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, 1998 ------------------ or [ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to . --------------- --------------- Commission File Number: 1-8389 ------ PUBLIC STORAGE, INC. -------------------- (Exact name of registrant as specified in its charter) California 95-3551121 - ------------------------------------------- ---------------------- (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 701 Western Avenue, Glendale, California 91201-2394 - ------------------------------------------- ---------------------- (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 the past 90 days. [ X ] Yes [ ] No Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of October 30, 1998: Common Stock, $.10 par value, 115,704,762 shares outstanding - ------------------------------------------------------------ Class B Common Stock, $.10 Par Value - 7,000,000 shares - ------------------------------------------------------- Equity Stock, Series A, $.01 Par Value - 225,000 shares - ------------------------------------------------------- PUBLIC STORAGE, INC. INDEX Pages PART I. FINANCIAL INFORMATION - ----------------------------- Item 1. Condensed Consolidated Balance Sheets at September 30, 1998 and December 31, 1997 1 Condensed Consolidated Statements of Income for the Three and Nine Months Ended September 30, 1998 and 1997 2 Condensed Consolidated Statements of Shareholders Equity for the Nine Months Ended September 30, 1998 3 Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 1998 and 1997 4- 5 Notes to Condensed Consolidated Financial Statements 6 - 14 Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations 15 - 27 PART II. OTHER INFORMATION (Items 2, 3 and 4 are not applicable) - -------------------------- Item 1. Legal Proceedings 28 Item 5. Other Information 28 - 29 Item 6. Exhibits and Reports on Form 8-K 29 PUBLIC STORAGE, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (Amounts in thousands, except share data) September 30, December 31, ASSETS 1998 1997 ------ ----------------- ----------------- (Unaudited) Cash and cash equivalents.................................................... $ 54,950 $ 41,455 Real estate facilities, at cost: Land...................................................................... 797,110 845,299 Buildings................................................................. 2,137,179 2,232,230 ----------------- ----------------- 2,934,289 3,077,529 Accumulated depreciation.................................................. (385,647) (378,248) ----------------- ----------------- 2,548,642 2,699,281 Construction in process................................................... 75,635 42,635 ----------------- ----------------- 2,624,277 2,741,916 ----------------- ----------------- Investment in real estate entities........................................... 430,171 225,873 Intangible assets, net....................................................... 205,960 212,944 Mortgage notes receivable from affiliates.................................... 24,856 21,807 Other assets................................................................. 71,619 67,650 ----------------- ----------------- Total assets................................................... $3,411,833 $ 3,311,645 ================= ================= LIABILITIES AND SHAREHOLDERS' EQUITY ------------------------------------ Revolving line of credit..................................................... $ - $ 7,000 Notes payable................................................................ 85,617 96,558 Accrued and other liabilities................................................ 77,380 70,648 ----------------- ----------------- Total liabilities................................................... 162,997 174,206 ----------------- ----------------- Minority interest............................................................ 150,532 288,479 Commitments and contingencies Shareholders' equity: Preferred Stock, $0.01 par value, 50,000,000 shares authorized, 11,129,650 shares issued and outstanding (13,261,984 issued and outstanding at December 31, 1997), at liquidation preference: Cumulative Preferred Stock, issued in series........................ 868,900 868,900 Convertible Preferred Stock......................................... - 53,308 Common stock, $0.10 par value, 200,000,000 shares authorized, 115,713,762 shares issued and outstanding (105,102,145 at December 31, 1997)...................................................... 11,573 10,511 Class B Common Stock, $0.10 par value, 7,000,000 shares authorized and issued.................................................................. 700 700 Paid-in capital........................................................... 2,172,115 1,903,782 Cumulative net income..................................................... 742,918 575,069 Cumulative distributions paid............................................. (697,902) (563,310) ----------------- ----------------- Total shareholders' equity.......................................... 3,098,304 2,848,960 ----------------- ----------------- Total liabilities and shareholders' equity..................... $3,411,833 $ 3,311,645 ================= ================= See accompanying notes. 1 PUBLIC STORAGE, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (Amounts in thousands, except per share data) (Unaudited) For the Three Months Ended For the Nine Months Ended September 30, September 30, --------------------------------- --------------------------------- 1998 1997 1998 1997 --------------- ---------------- --------------- ---------------- Revenues: Rental income: Self-storage facilities............ $ 129,385 $ 102,308 $ 360,950 $ 273,798 Portable self-storage.............. 6,780 2,566 18,069 4,140 Commercial properties ............. 1,833 11,526 21,229 27,694 Equity earnings of real estate entities. 6,662 4,414 16,598 14,652 Facility management fee................. 1,388 2,376 4,805 8,319 Interest and other income............... 3,921 2,817 11,925 7,489 --------------- ---------------- --------------- ---------------- 149,969 126,007 433,576 336,092 --------------- ---------------- --------------- ---------------- Expenses: Cost of operations: Self-storage facilities............ 37,755 29,617 108,593 82,392 Portable self-storage.............. 13,713 14,635 43,226 25,325 Commercial properties.............. 685 4,277 7,187 11,034 Cost of facility management............. 226 358 780 1,300 Depreciation and amortization.......... 26,217 23,651 79,628 64,141 General and administrative............. 2,684 1,911 7,246 5,185 Interest expense....................... 831 2,262 2,926 5,821 --------------- ---------------- --------------- ---------------- 82,111 76,711 249,586 195,198 --------------- ---------------- --------------- ---------------- Income before minority interest........ 67,858 49,296 183,990 140,894 Minority interest in income............ (5,572) (2,748) (16,141) (7,777) --------------- ---------------- --------------- ---------------- Net income................................ $ 62,286 $ 46,548 $ 167,849 $133,117 =============== ================ =============== ================ Net income allocation: Allocable to preferred shareholders..... $ 19,053 $ 18,316 $ 59,322 $68,134 Allocable to common shareholders........ 43,233 28,232 108,527 64,983 --------------- ---------------- --------------- ---------------- $ 62,286 $ 46,548 $ 167,849 $133,117 =============== ================ =============== ================ Per common share: Net income per share - Basic............ $0.37 $0.27 $0.96 $0.67 =============== ================ =============== ================ Net income per share - Diluted.......... $0.37 $0.27 $0.95 $0.67 =============== ================ =============== ================ Weighted average common shares - Basic................................ 116,421 102,964 113,311 96,586 =============== ================ =============== ================ Weighted average common shares - Diluted.............................. 116,726 103,536 113,762 97,154 =============== ================ =============== ================ See accompanying notes. 2 PUBLIC STORAGE, INC. CONDENSED CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY For the nine months ended September 30, 1998 (Amounts in thousands except share data) (Unaudited) Preferred Stock --------------------------- Class B Cumulative Common Common Paid-in Senior Convertible Stock Stock Capital ------------- ------------- ------------- ---------- ------------- Balances at December 31, 1997........................ $ 868,900 $ 53,308 $ 10,511 $ 700 $1,903,782 Issuance of common stock: Public issuance (7,951,821 shares).............. - - 794 - 233,731 Conversion of 8.25% Convertible Preferred Stock into common stock (3,589,552 shares)......... - (53,308) 359 - 52,949 Acquisition of investment in real estate entities and minority interest from affiliate (914,094 shares)................... - - 92 - 28,110 Acquisition of minority interests from third parties (316,595 shares) .................... - - 31 - 7,965 In connection with mergers (433,526 shares)..... - - 44 - 13,773 Exercise of stock options (192,429 shares)...... - - 21 - 2,901 Repurchase of Common Shares (2,786,400 shares) ...... - - (279) - (71,096) Net income........................................... - - - - - Cash distributions: Cumulative Senior Preferred Stock................. - - - - - 8.25% Convertible Preferred Stock................. - - - - - Common Stock...................................... - - - - - ------------- ------------- ------------- ---------- ------------- Balances at September 30, 1998....................... $ 868,900 $ - $ 11,573 $ 700 $2,172,115 ============= ============= ============= ========== ============= Total Cumulative Cumulative Shareholders' Net Income Distributions Equity ------------ -------------- --------------- Balances at December 31, 1997........................ $ 575,069 $ (563,310) $ 2,848,960 Issuance of common stock: Public issuance (7,951,821 shares).............. - - 234,525 Conversion of 8.25% Convertible Preferred Stock into common stock (3,589,552 shares)......... - - - Acquisition of investment in real estate entities and minority interest from affiliate (914,094 shares)................... - - 28,202 Acquisition of minority interests from third parties (316,595 shares) .................... - - 7,996 In connection with mergers (433,526 shares)..... - - 13,817 Exercise of stock options (192,429 shares)...... - - 2,922 Repurchase of Common Shares (2,786,400 shares) ...... - - (71,375) Net income........................................... 167,849 - 167,849 Cash distributions: Cumulative Senior Preferred Stock................. - (57,159) (57,159) 8.25% Convertible Preferred Stock................. - (2,163) (2,163) Common Stock...................................... - (75,270) (75,270) ------------ -------------- --------------- Balances at September 30, 1998....................... $ 742,918 $ (697,902) $ 3,098,304 ============ ============== =============== See accompanying notes. 3 PUBLIC STORAGE, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands) (Unaudited) For the Nine Months Ended September 30, ---------------------------------- 1998 1997 ---------------- --------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income.................................................................. $ 167,849 $ 133,117 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation and amortization............................................... 79,628 64,141 Depreciation included in equity in earnings of real estate entities......... 9,902 9,177 Minority interest in income................................................. 16,141 7,777 ---------------- --------------- Total adjustments.................................................... 105,671 81,095 ---------------- --------------- Net cash provided by operating activities........................ 273,520 214,212 ---------------- --------------- CASH FLOWS FROM INVESTING ACTIVITIES: Mortgage loans made to affiliates........................................... (33,000) - Principal payments received on mortgage notes to affiliates................. 27,456 897 Capital improvements to real estate facilities.............................. (19,257) (24,056) Construction in process..................................................... (58,371) (18,465) Investment in portable self-storage business................................ (7,649) (15,393) Acquisition of minority interests in consolidated real estate partnerships.. (17,508) (20,967) Proceeds from the disposition of real estate investments.................... 10,275 - Reduction in cash due to the deconsolidation of PSBP (Note 2)............... (11,259) - Refund of deposit on real estate purchase................................... 12,500 - Investment in real estate entities.......................................... (74,964) (58,728) Acquisition of real estate facilities....................................... (47,392) (50,172) Acquisition cost of business combinations................................... (84,576) (120,986) Other....................................................................... 