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, 2007
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: 001-33519
PUBLIC STORAGE
------------------------------------------------------
(Exact name of registrant as specified in its charter)
Maryland 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 at least the past 90 days.
[X] Yes [ ] No
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer [X] Accelerated Filer [ ] Non-accelerated Filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act).
[ ] Yes [X] No
Indicate the number of the registrant's outstanding common shares of beneficial
interest, as of November 7, 2007:
Common Shares of beneficial interest, $.10 par value per share - 170,559,969
shares
PUBLIC STORAGE
INDEX
Pages
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Condensed Consolidated Balance Sheets at
September 30, 2007 and December 31, 2006 1
Condensed Consolidated Statements of Income for the
Three and Nine Months Ended September 30, 2007 and 2006 2
Condensed Consolidated Statement of Shareholders' Equity
for the Nine Months Ended September 30, 2007 3
Condensed Consolidated Statements of Cash Flows
for the Nine Months Ended September 30, 2007 and 2006 4 - 5
Notes to Condensed Consolidated Financial Statements 6 - 41
Item 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 42 - 79
Item 3. Quantitative and Qualitative Disclosures about Market Risk 79 - 80
Item 4. Controls and Procedures 80 - 81
PART II. OTHER INFORMATION (Items 3, 4 and 5 are not applicable)
Item 1. Legal Proceedings 82
Item 1A. Risk Factors 82
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 82
Item 6. Exhibits 82
PUBLIC STORAGE
CONDENSED CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
September 30, December 31,
2007 2006
----------------- ----------------
(Unaudited)
ASSETS
Cash and cash equivalents.................................................... $ 168,586 $ 535,684
Real estate facilities, at cost:
Land...................................................................... 2,997,585 2,959,875
Buildings................................................................. 8,509,767 8,301,990
----------------- ----------------
11,507,352 11,261,865
Accumulated depreciation.................................................. (2,034,014) (1,754,362)
----------------- ----------------
9,473,338 9,507,503
Construction in process................................................... 103,657 90,038
----------------- ----------------
9,576,995 9,597,541
Investment in real estate entities........................................... 317,982 301,905
Goodwill..................................................................... 174,634 174,634
Intangible assets, net....................................................... 222,168 414,602
Restricted cash.............................................................. 20,844 19,900
Other assets................................................................. 148,414 154,207
----------------- ----------------
Total assets................................................... $ 10,629,623 $ 11,198,473
================= ================
LIABILITIES AND SHAREHOLDERS' EQUITY
Borrowings on bank credit facilities......................................... $ - $ 345,000
Notes payable................................................................ 1,004,507 1,466,284
Debt to joint venture partner................................................ 37,395 37,258
Preferred stock called for redemption........................................ - 302,150
Accrued and other liabilities................................................ 323,091 333,706
----------------- ----------------
Total liabilities................................................... 1,364,993 2,484,398
Minority interest:
Preferred partnership interests........................................... 325,000 325,000
Other partnership interests............................................... 181,772 181,030
Commitments and contingencies (Note 15)
Shareholders' equity:
Cumulative Preferred Shares of beneficial interest, $0.01 par value,
100,000,000 shares authorized, 1,739,500 shares issued (in series) and
outstanding, (1,712,600 at December 31, 2006) at liquidation preference. 3,527,500 2,855,000
Common Shares of beneficial interest, $0.10 par value, 650,000,000 shares
authorized, 169,402,880 shares issued and outstanding (169,144,467 at
December 31, 2006)...................................................... 16,941 16,915
Equity Shares of beneficial interest, Series A, $0.01 par value,
100,000,000 shares authorized, 8,744.193 shares issued and outstanding.. - -
Paid-in capital........................................................... 5,652,304 5,661,507
Cumulative net income..................................................... 3,792,940 3,503,292
Cumulative distributions paid............................................. (4,295,512) (3,847,998)
Accumulated other comprehensive income.................................... 63,685 19,329
----------------- ----------------
Total shareholders' equity.......................................... 8,757,858 8,208,045
----------------- ----------------
Total liabilities and shareholders' equity..................... $ 10,629,623 $ 11,198,473
================= ================
See accompanying notes.
1
PUBLIC STORAGE
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share amounts)
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ -------------------------------
2007 2006 2007 2006
-------------- ------------- ------------- -------------
Revenues:
Self-storage rental income.............................. $ 427,949 $ 328,782 $ 1,237,946 $ 842,361
Ancillary operating revenue............................. 37,754 29,827 107,903 77,500
Interest and other income............................... 3,257 12,651 6,337 27,773
-------------- ------------- ------------- -------------
468,960 371,260 1,352,186 947,634
-------------- ------------- ------------- -------------
Expenses:
Cost of operations (excluding depreciation and
amortization):
Self-storage facilities.............................. 143,371 109,106 441,657 286,204
Ancillary operations................................. 22,687 18,514 63,419 50,315
Depreciation and amortization............................ 147,767 113,463 491,725 212,057
General and administrative............................... 11,416 36,242 49,397 49,996
Interest expense......................................... 15,257 9,323 48,772 12,752
-------------- ------------- ------------- -------------
340,498 286,648 1,094,970 611,324
-------------- ------------- ------------- -------------
Income from continuing operations before equity in
earnings of real estate entities, casualty gain, gain
on disposition of real estate investments, foreign
currency exchange gain (loss), income from derivatives
and minority interest in income......................... 128,462 84,612 257,216 336,310
Equity in earnings of real estate entities................. 3,424 2,618 10,183 9,208
Casualty gain ............................................. - - 2,665 -
Gain on disposition of real estate investments............. 92 756 2,330 1,222
Foreign currency exchange gain (loss)...................... 30,384 (172) 40,977 (172)
Income from derivatives, net............................... 117 32 1,126 32
Minority interest in income............................... (8,304) (8,590) (21,611) (24,477)
-------------- ------------- ------------- -------------
Income from continuing operations.......................... 154,175 79,256 292,886 322,123
Cumulative effect of a change in accounting principle...... - - - 578
Discontinued operations.................................... (1,409) 1,925 (3,238) 1,558
-------------- ------------- ------------- -------------
Net income................................................. $ 152,766 $ 81,181 $ 289,648 $ 324,259
=============== ============== ============= =============
Net income allocation:
Allocable to preferred shareholders based on
distributions paid...................................... $ 60,333 $ 60,265 $ 176,424 $ 159,256
Allocable to preferred shareholders based on redemptions. - 21,643 - 21,643
Allocable to Equity Shares, Series A.................... 5,356 5,356 16,068 16,068
Allocable to common shareholders........................ 87,077 (6,083) 97,156 127,292
-------------- ------------- ------------- -------------
$ 152,766 $ 81,181 $ 289,648 $ 324,259
=============== ============== ============= =============
Net income (loss) per common share - basic
Continuing operations................................... $ 0.52 $ (0.05) $ 0.59 $ 0.94
Discontinued operations................................. (0.01) 0.01 (0.02) 0.01
-------------- ------------- ------------- -------------
$ 0.51 $ (0.04) $ 0.57 $ 0.95
=============== ============== ============= =============
Net income (loss) per common share - diluted
Continuing operations................................... $ 0.52 $ (0.05) $ 0.59 $ 0.93
Discontinued operations................................. (0.01) 0.01 (0.02) 0.01
-------------- ------------- ------------- -------------
$ 0.51 $ (0.04) $ 0.57 $ 0.94
=============== ============== ============= =============
Net income per depositary share representing Equity
Shares, Series A (basic and diluted) ................... $ 0.61 $ 0.61 $ 1.84 $ 1.84
=============== ============== ============= =============
Basic weighted average common shares outstanding........... 169,374 145,387 169,317 133,897
=============== ============== ============= =============
Diluted weighted average common shares outstanding......... 170,085 145,387 170,166 134,851
=============== ============== ============= =============
Weighted average Equity Shares, Series A (basic and
diluted)................................................ 8,744 8,744 8,744 8,744
=============== ============== ============= =============
See accompanying notes.
2
PUBLIC STORAGE
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Amounts in thousands, except share data)
(Unaudited)
Cumulative Cumulative Net
Preferred Shares Common Shares Paid-in Capital Income
------------------ --------------- --------------- --------------
Balance at December 31, 2006.............................. $ 2,855,000 $ 16,915 $ 5,661,507 $ 3,503,292
Issuance of cumulative preferred shares:
Series M (20,000 shares)............................. 500,000 - (15,233) -
Series N (6,900 shares).............................. 172,500 - (5,375) -
Issuance of common shares in connection with:
Exercise of employee stock options (191,095 shares)... - 19 8,033 -
Vesting of restricted shares (67,318 shares) .......... - 7 (7) -
Stock-based compensation expense (Note 13) ............... - - 3,379 -
Net income................................................ - - - 289,648
Cash distributions:
Cumulative preferred shares (Note 11).................. - - - -
Equity Shares, Series A ($1.838 per depositary share).. - - - -
Common Shares ($1.50 per share)........................ - - - -
Accumulated other comprehensive income:
Foreign currency translation adjustments not reflected
in net income........................................ - - - -
------------------ --------------- --------------- --------------
Balance at September 30, 2007............................. $ 3,527,500 $ 16,941 $ 5,652,304 $ 3,792,940
================== =============== =============== ==============
PUBLIC STORAGE
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
(Amounts in thousands, except share data)
(Unaudited)
Accumulated
Other Total
Cumulative Comprehensive Shareholders'
Distributions Income Equity
-------------- --------------- --------------
Balance at December 31, 2006.............................. $ (3,847,998) $ 19,329 $ 8,208,045
Issuance of cumulative preferred shares:
Series M (20,000 shares)............................. - - 484,767
Series N (6,900 shares).............................. - - 167,125
Issuance of common shares in connection with:
Exercise of employee stock options (191,095 shares)... - - 8,052
Vesting of restricted shares (67,318 shares) .......... - - -
Stock-based compensation expense (Note 13) ............... - - 3,379
Net income................................................ - - 289,648
Cash distributions:
Cumulative preferred shares (Note 11).................. (176,424) - (176,424)
Equity Shares, Series A ($1.838 per depositary share).. (16,068) - (16,068)
Common Shares ($1.50 per share)........................ (255,022) - (255,022)
Accumulated other comprehensive income:
Foreign currency translation adjustments not reflected
in net income........................................ - 44,356 44,356
-------------- --------------- --------------
Balance at September 30, 2007............................. $ (4,295,512) $ 63,685 $ 8,757,858
============== =============== ==============
See accompanying notes.
3
PUBLIC STORAGE
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
For the Nine Months Ended
September 30,
--------------------------------
2007 2006
--------------- ---------------
Cash flows from operating activities:
Net income............................................................... $ 289,648 $ 324,259
Adjustments to reconcile net income to net cash provided by operating
activities:
Amortization of note premium, net of increase in debt to joint venture
partner (Notes 7 and 8).............................................. (3,592) (838)
Gain on sales of real estate and real estate investments (Notes 4 and
14).................................................................. (2,330) (3,592)
Depreciation and amortization........................................... 491,725 212,057
Write off of capitalized development project costs...................... 1,615 9,319
Equity in earnings of real estate entities.............................. (10,183) (9,208)
Foreign currency exchange (gain) loss................................... (40,977) 172
Income from derivatives, net............................................ (1,126) (32)
Distributions received from the real estate entities (Note 5)........... 17,185 15,049
Minority interest in income............................................. 21,611 24,477
Other operating activities........................................... (11,985) 10,489
--------------- ---------------
Total adjustments.................................................... 461,943 257,893
--------------- ---------------
Net cash provided by operating activities............................ 751,591 582,152
--------------- ---------------
Cash flows from investing activities:
Capital improvements to real estate facilities ......................... (49,453) (44,366)
Construction in process................................................. (81,134) (70,903)
Acquisition of minority interests....................................... - (60,799)
Acquisition of real estate facilities................................... (72,787) (98,954)
(Deconsolidation) consolidation of partnerships (Note 2)................ (65) 3,024
Cash portion of the merger with Shurgard (Note 3)....................... - (161,284)
Proceeds from sales of real estate...................................... 2,008 11,281
Sale of real estate investments to affiliates (Note 10)................. 4,909 -
Additions to restricted cash............................................ (944) (3,358)
Proceeds from sales of held-to-maturity debt securities (Note 2)........ 6,019 8,079
--------------- ---------------
Net cash used in investing activities................................ (191,447) (417,280)
--------------- ---------------
Cash flows from financing activities:
Principal payments on notes payable..................................... (504,658) (687,508)
Net repayments on bank credit facilities................................ (345,000) -
Contributions received from European minority interests................. - 9,302
Proceeds from borrowings on European notes payable...................... 39,602 8,544
Net proceeds from the issuance of common shares......................... 8,052 78,899
Net proceeds from the issuance of cumulative preferred shares........... 651,892 1,048,945
Redemption of cumulative preferred shares............................... (302,150) (682,500)
Issuance of preferred partnership interests............................. - 100,000
Distributions paid to shareholders...................................... (447,514) (388,605)
Distributions paid to holders of preferred partnership interests (Note
10).................................................................. (16,209) (13,652)
Distributions paid to other minority interests.......................... (15,828) (11,037)
--------------- ---------------
Net cash used in financing activities................................ (931,813) (537,612)
--------------- ---------------
Net decrease in cash and cash equivalents................................... (371,669) (372,740)
Net effect of foreign exchange translation on cash.......................... 4,571 -
--------------- ---------------
Cash and cash equivalents at the beginning of the year...................... 535,684 481,995
--------------- ---------------
Cash and cash equivalents at the end of the period.......................... $ 168,586 $ 109,255
=============== ===============
See accompanying notes.
4
PUBLIC STORAGE
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
(Unaudited)
(Continued)
Supplemental schedule of non-cash investing and financing activities:
Foreign currency translation adjustment:
Real estate facilities, net of accumulated depreciation.............. $ (99,305) $ 20,849
Construction in process.............................................. (3,610) 643
Intangible assets, net............................................... (14,718) -
Other assets......................................................... (4,694) -
Notes payable........................................................ 26,337 (10,223)
Accrued and other liabilities........................................ 7,094 -
Minority interest - other partnership interests...................... 8,134 -
Accumulated other comprehensive income (loss)........................ 85,333 (11,269)
Deconsolidation of real estate entities:
Real estate facilities, net of accumulated depreciation.............. 41,409 -
Investment in real estate entities................................... (23,079) -
Intangible assets, net............................................... 1,816 -
Other assets......................................................... 344 -
Notes payable........................................................ (19,329) -
Accrued and other liabilities........................................ (544) -
Minority interests .................................................. (682) -
Real estate acquired in exchange for assumption of mortgage note........... - (4,590)
Mortgage note assumed in connection with acquisition of real estate........ - 4,590
Merger with Shurgard Storage Centers, Inc.:
Real estate facilities............................................. - (5,070,528)
Intangible assets.................................................. - (483,107)
Other assets....................................................... - (100,411)
Accrued and other liabilities...................................... - 162,730
Minority interest.................................................. - 144,351
Debt............................................................... - 1,999,535
Common stock....................................................... - 3,891
Paid in capital.................................................... - 3,182,255
Consolidation of entities pursuant to Emerging Issues Task Force Topic 04-5:
Minority interest - other partnership interests......................... - 3,963
Real estate facilities.................................................. - (22,459)
Investments in real estate entities..................................... - 20,846
Other assets............................................................ - (167)
Accrued and other liabilities........................................... - 841
Revaluation of debt to joint venture partner:
Debt due to joint venture partner.................................. - 1,386
Other assets....................................................... - (1,386)
See accompanying notes.
5
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
1. Description of the Business
---------------------------
Public Storage, Inc., formerly a California corporation, was
organized in 1980. Effective June 1, 2007, following approval by our
shareholders, we reorganized Public Storage, Inc. into Public Storage, a
Maryland real estate investment trust (referred to herein as "the Company",
"the Trust", "we", "us", or "our"). 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, generally on a month-to-month basis, for personal and
business use. Our self-storage facilities are located primarily in the
United States. As a result of the merger with Shurgard Storage Centers,
Inc. ("Shurgard") on August 22, 2006, we also have self-storage facilities
located in seven Western European countries (Note 3).
In addition to our self-storage facilities, we own (i) interests
in commercial properties containing commercial and industrial rental space,
(ii) interests in facilities that lease storage containers, and (iii) other
ancillary operations conducted at our self-storage locations comprised
principally of reinsurance of policies against losses to goods stored by
our self-storage tenants, retail sales of storage related products and
truck rentals.
At September 30, 2007, we had direct and indirect equity
interests in 2,012 self-storage facilities located in 38 states operating
under the "Public Storage" name, and 169 self-storage facilities located in
Europe which operate under the "Shurgard Storage Centers" name. We also
have direct and indirect equity interests in approximately 20 million net
rentable square feet of commercial space located in 11 states in the United
States.
Any reference to the number of properties, square footage, number
of tenant reinsurance policies outstanding and the aggregate coverage of
such reinsurance policies are unaudited and outside the scope of our
independent registered public accounting firm's review of our financial
statements in accordance with the standards of the Public Company
Accounting Oversight Board (United States).
2. Summary of Significant Accounting Policies
------------------------------------------
Basis of Presentation
---------------------
The accompanying unaudited condensed consolidated financial
statements have been prepared in accordance with U.S. generally accepted
accounting principles ("GAAP") for interim financial information and the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly,
they do not include all of the information and notes required by GAAP for
complete financial statements. In the opinion of management, all
adjustments (consisting of normal and recurring adjustments) considered
necessary for a fair presentation have been reflected in these unaudited
condensed consolidated financial statements. Operating results for the
three and nine months ended September 30, 2007 are not necessarily
indicative of the results that may be expected for the year ended December
31, 2007. The accompanying unaudited condensed consolidated financial
statements should be read together with the consolidated financial
statements and related notes included in the Company's Annual Report on
Form 10-K (and amendments thereto) for the year ended December 31, 2006.
Certain amounts previously reported have been reclassified to
conform to the September 30, 2007 presentation. In previous presentations,
certain cash balances held by our captive insurance entities which are
restricted as to their use were included in cash and cash equivalents on
the Company's condensed consolidated balance sheets. These restricted
balances are reclassified as "restricted cash" (see also "Restricted Cash"
below). In previous presentations, revenues and cost of operations with
respect to our Commercial facilities and Containerized Storage facilities
6
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
were reported on separate lines on our condensed consolidated statements of
income. In our current presentation, revenues with respect to each of these
operations, along with revenues from our tenant reinsurance, retail, truck
and property management operations, are included under the caption
"Revenues: Ancillary operations" and the related cost of operations are
included in "Expenses: Cost of operations - Ancillary operations" on our
accompanying condensed consolidated statements of income. Certain
reclassifications have also been made from previous presentations as a
result of discontinued operations.
Consolidation Policy
--------------------
Entities in which we have an interest are first evaluated to
determine whether, in accordance with the provisions of the Financial
Accounting Standards Board's Interpretation No. 46R, "Consolidation of
Variable Interest Entities," they represent Variable Interest Entities
("VIE's"). VIE's in which we are the primary beneficiary are consolidated.
Entities that are not VIE's that we control are consolidated.
For purposes of determining control, when we are the general
partner, we are considered to control the partnership unless the limited
partners possess substantial "kick-out" or "participative" rights as
defined in Emerging Issues Task Force Statement 04-5 - "Determining whether
a general partner or the general partners as a group, controls a limited
partnership or similar entity when the limited partners have certain
rights" ("EITF 04-5"). All significant intercompany balances and
transactions have been eliminated.
The accounts of the entities we control along with the accounts
of the VIE's that we are the primary beneficiary of are included in our
consolidated financial statements along with those of the Company. We
account for our investment in entities that we do not control, or entities
for which we are not the primary beneficiary and over which we have
significant influence, using the equity method of accounting. Changes in
consolidation status are reflected effective the date the change of control
or determination of primary beneficiary status occurred, and previously
reported periods are not restated. The entities that we consolidate during
the periods to which the reference applies, are referred to hereinafter as
the "Consolidated Entities." The entities that we have an interest in but
do not consolidate during the periods to which the reference applies, are
referred to hereinafter as the "Unconsolidated Entities."
Collectively, at September 30, 2007, the Company and the
Consolidated Entities own a total of 2,157 real estate facilities,
consisting of 1,979 self-storage facilities in the United States, 169
facilities in Europe, three industrial facilities used by the containerized
storage operations and six commercial properties.
At September 30, 2007, the Unconsolidated Entities are comprised
of our equity investments in various limited and joint venture partnerships
owning an aggregate of 33 self-storage facilities, as well as our ownership
of approximately 44% of the common equity of PS Business Parks, Inc.
("PSB"), which has interests in approximately 19.6 million net rentable
square feet of commercial space at September 30, 2007.
Deconsolidation of Certain Entities
-----------------------------------
On May 24, 2007, a judgment was rendered which resulted in our
losing effective control over several entities in which we had acquired an
interest in connection with the acquisition of Shurgard Storage Centers.
These entities owned 11 facilities with approximately 624,000 net rentable
square feet at September 30, 2007. Because of our loss of control, we
discontinued consolidation of these entities and therefore began to account
for them on the equity method, effective the date of the judgment.
Notwithstanding our loss of control, we continue to retain all of our
previous financial interests in these partnerships.
The deconsolidation of these entities resulted in an increase in
Investment in Real Estate Entities of $23,079,000, and adjustments to the
following balance sheet accounts, representing the balance sheet amounts of
these entities:
7
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
Total
--------------
Real estate facilities, net $ (41,409)
Intangible assets.......... (1,816)
Cash....................... (65)
Other assets............... (344)
Debt....................... 19,329
Accrued and other liabilities 544
Minority interest ......... 682
--------------
$ (23,079)
==============
Use of Estimates
----------------
The preparation of the consolidated financial statements in
conformity with GAAP 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 do not incur federal or
significant state tax 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 2007 and, accordingly, no provision
for income taxes has been made in the accompanying condensed consolidated
financial statements on income produced and distributed on real estate
rental operations.
Financial Instruments
---------------------
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 such as short-term treasury securities
or investment grade short-term commercial paper 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.
8
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
Financial assets that are exposed to credit risk consist
primarily of cash and cash equivalents and accounts receivable. Cash and
cash equivalents, consisting 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 small individual customer balances.
Due to the acquisition of European subsidiaries in the merger
with Shurgard, the results of our operations and our financial position are
affected by the fluctuations in the value of the euro, and to a lesser
extent, other European currencies, against the U.S. dollar.
Other assets at September 30, 2007 include investments totaling
$745,000 ($6,764,000 at December 31, 2006) representing held-to-maturity
Federal government agency securities stated at amortized cost, which
approximates fair value. Other assets at September 30, 2007 also include
derivative financial instruments totaling $5,660,000 ($11,810,000 at
December 31, 2006) reported at estimated fair value. See Note 9 for further
discussion of the fair value of our derivative financial instruments.
Restricted Cash
---------------
Restricted cash at September 30, 2007 and December 31, 2006,
consists of cash held by our captive insurance entities which, due to
insurance and other regulations with respect to required reserves and
minimum capital requirements, can only be utilized to pay captive claims.
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. Costs associated with the sale of
real estate facilities or interests in real estate investments are expensed
as incurred. Expenditures for repairs and maintenance are charged to
expense when 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
------------------------------
We evaluate impairment of goodwill 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, 2006.
We evaluate impairment of long-lived 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. No impairment was identified
from our evaluations as of September 30, 2007.
9
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
Accounting for Stock-Based Compensation
---------------------------------------
We utilize the Fair Value Method (as defined in Note 13) of
accounting for our employee stock options. Restricted share unit expense is
recorded over the relevant vesting period. See Note 13 for a discussion of
our accounting with respect to employee share options and restricted share
units.
Other Assets
------------
Other assets primarily consists of prepaid expenses, investments
in held-to-maturity debt securities, accounts receivable, assets associated
with our containerized storage business, merchandise inventory and rental
trucks. Included in other assets is approximately $61 million and $65
million at September 30, 2007 and December 31, 2006, respectively, from our
European operations.
Accrued and Other Liabilities
-----------------------------
Accrued and other liabilities consist primarily of real property
tax accruals, value-added tax accruals with respect to our European
operations, prepayments of rents, trade payables, losses and loss
adjustment liabilities for our self-insured risks (described below), and
accrued interest. Prepaid rent totaled $65,154,000 at September 30, 2007
($64,291,000 at December 31, 2006), while property and value-added tax
accruals approximated $110,077,000 at September 30, 2007 ($80,336,000 at
December 31, 2006).
We are self-insured for a portion of the risks associated with
our property and casualty losses, workers compensation, and employee health
care. We also utilize third-party insurance carriers to limit our self
insurance exposure. We accrue liabilities for uninsured losses and loss
adjustment expense, which at September 30, 2007 totaled $33,931,000
($31,532,000 at December 31, 2006). Liabilities for losses and loss
adjustment expenses include an amount we determine from loss reports and
individual cases and an amount, based on recommendations from an
independent actuary that is a member of the American Academy of Actuaries
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.
Through a wholly-owned subsidiary, we reinsure policies against
claims for losses to goods stored by tenants in our self-storage
facilities. For our United States operations, we have third-party insurance
coverage for losses from any individual event that exceeds a loss of
$1,500,000, to a maximum of $9,000,000. Estimated uninsured losses are
accrued as ancillary costs of operations.
While we believe that the amount of estimated accrued liabilities
with respect to tenant claims, property, casualty, workers compensation,
and employee healthcare are adequate, the ultimate losses that are actually
paid may be different than what we have accrued. The methods for making
such estimates and for establishing the resulting liabilities are regularly
reviewed.
Included in accrued and other liabilities is $91,783,000 and
$108,331,000 at September 30, 2007 and December 31, 2006, respectively,
from our European operations.
Goodwill and Intangible Assets
------------------------------
Goodwill represents the excess of acquisition cost over the fair
value of net tangible and identifiable intangible assets acquired in
business combinations. Each business combination from which our goodwill
arose was for the acquisition of single businesses and accordingly, the
10
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
allocation of our goodwill to our business segments (principally Domestic
Self-Storage) is based directly on such acquisitions. Our goodwill has an
indeterminate life in accordance with the provisions of Statement of
Financial Accounting Standards No. 142 ("SFAS 142").
As a result of the merger with Shurgard (Note 3), we acquired
finite-lived intangible assets comprised primarily of tenant intangibles
valued at $565,341,000 and the "Shurgard" tradename, which we continue to
use in Europe, valued at $18,824,000. Our intangible assets were increased
by $14,718,000 during the nine months ended September 30, 2007 due to the
impact of changes in exchange rates. During the nine months ended September
30, 2007, our intangible assets increased $5,135,000 for storage tenants in
place with respect to self-storage facility acquisitions. Also during the
nine months ended September 30, 2007, our intangible assets decreased
$1,816,000 in connection with the deconsolidation of our investment in
certain real estate entities (Note 5). Our finite-lived intangible assets
are reported net of accumulated amortization of $386,415,000 as of
September 30, 2007 ($175,944,000 as of December 31, 2006).
The tenant intangible assets are amortized relative to the
expected benefit of the tenants in place to each period and relative to the
benefit of the below-market leases. The Shurgard tradename has an
indefinite life and, accordingly, we do not amortize this asset but instead
analyze it on an annual basis for impairment.
Amortization expense of $53,320,000 and $210,471,000 was recorded
for our finite-lived intangible assets for the three and nine months ended
September 30, 2007, respectively. The estimated annual amortization expense
for our finite-lived intangible assets for the current year and each of the
next four years ending December 31 is as follows:
2007 (remainder of) $ 37,757,000
2008 79,838,000
2009 27,409,000
2010 16,418,000
2011 12,644,000
2012 and beyond 29,278,000
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 income
when collected. Tenant reinsurance premiums are recognized as premium
revenue when earned. Revenues from merchandise sales and truck rentals are
recognized when earned. 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 Entities.
We accrue for property tax expense based upon estimates and
historical trends. If these estimates are incorrect, the timing and amount
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.
During the second quarter of 2007, a share offering of Shurgard
Europe, our European operations, was initiated to be listed on Eurolist of
EuronextTM Brussels. Due to adverse market conditions, this offering was
withdrawn on June 21, 2007. There is no estimate as to when or if a future
offering may occur. We incurred $9.5 million in expenses related to the
proposed offering of shares which is included in general and administrative
expense for the nine months ended September 30, 2007.
11
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
Foreign Exchange Translation
----------------------------
The local currency is the functional currency for our European
subsidiaries. Assets and liabilities (other than for intercompany balances,
which are discussed below) are translated at end-of-period exchange rates
while revenues and expenses are translated at the average exchange rates in
effect during the period. The Euro was translated at an end-of-period
exchange rate of approximately 1.426 in U.S. dollars per Euro at September
30, 2007 (1.319 at December 31, 2006). Equity is translated at historical
rates and the resulting cumulative translation adjustments, to the extent
not included in net income, are included as a component of accumulated
other comprehensive income (loss) until the translation adjustments are
realized. Included in other accumulated comprehensive income was a
cumulative foreign currency translation adjustment gain of $63,685,000 at
September 30, 2007 ($19,329,000 at December 31, 2006).
With respect to intercompany balances among our European
subsidiaries and our domestic operations, when settlement of such
intercompany balances are not expected in the near term (generally within
one to two years), the impact of end-of-period exchange rate changes on the
expected settlement amounts in U.S. Dollars are reflected in accumulated
other comprehensive income (loss). However, for any other intercompany
balances where settlement is expected in the foreseeable future, changes in
exchange rates are recorded in income in the period in which the change
occurs. For the three and nine months ended September 30, 2007, we recorded
foreign currency exchange gains of $30,384,000 and $40,977,000,
respectively, on our condensed consolidated statements of income,
principally related to such intercompany balances. Substantially all of
such intercompany balances are expected to settle in the foreseeable
future. At September 30, 2007 and December 31, 2006, our European
subsidiaries had intercompany balances payable to our United States
operations totaling $556,186,000 and $542,162,000, respectively.
