[Wachtell, Lipton, Rosen & Katz Letterhead]
June 23, 2006
Mr. Michael McTiernan, Esq.
Ms. Jennifer Gowetski, Esq.
Division of Corporation
Finance Securities and Exchange Commission
100 F Street, N.E.
Washington, D.C. 20549
Re: Public Storage, Inc.
Amendment No. 3 to Registration Statement
On Form S-4
Filed June 20, 2006
File No. 333-133438
Public Storage, Inc.
Annual Report on Form 10-K
Filed February 16, 2006
File No. 1-08389
Dear Mr. McTiernan and Ms. Gowetski:
Set forth below are responses of Public Storage, Inc. ("PSI") to the comment of
the Staff of the Division of Corporation Finance that was set forth in your
letter dated June 21, 2006 regarding PSI's Annual Report on Form 10-K.
The Staff's comment, indicated in bold, is followed by responses on behalf of
PSI.
FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2005 - PUBLIC STORAGE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
INTANGIBLE ASSETS AND GOODWILL, PAGE F-12
1. WE NOTE THAT THE MAJORITY OF YOUR PROPERTY MANAGEMENT REVENUES AND EXPENSES
RELATED TO THE REMAINING PROPERTY MANAGEMENT CONTRACTS ARE ELIMINATED UPON
CONSOLIDATION, AS A RESULT OF YOUR ACQUISITION OF A MAJORITY OF THESE
PROPERTIES IN PRIOR YEARS. THE FUTURE CASH FLOWS RELATED TO THESE
MANAGEMENT CONTRACTS HAVE EFFECTIVELY BEEN TERMINATED, ON A CONSOLIDATED
BASIS, UPON ACQUISITION OF THE
Mr. Michael McTiernan
Ms. Jennifer Gowetski
June 23, 2006
Page 2
RELATED PROPERTIES. AS SUCH, PLEASE FURTHER EXPLAIN TO US HOW YOU EVALUATED
YOUR INTANGIBLE ASSET FOR IMPAIRMENT GIVEN THE EFFECTIVE TERMINATION OF
YOUR MANAGEMENT AGREEMENTS ASSOCIATED WITH PROPERTIES ACQUIRED AND
CORRESPONDING ELIMINATION OF ALL FUTURE CASH FLOWS ASSOCIATED WITH THESE
MANAGEMENT AGREEMENTS, ON A CONSOLIDATED BASIS.
BACKGROUND
In November 1995, PSI acquired PSMI (referred to hereinafter as the "1995
Acquisition") whose assets principally included interests in various affiliated
entities and management contracts that entitled PSI to manage approximately 563
self-storage facilities owned by the affiliated entities. In addition, as a
result of the 1995 Acquisition, PSI became self-administered.
The 1995 Acquisition was accounted for using the purchase method of accounting
pursuant to APB No. 16, accordingly, allocations of the total acquisition cost
to the net assets acquired were made based on the fair value of the assets
acquired and liabilities assumed.
Approximately $165 million of the purchase price was allocated to the management
contracts, the only identifiable intangible asset acquired. The management
contracts provide that PSI would be entitled to a fee equal to 6% of the gross
revenues generated at each managed facility in exchange for providing certain
property management services. The $165 million valuation was determined by PSI
based upon a discounted ten year projected cash flow analysis plus an assumed
terminal value at the end of year 10.
At the time of the 1995 Acquisition, PSI also determined that the appropriate
amortization period for the intangible asset was 25 years, after considering the
following factors: (i) the management contracts were with affiliated entities in
which, as a result of the 1995 Acquisition, PSI had significant influence over
the decision making process and termination of the contracts was unlikely, (ii)
the fee structure was consistent with the market, (iii) a competitor used a
similar amortization period for similar assets and (iv) the 25 years was
consistent with the estimated useful lives of the underlying real estate assets.
For reference, the purchase price allocation and amortization period was
discussed in more detail in a letter to the Staff dated September 22, 1995 in
response to the Staff's comment letter dated September 15, 1995.
Following the 1995 Acquisition, the revenues generated from the management of
the facilities, and the related expenses, were presented on PSI's financial
statements as management fee revenues and cost of operations. Over the course of
the next 10 years the amount of revenues and expenses related to the management
activities was reduced significantly due to the acquisition and consolidation of
a significant number of the managed facilities as described below, since such
properties became self-managed by PSI.
