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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, 2004
------------------
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 Identification Number)
incorporation or organization)
701 Western Avenue, Glendale, California 91201-2349
- ----------------------------------------- ----------
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (818) 244-8080.
--------------
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days.
[X] Yes [ ] No
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act).
[X] Yes [ ] No
Indicate the number of shares outstanding of each of the issuer's classes of
common stock, as of November 5, 2004:
Common Stock, $.10 Par Value - 129,231,802 shares
Depositary Shares Each Representing 1/1,000 of a Share of Equity Stock, Series
A, $.01 Par Value - 8,776,102 depositary shares (representing 8,776.102 shares
of Equity Stock, Series A)
Equity Stock, Series AAA, $.01 Par Value - 4,289,544 shares
PUBLIC STORAGE, INC.
INDEX
Pages
PART I. FINANCIAL INFORMATION
---------------------
Item 1. Financial Statements
Condensed Consolidated Balance Sheets at
September 30, 2004 and December 31, 2003 1
Condensed Consolidated Statements of Income for the
Three and Nine Months Ended September 30, 2004 and 2003 2
Condensed Consolidated Statement of Shareholders' Equity
for the Nine Months Ended September 30, 2004 3
Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2004 and 2003 4
Notes to Condensed Consolidated Financial Statements 5-35
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 36-65
Item 2A. Risk Factors 66-71
Item 3. Quantitative and Qualitative Disclosures about Market Risk 71
Item 4. Controls and Procedures 71
PART II. OTHER INFORMATION (Items 3 through 5 are not applicable)
-----------------
Item 1. Legal Proceedings 72-73
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 73-74
Item 6. Exhibits and Reports on Form 8-K 75-83
PUBLIC STORAGE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
September 30, December 31,
2004 2003
---------------- ----------------
(Unaudited)
ASSETS
Cash and cash equivalents.................................................... $ 475,280 $ 204,833
Real estate facilities, at cost:
Land...................................................................... 1,357,310 1,332,882
Buildings................................................................. 3,880,280 3,792,616
---------------- ----------------
5,237,590 5,125,498
Accumulated depreciation.................................................. (1,276,379) (1,153,059)
---------------- ----------------
3,961,211 3,972,439
Construction in process................................................... 40,686 69,620
Land held for development................................................. 7,580 12,236
Real estate facility held for sale, net of accumulated depreciation....... 2,914 -
---------------- ----------------
4,012,391 4,054,295
Investment in real estate entities........................................... 335,478 336,696
Goodwill..................................................................... 78,204 78,204
Intangible assets, net....................................................... 106,336 111,289
Notes receivable, including amounts due from related parties................. 487 100,510
Other assets................................................................. 69,737 82,242
---------------- ----------------
Total assets................................................... $ 5,077,913 $ 4,968,069
================ ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Notes payable................................................................ $ 35,260 $ 76,030
Preferred stock called for redemption........................................ - 115,000
Accrued and other liabilities................................................ 161,559 131,103
---------------- ----------------
Total liabilities................................................... 196,819 322,133
Minority interest:
Preferred partnership interests........................................... 285,000 285,000
Other partnership interests............................................... 118,767 141,137
Commitments and contingencies (Note 14)...................................... - -
Shareholders' equity:
Cumulative Preferred Stock, $0.01 par value, 50,000,000 shares authorized,
6,175,186 shares issued (in series) and outstanding, (5,763,986 at
December 31, 2003) at liquidation preference............................ 2,157,025 1,867,025
Common Stock, $0.10 par value, 200,000,000 shares authorized, 128,316,807
shares issued and outstanding (126,986,734 at December 31, 2003)........ 12,832 12,699
Equity Stock, Series A, $0.01 par value, 200,000,000 shares authorized,
8,776.102 shares issued and outstanding................................. - -
Paid-in capital........................................................... 2,452,978 2,438,632
Cumulative net income..................................................... 2,625,602 2,366,660
Cumulative distributions paid............................................. (2,771,110) (2,465,217)
---------------- ----------------
Total shareholders' equity.......................................... 4,477,327 4,219,799
---------------- ----------------
Total liabilities and shareholders' equity..................... $ 5,077,913 $ 4,968,069
================ ================
See accompanying notes.
1
PUBLIC STORAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
---------------------------- ---------------------------
2004 2003 2004 2003
------------ ------------ ------------ -----------
Revenues:
Rental income:
Self-storage facilities......................................... $ 219,908 $ 206,856 $ 639,025 $ 593,345
Commercial properties........................................... 2,707 2,712 8,064 8,299
Containerized storage facilities................................ 5,048 6,672 15,099 18,495
Tenant reinsurance premiums......................................... 6,210 5,755 18,266 16,551
Interest and other income........................................... 3,300 2,847 7,240 7,425
------------ ------------ ------------ -----------
237,173 224,842 687,694 644,115
------------ ------------ ------------ -----------
Expenses:
Cost of operations:
Self-storage facilities......................................... 74,075 70,977 224,119 206,655
Commercial properties........................................... 1,031 1,234 3,200 3,415
Containerized storage facilities................................ 3,073 3,823 8,741 10,713
Tenant reinsurance.............................................. 4,204 2,917 11,089 8,631
Depreciation and amortization....................................... 44,375 45,435 135,515 135,770
General and administrative.......................................... 5,527 4,642 15,983 13,321
Interest expense.................................................... - 296 100 1,121
------------ ------------ ------------ -----------
132,285 129,324 398,747 379,626
------------ ------------ ------------ -----------
Income from continuing operations before equity in earnings of real estate
entities, minority interest in income, asset impairment charge, and gain 104,888 95,518 288,947 264,489
on disposition of real estate investments.............................
Equity in earnings of real estate entities (Note 5)...................... 3,184 5,770 11,646 19,456
Asset impairment charge due to casualty loss (Note 4).................... (1,250) - (1,250) -
Gain on disposition of real estate investments........................... 1,286 47 1,286 807
Minority interest in income:
Preferred partnership interests:
Based on ongoing distributions.................................... (5,176) (6,726) (16,907) (20,179)
Special distribution and restructuring allocation (Note 8)........ - - (10,063) -
Other partnership interests......................................... (4,345) (4,418) (12,928) (12,403)
------------ ------------ ------------ -----------
Income from continuing operations........................................ 98,587 90,191 260,731 252,170
Discontinued operations (Note 3)......................................... (1,072) (444) (1,789) (1,487)
------------ ------------ ------------ -----------
Net income............................................................... $ 97,515 $ 89,747 $ 258,942 $ 250,683
============ ============ ============ ===========
Net income allocation:
- ---------------------
Allocable to preferred shareholders:
Based on distributions paid...................................... $ 40,471 $ 35,193 $ 117,293 $ 107,914
Based on redemptions of preferred stock.......................... 3,072 - 6,795 3,397
Allocable to Equity Stock, Series A................................. 5,375 5,375 16,126 16,126
Allocable to common shareholders.................................... 48,597 49,179 118,728 123,246
------------ ------------ ------------ -----------
$ 97,515 $ 89,747 $ 258,942 $ 250,683
============ ============ ============ ===========
Per common share - basic
Continuing operations............................................... $ 0.39 $ 0.39 $ 0.94 $ 1.00
Discontinued operations (Note 3).................................... (0.01) - (0.01) (0.01)
------------ ------------ ------------ -----------
$ 0.38 $ 0.39 $ 0.93 $ 0.99
============ ============ ============ ===========
Per common share -diluted
Continuing operations............................................... $ 0.39 $ 0.39 $ 0.93 $ 0.99
Discontinued operations (Note 3).................................... (0.01) - (0.01) (0.01)
------------ ------------ ------------ -----------
$ 0.38 $ 0.39 $ 0.92 $ 0.98
============ ============ ============ ===========
Net income per depositary share of Equity Stock, Series A (basic and
diluted)................................................................ $ 0.61 $ 0.61 $ 1.84 $ 1.84
============ ============ ============ ===========
Basic weighted average common shares outstanding......................... 128,085 125,528 127,635 124,740
============ ============ ============ ===========
Diluted weighted average common shares outstanding....................... 128,826 126,802 128,545 125,987
============ ============ ============ ===========
Weighted average shares of Equity Stock, Series A (basic and diluted).... 8,776 8,776 8,776 8,776
============ ============ ============ ============
See accompanying notes.
2
PUBLIC STORAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Amounts in thousands, except share data)
(Unaudited)
Cumulative Cumulative Net
Preferred Stock Common Stock Paid-in Capital Income
---------------- -------------- ---------------- ---------------
Balances at December 31, 2003............................. $ 1,867,025 $ 12,699 $ 2,438,632 $ 2,366,660
Issuance of cumulative preferred stock:
Series Y (1,600,000 shares).......................... 40,000 - - -
Series Z (4,500 shares).............................. 112,500 - (3,744) -
Series A (4,600 shares).............................. 115,000 - (3,823) -
Series B (4,350 shares).............................. 108,750 - (3,626) -
Series C (4,600 shares).............................. 115,000 - (3,823) -
Redemption of cumulative preferred stock, including redemption costs:
Series L (4,600 shares)................................ (115,000) - (21) -
Series M (2,250 shares)................................ (56,250) - (20) -
Series D (1,200,000 shares)............................ (30,000) - (20) -
Restructuring of Series N preferred units (Note 8)...... - - 2,063 -
Issuance of common stock in connection with:
Exercise of employee stock options (1,719,473 shares).. - 172 43,609 -
Vesting of restricted stock (20,300 shares) ........... - 2 (2) -
Stock based compensation expense (Note 11) ............... - - 1,946 -
Repurchase of common stock (409,700 shares)............... - (41) (18,193) -
Net income................................................ - - - 258,942
Cash distributions:
Cumulative preferred stock (Note 9).................... - - - -
Equity Stock, Series A ($1.84 per depositary share).... - - - -
Common Stock ($1.35 per share)......................... - - - -
---------------- -------------- ---------------- ---------------
Balances at September 30, 2004............................ $ 2,157,025 $ 12,832 $ 2,452,978 $ 2,625,602
================ ============== ================ ===============
PUBLIC STORAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Amounts in thousands, except share data)
(Unaudited)
Total
Cumulative Shareholders'
Distributions Equity
-------------- ---------------
Balances at December 31, 2003............................. $ (2,465,217) $ 4,219,799
Issuance of cumulative preferred stock:
Series Y (1,600,000 shares).......................... - 40,000
Series Z (4,500 shares).............................. - 108,756
Series A (4,600 shares).............................. - 111,177
Series B (4,350 shares).............................. - 105,124
Series C (4,600 shares).............................. - 111,177
Redemption of cumulative preferred stock, including
redemption costs:
Series L (4,600 shares)................................ - (115,021)
Series M (2,250 shares)................................ - (56,270)
Series D (1,200,000 shares)............................ - (30,020)
Restructuring of Series N preferred units (Note 8)...... - 2,063
Issuance of common stock in connection with:
Exercise of employee stock options (1,719,473 shares).. - 43,781
Vesting of restricted stock (20,300 shares) ........... - -
Stock based compensation expense (Note 11) ............... - 1,946
Repurchase of common stock (409,700 shares)............... - (18,234)
Net income................................................ - 258,942
Cash distributions:
Cumulative preferred stock (Note 9).................... (117,293) (117,293)
Equity Stock, Series A ($1.84 per depositary share).... (16,126) (16,126)
Common Stock ($1.35 per share)......................... (172,474) (172,474)
-------------- ---------------
Balances at September 30, 2004............................ $ (2,771,110) $ 4,477,327
============== ===============
See accompanying notes.
3
PUBLIC STORAGE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
Nine Months Ended
September 30,
-------------------------------------
2004 2003
---------------- ----------------
Cash flows from operating activities:
Net income.............................................................. $ 258,942 $ 250,683
Adjustments to reconcile net income to net cash provided by operating
activities:
Loss/(Gain) on sale of assets, net of impairment charge, and impact of
EITF Topic D-42 included in equity in earnings of real estate entities
(Note 5)........................................................... 2,109 (453)
Real estate impairment associated with casualty losses............... 1,250 -
Gain on sale of real estate investments.............................. (1,286) (807)
Depreciation and amortization........................................ 135,515 135,770
Depreciation included in equity in earnings of real estate entities.. 25,055 20,353
Minority interest in income.......................................... 39,898 32,582
Depreciation and other adjustments associated with discontinued
operations (Note 3) ............................................... 3,096 5,203
Other................................................................ 34,277 25,260
---------------- ----------------
Total adjustments........................................... 239,914 217,908
---------------- ----------------
Net cash provided by operating activities............... 498,856 468,591
---------------- ----------------
Cash flows from investing activities:
Principal payments received on mortgage notes receivable............. 100,023 23,410
Capital improvements to real estate facilities....................... (20,297) (20,470)
Construction in process and acquisition of land held for development. (55,780) (70,576)
Acquisition of minority interests (Note 8)........................... (24,851) (9,867)
Acquisition of real estate facilities................................ (8,293) -
Proceeds from the disposition of land and real estate facilities..... 7,437 12,655
Proceeds from the disposition of investments in real estate entities - 851
Investment in other real estate entities............................. (25,946) (26,728)
Other investments.................................................... (2,052) (7,821)
Other................................................................ 4,436 (13,405)
---------------- ----------------
Net cash used in investing activities................... (25,323) (111,951)
---------------- ----------------
Cash flows from financing activities:
Principal payments on notes payable.................................. (40,770) (33,835)
Net proceeds from the issuance of common stock....................... 43,781 42,860
Net proceeds from the issuance of preferred stock.................... 476,234 -
Repurchase of common stock........................................... (18,234) (6,001)
Redemption of preferred stock........................................ (316,311) (87,535)
Distributions paid to shareholders................................... (305,893) (292,821)
Distributions paid to holders of preferred partnership interests..... (16,907) (20,179)
Special distribution paid to holders of preferred partnership interests (8,000) -
(Note 8)...........................................................
Distributions paid to minority interests, net of reinvestments....... (16,986) (16,950)
---------------- ----------------
Net cash used in financing activities................... (203,086) (414,461)
---------------- ----------------
Net increase (decrease) in cash and cash equivalents...................... 270,447 (57,821)
Cash and cash equivalents at the beginning of the period.................. 204,833 103,124
---------------- ----------------
Cash and cash equivalents at the end of the period........................ $ 475,280 $ 45,303
================ ================
Supplemental schedule of non-cash investing and financial activities:
Acquisition of minority interest for consideration including common stock:
Real estate facilities............................................. - $ (16,687)
Minority Interest.................................................. - (6,690)
Issuance of common stock to acquire minority interest................ - 13,510
See accompabying notes.
4
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
1. Description of the Business
---------------------------
Public Storage, Inc. (the "Company") is a California corporation,
which was organized in 1980. We are a fully integrated, self-administered
and self-managed real estate investment trust ("REIT") whose principal
business activities include the acquisition, development, ownership and
operation of self-storage facilities which offer storage spaces for lease,
usually on a month-to-month basis, for personal and business use. In
addition, to a much lesser extent, we have interests in commercial
properties, containing commercial and industrial rental space, and
interests in facilities that lease storage containers.
We invest in real estate facilities by acquiring facilities
directly or by acquiring interest in real estate entities that own
facilities. At September 30, 2004, we had direct and indirect equity
interests in 1,421 self-storage facilities with 86.1 million net rentable
square feet located in 37 states operating under the "Public Storage" name.
We also have direct and indirect equity interests in approximately 20.2
million net rentable square feet of commercial and industrial space located
in 10 states.
2. Summary of Significant Accounting Policies
------------------------------------------
Basis of Presentation
---------------------
The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with 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.
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, 2004
are not necessarily indicative of the results that may be expected for the
year ended December 31, 2004. 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, 2003.
The consolidated financial statements include the accounts of the
Company and 37 controlled entities (the "Consolidated Entities").
Collectively, the Company and the Consolidated Entities own a total of
1,391 real estate facilities, consisting of 1,383 self-storage facilities,
five industrial facilities used by the containerized storage operations and
three commercial properties. All intercompany transactions among the
Company and the Consolidated Entities are eliminated in consolidation.
At September 30, 2004, we had equity investments in eight limited
partnerships in which we do not have a controlling interest. These limited
partnerships collectively own 38 self-storage facilities, which are managed
by the Company. In addition, at September 30, 2004, we own approximately
44% of the common equity of PS Business Parks, Inc. ("PSB"), which has
interests in approximately 18.4 million net rentable square feet of
commercial space at September 30, 2004. We do not control these entities;
accordingly, our investment in these limited partnerships and PSB
(collectively, the "Unconsolidated Entities") are accounted for using the
equity method.
Certain amounts previously reported have been reclassified to
conform to the September 30, 2004 presentation, including discontinued
operations (see Note 3).
5
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
Use of Estimates
----------------
The preparation of the consolidated financial statements in
conformity with accounting principles generally accepted in the United
States requires management to make estimates and assumptions that affect
the amounts reported in the consolidated financial statements and
accompanying notes. Actual results could differ from those estimates.
Income Taxes
------------
For all taxable years subsequent to 1980, the Company qualified
and intends to continue to qualify as a REIT, as defined in Section 856 of
the Internal Revenue Code. As a REIT, we are not taxed on that portion of
our taxable income which is distributed to our shareholders, provided that
we meet certain tests. We believe we will meet these tests during 2004 and,
accordingly, no provision for income taxes has been made in the
accompanying financial statements.
Financial Instruments
---------------------
The methods and assumptions used to estimate the fair value of
financial instruments are described below. We have estimated the fair value
of our financial instruments using available market information and
appropriate valuation methodologies. Considerable judgment is required in
interpreting market data to develop estimates of market value. Accordingly,
estimated fair values are not necessarily indicative of the amounts that
could be realized in current market exchanges.
For purposes of financial statement presentation, we consider all
highly liquid financial instruments purchased with a maturity of three
months or less to be cash equivalents.
Due to the short period to maturity of our cash and cash
equivalents, accounts receivable, other financial instruments included in
other assets, and accrued and other liabilities, the carrying values as
presented on the consolidated balance sheets are reasonable estimates of
fair value. The carrying amount of notes payable approximates fair value
because the aggregate applicable interest rate approximates current market
rates for similar loans and because the relatively short time until
maturity reduces the effect of differing interest rates.
Financial assets that are exposed to credit risk consist primarily
of cash and cash equivalents, accounts receivable, and notes receivable.
Cash and cash equivalents, which consist of short-term investments,
including commercial paper, are only invested in entities with an
investment grade rating. Accounts receivable are not a significant portion
of total assets and are comprised of a large number of individual
customers.
Included in cash and cash equivalents at September 30, 2004 is
$10,459,000 ($1,835,000 at December 31, 2003) cash held by the Company's
captive insurance programs. Insurance and other regulations place
significant restrictions on our ability to withdraw these funds for
purposes other than insurance activities. Our captive insurance programs
are conducted by STOR-Re Mutual Insurance Company, Inc. ("STOR-Re"), an
association captive insurance company owned by the Company and its
affiliates, which is approximately 90.1% owned by the Company and the
Consolidated Entities, and PS Insurance Company Hawaii, Ltd. ("PSIC-H"), a
captive insurer formed on December 31, 2003 which is wholly owned by a
subsidiary of the Company. Other assets at September 30, 2004 include
aggregate investments totaling $23,559,000 ($27,995,000 at December 31,
2003) in held to maturity debt securities owned by STOR-Re and PSIC-H
stated at amortized cost, which approximates fair value.
6
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
Real Estate Facilities
----------------------
Real estate facilities are recorded at cost. Costs associated with
the acquisition, development, construction, renovation and improvement of
properties are capitalized. Interest, property taxes, and other costs
associated with development incurred during the construction period are
capitalized as building cost. Expenditures for repairs and maintenance are
charged to expense as incurred. Depreciation is computed using the
straight-line method over the estimated useful lives of the buildings and
improvements, which are generally between 5 and 25 years.
Evaluation of Asset Impairment
------------------------------
In August 2001, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards No. 144, "Accounting for
the Impairment or Disposal of Long-Lived Assets" ("SFAS No. 144"). In June
2001, the FASB issued Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets" ("SFAS No. 142"). We adopted both of
these statements effective January 1, 2002.
With respect to goodwill, we evaluate impairment annually through
a two-step process. In the first step, if the fair value of the reporting
unit to which the goodwill applies is equal to or greater than the carrying
amount of the assets of the reporting unit, including the goodwill, the
goodwill is considered unimpaired and the second step is unnecessary. If,
however, the fair value of the reporting unit including goodwill is less
than the carrying amount, the second step is performed. In this test, we
compute the implied fair value of the goodwill based upon the allocations
that would be made to the goodwill, other assets and liabilities of the
reporting unit if a business combination transaction were consummated at
the fair value of the reporting unit. An impairment loss is recorded to the
extent that the implied fair value of the goodwill is less than the
goodwill's carrying amount. No impairments of our goodwill were identified
in our annual evaluation at December 31, 2003.
With respect to other long-lived assets, we evaluate such assets
on a quarterly basis. We first evaluate these assets for indicators of
impairment such as a) a significant decrease in the market price of a
long-lived asset, b) a significant adverse change in the extent or manner
in which a long-lived asset is being used or in its physical condition, c)
a significant adverse change in legal factors or the business climate that
could affect the value of the long-lived asset, d) an accumulation of costs
significantly in excess of the amount originally projected for the
acquisition or construction of the long-lived asset, or e) a current-period
operating or cash flow loss combined with a history of operating or cash
flow losses or a projection or forecast that demonstrates continuing losses
associated with the use of the long-lived asset. When any such indicators
of impairment are noted, we compare the carrying value of these assets to
the future estimated undiscounted cash flows attributable to these assets.
If the asset's recoverable amount is less than the carrying value of the
asset, then an impairment charge is booked for the excess of carrying value
over the asset's fair value.
Any long-lived assets which we expect to sell or otherwise dispose
of prior to their previously estimated useful life are stated at what we
estimate to be the lower of their estimated net realizable value (less cost
to sell) or their carrying value. We recorded $1,575,000 in impairment
charges related to assets of eight containerized storage operations
identified for closure during 2004 (see Note 3). In addition, as a result
of damage sustained at several of our facilities in Florida caused by
recent hurricanes, we recorded $1,250,000 in impairment charges related to
these assets during the three and nine months ended September 30, 2004. No
additional impairments were identified from our evaluations as of September
30, 2004.
7
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
Accounting for Stock-Based Compensation
---------------------------------------
We utilize the Fair Value Method (as defined in Note 11) of
accounting for our employee stock options issued after December 31, 2001,
and utilize the APB 25 Method (as defined in Note 11) for employee stock
options issued prior to January 1, 2002. Restricted Stock Unit expense is
recorded over the relevant vesting period. Included in general and
administrative expense for the three and nine months ended September 30,
2004, is $150,000 and $439,000, respectively, of compensation expense with
respect to stock options, as compared to $95,000 and $294,000,
respectively, for the same periods in 2003. During the three and nine
months ended September 30, 2004, a total of $559,000 and $1,676,000,
respectively, in restricted stock compensation expense was included in
general and administrative expense, as compared to $371,000 for the three
and nine months ended September 30, 2003. See Note 11 for a full discussion
of our accounting policies with respect to employee stock options and
restricted stock units.
Other Assets
------------
Other assets primarily consist of containers and equipment
associated with the containerized storage operations, assets associated
with the truck rental business, accounts receivable, prepaid expenses and
investments held by STOR-Re and PSIC-H (discussed below). Accounts
receivable from customers are net of allowances for doubtful accounts.
Containers and equipment utilized in our containerized storage
business totaled $5,480,000 at September 30, 2004 ($10,895,000 at December
31, 2003). The carrying amounts are net of accumulated depreciation and
asset impairment charges. As discussed in Note 3, during the nine months
ended September 30, 2004, impairment charges amounting to $1,575,000 were
recorded with respect to containers and equipment utilized in the
discontinued containerized storage operations.
Included in depreciation and amortization expense for the three
and nine months ended September 30, 2004 is $1,850,000 and $5,530,000,
respectively, related to other assets, as compared to $1,641,000 and
$4,734,000, respectively, for the same periods in 2003. Included in
discontinued operations for the three and nine months ended September 30,
2004 is depreciation expense of $219,000 and $725,000, respectively,
related to depreciation of containers and equipment of the discontinued
operations of the containerized storage business as compared to $647,000
and $2,157,000 for the three and nine months ended September 30, 2003,
respectively.
Other assets at September 30, 2004 include aggregate investments
totaling $23,559,000 ($27,995,000 at December 31, 2003) in held to maturity
debt securities owned by STOR-Re and PSIC-H stated at amortized cost, which
approximates fair market value.
Accrued and Other Liabilities
-----------------------------
Accrued and other liabilities consist primarily of trade payables,
real and personal property tax accruals, accrued interest, and losses and
loss adjustment liabilities, as discussed below.
Liabilities for losses and loss adjustment expenses include an
amount determined from loss reports and individual cases and an amount,
based on recommendations from an outside actuary using a frequency and
severity method, for losses incurred but not reported. Determining the
liability for unpaid losses and loss adjustment expense is based upon
estimates. While we believe that the amount is adequate, the ultimate loss
may be in excess of or less than the amounts provided. The methods for
making such estimates and for establishing the resulting liability are
continually reviewed.
8
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
STOR-Re, which is consolidated with the Company, was formed in
1994 as an association captive insurance company owned by the Company and
affiliates of the Company. STOR-Re provides limited property and liability
insurance to the Company and its affiliates for losses incurred during
policy periods prior to April 1, 2004, and was succeeded by PSIC-H with
respect to these insurance activities for policy periods following March
31, 2004. The Company also utilizes other insurance carriers to provide
property and liability insurance coverage in excess of STOR-Re's and
PSIC-H's limitations which are described in Note 14. STOR-Re and PSIC-H
accrue liabilities for covered losses and loss adjustment expense, which at
September 30, 2004 totaled $31,319,000 ($28,741,000 at December 31, 2003)
with respect to insurance provided to the Company and its affiliates.
PS Insurance Company, Ltd ("PSIC"), a wholly-owned subsidiary of
the Company, reinsured policies against claims for losses to goods stored
by tenants in our self-storage facilities for policy periods prior to March
31, 2004. PSIC-H succeeded PSIC with respect to these tenant insurance
activities effective April 1, 2004, and these entities utilize third-party
insurance coverage for losses from any individual event that exceeds a loss
of $500,000, to a maximum of $10,000,000. Losses below the third-party
insurers' deductible amounts are accrued as cost of operations for the
tenant insurance operations. Included in cost of operations for the three
and nine months ended September 30, 2004 is approximately $1.5 million in
estimated losses from tenant claims as a result of damage sustained from
the recent hurricanes in Florida. The accrued liability for losses and loss
adjustment expense with respect to tenant insurance activities totaled
$5,725,000 at September 30, 2004 ($2,486,000 at December 31, 2003),
including the aforementioned $1.5 million in estimated losses from tenant
claims.
Intangible Assets and Goodwill
------------------------------
Intangible assets consist of property management contracts
($165,000,000) and the excess of acquisition cost over the fair value of
net tangible and identifiable intangible assets or "goodwill" ($94,719,000)
acquired in business combinations. Our goodwill has an indeterminate life
and, accordingly, is not amortized. Our other intangibles have a defined
life and are amortized on a straight-line basis over a 25 year period.
Goodwill is net of accumulated amortization of $16,515,000 at
September 30, 2004 and December 31, 2003. At September 30, 2004, property
management contracts are net of accumulated amortization of $58,664,000
($53,711,000 at December 31, 2003). Included in depreciation and
amortization expense for each of the three and nine month periods ended
September 30, 2004 and 2003 is $1,651,000 and $4,953,000, respectively,
with respect to the amortization of property management contracts.
Revenue and Expense Recognition
-------------------------------
Rental income, which is generally earned pursuant to
month-to-month leases for storage space, is recognized as earned.
Promotional discounts are recognized as a reduction to rental income over
the promotional period, which is generally during the first month of
occupancy. Late charges and administrative fees are recognized as rental
income when collected. Tenant reinsurance premiums are recognized as
premium revenue when collected. Interest income is recognized as earned.
Equity in earnings of real estate entities is recognized based on our
ownership interest in the earnings of each of the unconsolidated real
estate entities.
We accrue for property tax expense based upon estimates and
historical trends. If these estimates are incorrect, the timing of expense
recognition could be affected.
Cost of operations, general and administrative expense, interest
expense, as well as television, yellow page, and other advertising
expenditures are expensed as incurred. Accordingly, the amounts incurred in
an interim period may not be indicative of the amounts to be incurred
during a full year. Television, yellow page, and other advertising expense
totaled $5,288,000 and $7,155,000 for the three months ended September 30,
2004 and 2003, respectively, and $18,896,000 and $18,900,000 for the nine
months ended September 30, 2004 and 2003, respectively.
9
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
Environmental Costs
-------------------
Our policy is to accrue environmental assessments and/or
remediation cost when it is probable that such efforts will be required and
the related cost can be reasonably estimated. Our current practice is to
conduct environmental investigations in connection with property
acquisitions. Although there can be no assurance, we are not aware of any
environmental contamination of any of our facilities, which, individually
or in the aggregate, would be material to our overall business, financial
condition, or results of operations.
Net Income per Common Share
---------------------------
Distributions paid to the holders of our Cumulative Preferred
Stock totaled $40,471,000 and $35,193,000 for the three months ended
September 30, 2004 and 2003, respectively, ($117,293,000 and $107,914,000
for the nine months ended September 30, 2004 and 2003, respectively) have
been deducted from net income to arrive at net income allocable to our
common shareholders.
Emerging Issues Task Force ("EITF") Topic D-42, "The Effect on the
Calculation of Earnings per Share for the Redemption or the Induced
Conversion of Preferred Stock" provides, among other things, that any
excess of (1) the fair value of the consideration transferred to the
holders of preferred stock redeemed over (2) the carrying amount of the
preferred stock should be subtracted from net earnings to determine net
earnings available to common stockholders in the calculation of earnings
per share. At the July 31, 2003 meeting of the EITF, the Securities and
Exchange Commission Observer clarified that for purposes of applying EITF
Topic D-42, the carrying amount of the preferred stock should be reduced by
the issuance costs of the preferred stock, regardless of where in the
stockholders' equity section those costs were initially classified on
issuance.
In conformity with the SEC Observer's clarification, an additional
$3,072,000 was allocated to preferred stockholders for the three months
ended September 30, 2004 (none in the three months ended September 30,
2003) for the excess of the redemption amount over the carrying amount of
our Cumulative Preferred Stock. For the nine months ended September 30,
2004 and 2003, $6,795,000 and $3,397,000, respectively, was allocated to
preferred stockholders for the excess of the redemption amount over the
carrying amount of our Cumulative Preferred Stock. It is our policy to
record such allocations at the time the securities are called for
redemption.
Net income allocated to our common shareholders has been further
allocated among our two classes of common stock; our regular common stock
and our Equity Stock, Series A. The allocation among each class was based
upon the two-class method. Under the two-class method, earnings per share
for each class of common stock is determined according to dividends
declared (or accumulated) and participation rights in undistributed
earnings. Under the two-class method, the Equity Stock, Series A was
allocated net income of $5,375,000 for each of the three months ended
September 30, 2004 and 2003 and $16,126,000 for each of the nine months
ended September 30, 2004 and 2003. The remaining $48,597,000 and
$49,179,000 for the three months ended September 30, 2004 and 2003,
respectively, was allocated to the regular common shareholders. For the
nine months ended September 30, 2004 and 2003, $118,728,000 and
$123,246,000, respectively, was allocated to the regular common
shareholders.
10
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
Basic net income per share is computed using the weighted average
common shares outstanding (prior to the dilutive impact of stock options
and restricted stock units outstanding). Diluted net income per common
share is computed using the weighted average common shares outstanding
(adjusted for the dilutive impact of stock options and restricted stock
units outstanding). Weighted average common shares excludes shares owned by
the Consolidated Entities for the three and nine months ended September 30,
2004 and 2003, as these shares of common stock are eliminated in
consolidation (see Note 9).
3. Discontinued Operations
------------------------
Statement of Financial Accounting Standards No. 144 ("SFAS No.
144") addresses accounting for discontinued operations. SFAS No. 144
requires the segregation of all disposed components of an entity with
operations that (i) can be distinguished from the rest of the entity and
(ii) will be eliminated from the ongoing operations of the entity in a
disposal transaction.