Accounting for Casualty Losses
------------------------------
Our policy is to record casualty losses or gains in the period
the casualty occurs equal to the differential between (a) the book value of
assets destroyed and (b) insurance proceeds, if any, that we expect to
receive in accordance with our insurance contracts. Potential insurance
proceeds that are subject to uncertainties, such as interpretation of
deductible provisions of the governing agreements or the estimation of
costs of restoration, are treated as contingent proceeds in accordance with
Statement of Financial Accounting Standards No. 5 ("SFAS 5"), and not
recorded until the uncertainties are satisfied. During the first quarter of
2007, we recorded a casualty gain totaling $2,665,000, representing the
realization of such contingent proceeds relating to hurricanes which
occurred in 2005.
Derivative Financial Instruments
--------------------------------
We have certain derivative financial instruments held by our two
joint ventures in Europe, including interest rate caps, interest rate
swaps, cross-currency swaps and foreign currency forward contracts. These
derivatives were entered into by the joint ventures in order to mitigate
currency and exchange rate fluctuation risk in connection with European
borrowings, and are not for speculative or trading purposes.
In accordance with the provisions of Statement of Financial
Accounting Standards No. 133, Accounting for Derivative Financial
Instruments and Hedging Activities ("SFAS 133"), derivative financial
instruments are measured at fair value and recognized on the balance sheet
as assets or liabilities.
As of September 30, 2007, none of the derivatives were considered
effective hedges because we believe it is not highly likely that the debt
and the related derivative instruments will remain outstanding for their
entire contractual period. Accordingly, all changes in the fair values of
the derivatives are reflected in earnings, along with the related cash
flows from these instruments, under "Income from derivatives, net" on our
condensed consolidated statements of income.
12
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
Other Comprehensive Income
--------------------------
Our comprehensive income is as follows (amounts in thousands):
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
------------------------------- --------------------------------
2007 2006 2007 2006
--------------- -------------- -------------- ---------------
Net income................................ $ 152,766 $ 81,181 $ 289,648 $ 324,259
Accumulated other comprehensive income
(loss):
Aggregate foreign currency translation
adjustments.......................... 58,396 (11,269) 85,333 (11,269)
Less: foreign currency translation
adjustments reflected in net income.. (30,384) - (40,977) -
--------------- -------------- -------------- ---------------
Total comprehensive income................ $ 180,778 $ 69,912 $ 334,004 $ 312,990
=============== ============== ============== ===============
Other comprehensive income reflects our net income, adjusted for
any portion of currency translation adjustments related to our European
subsidiaries measured from the beginning to the end of each respective
period, which have already been reflected in our net income.
Environmental Costs
-------------------
Our policy is to accrue environmental assessments and estimated
remediation costs when it is probable that such efforts will be required
and the related costs 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 our facilities, which individually or in the
aggregate would be material to our overall business, financial condition,
or results of operations.
Discontinued Operations
-----------------------
We segregate all of our disposed components that have operations
that can be distinguished from the rest of the Company and will be
eliminated from the ongoing operations of the Company in a disposal
transaction. Discontinued operations principally consists of the historical
operations related to facilities that were closed and are no longer in
operation and facilities that have been disposed of either through
condemnation by a local governmental agency or sale. In the three and nine
months ended September 30, 2007, loss from discontinued operations totaled
$1,409,000 and $3,238,000, respectively, as compared to net income totaling
$1,925,000 and $1,558,000, respectively for the same periods in 2006.
Net Income per Common Share
---------------------------
In computing net income allocated to our common shareholders, we
first allocate net income to our preferred shareholders. Distributions paid
to the holders of our Cumulative Preferred Shares totaling $60,333,000 and
$176,424,000 for the three and nine months ended September 30, 2007,
respectively, and $60,265,000 and $159,256,000 for the three and nine
months ended September 30, 2006, respectively, have been deducted from net
income to arrive at net income allocable to our common shareholders.
When we call any of our Cumulative Preferred Shares for
redemption, we record an additional allocation of income to our preferred
13
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
shareholders equal to the excess of a) the cash required to redeem the
securities over b) the "Book Value" (the net proceeds from the original
issuance of the securities) of the securities. An additional allocation of
$21,643,000 was recorded for the three and nine months ended September 30,
2006.
The remaining income allocated to our common shareholders has
been further allocated among our regular common shares and our Equity
Shares, 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 shares are determined according to dividends declared (or
accumulated) and participation rights in undistributed earnings. Under the
two-class method, the Equity Shares, Series A, were allocated net income of
$5,356,000 and $16,068,000 for each of the three and nine months ended
September 30, 2007 and 2006, respectively. Income of $87,077,000 and
$97,156,000 for the three and nine months ended September 30, 2007,
respectively, and loss of $6,083,000 and income of $127,292,000 for the
three and nine months ended September 30, 2006, respectively, was allocated
to the regular common shareholders.
Basic net income per share is computed using the weighted average
common shares outstanding (prior to the dilutive impact of stock options
and restricted share units outstanding). Diluted net income per common
share is computed using the weighted average common shares outstanding
(adjusted for the impact if dilutive, of stock options and restricted share
units outstanding). Weighted average common shares excludes shares owned by
the Consolidated Entities as described in Note 11 for all periods
presented, as these common shares are eliminated in consolidation.
Recently Issued Accounting Standards
------------------------------------
The Fair Value Option for Financial Assets and Financial
-----------------------------------------------------------------
Liabilities
-----------
In February 2007, the Financial Accounting Standards Board (the
"FASB") issued SFAS No. 159, "The Fair Value Option for Financial Assets
and Financial Liabilities, including an amendment of FASB Statement No.
115" ("SFAS No. 159"). SFAS No. 159 provides companies with an option to
report selected financial assets and liabilities at fair value. The
standard establishes presentation and disclosure requirements designed to
facilitate comparisons between companies that choose different measurement
attributes for similar types of assets and liabilities. SFAS No. 159 is
effective as of the beginning of an entity's first fiscal year beginning
after November 15, 2007. We do not expect the adoption of SFAS No. 159 to
have a material impact on our financial condition or results of operations.
Accounting for Uncertainty in Income Taxes
------------------------------------------
In July 2006, the FASB issued Interpretation No. 48, "Accounting
for Uncertainty in Income Taxes" ("FIN 48"). This interpretation, among
other things, creates a two step approach for evaluating uncertain tax
positions. Recognition (step one) occurs when an enterprise concludes that
a tax position, based solely on its technical merits, is
more-likely-than-not to be sustained upon examination. Measurement (step
two) determines the amount of benefit that more-likely-than-not will be
realized upon settlement. Derecognition of a tax position that was
previously recognized would occur when a company subsequently determines
that a tax position no longer meets the more-likely-than-not threshold of
being sustained. FIN 48 specifically prohibits the use of a valuation
allowance as a substitute for derecognition of tax positions, and it has
expanded disclosure requirements. FIN 48 was effective for fiscal years
beginning after December 15, 2006, in which the impact of adoption should
be accounted for as a cumulative-effect adjustment to the beginning balance
of retained earnings. We adopted the provisions of FIN 48 as of January 1,
2007. The adoption of FIN 48 had no material impact on our financial
position, operating results or cash flows. See Note 16 for further
discussion of our adoption of FIN 48.
14
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
Fair Value Measurement
----------------------
In 2006, the FASB issued SFAS No. 157, "Fair Value Measurement"
(SFAS No. 157). SFAS No. 157 provides guidance for using fair value to
measure assets and liabilities. The standard expands required disclosures
about the extent to which companies measure assets and liabilities at fair
value, the information used to measure fair value, and the effect of fair
value measurements on earnings. SFAS No. 157 applies whenever other
standards require (or permit) assets or liabilities to be measured at fair
value. SFAS No. 157 does not expand the use of fair value in any new
circumstances. SFAS No. 157 is effective for financial statements issued
for fiscal years beginning after November 15, 2007, and interim periods
within those fiscal years. We do not expect the impact to be material to
our financial condition or results of operations.
3. Merger with Shurgard
--------------------
On August 22, 2006, we merged with Shurgard, a REIT which had
interests in 487 self-storage facilities in the United States and 160
self-storage facilities in Europe.
Shurgard shareholders received 0.82 shares of Public Storage,
Inc. common stock for each share of Shurgard common stock they owned. Total
consideration for the merger was approximately $5,323,956,000.
The results of operations of the facilities acquired from
Shurgard have been included in our consolidated financial statements since
the merger date of August 22, 2006.
4. Real Estate Facilities
----------------------
Activity in real estate facilities is as follows:
15
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
Nine Months Ended
September 30, 2007
------------------
(Amounts in
thousands)
Real estate facilities, at cost:
Balance at December 31, 2006........................ $ 11,261,865
Newly developed facilities opened for operations.... 71,125
Acquisition of real estate facilities............... 67,652
Deconsolidation of Entities (Note 2) ............... (42,473)
Disposition of real estate facilities............... (1,239)
Capital improvements................................ 49,453
Impact of foreign exchange rate changes............. 100,969
------------------
Balance at September 30, 2007....................... 11,507,352
------------------
Accumulated depreciation:
Balance at December 31, 2006........................ (1,754,362)
Deconsolidation of Entities (Note 2) ............... 1,064
Additions during the year........................... (279,420)
Dispositions during the year........................ 368
Impact of foreign exchange rate changes............. (1,664)
------------------
Balance at September 30, 2007...................... (2,034,014)
------------------
Construction in process:
Balance at December 31, 2006........................ 90,038
Current development................................. 81,134
Newly developed facilities opened for operations.... (71,125)
Impact of foreign exchange rate changes............. 3,610
------------------
Balance at September 30, 2007....................... 103,657
------------------
Total real estate facilities at September 30, 2007..... $ 9,576,995
==================
During the nine months ended September 30, 2007, we completed six
development and seven expansion projects which in aggregate added
approximately 614,000 net rentable square feet of self-storage space at a
total cost of $71,125,000. In addition, we acquired seven self-storage
facilities (511,000 net rentable square feet) from third parties for an
aggregate cost of $72,787,000, in cash; $67,652,000 was allocated to real
estate facilities and $5,135,000 was allocated to intangibles, based upon
the estimated relative fair values of the land, buildings and intangibles.
Construction in process at September 30, 2007 includes 39
projects in the United States (1,711,000 net rentable square feet),
consisting of newly developed self-storage facilities, conversion of space
at facilities that was previously used for containerized storage and
expansions to existing self-storage facilities, with costs incurred of
$43,579,000 at September 30, 2007 and total estimated costs to complete of
$106,878,000. In addition, we have 16 projects to develop new self-storage
facilities in Europe (793,000 aggregate net rentable square feet), with
costs incurred at September 30, 2007 of $60,078,000 and total estimated
costs to complete of $84,184,000.
We capitalize interest incurred on debt during the course of
construction of our self-storage facilities. Interest capitalized for the
three and nine months ended September 30, 2007 was $1,297,000 and
$3,011,000, respectively, as compared to $530,000 and $1,599,000 for the
same periods in 2006.
During the nine months ended September 30, 2007, we have received
proceeds for partial condemnations and other disposals to certain of our
self-storage facilities for an aggregate of $2,008,000 and recorded a gain
16
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
of $1,137,000 as a result of these transactions. In connection with the
sale of limited liability partner interests in Shurgard Europe (Note 10),
we also recorded a gain of $1,193,000 for the three and nine months ended
September 30, 2007, representing the excess of the sales proceeds less the
book value of the interests sold. The gain is reflected in gain on
disposition of real estate investments on our accompanying condensed
consolidated statements of income.
Included in real estate facilities, accumulated depreciation, and
construction in process is $1.6 billion with respect to our European
operations at September 30, 2007.
5. Investment in Real Estate Entities
----------------------------------
Interests in entities for periods that they are either VIE's that
we are not the primary beneficiary of, or other non-VIE entities that we do
not have a controlling financial interest in, are accounted for using the
equity method of accounting. At September 30, 2007, our investments in real
estate entities consist of ownership interests in the Unconsolidated
Entities.
For the three and nine months ended September 30, 2007, we
recognized earnings from our investments in real estate entities of
$3,424,000 and $10,183,000, respectively, as compared to $2,618,000 and
$9,208,000 for the same periods in 2006.
We received cash distributions from our investments in real
estate entities for the nine months ended September 30, 2007 and 2006, of
$17,185,000 and $15,049,000, respectively.
During the nine months ended September 30, 2007, our investments
in real estates entities increased $23,079,000 due to the deconsolidation
of certain entities we had acquired an interest in, in connection with the
merger with Shurgard. See Note 2 for further information.
The following table sets forth our investments in real estate
entities at September 30, 2007 and December 31, 2006, and our equity in
earnings of real estate entities for the three and nine months ended
September 30, 2007 and 2006 (amounts in thousands):
Equity in Earnings of Real Equity in Earnings of Real
Investments in Real Estate Estate Entities for the Three Estate Entities for the Nine
Entities at Months Ended Septembe 30, Months Ended September 30,
-------------------------------- ------------------------------ -----------------------------
September 30, December 31,
2007 2006 2007 2006 2007 2006
--------------- -------------- --------------- -------------- ------------- -------------
PSB.......................... $ 277,049 $ 283,700 $ 2,522 $ 2,018 $ 8,236 $ 7,634
Other Investments............ 40,933 18,205 902 600 1,947 1,574
--------------- -------------- --------------- -------------- ------------- -------------
Total...................... $ 317,982 $ 301,905 $ 3,424 $ 2,618 $ 10,183 $ 9,208
=============== ============== =============== ============== ============= =============
Investment in PSB
-----------------
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, 2007. 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 both September 30, 2007 and December 31, 2006; 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, 2007 ($56.85 per share of PSB common stock), the shares and
units had a market value of approximately $723.3 million as compared to a
book value of $277.0 million.
17
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
At September 30, 2007, PSB owned approximately 19.6 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 selected financial information of
PSB; the amounts represent 100% of PSB's balances and not our pro-rata
share.
2007 2006
----------------- -----------------
(Amounts in thousands)
For the nine months ended September 30,
Total operating revenue.............................. $ 201,471 $ 180,050
Costs of operations and other operating expenses..... (68,603) (60,618)
Other income and expense, net........................ 1,013 3,799
Depreciation and amortization........................ (71,841) (63,720)
Discontinued operations.............................. - 1,643
Minority interest.................................... (9,888) (13,450)
----------------- -----------------
Net income......................................... $ 52,152 $ 47,704
================= =================
At September 30, At December 31,
2007 2006
----------------- -----------------
(Amounts in thousands)
Total assets (primarily real estate)................. $ 1,549,951 $ 1,462,864
Total debt........................................... 61,064 67,048
Preferred equity and preferred minority interests.... 811,000 705,250
Common equity and common minority interests.......... 631,199 648,172
Other Investments
-----------------
Other investments include an aggregate common equity ownership of
approximately 29% in a) 12 entities that own an aggregate of 33
self-storage facilities that we held on a consistent basis for each of the
three and nine months ended September 30, 2007 and 2006, respectively, and
b) entities owning 11 self-storage facilities which we deconsolidated
effective May 24, 2007 as described in Note 2.
The following table sets forth certain condensed financial
information (representing 100% of these entities' balances and not our
pro-rata share) with respect to these other investments:
18
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
2007 2006
------------- -----------
(Amounts in thousands)
For the nine months ended September
30,
Total revenue........................ $ 17,493 $ 17,209
Cost of operations and other expenses (7,908) (6,929)
Depreciation and amortization........ (2,210) (2,272)
------------- -----------
Net income....................... $ 7,375 $ 8,008
============= ===========
At September 30, At December 31,
2007 2006
----------------- ---------------
(Amounts in thousands)
Total assets (primarily storage
facilities)...................... $ 73,042 $ 73,031
Total liabilities.................... 21,205 21,112
Total Partners' equity............... 51,837 51,919
6. Revolving Line of Credit
------------------------
On December 27, 2006, we entered into a $300 million unsecured
short-term credit agreement (the "Bridge Loan") with a commercial bank that
matured April 1, 2007. Pursuant to the credit agreement, we borrowed $300
million at an initial interest rate of LIBOR plus 0.30% (5.63% at December
31, 2006). At December 31, 2006, our outstanding borrowings under this
facility totaled $300 million. On January 10, 2007, borrowings under this
facility were repaid in full and the Bridge Loan terminated.
On March 27, 2007, we entered into a five-year revolving credit
agreement (the "Credit Agreement") with an aggregate limit with respect to
borrowings and letters of credit of $300 million, and bears an annual
interest rate ranging from the London Interbank Offered Rate ("LIBOR") plus
0.35% to LIBOR plus 1.00% depending on our credit ratings (LIBOR plus 0.35%
at September 30, 2007). In addition, we are required to pay a quarterly
facility fee ranging from 0.10% per annum to 0.25% per annum depending on
our credit ratings (0.10% per annum at September 30, 2007). We had no
outstanding borrowings on our revolving line of credit at September 30,
2007 or at November 8, 2007.
The Credit Agreement includes various covenants, the more
significant of which require us to (i) maintain a leverage ratio (as
defined therein) of less than 0.55 to 1.00, (ii) maintain certain fixed
charge and interest coverage ratios (as defined therein) of not less than
1.5 to 1.0 and 1.75 to 1.0, respectively, and (iii) maintain a minimum
total shareholders' equity (as defined therein). We were in compliance with
all covenants of the Credit Agreement at September 30, 2007.
At September 30, 2007, we had undrawn standby letters of credit,
which reduce our borrowing capability with respect to our line of credit by
the amount of the letters of credit, totaling $20,408,000 ($21,068,000 at
December 31, 2006). The beneficiaries of these standby letters of credit
were primarily certain insurance companies associated with our captive
insurance and tenant re-insurance activities.
7. Notes Payable
-------------
The carrying amounts of our notes payable at September 30, 2007
and December 31, 2006 consist of the following (dollar amounts in
thousands):
19
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
September 30, December 31,
2007 2006
-------------- ---------------
Domestic Unsecured Notes Payable:
5.875% effective and stated note rate, interest only and payable
semi-annually, matures in March 2013................................ $ 200,000 $ 200,000
5.73% effective rate, 7.75% stated note rate, interest only and payable
semi-annually, matures in February 2011 (carrying amount includes
$11,877 of unamortized premium at September 30, 2007) .............. 211,877 214,033
6.53% effective rate, 7.625% stated note rate, interest only and payable
semi-annually, due April 2007....................................... - 50,119
7.66% senior unsecured note due January 2007........................... - 11,200
Domestic Mortgage Notes:
5.59% average effective rate fixed rate mortgage notes payable, secured by
53 real estate facilities with a net book value of $410,853 at
September 30, 2007 and stated note rates between 4.95% and 7.76%, due
between October 2007 and August 2015 (carrying amount includes $3,392
of unamortized premium at September 30, 2007) ...................... 145,021 166,737
Variable rate mortgage notes payable................................... - 8,428
5.29% average effective rate fixed rate mortgage notes payable, secured by
33 real estate facilities with a net book value of $187,678 at
September 30, 2007, stated note rates between 5.40% and 8.75%,
principal and interest payable monthly, due at varying dates between
October 2009 and September 2028 (carrying amount includes $3,771 of
unamortized premium at September 30, 2007).......................... 87,834 91,489
European Secured Notes Payable:
(euro)325 million notes payable due originally in 2011, but prepaid in
January 2007........................................................ - 428,760
First Shurgard credit agreement, due in 2008, secured by 38 real estate
facilities with a net book value of $282,300 at September 30, 2007
(interest rate of EURIBOR + 2.25%, 6.187% average for the nine months
ended September 30, 2007, 6.659% rate at September 30, 2007 which
approximate market rates)........................................... 185,111 172,832
Second Shurgard credit agreement, due in 2009, secured by 26 real estate
facilities with a net book value of $199,200 at September 30, 2007
(interest rate of EURIBOR + 2.25%, 6.187% average for the nine months
ended September 30, 2007, 6.659% rate at September 30, 2007 which
approximate market rates)........................................... 167,570 116,086
Liability under Capital Leases......................................... 7,094 6,600
-------------- ---------------
Total notes payable............................................. $ 1,004,507 $ 1,466,284
============== ===============
The 5.875% and 5.73% effective rate domestic unsecured notes
payable were recorded at their estimated fair value upon assumption based
upon estimated market rates for debt with similar terms and ratings. As of
September 30, 2007 the aggregate fair value of these notes was
approximately $415,344,000 as compared to the actual assumed balances of
$400,000,000. This initial premium of $15,344,000 is being amortized over
the remaining term of the notes using the effective interest method.
20
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
The domestic unsecured notes payable have various restrictive
covenants, the more significant of which require us to (i) maintain a ratio
of debt to total assets (as defined therein) of less than 0.60 to 1.00,
(ii) maintain a ratio of secured debt to total assets (as defined therein)
of less than 0.40 to 1.00, (iii) maintain a debt service coverage ratio (as
defined therein) of greater than 1.50 to 1.00, and (iv) maintain a ratio of
unencumbered assets to unsecured debt (as defined therein) of greater than
150%, all of which have been met at September 30, 2007.
The 5.59% average effective rate fixed rate domestic mortgage
notes were recorded at their estimated fair value based upon the estimated
market rate upon assumption of approximately 5.59%, an aggregate of
approximately $184,592,000 as compared to the actual assumed balances of an
aggregate of $179,827,000. This initial premium of $4,765,000 is being
amortized over the remaining term of the mortgage notes using the effective
interest method. These mortgage notes require interest and principal
payments to be paid monthly and have various restrictive covenants, all of
which we believe have been met at September 30, 2007.
On January 2, 2007, we repaid the (euro)325 million
collateralized European notes that were otherwise payable in 2011. We also
terminated the related European currency and interest rate hedges.
First Shurgard and Second Shurgard, joint venture partnerships in
which we have a 20% interest, (see Note 10) have senior credit agreements
denominated in euros to borrow, in aggregate, up to (euro)271 million
($386.5 million as of September 30, 2007). As of September 30, 2007, the
available amounts under those credit facilities were, in the aggregate,
(euro)22.5 million ($32.1 million). Our draws under the First Shurgard and
Second Shurgard credit facilities can be limited if the completion of
projects is not timely and if we have certain cost overruns. The credit
facilities also require us to maintain a maximum loan to value of the
collateral ratio and a minimum debt service ratio. As of September 30,
2007, we were in compliance with these financial covenants.
At September 30, 2007, approximate principal maturities of our
notes payable are as follows (amounts in thousands):
Domestic Domestic Liabilities
Unsecured Mortgage Notes European under
Notes Payable Payable Notes Payable Capital Leases Total
---------------- --------------- --------------- -------------- -------------
2007 (remainder of).......... $ 808 $ 2,097 $ 856 $ 18 $ 3,779
2008......................... 3,404 20,505 184,256 112 208,277
2009......................... 3,605 8,707 167,569 123 180,004
2010......................... 3,817 10,584 - 85 14,486
2011......................... 200,243 27,355 - 782 228,380
Thereafter................... 200,000 163,607 - 5,974 369,581
---------------- --------------- --------------- -------------- -------------
$ 411,877 $ 232,855 $ 352,681 $ 7,094 $ 1,004,507
================ =============== =============== ============== =============
Weighted average effective rate 5.8% 5.5% 6.2% 9.9% 5.9%
================ =============== =============== ============== =============
We incurred interest expense with respect to our notes payable,
capital leases, debt to joint venture partner and line of credit
aggregating $51,783,000 and $14,351,000 for the nine months ended September
30, 2007 and 2006, respectively. These amounts were comprised of
$55,375,000 and $15,189,000 in cash for the nine months ended September 30,
2007 and 2006, respectively, less $3,592,000 and $838,000 in amortization
of premium net of increase in debt to Joint Venture Partner described in
Note 8, respectively.
The net book value of the properties under capital leases was
$33,451,000 as of September 30, 2007, which is net of accumulated
depreciation of $1,241,000.
21
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
8. Debt to Joint Venture Partner
-----------------------------
On December 31, 2004, we sold seven self-storage facilities to an
unconsolidated affiliated joint venture for $22,993,000. On January 14,
2005, we sold an 86.7% interest in three additional self-storage facilities
to the joint venture for an aggregate amount of $27,424,000. Our partner's
combined equity contribution with respect to these transactions was
$35,292,000. Due to our continuing interest in these facilities and the
likelihood that we will exercise our option to acquire our partner's
interest, we have accounted for our partner's investment in these
facilities as, in substance, debt financing. Accordingly, our partner's
investment with respect to these facilities is accounted for as a liability
on our accompanying consolidated balance sheets. Our partner's share of
operations with respect to these facilities has been accounted for as
interest expense on our accompanying consolidated statements of income.
The outstanding balances of $37,395,000 and $37,258,000 due the
joint venture partner as of September 30, 2007 and December 31, 2006,
respectively, approximate the fair value of our partner's interest in these
facilities as of each respective date. On a quarterly basis, we review the
fair value of this liability, and to the extent fair value exceeds the
carrying value of the liability, an adjustment is made to increase the
liability to fair value, and to increase other assets, with the other
assets amortized over the remaining period term of the joint venture. We
increased the note balance by $1,386,000 during 2006 as a result of our
periodic review of fair value.
A total of $2,375,000 and $2,276,000 was recorded as interest
expense on our condensed consolidated statements of income with respect to
our Debt to Joint Venture Partner during the nine months ended September
30, 2007 and 2006, respectively, representing our partner's pro rata share
of net earnings with respect to the properties we sold to the Acquisition
Joint Venture (an 8.5% return on their investment). This interest expense
was comprised of a total of $2,239,000 and $2,146,000 paid to our joint
venture partner (an 8.0% return payable currently in accordance with the
partnership agreement) during the nine months ended September 30, 2007 and
2006, respectively, and increases in the Debt to Joint Venture Partner of
$136,000 and $130,000 for the nine months ended September 30, 2007 and
2006, respectively.
We expect that this debt will be repaid during 2008, assuming
that we exercise our option to acquire our partner's interest in the
Acquisition Joint Venture.
9. Derivative Financial Instruments
--------------------------------
As described in Note 2, under Derivative Financial Instruments,
we report these derivative financial instruments at fair value on our
consolidated balance sheet and changes in fair values for the nine months
ended September 30, 2007, have been recognized in earnings. The respective
balances of these financial instruments are included in other assets and
accrued and other liabilities as follows:
September 30, December 31,
2007 2006
-------------- ------------
(Amounts in thousands)
Assets:
Interest rate contracts......................... $ 5,660 $ 11,810
============== ============
Liabilities:
Interest rate contracts......................... $ - $ (4,162)
Foreign currency exchange contracts............. (1,146) (7,837)
-------------- ------------
$ (1,146) $ (11,999)
============== ============
For the nine months ended September 30, 2007, net income from
derivatives of $1,126,000 was comprised of a change in value of the related
instruments representing gain of $1,205,000, offset by $79,000 in net
payments incurred during the period under the underlying instruments.
22
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
On January 2, 2007, in connection with our prepayment of the
(euro)325 million collateralized notes at our European operations, we
terminated the related European currency and interest rate hedges.
10. 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 condensed consolidated financial statements.
Minority interest in income consists of the minority interests' share of
the operating results of the Consolidated Entities.
Preferred Partnership Interests
The following table summarizes the preferred partnership units
outstanding at September 30, 2007 and December 31, 2006:
September 30, 2007 December 31, 2006
Earliest Redemption
Date or Dates Distribution Units Carrying Units Carrying
Series Redeemed Rate Outstanding Amount Outstanding Amount
----------------- -------------------- ------------ ----------- ------------ ----------- -----------
(Amounts in thousands)
Series NN........ March 17, 2010 6.400% 8,000 $ 200,000 8,000 $ 200,000
Series Z......... October 12, 2009 6.250% 1,000 25,000 1,000 25,000
Series J......... May 9, 2011 7.250% 4,000 100,000 4,000 100,000
------------ ------------ ----------- -----------
Total............ 13,000 $ 325,000 13,000 $ 325,000
============ ============ =========== ===========
Income allocated to the preferred minority interests totaled
$16,209,000 and $13,652,000 for the nine months ended September 30, 2007
and 2006, respectively, comprised of distributions paid.
On May 9, 2006, one of the Consolidated Entities issued 4,000,000
units of our 7.25% Series J Preferred Partnership Units for cash proceeds
of $100,000,000.
Subject to certain conditions, the Series NN preferred units are
convertible into our 6.40% Series NN Cumulative Preferred Shares of
beneficial interest, the Series Z preferred units are convertible into our
6.25% Series Z Cumulative Preferred Shares of beneficial interest and the
Series J preferred units are convertible into our 7.25% Series J Cumulative
Preferred Shares of beneficial interest. The holders of the Series Z
preferred partnership units have a one-time option exercisable five years
from issuance (October 12, 2009), to require us to redeem their units for
$25,000,000 in cash, plus any unpaid distribution.
Other Partnership Interests
---------------------------
Income is allocated to the minority interests based upon their
pro rata interest in the operating results of the Consolidated Entities.
The following tables set forth the minority interests at September 30, 2007
and December 31, 2006 as well as the income allocated to minority interests
for the three and nine months ended September 30, 2007 and 2006 with
respect to the other partnership interests (amounts in thousands):
23
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
Minority Interest at
--------------------------------
September 30, December 31,
Description 2007 2006
---------------------------------- --------------- ---------------
European joint ventures........... $ 140,893 $ 140,034
European investors................ 3,607 -
Convertible Partnership Units..... 5,494 5,710
Other consolidated partnerships... 31,778 35,286
--------------- ---------------
Total other partnership interests. $ 181,772 $ 181,030
=============== ===============
Minority Interests Minority Interests
in Income (Loss) in Income (Loss)
for the Three Months Ended for the Nine Months Ended
-------------------------------- --------------------------------
September 30, September 30, September 30, September 30,
Description 2007 2006 2007 2006
-------------------------------- --------------- --------------- --------------- --------------
European joint ventures.......... $ (1,456) $ (1,279) $ (7,275) $ (1,279)
European investors............... (109) - (109) -
Convertible Partnership Units.... 121 120 132 356
Other consolidated partnerships.. 4,345 4,346 12,654 11,748
--------------- --------------- --------------- --------------
Total other partnership interests $ 2,901 $ 3,187 $ 5,402 $ 10,825
=============== =============== =============== ==============
Distributions paid to minority interests for the three months
ended September 30, 2007 and 2006 were $5,471,000 and $3,689,000,
respectively, and for the nine months ended September 30, 2007 and 2006
were $15,828,000 and $11,037,000, respectively. Minority interests
increased $8,134,000 as a result of the impact of foreign currency
translation in the nine months ended September 30, 2007.
