1,465     (78 ) (5.3 )%
Gain on sale of real estate assets     1,749     672     1,077   160.3 %
   
 
 
 
 
  Total other income (expense)   $ (29,360 ) $ (18,865 ) $ (10,495 ) 55.6 %
   
 
 
 
 

        Interest Expense and Loss on Debt Extinguishments—The increase in interest expense and loss on debt extinguishments was due primarily to additional debt and interest relating to new properties entering the lease-up stage being expensed rather than capitalized (interest was capitalized during the development phase) and $3,523 being paid to extinguish debt. Capitalized interest during the years ended December 31, 2004 and 2003 was $1,213 and $2,593, respectively. In addition, during 2004, the Company and the Predecessor acquired 44 new properties and bought out joint venture partners on 22 properties, which increased its average outstanding debt.

        Minority Interest—Fidelity Preferred Return—The decrease in minority interest—Fidelity preferred return for the year ended December 31, 2004 compared to the year ended December 31, 2003 was due to the redemption of the Fidelity minority interest on August 17, 2004.

        Minority Interest Operating Partnership—Loss allocated to the Operating Partnership represents 8.05% of the net loss subsequent to the IPO and totaled $113 for the year ended December 31, 2004.

        Loss Allocated to Other Minority Interests—The increase in loss allocated to other minority interests in 2004 compared to 2003 was primarily due to additional losses on lease-up properties allocated to Extra Space Development ("ESD") in 2004 under the joint venture operating agreements.

        Equity in Earnings of Real Estate Ventures—Equity in earnings of real estate ventures decreased in 2004 primarily due to the Predecessor purchasing its joint venture partner's interest in 18 self-storage facilities held by Extra Space Storage East One, LLC and these facilities being subsequently consolidated, offset by increased profitability of Extra Space West One, LLC.

        Gain on Sale of Real Estate Assets—The increase in gain on sale of real estate assets was due primarily to a gain of $1,920 on the sale of our joint venture interest in a property in Laguna Hills, California in August 2004.

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FUNDS FROM OPERATIONS

        FFO provides relevant and meaningful information about our operating performance that is necessary, along with net loss and cash flows, for an understanding of our operating results. FFO is defined by the National Association of Real Estate Investment Trusts, Inc. ("NAREIT") as net income (loss) computed in accordance with accounting principles generally accepted in the United States ("GAAP"), excluding gains or losses on sales of properties, plus depreciation and amortization and after adjustments to record unconsolidated partnerships and joint ventures on the same basis. We believe that to further understand our performance, FFO should be considered along with the reported net loss and cash flows in accordance with GAAP, as presented in the consolidated financial statements.

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

 
  For the Year Ended
December 31, 2005

 
Net Loss   $ (4,966 )

Plus:

 

 

 

 
  Real estate depreciation     20,105  
  Amortization of intangibles     10,345  
  Joint venture real estate depreciation     2,186  
Less:        
  Loss allocated to operating partnership minority interest     (434 )
   
 
Funds from operations   $ 27,236  
   
 
Funds from operations per share   $ 0.70  
   
 
Weighted average number of shares        
  Common stock (excluding unvested restricted shares)     35,481,538  
  OP units     3,283,059  
   
 
  Total     38,764,597  
   
 

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SAME-STORE STABILIZED PROPERTY RESULTS

        We consider same-store stabilized portfolio to consist of only those properties owned wholly at the beginning and at the end of the applicable periods presented and that had achieved stabilization as of the first day of such period. The following table sets forth operating data for the same-store portfolio for our same store portfolio. We consider the following same-store presentation to be meaningful in regards to the 38 properties shown below. These results provide information relating to property-level operating changes without the effects of acquisitions or completed developments.

 
   
   
   
   
   
   
  Company
  Predecessor
   
 
 
  Quarter Ended December 31,
   
  Year Ended December 31,
   
   
   
   
 
 
   
   
  Year Ended December 31,
   
 
 
  Percent
Change

  Percent
Change

  Percent
Change

 
 
  2005
  2004
  2005
  2004
  2004
  2003
 
Same-store rental revenues   $ 7,194   $ 6,857   4.9 % $ 28,010   $ 26,974   3.8 % $ 22,597   $ 21,861   3.4 %
Same-store operating expenses     2,414     2,330   3.6 %   9,578     8,993   6.5 %   7,385     7,189   2.7 %

Non same-store rental revenues

 

 

31,160

 

 

15,252

 

104.3

%

 

92,630

 

 

35,682

 

159.6

%

 

40,059

 

 

11,193

 

257.9

%
Non same-store operating expenses     12,264     6,600   85.8 %   36,385     17,073   113.1 %   18,681     7,669   143.6 %

Total rental revenues

 

 

38,354

 

 

22,109

 

73.5

%

 

120,640

 

 

62,656

 

92.5

%

 

62,656

 

 

33,054

 

89.6

%
Total operating expenses     14,678     8,930   64.4 %   45,963     26,066   76.3 %   26,066     14,858   75.4 %

Properties included in same-store

 

 

38

 

 

38

 

 

 

 

38

 

 

38

 

 

 

 

31

 

 

31

 

 

 

Comparison of the Year Ended December 31, 2005 to the Year Ended December 31, 2004

        Same-Store Rental Revenues.    The increase in same-store rental revenues was primarily due to increased rental rates and our ability to maintain occupancy.

        Same-Store Operating Expenses.    The increase in same-store operating expenses was primarily due to an increase in repairs and maintenance, snow removal costs and property taxes.

Comparison of the Year Ended December 31, 2004 to the Year Ended December 31, 2003

        Same-Store Rental Revenues.    The increase in same-store rental revenues was primarily due to increased rental rates and our ability to maintain occupancy.

        Same-Store Operating Expenses.    The increase in same-store operating expenses was primarily due to an increase in insurance and property taxes.

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CCS and CCU Property Performance:

        As described in our prospectus for our IPO, upon the achievement of certain levels of net operating income with respect to 14 of our pre-stabilized properties, our CCSs and our operating partnership's CCUs will convert into additional shares of common stock and OP units, respectively, beginning with the quarter ending March 31, 2006. The average occupancy of these 14 properties as of December 31, 2005 was 71.1% as compared to 59.1% at December 31, 2004. The table below outlines the performance of the properties for the quarter and year ended December 31, 2005 and 2004, respectively.

 
   
   
   
   
   
   
  Company
  Predecessor
   
 
 
  Quarter Ended December 31,
   
  Year Ended December 31,
   
   
   
   
 
 
   
   
  Year Ended December 31,
   
 
 
  Percent
Change

  Percent
Change

  Percent
Change

 
 
  2005
  2004
  2005
  2004
  2004
  2003
 
CCS/CCU rental revenues   $ 2,382   $ 1,805   32.0 % $ 8,432   $ 6,043   39.5 % $ 6,043   $ 3,043   98.6 %
CCS/CCU operating expenses     1,369     1,134   20.7 %   5,479     4,606   18.9 %   4,606     3,097   48.7 %
CCS/CCU net operating income     1,012     671   51.0 %   2,953     1,437   105.5 %   1,437     (54 ) 2,761 %
Non CCS/CCU rental revenues     35,972     20,304   77.2 %   112,208     56,613   98.2 %   56,613     30,011   88.6 %
Non CCS/CCU operating expenses     13,309     7,796   70.7 %   40,484     21,460   88.7 %   21,460     11,761   82.5 %
Total rental revenues     38,354     22,109   73.5 %   120,640     62,656   92.5 %   62,656     33,054   89.6 %
Total operating expenses     14,678     8,930   64.4 %   45,963     26,066   76.3 %   26,066     14,858   75.4 %

        The increase in CCS/CCU rental revenues was primarily due to increased occupancy. The increase in CCS/CCU operating expenses was primarily due to an increase in property taxes and repairs and maintenance.

CASH FLOWS

Comparison of the Year Ended December 31, 2005 to the Year Ended December 31, 2004

        Cash flows provided by (used in) operating activities were $14,771 and ($6,158) for the years ended December 31, 2005 and 2004, respectively. The increase in cash provided by operating activities was due to the addition of new stabilized properties through the SUSA acquisition and other acquisitions. There have also been lower cash funding requirements relating to our lease-up properties as occupancy has increased.

        Cash used in investing activities was ($614,834) and ($261,298) for the years ended December 31, 2005 and 2004, respectively. The increase in 2005 is primarily the result of the $530,972 of cash paid in the acquisition of Storage USA. This increase was offset by the fact that we acquired fewer other properties and had fewer development projects during 2005 compared to 2004. We also received payments of $26,783 related to the notes receivable acquired in conjunction with the SUSA transaction during 2005.

        Cash provided by financing activities was $604,387 and $280,039 for the years ended December 31, 2005 and 2004, respectively. The 2005 financing activities consisted primarily of net proceeds from share issuances of $271,537, additional borrowings of $808,936, including borrowings to fund the SUSA acquisition, offset by the repayment of $431,255 of line of credit and notes payable. The 2004 financial activities consisted primarily of net proceeds from share issuances of $264,475, additional borrowings of $418,154, including borrowings to fund the purchase of 44 stabilized properties and the development of existing projects, offset by the repayment of $325,917 of borrowings.

2005 OPERATIONAL SUMMARY

        2005 proved to be both a rewarding and challenging year for us. During the course of the year, we became the second largest operator of self-storage in the United States with the acquisition of SUSA,

37



and faced the expected challenges of a complex integration while attempting to maximize operational performance in a competitive marketplace.

        The SUSA acquisition took center stage in 2005 and commanded a majority of our efforts throughout the year, especially during the second and third quarters. Our operating results were positive, as revenue levels increased compared to those seen in 2004. However, our operational performance lagged internal expectations during the first six months of 2005 due to the resources required to close and integrate the SUSA acquisition.

        Operational performance improved significantly in the last six months of the year, largely due to the impact of the newly acquired SUSA properties and more aggressive pricing and discounting strategies instituted by RevMan. Mission critical business processes were completed shortly after the closing of the transaction, and the majority of the integration has been completed. As a result of completing this integration, we are hopeful that the recent performance trend will continue.

        The Florida and California markets were among our strongest performing markets, both before and after the SUSA acquisition. After the acquisition, our newly strengthened markets of Phoenix, Las Vegas and Washington D.C. were also recognized for their strong revenue growth. Metro-Chicago, Michigan, New Jersey, Ohio and Pennsylvania were among our weakest performing markets.

        Competitive pressure remains a factor to performance. However, due to the strength of self-storage fundamentals in many markets, the ability to raise rental rates continues to be evident. Despite these increases, many competitors are continuing with high levels of rental discounts, which act as a drag on revenue.

        On a same-store basis for our pre-SUSA, legacy properties, we experienced increased rental activity compared to 2004, while move-out activity was slightly lower. The SUSA properties experienced increased rental activity compared to 2004, while move-out activity was slightly lower.

OUTLOOK

        We anticipate continued strength in self-storage fundamentals due to positive economic conditions in many of our core markets. We believe that the ability to increase revenues in 2006 over levels achieved in 2005 exists.

        We have seen improvement in our recent year-on-year performance with both occupancy and revenue. Though there can be no assurance that this trend will continue, we believe that positive economic conditions, the quality and location of our property portfolio and the combination of technology and RevMan, with its ability to implement real-time pricing and promotions, will provide us with the opportunity to grow revenues in 2006.

        We anticipate continued competition from all operators, both public and private, in all of the markets in which we operate. Despite this, we expect a positive operating environment for self-storage operators, particularly for those with well-located, highly visible, and efficiently managed self-storage properties. We will continue to enhance operational processes and implement technology to maximize our effectiveness as an operator.

REVENUE OUTLOOK

        Increased revenues were seen by many operators in 2005. This was also true for us, as was illustrated by positive same-store revenue growth. The ability for us to leverage RevMan and our technology platform gives us a positive revenue outlook for 2006. We aim to achieve not the highest level of occupancy, but the highest sustainable level of revenue to increase stockholder value. This may mean lower occupancy levels when compared on a year-on-year basis. We will also selectively discount

38



certain sites and units based on occupancy, availability, and competitive parameters that are controlled through our point of sale software and RevMan.

        Rental discounts were flat in 2005 on our same-store portfolio compared to 2004 and remains an important factor for us. Our evolving system of analyzing different data as it relates to site performance, competitive variables and operational experience will drive site-level and portfolio performance in the future. The ability to proactively control discounts also rests upon the site management team, and we are developing several initiatives to assist our field personnel in this regard.

        With the acquisition of SUSA and our increased scale, advertising opportunities that only a few self-storage companies currently possess are now available to us. We will continue to look at communication tools that stretch marketing dollars further while investigating marketing channels to better communicate our services to prospective customers. Online marketing and commercial sales are two marketing programs that will be much more prominent in 2006, especially since the acquisition of SUSA. These programs were heavily utilized at SUSA, and we believe that they will have a positive affect on our ability to maximize revenues over time.

EXPENSE OUTLOOK

        Property taxes, utilities and repairs and maintenance were the main components of 2005's increased operating expenses. As we continue to acquire existing self-storage facilities, tax reassessments will continue to occur. Snow removal was the main factor behind the increase in repairs and maintenance and is largely uncontrollable. National vendor programs have and will continue to be pursued which may drive down the cost of facility maintenance due to increased scale. We are not forecasting any major increase in repairs and maintenance in 2005. We believe that through continued refinement of insurance and risk management processes that insurance costs can also be reduced.

LIQUIDITY AND CAPITAL RESOURCES

        As of December 31, 2005, we had approximately $28,653 available in cash and cash equivalents. We will be required to distribute at least 90% of our net taxable income, excluding net capital gains, to our stockholders on an annual basis to maintain our qualification as a REIT. We intend to use this cash to purchase additional self-storage properties in the first quarter of 2006. Therefore, it is unlikely that we will have any substantial cash balances that could be used to meet our liquidity needs. Instead, these needs must be met from cash generated from operations and external sources of capital.

        On September 9, 2004, we, as guarantor, and our Operating Partnership entered into a $100 million revolving line of credit ("Credit Facility"), which includes a $10 million swingline sub facility. The Credit Facility is collateralized by self-storage properties. The Operating Partnership intends to use the proceeds of the Credit Facility for general corporate purposes and acquisitions. As of December 31, 2005, the Credit Facility had approximately $76.1 million of available borrowings based on the assets collateralizing the Credit Facility. There was no principal balance outstanding under the Credit Facility as of December 31, 2005.

        On October 4, 2004, we entered into a reverse interest rate swap with U.S. Bank National Association, relating to our existing $61,770 fixed rate mortgage with Wachovia Bank, which is due 2009. Pursuant to the swap agreement, we will receive fixed interest payments of 4.30% and pay variable interest payments based on the one-month LIBOR plus .655% on a notional amount of $61,770. There were no origination fees or other up front costs incurred by us in connection with the swap agreement.

        As of December 31, 2005, we had approximately $866.8 million of debt, resulting in a debt to total capitalization ratio of 52.1%. As of December 31, 2005, the ratio of total fixed rate debt and other instruments to total debt is 89.1%. The weighted average interest rate of the total of fixed and variable rate debt at December 31, 2005 is 5.3%.