2,846 4,777 ---------------- --------------- Net cash used in investing activities............................ (300,899) (303,093) ---------------- --------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net paydowns on revolving line of credit.................................... (7,000) - Principal payments on notes payable......................................... (10,940) (8,094) Net proceeds from the issuance of preferred stock........................... - 144,925 Net proceeds from the issuance of common stock.............................. 237,447 127,550 Repurchase of the Company's common stock.................................... (71,375) - Reimbursement for properties contributed to development joint venture....... - 21,284 Distributions paid to shareholders.......................................... (134,592) (130,125) Distributions from operations to minority interests in real estate entities. (25,565) (14,201) Net reinvestment by minority interests in consolidated real estate entities. 52,899 3,347 ---------------- --------------- Net cash provided by financing activities........................ 40,874 144,686 ---------------- --------------- Net increase in cash and cash equivalents..................................... 13,495 55,805 Cash and cash equivalents at the beginning of the period...................... 41,455 26,856 ---------------- --------------- Cash and cash equivalents at the end of the period............................ $ 54,950 $ 82,661 ================ =============== See accompanying notes. 4 PUBLIC STORAGE, INC. CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Amounts in thousands) (Unaudited) (Continued) For the Nine Months Ended September 30, ---------------------------------- 1998 1997 ----------------- --------------- SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: Acquisition of real estate facilities in exchange for the assumption of notes payable, increase in minority interest, cancellation of mortgage note receivable, and reduction in investment.............................. $ (18,753) $ - Assumption of note payable in connection with the acquisition of real estate facilities................................................................ 14,526 - Cancellation of mortgage note receivable in connection with the acquisition of real estate facilities................................................. 2,495 - Assets and liabilities acquired with respect to business combinations: Real estate facilities.................................................... (225,202) (540,945) Other assets.............................................................. (670) (3,097) Accrued and other liabilities............................................. 3,793 16,640 Minority interest......................................................... 37,367 42,038 Reduction to investment in real estate entities: In connection with business combination................................... 86,319 152,378 In connection with acquisition of real estate facilities.................. 527 - Acquisition of minority interest and real estate in exchange for common stock: Real estate facilities.................................................... (19,475) - Minority interest......................................................... (17,098) - Accrued and unpaid dividends................................................. - (1,085) Issuance of common stock: In connection with the conversion of 8.25% convertible preferred stock.... 53,308 1,390 In connection with business combinations.................................. 13,817 212,000 In connection with the conversion of mandatory convertible preferred stock - 58,955 To acquire interests in real estate entities.............................. 17,133 - To acquire minority interest in consolidated real estate entities......... 19,065 - Conversion of 8.25% convertible preferred stock............................... (53,308) (1,390) Conversion of mandatory convertible preferred stock........................... - (58,955) Acquisition of investment in real estate entities for common stock............ (17,133) - Increase in minority interest in connection with the acquisition of real estate facilities......................................................... 1,205 - Effect of deconsolidation of PSBP (Note 2): Investments in real estate entities ...................................... (219,224) - Real estate facilities, net of accumulated depreciation................... 433,446 - Other assets.............................................................. 2,048 - Accrued and other liabilities............................................. (10,106) - Notes payable ............................................................ (14,526) - Minority interest......................................................... (202,897) - See accompanying notes. 5 PUBLIC STORAGE, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS September 30, 1998 1. Description of the business --------------------------- Public Storage, Inc. (the "Company") is a California corporation which was organized in 1980. The Company is a fully integrated, self-administered and self-managed real estate investment trust ("REIT") that acquires, develops, owns and operates self-storage facilities which offer self-storage spaces for lease, usually on a month-to-month basis, for personal and business use. The Company invests in real estate facilities primarily through the acquisition of wholly-owned facilities combined with the acquisition of equity interests in real estate entities owning real estate facilities. At September 30, 1998, the Company had direct and indirect equity interests in 1,191 properties located in 38 states, including 1,089 self-storage facilities, 99 commercial properties, and three industrial facilities for use in the operations of Public Storage Pickup and Delivery. All of the self-storage facilities are operated by the Company under the "Public Storage" name, while the commercial properties are operated by PS Business Parks, Inc., an affiliated public REIT, and its operating partnership (the REIT and partnership collectively referred to as "PSBP"). In 1996 and 1997, the Company organized Public Storage Pickup and Delivery, Inc. as a separate corporation and a related partnership (the corporation and partnership are collectively referred to as "PSPUD") to operate a portable self-storage business that rents storage containers to customers for storage generally in leased central warehouses. At September 30, 1998, PSPUD operated 48 facilities in 15 states. 2. Summary of significant accounting policies ------------------------------------------ Basis of presentation --------------------- The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles 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 generally accepted accounting principles for complete financial statements. The preparation of the consolidated financial statements in conformity with 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 estimates. In the opinion of management, all adjustments (consisting of normal recurring accruals) necessary for a fair presentation have been included. Operating results for the three and nine months ended September 30, 1998 are not necessarily indicative of the results that may be expected for the year ended December 31, 1998. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's annual report on Form 10-K for the year ended December 31, 1997. The consolidated financial statements include the accounts of the Company, PSPUD, and 22 controlled limited partnerships (the "Consolidated Entities"). Collectively, the Company and the Consolidated Entities own a total of 955 real estate facilities, consisting of 951 self-storage facilities, one commercial property, and three industrial facilities for use by PSPUD. At September 30, 1998, the Company also has equity investments in 26 other affiliated limited partnerships whose principal business is the ownership of 138 self-storage facilities in aggregate which are managed by the Company. In addition, the Company has an ownership interest in PSBP, which owns and operates 98 commercial properties. The Company's ownership interest in such real estate entities is less than 50% of the total equity interest and the Company's investments in these entities are accounted for using the equity method. From the time of PSBP's formation through March 31, 1998, the Company consolidated the accounts of PSBP in its financial statements. During the second quarter of 1998, the Company's ownership interest in PSBP was reduced below 50%, and accordingly, the Company ceased to have a controlling interest in PSBP. As a result, the Company, effective April 1, 1998, no longer includes the accounts of PSBP in its consolidated financial statements and has accounted for its investment during the second and third quarters of 1998 using the equity method. The income statement for the nine months ended September 30, 1998 6 includes the consolidated operating results of PSBP for the three months ended March 31, 1998 and the Company's equity in the income of PSBP for the second and third quarters of 1998. Accordingly, commercial property operations for the periods after March 31, 1998 reflect the commercial operations of facilities owned by the Company which have both self-storage and commercial use combined at the same property location. 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, the Company is not taxed on that portion of its taxable income which is distributed to its shareholders provided that the Company meets certain tests. The Company believes it will meet these tests during 1998 and, accordingly, no provision for income taxes has been made in the accompanying financial statements. Financial instruments --------------------- For purposes of financial statement presentation, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. Real estate facilities ---------------------- Real estate facilities are recorded at cost. Depreciation is computed using the straight-line method over the estimated useful lives of the buildings and improvements, which are generally between 5 and 25 years. Allowance for possible losses ----------------------------- The Company has no allowance for possible losses relating to any of its real estate investments, long-lived assets and mortgage notes receivable. The need for such an allowance is evaluated by management by means of periodic reviews of its investment portfolio. Intangible assets ----------------- Intangible assets consist of property management contracts ($165,000,000) and the cost over the fair value of net tangible and identifiable intangible assets ($67,726,000) acquired in a 1995 merger with an affiliate. Intangible assets are amortized by the straight-line method over 25 years. At September 30, 1998, intangible assets are net of accumulated amortization of $26,766,000 ($19,782,000 at December 31, 1997). Included in depreciation and amortization expense for the three and nine months ended September 30, 1998 and 1997 is $2,328,000 and $6,984,000, respectively, related to the amortization of intangible assets. Revenue and expense recognition ------------------------------- Property rents are recognized as earned. Equity in earnings of real estate entities are recognized based on the Company's ownership interest in the earnings of each of the unconsolidated real estate entities. Advertising costs are expensed as incurred. Net income per common share --------------------------- In 1997, the Financial Accounting Standards Board issued Statement No. 128, Earnings per Share. Statement 128 replaced the calculation of primary and fully diluted net income per share with basic and diluted net income per share. Unlike primary net income per share, basic net income per share excludes any dilutive effects of options, warrants and convertible securities. Diluted net income per share is very similar to the previously reported fully diluted net income per share. All net income per share amounts for all periods have been presented and where appropriate, restated to conform to Statement 128 requirements. Diluted net income per common share is computed using the weighted average common shares outstanding (adjusted for stock options). The Class B Common Stock is not included in the determination of net income per common share because all contingencies required for the conversion to common stock have not been satisfied as of September 30, 1998. In addition, for periods prior to the July 1, 1998 conversion 7 of the Company's convertible preferred stock into common stock (the conversion is discussed in Note 8), the inclusion of the effect of the assumed conversion of the Company's convertible preferred stock in the determination of net income per common share was anti-dilutive. In computing earnings per common share, preferred stock dividends totaling $19,053,000 and $18,316,000 for the three months ended September 30, 1998 and 1997, respectively, and $59,322,000 and $68,134,000 for the nine months ended September 30, 1998 and 1997, respectively, reduced income available to common stockholders. Reclassifications ----------------- Certain reclassifications have been made to the consolidated financial statements for 1997 in order to conform to the 1998 presentation. 