[PUBLIC STORAGE, INC. LOGO]
701 Western Avenue Tel: (818) 244-8080
Glendale, CA 91201-2349 Fax: (818) 548-9288
July 19, 2006
BY FACSIMILE 202-772-9210
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. (the "Company") to
the comments of the Staff of the Division of Corporation Finance that was set
forth in your letter dated July 18, 2006 regarding the Company's Annual Report
on Form 10-K.
Each of the Staff's comments, indicated in bold below, is followed by
responses on behalf of the Company.
WE ASK THAT YOU DEMONSTRATE THAT THE AMOUNT THAT SHOULD HAVE BEEN
ALLOCATED TO GOODWILL UNDER APB 16 IS NOT MATERIAL AND DETERMINE, BASED ON
SOME REASONABLE ALLOCATION, THE AMOUNT THAT SHOULD HAVE BEEN ALLOCATED TO
GOODWILL UPON ADOPTION OF SFAS 141 AND 142 AND CALCULATE THE AMORTIZATION
THAT SHOULD NOT HAVE BEEN TAKEN IN EACH HISTORICAL PERIOD.
Mr. Michael McTiernan, Esq.
Ms. Jennifer Gowetski, Esq.
July 19, 2006
Page 2
In November 1995, the Company acquired Public Storage Management, Inc.
(the "PSMI Merger") for an aggregate cost of approximately $550 million. The
following summarizes the net assets acquired as outlined in the Company's 1995
financial statements (in millions):
Investment in real estate entities $390
Other tangible assets 31
Property management contracts 165
Goodwill 68
Liabilities assumed and minority interest (104)
----
Total purchase cost $550
====
Independent appraisals were performed to arrive at valuations for the
investment in real estate entities as well as for substantially all of the other
tangible assets. No independent appraisals were performed with respect to the
valuations of the property management contracts.
In 1995, in correspondence to the SEC Staff, we indicated that the $165
million value assigned to the "property management contracts" was determined by
management based upon a 10 year discounted cash flow model. As the Company has
indicated, while we ascribed the $165 million value entirely to "property
management contracts" this 10 year discounted cash flow model effectively valued
the entire management company, as a whole, rather than simply the property
management contracts. Accordingly, the $165 million valuation represented our
estimate of the fair value of all of the intangible assets of the management
company which consisted of a number of identifiable intangible assets including
the management contracts, the "Public Storage" brand name, the workforce in
place, and the infrastructure. The remaining hard assets of the management
company acquired and liabilities assumed consisting of, for example, property,
plant and equipment and working capital, were not significant.
As indicated above, the value of the management contracts and the
additional identifiable intangible assets acquired in the PSMI Merger was
determined by the Company rather than by independent appraisals. In addition,
management did not separately determine the fair values of each of these
identifiable intangible assets in 1995. We believe, however, that had we
appropriately applied APB 16 to the PSMI Merger in 1995, the entire $165 million
would have been allocated to three items: (i) the management contracts, (ii) the
brand name and (iii) the workforce in place.
We believe that APB 16 supported the recognition of these types of
intangible assets as APB 16 required separate recognition of any intangible
asset that could be identified and named. SFAS 141 (Par. 39) differs from APB 16
in that it requires that intangible assets be recorded apart from goodwill if
they meet one of the criteria established in SFAS 141 (i.e., either the
contractual-legal criterion or the separability
Mr. Michael McTiernan, Esq.
Ms. Jennifer Gowetski, Esq.
July 19, 2006
Page 3
criterion). In applying the provisions of SFAS 141 to the PSMI Merger, only the
management contracts and the brand name would have been recognized as intangible
assets separate from goodwill. SFAS 141 Par. 39 eliminates the identification of
workforce in place as an intangible asset separate from goodwill.
Our prior letter to you indicated that we have now estimated the value of
the property management contracts that were acquired in the PSMI Merger at
approximately $23 million. We believe that the $23 million is at the lower end
of a range of possible valuations, which could be as high as $50 million. Using
the $23 million to establish the fair value of the management contracts in 1995
(which is the most conservative assumption) would result in the remaining $142
million being allocated to the brand name and the workforce in place.
In order to understand how much of the $142 million would have been
allocated to goodwill upon the adoption of SFAS 142 as of January 1, 2002, we
would need to bifurcate the $142 million between the brand name and workforce in
place. Given the passage of time and the fact that in the ordinary course the
Company has not retained detailed records from more than 10 years ago, it is not
possible to bifurcate the $142 million between the brand name and workforce in
place.