24
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
European Joint Ventures
-----------------------
Through the merger with Shurgard, we acquired an interest in two
joint venture entities: First Shurgard SPRI ("First Shurgard") formed in
January 2003 and Second Shurgard SPRL ("Second Shurgard") formed in May
2004. Those joint ventures were expected to develop or acquire up to
approximately 75 storage facilities in Europe. Through a wholly-owned
subsidiary, we have a 20% interest in each of these ventures. We have
determined that First Shurgard and Second Shurgard are each VIEs, and that
we are the primary beneficiary. Accordingly, First Shurgard and Second
Shurgard have been consolidated in our consolidated financial statements.
At September 30, 2007, First Shurgard and Second Shurgard had aggregate
total assets of $559.4 million ($501.0 million at December 31, 2006), total
liabilities of $380.4 million ($320.9 million at December 31, 2006), and
credit facilities collateralized by assets with a net book value of $481.5
million. At September 30, 2007, First Shurgard's and Second Shurgard's
creditors had no recourse to the general credit of Public Storage or
Shurgard Europe other than a commitment, to subscribe for up to $20 million
and an additional $10.7 million as of September 30, 2007 in preferred bonds
in order for First Shurgard to fulfill its obligations under its senior
credit agreement. We have an option to put 80% of the bonds issued by First
Shurgard to Crescent Euro Self Storage Investments, Shurgard Europe's
partner in the joint venture.
On September 5, 2006, we informed the joint venture partners of
First Shurgard and Second Shurgard of our intention to purchase their
interests in First Shurgard and Second Shurgard, pursuant to an "exit
procedure" that we believe is provided for in the respective agreements.
The exit procedure can, in certain circumstances, result in a third party
acquiring the facilities owned by First and Second Shurgard, including our
interest in these facilities. Our joint venture partners currently contest
whether we have the right to purchase their interests under this procedure.
On January 17, 2007, we filed an arbitration action with our joint venture
partner related to our intention to terminate the joint venture early. See
Note 15 for further discussion of the arbitration proceedings.
European Investors
------------------
In the second quarter of 2007, one of our European subsidiaries
sold limited liability partner interests ("LLP Interests") it held in
Shurgard Self-Storage SCA ("Shurgard Europe"), also an indirect subsidiary
of Public Storage, to various officers of the Company, other than our chief
executive officer. The aggregate proceeds of the sale were $4,909,000. The
sale price for the LLP Interests was the net asset value per LLP Interest
using, among other items, information provided by an independent third
party appraisal firm of the net asset value of Shurgard Europe as of March
31, 2007. The Company has a right to repurchase the LLP Interests upon (1)
upon a purchaser's termination of employment or (2) for any reason, on or
after May 14, 2008. The repurchase price is set at the lesser of (1) the
then net asset value per share or (2) the original purchase price with a
10% compounded annual return. In connection with the sale of these LLP
Interests, we recorded a gain of $1,193,000 for the nine months ended
September 30, 2007, representing the excess of the sales proceeds over the
book value of the LLP Interests sold. The gain is reflected in gain on
disposition of real estate investments on our accompanying condensed
consolidated statements of income. The investment of these various officers
is included in minority interest - other partnership interests on our
accompanying condensed consolidated balance sheet at September 30, 2007 and
their pro rata share of the earnings of Shurgard Europe are reflected in
minority interest in income - other partnership interests on our
accompanying condensed consolidated statements of income for the three and
nine months ended September 30, 2007.
Convertible Partnership Units
-----------------------------
At September 30, 2007 and December 31, 2006, one of the
Consolidated Entities had approximately 231,978 convertible 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 common shares of
the Company at the option of the unit-holder. Minority interest in income
with respect to Convertible Units reflects the Convertible Units' share of
our net income, 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.
25
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
Other Consolidated Partnerships
-------------------------------
The partnership agreements of the Other Consolidated Partnerships
included in the table above 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.
In connection with the merger with Shurgard, we obtained partial
equity interests in certain joint ventures. Following the merger with
Shurgard, in 2006 we acquired the minority interests in certain of these
joint ventures, for an aggregate of approximately $62,300,000 in cash. As a
result of these transactions, we obtained the remaining interest in a total
of 68 self-storage facilities. This acquisition was recorded as a reduction
in minority interest totaling $12,177,000, with the remainder allocated to
real estate ($50,123,000).
In May 2007 we discontinued the consolidation of certain of these
joint ventures due to our losing control of these entities. As a result,
minority interest in income with respect to these joint ventures ceased
effective May 2007, and $682,000 in minority interest was eliminated. See
Note 2 for further information.
The partnership agreements of the Shurgard Domestic Joint
Ventures 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.
At September 30, 2007 and December 31, 2006, the Other
Consolidated Partnerships reflect common equity interests that we do not
own in 33 entities owning an aggregate of 117 self-storage facilities.
Impact of SFAS No. 150
----------------------
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 setting 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 that the Other Minority
Interests would have to be treated as a liability, because these
partnerships have termination dates that cannot be unilaterally extended by
us and, upon termination, the net assets of these entities would be
liquidated and paid to the minority interest and us based upon relative
ownership interests. However, on October 29, 2003, the FASB decided to
defer indefinitely a portion of the implementation of SFAS No. 150, which
thereby deferred our requirement to recognize these minority interest
liabilities. We estimate that the fair value of the Other Partnership
Interests is approximately $450 million at December 31, 2006 and September
30, 2007.
26
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
11. Shareholders' Equity
--------------------
Cumulative Preferred Shares
---------------------------
At September 30, 2007 and December 31, 2006, we had the following
series of Cumulative Preferred Shares of beneficial interest outstanding:
At September 30, 2007 At December 31, 2006
Earliest ----------------------------- -----------------------------
Redemption Dividend Shares Carrying Shares Carrying
Series Date Rate Outstanding Amount Outstanding Amount
------------------- ------------- ------------- -------------- -------------- -------------- -------------
(Dollar amounts in thousands)
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 1,600,000 40,000
Series Z 3/5/09 6.250% 4,500 112,500 4,500 112,500
Series A 3/31/09 6.125% 4,600 115,000 4,600 115,000
Series B 6/30/09 7.125% 4,350 108,750 4,350 108,750
Series C 9/13/09 6.600% 4,600 115,000 4,600 115,000
Series D 2/28/10 6.180% 5,400 135,000 5,400 135,000
Series E 4/27/10 6.750% 5,650 141,250 5,650 141,250
Series F 8/23/10 6.450% 10,000 250,000 10,000 250,000
Series G 12/12/10 7.000% 4,000 100,000 4,000 100,000
Series H 1/19/11 6.950% 4,200 105,000 4,200 105,000
Series I 5/3/11 7.250% 20,700 517,500 20,700 517,500
Series K 8/8/11 7.250% 18,400 460,000 18,400 460,000
Series L 10/20/11 6.750% 9,200 230,000 9,200 230,000
Series M 1/9/12 6.625% 20,000 500,000 - -
Series N 7/2/12 7.000% 6,900 172,500 - -
-------------- -------------- -------------- -------------
Total Cumulative Preferred Shares 1,739,500 $ 3,527,500 1,712,600 $ 2,855,000
============== ============== ============== =============
The holders of our Cumulative Preferred Shares have general
preference rights with respect to liquidation and quarterly distributions.
Holders of the preferred shares, 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 shares (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 until events of default have been cured. At
September 30, 2007, there were no dividends in arrears and the Debt Ratio
was 8.2%.
Upon issuance of our Cumulative Preferred Shares of beneficial
interest, we classify the liquidation value as preferred equity on our
condensed consolidated balance sheet with any issuance costs recorded as a
reduction to paid-in capital. Upon redemption, we apply EITF Topic D-42,
allocating income to the preferred shareholders equal to the original
issuance costs.
On January 9, 2007, we issued 20,000 depositary shares, with each
depositary share representing 1/1,000 of a share of our 6.625% Cumulative
Preferred Shares, Series M. The offering resulted in $500,000,000 of gross
proceeds.
27
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
On July 2, 2007, we issued 6,900,000 depositary shares each
representing 1/1,000 of our 7.000% Cumulative Preferred Shares, Series N,
for gross proceeds of approximately $172,500,000.
During 2006, we issued four series of Cumulative Preferred
Shares: Series H - issued January 19, 2006, net proceeds totaling
$101,492,000, Series I - issued May 3, 2006, net proceeds totaling
$501,601,000, Series K - issued August 8, 2006, net proceeds totaling
$445,852,000 and Series L - issued October 20, 2006, net proceeds totaling
$223,623,000.
During 2006, we redeemed our Series R and Series S Cumulative
Preferred Shares at par value plus accrued dividends. In December 2006, we
called for redemption our Series T and Series U Cumulative Preferred
Shares, at par. The aggregated redemption value of $302,150,000 of these
two series was classified as a liability at December 31, 2006 and repaid in
the nine months ended September 30, 2007.
Equity Shares
-------------
The Company is authorized to issue 100,000,000 Equity Shares of
beneficial interest. The Articles of Amendment and Restatement of
Declaration of Trust provide that the Equity Shares may be issued from time
to time in one or more series and give our Board broad authority to fix the
dividend and distribution rights, conversion and voting rights, redemption
provisions and liquidation rights of each series of Equity Shares.
Equity Shares, Series A
-----------------------
At September 30, 2007 and December 31, 2006, we had 8,744,193
depositary shares outstanding, each representing 1/1,000 of an Equity
Share, Series A ("Equity Shares A"). The Equity Shares A rank on parity
with our common shares and junior to the Cumulative Preferred Shares with
respect to general preference rights and have 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 shares 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 representing the
Equity Shares A 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,
each of the depositary shares will be convertible at the option of the
shareholder into .956 common shares. The depositary shares are otherwise
not convertible into common shares. Holders of depositary shares vote as a
single class with holders of our common shares on shareholder matters, but
the depositary shares have the equivalent of one-tenth of a vote per
depositary share.
Equity Shares, Series AAA
-------------------------
In November 1999, we sold $100,000,000 (4,289,544 shares) of
Equity Shares, Series AAA ("Equity Shares AAA") to the Consolidated
Development Joint Venture. On November 17, 2005, upon the acquisition of
Mr. Hughes' interest in PSAC, we owned 100% of the partnership interest in
the Consolidated Development Joint Venture. For all periods presented, the
Equity Shares, Series AAA and related dividends are eliminated in
consolidation.
Common Shares
-------------
During the nine months ended September 30, 2007, we issued
258,413 common shares in connection with employee stock-based compensation.
28
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
At September 30, 2007 and December 31, 2006, certain entities we
consolidate owned 1,146,207 common shares. 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.
Dividends
---------
The following table summarizes dividends declared and paid during
the nine months ended September 30, 2007:
Distributions Per Share Total
or Depositary Share Distributions
--------------------- ---------------
Preferred Shares:
Series T.............................. $0.090 $ 548,000
Series U.............................. $0.259 1,557,000
Series V.............................. $1.406 9,703,000
Series W.............................. $1.219 6,459,000
Series X.............................. $1.209 5,805,000
Series Y.............................. $1.284 2,055,000
Series Z.............................. $1.172 5,274,000
Series A.............................. $1.148 5,283,000
Series B.............................. $1.336 5,811,000
Series C.............................. $1.238 5,694,000
Series D.............................. $1.159 6,258,000
Series E.............................. $1.266 7,152,000
Series F.............................. $1.209 12,093,000
Series G.............................. $1.313 5,250,000
Series H.............................. $1.303 5,473,000
Series I.............................. $1.359 28,139,000
Series K.............................. $1.359 25,012,000
Series L.............................. $1.266 11,644,000
Series M.............................. $1.210 24,200,000
Series N.............................. $0.437 3,014,000
---------------
176,424,000
Common Shares:
Equity Shares, Series A............... $1.838 16,068,000
Common ............................... $1.500 255,022,000
---------------
Total dividends.................... $ 447,514,000
===============
The dividend rate on our common shares was $0.50 per common share
and $1.50 per common share for the three and nine months ended September
30, 2007. The dividend rate on the Equity Share A was $0.6125 per
depositary share and $1.8375 per depositary share for the three and nine
months ended September 30, 2007, respectively.
12. Segment Information
-------------------
Description of Each Reportable Segment
--------------------------------------
Our reportable segments reflect significant operating activities
that are evaluated separately by management, comprised of the following
segments which are organized based upon their operating characteristics.
29
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
Our domestic self-storage segment comprises the direct ownership,
development, and operation of traditional storage facilities in the U.S.,
and the ownership of equity interests in entities that own storage
properties in the U.S. Our European self-storage segment comprises our
self-storage and associated activities owned by affiliated entities based
in Europe.
Our domestic ancillary operating segment represents all of our
other segments, which are reported as a group, including with respect to
our domestic operations (i) containerized storage, (ii) commercial property
operations, which reflects our interest in the ownership, operation, and
management of commercial properties both directly and through our interest
in PSB (iii) the reinsurance of policies against losses to goods stored by
tenants in our self-storage facilities, (iv) sale of merchandise at our
self-storage facilities, (v) truck rentals at our self-storage facilities
and (vi) management of facilities owned by third-party owners and
facilities owned by the Unconsolidated Entities.
Measurement of Segment Income (Loss) and Segment Assets -
-----------------------------------------------------------------
Domestic Self-Storage and Domestic Ancillary
--------------------------------------------
The domestic self-storage and domestic ancillary segments are
evaluated by management based upon the net segment income of each segment.
Net segment income represents net income in conformity with GAAP and our
significant accounting policies as denoted in Note 2, before interest and
other income, interest expense, and corporate general and administrative
expense. Interest and other income, interest expense, corporate general and
administrative expense, minority interest in income and gains and losses on
sales of real estate assets are not allocated to these segments because
management does not utilize them to evaluate the results of operations of
each segment. In addition, there is no presentation of segment assets for
these other segments because total assets are not considered in the
evaluation of these segments.
Measurement of Segment Income (Loss) and Segment Assets -
-----------------------------------------------------------------
European Operations
-------------------
The European segment operations are primarily independent of the
other segments, with separate management, debt, financing activities, and
capital allocation decisions. The operations of our European segment are
included in our financial statements effective August 23, 2006 when we
completed the merger with Shurgard. Accordingly, this segment is evaluated
by management as a stand-alone business unit and the European segment
presentation includes all of the revenues, expenses, and operations of this
business unit, including interest expense paid to outside parties and
general and administrative expense. Assets of our European operations at
September 30, 2007, include real estate with a book value of approximately
$1.6 billion ($1.4 billion at December 31, 2006), intangibles with a book
value of approximately $110 million ($167 million at December 31, 2006),
and other assets with a book value of approximately $61 million ($65
million at December 31, 2006). At September 30, 2007, liabilities of our
European operations include; intercompany payables of $556 million ($542
million at December 31, 2006), debt of $360 million ($724 million at
December 31, 2006) and accrued and other liabilities of $92 million ($108
million at December 31, 2006). At December 31, 2006, assets of our European
operations included approximately $480 million in cash (of which
approximately $429 million was utilized on January 2, 2007 to prepay the
(euro)325M collateralized notes).
Presentation of Segment Information
-----------------------------------
The following table reconciles the performance of each segment,
in terms of segment income, to our consolidated net income (amounts in
thousands):
30
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
For the three months ended September 30, 2007
Domestic Other Items Not
Domestic European Ancillary Allocated to Total
Self-Storage Operations Operations Segments Consolidated
--------------- ------------ ------------- --------------- --------------
(Amounts in thousands)
Revenues:
Self-storage rental income.................... $ 377,877 $ 50,072 $ - $ - $ 427,949
Ancillary operating revenue................... - 4,775 32,979 - 37,754
Interest and other income..................... - - - 3,257 3,257
--------------- ------------ ------------- --------------- --------------
377,877 54,847 32,979 3,257 468,960
--------------- ------------ ------------- --------------- --------------
Expenses:
Cost of operations (excluding depreciation and
amortization below):
Self-storage facilities.................... 121,949 21,422 - - 143,371
Ancillary operations....................... - 1,427 21,260 - 22,687
Depreciation and amortization.................. 114,965 31,899 903 - 147,767
General and administrative..................... - 2,193 - 9,223 11,416
Interest expense............................... - 5,917 - 9,340 15,257
--------------- ------------ ------------- --------------- --------------
236,914 62,858 22,163 18,563 340,498
--------------- ------------ ------------- --------------- --------------
Income (loss) from continuing operations before
equity in earnings of real estate entities,
gain on disposition of real estate
investments, foreign currency exchange gain,
income from derivatives and minority interest
in income..................................... 140,963 (8,011) 10,816 (15,306) 128,462
Equity in earnings of real estate entities....... 902 - - 2,522 3,424
Gain on disposition of real estate investments... - - - 92 92
Foreign currency exchange gain................... - 30,384 - - 30,384
Income from derivatives, net..................... - 117 - - 117
Minority interest in (income) loss............... (4,466) 1,565 - (5,403) (8,304)
--------------- ------------ ------------- --------------- --------------
Income (loss) from continuing operations......... 137,399 24,055 10,816 (18,095) 154,175
Discontinued operations.......................... - (151) - (1,258) (1,409)
--------------- ------------ ------------- --------------- --------------
Net income (loss)................................ $ 137,399 $ 23,904 $ 10,816 $ (19,353) $ 152,766
=============== ============ ============= =============== ==============
31
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
For the three months ended September 30, 2006
Domestic Other Items Not
Domestic European Ancillary Allocated to Total
Self-Storage Operations Operations Segments Consolidated
--------------- ------------ ------------- --------------- --------------
(Amounts in thousands)
Revenues:
Self-storage rental income.................... $ 311,434 $ 17,348 $ - $ - $ 328,782
Ancillary operating revenue................... - 1,562 28,265 - 29,827
Interest and other income..................... - - - 12,651 12,651
--------------- ------------ ------------- --------------- --------------
311,434 18,910 28,265 12,651 371,260
--------------- ------------ ------------- --------------- --------------
Expenses:
Cost of operations (excluding depreciation and
amortization below):
Self-storage facilities.................... 100,582 8,524 - - 109,106
Ancillary operations....................... - 636 17,878 - 18,514
Depreciation and amortization.................. 97,634 15,020 809 - 113,463
General and administrative..................... - 4,642 - 31,600 36,242
Interest expense............................... - 3,432 - 5,891 9,323
--------------- ------------ ------------- --------------- --------------
198,216 32,254 18,687 37,491 286,648
--------------- ------------ ------------- --------------- --------------
Income (loss) from continuing operations before
equity in earnings of real estate entities,
gain on disposition of real estate
investments, foreign currency exchange loss,
income from derivatives and minority interest
in income..................................... 113,218 (13,344) 9,578 (24,840) 84,612
Equity in earnings of real estate entities....... 600 - - 2,018 2,618
Gain on disposition of real estate investments... - - - 756 756
Foreign currency exchange loss................... - (172) - - (172)
Income from derivatives, net..................... - 32 - - 32
Minority interest in income...................... (4,466) 1,279 - (5,403) (8,590)
--------------- ------------ ------------- --------------- --------------
Income (loss) from continuing operations......... 109,352 (12,205) 9,578 (27,469) 79,256
Discontinued operations.......................... - (21) - 1,946 1,925
--------------- ------------ ------------- --------------- --------------
Net income (loss)................................ $ 109,352 $ (12,226) $ 9,578 $ (25,523) $ 81,181
=============== ============ ============= =============== ==============
32
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
For the nine months ended September 30, 2007
Domestic Other Items Not
Domestic European Ancillary Allocated to Total
Self-Storage Operations Operations Segments Consolidated
--------------- ------------ ------------- --------------- --------------
(Amounts in thousands)
Revenues:
Self-storage rental income.................... $ 1,097,655 $ 140,291 $ - $ - $ 1,237,946
Ancillary operating revenue................... - 12,878 95,025 - 107,903
Interest and other income..................... - - - 6,337 6,337
--------------- ------------ ------------- --------------- --------------
1,097,655 153,169 95,025 6,337 1,352,186
--------------- ------------ ------------- --------------- --------------
Expenses:
Cost of operations (excluding depreciation and
amortization below):
Self-storage facilities.................... 374,075 67,582 - - 441,657
Ancillary operations....................... - 4,125 59,294 - 63,419
Depreciation and amortization.................. 378,975 110,101 2,649 - 491,725
General and administrative..................... - 16,922 - 32,475 49,397
Interest expense............................... - 16,247 - 32,525 48,772
--------------- ------------ ------------- --------------- --------------
753,050 214,977 61,943 65,000 1,094,970
--------------- ------------ ------------- --------------- --------------
Income (loss) from continuing operations before
equity in earnings of real estate entities,
casualty gain, gain on disposition of real
estate investments, foreign currency exchange
gain, income from derivatives and minority
interest in income............................ 344,605 (61,808) 33,082 (58,663) 257,216
Equity in earnings of real estate entities....... 1,947 - - 8,236 10,183
Casualty gain.................................... 2,665 - - - 2,665
Gain on disposition of real estate investments... - - - 2,330 2,330
Foreign currency exchange gain................... - 40,977 - - 40,977
Income from derivatives, net..................... - 1,126 - - 1,126
Minority interest in (income) loss............... (12,677) 7,275 - (16,209) (21,611)
--------------- ------------ ------------- --------------- --------------
Income (loss) from continuing operations......... 336,540 (12,430) 33,082 (64,306) 292,886
Discontinued operations.......................... - (281) - (2,957) (3,238)
--------------- ------------ ------------- --------------- --------------
Net income (loss)................................ $ 336,540 $ (12,711) $ 33,082 $ (67,263) $ 289,648
=============== ============ ============= =============== ==============
33
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
For the nine months ended September 30, 2006
Domestic Other Items Not
Domestic European Ancillary Allocated to Total
Self-Storage Operations Operations Segments Consolidated
--------------- ------------ ------------- --------------- --------------
(Amounts in thousands)
Revenues:
Self-storage rental income.................... $ 825,013 $ 17,348 $ - $ - $ 842,361
Ancillary operating revenue................... - 1,562 75,938 - 77,500
Interest and other income..................... - - - 27,773 27,773
--------------- ------------ ------------- --------------- --------------
825,013 18,910 75,938 27,773 947,634
--------------- ------------ ------------- --------------- --------------
Expenses:
Cost of operations (excluding depreciation and
amortization below):
Self-storage facilities.................... 277,680 8,524 - - 286,204
Ancillary operations....................... - 636 49,679 - 50,315
Depreciation and amortization.................. 194,625 15,020 2,412 - 212,057
General and administrative..................... - 4,642 - 45,354 49,996
Interest expense............................... - 3,432 - 9,320 12,752
--------------- ------------ ------------- --------------- --------------
472,305 32,254 52,091 54,674 611,324
--------------- ------------ ------------- --------------- --------------
Income (loss) from continuing operations before
equity in earnings of real estate entities,
casualty gain, gain on disposition of real
estate investments, foreign currency exchange
loss, income from derivatives and minority
interest in income............................ 352,708 (13,344) 23,847 (26,901) 336,310
Equity in earnings of real estate entities....... 1,574 - - 7,634 9,208
Gain on disposition of real estate investments... - - - 1,222 1,222
Foreign currency exchange loss................... - (172) - - (172)
Income from derivatives, net..................... - 32 - - 32
Minority interest in income...................... (12,104) 1,279 - (13,652) (24,477)
--------------- ------------ ------------- --------------- --------------
Income (loss) from continuing operations......... 342,178 (12,205) 23,847 (31,697) 322,123
Cumulative effect of a change in accounting
principle..................................... - - - 578 578
Discontinued operations.......................... - (21) - 1,579 1,558
--------------- ------------ ------------- --------------- --------------
Net income (loss)................................ $ 342,178 $ (12,226) $ 23,847 $ (29,540) $ 324,259
=============== ============ ============= =============== ==============
13. Share-Based Compensation
------------------------
Stock Options
-------------
We have various stock option plans (collectively referred to as
the "PS Plans"). Under the PS Plans, the Company has granted non-qualified
options to certain trustees, 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 PS
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, 2002 vest generally
over a five-year period) and expire between eight years and ten years after
the date they became exercisable. The PS Plans also provide for the grant
of restricted stock (see below) to officers, key employees and service
providers on terms determined by an authorized committee of our Board.
34
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
We recognize compensation expense for share-based awards based
upon their fair value on the date of grant amortized over the applicable
vesting period (the "Fair Value Method"), less an allowance for estimated
future forfeited awards.
For the three and nine months ended September 30, 2007 we
recorded $695,000 and $1,301,000, respectively, in stock option
compensation expense related to options granted after January 1, 2002, as
compared to $360,000 and $958,000, for the same periods in 2006.
A total of 240,000 stock options were granted during the nine
months ended September 30, 2007, 191,095 shares were exercised, and no
shares were forfeited. A total of 1,651,839 stock options were outstanding
at September 30, 2007 (1,602,934 at December 31, 2006).
Restricted Share Units
----------------------
Outstanding restricted share units vest over a five or eight-year
period from the date of grant at the rate of one-fifth or one-eighth per
year, respectively. The employee receives additional compensation equal to
the per-share dividends received by common shareholders with respect to
restricted share units outstanding. Such compensation is accounted for as
dividends paid. Any dividends paid on units which are subsequently
forfeited are expensed. Upon vesting, the employee receives common shares
equal to the number of vested restricted share units in exchange for the
units.
The total value of each restricted share unit grant, based upon
the market price of our common shares at the date of grant, is amortized
over the vesting period as compensation expense. The related employer
portion of payroll taxes is expensed as incurred. Until December 31, 2005
(see below), forfeitures were recognized as experienced, reducing
compensation expense.
Effective January 1, 2006, in accordance with Statement of
Financial Accounting Standards No. 123 - revised ("FAS 123R"), we began
recording compensation expense net of estimates for future forfeitures (the
"Estimated Forfeiture Method"). In addition, we estimated the cumulative
compensation expense that would have been recorded through December 31,
2005, had we used the Estimated Forfeiture Method, would have been $578,000
lower. Accordingly, as prescribed by FAS 123R, we recorded this adjustment
as a cumulative effect of change in accounting principal on our
accompanying condensed consolidated statement of income for the nine months
ended September 30, 2006.
Outstanding restricted share units are included on a one-for-one
basis in our 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. For purposes of the
disclosures that follow, "fair value" on any particular date reflects the
closing market price of our common shares on that date.
During the nine months ended September 30, 2007, 170,175
restricted share units were granted, 69,992 restricted share units were
forfeited, and 100,477 restricted share units vested. This vesting resulted
in the issuance of 67,318 shares of the Company's common shares. In
addition, cash compensation was paid to employees in lieu of 30,485 common
shares based upon the market value of the shares at the date of vesting,
and used to settle the employees' tax liability generated by the vesting.
At September 30, 2007, approximately 616,176 restricted share
units were outstanding (616,470 at December 31, 2006). A total of
$1,751,000 and $6,013,000 in restricted share expense was recorded for the
three and nine months ended September 30, 2007, respectively, as compared
to $1,200,000 and $3,629,000, for the same periods in 2006.
35
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
14. Related Party Transactions
--------------------------
Relationships and transactions with the Hughes Family
-----------------------------------------------------
Mr. Hughes and his family (collectively the "Hughes Family") have
ownership interests in, and operate approximately 48 self-storage
facilities in Canada under the name "Public Storage" ("PS Canada") 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 27% of our common shares outstanding at
September 30, 2007. We have a right of first refusal to acquire the stock
or assets of the corporation that manages the 48 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, we have
no right to acquire this stock or assets unless the Hughes Family decides
to sell, the right of first refusal does not apply to the self-storage
facilities, and we receive no benefit from the profits and increases in
value of the Canadian self-storage facilities.
Through consolidated entities, we continue to reinsure risks
relating to loss of goods stored by tenants in the self-storage facilities
in Canada. During the nine months ended September 30, 2007 and 2006,
respectively, we received $666,000 and $759,000, respectively, in
reinsurance premiums attributable to the Canadian facilities. Since our
right to provide tenant reinsurance to the Canadian facilities may be
qualified, there is no assurance that these premiums will continue.
The Company and Mr. Hughes are co-general partners in certain
consolidated entities and affiliated entities of the Company that are not
consolidated, and the Hughes Family owns 47.9% of the voting stock of a
private REIT in which the Company holds 46% of the voting and 100% of the
nonvoting stock of the entity and substantially all the economic interest.
The Hughes Family also owns limited partnership interests in certain of
these partnerships and holds securities in PSB. The Company and the Hughes
Family receive distributions from these entities in accordance with the
terms of the partnership agreements or other organizational documents.
Other Related Party Transactions
--------------------------------
Ronald L. Havner, Jr. is our Vice-Chairman and Chief Executive
Officer, and he is Chairman of the Board of PSB.
Dann V. Angeloff, a trustee of the Company, is the general
partner of a limited partnership formed in June of 1973 that owns a
self-storage facility that is managed by us. We recorded management fees
with respect to this facility amounting to $18,000, and $55,000 for the
three and nine months ended September 30, 2007, respectively, compared to
$18,000 and $49,000 for the three and nine months ended September 30, 2006,
respectively.
PSB manages certain of the commercial facilities that we own
pursuant to management agreements for a management fee equal to 5% of
revenues. We paid a total of $177,000 and $542,000 for the three and nine
months ended September 30, 2007, respectively, as compared to $147,000 and
$442,000 for the three and nine months ended September 30, 2006,
respectively, in management fees with respect to PSB's property management
services. At September 30, 2007, included in other liabilities are normal
recurring amounts owed to PSB of $204,000 ($871,000 at December 31, 2006),
for unpaid management fees and certain other operating expenses related to
the managed facilities which are initially paid by PSB on our behalf and
then reimbursed by us.