During 2002, we adopted a business plan that included the closure
of 22 non-strategic containerized storage facilities. During 2003 and 2004,
an additional 17 facilities (nine and eight, respectively) were identified
as non-strategic and scheduled for closure. Each of these 39 containerized
storage facilities (collectively, the "Closed Facilities") represented
components of our containerized storage business segment. The related
assets of the Closed Facilities (consisting primarily of storage
containers) were deemed not recoverable from operations in future periods,
and as a result asset impairment charges for the excess of these assets'
net book value over their fair value, determined based upon the values of
similar assets, was recorded. In the three and nine months ended September
30, 2003, we recorded $1,274,000 and $2,024,000, respectively, in
impairment charges with respect to discontinued containerized storage
facilities. During the three months ended September 30, 2004 we recorded
asset impairment charges in the amount of $1,406,000 related to seven
discontinued facilities that we plan to vacate by the end of the first
quarter of 2005. For the nine months ended September 30, 2004 we recorded
asset impairment charges in the amount of $1,575,000 relating to the
closure of eight facilities and lease termination costs of $416,000 related
to two of the Closed Facilities.
Four self storage facilities that we owned in the Knoxville market
(the "Knoxville Facilities") were disposed of on July 25, 2003 for
aggregate gross proceeds of $11.0 million. The Company financed a
substantial part of the buyer's consideration in exchange for a note
receivable from the buyer, and in accordance with generally accepted
accounting principles, the Company deferred the sale and the corresponding
gain of approximately $4.2 million until October 2003 at which time the
note receivable was collected in full.
On October 16, 2003, we sold a self-storage facility located in
Perrysburg, Ohio for $2.3 million in cash. A gain of approximately $1.1
million was recognized from the sale of this property in the fourth quarter
of 2003. This facility and the Knoxville Facilities (collectively, the
"Sold Self-Storage Facilities") are reported as discontinued operations.
During the quarter ended September 30, 2004, we adopted a plan to
sell a commercial facility (the "Sold Commercial Facility") and, on October
28, 2004, this facility was sold for aggregate net proceeds of $3.8
million, resulting in a gain on sale of approximately $1.0 million which
will be recorded in the quarter ended December 31, 2004. The property's
historical operations have been reported as discontinued operations in the
financial statements.
The historical operations of the Closed Facilities (including the
asset impairment charges), the Sold Self-Storage Facilities and the Sold
Commercial Facility are classified as discontinued operations. The rental
income, cost of operations, and depreciation expense with respect to these
facilities for each period presented are included in the line-item
"Discontinued Operations" on the consolidated statement of income.
The following table summarizes the historical operations of the
Closed Facilities, the Sold Self-Storage Facilities, and the Sold
Commercial Facility:
11
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
Discontinued Operations:
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------ -------------------------------------
2004 2003 Change 2004 2003 Change
---------- ---------- ---------- ---------- ---------- -----------
(Amounts in thousands) (Amounts in thousands)
Rental income (a):
Closed Facilities............... $ 1,740 $4,964 $ (3,224) $ 6,267 $ 15,080 $ (8,813)
Sold Self-Storage Facilities.... - 504 (504) - 1,448 (1,448)
Sold Commercial Facility........ 105 100 5 279 302 (23)
---------- ---------- ---------- ---------- ---------- -----------
Total rental income............... 1,845 5,568 (3,723) 6,546 16,830 (10,284)
---------- ---------- ---------- ---------- ---------- -----------
Cost of operations (a):
Closed Facilities............... 1,154 3,468 (2,314) 5,176 12,435 (7,259)
Sold Self-Storage Facilities.... - 213 (213) - 603 (603)
Sold Commercial Facility........ 26 19 7 63 76 (13)
---------- ---------- ---------- ---------- ---------- -----------
Total cost of operations.......... 1,180 3,700 (2,520) 5,239 13,114 (7,875)
---------- ---------- ---------- ---------- ---------- -----------
Depreciation expense (a):
Closed Facilities............... 306 871 (565) 1,031 2,681 (1,650)
Sold Self-Storage Facilities.... - 142 (142) - 424 (424)
Sold Commercial Facility........ 25 25 - 74 74 -
---------- ---------- ---------- ---------- ---------- -----------
Total depreciation ............... 331 1,038 (707) 1,105 3,179 (2,074)
---------- ---------- ---------- ---------- ---------- -----------
Impairment charge/shutdown costs (b):
Closed Facilities............... 1,406 1,274 132 1,991 2,024 (33)
---------- ---------- ---------- ---------- ---------- -----------
Net discontinued operations (c)... $(1,072) $ (444) $ (628) $ (1,789) $ (1,487) $ (302)
========== ========== ========== ========== ========== ===========
(a) These amounts represent the historical operations of the Closed
Facilities, the Sold Self-Storage Facilities and the Sold Commercial
Facility, and include amounts previously classified as rental income,
cost of operations, and depreciation expense in the financial
statements in prior periods.
(b) Asset impairment charges for the three and nine months ended September
30, 2004 were $1,406,000 and $1,575,000, respectively. In addition to
asset impairment charges, total lease termination costs of $416,000
were recorded during the quarter ended June 30, 2004. During the three
and nine months ended September 30, 2003, $1,274,000 in asset
impairment charges were recorded with respect to four facilities closed
during that quarter. In addition, a $750,000 impairment charge was
recorded during the quarter ended June 30, 2003 with respect to a
closed containerized storage facility held for sale.
(c) Earnings per share for the three and nine months ended September 30,
2004 were reduced $0.01 due to the impact from discontinued operations.
Earnings per share for the nine months ended September 30, 2003 was
reduced $0.01 and there was no impact on the three months ended
September 30, 2003 due to the impact from discontinued operations.
12
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
4. Real Estate Facilities
------------------------
Activity in real estate facilities is as follows:
Nine Months Ended
September 30, 2004
(In thousands)
------------------
Operating facilities, at cost:
Balance at December 31, 2003........................ $ 5,125,498
Newly developed facilities opened for operations.... 85,089
Acquisition of minority interest (Note 8)........... 6,539
Acquisition of real estate facilities............... 8,293
Disposition of real estate facilities............... (1,870)
Transfer to real estate held for sale............... (3,382)
Casualty Losses..................................... (2,874)
Capital improvements................................ 20,297
------------------
Balance at September 30, 2004....................... 5,237,590
------------------
Accumulated depreciation:
Balance at December 31, 2003........................ (1,153,059)
Additions during the year........................... (125,412)
Transfer to real estate held for sale............... 468
Casualty Losses..................................... 1,624
------------------
Balance at September 30, 2004....................... (1,276,379)
------------------
Construction in process:
Balance at December 31, 2003........................ 69,620
Current development................................. 55,780
Transfers to land held for development.............. 375
Newly developed facilities opened for operations.... (85,089)
------------------
Balance at September 30, 2004....................... 40,686
------------------
Real estate held for sale:
Balance at December 31, 2003........................ -
Transfer from operating facilities.................. 3,382
Transfers from accumulated depreciation............. (468)
------------------
Balance at September 30, 2004....................... 2,914
------------------
Land held for development:
Balance at December 31, 2003........................ 12,236
Disposition of land................................. (4,281)
Transfers to construction in progress............... (375)
------------------
Balance at September 30, 2004....................... 7,580
------------------
Total real estate facilities........................... $ 4,012,391
==================
During the nine months ended September 30, 2004, we opened seven
newly developed self-storage facilities (505,000 net rentable square feet)
with an aggregate cost of $61,383,000. We also completed projects to
convert space previously used by our containerized storage business into
354,000 net rentable square feet of self-storage space for an aggregate
cost of $10,278,000, and two expansion projects to existing self-storage
facilities (108,000 net rentable square feet) for an aggregate cost of
$9,500,000. In addition, we incurred costs totaling $3,423,000 with respect
to visual and structural enhancements to our existing self-storage
facilities and incurred an additional $505,000 in costs with respect to
projects completed in 2003.
13
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
During the nine months ended September 30, 2004, we sold three
vacant parcels of land and received condemnation proceeds with respect to
two existing self-storage facilities, receiving net proceeds totaling
$7,437,000 and recording a gain on sale of $1,286,000.
As described in Note 15, "Subsequent Events," from October 1, 2004
through November 8, 2004, we acquired 32 additional self-storage facilities
at an aggregate cost of approximately $121.5 million, comprised of $57
million in cash, assumed debt totaling $39.5 million, and $25 million in
the Company's 6.25% Series Z Cumulative Redeemable Perpetual Preferred
Units.
In addition, in the quarter ended September 30, 2004, we recorded
a $1,250,000 impairment charge with respect to real estate assets
representing the net book value of assets destroyed as a result of
hurricanes occurring in the quarter in the state of Florida. This
impairment charge is comprised of $2,874,000 in buildings and $1,624,000 in
accumulated depreciation. This impairment charge is reflected on the
condensed consolidated statement of income as "Asset impairment charge due
to casualty loss."
Construction in process at September 30, 2004 consists primarily
of eight self-storage facilities (603,000 net rentable square feet) and 29
expansion projects and various remodeling projects to enhance the visual
and structural appeal of existing self-storage facilities (1,655,000 net
rentable square feet). In addition, we have four parcels of land held for
development with total costs of approximately $7,580,000.
Our policy is to capitalize interest incurred on debt during the
course of construction of our self-storage facilities. Interest capitalized
during the three and nine months ended September 30, 2004 was $685,000 and
$2,722,000, respectively, compared to $1,411,000 and $4,386,000 for the
same periods in 2003, respectively.
5. Investment in Real Estate Entities
----------------------------------
At September 30, 2004, our investments in real estate entities
consist of ownership interests in eight partnerships, which principally own
self-storage facilities, and our ownership interest in PSB. These interests
are non-controlling interests of less than 50% and are accounted for using
the equity method of accounting. Accordingly, earnings are recognized based
upon our ownership interest in each of the partnerships. The accounting
policies of these entities are similar to the Company's.
For the three and nine months ended September 30, 2004, we
recognized earnings from our investments of $3,184,000 and $11,646,000,
respectively, as compared to $5,770,000 and $19,456,000 for the same
periods in 2003, respectively. For the three and nine months ended
September 30, 2004, our equity in earnings includes our net pro-rata share
of PSB's application of EITF Topic D-42 and our pro-rata share of gains and
losses on sale of real estate assets, which reduced our equity in earnings
a total of $1,092,000 and $2,109,000, respectively. For the nine months
ended September 30, 2003, our equity in earnings includes our pro-rata
share of PSB's impairment charge with respect to real estate held for sale,
offset by a gain on sale of their real estate assets, which increased our
equity in earnings $453,000. See the condensed financial information with
respect to PSB below for further information regarding these items recorded
by PSB.
We acquired investments in real estate entities totaling
$2,999,000 and $272,000 for the nine months ended September 30, 2004 and
2003, respectively. We received distributions from our investments for the
nine months ended September 30, 2004 and 2003, in the amount of $15,863,000
and $12,900,000, respectively.
The following table sets forth our investments in real estate
entities at September 30, 2004 and December 31, 2003, and our equity in
earnings of real estate entities for the three and nine months ended
September 30, 2004 and 2003 (amounts in thousands):
14
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
Equity in Earnings of Real Equity in Earnings of Real
Investments in Real Estate Estate Entities for the Estate Entities for the Nine
Entities at Three Months Ended September 30, Months Ended September 30,
--------------------------------- -------------------------------- ----------------------------
September 30, December 31,
2004 2003 2004 2003 2004 2003
-------------- -------------- ------------- ----------- ----------- -----------
PSB (a).................. $ 278,620 $ 282,428 $ 1,567 $ 4,559 $ 7,263 $ 15,717
Acquisition Joint Venture (b) 2,920 - (10) - (10) -
Other Investments ....... 53,938 54,268 1,627 1,211 4,393 3,739
-------------- -------------- ------------- ----------- ----------- -----------
Total.................. $ 335,478 $ 336,696 $ 3,184 $ 5,770 $ 11,646 $ 19,456
============== ============== ============= =========== =========== ===========
(a) Equity in earnings of real estate entities includes our pro-rata share
of the net impact of gains/losses on sale of assets and impairment
charges relating to the impending sale of real estate assets as well as
our pro-rata share of the impact of the application of EITF Topic D-42
on redemptions of preferred securities recorded by PSB. Our net
pro-rata impact from these items resulted in a reduction of equity in
earnings of $2,109,000 for the nine months ended September 30, 2004, as
compared to an increase in equity in earnings of $453,000 for the nine
months ended September 30, 2003.
(b) In January 2004, we entered into a joint venture partnership with an
institutional investor for the purpose of acquiring up to $125.0
million of existing self-storage properties in the United States from
third parties. The venture is funded entirely with equity consisting of
30% from the Company and 70% from the institutional investor. The
venture had a nine-month investment period (through September 2004) to
identify and acquire facilities. Through September 30, 2004, the joint
venture had acquired two facilities at an aggregate cost of $9,086,000.
Investment in PS Business Parks, Inc.
-------------------------------------
PS Business Parks, Inc. is a REIT traded on the American Stock
Exchange, which controls an operating partnership (collectively, the REIT
and the operating partnership are referred to as "PSB"). We have a 44%
common equity interest in PSB as of September 30, 2004. This common equity
interest is comprised of our ownership of 5,418,273 shares of PSB's common
stock and 7,305,355 limited partnership units in the operating partnership
at December 31, 2003 and at September 30, 2004; these limited partnership
units are convertible at our option, subject to certain conditions, on a
one-for-one basis into PSB common stock. Based upon the closing price at
September 30, 2004 ($39.85 per share of PSB common stock), the shares and
units had a market value of approximately $507.0 million as compared to a
book value of $278.6 million.
At September 30, 2004, PSB wholly owned approximately 18.4 million
net rentable square feet of commercial space. In addition, PSB manages
commercial space owned by the Company and the Consolidated Entities
pursuant to property management agreements.
The following table sets forth the condensed statements of
operations for the nine months ended September 30, 2004 and for the same
period in 2003 (as restated for discontinued operations), and the condensed
balance sheets of PSB at September 30, 2004 and December 31, 2003. The
amounts below represent 100% of PSB's balances and not our pro-rata share.
15
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
Nine Months Ended September 30,
-----------------------------------
2004 2003
---------------- ---------------
(Amounts in thousands)
Total revenue prior to gains on sale............. $ 162,920 $ 144,677
Gain on sale of real estate and marketable 145 5,541
securities....................................
Impairment charges with respect to impending
sales of real estate.......................... - (5,907)
Cost of operations and other expenses............ (53,919) (44,590)
Depreciation and amortization.................... (53,559) (41,972)
Discontinued operations (a)...................... 1,223 4,354
Minority interest................................ (21,567) (23,613)
---------------- ---------------
Net income..................................... $ 35,243 $ 38,490
================ ===============
September 30, December 31,
2004 2003
---------------- ----------------
(Amounts in thousands)
Total assets (primarily real estate)............. $ 1,358,646 $ 1,358,861
Total debt....................................... 49,225 264,694
Other liabilities................................ 41,672 35,701
Preferred equity and preferred minority interest. 606,100 386,423
Common equity.................................... 661,649 672,043
(a) Included in discontinued operations for the three and nine months ended
September 30, 2004 are net gains on dispositions of a real estate of
$313,000 and $145,000, respectively. Discontinued operations for the
nine months ended September 30, 2003 includes $2,296,000 in equity in
income of discontinued joint venture.
Acquisition Joint Venture
-------------------------
In January 2004, we entered into a joint venture partnership with
an institutional investor for the purpose of acquiring up to $125.0 million
of existing self-storage properties in the United States from third parties
(the "Acquisition Joint Venture"). The venture is funded entirely with
equity consisting of 30% from the Company and 70% from the institutional
investor. The venture had a nine-month investment period (through September
2004) to identify and acquire facilities. Through September 30, 2004, the
joint venture had acquired two self-storage facilities at an aggregate cost
of $9,086,000 and we had invested $2,930,000 in this joint venture. For a
six-month period beginning 54 months after formation, we have the right to
acquire our joint venture partner's interest. If we do not exercise our
option, our joint venture partner can elect to purchase out interest in the
properties during a six-month period commencing upon expiration of our
six-month option period. If our joint venture partner fails to exercise its
option, the partnership will be liquated and the proceeds will be
distributed to the partners according to the joint venture agreement.
The following table sets forth certain condensed financial
information (representing 100% of this entity's balances and not our
pro-rata share) with respect to the Acquisition Joint Venture.
16
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
Nine Months Ended
September 30, 2004
------------------
(Amounts in
thousands)
Total revenue........................................ $ 133
Cost of operations and other expenses................ (72)
Depreciation and amortization........................ (31)
------------------
Net income......................................... $ 30
==================
September 30, 2004
------------------
(Amounts in
thousands)
Total assets (primarily storage facilities).......... $ 9,595
Liabilities.......................................... 100
Partners' equity..................................... 9,495
Other Investments
-----------------
The Other Investments consist primarily of an average 46% common
equity ownership, which we owned during each of the three and nine months
ended September 30, 2004 and 2003, in seven limited partnerships
(collectively, the "Other Investments") owning an aggregate of 36 storage
facilities. For the nine months ended September 30, 2004 we acquired
$69,000 in additional equity interests in these entities and $272,000 for
the nine months ended September 30, 2003.
The following table sets forth certain condensed financial
information (representing 100% of these entities' balances and not our
pro-rata share) with respect to Other Investments:
Nine Months Ended September 30,
-----------------------------------
2004 2003
---------------- ----------------
(Amounts in thousands)
Total revenue........................................ $ 21,089 $ 19,897
Cost of operations and other expenses................ (7,170) (6,862)
Depreciation and amortization........................ (1,781) (1,868)
---------------- ----------------
Net income......................................... $ 12,138 $ 11,167
================ ================
September 30, December 31,
2004 2003
---------------- ----------------
(Amounts in thousands)
Total assets (primarily storage facilities).......... $ 56,490 $ 56,592
Total debt........................................... 665 1,930
Other liabilities.................................... 1,644 1,618
Partners' equity..................................... 54,181 53,044
17
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
6. Revolving Line of Credit
------------------------
On March 25, 2004, we amended our $200 million credit facility.
The amendment extends the maturity date to April 1, 2007 and bears an
annual interest rate ranging from the London Interbank Offered Rate
("LIBOR") plus 0.45% to LIBOR plus 1.20% depending on our credit ratings
(currently LIBOR plus 0.45%). In addition, we are required to pay a
quarterly commitment fee ranging from 0.15% per annum to 0.30% per annum
depending on our credit ratings (currently the fee is 0.15% per annum). At
September 30, 2004 and at November 4, 2004, we had no outstanding
borrowings on our line of credit.
The amended Credit Agreement includes various covenants, the more
significant of which require us to (i) maintain a balance sheet leverage
ratio of less than 0.55 to 1.00, (ii) maintain certain quarterly interest
and fixed-charge coverage ratios (as defined therein) of not less than 2.25
to 1.0 and 1.5 to 1.0, respectively, and (iii) maintain a minimum total
shareholders' equity (as defined therein). In addition, we are limited in
our ability to incur additional borrowings (we are required to maintain
unencumbered assets with an aggregate book value equal to or greater than
1.5 times our unsecured recourse debt). We were in compliance with all
covenants of the Credit Agreement at September 30, 2004.
7. Notes Payable
-------------
Notes payable at September 30, 2004 and December 31, 2003 consist
of the following:
Carrying Amount
------------------------------
September 30, December 31,
2004 2003
-------------- -------------
(Amounts in thousands)
Unsecured senior notes:
7.47% note due January 2004............................. $ - $ 14,600
7.66% note due January 2007............................. 33,600 44,800
Mortgage notes payable:
10.55% mortgage notes secured by real estate facilities,
principal and interest payable monthly.............. - 14,863
7.134% to 8.75% mortgage notes secured by real estate
facilities, principal and interest payable monthly, due
at varying dates between October 2009 and September 2028 1,660 1,767
-------------- -------------
Total notes payable.............................. $ 35,260 $ 76,030
============== =============
All of our notes payable are fixed rate. The unsecured senior
notes require interest and principal payments to be paid semi-annually and
have various restrictive covenants, all of which have been met at September
30, 2004 and December 31, 2003. The 10.55% mortgage notes were paid in full
in June 2004 at face value. Mortgage notes payable at September 30, 2004
are secured by two real estate facilities having an aggregate net book
value of approximately $11 million at September 30, 2004.
18
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
At September 30, 2004, approximate principal maturities of notes
payable are as follows:
Unsecured
Senior Notes Mortgage Notes Total
------------- -------------- ----------
(Amounts in thousands)
2004 (remainder of).......... $ - $ 40 $ 40
2005......................... 11,200 156 11,356
2006......................... 11,200 170 11,370
2007......................... 11,200 185 11,385
2008......................... - 202 202
Thereafter................... - 907 907
------------- -------------- ----------
$ 33,600 $ 1,660 $ 35,260
============= ============== ==========
Weighted average rate........ 7.7% 7.9% 7.7%
============= ============== ==========
As described in Note 15, "Subsequent Events," we assumed
approximately $39.5 million of mortgage debt in connection with property
acquisitions from October 1, 2004 through November 8, 2004.
8. Minority Interest
-----------------
In consolidation, we classify ownership interests in the net
assets of each of the Consolidated Entities, other than our own, as
minority interest on the consolidated financial statements. Minority
interest in income consists of the minority interests' share of the
operating results of the Consolidated Entities.
Preferred Partnership Interests
-------------------------------
During 2000, one of our consolidated operating partnerships issued
preferred partnership units: March 17, 2000 - $240.0 million of 9.5% Series
N Cumulative Redeemable Perpetual Preferred Units and March 29, 2000 -
$75.0 million of 9.125% Series O Cumulative Redeemable Perpetual Preferred
Units. A portion of the 9.125% Series O Cumulative Redeemable Perpetual
Preferred Units ($30 million) was repurchased by the Company in 2001.
On March 22, 2004, certain investors who held $200 million of our
9.5% Series N Cumulative Redeemable Perpetual Preferred Units agreed, in
exchange for a special distribution of $8,000,000, to exchange their 9.5%
Series N Cumulative Redeemable Perpetual Preferred Units for $200 million
of our 6.4% Series NN Cumulative Redeemable Perpetual Preferred Units. The
investors also received a distribution for dividends that accrued from
January 1, 2004 through the effective date of the exchange.
The restructure of these Preferred Units resulted in an increase
in income allocated to minority interests and a reduction to the Company's
net income for the nine months ended September 30, 2004 of $10,063,000 from
(1) the special distribution to the holders of the preferred units
($8,000,000) and (2) the application of the SEC's clarification of EITF
Topic D-42 ($2,063,000). The $2,063,000 additional reduction in the
Company's net income represents the excess of the stated amount of the
preferred units over their carrying amount.
For the three months ended September 30, 2004 and 2003, the
holders of preferred units were paid distributions totaling $5,176,000 and
$6,726,000, respectively. For the nine months ended September 30, 2004 and
2003, preferred unitholders were paid distributions aggregating $24,907,000
(including the $8,000,000 special distribution) and $20,179,000,
respectively. Income allocated to the preferred minority interests was
$5,176,000 and $6,726,000 for the three months ended September 30, 2004 and
2003, respectively, comprised of distributions paid. Income allocated to
preferred minority interests for the nine months ended September 30, 2004
and 2003 was $26,970,000 (comprised of distributions paid and an allocation
of income of $2,063,000 resulting from the application of EITF Topic D-42)
and $20,179,000, respectively.
19
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
The following table summarizes the preferred partnership units
outstanding at September 30, 2004 and December 31, 2003:
At September 30, 2004 At December 31, 2003
Earliest Distribution Units Carrying Units Carrying
Series Redemption Date (a) Rate Outstanding Amount Outstanding Amount
- -------------- -------------------- ------------ ------------ -------------- ------------- ------------
(Amounts in thousands)
Series N...... March 17, 2005 9.500% 1,600 $ 40,000 9,600 $ 240,000
Series NN..... March 17, 2010 6.400% 8,000 200,000 - -
Series O...... March 29, 2005 9.125% 1,800 45,000 1,800 45,000
------------ -------------- ------------- ------------
Total 11,400 $ 285,000 11,400 $ 285,000
============ ============= ============ ============
(a) After these dates, at our option, we can call the units for redemption
at the issuance amount plus any unpaid distributions. The units are not
redeemable by the holder.
Subject to certain conditions, the Series N preferred units are
convertible into shares of our 9.5% Series N Cumulative Preferred Stock,
the Series O preferred units are convertible into shares of our 9.125%
Series O Cumulative Preferred Stock, and the Series NN preferred units are
convertible into shares of our 6.4% Series NN Cumulative Preferred Stock.
As described under Note 15, "Subsequent Events" below, we issued
$25,000,000 of our 6.25% Series Z Cumulative Redeemable Preferred Units
subsequent to September 30, 2004 in connection with property acquisitions.
The holders of these units have a one-time option, exercisable five years
from issuance, to require us to redeem their units for $25,000,000 cash
plus unpaid and accrued distributions. Subject to certain conditions, the
Series Z preferred units are convertible into shares of our 6.25% Series Z
Cumulative Preferred Stock.
Other Partnership Interests
---------------------------
The following table sets forth the minority interests at September
30, 2004 and December 31, 2003 as well as the distributions paid to
minority interests for the nine months ended September 30, 2004 and 2003
with respect to the other partnership interests (amounts in thousands):
Distributions to Minority
Minority Interest at Interest for the Nine Months Ended
September 30, December 31, September 30, September 30,
Description 2004 2003 2004 2003
- ----------------------------------------- --------------- ---------------- ---------------- ---------------
Consolidated Development Joint Venture... $ 65,047 $ 68,490 $ 7,383 $ 7,386
Convertible Partnership Units........... 6,265 6,259 213 320
Other consolidated partnerships.......... 47,455 66,388 9,390 9,244
--------------- ---------------- ---------------- ---------------
Total other partnership interests........ $ 118,767 $ 141,137 $ 16,986 $ 16,950
=============== ================ ================ ===============
20
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
Income is allocated to the minority interests based upon their
pro-rata interest in the operating results of the Consolidated Entities.
The following table sets forth minority interest in income with respect to
the other partnership interests for the three and nine months ended
September 30, 2004 and 2003 (amounts in thousands):
Minority Interest in Income for Minority Interest in Income for
the Three Months Ended September 30, the Nine Months Ended September 30,
------------------------------------ -----------------------------------
Description 2004 2003 2004 2003
- ----------------------------------------- ---------------- ---------------- -------------- ----------------
Consolidated Development Joint Venture... $ 1,563 $ 1,292 $ 3,940 $ 2,905
Convertible Partnership Units............ 88 86 219 233
Other Consolidated Partnerships.......... 2,694 3,040 8,769 9,265
---------------- ---------------- -------------- ----------------
Total other partnership interests........ $ 4,345 $ 4,418 $ 12,928 $ 12,403
================ ================ ============== =================
Consolidated Development Joint Venture
--------------------------------------
In November 1999, we formed a development joint venture (the
"Consolidated Development Joint Venture") with a joint venture partner
("PSAC Storage Investors, LLC") whose partners include a third party
institutional investor and B. Wayne Hughes ("Mr. Hughes"), to develop
approximately $100 million of self-storage facilities and to purchase $100
million of the Company's Equity Stock, Series AAA (see Note 9). At
September 30, 2004, the Consolidated Development Joint Venture was fully
committed having completed construction on 22 self-storage facilities for a
total cost of $108.6 million.
The Consolidated Development Joint Venture is funded solely with
equity capital consisting of 51% from the Company and 49% from PSAC Storage
Investors, LLC. The accounts of the Consolidated Development Joint Venture
are included in the Company's consolidated financial statements. The
accounts of PSAC Storage Investors, LLC are not included in the Company's
consolidated financial statements, as the Company has no ownership interest
in this entity. Minority interests primarily represent the total
contributions received from PSAC Storage Investors combined with the
accumulated net income allocated to PSAC Storage Investors, LLC, net of
cumulative distributions. The amounts included in our financial statements
with respect to the minority interest in the Consolidated Development Joint
Venture are denoted in the tables above.
The term of the Consolidated Development Joint Venture is 15
years; however, during the sixth year PSAC Storage Investors, LLC has the
right to cause an early termination of the partnership. If PSAC Storage
Investors, LLC exercises this right, we then have the option, but not the
obligation, to acquire their interest for an amount that will allow them to
receive an annual return of 10.75%. If the Company does not exercise its
option to acquire PSAC Storage Investors, LLC's interest, the partnership's
assets will be sold to third parties and the proceeds distributed to the
Company and PSAC Storage Investors, LLC in accordance with the partnership
agreement. If PSAC Storage Investors, LLC does not exercise its right to
early termination during the sixth year, the partnership will be liquidated
15 years after its formation with the assets sold to third parties and the
proceeds distributed to the Company and PSAC Storage Investors, LLC in
accordance with the partnership agreement.
PSAC Storage Investors, LLC provides Mr. Hughes with a fixed yield
of approximately 8.0% per annum on his preferred non-voting interest
(representing an investment of approximately $64.1 million at September 30,
2004). In addition, Mr. Hughes receives 1% of the remaining cash flow of
PSAC Storage Investors, LLC (estimated to be less than $50,000 per year).
If PSAC Storage Investors, LLC does not elect to cause an early
termination, Mr. Hughes' 1% interest in residual cash flow can increase to
10%.
21
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
In consolidation, the Equity Stock, Series AAA owned by the joint
venture and the related dividend income has been eliminated. Minority
interests primarily represent the total contributions received from PSAC
Storage Investors, LLC combined with the accumulated net income allocated
to PSAC Storage Investors, LLC, net of cumulative distributions.
See Note 13, "Recent Accounting Pronouncements" for further
discussion of the impact of recent accounting pronouncements on the
accounting for these interests.
Convertible Partnership Units
-----------------------------
As of September 30, 2004 and December 31, 2003, one of our
Consolidated Entities had approximately 237,935 convertible operating
partnership units ("Convertible Units") outstanding, representing a limited
partnership interest in the partnership. The Convertible Units are
convertible on a one-for-one basis (subject to certain limitations) into
the Company's common stock at the option of the unitholder. Minority
interest in income with respect to the Convertible Units reflects the
Convertible Units' share of the net income of the Company, with net income
allocated to minority interests with respect to weighted average
outstanding Convertible Units on a per unit basis equal to diluted earnings
per common share. During the nine months ended September 30, 2004 and the
year ended December 31, 2003, no units were converted.
Other Consolidated Partnerships
-------------------------------
At September 30, 2004, the other consolidated partnerships reflect
common equity interests that the Company does not own in 24 entities having
an interest in an aggregate of 123 self-storage facilities.
On June 30, 2004, we acquired the remaining minority interest we
did not own in one of the Consolidated Entities, for an aggregate of
$24,851,000 in cash. This acquisition had the effect of reducing minority
interest by $18,312,000, with the excess of cost over underlying book value
($6,539,000) allocated to real estate.
On April 28, 2003 we acquired through a merger all of the
remaining limited partnership interest not owned by the Company in PS
Partners IV, Ltd., a partnership which is consolidated with the Company.
The acquisition cost was $23,377,000, consisting of the issuance of 426,859
shares of our common stock ($13,510,000) valued at the closing price of our
common stock on the date of acquisition and cash of $9,867,000; this
acquisition had the effect of reducing minority interest by $6,690,000,
with the excess of cost over underlying book value ($16,687,000) allocated
to real estate.
The partnership agreements of the other consolidated partnerships
have termination dates that cannot be unilaterally extended by the Company
and, upon termination of each partnership, the net assets of these entities
would be liquidated and paid to the minority interests and the Company
based upon their relative ownership interests. See Note 13, "Recent
Accounting Pronouncements - Accounting for Certain Financial Instruments
with Characteristics of both Liabilities and Equity" for further discussion
of the impact of recent accounting pronouncements on the accounting for
these interests.
