SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the quarterly period ended September 30, 2006
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934
For the transition period from to .
------------- --------------
Commission File Number: 1-8389
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PUBLIC STORAGE, INC.
--------------------
(Exact name of registrant as specified in its charter)
California 95-3551121
---------------------------------------- --------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
701 Western Avenue, Glendale, California 91201-2349
---------------------------------------- -------------------------------------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (818) 244-8080.
--------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for at least the past 90 days.
[X] Yes [ ] No
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer [X] Accelerated Filer [ ] Non-accelerated Filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
[ ] Yes [X] No
Indicate the number of shares outstanding of the registrant's common stock, as
of November 7, 2006:
Common Stock, $.10 par value per share - 170,174,335 shares
PUBLIC STORAGE, INC.
INDEX
Pages
PART I. FINANCIAL INFORMATION
---------------------
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets at
September 30, 2006 and December 31, 2005 1
Condensed Consolidated Statements of Income for the
Three and Nine Months Ended September 30, 2006 and 2005 2 - 3
Condensed Consolidated Statement of Shareholders' Equity
for the Nine Months Ended September 30, 2006 4
Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2006 and 2005 5 - 6
Notes to Condensed Consolidated Financial Statements 7 - 41
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 42 - 80
Item 3. Quantitative and Qualitative Disclosures about Market Risk 80 - 81
Item 4. Controls and Procedures 82
PART II. OTHER INFORMATION (Items 3 and 5 are not applicable)
-----------------
Item 1. Legal Proceedings 83
Item 1A. Risk Factors 83 - 89
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 89
Item 4. Submission of Matters to a Vote of Security Holders 89 - 90
Item 6. Exhibits 90
PUBLIC STORAGE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
September 30, December 31,
2006 2005
----------------- ---------------
(Unaudited)
ASSETS
Cash and cash equivalents.................................................... $ 124,119 $ 493,501
Real estate facilities, at cost:
Land...................................................................... 3,605,184 1,540,357
Buildings................................................................. 7,570,507 4,390,127
----------------- ---------------
11,175,691 5,930,484
Accumulated depreciation.................................................. (1,655,737) (1,500,128)
----------------- ---------------
9,519,954 4,430,356
Construction in process................................................... 131,063 54,472
----------------- ---------------
9,651,017 4,484,828
Investment in real estate entities........................................... 301,868 328,555
Goodwill (Note 2)............................................................ 174,634 176,285
Intangible assets, net (Note 2).............................................. 432,481 -
Other assets................................................................. 170,737 69,317
----------------- ---------------
Total assets................................................... $ 10,854,856 $ 5,552,486
================= ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable................................................................ $ 1,426,533 $ 113,950
Debt to joint venture partner................................................ 37,214 35,697
Preferred stock called for redemption........................................ 143,750 172,500
Accrued and other liabilities................................................ 344,168 159,360
----------------- ---------------
Total liabilities................................................... 1,951,665 481,507
Minority interest:
Preferred partnership interests........................................... 325,000 225,000
Other partnership interests............................................... 174,704 28,970
Commitments and contingencies (Note 16)
Shareholders' equity:
Cumulative Preferred Stock, $0.01 par value, 50,000,000 shares authorized,
1,715,486 shares issued (in series) and outstanding, (1,698,336 at
December 31, 2005) at liquidation preference............................ 2,927,150 2,498,400
Common Stock, $0.10 par value, 200,000,000 shares authorized, 168,986,243
shares issued and outstanding (128,089,563 at December 31, 2005)........ 16,899 12,809
Equity Stock, Series A, $0.01 par value, 200,000,000 shares authorized,
8,744.193 shares issued and outstanding................................. - -
Paid-in capital........................................................... 5,659,924 2,430,671
Cumulative net income..................................................... 3,513,525 3,189,266
Cumulative distributions paid............................................. (3,702,742) (3,314,137)
Accumulated other comprehensive loss...................................... (11,269) -
----------------- ---------------
Total shareholders' equity.......................................... 8,403,487 4,817,009
----------------- ---------------
Total liabilities and shareholders' equity..................... $ 10,854,856 $ 5,552,486
================= ===============
See accompanying notes.
1
PUBLIC STORAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ------------------------
2006 2005 2006 2005
------------ ------------- ------------- -----------
Revenues:
Rental income:
Self-storage facilities........................................... $ 328,841 $ 243,702 $ 842,751 $ 706,303
Commercial properties............................................. 3,408 2,918 9,413 8,693
Containerized storage facilities.................................. 4,353 4,480 12,483 12,305
Ancillary operations................................................. 22,106 17,587 55,649 48,803
Interest and other income............................................ 12,651 4,717 27,773 11,004
------------ ------------- ------------- -----------
371,359 273,404 948,069 787,108
------------ ------------- ------------- -----------
Expenses:
Cost of operations (excluding depreciation and amortization below):
Self-storage facilities........................................... 109,216 80,273 286,376 242,319
Commercial properties............................................. 1,497 1,122 4,080 3,292
Containerized storage facilities.................................. 3,907 3,676 11,436 9,692
Ancillary operations.............................................. 13,447 11,613 35,759 32,170
Depreciation and amortization......................................... 113,531 47,896 212,206 144,074
General and administrative............................................ 36,242 5,621 49,996 16,890
Interest expense...................................................... 9,323 2,471 12,752 5,928
------------ ------------- ------------- -----------
287,163 152,672 612,605 454,365
------------ ------------- ------------- -----------
Income from continuing operations before asset impairment charge, gain
(loss) on disposition of real estate assets, equity in earnings of
real estate entities, foreign currency exchange loss, income from
derivatives and minority interest in income.......................... 84,196 120,732 335,464 332,743
Asset impairment charge due to casualty loss (Note 2)................... - (196) - (196)
Gain (loss) on disposition of real estate assets........................ 756 (142) 1,222 (89)
Equity in earnings of real estate entities (Note 6)..................... 2,618 9,853 9,208 20,382
Foreign currency exchange loss.......................................... (172) - (172) -
Income from derivatives, net............................................ 32 - 32 -
Minority interest in income:
Preferred partnership interests:
Based on ongoing distributions paid................................ (5,403) (3,591) (13,652) (12,556)
Allocation of redemption costs (Note 11)........................... - - - (874)
Other partnership interests........................................... (3,187) (3,652) (10,825) (12,925)
------------ ------------- ------------- -----------
Income from continuing operations....................................... 78,840 123,004 321,277 326,485
Cumulative effect of change in accounting principle (Note 14)........... - - 578 -
Discontinued operations (Note 4)........................................ 2,341 5,340 2,404 6,536
------------ ------------- ------------- -----------
Net income.............................................................. $ 81,181 $ 128,344 $ 324,259 $ 333,021
============ ============= ============= ===========
Net income allocation:
----------------------
Allocable to preferred shareholders:
Based on distributions paid........................................ $ 60,265 $ 43,726 $ 159,256 $ 126,286
Based on redemptions of preferred stock (Note 2)................... 21,643 - 21,643 1,904
Allocable to Equity Stock, Series A.................................. 5,356 5,356 16,068 16,087
Allocable to common shareholders..................................... (6,083) 79,262 127,292 188,744
------------ ------------- ------------- -----------
$ 81,181 $ 128,344 $ 324,259 $ 333,021
============ ============= ============= ===========
Net income (loss) per common share - basic
Continuing operations................................................ $ (0.06) $ 0.58 $ 0.93 $ 1.42
Discontinued operations.............................................. 0.02 0.04 0.02 0.05
------------ ------------- ------------- -----------
$ (0.04) $ 0.62 $ 0.95 $ 1.47
============ ============= ============= ===========
Net income (loss) per common share - diluted
Continuing operations................................................ $ (0.06) $ 0.58 $ 0.92 $ 1.41
Discontinued operations.............................................. 0.02 0.04 0.02 0.05
------------ ------------- ------------- -----------
$ (0.04) $ 0.62 $ 0.94 $ 1.46
============ ============= ============= ===========
See accompanying notes.
2
PUBLIC STORAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share amounts)
(Unaudited)
(Continued)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ------------------------
2006 2005 2006 2005
------------ ------------- ------------- -----------
Net income per depositary share of Equity Stock, Series A (basic and
diluted)............................................................. $ 0.61 $ 0.61 $ 1.84 $ 1.84
============ ============= ============= ===========
Basic weighted average common shares outstanding........................ 145,387 128,006 133,897 128,191
============ ============= ============= ===========
Diluted weighted average common shares outstanding...................... 145,387 128,742 134,851 128,844
============ ============= ============= ===========
Weighted average shares of Equity Stock, Series A (basic and diluted)... 8,744 8,744 8,744 8,755
============ ============= ============= ===========
See accompanying notes.
3
PUBLIC STORAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Amounts in thousands, except share data)
(Unaudited)
Cumulative Cumulative Net
Preferred Stock Common Stock Paid-in Capital Income
----------------- ------------- ---------------- --------------
Balance at December 31, 2005.............................. $ 2,498,400 $ 12,809 $ 2,430,671 $ 3,189,266
Issuance of cumulative preferred stock:
Series H (4,200 shares).............................. 105,000 - (3,508) -
Series I (20,700 shares)............................. 517,500 - (15,899) -
Series K (18,400 shares)............................. 460,000 - (14,148) -
Redemption of cumulative preferred stock:
Series R (20,400 shares)............................. (510,000) - - -
Series S (5,750 shares).............................. (143,750) - - -
Issuance of common stock in connection with:
Exercise of employee stock options (1,875,173 shares).. - 188 78,711 -
Vesting of restricted stock (102,364 shares) .......... - 10 (10) -
Merger with Shurgard Storage Centers, Inc. (38,913,187
shares) ............................................. - 3,891 3,182,255 -
Acquisition of minority interests (5,956 shares) ...... - 1 154 -
Stock-based compensation expense (Note 14) ............... - - 1,698 -
Net income................................................ - - - 324,259
Cash distributions:
Cumulative preferred stock (Note 12)................... - - - -
Equity Stock, Series A ($1.845 per depositary share)... - - - -
Common Stock ($1.50 per share)......................... - - - -
Accumulated other comprehensive loss:
Foreign currency translation adjustments............... - - - -
----------------- ------------- ---------------- --------------
Balance at September 30, 2006............................. $ 2,927,150 $ 16,899 $ 5,659,924 $ 3,513,525
================= ============= ================ ==============
Accumulated
Other Total
Cumulative Comprehensive Shareholders'
Distributions Loss Equity
--------------- --------------- ---------------
Balance at December 31, 2005.............................. $ (3,314,137) $ - $ 4,817,009
Issuance of cumulative preferred stock:
Series H (4,200 shares).............................. - - 101,492
Series I (20,700 shares)............................. - - 501,601
Series K (18,400 shares)............................. - - 445,852
Redemption of cumulative preferred stock:
Series R (20,400 shares)............................. - - (510,000)
Series S (5,750 shares).............................. - - (143,750)
Issuance of common stock in connection with:
Exercise of employee stock options (1,875,173 shares).. - - 78,899
Vesting of restricted stock (102,364 shares) .......... - - -
Acquisition of Shurgard Storage Centers (38,913,187
shares) ............................................. - - 3,186,146
Acquisition of minority interests (5,956 shares) ...... - - 155
Stock-based compensation expense (Note 14) ............... - - 1,698
Net income................................................ - - 324,259
Cash distributions:
Cumulative preferred stock (Note 12)................... (159,256) - (159,256)
Equity Stock, Series A ($1.845 per depositary share)... (16,068) - (16,068)
Common Stock ($1.50 per share)......................... (213,281) - (213,281)
Accumulated other comprehensive loss:
Foreign currency translation adjustments............... - (11,269) (11,269)
--------------- --------------- ---------------
Balance at September 30, 2006............................. $ (3,702,742) $ (11,269) $ 8,403,487
=============== =============== ===============
See accompanying notes.
4
PUBLIC STORAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
For the Nine Months Ended
September 30,
---------------------------
2006 2005
------------ -------------
Cash flows from operating activities:
Net income............................................................... $ 324,259 $ 333,021
Adjustments to reconcile net income to net cash provided by operating
activities:
Amortization of note premium (Note 8)................................... (968) (774)
Excess of effective interest over cash interest paid on debt to joint
venture partner (Note 9) ............................................ 130 130
Gain on sales of real estate facilities, net, including discontinued
operations........................................................... (3,592) (6,296)
Real estate impairment associated with casualty losses (Note 2)......... - 196
Depreciation and amortization, including discontinued operations........ 212,256 144,286
Expense of capitalized development project costs ....................... 9,319 -
Equity in earnings of real estate entities.............................. (9,208) (20,382)
Foreign currency exchange loss.......................................... 172 -
Income from derivatives, net............................................ (32) -
Distributions received from the real estate entities (Note 6)........... 15,049 17,015
Minority interest in income............................................. 24,477 26,355
Other operating activities.............................................. 10,290 14,789
------------ -------------
Total adjustments.................................................... 257,893 175,319
------------ -------------
Net cash provided by operating activities............................ 582,152 508,340
------------ -------------
Cash flows from investing activities:
Capital improvements to real estate facilities ......................... (44,366) (13,286)
Construction in process................................................. (70,903) (46,039)
Acquisition of minority interests (Note 11)............................. (60,799) (92,815)
Acquisition of real estate facilities................................... (98,954) (124,753)
Consolidation of partnerships (Note 2).................................. 3,024 -
Cash portion of the merger with Shurgard (Note 3)....................... (161,284) -
Proceeds from sales of real estate and real estate investments.......... 11,281 10,864
Proceeds from sales of held-to-maturity investments (Note 2)............ 8,079 4,953
Acquisition of held-to-maturity debt securities......................... - (5,823)
------------ -------------
Net cash used in investing activities................................ (413,922) (266,899)
------------ -------------
Cash flows from financing activities:
Principal payments on notes payable..................................... (687,508) (13,685)
Proceeds from borrowings on European notes payable...................... 8,544 -
Contributions received from European minority interests................. 9,302 -
Net proceeds from issuances of common stock............................. 78,899 6,624
Net proceeds from issuances of cumulative preferred stock............... 1,048,945 460,648
Repurchases of common stock............................................. - (4,990)
Redemption of cumulative preferred stock................................ (682,500) (112,392)
Redemption of preferred partnership interests........................... - (85,000)
Issuance of preferred partnership interests............................. 100,000 -
Distributions paid to shareholders...................................... (388,605) (322,195)
Distributions paid to holders of preferred partnership interests (Note
12).................................................................. (13,652) (12,556)
Distributions paid to other minority interests.......................... (11,037) (11,805)
Net proceeds from financing through acquisition joint venture (Note 9).. - 19,429
------------ -------------
Net cash used in financing activities................................ (537,612) (75,922)
------------ -------------
Net (decrease) increase in cash and cash equivalents........................ (369,382) 165,519
Cash and cash equivalents at the beginning of the year...................... 493,501 366,255
------------ -------------
Cash and cash equivalents at the end of the period.......................... $ 124,119 $ 531,774
============ =============
See accompanying notes.
5
PUBLIC STORAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
(Continued)
For the Nine Months Ended
September 30,
----------------------------
2006 2005
------------ -------------
Supplemental schedule of non-cash investing and financing activities:
Real estate acquired in exchange for assumption of mortgage note........ $ (4,590) $ -
Mortgage note assumed in connection with acquisition of real estate..... 4,590 -
Merger with Shurgard (Note 3):
Real estate facilities............................................... (5,070,528) -
Intangible assets.................................................... (483,107) -
Other Assets......................................................... (100,411) -
Accrued and other liabilities........................................ 162,730 -
Minority interest.................................................... 144,351 -
Debt................................................................. 1,999,535 -
Common Stock......................................................... 3,891 -
Paid-in capital...................................................... 3,182,255 -
Consolidation of entities pursuant to Emerging Issues Task Force Topic 04-5
(Note 2):
Minority interest.................................................... 3,963 -
Real estate facilities............................................... (22,459) -
Investments.......................................................... 20,846 -
Other Assets......................................................... (167) -
Accrued and Other Liabilities........................................ 841 -
Retirement of common stock and Equity Stock, Series A, received as a
distribution from affiliated entities (Note 2):
Common stock......................................................... - (64)
Paid-in capital...................................................... - (11,125)
Investment in real estate entities................................... - 11,189
Acquisition of minority interests in Consolidated Joint Venture in exchange
for debt (Note 11):
Minority Interest - other partnership interests...................... - (62,643)
Real estate facilities............................................... - (43,290)
Debt to related party................................................ - 64,513
Increase in debt to joint venture partner (Note 9)
Debt to joint venture partner........................................ 1,386 -
Other assets......................................................... (1,386) -
Foreign currency adjustment
Real estate facilities............................................... 20,849 -
Construction in process.............................................. 643 -
Notes payable........................................................ (10,223) -
Equity............................................................... (11,269) -
See accompanying notes.
6
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
1. Description of the Business
---------------------------
Public Storage, Inc. (referred to herein as "the Company", "we", "us"
or "our") is a California corporation, which was organized in 1980. We are a
fully integrated, self-administered and self-managed real estate investment
trust ("REIT") whose principal business activities include the acquisition,
development, ownership and operation of self-storage facilities which offer
storage spaces for lease, generally on a month-to-month basis, for personal and
business use. In addition, we have (i) interests in commercial properties,
containing commercial and industrial rental space, (ii) interests in facilities
that lease storage containers, and (iii) ancillary operations comprised
principally of reinsurance of policies against losses to goods stored by our
self-storage tenants, retail sales and truck rentals at our self-storage
locations. As described more fully in Note 3, "Merger with Shurgard," on August
22, 2006, the Company merged with Shurgard Storage Centers, Inc., ("Shurgard").
At September 30, 2006, we had direct and indirect equity interests in
2,003 self-storage facilities located in 38 states operating under the "Public
Storage" name, and 160 self-storage facilities located in seven European nations
which operate under the "Shurgard Storage Centers" name. We also have direct and
indirect equity interests in approximately 19 million net rentable square feet
of commercial space located in 10 states in the U.S.
2. Summary of Significant Accounting Policies
------------------------------------------
Basis of Presentation
---------------------
The accompanying unaudited condensed consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
in the United States ("GAAP") for interim financial information and the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do
not include all of the information and footnotes required by United States
generally accepted accounting principles for complete financial statements. In
the opinion of management, all adjustments (consisting of normal and recurring
adjustments) considered necessary for a fair presentation have been reflected in
these unaudited condensed consolidated financial statements. Operating results
for the three and nine months ended September 30, 2006 are not necessarily
indicative of the results that may be expected for the year ended December 31,
2006. The accompanying unaudited condensed consolidated financial statements
should be read together with the consolidated financial statements and related
notes included in the Company's Annual Report on Form 10-K for the year ended
December 31, 2005.
Certain amounts previously reported have been reclassified to conform
to the September 30, 2006 presentation. In previous presentations, intangible
assets were reported separately from goodwill on the Company's consolidated
balance sheet. We have now reclassified the intangible assets to goodwill (see
"Goodwill and Intangible Assets" below). In previous presentations, net income
from our truck rental, merchandise sales, and property management operations
were included on a net basis in "Interest and other income" in our consolidated
statements of income. In our current presentation, revenues with respect to each
of these operations, along with revenues from our tenant reinsurance operations,
are included under the caption "Revenues: Ancillary operations" and the related
cost of operations are included in "Expenses: Cost of operations - Ancillary
operations" on our accompanying condensed consolidated statements of income.
Certain reclassifications have also been made from previous presentations as a
result of discontinued operations (See Note 4).
7
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Consolidation Policy
--------------------
Entities in which we have an interest are first evaluated to determine
whether, in accordance with the provisions of the Financial Accounting Standards
Board's Interpretation No. 46R, "Consolidation of Variable Interest Entities,"
they represent Variable Interest Entities. Variable Interest Entities in which
we are the primary beneficiary are consolidated. Entities that are not Variable
Interest Entities that we control are consolidated. For purposes of determining
control, when we are the general partner, we are considered to control the
partnership unless the limited partners possess substantial "kick-out" or
"participative" rights as defined in Emerging Issues Task Force Statement 04-5 -
"Determining whether a general partner or the general partners as a group,
controls a limited partnership or similar entity when the limited partners have
certain rights" ("EITF 04-5"). All significant intercompany balances and
transactions have been eliminated.
In accordance with the guidance of EITF 04-5, effective January 1, 2006
we commenced consolidating the accounts of three partnerships that we previously
accounted for on the equity method. Our investment in these entities totaling
$20,846,000 was allocated to the real estate facilities, cash, other assets,
liabilities, and minority interests of these entities as described in the table
below (amounts in thousands).
Total
-------------
Real estate facilities..... $ 22,459
Cash....................... 3,024
Other assets............... 167
Accrued and other liabilities (841)
Minority interest ......... (3,963)
-------------
$ 20,846
=============
We have determined that we have variable interest entities that we are
the primary beneficiaries of that we acquired an interest in as a result of our
merger with Shurgard (see Note 3). The accounts of the entities we control along
with the accounts of the variable interest entities that we are the primary
beneficiary of, (collectively, the "Consolidated Entities") are included in our
consolidated financial statements along with those of the Company. Collectively,
the Company and the Consolidated Entities own a total of 2,172 real estate
facilities, consisting of 2,003 self-storage facilities in the United States (of
which 487 were acquired in the Shurgard merger), 160 facilities in Europe which
were acquired in the Shurgard merger, three industrial facilities used by the
containerized storage operations and six commercial properties.
At September 30, 2006, we had equity investments in five limited
partnerships in which we do not have a controlling interest. These limited
partnerships collectively own 22 self-storage facilities, which are managed by
the Company. In addition, at September 30, 2006, we own approximately 44% of the
common equity of PS Business Parks, Inc. ("PSB"), which has interests in
approximately 18.2 million net rentable square feet of commercial space at
September 30, 2006. Our investment in these limited partnerships and PSB
(collectively, the "Unconsolidated Entities") are accounted for using the equity
method.
Use of Estimates
----------------
The preparation of the consolidated financial statements in conformity
with United States generally accepted accounting principles requires management
to make estimates and assumptions that affect the amounts reported in the
consolidated financial statements and accompanying notes. Actual results could
differ from those estimates.
8
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Income Taxes
------------
For all taxable years subsequent to 1980, the Company qualified and
intends to continue to qualify as a REIT, as defined in Section 856 of the
Internal Revenue Code. As a REIT, we are not taxed on that portion of our
taxable income which is distributed to our shareholders, provided that we meet
certain tests. We believe we will meet these tests during 2006 and, accordingly,
no provision for income taxes has been made in the accompanying condensed
consolidated financial statements.
Financial Instruments
---------------------
We have estimated the fair value of our financial instruments using
available market information and appropriate valuation methodologies.
Considerable judgment is required in interpreting market data to develop
estimates of market value. Accordingly, estimated fair values are not
necessarily indicative of the amounts that could be realized in current market
exchanges.
For purposes of financial statement presentation, we consider all
highly liquid financial instruments such as short-term treasury securities or
investment grade short-term commercial paper to be cash equivalents.
Due to the short period to maturity of our cash and cash equivalents,
accounts receivable, other financial instruments included in other assets, and
accrued and other liabilities, the carrying values as presented on the
consolidated balance sheets are reasonable estimates of fair value.
Financial assets that are exposed to credit risk consist primarily of
cash and cash equivalents and accounts receivable. Cash and cash equivalents,
which consist of short-term investments, including commercial paper, are only
invested in entities with an investment grade rating. Accounts receivable are
not a significant portion of total assets and are comprised of a large number of
individual customers.
Included in cash and cash equivalents at September 30, 2006 is
$23,420,000 ($18,962,000 at December 31, 2005) held by our captive insurance
entities. Other assets at September 30, 2006 include investments totaling
$11,759,000 ($19,838,000 at December 31, 2005) in held-to-maturity Federal
government agency securities stated at amortized cost, which approximates fair
value. Insurance and other regulations place significant restrictions on our
ability to withdraw these funds for purposes other than insurance activities.
Other assets at September 30, 2006 also include derivative financial instruments
totaling $4,796,000 (none at December 31, 2005) reported at fair value. Accrued
and other liabilities at September 30, 2006 include derivative financial
instruments totaling $9,818,000 (none at December 31, 2005) reported at fair
value. See Note 10 for further discussion of our derivative financial
instruments. The carrying value of our notes payable at September 30, 2006 is
$1,426,533,000 ($113,950,000 at December 31, 2005) which approximates fair value
at those dates.
Real Estate Facilities
----------------------
Real estate facilities are recorded at cost. Costs associated with the
acquisition, development, construction, renovation, and improvement of
properties are capitalized. Interest, property taxes, and other costs associated
with development incurred during the construction period are capitalized as
building cost. Expenditures for repairs and maintenance expense are charged to
expense when incurred. Depreciation is computed using the straight-line method
over the estimated useful lives of the buildings and improvements, which are
generally between 5 and 25 years.
Accounting for Acquisition Joint Venture
----------------------------------------
In January 2004, we entered into a joint venture partnership with an
institutional investor for the purpose of acquiring up to $125,000,000 of
existing self-storage properties in the United States from third parties (the
"Acquisition Joint Venture"). The Acquisition Joint Venture is funded entirely
with equity consisting of 30% from the Company and 70% from the institutional
investor. For a six-month period beginning 54 months after formation, we have
9
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
the right to acquire our partner's interest based upon the market value of the
properties. If we do not exercise our option, our partner can elect to purchase
our interest in the properties during a six-month period commencing upon
expiration of our six-month option period. If our partner fails to exercise its
option, the Acquisition Joint Venture will be liquidated and the proceeds will
be distributed to the partners according to the joint venture agreement.
We have determined that the Acquisition Joint Venture is not a variable
interest entity, and we do not control this entity. Therefore, we do not
consolidate the accounts of the Acquisition Joint Venture on our accompanying
condensed consolidated financial statements.
During the year ended December 31, 2004, the Acquisition Joint Venture
acquired two facilities directly from third parties at an aggregate cost of
$9,086,000. We account for our investment with respect to these facilities using
the equity method, with our pro rata share of the income from these facilities
recorded as "Equity in earnings of real estate entities" on our accompanying
condensed consolidated statements of income. See Note 6 for further discussion
of these amounts.
In December 2004, we sold seven facilities to the Acquisition Joint
Venture for an aggregate of $22,993,000. During the first quarter of 2005, we
sold an interest in three additional facilities to the Acquisition Joint Venture
for an aggregate of approximately $27,755,000. Due to our continuing interest in
these facilities and the likelihood that we will exercise our option to acquire
our partner's interest, we have accounted for our partner's investment
($37,214,000 and $35,697,000 at September 30, 2006 and December 31, 2005,
respectively) in these facilities as, in substance, debt financing. Accordingly,
our partner's investment with respect to these ten facilities is accounted for
as a liability on our accompanying condensed consolidated balance sheets under
the caption "Debt to joint venture partner," with our partner's share of
operations with respect to these ten facilities accounted for as interest
expense on our accompanying condensed consolidated statements of income. On a
quarterly basis, we review the fair value of this liability, and to the extent
fair value exceeds the carrying value of the liability, an adjustment is made to
increase the liability to fair value, and to increase other assets, with the
other assets amortized over the remaining period term of the Acquisition Joint
Venture. See Note 9 for a discussion of the results of this review.
Evaluation of Asset Impairment
------------------------------
We evaluate impairment of goodwill annually through a two-step process.
In the first step, if the fair value of the reporting unit to which the goodwill
applies is equal to or greater than the carrying amount of the assets of the
reporting unit, including the goodwill, the goodwill is considered unimpaired
and the second step is unnecessary. If, however, the fair value of the reporting
unit including goodwill is less than the carrying amount, the second step is
performed. In this test, we compute the implied fair value of the goodwill based
upon the allocations that would be made to the goodwill, other assets and
liabilities of the reporting unit if a business combination transaction were
consummated at the fair value of the reporting unit. An impairment loss is
recorded to the extent that the implied fair value of the goodwill is less than
the goodwill's carrying amount. No impairments of our goodwill were identified
in our annual evaluation at December 31, 2005.
We evaluate impairment of long-lived assets on a quarterly basis. We
first evaluate these assets for indicators of impairment such as a) a
significant decrease in the market price of a long-lived asset, b) a significant
adverse change in the extent or manner in which a long-lived asset is being used
or in its physical condition, c) a significant adverse change in legal factors
or the business climate that could affect the value of the long-lived asset, d)
an accumulation of costs significantly in excess of the amount originally
projected for the acquisition or construction of the long-lived asset, or e) a
current-period operating or cash flow loss combined with a history of operating
or cash flow losses or a projection or forecast that demonstrates continuing
losses associated with the use of the long-lived asset. When any such indicators
of impairment are noted, we compare the carrying value of these assets to the
future estimated undiscounted cash flows attributable to these assets. If the
asset's recoverable amount is less than the carrying value of the asset, then an
impairment charge is booked for the excess of carrying value over the asset's
fair value.
10
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Any long-lived assets which we expect to sell or otherwise dispose of
prior to their previously estimated useful life are stated at what we estimate
to be the lower of their estimated net realizable value (less cost to sell) or
their carrying value. No impairments were identified from our evaluations as of
September 30, 2006.
Accounting for Stock-Based Compensation
---------------------------------------
We utilize the Fair Value Method (as defined in Note 14) of accounting
for our employee stock options. Restricted stock unit expense is recorded over
the relevant vesting period. See Note 14 for a discussion of our accounting with
respect to employee stock options and restricted stock units.
Other Assets
------------
Other assets primarily consists of prepaid expenses, investments in
held-to-maturity debt securities (described below), accounts receivable, assets
associated with our containerized storage business, merchandise inventory and
rental trucks.
Included in depreciation and amortization expense for the three and
nine months ended September 30, 2006, is $1,304,000 and $3,584,000,
respectively, compared to $1,376,000 and $5,159,000, respectively, for the same
periods in 2005, related to depreciation of other assets.
Accrued and Other Liabilities
-----------------------------
Accrued and other liabilities consist primarily of real and personal
property tax accruals, value-added tax ("VAT") with respect to our European
operations, prepayments of rents, trade payables, losses and loss adjustment
liabilities from our insurance programs (described below), and accrued interest.
Prepaid rent totaled $57,591,000 at September 30, 2006 ($26,145,000 at December
31, 2005).
STOR-Re Mutual Insurance Company, Inc. ("STOR-Re"), which is
consolidated with the Company, was formed in 1994 as an association captive
insurance company owned by the Company and affiliates of the Company. STOR-Re
provides limited property and liability insurance to the Company and its
affiliates for losses incurred during policy periods prior to April 1, 2004, and
was succeeded by PS Insurance Company Hawaii, Ltd. ("PSIC-H"), a wholly-owned
subsidiary of the Company with respect to these insurance activities for policy
periods following March 31, 2004. We also utilize other insurance carriers to
provide property and liability insurance coverage in excess of STOR-Re's and
PSIC-H's limitations which are described in Note 16. STOR-Re and PSIC-H accrue
liabilities for covered losses and loss adjustment expense, which at September
30, 2006 totaled $32,690,000 ($32,797,000 at December 31, 2005) with respect to
insurance provided to the Company and its affiliates.
Liabilities for losses and loss adjustment expenses include an amount
we determine from loss reports and individual cases and an amount, based on
recommendations from an independent actuary that is a member of the American
Academy of Actuaries using a frequency and severity method, for losses incurred
but not reported. Determining the liability for unpaid losses and loss
adjustment expense is based upon estimates. While we believe that the amount is
adequate, the ultimate loss may be in excess of or less than the amounts
provided. See Note 16 for a discussion of our maximum aggregate annual exposure,
assuming the occurrence of multiple significant events. The methods for making
such estimates and for establishing the resulting liability are reviewed
quarterly.
11
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
PS Insurance Company, Ltd ("PSIC"), a wholly-owned subsidiary of the
Company, reinsured policies against claims for losses to goods stored by tenants
in our self-storage facilities for policy periods prior to March 31, 2004.
PSIC-H succeeded PSIC with respect to these tenant re-insurance activities
effective April 1, 2004. Prior to January 1, 2006, both of these entities
utilize third-party insurance coverage for losses from any individual event that
exceeds a loss of $500,000, to a maximum of $10,000,000. Commencing January 1,
2006, PSIC-H covers losses up to $1,500,000 with third party insurers covering
the next $9,000,000 from any individual event. Losses below the third-party
insurers' deductible amounts are accrued as cost of operations for the tenant
re-insurance operations. Losses exceeding the third-party insurers' limit are
the responsibility of PSIC-H. See Note 16 for a discussion of our reinsured
policies outstanding at September 30, 2006.
The accrued liability for losses and loss adjustment expense with
respect to tenant insurance activities totaled $3,261,000 at September 30, 2006
($4,773,000 at December 31, 2005).
Goodwill and Intangible Assets
------------------------------
Goodwill represents the excess of acquisition cost over the fair value
of net tangible and identifiable intangible assets acquired in business
combinations. Each business combination from which our goodwill arose was for
the acquisition of single businesses and accordingly, the allocation of our
goodwill to our business segments is based directly on such acquisitions. Our
goodwill has an indeterminate life in accordance with the provisions of
Statement of Financial Accounting Standards No. 142 ("SFAS 142").
In prior periods, intangible assets (original acquisition cost of
$165,000,000 and net book value of $98,081,000 at December 31, 2005) were
presented on our consolidated balance sheets. For all periods presented herein,
we have reclassified this intangible asset to goodwill on our accompanying
condensed consolidated balance sheets and, in accordance with the provisions of
SFAS 142 as applied to the reclassification effective April 1, 2006, we ceased
amortization.
Included in depreciation and amortization expense for the nine months
ended September 30, 2006 is $1,651,000 (none for the three months ended
September 30, 2006) related to the amortization of our intangibles and goodwill,
as compared to $1,651,000 and $4,953,000 for the three and nine months ended
September 30, 2005, respectively. Goodwill is reported net of accumulated
amortization of $85,085,000 and $83,434,000 at September 30, 2006 and December
31, 2005, respectively, on our accompanying condensed consolidated balance
sheets.
As a result of the merger with Shurgard (Note 3), we acquired
finite-lived intangible assets, which were valued in our purchase accounting
analysis, represented by the value of the storage tenants in place of
$428,643,000 and by the land leases with rent payments that are below market,
valued at $35,639,000. The tenant intangible assets are being amortized relative
to the expected future benefit of the tenants in place to each period. Also as a
result of the merger with Shurgard, we acquired indefinite-lived intangible
assets, which were valued in our purchase accounting analysis, represented by
the value of the Shurgard tradename of $18,825,000. We continue to use the
Shurgard tradename in Europe. In accordance with the provisions of SFAS 142, we
are not amortizing these indefinite-lived intangible assets and are analyzing
them on an annual basis for recoverability. Amortization expense of $50,626,000
was recorded for our finite-lived intangible assets for the three months ended
September 30, 2006. The estimated annual amortization expense for our
finite-lived intangible assets for the current year and each of the next three
years ending December 31 is as follows:
2006 (after September 30, 2006) $ 94,800,000
2007 194,700,000
2008 55,898,000
2009 33,819,000
12
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Revenue and Expense Recognition
-------------------------------
Rental income, which is generally earned pursuant to month-to-month
leases for storage space, is recognized as earned. Promotional discounts are
recognized as a reduction to rental income over the promotional period, which is
generally during the first month of occupancy. Late charges and administrative
fees are recognized as income when collected. Tenant reinsurance premiums are
recognized as premium revenue when earned. Revenues from merchandise sales and
truck rentals are recognized when earned. Interest income is recognized as
earned. Equity in earnings of real estate entities is recognized based on our
ownership interest in the earnings of each of the Unconsolidated Entities.
We accrue for property tax expense based upon estimates and historical
trends. If these estimates are incorrect, the timing of expense recognition
could be affected.
Cost of operations, general and administrative expense, interest
expense, as well as television, yellow page, and other advertising expenditures
are expensed as incurred. Accordingly, the amounts incurred in an interim period
may not be indicative of the amounts to be incurred during a full year.
Television, yellow page, and other advertising expenses totaled $7,103,000 and
$24,726,000 for the three and nine months ended September 30, 2006,
respectively, and $7,486,000 and $24,049,000, respectively, for the same periods
in 2005. Television, yellow page, and other advertising expenses totaled
$1,075,000 for the three and nine months ended September 30, 2006 for our
European operations.
Foreign Exchange Translation Policy
-----------------------------------
The local currency is the functional currency for our European
subsidiaries. Assets and liabilities are translated at end-of-period rates while
revenues and expenses are translated at average rates in effect during the
period. Equity is translated at historical rates and the resulting cumulative
translation adjustments are included as a component of accumulated other
comprehensive income (loss) until the translation adjustments are realized.
Derivative Financial Instruments
--------------------------------
In connection with the Company's merger with Shurgard, we have acquired
certain preexisting derivative financial instruments held by Shurgard (the
"Shurgard Derivatives"), including interest rate caps, interest rate swaps,
cross-currency swaps and foreign currency forward contracts. We do not intend to
use derivative financial instruments for speculative or trading purposes.
In accordance with the provisions of Statement of Financial Accounting
Standards No. 133, Accounting for Derivative Financial Instruments and Hedging
Activities ("SFAS 133"), derivative financial instruments are measured at fair
value and recognized on the balance sheet as assets or liabilities.
As of September 30, 2006, and for the three and nine month periods then
ended, none of the Shurgard Derivatives were considered effective hedges because
we believe it is not highly likely that the debt and the related derivative
instruments will remain outstanding for their entire contractual period.
Accordingly, all changes in fair value are reflected in earnings, along with the
related cash flows from these instruments, under "net income from derivatives"
on our condensed consolidated statement of income. For the three and nine months
ended September 30, 2006, net income from derivatives was comprised of a change
in value of the related instruments representing a gain of $913,000, less
$881,000 in net payments incurred during the period under the underlying
instruments.
