Back to GetFilings.com

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended March 31, 2005

or

For the transition period from                      to                     .

Commission File Number: 001-32269

EXTRA SPACE STORAGE INC.

(Exact name of registrant as specified in its charter)

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

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

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

The number of shares outstanding of the registrant’s common stock, par value $0.01 per share, as of April 30, 2005 was 31,169,950.

Table of Contents

EXTRA SPACE STORAGE INC.

TABLE OF CONTENTS

Table of Contents

EXPLANATORY NOTE

The financial statements covered in this report for the three month period ended March 31, 2004 contain the results of operations and financial condition of Extra Space Storage LLC (“the Predecessor”) and its subsidiaries, the predecessor to Extra Space Storage Inc. (the “Company”) and its subsidiaries, prior to the consummation of the Company’s initial public offering on August 17, 2004.

STATEMENT ON FORWARD LOOKING INFORMATION

When used in this discussion and elsewhere in this Quarterly Report on Form 10-Q, the words “believes,” “anticipates,” “projects,” “should,” “estimates,” “expects” and similar expressions are intended to identify forward-looking statements within the meaning of that term in Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and in Section 21F of the Securities and Exchange Act of 1934, as amended (the “Exchange Act”). Such forward-looking statements involve known and unknown risks, uncertainties, and other factors, which may cause the actual results, performance or achievements of the Company to be materially different from those expressed or implied in the forward-looking statements. Such factors include, but are not limited to, changes in general economic conditions and in the markets in which the Company operates:

The Company disclaims any obligation to publicly release the results of any revisions to these forward-looking statements reflecting new estimates, events or circumstances after the date of this report.

2

Table of Contents

Part I. FINANCIAL INFORMATION

Extra Space Storage Inc.

Condensed Consolidated Balance Sheets

(Amounts in thousands, except per share data)

See accompanying notes

3

Table of Contents

Extra Space Storage Inc.

Condensed Consolidated Statements of Operations

(Amounts in thousands, except per share data)

(unaudited)

See accompanying notes

4

Table of Contents

Extra Space Storage Inc.

Condensed Consolidated Statements of Cash Flows

(Amounts in thousands)

(unaudited)

See accompanying notes

5

Table of Contents

Extra Space Storage Inc.

Condensed Consolidated Statements of Cash Flows - (Continued)

(Amounts in thousands)

(unaudited)

See accompanying notes

6

Table of Contents

Extra Space Storage Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

Amounts in thousands, except shares and per share data

The accompanying unaudited condensed consolidated financial statements of Extra Space Storage Inc. (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. The unaudited condensed consolidated financial statements for the interim periods ended March 31, 2005 and 2004, include all adjustments, which are, in the opinion of management, necessary for a fair presentation of the results for the interim periods. This includes all normal and recurring adjustments, and other accounting entries as described herein. The Condensed Consolidated Balance Sheet as of December 31, 2004, has been derived from the Company’s audited financial statements as of that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. Operating results for three months ended March 31, 2005 are not necessarily indicative of results that may be expected for the year ended December 31, 2005. For further information refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004 as filed with the Securities and Exchange Commission.

The Company, a self-administered and self-managed real estate investment trust (“REIT”), was formed on April 30, 2004 to own, operate, acquire and develop self-storage facilities located throughout the United States and continues the business of the Predecessor. The Company’s interest in its properties is held through its operating partnership Extra Space Storage LP (the “Operating Partnership”), and its primary assets are general partner and limited partner interest in the Operating Partnership.

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 March 31, 2005, the Company had direct and indirect equity interest in 148 storage facilities located in 20 states and operating under the “Extra Space Storage” name.

The Company operates in two distinct segments: the Property Management and Development segment and the Rental Operations segment. The Company’s Property Management and Development activities include acquiring, managing, developing and selling self-storage facilities. The Rental Operations segment includes rental operations of self-storage facilities.

On August 17, 2004, the Company completed its initial public offering (the “Offering”) of 20,200,000 shares of common stock. On September 1, 2004, the underwriters exercised their over allotment option and purchased 3,030,000 shares of common stock. The Company succeeded to the business conducted by Extra Space Storage LLC (the “Predecessor”).