39


        We expect to fund our short-term liquidity requirements, including operating expenses, recurring capital expenditures, dividends to stockholders, distributions to holders of OP units and interest on our outstanding indebtedness out of our operating cash flow, cash on hand and borrowings under our Credit Facility.

Long-Term Liquidity Needs

        Our long-term liquidity needs consist primarily of distributions to stockholders, new facility development, property acquisitions, principal payments under our borrowings and non-recurring capital expenditures. We do not expect that our operating cash flow will be sufficient to fund our long term liquidity needs and instead expect to fund such needs out of additional borrowings, joint ventures with third parties, and from the proceeds of public and private offerings of equity and debt. We may also use OP Units as currency to fund acquisitions from self-storage owners who desire tax-deferral in their exiting transactions.

OFF-BALANCE SHEET ARRANGEMENTS

        Except as disclosed in the notes to our financial statements, we do not currently have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purposes entities, which typically are established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes. Further, except as disclosed in the notes to our financial statements, we have not guaranteed any obligations of unconsolidated entities nor do we have any commitments or intent to provide funding to any such entities. Accordingly, we are not materially exposed to any financing, liquidity, market or credit risk that could arise if we had engaged in these relationships.

CONTRACTUAL OBLIGATIONS

        The following table sets forth information on payments due by period at December 31, 2005:

 
  Total
  Less Than
1 Year

  1-3 Years
  4-5 Years
  After
5 Years

Operating leases   $ 45,505   $ 4,465   $ 8,832   $ 8,336   $ 23,872
Notes payable, notes payable to trusts and line of credit                              
  Interest     276,930     45,569     90,453     81,855     59,053
  Principal     866,783     6,500     8,078     416,758     435,447
   
 
 
 
 
Total contractual obligations   $ 1,189,218   $ 56,534   $ 107,363   $ 506,949   $ 518,372
   
 
 
 
 

        As of December 31, 2005, the weighted average interest rate for all fixed rate loans was 5.3%, and the weighted average interest rate on all variable rate loans was 5.7%.

FINANCING STRATEGY

        We will continue to employ leverage in our capital structure in amounts determined from time to time by our board of directors. Although our board of directors has not adopted a policy which limits the total amount of indebtedness that we may incur, we will consider a number of factors in evaluating our level of indebtedness from time to time, as well as the amount of such indebtedness that will be either fixed or variable rate. In making financing decisions, our board of directors will consider factors including but not limited to:

40


        Our indebtedness may be recourse, non-recourse or cross-collateralized. If the indebtedness is non-recourse, the collateral will be limited to the particular properties to which the indebtedness relates. In addition, we may invest in properties subject to existing loans collateralized by mortgages or similar liens on our properties, or may refinance properties acquired on a leveraged basis. We may use the proceeds from any borrowings to refinance existing indebtedness, to refinance investments, including the redevelopment of existing properties, for general working capital or to purchase additional interests in partnerships or joint ventures or for other purposes when we believe it is advisable.

SEASONALITY

        The self-storage business is subject to seasonal fluctuations. A greater portion of revenues and profits are realized from May through September. Historically, our highest level of occupancy has been as of the end of July, while our lowest level of occupancy has been in late February and early March. Results for any quarter may not be indicative of the results that may be achieved for the full fiscal year.

RECENT ACCOUNTING PRONOUNCEMENTS

        In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123 (revised 2004), "Share—Based Payment," ("SFAS 123(R)") which requires companies to recognize in the statement of operations the grant date fair value of stock options and other equity based compensation issued to employees and disallows the use of the intrinsic value method of accounting for stock options, but expresses no preference for a type of valuation model. This statement supersedes APB No. 25, "Accounting for Stock Issued to Employees," but does not change the accounting guidance for share—based payment transactions with parties other than employees provided in SFAS No. 123 as originally issued. SFAS 123 (R) is effective for our year beginning January 1, 2006. We intend to use the "modified—prospective" method to report stock compensation upon adoption of SFAS 123(R). The stock-based compensation expense for 2006 is not expected to be materially different than the pro forma expense disclosed for 2005 under APB No. 25. We will allocate the expense for unvested stock options granted prior to January 1, 2006 over the vesting period, unless the options are forfeited.

        In June 2005, the Emerging Issues Task Force ("EITF") released Issue No. 04-5, "Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights" (EITF 04-05"). EITF 04-05 creates a framework for evaluating whether a general partner or a group of general partners controls a limited partnership and therefore should consolidate the partnership. EITF 04-05 states that the presumption of general partner control would be overcome only when the limited partners have certain specific rights as outlined in EITF 04-05. EITF 04-05 is effective immediately for all newly formed limited partnerships and for existing limited partnership agreements that are modified. For general partners in all other limited partnerships, EITF 04-05 is effective no later than the beginning of the first reporting

41



period in fiscal years beginning after December 15, 2005. Currently, this guidance will not materially affect our consolidated financial position, results of operations or statement of cash flows.


Item 7A.    Quantitative and Qualitative Disclosures About Market Risk

Market Risk

        Market risk refers to the risk of loss from adverse changes in market prices and interest rates. Our future income, cash flows and fair values of financial instruments are dependent upon prevailing market interest rates.

Interest Rate Risk

        Interest rate risk is highly sensitive to many factors, including governmental monetary and tax policies, domestic and international economic and political considerations and other factors beyond our control.

        As of December 31, 2005, we had $866.8 million in total debt of which $94.2 million is subject to variable interest rates (including the $61.8 million on which we have the reverse interest rate swap). If LIBOR were to increase or decrease by 100 basis points, the increase or decrease in interest expense on the variable rate debt would increase or decrease future earnings and cash flows by approximately $1.0 million annually.

        Interest rate risk amounts were determined by considering the impact of hypothetical interest rates on our financial instruments. These analyses do not consider the effect of any change in overall economic activity that could occur. Further, in the event of a change of that magnitude, we may take actions to further mitigate its exposure to the change. However, due to the uncertainty of the specific actions that would be taken and their possible effects, these analyses assume no changes in our financial structure.

        The fair value of fixed rate notes payable and notes payable to trusts at December 31, 2005 was $750,527. The carrying value of these fixed rate notes payable at December 31, 2005 was $772,570.

42



Item 8.    Financial Statements and Supplementary Data

EXTRA SPACE STORAGE INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND SCHEDULES

 
Reports of Independent Registered Public Accounting Firms

Financial Statements as of December 31, 2005 and 2004 and for the years ended December 31, 2005, 2004 and 2003:
 
Consolidated Balance Sheets
 
Consolidated Statements of Operations
 
Consolidated Statements of Redeemable Units and Members' and Stockholders' Equity (Deficit)
 
Consolidated Statements of Cash Flows
 
Notes to Consolidated Financial Statements

Financial Statement Schedule as of December 31, 2005:
 
Schedule III—Real Estate and Accumulated Depreciation

        All other schedules have been omitted since the required information is not present or not present in amounts sufficient to require submission of the schedule, or because the information required is included in the consolidated financial statements or notes thereto.

43



Report of Independent Registered Public Accounting Firm

The Board of Directors and Stockholders of Extra Space Storage Inc.

        We have audited the accompanying consolidated balance sheet of Extra Space Storage Inc. and subsidiaries ("the Company") as of December 31, 2005, and the related consolidated statements of operations, redeemable units and members' and stockholders' equity (deficit), and cash flows for the year ended December 31, 2005. Our audit also included the financial statement schedule listed in the Index at Item 8. These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audit.

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

        In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company at December 31, 2005, and the consolidated results of their operations and their cash flows for the year ended December 31, 2005, in conformity with U.S. generally accepted accounting principles. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.

        We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness the Company's internal control over financial reporting as of December 31, 2005, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 9, 2006 expressed an unqualified opinion thereon.

/s/ Ernst & Young LLP
Salt Lake City, Utah
March 9, 2006

44


Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders
Extra Space Storage, Inc.

        In our opinion, the accompanying consolidated balance sheet as of December 31, 2004 and the related consolidated statements of operations, of redeemable units and members' and shareholders' equity (deficit) and of cash flows for each of the two years in the period ended December 31, 2004 present fairly, in all material respects, the financial position of Extra Space Storage Inc. and its subsidiaries (the "Company") at December 31, 2004 and the results of their operations and their cash flows for each of the two years in the period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

/s/ PricewaterhouseCoopers LLP
Salt Lake City, Utah
March 10, 2005

45



Extra Space Storage Inc.

Consolidated Balance Sheets

(Dollars in thousands, except share data)

 
  December 31,
 
 
  2005
  2004
 
Assets:              
Real estate assets:              
  Net operating real estate assets   $ 1,201,959   $ 694,936  
  Real estate under development     10,719     1,963  
   
 
 
    Net real estate assets     1,212,678     696,899  
Investments in real estate ventures     90,898     6,182  
Cash and cash equivalents     28,653     24,329  
Restricted cash     18,373     4,430  
Receivables from related parties and affiliated real estate joint ventures     23,683     2,501  
Notes receivable     12,109      
Other assets, net     33,798     14,143  
   
 
 
      Total assets   $ 1,420,192   $ 748,484  
   
 
 
Liabilities, Minority Interests, and Stockholders' Equity:              
Notes payable   $ 747,193   $ 433,977  
Notes payable to trusts     119,590      
Line of credit         39,000  
Accounts payable and accrued expenses     13,261     3,444  
Other liabilities     23,785     7,003  
   
 
 
      Total liabilities     903,829     483,424  
   
 
 
Minority interest in Operating Partnership     36,010     21,453  
Other minority interests     225      

Commitments and contingencies

 

 

 

 

 

 

 

Stockholders' equity:

 

 

 

 

 

 

 
  Preferred stock, $0.01 par value, 50,000,000 shares authorized, no shares issued or outstanding          
  Common stock, $0.01 par value, 200,000,000 shares authorized, 51,765,795 and 31,169,950 shares issued and outstanding at December 31, 2005 and 2004, respectively     518     312  
  Paid-in capital     626,123     347,883  
  Deferred stock compensation     (2,374 )    
  Accumulated deficit     (144,139 )   (104,588 )
   
 
 
      Total stockholders' equity     480,128     243,607  
   
 
 
      Total liabilities, minority interests, and stockholders' equity   $ 1,420,192   $ 748,484  
   
 
 

See accompanying notes.

46



Extra Space Storage Inc.

Consolidated Statements of Operations

(Dollars in thousands, except per share data)

 
  Company
  Predecessor
 
 
  For the Year Ended December 31,
 
 
  2005
  2004
  2003
 
Revenues:                    
  Property rental   $ 120,640   $ 62,656   $ 33,054  
  Management and franchise fees     10,650     1,651     1,935  
  Tenant insurance     1,882          
  Acquisition and development fees     992     1,200     654  
  Other income     564     213     173  
   
 
 
 
    Total revenues     134,728     65,720     35,816  
   
 
 
 
Expenses:                    
  Property operations     45,963     26,066     14,858  
  Tenant insurance     1,023          
  Unrecovered development/acquisition costs and support payments     302     739     4,937  
  General and administrative     24,081     12,465     8,297  
  Depreciation and amortization     31,005     15,552     6,805  
   
 
 
 
    Total expenses     102,374     54,822     34,897  
   
 
 
 
Income before interest, loss on debt extinguishments, minority interests, equity in earnings of real estate ventures and gain on sale of real estate assets     32,354     10,898     919  
Interest expense     (42,549 )   (28,491 )   (18,746 )
Interest income     1,625     251     445  
Loss on debt extinguishments         (3,523 )    
Minority interest—Fidelity preferred return         (3,136 )   (4,132 )
Minority interest—Operating Partnership     434     113      
Loss allocated to other minority interests         2,290     1,431  
Equity in earnings of real estate ventures     3,170     1,387     1,465  
   
 
 
 
Loss before gain on sale of real estate assets     (4,966 )   (20,211 )   (18,618 )
Gain on sale of real estate assets         1,749     672  
   
 
 
 
Net loss   $ (4,966 ) $ (18,462 ) $ (17,946 )
   
 
 
 
Preferred return on Class B, C, and E units         (5,758 )   (5,336 )
Loss on early redemption of Fidelity minority interest         (1,478 )    
   
 
 
 
Net loss attributable to common stockholders   $ (4,966 ) $ (25,698 ) $ (23,282 )
   
 
 
 
Net loss per share—basic and diluted(1)   $ (0.14 ) $ (1.68 ) $ (5.62 )
   
 
 
 
Weighted average number of shares—basic and diluted     35,481,538     15,282,725     4,141,959  
Cash dividends paid per share common stock   $ 0.91   $ 0.34        

(1)
The basic loss per share does not include the potential effects of the CCSs and CCUs as such securities would not have participated in earnings for any of the periods presented and are antidilutive. These securities will not participate in distributions until they are converted, which cannot occur prior to March 31, 2006.

See accompanying notes.

47


Extra Space Storage Inc.

Consolidated Statements of Redeemable Units and Members' and Stockholders' Equity (Deficit)

(Dollars in thousands, except unit and share data)

 
  Redeemable
Units

  Members' and Stockholders' Equity
 
 
   
  Note
Receivable
from
Centershift

   
   
   
   
   
 
 
  Class C and
E Units

  Class A and
B Units

  Common
Stock

  Paid-in
Capital

  Deferred
Compensation

  Accumulated
Deficit

  Total Members' and
Stockholders'
Equity (Deficit)

 
Predecessor                                                  
Balances at December 31, 2002   $ 18,544   $ 45,374   $ (2,385 ) $   $   $   $ (34,017 ) $ 8,972  
Member units issued in acquisition of a real estate asset: C units (1,021,024 units) and A units (900,905 units)     1,021     180                         180  
Advances to Centershift             (1,798 )                   (1,798 )
Accrued interest on advances to Centershift             (310 )                   (310 )
Member contributions: C units (6,867,514 units), A units (16,218,769 units) and B units (6,505,986 units)     6,868     9,847                         9,847  
Redemption of units: C units (324,585 units), A units (100,263) and B units (1,870,943)     (325 )   (1,901 )                       (1,901 )
Return paid on Class C and Class E units                             (1,451 )   (1,451 )
Net loss                             (17,946 )   (17,946 )
   
 
 
 
 
 
 
 
 
Balances at December 31, 2003     26,108     53,500     (4,493 )               (53,414 )   (4,407 )
Member units issued in acquisition of real estate assets: C units (2,467,715 units), A units (1,593,665 units) and B units (241,513 units)     2,468     720                         720  
Member units issued in exchange for receivables: C units (944,370 units) and A units (6,666,667 units)     944     2,000                         2,000  
Members units issued to repay notes and related party payables: C units (1,466,250 units) and A units (862,500 units)     1,466     259                         259  
Member units granted to employees: A units (4,016,838 units)         1,205                         1,205  
Member contributions: C untis (14,985,500 units), A units (10,015,000 units) and B units (1,700,000 units)     14,986     4,705                         4,705  
Redemption of units: C units (20,835 units) and B units (222,500 units)     (21 )   (223 )                       (223 )
Redempion of units in exchange for note payable: A units (3,000,000 units) and B units (1,141,064 units)         (3,700 )                       (3,700 )
Redempion of units in exchange for land: C units (846,396 units)     (846 )                            
Distribution of equity ownership in Extra Space Development                             (9,000 )   (9,000 )
Distribution of note receivable from Centershift             4,493                 (4,493 )    
Return earned on Class B, C and E units                             (7,181 )   (7,181 )
Net loss                             (17,181 )   (17,181 )
   
 
 
 
 
 
 
 
 
Balances at August 16, 2004     45,105     58,466                     (91,269 )   (32,803 )

48


Extra Space Storage Inc.