For discussion purposes only, if one were to assume that, based on a
retroactive application of SFAS 142, the entire $142 million should have been
allocated to goodwill in 1995, the impact from this change to the Company's
financial statements from 1995 through 2001 would not have been material. There
would be no change to our balance sheets because all of the intangible assets
were grouped into a single line item called "Intangible assets, net" and
therefore were not separately disclosed. There would be no change to our income
statements because the amortization period of the goodwill acquired in the PSMI
Merger was 25 years which is the same as the amortization life we utilized for
the $165 million intangible asset. Accordingly, amortization expense would not
have changed. The footnotes to the financial statements, however, would have
been revised to indicate that goodwill was $142 million higher and the
intangible asset would have been $142 million lower.
Beginning in 2002, the Company adopted the provisions of SFAS No. 142. The
statement required companies to identify all intangible assets acquired prior to
July 1, 2001 that did not meet the new criteria for recognition apart from
goodwill and required that such intangible assets be reclassified to goodwill.
The statement specified that any unamortized balance related to an assembled
workforce will be reclassified to goodwill. Further the statement requires a
reassessment of the useful lives for those intangible assets acquired prior to
June 30, 2001 and a resulting adjustment of the remaining amortization periods.
Mr. Michael McTiernan, Esq.
Ms. Jennifer Gowetski, Esq.
July 19, 2006
Page 4
In adopting SFAS No. 142, had we determined the fair value of the
workforce in place in the application of APB 16 to the PSMI Merger, we would
have, upon such adoption, reclassified the remaining unamortized asset relating
to the workforce in place to goodwill and amortization of such asset would have
ceased. In addition, we would have reevaluated any amounts that would have been
allocated to the brand name to determine whether the remaining useful life
should remain the same. In this regard, we would have concluded that the brand
name would no longer be amortized, because it would continue to contribute to
the Company's cash flows indefinitely in the future and therefore have an
indefinite life. Our conclusion that the brand name would not be amortized is
based upon the guidance of paragraph 11 of SFAS 142, which indicates that if
there are no factors which limit the useful life of the trademark, then the
useful life of the asset shall be considered to be indefinite. The name "Public
Storage" and the associated logo are trademarked, we continue to use the brand
name in all of our self-storage facilities and most associated products, we
expect and have the resources to continuously renew the trademark as required by
law and defend it from encroachment, and do not contemplate changing the brand
name in the future. In addition, we would refer the Staff to Example 7 of
Appendix A to SFAS 142, which further supports an indefinite life for a brand
name when there is evidence to support continuous renewal and use of a
trademark.
Therefore, regardless of how much of the $142 million should have been
allocated to either the workforce in place or the brand name, no further
amortization would have been recorded with respect to the entire $142 million
from the beginning of 2002 through the present date.
Historically, from 2002 through 2005, amortization expense with respect to
the entire $142 million was approximately $5.68 million per year, representing
the amount of amortization that should not have been recorded in each year.
PLEASE PROVIDE US WITH A MATERIALITY ASSESSMENT OF THE ERROR TO
DETERMINE IF A CORRECTION TO YOUR HISTORICAL FINANCIAL STATEMENTS IS
NECESSARY.
As indicated above and further detailed below, for the period from
inception of the PSMI Merger through the period ended December 31, 2001, there
would be no change as a result of reclassifying a portion, if not all, of the
$142 million to goodwill other than to change footnote disclosures.
For the periods subsequent to 2001, an accounting error was made by
continuing to amortize intangible assets that should have ceased amortization as
a result of adopting SFAS No. 142 at the beginning of 2002. The following tables
summarize the impact from this error to the Company's balance sheets and income
statements for these periods:
Mr. Michael McTiernan, Esq.
Ms. Jennifer Gowetski, Esq.
July 19, 2006
Page 5
IMPACT TO BALANCE SHEET: 2005 2004 2003 2002
(Dollar amounts in thousands)
Adjustments to increase
intangible assets and
shareholders' equity to
correct the cumulative error
in recording amortization
expense $22,720 $17,040 $11,360 $5,680
HISTORICAL AMOUNTS:
Total assets $5,552,486 $5,204,790 $4,968,069 $4,843,662
Total shareholders' equity $4,817,009 $4,429,967 $4,219,799 $4,158,969
Adjustment as a percentage
of total assets 0.4% 0.3% 0.2% 0.1%
Adjustment as a percentage
of shareholders' equity 0.5% 0.4% 0.3% 0.1%
IMPACT TO INCOME STATEMENT: 2005 2004 2003 2002
(Dollar amounts in thousands,
except per share amounts)
Adjustments to correct the
error and reduce amortization
expense and increase net income $5,680 $5,680 $5,680 $5,680
Impact to earnings
per share - diluted $0.04 $0.04 $0.04 $0.05
HISTORICAL AMOUNTS:
Net income $456,393 $366,213 $336,653 $318,738
Net income allocable
to common shareholders $254,395 $178,063 $161,836 $141,423
Net income per share
- diluted $1.97 $1.38 $1.28 $1.14
Mr. Michael McTiernan, Esq.
