UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

  

(Mark One)

 

x

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

 

For the quarterly period ended September 30, 2016

 

OR

 

¨

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

 

For the transition period from                               to                              

 

001-36892

(Commission file number) 

 

JERNIGAN CAPITAL, INC.

(Exact name of registrant as specified in its charter)

  

Maryland		47-1978772
State or other jurisdiction of incorporation or organization		(I.R.S. Employer Identification No.)

 

6410 Poplar Avenue, Suite 650		38119
Memphis, Tennessee		(Zip Code)
(Address of principal executive offices)

 

(901) 567-9510

Registrant’s telephone number, including area code

 

Indicate by check mark whether the Registrant (1) has filed all reports 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 report(s), and (2) has been subject to such filing requirements for the past 90 days.

Yes    x   No    ¨

 

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

 

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

 

Large accelerated filer ¨	Accelerated filer ¨
Non-accelerated filer  x (Do not check if a smaller reporting company)	Smaller reporting company ¨

 

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

 

As of November 8, 2016, Jernigan Capital, Inc. had 5,960,043 shares of common stock outstanding.

 

 

Table of Contents

 

		Page
PART I.  FINANCIAL INFORMATION		3
Item 1. Financial Statements		3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		31
Item 3. Quantitative and Qualitative Disclosures About Market Risk		44
Item 4. Controls and Procedures		44
PART II.  Other information		45
Item 1. Legal Proceedings		45
Item 1A. Risk Factors		45
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds		45
Item 3. Defaults Upon Senior Securities		46
Item 4. Mine Safety Disclosures		46
Item 5. Other Information		46
Item 6. Exhibits		46

 

 

In this quarterly report on Form 10-Q (“report”), unless the context indicates otherwise, references to “Jernigan Capital,” “we,” “the Company,” “our” and “us” refer to the activities of and the assets and liabilities of the business and operations of Jernigan Capital, Inc.; “Operating Company” refers to Jernigan Capital Operating Company, LLC, a Delaware limited liability company; and “our Manager” refers to JCap Advisors, LLC, a Florida limited liability company.

  

PART I. FINANCIAL INFORMATION

 

ITEM 1. FINANCIAL STATEMENTS

 

JERNIGAN CAPITAL, INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share data)

 

		September 30, 2016				December 31, 2015
		(Unaudited)
Assets:
Cash and cash equivalents		$	13,009			$	43,859
Development property investments at fair value			84,986				40,222
Operating property loans at fair value			15,090				19,600
Investment in real estate venture			2,883				-
Other loans, at cost			6,243				1,192
Deferred offering costs			2,690				-
Prepaid expenses and other assets			727				293
Fixed assets, net			198				261
Total assets		$	125,826			$	105,427
Liabilities:
Senior loan participations		$	17,521			$	-
Due to Manager			579				698
Accounts payable, accrued expenses and other liabilities			796				808
Dividends payable			2,087				2,157
Total liabilities			20,983				3,663
Equity:
Jernigan Capital, Inc. stockholders’ equity:
Preferred stock, $0.01 par value, 100,000,000 shares authorized, none issued and outstanding at September 30, 2016 and December 31, 2015;			-				-
Common stock, $0.01 par value, 500,000,000 shares authorized at September 30, 2016 and December 31, 2015; 5,961,710 and 6,162,500 issued and outstanding at September 30, 2016 and December 31, 2015, respectively			60				62
Additional paid-in capital			108,982				110,634
Accumulated deficit			(4,199	)			(9,396	)
Total Jernigan Capital, Inc. stockholders' equity			104,843				101,300
Non-controlling interests			-				464
Total equity			104,843				101,764
Total liabilities and equity		$	125,826			$	105,427

 

See accompanying notes to consolidated financial statements.

 

 

JERNIGAN CAPITAL, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(in thousands, except per share data)

 

		Three months ended September 30,								Nine months ended September 30,
		2016				2015				2016				2015
Revenues:
Interest income from investments		$	1,698			$	578			$	4,374			$	735
Total investment income			1,698				578				4,374				735
Costs and expenses:
General and administrative expenses			1,463				1,213				4,102				2,000
Management fees to Manager			402				414				1,218				823
Transaction and other expenses			2				112				2,129				262
Restructuring costs			-				220				54				220
Deferred termination fee to Manager			-				158				239				308
Total costs and expenses			1,867				2,117				7,742				3,613
Operating loss			(169	)			(1,539	)			(3,368	)			(2,878	)
Other income (expense):
Equity in earnings from unconsolidated real estate venture			436				-				854				-
Change in fair value of investments			4,867				85				14,185				656
Interest expense			(148	)			-				(186	)			-
Other interest income			8				47				43				110
Total other income			5,163				132				14,896				766
Net income (loss)		$	4,994			$	(1,407	)		$	11,528			$	(2,112	)
Basic earnings (loss) per share attributable to common stockholders		$	0.84			$	(0.24	)		$	1.90			$	(0.55	)
Diluted earnings (loss) per share attributable to common stockholders		$	0.84			$	(0.24	)		$	1.90			$	(0.55	)
Dividends declared per share of common stock		$	0.35			$	0.35			$	1.05			$	0.70

 

See accompanying notes to consolidated financial statements.

 

 

JERNIGAN CAPITAL, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY

(Unaudited)

(in thousands, except share data)

 

																		Total				Non-
		Common Stock								Additional				Accumulated				Stockholders'				Controlling
		Shares				Amount				Paid-In Capital				Deficit				Equity				Interests				Total Equity
Balance at December 31, 2014			1,000			$	-			$	1			$	-			$	1			$	-			$	1
Retirement of stock			(1,000	)			-				(1	)			-				(1	)			-				(1	)
Public offering of common stock			5,750,000				58				114,942				-				115,000				-				115,000
Private placement of common stock			250,000				2				4,998				-				5,000				-				5,000
Equity offering costs			-				-				(9,609	)			-				(9,609	)			-				(9,609	)
Issuances of stock-based awards			162,500				2				(2	)			-				-				-				-
Stock-based compensation			-				-				167				-				167				-				167
Deferred termination fee to Manager			-				-				-				-				-				308				308
Dividends declared			-				-				-				(4,296	)			(4,296	)			-				(4,296	)
Net income (loss)			-				-				-				(2,112	)			(2,112	)			-				(2,112	)
Balance at September 30, 2015			6,162,500			$	62			$	110,496			$	(6,408	)		$	104,150			$	308			$	104,458

 

																		Total				Non-
		Common Stock								Additional				Accumulated				Stockholders'				Controlling				Total
		Shares				Amount				Paid-In-Capital				Deficit				Equity				Interests				Equity
Balance at December 31, 2015			6,162,500			$	62			$	110,634			$	(9,396	)		$	101,300			$	464			$	101,764
Repurchase and retirement of 213,078 shares of common stock			(213,078	)			(2	)			(3,150	)			-				(3,152	)			-				(3,152	)
Repurchase and retirement of 2,052 shares related to vested restricted stock			(2,052	)			-				(33	)			-				(33	)			-				(33	)
Issuances of stock-based awards			14,340				-				-				-				-				-				-
Stock-based compensation			-				-				828				-				828				-				828
Deferred termination fee to Manager			-				-				-				-				-				239				239
Effect of Management Agreement amendment (See Note 11)			-				-				703				-				703				(703	)			-
Dividends declared			-				-				-				(6,331	)			(6,331	)			-				(6,331	)
Net income			-				-				-				11,528				11,528				-				11,528
Balance at September 30, 2016			5,961,710			$	60			$	108,982			$	(4,199	)		$	104,843			$	-			$	104,843

 

 See accompanying notes to consolidated financial statements.

 

 

JERNIGAN CAPITAL, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(Dollars in thousands) 

 

		Nine Months Ended September 30,
		2016				2015
Cash flows from operating activities
Net income (loss)		$	11,528			$	(2,112	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Interest capitalized on outstanding loans			(2,635	)			(439	)
Change in fair market value of investments			(14,185	)			(656	)
Stock-based compensation			828				167
Equity in earnings from unconsolidated real estate venture			(824	)			-
Deferred termination fee to Manager			239				308
Depreciation			74				5
Amortization of deferred financing costs			3				-
Loss on disposal of assets			-				33
Accretion of origination fees			(468	)			-
Origination fees received in cash			205				-
Changes in operating assets and liabilities:
Interest receivable			-				(68	)
Other assets			(268	)			(98	)
Due to Manager			(151	)			516
Accounts payable, accrued expenses, and other liabilities			(12	)			677
Net cash used in operating activities			(5,666	)			(1,667	)
Cash flows from investing activities
Purchase of fixed assets			(11	)			(218	)
Capital contributions to real estate venture			(1,348	)			-
Return of capital from real estate venture			7,291				-
Advances to real estate venture			(11,761	)			-
Repayment of advances to real estate venture			11,761				-
Capitalized real estate venture costs			(226	)			-
Funding of investment portfolio:
Development property investments			(36,257	)			(27,984	)
Operating property loans			(246	)			(9,404	)
Other loans			(9,197	)			-
Repayment of investments			9,635				-
Net cash used in investing activities			(30,359	)			(37,606	)
Cash flows from financing activities
Senior loan participations			17,550				-
Deferred financing costs			(132	)			-
Deferred offering costs			(2,690	)
Stock repurchases			(3,152	)			-
Net proceeds from issuance of common stock			-				110,391
Dividends paid			(6,401	)			(2,139	)
Net cash provided by financing activities			5,175				108,252
Net change in cash and cash equivalents			(30,850	)			68,979
Cash and cash equivalents at the beginning of the period			43,859				1
Cash and cash equivalents at the end of the period		$	13,009			$	68,980
Supplemental disclosure of cash flow information:
Interest paid		$	141			$	-
Supplemental disclosure of non-cash investing and financing activities:
Dividends declared		$	2,087			$	2,157
Contribution of assets to real estate venture			7,693				-
Loans paid off with issuance of new loans			-				2,420

 

See accompanying notes to consolidated financial statements.

 

 

JERNIGAN CAPITAL, INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(in thousands, except share and per share data, percentages and as otherwise indicated)

 

1. ORGANIZATION AND FORMATION OF THE COMPANY

 

Jernigan Capital, Inc. (together with its consolidated subsidiaries, the “Company”) makes debt and equity investments in newly-constructed and existing self-storage facilities. The Company is a Maryland corporation that was organized on October 1, 2014. The Company closed its initial public offering of its common stock (the “IPO”) on April 1, 2015, and has used proceeds of the IPO primarily to fund real estate loans to private developers, owners and operators of self-storage facilities. The Company is structured as an Umbrella Partnership REIT (“UPREIT”) and conducts its investment activities through its operating company, Jernigan Capital Operating Company, LLC (the “Operating Company”). The Company is externally managed by JCAP Advisors, LLC (the “Manager”).

 

The Company has elected to be taxed as a real estate investment trust (“REIT”) under the Internal Revenue Code of 1986 (the “Code”), as amended. As a REIT, the Company generally will not be subject to U.S. federal income taxes on REIT taxable income, determined without regard to the deduction for dividends paid and excluded capital gains, to the extent that it annually distributes all of its REIT taxable income to stockholders and complies with various other requirements for qualification as a REIT set forth in the Code.

 

2. SIGNIFICANT ACCOUNTING POLICIES

 

Basis of Presentation

 

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The accompanying interim consolidated financial statements include all normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the results for the interim periods included therein. Substantially all operations are conducted through the Operating Company and all significant intercompany transactions and balances have been eliminated in consolidation.

 

Use of Estimates

 

The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect certain reported amounts and disclosures. Actual results could differ from those estimates.

 

Reclassification

 

In the Annual Report on Form 10-K for the year ended December 31, 2015, the Company reported on the Consolidated Balance Sheet $1.5 million of prepaid expenses and other assets, which included $1.2 million of other loan assets recorded at cost. In this Quarterly Report on Form 10-Q, we have reported the $1.2 million of other loans recorded at cost separately from prepaid expenses and other assets on the Consolidated Balance Sheet.

 

Variable Interest Entities

 

The Company invests in entities that may qualify as variable interest entities (“VIEs”). A VIE is a legal entity that lacks one or more of the characteristics of a voting interest entity. A VIE is defined as an entity in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. The determination of whether an entity is a VIE includes both a qualitative and quantitative analysis. Management bases the qualitative analysis on its review of the design of the entity, its organizational structure including allocation of decision-making authority and relevant financial agreements and the quantitative analysis on the forecasted cash flow of the entity. Management reassesses the initial evaluation of an entity as a VIE upon the occurrence of certain reconsideration events.

 

A VIE must be consolidated only by its primary beneficiary, which is defined as the party that, along with its affiliates and agents, has both the: (i) power to direct the activities that most significantly impact the VIE’s economic performance and (ii) obligation to absorb the losses of the VIE or the right to receive the benefits from the VIE, which could be significant to the VIE. Management determines whether the Company is the primary beneficiary of a VIE by considering qualitative and quantitative factors, including, but not limited to: which activities most significantly impact the VIE’s economic performance and which party controls such activities; the amount and characteristics of its investment; the obligation or likelihood for the Company or other interests to provide financial support; consideration of the VIE’s purpose and design, including the risks the VIE was designed to create and pass through to its variable interest holders and the similarity with and significance to the Company’s business activities and the other interests. Management reassesses the determination of whether the Company is the primary beneficiary of a VIE each reporting period.

 

Equity Investments

 

Investments in real estate ventures and entities over which the Company exercises significant influence but not control are accounted for using the equity method. In accordance with Accounting Standards Codification (“ASC”) 825, Financial Instruments (“ASC 825-10”), issued by the Financial Accounting Standards Board (“FASB”), the Company has elected the fair value option of accounting for its development property investments, which would otherwise be required to be accounted for under the equity method. The Company also holds an investment in a real estate venture that is accounted for under the equity method of accounting.

  

 

Loan Investments and Election of Fair Value Option of Accounting for Certain Loan Investments

 

The Company has elected the fair value option of accounting for all of its investment portfolio loan investments, including those that are required under GAAP to be accounted for under the equity method, in order to provide stockholders and others who rely on the Company’s financial statements with a more complete and accurate understanding of the Company’s economic performance including its revenues and value inherent in the Company’s equity participation in development projects. Changes in the fair value of these investments are recorded in change in fair value of investments within other income. All direct loan costs are charged to expense as incurred.

 

Each loan investment, including those recorded at cost and presented on the Consolidated Balance Sheets as other loans, is evaluated for impairment on a periodic basis. The Company also periodically evaluates the extent and impact of any credit deterioration associated with the performance and/or value of the underlying collateral property as well as the financial and operating capability of the borrower on a loan by loan basis. The Company also evaluates the financial wherewithal of any loan guarantors as well as the borrower’s competency in managing and operating the property. In addition, the Company considers the overall economic environment, real estate sector and geographic sub-market in which the borrower operates. A loan will be considered impaired when, based on current information and events, it is probable that the loan will not be collected according to the contractual terms of the loan agreement. Factors to be considered by management in determining impairment include payment status, collateral value and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. At September 30, 2016 and December 31, 2015, there were no loans in default.

   

Fair Value Measurement

 

The Company carries certain financial instruments at fair value because it has elected to apply the fair value option on an instrument by instrument basis under ASC 825-10. The Company’s financial instruments consist of cash, development property investments (which are typically comprised of a first mortgage loan, a mezzanine loan, and a 49.9% profits interest in the development project), operating property loans (loans secured by operating properties), the investment in real estate venture, other loans, receivables, senior loan participations, and payables.

 

The following table presents the financial instruments measured at fair value on a recurring basis at September 30, 2016:

 

		Fair Value Measurements Using
		Total				Level 1				Level 2				Level 3
Development property investments		$	84,986			$	-			$	-			$	84,986
Operating property loans			15,090				-				-				15,090
Total investments		$	100,076			$	-			$	-			$	100,076

 

The following table presents the financial instruments measured at fair value on a recurring basis at December 31, 2015:

 

		Fair Value Measurements Using
		Total				Level 1				Level 2				Level 3
Development property investments		$	40,222			$	-			$	-			$	40,222
Operating property loans			19,600				-				-				19,600
Total investments		$	59,822			$	-			$	-			$	59,822

 

Estimating fair value requires the use of judgment. The types of judgments involved depend upon the availability of observable market information. Management’s judgments include determining the appropriate valuation model to use, estimating unobservable inputs and applying valuation adjustments. See Note 4, Fair Value of Financial Instruments, for additional disclosure on the valuation methodology and significant assumptions, as well as the election of the fair value option for certain financial instruments.

 

Cash and Cash Equivalents

 

Cash, investments in money market accounts and certificates of deposit with original maturities of three months or less are considered to be cash equivalents. The Company places its cash and cash equivalents primarily with two financial institutions and, at times, cash held may exceed the Federal Deposit Insurance Corporation insurance limit. 

 

Other Loans

 

The Company’s other loans balance at September 30, 2016 includes principal balances for five revolving loan agreements and four mortgage loans. The Company’s other loans balance at December 31, 2015 includes principal balances for three revolving loan agreements and one mortgage loan. Because these loans are not part of the Company’s core investment portfolio, these loans are accounted for under the cost method.

 

 

Fixed Assets

 

Fixed assets are recorded at cost and consist of furniture, office and computer equipment, and software. Depreciation is computed on a straight-line basis over the estimated useful lives of the related assets, which range from three to seven years. Fixed assets are generally purchased by the Manager and the cost reimbursed by the Company. Maintenance and repair costs are charged to expense as incurred. Upon sale or retirement, the asset cost and related accumulated depreciation are eliminated from the respective accounts and any resulting gain or loss is included in income.

  

Revenue recognition

 

Interest income is recognized as earned on a simple interest basis and is reported in interest income from investments in the Consolidated Statements of Operations. Accrual of interest will be discontinued on a loan when management believes, after considering economic and business conditions and collection efforts, that the borrower’s financial condition is such that collection of interest is doubtful. The Company will recognize income on impaired loans when they are placed into non-accrual status on a cash basis when the loans are both current and the collateral on the loan is sufficient to cover the outstanding obligation to the Company. If these factors do not exist, the Company will not recognize income on such loans. Accrued interest generally is reversed when a loan is placed on non-accrual status. 

  

The Company’s loan origination fees are accreted into interest income over the term of the investment using the effective yield method.

 

Transaction and other expenses

 

Transaction and other expenses consist of non-capitalizable advisory fees and other unreimbursed expenses incurred in connection with various financing and investment transactions and are expensed as incurred. During the three and nine month periods ended September 30, 2016, the Company incurred $2 thousand and $2.1 million, respectively, of transaction and other expenses. During the three and nine months ended September 30, 2015, the Company incurred $0.1 million and $0.3 million, respectively.

 

Offering and Registration Costs

 

Underwriting commissions and offering costs incurred in connection with the Company’s stock offerings are reflected as a reduction of additional paid-in capital. Costs to prepare and file a registration statement on Form S-3 with the Securities and Exchange Commission and costs incurred related to the Series A Preferred Stock Purchase Agreement (defined in Note 9, Stockholders’ Equity) are included in deferred offering costs on the Consolidated Balance Sheet and will be reclassified to additional paid-in capital or to reduce the carrying value of debt upon the issuance of such securities. These costs will be charged to expense in the event such registration statement or purchase agreement is withdrawn or not used. Offering and registration costs represent professional fees, fees paid to various regulatory agencies, and other costs incurred in connection with the registration and sale of the Company’s securities.

 

Organization Costs

 

Costs incurred to organize the Company were expensed as incurred.

