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, 2005
------------------
or
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from to .
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Commission File Number: 1-8389
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 an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
[X] Yes [ ] No
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 each of the issuer's classes of
common stock, as of November 7, 2005:
Common Stock, $.10 Par Value - 129,188,828 shares
Depositary Shares Each Representing 1/1,000 of a Share of Equity Stock, Series
A, $.01 Par Value - 8,744,193 depositary shares (representing 8,744.193 shares
of Equity Stock, Series A)
Equity Stock, Series AAA, $.01 Par Value - 4,289,544 shares
PUBLIC STORAGE, INC.
INDEX
Pages
PART I. FINANCIAL INFORMATION
---------------------
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
September 30, 2005 and December 31, 2004 1
Condensed Consolidated Statements of Income for the
Three and Nine Months Ended September 30, 2005 and 2004 2
Condensed Consolidated Statement of Shareholders' Equity
for the Nine Months Ended September 30, 2005 3
Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2005 and 2004 4 - 5
Notes to Condensed Consolidated Financial Statements 6 - 37
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 38 - 68
Item 2A. Risk Factors 68 - 73
Item 3. Quantitative and Qualitative Disclosures about Market Risk 73
Item 4. Controls and Procedures 74
PART II. OTHER INFORMATION (Items 3, 4 and 5 are not applicable)
-----------------
Item 1. Legal Proceedings 75
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 75
Item 6. Exhibits 75
PUBLIC STORAGE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
September 30, December 31,
2005 2004
--------------- --------------
(Unaudited)
ASSETS
Cash and cash equivalents.................................................... $ 531,774 $ 366,255
Real estate facilities, at cost:
Land...................................................................... 1,495,326 1,431,148
Buildings................................................................. 4,252,542 4,079,602
--------------- --------------
5,747,868 5,510,750
Accumulated depreciation.................................................. (1,449,887) (1,320,200)
--------------- --------------
4,297,981 4,190,550
Construction in process................................................... 50,899 47,277
Land held for development................................................. 8,404 8,883
--------------- --------------
4,357,284 4,246,710
Investment in real estate entities........................................... 333,482 341,304
Goodwill..................................................................... 78,204 78,204
Intangible assets, net....................................................... 99,732 104,685
Other assets................................................................. 71,152 67,632
--------------- --------------
Total assets................................................... $ 5,471,628 $ 5,204,790
=============== =============
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable................................................................ $ 115,060 $ 129,519
Debt to joint venture partner................................................ 35,654 16,095
Debt to related party (Note 9)............................................... 64,513 -
Preferred stock called for redemption........................................ - 54,875
Accrued and other liabilities................................................ 162,401 145,431
--------------- --------------
Total liabilities................................................... 377,628 345,920
Minority interest:
Preferred partnership interests........................................... 225,000 310,000
Other partnership interests............................................... 32,007 118,903
Commitments and contingencies (Note 14)...................................... - -
Shareholders' equity:
Cumulative Preferred Stock, $0.01 par value, 50,000,000 shares authorized,
1,699,236 shares issued (in series) and outstanding, (3,980,186 at
December 31, 2004) at liquidation preference............................ 2,520,900 2,102,150
Common Stock, $0.10 par value, 200,000,000 shares authorized 128,034,490
shares issued and outstanding (128,526,450 at December 31, 2004)........ 12,803 12,853
Equity Stock, Series A, $0.01 par value, 200,000,000 shares authorized,
8,744.193 shares issued and outstanding (8,776.102 at December 31, 2004) - -
Paid-in capital........................................................... 2,435,068 2,457,568
Cumulative net income..................................................... 3,065,894 2,732,873
Cumulative distributions paid............................................. (3,197,672) (2,875,477)
--------------- --------------
Total shareholders' equity.......................................... 4,836,993 4,429,967
--------------- --------------
Total liabilities and shareholders' equity..................... $ 5,471,628 $ 5,204,790
=============== ==============
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,
----------------------------- --------------------------
2005 2004 2005 2004
------------- --------------- ------------ ------------
Revenues:
Rental income:
Self-storage facilities......................................... $ 243,822 $ 219,743 $ 706,634 $ 638,520
Commercial properties........................................... 2,918 2,707 8,693 8,064
Containerized storage facilities................................ 4,480 5,048 12,305 15,099
Tenant reinsurance premiums......................................... 6,332 6,210 18,499 18,266
Interest and other income........................................... 7,376 3,300 16,698 7,240
------------- --------------- ------------ ------------
264,928 237,008 762,829 687,189
------------- --------------- ------------ ------------
Expenses:
Cost of operations:
Self-storage facilities......................................... 80,308 74,002 242,429 223,953
Commercial properties........................................... 1,122 1,031 3,292 3,200
Containerized storage facilities................................ 3,676 3,073 9,692 8,741
Tenant reinsurance.............................................. 3,017 4,204 7,560 11,089
Depreciation and amortization....................................... 47,917 44,354 144,136 135,447
General and administrative.......................................... 5,621 5,527 16,890 15,983
Interest expense, including amounts paid to related party (Note 9).. 2,471 - 5,928 100
------------- --------------- ------------ ------------
144,132 132,191 429,927 398,513
------------- --------------- ------------ ------------
Income from continuing operations before asset impairment charge, gain/
(loss)on disposition of real estate assets, equity in earnings of
real estate entities and minority interest in income.................. 120,796 104,817 332,902 288,676
Asset impairment charge due to casualty loss (Note 2).................... (196) (1,250) (196) (1,250)
Gain/(loss) on disposition of real estate assets......................... (142) 1,286 (89) 1,286
Equity in earnings of real estate entities (Note 5)...................... 9,853 3,184 20,382 11,646
Minority interest in income:
Preferred partnership interests:
Based on ongoing distributions.................................... (3,591) (5,176) (12,556) (16,907)
Special distribution and restructuring allocation (Note 9)........ - - (874) (10,063)
Other partnership interests......................................... (3,652) (4,345) (12,925) (12,928)
------------- --------------- ------------ ------------
Income from continuing operations........................................ 123,068 98,516 326,644 260,460
Discontinued operations (Note 3)......................................... 5,276 (1,001) 6,377 (1,518)
------------- --------------- ------------ ------------
Net income............................................................... $ 128,344 $ 97,515 $ 333,021 $ 258,942
============= =============== ============ ============
Net income allocation:
- ---------------------
Allocable to preferred shareholders:
Based on distributions paid...................................... $ 43,726 $ 40,471 $ 126,286 $ 117,293
Based on redemptions of preferred stock.......................... - 3,072 1,904 6,795
Allocable to Equity Stock, Series A................................. 5,356 5,375 16,087 16,126
Allocable to common shareholders.................................... 79,262 48,597 188,744 118,728
------------- --------------- ------------ ------------
$ 128,344 $ 97,515 $ 333,021 $ 258,942
============= =============== ============ ============
Net income per common share - basic
Continuing operations............................................... $ 0.58 $ 0.39 $ 1.42 $ 0.94
Discontinued operations (Note 3).................................... 0.04 (0.01) 0.05 (0.01)
------------- --------------- ------------ ------------
$ 0.62 $ 0.38 $ 1.47 $ 0.93
============= =============== ============ ============
Net income per common share - diluted
Continuing operations............................................... $ 0.58 $ 0.39 $ 1.41 $ 0.93
Discontinued operations (Note 3).................................... 0.04 (0.01) 0.05 (0.01)
------------- --------------- ------------ ------------
$ 0.62 $ 0.38 $ 1.46 $ 0.92
============= =============== ============ ============
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......................... 128,006 128,085 128,191 127,635
============= =============== ============ ============
Diluted weighted average common shares outstanding....................... 128,742 128,826 128,844 128,545
============= =============== ============ ============
Weighted average shares of Equity Stock, Series A (basic and diluted).... 8,744 8,776 8,755 8,776
============= =============== ============ ============
See accompanying notes.
2
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
--------------- -------------- ---------------- ---------------
Balances at December 31, 2004............................. $ 2,102,150 $ 12,853 $ 2,457,568 $ 2,732,873
Issuance of cumulative preferred stock:
Series D (5,400 shares).............................. 135,000 - (4,453) -
Series E (5,650 shares).............................. 141,250 - (4,649) -
Series F (8,000 shares).............................. 200,000 - (6,500) -
Redemption of cumulative preferred stock, including
redemption costs:
Series F (2,300,000 shares)............................ (57,500) - (17) -
Impact of EITF Topic D-42 on redemption of Series N and
Series O preferred units (Note 9)....................... - - 874 -
Issuance of common stock in connection with:
Exercise of employee stock options (201,457 shares).... - 20 6,604 -
Vesting of restricted stock (26,468 shares) ........... - 2 (2) -
Stock based compensation expense ......................... - - 1,750 -
Repurchase of common stock (84,000 shares)................ - (8) (4,982) -
Stock distribution from unconsolidated real estate entities
(635,885 common shares and 31,909 Equity Stock, Series A,
depositary shares) (Note 5)............................... - (64) (11,125) -
Net income................................................ - - - 333,021
Cash distributions:
Cumulative preferred stock (Note 10)................... - - - -
Equity Stock, Series A ($1.84 per depositary share).... - - - -
Common Stock ($1.40 per share)......................... - - - -
--------------- -------------- ---------------- ---------------
Balances at September 30, 2005............................ $ 2,520,900 $ 12,803 $ 2,435,068 $ 3,065,894
=============== ============== ================ ===============
PUBLIC STORAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Amounts in thousands, except share data)
(Unaudited)
Total
Cumulative Shareholders'
Distributions Equity
-------------- --------------
Balances at December 31, 2004............................. $ (2,875,477) $ 4,429,967
Issuance of cumulative preferred stock:
Series D (5,400 shares).............................. - 130,547
Series E (5,650 shares).............................. - 136,601
Series F (8,000 shares).............................. - 193,500
Redemption of cumulative preferred stock, including
redemption costs:
Series F (2,300,000 shares)............................ - (57,517)
Impact of EITF Topic D-42 on redemption of Series N and
Series O preferred units (Note 9)....................... - 874
Issuance of common stock in connection with:
Exercise of employee stock options (201,457 shares).... - 6,624
Vesting of restricted stock (26,468 shares) ........... - -
Stock based compensation expense ......................... - 1,750
Repurchase of common stock (84,000 shares)................ - (4,990)
Stock distribution from unconsolidated real estate entities
(638,885 common shares and 31,909 Equity Stock, Series A,
depositary shares) (Note 5)............................... - (11,189)
Net income................................................ - 333,021
Cash distributions:
Cumulative preferred stock (Note 10)................... (126,286) (126,286)
Equity Stock, Series A ($1.84 per depositary share).... (16,087) (16,087)
Common Stock ($1.40 per share)......................... (179,822) (179,822)
-------------- --------------
Balances at September 30, 2005............................ $ (3,197,672) $ 4,836,993
============== ==============
See accompanying notes.
3
PUBLIC STORAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
Nine Months Ended
September 30,
---------------------------------
2005 2004
---------------- --------------
Cash flows from operating activities:
Net income................................................................. $ 333,021 $ 258,942
Adjustments to reconcile net income to net cash provided by operating
activities:
Amortization of note premium (Note 7)................................... (774) -
Excess of effective interest over cash interest paid on Debt to JV Partner
(Note 8).............................................................. 362 -
Gain on sale of real estate assets...................................... (5,091) (1,286)
Real estate impairment associated with casualty losses (Note 4)......... 196 1,250
Depreciation and amortization........................................... 144,136 135,447
Equity in earnings of real estate entities.............................. (20,382) (11,646)
Distributions received from investments in real estate entities (Note 5) 17,015 15,863
Minority interest in income............................................. 26,355 39,898
Depreciation and other adjustments associated with discontinued operations
(Note 3) ............................................................. (1,055) 3,164
Other................................................................... 21,879 35,965
---------------- --------------
Total adjustments.............................................. 182,641 218,655
---------------- --------------
Net cash provided by operating activities.................. 515,662 477,597
---------------- --------------
Cash flows from investing activities:
Payment on note receivable due from PS Business Parks (Note 13)......... - 100,000
Capital improvements to real estate facilities.......................... (13,286) (20,297)
Net acquisition of investments included in other assets (Note 2)........ (7,960) (1,665)
Construction in process................................................. (46,039) (55,780)
Acquisition of minority interests (Note 9).............................. (92,815) (24,851)
Acquisition of real estate facilities................................... (124,753) (8,293)
Acquisition of investments in real estate entities...................... - (2,999)
Proceeds from disposition of real estate assets......................... 10,864 7,437
Other investments....................................................... - 2,384
---------------- --------------
Net cash used in investing activities...................... (273,989) (4,064)
---------------- --------------
Cash flows from financing activities:
Principal payments on notes payable..................................... (13,685) (40,770)
Net proceeds from the issuance of common stock.......................... 6,624 43,781
Net proceeds from the issuance of preferred stock....................... 460,648 476,234
Net proceeds from financing through joint venture (Note 8).............. 19,197 -
Repurchase of common stock.............................................. (4,990) (18,234)
Redemption of preferred units........................................... (85,000) -
Redemption of preferred stock........................................... (112,392) (316,311)
Distributions paid to shareholders...................................... (322,195) (305,893)
Distributions paid to holders of preferred partnership interests........ (12,556) (16,907)
Special distribution paid to holders of preferred partnership interests
(Note 9).............................................................. - (8,000)
Distributions paid to other minority interests.......................... (11,805) (16,986)
---------------- --------------
Net cash used in financing activities...................... (76,154) (203,086)
---------------- --------------
Net increase in cash and cash equivalents.................................... 165,519 270,447
Cash and cash equivalents at the beginning of the period..................... 366,255 204,833
---------------- --------------
Cash and cash equivalents at the end of the period........................... $ 531,774 $ 475,280
================ ==============
See accompanying notes.
4
PUBLIC STORAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
Supplemental schedule of non-cash investing and financial activities: Retirement
of Common Stock and Equity Stock, Series A, received as a distribution from
affiliated entities (Note 5):
Common Stock....................................................... $ (64) $ -
Additional Paid-in Capital......................................... (11,125) -
Investment in real estate entities................................. 11,189 -
Acquisition of minority interest in Consolidated Joint Venture in exchange
for debt (Note 9):
Minority Interest - other partnership interests.................... (62,643) -
Real estate facilities............................................. (43,290) -
Debt to related party.............................................. 64,513 -
See accompanying notes.
5
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
1. Description of the Business
---------------------------
Public Storage, Inc. (the "Company") 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,
usually on a month-to-month basis, for personal and business use. In
addition, to a much lesser extent, we have interests in commercial
properties, containing commercial and industrial rental space, and other
ancillary businesses including reinsurance of policies against losses to
goods stored by our self-storage tenants, retail sales, and portable
container storage.
We invest in real estate facilities by acquiring facilities
directly or by acquiring interest in real estate entities that own
facilities. At September 30, 2005, we had direct and indirect equity
interests in 1,487 self-storage facilities with approximately 91 million
net rentable square feet located in 37 states operating under the "Public
Storage" name. We also have direct and indirect equity interests in
approximately 19 million net rentable square feet of commercial and
industrial space located in 10 states.
2. Summary of Significant Accounting Policies
------------------------------------------
Basis of Presentation
---------------------
The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with United States generally
accepted accounting principles for interim financial information and with
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
primarily of normal recurring accruals) necessary for a fair presentation
have been included. Operating results for the three and nine months ended
September 30, 2005 are not necessarily indicative of the results that may
be expected for the year ended December 31, 2005. For further information,
refer to the consolidated financial statements and footnotes thereto
included in our annual report on Form 10-K for the year ended December 31,
2004.
The condensed consolidated financial statements include the
accounts of the Company and 36 controlled entities (the "Consolidated
Entities"). Collectively, the Company and the Consolidated Entities own a
total of 1,455 real estate facilities, consisting of 1,449 self-storage
facilities, three industrial facilities used by the containerized storage
operations and three commercial properties. All intercompany transactions
among the Company and the Consolidated Entities are eliminated in
consolidation.
At September 30, 2005, we had equity investments in eight limited
partnerships in which we do not have a controlling interest. These limited
partnerships collectively own 38 self-storage facilities, which are managed
by the Company. In addition, at September 30, 2005, we own approximately
44% of the common equity of PS Business Parks, Inc. ("PSB"), which has
interests in approximately 17.4 million net rentable square feet of
commercial space at September 30, 2005. We do not control these entities;
accordingly, our investment in these limited partnerships and PSB
(collectively, the "Unconsolidated Entities") are accounted for using the
equity method.
Certain amounts previously reported have been reclassified to
conform to the September 30, 2005 presentation, including discontinued
operations (see Note 3).
6
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
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.
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 generally 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 2005 and, accordingly, no provision for income taxes has been made
in the accompanying financial statements.
Financial Instruments
---------------------
The methods and assumptions used to estimate the fair value of
financial instruments are described below. 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 condensed consolidated balance sheets are reasonable
estimates of fair value. The carrying amounts of notes payable approximate
fair value because the aggregate applicable interest rate approximates
current market rates for similar loans and because the relatively short
time until maturity reduces the effect of differing interest rates.
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, 2005 is
$16,424,000 ($1,984,000 at December 31, 2004) in cash held by our captive
insurance programs. Insurance and other regulations place significant
restrictions on our ability to withdraw these funds for purposes other than
insurance activities. Our captive insurance programs are conducted by (i)
STOR-Re Mutual Insurance Company, Inc. ("STOR-Re"), an association captive
insurance company owned by the Company and its affiliates, which is
7
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
approximately 90.1% owned by the Company and the Consolidated Entities, and
(ii) PS Insurance Company Hawaii, Ltd. ("PSIC-H"), a captive insurer formed
on December 31, 2003 which is wholly owned by a subsidiary of the Company.
Other assets at September 30, 2005 include aggregate investments totaling
$20,059,000 ($20,929,000 at December 31, 2004) in held to maturity debt
securities owned by STOR-Re and PSIC-H stated at amortized cost, which
approximates fair value.
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 are
charged to expense as incurred. Depreciation is computed using the
straight-line method over the estimated useful lives of the buildings and
improvements, which are generally from 5 to 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 $125.0 million
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 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
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 income statement. See Note 5 for further discussion of
these amounts.
In December 2004, we sold seven facilities that we had recently
acquired to the Acquisition Joint Venture for an aggregate of $22,993,000
representing our original cost. During the first quarter of 2005, we sold
an interest in three additional facilities that we had recently acquired
for aggregate proceeds of $27,424,000, representing the Acquisition Joint
Venture's acquired share of our original cost. Due to our continuing
interest in these facilities and our option to acquire our partner's
investment, as described above in year five, we are precluded from treating
these transactions as completed sales of facilities pursuant to Statement
of Financial Accounting Standards No. 66, "Accounting for Sales of Real
Estate" ("SFAS 66"). Therefore, we continue to reflect these properties and
associated operations on our condensed consolidated financial statements.
We believe that it is likely that we will exercise our option to
acquire our partner's interest and, accordingly, we consider the
transactions to be, in substance, debt financing. Our partner's 70%
investment in the Acquisition Joint Venture with respect to the ten
properties is therefore reflected as a liability on our condensed
consolidated balance sheet, "Debt to Joint Venture Partner," with our
partner's share of operations (an 8.5% return on their investment)
reflected on our condensed consolidated income statement as interest
expense. The balance of the liability is adjusted each quarter to equal the
current value to the extent fair value exceeds the original liability. See
Note 8 for a further discussion of these debt amounts.
8
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
Evaluation of Asset Impairment
------------------------------
With respect to goodwill, we evaluate impairment 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, 2004.
With respect to other long-lived assets, we evaluate such assets
on a quarterly basis. We first evaluate these assets for indications 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.
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 additional impairments were identified
from our evaluations as of September 30, 2005, except as noted under
"Accounting for Casualty Losses" below.
Accounting for Casualty Losses
------------------------------
It is our policy to record as a casualty loss or gain, in the
period the casualty occurs, the differential between a) the book value of
assets destroyed and b) any insurance proceeds that we expect to receive in
accordance with our insurance contracts. Potential proceeds from insurance
that are subject to any uncertainties, such as interpretation of deductible
provisions of the governing agreements, the estimation of costs of
restoration, or other such items, are treated as a contingent proceeds in
accordance with Statement of Financial Accounting Standards No. 5 ("SFAS
5"), and not recorded until the uncertainties are satisfied.
In the quarter ended September 30, 2005, several of our real
estate assets located in New Orleans and Florida were damaged as a result
of a hurricane. We have estimated that the costs to restore these
facilities will approximate $6.2 million. We have third-party insurance,
subject to certain deductibles, that covers restoration of physical damage
and the loss of income occasioned by physical damage to our facilities. We
expect our insurers to pay approximately $2,764,000 of the physical damage,
and the net book value of the assets destroyed was approximately
$2,960,000. Accordingly, we have recorded a casualty loss in the amount of
$196,000 in the quarter ended September 30, 2005. No income from business
interruption proceeds has been recorded during the quarter ended September
30, 2005, as specific deductible limits have not yet been reached based
upon losses to date. We recorded a similar loss in the quarter ended
September 30, 2004 amounting to $1,250,000, representing the net book value
of the assets destroyed (there were no insurance proceeds).
