| PUBLIC STORAGE INC /CA ITEM 1A Risk Factors ------------ In addition to the other information in our Form 10-K, you should consider the following factors in evaluating the Company: THE HUGHES FAMILY COULD CONTROL US AND TAKE ACTIONS ADVERSE TO OTHER SHAREHOLDERS At March 3, 2006, B Wagne Hughes Chairman of the Board and members of his family (the "e Hughes Family "e ) owned approximately 36prca of our outstanding shares of common stock |
| Consequently, the Hughes Family could control matters submitted to a vote of our shareholders, including electing directors, amending our organizational documents, dissolving and approving other extraordinary transactions, such as a takeover attempt, even though such actions may not be favorable to the other common shareholders |
| PROVISIONS IN OUR ORGANIZATIONAL DOCUMENTS MAY PREVENT CHANGES IN CONTROL Restrictions in our organizational documents may further limit changes in control |
| Unless our Board of Directors waives these limitations, no shareholder may own more than (1) 2dtta0prca of our outstanding shares of our common stock or (2) 9dtta9prca of the outstanding shares of each class or series of our preferred or equity stock |
| Our organizational documents in effect provide, however, that the Hughes Family may continue to own the shares of our common stock held by them at the time of the 1995 reorganization |
| In the event the Shurgard transaction is completed, the Hughes Family is permitted to acquire additional Common Stock to maintain their premerger holding percentage |
| These limitations are designed, to the extent possible, to avoid a concentration of ownership that might jeopardize our ability to qualify as a real estate investment trust or REIT These limitations, however, also may make a change of control significantly more difficult (if not impossible) even if it would be favorable to the interests of our public shareholders |
| These provisions will prevent future takeover attempts not approved by our board of directors even if a majority of our public shareholders deem it to be in their best interests because they would receive a premium for their shares over the shares &apos then market value or for other reasons |
| WE WOULD INCUR ADVERSE TAX CONSEQUENCES IF WE FAIL TO QUALIFY AS A REIT You will be subject to the risk that we may not qualify as a REIT REITs are subject to a range of complex organizational and operational requirements |
| As a REIT, we must distribute with respect to each year at least 90prca of our REIT taxable income to our shareholders |
| Other restrictions apply to our income and assets |
| Our REIT status is also dependent upon the ongoing qualification of our affiliate, PS Business Parks, Inc, as a REIT, as a result of our substantial ownership interest in that company |
| 14 For any taxable year that we fail to qualify as a REIT and are unable to avail ourselves of certain savings provisions set forth in the Code, we would be subject to federal income tax at the regular corporate rates on all of our taxable income, whether or not we make any distributions to our shareholders |
| Those taxes would reduce the amount of cash available for distribution to our shareholders or for reinvestment and would adversely affect our earnings |
| As a result, our failure to qualify as a REIT during any taxable year could have a material adverse effect upon us and our shareholders |
| Furthermore, unless certain relief provisions apply, we would not be eligible to elect REIT status again until the fifth taxable year that begins after the first year for which we fail to qualify |
| WE MAY PAY SOME TAXES, REDUCING CASH AVAILABLE FOR SHAREHOLDERS Even if we qualify as a REIT for federal income tax purposes, we are required to pay some federal, state and local taxes on our income and property |
| Several corporate subsidiaries of the Company have elected to be treated as "e taxable REIT subsidiaries "e of the Company for Federal income tax purposes since January 1, 2001 |
| A taxable REIT subsidiary is taxable as a regular corporation and is limited in its ability to deduct interest payments made to us in excess of a certain amount |
| In addition, if we receive certain payments and the economic arrangements among our taxable REIT subsidiaries and us are not comparable to similar arrangements among unrelated parties we will be subject to a 100prca penalty tax on those payments |
| To the extent that the Company or any taxable REIT subsidiary is required to pay Federal, state or local taxes, we will have less cash available for distribution to shareholders |
| WE HAVE BECOME INCREASINGLY DEPENDENT UPON AUTOMATED PROCESSES AND THE INTERNET AND ARE FACED WITH SECURITY SYSTEM RISKS We have become increasingly centralized and dependent upon automated information technology processes |
| While we have attempted to mitigate this risk through offsite backup procedures and contracted data centers that include, in some cases, redundant operations, we could still be severely impacted by a catastrophic occurrence, such as a natural disaster or a terrorist attack |