Consolidated Statements of Redeemable Units and Members' and Stockholders' Equity (Deficit)

(Dollars in thousands, except unit and share data)

 
  Redeemable
Units

  Members' and Stockholders' Equity
 
 
   
  Note
Receivable
from
Centershift

   
   
   
   
   
 
 
  Class C and
E Units

  Class A and
B Units

  Common
Stock

  Paid-in
Capital

  Deferred
Compensation

  Accumulated
Deficit

  Total Members' and
Stockholders'
Equity (Deficit)

 
Company                                                  
Issuance of common stock (7,939,950 shares) and CCUs (3,888,843 shares) in exchange for units: C units (25,832,407), E units (14,900,000), A units (77,474,775) and B units (34,339,370 units)     (40,733 )   (43,953 )       80     84,606             40,733  
Redemption of units: C units (4,372,358), A units (70,000 units) and B units (14,735,162 units)     (4,372 )   (14,513 )                       (14,513 )
Adjustment to establish minority interest in Operating Partnership                     (8,481 )           (8,481 )
Deconsolidation of Extra Space Development real estate ventures                     7,515             7,515  
Issuance of common stock in initial public offering, net of offering costs (23,230,000 shares)                 232     264,243             264,475  
Net loss                             (1,281 )   (1,281 )
Loss on early redemption of minority interest—Fidelity                             (1,478 )   (1,478 )
Dividends paid on common stock at $0.34 per share                             (10,560 )   (10,560 )
   
 
 
 
 
 
 
 
 
Balances at December 31, 2004                 312     347,883         (104,588 )   243,607  
Issuance of common stock, net of offering costs (20,000,000 shares)                 200     271,337             271,537  
Conversion of operating partnership units for common stock (400,000 shares)                 4     3,923             3,927  
Issuance of common stock upon the exercise of options (5,845 shares)                     7             7  
Restricted stock grants (190,000 shares)                 2     2,973     (2,975 )        
Amortization of deferred stock compensation                         601         601  
Net loss                             (4,966 )   (4,966 )
Dividends paid on common stock at $0.91 per share                             (34,585 )   (34,585 )
   
 
 
 
 
 
 
 
 
Balances at December 31, 2005   $   $   $   $ 518   $ 626,123   $ (2,374 ) $ (144,139 ) $ 480,128  
   
 
 
 
 
 
 
 
 

See accompanying notes.

49



Extra Space Storage Inc.

Consolidated Statements of Cash Flows

(Dollars in thousands)

 
  Company
  Predecessor
 
 
  For the Year Ended December 31,
 
 
  2005
  2004
  2003
 
Cash flows from operating activities:                    
  Net loss   $ (4,966 ) $ (18,462 ) $ (17,946 )
  Adjustments to reconcile net loss to net cash provided by (used in) operating activities:                    
    Depreciation and amortization     31,005     15,552     6,805  
    Amortization of deferred stock compensation     601          
    Amortization of discount on putable preferred interests in consolidated joint ventures         1,088     1,311  
    Minority interest—Fidelity preferred return         3,136     4,132  
    Loss allocated to minority interests     (434 )   (2,403 )   (1,431 )
    Member units granted to employees         1,205      
    Gain on sale of real estate assets         (1,749 )   (672 )
  Distributions from real estate ventures in excess of earnings     6,356     493     802  
    Accrued interest on advances to Centershift             (310 )
    Changes in operating assets and liabilities:                    
      Receivables from related parties     (18,691 )   (2,573 )   1,068  
      Other assets     (1,129 )   1,330     927  
      Accounts payable     2,309     2,020     (1,312 )
      Payables to related parties             174  
      Other liabilities     (280 )   (5,795 )   (2,074 )
   
 
 
 
    Net cash provided by (used in) operating activities     14,771     (6,158 )   (8,526 )
   
 
 
 
Cash flows from investing activities:                    
  Acquisition of real estate assets     (79,227 )   (245,717 )    
  Acquisition of Storage USA     (530,972 )        
  Investments in trust preferred securities     (3,590 )        
  Development and construction of real estate assets     (20,204 )   (19,487 )   (62,632 )
  Proceeds from sale of real estate assets         7,896     6,241  
  Investments in real estate ventures     (395 )   (793 )   (144 )
  Increase in cash resulting from de-consolidation of real estate assets and distribution of equity ownership in Extra Space Development and other properties         424     428  
  Change in restricted cash     (4,110 )   (5,608 )   (503 )
  Payments from (advances to) Centershift and Extra Space Development         3,562     (1,798 )
  Principal payments received on notes receivable     25,938          
  Purchase of equipment and fixtures     (2,274 )   (1,575 )   (798 )
   
 
 
 
    Net cash used in investing activities     (614,834 )   (261,298 )   (59,206 )
   
 
 
 

See accompanying notes.

50


 
  Company
  Predecessor
 
 
  For the Year Ended December 31,
 
 
  2005
  2004
  2003
 
Cash flows from financing activities:                    
  Proceeds from notes payable, notes payable to trust and line of credit     808,936     418,154     106,323  
  Principal payments on notes payable and line of credit     (431,255 )   (325,917 )   (61,613 )
  Deferred financing costs     (6,575 )   (8,393 )   (420 )
  Payments on other liabilities         (15 )   (113 )
  Net payments to related parties and putable preferred interests in consolidated joint ventures         (35,627 )   15,628  
  Member contributions         19,691     16,715  
  Return paid on Class B, C and E member units         (7,181 )   (1,451 )
  Redemption of units         (19,129 )   (2,226 )
  Minority interest investments     225     8,086     3,040  
  Minority interest distributions         (30 )   (566 )
  Redemption of Operating Partnership units held by minority interest     (895 )   (935 )    
  Distributions to Operating Partnership units held by minority interests     (3,008 )        
  Minority interest redemption by Fidelity         (15,558 )    
  Preferred return paid to Fidelity         (7,022 )   (2,300 )
  Proceeds from issuance of common shares, net     271,537     264,475      
  Proceeds from exercise of stock options     7          
  Dividends paid on common stock     (34,585 )   (10,560 )    
   
 
 
 
    Net cash provided by financing activities     604,387     280,039     73,017  
   
 
 
 
Net increase in cash and cash equivalents     4,324     12,583     5,285  
Cash and cash equivalents, beginning of the year     24,329     11,746     6,461  
   
 
 
 
Cash and cash equivalents, end of the year   $ 28,653   $ 24,329   $ 11,746  
   
 
 
 
Supplemental schedule of cash flow information                    
Interest paid, net of amounts capitalized   $ 37,645   $ 30,610   $ 17,892  

Supplemental schedule of noncash investing and financing activities:

 

 

 

 

 

 

 

 

 

 
Acquisitions:                    
  Real estate assets   $ 54,761   $ 59,740   $ 5,253  
  Payables to related parties         (21,827 )    
  Notes payable     (10,260 )   (18,565 )   (2,500 )
  Accounts payable and other liabilities     (21,680 )   (2,139 )   (1,552 )
  Minority interest in Operating Partnership     (22,821 )   (14,021 )    
  Member units         (3,188 )    
Member units issued in exchange for receivables         2,944      
Member units issued to repay notes and related party payables         1,190      
Redemption of units in exchange for note payable         3,700      
Adjustment to establish minority interest in Operating Partnership         8,481      
Redemption of units in exchange for land         846      
Restricted stock grants to employees     2,975          
Conversion of Operating Partnership units held by minotiry interests for common stock     3,927          

See accompanying notes.

51



Extra Space Storage Inc.

Notes to Consolidated Financial Statements

December 31, 2005

(Dollars in thousands, except shares and per share data)

1.     DESCRIPTION OF BUSINESS

Business

        Extra Space Storage Inc. (the "Company") is a self-administered and self-managed real estate investment trust ("REIT"), formed as a Maryland Corporation on April 30, 2004 to own, operate, manage, acquire and develop self-storage facilities located throughout the United States. The Company continues the business of Extra Space Storage LLC and its subsidiaries (the "Predecessor"), which had engaged in the self-storage business since 1977. The Company's interest in its properties is held through its operating partnership, Extra Space Storage LP (the "Operating Partnership"), which was formed on May 5, 2004. The Company's primary assets are general partner and limited partner interests in the Operating Partnership. This structure is commonly referred to as an umbrella partnership REIT, or UPREIT. The Company has elected to be taxed as a REIT under the Internal Revenue Code of 1986, as amended. To the extent the Company continues to qualify as a REIT, it will not be subject to tax, with certain limited exceptions, on the taxable income that is distributed to its stockholders.

        The Company invests in self-storage facilities by acquiring or developing wholly-owned facilities or by acquiring an equity interest in real estate entities. At December 31, 2005, the Company had direct and indirect equity interests in 546 storage facilities located in 34 states, including Washington D.C.

        The Company operates in two distinct segments: (1) property management and development; and (2) rental operations. The Company's property management and development activities include acquiring, managing, developing and selling self-storage facilities. The rental operations activities include rental operations of self-storage facilities. No single tenant accounts for more than 5% of rental income.

Initial Public Offering

        On August 17, 2004, the Company completed its initial public offering (the "Offering") of 20,200,000 shares of common stock, with proceeds to the Company of $234,825, net of offering costs of $17,675. As part of the offering, the Company granted the underwriters the right to purchase an additional 3,030,000 shares within 30 days after the Offering to cover over-allotments. On September 1, 2004, the underwriters exercised their right and purchased 3,030,000 shares of common stock with proceeds to the Company of $35,224, net of offering costs of $2,651. The Company also paid additional offering costs of $5,574 as part of the Offering.

        In connection with the Offering, the existing holders of Class A, Class B, Class C and Class E Units in the Predecessor exchanged these units for an aggregate of 7,939,950 shares of common stock, 1,608,437 Operating Partnership ("OP") units, 3,888,843 contingent conversion shares ("CCSs"), 200,046 contingent conversion units ("CCUs") and $18,885 in cash. As a result of this exchange, the Predecessor became a wholly-owned subsidiary of the Operating Partnership. As of December 31, 2005, the Operating Partnership is a 93.12% subsidiary of the Company. The transaction did not result in a change in the carrying value of the Predecessor's assets and liabilities because the exchange was accounted for at historical cost as a transfer of assets between companies under common control.

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2.     SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Basis of Presentation

        The consolidated financial statements include the results of operations and financial condition of the Predecessor for the period from January 1, 2004 through August 16, 2004 and the year ended December 31, 2003 and the results of operations and financial condition of the Company subsequent to the Offering.

        The consolidated financial statements are presented on the accrual basis of accounting in accordance with U.S. generally accepted accounting principles and include the accounts of the Company and its wholly or majority owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

        The Company follows FASB Interpretation No. 46R, "Consolidation of Variable Interest Entities" ("FIN 46R"), which addresses the consolidation of variable interest entities ("VIEs"). Under FIN 46R, arrangements that are not controlled through voting or similar rights are accounted for as VIEs. An enterprise is required to consolidate a VIE if it is the primary beneficiary of the VIE.

        Under FIN 46R, a VIE is created when (i) the equity investment at risk is not sufficient to permit the entity to finance its activities without additional subordinated financial support from other parties, or (ii) the entity's equity holders as a group either: (a) lack direct or indirect ability to make decisions about the entity through voting or similar rights, (b) are not obligated to absorb expected losses of the entity if they occur, or (c) do not have the right to receive expected residual returns of the entity if they occur. If an entity is deemed to be a VIE pursuant to FIN 46R, the enterprise that is deemed to absorb a majority of the expected losses or receive a majority of expected residual returns of the VIE is considered the primary beneficiary and must consolidate the VIE.

        Based on the provisions of FIN 46R, the Company has concluded that under certain circumstances when the Company (i) enters into option agreements for the purchase of land or facilities from an entity and pays a non-refundable deposit, or (ii) enters into arrangements for the formation of joint ventures, a VIE may be created under condition (ii) (b) or (c) of the previous paragraph. For each VIE created, the Company has considered expected losses and residual returns based on the probability of future cash flows as outlined in FIN 46R. If the Company is determined to be the primary beneficiary of the VIE, the assets, liabilities and operations of the VIE are consolidated with the Company's financial statements.

Use of Estimates

        The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

Real Estate Assets

        Real estate assets are stated at cost, less accumulated depreciation. Direct and allowable internal costs associated with the development, construction, renovation, and improvement of real estate assets

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are capitalized. Interest, property taxes, and other costs associated with development incurred during the construction period are capitalized. Capitalized interest during the years ended December 31, 2005, 2004 and 2003 was $460, $1,213 and $2,593, respectively.

        Expenditures for maintenance and repairs are charged to expense as incurred. Major replacements and betterments that improve or extend the life of the asset are capitalized and depreciated over their estimated useful lives. Depreciation is computed using the straight-line method over the estimated useful lives of the buildings and improvements, which are generally between 5 and 39 years.

        In connection with the Company's acquisition of properties, the purchase price is allocated to the tangible and intangible assets and liabilities acquired based on their estimated fair values. The value of the tangible assets, consisting of land and buildings, are determined as if vacant, that is, at replacement cost. Intangible assets, which represent the value of existing tenant relationships, are recorded at their estimated fair values. The Company measures the value of tenant relationships based on the Company's historical experience with turnover in its facilities. The Company amortizes to expense the tenant relationships on a straight-line basis over the average period that a tenant is expected to utilize the facility (currently estimated to be18 months).

        Intangible lease rights represent purchase price amounts allocated to leases on two properties that cannot be classified as ground or building leases. These rights are amortized to expense over the life of the lease.

Evaluation of Asset Impairment

        The Company evaluates long-lived assets which are held for use for impairment when events or circumstances indicate that there may be an impairment. When such an event occurs, the Company compares the carrying value of these long-lived assets to the undiscounted future net operating cash flows attributable to the assets. An impairment loss is recorded if the net carrying value of the asset exceeds the undiscounted future net operating cash flows attributable to the asset. The impairment loss recognized equals the excess of net carrying value over the related fair value of the asset. Management has determined no property was impaired and no impairment charges have been recognized for the years ended December 31, 2005, 2004 and 2003.

        When real estate assets are identified by management as held for sale, the Company discontinues depreciating the assets and estimates the fair value, net of selling costs. If the estimated fair value, net of selling costs, of the assets that have been identified for sale is less than the net carrying value of the assets, then a valuation allowance is established. Management has determined no property was held for sale at December 31, 2005. The operations of assets held for sale or sold during the period are presented as discontinued operations for all periods presented.