These amounts are based upon estimates and are subject to change
as we and our insurers (i) more fully evaluate the extent of physical
9
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
damage, which may not be fully determinable until commencement of repairs,
(ii) develop detailed restoration plans and (iii) evaluate the impact of
local conditions in the building labor and supplies markets on restoration
costs.
Accounting for Stock-Based Compensation
---------------------------------------
We utilize the Fair Value Method (as defined in Note 12) of
accounting for our employee stock options issued after December 31, 2001,
and utilize the APB 25 Method (as defined in Note 12) for employee stock
options issued prior to January 1, 2002. Restricted Stock Unit expense is
recorded over the relevant vesting period. See Note 12 for a full
discussion of our accounting policies with respect to employee stock
options and restricted stock units.
Other Assets
------------
Other assets primarily consist of containers and equipment
associated with the containerized storage operations, assets associated
with the truck rental business, accounts receivable, prepaid expenses and
investments held by STOR-Re and PSIC-H (discussed below). Accounts
receivable from customers are net of allowances for doubtful accounts.
Containers and equipment utilized in our containerized storage
business totaled $1,333,000 at September 30, 2005 ($4,395,000 at December
31, 2004). The carrying amounts are net of accumulated depreciation and
asset impairment charges. No impairment charges were recorded during the
three and nine months ended September 30, 2005 with respect to containers
and equipment utilized in the discontinued containerized storage
operations.
Included in depreciation and amortization expense for the three
and nine months ended September 30, 2005 is $1,376,000 and $5,159,000,
respectively, related to other assets, as compared to $1,852,000 and
$5,533,000 for the same period in 2004. Included in discontinued operations
for the three and nine months ended September 30, 2004 is depreciation
expense of $216,000 and $722,000, respectively, and $29,000 for the nine
months ended September 30, 2005 with respect to other assets (none for the
three months ended September 30, 2005).
Other assets at September 30, 2005 include aggregate investments
totaling $20,059,000 ($20,929,000 at December 31, 2004) in held to maturity
securities owned by STOR-Re and PSIC-H stated at amortized cost, which
approximates fair market value.
Accrued and Other Liabilities
-----------------------------
Accrued and other liabilities consist primarily of trade payables,
real and personal property tax accruals, prepayments of rents, accrued
interest, and losses and loss adjustment liabilities from our insurance
programs, as discussed below. Prepaid rent totals $25,551,000 and
$26,289,000 at September 30, 2005 and December 31, 2004, respectively.
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. The methods for making such estimates
and for establishing the resulting liability are continually reviewed.
10
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
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 PSIC-H with
respect to these insurance activities for policy periods following April 1,
2004. The Company also utilizes 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 14. STOR-Re and PSIC-H
accrue liabilities for estimated covered losses and loss adjustment
expense, which at September 30, 2005 totaled $33,596,000 ($34,192,000 at
December 31, 2004) with respect to insurance provided to the Company and
its affiliates.
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 April
1, 2004. PSIC-H succeeded PSIC with respect to these tenant insurance
activities effective April 1, 2004, and 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. Losses below the third-party
insurers' deductible amounts are accrued as cost of operations for the
tenant insurance operations.
We recorded approximately $500,000 in accrued losses with respect
to estimated insured tenant claims as a result of damage sustained as a
result of hurricanes which occurred in the third quarter of 2005, and
$1,500,000 during the quarter ended September 30, 2004 as a result of
hurricanes occurring in that quarter. In the second quarter of 2005, we
adjusted our estimate and reversed $500,000 of the amount accrued at
September 30, 2004 based upon historical trends and lapse of time.
The accrued liability for losses and loss adjustment expense with
respect to tenant insurance activities totaled $3,575,000 at September 30,
2005 ($4,898,000 at December 31, 2004), which includes the remaining future
estimated payments for tenant claims resulting from the aforementioned
hurricanes.
Intangible Assets and Goodwill
------------------------------
Intangible assets consist of property management contracts
($165,000,000) and the excess of acquisition cost over the fair value of
net tangible and identifiable intangible assets or "goodwill" ($94,719,000)
acquired in business combinations. Our goodwill has an indeterminate life
and, accordingly, is not amortized. Our other intangibles have a defined
life and are amortized on a straight-line basis over a 25-year period.
Goodwill is net of accumulated amortization of $16,515,000 at
September 30, 2005 and December 31, 2004. At September 30, 2005, property
management contracts are net of accumulated amortization of $65,268,000
($60,315,000 at December 31, 2004). Included in depreciation and
amortization expense for each of the three and nine month periods ended
September 30, 2005 and 2004 is $1,651,000 and $4,953,000, respectively,
with respect to the amortization of property management contracts.
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 rental
income when collected. Tenant reinsurance premiums are recognized as
premium revenue when collected. 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 real
estate entities.
11
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
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 expense
totaled $7,486,000 and $24,049,000 for the three and nine months ended
September 30, 2005 and $5,012,000 and $18,620,000 for the same periods in
2004, respectively.
Environmental Costs
-------------------
Our policy is to accrue environmental assessments and/or
remediation cost when it is probable that such efforts will be required and
the related cost 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 to 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 $43,726,000 and $40,471,000 for the three months ended
September 30, 2005 and 2004, respectively, have been deducted from net
income to arrive at net income allocable to our common shareholders
(dividends to Preferred Stock were $126,286,000 and $117,293,000 for the
nine months ended September 30, 2005 and 2004, 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 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.
In conformity with the SEC Observer's clarification, an additional
$3,072,000 and $6,795,000 was allocated to preferred stockholders for the
three and nine months ended September 30, 2004, respectively, as compared
to $1,904,000 for the nine months ended September 30, 2005 (none for the
three months ended September 30, 2005) for the excess of the redemption
amount over the carrying amount of our Cumulative Preferred Stock. It is
our policy to record such allocations at the time the securities are called
for redemption.
Net income allocated to our common shareholders has been further
allocated between 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 $5,375,000 for the three months
ended September 30, 2005 and 2004, respectively, and $16,087,000 and
$16,126,000 for the nine months ended September 30, 2005 and 2004,
respectively. The remaining $79,262,000 and $48,597,000 for the three
months ended September 30, 2005 and 2004, respectively, was allocated to
the regular common shareholders ($188,744,000 and $118,728,000,
respectively, for the nine months ended September 30, 2005 and 2004).
12
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
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). Weighted average common shares excludes shares owned by
the Consolidated Entities as described in Note 10 for all periods
presented, as these shares of common stock are eliminated in consolidation.
3. 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.
During 2002, 2003, and 2004, 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. With respect to facilities closed during 2004 asset
impairment charges totaling $1,406,000 and $1,575,000 were recorded for the
three and nine months ended September 30, 2004. In addition, lease
termination charges totaling $416,000 were recorded in the nine months
ended September 30, 2004. No asset impairment or lease termination charges
were recorded in the three or nine month periods in 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 (the "Eminent Domain Facility"). We received the proceeds,
totaling $6.6 million, from the disposal of this facility during the third
quarter of 2005 and recorded a gain of $5.2 million. The operations of this
facility prior to its disposition, and the gain on disposition were
classified as "discontinued operations" for all periods presented on our
September 30, 2005 income statement and included under the "Eminent Domain
Facility" in the table below.
During the fourth quarter of 2004, we sold a commercial property
(the "Sold Commercial Facility") to a third party and recorded a gain on
sale of $971,000. The historical operating results of this facility are
reported as discontinued operations, and are presented in the table below
as the "Sold Commercial Facility."
The following table summarizes the historical operations of each
component of our discontinued operations:
13
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
DISCONTINUED OPERATIONS:
- ------------------------
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------- ----------------------
2005 2004 2005 2004
---------- --------- ---------- ---------
(Amounts in thousands)
Rental income (a):
Closed Facilities............... $ - $ 1,740 $ 95 $ 6,267
Eminent Domain Facility......... 161 165 461 505
Sold Commercial Facility........ - 105 - 279
---------- --------- ---------- ---------
Total rental income............... 161 2,010 556 7,051
---------- --------- ---------- ---------
Cost of operations (a):
Closed Facilities............... - (1,154) (194) (5,176)
Eminent Domain Facility......... (45) (73) (220) (166)
Sold Commercial Facility........ - (26) - (63)
---------- --------- ---------- ---------
Total cost of operations.......... (45) (1,253) (414) (5,405)
---------- --------- ---------- ---------
Depreciation expense (a):
Closed Facilities............... - (306) (29) (1,031)
Eminent Domain Facility......... (20) (21) (59) (68)
Sold Commercial Facility........ - (25) - (74)
---------- --------- ---------- ---------
Total depreciation ............... (20) (352) (88) (1,173)
Other items (b)................... 5,180 (1,406) 6,323 (1,991)
---------- --------- ---------- ---------
Net discontinued operations (c)... $ 5,276 $(1,001) $ 6,377 $ (1,518)
========== ========= ========== =========
(a) These amounts represent the historical operations of the Closed
Facilities, the Eminent Domain Facility and the Sold Commercial
Facility, 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, 2005, we recorded a
gain totaling $5,180,000 in connection with the Eminent Domain Facility
(see Note 4). Also, for 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. Shutdown expenses for the
nine months ended September 30, 2004 were $1,991,000, including
$1,575,000 in asset impairment charges and $416,000 in lease
termination expenses recorded with respect to the Closed Facilities.
(c) Earnings per share increased by $0.04 and $0.05 per share for the three
and nine months ended September 30, 2005, respectively, as compared to
a decrease of $0.01 per share for each of the same periods in 2004, due
to the impact from discontinued operations.
14
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
4. Real Estate Facilities
----------------------
Activity in real estate facilities is as follows:
Nine Months Ended
September 30, 2005
------------------
(In thousands)
Operating facilities, at cost:
Balance at December 31, 2004........................ $ 5,510,750
Newly developed facilities opened for operations.... 41,848
Acquisition of real estate facilities............... 124,753
Acquisition of minority interest (Note 9)........... 69,312
Assets damaged by hurricane (Note 2)................ (4,230)
Dispositions (including Eminent Domain Facility
discussed in Note 3).............................. (7,851)
Capital improvements................................ 13,286
------------------
Balance at September 30, 2005....................... 5,747,868
------------------
Accumulated depreciation:
Balance at December 31, 2004........................ (1,320,200)
Additions........................................... (134,083)
Assets damaged by hurricane (Note 2)................ 1,270
Dispositions (including Eminent Domain Facility
discussed in Note 3).............................. 3,126
------------------
Balance at September 30, 2005....................... (1,449,887)
------------------
Construction in process:
Balance at December 31, 2004........................ 47,277
Current development................................. 46,039
Transfer to land held for development............... (569)
Newly developed facilities opened for operations.... (41,848)
------------------
Balance at September 30, 2005....................... 50,899
------------------
Land held for development:
Balance at December 31, 2004........................ 8,883
Dispositions........................................ (1,048)
Transfer from construction in process............... 569
------------------
Balance at September 30, 2005....................... 8,404
------------------
Total real estate at September 30, 2005................ $ 4,357,284
==================
During the nine months ended September 30, 2005, we opened three
newly developed self-storage facilities (259,000 net rentable square feet)
for an aggregate cost of $15,983,000. We also completed six projects which
converted space previously used by our containerized storage business into
324,000 net rentable square feet of self-storage space for an aggregate
cost of $12,696,000. In addition, we completed three expansion projects to
existing self-storage facilities adding 117,000 net rentable square feet
for an aggregate of $13,026,000, and we incurred trailing development costs
with respect to development projects completed in prior years, for an
aggregate net cost of $143,000.
During the nine months ended September 30, 2005, we disposed of
various parcels of land for an aggregate of $4,274,000, recording a loss on
sale of approximately $89,000. In addition, we disposed of a facility in
connection with an eminent domain proceeding, for an aggregate of
$6,590,000 recording a gain on sale of $5,180,000, which is included in
Discontinued Operations (see also Note 3).
15
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
During the nine months ended September 30, 2005, we acquired 21
self-storage facilities from third parties at an aggregate cost of
$124,753,000 in cash (1,469,000 net rentable square feet).
Construction in process at September 30, 2005 consists primarily
of seven self-storage facilities (579,000 net rentable square feet) with
costs incurred of $37,009,000 at September 30, 2005 and total estimated
costs of $80,973,000, 38 projects (2,309,000 net rentable square feet)
which expand or enhance the visual and structural appeal of our existing
self-storage facilities with cost incurred of $10,011,000 at September 30,
2005 and total estimated costs of $177,127,000, and 12 projects (926,000
net rentable square feet) to convert space at former containerized storage
facilities into self-storage space with cost incurred of $3,879,000 at
September 30, 2005 and total estimated costs of $33,168,000. In addition,
we have five parcels of land held for development with total costs of
approximately $8,404,000.
Our policy is to capitalize interest incurred on debt during the
course of construction of our self-storage facilities. Interest capitalized
during the three and nine months ended September 30, 2005 was $710,000 and
$2,054,000, respectively. Interest capitalized for the three and nine
months ended September 30, 2004 was $685,000 and $2,722,000, respectively.
5. Investment in Real Estate Entities
----------------------------------
At September 30, 2005, our investments in real estate entities
consist of ownership interests in eight partnerships, which principally own
self-storage facilities, and our ownership interest in PSB. 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 partnerships. The accounting
policies of these entities are similar to the Company's.
We received cash distributions from our investments for the nine
months ended September 30, 2005 and 2004, in the amount of $17,015,000 and
$15,863,000, respectively. In addition, during the nine months ended
September 30, 2005, we received a distribution from affiliated entities of
635,885 shares of our common stock and 31,909 depositary shares of our
Equity Stock, Series A, with an aggregate book value of $11,189,000.
The following table sets forth our investments in real estate
entities at September 30, 2005 and December 31, 2004, an our equity in
earnings of real estate entities for the three an nine months ended
September 30, 2005 and 2004 (amounts in thousands):
Equity in Earnings of Real Equity in Earnings of Real
Investments in Real Estate Estate Entities for the Estate Entities for the Nine
Entities at Three Months Ended September 30, Months Ended September 30,
-------------------------------- -------------------------------- ----------------------------
September 30, December 31,
2005 2004 2005 2004 2005 2004
-------------- -------------- --------------- -------------- ------------ ------------
PSB (a)....................... $ 289,457 $ 284,564 $ 8,251 $ 1,567 $ 15,829 $ 7,263
Acquisition Joint Venture..... 2,844 2,857 7 (10) (13) (10)
Other Investments ............ 41,181 53,883 1,595 1,627 4,566 4,393
-------------- -------------- --------------- -------------- ------------ ------------
Total....................... $ 333,482 $ 341,304 $ 9,853 $ 3,184 $ 20,382 $ 11,646
============== ============== =============== ============== ============ ============
(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
of these items resulted in an increase of equity in earnings of $5,458,000
and $7,033,000 for the three and nine months ended September 30, 2005,
respectively, as compared to a decrease in equity in earnings of $1,092,000
and $2,109,000 for the three and nine months ended September 30, 2004,
respectively.
16
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
Investment in PS Business Parks, Inc.
-------------------------------------
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, 2005. 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, 2005 and December 31, 2004; 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, 2005 ($45.80 per common share of PSB stock), the shares and
units had a market value of approximately $582.7 million as compared to a
book value of $289.5 million.
At September 30, 2005, PSB wholly owned approximately 17.4 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 each of the nine month periods ended September 30, 2005 and
2004 (as restated for discontinued operations), and the condensed balance
sheets of PSB at September 30, 2005 and December 31, 2004. The amounts
below represent 100% of PSB's balances and our pro rata share.
Nine Months Ended September 30,
-----------------------------------
2005 2004
---------------- ---------------
(Amounts in thousands)
Total revenue.................................... $ 164,305 $ 157,020
Cost of operations and general and administrative (53,011) (50,176)
Other income and expense, net.................... 1,914 (2,400)
Depreciation and amortization.................... (56,283) (51,862)
Discontinued operations (a)...................... 14,615 3,509
Minority interest (b)............................ (12,423) (20,472)
---------------- ---------------
Net income..................................... $ 59,117 $ 35,619
================ ===============
September 30, December 31,
2005 2004
---------------- ---------------
(Amounts in thousands)
Total assets (primarily real estate)............. $ 1,440,283 $ 1,363,829
Total debt....................................... 11,055 11,367
Other liabilities................................ 37,947 38,453
Preferred equity and preferred minority interest. 709,100 638,600
Common equity and common minority interest....... 682,181 675,409
(a) Included in discontinued operations for the nine months ended September 30,
2005 is a net gain on disposition of real estate of $16,529,000 as compared
to $145,000 for the same period in 2004.
(b) Minority interest for the nine months ended September 30, 2005 and 2004
includes $301,000 and $3,139,000, respectively, in EITF Topic D-42 charges
related to PSB's redemption of preferred units.
17
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
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 for the purpose of acquiring up to $125 million
in existing self-storage facilities from third parties. 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 Nine Months Ended
September 30, 2005 September 30, 2004
-------------------- --------------------
(Amounts in thousands)
Total revenue........................................ $ 961 $ 133
Other expenses, principally cost of operations....... (364) (72)
Depreciation and amortization........................ (202) (31)
-------------------- --------------------
Net income......................................... $ 395 $ 30
==================== ====================
At September 30, At December 31,
2005 2004
-------------------- --------------------
(Amounts in thousands)
Total assets (primarily self-storage facilities)..... $ 9,065 $ 9,168
Liabilities.......................................... 77 11
Partners' equity..................................... 8,988 9,157
Other Investments
-----------------
During the nine months ended September 30, 2005 we had an average
common equity ownership of approximately 40% in seven limited partnerships
(collectively, the "Other Investments") owning an aggregate of 36 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:
Nine Months Ended September 30,
--------------------------------
2005 2004
--------------- -------------
(Amounts in thousands)
Total revenue........................................ $ 21,936 $ 21,089
Other expenses, principally cost of operations....... (7,241) (7,170)
Depreciation and amortization........................ (1,554) (1,781)
--------------- -------------
Net income......................................... $ 13,141 $ 12,138
=============== =============
September 30, December 31,
2005 2004
-------------- -------------
(Amounts in thousands)
Total assets (primarily self-storage facilities)..... $ 50,037 $ 58,124
Other liabilities.................................... 2,256 1,853
Partners' equity..................................... 47,781 56,271
18
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
6. 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
million, that has a maturity date of April 1, 2007 and bears an annual
interest rate ranging from the London Interbank Offered Rate ("LIBOR") plus
0.45% to LIBOR plus 1.20% depending on our credit ratings (currently LIBOR
plus 0.45%). 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, 2005. At September 30,
2005 and at November 8, 2005, we had no outstanding borrowings on our line
of credit.
At September 30, 2005 and November 8, 2005, we had undrawn standby
letters of credit totaling $18,693,000. The beneficiaries of these standby
letters of credit were certain insurance companies associated with our
captive insurance and tenant insurance activities.
7. Notes Payable
-------------
Notes payable at September 30, 2005 and December 31, 2004 consist
of the following:
Carrying Amount
-------------------------------
September 30, December 31,
2005 2004
--------------- --------------
(Amounts in thousands)
Unsecured senior notes:
7.66% note due January 2007............................. $ 22,400 $ 33,600
Mortgage notes payable:
7.134% and 8.75% mortgage notes secured by two real estate
facilities with a net book value of $10.9 million, principal
and interest payable monthly, due at varying dates between
October 2009 and September 2028......................... 1,514 1,629
5.05% mortgage notes (including unamortized note premium of
$2.0 million)secured by 25 real estate facilities with a net
book value of $96.5 million,principal and interest due
monthly, due at varying dates between October 2010 and
May 2023.................................................... 39,307 41,470
5.25% mortgage notes (including unamortized note premium of
$3.6 million) secured by seven real estate facilities with a
net book value of $90.5 million, principal and interest due
monthly, due at varying dates between June 2011 and
July 2013 .............................................. 51,839 52,820
--------------- --------------
Total notes payable.............................. $ 115,060 $ 129,519
=============== ==============
All of our notes payable are fixed rate. The unsecured senior
notes require interest and principal payments to be paid semi-annually and
have various restrictive covenants, all of which have been met at September
30, 2005.
19
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
We assumed the 5.05% and 5.25% mortgage notes in connection with
property acquisitions in 2004. The stated interest rates on the notes range
from 5.4% to 8.1% with a weighted average of approximately 6.65%. The notes
were recorded at their estimated fair value based upon the estimated market
rate upon assumption of 5.05% and 5.25%, an aggregate of approximately
$94,693,000, as compared to actual assumed balances aggregating
approximately $88,247,000. This premium of approximately $6,446,000 over
the principal balance of the notes payable is amortized over the remaining
term of the loans based upon the effective interest method. During the nine
months ended September 30, 2005, we incurred $5,011,000 in interest expense
on these notes, comprised of $5,785,000 in cash less $774,000 in
amortization of premium.