36
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
PSB recently acquired commercial facilities which included
self-storage space. We are managing this self-storage space for them for a
management fee of 6% of revenues. We recorded management fees with respect
to these facilities amounting to $11,000 and $35,000 for the three and nine
months ended September 30, 2007 (none for the same periods in 2006).
Pursuant to a cost-sharing and administrative services agreement,
PSB reimburses us for certain administrative services that we provide to
them. PSB's share of these costs totaled approximately $76,000 and $228,000
for the three and nine months ended September 30, 2007, respectively, as
compared to $80,000 and $240,000 for the three and nine months ended
September 30, 2006, respectively.
We manage our wholly-owned self-storage facilities as well as the
facilities owned by the Consolidated Entities and affiliated entities that
are not consolidated on a joint basis, in order to take advantage of scale
and other efficiencies. As a result, significant components of self-storage
operating costs, such as payroll costs, advertising and promotion, data
processing, and insurance expenses are shared and allocated among the
various entities using methodologies meant to fairly allocate such costs
based upon the related activities. The amount of such expenses allocated to
Unconsolidated Entities was approximately $599,000 and $1,895,000 for the
three and nine months ended September 30, 2007, respectively, as compared
to $503,000 and $1,770,000 for the three and nine months ended September
30, 2006, respectively.
Stor-RE, a consolidated entity, and third party insurance
carriers provided PS Canada, the Company, PSB, and other affiliates of the
Company with liability and casualty insurance coverage until March 31,
2004. PS Canada owns a 2.2% interest and PSB owns a 4.0% interest in
Stor-RE. PS Canada and PSB obtained their own liability and casualty
insurance covering occurrences after April 1, 2004. For occurrences before
April 1, 2004, Stor-Re continues to provide liability and casualty
insurance coverage consistent with the relevant agreements.
On May 14, 2007, one of our European subsidiaries sold limited
liability partner interests ("LLP Interests") it held in Shurgard Europe,
also an indirect subsidiary of Public Storage, to various officers of the
Company, other than our chief executive officer. The aggregate proceeds of
the sale were $4,909,000. The sale price for the LLP Interests was the net
asset value per LLP Interest using, among other items, information provided
by an independent third party appraisal firm of the net asset value of
Shurgard Europe as of March 31, 2007. The Company has a right to repurchase
the LLP Interests (1) upon a purchaser's termination of employment or (2)
for any reason, on or after May 14, 2008. The repurchase price is set at
the lesser of (1) the then net asset value per share or (2) the original
purchase price with a 10% compounded annual return. In connection with the
sale of these LLP Interests, we recorded a gain of $1,193,000 during the
three months ended June 30, 2007, representing the excess of the sales
proceeds over the book value of the LLP Interests sold. The gain is
reflected in gain on disposition of real estate investments on our
accompanying condensed consolidated statements of income. The investment of
these various officers is included in minority interest - other partnership
interests on our accompanying condensed consolidated balance sheet at
September 30, 2007 and their pro rata share of the earnings of Shurgard
Europe are reflected in minority interest in income - other partnership
interests on our accompanying condensed consolidated statements of income
for the three and nine months ended September 30, 2007.
15. Commitments and Contingencies
-----------------------------
Legal Matters
-------------
Serrao v. Public Storage, Inc. (filed April 2003) (Superior Court
-----------------------------------------------------------------
of California - 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
37
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
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.
Based upon the uncertainty inherent in any putative class action,
we cannot presently determine the potential damages, if any, or the
ultimate outcome of this litigation. On November 3, 2003, the court granted
our motion to strike the plaintiff's nationwide class allegations and to
limit any putative class to California residents only. In August 2005, we
filed a motion to remove the case to federal court, but the case has been
remanded to the Superior Court. We are vigorously contesting the claims
upon which this lawsuit is based, including class certification efforts.
Drake v. Shurgard Storage Centers, Inc. (filed September 2002)
-----------------------------------------------------------------
(Superior Court of California - Orange County)
----------------------------------------------
This is a companion case to the Serrao matter discussed above.
The plaintiff alleges the same set of operative facts and seeks the same
relief as in Serrao against Shurgard, whose liability Public Storage
assumed following the merger of Public Storage and Shurgard on August 22,
2006. In June 2007, the Court certified a class of all Shurgard renters who
rented a storage unit at a Shurgard facility in California that was smaller
than represented. The maximum potential liability cannot presently be
estimated. We intend to vigorously contest the substantive merits of the
class certification while seeking an appellate writ challenging the Court's
certifications of the class.
Potter, et al v. Hughes, et al (filed December 2004) (United
-----------------------------------------------------------------
States District Court - Central District of California)
-------------------------------------------------------
In November 2002, a shareholder of the Company made a demand on
our Board challenging the fairness of the Company's acquisition of PS
Insurance Company, Ltd. ("PSIC") and related matters. PSIC was previously
owned by the Hughes Family. In June 2003, following the filing by the
Hughes Family of a complaint for declaratory relief asking the court to
find that the acquisition of PSIC and related matters were fair to the
Company, it was ruled that the PSIC transaction was just and reasonable as
to the Company and holding that the Hughes Family was not required to make
any payment to the Company.
At the end of December 2004, the same shareholder referred to
above and a second shareholder filed this shareholder's derivative
complaint naming as defendants the Company's directors (and two former
directors) and certain officers of the Company. The matters alleged in this
complaint relate to PSIC, the Hughes Family's Canadian self-storage
operations and the Company's 1995 reorganization. In July 2006, the Court
granted the defendants' motion to dismiss the amended Complaint without
leave to amend. In August 2006, Plaintiffs filed a notice of appeal of the
Court's decision. The appeal is currently pending. We believe the
litigation will not have any financially adverse effect on the Company
(other than the costs and other expenses relating to the lawsuit).
Brinkley v. Public Storage, Inc. (filed April 2005) (Superior
-----------------------------------------------------------------
Court of California - Los Angeles County)
-----------------------------------------
The plaintiff sued the Company on behalf of a purported class of
California non-exempt employees based on various California wage and hour
laws and seeking monetary damages and injunctive relief. In May 2006, a
motion for class certification was filed seeking to certify five
subclasses. Plaintiff sought certification for alleged meal period
violations, rest period violations, failure to pay for travel time, failure
to pay for mileage reimbursement, and for wage statement violations. In
38
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
October 2006, the Court declined to certify three out of the five
subclasses. The Court did, however, certify subclasses based on alleged
meal period and wage statement violations. Subsequently, the Company filed
a motion for summary judgment seeking to dismiss the matter in its
entirety. On June 22, 2007, the Court granted the Company's summary
judgment motion as to the causes of action relating to the subclasses
certified and dismissed those claims. The only surviving claims are those
relating to the named plaintiff only. The plaintiff has filed an appeal to
the Court's June 22, 2007 summary judgment ruling.
Simas v. Public Storage, Inc. (filed January 2006) (Superior
-----------------------------------------------------------------
Court of California - Orange County)
------------------------------------
The plaintiff brought this action against the Company on behalf
of a purported class who bought insurance coverage at the Company's
facilities alleging that the Company does not have a license to offer, sell
and/or transact storage insurance. The action was originally brought under
California Business and Professions Code Section 17200 and seeks retention,
monetary damages and injunctive relief. The Company filed a demurrer to the
complaint. While the demurrer was pending, the plaintiff amended the
complaint to allege a national class and claims for unfair business
practices, unjust enrichment, money had and received, and negligent and
intentional misrepresentation. Ultimately all claims except for unjust
enrichment were dismissed. A subsequent demurrer was filed and sustained
without leave to amend. The case was therefore dismissed. The plaintiff has
appealed the trial court's ruling.
European Joint Venture Arbitration Proceeding
---------------------------------------------
The Company holds indirectly a 20% interest in each of two joint
ventures in Europe, First Shurgard and Second Shurgard, that collectively
own 66 self-storage properties in Europe. On August 24, 2006, the Company,
through its affiliate, Shurgard Europe, served an exit notice on the
European joint venture partners informing them of its intention to purchase
their interests in First Shurgard and Second Shurgard pursuant to an early
exit procedure that the Company believes is provided for in the respective
joint venture agreements. The exit notice offered to pay the joint venture
partners an amount for their interests in accordance with the provisions of
the joint venture agreements. The joint ventures partners have contested
both the valuation of their interests and whether the Company has the right
to purchase its interests under this early exit procedure. Accordingly, it
is uncertain as to whether the Company will acquire such interests pursuant
to the early exit notice served. On January 17, 2007, Shurgard Europe filed
an arbitration request with the International Chamber of Commerce to compel
arbitration of the matter. The arbitration proceedings are ongoing.
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
our operations or financial position.
Insurance and Loss Exposure
---------------------------
We have historically carried comprehensive insurance, including
property, earthquake, general liability and workers compensation, through
nationally recognized insurance carriers and through our captive insurance
programs. Our insurance programs also insure affiliates of the Company. Our
estimated maximum annual exposure for losses that are below the deductibles
set forth in the third-party insurance contracts, assuming multiple
significant events occur, is approximately $37 million. In addition, if
losses exhaust the third-party insurers' limit of coverage of $75 million
for property coverage including earthquake coverage ((euro)25 million for
Europe) and $102 million 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.
39
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
Our tenant insurance program reinsures policies against claims
for losses to goods stored by tenants at our self-storage facilities. We
have third-party insurance coverage for claims paid exceeding $1,500,000
resulting from any individual event, to a limit of $9,000,000. At September
30, 2007, we had approximately 481,000 reinsured policies outstanding
representing aggregate coverage of approximately $1.2 billion.
Development and Acquisition of Real Estate Facilities
-----------------------------------------------------
We currently have 55 projects in our development pipeline,
consisting of newly developed self-storage facilities, expansions and
enhancements to existing self-storage facilities. The total estimated cost
of these facilities is approximately $295 million of which $103,657,000 has
been spent at September 30, 2007. These projects are subject to
contingencies. We expect to incur these expenditures over the next 12 - 24
months.
Operating Lease Obligations
---------------------------
We lease trucks, land, equipment and office space. At September
30, 2007, the future minimum rental payments required under our operating
leases for the years ending December 31, principally representing amounts
payable under land leases for our European subsidiaries, are as follows
(amounts in thousands):
2007 (remainder of)....................... $ 7,318
2008...................................... 19,257
2009...................................... 15,817
2010...................................... 12,083
2011...................................... 10,774
Thereafter................................ 205,398
-----------
$ 270,647
===========
We lease trucks, land, equipment and office space under various
operating leases. Certain leases are cancelable with substantial penalties.
Certain of our European land operating leases have indefinite terms or
extension options exercisable at the discretion of the lessee. For such
land leases we have disclosed operating lease obligations over the
estimated useful life of the related property.
Expenses under operating leases were approximately $7,397,000 and
$22,168,000 for the three and nine months ended September 30, 2007,
respectively, as compared to $7,482,000 and $12,052,000 for the three and
nine months ended September 30, 2006, respectively. Certain of our land
leases include escalation clauses, and we recognize related lease expenses
on a straight-line basis.
16. Income Taxes
------------
For all taxable years subsequent to 1980, the Company qualified
and we intend to continue to qualify the Company as a REIT, as defined in
Section 856 of the Internal Revenue Code. As a REIT, we do not incur
federal or significant state tax 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 2007 and, accordingly, no
provision for income taxes has been made in the accompanying condensed
consolidated financial statements on income produced and distributed on
real estate rental operations.
Domestic operations other than rental real estate are primarily
conducted through taxable REIT subsidiaries. Income of our taxable REIT
subsidiaries is subject to federal, state and local income taxes. We are
subject to the income tax provisions of the various European countries in
which we have rental real estate operations.
40
PUBLIC STORAGE
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
September 30, 2007
(Unaudited)
We adopted the provisions of Financial Accounting Standards Board
("FASB") Interpretation No. 48, "Accounting for Uncertainty in Income Taxes
- an interpretation of FASB Statement No. 109" ("FIN 48"), on January 1,
2007. FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in an enterprise's financial statement in accordance with FASB
Statement 109, "Accounting for Income Taxes", and prescribes a recognition
threshold and measurement process for financial statement recognition and
measurement of a tax position taken or expected to be taken in a tax
return. FIN 48 also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosures and
transition.
Based on our evaluation, we have concluded that there are no
significant uncertain tax positions requiring recognition in our financial
statements. Our evaluation was performed for the tax years ended December
31, 2003, 2004, 2005, 2006 and the first three quarters of 2007.
We may from time to time be assessed interest or penalties by
certain tax jurisdictions, although any such assessments have historically
been minimal and immaterial to our financial results. In the event we have
received an assessment for interest and/or penalties, it has been
classified in the financial statements as general and administrative
expense.
41
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 condensed consolidated financial statements and notes thereto.
Forward Looking Statements: All statements in this document, other than
statements of historical fact, are forward-looking statements which may be
identified by the use of the words "expects," "believes," "anticipates,"
"plans," "would," "should," "may," "estimates" and similar expressions. These
forward-looking statements are made pursuant to the safe-harbor provisions of
Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A
of the Securities Act of 1933, as amended. These forward-looking statements
involve known and unknown risks and uncertainties, which may cause Public
Storage's actual results and performance to be materially different from those
expressed or implied in the forward-looking statements. As a result, you should
not rely on these forward-looking statements as predictions of future events.
Factors and risks that may impact future results and performance include,
but are not limited to, those described in Item 1A, "Risk Factors" in the Public
Storage, Inc. Annual Report on Form 10-K for the year ended December 31, 2006
and in our other filings with the Securities and Exchange Commission. These
risks include the following: changes in general economic conditions and in the
markets in which we operate; the impact of competition from new and existing
storage and commercial facilities and other storage alternatives; difficulties
in our ability to successfully evaluate, finance and integrate acquired and
developed properties into our existing operations; risks associated with
international operations; the impact of the regulatory environment as well as
national, state, and local laws and regulations including, without limitation,
those governing REITs; difficulties in raising capital at reasonable rates;
delays in the development process; and economic uncertainty due to the impact of
war or terrorism.
We caution you not to place undue reliance on forward-looking statements,
which speak only as the date of this report or as of the dates indicated in the
statements. All of our forward looking statements, including those in this
report, are qualified in their entirely by this statement. We assume no
obligation to update publicly or otherwise revise any forward-looking
statements, whether as a result of new information, new estimates, or other
factors, events or circumstances after the date of this document, except where
expressly required by law.
CRITICAL ACCOUNTING POLICIES
Management's Discussion and Analysis of Financial Condition and Results of
Operations discusses our consolidated financial statements, which have been
prepared in accordance with U.S. generally accepted accounting principles
("GAAP"). The preparation of our financial statements and related disclosures in
conformity with GAAP and our discussion and analysis of our financial condition
and results of operations requires management to make judgments, assumptions and
estimates that affect the amounts reported in our consolidated financial
statements and accompanying notes. Note 2 to our condensed consolidated
financial statements summarizes the significant accounting policies and methods
used in the preparation of our condensed consolidated financial statements and
related disclosures.
Management believes the following are critical accounting policies whose
application has a material impact on the Company's financial presentation. That
is, they are both important to the portrayal of our financial condition and
results, and they require management to make judgments and estimates about
matters that are inherently uncertain.
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. We also believe that Shurgard qualified as a REIT. 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 income tax on the share of our taxable income that is distributed to our
shareholders.
We therefore do not estimate or accrue any federal income tax expense for
income earned and distributed related to REIT operations. This estimate could be
42
incorrect, because due to 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 be assured 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. In
addition, if Shurgard failed to qualify as a REIT, we generally would have
succeeded to or incurred significant tax liabilities.
IMPAIRMENT OF LONG-LIVED ASSETS: Substantially all of our assets consist of
long-lived assets, including real estate and other intangible assets. The
evaluation of our long-lived assets for impairment includes 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. Future events, or facts and circumstances that currently
exist, that we have not yet identified, could cause us to conclude in the future
that our 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 15 to our condensed 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 the estimated level of losses incurred using certain actuarial assumptions
followed in the insurance industry and based on recommendations from an
independent actuary that is a member of the American Academy of Actuaries. 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 recorded. At September
30, 2007, we had approximately 481,000 reinsured policies in the United States
outstanding representing aggregate coverage of approximately $1.2 billion.
ACCRUALS FOR CONTINGENCIES: We are exposed to business and legal liability
risks with respect to events that have occurred, but in accordance with GAAP, 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 15 to our
condensed consolidated financial statements.
ACCRUALS FOR OPERATING EXPENSES: We accrue for property tax expense and
certain 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.
VALUATION OF DERIVATIVES: As described in our Significant Accounting
Policies in Note 2 to our condensed consolidated financial statements, our
derivative instruments are not considered effective hedges. Accordingly, any
changes in value of these derivatives are reflected as an increase or decrease
in net income. The determination of the value of derivatives is based upon
significant judgment and assumptions including interest rates, currency rates,
and expected rates of return. The actual value of derivative instruments is
dependent upon many factors that our judgments and assumptions may not consider,
or may not consider effectively.
43
EUROPEAN NET OPERATING LOSSES - INCOME TAX TREATMENT: The Shurgard European
real estate operations generated significant operating losses from inception to
the date of our merger with Shurgard. We recorded a deferred tax asset arising
from the net operating loss carryforward as of the date of acquisition, and
concluded that a valuation allowance was required for the net amount of the
deferred tax asset. To the extent that we determine the valuation allowance is
no longer required, the change in the valuation allowance will first be treated
as a reduction of goodwill and other intangible assets related to the Shurgard
merger before being treated as a reduction to the provision for income taxes.
VALUATION OF ASSETS AND LIABILITIES ACQUIRED IN THE MERGER WITH SHURGARD:
In recording the merger with Shurgard, we have estimated the fair market value
of real estate, intangible assets, debt, and the other assets and other
liabilities of Shurgard that we acquired. In addition, we have estimated the
fair market value of the 38.9 million shares that we issued to the Shurgard
shareholders. These value estimates are based upon many assumptions, including
interest rates, market values of land and buildings in the United States and
Europe, estimated future cash flows from the tenant base in place, and the
recoverability of certain assets. While we believe that the assumptions we used
are reasonable, these assumptions are subject to a significant degree of
judgment, and others could come to materially different conclusions as to value.
If these assumptions were computed differently, our depreciation and
amortization expense, interest expense, real estate, debt, and intangible assets
could be materially different.
RESULTS OF OPERATIONS
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2007:
Net income for the three months ended September 30, 2007 was $152,766,000
compared to $81,181,000 for the same period in 2006, representing an increase of
$71,585,000. This increase in net income is primarily due to a foreign currency
exchange gain, reduction in general and administrative expense and improved
operations from our real estate facilities. These factors were partially offset
by increased depreciation and amortization expense.
Comparisons of our revenues, expenses, and weighted average shares
outstanding are significantly impacted by the merger with Shurgard, which closed
on August 23, 2006. The operating results with respect to the assets and
liabilities acquired in the merger with Shurgard are included in our operating
results from August 23, 2006 through September 30, 2006 during the quarter ended
September 30, 2006, as compared to the entire quarter ended September 30, 2007.
During the quarter ended September 30, 2007, we recognized a foreign
currency exchange gain of $30.4 million relating to intercompany loans between
our U.S. and European subsidiaries. The gain was the result of the continued
weakening of the US Dollar relative to the Euro during the quarter. See "Foreign
Exchange Gain" below for further information.
General and administrative expense declined $24.8 million in the quarter
ended September 30, 2007 as compared to the same period in 2006. This decline
was primarily due to the reduction in integration expenses associated with the
Shurgard merger, contract termination costs, and development costs that were
expensed with respect to terminated projects; these expenses aggregated $29.6
million in the quarter ended September 30, 2006 as compared to $1.4 million for
the same period in 2007.
Our Same Store net operating income, before depreciation expense, increased
by approximately $2,901,000 to $161,374,000, or 1.8%, as a result of a 1.7%
improvement in revenues partially offset by a 1.5% increase in cost of
operations. Aggregate net operating income for our newly developed, recently
expanded and acquired facilities (other than the Shurgard facilities) increased
by approximately $4,368,000 to $30,208,000 compared to the same period in 2006.
This increase was largely due to the impact of facilities acquired in 2005, 2006
and 2007, combined with continued fill-up of our newly developed and expansion
facilities.
44
For those facilities that were acquired in the Shurgard merger, net
operating income was approximately $92,996,000 for the quarter ended September
30, 2007 as compared to $35,363,000 (which reflects the operations of these
facilities from August 23, 2006 through September 30, 2006) for the same period
in 2006.
Depreciation and amortization expense for the quarter ended September 30,
2007 increased by $34.3 million, as compared to the same period in 2006. This
increase is primarily due to increased depreciation and amortization expense
with respect to the buildings and intangible assets acquired in the merger with
Shurgard.
For the three months ended September 30, 2007, net income allocable to our
common shareholders (after allocating net income to our preferred and equity
shareholders) was $87,077,000 or $0.51 per common share on a diluted basis
compared to a net loss of $6,083,000 or $0.04 per common share on a diluted
basis for the same period in 2006, representing an increase of $93,160,000 or
$0.55 per diluted common share. The increase in net income allocable to common
shareholders on an aggregate and per-share basis is due primarily to the impact
of the factors described above, combined with a decrease in income allocated to
preferred shareholders, as described below.
For the three months ended September 30, 2007 and 2006, we allocated
$60,333,000 and $60,265,000 of our net income, respectively, to our preferred
shareholders based on distributions paid. The year-over-year increase is due to
the issuance of additional preferred securities, partially offset by the
redemption of preferred securities that had higher dividend rates than the newly
issued preferred securities. In 2006, we also recorded allocations of income to
our preferred shareholders with respect to the application of EITF Topic D-42,
totaling $21,643,000 (or $0.15 per diluted common share) for the three months
ended September 30, 2006 in connection with the redemption of preferred
securities.
Weighted average diluted shares increased to 170,085,000 for the three
months ended September 30, 2007 from 145,387,000 for the three months ended
September 30, 2006. The increase in weighted average diluted shares is due
primarily to the impact of the issuance of 38.9 million shares in connection
with our merger with Shurgard, with approximately 16.7 million of such shares
being included in our operating results for the quarter ended September 30, 2006
(representing the weighted average outstanding of such shares from August 23,
2006 through September 30, 2006). The increase also includes the weighted
average impact of the exercise of approximately 1.8 million stock options issued
in connection with the merger with Shurgard principally during the quarter ended
September 30, 2006.
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2007:
Net income for the nine months ended September 30, 2007 was $289,648,000
compared to $324,259,000 for the same period in 2006, representing a decrease of
$34,611,000. This decrease is primarily due to a $279.7 million increase in
depreciation and amortization expense, due primarily to depreciation and
amortization with respect to the buildings and intangibles acquired in the
merger with Shurgard. Increased depreciation and amortization expense was
partially offset by a foreign currency exchange gain of $41.0 million and
improved operations from our real estate facilities.
Comparisons of our revenues, expenses, and weighted average shares
outstanding are significantly impacted by the merger with Shurgard, which closed
on August 23, 2006. The results with respect to the assets and liabilities
acquired in the merger with Shurgard are included in our operating results from
August 23, 2006 through September 30, 2006 during the nine months ended
September 30, 2006, as compared to the entire nine months ended September 30,
2007.
During the nine months ended September 30, 2007, we recognized a foreign
currency exchange gain aggregating $41.0 million relating to intercompany loans
between our U.S. and European subsidiaries. The gain was the result of the
continued weakening of the US Dollar relative to the Euro during the nine month
period ended September 30, 2007. See "Foreign Exchange Gain" below for further
information.
Same Store net operating income, before depreciation expense, increased by
$9,479,000 to $461,150,000, or 2.1%, as a result of a 2.1% improvement in
45
revenues partially offset by a 2.1% increase in cost of operations. Aggregate
net operating income for our newly developed, recently expanded and acquired
self-storage facilities (excluding the Shurgard facilities) increased by
approximately $12,090,000 to $81,213,000.
For those facilities that were acquired in the Shurgard merger, net
operating income was approximately $253,926,000 for the nine months ended
September 30, 2007, as compared to $35,363,000 (which reflects the operations of
these facilities from August 23, 2006 through September 30, 2006) for the same
period in 2006.
Net income allocable to our common shareholders (after allocating net
income to our preferred and equity shareholders) was $97,156,000 or $0.57 per
common share on a diluted basis for the nine months ended September 30, 2007
compared to $127,292,000 or $0.94 per common share on a diluted basis for the
same period in 2006, representing a decrease of $0.37 per common share, or
39.4%. The decrease in net income allocable to common shareholders and earnings
per common diluted share are due primarily to the impact of the factors
described above, partially offset by a decrease in income allocated to preferred
shareholders, as described below.
For the nine months ended September 30, 2007 and 2006, we allocated
$176,424,000 and $159,256,000 of our net income, respectively, to our preferred
shareholders based on distributions paid. The year-over-year increase is due to
the issuance of additional preferred securities, partially offset by the
redemption of preferred securities that had higher dividend rates than the newly
preferred securities issued. In 2006, we also recorded allocations of income to
our preferred shareholders with respect to the application of EITF Topic D-42,
totaling $21,643,000 (or $0.16 per diluted common share) for the nine months
ended September 30, 2006 in connection with the redemption of preferred
securities.
Weighted average diluted shares increased to 170,166,000 for the nine
months ended September 30, 2007 from 134,851,000 for the nine months ended
September 30, 2006. The increase in weighted average diluted shares is due
primarily to the impact of the issuance of 38.9 million shares in connection
with our merger with Shurgard, with approximately 5.6 million of such shares
being included in our operating results for the quarter ended September 30, 2006
(representing the weighted average outstanding of such shares from August 23,
2006 through September 30, 2006) and all such shares included in our weighted
average shares for the same period in 2007. The increase also includes the
weighted average impact of the exercise of approximately 1.8 million stock
options issued in connection with the merger with Shurgard principally during
the quarter ended September 30, 2006.
REAL ESTATE OPERATIONS
DOMESTIC SELF-STORAGE OPERATIONS: Our domestic self-storage operations are
by far the largest component of our operating activities, representing
approximately 81% of our total revenues generated for each of the three and nine
month periods ended September 30, 2007. Rental income with respect to our
domestic self-storage operations has grown from $311 million and $825 million
for the three and nine months ended September 30, 2006, respectively, to $378
million and $1,098 million for the three and nine months ended September 30,
2007, respectively, representing increases of $67 million, or approximately 22%
for the three months ended September 30, 2007 and $273 million, or approximately
33% for the nine months ended September 30, 2007. The year-over-year
improvements in rental income are due to improvements in the performance of
those facilities that we owned prior to January 1, 2005 (our "Same Store"
facilities), and the addition of new facilities to our portfolio, either through
our acquisition or development activities.
46
To enhance year-over-year comparisons, the following table summarizes, and
the ensuing discussion describes the operating results of these three groups,
our Same Store group, acquisition facilities and development facilities.
Domestic Self - Storage Operations Summary: Three Months Ended Nine Months Ended
------------------------------------------- ------------------------ ----------- ------------------------ -----------
September 30, September 30,
Percentage Percentage
2007 2006 Change 2007 2006 Change
----------- ----------- ----------- ----------- ----------- -----------
(Dollar amounts in thousands)
Rental income:
Same Store Facilities - Public Storage...... $ 237,434 $ 233,420 1.7 $ 693,272 $ 679,069 2.1%
Same Store Facilities - Shurgard............ 69,313 27,876 148.6% 200,804 27,876 620.3%
Other Facilities............................ 71,130 50,138 41.9% 203,579 118,068 72.4%
------- ------- ---- --------- ------- ----
Total rental income....................... 377,877 311,434 21.3% 1,097,655 825,013 33.0%
------- ------- ---- --------- ------- ----
Cost of operations before depreciation and
amortization (a):
Same Store Facilities - Public Storage...... 76,060 74,947 1.5% 232,122 227,398 2.1%
Same Store Facilities - Shurgard............ 21,818 8,516 156.2% 67,324 8,516 690.6%
Other Facilities............................ 24,071 17,119 40.6% 74,629 41,766 78.7%
------- ------- ---- --------- ------- ----
Total cost of operations................. 121,949 100,582 21.2% 374,075 277,680 34.7%
------- ------- ---- --------- ------- ----
Net operating income before depreciation and
amortization(a):
Same Store Facilities - Public Storage...... 161,374 158,473 1.8% 461,150 451,671 2.1%
Same Store Facilities - Shurgard............ 47,495 19,360 145.3% 133,480 19,360 589.5%
Other Facilities............................ 47,059 33,019 42.5% 128,950 76,302 69.0%
Total net operating income before ------- ------- ---- --------- ------- ----
depreciation and amortization (a)...... 255,928 210,852 21.4% 723,580 547,333 32.2%
------- ------- ---- --------- ------- ----
Depreciation and amortization expense:
Same Store Facilities - Public Storage...... (40,553) (41,294) (1.8)% (121,350) (121,643) (0.2)%
Same Store Facilities - Shurgard............ (44,595) (35,304) 26.3% (161,976) (35,304) 358.8%
Other Facilities............................ (29,817) (21,036) 41.7% (95,649) (37,678) 153.9%
------- ------- ---- --------- ------- ----
Total depreciation and amortization expense. (114,965) (97,634) 17.8% (378,975) (194,625) 94.7%
------- ------- ---- --------- ------- ----
Net operating income (loss):
Same Store Facilities - Public Storage...... 120,821 117,179 3.1% 339,800 330,028 3.0%
Same Store Facilities - Shurgard............ 2,900 (15,944) (118.2)% (28,496) (15,944) 78.7%
Other Facilities............................ 17,242 11,983 43.9% 33,301 38,624 (13.8)%
------- ------- ---- --------- ------- ----
Total net operating income.................. $ 140,963 $ 113,218 24.5 $ 344,605 $ 352,708 (2.3)%
------- ------- ---- --------- ------- ----
Weighted average square foot occupancy during
the period.................................. 89.2% 88.4% 0.9% 88.8% 88.0% 0.9%
Number of self-storage facilities (at end of
period)..................................... 1,979 1,979 0.0%
Net rentable square feet (in thousands, at end
of period):................................. 124,364 123,738 0.5%
(a) Total net operating income before depreciation and amortization or "NOI" is
a non-GAAP (generally accepted accounting principles) financial measure
that excludes the impact of depreciation and amortization expense. See Note
12 to our September 30, 2007 condensed consolidated financial statements,
"Segment Information," which includes a reconciliation of net operating
income before depreciation and amortization for this segment to our
consolidated net income. Although depreciation and amortization are
operating expenses, we believe that NOI is a meaningful measure of
operating performance, because we utilize NOI in making decisions with
respect to capital allocations, in determining current property values,
segment performance, and comparing period-to-period and market-to-market
property operating results. NOI is not a substitute for net operating
income after depreciation and amortization in evaluating our operating
results.