Investments in Real Estate Ventures

        The Company's investments in real estate joint ventures, where the Company has significant influence, but not control and joint ventures which are VIEs in which the Company is not the primary beneficiary are recorded under the equity method of accounting on the accompanying consolidated financial statements.

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        Under the equity method, the Company's investment in real estate ventures is stated at cost and adjusted for the Company's share of net earnings or losses and reduced by distributions. Equity in earnings of real estate ventures is generally recognized based on the Company's ownership interest in the earnings of each of the unconsolidated real estate ventures. For the purposes of presentation in the statement of cash flows, the Company follows the "look through" approach for classification of distributions from joint ventures. Under this approach, distributions are reported under operating cash flow unless the facts and circumstances of a specific distribution clearly indicate that it is a return of capital (e.g., a liquidating dividend or distribution of the proceeds from the joint venture's sale of assets) in which case it is reported as an investing activity.

        Management assesses whether there are any indicators that the value of the Company's investments in unconsolidated real estate ventures may be impaired when events or circumstances indicate that there may be an impairment. An investment is impaired if management's estimate of the fair value of the investment is less than its carrying value. To the extent impairment has occurred, and it is considered to be other than temporary, the loss is measured as the excess of the carrying amount of the investment over the fair value of the investment. No impairment charges were recognized for the years ended December 31, 2005, 2004 and 2003.

Cash and Cash Equivalents

        The Company's cash is deposited with financial institutions located throughout the United States of America and at times may exceed federally insured limits. The Company considers all highly liquid debt instruments with a maturity date of three months or less to be cash equivalents.

Restricted Cash

        Restricted cash is comprised of escrowed funds deposited with financial institutions located in various states relating to earnest money deposits on potential acquisitions, real estate taxes, insurance, capital expenditures and lease liabilities. As of December 31, 2005 and 2004, the Company has debt agreements that require the Company to have unrestricted cash of $1,500 available at all times.

Other Assets

        Other assets consist primarily of equipment and fixtures, deferred financing costs, accounts receivable, investment in trusts, prepaid expenses, and deferred advertising costs. Depreciation of equipment and fixtures is computed on a straight-line basis over three to seven years. Deferred financing costs are amortized to interest expense using the effective interest method over the terms of the respective debt agreements. Deferred direct response advertising costs are amortized to property operating expenses over a thirty-month period on a straight-line basis.

Derivative Instruments and Hedging Activities

        Statement of Financial Accounting Standards ("SFAS") No. 133, "Accounting for Derivative Instruments and Hedging Activities," as amended and interpreted, establishes accounting and reporting standards for derivative instruments and hedging activities. The accounting for changes in the fair value of derivatives depends on the intended use of the derivative and the resulting designation. Derivatives used to hedge the exposure to changes in the fair value of an asset, liability or firm commitment

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attributable to a particular risk, are considered fair value hedges. Derivatives used to hedge the exposure to variability in expected future cash flows, or other types of forecasted transactions, are considered cash flow hedges.

        For derivatives designated as fair value hedges, changes in the fair value of the derivative and the hedged item related to the hedged risk are recognized in earnings. For derivatives designated as cash flow hedges, the effective portion of changes in the fair value of the derivative is initially reported in other comprehensive income (loss), outside of earnings and subsequently reclassified to earnings when the hedged transaction affects earnings.

Fair Value of Financial Instruments

        The carrying values of cash and cash equivalents, receivables, other financial instruments included in other assets, accounts payable and accrued expenses, variable rate notes payable and other liabilities reflected in the consolidated balance sheets at December 31, 2005 and 2004 approximate the fair values. The fair value of fixed rate notes payable and notes payable to trusts at December 31, 2005 and 2004 was $750,527 and $333,579, respectively. The carrying value of these fixed rate notes payable and notes payable to trusts at December 31, 2005 and 2004 was $772,570 and $340,669, respectively.

Conversion of Operating Partnership Units

        Conversions of Operating Partnership units to common stock, when converted under the original provisions of the agreement, are accounted for by reclassifying the underlying net book value of the units from minority interest to equity in accordance with Emerging Issues Task Force Issue No. 95-7, "Implementation Issues Related to the Treatment of Minority Interest in Certain Real Estate Investment Trusts."

Revenue and Expense Recognition

        Rental revenues are recognized as earned based upon amounts that are currently due from tenants. Leases are generally on month-to-month terms. Prepaid rents are recognized on a straight-line basis over the term of the lease. Property expenses, including utilities, property taxes, repairs and maintenance and other cost to manage the facilities are recognized as incurred.

        Management and franchise fee revenue and tenant insurance revenue are recognized when earned. Development and acquisition fee revenue is recognized as development costs are incurred.

Real Estate Sales

        The Company evaluates real estate sales for both sale recognition and profit recognition in accordance with the provisions of SFAS No. 66, "Accounting for Sales of Real Estate". In general, sales of real estate and related profits/losses are recognized when all consideration has changed hands and risks and rewards of ownership have been transferred. Certain types of continuing involvement preclude sale treatment and related profit recognition; other forms of continuing involvement allow for sale recognition but require deferral of profit recognition.

        The Predecessor periodically sold properties into real estate joint ventures or identified properties for acquisition by newly formed joint ventures in which it retained an interest. In connection with

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certain of these transactions, the Predecessor and/or a significant unit holder provided certain financial guarantees to the lender; or to support a put right on a portion of the joint venture partner's interest that effectively provided for a return on and of their investment. These arrangements preclude sale accounting under SFAS No. 66 and, accordingly, the Predecessor has reflected these transactions using the financing method set forth in SFAS No. 66. Under this method, the putable portions of these joint ventures partners' interests are reflected as liabilities; the initial fair value of the joint venture partners' non-putable residual interests are reflected as minority interests with offsetting discounts attributed to the liabilities associated with the putable interests, "putable preferred interests in consolidated joint ventures." These discounts are amortized using the effective interest method over the period until the relevant put first becomes exercisable (generally a period of three to five years depending on the terms of the individual transaction). The preferred return on the putable interest liabilities, plus the amortization of the discounts, is reflected as interest expense in the consolidated statements of operations. The joint venture partners are allocated their proportionate share of any profits, except that losses may not be allocated in excess of the originally ascribed basis. Concurrent with the Offering, the Company redeemed all putable interest liabilities by purchasing 100% of its partners' interest in these properties.

Advertising Costs

        The Company incurs advertising costs primarily attributable to directory, direct mail, internet and other advertising. Direct response advertising costs were deferred and amortized to expense during the years ending December 31, 2004 and 2003. The Company recognized $4,374, $2,950 and $1,902 in advertising expense for the years ended December 31, 2005, 2004 and 2003, respectively.

Income Taxes

        The Company has elected to be treated as a REIT under Sections 856 through 860 of the Internal Revenue Code of 1986, as amended (the "Code"). In order to maintain its qualification as a REIT, among other things, the Company is required to distribute at least 90% of its REIT taxable income to its stockholders and meet certain tests regarding the nature of its income and assets. As a REIT, the Company is not subject to federal income tax with respect to that portion of its income which meets certain criteria and is distributed annually to the stockholders. The Company plans to continue to operate so that it meets the requirements for taxation as a REIT. Many of these requirements, however, are highly technical and complex. If the Company were to fail to meet these requirements, the Company would be subject to federal income tax. The Company is subject to certain state and local taxes. Provision for such taxes has been included in real estate and other taxes in the Company's consolidated statement of operations. For the year ended December 31, 2005, 100% (unaudited) of all distributions to stockholders qualify as a return of capital.

        The Company has elected to treat one of its existing corporate subsidiaries as taxable REIT subsidiaries ("TRS"). In general, a TRS of the Company may perform additional services for tenants of the Company and generally may engage in any real estate or non-real estate related business (except for the operation or management of health care facilities or lodging facilities or the provision to any person, under a franchise, license or otherwise, of rights to any brand name under which any lodging facility or health care facility is operated). A TRS is subject to corporate federal income tax.

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        The TRS has minimal book and tax income and has not recorded tax amounts under SFAS No. 109, "Accounting for Income Taxes," due to the amounts not being material.

        Prior to August 17, 2004, the Company elected to be treated as a partnership for tax purposes. The tax effects of the Company's operations were passed directly to members. Therefore, no provisions for income taxes were recorded in the accompanying consolidated financial statements for the Predecessor.

Stock-Based Compensation

        As permitted by SFAS No.123, "Accounting for Stock-Based Compensation," as amended by SFAS No. 148, "Accounting for Stock Based Compensation-Transition and Disclosure—an amendment of FASB Statement No. 123," the Company has elected to measure and record compensation cost relative to employee stock option costs in accordance with Accounting Principles Board Opinion ("APB") No. 25, "Accounting for Stock Issued to Employees," and related interpretations and make pro forma disclosures of net loss and basic and diluted loss per share as if the fair value method of valuing stock options had been applied. Under ABP No. 25, compensation cost is recognized for stock options granted to employees when the option price is less than the market price of the underlying common stock on the date of grant.

        For purposes of the pro forma disclosures, the Company applies SFAS No. 123, as amended by SFAS No. 148, which requires the Company to estimate the fair value of the employee stock options at the grant date using an option-pricing model. The Company recorded deferred stock compensation in stockholders' equity equal to the market value of the restricted shares on the date of grant and amortizes deferred stock compensation to expense over the vesting period.

        The following table represents the effect on net loss and loss per share as if the Company had applied the fair value based method and recognition provisions of SFAS No. 123, as amended:

 
  Company
  Predecessor
 
 
  Year ended December 31,
 
 
  2005
  2004
  2003
 
Net loss attributable to common stockholders as reported   $ (4,966 ) $ (25,698 ) $ (23,282 )
Add: Stock-based compensation expense included in reported net loss attributable to common stockholders     601          
Deduct: Stock-based compensation expense determined under fair value method for all awards     (1,261 ) $ (129 ) $  
   
 
 
 
Pro forma net loss   $ (5,626 ) $ (25,827 ) $ (23,282 )
   
 
 
 
Loss per common share                    
Basic and diluted—as reported   $ (0.14 ) $ (1.68 ) $ (5.62 )
Basic and diluted—pro forma   $ (0.16 ) $ (1.69 ) $ (5.62 )

        The above pro forma disclosures are not necessarily representative of the effects on reported net loss for future years.

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Net Loss Per Share

        Basic earnings (loss) per common share is computed by dividing the net income (loss) by the weighted average common shares outstanding, less unvested restricted stock. Diluted earnings (loss) per common share measures the performance of the Company over the reporting period while giving effect to all potential common shares that were dilutive and outstanding during the period. The denominator includes the number of additional common shares that would have been outstanding if the potential common shares that were dilutive had been issued and is calculated using the treasury stock method. Potential common shares are securities (such as options, warrants, convertible debt, and convertible OP units) that do not have a current right to participate in earnings but could do so in the future by virtue of their option or conversion right. In computing the dilutive effect of convertible securities, the number (i.e. net income or loss) is adjusted to add back any changes in earnings (loss) in the period associated with the convertible security. The numerator also is adjusted for the effects of any other non-discretionary changes in income or loss that would result from the assumed conversion of those potential common shares. In computing diluted earnings (loss) per share, only potential common shares that are dilutive, those that reduce earnings (loss) per share, are included. Since the Company generated a loss for 2005, the impact of inclusion of the potential conversion of securities into common shares is anti-dilutive and therefore diluted earnings per share is the same as basic earnings per share. Excluded from the computation of diluted common shares outstanding are: 173,750 shares of restricted stock grants, 3,032,398 stock options, and 3,825,787 convertible OP units.

        For the periods prior to the Offering, the weighted average number of common shares outstanding includes Class A units as if the Class A units had been converted to common stock using the initial public offering conversion ratio of one Class A unit to 0.08 shares of common stock. Basic and diluted earnings per share are calculated by dividing net the loss attributable to common stockholders by the weighted average shares outstanding. The net loss attributable to common stockholders represents the net loss, less the preferred return payable by the Predecessor on Class B, C and E units, less the loss on early redemption of Fidelity minority interest. The loss on early redemption of Fidelity minority interest represents additional preferred return paid to Fidelity for the period between the redemption date of September 9, 2004 and November 25, 2004. The amount was paid based on the agreement whereby Fidelity was entitled to a preferred return through November 25, 2004, regardless of the redemption date.

Recently Issued Accounting Standards

        In December 2004, the Financial Accounting Standards Board ("FASB") issued SFAS No. 123 (revised 2004), "Share-Based Payment," ("SFAS 123(R)") which requires companies to recognize in the statement of operations the grant date fair value of stock options and other equity based compensation issued to employees and disallows the use of the intrinsic value method of accounting for stock options, but expresses no preference for a type of valuation model. This statement supersedes APB No. 25, "Accounting for Stock Issued to Employees," but does not change the accounting guidance for share-based payment transactions with parties other than employees provided in SFAS No. 123 as originally issued. SFAS 123 (R) is effective for the Company's year beginning January 1, 2006. The Company intends to use the "modified-prospective" method to report stock compensation upon adoption of SFAS 123(R). The stock-based compensation expense for 2006 is not expected to be materially different than the pro forma expense disclosed for 2005 under APB No. 25. The Company will allocate the

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expense for unvested stock options granted prior to January 1, 2006 over the vesting period, unless the options are forfeited.

        In June 2005, the Emerging Issues Task Force ("EITF") released Issue No. 04-5, "Determining Whether a General Partner, or the General Partners as a Group, Controls a Limited Partnership or Similar Entity When the Limited Partners Have Certain Rights" (EITF 04-05"). EITF 04-05 creates a framework for evaluating whether a general partner or a group of general partners controls a limited partnership and therefore should consolidate the partnership. EITF 04-05 states that the presumption of general partner control would be overcome only when the limited partners have certain specific rights as outlined in EITF 04-05. EITF 04-05 is effective immediately for all newly formed limited partnerships and for existing limited partnership agreements that are modified. For general partners in all other limited partnerships, EITF 04-05 is effective no later than the beginning of the first reporting period in fiscal years beginning after December 15, 2005. Currently, this guidance will not materially affect the Company's consolidated financial position, results of operations or statement of cash flows.

Reclassifications

        Certain amounts in the 2004 and 2003 financial statements and supporting note disclosures have been reclassified to conform to the current year presentation, including the reclassification of interest income from total revenues to other revenue and expenses. Such reclassification did not impact previously reported net loss or accumulated deficit.