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

7

Table of Contents

Extra Space Storage Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

Amounts in thousands, except shares and per share data

exchange, the Predecessor became a wholly-owned subsidiary of the Operating Partnership and, as of March 31, 2005, is a 91.95% subsidiary of the Company.

As permitted by Statement of Financial Accounting Standards (“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 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, we apply 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 following table represents the effect on net loss and earnings per share if the Company had applied the fair value based method and recognition provisions of SFAS No. 123, as amended:

The fair value of options granted under the Plan was estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted average assumptions used: dividend yield of 7.3%, expected volatility of 21.9%, risk free interest rate of 3.5%, and expected life of 5 years. The weighted-average fair value of options at the date of grant was $1.09.

8

Table of Contents

Extra Space Storage Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

Amounts in thousands, except shares and per share data

Basic loss per share is computed using the weighted average common shares outstanding (prior to the dilutive impact of stock options outstanding). Diluted earnings per common share are computed using the weighted average common shares outstanding. No options or OP units were included in the computation of diluted net loss per share for the quarter ended March 31, 2005, because the effect would have been antidilutive. Options to purchase 1,647,500 shares of common stock were outstanding at March 31, 2005.

For the three months ended March 31, 2004, the weighted average number of common shares outstanding included Class A units, on a pro forma basis, 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.

The basic and diluted 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. These securities will not participate in distributions until they are converted. Such conversion cannot occur prior to March 31, 2006.

The Company has entered into a reverse interest rate swap agreement (“Swap Agreement”) in order to float $61.8 million 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 qualifies as a fair value hedge, as defined by SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities,” as amended and interpreted, 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 interest payments are recognized as an increase or decrease in interest expense.

The estimated fair value of the Swap Agreement at March 31, 2005 is a liability of $1.9 million. For the quarter ended March 31, 2005, interest expense has been reduced by $164 as a result of the Swap Agreement.

9

Table of Contents

Extra Space Storage Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

Amounts in thousands, except shares and per share data

The components of real estate assets are summarized as follows:

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 $6.6 million. The Company paid cash of $3.3 million and assumed a note payable for $3.3 million. The independent members of the Company’s Board of Directors approved this acquisition.

On January 18, 2005, the Company purchased one self-storage facility located in Avenel, New Jersey from a third party for $9.7 million. The Company paid cash of $5.6 million and assumed net liabilities of $4.1 million.

On February 28, 2005, the Company purchased one self-storage facility located in Atlanta, Georgia from a third party for cash of $11.8 million.

On March 8, 2005, the Company purchased four self-storage facilities located in Florida from a third party for cash of $29.6 million.

On March 28, 2005, the Company purchased one self-storage facility located in Green Acres, Florida from a third party for cash of $4.7 million.

10

Table of Contents

Extra Space Storage Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

Amounts in thousands, except shares and per share data

The pro forma financial information presented below gives effect to the acquisitions as if the acquisitions had occurred as of the beginning of the respective periods. The information presented below is for illustrative purposes only and is not indicative of results that would have been achieved if the acquisitions had occurred on January 1, 2005 and 2004, respectively, or results which may be achieved in the future.

At March 31, 2005 and December 31, 2004, the Company held minority investments in Extra Space West One LLC (“ESW”), which owns self-storage facilities in California, and Extra Space Northern Properties Six, LLC (“ESNPS”), which owns properties in California, Massachusetts, New Hampshire, New Jersey and New York.

At March 31, 2004, the Predecessor held a minority investment in Extra Space East One LLC (“ESE”), which owns self-storage facilities in Massachusetts, New Jersey and Pennsylvania. 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 these properties.

In addition to the investments in ESE, ESW and ESNPS, the Company also holds 10-50% investments in other entities, which own and develop self-storage facilities. 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 are generated in excess of these preferred returns, the Company would receive a higher percentage of the excess cash/profits than its equity interest percent (i.e. a disproportionate allocation).