13
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Other Comprehensive Income (Loss)
---------------------------------
Our comprehensive income (loss) is as follows:
For the Three Months Ended For the Nine Months Ended
-------------------------------- --------------------------------
September 30, September 30, September 30, September 30,
2006 2005 2006 2005
-------------- -------------- -------------- -------------
Net income................................ $ 81,181 $ 128,344 $ 324,259 $ 333,021
Accumulated other comprehensive loss:
Foreign currency translation
adjustments............................... (11,269) - (11,269) -
-------------- -------------- -------------- -------------
Total comprehensive income................ $ 69,912 $ 128,344 $ 312,990 $ 333,021
============== ============== ============== =============
The foreign currency translation adjustment represents the net currency
translation adjustment gains and losses related to our European subsidiaries
acquired in the merger with Shurgard measured from the date of the merger
through September 30, 2006. Amounts are presented net of minority interests.
Environmental Costs
-------------------
Our policy is to accrue environmental assessments and estimated
remediation costs when it is probable that such efforts will be required and the
related costs can be reasonably estimated. Our current practice is to conduct
environmental investigations in connection with property acquisitions. Although
there can be no assurance, we are not aware of any environmental contamination
of any of our facilities, which individually or in the aggregate would be
material to our overall business, financial condition, or results of operations.
Net Income per Common Share
---------------------------
Distributions paid to the holders of our Cumulative Preferred Stock
totaling $60,265,000 and $43,726,000 for the three months ended September 30,
2006 and 2005, respectively, have been deducted from net income to arrive at net
income allocable to our common shareholders (dividends paid to holders of our
Cumulative Preferred Stock totaled $159,256,000 and $126,286,000 for the nine
months ended September 30, 2006 and 2005, respectively).
Emerging Issues Task Force ("EITF") Topic D-42, "The Effect on the
Calculation of Earnings per Share for the Redemption or the Induced Conversion
of Preferred Stock" provides, among other things, that any excess of (1) the
fair value of the consideration transferred to the holders of preferred stock
redeemed over (2) the carrying amount of the preferred stock should be
subtracted from net earnings to determine net earnings available to common
stockholders in the calculation of earnings per share. At the July 31, 2003
meeting of the EITF, the Securities and Exchange Commission ("SEC") Observer
clarified that for purposes of applying EITF Topic D-42, the carrying amount of
the preferred stock should be reduced by the issuance costs of the preferred
stock, regardless of where in the stockholders' equity section those costs were
initially classified on issuance.
On September 28, 2006, we redeemed our 8.00% Series R Preferred Stock
for $510,000,000 plus accrued and unpaid dividends. In addition, on September
26, 2006, we called for redemption our 7.875% Series S Preferred Stock for
$143,750,000 plus accrued and unpaid dividends. The Series S was redeemed on
October 31, 2006. As a result of these redemptions, there was an additional
allocation to the preferred shareholders of approximately $21,643,000 ($0.16 per
common share, based upon the weighted average diluted shares during the nine
months ended September 30, 2006) during the three and nine months ended
September 30, 2006 (none and $1,904,000 for the same periods in 2005) from the
application of EITF Topic D-42. It is our policy to record such allocations at
the time the securities are called for redemption.
14
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Net income allocated to our common shareholders has been further
allocated among our two classes of common stock; our regular common stock and
our Equity Stock, Series A. The allocation among each class was based upon the
two-class method. Under the two-class method, earnings per share for each class
of common stock are determined according to dividends declared (or accumulated)
and participation rights in undistributed earnings. Under the two-class method,
the Equity Stock, Series A, was allocated net income of $5,356,000 and
$5,356,000 for three months ended September 30, 2006 and 2005, respectively, and
$16,068,000 and $16,087,000 for the nine months ended September 30, 2006 and
2005, respectively. A loss of $6,083,000 and income of $79,262,000 for the three
months ended September 30, 2006 and 2005, respectively, was allocated to the
regular common shareholders (income of $127,292,000 and $188,744,000 for the
nine months ended September 30, 2006 and 2005, respectively).
Basic net income per share is computed using the weighted average
common shares outstanding (prior to the dilutive impact of stock options and
restricted stock units outstanding). Diluted net income per common share is
computed using the weighted average common shares outstanding (adjusted for the
dilutive impact of stock options and restricted stock units outstanding). The
stock options and restricted stock units were anti-dilutive in the three months
ended September 30, 2006 and were not reflected in diluted net income per common
share for that period. Weighted average common shares excludes shares owned by
the Consolidated Entities as described in Note 12 for all periods presented, as
these shares of common stock are eliminated in consolidation.
Recently Issued Accounting Standards
------------------------------------
In July 2006, the Financial Accounting Standards Board (the "FASB")
issued Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" ("FIN
48"). This interpretation, among other things, creates a two step approach for
evaluating uncertain tax positions. Recognition (step one) occurs when an
enterprise concludes that a tax position, based solely on its technical merits,
is more-likely-than-not to be sustained upon examination. Measurement (step two)
determines the amount of benefit that more-likely-than-not will be realized upon
settlement. Derecognition of a tax position that was previously recognized would
occur when a company subsequently determines that a tax position no longer meets
the more-likely-than-not threshold of being sustained. FIN 48 specifically
prohibits the use of a valuation allowance as a substitute for derecognition of
tax positions, and it has expanded disclosure requirements. FIN 48 is effective
for fiscal years beginning after December 15, 2006, in which the impact of
adoption should be accounted for as a cumulative-effect adjustment to the
beginning balance of retained earnings. The Company is evaluating FIN 48 and has
not yet determined the impact the adoption will have on the consolidated
financial statements.
3. Merger with Shurgard
--------------------
On August 22, 2006, the Company merged with Shurgard, a REIT which
owned 487 self-storage facilities in the United States and 160 self-storage
facilities in Europe. We believe this merger will provide a number of strategic
and financial benefits and growth opportunities for us by solidifying our
position as the largest owner and operator of self-storage facilities in the
U.S., enhancing access to capital, eliminating duplicative general and
administrative expenses and improving cost efficiencies, increasing growth
opportunities and providing greater geographic and financial diversification.
The operations of Shurgard reside primarily within our existing Self-storage -
Domestic segment, and have resulted in a new segment, Self-storage - Europe.
Under the terms of the agreement, Shurgard shareholders received 0.82
shares of Public Storage common stock for each share of Shurgard common stock
they owned.
15
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Total consideration for the merger approximated $5,346,965,000,
comprised of i) the issuance of 38.9 million shares of Public Storage common
stock (valued at approximately $3,116,850,000 based upon the average of Public
Storage's share closing price for five days before, the day of and five days
after the acquisition announcement date of March 7, 2006), ii) the assumption of
Shurgard's domestic and European notes payable and capital leases with a fair
value of approximately $1,395,763,000 of which $67,275,000 was repaid following
the merger iii) the assumption of Shurgard's line of credit totaling
$603,772,000, which was repaid following the merger, iv) the issuance of vested
common stock options in exchange for Shurgard stock options, with an estimated
intrinsic value of approximately $69,296,000, and v) $161,284,000 in cash,
comprised of $137,916,000 to redeem Shurgard's outstanding preferred stock at
liquidation value, and approximately $49,404,000 in direct costs of the merger,
less $20,036,000 in cash held by Shurgard at the date of the merger.
We have allocated this aggregate purchase price to the tangible and
intangible net assets, as follows (amounts in thousands):
Operating real estate facilities $ 4,979,859
Construction in process 90,669
Intangible assets 483,107
Other assets 100,411
Accrued and other liabilities (162,730)
Minority interest (144,351)
---------------
Total allocated Purchase Price to net assets acquired $ 5,346,965
Intangible assets consist of the estimated value of Shurgard's existing
tenants in place, the estimated value of Shurgard's existing land leases, and
the estimated value of Shurgard's tradename, which we expect to continue to use
in Europe. Each intangible, except the Shurgard tradename, have finite lives.
See Note 2 for further discussion of the amortization method with respect to the
intangible assets acquired in the merger with Shurgard.
The results of operations of Shurgard have been included in our
condensed consolidated financial statements since the merger date of August 22,
2006. The unaudited pro forma data presented below assumes that the merger
occurred as of the beginning of the respective periods, and includes pro forma
adjustments to i) increase depreciation expense to reflect our book basis for
the buildings acquired, ii) increase amortization expense to reflect the
intangible assets acquired in the merger, iii) decrease interest income and
increase income allocated to preferred shareholders to reflect the financing of
the merger with cash on hand and the proceeds from preferred stock, and iv)
decrease the historical general and administrative expense of Shurgard that is
expected to be eliminated as a result of the merger. The unaudited pro forma
results have been prepared for comparative purposes only and do not purport to
be indicative of the results of operations that would have occurred had the
merger been consummated at the beginning of the periods presented.
16
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
----------- ------------ ------------ -----------
(Amounts in thousands, except per share data)
Revenues.......................... $437,877 $396,386 $1,271,171 $1,139,762
Net income........................ $ 23,305 $ 27,120 $ 153,501 $ 106,731
Loss per common share:
Basic........................... $ (0.38) $ (0.18) $ (0.38) $ (0.38)
Diluted......................... $ (0.38) $ (0.18) $ (0.38) $ (0.38)
4. Discontinued Operations
-----------------------
We segregate all of our disposed components that have operations that
(i) can be distinguished from the rest of the entity and (ii) will be eliminated
from the ongoing operations of the entity in a disposal transaction.
Since January 1, 2002, we closed a total of 43 containerized storage
facilities that were determined to be non-strategic (the "Closed Facilities").
As the decision was made to close each facility, the related assets were
evaluated for recoverability and asset impairment charges were recorded for the
excess of these assets' net book value over their fair value (less costs to
sell), determined based upon recent selling prices for similar assets. No asset
impairment or lease termination charges were recorded for these facilities
during the three or nine months ended September 30, 2006 and 2005.
During the first quarter of 2005, we sold the non-real estate assets of
six of the Closed Facilities, resulting in a gain on sale of approximately
$1,143,000.
During July 2005, in an eminent domain proceeding, one of our
self-storage facilities located in the Portland, Oregon market was condemned. We
received the proceeds, totaling $6,590,000, from the disposal of this facility
during the third quarter of 2005 and recorded a gain on sale of $5,180,000.
During the first quarter of 2006, in an eminent domain proceeding, one
of our self-storage facilities located in the Seattle, Washington market was
condemned. We received the proceeds from the condemnation of approximately
$4,257,000 in July 2006, and recorded a gain on disposition of approximately
$2,370,000 in the third quarter of 2006.
Collectively, the aforementioned facilities in Portland and Seattle are
referred to hereinafter as "the Eminent Domain Facilities". The operations of
these facilities prior to their disposition are classified as "discontinued
operations" for all periods presented on our condensed consolidated statements
of income and included under "Eminent Domain Facilities" in the table below.
17
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
The following table summarizes the historical operations of each
component of our discontinued operations:
Discontinued Operations:
------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
2006 2005 2006 2005
------------ --------- ---------- --------
(Amounts in thousands)
Rental income (a):
Eminent Domain Facilities....... $ 1 $ 281 $ 193 $ 792
Closed Facilities............... - - - 95
------------ --------- ---------- --------
Total rental income............... 1 281 193 887
------------ --------- ---------- --------
Cost of operations (a):
Eminent Domain Facilities....... 21 80 109 330
Closed Facilities............... - - - 194
------------ --------- ---------- --------
Total cost of operations.......... 21 80 109 524
------------ --------- ---------- --------
Depreciation expense (a):
Eminent Domain Facilities....... 9 41 50 121
Closed Facilities............... - - - 29
------------ --------- ---------- --------
Total depreciation ............... 9 41 50 150
Other items (b)................... 2,370 5,180 2,370 6,323
------------ --------- ---------- --------
Net discontinued operations (c)... $ 2,341 $ 5,340 $ 2,404 $ 6,536
============ ========= ========== ========
(a) These amounts represent the historical operations of the Eminent Domain
Facilities and the Closed Facilities, and include amounts previously
classified as rental income, cost of operations, and depreciation
expense in the financial statements in prior periods.
(b) For the three and nine months ended September 30, 2006 and 2005, we
recorded gains totaling $2,370,000 and $5,180,000, respectively, in
connection with the Eminent Domain Facilities (see Note 5). Also during
the nine months ended September 30, 2005, non-real estate assets of the
Closed Facilities were sold, resulting in a gain on sale of
approximately $1,143,000.
(c) Earnings per share were increased by $0.02 and $0.04 per share for the
three and nine months ended September 30, 2006, respectively, ($0.02
and $0.05 per share for the three and nine months ended September 30,
2005), due to the impact from discontinued operations.
18
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
5. Real Estate Facilities
Activity in real estate facilities is as follows:
Nine Months Ended
September 30, 2006
--------------------
(Amounts in
thousands)
Real estate facilities, at cost:
Balance at December 31, 2005........................ $ 5,930,484
Facilities consolidated pursuant to EITF 04-5 (Note 2) 22,459
Merger with Shurgard (Note 3)....................... 4,979,859
Newly developed facilities opened for operations.... 70,049
Acquisition of real estate facilities............... 103,544
Disposition of real estate facilities............... (3,505)
Acquisition of minority interests................... 49,284
Capital improvements................................ 44,366
Impact of foreign exchange rate changes............. (20,849)
--------------------
Balance at September 30, 2006....................... 11,175,691
--------------------
Accumulated depreciation:
Balance at December 31, 2005........................ (1,500,128)
Additions during the year........................... (156,395)
Dispositions during the year........................ 786
--------------------
Balance at September 30, 2006....................... (1,655,737)
--------------------
Construction in process:
Balance at December 31, 2005........................ 54,472
Current development................................. 70,903
Merger with Shurgard (Note 3)....................... 90,669
Expensing of development costs...................... (9,319)
Dispositions........................................ (4,970)
Newly developed facilities opened for operations.... (70,049)
Impact of foreign exchange rate changes............. (643)
--------------------
Balance at September 30, 2006....................... 131,063
--------------------
Total real estate facilities at September 30, 2006..... $ 9,651,017
====================
During the nine months ended September 30, 2006, we opened three newly
developed self-storage facilities (281,000 net rentable square feet) for an
aggregate cost of $49,519,000. We also completed three projects which converted
space previously used by our containerized storage business into 92,000 net
rentable square feet of self-storage space for an aggregate cost of $7,243,000.
In addition, we completed five expansion projects to existing self-storage
facilities adding 116,000 net rentable square feet for an aggregate cost of
$9,556,000, and we incurred trailing development costs with respect to
development projects completed in prior years, for an aggregate net cost of
$3,731,000.
During the nine months ended September 30, 2006, we received $466,000
of additional proceeds from a partial condemnation that occurred in 2005. These
additional proceeds are reflected as a gain on disposition of real estate on our
condensed consolidated statements of income for the three and nine months ended
September 30, 2006. During the nine months ended September 30, 2006, we disposed
of parcels of vacant land for an aggregate of $6,558,000, recording a gain of
$756,000. Also during the nine months ended September 30, 2006, we received the
proceeds, totaling $4,257,000, from the condemnation of one of our self-storage
facilities located in Seattle Washington, and recorded a gain of $2,370,000.
19
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Excluding self-storage facilities acquired in the merger with Shurgard
(see Note 3), during the nine months ended September 30, 2006, we acquired 12
self-storage facilities (872,000 net rentable square feet) from third parties at
an aggregate cost of $103,544,000, consisting of $98,954,000 in cash and assumed
mortgage debt totaling $4,590,000.
Construction in process at September 30, 2006 consists primarily of 44
projects (2,322,000 net rentable square feet) which expand or enhance the visual
and structural appeal of our existing self-storage facilities with costs
incurred of $71,707,000 at September 30, 2006 and total estimated costs to
complete of $147,525,000, and five projects (428,000 net rentable square feet)
to convert space at former containerized storage facilities into self-storage
space with costs incurred of $4,872,000 at September 30, 2006 and total
estimated costs to complete of $14,011,000. Also in connection with the merger
with Shurgard, we acquired a pipeline of future developments in existing
Shurgard markets in Europe, which at September 30, 2006 was comprised of 11
facilities (541,000 net rentable square feet) with costs incurred of
approximately $54,484,000 and total estimated costs to complete of approximately
$34,983,000.
Our policy is to capitalize interest incurred on debt during the course
of construction of our self-storage facilities. Interest capitalized for the
three and nine months ended September 30, 2006 was $530,000 and $1,599,000,
respectively. Interest capitalized for the three and nine months ended September
30, 2005 was $710,000 and $2,054,000, respectively.
6. Investment in Real Estate Entities
----------------------------------
At September 30, 2006, our investments in real estate entities consist
of ownership interests in the Unconsolidated Entities. These interests are
non-controlling interests of less than 50% and are accounted for using the
equity method of accounting. Accordingly, earnings are recognized based upon our
ownership interest in each of the entities. The accounting policies of these
entities are similar to those of the Company.
For the three and nine months ended September 30, 2006, we recognized
earnings from our investments in real estate entities of $2,618,000 and
$9,208,000, respectively, as compared to $9,853,000 and $20,382,000 for the same
periods in 2005.
Equity in earnings of real estate entities includes our pro rata share
of the net impact of gains/losses on sales of assets and impairment charges
relating to the impending sale of real estate assets as well as our pro rata
share of the impact of the application of EITF Topic D-42 on redemptions of
preferred securities recorded by PSB. Our net pro rata share from these items
resulted in a net decrease of equity in earnings of $576,000 and $282,000 for
the three and nine months ended September 30, 2006, respectively. For the three
and nine months ended September 30, 2005, our pro rata share of these items
resulted in net increases of $5,458,000 and $7,033,000, respectively. See the
condensed financial information with respect to PSB below for further
information regarding these items recorded by PSB.
We received cash distributions from our investments in real estate
entities for the nine months ended September 30, 2006 and 2005, of $15,049,000
and $17,015,000, respectively.
The following table sets forth our investments in real estate entities
at September 30, 2006 and December 31, 2005, and our equity in earnings of real
estate entities for the three and nine months ended September 30, 2006 and 2005
(amounts in thousands):
20
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Equity in Earnings of Real Equity in Earnings of Real
Investments in Real Estate Estate Entities for the Three Estate Entities for the Nine
Entities at Months Ended September 30, Months Ended September 30,
----------------------------------- ------------------------------- -----------------------------
September 30, December 31,
2006 2005 2006 2005 2006 2005
---------------- ---------------- --------------- ------------ -------------- --------------
PSB (a)...................... $ 285,260 $ 288,694 $ 2,018 $ 8,251 $ 7,634 $ 15,829
Acquisition Joint Venture.... 2,018 2,865 38 7 53 (13)
Other Investments (b)........ 14,590 36,996 562 1,595 1,521 4,566
---------------- ---------------- --------------- ------------ -------------- --------------
Total...................... $ 301,868 $ 328,555 $ 2,618 $ 9,853 $ 9,208 $ 20,382
================ ================ ============== ============== =============== ==============
(a) Equity in earnings of real estate entities includes our pro rata share
of the net impact of gains/losses on sale of assets and impairment
charges relating to the impending sale of real estate assets as well as
our pro rata share of the impact of the application of EITF Topic D-42
on redemptions of preferred securities recorded by PSB. Our net pro
rata share from these items resulted in a net decrease of equity in
earnings of $576,000 and $282,000 for the three and months ended
September 30, 2006, respectively. For the three and nine months ended
September 30, 2005, our pro rata share of these items resulted in net
increases of $5,458,000 and $7,033,000, respectively.
(b) As described in Note 2, effective January 1, 2006 we commenced
consolidating the accounts of three limited partnerships previously
accounted for under the equity method of accounting. As a result, we
decreased our investment in these partnerships by approximately
$20,846,000 on January 1, 2006.
Investment in PSB
-----------------
PS Business Parks, Inc. is a REIT traded on the American Stock
Exchange, which controls an operating partnership (collectively, the REIT and
the operating partnership are referred to as "PSB"). We have a 44% common equity
interest in PSB as of September 30, 2006. This common equity interest is
comprised of our ownership of 5,418,273 shares of PSB's common stock and
7,305,355 limited partnership units in the operating partnership at both
September 30, 2006 and December 31, 2005; these limited partnership units are
convertible at our option, subject to certain conditions, on a one-for-one basis
into PSB common stock. Based upon the closing price at September 30, 2006
($60.30 per share of PSB common stock), the shares and units had a market value
of approximately $767.2 million as compared to a book value of $285.3 million.
At September 30, 2006, PSB owned approximately 18.2 million net
rentable square feet of commercial space. In addition, PSB manages commercial
space owned by the Company and the Consolidated Entities pursuant to property
management agreements.
The following table sets forth the condensed statements of operations
for the nine months ended September 30, 2006 and 2005 (as restated for
discontinued operations), and the condensed balance sheets of PSB at September
30, 2006 and December 31, 2005. The amounts below represent 100% of PSB's
balances and not our pro rata share.
Nine Months Ended September 30,
-------------------------------------
2006 2005
---------------- -----------------
(Amounts in thousands)
Total revenue.................................... $ 180,050 $ 164,240
Cost of operations and other operating expenses.. (60,618) (52,938)
Other income and expense, net.................... 3,799 1,914
Depreciation and amortization.................... (63,720) (56,203)
Discontinued operations (a)...................... 1,643 14,549
Minority interest................................ (13,450) (12,445)
------------------ ---------------
Net income..................................... $ 47,704 $ 59,117
================== ================
21
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
September 30, December 31,
2006 2005
----------------- ----------------
(Amounts in thousands)
Total assets (primarily real estate)............. $ 1,442,588 $ 1,463,678
Total debt....................................... 43,267 25,893
Other liabilities................................ 45,357 39,126
Preferred equity and preferred minority interest. 705,250 729,100
Common equity and common minority interest....... 648,714 669,559
(a) Included in discontinued operations for the nine months ended September
30, 2006 is a net gain on disposition of real estate of $2,328,000
($16,529,000 for the same period in 2005).
Acquisition Joint Venture
-------------------------
As described more fully under "Accounting for Acquisition Joint
Venture" in Note 2, we formed a partnership (the "Acquisition Joint Venture") in
January 2004. Through December 31, 2004, the Acquisition Joint Venture had
acquired two self-storage facilities directly from third parties at an aggregate
cost of $9,086,000, of which our pro rata share was $2,930,000. Our investment
in these two facilities is accounted for using the equity method of accounting.
In December 2004, we sold seven facilities to the Acquisition Joint Venture as
well as interest in three facilities in the first quarter of 2005. Our
accounting for these ten facilities is described in Note 2.
The following table sets forth certain condensed financial information
(representing 100% of this entity's balances and not our pro rata share) with
respect to the two self-storage facilities acquired by the Acquisition Joint
Venture that we account for using the equity method of accounting:
Nine Months Ended September 30,
--------------------------------------
2006 2005
----------------- ----------------
(Amounts in thousands)
Total revenue........................................ $ 1,104 $ 961
Cost of operations and other expenses................ (407) (364)
Depreciation and amortization........................ (207) (202)
----------------- ----------------
Net income......................................... $ 490 $ 395
================= =================
September 30, December 31,
2006 2005
----------------- ----------------
(Amounts in thousands)
Total assets (primarily storage facilities).......... $ 8,350 $ 8,974
Liabilities.......................................... 82 62
Partners' equity..................................... 8,268 8,912
Other Investments
-----------------
Other Investments at September 30, 2006 consist primarily of our
aggregate 23% ownership interest in four limited partnerships (collectively, the
"Other Investments") owning an aggregate of 20 storage facilities. The following
table sets forth certain condensed financial information (representing 100% of
these entities' balances and not our pro rata share) with respect to Other
Investments:
22
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Nine Months Ended September 30,
--------------------------------------
2006 2005
------------------ ------------------
(Amounts in thousands)
Total revenue........................................ $ 11,989 $ 11,356
Cost of operations and other expenses................ (4,512) (4,344)
Depreciation and amortization........................ (1,305) (1,331)
------------------ ------------------
Net income......................................... $ 6,172 $ 5,681
================== ==================
September 30, December 31,
2006 2005
------------------ ------------------
(Amounts in thousands)
Total assets (primarily storage facilities).......... $ 40,298 $ 39,813
Other liabilities.................................... 1,280 1,178
Partners' equity..................................... 39,018 38,635
7. Revolving Line of Credit
------------------------
We have a revolving line of credit (the "Credit Agreement") with an
aggregate limit with respect to borrowings and letters of credit of
$200,000,000, that has a maturity date of April 1, 2007 and bears an annual
interest rate ranging from the London Interbank Offered Rate ("LIBOR") plus
0.50% to LIBOR plus 1.20% depending on our credit ratings (currently LIBOR plus
0.50%). In addition, we are required to pay a quarterly commitment fee ranging
from 0.15% per annum to 0.30% per annum depending on our credit ratings
(currently the fee is 0.15% per annum).
The Credit Agreement includes various covenants, the more significant
of which require us to (i) maintain a balance sheet leverage ratio of less than
0.55 to 1.00, (ii) maintain certain quarterly interest and fixed-charge coverage
ratios (as defined therein) of not less than 2.25 to 1.0 and 1.5 to 1.0,
respectively, and (iii) maintain a minimum total shareholders' equity (as
defined therein). In addition, we are limited in our ability to incur additional
borrowings (we are required to maintain unencumbered assets with an aggregate
book value equal to or greater than 1.5 times our unsecured recourse debt). We
were in compliance with all covenants of the Credit Agreement at September 30,
2006. At September 30, 2006 and November 8, 2006, we had no outstanding
borrowings on our line of credit.
At September 30, 2006 and November 8, 2006, excluding Shurgard, we had
undrawn standby letters of credit totaling $17,919,000. The beneficiaries of
these standby letters of credit were certain insurance companies associated with
our captive insurance and tenant re-insurance activities. At September 30, 2006
and November 8, 2006, we had undrawn standby letters of credit totaling
$3,149,000 assumed in the merger with Shurgard. The beneficiaries of these
standby letters of credit were certain insurance companies associated with
Shurgard's workers' compensation program and as collateral for certain
construction projects and a mortgage note.
8. Notes Payable
-------------
The carrying amounts of our notes payable at September 30, 2006 and
December 31, 2005 consist of the following:
23
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
September 30, December 31,
2006 2005
--------------- ---------------
(Amounts in thousands)
DOMESTIC NOTES PAYABLE:
5.875% effective and stated note rate, principal due in
March 2013 (a)...................................... $ 200,000 $ -
5.73% effective rate, 7.75% stated note rate, principal due in
February 2011(carrying amount includes $15,004 of unamortized
premium at September 30, 2006) (a)...................... 215,004 -
6.53% effective rate, 7.625% stated note rate, note principal
due in April 2007 (carrying amount includes $304 of unamortized
premium at September 30, 2006) (a)..................... 50,304 -
7.66% senior unsecured note due January 2007............... 11,200 22,400
DOMESTIC MORTGAGE NOTES:
Fixed rate mortgage notes payable, secured by 64 real estate
facilities with a net book value of $802,100 at September 30, 2006,
average effective interest rates of 5.59% and stated note rates
between 4.95% and 8.78%, due between December 2006 and August 2015
(carrying amount includes $4,683 of unamortized premium
at September 30, 2006) (b).............................. 169,751 -
Variable rate mortgage notes payable, secured by seven real
estate facilities with a net book value of $57,300 at
September 30, 2006, (average interest rate of 7.29%
at September 30, 2006), due between December 2007
and August 2010 (b)...................................... 12,332 -
Fixed rate mortgage notes payable, secured by 35 real estate
facilities with a net book value of $204,200 at September 30, 2006,
stated note rates between 5.05% and 8.75%, principal and
interest payable monthly, due at varying dates between October 2009
and September 2028 (carrying amount includes $4,708 of unamortized
premium at September 30, 2006 ) (c).................... 92,808 91,550
EUROPEAN NOTES PAYABLE ASSUMED FROM SHURGARD:
EUR 325 notes payable due in 2011, collateralized by 101 real estate
facilities with a net book value of $784,871 at September 30, 2006
(interest rate of EURIBOR + 0.51%, 3.578% average for quarter ended
September 30, 2006,
3.928% rate at September 30, 2006)...................... 412,280 -
First and Second Shurgard credit agreement, due in 2008 and
2009, secured by 53 real estate facilities with a net book value of
$363,970 at September 30, 2006 (interest rate of EURIBOR + 2.25%,
5.345% average for quarter ended September 30, 2006, 5.455% rate
at September 30, 2006).................................. 256,501 -
Liability under Capital Leases............................. 6,353 -
------------------- --------------
Total notes payable................................. $ 1,426,533 $ 113,950
================== ==============
(a) We assumed the 5.875%, 7.75%, and 7.625% notes payable in connection
with the merger with Shurgard. The notes were recorded at their
estimated fair value based upon the estimated market rate upon
assumption of approximately 5.875%, 5.73%, and 6.53%, respectively, an
aggregate of approximately $465,692,000 as compared to the actual
assumed balances of an aggregate $450,000,000. This initial premium of
$15,692,000 is amortized over the remaining term of the notes using the
effective interest method.
24
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
(b) We assumed additional domestic mortgage notes in connection with the
merger with Shurgard. The mortgage notes were recorded at their
estimated fair value based upon the estimated market rate upon
assumption of approximately 5.71%, an aggregate of approximately
$184,592,000 as compared to the actual assumed balances of an aggregate
$179,827,000. This initial premium of $4,765,000 is amortized over the
remaining term of the mortgage notes using the effective interest
method.
(c) We assumed a 5.58% mortgage note in connection with a property
acquisition during the first quarter of 2006. This note was recorded at
the stated rate, which we believe approximates the market rate for
similar mortgage notes.
The domestic notes payable require interest and principal payments to
be paid semi-annually and have various restrictive covenants, all of which have
been met at September 30, 2006. Balances at September 30, 2006 include
$476,508,000 in domestic notes payable acquired in the merger with Shurgard,
which includes $15,308,000 of unamortized premium.
The domestic mortgage notes require interest and principal payments to
be paid monthly and have various restrictive covenants, all of which have been
met at September 30, 2006.
We assumed a 5.58% mortgage note in connection with a property
acquisition during the first quarter of 2006. The note was recorded at the
stated rate, which we believe approximates the market rate for similar mortgage
notes.
We also assumed an additional $671,047,000 in debt in the merger with
Shurgard, comprised of Shurgard's line of credit totaling $603,772,000, and
certain variable rate notes totaling $67,275,000. This debt was repaid
immediately following the merger.
Balances at September 30, 2006 include $182,083,000 in domestic
mortgage notes payable acquired in the merger with Shurgard, which includes
$4,683,000 of unamortized premium.
First Shurgard and Second Shurgard have senior credit agreements
denominated in euros to borrow, in aggregate, up to EUR 271.1 million ($343.9
million as of September 30, 2006). As of September 30, 2006, the available
amount under those credit facilities was, in aggregate, EUR 68.9 million ($87.4
million). Our draws under the First Shurgard and Second Shurgard credit
facilities are determined on a development project basis, or on an acquisition
project basis when applicable for Second Shurgard, and can be limited if the
completion of projects is not timely and if we have certain cost overruns. The
credit facilities also require us to maintain a maximum loan to value of the
collateral ratio and a minimum debt service ratio. As of September 30, 2006, we
were in compliance with these financial covenants.
At September 30, 2006, approximate principal maturities of our notes
payable are as follows (amounts in thousands):
Domestic
Domestic Mortgage Notes European Capital Leases
Notes Payable Payable Notes Payable - Europe Total
--------------- --------------- --------------- ---------------- ------------
2006 (remainder of).......... $ 135 $ 6,470 $ 1,522 $ 251 $ 8,378
2007......................... 64,391 11,587 7,421 672 84,071
2008......................... 3,201 27,852 153,685 685 185,423
2009......................... 3,390 9,371 93,873 698 107,332
2010......................... 3,590 17,753 - 648 21,991
Thereafter................... 401,801 201,858 412,280 3,399 1,019,338
--------------- --------------- --------------- ---------------- ------------
$ 476,508 $ 274,891 $ 668,781 $6,353 $1,426,533
============== =============== ============== ================ ============
Weighted average rate........ 5.9% 5.6% 4.4% 9.9% 5.2%
============== =============== ============== ================ ============
25
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
We incurred interest expense with respect to our notes payable
aggregating $12,075,000 and $5,800,000 for the nine months ended September 30,
2006 and 2005, respectively. These amounts were comprised of $13,043,000 and
$6,574,000 in cash for the nine months ended September 30, 2006 and 2005,
respectively, less $968,000 and $774,000 in amortization of premium,
respectively.
9. Debt to Joint Venture Partner
-----------------------------
As described more fully in Note 2, our partner's equity contributions
with respect to certain transactions has been classified as debt under the
caption "Debt to Joint Venture Partner." The balances of $37,214,000 and
$35,697,000 as of September 30, 2006 and December 31, 2005, approximate the fair
value of our partners' interest in these facilities as of each respective date.
We increased the note balance by $1,386,000 at September 30, 2006 as a result of
our periodic review of fair value as described in Note 2.
A total of $2,276,000 and $2,182,000 was recorded as interest expense
on our condensed consolidated statements of income with respect to our Debt to
Joint Venture Partner during the nine months ended September 30, 2006 and 2005,
respectively, representing our partner's pro rata share of net earnings with
respect to the properties we sold to the Acquisition Joint Venture (an 8.5%
return on their investment). This interest expense was comprised of a total of
$2,146,000 and $2,052,000 paid to our joint venture partner (an 8.0% return
payable currently in accordance with the partnership agreement) during the nine
months ended September 30, 2006 and 2005, respectively, and increases in the
Debt to Joint Venture Partner of $130,000 for each of the nine month periods
ended September 30, 2006 and 2005, respectively.
We expect that this debt will be repaid during 2008, assuming that we
exercise our option to acquire our partner's interest in the Acquisition Joint
Venture.
10. Derivative Financial Instruments
--------------------------------
As described in Note 2, under Derivative Financial Instruments, we
report these derivative financial instruments at fair value on our unaudited
condensed consolidated balance sheet at September 30, 2006 and changes in fair
values from the date of the Shurgard merger through September 30, 2006, have
been recognized in earnings. The respective balances of these financial
instruments are included in other assets and accrued and other liabilities as
follows:
September 30, 2006
-------------------
(Amounts in
thousands)
Assets:
Debt-related contracts.............................. $ 3,553
Foreign currency exchange contracts................. 1,243
------------------
$ 4,796
==================
Liabilities:
Debt-related contracts.............................. $ (5,097)
Foreign currency exchange contracts................. (4,721)
------------------
$ (9,818)
==================
11. Minority Interest
-----------------
In consolidation, we classify ownership interests in the net assets of
each of the Consolidated Entities, other than our own, as minority interest on
the condensed consolidated financial statements. Minority interest in income
consists of the minority interests' share of the operating results of the
Consolidated Entities.
26
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Preferred Partnership Interests
The following table summarizes the preferred partnership units
outstanding at September 30, 2006 and December 31, 2005:
September 30, 2006 December 31,2005
-------------------------- --------------------------
Earliest Redemption
Date or Dates Distribution Units Carrying Units Carrying
Series Redeemed Rate Outstanding Amount Outstanding Amount
------------------ -------------------- ------------ ------------ ---------- -------------- ------------
(Amounts in thousands)
Series NN........ March 17, 2010 6.400% 8,000 $ 200,000 8,000 $ 200,000
Series Z......... October 12, 2009 6.250% 1,000 25,000 1,000 25,000
Series J......... May 9, 2011 7.250% 4,000 100,000 - -
---------- ----------- -------------- --------------
Total............ 13,000 $ 325,000 9,000 $ 225,000
========== =========== ============== ==============
Income allocated to the preferred minority interests totaled
$13,652,000 and $13,430,000 for the nine months ended September 30, 2006 and
2005, respectively, comprised of distributions paid and the allocation of income
resulting from the application of EITF Topic D-42 (see below).
On March 17, 2005, we redeemed all outstanding 9.5% Series N Preferred
Units ($40,000,000) and on March 29, 2005 we redeemed all outstanding 9.125%
Series O Preferred Units ($45,000,000), for their face value plus accrued
distributions, for cash. The redemption of these Preferred Units resulted in an
increase in income allocated to minority interests and a reduction to the
Company's net income for the three months ended March 31, 2005 of $874,000 as a
result of the application of the SEC's clarification of EITF Topic D-42 which
allocates the excess of the stated amount of the preferred units over their
carrying amount to the holders of the redeemed securities.
On May 9, 2006, one of the Consolidated Entities issued 4,000,000 units
of our 7.25% Series J Preferred Partnership Units for cash proceeds of
$100,000,000.
Subject to certain conditions, the Series NN preferred units are
convertible into shares of our 6.40% Series NN Cumulative Preferred Stock, the
Series Z preferred units are convertible into shares of our 6.25% Series Z
Cumulative Preferred Stock and the Series J preferred units are convertible into
shares of our 7.25% Series J Cumulative Preferred Stock. The holders of the
Series Z preferred partnership units, have a one-time option exercisable five
years from issuance (October 12, 2009), to require us to redeem their units for
$25,000,000 in cash, plus any unpaid distribution.