| In addition, an increasing portion of our business operations are conducted over the Internet, increasing the risk of viruses that could cause system failures and disruptions of operations despite our deployment of anti-virus measures |
| Experienced computer programmers may be able to penetrate our network security and misappropriate our confidential information, create system disruptions or cause shutdowns |
| In making real estate investments, we may borrow money, which increases the risk of loss |
| At December 31, 2005, our debt of dlra149dtta6 million was 2dtta7prca of our total assets |
| Certain securities have a liquidation preference over our common stock and Equity Stock, Series A If we liquidated, holders of our preferred securities would be entitled to receive liquidating distributions, plus any accrued and unpaid distributions, before any distribution of assets to the holders of our common stock and Equity Stock, Series A Holders of preferred securities are entitled to receive, when declared by our Board of Directors, cash distributions in preference to holders of our common stock and Equity Stock, Series A 15 SINCE OUR BUSINESS CONSISTS PRIMARILY OF ACQUIRING AND OPERATING REAL ESTATE, WE ARE SUBJECT TO REAL ESTATE OPERATING RISKS The value of our investments may be reduced by general risks of real estate ownership |
| Since we derive substantially all of our income from real estate operations, we are subject to the general risks of owning real estate-related assets, including: o lack of demand for rental spaces or units in a locale; o changes in general economic or local conditions; o natural disasters, such as earthquakes or hurricanes; o potential terrorist attacks; o changes in supply of or demand for similar or competing facilities in an area; o the impact of environmental protection laws; o changes in interest rates and availability of permanent mortgage funds which may render the sale or financing of a property difficult or unattractive; o changes in tax, real estate and zoning laws; and o tenant claims |
| In addition, we self-insure certain of our property loss, liability, and workers compensation risks; areas that other real estate companies may use third-party insurers for |
| This results in a higher risk of losses that are not covered by third-party insurance contracts, as described in Note 16 under "e Insurance and Loss Exposure "e to our consolidated financial statements at December 31, 2005 |
| There is significant competition among self-storage facilities and from other storage alternatives |
| Most of our properties are self-storage facilities, which generated most of our revenue for the year ended December 31, 2005 |
| Local market conditions will play a significant part in how competition will affect us |
| Competition in the market areas in which many of our properties are located from other self-storage facilities and other storage alternatives is significant and has affected the occupancy levels, rental rates and operating expenses of some of our properties |
| Any increase in availability of funds for investment in real estate may accelerate competition |
| Further development of self-storage facilities may intensify competition among operators of self-storage facilities in the market areas in which we operate |
| We may incur significant environmental costs and liabilities |
| As an owner and operator of real properties, under various federal, state and local environmental laws, we are required to clean up spills or other releases of hazardous or toxic substances on or from our properties |
| Certain environmental laws impose liability whether or not the owner knew of, or was responsible for, the presence of the hazardous or toxic substances |
| In some cases, liability may not be limited to the value of the property |
| The presence of these substances, or the failure to properly remediate any resulting contamination, whether from environmental or microbial issues, also may adversely affect the ownerapstas or operatorapstas ability to sell, lease or operate its property or to borrow using its property as collateral |
| We have conducted preliminary environmental assessments of most of our properties (and intend to conduct these assessments in connection with property acquisitions) to evaluate the environmental condition of, and potential environmental liabilities associated with, our properties |
| These assessments generally consist of an investigation of environmental conditions at the property (not including soil or groundwater sampling or analysis), as well as a review of available information regarding the site and publicly available data regarding conditions at other sites in the vicinity |
| In connection with these property assessments, our operations and recent property acquisitions, we have become aware that prior operations or activities at some facilities or from nearby locations have or may have resulted in contamination to the soil or groundwater at these facilities |
| In this regard, some of our facilities are or may be the subject of federal or state environment investigations or remedial actions |
| We have obtained, with respect to recent acquisitions, and intend to obtain with respect to pending or future acquisitions, appropriate purchase price adjustments or indemnifications that we believe are sufficient to cover any related potential liability |