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 as of December 31, 2004 or March 31, 2005.

11

Table of Contents

Extra Space Storage Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

Amounts in thousands, except shares and per share data

The components of investments in real estate ventures consist of the following:

The components of equity in earnings of real estate ventures consist of the following:

The components of other assets are summarized as follows:

The Company, as guarantor, and its Operating Partnership have entered into a $100 million revolving line of credit, which includes a $10 million swingline subfacility (the “Credit Facility”). The Credit Facility has an interest rate of 175 basis points over LIBOR (4.62% at March 31, 2005 and 4.15% at December 31, 2004). The Operating Partnership intends to use the proceeds of the Credit Facility for general corporate purposes. As of March 31, 2005, the Credit Facility has

12

Table of Contents

Extra Space Storage Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

Amounts in thousands, except shares and per share data

approximately $68.5 million of capacity based on the assets collateralizing the Credit Facility. The outstanding principal balance on the line of credit at March 31, 2005 and December 31, 2004 was $48.5 million and $39.0 million, respectively and is due September 2007. The Credit Facility is collateralized by mortgages on real estate assets.

The components of notes payable are summarized as follows:

Substantially all of the Company’s and the Predecessor’s real estate assets are pledged as collateral for the notes payable and line of credit detailed above. In addition, the Company is subject to certain restrictive covenants relating the outstanding notes payable, which the Company was in compliance at March 31, 2005.

The components of other liabilities are summarized as follows:

13

Table of Contents

Extra Space Storage Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

Amounts in thousands, except shares and per share data

On January 1, 2004, the Predecessor distributed its equity ownership in Extra Space Development (“ESD”), a subsidiary consolidated at that time, 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 $15.0 million. The Predecessor retained a receivable of $6.2 million from ESD and recorded a net distribution of $9.0 million. In September 2004, ESD repaid the amounts due to the Company using funds obtained through new loans on unencumbered properties. The Predecessor was required to continue to consolidate 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 does not intend to purchase these properties in the future. ESD paid the Company $52 and $0 in management fees for the three months ending March 31, 2005 and 2004, respectively.

The Company has determined that it holds a variable interest in properties in which ESD owns or has an ownership interest. The Company does not have an equity investment or interest. 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 fees and no additional loss can be attributed to the Company. The Company has determined that it is not the primary beneficiary in these agreements. Accordingly, such properties have not been consolidated subsequent to August 16, 2004.

On January 1, 2004, the Predecessor distributed the $4.5 million (including accrued interest of $438) note receivable from Centershift to the Class A unit holders. 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. The Company paid Centershift $101 and $133 for the three months ending March 31, 2005 and 2004, respectively for use of such software.

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 is also a limited partner of the Operating Partnership, and controls the operations of the Operating Partnership, holding a 91.95% majority ownership interest therein as of March 31, 2005. The remaining ownership interests in the Operating Partnership of 8.05% are held by certain former owners of assets acquired by the Operating Partnership subsequent to its formation. 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, 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

14

Table of Contents

Extra Space Storage Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

Amounts in thousands, except shares and per share data

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 elect to acquire those OP units in exchange for shares of common stock on a one-for-one basis, subject to anti-dilution adjustments provided in the Operating Partnership agreement. As of March 31, 2005, the Operating Partnership had 2,730,050 OP units outstanding and 200,046 shares of CCUs issued and outstanding.

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 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.

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 March 31, 2005, 31,169,950 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.

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,

15

Table of Contents

Extra Space Storage Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

Amounts in thousands, except shares and per share data

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.

The Company and the Predecessor operate in two distinct segments, Property Management and Development and Rental Operations. Financial information for the Company’s and Predecessor’s business segments are as follows:

16

Table of Contents

Extra Space Storage Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

Amounts in thousands, except shares and per share data

The Company and the Predecessor have guaranteed a mortgage loan held by an unconsolidated joint venture in which the Company has a non-controlling ownership interest. At March 31, 2005, the total amount of mortgage debt relating to this joint venture was $8.0 million. This mortgage loan matures May 20, 2005. If the joint venture defaulted on the loan, the Company may be forced to repay the loan. Repossessing and/or selling the self-storage facility and land that collateralizes the loan could reimburse the Company. The estimated fair market value of the encumbered assets at March 31, 2005 is $15 million. The Company had recorded no liability in relation to this guarantee as of March 31, 2005 and December 31, 2004. The fair value of the guarantee is not material. To date the joint venture has not defaulted on its mortgage debt. The Company believes the risk of having to perform on the guarantee is remote.