3.     REAL ESTATE ASSETS

        Real estate assets at December 31, 2005 and 2004 are summarized as follows:

 
  2005
  2004
 
Land   $ 304,892   $ 179,932  
Buildings and improvements     929,745     527,917  
Intangible assets—tenant relationships     22,174     12,026  
Intangible lease rights     3,400     3,400  
   
 
 
      1,260,211     723,275  
Less: accumulated depreciation and amortization     (58,252 )   (28,339 )
   
 
 
  Net operating real estate assets     1,201,959     694,936  
Real estate under development     10,719     1,963  
   
 
 
  Net real estate assets   $ 1,212,678   $ 696,899  
   
 
 

        The Company amortizes to expense intangible assets—tenant relationships on a straight-line basis over the average period that a tenant utilizes the facility (18 months). The Company amortizes to expense the intangible lease rights over the term of the lease (5 years). Amortization related to the tenant relationships and lease rights was $10,345 and $3,404 for 2005 and 2004, respectively. The majority balance of the unamortized tenant relationships at December 31, 2005 will be amortized in 2006. The remaining balance of the unamortized lease rights will be amortized over the next 12 to 23 years.

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4.     BUSINESS ACQUISITION

        To expand its business, on July 14, 2005, the Company, through its subsidiary Extra Space Storage LLC ("ESS LLC") and the Operating Partnership, closed the acquisition (the "Transaction") of various entities that collectively comprise the Storage USA self-storage business pursuant to the Purchase and Sale Agreement (the "Agreement"), dated May 5, 2005, between ESS LLC, the Operating Partnership, Security Capital Self Storage Incorporated, a Delaware corporation, PRISA Self Storage LLC, a Delaware limited liability company ("PRISA"), PRISA II Self Storage LLC, a Delaware limited liability company ("PRISA II"), PRISA III Self Storage LLC, a Delaware limited liability company ("PRISA III"), VRS Self Storage LLC, a Delaware limited liability company ("VRS"), WCOT Self Storage LLC, a Delaware limited liability company ("WCOT"), and the Prudential Insurance Company of America, a New Jersey corporation (together with its affiliates, "Prudential").

        In connection with the Transaction, the Company acquired 61 wholly-owned self storage properties, acquired Storage USA ("SUSA") Partnership, L.P.'s equity interest in joint ventures which collectively owned 78 properties and assumed the management of 60 franchises and third party owned properties. In addition, 259 of the self-storage properties were acquired in the Transaction by five separate limited liability companies owned by five subsidiaries of the Company (each, a "Company Sub") and Prudential. The limited liability company agreements govern the rights and responsibilities of each such limited liability company. The Company also acquired $37.7 million of notes receivable due from franchisees.

        The total purchase cost for SUSA of approximately $585.7 million consists of the following:

Cash   $ 530,972
Operating Partnership units issued (1,470,149 units)     22,821
Liabilities assumed     31,940
   
  Total purchase price   $ 585,733
   

        The total purchase price for the acquisition of SUSA has been allocated to tangible and intangible assets and liabilities based on their estimated fair values. The value of the tangible assets, consisting of land and buildings, are determined as if vacant, that is, at replacement cost. Other tangible assets and liabilities and intangible assets, which represent the value of existing tenant relationships, are recorded at their estimated fair value. The following table summarizes the estimated fair values of the assets acquired and liabilities assumed:

Tangible assets:      
  Land   $ 86,234
  Building     342,634
Intangibles assets:      
  Tenant relationships     9,009
Investment in real estate ventures     90,677
Other assets and liabilities, net     57,179
   
  Total assets acquired   $ 585,733
   

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        Intangible assets—tenant relationships are amortized on a straight-line basis over the average period that the Company's tenants utilized the facility (18 months).

        The following table reflects the results of the Company's operations on a pro forma basis as if the SUSA acquisition had been completed on January 1, 2004. The pro forma financial information is not necessarily indicative of the operating results that would have occurred had the acquisition been consummated on January 1, 2004, nor is it necessarily indicative of future operating results.

 
  Years ending December 31,
 
 
  2005
  2004
 
Revenues   $ 176,591   $ 137,808  
Net loss   $ (5,582 ) $ (25,694 )
Loss per share   $ (0.16 ) $ (1.68 )

5.     PROPERTY ACQUISITIONS

        On December 20, 2005, the Company purchased one self-storage facility located in Louisville, Kentucky from a franchisee in which the company had no equity ownership for cash of $3,659.

        On March 28, 2005, the Company purchased one self-storage facility located in Green Acres, Florida from a third party for cash of $4,702.

        On March 8, 2005, the Company purchased four self-storage facilities located in Orlando, Florida from a third party for cash of $29,575.

        On February 28, 2005, the Company purchased one self-storage facility located in Atlanta, Georgia from a third party for cash of $11,751.

        On January 18, 2005, the Company purchased one self-storage facility located in Avenel, New Jersey from a third party for $9,788. The Company paid cash of $5,564, assumed a note payable of $4,142 and other liabilities of $82.

        On January 1, 2005, the Company purchased one self-storage facility located in Palmdale, California from certain members of the Company's management team and a director for $6,707. The Company paid cash of $3,321, assumed a note payable for $3,342 and other liabilities of $44. The independent members of the Company's Board of Directors approved this acquisition.

        During December 2004, the Company purchased four self-storage facilities located in New Jersey and Pennsylvania from third parties for cash of $25,547.

        On August 27, 2004, the Company purchased 26 self-storage properties from Storage Spot Properties No. 1, L.P. and Storage Spot Properties No. 4, L.P. for cash of approximately $146,500. In addition, the seller received an additional $4,500 based on the operating performance of the 26 properties in 2005. The $4,500 paid in 2005 represents additional purchase price and was reflected within the basis of the assets acquired and liabilities assumed as the contingent payment was made within the allocation period as defined by SFAS No. 141, "Business Combinations."

        On August 26, 2004, the Company purchased one self-storage property located in Bronx, New York from a third party for cash of $14,175.

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        On August 23, 2004, the Company purchased the joint venture interests held by affiliates of the Moss Group in two joint ventures, which currently own two self-storage properties. The Company paid cash of $7,487, assumed debt of $7,394, other liabilities of $363 and issued 1,006,684 OP Units valued at $12,584.

        On August 19, 2004, the Company purchased one self-storage property located in Mesa, Arizona, and one self-storage property in Riverside, California from a third party. The Company paid cash of $4,314 and assumed debt of $4,386.

        On August 17, 2004, the Company purchased the joint venture interests held by Equibase Mini Warehouse and its affiliates in seven joint ventures, which currently own an aggregate of 30 self-storage properties, for an aggregate of approximately $35,800 in cash and 114,928 OP Units issued by the Operating Partnership valued at $1,437.

        On June 1, 2004, the Predecessor purchased nine self-storage facilities from Extra Space West One LLC, a joint venture in which the Predecessor was a member. The facilities are located in California, Florida and Utah. The Predecessor paid cash of $39,264, issued a note for $12,400 to its joint venture partner and assumed other liabilities of $726, for total consideration of $52,390.

        On May 4, 2004, the Predecessor purchased the joint venture partner's interest in Extra Space East One LLC. The Predecessor paid cash of $9,888 and issued a note for $8,400 to its joint venture partner for total consideration of $18,288.

        On April 1, 2004, the Predecessor purchased the joint venture partner's interest in two self-storage facilities in Tracy, California for $2,006. The Predecessor issued 455,069 Class C units valued at $455 and 267,688 Class A units valued at $80 and paid cash of $1,471.

        On March 31, 2004, the Predecessor purchased a self-storage facility in Marshfield, Massachusetts from members and third parties for $5,279. The Predecessor issued 724,544 Class C units valued at $725; 241,513 Class B units valued at $242, and 568,271 Class A units valued at $171. The Predecessor assumed debt of $3,086, other liabilities of $393 and related party payables of $662.

        During February 2004, the Predecessor purchased five self-storage facilities located in Massachusetts for cash totaling $34,150. Also in February 2004, the Predecessor purchased four self-storage facilities located in Maryland, New Jersey and Pennsylvania for cash totaling $45,100. All nine facilities were purchased from third parties.

        In January 2004, the Predecessor purchased the joint venture partner's interest in a self-storage facility in Manteca, California for $3,436. The Predecessor issued 778,102 Class C units valued at $778 and 457,706 Class A units valued at $137, assumed existing debt of $2,453 and other liabilities of $68 associated with the property. Also in January 2004, the Predecessor purchased an office park from members in Worcester, Massachusetts for $2,800. The Predecessor issued 510,000 Class C units valued at $510 and 300,000 Class A units valued at $90, assumed existing debt of $1,246, other liabilities of $589 and related party payables of $365.

        The following table reflects the unaudited results of the Company's and the Predecessor's operations on a pro forma basis as if the SUSA and property acquisitions referred to in the preceding paragraphs had been completed on January 1, 2005 and 2004, respectively. The pro forma financial information is not necessarily indicative of the operating results that would have occurred had the

63



acquisitions been consummated on January 1, 2004, nor is it necessarily indicative of future operating results.

 
  Years ending December 31,
 
 
  2005
  2004
 
Revenues   $ 179,581   $ 166,595  
Net loss   $ (5,165 ) $ (6,255 )
Loss per share   $ (0.15 ) $ (0.41 )

6.     INVESTMENTS IN REAL ESTATE VENTURES

        Investments in real estate ventures at December 31, 2005 and 2004 consist of the following:

 
   
   
  Investment balance at December 31,
 
  Excess Profit
Participation %

  Equity
Ownership %

 
  2005
  2004
Extra Space East One LLC ("ESE")   40 % 5 % $   $
Extra Space West One LLC ("ESW")   40 % 5 %   2,070     2,299
Extra Space Northern Properities Six, LLC ("ESNPS")   35 % 10 %   1,929     2,138
PRISA   17 % 2 %   13,824    
PRISA II   17 % 2 %   11,187    
PRISA III   20 % 5 %   4,954    
VRS   20 % 5 %   4,740    
WCOT   20 % 5 %   5,052    
Storage Portfolio I, LLC ("Teachers")   40 % 25 %   20,346    
Storage Portfolio Bravo II ("Heitman")   45 % 20 %   15,753    
Other minority owned properties   10-50 % 10-50 %   11,043     1,745
           
 
            $ 90,898   $ 6,182
           
 

        In these joint ventures, the Company and the joint venture partner generally receive a preferred return on their invested capital. To the extent that cash/profits in excess of these preferred returns are generated through operations or capital transactions, the Company would receive a higher percentage of the excess cash/profits than its equity interest.

        During the first and second quarter 2004, the Predecessor held a minority investment in Extra Space East One LLC ("ESE"). The Predecessor acquired its joint venture partner's interest in ESE on May 4, 2004. Subsequent to the acquisition of its partner's joint venture interest in ESE, the Company has consolidated the properties previously owned by ESE.

        To the extent that properties were sold/transferred into these ventures where such transactions did not qualify for sales treatment, those properties are reflected as being owned by the Predecessor in the consolidated financial statements with the joint venture partners' interests in these properties reflected as minority interests and putable preferred interests in consolidated joint ventures. There were no such transactions for the years ended December 31, 2005 or 2004.

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        Equity in earnings of real estate ventures for the years ended December 31, 2005, 2004, and 2003 consists of the following:

 
  Company
  Predecessor
 
  2005
  2004
  2003
Equity in earnings of ESE   $   $ 19   $
Equity in earnings of ESW     1,171     935     787
Equity in earningsof ESNPS     135     3     151
Equity in earnings of PRISA     265        
Equity in earnings of PRISA II     210        
Equity in earnings of PRISA III     70        
Equity in earnings of VRS     79        
Equity in earnings of WCOT     68        
Equity in earnings of Teachers     413        
Equity in earnings of Heitman     319        
Equity in earnings of other minority owned properties     440     430     527
   
 
 
    $ 3,170   $ 1,387   $ 1,465
   
 
 

        Equity in earnings of Teachers and Heitman includes the amortization of the Company's excess purchase price of approximately $19 million of these equity investments over its original basis. The excess basis is amortized over 40 years.

        Combined, condensed unaudited financial information of ESE, ESW, ESNPS, PRISA, PRISA II, PRISA III, VRS, WCOT, Teachers and Heitman as of December 31, 2005 and 2004 and for the years ended December 31, 2005, 2004, and 2003, follows:

 
  December 31,
BALANCE SHEETS

  2005
  2004
Assets:            
Net real estate assets   $ 1,971,972   $ 83,938
Other     77,037     7,088
   
 
    $ 2,049,009   $ 91,026
   
 
Liabilities and members' equity:            
Borrowings   $ 434,539   $ 52,043
Other liabilities     43,007     1,742
Members' equity     1,571,463     37,241
   
 
    $ 2,049,009   $ 91,026
   
 

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Years ended December 31,

STATEMENTS OF INCOME

  2005
  2004
  2003
Rents and other income   $ 157,558   $ 34,821   $ 22,987
Expenses     99,211     13,112     17,991
   
 
 
Net income   $ 58,347   $ 21,709   $ 4,996
   
 
 

        Information (unaudited) related to the real estate ventures' debt at December 31, 2005 is set forth below:

 
  Loan Amount
  Current
Interest Rate

  Debt
Maturity

ESW—Fixed   $ 16,650   4.59 % July 2010
ESNPS—Fixed     34,500   5.27 % June 2015
PRISA III—Fixed     145,000   4.97 % August 2012
VRS—Fixed     52,100   4.76 % August 2012
WCOT—Fixed     93,300   4.76 % August 2012
Heitman—Fixed     67,400   4.83 % July 2009
Teachers—Fixed     115,000   4.62 % April 2011
Other     105,265   various   various

7.     NOTES RECEIVABLE

        Notes receivable relate to construction advances SUSA had offered to certain franchisees. All properties are now in their operating phase. The notes are collateralized by the franchised properties and have terms up to five years. Interest payments are generally due monthly on the notes during the first two years of the term, with amortization of principal generally commencing in the third year based upon a 25-year schedule with the balance due at the due date. The loans bear interest based on a spread over the prime interest rate of 0.5% to 1.0%. Typically, advances represented 70%-90% of the anticipated cost of the project.

        Management periodically assesses historical payment history, payment status, prevailing economic and business conditions, specific loan terms and other relevant factors to determine whether any notes receivable should be placed on non-accrual status or otherwise adjusted for impairment. At December 31, 2005, none of the notes receivables are considered impaired.

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8.     OTHER ASSETS

        Other assets at December 31, 2005 and 2004 are summarized as follows:

 
  2005
  2004
 
Equipment and fixtures   $ 9,389   $ 7,115  
Less: accumulated depreciation     (4,977 )   (4,136 )
Deferred financing costs, net     12,151     6,899  
Deferred advertising costs, net     128     588  
Prepaid expenses and escrow deposits     5,114     2,305  
Accounts receivable, net     8,179     1,295  
Investments in Trusts (Note 10)     3,590      
Other     224     77  
   
 
 
    $ 33,798   $ 14,143  
   
 
 

9.     NOTES PAYABLE

        Notes payable at December 31, 2005 and 2004 are summarized as follows:

 
  2005
  2004
Mortgage and construction loans with banks bearing interest at fixed rates between 4.30% and 7.50%. The loans are collateralized by mortgages on real estate assets and the assignment of rents. Principal and interest payments are made monthly with all outstanding principal and interest due between March 31, 2009 and December 1, 2015.    $ 652,980   $ 278,899

Mortgage and construction loans with banks bearing floating interest rates (including loans subject to interest rate swaps) based on LIBOR and Prime. Interest rates based on LIBOR are between LIBOR plus 0.66% (5.05% and 3.06% at December 31, 2005 and December 31, 2004, respectively) and LIBOR plus 2.75% (7.14% and 5.15% at December 31, 2005 and December 31, 2004, respectively). Interest rates based on Prime are at Prime plus 0.5% (7.75% and 5.75% at December 31, 2005 and December 31, 2004, respectively). The loans are collateralized by mortgages on real estate assets and the assignment of rents. Principal and interest payments are made monthly with all outstanding principal and interest due between May 30, 2006 and August 24, 2009. 