 

Restructuring Costs

 

Restructuring costs consist of severance and benefits costs, lease termination costs, and other costs incurred by the Company in conjunction with consolidating its offices and moving its corporate headquarters. The Company recognizes these severance and other charges when the requirements of ASC 420, Exit or Disposal Cost Obligations (“ASC 420”), have been met regarding a plan of termination and when communication has been made to employees. All restructuring activities were completed during the quarter ended September 30, 2015.

 

Income Taxes

 

The Company has elected to be taxed as a REIT and to comply with the related provisions of the Code. Accordingly, the Company will generally not be subject to U.S. federal income tax to the extent of its distributions to stockholders and as long as certain asset, income and share ownership tests are met. The Company had no taxable income for the three and nine months ended September 30, 2016 and 2015. To qualify as a REIT, the Company must annually distribute at least 90% of its REIT taxable income to its stockholders and meet certain other requirements.

 

Earnings per Share (“EPS”)

 

Basic EPS includes only the weighted average number of common shares outstanding during the period. Diluted EPS includes the weighted average number of common shares and the dilutive effect of restricted stock and redeemable Operating Company units when such instruments are dilutive.

 

All outstanding unvested share-based payment awards that contain rights to nonforfeitable dividends are treated as participating in undistributed earnings with common shareholders. Awards of this nature are considered participating securities and the two-class method of computing basic and diluted EPS must be applied.

 

 

Comprehensive Income

 

For the three and nine months ended September 30, 2016 and 2015, comprehensive income equaled net income; therefore, separate Consolidated Statements of Comprehensive Income are not included in the accompanying consolidated financial statements.

 

Segment Reporting

 

The Company does not evaluate performance on a relationship specific or transactional basis and does not distinguish its principal business or group its operations on a geographical basis for purposes of measuring performance. Accordingly, the Company believes it has a single operating segment for reporting purposes in accordance with GAAP.

 

Recent Accounting Pronouncements

 

In August 2016, the FASB issued Accounting Standards Update (“ASU”) 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This ASU provides guidance on the classification of certain cash receipts and payments in the statement of cash flows, including distributions received from equity method investees. This guidance is effective for public business entities for fiscal years and for interim periods within those fiscal years, beginning after December 15, 2017, with early adoption being allowed. The Company is currently assessing the impact this new accounting guidance will have on its consolidated financial statements.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. This ASU significantly changes how entities will measure credit losses for most financial assets and certain other instruments that are not measured at fair value through net income. This guidance is effective for public business entities for fiscal years and for interim periods within those fiscal years, beginning after December 15, 2019, with early adoption being allowed as of the fiscal years beginning after December 15, 2018. The Company is currently assessing the impact this new accounting guidance will have on its consolidated financial statements.

 

In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718): Improvement to Employee Share-based Payment Accounting. This ASU simplifies several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities and classification on the statement of cash flows. This guidance is effective for public business entities for fiscal years and for interim periods within those fiscal years, beginning after December 15, 2016, with early adoption being allowed. The Company is currently assessing the impact this new accounting guidance will have on its consolidated financial statements.

 

In April 2015, the FASB issued ASU 2015-03, Interest-Imputation of Interest (Subtopic 835-30): Simplifying the Presentation of Debt Issuance Costs. This guidance simplifies the presentation of debt issuance costs by requiring that debt issuance costs be presented in the balance sheet as a deduction from the carrying amount of the related debt liability, consistent with debt discount or premiums. The recognition guidance for debt issuance costs is not affected by amendments in this update. This guidance is effective for public business entities for fiscal years and for interim periods within those fiscal years, beginning after December 15, 2015, with early adoption being allowed. The adoption of this ASU did not have a material impact on the Company’s consolidated financial statements.

 

In February 2015, the FASB issued ASU 2015-02, Amendments to the Consolidation Analysis. This ASU amends the assessment of whether a limited partnership or limited liability company is a variable interest entity; the effect that fees paid to a decision maker have on the consolidation analysis; how variable interests held by a reporting entity’s related parties or de facto agents affect its consolidation conclusion; and for entities other than limited partnerships and limited liability companies, clarifies how to determine whether the equity holders as a group have power over an entity. This guidance is effective for public business entities for fiscal years and for interim periods within those fiscal years, beginning after December 15, 2015, with early adoption being allowed. The Company early adopted the provisions of this ASU in 2015, and there was no impact on its consolidated financial statements as a result of the adoption.

   

In August 2014, the FASB issued ASU 2014-15, Presentation of Financial Statements-Going Concern (Subtopic 205-40): Disclosure of Uncertainties about an Entity’s Ability to Continue as a Going Concern. This ASU requires management to evaluate whether there are conditions and events that raise substantial doubt about the entity’s ability to continue as a going concern within one year after the financial statements are issued (or available to be issued when applicable) and, if so, disclose that fact. This ASU is effective for annual periods ending after December 15, 2016 and interim periods within annual periods beginning after December 15, 2016. Early adoption is permitted for annual or interim reporting periods for which the financial statements have not previously been issued. The adoption of this guidance is not expected to have a material effect on the Company’s consolidated financial statements and disclosures.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (“ASU 2014-09”), which is effective for fiscal years, and interim periods within those years, beginning on or after December 15, 2016. In August 2015, the FASB extended the effective date by one year to years beginning on and after December 15, 2017. The standard may be adopted as early as the original effective date but early adoption prior to that date is not permitted. This ASU outlines a new, single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance, including industry specific guidance. In March 2016, the FASB issued ASU 2016-08, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, as an amendment to ASU 2014-09. This amendment clarifies how to identify the unit of accounting for the principal versus agent evaluation, how to apply the control principle to certain types of arrangements, such as service transactions, and reframed the indicators in the guidance to focus on evidence that an entity is acting as a principal rather than as an agent. In April 2016 and May 2016, the FASB issued ASU 2016-10, Revenue from Contracts with Customers (Topic 606): Identifying Performance Obligations and Licensing, and ASU 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, respectively. ASU 2016-10 clarifies the existing guidance on identifying performance obligations and licensing implementation. ASU 2016-12 adds practical expedients related to the transition for contract modifications and further defines a completed contract, clarifies the objective of the collectability assessment and how revenue is recognized if collectability is not probable, and when non-cash considerations should be measured. The Company is currently assessing the impact these standards will have on its consolidated financial statements.

 

   

3. INVESTMENTS

 

The Company’s self-storage investments at September 30, 2016 consisted of the following:

 

·

Development Property Investments - The Company had 12 investments totaling an aggregate committed principal amount of approximately $89.4 million to finance the ground-up construction of, or conversion of existing buildings into, self-storage facilities. Each development property investment is funded over time as the developer constructs the project. Each development property investment is typically comprised of a first mortgage loan, a mezzanine loan, and a 49.9% interest in the positive cash flows (including the sale and refinancing proceeds after debt repayment) of the project. The loans are secured by the first mortgages on the projects and first priority security interests in the membership interests of the owners of the projects. Loans comprising development property investments are non-recourse with customary carve-outs and subject to completion guaranties, are interest-only with a fixed interest rate of 6.9% per annum and have a term of 72 months.

 

The Company also had four construction loan investments totaling an aggregate committed principal amount of approximately $36.8 million, each of which has a term of 18 months. Each construction loan is interest-only at a fixed interest rate of 6.9% per annum, has no equity participation and is secured by a first priority mortgage or deed of trust on the project. Each of these construction loans is subject to a purchase and sale agreement between the developer and a third-party purchaser, containing certain conditions, pursuant to which the financed project is anticipated to be sold and our loan repaid on or about the time a certificate of occupancy is issued for the financed self-storage facility.

 

·

Operating property loans - The Company had five term loans totaling $15.0 million of aggregate committed principal amount, the proceeds of which were used by borrowers to finance the acquisition of, refinance existing indebtedness on, or recapitalize operating self-storage facilities. These loans are secured by first mortgages on the projects financed, are interest-only with fixed interest rates ranging from 5.85% to 6.9% per annum, and generally have a term of 72 months.

 

The Company’s development property investments and operating property loans are collectively referred to herein as the Company’s investment portfolio.

 

As of September 30, 2016, the aggregate committed principal amount of the Company’s investment portfolio was approximately $141.2 million and outstanding principal was $86.2 million, as described in more detail in the table below:  

 

Closing Date		Metropolitan Statistical Area ("MSA")		Total Investment Commitment				Funded Investment(1)				Remaining Unfunded Commitment				Fair Value
Development property investments:
Loan investments with a profits interest:
4/21/2015		Orlando (2)		$	5,372			$	5,233			$	139			$	7,316
6/10/2015		Atlanta 1 (2)			8,132				7,513				619				10,066
6/19/2015		Tampa (2)			5,369				5,246				123				6,144
6/26/2015		Atlanta 2 (2)			6,050				5,493				557				8,559
6/29/2015		Charlotte 1 (2)			7,624				6,040				1,584				8,575
7/2/2015		Milwaukee (3)			7,650				5,044				2,606				5,728
7/31/2015		New Haven (3)			6,930				4,316				2,614				4,865
8/10/2015		Pittsburgh (3)			5,266				2,985				2,281				3,115
8/14/2015		Raleigh			8,998				1,217				7,781				1,161
9/30/2015		Jacksonville (2)			6,445				5,024				1,421				6,438
10/27/2015		Austin (3)			8,658				2,660				5,998				2,827
9/20/2016		Charlotte 2			12,888				1,301				11,587				1,178
				$	89,382			$	52,072			$	37,310			$	65,972
Construction loans:
8/5/2015		West Palm Beach			7,500				5,841				1,659				5,821
8/5/2015		Sarasota			4,792				2,590				2,202				2,569
11/17/2015		Chicago			6,808				4,529				2,279				4,496
12/23/2015		Miami			17,733				6,395				11,338				6,128
				$	36,833			$	19,355			$	17,478			$	19,014
		Subtotal		$	126,215			$	71,427			$	54,788			$	84,986
Operating property loans:
6/19/2015		New Orleans			2,800				2,800				-				2,841
7/7/2015		Newark			3,480				3,480				-				3,565
10/30/2015		Nashville			1,210				1,210				-				1,240
11/24/2015		Nashville			4,968				4,863				105				4,955
12/22/2015		Chicago			2,502				2,422				80				2,489
		Subtotal		$	14,960			$	14,775			$	185			$	15,090
		Total investments		$	141,175			$	86,202			$	54,973			$	100,076

  

(1)

Represents principal balance of loan gross of origination fees

(2)

Facility had received certificate of occupancy as of September 30, 2016. See Note 4, Fair Value of Financial Instruments, for information regarding recognition of entrepreneurial profit.

(3)

Facility had achieved at least 40% construction completion but had not received certificate of occupancy as of September 30, 2016. See Note 4, Fair Value of Financial Instruments, for information regarding recognition of entrepreneurial profit.

 

 

The following table provides a reconciliation of the funded principal to the fair market value of investments at September 30, 2016:

 

Funded principal		$	86,202
Adjustments:
Unamortized origination fees			(1,099	)
Net increase in fair value of investments			15,057
Other			(84	)
Fair value of investments		$	100,076

   

As of December 31, 2015, the aggregate committed principal amount of the Company’s investment portfolio was approximately $175.7 million and outstanding principal was $60.7 million, as described in more detail in the table below: 

 

Closing Date		Metropolitan Statistical Area ("MSA")		Total Investment Commitment				Funded Investment(1)				Remaining Unfunded Commitment				Fair Value
Development property investments:
Loan investments with a profits interest:
4/21/2015		Orlando		$	5,372			$	3,254			$	2,118			$	3,400
5/14/2015		Miami (2)			13,867				2,258				11,609				2,115
5/14/2015		Miami (2)			14,849				3,076				11,773				2,929
6/10/2015		Atlanta 1			8,132				4,723				3,409				4,829
6/19/2015		Tampa			5,369				3,720				1,649				3,820
6/26/2015		Atlanta 2			6,050				2,799				3,251				2,823
6/29/2015		Charlotte			7,624				1,124				6,500				1,554
7/2/2015		Milwaukee			7,650				2,529				5,121				2,463
7/31/2015		New Haven			6,930				997				5,933				960
8/10/2015		Pittsburgh			5,266				1,542				3,724				1,542
8/14/2015		Raleigh			8,998				1,026				7,972				934
9/25/2015		Fort Lauderdale (2)			13,230				2,144				11,086				2,009
9/30/2015		Jacksonville			6,445				1,213				5,232				1,180
10/27/2015		Austin			8,658				800				7,858				708
				$	118,440			$	31,205			$	87,235			$	31,266
Construction loans:
8/5/2015		West Palm Beach			7,500				2,011				5,489				1,951
8/5/2015		Sarasota			4,792				1,036				3,756				998
11/17/2015		Chicago			6,808				775				6,033				706
12/23/2015		Miami			17,733				5,655				12,078				5,301
				$	36,833			$	9,477			$	27,356			$	8,956
		Subtotal		$	155,273			$	40,682			$	114,591			$	40,222
Operating property loans:
6/19/2015		New Orleans			2,800				2,800				-				2,736
7/7/2015		Newark			3,480				3,480				-				3,416
10/30/2015		Nashville			1,210				1,210				-				1,192
11/10/2015		Sacramento			5,500				5,500				-				5,401
11/24/2015		Nashville			4,968				4,863				105				4,755
12/22/2015		Chicago			2,502				2,130				372				2,100
		Subtotal		$	20,460			$	19,983			$	477			$	19,600
		Total investments		$	175,733			$	60,665			$	115,068			$	59,822

 

(1)

Represents principal balance of loan gross of origination fees

 

(2)

These development property investments (having approximately $8.1 million of outstanding principal balances as of the time of contribution on March 31, 2016) were contributed to the SL1 Venture (defined in Note 5, Investment in Real Estate Venture) in partial satisfaction of the Company’s required $12.2 million capital commitment to the SL1 Venture. See Note 5, Investment in Real Estate Venture.

  

 

The following table provides a reconciliation of the funded principal to the fair market value of investments at December 31, 2015:

  

Funded principal		$	60,665
Adjustments:
Unamortized origination fees			(1,715	)
Net increase in fair value of investments			872
Fair value of investments		$	59,822

 

The Company has elected the fair value option of accounting for all of its investment portfolio investments in order to provide stockholders and others who rely on the Company’s financial statements with a more complete and accurate understanding of the Company’s economic performance, including its revenues and value inherent in its equity participation in development projects. See Note 4, Fair Value of Financial Instruments, for additional disclosure on the valuation methodology and significant assumptions.

 

On May 9, 2016, the Company received $5.6 million (including a prepayment penalty of $0.1 million recognized in interest income from investments in the Consolidated Statements of Operations) for the early payoff of an operating property loan in the Sacramento, California MSA.

 

No loans were in non-accrual status as of September 30, 2016 and December 31, 2015.

 

All of the Company’s development property investments with a profits interest would have been accounted for under the equity method had the Company not elected the fair value option. For the development property investments with a profits interest, the assets and liabilities of the equity method investees approximated $61.9 million and $52.1 million, respectively, at September 30, 2016 and approximated $44.4 million and $31.2 million, respectively, at December 31, 2015. These investees had revenues of approximately $0.3 million and a net operating loss of approximately $0.6 million for the nine months ended September 30, 2016. These investees had no significant revenues or expenses for the nine months ended September 30, 2015 since the development properties were under construction during this period. For the nine months ended September 30, 2016, the total income (interest income and change in fair value) from each of two development property investments with a profits interest exceeded 20% of the Company’s net income. The Company recorded total income for the nine months ended September 30, 2016 of $2.8 million from the Atlanta 1 MSA development property investment with a profits interest and $3.3 million from the Atlanta 2 MSA development property investment with a profits interest.

 

For one of the Company’s development property investments with a profits interest, an investor has an option to put its interest to the Company upon the event of default of the underlying property loans. The put, if exercised, requires the Company to purchase the member’s interest at the original purchase price plus a yield of 4.5% on such purchase price. The Company concluded that the likelihood of loss is remote and assigned no value to this put provision at September 30, 2016.

 

4. FAIR VALUE OF FINANCIAL INSTRUMENTS

 

The fair value option under ASC 825-10 allows companies to elect to report selected financial assets and liabilities at fair value. The Company has elected the fair value option of accounting for its development property investments and operating property loan investments in order to provide stockholders and others who rely on the Company’s financial statements with a more complete and accurate understanding of the Company’s economic performance, including its revenues and value inherent in its equity participation in self-storage development projects.

 

The Company applies ASC 820, Fair Value Measurements and Disclosures (“ASC 820”), which defines fair value, establishes a framework for measuring fair value in accordance with GAAP and expands disclosure of fair value measurements. ASC 820 defines fair value as the price that would be received for an investment in a current sale, which assumes an orderly transaction between market participants on the measurement date. ASC 820 requires the Company to assume that the investment is sold in its principal market to market participants or, in the absence of a principal market, the most advantageous market, which may be a hypothetical market. Market participants are defined as buyers and sellers in the principal or most advantageous market that are independent, knowledgeable, and willing and able to transact. In accordance with ASC 820, the Company has considered its principal market as the market for the purchase and sale of self-storage properties, which the Company believes would be the most likely market for the Company’s loan investments given the nature of the collateral securing such loans and the types of borrowers. ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. In accordance with ASC 820, these inputs are summarized in the three broad levels listed below:  

 

Level 1 -

Quoted prices for identical assets or liabilities in an active market.

 

Level 2 -	Financial assets and liabilities whose values are based on the following: (i) Quoted prices for similar assets or liabilities in active markets; (ii) Quoted prices for identical or similar assets or liabilities in non-active markets; (iii) Pricing models whose inputs are derived principally from or corroborated by observable market data for substantially the full term of the asset or liability.
Level 3 -	Prices or valuation techniques based on inputs that are both unobservable and significant to the overall fair value measurement.

 

The carrying values of cash, other loans, receivables, senior loan participations and payables approximate their fair values due to their short-term nature or due to a variable interest rate. These instruments are categorized as Level 1 instruments in the measurement of fair value. The below table summarizes the valuation techniques and inputs used to measure the fair value of items categorized in Level 3 of the fair value hierarchy.

 

 

    

Instrument		Valuation technique and assumptions		Hierarchy classification
Development property investments		Valuations are based using an Income Approach analysis, using the discounted cash flow method model, capturing the prepayment penalty / call price schedule as applicable.  The valuation models are calibrated to the total investment net drawn amount as of the issuance date.		Level 3
Development property investments with a profits interest  (a)		Valuations are based using an Income Approach analysis, using the discounted cash flow method model, capturing the prepayment penalty / call price schedule as applicable. The valuation models are calibrated to the total investment net drawn amount as of the issuance date factoring in the value of the profits interests.		Level 3
		An option-pricing method (OPM) framework is utilized to calculate the value of the profits interests.
Operating property loans		Valuations are based using an Income Approach analysis, using the discounted cash flow method model, capturing the prepayment penalty / call price schedule as applicable.		Level 3

 

(a)

Certain of the Company's development property investments include profits interests.

 

The Company’s development property investments and operating property loan investments are valued using two different valuation techniques. The first valuation technique is an income approach analysis of the debt instrument components of the Company’s investments. The second valuation technique is an option pricing model that is used to determine the fair value of any profits interests associated with an investment. The valuation models are calibrated to the total investment net drawn amount as of the issuance date factoring in the value of the profits interests. At the issuance date of each development property investment, generally the value of the property underlying such investment approximates the sum of the net investment drawn amount plus the developer’s equity investment.