3. Business combinations --------------------- Mergers with Affiliated REITS ----------------------------- On March 17, 1998, the Company, through PSBP, completed a merger transaction with an affiliated public REIT (Public Storage Properties XI, Inc.) whereby PSBP acquired all the outstanding stock of the REIT which the Company did not previously own. The aggregate acquisition cost of this merger was approximately $49.6 million, consisting of the issuance of $34.8 million of PSBP common stock (classified as minority interest on the Company's consolidated financial statements) and the Company's pre-existing investment in the affiliated REIT totaling $14.8 million. On May 8, 1998, the Company completed a merger transaction with an affiliated public REIT (Public Storage Properties XX, Inc.) whereby the Company acquired all the outstanding stock of the REIT which it did not previously own in exchange for cash and common stock of the Company. The aggregate acquisition cost of this merger was approximately $22.3 million, consisting of $4.8 million in cash, $13.8 million in the Company's common stock, and the Company's pre-existing investment in the affiliated REIT totaling $3.7 million. Affiliated Partnership Acquisitions ----------------------------------- In January 1998, the Company acquired all of the limited partnership interests in two affiliated partnerships. As a result of the Company's increased ownership interest and control of the partnerships, the Company began to consolidate the accounts of these partnerships. The total consideration in these transactions of $6.8 million consists of $5.2 million of cash and the Company's pre-existing investment of $1.6 million. During the third quarter of 1998, the Company acquired a limited partnership interest in an affiliated partnership for $74.6 million in cash. The acquisition of this interest increased the Company's ownership in the partnership in excess of 50%. Because of the Company's increased ownership interest and control of the partnership, the Company began to consolidate the accounts of this partnership. The total consideration in this transaction includes the $74.6 million cash acquisition cost as well as the Company's pre-existing investment of $66.2 million. The above mergers and acquisitions of affiliated partnership interests have been accounted for as purchases; accordingly, allocations of the total acquisition cost to the net assets acquired were made based on the fair value of such assets and liabilities as of the dates of each respective transaction. The fair market values of the assets and liabilities assumed with respect to the transactions are summarized as follows: 8 REIT Partnership mergers acquisitions Total ------------- ------------ ----------- (Amounts in thousands) Real estate facilities......... $ 73,971 $ 151,231 $ 225,202 Other assets................... 271 399 670 Accrued liabilities............ (2,280) (1,513) (3,793) Minority interest.............. (34,830) (2,537) (37,367) ------------- ------------ ----------- $ 37,132 $ 147,580 $ 184,712 ============= ============ =========== The historical operating results of the above business combinations prior to each respective acquisition date have not been included in the Company's historical operating results. Pro forma selected financial data for the nine months ended September 30, 1998 and 1997 as though the above business combinations had been effective at the beginning of each period are as follows: Nine Months Ended Nine Months Ended (In thousands, except per share data) September 30, 1998 September 30, 1997 - ------------------------------------- ------------------ ------------------ Revenues .............................. $ 444,952 $ 355,923 Net income............................. $ 167,313 $ 131,787 Net income per common share (Basic).... $ 0.95 $ 0.66 Net income per common share (Diluted).. $ 0.95 $ 0.66 The pro forma data does not purport to be indicative of operations that would have occurred had the business combinations occurred at the beginning of each period or future results of operations of the Company. Certain pro forma adjustments were made to the combined historical amounts to reflect expected reductions in general and administrative expenses combined with an estimated increase in depreciation and amortization expense. 4. Real estate facilities ---------------------- Activity in real estate facilities during 1998 is as follows: 9 In thousands Operating facilities, at cost: Balance at December 31, 1997............................... $ 3,077,529 Property acquisitions Business combinations (Note 3) .......................... 225,202 Other acquisitions...................................... 66,145 Newly opened development facilities......................... 25,371 Acquisition of minority interest........................... 19,475 Capital improvements........................................ 19,257 Property dispositions (Deconsolidation of PSBP)............ (498,690) -------------- Balance at September 30, 1998.............................. 2,934,289 -------------- Accumulated depreciation: Balance at December 31, 1997................................ (378,248) Additions during the year................................... (72,644) Property dispositions (Deconsolidation of PSBP)............ 65,245 -------------- Balance at September 30, 1998.............................. (385,647) -------------- Construction in progress: Balance at December 31, 1997................................ 42,635 Current development cost.................................... 58,371 Newly opened development facilities......................... (25,371) -------------- Balance at September 30, 1998.............................. 75,635 -------------- Total real estate facilities, net at September 30, 1998....... $ 2,624,277 ============== Construction in progress at September 30, 1998 consists of 15 self-storage facilities, 3 expansions of existing self storage facilities and 8 industrial facilities which could be utilized as portable self-storage facilities. Newly opened development facilities include 2 self storage facilities and 3 industrial facilities which are for use by the Company's PSPUD operations. Interest capitalized during the three and nine months ended September 30, 1998 was $997,000 and $3,277,000, respectively, compared to $332,000 and $1,421,000 for the same periods in 1997. As discussed in Note 2, effective April 1, 1998, the Company ceased to have a controlling interest in PSBP and, as a result, no longer includes the accounts of PSBP in its consolidated financial statements. In the above table, operating facilities and accumulated depreciation have been reduced to reflect the deconsolidation of PSBP. 5. Investment in real estate entities: ----------------------------------- The Company's investment in real estate entities at September 30, 1998 consists of (i) limited and general partnership interests in approximately 26 affiliated partnerships which principally own self-storage facilities, (ii) the Company's ownership interest in a joint venture established to develop and operate self-storage facilities and (iii) the Company's ownership interest in PSBP. Such interests are accounted for using the equity method of accounting. In April 1997, the Company formed a joint venture partnership with a state pension fund to participate in the development of approximately $220 million of self-storage facilities. The joint venture has opened a total of 19 facilities with a total cost of $92.4 million at September 30, 1998, and has 10 projects in process with an aggregate cost at September 30, 1998 of $34.7 million ($13.8 million to complete). The joint venture is currently reviewing the final 20 projects ($38.7 million incurred at September 30, 1998, with remaining costs to complete of $54.1 million). Upon approval of these additional 20 facilities, the joint venture will be fully committed. These 20 10 projects are currently being developed by the Company and the construction costs will be transferred to the joint venture once they have been approved. At September 30, 1998, included in construction in process is approximately $24.7 million, and included in real estate facilities is $14.0 million, with respect to these projects. During the nine months ended September 30, 1998, the Company recognized earnings from its investments totaling $16,598,000. Included in equity in earnings of real estate entities for the nine months ended September 30, 1998 is the Company's share of depreciation expense totaling $9,902,000. Summarized combined financial data (based on historical cost) with respect to those unconsolidated real estate entities in which the Company had an ownership interest at September 30, 1998 are as follows: For the nine months ended September 30, 1998 ------------------------------------------------------------------------ Other Development Equity Investments Joint Venture PSBP Total ------------------ ------------- ------------ ------------- (Amounts in thousands) Rental income........................ $ 48,959 $3,732 $ 61,459 $114,150 Other income 1,313 346 1,517 3,176 ------------------ ------------- ------------ ------------- Total revenues................... 50,272 4,078 62,976 117,326 ------------------ ------------- ------------ ------------- Cost of operations................... 16,267 2,293 18,361 36,921 Depreciation......................... 5,948 1,214 11,421 18,583 Other expenses....................... 6,341 56 3,374 9,771 ------------------ ------------- ------------ ------------- Total expenses................... 28,556 3,563 33,156 65,275 ------------------ ------------- ------------ ------------- Net income before minority interest.. 21,716 515 29,820 52,051 Minority interest ................... - - (8,696) (8,696) ------------------ ------------- ------------ ------------- Net income....................... $ 21,716 $515 $ 21,124 $43,355 ================== ============= ============ ============= At September 30, 1998: - ---------------------- Real estate, net .................... $ 169,887 $131,231 $644,694 $ 945,812 Total assets......................... 216,409 142,648 683,431 1,042,488 Total liabilities.................... 78,885 14,345 43,426 136,656 Minority interest.................... - - 152,611 152,611 Total equity......................... 137,524 128,303 487,394 753,221 The Company's investment (book value) at September 30, 1998..... $156,102 $44,600 $229,469 $430,171 The Company's effective average ownership interest at September 30, 1998............... 37% 30% 39% 33% 6. Revolving line of credit ------------------------ As of September 30, 1998, the Company had no borrowings on its unsecured credit agreement with a group of commercial banks. The credit agreement (the "Credit Facility") has a borrowing limit of $150.0 million and an expiration date of July 31, 2001. The expiration date may be extended by one year on each anniversary of the credit agreement. Interest on outstanding borrowings is payable monthly. At the option of the Company, the rate of interest charged is equal to (i) the prime rate or (ii) a rate ranging from the London Interbank Offered Rate ("LIBOR") plus 0.40% to LIBOR plus 1.10% depending on the Company's credit ratings and coverage ratios, as defined. In addition, the Company is required to pay a quarterly commitment fee of 0.250% (per annum). The Credit Facility allows the Company, at its option, to request the group of banks to propose the interest rate they would charge on specific borrowings not to exceed $50 million. However, in no case may the interest rate proposal be greater than the amount provided by the Credit Facility. 11 7. Minority interest ----------------- In consolidation, the Company classifies ownership interests other than its own in the net assets of each of the Consolidated Entities as minority interest on the consolidated financial statements. Minority interest in income consists of the minority interests' share of the operating results of the Company relating to the consolidated operations of the Consolidated Entities. During the nine months ended September 30, 1998, the Company reduced minority interest by approximately $17.1 million (the historical book value of such interests in the underlying net assets of the partnerships) through the acquisition of such interests for cash and through the issuance of common stock. The excess of the cost over the underlying book value ($19.5 million) has been allocated to real estate facilities in consolidation. Minority interest was increased by $37.4 million in connection with business combinations, representing the remaining partners' equity interest in the aggregate net assets (book value) of the partnerships. Minority interest was increased $47.6 million in connection with the issuance of common stock of PSBP in the first quarter of 1998 and $1.2 million in connection with the acquisition of real estate facilities by PSBP in the first quarter of 1998. Minority interest was reduced by approximately $202.9 million in the second quarter as a result of the deconsolidation of PSBP. 8. Shareholders' equity -------------------- Preferred stock --------------- At September 30, 1998 and December 31, 1997, the Company had the following series of Preferred Stock outstanding: At September 30, 1998 At December 31, 1997 ----------------------------- ---------------------------- Dividend Shares Carrying Shares Carrying Series Rate Outstanding Amount Outstanding Amount - ------------------------------------ ----------- ------------ ------------- ------------ ------------ Series A .......................... 