Ms. Jennifer Gowetski, Esq.
July 19, 2006
Page 6
Adjustment as a percentage
of net income, as adjusted for
the error 1.2% 1.6% 1.7% 1.8%
Adjustment as a percentage of
earnings per share - diluted,
as adjusted for the error 2.0% 2.8% 3.0% 4.2%
We believe the impact to the Company's financial statements for the errors
described above are not qualitatively or quantitatively material to the
financial statements as previously issued. In arriving at this conclusion we
evaluated the numerical impact to the financial statements as well as other
surrounding circumstances. In our evaluation, we referred to the guidance as
provided by Staff Accounting Bulletin No. 99 and as outlined below we considered
the following in assessing materiality:
CONSIDERATION EVALUATION
Did the misstatement arise from an The error was caused by a combination of
item capable of precise measurement both. The misstatement amount arose as a
or whether it arises from an result of an error classifying $165
estimate and, if so, the million as intangible assets for the
degree of imprecision in the property management contracts acquired in
estimate 1995. Upon further reflection and
analysis, the value of the property
management contracts should have been
substantially less with the remaining
portion attributable to other intangible
assets. This remaining portion should not
have continued to be amortized when the
Company adopted SFAS 142. As a result,
annual amortization expense was overstated
by approximately $5.68 million for each of
the years ended December 31, 2002 - 2005
(the periods subsequent to the adoption of
SFAS 142).
Did the misstatement mask a No. The Company has continued to increase
change in earnings or other its income from continuing operations for
trends the four years ended December 31, 2005
($329.9 million, $332.7 million, $367.1
million and $450.0 million) and net income
($318.7 million, $336.7 million, $366.2
million, and $456.4 million).
Mr. Michael McTiernan, Esq.
Ms. Jennifer Gowetski, Esq.
July 19, 2006
Page 7
Did the misstatement hide a No. The Company has consistently met
failure to meet analysts' analysts' expectations over the past
consensus expectations for the several years and does not provide
enterprise earnings estimates or guidance. Further,
the error resulted in an understatement of
income from continuing operations and net
income for the years ended December 31,
2002-2005.
In addition, analysts' estimates for the
Company's earnings are based on a non-GAAP
measure of Funds from Operations per
share, as defined, rather than GAAP
earnings per share. In this regard, the
error would have had no impact on Funds
from Operations per share for the years
ended December 31, 2002 through 2005, as
is the Company's practice with respect to
amortization of intangibles.
Did the misstatement change a loss No. The Company would have continued to
into income or vice versa report income from continuing operations
and net income for the years ended
December 31, 2002-2005, as noted above,
regardless of the impact from the error.
Did the misstatement concern a Yes. The property management contracts are
segment or other portion of the included in the self-storage reporting
registrant's business that has been segment which accounts for substantially
identified as playing a significant all of the Company's segment net income
role in the registrant's operations for the years ended December 31, 2002-
or profitability 2005. However, this is mitigated by the
fact that substantially all of the
Company's operations, earnings and assets
are concentrated in this one reporting
unit and the impact is not significant to
either the segment or the Company as a
whole.
Did the misstatement affect the No.
registrant's compliance with
regulatory requirements
Did the misstatement affect the No. In addition, after discussions with
registrant's compliance with the rating agencies, the misstatement
loan covenants or other would have no impact on the Company's debt
contractual requirements or preferred stock ratings.
Mr. Michael McTiernan, Esq.
Ms. Jennifer Gowetski, Esq.
July 19, 2006
Page 8
Did the misstatement have the No.
effect of increasing management's
compensation
Did the misstatement involve No.
concealment of an unlawful
transaction
Was the misstatement material No. As indicated above from a numerical
to the financial statements and qualitative perspective the
taken as a whole misstatement is not material to either the
balance sheet or income statement.
Further, the misstatement has no impact on
the Company's cash flows provided by
operating activities or liquidity.
As noted above, the Company has assessed the quantitative and qualitative
considerations of assessing materiality. Based on these assessments, the Company
has concluded that the potential misstatement of approximately $5.68 million per
year for fiscal years subsequent to 2001, as a result of the amounts improperly
included as amortizing intangible assets, is not material to the Company's
financial statements and to the users of those financial statements. In
addition, we believe that it is highly unlikely that the judgment of a
reasonable person relying upon the Company's financial statements would have
changed or been influenced by the correction of the amounts noted. Again please
keep in mind that investors and other users of our financial statements not only
use the GAAP measures of our financial performance, but also rely significantly
on the non-GAAP measure of Funds from Operations, which is not impacted by the
misstatement. Further, the potential misstatements were not intentional and do
not represent actions to manage earnings.