 

For development property investments with a profits interest, at a certain stage of construction, the option pricing method incorporates an adjustment to measure entrepreneurial profit. Entrepreneurial profit is a monetary return above total construction costs that provides compensation for the risk of a development project. Under this method, the value of each property is estimated based on the cost incurred to date, plus an estimated earned entrepreneurial profit.  Total entrepreneurial profit is estimated as the difference between the projected value of a property at stabilization and the total development costs, including land, building improvements, and lease-up costs.  Utilizing information obtained from the market coupled with the Company’s own experience, the Company has estimated that in most cases, approximately one-third of the entrepreneurial profit is earned during the construction period beginning when construction is approximately 40% complete and ending when construction is 100% complete, and approximately two-thirds of the entrepreneurial profit is earned from construction completion through stabilization. For properties between 40% and 100% complete, the Company has estimated the entrepreneurial profit adjustment to the enterprise value input used in the option pricing model to be equal to one-third of the estimated entrepreneurial profit, allocated on a straight-line basis. Six properties have reached construction completion at September 30, 2016. For the Company’s development property investments at or around completion of construction, a discounted cash flow model, based on periodically updated estimates of rental rates, occupancy and operating expenses, is the primary method for projecting value of a project. The Company also will consider inputs such as appraisals which differ from the developer’s equity investment, bona fide third-party offers to purchase development projects, sales of development projects, or sales of comparable properties in its markets.

 

 

Level 3 Fair Value Measurements

 

The following tables summarize the significant unobservable inputs the Company used to value its investments categorized within Level 3 as of September 30, 2016 and December 31, 2015. These tables are not intended to be all-inclusive, but instead to capture the significant unobservable inputs relevant to the Company’s determination of fair values.

  

As of September 30, 2016

Unobservable Inputs

Asset Category

Primary Valuation Techniques

Input

Estimated Range

Weighted Average

Development property investments

Income approach analysis

Market yields/ discount rate

7.20 - 8.68

%

8.00

%

Exit date

0.42 - 3.97 years

1.96 years

Development property investments with a profits interest (a)

Option pricing model

Volatility

75.26 - 75.87

%

75.54

%

Exit date

1.67 - 3.97 years

2.36 years

Capitalization rate (b)

5.25 - 5.50

%

5.47

%

Operating property loans

Income approach analysis

Market yields/ discount rate

5.37 - 6.66

%

6.24

%

Exit date (c)

4.75 - 5.92 years

5.26 years

 

(a)

The valuation technique for the development property investments with a profits interest does not differ from the development property investments without a profits interest. The development property investments with a profits interest only require incremental valuation techniques to determine the value of the profits interest. Therefore this line only focuses on the profits interest valuation.

(b)

Ten properties were 40% - 100% complete, thus requiring a capitalization rate to derive entrepreneurial profit. Capitalization rates are estimated based on current data derived from independent sources in the markets in which the Company holds investments.

(c)

The exit dates for the operating property loans are the contractual maturity dates.

 

 

As of December 31, 2015

Unobservable Inputs

Asset Category

Primary Valuation Techniques

Input

Estimated Range

Weighted Average

Development property investments

Income approach analysis

Market yields/ discount rate

7.74 - 9.35

%

8.77

%

Exit date

1.17 - 3.83 years

3.02 years

Development property investments with a profits interest (a)

Option pricing model

Volatility

72.46 - 73.12

%

72.82

%

Exit date

3.31 - 3.83 years

3.49 years

Capitalization rate (b)

6.00 - 6.50

%

6.38

%

Operating property loans

Income approach analysis

Market yields/ discount rate

6.22 - 7.53

%

6.91

%

Exit date (c)

5.50 - 6.68 years

5.97 years

 

(a)

The valuation technique for the development property investments with a profits interest does not differ from the development property investments without a profits interest. The development property investments with a profits interest only require incremental valuation techniques to determine the value of the profits interest. Therefore this line only focuses on the profits interest valuation.

(b)

Four properties were 40% - 100% complete, thus requiring a capitalization rate to derive entrepreneurial profit. Capitalization rates are estimated based on current data derived from independent sources in the markets in which the Company holds investments.

(c)

The exit dates for the operating property loans are the contractual maturity dates.

 

The fair value measurements are sensitive to changes in unobservable inputs. A change in those inputs to a different amount might result in a significantly higher or lower fair value measurement. The following provides a discussion of the impact of changes in each of the unobservable inputs on the fair value measurement. 

  

Market yields - changes in market yields and discount rates, each in isolation, may change the fair value of certain of the Company’s investments. Generally, an increase in market yields or discount rates may result in a decrease in the fair value of certain of the Company’s investments. The following fluctuations in the market yields/discount rates would have had the following impact on the fair value of our investments: 

 

		Increase (decrease) in fair value of investments
Change in market yields/discount rates (in millions)		September 30, 2016				December 31, 2015
Up 25 basis points		$	(0.4	)		$	(0.5	)
Down 25 basis points, subject to a minimum yield/rate of 10 basis points			0.4				0.4

 

Capitalization rate - changes in capitalization rate, in isolation and all else equal, may change the fair value of certain of the Company’s development investments containing profits interests. Generally an increase in the capitalization rate assumption may result in a decrease in the fair value of the entrepreneurial profit associated with certain of the Company’s investments. The following fluctuations in the capitalization rates would have had the following impact on the fair value of our investments:

 

		Increase (decrease) in fair value of investments
Change in capitalization rates (in millions)		September 30, 2016				December 31, 2015
Up 25 basis points		$	(1.7	)		$	(0.1	)
Down 25 basis points			1.8				0.1

 

Exit date - changes in exit date, in isolation and all else equal, may change the fair value of certain of the Company’s investments that have profits interests. Generally, an acceleration in the exit date assumption may result in an increase in the fair value of the profits interests in certain of the Company’s investments.

 

Volatility - changes in volatility, in isolation and all else equal, may change the fair value of certain of the Company’s investments that have profits interests. Generally, an increase in volatility may result in an increase in the fair value of the profits interests in certain of the Company’s investments.

 

Operating cash flow projections – changes in the operating cash flow projections of the underlying self-storage facilities, in isolation and all else equal, may change the fair value of certain of the Company’s investments that have profits interests. Generally, an increase in operating cash flow projections may result in an increase in the fair value of the profits interests in certain of the Company’s investments.

 

 

The Company also evaluates the impact of changes in instrument-specific credit risk in determining the fair value of investments. There were no gains or losses attributable to changes in instrument-specific credit risk in the three months and nine months ended September 30, 2016 and 2015.

 

Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of the Company’s investments may fluctuate from period to period. Additionally, the fair value of the Company’s investments may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that the Company may ultimately realize. Further, such investments are generally subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities. If the Company was required to liquidate an investment in a forced or liquidation sale, it could realize significantly less than the value at which the Company has recorded it. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the unrealized gains or losses reflected in the valuations currently assigned.

 

The following table presents changes in investments that use Level 3 inputs for the nine month period ended September 30, 2016:

 

Balance as of December 31, 2015		$	59,822
Net realized gains			-
Net unrealized gains			14,185
Fundings of principal and change in unamortized origination fees			36,627
Repayment of loan			(5,500	)
Payment-in-kind interest			2,635
Contribution of assets to Heitman Joint Venture			(7,693	)
Net transfers in or out of Level 3			-
Ending balance at September 30, 2016		$	100,076

 

As of September 30, 2016 and December 31, 2015, the total net unrealized appreciation on the investments that use Level 3 inputs was $15.1 million and $0.9 million, respectively.

 

For the three and nine months ended September 30, 2016 and 2015, all of the change in fair value of investments in the Company’s Consolidated Statements of Operations was attributable to unrealized gains relating to the Company’s Level 3 assets still held as of the respective balance sheet date.

 

Transfers between levels, if any, are recognized at the beginning of the quarter in which the transfers occur.

 

5. INVESTMENT IN REAL ESTATE VENTURE

 

On March 7, 2016, the Company, through its Operating Company, entered into the Limited Liability Company Agreement (the “JV Agreement”) of Storage Lenders LLC, a Delaware limited liability company, to form a real estate venture (the “SL1 Venture”) with HVP III Storage Lenders Investor, LLC (“HVP III”), an investment vehicle managed by Heitman Capital Management LLC (“Heitman”). The SL1 Venture was formed for the purpose of providing capital to developers of self-storage facilities identified and underwritten by the Company. HVP III committed $110.0 million for a 90% interest in the SL1 Venture, and the Company committed $12.2 million for a 10% interest.

 

On March 31, 2016, the Company contributed to the SL1 Venture three of its existing development property investments with a profits interest located in Miami and Fort Lauderdale, Florida that were not yet under construction. These investments had an aggregate committed principal amount of approximately $41.9 million and an aggregate drawn balance of $8.1 million. In exchange, the Company’s funding commitment of $12.2 million was reduced by $8.1 million, representing the Company’s initial “Net Invested Capital” balance as defined in the JV Agreement. The Company accounted for this contribution in accordance with ASC 845, Nonmonetary Transactions, and recorded an investment in the SL1 Venture based on the fair value of the contributed development property investments, which is the same as carryover basis. The fair value of the contributed development property investments as of March 31, 2016 was $7.7 million. Pursuant to the JV Agreement, Heitman, in fulfilling its $110.0 million commitment, provides capital to the SL1 Venture as cash is required, including funding draws on the three contributed development property investments. During the quarter ended September 30, 2016, HVP III and the Company agreed to true up the balances in the respective members’ capital accounts to be in accordance with the 90% commitment and 10% commitment made by HVP III and the Company, respectively. Accordingly, during the three months ended September 30, 2016, HVP III contributed cash of $7.3 million to the SL1 Venture, and the Company received a $7.3 million cash distribution as a return of its capital.

 

 

Under the JV Agreement, the Company will receive a priority distribution (after debt service and any reserve but before any other distributions) out of operating cash flow and residual distributions based upon 1% of the committed principal amount of loans made by the SL1 Venture, exclusive of the loans contributed to the SL1 Venture by the Company. Operating cash flow of the SL1 Venture (after debt service, reserves and the foregoing priority distributions) will be distributed in accordance with capital commitments. Residual cash flow from capital and other events (after debt service, reserves and priority distributions) will be distributed (i) pro rata in accordance with capital commitments (its “Percentage Interest”) until each member has received a return of all capital contributed; (ii) pro rata in accordance with each member’s Percentage Interest until Heitman has achieved a 14% internal rate of return; (iii) to Heitman in an amount equal to its Percentage Interest less 10% and to the Company in an amount equal to the Company’s Percentage Interest plus 10% until Heitman has achieved a 17% internal rate of return; (iv) to Heitman in an amount equal to its Percentage Interest less 20% and to the Company in an amount equal to the Company’s Percentage Interest plus 20% until Heitman has achieved a 20% internal rate of return; and (v) any excess to Heitman in an amount equal to its Percentage Interest less 30% and to the Company in an amount equal to the Company’s Percentage Interest plus 30%. However, the Company will not be entitled to any such promoted interest prior to the earlier to occur of the third anniversary of the JV Agreement and Heitman receiving distributions to the extent necessary to provide Heitman with a 1.48 multiple on its contributed capital.

 

Since the allocation of cash distributions and liquidating distributions are determined as described in the preceding paragraph, the Company has applied the hypothetical-liquidation-at-book-value (“HLBV”) method to allocate the earnings of SL1 Venture. Under the HLBV approach, the Company’s share of the investee’s earnings or loss is calculated by:

 

·

The Company’s capital account at the end of the period assuming that the investee was liquidated or sold at book value, plus

 

·

Cash distributions received by the Company during the period, minus

 

·

Cash contributions made by the Company during the period, minus

 

·

The Company’s capital account at the beginning of the period assuming that the investee were liquidated or sold at book value.

 

SL1 Venture has elected the fair value option of accounting for its development property investments with a profits interest, which are equity method investments of SL1 Venture. The assumptions used to value SL1 Venture’s investments are materially consistent with those used to value the Company’s investments. As of September 30, 2016, SL1 Venture had ten development property investments with a profits interest as described in more detail in the table below:

 

Closing Date		Metropolitan Statistical Area ("MSA")		Total Investment Commitment				Funded Investment(1)				Remaining Unfunded Commitment				Fair Value
5/14/2015		Miami 1 (2)		$	13,867			$	4,490			$	9,377			$	4,462
5/14/2015		Miami 2 (2)			14,849				3,763				11,086				3,712
9/25/2015		Fort Lauderdale (2)			13,230				2,793				10,437				2,739
4/15/2016		Washington DC			17,269				6,168				11,101				6,127
4/29/2016		Atlanta 1			10,223				221				10,002				123
7/19/2016		Jacksonville			8,127				636				7,491				556
7/21/2016		New Jersey			7,828				510				7,318				435
8/15/2016		Atlanta 2			8,772				505				8,267				419
8/25/2016		Denver			11,032				1,533				9,499				1,430
9/28/2016		Columbia			9,199				1,070				8,129				980
		Total		$	114,396			$	21,689			$	92,707			$	20,983

 

(1)

Represents principal balance of loan gross of origination fees

 

(2)

These development property investments (having approximately $8.1 million of outstanding principal at contribution) were contributed to the SL1 Venture on March 31, 2016 by the Company.

 

As of September 30, 2016, the SL1 Venture had total assets of $22.2 million and total liabilities of $0.1 million. During the three and nine months ended September 30, 2016, the SL1 Venture had net income of $0.4 million and $0.8 million, respectively, all of which was allocated to the Company under the HLBV method. At September 30, 2016, $0.2 million of transaction expenses were included in the carrying amount of the Company’s investment in the SL1 Venture. Additionally, the Company may from time to time make advances to the SL1 Venture. At September 30, 2016, the Company did not have any outstanding advances to the SL1 Venture.

 

In accordance with the JV Agreement, for each development property investment, the borrower must deliver to the SL1 Venture a completion guarantee whereby the borrower agrees to cover all costs in excess of the agreed-upon budget amount. Additionally, the Company is required to deliver to the SL1 Venture a backstop completion guarantee for each development property investment to guarantee completion in the event the borrower does not satisfy its obligations. The Company concluded that the likelihood of loss is remote and assigned no value to this guarantee as of September 30, 2016.

 

 

Under the JV Agreement, Heitman and the Company will seek to obtain and, if obtained, will share joint rights of first refusal to acquire self-storage facilities that are the subject of development property investments made by the SL1 Venture. Additionally, so long as the Company, through its operating subsidiary, is a member of the SL1 Venture and the SL1 Venture holds any assets, the Company will not make any investment of debt or equity or otherwise, directly or indirectly, in one or more new joint ventures or similar programs for the purposes of funding or providing development loans or financing, directly or indirectly, for the development, construction or conversion of self-storage facilities, in each case without first offering such opportunity to Heitman to participate on substantially the same terms as those set forth in the JV Agreement, either through the SL1 Venture or a newly formed real estate venture.

 

The JV Agreement permits Heitman to cause the Company to repurchase from Heitman its Developer Equity Interests (as defined in the JV Agreement) in certain limited circumstances. Under the JV Agreement, if a developer causes to be refinanced a self-storage facility with respect to which the SL1 Venture has made a development property investment and such refinancing does not coincide with a sale of the underlying self-storage facility, then at any time after the fourth anniversary of the commencement of the SL1 Venture, Heitman may either put to the Company its share of the Developer Equity Interests in respect of each such development property investment, or sell Heitman’s Developer Equity Interests to a third party. The Company concluded that the likelihood of loss is remote and assigned no value to the put.

 

The Company is the managing member of the SL1 Venture and will manage and administer (i) the day-to-day business and affairs of the SL1 Venture and any of its acquired properties and (ii) loan servicing and other administration of the approved development property investments. The Company will be paid a monthly expense reimbursement amount by the SL1 Venture in connection with its role as managing member, as set forth in the JV Agreement. Heitman may remove the Company as the managing member of the SL1 Venture if it commits an event of default (as defined in the JV Agreement), if it undergoes a change of control (as defined in the JV Agreement), if it becomes insolvent or if, during the Investment Period, the Company’s Chief Executive Officer ceases to have an active role in the finding and underwriting of potential development loans for the SL1 Venture, and, as a result of such cessation, the Company is not capable of fulfilling its duties and obligations under the JV Agreement, as reasonably determined by Heitman in good faith.

 

Heitman has the right to approve all “Major Decisions” of the SL1 Venture, as defined in the JV Agreement, including, but not limited to, each investment of capital, the incurrence of any indebtedness, the sale or other disposition of assets of the SL1 Venture, the replacement of the managing member, the acceptance of new members into the SL1 Venture and the liquidation of the SL1 Venture.

 

For four of the SL1 Venture development property investments with a profits interest, an investor has an option to put its interest to the Company upon the event of default of the underlying property loans. The put, if exercised, requires the Company to purchase the member’s interest at the original purchase price plus a yield of 4.5% on such purchase price. The Company concluded that the likelihood of loss is remote and assigned no value to these put provisions at September 30, 2016.

 

6. VARIABLE INTEREST ENTITIES

 

Development Property Investments

 

The Company holds variable interests in its development property investments. The Company has determined that these investees qualify as VIEs because the entities do not have enough equity to finance their activities without additional subordinated financial support. In determining whether the Company is the primary beneficiary of the VIEs, the Company identified the activities that most significantly impact the VIEs’ economic performance. Such activities are (1) managing the construction and operations of the project, (2) selecting the property manager, (3) financing decisions, (4) authorizing capital expenditures and (5) disposition of the property. Although the Company has certain participating and protective rights, it does not have the power to direct the activities that most significantly impact the VIEs’ economic performance and is not the primary beneficiary; therefore, the Company does not consolidate the VIEs.

 

The Company has recorded assets of $85.0 million and $40.2 million at September 30, 2016 and December 31, 2015, respectively, for its variable interest in the VIEs which is included in the development property investments at fair value line item in the Consolidated Balance Sheets. The Company’s maximum exposure to loss as a result of its involvement with the VIEs is as follows:

 

		September 30, 2016				December 31, 2015
Assets recorded related to VIEs		$	84,986			$	40,222
Unfunded loan commitments to VIEs			54,788				114,591
Maximum exposure to loss		$	139,774			$	154,813

 

The Company has a construction completion guaranty from the managing members of the VIEs or individual affiliates/owners of such managing members.

 

 

Investment in Real Estate Venture

 

The Company determined that the SL1 Venture qualifies as a VIE because it does not have enough equity to finance its activities without additional subordinated financial support. In determining whether the Company is the primary beneficiary of the entity, the Company identified the activities that most significantly impact the entity’s economic performance. Such activities are (1) approving self-storage development investments and acquiring self-storage properties, (2) managing directly-owned properties, (3) obtaining debt financing, and (4) disposing of investments. Although the Company has certain rights, it does not have the power to direct the activities that most significantly impact the entity’s economic performance and thus is not the primary beneficiary. As such, the Company does not consolidate the entity and accounts for its unconsolidated interest in the SL1 Venture using the equity method of accounting. The Company’s investment in the SL1 Venture is included in the investment in real estate venture balance in the Consolidated Balance Sheets, and earnings from the SL1 Venture are included in equity in earnings from unconsolidated real estate venture in the Company’s Consolidated Statements of Operations. The Company’s maximum contribution to the SL1 Venture is $12.2 million.

 

7. OTHER LOANS

 

The Company had executed five revolving loan agreements with an aggregate outstanding principal amount of $1.4 million at September 30, 2016. Four of the agreements are with individuals who are owners of limited liability companies, and the fifth agreement is with a limited liability company and is personally guaranteed. Four of the borrowers are either directly or indirectly owners of certain of the Company’s development property investments, and one is a prospective developer. Two of the agreements provide for borrowings of up to $0.5 million, one provides for borrowings of up to $0.25 million, one provides for borrowings of up to $0.65 million, and one agreement provides for borrowings of up to $1.0 million (total of $2.9 million) to fund expenses for pursuit costs to contract for and perform diligence on additional self-storage sites. The loan to the limited liability company is secured by a first priority security interest and assignment of its 100% interest in a limited liability company which owns one of the Company’s development investment properties. The loans bear interest at 6.9-7.0% per annum and are due in full in three years. During the nine month period ended September 30, 2016, the Company received repayments on these revolving loan agreements of $0.6 million. At December 31, 2015, the Company had executed three revolving loan agreements with an aggregate outstanding principal amount of $0.5 million. These loans are accounted for under the cost method, and fair value approximates cost at September 30, 2016. None of these loans are in non-accrual status and no allowance for loan loss was recorded by the Company as of September 30, 2016 and December 31, 2015.