22
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
9. Shareholders' Equity
--------------------
Cumulative Preferred Stock
--------------------------
At September 30, 2004 and December 31, 2003, we had the following
series of Cumulative Preferred Stock outstanding:
At September 30, 2004 At December 31, 2003
------------------------------ -----------------------------
Earliest
Redemption Dividend Shares Carrying Shares Carrying
Series Date (a) Rate Outstanding Amount Outstanding Amount
- ----------------------- -------------- ------------- -------------- -------------- ------------- -------------
(Dollar amount in thousands)
Series D 9/30/04 (c) 9.500% - $ - 1,200,000 $ 30,000
Series E 1/31/05 10.000% 2,195,000 54,875 2,195,000 54,875
Series F 4/30/05 9.750% 2,300,000 57,500 2,300,000 57,500
Series K 1/19/04 (b) 8.250% - - - -
(c)
Series L 3/10/04 (c) 8.250% - - 4,600 115,000
Series M 8/17/04 (c) 8.750% - - 2,250 56,250
Series Q 1/19/06 8.600% 6,900 172,500 6,900 172,500
Series R 9/28/06 8.000% 20,400 510,000 20,400 510,000
Series S 10/31/06 7.875% 5,750 143,750 5,750 143,750
Series T 1/18/07 7.625% 6,086 152,150 6,086 152,150
Series U 2/19/07 7.625% 6,000 150,000 6,000 150,000
Series V 9/30/07 7.500% 6,900 172,500 6,900 172,500
Series W 10/6/08 6.500% 5,300 132,500 5,300 132,500
Series X 11/13/08 6.450% 4,800 120,000 4,800 120,000
Series Y 1/2/09 6.850% 1,600,000 40,000 - -
Series Z 3/5/09 6.250% 4,500 112,500 - -
Series A 3/31/09 6.125% 4,600 115,000 - -
Series B 6/30/09 7.125% 4,350 108,750 - -
Series C 9/13/09 6.600% 4,600 115,000 - -
-------------- -------------- ------------- --------------
Total Cumulative Preferred Stock 6,175,186 $ 2,157,025 5,763,986 $ 1,867,025
============== ============== ============= ==============
(a) Except under certain conditions relating to the Company's qualification
as a REIT, the Cumulative Preferred Stock outstanding at September 30,
2004 is not redeemable prior to the dates indicated. On or after the
dates indicated, each series of Cumulative Senior Preferred Stock will
be redeemable, at the option of the Company, in whole or in part, at
$25.00 per share (or depositary share in the case of the Series M
through X, and Series Z, A, B and C), plus accrued and unpaid
dividends.
(b) The Series K Cumulative Preferred Stock was called for redemption in
December 2003 and was redeemed in January 2004 along with the unpaid
distributions from January 1, 2004 through the redemption date.
Accordingly, the redemption value of $115,000,000 was classified as a
liability at December 31, 2003.
(c) Series was redeemed on the date indicated, except Series K that was
redeemed on January 20, 2004.
Our Cumulative Preferred Stock, issued in series, has general
preference rights with respect to liquidation and quarterly distributions.
Holders of the preferred stock, except under certain conditions and as
noted below, will not be entitled to vote on most matters. In the event of
a cumulative arrearage equal to six quarterly dividends 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, 2004, there were no dividends in arrears and the
Debt Ratio was 0.6%.
23
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
During the first quarter of 2004, we issued three series of
Cumulative Preferred Stock: Series Y - issued January 2, 2004, net proceeds
$40,000,000, Series Z - issued March 5, 2004, net proceeds $108,756,000,
and Series A - issued March 19, 2004, net proceeds $111,177,000. On June
30, 2004 we issued our Series B Cumulative Preferred Stock for net proceeds
of $105,124,000 and on September 13, 2004 we issued our Series C Cumulative
Preferred Stock for net proceeds of $111,177,000. In addition during the
first quarter of 2004, we redeemed our Series K (which was called for
redemption in December 2003) and Series L Cumulative Preferred Stock, at
par. The total cost of redemption of Series L was $115,021,000 (including
redemption expenses), plus accrued dividends. During the third quarter we
redeemed our Series D and Series M Cumulative Preferred Stock for a total
cost of $30,020,000 and $56,270,000, respectively, (including redemption
expenses), plus accrued dividends.
During 2003, we issued our Series W and Series X Cumulative
Preferred Stock: Series W - issued on October 6, 2003, net proceeds of
$128,126,000 and Series X - issued November 13, 2003, net proceeds of
$116,020,000. In addition during 2003, we redeemed our Series B and Series
C Cumulative Preferred Stock, at par, at a total cost of $57,517,000 and
$30,018,000 (including related redemption expenses), respectively. In
December 2003, we called for redemption our Series K Cumulative Preferred
Stock, at par. The total cost of redemption of the Series K was
approximately $115,000,000, plus accrued dividends, on the redemption date,
January 20, 2004.
Equity Stock
------------
The Company is authorized to issue 200,000,000 shares of Equity
Stock. The Articles of Incorporation provide that the Equity Stock may be
issued from time to time in one or more series and gives the Board of
Directors broad authority to fix the dividend and distribution rights,
conversion and voting rights, redemption provisions and liquidation rights
of each series of Equity Stock.
Equity Stock, Series A
----------------------
At September 30, 2004, we had 8,776,102 depositary shares
outstanding, each representing 1/1,000 of a share of Equity Stock, Series A
("Equity Stock A"). The Equity Stock A ranks on a parity with common stock
and junior to the Cumulative Preferred Stock with respect to general
preference rights and has a liquidation amount which cannot exceed $24.50
per share. Distributions with respect to each depositary share shall be the
lesser of: (i) five times the per share dividend on our common stock or
(ii) $2.45 per annum. We have no obligation to pay distributions on the
depositary shares if no distributions are paid to common shareholders.
Except in order to preserve the Company's federal income tax
status as a REIT, we may not redeem the depositary shares before March 31,
2010. On or after March 31, 2010, we may, at our option, redeem the
depositary shares at $24.50 per depositary share. If the Company fails to
preserve its federal income tax status as a REIT, the depositary shares
will be convertible at the option of the shareholder into .956 shares of
common stock. The depositary shares are otherwise not convertible into
common stock. Holders of depositary shares vote as a single class with
holders of our common stock on shareholder matters, but the depositary
shares have the equivalent of one-tenth of a vote per depositary share.
24
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
Equity Stock, Series AA
-----------------------
In June 1997, we contributed $22,500,000 (225,000 shares) of
equity stock, designated as Equity Stock, Series AA ("Equity Stock AA") to
Diversified Storage Venture Fund, a consolidated partnership.
On June 30, 2004, the Equity Stock, Series AA was retired in
connection with our aforementioned acquisition of the remaining interests
we didn't own in Diversified Storage Venture Fund. For periods prior to
June 30, 2004, the Equity Stock AA was eliminated in consolidation.
Equity Stock, Series AAA
------------------------
In November 1999, we sold $100,000,000 (4,289,544 shares) of
Equity Stock, Series AAA ("Equity Stock AAA") to a newly formed joint
venture (the "Consolidated Development Joint Venture"). We control the
joint venture and consolidate its accounts, and accordingly the Equity
Stock AAA is eliminated in consolidation. The Equity Stock AAA ranks on a
parity with our common stock and junior to the Cumulative Preferred Stock
with respect to general preference rights, and has a liquidation amount
equal to 120% of the amount distributed to each common share. Annual
distributions per share are equal to the lesser of (i) five times the
amount paid per common share or (ii) $2.1564. We have no obligation to pay
distributions on these shares if no distributions are paid to common
shareholders.
Upon liquidation of the Consolidated Development Joint Venture, at
the Company's option either a) each share of Equity Stock AAA shall convert
into 1.2 shares of our common stock or b) the Company can redeem the Equity
Stock AAA at a per share amount equal to 120% of the market price of our
common stock. In addition, if the Company determines that it is necessary
to maintain its status as a Real Estate Investment Trust, subject to
certain limitations it may cause the redemption of shares of Equity Stock
AAA at a per share amount equal to 120% of the market price of our common
stock. The shares are not otherwise redeemable or convertible into shares
of any other class or series of the Company's capital stock. Other than as
required by law, the Equity Stock AAA has no voting rights.
Common Stock
------------
At September 30, 2004, entities consolidated with the Company
owned 893,432 common shares of the Company. These shares continue to be
legally issued and outstanding. In the consolidation process, these shares
and the related balance sheet amounts have been eliminated. In addition,
these shares are not included in the computation of weighted average shares
outstanding.
The following chart reconciles the Company's legally issued and
outstanding shares of common stock and the reported outstanding shares of
common stock at September 30, 2004 and December 31, 2003:
Reconciliation of Common Shares Outstanding At September 30, At December 31,
- ------------------------------------------- 2004 2003
--------------- ---------------
Legally issued and outstanding shares........ 129,210,239 127,710,466
Less - Shares owned by the Consolidated
Entities that are eliminated in (893,432) (723,732)
consolidation (a)........................
--------------- ---------------
Reported issued and outstanding shares....... 128,316,807 126,986,734
=============== ===============
(a) The increase in shares owned by the Consolidated Entities is
due to the Consolidated Entities' purchase of 169,700 shares of our common
stock during the nine months ended September 30, 2004.
25
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
Dividends
---------
The following table summarizes dividends declared and paid during
the nine months ended September 30, 2004:
Distributions Per
Share or Depositary
Share Total Distribution
------------------ --------------------
Preferred Stock:
Series D.............................. $1.776 $ 2,131,000
Series E.............................. $1.875 4,116,000
Series F.............................. $1.828 4,205,000
Series K.............................. $0.109 501,000
Series L ............................. $0.395 1,818,000
Series M.............................. $1.373 3,089,000
Series Q.............................. $1.613 11,126,000
Series R.............................. $1.500 30,600,000
Series S.............................. $1.477 8,490,000
Series T.............................. $1.430 8,700,000
Series U.............................. $1.430 8,580,000
Series V.............................. $1.406 9,703,000
Series W.............................. $1.219 6,459,000
Series X.............................. $1.209 5,805,000
Series Y.............................. $1.280 2,048,000
Series Z.............................. $0.898 4,043,000
Series A.............................. $0.770 3,542,000
Series B.............................. $0.450 1,959,000
Series C.............................. $0.082 378,000
--------------------
117,293,000
Common Stock:
Equity Stock, Series A................ $1.838 16,126,000
Common ............................... $1.350 172,474,000
--------------------
Total dividends.................... $305,893,000
====================
The dividend rate on the common stock was $0.45 per common share
and $1.35 per common share for the three and nine months ended September
30, 2004, respectively. The dividend rate on the Equity Stock A was $0.6125
per depositary share and $1.838 per depositary share for the three and nine
months ended September 30, 2004, respectively.
10. Segment Information
-------------------
Description of Each Reportable Segment
--------------------------------------
Our reportable segments reflect significant operating activities
that are evaluated separately by management. We have four reportable
segments: self-storage operations, containerized storage operations,
commercial property operations and tenant reinsurance operations.
The self-storage segment comprises the direct ownership,
development and operation of traditional storage facilities, and the
ownership of equity interests in entities that own self-storage properties.
The containerized storage operations represent another segment. The
commercial property segment reflects our interest in the ownership,
operation and management of commercial properties. The vast majority of the
commercial property operations are conducted through PSB, and to a much
lesser extent the Company and certain of its unconsolidated subsidiaries
own commercial space, managed by PSB, within facilities that combine
storage and commercial space for rent. The tenant reinsurance operations
reflect a business segment which reinsures policies against losses to goods
stored by tenants in our self-storage facilities.
26
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
Measurement of Segment Profit or Loss
-------------------------------------
We evaluate performance and allocate resources based upon the net
segment income of each segment. Net segment income represents net income in
conformity with accounting principles generally accepted in the United
States and our significant accounting policies as stated in Note 2, before
interest and other income, interest expense, corporate general and
administrative expense, and minority interest in income. The accounting
policies of the reportable segments are the same as those described in the
Summary of Significant Accounting Policies.
Interest and other income, interest expense, corporate general and
administrative expense, and minority interest in income and gains and
losses on sales of real estate assets are not allocated to segments because
management does not utilize them to evaluate the results of operations of
each segment.
Measurement of Segment Assets
-----------------------------
No segment data relative to assets or liabilities is presented,
because management does not consider the historical cost of the Company's
real estate facilities and investments in real estate entities in
evaluating the performance of operating management or in evaluating
alternative courses of action. The only other types of assets that might be
allocated to individual segments are trade receivables, payables, and other
assets which arise in the ordinary course of business, but they are also
not a significant factor in the measurement of segment performance.
Presentation of Segment Information
-----------------------------------
Our income statement provides most of the information required in
order to determine the performance of each of the Company's four segments.
The following tables reconcile the performance of each segment, in terms of
segment revenues and segment income, to our consolidated revenues and net
income. It further provides detail of the segment components of the income
statement item, "Equity in earnings of real estate entities."
The following table reconciles the revenue by segment to the
Company's consolidated revenues:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -----------------------
2004 2003 Change 2004 2003 Change
------------ ----------- ----------- ---------- ----------- ----------
(Dollar amounts in thousands)
Reconciliation of Revenues by Segment:
Self-storage property rentals................ $ 219,908 $ 206,856 $ 13,052 $ 639,025 $ 593,345 $ 45,680
Commercial property rentals.................. 2,707 2,712 (5) 8,064 8,299 (235)
Containerized storage........................ 5,048 6,672 (1,624) 15,099 18,495 (3,396)
Tenant reinsurance........................... 6,210 5,755 455 18,266 16,551 1,715
Interest and other income.................... 3,300 2,847 453 7,240 7,425 (185)
------------ ----------- ----------- ---------- ----------- ----------
Total revenues............................... $ 237,173 $ 224,842 $ 12,331 $ 687,694 $ 644,115 $ 43,579
============ =========== =========== ========== =========== ==========
27
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
The following table reconciles the performance of each segment to
our consolidated net income. It further provides detail of the segment
components of the income statement item, "Equity in earning of real estate
entities."
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- ----------------------
2004 2003 Change 2004 2003 Change
----------- ----------- ---------- ---------- ---------- ----------
(Amounts in thousands)
Reconciliation of Net Income by Segment:
Self-storage
Self-storage net operating income....................... $ 145,833 $135,879 $ 9,954 $ 414,906 $ 386,690 $ 28,216
Self-storage depreciation............................... (42,839) (43,613) 774 (130,643) (130,332) (311)
Equity in earnings - self - storage property operations. 1,744 1,607 137 5,014 4,724 290
Equity in earnings - depreciation (self-storage) ....... (402) (436) 34 (1,180) (1,265) 85
Discontinued operations (Note 3) ....................... - 149 (149) - 421 (421)
----------- ----------- ---------- ---------- ---------- ----------
Total self-storage segment net income............... 104,336 93,586 10,750 288,097 260,238 27,859
----------- ----------- ---------- ---------- ---------- ----------
Commercial properties
Commercial properties net operating income.............. 1,676 1,478 198 4,864 4,884 (20)
Depreciation and amortization - commercial properties... (464) (565) 101 (1,574) (1,815) 241
Equity in earnings - commercial property operations..... 15,959 16,148 (189) 49,753 48,339 1,414
Equity in earnings - depreciation (commercial (8,119) (6,779) (1,340) (23,875) (19,088) (4,787)
properties) .........................................
Discontinued operations (Note 3) ....................... 54 56 (2) 142 152 (10)
----------- ----------- ---------- ---------- ---------- ----------
Total commercial property segment net income........ 9,106 10,338 (1,232) 29,310 32,472 (3,162)
----------- ----------- ---------- ---------- ---------- ----------
Containerized storage
Containerized storage net operating income.............. 1,975 2,849 (874) 6,358 7,782 (1,424)
Containerized storage depreciation...................... (1,072) (1,257) 185 (3,298) (3,623) 325
Discontinued operations (Note 3) ....................... (1,126) (649) (477) (1,931) (2,060) 129
----------- ----------- ---------- ---------- ---------- ----------
Total containerized storage segment net income...... (223) 943 (1,166) 1,129 2,099 (970)
----------- ----------- ---------- ---------- ---------- ----------
Tenant Reinsurance
Tenant reinsurance net income.......................... 2,006 2,838 (832) 7,177 7,920 (743)
----------- ----------- ---------- ---------- ---------- ----------
Other items not allocated to segments
Equity in earnings - general and administrative and (5,998) (4,770) (1,228) (18,066) (13,254) (4,812)
other................................................
Interest and other income............................... 3,300 2,847 453 7,240 7,425 (185)
General and administrative.............................. (5,527) (4,642) (885) (15,983) (13,321) (2,662)
Interest expense........................................ - (296) 296 (100) (1,121) 1,021
Minority interest in income............................. (9,521) (11,144) 1,623 (39,898) (32,582) (7,316)
Asset impairment charge due to casualty loss............ (1,250) - (1,250) (1,250) - (1,250)
Gain on disposition of real estate...................... 1,286 47 1,239 1,286 807 479
----------- ----------- ---------- ---------- ---------- ----------
Total other items not allocated to segments (17,710) (17,958) 248 (66,771) (52,046) (14,725)
----------- ----------- ---------- ---------- ---------- ----------
Total consolidated net income...................... $ 97,515 $ 89,747 $ 7,768 $ 258,942 $ 250,683 $ 8,259
=========== =========== ========== ========== ========== ==========
28
11. Stock-Based Compensation
------------------------
Stock Options
-------------
The Company has a 1990 Stock Option Plan (the "1990 Plan") which
provides for the grant of non-qualified stock options. The Company has a
1994 Stock Option Plan (the "1994 Plan"), a 1996 Stock Option and Incentive
Plan (the "1996 Plan") and a 2000 Non-Executive/Non-Director Stock Option
and Incentive Plan (the "2000 Plan"), each of which provides for the grant
of non-qualified options and incentive stock options. (The 1990 Plan, the
1994 Plan, the 1996 Plan and the 2000 Plan are collectively referred to as
the "PSI Plans".) Under the PSI Plans, the Company has granted
non-qualified options to certain directors, officers and key employees to
purchase shares of the Company's common stock at a price equal to the fair
market value of the common stock at the date of grant. Generally, options
under the PSI Plans vest over a three-year period from the date of grant at
the rate of one-third per year (options granted after, December 31, 2003
vest generally over a five-year period) and expire (i) under the 1990 Plan,
five years after the date they became exercisable and (ii) under the 1994
Plan, the 1996 Plan and the 2000 Plan, ten years after the date of grant.
The 1996 Plan and the 2000 Plan also provide for the grant of restricted
stock to officers, key employees and service providers on terms determined
by an authorized committee of the Board of Directors.
Accounting principles generally accepted in the United States
permit, but do not require, companies to recognize compensation expense for
stock-based awards based on their fair value at date of grant, which is
then amortized as compensation expense over the vesting period (the "Fair
Value Method"). Companies can also elect to disclose, but not recognize as
an expense, stock option expense when stock options are granted to
employees at an exercise price equal to the market price at the date of
grant (the "APB 25 Method").
For periods prior to December 31, 2001, we utilized the APB 25
Method of accounting for employee stock options. As of January 1, 2002, we
adopted the Fair Value Method, and have elected to use the prospective
method of transition, whereby the Company applies the recognition
provisions of the Fair Value Method to all stock options granted after the
beginning of the year in which the Company adopts such method. Accordingly,
we recognize compensation expense in our income statement using the Fair
Value Method only with respect to stock options issued after January 1,
2002.
For the three and nine months ended September 30, 2004, we
recorded $150,000 and $439,000 in stock option compensation expense,
respectively, related to options granted after January 1, 2002. For the
same periods in 2003 we recorded $95,000 and $294,000, respectively. The
fair value of each option grant is estimated on the date of the grant using
the Black-Scholes option pricing model. The estimated average value of
187,500 stock options granted in the first nine months of 2004 was based
upon an estimated life of 5 years, a risk-free rate of 3.39%, an expected
dividend yield of 7%, and expected volatility of 0.227.
If we had recorded stock option expense applying the Fair Value
Method to all awards, we would have recognized an additional $439,000 and
$2,123,000 for the nine months ended September 30, 2004 and 2003,
respectively, in stock option compensation expense. Basic earnings per
share would have been $0.93 and $0.97 for the nine months ended September
30, 2004 and 2003, respectively. Diluted earnings per share would have been
$0.92 and $0.96 for the nine months ended September 30, 2004 and 2003,
respectively.
A total of 187,500 stock options were granted during the nine
months ended September 30, 2004, 1,719,473 shares were exercised, and
63,209 shares were forfeited. A total of 1,493,436 stock options were
outstanding at September 30, 2004 (3,088,618 at December 31, 2003).
29
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
Restricted Stock Units
----------------------
Restricted stock units vest over a five-year period from the date
of grant at the rate of one-fifth per year. The employee receives
additional compensation equal to the per-share dividends received by common
shareholders. Upon vesting, the employee receives regular common shares
equal to the number of vested restricted stock units in exchange for the
units. The total value of each restricted stock unit grant, based upon the
market price of the Company's common stock at the date of grant, combined
with the estimated payroll taxes and other payroll burden costs to be
incurred upon vesting, is amortized over the vesting period as compensation
expense. Outstanding restricted stock units are included on a one-for-one
basis in the Company's diluted weighted average shares, less a reduction
for the treasury stock method applied to the average cumulative measured
but unrecognized compensation expense during the period.
During the nine months ended September 30, 2004, 78,500 restricted
stock units were granted, 36,250 restricted stock units were forfeited, and
31,600 restricted stock units vested. This vesting resulted in the issuance
of 20,300 shares of the Company's common stock. In addition, cash
compensation was paid to employees in lieu of 11,300 shares of common stock
based upon the market value of the stock at the date of vesting, and used
to settle the employees' tax liability generated by the vesting.
At September 30, 2004, approximately 259,650 restricted stock
units were outstanding (249,000 at December 31, 2003). A total of $559,000
and $1,676,000 in restricted stock expense was recorded for the three and
nine months ended September 30, 2004, which includes amortization of the
fair value of the grant reflected as an increase to paid-in capital, as
well as accrued estimated burden to be incurred upon vesting. Restricted
stock expense was $371,000 for both the three and nine months ended
September 30, 2003.
12. Related Party Transactions
--------------------------
Relationships and Transactions with the Hughes Family
-----------------------------------------------------
B. Wayne Hughes, Chairman of the Board of Directors, and his
family (the "Hughes Family") have ownership interests in, and operate,
approximately 40 self-storage facilities in Canada under the name "Public
Storage" pursuant to a license agreement with the Company. We currently do
not own any interests in these facilities nor do we own any facilities in
Canada. The Hughes Family owns approximately 36% of our common stock
outstanding at September 30, 2004. We have a right of first refusal to
acquire the stock or assets of the corporation engaged in the operation of
the 40 self-storage facilities in Canada if the Hughes family or the
corporation agrees to sell them. However, we have no interest in the
operations of this corporation, have no right to acquire this stock or
assets unless the Hughes family decides to sell, and receive no benefit
from the profits and increases in value of the Canadian self-storage
facilities.
Prior to December 31, 2003, our personnel were engaged in the
supervision and the operation of these Canadian self-storage facilities and
provided certain administrative services for the Canadian owners, and
certain other services, primarily tax services, with respect to certain
other Hughes Family interests. The Hughes Family and the Canadian owners
reimbursed us at cost for these services, amounting to $155,000 and
$637,000 for the three and nine months ended September 30, 2003,
respectively (none for the nine months ended September 30, 2004). There
have been conflicts of interest in allocating the time of our personnel
between our properties, the Canadian properties, and certain other Hughes
Family interests. The sharing of personnel and systems with the Canadian
entities was substantially discontinued by December 31, 2003. The Canadian
entities claim that the Company owes them CND $653,424, representing the
amount charged to them for the development of certain systems that they no
longer utilize. This amount has been accrued on the Company's financial
statements for the nine months ended September 30, 2004.
30
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
In November 1999, we formed the Consolidated Development Joint
Venture with a joint venture partner whose partners include an
institutional investor and Mr. Hughes. This transaction is discussed more
fully in Note 8.
The Company, through subsidiaries, continues to reinsure risks
relating to loss of goods stored by tenants in the self-storage facilities
in Canada. The Company had acquired the tenant insurance business in
December 31, 2001 through its acquisition of PSIC.
The corporation engaged in the operations of the Canadian
facilities has advised us that it intends to reorganize the entities owning
and operating the Canadian facilities and has proposed that the Company
consent to this reorganization, which would impact the license agreement
and the right of first refusal agreement with the Company. The
reorganization is designed to enhance the entities' financial flexibility
and growth potential. In November 2004, the Board appointed a special
committee, comprised of independent directors, to consider the Company's
alternatives in this matter, including a possible investment in the
reorganized Canadian entities.
PS Business Parks, Inc.
-----------------------
Ronald L. Havner Jr., our Vice-chairman and Chief Executive
Officer, is also chairman of PSB and was CEO of PSB until August 12, 2003.
For 2003 services, Mr. Havner was compensated by PSB, as well as by the
Company.
Pursuant to a cost-sharing and administrative services agreement,
PSB reimburses the Company for certain administrative services. PSB's share
of these costs totaled approximately $85,000 for each of the three months
ended September 30, 2004 and 2003 and $255,000 for each of the nine months
ended September 30, 2004 and 2003, and were computed in accordance with a
methodology intended to fairly allocate these costs.
PSB manages certain of the commercial facilities owned by the
Company pursuant to management agreements for a management fee equal to 5%
of revenues. The Company paid a total of $141,000 and $423,000 for the
three and nine months ended September 30, 2004, respectively, as compared
to $125,000 and $424,000, respectively, for the same periods in 2003, in
management fees with respect to PSB's property management services.
In December 2003, the Company loaned $100,000,000 to PSB. This
loan bore interest at the rate of 1.45% per year. This loan, which was
fully repaid by March 8, 2004, was included in Notes Receivable at December
31, 2003. For the nine months ended September 30, 2004, we recorded
approximately $127,000 of interest income with respect to this loan.
STOR-Re Mutual Insurance Company, Inc.
--------------------------------------
STOR-Re, an entity that is consolidated by the Company and is
partially owned by PSB (approximately 4.0%) and the Unconsolidated Entities
(collectively 3.7%) and the owners of the Canadian self-storage facilities
(approximately 2.2%), provided limited property and liability insurance to
PSB and the owners of the Canadian self-storage facilities at commercially
competitive rates for losses occurring prior to April 1, 2004. PSB and the
Company utilized unaffiliated insurance carriers to provide property and
liability insurance in excess of STOR-Re's limitations. Effective April 1,
2004, PSB and the owners of the Canadian self-storage facilities have
obtained their own insurance coverage independent from the Company for
losses occurring after March 31, 2004.
31
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
At September 30, 2004, the Canadian entities owed STOR-Re USD
$63,526 for insurance premiums related to the periods prior to April 1, 2004.
13. Recent Accounting Pronouncements
--------------------------------
Accounting for Certain Financial Instruments with Characteristics of both
---------------------------------------------------------------------------
Liabilities and Equity
----------------------
In May 2003, the FASB issued Statement of Financial Accounting
Standards No. 150 - "Accounting for Certain Financial Instruments with
Characteristics of both Liabilities and Equity" ("SFAS No. 150"). This
statement prescribes reporting standards for financial instruments that
have characteristics of both liabilities and equity. This standard
generally indicates that certain financial instruments that give the issuer
a choice of settling an obligation with a variable number of securities or
settling an obligation with a transfer of assets, any mandatorily
redeemable security, and certain put options and forward purchase
contracts, should be classified as a liability on the balance sheet. With
the exception of minority interests, described below, we implemented SFAS
No. 150 on July 1, 2003, and the adoption had no impact on our financial
statements.
The provisions of SFAS No. 150 indicate certain minority interests
in consolidated entities are to be classified as liabilities at fair value.
However, on October 29, 2003, the FASB decided to defer indefinitely the
implementation of SFAS No. 150 as it relates to these minority interests.
FASB Interpretation No. 46 - Consolidation of Variable Interest Entities
------------------------------------------------------------------------
In January 2003, the FASB issued FASB Interpretation No. 46 -
"Consolidation of Variable Interest Entities, an interpretation of
Accounting Research Bulletin No. 51." This interpretation explains how to
identify variable interest entities and how an enterprise assesses its
interests in a variable interest entity to decide whether to consolidate
that entity. In general, a variable interest entity is a corporation,
partnership, trust, or any other legal structure used for business purposes
that either (a) does not have equity investors with voting rights, or (b)
has equity investors that do not provide sufficient financial resources for
the entity to support its activities. We adopted this statement effective
January 1, 2004 and the adoption had no effect.
14. Commitments and Contingencies
-----------------------------
Legal Matters
-------------
Serrao v. Public Storage, Inc. (filed April 2003)
--------------------------------------------------
(Superior Court - Orange County)
--------------------------------
The plaintiff in this case filed a suit against the Company on
behalf of a putative class of renters who rented self-storage units from
the Company. Plaintiff alleges that the Company misrepresented the size of
its storage units, has brought claims under California statutory and common
law relating to consumer protection, fraud, unfair competition, and
negligent misrepresentation, and is seeking monetary damages, restitution,
and declaratory and injunctive relief.
The claim in this case is substantially similar to those in
Henriquez v. Public Storage, Inc., which was disclosed in prior reports. In
January 2003, the plaintiff caused the Henriquez action to be dismissed.
Based upon the uncertainty inherent in any putative class action,
the Company cannot presently determine the potential damages, if any, or
the ultimate outcome of this litigation. On November 3, 2003, the court
granted the Company's motion to strike the plaintiff's nationwide class
allegations and to limit any putative class to California residents only.
The Company is vigorously contesting the claims upon which this lawsuit is
based including class certification efforts.
32
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
Salaam et al v. Public Storage, Inc. (filed February 2000) (Superior Court
---------------------------------------------------------------------------
- Sacramento County); Holzman et al v. Public Storage, Inc. (filed October
---------------------------------------------------------------------------
2004) (Superior Court - Sacramento County)
------------------------------------------
The plaintiffs in the Salaam case are suing the Company on behalf
of a putative class of California resident property managers who claim that
they were not compensated for all the hours they worked. The named
plaintiffs have indicated that their claims total less than $20,000 in
aggregate. On December 1, 2003, the California Court of Appeals affirmed
the Supreme Court's 2002 denial of plaintiff's motion for class
certification. The affirmation of the denial of class certification does
not address the claim under the California Unfair Business Practices Act.
The plaintiffs in the Holzman case, who are represented by the
same attorneys as the Salaam plaintiffs, are seeking substantially the same
claims with additional minor variations in an acknowledged second effort to
proceed as a class, in reliance on a recent California Supreme Court case.
The plaintiffs have not yet identified an aggregate value of their claims
which, on an individual basis, are alleged wage losses of $4,000 or less.
The plaintiffs also assert claims under the California Unfair Business
Practices Act.
The maximum potential liability for both of these cases cannot be
estimated, but can only be increased if claims are permitted to be brought
on behalf of others under the California Unfair Business Practices Act or,
in the Holzman case, if plaintiff prevails on a motion for class
certification.
The Company is continuing to vigorously contest the claims in
these cases and intends to resist any expansion beyond the named
plaintiffs, including by opposing claims on behalf of others under the
California Unfair Business Practices Act or, in the case of the Holzman
case, for class certification. The Company cannot presently determine the
potential damages, if any, or the ultimate outcome of this litigation.
Gustavson et al v. Public Storage, Inc. (filed June 2003) (Superior Court -
---------------------------------------------------------------------------
Los Angeles County)
-------------------
In November 2002, a shareholder of the Company made a demand on
the Board of Directors that challenged the fairness of the Company's
acquisition of PS Insurance Company, Ltd. ("PSIC") and demanded that the
Board recover the profits earned by PSIC from November 1995 through
December 2001 and that the entire purchase price paid by the Company for
PSIC in excess of PSIC's net assets be returned to the Company.
The contract to acquire PSIC was approved by the independent
directors of the Company in March 2001, and the transaction was closed in
December 2001. PSIC was formerly owned by B. Wayne Hughes, currently the
Chairman of the Board (and in 2001 also the Chief Executive Officer) of the
Company, B. Wayne Hughes, Jr., currently a director (and in 2001 also an
officer) of the Company and Tamara H. Gustavson, who in 2001 was an officer
of the Company. In exchange for the Hughes family's shares in PSIC, the
Company issued to them 1,439,765 shares of common stock (or a net of
1,138,733 shares, after taking into account 301,032 shares held by PSIC).
33
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
The shareholder has threatened litigation against the Hughes
family and the directors of the Company arising out of this transaction and
alleged a pattern of deceptive disclosures with respect to PSIC since 1995.
In December 2002, the Board held a special meeting to authorize an inquiry
by its independent directors to review the fairness to the Company's
shareholders of its acquisition of PSIC and the ability of the Company to
have started its own tenant reinsurance business in 1995. The Company
believes that, prior to the effectiveness in 2001 of the federal REIT
Modernization Act and corresponding California legislation that authorized
the creation and ownership of "taxable REIT subsidiaries," the ownership by
the Company of a reinsurance business relating to its tenants would have
jeopardized the Company's status as a REIT and that other REITs faced
similar concerns about tenant insurance programs.