Other Partnership Interests
---------------------------
Income is allocated to the minority interests based upon their pro rata
interest in the operating results of the Consolidated Entities. The following
tables set forth the minority interests at September 30, 2006 and December 31,
2005 as well as the income allocated to minority interests for the three and
nine months ended September 30, 2006 and 2005 with respect to the other
partnership interests (amounts in thousands):
27
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Minority Interest at
--------------------------------
September 30, December 31,
Description 2006 2005
------------------------------------------ -------------- ---------------
Convertible Partnership Units........... $ 6,031 $ 6,177
Newly Consolidated Partnerships.......... 4,372 -
Shurgard domestic joint ventures......... 8,912 -
Shurgard European joint ventures......... 131,983 -
Other consolidated partnerships.......... 23,406 22,793
------------- --------------
Total other partnership interests........ $ 174,704 $ 28,970
============= ==============
Minority Interests in Income (Loss) Minority Interests in Income (Loss)
for the Three Months Ended for the Nine Months Ended
----------------------------------- -----------------------------------
September 30, September 30, September 30, September 30,
Description 2006 2005 2006 2005
----------------------------------------- -------------- --------------- -------------- --------------
Convertible Partnership Units.......... $ 120 $ 148 $ 356 $ 350
Consolidated Development Joint Venture.. - 826 - 4,229
Newly Consolidated Partnerships......... 1,468 - 3,641 -
Shurgard domestic joint ventures........ 192 - 192 -
Shurgard European joint ventures........ (1,279) - (1,279) -
Other consolidated partnerships......... 2,686 2,678 7,915 8,346
------------- -------------- --------------- --------------
Total other partnership interests....... $ 3,187 $ 3,652 $ 10,825 $ 12,925
============= =============== =============== ==============
Distributions paid to minority interests for the three months ended
September 30, 2006 and 2005 were $3,570,000 and $2,607,000, respectively and for
the nine months ended September 30, 2006 and 2005 were $11,037,000 and
$11,805,000, respectively.
Convertible Partnership Units
-----------------------------
As of September 30, 2006, one of the Consolidated Entities had
approximately 231,978 convertible operating partnership units ("Convertible
Units") outstanding (237,934 at December 31, 2005) representing a limited
partnership interest in the partnership. The Convertible Units are convertible
on a one-for-one basis (subject to certain limitations) into our common stock at
the option of the unit-holder. Minority interest in income with respect to the
Convertible Units reflects the Convertible Units' share of our net income, with
net income allocated to minority interests with respect to weighted average
outstanding Convertible Units on a per unit basis equal to diluted earnings per
common share. During the three months ended September 30, 2006, a total of 5,956
units were converted into common shares (none during 2005). As a result of this
conversion, minority interest was reduced by $155,000.
Consolidated Development Joint Venture
--------------------------------------
In November 1999, we formed a development joint venture (the
"Consolidated Development Joint Venture") with a joint venture partner (PSAC
Storage Investors, LLC, referred to as "PSAC") whose partners included a third
party institutional investor and B. Wayne Hughes ("Mr. Hughes"), the Chairman of
the Board of the Company, to develop approximately $100,000,000 of self-storage
facilities and to purchase $100,000,000 of the our Equity Stock, Series AAA (see
Note 12). We owned a controlling interest in the Consolidated Development Joint
Venture and included the accounts of this partnership in our consolidated
financial statements since its inception. PSAC's interest in the Consolidated
Development Joint Venture was accounted for as minority interest, as denoted in
the above table.
28
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
On August 5, 2005, we acquired the institutional investor's interest in
PSAC for approximately $41,420,000 in cash and on November 17, 2005, we acquired
the remaining interest in PSAC from Mr. Hughes for $64,513,000 in cash.
Newly Consolidated Partnerships
-------------------------------
As further described in Note 2, effective January 1, 2006 we commenced
consolidating the accounts of three partnerships that we had previously
accounted for under the equity method of accounting. This consolidation resulted
in a $3,963,000 increase in minority interest on January 1, 2006. Effective
January 1, 2006, the income allocated to the interests we do not own in these
three partnerships is shown in the table above under Newly Consolidated
Partnerships.
Shurgard European Joint Ventures
--------------------------------
Through the merger with Shurgard, we acquired two joint venture
entities: First Shurgard SPRI (First Shurgard) formed in January 2003 and Second
Shurgard SPRL (Second Shurgard) formed in May 2004. Those joint ventures were
expected to develop or acquire up to approximately 75 storage facilities in
Europe. Shurgard Europe has a 20% interest in each of these ventures. We have
determined that First Shurgard and Second Shurgard are each VIEs, and that we
are the primary beneficiary. Accordingly, First Shurgard and Second Shurgard
have been consolidated in our unaudited condensed consolidated financial
statements. At September 30, 2006, First Shurgard and Second Shurgard had
aggregate total assets of $449.3 million, total liabilities of $284.3 million,
and credit facilities collateralized by assets with net book value of $256.5
million. As of September 30, 2006, First Shurgard's and Second Shurgard's
creditors had no recourse to the general credit of Public Storage or Shurgard
Europe other than a commitment, previously made by Shurgard, to subscribe to up
to $20 million and an additional EUR 7.5 million ($9.5 million as of September
30, 2006) in preferred bonds in order for First Shurgard to fulfill its
obligations under its senior credit agreement. We have an option to put 80% of
the bonds issued by First Shurgard to Crescent Euro Self Storage Investments,
Shurgard Europe's partner in the joint venture.
On September 5, 2006, we informed the joint venture partners of First
Shurgard and second Shurgard of our intention to purchase their interests in
First Shurgard and Second Shurgard, pursuant to an "exit procedure" that we
believe is provided for in the respective agreements. Our joint venture partners
currently contest whether we have the right to purchase their interests under
this procedure and, accordingly, it is uncertain as to whether we will acquire
their interests pursuant to these provisions.
On August 24, 2006, we informed the joint venture partners of First
Shurgard and Second Shurgard of our intention to purchase their interests in
First Shurgard and Second Shurgard, pursuant to an "exit procedure" that we
believe is provided for in the respective agreements. Our joint venture partners
currently contest whether we have the right to purchase their interests under
this procedure and, accordingly, it is uncertain as to whether we will acquire
their interest pursuant to these provisions.
Shurgard Domestic Joint Ventures
--------------------------------
Following the merger with Shurgard, we acquired the minority interests
in certain of Shurgard's joint ventures, for an aggregate of approximately
$60,799,000 in cash. As a result of these transactions, we obtained the
remaining interest in a total of 67 facilities. This acquisition was recorded as
a reduction in minority interest totaling $11,515,000, with the remainder
allocated to real estate ($49,284,000).
29
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
The partnership agreements of the Shurgard Joint Ventures have
termination dates that cannot be unilaterally extended by the Company and, upon
termination of each partnership, the net assets of these entities would be
liquidated and paid to the minority interests and the Company based upon their
relative ownership interests.
Other Consolidated Partnerships
-------------------------------
The partnership agreements of the Other Consolidated Partnerships
included in the table above have termination dates that cannot be unilaterally
extended by the Company and, upon termination of each partnership, the net
assets of these entities would be liquidated and paid to the minority interests
and the Company based upon their relative ownership interests.
At September 30, 2006, the Other Consolidated Partnerships reflect
common equity interests that we do not own in 22 entities owning an aggregate of
73 self-storage facilities.
In January 2005, we acquired a portion of the minority interest we did
not own in one of the Consolidated Entities for an aggregate of $4,366,000 in
cash. The acquisition resulted in the reduction of minority interest by
$2,828,000 with the excess of cost over underlying book value ($1,538,000)
allocated to real estate.
In April 2005, we acquired minority interests we did not own in two
Consolidated Entities for an aggregate of $32,432,000 in cash. The acquisition
resulted in a reduction of minority interest of $15,394,000 with the excess of
cost over underlying book value ($17,038,000) allocated to real estate.
In August 2005, we acquired the remaining minority interests we did not
own in the Consolidated Entities for an aggregate of $14,597,000 in cash. The
acquisition resulted in a reduction of minority interest of $7,151,000 with the
excess of cost over underlying book value ($7,446,000) allocated to real estate.
Impact of SFAS No. 150
----------------------
In May 2003, the FASB issued Statement of Financial Accounting
Standards No. 150 - "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity" ("SFAS No. 150"). This statement
prescribes reporting standards for financial instruments that have
characteristics of both liabilities and equity. This standard generally
indicates that certain financial instruments that give the issuer a choice of
setting an obligation with a variable number of securities or settling an
obligation with a transfer of assets, any mandatorily redeemable security, and
certain put options and forward purchase contracts, should be classified as a
liability on the balance sheet. With the exception of minority interests,
described above, we implemented SFAS No. 150 on July 1, 2003, and the adoption
had no impact on our accompanying condensed consolidated financial statements.
30
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
12. Shareholders' Equity
--------------------
Cumulative Preferred Stock
--------------------------
At September 30, 2006 and December 31, 2005, we had the following
series of Cumulative Preferred Stock outstanding:
At September 30, 2006 At December 31, 2005
------------------------------ --------------------------
Earliest
Redemption Dividend Shares Carrying Shares Carrying
Series Date (a) Rate Outstanding Amount Outstanding Amount
---------------- --------------- ------------ -------------- ------------- -------------- ------------
(Dollar amounts in thousands)
Series R 9/28/06 8.000% - $ - 20,400 $ 510,000
Series S 10/31/06 7.875% - - 5,750 143,750
Series T 1/18/07 7.625% 6,086 152,150 6,086 152,150
Series U 2/19/07 7.625% 6,000 150,000 6,000 150,000
Series V 9/30/07 7.500% 6,900 172,500 6,900 172,500
Series W 10/6/08 6.500% 5,300 132,500 5,300 132,500
Series X 11/13/08 6.450% 4,800 120,000 4,800 120,000
Series Y 1/2/09 6.850% 1,600,000 40,000 1,600,000 40,000
Series Z 3/5/09 6.250% 4,500 112,500 4,500 112,500
Series A 3/31/09 6.125% 4,600 115,000 4,600 115,000
Series B 6/30/09 7.125% 4,350 108,750 4,350 108,750
Series C 9/13/09 6.600% 4,600 115,000 4,600 115,000
Series D 2/28/10 6.180% 5,400 135,000 5,400 135,000
Series E 4/27/10 6.750% 5,650 141,250 5,650 141,250
Series F 8/23/10 6.450% 10,000 250,000 10,000 250,000
Series G 12/12/10 7.000% 4,000 100,000 4,000 100,000
Series H 1/19/11 6.950% 4,200 105,000 - -
Series I 5/3/11 7.250% 20,700 517,500 - -
Series K 8/8/11 7.250% 18,400 460,000 - -
------------- -------------- ----------- -------------
Total Cumulative Preferred Stock 1,715,486 $ 2,927,150 1,698,336 $ 2,498,400
============= ============== =========== =============
(a) Except under certain conditions relating to the Company's qualification
as a REIT, the Cumulative Preferred Stock are not redeemable prior to
the dates indicated. On or after the dates indicated, each series of
Cumulative Preferred Stock will be redeemable, at our option, in whole
or in part, at $25.00 per depositary share (or per share in the case of
the Series Y), plus accrued and unpaid dividends.
The holders of our Cumulative Preferred Stock have general preference
rights with respect to liquidation and quarterly distributions. Holders of the
preferred stock, except under certain conditions and as noted below, will not be
entitled to vote on most matters. In the event of a cumulative arrearage equal
to six quarterly dividends or failure to maintain a Debt Ratio (as defined) of
50% or less, holders of all outstanding series of preferred stock (voting as a
single class without regard to series) will have the right to elect two
additional members to serve on the Company's Board of Directors until events of
default have been cured. At September 30, 2006, there were no dividends in
arrears and the Debt Ratio was 12.8%.
Upon issuance of our Cumulative Preferred Stock, we classify the
liquidation value as preferred stock on our consolidated balance sheet with any
issuance costs recorded as a reduction to paid-in capital. Upon redemption, we
apply EITF Topic D-42, allocating income to the preferred shareholders equal to
the original issuance costs.
31
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
On January 19, 2006, we issued 4,000,000 depositary shares, with each
depositary share representing 1/1,000 of a share of our 6.95% Cumulative
Preferred Stock, Series H. The offering resulted in $100,000,000 of gross
proceeds. On January 27, 2006, we issued an additional 200,000 depository
shares, with each depositary share representing 1/1,000 of a share of our 6.95%
Cumulative Preferred Stock, Series H resulting in $5,000,000 of gross proceeds.
On May 3, 2006, we issued 20,700,000 depositary shares, with each depositary
share representing 1/1,000 of a share of our 7.25% Cumulative Preferred Stock,
Series I. The offering resulted in approximately $517,500,000 of gross proceeds.
During the first quarter of 2006, we redeemed our 8.60% Series Q
Cumulative Preferred Stock for $172,500,000 plus accrued and unpaid dividends.
The Series Q Cumulative Preferred Stock was called for redemption in December
2005; accordingly, the redemption value of $172,500,000 was classified as a
liability at December 31, 2005.
During 2005, we issued four series of Cumulative Preferred Stock:
Series D - issued February 28, 2005, net proceeds totaling $130,548,000, Series
E - issued April 27, 2005, net proceeds totaling $136,601,000, Series F - issued
August 23, 2005, net proceeds totaling $242,550,000 and Series G - issued
December 12, 2005, aggregate net proceeds totaling $96,886,000.
During the third quarter of 2006, we issued 18,400,000 depositary
shares each representing 1/1,000 of a share our 7.25% Cumulative Preferred
Stock, Series K, for gross proceeds of approximately $460 million (including the
underwriters' overallotment option, which was exercised).
On September 26, 2006, we called for redemption all outstanding
depositary shares representing interests in our 7.875% Cumulative Preferred
Stock Series S. The redemption occurred on October 31, 2006. The aggregate
redemption amount paid to all holders of the depositary shares, before payment
of accrued dividends, was approximately $143,750,000. The redemption value of
$143,750,000 is classified as a liability at September 30, 2006 on our unaudited
condensed consolidated balance sheet.
On September 28, 2006, we redeemed all of our outstanding 8.00% Series
R Cumulative Preferred Stock for $510,000,000 plus accrued and unpaid dividends.
Subsequent to September 30, 2006, we issued 9,200,000 depositary shares
each representing 1/1,000 of a share our 6.75% Cumulative Preferred Stock,
Series L, for gross proceeds of approximately $230,000,000.
Equity Stock
-------------
The Company is authorized to issue 200,000,000 shares of Equity Stock.
The Articles of Incorporation provide that the Equity Stock may be issued from
time to time in one or more series and gives the Board of Directors broad
authority to fix the dividend and distribution rights, conversion and voting
rights, redemption provisions and liquidation rights of each series of Equity
Stock.
Equity Stock, Series A
-----------------------
At September 30, 2006 and December 31, 2005, we had 8,744,193
depositary shares outstanding, each representing 1/1,000 of a share of Equity
Stock, Series A ("Equity Stock A"). The Equity Stock A ranks on parity with
common stock and junior to the Cumulative Preferred Stock with respect to
general preference rights and has a liquidation amount which cannot exceed
$24.50 per share. Distributions with respect to each depositary share shall be
the lesser of: (i) five times the per share dividend on our common stock or (ii)
$2.45 per annum. We have no obligation to pay distributions on the depositary
shares if no distributions are paid to common shareholders.
32
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Except in order to preserve the Company's Federal income tax status as
a REIT, we may not redeem the depositary shares before March 31, 2010. On or
after March 31, 2010, we may, at our option, redeem the depositary shares at
$24.50 per depositary share. If the Company fails to preserve its Federal income
tax status as a REIT, the depositary shares will be convertible at the option of
the shareholder into .956 shares of common stock. The depositary shares are
otherwise not convertible into common stock. Holders of depositary shares vote
as a single class with holders of our common stock on shareholder matters, but
the depositary shares have the equivalent of one-tenth of a vote per depositary
share.
Equity Stock, Series AAA
------------------------
In November 1999, we sold $100,000,000 (4,289,544 shares) of Equity
Stock, Series AAA ("Equity Stock AAA") to the Consolidated Development Joint
Venture. On November 17, 2005, upon the acquisition of Mr. Hughes' interest in
PSAC, we owned 100% of the partnership interest in the Consolidated Development
Joint Venture. For all periods presented, the Equity Stock, Series AAA and
related dividends are eliminated in consolidation.
Common Stock
------------
During the nine months ended September 30, 2006, we issued 168,575
shares of our Common Stock in connection with employee stock-based compensation.
On August 22, 2006, we issued 38,913,187 shares of our Common Stock in
connection with our merger with Shurgard (see Note 3). Subsequent to the
acquisition, we also issued 1,808,962 shares of our Common Stock to former
employees of Shurgard in connection with employee stock-based compensation
arrangements that existed at the time of the acquisition.
At September 30, 2006 and December 31, 2005, certain entities we
consolidate owned 1,146,207 shares of our Common Stock. These shares continue to
be legally issued and outstanding. In the consolidation process, these shares
and the related balance sheet amounts have been eliminated. In addition, these
shares are not included in the computation of weighted average shares
outstanding.
The following chart reconciles our legally issued and outstanding
shares of Common Stock and the reported outstanding shares of Common Stock at
September 30, 2006 and December 31, 2005:
September 30, December 31,
Reconciliation of Common Shares Outstanding 2006 2005
----------------------------------------------- -------------- --------------
Legally issued and outstanding shares....... 170,132,450 129,235,770
Less - Shares owned by entities we consolidate
that are eliminated in consolidation.... (1,146,207) (1,146,207)
-------------- --------------
Reported issued and outstanding shares...... 168,986,243 128,089,563
============== ==============
Dividends
---------
The following table summarizes dividends declared and paid during the
nine months ended September 30, 2006:
33
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Distributions Per
Share or Depositary Share Total Distributions
--------------------------- --------------------
Preferred Stock:
----------------
Series Q.............................. $0.108 $ 742,000
Series R.............................. $1.483 30,255,000
Series S.............................. $1.477 8,490,000
Series T.............................. $1.430 8,700,000
Series U.............................. $1.430 8,580,000
Series V.............................. $1.406 9,703,000
Series W.............................. $1.219 6,459,000
Series X.............................. $1.209 5,805,000
Series Y.............................. $1.284 2,055,000
Series Z.............................. $1.172 5,274,000
Series A.............................. $1.148 5,283,000
Series B.............................. $1.336 5,811,000
Series C.............................. $1.238 5,694,000
Series D.............................. $1.159 6,258,000
Series E.............................. $1.266 7,152,000
Series F.............................. $1.209 12,093,000
Series G.............................. $1.313 5,250,000
Series H.............................. $1.219 5,121,000
Series I.............................. $0.750 15,529,000
Series K.............................. $0.272 5,002,000
--------------
159,256,000
Common Stock:
Equity Stock, Series A................ $1.838 16,068,000
Common ............................... $1.500 213,281,000
---------------
Total dividends.................... $ 388,605,000
===============
The dividend rate on the common stock was $0.50 per common share and
$1.50 per common share for the three and nine months ended September 30, 2006,
respectively. The dividend rate on the Equity Stock A was $0.6125 per depositary
share and $1.8375 per depositary share for the three and nine months ended
September 30, 2006, respectively.
13. Segment Information
-------------------
Description of Each Reportable Segment
--------------------------------------
Our reportable segments reflect significant operating activities that
are evaluated separately by management. We have five reportable segments:
self-storage - Domestic operations, self-storage - Foreign operations,
containerized storage operations, commercial property operations, and ancillary
operations. These segments are organized generally based upon their operating
characteristics.
34
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
The self-storage - Domestic segment comprises the direct ownership,
development, and operation of traditional storage facilities in the U.S., and
the ownership of equity interests in entities that own storage properties in the
U.S. The self-storage - European segment comprises the direct ownership,
development, and operation of storage facilities in Europe. The containerized
storage operations represent another segment. The commercial property segment
reflects our interest in the ownership, operation, and management of commercial
properties. The vast majority of the commercial property operations are
conducted through PSB, and to a much lesser extent the Company and certain of
its unconsolidated subsidiaries own commercial space, managed by PSB, within
facilities that combine storage and commercial space for rent. The ancillary
operations include four sources of operating income: (i) the reinsurance of
policies against losses to goods stored by tenants in our self-storage
facilities, (ii) sale of merchandise at our self-storage facilities, (iii) truck
rentals at our self-storage facilities and (iv) management of facilities owned
by third-party owners and facilities owned by the Unconsolidated Entities.
Measurement of Segment Profit or Loss
-------------------------------------
We evaluate performance and allocate resources based upon the net
segment income of each segment. Net segment income represents net income in
conformity with GAAP and our significant accounting policies as denoted in Note
2, before interest and other income, interest expense, corporate general and
administrative expense, and minority interest in income. The accounting policies
of the reportable segments are the same as those described in the Summary of
Significant Accounting Policies.
Interest and other income, interest expense, corporate general and
administrative expense, minority interest in income and gains and losses on
sales of real estate assets are not allocated to segments because management
does not utilize them to evaluate the results of operations of each segment.
Measurement of Segment Assets
-----------------------------
No segment data relative to assets or liabilities is presented, because
we do not consider the historical cost of our real estate facilities and
investments in real estate entities in evaluating the performance of operating
management or in evaluating alternative courses of action. The only other types
of assets that might be allocated to individual segments are trade receivables,
payables, and other assets that arise in the ordinary course of business, but
they are also not a significant factor in the measurement of segment
performance.
Presentation of Segment Information
-----------------------------------
The following table reconciles the revenues of each segment to our
total revenues (thousands):
RECONCILIATION OF REVENUES BY SEGMENT
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------- ------------------------------
2006 2005 2006 2005
-------------- -------------- -------------- -------------
Self-Storage - Domestic...... $ 311,493 $ 243,702 $ 825,403 $ 706,303
Self-Storage - European...... 17,348 - 17,348 -
Commercial properties........ 3,408 2,918 9,413 8,693
Containerized storage facilities 4,353 4,480 12,483 12,305
Ancillary operations......... 22,106 17,587 55,649 48,803
Interest and other income not
allocated to segment......... 12,651 4,717 27,773 11,004
-------------- -------------- -------------- -------------
Total Revenues............ $ 371,359 $ 273,404 $ 948,069 $ 787,108
============== =============== ============== ==============
35
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
The following table reconciles the performance of each segment, in
terms of segment income, to our consolidated net income.
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ---------------------------
2006 2005 2006 2005
------------- ------------ ------------- -----------
(Amounts in thousands)
Reconciliation of Net Income by Segment:
Self-storage - Domestic
Self-storage net operating income before depreciation
and amortization .................................... $ 210,801 $ 163,429 $ 547,551 $ 463,984
Depreciation and amortization............................ (97,689) (47,021) (194,747) (139,863)
Equity in earnings - self-storage property operations.... 621 1,649 1,721 4,725
Discontinued operations (Note 4) ........................ 2,341 5,340 2,404 5,521
------------- ------------ ------------- -----------
Total self-storage - Domestic segment net income..... 116,074 123,397 356,929 334,367
------------- ------------ ------------- -----------
Self-storage - European
Self-storage net operating income before depreciation
and amortization .................................... 8,824 - 8,824 -
Depreciation and amortization............................ (15,020) - (15,020) -
------------- ------------ ------------- -----------
Total self-storage - European segment net income..... (6,196) - (6,196) -
------------- ------------ ------------- -----------
Commercial properties
Commercial properties net operating income before
depreciation and amortization......................... 1,911 1,796 5,333 5,401
Depreciation and amortization............................ (643) (562) (1,777) (1,721)
Equity in earnings - commercial property operations...... 8,885 9,385 26,741 26,978
------------- ------------ ------------- -----------
Total commercial property segment net income......... 10,153 10,619 30,297 30,658
------------- ------------ ------------- -----------
Containerized storage
Containerized storage net operating income before
depreciation............................................. 446 804 1,047 2,613
Containerized storage depreciation....................... (179) (313) (662) (2,490)
Discontinued operations (Note 4) ........................ - - - 1,015
------------- ------------ ------------- -----------
Total containerized storage segment net income....... 267 491 385 1,138
------------- ------------ ------------- -----------
Ancillary Operations
Revenue less cost of operations......................... 8,659 5,974 19,890 16,633
------------- ------------ ------------- -----------
Other items not allocated to segments
General and administrative and other included in equity in
earnings.............................................. (6,888) (1,181) (19,254) (11,321)
Cumulative effect of change in accounting principal...... - - 578 -
Interest and other income................................ 12,651 4,717 27,773 11,004
General and administrative............................... (36,242) (5,621) (49,996) (16,890)
Interest expense......................................... (9,323) (2,471) (12,752) (5,928)
Casualty loss............................................ - (196) - (196)
Gain (loss) on disposition of real estate assets......... 756 (142) 1,222 (89)
Foreign currency exchange loss........................... (172) - (172) -
Income from derivatives, net............................. 32 - 32 -
Minority interest in income.............................. (8,590) (7,243) (24,477) (26,355)
------------- ------------ ------------- -----------
Total other items not allocated to segments (47,776) (12,137) (77,046) (49,775)
------------- ------------ ------------- -----------
Total consolidated net income....................... $ 81,181 $ 128,344 $ 324,259 $ 333,021
============= ============ ============= ===========
14. Stock-Based Compensation
------------------------
Stock Options
-------------
We have a 1990 Stock Option Plan (the "1990 Plan"), which provides for
the grant of non-qualified stock options. We have a 1994 Stock Option Plan (the
"1994 Plan"), a 1996 Stock Option and Incentive Plan (the "1996 Plan"), a 2000
36
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Non-Executive/Non-Director Stock Option and Incentive Plan (the "2000 Plan"), a
2001 Non-Executive/Non-Director Stock Option and Incentive Plan (the "2001
Non-Executive Plan") and a 2001 Stock Option and Incentive Plan (the "2001
Plan"), each of which provides for the grant of non-qualified options and
incentive stock options. (The 1990 Plan, the 1994 Plan, the 1996 Plan and the
2000 Plan are collectively referred to as the "PSI Plans"). Under the PSI Plans,
the Company has granted non-qualified options to certain directors, officers and
key employees to purchase shares of the Company's common stock at a price equal
to the fair market value of the common stock at the date of grant. Generally,
options under the PSI Plans vest over a three-year period from the date of grant
at the rate of one-third per year (options granted after, December 31, 2002 vest
generally over a five-year period) and expire (i) under the 1990 Plan, five
years after the date they became exercisable and (ii) under the 1994 Plan, the
1996 Plan and the 2000 Plan, ten years after the date of grant. The 1996 Plan,
the 2000 Plan, the 2001 Non-Executive Plan and the 2001 Plan also provide for
the grant of restricted stock (see below) to officers, key employees and service
providers on terms determined by an authorized committee of the Board of
Directors.
We recognize compensation expense for stock-based awards based upon
their fair value on the date of grant amortized over the applicable vesting
period (the "Fair Value Method"), less an allowance for estimated future
forfeited awards.
For the three and nine months ended September 30, 2006 we recorded
$360,000 and $958,000, respectively, in stock option compensation expense
related to options granted after January 1, 2002, as compared to $240,000 and
$667,000, respectively, for the same periods in 2005.
A total of 157,500 stock options were granted during the nine months
ended September 30, 2006, 128,273 shares were exercised, and 2,000 shares were
forfeited. On August 22, 2006, in connection with our merger with Shurgard, we
converted each outstanding Shurgard stock option into 0.82 options exercisable
for shares of the Company's Common Stock. This conversion resulted in the
issuance of 1,912,828 stock options. As of September 30, 2006, 1,746,900 of the
1,912,828 stock options issued in this exchange were exercised. A total of
1,616,301 stock options were outstanding at September 30, 2006 (1,423,146 at
December 31, 2005).
Restricted Stock Units
----------------------
Outstanding restricted stock units vest over a five or eight-year
period from the date of grant at the rate of one-fifth or one-eighth per year,
respectively. The employee receives additional compensation equal to the
per-share dividends received by common shareholders with respect to restricted
stock units outstanding. Such compensation is accounted for as dividends paid.
Any dividends paid on units which are subsequently forfeited are expensed. Upon
vesting, the employee receives common shares equal to the number of vested
restricted stock units in exchange for the units.
The total value of each restricted stock unit grant, based upon the
market price of our common stock at the date of grant, is amortized over the
vesting period as compensation expense. The related employer portion of payroll
taxes is expensed as incurred. Until December 31, 2005 (see below), forfeitures
were recognized as experienced, reducing compensation expense.
Effective January 1, 2006, in accordance with Statement of Financial
Accounting Standards No. 123 - revised ("FAS 123R"), we began recording
compensation expense net of estimates for future forfeitures (the "Estimated
Forfeiture Method"). In addition, we estimated the cumulative compensation
expense that would have been recorded through December 31, 2005, had we used the
Estimated Forfeiture Method, would have been $578,000 lower. Accordingly, as
prescribed by FAS 123R, we recorded this adjustment as a cumulative effect of
change in accounting principal on our accompanying condensed consolidated
statement of income for the nine months ended September 30, 2006.
Outstanding restricted stock units are included on a one-for-one basis
in our diluted weighted average shares, less a reduction for the treasury stock
method applied to the average cumulative measured but unrecognized compensation
expense during the period. For purposes of the disclosures that follow, "fair
value" on any particular date reflects the closing market price of our common
stock on that date.
37
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
During the nine months ended September 30, 2006, 387,420 restricted
stock units were granted, 20,960 restricted stock units were forfeited, and
60,700 restricted stock units vested. This vesting resulted in the issuance of
40,302 shares of the Company's Common Stock. In addition, cash compensation was
paid to employees in lieu of 20,398 shares of Common Stock based upon the market
value of the stock at the date of vesting, and used to settle the employees' tax
liability generated by the vesting.
At September 30, 2006, approximately 605,590 restricted stock units
were outstanding (299,830 at December 31, 2005). A total of $1,481,000 and
$3,910,000 in restricted stock expense was recorded for the three and nine
months ended September 30, 2006, respectively ($956,000 and $2,912,000,
respectively, for the same periods in 2005).
15. Related Party Transactions
--------------------------
Relationships and transactions with the Hughes Family
-----------------------------------------------------
Mr. Hughes and his family (the "Hughes Family") have ownership
interests in, and operate approximately 44 self-storage facilities in Canada
under the name "Public Storage" ("PS Canada") pursuant to a license agreement
with the Company. We currently do not own any interests in these facilities nor
do we own any facilities in Canada. The Hughes Family owns approximately 27% of
our Common Stock outstanding at September 30, 2006. We have a right of first
refusal to acquire the stock or assets of the corporation that manages the 44
self-storage facilities in Canada, if the Hughes Family or the corporation
agrees to sell them. However, we have no interest in the operations of this
corporation, we have no right to acquire this stock or assets unless the Hughes
Family decides to sell, the right of first refusal does not apply to the
self-storage facilities, and we receive no benefit from the profits and
increases in value of the Canadian self-storage facilities.
Through PSIC and PSCI-H, we continue to reinsure risks relating to loss
of goods stored by tenants in the self-storage facilities in Canada. We acquired
the tenant insurance business on December 31, 2001 through its acquisition of
PSIC. During each of the nine months ended September 30, 2006 and 2005, we
received $759,000 and $795,000, respectively, in reinsurance premiums
attributable to the Canadian Facilities. Since our right to provide tenant
reinsurance to the Canadian Facilities may be qualified, there is no assurance
that these premiums will continue.
In November 1999, we formed the Consolidated Development Joint Venture
with a joint venture partner whose partners include an institutional investor
and Mr. Hughes. On August 5, 2005, we acquired the institutional investor's
interest in PSAC for approximately $41,420,000 in cash. This acquisition gave us
a controlling position in PSAC and the right to acquire the remaining interest
in PSAC held by Mr. Hughes, which we exercised, for a stipulated amount of
$64,513,000 plus accrued preferred return on November 17, 2005.
The Company and Mr. Hughes are co-general partners in certain of the
Consolidated Entities and the Unconsolidated Entities. Mr. Hughes and his family
also own limited partnership interests in certain of these partnerships. The
Company and Mr. Hughes and his family receive distributions from these
partnerships in accordance with the terms of the partnership agreements.
Other Related Party Transactions
--------------------------------
Ronald L. Havner, Jr. is our vice-chairman and chief executive officer,
and he is chairman of the board of PSB.
Dann V. Angeloff, a director of the Company, is the general partner of
a limited partnership formed in June 1973 that owns a self-storage facility that
is managed by us. We recorded management fees with respect to this facility
38
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
amounting to $18,000 and $49,000 for the three and nine months ended September
30, 2006, respectively, compared to $11,000 and $33,000 for the three and nine
months ended, September 30, 2005, respectively.
PSB manages certain of the commercial facilities that we own pursuant
to management agreements for a management fee equal to 5% of revenues. We paid a
total of $147,000, and $442,000 for the three and nine months ended September 30
2006, respectively, and $145,000 and $434,000, respectively, for the same
periods in 2005 in management fees with respect to PSB's property management
services. At September 30, 2006, we have recorded amounts owed to PSB of
$282,000 ($551,000 at December 31, 2005), for management fees and certain other
operating expenses related to the managed facilities, paid by PSB on our behalf.
These amounts are the result of a time lag between PSB paying such expenditures
and being reimbursed by us.
We manage the Company's wholly-owned self-storage facilities as well as
the facilities owned by the Unconsolidated Entities and the Consolidated
Entities on a joint basis, in order to take advantage of scale and other
efficiencies. As a result, significant components of self-storage operating
costs, such as payroll costs, advertising and promotion, data processing, and
insurance expenses are shared and allocated among the various entities using
methodologies meant to fairly allocate such costs based upon the related
activities. The total of such expenses which were included in the operations of
the Unconsolidated Entities were approximately $503,000, and $1,770,000 for the
three and nine months ended September 30, 2006, respectively, compared to
$974,000 and $3,193,000 for the three and nine months ended September 30, 2005,
respectively.
Pursuant to a cost-sharing and administrative services agreement, PSB
reimburses us for certain administrative services. PSB's share of these costs
totaled approximately $80,000 and $240,000 for the three and nine months ended
September 30, 2006, respectively, and $85,000 and $255,000, respectively, for
the same periods in 2005.
Stor-RE and third party insurance carriers have provided PS Canada, the
Company, PSB, and other affiliates of the Company with liability and casualty
insurance coverage until March 31, 2004. PS Canada has a 2.2% interest, and PSB
has a 4.0% interest, in Stor-RE. PS Canada and PSB obtained their own liability
and casualty insurance covering occurrences after April 1, 2004. For occurrences
before April 1, 2004, STOR-Re continues to provide liability and casualty
insurance coverage consistent with the relevant agreements.
16. Commitments and Contingencies
-----------------------------
LEGAL MATTERS
Serrao v. Public Storage, Inc. (filed April 2003) (Superior Court of California
--------------------------------------------------------------------------------
- Orange County)
----------------
The plaintiff in this case filed a suit against the Company on behalf
of a putative class of renters who rented self-storage units from the Company.
Plaintiff alleges that the Company misrepresented the size of its storage units,
has brought claims under California statutory and common law relating to
consumer protection, fraud, unfair competition, and negligent misrepresentation,
and is seeking monetary damages, restitution, and declaratory and injunctive
relief.
The claim in this case is substantially similar to those in Henriquez
v. Public Storage, Inc., which was disclosed in prior reports. In January 2003,
the plaintiff caused the Henriquez action to be dismissed.
Based upon the uncertainty inherent in any putative class action, we
cannot presently determine the potential damages, if any, or the ultimate
outcome of this litigation. On November 3, 2003, the court granted our motion to
strike the plaintiff's nationwide class allegations and to limit any putative
class to California residents only. In August 2005, we filed a motion to remove
the case to federal court, but the case has been remanded to the Superior Court.
We are vigorously contesting the claims upon which this lawsuit is based,
including class certification efforts.
39
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Drake v. Shurgard Storage Centers, Inc. (filed September 2002) (Superior Court
--------------------------------------------------------------------------------
of California - Orange County)
------------------------------
This is a companion case to the Serrao matter discussed above. The
plaintiff alleges the same set of operative facts and seeks the same relief as
in Serrao against Shurgard Storage Centers, Inc. ("Shurgard"), whose liability
Public Storage assumed following the merger of Public Storage and Shurgard on
August 22, 2006. There is currently pending a motion for class certification,
which has yet to be ruled on. We cannot presently determine the potential total
damages, if any, or the ultimate outcome of the litigation. We vigorously
contested the motion for class certification and will vigorously defend this
action.
Potter, et al v. Hughes, et al (filed December 2004) (United States District
--------------------------------------------------------------------------------
Court - Central District of California)
---------------------------------------
As previously reported, in November 2002, a shareholder of the Company
made a demand on the Board of Directors challenging the fairness of the
Company's acquisition of PS Insurance Company, Ltd. ("PSIC") and related
matters. PSIC was previously owned by the Hughes Family. In June 2003, following
the filing by the Hughes Family of a complaint for declaratory relief asking the
court to find that the acquisition of PSIC and related matters were fair to the
Company, it was ruled that the PSIC transaction was just and reasonable as to
the Company and holding that the Hughes Family was not required to make any
payment to the Company.
At the end of December 2004, the same shareholder referred to above and
a second shareholder filed this shareholder's derivative complaint naming as
defendants the Company's directors (and two former directors) and certain
officers of the Company. The matters alleged in this complaint relate to PSIC,
the Hughes Family's Canadian self-storage operations and the Company's 1995
reorganization. In July 2006, the Court granted the defendants' motion to
dismiss the amended Complaint without leave to amend. In August 2006, Plaintiffs
filed a notice of appeal of the Court's decision. We believe the litigation will
not have any financially adverse effect on the Company (other than the costs and
other expenses relating to the lawsuit).
Brinkley v. Public Storage, Inc. (filed April, 2005) (Superior Court of
--------------------------------------------------------------------------------
California - Los Angeles County)
--------------------------------
The plaintiff sued the Company on behalf of a purported class of
California non-exempt employees based on various California wage and hour laws
and seeking monetary damages and injunctive relief. In May 2006, a motion for
class certification was filed seeking to certify five subclasses. Plaintiff
sought certification for alleged meal period violations, rest period violations,
failure to pay for travel time, failure to pay for mileage reimbursement, and
for wage statement violations. In October 2006, the Court declined to certify
three out of the five subclasses. The Court did, however, certify subclasses
based on alleged meal period and wage statement violations. The maximum
potential liability cannot presently be estimated. We intend to vigorously
contest the substantive merits of the two remaining subclasses that were
certified.