Subsequent to the 1995 Acquisition, PSI acquired, from time to time, interests
in entities owning a significant number of the 563 properties. As PSI acquired
sufficient ownership interest to control the entities, the related properties
were included in the consolidated financial statements. Upon consolidation of
each property, PSI reclassified the profit from the property management
activities from management fee revenue and management cost of operations, to a
reduction in cost of operations for the related self-storage facilities.
Mr. Michael McTiernan
Ms. Jennifer Gowetski
June 23, 2006
Page 3
The following table, which is for illustrative purposes only, reflects the
impact of this consolidation process:
----------------------------------------------------------------------------
CONSOLIDATION ILLUSTRATION
Affiliated
PSI Partnership's Consolidation PSI
Unconsolidated Books Adjustment Consolidated
----------------------------------------------------------------------------
(A) (B) (C) (D)
REVENUES:
Rental Income 1,000 1,000
Property Management Revenues 60 (60) -
----------------------------------------------------------------------------
Total Revenues 60 1,000 (60) 1,000
COST OF OPERATIONS:
Self-storage cost of operations 608 12 620
Mgt. Fees paid to PSI 60 (60) -
Cost of Management 12 (12) -
----------------------------------------------------------------------------
Total cost of operations 12 668 (60) 620
Net Cash Flows $ 48 $ 332 $ - $ 380
============================================================================
(A) This column represents the cash flow stream generated by the
property management activities, $48 per year, which PSI purchased in
the 1995 Acquisition.
(B) This column reflects the cash flow stream, $332 per year, generated
by the facilities owned by the affiliated partnership prior to its
acquisition by PSI; these cash flows include a charge for the
management fee paid to PSI.
(C) This column represents the consolidation adjustment which
reclassifies the $48 profits from the management activities to a
reduction in cost of operations, assuming that PSI acquired the
affiliated partnership.
(D) PSI's consolidated operations reflect the $48 cash flow stream from
the management fees and the $332 in cash flows of the properties, or
a total of $380, all as self-storage operations, assuming that PSI
acquired the affiliated partnership.
ISSUE - RECOVERABILITY OF ASSET
The Staff has asked us to further explain how PSI evaluated its intangible asset
for impairment given the effective termination of its management agreements
associated with properties acquired and the corresponding elimination of all
future cash flows associated with these management agreements, on a consolidated
basis.
ANALYSIS AND CONCLUSION - IMPAIRMENT
Notwithstanding that the cash flows related to the management activities have
effectively been eliminated in consolidation and are no longer reflected on the
consolidated income statement as separate line items, the cash flows from the
management activities have not gone away. As illustrated in the above table, the
cash flow from the management of the properties has been reclassified in
consolidation as a reduction to the cost of operations of the properties.
Accordingly, the cash flow from the intangible asset acquired in the 1995
Acquisition continues to provide a benefit to PSI.
Mr. Michael McTiernan
Ms. Jennifer Gowetski
June 23, 2006
Page 4
PSI's view is that it effectively acquired the rights to 100% of the property
cash flow in two steps:
o first in the 1995 Acquisition, PSI acquired the management fee income
stream (the "Management Fee Interest") of each property (Column A on
the Consolidation Illustration above), and then
o subsequently, PSI acquired the remaining interest (referred to
hereinafter as the "Remaining Real Estate Interest"), representing the
remaining cash flow stream of the properties (Column B on the
Consolidation Illustration above). The price paid by PSI for the
Remaining Real Estate Interest represented an amount equal to the fair
value of that particular cash flow stream, which excludes the cash flow
stream represented in the Management Fee Interest, since PSI already
owned those cash flows.
To assume that the intangible asset was impaired because the related cash flow
had effectively been eliminated in consolidation would be misleading to users of
PSI's financial statements, in PSI's opinion. This is because in evaluating
management's ability to deploy capital at appropriate rates of return, investors
would associate 100% of the property cash flow with only a portion of the cost
to acquire such cash flows. Accordingly, the historical cost of the 100% assets
acquired are included appropriately as assets on PSI's balance sheet.
For further support of PSI's position that the asset is not impaired, PSI would
also point out that:
a) As noted above, upon acquisition of the affiliated partnerships, PSI
acquired the remaining cash flow stream excluding the cash flow from
the management of the properties (i.e., the Remaining Real Estate
Interest), rather than "re-purchasing" the entire 100%. In most of the
transactions involving the acquisition of the affiliated entities,
valuations were performed by third party appraisers. In those
valuations the appraiser acknowledged the 6% management fee by reducing
the future estimated cash flow stream of the real estate facilities in
determining their valuation. Accordingly, the values paid to acquire
the affiliated entities' interest in the real estate was for the
remaining cash flow which PSI did not already own.
b) The management fee cash flow stream can still be identified and
evaluated in PSI's books and records, allowing the net book value of
the management contracts to be evaluated separately for recoverability.