| Although we cannot provide any assurance, based on the preliminary environmental assessments, we believe we have funds available to cover any liability from environmental contamination or potential contamination and we are not aware of any environmental contamination of our facilities material to our overall business, financial condition or results of operation |
| 16 There has been an increasing number of claims and litigation against owners and managers of rental properties relating to moisture infiltration, which can result in mold or other property damage |
| When we receive a complaint concerning moisture infiltration, condensation or mold problems and/or become aware that an air quality concern exists, we implement corrective measures in accordance with guidelines and protocols we have developed with the assistance of outside experts |
| We seek to work proactively with our tenants to resolve moisture infiltration and mold-related issues, subject to our contractual limitations on liability for such claims |
| However, we can provide no assurance that material legal claims relating to moisture infiltration and the presence of, or exposure to, mold will not arise in the future |
| Delays in development and fill-up of our properties would reduce our profitability |
| Since January 1, 2001, we have opened 53 newly developed self-storage facilities and 17 facilities that combine self-storage and containerized storage space at the same location, with aggregate development costs of approximately dlra547 million |
| In addition, at December 31, 2005 we had 62 projects in development that are expected to be completed in approximately the next two years |
| These 62 projects have total estimated costs of approximately dlra323 million |
| Construction delays due to weather, unforeseen site conditions, personnel problems, and other factors, as well as cost overruns, would adversely affect our profitability |
| Delays in the rent-up of newly developed facilities as a result of competition or other factors would also adversely impact our profitability |
| Property taxes can increase and cause a decline in yields on investments |
| These real property taxes may increase in the future as property tax rates change and as our properties are assessed or reassessed by tax authorities |
| Such increases could adversely impact our profitability |
| We must comply with the Americans with Disabilities Act and fire and safety regulations, which can require significant expenditures |
| All our properties must comply with the Americans with Disabilities Act and with related regulations (the "e ADA "e ) |
| The ADA has separate compliance requirements for "e public accommodations "e and "e commercial facilities, "e but generally requires that buildings be made accessible to persons with disabilities |
| Various state laws impose similar requirements |
| A failure to comply with the ADA or similar state laws could result in government imposed fines on us and could award damages to individuals affected by the failure |
| In addition, we must operate our properties in compliance with numerous local fire and safety regulations, building codes, and other land use regulations |
| Compliance with these requirements can require us to spend substantial amounts of money, which would reduce cash otherwise available for distribution to shareholders |
| Failure to comply with these requirements could also affect the marketability of our real estate facilities |
| Any failure by us to manage acquisitions and other significant transactions successfully could negatively impact our financial results |
| As an increasing part of our business, we acquire other self-storage facilities |
| We also evaluate from time to time other significant transactions |
| If these facilities are not properly integrated into our system, our financial results may suffer |
| We incur liability from employment related claims |
| From time to time we must resolve employment related claims by corporate level and field personnel |
| We have no interest in Canadian self-storage facilities owned by the Hughes Family |
| B Wayne Hughes, Chairman of the Board, and his family (the "e Hughes Family "e ) have ownership interests in, and operate, approximately 44 self-storage facilities in Canada under the name "e Public Storage "e |
| We currently do not own any interests in these facilities nor do we own any facilities in Canada |
| We have a right of first refusal to acquire the stock or assets of the corporation engaged in the operation of the self-storage facilities in Canada if the Hughes Family or the corporation agrees to sell them |
| However, we have no ownership interest in the operations of this corporation, have no right to acquire their stock or assets unless the Hughes Family decides to sell, and receive no benefit from the profits and increases in value of the Canadian self-storage facilities |
| Prior to December 31, 2003, our personnel were engaged in the supervision and the operation of these properties and provided certain administrative services for the Canadian owners, and certain other services, primarily tax services, with respect to certain other Hughes Family interests |