In June 2003, the Hughes family filed a complaint for declaratory
relief relating to the Company's acquisition of PSIC naming the Company as
defendant. The Hughes family is seeking that the court make (i) a binding
declaration that the Company either is not entitled to recover profits or
other moneys earned by PSIC from November 1995 through December 2001; or
alternatively the amounts that the Hughes family should be ordered to
surrender to the Company if the court determines that the Company is
entitled to recover any such profits or moneys; and (ii) a binding
declaration either that the Company cannot establish that the acquisition
agreement was not just and reasonable as to the Company at the time it was
authorized, approved or ratified; or alternatively the amounts that the
Hughes family should surrender to the Company, if the court determines that
the agreement was not just and reasonable to the Company at that time. The
Hughes family is not seeking any payments from the Company. In the event of
a determination that the Hughes family is obligated to pay certain amounts
to the Company, the complaint states that they have agreed to be bound by
that determination to pay such amounts to the Company.
In July 2003 the Company filed an answer to the Hughes family's
complaint requesting a final judicial determination of the Company's rights
of recovery against the Hughes family in respect of PSIC. In September
2003, by order of the Superior Court, Justice Malcolm Lucas, a former chief
justice of the California Supreme Court, was appointed to try the case.
Discovery is proceeding and Justice Lucas has set this matter for trial at
the end of March, 2005. We believe that the lawsuit by the Hughes family
will ultimately resolve matters relating to PSIC and will not have any
financially adverse effect on the Company (other than the costs and other
expenses relating to the lawsuit).
Other Items
-----------
We are a party to various claims, complaints, and other legal
actions that have arisen in the normal course of business from time to time
that are not described above. We believe that it is unlikely that the
outcome of these other pending legal proceedings including employment and
tenant claims, in the aggregate, will have a material adverse impact upon
the operations or financial position of the Company.
INSURANCE AND LOSS EXPOSURE
Our facilities have historically carried comprehensive insurance,
including fire, earthquake, liability and extended coverage through STOR-Re
and PSIC-H, our captive insurance programs, and insure portions of these
risks through nationally recognized insurance carriers. Our captive
insurance programs also insure affiliates of the Company.
The Company, STOR-Re, PSIC-H, and its affiliates' maximum
aggregate annual exposure for losses that are below the deductibles set
forth in the third-party insurance contracts, assuming multiple significant
events occur, is approximately $35 million. In addition, if losses exhaust
the third-party insurers' limit of coverage of $125,000,000 for property
coverage and $101,000,000 for general liability, our exposure could be
greater. These limits are higher than estimates of maximum probable losses
that could occur from individual catastrophic events (i.e. earthquake and
wind damage) determined in recent engineering and actuarial studies.
Our tenant insurance program, operating through PSIC through March
31, 2004 and through PSIC-H beginning April 1, 2004, reinsures policies
against claims for losses to goods stored by tenants at our self-storage
facilities. We reinsure our risks with third-party insurers from any
individual event that exceeds a loss of $500,000, up to the policy limit of
$10,000,000.
34
PUBLIC STORAGE, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2004
(Unaudited)
DEVELOPMENT OF REAL ESTATE FACILITIES
We currently have 37 projects in our development pipeline,
including eight newly developed self-storage facilities and expansions to
29 existing self-storage facilities, with total estimated development costs
of $151,616,000, of which $40,686,000 has been spent through September 30,
2004. Development of these facilities is subject to various risks and
contingencies.
ACQUISITION OF REAL ESTATE FACILITIES
From October 1, 2004 through November 8, 2004, we acquired
additional facilities that were under contract at September 30, 2004, as
described below in Note 15, "Subsequent Events." As of November 5, 2004, we
have contracts to acquire 11 additional existing self-storage facilities at
an aggregate cost of approximately $124.9 million, consisting of $76.0
million in cash and approximately $48.9 million in assumed debt.
15. Subsequent Events
-----------------
From September 30, 2004 through November 5, 2004, we acquired 32
additional self-storage facilities at an aggregate cost of approximately
$121.5 million, comprised of $57.0 million in cash, assumed debt totaling
$39.5 million, and $25 million in the Company's 6.25% Series Z Cumulative
Redeemable Perpetual Preferred Units. The holders of the Series Z units
have a one-time option, exercisable five years from issuance, to require us
to redeem their units for $25 million cash plus unpaid and accrued
distributions.
On October 28, 2004, we sold the commercial facility described in
Note 3 as the "Sold Commercial Facility" for an aggregate of $3.8 million
in cash, at a gain of approximately $1.0 million which will be recognized
in the fourth quarter of 2004.
35
Item 2. Management's Discussion and Analysis of Financial Condition and
- ----------------------------------------------------------------------------
Results of Operations
- ---------------------
The following discussion and analysis should be read in conjunction
with our consolidated financial statements and notes thereto.
FORWARD LOOKING STATEMENTS: When used within this document, the words
"expects," "believes," "anticipates," "should," "estimates," and similar
expressions are intended to identify "forward-looking statements" within the
meaning of that term in Section 27A of the Securities Exchange Act of 1933, as
amended, and in Section 21E of the Securities Exchange Act of 1934, as amended.
Such forward-looking statements involve known and unknown risks, uncertainties,
and other factors, which may cause the actual results and performance of the
Company to be materially different from those expressed or implied in the
forward looking statements. Such factors are described in Item 2A, "Risk
Factors" and include changes in general economic conditions and in the markets
in which the Company operates and the impact of competition from new and
existing storage and commercial facilities and other storage alternatives, which
could impact rents and occupancy levels at the Company's facilities;
difficulties in the Company's ability to evaluate, finance and integrate
acquired and developed properties into the Company's existing operations and to
fill up those properties, which could adversely affect the Company's
profitability; the impact of the regulatory environment as well as national,
state, and local laws and regulations including, without limitation, those
governing Real Estate Investment Trusts, which could increase the Company's
expense and reduce the Company's cash available for distribution; consumers'
failure to accept the containerized storage concept which would reduce the
Company's profitability; difficulties in raising capital at reasonable rates,
which would impede the Company's ability to grow; delays in the development
process, which could adversely affect the Company's profitability; and economic
uncertainty due to the impact of war or terrorism could adversely affect our
business plan. We disclaim any obligation to publicly release the results of any
revisions to these forward-looking statements reflecting new estimates, events
or circumstances after the date of this report.
CRITICAL ACCOUNTING POLICIES
QUALIFICATION AS A REIT - INCOME TAX EXPENSE: We believe that we have
been organized and operated, and we intend to continue to operate, as a
qualifying Real Estate Investment Trust ("REIT") under the Internal Revenue Code
and applicable state laws. A qualifying REIT generally does not pay corporate
level income taxes on its taxable income that is distributed to its
shareholders, and accordingly, we do not pay or record as an expense income tax
on the share of our taxable income that is distributed to shareholders.
Given the complex nature of the REIT qualification requirements, the
ongoing importance of factual determinations and the possibility of future
changes in our circumstances, we cannot provide any assurance that we actually
have satisfied or will satisfy the requirements for taxation as a REIT for any
particular taxable year. For any taxable year that we fail or have failed to
qualify as a REIT and applicable relief provisions did not apply, we would be
taxed at the regular corporate rates on all of our taxable income, whether or
not we made or make any distributions to our shareholders. Any resulting
requirement to pay corporate income tax, including any applicable penalties or
interest, could have a material adverse impact on our financial condition or
results of operations. Unless entitled to relief under specific statutory
provisions, we also would be disqualified from taxation as a REIT for the four
taxable years following the year during which qualification was lost. There can
be no assurance that we would be entitled to any statutory relief.
36
IMPAIRMENT OF LONG-LIVED ASSETS: Substantially all of our assets
consist of long-lived assets, including real estate, assets associated with the
containerized storage business, goodwill, and other intangible assets. We
evaluate our goodwill for impairment on an annual basis, and on a quarterly
basis evaluate other long-lived assets for impairment. As described in Note 2 to
the consolidated financial statements, the evaluation of goodwill for impairment
entails valuation of the reporting unit to which goodwill is allocated, which
involves significant judgment in the area of projecting earnings, determining
appropriate price-earnings multiples, and discount rates. In addition, the
evaluation of other long-lived assets for impairment requires determining
whether indicators of impairment exist, which is a subjective process. When any
indicators of impairment are found, the evaluation of such long-lived assets
then entails projections of future operating cash flows, which also involves
significant judgment. We identified impairment charges as of September 30, 2004
related to i) our plan to close containerized storage facilities - see Note 3 to
the consolidated financial statements and ii) damages sustained as a result of
recent hurricanes in Florida. Future events, or facts and circumstances that
currently exist, that we have not yet identified, could cause us to conclude in
the future that other long lived assets are impaired. Any resulting impairment
loss could have a material adverse impact on our financial condition and results
of operations.
ESTIMATED USEFUL LIVES OF LONG-LIVED ASSETS: Substantially all of our
assets consist of depreciable, long-lived assets. We record depreciation expense
with respect to these assets based upon their estimated useful lives. Any change
in the estimated useful lives of those assets, caused by functional or economic
obsolescence or other factors, could have a material adverse impact on our
financial condition or results of operations.
ESTIMATED LEVEL OF RETAINED RISK AND UNPAID TENANT CLAIM LIABILITIES:
As described in Notes 2 and 14 to the consolidated financial statements, we
retain certain risks with respect to property perils, legal liability, and other
such risks. In addition, a wholly-owned subsidiary of the Company reinsures
policies against claims for losses to goods stored by tenants in our
self-storage facilities. In connection with these risks, we accrue losses based
upon our estimated level of losses incurred using certain actuarial assumptions
followed in the insurance industry and based upon our experience. While we
believe that the amounts of the accrued losses are adequate, the ultimate
liability may be in excess of or less than the amounts provided.
ACCRUALS FOR CONTINGENCIES: We are exposed to business and legal
liability risks with respect to events that have occurred, but in accordance
with accounting principles generally accepted in the United States, we have not
accrued for such potential liabilities because the loss is either not probable
or not estimable or because we are not aware of the event. Future events and the
result of pending litigation could result in such potential losses becoming
probable and estimable, which could have a material adverse impact on our
financial condition or results of operations. Some of these potential losses, of
which we are aware, are described in Note 14 to the consolidated financial
statements.
ACCRUALS FOR OPERATING EXPENSES: We accrue for property tax expense and
other operating expenses based upon estimates and historical trends and current
and anticipated local and state government rules and regulations. If these
estimates and assumptions are incorrect, our expenses could be misstated. Cost
of operations, interest expense, general and administrative expense, as well as
television, yellow page, and other advertising expenditures are expensed as
incurred. Accordingly, the amounts incurred in an interim period may not be
indicative of the amounts to be incurred in a full year.
37
OPERATING RESULTS FOR THE QUARTER ENDED SEPTEMBER 30, 2004:
- -----------------------------------------------------------
Net income for the three months ended September 30, 2004 was
$97,515,000 compared to $89,747,000 for the same period in 2003, representing an
increase of $7,768,000 or 8.7%. This increase is primarily due to improved
operations of our Consistent Group self-storage facilities, improved operations
of our newly developed facilities as their occupancies have continued to
increase, and a decrease in income allocable to minority interests as a result
of our restructuring of $200 million of our Series N preferred partnership
units. These items were partially offset by the impact of lower equity in
earnings from our investment in PS Business Parks ("PSB"), primarily due to
higher depreciation expense associated with the acquisition of significant real
estate assets by PSB during the fourth quarter of 2003 and a gain recorded by
PSB in the quarter ended September 30, 2003. In addition, net income for the
three months ended September 30, 2004 was negatively impacted by the recent
hurricanes experienced in Florida as described below.
Net income allocable to our common shareholders (after allocating net
income to our preferred and equity shareholders) was $48,597,000 or $0.38 per
common share on a diluted basis (based on 128,826,000 weighted average diluted
common equivalent shares) for the three months ended September 30, 2004 compared
to $49,179,000 or $0.39 per common share on a diluted basis (based on
126,802,000 weighted average diluted common equivalent shares) for the same
period in 2003, representing a decrease of 1.2% in the aggregate or 2.6% on a
per share basis. The decrease to net income allocable to common shareholders and
earnings per common diluted share are due to the impact of the factors described
above with respect to net income partially combined with an increase in net
income allocated to our preferred shareholders.
For the three months ended September 30, 2004 and 2003, we allocated
$40,471,000 and $35,193,000 of our net income, respectively, to our preferred
shareholders based on their distributions. For the three months ended September
30, 2004, we recorded an additional allocation of net income to our preferred
shareholders and a corresponding reduction of net income allocation to our
common shareholders of $3,072,000 with respect to our redemption of our Series M
and Series D Preferred Stock, pursuant to Emerging Issues Task Force Topic D-42
("EITF Topic D-42").
Weighted average diluted shares increased from 126,802,000 for the
three months ended September 30, 2003 to 128,826,000 for the three months ended
September 30, 2004 due primarily to the exercise of employee stock options.
OPERATING RESULTS FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2004:
- ---------------------------------------------------------------
Net income for the nine months ended September 30, 2004 was
$258,942,000 compared to $250,683,000 for the same period in 2003, representing
an increase of $8,259,000 or 3.3%. This increase is primarily due to improved
operations of our Consistent Group self-storage facilities, improved operations
of our newly developed facilities as they have continued to increase their
occupancies, and a decrease in income allocable to minority interests as a
result of our restructuring of $200 million of our Series N preferred
partnership units. This increase is partially offset by an increase in the
allocation of income to minority interest of $10,063,000 attributable to the
restructuring of our Series N preferred partnership interests and increased
general and administrative expense attributable primarily to increased
stock-based compensation expense. Net income was also negatively impacted by
decreased equity in earnings from PSB, which is attributable primarily to
increased depreciation expense associated with PSB's acquisition of significant
real estate assets during the fourth quarter of 2003. In addition, net income
for the nine months ended September 30, 2004 was negatively impacted by the
recent hurricanes experienced in Florida as described below.
38
Net income allocable to our regular common shareholders (after
allocating net income to our preferred and equity shareholders), was
$118,728,000 or $0.92 per common share on a diluted basis (based on 128,545,000
weighted average diluted common equivalent shares) for the nine months ended
September 30, 2004 compared to $123,246,000 or $0.98 per common share on a
diluted basis (based on 125,987,000 weighted average diluted common equivalent
shares) for the same period in 2003, representing a decrease of 3.7% in the
aggregate or 6.1% on a per share basis. The decrease to our net income allocable
to common shareholders and earnings per common diluted share are primarily due
to an increase in net income allocated to our preferred shareholders based upon
distributions paid.
For the nine months ended September 30, 2004 and 2003, we allocated
$117,293,000 and $107,914,000 of our net income respectively, to our preferred
shareholders based on their distributions. In addition, for the nine months
ended September 30, 2004 and 2003, we allocated a total of $6,795,000 and
$3,397,000 to our preferred shareholders due the application of EITF Topic D-42
with respect to our redemption of our various series of our preferred stock.
Weighted average diluted shares increased from 125,987,000 for the nine
months ended September 30, 2003 to 128,545,000 for the nine months ended
September 30, 2004 due primarily to the exercise of employee stock options.
EFFECTS OF HURRICANES:
During the third quarter of 2004, several of our facilities, primarily
located in Florida, incurred damage due to Hurricanes Charley, Frances, Ivan and
Jeanne. We estimate that the uninsured property damages sustained total $3.7
million, consisting of $2.9 million of expenditures that will be capitalized and
$800,000 of repairs and maintenance.
Approximately $200,000 of the repairs and maintenance had been
completed and included in cost of operations as of September 30, 2004. We expect
that the remaining $600,000 will be completed and expensed as part of cost of
operations during the fourth quarter of 2004.
During the third quarter of 2004, we eliminated the net carrying value
($1,250,000) of the damaged assets from our balance sheet and included the
charge as a reduction to our net income in the line item "Asset impairment
charge due to casualty loss." These assets will ultimately be replaced by the
abovementioned capital expenditures.
In addition, we incurred $1.5 million in estimated potential losses
from tenant claims against our reinsurance subsidiary (PSIC-H) as a result of
damages from the hurricanes. This subsidiary reinsures policies against claims
for losses to goods stored by tenants in our facilities. This $1.5 million in
losses is reflected on the income statement in "Cost of operations - Tenant
reinsurance."
REAL ESTATE OPERATIONS
SELF-STORAGE OPERATIONS: Our self-storage operations are by far the
largest component of our operations, representing approximately 93% of our total
revenues generated for the nine months ended September 30, 2004. As a result of
acquisitions and development of self-storage facilities, year over year
comparisons as presented on the consolidated statements of income with respect
to our self-storage operations are not meaningful.
To enhance year over year comparisons, the following table summarizes,
and the ensuing discussion describes, the operating results of (i) 1,194
self-storage facilities that are reflected in the financial statements on a
stabilized basis since January 1, 2002 (the "Consistent Group"), (ii) 66
facilities that were acquired since January 1, 2000 ( the "Acquired
Facilities"), (iii) 41 facilities that were owned prior to January 1, 2002 but
were not stabilized due primarily to expansions in their net rentable square
footage (the "Expansion Facilities") and (iv) 82 newly-developed facilities that
were opened after January 1, 2000 (the "Developed Facilities"):
39
Self - storage operations summary: Three Months Ended September 30, Nine Months Ended September 30
- ---------------------------------- ------------------------------------- ------------------------------------
Percentage Percentage
2004 2003 Change 2004 2003 Change
------------ ----------- ------------ ------------ ----------- ----------
(Dollar amounts in thousands)
Revenues (a):
Consistent Group (b)................ $ 184,897 $ 178,301 3.7% $ 541,414 $ 515,553 5.0%
Acquired Facilities (c)............. 12,988 11,933 8.8% 37,365 34,007 9.9%
Expansion Facilities (d)............ 7,268 6,569 10.6% 20,784 18,441 12.7%
Developed Facilities (e)............ 14,755 10,053 46.8% 39,462 25,344 55.7%
------------ ----------- ------------ ------------ ----------- ----------
Total rental income............... 219,908 206,856 6.3% 639,025 593,345 7.7%
------------ ----------- ------------ ------------ ----------- ----------
Cost of operations:
Consistent Group.................... 61,143 60,221 1.5% 186,101 174,870 6.4%
Acquired Facilities................. 4,392 3,985 10.2% 12,783 11,952 7.0%
Expansion Facilities................ 2,534 2,447 3.6% 7,619 7,181 6.1%
Developed Facilities................ 6,006 4,324 38.9% 17,616 12,652 39.2%
------------ ----------- ------------ ------------ ----------- ----------
Total cost of operations............ 74,075 70,977 4.4% 224,119 206,655 8.5%
------------ ----------- ------------ ------------ ----------- ----------
Net operating income (before depreciation):
Consistent Group.................... 123,754 118,080 4.8% 355,313 340,683 4.3%
Acquired Facilities................. 8,596 7,948 8.2% 24,582 22,055 11.5%
Expansion Facilities................ 4,734 4,122 14.8% 13,165 11,260 16.9%
Developed Facilities................ 8,749 5,729 52.7% 21,846 12,692 72.1%
------------ ----------- ------------ ------------ ----------- ----------
Total net operating income.......... 145,833 135,879 7.3% 414,906 386,690 7.3%
Depreciation and amortization......... (42,839) (43,613) (1.8)% (130,643) (130,332) 0.2%
------------ ----------- ------------ ------------ ----------- ----------
Operating Income.................... $ 102,994 $ 92,266 11.6% $ 284,263 $ 256,358 10.9%
============ =========== ============ ============ =========== ===========
Number of self-storage facilities (at end
of period):............................. 1,383 1,370 0.9% 1,383 1,370 0.9%
Net rentable square feet (at end of period
- - in thousands):........................ 83,842 82,716 1.4% 83,842 82,716 1.4%
(a) Revenue includes late charges and administrative fees and is net of
promotional discounts given. Rental income does not include retail sales,
truck rental income or tenant insurance revenues generated at the
facilities.
(b) The Consistent Group includes 1,194 facilities containing 69,402,000 net
rentable square feet that have been owned prior to January 1, 2002, and
operated at a mature, stabilized occupancy level since January 1, 2002.
(c) The Acquired Facilities includes 66 facilities containing 4,114,000 net
rentable square feet that were acquired after January 1, 2000, that were
substantially all mature, stabilized facilities at the time of their
acquisition.
(d) The Expansion Facilities includes 41 facilities containing 4,126,000 net
rentable square feet (of which 690,000 square feet is industrial space
developed for containerized storage activities). These facilities were
owned since January 1, 2002, however, operating results are not comparable
throughout the periods presented due primarily to expansions in their net
rentable square feet or their conversion into Combination Facilities
(described below). Since January 1, 2000, we completed construction on
expansion projects to these facilities with a total cost of $80.5 million.
(e) The Developed Facilities includes 82 facilities containing 6,200,000 net
rentable square feet (of which 497,000 square feet is industrial space
initially developed for use in containerized storage activities, see
"Containerized Storage" and "Discontinued Operations"). These facilities
were developed and opened since January 1, 2000 at a total cost of $579.4
million.
Self-Storage Operations - Consistent Group
We increased the number of facilities included in the Consistent Group
of facilities from 1,164 at December 31, 2003 to 1,194 facilities. The increase
in the Consistent Group's pool of facilities is due to the inclusion of 30
facilities. These facilities were previously Acquired Facilities, Developed
Facilities, or the Expansion Facilities that had reached stabilization and had
been owned at January 1, 2002.
40
As a result of the change in the Consistent Group, the relative
weighting of markets has changed. Accordingly, comparisons should not be made
between information presented in 2003 for the Consistent Group pool of 1,164
facilities and the current Consistent Group pool of 1,194 facilities in order to
identify trends in occupancies, realized rents per square foot, or operating
results.
The Consistent Group consists of facilities that have operated at a
stabilized level of operations since January 1, 2002. This group of facilities
contains approximately 69,402,000 net rentable square feet, representing
approximately 83% of the aggregate net rentable square feet of our self-storage
portfolio. Revenues and operating expenses with respect to this group of
properties are set forth in the above Self-Storage Operations table under the
caption, "Consistent Group." The following table sets forth additional operating
data with respect to the Consistent Group of facilities:
CONSISTENT GROUP Three Months Ended September 30,
---------------- --------------------------------------
Percentage
2004 2003 Change
------------ ------------ ----------
(Dollar amounts in thousands except weighted average amounts)
Revenues:
Rental income, net of discounts................ $ 177,070 $ 170,882 3.6%
Late charges and administrative fees collected. 7,827 7,419 5.5%
------------ ------------ ----------
Total revenues................................. 184,897 178,301 3.7%
Cost of operations:
Property taxes................................. 16,892 16,162 4.5%
Direct property payroll........................ 13,824 13,539 2.1%
Cost of managing facilities.................... 5,596 5,422 3.2%
Advertising and promotion...................... 4,126 5,884 (29.9)%
Utilities...................................... 4,728 4,249 11.3%
Repairs and maintenance........................ 5,202 4,596 13.2%
Telephone reservation center................... 2,609 2,655 (1.7)%
Property insurance............................. 1,892 2,103 (10.0)%
Other.......................................... 6,274 5,611 11.8%
------------ ------------ ----------
Total cost of operations....................... 61,143 60,221 1.5%
------------ ------------ ----------
Net operating income before depreciation......... 123,754 118,080 4.8%
Depreciation..................................... (33,470) (35,889) (6.7)%
------------ ------------ ----------
Operating income................................. $ 90,284 $ 82,191 9.8%
============ ============ ==========
Gross margin (before depreciation)............... 66.9% 66.2% 1.1%
Weighted average for the period:
Square foot occupancy (a)..................... 91.8% 91.9% (0.1)%
Realized annual rent per occupied square foot
(b)......................................... $ 11.12 $ 10.72 3.7%
REVPAF (c).................................... $ 10.21 $ 9.85 3.7%
CONSISTENT GROUP Nine Months Ended September 30,
---------------- ------------------------------------------
Percentage
2004 2003 Change
------------ ------------ -----------
(Dollar amounts in thousands except weighted average amounts)
Revenues:
Rental income, net of discounts................ $ 518,116 $ 494,615 4.8%
Late charges and administrative fees collected. 23,298 20,938 11.3%
------------ ------------ -----------
Total revenues................................. 541,414 515,553 5.0%
Cost of operations:
Property taxes................................. 50,215 47,959 4.7%
Direct property payroll........................ 41,585 40,412 2.9%
Cost of managing facilities.................... 17,069 15,688 8.8%
Advertising and promotion...................... 14,544 15,473 (6.0)%
Utilities...................................... 13,307 12,155 9.5%
Repairs and maintenance........................ 15,724 13,002 20.9%
Telephone reservation center................... 7,905 7,408 6.7%
Property insurance............................. 6,391 6,053 5.6%
Other.......................................... 19,361 16,720 15.8%
------------ ------------ -----------
Total cost of operations....................... 186,101 174,870 6.4%
------------ ------------ -----------
Net operating income before depreciation......... 355,313 340,683 4.3%
Depreciation..................................... (104,450) (107,837) (3.1)%
------------ ------------ -----------
Operating income................................. $ 250,863 $ 232,846 7.7%
============ ============ ===========
Gross margin (before depreciation)............... 65.6% 66.1% (0.8)%
Weighted average for the period:
Square foot occupancy (a)..................... 90.9% 88.7% 2.5%
Realized annual rent per occupied square foot (b) $ 10.95 $ 10.71 2.2%
REVPAF (c).................................... $ 9.95 $ 9.50 4.7%
Weighted average at September 30:
Square foot occupancy......................... 91.9% 92.0% (0.1)%
In place annual rent per occupied square foot
(d)........................................ $ 12.35 $ 11.60 6.4%
Total net rentable square feet (in thousands).... 69,402 69,402 -
(a) Square foot occupancies represent weighted average occupancy levels over
the entire period.
(b) Realized annual rent per occupied square foot is computed by annualizing
the result of dividing annualized rental income, net of discounts by the
weighted average occupied square footage for the period. Realized rents per
square foot take into consideration promotional discounts, bad debt costs,
credit card fees and other costs which reduce rental income from the
contractual amounts due.
(c) Annualized revenue per available square foot ("REVPAF") represents
annualized rental income, net of discounts divided by total available net
rentable square feet.
(d) In place annual rent per occupied square foot represents contractual rents
per occupied square foot without reductions for promotional discounts.
41
During the third quarter of 2004, net operating income before depreciation for
the Consistent Group of facilities increased 4.8% as compared to the same period
in 2003, due to the following:
o REVPAF increased 3.7% from $9.85 per square foot in the third quarter
of 2003 to $10.21 in the third quarter of 2004. This was attributable
primarily to a 3.7% increase in realized annual rent per occupied
square foot from $10.72 for the three months ended September 30, 2003
to $11.12 for the same period in 2004, partially offset by a 0.1%
decline in average occupancy.
o The impact of the increase in REVPAF was partially offset by a 1.5%
increase in operating expenses from $60.2 million in the third quarter
of 2003 to $61.1 million in the third quarter of 2004. This increase in
cost of operations is primarily due to 1) increased repairs and
maintenance expense due to our desire to continue to address
maintenance at our facilities and improve their "rent ready" condition,
2) increases in property taxes and 3) increases in cost of managing
facilities. These impacts were offset partially by a decrease in
advertising and promotional expense, which was due primarily to a
$1,274,000 (40.2%) decrease in television advertising as we have
reduced both the volume and number of markets for our media programs in
the third quarter of 2004 as compared to the same period in 2003.
Operating income for the Consistent Group of facilities increased 9.8% for the
three months ended September 30, 2004 as compared to the same period in 2003,
due to the factors noted above with respect to net operating income before
depreciation, as well as a reduction in depreciation expense with respect to
capital expenditures due to increases in capital expenditures becoming fully
depreciated relative to new capital expenditures coming on-line.
During the nine months ended September 30, 2004, net operating income before
depreciation for the Consistent Group of facilities increased 4.3% as compared
to the same period in 2003, due to the following:
o REVPAF increased 4.7% from $9.50 per square foot in the nine months
ended September 30, 2003 to $9.95 in the nine months ended September
30, 2004. This was attributable primarily to a 2.5% increase in
weighted average occupancy levels, combined with a 2.2% increase in
realized annual rent per occupied square foot from $10.71 for the nine
months ended September 30, 2003 to $10.95 for the same period in 2004.
o The impact of the increase in REVPAF was offset by a 6.4% increase in
operating expenses from $174.9 million in the first nine months of 2003
to $186.1 million in the same period in 2004. This increase is
primarily due to 1) higher repairs and maintenance as we continue to
address maintenance at our facilities and improve their "rent ready"
condition and 2) an increase in direct property payroll and cost of
management attributable to higher wage rates and increased incentives
to property personnel. These impacts were offset partially by a
decrease in advertising and promotional expense, which was due
primarily to a $732,000 (9.7%) decrease in media advertising as we have
reduced both the volume and number of markets for our media programs
during the second and third quarters of 2004 as compared to the same
periods in 2003.
Operating income for the Consistent Group of facilities increased 7.7% for the
three months ended September 30, 2004 as compared to the same period in 2003,
due to the factors noted above with respect to net operating income before
depreciation, as well as a reduction in depreciation expense with respect to
capital expenditures due to increases in capital expenditures becoming fully
depreciated relative to new capital expenditures coming on-line.
REVENUE OUTLOOK
As previously reported, we suffered operating difficulties in our
self-storage portfolio in 2001, 2002, and 2003. Our occupancy levels dropped
below historical levels in late 2001 and 2002 due to a change in marketing
strategy to aggressively increase rental rates and reduce the amount of
promotional discounts offered to new tenants.
42
Throughout late 2002 and 2003, we focused upon regaining occupancy
levels through increased advertising and promotional discounting. By the end of
2003, we had attained our goal of reestablishing our occupancy levels to
historical levels. This improvement in occupancy levels enabled us to begin to
increase rates that we charge to new tenants. More importantly, throughout 2003
and in the first nine months of 2004 we experienced positive year-over-year
trends in the growth of our quarterly REVPAF, resulting in continued growth in
rental income.
Our current occupancy levels have been achieved in large part by the
elevated move-in activity experienced in 2003 and into the first quarter of
2004. It is our experience that following a period of fill-up, the tenant base
tends to have a higher level of move-outs relative to the existing tenant base.
Our portfolio experienced an elevated level of move-outs in 2003 and into the
second quarter of 2004. During the second and third quarters of 2004, the level
of move-out activity declined as compared to the same periods in 2003. This
decline, in part, enabled us to reduce the level of media advertising while
still maintaining occupancies relatively consistent with the comparable periods
in 2003. We will continue to be vigilant in maintaining our occupancy levels by
monitoring our level of move-outs, and sustaining a sufficient level of move-ins
through our pricing and marketing activities.
We believe that future growth in rental income will be primarily from
increases in average rental rates, rather than increases in occupancy levels,
and that we will utilize our pricing and promotional strategies to meet this
goal. We continue to regularly evaluate our call volume, reservation activity,
and move-in/move-out rates for each of our markets relative to our marketing
activities and rental rates. In addition, we are evaluating market supply and
demand factors and, based upon these analyses, we are continuing to adjust our
marketing activities in specific markets.
There can be no assurance that we will achieve our goal of increases in
average rental rates, while sustaining our occupancy levels.
EXPENSE OUTLOOK
Our increases in operating expenses in the three and nine months ended
September 30, 2004 as compared to the same periods in 2003 are primarily
attributable to programs which we began to initiate in the second and third
quarters of 2003. Repairs and maintenance costs increased due to our desire to
continue to address maintenance at our facilities and improve their "rent ready"
condition. Payroll and property management costs also increased due to our
concerted effort to increase staffing levels and incentive programs.
Advertising and promotion costs increased in the first quarter of 2004
as compared to the same period of 2003; however, they were lower in the second
and third quarters of 2004 as compared to the same periods in 2003. The increase
in the first quarter of 2004 as compared to the same period in 2003 was due to
higher television advertising costs associated with our continued efforts to
increase occupancy levels. In the second and third quarters of 2004, we had
reached a high level of occupancies and we reduced the intensity of our
television advertising program. As a result of lower television advertising,
advertising and promotional expenses decreased in the three months ended
September 30, 2004 as compared to the same period in 2003. We expect the level
of advertising and promotion costs in the fourth quarter of 2004 to be higher
than the fourth quarter of 2003. There can be no assurance of additional move-in
activity as a result of our media programs.
We expect that property taxes will increase approximately 4% to 5% in
the fourth quarter of 2004 as compared to 2003.
We expect that the year over year rate of growth in our operating
expenses will be lower than the level of expense increases incurred in the
nine-month period ending September 30, 2004, but higher than that experienced in
the quarter ended September 30, 2004.