PLEASE TELL US HOW YOU WOULD ALLOCATE THE GOODWILL AMONG YOUR REPORTING
UNITS AND HOW YOU WOULD ASSESS THE GOODWILL FOR IMPAIRMENT. ALTERNATIVELY,
PLEASE PROVIDE AN ACCOUNTING ARGUMENT FOR WHY APB 16'S REQUIREMENT TO CALCULATE
GOODWILL WAS NOT APPLICABLE TO THIS BUSINESS AND WHY THE INTANGIBLES AND
GOODWILL SHOULD NOT HAVE BEEN SEPARATED UPON ADOPTION OF SFAS 141 AND 142 WHEN
PARAGRAPH 61(A) OF SFAS 141 REQUIRES THAT ALL INTANGIBLE ASSETS THAT DO NOT MEET
THE CRITERIA FOR SEPARATE RECOGNITION BE RECLASSIFIED AS GOODWILL.
In defining our reporting units, we referred to the guidance of Paragraph
30 of SFAS 142. At the time of the PSMI Merger, our operating segments, as per
the guidance of paragraphs 10 - 15 of SFAS 131, comprised (a) our self-storage
operations, representing the rental income, equity in earnings, and related
expenses of the self-storage facilities we have an interest in and manage, (b)
our merchandise sales operations, (c) our truck rental operations, and (d) our
commercial property operations.
Mr. Michael McTiernan, Esq.
Ms. Jennifer Gowetski, Esq.
July 19, 2006
Page 9
We consider each of these operating segments separate "reporting units" within
the guidance of Paragraph 30 of SFAS 142.
We would have allocated goodwill to each of these reporting units based
upon their relative level of expected benefits from the PSMI Merger. Because the
vast majority of our operations are derived from the self-storage reporting unit
(representing in excess of 90% of our revenues in 1996), it derived
substantially all of benefits from the PSMI Merger and, accordingly,
substantially all of the goodwill would be allocated to the self-storage
reporting unit. The remainder would have been allocated to our merchandise,
truck rental, and commercial property reporting units.
In assessing the goodwill for impairment, based on the assumption that we
have now allocated the $142 million discussed above to goodwill and the
applicable operating units, we would follow the guidance of paragraph 19 of SFAS
142, which describes the "first step" of the impairment test. This test would
have been performed initially as of January 1, 2002 in accordance with the
implementation guidance of SFAS 142. Please note that we have followed this
guidance since adopting SFAS 142 with respect to the recorded goodwill on our
balance sheet at each applicable period through December 31, 2005.
In this first test, we have estimated the enterprise value of the Company
at approximately $6.5 billion, comprised of the market value of our common and
preferred stock and the book value of debt and minority interest at December 31,
2001. We have allocated this aggregate $6.5 billion in total estimated
enterprise value to each reporting unit to derive each respective reporting
unit's estimated enterprise value, and compared that to each reporting unit's
allocation of the carrying value of the Company's $4.6 billion in total assets.
We believe through this process we have established that the enterprise value of
each reporting unit exceeded its carrying amount (book value), including the
allocated goodwill, as adjusted for the $142 million, and have thereby concluded
that the goodwill was not impaired.
Based on this analysis, and the allocation of the $142 million to
goodwill, we have concluded, considering the level and profitability of
operations at each of the reporting units as well as the increase in our common
stock price from $33.40 at December 31, 2001 to approximately $67.72 at December
31, 2005, that there was no impairment of goodwill as at each reporting date.
CONCLUSION
We believe that the impact from the accounting errors with respect to the
intangible assets acquired in the PSMI Merger to the Company's financial
statements has not been
Mr. Michael McTiernan, Esq.
Ms. Jennifer Gowetski, Esq.
July 19, 2006
Page 10
material and no restatement is necessary. We have discussed the above matters
with Ernst & Young's national office, who concurs with the conclusions reached.
We propose that on a prospective basis, beginning with our quarterly
report on Form 10-Q for the period ended June 30, 2006 that we do the following:
1. Cease amortization of the $142 million intangible asset.
2. Reclassify the portion of the net remaining amount of the
intangible asset (approximately $14 million as of December 31,
2005) with respect to the management contracts to real estate.
3. Reclassify the net remaining amount of the intangible asset
(approximately $84 million as of December 31, 2005) with respect
to both the workforce and brand name to a caption entitled
"goodwill." The combination of this adjustment with the adjustment
above will eliminate the "intangible assets" entirely.
4. Expand footnote disclosures to discuss the above adjustments.
Should you require further clarification of any of the issues raised in
this letter, please contact the undersigned at 818-244-8080 x1300.
Very truly yours,
/s/ John Reyes
John Reyes
Senior Vice President and
Chief Financial Officer