10.000% 1,825,000 $ 45,625,000 1,825,000 $ 45,625,000 Series B .......................... 9.200% 2,386,000 59,650,000 2,386,000 59,650,000 Series C........................... Adjustable 1,200,000 30,000,000 1,200,000 30,000,000 Series D........................... 9.500% 1,200,000 30,000,000 1,200,000 30,000,000 Series E........................... 10.000% 2,195,000 54,875,000 2,195,000 54,875,000 Series F........................... 9.750% 2,300,000 57,500,000 2,300,000 57,500,000 Series G .......................... 8.875% 6,900 172,500,000 6,900 172,500,000 Series H .......................... 8.450% 6,750 168,750,000 6,750 168,750,000 Series I .......................... 8.625% 4,000 100,000,000 4,000 100,000,000 Series J .......................... 8.000% 6,000 150,000,000 6,000 150,000,000 ------------ ------------- ------------ ------------ Total Senior Preferred Stock.... 11,129,650 868,900,000 11,129,650 868,900,000 Convertible........................ 8.250% - - 2,132,334 53,308,000 ------------ ------------- ------------ ------------ 11,129,650 $868,900,000 13,261,984 $922,208,000 ============ ============= ============ ============ The Series A through Series J stock (collectively the "Senior Preferred Stock") have general preference rights with respect to liquidation and quarterly distributions. Holders of the Company's preferred stock, except under certain conditions and as noted below, will not be entitled to vote on most matters. In the event of a cumulative arrearage equal to six quarterly dividends or failure to maintain a Debt Ratio (as defined) of 50% or less, holders of all outstanding series of preferred stock (voting as a single class without regard to series) will have the right to elect two additional members to serve on the Company's Board of Directors until events of default have been cured. At September 30, 1998, there were no dividends in arrears and the Debt Ratio was 2.5%. 12 Except under certain conditions relating to the Company's qualification as a REIT, the Senior Preferred Stock are not redeemable prior to the following dates: Series A - September 30, 2002, Series B - March 31, 2003, Series C - June 30, 1999, Series D - September 30, 2004, Series E - January 31, 2005, Series F - April 30, 2005, Series G - December 31, 2000, Series H - January 31, 2001, Series I - October 31, 2001, Series J - August 31, 2002. On or after the respective dates, each of the series of Senior Preferred Stock will be redeemable at the option of the Company, in whole or in part, at $25 per share (or depository share in the case of the Series G, Series H, Series I and Series J), plus accrued and unpaid dividends. On June 1, 1998, the Company exercised its option to redeem the Convertible Preferred Stock for common stock at the conversion rate of 1.6835 shares of common stock for each share of Convertible Preferred Stock. Pursuant to the redemption, which was effective as of July 1, 1998, the Company issued 3,503,343 shares of common stock. Equity Stock ------------ In June 1997, the Company contributed $22,500,000 (225,000 shares) of its Equity Stock, Series A ("Equity Stock") to a partnership in which the Company is the general partner. As a result of this contribution, the Company obtained a majority interest in the Partnership and began to consolidate the accounts of the Partnership. The Equity Stock ranks on a parity with Common Stock and junior to the Company's Cumulative Senior Preferred Stock with respect to general preference rights and has a liquidation amount of ten times the amount paid to each Common Share up to a maximum of $100 per share. Quarterly distributions per share on the Equity Stock are equal to the lesser of (i) 10 times the amount paid per share of Common Stock or (ii) $2.20. Common Stock ------------ During the first nine months of 1998, the Company issued 7,951,821 shares of common stock in public and private offerings, raising net proceeds of approximately $234.5 million. In addition, the Company issued 433,526 shares of common stock ($13.8 million) in connection with the merger with an affiliated REIT, 3,589,552 shares ($53.3 million) in connection with Convertible Preferred Stock conversions, 1,230,689 shares ($36.2 million) in connection with the acquisition of partnership interests, and 192,429 shares ($2.9 million) in connection with the exercise of stock options. On June 12, 1998, the Company announced that the Board of 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. Through September 30, 1998 the Company has repurchased a total of 2,786,400 shares of common stock at an aggregate cost of approximately $71.4 million. From October 1, 1998 through November 4, 1998, the Company repurchased an additional 33,000 shares of common stock at an aggregate cost of approximately $902,000. Class B Common Stock -------------------- The Class B Common Stock will (i) not participate in distributions until the later to occur of funds from operations ("FFO") per Common Share as defined below, aggregating $1.80 during any period of four consecutive calendar quarters, or January 1, 2000; thereafter, the Class B Common Stock will participate in distributions (other than liquidating distributions), at the rate of 97% of the per share distributions on the Common Stock, provided that cumulative distributions of at least $0.22 per quarter per share have been paid on the Common Stock, (ii) not participate in liquidating distributions, (iii) not be entitled to vote (except as expressly required by California law) and (iv) automatically convert into Common Stock, on a share for share basis, upon the later to occur of FFO per Common Share aggregating $3.00 during any period of four consecutive calendar quarters or January 1, 2003. For these purposes, FFO means net income (loss) before (i) gain (loss) on early extinguishment of debt, (ii) minority interest in income and (iii) gain (loss) on disposition of real estate, adjusted as follows: (i) plus depreciation and amortization, and (ii) less FFO attributable to minority interest. FFO per Common Share means FFO less preferred stock dividends (other than dividends on convertible preferred stock) divided by the outstanding weighted average shares of Common Stock assuming conversion of all outstanding convertible securities and the Class B Common Stock. 13 For these purposes, FFO per share of Common Stock (as defined) was $2.01 for the four consecutive calendar quarters ended September 30, 1998. Dividends --------- The following summarizes dividends paid during the first nine months of 1998: Distributions Per Share or Total Depository Share Distributions ---------------- ------------- Series A.............................. $ 1.874 $ 3,420,000 Series B.............................. $ 1.725 4,116,000 Series C.............................. $ 1.265 1,518,000 Series D.............................. $ 1.783 2,139,000 Series E.............................. $ 1.875 4,116,000 Series F.............................. $ 1.827 4,203,000 Series G.............................. $ 1.664 11,484,000 Series H.............................. $ 1.584 10,695,000 Series I.............................. $ 1.617 6,468,000 Series J.............................. $ 1.500 9,000,000 Convertible........................... $ 1.032 2,163,000 ------------- 59,322,000 Common................................ $ 0.660 75,270,000 ------------- Total dividends paid $134,592,000 ============= The dividend rate on the Series C Preferred Stock for the third quarter of 1998 was equal to 6.75% per annum. The dividend rate per annum will be adjusted quarterly and will be equal to the highest of one of three U.S. Treasury indices (Treasury Bill Rate, Ten Year Constant Maturity Rate, or Thirty Year Constant Maturity Rate) multiplied by 110%. However, the dividend rate for any dividend period will neither be less than 6.75% per annum nor greater than 10.75%. The dividend rate for the quarter ending September 30, 1998 will be equal to 6.75% per annum. 9. Subsequent Events ----------------- Proposed Merger With Storage Trust Realty. ---------------------------------------------- The Company and Storage Trust Realty ("Storage Trust"), a New York Stock Exchange listed REIT, have entered into an Agreement and Plan of Merger among Storage Trust, the Company and Newco Merger Subsidiary, Inc., a subsidiary of the Company ("PSI Sub"), dated as of November 12, 1998 (the "Merger Agreement"). Storage Trust is a fully integrated, self-managed and self-administered REIT headquartered in Columbia, Missouri, engaged in the management and ownership of 237 self-storage stores located in 16 states totaling approximately 12.5 million net rentable square feet and 109,000 units. Under the Merger Agreement, PSI Sub would be merged into Storage Trust, and each share of beneficial interest of Storage Trust would be exchanged for 0.86 shares of the Company's common stock. This exchange ratio implies an enterprise value for Storage Trust of approximately $600 million, including the assumption of approximately $192 million of indebtedness. Upon the effectiveness of the merger, the Company's board of directors would be expanded by one seat and Mr. Daniel C. Staton, Storage Trust's Chairman of the Board, would be elected as a new member of the Company's board of directors. The merger has been structured as a tax free transaction. The transaction is expected to be completed in the first quarter of 1999. The transaction is subject to the approval of the shareholders of Storage Trust and customary regulatory approvals and other conditions. 14 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS ----------------------------------------------------------------------- OF OPERATIONS ------------- Forward Looking Statements -------------------------- Management's Discussion and Analysis of Financial Condition and Results of Operations contains "forward looking" statements that involve risks and uncertainties and are based upon a number of assumptions. Actual results and trends may differ materially depending upon a number of factors. Information regarding these factors is contained in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1997 and in the reports for the quarterly periods on Form 10-Q for the quarters ended March 31, 1998 and June 30, 1998. Results of Operations --------------------- Net income for the three months ended September 30, 1998 was $62,286,000 compared to $46,548,000 for the same period in 1997, representing an increase of $15,738,000 or 33.8%. Net income for the nine months ended September 30, 1998 was $167,849,000 compared to $133,117,000 for the same period in 1997, representing an increase of $34,732,000 or 26.1%. The increases in net income for the three and nine months ended September 30, 1998 compared to the same periods in 1997 was primarily the result of improved property operations and the acquisition of additional real estate facilities and partnership interests during 1997 and 1998. The variance in the three month periods also reflects a decrease in startup operating losses on the Company's Pickup and Delivery business, while the variance in the nine month periods also reflects an increase in such losses. Net income allocable to common shareholders was $43,233,000 or $0.37 per common share on a diluted basis (based on 116,726,000 weighted average diluted shares) for the three months ended September 30, 1998 compared to $28,232,000 or $0.27 per common share on a diluted basis (based on 103,536,000 weighted average diluted shares) for the same period in 1997. In computing net income per common share, dividends to the Company's preferred shareholders ($19,053,000 and $18,316,000 for the three months ended September 30, 1998 and 1997, respectively) have been deducted from net income in determining net income allocable to the Company's common shareholders. Net income allocable to common shareholders was $108,527,000 or $0.95 per common share on a diluted basis (based upon 113,762,000 weighted average diluted shares) for the nine months ended September 30, 1998 compared to $64,983,000 or $0.67 per common share on a diluted basis (based upon 97,154,000 weighted average diluted shares) for the same period in 1997. In computing net income per common share, dividends to the Company's preferred shareholders ($59,322,000 and $68,134,000 for the nine months ended September 30, 1998 and 1997, respectively) have been deducted from net income in determining net income allocable to the Company's common shareholders. Net income allocable to common shareholders has been negatively impacted by operating losses generated from the portable self-storage business of $6,933,000 or approximately $0.06 per common share on a diluted basis for the three months ended September 30, 1998, compared to $12,069,000 or approximately $0.12 per common share on a diluted basis for the same period in 1997. Losses on the portable self-storage business for the nine months ended September 30, 1998 were $25,157,000 or approximately $0.22 per common share, compared to $21,185,000 or approximately $0.22 per common share for the same period in 1997. Net income allocable to common shareholders was reduced by $13,412,000 in the nine months ended September 30, 1997 as a result of a special dividend on the Series CC Convertible Preferred Stock paid at the end of the first quarter of 1997. As a result of the special dividend, the Company would not have to pay another dividend with respect to this stock until the quarter ended March 31, 1999. During the second quarter of 1997, the Series CC Convertible Preferred Stock converted into common stock of the Company. Accordingly, all of the $13,412,000 of dividends were treated in the second quarter of 1997 as an allocation of net income to the preferred shareholders in determining the allocation of net income to the common shareholders. Real Estate Operations ---------------------- Rental income and cost of operations have increased for the nine months ended September 30, 1998 compared to the same period in 15 1997 due to the Company's merger and acquisition activities throughout 1997 and 1998. As a result of these activities, the number of self storage facilities included in the Company's consolidated financial statements has increased from 863 at September 30, 1997 to 951 at September 30, 1998. SELF-STORAGE OPERATIONS: The Company's self-storage operations account for the vast majority of the total property operations and represent the largest comparison variances from period to period. The following table outlines the historical operating results of self-storage operations. Summary of Self-storage operations - Historical ----------------------------------------------- Three months ended Nine months ended September 30, September 30, ---------------------------- -------------------------- 1998 1997 Change 1998 1997 Change ------------- ------------- -------- ------------ ------------ -------- (Amounts in thousands, except per square foot data) Rental income Pre - 1997 Acquisitions... $ 94,656 $ 88,195 7.3% $ 273,788 255,213 7.3% 1997 and 1998 acquisitions 34,729 14,113 87,162 18,585 ------------- ------------- -------- ------------ ------------ -------- 129,385 102,308 26.5% 360,950 273,798 31.8% ------------- ------------- -------- ------------ ------------ -------- Cost of Operations (before depreciation) Pre - 1997 Acquisitions... 27,705 25,736 7.7% 82,312 77,305 6.5% 1997 and 1998 acquisitions 10,050 3,881 26,281 5,087 ------------- ------------- -------- ------------ ------------ -------- 37,755 29,617 27.5% 108,593 82,392 31.8% ------------- ------------- -------- ------------ ------------ -------- Net operating income Pre - 1997 Acquisitions... 66,951 62,459 7.2% 191,476 177,908 7.6% 1997 and 1998 acquisitions 24,679 10,232 60,881 13,498 ------------- ------------- -------- ------------ ------------ -------- $ 91,630 $ 72,691 26.1% $ 252,357 $ 191,406 31.8% ============= ============= ======== ============ ============ ======== Net rentable square feet (at the end of the period, in 000's).... 57,061 52,031 9.7% 57,061 52,031 9.7% Number of facilities (at the end of the period).................. 951 863 10.2% 951 863 10.2% PRE - 1997 ACQUISITIONS: Weighted average annualized realized rent per occupied square foot..................... $9.60 $8.88 8.1% $9.36 $8.76 6.8% Weighted average annualized scheduled rent per square foot.. $9.72 $9.36 3.8% $9.72 $9.36 3.8% Weighted average occupancy for the period...................... 93.2% 93.3% (0.1%) 92.3% 91.2% 1.1% Rental income for the three months ended September 30, 1998 is net of promotional discounts totaling $3.7 million compared to $4.0 million for the same period in 1997. Rental income for the nine months ended September 30, 1998 is net of promotional discounts totaling $11.4 million compared to $10.3 million for the same period in 1997. In addition, included in cost of operations for the three months ended September 30, 1998 are costs associated with the telephone reservation center and advertising totaling $2.0 million, compared to $1.2 million for the same period in 1997. Included in cost of operations for the nine months ended September 30, 1998 are costs associated with the telephone reservation center and advertising totaling $5.0 million, compared to $2.2 million for the same period in 1997. In 1997 and through September 30, 1998, the Company acquired a total of 230 self-storage facilities, of which 221 were existing mature facilities obtained from affiliated entities and managed by the Company, 4 were newly developed facilities and 5 were third party 16 acquisitions of existing mature facilities. Accordingly, the Company has knowledge of the historical operations of the existing mature facilities obtained from affiliates prior to when the Company acquired the facilities. The following table summarizes the pro forma operating results of all of the Company's self-storage facilities, excluding the development facilities summarized in the table which follows, assuming that the Company owned all of the facilities as of January 1, 1997: Pro forma summary of self-storage operations: --------------------------------------------- Three months ended Nine months ended September 30, September 30, ---------------------------- -------------------------- 1998 1997 Change 1998 1997 Change ------------- ------------- -------- ------------ ------------ -------- Pro forma Pro forma (Amounts in thousands) Rental income................. $128,469 $119,466 7.5% $371,274 $345,268 7.5% Cost of operations............ 37,386 34,923 7.1% 111,733 105,589 5.8% ------------- ------------- -------- ------------ ------------ -------- Net operating income.......... $ 91,083 $ 84,543 7.7% $259,541 $ 239,679 8.3% ============= ============= ======== ============ ============ ======== The above table excludes the property operations of the Company's newly developed properties (2 opened in 1998, 2 opened in 1997 and 4 opened in 1996) which are in various stages of "fill-up." The aggregate development cost of these 8 facilities totaled approximately $37 million. The historical property operations with respect to these facilities are as follows: Three months ended Nine months ended September 30, September 30, ---------------------------- -------------------------- 1998 1997 Change 1998 1997 Change ------------- ------------- -------- ------------ ------------ -------- (Amounts in thousands) Rental income................. $ 916 $ 651 40.7% $ 2,449 $ 1,332 83.9% Cost of operations............ 369 277 33.2% 917 723 26.8% ------------- ------------- -------- ------------ ------------ -------- Net operating income.......... $ 547 $ 374 46.3% $ 1,532 $ 609 151.6% ============= ============= ======== ============ ============ ======== Through September 30, 1998, the majority of the Company's self-storage development activities have been conducted within the Development Joint Venture, a partnership created in April 1997 between the Company and a state pension plan to fund the development of approximately $220 million of self-storage facilities. The Development Joint Venture is funded solely with equity capital consisting of 30% from the Company and 70% from the state pension fund. Due to the Company's ownership in the Development Joint Venture being less than 50% and the Company's lack of control, the operations of the Development Joint Venture are not consolidated with the Company's. The Company accounts for its investment using the equity method, accordingly, its pro rata share of the operations of the Development Joint Venture are reflected in "Equity earnings from real estate entities." COMMERCIAL PROPERTY OPERATIONS: The Company's commercial property operations principally consist of the operations of PSBP, an affiliated real estate investment trust. The following table sets forth the historical commercial property amounts included in the Company's financial statements: 17 Commercial Property Operations - Historical ------------------------------------------- Three months ended Nine months ended September 30, September 30, ---------------------------- -------------------------- 1998 1997 Change 1998 1997 Change ------------- ------------- -------- ------------ ------------ --------- (Amounts in thousands) Rental income................. $ 1,833 $11,526 (84.1)% $ 21,229 $ 27,694 (23.3)% Cost of operations............ 685 4,277 (84.0)% 7,187 11,034 (34.9)% ------------- ------------- -------- ------------ ------------ --------- Net operating income.......... $ 1,148 $ 7,249 (84.2)% $ 14,042 $ 16,660 (15.7)% ============= ============= ======== ============ ============ ========= During the second quarter of 1998, the Company's ownership interest in PSBP was reduced below 50%, and accordingly, the Company ceased to have a controlling interest in PSBP. As a result, effective April 1, 1998, the Company no longer includes the accounts of PSBP in its consolidated financial statements and has accounted for its investment during the second and third quarters of 1998 using the equity method (see "Equity in earnings of real estate entities"). The income statement for the nine months ended September 30, 1998 includes the consolidated operating results of PSBP for the three months ended March 31, 1998. The significant decrease in rental income and cost of operations for the three and nine months ended September 30, 1998 reflects the Company's deconsolidation of PSBP. The following table summarizes the pro forma commercial operations of the Company assuming that the operations of PSBP were not consolidated with the Company's accounts (i.e., as if the Company had consistently used the equity method of accounting for its investment in PSBP): Pro forma summary of commercial operations: ------------------------------------------- Three months ended Nine months ended September 30, September 30, ---------------------------- -------------------------- 1998 1997 Change 1998 1997 Change ------------- ------------- -------- ------------ ------------ --------- Pro forma Pro forma (Amounts in thousands) Rental income................. $1,833 $1,734 5.7% $5,369 $5,073 5.8% Cost of operations............ 685 693 (1.2%) 2,076 2,160 (3.9%) ------------- ------------- -------- ------------ ------------ --------- Net operating income.......... $1,148 $1,041 10.3% $3,293 $2,913 13.0% ============= ============= ======== ============ ============ ========= EQUITY IN EARNINGS OF REAL ESTATE ENTITIES: In addition to its ownership of 12,459,328 common shares and operating partnership units in PSBP, the Company had general and limited partnership interests in 26 limited partnerships at September 30, 1998 (PSBP and the limited partnerships are collectively referred to as the "Unconsolidated Entities"). Due to the Company's limited ownership interest and control of these entities, the Company does not consolidate the accounts of these entities for financial reporting purposes, and accounts for such investments using the equity method. Equity in earnings of real estate entities for the three and nine months ended September 30, 1998 consists of the Company's pro rata share of the Unconsolidated Entities based upon the Company's ownership interest for the period. The following table sets forth the significant components of the Company's equity in earnings of real estate entities. 18 Historical summary: ------------------- Three months ended Nine months ended September 30, September 30, ---------------------------- -------------------------- 1998 1997 Change 1998 1997 Change ------------- ------------- -------- ------------ ------------ --------- ( Amounts in thousands) Property operations: PSBP..................... $7,437 $ - $7,437 $14,881 $ - $14,881 Development Joint Venture 252 58 194 432 40 392 Other partnerships....... 