At September 30, 2005, approximate principal maturities of notes
payable are as follows:
Unsecured Mortgage
Senior Notes Notes Total
-------------- ------------ ----------
(Amounts in thousands)
2005 (remainder of).......... $ - $ 893 $ 893
2006......................... 11,200 4,539 15,739
2007......................... 11,200 4,783 15,983
2008......................... - 5,034 5,034
2009......................... - 5,213 5,213
Thereafter................... - 72,198 72,198
-------------- ------------ ----------
$ 22,400 $ 92,660 $ 115,060
============== ============ ==========
Weighted average rate........ 7.7% 5.2% 5.7%
============== ============ ==========
8. Debt to Joint Venture Partner
-----------------------------
As described more fully in Note 2, we accounted for facilities
sold to our Acquisition Joint Venture as financing transactions pursuant to
SFAS 66. As a result, the fair value of our partner's interest in these
facilities ($35,654,000 at September 30, 2005 and $16,095,000 at December
31, 2004) is accounted for as debt on our condensed consolidated balance
sheets.
On December 31, 2004, we sold seven self-storage facilities that
we had acquired in 2004 from third parties to our Acquisition Joint Venture
for $22,993,000, an amount that was equal to fair value and our cost; this
transaction increased Debt to Joint Venture Partner by $16,095,000.
On January 14, 2005, we sold an interest in three additional
facilities we had recently acquired for an aggregate amount of $27,424,000,
an amount equal to the acquired pro rata share of cost and market value;
this transaction increased the Debt to Joint Venture Partner by
$19,197,000, representing our Joint Venture Partner's interest in the
acquisition.
A total of $2,182,000 was recorded as interest expense on our
consolidated income statement with respect to our Debt to Joint Venture
Partner during the nine months ended September 30, 2005, 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);
a total of $1,820,000 was 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, 2005, with the debt balance increasing
$362,000.
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.
20
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
9. Minority Interest and Debt to Related Party
-------------------------------------------
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 or,
when such ownership interests represent liabilities, as debt. Minority
interest in income consists of the minority interests' share of the
operating results of the Consolidated Entities.
Preferred Partnership Interests
-------------------------------
The following table summarizes the preferred partnership units
outstanding at September 30, 2005 and December 31, 2004:
At September 30, 2005 At December 31, 2004
----------------------------- --------------------------
Earliest Distribution Units Carrying Units Carrying
Series Redemption Date (a) Rate Outstanding Amount Outstanding Amount
- -------------- ------------------- ------------ ----------- ------------- ----------- -----------
(Amounts in thousands)
Series N...... March 17, 2005 (b) 9.500% - $ - 1,600 $ 40,000
Series NN..... March 17, 2010 6.400% 8,000 200,000 8,000 200,000
Series O...... March 29, 2005 (b) 9.125% - - 1,800 45,000
Series Z...... October 12, 2009 6.250% 1,000 25,000 1,000 25,000
----------- ------------- ----------- -----------
9,000 $ 225,000 12,400 $ 310,000
=========== ============= =========== ===========
(a) After these dates, at our option, we can call the units for redemption at
the issuance amount plus any unpaid distributions. The units are not
redeemable by the holder with the exception of the Series Z units. The
holders of the Series Z units have a one-time option, exercisable five
years from issuance, to require us to redeem their units for $25,000,000
cash plus unpaid and accrued distributions.
(b) On March 17, 2005 we redeemed all outstanding Series N Preferred Units
($40,000,000) and on March 29, 2005, we redeemed all outstanding Series O
Preferred Units ($45,000,000), at their carrying amount plus accrued
distributions.
Income allocated to the preferred minority interests totaled
$3,591,000 and $13,430,000 for the three and nine months ended September
30, 2005, respectively, as compared to $5,176,000 and $26,970,000 for the
same periods in 2004, respectively, comprised of distributions paid and the
allocation of income resulting from the application of EITF Topic D-42.
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.
On March 22, 2004, certain investors who held $200 million of our
9.5% Series N Cumulative Redeemable Perpetual Preferred Units agreed, in
exchange for a special distribution of $8,000,000, to exchange their 9.5%
Series N Cumulative Redeemable Perpetual Preferred Units for $200 million
of our 6.4% Series NN Cumulative Redeemable Perpetual Preferred Units. The
investors also received a distribution for dividends that accrued from
January 1, 2004 through the effective date of the exchange.
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 during the three months ended March 31, 2005 of $874,000 as a result
21
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
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. During the first
quarter of 2004, income allocated to minority interests was increased by
$10,063,000 from (i) the special distribution to the holders of the
preferred units ($8,000,000) and (ii) the application of the SEC's
clarification of EITF Topic D-42 ($2,063,000).
Subject to certain conditions, the Series NN preferred units are
convertible into shares of our 6.400% Series NN Cumulative Preferred Stock
and the Series Z preferred units are convertible into shares of our 6.250%
Series Z Cumulative Preferred Stock. The holders of the Series Z units have
a one-time option, exercisable five years from issuance, to require us to
redeem their units for $25,000,000 cash plus unpaid and accrued
distributions.
Other Partnership Interests
---------------------------
The following table sets forth the minority interests at September
30, 2005 and December 31, 2004 (amounts in thousands):
Minority Interest at
-----------------------------
September 30, December 31,
Description 2005 2004
- ---------------------------------------- ------------- ------------
Consolidated Development Joint Venture... $ - $ 64,297
Convertible Partnership Units........... 6,177 6,160
Other consolidated partnerships.......... 25,830 48,446
------------- ------------
Total other partnership interests........ $ 32,007 $ 118,903
============= ============
Income is allocated to the minority interests based upon their pro
rata interest in the operating results of the Consolidated Entities. The
following table sets forth minority interest in income with respect to the
other partnership interests for the three and nine months ended September
30, 2005 and 2004 (amounts in thousands):
Minority Interest in Income for the Minority Interest in Income for the
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------------------- -----------------------------------
Description 2005 2004 2005 2004
- ------------------------------------------- --------------- ---------------- -------------- ---------------
Consolidated Development Joint Venture...... $ 826 $ 1,563 $ 4,229 $ 3,940
Convertible Partnership Units............... 148 88 350 219
Other Consolidated Partnerships............. 2,678 2,694 8,346 8,769
--------------- ---------------- -------------- ---------------
Total other partnership interests........... $ 3,652 $ 4,345 $ 12,925 $ 12,928
=============== ================ ============== ===============
Distributions paid to minority interests with respect to the other
partnership interests for the nine months ended September 30, 2005 and 2004
were $11,805,000 and $16,986,000, respectively.
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") whose partners included a third party
institutional investor and B. Wayne Hughes ("Mr. Hughes"), the Company's
chairman, to develop approximately $100 million of self-storage facilities
and to purchase $100 million of our Equity Stock, Series AAA (see Note 10).
At September 30, 2005, the Consolidated Development Joint Venture owned 22
self-storage facilities that it had developed for a total cost of $108.6
million.
22
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
The Consolidated Development Joint Venture is funded solely with
equity capital consisting of 51% from us and 49% from PSAC Storage
Investors, LLC. The accounts of the Consolidated Development Joint Venture
have been included in our condensed consolidated financial statements since
its formation. Prior to September 30, 2005, minority interests on our
condensed consolidated balance sheet primarily represents the total
contributions received from PSAC Storage Investors, LLC combined with the
accumulated net income allocated to PSAC Storage Investors, LLC, net of
cumulative distributions.
PSAC Storage Investors, LLC provides Mr. Hughes with a fixed yield
of approximately 7.9972% per annum on his preferred non-voting interest
(representing an investment of approximately $64.1 million at September 30,
2005). In addition, Mr. Hughes receives 1% of the remaining cash flow of
PSAC Storage Investors, LLC (estimated to be less than $50,000 per year).
Since its formation through August 4, 2005, the accounts of PSAC Storage
Investors, LLC were not included in our consolidated financial statements.
On August 5, 2005 we acquired the third party institutional
investor's partnership interest in PSAC Storage Investors, LLC for
approximately $41.4 million in cash, and commenced consolidating the
accounts of PSAC Storage Investors, LLC. This acquisition also gave us an
option to acquire Mr. Hughes' interest in PSAC Storage Investors, LLC. We
have exercised this option and will acquire Mr. Hughes' interest on
November 17, 2005 for an aggregate of $64.5 million in cash. The amounts
owed to Mr. Hughes with respect to his preferred non-voting interest are
reflected on our balance sheet as "Debt to related party," and the
preferred return that he accrued from August 5, 2005 through September 30,
2005 amounting to $789,000 is reflected on our income statement as interest
expense. This debt will be extinguished on November 17, 2005 when we
acquire his interest.
The total acquisition cost of the August 5, 2005 transaction was
$105,933,000, comprised of the $41,420,000 in cash paid to the third-party
institutional investor and $64,513,000 in debt to Mr. Hughes. The total
acquisition cost was allocated to minority interest ($62,643,000) and real
estate ($43,290,000).
In consolidation, the Equity Stock, Series AAA, owned by the joint
venture and the related dividend income have been eliminated.
Convertible Partnership Units
-----------------------------
As of September 30, 2005 and December 31, 2004, one of the
Consolidated Entities had approximately 237,935 convertible operating
partnership units ("Convertible Units") outstanding, 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 unitholder. 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
nine months ended September 30, 2005 and the year ended December 31, 2004,
no units were converted.
Other Consolidated Partnerships
-------------------------------
At September 30, 2005, the other consolidated partnerships reflect
common equity interests that we do not own in 22 entities having an
interest in an aggregate of 73 self-storage facilities. At December 31,
2004, the consolidated partnerships included 24 entities having an interest
in an aggregate of 123 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.
23
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
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.
On June 30, 2004, we acquired the remaining minority interest we
did not own in one of the Consolidated Entities, for an aggregate of
$24,851,000 in cash. This acquisition had the effect of reducing minority
interest by $18,312,000, with the excess of cost over underlying book value
($6,539,000) allocated to real estate.
24
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
10. Shareholders' Equity
--------------------
Cumulative Preferred Stock
--------------------------
At September 30, 2005 and December 31, 2004, we had the following
series of Cumulative Preferred Stock outstanding:
At September 30, 2005 At December 31, 2004
Earliest --------------------------- ---------------------------
Redemption Dividend Shares Carrying Shares Carrying
Series Date (a) Rate Outstanding Amount Outstanding Amount
- ----------------- -------------- --------- ----------- ------------ ----------- -----------
(Dollar amount in thousands)
Series F 5/2/05 (b) 9.750% - $ - 2,300,000 $ 57,500
Series Q 1/19/06 8.600% 6,900 172,500 6,900 172,500
Series R 9/28/06 8.000% 20,400 510,000 20,400 510,000
Series S 10/31/06 7.875% 5,750 143,750 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 - -
Series E 4/27/10 6.750% 5,650 141,250 - -
Series F (c) 8/23/10 6.450% 8,000 200,000 - -
----------- ------------ ----------- -----------
Total Cumulative Preferred Stock 1,699,236 $2,520,900 3,980,186 $ 2,102,150
=========== ============ =========== ===========
(a) Except under certain conditions relating to the Company's qualification as
a REIT, the Cumulative Preferred Stock outstanding at September 30, 2005
are not redeemable prior to the dates indicated. On or after the dates
indicated, each series of Cumulative Senior 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.
(b) The Series F Cumulative Preferred Stock was called for redemption on March
31, 2005 and was redeemed in May 2005 along with the unpaid distributions
from April 1, 2005 through the redemption date.
(c) On October 3, 2005, we issued an additional 2,000 shares of our 6.45%
Series F Preferred Stock resulting in gross proceeds of $50 million.
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, 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. In the case of one of the series of preferred stock, the holders
have this same right if we fail to maintain a Debt Ratio (as defined) of
50% or more. At September 30, 2005, there were no dividends in arrears and
the Debt Ratio was 3.1%.
Upon issuance of our Preferred Stock, we classify the liquidation
value as preferred stock on our consolidated balance sheet with any
issuance costs recorded as a reduction to additional paid-in capital. Upon
redemption, we apply EITF Topic D-42, allocating income to the preferred
shareholders equal to the original issuance costs.
25
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
During the first quarter of 2005, we issued our 6.18% Series D
Cumulative Preferred Stock for net proceeds of $130,547,000. On April 27,
2005, we issued our 6.75% Cumulative Preferred Stock, Series E, for net
proceeds of $136,601,000. On August 23, 2005, we issued our 6.45% Series F
Cumulative Preferred Stock for net proceeds of $193,500,000. A subsequent
issuance of an additional 2,000,000 depositary shares, each representing
1/1,000 of a share of our 6.45% Series F Cumulative Preferred Stock, were
issued on October 3, 2005, resulting in net proceeds of $48,225,000.
During the first quarter of 2005, we redeemed our 10.0% Series E
Cumulative Preferred Stock for $54,875,000 plus accrued and unpaid
dividends. The Series E Cumulative Preferred Stock was called for
redemption in December 2004; accordingly, the redemption value of
$54,875,000 was classified as a liability at December 31, 2004. In
addition, on May 2, 2005, we redeemed our 9.75% Series F Cumulative
Preferred Stock, which was called for redemption during the first quarter
of 2005, for $57,500,000 plus accrued and unpaid dividends and $17,000 of
redemption costs.
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, 2005, we had 8,744,193 depositary shares
outstanding (8,776,102 at December 31, 2004), each representing 1/1,000 of
a share of Equity Stock, Series A ("Equity Stock A"). We received 31,909
depositary shares from a distribution from affiliated entities at March 31,
2005 (see Note 5). 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 not less than
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.
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 a newly formed joint
venture (the "Consolidated Development Joint Venture"). We control the
joint venture and consolidate its accounts, and accordingly the Equity
Stock AAA is eliminated in consolidation. The Equity Stock AAA ranks on a
parity with our common stock and junior to the Cumulative Preferred Stock
26
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
with respect to general preference rights, and has a liquidation amount
equal to 120% of the amount distributed to each common share. Annual
distributions per share shall be not less than the lesser of (i) five times
the amount paid per common share or (ii) $2.1564. We have no obligation to
pay distributions on these shares if no distributions are paid to common
shareholders.
Upon liquidation of the Consolidated Development Joint Venture, at
the Company's option either a) each share of Equity Stock AAA shall convert
into 1.2 shares of our common stock or b) the Company can redeem the Equity
Stock AAA at a per share amount equal to 120% of the market price of our
common stock. In addition, if the Company determines that it is necessary
to maintain its status as a REIT, subject to certain limitations it may
cause the redemption of shares of Equity Stock AAA at a per share amount
equal to 120% of the market price of our common stock. The shares are not
otherwise redeemable or convertible into shares of any other class or
series of the Company's capital stock. Other than as required by law, the
Equity Stock AAA has no voting rights.
On November 17, 2005, upon the acquisition of Mr. Hughes' interest
in PSAC Storage Investors, LLC (Note 9), we will own 100% of the
partnership interest in the Consolidated Development Joint Venture. We plan
on retiring the Equity Stock AAA at that time.
Common Stock
------------
During the nine months ended September 30, 2005, we issued 227,925
shares of Common Stock in connection with stock-based compensation. In
addition, one of the Consolidated Entities acquired 84,000 shares of our
Common Stock for $4,990,000; these shares were eliminated in consolidation.
We also received a distribution of 503,110 shares, and one of the
Consolidated Entities received 132,775 shares, of our Common Stock
previously held by affiliated entities. The 503,110 shares that we received
were retired.
At September 30, 2005, the Consolidated Entities owned 1,146,207
common shares of the Company. 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, 2005 and December 31, 2004:
Reconciliation of Common Shares Outstanding At September 30, At December 31,
- ------------------------------------------- 2005 2004
---------------- ---------------
Legally issued and outstanding shares......... 129,180,697 129,455,882
Less - Shares owned by the Consolidated
Entities that are eliminated in
consolidation (a)......................... (1,146,207) (929,432)
---------------- ---------------
Reported issued and outstanding shares........ 128,034,490 128,526,450
=============== ===============
(a) The increase in shares owned by the Consolidated Entities is
due to the Consolidated Entities' purchase of 84,000 shares of our common
stock during the nine months ended September 30, 2005 and one of the
Consolidated Entities' receipt of 132,775 shares of our common stock in a
distribution from affiliates on March 31, 2005.
27
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
Dividends
---------
The following table summarizes dividends declared and paid during the
nine months ended September 30, 2005:
Distributions Per
Share or Depositary Total
Share Distributions
--------------------- -------------
Preferred Stock:
Series E.............................. $0.208 $ 457,000
Series F.............................. $0.819 1,884,000
Series Q.............................. $1.612 11,126,000
Series R.............................. $1.500 30,600,000
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.............................. $0.901 4,867,000
Series E.............................. $0.726 4,102,000
Series F.............................. $0.175 1,396,000
--------------
126,286,000
Common Stock:
Equity Stock, Series A................ $1.838 16,087,000
Common ............................... $1.400 179,822,000
--------------
Total dividends.................... $ 322,195,000
==============
The dividends paid on the common stock amounted to $0.50 per
common share and $1.40 per common share for the three and nine months ended
September 30, 2005, 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, 2005, respectively.
11. Segment Information
-------------------
Description of Each Reportable Segment
--------------------------------------
Our reportable segments reflect significant operating activities
that are evaluated separately by management. We have four reportable
segments: self-storage operations, containerized storage operations,
commercial property operations and tenant reinsurance operations.
The self-storage segment comprises the direct ownership,
development and operation of traditional storage facilities, and the
ownership of equity interests in entities that own self-storage properties.
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 tenant reinsurance operations
reflect a business segment which reinsures policies against losses to goods
stored by tenants in our self-storage facilities.
28
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
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 U.S. generally accepted accounting principles and our
significant accounting policies as stated 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, and minority interest in income 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 management does not consider the historical cost of the Company's
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 which 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
-----------------------------------
Our condensed consolidated income statement provides the
information required in order to determine the revenues of each of our four
segments. The following table reconciles the performance of each segment,
in terms of segment income, to our consolidated net income.
29
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ----------------------
2005 2004 Change 2005 2004 Change
------------ ----------- ----------- ----------- ---------- --------
(Amounts in thousands)
Reconciliation of Net Income by Segment:
- ----------------------------------------
Self-storage
Self-storage net operating income...................... $ 163,514 $ 145,741 $ 17,773 $ 464,205 $414,567 $49,638
Self-storage depreciation.............................. (47,042) (42,818) (4,224) (139,925) (130,575) (9,350)
Equity in earnings - self-storage property operations.. 2,119 1,744 375 6,103 5,014 1,089
Equity in earnings - depreciation (self-storage) ...... (470) (402) (68) (1,378) (1,180) (198)
Discontinued operations (Note 3) ...................... 5,276 71 5,205 5,362 271 5,091
------------ ----------- ----------- ----------- ---------- --------
Total self-storage segment net income.............. 123,397 104,336 19,061 334,367 288,097 46,270
------------ ----------- ----------- ----------- ---------- --------
Commercial properties
Commercial properties net operating income............. 1,796 1,676 120 5,401 4,864 537
Depreciation and amortization - commercial properties.. (562) (464) (98) (1,721) (1,574) (147)
Equity in earnings - commercial property operations.... 17,737 15,959 1,778 51,865 49,753 2,112
Equity in earnings - depreciation (commercial
properties) ........................................ (8,352) (8,119) (233) (24,887) (23,875) (1,012)
Discontinued operations (Note 3) ...................... - 54 (54) - 142 (142)
------------ ----------- ----------- ----------- ---------- --------
Total commercial property segment net income...... . 10,619 9,106 1,513 30,658 29,310 1,348
------------ ----------- ----------- ----------- ---------- --------
Containerized storage
Containerized storage net operating income............. 804 1,975 (1,171) 2,613 6,358 (3,745)
Containerized storage depreciation..................... (313) (1,072) 759 (2,490) (3,298) 808
Discontinued operations (Note 3) ...................... - (1,126) 1,126 1,015 (1,931) 2,946
------------ ----------- ----------- ----------- ---------- --------
Total containerized storage segment net income..... 491 (223) 714 1,138 1,129 9
------------ ----------- ----------- ----------- ---------- --------
Tenant Reinsurance
Tenant reinsurance net income......................... 3,315 2,006 1,309 10,939 7,177 3,762
------------ ----------- ----------- ----------- ---------- --------
Other items not allocated to segments
-------------------------------------
General and administrative and other included in
equity in earnings.................................. (1,181) (5,998) 4,817 (11,321) (18,066) 6,745
Interest and other income............................. 7,376 3,300 4,076 16,698 7,240 9,458
General and administrative............................. (5,621) (5,527) (94) (16,890) (15,983) (907)
Interest expense....................................... (2,471) - (2,471) (5,928) (100) (5,828)
Casualty loss.......................................... (196) (1,250) 1,054 (196) (1,250) 1,054
Gain on sale of real estate............................ (142) 1,286 (1,428) (89) 1,286 (1,375)
Minority interest in income............................ (7,243) (9,521) 2,278 (26,355) (39,898) 13,543
------------ ----------- ----------- ----------- ---------- --------
Total other items not allocated to segments........ (9,478) (17,710) 8,232 (44,081) (66,771) 22,690
------------ ----------- ----------- ----------- ---------- --------
Total consolidated net income...................... $ 128,344 $ 97,515 $ 30,829 $ 333,021 $258,942 $74,079
============ =========== =========== =========== ========== ========
30
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
12. 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 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.