Simas v. Public Storage, Inc. (filed January, 2006) (Superior Court of
--------------------------------------------------------------------------------
California - Orange County)
---------------------------
The plaintiff brings this action against the Company on behalf of a
purported class who bought insurance coverage at Company's facilities alleging
that the Company does not have a license to offer, sell and/or transact storage
insurance. The action was brought under California Business and Professions Code
Section 17200 and seeks retention, monetary damages and injunctive relief. The
Company filed a demurrer to the complaint. While the demurrer was pending,
Plaintiff amended the complaint to allege a national class and claims for unfair
business practices, unjust enrichment, money had and received, and negligent and
intentional misrepresentation. We renewed our demurrer and moved to strike the
national class allegations. The Court dismissed all the claims with leave to
amend, except for the claim for unjust enrichment. Based on this ruling, the
Court held that the motion to strike was moot. Plaintiff elected not to amend
her complaint and is therefore only proceeding with the claim for unjust
enrichment. We are vigorously contesting the claims upon which this lawsuit is
based, including any efforts for class certification.
40
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2006
(Unaudited)
Other Items
-----------
We are a party to various claims, complaints, and other legal actions
that have arisen in the normal course of business from time to time that are not
described above. We believe that it is unlikely that the outcome of these other
pending legal proceedings including employment and tenant claims, in the
aggregate, will have a material adverse impact upon our operations or financial
position.
INSURANCE AND LOSS EXPOSURE
Our facilities have historically carried insurance, including fire,
earthquake, flood, and general liability coverage through STOR-Re and PSIC-H,
our captive insurance programs, and insure portions of these risks through
nationally recognized insurance carriers. Our captive insurance programs also
insure affiliates of the Company.
The Company, STOR-Re, PSIC-H and its affiliates' maximum aggregate
annual exposure for losses that are below the deductibles set forth in the
third-party insurance contracts, assuming multiple significant events occur, is
approximately $35,000,000. In addition, if losses exhaust the third-party
insurers' limit of coverage of $125,000,000 for property coverage (a maximum of
$80,000,000 with respect to earthquake coverage) and $102,000,000 for general
liability, our exposure could be greater. These limits are higher than estimates
of maximum probable losses that could occur from individual catastrophic events
(i.e. earthquake and wind damage) determined in engineering and actuarial
studies.
Our tenant re-insurance program, operating through PSIC through March
31, 2004, and through PSIC-H beginning April 1, 2004, reinsures policies against
claims for losses to goods stored by tenants at our self-storage facilities. For
2005, we had outside third-party insurance coverage for claims paid exceeding
$500,000 resulting from any individual event, to a limit of $10,000,000.
Effective January 1, 2006, such coverage was revised to cover claims paid
exceeding $1,500,000 resulting from any individual event, to a limit of
$9,000,000. At September 30, 2006, we had approximately 368,000 reinsured
policies outstanding representing aggregate coverage of approximately $877
million.
DEVELOPMENT AND ACQUISITION OF REAL ESTATE FACILITIES
We currently have 60 projects in our development pipeline, including
expansions and enhancements to existing self-storage facilities. The total
estimated cost of these facilities is approximately $327,582,000, of which
$131,063,000 has been spent at September 30, 2006. These projects are subject to
contingencies. See Note 5 for further discussion of our development projects as
of September 30, 2006.
Subsequent to September 30, 2006, we did not acquire and are not
currently under contract to acquire any additional self-storage facilities from
third parties.
17. Subsequent Events
-----------------
On October 17, 2006, we issued 9,200,000 depositary shares each
representing 1/1,000 of a share our 6.75% Cumulative Preferred Stock, Series L,
for gross proceeds of approximately $230 million (including the underwriters'
overallotment option, which was exercised).
41
Item 2. Management's Discussion and Analysis of Financial Condition and Results
--------------------------------------------------------------------------------
of Operations
-------------
The following discussion and analysis should be read in conjunction
with our condensed consolidated financial statements and notes thereto.
Forward Looking Statements: All statements in this document, other than
statements of historical fact, are forward-looking statements which may be
identified by the use of the words "expects," "believes," "anticipates,"
"should," "estimates" and similar expressions. These forward-looking statements
involve known and unknown risks and uncertainties, which may cause Public
Storage's actual results and performance to be materially different from those
expressed or implied in the forward-looking statements. Factors and risks that
may impact future results and performance are described in Item 1A, "Risk
Factors" in Part II of this Quarterly Report on Form 10Q. These risks include,
but are not limited to, the following: risks related to the merger with Shurgard
including difficulties that may be encountered in integrating Public Storage and
Shurgard, loss of personnel as a result of the merger, and the impact of the
merger on occupancy and rental rates, the inability to realize or delays in
realizing expected results from the merger, unanticipated operating costs
resulting from the merger, and risks associated with international operations;
changes in general economic conditions and in the markets in which Public
Storage operates; the impact of competition from new and existing storage and
commercial facilities and other storage alternatives, which could impact rents
and occupancy levels at our facilities; difficulties in Public Storage's ability
to evaluate, finance and integrate acquired and developed properties into its
existing operations and to fill up those properties, which could adversely
affect our profitability; the impact of the regulatory environment as well as
national, state, and local laws and regulations including, without limitation,
those governing Real Estate Investment Trusts, which could increase our expenses
and reduce cash available for distribution; consumers' failure to accept the
containerized storage concept; difficulties in raising capital at reasonable
rates, which would impede our ability to grow; delays in the development
process; economic uncertainty due to the impact of war or terrorism. We disclaim
any obligation to update publicly or otherwise revise any forward-looking
statements, whether as a result of new information, new estimates, or other
factors, events or circumstances after the date of this document, except where
expressly required by law.
CRITICAL ACCOUNTING POLICIES
Management's Discussion and Analysis of Financial Condition and Results
of Operations discusses our consolidated financial statements, which have been
prepared in accordance with generally accepted accounting principles in the
United States ("GAAP"). The preparation of our financial statements and related
disclosures in conformity with GAAP and our discussion and analysis of our
financial condition and results of operations requires management to make
judgments, assumptions and estimates that affect the amounts reported in our
condensed consolidated financial statements and accompanying notes. Note 2 to
our condensed consolidated financial statements summarizes the significant
accounting policies and methods used in the preparation of our condensed
consolidated financial statements and related disclosures.
Management believes the following are critical accounting policies
whose application has a material impact on our financial presentation. That is,
they are both important to the portrayal of our financial condition and results,
and they require management to make judgments and estimates about matters that
are inherently uncertain.
QUALIFICATION AS A REIT - INCOME TAX EXPENSE: We believe that we have
been organized and operated, and we intend to continue to operate, as a
qualifying Real Estate Investment Trust ("REIT") under the Internal Revenue Code
and applicable state laws. A qualifying REIT generally does not pay corporate
level income taxes on its taxable income that is distributed to its
shareholders, and accordingly, we do not pay income tax on the share of our
taxable income that is distributed to our shareholders.
We therefore do not estimate or accrue any federal income tax expense.
This estimate could be incorrect, because due to the complex nature of the REIT
qualification requirements, the ongoing importance of factual determinations and
the possibility of future changes in our circumstances, we cannot be assured
that we actually have satisfied or will satisfy the requirements for taxation as
a REIT for any particular taxable year. For any taxable year that we fail or
have failed to qualify as a REIT and applicable relief provisions did not apply,
42
we would be taxed at the regular corporate rates on all of our taxable income,
whether or not we made or make any distributions to our shareholders. Any
resulting requirement to pay corporate income tax, including any applicable
penalties or interest, could have a material adverse impact on our financial
condition or results of operations. Unless entitled to relief under specific
statutory provisions, we also would be disqualified from taxation as a REIT for
the four taxable years following the year during which qualification was lost.
There can be no assurance that we would be entitled to any statutory relief.
IMPAIRMENT OF LONG-LIVED ASSETS: Substantially all of our assets
consist of long-lived assets, including real estate and goodwill. We evaluate
our goodwill for impairment on an annual basis, and on a quarterly basis
evaluate other long-lived assets for impairment. As described in Note 2 to our
condensed consolidated financial statements, the evaluation of goodwill for
impairment entails valuation of the reporting unit to which goodwill is
allocated, which involves significant judgment in the area of projecting
earnings, determining appropriate price-earnings multiples, and discount rates.
In addition, the evaluation of other long-lived assets for impairment requires
determining whether indicators of impairment exist, which is a subjective
process. When any indicators of impairment are found, the evaluation of such
long-lived assets then entails projections of future operating cash flows, which
also involves significant judgment. Future events, or facts and circumstances
that currently exist, that we have not yet identified, could cause us to
conclude in the future that other long-lived assets are impaired. Any resulting
impairment loss could have a material adverse impact on our financial condition
and results of operations.
ESTIMATED USEFUL LIVES OF LONG-LIVED ASSETS: Substantially all of our
assets consist of depreciable, long-lived assets. We record depreciation expense
with respect to these assets based upon their estimated useful lives. Any change
in the estimated useful lives of those assets, caused by functional or economic
obsolescence or other factors, could have a material adverse impact on our
financial condition or results of operations.
ESTIMATED LEVEL OF RETAINED RISK AND UNPAID TENANT CLAIM LIABILITIES:
As described in Notes 2 and 16 to our condensed consolidated financial
statements, we retain certain risks with respect to property perils, legal
liability, and other such risks. In addition, a wholly-owned subsidiary of the
Company reinsures policies against claims for losses to goods stored by tenants
in our self-storage facilities. In connection with these risks, we accrue losses
based upon the estimated level of losses incurred using certain actuarial
assumptions followed in the insurance industry and based on recommendations from
an independent actuary that is a member of the American Academy of Actuaries.
While we believe that the amounts of the accrued losses are adequate, the
ultimate liability may be in excess of or less than the amounts recorded. At
September 30, 2006, we had approximately 368,000 reinsured policies outstanding
representing aggregate coverage of approximately $877 million.
ACCRUALS FOR CONTINGENCIES: We are exposed to business and legal
liability risks with respect to events that have occurred, but in accordance
with accounting principles generally accepted in the United States, we have not
accrued for such potential liabilities because the loss is either not probable
or not estimable or because we are not aware of the event. Future events and the
result of pending litigation could result in such potential losses becoming
probable and estimable, which could have a material adverse impact on our
financial condition or results of operations. Some of these potential losses, of
which we are aware, are described in Note 16 to our condensed consolidated
financial statements.
ACCRUALS FOR OPERATING EXPENSES: We accrue for property tax expense and
certain other operating expenses based upon estimates, historical trends and
current and anticipated local and state government rules and regulations. If
these estimates and assumptions are incorrect, our expenses could be misstated.
Cost of operations, interest expense, general and administrative expense, as
well as television, yellow page, and other advertising expenditures are expensed
as incurred.
VALUATION OF DERIVATIVES: As described in our Significant Accounting
Policies in Note 2 to our condensed consolidated financial statements, our
derivative instruments are not considered effective hedges. Accordingly, any
changes in value of these derivatives are reflected as an increase or decrease
in net income. The determination of the value of derivatives is based upon
significant judgment and assumptions including interest rates, currency rates,
and expected rates of return. The actual value of derivative instruments is
dependent upon many factors that our judgments and assumptions may not consider,
or may not consider effectively.
43
VALUATION OF ASSETS AND LIABILITIES ACQUIRED IN THE MERGER WITH
SHURGARD: In recording the merger with Shurgard, we have estimated the value of
real estate, intangible assets, debt, and the other assets and other liabilities
of Shurgard that we acquired. In addition, we have estimated the fair market
value of the 38.9 million shares that we issued to the Shurgard shareholders.
These value estimates are based upon many assumptions, including interest rates,
market values of land and buildings in the United States and Europe, estimated
future cash flows from the tenant base in place, and the recoverability of
certain assets. While we believe that the assumptions we used are reasonable,
these assumptions are subject to a significant degree of judgment, and others
could come to materially different conclusions as to value. If these assumptions
were computed differently, our depreciation and amortization expense, interest
expense, real estate, debt, and intangible assets could be materially different.
Further, these valuation estimates are preliminary, subject to further analysis,
and could change.
MERGER WITH SHURGARD
As previously announced, on March 6, 2006, the boards of directors of
Public Storage and Shurgard approved a definitive merger agreement under which
Public Storage merged with Shurgard. The merger was approved by the shareholders
of both companies and was completed on August 22, 2006. Under the terms of the
merger agreement, Public Storage issued, in a taxable transaction, approximately
39 million shares of common stock to holders of Shurgard's common stock and
assumed Shurgard's debt of approximately $2.0 billion. On the day of the merger,
we repaid Shurgard's line of credit and certain variable rate notes, totaling
approximately $671 million, with the remaining $1.3 billion in Shurgard debt
remaining outstanding. In addition, approximately $138 million of Shurgard's
preferred stock was redeemed on the day of the merger. Shortly following the
merger, we incurred an additional $49.4 million in cash costs primarily for
attorneys, bankers, and severance payments to Shurgard employees.
In addition, pursuant to the merger we issued a total of 1.9 million
stock options to former holders of Shurgard stock options. Approximately 1.7
million of these stock options were exercised through September 30, 2006,
resulting in aggregate exercise proceeds totaling approximately $74.4 million.
Included in general and administrative expense for the three and nine
months ended September 30, 2006, respectively, are costs related to the merger,
as well as expenditures in planning and completing the integration of the two
companies of approximately $18.1 million and $20.5 million, respectively.
In the fourth quarter, we expect to incur an additional $15 million to
$20 million of additional costs related to the integration of the two companies,
as well as costs associated with winding down Shurgard's business affairs.
RESULTS OF OPERATIONS
---------------------
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2006:
Net income for the three months ended September 30, 2006 was
$81,181,000 compared to $128,344,000 for the same period in 2005, representing a
decrease of $47,163,000, or 36.7%. This decrease is primarily due to significant
increases in depreciation and amortization expense, general and administrative
expense and interest expense. Depreciation and amortization increased by
approximately $65.6 million due primarily to the addition of real estate
facilities and intangible assets acquired in the merger with Shurgard Storage
44
Centers, Inc. ("Shurgard") and the corresponding depreciation and amortization
related to such assets. General and administrative expense increased by
approximately $30.6 million principally as a result of integration expenses
related to the Shurgard merger, development costs that were expensed with
respect to terminated projects and contract termination fees; these costs in
aggregate totaled $29.6 million. In connection with the merger, we assumed $1.3
billion in debt, and, as a result, interest expense increased by approximately
$6.9 million.
The negative impacts to our net income from the above mentioned items
were partially offset by improved operations from our Same Store group of
facilities, continued growth in operations from our newly developed and recently
expanded facilities, continued growth in our recently acquired self-storage
facilities including the facilities acquired in the merger with Shurgard, as
well as higher interest income.
Our Same Store net operating income, before depreciation expense,
increased by approximately $9,256,000, or 6.6%, as a result of a 6.1%
improvement in revenues partially offset by a 5.0% increase in cost of
operations. Aggregate net operating income for our newly developed and recently
expanded and acquired facilities (other than the Shurgard facilities) increased
by approximately $8,815,000. This increase was largely due to the impact of
facilities acquired in 2005 and 2006, combined with continued fill-up of our
newly developed and expansion facilities. For those facilities that were
acquired in the merger, net operating income was approximately $35,363,000,
reflecting the results from the date of the merger, August 22, 2006, through
September 30, 2006. Interest income increased as a result of earning higher
interest rates on invested cash balances combined with significantly higher
average cash balances invested in interest-bearing accounts as compared to the
same period in 2005. Higher invested cash balances were primarily due to gross
proceeds received from the issuance of Preferred Stock and Preferred Partnership
Units in the second and third quarters of 2006. Substantially all of this cash
was subsequently used to fund the cash requirements with respect to the Shurgard
merger.
We had a net loss allocable to our common shareholders (after
allocating net income to our preferred and equity shareholders) of $6,083,000 or
$0.04 per common share on a diluted basis for the three months ended September
30, 2006 compared to income allocable to common shareholders of $79,262,000 or
$0.62 per common share on a diluted basis for the same period in 2005,
representing a decrease of $85,345,000 or $0.66 per diluted common share. The
decreases in net income allocable to common shareholders on an aggregate and
per-share basis are due primarily to the impact of the factors described above,
combined with an increase in income allocated to preferred shareholders, as
described below.
For the three months ended September 30, 2006 and 2005, we allocated
$60,265,000 and $43,726,000 of our net income, respectively, to our preferred
shareholders based on distributions paid. The year-over-year increase is due to
the issuance of additional preferred securities, partially offset by the
redemption of preferred securities that had higher dividend rates than the newly
issued preferred securities. We also recorded allocations of income to our
preferred shareholders with respect to the application of EITF Topic D-42, and
recorded our equity share of such charges, totaling $21,643,000 (or $0.15 per
diluted common share) for the three months ended September 30, 2006 in
connection with the redemption of preferred securities.
Weighted average diluted shares increased to 145,387,000 for the three
months ended September 30, 2006 from 128,742,000 for the three months ended
September 30, 2005. The increase in weighted average diluted shares is due
primarily to the issuance of approximately 38.9 million shares in the merger
with Shurgard, which are included in our weighted average shares from August 22,
2006 through September 30, 2006.
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2006:
Net income for the nine months ended September 30, 2006 was
$324,259,000 compared to $333,021,000 for the same period in 2005, representing
a decrease of $8,762,000, or 2.6%. This decrease is primarily reflective of the
third-quarter impacts described above with respect to depreciation and
amortization, general and administrative expense and interest expense. These
items were partially offset by improved operations from our Same Store, newly
developed and acquired self-storage facilities (including the facilities
acquired from Shurgard), reduced minority interest in income and higher interest
income.
45
Same Store net operating income, before depreciation expense, increased
by $23,903,000, or 5.9%, as a result of a 5.6% improvement in revenues partially
offset by a 5.1% increase in cost of operations. Aggregate net operating income
for our newly developed, acquired and expansion self-storage facilities
(excluding the Shurgard facilities) increased by approximately $24,895,000
largely due to the impact of facilities acquired in 2005 and 2006, combined with
continued fill-up of our newly developed and expansion facilities. We earned an
aggregate of $35,363,000 in net operating income in the third quarter with
respect to the facilities acquired in the merger with Shurgard, reflecting their
operating results from the date of the merger, August 22, 2006, through
September 30, 2006. Minority interest in income declined due to the acquisition
of minority interests that occurred in 2005. Interest income increased as a
result of earning higher interest rates on invested cash balances, combined with
higher average cash balances invested in interest-bearing accounts as compared
to the same period in 2005.
Net income allocable to our common shareholders (after allocating net
income to our preferred and equity shareholders) was $127,292,000 or $0.94 per
common share on a diluted basis for the nine months ended September 30, 2006
compared to $188,744,000 or $1.46 per common share on a diluted basis for the
same period in 2005, representing a decrease of $0.52 per common share, or a
decrease of 36%. The decreases in net income allocable to common shareholders
and earnings per common diluted share are due primarily to the impact of the
factors described above, in addition to increased income allocated to preferred
shareholders, described below.
For the nine months ended September 30, 2006 and 2005, we allocated
$159,256,000 and $126,286,000 of our net income, respectively, to our preferred
shareholders based on distributions paid. The year-over-year increase is due to
the issuance of additional preferred securities, partially offset by the
redemption of preferred securities that had higher dividend rates than the newly
issued preferred securities. We also recorded allocations of income to our
preferred shareholders with respect to the application of EITF Topic D-42
totaling $21,643,000 (or $0.16 per diluted common share) and $1,904,000 (or
$0.01 per diluted common share), for the nine months ended September 30, 2006
and 2005, respectively.
Weighted average diluted shares increased to 134,851,000 for the nine
months ended September 30, 2006 from 128,844,000 for the nine months ended
September 30, 2005. The increase in weighted average diluted shares is due
primarily to the issuance of approximately 38.9 million shares in the merger
with Shurgard, which are included in our weighted averages shares from August
22, 2006 through September 30, 2006.
In the ensuing discussions of our operations, we present "net operating
income before depreciation and amortization and cost of operations before
depreciation and amortization", which excludes the impact of depreciation
expense. Although depreciation is an operating expense, we believe that these
operating metrics are meaningful measures of operating performance, because we
utilize these measures in making decisions with respect to capital allocations,
in determining current property values, segment performance, and comparing
period to period and market to market property operating results. Included in
Note 13 to our September 30, 2006 condensed consolidated financial statements,
"Segment Information," is a reconciliation of net operating income (before
depreciation) by each respective operating segment to our consolidated net
income.
REAL ESTATE OPERATIONS
----------------------
SELF-STORAGE OPERATIONS: Our self-storage operations are by far the
largest component of our operations, representing approximately 89% of our total
revenues generated for the nine months ended September 30, 2006. The
improvements in rental income for the periods presented on our condensed
consolidated statements of income for the three and nine months ended September
30, 2006 are due to improvements in the performance of those facilities that we
owned prior to January 1, 2004, and the addition of new facilities to our
portfolio, either through our acquisition or development activities.
To enhance year-over-year comparisons, the following table summarizes,
and the ensuing discussion describes, the self-storage operating results.
46
Self - storage operations summary:
----------------------------------
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------- ------------------------------------
2006 2005 Percentage 2006 2005 Percentage
Change Change
----------- ------------ ----------- ---------- ---------- --------------
(Dollar amounts in thousands)
Rental income (a):
Same Store Facilities (b)................... $ 221,386 $ 208,745 6.1% $ 644,446 $ 610,106 5.6%
Shurgard U.S. Facilities (c)................ 38,941 - - 38,941 - -
Shurgard European Facilities (d)............ 17,348 - - 17,348 - -
Acquired Facilities (e)..................... 17,454 10,674 63.5% 47,659 27,001 76.5%
Expansion Facilities (f).................... 13,982 11,750 19.0% 39,778 34,501 15.3%
Developed Facilities (g).................... 16,044 12,533 28.0% 43,705 34,695 26.0%
Newly consolidated facilities (h)........... 3,686 - - 10,874 - -
----------- ------------ ----------- ---------- ---------- --------------
Total rental income....................... 328,841 243,702 34.9% 842,751 706,303 19.3%
----------- ------------ ----------- ---------- ---------- --------------
Cost of operations before depreciation and
amortization (i):
Same Store Facilities....................... 71,115 67,730 5.0% 215,894 205,457 5.1%
Shurgard U.S. Facilities.................... 12,402 - - 12,402 - -
Shurgard European Facilities................ 8,524 - - 8,524 - -
Acquired Facilities......................... 6,605 4,200 57.3% 18,612 11,508 61.7%
Expansion Facilities........................ 4,220 4,033 4.6% 12,758 11,978 6.5%
Developed Facilities........................ 5,426 4,310 25.9% 15,542 13,376 16.2%
Newly consolidated facilities............... 924 - - 2,644 - -
----------- ------------ ----------- ---------- ---------- --------------
Total cost of operations.................... 109,216 80,273 36.1% 286,376 242,319 18.2%
----------- ------------ ----------- ---------- ---------- --------------
Net operating income before depreciation and
amortization(j):
Same Store Facilities....................... 150,271 141,015 6.6% 428,552 404,649 5.9%
Shurgard U.S. Facilities.................... 26,539 - - 26,539 - -
Shurgard European Facilities................ 8,824 - - 8,824 - -
Acquired Facilities......................... 10,849 6,474 67.6% 29,047 15,493 87.5%
Expansion Facilities........................ 9,762 7,717 26.5% 27,020 22,523 20.0%
Developed Facilities........................ 10,618 8,223 29.1% 28,163 21,319 32.1%
Newly consolidated facilities............... 2,762 - - 8,230 - -
----------- ------------ ----------- ---------- ---------- --------------
Total net operating income before depreciation
and amortization (j)........................ 219,625 163,429 34.4% 556,375 463,984 19.9%
----------- ------------ ----------- ---------- ---------- --------------
Depreciation and amortization expense:
Same Store Facilities....................... (37,270) (38,478) (3.1)% (112,290) (115,710) (3.0)%
Shurgard U.S. Facilities.................... (48,032) - - (48,032) - -
Shurgard European Facilities................ (15,020) - - (15,020) - -
Acquired Facilities......................... (4,649) (2,508) 85.4% (13,166) (6,571) 100.4%
Expansion Facilities........................ (3,765) (2,739) 37.5% (9,780) (7,998) 22.3%
Developed Facilities........................ (3,857) (3,296) 17.0% (10,975) (9,584) 14.5%
Newly consolidated facilities............... (116) - - (504) - -
----------- ------------ ----------- ---------- ---------- --------------
Total depreciation and amortization expense. (112,709) (47,021) 139.7% (209,767) (139,863) 50.0%
----------- ------------ ----------- ---------- ---------- --------------
Net operating income:
Same Store Facilities....................... 113,001 102,537 10.2% 316,262 288,939 9.5%
Shurgard U.S. Facilities.................... (21,493) - - (21,493) - -
Shurgard European Facilities................ (6,196) - - (6,196) - -
Acquired Facilities......................... 6,200 3,966 56.3% 15,881 8,922 78.0%
Expansion Facilities........................ 5,997 4,978 20.5% 17,240 14,525 18.7%
Developed Facilities........................ 6,761 4,927 37.2% 17,188 11,735 46.5%
Newly consolidated facilities............... 2,646 - - 7,726 - -
----------- ------------ ----------- ---------- ---------- --------------
Total net operating income.................. $106,916 $116,408 (8.2)% $346,608 $324,121 6.9%
=========== =========== =========== ========== =========== ===============
Number of self-storage facilities (at end of
period)........................................ 2,140 1,448 47.8%
Net rentable square feet (in thousands, at end of
period) (k): ............................... 132,190 87,537 51.0%
47
(a) Rental income includes late charges and administrative fees and is net
of promotional discounts given. Rental income excludes retail sales,
truck rental income and tenant reinsurance revenues generated at these
facilities. Such ancillary revenues are reflected as a component of
"Ancillary Operations" on our condensed consolidated statements of
income.
(b) The Same Store Facilities include 1,266 facilities containing
73,946,000 net rentable square feet that have been owned prior to
January 1, 2004 and operated at a mature, stabilized occupancy level
since January 1, 2004.
(c) The Shurgard U.S. Facilities include 487 facilities containing
32,143,000 net rentable square feet that were acquired on August 22,
2006.
(d) The Shurgard European Facilities include 160 facilities containing
8,385,000 net rentable square feet that were acquired on August 22,
2006.
(e) The Acquired Facilities include 89 facilities containing 6,383,000 net
rentable square feet that were acquired after January 1, 2004.
(f) The Expansion Facilities include 61 facilities containing 5,352,000 net
rentable square feet of self-storage space; these facilities were owned
since January 1, 2004, however, operating results are not comparable
throughout the periods presented due primarily to expansions in their
net rentable square feet (described below).
(g) The Developed Facilities include 61 facilities containing 5,102,000 net
rentable square feet of self-storage space. These facilities were
developed and opened since January 1, 2002 at a total cost of $538.9
million.
(h) Effective January 1, 2006, in connection with our implementation of
EITF 04-5, we commenced consolidation of the accounts of three limited
partnerships that we had previously accounted for on the equity method
of accounting. As a result, we began including the revenues and cost of
operations of 16 facilities with an aggregate of 879,000 net rentable
square feet in the table above.
(i) Cost of operations includes all costs, both direct and indirect costs,
incurred in the operating activities of the facilities. Cost of
operations excludes, costs associated with retail sales, truck rentals,
and tenant reinsurance activities; such costs are reflected under
"Ancillary Operations" on our income statement.
(j) Total net operating income before depreciation and amortization, which
is a non-GAAP measure, for our self-storage segment is presented in
Note 13 to our September 30, 2006 condensed consolidated financial
statements, "Segment Information," which includes a reconciliation of
net operating income before depreciation and amortization for this
segment to our consolidated net income.
(k) Square footage does not include 424,000 net rentable square feet of
industrial space initially developed for pick-up and delivery
activities. This space is being converted into self-storage space; see
"Development Pipeline Summary" below.
In the discussion that follows, we present realized annual rent per
occupied square foot, which is computed by dividing rental income, before late
charges and administrative fees, by the weighted average occupied square footage
for the period. We also present annualized rental income per available square
foot ("REVPAF"), which represents annualized rental income, before late charges
and administrative fees, divided by total available net rentable square feet.
Late charges and administrative fees are excluded to more effectively measure
our ongoing level of revenue associated with the leasing of the units.
SELF-STORAGE OPERATIONS - SAME STORE FACILITIES
The Same Store Facilities contain approximately 73.9 million net
rentable square feet, representing approximately 56% of the aggregate net
rentable square feet of our consolidated self-storage portfolio. Revenues and
operating expenses with respect to this group of properties are set forth in the
above Self-Storage Operations table under the caption, "Same Store Facilities."
These facilities are included in the Same Store Facilities because they are all
stabilized and owned since January 1, 2004 and therefore provide meaningful
comparative data for 2004, 2005 and 2006. The following table sets forth
additional operating data with respect to the Same Store Facilities:
48
SAME STORE FACILITIES Three Months Ended September 30, Nine Months Ended September 30,
----------------------------------- ----------------------------------
Percentage Percentage
2006 2005 Change 2006 2005 Change
------------ ----------- ---------- ------------ ------------ ----------
(Dollar amounts in thousands, except weighted average amounts)
Rental income...................................... $ 211,252 $ 199,139 6.1% $ 615,556 $ 583,088 5.6%
Late charges and administrative fees collected..... 10,134 9,606 5.5% 28,890 27,018 6.9%
------------ ----------- ---------- ------------ ------------ ----------
Total rental income............................. 221,386 208,745 6.1% 644,446 610,106 5.6%
------------ ----------- ---------- ------------ ------------ ----------
Cost of operations before depreciation and amortization:
Payroll expense............................... 22,185 20,224 9.7% 65,924 62,275 5.9%
Property taxes................................ 20,376 19,573 4.1% 60,385 57,906 4.3%
Repairs and maintenance....................... 6,925 6,294 10.0% 20,731 19,344 7.2%
Advertising and promotion..................... 4,582 5,248 (12.7)% 17,977 18,032 (0.3)%
Utilities..................................... 5,113 4,764 7.3% 14,275 13,137 8.7%
Property insurance............................ 2,860 1,932 48.0% 7,879 6,180 27.5%
Telephone reservation center.................. 2,055 2,239 (8.2)% 6,106 6,033 1.2%
Other cost of management...................... 7,019 7,456 (5.9)% 22,617 22,550 0.3%
------------ ----------- ---------- ------------ ------------ ----------
Total cost of operations........................ 71,115 67,730 5.0% 215,894 205,457 5.1%
------------ ----------- ---------- ------------ ------------ ----------
Net operating income before depreciation and
amortization (e)................................... 150,271 141,015 6.6% 428,552 404,649 5.9%
Depreciation and amortization...................... (37,270) (38,478) (3.1)% (112,290) (115,710) (3.0)%
------------ ----------- ---------- ------------ ------------ ----------
Net operating income.............................. $ 113,001 $ 102,537 10.2% $ 316,262 $ 288,939 9.5%
============ =========== =========== ============ ============ ==========
Gross margin (before depreciation and amortization) 67.9% 67.6% 0.4% 66.5% 66.3% 0.3%
Weighted average for the fiscal year:
Square foot occupancy (a)....................... 91.4% 91.7% (0.3)% 91.2% 91.2% 0.0%
Realized annual rent per occupied square foot (b) $12.50 $11.75 6.4% $12.17 $11.53 5.6%
REVPAF (c)...................................... $11.43 $10.77 6.1% $11.10 $10.51 5.6%
Weighted average at September 30:
Square foot occupancy........................... 90.5% 91.6% (1.2)%
In place annual rent per occupied square foot (d) $13.51 $12.85 5.1%
Total net rentable square feet (in thousands)...... 73,946 73,946 -
(a) Square foot occupancies represent weighted average occupancy levels
over the entire period.
(b) Realized annual rent per occupied square foot is computed by dividing
rental income, prior to late charges and administrative fees, by the
weighted average occupied square footage for the period. Realized
annual rent per occupied square foot takes into consideration
promotional discounts, credit card fees and other costs that reduce
rental income from the contractual amounts due.
(c) Annualized rental income per available square foot ("REVPAF")
represents annualized rental income, prior to late charges and
administrative fees, divided by total available net rentable square
feet.
(d) In place annual rent per occupied square foot represents annualized
contractual rents per occupied square foot without reductions for
promotional discounts, and excludes late charges and administrative
fees.
(e) Total net operating income before depreciation and amortization, which
is a non-GAAP measure, for our same store facilities represents a
portion of our total self-storage segment's net operating income before
depreciation and amortization, and is reconciled to the segment total
in the table "self-storage operations summary" above. A reconciliation
of our total self-storage segment's net operating income before
depreciation and amortization to consolidated net income is included in
Note 13 to our September 30, 2006 condensed consolidated financial
statements, "Segment Information."
Rental income increased approximately 6.1% and 5.6% for the three and
nine months ended September 30, 2006, respectively, as compared to the same
periods in 2005. These increases were primarily attributable to higher average
realized annual rental rates per occupied square foot, which were 6.4% and 5.6%
higher for the three and nine months ended September 30, 2006, respectively, as
compared to the same periods in 2005. Our occupancy levels remained
approximately flat for each of the periods.
49
Our primary goal is to continue to grow rental income in a consistent
and sustainable manner. Growth in rental income will depend upon various
factors, including our ability to (i) maintain high occupancy levels, (ii)
increase rental rates charged to both new and existing customers, and (iii)
reduce the amount of promotional discounts to attract new tenants.
Demand for self-storage space in each market is affected by many
factors which are beyond our control. Such factors include general economic
conditions, moving activities, changes in demographic trends and population
density, as well as the level of development of new self-storage facilities. We
believe that our share of the overall storage demand in any particular market is
impacted by our and our competitors' marketing, pricing, and promotional
activities, as well as the quality of execution of our property personnel at the
facilities.
We regularly evaluate the level of demand for our self-storage space by
monitoring reservation activity, move-ins, move-outs, and the level of telephone
and internet inquiries as a primary basis for our marketing, pricing, and
promotional decisions, as well as to identify localized execution issues. There
can be no assurance that we will achieve our goal of sustainable growth in our
rental income, while sustaining our occupancy levels.
Due to the merger with Shurgard, we have acquired an additional 487
self-storage facilities in the United States, including 383 facilities we refer
to below as the Shurgard domestic same-store facilities, and 104 additional
facilities which are referred to as the Shurgard domestic non-same store
facilities. These facilities have an aggregate occupancy of approximately 84.4%
at September 30, 2006, as compared to 91.4% for the Public Storage Same-Store
facilities. It is our objective to close this occupancy gap, by raising average
occupancies of the acquired Shurgard properties to levels experienced by Public
Storage's Same Stores. We believe, at least in the short term, this strategy
will put pressure on occupancies and rental rate growth on the existing Same
Store Facilities as demand may shift to the acquired Shurgard facilities as we
adjust the level of discounts and monthly rents. In attempting to accomplish
this objective, we have significantly expanded our domestic pricing,
promotional, and media programs, and aggregate media costs will more than double
in the fourth quarter versus the aggregate level of spending incurred in the
fourth quarter of 2005. These costs will be allocated to all the facilities,
including the same-store as well as the acquired Shurgard facilities.
Cost of operations (excluding depreciation and amortization) increased
by 5.0% and 5.1% for the three and nine months ended September 30, 2006,
respectively, as compared to the same periods in 2005.
Payroll expense has increased 9.7% and 5.9% for the three and nine
months ended September 30, 2006, respectively, as compared to the same periods
in 2005, due principally to higher wage rates required for some of our job
classifications because of a tight labor market in several market areas, higher
overtime hours required due to understaffing issues, and the absence of a
workers compensation adjustment in the third quarter of 2005 which reflected
improving trends. We expect this trend to continue in the fourth quarter of
2006.
Repairs and maintenance expenditures increased 10.0% and 7.2% during
the three and nine months ended September 30, 2006. During the second quarter,
we experienced higher repair and maintenance costs to address certain deferred
maintenance issues localized to a few markets. We expect this trend to continue
in the fourth quarter of 2006.
Advertising and promotion costs decreased 12.7% and 0.3% for the three
and nine months ended September 30, 2006, respectively, compared to the same
periods in 2005. The decreases in advertising and promotion costs for the three
and nine months ended September 30, 2006 are due principally to decreases in
internet and television advertising expenses. Television advertising decreased
from $2,314,000 to $1,082,000 in the three months ended September 30, 2006 as
compared to the same period in 2005, and decreased from $8,857,000 to $7,671,000
for the nine months ended September 30, 2006 as compared to the same period in
2005. We expect fourth quarter advertising and promotional expenses to increase
significantly in the fourth quarter, as noted above.
As described below under "Shurgard Same-Store Facilities," certain cost
savings in the area of yellow page advertising and call center expenses will
benefit the same-store facilities as these benefits are allocated among all the
facilities in our portfolio.
50
Utility expenses increased 7.3% and 8.7% during the three and nine
months ended September 30, 2006, due principally to higher energy costs. These
levels of increases are expected to persist during the remainder of 2006.
Insurance expense increased 48.0% and 27.5% for the three and nine
months ended September 30, 2006, reflecting significant increases in property
insurance resulting primarily from the hurricanes experienced in 2005. These
rate increases became effective with our policy year starting April 1, 2006. We
expect to realize certain economies due to the merger with Shurgard and,
accordingly, expect the increases to moderate in the fourth quarter of 2006 and
the first quarter of 2007.