3,061 7,004 (3,943) 13,729 24,969 (11,240) ------------- ------------- -------- ------------ ------------ --------- 10,750 7,062 3,688 29,042 25,009 4,033 ------------- ------------- -------- ------------ ------------ --------- Depreciation: PSBP..................... (2,423) - (2,423) (4,818) - (4,818) Development Joint Venture (173) (58) (115) (364) (70) (294) Other partnerships....... (667) (2,422) 1,755 (4,720) (9,107) 4,387 ------------- ------------- -------- ------------ ------------ --------- (3,263) (2,480) (783) (9,902) (9,177) (725) ------------- ------------- -------- ------------ ------------ --------- Other: (1) PSBP..................... (275) - (275) (776) - (776) Development Joint Venture 29 25 4 87 43 44 Other partnerships....... (579) (193) (386) (1,853) (1,223) (630) ------------- ------------- -------- ------------ ------------ --------- (825) (168) (657) (2,542) (1,180) (1,362) ------------- ------------- -------- ------------ ------------ --------- Total equity in earnings of real estate entities....... $6,662 $4,414 $2,248 $16,598 $14,652 $1,946 ============= ============= ======== ============ ============ ========= (1) "Other" reflects the Company's share of general and administrative expense, interest expense, interest income, and other non-property, non-depreciation related operating results of these entities. Equity in earnings of real estate entities increased $2,248,000 and $1,946,000 in the three and nine months ended September 30, 1998 from the same periods in 1997. These increases include the impact of the Company's deconsolidation of PSBP, where the Company's share of earnings of PSBP after March 31, 1998 is reflected in equity in earnings of real estate entities. These impacts was partially offset by the impact of affiliated REIT mergers and the acquisition of partnership interests which occurred in 1997 and 1998 resulting in the consolidation of additional ownership entities. PORTABLE SELF-STORAGE BUSINESS: Public Storage Pick-up & Delivery ("PSPUD") incurred approximately $6.9 million of operating losses during the third quarter of 1998 compared to operating losses of approximately $12.1 million for the same period in 1997. The Company believes that the quarterly losses from the PSPUD operations peaked during the third quarter of 1997. Operating losses of PSPUD were approximately $10.5 million for the fourth quarter of 1997, $9.9 million for the first quarter of 1998, $8.3 million for the second quarter of 1998, and $6.9 million for the third quarter of 1998. The Company believes this trend of decreasing operating losses will continue with increases in PSPUD's revenues. FACILITY MANAGEMENT OPERATIONS: The property management contracts generally provide for compensation equal to 6% of gross revenues of the self-storage facilities managed. Under the supervision of the property owners, the Company coordinates rental policies, rent collections, marketing activities, the purchase of equipment and supplies, maintenance activity, and the selection and engagement of vendors, suppliers and independent contractors. In addition, the Company assists and advises the property owners in establishing policies for the hire, discharge and supervision of employees for the operation of these facilities, including resident managers, assistant managers, relief managers and billing and maintenance personnel. Property management operations reflect the activities with respect to the management of facilities owned by affiliated unconsolidated entities. As a result, the revenues generated from its property management operations are generally predictable and dependent upon the future growth of rental income for these affiliated properties. The Company has in the past acquired, and may continue to seek to acquire in the future, real estate facilities owned by affiliated entities which are not consolidated with the Company. The 19 acquisition of such facilities reduces management fee income to the Company and is offset by a corresponding reduction in the cost of property operations. During the three months ended September 30, 1998, the Company's property management operations generated net operating income of $1,162,000 on revenues of $1,388,000 and expenses of $226,000 as compared to net operating income of $2,018,000 on revenues of $2,376,000 and expenses of $358,000 during the same period in 1997. During the nine months ended September 30, 1998, the Company's property management operations generated net operating income of $4,025,000 on revenues of $4,805,000 and expenses of $780,000 as compared to net operating income of $7,019,000 on revenues of $8,319,000 and expenses of $1,300,000 during the same period in 1997. The decreases in property management operations are due to the Company's acquisition of facilities which it previously managed for third parties and affiliated entities for a fee, as well as the Company's deconsolidation of PSBP. INTEREST AND OTHER INCOME: The Company operates additional businesses through affiliates, including retail sales of locks, boxes, and packing supplies as well as the rental of trucks. The net results of these two businesses are presented along with interest and other income, as "interest and other income." The components of interest and other income are detailed as follows: Three months ended September 30, Nine months ended September 30, ---------------------------------- ---------------------------------- 1998 1997 Dollar Charge 1998 1997 Dollar Charge ---------- ------- ------------- --------- --------- ------------- (Amounts in thousands) Sales of Packaging Material and Truck Rentals: Revenues............................. $2,572 $1,538 $1,034 $6,243 $3,691 $2,552 Cost of operations................... (1,764) (1,227) (537) (4,897) (2,944) (1,953) ---------- ------- ------------- --------- --------- ------------- Net operating income....... 808 311 497 1,346 747 599 Interest and other income............ 3,113 2,506 607 10,579 6,742 3,837 ---------- ------- ------------- --------- --------- ------------- Total interest and other income.. $3,921 $2,817 $1,104 $11,925 $7,489 $4,436 ========== ======= ============= ========= ========= ============= Interest and other income principally consists of interest earned on cash balances and interest related to mortgage notes receivable. The increase in interest income for the three and nine months ended September 30, 1998 compared to the same periods in 1997 is primarily due to increased interest income on excess cash balances. DEPRECIATION AND AMORTIZATION: Depreciation and amortization expense has increased $2,566,000, to $26,217,000 for the three months ended September 30, 1998 as compared to $23,651,000 for the same period in 1997. Depreciation and amortization expense has increased $15,487,000, to $79,628,000 for the nine months ended September 30, 1998 as compared to $64,141,000 for the same period in 1997. These increases are principally due to the acquisition of additional real estate facilities during 1997 and 1998, offset partially by the Company's change in accounting method with respect to its investment in PSBP. GENERAL AND ADMINISTRATIVE EXPENSE: General and administrative expense has increased $773,000, to $2,684,000 for the three months ended September 30, 1998 as compared to $1,911,000 for the same period in 1997. General and administrative expense has increased $2,061,000, to $7,246,000 for the nine months ended September 30, 1998 as compared to $5,185,000 for the same period in 1997. These increases are due to the growth in the size of the Company. MINORITY INTEREST IN INCOME: Minority interest in income represents the income allocable to equity interests in the consolidated entities which are not owned by the Company. Minority interest in income for the three months ended September 30, 1998 was $5,572,000 compared to $2,748,000 for the same period in 1997. Minority interest in income for the nine months ended September 30, 1998 was $16,141,000 compared to $7,777,000 for the same period in 1997. The increases in minority interest in income are primarily the result of the Company's acquisition of sufficient ownership interest (but not 100% ownership) and control in affiliated partnerships allowing the inclusion of the accounts of these partnerships in the Company's consolidated financial statements combined with improved property operations for those partnerships already consolidated with the Company whereby the minority interest participate in the improved operations through increased earnings. However, these increases are 20 partially offset in the nine-month period by the effect of the Company's deconsolidation of PSBP whereby the minority interest with respect to PSBP after March 31, 1998 was removed from the Company's consolidated financial statements. SUPPLEMENTAL PROPERTY DATA At September 30, 1998, the Company's investment portfolio consists of (i) wholly-owned properties owned by the Company, (ii) properties owned by real estate partnerships in which the Company has significant ownership interests (the "Consolidated Partnerships"), (iii) properties owned by real estate entities (partnerships and PS Business Parks Inc.) in which the Company's ownership interest and control are not sufficient to warrant the consolidation of such entities (the "Unconsolidated Entities") and (iv) three properties for the use of PSPUD. The following table summarizes the Company's investment in real estate facilities as of September 30, 1998, excluding the three real estate facilities for use by the Company's PSPUD operations: Number of Facilities in which the Net Rentable Square Footage Company has an ownership interest (in thousands) ------------------------------------- --------------------------------- Self-Storage Commercial Self-Storage Commercial Facilities Properties Total Facilities Properties Total ------------------------- ----------- ------------------------ -------- Wholly-owned facilities 597 1 598 36,350 9 36,359 Facilities owned by Consolidated Partnerships 354 - 354 20,711 - 20,711 -------------- ---------- ----------- ----------- ------------ -------- Total consolidated facilities 951 1 952 57,061 9 57,070 Facilities owned by Unconsolidated Entities 138 98 236 7,896 10,334 18,230 -------------- ---------- ----------- ----------- ------------ -------- Total facilities in which the Company has an ownership interest (A) 1,089 99 1,188 64,957 10,343 75,300 ============== ========== =========== =========== ============ ======== (A) Excludes three industrial facilities the Company owns which are for use by the Company's PSPUD operations. In order to evaluate how the Company's overall portfolio has performed, management analyzes the operating performance of a consistent group of self-storage facilities representing 985 (57.6 million net rentable square feet) of the 1,089 self-storage facilities (herein referred to as "Same Store" self-storage facilities) which have been operated under the "Public Storage" name for at least the past three years. At September 30, 1998, the Company had ownership interests in a total of 1,089 mini-warehouse facilities. Of these 1,089 properties, 985 or 90% of the mini-warehouses have been in operation and managed by Public Storage, Inc. since January 1, 1994. The following table summarizes the operating results of these 985 properties: 21 Same Store mini-warehouse facilities (985 facilities): ------------------------------------------------------ (historical property operations) Three months ended September 30, Nine months ended September 30, --------------------------------------- ------------------------------------ 1998 1997 Change 1998 1997 Change ---------- ----------- ------ --------- --------- ------ Rental income............... $135,397 $125,344 8.0% $390,589 $362,226 7.8% Cost of operations (includes an imputed 6% property management fee)........... 45,560 42,249 7.8% 135,822 127,480 6.5% ---------- ----------- ------ --------- --------- ------ Net operating income (1).... $ 89,837 $ 83,095 8.1% $254,767 $234,746 8.5% ========== =========== ====== ========= ========= ====== Gross profit margin (2)..... 66.4% 66.3% 0.1% 65.2% 64.8% 0.4% - ----------------------------------------------------------------------------------------------------------------- Weighted Average: Occupancy during the period.............. 93.6% 93.6% 0.0% 92.6% 91.6% 1.0% Annualized realized rent per sq. ft. for period.(3)............. $10.08 $9.24 9.1% $9.72 $9.12 6.6% Annualized scheduled rent per sq. ft. for period.. $10.32 $9.84 4.9% $10.20 $9.84 3.7% 1. Assumes payment of property management fees on all facilities, including those facilities owned by the Company for which no fee is paid. 2. Gross profit margin is computed by dividing property net operating income (which excludes depreciation expense) by rental revenues. Cost of operations include a 6% management fee. The gross profit margin excluding the property management fee was 72.4% and 72.3% for the three months ended September 30, 1998 and 1997, respectively; and 71.2% and 70.8% for the nine months ended September 30, 1998 and 1997, respectively. 