47
In the discussion that follows, we present realized annual rent per
occupied square foot, which is computed by dividing rental income, before late
charges and administrative fees, by the weighted average occupied square footage
for the period. We also present annualized rental income per available square
foot ("REVPAF"), which represents annualized rental income, before late charges
and administrative fees, divided by total available net rentable square feet.
Late charges and administrative fees are excluded to more effectively measure
our ongoing level of revenue associated with the leasing of the units.
In the above table, the significant increases in revenues and cost of
operations, in the three and nine months ended September 30, 2007 as compared to
the same periods in 2006, are primarily due to the acquisition of self-storage
facilities in connection with the merger with Shurgard which was completed on
August 23, 2006 (see Note 3 to the condensed consolidated financial statements).
As a result of the merger, we acquired interests in 487 self-storage facilities
(32.3 million net rentable square feet) located in the United States, including
459 wholly-owned facilities and 28 facilities owned by joint ventures in which
we have an interest. Effective May 24, 2007, due to a loss in control of certain
partnerships, we began deconsolidating 11 of these facilities containing 624,000
net rentable square feet. Included in the line item "Other Facilities" in the
table above is the operating data with respect to these 11 facilities from
August 23, 2006 through May 24, 2007. The operating results of all of the other
facilities acquired in the merger and located in the United States are included
in our financial statements and in the above table for the period we owned the
facilities.
Immediately preceding the close of the merger, all of the acquired
facilities in the United States were integrated into our property management
systems, centralized pricing systems, national call center, and website.
Temporary signage, re-branding the facilities from "Shurgard" to "Public
Storage", was also put into place immediately after the close of the merger.
Our property management personnel worked diligently to absorb this large
acquisition of facilities. Training and hiring new property managers were key
elements for the successful integration process. New employees needed to be
trained on how to use our property management systems and follow our operating
policies and procedures. As expected in a merger of this nature, immediately
following the close of the merger, turnover at the property manager level was
higher than we normally experience. In anticipation of such turnover, we began
to hire additional "bench" property managers in the second quarter of 2006 to
fill openings when turnover occurred. Although this strategy was effective at
keeping properties opened for business, it did result in incurring additional
payroll costs in the second, third and fourth quarters of 2006 due to the
additional head count.
As a result of the merger, the amount of vacant space increased
significantly in our system. The acquired Shurgard portfolio of 487 facilities
in the United States had aggregate average square foot occupancy of 84.4% at
August 31, 2006, which was 530 basis points below the 89.7% for the existing
Public Storage portfolio. Average rental rates were approximately the same for
each of the portfolios. Our goal has been to increase our overall portfolio
occupancy in order to be in a position to drive rental rates. The primary focus
in meeting our goal has been to work to improve the Shurgard portfolio's overall
occupancy level to the occupancy level experienced by our existing portfolio.
In order to increase move-in volumes and ultimately increase occupancy
levels as quickly as possible, and because there is typically low seasonal
demand in the fourth and first quarters, we were much more aggressive at
reducing our pricing, and increasing promotional discounts and marketing
programs during the fourth quarter of 2006 and continued doing so during the
first nine months of 2007. We have substantially increased our media advertising
expenditures to $5.2 million and $21.8 million for the three and nine months
ended September 30, 2007 as compared to $1.6 million and $10.2 million,
respectively, in the same periods in 2006.
We have made significant progress in improving the occupancy level of the
Shurgard portfolio. However, this improvement has come somewhat at the expense
of in a reduction in the Public Storage Same Store Facilities' occupancies and
reduced growth in rates. We believe that the more aggressive pricing and
discounting at the Shurgard properties, combined with the fact that the Shurgard
properties have relatively more vacant spaces to rent, has resulted in shifting
of new tenant flow not only from our competitors, but also from our existing
portfolio to the Shurgard properties during the past nine months, putting some
pressure on occupancies and rental rate growth for the Public Storage Same Store
Facilities.
Short-term occupancy increases, like those we have experienced in the
Shurgard portfolio, tend to result in a higher proportion of short-term tenants
and a resulting increase in move-out ratios, which subsides over time. We
believe this is related to the nature of the occupancy stabilization process,
which we have observed to have two principal stages -- first, the physical
fill-up of the facilities, then the achievement of a stable tenant base with
historical levels of move-outs, as successive groups of tenants move in, the
tenants in such groups with short-term needs (such as moving) move out, and the
tenants with long-term storage needs remain.
Until recently, it has been difficult to see the benefits of the strategy
we are employing to increase occupancies in our short-term operating results,
48
because promotional discounts and marketing expense adversely affect earnings in
the month the customer moves in, while the revenue from these tenants are
reflected in our operating results throughout their tenancy.
However, as the occupancies of the Shurgard Same Store Facilities have
approached the Public Storage historical levels for the last two quarters, we
believe we are close to achieving a tenant base with historical move-out rates.
As a result, the more aggressive pricing and discounting at the Shurgard Same
Store Facilities has begun to subside, providing rental rate growth and putting
less pressure on the Public Storage Same Store Facilities. Realized rent per
occupied square foot for the Shurgard Same Store Facilities for the quarter
ended September 30, 2007 was 1.2% higher as compared to the same period in 2006
(compared to a 1.3% reduction during the first six months of 2007 as compared to
the same period in 2006). We believe that achieving our goal of high occupancies
with a stabilized tenant base will continue to positively impact our future
operating income by a) allowing us to reduce customer acquisition costs such as
advertising and promotion, as we will have to attract fewer new tenants to
replace vacating tenants and b) allowing us to be more aggressive in raising
rental rates to new and existing tenants.
In addition to our strategy to increase Shurgard occupancies, our operating
results have been, and will continue to be, impacted by the general economic
trends that affect the self-storage business. While it is difficult to quantify
the impact of these economic trends, and even more difficult to predict what the
impact will be in the future, we do believe that several such factors, including
the slowdown in the national housing market as well as reduced year-over-year
demand in markets which had enhanced self-storage demand in 2005 and 2006 due to
the hurricanes (such as in Florida), have impacted our operating results.
We expect to continue with aggressive pricing, promotional discounts
and marketing in the fourth quarter to continue to drive improvement in our
overall occupancy levels. We expanded our media programs in the third quarter of
2007 and were on television in approximately 24 markets versus 14 markets in the
third quarter of 2006. Future media advertising expenditures are not
determinable at this time, and will be driven in part by demand for our
self-storage spaces, our current occupancy levels, as well as our evaluation of
the most effective mix of yellow page, media, and Internet advertising.
We continue to believe that the acquisition of the Shurgard portfolio
provides operational efficiencies, specifically in the areas of marketing,
national call center, and indirect overhead costs that support the operations of
the facilities. We do not believe that these efficiencies are fully realized and
reflected in our operating results due to the recent integration, increased
property manager head count and increased marketing costs, as noted above.
SAME STORE FACILITIES - PUBLIC STORAGE
The facilities included in the Public Storage Same Store Facilities are all
stabilized and have been owned since January 1, 2005 and therefore provide
meaningful comparative data for 2006 and 2007. The Public Storage Same Store
Facilities contain approximately 77.8 million net rentable square feet,
representing approximately 63% of the aggregate net rentable square feet of our
consolidated domestic 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, "Same Store Facilities - Public Storage."
The following table sets forth additional operating data with respect to the
Same Store Facilities:
49
SAME STORE FACILITIES - PUBLIC STORAGE Three Months Ended Nine Months Ended
------------------------------------------- ------------------------ ----------- ------------------------ ----------
September 30, September 30,
Percentage Percentage
2007 2006 Change 2007 2006 Change
----------- ----------- ----------- ----------- ----------- ----------
(Dollar amounts in thousands, except weighted average amounts)
Rental income...................................... $ 226,794 $ 222,884 1.8% $ 662,57 $ 649,036 2.1%
Late charges and administrative fees collected..... 10,640 10,536 1.0% 30,695 30,033 2.2%
--------- ---------- ------- ---------- ----------- -------
Total rental income............................. 237,434 233,420 1.7% 693,272 679,069 2.1%
--------- ---------- ------- ---------- ----------- -------
Cost of operations before depreciation and amortization:
Direct property payroll....................... 15,433 16,528 (6.6)% 47,672 48,671 (2.1)%
Property taxes................................ 22,718 21,700 4.7% 67,219 64,418 4.3%
Repairs and maintenance....................... 7,924 7,319 8.3% 21,981 21,860 0.6%
Advertising and promotion..................... 5,947 4,772 24.6% 21,836 18,793 16.2%
Utilities..................................... 5,583 5,582 0.0% 16,123 15,511 3.9%
Property insurance............................ 2,104 3,021 (30.4)% 6,935 8,326 (16.7)%
Telephone reservation center.................. 1,995 2,155 (7.4)% 6,246 6,402 (2.4)%
Other cost of management...................... 14,356 13,870 3.5% 44,110 43,417 1.6%
--------- ---------- ------- ---------- ---------- -------
Total cost of operations........................ 76,060 74,947 1.5% 232,122 227,398 2.1%
Net operating income before depreciation and --------- ---------- ------- ---------- ---------- -------
amortization (e)................................... 161,374 158,473 1.8% 461,150 451,671 2.1%
Depreciation and amortization...................... (40,553) (41,294) (1.8)% (121,350) (121,643) (0.2)%
--------- ---------- ------- ---------- ----------- -------
Net operating income.............................. $ 120,821 $ 117,179 3.1% $ 339,800 $ 330,028 3.0%
========= ========== ======= ========== =========== =======
Gross margin (before depreciation and amortization) 68.0% 67.9% 0.1% 66.5% 66.5% -
Weighted average for the fiscal year:
Square foot occupancy (a)....................... 90.5% 91.3% (0.9)% 90.6% 91.2% (0.7)%
Realized annual rent per occupied square foot (b) $ 12.89 $ 12.55 2.7% $ 12.54 $ 12.20 2.8%
REVPAF (c)...................................... $ 11.66 $ 11.46 1.7% $ 11.36 $ 11.13 2.1%
Weighted average at September 30:
Square foot occupancy........................... 89.5% 90.5% (1.1)%
In place annual rent per occupied square foot (d) $ 13.97 $ 13.54 3.2%
Total net rentable square feet (in thousands)...... 77,782 77,782 -
Number of facilities............................... 1,316 1,316 -
(a) Square foot occupancies represent weighted average occupancy levels over
the entire period.
(b) Realized annual rent per occupied square foot is computed by dividing
rental income, prior to late charges and administrative fees, by the
weighted average occupied square footage for the period. Realized annual
rent per occupied square foot takes into consideration promotional
discounts, credit card fees and other costs that reduce rental income from
the contractual amounts due.
(c) Annualized rental income per available square foot ("REVPAF") represents
annualized rental income, prior to late charges and administrative fees,
divided by total available net rentable square feet.
(d) In place annual rent per occupied square foot represents annualized
contractual rents per occupied square foot without reductions for
promotional discounts, and excludes late charges and administrative fees.
(e) Total net operating income before depreciation and amortization or "NOI" is
a non-GAAP (generally accepted accounting principles) financial measure
that excludes the impact of depreciation and amortization expense, for our
Same Store facilities represents a portion of our total self-storage
segment's net operating income before depreciation and amortization, and is
reconciled to the segment total in the table "domestic self-storage
operations summary" above. A reconciliation of our total self-storage
segment's net operating income before depreciation and amortization to
consolidated net income is included in Note 12 to our September 30, 2007
condensed consolidated financial statements, "Segment Information."
Although depreciation and amortization are operating expenses, we believe
that NOI is a meaningful measure of operating performance, because we
utilize NOI in making decisions with respect to capital allocations, in
determining current property values, segment performance, and comparing
period-to-period and market-to-market property operating results. NOI is
not a substitute for net operating income after depreciation and
amortization in evaluating our operating results.
50
Rental income increased approximately 1.7% and 2.1% in the three and nine
months ended September 30, 2007 as compared to the same periods in 2006. These
increases were primarily attributable to higher average realized annual rental
rates per occupied square foot, which were 2.7% and 2.8% higher in the three and
nine months ended September 30, 2007 as compared to the same periods in 2006,
offset partially by lower occupancy levels.
In the beginning of 2006, the quarterly year-over-year growth in rental
income was consistent for each quarter, as rental income growth was 5.5% for the
quarter ended March 31, 2006, and started accelerating to 5.9% for the quarter
ended June 30, 2006 and 6.3% for the quarter ended September 30, 2006. For the
quarter ended December 31, 2006, the year-over-year growth in rental income
slowed to 3.5%. In 2007, rental income for the quarters ended March 31, 2007,
June 30, 2007 and September 30, 2007 were 2.9%, 1.7% and 1.7%, respectively.
This reduction in growth was the result of lower occupancy levels combined with
a reduction in year-over-year growth in realized rents.
It is difficult for us to pinpoint the exact causes for this slow down and
the degree to which such causes have negatively affected the growth in rental
income. We believe, however, that the reduction was due to a number of factors
including; (i) the increased number of vacant spaces added to our overall system
as a result of the Shurgard merger and our aforementioned focus on improving the
occupancies of the Shurgard portfolio, (ii) hurricane activity that created
unusual demand for storage space in our Florida markets in 2005 and 2004, making
year-over-year trends in 2007 less favorable, (iii) general economic conditions,
specifically the slow down in housing sales and moving activity, and (iv)
increased competition. Many of these factors are beyond our control.
As indicated above, it has been our objective to close the occupancy gap
between the acquired Shurgard properties versus the Public Storage existing
portfolio and achieve a stabilized tenant base. We believe that this strategy
has put pressure on occupancies and rental rate growth on our existing Same
Store facilities since the merger, as demand appears to have shifted somewhat to
the acquired Shurgard facilities as we have adjusted the level of discounts and
monthly rents at the acquired Shurgard facilities to accelerate occupancy
growth. Because it was important for us to maintain our occupancy levels in the
Public Storage Same Store portfolio, we adjusted rental rates and the level of
promotional discounts offered to new tenants as a means to expand move-in
volumes throughout the entire portfolio. It has been challenging to maintain
occupancy levels at our Same Store group of facilities, while at the same time
trying to continue to improve the occupancy levels of the acquired Shurgard
facilities and achieve a stabilized tenant base.
However, since we believe that we have now closed the occupancy gap between
the acquired Shurgard properties versus the Public Storage existing portfolio
and have achieved a stabilized tenant base, we expect that the pressure on
Public Storage Same Store portfolio should subside. Despite this positive
development, the other aforementioned factors noted above may still continue to
have a negative impact on our revenue growth, and as a result it is unclear as
to when we may achieve substantially higher levels of revenue growth in the
Public Storage Same Store pool than we have been achieving so far in 2007.
Cost of operations (excluding depreciation and amortization) increased by
1.5% and 2.1% in the three and nine months ended September 30, 2007 as compared
to the same periods in 2006.
Payroll expense has decreased by 6.6% and 2.1% in the three and nine months
ended September 30, 2007 as compared to the same periods in 2006. The decrease
experienced is primarily due to a reduction in payroll hours incurred resulting
from improved staffing levels, over-staffing in the second and third quarters of
2006 due to the accelerated hiring of "bench" property managers in anticipation
of the Shurgard merger, offset partially by higher wage rates.
Property tax expense increased 4.7% and 4.3% in the three and nine months
ended September 30, 2007, respectively, as compared to the same periods in 2006,
due to higher assessments.
Repairs and maintenance expenditures increased 8.3% and 0.6% in the three
and nine months ended September 30, 2007, respectively. We expect repairs and
maintenance expenditures to be higher in the remainder of 2007 as compared to
the same period in 2006.
51
Advertising and promotion is comprised principally of media (television and
radio), yellow page, and Internet advertising. Our Same Stores pro rata share of
advertising and promotion costs increased 24.6% and 16.2% in the three and nine
months ended September 30, 2007 as compared to the same periods in 2006.
Media advertising for the Same Store properties increased from $1,049,000
in the three months ended September 30, 2006 to $2,885,000 in the three months
ended September 30, 2007. We expect to continue with aggressive pricing,
promotional discounts and marketing in the fourth quarter to continue to drive
improvement in our overall occupancy levels, however, comparisons to prior year
with respect to marketing and advertising should be more favorable in the fourth
quarter because we significantly increased our television advertising in the
fourth quarter of 2006 as compared to the third quarter of 2006. Future media
advertising expenditures are not determinable at this time, and will be driven
in part by demand for our self-storage spaces, our current occupancy levels, as
well as our evaluation of the most effective mix of yellow page, media, and
Internet advertising.
Our Internet advertising expenses decreased from $828,000 for the three
months ended September 30, 2006 to $687,000 for the same period in 2007 and
increased from $2,167,000 for the nine months ended September 30, 2006 to
$2,234,000 for the same period in 2007. We expect that Internet advertising will
continue to grow as that marketing channel becomes a more important source of
new tenants.
Yellow page advertising expenditures for the Public Storage Same Store
portfolio decreased from $2,134,000 and $6,777,000 in the three and nine months
ended September 30, 2006 to $1,839,000 and $6,148,000 in the three months and
nine months ended September 30, 2007, respectively. The decrease is a result of
certain efficiencies related to the merger with Shurgard, specifically the
allocation of costs over a larger pool of properties.
Utility expenses remained flat for the three ended September 30, 2007 and
increased from $15,511,000 to $16,123,000 for the nine months ended September
30, 2007, respectively, due principally to higher energy costs as compared to
the same periods in 2006. Continued levels of increases are expected during the
remainder of 2007.
Insurance expense decreased 30.4% and 16.7% in the three and nine months
ended September 30, 2007, respectively, as compared to the same periods in 2006
reflecting significant decreases in property insurance resulting primarily from
the softer insurance markets.
Telephone reservation center costs decreased slightly from $2,155,000 and
$6,402,000 in the three and nine months ended September 30, 2006, respectively,
to $1,995,000 and $6,246,000 in the three and nine months ended September 30,
2007, respectively. We continue to evaluate our telephone reservation center as
we evaluate the appropriate staffing levels and location of personnel relative
to our expanded portfolio, and as a result, expect telephone reservation center
costs to remain somewhat volatile during the remainder of 2007 until we
determine our appropriate ongoing level of expenses.
52
The following table summarizes selected quarterly financial data with
respect to the Same Store Facilities:
For the Quarter Ended
------------------------------------------------------------------------------------------
March 31 June 30 September 30 December 31 Entire Year
------------- ------------ -------------- ------------- -------------
(Amounts in thousands, except for per square foot amount)
Total rental income:
2007 $ 225,677 $ 230,161 $ 237,434 - -
2006 $ 219,297 $ 226,352 $ 233,420 $ 227,007 $ 906,076
Total cost of operations (excluding depreciation and amortization):
2007 $ 77,828 $ 78,234 $ 76,060 - -
2006 $ 75,802 $ 76,649 $ 74,947 $ 72,149 $ 299,547
Property tax expense:
2007 $ 22,871 $ 21,630 $ 22,718 - -
2006 $ 21,988 $ 20,730 $ 21,700 $ 18,844 $ 83,262
Media advertising expense:
2007 $ 3,365 $ 5,333 $ 2,885 - -
2006 $ 4,130 $ 2,802 $ 1,049 $ 3,823 $ 11,804
REVPAF:
2007 $ 11.09 $ 11.32 $ 11.66 - -
2006 $ 10.79 $ 11.13 $ 11.46 $ 11.16 $ 11.13
Weighted average realized annual rent per occupied square foot:
2007 $ 12.35 $ 12.37 $ 12.89 - -
2006 $ 11.97 $ 12.08 $ 12.55 $ 12.42 $ 12.26
Weighted average occupancy levels for the period:
2007 89.8% 91.5% 90.5% - -
2006 90.1% 92.1% 91.3% 89.8% 90.8%
53
ANALYSIS OF REGIONAL TRENDS
The following table sets forth regional trends in our Same Store Facilities:
Three Months Ended Nine Months Ended
------------------------- ----------- ------------------------- ----------
September 30, September 30,
Percentage Percentage
2007 2006 Change 2007 2006 Change
----------- ----------- ----------- ----------- ----------- ----------
(Amounts in thousands, except for weighted average data)
Same Store Facilities Operating Trends
by Region
Rental income:
Southern California (133 facilities) $ 38,406 $ 37,390 2.7% $ 112,680 $ 109,598 2.8%
Northern California (133 facilities) 28,794 28,031 2.7% 84,092 81,453 3.2%
Texas (156 facilities).......... 21,554 20,880 3.2% 62,309 60,338 3.3%
Florida (141 facilities)........ 26,303 27,095 (2.9)% 78,597 79,932 (1.7)%
Illinois (92 facilities)........ 17,381 16,804 3.4% 50,190 48,191 4.1%
Georgia (60 facilities)......... 8,231 8,322 (1.1)% 24,248 24,139 0.5%
All other states (601 facilities) 96,765 94,898 2.0% 281,156 275,418 2.1%
----------- ----------- ----------- ----------- ----------- ----------
Total rental income................. 237,434 233,420 1.7% 693,272 679,069 2.1%
Cost of operations before depreciation and amortization:
Southern California.............. 8,112 8,002 1.4% 24,961 25,289 (1.3)%
Northern California.............. 7,008 7,041 (0.5)% 21,445 21,413 0.1%
Texas............................ 8,942 9,016 (0.8)% 27,056 27,024 0.1%
Florida.......................... 9,210 8,958 2.8% 27,186 25,845 5.2%
Illinois......................... 6,834 6,415 6.5% 21,863 21,083 3.7%
Georgia.......................... 2,734 2,646 3.3% 8,280 8,091 2.3%
All other states................. 33,220 32,869 1.1% 101,331 98,653 2.7%
----------- ----------- ----------- ----------- ----------- ----------
Total cost of operations............ 76,060 74,947 1.5% 232,122 227,398 2.1%
Net operating income before depreciation and amortization:
Southern California.............. 30,294 29,388 3.1% 87,719 84,309 4.0%
Northern California.............. 21,786 20,990 3.8% 62,647 60,040 4.3%
Texas............................ 12,612 11,864 6.3% 35,253 33,314 5.8%
Florida.......................... 17,093 18,137 (5.8)% 51,411 54,087 (4.9)%
Illinois......................... 10,547 10,389 1.5% 28,327 27,108 4.5%
Georgia.......................... 5,497 5,676 (3.2)% 15,968 16,048 (0.5)%
All other states................. 63,545 62,029 2.4% 179,825 176,765 1.7%
----------- ----------- ----------- ----------- ----------- ----------
Total net operating income before
depreciation and amortization.... $ 161,374 $ 158,473 1.8% $ 461,150 $ 451,671 2.1%
Weighted average occupancy:
Southern California.............. 90.4% 91.0% (0.7)% 90.7% 91.4% (0.8)%
Northern California.............. 89.9% 90.5% (0.7)% 90.3% 90.6% (0.3)%
Texas............................ 91.7% 91.5% 0.2% 91.2% 91.1% 0.1%
Florida.......................... 89.4% 92.6% (3.5)% 90.4% 93.1% (2.9)%
Illinois......................... 90.0% 91.0% (1.1)% 89.8% 89.8% 0.0%
Georgia.......................... 91.0% 92.6% (1.7)% 90.8% 92.9% (2.3)%
All other states................. 90.6% 91.2% (0.7)% 90.6% 90.8% (0.2)%
----------- ----------- ----------- ----------- ----------- ----------
Total weighted average occupancy.... 90.5% 91.3% (0.9)% 90.6% 91.2% (0.7)%
REVPAF:
Southern California.............. $ 17.63 $ 17.16 2.7% $ 17.24 $ 16.78 2.7%
Northern California.............. 15.14 14.76 2.6% 14.75 14.30 3.1%
Texas............................ 8.32 8.05 3.4% 8.02 7.76 3.4%
Florida.......................... 11.95 12.33 (3.1)% 11.90 12.13 (1.9)%
Illinois......................... 11.77 11.39 3.3% 11.35 10.90 4.1%
Georgia.......................... 8.56 8.66 (1.2)% 8.40 8.39 0.1%
All other states................. 10.67 10.45 2.1% 10.35 10.12 2.3%
----------- ----------- ----------- ----------- ----------- ---------
Total REVPAF........................ $ 11.66 $ 11.46 1.7% $ 11.36 $ 11.13 2.1%
54
Same Store Facilities Operating Three Months Ended Nine Months Ended
Trend by Region (Continued) ------------------------- ----------- ------------------------- ----------
September 30, September 30,
Percentage Percentage
2007 2006 Change 2007 2006 Change
----------- ----------- ----------- ----------- ----------- ----------
(Amounts in thousands, except for weighted average data)
Realized annual rent per occupied square foot:
Southern California.............. $ 19.50 $ 18.86 3.4% $ 19.01 $ 18.36 3.5%
Northern California.............. 16.85 16.31 3.3% 16.33 15.79 3.4%
Texas............................ 9.08 8.80 3.3% 8.79 8.52 3.2%
Florida.......................... 13.37 13.31 0.5% 13.17 13.03 1.1%
Illinois......................... 13.08 12.52 4.5% 12.64 12.14 4.1%
Georgia.......................... 9.41 9.36 0.5% 9.25 9.03 2.4%
All other states................. 11.78 11.46 2.8% 11.42 11.15 2.4%
----------- ----------- ----------- ----------- ----------- ----------
Total realized rent per square foot. $ 12.89 $ 12.55 2.7% $ 12.54 $ 12.20 2.8%
=========== =========== =========== =========== =========== ==========
In place annual rent per occupied square foot at September 30:
Southern California................. $ 20.45 $ 19.74 3.6%
Northern California................. 17.66 17.08 3.4%
Texas............................... 9.45 9.27 1.9%
Florida............................. 14.30 13.99 2.2%
Illinois............................ 13.55 13.10 3.4%
Georgia............................. 10.10 9.88 2.2%
All other states.................... 12.30 12.06 2.0%
----------- ----------- ----------
Total in place rent per occupied square foot: $ 13.97 $ 13.54 3.2%
=========== =========== ==========
The Southern California Market consists principally of the greater Los
Angeles area and San Diego, and has historically been a source of strong growth
due to its diverse economy and continued population growth. In addition,
barriers to entry in the form of difficult permitting requirements tend to
reduce the potential for increased competition in the infill locations where we
focus our operations.
The Northern California market consists principally of San Francisco and
related peripheral areas. While this area has a vibrant economy and relatively
strong population growth, it has been subject to general economic conditions,
principally issues associated with the technology sector. In addition, there has
been increased competition in the areas that we do business, principally in the
peripheral areas near San Francisco, due to new supply. As a result, revenue
growth in this area has been average relative to our other markets.
The Texas market principally includes Dallas, Houston and San Antonio. This
market has historically been subject to volatility due to minimal regulatory
restraint upon building, which results in cycles of overbuilding and absorption.
For the last few years, we have been in a period of increased supply and
competition in the areas we operate, and as a result revenue growth has been
average relative to other markets.
The Florida market principally includes Miami, Orlando, Tampa, and West
Palm Beach. These markets were our strongest in terms of revenue growth in 2005
and 2006, due in part to increased moving and storage demand resulting from the
impact of hurricane activity in 2005 and 2004. However, growth in revenues
during the first nine months of 2007 has moderated due primarily to the lack of
hurricane activity during the 2006 season resulting in difficult year-over-year
comparisons, and we expect this trend to continue throughout 2007. Over the
longer term, we believe that this market benefits from continued strong
population growth and barriers to entry.
55
SAME STORE FACILITIES - SHURGARD
In connection with the Shurgard merger, we acquired 487 self-storage
facilities in the United States located in 23 states. A total of 343 facilities
have been operating at a stabilized occupancy level for several years under
Shurgard management prior to the merger and then under the Public Storage
management following the merger. These stabilized facilities are referred to as
"Shurgard Same Store Facilities."
As reflected in a preceding table entitled "Domestic self - storage
operations summary" above, the historical operating results for this group of
facilities increased significantly for both the three and nine months ended
September 30, 2007 as compared to the same periods in 2006. This increase was
primarily the result of having only a partial period's operating results in the
2006 periods; from August 23, 2006 (date of the Shurgard merger) through
September 30, 2006.
To provide additional comparative operating data, the table below sets
forth the operations of the Shurgard Same Store Facilities for the entire
periods presented without regard to the timing of the merger. We believe that
this presentation more effectively portrays how these facilities are performing,
notwithstanding that the data presented for the 2006 periods do not represent
that actual results included in our operations for the 2006 periods.