As of January 1, 2002, 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"). We
recognize compensation expense in our income statement using the Fair Value
Method only with respect to stock options issued after January 1, 2002. We
disclose, but do not record, stock option expense with respect to stock
options granted prior to January 1, 2002 (the "APB 25 Method").
Substantially all stock options are issued to employees.
For the three and nine months ended September 30, 2005 we recorded
$240,000 and $667,000, respectively, in stock option compensation expense
related to options granted after January 1, 2002, as compared to $150,000
and $439,000, respectively, for the same periods in 2004. The fair value of
each option grant is estimated on the date of the grant using the
Black-Scholes option pricing model. The estimated per option value of
205,000 stock options granted in the first nine months of 2005 was based
upon an estimated life of 5 years, an average risk-free rate of 3.9%, an
expected dividend yield of 7%, and an average expected volatility of 0.22.
If we had recorded stock option expense applying the Fair Value
Method to all awards, we would have recognized an additional $439,000 for
the nine months ended September 30, 2004 in stock option compensation
expense (none for the same period in 2005). Basic and diluted earnings per
share would have been $0.93 and $0.92, respectively for the nine months
ended September 30, 2004.
A total of 205,000 stock options were granted during the nine
months ended September 30, 2005, 201,457 shares were exercised, and 57,235
shares were forfeited. A total of 1,388,209 stock options were outstanding
at September 30, 2005 (1,441,901 at December 31, 2004).
Restricted Stock Units
----------------------
Restricted stock units vest over a five-year period from the date
of grant at the rate of one-fifth per year. The employee receives
additional compensation equal to the per-share dividends received by common
31
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
shareholders. Upon vesting, the employee receives regular 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 the Company's Common Stock at the date of grant, combined
with the estimated payroll taxes and other payroll burden costs to be
incurred upon vesting, is amortized over the vesting period as compensation
expense. Outstanding restricted stock units are included on a one-for-one
basis in the Company's 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.
From December 31, 2004 through September 30, 2005, 168,550
restricted stock units were granted, 60,100 restricted stock units were
forfeited, and 37,000 restricted stock units vested. This vesting resulted
in the issuance of 26,468 shares of the Company's Common Stock. In
addition, cash compensation was paid to employees in lieu of 10,532 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, 2005, approximately 323,490 restricted stock
units were outstanding (252,040 at December 31, 2004). A total of $956,000
and $2,912,000 in restricted stock expense was recorded for the three and
nine months ended September 30, 2005, respectively ($559,000 and
$1,676,000, respectively, for the same periods in 2004) which includes
amortization of the fair value of the grant reflected as an increase to
paid-in capital, as well as accrued estimated burden to be incurred upon
vesting.
13. Related Party Transactions
--------------------------
Relationships and transactions with the Hughes Family
-----------------------------------------------------
B. Wayne Hughes, Chairman of the Board, and his family (the
"Hughes Family") have ownership interests in, and operate approximately 44
self-storage facilities in Canada under the name "Public Storage" 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 36% of our Common Stock outstanding at
September 30, 2005. 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.
Prior to December 31, 2003, our personnel were engaged in the
supervision and the operation of these Canadian self-storage facilities 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 (U.S. $542,499 and $638,000 in
respect of the Canadian operations for 2003 and 2002, respectively, and
U.S. $151,063 and $167,930 for other services during 2003 and 2002,
respectively). There have been conflicts of interest in allocating the time
of our personnel between our properties, the Canadian properties, and
certain other Hughes Family interests. The sharing of personnel and systems
with the Canadian entities was substantially discontinued by December 31,
2003. The Canadian entities claim that the Company owes them CAD $653,424
representing the amount charged to them for the development of certain
systems that they no longer utilize. On October 27, 2005, the Company's
Board of Directors (with B. Wayne Hughes and B. Wayne Hughes Jr.
abstaining) approved the reimbursement of the CAD $653,424 in system
development costs plus interest, accrued at 4% per annum, of CAD $52,274.
These costs have been accrued on our financial statements as of September
30, 2005.
The Company, through subsidiaries, continues to reinsure risks
relating to loss of goods stored by tenants in the self-storage facilities
in Canada. The Company had acquired the tenant insurance business on
32
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
December 31, 2001 through its acquisition of PSIC. During the nine months
ended September 30, 2005 and 2004, PSIC received $795,000 and $783,000,
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.
The corporation engaged in the operation of the Canadian
facilities has advised us that it intends to reorganize the entities owning
and operating the Canadian facilities and has proposed that the Company
consent to this reorganization, which would impact the license agreement
and the right of first refusal agreement with the Company, and might also
impact our ability to provide tenant reinsurance. The reorganization is
designed to enhance the entities' financial flexibility and growth
potential. In November 2004, the Board appointed a special committee,
comprised of independent directors, to consider the Company's alternatives
in this matter, including a possible investment in the reorganized Canadian
entities.
In November 1999, we formed the Consolidated Development Joint
Venture with a joint venture partner whose partners include an
institutional investor and Mr. Hughes. We subsequently acquired the
institutional investor's interest in August 2005 and notified Mr. Hughes of
our intent to acquire his interest on November 17, 2005. This arrangement
is discussed more fully in Note 9.
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, chief executive
officer, and President, and he is also chairman of the board of PSB. Until
August 2003, Mr. Havner was also the Chief Executive Officer of PSB. For
2003 and 2004 services, Mr. Havner was compensated by PSB as well as by the
Company.
In December 2003, we loaned $100,000,000 to PSB. This loan bore
interest at the rate of 1.45% per year. This loan, which was fully repaid
on March 8, 2004, was included in Notes Receivable at December 31, 2003.
Dann V. Angeloff, a director of the Company, is the general
partner of a limited partnership formed in June of 1973 that owns a
self-storage facility that is managed by the Company. The Company received
management fees with respect to this facility amounting to $33,000 and
$31,000 for the nine months ended September 30, 2005 and 2004,
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 $145,000 and $434,000 for the three and nine
months ended September 30, 2005, respectively, and $141,000 and $423,000,
respectively, for the same periods in 2004 in management fees with respect
to PSB's property management services.
Pursuant to a cost-sharing and administrative services agreement,
PSB reimburses us for certain administrative services. PSB's share of these
costs totaled approximately $85,000 and $255,000 for each of the three and
nine months ended September 30, 2005 and 2004, respectively.
STOR-Re provides limited property and liability insurance to the
Company, PSB and our affiliates for losses incurred during policy periods
prior to April 1, 2004. Beginning April 1, 2004, this insurance is provided
by PSIC-H for the Company and our affiliates, but not for PSB and the
Canadian facilities.
33
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
14. Commitments and Contingencies
-----------------------------
LEGAL MATTERS
Serrao v. Public Storage, Inc. (filed April 2003) (Superior Court - 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. There can be no
assurance that this motion will be granted. We are vigorously contesting
the claims upon which this lawsuit is based including class certification
efforts.
Gustavson, et al v. Public Storage, Inc. (filed June 2003) (Superior Court
---------------------------------------------------------------------------
- Los Angeles County); Potter, et al v. Hughes, et al (filed December 2004)
---------------------------------------------------------------------------
(United States District Court - Central District of California)
---------------------------------------------------------------
In November 2002, a shareholder of the Company made a demand on
the Board of Directors that challenged the fairness of the Company's
acquisition of PS Insurance Company, Ltd. ("PSIC") and demanded that the
Board recover the profits earned by PSIC from November 1995 through
December 2001 and that the entire purchase price paid by the Company for
PSIC in excess of PSIC's net assets be returned to the Company.
The contract to acquire PSIC was approved by the independent
directors of the Company in March 2001, and the transaction was closed in
December 2001. PSIC was formerly owned by B. Wayne Hughes, currently the
Chairman of the Board (and in 2001 also the Chief Executive Officer) of the
Company, B. Wayne Hughes, Jr., currently a director (and in 2001 also an
officer) of the Company and Tamara H. Gustavson, who in 2001 was an officer
of the Company. In exchange for the Hughes family's shares in PSIC, we
issued to them 1,439,765 shares of Common Stock (or a net of 1,138,733
shares, after taking into account 301,032 shares held by PSIC).
The shareholder has threatened litigation against the Hughes
family and the directors of the Company arising out of this transaction and
alleged a pattern of deceptive disclosures with respect to PSIC since 1995.
In December 2002, the Board held a special meeting to authorize an inquiry
by its independent directors to review the fairness to the Company's
shareholders of its acquisition of PSIC and the ability of the Company to
have started its own tenant reinsurance business in 1995. We believe that,
prior to the effectiveness in 2001 of the federal REIT Modernization Act
and corresponding California legislation that authorized the creation and
ownership of "taxable REIT subsidiaries," our ownership of a reinsurance
business relating to its tenants would have jeopardized our status as a
REIT and that other REITs faced similar concerns about tenant insurance
programs.
34
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
In June 2003, the Hughes family filed a complaint (Gustavson, et
al v. Public Storage, Inc.) for declaratory relief relating to the
Company's acquisition of PSIC naming the Company as defendant. The Hughes
family is seeking that the court make (i) a binding declaration that the
Company either is not entitled to recover profits or other moneys earned by
PSIC from November 1995 through December 2001; or alternatively the amounts
that the Hughes family should be ordered to surrender to the Company if the
court determines that the Company is entitled to recover any such profits
or moneys; and (ii) a binding declaration either that the Company cannot
establish that the acquisition agreement was not just and reasonable as to
the Company at the time it was authorized, approved or ratified; or
alternatively the amounts that the Hughes family should surrender to the
Company, if the court determines that the agreement was not just and
reasonable to the Company at that time. The Hughes family is not seeking
any payments from the Company. In the event of a determination that the
Hughes family is obligated to pay certain amounts to the Company, the
complaint states that they have agreed to be bound by that determination to
pay such amounts to the Company.
In July 2003, the Company filed an answer to the Hughes family's
complaint requesting a final judicial determination of the Company's rights
of recovery against the Hughes family in respect of PSIC. In September
2003, by order of the Superior Court, Justice Malcolm Lucas, a former chief
justice of the California Supreme Court, was appointed to try the case.
This matter was tried in June 2005. In October 2005, Judge Lucas rendered
his decision, ruling against the Company by finding 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. The
Superior Court has formally entered this decision and will enter judgment
accordingly.
At the end of December 2004, the same shareholder referred to
above and a second shareholder filed a shareholder's derivative complaint
(Potter, et al v. Hughes, et al) naming as defendants the Company's
directors (and two former directors) and certain officers of the Company.
The matters alleged in the Potter complaint relate to PSIC, the Hughes
family's Canadian mini-warehouse operations and the Company's 1995
reorganization. In June 2005, the court granted the defendants' motion to
dismiss the Potter complaint with leave to amend the complaint. In July
2005, the plaintiffs filed an amended complaint, and the defendants filed a
motion to dismiss the amended complaint. The matter is currently under
submission. 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 et al v. Public Storage, Inc. (filed April, 2005) (Superior court
---------------------------------------------------------------------------
of California - Los Angeles County)
-----------------------------------
The Brinkley plaintiffs are suing the Company on behalf of a
purported class of California property managers who claim that they were
not compensated for all the hours they worked. The Brinkley suit is based
upon California wage and hour laws. The maximum potential liability cannot
be estimated, but would be increased if a class or classes are certified
or, if claims are permitted to be brought on behalf of others under the
California Unfair Business Practices Act. We are vigorously contesting the
claims and intends to resist any expansion beyond the named plaintiffs on
the grounds of lack of commonality of claims. We do not believe that this
matter will have any material adverse effect on the results of operations
of the Company.
Inhan et al v. Public Storage, Inc (filed May, 2005) (United States
---------------------------------------------------------------------------
District Court - Southern District of Florida)
----------------------------------------------
Inhan and a co-plaintiff are suing the Company in Florida claiming
they were not compensated for all hours worked under the Federal Fair Labor
Standards Act. The suit is brought as a putative class action. The time to
add additional parties in this action has expired and no additional parties
have been added. The Company vigorously contests the claims and although
the maximum potential liability cannot be estimated, the fact that the time
to add additional parties in this action has expired limits the maximum
potential liability. As a result, we believe this matter is no longer
potentially material and therefore will no longer report on it.
35
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(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 comprehensive insurance,
including fire, earthquake, flood, liability and extended 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 million. In addition, if losses exhaust
the third-party insurers' limit of coverage of $125,000,000 for property
coverage and $101,000,000 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 recent engineering and actuarial studies.
Our tenant 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. We reinsure our risks with third-party insurers from any
individual event that exceeds a loss of $500,000, up to the policy limit of
$10,000,000.
DEVELOPMENT OF REAL ESTATE FACILITIES
At September 30, 2005 we have 57 projects (3,814,000 net rentable
square feet) in our development pipeline, including seven newly developed
self-storage facilities and expansions to 50 existing self-storage
facilities, with total estimated development costs of $291.3 million, of
which $50.9 million has been spent through September 30, 2005. Development
of these facilities is subject to various risks and contingencies.
ACQUISITION OF REAL ESTATE FACILITIES
At November 7, 2005, we are under contract to acquire seven
additional facilities (total approximate net rentable square feet of
481,000) at an aggregate cost of approximately $70 million, including the
assumption of debt on one of these facilities totaling approximately $5
million. We anticipate that these acquisitions will be funded entirely by
us. Each of these contracts is subject to significant contingencies, and
there is no assurance that any of these facilities will be acquired.
15. Subsequent Events
-----------------
We acquired seven additional facilities for approximately $78.2
million with 586,000 net rentable square feet between October 1, 2005 and
October 26, 2005. These acquisitions were entirely funded by us.
On October 3, 2005, we issued an additional 2,000,000 depositary
shares, with each share representing 1/1,000 of a share, in our 6.45%
Series F Cumulative Preferred Stock resulting in $50 million of gross
proceeds.
On October 24, 2005, Hurricane Wilma struck southern Florida,
where we have 111 self-storage facilities in the Miami, West Palm Beach and
Tampa areas. As a result of damage sustained and lack of electrical power,
many of these facilities were not operational and therefore could not
process move-ins or move-outs for a period of time. Currently all of the
self-storage facilities are operational; however, many units within several
facilities are not rentable pending repairs. We also had one commercial
property that sustained significant damage that will require us to vacate
36
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2005
(Unaudited)
certain existing tenants in order to make the necessary repairs. With
respect to our self-storage facilities, we do not anticipate any
significant adverse impact to our earnings going forward as a result of
damages sustained from the hurricane. With respect to the commercial
property, we expect the operations will be significantly affected until
repairs are made to the facility. Net operating income generated by this
commercial property for the nine months ended September 30, 2005 was
approximately $500,000.
Our current estimate of costs to restore our facilities from
physical damage ranges from $4.0 to $4.5 million. We have insurance that
covers physical damage and business interruption, subject to certain
limitations. The amount of insurance proceeds that we would expect to
recover is currently not determinable.
16. Recent Accounting Pronouncement
-------------------------------
Issue 04-05 of the Emerging Issues Task Force ("EITF 04-05")
states that the general partner in a partnership is presumed to control
that limited partnership, for purposes of determining whether to
consolidate an interest in an entity or to apply the equity method of
accounting. If the limited partners have either (1) the substantive ability
- through a simple majority vote - to liquidate the partnership or remove
the general partner without cause, or (2) substantive participating rights,
the general partner does not control the limited partnership.
The effective date for applying the guidance in EITF 04-05 is June
29, 2005 for new limited partnerships, or no later than our fiscal year
beginning January 1, 2006.
We have not fully quantified the impact of this statement on our
consolidated financial statements, but we do not believe that the impact
will be significant.
37
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 consolidated financial statements and notes thereto.
FORWARD LOOKING STATEMENTS: When used within this document, the words "expects,"
"believes," "anticipates," "should," "estimates," and similar expressions are
intended to identify "forward-looking statements" within the meaning of that
term in Section 27A of the Securities Exchange Act of 1933, as amended, and in
Section 21E of the Securities Exchange Act of 1934, as amended. Such
forward-looking statements involve known and unknown risks, uncertainties, and
other factors, which may cause our actual results and performance to be
materially different from those expressed or implied in the forward looking
statements. Such factors are described in Item 2A, "Risk Factors" and include
changes in general economic conditions and in the markets in which we operate,
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 our ability to evaluate,
finance and integrate acquired and developed properties into our 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 expense and reduce our cash
available for distribution; consumers' failure to accept the containerized
storage concept which would reduce our profitability; difficulties in raising
capital at reasonable rates, which would impede our ability to grow; delays in
the development process, which could adversely affect our profitability;
economic uncertainty due to the impact of war or terrorism could adversely
affect our business plan; the costs associated with pursuing a potential
transaction with Shurgard, the risk that no transaction with Shurgard occurs,
the risks associated with Public Storage's ability to successfully integrate the
operations of Shurgard, if a transaction is consummated, and assumptions with
respect to the benefits to be realized from a potential transaction with
Shurgard, future revenues of Shurgard and Public Storage, the expected
performance of Shurgard and Public Storage and the expected cash flows of
Shurgard and Public Storage and other risks related to our proposal to acquire
Shurgard which are described in Item 2A. We disclaim any obligation to publicly
release the results of any revisions to these forward-looking statements
reflecting new estimates, events or circumstances after the date of this report.
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 U.S. generally accepted accounting principles. The
preparation of financial statements and related disclosures in conformity with
United States generally accepted accounting principles 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 consolidated financial statements and accompanying notes. Note 2
to our consolidated financial statements summarizes the significant accounting
policies and methods used in the preparation of our 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 or record as an expense income tax
on the share of our taxable income that is distributed to shareholders.
We therefore don't 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
38
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,
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, assets associated with the
containerized storage business, goodwill, and other intangible assets. 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
the 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 14 to the 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 our 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 provided.
ACCRUALS FOR CONTINGENCIES: We are exposed to business and legal
liability risks with respect to events that have occurred, but in accordance
with U.S. generally accepted accounting principles, 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 14 to the consolidated financial statements.
ACCRUALS FOR OPERATING EXPENSES: We accrue for property tax expense and
other operating expenses based upon estimates and 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. Accordingly, the amounts incurred in an interim period may not be
indicative of the amounts to be incurred in a full year.
39
RESULTS OF OPERATIONS
- ---------------------
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2005:
Net income for the three months ended September 30, 2005 was
$128,344,000 compared to $97,515,000 for the same period in 2004, representing
an increase of $30,829,000 or 32%. This increase is primarily due to improved
operations from our Same Store, newly developed and acquired self-storage
facilities, an increase in equity earnings of real estate entities, improved
tenant reinsurance operations, a gain on the disposition of real estate assets,
and higher interest income. These items were partially offset by increases in
depreciation and interest expense. Equity in earnings of real estate entities
increased primarily as a result of our pro-rata share of gain from the sale of
real estate recorded by PS Business Parks in the quarter ended September 30,
2005.
Net income allocable to our common shareholders (after allocating net
income to our preferred and equity stock shareholders) was $79,262,000 or $0.62
per common share on a diluted basis for the three months ended September 30,
2005 compared to $48,597,000 or $0.38 per common share on a diluted basis for
the same period in 2004, representing an increase of $0.24 per common share, or
63%. The increases in net income allocable to common shareholders and earnings
per common diluted share are due primarily to the impact of the factors
described above with respect to the increase in net income. Weighted average
diluted shares decreased to 128,742,000 for the three months ended September 30,
2005 from 128,826,000 for the three months ended September 30, 2004.
For the three months ended September 30, 2005 and 2004, we allocated
$43,726,000 and $40,471,000 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
preferred securities issued. For the three months ended September 30, 2004, we
also recorded an additional allocation of net income to our preferred
shareholders and a corresponding reduction of net income allocation to our
common shareholders of $3,072,000 or $0.02 per common share with respect to our
redemption of our Series M and Series D Preferred stock, pursuant to Emerging
Issues Task Force Topic D-42 ("EITF Topic D-42").