As indicated in the previous correspondence with the Staff dated June
19, 2006, PSI identified no impairments of PSI's intangible assets
through its impairment review process described therein.
c) The management fee cash flow stream was originally purchased, could be
marketed, and as a result has a determinable market value.
ANALYSIS AND CONCLUSION - BALANCE SHEET CLASSIFICATION
As PSI indicated above, it believes that the acquisition of 100% of the cash
flows of each property has been accomplished first through the acquisition of
the applicable management contract during the 1995 Acquisition (i.e., the
Management Fee Interest), and subsequently through the acquisition of the
Remaining Real Estate Interest.
Mr. Michael McTiernan
Ms. Jennifer Gowetski
June 23, 2006
Page 5
As PSI acquired and then consolidated each property, the property became
self-managed by PSI. Consequently, the related management operations on PSI's
income statement were reclassified as self-storage operations. Accordingly, upon
further reflection, PSI has concluded that the net book value of the intangible
asset created upon the consummation of the 1995 Acquisition, associated with the
individual facility, at the time each facility was consolidated, should have
likewise been reclassified to real estate. This reclassification would properly
match the cost of the real estate assets with the associated cash flows. This
reclassified net book value would thereinafter be depreciated in accordance with
PSI's depreciation policy, over 25 years.
PSI believes that the balance sheet impact of this reclassification is
immaterial, representing a reclassification at December 31, 2005 of
approximately $85,000,000 from intangible assets to real estate assets,
representing an approximately 1.9% increase to real estate assets, and no impact
to total assets.
Because PSI believes that this balance sheet reclassification is immaterial PSI
believes that it should reflect and disclose this adjustment in future filings
only, rather than filing amended financial statements. Under this treatment, in
future filings, PSI would reclassify amounts as presented for current and any
previous periods presented with respect to the balance sheet (e.g., reducing
intangibles and increasing real estate by approximately $85,000,000). PSI
believes that restatement and re-filing of prior period financial statements is
not necessary given the immateriality of this adjustment.
ANALYSIS AND CONCLUSION - INCOME STATEMENT IMPACT OF RECLASSIFICATION
In addition, if the aforementioned reclassifications had been recorded as each
respective property was consolidated, aggregate depreciation and amortization
expense would have been reduced by a total of approximately $500,000 per year
with a corresponding increase to net income. This reduction is due to the
"re-set" of depreciation expense as the partially depreciated net book value of
the management contracts was reclassified to real estate and the resulting
remaining net building amount was depreciated over a 25 year remaining life.
PSI believes the impact of this difference is immaterial to its income
statement, statement of cash flows, and statement of stockholders equity,
representing approximately 0.1%, 0.1%, and 0.1%, respectively, of 2005, 2004,
and 2003 net income, and approximately 0.2%, 0.3%, and 0.3%, respectively, of
2005, 2004, and 2003 net income available to common shareholders. Due to the
clear immateriality of this adjustment PSI would propose that the effects of
this reclassification only be presented prospectively. That is, depreciation in
future periods would be reduced by approximately $500,000 per year from what it
would have been in the absence of this change, but there would be no restatement
of previously reported depreciation expense in any Commission filing.
The national office of Ernst & Young has been consulted on the issues raised in
this letter, and is in agreement with PSI's conclusions that a) the management
contract asset has not been impaired as a result of the acquisition of the real
estate or otherwise, b) the net book value of the management contracts should
have been reclassified to real estate at the time each facility was
consolidated, c) that the balance sheet impact of this reclassification is
immaterial and it is acceptable that it be adjusted in future filings only, and
d) that the income statement impact of the change is not material and therefore,
it is acceptable that there be no restatement of PSI's income
Mr. Michael McTiernan
Ms. Jennifer Gowetski
June 23, 2006
Page 6
statement for any period already presented with respect to the depreciation and
amortization impact.
Should you require further clarification of any of the issues raised in this
letter, please contact the undersigned at (212) 403-1314.
Sincerely yours,
/s/ David E. Shapiro
--------------------------
David E. Shapiro
Wachtell, Lipton, Rosen & Katz
51 West 52nd Street
New York, New York 10019
Tel: (212) 403-1314
Fax: (212) 403-2314