 

As of September 30, 2016, the Company also had an aggregate balance of $4.9 million related to four loans extended to four limited liability companies that are under common control with borrowers in certain of the Company’s development property investments. These loans are secured by first mortgages on real and personal property, are personally guaranteed, and are interest-only with a fixed interest rate of 6.9% per annum, and mature in three to nine months. The maturities are based upon the estimated time needed to prepare the sites for closing into a development loan. During the nine months ended September 30, 2016, the Company received aggregate repayments of $3.4 million related to two loans and entered into five new loans with an aggregate balance of $7.6 million. At December 31, 2015, the Company had executed one loan agreement of $0.7 million to a limited liability company that was under common control with a borrower in a development property investment. These loans are accounted for under the cost method, and fair value approximates cost at September 30, 2016. None of these loans are in non-accrual status and no allowance for loan loss was recorded by the Company as of September 30, 2016 and December 31, 2015.

 

8. SENIOR PARTICIPATIONS

 

On April 29, 2016, the Company sold senior participations (the “Operating Property A Notes”) in two separate operating property loans in the Nashville, Tennessee and New Orleans, Louisiana MSAs, having an aggregate outstanding principal balance of $7.8 million, to a regional commercial bank in exchange for cash consideration of $5.0 million. The sale of Operating Property A Notes was effected pursuant to participation agreements between the bank and the Company (the “Participation Agreements”). Under the Participation Agreements, the Company will continue to service the underlying loans so long as it is not in default under the Participation Agreements. The bank has the option to “put” either of the senior participations to the Company in the event the underlying borrower defaults on the underlying loan or if the Company defaults under the applicable Participation Agreement. The Company will pay to the bank interest on the outstanding balance of the Operating Property A Notes at the rate of 30-day LIBOR plus 3.85%, or 4.37% at September 30, 2016. The Operating Property A Notes mature on April 1, 2019, at which time the Company is obligated to repurchase the Operating Property A Notes at the then outstanding principal balances thereof. As part of the Participation Agreements, the Company will maintain a minimum aggregate balance of $0.5 million in depository or money market accounts at the bank. The outstanding balance for the Operating Property A Notes at September 30, 2016 was $5.0 million.

  

On May 27, 2016, the Company sold a third senior participation in a construction loan on a facility in the Miami, Florida MSA (“the Miami A Note”), having a commitment amount of $17.7 million, to the same commercial bank that purchased the Operating Property A Notes in exchange for a commitment by the bank to provide net proceeds of $10.0 million to fund construction draws under the construction loan (the “Miami A Note Sale”) once the total outstanding principal balance exceeds $7.7 million. The Miami A Note Sale was effected pursuant to a participation agreement between the bank and the Company (the “Miami Participation Agreement”). Under the Miami Participation Agreement, the Company will continue to service the underlying loan so long as it is not in default under the Miami Participation Agreement. The bank has the option to “put” the senior participation to the Company in the event the underlying borrower defaults on the underlying loan or if the Company defaults under the Miami Participation Agreement. The Company will pay to the bank interest on the outstanding balance of the Miami A Note at the rate of 30-day LIBOR plus 3.10%, or 3.62% at September 30, 2016. The Company also paid a loan fee of 100 basis points, or $0.1 million upon closing of the loan. The Miami A Note matures on July 1, 2017, at which time the Company is obligated to repurchase the Miami A Note at the then outstanding principal balance thereof. No proceeds have been received as of September 30, 2016 from the Miami A Note.

 

 

On July 26, 2016, the Company sold to a national commercial bank operating in the Company’s markets senior participations in the construction loans of four separate development property investments with a profits interest (the “July 2016 A Notes”) (one in the Orlando, Florida MSA, two in the Atlanta, Georgia MSA, and one in the Tampa, Florida MSA) having an aggregate committed principal balance of approximately $21.8 million and earning interest at a rate of 6.9% per annum, in exchange for a commitment by the bank to provide net proceeds of $14.2 million ( the “July 2016 A Note Sales”). Construction has been completed and certificates of occupancy have been issued for these properties. At closing, the bank paid to the Company approximately $12.5 million for senior participations in the construction loans and will fund up to a total of $14.2 million as future draws are made on the construction loans. The Company will pay interest to the bank on its senior participations at the annual rate of 30-day LIBOR plus 3.50%, or 4.02% at September 30, 2016. The July 2016 A Notes mature on August 1, 2019, at which time the Company is obligated to repurchase the July 2016 A Notes at the then outstanding principal balance thereof. The outstanding balance for the July 2016 A Notes at September 30, 2016 was $12.5 million.

 

The table below details the bank commitments and outstanding balances of our various senior participations at September 30, 2016 (dollars in thousands):

 

		Commitment by Bank				Amount Borrowed				Remaining Funds
Operating Property A Notes		$	5,049			$	5,049			$	-
Miami A Note			10,001				-				10,001
July 2016 A Notes			14,185				12,501				1,684
Total		$	29,235			$	17,550			$	11,685

 

9. STOCKHOLDERS’ EQUITY

 

The Company was organized in Maryland on October 1, 2014, and under the Company’s Articles of Incorporation, as amended, the Company is authorized to issue up to 500,000,000 shares of common stock and 100,000,000 shares of preferred stock. The sole stockholder of the Company prior to the closing of its IPO was the founder and chief executive officer, who is an affiliate of the Company. The founder’s initial capital contribution to the Company was $1.0 thousand made on October 2, 2014, in exchange for 1,000 shares of common stock. These shares were retired effective with the IPO.

 

Common Stock Offering

 

On April 1, 2015, the Company closed its IPO and received $93.0 million in proceeds, net of underwriter’s discount. Simultaneously, the Company received $5.0 million in proceeds from the concurrent private placement with an affiliate of its founder. In connection with these transactions, the Company issued 5,000,000 and 250,000 shares of common stock, respectively and the initial 1,000 shares of common stock issued on October 2, 2014 were retired.

 

On April 9, 2015, the Company completed the sale of shares of common stock to the underwriters of its IPO pursuant to the underwriters’ over-allotment option. The Company issued 750,000 shares of common stock and received $14.0 million, net of underwriters’ discount.

 

Stock Repurchase Plan

 

On May 20, 2016, the Company’s Board of Directors authorized a share repurchase program for the repurchase of up to $10.0 million of the outstanding shares of common stock of the Company. As of September 30, 2016, the Company had repurchased and retired a total of 213,078 shares of its common stock at an aggregate cost of approximately $3.2 million. As of September 30, 2016, the Company has $6.8 million remaining under the Board’s authorization to repurchase shares of its common stock.

 

Equity Incentive Plan

 

In connection with the IPO, the Company established the 2015 Equity Incentive Plan for the purpose of attracting and retaining directors, executive officers, investment professionals and other key personnel and service providers, including officers and employees of the Manager and other affiliates, and to stimulate their efforts toward the Company’s continued success, long-term growth and profitability. The 2015 Equity Incentive Plan provides for the grant of stock options, share awards (including restricted common stock and restricted stock units), stock appreciation rights, dividend equivalent rights, performance awards, annual incentive cash awards and other equity-based awards, including Long-Term Incentive Plan (“LTIP”) units, which are convertible on a one-for-one basis into Operating Company Units (“OC Units”).  A total of 200,000 shares of common stock are reserved for issuance pursuant to the 2015 Equity Incentive Plan, subject to certain adjustments set forth in the plan. On April 1, 2015, each non-employee director of the Company received an award of 2,500 shares of restricted common stock (total of 10,000 shares) which vest ratably over a three-year period. On June 15, 2015, in connection with the appointment of the Company’s President and Chief Operating Officer (an employee of the Manager), 100,000 shares of restricted common stock were granted, which shares vest ratably over a five-year period. During the quarter ended September 30, 2015, the Company granted 52,500 shares of restricted common stock to an executive officer (an employee of the Manager) and key employees of the Manager, which shares vest ratably over a three-year period. The Manager provides services to the Company. On May 20, 2016, each non-employee director of the Company received an award of 3,585 shares of common stock (total of 14,340 shares) which immediately vested on the grant date.

 

 

Restricted Stock Awards

 

The 2015 Equity Incentive Plan permits the issuance of restricted stock awards to employees and non-employee directors. Granted stock awards at September 30, 2016 and December 31, 2015 aggregated 176,840 and 162,500 service-based stock awards, respectively, of which 17,500 and 55,172 vested during the three and nine months ended September 30, 2016, respectively, 40,832 will vest in 2017, 40,836 will vest in 2018, and 20,000 will vest in 2019 and 2020, respectively. Non-vested shares are earned over the respective vesting period based on a service condition only. Expenses related to restricted stock awards are charged to compensation expense and are recognized over the respective vesting period (primarily three to five years) of the awards. For restricted stock issued to non-employee directors of the Company, compensation expense is based on the market value of the shares at the grant date. For restricted stock awards issued to employees of the Manager, compensation expense is remeasured at each reporting date based on the then current value of the Company’s common stock.

 

The Company recognized approximately $0.3 million and $0.1 million of stock-based compensation expense for the three months ended September 30, 2016 and 2015, respectively, and $0.8 million and $0.2 million of stock-based compensation expense for the nine months ended September 30, 2016 and 2015, respectively. As of September 30, 2016 and December 31, 2015, the total unrecognized compensation cost related to the Company’s restricted shares was approximately $2.1 million and $2.2 million, respectively, based on the grant date market value for awards issued to non-employee directors of the Company and based on the measurement of awards using the Company’s stock price of $19.17 and $14.95 as of September 30, 2016 and December 31, 2015, respectively, for awards issued to employees of the Manager. This cost is expected to be recognized over the remaining weighted average period of 3.1 years. The Company presents stock-based compensation expense in general and administrative expenses in the Consolidated Statements of Operations.

 

A summary of changes in the Company’s restricted shares for the three and nine months ended September 30, 2016 and 2015 is as follows: 

 

		Three Months Ended September 30, 2016								Three Months Ended September 30, 2015
		Shares				Weighted average grant date fair value				Shares				Weighted average grant date fair value
Nonvested at June 30,			139,168			$	19.91				110,000			$	20.67
Granted			-				-				52,500				18.82
Vested			(17,500	)			18.64				-				-
Forfeited			-				-				-				-
Nonvested at September 30,			121,668			$	20.10				162,500			$	20.08

 

		Nine Months Ended September 30, 2016								Nine Months Ended September 30, 2015
		Shares				Weighted average grant date fair value				Shares				Weighted average grant date fair value
Nonvested at December 31,			162,500			$	20.08				-			$	-
Granted			14,340				13.95				162,500				20.08
Vested			(55,172	)			18.27				-				-
Forfeited			-				-				-				-
Nonvested at September 30,			121,668			$	20.10				162,500			$	20.08

  

Nonvested restricted shares receive dividends which are nonforfeitable.

 

 

Series A Preferred Stock Private Placement

 

On July 27, 2016 (the “Effective Date”), the Company entered into a Stock Purchase Agreement (the “Purchase Agreement”) with accounts managed by NexPoint Advisors, L.P., an affiliate of Highland Capital Management, L.P. (collectively, the “Buyers”) relating to the issuance and sale, from time to time until the second anniversary of the Effective Date (such period, the “Commitment Period”), of up to $100 million in shares of the Company’s newly designated Series A Preferred Stock, par value $0.01 per share (the “Series A Preferred Stock”), at a price of $1,000 per share (the “Liquidation Value”) (subject to a minimum amount of $50 million of Series A Preferred Stock to be issued and sold by the Company on or prior to the expiration of the Commitment Period), which may be increased at the request of the Company up to $125 million. The sale of shares of Series A Preferred Stock pursuant to the Purchase Agreement may occur from time to time, in minimum monthly increments of $5 million, maximum monthly increments of $15 million and maximum increments of $35 million over any rolling three month period, all to be completed during the Commitment Period.

 

The Company expects to contribute the net proceeds from issuances and sales of the Series A Preferred Stock to the Operating Company in exchange for newly designated Series A Preferred membership units in the Operating Company having economic terms and designations, powers, preferences, rights and restrictions that are substantially similar to the Series A Preferred Stock.

 

The Series A Preferred Stock will rank senior to the shares of the Company’s common stock, par value $0.01 per share (the “Common Stock”), with respect to distribution rights and rights upon liquidation, winding up and dissolution of the Company, on parity with any class or series of capital stock of the Company expressly designated as ranking on parity with the Series A Preferred Stock with respect to distribution rights and rights upon liquidation, winding up and dissolution of the Company, junior to any class or series of capital stock of the Company expressly designated as ranking senior to the Series A Preferred Stock with respect to distribution rights and rights upon liquidation, winding up and dissolution of the Company and junior in right of payment to the Company’s existing and future indebtedness.

 

Holders of Series A Preferred Stock will be entitled to a cumulative cash distribution (“Cash Distribution”) equal to (A) 7.0% per annum on the Liquidation Value for the period beginning on the respective date of issuance until the sixth anniversary of the Effective Date, payable quarterly in arrears, (B) 8.5% per annum on the Liquidation Value for the period beginning the day after the sixth anniversary of the Effective Date and for each year thereafter so long as the Series A Preferred Stock remains issued and outstanding, payable quarterly in arrears, and (C) an amount in addition to the amounts in (A) and (B) equal to 5.0% per annum on the Liquidation Value upon the occurrence of certain triggering events (a “Cash Premium”). In addition, the holders of the Series A Preferred Stock will be entitled to a cumulative dividend payable in-kind in shares of Common Stock or additional shares of Series A Preferred Stock, at the election of the holders (the “Stock Dividend”), equal in the aggregate to the lesser of (Y) 25% of the incremental increase in the Company’s book value (as adjusted for equity capital issuances, share repurchases and certain non-cash expenses) plus, to the extent the Company owns equity interests in income-producing real property, the incremental increase in net asset value (provided, however, that no interest in the same real estate asset will be double counted) and (Z) an amount that would, together with the Cash Distribution, result in a 14.0% internal rate of return for the holders of the Series A Preferred Stock from the date of issuance of the Series A Preferred Stock, as set forth in the Articles Supplementary classifying the Series A Preferred Stock (the “Articles Supplementary”). Triggering events that will trigger the payment of a Cash Premium with respect to a Cash Distribution include: (i) the occurrence of certain change of control events affecting the Company after the third anniversary of the Effective Date, (ii) the Company’s ceasing to be subject to the reporting requirements of Section 13 or Section 15(d) of the Exchange Act, (iii) the Company’s failure to remain qualified as a real estate investment trust, (iv) an event of default under the Purchase Agreement (as described below), (v) the failure by the Company to register for resale shares of Common Stock pursuant to the Registration Rights Agreement (a “Registration Default”), (vi) the Company’s failure to redeem the Series A Preferred Stock as required by the Purchase Agreement, or (vii) the filing of a complaint, a settlement with, or a judgment entered by the Securities and Exchange Commission against the Company or any of its subsidiaries or a director or executive officer of the Company relating to the violation of the securities laws, rules or regulations with respect to the business of the Company. Accrued but unpaid Cash Distributions and Stock Dividends on the Series A Preferred Stock will accumulate and will earn additional Cash Distributions and Stock Dividends as calculated above, compounded quarterly.

 

The holders of Series A Preferred Stock have the right to purchase their pro rata share of any qualified offering of Common Stock, which consists of any offering by the Company of Common Stock except any shares of Common Stock issued (i) in connection with a merger, consolidation, acquisition or similar business combination, (ii) in connection with a joint venture, strategic alliance or similar corporate partnering arrangement, (iii) in connection with any acquisition of assets by the Company, (iv) at market prices pursuant to a registered at-the-market program and/or (v) as part of a compensatory or employment arrangement.

 

So long as shares of Series A Preferred Stock remain outstanding, the Company is required to maintain a ratio of debt to total tangible assets determined under U.S. generally accepted accounting principles of no more than 0.4:1, measured as of the last day of each fiscal quarter.

 

 

The Series A Preferred Stock may be redeemed at the Company’s option (i) after five years from the Effective Date at a price equal to 105% of the Liquidation Value per share plus the value of all accumulated and unpaid Cash Distributions and Stock Dividends, and (ii) after six years from the Effective Date at a price equal to 100% of the Liquidation Value per share plus the value of all accumulated and unpaid Cash Distributions and Stock Dividends. In the event of certain change of control events affecting the Company prior to the third anniversary of the Effective Date, the Company must redeem all shares of Series A Preferred Stock for a price equal to (a) the Liquidation Value, plus (b) accumulated and unpaid Cash Distributions and Stock Dividends, plus (c) a make-whole premium designed to provide the holders of the Series A Preferred Stock with a return on the redeemed shares equal to a 14.0% internal rate of return through the third anniversary of the Effective Date.

 

Holders of Series A Preferred Stock will be entitled to a separate class vote with respect to (i) any amendments to the Company’s Amended and Restated Articles of Incorporation (the “Charter”), as supplemented by the Articles Supplementary, or bylaws that would alter or change the rights, preferences, privileges or restrictions of the Series A Preferred Stock so as to materially and adversely affect such Series A Preferred Stock and (ii) by reclassification or otherwise, any issuances by the Company of securities that are senior to, or equal in priority with, the Series A Preferred Stock.

 

In the event of any liquidation, dissolution or winding up of the Company, the holders of the Series A Preferred Stock shall be entitled to receive an amount equal to the greater of (i) the Liquidation Value, plus all accumulated but unpaid Cash Distributions and Stock Dividends thereon to, but not including, the date of any liquidation, but excluding any Cash Premium and (ii) the amount that would be paid on such date in the event of a redemption following a change of control.

 

Pursuant to the Purchase Agreement and the Articles Supplementary, the Company increased the size of its Board by one director and elected James Dondero as preferred representative of the Buyers, to the Board for a term expiring at the Company’s 2017 annual meeting of stockholders. Thereafter, so long as any shares of the Series A Preferred Stock are outstanding, the Company will nominate one person to be designated by the holders of the Series A Preferred Stock as a designee for election by the Company’s stockholders to the Board. If the Company has not paid the full amount of the Cash Distribution or the Stock Dividend on the shares of the Series A Preferred Stock for six or more quarterly dividend periods (whether or not consecutive), the Company will increase the size of the Board by two directors and will nominate two additional persons to be designated by the holders of the Series A Preferred Stock as designees for election to the Board by the Company’s stockholders at the next annual or special meeting of stockholders to serve until the Company pays in full all accumulated and unpaid Cash Distributions and Stock Dividends.

 

Further, at any time that the Series A Preferred Stock remains outstanding, if Dean Jernigan, the Company’s current Chief Executive Officer and Chairman of the Board, voluntarily leaves the position of Chief Executive Officer, and is not serving as the Executive Chairman of the Board (a “Key Man Event”), the holders of the Series A Preferred Stock shall have the right to accept or reject the service of any person as Chief Executive Officer (or such person serving as the principal executive officer) of the Company.

 

The Purchase Agreement requires that the Company and its subsidiaries conduct their business in the ordinary course of business consistent with past practice and use reasonable best efforts to (i) preserve substantially intact the business organization and (ii) avoid becoming subject to the requirements of the Investment Company Act of 1940, as amended. Additionally, the Company and its subsidiaries may not change or alter materially its method of accounting or the manner in which it keeps its accounting books and records unless required by the Securities and Exchange Commission to reflect changes in U.S. generally accepted accounting principles or, in the business judgment of the Board, such change would be in the best interests of the Company or stockholders.