Shurgard Domestic Same Store Facilities: (a) Three Months Ended Nine Months Ended
------------------------- --------- -------------------------- --------
September 30, September 30,
Percentage Percentage
2007 2006 Change 2007 2006 Change
------------ ---------- --------- ----------- ---------- ---------
Revenues: (Dollar amounts in thousands, except weighted average amounts)
Rental income................................. $ 67,041 $ 62,826 6.7% $ 194,351 $ 185,603 4.7%
Late charges and administrative fees collected 2,272 2,364 (3.9)% 6,453 6,569 (1.8)%
------------ ---------- --------- ------------ ----------- --------
Total revenues (b)............................ 69,313 65,190 6.3% 200,804 192,172 4.5%
------------ ---------- --------- ------------ ----------- --------
Cost of operations (excluding depreciation):
Property taxes ............................... 6,713 6,329 6.1% 19,907 18,499 7.6%
Direct property payroll....................... 4,214 6,922 (39.1)% 13,208 22,273 (40.7)%
Advertising and promotion..................... 1,513 1,323 14.4% 5,625 3,218 74.8%
Utilities..................................... 1,870 1,963 (4.7)% 5,526 5,378 2.8%
Repairs and maintenance....................... 2,034 1,299 56.6% 6,032 4,251 41.9%
Telephone reservation center.................. 519 162 220.4% 1,626 162 903.7%
Property insurance............................ 625 491 27.3% 2,032 1,172 73.4%
Other costs of management..................... 4,330 5,190 (16.6)% 13,368 17,139 (22.0)%
------------ ---------- --------- ------------ ----------- --------
Total cost of operations (b).................... 21,818 23,679 (7.9)% 67,324 72,092 (6.6)%
------------ ---------- --------- ------------ ----------- --------
Net operating income (excluding depreciation) (c) $ 47,495 $ 41,511 14.4% $ 133,480 $ 120,080 11.2%
============ ========== ========= ============ =========== ========
Gross margin (before depreciation)................ 68.5% 63.7% 7.5% 66.5% 62.5% 6.4%
Weighted average for the period:
Square foot occupancy (d)....................... 89.4% 84.8% 5.4% 88.7% 84.2% 5.3%
Realized annual rent per occupied square foot (e) $ 13.76 $ 13.60 1.2% $ 13.40 $ 13.48 (0.6)%
REVPAF (f) (g).................................. $ 12.30 $ 11.53 6.7% $ 11.89 $ 11.35 4.8%
Weighted average at September 30:
Square foot occupancy........................... 88.5% 84.7% 4.5%
In place annual rent per occupied square foot (h) $ 14.68 $ 14.60 0.5%
Total net rentable square feet (in thousands)..... 21,797 21,797 -
Number of facilities.............................. 343 343 -
(a) Operating data reflects the operations of these facilities without regard
to the time period in which Public Storage owned the facilities.
56
(b) Revenues and cost of operations do not include ancillary revenues and
expenses generated at the facilities with respect to tenant reinsurance,
and retail sales and truck rentals. "Other costs of management" included in
cost of operations principally represents all the indirect costs incurred
in the operations of the facilities. Indirect costs principally include
supervisory costs and corporate overhead cost incurred to support the
operating activities of the facilities. These amounts presented herein will
not necessarily compare to amounts previously presented by Shurgard in its
public reporting due to differences in classification of revenues and
expenses, including tenant reinsurance, retail sales and truck rental
activities which are included on our income statement under "ancillary
operations" but were previously presented by Shurgard as self-storage
revenue and operating expenses.
(c) Net operating income (excluding depreciation) or "NOI" is a non-GAAP
(generally accepted accounting principles) financial measure that excludes
the impact of depreciation expense. Although depreciation is an operating
expense, we believe that NOI is a meaningful measure of operating
performance, because we utilize NOI in making decisions with respect to
capital allocations, in determining current property values, segment
performance, and comparing period-to-period and market-to-market property
operating results. NOI is not a substitute for net operating income after
depreciation in evaluating our operating results. We have not presented
depreciation expense for these facilities because the depreciation expense
is based upon historical cost, which is substantially different before the
merger and after.
(d) Square foot occupancies represent weighted average occupancy levels over
the entire period.
(e) Realized annual rent per occupied square foot is computed by annualizing
the result of dividing rental income by the weighted average occupied
square footage for the period. Realized annual rent per occupied square
foot takes into consideration promotional discounts and other costs that
reduce rental income from the contractual amounts due.
(f) Annualized rental income per available square foot ("REVPAF") represents
annualized rental income divided by total available net rentable square
feet.
(g) Late charges and administrative fees are excluded from the computation of
realized annual rent per occupied square foot and REVPAF because exclusion
of these amounts provides a better measure of our ongoing level of revenue,
by excluding the volatility of late charges, which are dependent
principally upon the level of tenant delinquency, and administrative fees,
which are dependent principally upon the absolute level of move-ins for a
period.
(h) In place annual rent per occupied square foot represents annualized
contractual rents per occupied square foot without reductions for
promotional discounts, and excludes late charges and administrative fees.
On the date of the merger, we successfully installed our real-time property
operation system at all U.S. Shurgard locations. As a result, these facilities
are integrated into our national call center, website, and management structure.
The integration of these facilities into our operations has resulted in
additional benefits and cost savings.
As noted above, the Public Storage Same-Store Facilities had occupancies of
approximately 90.6% at September 30, 2007, as compared to 88.7% for the acquired
Shurgard Same Store Facilities. It has been our objective to continue to close
this occupancy gap in order to increase REVPAF. In attempting to accomplish this
objective, we significantly expanded our domestic pricing, promotional, and
media programs, and as a result, aggregate media costs increased in the first
two quarters of 2007 versus the aggregate level of spending incurred for the
same period in 2006.
As a result, we have improved the occupancy of the Shurgard Same-Store
Facilities, with average occupancy up 5.3% at September 30, 2007 as compared to
September 30, 2006. As we have raised the occupancy of the Shurgard Same-Store
facilities, we have recently been able to be less aggressive on pricing and as a
result our trends in realized rent per occupied square foot trends have improved
from a reduction of 1.3% in the first six months of 2007 as compared to the same
period in 2006, to a 1.2% increase in the third quarter of 2007 as compared to
the same period in 2006. For the fourth quarter of 2007, we expect revenue
growth for this group of properties to be higher than the Public Storage Same
Store group, primarily due to a higher year-over year occupancy spread.
Property tax expense increased 6.1% and 7.6% in the three and nine months
ended September 30, 2007, respectively, as compared to the same periods in 2006,
due to higher assessments following the merger, including properties in
California.
57
Beginning January 2007, former Shurgard employees became participants in
the Public Storage compensation and benefit plan, which in general has lower
wage rates and benefit plan costs than the historical Shurgard plan. This
decline is reflected in direct payroll costs, which have declined 39.1% and
40.7% in the three and nine months ended September 30, 2007, respectively, as
compared to the same periods in 2006. We expect these reduction trends to
moderate in the fourth quarter of 2007, because turnover of former Shurgard
employees was high immediately following the merger and as a result in the
fourth quarter of 2006 the proportion of legacy Shurgard employees, at the
higher wage rates and benefit plan costs, was lower than in the third quarter of
2006.
Overall advertising and promotion increased 14.4% and 74.8% in the three
and nine months ended September 30, 2007, respectively, as compared to the same
periods in 2006, due primarily to our media advertising expenditures, offset
partially by lower yellow page advertising expense. As noted previously, we
increased advertising and promotional activities immediately following the
merger with Shurgard and continued through the first nine months of 2007 in
order to improve the occupancy levels of the facilities acquired in the merger.
Utility expense decreased 4.7% in the three months ended September 30, 2007
and increased 2.8% in the nine months ended September 30, 2007, as compared to
the same periods in 2006, due primarily to higher utility rates.
Other cost of management, which principally includes supervisory and
indirect overhead costs, decreased by 16.6% and 22.0% for the three and nine
months ended September 30, 2007, as compared to the same periods in 2006. These
reductions principally represent the synergies created by the merger and the
elimination of duplicative operating functions.
58
OTHER FACILITIES
In addition to the Public Storage and Shurgard Same Store groups of
facilities, at September 30, 2007, we had 320 facilities that were not
classified into either of these pools. These properties include recently
acquired facilities, recently developed facilities and facilities that were
recently expanded by adding additional storage units. In general, these
facilities are not stabilized with respect to occupancies or rental rates. As a
result of the fill-up process and timing of when the facilities were put into
place, year-over-year changes can be significant.
The following table summarizes operating data with respect to these
facilities.
OTHER FACILITIES - NON STABILIZED Three Months Ended Nine Months Ended
September 30 September 30,
----------------------- --------- ---------------------- ----------
2007 2006 Change 2007 2006 Change
---------- ---------- --------- ---------- --------- ----------
(Dollar amounts in thousands, except square foot amounts)
Rental income:
Facilities put in place in 2007............... $ 799 $ - $ 799 $ 1,189 $ - $ 1,189
Facilities put in place in 2006............... 34,241 16,709 17,532 98,319 25,792 72,527
Facilities put in place prior to 2006......... 14,320 12,955 1,365 40,940 35,916 5,024
Deconsolidated Shurgard facilities (a)........ - 585 (585) 2,198 585 1,613
Expansion facilities.......................... 21,770 19,889 1,881 60,933 55,775 5,158
--------- ---------- ---------- ---------- --------- ---------
Total rental income........................... 71,130 50,138 20,992 203,579 118,068 85,511
--------- ---------- ---------- ---------- --------- ---------
Cost of operations before depreciation and
amortization:
Facilities put in place in 2007............... $ 396 $ - $ 396 $ 613 $ - $ 613
Facilities put in place in 2006............... 11,875 5,981 5,894 37,402 8,757 28,645
Facilities put in place prior to 2006......... 4,598 4,382 216 14,078 13,238 840
Deconsolidated Shurgard facilities (a)........ - 234 (234) 916 234 682
Expansion facilities.......................... 7,202 6,522 680 21,620 19,537 2,083
--------- ---------- ---------- ---------- --------- ---------
Total cost of operations 24,071 17,119 6,952 74,629 41,766 32,863
--------- ---------- ---------- ---------- --------- ---------
Net operating income before depreciation and
amortization:
Facilities put in place in 2007............... $ 403 $ - $ 403 $ 576 $ - $ 576
Facilities put in place in 2006............... 22,366 10,728 11,638 60,917 17,035 43,882
Facilities put in place prior to 2006......... 9,722 8,573 1,149 26,862 22,678 4,184
Deconsolidated Shurgard facilities (a)........ - 351 (351) 1,282 351 931
Expansion facilities.......................... 14,568 13,367 1,201 39,313 36,238 3,075
--------- ---------- ---------- ---------- --------- ---------
Total net operating income before depreciation and
amortization (b) 47,059 33,019 14,040 128,950 76,302 52,648
Depreciation and amortization.................... (29,817) (21,036) (8,781) (95,649) (37,678) (57,971)
--------- ---------- ---------- ---------- --------- ---------
Net operating income.......................... $ 17,242 $ 11,983 $ 5,259 $ 33,301 $ 38,624 $ (5,323)
========= ========== ========== ========== ========= =========
Weighted average square foot occupancy during the
period:
Facilities put in place in 2007............... 59.7% - - 61.9% - -
Facilities put in place in 2006............... 85.9% 80.2% 7.1% 83.4% 80.2% 4.0%
Facilities put in place prior to 2006......... 86.7% 84.5% 2.6% 86.0% 82.1% 4.8%
Deconsolidated Shurgard facilities (a)........ - 84.6% - 89.0% 84.6% 5.2%
Expansion facilities 82.9% 82.3% 0.7% 81.6% 79.9% 2.1%
--------- ---------- ---------- ---------- --------- ---------
84.7% 81.8% 3.5% 83.1% 80.6% 3.1%
========= ========== ========== ========== ========= =========
59
OTHER FACILITIES - NON STABILIZED Three Months Ended Nine Months Ended
September 30 September 30,
----------------------- --------- ---------------------- ----------
2007 2006 Change 2007 2006 Change
---------- ---------- --------- ---------- --------- ----------
Weighted average realized annual rent per occupied
square foot for the period:
Facilities put in place in 2007............... $ 15.41 $ - - $ 15.12 $ - -
Facilities put in place in 2006............... 12.74 12.32 3.4% 12.41 11.91 4.2%
Facilities put in place prior to 2006 ........ 14.74 13.71 7.5% 14.17 13.06 8.5%
Deconsolidated Shurgard facilities (a)........ - 9.82 - 9.52 9.82 (3.1)%
Expansion facilities 13.12 12.81 2.4% 12.83 12.43 3.2%
---------- ---------- --------- ---------- --------- ---------
$ 13.33 $ 12.89 3.4% $ 12.91 $ 12.51 3.2%
========== ========== ========= ========== ========= =========
In place annual rent per occupied square foot at
September 30:
Facilities put in place in 2007............... $ 16.79 $ - -
Facilities put in place in 2006............... 13.89 13.57 2.4%
Facilities put in place prior to 2006 ........ 15.89 14.87 6.9%
Deconsolidated Shurgard facilities (a)........ - 14.62 -
Expansion facilities 14.15 13.82 2.4%
---------- --------- ----------
$ 14.37 $ 13.90 3.4%
========== ========= ==========
At September 30:
Number of Facilities:
Facilities put in place in 2007............ 9 - 9
Facilities put in place in 2006 (c)........ 166 164 2
Facilities put in place prior to 2006 ..... 58 58 -
Deconsolidated Shurgard facilities (a)..... - 11 (11)
Expansion facilities....................... 87 87 -
---------- --------- ----------
320 320 -
========== ========= ==========
Net rentable square feet (in thousands):
Facilities put in place in 2007............ 613 - 613
Facilities put in place in 2006............ 12,057 11,819 238
Facilities put in place prior to 2006...... 4,352 4,352 -
Deconsolidated Shurgard facilities (a)..... - 624 (624)
Expansion facilities....................... 7,763 7,424 339
---------- --------- ----------
24,785 24,219 566
========== ========= ==========
(a) Represents the operations of 11 facilities acquired in the merger with
Shurgard which we no longer consolidate in our financial statements
effective May 24, 2007. The operations for these facilities from August 23,
2006 through May 24, 2007 are included in this table.
(b) Total net operating income before depreciation and amortization or "NOI" is
a non-GAAP (generally accepted accounting principles) financial measure
that excludes the impact of depreciation and amortization expense, for our
self-storage facilities represents a portion of our total self-storage
segment's net operating income before depreciation, and is denoted in the
table "self-storage operations summary" above. A reconciliation of our
total self-storage segment's net operating income before depreciation to
consolidated net income is included in Note 12 to our September 30, 2007
condensed consolidated financial statements, "Segment Information."
Although depreciation and amortization are operating expenses, we believe
that NOI is a meaningful measure of operating performance, because we
utilize NOI in making decisions with respect to capital allocations, in
determining current property values, segment performance, and comparing
period-to-period and market-to-market property operating results. NOI is
not a substitute for net operating income after depreciation and
amortization in evaluating our operating results.
(c) Includes 133 facilities acquired in the Shurgard merger which are not
stabilized, as well as 33 other facilities that were acquired or newly
developed in 2006.
60
The properties denoted under "Facilities put in place in 2007" and
"Facilities put in place in 2006" were put into operation within the Public
Storage system at various dates throughout each period presented. Accordingly,
rental income, cost of operations, depreciation, net operating income, weighted
average square foot occupancies and realized rents per square foot represent the
operating results for the partial period that we owned the facilities during the
year acquired. In addition, in place rents per occupied square foot at September
30, 2007 and 2006, reflect the amounts for those facilities we owned at each of
those respective dates.
In the first nine months of 2007, we acquired seven facilities, in single
property transactions, for an aggregate cost of $72,787,000. These facilities
contain, in aggregate approximately, 511,000 net rentable square feet, with one
facility located in Hawaii and the remainder in California. In addition, we
completed development of two facilities with aggregate square footage of
approximately 102,000 and cost of $13,710,000.
We believe our presence in and knowledge of substantially all of the major
markets in the United States enhances our ability to identify attractive
acquisition opportunities and capitalize on the overall fragmentation in the
storage industry. Our acquisitions consist of facilities that have been
operating for a number of years as well as newly constructed facilities that
were in the process of filling up to stabilized occupancy levels. In either
case, we have been able to leverage off of our operating strategies and improve
the occupancy levels of the facilities, or with respect to the newly developed
facilities we have been able to accelerate the fill-up pace.
We expect that our non-stabilized facilities will continue to provide
earnings growth during 2007 and into 2008 as these facilities continue to
improve their occupancy levels as well as realized rental rates.
We acquired 487 self-storage facilities in 23 U.S. states with 32.3 million
net rentable square feet in connection with the Shurgard merger. Effective May
24, 2007, due to a loss in control of the related partnerships that owned these
facilities, we began deconsolidating 11 of these facilities with an aggregate of
624,000 net rentable square feet (referred to hereinafter as "The Deconsolidated
Shurgard Properties."). The 476 Shurgard facilities that continue to be
consolidated on our financial statements at September 30, 2007 are referred to
as the "Consolidated Shurgard Properties." With respect to the Consolidated
Shurgard Properties, the operating data presented in the table above reflects
the historical data from January 1 through September 30, 2007, the period owned
and operated by Public Storage. With respect to the Deconsolidated Shurgard
Properties, the operating data presented includes the historical data from
August 23, 2006 through May 24, 2007. Our pro-rata share of the operating
results of the Deconsolidated Shurgard Properties after May 24, 2007 are
presented as a component of Equity in Earnings of Real Estate Entities.
Development of self-storage facilities causes short-tem earnings dilution
because of the extended time to stabilize a self-storage facility. We have
developed self-storage facilities, despite the short-term earnings dilution,
because it is advantageous for us to continue to expand our asset base and
benefit from the resulting increase critical mass, with facilities that will
improve our portfolio's overall average construction and location quality.
The decision to commence development of any particular self-storage
location is based upon several factors with respect to that local market,
including our estimate of current and future general economic conditions,
demographic conditions, population growth, the likelihood of and cost of
obtaining permits, construction costs, as well as the level of demand at our
existing self-storage facilities in proximity to the prospective facility. Our
level of new development starts has declined significantly in the last few years
due to increased in construction cost, increases in competition with retail,
condominium, and apartment operators for quality construction sites in urban
locations, and more difficult zoning and permitting requirements, which has
reduced the number of attractive sites available for development and reduced our
development of facilities. It is unclear when, or if, these conditions will
improve.
61
SHURGARD EUROPEAN OPERATING DATA
In the merger with Shurgard, we acquired 160 facilities located in seven
European countries with an aggregate of 8,385,000 net rentable square feet.
During 2007, we opened four facilities in Europe with an aggregate of 203,000
net rentable square feet. At September 30, 2007, our European operations
comprise 169 facilities with an aggregate of 8,846,000 net rentable square feet,
of which, 96 of these facilities are referred to as the Europe Same Store
Facilities (defined below). Of the 169 facilities, 103 facilities are wholly
owned, with the remaining 66 facilities owned by the European Development Joint
Venture, in which we have a 20% equity interest.
Europe self - storage operations summary: Three Months Ended Nine Months Ended
----------------------------------------- September 30, September 30,
------------------------ ----------- -------------------------- ------------
Percentage Percentage
2007 2006 Change 2007 2006 Change
----------- ----------- ----------- ---------- ------------ -----------
(Dollar amounts in thousands)
Rental income:
Same Store Facilities - Shurgard Europe (a). $ 32,798 $ 12,012 173.0 $ 93,393 $ 12,012 677.5%
Other wholly-owned facilities (b)........... 2,250 955 135.6% 6,768 955 608.7%
Joint Venture Facilities (c) (d)............ 15,024 4,381 242.9% 40,130 4,381 816.0%
----------- ----------- ----------- ---------- ------------ -----------
Total rental income....................... 50,072 17,348 188.6% 140,291 17,348 708.7%
----------- ----------- ----------- ---------- ------------ -----------
Cost of operations before depreciation and
amortization (e):
Same Store Facilities - Shurgard Europe..... 12,033 5,048 138.4% 37,756 5,048 647.9%
Other wholly-owned facilities............... 816 375 117.6% 2,646 375 605.6%
Joint Venture Facilities.................... 8,573 3,101 176.5% 27,180 3,101 776.5%
----------- ----------- ----------- ---------- ------------ -----------
Total cost of operations................. 21,422 8,524 151.3% 67,582 8,524 692.8%
----------- ----------- ----------- ---------- ------------ -----------
Net operating income before depreciation and
amortization (e):
Same Store Facilities - Shurgard Europe..... 20,765 6,964 198.2% 55,637 6,964 698.9%
Other wholly-owned facilities............... 1,434 580 147.2% 4,122 580 610.7%
Joint Venture Facilities.................... 6,451 1,280 404.0% 12,950 1,280 911.7%
----------- ----------- ----------- ---------- ------------ -----------
Total net operating income before
depreciation and amortization (e)...... 28,650 8,824 224.7% 72,709 8,824 724.0%
Depreciation and amortization expense.......... (31,899) (15,020) 112.4% (110,101) (15,020) 633.0%
----------- ----------- ----------- ---------- ------------ -----------
Net operating loss............................. $ (3,249) $ (6,196) (47.6)% $ (37,392) $ (6,196) 503.5%
=========== =========== =========== ========== ============ ===========
Weighted average square foot occupancy during
the period..................................
Same Store Facilities - Shurgard Europe... 91.0% 87.5% 4.0% 89.7% 87.5% 2.5%
Other wholly-owned facilities............. 88.1% 89.2% (1.2)% 88.1% 89.2% (1.2)%
Joint Venture Facilities.................. 78.6% 70.6% 11.3% 73.3% 70.6% 3.8%
----------- ----------- ----------- ---------- ------------ -----------
86.4% 81.9% 5.5% 83.6% 81.9% 2.1%
=========== =========== =========== ========== ============ ===========
At September 30:
Number of Facilities:
Same Store Facilities - Shurgard Europe... 96 96 -
Other wholly-owned facilities............. 7 7 -
Joint Venture Facilities.................. 66 57 15.8%
---------- ------------ -----------
169 160 5.6%
========== ============ ===========
Net rentable square feet (in thousands):
Same Store Facilities - Shurgard Europe... 5,286 5,286 -
Other wholly-owned facilities............. 291 291 -
Joint Venture Facilities.................. 3,269 2,808 16.4%
---------- ------------ -----------
8,846 8,385 5.5%
========== ============ ===========
62
(a) The European Same Store facilities, described below, are comprised of 96
facilities that are wholly owned. (b) The other wholly-owned facilities
include seven facilities that we wholly own, which are not considered
European Same Store facilities.
(c) There are four facilities, which were acquired or developed the first nine
months of 2007 for an aggregate of approximately $31,271,000. These
facilities are owned by the European Development Joint Venture.
(d) The European Development Joint Venture, in which we have a 20% equity
interest, owns an additional 62 facilities which were acquired or developed
from 2003 to 2006.
(e) Total net operating income before depreciation and amortization or "NOI" is
a non-GAAP (generally accepted accounting principles) financial measure
that excludes the impact of depreciation and amortization expense, for our
commercial property segment is presented in Note 12 to our condensed
consolidated financial statements, "Segment Information," which includes a
reconciliation of net operating income before depreciation for this segment
to our consolidated net income. Although depreciation and amortization are
operating expenses, we believe that NOI is a meaningful measure of
operating performance, because we utilize NOI in making decisions with
respect to capital allocations, in determining current property values,
segment performance, and comparing period-to-period and market-to-market
property operating results. NOI is not a substitute for net operating
income after depreciation and amortization in evaluating our operating
results.
Amounts presented in the table above reflect significant increases in
revenues and cost of operations, in the three and nine months ended September
30, 2007 as compared to the same periods in 2006, due to the merger with
Shurgard which was completed on August 23, 2006 (see Note 3 to the condensed
consolidated financial statements). The operating results of all of the
facilities acquired in the merger and located in Europe are included in our
financial statements and in the table above for the period we owned the
facilities.
The Joint Venture opened four facilities in 2007 with an aggregate
development cost of $31,271,000. Revenues and expenses presented in the table
above with respect to these properties totaled $231,000 and $486,000,
respectively, for the three months ended September 30, 2007 and $325,000 and
$1,102,000, respectively for the nine months ended September 30, 2007.
The operating data presented in the table below reflect the historical data
from January 1 to September 30, 2006, the period for which the 96 facilities,
which have been operated by Shurgard since January 1, 2005, with the historical
data from January 1 through September 30, 2007, the period operated under Public
Storage. In addition, such amounts are reflected utilizing the average exchange
rates for the three months ended September 30, 2007, rather than the respective
exchange rates in effect for each period. We present this data on such a
"constant exchange rate" basis because we believe it allows comparability of the
various periods, and isolates the impact of exchange rates with respect to the
trends in revenues and cost of operations.
As a result, the data presented below does not reflect the actual results
included in our operations for the three and nine months ended September 30,
2006, and does not represent the actual amounts reflected in our financial
statements for the quarter or nine months ended September 30, 2007. We have
applied our definition of what qualifies as a Same Store. As a result, the
number of properties included in the Shurgard European Same Store portfolio has
decreased from 123 facilities (as reported by Shurgard in the second quarter of
2006) to 96 facilities as is currently being reported.
63
Selected Operating Data for the 96 facilities
operated by Shurgard Europe on a stabilized basis
since January 1, 2005 ("Europe Same Store
Facilities"): (a)
-------------- Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ ----------------------------------------
Percentage Percentage
2007 2006 Change 2007 2006 Change
------------ ----------- ----------- ------------ ------------ --------------
(Dollar amounts in thousands, except weighted average data, utilizing constant
exchange rates) (b)
Revenues:
Rental income................................. $ 32,475 $ 29,660 9.5% $ 92,478 $ 84,229 9.8%
Late charges and administrative fees collected 323 286 12.9% 915 820 11.6%
------------ ----------- ----------- ------------ ------------ --------------
Total revenues (c)............................ 32,798 29,946 9.5% 93,393 85,049 9.8%
Cost of operations (excluding depreciation):
Property taxes ............................... 1,525 1,359 12.2% 4,187 3,978 5.3%
Direct property payroll....................... 3,680 4,159 (11.5)% 10,889 12,288 (11.4)%
Advertising and promotion..................... 738 1,270 (41.9)% 3,270 4,725 (30.8)%
Utilities..................................... 630 749 (15.9)% 2,202 2,457 (10.4)%
Repairs and maintenance....................... 790 967 (18.3)% 2,351 2,685 (12.4)%
Property insurance............................ 231 373 (38.1)% 932 1,114 (16.3)%
Other costs of management..................... 4,439 4,712 (5.8)% 13,925 14,053 (0.9)%
------------ ----------- ----------- ------------ ------------ --------------
Total cost of operations (c).................... 12,033 13,589 (11.5)% 37,756 41,300 (8.6)%
------------ ----------- ----------- ------------ ------------ --------------
Net operating income (excluding depreciation) (d) $ 20,765 $ 16,357 26.9% $ 55,637 $ 43,749 27.2%
============ =========== =========== ============ ============ ==============
Gross margin (before depreciation)................ 63.3% 54.6% 15.9% 59.6% 51.4% 16.0%
Weighted average for the period:
Square foot occupancy (e)....................... 91.0% 86.7% 5.0% 89.7% 84.0% 6.8%
Realized annual rent per occupied square foot (f) $27.00 $25.89 4.3% $26.01 $25.29 2.8%
REVPAF (g) (h).................................. $24.57 $22.44 9.5% $23.33 $21.25 9.8%
Weighted average at September 30:
Square foot occupancy........................... 91.4% 88.4% 3.4%
In place annual rent per occupied square foot (i) $28.34 $26.41 7.3%
Total net rentable square feet (in thousands)..... 5,286 5,286 -
(a) Operating data reflects the operations of these facilities without regard
to the time period in which Public Storage owned the facilities; only the
amounts for the period January 1 through September 30, 2007 are included in
our consolidated operating results.
(b) The majority of our European operations are denominated in Euros. For
comparative purposes, amounts for the three months ended September 30, 2006
and 2007 are translated at constant exchange rates representing the average
exchange rates for the three months ended September 30, 2007. Amounts for
the nine months ended September 30, 2006 and 2007 are also translated at
constant exchange rates, representing the average exchange rates for the
nine months ended September 30, 2007. The average exchange rate for the
Euro was approximately 1.374 and 1.344, respectively, in US Dollars per
Euro for the three and nine months ended September 30, 2007, respectively.
(c) Revenues and cost of operations do not include ancillary revenues and
expenses generated at the facilities with respect to tenant reinsurance and
retail sales. "Other costs of management" included in cost of operations
principally represents all the indirect costs incurred in the operations of
the facilities. Indirect costs principally include supervisory costs and
corporate overhead cost incurred to support the operating activities of the
facilities. These amounts presented herein will not necessarily compare to
amounts previously presented by Shurgard in its public reporting due to
differences in classification of revenues and expenses, including tenant
reinsurance, retail sales, and truck rental activities which are included
on our income statement under "ancillary operations" but were previously
presented by Shurgard as self-storage revenue and operating expenses.
(d) Net operating income (excluding depreciation) or "NOI" is a non-GAAP
(generally accepted accounting principles) financial measure that excludes
the impact of depreciation expense. Although depreciation is an operating
expense, we believe that NOI is a meaningful measure of operating
performance, because we utilize NOI in making decisions with respect to
capital allocations, in determining current property values, segment
64
performance, and comparing period-to-period and market-to-market property
operating results. NOI is not a substitute for net operating income after
depreciation in evaluating our operating results. We have not presented
depreciation and amortization expense for these facilities because the
depreciation and amortization expense is based upon historical cost, which
is substantially different before the merger and after.
(e) Square foot occupancies represent weighted average occupancy levels over
the entire period.
(f) Realized annual rent per occupied square foot is computed by annualizing
the result of dividing rental income by the weighted average occupied
square footage for the period. Realized annual rent per occupied square
foot takes into consideration promotional discounts and other costs that
reduce rental income from the contractual amounts due.
(g) Annualized rental income per available square foot ("REVPAF") represents
annualized rental income divided by total available net rentable square
feet.
(h) Late charges and administrative fees are excluded from the computation of
realized annual rent per occupied square foot and REVPAF because exclusion
of these amounts provides a better measure of our ongoing level of revenue,
by excluding the volatility of late charges, which are dependent
principally upon the level of tenant delinquency, and administrative fees,
which are dependent principally upon the absolute level of move-ins for a
period.
(i) In place annual rent per occupied square foot represents annualized
contractual rents per occupied square foot without reductions for
promotional discounts, and excludes late charges and administrative fees.
The European Same Store properties continue to reflect above average
growth. With occupancy stabilized at above 90%, we believe we have pricing power
and expect to generate additional growth through rental rate increases. The
properties are also benefiting from expense control, resulting in negative
expense growth. The European team is selectively adapting various operating
strategies we use in the United States and incorporating them into their
operating model.