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005:
Net income for the nine months ended September 30, 2005 was
$333,021,000 compared to $258,942,000 for the same period in 2004, representing
an increase of $74,079,000, or 29%. This increase is primarily due to improved
operations from our Same Store, newly developed and acquired self-storage
facilities, reduced minority interest in income, an increase in equity earnings
of real estate entities, improved tenant reinsurance operations, increased gains
on the disposition of real estate assets and higher interest income. These items
were partially offset by increases in depreciation and interest expense. Equity
in earnings of real estate entities increased due to our pro-rata share of gain
from the sale of real estate recorded by PS Business Parks in the nine months
ended September 30, 2005.
Minority interest in income declined primarily due to a reduction in
redemption and restructuring costs associated with preferred partnership units
in 2004, combined with the redemption of preferred partnership units during
2005. We allocated income to minority interests pursuant to EITF Topic D-42
totaling $874,000 and $2,063,000 for the nine months ended September 30, 2005
and 2004, respectively. In addition, during the nine months ended September 30,
2004, we allocated $8.0 million to preferred minority interests as a result of a
special distribution associated with a restructuring.
Net income allocable to our common shareholders (after allocating net
income to our preferred and equity stock shareholders) was $188,744,000 or $1.46
per common share on a diluted basis for the nine months ended September 30, 2005
compared to $118,728,000 or $0.92 per common share on a diluted basis for the
same period in 2004, representing an increase of $0.54 per common share, or 59%.
40
The increases in net income allocable to common shareholders and earnings per
common diluted share are due primarily to the impact of the factors described
above with respect to the increase in net income, partially offset by an
increase in net income allocated to our preferred shareholders. Weighted average
diluted shares increased to 128,844,000 for the nine months ended September 30,
2005 from 128,545,000 for the nine months ended September 30, 2004.
For the nine months ended September 30, 2005 and 2004, we allocated
$126,286,000 and $117,293,000 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 at higher dividend rates than the newly
preferred securities issued. We also recorded allocations of income to our
preferred shareholders with respect to the application of EITF Topic D-42
totaling $1,904,000 (or $0.01 per common share) and $6,795,000 (or $0.05 per
common share) for the nine months ended September 30, 2005 and 2004,
respectively.
REAL ESTATE OPERATIONS
- ----------------------
SELF-STORAGE OPERATIONS: Our self-storage operations are by far the
largest component of our operations, representing approximately 93% of our total
revenues generated for the nine months ended September 30, 2005. As a result of
acquisitions and development of self-storage facilities, year over year
comparisons as presented on the consolidated statements of income with respect
to our self-storage operations are not meaningful.
To enhance year over year comparisons, the following table summarizes,
and the ensuing discussion describes, the operating results of (i) 1,260
self-storage facilities that are reflected in the financial statements on a
stabilized basis since January 1, 2003 (the "Same Store" facilities"
facilities), (ii) 66 facilities that were acquired in 2004 and the first nine
months of 2005 ( the "Acquired Facilities"), (iii) 56 facilities that were owned
prior to January 1, 2003 but were not stabilized due primarily to expansions in
their net rentable square footage (the "Expansion Facilities") and (iv) 67
newly-developed facilities that were opened after January 1, 2001 (the
"Developed Facilities"):
41
Self - storage operations summary: Three Months Ended September 30, Nine Months Ended September 30,
---------------------------------- ------------------------------------- -------------------------------------
Percentage Percentage
2005 2004 Change 2005 2004 Change
------------ ----------- ----------- ------------ ----------- ----------
(Dollar amounts in thousands)
Rental income (a):
Same Store Facilities (b)........... $ 206,857 $ 197,162 4.9% $ 604,752 $ 576,765 4.9%
Acquired Facilities (c)............. 10,674 95 - 27,001 95 -
Expansion Facilities (d)............ 11,248 10,797 4.2% 32,983 30,953 6.6%
Developed Facilities (e)............ 15,043 11,689 28.7% 41,898 30,707 36.4%
------------ ----------- ----------- ------------ ----------- ----------
Total rental income............... 243,822 219,743 11.0% 706,634 638,520 10.7%
------------ ----------- ----------- ------------ ----------- ----------
Cost of operations (f):
Same Store Facilities............... 66,927 65,616 2.0% 202,928 199,199 1.9%
Acquired Facilities................. 4,200 103 - 11,508 103 -
Expansion Facilities................ 4,007 3,480 15.1% 11,940 10,564 13.0%
Developed Facilities................ 5,174 4,803 7.7% 16,053 14,087 14.0%
------------ ----------- ----------- ------------ ----------- ----------
Total cost of operations............ 80,308 74,002 8.5% 242,429 223,953 8.2%
------------ ----------- ----------- ------------ ----------- ----------
Net operating income (before depreciation):
Same Store Facilities............... 139,930 131,546 6.4% 401,824 377,566 6.4%
Acquired Facilities................. 6,474 (8) - 15,493 (8) -
Expansion Facilities................ 7,241 7,317 (1.0)% 21,043 20,389 3.2%
Developed Facilities................ 9,869 6,886 43.3% 25,845 16,620 55.5%
------------ ----------- ----------- ------------ ----------- ----------
Total net operating income before
depreciation...................... 163,514 145,741 12.2% 464,205 414,567 12.0%
Depreciation and amortization ........ (47,042) (42,818) 9.9% (139,925) (130,575) 7.2%
------------ ----------- ----------- ------------ ----------- ----------
Net operating income................ $ 116,472 $ 102,923 13.2% $ 324,280 $ 283,992 14.2%
============ =========== =========== ============ =========== ==========
Number of self-storage facilities (at end
of period):............................. 1,449 1,382 4.8%
Net rentable square feet (at end of period
- in thousands):........................ 88,406 83,497 5.9%
(a) Rental income includes late charges and administrative fees and is net of
promotional discounts given. Rental income does not include retail sales,
truck rental income or tenant insurance revenues generated at the
facilities.
(b) The Same Store Facilities include 1,260 facilities containing 73,311,000
net rentable square feet that have been owned prior to January 1, 2003, and
operated at a mature, stabilized occupancy level since January 1, 2003.
(c) The Acquired Facilities include 66 facilities containing 4,574,000 net
rentable square feet that were acquired after January 1, 2003, and were
substantially all mature, stabilized facilities at the time of their
acquisition.
(d) The Expansion Facilities include 56 facilities containing 4,556,000 net
rentable square feet of self-storage space and 426,000 square feet of
containerized storage space. These facilities were owned since January 1,
2003, however, operating results are not comparable throughout the periods
presented due primarily to expansions in their net rentable square feet
(described below). Since January 1, 2003, we completed construction on
expansion projects to these facilities with a total cost of $41.3 million.
(e) The Developed Facilities include 67 facilities containing 5,174,000 net
rentable square feet of self-storage space and 365,000 net rentable square
feet of industrial space initially developed for use in containerized
storage activities (see "Containerized Storage" and "Discontinued
Operations"). These facilities were developed and opened since January 1,
2001 at a total cost of $523.3 million.
(f) Cost of operations includes all costs, both direct and indirect costs,
incurred in the operating activities of the facilities.
42
Self-Storage Operations - Same Store Facilities
At September 30, 2005, our "Same Store" portfolio consists of 1,260
facilities, which represents the facilities that we have consolidated in our
financial statements and have been operating on a stabilized basis throughout
2003, 2004, and the first nine months of 2005. During the quarter ended
September 30, 2005, we removed a total of nine facilities from the Same Store
pool because the operations of these facilities were no longer comparable to
prior periods; these facilities are now included in the "expansion facilities"
below. These nine facilities included eight facilities located in New Orleans
that were damaged by the impact of Hurricane Katrina and one facility located in
Houston that was partially condemned due to eminent domain proceedings. The new
Same Store pool of 1,260 facilities should not be compared to the pool of 1,269
facilities presented in prior filings when evaluating trends in operations.
The Same Store Facilities contain approximately 73,311,000 net rentable
square feet, representing approximately 83% of the aggregate net rentable square
feet of our 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." The following table sets forth
additional operating data with respect to the Same Store Facilities:
SAME STORE FACILITIES Three Months Ended September 30, Nine Months Ended September 30,
--------------------- ------------------------------------ --------------------------------------
Percentage Percentage
2005 2004 Change 2005 2004 Change
----------- ------------ ----------- ------------ ----------- -----------
(Amounts in thousands except weighted average amounts)
Revenues:
Rental income, net of discounts................ $ 197,329 $ 188,991 4.4% $ 577,941 $ 552,453 4.6%
Late charges and administrative fees collected. 9,528 8,171 16.6% 26,811 24,312 10.3%
----------- ------------ ----------- ------------ ----------- -----------
Total revenues................................. 206,857 197,162 4.9% 604,752 576,765 4.9%
Cost of operations:
Property taxes................................. 19,261 18,375 4.8% 56,816 54,735 3.8%
Payroll expense................................ 20,096 20,357 (1.3)% 61,911 61,149 1.2%
Advertising and promotion...................... 5,182 4,373 18.5% 17,740 15,402 15.2%
Utilities...................................... 4,657 4,313 8.0% 12,831 12,130 5.8%
Repairs and maintenance........................ 6,172 6,351 (2.8)% 19,084 19,034 0.3%
Telephone reservation center................... 2,217 2,760 (19.7)% 5,976 8,367 (28.6)%
Property insurance............................. 1,929 2,241 (13.9)% 6,145 6,923 (11.2)%
Other cost of managing facilities.............. 7,413 6,846 8.3% 22,425 21,459 4.5%
----------- ------------ ----------- ------------ ----------- -----------
Total cost of operations....................... 66,927 65,616 2.0% 202,928 199,199 1.9%
----------- ------------ ----------- ------------ ----------- -----------
Net operating income before depreciation......... 139,930 131,546 6.4% 401,824 377,566 6.4%
Depreciation..................................... (38,096) (36,773) 3.6% (114,685) (113,133) 1.4%
----------- ------------ ----------- ------------ ----------- -----------
Net operating income............................. $ 101,834 $ 94,773 7.5% $ 287,139 $ 264,433 8.6%
=========== ============ =========== ============ =========== ===========
Gross margin (before depreciation)............... 67.6% 66.7% 1.3% 66.4% 65.5% 1.4%
Weighted average for the period:
Square foot occupancy (a)..................... 91.7% 91.9% (0.2)% 91.2% 91.1% 0.1%
Realized annual rent per occupied square foot
(b)......................................... $ 11.74 $ 11.22 4.6% $ 11.53 $ 11.03 4.5%
Annualized REVPAF (c)......................... $ 10.77 $ 10.31 4.5% $ 10.51 $ 10.05 4.6%
Weighted average at September 30:
Square foot occupancy......................... 91.6% 92.0% (0.4)%
In place annual rent per occupied square foot
(d)........................................ $ 12.83 $ 12.20 5.2%
Total net rentable square feet .................. 73,311 73,311 -
(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
annualized rental income, net of discounts, by the weighted average
occupied square footage for the period. Realized rents per square foot
takes into consideration promotional discounts, bad debt costs, credit card
fees and other costs which reduce rental income from the contractual
amounts due. Realized rents per occupied square foot exclude late charges
and administrative fees collected, and it is presented because we believe
realized rents per occupied square foot is an important measure of our
operations.
43
(c) Annualized rental income per available square foot ("REVPAF") represents
annualized rental income, net of discounts, divided by total available net
rentable square feet. REVPAF excludes late charges and administrative fees
collected. REVPAF is presented because we use it to measure our performance
and believe it is useful for investors to evaluate our operations.
(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.
During the three months ended September 30, 2005, net operating income (before
depreciation) for the Same Store facilities increased 6.4% as compared to the
same period in 2004, due to the following:
o Annualized REVPAF increased 4.5% from $10.31 per square foot in the
three months ended September 30, 2004 to $10.77 in the three months
ended September 30, 2005. This was attributable primarily to a 4.6%
increase in realized annual rent per occupied square foot from $11.22
for the three months ended September 30, 2004 to $11.74 for the same
period in 2005.
o The impact of the increase in annualized REVPAF was partially offset by
a 2.0% increase in operating expenses from $65.6 million in the three
months ended September 30, 2004 to $66.9 million in the three months
ended September 30, 2005. This increase in cost of operations is
primarily due to increased property taxes, advertising and promotion
and utilities expense, partially offset by decreases to payroll,
repairs and maintenance, property insurance and telephone reservation
costs. The decrease in payroll expense from $20,357,000 for the three
months ended September 30, 2004 to $20,096,000 for the same period in
2005 is primarily due to a reduction in workers' compensation expense.
During the nine months ended September 30, 2005, net operating income (before
depreciation) for the Same Store facilities increased 6.4% as compared to the
same period in 2004, due to the following:
o Annualized REVPAF increased 4.6% from $10.05 per square foot in the
nine months ended September 30, 2004 to $10.51 in the nine months ended
September 30, 2005. This was attributable primarily to a 4.5% increase
in realized annual rent per occupied square foot from $11.03 for the
nine months ended September 30, 2004 to $11.53 for the same period in
2005.
o The impact of the increase in annualized REVPAF was partially offset by
a 1.9% increase in operating expenses from $199.2 million in the nine
months ended September 30, 2004 to $202.9 million in the nine months
ended September 30, 2005. This increase in cost of operations is
primarily due to increased property taxes, advertising and promotion
and utilities expense, partially offset by decreases to property
insurance and telephone reservation center costs.
ANALYSIS OF REVENUE TRENDS
We experience minor seasonal fluctuations in the occupancy levels of
self-storage facilities with occupancies generally higher in the summer months
than in the winter months. We believe that these fluctuations result in part
from increased moving activity during the summer. We also believe that our
occupancy levels with respect to the Same Store facilities have become more
stabilized and therefore further year-over-year gains in occupancy levels will
be difficult to generate.
Our growth in rental income will depend on various factors, including
our ability to maintain high occupancy levels, increase rental rates charged to
both new and existing customers, and to reduce the amount of promotional
discounts given to new tenants. We believe that future growth in rental income
will come primarily from increases in average rental rates and reduced
promotional discounts rather than year-over-year increases in occupancy levels.
44
Going into the fourth quarter of 2005, we believe that our same store
facilities are well positioned for further revenue growth, as in-place annual
rental rates were 5.2% higher at September 30, 2005 as compared to the same
period in 2004, offset partially by occupancy levels that were 0.4% lower.
Although we have experienced a reduction in occupancy levels during the
third quarter, as compared to last year, we do not believe that it is indicative
of waning demand for self-storage space. We believe the reduction, in large
part, was due to our pricing and promotional activities during the quarter that
were designed to reduce the number of short-term tenants moving into our
facilities. As a consequence of this strategy, our move in volumes were reduced,
which in turn had a negative impact on our occupancy levels.
As we have indicated in the past, our primary strategy is to grow
REVPAF in a sustainable manner. In this regard, we will adjust our pricing,
promotional, and media strategies throughout the year. Some of these adjustments
could result in putting pressure on our occupancy levels in order to try to
enhance (i) the length of stay of our tenants, (ii) realized rent per occupied
square foot, or (iii) minimize promotional discounts given, all of which impact
REVPAF.
There can be no assurance that we will achieve our goal of increases in
REVPAF, while sustaining our occupancy levels.
ANALYSIS OF EXPENSE TRENDS
Total cost of operations for the Same Store facilities increased 2.0%
in the third quarter of 2005 as compared to the same period in 2004, and only
1.9% for the nine months ended September 30, 2005 as compared to the same period
in 2004.
Repairs and maintenance expense for the nine months ended September 30,
2005 was modestly higher than the amount incurred in the same period in 2004. We
expect to see a moderate increase in repairs and maintenance expenses in the
fourth quarter and into 2006.
The percentage decrease in telephone reservation center costs has
declined on a quarter-over-quarter basis as the year has progressed, and we
believe the expenses incurred in the third quarter are close to a stabilized
expense level.
Property payroll was also lower, in part due to a reduction in workers
compensation costs. We have bolstered our safety programs over the past two
years and improved our workers compensation claims management skills, and these
efforts are starting to have a positive impact on reducing workers compensation
claims.
Overall, our operating expense growth was more moderate than we
anticipated. We believe this will change next year and return to a 3% to 5%
year-over-year growth, excluding advertising.
Our media advertising costs are expected to remain consistent in the
fourth quarter relative to the same period in the prior year. However, our media
advertising costs will remain volatile during 2006 as we evaluate our markets,
occupancies, and trends.
45
The following table summarizes selected quarterly financial data with respect to
the Same Store Facilities:
Three Months Ended
----------------------------------------------------------------------
March 31, June 30, September 30, December 31, Full Year
------------- -------------- --------------- -------------- ------------
(Amounts in thousands, except for per square foot amounts)
Total rental income:
2005............ $ 196,373 $ 201,522 $ 206,857
2004............ $ 187,227 $ 192,376 $ 197,162 $ 196,420 $ 773,185
Total cost of operations:
2005............ $ 69,164 $ 66,837 $ 66,927
2004............ $ 67,448 $ 66,135 $ 65,616 $ 67,345 $ 266,544
Media advertising expense:
2005............ $ 3,522 $ 2,940 $ 2,309
2004............ $ 3,290 $ 1,956 $ 1,988 $ 3,060 $ 10,294
REVPAF:
2005............ $ 10.25 $ 10.51 $ 10.77
2004............ $ 9.77 $ 10.06 $ 10.31 $ 10.27 $ 10.10
Weighted average realized
annual rent per occupied
square foot for the period:
2005............ $ 11.41 $ 11.41 $ 11.74
2004............ $ 10.90 $ 10.99 $ 11.22 $ 11.31 $ 11.10
Weighted average occupancy
levels for the period:
2005............ 89.9% 92.1% 91.7%
2004............ 89.7% 91.5% 91.9% 90.8% 91.0%
46
ANALYSIS OF REGIONAL TRENDS
The following table sets forth regional trends in our Same Store
Facilities. We believe that net operating income improvements in Florida are
attributable in part to higher demand for storage space resulting from the
series of hurricanes that occurred in the third quarter of 2004 and throughout
the current hurricane season in 2005.