 

Future issuances of shares of Series A Preferred Stock at any one or more closings after the Effective Date are contingent upon the satisfaction of certain conditions at the time of such proposed purchase, including that (i) the representations and warranties of the Purchase Agreement remain true and correct in all material respects and the Company has complied with all covenants and conditions under the Purchase Agreement, the Articles Supplementary, the Registration Rights Agreement and the documents related thereto, (ii) no material adverse effect (as such term is defined in the Purchase Agreement) has occurred, (iii) there is no suspension of trading of the Common Stock on the New York Stock Exchange or such other market or exchange on which the Common Stock is then listed or traded (the “Principal Market”), (iv) a Key Man Event shall not have occurred, as described above, and (v) the Company has delivered certain customary closing deliverables.

 

An event of default under the Purchase Agreement terminates the obligation of the Buyers to acquire shares of Series A Preferred Stock from the Company and also triggers the Cash Premium described above. Such events of default under the Purchase Agreement include (i) a Registration Default, (ii) the suspension of trading or delisting of the Common Stock on the Principal Market, (iii) the failure by the transfer agent of the Company to issue shares of the Series A Preferred Stock to the Buyers (subject to an applicable cure period), (iv) the Company’s breach of a representation or warranty, covenant or other term or condition under the Purchase Agreement, Articles Supplementary, the Registration Rights Agreement or the documents related thereto that has a material adverse effect (subject to an applicable cure period), (v) the failure of the Company to sell $50 million of shares of Series A Preferred Stock on or prior to the tenth business day after the expiration of the Commitment Period, (vi) an event of default under any secured indebtedness of the Company, or (vii) certain bankruptcy proceedings.

 

The holders of the Series A Preferred Stock will have certain customary registration rights with respect to the Common Stock issued as Stock Dividends pursuant to the terms of a Registration Rights Agreement.

 

 

The issuance and sale of the Series A Preferred Stock, and the issuance of shares of common stock and/or additional shares of Series A Preferred Stock issuable as Stock Dividends, will be exempt from registration under the Securities Act of 1933, as amended (the “Securities Act”) pursuant to Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D thereunder. The Buyers represented to the Company that they are “accredited investors” as defined in Rule 501 of the Securities Act and that the Series A Preferred Stock is being acquired for investment purposes and not with a view to, or for sale in connection with, any distribution thereof, and appropriate legends will be affixed to any certificates evidencing the shares of Series A Preferred Stock or Common Stock issuable pursuant to the Stock Purchase Agreement.

 

As of September 30, 2016, the Company had not issued any shares of Series A Preferred Stock.

 

10. EARNINGS PER SHARE

 

Basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the period.  All outstanding unvested restricted share awards contain rights to non-forfeitable dividends and participate in undistributed earnings with common shareholders and, accordingly, are considered participating securities that are included in the two-class method of computing basic earnings per share. Both the unvested restricted shares, and the related impact to earnings, are considered when calculating earnings per share on a diluted basis with our diluted earnings per share being the more dilutive of the treasury stock or two-class methods.  Redeemable Operating Company Units are included in dilutive earnings per share calculations when they are dilutive to earnings per share. For the three and nine months ended September 30, 2016 and 2015, the Company’s basic earnings per share is computed using the two-class method, and our diluted earnings per share is computed using the more dilutive of the treasury stock method or two-class method:  

 

		Three months ended September 30,								Nine months ended September 30,
		2016				2015				2016				2015
Shares outstanding
Weighted average common shares - basic			5,831,135				6,000,000				5,926,215				4,000,330
Effect of dilutive securities (1)			131,958				-				149,971				-
Weighted average common shares, all classes			5,963,093				6,000,000				6,076,186				4,000,330
Calculation of Earnings per Share - basic
Net income (loss)		$	4,994			$	(1,407	)		$	11,528			$	(2,112	)
Net income allocated to unvested restricted shares			(111	)			-				(285	)			-
Dividends declared on unvested restricted shares			n/a				(57	)			n/a				(95	)
Net income (loss), adjusted, attributable to common shareholders		$	4,883			$	(1,464	)		$	11,243			$	(2,207	)
Weighted average common shares - basic			5,831,135				6,000,000				5,926,215				4,000,330
Earnings (loss) per share - basic		$	0.84			$	(0.24	)		$	1.90			$	(0.55	)
Calculation of Earnings per Share - diluted
Net income (loss)		$	4,994			$	(1,407	)		$	11,528			$	(2,112	)
Dividends declared on unvested restricted shares			n/a				(57	)			n/a				(95	)
Net income (loss), adjusted, attributable to common shareholders		$	4,994			$	(1,464	)		$	11,528			$	(2,207	)
Weighted average common shares - diluted			5,963,093				6,000,000				6,076,186				4,000,330
Earnings (loss) per share - diluted		$	0.84			$	(0.24	)		$	1.90			$	(0.55	)

 

(1)

For the three and nine months ended September 30, 2015, potentially dilutive securities are not included in the diluted earnings per share calculation as they are not dilutive.

  

 

11. RELATED PARTY TRANSACTIONS

 

The Company’s founder was reimbursed for $0.1 million of organizational costs and $0.1 million of offering costs in April 2015 following the closing of the Company’s IPO.

 

Equity Method Investments

 

Certain of the Company’s development property investments are equity method investments for which the Company has elected the fair value option of accounting. The fair value of these equity method investments at September 30, 2016 and December 31, 2015 were $66.0 million and $31.3 million, respectively. The interest income realized and the change in fair value from these equity method investments was $5.7 million and $0.5 million for the three months ended September 30, 2016 and 2015, respectively, and $15.7 million and $1.2 million for the nine months ended September 30, 2016 and 2015, respectively.

 

The Company’s investment in the real estate venture, the SL1 Venture, has a carrying amount of $2.9 million at September 30, 2016 and the earnings from this venture were $0.4 million and $0.9 million for the three and nine months ended September 30, 2016, respectively.

  

Management Agreement

 

On April 1, 2015, the Company entered into a management agreement with its Manager (the “Management Agreement”). Pursuant to the terms of the Management Agreement, the Manager will be responsible for (a) the Company’s day-to-day operations, (b) determining investment criteria and strategy in conjunction with the Company’s Board of Directors, (c) sourcing, analyzing, originating, underwriting, structuring, and acquiring the Company’s portfolio investments, and (d) performing portfolio management duties. The Manager has an Investment Committee that approves investments in accordance with the Company’s investment guidelines, investment strategy, and financing strategy.

 

On May 23, 2016, the Company entered into an Amended and Restated Management Agreement (the “Amended and Restated Management Agreement”) by and among the Company, the Operating Company and the Manager that amends and restates the original Management Agreement dated April 1, 2015. The Amended and Restated Management Agreement was approved on behalf of the Company and the Operating Company by a unanimous vote of the Nominating and Corporate Governance Committee of the Company’s Board of Directors, which consists solely of independent directors.

 

The Amended and Restated Management Agreement modifies certain procedures with respect to the future internalization of the Manager (as described in the Amended and Restated Management Agreement, an “Internalization Transaction”). Prior to entry into the Amended and Restated Management Agreement, if no Internalization Transaction had occurred prior to the end of the last renewal term, the Manager would have been entitled to the Termination Fee (as defined in the Amended and Restated Management Agreement) and the Company would not have acquired the assets of the Manager.  The Amended and Restated Management Agreement, however, requires an Internalization Transaction at the end of the last renewal term (if an Internalization Transaction or termination of the Amended and Restated Management Agreement has not occurred prior to that date).  The Internalization Price in such event would equal the Termination Fee amount and the Company would receive the Manager’s assets.  Accordingly, the amount the Manager would receive has not changed, but the Company now would receive the assets of the Manager, which it would not have received prior to the Amended and Restated Management Agreement. 

 

Under the Amended and Restated Management Agreement, if an Internalization Transaction has not occurred prior to March 31, 2023, the last day of the last renewal term, then the Manager and the Company shall consummate an Internalization Transaction to be effective as of that date and all assets of the Manager (or, alternatively, all of the equity interests in the Manager) shall be conveyed to and acquired by the Operating Company in exchange for the Internalization Price (as described herein). At such time, all employees of the Manager shall become employees of the Operating Company and the Manager shall discontinue all business activities. Unlike an Internalization Transaction that occurs prior to the end of the final renewal term of the Amended and Restated Management Agreement, an Internalization Transaction that occurs at the end of the final renewal term shall not require a fairness opinion, the approval of a special committee of the Company’s Board of Directors or the approval of the Company’s stockholders.

 

The “Internalization Price” payable in the event of an Internalization Transaction at the end of the last renewal term shall be equal to the Termination Fee and the Board of Directors of the Company has no discretion to change such Internalization Price or the conditions applicable to its payment.

 

The Internalization Price paid to the Manager in any Internalization Transaction will be payable by the Operating Company in the number of units of limited liability company interests (“OC Units”) of the Operating Company equal to the Internalization Price, divided by the volume-weighted average of the closing market price of the common stock of the Company for the ten consecutive trading days immediately preceding the date with respect to which value must be determined. However, if the common stock of the Company is not traded on a national securities exchange at the time of closing of any Internalization Transaction, then the number of OC Units shall be determined by agreement between the Board of Directors of the Company and the Manager or, in the absence of such agreement, the Internalization Price shall be paid in cash.

 

 

Prior to entry into the Amended and Restated Management Agreement, any Termination Fee would have been payable by the Operating Company in OC Units equal to the Termination Fee divided by the average of the daily market price of the Common Stock for the ten consecutive trading days immediately preceding the date of termination within 90 days after occurrence of the event requiring the payment of the Termination Fee. In accordance with ASC 505-50, Equity - Equity-based Payments to Non-Employees, since the number of OC Units to be issued was dependent upon different possible outcomes, the Company recognized the lowest aggregate amount within the range of outcomes. Accordingly, the Company estimated the deferred termination fee payable and accrued the expense over the term of the Management Agreement. Upon entry into the Amended and Restated Management Agreement, the Company ceased recognizing the deferred termination fee expense and reclassified the Non-Controlling Interests to Additional Paid-In-Capital since the Termination Fee is no longer certain of being paid other than in exchange for either the assets or equity of the Manager. Accordingly, the Company recorded no expense and $0.2 million of expense for the deferred termination fee for the three months ended September 30, 2016 and 2015, respectively, and $0.2 million and $0.3 million of expense for the deferred termination fee for the nine months ended September 30, 2016 and 2015, respectively.

 

The initial term of the Management Agreement will be five years, with up to a maximum of three, one-year extensions that end on the applicable anniversary of the completion of the Company’s offering. The Company’s independent directors will review the Manager’s performance annually. Following the initial term, the Management Agreement may be terminated annually upon the affirmative vote of at least two-thirds of the Company’s independent directors based upon: (a) the Manager’s unsatisfactory performance that is materially detrimental to the Company; or (b) the Company’s determination that the management fees payable to the Manager are not fair, subject to the Manager’s right to prevent termination based on unfair fees by accepting a reduction of management fees agreed to by at least two-thirds of the independent directors. The Company will provide its Manager with 180 days’ prior notice of such a termination. Upon such a termination, the Company will pay the Manager a Termination Fee except as provided below.

 

No later than 180 days prior to the end of the initial term of the Management Agreement, the Manager will offer to contribute to the Company’s Operating Company at the end of the initial term all of the assets or equity interests in the Manager at the internalization price and on such terms and conditions included in a written offer provided by the Manager.

 

Upon receipt of the Manager’s initial internalization offer, a special committee consisting solely of the Company’s independent directors may accept the Manager’s proposal or submit a counter offer to the Manager. If the Manager and the special committee are unable to agree, the Manager and the special committee will repeat this process annually during the term of any extension of the Management Agreement. Acquisition of the Manager pursuant to this process requires a fairness opinion from a nationally recognized investment banking firm and stockholder approval, in addition to approval by the special committee. As described above, if an Internalization Transaction has not occurred prior to March 31, 2023, the last day of the last renewal term, then the Manager and the Company shall consummate an Internalization Transaction to be effective as of that date, and such Internalization Transaction shall not require a fairness opinion, the approval of a special committee of the Company’s Board of Directors or the approval of the Company’s stockholders.

 

If the Management Agreement terminates other than for Cause, voluntary non-renewal by the Manager or the Company being required to register as an investment company under the Investment Company Act of 1940, then the Company shall pay to the Manager, on the date on which such termination is effective, a Termination Fee equal to the greater of (i) three times the sum of the average annual Base Management Fee and Incentive Fee earned by the Manager during the 24-month period prior to such termination, calculated as of the end of the most recently completed fiscal quarter prior to the date of termination, or (ii) the offer price, which will be based on the lesser of (a) the Manager’s earnings before interest, taxes, depreciation and amortization (adjusted for unusual, extraordinary and non-recurring charges and expenses), or “EBITDA” annualized based on the most recent quarter ended, multiplied by a specific multiple, or EBITDA Multiple, depending on the Company’s achieved total annual return, and (b) the Company’s equity market capitalization multiplied by a specific percentage, or Capitalization Percentage, depending on the Company’s achieved total return (the Internalization Price). Any Termination Fee will be payable by the Operating Company in cash.

 

The Company also may terminate the Amended and Restated Management Agreement at any time, including during the initial term, without the payment of any Termination Fee, with 30 days’ prior written notice from the Board of Directors, for cause. “Cause” is defined as: (i) the Manager’s continued breach of any material provision of the Amended and Restated Management Agreement following a prescribed period; (ii) the occurrence of certain events with respect to the bankruptcy or insolvency of the Manager; (iii) a change of control of the Manager that a majority of the Company’s independent directors determines is materially detrimental to the Company; (iv) the Manager committing fraud against the Company, misappropriating or embezzling the Company’s funds, or acting grossly negligent in the performance of its duties under the Amended and Restated Management Agreement; (v) the dissolution of the Manager; (vi) the Manager fails to provide adequate or appropriate personnel that are reasonably necessary for the Manager to identify investment opportunities for the Company and to manage and develop the Company’s investment portfolio if such default continues uncured for a period of 60 days after written notice thereof, which notice must contain a request that the same be remedied; (vii) the Manager is convicted (including a plea of nolo contendere) of a felony; or (viii) both the current Chief Executive Officer and the current President and Chief Operating Officer are no longer senior executive officers of the Manager or the Company during the term of the Amended and Restated Management Agreement other than by reason of death or disability.

 

 

The Manager may terminate the Amended and Restated Management Agreement if the Company becomes required to register as an investment company under the 1940 Act, with such termination deemed to occur immediately before such event, in which case the Company would not be required to pay the Manager a Termination Fee. The Manager may also decline to renew the Amended and Restated Management Agreement by providing the Company with 180 days’ written notice, in which case the Company would not be required to pay a Termination Fee.

 

The Amended and Restated Management Agreement provides for the Manager to earn a base management fee and an incentive fee. In addition, the Company will reimburse certain expenses of the Manager, excluding the salaries and cash bonuses of the Manager’s chief executive officer and chief financial officer, a portion of the salary of the president and chief operating officer, and certain other costs as determined by the Manager in accordance with the Amended and Restated Management Agreement. Certain prepaid expenses and fixed assets are also purchased through the Manager and reimbursed by the Company. In the event that the Company terminates the Amended and Restated Management Agreement per the terms of the agreement, other than for cause or the Company being required to register as an investment company, there will be a Termination Fee due to the Manager. Amounts reimbursable to the Manager for expenses are included in general and administrative expenses in the Consolidated Statements of Operations and totaled $0.8 million for both the three months ended September 30, 2016 and 2015, and $2.4 million and $1.3 million for the nine months ended September 30, 2016 and 2015, respectively.

 

Management Fees

 

As of September 30, 2016, the Company did not have any personnel. As a result, the Company is relying on the properties, resources and personnel of the Manager to conduct operations. The Company has agreed to pay the Manager a base management fee in an amount equal to 0.375% of the Company’s stockholders’ equity (a 1.5% annual rate) calculated and payable quarterly in arrears in cash. For purposes of calculating the base management fee, the Company’s stockholder’s equity means: (a) the sum of (i) the net proceeds from all issuances of the Company’s equity securities since inception (allocated on a pro rata daily basis for such issuances during the fiscal quarter of any such issuance), plus (ii) the Company’s retained earnings at the end of the most recently completed fiscal quarter (without taking into account any non-cash equity compensation expense incurred in current or prior periods); less (b) any amount that the Company pays to repurchase the Company’s common stock since inception, provided that if the Company’s retained earnings are in a net deficit position (following any required adjustments set forth below), then retained earnings shall not be included in stockholders’ equity. It also excludes (x) any unrealized gains and losses and other non-cash items that have impacted stockholders’ equity as reported in the Company’s financial statements prepared in accordance with accounting principles generally accepted in the United States, or GAAP, and (y) one-time events pursuant to changes in GAAP (such as a cumulative change to the Company’s operating results as a result of a codification change pursuant to GAAP), and certain non-cash items not otherwise described above (such as depreciation and amortization), in each case after discussions between the Company’s Manager and the Company’s independent directors and approval by a majority of the Company’s independent directors. As a result, the Company’s stockholders’ equity, for purposes of calculating the base management fee, could be greater or less than the amount of stockholders’ equity shown on the Company’s financial statements. The base management fee is payable independent of the performance of the Company’s portfolio. The Manager computes the base management fee within 30 days after the end of the fiscal quarter with respect to which such installment is payable and promptly delivers such calculation to the Company’s Board of Directors. The amount of the installment shown in the calculation is due and payable no later than the date which is five business days after the date of delivery of such computation to the Board of Directors. The calculation generally will be reviewed by the Board of Directors at their regularly scheduled quarterly board meeting. The base management fee was $0.4 million for the three months ended September 30, 2016 and 2015, respectively, and $1.2 million and $0.8 million for the nine months ended September 30, 2016 and 2015, respectively. At September 30, 2016 and December 31, 2015, the Company had outstanding Due to Manager of $0.6 million and $0.7 million, respectively, consisting of the management fees payable and certain general and administrative fees payable.

 

Incentive Fee

 

The Manager is entitled to an incentive fee with respect to each fiscal quarter (or part thereof that the Amended and Restated Management Agreement is in effect) in arrears in cash. The incentive fee will be an amount, not less than zero, determined pursuant to the following formula:

 

IF = .20 times (A minus (B times .08)) minus C

 

In the foregoing formula:

 

· A equals the Company’s Core Earnings (as defined below) for the previous 12-month period;

 

· B equals (i) the weighted average of the issue price per share of the Company’s common stock of all of its public offerings of common stock, multiplied by (ii) the weighted average number of all shares of common stock outstanding (including (i) any restricted stock units and any restricted shares of common stock in the previous 12-month period and (ii) shares of common stock issuable upon conversion of outstanding OC Units); and

 

· C equals the sum of any incentive fees earned by the Manager with respect to the first three fiscal quarters of such previous 12-month period.