The Company has guaranteed a construction loan for an unconsolidated partnership that owns a development property in Baltimore, Maryland. The property is owned by a joint venture in which the Company has a 10% equity interest. This guarantee was entered into in November 2004. At March 31, 2005, the total amount of mortgage debt relating to this joint venture was $1.4 million. This mortgage loan matures December 1, 2007. If the joint venture defaults on the loan, the Company may be forced to repay the loan. Repossessing and/or selling the self-storage facility and land that collateralizes the loan could reimburse the Company. The estimated fair market value of the encumbered assets at March 31, 2005 is $3.8 million. The Company has recorded no liability in relation to this guarantee as of March 31, 2005 and December 31, 2004. The fair value of the guarantee is not material. To date the joint venture has not defaulted on its 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 March 31, 2005, The Company is not presently involved in any material litigation nor, to its knowledge, are any material litigation threatened against it, or its properties.

On April 8, 2005, the Company completed a private offering of $35.0 million in Trust Preferred Securities (“Trust Preferred Securities”), liquidation amount of $1.00 per Trust Preferred Security. The Trust Preferred Securities were issued through a wholly owned subsidiary of Extra Space Storage, LP (the “Operating Partnership”), a wholly owned Delaware statutory trust subsidiary, ESS Statutory Trust I (the “Trust”). The Trust issued 1,083 common securities of the Trust to the Operating Partnership for a purchase price of $1.1 million. The Trust used proceeds from the sale of the Trust Preferred Securities and the common securities to purchase the Operating Partnership’s Junior Subordinated Note (the “Note”), in the aggregate principal amount of $36.1 million. The Note has a variable rate equal to the three-month LIBOR plus 2.25% per annum, with quarterly interest payments beginning June 30, 2005. The interest on the Note 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.

17

Table of Contents

Extra Space Storage Inc.

Notes to Condensed Consolidated Financial Statements (unaudited)

Amounts in thousands, except shares and per share data

On May 5, 2005, the Company and joint venture partner Prudential Real Estate Investors (“PREI”), the real estate investment and advisory business of Prudential Financial, Inc., entered into a definitive agreement to acquire Storage USA from GE Commercial Finance, a unit of the General Electric Corp. (NYSE: GE) for $2.3 billion in cash. The purchase does not require stockholder approval but is subject to other customary closing conditions. Company management expects the acquisition to be completed in July 2005. When completed, the transaction will be the largest to date in the self-storage industry.

Storage USA, based in Memphis, Tennessee, is currently the fourth largest operator of self-storage facilities in the U.S., operating 458 self-storage properties in 31 states and Washington, D.C. Storage USA manages over 31 million net rentable square feet with nearly 250,000 tenants.

The Company will acquire one-hundred percent of 61 Storage USA facilities, and through the PREI joint venture, will acquire a minority ownership interest in an additional 259 Storage USA properties. The Company will also acquire Storage USA’s equity interest in 54 joint venture properties, will assume the management of 84 franchise and managed properties and will purchase all other corporate assets and liabilities.

In December 2004, the FASB issued SFAS No. 123R, “Share–Based Payment”. SFAS No. 123R is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation”, and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Among other items, SFAS No. 123R eliminates the use of ABP Opinion No. 25 and the intrinsic value method of accounting, and requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, based on the grant date fair value of those awards, in the financial statements. The effective date of SFAS No. 123R is the first reporting period beginning after June 15, 2005, which is third quarter 2005 for calendar year companies, although early adoption is allowed. However, on April 14, 2005, the Securities and Exchange Commission (“SEC”) announced that the effective date of SFAS No. 123R will be suspended until January 1, 2006, for calendar year companies.