SAME STORE FACILITIES' OPERATING TRENDS BY REGION:
- --------------------------------------------------
Three Months Ended September 30, Nine months ended September 30,
------------------------------------ --------------------------------------
Percentage Percentage
2005 2004 Change 2005 2004 Change
------------ ----------- ---------- ----------- ----------- ----------
(Dollar amounts in thousands)
Rental income:
Southern California (126 facilities).. $ 33,893 $ 31,928 6.2% $ 99,685 $ 93,295 6.8%
Northern California (131 facilities).. 25,987 24,834 4.6% 75,820 73,089 3.7%
Texas (150 facilities)................ 18,408 17,948 2.6% 53,970 53,071 1.7%
Florida (126 facilities).............. 20,108 18,336 9.7% 58,900 53,320 10.5%
Illinois (88 facilities).............. 15,166 14,790 2.5% 44,330 42,994 3.1%
Georgia (58 facilities)............... 7,013 6,465 8.5% 20,419 19,004 7.4%
All other states (581 facilities)..... 86,282 82,861 4.1% 251,628 241,992 4.0%
------------ ----------- ---------- ----------- ----------- ----------
Total rental income....................... 206,857 197,162 4.9% 604,752 576,765 4.9%
------------ ----------- ---------- ----------- ----------- ----------
Cost of operations:
Southern California.................... 7,167 7,042 1.8% 22,002 21,702 1.4%
Northern California.................... 6,446 6,080 6.0% 19,455 18,797 3.5%
Texas.................................. 8,185 7,900 3.6% 24,261 23,789 2.0%
Florida................................ 6,896 7,221 (4.5)% 20,688 21,280 (2.8)%
Illinois............................... 6,087 5,835 4.3% 18,994 19,265 (1.4)%
Georgia................................ 2,315 2,425 (4.5)% 7,071 6,995 1.1%
All other states....................... 29,831 29,113 2.5% 90,457 87,371 3.5%
------------ ----------- ---------- ----------- ----------- ----------
Total cost of operations.................. 66,927 65,616 2.0% 202,928 199,199 1.9%
------------ ----------- ---------- ----------- ----------- ----------
Net operating income (before depreciation):
Southern California.................... 26,726 24,886 7.4% 77,683 71,593 8.5%
Northern California.................... 19,541 18,754 4.2% 56,365 54,292 3.8%
Texas.................................. 10,223 10,048 1.7% 29,709 29,282 1.5%
Florida................................ 13,212 11,115 18.9% 38,212 32,040 19.3%
Illinois............................... 9,079 8,955 1.4% 25,336 23,729 6.8%
Georgia................................ 4,698 4,040 16.3% 13,348 12,009 11.1%
All other states....................... 56,451 53,748 5.0% 161,171 154,621 4.2%
------------ ----------- ---------- ----------- ----------- ----------
Total net operating income................ $ 139,930 $ 131,546 6.4% $ 401,824 $ 377,566 6.4%
------------ ----------- ---------- ----------- ----------- ----------
Weighted average square foot occupancy:
Southern California.................... 92.1% 93.1% (1.1)% 92.4% 91.8% 0.7%
Northern California.................... 91.0% 90.1% 1.0% 90.8% 89.5% 1.5%
Texas.................................. 90.8% 90.6% 0.2% 90.1% 90.2% (0.1)%
Florida................................ 94.4% 93.5% 1.0% 93.2% 92.1% 1.2%
Illinois............................... 90.7% 92.0% (1.4)% 89.8% 90.3% (0.6)%
Georgia................................ 92.8% 92.0% 0.9% 92.3% 91.0% 1.4%
All other states....................... 91.5% 92.1% (0.7)% 91.1% 91.4% (0.3)%
------------ ----------- ---------- ----------- ----------- ----------
Total weighted average occupancy......... 91.7% 91.9% (0.2)% 91.2% 91.1% 0.1%
------------ ----------- ---------- ----------- ----------- ----------
47
SAME STORE FACILITIES' OPERATING TRENDS BY REGION: (CONTINUED)
- --------------------------------------------------------------
Three months ended September 30, Nine months ended September 30,
------------------------------------ --------------------------------------
Percentage Percentage
2005 2004 Change 2005 2004 Change
------------ ----------- ---------- ----------- ----------- ----------
REVPAF:
Southern California................... $16.55 $15.65 5.7% $16.24 $15.23 6.6%
Northern California................... 14.06 13.49 4.2% 13.69 13.24 3.4%
Texas................................. 7.53 7.36 2.3% 7.37 7.26 1.5%
Florida............................... 10.67 9.75 9.4% 10.43 9.42 10.7%
Illinois.............................. 10.76 10.58 1.7% 10.51 10.26 2.4%
Georgia............................... 7.91 7.31 8.2% 7.69 7.16 7.4%
All other states...................... 9.90 9.57 3.5% 9.65 9.30 3.8%
------------ ----------- ---------- ----------- ----------- ----------
Total REVPAF:............................ $10.77 $10.31 4.5% $10.51 $10.05 4.6%
------------ ----------- ---------- ----------- ----------- ----------
Realized annual rent per occupied square foot:
Southern California................... $17.97 $16.81 6.9% $17.57 $16.59 5.9%
Northern California................... 15.45 14.97 3.2% 15.08 14.79 2.0%
Texas................................. 8.30 8.12 2.1% 8.18 8.04 1.7%
Florida............................... 11.30 10.43 8.3% 11.19 10.23 9.4%
Illinois.............................. 11.86 11.50 3.1% 11.70 11.36 3.0%
Georgia............................... 8.53 7.95 7.3% 8.33 7.87 5.8%
All other states...................... 10.82 10.39 4.2% 10.59 10.18 4.0%
------------ ----------- ---------- ----------- ----------- ----------
Total realized annual rent per occupied
square foot:........................... $11.74 $11.22 4.6% $11.53 $11.03 4.5%
------------ ----------- ---------- ----------- ----------- ----------
48
Self-Storage Operations - Acquired Facilities
The "Acquired Facilities," at September 30, 2005, are comprised of 66
self-storage facilities containing 4,574,000 net rentable square feet that were
acquired in 2004 and the first nine months of 2005. The following table
summarizes operating data with respect to these facilities:
ACQUIRED FACILITIES
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------------- --------------------------------------
2005 2004 Change 2005 2004 Change
------------ ------------ ----------- ----------- ---------- ----------
(Dollar amounts in thousands)
Rental income:
Self-storage facilities acquired in 2005.... $ 2,748 $ - $ 2,748 $ 4,625 $ - $ 4,625
Self-storage facilities acquired in 2004.... 7,926 95 7,831 22,376 95 22,281
------------ ------------ ----------- ----------- ---------- ----------
Total rental income....................... 10,674 95 10,579 27,001 95 26,906
------------ ------------ ----------- ----------- ---------- ----------
Cost of operations:
Self-storage facilities acquired in 2005 ... 1,195 - 1,195 2,146 - 2,146
Self-storage facilities acquired in 2004 ... 3,005 103 2,902 9,362 103 9,259
------------ ------------ ----------- ----------- ---------- ----------
Total cost of operations.................. 4,200 103 4,097 11,508 103 11,405
------------ ------------ ----------- ----------- ---------- ----------
Net operating income (loss) before depreciation:
Self-storage facilities acquired in 2005 ... 1,553 - 1,553 2,479 - 2,479
Self-storage facilities acquired in 2004 ... 4,921 (8) 4,929 13,014 (8) 13,022
------------ ------------ ----------- ----------- ---------- ----------
Net operating income before depreciation.... 6,474 (8) 6,482 15,493 (8) 15,501
Depreciation.................................. (2,508) (39) (2,469) (6,571) (39) (6,532)
------------ ------------ ----------- ----------- ---------- ----------
Net operating income........................ $ 3,966 $ (47) $ 4,013 $ 8,922 $ (47) $ 8,969
============ ============ =========== =========== ========== ==========
Weighted average square foot occupancy during
the period:
Self-storage facilities acquired in 2005.... 87.4% - - 70.8% - -
Self-storage facilities acquired in 2004 ... 90.2% 64.4% 40.1% 85.3% 64.4% 32.5%
------------ ------------ ----------- ----------- ---------- ----------
89.4% 64.4% 38.8% 82.5% 64.4% 28.1%
============ ============ =========== =========== ========== ==========
Net rentable square feet (at end of period -
in thousands):
Self-storage facilities acquired in 2005.... 1,469 - 1,469
Self-storage facilities acquired in 2004 ... 3,105 139 2,966
----------- ---------- ----------
4,574 139 4,435
=========== ========== ==========
Number of facilities (at end of period):
Self-storage facilities acquired in 2005.... 21 - 21
Self-storage facilities acquired in 2004 ... 45 2 43
----------- ---------- ----------
66 2 64
=========== ========== ==========
Cost of acquisitions (at end of period -
in thousands):
Self-storage facilities acquired in 2005.... $ 124,753 $ - $ 124,753
Self-storage facilities acquired in 2004 ... 259,487 8,293 251,194
----------- ---------- ----------
$ 384,240 $ 8,293 $ 375,947
=========== ========== ==========
49
During 2004, we acquired 45 facilities at an aggregate cost of
approximately $259,487,000, comprised of three facilities acquired for an
aggregate of $17.8 million, as well as the following larger portfolio
acquisitions:
o Twenty-six facilities acquired in October 2004 from a third party for
an aggregate cost of approximately $102.4 million. This acquisition
increased our presence in the Minneapolis and Milwaukee markets, and
will allow us to cost-effectively introduce media advertising in these
markets, improve our yellow page ad placement, and drive operational
efficiency. In addition, the average rental rates and average
occupancies of these properties, prior to acquisition, were lower than
comparable properties that we currently own in these markets.
o Six facilities acquired in October 2004 in Dallas from a third party
for an aggregate of approximately $19.8 million. We believe that this
acquisition improved our presence in submarkets of Dallas where we were
underrepresented.
o Ten facilities acquired in November 2004 in the Miami market for an
aggregate of $119.5 million. We believe that these properties are
well-built and located in highly desirable submarkets in Miami. These
facilities were built between 1997 and 2003.
In January 2005, we acquired a total of five facilities in New York and
one facility in Illinois for an aggregate of $23,751,000 in cash (an aggregate
of 367,000 net rentable square feet). During the quarter ended June 30, 2005 we
acquired a total of four facilities in New Jersey, two facilities in Illinois
and two facilities in Georgia for an aggregate of $58,705,000 (an aggregate of
553,000 net rentable square feet). In the quarter ended September 30, 2005 we
acquired a total of five facilities in Georgia, one in Florida and one in North
Carolina for an aggregate of $47,297,000 in cash (an aggregate of 549,000 net
rentable square feet).
Revenues and expenses for the 2005 acquisitions, in the table above,
represent the results of these acquisitions from the respective acquisition
dates through September 30, 2005.
In addition to the 21 facilities acquired in the nine months ended
September 30, 2005, we acquired seven additional facilities located in Florida,
New York and California for approximately $78.2 million with 586,000 net
rentable square feet between October 1, 2005 and November 7, 2005. Also, at
November 7, 2005, we are under contract to acquire seven additional facilities
(total approximate net rentable square feet of 481,000) at an aggregate cost of
approximately $70 million, including the assumption of debt on one of these
facilities totaling approximately $5 million. These acquisitions will be funded
entirely by us. Each of these contracts is subject to significant contingencies,
and there is no assurance that any of these facilities will be acquired.
Self-Storage Operations - Expansion Facilities
As a result primarily of expansions to existing self-storage
facilities, the net rentable space at certain of our self-storage facilities has
changed. Accordingly, the operating results are not comparable on a year over
year basis. The operating results for these facilities are presented in the
table below.
50
EXPANSION FACILITIES
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------------- ---------------------------------------
2005 2004 Change 2005 2004 Change
------------ ------------ ---------- ------------- ----------- -----------
(Dollar amounts in thousands)
Rental income:
New Orleans facilities (a).................. $ 1,031 $ 1,510 $ (479) $ 3,986 $ 4,355 $ (369)
Other expansion facilities.................. 10,217 9,287 930 28,997 26,598 2,399
------------ ------------ ---------- ------------- ----------- -----------
Total rental income....................... 11,248 10,797 451 32,983 30,953 2,030
------------ ------------ ---------- ------------- ----------- -----------
Cost of operations:
New Orleans facilities...................... 500 490 10 1,475 1,458 17
Other expansion facilities.................. 3,507 2,990 517 10,465 9,106 1,359
------------ ------------ ---------- ------------- ----------- -----------
Total cost of operations.................. 4,007 3,480 527 11,940 10,564 1,376
------------ ------------ ---------- ------------- ----------- -----------
Net operating income before depreciation:
New Orleans facilities...................... 531 1,020 (489) 2,511 2,897 (386)
Other expansion facilities.................. 6,710 6,297 413 18,532 17,492 1,040
------------ ------------ ---------- ------------- ----------- -----------
Net operating income before depreciation.... 7,241 7,317 (76) 21,043 20,389 654
Depreciation.................................. (2,633) (2,398) (235) (7,571) (7,077) (494)
------------ ------------ ---------- ------------- ----------- -----------
Net operating income........................ $ 4,608 $ 4,919 $ (311) $ 13,472 $ 13,312 $ 160
============ ============ ========== ============= =========== ===========
Weighted average square foot occupancy during
the period:
New Orleans facilities (a).................. 91.7% 91.7% - 90.6% 91.9% (1.4)%
Other expansion facilities.................. 87.7% 85.3% 2.8% 84.8% 84.2% 0.7%
------------ ------------ ---------- ------------- ----------- -----------
88.1% 86.0% 2.4% 85.4% 85.0% 0.5%
============ ============ ========== ============= =========== ===========
Number of facilities (at end of period)........
New Orleans facilities...................... 8 8 -
Other expansion facilities.................. 48 48 -
------------- ----------- ----------
56 56 -
============= =========== ==========
Net rentable square feet (in thousands, at end
of period).....................................
New Orleans facilities...................... 524 524 -
Other expansion facilities - industrial space 426 619 (193)
Other expansion facilities - self-storage
space....................................... 4,032 3,745 287
------------- ----------- ----------
4,982 4,888 94
============= =========== ==========
(a) Physical occupancy remained stable for the quarter September 30, 2005 as
compared to the same period in 2004. However, revenues declined in the
period because we have recorded rent allowances for certain tenants who
still remain as tenants.
Our Expansion Facilities include eight of our facilities located in New
Orleans that were damaged as a result of the impact of Hurricane Katrina. All of
the facilities were closed for operations for several weeks following the
hurricane; however, all but three of these facilities have since reopened. The
five that are operating are not operating at full capacity, as many units are
unavailable for lease due to damage. Two of the three facilities that remain
closed will not be able to reopen at all without substantial restoration and
repair work.
During the quarter ended September 30, 2005, our net operating income
(before depreciation) for these eight facilities was $531,000 compared to
$1,020,000 for the same period last year, a reduction of $489,000, or 48%. For
the first six months of 2005, net operating income (before depreciation) was
$1,980,000 as compared to $1,877,000 for same period in 2004, an increase of
$103,000 or 5%. With respect to the two facilities that have been significantly
damaged and should remain inoperable for the foreseeable future, net operating
income (before depreciation) was $129,000 for the third quarter of 2005 compared
to $255,000 for the same period last year and $463,000 for the first six months
of 2005 compared to $454,000 for same period in 2004.
Notwithstanding that five 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.
51
The remaining 48 facilities contain approximately 4,032,000 net
rentable square feet of self-storage space at September 30, 2005, and 426,000
square feet of industrial space developed for containerized storage activities -
see "Containerized Storage" and "Discontinued Operations". The aggregate
construction costs to complete these expansions totaled approximately $41.3
million since January 1, 2003.
We expect that the Expansion Facilities, other than the New Orleans
facilities, will continue to provide growth to our earnings into 2005 as we
continue to fill the newly added vacant space. The weighted average occupancy
level of these facilities was 84.8% and 84.2% for the nine months ended
September 30, 2005 and 2004, respectively.
Included in our development pipeline are 50 projects that repackage and
expand these existing facilities, with an aggregate estimated cost of $210.3
million at September 30, 2005. These activities will increase our self-storage
space by an aggregate of 3,235,000 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 and structural appeal, provide an important means to improve the
Company's earnings. 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 50 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, 2003. These newly developed
facilities have an aggregate of 5,174,000 net rentable square feet of
self-storage space, and 365,000 net rentable square feet of industrial space
developed originally for our containerized storage business. Aggregate
development cost for these 67 facilities was approximately $523.3 million at
September 30, 2005. 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:
52
DEVELOPED FACILITIES
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------------- --------------------------------------
2005 2004 Change 2005 2004 Change
------------ ------------ ----------- ----------- ------------ ----------
(Dollar amounts in thousands)
Rental income:
Self-storage facilities opened in 2005...... $ 154 $ - $ 154 $ 204 $ - $ 204
Self-storage facilities opened in 2004...... 1,505 399 1,106 3,759 546 3,213
Self-storage facilities opened in 2003...... 3,355 2,520 835 9,410 5,906 3,504
Self-storage facilities opened in 2002 and
2001........................................ 5,607 5,000 607 16,131 13,883 2,248
Combination facilities...................... 4,422 3,770 652 12,394 10,372 2,022
------------ ------------ ----------- ----------- ------------ ----------
Total rental income....................... 15,043 11,689 3,354 41,898 30,707 11,191
------------ ------------ ----------- ----------- ------------ ----------
Cost of operations:
Self-storage facilities opened in 2005...... 187 - 187 304 - 304
Self-storage facilities opened in 2004...... 525 389 136 1,703 792 911
Self-storage facilities opened in 2003...... 1,047 1,171 (124) 3,146 3,301 (155)
Self-storage facilities opened in 2002 and
2001........................................ 1,913 1,797 116 5,893 5,834 59
Combination facilities...................... 1,502 1,446 56 5,007 4,160 847
------------ ------------ ----------- ----------- ------------ ----------
Total cost of operations.................. 5,174 4,803 371 16,053 14,087 1,966
------------ ------------ ----------- ----------- ------------ ----------
Net operating income (loss) before depreciation:
Self-storage facilities opened in 2005...... (33) - (33) (100) - (100)
Self-storage facilities opened in 2004...... 980 10 970 2,056 (246) 2,302
Self-storage facilities opened in 2003...... 2,308 1,349 959 6,264 2,605 3,659
Self-storage facilities opened in 2002 and
2001........................................ 3,694 3,203 491 10,238 8,049 2,189
Combination facilities...................... 2,920 2,324 596 7,387 6,212 1,175
------------ ------------ ----------- ----------- ------------ ----------
Net operating income before depreciation.... 9,869 6,886 2,983 25,845 16,620 9,225
Depreciation.................................. (3,805) (3,608) (197) (11,098) (10,326) (772)
------------ ------------ ----------- ----------- ------------ ----------
Net operating income........................ $ 6,064 $ 3,278 $ 2,786 $ 14,747 $ 6,294 $ 8,453
============ ============ =========== =========== ============ ==========
Weighted average square foot occupancy during the period:
Self-storage facilities opened in 2005...... 29.1% - - 15.0% - -
Self-storage facilities opened in 2004...... 82.0% 42.8% 91.5% 66.3% 33.1% 100.3%
Self-storage facilities opened in 2003...... 91.0% 78.5% 15.9% 86.7% 66.1% 31.2%
Self-storage facilities opened in 2002 and
2001........................................ 93.1% 92.6% 0.5% 92.3% 91.0% 1.4%
Combination facilities...................... 82.1% 87.4% (6.1)% 78.6% 84.0% (6.4)%
------------ ------------ ----------- ----------- ------------ ----------
84.9% 84.0% 1.1% 82.2% 80.4% 2.2%
============ ============ =========== =========== ============ ==========
53
DEVELOPED FACILITIES (Continued)
Nine Months Ended September 30,
-------------------------------
2005 2004 Change
---------- --------- --------
(Dollar amounts in thousands)
Square footage (at end of period):
Self-storage facilities opened in 2005..... 259 - 259
Self-storage facilities opened in 2004..... 505 505 -
Self-storage facilities opened in 2003..... 994 994 -
Self-storage facilities opened in 2002 and
2001....................................... 1,747 1,747 -
Combination facilities - industrial space
(a)........................................ 365 597 (232)
Combination facilities - self-storage
space (a).................................. 1,669 1,316 353
---------- --------- --------
5,539 5,159 380
========== ========= =========
Number of facilities (at end of period):
Self-storage facilities opened in 2005..... 3 - 3
Self-storage facilities opened in 2004..... 7 7 -
Self-storage facilities opened in 2003..... 14 14 -
Self-storage facilities opened in 2002 and
2001....................................... 26 26 -
Combination Facilities ................... 17 17 -
---------- --------- ---------
67 64 3
========== ========= =========
Cumulative development cost (at end of
period):
Self-storage facilities opened in 2005..... $ 15,983 $ - $ 15,983
Self-storage facilities opened in 2004..... 60,573 61,383 (810)
Self-storage facilities opened in 2003..... 107,452 107,452 -
Self-storage facilities opened in 2002 and
2001....................................... 163,926 163,926 -
Combination Facilities (a) ................ 175,370 163,825 11,545
---------- --------- ---------
$523,304 $496,586 $ 26,718
========== ========= =========
(a) The industrial space was originally developed for use by our containerized
storage business. During the fourth quarter of 2004, and the first nine
months of 2005, we have converted industrial space no longer used by the
discontinued containerized storage business into traditional self-storage
space, at an aggregate cost of $11,545,000.
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 operations, the facility is
entirely vacant, generating no rental income. Historically, we estimated that on
average it takes approximately 36 months for a newly developed facility to fill
up and reach a targeted occupancy level of approximately 90%.
We believe that our newly developed facilities are affected by the same
operating trends noted with respect to our Same Store facilities. However,
because such facilities increase their occupancy during their stabilization
period, they tend to offer lower rates, and move-in discounts have a more
pronounced effect upon realized rents because these facilities tend to have a
higher proportion of newer tenants. 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 tenants at higher
rates.
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 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 the related
54
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 cost for these facilities for the nine months
ended September 30, 2005, based upon net operating income before depreciation,
was approximately 6.6%, which is lower than our ultimate yield expectations. We
expect these yields to improve as these facilities continue to fill up and reach
a stabilized occupancy level as well as stabilized rental rates.
Our newly developed facilities have been subject to the same factors
denoted above with respect to our Same Store Facilities. The facilities
developed in 2001 and 2002 have contributed to our earnings growth, with net
operating income before depreciation increasing $2,189,000, or 27.2%, in the
nine months ended September 30, 2005 as compared to the same period in 2004
($491,000, or 15.3%, for the quarter ended September 30, 2005 as compared to the
same period in 2004). This growth was primarily due to higher rental rates
during the 2005 period as compared to the same period in 2004, as the tenant
base continues to mature and existing tenants, who moved in at lower rates, have
their rates increased or are replaced with higher-rent tenants.
Properties developed in 2003 had increases in net operating income of
$3,659,000 for the nine months ended September 30, 2005 as compared to the same
period in 2004, through a combination of an increase in average occupancies from
66.1% for the nine months ended September 30, 2004 to 86.7% for the same period
in 2005, and an increase in rates. The facilities developed in 2004 and 2005 had
increases in net operating income, primarily due to the physical fill-up of
these facilities.
With respect to our Combination Facilities, we have been steadily
converting this industrial space into self-storage space. As of September 30,
2005, 11 of the 17 Combination Facilities have been converted into entirely
self-storage. The remaining six facilities are expected to be converted over the
next two years. Weighted average square foot occupancy levels for the
Combination Facilities was 82.1% for the quarter ended September 30, 2005 as
compared to 87.4% for the same period in 2004, the decrease due to the addition
of additional net rentable square feet.
We continue to develop facilities, despite the short-term earnings
dilution experienced during the fill-up period, because we believe that the
ultimate returns on developed facilities are favorable. In addition, we believe
that it is advantageous for us to continue to expand our asset base and benefit
from the resultant increased critical mass, with facilities that will improve
our portfolio's overall average construction and location quality.