 

 

Notwithstanding application of the incentive fee formula, no incentive fee shall be paid with respect to any fiscal quarter unless cumulative annual stockholder total return for the four most recently completed fiscal quarters is greater than 8%. Any computed incentive fee earned but not paid because of the foregoing hurdle will accrue until such 8% cumulative annual stockholder total return is achieved. The total return is calculated by adding stock price appreciation (based on the volume-weighted average of the closing price of the Company’s common stock on the NYSE (or other applicable trading market) for the last ten consecutive trading days of the applicable computation period minus the volume-weighted average of the closing market price of the Company’s common stock for the last ten consecutive trading days of the period immediately preceding the applicable computation period) plus dividends per share paid during such computation period, divided by the volume-weighted average of the closing market price of the Company’s common stock for the last ten consecutive trading days of the period immediately preceding the applicable computation period. For purposes of computing the Incentive Fee, “Core Earnings” is defined as net income (loss) determined under GAAP, plus non-cash equity compensation expense, the incentive fee, depreciation and amortization (to the extent that the Company forecloses on any facilities underlying the Company’s target investments), any unrealized losses or other non-cash expense items reflected in GAAP net income (loss), less any unrealized gains reflected in GAAP net income. The amount will be adjusted to exclude one-time events pursuant to changes in GAAP and certain other non-cash charges after discussions between the Manager and the Company’s independent directors and after approval by a majority of the independent directors.

  

The Manager computes each quarterly installment of the incentive fee within 45 days after the end of the fiscal quarter with respect to which such installment is payable and promptly delivers such calculation to the Company’s Board of Directors. The amount of the installment shown in the calculation is due and payable no later than the date which is five business days after the date of delivery of such computation to the Board of Directors. The calculation generally will be reviewed by the Board of Directors at their regularly scheduled quarterly board meeting. The Manager has not earned an incentive fee for the three and nine months ended September 30, 2016 and 2015.

 

12. RESTRUCTURING COSTS

 

On August 11, 2015, the Company’s Board of Directors approved consolidating its offices and moving the corporate headquarters to Memphis, Tennessee. In connection with the consolidation and moving of the Company’s headquarters, the Company added legal, accounting, loan administration and business development personnel in Memphis and closed its offices in Miami, Florida and Cleveland, Ohio. The consolidation was completed by the end of the third quarter of 2015.

 

Restructuring costs reflected in the accompanying Consolidated Statements of Operations relate primarily to one-time termination benefits and lease termination costs. The Company recognizes these severance and other charges when the requirements of ASC 420 have been met regarding a plan of termination and when communication has been made to employees. The Company incurred no restructuring costs in the three months ended September 30, 2016 and $54.0 thousand in restructuring costs in the nine months ended September 30, 2016. The Company incurred $0.2 million in restructuring costs during the three and nine month periods ended September 30, 2015.

 

		Three Months Ended September 30, 2016
Cost Type		Restructuring costs liability at June 30, 2016				Restructuring costs incurred				Cash payments				Non-cash activity				Restructuring costs liability at September 30, 2016				Total cumulative restructuring costs incurred or expected to be incurred
Severance		$	-			$	-			$	-			$	-			$	-			$	97
Fixed asset disposal			-				-				-				-				-				33
Lease termination			102				-				(13	)			-				89				187
Other			-				-				-				-				-				13
Total restructuring costs		$	102			$	-			$	(13	)		$	-			$	89			$	330

 

 

		Nine Months Ended September 30, 2016
Cost Type		Restructuring costs liability at December 31, 2015				Restructuring costs incurred				Cash payments				Non-cash activity				Restructuring costs liability at September 30, 2016				Total cumulative restructuring costs incurred or expected to be incurred
Severance		$	-			$	-			$	-			$	-			$	-			$	97
Fixed asset disposal			-				-				-				-				-				33
Lease termination			85				64				(60	)			-				89				187
Other			10				-				-				(10	)			-				13
Total restructuring costs		$	95			$	64			$	(60	)		$	(10	)		$	89			$	330

 

13. SUBSEQUENT EVENTS

 

The Company’s management has evaluated subsequent events through the date of issuance of the consolidated financial statements included herein. Other than those disclosed below, there have been no subsequent events that occurred during such period that require disclosure or recognition in the accompanying consolidated financial statements.

 

Series A Preferred Stock

 

On October 4, 2016, the Company issued 10,000 restricted shares of the Series A Preferred Stock to the Buyers and received $10.0 million in proceeds pursuant to the terms of the Purchase Agreement.

 

Senior Participations

 

On October 11, 2016, the Company received $0.7 million of additional funds from existing senior participations in the construction loans on four of its development property investments with a profits interest.

 

On October 18, 2016, the Company sold to a local Memphis, Tennessee-based community bank a senior participation in the construction loan of one of the Company’s development property investments with a profits interest in Charlotte, North Carolina. The construction loan has a committed principal balance of approximately $6.8 million and earns interest at a rate of 6.9% per annum. Construction has been completed and a certificate of occupancy has been issued for this property. At closing, the bank paid to the Company approximately $3.4 million for the senior participation in the construction loan and will fund up to a total of $4.4 million as future draws are made on the construction loan. The Company will pay interest to the bank on its senior participation at the annual rate of 30-day LIBOR plus 3.50%, which translates to a current rate of approximately 4.02%.

 

Dividend Declaration

 

On November 3, 2016, the Company announced that its Board of Directors declared a cash dividend of $0.35 per share of common stock for the quarter ending December 31, 2016. The dividend is payable on January 13, 2017 to stockholders of record on January 3, 2017.

 

 

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

 

Note Regarding Forward-Looking Statements

 

We make statements in this Quarterly Report on Form 10-Q that are forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (set forth in Section 27A 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”)). These forward-looking statements include, without limitation, statements about our estimates, expectations, predictions and forecasts of our future business plans and financial and operating performance and/or results, as well as statements of management’s goals and objectives and other similar expressions concerning matters that are not historical facts. When we use the words “may,” “should,” “could,” “would,” “predicts,” “potential,” “continue,” “expects,” “anticipates,” “future,” “intends,” “plans,” “believes,” “estimates” or similar expressions or their negatives, as well as statements in future tense, we intend to identify forward-looking statements. Although we believe that the expectations reflected in such forward-looking statements are based upon reasonable assumptions, beliefs and expectations, such forward-looking statements are not predictions of future events or guarantees of future performance and our actual financial and operating results could differ materially from those set forth in the forward-looking statements. Some factors that might cause such differences are described in the section entitled “Risk Factors” in this report and in the Annual Report on Form 10-K for the year ended December 31, 2015 (the “2015 Form 10-K”), which was filed with the Securities and Exchange Commission (“SEC”) on April 5, 2016, which factors include, without limitation, the following:

 

	·	our ability to successfully source, structure, negotiate and close investments in self-storage facilities
	·	changes in our business strategy and the market’s acceptance of our investment terms
	·	our ability to fund our outstanding and future loan commitments
	·	availability, terms and our rate of deployment of equity and debt capital
	·	our manager’s ability to hire and retain qualified personnel
	·	changes in the self-storage industry, interest rates or the general economy
	·	the degree and nature of our competition
	·	volatility in the value of our assets carried at fair market value
	·	general volatility of the capital markets and the market price of our common stock.

 

Given these uncertainties, undue reliance should not be placed on our forward-looking statements. We assume no duty or responsibility to publicly update or revise any forward-looking statement that may be made to reflect future events or circumstances or to reflect the occurrence of unanticipated events. We urge you to review the disclosures concerning risks in the sections entitled “Risk Factors,” “Forward-Looking Statements,” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the 2015 Form 10-K.

 

Overview

 

We are a commercial real estate company incorporated in Maryland that provides capital to private developers, owners and operators of self-storage facilities. Our principal business objective is to deliver attractive long-term risk-adjusted returns to our stockholders by investing primarily in newly-constructed self-storage facilities, which we refer to as development property investments. We expect to generate attractive long-term returns on development property investments through interest payments (typically at a fixed rate) on our invested capital together with a 49.9% interest in the positive cash flows from operations, sales and/or refinancings of the self-storage facility, which we refer to herein as “Profits Interests.” We also generate cash flows from construction loans and operating property loans in the form of interest payments, origination fees, and occasional prepayment fees. In addition, in connection with many of our development property investments, we obtain a right of first refusal to acquire the subject property. In the future, we expect to acquire self-storage properties by exercising our rights of first refusal.

 

We account for our development property investments and operating property loans at fair value. Under fair value accounting, each of our development property investments and operating property loans is re-valued each quarter, and any unrealized appreciation and depreciation from those financial instruments is reflected in the carrying values of those investments in our Consolidated Balance Sheets and in our Consolidated Statements of Operations. We believe reflecting our investments at fair value provides our stockholders and others who rely on our financial statements with a more complete and accurate understanding of our economic performance, including our revenues and the intrinsic value inherent in our Profits Interests as newly-developed self-storage facilities we finance are occupied, leased-up and become stabilized.

 

As of September 30, 2016, we had 21 investments, for an aggregate committed principal amount of $141.2 million, including 12 development property investments totaling approximately $89.4 million of aggregate committed principal amount, each of which provides us with a Profits Interest, four construction loans totaling approximately $36.8 million of aggregate committed principal amount and five operating property loans totaling approximately $15.0 million of aggregate committed principal amount. Each of the development property investments is in a primary or secondary market with demographics that management believes will support successful lease-up and value creation in the property. Each construction loan has an 18-month term, and each self-storage facility for which we have provided construction financing is subject to a binding purchase and sale agreement between the developer and a third-party purchaser to be completed shortly after a certificate of occupancy is issued with respect to the subject property at a contract price sufficient to repay our construction loan. As of September 30, 2016, we had funded approximately $86.2 million of the aggregate committed principal amount of our closed investments. We have funded all of our investments to date with the net proceeds from our initial public offering of common stock (“IPO”) and concurrent private placement, which were consummated on April 1, 2015, and proceeds from the sale of senior participations, which we also refer to as “A notes”, in certain investments.

 

 

On March 7, 2016, we, through our Operating Company, entered into the Limited Liability Company Agreement (the “JV Agreement”) of Storage Lenders LLC, a Delaware limited liability company, to form a real estate venture (the “SL1 Venture”) with HVP III Storage Lenders Investor, LLC (“HVP III”), an investment vehicle managed by Heitman Capital Management LLC (“Heitman”). The SL1 Venture was formed for the purpose of providing capital to developers of self-storage facilities identified and underwritten by us. HVP III committed $110.0 million for a 90% interest in the SL1 Venture, and we committed $12.2 million for a 10% interest. On March 31, 2016, we contributed to the SL1 Venture three self-storage development investments in Miami and Fort Lauderdale, Florida that were not yet under construction. These investments had an aggregate committed principal amount of approximately $41.9 million and aggregate drawn balances of $8.1 million. In addition, as of September 30, 2016, the SL1 Venture had closed on seven new development property investments with a profits interest with an aggregate commitment amount of $72.5 million, bringing the total aggregate commitment of SL1 Venture’s investments to $114.4 million as of September 30, 2016. During the quarter ended September 30, 2016, HVP III and the Company agreed to true up the balances in the respective members’ capital accounts to be in accordance with the 90% commitment and 10% commitment made by HVP III and the Company, respectively. Accordingly, during the three months ended September 30, 2016, HVP III contributed cash of $7.3 million to the SL1 Venture, and the Company received a $7.3 million cash distribution as a return of its capital.

  

Under the JV Agreement, we will receive a priority distribution (after debt service and any reserve but before any other distributions) out of operating cash flow and residual distributions based upon 1% of the committed principal amount of loans made by the SL1 Venture, exclusive of the loans contributed to the SL1 Venture by us. Operating cash flow of the SL1 Venture (after debt service, reserves and the foregoing priority distributions) will be distributed in accordance with capital commitments. Residual cash flow from capital and other events (after debt service, reserves and priority distributions) will be distributed (i) pro rata in accordance with capital commitments (its “Percentage Interest”) until each member has received a return of all capital contributed; (ii) pro rata in accordance with each member’s Percentage Interest until Heitman has achieved a 14% internal rate of return; (iii) to Heitman in an amount equal to its Percentage Interest less 10% and to us in an amount equal to our Percentage Interest plus 10% until Heitman has achieved a 17% internal rate of return; (iv) to Heitman in an amount equal to its Percentage Interest less 20% and to us in an amount equal to our Percentage Interest plus 20% until Heitman has achieved a 20% internal rate of return; and (v) any excess to Heitman in an amount equal to its Percentage Interest less 30% and to us in an amount equal to our Percentage Interest plus 30%. However, we will not be entitled to any such promoted interest prior to the earlier to occur of the third anniversary of the JV Agreement and Heitman receiving distributions to the extent necessary to provide Heitman with a 1.48 multiple on its contributed capital. See Note 5 of the accompanying interim consolidated financial statements.

 

The Company is externally managed and advised by JCAP Advisors, LLC (the “Manager”). The Manager is led by our founder and chief executive officer, Dean Jernigan, and our president and chief operating officer, John A. Good. Mr. Jernigan is a 30-year veteran of the self-storage industry, including a combined 16 years as the chief executive officer of Storage USA and CubeSmart, both New York Stock Exchange listed self-storage REITs. During his time at these two companies, Mr. Jernigan oversaw the investment of over $3 billion of capital in the self-storage industry. Mr. Good has over 28 years working with senior management teams and boards of directors of public companies in the REIT and financial services industries on corporate finance, corporate governance, merger and acquisition, tax, executive compensation, joint venture, and strategic planning projects as a nationally recognized corporate and securities lawyer. Prior to joining the Company, he served as lead counsel on over 200 securities offerings, including our IPO, raising in excess of $25 billion over the past 25 years, with more than 125 of those deals being in the REIT industry. We believe the industry experience and depth of relationships of our senior management team and other investment professionals provide us with a significant competitive advantage in sourcing, evaluating, underwriting and servicing self-storage investments.

 

We are a Maryland corporation that has elected to be taxed as a REIT under the Internal Revenue Code of 1986 (the “Code”). As a REIT, we generally will not be subject to U.S. federal income taxes on our taxable income, determined without regard to the deduction for dividends paid and excluding any net capital gains, to the extent that we annually distribute all of our REIT taxable income to stockholders and comply with certain other requirements for qualification as a REIT set forth in the Code. We are structured as an UPREIT and conduct our investment activities through our Operating Company. We also intend to operate our business in a manner that will permit us to maintain our exemption from registration under the Investment Company Act of 1940.

 

 

Factors Impacting Our Operating Results

 

The results of our operations are affected by a number of factors and primarily depend on, among other things, the pace with which we are able to deploy capital into development property investments, the level of our total investment income, changes in the fair value of our assets and the performance of self-storage facilities in which we have invested, either directly or through the SL1 Venture. Our total investment income includes interest income from investments, which also reflects the accretion of origination fees, and is recognized based on the contractual rate and the outstanding principal balance of the loans we originate. The objective of the interest method is to arrive at periodic interest income that yields a level rate of return over the loan term. Interest rates may vary according to the type of loan, conditions in the financial markets, credit worthiness of our borrowers, competition and other factors, none of which can be predicted with any certainty. Our operating results may also be impacted by credit losses in excess of initial anticipations or unanticipated credit events experienced by borrowers. Our income also includes earnings from our investment in the SL1 Venture, which is calculated based on the allocation of earnings as prescribed in the JV Agreement. In addition, our operating results are affected by the valuation of our development property investments and our operating property loans. These investments are marked to fair value each quarter, and increases and decreases in fair value are reflected in the carrying values of the investments in our Consolidated Balance Sheets and as unrealized increases/decreases in fair value in our Consolidated Statements of Operations. In the future we may make additional equity investments in self-storage facilities, either for fee simple ownership by our Operating Company or in joint ventures with institutional or other strategic partners. In the event we own self-storage facilities in the future, our operating results also will include rental income and related operating expenses from such self-storage facilities. In that regard, in connection with many of our development investments, we have obtained rights of first refusal in connection with potential future sales of self-storage facilities that we finance. Our results for the three and nine months ended September 30, 2016 also were impacted by our accounting methods as discussed below.

 

Changes in Fair Value of Our Assets

 

The Company has elected the fair value option of accounting for our investment portfolio. We have elected fair value accounting for these financial instruments because we believe such accounting provides stockholders and others who rely on our financial statements with a more complete and accurate understanding of our economic performance, including our revenues and the intrinsic value inherent in the Profits Interests we possess. Under the fair value option, we mark our development property investments and operating property loans to estimated fair value at the end of each accounting period, with corresponding increases or decreases in fair value being reflected in our Consolidated Statements of Operations. There is no active secondary market for our development property investments and operating property loans and no readily available market value; accordingly, our determination of fair value requires judgment and extensive use of estimates. Due to the inherent uncertainty of determining the fair value of investments that do not have a readily available market value, the fair value of our development property investments and operating property loans may fluctuate from period to period. Additionally, the fair value of our development property investments and operating property loans may differ significantly from the values that would have been used had a ready market existed for such investments and may differ materially from the values that we may ultimately realize. Our development property investments and operating property loans are generally subject to legal and other restrictions on resale or otherwise are less liquid than publicly traded securities. If we were required to liquidate an investment in a forced or liquidation sale, we could realize significantly less than the value at which we have recorded it. In addition, changes in the market environment and other events that may occur over the life of the investments may cause the gains or losses ultimately realized on these investments to be different than the unrealized gains or losses reflected in the valuations currently assigned.

 

Changes in Market Interest Rates

 

With respect to our business operations, increases in interest rates, in general, may over time cause: the interest expense associated with our borrowings to increase; the value of our loan portfolio to decline; interest rates on any floating rate loans to reset, although on a delayed basis, to higher interest rates; and to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to increase. Conversely, decreases in interest rates, in general, may over time cause: the interest expense associated with our borrowings to decrease; the value of our mortgage loan portfolio to increase; interest rates on any floating rate loans to reset, although on a delayed basis, to lower interest rates; and to the extent we enter into interest rate swap agreements as part of our hedging strategy, the value of these agreements to decrease.

 

Credit Risk

 

We are subject to varying degrees of credit risk in connection with our target investments. Our Manager seeks to mitigate this risk by seeking to originate or acquire loans of higher quality at appropriate prices given anticipated and unanticipated losses, by utilizing a comprehensive selection, underwriting and due diligence review process, and by proactively monitoring originated or acquired loans. Nevertheless, unanticipated credit losses could occur that could adversely impact our operating results.

 

Market Conditions

 

We believe that present market conditions are favorable for realizing attractive risk-adjusted returns on investments in self-storage facilities owned by private operators. While construction in the self-storage sector remains low compared to historical averages, the sector has experienced increased construction starts recently and the trend is expected to continue upwards. In addition, the number of purchase and sale transactions has been increasing, fueled by investor appetite for self-storage’s cash flow performance. The key demand drivers of the self-storage sector include population mobility and new job creation, both of which are experiencing increases since the recession. These drivers have created demand for self-storage, which in turn have developers looking to develop and match demand with supply. The main deterrent for developers is the lack of financing available in the sector. Currently, lenders are only willing to lend up to 70% LTV, whereas our substantial industry knowledge enables us to make loans at ratios of 90% LTC and LTV.

 

 

Recent Developments

 

Third Quarter Dividend Declaration and Payment

 

On September 2, 2016, the Company announced that our Board of Directors declared a cash dividend of $0.35 per share of common stock for the quarter ending September 30, 2016. The dividend was paid on October 14, 2016 to stockholders of record on October 1, 2016.

 

Fourth Quarter Dividend Declaration

 

On November 3, 2016, the Company announced that our Board of Directors declared a cash dividend of $0.35 per share of common stock for the quarter ending December 31, 2016. The dividend is payable on January 13, 2017 to stockholders of record on January 3, 2017.

 

Senior Participations

 

On October 11, 2016, the Company received $0.7 million of additional funds from existing senior participations in the construction loans on four of our development property investments with a profits interest.