The following table sets forth certain regional trends in the Europe
Same Store facilities:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- --------------------------------------
Percentage Percentage
2007 2006 Change 2007 2006 Change
------------ ----------- ---------- ----------- ------------ ----------
(Dollar amounts in thousands, except per square foot amounts)
Rental income:
Belgium..................................... $ 4,072 $ 3,709 9.8% $ 11,589 $ 10,735 8.0%
Denmark..................................... 1,501 1,315 14.1% 4,265 3,733 14.3%
France...................................... 8,298 7,709 7.6% 23,747 21,846 8.7%
Netherlands................................. 6,680 5,838 14.4% 18,813 16,634 13.1%
Sweden...................................... 6,833 6,358 7.5% 19,568 18,239 7.3%
United Kingdom.............................. 5,414 5,017 7.9% 15,411 13,862 11.2%
------------ ----------- ---------- ----------- ------------ ----------
Total rental income....................... $ 32,798 $ 29,946 9.5% $ 93,393 $ 85,049 9.8%
============ =========== ========== =========== ============ ==========
Cost of operations before depreciation and
amortization (a):
Belgium..................................... $ 1,669 $ 2,021 (17.4)% $ 5,034 $ 6,090 (17.3)%
Denmark..................................... 452 653 (30.8)% 1,529 1,956 (21.8)%
France...................................... 3,204 3,609 (11.2)% 10,316 10,737 (3.9)%
Netherlands................................. 2,407 2,624 (8.3)% 7,471 8,059 (7.3)%
Sweden...................................... 2,317 2,571 (9.9)% 7,447 8,181 (9.0)%
United Kingdom.............................. 1,984 2,111 (6.0)% 5,959 6,277 (5.1)%
------------ ----------- ---------- ----------- ------------ ----------
Total cost of operations before
depreciation and amortization............. $ 12,033 $ 13,589 (11.5)% $ 37,756 $ 41,300 (8.6)%
============ =========== ========== =========== ============ ==========
65
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- --------------------------------------
Percentage Percentage
2007 2006 Change 2007 2006 Change
------------ ----------- ---------- ----------- ------------ ----------
(Dollar amounts in thousands, except per square foot amounts)
Weighted average occupancy levels for the period:
Belgium..................................... 88.8% 81.3% 9.2% 86.5% 79.2% 9.2%
Denmark..................................... 93.7% 91.1% 2.9% 93.9% 90.0% 4.3%
France...................................... 91.1% 89.2% 2.1% 90.4% 86.1% 5.0%
Netherlands................................. 90.1% 84.8% 6.3% 88.5% 81.4% 8.7%
Sweden...................................... 92.7% 90.5% 2.4% 92.1% 88.6% 4.0%
United Kingdom.............................. 92.5% 85.6% 8.1% 90.1% 81.6% 10.4%
------------ ----------- ---------- ----------- ------------ ----------
91.0% 86.7% 5.0% 89.7% 84.0% 6.8%
============ =========== ========== =========== ============ ==========
Weighted average realized annual rent per
occupied square foot:
Belgium..................................... $ 18.13 $ 18.06 0.4% $ 17.66 $ 17.91 (1.4)%
Denmark..................................... 30.26 27.29 10.9% 28.59 26.15 9.3%
France...................................... 29.14 27.56 5.7% 28.00 26.97 3.8%
Netherlands................................. 25.07 23.29 7.6% 23.96 23.03 4.0%
Sweden...................................... 25.84 24.70 4.6% 24.86 24.11 3.1%
United Kingdom.............................. 43.15 43.21 (0.1)% 42.04 41.76 0.7%
------------ ----------- ---------- ----------- ------------ ----------
$ 27.00 $ 25.89 4.3% $ 26.01 $ 25.29 2.8%
============ =========== ========== =========== ============ ==========
Net rentable square feet (in thousands):
Belgium..................................... 999 999 -
Denmark..................................... 210 210 -
France...................................... 1,236 1,236 -
Netherlands................................. 1,172 1,172 -
Sweden...................................... 1,130 1,130 -
United Kingdom.............................. 539 539 -
----------- ------------ ----------
5,286 5,286 -
=========== ============ ==========
Number of facilities:
Belgium..................................... 17 17 -
Denmark..................................... 4 4 -
France...................................... 23 23 -
Netherlands................................. 22 22 -
Sweden...................................... 20 20 -
United Kingdom.............................. 10 10 -
----------- ------------ ----------
96 96 -
=========== ============ ==========
66
ANCILLARY OPERATIONS: Ancillary operations include (i) the reinsurance
of policies against losses to goods stored by tenants in our self-storage
facilities, (ii) sale of merchandise at our self-storage facilities, (iii)
containerized storage operations, (iv) truck rentals at our self-storage
facilities and (v) commercial property operations, and (vi) management of
facilities owned by third-party owners and facilities owned by affiliates that
are not included in our consolidated financial statements.
The following table sets forth our ancillary operations:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------ -------------------------
2007 2006 Change 2007 2006 Change
------------ ----------- ---------- ------------- ----------- ------------
(Amounts in thousands)
Revenues:
Tenant reinsurance............. $ 15,646 $ 9,790 $ 5,856 $ 44,254 $ 24,379 $ 19,875
Merchandise sales............... 10,072 7,566 2,506 29,178 18,879 10,299
Containerized storage........... 3,952 4,313 (361) 11,259 12,438 (1,179)
Truck rentals................... 3,640 4,106 (466) 9,795 10,535 (740)
Commercial property operations.. 3,777 3,408 369 11,391 9,413 1,978
Property management............. 667 644 23 2,026 1,856 170
------------ ----------- ---------- ------------- ----------- ------------
Total revenues............... $ 37,754 $ 29,827 $ 7,927 $ 107,903 $ 77,500 $ 30,403
------------ ----------- ---------- ------------- ----------- ------------
Cost of operations:
Tenant reinsurance ............. 5,981 3,714 2,267 15,261 9,929 5,332
Merchandise sales............... 7,708 6,347 1,361 22,812 16,541 6,271
Containerized storage........... 3,565 3,570 (5) 9,923 10,476 (553)
Truck rentals................... 3,883 3,328 555 10,848 9,089 1,759
Commercial property operations.. 1,486 1,497 (11) 4,393 4,080 313
Property management............. 64 58 6 182 200 (18)
------------ ----------- ---------- ------------- ----------- ------------
Total cost of operations..... 22,687 18,514 4,173 63,419 50,315 13,104
------------ ----------- ---------- ------------- ----------- ------------
Depreciation and amortization:
Tenant reinsurance............. - - - - - -
Merchandise sales............... - - - - - -
Containerized storage........... 239 166 73 657 635 22
Truck rentals................... - - - - - -
Commercial property operations.. 664 643 21 1,992 1,777 215
Property management............. - - - - - -
------------ ----------- ---------- ------------- ----------- ------------
Total depreciation........... 903 809 94 2,649 2,412 237
------------ ----------- ---------- ------------- ----------- ------------
Net Income:
Tenant reinsurance............. 9,665 6,076 3,589 28,993 14,450 14,543
Merchandise sales............... 2,364 1,219 1,145 6,366 2,338 4,028
Containerized storage........... 148 577 (429) 679 1,327 (648)
Truck rentals................... (243) 778 (1,021) (1,053) 1,446 (2,499)
Commercial property operations.. 1,627 1,268 359 5,006 3,556 1,450
Property management............. 603 586 17 1,844 1,656 188
------------ ----------- ---------- ------------- ----------- ------------
Total net operating income...... $ 14,164 $ 10,504 $ 3,660 $ 41,835 $ 24,773 $ 17,062
============ =========== ========== ============= =========== ============
Our ancillary operations have increased significantly in the three and
nine months ended September 30, 2007 as compared to the same periods in 2006.
This increase is attributable primarily to the self-storage facilities we
acquired in the Shurgard merger, which has given us more locations in which to
conduct our tenant reinsurance and merchandise activities, as well as due to
additional commercial space acquired in the merger with Shurgard.
67
Tenant reinsurance operations: We reinsure policies offered through a
non-affiliated insurance broker against losses to goods stored by tenants in our
self-storage facilities. Revenues are comprised of fees charged to tenants
electing such policies. Cost of operations primarily includes claims paid that
are not covered by our outside third-party insurers, as well as claims adjusting
expenses.
The significant increase in tenant reinsurance revenues is due
primarily to the increase in properties associated with the acquisition of
Shurgard. For the three months ended September 30, 2006 and 2007, respectively,
tenant insurance revenues included $745,000 and $2,453,000 with respect to the
Shurgard facilities in the United States; for the nine months ended September
30, 2006 and 2007, tenant insurance revenues included $745,000 and $6,992,000
with respect to the Shurgard facilities in the United States. For the three
months ended September 30, 2006 and 2007, respectively, tenant insurance
revenues included $784,000 and $2,544,000 with respect to the Shurgard
facilities in Europe; for the nine months ended September 30, 2006 and 2007,
tenant insurance revenues included $784,000 and $6,820,000 with respect to the
Shurgard facilities in Europe.
Further contributing to our increase in tenant reinsurance revenues
were higher rates, and an increase in the percentage of our existing tenants
retaining such policies, with respect to our tenant insurance activities in the
United States. For the three and nine months ended September 30, 2007,
approximately 44.4% and 43.3%, respectively, of our self-storage tenant base had
such policies, as compared to approximately 33.2% and 32.7% for the same periods
in 2006.
The future level of tenant reinsurance revenues is largely dependent
upon the number of new tenants electing to purchase policies, the level of
premiums charged for such insurance, and the number of tenants that continue
participating in the insurance program.
The future cost of operations will be dependent primarily upon the
level of losses incurred, including the level of catastrophic events, such as
hurricanes, that occur and affect our properties.
Merchandise and truck rental operations: Our subsidiaries sell locks,
boxes, and packing supplies to our tenants as well as the general public.
Revenues and cost of operations for these activities are included in the table
above as "Merchandise Sales." In addition, at selected locations, our
subsidiaries maintain trucks on site for rent to our self-storage customers and
the general public on a short-term basis for local use. In addition, we also act
as an agent for a national truck rental company to provide their rental trucks
to customers for long-distance use. The revenues and cost of operations for
these activities are included in the table above as "Truck rentals."
These activities generally serve as an adjunct to our self-storage
operations providing our tenants with goods and services that they need in
connection with moving and storing their goods.
The primary factors impacting the level of operations of these
activities is the level of customer traffic at our self-storage facilities,
including the level of move-ins. The significant increase in merchandise
revenues is due primarily to the increase in properties associated with the
acquisition of Shurgard. For the three months ended September 30, 2006 and 2007,
respectively, merchandise revenues included $929,000 and $2,260,000 with respect
to the Shurgard facilities in the United States; for the nine months ended
September 30, 2006 and 2007, merchandise revenues included $929,000 and
$6,738,000 with respect to the Shurgard facilities in the United States. For the
three months ended September 30, 2006 and 2007, respectively, merchandise
revenues included $778,000 and $2,231,000 with respect to the Shurgard
facilities in Europe; for the nine months ended September 30, 2006 and 2007,
merchandise revenues included $778,000 and $6,058,000 with respect to the
Shurgard facilities in Europe.
For the three months ended September 30, 2006 and 2007, respectively,
truck revenues included $290,000 and $524,000 with respect to the Shurgard
facilities in the United States; for the nine months ended September 30, 2006
and 2007, truck revenues included $290,000 and $1,353,000 with respect to the
Shurgard facilities in the United States.
Containerized storage operations: We have containerized storage
facilities located in eight densely populated markets with above-average rent
and income.
68
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 certain non-core services
which were eliminated, such as handling and packing customers' goods from city
to city. Direct operating costs principally includes payroll, equipment lease
expense, utilities and vehicle expenses (fuel and insurance).
We closed certain containerized storage locations; the results of these
facilities for all periods presented have been reclassified to the line item
"discontinued operations."
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's operations, based on which
we have closed certain of these facilities in recent years, and we may decide to
close additional facilities in the future.
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 PSB. Our investment
in PSB is accounted for using the equity method of accounting, and accordingly
our share of PSB's earnings is reflected as "Equity in earnings of real estate
entities," below.
Our commercial operations are comprised of 1,561,000 net rentable
square feet of commercial space, which is principally operated at certain of the
self-storage facilities. The significant increase in commercial property
revenues is due principally to commercial space in the facilities we acquired
from Shurgard in the United States. For the three months ended September 30,
2006 and 2007, respectively, commercial revenues included $391,000 and $701,000
with respect to the facilities we acquired from Shurgard. For the nine months
ended September 30, 2006 and 2007, respectively, these acquired Shurgard
facilities generated $391,000 and $2,136,000 in revenues.
Our commercial property operations consist primarily of facilities that
are at a stabilized level of operations, and generally reflect the conditions in
the markets in which they operate. Other than the continuing year-over-year
growth due to the increase in commercial space in the Shurgard properties, we do
not expect any significant growth in net operating income from this segment of
our business for 2007.
EQUITY IN EARNINGS OF REAL ESTATE ENTITIES: In addition to our
ownership of equity interests in PSB, we have interests in 12 entities owning 33
properties at September 30, 2007. (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 manage each
of these facilities for a management fee that is included in "Ancillary
Operations."
Equity in earnings of real estate entities for the three and nine
months ended September 30, 2007 and 2006 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:
69
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- -------------------------
2007 2006 Change 2007 2006 Change
------------ ----------- ------------ ------------ ------------ ------------
(Amounts in thousands)
Property operations:
PSB $ 20,890 $ 18,664 $ 2,226 $ 60,952 $ 54,775 $ 6,177
Deconsolidated Shurgard Facilities..... 709 - 709 992 - 992
Other investments (1).................. 845 873 (28) 2,400 2,438 (38)
------------ ----------- ------------ ------------ ------------ ------------
22,444 19,537 2,907 64,344 57,213 7,131
------------ ----------- ------------ ------------ ------------ ------------
Depreciation:
PSB.................................... (11,117) (9,779) (1,338) (31,547) (28,034) (3,513)
Deconsolidated Shurgard Facilities..... (149) - (149) (234) - (234)
Other investments (1).................. (253) (252) (1) (772) (717) (55)
------------ ----------- ------------ ------------ ------------ ------------
(11,519) (10,031) (1,488) (32,553) (28,751) (3,802)
------------ ----------- ------------ ------------ ------------ ------------
Other: (2)
PSB (3)................................ (7,251) (6,867) (384) (21,169) (19,107) (2,062)
Deconsolidated Shurgard Facilities..... (270) - (270) (398) - (398)
Other investments (1).................. 20 (21) 41 (41) (147) 106
------------ ----------- ------------ ------------ ------------ ------------
(7,501) (6,888) (613) (21,608) (19,254) (2,354)
------------ ----------- ------------ ------------ ------------ ------------
Total equity in earnings of real estate
entities.................................. $ 3,424 $ 2,618 $ 806 $ 10,183 $ 9,208 $ 975
============ =========== ============ ============ ============ ============
(1) Amounts reflect equity in earnings recorded for investments that have been
held consistently throughout each of the three and nine months ended
September 30, 2007 and 2006.
(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 $819,000 and $1,870,000 for the three and nine
months ended September 30, 2007, respectively, as compared to $271,000 and
$729,000 for the three and nine months ended September 30, 2006,
respectively.
(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.
Equity in earnings of real estate entities includes our pro rata share
of the net impact of gains/losses on sales 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 share from these items
resulted in a net decrease of equity in earnings of $19,000 for the three months
ended September 30, 2006 and a net increase of $293,000 for the nine months
ended September 30, 2006 (none for the same periods in 2007).
Our future equity income from PSB will be dependent entirely upon PSB's
operating results. Our investment in PSB provides us with some diversification
into another asset type. We have no plans of disposing of our investment in PSB.
PSB's filings and selected financial information can be accessed through the
Securities and Exchange Commission, and on its website, www.psbusinessparks.com.
The Deconsolidated Shurgard Facilities include 11 properties in which
we have a partial equity interest, acquired in the merger with Shurgard, and
which are subject to mortgage loans aggregating approximately $19 million at
September 30, 2007. We commenced deconsolidating these properties effective May
24, 2007 due to a loss of control in the entities owning these properties;
accordingly, equity in earnings of real estate entities includes, the operating
results of these 11 properties and the associated interest expense incurred
after May 24, 2007.
The "Other Investments" are comprised five limited partnerships, which
own 22 properties, for which we held an approximate consistent level of equity
interest throughout each of the periods presented. Our future earnings with
70
respect to the "Other Investments" will be dependent upon the operating results
of the 22 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 our
self-storage facilities as discussed above.
See Note 5 to our condensed consolidated financial statements for the
operating results of these entities for the three and nine months ended
September 30, 2007 and 2006.
OTHER INCOME AND EXPENSE ITEMS
INTEREST AND OTHER INCOME: Interest and other income was $3,257,000 and
$6,337,000 for the three and nine months ended September 30, 2007, respectively,
as compared to $12,651,000 and $27,773,000 for the three and nine months ended
September 30, 2006, respectively. These decreases are due primarily to lower
average cash balances. We had significant levels of uninvested cash in the three
and nine months ended September 30, 2006 as we had issued preferred securities
in anticipation of our cash requirements with respect to the Shurgard merger.
DEPRECIATION AND AMORTIZATION: Depreciation and amortization expense
was $147,767,000 and $491,725,000 for the three and nine months ended September
30, 2007, respectively, as compared to $113,463,000 and $212,057,000 for the
three and nine months ended September 30, 2006, respectively. The increases in
depreciation and amortization for the three months ended September 30, 2007, as
compared to the same period in 2006 are due primarily to $53,320,000 and
$210,471,000 in amortization expense recorded during the three and nine months
ended September 30, 2007, respectively, on the intangible assets, which were
primarily acquired in the Shurgard merger. These intangible assets were valued
in our purchase accounting analysis at $565,341,000 and are being amortized
relative to the expected future benefit of the tenants in place to each period.
Amortization of the intangible assets is expected to be approximately
$37,757,000 in the fourth quarter of 2007.
The remainder of the increase in depreciation and amortization for the
three and nine months ended September 30, 2007 as compared to the same periods
in 2006 is due primarily to buildings acquired in the Shurgard merger and to our
newly developed and acquired facilities. See Notes 2 and 3 to our condensed
consolidated financial statements for further discussion of the Shurgard merger
and the acquisition of tangible and intangible assets.
GENERAL AND ADMINISTRATIVE: General and administrative expense was
$11,416,000 and $49,397,000 for the three and nine months ended September 30,
2007, respectively, as compared to $36,242,000 and $49,996,000 for the three and
nine months ended September 30, 2006, respectively. General and administrative
expense principally consists of state income taxes, investor relations expenses
and corporate and executive salaries. In addition, general and administrative
expenses 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 and stock-based
compensation, and product research and development expenditures.
For the three months ended September 30, 2007, general and
administrative expense includes (i) development costs that were expensed with
respect to terminated projects totaling $1.3 million ($9.3 million for the same
period in 2006) and (ii) ongoing general and administrative expense related to
our European operations for the entire quarter ended September 30, 2007
(includes amounts only from August 23, 2006 with respect to the same period in
2006). In addition, for the three months ended September 30, 2006, general and
administrative expense includes integration expenses incurred in connection with
the merger with Shurgard totaling approximately $18.1 million and contract
termination cost aggregating $2.2 million. For the nine months ended September
30, 2007, general and administrative expense includes (i) development costs that
were expensed with respect to terminated projects totaling $1.6 million ($9.3
million for the same period in 2006), (ii) additional expenses incurred in
connection with the merger with Shurgard totaling approximately $5.3 million
($20.5 million for the same period in 2006), (iii) $9.6 million related to our
proposed offering of shares in our European business, (iv) $2.0 million
associated with our reorganization as a Maryland REIT and (v) ongoing general
and administrative expense related to our European operations for the entire
nine month period ended September 30, 2007 (includes amounts only from August
23, 2006 with respect to the same period in 2006). In addition, for the nine
months ended September 30, 2006, we incurred contract termination costs of $2.2
million.
71
We expect that for the fourth quarter of 2007, general and
administrative expense will approximate $10 million to $13 million.
INTEREST EXPENSE: Interest expense was $15,257,000 and $48,772,000 for
the three and nine months ended September 30, 2007, respectively, as compared to
$9,323,000 and $12,752,000, respectively, for the same periods in 2006. Interest
capitalized during the three and nine months ended September 30, 2007, was
$1,297,000 and $3,011,000, respectively, compared to $530,000 and $1,599,000 for
the same periods in 2006. The increase in interest expense is primarily due to
$44,382,000 in interest incurred on the debt and other obligations we assumed in
the Shurgard merger for the nine months ended September 30, 2007 ($7,970,000 for
the same period in 2006), as well as $1,797,000 of interest on borrowings
against our line of credit. These amounts are partially offset by a decrease of
$679,000 in interest expense due to lower balances on our outstanding notes. See
also Notes 6, 7 and 8 to our condensed consolidated financial statements for a
schedule of our debt balances, principal repayment requirements, and average
interest rates.
GAIN ON DISPOSITION OF REAL ESTATE INVESTMENTS: During the nine months
ended September 30, 2007, we have received proceeds for partial condemnations
and other disposals to certain of our self-storage facilities for an aggregate
of $2,008,000 and recorded a gain of $1,137,000 on our condensed consolidated
statements of income for the three and nine months ended September 30, 2007 as a
result of these transactions.
On May 14, 2007, one of European subsidiaries, sold limited liability
partner interests ("LLP Interests") it held in Shurgard Self-Storage SCA,
("Shurgard Europe"), also an indirect subsidiary of Public Storage, to various
officers of the Company other than our chief executive officer. The aggregate
proceeds of the sale were $4,909,000. The sale price for the LLP Interests was
the net asset value per LLP Interest using, among other items, information
provided by an independent third party appraisal firm of the net asset value of
Shurgard Europe as of March 31, 2007. The Company has a right to repurchase the
LLP Interests (1) upon a purchaser's termination of employment or (2) for any
reason, on or after May 14, 2008. The repurchase price is set at the lesser of
(1) the then net asset value per share or (2) the original purchase price with a
10% compounded annual return. In connection with the sale of these LLP
Interests, we recorded a gain of $1,193,000 for the three and nine months ended
September 30, 2007, representing the excess of the sales proceeds less the book
value of the LLP Interests sold. The gain is reflected in gain on disposition of
real estate investments on our accompanying condensed consolidated statements of
income. The investment of these various officers is included in minority
interest - other partnership interests on our accompanying condensed
consolidated balance sheet at September 30, 2007 and their pro rata share of the
earnings of Shurgard Europe are reflected in minority interest in income - other
partnership interests on our accompanying condensed consolidated statements of
income for the three and nine months ended September 30, 2007.
During the three months ended September 30, 2006, we received $466,000
of additional proceeds from a partial condemnation that occurred in 2005. These
additional proceeds are reflected as a gain on disposition of real estate
investments on our condensed consolidated statements of income for the three and
nine months ended September 30, 2006. Also during the nine months ended
September 30, 2006, we disposed of parcels of vacant land for an aggregate of
$4,970,000. The net proceeds were equal to the book value of these parcels;
accordingly, no gain or loss was recorded.
FOREIGN EXCHANGE GAIN: At September 30, 2007, our European subsidiaries
owed approximately (euro)389 million ($556 million as of September 30, 2007) to
our domestic subsidiaries. The loans are eliminated in consolidation for
financial reporting purposes. We expect our European subsidiaries to obtain
external financing in the next 12 to 24 months, which will fund the repayment of
the loan. The loans which are denominated in Euros have not been hedged. The
amount of US dollars that will be received on repayment will depend upon the
exchange rates at the time. Based upon the change in estimated US dollars to be
received caused by fluctuation in currency rates during each respective period,
foreign currency translation gains of $30.4 million and $41.0 million,
respectively, were recorded in the three and nine months ended September 30,
2007. The US Dollar exchange rate relative to the Euro was approximately 1.319,
1.347, and 1.426 at December 31, 2006, June 30, 2007, and September 30, 2007,
respectively.
72
Future foreign exchange gains will be dependent primarily upon the
movement of the Euro relative to the US Dollar, the level of our intercompany
debt and our expectations with respect to repaying intercompany debt. At
September 30, 2007 our European subsidiaries had intercompany balances payable
to our United States operations totaling approximately $556 million.
HURRICANE CASUALTY GAIN: Our policy is to record casualty losses or
gains in the period the casualty occurs equal to the differential between (a)
the book value of assets destroyed and (b) insurance proceeds, if any, that we
expect to receive in accordance with our insurance contracts. Potential
insurance proceeds that are subject to uncertainties, such as interpretation of
deductible provisions of the governing agreements or the estimation of costs of
restoration, are treated as a contingent proceeds in accordance with Statement
of Financial Accounting Standards No. 5 ("SFAS 5"), and not recorded until the
uncertainties are satisfied. During the first quarter of 2007, we recorded a
casualty gain totaling $2,665,000, representing the realization of such
contingent proceeds relating to hurricanes which occurred in 2005.
INCOME FROM DERIVATIVES, NET: This represents a net gain as recognized
for the changes in the fair market values of those derivative financial
instruments that do not qualify for hedge accounting treatment under SFAS No.
133 combined with net payments from derivative instruments. The gain of $117,000
for the three months ended September 30, 2007 is primarily due to gains of
$68,000 in changes in value of our interest rate swaps and currency forward
contracts on the euro that do not qualify for hedge accounting combined with
receipts of $49,000 relative to certain interest rate swaps and foreign currency
exchange derivatives acquired in the Shurgard merger as described under Note 3
to our condensed consolidated financial statements. The gain of $1,126,000 for
the nine months ended September 30, 2007 is primarily due to gains of $1,205,000
in changes in value of our interest rate swaps and currency forward contracts on
the euro that do not qualify for hedge accounting combined with payments of
$79,000 relative to certain interest rate swaps and foreign currency exchange
derivatives acquired in the Shurgard merger.
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, 2007 and 2006:
73
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------- --------------------------
2007 2006 Change 2007 2006 Change
------------- ----------- ----------- ------------- ------------- ------------
(Amounts in thousands)
Preferred partnership interests (a).......... $ 5,403 $ 5,403 $ - $ 16,209 $ 13,652 $ 2,557
Convertible Partnership Units (b)............ 121 120 1 132 356 (224)
Shurgard U.S. minority interests (c)......... 180 191 (11) 624 191 433
Shurgard European minority interests (d)..... (1,456) (1,279) (177) (7,275) (1,279) (5,996)
European investors (e)....................... (109) - (109) (109) - (109)
Other minority interests (f)................. 4,165 4,155 10 12,030 11,557 473
------------- ----------- ----------- ------------- ------------- ------------
Total minority interests in income....... $ 8,304 $ 8,590 $ (286) $ 21,611 $ 24,477 $ (2,866)
============= =========== =========== ============= ============= ============
(a) On May 9, 2006, one of our Consolidated Entities issued $100,000,000 of its
7.25% Series J Preferred Partnership Units. Accordingly, ongoing
distributions with respect to preferred partnership interest have
increased.
(b) These amounts reflect the minority interests represented by the Convertible
Partnership Units (see Note 10 to our condensed consolidated financial
statements).
(c) These amounts reflect income allocated to minority interests in entities we
acquired in the merger with Shurgard, and include $159,000 and $555,000 in
depreciation in the three and nine months ended September 30, 2007,
respectively, as compared to $55,000 for each of the same periods in 2006.
(d) These amounts reflect income allocated to our minority partner's 80%
interest in the European joint ventures, First Shurgard and Second
Shurgard. These amounts are negative because the related joint ventures
operations are at a loss position. Included in these minority interest
amounts is (i) depreciation expense for the three and nine months ended
September 30, 2007, of $2,674,000 and $8,281,000, respectively, compared to
$742,000 for each of the same periods in 2006, (ii) interest expense for
the three and nine months ended September 30, 2007, of $4,036,000 and
$11,082,000, respectively, compared to $1,829,000 for each of the same
periods in 2006 and (iii) derivatives and foreign exchange gains of
$603,000 and $2,509,000, respectively, compared to $66,000 for each of the
same periods in 2006.
(e) These amounts reflect income allocated to the interest owned by various
officers of the Company, as described on Note 10 to our consolidated
financial statement. These amounts include depreciation expense aggregating
$190,000 for the three and nine months ended September 30, 2007.
(f) These amounts reflect income allocated to minority interests that were
outstanding consistently throughout the three and nine months ended
September 30, 2007 and 2006. Included in minority interest in income is
$128,000 and $454,000 in depreciation expense for the three and nine months
ended September 30, 2007, respectively, as compared to $108,000 and
$500,000 for the same periods in 2006.
Other minority interests reflect income allocated to minority interests
that have maintained a consistent level of interest throughout 2006 and the nine
months ended September 30, 2007, comprised of investments in the Consolidated
Entities described in Note 10 to our condensed consolidated 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.
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 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 used to make distributions 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 scheduled and optional principal payments on debt and
for reinvestment.
74
Nine Months Ended September 30,
----------------------------------
2007 2006
---------------- --------------
(Amounts in thousands)
Net cash provided by operating activities (a)................... $ 751,591 $ 582,152
Distributions to minority interest (Preferred Units)............ (16,209) (13,652)
Distributions to minority interest (common equity).............. (15,828) (11,037)
---------------- --------------
Cash from operations allocable to our shareholders.............. 719,554 557,463
---------------- --------------
Capital improvements to maintain our facilities................. (49,453) (44,366)
Remaining operating cash flow available for distributions to our
shareholders................................................ 670,101 513,097
Distributions paid:
Preferred share dividends..................................... (176,424) (159,256)
Equity Shares, Series A dividends............................. (16,068) (16,068)
Distributions to common shareholders.......................... (255,022) (213,281)
---------------- --------------
Cash available for principal payments on debt and reinvestment.. $ 222,587 $ 124,492
================ ==============
(a) Represents net cash provided from operating activities as presented on our
September 30, 2007 Condensed Consolidated Statements of Cash Flows.