We expect that over the next 24 months, the Developed Facilities will
continue to have a negative impact to our earnings when also considering
financing costs with respect to the invested capital. Furthermore, the 57
expansion and newly developed facilities in our development pipeline, described
in "Liquidity and Capital Resources - Acquisition and Development of Facilities"
that will be opened for operation over the next 24 months are also expected to
negatively impact our earnings until they reach a stabilized occupancy level.
Our earnings will continue to be negatively impacted by any future newly
developed facilities until they reach a stabilized occupancy level.
COMMERCIAL PROPERTY OPERATIONS: Commercial property operations included
in our consolidated financial statements include commercial space owned by the
Company and 36 controlled entities (the "Consolidated Entities"). 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.
Our commercial operations are comprised of 1,040,000 net rentable
square feet of commercial space operated at certain of the self-storage
facilities, and three stand-alone commercial facilities having a total of
215,000 net rentable square feet.
55
The results of our commercial operations are provided in the table
below:
Commercial Property Operations:
(excluding discontinued operations)
Three Months Ended September 30, Nine Months Ended September 30,
---------------------------------- -----------------------------------
2005 2004 Change 2005 2004 Change
------------ ----------- --------- ----------- ---------- ----------
Rental income......................... $ 2,918 $ 2,707 $ 211 $ 8,693 $ 8,064 $ 629
Cost of operations................... (1,122) (1,031) (91) (3,292) (3,200) (92)
------------ ----------- --------- ----------- ---------- ----------
Net operating income............... 1,796 1,676 120 5,401 4,864 537
Depreciation......................... (562) (464) (98) (1,721) (1,574) (147)
------------ ----------- --------- ----------- ---------- ----------
Operating income................... $ 1,234 $ 1,212 $ 22 $ 3,680 $ 3,290 $ 390
============ =========== ========= =========== ========== ==========
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
2005.
CONTAINERIZED STORAGE OPERATIONS:
We have closed many of our containerized storage facilities in 2002,
2003, and 2004, and have refined our market and product focus to twelve
facilities located in eight densely populated markets with above-average rent
and income. The operations with respect to the facilities other than the twelve
ongoing facilities are included in "Discontinued Operations" on our income
statement. The operations of the twelve remaining facilities are included in
continuing operations and are reflected on the table below:
Containerized Storage:
(excluding discontinued operations)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- -----------------------------------
2005 2004 Change 2005 2004 Change
---------- --------- --------- ---------- ---------- -----------
(Amounts in thousands)
Rental and other income ............ $ 4,480 $ 5,048 $ (568) $12,305 $ 15,099 $ (2,794)
Cost of operations.................. (3,676) (3,073) (603) (9,692) (8,741) (951)
---------- --------- --------- ---------- ---------- -----------
Net operating income............. 804 1,975 (1,171) 2,613 6,358 (3,745)
Depreciation expense (a)............ (313) (1,072) 759 (2,490) (3,298) 808
---------- --------- --------- ---------- ---------- -----------
Operating income................ $ 491 $ 903 $ (412) $ 123 $ 3,060 $ (2,937)
========== ========= ========= ========== ========== ===========
(a) Depreciation expense principally relates to the depreciation of containers;
however, depreciation expense for the three and nine months ended September
30, 2005 includes $262,000 and $786,000, related to real estate facilities
compared to $258,000 and $764,000 for the same periods in 2004,
respectively.
Rental and other income includes monthly rental charges, net of
discounts, 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. Rental income decreased to $4,480,000 and $12,305,000 for the three and
nine months ended September 30, 2005 from $5,048,000 and $15,099,000 for the
same period in 2004, primarily as a result of the elimination of these non-core
services and a decline in average occupancy. At September 30, 2005, there were
approximately 22,410 occupied containers in the continuing facilities as
compared to 22,672 at September 30, 2004.
Direct operating costs principally includes payroll, equipment lease
expense, utilities and vehicle expenses. While the costs associated with the
eliminated non-core services were reduced, these reductions were substantially
56
offset by increased marketing expenditures, primarily yellow page advertising
and television media costs, which increased in the aggregate by $1,007,000 and
$1,808,000 for the three and nine months ended September 30, 2005 compared to
the same periods in 2004.
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.
TENANT REINSURANCE OPERATIONS: Through a subsidiary of the Company, we
reinsure policies against losses to goods stored by tenants in our self-storage
facilities. The tenant reinsurance operations are included in the income
statement under "Revenues - tenant reinsurance premiums" and "Cost of operations
- - tenant reinsurance." Revenues totaled $18,499,000 and $18,266,000 for the nine
months ended September 30, 2005 and 2004, respectively, and cost of operations
totaled $7,560,000 and $11,089,000, respectively. The tenant reinsurance
business earned net operating income of $10,939,000 and $7,177,000,
respectively.
As a result of hurricanes which occurred in the third quarter of 2005,
we have accrued $500,000 for estimated tenant claims for insured losses.
An accrual in the amount of $1,500,000 was recorded in the quarter
ended September 30, 2004 as a result of hurricanes which occurred during the
period for estimated tenant claims for insured losses. To date we have paid
approximately $500,000 in claims. Based upon historical trends and the lapse of
time, during the quarter ended June 30, 2005, we decreased our estimated future
claims accrual by $500,000, reducing cost of operations in the quarter.
Our tenant reinsurance revenues are dependent upon our occupancy level,
the level of move-in activity, the level of new tenants that opt for insurance,
and the time that such tenants remain as insured tenants. For the nine months
ended September 30, 2005 and 2004, approximately 33% and 35%, respectively, of
our self-storage tenant base had such policies. Tenant insurance expense is
attributable primarily to the level of claims.
We have outside third-party insurance coverage for losses from any
individual event that exceeds a loss of $500,000, to a limit of $10,000,000.
Losses below these amounts are accrued as cost of operations for the tenant
reinsurance operations.
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, 2005 (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, 2005 and 2004 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:
57
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------- -----------------------------------
2005 2004 Change 2005 2004 Change
---------- ---------- ----------- --------- ---------- ---------
(Amounts in thousands)
Property operations:
PSB $17,737 $15,959 $1,778 $51,865 $49,753 $2,112
Acquisition Joint Venture.............. 75 21 54 189 21 168
Other investments (1).................. 2,044 1,723 321 5,914 4,993 921
---------- ---------- ----------- --------- ---------- ---------
19,856 17,703 2,153 57,968 54,767 3,201
---------- ---------- ----------- --------- ---------- ---------
Depreciation:
PSB.................................... (8,352) (8,119) (233) (24,887) (23,875) (1,012)
Acquisition Joint Venture.............. (68) (31) (37) (202) (31) (171)
Other investments (1).................. (402) (371) (31) (1,176) (1,149) (27)
---------- ---------- ----------- --------- ---------- ---------
(8,822) (8,521) (301) (26,265) (25,055) (1,210)
---------- ---------- ----------- --------- ---------- ---------
Other: (2)
PSB (3)................................ (1,134) (6,273) 5,139 (11,149) (18,615) 7,466
Other investments (1).................. (47) 275 (322) (172) 549 (721)
---------- ---------- ----------- --------- ---------- ---------
(1,181) (5,998) 4,817 (11,321) (18,066) 6,745
---------- ---------- ----------- --------- ---------- ---------
Total equity in earnings of real estate
entities.................................. $9,853 $3,184 $6,669 $20,382 $11,646 $8,736
========== ========== =========== ========= =========== =========
(1) 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, 2005 and 2004.
(2) "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 $131,000 and $375,000 for the three and nine months
ended September 30, 2005, as compared to $211,000 and $1,157,000,
respectively, for the same periods in 2004.
(3) "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.
The increase in equity in earnings of real estate entities for the
three and nine months ended September 30, 2005 as compared to the same period in
2004 is principally due to our pro-rata share of PSB's gain on sale of real
estate assets combined with a reduction in our share of PSB's EITF D-42 charge.
Our net pro-rata share of these items resulted in an increase in equity in
earnings of $5,458,000 and $7,033,000 for the three and nine months ended
September 30, 2005, as compared to a net decrease in equity earnings of
$1,092,000 and $2,109,000, respectively, for the same periods in 2004.
Equity in earnings of PSB represents our pro-rata share (an average of
approximately 44% for the nine months ended September 30, 2005 and 2004) of the
earnings of PSB. Throughout 2004 and the first nine months of 2005, 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, 2005, PSB owned and operated 17.4 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, 2005 pursuant to
property management agreements.
Our future equity income from PSB will be dependent entirely upon PSB's
operating results. 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
58
more fully in Note 2 to the Consolidated Financial Statements for the quarter
ended September 30, 2005, 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 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 seven limited partnerships, for which we held an approximately
consistent level of equity interest throughout 2004 and the first nine months of
2005. 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 property management fee that is included in "Interest and Other
Income" on our condensed consolidated income statement. The limited partners
consist of numerous individual investors, including the Company, which
throughout the 1990's acquired units 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 36 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 5 to the consolidated financial statements for the operating results of
these entities for the nine months ended September 30, 2005 and 2004.
OTHER INCOME AND EXPENSE ITEMS
- ------------------------------
INTEREST AND OTHER INCOME: Interest and other income includes (i) the
net operating results from our third party property management operations, (ii)
the net operating results from our merchandise sales and consumer truck rentals
and (iii) interest income principally from cash reserves.
Interest and other income was $7,376,000 and $16,698,000 for the three
and nine months ended September 30, 2005, respectively, as compared to
$3,300,000 and $7,240,000, respectively, for the same periods in 2004. This
increase is due primarily to higher interest income on cash balances due to
higher average interest rates combined with improved operations of our truck,
retail, and property management operations, as described below.
Included in our interest and other income is net income for our truck,
retail, and property management operations of approximately $2,872,000 and
$1,746,000 for the three months ended September 30, 2005 and 2004, respectively,
and $5,831,000 and $3,498,000 for the nine months ended September 30, 2005 and
2004, respectively. These increases are due primarily due to our retail
operations that have improved largely due to the increase in the number of
facilities in the portfolio.
As discussed more fully in "Liquidity and Capital Resources" below, at
September 30, 2005, we had cash balances totaling approximately $532 million,
which includes significant proceeds from recent equity issuances. These balances
are typically invested in short-term low-risk securities. The future level of
interest and other income will be partially dependent upon the timing of our
investment of these unused offering proceeds and the level of interest earned on
these short-term investments. For the three months ended September 30, 2005
average interest rates on cash reserves was approximately 3.5% as compared to
1.5% for the same period in 2004.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization expense
was $47,917,000 and $144,136,000 for the three and nine months ended September
30, 2005, respectively, as compared to $44,354,000 and $135,447,000 for the same
period in 2004. The increase in depreciation and amortization for the three and
nine months ended September 30, 2005 as compared to the same period in 2004 is
due primarily to increased depreciation with respect to newly developed and
acquired facilities, offset partially by a reduction in depreciation with
respect to maintenance capital expenditures.
Included in depreciation expense with respect to our real estate
facilities was $44,890,000 and $134,024,000 for the three and nine months ended
September 30, 2005, respectively, as compared to $40,851,000 and $124,961,000
for the same period in 2004, respectively. The increase in depreciation and
amortization with respect to real estate facilities for the three and nine
months ended September 30, 2005 as compared to the same period in 2004 is due
primarily to an increase in depreciation with respect to newly developed and
59
acquired facilities. Depreciation expense with respect to other assets was
$1,376,000 and $5,159,000 for the three and nine months ended September 30,
2005, respectively, as compared to $1,852,000 and $5,533,000 for the same period
in 2004, respectively. Depreciation expense also includes $1,651,000 and
$4,953,000 for each of the three and nine months, respectively, ended September
30, 2005 and 2004, relating to the amortization of property management
contracts.
Depreciation and amortization for the three months ended September 30,
2005 with respect to developed and acquired real estate facilities added during
the quarter ended September 30, 2005 amounted to approximately $140,000. We
expect that the quarterly depreciation and amortization expense, with respect to
these facilities, will approximate $359,000 for quarters beginning with fourth
quarter of 2005.
GENERAL AND ADMINISTRATIVE: General and administrative expense was
$5,621,000 and $16,890,000 for the three and nine months ended September 30,
2005, as compared to $5,527,000 and $15,983,000 for the same period in 2004,
representing an increase of approximately $94,000 and $907,000, respectively.
General and administrative expense principally consists of state income taxes,
investor relations expense and corporate and executive salaries. In addition,
general and administrative expense includes expenses that vary greatly 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, stock-based compensation and product research and development
expenditures.
The increase in general and administrative expense for the three and
nine months ended September 30, 2005 as compared to the same period in 2004 is
due to increased restricted stock and stock option expense attributable to
additional grants of restricted stock units and stock options, combined with
increased professional fees. These impacts were partially offset in the nine
month period as a result of a $450,000 reduction in legal liabilities recorded
in the quarter ended March 31, 2005, as well as a decrease in employee
termination costs during the nine months ended September 30, 2005 as compared to
the same period in 2004.
INTEREST EXPENSE: Interest expense was $2,471,000 and $5,928,000 for
the three and nine months ended September 30, 2005, respectively, and $100,000
for the nine months ended September 30, 2004 (none for the three months ended
September 30, 2004). Interest capitalized during the three and nine months ended
September 30, 2005 was $710,000 and $2,054,000, respectively, as compared to
$685,000 and $2,722,000 for the three and nine months ended September 30, 2004.
The increase in interest expense is due to (i) $94.7 million in debt assumed, at
an average interest rate of approximately 5.2%, in connection with property
acquisitions in 2004, (ii) $35.6 million in debt to our Acquisition Joint
Venture Partner at an average interest rate of 8.5%, as described more fully in
Note 8 to the consolidated financial statements for the quarter ended September
30, 2005, (iii) $64.5 million in debt to related party recorded in connection
with the acquisition of minority interest described in Note 9 to the September
30, 2005 financial statements, combined with a reduction in capitalized interest
due to lower development balances. See Notes 7, 8 and 9 to the September 30,
2005 consolidated financial statements for schedules and further discussion on
our debt balances, principal repayment requirements, and average interest rates.
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, 2005 and 2004:
60
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------------- -----------------------------------------
2005 2004 Change 2005 2004 Change
----------- ----------- ---------- ----------- ------------ -----------
(Amounts in thousands)
Preferred partnership interests:
Ongoing distributions (b).......... $ 3,591 $ 5,176 $ (1,585) $ 12,556 $ 16,907 $ (4,351)
Special Distribution and EITF
Topic D-42 allocations (a)....... - - - 874 10,063 (9,189)
Consolidated Development Joint Venture (c) 826 1,563 (737) 4,229 3,940 289
Convertible Partnership Units (d)....... 148 88 60 350 219 131
Acquired minority interests (e) ........ 120 884 (764) 1,197 3,224 (2,027)
Other minority interests (f)............ 2,558 1,810 748 7,149 5,545 1,604
----------- ----------- ---------- ----------- ------------ -----------
Total minority interests in income.. $ 7,243 $ 9,521 $ (2,278) $ 26,355 $ 39,898 $ (13,543)
=========== =========== ========== =========== ============ ===========
(a) As described more fully below, holders of $200 million of our Series N
preferred partnership units agreed to a restructuring which included
reducing their distribution rate from 9.5% to 6.4% in exchange for a
special distribution of $8,000,000. This special distribution, combined
with $2,063,000 in costs incurred at the time the units were originally
issued that were charged against income in accordance with the Securities
and Exchange Commissions clarification of EITF Topic D-42, are included in
minority interest in income for the nine months ended September 30, 2004 as
are $874,000 in such original issuance cost with respect to the nine months
ended September 30, 2005 based on the redemption of preferred units.
(b) The decrease in ongoing distributions is due to the reduction in the rate
on $200 million of the preferred partnership units from 9.5% to 6.4%,
effective March 22, 2004, the redemption of $40 million of our 9.5% Series
N Preferred Units on March 17, 2005 and $45 million of our 9.125% Series O
Preferred units on March 29, 2005. These impacts were partially offset by
the issuance of $25 million of our 6.25% Series Z Preferred Units in the
connection with an acquisition in the fourth quarter of 2004.
(c) These amounts reflect income allocated to the minority interests in the
Consolidated Development Joint Venture. Included in minority interest in
income is $322,000 and $2,051,000 in depreciation expense for the three and
nine months ended September 30, 2005, respectively, as compared to $887,000
and $2,741,000 for the same periods in 2004.
(d) These amounts reflect the minority interests represented by the Convertible
Partnership Units (see Note 8 to the consolidated financial statements).
Included in minority interest in income is $88,000 and $264,000 in
depreciation expense for the three and nine months ended September 30,
2005, respectively, as compared to $81,000 and $247,000 for the same
periods in 2004.
(e) These amounts reflect income allocated to minority interests that the
Company acquired in 2004 and the first nine months of 2005 and are no
longer outstanding at September 30, 2005. Included in minority interest in
income is $31,000 and $295,000 in depreciation expense for the three and
nine months ended September 30, 2005, respectively, as compared to $250,000
and $1,051,000 for the same periods in 2004.
(f) These amounts reflect income allocated to minority interests that were
outstanding consistently throughout the three and nine months ended
September 30, 2005 and 2004. Included in minority interest in income is
$162,000 and $536,000 in depreciation expense for the three and nine months
ended September 30, 2005, respectively, as compared to $339,000 and
$812,000 for the same periods in 2004.
On June 30, 2004, we acquired minority interests in one of the
consolidated entities for an aggregate of $24,851,000 in cash. In January 2005,
we acquired additional minority interest for an aggregate of $4,366,000 in cash.
In April 2005, we acquired minority interest for an aggregate of $32,432,000 in
cash. In August 2005, we acquired additional minority interests for an aggregate
of $14,597,000 in cash. The income allocated to these interests is included in
the table above under the "Acquired Minority Interests."
On March 22, 2004, certain investors who held $200 million of our 9.5%
Series N Cumulative Redeemable Perpetual Preferred Units agreed, in exchange for
a special distribution of $8,000,000, to a reduction in the distribution rate on
their preferred units from 9.50% per year to 6.40% per year, and an extension of
the call date for these securities to March 17, 2010. The investors also
received their distribution that accrued from January 1, 2004 through the
effective date of the exchange.
61
As a result of this agreement, income allocable to minority interests
increased, and the Company's net income decreased $10,063,000 due to (i) the
$8,000,000 cash payment to the holders of the preferred units and (ii) the
application of the SEC Observer's recent clarification of EITF Topic D-42, "The
Effect on the Calculation of Earnings per Share for the Redemption or Induced
Conversion of Preferred Stock" totaling $2,063,000, which represents the excess
of the $200 million stated amount of the preferred units over their carrying
amount.
Our minority interest partner in the Consolidated Development Joint
Venture is PSAC Storage Investors, LLC, a partnership that was owned by a third
party institutional investor and Mr. Hughes, the Company's Chairman. On August
5, 2005, we acquired the institutional investors interest in PSAC Investors,
LLC. As part of the acquisition, we also obtained and subsequently exercised the
right to acquire Mr. Hughes' interest on November 17, 2005. As a result of these
events: (i) we ceased allocating income to minority interests with respect to
the Consolidated Development Joint Venture effective August 5, 2005 and (ii) Mr.
Hughes' interest in the Consolidated Development Joint Venture has been
classified as debt on our balance sheet and income with respect to Mr. Hughes'
interest in the Consolidated Development Joint Venture for the period from
August 5, 2005 through September 30, 2005, has been classified as interest
expense on our income statement.
Other minority interests reflect income allocated to minority interests
that have maintained a consistent level of interest throughout 2004 and the
three and nine months ended September 30, 2005, comprised of investments in the
Consolidated Entities described in Note 9 to the Company's 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.
Discontinued Operations: During the nine months ended September 30,
2005, we designated one of our self-storage facilities that was the subject of a
condemnation proceeding as a discontinued facility. This facility is referred to
as the "Eminent Domain Facility" and we received the proceeds from the sale of
this facility during the third quarter of 2005 and recorded a gain of $5.2
million.
During the third quarter of 2004, we entered into an agreement to sell
one of our commercial facilities located in West Palm Beach, Florida. The
facility sale closed on October 28, 2004. This facility is referred to as the
"Sold Commercial Facility".
As described more fully in Note 3 to the 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."
The current and prior period operations for the Eminent Domain
Facility, the Sold Commercial Facility and the Closed Facilities have been
reclassified into the line-item "Discontinued Operations" on our consolidated
income statement.