| The Hughes Family and the Canadian owners reimbursed us at cost for these services in the amount of dlra542cmam499 with respect to the Canadian operations and dlra151cmam063 for other services during 2003 (in United States dollars) |
| There were conflicts of interest in allocating time of our personnel between Company properties, the Canadian properties, and certain other Hughes Family interests |
| The sharing of our personnel with the Canadian entities was substantially eliminated by December 31, 2003 |
| 17 Through our subsidiaries, we continue to reinsure risks relating to loss of goods stored by tenants in the self-storage facilities in Canada |
| We acquired the tenant insurance business on December 31, 2001 through our acquisition of PSIC During the years ended December 31, 2005, 2004 and 2003, PSIC received dlra1cmam052cmam000, dlra1cmam069cmam000, and dlra1cmam017cmam000, respectively, in reinsurance premiums attributable to the Canadian operations |
| Since PSICapstas right to provide tenant reinsurance to the Canadian facilities may be qualified, there is no assurance that these premiums will continue |
| OUR CONTAINERIZED STORAGE BUSINESS HAS INCURRED OPERATING LOSSES Public Storage Pickup & Delivery ( "e PSPUD "e ) was organized in 1996 to operate a containerized storage business |
| We own all of the economic interest of PSPUD Since PSPUD will operate profitably only if it can succeed in the relatively new field of containerized storage, we cannot provide any assurance as to its profitability |
| Since 2002, PSPUD closed or consolidated facilities that were deemed not strategic to its business plan, and has 12 facilities open at December 31, 2005 |
| INCREASES IN INTEREST RATES MAY ADVERSELY AFFECT THE PRICE OF OUR COMMON STOCK One of the factors that influences the market price of our common stock and our other securities is the annual rate of distributions that we pay on the securities, as compared with interest rates |
| An increase in interest rates may lead purchasers of REIT shares to demand higher annual distribution rates, which could adversely affect the market price of our common stock and other securities |
| TERRORIST ATTACKS AND THE POSSIBILITY OF WIDER ARMED CONFLICT MAY HAVE AN ADVERSE IMPACT ON OUR BUSINESS AND OPERATING RESULTS AND COULD DECREASE THE VALUE OF OUR ASSETS Terrorist attacks and other acts of violence or war, such as those that took place on September 11, 2001, could have a material adverse impact on our business and operating results |
| There can be no assurance that there will not be further terrorist attacks against the United States or its businesses or interests |
| Attacks or armed conflicts that directly impact one or more of our properties could significantly affect our ability to operate those properties and thereby impair our operating results |
| Further, we may not have insurance coverage for losses caused by a terrorist attack |
| Such insurance may not be available, or if it is available and we decide to obtain such terrorist coverage, the cost for the insurance may be significant in relationship to the risk overall |
| In addition, the adverse effects that such violent acts and threats of future attacks could have on the United States economy could similarly have a material adverse effect on our business and results of operations |
| Finally, further terrorist acts could cause the United States to enter into a wider armed conflict, which could further impact our business and operating results |
| DEVELOPMENTS IN CALIFORNIA MAY HAVE AN ADVERSE IMPACT ON OUR BUSINESS We are headquartered in, and approximately one-quarter of our properties are located in, California |
| California is facing budgetary problems |
| Action that may be taken in response to these problems, such as an increase in property taxes on commercial properties, could adversely impact our business and results of operations |
| In addition, we could be adversely impacted by efforts to reenact legislation mandating medical insurance for employees of California businesses and members of their families |
| OUR PROPOSED ACQUISITION OF SHURGARD SUBJECTS US TO ADDITIONAL RISKS We have entered into an agreement to acquire Shurgard Storage Centers, Inc |
| ( "e Shurgard "e ), a publicly held REIT that has interests in approximately 646 self-storage facilities located in the United States and Europe |
| Under the agreement, and based upon our December 31, 2005 balance sheet and Shurgardapstas September 30, 2005 balance sheet included in its related Form 10-Q, i) we would issue 0dtta82 shares of our common stock for each share of Shurgard common stock which would increase our common shares outstanding from 128cmam089cmam563 to approximately 166cmam460cmam200 shares, ii) we would assume Shurgard debt which totals approximately dlra1dtta8 billion at September 30, 2005, increasing our debt outstanding (assuming no prepayment) from dlra150 million to approximately dlra2dtta0 billion, and iii) dlra136 million of Shurgard preferred stock would be redeemed |