 

On October 18, 2016, we sold to a local Memphis, Tennessee-based community bank a senior participation in the construction loan of one of our development property investments with a profits interest in Charlotte, North Carolina. The construction loan has a committed principal balance of approximately $6.8 million and earns interest at a rate of 6.9% per annum. Construction has been completed and a certificate of occupancy has been issued for this property. At closing, the bank paid to the Company approximately $3.4 million for the senior participation in the construction loan and will fund up to a total of $4.4 million as future draws are made on the construction loan. We will pay interest to the bank on our senior participation at the annual rate of 30-day LIBOR plus 3.50%, which translates to a current rate of approximately 4.02%. See Note 13 of the accompanying interim consolidated financial statements.

 

Series A Preferred Stock Private Placement

 

On July 27, 2016 (the “Effective Date”), we entered into a Stock Purchase Agreement (the “Purchase Agreement”) with accounts managed by NexPoint Advisors, L.P., an affiliate of Highland Capital Management, L.P. (collectively, the “Buyers”) relating to the issuance and sale, from time to time until the second anniversary of the Effective Date (such period, the “Commitment Period”), of up to $100 million in shares of our newly designated Series A Preferred Stock, par value $0.01 per share (the “Series A Preferred Stock”), at a price of $1,000 per share (the “Liquidation Value”) (subject to a minimum amount of $50 million of Series A Preferred Stock to be issued and sold by the Company on or prior to the expiration of the Commitment Period), which may be increased at our request up to $125 million. The sale of shares of Series A Preferred Stock pursuant to the Purchase Agreement may occur from time to time, in minimum monthly increments of $5 million, maximum monthly increments of $15 million and maximum increments of $35 million over any rolling three month period, all to be completed during the Commitment Period. We did not issue Series A Preferred Stock during the quarter ended September 30, 2016. See Note 9 of the accompanying interim consolidated financial statements.

 

On October 4, 2016, we issued 10,000 restricted shares of Series A Preferred Stock to the Buyers and received $10.0 million in proceeds pursuant to the terms of the Purchase Agreement.

 

Investment Activity

 

Our self-storage investments at September 30, 2016 consisted of the following:

 

·

Development Property Investments - We had 12 investments totaling an aggregate committed principal amount of approximately $89.4 million to finance the ground-up construction of, or conversion of existing buildings into, self-storage facilities. Each development property investment is funded over time as the developer constructs the project. Each development property investment is typically comprised of a first mortgage loan, a mezzanine loan, and a 49.9% interest in the positive cash flows (including the sale and refinancing proceeds after debt repayment) of the project. The loans are secured by the first mortgages on the projects and first priority security interests in the membership interests of the owners of the projects. Loans comprising development property investments are non-recourse with customary carve-outs and subject to completion guaranties, are interest-only with a fixed interest rate of 6.9% per annum and have a term of 72 months.

 

We also had four construction loan investments totaling an aggregate committed principal amount of approximately $36.8 million, each of which has a term of 18 months. Each construction loan is interest-only at a fixed interest rate of 6.9% per annum, has no equity participation and is secured by a first priority mortgage or deed of trust on the project. Each of these construction loans is subject to a purchase and sale agreement between the developer and a third-party purchaser, containing certain conditions, pursuant to which the financed project is anticipated to be sold and our loan repaid on or about the time a certificate of occupancy is issued for the financed self-storage facility.

 

·

Operating property loans - We had five term loans totaling $15.0 million of aggregate committed principal amount, the proceeds of which were used by borrowers to finance the acquisition of, refinance existing indebtedness on, or recapitalize operating self-storage facilities. These loans are secured by first mortgages on the projects financed, are interest-only with fixed interest rates ranging from 5.85% to 6.9% per annum, and generally have a term of 72 months.

 

 

Our development property investments and operating property loans are collectively referred to herein as our investment portfolio.

 

As of September 30, 2016, the aggregate committed principal amount of our investment portfolio is approximately $141.2 million and outstanding principal is $86.2 million, as described in more detail in the table below (dollars in thousands): 

 

Closing Date		Metropolitan Statistical Area ("MSA")		Total Investment Commitment				Funded Investment(1)				Remaining Unfunded Commitment				Fair Value
Development property investments:
Loan investments with a profits interest:
4/21/2015		Orlando (2)		$	5,372			$	5,233			$	139			$	7,316
6/10/2015		Atlanta 1 (2)			8,132				7,513				619				10,066
6/19/2015		Tampa (2)			5,369				5,246				123				6,144
6/26/2015		Atlanta 2 (2)			6,050				5,493				557				8,559
6/29/2015		Charlotte 1 (2)			7,624				6,040				1,584				8,575
7/2/2015		Milwaukee (3)			7,650				5,044				2,606				5,728
7/31/2015		New Haven (3)			6,930				4,316				2,614				4,865
8/10/2015		Pittsburgh (3)			5,266				2,985				2,281				3,115
8/14/2015		Raleigh			8,998				1,217				7,781				1,161
9/30/2015		Jacksonville (2)			6,445				5,024				1,421				6,438
10/27/2015		Austin (3)			8,658				2,660				5,998				2,827
9/20/2016		Charlotte 2			12,888				1,301				11,587				1,178
				$	89,382			$	52,072			$	37,310			$	65,972
Construction loans:
8/5/2015		West Palm Beach			7,500				5,841				1,659				5,821
8/5/2015		Sarasota			4,792				2,590				2,202				2,569
11/17/2015		Chicago			6,808				4,529				2,279				4,496
12/23/2015		Miami			17,733				6,395				11,338				6,128
				$	36,833			$	19,355			$	17,478			$	19,014
		Subtotal		$	126,215			$	71,427			$	54,788			$	84,986
Operating property loans:
6/19/2015		New Orleans			2,800				2,800				-				2,841
7/7/2015		Newark			3,480				3,480				-				3,565
10/30/2015		Nashville			1,210				1,210				-				1,240
11/24/2015		Nashville			4,968				4,863				105				4,955
12/22/2015		Chicago			2,502				2,422				80				2,489
		Subtotal		$	14,960			$	14,775			$	185			$	15,090
		Total investments		$	141,175			$	86,202			$	54,973			$	100,076

 

(1)

Represents principal balance of loan gross of origination fees

(2)

Facility had received certificate of occupancy as of September 30, 2016. See Note 4 of the accompanying interim consolidated financial statements for information regarding recognition of entrepreneurial profit.

(3)

Facility had achieved at least 40% construction completion as of September 30, 2016. See Note 4 of the accompanying interim consolidated financial statements for information regarding recognition of entrepreneurial profit.

 

 

As of September 30, 2016, SL1 Venture had ten development property investments with a profits interest as described in more detail in the table below (dollars in thousands):

 

Closing Date		Metropolitan Statistical Area ("MSA")		Total Investment Commitment				Funded Investment(1)				Remaining Unfunded Commitment				Fair Value
5/14/2015		Miami 1 (2)		$	13,867			$	4,490			$	9,377			$	4,462
5/14/2015		Miami 2 (2)			14,849				3,763				11,086				3,712
9/25/2015		Fort Lauderdale (2)			13,230				2,793				10,437				2,739
4/15/2016		Washington DC			17,269				6,168				11,101				6,127
4/29/2016		Atlanta 1			10,223				221				10,002				123
7/19/2016		Jacksonville			8,127				636				7,491				556
7/21/2016		New Jersey			7,828				510				7,318				435
8/15/2016		Atlanta 2			8,772				505				8,267				419
8/25/2016		Denver			11,032				1,533				9,499				1,430
9/28/2016		Columbia			9,199				1,070				8,129				980
		Total		$	114,396			$	21,689			$	92,707			$	20,983

 

(1)

Represents principal balance of loan gross of origination fees

(2)

These development property investments (having approximately $8.1 million of outstanding principal balances at contribution) were contributed to the SL1 Venture on March 31, 2016.

 

Business Outlook

 

As of September 30, 2016, we have funded our investments with proceeds from the IPO and concurrent private placement and sales of senior participations in certain of our investments. As of September 30, 2016, we had unrestricted cash of approximately $13.0 million and remaining unfunded commitments of $55.0 million related to our investment portfolio. Subsequent to September 30, 2016, we received $10.0 million of proceeds from the issuance of Series A Preferred Stock and $3.4 million from the Charlotte A Note Sale. From our unrestricted cash, proceeds from A note sales, proceeds from issuances of Series A Preferred Stock, and anticipated proceeds from other potential capital markets transactions, we believe that we will have sufficient capital to fund our operations for at least the next 12 months.

 

We continue to experience robust demand for our capital for the development of state-of-the-art Class A self-storage facilities in top U.S. markets. As of September 30, 2016, we had executed term sheets for investments in 13 separate self-storage development projects for an aggregate capital commitment of up to approximately $127.5 million. We anticipate that substantially all of the remaining capital in the SL1 Venture will be committed in 2016. Subsequent to September 30, 2016, we have received executed term sheets for an additional three projects, which term sheets could produce capital commitments of an additional $30.3 million. We can provide no assurance that any of the existing or future projects subject to term sheets will produce actual investment commitments or if all term sheets will meet all conditions necessary to consummate investment commitments, and we can provide no assurance that we will have adequate capital to close all such prospective commitments in the future.  

 

Throughout the current fiscal year, we have continued to fund development draws on the 11 development property investments to which we had committed an aggregate of approximately $76.5 million at December 31, 2015. As of September 30, 2016, six of those development properties had achieved certificates of occupancy, and we have realized a significant portion of the potential profit on these developments through our fair value adjustments. We currently expect certificates of occupancy to be issued on two of the remaining projects in the fourth quarter, on another two projects in the first quarter of 2017 and the final initial project in the fourth quarter of 2017. Since as many as 8 of the 11 initial development properties will have achieved certificates of occupancy during 2016, the amount of fair value adjustments for potential profit to be realized on those projects in 2017 and beyond is expected to be less than was recorded in 2016. Moreover, from January 1 through August 31, 2016, all development property investments were made through the SL1 Venture, of which we have a 10% interest, as well as potential residual interests upon our SL1 Venture partners achieving certain internal rates of return on their invested capital. Accordingly, we do not expect to record significant fair value adjustments during 2017 from the SL1 Venture. On the strength of our $125 million Series A Preferred Stock forward commitment from affiliates of Highland Capital Management, L.P., additional capital from senior participation sales and our anticipated ability to access public equity through our effective shelf registration statement, we resumed investing “on-balance sheet” in late September 2016 with a $12.9 million commitment to a project in Charlotte, North Carolina, which is not expected to be completed until the first quarter of 2018. We anticipate closing commitments for additional development property investments totaling between $60 million and $75 million during the fourth quarter 2016, and between $75 million and $90 million during the first quarter 2017. Most of these projects are not projected to commence construction until later in the first quarter or during the second quarter of 2017, so the amount of fair value adjustments for anticipated profits on these projects is expected to be limited in 2017 and is anticipated to accelerate in 2018.

 

 

During the nine months ended September 30, 2016, the underlying self-storage facilities of six of our development property investments with a profits interest each received certificates of occupancy and commenced operations. The following table reflects occupancy data as of November 6, 2016 for these six facilities:

 

Location		Date Opened		# Days Open				Occupancy
Riverview, Florida (Tampa)		April 11, 2016			210				64.4	%
Ocoee, Florida (Orlando)		May 1, 2016			190				63.4	%
Marietta, Georgia (Atlanta)		May 24, 2016			167				43.8	%
Alpharetta, Georgia (Atlanta)		May 25, 2016			166				31.0	%
Jacksonville, FL		August 12, 2016			87				34.0	%
Charlotte, NC		August 18,2016			81				11.1	%
Average					150				41.3	%

  

The occupancy rates noted above pertain to the aforementioned six properties only and are not indicative of future lease-up rates of other facilities that will commence operations.

 

Critical Accounting Policies

 

There have been no significant changes to our critical accounting policies as disclosed in the 2015 Form 10-K.

 

Recent Accounting Pronouncements

 

A discussion of recent accounting pronouncements affecting the Company is included in Note 2 of the accompanying interim consolidated financial statements.

 

Results of Operations

 

The following discussion of our results of operations should be read in conjunction with the interim consolidated financial statements and the accompanying notes thereto. 

 

Comparison of the three months ended September 30, 2016 and September 30, 2015:

 

(Dollars in thousands)		Three months ended
		September 30, 2016				September 30, 2015
Revenues:
Interest income from investments		$	1,698			$	578
Total investment income			1,698				578
Costs and expenses:
General and administrative expenses			1,463				1,213
Management fees to Manager			402				414
Transaction and other expenses			2				112
Restructuring costs			-				220
Deferred termination fee to Manager			-				158
Total costs and expenses			1,867				2,117
Operating loss			(169	)			(1,539	)
Other income (expense):
Equity in earnings from unconsolidated real estate venture			436				-
Change in fair value of investments			4,867				85
Interest expense			(148	)			-
Other interest income			8				47
Total other income			5,163				132
Net income (loss)		$	4,994			$	(1,407	)

 

Revenues

 

Total interest income from investments for the three months ended September 30, 2016 was $1.7 million, an increase of $1.1 million from the three months ended September 30, 2015, and consists of interest earned on the outstanding principal balances on our investment portfolio and other assets and accretion of origination fees. Interest rates on the majority of our investment portfolio and other assets are 6.9% per annum. The increase is primarily attributed to the increase in the outstanding principal balances of our investment portfolio and other assets.

 

 

Expenses

 

The following table provides a detail of total general and administrative expenses (dollars in thousands):

 

		Three months ended
		September 30, 2016				September 30, 2015
Compensation and benefits		$	944			$	539
Occupancy			114				79
Business development			96				206
Professional fees			128				382
Other			181				7
Total general and administrative expenses		$	1,463			$	1,213

 

Total general and administrative expenses

 

Total general and administrative expenses for the three months ended September 30, 2016 were $1.5 million, an increase of $250 thousand from the three months ended September 30, 2015. Compensation and benefits for the three months ended September 30, 2016 increased primarily due to the Company’s ramp-up in personnel late in the third quarter of 2015. Additionally, compensation and benefits included $341 thousand and $133 thousand of stock-based compensation expense for the three months ended September 30, 2016 and September 30, 2015, respectively.

 

Transaction and other expenses

 

For the three months ended September 30, 2016, the transaction and other expenses of $2 thousand primarily consist of advisory fees and other expenses incurred in connection with the Company’s various financing transactions. The $0.1 million of transaction and other expenses for the three months ended September 30, 2015 consist of legal fees incurred in connection with the structuring and closing of our self-storage investments.

 

Other operating expenses

 

The management fees of $0.4 million in each of the three months ended September 30, 2016 and September 30, 2015 relate to the fee earned by the Manager pursuant to the management agreement. The restructuring costs incurred during the three months ended September 30, 2015 relate to exit costs incurred by closing the Miami, Florida and Cleveland, Ohio offices in the third quarter of 2015. The deferred termination fees to our Manager of $0.2 million for the three months ended September 30, 2015 represent the accrual over the term of the management agreement of the deferred termination fee payable by our Operating Company in OC Units pursuant to the management agreement. On May 23, 2016, we amended the management agreement thus resulting in the cessation of this accrual.

 

Other income (expense)

 

For the three months ended September 30, 2016 and September 30, 2015, we recorded other income of $5.2 million and $0.1 million, respectively, which primarily relates to the change in fair value of investments. The change in fair value of investments increased due to changes in market yields and entrepreneurial profit adjustments. The $0.4 million of equity in earnings from unconsolidated real estate venture in the three months ended September 30, 2016 relates to our allocated earnings from the SL1 Venture. Interest expense for the three months ended September 30, 2016 was $148 thousand and relates to interest incurred on the Company’s senior A note participations.

 

Comparison of the nine months ended September 30, 2016 and September 30, 2015:

 

We commenced operations on April 1, 2015 upon closing our IPO. Prior to that time, we had no operations; however, the Company incurred a net loss of $0.1 million during the three months ended March 31, 2015 due to organization costs for which we reimbursed our Company’s founder in April 2015.

 

 

(Dollars in thousands)		Nine months ended September 30,
		2016				2015
Revenues:
Interest income from investments		$	4,374			$	735
Total investment income			4,374				735
Costs and expenses:
General and administrative expenses			4,102				2,000
Management fees to Manager			1,218				823
Transaction and other expenses			2,129				262
Restructuring costs			54				220
Deferred termination fee to Manager			239				308
Total costs and expenses			7,742				3,613
Operating loss			(3,368	)			(2,878	)
Other income (expense):
Equity in earnings from unconsolidated real estate venture			854				-
Change in fair value of investments			14,185				656
Interest expense			(186	)			-
Other interest income			43				110
Total other income			14,896				766
Net income (loss)		$	11,528			$	(2,112	)

 

Revenues

 

Total interest income from investments for the nine months ended September 30, 2016 was $4.4 million, an increase of $3.6 million from the nine months ended September 30, 2015 and consists of interest earned on the outstanding principal balances on our investment portfolio and other assets, accretion of origination fees, and prepayment fee income. Interest rates on the majority of our investment portfolio and other assets are 6.9% per annum. Approximately $0.2 million of the increase is attributed to the acceleration of $0.1 million of origination fee accretion and the recognition of $0.1 million of prepayment fee income received in conjunction with the repayment of an operating property loan during the nine months ended September 30, 2016. The remaining increase is primarily attributed to the increase in the outstanding principal balances of our investment portfolio and other assets.

 

Expenses

 

The following table provides a detail of total general and administrative expenses (dollars in thousands):

 

		Nine months ended September 30,
		2016				2015
Compensation and benefits		$	2,547			$	765
Occupancy			303				130
Business development			316				390
Professional fees			526				605
Other			410				110
Total general and administrative expenses		$	4,102			$	2,000

 

Total general and administrative expenses

 

Total general and administrative expenses for the nine months ended September 30, 2016 were $4.1 million, an increase of $2.1 million from the nine months ended September 30, 2015. The majority of the increase was attributed to the growth of the Company and its business activities, including an increase in headcount and stock-based compensation. Compensation and benefits included $828 thousand and $167 thousand of stock-based compensation for the nine months ended September 30, 2016 and 2015, respectively.

 

Transaction and other expenses

 

For the nine months ended September 30, 2016, the transaction and other expenses of $2.1 million primarily consisted of advisory fees and other expenses incurred in connection with the Company’s various financing transactions. The $0.3 million of transaction and other expenses for the nine months ended September 30, 2015 consisted of legal fees incurred by us in connection with the structuring and closing of our self-storage investments.

 

 

Other operating expenses

 

The management fees of $1.2 million and $0.8 million in the nine months ended September 30, 2016 and 2015, respectively, relate to the fee earned by the Manager pursuant to the management agreement. The restructuring costs incurred during each of the nine month periods ended September 30, 2016 and 2015 relate to exit costs incurred by closing the Miami, Florida and Cleveland, Ohio offices in the third quarter of 2015. The deferred termination fees to our Manager of $0.2 million and $0.3 million for the nine months ended September 30, 2016 and 2015, respectively, represent the accrual over the term of the management agreement of the deferred termination fee payable by our Operating Company in OC Units pursuant to the management agreement. On May 23, 2016, we amended the management agreement thus resulting in the cessation of this accrual.

 

Other income (expense)

 

For the nine months ended September 30, 2016 and 2015, we recorded other income of $14.9 million and $0.8 million, respectively, which primarily relates to the change in fair value of investments and our equity in earnings from the SL1 Venture. The change in fair value of investments increased due to changes in market yields and entrepreneurial profit adjustments. The $0.9 million of equity in earnings from unconsolidated real estate venture in the nine months ended September 30, 2016 relates to our allocated earnings from the SL1 Venture. Interest expense for the nine months ended September 30, 2016 was $186 thousand and relates to interest incurred on the Company’s senior A Note participations.

 

Adjusted Earnings

 

Adjusted Earnings is a measure that is not specifically defined by accounting principles generally accepted in the United States (“GAAP”) and is defined as net income (computed in accordance with GAAP) plus stock-based compensation expense, transaction and other expenses, deferred termination fee to manager, and restructuring costs.