Telephone reservation center costs decreased 8.2% for the three months
ended September 30, 2006 and increased 1.2% for the nine months ended September
30, 2006, compared to the same periods in 2005. In preparation for our seasonal
rental period, we increased our staffing levels earlier this year compared to
the same period in 2005, resulting in higher payroll costs. We began to realize
certain benefits from the increased staffing through better conversion ratios
and lower temporary staffing costs during the three months ended September 30,
2006. We expect to continue to realize such benefits through the remainder of
2006.
The following table summarizes selected quarterly financial data with
respect to the Same Store Facilities:
For the Quarter Ended
------------------------------------------------------------------------------------------
March 31 June 30 September 30 December 31 Entire Year
------------- ------------- -------------- -------------- -------------
(Amounts in thousands, except for per square foot amounts)
Total rental income:
2006 $ 208,228 $ 214,832 $ 221,386
2005 $ 198,059 $ 203,302 $ 208,745 $ 208,272 $ 818,378
Total cost of operations
(excluding depreciation
and amortization):
2006 $ 72,030 $ 72,749 $ 71,115
2005 $ 69,991 $ 67,736 $ 67,730 $ 65,873 $ 271,330
Property tax expense:
2006 $ 20,663 $ 19,346 $ 20,376
2005 $ 19,931 $ 18,402 $ 19,573 $ 17,025 $ 74,931
Media advertising
expense:
2006 $ 3,978 $ 2,611 $ 1,002
2005 $ 3,588 $ 2,955 $ 2,314 $ 2,141 $ 10,998
REVPAF:
2006 $ 10.77 $ 11.10 $ 11.43
2005 $ 10.25 $ 10.52 $ 10.77 $ 10.76 $ 10.58
Weighted average realized
annual rent per occupied
square foot:
2006 $ 11.94 $ 12.05 $ 12.50
2005 $ 11.41 $ 11.42 $ 11.75 $ 11.89 $ 11.61
Weighted average occupancy levels for the period:
2006 90.2% 92.1% 91.4%
2005 89.9% 92.1% 91.7% 90.5% 91.1%
51
ANALYSIS OF REGIONAL TRENDS
---------------------------
The following table sets forth regional trends in our Same Store
Facilities:
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------ --------------------------------------
2006 2005 Change 2006 2005 Change
------------ ----------- ---------- ------------ ------------- ---------
(Amounts in thousands, except for per square foot amounts)
SAME STORE FACILITIES OPERATING TRENDS
BY REGION
Rental income:
Southern California (126
facilities)...................... $ 35,871 $ 34,066 5.3% $ 105,231 $ 100,181 5.0%
Northern California (127
facilities)...................... 26,822 25,292 6.0% 77,983 73,801 5.7%
Texas (149 facilities).......... 19,625 18,287 7.3% 56,772 53,596 5.9%
Florida (130 facilities)........ 22,793 21,057 8.2% 67,347 61,662 9.2%
Illinois (91 facilities)........ 16,577 15,635 6.0% 47,556 45,680 4.1%
Georgia (58 facilities)......... 7,671 7,013 9.4% 22,285 20,419 9.1%
All other states (585 facilities) 92,027 87,395 5.3% 267,272 254,767 4.9%
------------ ----------- ---------- ------------ ------------- ---------
Total rental income................. 221,386 208,745 6.1% 644,446 610,106 5.6%
Cost of operations before depreciation
and amortization:
Southern California.............. 7,530 7,216 4.4% 23,905 22,133 8.0%
Northern California.............. 6,747 6,303 7.0% 20,485 19,060 7.5%
Texas............................ 8,519 8,091 5.3% 25,576 24,055 6.3%
Florida.......................... 7,818 7,199 8.6% 22,567 21,561 4.7%
Illinois......................... 6,356 6,245 1.8% 20,892 19,447 7.4%
Georgia.......................... 2,452 2,315 5.9% 7,503 7,071 6.1%
All other states................. 31,693 30,361 4.4% 94,966 92,130 3.1%
------------ ----------- ---------- ------------ ------------- ---------
Total cost of operations............ 71,115 67,730 5.0% 215,894 205,457 5.1%
Net operating income before depreciation
and amortization:
Southern California.............. 28,341 26,850 5.6% 81,326 78,048 4.2%
Northern California.............. 20,075 18,989 5.7% 57,498 54,741 5.0%
Texas............................ 11,106 10,196 8.9% 31,196 29,541 5.6%
Florida.......................... 14,975 13,858 8.1% 44,780 40,101 11.7%
Illinois......................... 10,221 9,390 8.8% 26,664 26,233 1.6%
Georgia.......................... 5,219 4,698 11.1% 14,782 13,348 10.7%
All other states................. 60,334 57,034 5.8% 172,306 162,637 5.9%
------------ ----------- ---------- ------------ ------------- ---------
Total net operating income before
depreciation and amortization.... $ 150,271 $ 141,015 6.6 $ 428,552 $ 404,649 5.9%
Weighted average occupancy:
Southern California.............. 91.0% 92.2% (1.3)% 91.4% 92.4% (1.1)%
Northern California.............. 90.5% 91.0% (0.5)% 90.6% 90.7% (0.1)%
Texas............................ 91.4% 90.8% 0.7% 91.1% 90.1% 1.1%
Florida.......................... 92.7% 94.4% (1.8)% 93.3% 93.3% 0.0%
Illinois......................... 90.9% 90.8% 0.1% 89.8% 89.8% 0.0%
Georgia.......................... 92.5% 92.8% (0.3)% 92.9% 92.3% 0.7%
All other states................. 91.3% 91.5% (0.2)% 90.9% 91.1% (0.2)%
------------ ----------- ---------- ------------ ------------- ---------
Total weighted average occupancy.... 91.4% 91.7% (0.3)% 91.2% 91.2% 0.0%
REVPAF:
Southern California.............. $ 17.44 $ 16.55 5.4% $ 17.06 $ 16.24 5.0%
Northern California.............. 14.85 14.00 6.1% 14.40 13.63 5.6%
Texas............................ 8.06 7.53 7.0% 7.78 7.37 5.6%
Florida.......................... 11.66 10.76 8.3% 11.49 10.52 9.2%
Illinois......................... 11.39 10.72 6.2% 10.90 10.48 4.0%
Georgia.......................... 8.61 7.91 9.0% 8.35 7.68 8.7%
All other states................. 10.46 9.93 5.4% 10.14 9.67 4.9%
------------ ----------- ---------- ------------ ------------- ---------
Total REVPAF........................ $ 11.43 $ 10.77 6.1% $ 11.10 $ 10.51 5.6%
52
SAME STORE FACILITIES OPERATING
TRENDS BY REGION (CONTINUED)
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------ --------------------------------------
2006 2005 Change 2006 2005 Change
------------ ----------- ---------- ------------ ------------- ---------
Realized annual rent per occupied square foot:
Southern California.............. $ 19.16 $ 17.95 6.7% $ 18.67 $ 17.57 6.3%
Northern California.............. 16.41 15.38 6.7% 15.89 15.03 5.7%
Texas............................ 8.82 8.29 6.4% 8.54 8.18 4.4%
Florida.......................... 12.57 11.40 10.3% 12.31 11.27 9.2%
Illinois......................... 12.53 11.81 6.1% 12.14 11.67 4.0%
Georgia.......................... 9.31 8.53 9.1% 8.99 8.32 8.1%
All other states................. 11.45 10.85 5.5% 11.15 10.61 5.1%
------------ ----------- ---------- ------------ ------------- ---------
Total realized rent per square foot. $ 12.50 $ 11.75 6.4% $ 12.17 $ 11.53 5.6%
In place annual rent per occupied square foot at September 30:
Southern California.............. $ 20.54 $ 19.42 5.8%
Northern California.............. 17.61 16.71 5.4%
Texas............................ 9.56 9.08 5.3%
Florida.......................... 13.58 12.60 7.8%
Illinois......................... 13.61 12.97 4.9%
Georgia.......................... 10.21 9.48 7.7%
All other states................. 12.38 11.88 4.2%
------------ ------------- ---------
Total in place rent per occupied
square foot....................... $ 13.51 $ 12.85 5.1%
Shurgard Domestic Operating Data
In the merger with Shurgard, we acquired 487 facilities located in 21
states with an aggregate of 32.1 million net rentable square feet. The following
chart sets forth the operations of the Shurgard Facilities from August 22, 2006
through September 30, 2006, the period operated under Public Storage and
consolidated in our financial statements (amounts in thousands):
53
From August 22,
2006 through
September 30, 2006
------------------
Rental income:
Same Store - 383 facilities............... $ 31,237
Non-Same Store - 104 facilities........... 7,704
------------------
Total rental income.......................... 38,941
Cost of operations (excluding depreciation):
Same Store................................ 9,582
Non-Same Store............................ 2,820
------------------
Total cost of operations..................... 12,402
Net operating income before depreciation (a):
Same Store................................ 21,655
Non-Same Store............................ 4,884
------------------
Total net operating income before 26,539
depreciation.................................
Depreciation and amortization................ (48,032)
------------------
Net operating income...................... $ (21,493)
==================
Weighted average square foot occupancy
during the period:........................... 84.4%
Weighted average realized annual rent per
occupied square foot for the period:......... $ 12.89
In place annual rent per occupied square
foot at September 30:........................ $ 13.86
(a) Total net operating income before depreciation, which is a non-GAAP
measure, for our commercial property segment is presented in Note 13 to
our condensed consolidated financial statements, "Segment Information,"
which includes a reconciliation of net operating income before
depreciation for this segment to our consolidated net income.
As noted above, our Same-Store facilities had occupancies of
approximately 91.4% at September 30, 2006, as compared to 84.4% for the acquired
Shurgard Same Store portfolio. It is our objective to close this occupancy gap
in order to increase REVPAF. In attempting to accomplish this objective, we have
significantly expanded our domestic pricing, promotional, and media programs,
and aggregate media costs will more than double in the fourth quarter versus the
aggregate level of spending incurred in the fourth quarter of 2005. There can be
no assurance that we will meet our objectives or that any increase in
occupancies will not be offset by lower realized rent per occupied square foot
either due to promotional discounts or lower monthly rent in the acquired
Shurgard facilities or the Same Store facilities.
The operating data presented in the table below reflects the historical
data through August 22, 2006, the period for which the facilities were operated
under Shurgard combined with the historical data from August 22, 2006 through
September 30, 2006, the period operated under Public Storage. Accordingly, the
data presented below does not reflect the actual results included in our
operations for the three and nine months ended September 30, 2006 and 2005 and
does not purport to project results of operations for any future date or period.
We have applied our definition of what qualifies as a Same Store and, as a
result, the number of properties included in the Shurgard Domestic Same Store
portfolio has decreased from 462 facilities (as reported by Shurgard in the
second quarter of 2006) to 383 facilities as is currently being reported.
54
Selected Operating Data for the 383 facilities
----------------------------------------------
operated by Shurgard on a stabilized basis since
------------------------------------------------
January 1, 2004 ("Shurgard Domestic Same Store
----------------------------------------------
Facilities"): (a)
-----------------
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------------- -------------------------------------
Percentage Percentage
2006 2005 Change 2006 2005 Change
------------ ------------ ----------- ------------ ----------- -----------
(Dollar amounts in thousands, except weighted average data) (b)
Revenues:
Rental income................................. $ 70,625 $ 68,232 3.5% $ 208,278 $ 197,930 5.2%
Late charges and administrative fees collected 2,667 2,567 3.9% 7,417 7,147 3.8%
------------ ------------ ----------- ------------ ----------- -----------
Total revenues (b)............................ 73,292 70,799 3.5% 215,695 205,077 5.2%
Cost of operations (excluding depreciation):
Property taxes ............................... 7,107 6,489 9.5% 20,764 19,292 7.6%
Payroll expense............................... 11,620 12,014 (3.3)% 36,303 35,730 1.6%
Advertising and promotion..................... 2,045 1,975 3.5% 5,099 5,581 (8.6)%
Utilities..................................... 2,215 2,108 5.1% 6,094 5,434 12.1%
Repairs and maintenance....................... 1,505 1,733 (13.2)% 4,785 4,944 (3.2)%
Property insurance............................ 565 377 49.9% 1,354 1,247 8.6%
Other costs of management..................... 2,559 2,579 (0.8)% 7,909 7,641 3.5%
------------ ------------ ----------- ------------ ----------- -----------
Total cost of operations (b).................... 27,616 27,275 1.3% 82,308 79,869 3.1%
------------ ------------ ----------- ------------ ----------- -----------
Net operating income (excluding depreciation) (c) $ 45,676 $ 43,524 4.9% $ 133,387 $ 125,208 6.5%
============ ============ =========== ============ =========== ===========
Gross margin (before depreciation)................ 62.3% 61.5% 1.3% 61.8% 61.1% 1.1%
Weighted average for the period:
Square foot occupancy (d)....................... 85.9% 88.1% (2.5)% 85.6% 86.7% (1.3)%
Realized annual rent per occupied square foot (e) $ 13.28 $ 12.51 6.2% $ 13.10 $ 12.29 6.6%
REVPAF (f) (g).................................. $ 11.41 $ 11.02 3.5% $ 11.21 $ 10.66 5.2%
Weighted average at September 30:
Square foot occupancy........................... 85.8% 87.7% (2.2)%
Total net rentable square feet (in thousands)..... 24,765 24,765 -
(a) Operating data reflects the operations of these facilities without
regard to the time period in which Public Storage owned the facilities;
only the amounts for the period August 23, 2006 through September 30,
2006 are included in our consolidated operating results, totaling
$31,237,000 in revenues and $9,582,000 in cost of operations.
(b) Revenues and cost of operations do not include ancillary revenues and
expenses generated at the facilities with respect to tenant
reinsurance, and retail sales and truck rentals. "Other costs of
management" included in cost of operations principally represents all
the indirect costs incurred in the operations of the facilities.
Indirect costs principally include supervisory costs and corporate
overhead cost incurred to support the operating activities of the
facilities. These amounts presented herein will not necessarily compare
to amounts previously presented by Shurgard in its public reporting due
to differences in classification of revenues and expenses, including
tenant reinsurance, retail sales and truck rental activities which are
included on our income statement under "ancillary operations" but were
previously presented by Shurgard as self-storage revenue and operating
expenses.
(c) Net operating income (before depreciation) or "NOI" is a non-GAAP
(generally accepted accounting principles) financial measure that
excludes the impact of depreciation expense. Although depreciation is
an operating expense, we believe that NOI is a meaningful measure of
operating performance, because we utilize NOI in making decisions with
respect to capital allocations, in determining current property values,
segment performance, and comparing period-to-period and
market-to-market property operating results. NOI is not a substitute
for net operating income after depreciation in evaluating our operating
results. We have not presented depreciation expense for these
facilities because the depreciation expense is based upon historical
cost, which is substantially different before the merger and after.
(d) Square foot occupancies represent weighted average occupancy levels
over the entire period.
55
(e) Realized annual rent per occupied square foot is computed by
annualizing the result of dividing rental income by the weighted
average occupied square footage for the period. Realized annual rent
per occupied square foot takes into consideration promotional discounts
and other costs that reduce rental income from the contractual amounts
due.
(f) Annualized rental income per available square foot ("REVPAF")
represents annualized rental income divided by total available net
rentable square feet.
(g) Late charges and administrative fees are excluded from the computation
of realized annual rent per occupied square foot and REVPAF because
exclusion of these amounts provides a better measure of our ongoing
level of revenue, by excluding the volatility of late charges, which
are dependent principally upon the level of tenant delinquency, and
administrative fees, which are dependent principally upon the absolute
level of move-ins for a period.
On the date of the merger, we successfully installed our real-time
property operation system at all U.S. Shurgard locations. As a result, these
facilities are integrated into our national call center, website, and management
structure. The integration of these facilities into our operations should have
additional benefits and cost savings.
Beginning January 2007, all field personnel will be under a revised
Public Storage compensation and benefit plan. The cost savings from implementing
the new plan along with a more efficient staffing mix are expected to be in
excess of $5 million per year.
Marketing costs, exclusive of media, will be lower as a result of
combining Yellow Page advertising and terminating Shurgard's marketing programs.
There will be approximately $5 million in savings that will phase in over the
next year over the level of yellow page expenses incurred by Shurgard, resulting
in lower per-property expenses for all of the facilities in our portfolio as
costs are spread over a larger base. We expect property tax expense to be higher
than that experienced by Shurgard due to higher assessments following the
merger.
SHURGARD EUROPEAN OPERATING DATA
In the merger with Shurgard, we acquired 160 facilities located in
seven European countries with an aggregate of 8,385,000 net rentable square
feet. The following chart sets forth the operations of the Shurgard Facilities
from August 22, 2006 through September 30, 2006, the period operated under
Public Storage and consolidated in our financial statements (amounts in
thousands):
From August 22,
2006 through
September 30, 2006
------------------
Rental income:
Same Store - 96 facilities................ $ 12,012
Non-Same Store - 64 facilities............ 5,336
------------------
Total rental income.......................... 17,348
Cost of operations (excluding depreciation):
Same Store................................ 5,048
Non-Same Store............................ 3,476
------------------
Total cost of operations..................... 8,524
Net operating income before depreciation (a):
Same Store................................ 6,964
Non-Same Store............................ 1,860
------------------
Total net operating income before 8,824
depreciation.................................
Depreciation and amortization................ (15,020)
------------------
Net operating loss........................ $ (6,196)
==================
Weighted average square foot occupancy
during the period:........................... 81.9%
Weighted average realized annual rent per
occupied square foot for the period:......... $ 23.13
In place annual rent per occupied square
foot at September 30:........................ $ 22.77
(a) Total net operating income before depreciation, which is a non-GAAP
measure, for our commercial property segment is presented in Note 13 to
our condensed consolidated financial statements, "Segment Information,"
which includes a reconciliation of net operating income before
depreciation for this segment to our consolidated net income.
56
The operating data presented in the table below reflect the historical
data through August 22, 2006, the period for which the facilities were operated
under Shurgard combined with the historical data from August 22, 2006 through
September 30, 2006, the period operated under Public Storage. Accordingly, the
data presented below does not reflect the actual results included in our
operations for the three and nine months ended September 30, 2006 and 2005. We
have applied our definition of what qualifies as a Same Store. As a result, the
number of properties included in the Shurgard European Same Store portfolio has
decreased from 123 facilities (as reported by Shurgard in the second quarter of
2006) to 96 facilities as is currently being reported.
Selected Operating Data for the 96 facilities
---------------------------------------------------
operated by Shurgard Europe on a stabilized basis
----------------------------------------------------
since January 1, 2004 ("Europe Same Store
---------------------------------------------------
Facilities"): (a)
----------------
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------------- -------------------------------------
Percentage Percentage
2006 2005 Change 2006 2005 Change
------------- ------------ ------------ ------------- ----------- -----------
(Dollar amounts in thousands, except weighted average data, utilizing
constant exchange rates) (b)
Revenues:
Rental income................................. $ 27,539 $ 24,535 12.2% $ 77,737 $ 68,546 13.4%
Late charges and administrative fees collected 266 251 6.0% 757 610 24.1%
------------- ------------ ------------ ------------- ----------- -----------
Total revenues (c)............................ 27,805 24,786 12.2% 78,494 69,156 13.5%
Cost of operations (excluding depreciation):
Property taxes ............................... 1,261 1,174 7.4% 3,665 3,423 7.1%
Payroll expense............................... 5,198 5,189 0.2% 15,858 16,084 (1.4)%
Advertising and promotion..................... 1,179 1,689 (30.2)% 4,358 5,663 (23.0)%
Utilities..................................... 695 565 23.0% 2,266 2,051 10.5%
Repairs and maintenance....................... 898 807 11.3% 2,479 2,459 0.8%
Property insurance............................ 346 403 (14.1)% 1,028 1,150 (10.6)%
Leasehold expense............................. 635 756 (16.0)% 1,815 1,723 5.3%
Other costs of management..................... 2,396 2,615 (8.4)% 6,651 7,910 (15.9)%
------------- ------------ ------------ ------------- ----------- -----------
Total cost of operations (c).................... 12,608 13,198 (4.5)% 38,120 40,463 (5.8)%
------------- ------------ ------------ ------------- ----------- -----------
Net operating income (excluding depreciation) (d) $ 15,197 $ 11,588 31.1% $ 40,374 $ 28,693 40.7%
============= ============ ============ ============= =========== ===========
Gross margin (before depreciation)................ 54.7% 46.8% 16.9% 51.4% 41.5% 23.9%
Weighted average for the period:
Square foot occupancy (e)....................... 86.7% 81.3% 6.6% 84.0% 77.2% 8.8%
Realized annual rent per occupied square foot (f) $ 24.01 $ 22.81 5.3% $ 23.32 $ 22.38 4.2%
REVPAF (g) (h).................................. $ 20.82 $ 18.54 12.3% $ 19.59 $ 17.27 13.4%
Weighted average at September 30:
Square foot occupancy........................... 88.3% 82.5% 7.0%
In place annual rent per occupied square foot (i) $ 23.42 $ 22.51 4.0%
Total net rentable square feet (in thousands)..... 5,291 5,291 -
(a) Operating data reflects the operations of these facilities without
regard to the time period in which Public Storage owned the facilities;
only the amounts for the period August 23, 2006 through September 30,
2006 are included in our consolidated operating results.
(b) Amounts for all periods have been translated from local currencies to
U.S. dollars at a constant exchange rate of 1.25 US Dollars to Euros.
(c) Revenues and cost of operations do not include ancillary revenues and
expenses generated at the facilities with respect to tenant reinsurance
and retail sales. "Other costs of management" included in cost of
operations principally represents all the indirect costs incurred in
the operations of the facilities. Indirect costs principally include
supervisory costs and corporate overhead cost incurred to support the
operating activities of the facilities. These amounts presented herein
will not necessary compare to amounts previously presented by Shurgard
in its public reporting due to differences in classification of
revenues and expenses, including tenant reinsurance, retail sales, and
truck rental activities which are included on our income statement
under "ancillary operations" but were previously presented by Shurgard
as self-storage revenue and operating expenses.
57
(d) Net operating income (before depreciation) or "NOI" is a non-GAAP
(generally accepted accounting principles) financial measure that
excludes the impact of depreciation expense. Although depreciation is
an operating expense, we believe that NOI is a meaningful measure of
operating performance, because we utilize NOI in making decisions with
respect to capital allocations, in determining current property values,
segment performance, and comparing period-to-period and
market-to-market property operating results. NOI is not a substitute
for net operating income after depreciation in evaluating our operating
results.
(e) Square foot occupancies represent weighted average occupancy levels
over the entire period.
(f) Realized annual rent per occupied square foot is computed by
annualizing the result of dividing rental income by the weighted
average occupied square footage for the period. Realized annual rent
per occupied square foot takes into consideration promotional discounts
and other costs that reduce rental income from the contractual amounts
due.
(g) Annualized rental income per available square foot ("REVPAF")
represents annualized rental income divided by total available net
rentable square feet.
(h) Late charges and administrative fees are excluded from the computation
of realized annual rent per occupied square foot and REVPAF because
exclusion of these amounts provides a better measure of our ongoing
level of revenue, by excluding the volatility of late charges, which
are dependent principally upon the level of tenant delinquency, and
administrative fees, which are dependent principally upon the absolute
level of move-ins for a period.
(i) In place annual rent per occupied square foot represents annualized
contractual rents per occupied square foot without reductions for
promotional discounts, and excludes late charges and administrative
fees.
The European Same Store properties' NOI growth of over 30%
significantly exceeded our expectations. The European team is selectively
adapting various operating strategies we use in the United States and
incorporating them into their operating model.
SELF-STORAGE OPERATIONS - ACQUIRED FACILITIES
During 2004, 2005 and the first nine months of 2006, we acquired a
total of 89 self-storage facilities containing 6,383,000 net rentable square
feet. The following table summarizes operating data with respect to these
facilities.
ACQUIRED SELF-STORAGE FACILITIES
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------------- --------------------------------------
2006 2005 Change 2006 2005 Change
------------ ----------- ------------ ------------ ---------- -----------
(Dollar amounts in thousands, except square foot amounts)
Rental income:
Self-storage facilities acquired in 2006...... $ 2,168 $ - $ 2,168 $ 4,007 $ - $ 4,007
Self-storage facilities acquired in 2005...... 6,537 2,748 3,789 18,353 4,625 13,728
Self-storage facilities acquired in 2004...... 8,749 7,926 823 25,299 22,376 2,923
------------ ----------- ------------ ------------ ---------- -----------
Total rental income........................... 17,454 10,674 6,780 47,659 27,001 20,658
------------ ----------- ------------ ------------ ---------- -----------
Cost of operations before depreciation and
amortization :
Self-storage facilities acquired in 2006...... 1,061 - 1,061 2,003 - 2,003
Self-storage facilities acquired in 2005...... 2,424 1,195 1,229 7,278 2,146 5,132
Self-storage facilities acquired in 2004...... 3,120 3,005 115 9,331 9,362 (31)
------------ ----------- ------------ ------------ ---------- -----------
Total cost of operations...................... 6,605 4,200 2,405 18,612 11,508 7,104
------------ ----------- ------------ ------------ ---------- -----------
Net operating income before depreciation and amortization:
Self-storage facilities acquired in 2006...... 1,107 - 1,107 2,004 - 2,004
Self-storage facilities acquired in 2005...... 4,113 1,553 2,560 11,075 2,479 8,596
Self-storage facilities acquired in 2004...... 5,629 4,921 708 15,968 13,014 2,954
------------ ----------- ------------ ------------ ---------- -----------
Total net operating income before depreciation and
amortization (a).............................. 10,849 6,474 4,375 29,047 15,493 13,554
Depreciation and amortization.................... (4,649) (2,508) (2,141) (13,166) (6,571) (6,595)
------------ ----------- ------------ ------------ ---------- -----------
Net operating income.......................... $ 6,200 $ 3,966 $ 2,234 $ 15,881 $ 8,922 $ 6,959
============ =========== ============ ============ ========== ===========
58
ACQUIRED SELF-STORAGE FACILITIES (Continued)
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------------- --------------------------------------
2006 2005 Change 2006 2005 Change
------------ ----------- ------------ ------------ ---------- -----------
Weighted average square foot occupancy during the
period:
Self-storage facilities acquired in 2006...... 73.3% - - 69.1% - -
Self-storage facilities acquired in 2005...... 86.3% 87.4% (1.3)% 84.5% 70.8% 19.4%
Self-storage facilities acquired in 2004...... 89.6% 90.2% (0.7)% 88.3% 85.3% 3.5%
------------ ----------- ------------ ------------ ---------- -----------
86.1% 89.4% (3.7)% 85.0% 82.5% 3.0%
============ =========== ============ ============ ========== ===========
Weighted average realized annual rent per occupied
square foot for the period (b):
Self-storage facilities acquired in 2006...... $ 12.88 $ - - $ 13.37 $ - -
Self-storage facilities acquired in 2005...... 12.07 10.05 20.1% 11.57 9.55 21.2%
Self-storage facilities acquired in 2004...... 12.08 10.88 11.0% 11.78 10.60 11.1%
------------ ----------- ------------ ------------ ---------- -----------
$ 12.17 $ 10.66 14.2% $ 11.79 $ 10.42 13.1%
============ =========== ============ ============ ========== ===========
In place annual rent per occupied square foot at
September 30 (c):
Self-storage facilities acquired in 2006...... $ 14.53 $ - -
Self-storage facilities acquired in 2005...... 13.28 11.50 15.5%
Self-storage facilities acquired in 2004...... 13.01 11.99 8.5%
------------ ---------- -----------
13.29 11.85 12.2%
============ ========== ===========
Number of Facilities at September 30:
2006........................................ 12 - 12
2005........................................ 32 21 11
2004........................................ 45 45 -
------------ ---------- -----------
89 66 23
============ ========== ===========
Net rentable square feet at September 30:
Self-storage facilities acquired in 2006...... 872 - 872
Self-storage facilities acquired in 2005...... 2,390 1,469 921
Self-storage facilities acquired in 2004 (d).. 3,121 3,105 16
------------ ---------- -----------
6,383 4,574 1,809
============ ========== ===========
Cumulative acquisition cost at September 30:
Self-storage facilities acquired in 2006...... $ 103,544 $ - $ 103,544
Self-storage facilities acquired in 2005...... 254,549 124,753 129,796
Self-storage facilities acquired in 2004 (d).. 260,801 259,487 1,314
------------ ---------- -----------
$ 618,894 $ 384,240 $ 234,654
============ ========== ===========
(a) Total net operating income before depreciation and amortization, which
is a non-GAAP measure, for our acquired self-storage facilities
represents a portion of our total self-storage segment's net operating
income before depreciation and amortization, and is reconciled to the
segment total in the table "self-storage operations summary" above. A
reconciliation of our total self-storage segment's net operating income
before depreciation and amortization to consolidated net income is
included in Note 13 to our September 30, 2006 condensed consolidated
financial statements, "Segment Information."
(b) Realized annual rent per occupied square foot is computed by dividing
rental income, prior to late charges and administrative fees, by the
weighted average occupied square footage for the period. Realized
annual rent per occupied square foot takes into consideration
promotional discounts, credit card fees and other costs that reduce
rental income from the contractual amounts due.
(c) In place annual rent per occupied square foot represents annualized
contractual rents per occupied square foot without reductions for
promotional discounts, and excludes late charges and administrative
fees.
(d) During 2005, we expanded one of the 2004 acquisitions, adding 12,000
net rentable square feet at a cost of $1,314,000.
59
The 2005 and 2006 acquisitions were acquired at various dates
throughout each period. Accordingly, rental income, cost of operations,
depreciation, net operating income, weighted average square foot occupancies and
realized rents per square foot represent the operating results for the partial
period that we owned the facilities during the year acquired. In addition, in
place rents per occupied square foot at September 30, 2006 and 2005, reflect the
amounts for those facilities we owned at each of those respective dates.
During 2004, we acquired a total of 45 self-storage facilities with
cumulative acquisition costs of approximately $260,801,000, containing an
aggregate of approximately 3,121,000 net rentable square feet and are located
principally in the Buffalo, Dallas, Miami, Milwaukee, and Minneapolis
metropolitan areas.
During 2005, we acquired a total of 32 self-storage facilities,
principally in single-property transactions, for an aggregate cost of
$254,549,000. These facilities contain in the aggregate approximately 2,390,000
net rentable square feet and are located principally in the Atlanta, Chicago,
Miami, and New York metropolitan areas.
For the nine months ended September 30, 2006, we acquired a total of 12
self-storage facilities, each in a single-property transaction, containing an
aggregate of approximately 872,000 net rentable square feet for an aggregate
cost of $103,544,000 located in California, Florida, Illinois, New York,
Virginia, New Jersey, Delaware, Georgia and Colorado.
We believe our presence in and knowledge of substantially all of the
major markets in the United States enhances our ability to identify attractive
acquisition opportunities and capitalize on the overall fragmentation in the
storage industry. Our acquisitions consist of facilities that have been
operating for a number of years as well as newly constructed facilities that
were in the process of filling up to stabilized occupancy levels. In either
case, we have been able to leverage off of our operating strategies and improve
the occupancy levels of the facilities, or with respect to the newly developed
facilities we have been able to accelerate the fill-up pace.
We expect that our acquisitions will continue to provide earnings
growth during the remainder of 2006 as these facilities continue to improve
their occupancy levels as well as realized rental rates.
SELF-STORAGE OPERATIONS - EXPANSION FACILITIES
Our expansion facilities consist of (i) 53 self-storage facilities that
we have owned for a number of years and have recently expanded, or are in the
process of expanding, the amount of square footage available for rent combined
with (ii) eight self-storage facilities located in New Orleans that were heavily
impacted by Hurricane Katrina during 2005. The 53 self-storage facilities are
generally older facilities that are located in prime locations where we have
added additional space by either constructing new buildings on available land at
the existing site or by demolishing existing single story buildings and
rebuilding multi-story buildings in their place.
The operating results of these 53 expansion facilities and the eight
facilities located in New Orleans are not comparable on a year over year basis
due to the addition of square footage or the damage caused by the hurricane, in
the case of the New Orleans facilities. The operating results for these
facilities are presented in the table below.
60
EXPANSION SELF-STORAGE FACILITIES
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- --------------------------
2006 2005 Change 2006 2005 Change
------------- ------------- ------------ ------------- ------------ ---------
Rental income:
--------------
New Orleans facilities (a) ............... $ 1,401 $ 1,031 $ 370 $ 4,362 $ 3,986 $ 376
Other expansion facilities................ 12,581 10,719 1,862 35,416 30,515 4,901
------------- ------------- ------------ ------------- ------------ ---------
Total rental income..................... 13,982 11,750 2,232 39,778 34,501 5,277
------------- ------------- ------------ ------------- ------------ ---------
Cost of operations before depreciation:
---------------------------------------
New Orleans facilities.................... 456 500 (44) 1,229 1,475 (246)
Other expansion facilities................ 3,764 3,533 231 11,529 10,503 1,026
------------- ------------- ------------ ------------- ------------ ---------
Total cost of operations................ 4,220 4,033 187 12,758 11,978 780
------------- ------------- ------------ ------------- ------------ ---------
Net operating income before depreciation:
-----------------------------------------
New Orleans facilities.................... 945 531 414 3,133 2,511 622
Other expansion facilities................ 8,817 7,186 1,631 23,887 20,012 3,875
------------- ------------- ------------ ------------- ------------ ---------
Total net operating income before depreciation 9,762 7,717 2,045 27,020 22,523 4,497
(b)
Depreciation................................ (3,765) (2,739) (1,026) (9,780) (7,998) (1,782)
------------- ------------- ------------ ------------- ------------ ---------
Net operating income...................... $ 5,997 $ 4,978 $ 1,019 $ 17,240 $ 14,525 $ 2,715
============= ============= ============ ============= ============ =========
Weighted average square foot occupancy during the
-------------------------------------------------
period:
-------
New Orleans facilities (c)................ 82.1% 91.7% (10.5)% 82.9% 90.6% (8.5)%
Other expansion facilities................ 83.5% 87.7% (4.8)% 81.0% 85.3% (5.0)%
------------- ------------- ------------ ------------- ------------ ---------
83.4% 87.4% (4.6)% 81.2% 86.0% (5.6)%
============= ============= ============ ============= ============ =========
Weighted average realized rent per occupied square
--------------------------------------------------
foot during the period (d):
---------------------------
New Orleans facilities (c) ............... $ 9.90 $ 8.16 21.3% $ 8.68 $ 10.59 (18.0)%
Other expansion facilities................ 12.84 11.87 8.2% 12.44 11.80 5.4%
------------- ------------- ------------ ------------- ------------ ---------
$ 12.62 $ 11.56 9.2% $ 12.14 $ 11.65 4.2%
============= ============= ============ ============= ============ =========
In place annual rent per occupied square foot at
------------------------------------------------
September 30 (e):
New Orleans facilities (c) ............... $ 14.41 $ 13.39 7.6%
Other expansion facilities................ 13.93 13.26 5.1%
------------ ------------ ---------
$ 13.97 $ 13.27 5.3%
============ ============ =========
Number of Facilities at September 30:
-------------------------------------
New Orleans facilities.................... 8 8 -
Other expansion facilities................ 53 53 -
------------ ------------ ---------
61 61 -
============ ============ =========
Net rentable square feet (in thousands,
---------------------------------------
at end of period) (f):
----------------------
New Orleans facilities.................... 524 524 -
Other expansion facilities................ 4,828 4,123 705
------------ ------------ ---------
5,352 4,647 705
============ ============ =========
(a) Rental income for the New Orleans Facilities for the three and nine
months ended September 30, 2006 includes $277,000 and $1,217,000,
respectively, in business interruption proceeds we expect to receive
from our insurers, relative to losses occurring in each respective
period (none for the same periods in 2005).
61
(b) Total net operating income before depreciation, which is a non-GAAP
measure, for our expansion self-storage facilities represents a portion
of our total self-storage segment's net operating income before
depreciation, and is reconciled to the segment total in the table
"self-storage operations summary" above. A reconciliation of our total
self-storage segment's net operating income before depreciation to
consolidated net income is included in Note 13 to our September 30,
2006 condensed consolidated financial statements, "Segment
Information."
(c) Occupied and available square footage excludes the impact of units
taken offline due to hurricane damage, where such amounts are factored
in to the computations of weighted average square foot occupancy,
weighted average realized rent per occupied square foot, and in place
annual rent per occupied square foot.
(d) Realized annual rent per occupied square foot is computed by dividing
rental income, prior to late charges and administrative fees, by the
weighted average occupied square footage for the period. Realized
annual rent per occupied square foot takes into consideration
promotional discounts, credit card fees and other costs that reduce
rental income from the contractual amounts due. Realized rent per
square foot excludes the impact of $277,000 and $1,217,000 in business
interruption proceeds we expect to receive from our insurers relative
to the New Orleans facilities for the three and nine months ended
September 30, 2006, respectively (none for the same periods in 2005).
(e) In place annual rent per occupied square foot represents annualized
contractual rents per occupied square foot without reductions for
promotional discounts, and excludes late charges and administrative
fees.
(f) Square footage excludes 299,000 net rentable containerized storage
space initially developed for the containerized storage business at
September 30, 2006, but includes square footage taken offline due to
hurricane damage.
All of the New Orleans facilities were closed for operations for
several weeks following the hurricane; however, all but two of these facilities
have since reopened. The six that are operating are not operating at full
capacity, as many units are unavailable for lease due to damage. The two
facilities that remain closed will not be able to reopen at all without
substantial restoration and repair work. Notwithstanding that six of our
facilities in New Orleans are currently operating, we believe that the indirect
economic effects of the hurricane on the city may have a negative impact on our
facilities' operating results, and these effects are expected to continue for an
indeterminate time period. Included in revenues for the three and nine months
ended September 30, 2006 are $277,000 and $1,217,000, respectively, in expected
business interruption proceeds for these facilities, representing the loss of
business for the nine months ended September 30, 2006.