SFAS No. 123 permits companies to adopt its requirements using either a “modified prospective” method, or a “modified retrospective” method. Under the “modified prospective” method, compensation cost is recognized in the financial statements beginning with the effective date, based on the requirements of SFAS No. 123R for all share-based payments granted after that date, based on the requirements of SFAS No. 123 for all unvested awards granted prior to the effective date of SFAS No. 123R. Under the “modified retrospective” method, the requirements are the same as under the “modified prospective” method, but also permits entities to restate financial statements of previous periods based on pro forma disclosures made in accordance with SFAS No. 123.

The Company currently utilizes a standard option pricing model (Black-Scholes) to measure the fair value of stock options granted to Employees. While SFAS No. 123R permits entities to continue to use such a model, the standard also permits the use of a “lattice” model. The Company has not yet determined which model it will use to measure the fair value of employee stock options under the adoption of SFAS No. 123R.

The Company currently expects to adopt SFAS No. 123R effective January 1, 2006, based on the new effective date announced by the SEC; however, the Company has not determined which of the aforementioned adoption methods it will use. In addition, the Company has not determined the financial statement impact of adopting SFAS No. 123R for periods beyond 2005.

18

Table of Contents

Extra Space Storage Inc.

Amounts in thousands, except shares and per share data

The following discussion and analysis should be read in conjunction with our “Unaudited Condensed Consolidated Financial Statements” and the Notes to Unaudited Condensed Consolidated Financial Statements” contained in this report and the “Consolidated Financial Statements,” “Notes to Consolidated Financial Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” contained in our Form 10-K for the year ended December 31, 2004. The Company makes statements in this section that are forward-looking statements within the meaning of the federal securities laws. For a complete discussion of forward-looking statements, see the section in this Form 10-Q entitled “Statement on Forward Looking Information.”

OVERVIEW

The Company is a fully integrated, self-administered and self-managed real estate investment trust formed to continue the business commenced in 1977 by its predecessor companies to own, operate, acquire, develop and redevelop professionally managed self-storage properties. Since 1996, the Company’s fully integrated development and acquisition teams have completed the development or acquisition of more than 150 self-storage properties. To maximize revenue-generating opportunities for the properties, the Company employs a state-of-the-art, proprietary, web-based tracking and yield management technology called STORE. Developed by the Company’s management team, STORE enables the Company to analyze, set and adjust rental rates in real time across its portfolio in order to respond to changing market conditions. The Company derives substantially all of its revenues from rents received from tenants under existing leases on each of its self-storage properties. The Company operates in competitive markets, where consumers have multiple self-storage properties from which to choose. Competition has and will continue to impact the Company’s results. The Company experiences minor seasonal fluctuations in occupancy levels, with occupancy levels higher in the summer months due to increased activity. The Company’s operating results, therefore, depend materially on its ability to lease available self-storage space and on the ability of its tenants to make required rental payments. The Company believes it is 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.

The Company continues to evaluate a range of new growth initiatives and opportunities in order to enable it to maximize stockholder value. These include:

19

Table of Contents

Extra Space Storage Inc.

Amounts in thousands, except shares and per share data

PROPERTIES

As of March 31, 2005, the Company owned and operated 148 properties located in 20 states. Of the 148 properties, 130 are wholly owned and 18 are held in joint ventures with third parties. The properties are operated under the service-marked Extra Space Storage brand name. As of March 31, 2005, the properties contained an aggregate of approximately 9.8 million net rentable square feet of space configured in approximately 92,500 separate storage units. The properties are generally situated in convenient, highly visible locations clustered around large population centers such as Boston, Chicago, Los Angeles, Miami, New York/Northern New Jersey and San Francisco. These areas all enjoy 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 the Company to reduce its operating costs through economies of scale. The Company considers 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 85% occupancy rate, or has been open for four years.

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

20

Table of Contents

Extra Space Storage Inc.

Amounts in thousands, except shares and per share data

Stabilized Property Data Based on Location