3. Realized rent per square foot represents the actual revenue earned per occupied square foot during the period - annualized. Management believes this is a more relevant measure than the scheduled rental rates, since scheduled rates can be discounted through the use of promotions. Rental income for the Same Store facilities included promotional discounts totaling $3.6 million for the three months ended September 30, 1998, compared to $4.8 million for the same period in 1997. Rental income for the Same Store facilities included promotional discounts totaling $12.0 million for the nine months ended September 30, 1998, compared to $13.6 million for the same period in 1997. Promotional discounts are attributable to promotional activities offered through the national telephone reservation center. Cost of operations for the three months ended September 30, 1998 increased due to (i) advertising and promotion, which increased $779,000 due primarily to the Company's national telephone reservations center and television advertising in certain markets, (ii) property taxes, which increased $622,000, due primarily to higher assessments and (iii) management fees, which increased $535,000, due to increased rental income. Cost of operations for the nine months ended September 30, 1998 increased due to (i) advertising and promotion, which increased $3.3 million due primarily to the Company's national telephone reservations center and television advertising in certain markets and (ii) property taxes, which increased $2.2 million, due primarily to higher assessments and (iii) management fees, which increased $1.7 million, due to increased rental income. Liquidity and Capital Resources ------------------------------- The Company has operated and intends to continue to operate in a self-sufficient manner without reliance on external sources of financing to fund its ongoing operating needs. The Company believes that funds internally generated from ongoing operations will continue to be sufficient to enable it to meet its operating expenses, capital improvements, debt service requirements and distributions to shareholders for the foreseeable future. Over the past six years, funds internally generated from ongoing operations were in excess of the Company's operating needs, allowing the Company to retain cash flow, which it used to acquire additional real estate investments or make optional principal repayments on debt. 22 INTERNALLY GENERATED CASH FLOWS: The Company believes that important measures of its performance as well as its liquidity are cash provided by operations and funds from operations ("FFO") and the ability of these measures to fund the Company's operating requirements (i.e., capital improvements, principal payments on debt and distribution requirements). Net cash provided by operations (as determined in accordance with generally accepted accounting principles) reflects the cash generated from the Company's business before distributions to various equity holders, including the preferred shareholders, capital expenditures or mandatory principal payments on debt. Net cash provided by operations has increased to $273,520,000 from $214,212,000 for the nine months ended September 30, 1998 and 1997, respectively. The following table summarizes the Company's ability to pay the minority interests' distributions, its dividends to the preferred shareholders and capital improvements to maintain the facilities through the use of cash provided by operating activities. The remaining cash flow is available to the Company to make both scheduled and optional principal payments on debt, pay distributions to common shareholders and for reinvestment. For the Nine Months Ended September 30, --------------------------------------- 1998 1997 ----------------- -------------------- (Amounts in thousands) Net income.................................................. $ 167,849 $ 133,117 Depreciation and amortization............................... 79,628 64,141 Depreciation from unconsolidated real estate investments............................................... 9,902 9,177 Minority interest in income................................. 16,141 7,777 ----------------- -------------------- Net cash provided by operating activities................. 273,520 214,212 Distributions from operations to minority interests (funds from operations allocable to minority interests) ............................................... (25,565) (14,106) ----------------- -------------------- Cash from operations/FFO available to the Company's shareholders.............................................. 247,955 200,106 Less: preferred stock dividends (A)......................... (59,322) (54,722) ----------------- -------------------- Cash from operations/FFO available to common shareholders.............................................. 188,633 145,384 Capital improvements to maintain facilities................. (19,257) (24,056) Add back: minority interest share of capital improvements.............................................. 1,582 1,403 ----------------- -------------------- Funds available for principal payments on debt, common dividends and reinvestment................................ 170,958 122,731 Cash distributions to common shareholders................... (75,270) (63,076) ----------------- -------------------- Funds available for principal payments on debt and investment................................................ $ 95,688 $ 59,655 ================= ==================== (A) 1997 amount excludes $13,412 non-recurring payment of dividends with respect to Series CC Convertible Preferred Stock. See the consolidated statements of cash flows for the nine months ended September 30, 1998 and 1997 for additional information regarding the Company's investing and financing activities. FFO increased to $247,955,000 for the nine months ended September 30, 1998 compared to $200,106,000 for the same period in 1997. FFO applicable to the common shareholders (after deducting preferred stock dividends) increased to $188,633,000 for the nine months ended September 30, 1998 compared to $145,384,000 for the same period in 1997. FFO is used by many financial analysts in evaluating REITs. The Company defines FFO as net income (loss) (computed in accordance with GAAP) before (i) gain (loss) on disposition of real estate, adjusted as follows: (i) plus depreciation and amortization, and (ii) less FFO attributable to minority interest. The National Association of Real Estate Investment Trusts, Inc. ("NAREIT") definition of FFO does not specifically address the treatment of minority interest in the determination of FFO. In the case of the Company, FFO represents amounts attributable to its shareholders after deducting amounts attributable to the minority interests. FFO does not take into consideration scheduled principal payments on debt, capital improvements, distributions and other obligations of the Company. 23 Accordingly, FFO is a supplemental performance measure and is not a substitute for the Company's cash flow or net income (as discussed above) as a measure of the Company's liquidity or operating performance. RETENTION OF OPERATING CASH FLOWS: Operating as a REIT, the Company's ability to retain cash flow for reinvestment is restricted. In order for the Company to maintain its REIT status, a substantial portion of its operating cash flows must be used to make distributions to its shareholders. Remaining cash flows must then be sufficient to fund necessary capital improvements and scheduled debt service requirements. Accordingly, the Company's ability to be self-sufficient is predicated on its ability to generate sufficient operating cash flows to satisfy its REIT distribution requirements, capital improvement requirements, scheduled debt service requirements, and provide funds for additional investments. Over the past four years, the Company's distribution policy has enabled it to retain significant funds (after capital improvements) to make additional investments and debt reductions. During the first nine months of 1998 and 1997, the Company distributed to common shareholders approximately 44.0% and 51.4% of its FFO available to common shareholders, respectively, allowing it to retain approximately $95.7 million and $59.7 million, respectively, after satisfying its capital improvements and dividend requirements. DISTRIBUTION REQUIREMENTS: During the first nine months of 1998, the Company paid dividends totaling $57,159,000 to the holders of the Company's Senior Preferred Stock, $2,163,000 to the holders of the Convertible Preferred Stock, and $75,270,000 to the holders of Common Stock. On June 1, 1998, the Company exercised its option to redeem the Convertible Preferred Stock for Common Stock, and the redemption was effective July 1, 1998. Distribution requirements for fiscal 1998 with respect to the Senior Preferred Stock and Convertible Preferred Stock (prior to the redemption) will be approximately $78 million. CAPITAL IMPROVEMENT REQUIREMENTS: During 1998, the Company has budgeted approximately $23.0 million for capital improvements for its self-storage facilities. The minority interests' share of the estimated capital improvements is approximately $3.5 million. During the first nine months of 1998, the Company incurred capital improvements of approximately $19.3 million, of which $857,000 was for PSBP in the first quarter of 1998 and the remainder was for all of the Company's other facilities. DEBT SERVICE REQUIREMENTS: The Company does not believe it has any significant refinancing risks with respect to its mortgage debt, all of which is at a fixed rate. At September 30, 1998, the Company had total outstanding notes payable of $85.6 million. Approximate principal maturities of notes payable at September 30, 1998 are as follows: Fixed Rate Mortgage Debt 7.08% Unsecured (Weighted Senior Notes average rate of 10.4%) Total ------------ ---------------------- ---------- (Amounts in thousands) 1998 (remainder of) $ 3,625 $ 565 $ 4,190 1999 8,000 6,398 14,398 2000 8,750 2,622 11,372 2001 9,500 2,910 12,410 2002 9,750 3,229 12,979 Thereafter 10,000 20,268 30,268 ------------ ---------------------- --------- $ 49,625 $ 35,992 $ 85,617 ============= ====================== ========= EXTERNAL FINANCING: Despite the Company's ability to retain a portion of its internally generated cash flow, the Company's growth strategies have required the Company to seek external financing. The Company has an unsecured $150.0 million revolving credit facility with a group of banks which it uses as a temporary source of acquisition financing. The Company, however, seeks to ultimately finance all acquisitions with permanent sources of capital. As a result, the Company has raised capital through the public issuance of both common and preferred stock which was used to repay borrowings and make additional investments in real estate assets. The Company believes that its size and financial flexibility enable it to access capital for growth when appropriate. The Company's financial profile is characterized by a low level of debt to total capitalization, increasing net income, increasing cash flow from operations, and a 24 conservative dividend payout ratio with respect to the common stock. The Company's credit ratings on its Senior Preferred Stock by each of the three major credit agencies are Baa2 by Moody's and BBB+ by Standard and Poors and Duff & Phelps. The Company's portfolio of real estate facilities remains substantially unencumbered. At September 30, 1998, the Company had debt outstanding of $85.6 million and had consolidated real estate facilities with a book value of $2.6 billion. The Company, however, has been averse to financing its acquisitions with debt and generally will only increase its mortgage borrowing through the assumption of pre-existing debt on acquired real estate facilities. Over the past three years the Company has funded substantially all of its acquisitions with permanent capital (both common and preferred stock). Unlike many other real estate companies, the Company has elected to use preferred stock despite the fact that the coupon rates of its preferred stock exceeds current rates on conventional debt. The Company has chosen this alternative for the following reasons: (i) the Company's perpetual preferred stock has no sinking fund requirements or maturity date and does not require redemption, all of which eliminate any future refinancing risks, (ii) preferred stock allows the Company to leverage the common stock without the attendant interest rate or refinancing risks of debt, and (iii) dividends on the preferred stock can be applied to the Company's REIT distributions requirements, which have helped the Company to satisfy these requirements. During the first nine months of 1998, the Company issued 7,951,821 shares of common stock in public and private offerings, raising net proceeds of approximately $234.5 million. An additional 1,230,689 shares of common stock were issued in connection with the acquisition of partnership interests, and 433,526 shares were issued in connection with the merger of an affiliated REIT with the Company in May 1998. REPURCHASES OF THE COMPANY'S COMMON STOCK: On June 12, 1998, the Company announced that the Board of 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. Through September 30, 1998 the Company has repurchased a total of 2,786,400 shares of common stock at an aggregate cost of $71.4 million. In the fourth quarter through November 4, 1998, the Company repurchased an additional 33,000 shares of common stock at an aggregate cost of approximately $902,000. DEVELOPMENT ACTIVITIES: As previously announced, in April 1997, the Company and an institutional investor formed a joint venture partnership for the purpose of developing up to $220 million of self-storage facilities. The venture will be funded solely with equity capital consisting of 30% from the Company and 70% from the institutional investor. The Company has invested approximately $44.6 million in the joint venture at September 30, 1998. During the nine months ended September 30, 1998, the joint venture opened 12 new self storage facilities that it had developed (approximately 709,000 net rentable sq. ft.). As of September 30, 1998, the joint venture was committed to developing 10 additional projects (approximately 658,000 net rentable square feet) that were in process, with total costs incurred of $34.7 million and estimated remaining costs to complete of $13.8 million. The joint venture is currently reviewing the final 20 projects ($38.7 million incurred at September 30, 1998, with remaining costs to complete of $54.1 million). Upon approval of these additional 20 facilities, the joint venture will be fully committed. These 20 projects are currently being developed by the Company and the construction costs will be transferred to the joint venture once they have been approved. At September 30, 1998, included in construction in process is approximately $24.7 million, and included in real estate facilities is $14.0 million, with respect to these projects. The Company has identified 49 additional self storage development projects (2,847,000 net rentable square feet) with total estimated development costs of approximately $179 million. Most of these projects have already been approved by the Board of Directors, but their development is subject to significant contingencies. The Company will fund this development through cash flow from operations, borrowings on its line of credit, the issuance of additional equity securities, or other means. 