We expect that the Expansion Facilities, other than the New Orleans
facilities, will continue to provide growth to our earnings during the remainder
of 2006 as we continue to rent the newly added vacant space. The weighted
average occupancy level of these facilities was 83.5%, and 81.0% for the three
and nine months ended September 30, 2006, respectively. For the three and nine
months ended September 30, 2005, the weighted average occupancy level of these
facilities was 87.7% and 85.3%, respectively.
We expect that we will continue to redevelop additional facilities; at
September 30, 2006, we have five projects with an aggregate cost of $18,883,000
to convert the containerized storage space into self-storage space and 44 other
expansion and repackaging projects to enhance the visual appeal of our
facilities or increase their net rentable space at an aggregate cost of
$219,232,000. These activities will increase our self-storage space by an
aggregate of 2,750,000 net rentable square feet and will result in short-term
dilution to earnings. However, we believe that expansion of our existing
self-storage facilities in markets that have unmet storage demand, and improving
our existing facilities' competitive position through enhancing their visual
appeal, provide an important means to improve the Company's earnings. Further,
the construction cost for these expansions is generally lower on a per-square
foot basis than the development of a new facility, resulting in a higher yield
potential on invested capital. There can be no assurance about the future level
of such expansion and enhancement opportunities, and these projects are subject
to contingencies.
SELF-STORAGE OPERATIONS - DEVELOPED FACILITIES
We have 44 newly developed self-storage facilities, and 17 facilities
that were developed to contain both self-storage and containerized storage at
the same location ("Combination Facilities") that have not been operating at a
stabilized level of operations since January 1, 2004. At September 30, 2006,
these newly developed facilities have an aggregate of 5,102,000 net rentable
62
square feet of self-storage space and 125,000 net rentable square feet of
industrial space developed originally for our containerized storage business.
Aggregate development cost for these 61 facilities was approximately
$539,174,000 at September 30, 2006. The operating results of the self-storage
facilities and Combination Facilities are reflected in the Self-Storage
Operations table under the caption, "Developed Facilities." These facilities are
not included in the "Same Store" portfolio because their operations have not
been stabilized.
The following table sets forth the operating results and selected
operating data with respect to the Developed Facilities:
DEVELOPED SELF-STORAGE FACILITIES Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2006 2005 Change 2006 2005 Change
------------- ----------- ----------- ----------- ------------ -----------
(Amounts in thousands, except per square foot amounts and facility count)
Rental income:
Self-storage facilities opened in 2006....... $ 375 $ - $ 375 $ 431 $ - $ 431
Self-storage facilities opened in 2005....... 784 154 630 1,737 204 1,533
Self-storage facilities opened in 2004....... 2,047 1,505 542 5,407 3,759 1,648
Self-storage facilities opened in 2003 and 2002 7,322 6,452 870 20,841 18,338 2,503
Combination facilities....................... 5,516 4,422 1,094 15,289 12,394 2,895
------------- ----------- ----------- ----------- ------------ -----------
Total rental income....................... 16,044 12,533 3,511 43,705 34,695 9,010
------------- ----------- ----------- ----------- ------------ -----------
Cost of operations before depreciation:
Self-storage facilities opened in 2006....... 344 - 344 458 - 458
Self-storage facilities opened in 2005....... 381 187 194 1,201 304 897
Self-storage facilities opened in 2004....... 641 525 116 1,770 1,703 67
Self-storage facilities opened in 2003 and 2002 2,161 2,096 65 6,556 6,362 194
Combination facilities....................... 1,899 1,502 397 5,557 5,007 550
------------- ----------- ----------- ----------- ------------ -----------
Total cost of operations before depreciation 5,426 4,310 1,116 15,542 13,376 2,166
------------- ----------- ----------- ----------- ------------ -----------
Net operating income before depreciation:
Self-storage facilities opened in 2006....... 31 - 31 (27) - (27)
Self-storage facilities opened in 2005....... 403 (33) 436 536 (100) 636
Self-storage facilities opened in 2004....... 1,406 980 426 3,637 2,056 1,581
Self-storage facilities opened in 2003 and 2002 5,161 4,356 805 14,285 11,976 2,309
Combination facilities....................... 3,617 2,920 697 9,732 7,387 2,345
------------- ----------- ----------- ----------- ------------ -----------
Net operating income before depreciation (a) 10,618 8,223 2,395 28,163 21,319 6,844
Depreciation.................................. (3,857) (3,296) (561) (10,975) (9,584) (1,391)
------------- ----------- ----------- ----------- ------------ -----------
Net operating income........................ $ 6,761 $ 4,927 $ 1,834 $ 17,188 $ 11,735 $ 5,453
============= =========== =========== =========== ============ ===========
Weighted average square foot occupancy during
the period:
Self-storage facilities opened in 2006....... 35.5% - - 26.0% - -
Self-storage facilities opened in 2005....... 52.8% 29.1% 81.4% 42.6% 15.0% 184.0%
Self-storage facilities opened in 2004....... 89.5% 82.0% 9.1% 87.0% 66.3% 31.2%
Self-storage facilities opened in 2003 and 2002 91.9% 91.9% 0.0% 92.1% 90.2% 2.1%
Combination facilities....................... 80.6% 82.1% (1.8)% 77.8% 78.6% (1.0)%
------------- ----------- ----------- ----------- ------------ -----------
81.0% 82.3% (1.6)% 79.2% 80.9% (2.1)%
============= =========== =========== =========== ============ ===========
Weighted average realized rent per occupied
square foot during the period (b):
Self-storage facilities opened in 2006....... $ 13.97$ - - $ 11.2$ - -
Self-storage facilities opened in 2005....... 12.15 8.02 51.5% 11.07 6.95 59.3%
Self-storage facilities opened in 2004....... 16.79 14.43 16.4% 16.03 13.74 16.7%
Self-storage facilities opened in 2003 and 2002 15.69 13.88 13.0% 14.94 13.40 11.5%
Combination facilities....................... 13.71 12.84 6.8% 13.36 12.70 5.2%
------------- ----------- ----------- ----------- ------------ -----------
$ 14.78 $ 13.42 10.1% $ 14.20 $ 13.10 8.4%
============= =========== =========== =========== ============ ===========
63
DEVELOPED SELF-STORAGE FACILITIES
(continued)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2006 2005 Change 2006 2005 Change
------------- ----------- ----------- ----------- ------------ -----------
(Amounts in thousands, except per square foot amounts and facility count)
In place annual rent per occupied square foot at
-------------------------------------------------
September 30 (c):
Self-storage facilities opened in 2006....... $ 23.2$ $ - -
Self-storage facilities opened in 2005....... 14.71 12.29 19.7%
Self-storage facilities opened in 2004....... 17.88 16.57 7.9%
Self-storage facilities opened in 2003 and 2002 16.54 15.09 9.6%
Combination facilities....................... 14.97 14.02 6.8%
----------- ------------ -----------
$ 16.13 $ 14.77 9.2%
=========== ============ ===========
Number of facilities at September 30:
Self-storage facilities opened in 2006....... 3 - 3
Self-storage facilities opened in 2005....... 6 3 3
Self-storage facilities opened in 2004....... 7 7 -
Self-storage facilities opened in 2003 and 2002 28 28 -
Combination facilities....................... 17 17 -
----------- ------------ -----------
61 55 6
=========== ============ ===========
Square Footage at September 30:
Self-storage facilities opened in 2006....... 281 - 281
Self-storage facilities opened in 2005....... 463 259 204
Self-storage facilities opened in 2004....... 505 505 -
Self-storage facilities opened in 2003 and 2002 1,937 1,937 -
Combination facilities (d)................... 1,916 1,669 247
----------- ------------ -----------
5,102 4,370 732
=========== ============ ===========
Cumulative development cost at September 30:
Self-storage facilities opened in 2006....... $ 49,519 $ - $ 49,519
Self-storage facilities opened in 2005....... 37,820 15,893 21,927
Self-storage facilities opened in 2004....... 60,579 60,573 6
Self-storage facilities opened in 2003 and 2002 211,621 204,473 7,148
Combination facilities (d)................... 179,635 175,370 4,265
----------- ------------ -----------
$539,174 $456,309 $ 82,865
=========== ============ ===========
(a) Total net operating income before depreciation, which is a non-GAAP
measure, for our developed self-storage facilities represents a portion
of our total self-storage segment's net operating income before
depreciation, and is denoted in the table "self-storage operations
summary" above. A reconciliation of our total self-storage segment's
net operating income before depreciation to consolidated net income is
included in Note 13 to our September 30, 2006 condensed consolidated
financial statements, "Segment Information."
(b) Realized annual rent per occupied square foot is computed by dividing
rental income, prior to late charges and administrative fees, by the
weighted average occupied square footage for the period. Realized
annual rent per occupied square foot takes into consideration
promotional discounts, credit card fees and other costs that reduce
rental income from the contractual amounts due, and therefore amounts
for the three and nine months ended September 30, 2006 and 2005 may not
be comparable to the same periods in prior years for self-storage
facilities opened in 2006 and 2005. We typically provide significant
promotional discounts to new tenants when a facility first opens for
operations. As facilities reach a stabilized occupancy level, the
amounts of discounts given will be reduced significantly.
(c) In place annual rent per occupied square foot represents annualized
contractual rents per occupied square foot without reductions for
promotional discounts, and excludes late charges and administrative
fees.
(d) Square footages exclude industrial space developed for containerized
storage activities totaling 125,000 net rentable square feet at
September 30, 2006. Since January 1, 2003, we have converted industrial
space no longer used by the discontinued containerized storage business
into 1,553,000 net rentable square feet of traditional self-storage
space, at an aggregate cost of $25,964,000.
64
Unlike many other forms of real estate, we are unable to pre-lease our
newly developed facilities due to the nature of our tenants. Accordingly, at the
time a newly developed facility first opens for operation the facility is
entirely vacant generating no rental income. Historically, we estimated that on
average it takes approximately 24 to 36 months for a newly developed facility to
fill up and reach a targeted occupancy level of approximately 90%.
As these facilities approach the targeted occupancy level of
approximately 90%, rates are increased, resulting in further improvement in net
operating income as the existing tenants, which moved in at lower rates, have
their rates increased or are replaced by new tenants paying higher rates. This
process of reaching stabilized rental rates can take approximately another 12 to
24 months following the time when the facilities reach a stabilized occupancy
level. In addition, move-in discounts have a more pronounced effect upon
realized rental rates for the newly developed facilities, because such
facilities tend to have a higher ratio of newer tenants.
Property operating expenses are substantially fixed, consisting
primarily of payroll, property taxes, utilities, and marketing costs. The rental
revenue of a newly developed facility will generally not cover its property
operating expenses (excluding depreciation) until the facility has reached an
occupancy level of approximately 30% to 35%. However, at that occupancy level,
the rental revenues from the facility are still not sufficient to cover related
depreciation expense and cost of capital with respect to the facility's
development cost. During construction of the self-storage facility, we
capitalize interest costs and include such cost as part of the overall
development cost of the facility. Once the facility is opened for operations
interest is no longer capitalized.
The annualized yield on costs for these facilities for the nine months
ended September 30, 2006, based on net operating income before depreciation, was
approximately 7.0%, which is lower than our ultimate yield expectations. We
expect these yields to increase as these facilities reach stabilization of both
occupancy levels and realized rents. Properties that were developed before 2005
have contributed greatly to our earnings growth. The growth in properties
developed in 2004 was principally due to occupancy growth, and growth for
properties developed in 2003 and 2002 were due principally to rate increases. We
expect that these facilities will continue to provide growth to our earnings.
Development of self-storage facilities causes short-term earnings
dilution because, as mentioned above, of the extended time to stabilize a
self-storage facility. We have developed self-storage facilities, despite the
short-term earnings dilution, because it is advantageous for us to continue to
expand our asset base and benefit from the resulting increased critical mass,
with facilities that will improve our portfolio's overall average construction
and location quality.
The decision to commence development of any particular self-storage
location is based upon several factors with respect to that local market,
including our estimate of current and future general economic conditions,
demographic conditions, population growth, the likelihood of and cost of
obtaining permits, construction costs, as well as the level of demand at our
existing self-storage facilities in proximity to the prospective facility. Our
level of new development starts has declined significantly in the last few years
due to increases in construction costs, increases in competition with retail,
condominium, and apartment operators for quality construction sites in urban
locations, and more difficult zoning and permitting requirements, which has
reduced the number of attractive sites available for development and reduced our
development of facilities. It is unclear when, or if, these conditions will
improve.
SELF-STORAGE OPERATIONS - NEWLY CONSOLIDATED FACILITIES
Effective January 1, 2006, as described in Note 2 to our condensed
consolidated financial statements, we are including the accounts of three
limited partnerships that we had previously accounted for under the equity
method of accounting. These facilities are substantially all mature facilities
that we have managed and had an interest in for several years. These 16
facilities have an aggregate of 879,000 net rentable square feet. Accordingly,
their future operating characteristics and past operating history are similar to
those of our Same Store facilities.
65
The following chart sets forth the operations of the Newly Consolidated
Facilities (amounts in thousands):
Three Months Nine Months
Ended Ended
September 30, 2006 September 30, 2006
------------------ --------------------
Rental income............................... $ 3,686 $ 10,874
Cost of operations (excluding depreciation). 924 2,644
------------------ --------------------
Net operating income before depreciation (a) 2,762 8,230
Depreciation................................ (116) (504)
------------------ --------------------
Net operating income..................... $ 2,646 $ 7,726
================== ====================
Weighted average square foot occupancy
during the period:.......................... 89.6% 89.1%
Weighted average realized annual rent per
occupied square foot for the period:........ $ 16.77 $ 16.47
In place annual rent per occupied square
foot at September 30:....................... $ 18.88
(a) Total net operating income before depreciation, which is a non-GAAP
measure, for our commercial property segment is presented in Note 13 to
our condensed consolidated financial statements, "Segment Information,"
which includes a reconciliation of net operating income before
depreciation for this segment to our consolidated net income.
COMMERCIAL PROPERTY OPERATIONS: Commercial property operations included
in our consolidated financial statements include commercial space owned by the
Company and entities consolidated by the Company. We have a much larger interest
in commercial properties through our ownership interest in PS Business Parks
Inc. and its consolidated operating partnership (PS Business Parks, Inc. and its
consolidated operating partnership are hereinafter referred to as "PSB"). Our
investment in PSB is accounted for using the equity method of accounting, and
accordingly our share of PSB's earnings is reflected as "Equity in earnings of
real estate entities," see below.
We acquired 309,000 net rentable square feet in the merger with
Shurgard. As a result, at September 30, 2006 total net rentable square feet
increased to 1,605,000 from 1,296,000 at June 30, 2006. Our commercial space is
principally operated at certain of the self-storage facilities.
The results of our commercial operations are provided in the table
below (amounts in thousands):
Commercial Property Operations:
(excluding discontinued operations)
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------ -------------------------------------
2006 2005 Change 2006 2005 Change
------------ ----------- ----------- ------------ ----------- -----------
Rental income......................... $ 3,408 $ 2,918 $ 490 $ 9,413 $ 8,693 $ 720
Cost of operations.................... (1,497) (1,122) (375) (4,080) (3,292) (788)
------------ ----------- ----------- ------------ ----------- -----------
Net operating income before
depreciation (a)................... 1,911 1,796 115 5,333 5,401 (68)
Depreciation......................... (643) (562) (81) (1,777) (1,721) (56)
------------ ----------- ----------- ------------ ----------- -----------
Operating income................... $ 1,268 $ 1,234 $ 34 $ 3,556 $ 3,680 $ (124)
============ =========== =========== ============ =========== ===========
(a) Total net operating income before depreciation, which is a non-GAAP
measure, for our commercial property segment is presented in Note 13 to
our September 30, 2006 condensed consolidated financial statements,
"Segment Information," which includes a reconciliation of net operating
income before depreciation for this segment to our consolidated net
income.
Our commercial property operations consist primarily of facilities that
are at a stabilized level of operations, and generally reflect the conditions of
the markets in which they operate. We do not expect any significant growth in
net operating income from this segment of our business for the remainder of
2006.
66
Containerized Storage Operations: We have closed many of our
containerized storage facilities since 2002, and have refined our market and
product focus to 12 facilities located in eight densely populated markets with
above-average rent and income. The operations with respect to the facilities
other than the 12 ongoing facilities are included in "Discontinued Operations"
on our income statement. The operations of the 12 remaining facilities are
included in PSPUD's continuing operations and are reflected on the table below:
Containerized Storage:
(excluding discontinued operations)
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------- -----------------------------------
2006 2005 Change 2006 2005 Change
----------- ---------- ---------- ---------- ---------- -----------
(Amounts in thousands)
Rental and other income ............ $ 4,353 $ 4,480 $ (127) $12,483 $12,305 $ 178
Cost of operations:
Direct operating costs.......... 3,135 3,308 (173) 9,234 8,602 632
Facility lease expense.......... 772 368 404 2,202 1,090 1,112
----------- ---------- ---------- ---------- ---------- -----------
Total cost of operations...... 3,907 3,676 231 11,436 9,692 1,744
----------- ---------- ---------- ---------- ---------- -----------
Net operating (loss) income before
depreciation (a).................... 446 804 (358) 1,047 2,613 (1,566)
Depreciation expense (b)......... (179) (313) 134 (662) (2,490) 1,828
----------- ---------- ---------- ---------- ---------- -----------
Operating (loss) income............. $ 267 $ 491 $ (224) $ 385 $ 123 $ 262
=========== ========== ========== ========== ========== ===========
(a) Total net operating income before depreciation, which is a non-GAAP
measure described above, for our containerized storage segment is
presented in Note 13 to our September 30, 2006 condensed consolidated
financial statements, "Segment Information," which includes a
reconciliation of net operating income before depreciation for this
segment to our consolidated net income.
(b) Depreciation expense principally relates to the depreciation of
containers; however, depreciation expense for the three and nine months
ended September 30, 2006 includes $126,000 and $504,000, respectively,
related to real estate facilities compared to $262,000 and $786,000 for
the same periods in 2005, respectively.
Rental and other income includes monthly rental charges to customers
for storage of the containers, service fees charged for pickup and delivery of
containers to customers' homes and businesses and certain non-core services
which were eliminated, such as handling and packing customers' goods from city
to city. At September 30, 2006, there were approximately 21,065 occupied
containers in the continuing facilities.
Direct operating costs principally includes payroll, equipment lease
expense, utilities and vehicle expenses (fuel and insurance). Direct operating
costs for the three and nine months ended September 30, 2006 also includes
approximately $337,000 and $960,000 of research and development costs,
respectively. Facility lease expense has increased significantly as we have
moved the operations from wholly-owned combination facilities to facilities that
we lease from third parties.
There can be no assurance as to the level of the containerized storage
business's expansion, level of gross rentals, level of move-outs or
profitability. We continue to evaluate the business operations, and additional
facilities may be closed.
ANCILLARY OPERATIONS: Our Ancillary operations include the operating
results of our tenant insurance, truck rental, merchandise, and third-party
property management operations. The following table sets forth our ancillary
operations:
67
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------- ------------------------
2006 2005 Change 2006 2005 Change
----------- ---------- ------------ ------------ ----------- ----------
(Amounts in thousands)
Revenues:
Tenant reinsurance premiums..... $ 9,790 $ 6,332 $ 3,458 $ 24,379 $ 18,499 $ 5,880
Merchandise sales............... 7,566 6,261 1,305 18,879 17,513 1,366
Truck rentals................... 4,106 4,208 (102) 10,535 10,550 (15)
Property management............. 644 786 (142) 1,856 2,241 (385)
----------- ---------- ------------ ------------ ----------- ----------
Total revenues............... 22,106 17,587 4,519 55,649 48,803 6,846
----------- ---------- ------------ ------------ ----------- ----------
Cost of operations:
Tenant reinsurance.............. 3,714 3,017 697 9,929 7,560 2,369
Merchandise sales............... 6,347 5,096 1,251 16,541 14,380 2,161
Truck rentals................... 3,328 3,322 6 9,089 9,722 (633)
Property management............. 58 178 (120) 200 508 (308)
----------- ---------- ------------ ------------ ----------- ----------
Total cost of operations..... 13,447 11,613 1,834 35,759 32,170 3,589
----------- ---------- ------------ ------------ ----------- ----------
Net operating income:
Tenant reinsurance.............. 6,076 3,315 2,761 14,450 10,939 3,511
Merchandise sales............... 1,219 1,165 54 2,338 3,133 (795)
Truck rentals................... 778 886 (108) 1,446 828 618
Property management............. 586 608 (22) 1,656 1,733 (77)
----------- ---------- ------------ ------------ ----------- ----------
Total net operating income... $ 8,659 $ 5,974 $ 2,685 $ 19,890 $ 16,633 $ 3,257
=========== ========== ============ ============ =========== ==========
Tenant reinsurance operations
-----------------------------
PSIC reinsures policies against losses to goods stored by tenants in
our self-storage facilities. Revenues are comprised of fees charged to tenants
electing such policies. Cost of operations primarily includes claims paid that
are not covered by our outside third-party insurers (described below), as well
as claims adjusting expenses.
For 2005, we had outside third-party insurance coverage for claims paid
exceeding $500,000 resulting from any individual event, to a limit of
$10,000,000. Effective January 1, 2006, such coverage was revised to cover
claims paid exceeding $1,500,000 resulting from any individual event, to a limit
of $9,000,000.
The future level of tenant reinsurance revenues is largely dependent
upon the number of new tenants electing to purchase policies, premiums charged
for such insurance and existing tenant retention to continue participating in
the insurance program. For the nine months ended September 30, 2006 and 2005,
approximately 32.4% and 33.0%, respectively, of our self-storage tenant base had
such policies. During 2005 and 2004, we experienced damage caused by hurricanes
to several of our facilities in our Florida and New Orleans markets. As a result
of such damage, we recorded estimated tenant claim expense during the quarter in
which the damage occurred. As time progressed, the tenant claims liabilities
were adjusted, either increasing or decreasing the liabilities, based on actual
claims history. As a result of these adjustments, we experienced significant
volatility in our reported quarterly cost of operations, particularly with
respect to 2005.
The future cost of operations will be dependent primarily upon the
level of losses incurred, including the level of catastrophic events, such as
hurricanes, that occur and affect our properties. The aforementioned increase in
the deductible of $1,500,000 per event could result in higher loss expense in
the remainder of 2006, depending upon the number of catastrophic losses that
occur.
For the quarter ended September 30, 2006, tenant reinsurance revenues
and cost of operations, respectively, included $745,000 and $291,000 with
respect to the Shurgard facilities we acquired in the United States, and
$784,000 and $260,000 for the Shurgard facilities in Europe.
68
Merchandise and truck rental operations
---------------------------------------
Through a taxable REIT subsidiary, all of our self-storage facilities
sell locks, boxes, and packing supplies to our tenants as well as the general
public. Revenues and cost of operations for these activities are included in the
table above as "Merchandise Sales." In addition, at selected locations, our
subsidiary maintains trucks on site for rent to our self-storage customers and
the general public on a short-term basis for local use. In addition, we also act
as an agent for a national truck rental company to provide their rental trucks
to customers for long-distance use. The revenues and cost of operations for
these activities are included in the table above as "Truck rentals."
These activities generally serve as an adjunct to our self-storage
operations providing our tenants with goods and services that they need in
connection with moving and storing their goods.
The revenues of these activities have remained relatively stable during
the periods reflected in the table above. Cost of operations with respect to
merchandise sales has increased approximately $1,251,000, or 24.5% for the three
months ended September 30, 2006 as compared to the same period in 2005. This
increase has been caused primarily by higher payroll costs, as we have added
more retail store managers combined with higher cost of purchasing inventory for
sale. The primary factors impacting the levels of operations of these activities
are the levels of customer traffic at our self-storage facilities, including the
levels of move-ins.
For the quarter ended September 30, 2006, merchandise revenues and cost
of operations, respectively, included $929,000 and $481,000 with respect to the
Shurgard facilities we acquired in the United States, and $778,000 and $376,000
for the Shurgard facilities in Europe.
For the quarter ended September 30, 2006, truck revenues and cost of
operations, respectively, included $290,000 and $234,000 with respect to the
Shurgard facilities we acquired in the United States.
Property management operations
------------------------------
We manage 34 self-storage facilities on behalf of third-party owners
and 22 self-storage facilities that are owned by the Unconsolidated Entities.
Under the supervision of the property owners, we coordinate rental policies,
rent collections, marketing activities, the purchase of equipment and supplies,
maintenance activities, and the selection and engagement of vendors, suppliers,
and independent contractors. We also assist and advise the property owners in
establishing policies for the hire, discharge, and supervision of employees for
the operation of these facilities.
Property management operations declined in the nine months ended
September 30, 2006 as compared to the same period in 2005, due to our
consolidation, effective January 1, 2006, of three partnerships owning 16
self-storage facilities that we had previously accounted for under the equity
method of accounting. This resulted in the elimination in consolidation of
management fee income and cost of operations with respect to these three
partnerships for periods after January 1, 2006.
Our operating income from these activities is generally dependent upon
the revenues earned at the managed facilities, because our management fee is
based upon revenues. Management contracts with the third-party owners can be
terminated by either party upon 60 days written notice.
EQUITY IN EARNINGS OF REAL ESTATE ENTITIES: In addition to our
ownership of equity interests in PSB, we had general and limited partnership
interests in eight limited partnerships at September 30, 2006. (PSB and the
limited partnerships are collectively referred to as the "Unconsolidated
Entities"). Due to our limited ownership interest and limited control of these
entities, we do not consolidate the accounts of these entities for financial
reporting purposes. We account for such investments using the equity method.
Equity in earnings of real estate entities for the three and nine
months ended September 30, 2006 and 2005 consists of our pro-rata share of the
Unconsolidated Entities based upon our ownership interest for the period. The
following table sets forth the significant components of equity in earnings of
real estate entities:
69
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- -------------------------
2006 2005 Change 2006 2005 Change
------------ ------------ ------------ ------------ ----------- ------------
(Amounts in thousands)
Property operations:
PSB.................................... $ 18,664 $ 17,737 $ 927 $ 54,775 $ 51,865 $ 2,910
Acquisition Joint Venture.............. 110 75 35 297 189 108
Newly consolidated partnerships (1).... - 1,322 (1,322) - 3,912 (3,912)
Other investments (2).................. 763 722 41 2,141 2,002 139
------------ ------------ ------------ ------------ ----------- ------------
19,537 19,856 (319) 57,213 57,968 (755)
------------ ------------ ------------ ------------ ----------- ------------
Depreciation:
PSB.................................... (9,779) (8,352) (1,427) (28,034) (24,887) (3,147)
Acquisition Joint Venture.............. (70) (68) (2) (207) (202) (5)
Newly consolidated partnerships (1).... - (216) 216 - (632) 632
Other investments (2).................. (182) (186) 4 (510) (544) 34
------------ ------------ ------------ ------------ ----------- ------------
(10,031) (8,822) (1,209) (28,751) (26,265) (2,486)
------------ ------------ ------------ ------------ ----------- ------------
Other: (3)
PSB (4)................................ (6,867) (1,134) (5,733) (19,107) (11,149) (7,958)
Newly consolidated partnerships (1).... - (31) 31 - (110) 110
Other investments (2).................. (21) (16) (5) (147) (62) (85)
------------ ------------ ------------ ------------ ----------- ------------
(6,888) (1,181) (5,707) (19,254) (11,321) (7,933)
------------ ------------ ------------ ------------ ----------- ------------
Total equity in earnings of real estate
entities.................................. $ 2,618 $ 9,853 $ (7,235) $ 9,208 $ 20,382 $ (11,174)
============ ============ ============ ============ =========== ============
(1) As described more fully in Note 2 to our financial statements, we
commenced consolidating the accounts of three limited partnerships that
we had previously accounted for under the equity method of accounting.
Accordingly, equity in income with respect to these partnerships ceased
effective January 1, 2006.
(2) Amounts primarily reflect equity in earnings recorded for investments
that have been held consistently throughout each of the three and nine
months ended September 30, 2006 and 2005.
(3) "Other" reflects our share of general and administrative expense,
interest expense, interest income, and other non-property;
non-depreciation related operating results of these entities. The
amount of interest expense included in "other" is $271,000 and $729,000
for the three and nine months ended September 30, 2006, respectively,
as compared to $131,000 and $375,000, respectively, for the same
periods in 2005.
(4) "Other" with respect to PSB also includes our pro-rata share of gains
on sale of real estate assets, impairment charges relating to pending
sales of real estate and the impact of PSB's application of the SEC's
clarification of EITF Topic D-42 on redemptions of preferred
securities.
Equity in earnings of real estate entities includes our pro rata share
of the net impact of gains/losses on sales of assets and impairment charges
relating to the impending sale of real estate assets as well as our pro rata
share of the impact of the application of EITF Topic D-42 on redemptions of
preferred securities recorded by PSB. Our net pro rata share from these items
resulted in a net decrease of equity in earnings of $576,000 and $282,000 for
the three and nine months ended September 30, 2006, respectively. For the three
and nine months ended September 30, 2005, our pro rata share of these items
resulted in net increases of $5,458,000 and $7,033,000, respectively.
The impact of the PSB items discussed above led to a decrease in equity
in earnings of real estate entities totaling $6,034,000 and $7,315,000,
respectively, when comparing the three and nine month periods ended September
30, 2006 to the same periods in 2005. In addition, equity in earnings real
estate entities decreased due to our consolidation of three limited partnerships
effective January 1, 2006 as described in Note 2 to our condensed consolidated
financial statements. As a result of this consolidation, equity in income with
respect to these partnerships ceased effective January 1, 2006.
70
Equity in earnings of PSB represents our pro rata share (approximately
44% for the nine months ended September 30, 2006 and 2005) of the earnings of
PSB. Throughout 2005 and the nine months ended September 30, 2006, we owned
5,418,273 common shares and 7,305,355 operating partnership units (units which
are convertible into common shares on a one-for-one basis) in PSB. At September
30, 2006, PSB owned and operated 18.2 million net rentable square feet of
commercial space located in eight states. PSB also manages commercial space
owned by the Company and affiliated entities at September 30, 2006 pursuant to
property management agreements.
Our future equity income from PSB will be dependent entirely upon PSB's
operating results. Our investment in PSB provides us with some diversification
into another asset type. We have no plans of disposing of our investment in PSB.
PSB's filings and selected financial information can be accessed through the
Securities and Exchange Commission, and on its website, www.psbusinessparks.com.
In January 2004, we entered into a joint venture partnership with an
institutional investor for the purpose of acquiring up to $125.0 million of
existing self-storage properties in the United States from third parties (the
"Acquisition Joint Venture"). The venture is funded entirely with equity
consisting of 30% from us and 70% from the institutional investor. As described
more fully in Note 2 to our condensed consolidated financial statements for the
nine months ended September 30, 2006, our pro-rata share of earnings with
respect to two of the facilities acquired directly from third parties by the
Acquisition Joint Venture in 2004, at an aggregate cost of $9,086,000, are
reflected in Equity in Earnings in the table above. Our initial investment in
the Acquisition Joint Venture with respect to these two facilities was
approximately $2,930,000. Our future equity in earnings with respect to the
Acquisition Joint Venture will be dependent upon the level of earnings generated
by these two properties.
The "Other Investments" are comprised primarily of our equity in
earnings from four limited partnerships, for which we held an approximate
consistent level of equity interest throughout 2005 and the first nine months of
2006. The Company formed these limited partnerships during the 1980's. We are
the general partner in each limited partnership, and manage each of these
facilities for a management fee that is included in "Ancillary operations." The
limited partners consist of numerous individual investors, including the
Company, which throughout the 1990's acquired units of limited partnership
interests in these limited partnerships in various transactions.
Our future earnings with respect to the "Other Investments" will be
dependent upon the operating results of the 20 self-storage facilities that
these entities own. The operating characteristics of these facilities are
similar to those of the Company's self-storage facilities, and are subject to
the same operational issues as the Same Store Facilities as discussed above. See
Note 6 to our condensed consolidated financial statements for the operating
results of these entities for the nine months ended September 30, 2006 and 2005.
OTHER INCOME AND EXPENSE ITEMS
INTEREST AND OTHER INCOME: Interest and other income was $12,651,000
and $27,773,000 for the three and nine months ended September 30, 2006,
respectively, as compared to $4,717,000 and $11,004,000, respectively, for the
same periods in 2005. This increase is due to earning higher interest rates on
invested cash balances combined with significantly higher average cash balances
invested in interest-bearing accounts as compared to the same periods in 2005.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization expense
was $113,531,000 and $212,206,000 for the three and nine months ended September
30, 2006, respectively, compared to $47,896,000 and $144,074,000 for the same
periods in 2005.
71
The increase in depreciation and amortization for the three and nine
months ended September 30, 2006, as compared to the same period in 2005 is due
primarily to $50,626,000 in amortization expense recorded during the three
months ended September 30, 2006 on the intangible assets for the value of the
storage tenants in place which we acquired in the Shurgard merger. These
intangible assets were valued in our purchase accounting analysis at
$483,107,000 and are being amortized over a three year useful life. Amortization
is expected to be approximately $94,800,000 in the fourth quarter of 2006,
$69,700,000 in the first quarter of 2007 and approximately $125,000,000 during
the remainder of 2007.
The remainder of the increase in depreciation and amortization for the
three and nine months ended September 30, 2006 as compared to the same periods
in 2005 is due primarily to assets acquired in the Shurgard merger and to our
newly developed and acquired facilities. See Notes 2 and 3 to our unaudited
condensed consolidated financial statements for further discussion of the
Shurgard merger and the acquisition of tangible and intangible assets.
Also included in depreciation and amortization expense for the nine
months ended September 30, 2006 is $1,651,000 (none for the three months ended
September 30, 2006) related to the amortization of intangibles, as compared to
$1,651,000 and $4,953,000 for the three and nine months ended September 30,
2005, respectively. Amortization ceased as of April 1, 2006, as described more
fully in Note 2 to our unaudited condensed consolidated financial statements.
GENERAL AND ADMINISTRATIVE: General and administrative expense was
$36,242,000 and $49,996,000 for the three and nine months ended September 30,
2006, as compared to $5,621,000 and $16,890,000 for the same periods in 2005,
representing increases of $30,621,000 and $33,106,000, respectively. General and
administrative expense principally consists of state income taxes, investor
relations expenses and corporate and executive salaries. In addition, general
and administrative expenses includes expenses that vary depending on the
Company's activity levels in certain areas, such as overhead associated with the
acquisition and development of real estate facilities, employee severance and
stock-based compensation, and product research and development expenditures.
General and administrative expense for the three months ended September
30, 2006 include costs and expenses totaling $18,086,000 incurred in connection
with the integration of Shurgard and Public Storage, costs for cancelled
development projects in the U.S. and Europe totaling $9,319,000 and contract
termination fees of $2,233,000. We expect to incur an additional $15 million to
$20 million in additional integration costs in the fourth quarter of 2006.
Restricted stock and stock option expense amounted to approximately
$1,841,000 and $4,868,000 for the three and nine months ended September 30,
2006, respectively, as compared to $1,196,000 and $3,579,000, respectively, for
the same periods in 2005.
INTEREST EXPENSE: Interest expense was $9,323,000 and $12,752,000 for
the three and nine months ended September 30, 2006, respectively, compared to
$2,471,000 and $5,928,000, respectively, for the same periods in 2005. Interest
capitalized during the three and nine months ended September 30, 2006 was
$530,000 and $1,599,000, respectively, as compared to $710,000 and $2,054,000,
respectively, for the same periods in 2005. The increase in interest expense is
primarily due to $7,154,000 in interest incurred on the debt and other
obligations we assumed in the Shurgard merger partially offset by a decrease of
$669,000 in interest expense due to lower balances on our outstanding notes. See
also Notes 8 and 9 to our unaudited condensed consolidated financial statements
for a schedule of our debt balances, principal repayment requirements, and
average interest rates. Based upon the level of debt outstanding at September
30, 2006, and the interest rates in effect at that time on the various variable
rate components of our debt and the fixed rates of interest, interest expense
would be approximately $16,985,000 in the fourth quarter of 2006 with respect to
the debt we assumed from Shurgard.
72
During the three months ended September 30, 2006, we paid $881,000
related to interest rate and currency swaps acquired in the Shurgard merger. We
have included this $881,000 as a reduction of income on derivatives, net on our
unaudited condensed consolidated statement of operations for the three and nine
months ended September 30, 2006. See discussion below under Income from
Derivatives, Net.
FOREIGN EXCHANGE LOSS: We had foreign exchange losses of $172,000 for
the three and nine months ended September 30, 2006.
INCOME FROM DERIVATIVES, NET: This represents a gain as recognized for
the changes in the fair market values of those derivative financial instruments
that do not qualify for hedge accounting treatment under SFAS No. 133 offset by
interest expense incurred on certain derivative instruments. The gain of $32,000
for the three and nine months ended September 30, 2006 is primarily the net
effect of gains of $913,000 in changes in value of our interest rate swaps and
currency forward contracts on the euro that do not qualify for hedge accounting,
partially offset by payments of $881,000 incurred in connection with certain
interest rate swaps and foreign currency exchange derivatives acquired in the
Shurgard merger as described under Note 3 to our condensed consolidated
financial statements.