43
The following table summarizes selected financial data with respect to the
Consistent Group of facilities:
Three Months Ended
----------------------------------------------------------------------
March 31, June 30, September 30, December 31, Full Year
------------- ------------- --------------- ------------ -------------
(Amounts in thousands, except for per square foot amounts)
Total rental income:
2004............ $ 175,923 $ 180,594 $ 184,897
2003............ $ 165,821 $ 171,431 $ 178,301 $ 176,184 $ 691,737
Total cost of operations:
2004............ $ 63,022 $ 61,936 $ 61,143
2003............ $ 55,379 $ 59,270 $ 60,221 $ 63,000 $ 237,870
Media advertising expense:
2004............ $ 3,098 $ 1,842 $ 1,892
2003............ $ 1,580 $ 2,818 $ 3,166 $ 1,098 $ 8,662
REVPAF:
2004............ $ 9.69 $ 9.96 $ 10.21
2003............ $ 9.18 $ 9.48 $ 9.85 $ 9.75 $ 9.57
Weighted average realized
annual rent per occupied
square foot for the period:
2004............ $ 10.83 $ 10.90 $ 11.12
2003............ $ 10.81 $ 10.63 $ 10.72 $ 10.75 $ 10.72
Weighted average occupancy levels for the period:
2004............ 89.5% 91.4% 91.8%
2003............ 84.9% 89.2% 91.9% 90.7% 89.2%
Weighted average occupancy at October 31:
2004............ 91.4%
2003............ 91.7%
Television advertising expense in October:
2004............ $ -
2003............ $ 604
44
ANALYSIS OF REGIONAL TRENDS
The following table sets forth regional trends in our Consistent Group
of facilities:
Consistent Group Operating Trends by Region:
Three months ended September 30, Nine months ended September 30,
Percentage Percentage
2004 2003 Change 2004 2003 Change
------------ ----------- ---------- ------------ ----------- -----------
(Dollar amounts in thousands)
Rental income:
Southern California (124 facilities).. $ 31,224 $ 29,886 4.5% $ 91,296 $ 86,905 5.1%
Northern California (124 facilities).. 23,368 22,820 2.4% 68,884 66,886 3.0%
Texas (143 facilities)................ 16,890 16,516 2.3% 49,919 47,762 4.5%
Florida (116 facilities).............. 16,734 15,885 5.3% 48,759 45,757 6.6%
Illinois (79 facilities).............. 13,126 12,740 3.0% 38,179 36,811 3.7%
Georgia (60 facilities)............... 6,719 6,577 2.2% 19,759 18,925 4.4%
All other states (548 facilities)..... 76,836 73,877 4.0% 224,618 212,507 5.7%
------------ ----------- ---------- ------------ ----------- -----------
Total rental income....................... 184,897 178,301 3.7% 541,414 515,553 5.0%
------------ ----------- ---------- ------------ ----------- -----------
Cost of operations:
Southern California.................... 6,868 6,701 2.5% 21,194 20,505 3.4%
Northern California.................... 5,672 5,844 (2.9)% 17,578 17,367 1.2%
Texas.................................. 7,453 7,734 (3.6)% 22,404 21,529 4.1%
Florida................................ 6,627 6,289 5.4% 19,529 17,894 9.1%
Illinois............................... 5,205 5,162 0.8% 17,129 15,858 8.0%
Georgia................................ 2,515 2,319 8.5% 7,224 6,856 5.4%
All other states....................... 26,803 26,172 2.4% 81,043 74,861 8.3%
------------ ----------- ---------- ------------ ----------- -----------
Total cost of operations.................. 61,143 60,221 1.5% 186,101 174,870 6.4%
------------ ----------- ---------- ------------ ----------- -----------
Net operating income (before depreciation):
Southern California.................... 24,356 23,185 5.1% 70,102 66,400 5.6%
Northern California.................... 17,696 16,976 4.2% 51,306 49,519 3.6%
Texas.................................. 9,437 8,782 7.5% 27,515 26,233 4.9%
Florida................................ 10,107 9,596 5.3% 29,230 27,863 4.9%
Illinois............................... 7,921 7,578 4.5% 21,050 20,953 0.5%
Georgia................................ 4,204 4,258 (1.3)% 12,535 12,069 3.9%
All other states....................... 50,033 47,705 4.9% 143,575 137,646 4.3%
------------ ----------- ---------- ------------ ----------- -----------
Total net operating income................ $ 123,754 $ 118,080 4.8% $ 355,313 $ 340,683 4.3%
------------ ----------- ---------- ------------ ----------- -----------
Weighted average occupancy:
Southern California.................... 93.0% 92.0% 1.1% 91.7% 90.5% 1.3%
Northern California.................... 90.0% 90.4% (0.4)% 89.4% 88.4% 1.1%
Texas.................................. 90.5% 92.3% (2.0)% 90.0% 88.6% 1.6%
Florida................................ 93.4% 92.6% 0.9% 92.0% 90.1% 2.1%
Illinois............................... 91.9% 91.9% 0.0% 90.2% 87.4% 3.2%
Georgia................................ 92.0% 92.7% (0.8)% 91.0% 89.6% 1.6%
All other states....................... 91.8% 91.9% (0.1)% 91.1% 88.1% 3.4%
------------ ----------- ---------- ------------ ----------- -----------
Total weighted average occupancy......... 91.8% 91.9% (0.1)% 90.9% 88.7% 2.5%
------------ ----------- ---------- ------------ ----------- -----------
45
Consistent Group Operating Trends by Region: (Continued)
Three Months Ended September 30, Nine Months Ended September 30,
Percentage Percentage
2004 2003 Change 2004 2003 Change
----------- --------- ---------- --------- -------- ----------
REVPAF:
Southern California................... $15.41 $14.78 4.3% $15.01 $14.33 4.8%
Northern California................... 13.46 13.20 2.0% 13.23 12.89 2.6%
Texas................................. 7.23 7.08 2.1% 7.12 6.82 4.4%
Florida............................... 9.72 9.18 5.9% 9.41 8.80 6.9%
Illinois.............................. 10.45 10.16 2.9% 10.14 9.81 3.3%
Georgia............................... 7.34 7.18 2.2% 7.19 6.89 4.3%
All other states...................... 9.43 9.07 4.0% 9.18 8.71 5.3%
----------- --------- ---------- --------- -------- ----------
Total REVPAF:............................ $10.21 $9.85 3.7% $9.95 $9.50 4.7%
----------- --------- ---------- --------- -------- ----------
Realized annual rent per occupied square foot:
Southern California................... $16.57 $16.06 3.2% $16.37 $15.83 3.4%
Northern California................... 14.95 14.60 2.4% 14.80 14.58 1.5%
Texas................................. 7.99 7.67 4.2% 7.92 7.70 2.8%
Florida............................... 10.40 9.91 5.0% 10.22 9.77 4.7%
Illinois.............................. 11.37 11.05 2.9% 11.24 11.23 0.1%
Georgia............................... 7.98 7.75 3.0% 7.90 7.69 2.7%
All other states...................... 10.27 9.87 4.1% 10.08 9.89 1.9%
----------- --------- ---------- --------- -------- ----------
Total realized annual rent per occupied
square foot:........................... $11.12 $10.72 3.7% $10.95 $10.71 2.2%
----------- --------- ---------- --------- -------- ----------
46
Self-Storage Operations - Acquired Facilities
The "Acquired Facilities," at September 30, 2004, are comprised of 66
self-storage facilities containing 4,114,000 net rentable square feet that were
acquired in 2000, 2001, 2002, and 2004. The following table summarizes operating
data with respect to these 66 facilities:
ACQUIRED FACILITIES
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------ ------------------------------------
2004 2003 Change 2004 2003 Change
------------ ------------ --------- ----------- ----------- ----------
(Dollar amounts in thousands)
Rental income:
Self-storage facilities acquired in 2004 (a) $ 95 $ - $ 95 $ 95 $ - $ 95
Self-storage facilities acquired in 2002 (b) 11,393 10,540 853 32,935 30,169 2,766
Self-storage facility acquired in 2001 (c).. 153 149 4 435 418 17
Self-storage facilities acquired in 2000 (d) 1,347 1,244 103 3,900 3,420 480
------------ ------------ --------- ----------- ----------- ----------
Total rental income....................... 12,988 11,933 1,055 37,365 34,007 3,358
------------ ------------ --------- ----------- ----------- ----------
Cost of operations:
Self-storage facilities acquired in 2004 (a) 103 - 103 103 - 103
Self-storage facilities acquired in 2002 (b) 3,665 3,326 339 10,831 10,161 670
Self-storage facility acquired in 2001 (c).. 55 47 8 172 130 42
Self-storage facilities acquired in 2000 (d) 569 612 (43) 1,677 1,661 16
------------ ------------ --------- ----------- ----------- ----------
Total cost of operations.................. 4,392 3,985 407 12,783 11,952 831
------------ ------------ --------- ----------- ----------- ----------
Net operating income (loss) before depreciation:
- -----------------------------------------------
Self-storage facilities acquired in 2004 (a) (8) - (8) (8) - (8)
Self-storage facilities acquired in 2002 (b) 7,728 7,214 514 22,104 20,008 2,096
Self-storage facility acquired in 2001 (c).. 98 102 (4) 263 288 (25)
Self-storage facilities acquired in 2000 (d) 778 632 146 2,223 1,759 464
------------ ------------ --------- ----------- ----------- ----------
Net operating income...................... 8,596 7,948 648 24,582 22,055 2,527
Depreciation.................................. (2,926) (2,640) (286) (7,720) (7,441) (279)
------------ ------------ --------- ----------- ----------- ----------
Operating Income............................ $ 5,670 $ 5,308 $ 362 $ 16,862 $ 14,614 $ 2,248
============ ============ ======== =========== =========== ==========
Weighted average square foot occupancy during the
period:
Self-storage facilities acquired in 2004 (a) 64.4% - - 64.4% - -
Self-storage facilities acquired in 2002 (b) 93.2% 93.0% 0.2% 92.8% 89.2% 4.0%
Self-storage facility acquired in 2001 (c).. 95.3% 96.7% (1.4)% 94.2% 91.4% 3.0%
Self-storage facilities acquired in 2000 (d) 92.6% 91.3% 1.4% 91.7% 82.6% 11.0%
------------ ------------ --------- ----------- ----------- ----------
92.2% 92.8% (0.6)% 91.8% 88.4% 3.8%
============ ============ ======== =========== =========== ==========
Number of self-storage facilities (at end of
period)........................................ 66 64 2 66 64 2
Net rentable square feet (in thousands, at end of
period)..................................... 4,114 3,975 139 4,114 3,975 139
Cumulative acquisition cost (at end of period). $ 353,449 $ 345,156 $ 8,293 $ 353,449 $ 345,156 $ 8,293
(a) The 2004 acquisitions include one property acquired on July 8, 2004 at an
aggregate cost of $2,914,000 in cash, and an additional facility acquired
on July 15, 2004 for an aggregate cost of $5,379,000 in cash. The facility
acquired on July 15, 2004 was opened by the previous owner in May of 2004.
This facility had an occupancy of 34.3% at September 30, 2004 and is still
in the fill-up stage.
(b) The 2002 acquisitions includes 47 properties acquired on January 16, 2002
from an affiliated development joint venture at a total cost of
$269,898,000 and nine facilities acquired from third parties at a total
cost of $30,117,000.
(c) The single 2001 acquisition was acquired from a third party at a cost of
$3,503,000.
(d) The 2000 acquisitions are comprised of seven facilities acquired from third
parties at a total cost of $41,638,000.
47
Historically, we have not acquired a significant number of properties
through third-party acquisitions; we had acquired only 17 such facilities in the
three years ended December 31, 2003. However, during October, 2004, we acquired
32 facilities at an aggregate cost of $121.5 million in two separate
transactions. No additional facilities were acquired from October 31, 2004
through November 8, 2004. In addition, we have contracts to acquire 11
additional existing self-storage facilities at an aggregate cost of
approximately $124.9 million, comprised of a combination of cash and assumption
of debt, as described under "Acquisition and Development of Real Estate
Facilities" under "Liquidity and Capital Resources" for further information.
In one of these October transactions, we acquired 26 facilities at an
aggregate cost of approximately $101 million. We expect the first-year
pre-depreciation net operating income yield on cost to be a relatively modest
6%. However, we believe that this acquisition will allow us to increase our
presence in the Minneapolis and Milwaukee markets, and will allow us to
cost-effectively introduce media advertising in these markets, significantly
improve our yellow page ad placement, and drive operational efficiency. In
addition, the average rental rates and average occupancies of these properties
are lower than comparable properties that we currently own in these markets. As
a result of these factors, we expect the pre-depreciation net operating yield on
cost to increase to approximately 9% in three years.
In the other October transaction, we acquired an additional six
facilities in the Dallas market for an aggregate of approximately $20 million in
cash. We expect the first-year pre-depreciation net operating income yield on
cost to approximate 8%, and believe that this acquisition will improve the
operational efficiency of our existing portfolio.
While there can be no assurance as to the level of acquisition
activities, we expect that future acquisitions will either offer attractive
first-year returns, or provide future avenues for growth in our existing
operations, or both.
For reasons similar to our Consistent Group of facilities, the Acquired
Facilities have experienced improvements in revenues, and increased costs of
operations, for the third quarter of 2004 as compared to the same period in
2003.
Self-Storage Operations - Expansion Facilities
As a result of expansions and conversions of certain Combined
Facilities (defined below), certain self-storage facilities' operations have not
been at a stabilized level of operations since January 1, 2002. For the quarter
ended September 30, 2004, the weighted average occupancy level was approximately
86.7% as compared to 82.1% for the same period in 2003. The operating results
for these facilities are presented in the Self-Storage Operations table above
under the caption, "Expansion Facilities."
Depreciation expense with respect to the Expansion Facilities was
$2,204,000 and $6,102,000 for the three and nine months ended September 30,
2004, respectively, as compared to $1,760,000 and $5,499,000, respectively, for
the same periods in 2003. These 41 facilities contain approximately 4,126,000
net rentable square feet at September 30, 2004 (which includes the expanded
space, and 690,000 square feet of industrial space developed for containerized
storage activities - see "Containerized Storage" and "Discontinued Operations").
Since January 1, 2000, we completed construction on expansion projects to these
facilities with a total cost of $80.5 million.
As described under "Liquidity and Capital Resources," our development
pipeline includes the expansion or enhancement of 29 existing self-storage
facilities for an aggregate of $75,851,000 in development costs, which will
result in short-term dilution to earnings from these activities. However, we
believe that expansion of our existing self-storage facilities in markets that
have unmet storage demand, and improving our existing facilities' competitive
position through enhancing their visual and structural appeal, provide an
important means to improve the Company's earnings. There can be no assurance
about the future level of such expansion and enhancement opportunities.
Self-Storage Operations - Developed Facilities
Since January 1, 2000, we have opened 65 newly developed self-storage
facilities and 17 facilities that were developed to contain both self-storage
and containerized storage at the same location ("Combination Facilities"). These
newly developed facilities have an aggregate of 6,200,000 net rentable square
feet (of which 497,000 net rentable square feet is industrial space developed
for containerized storage activities - see "Containerized Storage" and
"Discontinued Operations"). Aggregate development cost for these 82 facilities
was approximately $579,405,000. The operating results of the self-storage
facilities and Combination Facilities are reflected in the Self-Storage
Operations table under the caption, "Developed Facilities."
48
The following table sets forth the operating results and selected
operating data with respect to the Developed Facilities:
DEVELOPED FACILITIES
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------- -----------------------------------
2004 2003 Change 2004 2003 Change
----------- ---------- ---------- ----------- ----------- ----------
(Amounts in thousands)
Rental income:
Self-storage facilities............ $ 10,985 $ 7,112 $ 3,873 $ 29,090 $ 17,772 $ 11,318
Combination Facilities............. 3,770 2,941 829 10,372 7,572 2,800
----------- ---------- ---------- ----------- ----------- ----------
Total rental income.............. 14,755 10,053 4,702 39,462 25,344 14,118
----------- ---------- ---------- ----------- ----------- ----------
Cost of operations:
Self-storage facilities............ 4,560 3,301 1,259 13,456 9,057 4,399
Combination Facilities............. 1,446 1,023 423 4,160 3,595 565
----------- ---------- ---------- ----------- ----------- ----------
Total cost of operations......... 6,006 4,324 1,682 17,616 12,652 4,964
----------- ---------- ---------- ----------- ----------- ----------
Net operating income before depreciation:
- ----------------------------------------
Self-storage facilities............ 6,425 3,811 2,614 15,634 8,715 6,919
Combination Facilities............. 2,324 1,918 406 6,212 3,977 2,235
----------- ---------- ---------- ----------- ----------- ----------
Net operating income............. 8,749 5,729 3,020 21,846 12,692 9,154
Depreciation......................... (4,239) (3,324) (915) (12,371) (9,555) (2,816)
----------- ---------- ---------- ----------- ----------- ----------
Operating income................... $ 4,510 $ 2,405 $ 2,105 $ 9,475 $ 3,137 $ 6,338
=========== ========== ========== =========== =========== ==========
Weighted average square foot occupancies
for the period:
Self-storage facilities............ 83.8% 75.5% 11.0% 79.0% 62.9% 25.6%
Combination Facilities............. 87.4% 86.7% 0.8% 84.0% 75.4% 11.4%
----------- ---------- ---------- ----------- ----------- ----------
Total............................ 84.9% 79.8% 6.4% 80.5% 67.4% 19.4%
=========== ========== ========== =========== =========== ==========
Self-storage facilities, at end of
period:
Number of facilities............... 65 52 13
Net rentable square feet........... 4,320 3,435 885
Total development cost............. $ 415,580 $308,933 $106,647
Combination Facilities, at end of period:
Number of facilities............... 17 17 -
Net rentable square feet (a) (b)... 1,880 1,861 19
Total development cost (a) (b)..... $ 163,825 $155,586 $ 8,239
(a) During 2003, we completed the conversion of 166,000 net rentable square
feet of containerized storage space into 166,000 net rentable square feet
of self-storage space at an aggregate cost of $4,500,000. During the nine
months ended September 30, 2004, we completed the conversion of 144,000
net rentable square feet of containerized storage space into 172,000 net
rentable square feet of self-storage space at an aggregate cost of
$5,038,000.
(b) Approximately 497,000 net rentable square feet of this storage space
represents industrial space that was developed for use in containerized
storage activities.
49
The following table summarizes operating data for the 65 newly
developed self-storage facilities that opened since January 1, 2000:
DEVELOPED SELF-STORAGE FACILITIES
Three Months Ended September 30, Nine Months Ended September 30,
2004 2003 Change 2004 2003 Change
------------ ------------ ----------- ------------ ------------ ------------
(Dollar Amounts in thousands)
Rental income:
Self-storage facilities opened in 2004...... $ 399 $ - $ 399 $ 546 $ - $ 546
Self-storage facilities opened in 2003...... 2,520 533 1,987 5,906 726 5,180
Self-storage facilities opened in 2002...... 2,754 1,960 794 7,502 4,611 2,891
Self-storage facilities opened in 2000 and 2001 5,312 4,619 693 15,136 12,435 2,701
------------ ------------ ----------- ------------ ------------ ------------
Total rental income....................... 10,985 7,112 3,873 29,090 17,772 11,318
------------ ------------ ----------- ------------ ------------ ------------
Cost of operations:
Self-storage facilities opened in 2004...... 389 - 389 792 - 792
Self-storage facilities opened in 2003...... 1,171 364 807 3,301 674 2,627
Self-storage facilities opened in 2002...... 985 966 19 3,132 2,642 490
Self-storage facilities opened in 2000 and 2001 2,015 1,971 44 6,231 5,741 490
------------ ------------ ----------- ------------ ------------ ------------
Total cost of operations.................. 4,560 3,301 1,259 13,456 9,057 4,399
------------ ------------ ----------- ------------ ------------ ------------
Net operating income (loss) before depreciation:
Self-storage facilities opened in 2004...... 10 - 10 (246) - (246)
Self-storage facilities opened in 2003...... 1,349 169 1,180 2,605 52 2,553
Self-storage facilities opened in 2002...... 1,769 994 775 4,370 1,969 2,401
Self-storage facilities opened in 2000 and 2001 3,297 2,648 649 8,905 6,694 2,211
------------ ------------ ----------- ------------ ------------ ------------
Net operating income........................ 6,425 3,811 2,614 15,634 8,715 6,919
Depreciation.................................. (3,008) (2,196) (812) (8,693) (6,187) (2,506)
------------ ------------ ----------- ------------ ------------ ------------
Operating income............................ $ 3,417 $ 1,615 $ 1,802 $ 6,941 $ 2,528 $ 4,413
============ ============ =========== ============ ============ ============
Weighted average square foot occupancy during the
period:
Self-storage facilities opened in 2004...... 42.8% - - 33.1% - -
Self-storage facilities opened in 2003...... 78.5% 44.9% 74.8% 66.1% 31.1% 112.5%
Self-storage facilities opened in 2002...... 91.5% 72.6% 26.0% 88.4% 55.7% 56.7%
Self-storage facilities opened in 2000 and 2001 93.8% 89.8% 4.5% 93.6% 79.5% 17.7%
------------ ------------ ----------- ------------ ------------ ------------
83.8% 73.9% 13.4% 79.0% 61.0% 29.5%
============ ============ =========== ============ ============ ============
Number of facilities:
Self-storage facilities opened in 2004...... 7 - 7
Self-storage facilities opened in 2003...... 14 8 6
Self-storage facilities opened in 2002...... 14 14 -
Self-storage facilities opened in 2000 and 2001 30 30 -
------------ ------------ ------------
65 52 13
============ ============ ============
Cumulative Development Cost:
Self-storage facilities opened in 2004...... $ 61,383 $ - $ 61,383
Self-storage facilities opened in 2003...... 107,452 65,796 41,656
Self-storage facilities opened in 2002 (a).. 97,021 93,413 3,608
Self-storage facilities opened in 2000 and 2001 149,724 149,724 -
------------ ------------ ------------
$ 415,580 $ 308,933 $ 106,647
============ ============ ============
(a) In the quarter ended September 30, 2004, we expanded an existing
self-storage facility that was originally developed in 2002, adding 33,000
net rentable square feet at a cost of $3,134,000.
50
Unlike many other forms of real estate, we are unable to pre-lease our
newly developed facilities due to the nature of our tenants. Accordingly, at the
time a newly developed facility first opens for operations, the facility is
entirely vacant, generating no rental income. We estimate that on average it
takes approximately 36 months for a newly developed facility to fill up and
reach a targeted occupancy level of approximately 90%.
We believe that the newly developed self-storage facilities have been
affected by the operating trends in occupancy and realized rents noted above
with respect to the consistent group of facilities. In addition, move-in
discounts, which increased significantly, have had a more pronounced effect upon
realized rents for the newly developed facilities, because such facilities have
to attract substantially all new tenants, generally offering lower rates and a
higher proportion of move-in incentives. During the three and nine months ended
September 30, 2004, respectively, the newly developed self-storage facilities
had a weighted average occupancy level of approximately 83.8% and 79.0%,
respectively, as compared to 79.0% and 61.0%, respectively during the same
periods in 2003.
Property operating expenses are substantially fixed, consisting
primarily of payroll, property taxes, utilities, and marketing costs. The rental
revenue of a newly developed facility will generally not cover its property
operating expenses (excluding depreciation) until the facility has reached an
occupancy level of approximately 30% to 35%. However, at that occupancy level,
the rental revenues from the facility are still not sufficient to cover the
related depreciation expense and cost of capital with respect to the facility's
development cost. During construction of the self-storage facility, we
capitalize interest costs and include such cost as part of the overall
development cost of the facility. Once the facility is opened for operations,
interest is no longer capitalized.
Due to the relationship between the generation of rental income and
immediate recognition of expenses upon opening of a facility, our development
activities have had a negative impact on our net income. We estimate that our
net income has been negatively impacted by approximately $25,499,000 and
$24,462,000, for the nine months ended September 30, 2004 and 2003,
respectively, as a result of the difference between the revenues generated by
the Developed Facilities and the operating expenses, depreciation, and cost of
capital (at an assumed rate of 8%) with respect to these facilities as described
above. These amounts include approximately $12,371,000 and $9,555,000, for the
nine months ended September 30, 2004 and 2003, respectively, in depreciation
expense.
We continue to develop facilities, despite the short-term earnings
dilution experienced during the fill-up period, because we believe that the
ultimate returns on developed facilities are favorable. In addition, we believe
that it is advantageous for us to continue to expand our asset base and benefit
from the resultant increased critical mass, with facilities that will improve
our portfolio's overall average construction and location quality.
We expect that over at least the next 24 months, the Developed
Facilities will continue to have a negative impact to our earnings. Furthermore,
the 37 expansion and newly developed facilities in our development pipeline,
with total estimated costs of $151,616,000, described in "Liquidity and Capital
Resources - Acquisition and Development of Facilities" that will be opened for
operation over the next 12 - 24 months will also negatively impact our earnings
until they reach a stabilized occupancy level. Our earnings will continue to be
negatively impacted by any future newly developed facilities until they reach a
stabilized occupancy level.
COMMERCIAL PROPERTY OPERATIONS: Commercial property operations included
in our consolidated financial statements include commercial space owned by the
Company and entities consolidated by the Company. We have a much larger interest
in commercial properties through our ownership interest in PS Business Parks
Inc. and its consolidated operating partnership (PS Business Parks, Inc. and its
consolidated operating partnership are hereinafter referred to as "PSB"). Our
investment in PSB is accounted for on the equity method of accounting, and
accordingly our share of PSB's earnings is reflected as "Equity in earnings of
real estate entities," see below.
Our commercial operations are comprised of 1,187,000 net rentable
square feet of commercial space operated at certain of the self-storage
facilities, and two stand-alone commercial facilities having a total of 142,000
net rentable square feet. One of these stand-alone commercial facilities was
previously used for containerized storage and is being converted into 138,000
net rentable square feet of traditional self-storage space at a cost of
$4,481,000.
51
The following table sets forth the historical commercial property
amounts included in the financial statements:
Commercial Property Operations:
(excluding discontinued operations)
Three Months Ended September 30, Nine Months Ended September 30,
----------------------------------- ------------------------------------
2004 2003 Change 2004 2003 Change
------------ ---------- --------- ----------- ----------- ----------
Rental income......................... $ 2,707 $ 2,712 $ (5) $ 8,064 $ 8,299 $ (235)
Cost of operations................... (1,031) (1,234) (203) (3,200) (3,415) 215
------------ ---------- --------- ----------- ----------- ----------
Net operating income............... 1,676 1,478 198 4,864 4,884 (20)
Depreciation......................... (464) (565) 101 (1,574) (1,815) 241
------------ ---------- --------- ----------- ----------- ----------
Operating income................... $ 1,212 $ 913 $ 299 $ 3,290 $ 3,069 $ 221
============ ========== ========= =========== ============ ===========
CONTAINERIZED STORAGE OPERATIONS: In August 1996, Public Storage Pickup
& Delivery ("PSPUD"), a subsidiary of the Company, made its initial entry into
the containerized storage business through its acquisition of a single facility
operator located in Irvine, California. At December 31, 2001, PSPUD had 55
facilities that were opened between 1996 and 2001 either through development or
leasing of facilities. Throughout 2002 and 2003, we reevaluated our operational
strategy and closed 31 facilities. In the first quarter of 2004, we closed an
additional non-strategic facility. During the second quarter of 2004, we
consolidated the operations of three locations in the Chicago market into a
single leased facility with approximately the same capacity and service area as
the three facilities replaced.
During the quarter ended September 30, 2004, we continued to refine our
business strategy and will narrow our market and product focus to just
twelve facilities located in eight densely populated markets with above-average
rent and income.
As a result, during the third quarter of 2004, we began the process to
close seven additional facilities. In addition, we plan to consolidate the
operations of four facilities serving a portion of the Los Angeles market into
two leased facilities with approximately the same capacity and service area as
the four facilities replaced. These existing and consolidated facilities,
including the existing and replacement facilities denoted in the Chicago
consolidation denoted above, are referred to as the "Consolidated Facilities."
The operations with respect to the facilities closed in 2002, 2003 and
2004, including historical operating results for previous periods, are not
included in the table below and instead are included in "Discontinued
Operations" on our income statement. The operations of the remaining facilities,
including the Consolidated Facilities, are included in PSPUD's continuing
operations and are reflected on the table below:
52
Containerized Storage:
(excluding discontinued operations)
Three Months Ended September 30, Nine Months Ended September 30,
---------------------------------- ----------------------------------
2004 2003 Change 2004 2003 Change
----------- ---------- ----------- -------- ---------- ---------
(Amounts in thousands)
Rental and other income ............ $ 5,048 $ 6,672 $ (1,624) $15,099 $ 18,495 $ (3,396)
----------- ---------- ----------- -------- ---------- ---------
Cost of operations:
Direct operating costs.......... 2,727 3,538 (811) 7,764 9,859 (2,095)
Facility lease expense.......... 346 285 61 977 854 123
----------- ---------- ----------- -------- ---------- ---------
Total cost of operations...... 3,073 3,823 (750) 8,741 10,713 (1,972)
----------- ---------- ----------- -------- ---------- ---------
Operating income prior to depreciation 1,975 2,849 (874) 6,358 7,782 (1,424)
Depreciation expense (a)......... (1,072) (1,257) 185 (3,298) (3,623) 325
----------- ---------- ----------- -------- ---------- ---------
Operating income.................... $ 903 $ 1,592 $ (689) $ 3,060 $ 4,159 $ (1,099)
=========== ========== =========== ======== ========== =========
(a) Depreciation expense principally relates to the depreciation of containers;
however, depreciation expense for the three and nine months ended September
30, 2004 includes $261,000 and $767,000, respectively, related to real
estate facilities compared to $374,000 and $928,000 for the same periods in
2003, respectively.
Rental and other income includes monthly rental charges to customers
for storage of the containers, service fees charged for pickup and delivery of
containers to customers' homes and businesses and, prior to the termination of
this moving service, moving service fees to move customers' goods from city to
city. Rental income decreased to $5,048,000 for the three months ended September
30, 2004 from $6,672,000 for the same period in 2003, primarily as a result of
the termination of our long-distance moving service. At September 30, 2004,
there were approximately 22,672 occupied containers in the continuing
facilities.
Direct operating costs principally includes payroll, equipment lease
expense, utilities and vehicle expenses (fuel and insurance). The reduction in
direct operating costs is due primarily to the aforementioned termination of our
long-distance moving service.
There can be no assurance as to the level of the containerized storage
business's expansion, level of gross rentals, level of move-outs or
profitability. We continue to evaluate the business operations, and additional
facilities may be closed.
TENANT REINSURANCE OPERATIONS: Through a subsidiary of the Company, we
reinsure policies against losses to goods stored by tenants in our self-storage
facilities. The tenant reinsurance operations are included in the income
statement under "Revenues - tenant reinsurance premiums" and "Cost of operations
- - tenant reinsurance."
TENANT REINSURANCE OPERATIONS
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------------- ---------------------------------------
2004 2003 Change 2004 2003 Change
---------- ---------- ----------- ----------- ---------- ----------
(Amounts in thousands)
Tenant reinsurance premiums.......... $ 6,210 $ 5,755 $ 455 $ 18,266 $ 16,551 $ 1,715
Cost of operations.................. (4,204) (2,917) (1,287) (11,089) (8,631) (2,458)
---------- ---------- ----------- ----------- ---------- ----------
Operating income.................. $ 2,006 $ 2,838 $ (832) $ 7,177 $ 7,920 $ (743)
========== ========== =========== =========== ========== ==========
The level of tenant reinsurance revenues is largely dependent upon our
occupancy level and move-in activity. New insurance business comes from tenants
who sign up for insurance as they move into our self-storage facilities.
We implemented increased tenant insurance pricing for our self-storage
tenants moving in after December 31, 2003. Revenues have increased due to higher
pricing, and the pricing change should continue to have a greater impact on our
average pricing as a higher proportion of tenants are subject to the revised
pricing. However, we have seen a reduction in the proportion of tenants
selecting insurance. During the three and nine months ended September 30, 2004,
34% and 35%, respectively, of our self-storage tenants had tenant insurance, as
compared to 36% and 36%, respectively, for the same periods in 2003. There can
be no assurance as to the ultimate impact of our pricing change.
53
We have outside third-party insurance coverage for losses from any
individual event that exceeds a loss of $500,000, to a limit of $10,000,000.
Losses below these amounts are accrued as cost of operations for the tenant
reinsurance operations. The increase in cost of operations for the three and
nine months ended September 30, 2004 is due to $1,500,000 in estimated tenant
claim payments resulting from a series of hurricanes in Florida that occurred in
the quarter ended September 30, 2004.
EQUITY IN EARNINGS OF REAL ESTATE ENTITIES: In addition to our
ownership of equity interests in PSB, we had general and limited partnership
interests in eight limited partnerships at September 30, 2004. (PSB and the
limited partnerships are collectively referred to as the "Unconsolidated
Entities"). Due to our limited ownership interest and limited control of these
entities, we do not consolidate the accounts of these entities for financial
reporting purposes. We account for such investments using the equity method.