 

 

94,213

 

 

155,078
   
 

 

 

$

747,193

 

$

433,977
   
 

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        The following table summarizes the scheduled maturities of notes payable at December 31:

2006   $ 6,500
2007     6,525
2008     1,553
2009     303,358
2010     113,400
Thereafter     315,857
   
    $ 747,193
   

        Real estate assets are pledged as collateral for the notes payable. The Company is subject to certain restrictive covenants relating to the outstanding notes payable. The Company was in compliance with all covenants at December 31, 2005.

        In October 2004, the Company entered into a reverse interest rate swap agreement ("Swap Agreement") to float $61,770 of 4.30% fixed interest rate secured notes due in June 2009. Under this Swap Agreement, the Company will receive interest at a fixed rate of 4.30% and pay interest at a variable rate equal to LIBOR plus 0.655%. The Swap Agreement matures at the same time the notes are due. This Swap Agreement is a fair value hedge, as defined by SFAS No. 133, and the fair value of the Swap Agreement is recorded as an asset or liability, with an offsetting adjustment to the carrying value of the related note payable. Monthly variable interest payments are recognized as an increase or decrease in interest expense.

        The estimated fair value of the Swap Agreement at December 31, 2005 and 2004 was reflected as an other liability of $2,151 and $532, respectively. For the years ended December 31, 2005 and 2004 interest expense has been reduced by $70 and $243, respectively, as a result of the Swap Agreement.

        During the year ended December 31, 2004, the Company and the Predecessor refinanced approximately $143,840 of borrowings. As a result of these refinancings, approximately $819 of unamortized deferred financing costs associated with the loans that were repaid was written off, and approximately $5,687 of defeasance costs was paid. Defeasance costs of $3,523 are included in loss on debt extinguishments in the consolidated statement of operations. An additional $2,164 of defeasance costs was included in the purchase price of property acquisitions.

        On July 14, 2005, the Company entered into $313,000 of new mortgages which are collateralized by 57 of the 61 wholly-owned properties purchased in conjunction with the SUSA acquisition. These mortgages bear interest at fixed rates of 5.26% or 5.29% and mature in five or 10 years after inception.

        On August 27, 2004, the Company entered into a new $111,000 senior 4.65% fixed rate mortgage in conjunction with the purchase of 26 self-storage properties.

        On August 26, 2004, the Company closed a $37,000 variable rate mortgage. This mortgage is collateralized by five properties and bears interest at a variable rate equal to LIBOR plus 1.75% and matures in three years after inception with a two-year extension available at the Company's option.

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10.   NOTES PAYABLE TO TRUSTS

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

        During May 2005, ESS Statutory Trust II (the "Trust II"), a newly formed Delaware statutory trust and a wholly-owned, unconsolidated subsidiary of the Operating Partnership of the Company, issued an aggregate of $41.0 million of preferred securities which mature on June 30, 2035. In addition, the Trust II issued 1,269 of Trust common securities to the Operating Partnership for a purchase price of $1.3 million. On May 24, 2005 the proceeds from the sale of the preferred and common securities of $42.3 million were loaned in the form of a note to the Operating Partnership ("Note 2"). Note 2 has a fixed rate of 6.67% through June 30, 2010, and then will be payable at a variable rate equal to the three-month LIBOR plus 2.40% per annum. The interest on Note 2, payable quarterly, will be used by the Trust II to pay dividends on the trust preferred securities. The trust preferred securities may be redeemed by the Trust with no prepayment premium after June 30, 2010.

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

        Under FIN 46R, Trust, Trust II and Trust III are VIEs that are not consolidated because the Company is not the primary beneficiary. A debt obligation has been recorded in the form of notes as discussed above for the proceeds, which are owed to the Trust, Trust II, and Trust III by the Company.

11.   LINE OF CREDIT

        The Company, as guarantor, and its Operating Partnership have entered into a $100.0 million revolving line of credit, which includes a $10.0 million swingline subfacility (the "Credit Facility").

        The Credit Facility has an interest rate of 175 basis points over LIBOR (6.14% and 4.15% at December 31, 2005 and 2004, respectively). The Operating Partnership intends to use the proceeds of the Credit Facility for general corporate purposes. As of December 31, 2005, the Credit Facility has approximately $76.1 million of capacity based on the assets collateralizing the Credit Facility. The

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outstanding principal balance on the line of credit at December, 2005 and 2004 was $0 and $39.0 million, respectively. The maturity date on the line of credit is September 2007. The Credit Facility is collateralized by mortgages on certain real estate assets.

12.   PUTABLE PREFERRED INTERESTS IN CONSOLIDATED JOINT VENTURES AND OTHER MINORITY INTERESTS

        On August 17, 2004, the Company purchased its joint venture partner's 49.5% interest in Extra Space Properties Three, LLC. Prior to the purchase of its joint venture partner's interest, the Predecessor owned a 50.5% interest in Extra Space Properties Three, LLC. This arrangement provided for a preferred return of 12% on certain capital provided by both the Predecessor and the joint venture partner, and thereafter returns were split based upon percentage residual interests.

        The Company also purchased its joint venture partner's interests in 15 other self-storage facilities on August 17, 2004. The Predecessor had entered into these joint venture agreements with other entities controlled by Equibase Mini Warehouse. These arrangements provided for a preferred return of either 10% or 12%, depending on the specific agreement, on certain capital provided by the joint venture partner and thereafter returns were split based on the indicated percentage interests (generally 40% to the Predecessor and 60% to the investors).

        Prior to the buyout of the Predecessor's joint ventures partners (entities controlled by Equibase Mini Warehouse), the Predecessor and/or a significant unit holder provided certain financial guarantees to the secured lender (generally providing for performance under the loan, including principal and interest payments), or to support a put right on a portion of the joint venture partner's interest after a fixed period (generally either three or five years), that effectively provided for a return on and of the preferred portion of their investment. In addition, after a fixed period (generally either three or five years), the joint venture had the right to redeem the preferred capital at an amount equal to its unreturned contribution plus any accrued preferred return. Upon exercise of the put or call on the preferred portion of their investment, the joint venture investors would continue to hold their residual equity interests. As a result of the put rights and guarantees, the Predecessor consolidated the properties and related debt until the put rights and guarantees were satisfied or have expired. At December 31, 2003, all the joint venture properties were consolidated. The financial guarantees to the secured lender would generally expire upon satisfaction of the related loan at maturity or refinancing. The put rights and related guarantees had no stated maturity and would only expire upon exercise or through redemption of the preferred interests through a capital event.

        On August 17, 2004, the Company completed the acquisition of joint venture interests held by Equibase Mini Warehouse and its affiliates in seven joint ventures, which currently own an aggregate of 30 self-storage properties, for an aggregate of approximately $35,800 in cash and 114,928 OP units issued by the Operating Partnership valued at $1,437.

        Upon completion of the Offering, the Company was released from all puts and guarantees relating to the remaining Equibase joint ventures. These guarantees and puts were transferred to Extra Space Development and a stockholder of the Company. Accordingly, these properties were deconsolidated as of August 17, 2004. The operating results through August 16, 2004 relating to the properties that were deconsolidated are included in the consolidated statements of operations.

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        During the years ended December 31, 2005, 2004 and 2003, the Company reflected interest expense on the putable preferred interests of $0, $4,227 and $4,951, respectively, including amortization of discounts ascribed at issuance of $0, $1,043 and $1,311, respectively.

        During the formation of ESE and ESW, the Predecessor agreed to guarantee the financial performance of certain properties, which were acquired on behalf of those entities. As a result of these guarantees, the Predecessor consolidated these properties until these performance guarantees were satisfied or expired. During 2003, the guarantees related to two properties were either satisfied or expired. During the year ended December 31, 2003, the Predecessor recognized $1,283 of expense related to these guarantees. These amounts are classified as a component of unrecovered development / acquisition costs and support payments. At December 31, 2004 and 2003, there were no active guarantees related to these properties.

13.   OTHER LIABILITIES

        Other liabilities at December 31, 2005 and 2004 are summarized as follows:

 
  2005
  2004
Deferred rental income   $ 7,322   $ 4,414
Accrued interest     3,413     874
Accrued taxes and security deposits     1,618     881
Fair value of interest rate swap     2,151     532
SUSA lease obligation liability     3,068    
Property insurance payable     2,299    
Other liabilities     3,914     302
   
 
    $ 23,785   $ 7,003
   
 

        As a result of the acquisition of SUSA, the Company recorded restructuring liabilities of $4,638 relating to the assumption of a lease for a facility that will no longer be used in the Company's operations and $2,441 for severance costs related to terminated employees of the prior business.

        The following table sets for the restructuring activity during the year ended December 31, 2005:

 
  Accrued
restructuring
liabilities at
July 14,
2005

  Cash Paid
  Accrued
restructuring
liabilities at
December 31,
2005

Facility exit costs   $ 4,638   $ (1,570 ) $ 3,068
Severance costs     2,442     (2,062 )   380
   
 
 
Total   $ 7,080   $ (3,632 ) $ 3,448
   
 
 
Allocated to:                  
Continuing operations   $ 7,080   $ (3,632 ) $ 3,448
Discontinued operations            
   
 
 
    $ 7,080   $ (3,632 ) $ 3,448
   
 
 

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14.   RELATED PARTY AND AFFILIATED REAL ESTATE JOINT VENTURE TRANSACTIONS

        The Company and the Predecessor provide management and development services for certain joint ventures, franchise, third party and other related party properties. Management agreements provide generally for management fees of 6% of gross rental revenues for the management of operations at the self-storage facilities. The Company and the Predecessor earn interest income during the development period equal to 10% of its net investment in the development property. The Company and the Predecessor earn development fees of 4%-6% of budgeted costs on developmental projects and acquisition fees of 1% of the gross purchase price or the completed costs of development of acquired properties. As discussed in Note 5, the Company has purchased self-storage properties from related parties and affiliated entities.

        Management fee revenue for related party and affiliated real estate joint ventures for the years ending December 31, 2005, 2004 and 2003 is summarized as follows:

 
   
  Company
  Predecessor
 
   
  2005
  2004
  2003
ESE   Affiliated real estate joint ventures   $   $ 95   $ 364
ESW   Affiliated real estate joint ventures     374     511     674
ESNPS   Affiliated real estate joint ventures     397     382     353
PRISA   Affiliated real estate joint ventures     2,391        
PRISA II   Affiliated real estate joint ventures     1,913        
PRISA III   Affiliated real estate joint ventures     871        
VRS   Affiliated real estate joint ventures     514        
WCOT   Affiliated real estate joint ventures     688        
Teachers   Affiliated real estate joint ventures     548        
Heitman   Affiliated real estate joint ventures     477        
ESD   Related party     292     26      
Other, franchisees and third parties   Affiliated real estate joint ventures     2,185     637     544
       
 
 
        $ 10,650   $ 1,651   $ 1,935
       
 
 

        Acquisition and development fee revenue for related party and affiliated real estate joint ventures for the years ending December 31, 2005, 2004 and 2003 is summarized as follows:

 
   
  Company
  Predecessor
 
   
  2005
  2004
  2003
ESW   Affiliated real estate joint ventures   $   $ 161   $ 577
ESNPS   Affiliated real estate joint ventures             40
Everest   Affiliated real estate joint ventures     260     235    
Yancy   Affiliated real estate joint ventures     444        
ESD   Related party     288     804     37
       
 
 
        $ 992   $ 1,200   $ 654
       
 
 

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        During the years ended December 31, 2004 and 2003, management fee expense of $2,775 and $7,933, respectively, was recorded for services provided to support the Company's and the Predecessor's self-storage facilities by Extra Space Management, Inc. ("ESMI"), a corporation that shared common ownership with the Predecessor, including stockholders who were officers of the Predecessor. Under this agreement, ESMI provided employees who supported the operations of existing self-storage facilities and the acquisition and development of new self-storage facilities by the Predecessor. On March 31, 2004, the Predecessor purchased all of the outstanding common stock of ESMI for its net book value of $184. ESMI had equipment and fixtures of $256, other assets of $736 and liabilities of $808.

        Real estate under development includes capitalized internal development costs paid by ESMI on behalf of the Company of $1,198 and $1,797 for the years ended December 31, 2004 and 2003, respectively.

        Related party and affiliated company balances as of December 31, 2005 and 2004 are summarized as follows:

 
  2005
  2004
Receivables:            
Development fees   $ 2,552   $ 1,839
Other receivables from properties     15,379     400
Receivables from Prudential relating to SUSA acquisition     4,713    
Other receivables from related parties     1,039     262
   
 
    $ 23,683   $ 2,501
   
 

        Other receivables from properties consist of amounts due for expenses paid on behalf of the properites that the Company manages and management fees. Receivables from Prudential relating to SUSA acquisition represents amounts receivable from Prudential for general and administrative expenses, severance paid, and lease expenses paid relating to the SUSA acquisition. The Company believes that all of these related party receivables are fully collectible. The Company does not have any payables to related parties at December 31, 2005 and 2004.

        On January 1, 2004, the Predecessor distributed its equity ownership in Extra Space Development LLC ("ESD"), a consolidated subsidiary, to its Class A members. ESD owned 13 early-stage development properties, two parcels of undeveloped land, and a note receivable. The net book value of the distributed properties and related liabilities was approximately $15,000. The Predecessor retained a receivable of $6,212 from ESD and recorded a net distribution of $9,000. In September 2004, ESD repaid the amounts due the Company using funds obtained through new loans on unencumbered properties. The Predecessor was required to continue consolidating certain of the properties due to financial guarantees. Concurrent with the initial public offering, the Company was released from all guarantees, and the properties were deconsolidated as of August 16, 2004.

        The Company has determined that it has a variable interest in properties in which ESD owns or has an ownership interest. The Company does not have an equity investment or interest, and it is not the primary beneficiary. This variable interest is a result of management and development contracts that are held by the Company. The variable interest is limited to the management and development

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fees and there is not any additional loss that can be attributed to the Company. The Company has determined that it is not the primary beneficiary in these agreements. Accordingly, these properties have not been consolidated subsequent to August 16, 2004.