Cash available for principal payments on debt and reinvestment
increased from $124.5 million in the nine months ended September 30, 2006 to
$222.6 million in the nine months ended September 30, 2007 principally due to
improved operations from our Same Store group of facilities, continued growth in
operations from our newly developed and recently expanded facilities, continued
growth in our recently acquired self-storage facilities including the facilities
acquired in the merger with Shurgard, as well as additional tax depreciation
with respect to the assets acquired in the merger with Shurgard which serves to
reduce our required distributions.
Our financial profile is characterized by a low level of debt-to-total
capitalization and a conservative dividend payout ratio with respect to our
common shares. We expect to fund our growth strategies and debt obligations with
(i) cash on hand at September 30, 2007, (ii) internally generated retained cash
flows and (iii) proceeds from issuing equity securities. In general, our current
strategy is to continue to finance our growth with permanent capital; in the
form of either common or preferred equity.
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 shares have no sinking fund requirement or maturity date and do 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
shares at any time, which enable us to refinance higher coupon preferred shares
with new preferred stock at lower rates if appropriate, (iv) preferred shares do
not contain covenants, thus allowing us to maintain significant financial
flexibility, and (v) dividends on the preferred shares can be applied to satisfy
our REIT distribution requirements.
Our credit ratings on each outstanding series of preferred shares are
"Baa1" by Moody's and "BBB+" by Standard & Poor's.
On March 27, 2007, we entered into a five-year revolving credit
agreement (the "Credit Agreement") with an aggregate limit with respect to
borrowings, letters of credit and foreign currency borrowings in Euros or
British pounds of $300 million. Amounts drawn under the Credit Agreement bear an
75
annual interest rate ranging from the London Interbank Offered Rate ("LIBOR")
plus 0.35% to LIBOR plus 1.00% depending on our credit ratings (LIBOR plus 0.35%
at September 30, 2007). In addition, we are required to pay a quarterly facility
fee ranging from 0.10% per annum to 0.25% per annum depending on our credit
ratings (0.10% per annum at September 30, 2007). We had no outstanding
borrowings on our revolving line of credit at September 30, 2007 or November 8,
2007.
The Credit Agreement includes various covenants, the more significant
of which require us to (i) maintain a leverage ratio (as defined therein) of
less than 0.55 to 1.00, (ii) maintain certain fixed charge and interest coverage
ratios (as defined therein) of not less than 1.5 to 1.0 and 1.75 to 1.0,
respectively, and (iii) maintain a minimum total shareholders' equity (as
defined therein). We were in compliance with all covenants of the Credit
Agreement at September 30, 2007.
RECENT ISSUANCE AND 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.
On January 9, 2007, we issued our 6.625% Series M Preferred Stock for
gross proceeds of $500 million. On January 18, 2007, we redeemed our 7.625%
Series T Cumulative Preferred Shares totaling $152.2 million and on February 19,
2007, we redeemed our 7.625% Series U Cumulative Preferred Shares totaling
$150.0 million. These redemptions were funded with cash on hand and funds raised
through the issuance of our Series M preferred stock. On July 2, 2007, we issued
our 7.000% Series N Preferred Shares for gross proceeds of $172.5 million. We
currently have approximately $172.5 million of additional preferred securities
that became redeemable at our option as of September 30, 2007. We have not
called this series for redemption due to the state of current credit markets and
our belief that we could not issue a similar preferred security at a lower rate.
From time-to-time, we may raise additional capital primarily through
the issuance of lower rate preferred securities, in advance of the redemption
dates to ensure that we have available funds to redeem these securities. The
timing and our ability to issue additional preferred securities to finance the
redemption of these preferred securities depends on many factors and
accordingly, there is no assurance that we will be able to raise the necessary
capital and at appropriate rates to redeem these securities.
EUROPEAN FINANCING: As we previously disclosed, we attempted to
liquidate a portion of our investment in our European subsidiaries through an
initial public offering, and although market conditions are not favorable at
this time for such a transaction, we continue to evaluate our alternatives and
still believe that a public entity is the best structure for our European
operations' long-term growth. At September 30, 2007, our European subsidiaries
owed approximately (euro)389 million ($556 million as of September 30, 2007) to
our domestic subsidiaries. We expect our European subsidiaries to obtain
external financing in the next 12 to 24 months, which will fund the repayment of
the loan, resulting in the receipt of additional cash. The loans, which are
denominated in Euros have not been hedged, to limit our exposure to fluctuation
in exchange rates between the Euro and the US Dollar; and; as a result, the
amount of U.S. Dollars that will be received on repayment will depend upon
exchange rates at the time.
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.
We estimate the distribution requirement with respect to our preferred
shares outstanding at September 30, 2007 to be approximately $241 million per
year. The annual distribution requirement with respect to our Series N Preferred
Shares issued on July 2, 2007 is approximately $12.1 million. We estimate that
the annual distribution requirement with respect to the preferred partnership
units outstanding at September 30, 2007, to be approximately $21.6 million per
year.
76
During the nine months ended September 30, 2007, we paid dividends
totaling $255,022,000 ($1.50 per common share) to the holders of our common
shares. Based upon shares outstanding at November 8, 2007 and a quarterly
distribution of $0.50 per share, which was declared by our Board on November 8,
2007 and payable on December 31, 2007, to shareholders of record as of December
14, 2007, we estimate a dividend payment with respect to our common shares of
approximately $85 million for the fourth quarter of 2007.
During each of the nine months ended September 30, 2007 and 2006, we
paid cash dividends totaling $16,068,000 to the holders of our Equity Shares,
Series A. With respect to the depositary shares representing Equity Shares,
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 share or (ii) $2.45. The depositary shares are non-cumulative, and
have no preference over our common shares either as to dividends or in
liquidation. With respect to the Equity Shares, Series A outstanding at
September 30, 2007, we estimate the total regular distribution for the fourth
quarter of 2007 to be approximately $5.4 million.
CAPITAL IMPROVEMENT REQUIREMENTS: During 2007, we have budgeted
approximately $75,000,000 for capital improvements for our facilities. Capital
improvements include major repairs or replacements to the facilities, which keep
the facilities in good operating condition and maintain their visual appeal.
Capital improvements do not include costs relating to the development or
expansion of facilities. During the nine months ended September 30, 2007, we
incurred capital improvements of approximately $49,453,000. 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.
DEBT SERVICE REQUIREMENTS: At September 30, 2007, we have total
outstanding debt of approximately $1 billion. We do not believe we have any
significant refinancing risks with respect to our debt.
On January 2, 2007, we retired approximately $429 million of debt
assumed from Shurgard that was secured by substantially all of our wholly-owned
facilities in Europe.
Our portfolio of real estate facilities remains substantially
unencumbered. At September 30, 2007, we have domestic mortgage debt outstanding
of $233 million, which encumbers 86 self-storage facilities with an aggregate
net book value of approximately $599 million. In Europe, mortgage debt at
September 30, 2007 totaled $353 million and encumbers 64 facilities, owned by
consolidated joint ventures (we have a 20% interest in each joint venture), with
an aggregate net book value of approximately $482 million at September 30, 2007.
We anticipate that our retained operating cash flow will continue to be
sufficient to enable us to make scheduled principal payments. See Notes 7 and 8
to our condensed consolidated financial statements for approximate principal
maturities of such borrowings. It is our current intention to fully amortize our
outstanding debt as opposed to refinance debt maturities with additional debt.
Alternatively, we may prepay debt and finance such prepayments with retained
operating cash flow or proceeds from the issuance of preferred securities.
ACQUISITION AND DEVELOPMENT OF FACILITIES: During 2007, we will
continue to seek to acquire additional self-storage facilities from third
parties; however, it is difficult to estimate the amount of third party
acquisitions we will undertake.
At September 30, 2007, we have a development "pipeline" of 39 projects
in the U.S. and 16 projects in Europe, consisting of newly developed
self-storage facilities, conversion of space at facilities that was previously
used for containerized storage and expansions to existing self-storage
facilities. At September 30, 2007, we have acquired the land for all of the U.S
projects and nine of the projects in Europe.
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 to complete development to be
approximately $191.1 million and will be incurred over the next 24 months. The
following table sets forth certain information with respect to our development
pipeline.
77
DEVELOPMENT PIPELINE SUMMARY
AS OF SEPTEMBER 30, 2007 Total
Number Net estimated Costs incurred
of rentable development through Costs to
projects sq. ft. costs 09/30/07 complete
--------- ---------- ------------- --------------- --------------
(Amounts in thousands, except number of projects)
U.S. under construction 16 751 $ 65,195 $ 37,820 $ 27,375
U.S. in development, land acquired 23 960 85,262 5,759 79,503
European projects in construction 9 495 96,131 57,967 38,164
European projects under development 7 298 48,131 2,111 46,020
--------- ---------- ------------- --------------- --------------
Total Development Pipeline 55 2,504 $ 294,719 $ 103,657 $ 191,062
========= ========== ============= =============== ==============
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 to complete development will
be incurred over the next 24 months. Substantially all of the future costs for
the seven European projects that are in construction will be funded by the
Shurgard European Joint Ventures, in which we have a 20% interest, and which
have a substantial degree of funding by debt. The future costs with respect to
all other development projects will be funded by us.
CONTRACTUAL OBLIGATIONS: Our significant contractual obligations at
September 30, 2007 and their impact on our cash flows and liquidity are
summarized below for the years ending December 31 (amounts in thousands):
Total 2007 2008 2009 2010 2011 Thereafter
----------- ---------- ------------ ----------- ----------- ----------- -------------
Long-term debt (1) ............ $1,163,719 $ 12,114 $ 243,951 $ 214,326 $ 48,137 $ 250,909 $ 394,282
Capital leases (2)............. 43,245 193 767 782 726 1,408 39,369
Operating leases (3)........... 270,647 7,318 19,257 15,817 12,083 10,774 205,398
Construction commitments (4)... 65,539 53,260 12,279 - - - -
----------- ---------- ------------ ----------- ----------- ----------- -------------
Total.......................... $1,543,150 $ 72,885 $ 276,254 $ 230,925 $ 60,946 $ 263,091 $ 639,049
=========== ========== ============ =========== =========== =========== =============
(1) Amounts include interest payments on our notes payable based on their
contractual terms. See Note 7 to our condensed consolidated financial
statements for additional information on our notes payable. Debt to Joint
Venture Partner is not reflected since we have not exercised our option to
acquire our partner's interest.
(2) This line item reflects amounts due on five European properties with
commitments extending to April 2052 that we assumed in the merger with
Shurgard.
(3) We lease trucks, land, equipment and office space under various operating
leases. Certain leases are cancelable with substantial penalties.
(4) Includes obligations for facilities currently under construction at
September 30, 2007 as described above under "Acquisition and Development of
Facilities."
In January 2004, we entered into a joint venture partnership with an
institutional investor for the purpose of acquiring up to $125,000,000 of
existing self-storage properties in the United States from third parties (the
"Acquisition Joint Venture"). As described more fully in Note 8 to our September
30, 2007 condensed consolidated financial statements, our partner's equity
78
contributions with respect to certain transactions are classified as debt under
the caption "Debt to Joint Venture Partner" in our condensed consolidated
balance sheets. At September 30, 2007, our Debt to Joint Venture Partner was
$37,395,000. For a six-month period beginning 54 months after formation, we have
the right to acquire our partner's interest based upon the market value of the
properties. If we do not exercise our option, our partner can elect to purchase
our interest in the properties during a six-month period commencing upon
expiration of our six-month option period. If our partner fails to exercise its
option, the Acquisition Joint Venture will be liquidated and the proceeds will
be distributed to the partners according to the joint venture agreement. We have
not included our Debt to Joint Venture Partner as a contractual obligation in
the table above, since we only have the right, rather than a contractual
obligation, to acquire our partner's interest.
OFF-BALANCE SHEET ARRANGEMENTS: At September 30, 2007 we had no
material off-balance sheet arrangements as defined under Regulation S-K
303(a)(4) and the instructions thereto.
STOCK REPURCHASE PROGRAM: Our Board has 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. During 2004, we repurchased 445,700
shares for approximately $20.3 million. During 2005, we repurchased 84,000
shares for approximately $5.0 million. During 2006 or 2007 (through November 8,
2007), we did not repurchase any shares. From the inception of the repurchase
program through September 30, 2007, we have repurchased a total of 22,201,720
common shares at an aggregate cost of approximately $567.2 million.
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 either of common
shares or preferred shares. At September 30, 2007, our debt as a percentage of
total shareholders' equity (based on book values) was 11.9%.
Our preferred shares are not redeemable at the option of the holders.
Our Series V shares are currently redeemable. Except under certain conditions
relating to the Company's qualification as a REIT, the preferred shares are not
redeemable by the Company prior to the following dates: 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 - September 30, 2009, Series C -
September 13, 2009, Series D - February 28, 2010, Series E - April 27, 2010,
Series F - August 23, 2010, Series G - December 12, 2010, Series H - January 19,
2011, Series I - May 3, 2011, Series K - August 8, 2011, Series L - October 20,
2011, Series M - January 9, 2012 and Series N - July 2, 2012. On or after the
respective dates, each of the series of preferred shares will be redeemable at
the option of the Company, in whole or in part, at $25 per depositary share (or
share in the case of the Series Y), plus accrued and unpaid dividends through
the redemption date.
Our market risk sensitive instruments include notes payable and
borrowing on bank credit facilities, which totaled $1,004,507,000 and none,
respectively, at September 30, 2007.
We are exposed to changes in interest rates primarily from the floating
rate debt arrangements we acquired in the merger with Shurgard.
We have foreign currency exposures related to our investment in the
construction, acquisition, and operation of storage centers in countries outside
the U.S. to the extent such activities are financed with financial instruments
or equity denominated in non-functional currencies. The aggregate book value of
such real estate and intangibles was approximately $1.7 billion at September 30,
2007. Since all foreign debt is denominated in the corresponding functional
currency, our currency exposure is limited to our equity investment in those
countries. Countries in which Shurgard had exposure to foreign currency
fluctuations include Belgium, France, the Netherlands, Sweden, Denmark, Germany
and the United Kingdom.
The table below summarizes annual debt maturities and weighted-average
interest rates on our outstanding debt at the end of each year (based on
relevant LIBOR of 5.12% and a EURIBOR of 4.41% at September 30, 2007 and the
applicable forward curve for following years) and fair values required to
evaluate our expected cash-flows under debt agreements and our sensitivity to
interest rate changes at September 30, 2007 (dollar amounts in thousands).
79
2007 2008 2009 2010 2011 Thereafter Total Fair Value
---------- --------- ---------- ----------- -------- ----------- ----------- ------------
Fixed rate debt........ $ 2,154 $ 23,961 $ 12,365 $ 14,457 $228,197 $ 363,598 $ 644,732 $ 644,732
Average interest rate.. 6.52% 6.37% 6.01% 6.10% 5.83% 5.79%
----------------------------------------------------------------------------------------------------------------------------
Variable rate debt (1). $ - $ - $ - $ - $ - $ - $ - $ -
Average interest rate..
----------------------------------------------------------------------------------------------------------------------------
Variable rate EURIBOR
debt (2)............. $ 856 $184,256 $ 167,569 $ - $ - $ - $ 352,681 $ 352,681
Average interest rate.. 6.11% 6.11% 6.11%
----------------------------------------------------------------------------------------------------------------------------
Interest rate swaps
Swap on EURIBOR........ $ - $ 933 $ 2,175 $ - $ - $ - $ 3,108 $ 3,108
(1) Amounts include borrowings under our line of credit, which expires in 2012.
(2) First Shurgard and Second Shurgard have senior credit agreements
denominated in euros to borrow, in aggregate, up to (euro)271 million
($386.5 million as of September 30, 2007). As of September 30, 2007, the
available amount under those credit facilities was in aggregate (euro)22.5
million ($32.1 million).
At September 30, 2007, we were party to pay-fixed, receive-variable
interest rate swaps. The notional amounts, the weighted-average pay rates and
the terms of these agreements are summarized as follows:
2007 2008 2009 2010 2011 Thereafter
---------- ---------- --------- --------- --------- -----------
Notional amounts (in millions)... $ 248.0 $ 122.0 $ - $ - $ - $ -
Weighted average interest rate... 3.75% 3.72% - - - -
Based on our outstanding variable-rate EURIBOR debt and interest rate
swaps at September 30, 2007, a hypothetical increase in the interest rates of
100 basis points would cause the value of our derivative financial instruments
to increase by $2.5 million. Conversely, a hypothetical decrease in the interest
rates of 100 basis points would cause the value of our derivative financial
instruments to decrease by $2.6 million.
On January 2, 2007, we prepaid the (euro)325 million collateralized
notes ($429 million at December 31, 2006) at our European operations that were
otherwise payable in 2011. We also terminated the related European currency and
interest rate hedges. Accordingly, the remaining debt in Europe relates to the
joint venture properties, in which we have a 20% equity interest, and which are
consolidated for financial reporting purposes.
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.
80
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.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
The information set forth under the heading "Legal Matters" in Note 15
to the Condensed Consolidated Financial Statements in this Form 10-Q is
incorporated by reference in this Item 1.
ITEM 1A. RISK FACTORS
As of September 30, 2007, no material changes had occurred in our risk
factors as discussed in Item 1A of the Public Storage, Inc. Annual Report on
Form 10-K for the year ended December 31, 2006.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
On June 12, 1998, our Board authorized the repurchase from time to time
of up to 10,000,000 common shares on the open market or in privately negotiated
transactions. On subsequent dates our Board increased the repurchase
authorization, the last being April 13, 2001, when our Board increased the
repurchase authorization to 25,000,000 shares. The Company has repurchased a
total of 22,201,720 common shares under this authorization. The Company did not
repurchase any common shares during the nine months ended September 30, 2007.
ITEM 6. EXHIBITS
Exhibits required by Item 601 of Regulation S-K are filed herewith or
incorporated herein by reference and are listed in the attached Exhibit Index
which is incorporated herein by reference.
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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, 2007
PUBLIC STORAGE
By: /s/ John Reyes
-------------------------------------
John Reyes
Senior Vice President and Chief
Financial Officer(Principal financial
officer and duly authorized officer)
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PUBLIC STORAGE
INDEX TO EXHIBITS (1)
(Items 15(a)(3) and 15(c))
3.1 Articles of Amendment and Restatement of Declaration of Trust of Public
Storage, a Maryland real estate Anvestment trust. Filed with the
Registrant's Current Report on Form 8-K dated June 6, 2007 and
incorporated by reference herein.
3.2 Bylaws of Public Storage, a Maryland real estate investment trust. Filed
with the Registrant's Current Beport on Form 8-K dated June 6, 2007 and
incorporated by reference herein.
3.3 Articles Supplementary for Public Storage Equity Shares, Series A. Filed
with the Registrant's Current Aeport on Form 8-K dated June 6, 2007 and
incorporated by reference herein.
3.4 Articles Supplementary for Public Storage Equity Shares, Series AAA.
Filed with the Registrant's Current Aeport on Form 8-K dated June 6, 2007
and incorporated by reference herein.
3.5 Articles Supplementary for Public Storage 7.500% Cumulative Preferred
Shares, Series V. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein. R
3.6 Articles Supplementary for Public Storage 6.500% Cumulative Preferred
Shares, Series W. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein. R
3.7 Articles Supplementary for Public Storage 6.450% Cumulative Preferred
Shares , Series X. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein.
3.8 Articles Supplementary for Public Storage 6.850% Cumulative Preferred
Shares, Series Y. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein.
3.9 Articles Supplementary for Public Storage 6.250% Cumulative Preferred
Shares, Series Z. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein.
3.10 Articles Supplementary for Public Storage 6.125% Cumulative Preferred
Shares, Series A. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein.
3.11 Articles Supplementary for Public Storage 7.125% Cumulative Preferred
Shares, Series B. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein. R
3.12 Articles Supplementary for Public Storage 6.600% Cumulative Preferred
Shares, Series C. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein.
3.13 Articles Supplementary for Public Storage 6.180% Cumulative Preferred
Shares, Series D. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein.
3.14 Articles Supplementary for Public Storage 6.750% Cumulative Preferred
Shares, Series E. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein. R
3.15 Articles Supplementary for Public Storage 6.450% Cumulative Preferred
Shares, Series F. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein.
3.16 Articles Supplementary for Public Storage 7.000% Cumulative Preferred
Shares, Series G. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein.
84
3.17 Articles Supplementary for Public Storage 6.950% Cumulative Preferred
Shares, Series H. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein.
3.18 Articles Supplementary for Public Storage 7.250% Cumulative Preferred
Shares, Series I. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein.
3.19 Articles Supplementary for Public Storage 7.250% Cumulative Preferred
Shares, Series K. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein.
3.20 Articles Supplementary for Public Storage 6.750% Cumulative Preferred
Shares, Series L. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein.
3.21 Articles Supplementary for Public Storage 6.625% Cumulative Preferred
Shares, Series M. Filed with the Aegistrant's Current Report on Form 8-K
dated June 6, 2007 and incorporated by reference herein.
3.22 Articles Supplementary for Public Storage 7.000% Cumulative Preferred
Shares, Series N. Filed with the Aegistrant's Current Report on Form 8-K
dated June 28, 2007 and incorporated by reference herein.
4.1 Master Deposit Agreement, dated as of May 31, 2007. Filed with the
Registrant's Current Report on Form 8-K dated June 6, 2007 and
incorporated by reference herein.
10.1 Amended Management Agreement between Registrant and Public Storage
Commercial Properties Group, Inc. dated as of February 21, 1995. Filed
with Public Storage Inc.'s ("PSI") Annual Report on Form 10-K for the
year ended December 31, 1994 (SEC File No. 001-0839) and incorporated
herein by reference.
10.2 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 (SEC File No. 001-11186) and incorporated herein by
reference.
10.3 Limited Partnership Agreement of PSAF Development Partners, L.P. Filed
with PSI's Quarterly Report on Form 10-Q for the quarterly period ended
March 31, 1997 (SEC File No. 001-0839) and incorporated herein by
reference.
10.4 Agreement of Limited Partnership of PS Business Parks, L.P. Filed with PS
Business Parks, Inc.'s Quarterly Report on Form 10-Q for the quarterly
period ended June 30, 1998 (SEC File No. 001-10709) and incorporated
herein by reference.
10.5 Amended and Restated Agreement of Limited Partnership of Storage Trust
Properties, L.P. (March 12, 1999). Filed with PSI's Quarterly Report on
Form 10-Q for the quarterly period ended June 30, 1999 (SEC File No.
001-0839) and incorporated herein by reference.
10.6 Limited Partnership Agreement of PSAC Development Partners, L.P. Filed
with PSI's Current Report on Form 8-K dated November 15, 1999 (SEC File
No. 001-0839) and incorporated herein by reference.
10.7 Agreement of Limited Liability Company of PSAC Storage Investors, L.L.C.
Filed with PSI's Current Report on Form 8-K dated November 15, 1999 (SEC
File No. 001-0839) and incorporated herein by reference.
10.8 Amended and Restated Agreement of Limited Partnership of PSA
Institutional Partners, L.P. Filed with PSI's Annual Report on Form 10-K
for the year ended December 31, 1999 (SEC File No. 001-0839) and
incorporated herein by reference.
85
10.9 Amendment to Amended and Restated Agreement of Limited Partnership of PSA
Institutional Partners, L.P. Filed with PSI's Quarterly Report on Form
10-Q for the quarterly period ended June 30, 2000 (SEC File No. 001-0839)
and incorporated herein by reference.
10.10 Second Amendment to Amended and Restated Agreement of Limited Partnership
of PSA Institutional Partners, L.P. Filed with PSI's Quarterly Report on
Form 10-Q for the quarterly period ended March 31, 2004 (SEC File No.
001-0839) and incorporated herein by reference.
10.11 Third Amendment to Amended and Restated Agreement of Limited Partnership
of PSA Institutional Partners, L.P. Filed with PSI's Quarterly Report on
Form 10-Q for the quarterly period ended September 30, 2004 (SEC File No.
001-0839) and incorporated herein by reference.
10.12 Limited Partnership Agreement of PSAF Acquisition Partners, L.P. Filed
with PSI's Annual Report on Form 10-K for the year ended December 31,
2003 (SEC File No. 001-0839) and incorporated herein by reference.
10.13 Credit Agreement by and among Registrant, Wells Fargo Bank, National
Association and Wachovia Bank, National Association as co-lead arrangers,
and the other financial institutions party thereto, dated March 27, 2007.
Filed with PSI's Current Report on Form 8-K on April 2, 2007 (SEC File
No. 001-0839) and incorporated herein by reference.
10.14 Senior Credit Agreement dated May 26, 2003, as amended by Amendment
Agreements dated July 11, 2003 and December 2, 2003, by and among First
Shurgard Sprl, First Shurgard Finance Sarl, First Shurgard Deutschland
GmbH, Societe Generale and others. Incorporated by reference to Exhibit
10.1 filed with the Current Report on Form 8-K dated February 21, 2005
filed by Shurgard Storage Centers, Inc. ("Shurgard") (SEC File No.
001-11455).
10.15 Amendment and Waiver Agreement dated February 21, 2005 to the Senior
Credit Agreement dated May 26, 2003, as amended as of December 2, 2003,
by and among First Shurgard Sprl, First Shurgard Finance Sarl, First
Shurgard Deutschland GmbH, Societe Generale and others. Incorporated by
reference to Exhibit 10.2 filed with the Current Report on Form 8-K dated
February 21, 2005 filed by Shurgard (SEC File No. 001-11455).
10.16 Credit Facility Agreement dated July 12, 2004, between Second Shurgard
SPRL, Second Shurgard Finance SARL, the Royal Bank of Scotland as
Mandated Lead Arranger, the Royal Bank of Scotland PLC as Facility Agent.
Incorporated by reference to Exhibit 10.43 filed with the Report on Form
10-Q for the quarter ended June 30, 2004 filed by Shurgard (SEC File No.
001-11455).
10.17* Employment Agreement between Registrant and B. Wayne Hughes dated as of
November 16, 1995. Filed with PSI's Annual Report on Form 10-K for the
year ended December 31, 1995 (SEC File No. 001-0839) and incorporated
herein by reference.
10.18* Shurgard Storage Centers, Inc. 1995 Long Term Incentive Compensation
Plan. Incorporated by reference to Appendix B of Definitive Proxy
Statement dated June 8, 1995 filed by Shurgard (SEC File No. 001-11455).
10.19* Shurgard Storage Centers, Inc. 2000 Long-Term Incentive Plan.
Incorporated by reference to Exhibit 10.27 Annual Report on Form 10-K for
the year ended December 31, 2000 filed by Shurgard (SEC File No.
001-11455).
10.20* Shurgard Storage Centers, Inc. 2004 Long Term Incentive Compensation
Plan. Incorporated by reference to Appendix A of Definitive Proxy
Statement dated June 7, 2004 filed by Shurgard (SEC File No. 001-11455).
10.21* Public Storage, Inc. 1996 Stock Option and Incentive Plan. Filed with
PSI's Annual Report on Form 10-K for the year ended December 31, 2000
(SEC File No. 001-0839) and incorporated herein by reference.
86
10.22* Public Storage, Inc. 2000 Non-Executive/Non-Director Stock Option and
Incentive Plan. Filed with PSI's Registration Statement on Form S-8 (SEC
File No. 333-52400) and incorporated herein by reference.
10.23* Public Storage, Inc. 2001 Non-Executive/Non-Director Stock Option and
Incentive Plan. Filed with PSI's Registration Statement on Form S-8 (SEC
File No. 333-59218) and incorporated herein by reference.
10.24* Public Storage, Inc. 2001 Stock Option and Incentive Plan ("2001 Plan").
Filed with PSI's Registration Statement on Form S-8 (SEC File No.
333-59218) and incorporated herein by reference.
10.25* Form of 2001 Plan Non-qualified Stock Option Agreement. Filed with PSI's
Quarterly Report on Form 10-Q for the quarterly period ended September
30, 2004 (SEC File No. 001-0839) and incorporated herein by reference.
10.26* Form of 2001 Plan Restricted Share Unit Agreement. Filed with PSI's
Quarterly Report on Form 10-Q for the quarterly period ended September
30, 2004 (SEC File No. 001-0839) and incorporated herein by reference.
10.27* Form of 2001 Plan Non-Qualified Outside Director Stock Option Agreement.
Filed with PSI's Quarterly Report on Form 10-Q for the quarterly period
ended September 30, 2004 (SEC File No. 001-0839) and incorporated herein
by reference.
10.28* Public Storage, Inc. Performance Based Compensation Plan for Covered
Employees. Filed with PSI's Current Report on Form 8-K dated May 11, 2005
(SEC File No. 001-0839) and incorporated herein by reference.
10.29* Public Storage 2007 Equity and Performance-Based Incentive Compensation
Plan. Filed as Exhibit 4.1 to Registrant's Registration Statement on Form
S-8 (SEC File No. 333-144907) and incorporated herein by reference.
10.30* Form of 2007 Plan Restricted Stock Unit Agreement. Filed with
Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30,
2007 and incorporated herein by reference.
10.31* Form of 2007 Plan Stock Option Agreement. Filed with Registrant's
Quarterly Report on Form 10-Q for the quarter ended June 30, 2007 and
incorporated herein by reference.
10.32 Form of Stock Purchase Agreement. Filed with Registrant's Quarterly
Report on Form 10-Q for the quarter ended June 30, 2007 and incorporated
herein by reference.
10.33* Form of Indemnity Agreement. Filed with Registrant's Amendment No. 1 to
Registration Statement on Form S-4 (SEC File No. 333-141448) and
incorporated herein by reference.
11 Statement Re: Computation of Earnings per Share. Filed herewith.
12 Statement Re: Computation of Ratio of Earnings to Fixed Charges and
Preferred Stock Dividends. 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.
32 Certification pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
Filed herewith.
* Compensatory benefit plan or arrangement or management contract.
(1) SEC File No. 001-33519 unless otherwise indicated.
87