Equity in earnings of real estate entities for the three and nine
months ended September 30, 2004 and 2003 consists of our pro-rata share of the
Unconsolidated Entities based upon our ownership interest for the period. The
following table sets forth the significant components of equity in earnings of
real estate entities:
Three Months Ended September 30, Nine Months Ended September 30,
----------------------------------- --------------------------------------
2004 2003 Change 2004 2003 Change
---------- --------- ---------- --------- -------- --------
(Amounts in thousands)
Property operations:
PSB $15,959 $16,148 $(189) $49,753 $48,339 $ 1,414
Acquisition Joint Venture.............. 21 - 21 21 - 21
Other investments (1).................. 1,723 1,607 116 4,993 4,724 269
---------- --------- ---------- --------- -------- --------
17,703 17,755 (52) 54,767 53,063 1,704
---------- --------- ---------- --------- -------- --------
Depreciation:
PSB.................................... (8,119) (6,779) (1,340) (23,875) (19,088) (4,787)
Acquisition Joint Venture.............. (31) - (31) (31) - (31)
Other investments (1).................. (371) (436) 65 (1,149) (1,265) 116
---------- --------- ---------- --------- -------- --------
(8,521) (7,215) (1,306) (25,055) (20,353) (4,702)
---------- --------- ---------- --------- -------- --------
Other: (2)
PSB (3)................................ (6,273) (4,810) (1,463) (18,615) (13,534) (5,081)
Other investments (1).................. 275 40 235 549 280 269
---------- --------- ---------- --------- -------- --------
(5,998) (4,770) (1,228) (18,066) (13,254) (4,812)
---------- --------- ---------- --------- -------- --------
Total equity in earnings of real estate
entities.................................. $3,184 $5,770 $(2,586) $11,646 $19,456 $(7,810)
========== ========= ========== ========= ======== =========
(1) Amounts primarily reflect equity in earnings recorded for investments that
have been held consistently throughout each of the three and nine months
ended September 30, 2004 and 2003.
(2) "Other" reflects our share of general and administrative expense, interest
expense, interest income, and other non-property; non-depreciation related
operating results of these entities. The amount of interest expense
included in "other" is $211,000 and $1,157,000, respectively for the three
and nine months ended September 30, 2004, respectively, as compared to
$419,000 and $1,354,000, respectively, for the same periods in 2003.
(3) "Other" with respect to PSB also includes our pro-rata share of gains on
sale of real estate assets, impairment charges relating to pending sales of
real estate and the impact of PSB's application of the SEC's clarification
of EITF Topic D-42 on redemptions of preferred securities. Our net pro-rata
share of these items totaled net income reduction of $1,092,000 and
$2,109,000 for the three and nine months ended September 30, 2004,
respectively. Our net pro-rata share of these items increased net income
$453,000 for the nine months ended September 30, 2003 (no impact for the
three months ended September 30, 2003).
54
The decrease in equity in earnings of real estate entities for the
three months ended September 30, 2004 as compared to the same period in 2003 is
due primarily to a reduction in our share of PSB's earnings, which is due to
higher depreciation due to PSB's significant asset acquisitions in the fourth
quarter of 2003. The decrease in equity in earnings for the three and nine
months ended September 30, 2004 also includes our $1,228,000 and $2,171,000
share of EITF Topic D-42 charges recorded by PSB. The decrease in equity in
earnings for the nine months September 30, 2004 also includes the net impact of
PSB's impairment charges and gains on sale of real estate for the nine months
ended September 30, 2003, of which our pro-rata share was net income totaling
$453,000.
Equity in earnings of PSB represents our pro-rata share (an average of
approximately 44% for the three and nine months ended September 30, 2004 and
2003) of the earnings of PSB. As of September 30, 2004, we owned 5,418,273
common shares and 7,305,355 operating partnership units (units which are
convertible into common shares on a one-for-one basis) in PSB. At September 30,
2004, PSB owned and operated 18.4 million net rentable square feet of commercial
space located in eight states. PSB also manages commercial space owned by the
Company and affiliated entities at September 30, 2004 pursuant to property
management agreements.
Our future equity income from PSB will be dependent entirely upon PSB's
operating results. PSB's filings and selected financial information can be
accessed through the Securities and Exchange Commission, and on its website,
www.psbusinessparks.com.
In January 2004, we entered into a joint venture partnership with an
institutional investor for the purpose of acquiring up to $125.0 million of
existing self-storage properties in the United States from third parties (the
"Acquisition Joint Venture"). The venture is funded entirely with equity
consisting of 30% from the Company and 70% from the institutional investor. The
venture had a nine-month investment period (through September 2004) to identify
and acquire facilities. Through September 30, 2004, the joint venture had
acquired two self-storage facilities at an aggregate cost of $9,086,000, and we
had invested $2,930,000 in this joint venture. Our pro-rata share of earnings
with respect to the Acquisition Joint Venture is included in the table above.
Our future equity in earnings with respect to the Acquisition Joint
Venture will be dependent upon the level of earnings generated by the properties
currently owned by the Acquisition Joint Venture, and the earnings generated
from any other potential acquisitions made by the Acquisition Joint Venture. We
are currently working with our joint venture partner for the potential inclusion
of certain of the facilities acquired in 2004 or currently under contract in the
Acquisition Joint Venture, notwithstanding the expiration of the investment
period. However, there can be no assurance that the Acquisition Joint Venture
will acquire any additional facilities. See Note 5 to the condensed consolidated
financial statements for the operating results of this entity for the nine
months ended September 30, 2004.
The "Other Investments" is comprised primarily of our equity in
earnings from seven limited partnerships, for which we held an approximately
consistent level of equity interest during each of the nine months ended
September 30, 2004 and 2003. These limited partnerships were formed by the
Company during the 1980's. We are the general partner in each limited
partnership, and manage each of these facilities for a management fee that is
included in "Interest and Other Income." The limited partners consist of
numerous individual investors, including the Company, which throughout the
1990's acquired units of limited partnership interests in these limited
partnerships in various transactions.
In the second quarter of 2003, we sold our entire interest in a real
estate entity for cash of $851,000 and recognized a gain on the sale of
$316,000.
Our future earnings with respect to the "Other investments" will be
dependent upon the operating results of the 36 self-storage facilities that
these entities own. The operating characteristics of these facilities are
similar to those of the Company's self-storage facilities, and are subject to
the same operational issues as the Consistent Group of self-storage facilities
as discussed above. See Note 5 to the consolidated financial statements for the
operating results of these entities for the nine months ended September 30, 2004
and 2003.
55
OTHER INCOME AND EXPENSE ITEMS
INTEREST AND OTHER INCOME: Interest and other income includes (i) the
net operating results from our third party property management operations, (ii)
the net operating results from our merchandise sales and consumer truck rentals
and (iii) interest income.
Interest and other income was $3,300,000 and $7,240,000 for the three
and nine months ended September 30, 2004, respectively, as compared to
$2,847,000 and $7,425,000, respectively, for the same periods in 2003. The
quarterly increase is reflective of higher interest income on cash balances due
to higher average cash balances and higher average interest rates. The decrease
for the nine months ended primarily reflects lower interest income due to the
payoff of notes receivable, offset partially by higher interest income on cash
balances.
As discussed more fully in "Liquidity and Capital Resources" below, at
September 30, 2004, we had cash balances totaling approximately $475,280,000,
which includes significant proceeds from recent equity issuances. These balances
are typically invested in short-term low-risk securities that, during the
quarter ended September 30, 2004, earned a nominal yield. Our future interest
and other income will be partially dependent upon the timing of our investment
of these unused offering proceeds and the level of interest earned on these
short-term investments.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization expense
was $44,375,000 and $135,515,000 for the three and nine months ended September
30, 2004, respectively, as compared to $45,435,000 and $135,770,000,
respectively for the same periods in 2003. The decrease in depreciation and
amortization for the three and nine months ended September 30, 2004 as compared
to the same periods in 2003 is due primarily to a reduction in depreciation with
respect to maintenance capital expenditures, offset partially by an increase in
depreciation with respect to newly developed and acquired facilities.
Included in depreciation expense with respect to our real estate
facilities was $40,874,000 and $125,032,000 for the three and nine months ended
September 30, 2004, respectively, as compared to $42,143,000 and $126,083,000
for the same period in 2003, respectively. The decrease in depreciation and
amortization with respect to real estate facilities for the three months ended
September 30, 2004 as compared to the same period in 2003 is due primarily to a
reduction in depreciation with respect to maintenance capital expenditures,
offset partially by an increase in depreciation with respect to newly developed
and acquired facilities. Depreciation expense with respect to other assets,
primarily depreciation of equipment and containers associated with the
containerized storage operations, was $1,850,000 and $5,530,000 for the three
and nine months ended September 30, 2004, respectively, as compared to
$1,641,000 and $4,734,000 for the same period in 2003, respectively.
Depreciation expense also includes $1,651,000 and $4,953,000 for each of the
three and nine months, respectively, ended September 30, 2004 and 2003, relating
to the amortization of property management contracts.
Depreciation and amortization for the three and nine months ended
September 30, 2004 with respect to developed real estate facilities opened
during the first nine months of 2004 amounted to approximately $307,000 and
$534,000, respectively. We expect the quarterly depreciation and amortization
expense with respect to these facilities for quarters beginning with fourth
quarter of 2004 will approximate $395,000.
GENERAL AND ADMINISTRATIVE: General and administrative expense was
$5,527,000 and $15,983,000 for the three and nine months ended September 30,
2004, as compared to $4,642,000 and $13,321,000 for the same period in 2003.
General and administrative expense principally consists of state income taxes,
investor relation expenses and corporate and executive salaries. In addition,
general and administrative expense includes expenses that vary depending on the
Company's activity levels in certain areas, such as overhead associated with the
acquisition and development of real estate facilities, employee severance,
stock-based compensation and product research and development expenditures.
56
The increase in general and administrative expense for the three months
ended September 30, 2004 as compared to the same period in 2003 is primarily due
to increased stock-based compensation expense from $825,000 to $1,001,000, as
well as an increase of $536,000 for employee termination costs. The increase in
general and administrative expense for the nine months ended September 30, 2004
as compared to the same period in 2003 is primarily due to increased stock-based
compensation expense from $1,259,000 to $2,983,000, as well as, an increase of
$666,000 for employee termination costs.
Stock-based compensation expense for the three months ended September
30, 2004 included $150,000 in stock option expense, $559,000 in restricted stock
expense and $292,000 in payroll taxes and other costs associated with employees'
exercise of approximately 584,000 stock options in the three months ended
September 30, 2004. Stock-based compensation expense for the three months ended
September 30, 2003, included $95,000 in stock option expense, $371,000 in
restricted stock expense and $359,000 in payroll taxes and other costs
associated with employees' exercise of 859,000 stock options during the three
months ended September 30, 2003.
Stock-based compensation expense for the nine months ended September
30, 2004 included $439,000 in stock option expense, $1,676,000 in restricted
stock expense and $868,000 in payroll taxes and other costs associated with
employees' exercise of approximately 1,719,000 stock options in the nine months
ended September 30, 2004. Stock-based compensation expense for the nine months
ended September 30, 2003 included $294,000 in stock option expense, $371,000 in
restricted stock expense and $594,000 in payroll taxes and other costs
associated with employees' exercise of 1,730,000 stock options during the nine
months ended September 30, 2003.
Restricted stock expense, based upon restricted stock units outstanding
at September 30, 2004, should approximate $600,000 for the fourth quarter of
2004, while stock option expense should approximate $225,000 for the fourth
quarter of 2004, exclusive of payroll taxes on exercise of options. Future
grants of restricted stock units and stock options could further increase our
future stock-based compensation expense. The future level of payroll taxes and
other costs associated with the employees' exercise of stock options will depend
upon the timing of the employees' exercise of approximately 1.5 million stock
options outstanding at September 30, 2004, the Company's stock price at the time
of exercise, and the level of future grants of stock options.
INTEREST EXPENSE: Interest expense was $296,000 for the three months
ended September 30, 2003 (none for the three months ended September 30, 2004).
Interest expense was $100,000 and $1,121,000 for the nine months ended September
30, 2004 and 2003, respectively. Interest capitalized during the three and nine
months ended September 30, 2004 was $685,000 and $2,722,000, respectively, as
compared to $1,411,000 and $4,386,000, respectively, for the same periods in
2003. The decrease in interest expense (prior to capitalized interest) in 2004
compared to 2003 is principally the result of lower interest expense on notes
payable due to scheduled principal repayments. The reduction in capitalized
interest is a result of a lower average balance of in-process development
projects.
As described in Note 15, "Subsequent Events," in October 2004 we
assumed approximately $39.5 million in mortgage debt in connection with the
acquisition of several facilities, which will increase interest expense (prior
to capitalized interest). Our interest expense will increase due to this
assumption of additional debt, but will decrease as we make scheduled principal
payments.
MINORITY INTEREST IN INCOME: Minority interest in income represents the
income allocable to equity interests in Consolidated Entities, which are not
owned by the Company. The following table summarizes minority interest in income
for the three and nine months ended September 30, 2004 and 2003:
57
Three Months Ended September 30, Nine Months Ended September 30,
--------------------------------------- --------------------------------------
2004 2003 Change 2004 2003 Change
--------- ----------- ---------- ---------- ----------- ----------
(Amounts in thousands)
Preferred partnership interests:
Ongoing distributions (b).......... $ 5,176 $ 6,726 $ (1,550) $ 16,907 $ 20,179 $ (3,272)
Special Distribution and EITF
Topic D-42 (a)................... - - - 10,063 - 10,063
Consolidated Development Joint Venture (c) 1,563 1,292 271 3,940 2,905 1,035
Convertible Partnership Units (d)....... 88 86 2 219 233 (14)
Acquired minority interests (e) ........ - 424 (424) 842 1,738 (896)
Other minority interests (f)............ 2,694 2,616 78 7,927 7,527 400
--------- ----------- ---------- ---------- ----------- ----------
Total minority interests in income.. $ 9,521 $ 11,144 $ (1,623) $ 39,898 $ 32,582 $ 7,316
========= =========== =========== ========== ============ ==========
(a) As described more fully below, holders of $200,000,000 of our Series N
preferred partnership units agreed to a restructuring which included
reducing their distribution rate from 9.5% to 6.4% in exchange for a
special distribution of $8,000,000. This special distribution, combined
with $2,063,000 in costs incurred at the time the units were originally
issued that were charged against income in accordance with the Securities
and Exchange Commissions clarification of EITF Topic D-42, are included in
minority interest in income.
(b) The decrease in ongoing distributions is due to the reduction in rate on
$200,000,000 of the preferred partnership units from 9.5% to 6.4%,
effective March 22, 2004. Ongoing distributions, beginning in the second
quarter of 2004, amounted to approximately $5,176,000 per quarter.
(c) These amounts reflect income allocated to the minority interests in the
Consolidated Development Joint Venture. Included in minority interest in
income is $887,000 and $2,741,000 in depreciation expense for the three and
nine months ended September 30, 2004, respectively, as compared to $889,000
and $2,554,000 for the same period in 2003.
(d) These amounts reflect the minority interests represented by the Convertible
Partnership Units (see Note 8 to the consolidated financial statements).
Included in minority interest in income is $81,000 and $247,0000 in
depreciation expense for the three and nine months ended September 30,
2004, respectively, as compared to $66,000 and $253,000 for the same period
in 2003.
(e) These amounts reflect income allocated to minority interests that the
Company acquired in April 2003 and September 2004 and are no longer
outstanding at September 30, 2004. Included in minority interest in income
is $309,000 in depreciation expense for the nine months ended September 30,
2004 (none for the three months ended September 30, 2004). Included in
minority interest in income is $181,000 and $682,000, respectively, for the
three and nine months ended September 30, 2003.
(f) These amounts reflect income allocated to minority interests that were
outstanding consistently throughout the three and nine months ended
September 30, 2004 and 2003. Included in minority interest in income is
$589,000 and $1,554,000 in depreciation expense for the three months and
nine months ended September 30, 2004, respectively, as compared to $371,000
and $1,251,000 for the same period in 2003.
On March 22, 2004, certain investors who hold $200 million of our 9.5%
Series N Cumulative Redeemable Perpetual Preferred Units agreed, in exchange for
a special distribution of $8,000,000, to a reduction in the distribution rate on
their preferred units from 9.50% per year to 6.40% per year, and an extension of
the call date for these securities to March 17, 2010. The investors also
received their distribution that accrued from January 1, 2004 through the
effective date of the exchange.
As a result of this agreement, income allocable to minority interests
increased, and the Company's net income decreased $10,063,000 due to (1) the
$8,000,000 cash payment to the holders of the preferred units and (2) the
application of the SEC Observer's recent clarification of EITF Topic D-42, "The
Effect on the Calculation of Earnings per Share for the Redemption or Induced
Conversion of Preferred Stock" totaling $2,063,000, which represents the excess
of the $200 million stated amount of the preferred units over their carrying
amount. Beginning with the second quarter of 2004, this restructuring will
result in a decrease in income allocable to minority interests causing an
increase in our net income by $1.55 million per quarter.
58
As described in Note 15, "Subsequent Events," we issued $25,000,000 of
our 6.25% Series Z Cumulative Redeemable Perpetual Preferred Units in connection
with a property acquisition in October 2004. Additional income will be allocated
to the holders of these minority interests.
The increase in minority interest in income with respect to the
Consolidated Development Joint Venture is due to an increase in income with
respect to the properties owned by this entity. We expect that minority interest
in income with respect to the Consolidated Development Joint Venture will
continue to increase as the properties owned by this entity, substantially all
of which are newly developed facilities in the fill-up stage, continue to
stabilize their operations and increase the earnings of this entity.
The acquired minority interests reflect earnings allocated to interests
the Company didn't own in one of the Consolidated Entities, acquired on June 30,
2004, for an aggregate of $24,851,000 in cash. We allocated a total of $842,000
in net income to these interests (including $309,000 in depreciation) for the
nine months ended September 30, 2004. In addition, we acquired the interests we
didn't own in PS Partners IV, Ltd. on April 28, 2003 for an aggregate cost of
approximately $23,377,000. Following the Company's acquisition of these
interests, there will be no further income allocated to these interests.
Other minority interests reflect income allocated to minority interests
that have maintained a consistent level of interest throughout the three and
nine months ended September 30, 2004 and 2003, comprised of investments in the
Consolidated Entities described in Note 8 to the Company's financial statements.
The level of income allocated to these interests in the future is dependent upon
the operating results of the storage facilities that these entities own, as well
as any minority interests that the Company acquires in the future.
DISCONTINUED OPERATIONS: During the third quarter of 2004, we entered
into an agreement to sell one of our commercial facilities located in West Palm
Beach, Florida. The facility sale closed on October 28, 2004 (see Footnote 15 -
"Subsequent Events"). This facility is referred to as the "Sold Commercial
Facility".
During the first quarter of 2003, we entered into a business plan to
exit the Knoxville, Tennessee market, and listed our four self-storage
facilities (the "Knoxville Facilities") in this market for sale. In addition, in
October 2003, we sold a self-storage facility located in Perrysburg, Ohio
(collectively, the "Sold Self-Storage Facilities").
As described more fully in Note 3 to the consolidated financial
statements, during 2002, 2003 and 2004, we implemented a business plan which
included the closure of 39 of 55 containerized storage facilities that were open
at December 31, 2001. The 39 facilities are hereinafter referred to as the
"Closed Facilities."
The current and prior period operations for the Sold Self-Storage
Facilities the Sold Commercial Facility and Closed Facilities have been
reclassified into the line-item "Discontinued Operations" on our consolidated
income statement.
The following table summarizes the historical operations of the Sold
Self-Storage Facilities, Sold Commercial Facility and the Closed Facilities:
59
DISCONTINUED OPERATIONS:
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------ ---------------------------------------
2004 2003 Change 2004 2003 Change
----------- -------- ---------- ---------- ---------- -----------
(Amounts in thousands) (Amounts in thousands)
Rental income (a):
Closed Facilities............... $ 1,740 $4,964 $ (3,224) $ 6,267 $ 15,080 $ (8,813)
Sold Self-Storage Facilities.... - 504 (504) - 1,448 (1,448)
Sold Commercial Facility........ 105 100 5 279 302 (23)
----------- -------- ---------- ---------- ---------- -----------
Total rental income............... 1,845 5,568 (3,723) 6,546 16,830 (10,284)
----------- -------- ---------- ---------- ---------- -----------
Cost of operations (a):
Closed Facilities............... 1,154 3,468 (2,314) 5,176 12,435 (7,259)
Sold Self-Storage Facilities.... - 213 (213) - 603 (603)
Sold Commercial Facility........ 26 19 7 63 76 (13)
----------- -------- ---------- ---------- ---------- -----------
Total cost of operations.......... 1,180 3,700 (2,520) 5,239 13,114 (7,875)
----------- -------- ---------- ---------- ---------- -----------
Depreciation expense (a):
Closed Facilities............... 306 871 (565) 1,031 2,681 (1,650)
Sold Self-Storage Facilities.... - 142 (142) - 424 (424)
Sold Commercial Facility........ 25 25 - 74 74 -
----------- -------- ---------- ---------- ---------- -----------
Total depreciation ............... 331 1,038 (707) 1,105 3,179 (2,074)
----------- -------- ---------- ---------- ---------- -----------
Impairment charge/shutdown costs (b):
Closed Facilities............... 1,406 1,274 132 1,991 2,024 (33)
----------- -------- ---------- ---------- ---------- -----------
Net discontinued operations (c)... $(1,072) $ (444) $ (628) $ (1,789) $ (1,487) $ (302)
========== ======== ========== ========== ========== ============
(a) These amounts represent the historical operations of the Closed
Facilities and the Sold Self-Storage Facilities, and include amounts
previously classified as rental income, cost of operations, and
depreciation expense related to real estate and other assets, utilized
by the Closed Facilities, in the financial statements in prior periods.
(b) Asset impairment charges for the three and nine months ended September
30, 2004 were $1,406,000 and 1,575,000, respectively. In addition to
the asset impairment charges, lease termination costs of $416,000 were
recorded during the quarter ended June 30, 2004. During the three and
nine months ended September 30, 2003, $1,274,000 in asset impairment
charges were recorded with respect to four facilities closed during
that quarter. In addition a $750,000 impairment charge was recorded
during the quarter ended June 30, 2003 with respect to a closed
containerized storage facility held for sale.
(c) Earnings per share for the three and nine month periods ended September
30, 2004 and the nine months ended September 30, 2003, were reduced
$0.01 due to the impact from discontinued operations. There was no
impact on earnings per share for the three months ended September 30,
2003.
GAIN (LOSS) ON DISPOSITION OF REAL ESTATE: During the three months
ended September 30, 2004, we sold three vacant parcels of land and received
proceeds as a result of the partial condemnation of two existing self-storage
facilities, receiving net proceeds totaling $7,437,000 and recording a gain on
sale of $1,286,000.
During the first quarter of 2003, we disposed of two self-storage
facilities and a parcel of land for an aggregate of $7,713,000 in cash, and
recognized a gain on disposition of $14,000. During the second quarter of 2003,
we disposed of two additional parcels of land for an aggregate of $4,147,000,
recognizing a gain on disposition of $430,000, and disposed of an investment in
real estate entities for an aggregate of $851,000, recognizing a gain of
approximately $316,000. During the quarter ended September 30, 2003, we disposed
of a parcel of land for $795,000 in cash, and recognized a gain on disposition
of $47,000.
60
LIQUIDITY AND CAPITAL RESOURCES
We believe that our internally generated net cash provided by operating
activities will continue to be sufficient to enable us to meet our operating
expenses, capital improvements, debt service requirements and distributions to
shareholders for the foreseeable future.
Operating as a real estate investment trust ("REIT"), our ability to
retain cash flow for reinvestment is restricted. In order for us to maintain our
REIT status, a substantial portion of our operating cash flow must be
distributed to our shareholders (see "Requirement to Pay Distributions" below).
However, despite the significant distribution requirements, we have been able to
retain a significant amount of our operating cash flow. The following table
summarizes our ability to fund distributions to the minority interest, capital
improvements to maintain our facilities, and distributions to our shareholders
through the use of cash provided by operating activities. The remaining cash
flow generated is available to make both principal payments on debt and for
reinvestment.
Nine Months Ended September 30,
-----------------------------------
2004 2003
----------------- ----------------
(Amounts in thousands)
Net cash provided by operating activities....................... $ 498,856 $ 468,591
Allocable to minority interest (Preferred Units) - ongoing (16,907) (20,179)
distributions...................................................
Allocable to minority interest (Preferred Units) - special (8,000) -
distribution (a)................................................
Allocable to minority interest (common equity).................. (17,779) (17,143)
----------------- ----------------
Cash from operations allocable to our shareholders.............. 456,170 431,269
Capital improvements to maintain our facilities................. (20,297) (20,470)
Add back: minority interest share of capital improvements to
maintain facilities......................................... 441 504
----------------- ----------------
Remaining operating cash flow available for distributions to our
shareholders................................................ 436,314 411,303
Distributions paid:
Preferred stock dividends..................................... (117,293) (107,914)
Equity Stock, Series A dividends.............................. (16,126) (16,126)
Distributions to Common shareholders.......................... (172,474) (168,781)
----------------- ----------------
Cash available for principal payments on debt and reinvestment.. $ 130,421 $ 118,482
================= ================
(a) The $8 million special distribution was paid to a unitholder of our 9.5%
Series N Cumulative Redeemable Perpetual Preferred Units in conjunction
with a March 22, 2004 agreement that, among other things, lowered the
distribution rate from 9.5% to 6.4%.
Our financial profile is characterized by a low level of debt to total
capitalization and a conservative dividend payout ratio with respect to the
common stock. We expect to fund our growth strategies with cash on hand at
September 30, 2004, internally generated retained cash flows and proceeds from
issuing equity securities. In general, our current strategy is to continue to
finance our growth with permanent capital; either common or preferred equity. We
have in the past used our $200 million line of credit as temporary "bridge"
financing and repaid those amounts with internally generated cash flows and
proceeds from the placement of permanent capital. At September 30, 2004, we had
no outstanding borrowings under our $200 million bank line of credit.
Over the past three years, we have funded substantially all of our
acquisitions with permanent capital (both common and preferred securities). We
have elected to use preferred securities as a form of leverage despite the fact
that the dividend rates of our preferred securities exceed the prevailing market
interest rates on conventional debt. We have chosen this method of financing for
the following reasons: (i) under the REIT structure, a significant amount of
operating cash flow needs to be distributed to our shareholders, making it
difficult to repay debt with operating cash flow alone, (ii) our perpetual
preferred stock has no sinking fund requirement or maturity date and does not
require redemption, all of which eliminate any future refinancing risks, (iii)
after the end of a non-call period, we have the option to redeem the preferred
stock at any time, which in 2002 and 2001 enabled us to effectively refinance
higher coupon preferred stock with new preferred stock at lower rates, (iv)
preferred stock does not contain onerous covenants, thus allowing us to maintain
significant financial flexibility, and (v) dividends on the preferred stock can
be applied to our REIT distribution requirements.
Our credit ratings on each of our series of Cumulative Preferred Stock
are "Baa2" by Moody's and "BBB+" by Standard & Poor's.
61
Our portfolio of real estate facilities remains substantially
unencumbered. At September 30, 2004, we had mortgage debt outstanding of $1.7
million (which encumbers two facilities with a book value of approximately $11
million) and unsecured long-term debt in the amount of $33.6 million. As
described in Note 15, "Subsequent Events" in the Company's September 30, 2004
financial statements, the Company acquired 26 facilities, subject to
approximately $39.5 million in mortgage debt at an average interest rate of
6.5%.
We believe that our size and financial flexibility enables us to access
capital when appropriate.
RECENT ISSUANCE OF PREFERRED STOCK AND PROJECTED REDEMPTION OF
PREFERRED SECURITIES: One of our financing objectives over the past several
years has been to reduce our average cost of capital with respect to our
preferred securities. Accordingly, we have redeemed higher rate preferred
securities outstanding and have financed the redemption with cash on-hand or
from the proceeds from the issuance of lower rate preferred securities.
For the remainder of 2004 and 2005, we have approximately $197.4
million of preferred securities that become redeemable at our option. The
weighted average annual dividend rate with respect to these securities is
approximately 9.6%; a rate significantly higher than current market conditions.
However, during the fourth quarter of 2003 and into 2004, we became increasingly
concerned that conditions soon change and that dividend rates with respect to
new offerings of preferred securities would begin to rise. It was our desire to
limit our "refinancing risk" with respect to anticipated rising rates.
In that regard, over the past year, we have issued approximately $743.8
million of our preferred stock raising net proceeds of approximately $720.4
million. The weighted average annual dividend rate with respect to these
securities is approximately 6.5% (6.7% based on the net proceeds received).
During the first quarter of 2004, we utilized $230 million of the
capital raised to redeem our 8.25% Series K preferred stock and our 8.25% Series
L preferred stock. In addition, during the first quarter of 2004, we
restructured $200 million of our 9.5% Series N preferred units reducing the
annual dividend rate to 6.4%; we would not have been able to call these
securities until November 2005. During the third quarter of 2004, we redeemed
our 8.75% Series M Preferred Stock and our 9.5% Series D Preferred Stock, which
had an aggregate liquidation value of $86,250,000.
We have $197,375,000 in preferred securities that, at our option,
become redeemable in the remainder of 2004 and 2005, with an average coupon of
9.626%, as follows:
Earliest
Redemption Dividend Liquidation
Security Date Rate Value (000's)
- ----------------------------------- ---------- --------- -------------
Series E Preferred Stock 1/31/05 10.000% $ 54,875
Series N Preferred Units 3/17/05 9.500% 40,000
Series O Preferred Units 3/29/05 9.125% 45,000
Series F Preferred Stock 4/30/05 9.750% 57,500
-------- --------------
Total securities available for
redemption through 12/31/05 9.626% $ 197,375
======== ==============
We expect to fund these redemptions from cash on hand, which totaled
$475,280,000 at September 30, 2004. If, however, our cash on hand is utilized
for alternative investments such as the acquisition or development of real
estate assets, we intend to issue additional lower-rate preferred securities to
redeem these securities. There can be no assurance that we would be able to
issue additional preferred securities at a lower rate.
As a result of the upcoming redemptions of preferred securities noted
above, we expect that the related charges with respect to the application of
EITF Topic D-42 will be approximately $1,929,000 in the fourth quarter of 2004,
and $2,778,000 in the first quarter of 2005.
62
REQUIREMENT TO PAY DISTRIBUTIONS: We have operated, and intend 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 we will at all times so
qualify. To the extent that the Company continues to qualify as a REIT, we will
not be taxed, with certain limited exceptions, on the taxable income that is
distributed to our shareholders, provided that at least 90% of our taxable
income is so distributed to our shareholders prior to filing of the Company's
tax return. We have satisfied the REIT distribution requirement since 1980.
During the nine months ended September 30, 2004 and 2003, we paid cash
dividends totaling $117,293,000 and $107,914,000, respectively, to the holders
of our Cumulative Preferred Stock. We estimate the distribution requirements
with respect to our Preferred Stock outstanding at September 30, 2004 to be
approximately $162.5 million per year, which includes approximately $19.0
million with respect to the preferred series denoted above that are anticipated
to be redeemed.
During the nine months ended September 30, 2004 and 2003, we paid cash
dividends totaling $16,907,000 and $20,179,000, respectively, to the holders of
our preferred partnership units. On March 22, 2004, certain investors who hold
$200 million of our 9.5% Series N Cumulative Redeemable Preferred Units agreed,
in exchange for a special distribution of $8,000,000, to a reduction in the
distribution rate on their preferred units from 9.5% per year to 6.4% per year.
We estimate that the distribution requirement with respect to the preferred
partnership units outstanding at September 30, 2004 to be approximately $20.7
million per year, which includes approximately $7.9 million with respect to the
two unit series denoted above that we expect to redeem.
As described below, we issued $25,000,000 of our 6.25% Series Z
Cumulative Redeemable Perpetual Preferred Units in connection with a property
acquisition in October 2004. Our annual distribution requirement with respect to
these units will approximate $1.6 million. The holders of these units have a
one-time option, exercisable five years after issuance, to require us to redeem
these units in cash, at par plus any accrued but unpaid distributions.