        On January 1, 2004, the Predecessor distributed the $4,493 (including accrued interest of $438) note receivable from Centershift, related party software service provider, which is partially owned by a certain director and members of management of the Company, to its Class A members. Effective January 1, 2004, the Company entered into a license agreement with Centershift which secures a perpetual right for continued use of STORE (the site management software used at all sites operated by the Company) in all aspects of the Company's property acquisition, development, redevelopment and operational activities. During the years ended December 31, 2005, 2004 and 2003, the Company paid Centershift $739, $441 and $175, respectively, relating to the purchase of software and to license agreements.

15.   MINORITY INTEREST IN OPERATING PARTNERSHIP

        The Company's interest in its properties is held through the Operating Partnership. ESS Holding Business Trust I, a wholly owned subsidiary of the Company, is the sole general partner of the Operating Partnership. The Company through ESS Business Trust II, a wholly owned subsidiary of the Company, is also a limited partner of the Operating Partnership. Between its general partner and limited partner interests, the Company holds a 93.12% majority ownership interest therein as of December 31, 2005. The remaining ownership interests in the Operating Partnership of 6.88% are held by certain former owners of assets acquired by the Operating Partnership, which include a director and officers of the Company. The Company and Operating Partnership were formed to continue to operate and expand the business of the Predecessor.

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

        On July 14, 2005 the Company issued 1,470,149 OP units valued at $21.6 million in conjunction with the Transaction. On September 9, 2005 and November 2, 2005, 350,000 and 50,000 OP units were redeemed in exchange for common stock, respectively. As of December 31, 2005, the Operating Partnership had 3,825,787 and 200,046 shares of OP units and CCUs outstanding, respectively.

        Unlike the OP units, CCUs do not carry any voting rights. Upon the achievement of certain performance thresholds relating to 14 early-stage lease-up properties, all or a portion of the CCUs will be automatically converted into shares of the Company's common stock. Initially, each CCU will be convertible on a one-for-one basis into shares of common stock, subject to customary anti-dilution adjustments. Beginning with the quarter ending March 31, 2006, and ending with the quarter ending December 31, 2008, the Company will calculate the net operating income from the 14 wholly owned

74



early-stage lease-up properties over the 12-month period ending in such quarter. Within 35 days following the end of each quarter referred to above, some or all of the CCUs will be converted so that the total percentage (not to exceed 100%) of CCUs issued in connection with the formation transactions that have been converted to common stock will be equal to the percentage determined by dividing the net operating income for such period in excess of $5.1 million by $4.6 million. If any CCU remains unconverted through the calculation made in respect of the 12-month period ending December 31, 2008, such outstanding CCUs will be cancelled and restored to the status of authorized but unissued shares of common stock.

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

16.   REDEEMABLE MINORITY INTEREST—FIDELITY

        Through December 31, 2003, the Predecessor, through a consolidated subsidiary, Extra Space Properties Four, LLC, had received net cash proceeds of $14,156 (net of transaction costs of $1,403) from FREAM No. 39, LLC and Fidelity Pension Fund Real Estate Investments (collectively, "Fidelity"). The Predecessor was accreting the discount related to the transaction costs over the five-year period ending November 25, 2006; the first date the investment was redeemable by Fidelity.

        This investment earned a 22% preferred return, of which, 9% was payable quarterly with the remainder payable upon redemption. The earliest date at which the investment could be repaid without penalty at the option of the Predecessor was November 25, 2004. The investment was redeemable November 25, 2006 at the option of Fidelity. As of December 31, 2003, the Predecessor owed Fidelity $3,810, in unpaid preferred return which had been accrued and was included in the redeemable minority interest-Fidelity.

        On September 9, 2004, the Operating Partnership completed its acquisition of the preferred equity interest held by Fidelity in Extra Space Properties Four LLC. This interest was acquired for approximately $21,530 in cash, which included the preferred return through November 25, 2004. The Company recorded a loss on early redemption of $1,478.

17.   STOCKHOLDERS' AND MEMBERS' EQUITY

Stockholders' Equity

        On December 9, 2005, the Company closed a public common stock offering of 13,800,000 shares at an offering price of $14.57 per share, for aggregate gross proceeds of $201.1 million. Transaction costs were $10.9 million, resulting in net proceeds of $190.2 million. The proceeds were used to repay outstanding bridge and franchise loans and for general corporate purposes, including potential acquisitions and debt repayment.

        On June 20, 2005 the Company completed a private placement of 6,200,000 shares of its common stock at an offering price of $13.47 per share, for aggregate gross proceeds of $83.5 million. Transaction costs were $2.2 million, resulting in net proceeds of $81.3 million. The shares were issued pursuant to an exemption from the registration requirements of Section 5 of the Securities Act of 1933, as amended. Pursuant to the terms of the registration rights agreement, the Company filed a registration

75



statement covering the shares on September 22, 2005. The registration statement was deemed effective on November 14, 2005.

        On July 14, 2005, the Company granted 190,000 shares of restricted stock to employees, without consideration. At the date of the grant, the recipient had all rights of a stockholder including the right to vote and receive dividends subject to restrictions on transfers and forfeiture provisions. The forfeiture and transfer restriction on the shares lapse over a three to four year period beginning on the date of grant. The Company recorded deferred stock compensation in stockholders' equity equal to the market value of the restricted shares on the date of grant and amortizes deferred stock compensation to expense over the vesting period. For the year ending December 31, 2005, $601 of amortization expense of this deferred stock compensation is included in general and administrative expense.

        The Company's charter provides that it can issue up to 200,000,000 shares of common stock, $0.01 par value per share, 4,100,000 CCSs, $.01 par value per share, and 50,000,000 shares of preferred stock, $0.01 par value per share. As of December 31, 2005, 51,765,795 shares of common stock were issued and outstanding, 3,888,843 shares of CCSs were issued and outstanding and no shares of preferred stock were issued and outstanding.

        All stockholders of the Company's common stock are entitled to receive dividends and to one vote on all matters submitted to a vote of stockholders. The transfer agent and registrar for the Company's common stock is American Stock Transfer & Trust Company.

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

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

Members' Equity

        Members' profits, losses and distributions of the Predecessor were allocated in accordance with the terms of the operating agreement, as amended. Member unit holders included members of management. Member interests were divided into four classes of units.

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        Class A units were common units with voting rights and no par value. There were also non-voting Class A units held by certain employees. During April 2004, the Predecessor granted 4,019,837 Class A Units, valued at $0.30 per unit, to certain employees, resulting in a compensation charge of $1,205. All A units were redeemed or converted to common stock as of August 17, 2004 at the option of the holder.

        Class B units were preferred units with a par value of $1.00. These units were non-convertible, non-voting and earned a 9% preferred return (non-compounding) with no current dividend paid. The 9% preferred return was paid based upon available funds, including upon liquidation or termination. All B units were redeemed or converted to common stock as of August 17, 2004 at the option of the holder.

        Class C units were preferred units with a par value of $1.00. These units were non-convertible, non-voting and earned a 9% preferred return with current dividends paid quarterly. All C units were redeemed or converted to common stock as of August 17, 2004 at the option of the holder.

        Class E units were preferred units with a par value of $1.00. These units were non-convertible, non-voting and earned a 7% preferred return with current dividends paid quarterly. These units were redeemable after July 1, 2004 at the option of the holder. All E units were redeemed or converted to common stock as of August 17, 2004 at the option of the holder.

        Class B, C and E units did not participate in the distribution of profits after payment of the preferred return.

18.   STOCK OPTION PLAN

        As of December 31, 2005, the Company has authorized 8,800,000 shares of common stock for issuance under the Company's stock option plans: the 2004 Long-Term Incentive Compensation Plan, and the 2004 Non-Employee Directors' Share Plan. Under the terms of the Plans, the exercise price of an option shall be determined by the Compensation, Nominating and Governance Committee and reflected in the applicable award agreement. Each option will be exercisable after the period or periods specified in the award agreement, which will generally not exceed 10 years from the date of grant (or five years in the case of an incentive stock option granted to a 10% stockholder, if permitted under the Plans). Options will be exercisable at such times and subject to such terms as determined by the Compensation, Nominating and Governance Committee, but under no circumstances may be exercised if such exercise would cause a violation of the ownership limit in the Company's charter. Unless otherwise determined by the Compensation, Nominating and Governance Committee at the time of grant, such stock options shall vest ratably over a four-year period beginning on the date of grant.

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        The following table summarizes the Company's stock options outstanding as of December 31, 2005 and 2004, as well as changes during the years then ended:

 
  Year Ended December 31,
 
  2005
  2004
 
  Shares
  Weighted-Average
Exercise Price

  Shares
  Weighted-Average
Exercise Price

Options outstanding, beginning of year   1,568,000   $ 12.50     $
Options granted   1,652,049     15.17   1,680,000     12.50
Options forfeited   (35,776 )   (12.50 ) (112,000 )   12.50
Options exercised   (151,875 )   (13.68 )    
   
 
 
 
Options outstanding, end of year   3,032,398   $ 13.89   1,568,000   $ 12.50
   
 
 
 

        The following table presents information relating to stock options outstanding as of December 31, 2005:

 
  Options Outstanding
  Options Exercisable
Range of Exercise Prices
  Shares
  Weighted-Average
Remaining
Contractual Life

  Weighted-Average
Exercise Price

  Shares
  Weighted-Average
Exercise Price

12.50 - 13.00   1,513,349   8.6   $ 12.51   342,474   $ 12.50
13.01 - 13.50   45,000   9.2     13.20      
13.51 - 14.00   66,500   9.2     13.77      
14.01 - 14.50   148,500   9.6     14.21      
14.51 - 15.00   111,000   9.6     14.86      
15.01 - 15.50   79,000   9.7     15.12      
15.51 - 16.00   1,023,549   9.5     15.63      
16.01 - 16.50   45,500   9.6     16.13      
   
 
 
 
 
    3,032,398   9.1   $ 13.89   342,474   $ 12.50
   
 
 
 
 

        The weighted average fair value of stock options granted in 2005 and 2004 was $1.25 and $1.09, respectively. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions for 2005 and 2004:

 
  2005
  2004
 
Risk-free interest rate   3.71 % 3.45 %
Dividend yield   6.9 % 7.3 %
Expected volatility   21 % 22 %
Average expected term (years)   5   5  

19.   EMPLOYEE BENEFIT PLAN

        The Company has a retirement savings plan under Section 401(k) of the Internal Revenue Code under which eligible employees can contribute up to 15% of their annual salary, subject to a statutory

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prescribed annual limit. For 2005, the Company made matching contributions to the plan of $349 based on 50% of the first 6% of an employee's compensation.

20.   GAIN ON SALE OF REAL ESTATE ASSETS

        On August 12, 2004, the Predecessor sold its minority equity interest in a storage facility in Laguna Hills, California to its joint venture partner for cash of $1,490 and repayment of a $2,000 related party payable for a total of $3,490, resulting in a gain of $1,920.

        During January 2004, the Company sold a self-storage facility in Walnut, California for $6,406 to ESW. The Company recognized a loss on the sale of $171.

        During 2003, the Company sold a self-storage facility in Kings Park, New York for $6,241 to ESE. The Company recognized a gain on the sale of $672.

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21.   SEGMENT INFORMATION

        The Company and the Predecessor operate in two distinct segments; (1) property management and development and (2) rental operations. Financial information for the Company's and the Predecessor's business segments are set forth below:

 
  Company
  Predecessor
 
 
  For the years ended December 31,
 
 
  2005
  2004
  2003
 
Statements of Operations                    
Total revenues                    
  Property management and development   $ 14,088   $ 3,064   $ 2,762  
  Rental operations     120,640     62,656     33,054  
   
 
 
 
    $ 134,728   $ 65,720   $ 35,816  
   
 
 
 
Operating expenses, including depreciation and amortization                    
  Property management and development   $ 25,762   $ 13,519   $ 13,262  
  Rental operations     76,612     41,303     21,635  
   
 
 
 
    $ 102,374   $ 54,822   $ 34,897  
   
 
 
 
Income (loss) before interest, minority interests, equity in earnings of real estate ventures and gain on sale of real estate assets                    
  Property management and development   $ (11,674 ) $ (10,455 ) $ (10,500 )
  Rental operations     44,028     21,353     11,419  
   
 
 
 
    $ 32,354   $ 10,898   $ 919  
   
 
 
 
Interest expense                    
  Property management and development   $ 911   $ 329   $ 183  
  Rental operations     41,638     31,685     18,563  
   
 
 
 
    $ 42,549   $ 32,014   $ 18,746  
   
 
 
 
Interest income                    
  Property management and development   $ 1,625   $ 251   $ 445  
   
 
 
 
Gain on sale of real estate assets                    
  Property management and development   $   $ 1,749   $ 672  
   
 
 
 
Equity in earnings of real estate ventures                    
  Rental operations   $ 3,170   $ 1,387   $ 1,465  
   
 
 
 
Income (loss) before minority interests                    
  Property management and development   $ (10,960 ) $ (8,784 ) $ (9,566 )
  Rental operations     5,560     (8,945 )   (5,679 )
   
 
 
 
    $ (5,400 ) $ (17,729 ) $ (15,245 )
   
 
 
 
Depreciation and amortization expense                    
  Property management and development   $ 356   $ 315   $ 27  
  Rental operations     30,649     15,237     6,778  
   
 
 
 
    $ 31,005   $ 15,552   $ 6,805  
   
 
 
 
Statements of Cash Flows                    
Acquisition of real estate assets                    
  Property management and development   $ (79,227 ) $ (245,717 ) $  
   
 
 
 
Acquisition of SUSA                    
  Property management and development   $ (530,972 ) $   $  
   
 
 
 
Development and construction of real estate assets                    
  Property management and development   $ (20,204 ) $ (19,487 ) $ (62,632 )
   
 
 
 

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December 31,

 
  2005
  2004
Balance Sheets            
Investment in real estate ventures            
  Rental operations   $ 90,898   $ 6,182

Total assets

 

 

 

 

 

 
  Property management and development     179,770     32,608
  Property operations     1,240,422     715,876
   
 
    $ 1,420,192   $ 748,484
   
 

22.   DECONSOLIDATION OF ASSETS

        As a result of the distribution of the Predecessor's equity ownership in Extra Space Development ("ESD") and the release of all puts and guarantees on August 16, 2004, the Predecessor deconsolidated certain properties during the year ended December 31, 2004. The operating results through August 16, 2004 relating to the properties that were deconsolidated are included in the consolidated statements of operations. As a result of the deconsolidation, the following assets and liabilities were removed from the Predecessor's accounts:

Cash   $ (449 )
Construction in progress     78,621  
Restricted cash     307  
Other assets     11,098  
Liabilities     (66,287 )
Putable interests     (12,192 )
Minority interest     (9,613 )

        The Company previously consolidated a property in Pico Rivera, California in which neither the Company nor the Predecessor has any equity or profits interest. The property was owned by the Predecessor, and sold at cost to certain former members of the Predecessor. However, the Company and the Predecessor continued to guarantee the mortgage loan on the property, and therefore, consolidated the property's operations until the loan guarantee was satisfied or released. In December 2004, this loan guarantee was released and the property was deconsolidated. As a result of the deconsolidation, the following assets and liabilities were removed from the Predecessor's accounts:

Cash   $ 25  
Construction in progress     3,001  
Related party receivable     (1,054 )
Other assets     154  
Liabilities     (2,341 )
Minority interest     215  

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23.   COMMITMENTS AND CONTINGENCIES

        The Company has an operating lease on its corporate offices and owns nine self-storage facilities that are subject to ground leases. At December 31, 2005, future minimum rental payments under these non-cancelable operating leases are as follows:

2006   $ 4,465
2007     4,505
2008     4,327
2009     4,207
2010     4,129
Thereafter     23,872
   
    $ 45,505
   

        The monthly rental amount for one of the ground leases is the greater of a minimum amount or a percentage of gross monthly receipts. The Company recorded rent expense of $2,591, $1,332 and $277 related to these leases in the years ended December 31, 2005, 2004 and 2003, respectively.