 

Adjusted Earnings should not be considered as an alternative to net income or any other GAAP measurement of performance, as an indicator of operating performance or as an alternative to cash flow from operating, investing, and financing activities as a measure of liquidity. We believe that Adjusted Earnings is helpful to investors as a starting point in measuring our operational performance, because it excludes various non-cash items and other costs included in net income that do not relate to or are not indicative of our operating performance, which can make periodic and peer analyses of operating performance more difficult. The Company’s computation of Adjusted Earnings may not be comparable to other key performance indicators reported by other REITs or real estate companies.

 

The following tables are reconciliations of Adjusted Earnings (Loss) to net income (loss):

 

		Three months ended September 30,
		2016				2015
Net income (loss)		$	4,994			$	(1,407	)
Plus: stock-based compensation			341				133
Plus: transaction and other expenses			2				112
Plus: deferred termination fee to Manager			-				158
Plus: restructuring costs			-				220
Adjusted Earnings (Loss)		$	5,337			$	(784	)

 

		Nine months ended September 30,
		2016				2015
Net income (loss)		$	11,528			$	(2,112	)
Plus: stock-based compensation			828				167
Plus: transaction and other expenses			2,129				262
Plus: deferred termination fee to Manager			239				308
Plus: restructuring costs			54				220
Adjusted Earnings (Loss)		$	14,778			$	(1,155	)

 

Liquidity and Capital Resources

 

Liquidity is a measure of our ability to meet potential cash requirements, including commitments to fund our investment portfolio, repay borrowings, fund and maintain our assets and operations, make distributions to our stockholders and other general business needs. We will use significant cash to originate our target investments, make distributions to our stockholders and fund our operations.

 

 

Liquidity

 

As of September 30, 2016, the Company had unrestricted cash of $13.0 million. Subsequent to September 30, 2016, the Company has received $10.0 million of proceeds from the issuance of Series A Preferred Stock and $3.4 million from the Charlotte A Note Sale. Additionally, the Company has $115.0 million of shares of Series A Preferred Stock that may be issued from time to time, and the Company has an effective shelf registration statement on Form S-3 filed with the Securities and Exchange Commission for the issuance of up to $500 million of the Company’s or the Operating Company’s debt and equity securities. At September 30, 2016, we have unfunded commitments of $55.0 million related to our investment portfolio, and we expect to close the investments represented by the 16 executed term sheets with aggregate commitments of $157.8 million within the next 12 months. We also expect to close an unknown number of additional investments not currently subject to term sheets within the next 12 months. We intend to fund these investments and commitments with the sources described above and from the sales of additional senior participations on our investment portfolio, and we believe that we will have sufficient capital to fund our operations for at least the next 12 months.

 

Cash Flows

 

The following table sets forth changes in cash and cash equivalents:

 

		Nine months ended September 30,
		2016				2015
Net income (loss)		$	11,528			$	(2,112	)
Adjustments to reconcile net income (loss) to net cash used in operating activities			(17,194	)			445
Net cash used in operating activities			(5,666	)			(1,667	)
Net cash used in investing activities			(30,359	)			(37,606	)
Net cash provided by financing activities			5,175				108,252
Change in cash and cash equivalents		$	(30,850	)		$	68,979

 

Cash decreased $30.9 million during the nine months ended September 30, 2016 as compared to an increase in cash of $69.0 million during the nine months ended September 30, 2015. Net cash used in operating activities for the nine months ended September 30, 2016 and 2015 was $5.7 million and $1.7 million, respectively, reflecting an increase in cash used of $4.0 million. During the nine months ended September 30, 2016, this increase was primarily attributable to our increase in general and administrative expenses in the 2016 period as compared to the 2015 period, which was largely driven by our overall growth and increase in headcount. The primary components of cash used in operating activities during the nine months ended September 30, 2016 were net income of $11.5 million and an increase in other noncash adjustments to net income of approximately $1.3 million. These increases were offset by interest capitalized on outstanding loans of $2.6 million, change in fair value of investments of $14.2 million, equity in earnings from unconsolidated real estate venture of $0.8 million, accretion of origination fees of $0.5 million, and a net decrease of $0.4 million for changes in operating assets and liabilities.

 

Net cash used in investing activities for the nine months ended September 30, 2016 and 2015 was $30.4 million and $37.6 million, respectively. For the nine months ended September 30, 2016, the cash used for investing activities consisted primarily of $36.5 million to fund investments, $9.2 million to fund other loans, and $1.3 million to fund capital contributions to the SL1 Venture, offset by a $7.3 million return of capital from the SL1 Venture and $9.6 million from repayments of an operating property loan investment and other loan investments.

 

Net cash provided by financing activities for the nine months ended September 30, 2016 totaled $5.2 million and related to $6.4 million of dividends paid and $3.2 million of stock repurchases offset by $17.6 million of cash received in conjunction with the sale of senior loan participations on certain of our investments. For the nine months ended September 30, 2015, cash provided by financing activities totaled $108.3 million and related primarily to the proceeds from the issuance of our common stock of $120.0 million, less offering costs of $9.6 million.

 

Equity Capital Policies

 

Subject to applicable law, our board of directors has the authority, without further stockholder approval, to issue additional authorized common stock and preferred stock or otherwise raise capital, including through the issuance of senior securities, in any manner and on the terms and for the consideration it deems appropriate, including in exchange for property. Common stockholders will have no preemptive right to additional shares issued in any offering, and any offering may cause a dilution of your investment.

 

On July 27, 2016, we entered into the Purchase Agreement relating to the issuance and sale, from time to time until the termination of the Commitment Period, of up to $100 million in shares of our newly designated Series A Preferred Stock, subject to a minimum amount of $50 million of Series A Preferred Stock to be issued and sold by us on or prior to the expiration of the Commitment Period, which may be increased at our request up to $125 million. The sale of shares of Series A Preferred Stock pursuant to the Purchase Agreement may occur from time to time in $5 million minimum increments in one or more closings during the Commitment Period. The Series A Preferred Stock will rank senior to the shares of common stock, with respect to distribution rights and rights upon liquidation, winding up and dissolution of the Company, on parity with any class or series of our capital stock expressly designated as ranking on parity with the Series A Preferred Stock with respect to distribution rights and rights upon liquidation, winding up and dissolution of the Company, junior to any class or series of capital stock of the Company expressly designated as ranking senior to the Series A Preferred Stock with respect to distribution rights and rights upon liquidation, winding up and dissolution of the Company and junior in right of payment to our existing and future indebtedness.

 

 

Leverage Policies

 

As of September 30, 2016 we have funded our loan portfolio with the proceeds of the IPO and the concurrent private placement and the sale of senior participations on certain of our investments. In the future, we may utilize equity raised in follow-on offerings and/or borrowing against our target investments in accordance with our investment guidelines in order to increase the size of our loan portfolio and potential return to stockholders. Our investment guidelines state that our leverage will generally not exceed 50% of the total value of our loan portfolio. We may borrow up to 100% of the principal value of certain development property loans. Our actual leverage will depend on our mix of loans. Our charter and bylaws do not limit the amount of indebtedness we can incur, and our board of directors has discretion to deviate from or change our investment guidelines at any time. We will use corporate leverage for the sole purpose of financing our portfolio and not for the purpose of speculating on changes in interest rates. Our financing strategy focuses on the use of match-funded financing structures. This means that we will seek to match the maturities and/or repricing schedules of our financial obligations with those of our loan portfolio to minimize the risk that we will have to refinance our liabilities prior to the maturities of our loans and to reduce the impact of changing interest rates on earnings. We will disclose any material changes to our leverage policies in the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of the quarterly report on Form 10-Q or annual report on Form 10-K for the period in which the change is made, or in a Current Report on Form 8-K if required by the rules of the SEC or the board of directors deems it advisable, in its sole discretion.  

 

In connection with the Series A Preferred Stock Private Placement, we are required to maintain a ratio of debt to total tangible assets determined under U.S. generally accepted accounting principles of no more than 0.4:1, measured as of the last day of each fiscal quarter. See “–Recent Developments - Series A Preferred Stock Private Placement.” The Company was in compliance as of September 30, 2016.

 

Future Revisions in Policies and Strategies

 

The board of directors has the power to modify or waive our investment policies and strategies without the consent of our stockholders to the extent that the board of directors (including a majority of our independent directors) determines that a modification or waiver is in the best interest of our stockholders. Among other factors, developments in the market that either affect the policies and strategies mentioned herein or that change our assessment of the market may cause our board of directors to revise our policies and strategies.

 

Contractual Obligations and Commitments

 

The following table reflects our total contractual cash obligations as of September 30, 2016:

 

Contractual Obligations		2016				2017				2018				2019				2020 and thereafter				Total
Long-Term Debt Obligations (1)		$	-			$	-			$	-			$	17,550			$	-			$	17,550
Operating Lease Obligations			74				301				209				2				2				588
Total		$	74			$	301			$	209			$	17,552			$	2			$	18,138

 

(1)

Represents principal payments gross of discounts and debt issuance costs.

 

At September 30, 2016, we had $55.0 million of unfunded loan commitments related to our investment portfolio. These commitments are funded over the 18-24 months following the investment closing date as construction is completed. At September 30, 2016, we had $1.5 million of unfunded loan commitments related to our other assets. See “-Liquidity and Capital Resources - Liquidity.”

 

As of September 30, 2016, we had unrestricted cash of approximately $13.0 million.

 

Off-Balance Sheet Arrangements

 

At September 30, 2016 and December 31, 2015, we did not have any relationships, including those with unconsolidated entities or financial partnerships, for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources that are material to investors.

 

Our investment in real estate venture is recorded using the equity method as we do not have a controlling interest.

 

 

Dividends

 

For the quarter ended September 30, 2016, we declared a cash dividend to our stockholders of $0.35 per share, payable on October 14, 2016 to stockholders of record on October 1, 2016. We intend to make regular quarterly distributions to holders of our common stock. U.S. federal income tax law generally requires that a REIT annually distribute at least 90% of its REIT taxable income, without regard to the deduction for dividends paid and excluding net capital gains, and that it pay tax at regular corporate rates to the extent that it annually distributes less than 100% of its net taxable income. We intend to pay regular quarterly dividends to our stockholders in an amount equal to or greater than our net taxable income, if and to the extent authorized by our Board of Directors. Before we pay any dividend, whether for U.S. federal income tax purposes or otherwise, we must first meet both our operating requirements and debt service on any secured funding facilities, other lending facilities, repurchase agreements and other debt payable. If our cash available for distribution is less than our net taxable income, we could be required to reduce our dividends, sell assets or borrow funds to make cash distributions or we may make a portion of the required distribution in the form of a taxable stock distribution or distribution of debt securities.

 

Inflation

 

Virtually all of our assets and liabilities will be interest rate sensitive in nature. As a result, interest rates and other factors influence our performance far more so than does inflation. Changes in interest rates do not necessarily correlate with inflation rates or changes in inflation rates. Our financial statements are prepared in accordance with GAAP and our distributions will be determined by our board of directors consistent with our obligation to distribute to our stockholders at least 90% of our REIT taxable income on an annual basis in order to maintain our REIT qualification; in each case, our activities and balance sheet are measured with reference to historical cost and/or fair market value without considering inflation.  

 

 

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

We seek to manage our risks related to the credit quality of our assets, interest rates, liquidity, prepayment speeds and market value while, at the same time, seeking to provide an opportunity to stockholders to realize attractive risk-adjusted returns through ownership of our capital stock. While we do not seek to avoid risk completely, we believe the risk can be quantified from historical experience and seek to actively manage that risk, to earn sufficient compensation to justify taking those risks and to maintain capital levels consistent with the risks we undertake.

 

There have been no material changes in our credit risk, interest rate risk, interest rate mismatch risk, or real estate risks from what was disclosed in the 2015 Form 10-K.

 

Market Risk

 

Our development property investments and operating property loans generally will be reflected at their estimated fair value, with changes in fair market value recorded in our income. The estimated fair value of these investments fluctuates primarily due to changes in interest rates, capitalization rates, and other factors. Generally, in a rising interest rate environment, the estimated fair value of the fixed-rate securities would be expected to decrease; conversely, in a decreasing interest rate environment, the estimated fair value of the fixed-rate securities would be expected to increase. As market volatility increases or liquidity decreases, the fair value of our investments may be adversely impacted. If we are unable to readily obtain independent pricing to validate our estimated fair value of any loan investment in our portfolio, the fair value gains or losses recorded in income may be adversely affected.

 

The following fluctuations in the market yields/discount rates would have had the following impact on the fair value of our investments:

 

		Increase (decrease) in fair value of investments
Change in market yields/discount rates (in millions)		September 30, 2016				December 31, 2015
Up 25 basis points		$	(0.4	)		$	(0.5	)
Down 25 basis points, subject to a minimum yield/rate of 10 basis points			0.4				0.4

 

The following fluctuations in the capitalization rates would have had the following impact on the fair value of our investments:

 

		Increase (decrease) in fair value of investments
Change in capitalization rates (in millions)		September 30, 2016				December 31, 2015
Up 25 basis points		$	(1.7	)		$	(0.1	)
Down 25 basis points			1.8				0.1

 

ITEM 4. CONTROLS AND PROCEDURES

 

Evaluation of Disclosure Controls and Procedures

 

We conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this quarterly report on Form 10-Q. The controls evaluation was conducted under the supervision and with the participation of management, including our Chief Executive Officer, President and Chief Operating Officer, and Chief Financial Officer. Disclosure controls and procedures are controls and procedures designed to reasonably assure that information required to be disclosed in our reports filed under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), such as this quarterly report on Form 10-Q, is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures are also designed to reasonably assure that such information is accumulated and communicated to our management, including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

Based on the controls evaluation, our Chief Executive Officer and Chief Financial Officer have concluded that, as of the end of the period covered by this Quarterly Report on Form 10-Q, our disclosure controls and procedures were effective to provide reasonable assurance that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified by the SEC, and that material information related to our company and our consolidated subsidiaries is made known to management, including the Chief Executive Officer and Chief Financial Officer.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal controls over financial reporting during the quarter ended September 30, 2016 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.   

 

 

PART II. OTHER INFORMATION

 

ITEM 1. LEGAL PROCEEDINGS

 

From time to time, we may be involved in various claims and legal actions in the ordinary course of business. We are not currently involved in any legal proceedings.

 

ITEM 1A. RISK FACTORS

 

The discussion of our business and operations should be read together with the risk factors contained in Part I, Item 1A of our 2015 Form 10-K, which describes various risks and uncertainties to which we are or may be subject. These risks and uncertainties have the potential to affect our business, financial condition, results of operations, cash flows and prospects in a material adverse manner.

 

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS FROM REGISTERED SECURITIES

 

Unregistered Sales of Equity Securities

 

On October 4, 2016, we issued an aggregate of 10,000 restricted shares of Series A Preferred Stock to the Buyers pursuant to the terms of the Purchase Agreement. The issuance of the Series A Preferred Stock to the Buyers was effected in reliance upon an exemption from registration under the Securities Act of 1933 pursuant to Section 4(a)(2) of the Securities Act and Rule 506 of Regulation D thereunder.

 

Use of Proceeds from Registered Securities

 

On April 1, 2015, we completed the IPO, pursuant to which we sold 5,000,000 shares of our common stock at a price per share of $20 and generated gross proceeds of $100.0 million. On April 9, 2015, we sold an additional 750,000 shares of our common stock at a price per share of $20 to the underwriters of the initial public offering pursuant to the underwriters’ option to purchase additional shares. The aggregate net proceeds to us in the IPO, including the overallotment shares, after deducting the underwriting discount and commissions and expenses payable by us, were approximately $105.0 million. All of the shares were sold pursuant to our registration statement on Form S-11, as amended (File No. 333-203185), that was declared effective by the SEC on March 26, 2015. Raymond James & Associates, Inc. served as the book-running manager for the offering. Robert W. Baird & Co. Incorporated and Wunderlich Securities, Inc. served as co-managers.

 

As of September 30, 2016, the net proceeds from the IPO had been used as follows: (i) approximately $277,000 to reimburse Mr. Jernigan for amounts advanced or incurred in connection with the IPO and organization costs; (ii) approximately $10.7 million in dividends to shareholders, (iii) approximately $8.7 million to fund operations, and (iv) the remaining $85.3 million to fund loan transactions. As of September 30, 2016, no net proceeds from our IPO offering remained.

 

Repurchases of Common Stock

 

The following table provides information about repurchases of the Company’s common shares during the three months ended September 30, 2016:

 

		Total Number of Shares Purchased				Average Price Paid Per Share				Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs				Maximum Dollar Value that May Yet Be Purchased Under the Plans or Programs (1) (dollars in thousands)
July 1- July 31			-			$	-				-			$	6,848
August 1- August 31			-				-				-				6,848
September 1- September 30			-				-				-				6,848
Total			-			$	-				-			$	6,848

 

(1)

On May 23, 2016, we announced a program permitting us to repurchase a portion of our outstanding common stock not to exceed a dollar maximum of $10.0 million established by our Board of Directors.

  

 

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

 

None.

 

ITEM 4. MINE SAFETY DISCLOSURES

 

Not applicable.

 

ITEM 5. OTHER INFORMATION

 

Not applicable.

 

ITEM 6. EXHIBITS

 

The exhibits listed in the accompanying Exhibit Index, which is incorporated herein by reference, are filed or furnished as part of this Quarterly Report on Form 10-Q.

 

 

SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

		JERNIGAN CAPITAL, INC.
Date: November 8, 2016	By:	/s/ Dean Jernigan
		Dean Jernigan
		Chairman and Chief Executive Officer (Principal Executive Officer)
Date: November 8, 2016	By:	/s/ William C. Drummond
		William C. Drummond
		Senior Vice President, Chief Financial Officer, and Treasurer (Principal Financial and Accounting Officer)

 

 

EXHIBIT INDEX

 

Exhibit Number		Exhibit Description
3.1		Articles Supplementary of Jernigan Capital, Inc. Designating the Rights and Preferences of the Series A Preferred Stock (Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K, filed on July 28, 2016)
10.1		Stock Purchase Agreement dated as of July 27, 2016 by and between Jernigan Capital, Inc. and certain funds managed or advised by Highland Capital Management, L.P. (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K, filed on July 28, 2016)
10.2		Amendment No. 1 to Limited Liability Company Agreement of Jernigan Capital Operating Company, LLC, dated July 27, 2016 (Incorporated by reference to Exhibit 10.2 to the Company’s Current Report on Form 8-K, filed on July 28, 2016)
10.3		Registration Rights Agreement, dated as of July 27, 2016, by and between Jernigan Capital, Inc. and certain funds managed or advised by Highland Capital Management, L.P. or its controlled affiliates (Incorporated by reference to Exhibit 10.3 to the Company’s Current Report on Form 8-K, filed on July 28, 2016)
10.4		Indemnification Agreement with James D. Dondero (Incorporated by reference to Exhibit 10.1 to the Company’s Quarterly Report on Form 10-Q, filed on August 8, 2016)
31.1		Rule 13a-14(a) Certification of Chief Executive Officer
31.2		Rule 13a-14(a) Certification of Chief Financial Officer
32.1*		Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Extension Schema
101.CAL		XBRL Taxonomy Extension Calculation Linkbase
101.DEF		XBRL Taxonomy Definition Linkbase
101.LAB		XBRL Taxonomy Extension Label Linkbase
101.PRE		XBRL Taxonomy Extension Presentation Linkbase

 

*This certification is deemed not filed for purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that section, nor shall it be deemed incorporated by reference into any filing under the Securities Act or the Exchange Act.