| The transaction is targeted to close by the end of the second quarter of 2006 |
| 18 Completion of the transaction is not assured and is subject to risks, including that shareholders of either Public Storage or Shurgard do not approve the transaction or that the other closing conditions are not satisfied |
| In addition, Shurgard may under limited circumstances terminate the agreement to take a superior proposal |
| Public Storage and Shurgard are not aware of any significant governmental approvals that are required for consummation of the merger |
| If any approval or action is required, it is presently contemplated that Public Storage and Shurgard would use their reasonable best efforts to obtain such approval |
| In addition to the general risks related to real estate noted above which may also adversely impact Shurgardapstas operations, we are also subject to the following risks in connection with our acquisition of Shurgard into our operations, including without limitation the following: o difficulties in the integration of operations, technologies and personnel of Shurgard; o inability to realize or delays in realizing expected synergies; o unanticipated operating costs; o diversion of our managementapstas attention away from other business concerns; o exposure to any undisclosed or unknown potential liabilities of Shurgard; o potential underinsured losses on Shurgard properties; and o risk of failure to mitigate any Shurgard material weaknesses in internal control to the extent that it affects our internal controls |
| Shurgard also holds many of its properties through joint ventures, which have additional risks, including risks related to the financial strength, common business goals and strategies and cooperation of the venture partner, as well as the inability to take some actions that may require approval by the venture partner |
| In addition, Shurgard holds substantially all of its real estate investments in Europe indirectly through partnerships and joint venture arrangements |
| If we are unable to effectively control these indirect investments, there is a risk that our ownership of the joint ventures could cause us to lose our REIT status |
| We have assumed based on public filings that Shurgard has qualified and will continue to qualify as a REIT and that we would be able to continue to qualify as a REIT following an acquisition |
| However, if Shurgard has failed or fails to qualify as a REIT, we might succeed to or incur significant tax liabilities and possibly lose our REIT status should disqualifying activities continue after the acquisition |
| Shurgard has a greater level of debt than we do, as well as derivative instruments that we would assume |
| Shurgardapstas outstanding borrowings on its lines of credit (dlra569 million at September 30, 2005) would become payable immediately upon completion of the merger |
| In addition, there would be additional cash costs related to the merger, cash requirements for the redemption of dlra136 million of Shurgardapstas preferred stock on the merger date, and additional possible cash requirements following the merger |
| Our cash on hand and available borrowing capacity on our line of credit would be insufficient to fund these immediate capital requirements and, accordingly, we may look to obtain a larger line of credit, bridge financing, or issue preferred or common equity |
| As a result, this transaction may result in an increase in our exposure to interest rate and refinancing risks |
| 19 We would also be acquiring Shurgardapstas international operations in Europe, which consist principally of facilities that have been completed in the last few years and are in various stages of fill-up |
| Shurgardapstas international operations have not been profitable, and there is no assurance they will ultimately be profitable |
| We have limited experience in international operations, which may adversely impact our ability to operate profitably in Europe |
| In addition, these operations have specific inherent risks, including without limitation the following: o currency risks, including currency fluctuations; o unexpected changes in legislative and regulatory requirements; o potentially adverse tax burdens; o burdens of complying with different permitting standards, labor laws and a wide variety of foreign laws; o obstacles to the repatriation of earnings and cash; o regional, national and local political uncertainty; o economic slowdown and/or downturn in foreign markets; o difficulties in staffing and managing international operations; and o reduced protection for intellectual property in some countries |
| In connection with the proposed acquisition of Shurgardapstas European operations, we will be evaluating various strategic alternatives, including, but not limited to, public or private offerings of securities, one or more possible joint ventures, and possible asset acquisitions and/or sales |
| The foregoing description of the terms and conditions of our agreement to acquire Shurgard does not purport to be complete, and is qualified in its entirety by reference to the full text of the merger agreement, a copy of which is filed with our current report on Form 8-K dated March 7, 2006 |