        The Company has guaranteed three construction loans for unconsolidated partnerships that own development properties in Baltimore, Maryland, Chicago, Illinois and Peoria, Arizona. These properties are owned by joint ventures in which the Company has 10% equity interests. These guarantees were entered into in November 2004, July 2005 and August 2005, respectively. At December 31, 2005, the total amount of guaranteed mortgage debt relating to these joint ventures was $12,073 (unaudited). These mortgage loans mature December 1, 2007, July 28, 2008 and August 31, 2008, respectively. If the joint ventures default on the loans, the Company may be forced to repay the loans. Repossessing and/or selling the self-storage facilities and land that collateralize the loans could provide funds sufficient to reimburse the Company. The estimated fair market value of the encumbered assets at December 31, 2005 is $17,665 (unaudited). The Company has recorded no liability in relation to this guarantee as of December 31, 2005. The fair value of the guarantee is not material. To date, the joint ventures have not defaulted on their mortgage debt. The Company believes the risk of having to perform on the guarantee is remote.

        The Company has been involved in routine litigation arising in the ordinary course of business. As of December 31, 2005, the Company is not presently involved in any material litigation nor, to its knowledge, is any material litigation threatened against the Predecessor or its properties.

24.   RISK MANAGEMENT AND USE OF FINANCIAL INSTRUMENTS

        In the normal course of its on-going business operations, the Company encounters economic risk. There are three main components of economic risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk on its interest-bearing liabilities. Credit risk is the risk of inability or unwillingness of tenants to make contractually required payments. Market risk is the risk of declines in the value of properties due to changes in rental rates, interest rates or other market factors affecting the value of properties held by the Company. As previously disclosed in Note 9, the Company has entered into a Swap Agreement to mange its risk.

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25.   SUPPLEMENTARY QUARTERLY FINANCIAL DATA (UNAUDITED)

 
  Three months ended
 
 
  March 31,
2005

  June 30,
2005

  September 30,
2005

  December 31,
2005

 
Revenues   $ 22,918   $ 24,617   $ 43,135   $ 45,683  
   
 
 
 
 
Cost of operations   $ 17,692   $ 18,742   $ 33,014   $ 32,926  
   
 
 
 
 
Net loss   $ (640 ) $ (1,220 ) $ (2,859 ) $ (247 )
   
 
 
 
 
Net loss attributable to common stockholders   $ (640 ) $ (1,220 ) $ (2,859 ) $ (247 )
   
 
 
 
 
Net loss—basic and diluted   $ (0.02 ) $ (0.04 ) $ (0.08 ) $ (0.00 )

 


 

Predecessor


 

Company


 
 
  Three months ended
 
 
  March 31,
2004

  June 30,
2004

  September 30,
2004

  December 31,
2004

 
Revenues   $ 10,926   $ 13,929   $ 18,168   $ 22,948  
   
 
 
 
 
Cost of operations   $ 10,555   $ 12,428   $ 14,808   $ 17,031  
   
 
 
 
 
Net loss   $ (6,032 ) $ (7,036 ) $ (5,077 ) $ (317 )
   
 
 
 
 
Net loss attributable to common stockholders   $ (8,178 ) $ (9,183 ) $ (8,020 ) $ (317 )
   
 
 
 
 
Net loss—basic and diluted   $ (1.64 ) $ (1.49 ) $ (0.53 ) $ (0.01 )

26.   SUBSEQUENT EVENTS

        On February 15, 2006, the Company purchased three self-storage facilities located in Lakewood and Tacoma, Washington from a third party for cash of $17,866.

        On January 17, 2006, the Company purchased one self-storage facility located in Dacula, Georgia from a franchisee for cash of $5,050.

        On January 13, 2006, the Company purchased one self-storage facility located in Venice, Florida from a franchisee for cash of $8,000.

        On January 6, 2006, the Company purchased one self-storage facility located in Deland, Florida from a franchisee for cash of $5,300.

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Extra Space Storage Inc.

Schedule III

Real Estate and Accumulated Depreciation

(Dollars in thousands)

 
   
   
   
   
   
   
   
   
  Gross carrying amount at
December 31, 2005

   
   
Property Name
  State
  Debt
  Land
initial cost

  Building and
improvements
Initial cost

  Land costs
subsequent
to acquisition

  Building costs
subsequent
to acquisition

  Land
Adjustment(1)

  Building
Adjustment(1)

  Land
  Building and
improvements

  Total
  Accumulated
depreciation

  Date acquired
or development
completed

Fort Myers   FL   $ 4,400   $ 1,985   $ 4,983   $   $ 1   $   $   $ 1,985   $ 4,984   $ 6,969   $ 60   Jul-05
Marina Del Rey   CA     18,400     4,248     23,549                     4,248     23,549     27,797     271   Jul-05
Wethersfield   UT     4,000     1,349     4,372                     1,349     4,372     5,721     52   Jul-05
Watsonville   CA     3,400     1,699     3,056                     1,699     3,056     4,755     36   Jul-05
Naples   FL     5,400     2,570     5,102                     2,570     5,102     7,672     62   Jul-05
Hemet   CA     5,300     1,146     6,369                     1,146     6,369     7,515     74   Jul-05
Memphis   TN     2,100     976     1,725         2             976     1,726     2,702     23   Jul-05
Tamiami   FL     6,100     2,979     5,351         3             2,979     5,354     8,333     63   Jul-05
Chatsworth   CA     11,200     3,594     11,166         127             3,594     11,293     14,887     131   Jul-05
West Valley City   UT     2,000     461     1,722                     461     1,722     2,183     21   Jul-05
Memphis   TN     3,100     814     2,766         5             814     2,771     3,585     36   Jul-05
Aloha   OR     6,200     1,221     6,262                     1,221     6,262     7,483     75   Jul-05
Grandville   MI     1,700     726     1,298                     726     1,298     2,024     16   Jul-05
Sacramento   CA     4,196     852     4,720                     852     4,720     5,572     55   Jul-05
Hackensack   NJ     9,500     2,283     11,234         9             2,283     11,243     13,526     130   Jul-05
Phoenix   AZ     7,400     1,441     7,982         6             1,441     7,988     9,429     96   Jul-05
Louisville   KY     3,000     586     3,244         32             586     3,276     3,862     40   Jul-05
Long Beach   CA     6,200     1,403     7,595                     1,403     7,595     8,998     88   Jul-05
Kent   OH     1,500     220     1,206         8             220     1,214     1,434     16   Jul-05
New Paltz   NY     5,000     2,059     3,715         15             2,059     3,730     5,789     46   Jul-05
Stone Mountain   GA     2,142     925     3,505                     925     3,505     4,430     42   Jul-05
Columbus   OH     2,900     483     2,654         13             483     2,667     3,150     32   Jul-05
Houston   TX     3,400     749     4,122                     749     4,122     4,871     51   Jul-05
Austin   TX     2,400     1,105     2,313                     1,105     2,313     3,418     33   Jul-05
Plano   TX     3,300     1,613     2,871         12             1,613     2,883     4,496     43   Jul-05
Dallas   TX     4,400     1,010     5,547         32             1,010     5,579     6,589     66   Jul-05
N Highlands   CA     2,200     696     2,806         295             696     3,101     3,797     35   Jul-05
Cordova   TN     2,700     852     2,720                     852     2,720     3,572     34   Jul-05
Mt Vernon   NY     5,100     1,585     6,025                     1,585     6,025     7,610     72   Jul-05
Cordova   TN     6,900     1,351     7,476         15             1,351     7,491     8,842     90   Jul-05
Towson   MD     4,100     861     4,742                     861     4,742     5,603     55   Jul-05
West Palm Bch   FL     2,600     1,449     2,586         7             1,449     2,593     4,042     32   Jul-05
Plainville   MA     5,400     2,223     4,430         1             2,223     4,431     6,654     60   Jul-05
Columbus   OH     1,500     374     2,059                     374     2,059     2,433     26   Jul-05
Columbus   OH     3,800     601     3,336                     601     3,336     3,937     40   Jul-05
New York   NY     16,400     3,060     16,978         19             3,060     16,997     20,057     195   Jul-05
Philadelphia   PA     9,000     1,470     8,162         25             1,470     8,187     9,657     95   Jul-05
Bethesda   MD     12,800         18,331         2                 18,333     18,333     213   Jul-05
Mt Clemens   MI     2,100     798     1,796                     798     1,796     2,594     21   Jul-05
Seattle   WA     7,400     2,727     7,241                     2,727     7,241     9,968     85   Jul-05
Oceanside   CA     9,700     3,241     11,361                     3,241     11,361     14,602     132   Jul-05

84


 
   
   
   
   
   
   
   
   
  Gross carrying amount at
December 31, 2005

   
   
Property Name
  State
  Debt
  Land
initial cost

  Building and
improvements
Initial cost

  Land costs
subsequent
to acquisition

  Building costs
subsequent
to acquisition

  Land
Adjustment(1)

  Building
Adjustment(1)

  Land
  Building and
improvements

  Total
  Accumulated
depreciation

  Date acquired
or development
completed

Louisville   KY   2,967   1,218   4,611     4       1,218   4,615   5,833   52   Jul-05
Tom's River   NJ   8,300   1,790   9,935     6       1,790   9,941   11,731   120   Jul-05
Louisville   KY     892   2,677           892   2,677   3,569   3   Dec-05
Everett   MA   3,750   692   2,129     3       692   2,132   2,824   25   Jul-05
Falls Church   VA   6,200   1,259   6,975     10       1,259   6,985   8,244   82   Jul-05
Denver   CO   2,250   368   1,574           368   1,574   1,942   20   Jul-05
Fred Oaks Rd   VA   5,100   2,067   4,261           2,067   4,261   6,328   53   Jul-05
Chicago   IL   3,200   449   2,471     7       449   2,478   2,927   29   Jul-05
Chicago   IL   2,900   472   2,582     8       472   2,590   3,062   30   Jul-05
Chicago   IL   4,400   621   3,428     2       621   3,430   4,051   40   Jul-05
Nashua   NH       755             755   755   9   Jul-05
Linden   NJ   6,700   1,517   8,384     7       1,517   8,391   9,908   98   Jul-05
Johnston   RI   7,100   2,658   4,799     22       2,658   4,821   7,479   59   Jul-05
Stoneham   MA   5,400   944   5,241           944   5,241   6,185   61   Jul-05
North Bergen   NJ   11,000   2,299   12,728     3       2,299   12,731   15,030   148   Jul-05
Parlin   NJ   6,700   2,517   4,516     32       2,517   4,548   7,065   59   Jul-05
Las Vegas   NV   3,900   748   4,131     126       748   4,257   5,005   51   Jul-05
Arnold   MD   9,500   2,558   9,446           2,558   9,446   12,004   111   Jul-05
Columbia   MD   8,400   1,736   9,632     2       1,736   9,634   11,370   112   Jul-05
WPB   FL   4,000   1,752   4,909     1       1,752   4,910   6,662   59   Jul-05
Grandview   MO   1,100   612   1,770     7       612   1,777   2,389   22   Jul-05
Foxboro   MA   3,680   759   4,158     19       759   4,177   4,936   664   May-04
Hudson   MA   2,800   806   3,122     36       806   3,158   3,964   504   May-04
Worcester   MA   1,784   212   2,308     1,649       212   3,957   4,169   459   May-04
Claremont   CA   2,624   1,472   2,012     3       1,472   2,015   3,487   82   Jun-04
Kearns   UT   2,520   642   2,607     18       642   2,625   3,267   108   Jun-04
San Bernardino   CA   3,376   1,213   3,061     11       1,213   3,072   4,285   125   Jun-04
Torrance   CA   6,960   3,710   6,271     58       3,710   6,329   10,039   262   Jun-04
Auburn   MA   3,680   918   3,728     10       918   3,738   4,656   501   May-04
Oxford   MA   1,647   482   1,762     68   46   168   528   1,998   2,526   308   Oct-99
Livermore   CA   4,920   1,134   4,615     5       1,134   4,620   5,754   188   Jun-04
Norwood   MA     2,160   2,336     1,158   61   95   2,221   3,589   5,810   323   Aug-99
Pico Rivera   CA   3,500   1,150   3,450     13       1,150   3,463   4,613   363   Aug-00
Northboro   MA   2,608   280   2,715     197       280   2,912   3,192   367   Feb-01
Raynham   MA   3,640   588   2,270     66   82   323   670   2,659   3,329   232   May-00
Brockton   MA   2,440   647   2,762     11       647   2,773   3,420   299   May-04
Ashland   MA     474   3,324     127       474   3,451   3,925   275   Jun-03
Richmond   CA   4,696   953   4,635     30       953   4,665   5,618   189   Jun-04
Hawthorne   CA   3,840   1,532   3,871     37       1,532   3,908   5,440   162   Jun-04
Glendale   CA   4,480     6,084     22         6,106   6,106   249   Jun-04
Parlin   NJ   4,240     5,273     41         5,314   5,314   742   May-04
Marshfield   MA     1,039   4,155     25       1,039   4,180   5,219   183   Mar-04
Doylestown   PA   3,824   220   3,442     88   24   384   244   3,914   4,158   312   Nov-99
Glen Rock   NJ   4,080   1,109   2,401     41   113   246   1,222   2,688   3,910   218   Mar-01
Hoboken   NJ     2,687   6,092     42       2,687   6,134   8,821   550   Jul-02
Lyndhurst   NJ   6,944   2,679   4,644     56   250   437   2,929   5,137   8,066   419   Mar-01
Penn Ave   PA   2,960   889   4,117     30       889   4,147   5,036   520   May-04
Kennedy   PA   2,544   736   3,173     20       736   3,193   3,929   429   May-04

85


 
   
   
   
   
   
   
   
   
  Gross carrying amount at
December 31, 2005

   
   
Property Name
  State
  Debt
  Land
initial cost

  Building and
improvements
Initial cost

  Land costs
subsequent
to acquisition

  Building costs
subsequent
to acquisition

  Land
Adjustment(1)

  Building
Adjustment(1)

  Land
  Building and
improvements

  Total
  Accumulated
depreciation

  Date acquired
or development
completed

Stoughton   MA   3,080   1,754   2,769     16       1,754   2,785   4,539   339   May-04
Plainview   NY     4,287   3,710     109       4,287   3,819