The following table summarizes the historical operations of the Eminent
Domain Facility, the Sold Commercial Facility and the Closed Facilities:
62
Discontinued Operations:
Three Months Ended September 30, Nine Months Ended September 30,
----------------------------------- -----------------------------------
2005 2004 Change 2005 2004 Change
------------ ----------- ---------- ---------- ---------- ----------
(Amounts in thousands) (Amounts in thousands)
Rental income:
Closed Facilities............... $ - $1,740 $ (1,740) $ 95 $6,267 $(6,172)
Eminent Domain Facility......... 161 165 (4) 461 505 (44)
Sold Commercial Facility........ - 105 (105) - 279 (279)
------------ ----------- ---------- ---------- ---------- ----------
Total rental income............... 161 2,010 (1,849) 556 7,051 (6,495)
------------ ----------- ---------- ---------- ---------- ----------
Cost of operations:
Closed Facilities............... - (1,154) 1,154 (194) (5,176) 4,982
Eminent Domain Facility......... (45) (73) 28 (220) (166) (54)
Sold Commercial Facility........ - (26) 26 - (63) 63
------------ ----------- ---------- ---------- ---------- ----------
Total cost of operations.......... (45) (1,253) 1,208 (414) (5,405) 4,991
------------ ----------- ---------- ---------- ---------- ----------
Depreciation expense:
Closed Facilities............... - (306) 306 (29) (1,031) 1,002
Eminent Domain Facility......... (20) (21) 1 (59) (68) 9
Sold Commercial Facility........ - (25) 25 - (74) 74
------------ ----------- ---------- ---------- ---------- ----------
Total depreciation ............... (20) (352) 332 (88) (1,173) 1,085
Other items....................... 5,180 (1,406) 6,586 6,323 (1,991) 8,314
------------ ----------- ---------- ---------- ---------- ----------
Net discontinued operations....... $ 5,276 $(1,001) $ 6,277 $ 6,377 $(1,518) $ 7,895
============ =========== ========== ========== ========== ==========
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.
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.
63
Nine Months Ended September 30,
------------------------------------
2005 2004
---------------- ----------------
(Amounts in thousands)
Net cash provided by operating activities....................... $ 515,662 $ 477,597
Distributions to minority interest (Preferred Units) - ongoing.. (12,556) (16,907)
Distributions to minority interest (Preferred Units) - special (a) - (8,000)
Distributions to minority interest (common equity) (b).......... (11,805) (16,986)
---------------- ----------------
Cash from operations available to our shareholders.............. 491,301 435,704
Capital improvements to maintain our facilities................. (13,286) (20,297)
---------------- ----------------
Remaining operating cash flow available for distributions to our
shareholders................................................ 478,015 415,407
Distributions paid:
Preferred stock dividends..................................... (126,286) (117,293)
Equity Stock, Series A dividends.............................. (16,087) (16,126)
Distributions to Common shareholders.......................... (179,822) (172,474)
---------------- ----------------
Cash available for principal payments on debt and reinvestment.. $ 155,820 $ 109,514
================ =================
(a) The $8 million special distribution was paid to a unitholder of our 9.5%
Series N Cumulative Redeemable Perpetual Preferred Units in conjunction
with a March 22, 2004 agreement that, among other things, lowered the
distribution rate from 9.5% to 6.4%.
(b) Represents distributions to the common interests we do not own in the
Consolidated Entities.
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, 2005, 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 million line of credit as temporary "bridge"
financing and repaid those amounts with internally generated cash flows and
proceeds from the placement of permanent capital. At September 30, 2005, we had
no outstanding borrowings under our $200 million bank line of credit.
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, 2005, we had mortgage debt outstanding of $92.7
million (which encumbers 34 facilities with a book value of approximately $198
million) and unsecured debt in the amount of $22.4 million. We also have Debt to
Joint Venture Partner amounting to $35.7 million with respect to ten real estate
facilities with an aggregate book value of approximately $49 million, as well as
$64.5 million in debt to related party with respect to 22 facilities with a net
book value of $96 million.
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RECENT ISSUANCE OF PREFERRED STOCK AND PROJECTED 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.
We believe that our size and financial flexibility enables us to access
capital when appropriate. Since the beginning of 2005 through September 30,
2005, we have raised approximately $476.3 million of our Cumulative Preferred
Stock, and used approximately $142.5 million of these net proceeds in order to
redeem higher-coupon preferred securities.
On January 19, 2006, we intend to redeem our 8.6% Series Q Cumulative
Preferred Stock totaling $172.5 million. We anticipate that this redemption will
be funded with current cash on-hand. In addition, in September 2006 and October
2006, we have the option to redeem our 8.0% Series R and 7.875% Series S
Cumulative Preferred Stock, respectively, requiring aggregate funding of
approximately $653.8 million. From time-to-time, we may raise additional capital
primarily through the issuance of lower rate preferred securities, in advance of
the redemption dates to ensure that we have available funds to redeem these
securities. The timing and our ability to issue additional preferred securities
are dependent on many factors. There is no assurance that we will be able to
raise the necessary capital and at appropriate rates to redeem these securities.
REQUIREMENT TO PAY DISTRIBUTIONS: We estimate the distribution
requirement with respect to our Preferred Stock outstanding at November 7, 2005
to be approximately $185.4 million per year. We estimate that the annual
distribution requirement with respect to the preferred partnership units
outstanding at September 30, 2005 to be approximately $14.4 million per year.
During the nine months ended September 30, 2005, we paid cash dividends
totaling $16,087,000 to the holders of our Equity Stock, Series A, as compared
to $16,126,000 for the same period in 2004. 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 of not less than the lesser of (i) five times the
per share dividend on the common stock or (ii) $2.45 per share. 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, 2005, we estimate the total regular distribution
for the fourth quarter of 2005 to be approximately $5.4 million.
During the nine months ended September 30, 2005, we paid dividends
totaling $179,822,000 ($1.40 per common share) to the holders of our common
stock. Based upon shares outstanding at September 30, 2005 and a quarterly
distribution of $0.50 per share, which was declared by the Board of Directors on
October 27, 2005, we estimate a dividend payment with respect to our common
stock of approximately $64.0 million for the fourth quarter of 2005.
CAPITAL IMPROVEMENT REQUIREMENTS: For 2005, we budgeted approximately
$30 million for capital improvements. During the nine months ended September 30,
2005, we incurred capital improvements of approximately $13.3 million. 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 expect capital expenditures
for 2006 to be higher than the capital expenditures we have budgeted for 2005.
DEBT SERVICE REQUIREMENTS: We do not believe we have any significant
refinancing risks with respect to our debt, all of which is fixed rate. At
September 30, 2005, we had total outstanding debt of approximately $215.2
million. See Notes 7, 8 and 9 to the consolidated financial statements for
approximate principal maturities of such borrowings.
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 debt as opposed to refinance debt maturities
with additional debt.
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ACQUISITION AND DEVELOPMENT OF REAL ESTATE FACILITIES: During 2005, 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. For 2005, we do not anticipate that our joint
venture partnerships will fund additional acquisitions from third parties or
developments, all of which we expect to be funded entirely by the Company.
In addition to the facilities acquired in the nine months ended
September 30, 2005, we acquired seven additional facilities for approximately
$78.2 million with 586,000 net rentable square feet between October 1, 2005 and
November 7, 2005. Also, at November 7, 2005, we are under contract to acquire
seven additional facilities (total approximate net rentable square feet of
481,000) at an aggregate cost of approximately $70 million, including the
assumption of debt amounting to approximately $5 million. These acquisitions
will be funded entirely by us. Each of these contracts is subject to significant
contingencies.
On January 18, 2005, we acquired an interest in the Consolidated
Entities for cash totaling $4.4 million, on April 22, 2005 we acquired an
additional interest in the Consolidated Entities for an aggregate of $32.4
million, and on August 12, 2005, we acquired interest in the Consolidate
Entities for cash totaling $14.6 million.
As described more fully in Note 9 to our September 30, 2005 financial
statements, on August 5, 2005, we acquired the third party institutional
investor's interest in PSAC Storage Investors, LLC for approximately $41.4
million in cash. On November 17, 2005, we will acquire Mr. Hughes' interest in
PSAC Storage Investors, LLC for approximately $64.5 million in cash. This
acquisition will be funded from cash on-hand.
At September 30, 2005 we have a development "pipeline" of 57 projects
consisting of self-storage facilities, conversion of space at facilities that
was previously used for containerized storage and expansions to existing
self-storage facilities with an aggregate estimated cost of approximately $291.3
million. At September 30, 2005, we have acquired the land for 55 of these
projects, which have an aggregate estimated cost of approximately $276.6
million, and costs incurred as of September 30, 2005 of approximately $50.2
million. The remaining facilities represent identified sites where we have an
agreement in place to acquire the land, generally within one year. We anticipate
that the development of these projects will be funded solely by the Company.
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 of approximately $240.4
million will be incurred over the next 24 months. The following table sets forth
certain information with respect to our development pipeline.
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DEVELOPMENT PIPELINE SUMMARY (as of September 30, 2005):
Total
Number Net estimated Costs incurred
of rentable development through Costs to
projects sq. ft. costs 9/30/05 complete
--------- -------- ------------- --------------- ---------
(Amounts in thousands, except number of projects)
Facilities currently under construction:
Self-storage facilities 5 439 $ 63,699 $ 34,291 $ 29,408
Expansions and other enhancements to
existing self-storage facilities 14 799 39,384 12,829 26,555
--------- -------- ------------- --------------- ---------
19 1,238 103,083 47,120 55,963
Facilities awaiting construction, where land
is acquired:
Self-storage facilities 1 57 6,084 2,126 3,958
Expansions and other enhancements to
existing self-storage facilities 35 2,392 167,476 991 166,485
--------- -------- ------------- --------------- ---------
36 2,449 173,560 3,117 170,443
Self-storage facilities awaiting
construction, where land has not yet been
acquired:
Self-storage facilities 1 83 11,190 592 10,598
Expansions and other enhancements to
existing self-storage facilities 1 44 3,435 70 3,365
--------- -------- ------------- --------------- ---------
2 127 14,625 662 13,963
--------- -------- ------------- --------------- ---------
Total Development Pipeline 57 3,814 $ 291,268 $ 50,899 $240,369
========= ======== ============= =============== ==========
Included in the 50 "expansions and other enhancements of existing
self-storage facilities" are 12 projects associated with the conversion of
industrial space, previously used by the discontinued containerized storage
operations, into self-storage space. The total amount of self-storage space to
come on line from these 12 conversions is approximately 926,000 net rentable
square feet of traditional self-storage space at a cost of $33,168,000. Also
included are enhancements which, while they do not add significant incremental
square footage, improve the visual and structural appeal of our existing
self-storage facilities.
PROPOSAL TO ACQUIRE SHURGARD STORAGE CENTERS: In July 2005, we made an
unsolicited proposal for the combination of the Company and Shurgard Storage
Centers, Inc. (NYSE:SHU) through a merger in which each share of SHU common
stock would be exchanged for .80 shares of our common stock. SHU rejected our
proposal.
Recently, SHU announced that its Board of Directors had authorized
SHU's management and financial advisors to explore strategic alternatives to
maximize shareholder value, including without limitation a sale of SHU,
formation of asset joint ventures with strategic partners, a sale of certain
assets or operations, and continued implementation of SHU's strategic business
plan.
We may amend, modify, withdraw or otherwise change our proposal whether
in response to SHU's exploration of strategic alternatives or otherwise,
including without limitation to increase or decrease the amount and nature of
the consideration offered, including to offer a higher or lower exchange ratio
or greater or lower per share consideration consisting in part or in whole of
cash or other consideration, to change the structure of the proposed transaction
or change the method of financing any such transaction. In reaching any
conclusion as to our future course of action, we will take into consideration
67
various factors, such as the business and prospects of our business and SHU's
business, other factors concerning us and SHU, including factors in connection
with SHU's announced exploration of strategic alternatives, other business
opportunities available to us, and general economic and stock market conditions.
If we do not make any changes to our proposal and acquire SHU for .80
shares of our common stock, the acquisition would (1) increase the number of
shares of our common stock from approximately 128,034,490 to 165,469,258, (2)
increase the liquidation preference of our preferred stock from $2,570,900,000
to $2,707,150,000 (including $50,000,000 issued on October 3, 2005) and (3)
increase our debt from approximately $215,227,000 to an estimated $2,045,424,000
(assuming no prepayment). Alternative transactions involving a higher or lower
exchange ratio or greater or lower per share consideration consisting in part or
in whole of cash or other consideration would result in different pro forma
impacts on our company and balance sheet. Our estimate of SHU's debt, preferred
and common shares outstanding is from SHU's September 30, 2005 balance sheet
included in its earnings press release for the period ended September 30, 2005
and our information is per our September 30, 2005 balance sheet.
SHU has reported that it is a real estate investment trust that
operates approximately 644 self-storage facilities in the United States and
Europe.
REPURCHASES OF THE COMPANY'S COMMON STOCK: The Company's Board of
Directors authorized the repurchase from time to time of up to 25,000,000 shares
of our common stock on the open market or in privately negotiated transactions.
For the nine months ended September 30, 2005, we repurchased 84,000 shares of
our common stock for approximately $4,990,000.
From the initial authorization through September 30, 2005, we have
repurchased a total of 22,201,720 shares of common stock at an aggregate cost of
approximately $567.1 million.
ITEM 2A. RISK FACTORS
In addition to the other information in our Form 10-Q and our Form 10-K
for the year ended December 31, 2004, you should consider the following factors
in evaluating the Company:
THE HUGHES FAMILY COULD CONTROL US AND TAKE ACTIONS ADVERSE TO OTHER
SHAREHOLDERS.
At November 7, 2005, the Hughes family owned approximately 36% of our
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. 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 FAIL TO QUALIFY AS A REIT.
You will be 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 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 PSB as a
REIT, as a result of our substantial ownership interest in that company.
68
For any taxable year that we fail to qualify as a REIT and the relief
provisions do not apply, we would be taxed at the regular 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. 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 a fully taxable corporation and
may be limited in its ability to deduct interest payments made to us. 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.
WE AND OUR SHAREHOLDERS ARE SUBJECT TO FINANCING RISKS.
Debt increases the risk of loss. In making real estate investments, we
may borrow money, which increases the risk of loss. At September 30, 2005, our
debt of $215.2 million was 3.9% of our total assets.
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;
69
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 that other real estate companies may use
third-party insurers for. This results in a higher risk of losses that are not
covered by third-party insurance contracts, as described in Note 14 to our
consolidated financial statements at September 30, 2005 under "Insurance and
Loss Exposure."
There is significant competition among self-storage facilities and from
other storage alternatives. Most of our properties are self-storage facilities,
which generated 92% of our revenue for the three months ended September 30,
2005. 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
70
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, 2001, we have opened 50 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 $523.3 million. In addition, at September 30, 2005 we had 57 projects
in development that are expected to be completed in approximately the next two
years. These 57 projects have total estimated costs of $291.3 million.
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.
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.
B. Wayne Hughes, Chairman of the Board, and his family (the "Hughes
Family") have ownership interests in, and operate, approximately 40 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.
The Company, through subsidiaries, continues to reinsure risks relating
to loss of goods stored by tenants in the self-storage facilities in Canada. The
Company had acquired the tenant insurance business on December 31, 2001 through
71
its acquisition of PSIC. During the nine months ended September 30, 2005, and
the full years ended December 31, 2004 and 2003, PSIC received $795,000,
$1,069,000, and $1,017,000, respectively, in reinsurance premiums attributable
to the Canadian Facilities. PSIC has no contractual right to provide tenant
reinsurance to the Canadian Facilities and there is no assurance that these
premiums will continue.
The corporation engaged in the operations of the Canadian facilities
has advised us that it intends to reorganize the entities owning and operating
the Canadian facilities and has proposed that the Company consent to this
reorganization, which would impact the license agreement and the right of first
refusal agreement with the Company. The reorganization is designed to enhance
the entities' financial flexibility and growth potential. In November 2004, the
Board appointed a special committee, comprised of independent directors, to
consider the Company's alternatives in this matter, including a possible
investment in the reorganized Canadian entities.
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
and $1,138,000 for the nine months ended September 30, 2005. Since 2002, PSPUD
closed or consolidated all but 12 facilities that were deemed not strategic to
our business plan.
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.
2003 TAX LEGISLATION COULD ADVERSELY AFFECT THE PRICE OF OUR STOCK.
Tax legislation enacted in 2003 generally reduces the maximum tax rate
for dividends payable to individuals to 15% through 2008. Dividends paid by
REITs, however, generally continue to be taxed at the normal rate applicable to
the individual recipient, rather than the preferential rates applicable to other
dividends. Although this legislation does not adversely affect the taxation of
REITs or dividends paid by REITs, the more favorable rates applicable to regular
corporate dividends could cause investors who are individuals to perceive
investments in REITs to be relatively less attractive than investments in the
stocks of non-REIT corporations that pay dividends, which could adversely affect
the value of the stock of REITs, including our common stock.
72
DEVELOPMENTS IN CALIFORNIA MAY HAVE AN ADVERSE IMPACT ON OUR BUSINESS.
We are headquartered in, and approximately one-quarter of our
properties are located in, California. California is facing serious 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.
OUR BID FOR SHU MAY NOT BE SUCCESSFUL AND IF IT IS WE MAY BE SUBJECT TO
ADDITIONAL RISKS.
We have made a proposal to acquire SHU, which SHU's board of directors
has rejected. We may amend, modify, withdraw or otherwise change our proposal
whether in response to SHU's exploration of strategic alternatives or otherwise,
including without limitation to increase or decrease the amount and nature of
the consideration offered, including to offer a higher or lower exchange ratio
or greater or lower per share consideration consisting in part or in whole of
cash or other consideration, to change the structure of the proposed transaction
or change the method of financing any such transaction. We may also incur
substantial additional indebtedness in connection with an acquisition of SHU.
This transaction may result in significant costs and attention of
management and there is no assurance that any agreement will be reached or as to
the terms (including consideration, structure and financing) of any such
agreement.
If we do reach an agreement with SHU and the acquisition of SHU is
consummated, or a transaction is otherwise effected without any agreement with
SHU, then we may be subject to additional risks, including, without limitation,
difficulties in the integration of operations, technologies, and personnel of
SHU, diversion of management's attention away from other business concerns, the
assumption of additional debt and expenses and the incurrence of additional debt
in connection with the financing of a transaction, risks of international
operations and exposure to any undisclosed or unknown potential liabilities of
SHU, including risks related to SHU's European operations. In addition, we have
assumed based on public filings, that SHU has qualified and will continue to
qualify as a REIT and that we would be able to continue to qualify as a REIT
following an acquisition. However, if SHU fails to qualify as a REIT, we might
lose our REIT status and incur significant tax liabilities.
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, 2005, our debt as a percentage of total
shareholders' equity (based on book values) was 4.4%.
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 Q - January 19, 2006, Series R - September 28, 2006,
Series S - October 31, 2006, 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 and Series F - August
23, 2010. 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 debt, which totaled
$215.2 million at September 30, 2005. All of the Company's debt bears interest
at fixed rates. See Notes 8 and 9 to the consolidated financial statements at
September 30, 2005 for approximate principal maturities of the notes payable at
September 30, 2005.
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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.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information set forth under the heading "Legal Matters" in Note 14
to the Consolidated Financial Statements in this Form 10-Q is incorporated by
reference in this Item 1.
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 Board of 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 quarter ended September 30, 2005.
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.
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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, 2005
PUBLIC STORAGE, INC.
By: /s/ John Reyes
-------------------------------------------------
John Reyes
Senior Vice President and Chief Financial Officer
(Principal financial officer and duly authorized
officer)
EXHIBIT NO. EXHIBIT INDEX
- ----------- ---------------------------------------------------------------
3.1 Certificate of Determination for 6.45% Cumulative Preferred
Stock, Series F. Filed with Registrant's Form 8-A Registration
Statement on August 17, 2005 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.
3.2 Amendment to Certificate of Determination for 9.750% Cumulative
Preferred Stock, Series F. Filed as Exhibit 3.2 to Registrant's
Current Report on Form 8-K on August 17, 2005 and incorporated
herein by reference.
3.3 Amendment to Certificate of Determination for 6.45% Cumulative
Preferred Stock, Series F. Filed with Registrant's Form 8-A
Registration Statement on September 16, 2005 Depositary Shares
Each Representing 1/1,000 of a Share of 6.45% Cumulative
Preferred Stock, Series F and incorporated herein by reference.
10.1 Deposit Agreement dated as of August 17, 2005 among Registrant,
Equiserve Inc., Equiserve Trust Company N.A. and the holders of
depositary receipts evidencing Depositary Shares Each
Representing 1/1,000 of a Share of 6.45% Cumulative Preferred
Stock, Series F. Filed with Registrant's Form 8-A Registration
Statement on August 17, 2005 relating to Depositary Shares Each
Representing 1/1,000 of a Share of 6.45% Cumulative Preferred
Stock, Series F and incorporated herein by reference.
10.2 Deposit Agreement dated as of September 16, 2005 among
Registrant, Equiserve Inc., Equiserve Trust Company N.A. and
the holders of depositary receipts evidencing additional
Depositary Shares Each Representing 1/1,000 of a Share of 6.45%
Cumulative Preferred Stock, Series F. Filed with Registrant's
Form 8-A Registration Statement on September 16, 2005 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.
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.
77