Public Storage, Inc.
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701 Western Avenue Tel: (818) 244-8080
Glendale, CA 91201-2349 Fax: (818) 548-9288
July 21, 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 were set
forth in your letter dated July 18, 2006 regarding the Company's Annual Report
on Form 10-K, which have been updated to reflect our discussions today.
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.
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 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.
In order to understand how much of the $165 million would have been
allocated to goodwill upon the adoption of SFAS 142 as of January 1, 2002, we
would need to allocate the $165 million among the management contracts, 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 do so.
Because we are unable to properly segregate the entire $165 million to each
component item, as indicated above, we have concluded, based on our discussions
today with the Staff, that the entire $165 million should have been allocated to
goodwill, and 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 $165 million higher and the intangible asset would
have been $165 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.
Historically, from 2002 through 2005, amortization expense with respect to
the entire $165 million was approximately $6.6 million per year, representing
the amount of amortization that should not have been recorded in each year
assuming that the entire $165 million was classified as goodwill.
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 the entire $165 million to
goodwill other than to change footnote disclosures.
For the periods subsequent to 2001, an accounting error was made by
continuing to amortize the intangible assets, which we have now concluded should
have been entirely allocated to goodwill, and thus we 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:
IMPACT TO BALANCE SHEET: 2005 2004 2003 2002
---- ---- ---- ----
(Dollar amounts in thousands)
Adjustments to increase goodwill
and shareholders' equity to
correct the cumulative error
in recording amortization
expense $26,400 $19,800 $13,200 $6,600
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 0.5% 0.4% 0.3% 0.1%
Adjustment as a percentage of
shareholders' equity 0.5% 0.4% 0.3% 0.2%
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 6,600 $6,600 6,600 $6,600
Impact to earnings per share -
diluted $0.05 $0.05 $0.05 $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
Adjustment as a percentage of net
income, as adjusted for the
error 1.4% 1.8% 1.9% 2.0%
Adjustment as a percentage of
earnings per share - diluted,
as adjusted for the error 2.5% 3.5% 3.8% 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 The error was caused by a combination
an item capable of precise measurement of both. The misstatement amount
or whether it arises from an estimate arose as a result of an error
and, if so, the degree of imprecision classifying $165 million as intangible
in the estimate assets for the property management
contracts acquired in 1995. Upon
further reflection and analysis, the
entire $165 million should have been
allocated to goodwill and amortization
should have ceased upon adoption of
SFAS 142. 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 $6.6 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 change in No. The Company has continued to
earnings or other trends increase its income from continuing
operations for 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).
Did the misstatement hide a failure to No. The Company has consistently met
meet analysts' consensus expectations analysts' expectations over the past
for the enterprise several years and does not provide
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
into income or vice versa to 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 segment Yes. The goodwill relates almost
or other portion of the registrant's entirely to the self-storage reporting
business that has been identified as segment which accounts for
playing a significant role in the substantially all of the Company's
registrant's operations or segment net income for the years
profitability ended December 31, 2002-2005. 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
Registrant's compliance with loan with the rating agencies, the
covenants or other contractual misstatement would have no impact on
requirements the Company's debt or preferred stock
ratings.
Did the misstatement have the effect No.
of increasing management's
compensation
Did the misstatement involve No.
concealment of an unlawful transaction
Was the misstatement material to the No. As indicated above from a
financial statements taken as a whole numerical and qualitative perspective
the 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 $6.6 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. 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 entire $165 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 $165 million, and have thereby concluded
that the goodwill was not impaired.
Based on this analysis, and the allocation of the $165 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 the
intangible assets acquired in the PSMI Merger to the Company's financial
statements has not been 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 $165 million intangible asset.
2. Reclassify the net remaining amount of the intangible asset
(approximately $98 million as of December 31, 2005) to goodwill.
3. 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