During each of the nine months ended September 30, 2004 and 2003, we
paid cash dividends totaling $16,126,000 to the holders of our Equity Stock,
Series A. With respect to the depositary shares of Equity Stock, Series A, we
have no obligation to pay distributions if no distributions are paid to the
common shareholders. To the extent that we do pay common distributions in any
year, the holders of the depositary shares receive annual distributions equal to
the lesser of (i) five times the per share dividend on the common stock or (ii)
$2.45. The depositary shares are non-cumulative, and have no preference over our
common stock either as to dividends or in liquidation. With respect to the
Equity Stock, Series A outstanding at September 30, 2004, we estimate the total
regular distribution for the remainder of 2004 to be approximately $5.4 million
assuming that dividends of at least $0.49 per share per year are paid to the
common shareholders.
During the nine months ended September 30, 2004, we paid dividends
totaling $172,474,000 ($1.35 per common share) to the holders of our common
stock. Based upon shares outstanding at September 30, 2004 and a quarterly
distribution of $0.45 per share, which was declared by the Board of Directors on
November 4, 2004 and payable on December 31, 2004, we estimate dividend payments
with respect to our common stock of approximately $57.7 million for the fourth
quarter of 2004.
CAPITAL IMPROVEMENT REQUIREMENTS: For 2004, we estimate a total of
approximately $30.0 to $35.0 million for capital improvements. During the nine
months ended September 30, 2004, we incurred capital improvements of
approximately $20.3 million. Capital improvements include major repairs or
replacements to the facilities that maintain the facilities' existing operating
condition and visual appeal. Capital improvements do not include costs relating
to the development or expansion of facilities, or expenditures associated with
improving the visual and structural appeal of our existing self-storage
facilities.
DEBT SERVICE REQUIREMENTS: We do not believe we have any significant
refinancing risks with respect to our notes payable, all of which are fixed
rate. At September 30, 2004, we had total outstanding notes payable of
approximately $35.3 million. See Note 7 to the consolidated financial statements
for approximate principal maturities of such borrowings.
63
As described below, our total mortgage debt increased by approximately
$39.5 million (at an average interest rate of approximately 6.5%), to a total of
approximately $74.8 million, with the acquisition of real estate facilities in
October 2004, as discussed below.
We anticipate that our retained operating cash flow will continue to be
sufficient to enable us to make scheduled principal payments. It is our current
intention to fully amortize our debt as opposed to refinance debt maturities
with additional debt.
ACQUISITION AND DEVELOPMENT OF REAL ESTATE FACILITIES: No facilities
were acquired from third parties during the year ended December 31, 2003.
During the first nine months of 2004, we acquired two facilities with
an aggregate of 139,000 net rentable square feet, for an aggregate of $8,293,000
in cash. In addition, our Acquisition Joint Venture acquired two facilities as
discussed below.
During October 2004, we acquired 32 facilities at a total cost of
$121.5 million, including post-acquisition costs of computer, signage and other
efforts in conforming these facilities to Public Storage visual and operating
standards. The consideration for these acquisitions consisted of the assumption
of $39.5 million of debt, the issuance of $25.0 million of 6.25% Series Z
Preferred Units and $57.0 million in cash. The facilities are located in
Minnesota, Texas and Wisconsin and contain 2,002,000 net rentable square feet of
space (14,873 rentable units).
In addition, we have contracts to acquire 11 additional existing
self-storage facilities at an aggregate cost of approximately $124.9 million,
consisting of the assumption of $48.9 million in debt and $76.0 million in cash.
Each of these contracts is subject to significant contingencies, and there is no
assurance that any of these facilities will be acquired.
On January 1, 2004, we entered into a joint venture (the "Acquisition
Joint Venture") with an institutional investor for the purpose of acquiring up
to $125.0 million of existing self-storage properties in the United States from
third parties. The Acquisition Joint Venture is funded entirely with equity
consisting of 30% from the Company and 70% from the institutional investor. The
Acquisition Joint Venture acquired two facilities during the quarter ended
September 30, 2004, with approximately 150,000 net rentable square feet for an
aggregate of approximately $9.1 million cash. The venture had a nine month
investment period (through September 30, 2004) to identify and acquire
facilities. We are currently working with our joint venture partner for the
potential inclusion of certain of the facilities acquired in 2004 or currently
under contract in the Acquisition Joint Venture, notwithstanding the expiration
of the investment period. However, there can be no assurance that the
Acquisition Joint Venture will acquire any additional facilities.
If the Acquisition Joint Venture does not acquire these facilities, we
expect to fund these acquisitions entirely from our cash on hand.
In June 2004, we acquired a limited partnership interest in one of our
Consolidated Entities, at an acquisition cost of approximately $24,851,000.
In November 1999, we formed a joint venture partnership for the
development of approximately $100 million of self-storage facilities. The
venture is funded solely with equity capital consisting of 51% from us and 49%
from the joint venture partner. The term of the joint venture is 15 years. After
six years, the joint venture partner has the right to cause the Company to
purchase the joint venture partner's interest for an amount necessary to provide
the joint venture partner with a maximum return of 10.75% or less in certain
circumstances. Our estimate of the purchase price of this interest is
approximately $105 million.
64
We currently have a development "pipeline" of 37 projects consisting of
self-storage facilities, conversion of space at facilities that was previously
used for containerized storage and expansions to existing self-storage
facilities with an aggregate estimated cost of approximately $151.6 million. At
September 30, 2004, we have acquired the land for 36 of these projects, which
have an aggregate estimated cost of approximately $146.0 million, and costs
incurred as of September 30, 2004 of approximately $40.7 million. The remaining
facility represents an identified site where we have an agreement in place to
acquire the land, generally within one year. We anticipate that the development
of these projects will be funded solely by the Company.
The development and fill-up of these storage facilities is subject to
significant contingencies such as obtaining appropriate governmental approvals.
We estimate that the amount remaining to be spent of approximately $110.9
million will be incurred over the next 24 months. The following table sets forth
certain information with respect to our development pipeline.
Development Pipeline Summary
Number Net Total Costs incurred
of rentable estimated through Costs to
projects sq. ft. development 9/30/04 complete
--------- --------- ------------ -------------- -----------
(Amounts in thousands)
Facilities currently under construction:
Self-storage facilities 4 261 $ 24,389 $ 11,082 $ 13,307
Expansions and other enhancements to
existing self-storage facilities 9 454 22,439 9,685 12,754
--------- --------- ------------ -------------- -----------
13 715 46,828 20,767 26,061
Facilities awaiting construction, where land
is acquired:
Self-storage facilities 3 286 45,806 17,696 28,110
Expansions and other enhancements to
existing self-storage facilities 20 1,201 53,412 1,990 51,422
--------- --------- ------------ -------------- -----------
23 1,487 99,218 19,686 79,532
Self-storage facilities awaiting
construction, where land has not yet been
acquired 1 56 5,570 233 5,337
--------- --------- ------------ -------------- -----------
Total Development Pipeline 37 2,258 $ 151,616 $ 40,686 $ 110,930
========= ========= ============ ============== ===========
Included in the 29 "expansions and other enhancements of existing
self-storage facilities" are 17 projects associated with the conversion of
industrial space, previously used by the discontinued containerized facility
operations, into self-storage space. The total amount of self-storage space to
come on line from these 17 conversions is approximately 1,192,000 net rentable
square feet of traditional self-storage space at a cost of $40,754,000. Also
included are enhancements which, while they do not add significant incremental
square footage, improve the visual and structural appeal of our existing
self-storage facilities.
We estimate that our development spending in 2005, including the
amounts denoted above with respect to our development pipeline, will approximate
$75 million.
In addition to the above projects, we have four parcels of land held
for development with total costs of approximately $7,580,000 at September 30,
2004.
REPURCHASES OF THE COMPANY'S COMMON STOCK: The Company's Board of
Directors authorized the repurchase from time to time of up to 25,000,000 shares
of our common stock on the open market or in privately negotiated transactions.
For the nine months ended September 30, 2004, we repurchased 409,700 shares of
our common stock for approximately $18,234,000.
From the initial authorization through November 5, 2004, we have
repurchased a total of 22,081,720 shares of common stock at an aggregate cost of
approximately $560.1 million.
65
ITEM 2A. RISK FACTORS
- -----------------------
In addition to the other information in our Form 10-Q and our Form 10-K
for the year ended December 31, 2003, you should consider the following factors
in evaluating the Company:
THE HUGHES FAMILY COULD CONTROL US AND TAKE ACTIONS ADVERSE TO OTHER
SHAREHOLDERS.
At September 30, 2004, the Hughes family owned approximately 36% of our
outstanding shares of common stock. Consequently, the Hughes family could
control matters submitted to a vote of our shareholders, including electing
directors, amending our organizational documents, dissolving and approving other
extraordinary transactions, such as a takeover attempt, even though such actions
may not be favorable to the other common shareholders.
PROVISIONS IN OUR ORGANIZATIONAL DOCUMENTS MAY PREVENT CHANGES IN CONTROL.
Restrictions in our organizational documents may further limit changes
in control. Unless our board of directors waives these limitations, no
shareholder may own more than (1) 2.0% of our outstanding shares of our common
stock or (2) 9.9% of the outstanding shares of each class or series of our
preferred or equity stock. Our organizational documents in effect provide,
however, that the Hughes family may continue to own the shares of our common
stock held by them at the time of the 1995 reorganization. These limitations are
designed, to the extent possible, to avoid a concentration of ownership that
might jeopardize our ability to qualify as a real estate investment trust or
REIT. These limitations, however, also may make a change of control
significantly more difficult (if not impossible) even if it would be favorable
to the interests of our public shareholders. These provisions will prevent
future takeover attempts not approved by our board of directors even if a
majority of our public shareholders deem it to be in their best interests
because they would receive a premium for their shares over the shares' then
market value or for other reasons.
WE WOULD INCUR ADVERSE TAX CONSEQUENCES IF WE FAIL TO QUALIFY AS A REIT.
You will be subject to the risk that we may not qualify as a REIT.
REITs are subject to a range of complex organizational and operational
requirements. As a REIT, we must distribute at least 90% of our REIT taxable
income to our shareholders, including not only holders of our common stock and
equity stock but also holders of our preferred stock. Failure to pay full
dividends on the preferred stock would prevent us from paying dividends on our
common stock and could jeopardize our qualification as a REIT. Other
restrictions apply to our income and assets. Our REIT status also depends upon
the ongoing qualification of PS Business Parks, Inc. as a REIT, as a result of
our substantial ownership interest in that company.
For any taxable year that we fail to qualify as a REIT and the relief
provisions do not apply, we would be taxed at the regular corporate rates on all
of our taxable income, whether or not we make any distributions to our
shareholders. Those taxes would reduce the amount of cash available for
distribution to our shareholders or for reinvestment. As a result, our failure
to qualify as a REIT during any taxable year could have a material adverse
effect upon us and our shareholders. Furthermore, unless certain relief
provisions apply, we would not be eligible to elect REIT status again until the
fifth taxable year that begins after the first year for which we fail to
qualify.
COMPLIANCE WITH SECTION 404 OF THE SARBANES - OXLEY ACT
Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002, we will be
required, beginning with our fiscal year ending December 31, 2004, to include in
our annual report our assessment of the effectiveness of our internal control
over financial reporting and our audited financial statements as of that date.
Furthermore, our independent registered public accounting firm, Ernst & Young,
will be required to attest to whether our assessment of the effectiveness of our
internal control over financial reporting is fairly stated in all material
respects and separately report on whether it believes we maintained, in all
material respects, effective internal control over financial reporting as of
December 31, 2004. We have not yet completed our assessment of the effectiveness
of our internal control.
66
While we believe that we will meet these requirements, if we fail to
timely complete this assessment, or if our independent registered public
accounting firm cannot timely attest to our assessment, we could be subject to
regulatory sanctions and a loss of public confidence in our internal control. In
addition, any failure to implement required new or improved controls, or
difficulties encountered in their implementation, could harm our operating
results or cause us to fail to timely meet our regulatory reporting obligations.
PS Business Parks, Inc., ("PSB"), an entity that we have a 44% equity
interest in at September 30, 2004, is subject to the same reporting requirement.
PSB is currently behind schedule in completing its assessment of the
effectiveness of its internal controls; however, PSB's management believes that
it will be able to timely complete its assessment. Because we record our equity
share of PSB's reported net income in our income statements, PSB's failure to
timely complete its assessment of internal control, or its failure to implement
effective internal controls, could affect the reliability of our recorded Equity
in Earnings of Unconsolidated Entities and, consequently, our net income.
WE MAY PAY SOME TAXES, REDUCING CASH AVAILABLE FOR SHAREHOLDERS.
Even if we qualify as a REIT for Federal income tax purposes, we are
required to pay some federal, state and local taxes on our income and property.
Several corporate subsidiaries of the Company have elected to be treated as
"taxable REIT subsidiaries" of the Company for federal income tax purposes since
January 1, 2001. A taxable REIT subsidiary is a fully taxable corporation and is
limited in its ability to deduct interest payments made to us. In addition, we
will be subject to a 100% penalty tax on some payments that we receive if the
economic arrangements among our tenants, our taxable REIT subsidiaries and us
are not comparable to similar arrangements among unrelated parties. To the
extent that the Company or any taxable REIT subsidiary is required to pay
federal, state or local taxes, we will have less cash available for distribution
to shareholders.
WE WOULD INCUR A CORPORATE LEVEL TAX IF WE SELL CERTAIN ASSETS.
We will generally be subject to a corporate level tax on any net
built-in gain if, before November 2005, we sell any of the assets we acquired in
the November 1995 reorganization.
WE MAY BE DEPENDENT UPON AUTOMATED PROCESSES AND THE INTERNET.
We have become increasingly centralized and dependent upon automated
information technology processes. As a result, we could be severely impacted by
a catastrophic occurrence, such as a natural disaster or a terrorist attack. In
addition, a portion of our business operations are conducted over the internet,
increasing the risk of viruses that could cause system failures and disruptions
of operations.
WE AND OUR SHAREHOLDERS ARE SUBJECT TO FINANCING RISKS.
Debt increases the risk of loss. In making real estate investments, we
may borrow money, which increases the risk of loss. At September 30, 2004, our
debt of $35.3 million was less than 1.0% of our total assets.
Certain securities have a liquidation preference over our common stock
and Equity Stock, Series A. If we liquidated, holders of our preferred
securities would be entitled to receive liquidating distributions, plus any
accrued and unpaid distributions, before any distribution of assets to the
holders of our common stock and Equity Stock, Series A. Holders of preferred
securities are entitled to receive, when declared by our board of directors,
cash distributions in preference to holders of our common stock and Equity
Stock, Series A.
SINCE OUR BUSINESS CONSISTS PRIMARILY OF ACQUIRING AND OPERATING REAL ESTATE, WE
ARE SUBJECT TO REAL ESTATE OPERATING RISKS.
67
The value of our investments may be reduced by general risks of real
estate ownership. Since we derive substantially all of our income from real
estate operations, we are subject to the general risks of owning real
estate-related assets, including:
o lack of demand for rental spaces or units in a locale;
o changes in general economic or local conditions;
o Natural disasters, such as earthquakes;
o potential terrorist attacks;
o changes in supply of or demand for similar or competing facilities in
an area;
o the impact of environmental protection laws;
o changes in interest rates and availability of permanent mortgage funds
which may render the sale or financing of a property difficult or
unattractive; and
o changes in tax, real estate and zoning laws.
In addition, we self-insure certain of our property loss, liability,
and workers compensation risks that other real estate companies may use
third-party insurers for. This results in a higher risk of losses that aren't
covered by third-party insurance contracts, as described in Note 14 to the
Company's financial statements at September 30, 2004 under "Insurance and Loss
Exposure."
There is significant competition among self-storage facilities and from
other storage alternatives. Most of our properties are self-storage facilities,
which generated 93% of our revenue for the nine months ended September 30, 2004.
Local market conditions will play a significant part in how competition will
affect us. Competition in the market areas in which many of our properties are
located from other self-storage facilities and other storage alternatives is
significant and has affected the occupancy levels, rental rates and operating
expenses of some of our properties. Any increase in availability of funds for
investment in real estate may accelerate competition. Further development of
self-storage facilities may intensify competition among operators of
self-storage facilities in the market areas in which we operate.
We may incur significant environmental costs and liabilities. As an
owner and operator of real properties, under various federal, state and local
environmental laws, we are required to clean up spills or other releases of
hazardous or toxic substances on or from our properties. Certain environmental
laws impose liability whether or not the owner knew of, or was responsible for,
the presence of the hazardous or toxic substances. In some cases, liability may
not be limited to the value of the property. The presence of these substances,
or the failure to properly remediate any resulting contamination, whether from
environmental or microbial issues, also may adversely affect the owner's or
operator's ability to sell, lease or operate its property or to borrow using its
property as collateral.
We have conducted preliminary environmental assessments of most of our
properties (and intend to conduct these assessments in connection with property
acquisitions) to evaluate the environmental condition of, and potential
environmental liabilities associated with, our properties. These assessments
generally consist of an investigation of environmental conditions at the
property (not including soil or groundwater sampling or analysis), as well as a
review of available information regarding the site and publicly available data
regarding conditions at other sites in the vicinity. In connection with these
property assessments, our operations and recent property acquisitions, we have
become aware that prior operations or activities at some facilities or from
nearby locations have or may have resulted in contamination to the soil or
groundwater at these facilities. In this regard, some of our facilities are or
may be the subject of federal or state environment investigations or remedial
actions. We have obtained, with respect to recent acquisitions, and intend to
obtain with respect to pending or future acquisitions, appropriate purchase
price adjustments or indemnifications that we believe are sufficient to cover
any related potential liability. Although we cannot provide any assurance, based
on the preliminary environmental assessments, we believe we have funds available
to cover any liability from environmental contamination or potential
contamination and we are not aware of any environmental contamination of our
facilities material to our overall business, financial condition or results of
operation.
68
There has been an increasing number of claims and litigation against
owners and managers of rental properties relating to moisture infiltration,
which can result in mold or other property damage. When we receive a complaint
concerning moisture infiltration, condensation or mold problems and/or become
aware that an air quality concern exists, we implement corrective measures in
accordance with guidelines and protocols we have developed with the assistance
of outside experts. We seek to work proactively with our tenants to resolve
moisture infiltration and mold-related issues, subject to our contractual
limitations on liability for such claims. However, we can make no assurance that
material legal claims relating to moisture infiltration and the presence of, or
exposure to, mold will not arise in the future.
Delays in development and fill-up of our properties would reduce our
profitability: Since January 1, 2000, we have opened 65 newly developed self
storage facilities and 17 facilities that combine self-storage and containerized
storage space at the same location, with aggregate development costs of $579.4
million. In addition, at September 30, 2004 the Company had 37 projects in
development that are expected to begin construction generally by December 31,
2004. These 37 projects have total estimated costs of $151.6 million.
Construction delays due to weather, unforeseen site conditions, personnel
problems, and other factors, as well as cost overruns, would adversely affect
the Company's profitability. Delays in the rent-up of newly developed facilities
as a result of competition or other factors would also adversely impact the
Company's profitability.
Property taxes can increase and cause a decline in yields on
investments. Each of our properties is subject to real property taxes. These
real property taxes may increase in the future as property tax rates change and
as our properties are assessed or reassessed by tax authorities. Such increases
could adversely impact the Company's profitability.
We must comply with the Americans with Disabilities Act and fire and
safety regulations, which can require significant expenditures: All our
properties must comply with the Americans with Disabilities Act and with related
regulations (the "ADA"). The ADA has separate compliance requirements for
"public accommodations" and "commercial facilities," but generally requires that
buildings be made accessible to persons with disabilities. Various state laws
impose similar requirements. A failure to comply with the ADA or similar state
laws could result in government imposed fines on us and the award of damages to
individuals affected by the failure. In addition, we must operate our properties
in compliance with numerous local fire and safety regulations, building codes,
and other land use regulations. Compliance with these requirements can require
us to spend substantial amounts of money, which would reduce cash otherwise
available for distribution to shareholders. Failure to comply with these
requirements could also affect the marketability of our real estate facilities.
WE HAVE NO INTEREST IN CANADIAN SELF-STORAGE FACILITIES OWNED BY THE HUGHES
FAMILY.
B. Wayne Hughes, Chairman of the Board, and his family (the "Hughes
Family") have ownership interests in, and operate, approximately 40 self-storage
facilities in Canada under the name "Public Storage." We currently do not own
any interests in these facilities nor do we own any facilities in Canada. The
Hughes Family owns approximately 36% of our common stock outstanding at
September 30, 2004. We have a right of first refusal to acquire the stock or
assets of the corporation engaged in the operation of the 40 self-storage
facilities in Canada if the Hughes family or the corporation agrees to sell
them. However, we have no interest in the operations of this corporation, have
no right to acquire this stock or assets unless the Hughes family decides to
sell, and receive no benefit from the profits and increases in value of the
Canadian self-storage facilities.
69
Company personnel have been engaged in the supervision and the
operation of these properties and have provided certain administrative services
for the Canadian owners, and certain other services, primarily tax services,
with respect to certain other Hughes Family interests. The Hughes Family and the
Canadian owners have reimbursed us at cost for these services in the amount of
US$ 542,499 with respect to the Canadian operations and US$151,063 for other
services during 2003. There have been conflicts of interest in allocating time
of our personnel between Company properties, the Canadian properties, and
certain other Hughes Family interests. The sharing of Company personnel with the
Canadian entities was substantially eliminated by December 31, 2003.
The corporation engaged in the operations of the Canadian facilities
has advised us that it intends to reorganize the entities owning and operating
the Canadian facilities and has proposed that the Company consent to this
reorganization, which would impact the license agreement and the right of first
refusal agreement with the Company. The reorganization is designed to enhance
the entities' financial flexibility and growth potential. In November 2004, the
Board appointed a special committee, comprised of independent directors, to
consider the Company's alternatives in this matter, including a possible
investment in the reorganized Canadian entities.
OUR CONTAINERIZED STORAGE BUSINESS HAS INCURRED OPERATING LOSSEs.
Public Storage Pickup & Delivery ("PSPUD") was organized in 1996 to
operate a containerized storage business. We own all of the economic interest of
PSPUD. Since PSPUD will operate profitably only if it can succeed in the
relatively new field of containerized storage, we cannot provide any assurance
as to its profitability. PSPUD incurred operating losses of $10,058,000 in 2002,
generated an operating profit of $2,543,000 in 2003 and $1,129,000 for the nine
months ended September 30, 2004. PSPUD closed 39 of 55 facilities that were
deemed not strategic to the Company's business plan since 2002.
INCREASES IN INTEREST RATES MAY ADVERSELY AFFECT THE PRICE OF OUR COMMON STOCK.
One of the factors that influences the market price of our common stock
and out other securities is the annual rate of distributions that we pay on the
securities, as compared with interest rates. An increase in interest rates may
lead purchasers of REIT shares to demand higher annual distribution rates, which
could adversely affect the market price of our common stock and other
securities.
TERRORIST ATTACKS AND THE POSSIBILITY OF WIDER ARMED CONFLICT MAY HAVE AN
ADVERSE IMPACT ON OUR BUSINESS AND OPERATING RESULTS AND COULD DECREASE THE
VALUE OF OUR ASSETS.
Terrorist attacks and other acts of violence or war, such as those that
took place on September 11, 2001, could have a material adverse impact on our
business and operating results. There can be no assurance that there will not be
further terrorist attacks against the United States or its businesses or
interests. Attacks or armed conflicts that directly impact one or more of our
properties could significantly affect our ability to operate those properties
and thereby impair our operating results. Further, we may not have insurance
coverage for losses caused by a terrorist attack. Such insurance may not be
available, or if it is available and we decide to obtain such terrorist
coverage, the cost for the insurance may be significant in relationship to the
risk overall. In addition, the adverse effects that such violent acts and
threats of future attacks could have on the U.S. economy could similarly have a
material adverse effect on our business and results of operations. Finally,
further terrorist acts could cause the United States to enter into a wider armed
conflict which could further impact our business and operating results.
RECENTLY ENACTED TAX LEGISLATION COULD ADVERSELY AFFECT THE PRICE OF OUR STOCK.
Recently enacted tax legislation generally reduces the maximum tax rate
for dividends payable to individuals to 15% through 2008. Dividends payable by
REITs, however, generally continue to be taxed at the normal rate applicable to
the individual recipient, rather than the preferential rates applicable to other
dividends. Although this legislation does not adversely affect the taxation of
REITs or dividends paid by REITs, the more favorable rates applicable to regular
corporate dividends could cause investors who are individuals to perceive
investments in REITs to be relatively less attractive than investments in the
stocks of non-REIT corporations that pay dividends, which could adversely affect
the value of the stock of REITs, including our common stock.
70
DEVELOPMENTS IN CALIFORNIA MAY HAVE AN ADVERSE IMPACT ON OUR BUSINESS.
We are headquartered in, and approximately one-quarter of our
properties are located in, California. California is facing serious budgetary
problems. Action that may be taken in response to these problems, such as an
increase in property taxes on commercial properties, could adversely impact our
business and results of operations. In addition, we could be adversely impacted
by the recently enacted legislation and recent ballot initiatives mandating
medical insurance for employees of California businesses and members of their
families beginning in 2006.
ITEM 3. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK
- -------------------------------------------------------------------
To limit our exposure to market risk, we principally finance our
operations and growth with permanent equity capital, consisting of either common
or preferred stock. At September 30, 2004, our debt as a percentage of total
shareholders' equity (based on book values) was 0.8%.
Our preferred stock is not redeemable at the option of the holders.
Except under certain conditions relating to the Company's qualification as a
REIT, the Preferred Stock is not redeemable by the Company prior to the
following dates: Series E - January 31, 2005, Series F - April 30, 2005, Series
Q - January 19, 2006, Series R - September 28, 2006, Series S - October 31,
2006, Series T - January 18, 2007, Series U - February 19, 2007, Series V -
September 30, 2007, Series W - October 6, 2008, Series X - November 13, 2008,
Series Y - January 2, 2009, Series Z - March 5, 2009, Series A - March 31, 2009,
Series B - June 30, 2009 and Series C - September 13, 2009. On or after the
respective dates, each of the series of Preferred Stock will be redeemable at
the option of the Company, in whole or in part, at $25 per share (or depositary
share in the case of the Series Q through Series X, Series Z, Series A through
Series C), plus accrued and unpaid dividends through the redemption date.
Our market risk sensitive instruments include notes payable, which
totaled $35.3 million at September 30, 2004 ($74.8 million including $39.5 in
debt assumed in connection with property acquisitions from October 1, 2004
through November 8, 2004). All of the Company's notes payable bear interest at
fixed rates. See Note 7 to the consolidated financial statements at September
30, 2004 for approximate principal maturities of the notes payable at September
30, 2004.
ITEM 4. CONTROLS AND PROCEDURES
- --------------------------------
The Company maintains disclosure controls and procedures that are
designed to ensure that information required to be disclosed in reports the
Company files and submits under the Exchange Act, is recorded, processed,
summarized and reported within the time periods specified in accordance with SEC
guidelines and that such information is communicated to the Company's
management, including its Chief Executive Officer and Chief Financial Officer,
to allow timely decisions regarding required disclosure based on the definition
of "disclosure controls and procedures" in Rules 13a-15(e) of the Exchange Act.
In designing and evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and
operated, can provide only reasonable assurance of achieving the desired control
objectives and management necessarily was required to apply its judgment in
evaluating the cost-benefit relationship of possible controls and procedures in
reaching that level of reasonable assurance. Also, the Company has investments
in certain unconsolidated entities. As the Company does not control or manage
these entities, its disclosure controls and procedures with respect to such
entities are substantially more limited than those it maintains with respect to
its consolidated subsidiaries.
As of the end of the fiscal quarter covered by this report, the Company
carried out an evaluation, under the supervision and with the participation of
the Company's management, including the Company's Chief Executive Officer and
the Company's Chief Financial Officer, of the effectiveness of the design and
operation of the Company's disclosure controls and procedures (as such term is
defined in Rules 13a - 15(e) and 15d - 15(e) under the Securities Act of 1934 as
amended) as of the end of the period covered by this report. Based upon this
evaluation, the Company's Chief Executive Officer and Chief Financial Officer
concluded that, as of the end of such period, the Company's disclosure controls
and procedures were effective.
There have not been any changes in our internal control over financial
reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the
Exchange Act) during the fiscal quarter to which this report relates that have
materially affected, or are reasonably likely to materially affect, our internal
control over financial reporting.
71
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
-----------------
Serrao v. Public Storage, Inc. (filed April 2003)
- --------------------------------------------------
(Superior Court - Orange County)
- --------------------------------
The plaintiff in this case filed a suit against the Company on behalf
of a putative class of renters who rented self-storage units from the Company.
Plaintiff alleges that the Company misrepresented the size of its storage units,
has brought claims under California statutory and common law relating to
consumer protection, fraud, unfair competition, and negligent misrepresentation,
and is seeking monetary damages, restitution, and declaratory and injunctive
relief.
The claim in this case is substantially similar to those in Henriquez
v. Public Storage, Inc., which was disclosed in prior reports. In January 2003,
the plaintiff caused the Henriquez action to be dismissed.
Based upon the uncertainty inherent in any putative class action, the
Company cannot presently determine the potential damages, if any, or the
ultimate outcome of this litigation. On November 3, 2003, the court granted the
Company's motion to strike the plaintiff's nationwide class allegations and to
limit any putative class to California residents only. The Company is vigorously
contesting the claims upon which this lawsuit is based including class
certification efforts.
Salaam et al v. Public Storage, Inc. (filed February 2000) (Superior Court -
- --------------------------------------------------------------------------------
Sacramento County); Holzman et al v. Public Storage, Inc. (filed October 2004)
- ------------------------------------------------------------------------------
(Superior Court - Sacramento County)
- ------------------------------------
The plaintiffs in the Salaam case are suing the Company on behalf of a
putative class of California resident property managers who claim that they were
not compensated for all the hours they worked. The named plaintiffs have
indicated that their claims total less than $20,000 in aggregate. On December 1,
2003, the California Court of Appeals affirmed the Supreme Court's 2002 denial
of plaintiff's motion for class certification. The affirmation of the denial of
class certification does not address the claim under the California Unfair
Business Practices Act.
The plaintiffs in the Holzman case, who are represented by the same
attorneys as the Salaam plaintiffs, are seeking substantially the same claims
with additional minor variations in an acknowledged second effort to proceed as
a class, in reliance on a recent California Supreme Court case. The plaintiffs
have not yet identified an aggregate value of their claims which, on an
individual basis, are alleged wage losses of $4000 or less. The plaintiffs also
assert claims under the California Unfair Business Practices Act.
The maximum potential liability for both of these cases cannot be
estimated, but can only be increased if claims are permitted to be brought on
behalf of others under the California Unfair Business Practices Act or, in the
Holzman case, if plaintiff prevails on a motion for class certification.
The Company is continuing to vigorously contest the claims in these
cases and intends to resist any expansion beyond the named plaintiffs, including
by opposing claims on behalf of others under the California Unfair Business
Practices Act or, in the case of the Holzman case, for class certification. The
Company cannot presently determine the potential damages, if any, or the
ultimate outcome of this litigation.
Gustavson et al v. Public Storage, Inc. (filed June 2003)
- ----------------------------------------------------------
(Superior court - Los Angeles County)
- -------------------------------------
In November 2002, a shareholder of the Company made a demand on the
Board of Directors that challenged the fairness of the Company's acquisition of
PS Insurance Company, Ltd. ("PSIC") and demanded that the Board recover the
profits earned by PSIC from November 1995 through December 2001 and that the
entire purchase price paid by the Company for PSIC in excess of PSIC's net
assets be returned to the Company.
72
The contract to acquire PSIC was approved by the independent directors
of the Company in March 2001, and the transaction was closed in December 2001.
PSIC was formerly owned by B. Wayne Hughes, currently the Chairman of the Board
(and in 2001 also the Chief Executive Officer) of the Company, B. Wayne Hughes,
Jr., currently a director (and in 2001 also an officer) of the Company and
Tamara H. Gustavson, who in 2001 was an officer of the Company. In exchange for
the Hughes family's shares in PSIC, the Company issued to them 1,439,765 shares
of common stock (or a net of 1,138,733 shares, after taking into account 301,032
shares held by PSIC).
The shareholder has threatened litigation against the Hughes family and
the directors of the Company arising out of this transaction and alleged a
pattern of deceptive disclosures with respect to PSIC since 1995. In December
2002, the Board held a special meeting to authorize an inquiry by its
independent directors to review the fairness to the Company's shareholders of
its acquisition of PSIC and the ability of the Company to have started its own
tenant reinsurance business in 1995. The Company believes that, prior to the
effectiveness in 2001 of the federal REIT Modernization Act and corresponding
California legislation that authorized the creation and ownership of "taxable
REIT subsidiaries," the ownership by the Company of a reinsurance business
relating to its tenants would have jeopardized the Company's status as a REIT
and that other REITs faced similar concerns about tenant insurance programs.