MINORITY INTEREST IN INCOME: Minority interest in income represents the
income allocable to equity interests in Consolidated Entities, which are not
owned by the Company. The following table summarizes minority interest in income
for the three and nine months ended September 30, 2006 and 2005:
73
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------- ---------------------------
2006 2005 Change 2006 2005 Change
------------ -------------- ---------- ----------- ----------- -----------
(Amounts in thousands)
Preferred partnership interests:
Ongoing distributions (a)................. $ 5,403 $ 3,591 $ 1,812 $ 13,652 $ 12,556 $ 1,096
Special Distribution and EITF Topic D-42 (b) - - - - 874 (874)
Acquired minority interests (c).............. - 1,309 (1,309) - 5,426 (5,426)
Newly consolidated partnerships (d).......... 1,468 - 1,468 3,641 - 3,641
Convertible Partnership Units (e)............ 120 148 (28) 356 350 6
Shurgard U.S. minority interests (f) 191 - 191 191 - 191
Shurgard U.S European minority interests (g). (1,279) - (1,279) (1,279) - (1,279)
Other minority interests (h)................. 2,687 2,195 492 7,916 7,149 767
------------ -------------- ---------- ----------- ----------- -----------
Total minority interests in income....... $ 8,590 $ 7,243 $ 1,347 $ 24,477 $ 26,355 $ (1,878)
============ ============== ========== =========== =========== ===========
(a) The increase in ongoing distributions is due to the issuance of
additional preferred partnership units offset by the redemption of
$40,000,000 of our 9.5% Series N Preferred Units on March 17, 2005 and
$45,000,000 of our 9.125% Series O Preferred units on March 29, 2005.
(b) In accordance with the Securities and Exchange Commissions
clarification of EITF Topic D-42, are original issuance costs with
respect to our first quarter of 2005 redemption of preferred units
included in minority interest in income for the three months ended
March 31, 2005 totaling $874,000.
(c) These amounts reflect income allocated to minority interests that the
Company acquired in 2005 and are no longer outstanding at September 30,
2006.
(d) These amounts reflect income allocated to minority interests for three
entities that we commenced consolidating the accounts for effective
January 1, 2006 (see Note 2 to our condensed consolidated financial
statements). Included in minority interest in income for the three and
nine months ended September 30, 2006 was $32,000 and $98,000,
respectively, in depreciation expense.
(e) These amounts reflect the minority interests represented by the
Convertible Partnership Units (see Note 11 to our condensed
consolidated financial statements).
(f) These amounts reflect income allocated to minority interests in
entities we acquired in the merger with Shurgard, and include $55,000
in depreciation in the three and nine months ended September 30, 2006.
(g) These amounts reflect income allocated to minority interests from
entities we acquired in the merger with Shurgard. These interests
include the 80% partner's interests in the European joint ventures,
First Shurgard and Second Shurgard, as well as those in domestic joint
ventures. Included in minority interest in income is $742,000 for the
three and nine months ended September 30, 2006 in depreciation, and
$1,829,000 in interest expense.
(h) These amounts reflect income allocated to minority interests that were
outstanding consistently throughout the nine months ended September 30,
2006 and 2005. Included in minority interest in income is $109,000 and
$401,000 in depreciation expense for the three and nine months ended
September 30, 2006, respectively, as compared to $57,000 and $536,000
for the same periods in 2005.
Other minority interests reflect income allocated to minority interests
that have maintained a consistent level of interest throughout 2005 and the nine
months ended September 30, 2006, comprised of investments in the Consolidated
Entities described in Note 9 to our condensed consolidated financial statements.
The level of income allocated to these interests in the future is dependent upon
the operating results of the storage facilities that these entities own, as well
as any minority interests that the Company acquires in the future.
On May 9, 2006, one of our Consolidated Entities issued $100,000,000 of
its 7.25% Series J Preferred Partnership Units. Accordingly, ongoing
distributions with respect to preferred partnership interest are expected to
increase.
74
Discontinued Operations: As described more fully in Note 4 to our
condensed consolidated financial statements, during 2002, 2003 and 2004, we
implemented a business plan which included the closure of 43 of 55 containerized
storage facilities that were open at December 31, 2001. The 43 facilities are
hereinafter referred to as the "Closed Facilities."
During July 2005, in an eminent domain proceeding, one of our
self-storage facilities located in the Portland, Oregon market was condemned by
local governmental authorities. Additionally, in July 2006, one of our
self-storage facilities in our Seattle, Washington market was condemned by local
governmental authorities in an eminent domain proceeding. Collectively, these
Portland and Seattle facilities are referred to as "the Eminent Domain
Facilities".
The following table summarizes the historical operations of the Eminent
Domain Facilities and the Closed Facilities:
DISCONTINUED OPERATIONS:
------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------- ------------------------
2006 2005 Change 2006 2005 Change
------------ ------------ ----------- ------------ ------------ ----------
(Amounts in thousands)
Rental income....................... $ 1 $ 281 $ (280) $ 193 $ 887 $ (694)
Cost of operations................... (21) (80) 59 (109) (524) 415
Depreciation and amortization ...... (9) (41) 32 (50) (150) 100
------------ ------------ ----------- ------------ ------------ ----------
Income before other items........... (29) 160 (189) 34 213 (179)
Other items:
Net gain on disposition of assets 2,370 5,180 (2,810) 2,370 6,323 (3,953)
------------ ------------ ----------- ------------ ------------ ----------
Net discontinued operations......... $ 2,341 $ 5,340 $ (2,999) $ 2,404 $ 6,536 $(4,132)
============ ============ =========== ============ ============ ==========
LIQUIDITY AND CAPITAL RESOURCES
-------------------------------
We believe that our internally generated net cash provided by operating
activities will continue to be sufficient to enable us to meet our operating
expenses, capital improvements, debt service requirements and distributions to
shareholders for the foreseeable future. In addition, at September 30, 2006,
cash on hand totaled $124,119,000 and we had no outstanding borrowings under our
$200,000,000 bank line of credit. We anticipate that a significant portion of
the cash on-hand will be utilized in connection with the proposed merger with
Shurgard, see below.
Operating as a real estate investment trust ("REIT"), our ability to
retain cash flow for reinvestment is restricted. In order for us to maintain our
REIT status, a substantial portion of our operating cash flow must be
distributed to our shareholders (see "Requirement to Pay Distributions" below).
However, despite the significant distribution requirements, we have been able to
retain a significant amount of our operating cash flow. The following table
summarizes our ability to fund distributions to the minority interest, capital
improvements to maintain our facilities, and distributions to our shareholders
through the use of cash provided by operating activities. The remaining cash
flow generated is available to make both principal payments on debt and for
reinvestment.
75
Nine Months Ended September 30,
-------------------------------------
2006 2005
----------------- ------------------
(Amounts in thousands)
Net cash provided by operating activities....................... $ 582,152 $ 508,340
Distributions to minority interest (Preferred Units)............ (13,652) (12,556)
Distributions to minority interest (common equity).............. (11,037) (11,805)
----------------- ------------------
Cash from operations allocable to our shareholders.............. 557,463 483,979
Capital improvements to maintain our facilities................. (44,366) (13,286)
----------------- ------------------
Remaining operating cash flow available for distributions to our
shareholders................................................ 513,097 470,693
Distributions paid:
Preferred stock dividends..................................... (159,256) (126,286)
Equity Stock, Series A dividends.............................. (16,068) (16,087)
Distributions to Common shareholders.......................... (213,281) (179,822)
----------------- ------------------
Cash available for principal payments on debt and reinvestment.. $ 124,492 $ 148,498
================= ==================
Our financial profile is characterized by a low level of debt-to-total
capitalization and a conservative dividend payout ratio with respect to the
common stock. We expect to fund our growth strategies with cash on hand at
September 30, 2006, internally generated retained cash flows and proceeds from
issuing equity securities. In general, our current strategy is to continue to
finance our growth with permanent capital; either common or preferred equity. We
have in the past used our $200,000,000 line of credit as temporary "bridge"
financing and repaid those amounts with internally generated cash flows and
proceeds from the placement of permanent capital.
Over the past three years, we have funded substantially all of our
acquisitions with permanent capital (both common and preferred securities). We
have elected to use preferred securities as a form of leverage despite the fact
that the dividend rates of our preferred securities exceed the prevailing market
interest rates on conventional debt. We have chosen this method of financing for
the following reasons: (i) under the REIT structure, a significant amount of
operating cash flow needs to be distributed to our shareholders, making it
difficult to repay debt with operating cash flow alone, (ii) our perpetual
preferred stock has no sinking fund requirement or maturity date and does not
require redemption, all of which eliminate any future refinancing risks, (iii)
after the end of a non-call period, we have the option to redeem the preferred
stock at any time, which enabled us to effectively refinance higher coupon
preferred stock with new preferred stock at lower rates, (iv) preferred stock
does not contain onerous covenants, thus allowing us to maintain significant
financial flexibility, and (v) dividends on the preferred stock can be applied
to our REIT distribution requirements.
Our credit ratings on each of our series of Cumulative Preferred Stock
are "Baa2" by Moody's and "BBB+" by Standard & Poor's.
Our portfolio of real estate facilities remains substantially
unencumbered. At September 30, 2006, we have domestic mortgage debt outstanding
of $274,891,000, which encumbers 106 facilities with an aggregate net book value
of approximately $1,063,558,000 and European mortgage debt and capital leases
outstanding of $675,134,000, which encumbers 154 facilities with an aggregate
net book value of approximately $1,148,841,000. At September 30, 2006, we also
have Debt to Joint Venture Partner amounting to $37,214,000 with respect to ten
real estate facilities with an aggregate net book value of approximately
$47,951,000. The remaining debt on our balance sheet totaling $476,508,000 does
not specifically encumber real estate facilities.
For the nine months ended September 30, 2006, our cash available for
principal payments on debt and reinvestment declined from $148,498,000 to
$124,492,000 due to the impact of merger integration expenses approximately
$20.1 million for the nine months ended September 30, 2006, as well as the
impact of paying an entire quarter's distribution on the 39.1 million shares
issued to former Shurgard shareholders while the operating cash flows were
reflected only from August 22, 2006 through September 30, 2006.
76
Recent Issuance and Redemption of Preferred Securities: One of our
financing objectives over the past several years has been to reduce our average
cost of capital with respect to our preferred securities. Accordingly, we have
redeemed higher rate preferred securities outstanding and have financed the
redemption with cash on-hand or from the proceeds from the issuance of lower
rate preferred securities.
On September 28, 2006, we redeemed our 8.000% Series R Preferred Stock
for $510 million, plus accrued and unpaid dividends. The Series R was called for
redemption in August 2006. On September 26, 2006, we called for redemption our
7.875% Series S Preferred Stock for $143.75 million, plus accrued and unpaid
dividends. The Series S was redeemed on October 31, 2006. As a result of these
redemptions, there was an additional allocation to the preferred shareholders
during the three months ended September 30, 2006 of approximately $21,643,000
($0.15 per common share, based upon the weighted average diluted shares during
the three months ended September 30, 2006) from the application of EITF Topic
D-42. We believe that our size and financial flexibility enables us to access
capital when appropriate.
During the ten months ended October 31, 2006, we have received net
proceeds of approximately $1.3 billion from the issuance of cumulative Preferred
Stock and $100 million of our preferred partnership units. We used approximately
$826.3 million of these net proceeds in order to redeem higher-coupon preferred
securities.
REQUIREMENT TO PAY DISTRIBUTIONS: We estimate the distribution
requirement with respect to our Preferred Stock outstanding at September 30,
2006 to be approximately $203.7 million per year. We estimate that the annual
distribution requirement with respect to the preferred partnership units
outstanding at September 30, 2006, to be approximately $21.6 million per year.
During each of the nine months ended September 30, 2006 and 2005, we
paid cash dividends totaling $16,068,000 and $16,087,000, respectively, to the
holders of our Equity Stock, Series A. With respect to the depositary shares of
Equity Stock, Series A, we have no obligation to pay distributions if no
distributions are paid to the common shareholders. To the extent that we do pay
common distributions in any year, the holders of the depositary shares receive
annual distributions equal to the lesser of (i) five times the per share
dividend on the common stock or (ii) $2.45. The depositary shares are
non-cumulative, and have no preference over our common stock either as to
dividends or in liquidation. With respect to the Equity Stock, Series A
outstanding at September 30, 2006, we estimate the total regular distribution
for the fourth quarter of 2006 to be approximately $5.4 million.
During the nine months ended September 30, 2006, we paid dividends
totaling $213,281,000 ($1.50 per common share) to the holders of our common
stock. Based upon shares outstanding at November 2, 2006 and a quarterly
distribution of $0.50 per share, which was declared by the Board of Directors on
November 2, 2006 and payable on December 28, 2006, to shareholders of record as
of December 15, 2006, we estimate a dividend payment with respect to our common
stock of approximately $84.5 million for the fourth quarter of 2006.
CAPITAL IMPROVEMENT REQUIREMENTS: For the fourth quarter of 2006, we
expect to spend approximately $25 million for capital improvements, excluding
signage and other improvements to the Shurgard portfolio. During the nine months
ended September 30, 2006, we incurred capital improvements of approximately
$44,366,000. Capital improvements include major repairs or replacements to the
facilities that maintain the facilities' existing operating condition and visual
appeal. Capital improvements do not include costs relating to the development or
expansion of facilities, or expenditures associated with improving the visual
and structural appeal of our existing self-storage facilities. We also expect to
incur approximately $20 million of capital expenditures to install Public
Storage signage on the Shurgard facilities in the United States.
DEBT SERVICE REQUIREMENTS: We do not believe we have any significant
refinancing risks with respect to our debt, all but $12,332,000 of which is
fixed rate. At September 30, 2006, we have total outstanding debt of
approximately $1,463,747,000. See Notes 8 and 9 to our condensed consolidated
financial statements for approximate principal maturities of such borrowings.
77
We anticipate that our retained operating cash flow will continue to be
sufficient to enable us to make scheduled principal payments. It is our current
intention to fully amortize our domestic debt totaling $788,613,000 as opposed
to refinance debt maturities with additional debt. Our European debt inclusive
of capital leases totals $675,134,000 at September 30, 2006; we expect to
refinance approximately $400 million of this debt in early 2007.
ACQUISITION AND DEVELOPMENT OF REAL ESTATE FACILITIES: During 2006, we
will continue to seek to acquire additional self-storage facilities from third
parties; however, it is difficult to estimate the amount of third party
acquisitions we will undertake.
At September 30, 2006, we have a development "pipeline" of 49 projects
in the U.S. consisting of self-storage facilities, conversion of space at
facilities that was previously used for containerized storage and expansions to
existing self-storage facilities. At September 30, 2006, we have acquired the
land for all of these projects.
The development and fill-up of these storage facilities is subject to
significant contingencies such as obtaining appropriate governmental approvals.
We estimate that the amount remaining to be spent to complete development to be
approximately $161.5 million and will be incurred over the next 24 months. The
following table sets forth certain information with respect to our development
pipeline.
DEVELOPMENT PIPELINE SUMMARY - U.S.
as of September 30, 2006
Total
Number Net estimated Costs incurred
of rentable development through Costs to
projects sq. ft. costs 09/30/06 complete
-------- ---------- -------------- ---------------- -----------
(Amounts in thousands, except number of projects)
Under construction:
PUD conversions 2 152 $ 6,175 $ 4,216 $ 1,959
Expand/repackage existing self-storage
facilities 8 315 33,984 9,539 24,445
Expand/repackage existing Shurgard
self-storage facilities 15 614 62,773 50,186 12,587
-------- ---------- -------------- ---------------- -----------
25 1,081 102,932 63,941 38,991
-------- ---------- -------------- ---------------- -----------
In development, land acquired:
PUD conversions 3 276 12,708 656 12,052
Expand/repackage existing self-storage
facilities 21 1,393 122,475 11,982 110,493
-------- ---------- -------------- ---------------- -----------
24 1,669 135,183 12,638 122,545
-------- ---------- -------------- ---------------- -----------
Total Development Pipeline 49 2,750 $ 238,115 $ 76,579 $ 161,536
======== ========== ============== ================ ===========
At September 30, 2006, we have a development "pipeline" of 11 projects
in Europe consisting of self-storage facilities. At September 30, 2006, we have
acquired the land for all of these projects.
The development and fill-up of these storage facilities is subject to
significant contingencies such as obtaining appropriate governmental approvals.
We estimate that the amount remaining to be spent to complete development to be
approximately $35.0 million and will be incurred over the next 24 months.
Substantially all of these future costs will be funded by the Shurgard European
Joint Ventures, in which we have a 20% interest, and which have a substantial
degree of funding by debt. The following table sets forth certain information
with respect to our development pipeline.
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DEVELOPMENT PIPELINE SUMMARY - EUROPE
as of September 30, 2006
Total
Number Net estimated Costs incurred
of rentable development through Costs to
projects sq. ft. costs 09/30/06 complete
-------- ---------- -------------- ---------------- -----------
(Amounts in thousands, except number of projects)
Under construction:
Self-storage facilities 9 452 $ 71,628 $ 47,495 $ 24,133
In development, land acquired:
Self-storage facilities 2 89 17,839 6,989 10,850
-------- ---------- -------------- ---------------- -----------
Total Development Pipeline 11 541 $ 89,467 $ 54,484 $ 34,983
======== ========== ============== ================ ===========
CONTRACTUAL OBLIGATIONS
Our significant contractual obligations at September 30, 2006 and their
impact on our cash flows and liquidity are summarized below for the years ending
December 31 (amounts in thousands):
Total 2006 2007 2008 2009 2010 Thereafter
------------ ----------- ----------- ----------- ----------- ----------- -----------
Long-term debt:
Public Storage (1) ......... $ 132,756 $ 2,613 $ 20,869 $ 9,596 $ 9,514 $ 9,281 $ 80,883
Shurgard U.S. (2)........... 830,585 10,329 95,221 58,973 39,138 47,077 579,847
Shurgard Europe (2)......... 698,144 1,607 7,829 162,138 99,036 - 427,534
Capital leases (3)............ 36,423 251 672 685 698 648 33,469
Operating leases:
Public Storage (4).......... 66,663 2,593 10,737 7,466 5,367 2,932 37,568
Shurgard U.S. (5)........... 62,882 1,498 5,021 3,680 3,628 3,694 45,361
Shurgard Europe (5)......... 140,562 1,466 5,255 5,217 5,064 4,267 119,293
Construction commitments:
Public Storage (6).......... 26,404 14,145 12,259 - - - -
Shurgard U.S. (7)........... 12,583 2,601 9,982 - - - -
Shurgard Europe (7)......... 24,133 23,952 83 98 - - -
============ =========== =========== =========== =========== =========== ===========
Total......................... $ 2,031,135 $ 61,055 $ 167,928 $ 247,853 $ 162,445 $ 67,899 $ 1,323,955
============ =========== =========== =========== =========== =========== ===========
(1) Amounts include interest payments on our notes payable based on their
contractual terms. See Note 8 to our condensed consolidated financial
statements for additional information on our notes payable. Debt to
Joint Venture Partner is not reflected since we have not exercised our
option to acquire our partner's interest.
(2) Amounts include interest payments on our notes payable based on their
contractual terms that we assumed in the merger with Shurgard. See Note
8 to our condensed consolidated financial statements for additional
information on our notes payable.
(3) This line item reflects amounts due on five European properties with
commitments extending to April 2052 that we assumed in the merger with
Shurgard.
(4) We lease trucks, land, equipment and office space under various
operating leases. Certain leases are cancelable with substantial
penalties.
(5) Amounts include leases for land, equipment and office space under
various operating lease that we assumed in the merger with Shurgard.
Certain leases are cancelable with substantial penalties.
79
(6) Includes obligations for facilities currently under construction at
September 30, 2006 as described above under "Acquisition and
Development of Real Estate Facilities."
(7) Includes obligations for facilities currently under construction at
September 30, 2006 that we assumed in the merger with Shurgard as
described above under "Acquisition and Development of Real Estate
Facilities."
In January 2004, we entered into a joint venture partnership with an
institutional investor for the purpose of acquiring up to $125,000,000 of
existing self-storage properties in the United States from third parties (the
"Acquisition Joint Venture"). As described more fully in Note 2 to our September
30, 2006 condensed consolidated financial statements, our partner's equity
contributions with respect to certain transactions are classified as debt under
the caption "Debt to Joint Venture Partner" in our condensed consolidated
balance sheets. At September 30, 2006, our Debt to Joint Venture Partner was
$37,214,000. For a six-month period beginning 54 months after formation, we have
the right to acquire our partner's interest based upon the market value of the
properties. If we do not exercise our option, our partner can elect to purchase
our interest in the properties during a six-month period commencing upon
expiration of our six-month option period. If our partner fails to exercise its
option, the Acquisition Joint Venture will be liquidated and the proceeds will
be distributed to the partners according to the joint venture agreement. We have
not included our Debt to Joint Venture Partner as a contractual obligation in
the table above, since we only have the right, rather than a contractual
obligation, to acquire our partner's interest.
OFF-BALANCE SHEET ARRANGEMENTS
At September 30, 2006, we had no off-balance sheet arrangements as
defined under Regulation S-K 303(a)(4) and the instructions thereto.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
-------------------------------------------------------------------
To limit our exposure to market risk, we principally finance our
operations and growth with permanent equity capital, consisting of either common
or preferred stock. At September 30, 2006, our debt as a percentage of total
shareholders' equity (based on book values) was 19.1%.
Our preferred stock is not redeemable at the option of the holders.
Except under certain conditions relating to the Company's qualification as a
REIT, the Preferred Stock is not redeemable by the Company prior to the
following dates: Series T - January 18, 2007, Series U - February 19, 2007,
Series V - September 30, 2007, Series W - October 6, 2008, Series X - November
13, 2008, Series Y - January 2, 2009, Series Z - March 5, 2009, Series A - March
31, 2009, Series B - June 30, 2009, Series C - September 13, 2009, Series D -
February 28, 2010, Series E - April 27, 2010, Series F - August 23, 2010, Series
G - December 12, 2010, Series H - January 19, 2011, Series I - May 3, 2011,
Series K - August 8, 2011 and Series L - October 20, 2011. On or after the
respective dates, each of the series of Preferred Stock will be redeemable at
the option of the Company, in whole or in part, at $25 per depositary share (or
share in the case of the Series Y), plus accrued and unpaid dividends through
the redemption date.
Our market risk sensitive instruments include notes payable, which
totaled $1,426,533,000 at September 30, 2006. The table below summarizes the
annual debt maturities and weighted-average interest rates on our outstanding
debt, excluding the debt acquired in the merger with Shurgard, at the end of
each year (dollar amounts in thousands):
2006 2007 2008 2009 2010 Thereafter Total Fair Value
---------- ---------- ---------- ---------- ---------- ---------- ----------- -----------
Fixed rate debt (a)... $ 1,186 $ 16,098 $ 5,155 $ 5,358 $ 5,404 $70,691 $ 103,892 $ 103,892
(a) Average interest rate of 5.25%.
80
We are exposed to changes in interest rates primarily from the floating
rate debt arrangements we acquired in the merger with Shurgard.
We have foreign currency exposures related to our investment in the
construction, acquisition, and operation of storage centers in countries outside
the U.S. to the extent such activities are financed with financial instruments
or equity denominated in non-functional currencies. Since all foreign debt is
denominated in the corresponding functional currency, our currency exposure is
limited to our equity investment in those countries. Countries in which Shurgard
had exposure to foreign currency fluctuations include Belgium, France, the
Netherlands, Sweden, Denmark, Germany and the United Kingdom.
The table below summarizes annual debt maturities and weighted-average
interest rates on outstanding debt that we acquired in the merger with Shurgard
at the end of each year (based on relevant LIBOR 4.90% and a EURIBOR of 3.272%
at September 30, 2006 and a forward yield curve for following years) and fair
values required to evaluate our expected cash-flows under debt agreements and
our sensitivity to interest rate changes at September 30, 2006 (dollar amounts
in thousands).
2006 2007 2008 2009 2010 Thereafter Total Fair Value
---------- ----------- ---------- ---------- ---------- ------------ --------- -------------
Fixed rate debt (1).... $ 5,418 $ 59,880 $ 25,898 $ 7,402 $ 15,939 $ 532,854 $ 647,391 $ 647,391
Average interest rate.. 6.71% 6.61% 6.60% 6.60% 6.61% 5.88%
Variable rate EURIBOR
debt (2)............. $ 1,522 $ 7,421 $153,685 $ 93,873 $ - $ 412,280 $ 668,781 $ 668,781
Average interest rate.. 4.50% 4.86% 4.75% 4.23% 4.32%
Interest rate swaps
Swap on EURIBOR........ $ - $ - $ (418) $ (213) $ - $ (703) $ (1,334) $ (1,334)
(1) The fair value of our fixed rate debt decreased by $24 million, from
$649 million at December 31, 2005, due primarily to an increase in
market interest rates.
(2) First Shurgard and Second Shurgard have senior credit agreements
denominated in euros to borrow, in aggregate, up to EUR 271.1 million
($343.9 million as of September 30, 2006). As of September 30, 2006,
the available amount under those credit facilities was in aggregate
EUR 68.9 million ($87.4 million).
At September 30, 2006, through our merger with Shurgard, we were party
to pay-fixed, receive-variable interest rate swaps. The notional amounts, the
weighted-average pay rates and the terms of these agreements are summarized as
follows:
2006 2007 2008 2009 2010 Thereafter
----------- ---------- ---------- ---------- --------- -----------
Notional amounts (in millions). $ 702.1 $ 719.4 $ 628.3 $ 500.2 $ 412.3 $ 412.3
Weighted average interest rate. 4.97% 4.99% 4.83% 4.54% 4.23% 4.23%
Based on our outstanding variable-rate EURIBOR debt and interest rate
swaps at September 30, 2006, a hypothetical increase in the interest rates of
100 basis points would cause the value of our derivative financial instruments
to increase by EUR 20 million. Conversely, a hypothetical decrease in the
interest rates of 100 basis points would cause the value of our derivative
financial instruments to decrease by EUR 20 million.
81
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in reports the
Company files and submits under the Exchange Act, is recorded, processed,
summarized and reported within the time periods specified in accordance with SEC
guidelines and that such information is communicated to the Company's
management, including its Chief Executive Officer and Chief Financial Officer,
to allow timely decisions regarding required disclosure based on the definition
of "disclosure controls and procedures" in Rules 13a-15(e) of the Exchange Act.
In designing and evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives and management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures in
reaching that level of reasonable assurance. Also, the Company has investments
in certain unconsolidated entities. As the Company does not control or manage
these entities, its disclosure controls and procedures with respect to such
entities are substantially more limited than those it maintains with respect to
its consolidated subsidiaries.
As of the end of the fiscal quarter covered by this report, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the Company's Chief Executive Officer and
the Company's Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures (as such term is
defined in Rules 13a - 15(e) and 15d - 15(e) under the Securities Act of 1934 as
amended) as of the end of the period covered by this report. Based upon this
evaluation, the Company's Chief Executive Officer and Chief Financial Officer
concluded that, as of the end of such period, the Company's disclosure controls
and procedures were effective.
There have not been any changes in our internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during the fiscal quarter to which this report relates that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
82
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information set forth under the heading "Legal Matters" in Note 16
to the Consolidated Financial Statements in this Form 10-Q is incorporated by
reference in this Item 1.
ITEM 1A. RISK FACTORS
In addition to the other information in our Form 10-Q and our Form 10-K
for the year ended December 31, 2005, you should consider the following factors
in evaluating the Company:
WE ARE SUBJECT TO ADDITIONAL RISKS AS A RESULT OF THE SHURGARD MERGER.
In addition to the general risks related to real estate described below
which may also adversely impact Shurgard's operations, we are also subject to
the following risks in connection with the Shurgard merger and integrating
Shurgard into our operations, including without limitation the following:
o difficulties in the integration of operations, technologies and
personnel of Shurgard;
o inability to realize or delays in realizing expected synergies and
results;
o unanticipated operating costs;
o diversion of our management's attention away from other business
concerns;
o exposure to any undisclosed or unknown potential liabilities of
Shurgard;
o risks related to real estate markets in the United States and in
Europe which are new markets for us or in which our operations will
be more concentrated as a result of the merger;
o potential underinsured losses on Shurgard properties; and
o risk of failure to mitigate any weaknesses in internal control at the
operations we acquired from Shurgard to the extent that it affects
our internal controls.
We have never undertaken to integrate a company as large as Shurgard or
one with overseas operations. The success of the merger will depend, in part, on
our ability to realize the anticipated cost savings from combining the
businesses of Public Storage and Shurgard. However, to realize the anticipated
benefits from the merger, we must successfully combine the businesses of Public
Storage and Shurgard in a manner that permits those cost savings to be realized.
If we are not able to successfully achieve these objectives, the anticipated
benefits of the merger may not be realized fully or at all or may take longer or
cost more to realize than expected. It is possible that the integration process
could result in the loss of valuable employees, a decline in occupancy and/or
rental rates, the disruption of each company's ongoing businesses or
inconsistencies in standards, controls, procedures, practices, policies and
compensation arrangements that adversely affect our ability to maintain
relationships with tenants and employees or to achieve the anticipated benefits
of the merger. Further, the size of the transaction may make integration of
Public Storage and Shurgard difficult, expensive and disruptive, adversely
affecting the combined company's revenues and earnings, and implementation of
merger integration efforts may divert management's attention from other
strategic priorities. In addition, the merger was structured so that it should
have been a taxable transaction for U.S. Federal income tax purposes. As a
result, the combined company should have the benefit of a step-up in tax basis
in Shurgard's assets. It is possible that the IRS may challenge the step-up in
basis. If such challenge were sustained, we would not achieve this benefit,
which would reduce our depreciation deductions and our ability to retain cash
flow.
We also acquired Shurgard's international operations in Europe, which
consist principally of facilities that have been completed in the last few years
and are in various stages of fill-up. Shurgard's international operations have
not been profitable, and there is no assurance they will ultimately be
profitable. Also, Shurgard had a number of non-stabilized properties and
construction activity, and delays in construction and fill-up could result in
additional costs. We have no experience in European operations, which may
adversely impact our ability to operate profitably in Europe. In addition, these
operations have specific inherent risks, including without limitation the
following:
83
o currency risks, including currency fluctuations and risks related to
foreign currency hedging activities;
o unexpected changes in legislative and regulatory requirements;
o potentially adverse tax burdens;
o burdens of complying with different permitting standards,
environmental and labor laws and a wide variety of foreign laws;
o obstacles to the repatriation of earnings and cash;
o regional, national and local political uncertainty;
o economic slowdown and/or downturn in foreign markets;
o difficulties in staffing and managing international operations;
o reduced protection for intellectual property in some countries; and
o inability to effectively control less than wholly owned partnerships
and joint ventures.
Shurgard also held many of its properties through interests in joint
ventures that we acquired and which have additional risks, including risks
related to the financial strength, common business goals and strategies and
cooperation of the venture partner, as well as the inability to take some
actions that may require approval by the venture partner. In addition, Shurgard
held substantially all of its real estate investments in Europe indirectly
through partnerships and joint venture arrangements. If we are unable to
effectively control these indirect investments, there is a risk that our
ownership of the joint ventures could cause us to lose our REIT status. These
investments also carry the risks that we may not control the legal entity that
has title to the real estate, that the enterprise in which we invested may have
liabilities that weren't disclosed at the time of the investment, and the risk
that these investments may not be easily sold or readily accepted as collateral
by our lenders.
As a share of total operations, particularly in Europe, Shurgard had
more recently developed properties whose occupancies have not stabilized and had
more construction activity than Public Storage, which increase costs. Delays in
construction and fill-up could result in additional cost.
Some of the facilities we acquired in the Shurgard merger will be
subject to property tax reappraisal that could increase property tax expense and
adversely affect our profitability. Up to 17% of the domestic properties we
acquired in the merger are located in jurisdictions that may provide for
property tax reappraisal upon a change of ownership and so may face such a
reassessment. We are not currently able to quantify the possible increases in
property tax expense.
We have assumed based on public filings that Shurgard qualified as a
real estate investment trust for United States federal income tax purposes,
referred to hereinafter as a REIT and that we would be able to continue to
qualify as a REIT following the Shurgard merger. However, if Shurgard failed to
qualify as a REIT, we generally would have succeeded to or incurred significant
tax liabilities (including the significant tax liability that would have
resulted from the deemed sale of assets by Shurgard pursuant to the merger) and
we could possibly lose our REIT status should disqualifying activities continue
after the Shurgard merger.
We are also subject to additional financing risks as a result of the
Shurgard merger. Shurgard had a significantly greater level of debt than we did,
with more fixed and floating rate debt as well as derivative instruments, that
we assumed as a result of the merger. At September 30, 2006, our debt, of
$1,463,747,000 was 13.5% of our total assets as compared to our pre-merger
indebtedness at June 30, 2006 of $141 million, which was 2.3% of our assets. The
larger indebtedness increases our interest expense, exposes us to the risk of
increases in interest rates, and subjects us to greater refinancing risks. We
may look to obtain a larger line of credit, bridge financing or other
indebtedness, or issue additional preferred or common equity to provide
liquidity as Shurgard's borrowings come due.
84
The Shurgard debt agreements we assumed also have covenants that could
limit our activities. Failure to comply with such covenants could cause a
default under the applicable debt agreement, which could allow the lenders or
other debt holders to declare all borrowings outstanding to be due and payable.
PUBLIC STORAGE SHAREHOLDERS INCURRED IMMEDIATE DILUTION FOLLOWING COMPLETION OF
THE SHURGARD MERGER.
Public Storage shareholders incurred immediate dilution in connection
with the merger. During 2005, Public Storage shareholders would have incurred a
loss of $0.45 per share (diluted) on a pro forma basis compared to earnings of
$1.93 per share (diluted) on a historical basis primarily as a result of an
increase in depreciation and amortization expense. No adjustments have been made
to the pro forma financial information to reflect certain expected self-storage
operating cost savings or increases in property taxes resulting from the merger
because they have not been quantified.
THE HUGHES FAMILY COULD CONTROL US AND TAKE ACTIONS ADVERSE TO OTHER
SHAREHOLDERS.
At September 30, 2006, B. Wayne Hughes, Chairman of the Board and his
family (the "Hughes family") owned approximately 26.7% of our aggregate
outstanding shares of common stock. Consequently, the Hughes family could
control matters submitted to a vote of our shareholders, including electing
directors, amending our organizational documents, dissolving and approving other
extraordinary transactions, such as a takeover attempt, even though such actions
may not be favorable to the other common shareholders.
PROVISIONS IN OUR ORGANIZATIONAL DOCUMENTS MAY PREVENT CHANGES IN CONTROL.
Restrictions in our organizational documents may further limit changes
in control. Unless our Board of Directors waives these limitations, no
shareholder may own more than (1) 2.0% of our outstanding shares of our common
stock or (2) 9.9% of the outstanding shares of each class or series of our
preferred or equity stock. Our organizational documents in effect provide,
however, that the Hughes family may continue to own the shares of our common
stock held by them at the time of the 1995 reorganization. Our Board has
authorized the Hughes family to acquire additional shares of our common stock to
maintain their pre-merger holding percentage. These limitations are designed, to
the extent possible, to avoid a concentration of ownership that might jeopardize
our ability to qualify as a real estate investment trust or REIT. These
limitations, however, also may make a change of control significantly more
difficult (if not impossible) even if it would be favorable to the interests of
our public shareholders. These provisions will prevent future takeover attempts
not approved by our board of directors even if a majority of our public
shareholders deem it to be in their best interests because they would receive a
premium for their shares over the shares' then market value or for other
reasons.
WE WOULD INCUR ADVERSE TAX CONSEQUENCES IF WE OR SHURGARD FAILED TO QUALIFY AS A
REIT.
We have assumed based on public filings that Shurgard qualified as a
real estate investment trust for United States federal income tax purposes,
referred to hereinafter as a REIT and that we will be able to continue to
qualify as a REIT following the Shurgard merger. However, if Shurgard failed to
qualify as a REIT, we generally would have succeeded to or incurred significant
tax liabilities (including the significant tax liability that would have
resulted from the deemed sale of assets by Shurgard pursuant to the merger) and
we could possibly lose our REIT status should disqualifying activities continue
after the Shurgard merger.
Investors are also subject to the risk that we may not qualify as a
REIT. REITs are subject to a range of complex organizational and operational
requirements. As a REIT, we must distribute with respect to each year at least
90% of our REIT taxable income to our shareholders. Other restrictions apply to
our income and assets. Our REIT status is also dependent upon the ongoing
qualification of our affiliate, PS Business Parks, Inc., as a REIT, as a result
of our substantial ownership interest in that company.
For any taxable year that we fail to qualify as a REIT and are unable
to avail ourselves of certain savings provisions set forth in the Internal
Revenue Code of 1986, we would be subject to federal income tax at the regular
85
corporate rates on all of our taxable income, whether or not we make any
distributions to our shareholders. Those taxes would reduce the amount of cash
available for distribution to our shareholders or for reinvestment and would
adversely affect our earnings. As a result, our failure to qualify as a REIT
during any taxable year could have a material adverse effect upon us and our
shareholders. Furthermore, unless certain relief provisions apply, we would not
be eligible to elect REIT status again until the fifth taxable year that begins
after the first year for which we fail to qualify.
WE MAY PAY SOME TAXES, REDUCING CASH AVAILABLE FOR SHAREHOLDERS.
Even if we qualify as a REIT for federal income tax purposes, we are
required to pay some federal, state and local taxes on our income and property.
Several corporate subsidiaries of the Company have elected to be treated as
"taxable REIT subsidiaries" of the Company for federal income tax purposes since
January 1, 2001. A taxable REIT subsidiary is taxable as a regular corporation
and is limited in its ability to deduct interest payments made to us in excess
of a certain amount. In addition, if we receive certain payments and the
economic arrangements among our taxable REIT subsidiaries and us are not
comparable to similar arrangements among unrelated parties we will be subject to
a 100% penalty tax on those payments. To the extent that the Company or any
taxable REIT subsidiary is required to pay federal, state or local taxes, we
will have less cash available for distribution to shareholders.