25 SUBSEQUENT EVENT - PROPOSED MERGER WITH STORAGE TRUST REALTY: The Company and Storage Trust Realty ("Storage Trust"), a New York Stock Exchange listed REIT, have entered into an Agreement and Plan of Merger among Storage Trust, the Company and Newco Merger Subsidiary, Inc., a subsidiary of the Company ("PSI Sub"), dated as of November 12, 1998 (the "Merger Agreement"). Storage Trust is a fully integrated, self-managed and self-administered REIT headquartered in Columbia, Missouri, engaged in the management and ownership of 237 self-storage stores located in 16 states totaling approximately 12.5 million net rentable square feet and 109,000 units. Under the Merger Agreement, PSI Sub would be merged into Storage Trust, and each share of beneficial interest of Storage Trust would be exchanged for 0.86 shares of the Company's common stock. This exchange ratio implies an enterprise value for Storage Trust of approximately $600 million, including the assumption of approximately $192 million of indebtedness. Upon the effectiveness of the merger, the Company's board of directors would be expanded by one seat and Mr. Daniel C. Staton, Storage Trust's Chairman of the Board, would be elected as a new member of the Company's board of directors. The merger has been structured as a tax free transaction. The transaction is expected to be completed in the first quarter of 1999. The transaction is subject to the approval of the shareholders of Storage Trust and customary regulatory approvals and other conditions. REIT STATUS: The Company believes that it has operated, and intends to continue to operate, in such a manner as to qualify as a REIT under the Internal Revenue Code of 1986, but no assurance can be given that it will at all times so qualify. To the extent that the Company continues to qualify as a REIT, it will not be taxed, with certain limited exceptions, on the taxable income that is distributed to its shareholders. As a REIT, the Company is not taxed on that portion of its taxable income which is distributed to its shareholders provided that at least 95% of its taxable income is so distributed prior to filing of the Company's tax return. The Company has satisfied the REIT distribution requirement beginning with its taxable year for 1981. IMPACT OF THE YEAR 2000 ISSUE: The Company has completed an assessment of all of its hardware and software applications to identify susceptibility to what is commonly referred to as the "Y2K Issue" whereby certain computer programs have been written using two digits rather than four to define the applicable year. Any of the Company's computer programs or hardware with the Y2K Issue that have date-sensitive applications or embedded chips may recognize a date using "00" as the year 1900 rather than the year 2000, resulting in miscalculations or system failure causing disruptions of operations. Many of the Company's critical applications, relative to the direct management of properties and the Company's Pickup and Delivery logistics systems, have recently been replaced and the Company believes they are already Year 2000 compliant. The Company has an implementation in process on the remaining critical applications, including its general ledger and related systems, that are believed to have Y2K issues. The Company expects the implementation to be complete by June 1999. Contingency plans have been developed for use in case the Company's implementations are not completed on a timely basis. While the Company presently believes that the impact of the Y2K Issue on its systems can be mitigated, if the Company's plan for ensuring Year 2000 Compliance and the related contingency plans were to fail, be insufficient, or not be implemented on a timely basis, Company operations could be materially impacted. Certain of the Company's other non-computer related systems that may be impacted by the Y2K Issue, such as security systems, are currently being evaluated, and the Company expects the evaluation to be complete by June 1999. The Company expects the implementation of any required solutions to be complete in advance of December 31, 1999. The Company has not fully evaluated the impact of lack of Year 2000 compliance on these systems, but has no reason to believe that lack of compliance would materially impact the Company's operations. The Company exchanges electronic data with certain outside vendors in the banking and payroll processing areas. The Company has been advised by these vendors that their systems are or will be Year 2000 compliant, but has requested a Year 2000 compliance certification from these entities. The Company is not aware of any other vendors, suppliers, or other external agents with a Y2K Issue that would 26 materially impact the Company's results of operations, liquidity, or capital resources. However, the Company has no means of ensuring that external agents will be Year 2000 compliant, and there can be no assurance that the Company has identified all such external agents. The inability of external agents to complete their Year 2000 compliance process in a timely fashion could materially impact the Company. The effect of non-compliance by external agents is not determinable. The total cost of the Company's year 2000 compliance activities (which primarily consists of the costs of new systems) is estimated at approximately $3.6 million, of which $2.4 million has been incurred to date. These costs are capitalized. The costs of the projects and the date on which the Company believes that it will be Year 2000 compliant are based upon management's best estimates, and were derived utilizing numerous assumptions of future events. There can be no assurance that these estimates will be achieved, and actual results could differ materially from those anticipated. There can be no assurance that the company has identified all potential Y2K Issues either within the Company or at external agents. In addition, the impact of the Y2K issue on governmental entities and utility providers and the resultant impact on the Company, as well as disruptions in the general economy, may be material but cannot be reasonably determined or quantified. 27 PART II. OTHER INFORMATION Item 1 Legal Proceedings ----------------- PUBLIC STORAGE, INC. V AT&T CORPORATION, ET. AL., U. S. District Court for Central District of California (Filed May 20, 1998) The Company is seeking declaratory and injunctive relief and indemnification against a group of long-distance and local telephone carrier defendants and others. Certain of the defendants are demanding payments, aggregating in excess of $3 million from the Company for unauthorized, fraudulent long-distance telephone calls placed by unknown third parties through the Company's telephone lines. The District Court has dismissed the Company's claims against the long-distance and local carrier defendants, and the Company is evaluating its alternatives. The Company believes that these charges are covered by insurance, although the insurance carrier has not acknowledged coverage. Except as described above and in the Company's 1997 Annual Report on Form 10-K, there are no material pending legal proceedings involving the Company or its subsidiaries. Item 5. Other Information ----------------- (a) PROPOSED MERGER. The Company and Storage Trust Realty ("Storage Trust"), a New York Stock Exchange listed REIT, have entered into an Agreement and Plan of Merger among Storage Trust, the Company and Newco Merger Subsidiary, Inc., a subsidiary of the Company ("PSI Sub"), dated as of November 12, 1998 (the "Merger Agreement"). Storage Trust is a fully integrated, self-managed and self-administered REIT headquartered in Columbia, Missouri, engaged in the management and ownership of 237 self-storage stores located in 16 states totaling approximately 12.5 million net rentable square feet and 109,000 units. Under the Merger Agreement, PSI Sub would be merged into Storage Trust, and each share of beneficial interest of Storage Trust would be exchanged for 0.86 shares of the Company's common stock. This exchange ratio implies an enterprise value for Storage Trust of approximately $600 million, including the assumption of approximately $192 million of indebtedness. Upon the effectiveness of the merger, the Company's board of directors would be expanded by one seat and Mr. Daniel C. Staton, Storage Trust's Chairman of the Board, would be elected as a new member of the Company's board of directors. The merger has been structured as a tax free transaction. The transaction is expected to be completed in the first quarter of 1999. The transaction is subject to the approval of the shareholders of Storage Trust and customary regulatory approvals and other conditions. For further information regarding the merger, see the Merger Agreement which is referenced as Exhibit 2 28 hereto and is incorporated herein by this reference and the Company's and Storage Trust's joint press release dated November 12, 1998 which is referenced as Exhibit 99 hereto and is incorporated herein by this reference. (b) Revised Deadlines for Receipt of Shareholder Proposals for Consideration at 1999 Annual Meeting. The Company expects to hold its 1999 Annual Meeting of Shareholders in May 1999. Any proposal that a shareholder wishes to submit for inclusion in the Company's Proxy Statement for the 1999 Annual Meeting of Shareholders ("1999 Proxy Statement") pursuant to Securities and Exchange Commission Rule 14a-8 must be received by the Company no later than January 1, 1999. In addition, notice of any proposal that a shareholder wishes to propose for consideration at the 1999 Annual Meeting of Shareholders, but does not seek to include in the Company's 1999 Proxy Statement pursuant to Rule 14a-8, must be delivered to the Company no later than March 1, 1999 if the proposing shareholder wishes for the Company to describe the nature of the proposal in its 1999 Proxy Statement as a condition to exercising its discretionary authority to vote proxies on the proposal. Any shareholder proposals or notices submitted to the Company in connection with the 1999 Annual Meeting of Shareholders should be addressed to: Sarah Hass, Secretary, Public Storage, Inc., 701 Western Avenue, Glendale, California 91201-2397. Item 6 Exhibits and Reports on Form 8-K -------------------------------- (a) The following Exhibits are included herein: (2) Agreement and Plan of Merger by and among Storage Trust Realty, Public Storage, Inc., and Newco Merger Subsidiary, Inc. dated as of November 12, 1998. Filed with Storage Trust's Current Report on Form 8-K dated November 12, 1998 and incorporated herein by reference. (11) Statement re: Computation of Earnings per Share (12) Statement re: Computation of Ratio of Earnings to Fixed Charges (27) Financial Data Schedule (99) Public Storage, Inc.'s and Storage Trust Realty's joint press release dated November 12, 1998. Filed with Storage Trust's Current Report on Form 8-K dated November 12, 1998 and incorporated herein by reference. (b) Reports on Form 8-K None. 29 SIGNATURES Pursuant to the requirements 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 13, 1998 PUBLIC STORAGE, INC. BY: /s/ John Reyes --------------- John Reyes Senior Vice President and Chief Financial Officer (Principal financial officer) 30