In June 2003, the Hughes family filed a complaint for declaratory
relief relating to the Company's acquisition of PSIC naming the Company as
defendant. The Hughes family is seeking that the court make (i) a binding
declaration that the Company either is not entitled to recover profits or other
moneys earned by PSIC from November 1995 through December 2001; or alternatively
the amounts that the Hughes family should be ordered to surrender to the Company
if the court determines that the Company is entitled to recover any such profits
or moneys; and (ii) a binding declaration either that the Company cannot
establish that the acquisition agreement was not just and reasonable as to the
Company at the time it was authorized, approved or ratified; or alternatively
the amounts that the Hughes family should surrender to the Company, if the court
determines that the agreement was not just and reasonable to the Company at that
time. The Hughes family is not seeking any payments from the Company. In the
event of a determination that the Hughes family is obligated to pay certain
amounts to the Company, the complaint states that they have agreed to be bound
by that determination to pay such amounts to the Company.
In July 2003 the Company filed an answer to the Hughes family's
complaint requesting a final judicial determination of the Company's rights of
recovery against the Hughes family in respect of PSIC. In September 2003, by
order of the Superior Court, Justice Malcolm Lucas, a former chief justice of
the California Supreme Court, was appointed to try the case. Discovery is
proceeding and Justice Lucas has set this matter for trial at the end of March,
2005. We believe that the lawsuit by the Hughes family will ultimately resolve
matters relating to PSIC and will not have any financially adverse effect on the
Company (other than the costs and other expenses relating to the lawsuit).
The Company is a party to various claims, complaints, and other legal
actions that have arisen in the normal course of business from time to time. The
Company believes that the outcome of these other pending legal proceedings, in
the aggregate, will not have a material adverse effect upon the operations or
financial portion of the Company.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
-----------------------------------------------------------
On June 12, 1998, we announced that the Board of Directors (the
"Directors") authorized the repurchase from time to time of up to 10,000,000
shares of the Company's common stock on the open market or in privately
negotiated transactions. On subsequent dates the Directors increased the
repurchase authorization, the last being April 13, 2001, when the Board of
Directors increased the repurchase authorization to 25,000,000 shares.
The following table contains information regarding the company's
repurchase of its common stock during the quarter.
73
ISSUER PURCHASES OF EQUITY SECURITIES:
Total Number of Maximum Number of
Shares Purchased as Shares that May
Total Number Part of Publicly Yet Be Purchased
of Shares Average Price Announced Plans or Under the Plans or
Period Covered Purchased Paid per Share Programs Programs
- ----------------------------------- ------------- -------------- -------------------- ------------------
July 1 through July 31, 2004 - - 22,081,720 2,918,280
August 1 through August 31, 2004 - - 22,081,720 2,918,280
September 1 through September 30,
2004 - - 22,081,720 2,918,280
------------- --------------
Total - -
============= ==============
See Notes 8, 9 and 15 for additional information on repurchases and
redemptions of equity securities.
74
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits:
3.1 Restated Articles of Incorporation. Filed with Registrant's
Registration Statement No. 33-54557 and incorporated herein by
reference.
3.2 Certificate of Determination for the 10% Cumulative Preferred Stock,
Series A. Filed with Registrant's Registration Statement No. 33-54557
and incorporated herein by reference.
3.3 Amendment to Certificate of Determination for the 10% Cumulative
Preferred Stock, Series A. Filed with the Registrant's Form 10-Q for
the quarterly period ended March 31, 2004 and incorporated herein by
reference.
3.4 Certificate of Determination for the 9.20% Cumulative Preferred Stock,
Series B. Filed with Registrant's Registration Statement No. 33-54557
and incorporated herein by reference.
3.5 Amendment to Certificate of Determination for the 9.20% Cumulative
Preferred Stock, Series B. Filed with Registrant's Registration
Statement No. 33-56925 and incorporated herein by reference.
3.6 Amendment to Certificate of Determination for the 9.20% Cumulative
Preferred Stock Series B. Filed with the Registrant's Form 10-Q for the
quarterly period ended June 30, 2004 and incorporated herein by
reference.
3.7 Certificate of Determination for the 8.25% Convertible Preferred Stock.
Filed with Registrant's Registration Statement No. 33-54557 and
incorporated herein by reference.
3.8 Certificate of Determination for the Adjustable Rate Cumulative
Preferred Stock, Series C. Filed with Registrant's Registration
Statement No. 33-54557 and incorporated herein by reference.
3.9 Amendment to Certificate of Determination for the Adjustable Rate
Cumulative Preferred Stock Series C. Filed herewith.
3.10 Certificate of Determination for the 9.50% Cumulative Preferred Stock,
Series D. Filed with Registrant's Form 8-A/A Registration Statement
relating to the 9.50% Cumulative Preferred Stock, Series D and
incorporated herein by reference.
3.11 Certificate of Determination for the 10% Cumulative Preferred Stock,
Series E. Filed with Registrant's Form 8-A/A Registration Statement
relating to the 10% Cumulative Preferred Stock, Series E and
incorporated herein by reference.
3.12 Certificate of Determination for the 9.75% Cumulative Preferred Stock,
Series F. Filed with Registrant's Form 8-A/A Registration Statement
relating to the 9.75% Cumulative Preferred Stock, Series F and
incorporated herein by reference.
3.13 Registration Statement No. 33-63947 and incorporated herein by
reference.
3.14 Certificate of Amendment of Articles of Incorporation. Filed with
Registrant's Registration Statement No. 33-63947 and incorporated
herein by reference.
3.15 Certificate of Determination for the 8-7/8% Cumulative Preferred Stock,
Series G. Filed with Registrant's Form 8-A/A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 8-7/8% Cumulative Preferred Stock, Series G and incorporated herein
by reference.
75
3.16 Certificate of Determination for the 8.45% Cumulative Preferred Stock,
Series H. Filed with Registrant's Form 8-A/A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 8.45% Cumulative Preferred Stock, Series H and incorporated herein
by reference.
3.17 Certificate of Determination for the Convertible Preferred Stock,
Series CC. Filed with Registrant's Registration Statement No. 333-03749
and incorporated herein by reference.
3.18 Certificate of Correction of Certificate of Determination for the
Convertible Participating Preferred Stock. Filed with Registrant's
Registration Statement No. 333-08791 and incorporated herein by
reference.
3.19 Certificate of Determination for 8-5/8% Cumulative Preferred Stock,
Series I. Filed with Registrant's Form 8-A/A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 8-5/8% Cumulative Preferred Stock, Series I and incorporated herein
by reference.
3.20 Certificate of Amendment of Articles of Incorporation. Filed with
Registrant's Registration Statement No. 333-18395 and incorporated
herein by reference.
3.21 Certificate of Determination for Equity Stock, Series A. Filed with
Registrant's Form 10-Q for the quarterly period ended June 30, 1997 and
incorporated herein by reference.
3.22 Certificate of Determination for Equity Stock, Series AA. Filed with
Registrant's Form 10-Q for the quarterly period ended September 30,
1999 and incorporated herein by reference.
3.23 Certificate Decreasing Shares Constituting Equity Stock, Series A.
Filed with Registrant's Form 10-Q for the quarterly period ended
September 30, 1999 and incorporated herein by reference.
3.24 Certificate of Determination for Equity Stock, Series A. Filed with
Registrant's Form 10-Q for the quarterly period ended September 30,
1999 and incorporated herein by reference.
3.25 Certificate of Determination for 8% Cumulative Preferred Stock, Series
J. Filed with Registrant's Form 8-A/A Registration Statement relating
to the Depositary Shares Each Representing 1/1,000 of a Share of 8%
Cumulative Preferred Stock, Series J and incorporated herein by
reference.
3.26 Certificate of Correction of Certificate of Determination for the 8.25%
Convertible Preferred Stock. Filed with Registrant's Registration
Statement No. 333-61045 and incorporated herein by reference.
3.27 Certificate of Determination for 8-1/4% Cumulative Preferred Stock,
Series K. Filed with Registrant's Form 8-A/A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 8-1/4% Cumulative Preferred Stock, Series K and incorporated herein
by reference.
3.28 Certificate of Determination for 8-1/4% Cumulative Preferred Stock,
Series L. Filed with Registrant's Form 8-A/A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 8-1/4% Cumulative Preferred Stock, Series L and incorporated herein
by reference.
3.29 Certificate of Determination for 8.75% Cumulative Preferred Stock,
Series M. Filed with Registrant's Form 8-A/A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 8.75% Cumulative Preferred Stock, Series M and incorporated herein
by reference.
3.30 Certificate of Determination for Equity Stock, Series AAA. Filed with
Registrant's Current Report on Form 8-K dated November 15, 1999 and
incorporated herein by reference.
3.31 Certificate of Determination for 9.5% Cumulative Preferred Stock,
Series N. Filed with Registrant's Annual Report on Form 10-K for the
year ended December 31, 1999 and incorporated herein by reference.
76
3.32 Certificate of Determination for 9.125% Cumulative Preferred Stock,
Series O. Filed with Registrant's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 2000 and incorporated herein by
reference.
3.33 Certificate of Determination for 8.75% Cumulative Preferred Stock,
Series P. Filed with Registrant's Quarterly Report on Form 10-Q for the
quarterly period ended June 30, 2000 and incorporated herein by
reference.
3.34 Certificate of Determination for 8.600% Cumulative Preferred Stock,
Series, Q. Filed with Registrant's Form 8-A/A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 8.600% Cumulative Preferred Stock, Series Q and incorporated herein
by reference.
3.35 Amendment to Certificate of Determination for Equity Stock, Series A.
Filed with Registrant's Quarterly Report on Form 10-Q for the quarterly
period ended June 30, 2001 and incorporated herein by reference.
3.36 Certificate of Determination for 8.000% Cumulative Preferred Stock,
Series R. Filed with Registrant's Form 8-A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 8.000% Cumulative Preferred Stock, Series R and incorporated herein
by reference.
3.37 Certificate of Determination for 7.875% Cumulative Preferred Stock,
Series S. Filed with Registrant's Form 8-A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 7.875% Cumulative Preferred Stock, Series S and incorporated herein
by reference.
3.38 Certificate of Determination for 7.625% Cumulative Preferred Stock,
Series T. Filed with Registrant's Form 8-A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 7.625% Cumulative Preferred Stock, Series T and incorporated herein
by reference.
3.39 Certificate of Determination for 7.625% Cumulative Preferred Stock,
Series U. Filed with Registrant's Form 8-A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 7.625% Cumulative Preferred Stock, Series U and incorporated herein
by reference.
3.40 Amendment to Certificate of Determination for 7.625% Cumulative
Preferred Stock, Series T. Filed with Registrant's Quarterly Report on
Form 10-Q for the quarterly period ended September 30, 2002 and
incorporated herein by reference.
3.41 Certificate of Determination for 7.500% Cumulative Preferred Stock,
Series V. Filed with Registrant's Form 8-A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 7.500% Cumulative Preferred Stock, Series V and incorporated herein
by reference.
3.42 Certificate of Determination for 6.500% Cumulative Preferred Stock,
Series W. Filed with Registrant's Form 8-A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 6.500% Cumulative Preferred Stock, Series W and incorporated herein
by reference.
3.43 Certificate of Determination for 6.450% Cumulative Preferred Stock,
Series X. Filed with Registrant's Form 8-A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 6.450% Cumulative Preferred Stock, Series X and incorporated herein
by reference.
3.44 Certificate of Determination for the 6.85% Cumulative Preferred Stock,
Series Y. Filed with the Registrant's Form 10-Q for the quarterly
period ended March 31, 2004 and incorporated herein by reference.
3.45 Certificate of Determination for 6.250% Cumulative Preferred Stock,
Series Z. Filed with Registrant's Form 8-A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 6.250% Cumulative Preferred Stock, Series Z and incorporated herein
by reference.
77
3.46 Certificate of Determination for 6.125% Cumulative Preferred Stock,
Series A. Filed with Registrant's Form 8-A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 6.125% Cumulative Preferred Stock, Series A and incorporated herein
by reference.
3.47 Certificate of Determination for 6.40% Cumulative Preferred Stock,
Series NN. Filed with Registrant's Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 2004 and incorporated herein by
reference.
3.48 Certificate of Determination for 7.125% Cumulative Preferred Stock,
Series B. Filed with Registrant's Form 8-A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 7.125% Cumulative Preferred Stock, Series B and incorporated herein
by reference.
3.49 Certificate of Determination for 6.60% Cumulative Preferred Stock,
Series C. Filed with Registrant's Form 8-A Registration Statement
relating to the Depositary Shares Each Representing 1/1,000 of a Share
of 6.60% Cumulative Preferred Stock, Series C and incorporated herein
by reference.
3.50 Bylaws, as amended. Filed with Registrant's Registration Statement No.
33-64971 and incorporated herein by reference.
3.51 Amendment to Bylaws adopted on May 9, 1996. Filed with Registrant's
Registration Statement No. 333-03749 and incorporated herein by
reference.
3.52 Amendment to Bylaws adopted on June 26, 1997. Filed with Registrant's
Registration Statement No. 333-41123 and incorporated herein by
reference.
3.53 Amendment to Bylaws adopted on January 6, 1998. Filed with Registrant's
Registration Statement No. 333-41123 and incorporated herein by
reference.
3.54 Amendment to Bylaws adopted on February 10, 1998. Filed with
Registrant's Current Report on Form 8-K dated February 10, 1998 and
incorporated herein by reference.
3.55 Amendment to Bylaws adopted on March 4, 1999. Filed with Registrant's
Current Report on Form 8-K dated March 4, 1999 and incorporated herein
by reference.
3.56 Amendment to Bylaws adopted on May 6, 1999. Filed with Registrants'
Form 10-Q for the quarterly period ended June 30, 1999 and incorporated
herein by reference.
3.57 Amendment to Bylaws adopted on November 7, 2002. Filed with
Registrant's Quarterly Report on Form 10-Q for the quarterly period
ended September 30, 2002 and incorporated herein by reference.
3.58 Amendment to Bylaws adopted on May 8, 2003. Filed with Registrant's
Quarterly Report on Form 10-Q for the quarterly period ended March 31,
2003 and incorporated herein by reference.
3.59 Amendment to Bylaws adopted on August 5, 2003. Filed with Registrant's
Quarterly Report on Form 10-Q for the quarterly period ended June 30,
2003 and incorporated herein by reference.
3.60 Amendment to Bylaws adopted on March 11, 2004. Filed with Registrant's
Annual Report on Form 10-K for the year ended December 31, 2003 and
incorporated herein by reference.
10.1 Second Amended and Restated Management Agreement by and among
Registrant and the entities listed therein dated as of November 16,
1995. Filed with PS Partners, Ltd.'s Annual Report on Form 10-K for the
year ended December 31, 1996 and incorporated herein by reference.
78
10.2 Amended Management Agreement between Registrant and Public Storage
Commercial Properties Group, Inc. dated as of February 21, 1995. Filed
with Registrant's Annual Report on Form 10-K for the year ended
December 31, 1994 and incorporated herein by reference.
10.3 Loan Agreement between Registrant and Aetna Life Insurance Company
dated as of July 11, 1988. Filed with Registrant's Current Report on
Form 8-K dated July 14, 1988 and incorporated herein by reference.
10.4 Amendment to Loan Agreement between Registrant and Aetna Life Insurance
Company dated as of September 1, 1993. Filed with Registrant's Annual
Report on Form 10-K for the year ended December 31, 1993 and
incorporated herein by reference.
10.5 Second Amended and Restated Credit Agreement by and among Registrant,
Wells Fargo Bank, National Association, as agent, and the financial
institutions party thereto dated as of February 25, 1997. Filed with
Registrant's Registration Statement No. 333-22665 and incorporated
herein by reference.
10.6 Note Assumption and Exchange Agreement by and among Public Storage
Management, Inc., Public Storage, Inc., Registrant and the holders of
the notes dated as of November 13, 1995. Filed with Registrant's
Registration Statement No. 33-64971 and incorporated herein by
reference.
10.7 Registrant's 1990 Stock Option Plan. Filed with Registrant's Annual
Report on Form 10-K for the year ended December 31, 1994 and
incorporated herein by reference.
10.8* Registrant's 1994 Stock Option Plan. Filed with Registrant's Annual
Report on Form 10-K for the year ended December 31, 1997 and
incorporated herein by reference.
10.9* Registrant's 1996 Stock Option and Incentive Plan. Filed with
Registrant's Annual Report on Form 10-K for the year ended December 31,
2000 and incorporated herein by reference.
10.10 Deposit Agreement dated as of December 13, 1995, among Registrant, The
First National Bank of Boston, and the holders of the depositary
receipts evidencing the Depositary Shares Each Representing 1/1,000 of
a Share of 8-7/8% Cumulative Preferred Stock, Series G. Filed with
Registrant's Form 8-A/A Registration Statement relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 8-7/8%
Cumulative Preferred Stock, Series G and incorporated herein by
reference.
10.11 Deposit Agreement dated as of January 25, 1996, among Registrant, The
First national Bank of Boston, and the holders of the depositary
receipts evidencing the Depositary Shares Each Representing 1/1,000 of
a Share of 8.45% Cumulative Preferred Stock, Series H. Filed with
Registrant's Form 8-A/A Registration Statement relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 8.45%
Cumulative Preferred Stock, Series H and incorporated herein by
reference.
10.12** Employment Agreement between Registrant and B. Wayne Hughes dated as of
November 16, 1995. Filed with Registrant's Annual Report on Form 10-K
for the year ended December 31,1995 and incorporated herein by
reference.
10.13 Deposit Agreement dated as of November 1, 1996, among Registrant, The
First National Bank of Boston, and the holders of the depositary
receipts evidencing the Depositary Shares Each Representing 1/1,000 of
a Share of 8-5/8% Cumulative Preferred Stock, Series I. Filed with
Registrant's Form 8-A/A Registration Statement relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 8-5/8%
Cumulative Preferred Stock, Series I and incorporated herein by
reference.
10.14 Limited Partnership Agreement of PSAF Development Partners, L.P.
between PSAF Development, Inc. and the Limited Partner dated as of
April 10, 1997. Filed with Registrant's Form 10-Q for the quarterly
period ended June 30, 1997 and incorporated herein by reference.
79
10.15 Deposit Agreement dated as of August 28, 1997 among Registrant, The
First National Bank of Boston, and the holders of the depositary
receipts evidencing the Depositary Shares Each Representing 1/1,000 of
a Share of 8% Cumulative Preferred Stock, Series J. Filed with
Registrant's Form 8-A/A Registration Statement relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 8% Cumulative
Preferred Stock, Series J and incorporated herein by reference.
10.16 Agreement of Limited Partnership of PS Business Parks, L.P. dated as of
March 17, 1998. Filed with PS Business Parks, Inc.'s Quarterly Report
on Form 10-Q for the quarterly period ended June 30, 1998 and
incorporated herein by reference.
10.17 Deposit Agreement dated as of January 19, 1999 among Registrant,
BankBoston, N.A. and the holders of the depositary receipts evidencing
the Depositary Shares Each Representing 1/1,000 of a Share of 8-1/4%
Cumulative Preferred Stock, Series K. Filed with Registrant's Form
8-A/A Registration Statement relating to the Depositary Shares Each
Representing 1/1,000 of a Share of 8-1/4% Cumulative Preferred Stock,
Series K and incorporated herein by reference.
10.18 Agreement and Plan of Merger among Storage Trust Realty, Registrant and
Newco Merger Subsidiary, Inc. dated as of November 12, 1998. Filed with
Registrant's Registration Statement No. 333-68543 and incorporated
herein by reference.
10.19 Amendment No. 1 to Agreement and Plan of Merger among Storage Trust
Realty, Registrant, Newco Merger Subsidiary, Inc. and STR Merger
Subsidiary, Inc. dated as of January 19, 1999. Filed with registrant's
Registration Statement No. 333-68543 and incorporated herein by
reference.
10.20 Amended and Restated Agreement of Limited Partnership of Storage Trust
Properties, L.P., dated as of March 12, 1999. Filed with Registrant's
Form 10-Q for the quarterly period ended June 30, 1999 and incorporated
herein by reference.
10.21* Storage Trust Realty 1994 Share Incentive Plan. Filed with Storage
Trust Realty's Annual Report on Form 10-K for the year ended December
31, 1997 and incorporated herein by reference.
10.22 Amended and Restated Storage Trust Realty Retention Bonus Plan
effective as of November 12, 1998. Filed with Registrant's Registration
Statement No. 333-68543 and incorporated herein by reference.
10.23 Deposit Agreement dated as of March 10, 1999 among Registrant,
BankBoston, N.A. and the holders of the depositary receipts evidencing
the Depositary Shares Each Representing 1/1,000 of a Share of 8-1/4%
Cumulative Preferred Stock, Series L. Filed with Registrant's Form
8-A/A Registration Statement relating to the Depositary Shares Each
Representing 1/1,000 of a Share of 8-1/4% Cumulative Preferred Stock,
Series L and incorporated herein by reference.
10.24 Note Purchase Agreement and Guaranty Agreement with respect to
$100,000,000 of Senior Notes of Storage Trust Properties, L.P. Filed
with Storage Trust Realty's Annual Report on Form 10-K for the year
ended December 31, 1996 and incorporated herein by reference.
10.25 Deposit Agreement dated as of August 17, 1999 among Registrant,
BankBoston, N.A. and the holders of the depositary receipts evidencing
the Depositary Shares Each Representing 1/1,000 of a Share of 8.75%
Cumulative Preferred Stock, Series M. Filed with Registrant's Form
8-A/A Registration Statement relating to the Depositary Shares Each
Representing 1/1,000 of a Share of 8.75% Cumulative Preferred Stock,
Series M and incorporated herein by reference.
10.26 Limited Partnership Agreement of PSAC Development Partners, L.P. among
PS Texas Holdings, Ltd., PS Pennsylvania Trust and PSAC Storage
Investors, L.L.C. dated as November 15, 1999. Filed with Registrant's
Current Report on Form 8-K dated November 15, 1999 and incorporated
herein by reference.
80
10.27 Agreement of Limited Liability Company of PSAC Storage Investors,
L.L.C. dated as of November 15, 1999. Filed with Registrant's Current
Report on Form 8-K dated November 15, 1999 and incorporated herein by
reference.
10.28 Deposit Agreement dated as of January 14, 2000 among Registrant,
BankBoston, N.A. and the holders of the depositary receipts evidencing
the Depositary Shares Each Representing 1/1,000 of a Share of Equity
Stock, Series A. Filed with Registrant's Form 8-A/A Registration
Statement relating to the Depositary Shares Each Representing 1/1,000
of a Share of Equity Stock, Series A and incorporated herein by
reference.
10.29 Amended and Restated Agreement of Limited Partnership of PSA
Institutional Partners, L.P. among PS Texas Holdings, Ltd. and the
Limited Partners dated as of March 29, 2000. Filed with Registrant's
Annual Report on Form 10-K for the year ended December 31, 1999 and
incorporated herein by reference.
10.30 Amended and Restated Agreement of Limited Partnership of PSA
Institutional Partners, L.P. among PS Texas Holdings, Ltd. and the
Limited Partners dated as of August 11, 2000. Filed with Registrant's
Quarterly Report on Form 10-Q for the quarterly period ended June 30,
2000 and incorporated herein by reference.
10.31* Registrant's 2000 Non-Executive/Non-Director Stock Option and Incentive
Plan. Filed with Registrant's Registration Statement No, 333-52400 and
incorporated herein by reference.
10.32 Deposit Agreement dated as of January 19, 2001 among Registrant, Fleet
National Bank and the holders of the depositary receipts evidencing the
Depositary Shares Each Representing 1/1,000 of a Share of 8.600%
Cumulative Preferred Stock, Series Q. Filed with Registrant's Form
8-A/A Registration Statement relating to the Depositary Shares Each
Representing 1/1,000 of a Share of 8.600% Cumulative Preferred Stock,
Series Q and incorporated herein by reference.
10.33* Registrant's 2001 Non-Executive/Non-Director Stock Option and Incentive
Plan. Filed with Registrant's Registration Statement No. 333-59218 and
incorporated herein by reference.
10.34* Registrant's 2001 Stock Option and Incentive Plan. Filed with
Registrant's Registration Statement No. 333-59218 and incorporated
herein by reference.
10.35 Deposit Agreement dated as of September 28, 2001 among Registrant,
Fleet National Bank and the holders of the depositary receipts
evidencing the Depositary Shares Each Representing 1/1,000 of a Share
of 8.000% Cumulative Preferred Stock, Series R. Filed with Registrant's
Form 8-A Registration Statement relating to the Depositary Shares Each
Representing 1/1,000 of a Share of 8.000% Cumulative Preferred Stock,
Series R and incorporated herein by reference.
10.36 Deposit Agreement dated as of October 31, 2001 among Registrant, Fleet
National Bank and the holder of the depositary receipts evidencing the
Depositary Shares Each Representing 1/1,000 of a Share of 7.875%
Cumulative Preferred Stock, Series S. Filed with Registrant's Form 8-A
Registration Statement relating to the Depositary Shares Each
Representing 1/1,000 of a Share of 7.875% Cumulative Preferred Stock,
Series S and incorporated herein by reference.
10.37 Credit Agreement by and among Registrant, Wells Fargo Bank, National
Association, as agent, and the financial institutions party thereto
dated as of November 1, 2001. Filed with Registrant's Quarterly Report
on Form 10-Q for the quarterly period ended September 30, 2001 and
incorporated herein by reference.
10.38 Deposit Agreement dated as of January 18, 2002 among Registrant,
Equiserve Trust Company N.A. and the holders of the depositary receipts
evidencing the Depositary Shares Each Representing 1/1,000 of a Share
of 7.625% Cumulative Preferred Stock, Series T. Filed with Registrant's
Form 8-A Registration Statement relating to the Depositary Shares Each
Representing 1/1,000 of a Share of 7.625% Cumulative Preferred Stock,
Series T and incorporated herein by reference.
81
10.39 Deposit Agreement dated as of February 19, 2002 among Registrant,
Equiserve Trust Company N.A. and the holders of the depositary receipts
evidencing the Depositary Shares Each Representing 1/1,000 of a Share
of 7.625% Cumulative Preferred Stock, Series U. Filed with Registrant's
Form 8-A Registration Statement relating to the Depositary Shares Each
Representing 1/1,000 of a Share of 7.625% Cumulative Preferred Stock,
Series U and incorporated herein by reference.
10.40 Deposit Agreement dated as of September 30, 2002 among Registrant,
Equiserve Trust Company N.A. and the holders of the depositary receipts
evidencing the Depositary Shares Each Representing 1/1,000 of a Share
of 7.500% Cumulative Preferred Stock, Series V. Filed with Registrant's
Form 8-A Registration Statement relating to the Depositary Shares Each
Representing 1/1,000 of a Share of 7.500% Cumulative Preferred Stock,
Series V and incorporated herein by reference.
10.41** Employment Agreement between Registrant and Harvey Lenkin dated as of
August 5, 2003. Filed with Registrant's Quarterly Report on Form 10-Q
for the quarterly period ended June 30, 2003 and incorporated herein by
reference.
10.42 Deposit Agreement dated as of October 6, 2003 among Registrant,
Equiserve Inc., Equiserve Trust Company N.A. and the holders of the
depositary receipts evidencing the Depositary Shares Each Representing
1/1,000 of a Share of 6.500% Cumulative Preferred Stock, Series W.
Filed with Registrant's Form 8-A Registration Statement relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 6.500%
Cumulative Preferred Stock, Series W and incorporated herein by
reference.
10.43 Deposit Agreement dated as of November 13, 2003 among Registrant,
Equiserve Inc., Equiserve Trust Company N.A. and the holders of the
depositary receipts evidencing the Depositary Shares Each Representing
1/1,000 of a Share of 6.450% Cumulative Preferred Stock, Series X.
Filed with Registrant's Form 8-A Registration Statement relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 6.450%
Cumulative Preferred Stock, Series X and incorporated herein by
reference.
10.44 Deposit Agreement dated as of March 5, 2004 among Registrant, Equiserve
Inc., Equiserve Trust Company N.A. and the holders of the depositary
receipts evidencing the Depositary Shares Each Representing 1/1,000 of
a Share of 6.250% Cumulative Preferred Stock, Series Z. Filed with
Registrant's Form 8-A Registration Statement relating to the Depositary
Shares Each Representing 1/1,000 of a Share of 6.250% Cumulative
Preferred Stock, Series Z and incorporated herein by reference.
10.45 Limited Partnership Agreement of PSAF Acquisition Partners, L.P.
between PS Texas Holdings, Ltd. and the Limited Partner dated as of
December 18, 2003. Filed with Registrant's Annual Report on Form 10-K
for the year ended December 31, 2003 and incorporated herein by
reference.
10.46 Second Amendment to Amended and Restated Agreement of Limited
Partnership of PSA Institutional Partners, L.P. among PS Texas
Holdings, Ltd. and the Limited Partners dated as of March 22, 2004.
Filed with Registrant's Quarterly Report on Form 10-Q for the quarterly
period ended March 31, 2004 and incorporated herein by reference.
10.47 Second Amendment to Credit Agreement by and among Registrant, Wells
Fargo Bank, National Association, as agent, and the financial
institutions party thereto dated as of March 25, 2004. Filed with
Registrant's Quarterly Report on Form 10-Q for the quarterly period
ended March 31, 2004 and incorporated herein by reference.
10.48 Deposit Agreement dated as of March 31, 2004 among Registrant,
Equiserve Inc., Equiserve Trust Company N.A. and the holders of the
depositary receipts evidencing the Depositary Shares Each Representing
1/1,000 of a Share of 6.125% Cumulative Preferred Stock, Series A.
Filed with Registrant's Form 8-A Registration Statement relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 6.125%
Cumulative Preferred Stock, Series A and incorporated herein by
reference.
82
10.49 Deposit Agreement dated as of June 30, 2004 among Registrant, Equiserve
Inc., Equiserve Trust Company N.A. and the holders of the depositary
receipts evidencing the Depositary Shares Each Representing 1/1,000 of
a Share of 7.125% Cumulative Preferred Stock, Series B. Filed with
Registrant's Form 8-A Registration Statement relating to the Depositary
Shares Each Representing 1/1,000 of a Share of 7.125% Cumulative
Preferred Stock, Series B and incorporated herein by reference.
10.50 Deposit Agreement dated as of September 13, 2004 among Registrant,
Equiserve Inc., Equiserve Trust Company N.A. and the holders of the
depositary receipts evidencing the Depositary Shares Each Representing
1/1,000 of a Share of 6.60% Cumulative Preferred Stock, Series C. Filed
with Registrant's Form 8-A Registration Statement relating to the
Depositary Shares Each Representing 1/1,000 of a Share of 6.60%
Cumulative Preferred Stock, Series C and incorporated herein by
reference.
10.51 Amended and Restated Agreement of Limited Partnership of PSA
Institutional Partners, L.P. among PS Texas Holdings, Ltd. and the
Limited Partners dated as of October 12, 2004. Filed herewith.
11 Statement Re: Computation of Earnings per Share. Filed herewith.
12 Statement Re: Computation of Ratio of Earnings to Fixed Charges. Filed
herewith.
31.1 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002. Filed herewith.
31.2 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002. Filed herewith.
31.3 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of
2002. Filed herewith.
32 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of
2002. Filed herewith.
91.1 2001 Stock Option and Incentive Plan Non-Qualified Stock Option
Agreement. Filed herewith.
99.2 Restricted Stock Unit Agreement. Filed herewith.
99.3 2001 Stock Option and Incentive Plan Outside Director, Stock Option
Agreement. Filed herewith.
* Compensatory benefit plan.
** Management contract.
(b) Reports on Form 8-K
The Company furnished a Current Report on from 8-K dated August 5, 2004
(filed August 6, 2004), pursuant to Item 7 with its press release
announcing its results for the quarter ended June 30, 2004.
The Company filed a Current Report on Form 8-K, dated September 8, 2004
(filed September 9, 2004), pursuant to Item 5, in connection with the
Company's public offering in September 2004 of depositary shares, each
representing 1/1,000 of a share of the Company's 6.60% Cumulative
Preferred Stock, Series C.
83
SIGNATURES
Pursuant to the requirement of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
DATED: November 9, 2004
PUBLIC STORAGE, INC.
By: /s/ John Reyes
-------------------------------------
John Reyes
Senior Vice President and
Chief Financial Officer
(Principal financial officer and duly
authorized officer)
84