WE HAVE BECOME INCREASINGLY DEPENDENT UPON AUTOMATED PROCESSES AND THE INTERNET
AND ARE FACED WITH SECURITY SYSTEM RISKS.
We have become increasingly centralized and dependent upon automated
information technology processes. As a result, we could be severely impacted by
a catastrophic occurrence, such as a natural disaster or a terrorist attack. In
addition, a portion of our business operations are conducted over the Internet,
increasing the risk of viruses that could cause system failures and disruptions
of operations. Experienced computer programmers may be able to penetrate our
network security and misappropriate our confidential information, create system
disruptions or cause shutdowns.
CERTAIN SECURITIES HAVE A LIQUIDATION PREFERENCE OVER OUR COMMON STOCK AND
EQUITY STOCK, SERIES A.
If we liquidated, holders of our preferred securities would be entitled
to receive liquidating distributions, plus any accrued and unpaid distributions,
before any distribution of assets to the holders of our common stock and equity
stock, series A. Holders of preferred securities are entitled to receive, when
declared by our board of directors, cash distributions in preference to holders
of our common stock and equity stock, Series A.
SINCE OUR BUSINESS CONSISTS PRIMARILY OF ACQUIRING AND OPERATING REAL ESTATE, WE
ARE SUBJECT TO REAL ESTATE OPERATING RISKS.
The value of our investments may be reduced by general risks of real
estate ownership. Since we derive substantially all of our income from real
estate operations, we are subject to the general risks of owning real
estate-related assets, including: o lack of demand for rental spaces or units in
a locale;
o changes in general economic or local conditions;
o natural disasters, such as earthquakes;
o potential terrorist attacks;
o changes in supply of or demand for similar or competing facilities in
an area;
o the impact of environmental protection laws;
o changes in interest rates and availability of permanent mortgage
funds which may render the sale or financing of a property difficult
or unattractive;
o changes in tax, real estate and zoning laws; and
o tenant claims.
In addition, we self-insure certain of our property loss, liability,
and workers compensation risks for which other real estate companies may use
third-party insurers. This results in a higher risk of losses that are not
covered by third-party insurance contracts, as described in Note 16 under
"Insurance and Loss Exposure" to our consolidated financial statements included
in this quarterly report on Form 10-Q for the quarter ended September 30, 2006.
86
There is significant competition among self-storage facilities and from
other storage alternatives. Most of our properties are self-storage facilities,
which generated most of our revenue for the nine months ended September 30,
2006. Local market conditions will play a significant part in how competition
will affect us. Competition in the market areas in which many of our properties
are located from other self-storage facilities and other storage alternatives is
significant and has affected the occupancy levels, rental rates and operating
expenses of some of our properties. Any increase in availability of funds for
investment in real estate may accelerate competition. Further development of
self-storage facilities may intensify competition among operators of
self-storage facilities in the market areas in which we operate.
We may incur significant environmental costs and liabilities. As an
owner and operator of real properties, under various federal, state and local
environmental laws, we are required to clean up spills or other releases of
hazardous or toxic substances on or from our properties. Certain environmental
laws impose liability whether or not the owner knew of, or was responsible for,
the presence of the hazardous or toxic substances. In some cases, liability may
not be limited to the value of the property. The presence of these substances,
or the failure to properly remediate any resulting contamination, whether from
environmental or microbial issues, also may adversely affect the owner's or
operator's ability to sell, lease or operate its property or to borrow using its
property as collateral.
We have conducted preliminary environmental assessments of most of our
properties (and intend to conduct these assessments in connection with property
acquisitions) to evaluate the environmental condition of, and potential
environmental liabilities associated with, our properties. These assessments
generally consist of an investigation of environmental conditions at the
property (not including soil or groundwater sampling or analysis), as well as a
review of available information regarding the site and publicly available data
regarding conditions at other sites in the vicinity. In connection with these
property assessments, our operations and recent property acquisitions, we have
become aware that prior operations or activities at some facilities or from
nearby locations have or may have resulted in contamination to the soil or
groundwater at these facilities. In this regard, some of our facilities are or
may be the subject of federal or state environment investigations or remedial
actions. We have obtained, with respect to recent acquisitions, and intend to
obtain with respect to pending or future acquisitions, appropriate purchase
price adjustments or indemnifications that we believe are sufficient to cover
any related potential liability. Although we cannot provide any assurance, based
on the preliminary environmental assessments, we believe we have funds available
to cover any liability from environmental contamination or potential
contamination and we are not aware of any environmental contamination of our
facilities material to our overall business, financial condition or results of
operation.
There has been an increasing number of claims and litigation against
owners and managers of rental properties relating to moisture infiltration,
which can result in mold or other property damage. When we receive a complaint
concerning moisture infiltration, condensation or mold problems and/or become
aware that an air quality concern exists, we implement corrective measures in
accordance with guidelines and protocols we have developed with the assistance
of outside experts. We seek to work proactively with our tenants to resolve
moisture infiltration and mold-related issues, subject to our contractual
limitations on liability for such claims. However, we can make no assurance that
material legal claims relating to moisture infiltration and the presence of, or
exposure to, mold will not arise in the future.
Delays in development and fill-up of our properties would reduce our
profitability. Since January 1, 2002, through September 30, 2006, we have opened
44 newly developed self-storage facilities and 17 facilities that combine
self-storage and containerized storage space at the same location, with
aggregate development costs of approximately $538.9 million. In addition, our
development efforts in the United States and Europe at September 30, 2006
consist of 60 projects with total estimated costs of $328 million. We anticipate
the development of these 60 projects to be completed in the next two years.
Construction delays due to weather, unforeseen site conditions, personnel
problems, and other factors, as well as cost overruns, would adversely affect
our profitability. Delays in the rent-up of newly developed facilities as a
result of competition or other factors would also adversely impact our
profitability.
87
Property taxes can increase and cause a decline in yields on
investments. Each of our properties is subject to real property taxes. These
real property taxes may increase in the future as property tax rates change and
as our properties are assessed or reassessed by tax authorities. Such increases
could adversely impact our profitability.
We must comply with the Americans with Disabilities Act and fire and
safety regulations, which can require significant expenditures. All our
properties must comply with the Americans with Disabilities Act and with related
regulations (the "ADA"). The ADA has separate compliance requirements for
"public accommodations" and "commercial facilities," but generally requires that
buildings be made accessible to persons with disabilities. Various state laws
impose similar requirements. A failure to comply with the ADA or similar state
laws could result in government imposed fines on us and could award damages to
individuals affected by the failure. In addition, we must operate our properties
in compliance with numerous local fire and safety regulations, building codes,
and other land use regulations. Compliance with these requirements can require
us to spend substantial amounts of money, which would reduce cash otherwise
available for distribution to shareholders. Failure to comply with these
requirements could also affect the marketability of our real estate facilities.
Any failure by us to manage acquisitions and other significant
transactions successfully could negatively impact our financial results. As an
increasing part of our business, we acquire other self-storage facilities. We
also evaluate from time to time other significant transactions. If these
facilities are not properly integrated into our system, our financial results
may suffer.
We incur liability from employment related claims. From time to time we
must resolve employment related claims by corporate level and field personnel.
WE HAVE NO INTEREST IN CANADIAN SELF-STORAGE FACILITIES OWNED BY THE HUGHES
FAMILY.
The Hughes Family has ownership interests in, and operates,
approximately 44 self-storage facilities in Canada under the name "Public
Storage." We currently do not own any interests in these facilities nor do we
own any facilities in Canada. We have a right of first refusal to acquire the
stock or assets of the corporation engaged in the operation of the self-storage
facilities in Canada if the Hughes family or the corporation agrees to sell
them. However, we have no ownership interest in the operations of this
corporation, have no right to acquire their stock or assets unless the Hughes
family decides to sell, and receive no benefit from the profits and increases in
value of the Canadian self-storage facilities.
Prior to December 31, 2003, Company personnel were engaged in the
supervision and the operation of these properties and provided certain
administrative services for the Canadian owners, and certain other services,
primarily tax services, with respect to certain other Hughes Family interests.
The Hughes Family and the Canadian owners reimbursed us at cost for these
services in the amount of $542,499 with respect to the Canadian operations and
$151,063 for other services during 2003 (in United States dollars). There were
conflicts of interest in allocating time of our personnel between Company
properties, the Canadian properties, and certain other Hughes Family interests.
The sharing of Company personnel with the Canadian entities was substantially
eliminated by December 31, 2003.
Through our subsidiaries, we continue to reinsure risks relating to
loss of goods stored by tenants in the self-storage facilities in Canada. We
acquired the tenant insurance business on December 31, 2001 through our
acquisition of PSIC. For each of the nine-month periods ended September 30, 2006
and 2005, PSIC received $759,000 and $795,000, respectively, in reinsurance
premiums attributable to the Canadian Facilities. Since PSIC's right to provide
tenant reinsurance to the Canadian Facilities may be qualified, there is no
assurance that these premiums will continue.
OUR CONTAINERIZED STORAGE BUSINESS HAS INCURRED OPERATING LOSSES.
Public Storage Pickup & Delivery ("PSPUD") was organized in 1996 to
operate a containerized storage business. We own all of the economic interest of
PSPUD. Since PSPUD will operate profitably only if it can succeed in the
relatively new field of containerized storage, we cannot provide any assurance
as to its profitability. PSPUD incurred an operating loss of $10,058,000 in
2002, and generated operating profits of $2,543,000 in 2003, $684,000 in 2004,
$1,818,000 for 2005 and $385,000 for the nine months ended September 30, 2006.
Since 2002, PSPUD closed or consolidated facilities that were deemed not
strategic to its business plan, and had 12 facilities open at September 30,
2006.
88
INCREASES IN INTEREST RATES MAY ADVERSELY AFFECT THE PRICE OF OUR COMMON STOCK.
One of the factors that influences the market price of our common stock
and our other securities is the annual rate of distributions that we pay on the
securities, as compared with interest rates. An increase in interest rates may
lead purchasers of REIT shares to demand higher annual distribution rates, which
could adversely affect the market price of our common stock and other
securities.
TERRORIST ATTACKS AND THE POSSIBILITY OF WIDER ARMED CONFLICT MAY HAVE AN
ADVERSE IMPACT ON OUR BUSINESS AND OPERATING RESULTS AND COULD DECREASE THE
VALUE OF OUR ASSETS.
Terrorist attacks and other acts of violence or war, such as those that
took place on September 11, 2001, could have a material adverse impact on our
business and operating results. There can be no assurance that there will not be
further terrorist attacks against the United States or its businesses or
interests. Attacks or armed conflicts that directly impact one or more of our
properties could significantly affect our ability to operate those properties
and thereby impair our operating results. Further, we may not have insurance
coverage for losses caused by a terrorist attack. Such insurance may not be
available, or if it is available and we decide to obtain such terrorist
coverage, the cost for the insurance may be significant in relationship to the
risk overall. In addition, the adverse effects that such violent acts and
threats of future attacks could have on the United States economy could
similarly have a material adverse effect on our business and results of
operations. Finally, further terrorist acts could cause the United States to
enter into a wider armed conflict, which could further impact our business and
operating results.
DEVELOPMENTS IN CALIFORNIA MAY HAVE AN ADVERSE IMPACT ON OUR BUSINESS.
We are headquartered in, and approximately one-fifth of our properties
in the United States are located in, California. California is facing budgetary
problems. Action that may be taken in response to these problems, such as an
increase in property taxes on commercial properties, could adversely impact our
business and results of operations. In addition, we could be adversely impacted
by efforts to reenact legislation mandating medical insurance for employees of
California businesses and members of their families.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
-----------------------------------------------------------
On June 12, 1998, we announced that the Board of Directors (the
"Directors") authorized the repurchase from time to time of up to 10,000,000
shares of the Company's common stock on the open market or in privately
negotiated transactions. On subsequent dates the Directors increased the
repurchase authorization, the last being April 13, 2001, when the Board of
Directors increased the repurchase authorization to 25,000,000 shares. The
Company has repurchased a total of 22,201,720 shares of Common Stock under this
authorization. The Company did not repurchase any shares of Common Stock during
the nine months ended September 30, 2006.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
---------------------------------------------------
The Company held its annual meeting of shareholders on August 22, 2006,
and the following matters were voted on at the meeting:
1. The election of the following directors for the succeeding year or until
their successors are duly qualified and elected:
89
Total Votes
----------------------------------------
Name Total Votes For Total Votes Withheld
----------------------- ------------------- --------------------
B. Wayne Hughes 81,995,900 32,355,081
Ronald L. Havner, Jr. 112,061,211 2,289,770
Robert J. Abernethy 102,833,568 11,517,413
Dann V. Angeloff 109,438,064 4,912,918
William C. Baker 111,647,148 2,703,834
John T. Evans 103,509,361 10,841,621
Uri P. Harkham 112,426,967 1,924,014
B. Wayne Hughes, Jr. 82,165,618 32,185,364
Harvey Lenkin 112,011,694 2,339,288
Daniel C. Staton 103,522,945 10,828,036
2. The shareholders approved the merger agreement dated as of March 6, 2006 by
and among Public Storage, Inc., Shurgard Storage Centers, Inc., and ASKL
Sub LLC and the transactions contemplated thereby, including the issuance
of Public Storage common stock. Of the shares of common stock voted at the
meeting, 104,832,667 votes were cast in favor of the merger agreement;
255,745 shares voted against; 645,790 shares abstained; and 8,034,510 were
broker non-votes. Of the Company's shares of Equity Stock, Series A and
Equity Stock, Series AAA voting together as a class, 4,524,362 votes were
cast in favor of the merger agreement, 8,614 shares voted against; 3,187
shares abstained; and 335,650 were broker non-votes.
3. The shareholders approved ratification of the appointment of Ernst & Young
LLP as the Company's independent auditors for the fiscal year ended
December 31, 2006. There were 100,506,454 votes cast for ratification;
12,899,735 votes cast against ratification; and 944,792 votes abstained.
ITEM 6. EXHIBITS
Exhibits required by Item 601 of Regulation S-K are filed herewith or
incorporated herein by reference and are listed in the attached Exhibit Index
which is incorporated herein by reference.
90
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DATED: November 9, 2006
PUBLIC STORAGE, INC.
By: /s/ John Reyes
--------------
John Reyes
Senior Vice President and Chief
Financial Officer (Principal
financial officer and duly
authorized officer)
91
Exhibit No. Exhibit Index
----------- -------------------------------------------------------------------
3.1 Restated Articles of Incorporation of Storage Equities, Inc. Filed
with Registrant's Registration Statement on Form S-4 (SEC File No.
33-54557) and incorporated herein by reference.
3.2 Certificate of Amendment of Articles of Incorporation of Storage
Equities, Inc. Filed with Registrant's Registration Statement on
Form S-3/A (SEC File No. 33-63947) and incorporated herein by
reference.
3.3 Certificate of Amendment of Articles of Incorporation of Public
Storage, Inc. Filed with Registrant's Registration Statement on
Form S-3 (SEC File No. 333-18395) and incorporated herein by
reference.
3.4 Certificate of Determination of Preferences of 10% Cumulative
Preferred Stock, Series A of Storage Equities, Inc. Filed with
Registrant's Registration Statement on Form S-4 (SEC File No.
33-54557) and incorporated herein by reference.
3.5 Amendment to Certificate of Determination of Preferences of 10%
Cumulative Preferred Stock, Series A of Public Storage, Inc. Filed
with the Registrant's Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 2004 and incorporated herein by
reference.
3.6 Certificate of Determination of Preferences of 9.20% Cumulative
Preferred Stock, Series B of Storage Equities, Inc. Filed with
Registrant's Registration Statement on Form S-4 (SEC File No.
33-54557) and incorporated herein by reference.
3.7 Amendment to Certificate of Determination of Preferences of 9.20%
Cumulative Preferred Stock, Series B of Storage Equities, Inc.
Filed with Registrant's Registration Statement on Form S-4 (SEC
File No. 33-56925) and incorporated herein by reference.
3.8 Amendment to Certificate of Determination of Preferences of 9.20%
Cumulative Preferred Stock, Series B of Public Storage, Inc. Filed
with the Registrant's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 2004 and incorporated herein by
reference.
3.9 Certificate of Determination of Preferences of 8.25% Convertible
Preferred Stock of Public Storage, Inc. Filed with Registrant's
Registration Statement on Form S-4 (SEC File No. 33-54557) and
incorporated herein by reference.
3.10 Certificate of Determination of Preferences of Adjustable Rate
Cumulative Preferred Stock, Series C of Storage Equities, Inc.
Filed with Registrant's Registration Statement on Form S-4 (SEC
File No. 33-54557) and incorporated herein by reference.
3.11 Amendment to Certificate of Determination of Preferences of
Adjustable Rate Cumulative Preferred Stock, Series C of Public
Storage, Inc. Filed with Registrant's Quarterly Report on Form 10-Q
for the quarterly period ended September 30, 2004 and incorporated
herein by reference.
3.12 Certificate of Determination of Preferences of 9.50% Cumulative
Preferred Stock, Series D of Storage Equities, Inc. Filed with
Registrant's Registration Statement on Form 8-A/A relating to the
9.50% Cumulative Preferred Stock, Series D and incorporated herein
by reference.
3.13 Amendment to Certificate of Determination of Preferences of 9.50%
Cumulative Preferred Stock, Series D of Public Storage, Inc. Filed
with Registrant's Annual Report on Form 10-K for the year ended
December 31, 2004 and incorporated herein by reference.
3.14 Certificate of Determination of Preferences of 10% Cumulative
Preferred Stock, Series E of Storage Equities, Inc. Filed with
Registrant's Registration Statement on Form 8-A/A relating to the
10% Cumulative Preferred Stock, Series E and incorporated herein by
reference.
3.15 Amendment to Certificate of Determination of Preferences of 10%
Cumulative Preferred Stock, Series E of Public Storage, Inc. Filed
with Registrant's Current Report on Form 8-K dated April 25, 2005
and incorporated herein by reference.
92
3.16 Certificate of Determination of Preferences of 9.75% Cumulative
Preferred Stock, Series F of Storage Equities, Inc. Filed with
Registrant's Registration Statement on Form 8-A/A relating to the
9.75% Cumulative Preferred Stock, Series F and incorporated herein
by reference.
3.17 Amendment to Certificate of Determination of Preferences of 9.750%
Cumulative Preferred Stock, Series F of Public Storage, Inc. Filed
with Registrant's Current Report on Form 8-K dated August 17, 2005
and incorporated herein by reference.
3.18 Certificate of Determination of Preferences of 8-7/8% Cumulative
Preferred Stock, Series G of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A/A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 8-7/8%
Cumulative Preferred Stock, Series G and incorporated herein by
reference.
3.19 Certificate of Determination of Preferences of 8.45% Cumulative
Preferred Stock, Series H of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A/A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 8.45%
Cumulative Preferred Stock, Series H and incorporated herein by
reference.
3.20 Certificate of Determination of Preferences of Convertible
Preferred Stock, Series CC of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form S-4 (SEC File No.
333-03749) and incorporated herein by reference.
3.21 Certificate of Correction of Certificate of Determination of
Preferences of Convertible Participating Preferred Stock of Public
Storage, Inc. Filed with Registrant's Registration Statement on
Form S-4 (SEC File No. 333-08791) and incorporated herein by
reference.
3.22 Certificate of Determination of Preferences of 8 5/8% Cumulative
Preferred Stock, Series I of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A/A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 8 5/8%
Cumulative Preferred Stock, Series I and incorporated herein by
reference.
3.23 Certificate of Determination of Equity Stock, Series A of Public
Storage, Inc. Filed with Registrant's Quarterly Report on Form 10-Q
for the quarterly period ended June 30, 1997 and incorporated
herein by reference.
3.24 Certificate of Determination of Preferences of 8% Cumulative
Preferred Stock, Series J of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A/A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 8%
Cumulative Preferred Stock, Series J and incorporated herein by
reference.
3.25 Certificate of Correction of Certificate of Determination of
Preferences of 8.25% Convertible Preferred Stock of Public Storage,
Inc. Filed with Registrant's Registration Statement on Form S-4
(SEC File No. 333-61045) and incorporated herein by reference.
3.26 Certificate of Determination of Preferences of 8 1/4% Cumulative
Preferred Stock, Series K of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A/A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 8 1/4%
Cumulative Preferred Stock, Series K and incorporated herein by
reference.
3.27 Certificate of Determination of Preferences of 8 1/4% Cumulative
Preferred Stock, Series L of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A/A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 8 1/4%
Cumulative Preferred Stock, Series L and incorporated herein by
reference.
3.28 Certificate of Determination of Preferences of 8.75% Cumulative
Preferred Stock, Series M of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A/A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 8.75%
Cumulative Preferred Stock, Series M and incorporated herein by
reference.
93
3.29 Certificate of Determination of Equity Stock, Series AA of Public
Storage, Inc. Filed with Registrant's Quarterly Report on Form 10-Q
for the quarterly period ended September 30, 1999 and incorporated
herein by reference.
3.30 Certificate Decreasing Shares Constituting Equity Stock, Series A
of Public Storage, Inc. Filed with Registrant's Quarterly Report on
Form 10-Q for the quarterly period ended September 30, 1999 and
incorporated herein by reference.
3.31 Certificate of Determination of Equity Stock, Series A of Public
Storage, Inc. Filed with Registrant's Quarterly Report on Form 10-Q
for the quarterly period ended September 30, 1999 and incorporated
herein by reference.
3.32 Certificate of Amendment of Certificate of Determination of Equity
Stock, Series A of Public Storage, Inc. Filed with Registrant's
Quarterly Report on Form 10-Q for the quarterly period ended June
30, 2001 and incorporated herein by reference.
3.33 Certificate of Determination of Equity Stock, Series AAA of Public
Storage, Inc. Filed with Registrant's Current Report on Form 8-K
dated November 15, 1999 and incorporated herein by reference.
3.34 Certificate of Determination of Preferences of 9.5% Cumulative
Preferred Stock, Series N of Public Storage, Inc. Filed with
Registrant's Annual Report on Form 10-K for the year ended December
31, 1999 and incorporated herein by reference.
3.35 Certificate of Determination of Preferences of 9.125% Cumulative
Preferred Stock, Series O of Public Storage, Inc. Filed with
Registrant's Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 2000 and incorporated herein by reference.
3.36 Certificate of Determination of Preferences of 8.75% Cumulative
Preferred Stock, Series P of Public Storage, Inc. Filed with
Registrant's Quarterly Report on Form 10-Q for the quarterly period
ended June 30, 2000 and incorporated herein by reference.
3.37 Certificate of Determination of Preferences of 8.600% Cumulative
Preferred Stock, Series Q of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A/A (No. 001-08389)
relating to the Depositary Shares Each Representing 1/1,000 of a
Share of 8.600% Cumulative Preferred Stock, Series Q and
incorporated herein by reference.
3.38 Certificate of Amendment of Certificate of Determination of Equity
Stock, Series A of Public Storage, Inc. Filed with Registrant's
Quarterly Report on Form 10-Q for the quarterly period ended June
30, 2001 and incorporated herein by reference.
3.39 Certificate of Determination of Preferences of 8.000% Cumulative
Preferred Stock, Series R of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 8.000%
Cumulative Preferred Stock, Series R and incorporated herein by
reference.
3.40 Certificate of Determination of Preferences of 7.875% Cumulative
Preferred Stock, Series S of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 7.875%
Cumulative Preferred Stock, Series S and incorporated herein by
reference.
3.41 Certificate of Determination of Preferences of 7.625% Cumulative
Preferred Stock, Series T of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 7.625%
Cumulative Preferred Stock, Series T and incorporated herein by
reference.
3.42 Certificate of Determination of Preferences of 7.625% Cumulative
Preferred Stock, Series U of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A relating to
Depositary Shares Each Representing 1/1,000 of a Share of 7.625%
Cumulative Preferred Stock, Series U and incorporated herein by
reference.
94
3.43 Amendment to Certificate of Determination of Preferences of 7.625%
Cumulative Preferred Stock, Series T of Public Storage, Inc. Filed
with Registrant's Quarterly Report on Form 10-Q for the quarterly
period ended September 30, 2002 and incorporated herein by
reference.
3.44 Certificate of Determination of Preferences of 7.500% Cumulative
Preferred Stock, Series V of Public Storage, Inc. Filed with
Registrant's Registration Statement Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 7.500%
Cumulative Preferred Stock, Series V and incorporated herein by
reference.
3.45 Certificate of Determination of Preferences of 6.500% Cumulative
Preferred Stock, Series W of Public Storage, Inc. Filed with
Registrant's Registration Statement Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 6.500%
Cumulative Preferred Stock, Series W and incorporated herein by
reference.
3.46 Certificate of Determination of Preferences 6.450% Cumulative
Preferred Stock, Series X of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 6.450%
Cumulative Preferred Stock, Series X and incorporated herein by
reference.
3.47 Certificate of Determination of Preferences of 6.85% Cumulative
Preferred Stock, Series Y of Public Storage, Inc. Filed with the
Registrant's Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 2004 and incorporated herein by reference.
3.48 Certificate of Determination of Preferences of 6.250% Cumulative
Preferred Stock, Series Z of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 6.250%
Cumulative Preferred Stock, Series Z and incorporated herein by
reference.
3.49 Certificate of Determination of Preferences of 6.125% Cumulative
Preferred Stock, Series A of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 6.125%
Cumulative Preferred Stock, Series A and incorporated herein by
reference.
3.50 Certificate of Determination of Preferences of 6.40% Cumulative
Preferred Stock, Series NN of Public Storage, Inc. Filed with
Registrant's Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 2004 and incorporated herein by reference.
3.51 Certificate of Determination of Preferences of 7.125% Cumulative
Preferred Stock, Series B of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 7.125%
Cumulative Preferred Stock, Series B and incorporated herein by
reference.
3.52 Certificate of Determination of Preferences of 6.60% Cumulative
Preferred Stock, Series C of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 6.60%
Cumulative Preferred Stock, Series C and incorporated herein by
reference.
3.53 Certificate of Determination of Preferences of 6.18% Cumulative
Preferred Stock, Series D of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 6.18%
Cumulative Preferred Stock, Series D and incorporated herein by
reference.
3.54 Certificate of Determination of Preferences of 6.75% Cumulative
Preferred Stock, Series E of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a share of 6.75%
Cumulative Preferred Stock, Series E and incorporated herein by
reference.
3.55 Certificate of Determination of Preferences of 6.45% Cumulative
Preferred Stock, Series F of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 6.45%
Cumulative Preferred Stock, Series F and incorporated herein by
reference.
95
3.56 Amendment to Certificate of Determination of Preferences 6.45%
Cumulative Preferred Stock, Series F of Public Storage, Inc. Filed
with Registrant's Registration Statement on Form 8-A relating to
the Depositary Shares Each Representing 1/1,000 of a Share of 6.45%
Cumulative Preferred Stock, Series F and incorporated herein by
reference.
3.57 Certificate of Determination of Preferences of 7.00% Cumulative
Preferred Stock, Series G of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 7.00%
Cumulative Preferred Stock, Series G and incorporated herein by
reference.
3.58 Certificate of Determination of Preferences of 6.95% Cumulative
Preferred Stock, Series H of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 6.95%
Cumulative Preferred Stock, Series H and incorporated herein by
reference.
3.59 Certificate of Determination of Preferences of 7.25% Cumulative
Preferred Stock, Series I of Public Storage, Inc. Filed with
Registrant's Registration Statement on Form 8-A relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 7.25%
Cumulative Preferred Stock, Series I and incorporated herein by
reference.
3.60 Certificate of Determination of Preferences of 7.25% Cumulative
Preferred Stock, Series J of Public Storage, Inc. Filed with
Registrant's Current Report on Form 8-K filed May 9, 2006 relating
to the Depositary Shares Each Representing 1/1,000 of a Share of
7.25% Cumulative Preferred Stock, Series J and incorporated herein
by reference.
3.61 Certificate of Determination of Preferences of 7.25% Cumulative
Preferred Stock, Series K of Public Storage, Inc. Filed with
Registrant's Current Report on Form 8-K filed August 4, 2006
relating to the Depositary Shares Each Representing 1/1,000 of a
Share of 7.25% Cumulative Preferred Stock, Series K and
incorporated herein by reference.
3.62 Certificate of Determination of Preferences of 6.75% Cumulative
Preferred Stock, Series L of Public Storage, Inc. Filed with
Registrant's Current Report on Form 8-K filed October 18, 2006
relating to the Depositary Shares Each Representing 1/1,000 of a
Share of 6.75% Cumulative Preferred Stock, Series L and
incorporated herein by reference.
3.63 Amendment to Certificate of Determination of Determination of
Preferences of Cumulative Preferred Stock, Series G (8.875%), H
(8.45%), I (8.625%), J (8%), K (8.25%), L (8.25%), M (8.75%), N
(9.5%), O (9.125%) and P (8.75%) of Public Storage, Inc. Filed with
Registrant's Current Report on Form 8-K dated November 22, 2005 and
incorporated herein by reference.
3.64 Revised Bylaws of Storage Equities, Inc. Filed with Registrant's
Registration Statement on Form S-4/A (SEC File No. 33-64971) and
incorporated herein by reference.
3.65 Amendment to Bylaws of Public Storage, Inc. adopted on May 9, 1996.
Filed with Registrant's Registration Statement on Form S-4 (Sec
File No. 333-03749) and incorporated herein by reference.
3.66 Amendment to Bylaws of Public Storage, Inc. adopted on June 26,
1997. Filed with Registrant's Registration Statement on Form S-3/A
(SEC File No. 333-41123) and incorporated herein by reference.
3.67 Amendment to Bylaws of Public Storage, Inc. adopted on January 6,
1998. Filed with Registrant's Registration Statement on Form S-3/A
(SEC File No. 333-41123) and incorporated herein by reference.
3.68 Amendment to Bylaws of Public Storage, Inc. adopted on February 10,
1998. Filed with Registrant's Current Report on Form 8-K dated
February 10, 1998 and incorporated herein by reference.
3.69 Amendment to Bylaws of Public Storage, Inc. adopted on March 4,
1999. Filed with Registrant's Current Report on Form 8-K dated
March 4, 1999 and incorporated herein by reference.
96
3.70 Amendment to Bylaws of Public Storage, Inc. adopted on May 6, 1999.
Filed with Registrant's Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 1999 and incorporated herein by
reference.
3.71 Amendment to Bylaws of Public Storage, Inc. adopted on November 7,
2002. Filed with Registrant's Quarterly Report on Form 10-Q for the
quarterly period ended September 30, 2002 and incorporated herein
by reference.
3.72 Amendment to Bylaws of Public Storage, Inc. adopted on May 8, 2003.
Filed with Registrant's Quarterly Report on Form 10-Q for the
quarterly period ended March 31, 2003 and incorporated herein by
reference.
3.73 Amendment to Bylaws of Public Storage, Inc. adopted on August 5,
2003. Filed with Registrant's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 2003 and incorporated herein by
reference.
3.74 Amendment to Bylaws of Public Storage, Inc. adopted on March 11,
2004. Filed with Registrant's Annual Report on Form 10-K for the
year ended December 31, 2003 and incorporated herein by reference.
3.75 Amendments to Bylaws of Public Storage, Inc. adopted on August 22,
2006. Filed with Registrant's Current Report on Form 8-K filed
August 23, 2006 and incorporated herein by reference.
4.1 Registration Rights Agreement dated as of May 9, 2006 relating to
7.25% Series J Cumulative Preferred Stock of the Registrant. Filed
with Registrant's Current Report on Form 8-K dated May 9, 2006 and
incorporated herein by reference.
4.2 Indenture dated April 25, 1997, between Shurgard Storage Centers
Inc. ("Shurgard") and LaSalle National Bank, as Trustee.
Incorporated by reference to Exhibit 10 to the Quarterly Report on
Form 10-Q for the quarter ended March 31, 1997 filed by Shurgard
(SEC File No. 0-11455).
4.3 Supplemental Indenture dated July 11, 1997. Incorporated by
reference to Exhibit 4.4 to the Annual Report on Form 10-K for the
year ended December 31, 1997 filed by Shurgard
4.4 Form of 7(5)/8% Notes due 2007. Incorporated by reference to
Exhibit 4.2 to the Current Report on Form 8-K dated April 22, 1997
filed by Shurgard
4.5 Form of 7(3)/4% Notes due 2011. Incorporated by reference to
Exhibit 4.4 to the Registration Statement on Form S-4 filed on June
20, 2001 filed by Shurgard
4.6 Form of 5.875% Notes due 2013. Incorporated by reference to Exhibit
4.1 to the Current Report on Form 8-K dated March 20, 2003 filed by
Shurgard.
10.1. Deposit Agreement dated as of August 8, 2006 among Registrant and
Computershare Trust Company N.A. and the holders of depositary
receipts evidencing the Depositary Shares Each Representing 1/1,000
of a share of 7.25% Cumulative Preferred Stock, Series K. Filed
with Registrant's Registration Statement on Form 8-A relating to
the Depositary Shares Each Representing 1/1,000 of a Share of 7.25%
Cumulative Preferred Stock, Series K and incorporated herein by
reference.
10.2. Deposit Agreement dated as of October 20, 2006 among Registrant and
Computershare Trust Company N.A. and the holders of depositary
receipts evidencing the Depositary Shares Each Representing 1/1,000
of a share of 6.75% Cumulative Preferred Stock, Series L. Filed
with Registrant's Registration Statement on Form 8-A relating to
the Depositary Shares Each Representing 1/1,000 of a Share of 6.75%
Cumulative Preferred Stock, Series L and incorporated herein by
reference.
10.3. Senior Credit Agreement daed May 26, 2003, as amended by Amendment
Agreements dated July 11, 2003 and December 2, 2003, by and among
First Shurgard Sprl, First Shurgard Finance Sarl, First Shurgard
Deutschland GmbH, Societe Generale and others. Incorporated by
reference to Exhibit 10.1 filed with the Current Report on Form 8-K
dated February 21, 2005 filed by Shurgard Storage Centers, Inc.
("Shurgard")(SEC File No. 0-11455).
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10.4. Amendment and Waiver Agreement dated February 21, 2005 to the
Senior Credit Agreement dated May 26, 2003, as amended as of
December 2, 2003, by and among First Shurgard Sprl, First Shurgard
Finance Sarl, First Shurgard Deutschland GmbH, Societe Generale and
others. Incorporated by reference to Exhibit 10.2 filed with the
Current Report on Form 8-K dated February 21, 2005 filed by
Shurgard.
10.5. Credit Facility Agreement dated July 12, 2004, between Second
Shurgard SPRL, Second Shurgard Finance SARL, the Royal Bank of
Scotland as Mandated Lead Arranger, the Royal Bank of Scotland PLC
as Facility Agent. Incorporated by reference to Exhibit 10.43 filed
with the Report on Form 10-Q for the quarter ended June 30, 2004
filed by Shurgard.
10.6. Subscription Agreement dated October 11, 2004, among Self-Storage
Securitization B.V., Shurgard Self Storage SCA, et al and Citigroup
Global Markets Ltd. Incorporated by reference to Exhibit 10.1 filed
with the Current Report on Form 8-K dated October 15, 2004 filed by
Shurgard.
10.7. Trust Deed as of October 15, 2004, between Self-Storage
Securitisation B.V. and Citicorp Trustee Company Limited.
Incorporated by reference to Exhibit 10.1 filed with the Current
Report on Form 8-K dated October 21, 2004 filed by Shurgard.
10.8. Master Framework Agreement dated as of October 15, 2004 among
Self-Storage Securitisation B.V., Shurgard Self Storage SCA,
Citicorp Trustee Company Limited, Citibank, N.A., Citigroup Global
Markets Limited, Citibank International plc, Barclays Bank PLC and
the other parties named therein. Incorporated by reference to
Exhibit 10.2 filed with the Current Report on Form 8-K dated
October 21, 2004 filed by Shurgard.
10.9. Agency Agreement dated as of October 15, 2004, among Self-Storage
Securitisation B.V., Citicorp Trustee Company Limited, Citibank,
N.A. and Citibank International PLC. Incorporated by reference to
Exhibit 10.3 filed with the Current Report on Form 8-K dated
October 21, 2004 filed by Shurgard.
10.10. Issuer/Borrower Facility Agreement dated as of October 15, 2004,
among Shurgard Self Storage SCA, Self Storage Securitisation B.V.,
Citicorp Trustee Company Limited and the other parties named
therein. Incorporated by reference to Exhibit 10.4 filed with the
Current Report on Form 8-K dated October 21, 2004 filed by
Shurgard.
10.11. Liquidity Facility Agreement dated as of October 15, 2004, among
Self-Storage Securitisation B.V., Barclays Bank PLC, Citicorp
Trustee Company Limited and Shurgard Self Storage SCA. Incorporated
by reference to Exhibit 10.5 filed with the Current Report on Form
8-K dated October 21, 2004 filed by Shurgard.
10.12. Tax Deed of Covenant dated as of October 15, 2004, among Self
-Storage Securitisation B.V., Shurgard Self Storage SCA, Citigroup
Global Markets Limited, Citicorp Trustee Company Limited and the
other parties named therein. Incorporated by reference to Exhibit
10.6 filed with the Current Report on Form 8-K dated October 21,
2004 filed by Shurgard.
11 Statement Re: Computation of Earnings per Share. Filed herewith.
12 Statement Re: Computation of Ratio of Earnings to Fixed Charges.
Filed herewith.
31.1 Rule 13a-14(a)/15d-14(a) Certification of Chief Executive Officer.
Filed herewith.
31.2 Rule 13a-14(a)/15d-14(a) Certification of Chief Financial Officer.
Filed herewith.
32 Section 1350 Certification of Chief Executive Officer and Chief
Financial Officer. Filed herewith.
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